On 16 April, the European Parliament adopted in Plenary a Regulation on the prudential requirements for investment firms (IFR) and a Directive on the prudential supervision of investment firms (IFD).

There are about 6,000 investment firms in the EEA, which are all currently subject to the CRD 4/CRR regime. IFR/IFD introduces prudential requirements for investment firms, tailored to their activities and asset size. While many investment firms will see a tailored regime as a positive step, the implications of the new regime will differ from firm to firm. Each firm will need to assess what the regime change means for it and take action accordingly. However, some key implications will not be known fully until the supporting delegated acts (DAs), implementing acts (IAs) and technical standards are developed.   

IFR/IFD also revises the MiFID II/MiFIR third-country regime for investment services. The revised regime is not as restrictive in terms of market access as it could have been, based on some of the proposals that were put forward during negotiations. However, in the event that third countries are deemed equivalent in future, firms are likely to face additional requirements. The revisions also pave the way for the possibility of partial equivalence, with national regimes continuing to apply for those services/activities where the European Commission has not granted equivalence.

This briefing provides an overview of the key changes contained in the IFR/IFD texts. See our previous blog for an overview of the original Commission proposals. While the changes we highlight would apply to all EU investment firms, we make specific reference to the IFPRU and BIPRU regimes for UK firms in some places. To note, the texts have not yet been published in the Official Journal (OJ) and so, while we do not anticipate any changes at this stage, this is still theoretically possible.

What categories will there be under the new regime?

The prudential regime that will apply to investment firms under IFR/IFD will depend upon their category, as shown in the table below. The “class 1 minus” category was not in the original Commission proposal, but was introduced in response to concern that an insufficient number of firms would be caught by the “class 1” category.


Which investment firms will fall into this category?

Which prudential regime will apply?

“Class 1”

“Systemic firms” that deal on own account and/or underwrite or place financial instruments on a firm commitment basis and meet specified thresholds in terms of asset size. While the text sets out how the calculations will apply to the undertaking itself and, where relevant, other undertakings in the group or the EU branches of third-country firms, in general, the asset threshold is set at EUR 30bn.


“Class 1 minus”

“Systemic firms” that deal on own account and/or underwrite or place financial instruments on a firm commitment basis, but, in general, have a smaller asset size than “class 1” (broadly speaking, this is set at EUR 15bn, although again the text sets out how calculations apply in a group context).

Competent authorities may also permit investment firms that fall below the thresholds, in certain situations, to “opt-in” to the “class 1 minus” category. Competent authorities will also have the discretion to categorise investment firms which do not otherwise meet the criteria as “class 1 minus”, subject to them meeting certain conditions, such as the total value of their consolidated assets exceeding EUR 5bn.


“Class 2”

The default for all investment firms unless they meet the specified criteria to be either “class 1”, “class 1 minus” or “class 3”.


“Class 3”

“Small and non-interconnected firms” which do not undertake any higher risk activities (e.g. dealing on own account, trading financial instruments, or holding client money/assets) and fall below a range of size related criteria/thresholds. For example, assets under management (AUM), calculated as specified in IFR, should be less than EUR 1.2bn. For some thresholds, the assessment will be based on the combined value across all investment firms that are part of the same group, in order to prevent regulatory arbitrage. 


*To note, the “class” terms are not official IFR/IFD terminology, but used for ease in this briefing to distinguish between the different categories. The table does not provide an exhaustive description of the category definitions. Firms will need to read the text closely to determine which category applies to them.

What changes lie ahead for “class 1” and “class 1 minus” firms?

The most significant changes for “class 1” firms are likely to be in relation to authorisation and supervision. “Class 1” firms will be re-categorised as credit institutions under CRD 4/CRR and will need to re-authorise as such. Therefore, they would become subject to the Single Supervisory Mechanism (SSM) if located in the Eurozone and could lose current exemptions that apply to certain investment firms (e.g. in relation to liquidity and the leverage ratio).

The changes for “class 1 minus” firms are not likely to be significant as they will remain authorised as investment firms and continue to be subject to prudential regulation under CRR and be supervised for compliance with prudential requirements under Titles VII and VIII of CRD 4. However, they will need to look closely at how investment firm exemptions have been carried forward into the revised text in CRD 5/CRR 2.

