All change for prudential requirements

Peter Ray and Jane Stoakes

As we have discussed in previous Regulatory Focus newsletters, the financial rules for investment firms are undergoing substantial revision to move away from a banking approach and to better align capital requirements with the risks that investment firms face.

The FCA’s domestic implementation of the EU’s Investment Firm Prudential Regime (IFPR) is coming into force from 1 January 2022. The FCA is implementing the IFPR through a new sourcebook called “MIFIDPRU.” This change in the prudential rules directly impacts UK firms authorized under UK MiFID and groups that they are part of as well as Collective Portfolio Management Investment Firms (CPMIs) that undertake MiFID business.

The proposed new financial rules will require MiFID investment firms and CPMIs operating in the UK to overhaul the way they measure and report their Own Funds Requirement and Liquid Asset Requirement. MIFIDPRU represents a major change for investment firms, so it is critical that firms act now to adequately prepare for the new regime.

The following firms will be caught by the new IFPR:

  • MiFID investment firms subject to the Prudential Sourcebook for Banks, Building. Societies and Investment Firms. (BIPRU) and the General Prudential sourcebook (GENPRU)
  • CPMIs 
  • Full-scope, limited activity and limited license firms subject to IFPRU and the Capital Requirements Regulation (CRR)
  • Local investment firms
  • Matched principal traders
  • Exempt Capital Adequacy Directive (Exempt CAD) firms
  • Investment firms that were previously exempt under Article 3 of MiFID but opted in
  • Various specialist commodities derivatives investment firms

The FCA has already published one discussion paper, three consultation papers (the most recent of which was issued on 6th August) and two policy statements on IFPR. These are to be followed by a final policy statement to be issued later in the year.

Depending on the size of the firm and its activities, there will be two types of firm—a small, non-interconnected (SNI) firm and a non-small non-interconnected (non-SNI) firm. New capital requirements known as K-factors will apply to non-SNI firms, and firms will need procedures in place to be able to calculate these.

Another major change in the rules will be that the Individual Capital Adequacy Assessment Process (ICAAP) will be changed to a new regime called the Individual Capital and Risk Assessment (ICARA) process. 

Firms will need to document this new ICARA process, and regulatory reporting formats will also be changed. In addition, revised remuneration policies, plus supporting compliance and monitoring collateral, will need to be put in place. 

Firms have just over four months until 1 January 2022 when these new rules will be implemented. If the IFPR applies to your firm, we strongly recommend that you focus on the following key areas now:

  1. Understanding your firm’s classification as an SNI or non-SNI firm and the associated capital requirements
  2. Analyzing any possible consolidation requirements
  3. Calculating K-factors if applicable to your firm
  4. Reviewing the effects of the new requirements on the firm’s capital position with and without the use of transitional provisions
  5. Analyzing the effects of the Liquid Asset Requirement
  6. Ensuring key components of the ICARA process are in place, such as:
    • Stress tests on capital and capital requirements
    • Implementing a wind-down planning guide in line with FCA guidance
    • Ensuring the firm’s liquidity policy is up to date and fit for purpose
  7. Reviewing and updating remuneration policies in line with the new requirements
  8. Understanding the new disclosure regime

If you have questions concerning the new regime, contact your usual Kroll consultant for assistance.

Environmental, Social and Governance (ESG) matters

ESG remains a hot topic for the government, firms, investors, clients and regulators. Over the coming weeks and months, we will keep our readers informed of arising ESG matters and will plan to run some events on ESG after the summer holidays. A summary of recent ESG activity from the FCA can be found below:

New FCA proposals published on climate-related disclosure rules

Peter Timson and Peter Ray 

22 June 2021

Following the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD), the FCA has proposed to extend the application of its TCFD-aligned listing rule to issuers of standard listed equity shares and to introduce TCFD-aligned disclosure requirements for asset managers, life insurers and FCA-regulated pension providers. 

These new proposals represent the first substantive policy proposals by the FCA for the UK asset management/owner sectors since the end of the EU withdrawal period and are designed to ensure that each part of the investment chain is fully informed about climate-related risks and opportunities.

The purpose of this will be to encourage firms to invest in more sustainable ventures in keeping with the FCA’s commitment to the UK government’s target of a net-zero economy by 2050.

The FCA is also inviting views on other ESG issues in capital markets. The FCA intends to confirm its final policy on climate-related disclosures before the end of 2021 and is seeking feedback on both consultations by 10 September 2021. Stakeholder views on ESG-related issues will be considered separately, with a view to publish a feedback statement in the first half of 2022.

The full press release can be found here

High-level summary of the FCA’s consultation for asset managers, life insurers and FCA-regulated pension providers

Jane Stoakes

22 June 2021

The key aim of FCA’s consultation paper (CP 21/17) is to increase transparency and enable clients and consumers to make considered choices while remaining proportionate for firms. 

The FCA proposals do not apply to firms with less than £5 billion in assets under management on a three-year rolling average to be assessed annually. The FCA said that its proposals will cover 98% of assets under management in the UK. 

In our view, even if firms are not in scope of these proposed rules, we envisage that they may wish to opt in to maintain competitive advantage and therefore may wish to make themselves familiar with the proposals and any further regulatory developments. 

The FCA designed the proposed regime with international consistency in mind and recognizes that some firms will already be subject to the EU’s Sustainable Finance Disclosure Regulation (SFDR). Where firms have to comply with both regimes, the FCA proposes that firms make disclosures under each regime.

