The FCA’s new Investment Firm Prudential Regime (IFPR) will be introduced at the start of 2022. To help firms prepare for the new regime, Wheelhouse Advisors has worked with a cross-section of the market to assess the impact of the new arrangements. One group in particular, Exempt-CAD firms, look set to see a relatively heightened degree of change.

So, what’s changing? Capital requirements is the headline-grabber, but alongside that sit other concerns such as liquidity, consolidation within group structures and significantly increased reporting burdens. Also of note is the introduction of the Internal Capital and Risk Assessment (ICARA) process. The ICARA process replaces the Internal Capital Adequacy Assessment Process (ICAAP) and, for BIRPU, IFPRU or CPMI firms, will be an evolution of the current landscape. Exempt-CAD firms, however, have not been required to undertake an ICAAP under the current regulatory framework, making for a steeper learning curve than other categories of firm captured under the new IFPR.

Capital Requirements

Capital requirements under the new prudential regime will mean a shift away from the €50,000 of regulatory capital firms must currently hold against the risks they take. As a minimum, Exempt-CAD firms will now have to set at least £75,000 aside.

However, our impact assessments show that under IFPR it is likely that Exempt-CAD firms will see their Total Own Funds Requirements (TOFR) calculated based on the higher of Fixed Overheads Requirement (FOR) or the sum of K-factor requirements (KFR). The FOR equate to 25% of a firm’s overheads and KFR is a more complex calculation based on the types and volume of business a firm conducts, principally culminating in what’s called the risk-to-customer (RtC) requirement.

The TOFR is the largest of either the £75,000 minimum, or the calculation made for FOR or KFR. For some Exempt-CAD firms, we have identified an increase in capital requirements of up to 20-fold. At the lower end, 5-fold increases are alarmingly commonplace.

This points towards capital requirements calculations becoming a board-room topic in the not-too-distant future. Taking early steps to understanding your firm’s position and exposure will help you in developing mitigation processes or working in a way that maximises the benefits of the new prudential regime.

Prudential consolidation

Exempt-CAD firms have, to date, not been subject to any regime that brings the broader corporate group structure into scope of prudential rules. The IFPR changes this meaning any firm which sits in a group, even the simplest of structures, has some analysis work to complete to ensure any UK parent entities within the group are adequately capitalised.

A common arrangement has been deployed is for a UK corporate parent company to borrow monies to fund the investment of regulatory capital into its subsidiary – the MiFID investment firm soon to be subject to IFPR. This is an arrangement that regulators discourage and so any such parent company would need to be adequately capitalised under the new regime.

A very useful carve-out for “sufficiently simple” groups is on offer, meaning full prudential consolidation can be avoided if UK parent companies can prove, on an ongoing basis, it holds sufficient equity to cover its investments in subsidiary entities plus any group contingent liabilities. This will likely be an incredibly useful aspect of the new regime for Exempt-CAD firms which may not have previously been required to consider group capital adequacy.

ICARA

The Internal Capital Adequacy and Risk Assessment process will be a new and labour-intensive undertaking for Exempt-CAD firms, who will need to demonstrate the controls, risk management and governance processes of the firm through this new measure. This will be documented on an annual basis.

The FCA has made clear that it expects all firms to improve the current approach to risk assessment, with the new regime changing the way pillar 2 is calculated. For many, this will be a formalisation of existing best-practices across the industry, but for Exempt-CAD firms this represents a fundamentally new approach.

Action to take

First and foremost, it is important to fully understand and interpret the ways in which the new prudential regime is likely to affect your firm.

The impact assessments we have completed do point towards some major changes for Exempt-CAD firms, and far beyond just the capital requirements, but these are certainly surmountable with the correct planning and execution.

While the FCA’s 2020 discussion paper (DP20-2) set out the majority of what will crystallise into the new regime, further detail is contained in the first two IFPR consultation papers (CP20-24 and CP21-7) and there is still a further consultation paper that is set to be unveiled in 2021. The expectation is that the FCA’s IFPR will mimic and improve upon much of what comes with IFD/IFR (Europe’s equivalent regime, set to be introduced in June 2021), but there may yet be changes, particularly for firms set to undergo the greatest upheaval against current arrangements.

A clear view as to your potential exposure is vital in providing the foundations for a successful transition to the new regime. For support in assessing the impact on your firm, speak to an expert and continue to read more on the topic.