Ready for change: The new prudential regime for Investment Firms - Gerry Cross, Director of Policy & Risk and Asset Management and Investment Banks (Interim)

29 January 2021 Speech

Gerry Cross

Speech to KPMG Investment Firms Regulation and Directive Webinar, 27 January 2021

Good afternoon. 

I would like to thank KPMG for inviting me to speak to you today. 

The new prudential regime for investment firms is applicable for firms from 26 June 2021.

This framework, set out in the Investment Firms Regulation and Directive (IFR/IFD), marks a coming of age for investment firms regulation. It reflects significant progress not only in the way we approach the regulation of investment firms, but also in how the financial system, and the role of the non-bank sector, has evolved over recent years and particular in the wake of the great financial crisis. It has, in addition, added relevance for us in Ireland. Not only is it strongly based on the principles of risk-relevance and proportionality, concepts which are at the heart of the Central Bank of Ireland’s own approach to regulation, it also addresses key issues of international integration and technological innovation, issues which are a key concerns at the current moment.

I want to structure my comments about the IFR/IFD today under three broad headings:

Firstly: the changing landscape for investment firms;

Secondly; the international dimension; and

Thirdly; principles of good regulation in the IFR/IFD.

Investment firms the changing landscape:

There are three dimensions in which the role and nature of the investment firms sector has changed significantly and continues to change over the recent and current period.

Firstly, one of the lessons of the Great Financial Crisis was that not only had the financial system, particularly in Europe, become too concentrated on, and too correlated with, the banking sector as a means of financing the economy, but also the regulation of those banks had become much weaker than it needed to be. This has given rise not only to a very significant tightening in the regulation of the banking sector but also a realisation, given political form in the shape of Capital Markets Union, of the need to significantly enhance the role of capital markets and the non-bank sector.

During that period the role of the non-bank sector has increased significantly. As noted by Luis de Guindos, Vice President of the ECB in a speech he made at the start of last year: “In the euro area, total assets held by non-banks have almost doubled over the last ten years, growing from €23 trillion in 2008 to €45 trillion in June 2019. Non-banks currently account for around 55% of the euro area financial sector…Whereas in 2008 non-banks accounted for 14% of the euro area financial sector’s loans to non-financial corporations, that share roughly doubled in a decade.”1

Secondly, here in Ireland, we have seen the evolution of the financial sector accelerated by the decision of the UK to leave the European Union. The new legal context, combined with the uncertainties and added complexities that have resulted from Brexit have caused many firms, which previously did business in the EU from the UK, to seek regulatory authorisation in other jurisdictions including Ireland. And as you will all know the Central Bank has had a very clear approach: if you want to be authorised here, you have to be clearly and demonstrably running your business from here. This has meant that we have seen a significant evolution in the number and types of firms doing business in Ireland over recent years.

As a result, the financial services landscape in Ireland is materially different to that of a decade ago. There has been a level of consolidation within the wealth management sector and a material growth in investment firms which leverage technology and innovation. This has changed the dynamic as well as the size of the Investment Firm sector in Ireland Post-Brexit.  The number of firms in the sector has increased materially with an additional €100bln of investor assets managed in the sector.

It has given rise to:

  • More complex business models operating in the sector, including Investment Banking, Broker Dealers and Market Infrastructure entities
  • An increase in the migration of trading & capital markets activities into existing Irish authorised firms
  • Increased market materiality for the Irish sector.

Thirdly, we see the continued impact of rapid technological change and how this is driving developments in business models and service offerings.

In an increasingly digitalised world, investment firms are rapidly innovating to meet client demands and gain market share.  Both retail and professional client’s demands have and will continue to change.  24 hour trading, online interfaces, modelling capabilities are ever changing.  But in addition to the front end interface between firm and client we are also seeing the criticality of technology and innovation in how firms access markets and how they manage and report risks.  This is calling for ever more technology focused capability and capacity in the governance, risk, and control structures embedded in each firm.

