A new EU prudential and remuneration regime for investment firms

The Investment Firms Regulation and Directive will overhaul the prudential regulation of the majority of EU investment firms, and significantly change the remuneration rules for some firms. This page sets out the key impacts for investment firms and provides links to related content, including on plans for implementing the regime in the UK.

Key impacts of the IFR / IFD

Classification to become more risk sensitive

Investment firms will fall into one of four prudential classes depending on the type of activities they are licensed to perform, and – this is new for many firms - the scale of their activity and size of their assets. Firms will need to make potentially complex assessments as to which class they fall into and will need processes for monitoring whether their classification changes over time, as moving between classes will have a potentially onerous impact on their prudential treatment.

Bank licence for Class 1 firms

Investment firms that are licensed to deal on own account and/or provide underwriting/placing on a firm commitment basis, and that have assets above €30bn (individually or on a group basis) will be Class 1 firms. They will need to become licensed as credit institutions (i.e. banks) and will become subject to the liquidity coverage ratio (in some jurisdictions for the first time) as well as other CRR prudential rules such as the leverage ratio. Class 1 firms incorporated in the Euro area will also become subject to the prudential supervision of the European Central Bank which (amongst other things) will require these firms to establish working relationships with their new prudential supervisor.

Significant prudential and remuneration requirements for Class 1 minus firms

Investment firms which have dealing on own account and/or underwriting/firm placing permissions but do not meet the €30bn asset threshold for Class 1 may still find themselves subject to the same rules as Class 1 firms if they meet certain lower asset thresholds. These ‘Class 1 minus’ firms will not become credit institutions but will, nevertheless, be subject to the more stringent prudential requirements in CRR/CRDIV (and soon CRR2/CRDV), including the leverage ratio, complex liquidity rules and capital buffers. The impact of this could be significant for some firms, particularly if Class 1 minus classification is at the instigation of their local regulator. Class 1 minus firms will also be subject to the stringent remuneration rules in CRDIV (as amended by CRDV), including bonus cap, malus and clawback provisions, deferral of variable pay and non-cash rules.

Some firms capable of being in Class 3 may still find themselves in Class 2 due to volume of activity

Because the new prudential classification does not simply categorise investment firms by reference to their scope of permissions, exempt-CAD or BIPRU firms in the UK (and those in equivalent categories in other EU jurisdictions) may find themselves in Class 2 under the new regime. This will be the case for any investment firms exceeding, individually or on a group basis, any one or more of four thresholds set by reference to (i) assets under management (including ongoing non-discretionary advisory arrangements), (ii) client orders handled (or received and transmitted), (iii) annual gross turnover, or (iv) on- and off-balance sheet assets. We explain these thresholds in more detail in our report and indicate how these may impact portfolio managers and investment advisers.

More stringent requirements on capital for some Class 2/3 firms

IFR/IFD treats the same instruments as eligible capital as those that are eligible under CRR. The proportions of CET1, AT1 and T2 capital are also similar to those in CRR. Firms that are currently subject to less stringent rules on own funds will need to review their capital instruments. The IFR’s rules for deductions from CET1 are less sophisticated than those in CRR, which may adversely impact Class 2 and 3 firms.

Monitoring Class 2 firm risks and impact on variable capital

Class 2 firms will need to put in place governance and processes to monitor how the risks they pose to their clients, the market and to themselves develop over time. This will involve Class 2 firms calculating their so-called K-Factors - the method introduced by the IFR/IFD for evaluating the risks posed by a firm – and translating these into variable capital requirements. Some Class 2 firms will become subject to variable capital requirements for the first time.

More stringent remuneration requirements for Class 2 firms

Class 2 firms will be subject to concrete remuneration requirements including a requirement to issue at least 50% of variable pay in non-cash instruments, deferral of a proportion of variable pay for 3 to 5 years, malus and clawback. Class 2 firms will also need to publicly disclose certain aspects of their remuneration system and of the awards made. Some Class 2 firms will need to establish a remuneration committee.

