By Kwame Frimpong
The call for financial institutions to provide regulators with more and better data is not aimed just at banks. Investment firms authorized under MiFID that do business in the European Economic Area and the United Kingdom face equivalent requirements under a framework known as the Investment Firm Directive/Investment Firm Regulation (IFD/IFR) that went into effect this year in the EU and that will go into effect in the UK in January 2022.
If you are wondering whether your firm is one of those to which the rules of the new prudential regime apply, the answer, as you must have suspected, is: “Probably.”
IFD/IFR was created by the European Banking Authority to establish a new prudential framework for EU investment firms previously caught by the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR). IFD/IFR imposes a fresh set of requirements that all but the largest, systemically important investment firms (that will have to remain compliant with CRD/CRR) must use to calculate capital requirements.
The prospect of meaningful changes to capital requirements is why the framework is important to the many firms that will have to transition to this new regime, along with their executives and shareholders. The complexity and frequency of the calculations that will be mandated under IFD/IFR are why the new framework is important to your data systems, and to everyone who depends on them.
Same old, same old, plus something new
As highlighted in our earlier commentaries on this topic, the required Pillar 1 capital for designated Class 2 firms under the new framework, will be the higher of its permanent minimum requirement, its fixed overhead requirement and its requirement based on measures called K-factors that have been devised to quantify various sources of risk to which investment firms are susceptible.
Class 2 firms will be used to the first two calculation inputs. It is in determining values for the various K-factors that any weakness in their data infrastructure will be found out. Take Risk-to-Client, one of the three main K-factor requirements. Calculating specifically the values for assets under management (AUM), assets safeguarded and administered (ASA) and client orders handled (COH) will require using historical data that may be difficult to source because many investment firms never have had to source this data until now. This is data that is hard to assemble, and in some cases it must be collected daily over many months for use in each submission.
Beyond the minutiae involved in calculating individual K-factors, investment firms whose systems have been set up to meet regulatory reporting requirements under old regimes are bound to run into data quality issues when adjusting to life under IFD/IFR. The sheer volume of required data will pose a challenge, as will sourcing various types of data, which may be stored in different systems. Once the data is gathered, it will have to be collated, validated, cleansed and reconciled.
No need to build from the bottom up
Once they are aware of the obstacles that the new, beefed-up prudential regime is putting in their path, and begin to assess their systems, firms may be unsure how to close the gap between what they have and what they need. Given the significant changes that IFD/IFR is ushering in, and the urgency of coming into compliance – the rules must begin to be applied to submissions for the quarter ending September 30 in the EU. So, for Class 2 firms this is not the time to reinvent the wheel if your systems are not yet up to the task. You need to get rolling fast.
Your best approach is to choose a solution that would enable your firm to fast-track to data harvesting by implementing the needed data points into the data model. The solution should be designed with a common data warehouse, dictionaries, and taxonomies to facilitate integration among a firm’s many functions, related not just to securities activities but others that it may be involved in, and ensure consistency and transparency and a pristine audit trail. Another important feature will be a modular design to provide the flexibility needed to give users only what they need, even as that changes over time.
The best solution for a given institution depends on its activities and where it operates, but a larger, industry-leading provider is likely to have the most extensive suite of programs, and it should be able to benefit most from economies of scale. Perhaps most important, an industry leader’s greater expertise and experience will leave it better placed to manage the next round of change to regulatory regimes and to its clients’ business.