Preparing for IFPR: The Time to Act is Now

According to Frimpong, the K-factor requirements are the most significant innovation in the new regime. They also present regulated entities with a substantial data challenge, since firms need to put in place a framework for collecting, storing and validating large amount of data they have not used before, he said.

Investment firms will need to apply those K-factors that are relevant to their business model. The new regulation defines three categories of K-factor. The Risk-to-Client (RtC) K-factors are designed to measure proxies for business areas of the investment firm that pose risk of harm to the firm’s own funds, with four specific K-factors identified: assets under management; assets safeguarded and administered; client money held; and client orders handled.

The Risk-to-Market (RtM) K-factors apply only to firms with a trading book and that deal on their own account or on behalf of clients. Here, two K-factors have been defined: net position risk and clearing margin given. The Risk-to-Firm (RtF) K-factors are also applicable to firms trading on their own account, and focus on counterparty risk and large exposures: exposure to trading counterparties default; concentration risk (based on large exposures to specific counterparties) and daily trading flow.

Frimpong said investment firms will be required to calculate the K-factors that apply to them, according to the specific formulas set out for each. Some calculations will be familiar to practitioners. For RtF, for example, the calculation is based on a simplified version of firms’ counterparty credit risk (CRR) calculation as it applies to derivatives transactions and the K-CON is identical to current rules for large exposures under CRR.

But, Frimpong pointed out, firms will need to put in place mechanisms for collecting the information they need to ensure they have the required data points covered under the regulation. “Firms need systems and processes to collect, store and validate large amounts of data that they would not previously have had to do for CRR,” he said. “This is something that firms need to look out for.”

In addition to understanding the K-factors, it's important for firms to understand their classifications, and how that classification may change if they cross capital requirement thresholds, since this may trigger the application of different sets of K-factors. Frimpong also pointed out that the new regulation introduces changes to firms’ regulatory reporting obligations. Reporting is simpler in the UK, he said, although the underlying calculations are in line with the EU (see diagram, below).

Panellists on the webinar identified several key challenges posed by IFPR, the first of which is to understand the regulation and how to apply it to your firm. One panellist mentioned that his firm had discovered elements that were not clear and sought external advice on these.

Another challenge is putting in place the appropriate systems to calculate some of the K-factors. This must be accurate and auditable, and capable of daily risk management under IFPR’s Internal Capital & Risk Assessment process (ICARA), which is new to markets, clients and firms, and aligns potential harms to firms’ own activities.

In terms of what actions firms should be taking now, the panel acknowledged that firms have yet to have sight of a final text with nine months to compliance. Panellists urged attendees to read up on the FCA’s guidance so far, as well as pending issuances expected next month on K-factors and liquidity risk, and further clarification expected in July. Audience members were also urged to scour the EU’s communications on IFR/IFD for further insight. Given the tight turnaround, panellists said they expected to see transitional provisions and forbearance on deadline day.

In the meantime, firms should be looking to identify their classification, and reviewing their own funds to identify whether they will be subject to a change in capital adequacy requirements. Although the possibility of a delay in the implementation date was mooted - the three FCA consultations and policy statements won’t be completed until late October/early November, leaving the marketplace little time to understand the rules. The panellists said firms should get on with implementation as rules come into force soon. Again, they recommended looking to the EU, as one panellist put it: “FCA rules will probably follow EU technical standards with some deviations, so firms can start implementing in line with EU draft rules knowing that not much will change.”