Reed Smith Client Alerts

The new EU prudential regime for investment firms will increase the capital requirements of those MiFID investment firms that are currently restricted to providing investment advisory services and/or reception and transmission of orders and do not hold client money or securities (so called ‘Exempt CAD firms’).

Exempt CAD firms currently benefit from a capital requirement of just EUR 50,000 and enjoy a limited application of other prudential requirements regardless of the size of their business. This treatment is not carried forward in the new regime – comprising the Investment Firms Regulation and Directive (IFR/IFD) – which is scheduled to apply from 26 June 2021. Unless an exemption applies, such firms will become subject to a fixed overheads requirement and, in some cases, may be subject to the complexities of the variable capital requirement involving the so-called K-factors.

Auteurs: David Calligan Bhav Panchal

Overview of the new prudential regime

Given that Exempt CAD firms do not deal on own account, underwrite or otherwise take on principal risk, they will not be categorised as class 1 firms (so they will not be treated as if they are banks and will not be subject to the capital requirements in the current CRR/CRD regime). They will be class 2 firms (and so subject to the full application of the new regime unless they can meet all of the tests to qualify as a class 3 small and non-interconnected firm). Please see our previous alert for an overview of the classification of firms under the IFR/IFD. 

Exempt CAD firms will become subject to a higher permanent minimum capital requirement (i.e. initial capital requirement) of EUR 75,000. However, this is just one element of the new own funds requirement which will require those larger Exempt CAD firms that become class 2 firms to maintain capital above the highest of three figures: (a) EUR 75,000; (b) the fixed overheads requirement; and (c) the new K-factor requirement. A class 3 firm is exempt from the K-factor requirement but will be required to meet the higher of EUR 75,000 and the fixed overheads requirement.

The fixed overheads requirement

All Exempt CAD firms will have to calculate a fixed overheads requirement for the first time. This requirement is calculated by taking one quarter of the fixed overheads of the firm from the previous accounting year. The full details of how to calculate this figure will be the subject of regulatory technical standards in due course, but it is unlikely to change much from the current approach in the CRR regime as there will be deductions for elements of variable expenditure such as discretionary bonuses and other discretionary appropriations of profit. The application of this requirement will require those Exempt CAD firms with substantial fixed expenses to hold significantly more capital (although there is time to build this up - see ‘Transitional relief’ below).

How do we qualify as a class 3 firm?

Class 3 firms are seen as lower risk and so are subject to a reduced capital and reporting burden under the new regime relative to class 2 firms. The conditions in the following table must all be met in order to qualify as a class 3 firm.

Conditions for qualifying as a class 3 firm