- ECB in focus
ECB becomes new supervisor for systemic investment firms
Dr Alexander Behrens
Frankfurt am Main
Regulatory Practice Prof.
Frankfurt am Main
01 February 2022
Background: The new investment firm regime
The new IFR and Investment Firm Directive (IFD) introduce a novel prudential regime for investment firms that better reflects the risk profiles of the individual classes of firms and seeks to improve the effectiveness of their supervision.
The existing EU regulation of investment services, based on the Markets in Financial Instruments Regulation (MiFIR) and the Markets in Financial Instruments Directive (MiFID2) will continue. The new regime however moves away from a categorisation based on the services under MiFIR/MiFID2. Instead, it uses quantitative indicators to reflect its prudential concerns. The IFR/IFD regime reinforces the previously applicable prudential rules, especially for large investment firms and seeks to establish a level-playing field between large and systemic firms.
The new rules divide investment firms into three broad classes with different rules applicable to each. On the one hand, the vast majority of medium and small investment firms (Classes 2 and 3) will no longer be subject to the CRR/CRD requirements, but to a specific prudential regime more tailored to their activities, risk profile and size. On the other hand, larger firms remain subject to CRR/CRD ('Class 1 minus') with the largest and systemically important firms (Class 1) additionally required to apply for authorisation as credit institutions from 26 June 2021 onwards.
Classification of Class 1 investment firms
An investment firm will be classified as Class 1 and fall within the amended definition of 'credit institution' in the CRR if it meets the following cumulative conditions:
- The firm’s authorisations include at least one of the following permissions: (a) dealing on its own account; (b) underwriting of financial instruments, or (c) placing of financial instruments on a firm commitment basis (three of the activities regulated under MiFID2); and
- The firm has total consolidated assets exceeding EUR 30 billion either on a stand-alone basis or at a group level if it belongs to a group whose entities individually do not exceed that threshold but when combined reach at least EUR 30bn.
The consolidated supervisor has a discretionary power to classify other investment firms as Class 1 if certain criteria are met, to prevent the risk of circumvention or potential risks to financial stability.
Investment firms that meets the conditions are required to apply for a banking licence but may carry on their activities based on the MiFIR/MiFID2 regime while the licensing process is ongoing. The process will take some time and, as of 1 February 2022 no licences have been granted.
In general, the ECB will take over direct supervision of those investment firms. The ECB will be the direct supervisor of an institution classified as 'significant'. The ECB expects to apply the classification in most cases since one marker of ‘significance’ is that the institution holds EUR 30bn or more in assets, which will by definition be the case for but all newly authorised credit institutions.
The licence application is subject to the established authorisation process developed by the ECB since 2014 when it first took over the supervision of systemic banks. Also relevant may be national variations in the implementation of the IFD which the ECB is to take into account as it is to apply EU law and national law transposing directives.
As part of the 'common procedures' approach, the ECB is responsible for all licensing decisions relating to credit institutions in the Eurozone. The entry point for the application however is the national competent authority (NCA) of the Member State in which the investment firm is established. This will ordinarily be its present regulator that also approved its current licence. The ECB will closely cooperate with the relevant NCAs in assessing the application.
Transitioning to a new regulator
It is clear that the change for the new Class 1 investment firms will be substantial, not only because they have to obtain a completely new licence but also because it involves a switch of regulators. This generates a whole array of considerations including the ECB onboarding process, supervisory fees and the annual SREP.
ECB onboarding procedure
The application for the licence as a credit institution will 'onboard' the institution to the ECB’s list of supervised entities and allow the ECB to familiarise itself with the entity. Institutions on the other hand should be aware that:
- The process of becoming authorised is relatively lengthy and licensing procedures typically take between 6 and 12 months;
- They must provide detailed information to the ECB as part of the process, including information on their capital position, business plan, financial projections, operational structure, governance arrangements, internal controls and risk management. This may be more onerous as what was required for their previous licence procedure with their NCA;
- As part of the licensing procedure the ECB will scrutinise the information provided and may issue supervisory findings. In particular, asset quality reviews often result in findings. The review may be more rigorous than that conducted by the NCA; and
- There will be a change in personnel that the firm will be dealing with. The ECB will form a new joint supervisory team (JST) comprised of staff of both the ECB and of relevant NCAs in member states in which authorised members of the group are established. It will take some time to get used to the new supervisory team.
Another change that needs to be borne in mind is that newly authorised credit institutions are under an obligation to pay annual supervisory fees to the ECB. Since fees are calculated according to the institution’s importance with total assets and total risk exposure leading to the fee outcome, the fee level may be substantial and is likely to far exceed the current fee level (if any). Find more information on fees on the dedicated ECB webpage.
As ECB supervised entities, investment firms will be subject to the Supervisory Review and Evaluation Process (SREP) carried out on a continuous basis by the JST. The ECB will adopt an annual SREP decision, which sets out specific measures to be implemented during the following year. Such measures may address capital, liquidity, risk management and governance. Although the institution will have previously been subject to ongoing supervision, the scope, frequency and intensity of the review is now likely to be greater than it was when the firm was subject to supervision only by its NCA.
Finally, institutions should take into account that the ECB will have a different supervisory culture compared to their previous supervisor.
See the ECB's 2019 guide to assessment of licence applications here.
Read the Investment Firm Regulation (Regulation (EU) 2019/2033 here.
Read the Investment Firm Directive (Directive (EU) 2019/2034) here.