Just in time for Christmas, the EBA published its long-awaited report setting out recommendations for a review of the current prudential regime for investment firms. Produced at the request of the European Commission, and in cooperation with ESMA, the report identified a number of issues in the current application of the CRD/CRR requirements to investment firms (including a lack of adequate risk sensitivity and the complexity of the framework stemming from the current categorisation of firms based on MiFID definitions) and suggested a new approach to their categorisation. The latter would distinguish between systemic and "bank-like" investment firms, to which full CRD/CRR requirements should apply, and other investment firms namely those that are not considered 'systemic' or 'interconnected'. For the 'non-systemic' firms, the EBA recommended that requirements should be tailored to reflect the risks specific to their activities.
A 'more proportionate and risk-based' regime: what's in store?
The good news for the industry is that the EBA has acknowledged that the CRD/CRR regime does not appropriately capture the risks attached to activities of investment firms. While at this stage it is too early to draw specific conclusions, it is safe to assume that for smaller players or those not running 'bank-like' activities (such as market making or taking a margin on credit risks), the situation is likely to change substantially and for the better. In the meantime, the review raises a number of important questions.
First of all, the review is set to change the definition of 'investment firm' and potentially the range of firms caught by the CRD IV framework. Currently, the definition is tied to the MiFID activities undertaken by firms. MiFID II (originally planned to kick-in at the start of 2017 but likely to be delayed till 2018) could bring new firms into the scope of CRD IV/CRR (as more firms will now be classified as MiFID ones). The review is set to break the link with MiFID and offer a more suitable definition of an investment firm for CRD/CRR purposes. There is a question of whether this definition will capture firms currently benefiting from the exemption to CRD IV in Article 95(2) of the CRR and, thus, remaining under the CRD III treatment.
Secondly, the new categorisation proposed by the EBA, which will be underpinned by a set of quantitative and qualitative criteria, will significantly reduce the complexity in classifying different types of firms. The EBA's report suggested that any 'bank-like' investment firms meeting certain thresholds (or those that would otherwise present a clear risk to financial stability in normal conditions) will be deemed 'systemic'. However, it remains unclear what these thresholds will be (and whether they will be linked to the FSB's and IOSCO's work on systemic importance of non-bank non-insurer financial institutions) and what activities will be branded 'bank-like' (this might link to the FSB's taxonomy of 'shadow banking activities'). At the same time, the EBA recognised that only a small minority of MiFID firms carry out 'bank-like' intermediation and underwriting risks at a significant scale, so this group of firms could be relatively small.
For firms that will be categorised as 'non-systemic' or not 'bank-like', the EBA recommended developing a less complex prudential regime to address the specific risks arising from their investment business, including specifically credit, market, operational and liquidity risks along with those related to holding client money and securities. For small and non-interconnected firms, the EBA thought a very simple regime (designed to allow them to be wound down in an orderly manner) would be appropriate. They should also benefit from simplified reporting obligations. The fact that the EBA has specifically referenced client money risks (to which CRD III firms are not subject) indicates that this exemption for firms not holding client money may remain. Depending on where the rules land, some firms may want to reconsider whether they should take on client money.
Another aspect of the CRD IV regime that needs to be clarified is remuneration. In this regard, the EBA intends to send its advice to the European Commission suggesting legislative amendments that would allow for a broader application of the proportionality principle and exempt certain firms from specific requirements. Just before Christmas, the EBA also published its guidelines on sound remuneration policies and an opinion on the application of proportionality. While based on the current wording of CRD IV, competent authorities should not be permitted to 'neutralise' or disapply entire provisions under CRD IV, the EBA also recommended that small and non-complex institutions should be permitted by competent authorities to disapply certain requirements, particularly those related to deferral, pay-out instruments and discretionary pension benefits, to recognise the proportionality principle.
Next steps
At this stage, the EBA has provided no specific thresholds or criteria for categorisation of firms and no calibrations for a new prudential framework. It is therefore too early to say what implications this review will have for each category of investment firms but it shows the EBA has listened to both the FCA's and firms' concerns about the inappropriateness of the current regime. The benefits of this review could be wide-ranging to CRD IV firms and particularly to the asset management industry.
Following the EBA's report, the European Commission is now expected to report to the European Parliament and Council. If it is given the green light, the EBA will prepare a second, more detailed report with specific thresholds for categorisation and calibrations for a new prudential regime. To inform this follow-up report, the EBA will conduct a data collection exercise and firms should be ready to take the opportunity to input. Given the amount of work that will be required, it is unlikely that we will see any legislative proposal on the new prudential regime for investment firms before 2017. The EBA also recommended extending the waiver for commodity trading firms (that are currently exempt from the large exposures and capital adequacy provisions) until 31 December 2020. The latter has already been followed up on by the European Commission with the legislative proposal amending the CRR to that effect. The extension of the waiver suggests an aim to have new rules for investment firms implemented by 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
