knowledge | 18 January 2018 |

European Commission Proposes New Prudential Regime for Investment Firms

Non-systemically important investment firms could be subject to a new prudential regime following the European Commission’s publication of two new legislative proposals before Christmas. In essence, these proposals aim at differentiating the prudential requirements applicable to investment firms, depending on their size, nature and complexity. They also amend existing corporate governance and remuneration requirements, including the controversial CRD IV bonus cap and the MiFIR third-country equivalence requirements.


The EU regulatory framework for investment firms consists of two main parts. First, MiFID II/MiFIR sets out requirements relating to authorisation and conduct of business, as well as other requirements governing the orderly functioning of financial markets.  Second, investment firms fall within the prudential framework set out in CRR/CRD IV, which applies to certain investment firms as well as to credit institutions.

The CRR/CRD IV framework is primarily focussed on the risks faced and posed by credit institutions and is largely calibrated to address the lending and deposit-taking functions of credit institutions through economic cycles. Consequently, according to the European Commission, it does not effectively capture the actual risks posed by many EU investment firms.

Specifically, in contrast to credit institutions, investment firms do not take deposits or make loans, meaning that they are far less exposed to credit or liquidity risk. Instead the risks faced by investment firms largely relate to the relevant firm’s clients and the markets in which it operates.  Moreover, as compared to credit institutions, investment firms tend to be significantly less connected with the broader financial system.

The Commission’s proposals seek to introduce prudential requirements for investment firms and corresponding supervisory arrangements that are adapted to their risk profile and business model, without compromising financial stability.  The proposals take into account advice given by the EBA and ESMA in December 2015 and by the EBA in November 2017, in response to calls for advice sent by the Commission.  See our related briefing here.

Overview of the Proposals

The proposed prudential framework for investment firms comprises a proposed Regulation and a proposed Directive.  The proposed Regulation lays down uniform prudential requirements relating to: capital requirements; concentration risks; liquidity requirements; reporting and public disclosure. It also amends MiFIR.

The proposed Directive sets out requirements for the appointment of prudential supervisory authorities, initial capital, the supervisory powers and tools for the prudential supervision of investment firms by the competent authorities and the publication requirements for competent authorities in the field of prudential regulation and supervision. It includes revised rules on corporate governance and remuneration.

Classes of Investment Firms

The proposals categorise investment firms into three separate classes on the basis of their risk profiles.

Class 1 comprises systemically important investment firms, including investment firms with total assets above EUR30bn and which provide the MiFID II services of underwriting and dealing on own account.

These firms will remain under the CRR/CRD IV framework and be treated in the same way as large credit institutions.  Significantly this means that their operations in Member States participating in the Banking Union will be subject to direct supervision by the European Central Bank in the Single Supervisory Mechanism. To achieve this, the proposal amends the definition of credit institution in the CRR.

Class 2 includes any investment firm that meets any of the following size thresholds:

  • assets under management higher than EUR 1.2bn under both discretionary portfolio management and non-discretionary (advisory) arrangements;
  • client orders handled of at least EUR 100m per day for cash trades and/or at least EUR 1bn per day for derivatives;
  • balance sheet total higher than EUR 100m;
  • total gross revenues higher than EUR 30m;
  • exposure to risks from trading financial instruments higher than zero; and
  • client assets or money held higher than zero.

Class 3 covers small and non-interconnected firms, which are firms that do not deal on own account or incur risk from trading financial instruments, have no client assets or money under their control and fall below the thresholds applicable to Class 2 firms, set out above.

Initial Capital

The proposed Directive revises and harmonises the levels of initial capital to be held by an investment firm on the basis of the services and activities that the firm is authorised to carry out under MiFID II.

A firm authorised to provide the investment services or to perform the investment activities of dealing on own account, underwriting or placing on a firm commitment basis, or operating a multilateral trading facility (MTF) or organised trading facility (OTF) will be subject to a minimum initial capital requirement of EUR 750,000.

An investment firm that is not authorised to provide the above investment services/activities and which does not hold client money or securities will need to have initial capital of EUR 75,000. All other investment firms must have a minimum initial capital of EUR 150,000.

Capital Requirements

A Class 1 firm’s capital requirement will be calculated in accordance with CRR/CRD IV.

A Class 2 firm’s capital requirement will be the highest of its fixed overheads requirement, its initial capital requirement or its k-factor requirement.

“K-factors” are the capital requirements set out in the proposed Regulation for risks that an investment firm poses to customers, markets and to itself.

  • Risks to customer (RtC) encompasses the following K-factors: assets under management, client money held, assets safeguarded and administered, and client orders handled;
  • Risks to market (RtM) encompasses a K-factor for net position risk based on the market risk requirements of the CRR, or alternatively, if permitted by the competent authority, one based on margins posted with clearing members for trades guaranteed by the latter; and
  • Risks to firm (RtF) encompasses K-factors for trading counterparty default, for concentration risk in excess of defined thresholds and for daily trading flows.

A Class 3 firm must have minimum capital which equals the highest of its fixed overheads requirement or its initial capital requirement.

Corporate Governance and Remuneration

The proposed Directive aims to ensure the consistency of remuneration and governance rules applicable under CRD IV as well as those applicable to UCITS and under the Alternative Investment Fund Managers Directive.

Significantly, the proposal does not set a specific limit on the ratio between variable and fixed components of available remuneration. Instead, a MiFID investment firm must set the appropriate ratio between the variable and fixed components in its remuneration policy, taking into account the relevant firm’s business activities and associated risks.

Class 1 firms will be subject to the remuneration requirements set out in CRD IV.

Third Country Firms

The proposed Regulation imposes a reporting obligation on third-country firms providing investment services or activities in the EU under MiFIR. Such firms will be required to report to ESMA annually about:

  • the scale and scope of the services and activities carried out by the firm in the EU;
  • the turnover and the aggregated value of the assets corresponding to the above services and activities;
  • whether investor protection arrangements have been taken, and a detailed description thereof; and
  • the risk management policy and arrangements applied by the firm to the carrying out of the above services and activities.

The proposed Regulation will also amend MiFIR to specify that the Commission, when adopting an equivalence decision, should take into account the systemic importance of the services and activities that the third-country firms will carry out in the EU. If such services and activities are likely to be of systemic importance, an equivalence assessment will need to be based on a detailed and granular assessment.


If the proposals are adopted in their current form, the vast majority of investment firms will be entirely carved out from the CRR/CRD IV framework.  According to the Commission, this will mean lower compliance costs leading to:

  • improved overall conditions for businesses;
  • increased market entry and competition; and
  • improved investor access to new opportunities and better ways of managing their risks.

As such, we expect that most investment firms will welcome the Commission’s proposals. The abolition of the bonus cap is likely to be of the source of particular relief as this has proved to be a significant headache for some firms whose business model depends on their ability to adjust remuneration upwards or downwards depending on profits. 

This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.

Key contacts