What changes lie ahead for “class 2” and “class 3” firms?

Own funds requirements

“Class 2” firms will be required to conduct a new “k-factor” risk assessment to determine their capital requirements, based on the extent to which they participate in certain risk-related activities. They will be required to hold own funds based on the higher of their permanent minimum requirement (PMR), fixed overhead requirement (FOR), or k-factor calculation. “Class 3” firms will be required to hold own funds based on the higher of their PMR or FOR, but will not have to consider the k-factor approach.

“Class 2 and 3” firms should note that the FOR calculation and, in particular, allowable deductions, are expected to be aligned to the current CRD 4/IFPRU approach (i.e. rather than BIPRU). This may result in higher FOR amounts for firms that are currently under BIPRU. The European Banking Authority (EBA) should provide further detail via a regulatory technical standard (RTS) within 12 months from the entry into force of IFR.

In addition to these own funds requirements, “class 2 and 3” firms may also have to consider potential Pillar 2 implications (noted below) in order to determine the overall level of capital that they should hold. 

Internal Capital Adequacy and Risk Assessment Process (ICARP)

In line with existing BIPRU and IFPRU requirements, “class 2” firms will need to ensure that they have effective internal arrangements to assess and maintain adequate capital and liquid assets relative to their business model and risk profile (i.e. similar to the existing Internal Capital Adequacy Assessment Process (ICAAP) and the liquidity risk management assessment requirements under BIPRU 12). As with existing ICAAPs, these arrangements should also be subject to regular internal review. 

While the obligation to maintain adequate capital and liquidity assessment arrangements that applies to “class 2” firms will not automatically apply to “class 3” firms, competent authorities will have the discretion to apply them to individual “class 3” firms where deemed appropriate.

Supervisory Review and Evaluation Process (SREP)

Similar to their existing arrangements for BIPRU and IFPRU firms, if deemed appropriate, competent authorities may subject “class 2 and 3” firms to a SREP, to assess the management and coverage of their key risks, business model, and governance arrangements; and the use of internal models.  As recommended in the initial EBA proposals, where firms fail to meet the IFR/IFD requirements, competent authorities will have the power to apply a range of measures including additional capital and liquidity requirements; business activity, (variable) remuneration and dividend/interest payment restrictions; and other risk reducing/mitigation actions.

Liquidity requirement

The new regime will introduce a requirement for “class 2 and 3” firms to maintain liquid assets equivalent to at least a third of their FOR. However, “class 3” firms may be able to utilise a broader range of qualifying assets to meet their minimum liquidity requirement. 

Firms should note that this is a minimum liquidity requirement. It is likely that many BIPRU and IFPRU firms may already be aware of a need to maintain higher levels based on their existing assessment of their own business model, risk appetite etc. (e.g. as currently assessed under the BIPRU 12 liquidity risk management requirements). Firms’ ICARP assessment (as noted above) could also suggest that a higher level of liquidity should be maintained.

Prudential consolidation

The EBA’s 2017 proposals envisaged that IFR/IFD should essentially be applied on a solo basis, which would have made for a simpler regime than under CRD 4/CRR. However, like in CRD 4/CRR, IFR requires relevant “class 2 or 3” firms to comply with the IFR own funds, capital requirements, concentration risk, disclosure and reporting requirements on a consolidated basis. As an exception to this, competent authorities may allow groups to waive these consolidated supervision requirements provided they satisfy a group capital test, and their structures and activities are deemed to be simple and not significantly risky. The EBA will endeavour to provide further details on prudential consolidation via an RTS within 12 months from the entry into force of IFR. 


In line with existing BIPRU and IFPRU requirements, “class 2” firms will be required (on a solo and consolidated basis), to have robust internal governance; transparent and consistent lines of responsibility; effective strategy, risk appetite, control, remuneration and risk management arrangements; and meet regulatory reporting requirements.


Similar to the existing Pillar 3 disclosure requirements, “class 2” firms will need to make public disclosures on a range of items including their risk management arrangements, governance, remuneration, own funds, capital requirements and capital adequacy assessment approach.

“Class 3” firms that have not issued any Additional Tier 1 capital instruments will not be subject to the public disclosure requirements to which “class 2” firms will be subject. 


