At a glance:

  • Certain large EU and third-country investment firms and groups will have to become credit institutions under the new EU prudential regime.
  • The UK will have its own framework, under which PRA-designated investment firms will not be required to convert.
  • Important questions remain about how the UK assets of investment groups will be treated.


On 25 December last year, the EU Investment Firms Regulation (IFR) and Investment Firms Directive (IFD) entered into force. They introduce a new prudential regime for investment firms, tailored specifically to their activities and asset size. The new package represents a significant shift in the current prudential landscape. Most provisions in both the IFR and IFD will apply from 26 June 2021[i]. The new regime will replace the CRR/CRD for most investment firms – except systemically important and larger firms. Those firms will remain subject to the bank capital regime, and in the EU some will have to apply for authorisation as credit institutions (CIs).

In June, HMT published its Policy Statement on prudential standards, setting out its proposed approach to UK domestic implementation of the regime; this was closely followed by a Discussion Paper from the FCA, which provides more specifics. HMT intends to legislate for the implementation of IFR/IFD through the Financial Services Bill, by summer 2021, and the new framework will be known as the Investment Firms Prudential Regime (IFPR). The IFPR is intended to achieve essentially similar outcomes to those in the EU; the UK will however implement targeted deviations to take into account specificities of its own market. One such targeted deviation, indicated already in the papers published by HMT and regulators, relates to the largest investment firms and the CI authorisation requirement.

This blog explores key new requirements for those large investment firms, so called “Class 1”[ii] – as set out by IFR/IFD, and followed by the EBA’s draft Regulatory Standards (RTSs), HMT Policy Statement and FCA Discussion Paper, all published in June. For implications of the new regime for Classes 2 and 3 see our earlier blog here.


New definition of credit institution

IFR amends the definition of CI in the CRR so that it goes beyond the acceptance of deposits. In particular, firms that deal on their own account or underwrite/place financial instruments on a firm commitment basis, and satisfy certain threshold criteria, will have to apply for authorisation as a CI. As CIs, these firms will be subject to direct supervision by the ECB within the Single Supervisory Mechanism (SSM). This will require them to meet the key SSM supervisory requirements, such as being subject to the ECB’s comprehensive assessment, including the Asset Quality Review.

The IFR applies three tests to determine which firms fall into the Class 1 category:

1) Those whose total consolidated assets are equal to or exceed €30 billion. We expect that there will initially be only a handful of firms meeting this criterion.

2) Firms below this threshold can still however be categorised as Class 1 if they are part of a group. This can happen in two scenarios:

   a) First, when they belong to a group where the total consolidated assets of all own account dealing and underwriting firms in the EEA with individual total assets below the threshold, are cumulatively equal to or exceed €30 billion. It seems that even though this definition would exclude the largest firms (i.e. above the threshold) from the calculation, it still has the potential to apply to a large number of smaller firms within a group, depending on the group’s relevant cumulative assets.

   b) Second, the definition would capture a situation where the entity with less than €30bn of assets is part of a group where the total consolidated assets of all dealing/underwriting firms in that group are equal or exceed €30 billion - and their consolidating supervisor designates it as Class 1 (any entity with assets itself above €30bn is also included in the calculation, in contrast to the case above). This provision aims to address potential circumvention and financial stability issues. This gives supervisors certain discretion to bring into scope all smaller firms within a group as soon as there is one exceeding €30 billion in assets, or large groups comprising a number of smaller firms – even if none of them exceeds the threshold on its own. This designation would be done on an individual basis, and firms will be notified directly in such cases.

IFR specifies that for firms in third-country groups, the total assets of each branch of that group authorised in the EU should be included in the calculation of the combined total value for the purposes of the tests set out in 2a and 2b above.

Commodity and emission allowance dealers are excluded from the scope of the new definition altogether.


Calculation of thresholds

The scope and methodology for calculating the threshold is specified in an RTS proposed by the EBA, currently under consultation. It sets out the definition of assets and calculation of their values, how to calculate assets of relevant branches of third-country groups, and which undertakings to consider in the calculation of the threshold. Although Level 1 legislation stipulates the average monthly total assets should be calculated over 12 consecutive months, implying potentially 12 monthly data points, the EBA concluded that monthly calculations may be too burdensome and proposed a quarterly basis (using linear interpolation to calculate monthly figures). This is certainly a welcome move, particularly for complex groups. For the purposes of defining the concept of assets, the RTS took into account the different accounting standards applicable to investment firms and credit institutions, and adopted a hierarchical approach to ensure consistency with the SSM Framework Regulation.