The growing prevalence of trading firms deploying algorithms in recent years has re-shaped market structures and fundamentally changed the operation and business models of regulated firms involved in providing market liquidity and in proprietary trading. In 2016, it was estimated that approximately 10% of trades on the Irish stock exchange were executed by an algorithm. In 2019, that number was closer to 90%2.

Last year, the Central Bank conducted a thematic review across a number of algorithmic trading firms to assess how they have incorporated the requirements set out in RTS 6 of MiFID II3 in their risk management and control frameworks. RTS 6 requirements fall broadly into five core principles, (i) algorithmic trading governance and oversight, (ii) development and testing of trading algorithms, (iii) risk measurement and control, (iv) processes and controls and (v) trade lifecycle management.

The primary output from this thematic review will result in supervisors issuing entity specific risk mitigation programmes where identified risks are outside of the Central Bank of Ireland’s risk appetite. Furthermore, an industry communication will issue with clarification and guidance on the key findings of the thematic review.  

Whilst certain positive practices were observed, significant improvements are required. The supervision team observed varying levels of maturity across governance, control and risk management frameworks of in-scope firms. Common themes noted  include:

(i) A lack of clearly defined roles, board reporting and reporting lines, and a lack of appropriate delineation between the three lines of defence.

(ii) Insufficient formality with respect to key documentation. This speaks to this sector being at the relative early stages of maturity and also the extent to which firms leverage group documentation.

 (i) An over-reliance on Group with insufficient autonomy at local entity level. This was evidenced through an absence of local Board involvement in setting or challenging of the key controls and in the oversight of the development of trading algorithms.

 These findings do not align to Central Bank of Ireland’s expectations, given the nature, scale and complexity of firms within scope of this review.

The Central Bank will continue to drive higher standards of governance and oversight of technology and the material deficiencies identified in this review underscore the importance for the investment firm sector to continue to invest in the risk management and control environment needed to support technological evolution in their business.

EU and International

An important feature of the new IFR/IFD framework is the issue of firms authorised in third countries that want to do business in the EU. This of course is a part of the bigger question – which has acquired additional importance in the wake of Brexit – as to how EU capital markets should be best integrated into international ones. In other words how should one balance the benefits of open global markets and the cross-border provision of financial services on the one hand with the crucial need to ensure financial stability, protect investors and consumers, and secure the fair and orderly functioning of financial markets on the other?

In determining the extent to which third country firms should be able to have access to EU markets, there are three principles that should be applied. To the extent that these principles are met, then access should be permitted. Importantly, we should not impose restrictions that go beyond these. The three principles are the following:

  • Services that are offered in the EU should be subject to and provided in accordance with EU norms and standards. This means that the firms offering the services either need to be authorised and supervised in the EU or be subject to a regulatory and supervisory regime in their home jurisdiction that delivers the same outcomes, with those outcomes being considered at an appropriate level of granularity.
  • Entities that are authorised in the EU must demonstrably be run and managed from the EU and be subject to effective supervision by EU competent authorities. What this means is that while the cross-border integration of activities and, for example, groups can deliver significant benefits for consumers and economies, it is fundamental that this does not result in activities somehow falling outside the oversight of EU regulatory and supervisory authorities. So, for example, outsourcing and delegation must be done in such a way that the do not result in the business effectively being run outside the remit of the EU authorising and supervising authorities.
  • EU financial stability must be fully secured. The relevance of this principle has been significantly enhanced as a result of Brexit. With the UK no longer part of the European system of financial supervision, ensuring that financial stability in both jurisdictions is achieved is no longer as integrated an effort as it was previously. This means that integration of financial markets can only go as far as the mechanisms and restrictions necessary to ensure respective financial stability permit.

The IFR amends the MiFIR framework – which has not yet been implemented  – for third country firms to access the EU’s passporting regime. Such firms can only do so where the European Commission has made a finding of equivalence concerning their home state regulatory, supervisory and legal frameworks.

