EBA recommends new prudential framework for investment firms

On December 14th 2015, the European Banking Authority (the “EBA”) published a report with recommendations, in response to the European Commission’s call for advice on the suitability of certain aspects of the prudential regime for investment firms.

"The report highlights three key deficiencies of the current prudential regime, which consists of the Markets in Financial Instruments Directive (MiFID), the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR)."

These deficiencies are (1) divergent implementations of MiFID rules across Member States, (2) insufficient sensitivity to risk stemming from the size and systemic importance of investment firms, and (3) overly complex and inconsistent categorisations of investment firms under the CRD/CRR regime. As a result, prudential requirements vary widely between firms that conduct similar activities and pose similar risks to market participants, while the differences in nature, scale and complexity of investment activities are only partially captured by the different categorisations.

To remedy these deficiencies, the EBA recommends replacing the activities-based approach with a categorisation that centres around indicators related to systemic importance and financial stability risks. The EBA identifies three categories or ‘tiers’:

  • systemic and ‘bank-like’ investment firms, to which all CRD/CRR requirements should be applied (tier 1);
  • ‘non-systemic’ investment firms with a more limited set of prudential requirements (tier 2); and
  • very small firms with ‘non-interconnected’ services (tier 3).

In addition, the EBA recommends designing a modified prudential regime for firms in tiers 2 and 3. That regime should include adequate quantitative and qualitative parameters, simplified and proportionate to the specific systemic risks these firms pose. This regime must also pursue the aim of improving the Single Rulebook, which is to provide a set of harmonised prudential rules across the European Union.

The third recommendation of the EBA is to extend the waiver for commodity trading firms from the CRD/CRR framework until the new categorisation is put in place or, at the latest, until December 31st 2020. Under the current rules, commodity firms are exempt from CRR provisions on large exposures and capital adequacy until December 31st 2017. The EBA recommends that regulators assess whether a more proportionate prudential framework would be suitable for these firms.

If the EBA’s recommendations are followed by the European Commission, some investment firms could face more stringent prudential requirements, whereas other investment firms could be subject to lighter prudential requirements. The impact of a new prudential regime will also depend on the degree to which it provides Member States with the flexibility to set quantitative or qualitative parameters at the national level.

On December 16th 2015, the European Commission issued a proposal adopting the recommendation to extend the waiver for commodity firms. In this proposal, the Commission stated that finalising the review of the prudential regime and adopting new legislation, to the extent required, will not be done before the end of 2017.