By A Paris – January 2022 may seem far away but the preparations financial services firms in the UK need to make to comply with the incoming Investment Firm Prudential Regime (IFPR) are considerable and they need to think about it now, if they haven’t done so already. The new rules are going to usher in significant change for a large swathe of firms active in the UK market.
Though there are no industry-wide statistics on how many firms have set plans in motion to ensure compliance, a poll taken during a webinar organised by Wolters Kluwer in April 2021, found 11 percent of attendees had not yet started their preparations. A third of the audience on the other hand had begun their IFPR project and half were either in the process of conducting analysis in this regard or looking for a market solution.
The Financial Conduct Authority’s aim in introducing the regulation is to develop a single prudential regime for all FCA-regulated investment firms, to reduce barriers to entry and allow for better competition.
The new law also means several firms will, for the first time, have meaningful capital and liquidity requirements, in line with the potential risk they post to their clients, themselves and the broader industry. These risks are categorised by a “K factors” approach. In the law these are divided into three groups – risks to client (RtC); risks to market (RtM); and risks to firm (RtF).
Before this regulation was announced firms did carry out thorough risk assessments on these factors however, Priya Mehta, Head of FCA Advisory and Regulatory Reporting Services, Buzzacott points out: “Very rarely did we see any capital set aside to cover those risks. It was not something mandated by the FCA. Under the IFPR firms cannot get away with the old approach of quantifying and identifying risks but not putting aside additional funds to meet those requirements.”
According to the association of Personal Investment Management and Financial Advice (PIMFA), the IFPR is likely to be comparable in size and complexity to MiFID II in terms of its impact and will require fundamental changes to how firms approach risk, liquidity and capital.
Giulia Lupato, Head of Regulatory Policy and Compliance at PIMFA comments in a press release: “The IFPR will have a significant impact on MiFID investment firms and involves fundamental changes to the way in which they work. It is vital that firms begin to analyse how these changes will affect them and to begin to make preparations.”
Higher burden
The K factors are typically inherent in small and mid-sized investment firms and these are the types of entities expected to be most impacted by this new legislation.
Lawyers at Freshfields Bruckhaus Deringer elaborate: “The effect of the FCA’s proposals in these two consultations will be to change the regulatory capital regime that applies to those firms currently classified as exempt CAD firms. These firms have historically benefited from a comparatively ‘light touch’ regulatory regime with a minimum initial capital requirement of EUR50,000 (or professional indemnity insurance meeting the requirements prescribed by the FCA).”
The regulatory burden on these firms is set to rise under IFPR. Previously exempt-CAD can now be subject to GBP75,000 as a permanent minimum requirement if carrying out limited investment activities. They may also be liable for a new fixed overheads requirement amounting to a quarter of the firm’s fixed overheads from the previous accounting year. In addition, the new regime stipulates that, depending on what activities they undertake and the risk their investment business carries, some of these firms may also have a new ‘K-factor’ requirement.
Outlook and potential concerns
Although the regulatory burden will increase in the short-term, Mehta expects that a few years down the line, the industry will start to appreciate the simplicity ushered in by the new rules.
Jamie Cooke, managing director of fscom, writes: “We regard the measures envisaged for the prudential regime as pragmatic and welcome.”
Lupato at PIMFA notes: “We are pleased to see the FCA has recognised that achieving operational resilience is a journey personal to each firm, as well as the challenges posed by third parties and supply chains. We hope this will result in a proportionate approach to supervision when it comes to firms’ mapping of complex supply chains.
“We also appreciate the FCA agreeing to soften the initial, proposed deadline of three years from the date the rules come into effect by introducing a 4-year ‘staged’ approach.”
Partners at Macfarlanes however highlight: “The FCA has stated that the ongoing regulatory costs for firms should be lower as a result of the changes. However, our view is that this may not always be the case and firms should scrutinise the changes carefully to identify the impact upon them.
“It does seem clear that the simplification of the regime should free up management time and reduce time spent on complex capital calculations that do little to help firms manage risk. The FCA has indicated its view that the changes should also reduce barriers to entry to the market and allow for better competition.”
Cooke signals areas that fscom feels may present some concerns: “In assessing the elevated level of interest in a firm’s use of custodians, we make the reasonable assumption that the regulator would have a strong preference for a firm to hold accounts (client and proprietary) with multiple providers, not just one.
“Theoretically, such a concern is perfectly understandable. On a practical level however the difficulties in securing trust accounts from UK banks are well documented and we would hope that commercial reality will be a factor in the FCA’s consideration of this risk.” n
