This report examines the prudential framework for investment firms, addressing the categorization of these firms and the conditions required for them to be considered small and non-interconnected. It also analyzes liquidity requirements and risks not covered by existing K-factors. Finally, the report discusses the implications of the adoption of the Banking Package and the governance of remuneration within…
This document is a 167-page technical report published in 2025 by the European Banking Authority (EBA) in response to a Call for Advice from the European Commission concerning the prudential framework applicable to investment firms. The scope covers the categorization of investment firms, the adequacy of prudential requirements (including K-factors), prudential consolidation, liquidity requirements, regulatory interactions, remuneration, as well as the impacts of crypto-assets and related activities. The report is based on quantitative analyses, public consultations, and data collected from competent authorities and sector stakeholders (p. 1-54).
- Subject: The report responds to the European Commission's request to assess and propose improvements to the prudential framework for investment firms, notably the IFR/IFD regulation.
- Importance: This framework aims to ensure regulation that is appropriate, proportionate, and sensitive to the specific risks of investment firms, distinct from banks, while guaranteeing financial stability and client protection.
- Main findings:
- The current framework generally meets its objectives, providing a robust regime adapted to the size, activities, and complexity of investment firms.
- Technical issues remain, notably regarding the clarity of categorization thresholds, consistency of definitions, transitions between categories, and consideration of emerging risks such as crypto-assets.
- The categorization into three classes (Class 1, Class 2, Class 3) is relevant but requires clarifications and harmonizations, especially on the 5, 15, and 30 billion euro consolidated asset thresholds.
- The K-factor system is innovative and suitable but can be improved in its definitions and calculations.
- The three-month wind-down period for fixed overhead requirements (FOR) is generally appropriate.
- The inclusion of costs related to non-MiFID activities in the FOR is justified to avoid disorderly wind-downs.
- Conclusions: The IFR/IFD framework is overall effective but must be adjusted to improve coherence, proportionality, transparency, and the ability to integrate sector developments, notably risks related to crypto-assets.
- Recommendations:
- Maintain the current categorization methodology but harmonize thresholds and clarify definitions.
- Maintain the Class 1 minus category with strengthened criteria to better reflect risk profiles.
- Remove certain notification obligations and reporting thresholds to improve supervision.
- Increase size thresholds for qualification in Class 3.
- Maintain the three-month wind-down period for the FOR.
- Do not differentiate cost deductions by business model for the FOR.
- Integrate exchange rate fluctuations related to client funds as deductions in the FOR under strict conditions.
- Clarify the treatment of profit distributions in the FOR calculation.
- Improve definitions and calculations of K-factors to better reflect risks.
- Continue monitoring and integrating risks related to crypto-assets and new activities.
(p. 11-14)
- The IFR/IFD prudential framework was introduced to address shortcomings of the CRR/CRD IV regime applied to investment firms, notably in terms of complexity, risk sensitivity, and national harmonization.
- The objective is to establish a framework adapted to the specific risks of investment firms, proportionate to their size and activities, and to prevent regulatory arbitrage.
- The European Commission requested the EBA and ESMA to provide a technical opinion on several key aspects: categorization, prudential requirements, consolidation, liquidity, regulatory interactions, remuneration, crypto-assets, ESG risks, and specific activities (commodities, energy).
- The report is based on extensive public consultation, quantitative data collection, and close cooperation with competent authorities.
- The report’s limitations include the absence of detailed analysis on some topics already covered by other EBA publications and the exclusion of activities related to commodity markets, which will be addressed in a subsequent report.
(p. 11-13)
Categorization of investment firms:
- Three main classes: Class 1 (large, systemic, banking activities), Class 2 (intermediate), Class 3 (small, non-interconnected).
- Key thresholds: 30 billion EUR (Class 1), 15 billion EUR (Class 1 minus), 5 billion EUR (complementary criteria).
- Need to harmonize calculation methodologies and scope of thresholds to avoid inconsistencies and regulatory arbitrage.
- Maintenance of the Class 1 minus category with proposals for additional indicators to better reflect systemic risk.
- Recommendation to remove certain notification obligations for the EBA and lower reporting thresholds for groups.
