Response to discussion on the potential review of the investment firms’ prudential framework
Q5: Is it necessary to differentiate the deductibles by activity or by business model for the purpose of calculating the FOR? If yes, which items should then be considered and for what reasons?
Differentiating the deductibles by activity and business model may reduce regulatory effectiveness due to the unique nature of business models, potentially leading to underrepresentation and an uneven competitive landscape. Regulators might find themselves perpetually behind, resulting in an inequitable environment. Firms could engage with National Competent Authorities, for bespoke deductions based on individual business models, ensuring adequate capital for orderly wind-downs. However, this could compromise harmonization across the Union. Thus, if harmonization is the goal, Q5 should not be pursued further.
Q7: Should the FOR be calculated distinguishing the costs related to non-MiFID activities, which criteria should be considered? What kind of advantages or disadvantages would this have in practice?
The fixed overhead requirement is largely computed based on the Firm’s financial position. The EBA/ESMA’s query overlooks the extent of the diversity of business operations and strategies. Should EBA/ESMA proceed with implementation of distinguishing costs; this will increase operational complexities in segregating costs related to investment services from others, such as employee salaries and technology expenses across service lines. Moreover, maintaining a 25% fixed overhead requirement should address the winding down of an Investment Firm as a whole rather than focusing solely on winding down of investment service(s) line(s).
Q31: What would be costs or benefits of extending existing reporting requirement to financial information? Which other elements should be considered before introducing such requirement?
The proposed enhancement of financial reporting for Class 3 Investment Firms by EBA/ESMA warrants careful consideration. The initiative aims to scrutinize the evolution of these firms’ capital base and their adequacy against regulatory capital requirements. However, this move could diverge from the IFR and IFD’s intent to create a regulatory framework proportionate to a firm’s risk profile.
The imposition of quarterly reporting aligns Class 3 firms with larger entities, escalating their costs due to the lack of a standardized and free XBRL conversion tool across Member States. This not only quadruples financial burdens for data conversion but also amplifies operational demands, particularly for start-ups Investment Firms that could meet the definitions of small and non-interconnected under article 12(1) of the IFR. It may therefore be construed as an additional barrier for entry. Indeed, by definition such Class 3 Investment Firms are deemed to be small and non-interconnected and therefore do not pose systemic risk when compared to other classes of Investment Firms.
Moreover, the discussion paper’s point 253 suggests that supervisory bodies intend to use these reports for ongoing financial surveillance, questioning the efficacy of such measures in bolstering market integrity or consumer protection. It suggests that redirecting national competent authority resources to monitor lower-risk Class 3 firms may detract from overseeing higher-risk entities, thus undermining the national competent authorities’ overarching goal of financial stability within the EU. This is also based on the statistical information supplied by the EBA/ESMA within the Discussion Paper in which 1295 Firms were noted to be classified as Class 3 Investment Firms (57%) out of 2262 [excluding Class 1 Firms].
In light of these considerations, it is imperative to evaluate the implications of increased reporting on Class 3 Investment Firms thoroughly. Specifically, a cost-benefit analysis with respect to the effectiveness of such implementations on consumer protection and marketing integrity and efficiency in the medium to long term should be pursued.
Ongoing statistical monitoring of capital is essential for all Investment Firms, however quarterly centralization with national authorities is not recommended. Instead, it is suggested that Investment Firms should be responsible for their compliance with PMR and FOR. Our proposal includes that the function within the Investment Firm responsible for capital monitoring and risk management handles ongoing financial risk reviews. In case of non-compliance, the Compliance Function would report to the national competent authorities. Competent authorities could consequently focus on ensuring that appropriate governance is maintained at the individual Investment Firm level. This approach would prevent additional reporting burdens [financial and operational] and ensure that a risk-based approach in regulatory oversight is maintained without the imposing additional obstacles.