Financial stability, financial services and Capital Markets union

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Prudential treatment of investment firms

Overall state of play:

Evaluation finalised, SWD(2017)481, 20.12. 2017
Commission Proposals adopted by the Commission on 20.12.2017, COM(2017)790 and COM(2017)791
Legal Act - Adopted: Regulation (EU) 2019/2033, Date of entry into force: 25.12.2019; Directive (EU) 2019/2034, Date of entry into force: 25.12.2019

State of play, main conclusions, outlook

Investment firms had previously been subject to the Capital Requirements Regulation and Directive - CRR/CRDIV, which is largely designed for banks. This framework was widely recognised to be disproportionate and inappropriate for the vast majority of investment firms, whose activities and risks are limited.

The Commission’s proposals set out an appropriate prudential regime catering for investment firm business models with proportionate and calibrated requirements within the wider Capital Market Union and Better Regulation agendas. Besides more appropriate rules for capital, liquidity and other key prudential requirements, the regulation and directive also contain appropriate governance and remunerations rules for investment firms.

The simplification of the prudential rules for the vast majority of investment firms considerably reduces their administrative and compliance burdens. Various redundant regulatory and reporting requirements have been removed, therefore allowing capital dedicated to regulatory purposes to switch to more productive uses. This supports the aims of the Capital Markets Union by helping investment firms play their role in mobilising savings from investors towards productive uses. The actual risks of investment firms are also better captured under targeted rules, reassuring their clients and market counterparties that they will not be unduly impacted by the risks and possible problems incurred by firms. This is expected to contribute to greater stability and resilience in securities markets.

Estimated savings and benefits

The costs of the former CRR/CRD regime in terms of capital and compliance depended on the type of an investment firm. Because of the variety and size of investment firms in the market, detailed industry-wide and firm-level information was difficult to obtain for analytical and comparative purposes. However, based on available evidence, it can be concluded that, for several types of firms, the former bank-centric prudential rules imposed non-negligible capital and compliance costs. This was seen as disproportionate to the benefits achieved and detrimental for market entry and the development of a more competitive market. While the revised framework does not explicitly target an overall decrease in capital across investment firms, its better distribution according to actual risks together with a simpler and more appropriate framework should reduce compliance costs considerably. These are estimated to be in the range of EUR 10 000 to 100 000 depending on the type and size of firm. The adopted legislation also permits that some investment firms can stay subject to the existing rulebook, for instance if this would be more efficient for them, provided their supervisor agrees.

State of Play:

Evaluation finalised, SWD(2017)481, 20.12.2017

Scope:

Evaluation of the prudential framework of investment firms under the Capital Requirements Regulation and Directive (Regulation (EU) No 575/2013 (Capital Requirements Regulation, or CRR) and Directive 2013/36/EU (Capital Requirements Directive IV, or CRD IV)).

Evaluation findings:

The evaluation by the European Banking Authority and its assessment by the Commission services found that many of the CRDIV/CRR rules were ineffective and inefficient in achieving their objectives for most investment firms, primarily due to the fact that (i) the prudential regime was overly complex and its application to investment firms resulted in often disproportionate requirements, (ii) it was not appropriate for investment firms’ business models and risk profiles and therefore captured their risks poorly and (iii) differing national transposition of the rules and use of options in the framework reduced the level playing field for investment firms across the EU. Importantly, the CRD/CRR regime was however assessed to be an efficient regulatory framework for large and systemic investment firms whose size, risk profile and interconnectedness with other participants in financial markets make them ‘bank-like’ in character.

However, for other firms (such as medium sized and smaller investment firms), the banking prudential regime was assessed to create (i) excessive complexity and disproportionate compliance burdens especially for many small and medium-sized firms; (ii) poorly tailored and risk-insensitive prudential metrics and requirements for accurately capturing the risks of investment firms; and (iii) cases of diverging national implementation of the rules and a fragmented regulatory landscape across the EU.

State of Play:

Adopted by the Commission on 20 December 2017, COM(2017)790 and COM(2017)791

Which objective(s) does the Commission pursue?

The proposed rules set up an EU prudential framework for all investment firms which is up-to-date and proportionate to their risks, and delivers results for citizens and businesses effectively, efficiently and at minimum cost.

Investment firms are divided into three classes based on their size and activities to better capture their risks and provide for appropriate prudential requirements. Large investment firms remain in the CRR/CRD alongside banks, with the most systemic set to become subject to supervision by bank prudential authorities. Other firms are subject to a distinct framework more in line with their risks and business profile.

Simplified requirements apply to small and non-interconnected firms, defined as those who do not undertake activities involving trading financial instruments for their own account and who conduct other investment services below certain thresholds. Firms which do not meet these requirements are subject to new rules to determine their capital requirements based on a relevant set of risk factors relevant for their activities. Some of these risk factors were new while others simplified existing CRR-provisions where the latter already address the risks to a large extent.

