On 20 December, the European Commission adopted proposals that will change the way investment firms are required to evaluate their risks. The aim is to simplify their prudential rules and facilitate the work of their supervisors. This will mean clients using investment firms to access capital markets will be better protected against potential risks and will have a broader choice of services. By broadening access to finance, the proposals represent another step towards an EU capital markets union. Furthermore, they reinforce the banking union by placing the prudential and supervisory treatment of the EU's largest investment firms at the same level as that of banks.

A simpler regime

At the moment, investment firms are subject to the same prudential rules as banks. However, unlike banks, investment firms do not take deposits or make loans on a large scale. Instead, they provide services that bring investors and companies together and help them to manage their financial risks. This means that in general, they are not exposed to the same risks as banks.

The current rules take these differences into account to some degree. Overall however, they mean that investment firms must comply with requirements that are largely targeted at the risks faced and posed by banks. This focus on banks also means that many of the risks specific to investment firms are not addressed. As a result, clients and – in some cases – broader financial markets are potentially exposed to excessive risks in case of problems.

The proposals aim to resolve these problems in two basic ways. First, by removing all but the largest and most risky investment firms from the prudential rules for banks. And second, by introducing new targeted requirements that specifically address investment firms' particular risks. For the first time, risks to customers in specific services provided by investment firms would be covered by new proportionate capital requirements. Firms that trade financial instruments, meanwhile, would continue to be covered by rules modeled on the existing legislation, albeit in a simplified form.           

In addition, simplified rules would ensure that investment firms have sufficient liquid assets to meet their obligations, as well as good governance and remuneration arrangements to ensure stable and appropriate management of the firm. The parent companies of groups of investment firms would be required to ensure sufficient capital to support their holdings in the firms.   

Systemic investment firms

While the current rules are not appropriate for the vast majority of investment firms, a small number resemble banks closely in terms of risks and systemic importance. These will therefore be treated as credit institutions and continue to be covered by the existing bank prudential rules, subject to supervision by banking authorities. This will ensure that the rules and supervision remain consistent for companies that represent comparable risks. For firms situated in Member States that are part of the banking union, their supervision will shift from national authorities to the Single Supervisory Mechanism under the aegis of the European Central Bank. 

The proposals will now be discussed by the European Parliament and the Council. They should be adopted by mid-2019 and apply by the start of 2021.

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