|Investment firm (MiFID definitions)|
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"Investment firm" under the Markets in Financial Instruments Directive (MiFID) means "any legal person whose regular occupation or business is the provision of one or more investment services to third parties and/or the performance of one or more investment activities on a professional basis" (Article 4(1)).
The MiFID definition, therefore, covers all natural an legal persons who perform investment services and activities using financial instruments, as a regular occupation or business, and on a professional basis.
Where a person meets these criteria and is not otherwise exempt from MiFID it will require authorisation as an investment firm.
In this context authorisation is a consequence rather than a part of the definition.
The MiFID lays down organisational, governance, consumer protection and market functioning regulations, as well as sets out the passporting process for those firms that provide one of the MiFID II listed services, i.e.:
- investment advice to clients,
- management of client portfolios,
- execution of clients' orders on financial instruments,
- reception and transmission of orders on financial instruments,
- dealing with own account,
- market making,
- placing of financial instruments, and
- operating trading facilities.
Explanatory memorandum to the European Commission’s Proposal of 20 December 2017 for a directive on the prudential supervision of investment firms adds, however, based on information from the EBA, that around 85 % of EEA (European Economic Area) investment firms limit their activities to only four positions: offering investment advice, receiving and transmitting orders, managing portfolios and executing orders.
Nearly 40% of EEA investment firms are authorised exclusively to provide investment advice.
Around 20% are authorised to carry out dealing on own account and underwriting, the services which currently entail the most stringent prudential requirements.
Around a quarter of all EU investment firms trade in financial instruments, either for the firm itself or for its clients.
Contrary to credit institutions, investment firms do not accept deposits, nor do they provide loans on a significant scale.
They do however compete with credit institutions in providing investment services, which credit institutions can offer to their customers under their banking licence.
The European Commission’s “Proposal for a regulation on the prudential requirements of investment firms and amending Regulations (EU) No 575/2013, (EU) No 600/2014 and (EU) No 1093/2010” of December 2017 (p. 2) contains the following characteristics of the investment firms typical activities:
“Unlike credit institutions, investment firms do not take deposits or make loans. This means that they are a lot less exposed to credit risk and the risk of depositors withdrawing their money at short notice. Their services focus on financial instruments – unlike deposits, these are not payable at par but fluctuate according to market movements. They do however compete with credit institutions in providing investment services, which credit institutions can offer to their customers under their banking licence. Credit institutions and investment firms are therefore two qualitatively different institutions with different primary business models but with some overlap in the services they can provide.”
The European Banking Authority (EBA) Report on Investment Firms, Response to the Commission's Call for Advice of December 2014 (EBA/Op/2015/20, p. 6) observes the European investment services landscape comprises various types of operators.
“The risks which investment firms themselves incur and pose for their clients and the wider markets in which they operate depend on the nature and volume of their activities, including whether investment firms act as agents for their clients and are not party to the resulting transactions themselves, or whether they act as principals to the trades,” reads Recital 3 of the European Commission’s Proposal of 20 December 2017 for a regulation on the prudential requirements of investment firms.
Also Recitals to the Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive acknowledge investment firms vary widely in their size, their structure and the nature of their business.
The above EBA Report of December 2014 evidences a little more than 6 500 investment firms initially authorised and regulated by MiFID (in number, just over half of these are based in the UK. The United Kingdom, Germany and France are the main jurisdictions for over 70% of the investment firm population of the European Union).
The EBA estimates that some eight investment firms, largely concentrated in the UK, control around 80 % of the assets of all investment firms in the EEA, while most EEA investment firms are small or medium-sized.
Undertakings which are not a legal persons may also be licensed as an investment firm if they fulfil the following conditions:
(a) their legal status ensures a level of protection for third parties' interest equivalent to that afforded by legal persons and
(b) they are subject to equivalent prudential supervision appropriate to their legal form.
According to the present regulatory framework all investment firms are subject to the same EU prudential rules as credit institutions - the Capital Requirements Regulation and Directive (CRR/CRDIV), which were developed for banks and lay down the amount of capital, liquidity and other risk management requirements.
The prudential framework for investment firms in the CRR/CRD IV works in conjunction with MiFID.
MiFID sets out the conditions for the authorisation of investment firms.
It also determines how they should behave on financial markets when providing their services (e.g. in terms of conduct of business).
Credit institutions are also subject to some MiFID provisions when providing investment services.
The MiFID II level 2 regulation - Commission Delegated Regulation 2017/565 of 25 April 2016 has adapted a regulatory regime to diversity of investment firms while imposing certain fundamental regulatory requirements which are appropriate for all firms.
To ensure the uniform application of the various relevant provisions, it also establishes a harmonised set of organisational requirements and operating conditions for investment firms.
