This briefing note is for the exclusive use of the clients of Fulcrum Compliance Ltd. It is not intended as a comprehensive guide to FCA’s Consultation Paper, but as a guide to discussions with retained clients over the implementation period.

Clients will be aware of these impending changes from our previous Newsletters.
These can be accessed as follows:

• Newsletters: July and December 2020;
• Compliance Monitor: September 2020;
• Client email: January 2021.

In this email we consider the further impact of FCA’s second Consultation Paper CP21/7, published in April 2021. This email should be read in the context of our previous email above.

Background
In January 2022, all MiFID investment firms will move away from their existing capital regime (i.e. BIPRU / IFPRU / Exempt-CAD) to a new Investment Firms Prudential Regime. This will require increases in regulatory capital for most firms covered by these rules, with important exemptions.

Q: What will my new capital requirement be?
In their previous CP, FCA outlined the requirements as follows:

• For SNIs: the greater of the “Permanent Minimum Requirement” and the “Fixed Overhead Requirement”
• For non-SNIs: the greater of the “Permanent Minimum Requirement”, the “Fixed Overhead Requirement” and the “K-factor requirement”.

The “Permanent Minimum Requirement” will rise to £75,000, £150,000 or £750,000, depending on the firm’s permissions.

FCA has now defined the Fixed Overhead Requirement as 25% of relevant expenditure, i.e. total expenditure less certain deductions. This must be recalculated in the event of material increases or decreases in expenditure – but FCA’s permission must be sought to reduce it. The new calculation will apply to some AIFMD firms as well as MiFID firms.

FCA has further defined the K-factor requirements in addition to the principal dealing K-factor. (These only apply to non-SNI firms.) Firms with these activities will need to provide as follows:

• 0.04% of client assets and money held (including those amounts held by third parties);
• 0.02% of assets under management, including both those under discretionary arrangements and advisory managed arrangements, (including those amounts held by third parties);
• 0.1% of the value of cash orders handled, 0.01% of the value of derivative orders handled.

Q: What are the new liquidity requirements?
All firms in scope will be subject to a Liquid Assets Requirement. This will be calculated as 1/3 of the FOR and must be held in “Core Liquid Assets” e.g. short-term UK bank deposits, UK Gilts.

Smaller firms will be allowed to include trade receivables in this calculation, up to 1/3 of the Liquid Assets Requirement.

Q: Are there additional capital requirements?
FCA’s view is that the capital indicated by the combination of the Permanent Minimum Requirement, the Fixed Overhead Requirement and the K-factor
requirement may not be enough to allow the firm to be viable throughout the economic cycle and cater for an orderly wind down.

Therefore it is proposing that all firms subject to this regime estimate those risks and calculate an “Own Funds Threshold Requirement”, which will be the higher of the PMR, own funds needed for ongoing operations and own funds needed for a wind down.

Q: How do I calculate an “Own Funds Threshold Requirement”?
This will vary from firm to firm, so FCA has set out a process which firms should use to calculate this amount. This is the “Internal Capital Adequacy and Risk Assessment” (ICARA) process and will be familiar to firms who previously completed an ICAAP.

The requirement is that firms should consider the types of harm they might be subject to and estimate additional own funds or liquid assets necessary to fund them. The whole exercise must take place at least annually and be approved by the Board.

Q: Do the results of the ICARA need to be reported to FCA?
Yes, in a new annual return that FCA will roll out in Reg. Data.

In addition, firms are required to notify FCA is their capital resources fall below 110% of the calculated Own Funds Threshold Requirement. FCA’s expectation is that at this point, the firm will have a plan to re-capitalise. FCA’s further expectation is that if resources fall below the FOH, or liquid assets below the liquid assets requirement, the firm will implement its wind-down plan.

Q: What are FCA’s requirements for remuneration?
Risk, Nomination and Remuneration Committees will only be a requirement for the largest firms. But all firms – including SNIs – will have to follow at least the “basic remuneration requirements”.

This will require the firm to have a Remuneration Policy which addresses potential conflicts of interest and the balance between fixed and variable remuneration. This will need to be reviewed by the Board annually. There will also be an annual return to FCA on remuneration matters.

Q: What should I do now?
We said in our initial email that firms should consider whether they need to be a MiFID firm. Can you restrict your business to non-MiFID activity? It is our belief that the requirements of this regime are sufficiently onerous – even when implemented in a proportionate manner – that the benefits of remaining a MiFID firm may be outweighed by the overhead necessary to comply with these requirements.

For example, your firm may have chosen to opt into MiFID, perhaps to take advantage of the MiFID passports previously available. These are no longer available. Alternatively, you may only advise and make arrangements. In either case, it may be possible to vary your FCA Permission to clarify that you are no longer a MiFID firm and are outside the scope of this regime. This will require you to restrict your business scope – but for certain firms (particularly corporate finance firms), that may be a practical solution.

If this is neither practical nor possible for you, now is the time to do some modelling. Consider which is the higher of the new permanent minimum requirement and a quarter’s running costs (and K-factors if applicable). Consider the risks you face. Is additional capital required to meet them? Do you have that in Tier 1 equity?

Next steps
Fulcrum Compliance will be considering these issues with retained clients at scheduled meetings in the coming quarter. If you have any queries in the meantime, please do get in touch.