Reed Smith Client Alerts

The new EU prudential regime for investment firms – comprising the Investment Firms Regulation and Directive (IFR/IFD) – will sweep away the favourable prudential treatment currently experienced by many investment firms that offer matched principal trading (so called ‘125K limited licence firms’).

125K limited licence firms that have permission to deal as principal and hold client money currently benefit from a minimum capital requirement of EUR 125,000 (instead of EUR 730,000) and enjoy a limited application of other prudential requirements because they are restricted to conducting “matched principal” trading, where they hedge client trades on a back-to-back basis and are seldom exposed to market risk. These benefits are not carried forward in the new regime (which is scheduled to apply from 26 June 2021) and so the dividing line between limited licence and full scope will cease to exist.

Authors: David Calligan Tim Dolan Karen Butler Bhav Panchal

Euro banknotes on the map of Europe

Overview of the new prudential regime

Those 125K limited licence firms that deal on own account (as defined in MiFID II) and hold client money will be categorised as ‘class 2 firms’ (unless they have very large group balance sheets), meaning that they will be subject to the full application of the new regime. See our previous alert for an overview of the classification of firms under the IFR and IFD on reedsmith.com.

These firms will become subject to a much higher minimum capital requirement of EUR 750,000 in common with other firms that deal on own account. Any firm that is currently a 125K limited licence firm but does not have any form of principal dealing permission will likely become subject to a new minimum capital requirement of EUR 150,000. This minimum requirement is just one element of the new own funds requirement which will require firms that deal on own account to maintain capital above the highest of three figures: (a) EUR 750,000; (b) the fixed overheads requirement; and (c) the new K-factor requirement.

The K-factor requirement is the biggest change in the new regime. It applies percentages (‘coefficients’) to the value of specific risks encountered by firms. The new regime is intended to be a major improvement as it is calibrated to the risks of investment firms rather than banks. The risk categories and their corresponding components are set out in the following table.

200506 Client Alert 2020-298 Table 1