Consilium agrees position on IFR and IFD – moving to a new prudential regulatory regime for investment firms



What’s happening and why now?

On January 7, 2019 the Council or “Consilium” of the European Union, which is part of the EU bicameral legislature and represents the executive governments of the EU’s Member States, announced1 that it had endorsed the European Commission’s (the Commission) legislative proposals for prudential requirements for investment firms: the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD), originally proposed December 2017. The aim of the proposals is to create a new, simpler and more risk-sensitive prudential capital regime for MiFID Investment Firms built around quantitative metrics, called “K-Factors,” that define regulatory capital levels in a more proportionate manner than existing rules (CRR/CRD IV), which were drafted with the banking sector in mind and which are themselves subject to reform work during 2019 in the form the EU’s “Banking Package” i.e. CRR 2/CRD V, SRMR 2 and BRRD 2. The IFR/IFD framework makes a number of technical amendments to CRR/CRD IV as well as the MiFID II/MiFIR frameworks, including in respect of general rules on third-country access and extraterritorial application of principles of EU financial services law (or supervisory outcomes) to such third-country firms. It remains to be seen, given all the other tabled amendments to that framework whether the EU will publish a fully consolidated version reflecting all changes in the pipeline. 

This Client Alert provides an overview of the Consilium’s tabled changes and how the 6,000+ firms affected by the IFD and IFR, notably those that provide “bank-like” activity will be regulated for prudential capital purposes. While some smaller firms may not face much change, it is those “Class 1” firms, i.e., those that provide “bank-like” services and which are domiciled in or operating through the Eurozone and its Banking Union that may, in addition to higher prudential capital requirements, also become subject to supervision by the European Central Bank (ECB) in its role at the helm of the Single Supervisory Mechanism (SSM) either due to their size or pursuant to a supervisory decision in accordance with Art. 4(a) IFD – the introduction by the Consilium of that power is also in keeping with how the ECB-SSM can decide to include specific entities within its supervisory remit. 

This Client Alert should be read in conjunction with the first part of our Eurozone Hub’s coverage on this development.2 Key changes and likely further developments are highlighted herein. In terms of the legislative process, the Consilium’s agreed position on IFR/IFD3 will now be finalized between the Council and the Parliament (the former have already voted on its position on September 24, 2018) presumably prior to the European Parliamentary elections in May 2019. This would mean that the IFR/IFD Regime would enter into force by mid to late 2019 at the earliest with a new five-year transition period allowing affected firms time to transition. With all that is set to be advanced additionally in the EU’s regulatory and supervisory pipeline, as flagged in our earlier coverage, many firms may want to take early pre-emptive action either to source new regulatory capital or to put in place arrangements to limit risks that could flow into the K-Factors. This forward planning may lead to firms looking at rearranging regulated activities and who does what and where. 

What is certain is that the IFR/IFD framework will also change the supervisory tone of national competent authorities (NCAs) as well as the ECB-SSM, as the IFR/IFD introduces much more prescriptive requirements on cooperation and data-sharing between authorities as well as cross-border supervisory inspections. This would mark a major departure and shift in how supervision is administered in practice for MiFID Investment Firms and begin to move much closer to reflect the current set-up of the ECB-SSM, including a greater sharing of supervisory data with monetary authorities, including in their financial stability as well as payment and settlement systems oversight roles. 

What does the IFR/IFD aim to create?

In summary, the IFR/IFD framework aims to create a more risk-focused regime that is tailored and reflective of the activities of an Investment Firm rather than to continue to treat all Investment Firms in an identical fashion pursuant to CRR/CRD IV. Two core concepts that change how current prudential requirements apply to Investment Firms are at the heart of the proposal:

1. Creating classes of Investment Firms

These can be distinguished between those that are:

  • Class 1 Firms = systemic firms that undertake “bank like activity” and which will be reclassified as credit institutions and continue to be subject to the full CRD IV/CRR Framework, as amended by the EU’s Banking Package and for the Banking Union, how those rules are applied by the SSM. The IFR/IFD regime will not apply to Class 1 Firms.
  • Class 2 Firms = other non-systemic Investment Firms whose activity places these above quantitative thresholds that are used to categorize Class 3 entities.
  • Class 3 Firms = smaller and non-interconnected entities to which a simplified version of the regime applies.