The RTS clarifies that firms that are part of third-country groups should calculate their branch assets following the statistical data reporting principles in the ECB Regulation on the balance sheet of monetary financial institutions, or similar provisions for non-euro area branches. For the purposes of this RTS the EBA defines the ”relevant third-country branch” as meaning a branch of third-country groups which is authorised to carry out relevant activities in the EU and is not a commodity and/or emission allowance dealer, a collective investment undertaking, or an insurance undertaking. For more detail on the standards proposed by the EBA, together with the implications for firms, please see our earlier blog here.


Application - deadlines and information to be provided

IFD, amending CRD IV, specifies that firms that fulfil the above criteria will be required to submit their application for authorisation as a CI within specified timeframes. Firms that exceed the threshold should do so at the latest on the day when the average of their total monthly assets calculated over a period of 12 consecutive months, is equal to or exceeds the threshold (individually or on a group basis, as detailed above).

Until the new authorisation is granted, firms can continue carrying out their activities under their current MiFID authorisation. The authorising competent authority is expected to ensure the authorisation process is streamlined and takes into account already available information. IFD itself does not specify what this will entail in practice, but another EBA RTS has now set out the detail. So, information required will encompass a programme of the applicant’s activities and operations, its history, structural organisation, internal control systems and auditors, certain financial information, initial capital, effective direction, data on shareholders or members with qualifying holdings, and largest 20 shareholders or members. Competent authorities may also request additional information, before or following the assessment. Helpfully though, the RTS confirms that unless the competent authority requires otherwise, the application is not required to provide this information where it already holds it, or where it has been obtained from another competent authority - provided that the applicant certifies that such information is a true, accurate and complete account of its situation to date to the point of authorisation. Firms with a recent Brexit authorisation may be able to use this route.

Even though IFD applies only from 26 June next year, firms that met the new CI criteria on 24 December 2019 must apply for authorisation by 27 December 2020. This specific deadline falls before the end of the Brexit transition period and so caused some uncertainty and debate as to its UK application. However, HMT and the PRA have clarified that they will not require UK firms that meet the threshold test to become authorised as CIs. The authorities had concluded that UK systemic investment firms (“designated investment firms”) are already prudentially regulated and supervised under CRR/CRD (by the PRA), and this will remain the case after the implementation of the IFPR. This is a welcome development as it offers UK-based firms clarity and saves unnecessary burdens. However, the FCA Discussion Paper points out that those firms should still consider whether the consequential changes to CRR - set out in the IFR - would affect them if applied similarly in the UK. Those changes amend CRR in a number of ways (for example, change certain definitions, or add detail on prudential requirements for parent undertakings).

There is another complication however that none of the recent publications seems to address – namely, the treatment of UK assets for EU and third-country groups. The UK was a member of the EU on 24 December 2019 and will still be in the transition period by 27 December 2020 (during which Union law is applicable to and in the UK). The question arises of whether UK assets during the transition period should be included in the calculation of the aforementioned thresholds. The answer to this may hinge on a legal interpretation of whether UK assets would count as EU assets over that period. This may require further guidance, as in the absence of any indication to the contrary UK assets still seem to count towards these thresholds.


Timing

IFR/IFD are already in force and will apply in the EU from 26 June next year. The EBA consultation on its proposed standards closed on 4 September. The legislative deadline for submitting the drafts to the Commission is 26 December 2020. This date is virtually the same as that by which first wave firms have to submit their application for authorisation. It leaves them with little time to conduct the threshold calculations and submit applications, even if the EBA succeeds in submitting those RTS by end-November which it has indicated in its Roadmap is its aim. If the standards are not ready in sufficient time, we would expect the authorities either to provide firms with more time or at least issue a clarification as to their position.

In the UK, the Government will endeavour to implement IFPR by summer 2021, broadly in line with the EU’s implementation timetable. However, this is dependent on the passage of the FS Bill through Parliament. The FCA Discussion Paper is open for comments until 25 September. Once the FCA has considered the feedback it plans to publish a consultation later in 2020. We do not expect the position on CI authorisation to change.


[i] While IFD requires national transposition of its provisions, IFR will be binding and directly applicable in all Member States.

[ii] The term ’class’ is not official IFR/IFD terminology but is commonly used to distinguish between the different categories of firms.