Firms falling within the remit of the FCA’s new Investment Firm Prudential Regime (IFPR) cannot afford to be passive. They need to set themselves on the right path now if they are to meet the January 2022 compliance deadline. Some firms have a long road ahead as the new rules mean a ten-fold rise in their capital requirements.
“This regulation is meant to simplify the current regime,” explains Priya Mehta, Head of FCA Advisory and Regulatory Reporting Services, Buzzacott. “At the moment, we have multiple versions of these regulations which worked together and have been imposed on different types of firms. This law unwinds those positions. As a result, there will only be two categories of FCA regulated investment firms, rather that the six or seven different types there are now.”
This will be a challenge in the short-term but Mehta expects that a few years down the line, the industry will start to appreciate the simplicity ushered in by the new rules.
Although most firms regulated by the FCA are impacted by the IFPR, there is a bigger onus on smaller players as they will need to make more significant changes to their processes and business model than larger firms.
“Under the IFPR, firms will need to carry out a prescriptive risk assessment. However, the difference will be that they need to quantify the risks identified through that assessment and physically put capital aside to cover them. This is going to be the biggest challenge,” Mehta outlines.
The new rules impose a 10 percent buffer on top of the capital requirements which needs to be maintained. If firms dip into that buffer, it triggers an early warning notification which the firm is obliged to report back to the FCA.
Firms are expected to set out triggers and the moment they breach any of those, they should technically start the wind down process. In truth, most firms will inject more capital to keep themselves going. However, those red flags now need to be properly quantified and monitored on an ongoing basis which is the biggest challenge.
“This is a big step and a significant change which is not really necessary for some of the firms in question. Essentially, nothing about their business has changed but their capital requirements are going to go up ten-fold as a result of this regulation. They have five years to build that up but we still think it’s somewhat unnecessary,” Mehta remarks.
She says that settling into the process of not dipping into the 10 percent buffer is something firms will need to get used to. An early notification warning will mean they need to take remedial action, which will, in turn, most likely be recorded as a breach on their register. “Having such breaches on your record as a firm is not ideal and these are things which investors could well pick up on. Therefore, keeping a clean record in this new environment will be very important,” Mehta advises.
In terms of client reactions to these new rules, Mehta acknowledges they are taking different approaches: “There are ones who want to know upfront how it’s going to affect them. They jumped on board and wanted to get their risk assessment done straight away. This gave them the peace of mind of knowing what’s going to change for them, if anything.”
Worryingly however, she says a few firms have been passive about it. Mehta stresses the importance of planning ahead since the FCA has kept to its projected timeline. This means it’s most likely going to stick to the January 2022 compliance cut off, which firms will have to adhere to if they want to remain in business. She notes that the guidance is mandatory and needs to be submitted: “The FCA expects to see a very detailed articulated plan.”
Firms can do several things to prepare for the deadline and set themselves on the right path. Mehta says: “First of all, they can carry out a full impact assessment to know how the IFPR is going to impact part of their operations and compliance. Then they need to know what measures they need to take to meet the January deadline.
“Firms are simply expected to become compliant by first of January 2022. They cannot come to this realisation in November or December of this year and hope to meet that deadline. The to-do list to comply with the IFPR is not short so the sooner they start, the better it is.”
No quick fix
The legislation speaks about identifying “harms” – harm the firm can potentially cause itself, its clients, counterparties or the market. “The FCA has published a lot of guidance around what different types of firms need to focus on,” Mehta says. “For example if you trade on your own account, you need to consider some additional harms.”
Buzzacott has been working with clients to help them identify the harms relevant to their firm. “A large part of the work we’re currently doing is putting together different levels of checklists which the clients will need to work on. This is not always straightforward. If I ask an open-ended question about what harm a client thinks their business poses to the industry, I wouldn’t get a satisfactory answer. Therefore, we need to ask closed-ended questions to identify the relevant harms as listed in the regulation.”
The approach needs to be very tailored and structured. Mehta notes there is no template which will fit all firms, which is why she reiterates the importance of being prepared well ahead of the deadline: “It has to be considered on a bespoke basis and the answer is not a quick fix. There is not much time left to delay dealing with this anymore – firms need to address it now.”
Priya Mehta, Partner, Buzzacott
Priya Mehta has worked in the financial services industry since 2000. She works closely with many FCA regulated entities including UK and US based fund managers, investment advisory firms, brokers and asset management companies. Priya provides clients with much needed guidance on key regulations including CRD IV, AIFMD, MiFID II, SMCR and the latest IFPR and helps them with on-going capital adequacy and liquidity monitoring, compliance with client money rules and documenting ICAAPs/ICARAs and wind down plans.