Is your firm ready for the UK’s new prudential regime?

Coming into effect in the UK on January 1, 2022, the Investment Firm Prudential Regime (IFPR) will overhaul the prudential regulations that are currently applicable to MiFID investment firms. This will bring significant changes to the way investment firms assess their capital adequacy and monitor associated risks.

Post-Brexit, the IFPR serves as the UK’s version of the EU’s prudential regime, the Investment Firm Regulation and Directive (IFR/IFD). The IFPR will greatly simplify the UK’s current prudential regulation for FCA-regulated firms and will be applicable to all prudential categories for MiFID investment firms, such as Exempt CAD, BIPRU, and various IFPRU categories. In doing so, it will replace the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR) for such firms.

Calculating minimum capital

Under the new regime, investment firms will face several changes to the minimum amount of capital they need to hold as represented by the Own Funds Requirement. The three elements to this are the Fixed Overheads Requirement (FOR), the Permanent Minimum Requirement (PMR) and the new K-Factor Requirement (KFR), with the Own Funds Requirement equal to the highest of the three.  In order to meet these new regulations, firms will have to ensure sufficient capital resources are available as they could potentially see significant increases in their capital requirement – ranging from 300% to 2,300%.

An investment firm’s FOR must be calculated as a quarter of their fixed overheads for the preceding year’s audited accounts.

The KFR is a new requirement for firms to calculate and is based on the activities of the firm, geared specifically towards the risks faced by investment firms, the clients they serve and the wider market. Relevant business activities include client assets safeguarded and administered, client money held, assets under management and client orders handled. Due to this, the FCA has tailored the IFPR to the specific nature of a firm’s business – the larger and more complex a firm is, the more K-factors will be applied. If a firm is smaller in size, they are likely to have fewer K-factors to calculate and report on.

Once calculated, the FOR and new KFR must be compared against a firm’s PMR to understand where their Own Funds Requirement is set. These three requirements are aimed at ensuring investment firms maintain a minimum amount of capital to facilitate the early stages of a wind-down process, if it becomes necessary.

In addition, the IFPR introduces a requirement for investment firms to hold liquid assets that are at least equal to a third of its FOR, plus 1.6% of the total amount of any guarantees provided to clients. This requirement ensures that a firm has immediate access to resources in the event of wind-down.

Reporting on capital

The central element of the IFPR aims to ensure firms are always holding sufficient capital and reporting it accurately. Therefore, a large portion of the work required for the IFPR will be spent on determining the correct capital firms need to hold, as well as calculating and monitoring this capital on a monthly basis.

Firms need to perform several calculations on all elements of the IFPR. Doing this is likely to involve extensive amounts of data, which will take significant human resource to analyse and calculate. While Excel has traditionally been a common way to perform such calculations, it faces inherent challenges when tasked with handling large data volumes and complex calculation steps.

To reduce the time and reliance on internal resources, firms can look to automate these calculations with a bespoke solution. An automated solution will work in conjunction with a firm’s source data, perform the necessary calculations and then present the output in the format required by the FCA. Automation further removes the burden of manual processing, ensuring the numbers reported are both accurate and in the correct format. Firms can also benefit from additional control around workflow and approval by automating IFPR calculations, which will demonstrate an ongoing oversight of the underlying data and regulatory returns.

Avoiding penalties

Calculating these figures is both complex and time-consuming, which presents a challenge as it needs to be performed on a monthly basis and submitted to the FCA each quarter. Firms that fail to report or report inaccurately will risk sanctions from the FCA, which can in turn lead to fines and the removal of permissions to operate as a firm.

Alongside quarterly reporting, the FCA is also introducing threshold reporting requirements, where a firm must provide notice should its own funds fall to prescribed levels. For example, if a firm’s own resources fall to 110% of its Own Funds Threshold Requirement, a notification must be sent to FCA. This is to ensure the FCA is fully aware of any firm that may be likely to face prudential harm. Hence, reporting accurately and on time is of crucial importance under the new regime.

While a single streamlined Prudential Regime will identify key risks to clients and markets when firms are assessing their prudential requirements, it will also place a large burden on firms to ensure they are calculating and reporting accurately on their capital and liquidity. In the lead up to the IFPR, investment firms need to know not only their capital and liquidity requirements, but also to have their reporting frameworks in place.

With less than two weeks to go, it’s time for firms to take action.