Prudential requirements of investment firms

SUMMARY OF:

Regulation (EU) 2019/2033 on the prudential requirements of investment firms

WHAT IS THE AIM OF THE REGULATION?

It sets out new prudential requirements* and supervisory arrangements for certain categories of investment firms.
For these categories, it sets out specific requirements on own funds, concentration risk, liquidity risk, reporting and public disclosure.
The regulation, also known as the investment firms regulation (IFR), introduces prudential requirements that are proportionate to a firm’s size, nature, complexity, risk profile and business model, while ensuring adequate protection of its customers and of the markets in which it operates.

KEY POINTS

The IFR sets out prudential requirements that are proportionate to the nature, size and complexity of an investment firm’s activities.
The IFR applies to investment firms that:
- are not subject to Regulation (EU) No 575/2013 (capital requirements regulation (CRR) – see summary); and
- are sufficiently small and non-interconnected (‘class 3’ investment firms – see IFR Article 12); or
- do not fall under either of the two other categories (‘class 2’ investment firms). The ‘class 2’ category comprises investment firms that are too small for the ‘class 1’ category (subject to CRR rules) yet are bigger and more interconnected than the ‘class 3’ category.
Investment firms which deal on their own account, underwrite financial instruments and/or place financial instruments on a firm commitment basis are subject to the CRR rules if:
- their consolidated assets are over €30 billion (‘class 1’ firms); or,
- their consolidated assets are over €15 billion, or their consolidated assets are over €5 billion and they are designated by their competent authorities based on specific criteria (‘class 1 minus’ firms).
‘Class 1’ firms have to apply for authorisation as credit institutions, while ‘class 1 minus’ firms remain authorised as investment firms but are subject to the prudential requirements applicable to banks under the CRR and the capital requirements directive.

Capital requirements set out in the IFR consist of:

a fixed overheads requirement (FOR) equal to a quarter of the firm’s annual fixed overheads;
a permanent minimum capital requirement (PMR) of €75,000, €150,000, or €750,000, depending on the firm’s activities; and
an overall ‘K-factor’ capital requirement based on three main types of risks:
- risk-to-client,
- risk-to-market, and
- risk-to-firm.

‘Class 3’ firms are subject to lighter requirements than ‘class 2’ firms: while capital requirements for a ‘class 3’ firm are equal to whichever of its FOR and PMR is higher, capital requirements for a ‘class 2’ firm are equal to whichever of its FOR, PMR and overall K-factor requirement is higher.

Disclosure rules for investment firms require them to provide annual information on:

their risk management objectives and policies;
their governance arrangements;
their own funds compositions and requirements;
their pay policies and practices for the staff categories that have a material impact on the firms’ risk profile, including aspects related to gender neutrality, the gender pay gap and fixed and variable payments;
their investment policies;
their environmental, social and governance risks.

In amending Regulation (EU) No 600/2014 (the markets in financial instruments regulation – see summary), the IFR has also enhanced and reinforced the regulation’s ‘equivalence framework’, which provides rules for the provision of markets in financial instruments directive (MiFID) services in the European Union (EU) by firms based in non-EU countries for which the European Commission has adopted an ‘equivalence decision’, i.e. has assessed that those countries’ legally binding prudential, organisational and business conduct rules are equivalent to those in place in the EU.

The IFR also amends Regulations (EU) No 1093/2010 (see summary), (EU) No 575/2013 and (EU) No 806/2014 (see summary).

Delegated acts

The Commission has powers to adopt delegated acts in the form of regulatory and implementing technical standards developed by the European Banking Authority (EBA), in close cooperation with the European Securities and Markets Authority where applicable, to supplement the regulation and ensure that its requirements are applied uniformly.

EBA Roadmap

An overview of the EBA’s work plan for the development of these technical standards is available here: EBA roadmap on investment firms.
Some of these technical standards have already been published in the Official Journal of the European Union (see ‘Related documents’ below) and may be found on the EBA’s website.

Report

The Commission, after consulting the EBA and the European Securities and Markets Authority, should submit a report on the application of the IFR to the European Parliament and the Council of the European Union by 26 June 2024, together with a legislative proposal to review the framework if needed.

FROM WHEN DOES THE REGULATION APPLY?

It has applied since 26 June 2021.

BACKGROUND

Several thousand investment firms operate in the European Economic Area. They play key roles in savings and investment. They range from one-person companies to large international groups.
Until 25 June 2021, they were subject to the same capital, liquidity and risk management rules as banks to ensure they had sufficient resources to cover any potential losses from their activities. However, these rules failed to take fully into account the firms’ specific features.
For further information, see:
- Prudential rules for investment firms (European Commission)
- Investment firms (European Banking Authority).

KEY TERMS

Prudential requirements. EU rules on prudential requirements mainly concern the amount of capital and liquidity that banks hold. The goal of these rules is to strengthen the resilience of the EU banking sector so that it can better absorb economic shocks, while ensuring that banks continue to finance economic activity and growth.

MAIN DOCUMENT

Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014 (OJ L 314, 5.12.2019, pp. 1–63).

Successive amendments to Regulation (EU) 2019/2033 have been incorporated in the original text. This consolidated version is of documentary value only.