Background

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 previous FC Newsletters. We discussed them in our Newsletters in July and December 2020, and wrote about the implications of the proposed changes in Compliance Monitor in September 2020. The publication by FCA in December 2020 of its first tangible proposals is the opportunity to consider their potential implications.

Summary

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.

Unfortunately, all of the detailed rules are not yet available and will only be released later in the year as FCA issues further consultation papers. However, it is possible to make some initial planning assumptions now which will help to mitigate the potential impact of these changes. This Briefing Note seeks to clarify these.

It is FC’s intention that these issues will be discussed at our regular client meetings.

Application and categorisation

Q: Are you affected by these changes?
These changes only affect MiFID firms.

Firms which only have AIFMD permissions, or are not MiFID firms, are not affected by these changes. This includes corporate finance advisers who only have permission to advise and arrange and are prudentially regulated under IPRU-INV. (These firms will currently complete FCA Gabriel return FSA033 or FSA035.)

Q: Do you need to be a MiFID firm?
If you are a MiFID firm, it may be the time to cease to be one.

Your firm may have chosen to opt into MiFID, perhaps to take advantage of the MiFID passports previously available. With the advent of Brexit, these are no longer of value. You may have permission to deal as principal.

If you don’t use the principal dealing permission, or the passports, and only advise and make arrangements, it may be worthwhile varying 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. (Unfortunately, it will not be possible to calculate precisely the cost of remaining in the MiFID regime until FCA publishes further rules later in the year.)

Q: I am definitely a MiFID firm. How can I mitigate the impact of these rule changes?
By meeting the criteria of a “small, non-interconnected” firm (“SNI”).

To meet this definition you must meet the following criteria:

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Measure	Threshold
Assets under management	< £1.2 billion
Client orders handled – cash trades	< £100 million per day
Assets under management	< £1.2 billion
Client orders handled – derivative trades	< £1 billion per day
Assets safeguarded and administered	zero
Client money held	zero
On- and off-balance sheet total	< £100 million
Total annual gross revenue from investment services and activities	< £30 million

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It’s not possible to meet this definition if you deal as principal or hold any amount of client assets or money. Now is the time to consider whether principal dealing or holding client money is key to your business.

Q: My firm is part of a group. What are the implications for me?
The new rules will apply on a consolidated basis.

CP20/24 makes clear that the new rules will apply not just to the regulated entity, but to its wider group. The regulated firm may be the parent or subsidiary in that group.

As an alternative, it is possible to seek FCA’s permission to apply a “group capital test” as an alternative to prudential consolidation. To achieve this the parent must show that it holds sufficient regulatory capital to support the investment in subsidiaries. FCA will only allow this when the group’s capital structure is simple and poses minimal risk to others.

Q: What changes will I need to make to my capital base?
The new rules require that most capital should be of “Core Equity Tier 1”, i.e. shareholder’s funds and audited retained earnings and reserves. Tier 3 subordinated debt will no longer count towards regulatory capital. If you are currently reliant on Tier 3 capital, you’ll need to replace this over the 5-year transitional period. (We’ll address the transition period in later Briefings).

Q: What will my new capital requirement be?
In summary, the requirements will be 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 the following:

• £75,000 for those with permission only to receive and transmit orders, manage, advise and execute and who do not hold client assets;
• £750,000 for those who deal on own account, even if this is only on a matched principal basis;
• £150,000 for all other firm types.

The “Fixed Overhead Requirement” will be defined by FCA in later consultations, but for planning purposes, assume one quarter’s running costs.

The “K-factor requirement” has to date only been defined by FCA for principal dealers. Other K-factors for other non-SNI firms will be discussed in later consultations.

Q: Are there other requirements?
Yes.

All firms will be required to monitor their concentrations risk. Non-SNI forms will need to report on this to FCA.

All firms will need to report to FCA on at least a quarterly basis on capital adequacy, as well as on liquidity, the Fixed Overhead Requirement and K-factors. Details of the reporting will be released in later consultations. These will also cover governance, risk management and remuneration.

Q: What should I do now?
Consider whether you need to be a MiFID firm. Can you restrict your business to non- MiFID activity?

Consider your FCA scope of permission. Do you have permission to deal as principal? Are you allowed to hold client assets or money? Do you really need these for your business?

Do some initial modelling. Consider which is the higher of the new permanent minimum requirement and a quarter’s running costs (and K-factor if you deal as principal.). 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.