Cyprus Investment Firms – Changes to Capital Requirements and Reporting – Financial Services

CHANGES TO CAPITAL ADEQUACY REPORTS

INVESTMENT COMPANIES REGULATION (IFR) AND INVESTMENT COMPANIES DIRECTIVE (IFD)

Applies from Q2 2021 and Q3 2021

REPORT

The existing CRR and CRD do not take into account that investment firms have different business models and business risks than credit institutions.

For example, unlike banks, investment firms do not accept large deposits or large portfolios of personal and corporate loans. Therefore, there is no trading risk other than counterparty risk in almost all cases. In addition, not all investment firms are the same size and have the same impact on the regional or global economy. Accordingly, the Commission has introduced IFR and IFD to ensure that these differences are reflected in the EU prudential framework applicable to investment firms.

The preparation of the New Information on capital adequacy does not rely heavily on investment firms’ balance sheets, but rather on a better-tailored combination of income statement and balance sheet risks captured by so-called k-factors. Therefore, the used risk-weighted assets (RWA) by the CRR will cease to be used. More data from investment firms is needed to complement the new capital adequacy reports. Therefore, the configuration, contribution, support and assistance of the investment firm is a prerequisite to be able to collect the necessary information.

NEW CAPITAL REQUIREMENTS

Class 2 investment firms

Class 2 investment firms must at all times have own funds which amount to at least the higher of the following amounts:

  1. Required fixed overhead (25% of previous years’ overhead)

  2. Minimum permanent capital required

  3. Their K-factor requirement

Class 3 investment firms

Class 3 investment firms must at all times have own funds amounting to at least the higher of the following amounts:

  1. Required fixed overhead (25% of previous years’ overhead)

  2. Minimum permanent capital required

  3. Their K-factor requirement (because K-factors do not apply to category 3)

K-FACTORS

The K-factors below aim to capture the risks the investment firm poses to itself, its liquidity and its clients;

  • Client risk: how can the investment firm harm its clients?

  • Market risk: how much exposure do investment firms have based on their positions?

  • Business risk: captures counterparty risk and operational trading risks

PREPARATION OF CAPITAL ADEQUACY REPORTS

In a nutshell, we summarize what you need to pay attention to and what investment firms need to be able to prepare and submit their new capital adequacy reports (COREP). We list below the information and steps that an investment firm must follow in order to be able to complete its capital adequacy report for the Q2 2021 period which is a test period and for the Q3 2021 and subsequent periods .

Step 1 – Categorization of the investment firm

All investment firms are now classified in 3 sizes; “Class 1”, “Class 2”, “Class 3”.

The size distinction depends on the activities, size, interconnectedness and of course the systemic importance of investment firms.

Class 1 – are large systematic investment firms and will be treated as credit institutions because they exceed specific criteria according to the IRD.

Class 2 – are investment firms that will apply the new IFRs and IFDs on a quarterly basis and that go beyond the categorization of “small non-interconnected investment firms”.

Class 3 – are the smaller investment firms that will apply the shorter IFR and IFD on an annual basis referred to as “small non-interconnected investment firms”.

The first step, therefore, is to determine where our investment firm is located and this will be determined by assessing the requirements of Article 12 of the IFR.

Non-systemic investment firms

Determine whether your investment firm is a Class 2 or Class 3 investment firm by applying Article 12 of the RIF.

Small and non-interconnected investment firms within the meaning of Article 12 of the IFR:

We provide below an excerpt from Article 12 of the IFR which sets out the conditions for an investment firm to fall into category 3. If any of the conditions below do not apply, the investment firm will be classified as a class 2 investment firm.

Extract

“1. Investment firms are considered to be small and non-interconnected investment firms for the purposes of this Regulation when they meet all of the following conditions of Article 12 of the RIF:

  1. Assets under management measured in accordance with Article 17 are less than EUR 1.2 billion;

  2. client COH (client orders processed daily) measured in accordance with Article 20 is less than either:
  1. 100 million euros/day for cash transactions; Where

  2. 1 billion euros/day for derivatives.

    (c) ASA (Assets Safeguarded and Administered) measured pursuant to Section 19 is zero;

    (d) CMH (Client Money Held) measured in accordance with clause 18 is zero;

    (e) DTF (daily trading flow) measured in accordance with Article 33 is equal to zero;

    (f) NPR or CMG measured in accordance with Articles 22 and 23 is zero;

    (g) TCD (trading counterparty default) measured in accordance with Article 26 is equal to zero;

    (h) the balance sheet and off-balance sheet total of the investment firm is less than EUR 100 million;

    (i) the total annual gross income from the investment firm’s investment services and activities is less than EUR 30 million, calculated on average on the basis of the annual figures for the two-year period immediately preceding the exercise considered.

If the above applies, your investment firm falls under class 3. Otherwise, it falls under class 2.

Step 2 – Data collection

To be able to complete the new COREP forms, more detailed data will need to be extracted from the back office and trading departments in addition to the information required to prepare the previous capital adequacy reports, forms 061 082 and 083 (such as periodic balances, balance sheet for the period, latest audited financial statements available).

New additional information needed:

  • Total monthly assets under management

  • Total daily funds held by clients – Segregated and non-segregated

  • Assets protected and administered

  • Total Daily Customer Orders Fulfilled – Cash Value

  • Total daily client orders processed – Derivatives

  • Clearing margin given – additional detail from CMG

  • Daily trading feed – spot trades

  • Daily trading feed – derivatives transactions

  • Five, if available counterparties or group of related counterparties where the largest amount of client money is held

  • Five, if available counterparties or group of related counterparties where the largest number of securities is held

  • Five, if available counterparties or group of related counterparties where the largest amount of the firm’s own cash is deposited held

  • Five, if available counterparties or group of related counterparties from which most of the companies profits are derived

  • Five, if available, largest trading book exposures

  • Five, if any, largest non-trading book exposures calculated taking into account off-book assets

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The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.