The final report on SREP guidelines provides a framework for the assessment and supervision of investment firms. It addresses key aspects such as business model analysis, internal governance, and the assessment of capital and liquidity risks. The guidelines aim to ensure proportionate and effective supervision of investment firms, taking into account their structure and specific vulnerabilities.
This document is the final report of the joint guidelines of the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) on common procedures and methodologies for the Supervisory Review and Evaluation Process (SREP) of investment firms, pursuant to Directive (EU) 2019/2034. Published in 2022, this 163-page guide is addressed to competent authorities supervising investment firms of classes 2 and 3, according to the classification of Regulation (EU) 2019/2033, excluding large investment firms classified as credit institutions. The scope covers governance, risk management, capital, liquidity, business model aspects, and the proportionate implementation of the SREP, applicable from 19 June 2023 (p. 1-52).
The main subject is the establishment of a harmonized framework for the Supervisory Review and Evaluation Process (SREP) of investment firms, to ensure consistent and effective supervision within the European Union. This framework is crucial to assess viability, business model sustainability, and the risk profile of investment firms, and to define necessary prudential measures. Major findings are that the SREP relies on four key elements: business model analysis, internal governance and controls assessment, capital and liquidity risk evaluation, and adequacy of own funds and liquidity resources. A common rating system distinguishes risk and viability scores, allowing a consolidated evaluation reflecting the overall health of the firm. These guidelines introduce a classification into four categories of investment firms, modulating the frequency, depth, and intensity of assessments according to size and risk profile. They also integrate coordination between prudential authorities, AML/CFT, and market authorities, as well as linkage with early intervention and resolution mechanisms, notably to identify firms “in default or likely to be so.” The main recommendations are that competent authorities apply these guidelines proportionately, ensure continuous dialogue with firms, use scores to prioritize resources and measures, and cooperate closely with other authorities for holistic supervision. Implementation is planned from 19 June 2023, with compliance reporting expected two months after the publication of official translations (p. 4-15).
The document responds to the obligation set by Article 45 of Directive (EU) 2019/2034, which requires the EBA and ESMA to establish common guidelines for the SREP of investment firms, to ensure consistent and effective application of prudential rules. Before this directive, some investment firms were subject to rules applicable to credit institutions, without consideration of their specificities. The new regulation clearly distinguishes classes of investment firms, with an adapted framework for classes 2 and 3. The objective is to harmonize supervisory practices, ensure adequate prudential treatment of risks specific to investment firms, and guarantee a level of supervision proportionate to their size, complexity, and risk profile. The guide specifies procedures, methodologies, evaluation criteria, and modalities for applying prudential measures, while leaving room for judgment to competent authorities within the applicable legislation. The scope excludes large investment firms (class 1) which remain subject to credit institution rules (p. 6-17).
- Common SREP framework: The SREP is structured around ten key components, including the categorization of investment firms into four categories according to their size and risk profile, monitoring of key indicators, business model analysis, internal governance assessment, capital and liquidity risk analysis, assessment of own funds and liquidity resources adequacy, overall evaluation, and implementation of prudential measures (p. 8-9).
- Categorization and proportionality: Categories 1 to 3 are defined according to asset and off-balance sheet exposure thresholds, as well as the nature of activities performed. The category of small non-interconnected firms benefits from lighter supervision. The frequency of assessments and intensity of dialogue with firms vary according to these categories, with minimum engagement requirements defined (p. 24-33).
- Monitoring of key indicators: Authorities must regularly monitor financial and non-financial indicators adapted to the size, business model, and risk profile of firms, to detect any significant change or anomaly justifying a SREP reassessment (p. 34-35).
- Business Model Analysis (BMA): The evaluation covers short-term viability (12 months) and medium-term strategic sustainability (at least 3 years), combining quantitative analyses (P&L, balance sheet, concentrations, risk appetite) and qualitative factors (external factors, key dependencies). The BMA identifies major vulnerabilities and integrates risks related to money laundering and terrorist financing (ML/TF) in cooperation with AML/CFT supervisors (p. 36-41).
- Internal governance and controls assessment: The objective is to verify the adequacy of governance and control arrangements relative to the risk profile and complexity of the firm, including risk management, remuneration policies, business continuity, and IT-related risks (p. 46-60).
- Capital risk assessment: Risks are analyzed in terms of client risk, market risk, firm risk, and other relevant risks, to determine the adequacy of own funds and the need for additional requirements (Pillar 2) (p. 63-84).
- Liquidity risk assessment: The analysis covers the capacity to meet liquidity needs under normal and stressed conditions, considering the specifics of market activities, notably market making and proprietary trading (p. 103-110).
- Rating and scoring: A common rating system assigns risk scores (1 to 4) to individual risks and viability scores to SREP elements and the overall evaluation, facilitating communication, prioritization, and decision-making. The overall score may trigger supervisory or early intervention measures, and identify firms “in default or likely to be so” (p. 11-12, 27-29).
- Inter-authority cooperation: The SREP integrates information from other supervisory activities, including AML/CFT, investor protection, and recovery plans, with structured information exchange between prudential authorities, AML/CFT, and market authorities (p. 12-14).
- Prudential measures and link to resolution: SREP results serve as a basis for implementing quantitative and qualitative measures, including additional capital and liquidity requirements, as well as for determining default situations, triggering early intervention or resolution procedures under the applicable framework (p. 14-15).
- Organization and implementation: Authorities must clearly define responsibilities, procedures, dialogue modalities with firms, and approval and escalation mechanisms, ensuring compliance with transparency and communication obligations (p. 29-30).
- Established facts: The SREP is a structured and harmonized process to supervise investment firms of classes 2 and 3, based on a proportionate approach and integrating precise categorization. The framework covers all significant risks and incorporates a common rating facilitating comparability and communication. Cooperation between prudential authorities, AML/CFT, and market authorities is formalized for comprehensive supervision. The link with early intervention and resolution mechanisms is clearly defined.
- Assumptions: Effective implementation relies on the capacity of competent authorities to apply the guidelines with adequate supervisory judgment, to have reliable information, and to coordinate their actions. Proportionality is assumed to allow adaptation of resources and depth of assessments according to firm characteristics.
- Interpretations: The integrated SREP approach allows identification of vulnerabilities specific to investment firms, notably regarding business model and ML/TF risks. The scoring system, although not automatic, serves as a decision-support and prioritization tool. Inter-authority cooperation is essential for effective supervision.
- Uncertainties: The effectiveness of the framework will depend on data quality, authorities’ capacity to apply proportionality without compromising rigor, and coordination among different authorities. The real impact of measures taken on the stability of investment firms remains to be observed in practice.
The guidelines finalized by the EBA and ESMA define a common and harmonized framework for the SREP of investment firms of classes 2 and 3, applicable from 19 June 2023. They recommend that competent authorities adopt these procedures and methodologies integrating the principle of proportionality, establish a common rating system to facilitate supervision and communication, and ensure continuous dialogue with supervised firms. Authorities must cooperate closely with AML/CFT supervisors and market authorities for comprehensive risk analysis. The framework also provides for consideration of SREP results in implementing prudential measures, including additional capital and liquidity requirements, and in determining default situations leading to early intervention or resolution. Authorities must notify their compliance with these guidelines within two months following the publication of official translations. This framework aims to strengthen financial stability, client protection, and market integrity within the European Union.
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