CRR investment firms - evolution of prudential requirements
Typically, prudential requirements on financial institutions are designed to:
(i) ensure that they have sufficient resources to remain financially viable and to carry out their services through economic cycles; or
(ii) enable an orderly wind-down without causing undue economic harm to their customers or to the stability of the markets they operate in.
The prudential framework applied to investment firms depends on the firm's categorisation within the CRD IV framework. This categorisation is currently primarily determined by the investment services and activities it offers and undertakes, as set out in Annex I of the MiFID.
The term 'investment firm' is defined in the CRR by referring to the definition of the MiFID, albeit the legal definition excludes upfront a number of firms and credit institutions themselves.
This means that the CRR definition is a subset of those firms subject to the MiFID definition.
CRR investment firm is defined in subparagraph (2) of Article 4(1) of the CRR as a MiFID investment firm, excluding:
(i) credit institutions;
(ii) local firms; and
(iii) firms that do not hold client money and perform a combination of MiFID services (transmitting orders, executing orders, portfolio management, and investment advice).
Credit institutions are excluded from the CRR definition of 'investment firm' because, even though they may provide investment services, they already fall within the regular scope of the CRR as credit institutions.
The exclusion of local firms was based on the assumption that local firms were small and would pose a minimal risk to the financial system or not be subject to competition issues (EBA's Report on Investment Firms of December 2014, p. 13).
The said Report concludes that "current total population of non-bank firms conducting any sort of investment business is not straightforward when it comes to prudential coverage: it comprises firms that are exempt from the MiFID, MiFID firms that are exempt from the CRR, and MiFID firms that are subject to different types of requirements under the CRR".
The categorisation of investment firms in CRD IV has a direct influence on a firm's initial capital requirement, which remains the basic and most common prudential 'building block' for investment services providers; every investment firm should, by default, be subject to a EUR 730 000 requirement (Article 28 of the CRD), with this amount being reduced to EUR 125 000 (Article 29 of the CRD) if a firm neither deals on own account nor underwrites under firm commitment while still holding client money or securities (EBA's Report on Investment Firms of December 2014, p. 14).
The aforementioned EBA's Report of December 2014 (p. 15, 16) identifies at least 11 different prudential categories of investment firms within the CRR framework.
Table: Categorisation of MiFID investment firms within the CRD framework
The CRD IV framework makes a distinction between:
a) those firms that are included in the CRR definition of 'investment firm' (CRR investment firms, categories 5 to 11);
c) those firms that are excluded from both the CRR definition of 'investment firm' and the scope of CRD IV (categories 1 to 3), but are still subject to a minimum level of initial capital (for the purpose of receiving authorisation under the MiFID and the ability to use a passport under that Directive), as laid down in the CRD.
Table focuses solely on the combined provisions as set out in the MiFID and CRD IV. The table does not take into account national transpositions and options, which can apply to:
i) the number of different categories of investment firms;
ii) the definition of MiFID investment services and activities; and
iii) the minimum level of initial capital applicable to each of the categories.
"The MiFID was implemented by way of national transpositions. The application of provisions to some services might give rise to diverging applications at the national level of MiFID investment services and activities. Because of this, it appears that there are some variations with respect to the required level of initial capital requested for particular types of investment services or activities, leading to different (e.g. more granular or, in some cases, fewer) categorisations depending on the jurisdiction where the investment firm actually operates," the EBA's Report of December 2014 concludes.
This thread is followed in the Explanatory Memorandum to the Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012, 23.11.2016, COM(2016) 850 final 2016/0360 (COD) (p. 22, 23):
"The review under Article 508(3) on investment firms is now in its second phase. In a first report published in December 2015, EBA found that the bank-like rules under the CRR were not fit for purpose for the majority of investment firms with the exception of the more systemic ones that pose risks similar to those faced by credit institutions. At the request of the Commission, the EBA is conducting additional analytical work and a data-gathering exercise in order to articulate a more appropriate and proportionate capital treatment for investment firms which will cover all parameters of a possible new regime. EBA is expected to deliver their final input to the Commission in June 2017. The Commission intends to present legislative proposals setting-up a specific prudential framework for non-systemic investment firms by the end of 2017.
Pending the adoption of these proposals, it is considered appropriate to allow investment firms that are not systemic to apply the CRR in the version as it stood before the amendments come into force. Systemic investment firms will, for their part, be subject to the amended version of the CRR. This will ensure that systemic firms are treated appropriately while alleviating the regulatory burden for non-systemic firms who would otherwise have to temporarily apply a new set of rules designed for credit institutions and systemic investment firms during the period preceding the final adoption of the dedicated investment firms' prudential framework that will be proposed in 2017."