2. Setting of capital requirements in a manner that is more proportionate to the risks specific to the Class of Investment Firms. The “Class” that an Investment Firm will fall into will trigger the relevant minimum amount of regulatory capital levels.

3. Standardizing relevant conduct of business obligations, supervisory tools and internal model governance. All Classes of Investment Firm are required to comply with additional conduct of business requirements—predominantly internal governance, risk management, reporting, remuneration and other conduct of business matters that seem to be duplicative of measures already legislated for in MiFID II/MiFIR (or to a certain degree CRR/CRD IV) as well as other legislation. The key difference is that the IFD, where the bulk of these requirements are stipulated, tasks the EBA and ESMA to publish Guidelines setting out further compliance expectations.  The IFD also sets out how the EU’s Supervisory Review and Evaluation Process (SREP), an integral part of the supervisory cycle, will be applied to firms in scope of the IFR/IFD. Similar rules are set out in how competent authorities review investment firms’ compliance with permissions to use internal models, given the ECB-SSM’s own efforts in expanding—while also streamlining—how these parts of the Single Rulebook are applied to BUSIs, it is conceivable that some of the lessons learned and supervisory principles and processes could be mapped over to how the new IFR/IFD framework might be applied to firms. 

The allocation to a specific Class is driven by both the type of MiFID Investment Activity pursuant to MiFID II/MiFIR (i.e., qualitative consideration) and the K-Factor values (i.e., quantitative considerations). For many firms, especially for so called “exempt CAD” advisory firms such as those relocating from the UK, the initial capital could go from EUR 5,000 to 75,000. For the breadth of other Investment Firms, the increases could go from EUR 50,000 to 75,000, possibly 150,000 up to a maximum of EUR 5 million for so-called Class 1 Investment Firms and/ or credit institutions. Those dealing on own account and  (and the key word is “and”) underwriting of financial instruments will have initial capital set at EUR 750,000. 

In short, K-Factors are clearly costly in terms of increased own fund requirements but will also likely be costly in terms of investment in systems and resources needed to identify, mitigate and manage risks generally as well as those specifically relevant to the K-Factors. A number of affected firms will most likely look to recoup the costs elsewhere.

The following presents an overview of the K-Factors, which have been grouped into three categories, reflecting three risk types:

K-Factor Type Overall K-Factor(s).4 Description
Changes made by the Consilium proposal set out in bold and italic

Risk to Client (RtC)


Assets under management - under both discretionary portfolio management and non-discretionary (advisory) arrangements that are of an “on-going nature.”

The Consilum proposal introduces and defines the term “investment advice of an on-going nature” as “investment advice involving a continuous or periodic assessment of a client portfolio of financial instruments on the basis of a contractual arrangement.”

The definition of “financial instrument” was amended to that of MiFID II from CRD IV.

Moreover, the revisions also call for AUM to be calculated on the first as opposed to within the first 14 business days of each calendar month.


Client money held.

Moreover, the revisions also call for CMH to be calculated over a six-month as opposed to a three-month horizon, and in the case of missing actual data use proxies by reference to the data supplied as part of the license application.


Assets safeguarded and administered.

The Consilium’s revisions also call for AUM to be calculated on the first as opposed to within the first 14 business days of each calendar month.


Client orders handled - execution only in name of customer and reception and transmission of orders.

Risk to


Net position risk - based on the market risk requirements of the CRR II Proposal and made appropriate for investment firms (only applicable to trading book positions).


The Consilium proposal amends this substantially from: Clearing member guarantee – amount of initial margins posted with a clearing member, where the execution and settlement of transactions of an investment firm dealing on own account take place under the responsibility of a general clearing member.

To: “Clearing margin given to the amount of total margin required by a clearing member or qualifying CCP, where an execution and settlement of transactions of an investment firm dealing on account take place under the responsibility of a clearing member.”

