EU agrees new prudential requirements for investment firms

Out-Law News | 13 Nov 2019 | 10:30 am | 2 min. read

New prudential requirements and supervisory arrangements for EU investment firms are expected to be introduced next year following approval by the European Council.

Currently, EU investment firms are subject to the same capital, liquidity and risk management rules as banks. The new investment firms' regulation (103-page / 1.2MB PDF) and directive (158-page / 1.7MB PDF) will, once in force, introduce a bespoke regulatory framework for investment firms, differentiated according to the individual firm's risk profile and business model while preserving financial stability.

The new regulation and directive will be signed by the European Council in the week of 25 November, and will then be published in the Official Journal of the EU. They will come into force six months after publication.

Budd Elizabeth

Elizabeth Budd


The new risk factors align more closely to the activities of investment firms and the calculation is intended to be more straightforward and proportionate to the size of firm.

Financial regulation expert Elizabeth Budd of Pinsent Masons, the law firm behind Out-Law, said that although the UK is due to have exited the EU by the time the new requirements are anticipated to come into force in June 2021, the contents of the new regulation and directive would be relevant to UK investment firms.

"The impetus for this new directive came from the UK, and UK regulators have committed to issuing draft prudential rules for UK firms in the second half of 2019," she said.

"However, it is concerning that under the new EU rules there is a more strict regime around equivalence, which would require annual reporting to the European Securities and Markets Authority (ESMA) of activities carried on in the EU by third country firms – which would include UK firms in a no deal Brexit scenario," she said.

There are currently around 6,000 investment firms in the European Economic Area, according to the European Council. Many of these are small, although a limited number of firms hold a significant proportion of all assets and provide a very broad range of services.

Once the new regime is in force, different requirements will apply to firms based on their size, nature and complexity. The largest, 'class 1', firms, which carry out bank-like activities and pose similar risks to banks, would remain subject to the banking capital requirements regulation and directive (CRR/CRD IV). Smaller 'class 2' and 'class 3' firms which are not considered systemic would be subject to a new regime with dedicated prudential requirements, although national regulators may choose to continue to apply banking requirements on a case by case basis.

Capital requirements for class 2 and class 3 firms under the new regime would be calculated based on a number of risk factors, called 'k-factors'. These include an assessment of assets under management, client money, daily trading flow and net position risk.

"These concepts align more closely to the activities of investment firms and the calculation is intended to be more straightforward and proportionate to the size of firm," said Elizabeth Budd.

"Very large investment firms will, however, remain within the banking regime under CRD IV, on the basis that they present a similar systemic risk to banks," she said.