Prudential regulation of credit institutions and investment firms Investment Firms Prudential Regime
Investment firms provide a range of services which give investors access to securities and derivatives markets. Investment firms differ from credit institutions in that they do not typically accept deposits or grant traditional loans; instead, investment firms provide investment services and perform investment activities. This means that, whilst there is some overlap, the risks posed and faced by investment firms, and the impact of those risks, are different from those of credit institutions. The current prudential regulatory framework does not adequately cater for these differences. The consequence is that the current prudential framework for investment firms:
can be disproportionate – the requirements do not account for differences in size or business models of investment firms;
can be inappropriate – the requirements are currently based on risks to which investment firms may not be exposed, whilst insufficiently addressing the risks to which they are exposed, the risks they may pose to consumers and to the integrity of the UK financial system, and the potential harms they could cause;
may impose unnecessary administrative and compliance burdens – this is as a result of having to comply with a regime for which much of the administration, compliance, and reporting is not designed for investment firms.
	The Act enables the introduction by the FCA of a tailored Investment Firms Prudential Regime (IFPR) that aims to address the issues set out above. The IFPR will apply to investment firms prudentially regulated by the FCA and their holding companies. In contrast, investment firms that are systemically important to the financial system will continue to be prudentially regulated by the Prudential Regulation Authority (PRA) and will continue to be subject to Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms (the Capital Requirements Regulation or CRR). The PRA will continue to designate the investment firms that will be regulated under the CRR consistent with the PRA designation framework (Bank of England, Statement of Policy, ‘Designation of investment firms for prudential supervision by the Prudential Regulation Authority’, March 2013).
	The IFPR will ensure that the UK has a more effective prudential regime for investment firms. This is in the context of the EU having adopted legislation for a new investment firm regime (Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms (EU IFR), and Directive (EU) 2019/2034 of the European Parliament and of the Council of 27 November 2019 on the prudential supervision of investment firms (EU IFD)) in 2019. The UK played an instrumental role in designing this regime and the Government and the FCA remain supportive of its intended outcomes. The EU IFR/EU IFD legislation did not apply in the EU at the end of the Transition Period, and therefore does not form part of retained EU law in the UK.
	The Act enables the majority of the IFPR to be specified through rules made by the FCA. In a discussion paper published in June 2020 (FCA Discussion Paper, ‘Prudential requirements for MiFID investment firms’, June 2020), the FCA solicited views on its proposed rules. This approach will mean that the FCA is responsible for designing and setting the detailed firm-level requirements that apply to FCA-regulated investment firms, as well as supervising those firms. It will also mean that the UK’s prudential regulation regime for FCA-regulated investment firms is flexible, with the FCA able to update its rules to reflect industry changes. The FCA’s rules will be made using its existing rule-making powers under the Financial Services and Markets Act 2000 (FSMA) and the new rule-making powers introduced in the Act in relation to unauthorised parent companies of FCA-regulated investment firms.
	As this regime is entirely new, the Act places an obligation on the FCA to introduce prudential rules for FCA investment firms. The Act details the areas for which the FCA must introduce rules – for capital, liquidity, exposure to concentration risk, reporting, public disclosure, governance arrangements and remuneration policies. Taken together, these are key prudential requirements relevant to investment firms. For the purposes of this regime, an "FCA investment firm" is an investment firm that- (a) has a Part 4A permission to carry on one or more regulated activities; (b) is not designated by the PRA; and (c) has its registered office or, if it has no registered office, its head office in the UK.
	To reflect the increased rule-making responsibilities of the FCA in this area, this Act introduces an enhanced accountability framework for the FCA. This framework imposes additional requirements on the FCA to enable greater scrutiny and transparency of its decision-making when implementing the IFPR. When making rules to implement and maintain parts of the IFPR, the FCA is required to have regard to a new list of matters. The matters relate to important public policy considerations, including: relevant international standards; the relative standing of the UK as a place for internationally active investment firms to carry on activities; the target for Net Zero emissions as set out in the Climate Change Act 2008; and financial services equivalence, granted by and for the UK, along with any further matters that HM Treasury may specify in regulations. These matters do not change the status of the FCA’s strategic and operational objectives as established in FSMA.
	In consultations, the FCA is required to publish an explanation of how having regard to the above matters have affected the proposed rules (aside from equivalence, where, instead, the FCA will consult the Treasury). When the FCA makes the final rules, it must publish an explanation complying with the above as well as a summary of the purpose of the new rules, in addition to fulfilling its existing FSMA publication requirements.
	The Act includes further provisions to support the introduction of the IFPR and ensure that the FCA can regulate and supervise FCA investment firms effectively. The Act therefore amends the CRR to cease its application to investment firms, other than those designated by the PRA. It extends the FCA’s investigative and supervisory powers to allow it to effectively supervise the IFPR and to amend rules to reflect changes to CRR, as instituted by the PRA.
	As country-by-country reporting is relevant to the activities of FCA investment firms, the Act makes amendments to the Capital Requirements (Country-by-Country Reporting) Regulations 2013 (S.I. 2013/3118) to ensure their continued application to investment firms, now that these firms are subject to a bespoke regulatory regime. HM Treasury will introduce further amendments to existing legislation required by the introduction of the IFPR by a separate statutory instrument, made using powers contained in the Act.