The activities of investment firms are governed at EU-level by the Markets in Financial Instruments Directive. In addition, EU investment firms are also subject to prudential rules that aim to ensure that investment firms have sufficient resources to cover potential losses from their activities. This reduces the risk of their failure of those firms and hence the risk of undue economic harm to their customers or disruption in markets they operate in.
Until 25 June 2021, the prudential rules for investment firms were part of the wider EU prudential framework which applies to banks, as set out in Regulation (EU) No 575/2013 and Directive 2013/36/EU, also known as the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD), respectively.
On 26 June 2021, most investment firms became subject to a new prudential framework, composed of Regulation (EU) 2019/2033 and Directive (EU) 2019/2034, also known as the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD), respectively.
The IFR-IFD framework
The new prudential framework for investment firms set out in the IFR and the IFD is designed to reflect better the nature, size, and complexity of investment firms’ activities compared to the CRR/CRD framework. One key aspect of the new framework is that it provides for simpler and more bespoke capital requirements for investment firms. The capital requirements set in the IFR are composed of three items:
- a fixed overheads requirement (FOR), equal to a quarter of the annual fixed overheads of the firm;
- a permanent minimum capital requirement (PMR) of EUR 75 000, EUR 150 000, or EUR 750 000, depending on the activities of the investment firm;
- an overall “K-factor” capital requirement, which is the sum of “K-factor requirements” grouped in three categories: Risk-to-Client (RtC), Risk-to-Market (RtM), Risk-to-Firm (RtF).
The IFR and the IFD apply to investment firms deemed sufficiently small and non-interconnected (so called “class 3” firms) and to investment firms not falling under any of the other categories (so called “class 2” firms). The large majority of EU investment firms fall in these two categories.
“Class 3” firms are subject to lighter requirements than “class 2” firms. Specifically, the capital requirement for a class 3 firm is equal to the higher of its FOR and PMR. The capital requirement for a class 2 firm is equal to the higher of its FOR, PMR and overall K-factor capital requirement.
However, some investment firms remain subject to the CRR/CRD rules. This is the case for investment firms that perform dealing on account or underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis and meet a EUR 30 bn threshold for their consolidated assets (so called “class 1” firms). It is also the case for investment firms that perform dealing on account or underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis and meet a EUR 15 bn threshold in terms of their consolidated assets or meet a EUR 5 bn threshold and are designated by their competent authorities following specific criteria (so called “class 1 minus” firms).
While “class 1” firms have to apply to be authorised as credit institutions, “class 1 minus” firms remain authorised as investment firms.
The contribution from the ESAs
The European Banking Authority (EBA), in consultation with the European Securities and Markets Authority (ESMA), has been working to deliver regulatory products to complete the new rules, as mandated under the IFR-IFD.
The IFR and IFD are subject to the following corrigenda: