Explanatory Memorandum to COM(2017)791 - Prudential supervision of investment firms - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2017)791 - Prudential supervision of investment firms. |
|---|---|
| source | COM(2017)791  |
| date | 20-12-2017 |
• Reasons for and objectives of the proposal
The EU needs stronger capital markets in order to promote investment, unlock new sources of financing for companies, offer households better opportunities and strengthen the Economic and Monetary Union. The Commission is committed to putting in place all the remaining building blocks in order to complete the Capital Markets Union (CMU) by 20191.
Investment firms provide a range of services that give investors access to securities and derivatives markets (investment advice, portfolio management, brokerage, execution of orders etc.). Investment firms and the services they provide form a vital cog in a well-functioning CMU. They play an important role in facilitating savings and investment flows across the EU, with various services used to support effective capital allocation and risk m anage m ent.
There are investment firms in all Member States. According to information compiled by the European Banking Authority (EBA), there were 6 051 investment firms in the European Economic Area (EEA)2 at the end of 2015. These include firms providing a limited set of services to retail customers in the main through to those offering a number of services to a broad range of retail, professional and corporate clients.
Based on information from the EBA, around 85 % of EEA investment firms limit their activities to:
• offering investm ent advice;
• receiving and transmitting orders;
• managing portfolios; and
• executing orders.
Contents
- Acting as an important hub for capital markets and investment activities, the UK has the largest number of EEA investment firms, with roughly half of them based there, followed by
- A Directive is chosen since its provisions replace those in CRD IV relating to investment firms. This ensures that its provisions can be transposed by Member States in accordance
- a workshop on the costs of the current regime on 30 May 2017; and
- Opinion of the European Banking Authority on issues related to the departure of the United Kingdom
- are introduced for investment firms and
Acting as an important hub for capital markets and investment activities, the UK has the largest number of EEA investment firms, with roughly half of them based there, followed by
Germany, France, the Netherlands and Spain. Most EEA investment firms are small or medium-sized. The EBA estimates that some eight investment firms, largely concentrated in
the UK, control around 80 % of the assets of all investment firms in the EEA.
As one of the new priority actions to strengthen capital markets and build a CMU, the Commission therefore announced in its Mid-Term Review of the Capital Markets Union Action Plan that it would propose a more effective prudential and supervisory framework for investment firms, calibrated to the size and nature of investment firms, in order to boost
competition and improve investors’ access to new opportunities and better ways of managing
1 See ‘Communication on the Mid-Term Review of the Capital Markets Union Action Plan’, COM(2017) 292 final, 8 June 2017; and, ‘Communication on Reinforcing integrated supervision to strengthen Capital Markets Union and financial integration in a changing environment’, COM(2017) 542 final, 20 September 2017.
2 EBA report on investment firms, response to Commission’s call for advice of December 2014 (EBA/Op/2015/20), Table 12: Population of investment firms, by category, by country, p. 96. www.eba.europa.eu/documents/10180/983359%2BReport%2Bon%2Binvestment%2Bfirms.pdf">https://www.eba.europa.eu/documents/10180/983359+Report+on+investment+firms.pdf
3
their risks. In view of the pivotal role played by UK investment firms in this area to date, the UK’s decision to withdraw from the EU further underlines the need to update the regulatory architecture in the EU in order to support this development.
The proposals covering this Directive and the accompanying Regulation (‘the proposals’) were included in the 2017 Commission Work Programme as a REFIT exercise. They aim to ensure that investment firms are subject to capital, liquidity and other key prudential requirements and corresponding supervisory arrangements that are adapted to their business yet sufficiently robust to capture the risks of investment firms in a prudentially sound manner in order to protect the stability of the EU’s financial markets. The proposals are the outcome of a review mandated by Articles 493(2), 498(2), 508(2) and 508(3) of Regulation (EU) No 575/2013 (Capital Requirements Regulation, or CRR)4 which, together with Directive 2013/36/EU (Capital Requirements Directive IV, or CRD IV)5, constitute the current prudential framework for investment firms. When agreeing these texts, co-legislators decided that the framework for investment firms should be reviewed given that its rules are largely geared to credit institutions.
Unlike credit institutions, investment firms do not take deposits or make loans. This means that they are a lot less exposed to credit risk and the risk of depositors withdrawing their money at short notice. Their services focus on financial instruments – unlike deposits, these are not payable at par but fluctuate according to market movements. They do however compete with credit institutions in providing investment services, which credit institutions can offer to their customers under their banking licence. Credit institutions and investment firms are therefore two qualitatively different institutions with different primary business models but with some overlap in the services they can provide.
Investment firms have been subject to EU prudential rules alongside credit institutions since 1993, the year in which the first EU framework governing the activities of investment firms entered into force. Now replaced by the Markets in Financial Instruments Directive (MiFID)6 and, as of January 2018, by MiFID II / MiFIR7, this framework sets out the conditions for authorisation and organisational and business conduct requirements under which investment services can be provided to investors as well as other requirements governing the orderly functioning of financial markets.
The prudential framework for investment firms in the CRR/CRD IV works in conjunction with MiFID. Typically, prudential requirements on financial institutions are designed to (i) ensure that they have sufficient resources to remain financially viable and to carry out their services through economic cycles; or (ii) enable an orderly wind-down without causing undue economic harm to their customers or to the stability of the markets they operate in. As a result, they should aim to reflect the risks that different financial institutions face and pose,
4 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 and amending Regulation (EU) No 648/2012 (OJ L 176, 27.6.2013, p.
1).
5 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (OJ L 176, 27.6.2013, p. 338).
6 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC (OJ L 145, 30.4.2004, p.
1).
7 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (OJ L 173, 12.6.2014, p. 349-496) and Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on
be proportionate to the likelihood of the risks occurring, and broadly strike a balance between ensuring the safety and soundness of different financial institutions and avoiding excessive costs which could hinder them from carrying out their business in a viable way.
Systemic investment firms, a number of which are identified as global, or other systemically important institutions under Article 131 of CRD IV should still be subject to the CRR/CRD IV framework, including the amendments proposed by the Commission on 23 November 20168, in accordance with the revised approach for identifying them in the proposals. This is because these firms typically incur and underwrite risks on a significant scale throughout the single market. Their activities expose them to credit risk, which is mainly in the form of counterparty credit risk as well as market risk for positions they take on own account, whether for their clients or themselves. They therefore constitute a greater risk to financial stability given their size and interconnectedness. In light of these risks and in order to ensure a level playing field, such systemic investment firms should be treated as credit institutions.
As announced in the Commission Communication of September 2017 on the review of the European Supervisory Authorities9 (ESAs), this would also imply among other things that their operations in Member States participating in the Banking Union are subject to direct supervision by the ECB in the Single Supervisory Mechanism. At present, these firms are largely concentrated in the UK but are in the process of considering plans to relocate parts of their operations to the EU-27, notably to Member States participating in the Banking Union. While this covers only a small number of firms, they nevertheless represent a sizeable share of the total assets and business volume of all investment firms in the EU.
For other investment firms, the fact that the current prudential framework focuses on credit institutions and the risks they face and pose rather than investment firms is more problematic. The services provided by these firms and the risks they can create are, to a large extent, not explicitly addressed by the existing rules. Of the eight investment services that investment firms are authorised to perform under MiFID10, only (i) dealing on own account; and (ii) underwriting or placing instruments on a firm commitment basis have clear corresponding requirements under the CRR. For the other investment services (reception and transmission of orders, execution of orders, portfolio management, investment advice, placing instruments without a firm commitment basis, operation of a multilateral trading facility), such requirements are missing and result in approximate coverage of the risks involved. While limited in some cases, the risks inherent in these activities for the firm and, as a consequence, for the firm’s clients and the wider markets they operate in are therefore not captured in a targeted way.
This gives rise to three main problems, which are assessed in the staff working document accompanying the proposals.
8 In line with the second set of advice from EBA of October 2016 (Opinion of the European Banking Authority on the First Part of the Call for Advice on Investment Firmswww.eba.europa.eu/documents/10180/1639033/Opinion%2Bof%2Bthe%2BEuropean%2BBanking%2BAuthority%2Bon">https://www.eba.europa.eu/documents/10180/1639033/Opinion+of+the+European+Banking+Authority+on +the+First+Part+of+the+Call+for+Advice+on+Investment+Firms+%28EBA-Op-2016-16%29.pdf,) the Commission proposed in November 2016 that investment firms identified as global or as other systemically important institutions (G-SIIs, O-SIIs) in accordance with Article 131 of the Capital Requirements Directive should still be subject to the revised Capital Requirements Regulation. In March 2017, there were eight investment firms in this group, all based in the UK. The Commission also proposed that other investment firms could be unaffected by these changes. See: Commission proposals to revise the Capital Requirements Regulation and Directive of 23 November 2016, https://ec.europa.eu/info/law/banking-prudential-requirements-directive-2013-36-eu/upcoming_en
9 COM(2017) 542 final.
10
First, while the framework caters to some extent to the different types of business profiles of investment firms in the form of exemptions, it is a source of considerable regulatory complexity for many firms in general. Second, its detailed requirements and exemptions constitute a crude and risk-insensitive proxy for the actual risks incurred and posed by investment firms, which differ from those of banks. Third, due to its inherent complexity and lack of risk sensitivity, its implementation by Member States gives rise to fragmentation in the overall regulatory landscape for investment firms, with scope for harmful regulatory arbitrage. This could threaten the integrity and functioning of the single market.
The objectives of the proposals are to address the problems of the existing framework while facilitating the take-up and pursuit of business by investment firms where possible. Specifically, they set out a prudential framework that is better adapted to their business models. They consist of more appropriate and risk-sensitive requirements for investment firms, better targeting the risks they actually pose and incur across different types of business models. Finally, they constitute a more streamlined regulatory toolkit to enable prudential supervisors to carry out their oversight effectively.
Finally, MiFID II and MiFIR were adopted in the wake of the financial crisis to cover securities markets, investment intermediaries and trading venues. The new framework reinforces and replaces the current MiFID I framework. In the context of the revision of the prudential framework for EU investment firms, the absence of a mandatory reporting requirement for third-country firms active in Member States through branches has been identified as a weakness. National competent authorities are unable to assess on a regular basis the volume of financial services activities carried out by branches of third-country firms on their territories. This proposal would therefore give competent authorities the appropriate tools to monitor these activities.
As mandated by the Articles of the CRR, the review of the prudential framework for investment firms has been carried out in consultation with EBA, the European Securities and Markets Authority (ESMA) and the national competent authorities represented in these ESAs. Following a first call for advice by the Commission in December 2014, EBA published its first report on the current prudential framework for investment firms, calling for changes to the current approach for all but the largest and most systemic investment firms in December 201511. Following a second call for advice by the Commission in June 2016, EBA published a discussion paper for consultation focusing on a potential new prudential regime for the vast majority of investment firms in November 201612. Taking account of the feedback and the additional data it had gathered from investment firms together with national competent authorities, EBA published its final recommendations in September 201713. The proposals build on these recommendations in all key respects except for the identification of systemic investment firms, for the reasons explained in the accompanying staff working document and summarised under the section on ‘impact assessment’ below.
11 EBA report on investment firms, response to Commission’s call for advice of December 2014 (EBA/Op/2015/20), www.eba.europa.eu/documents/10180/983359%2BReport%2Bon%2Binvestment%2Bfirms.pdf">www.eba.europa.eu/documents/10180/983359+Report+on+investment+firms.pdf
12 Designing a new prudential regime for investment firms (EBA/DP/2016/02), www.eba.europa.eu/documents/10180/1647446%2BPaper%2Bon%2Ba%2Bnew%2Bprudential%2Bregime%2Bfor%2BIn">https://www.eba.europa.eu/documents/10180/1647446+Paper+on+a+new+prudential+regime+for+In vestment+Firms+%28EBA-DP-2016-02 %29.pdf/cf75b87e-2db3-47a3-b1f3-8a30fa6962da
13 EBA opinion on the design of a new prudential framework for investment firms (EBA/Op/2017/11), www.eba.europa.eu/documents/10180/1976637/EBA%2BAdvice%2Bon%2BNew%2BPrudential%2BFramework%2Bon%2BInve">www.eba.europa.eu/documents/10180/1976637/EBA+Advice+on+New+Prudential+Framework+on+Inve
Consistency
with existing policy provisions in the policy area
This proposal complements the ongoing review of the CRR/CRD IV regime for credit institutions following the proposals adopted by the Commission on 23 November 2016, which allowed all non-systemic investment firms to opt out of its revised provisions14. This option was introduced in recognition of the fact that these revised provisions were not designed with most investment firms in mind and they would have created further complexity in the existing rulebook. The review of the prudential regime for most investment firms also put forward in this proposal was already well underway at the time, and subjecting them to an even more complex regime for a brief period pending the application of the new regime was considered disproportionate. This proposal therefore creates a new regime for the majority of investment firms by carving them entirely out of the CRR/CRD IV framework and leaving only systemic investment firms within the scope of the latter, including its revised provisions, in accordance with the revised approach for identifying them in this proposal.
The proposal is also consistent with MiFID and MiFID II / MiFIR. By setting prudential requirements that are tailored to the business and risks of investment firms, it clarifies when and why these requirements apply. As such, it overcomes some cases of arbitrary application of prudential requirements in the current framework, which arise because they are set first and foremost in relation to investment services listed in MiFID rather than the actual buildup of risks in the type and volumes of business conducted by investment firms.
• Consistency with other EU policies
Investment firms play an important role in facilitating investment flows across the EU. Accordingly, the review also forms part of the Commission initiatives to ensure a strong and fair single market with a well-functioning financial system and CMU in order to mobilise investments and boost growth and jobs15. A more suitable prudential and supervisory framework with lower compliance costs for investment firms should help (i) improve the overall conditions for businesses; (ii) boost market entry and competition in the process; and (iii) improve investors’ access to new opportunities and better ways of managing their risks.
The revised approach for identifying systemic investment firms that should remain under the CRR/CRD IV framework is also consistent with the objective of avoiding loopholes in the functioning of the Banking Union. Recent structural market developments indicate that third-country banking groups have increasingly complex structures in the EU, operating through entities that escape supervision by the ECB under the Single Supervisory Mechanism. As outlined in the Commission Communication of October 2017 on completing the Banking Union16, ensuring that systemic investment firms remain in the CRR/CRD IV in accordance with the approach for identifying them in this proposal also brings them under the prudential supervision by banking supervisors and, for their operations in Member States participating in the Banking Union, under the prudential oversight of the ECB.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Legal basis
14 Commission proposals to revise the Capital Requirements Regulation and Directive of 23 November 2016, https://ec.europa.eu/info/law/banking-prudential-requirements-directive-2013-36-eu/upcoming_en
15 Communication on the Mid-Term Review of the Capital Markets Union Action Plan, June 2017 (COM(2017) 292), https://ec.europa.eu/info/publications/mid-term-review-capital-markets-union-action-plan_en
16
The Treaty on the Functioning of the European Union confers on the European in stitutions th e competence to lay down appropriate provisions by way of Directives to make it easier for persons to take up and pursue commercial activities across the EU (Article 53 TFEU). This extends to legislation dealing with the prudential supervision of providers of financial services, in this case investm ent firms. The provisions of this proposed Directive replace those in CRD IV, which are also based on Article 53 T FEU, as they relate to invest ment firms.
Subsidiarity
The proposal revises and simplifies the existing EU rules that govern the prudential treatment of investment firms in order to (i) better accommodate and address risks in their business models; (ii) improve the level playing field among firms; and (iii) enhance supervisory convergence. To achieve this, a new EU framework should replace the existing one rather than devolve these choices to regulatory frameworks in the Member States. This is because inve stment firms authorised under MiFID today routinely provide their services to customers across EU borders. Separate and disjointed changes to the rules by Member States could introduce competitive distortions and discriminatory treatment, which would fragment the single market. This could increase cases of harmful regulatory arbitrage, with possible knock-on effects for financial stability and investor protection in other Member States in case of problems. It could also skew the range and type of investment services that are available in a given Member State, to the possible detriment of overall market efficiency and investor choice. The revised rules should avoid undue regulatory disparities and ensure a level playing field for all authorised firms across the single market.
Proportionality
As a REFIT exercise, the key objective is to render the new framework more suitable, relevant and proportionate compared to the existing framework for investment firms. Accordingly, this proposal strikes a balance between ensuring that the requirements are at once:
• comprehensive and robust enough to capture the risks of investment firms in a prudentially sound manner; and
• flexible enough to cater to the various types of business models without impeding their ability to operate in a commercially viable way.
The proposal is mindful of ensuring that the costs of the regime in terms of both capital requirements and associated compliance and administrative costs, which are generated by the need to manage the staff and systems in order to run the new requirements as well as report on compliance to supervisors, are kept to the minimum to achieve this balance.
As outlined in the accompanying staff working document, these associated costs are expected to decrease on an ongoing basis, with some new one-off costs at the outset. In terms of capital, an overarching policy choice that has underpinned work on the review and impacts the above is the objective of ensuring that, on aggregate, EU-wide capital requirements on investment firms do not increase too much. This translates into different distribution effects for some types of firms. These are alleviated by the provisions of the proposal so that the biggest impacts are phased in and capped.
Choice of
instrument
A Directive is chosen since its provisions replace those in CRD IV relating to investment firms. This ensures that its provisions can be transposed by Member States in accordance
with relevant national administrative arrangements consistent with existing practice.
3. RESULTS OF EX-POST ASSESSMENTS, STAKEHOLDER
CONSULTATIONS AND IMPACT ASSESSMENTS
• Ex-post assessment of existing legislation
The assessment of the existing CRR/CRD IV framework, which is based on the analysis carried out by the EBA and ESMA in their 2015 report17 in particular and on the parallel work and analysis of the Commission services, is summarised in the accompanying staff working document.
It concludes that the existing rules, which are based on international regulatory standards for large banking groups and targeted at the risks of banks, only partially achieve their aims in terms of (i) ensuring sufficient capital for the risks of most investment firms; (ii) keeping compliance costs in check; (iii) securing a level playing field across the EU; and (iv) ensuring effective prudential oversight. Many of its provisions are considered ineffective and inefficient in this regard. The exception is large and systemic investment firms whose size, risk profile and interconnectedness with other participants in financial markets make them ‘bank-like’ in character.
For the rest, the status quo was assessed to create (i) excessive complexity and disproportionate compliance burdens especially for many small and medium-sized firms; (ii) poorly tailored and risk-insensitive prudential metrics and requirements for accurately capturing the risks of investment firms; and (iii) cases of diverging national implementation of the rules and a fragmented regulatory landscape across the EU.
• Stakeholder consultations
Stakeholders were consulted at several points during the review. In terms of the main milestones, following a first call for advice by the Commission in December 2014, EBA published a report on the current prudential framework for investment firms together with proposals for changes in December 2015. This constitutes a comprehensive and publicly available analysis of the status quo, with data on numbers and types of investment firms in Member States. This analysis helped extend the review to stakeholders who may not be directly impacted by the rules and encouraged them to join in the subsequent discussion.
On 4 November 2016, EBA published a discussion paper for consultation focusing on a potential new prudential regime for investment firms. The paper was open for comments for 3 months. EBA published its draft recommendations on 3 July 2017, inviting comments from stakeholders. Its work was also supported by a detailed data-gathering exercise involving investment firms. This was carried out by national competent authorities on behalf of EBA in two stages in 2016 and 2017.
Given the detailed public consultation and data collection undertaken by EBA, the Commission considered it unnecessary to run a general public consultation in parallel. The Commission services instead consulted stakeholders in a targeted fashion to gather further views on the main elements of the review. This included:
17 EBA report on investment firms, response to Commission’s call for advice of December 2014
(EBA/Op/2015/20), www.eba.europa.eu/documents/10180/983359">https://www.eba.europa.eu/documents/10180/983359-
•
a roundtable with industry stakeholders (investment firms, investors, law firms, consultants) on 27 January 2017 on EBA draft proposals for a future regime;
a workshop on EBA’s draft final recommendations on 17 July 2017.
The review was discussed with Member States in the Financial Services Committee in March and October 2017 and in the Experts Group on Banking, Payments and Insurance in June and September 2017. Stakeholder input received on the Commission’s inception impact assessment published in March 2017 was also taken into account18. Finally, the Commission also considered input received previously in the wide-ranging call for evidence on the efficiency, consistency and coherence of the overall EU regulatory framework for financial services, in which several respondents pointed to various issues relevant for the review19.
Investment firms represent various business models, and their views tend to focus on aspects of the proposals specific to them. This complicates cross-cutting comparisons of the relative weight of stakeholder positions. However, in general the large majority of stakeholders welcome a tailored prudential framework more suited to their business models. They stress that their systemic relevance is limited and that capital requirements should focus on ensuring they can be wound down in an orderly way. In terms of specific requirements that apply to their particular business model, investment firms that conduct agency-only services and do not enter into transactions in financial instruments using their own balance sheet generally criticise proposals for linking capital requirements to the size of the client portfolios they manage in a linear way. While many firms that trade on own account agree that the existing framework for capturing market risk has some merit in light of the risks they incur and pose, other trading firms note that it exaggerates risks in the methods and products they trade in. These views have been taken into account in the calibration of the proposed new risk metrics (K-factors — see below) and the possibility to phase in and cap higher requirements.
Collection and use of
expertise
The review was carried out based on comprehensive advice provided by EB A in consultation with ESMA, as required by the relevant Articles in CRR, which constitute the legal basis for the review (notably Article 508(2) and (3)). The main public outputs of the EBA were as
follows:
• the December 2015 report setting out a comprehensive assessment of the status quo and initial recommendations for changes;
• the November 2016 discussion paper published for consultation on the contours of a possible new regime; and
• the September 2017 final
the September 2017 final report with detailed recommendations.
The precise calibration of the recommendations for new capital requirements was supported by a detailed data-gathering exercise involving investment firms. This was carried out by national competent authorities on behalf of EBA in two stages in 2016 and 2017. The Commission was involved throughout and was able to benefit from the discussions assessing the advantages and disadvantages of the detailed policy recommendations as they unfolded.
18 https://ec.europa.eu/info/law/better-regulation/initiatives/ares-2017-1546878_en
19 See e.g. various replies submitted in the Commission’s Call for Evidence of 2015
• Impact assessment
According to the Better Regulation Toolbox (tool #9), no Commission impact assessment is necessary whenever an EU agency has been mandated to carry out policy design work and related analysis, to the extent that the Commission proposal does not deviate much from the agency’s recommendations and the Commission services consider its assessment to be of sufficient quality.
While the Regulatory Scrutiny Board examined a draft impact assessment for this initiative, a staff working document was deemed more appropriate given that the specific mandate of the review is based on the advice of the ESAs and their stakeholder consultation and technical work. The objective of the staff working document accompanying the proposals is therefore to explain the advice given by the ESAs, including the results of their analysis and consultation, while providing the Commission services’ views on its conclusions, with a view to guiding the Commission’s decision-making.
On capital requirements, EBA assesses that its advice would increase these on aggregate for all non-systemic EU investment firms by 10 % compared to Pillar 1 requirements today, and decrease them by 16 % compared to total requirements applied as a result of Pillar 2 add-ons. The way in which these impacts would be distributed among investment firms depends on their size, which investment services they provide and how the new capital requirements will apply to them. As detailed in the Staff Working Document accompanying the proposals, including its Annex II, the 10% aggregate increase in Pillar 1 requirements is the sum of considerably lower requirements for some and increases in excess of 10% for others. On available own funds, EBA finds that only a few firms would fail to have sufficient capital to comfortably meet the new requirements – this involves just a small number of investment advisors, trading firms and multiservice firms. However, for firms in this group whose increases would be over twice their current requirements, a cap could be granted for a number of years.
The accompanying staff working document concludes that, overall, EBA’s recommendations are considered to be an appropriate and proportionate means of achieving the review’s objectives in an effective and efficient manner compared to the status quo. More generally, EBA’s advice is a clear positive step towards a prudential framework for investment firms that can both ensure that they operate on a sound financial basis while not hindering their commercial prospects. As such, it should support the review’s aims in a balanced fashion. On the one hand, it should help ensure that the risks of investment firms for customers and markets are addressed in a more targeted way both in their ongoing operations and in case they need to be wound down. On the other, it should help ensure that they can fully perform their role in facilitating investment flows across the EU, which is consistent with the aims of the CMU to mobilise savings and investments in order to boost growth and jobs.
It only diverges with EBA’s recommendations on the identification of systemic investment firms. Rather than postpone this so it is clarified via criteria to be developed in technical rules implementing the proposals as EBA recommends, it is considered more appropriate to set this out in the proposals themselves in order to ensure a regulatory level playing field between credit institutions and systemic investment firms. On this point, the proposals go beyond EBA’s advice in its opinion on the review of investment firms. However, the proposals thereby deliver on EBA's opinion on issues related to the UK’s decision to leave the EU20.
Opinion of the European Banking Authority on issues related to the departure of the United Kingdom
20
Regulatory
fitness and simplification
As outlined in the accompanying staff working document, simplification of the prudential rules for the vast majority of investment firms is expected to considerably reduce their administrative and compliance burdens. Various redundant regulatory and reporting requirements could be removed, allowing capital dedicated to regulatory purposes to switch to more productive uses. The proposals, by setting capital and other prudential requirements, including remuneration and governance, that are proportionate to investment firms alleviate for the first time the significant costs that firms incur as a result of the bank-centric requirements of the current regime. This would put an end to the complicated task of matching and reconciling business data to an ill-fitted regulatory framework and reporting regime.
Investment firms that are SMEs21 are expected to be among the main beneficiaries. A more proportionate and appropriate prudential framework for them should help improve the conditions for conducting business, and barriers to entry should decrease. For example, streamlining the onerous reporting framework should reduce administrative burdens and compliance costs for SMEs, including innovative firms seeking to grow through digital means. Similarly, by exempting small and non-interconnected investment firms from the current governance and remuneration rules as laid down under the current CRD IV/CRR, the proposals would reduce administrative and compliance costs for these enterprises. Some one-off costs of transitioning to the new regime are to be expected as firms need to overhaul risk management systems, update compliance departments and revise contracts with law firms and other service providers that are currently used to facilitate compliance. However, the compliance cost savings should support the CMU’s aims in general by helping investment firms play their role in mobilising savings from investors towards productive uses.
In terms of compliance costs, firms are set to save tens of thousands to hundreds of thousands of euros depending on the type and size of firm. How these reductions in compliance costs relate and compare to changes in capital requirements for different types of firms is not known at this stage, but should feature in the future monitoring and evaluation of the framework.
• Fundamental rights
This proposal strengthens the exercise of the right of various investment firms to conduct their business unencumbered by rules designed primarily for other types of participants in financial markets. The legislative measures in the proposals setting out rules for remuneration in investment firms observe the principles recognised by the Charter of Fundamental Rights of the European Union, notably the freedom to conduct a business and the right of collective bargaining and action.
4. BUDGETARY IMPLICATIONS
The proposal will not have implications for the EU budget.
5. OTHER ELEMENTS
www.eba.europa.eu/documents/10180/1756362/EBA%2BOpinion%2Bon%2BBrexit%2BIssues%2B%2528EBA-Op-201712">www.eba.europa.eu/documents/10180/1756362/EBA+Opinion+on+Brexit+Issues+%28EBA-Op-2017-12 %29.pdf
21 As defined in the Commission Recommendation of 6 May 2003 concerning the definition of micro,
small and medium-sized enterprises (OJ L 124, 20.5.2003, p. 36-41), i.e. enterprises which employ fewer than 250 persons and which have an annual turnover not exceeding EUR 50 million, and/or an annual balance sheet
Implementation plans
and monitoring, evaluation and reporting arrangements
The envisaged changes by the proposals should be evaluated in order to determine the degree to which the following objectives have been met:
• a simpler categorisation of investment firms in a manner that captures their different risk profiles;
• a set of prudential rules, notably on capital, liquidity, remuneration and governance requirements, that are appropriate, proportionate and sensitive to the specific risks that investment firms are exposed to and that ensure that capital is assigned to where it is needed;
• a framework that corresponds to the risks inherent in the nature and range of activities undertaken by investment firms in a direct and discernible way and thereby sup ports taking up the busi ness; and
• a streamlined supervisory toolkit to enable the full and accurate oversight of business practices and the associated risks.
To this end, some of the following information could be gathered as part of a future review in order to serve as indicators in evaluating the impact of the proposed changes: (i) compliance costs in terms of staff, legal advice and regulatory reporting; (ii) levels of capital requirements; (iii) other new costs e.g. from liquidity rules; (iv) evolution in the numbers of firms between the different categories; (v) changes in recourse to Pillar 2 add-ons by competent authorities; (vi) cases and impact of failure of investment firms under the new regime; and (vii) evolution of the size of investment firms in terms of assets and client order volum es.
• Detailed explanation of the specific provisions of the proposal
Subject matter and scope
The proposal sets out requirements for the appointment of prudential supervisory authorities, the initial capital of investment firms, the supervisory powers and tools for the prudential supervision of investment firms by the competent authorities, and the publication requirements for competent authorities in the field of prudential regulation and supervision.
The Directive applies to all investment firms covered by MIFID II, which is set to apply as of January 2018.
Appointment and powers of
supervisory authorities
The proposal requires Member States to appoint an authority to exercise the powers for prudential supervision under this Directive, transferring the applicable provisions from CRD IV to this Directive. Member States can either bestow these onto an existing authority in the shape of the function and powers granted under CRD IV or vest them in a new authority.
Initial capital
Levels of initial capital, based on the services and activities that investment firms are authorised to provide in accordance with MIFID, are revised and harmonised across the EU from the levels stipulated in CRD IV to take into account inflation since these levels were set. Transitional arrangements are provided to allow smaller firms in particular to attain the new amounts of initial capital where necessary.
Home/host
powers
Competences in accordance with CRD IV are conferred upon home and host authorities for the prudential supervision of investment firms. Relevant cooperation arrangements between authorities should be established.
Exchange of
information and professional secrecy
Provisions for the exchange of information between competent authorities on prudential supervision and professional secrecy are introduced based on CRD IV and complementing MiFID II.
Penalties
In line with CRD IV, Member States are required to establish administrative penalties and other administrative measures which are effective, proportionate and dissuasive in order to sanction violations under the provisions of this Directive and [Regulation (EU) No ----/--].
Internal capital
adequacy and supervisory review and evaluation
Simplified requirements based on those in CRD IV
competent authorities to assess the adequacy of arrangements and procedures in order to ensure that firms comply with the provisions of this Directive and [Regulation (EU) No ----/--].
Competent authorities should have powers to review and evaluate the prudential situation of investment firms and, where necessary, to exercise powers to require changes in areas such as internal governance and controls, risk management processes and procedures and, where necessary, set additional requirements, including in particular capital and liquidity requirements.
Governance and remuneration
In line with the assessment by the EBA in its Advice22 and the evaluation of this EBA assessment carried out by the Commission services in the accompanying staff working document, the rules on corporate governance and remuneration are revised in order to ensure the orderly functioning of investment firms and to prevent excessive risk-taking by their staff.
At the same time, these rules aim to reflect the differences in risks posed by credit institutions and investment firms. It is not considered proportionate to apply the requirements of this Directive to governance arrangements, remuneration policies and practices of small and non-interconnected investment firms. The proposal aims to ensure the consistency of remuneration and governance rules across the different pieces of legislation, including CRD IV, Directive 2009/65/EC (UCITS) and 2011/61/EU (AIFMD).
While the proposal does not set a specific limit on the ratio between variable and fixed components of variable remuneration, it requires that investment firms set appropriate ratios themselves. This takes into account the potential impact that setting a single ratio could have on the cost flexibility and profitability of some investment firms.
www.eba.europa.eu/documents/10180/1976637/EBA%2BAdvice%2Bon%2BNew%2BPrudential%2BFramework%2B">www.eba.europa.eu/documents/10180/1976637/EBA+Advice+on+New+Prudential+Framework+
22
The findings of Commission Report COM(2016) 510 revealed that the deferral and pay-out in instruments requirements are generally not efficient in the case of small and non-complex investment firms and for staff with low levels of variable remuneration. The Commission therefore proposes to set a threshold at firm and staff levels below which investment firms and/or staff members will benefit from the derogations from the application of the rules on the deferral and pay-out in instruments.
Third countries
Agreements with third countries may be concluded by the Union regarding the means of supervising compliance with the group capital test. Administrative cooperation arrangements with third countries supervisory authorities may be concluded by the Member States and EBA to facilitate the exchange of information.
Systemic investment firms
The proposal for a Regulation accompanying this proposal for a Directive contains a provision that would change the definition of credit institutions to include undertakings whose business includes dealing on own account or underwriting or placing financial instruments on a firm commitment basis, where the total value of the assets of the undertaking is EUR 30 billion or more. This proposal for a directive contains complementary provisions on the process for seeking authorisation as a credit institution.