Financial Services & Regulation

On the 26th of June 2021 a new prudential regime will enter into force for investment firms across the European Union including for Cyprus Investment Firms (“CIFs”). The new regulatory framework consists of Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014 (hereinafter the “IFR”) and Directive (EU) 2019/2034 of the European Parliament and of the Council of 27 November 2019 on the prudential supervision of investment firms and amending Directives 2002/87/EC, 2009/65/EC, 2011/61/EU, 2013/36/EU, 2014/59/EU and 2014/65/EU (hereinafter the “IFD”).

The reason for introducing this new regime is that the current legal framework being the Directive 2013/36/EU and Regulation (EU) No. 575/2013 on capital requirements for credit institutions and investment firms (hereinafter the “CRDIV” and “CRR” respectively), which applies to both credit institutions and investment firms, focuses on typical banking risks and therefore is not adapted to the risks run by investment firms.

It must be noted at that point that on the 7th June 2019, the Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 (hereinafter the ‘CRR2’) was published on the Official Journal of the European Union, amending Regulation CRR 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 Regulation (EU) No 648/2012.  CRR2 shall enter into force on the 28th June 2021, with some exemptions. Similarly, on the 7th June 2019, the Directive (EU) 2019/878 of the European Parliament and of the Council of May 20, 2019 (hereinafter the “CRDV”) was published on the Official Journal of the European Union, amending CRDIV as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures. CRDV shall enter into force on the 28th June 2021, with some exemptions.

The new IFR/IFD framework will introduce a new classification of investment firms based on their activities, size, and interconnectedness with other financial and economic actors, and such classification resulting in differentiated requirements applying to investment firms authorised and supervised under the Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on Markets in Financial Instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (hereinafter the “MiFID II”), including CIFs. More specifically, IFR will become directly applicable in Cyprus on June 26, 2021 whereas Cyprus, as an EU member state, should transpose IFD into national legislation by June 26, 2021.

Categorisation of investment firms

Under the new regime, a distinction is made between three categories of investment firms. The applicable prudential rules vary, depending on the category to which the investment firm belongs.

More specifically, investment firms will be categorized, subject to specific conditions, as follows:

Class 1A: This will consist of large, systemically relevant investment firms that in many respects show similarities with systemically relevant credit institutions, except that these investment firms do not meet the criteria to qualify as a credit institution (they cannot hold deposits or other repayable funds). As ‘quasi-banks’, these systemically relevant investment firms are requalified as credit institutions and will require a credit institution authorization supervised under the CRR2/CRDV capital framework.

Class 1B: will consist investment firms that will remain as investment firms under Cyprus Stock Exchange Commission’s (hereinafter the “CySEC”) supervision but will be supervised under CRR2/CRDV for prudential requirements.

Class 2: This will consist of investment firms which will not (or no longer) meet any of the conditions of the investment firms of Class 1a; 1b; and 3 and which will be subject to the new IFR and IFD regime. In order to qualify as a Category 2 investment firm, the investment firm must therefore establish that (i) it is not a Class 1 (1a or 1b) investment firm, and (ii) it exceeds one of the threshold values to qualify as a Class 3 investment firm.

Class 3: This will consist of investment firms which qualify as small and non-interconnected investment firms provided, they meet all the conditions of this Class as set out by CySEC. Investment firms under this class will be subject to the new IFR and IFD regime with certain exceptions.

As mentioned above, the investment firm will fall into a specific class (above) provided it meets the conditions of the class in question as set out by the applicable legal framework. Just as the current CRR/CRDIV regime, the new prudential regime for investment firms is also based on the Three-Pillar regulatory model of Basel II. The first Pillar covers minimum capital and liquidity requirements. The second Pillar regulates the investment firm’s accountability to the regulator for capital and liquidity adequacy. If the regulator deems the capital to be insufficient, a corrective requirement can be imposed on the company in the form of what is known as a ‘SREP decision’. On the basis of the third Pillar, the investment firm is required to publish information about the prudential requirements, risk management and principles of the remuneration policy. In particular, the new regime modifies the implementation of the Pillar I capital requirements with the introduction of a simpler applicable framework, focused on the nature of the investment firm’s business and the resulting risks. As CySEC eloquently put it in its issued practical guide:

The new prudential framework for investment firms takes into account the particular business practises of different types of investment firms and especially their size and interconnectedness with other financial and economic actors. The new prudential requirements are calibrated in a manner proportionate to the type of investment firm, the best interests of the clients of that type of investment firm and the promotion of the smooth and orderly functioning of the markets in which that type of investment firm operates. They also mitigate identified areas of risk and help ensure that, if an investment firm fails, it can be wound down in an orderly manner with minimal disruption to the stability of financial markets.

Importantly, CySEC has issued Circular C426 on the 2nd of February 2021 entitled “Updates for the New Prudential Framework of Investment Firms”. It has been made clear thereunder that all CIFs will be subject to this new prudential regime (comprising of the IFR and the IFD), under which the approach for the calculation of the minimum capital requirements is way different from the ‘risk weighted assets’ approach of regulatory regime applicable today.

In light of the above, CySEC urges all CIFs to study the upcoming regulatory regime carefully in order to be able to:

    1. Identify the class they will be categorized at from 26th June 2021;
    2. Familiarise themselves with the new templates and the way their new capital requirement will be calculated;
    3. Identify the data needed to be collected and reported, especially in regards to the calculation of K-Factors; and
    4. Review their internal records and systems and make the necessary changes to ensure that the required historical data for the K-Factors will be available to calculate their new capital requirements. This information should be readily available at all times.

Finally, CySEC expects CIFs to start making their own assessment on the impact that the IFR and IFD will have on their own funds, concentration risk, liquidity risk, disclosure, reporting, remuneration requirements and take the necessary early actions to ensure compliance by the date of entry into force (i.e., on 26th June 2021).

You can find a copy of Circular C426 by clicking here. Additionally, by clicking here you may access the practical guide for the new prudential framework issued by CySEC.

For further information on our Financial Services & Regulation practice please do not hesitate to contact us.

DisclaimerThis note serves as a general overview of the relevant Cyprus and EU legislation and the information set out shall not be considered as a legal advice nor shall be relied upon by any natural or legal person. G.C. Hadjikyprianou & Associates LLC shall not be liable for any damages incurred by any person who relied solely on the information provided herein. For the avoidance of any doubt, this note is merely intended to highlight key issues and not to be comprehensive and no party shall re-produce and/or use the same without our prior written consent. Use of the information provided herein is subject to our Terms of Use.