Communicating with the FCA: Common pitfalls to avoid

The MIF007 return is one of the annual obligations for all MIFIDPRU firms, the completion of which requires the intensive exercise of updating all elements of the firm’s ICARA process. The return is designed to capture important information relating to the ICARA process including the following: 

- Own Funds Threshold Requirement (OFTR)

- Liquid Assets Threshold Requirement (LATR)

- Assessments to wind down

- Assessments from ongoing operations

- Description of risks

- Firm’s regulatory permissions and activities

How to ensure accurate completion of the MIF007 return

Consistency of information relating to the threshold requirements

The two key observations in the FCA’s multi-firm review were the inconsistency across the ICARA documents and the lack of integration between the different assessments. After completing the ICARA process, it is  critical to ensure that the MIF007 return reconciles with the assessments included throughout the documents. Following the submission of the MIF007 return, other regulatory returns will also need to reflect the Overall Financial Adequacy Rule (OFAR) assessments. More specifically, the MIF001 - Own Funds and the MIF002 Liquid Assets returns must be updated to reflect the revised OFTR and the LATR accordingly. 

Services and activities provided

‘Use it or lose it’ is the FCA’s message. Through the MIF007, firms are required to confirm the MiFID services provided and other business activities conducted. As a result, firms that are not using their permissions are coming under increased pressure to apply for a variation of permissions (VoP). This can be frustrating for firms that hold permissions in anticipation of future business ventures, particularly considering that obtaining new permissions can be a lengthy process and therefore could result in missed business opportunities.

Group ICARA and group risks

The FCA has also stressed the impact of group membership on the ICARA process, and how firms should consider the governance and operational relationships when determining the assessment from ongoing operations and the assessment to wind down. Where there is insufficient consideration of group-wide wind down plans, it may lead to incomplete assessments of harms that need to be mitigated. Where firms are completing a group ICARA process, the FCA expects them to include a clear assessment of the risks of each individual firm, and their contribution to the assessment of adequate resources for each entity. 

The ICARA process and ultimately the submission of the MIF007 return should not be underestimated. It is clear from recent FCA publications that senior management need to actively engage with the process and the conclusions need to be conveyed clearly and accurately through the MIF007 return. 

The FIN067 return is an additional reporting requirement for Collective Portfolio Management Investment Firms (CPMIs). CPMIs are investment firms that are regulated under both the AIFMD and MiFID regime. As a result of being dual-regulated, CPMI firms are required to comply with the financial adequacy rules under both regimes. Whilst there are a lot of similarities between the two, there are also some important differences, especially with respect to definitions and the calculation methodologies applied. We have summarised the most important areas below.

Liquidity

The calculation of regulatory liquid assets under the two regimes is notably different. MIFIDPRU applies stricter rules on which instruments would qualify as a core liquid asset as defined in MIFIDPRU 6.3. For example, accrued income cannot be considered, trade debtors are subject to aggressive haircuts, and non-GBP cash can only be included to the extent the firm incurs expenditure in that currency. Under AIFMD the liquid asset definition is much more lenient, allowing firms to recognise most assets so long as they can be readily converted into cash within one month. The calculation of the liquidity requirement is also different under both regimes, with the AIFMD requirement being much higher for the majority of firms. Taking all of these differences into account, it is no wonder it continues to be a constant challenge for firms to make sure they are correctly monitoring all requirements and therefore ensuring that they are compliant with both regimes on an ongoing basis.

Measurement of assets under management (AUM)

Another key difference between the regimes is the measurement of AUM. Assets managed using the firm’s MiFID permissions are measured on a net basis when calculating the K-AUM capital requirement metric, whereas the calculation of the funds under management (FUM) requirement under the AIFMD legislation requires firms to value their portfolio on a gross basis before applying the own funds requirement coefficient. We explored the AUM conundrum in more detail in a separate article which can be found here.

Capital requirements

In September 2023 there was a considerable change to the MIFIDPRU rules which meant a firm’s Own Funds Threshold Requirement (OFTR) can no longer be lower than a firm’s requirement under any other prudential regime. This change had a big impact on CPMI firms that have a higher requirement under the AIFMD regime, ultimately increasing the OFTR and therefore in turn the early warning indicator buffer that is applied on top of the OFTR. This change generally led to an increase in the capital requirement across the board for CPMI firms.

For dual-regulated firms, it is crucial to understand the nuances between the two regimes and ensure that the firm is accurately calculating and reporting its requirements in line with the applicable legislation.

The MIF003 return is intended to confirm the classification of a firm between ‘Small & Non-Interconnected’ (SNI) firm and Non-Small & Non-Interconnected’ (Non-SNI) firm. The return provides the FCA with insight into a firm’s level of activity and allows monitoring against the thresholds set by the FCA which help keep track of the size, complexity, and any current trends in the firm’s data. 

Key points to note are as follows:

Application 

This return needs to be completed by ALL MIFIDPRU firms; not just Non-SNI firms. 

Scope of reporting 

Data should be completed in respect of an investment firm’s MiFID business activities. If an investment firm is unable to separate its MiFID and non-MiFID activities, it must treat all activities as MiFID-related for the purposes of this report.

Metric vs K-Factor values

Firms need to report the values used for the calculation of the K-Factor requirement, unless otherwise specified by the FCA, and these values should reflect the activities undertaken by the firm. The applicable information must be supplied irrespective of the firm classification. For example, an SNI firm with average ‘assets under management/advisory’ below the £1.2bn threshold still needs to report the AUM values in the MIF003 return even though it does not have to calculate and report the K-AUM figure in the MIF001 return until it is classified as a Non-SNI firm.    