Moreover, the Consilium proposal defines “clearing member” with reference to EMIR but limits it those undertakings that are established in an EU Member State. This may have some spillover effects on various clearing relationships/documentation.

Risk to Firm (RtF)


Daily trading flow - value of transactions where the firm is trading on own name (on own account or in execution of client orders) (only applicable to trading book positions.)


Trading counterparty default - based on the BCBS proposals for counterparty credit risk and simplified for investment firms (only applicable to trading book positions.) Takes into account OTC derivatives, “long-settlement transactions,” “repurchase transactions” (repurchase and reverse repurchase transactions that are Securities Financing Transactions for the purposes of the same named Regulation - SFTR), and “securities or commodities lending or borrowing transactions.”

Changes proposed by the Consilium explicitly now reference “Securities Financing Transactions” for the purposes of the SFTR as well as “loans granted by the investment firm on an ancillary basis as part of an investment service” – and this would cover a breadth of activity of non-SFTR covered margin lending as well as prime brokerage related credit facilities.


Concentration - taking inspiration from the CRR large exposures regime for trading book and simplified for investment firms (only applicable to trading book positions.)

What are the Consilium’s changes to the proposed K-Factors and the “other” obligations?

The Consilium’s proposed changes, including as set out in the table above, provide technical clarifications to the various K-Factors and “other” obligations set out in the IFR/IFD, namely that:

1. A much more refined approach to defining which Investment Firms will be treated as Class 1 Firms than under the previous proposal. This includes those that are authorized and supervised pursuant to MiFID II to carry out any of the activities of:

  • Dealing on own account; or
  • Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis,

and where:

  • The total value of the “consolidated assets of the investment firm” exceeds EUR 15 billion, calculated as an average of the last 12 consecutive months and excluding the value of individual assets of any subsidiaries carrying out the activities in point 1 are established outside the EU; or
  • The total value of the consolidated assets of the Investment Firm is less than EUR 15 billion, and the Investment Firm is part of a group in which the total value of the consolidated assets of all undertakings in the group that carry out any of the activities in points 1 (a) and (b) exceed EUR 15 billion, calculated as an average of the last 12 consecutive months and excluding the value of individual assets of any subsidiaries carrying out the activities in point 1 established outside the EU; or
  • The Investment Firm, which must have a total value of consolidated assets exceeding EUR 5 billion as an average of the last consecutive 12 months) is subject to a decision by the competent authority (NCA or ECB-SSM) pursuant to Art. 4(a) IFD taking it into scope of the IFR/IFD framework as a Class 1 Firm.  A decision may be granted if there are grounds to suggest that not supervising it as a Class 1 Firm could lead to at least any of the following: the potential for systemic risk in the event of the firm’s failure, its roles as a clearing member or on the basis of the complexity of the nature of the firm and its interconnectedness with the financial system including the significance of its cross-border activities.5We would imagine that Art. 4(a) IFD measure will be the primary means of bringing MiFID Investment Firms that are connected to BUSIs into the scope of Banking Union supervision.

The above does not apply to any of the following:

  1. A “commodity and emission allowance dealer”
  2. A “collective investment undertaking” – and one assumes this applies to the management company
  3. An insurance undertaking – it is not clear whether this also applies to reinsurance undertaking or any other firm covered by Solvency II or the IORPS 2 Directive i.e. pension funds – where not covered by a collective investment undertaking.

2. In borrowing from the concepts of threshold triggers, as introduced say by EMIR, Investment Firms are required to notify the competent authority, which may be a NCA plus the ECB-SSM, without undue delay where it breaches the threshold. A Class 1 Firm which no longer meets the thresholds over a period of 12 consecutive months, or where a competent authority decides it no longer meets the thresholds will be downgraded to a Class 2 Firm.

