In its recent consultation [CP25/10: Definition of capital for FCA investment firms] (Consultation), the Financial Conduct Authority (FCA) has stated that it wants to amend its capital rules for investment firms — such as wealth managers, financial advisers, and brokers — set out in the MIFIDPRU section of the FCA rules. The amendments are designed to make regulatory compliance more straightforward and tailored to the needs of investment firms.
It applies to investment firms and UK parent entities required to comply with MIFIDPRU 3. The FCA invites feedback on the proposals by 12 June 2025. The final rules are expected to be published in h3 2025, with the new framework coming into force on 1 January 2026.
The Consultation is part of what appears to be an ongoing programme of regulatory simplification through the reduction of rules and guidance. This is positive: Although the amounts and ratios of capital governing investment firms remain materially unchanged, the rules will be more aligned with their businesses, moving away from the broad-brush application of the rules in the EU Capital Requirements Regulation (UKCRR), which were designed for banks and "on-shored" into UK law. More specifically, the Consultation addresses an issue that has given founders, investors, and their advisers headaches and that potentially discouraged investment, especially investment in early-stage firms.
Having to Rank Last
The strict rules on what qualifies as core equity tier 1 (CET1) capital for inclusion in the regulatory capital of investment firms hindered investment in these firms in cases where founders and investors wanted to use shares with different classes of rights as part of their financing and employee incentive strategies.
Specifically, one barrier to investment is the current rule in the UKCRR which requires that for shares to be CET1 eligible, they must be run below all other claims in the event of a liquidation. It has prevented, for example, the issuing of shares that only give the holders — usually employees — rights if the firm achieves an identified level (or hurdle rate) of profitability from ranking equally in a liquidation with CET1 shares. This would result in, for example, investors having to rank behind these employees in the event of a firm's insolvency, potentially discouraging investment, especially the riskier type of investment made by a venture investor in a fintech investment firm.
The Fix: First Amongst Equals
In the Consultation, the FCA seeks to clarify that a firm's issuance non-CET1 shares that rank equally in a liquidation with other shares will not exclude those other shares from being CET1 eligible. The FCA also wants to clarify that non-CET1 shares which carry a claim on a given proportion of a firm's residual assets in a liquidation will not undermine the quality of CET1 shares. The FCA justifies this because the CET1 shareholders' potential return would remain unlimited and they could still lose the full amount of their investment.
The FCA will seek to offset any risk to investors by requiring clear disclosure of these "non-standard ranking arrangements," but the proposed removal of a rule seen as a disproportionate imposition of form over substance, if followed through, will be a small triumph for funders of and investors in early stage firms, which aligns the rules for investment firms with those of, for example, mortgage lenders. One can only hope that HM Treasury will follow the FCA by revisiting the initial capital rules for payment services and e-money institutions, which also draw on the UKCRR.
The Other Points in the Consultation
General changes
- Simplification: The Consultation proposes to simplify the rules for what qualifies as regulatory capital, reducing the volume of legal text by approximately 70%.
- Alignment: The new rules will be better aligned with the business models of investment firms, as opposed to banks.
- Consolidation: Requirements will be consolidated into MIFIDPRU 3, removing cross-references to the UKCRR.
Specific changes
- CET1 Capital: In addition to the point noted above on the pari passu treatment on non-CET1 items, clear criteria for CET1 items, including shares and other financial instruments, share premium accounts, retained earnings, and other reserves
- Additional Tier 1 (AT1) Capital: Conditions for AT1 instruments, including loss absorption mechanisms and perpetual nature
- Tier 2 (T2) Capital: Requirements for T2 instruments, including subordination, maturity, and amortisation rules
Deductions and filters
- Deductions: Specific deductions from CET1, AT1, and T2 items, including holdings of own instruments and those of financial sector entities
- Prudential Filters: Adjustments for cash flow hedges, changes in own credit standing, and additional valuation adjustments for the trading book
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