Importantly the new requirements distinguish between firms that are likely to be of systemic importance for the EU and other firms. In the case of the former, the equivalence assessment has to be detailed and granular and the Commission can impose additional operational requirements in respect of such firms. This approach is, in principle, aligned with the principles set out above and thus to be welcomed.

While I am on the topic of third country aspects, it is to be noted that certain aspects of the scope of application of the methodology for calculation the Class 1 threshold, consulted on by the EBA last year, remain to be concluded. Further communication on this can be expected shortly.

Key features of IFD/IFR

At the Central Bank of Ireland, our approach to regulation can be said to reflect three key features:

  1. An outcomes focus. We seek to clear as to what is sought to be achieved and then focus on achieving those outcomes;
  2. A risk-based approach. We have finite resources and an obligation to use them to optimal effect. So we deploy our resources on the basis of assessing the relative size and scale of the risks that arise and seeking to ensure that we focus on the most important ones; and
  3. Proportionality. Firms and individuals should be subject to regulatory burden in proportion to their size, scale and the risks they could pose to consumers, investors or the financial system.

We have been strong supporters of the new Investment Firms framework, because it too is based on these three features. It is outcomes focused, risk driven and embeds proportionality.

First of all it divides investment firms into different classes – essentially depending upon size, scale and activities or what in the Central Bank of Ireland we describe as impact – and applying different treatments depending upon the category.

Large systemic investment firms engaging in bank-like activities4 and operating above a prescribed threshold5 are known as Class 1 firms.  Such firms will be required to seek authorisation as a credit institution and to apply the existing CRD/CRR prudential regime6.

Smaller investment firms that also engage in bank-like activities and operate above a lower prescribed threshold7, whose failure could represent a threat to financial stability or where they meet other criteria may be required to apply the CRR Regime while retaining their authorisation as an investment firm.  Such investment firms are referred to as Class 1 minus firms.  

Very small, non-interconnected investment firms that do not hold client assets, known as Class 3 firms, will be subject to a simplified and less onerous prudential regime again very suited to their risk profile. Their own funds requirement will be the higher of their permanent minimum capital requirement set at the initial capital requirement required for authorisation or their fixed overhead requirement and should be relatively easy to calculate.    This ensures the level of capital required never falls below that required at the time of authorisation.

The remaining non-systemic investment firms, or Class 2 firms, will be subject to a new bespoke prudential regime that aims to align the prudential requirements applying with the range and level of activities undertaken by each particular firm.  The own funds requirement for Class 2 firms will be the higher of their permanent minimum capital requirement, their fixed overhead requirement or a new K-factor requirement that I will discuss in a moment.  


To achieve a proportional regime the so-called K-factor capital requirements framework has been developed for Class 2 investment firms.  The great merit of this framework is that it is explicitly based on addressing the specific harm that could be caused by the disorderly failure of the type of firm in question.

The K-factors are a set of observable proxies that represent the risks or harm that an investment firm might cause to itself and others, both customers and the market as a whole, combined with a set of scalars to reflect the size or scale of the firm that are used to determine the actual amount of capital required and are used to align the interests of the of the firm with the best interests of the client or market place.  

The K-factors applying to each individual investment firm and the resulting capital requirements applying depend on the range and extent of services provided and the amount of capital required increases in direct proportion to the scale of activities undertaken.  For example, the higher the amount of assets under management, the higher the amount of capital required to take into account the potential harm arising. 

Client Assets

Amongst the K-factors, as mentioned, there is an important focus on the importance of the scale of client assets held to the risk profile of a firm. I want to take the opportunity to note that the safety of client assets is in itself a key concern and focus of the Central Bank in general.

Firms holding client assets must comply with the Central Bank’s Client Assets Requirements (CAR). The aim of these important requirements is to minimise the risk of loss or misuse of client assets by investment firms and, in the event, of the insolvency of an investment firm, enable the efficient and cost effective return of those client assets to the firm’s clients. The protection of client assets is a key regulatory and supervisory priority for the Central Bank and we welcome the automatic treatment of a firm that may hold client assets, even on an intraday basis, as a Class 2 firm.

