A new and important regulatory framework to apply to all investment firms: IFD & IFR

09/06/20

In brief

A new prudential framework for investment firms is being introduced by the Investment Firms Directive and Regulation (IFD & IFR) with the implementation timeline as from 26 June 2021.

The aim of the new regime is to distinguish between, on the one hand, “bank-like” investment firms, which will remain under CRD IV/CRR (i.e. “Basel III as transposed in the European Union”); and, on the other, other investments firms, which will be subject to new rules and principles specifically tailored for their business and risk profiles.The new framework introduces a new approach to the calculation of the regulatory capital requirements and for most of the investment firms it will result in increased capital needs, subject to transitional phasing-in. New remuneration rules, internal governance, disclosure and reporting requirements will also be introduced. 

The IFD & IFR have given a significant number of mandates to the European Banking Authority (EBA) and on 4 June 2020 the EBA published its roadmap on the implementation of the new framework as well as first consultation papers, available until 4 September 2020.The public hearings will be held on 30 June 2020.

In detail

The prudential regulation that governs the exercise of investment services currently stems from the Capital Requirements Directive IV (Directive 2013/36/EU, CRD IV) and the Capital Requirements Regulation (Directive 2013/36/EU, CRR). Depending on the services provided, size and interconnectedness, some of the investment firms are exempt from prudential regulation, some are subject to lighter prudential regulations, and others are subject to the full set of CRD IV and CRR provisions.

Considering that investment firms’ services and risk profiles are not always properly captured by the banking prudential framework, the European Commission developed a new prudential regime. On 5 December 2019, the Investment Firms Directive (Directive (EU) 2019/2034, IFD) and the Investment Firms Regulation (Regulation (EU) 2019/2033, IFR) were published in the Official Journal of the European Union and entered into force on 25 December 2019. On 26 June 2021 the IFR will be directly applicable in all Member States and the IFD should be transposed in the local law on the same date.  The exceptions are the environmental, social and governance (ESG) risks disclosures, including physical and transition risks, which are delayed to 26 December 2022. Capital requirements are subject to a 5 year phase-in period.

The new prudential framework introduces a new approach to classify investment firms and a different prudential regime will be applied to each class. For most of the investment firms it will result in increased capital needs, subject to the five year phase-in period. 

Investment firms classification and prudential framework: 

Investment firms falling under the IFD and the IFR are defined by the reference to Article 4(1) of Markets in Financial Instruments Directive (Directive (EU) 2014/65/EU, MiFID II), which means that this regulatory framework will directly impact all MiFID II investment firms but not credit institutions, insurers and other financial services firms. 

The investment firms’ population will be split into three classes according to their size and complexity and each will be subject to a specific prudential framework.

  • Class 1: Systematic investment firms or investment firms exposed to the same types of risks as credit institutions, to which the full CRD/CRR requirements will continue to be applied.

  • Class 2: Investment firms that are not included in Class 1 or Class 3 will be subject to the full prudential IFR/IFD regime.

  • Class 3: Small and non-interconnected investment firms will be subject to the limited scope prudential IFR/IFD regime.

flash news

The IFR / IFD prudential framework includes the following elements:

  1. Pillar 1 requirements include minimum regulatory capital, liquidity buffer and concentration risk limits (Class 3 firms will be partially exempted from some of the elements).

  2. Pillar 2 capital add-ons based on ICAAP / ILAAP and SREP (very limited application to Class 3 firms).

  3. Pillar 3 disclosure and reporting requirements (scope and frequency of the reporting differs for Class 2 and Class 3 firms, the latter are also subject to limited disclosure obligations).

  4. New remuneration framework and internal governance principles (not applicable to Class 3 firms).

Next steps of the implementation of the new prudential framework

The Investment Firm Directive and Regulation have given a significant number of mandates to the European Banking Authority, often in consultation with the European Securities and Markets Authority (ESMA). On 4 June 2020, the EBA published its roadmap on the implementation of the IFD & IFR and defined six thematic areas within its mandates as follows:

  • Thresholds and criteria for investment firms to be subject to the CRR;

  • Capital requirements and composition;

  • Reporting and disclosure;

  • Remuneration and governance;

  • Supervisory convergence and the supervisory review process (SREP);

  • Environmental, social and governance aspects (ESG factors and risks).

Depending on the deadline set up by the prudential framework, the EBA established the following timeline:

flash news

Also, on 4 June 2020 the EBA launched public consultations on the first sets of deliverables:

  1. Consultation paper on draft Regulatory Technical Standard (RTS) on prudential requirements for investment firms, including such topics as the reclassification of certain investment firms to credit institutions, the capital requirements for investment firms at solo level and the scope and methods of prudential consolidation for investment firm groups.

  2. Consultation paper on draft Implementing Technical Standard (ITS) and RTS on reporting and disclosures for investment firms, including topics as level of capital, concentration risk, liquidity, the level of activities and disclosure of own funds, the information that investment firms have to provide to ensure the monitoring of the threshold for the determination of whether an investment firm has to apply for authorisation as credit institution.

  3. Consultation papers on draft RTS on remuneration requirements, including specification of the instruments to be used on variable remuneration and possible alternative arrangements, criteria to identify material risk takers.

All the consultations launched are open until 4 September 2020. The public hearings will be held on 30 June 2020.

In conclusion

The new prudential regime will have a significant impact on the investment firms and thus steps to adapt to the new reality will have to be taken proactively. We will continue to inform you on further developments in this area.

1. PwC Luxembourg (www.pwc.lu) is the largest professional services firm in Luxembourg with 3,000 people employed from 75 different countries. PwC Luxembourg provides audit, tax and advisory services including management consulting, transaction, financing and regulatory advice. The firm provides advice to a wide variety of clients from local and middle market entrepreneurs to large multinational companies operating from Luxembourg and the Greater Region. The firm helps its clients create the value they are looking for by contributing to the smooth operation of the capital markets and providing advice through an industry-focused approach.

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Jean-Philippe Maes

Risk & Regulatory Partner, PwC Luxembourg

Tel: +352 49 48 48 2874

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