Are the complexities of the new Investment Firms Regulation (IFR) to investment firms as kryptonite is to superman?

By Richard Moss, global product manager, Capital, AxiomSL

October 28, 2020 | AxiomSL

Even though investment firms have very different primary business models and risk profiles as opposed to lending institutions, to date, for regulatory purposes many have been considered credit institutions and accordingly report under the Basel-driven capital requirements regulation (CRR). The CRR approach is too broad to effectively account for the risks faced by both investment firms and credit institutions. The IFR regime, according to the broader Investment Firms Directive (IFD), seeks to create a regulation with requirements that are proportionate to the size of the firms expected to comply, based on designated categories determined by thresholds that use K-factors (quantitative indicators). However, just as it may be surprising that kryptonite makes Superman weak, the IFD / IFR regime unexpectedly makes things more complicated.

Heroic intentions, but unintended consequences
With the June 26, 2021 deadline looming, investment management firms operating in Europe must implement IFR based on their designated category. IFR reporting will include new data collection, categorisation, capital calculations, and requirements, plus, reporting will be more frequent. An additional complexity is that both the requirements and the implementation timeline for the U.K. will be different from those in Europe, with those details still pending. Layers of complications may leave firms feeling like they need to call on Superman for help.

Even a superhero can’t make this fly away
Firms will be facing a multi-faceted problem and the new calculations will alter their perspective on their capital holdings. In fact, the European Banking Authority estimates that based on the results of IFR reporting, capital requirements for investment firms overall are expected to increase by 10 percent. Problems requiring some superhero muscle include:

  • Collecting more data from across disparate sources
  • Accessing often difficult to obtain operational data
  • Addressing more complex calculations and operating IFR in parallel with existing CRR reporting — including standardised approach (SA) and capital floor thresholds
  • Reporting using XBRL format, and IFR and COREP templates Achieving transparent reconciliation results

It’s a bird, it’s a plane…No, it’s the K-factors
In addition to the aforementioned challenges, the K-factor methodology is the most significant change to the IFR regime and may cause the most distress for organisations given its complexity. Firms must continuously monitor their eligibility thresholds and provide evidence of such to regulators. As an example of the methodology’s complexity, K-factors including NPR, K-TCD and K-con focus on different areas of risk — market, credit and large exposure respectively — all of which must be taken into consideration. While there is significant overlap between the principles of these K-factors and CRR, they are not identical.

Faster than a speeding bullet: Superman adapts quickly to change
As the regulation evolves, investments firms will need to monitor changes and adapt quickly. Although this may not be a task requiring superhuman abilities, preparing for the IFR regime and any ongoing changes still presents formidable challenges, including:

  • Alignment with the K-factor rules and IFR taxonomy requirements
  • Precise submission histories to withstand audit scrutiny
  • Demonstrated compliance with BCBS 239 data quality and governance objectives
Firms can go from Clark Kent to Superman by implementing IFR quickly, and then adeptly continue to manage the regime within a holistic, data-driven ecosystem that addresses risk management, data governance and calculation changes.

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