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Prudential rules for investment firm
The EU has established a prudential framework specifically tailored for investment firms, known as the IFR-IFD framework, which aims to ensure that these firms maintain sufficient resources to mitigate potential losses and reduce the risk of failure. This framework is integral in safeguarding the interests of customers and maintaining stability in financial markets.
The IFR-IFD Framework Overview
Key Elements of the IFR-IFD Framework
Classification of Investment Firms
Role of European Supervisory Authorities (ESAs)
This framework represents a significant step in the EU's approach to regulating investment firms, emphasizing proportionality and risk sensitivity to ensure the stability and integrity of financial markets.
The IFR-IFD Framework Overview
- Prior to 26 June 2021: Investment firms were subject to the broader prudential rules applicable to banks under the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD).
- Post 26 June 2021: A new, bespoke prudential framework for investment firms was implemented, comprising the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD).
Key Elements of the IFR-IFD Framework
- Tailored Requirements: The framework is designed to reflect the nature, size, and complexity of investment firms, distinguishing them from banks.
- Simplified Capital Requirements: It introduces simpler capital requirements, which include:
- Fixed Overheads Requirement (FOR): A quarter of the firm's annual fixed overheads.
- Permanent Minimum Capital Requirement (PMR): Ranges from EUR 75,000 to EUR 750,000, depending on the firm's activities.
- K-factor Capital Requirement: A sum of requirements across three categories - Risk-to-Client (RtC), Risk-to-Market (RtM), Risk-to-Firm (RtF).
Classification of Investment Firms
- Class 3 Firms: Smaller and non-interconnected firms, subject to lighter requirements.
- Class 2 Firms: Firms that do not fit into other categories, with capital requirements based on the higher of FOR, PMR, and K-factor requirements.
- Class 1 and Class 1 Minus Firms: Larger firms engaged in significant activities like dealing on account, which remain subject to CRR/CRD rules. Class 1 firms must be authorized as credit institutions, while Class 1 minus firms continue as authorized investment firms.
Role of European Supervisory Authorities (ESAs)
- The European Banking Authority (EBA), in consultation with the European Securities and Markets Authority (ESMA), has been working to deliver regulatory products to complete the new rules, as mandated under the IFR-IFD.
This framework represents a significant step in the EU's approach to regulating investment firms, emphasizing proportionality and risk sensitivity to ensure the stability and integrity of financial markets.