3. The Consilium’s proposals in the IFR welcomingly also permit prudential consolidation in accordance with existing EU principles, either on the basis of applying for a consolidated treatment or a waiver. This means that Art. 5 IFR would permit certain entities that are part of a group subject to consolidated supervision or themselves the parent undertaking of the group may “benefit” from consolidated prudential regulatory treatment. New additions in Art. 7 IFR require, in keeping with the CRR/CRD IV regime, that both the parent undertaking and the subsidiaries set up a “proper organization structure and appropriate internal control mechanisms to ensure that data required for consolidation are duly processed and forwarded.”

4. The change to the terminology in RtC from “Customer” to Client would suggest that this is not just relevant to “Retail Clients” but applies to a much wider base.

5. Changes to the K-CMG factor are fundamental in nature and may redefine both the quantitative prudential requirements but also have qualitative impact that requires redocumenting arrangements and relationships.

6. Client money that is deposited with a bank account or a custodian in the name of the client but where the investment firm has access to these funds via a “third party mandate” will not count towards the K-CMH factor i.e. the client money held. The issue with this change is that it is unclear as to what constitutes a “third-party mandate”.

7. The K-RtM factor i.e. risk to market indicator for Investment Firms which deal on own account is based on the rules for market risk for positions in financial instruments, in foreign exchange and in commodities in accordance with CRR (as amended by CRR 2).  The original proposed wording had permitted that firms could apply the CRR Standardized Approach if under a EUR 300 million threshold. This threshold has been eliminated so that firms can pick to apply the CRR Standardized Approach, the Revised Standardized Approach or the use of Internal Models.

8. Changes in the IFD introduce requirements that facilitate information sharing between the relevant competent authorities, often in other Member States, as to the operations of the Investment Firm, clearing member and/or CCP.

9. “Small and non-interconnected” i.e. Class 3 Investment Firms are to be exempted from the requirement to hold one third of their fixed overheads requirements in liquid assets, and the corresponding haircuts on the Commission Delegated Regulation on the Liquid Coverage Ratio. Those non-exempted “small and non-interconnected firms” and those which are not licensed to carry out trading or underwriting activities are permitted to include items related to trade debtors and fees or commissions receivable within 30 days as liquid assets, provided they do not exceed one-third of the minimum liquidity requirement, do not count towards additional liquidity requirements set by a NCA and are subject to a 50% haircut.

10. The Consilium also makes relevant changes in the definition of an “ancillary services undertaking” which now means an undertaking the principal activity of which consists of owning or managing property [undefined term], managing data-processing services or a similar activity which is ancillary to the principal activity of one or more investment firm.” This raises a number of questions as to whether it may cover a wider set of business that may historically be outside the scope of the EU’s financial services regulatory perimeter.

11. In order to ensure that the refined definition of “Trading Book,” which now includes financial instruments and commodities (it is unclear whether physical commodities) held by an investment firm (we assume “held” includes custody and other arrangements including when (sourced) on loan) either with trading intent or in order to hedge positions held with trading intent, the Commission proposal defines “positions held with trading intent” which includes any of the following:

  • Proprietary positions and positions arising from client-servicing and market-making
  • Positions intended to be resold short-term
  • Positions to benefit from actual or expected short-term price differences between buying and selling price differences or from other price or interest rate variations.

12. The Consilium’s proposed changes also amend the counterparty type specific risk factors that apply to various types of entities—notably exposures to central governments, central banks and public sector entities are no longer risk free. Other “refinements” include changes to how the replacement costs of certain transactions are treated, including securities financing transactions where both legs of the transactions are securities.

13. In order to prevent anti-avoidance and regulatory arbitrage, competent authorities (NCAs and ECB-SSM) are instructed to “endeavor to avoid situations where Investment Firms would structure their operations to avoid the thresholds set in [the IFR], or to unduly limit [the competent authorities] discretion to subject [the Investment Firms] to the requirements of the [CRR/CRD IV Framework]” and thus categorize those as Class 1 Firms.