The FCA is seeking to achieve three outcomes:

  • Better outcomes for clients and consumers in relation to greater transparency about how firms are managing climate-related risks and opportunities in their investment decision-making process, enabling them to make informed decisions 
  • Deeper consideration of climate-related risks and opportunities by firms that are in scope of the proposals
  • Coordinated information flow along the investment chain, understanding that appropriate pricing and efficient allocation of capital is dependent on all parties along the investment chain providing good and consistent information

The key elements of the FCA’s proposals are:

  • Entity-level disclosures to be published annually by firms
  • Public or on-demand product level disclosures to be produced annually by firms

A phased implementation of the new FCA rules is proposed as follows:

Phase 1—effective from 1 January 2022

  • Applies to asset managers with assets under management of more than £50 bn based on a three-year rolling average (enhanced firms under the Senior Managers and Certification Regime)
  • Applies to asset owners with £25 bn or more in assets under management or administration
    • First disclosures to be made by 30 June 2023 and on 30 June each calendar year thereafter, based on activities over the previous 12 months
    • Products and portfolio level disclosures to be made by 30 June each year

Phase 2—effective from 1 January 2023

  • Applies to the remaining asset managers and asset owners in scope of the rules
  • First disclosures to be made by 30 June 2024
  • Subsequent disclosures to be made on 30 June each calendar year thereafter
  • On-demand disclosures to institutional clients must be provided starting 1 July 2024

Feedback on this consultation paper, which can be found here, is invited from firms by 10 September 2021. 

Please contact us if you would like to discuss this further.

The FCA writes to Authorized Fund Managers (AFMs) about its concerns and expectations in relation to ESG 

Laura Febbrari, Darragh Finn and Jane Stoakes

19 July 2021

The FCA wrote to AFM Chairs about its concerns regarding poorly drafted and, in some cases, misleading fund applications in relation to ESG strategies and about its expectations for improvement.

The FCA has reviewed numerous applications for authorization of investment funds with an ESG focus that have not met expectations. 

Therefore, the FCA expects to see material improvements in this area and has set out its expectations for firms within a set of guiding principles on making clear and not misleading claims. 

The guidance sits under three principles, with the overarching principle that a fund’s ESG/sustainability focus should be reflected consistently in its design, delivery and disclosure. The three guiding principles are as follows:

  • The design of responsible or sustainable investment funds and disclosure of key design elements in fund documentation
    References to ESG (or related terms) in a fund’s name, financial promotions or fund documentation should fairly reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund.
  • The delivery of ESG investment funds and ongoing monitoring of holdings
    The resources (including skills, experience, technology, research, data and analytical tools) that a firm applies in pursuit of a fund’s stated ESG objectives should be appropriate. The way that a fund’s ESG investment strategy is implemented, and the profile of its holdings, should be consistent with its disclosed objectives on an ongoing basis.
  • Precontractual and ongoing periodic disclosures on responsible or sustainable investment funds should be easily available to consumers and contain information that helps them make investment decisions.
    ESG-/sustainability-related information in a key investor information document should be easily available and written in a clear, succinct and comprehensible manner, avoiding the use of jargon and technical terms when everyday words can be used instead. Funds should disclose information to help consumers make an informed judgement about the merits of investing in a fund. Periodic fund disclosures should include evaluation against stated ESG/sustainability characteristics, themes or outcomes, as well as evidence of actions taken in pursuit of the fund’s stated aims.

The FCA provides guidance and key considerations for firms under each principle.

Firms can find the FCA’s letter and guiding principles here.

Although this letter is aimed at AFMs, the guidance from the FCA could be applied to any fund that has, or claims to have, an ESG strategy or focus. We therefore recommend that all relevant asset managers work through the FCA’s guidelines to assess whether any improvements could be made. 

Discussion paper 21/2: Diversity and inclusion in the financial sector—working together to drive change

Amelie Snape and Jane Stoakes

7 July 2021

The FCA and Prudential Regulatory Authority (PRA) have published a discussion paper (DP 21/2) seeking views on their regulatory plans to improve diversity and inclusion within the financial services industry. DP 21/2 highlights the importance of reducing the risk of groupthink to improve decision-making in firms and promote diversity of thought. Diversity and inclusion are important elements of ESG.

In addition to seeking feedback on how diversity, inclusion and other relevant terms are defined and used in a regulatory context, the discussion paper also invites views on:

  • The pros and cons of collecting and monitoring diversity and inclusion data
  • The types of data that should be collected
  • How regulators might use such data to assess whether increased diversity and inclusion results in better decision-making and product development within firms

DP 21/2 sets out policy options for driving progress on diversity and inclusion and at the same time recognizes the critical role of culture to support such initiatives within firms. Policy options include the use of targets for representation, measures to make senior leaders directly accountable for diversity and inclusion within firms, linking remuneration to diversity and inclusion metrics and how regulators might consider diversity and inclusion in non-financial misconduct.

Within this context, the FCA and PRA are also seeking wider views on how to best achieve diversity at the board level, whether there should be mandated allocation of diversity and inclusion responsibilities to Senior Managers and, critically, whether firms should have and publish a diversity and inclusion policy and be subject to mandatory public disclosures on diversity data.

Feedback is welcomed by 30 September 2021. The full discussion paper can be found here.

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