Investment firm groups and consolidation

The default rule is that investment firms must comply with the key prudential requirements of IFR/IFD on a solo basis. However, a consolidation framework also requires groups of EU investment firms to comply on a consolidated basis. Local regulators may allow small and non-complex groups of investment firms to apply a group capital test instead of consolidation.

Level 1

Investment Firms Regulation (IFR) was published in the Official Journal on 5 December 2019.

  • Corrigendum to IFR was published in the Official Journal on 24 January 2020 (Draft RTS/ITS relating to the amended MiFIR third-country equivalence regime are now due in September 2020, rather than 2021).

Investment Firms Directive (IFD) was published in the Official Journal on 5 December 2019.

Level 2

The EBA has published a Roadmap for EBA mandates arising from IFR/IFD, which splits EBA publications into 4 phases (due between December 2020 and June 2025).

There are no draft or final Level 2 measures yet but the EBA published the following consultation papers (constituting Phase 1 of the EBA mandates) on 4 June 2020 (open until 4 September 2020). The final drafts are expected in December 2020.

EBA/CP/2020/06 on classification and prudential requirements for investment firms covering:

  • Draft RTS on the information to be provided for the authorisation of investment firms as credit institutions (Article 8a(6) point a) of the CRD)
  • Draft RTS on the calculation of the threshold referred to in Article 4(1)(1b) CRR (Article 8a(6) point b) of the CRD)
  • Draft RTS to specify the calculation of the fixed overheads requirement and to define the notion of a material change (Article 13 (4) of the IFR)
  • Draft RTS to specify the methods for measuring the K-factors (Article 15(5), point a) of the IFR)
  • Draft RTS on the definition of segregated account (Article 15 (5) point b) of the IFR)
  • Draft RTS to specify adjustments to the K-DTF coefficients (Article 15(5) point c) of the IFR)
  • Draft RTS to specify the calculation of the amount of the total margin for the calculation of K-CMG (Article 23(3) of the IFR)
  • Draft RTS on the criteria for subjecting certain investment firms to the CRR (Article 5 (6) of the IFD)
  • Draft RTS on prudential consolidation of investment firms groups (Article 7(5) of the IFR)

EBA/CP/2020/07 on supervisory reporting and disclosures for investment firms and Annexes (containing the draft RTS/ITS) covering:

  • Draft ITS on reporting requirements for investment firms under Article 54(3) and on disclosures requirements under Article 49(2) of IFR
  • Draft RTS on the monitoring of information related to the thresholds for credit institutions reporting requirements for investment firms under Article 55(5) of IFR

EBA/CP/2020/08 on pay out in instruments for variable remuneration covering:

  • Draft RTS on classes of instruments that adequately reflect the credit quality of the investment firm as a going concern and possible alternative arrangements that are appropriate to be used for the purposes of variable remuneration (Art 32(8) IFD)

EBA/CP/2020/09 on criteria to identify material risk takers covering:

  • RTS on criteria to identify categories of staff whose professional activities have a material impact on an investment firm's risk profile or assets it manages under Directive (IFD) 2019/2034 of the European Parliament and of the Council on the prudential supervision of investment firms (Art 30(4) IFD)
Background materials

EBA report (December 2015) highlighting weaknesses in existing prudential framework for investment firms.

First EBA opinion (October 2016) containing advice on analysis relating the class 1 firms.

EBA discussion paper (November 2016) on new prudential framework (including K-factors) for class 2 and 3 investment firms.

Second EBA opinion (September 2017) containing advice on the prudential requirements for class 2 and 3 investment firms.

Commission proposals for an Investment firms regulation (IFR) and an Investment firms directive (IFD) (December 2017).

UK prudential regime for investment firms

HM Treasury policy statement (23 June 2020) on implementation of the EU prudential regimes (for credit institutions and investment firms).

FCA DP20/2 on the UK prudential regime for investment firms.

We regularly hold breakfast briefings, webinars and roundtables on current financial regulatory topics, including the latest developments on IFR/IFD. If you would like more information about these events, please get in touch with your usual Linklaters contact or one of the team listed below.

Explore our reports

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Second FCA CP on IFPR: Remuneration requirements

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A new EU prudential and remuneration regime for investment firms

July 2019

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