Also the Commission staff working document of 20 December 2017 “Review of the prudential framework for investment firms, accompanying the proposals for a regulation and directive on the prudential requirements and supervision of investment firms” refers to the fact that:
“Under the current CRR/CRDIV-framework, investment firms can be grouped into 11 categories primarily determined by the investment services they are authorised to undertake under MiFID, and whether they hold money and securities belonging to their clients. This categorisation reflects multiple historic and implicit assumptions of the risks and prudential relevance of these services and functions and of how effectively the available risk-metrics developed principally for banks capture and address those risks. Consequently, investment firms which conduct a broad range of services are subject to the same requirements as credit institutions in terms of capital requirements for credit, market and operational risk, and potentially liquidity, leverage, remuneration and governance rules, while firms with limited authorisations (typically those which are considered less risky, i.e. investment advice, reception and transmission of orders) are largely exempt from most of these requirements.”
December 2017 amendment package of the EU prudential rules for investment firms
Based on the foregoing recommendations and analyses the European Commission adopted on 20 December 2017 draft amendments of the EU prudential rules, with the aim to introduce more proportionate and risk-sensitive governing framework for investment firms.
The said legislative initiative consists of two acts that would amend the existing framework set out in the CRD IV/CRR and in the MiFID2/MiFIR:
1. the Proposal for a regulation on the prudential requirements of investment firms and amending Regulations (EU) No 575/2013, (EU) No 600/2014 and (EU) No 1093/2010,
New rules split investment firms into two groups:
1. the vast majority of investment firms in the EU would no longer be subject to rules that were originally designed for banks;
2. the largest and most systemic investment firms would be subject to the same regime as European banks.
Major innovations include, in particular:
- the capital requirements for the smallest and least risky investment firms will be set in a simpler way, these firms would not be subject to any additional requirements on corporate governance or remuneration,
- for larger firms, the rules introduce a new way of measuring their risks based on their business models,
- for firms which trade financial instruments, these will be combined with a simplified version of existing rules,
- systemic investment firms which carry out certain bank-like activities (i.e. underwriting and dealing on own account) and have assets over €30 billion would be defined as credit institutions and fully subject to the same treatment as banks (as announced in the Commission's review of the European Supervisory Authorities (ESAs), this means that their operations in Member States participating in the Banking Union are subject to direct supervision by the ECB in the Single Supervisory Mechanism).
The proposal gives investment firms a transitional period of five years before they must apply the new requirements in full.
Categorisation of investment firms
According to the review of prudential requirements for investment firms proposed by the European Commission in December 2017 the largest investment firms would remain under the prudential regime of CRR/CRDIV and would be supervised as significant credit institutions.
Smaller firms would enjoy a new bespoke regime with dedicated prudential requirements.
Investment firms would be divided into three classes, each of those capturing different risk profiles.
Class 1 would include investment firms, with total assets above €30bn and which provide underwriting services (underwriting is a commitment to take up on own books financial instruments when others do not buy them) and dealing on own account (an investment firm deals on own account when it trades in financial instruments against its own proprietary capital).
Class 2 firms would be those above any of the following size thresholds:
Class 3 firms would be those below all of the above thresholds. They would be subject to the least complex requirements.
Table: Categorisation of investment firms according to the European Commission proposal of 20 December 2017 for the amendment of the EU prudential rules for investment firms
Impact on capital requirements for investment firms
Currently, under the CRR/CRDIV framework the amount of initial capital that is required for a investment firm to be authorised is, by default, EUR 730 000 (Article 29 CRDIV).
This is reduced to EUR 125 000 in cases where a firm does not deal on its own account or underwrite on a firm commitment basis while still holding client money or securities and, if Member States choose, to EUR 50 000 if such a firm is not authorised to hold client money or securities.
In some cases, Member States have also adopted entirely different initial capital requirements, partly due to the fact that the levels in CRDIV have not been amended since 1993.
The problem is also compounded by the fact that neither MiFID nor the CRR contain a precise definition of holding client assets.
Therefore, different determinations of whether client assets are "held" under accounting or prudential norms, notwithstanding requirements to ensure they are properly segregated from the firm's own assets, can mean that the application of these rules may differ across Member States (the said Commission staff working document of 20 December 2017, p. 13).
According to the EBA's preliminary analyses, aggregate capital requirements for all EU investment firms are not expected to change significantly as a result of projected changes.
The new capital requirements are expected to be 16% lower than today's total level of harmonised requirements and capital add-ons imposed by supervisors (European Commission, Fact Sheet, Frequently asked questions: Revised Framework for Investment Firms, 20 December 2017).
This more than offsets the 10% increase in the harmonised requirements applicable to all EU firms.
