Large investment firms: new licence, new supervisor
19 May 2021
Investment firms play an important role in capital markets because they offer investors access to securities and derivatives markets through a number of different services, including investment advice, portfolio management, brokerage, order execution, proprietary trading and underwriting. These firms are regulated and supervised for a number of reasons, including to preserve financial stability, protect investors and ensure an orderly failure in the event of a firm’s insolvency. From 26 June 2021 investment firms will be subject to a new European regulatory regime. These new rules are intended to better reflect the actual risks taken by the different types of investment firms and to make the supervision of such firms more effective. The new regime introduces various categories of investment firms. The largest firms will be classified as credit institutions and will therefore need to be licensed as such. These bank-like firms will continue to be subject to the Capital Requirements Regulation and Directive. In most cases, the ECB will assume responsibility for their direct supervision. Smaller investment firms will be subject to a new regime that is more tailored to their activities, risk profile and size.
Large investment firms carry out bank-like activities, meaning that they take on credit risk and market risk – the same types of risk that banks are exposed to. Under the new rules, an investment firm qualifies as a credit institution if it deals on its own account or underwrites or places financial instruments on a firm commitment basis – i.e. it undertakes to arrange the placing of instruments with investors and to purchase some or all of these securities should the placing fail – and has total assets of more than €30 billion. Classification as a credit institution is either on a stand-alone basis or on a combined basis. A firm qualifies as a credit institution on a combined basis if it belongs to a group of entities that individually have assets below €30 billion but whose total assets when combined reach or exceed this figure.
The consolidating supervisor (i.e. the supervisor responsible for the supervision of banking groups on a consolidated basis) has the discretionary power to classify other investment firms as credit institutions if certain quantitative and qualitative conditions are met. First, the investment firm needs to be part of a group in which the combined value of the assets of all group entities with relevant activities reaches or exceeds €30 billion. Second, it is considered that the investment firm poses a risk of circumvention of rules and risks to the financial stability of the European Union. The ECB will consider whether a group has set up its structure and activities with the aim of circumventing the new supervisory regime for large investment firms. The ECB’s assessment of risks to financial stability covers several aspects, including the size of the investment firm, the nature, scale and complexity of its activities, its interconnectedness with the financial system and whether or not it is a member of a central clearing counterparty.
The new regime introduces some important changes for large and systemic investment firms. The most consequential is the requirement to apply for a licence as a credit institution. The ECB will assess applications using its established processes for the licensing of credit institutions. This means that the entry point for all applications is the national supervisor of the country where the credit institution will be located, irrespective of whether the significance criteria are met or not. The national supervisors and the ECB cooperate closely throughout the licensing process. However, the ECB is ultimately responsible for taking licensing decisions on all applicant credit institutions. Cooperation with market authorities and the sharing of knowledge and information about the new credit institutions will be an important part of the licensing and supervision of new credit institutions. While waiting for the new licence to be granted, an investment firm may continue to provide services under its current investment firm licence, although this will ultimately depend on how a Member State transposes the rules.
There will also be important changes to supervision. If the new credit institution – i.e. the investment firm with a new licence – is considered significant under the applicable criteria, it will be directly supervised by the ECB. If it is classified as less significant, the national competent authority will be responsible for its direct supervision. In line with its normal practice, the ECB will carry out a comprehensive assessment of any new credit institutions under its direct supervision. In preparation for its new supervisory responsibilities and to ensure a smooth transition to the new supervisory regime, the ECB reviewed its supervisory approach and methodologies. It concluded that they are fit for purpose and can be adapted in due course, if necessary.
With the new regime just around the corner, large investment firms need to prepare. Firms that qualify as a credit institution should gather the detailed information required for the licence application. This includes information on the capital position, business plan, financial projections, operational structure, governance arrangements, internal controls and risk management (see the ECB Guide to assessments of licence applications). The ECB encourages large investment firms to reach out to their supervisors to start a dialogue on the transition to the new regime.