Response to discussion on the potential review of the investment firms’ prudential framework
Q1: What would be the operational constraints of potentially removing the threshold?
Please note that we have chosen to consolidate all of our input in the attached letter in addition to responses to some of the questions listed below.
Q4: Should the minimum level of the own funds requirements be different depending on the activities performed by investment firms or on firms’ business model? If yes, which elements should be considered in setting such minimum?
There is no need to introduce an FOR methodology that distinguishes between different types of business models as any attempt to insert a methodology that tries to cater for the variety of investment firms and business models as this would by definition result in a less sophisticated/tailored assessment of a firm's wind-down capital than the Pillar 2 SREP assessment. Pillar 1 k-factors are tailored to capture firm specific risks linked to their activities and services and adequately capitalise those within their aggregated Pillar 1 k-factor requirements. There is therefore no need to introduce business model/activity variance in FOR in order to preserve the existing approach in line with the SREP guidelines and the Pillar 2 assessments that firms conduct.
As the EBA has also pointed out in paragraph 50 of the DP, own funds requirements are driven by the k-factors and not by FOR as the former deliver a higher own funds requirement. In practical terms this also means that even in situations where an investment firm would require a longer wind-down period than 3 months - e.g. because of extremely illiquid positions on its books that require a longer period to liquidate - this would be adequately reflected in the own funds requirements delivered by the k-factor methodology and therefore ensure that there is sufficient wind-down capital available at the investment firm.
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?
One could argue that there are good reasons for making some distinction between some business models of investment firms, but this would need to be balanced against the risk of adding unnecessary complexity to the FOR calculations. The introduction of the specific deductibility of trading fees for investment firms who are market makers makes sense in light of the relative size of overall expenses these fees represent for typical market makers. This was ultimately recognised by the European Commission in Delegated Regulation 2022/1455 and should be maintained as such. There may be other specific activities of investment firms that should be recognised as deductible activities, but as pointed out this should be balanced against the need for keeping the FOR methodology as simple as possible.
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?
It does not make sense to distinguish between different types of activities for the purposes of setting the FOR requirement. FOR is intended to be a gone concern capital base that ensures the orderly wind-down of a firm, irrespective of the type of activities the firm conducts. FOR is deliberately intended to ensure sufficient gone concern capital based on the fact that investment firms are not systemically important, not in need of public intervention/support, and should be allowed to fail.
Q18: Investment firms performing MiFID activities 3 and 6 (trading on own account and underwriting on a firm commitment basis) are more exposed to unexpected liquidity needs because of market volatility. What would be the best way to measure and include liquidity needs arising from these activities as a liquidity requirement?
Due to the very varied nature of investment firms and the type of business they operate, it would be rather complex to determine a standard methodology with which to map the liquidity needs of such firms - not to mention stress test them appropriately. We would therefore concur with the conclusions drawn by the EBA in favour of maintaining a simple methodology that use the Fixed Overhead Requirement as a proxy for determining a firm's liquidity requirements. We would also urge the EBA to conduct an assessment of whether firms have experienced any liquidity shortfalls in the period since the IFR/IFD has been in force before determining whether the current requirement of 1 month of FOR is sufficient or whether it should be increased to 3 months. The DP does not disclose any evidence as to why the current liquidity requirements are "too soft". We would therefore request a quantitative assessment be conducted first, before requirements are increased.
Q20: Investment firms, providing any of the MiFID services, but exposed to substantial exchange foreign exchange risk may be exposed to liquidity risks. What would be the best way to measure such risk in order to take them into account for the purposes of the liquidity requirements?
Investment firms with a European holding company generally operate in a structure in which the holding companies hold investments in non-EU subsidiaries who may be operating with functional currencies other than the Euro to cover their local capital requirements, liquidity needs, and costs. in principle holding companies will have no desire to repatriate these investments and therefore be in a situation where they would have to be converted back into Euro. Any changes in the value (against the Euro) of the functional currencies of non-EU subsidiaries will therefore not trigger the need for additional capital injections from holding company level. Even though the value against the Euro may have changed, subsidiaries not using the Euro as their functional currency will continue to cover their local requirements and liabilities in local currency, irrespective of its relative value against the Euro. Moreover, each foreign subsidiaries will have a specific market risk framework for FX exposures, with FX exposures within the trading book being assessed by and appropriately margined with the relevant clearing firm. Therefore, we do not see why investment firms would be exposed to substantial liquidity risks as a result of foreign exchange moves.
Q21: Are there scenarios where the dependency on service providers, especially in third countries, if disrupted, may lead to unexpected liquidity needs? What type of services such providers perform?