Capital requirements may increase more for some investment firms whose risks would be captured for the first time.
Exemption from concentration rules for commodity and emission allowance dealers
Interestingly, the said European Commission’s Proposal of 20 December 2017 for a regulation on the prudential requirements of investment firms envisages in Article 41 the specific exemption from concentration rules (included in the Part 4 of the draft regulation) for commodity and emission allowance dealers.
The aforementioned Article 41 stipulates that the provisions of the said Part 4 do not apply to commodity and emission allowance dealers when all the following conditions are met for intra-group transactions:
(a) the other counterparty is a non-financial counterparty;
(b) both counterparties are included in the same consolidation;
(c) both counterparties are subject to appropriate centralised risk evaluation, measurement and control procedures;
(d) the transaction can be assessed as reducing risks directly relating to the commercial activity or treasury financing activity of the non-financial counterparty or of that group.
Eligibility to be a member or participant of a regulated market or an MTF
The eligibility to be a member of a regulated market or an MTF in the EU is not restricted to investment firms only, Article 53(3) of MiFID II provides that an entity that is not an investment firm or a credit institution can be a member of a regulated market under certain conditions, this rule being extended to MTFs by Article 19(2) of MiFID II.
Hence, entities exempted from MiFID authorisation under Article 2(1) can also be a member or participant of a regulated market or an MTF.
The above stance is supported by the ESMA’s answer to the Question 4 (Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-38, Multilateral and bilateral systems, General, updated on 07.07.2017).
Eligibility to provide DEA to an EU trading venue
Non-EU firms (including non-EU firms licensed in an equivalent jurisdiction) or EU firms without a MiFID II licence are not allowed to provide DEA to their clients.
This applies regardless of where the clients using the DEA service are located (the rule underlined by ESMA’s answer to the Question 25 (Questions and Answers on MiFID II and MiFIR market structures topics, ESMA70-872942901-3, Direct Electronic Access (DEA) and algorithmic trading, updated on 15 November 2017).
Authorisation process of investment firms
Criteria for the authorisation process of investment firms under MiFID II are stipulated uniformly across the European Union Member States in the Commission Delegated Regulation (EU) 2017/1943 of 14 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards on information and requirements for the authorisation of investment firms.
The said Regulation is structured in the following way:
- Articles 1 to 7 detail the information to be provided to the competent authorities by investment firms as part of the process for granting and refusing requests for authorisation;
- Articles 8 to 10 set out the requirements applicable to the management of investment firms and the requirements applicable to shareholders and members with qualifying holdings, as well as obstacles which may prevent effective exercise of the supervisory functions of the competent authority.
The above Regulation is largely based on the existing standards and forms contained in the CESR (ESMA's predecessor) Protocol on MiFID Notifications, hence the EU financial regulator does not expect the costs implied by these rules to be significant.
Third country equivalence for investment services
MiFiDII/MIFIR provides a framework under which the European Commission may take a decision to recognise a third country's prudential and market conduct framework as equivalent to EU rules for certain types of activities directed at professional clients.
As long as such a decision has not been taken, the EU Member States national rules apply for third country firms.
Consequently, every EU Member State is free to determine itself the conditions according to which firms based in third countries may access their market.
As the proposals of 20 December 2017 change the EU prudential rules for investment firms, the equivalence test must also be adjusted to include these new rules (European Commission, Fact Sheet, Frequently asked questions: Revised Framework for Investment Firms, 20 December 2017).
Status of investment firms under REMIT
20 December 2017 European Commission proposal for the amendment of the EU prudential rules for investment firms:
Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive
Commission Delegated Regulation (EU) 2017/1943 of 14 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards on information and requirements for the authorisation of investment firms
Commission Delegated Regulation (EU) 2017/576 of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards for the annual publication by investment firms of information on the identity of execution venues and on the quality of execution
Commission Implementing Regulation (EU) 2017/1093 of 20 June 2017 laying down implementing technical standards with regard to the format of position reports by investment firms and market operators (ITS 4)
Commission Delegated Regulation (EU) 2017/1018 of 29 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards specifying information to be notified by investment firms, market operators and credit institutions
Commission Delegated Regulation (EU) of 14.7.2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards on information and requirements for the authorisation of investment firms, C(2016) 4417 final
Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012, 23.11.2016, COM(2016) 850 final 2016/0360 (COD), p. 22, 23
Consultation Paper of 28.10.2016 Joint ESMA and EBA Guidelines on the assessment of the suitability of members of the management body and key function holders under Directive 2013/36/EU and Directive 2014/65/EU, ESMA/2016/1529 and Annex
|Last Updated on Thursday, 11 January 2018 12:28|