We anticipate that the IFD remuneration rules will have the most significant impact on “class 2” firms, which will be subject to CRD 4-type pay rules for staff identified as material risk-takers (MRTs). “Class 3” firms will be subject to the more principles-based and less onerous MiFID/MiFID II remuneration rules.

Although “class 2” firms will be relieved that the bonus cap will not apply, they will be required to set appropriate ratios between the variable and the fixed component of the total remuneration of their MRTs. Additional remuneration requirements for MRTs include provisions around the minimum deferral of variable remuneration, the requirement to pay at least 50% of variable remuneration in instruments (e.g. shares and non-cash instruments), and the application of malus or clawback to allow firms to reduce up to 100% of variable remuneration.

The deferral and payment in instruments requirements may be switched off for investment firms where the average value of on- and off-balance sheet assets over the preceding four years is equal to or less than EUR 100 million (Member States may increase this to EUR 300 million subject to certain conditions), and for individuals whose annual variable remuneration does not exceed EUR 50,000 and does not represent more than 25% of the individual's total annual remuneration.

Overall, in the UK, we expect the implications to be felt mostly by those “class 2” firms which are currently able to disapply the more onerous CRD structural remuneration requirements under the principle of proportionality. Given that the proposed firm-wide and individual thresholds set out in IFD (discussed in the paragraph above) are significantly lower than the current FCA thresholds, some firms could become subject to the key rules on deferral and payment in instruments in the future. However, the full impact on UK firms will not become fully clear until the FCA has determined its approach.

Third-country changes

IFR/IFD amend the MiFID II/MiFIR third-country regime for investment services/activities. Equivalence assessments have been strengthened. For example, the Commission will be required to undertake granular assessments where third-country firms are likely to be of systemic importance to the EU and the Commission may attach specific operational conditions to equivalence decisions with which firms would be required to comply.

In addition, the Commission will be able to limit equivalence decisions to specific services or activities, although national regimes can continue to apply for services or activities not covered by a Commission equivalence decision. In some respects, it is possible that this increases the chances that the Commission will grant some third countries some form of equivalence: firms may prefer partial equivalence, if the choice is none at all. ESMA and the Commission will have annual reporting obligations on equivalence decisions and there will be wider scope, under certain conditions, to prohibit or restrict the activities of registered third-country firms temporarily, or permanently withdraw registration.

Registered third-country firms and branches will also have to report annually to ESMA on the scale and scope of their EU services/activities and registered third-country firms will be subject to record-keeping requirements.

As no third country has yet been deemed equivalent in relation to investment services/activities under MiFIR, access to the EU by third-country firms is currently in line with national regimes. Therefore, the revisions to this regime in IFR/IFD are largely academic at this stage. However, this will change if, and when, third countries start to be deemed equivalent in future. A key question for third-country firms will be how access under the regime would differ from current access under national regimes.

What’s next?

We expect OJ publication in around Q3 2019. IFR/IFD will apply 18 months after entry into force. In its 2019/20 Business Plan, the FCA confirmed that it will consult on introducing a new prudential regime for investment firms, aligned to IFR/IFD, in Q4 2019, once the EU IFR/IFD is finalised.

Firms, particularly those in “class 2 and 3”, will need to await the development of a large programme of DAs, IAs and technical standards to gain further clarity on how the new prudential regime will affect them and how they should prepare.

Firms that meet the “class 1” thresholds when IFD enters into force can continue operating under their investment firm authorisation until their credit institution authorisation is granted; they will have one year and one day following IFD entry into force to apply for credit institution authorisation.  

“Class 2 and 3” firms may be able to make use of a five-year transitional period from the application date of IFR in relation to capital requirements. For example, investment firms would be able to cap the increase in their capital requirements at twice that under their pre-IFR arrangements for five years.

Regarding the third-country regime, it is not yet clear how long before the Commission starts equivalence assessments (the Commission would first need to adopt a DA in relation to the determination of “systemic” that would trigger granular equivalence assessments), how long the process could take, and which third countries will be prioritised in assessments.

Firms should now review the IFR/IFD requirements and do an initial assessment of which category they will fall into and what the rule changes will mean for them. In addition, firms should also bear in mind how planned strategy and business model changes could affect their “class” category, for example, where firms are building their investment services/activities in the EU.