Simplifying the regulatory capital framework for investment firms

Start with where the rules live. To work out a firm’s Common Equity Tier 1 requirement today, you can’t go to one place. The answer is dispersed across MIFIDPRU 3, several articles of the onshored UK CRR, the annexes to those articles, and the deduction rules that sit alongside them. A compliance officer reconstructing the CET1 position is assembling it from two rulebooks, which is error-prone. The errors that produces are real, and the FCA looks closely at capital-calculation mistakes.

The cross-reference also drags in material that has nothing to do with investment firms. The UK CRR carries requirements aimed at globally systemically important banks. Those provisions mean nothing to a 30-person discretionary manager, yet they sit inside the framework that the manager’s compliance team has to read past to reach what does apply.

There’s a quieter problem the reform is partly aimed at. The MIFIDPRU framework points to a frozen, point-in-time version of the UK CRR. As the PRA keeps updating the banking rules for banks, the version investment firms are pinned to drifts further from the live text. The reference goes progressively out of date, and new entrants meet a framework that is both complex and dated. Pulling the definitions into MIFIDPRU directly closes that gap, because the FCA can then keep the investment firm rules current as investment firm rules.

Instead of telling firms to apply UK CRR articles by reference, the FCA proposes to write the relevant own funds requirements directly into MIFIDPRU 3. The projected cut in legal text is roughly 70 percent. It cuts the volume of material a firm reads to find the obligation, not the obligation itself.

The benefits follow from consolidation. One framework rather than two stitched together. Lower ongoing compliance cost, because the rules are findable. Lower barriers for new firms, which matters for a market the FCA wants to keep competitive. Text that reads the way investment firms actually operate. And room for the FCA to adjust investment firm rules without waiting on, or getting tangled in, banking rule changes.

The things that set how much capital you hold don’t move. The amounts stay the same. The Basel-derived quality standards for what counts as capital stay in place. The split between Common Equity Tier 1, Additional Tier 1 and Tier 2 remains. The consolidated capital safeguards for groups continue. The required amount of capital is unchanged; only how easily you can show it improves.

The clearest illustration of why legibility matters is the test that applies when a firm wants to reduce its own funds, say through a buyback or a distribution out of capital.

As things stand, a firm has to show that, after the reduction, it will keep exceeding its applicable capital requirements by a margin that the FCA considers necessary. The trouble is that phrase, “that the FCA considers necessary.” From the firm’s side of the table it’s subjective. The firm is asked, in effect, to guess the margin the regulator has in mind and to plan a capital action around the guess, which makes the decision hard to defend to shareholders and the board.

The proposed approach swaps the guess for a standard the firm can apply itself. The firm has to show that it will keep exceeding its own funds threshold requirement by a margin sufficient to ensure adequate financial resilience for the foreseeable future. The reference point becomes the firm’s own funds threshold requirement, which the firm already calculates, and the test becomes one the firm can evidence through its own analysis rather than by inferring the regulator’s expectation.

Take a worked case. A firm holds £15m of own funds. Its own funds threshold requirement is £10m. It wants to buy back £3m of stock. After the buyback it holds £12m, a £2m buffer over the threshold. Under the proposed test the firm doesn’t ask what margin the FCA might want. It asks whether £2m is sufficient for foreseeable resilience, and it answers with documented stress tests, an analysis of its business strategy and forward projections, and a clear line back to its ICARA. The decision is defensible because it’s evidenced against the firm’s own threshold and its own forward view, not against an unstated supervisory expectation. The reform gives the firm its own number to measure against, without lowering the threshold.

The IFPR was designed to be proportionate, and its structure is. A firm’s own funds requirement is the higher of three things: the permanent minimum requirement, a flat floor set by the firm’s permission type; the fixed overheads requirement, broadly a quarter of the firm’s annual fixed costs, meant to fund an orderly wind-down; and the K-factor requirement, a set of activity-based metrics that scale capital to the risks a firm poses to clients, to markets, and to itself. For most small advisory and discretionary firms the fixed overheads requirement is the binding constraint and the K-factors rarely make a difference. For larger firms dealing on own account or holding client assets, the K-factors matter a great deal.

Much of the proportionality turns on one classification: whether a firm is a small and non-interconnected firm, an SNI, or not. The SNI thresholds look at assets under management, client orders handled, balance sheet size, and whether the firm holds client money or assets. An SNI firm gets a lighter version of the regime: simpler ICARA expectations, reduced disclosure, no requirement for certain K-factors. The error I see repeatedly is a firm that has grown across an SNI threshold without noticing, so it’s running a lighter regime than it’s now entitled to. The thresholds have to be monitored. They have to be monitored, because crossing one changes the obligations.

The reform doesn’t change these mechanics, but it makes them easier to apply, because the definitions a firm needs to classify itself and calculate its requirement will sit in one rulebook rather than being assembled out of a banking regulation. For a growing firm, it means knowing your category rather than inferring it from cross-references.

The bank-derived complexity shows most for groups, which is where consolidating the text helps most. A UK investment firm group has to apply prudential requirements on a consolidated basis, or meet the group capital test as an alternative for simpler structures. Working out the consolidated own funds position today means navigating the same cross-referenced UK CRR provisions, including consolidation mechanics written with banking groups in mind, and then stripping out the parts that only apply to large banks.

The globally systemic bank provisions add text a group’s compliance team has to read. Pulling the relevant consolidation rules into MIFIDPRU directly, and leaving the bank-only material behind, takes out a genuine source of confusion for group structures. The capital outcome is unchanged, but the calculation gets shorter — a recurring saving for a group consolidating every period.

What the reform changes, and what it leaves alone.

The IFPR is a package; liquidity and concentration matter for resilience alongside own funds. The basic liquid assets requirement obliges a firm to hold liquid assets equal to at least a third of its fixed overheads requirement, plus an amount to cover guarantees it has given to clients. An orderly wind-down needs liquid resources, so the regime requires genuine liquidity, not just balance-sheet adequacy. The ICARA has to assess liquidity needs over the firm’s planning horizon and through stress, and the firm has to be able to show the liquid assets are there and are liquid.

Concentration risk is the third element. Under MIFIDPRU 5, firms monitor exposures that are large relative to their own funds, including concentrations to individual counterparties and, for many smaller firms especially, concentration of their own cash with a small number of banks. A boutique that keeps all its operating cash and its liquid assets requirement at a single bank is carrying a concentration the regime expects it to recognise and manage. None of this changes under the reform either, but all of it becomes easier to find and apply once the framework is consolidated, and all of it feeds the same ICARA the capital reduction test now leans on. The IFPR treats capital, liquidity and concentration as one resilience position, and the reform puts it in one place.

The reform makes the ICARA more central, because the capital-reduction test now points back to it. This is also where firms most often have a document rather than a process.

Done well, the ICARA is a live assessment the firm owns, not a long adviser-written file opened once a year. It states a capital number and a wind-down figure and stops there. When the firm wants to do something real, like return capital, the ICARA does not support the decision, so the work gets redone in a hurry.

It identifies the harms the firm could cause to clients and markets, sizes them, and sets the own funds and liquidity needed to cover both ongoing operations and an orderly wind-down. Its stress scenarios are specific to the business, not borrowed boilerplate. When the firm contemplates a capital reduction, the ICARA is the first thing it reaches for, because the buffer analysis, the stress tests and the forward projections are already in it. The board reviews it, challenges it, and signs it knowing what it says. The proposed capital-reduction test relies on a working ICARA.

This insight is provided for general informational purposes only and doesn’t constitute legal, investment, or regulatory advice.