Conditions for qualification as small and non-interconnected (Class 3):
- Nine cumulative quantitative criteria, including assets under management (<1.2 billion EUR), client orders, absence of custody assets, balance sheet size (<100 million EUR), revenues (<30 million EUR).
- Proposal to increase size thresholds to 200 million EUR for the balance sheet and 50 million EUR for revenues.
- Maintenance of the current framework for the transition between Class 2 and Class 3, without additional transitional periods.
Fixed overhead requirements (FOR):
- Calculation based on one quarter of fixed overheads, with specific deductions.
- Three-month wind-down period deemed appropriate for all types of firms, without differentiation by business model.
- No recommendation to adapt deductions by business model to preserve simplicity.
- Deduction of exchange rate fluctuations related to client funds allowed only if fund segregation complies with Directive 2017/593.
- Clarification needed on the treatment of profit distributions in the FOR calculation to avoid misinterpretations.
Existing K-factors:
- Innovative system capturing client risks (K-AUM, K-CMH, K-ASA, K-COH), market (K-NPR, K-CMG), and counterparty (K-TCD) risks.
- Need to improve definitions and methodologies to better reflect actual risks.
- Discussion on the possible introduction of new K-factors to cover unaddressed risks.
Regulatory interactions and crypto-assets:
- Analysis of interactions between IFR/IFD, CRR/CRD, MiFID, MiCA, UCITS/AIFM.
- Need to integrate risks related to crypto-assets and new associated services.
Remuneration and governance:
- Review of scope, policies, remuneration committees, variable remuneration requirements, and transparency.
- Proposal of adjustments to improve coherence and proportionality.
(p. 15-54)
- The IFR/IFD framework is generally effective and adapted to the risks of investment firms, with clear categorization into three classes.
- Categorization thresholds present inconsistencies in their definition and calculation, which may lead to divergent application and regulatory arbitrage risks.
- The three-month wind-down period for FOR calculation is validated by historical data, with no correlation to activity type.
- Costs related to non-MiFID activities must be included in the FOR calculation to avoid disorderly wind-downs.
- Exchange rate fluctuations related to client funds can be deducted from the FOR only if fund segregation complies with strict rules.
- Profit distributions must not be deducted from fixed costs, clarifying a misinterpretation.
- The K-factor system covers main risks well but requires methodological improvements and consideration of new risks.
- The transition between Class 2 and Class 3 is frequent but the current framework is considered proportionate and adequate.
- Integration of risks related to crypto-assets and new activities is a major challenge for the future prudential framework.
- Recommendations aim to strengthen coherence, transparency, proportionality, and adaptability of the framework.
- Uncertainties remain regarding the precise impact of proposed changes on operational costs and firms’ competitiveness.
(p. 11-54)
- The IFR/IFD prudential framework meets its initial objectives but can be improved on several technical points.
- Key recommendations:
- Maintain the current categorization methodology while harmonizing the 5, 15, and 30 billion EUR thresholds for better coherence.
- Maintain the Class 1 minus category, complementing assessment with additional harmonized risk indicators.
- Remove the direct notification obligation to the EBA for threshold breaches and lower the 5 billion EUR reporting threshold for groups.
- Increase thresholds for Class 3 qualification to 200 million EUR for total assets and 50 million EUR for annual revenues.
- Maintain the three-month wind-down period for FOR calculation, without differentiation by business model.
- Do not modify cost deductions by business model to preserve simplicity and coherence.
- Include exchange rate fluctuations related to client funds as deductions in the FOR only if segregation complies with Directive 2017/593.
- Clarify the treatment of profit distributions in the FOR calculation to avoid inappropriate deductions.
- Improve definitions and calculations of K-factors to better reflect risks, and consider new K-factors to cover unaddressed risks.
- Continue monitoring and integrating risks related to crypto-assets and related activities.
- These measures aim to strengthen the robustness, proportionality, transparency, and competitiveness of the prudential framework for investment firms in the European Union.
(p. 14-54)
Synthesis note written from the full document by DataSAI Academy. This note comes from the scientific library of the DataSAI Academy, open to all.