14. The Consilium has also revisited the requirements for NCAs to monitor and require the public disclosure of the remuneration arrangements of “high earners.” These were already quite detailed, and the Consilium deleted reference to details permitting those arrangements be published on an aggregate as opposed to a more granular basis. While the IFR is clear that Investment Firms should disclose their levels of regulatory capital publicly, their prudential requirements, their governance arrangements as well as their remuneration policies and practices, it will remain to be seen whether affected firms (primarily Class 2 and Class 3 that issue financial instruments that qualify as AT 1 for capital purposes will find grounds to dispute this requirement.

15. The EBA and ESMA are also tasked to maintain a list of “all forms of funds or instruments in each Member State that qualify as such own funds.”

16. The Consilium also makes changes to Part 7 of the IFR requiring that Class 1 and Class 2 Investment Firms report to the competent authorities on a quarterly basis. Class 3 firms may, subject to available derogations, report annually rather than quarterly. The original requirement was for regulatory reporting on level of composition of own funds, capital requirements (incl. calculations), balance sheet and revenue breakdown by investment services and applicable K-Factor, liquidity requirements and concentration risk was to be disclosed annually.  All firms are required to report annually their concentration risks in respect of various exposures on an individual and aggregate basis.

How do the Consilium’s changes affect the EU’s equivalence regime

In limited cases the European Commission may grant an “Equivalence Decision” communicating that, in its assessment the regulatory and/or supervisory regime of a non-EU country i.e. a “third-country” such as the UK post-Brexit is (fully or partially) equivalent to the corresponding EU regime. Equivalence Decisions, under current rules, may be withdrawn at short notice, even if granted for an indefinite period, and the European Commission is strengthening generally how it reviews, assesses and grants or withdraws its Decisions. If a third-country’s entirety of parts of its supervisory framework or authorities are deemed equivalent, then a third-country entity may benefit from “comparably” relaxed rules of access to EU financial markets.  Changes by the Consilium to the IFR clarify that an equivalence decision for firms subject to the IFR/IFD framework should:

“…consider specific prudential, organizational or business conduct requirements as equivalent only where the same effect is achieved… the Commission may, where appropriate adopt equivalence decisions limited to specific services and activities or categories of services and activities…” as listed in Section A of Annex 1 of MiFID II.

More interestingly, the Consilium uses the IFR to amend the last sub-paragraph of Article 46(4) MiFIR that permits third-country access rights using national regimes in the absence of a Commission Equivalence Decision. The proposed changes confirm existing rules that limit third-country entities (with or without branch) to only being able to provide investment services or perform investment activities together with ancillary services to MiFID eligible counterparties and professional clients – as opposed to retail clients as is currently the case. That being said, this provision would still have to be considered in light of the above and the EU’s prescriptive Supervisory Principles on Relocations (SPoRs),6 which favor compelling firms to establish subsidiaries as opposed to rely on this provision.

Moreover, the Consilium’s proposed amendments to the IFR/IFD framework further clarifies that the following would not constitute permitted “reverse solicitation” where:

“…without prejudice to intragroup relationships, where a third-country firm, including through an entity acting on its behalf or having close links with such third-country firm or any other person acting on behalf of such entity, solicits clients or potential clients in the [EU] it shall not be deemed as a service provided on the own exclusive imitative of the client. An initiative by such clients shall not entitle the third-country firm to market new categories of investment product or investment services to that client.”

Lastly, the IFR changes proposed by the Consilium cement rules on how ESMA may undertake monitoring and on-site inspections of third-country firms, including coordination with third-country authorities as well as existing EU rules on the supervision of EU branches of third-country institutions where the EU branch is considered as “significant”. The Consilium also proposes that ESMA be tasked with publishing an annual list of third-country branches active in the EU, including the name of the parent entity. This requirement is in addition to the IFD setting out more prescriptive reporting obligations that branches will have to report to NCAs annually in terms of their operations but new data items relating to governance arrangements as well as details on key function holders. We would expect that the ESAs will publish further information on the type and granularity of these new data items.

Extending ESMA’s, EBA’s and NCAs’ MiFIR (temporary) intervention powers to third-country entities?