Balance Sheet and revenue thresholds – mandatory boxes

• 25A – on -and off-Balance Sheet Total: This field requires the sum of assets from both on and off-balance sheet categories, based on finalised and approved figures from the most recent financial year. 

• 26A – Annual Gross Revenue from MiFID Services: Firms must report the total annual gross revenue derived from MiFID services and activities, using figures from the most recent approved financial year. In cases where the revenue split between MiFID and non-MiFID activities cannot be determined, firms should report total revenue. 

For both thresholds, if the firm's accounts are not finalised within six months of its financial year end, provisional data should be reported.

The aim of this return is for the FCA to determine that a parent undertaking in an investment firm group (IFG) is holding an appropriate amount and quality of capital to cover its investments into MIFIDPRU firms that are part of the IFG.

Following the introduction of IFPR in 2022, most GCT exemptions were granted by the FCA to simplified group structures where the regulated activities and thereby the risks were concentrated in the MIFIDPRU firm. This means that although the firm, along with other entities within the group, forms an investment firm group, the FCA’s supervision is focused on the regulated firm only, and there is no requirement to carry out consolidated reporting. Where the FCA has granted a GCT exemption, a UK parent entity and any other GCT parent undertakings in the investment firm group must hold own funds instruments sufficient to cover the sum of the following:

1. the sum of the full book value of their holdings, subordinated claims and instruments in relevant financial undertakings in the investment firm group; and
2. the total amount of their contingent liabilities in favour of relevant financial undertakings in the investment firm group.

Crucial aspects of MIF006 are as follows:

Testing

The above-mentioned tests must be met at all times. This can become a problem in the scenario where the UK parent entity is making losses which in turn would reduce its regulatory capital, and therefore could mean that the UK parent will need to increase its own funds to remain complaint. 

Book Value

The term ‘book value’ is not clearly defined in the FCA Handbook and the return will validate even if the conditions aren’t met, which is misleading and can go unnoticed quite easily. 

We recommend building the financial GCT tests within your working papers that have been set up for the process of monitoring of the OFAR.

Permission to classify an issuance of capital instruments as common equity tier 1 (CET1) capital and the notification of a subsequent issuance of capital instruments previously qualifying as CET1 capital.

Firms looking to issue capital instruments as CET1 Capital must first gain permission from the FCA by submitting the MIFIDPRU 3 Annex 2R form under MIFIDPRU 3.3.3R(1).

Any subsequent issuances of capital instruments that have already received permission from the FCA, under the permission application above, are also required to be notified to the FCA by completing the MIFIDPRU 3 Annex 3R form under MIFIDPRU 3.3.3R(2).

These two forms play a vital part in a firm’s capital adequacy maintenance and the ability to keep a surplus over the Own Funds Threshold Requirement. If a firm issues CET1 capital but does not notify the FCA through one of the above forms, then the issued capital cannot be treated as regulatory own funds in the firm's prudential calculations.

There is also a separate permission form to be completed if you are issuing Additional Tier 1 or Tier 2 capital.

Common Pitfalls

Planning:

Even though the MIFIFPRU 3 Annex 3R is only a notification and therefore does not require the FCA’s permission, firms should be aware that they are required to wait 20 business days following the notification in order to consider that capital as regulatory capital. This can lead to temporary regulatory breaches where a firm has not planned this process ahead of time. 

Application:

When IFPR was introduced, all firms were expected to notify the FCA under MIFIDPRU TP7 to designate the existing capital as CET1 capital, where appropriate. Firms who have missed this step will need to make sure that they submit the MIFIDPRU 3 Annex 2R form under MIFIDPRU 3.3.3R(1) and apply for permission, rather than just notifying the FCA of a subsequent issuance, when injecting further capital going forward.

Proposed reduction, repurchase, reclassify, call or redemption of own funds instruments requires a notification.

Firms looking to reduce their Own Funds must first gain permission from the FCA by submitting the MIFIDPRU 3 Annex 4R notification form.

The form requires input from the firm with regards to the rationale behind the capital reduction and supporting calculations that demonstrate that the firm will have sufficient Own Funds following the proposed capital reduction, including in stressed conditions. 

Common Pitfalls

Detail:

The application and permission process can take up to six months and therefore firms should plan ahead regarding their capital reduction process. To prevent the FCA requesting more information and in turn delaying the process, firms should provide a sufficiently detailed analysis and put forward a strong rationale behind the reduction. 

The FCA requires firms to make a notification when their Own Funds or Liquid Assets fall below the following thresholds: 

• Early warning indicator 
• Thresholds requirements 
• Wind down triggers

Firms must notify the FCA immediately through the MIFIDPRU 7 Annex 4R (Own Funds) or MIFIDPRU 7 Annex 5R (Liquid Assets) forms. 

The forms require firms to provide details regarding the Own Funds or Liquid Asset levels, threshold requirements, an explanation of why the breach occurred, if a further breach is likely, and finally, which recovery actions have/will be taken to rectify the breach.

Common Pitfalls

Ongoing Monitoring:

Monitoring of the financial requirements is an ongoing process, therefore these notifications are applicable to firms at all times as opposed to at the quarter end when the regulatory returns are prepared and submitted. 

On top of this, there are more than 25 notifications/permissions within MIFIDPRU. It is each individual firm’s responsibility to be aware of the notifications/permissions that are applicable to them and to ensure they are submitted in a timely manner if a trigger event occurs.