Estimated savings and benefits

The proposal for simplifying prudential rules for the vast majority of investment firms was expected to considerably reduce their administrative and compliance burdens. Various redundant regulatory and reporting requirements were removed, allowing capital dedicated to regulatory purposes to switch to more productive uses. Investment firms would be relieved of the complicated task of matching and reconciling business data to an ill-fitted regulatory framework and reporting regime.

Investment firms that are SMEs were expected to be among the main beneficiaries. A more proportionate and appropriate prudential framework for them would help improve the conditions for conducting business, and barriers to entry should decrease. For example, streamlining the onerous reporting framework would reduce administrative burdens and compliance costs for SMEs. Similarly, by exempting small and non-interconnected investment firms from the governance and remuneration rules as laid down under the current CRD/CRR, the proposals reduced administrative and compliance costs for these enterprises. Some one-off costs of transitioning to the new regime were expected as firms would need to overhaul risk management systems, update compliance departments and revise contracts with law firms and other service providers that were used to facilitate compliance. However, the compliance cost savings supported the CMU’s aims in general by helping investment firms play their role in mobilising savings from investors towards productive uses.

In terms of compliance costs, firms are set to save in the range of EUR 10 000 to 100 000 depending on the type and size of firm based on the estimation from the impact assessment.

State of Play:

Adopted; Regulation (EU) 2019/2033, Date of entry into force: 25.12.2019
Adopted; Directive (EU) 2019/2034, Date of entry into force: 25.12.2019

Outcome of legislative procedure

The main changes introduced by the co-legislators were the following:

- A set of additional categories of investment firms carrying out specific activities which are either required to remain in CRR/CRD in view of their larger size and risk-profile, or can opt-in to do so subject to supervisory approval;

- Further options for the smallest firms to be subject to the simplest requirements and avoid application of some more stringent rules in terms of capital, liquidity, governance and remuneration, both in the transition to, and upon full application, of the new regime;

- Targeted changes to align specific provisions applicable to investment firms with trading activities more closely to the corresponding rules under CRR;

- Rules for specific larger investment firms to disclose aspects of their policy in relation to their holdings and associated voting rights and decisions;

- Reports and review clauses on environmental, governance and social (ESG) risks.

Estimated savings and benefits

The estimated savings and benefits identified in the impact assessment remain applicable.

State of Play:

• Date of entry into force: 25 December 2019.
• Date of entry into application: 26 June 2021.

Implementation reported by Member States

The transposition deadline of the Directive was 26 June 2021. As of December 2022, 25 Member States have notified full transposition of the Directive and 2 more Member States have notified partial transposition. The Commission is currently in the process of assessing the conformity of the notified national measures transposing the IFD.

Implementing and Delegated Acts Supplementing the Regulation

Eleven technical standards have been adopted by the Commission, as of December 2022, related to the IFR/IFD framework.

On 6 August 2021, the RTS specifying the criteria for subjecting certain investment firms to the requirements of Regulation (EU) No 575/2013 was adopted by the Commission, and was published at the OJEU on 7 December 2021.

On 13 August 2021, two RTS were adopted by the Commission, specifying appropriate criteria to identify categories of staff whose professional activities have a material impact on the risk profile of an investment firm or of the assets that it manages and the 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, respectively. Both were published on 7 December 2021.

On 22 September 2021, the RTS on adjustments to the K-factor “daily trading flow” (K-DTF) coefficients was adopted by the Commission (published on 20 January 2022), as well as the RTS on methods for measuring the K-factors referred to in Article 15 of the IFR (published on 11 January 2022).

Two further RTS were adopted by the Commission on 24 September 2021, one specifying the amount of total margin for the calculation of the K-factor “clear margin given” (K-CMG) (published on 22 February 2022) and the other specifying the notion of segregated accounts to ensure client money’s protection in the event of an investment firm’s failure (published on 11 January 2022).

On 11 March 2022, the RTS specifying the templates for investment policy disclosures was adopted by the Commission and was published at the OJEU on 6 July 2022.

On 11 April 2022, the RTS to supplement the calculation of the own funds requirement for investment firms based on fixed overheads was adopted by the Commission and was published at the OJEU on 5 September 2022.

Additionally, one Implementing Technical Standard (ITS) for the application of the IFR with regard to supervisory reporting and disclosures of investment firms was adopted on 10 December 2021 and published on 22 December 2021.

Another ITS setting out the format, structure, content lists and annual publication date of the information to be disclosed by competent authorities was adopted on 8 March 2022 and published on 9 March 2022.