Investment firms authorized under the Markets in Financial Instruments Directive (“MiFID”) provide a range of services and activities to investors in financial markets. The population of investment firms in the EU is diverse and firms vary widely in terms of size, business model, activities undertaken, risk profile, complexity and interconnectedness.
In 2019, the European Commission developed a new prudential framework, consisting of Directive (EU) 2019/2034 (“IFD”) and Regulation (EU) 2019/2033 (“IFR”), collectively referred to as (“IFR/IFD Framework”) to better reflect the diversity of business models, operations and risks to which these EU investment firms are exposed. The new IFR/IFD framework has been created to create a more appropriate framework for investment firms The main objectives are to ensure the safe operation of investment firms, to enhance their soundness and stability and to better manage their risks vis-à-vis clients, the market and the firms themselves The framework also ensures to do so while keeping systemic investment firms (the largest type) under the prudential requirements and oversight of the Capital Requirements Regulation and the Capital Requirements Directive (“ CRR/CRD framework”).
Scope and applicability
The IFR/IFD framework applies to investment firms authorized and supervised under Directive 2014/65/EU (“MiFID II”) and to managers of alternative de minimis investment funds (“AIFM”) providing MiFID services. The IFR/IFD Guidelines do not apply to Credit Institutions, even when they offer ancillary services to MiFID, full-scope UCITS Management Companies and AIFMs.
Applicability can get tricky in some cases; if you have certain companies offering a variety of services which may be affected by an overlap of different regulatory regimes. The local competent authority, the Malta Financial Services Authority (“MFSA”), in its quest to better guide the industry in this regard, has issued a series of communications to inform investment services licensees of the changes relating to this prudential regulation for investment. Companies.
Impact and changes of the IFR/IFD framework
The new prudential regime has introduced a series of new and/or enhanced information and reporting requirements for scoped investment firms. The objective of these new requirements is to ensure that these businesses are run in an orderly manner and in the best interests of their clients and to guarantee the safety and soundness of investment businesses while avoiding the imposition of a disproportionate administrative burden and therefore introducing proportionate measures and risk-sensitive rules for investment firms. This effectively meant that most investment firms in the EU would no longer be subject to the rules originally designed for credit institutions, with the exception of the largest and most systemic investment firms, which however remain subject the same prudential regime as European credit institutions. Institutions (i.e. the CRR/CRD framework).
The main changes brought by the new IFR/IFD framework include the process of prudential control of investment firms, prudential reports, information obligations, variable remuneration policies, governance, mandates linked to economic, social and and governance (ESG) and prudential convergence. However, two major changes concerned the classification of companies and the calculations of capital requirements and composition.
The new framework has established a system for reclassifying investment firms according to their activity and therefore the risks to which they are exposed. Investment firms are now classified into three classes and one subclass, namely;
- Class 1 including the sub-classification of Class 1 Minus;
- Class 2 and;
- Class 3.
The largest systemic investment firms (class 1 firms) will continue to apply the current CRR/CRD framework, while the new prudential regime will apply to investment firms that are not considered systemic due to their size and/or their interconnection within the broader financial system. , i.e. mainly class 2 firms. Smaller non-interconnected investment firms (class 3 firms) may benefit from exemptions from the regulatory requirements of their competent authorities, on an assessment and on a case-by-case basis . The companies had to establish their new classification and communicate it to the regulator by the fourth quarter of 2021.
Another major change concerns the calculations of corporate capital requirements and composition, which are likely to be deemed more creditable under the new framework. The new capital requirements now introduce quantitative indicators (the “K-factors”) to accurately reflect the risks faced by investment firms. There are three groups of K-factors: risk to customers, risk to market access, and risk to the business itself. Class 2 firms will be required to calculate their capital requirement using K-factors, while Class 3 investment firms will need to monitor related metrics to ensure they have not reached their threshold of categorization. In the case of a final scenario, a reclassification exercise should be undertaken.
The prudential reporting framework has been remodeled under the new IFR/IFD framework. The format in which investment firms will have to report the applicable annexes has also been replaced by the global format used for the exchange of business information, better known as “XBRL”, which will eventually give way to the European Banking Authority.
These new reporting requirements became applicable from the third quarter of 2021 for all firms whose accounting year ends on 31 December 2021. For investment firms whose accounting year-end is different, the new reporting framework becomes applicable once the reporting period covers at least three months. within the framework of the applicability of the IFR/IFD framework.
The local regulator has informed the industry that from the third quarter of 2021, all investment firms providing MiFID services to retail, professional and/or eligible counterparties are required to submit a new report entitled “MiFID Firms Quarterly Reporting ” (the “MFQR”). The MFQR is composed of three main sections namely:
- Part A on driving data
- Part B relating to prudential data
- Part C relating to exposure to Maltese banks
This meant that conduct data, previously included in the conduct data report (for former category 1 investment services licensees and credit institutions authorized under the investment services) and in the COREP report (for former category 2 and category 3 investment services license holders), will have to be submitted in this new separate report. The MFQR also includes a number of supervisory tabs to cover financial information that was captured in the previous COREP reporting but not captured in the European Banking Authority’s XBRL reporting.
Going forward, the MFQR must be submitted within 42 days of the end of the applicable reporting period along with the prudential tabs in the companies’ annual MiFID quarterly report (Q4) to be audited by the company’s external auditor and submitted to the regulator (including the auditor’s report) no later than four months after the accounting reference date.
The flowchart below is intended to facilitate the reporting requirements applicable under the new IFR/IFD framework:
Impact and future
The regulator has made significant changes to ensure proper transposition and implementation of the IFR/IFD framework, as well as various other regulations and directives. This also takes into account that the new IFR/IFD framework has changed the “old” categories for investment services licensees and introduced “new” classes for them.
The regulator has taken particular care to create titles with the names of the relevant chapters of the regulation and has inserted a rule that refers the licensee to the relevant chapter of the regulation. Additionally, the updated Rulebook has been divided into three main parts:
- Part 1 General: All classes;This part applies to all categories of investment firms, containing internal provisions and partially transposing MiFID II and the FDI.
- Part 2: Class 1 and Class 1 minus; This part automatically applies to the largest investment firms, class 1, which are subject to the CRR and the CRD. Class 1 minus companies may also be subject to this area of the regulation, where they meet certain criteria of the IFRD package and the MFSA deems it necessary. This part implements the CRR and partially transposes the CRD.
- Part 3: Class 1 Less, Class 2 and 3; This part implements the IFR and partially transposes the IFD, which governs and regulates class 2 and 3 companies. This part applies to all class 1 companies less on a case-by-case basis, as the AMSF deems appropriate, given that the EU framework allows the AMSF to determine which framework Class 1 minus undertakings should fall under.
As you would expect, investment firms are still digesting these many changes, often leading to long hours of debate over the applicability and overlap of all the different frameworks and regulations. Nevertheless, this should be done keeping in mind the specific business model of the investment firm.
Navigating the complex regulatory environment to ensure that all regulatory (and ultimately fiduciary) responsibilities are met, including submitting the various regulatory reports on time, can indeed seem daunting. This is, however, necessary to avoid unnecessary and unwarranted violations and associated hassles.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.