1. An RTS to accompany the implementation of the SREP for investment firms
Investment firms authorized under MiFID vary considerably in terms of size, business model, risk profile, complexity and interconnectedness, ranging from one-man firms to large internationally active groups. This requires a proportionate regulatory and supervisory framework.
The new regime for investment firms distinguishes between:
- Class 1 investment firms deemed similar in terms of business models and risk profiles to banks. These will remain subject to the prudential and supervisory requirements of the CRR and CRD.
- Firms that have become subject to the new FFI and DFI requirements, based on their systemic importance and other criteria, including size and types of MiFiD activities:
- Class 2 investment firms (intermediate and interconnected size).
- Class 3 investment firms comprising only small non-interconnected investment firms.
2. Objectives of the rts and framework of application
Prior to the entry into force of the IFR and IFD on 26 December 2019, P2R requirements for investment firms were determined from the CRR and CRDIV, although some investment firms were exempted.
EBA has developed a RTS on the determination of P2R for Category 2 or 3 investment firms under the SREP. These draft RTS clarify how competent authorities will measure risks faced by investment firms and others risk that are not fully covered by Pillar 1 capital requirements.
This RTS aims to ensure a consistent and proportionate application of supervisory practices across the EU based on the principle of proportionality, while maintaining the risk sensitivity of the calculation of Pillar 2 capital requirements.
As the application of P2R is the result of a comprehensive SREP process, this RTS should be read in conjunction with the EBA SREP guideline on investment firms. The approach specified in this RTS builds on the structure of capital requirements set out in the IFR which differentiates between Class 2 and Class 3 investment firms and reflects the different objectives of capital requirements.
3. The supervisory roadmap under the srep for investment firms
Competent authorities should:
- Establish additional capital requirements for Class 2 and Class 3 investment firms to cover the risk of a disorderly wind-up, which could pose a threat to their clients, counterparties and the wider markets in which they operate if they fail.
- Determine additional capital requirements (P2R) for Class 2 investment firms.
- Determine the likelihood of failure of the investment firm, by analyzing the significant risks associated with the investment firm’s activities, including risks to clients, markets and the investment firms themselves.
- Take into account in the P2R any other risks faced by investment firms that are not covered by Pillar 1 capital requirements.
4. P2R determination methodology for investment compagnies
4.1. General principle of the methodology
The RTS proposes a number of indicative qualitative measures to facilitate the identification, assessment and quantification of significant risks including risks that are not covered or not sufficiently covered by the Pillar 1 capital requirements. The proposed measures reflect the size, complexity of activities and business models of the various investment firms across the EU.
The RTS also focuses on situations where the investment firm is exposed to risks, or has risks to others, that are material and are not sufficiently covered by minimum Pillar 1 capital requirements. Other aspects of setting the additional P2R capital requirement are set out in more detail in the SREP guideline for investment firms.
The proposed RTS details the methodology for competent authorities to assess, determine and, if necessary, update the P2R that investment firms should hold to cover the relevant risks:
- On the one hand, P2R should reduce the likelihood of failure of investment firms by covering the risks associated with their ongoing activities, including in particular their client risks, firm risks and market risks.
- On the other hand, competent authorities should also assess the risk of a disorderly winding up of the activities of investment firms, which could pose a threat to their clients, their counterparties and the wider markets in which they operate, should they fail.
This dual objective of P2R justifies a dichotomous approach separating the assessment of the risks associated with the activities of the investment firm and the risk of a disorderly winding up. It is also consistent with the structure of the Pillar 1 minimum capital requirements.
In addition, investment firms may be exposed to other risks that cannot reasonably be attributed to Pillar 1 capital requirements. These include risks such as ICT risk and other operational risks that are not covered by the minimum Pillar 1 capital requirements. Where these risks are significant in nature, competent authorities will need to assess their impact separately and take them into account in the P2R framework, regardless of the type of binding requirement for a given investment firm.
The RTS specifies a number of indicative measures to assist competent authorities in identifying, assessing and quantifying material risks and risk elements not covered or insufficiently covered by Pillar I capital. The proposed parameters reflect the size, complexity of activities and business model of different investment firms in the EU.
The frequency of the supervisory review and assessment processes varies according to the size and risk profiles of the investment firm. In order to ensure the adequacy of P2R over time, the RTS specifies the situations in which these requirements should be reviewed and updated.
4.2. The different stages of P2R calculation
The P2R calculation generally follows the following steps:
- An investment firm determines the minimum Pillar 1 capital requirements as the higher of PCMR, FOR and KFR:
- PCMR being the known minimum permanent capital requirements (PCMR).
- FOR being the fixed overhead requirements (FOR).
- KFR being the capital requirements related to K-factors for class 2 firms.
The competent authority shall then calculate the total capital deemed adequate to cover all the risks of the investment firm as the higher of:
- Adequate capital to cover the risk of disorderly winding up of the investment firm’s business.
- Adequate capital to cover client, firm and market risks arising from its activities
The competent authority shall determine the level of additional Pillar 2 capital in respect of the risks covered by the capital requirements as the difference between total capital and Pillar 1 capital. The result of this deduction shall be set at the level of the minimum capital requirements.
- The competent authority shall also calculate the own funds deemed adequate to cover any other risks which are not covered by any capital requirements. Since such own funds cannot be considered as covered by capital requirements, they shall be considered, if not zero, as the minimum Pillar 2 add-on.
- The competent authority determines the P2R by adding the minimum Pillar 2 add-on to the level of additional Pillar 2 capital relating to the risks covered by the capital requirements. This P2R can be further adjusted by taking additional analyses described in the SREP guideline for investment firms.
Consultation paper on RTS on pillar 2 add-ons for investment firms: EBA/CP/2021/34.
Abreviations and Glossary
EBA: European Banking Authority
SREP: Supervisory Review Evaluation Process
RTS: Regulatory Technical Standards
CRR2: Capital Requirement Regulation 2
IFR- Regulation (EU) 2019/2033
IFD – Directive (EU) 2019/2034
CRR – Regulation (EU) No 575/2013
CRD – Directive 2013/36/EU