Investment Firms Prudential Regime - changes to MRT identification

Overview

• The Investment Firms Prudential Regime (IFPR), comprised of the
  Investment Firms Regulation (IFR) and Investment Firms Directive
  (IFD), will likely start coming into force for UK firms from 26 June.

• See our summary of the remuneration and governance aspects of the new regime here.

• On 5 June 2020, the EBA published draft Regulatory Technical
  Standards (RTS) for consultation. The draft RTS specify criteria for
  Class 2 investment firms (not small and non-interconnected firms)
  to use to identify the categories of individuals “whose professional
  activities have a material impact on the risk profile of the
  investment firm or the assets that it manages” (Material Risk
  Takers or MRTs). MRTs will be subject to specific remuneration
  rules under the regime.

• The proposals for identifying MRTs in the draft RTS include
  qualitative and quantitative criteria and would result in significant
  changes for many UK investment firms.

New MRT identification criteria

The proposed criteria are aimed at ensuring a harmonised approach to MRT identification across Member States, covering the risks most relevant to investment firms. They are similar to the rules used to identify MRTs by firms subject to the Capital Requirements Directive (CRD) but have been adapted to reflect the specific nature of investment firm services.

While IFPRU firms will be familiar with applying qualitative and quantitative criteria to identify their MRTs, BIPRU firms and CPMI firms will not be used to adopting such prescribed standards. Even for IFPRU firms, the proposed categories of staff to be automatically captured as risk takers are very different to those captured under the CRD and would require adjustment to existing procedures.

Qualitative criteria

An individual will be an MRT if they fall into any of the qualitative categories listed below.

• Management body and senior management. The individual is a member of the management body (in its management or supervisory function) or
  senior management.

• Managerial responsibility for material business unit. The individual
  has managerial responsibility for a business unit that contributes
  to more than [10%/20%] (the EBA is consulting on the appropriate
  threshold) of the firm’s total own funds requirement at the end of
  the preceding financial year. Managerial responsibility means
  heading a business unit or control function and being directly
  accountable to the management body, a member of the management body
  or senior management. Own funds will be calculated based on
  K-factors capturing risks to clients, firm and markets under the
  new regime.

• Managerial responsibility for control and other functions. The
  individual has managerial responsibility for the activities of a
  control function or for the prevention of money laundering and
  terrorist financing.

• Responsible for managing, monitoring or mitigating material risks.
  The individual has managerial responsibility for a material risk or
  is a voting member of a committee responsible for managing,
  monitoring and mitigating a material risk to which the firm is
  exposed. Material risk is defined by reference to Article 28(3) of
  the IFD, which requires firms to establish reporting lines to the
  management body for all material risks and risk management policies.
  The consultation paper explains that this criterion aims to capture
  staff responsible for material risks not captured previously.
• Managerial responsibility in areas impacting the firm’s K-factors.
  The individual has managerial responsibility for the execution or
  approval of processes or systems, performing economic analysis,
  management of outsourcing arrangements of certain critical or
  important functions or providing information technology or security
  relevant for the firm’s business activities regarding:

(a) the management or safeguarding of assets under both discretionary portfolio management and nondiscretionary advisory arrangements of an ongoing nature;

(b) the administration or safeguarding of client money held both on segregated accounts and on non‐segregated accounts;

(c) the execution of client orders; and/or

(d) the execution of trading activities.

Critical or important functions are defined by cross-referring to Commission Delegated Regulation (EU) 2017/565, which supplements MiFID 2 regarding firms’ organisational requirements and operating conditions. An operational function is critical or important where a performance defect or failure would materially impair the firm’s compliance with its obligations under MiFID 2, its financial performance or the soundness or continuity of its investment services and activities.

• Authority or voting member for the introduction of new products. The
  individual has authority to approve or veto new products or is a
  voting member of a committee which has authority to do this.

Quantitative criteria

Under the draft quantitative criteria, an individual will be an MRT if they fall into any of the categories listed below.

• The individual’s total remuneration is ≥ €500,000 and ≥ the
  average remuneration of members of the management body and senior
  management in or for the preceding financial year.

• The individual has been awarded total remuneration ≥ €750,000 in
  or for the preceding financial year.

• For firms with over 1,000 staff members, the individual is within the
  0.3% of staff who have been awarded the highest total remuneration in or for the preceding financial year.

• In or for the preceding financial year, the individual was awarded
  total remuneration ≥ the lowest total remuneration awarded to a staff
  member who meets certain qualitative criteria in the RTS (they are a
  member of the management body in its management function or senior
  management; have managerial responsibility for a material business
  unit; are responsible for managing, monitoring or mitigating material
  risks; have managerial responsibility in areas impacting K-factors;
  or have authority or are a voting member for the introduction of new
  products).

However, the draft RTS allows firms to exclude staff from MRT identification if they meet any of the criteria listed above but the firm determines the individual has no impact on the firm’s risk profile or the assets that it manages. Firms must seek prior approval from their national regulator before excluding individuals who have been awarded total remuneration ≥ €750,000 or whose remuneration is within the top 0.3% of staff (where the firm has more than 1,000 staff members). Firms will not be granted such prior approval for individuals who have been awarded total remuneration ≥ EUR 1 million unless exceptional circumstances exist.

Timing

The consultation on the proposed RTS will close on 4 September 2020. We will be working with clients and industry bodies to feed into the consultation process.