The Consilium also (oddly) uses the IFR to make amendments to ESMA’s,  EBA’s and NCAs’ current (temporary) intervention powers, which have been used at the time of writing by ESMA and certain NCAs in respect of certain retail options and CFDs (see coverage from our Eurozone Hub) to  apply temporary intervention powers to third-country firms providing services or performing activities in the EU. The extension of powers means that ESMA/EBA/NCAs would be able to withdraw registration or temporarily prohibit or restrict the activities of such third-country entity in a similar fashion as to how such powers may already be applied to EU entities.

Outlook and next steps

The Consilium has introduced a number of fundamental changes to what was already a very complex overhaul of the EU’s prudential capital regime for MiFID Investment Firms. The IFR/IFD is potentially more “sophisticated” in how firms can, once they factor in which Class they belong to, calculate their prudential requirements. This will likely also mean that firms will want to, regardless of the end-state of the IFR/IFD will already want to:

  • Map and scenario plan what type of Class they might fall into and what Class their counterparties might fall into and set internal barriers to ensure they remain in a given Class and their set prudential regulatory requirements
  • Consider which prudential consolidation measures they might apply for and whether their systems and controls may be deemed to be “suitable” to avail of possibly more favorable treatment
  • Consider whether arrangements need to be put in place to facilitate exchange of data sets as it relates to investment firms, clearing members and/or CCPs
  • Take note that ECB-SSM may, when permitted, streamline the application and also the elimination of national options and derogations introduced by IFR/IFD.

If this proposal stays as is, and we do expect some change (mostly clarifications rather than backtracking)—and we are happy to advise on how to draft that in a sounder manner—then we do foresee that this could shift competition amongst peers in an established sector of intermediaries, investors and pools of capital, liquidity and financial product innovation. This could have a far greater set of unintended consequences than many EU and Eurozone supervisory policymakers may actually desire. That being said, given the (renewed) overarching desire to scrutinize the “non-banking financial sector” (i.e. the sector formally known as “shadow banking”) more closely, the IFR/IFD is, for policymakers, the “perfect” legislative instrument to do just that.

With the breadth of the European System of Financial Supervision i.e. NCAs and European Supervisory Authorities (EBA, ESMA an EIOPA) all scheduled (at some point) to receive greater powers due to a range of related reform initiatives, and with the ECB-SSM’s mandate growing, there is a perception that those institutions would be able to set, agree and then supervise the new IFR/IFD framework and its K-Factors without disagreement. That remains to be seen, especially in light of much more complex calculations and supervisory discussions in a new framework, which is supposed to deliver a prudential regime that is more proportionate to the risks faced and generated by MiFID Investment Firms.

  1. See here.
  2. See the first part of our dedicated coverage on the original proposal in this development from our Eurozone Hub available here.
  3. Additions are highlighted in bold and underline in the following documents:
    1. IFR available here
    2. IFD available here
  4. Relevant components and coefficients not discussed
  5. It remains to be seen whether this concept, which at present is undefined, would follow how the SSM determines significance for the purposes of whether a BUSI is directly or indirectly ECB-SSM supervised. Those criteria are to fulfil at least one of the following or where the ECB-SSM decides it needs to apply high-supervisory standards consistently:
    1. Size – the total value of assets exceeds EUR 30 billion – NB the IFR/IFD thresholds are lower i.e. at EUR 15 billion or 5 billion;
    2. Economic importance – for the specific country or the EU economy as a whole – NB the IFR/IFD has the same criteria;
    3. Cross-border - the total value of its assets exceeds EUR 5 billion, and the ratio of its cross-border assets/liabilities in more than one other Banking Union Member State to its total assets/liabilities is more than 20% - the IFR/IFD does not have this granular level of criteria even if it looks at cross-border exposure; 
    4. Public financial assistance - The BUSI has received direct public financial assistance from the European Stability Mechanism or the European Financial Stability Facility – NB this is not catered for in the IFR/IFD; or
    5.“one of three” – the BUSI is one of the most three significant banks in a particular Member State – NB a conceptual equivalent is not catered for in the IFR/IFD.
  6. Click here for more.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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