Investment firms – including Optiver – tend to operate with fully capitalised/funded subsidiaries in third countries to ensure that subsidiaries are able to meet their local needs on an ongoing basis. There are potential scenarios that could cause disruption such as the interruption of clearing services/credit lines from clearing firms, but such events would only have a temporary effect as firms as part of their own prudent risk management would designate back-up clearing services that they can fall back on in the event of a disruption.
Q27: Is the different scope of application of remuneration requirements a concern for firms regarding the level playing field between different investment firms (class 1 minus and class 2), UCITS management companies and AIFMs, e.g., in terms of the application of the remuneration provisions, the ability to recruit and retain talent or with regard to the costs for the application of the requirements?
We reiterate that the consolidated application and in particular the extension of the IFR-IFD requirements on governance and remuneration to operations outside of the EU has a substantial impact on the competitiveness of EU headquartered firms on a global scale (level playing field). Consolidated application of such requirements undermines the ability of EU firms to compete on an even footing with peers in non-EU markets in particular as far as it concerns attraction and retention of talent. We reiterate that it would seem appropriate that carveouts from prudential consolidation should be made available to EU headquartered firms to allow for the disapplication of - at the very least - the IFD/CRD governance and remuneration requirements to non-EU subsidiaries to enable EU headquartered firms to compete on a level playing field in the non-EU markets they are active in.
Q28: Are the different provisions on remuneration policies, related to governance requirements and the different approach to identify the staff to whom they apply a concern for firms regarding the level playing field between different investment firms (class 1 minus under CRD or class 2 under IFD), UCITS management companies and AIFMs, e.g. in terms of the application of the remuneration provisions, the ability to recruit and retain talent or with regard to the costs for the application of the requirements?
The identification of quantitative material risk takers as required under IFD and further set out in the relevant RTS is based on the assumption that certain levels of remuneration correspond with a staff member’s contribution to the risk profile of the firm. I.e., when a staff member receives a certain level of remuneration (>€500k), that person is assumed to have responsibilities or duties which can materially affect the investment firm’s risk profile.
The level of remuneration of a given individual is, however, not necessarily a function of responsibilities or duties, but rather a function of the individual’s skillset and line of work. For instance, in the field of technology, financial institutions compete with other FinTech institutions and global technology firms to attract and retain top talent. In order to attract top talent, it is not unheard of that prospective candidates receive offers in excess of the quantitative MRT threshold. While such candidates undoubtedly bring value to financial institutions, their role and responsibilities are much narrower than employees with a larger scope of responsibilities.
Concretely, utilising remuneration levels to determine whether a person qualifies as a material risk taker is a poor proxy and reduces the ability of financial institutions to compete with, for instance, larger technology companies, which are not subject to similar rules for comparable work.
We are of the view that the concept of a quantitative MRT leads to the identification of staff which does not truly affect the risk profile of the firm. However, these provisions do impose a significant cost on investment firms, inter alia on the identification of those quantitative MRTs and the requesting of waivers from the NCA, which are to be substantiated on an individual basis. This is coupled with the costs of ensuring changes to the compensation structure of employees (payment in instruments, deferrals) are communicated and implemented adequately. As such, we are of the view that determination of MRTs should be made solely along a qualitative axis. This also aligns with the view of the FCA as expressed in paragraph 9.59 of their IFPR Consultation Paper C21/7 as published in April 2021.
Q30: Are the different provisions regarding the oversight on remuneration policies, disclosure and transparency a concern for firms regarding the level playing field between different investment firm, UCITS management companies and AIFMs, e.g., with regard to the costs for the application of the requirements or the need to align these underlying provisions? Please provide a reasoning for your position.
Investment firms subject to IFD are held to disclosure requirements and transparency obligations which are aligned closely with those requirements and obligations applicable to credit institutions. The data collection exercises regarding remuneration, high earners and the gender pay gap require a significant expenditure of internal resources, and the publications resulting from these data collection exercises produce data that can be used to identify or infer personal data relating to the remuneration levels of individuals within a given investment firm. The risk thereof is compounded by the ongoing obligation on investment firms to make public aggregated quantitative information on remuneration, broken down by senior management and identified staff under Article 51(c) IFD. As a result, investment firms should in our view not be required to make public aggregated quantitative information under Article 51(c) IFD where this would permit third parties to identify or infer levels of remuneration of individual members staff.
Further, in our experience, the resource expenditure on the aforementioned data collection exercises can be significant. The various data collection exercises require a differing logic on the calculation and allocation of income, including on whether members of staff are within the scope of reporting. By way of example, a member of staff qualifying as high earner is within the scope of higher earner reporting irrespective of whether that member of staff is employed by year’s end, but falls outside the scope of gender pay gap reporting. These different methodologies require firms, in effect, to set up three reporting mechanisms with individual specifications.