Guidelines on liquidity exemption investment firms - Art 43(4) IFR.pdf

General Information

This document is a guide published by the European Banking Authority (EBA) in 2022, entitled "Guidelines on liquidity exemption investment firms - Art 43(4) IFR." It specifies the criteria allowing competent authorities to exempt certain small non-interconnected investment firms from the liquidity requirements provided by Article 43(1) of Regulation (EU) 2019/2033 (IFR). The scope covers investment firms subject to the IFR/IFD framework, particularly those meeting the conditions of Article 12(1) of the same regulation, within the territory of the European Union, as of 28 November 2022. The guide details the investment services eligible for the exemption, the exemption criteria, as well as the modalities for granting and withdrawing this exemption (p. 1-14).

Executive Summary

The EBA guide addresses the exemption of small non-interconnected investment firms from the mandatory liquidity requirements imposed by Regulation (EU) 2019/2033 (IFR). This topic is crucial as it aims to balance the need to ensure financial stability and market protection with the proportionality of regulatory requirements for small entities less exposed to liquidity risks. The main findings are that these small firms do not hold client assets, which reduces their exposure to liquidity risks related to client losses, but they must nevertheless have sufficient liquid resources to ensure an orderly wind-down of their activities. The guide precisely defines the investment services eligible for the exemption, notably excluding firms granting credits, operating securities lending, or managing trading platforms (MTF/OTF), due to associated liquidity risks. The exemption assessment must be based on an analysis of liquidity needs under normal and stressed conditions, including off-balance sheet positions. The exemption process is triggered upon the investment firm's request, which must provide detailed information to the competent authority, which may withdraw the exemption if criteria are no longer met, with a maximum 90-day period to comply with liquidity requirements. These guidelines aim to harmonize the application of the exemption within the European Union, thus ensuring equal treatment and consistent supervision (p. 3-14).

Context and Objectives

Before the entry into force of the IFR/IFD in June 2021, prudential rules applicable to investment firms were integrated within the broader framework of requirements for credit institutions, without specific harmonized liquidity requirements. The IFR introduces for the first time uniform liquidity requirements, imposing on investment firms to hold a minimum amount of liquidity equivalent to one-third of their fixed overheads, to ensure an orderly wind-down of their activities. However, the regulation provides a possible exemption for small non-interconnected investment firms, subject to rigorous assessment by competent authorities. The guide's objective is to specify the exemption criteria, ensure uniform application across the Union, and define practical modalities for granting and withdrawing this exemption, while considering the specific risks related to the activities carried out by these firms (p. 4-7).

Summary of Key Points by Theme

Investment services eligible for the exemption: Only firms providing a limited set of services are eligible, notably reception and transmission of orders, order execution on behalf of clients, portfolio management, investment advice, and placement without firm commitment. Services involving high liquidity risks, such as granting credits or loans, third-party guarantees, or securities lending, exclude the exemption (p. 11-13).

Liquidity risk assessment: Competent authorities must analyze firms' liquid resource needs under normal and stressed conditions, considering cash flows, off-balance sheet positions, and risks related to foreign exchange operations. The exemption can only be granted if the firm is not exposed to significant liquidity risks (p. 5-6, 12-13).

Exemption procedure: The exemption is granted upon the investment firm's request, which must provide complete documentation describing its activities and demonstrating compliance with criteria. Authorities may request additional information and must immediately notify the firm in case of exemption withdrawal. In case of withdrawal, the firm has a maximum of 90 days to comply with liquidity requirements (p. 11-14).

Economic impact and harmonization: The introduction of these guidelines aims to standardize the exemption's application in the EU, ensuring fair treatment. The impact analysis highlights that initial costs for authorities and firms are moderate, but the savings realized by exempted firms on liquid asset holding costs are real. However, the granularity of criteria may limit the extent of exemptions granted (p. 14-19).

Public consultation and feedback: Two responses were received during the public consultation, raising concerns about the administrative burden related to the exemption request and the limitation of eligible services. The EBA confirmed that documentary requirements must be limited to already available information and that exclusions, notably for firms operating trading platforms, are justified by their specific role. The guidelines were not modified on these points (p. 20-25).

Main Findings and Lessons Learned

Findings: The IFR imposes harmonized liquidity requirements for all investment firms, with a possible exemption for small non-interconnected entities. These firms do not hold client assets, thus reducing certain liquidity risks. The exemption is conditioned on a rigorous assessment of liquidity risks related to activities carried out and positions held.

Assumptions: The exemption is based on the assumption that small investment firms providing only certain limited services present a low or negligible liquidity risk. The assessment must consider normal and stressed conditions, as well as off-balance sheet flows.

Interpretations: The EBA interprets that certain activities, notably granting credits, securities lending, or managing trading platforms, generate liquidity risks incompatible with the exemption. The exemption procedure must be proportionate but sufficiently detailed to ensure uniform application.

Uncertainties: The precise economic impact of the exemption is difficult to quantify due to the diversity of profiles of the firms concerned and the lack of regular collection of detailed data at the European level. The weight of administrative costs related to the exemption request could discourage some firms from applying, thus limiting expected benefits.

Conclusions and Author's Recommendations

The EBA concludes that the exemption of small non-interconnected investment firms from liquidity requirements must be applied rigorously, based on precise criteria and a thorough assessment of liquidity risks. The guide recommends that competent authorities grant the exemption only to firms providing a restricted set of investment services, excluding those exposed to high liquidity risks. It is also recommended that authorities ensure continuous monitoring of exemption conditions and withdraw it as soon as criteria are no longer met, with a 90-day period for compliance. Finally, the guide emphasizes the need for harmonized application within the European Union to ensure fair treatment and enhanced financial stability. Competent authorities must notify their compliance with these guidelines before 28 November 2022 (p. 3-14, 19-25).