The post-Brexit impact on investment firms: How might regulatory divergence affect the competitiveness of UK firms?

As custodians of sensitive personal and financial data, financial services firms have always been an obvious target for cyber-attackers, but the pandemic has brought fresh security challenges.  

With the regulatory challenges for firms already becoming apparent in a post-Brexit UK, we’re taking a look at the imminent changes to investment regulation for both EU and UK companies, and the difficulties arising from variable timelines.

We’ll look at the recent FCA Consultation Paper CP 20/24, which introduces a new sourcebook that almost, but not quite, matches the EU plans for investment companies.

The original plan - keeping FCA regulation in-line with the EU

On the face of it, when the EU’s Investment Firm Regulation and the Investment Firm Directive (IFR/IFD) is compared with the UK’s Investment Firms Prudential Regulation (IFPR) there seems to be a ‘business as usual’ approach regarding the introduction of EU regulation into UK business. Keeping FCA regulation in line with the EU may not be the best way to demonstrate a new-found independence from Europe, but it is certainly cheaper when a firm is required to follow only one set of rules.

In principle, that was the plan. Unfortunately, 2020 Brexit delays, COVID-19, and the ongoing EU negotiations regarding the structure of the UK’s financial services have resulted in an inevitable pushing back of the UK timeline by the FCA.

Although EU member states are required to have IFR/IFD operable by the end of June, The FCA only started the first consultation on new prudential rules the week before Christmas. With another two rounds of consultation still to take place, the FCA is looking to an implementation date just over six months later, in January 2022.

For those operating cross-borders, even with their new post-Brexit corporate structures, we already have regulatory divergence to add to the dual reporting mechanisms.

IFR/IFD – more similarities than differences?

It’s not the purpose of this article to give a full run-down on the rule changes for IFR, but it does aim to highlight some important differences of approach on both sides of the Channel, and the potential for adding an additional regulatory burden to EU rules when they enter the FCA’s Handbook.

As a member of the EU, the FCA were a staunch supporter of the plans for IFR, and still boasts of its involvement during initial policy development discussions with the European Banking Authority and the EU. It is no surprise, then, that there are far more similarities than differences.

The IFR establishes a new prudential regime for MiFID organisations, to a certain extent mirroring the renumeration rules set out in the newest Capital Requirements Directive (CRD V).

Unfortunately, ‘to a certain extent’ is not the same thing as ‘identical’. Under IFR, most investment firms dealing on own account or providing underwriting services are now subject to the rules, where they are considered systemically important. These organisations will now need to comply with the prudential requirements of the most recent Capital Requirements Directive.  (All investment firms with over €15 Billion will be caught, regardless of their systemic importance).

The main impact from the IFR will be a different way of calculating capital and liquidity requirements, with wide deviations in methods depending on sector and size of organisation. This will result in some firms needing to reconsider their business model and internal structures.

In addition to this, the expansion of certain governance requirements and increasing restrictions on renumeration policies within the wider investment community will require some difficult conversations.

Expanding the reach of IFPR

For UK firms, the IFR changes, in theory, do not affect them at all. Unless they also transact business in an EU state and must follow the rules of their new regulators.

In fact, the UK system is set to change quite dramatically from January 2022, expanding the reach of IFPR beyond the minimum requirements of the EU and gold-plating the IFR. One major consultancy firm expects a further 1000 firms will be required to complete the replacement for ICAAP, the ICARA (Internal Capital Adequacy and Risk Assessment), a considerable new regulatory burden.

UK firms will follow the majority of IFR changes through IFPR, but not all, on different timescales, with slightly different approaches.

The introduction of the new FCA sourcebook MIFIDPRU will incorporate these changes and reflect the onshoring of previous EU rules. IFPRU, BIPRU and Exempt CAD prudential categories will cease to exist.

Another obvious change is the new reporting system, now separate from the EU and requiring a duplication of effort and splitting the geographical source of business. Given the timing differences in implementation, there will be at least six months of parallel reporting for some firms.

Continue to engage with the regulators

In conclusion, we all know that Brexit has happened, and that there was a desire for the UK to strike forward with a globally competitive financial services market.

To do that, it is even more important than ever that members of the UK financial services industry study the FCA consultation papers and have their voices heard. We all must understand how rule changes affect our clients and business models and challenge when these do not meet our requirements.

If there is to be an improved regulatory structure that does not rely solely on the EU, we must all fully engage with the regulators and help produce rules that are both fair and profitable.

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