How the EU capital adequacy regime will apply to those with DIM permissions

  • Describe the importance of new EU capital adequacy requirements
  • Identify how it will apply
  • Explain how it will work going forwards, post-Brexit

Most DIMs will also be Class 3 investment firms. The capital requirement required will be one quarter of their annual fixed overheads and their initial capital requirement.

Unlike Class 2 firms, they will not have to assess their capital based on the K-factors, but they will have to monitor them in order to assess whether they become Class 2 firms.

In addition, Class 2 and Class 3 investment firms will be subject to concentration risk monitoring and reporting.

At the moment, BIPRU firms in the UK fall outside the scope of the CRR regime which means they are not subject to group supervision.

However, this could change with the introduction of the new regime because investment firms will be dragged into the IFR/IFD prudential scheme. In many instances this will trigger group-wide prudential regulatory requirements for the first time.

And there is more; the new regime will require Class 2 and 3 investment firms to be subject to a basic liquidity requirement which will be calibrated at one third of annual overheads.

These requirements must be met with cash and other high-quality liquid assets, though it is expected that Class 3 firms will be able to use a wider range of assets for this purpose.

For many, this will be the first time they have been subject to this type of requirement. However, it may be that Class 3 firms may be exempted from this requirement and this is something that is no doubt being discussed in the ongoing consultation process established by the FCA.

Class 2 and 3 investment firms will also be subject to other supervisory requirements under IFD, which for many firms will be entirely new.

Class 2 firms will have to establish internal capital and liquidity adequacy assessment processes (ICAAP/ILAAP), internal governance processes on treatment of risks, country-by-country reporting and (perhaps the most eye-catching) remuneration rules similar to the rules that apply to credit institutions. 

Class 3 firms are not subject to these requirements, although their competent authority will be able to impose ICAAP/ ILAAP requirements on them as the FCA does under current BIPRU rules.

In addition, IFD envisages a more active role for competent authorities of both Class 2 and 3 investment firms, including a supervisory review and evaluation process (SREP) and the possibility for the imposition of supplementary Pillar 2 capital and liquidity requirements on those firms.

IFD also requires the EBA to submit a report (within two years after entry into force) on the introduction of criteria on environmental, social and governance (ESG) risks and how investment firms can take account of these risks in their risk management and how supervisors can assess the impact of those risks in their SREP. 

Based on this report, the European Banking Authority (EBA) may choose to adopt guidelines to introduce criteria for ESG-related risks into the SREP for both Class 2 and 3 investment firms. If the EBA do this, then it is probable that the FCA will also look to do something similar in the light of the developing promotion of ESG based investments.