While not directly related to the implementation of the IFR/IFD, it’s worth noting that the Central Bank has recently published a Consultation Paper on enhancements to the Central Bank Client Asset Requirements in December8. CP133, seeks stakeholders’ views on proposed enhancements to the CAR, including broadening the scope and application of the CAR to credit institutions and targeted enhancements relating to wholesale activities in light of the changing landscape for investment firms. The consultation period is open until 10 March 2021 and the Central Bank welcomes views on the proposed enhancements.

Remuneration & Governance

Since the onset of the great financial crisis over a decade ago the global regulatory community, including the Central Bank of Ireland, have sought to elevate the importance of good governance and remuneration practices.  In the area of remuneration a key contributor to the Great Financial Crisis was the misalignment of individuals’ incentives to take risks with the safety and sound functioning of firms and of the financial system as a whole. Put simply: short term bonuses trumped longer term soundness.

The IFR/IFD governance and remuneration requirements depend on the classification of the particular firm and its balance sheet size. 

At one end of the spectrum Class 1 firms will be subject to the governance and remuneration requirements of CRD.  This is considered appropriate as they engage in bank-like activities and are systemic investment firms whose failure could pose a threat to financial stability.

On the other end of the spectrum Class 3 firms will be subject to the existing MiFID II governance and remuneration requirements given their low impact classification. 

Class 2 firms however will be subject to the governance and remuneration requirements set out in the IFD.  These firms must have remuneration policies and practices which are consistent with and promote sound, and effective risk management and, where total assets exceed €100 million, establish remuneration and risk committees, the former of which must be gender- balanced.

Variable remuneration requirements are closely modelled on those contained within the CRD i.e. there are strong requirements aligning remuneration incentives with the medium and longer term risks to the firm.  There are two key differences with the CRD: The absence of a mandatory bonus cap; and investment firms are exempt from the requirements to pay out variable remuneration in instruments or from deferring the payment of variable remuneration where the firm has on and off balance sheet assets equal to or less than €100 million9

For those Class 2 firms that were not previously subject to the CRD/CRR remuneration rules this will represent an uplift in the requirements applicable.  Additionally those firms previously subject to the CRD/CRR regime will be required to review and adapt their policies to ensure they are in line with the new requirements including relevant guidelines once published. 

NCA Discretions

As a regulator we aim to be transparent about our priorities and how we will approach certain issues and recognise the importance of open and early communication with regulated entities to allow them to engage in effective and efficient planning for a new regime.  Therefore another key area of preparation for the Central Bank has been our review of the competent authority discretions contained in the IFR/IFD.  In this regard we have recently published a consultation paper setting out our proposed treatment of NCA discretions set out in the IFR/IFD.

Key discretions discussed in this consultation paper relate to the requirement for Class 3 firms to complete an ICAAP, the decision not to automatically exempt Class 3 firms from the liquidity requirement and the Central Bank’s proposal to exercise the discretion to subject investment firms with consolidated assets of greater than €5 billion to the CRR requirements on a case-by-case basis having due regard to the level 2 RTS developed by the EBA.  In this regard the Central Bank is aware that some investment firms present comparable risk to financial stability as that posed by credit institutions and some investment firms business plans may be such that they are likely to be required to apply the CRR Regime in the near future as they move towards meeting the €15 billion threshold. It may make regulatory sense to move such firms across to the CRR regime at an earlier date to allow for effective and efficient supervision.  

Preparation for the IFR/IFD

The IFR/IFD entered into force in December 2019 and will be applicable for all firms from 26 June 2021.  We appreciate that both COVID-19 and Brexit were impactful for firms throughout 2020. However, at this point we expect that firms’ preparation for the IFR/IFD has been discussed at board level and that firms have stood up their implementation projects.

In terms of key issues, each firm should have carried out its analysis and determined which IFR investment firm class it will be.  Clarity on this issue is critical as it will dictate the firms’ own funds requirements and the extent of the applicability of other requirements under the IFR including reporting, governance, disclosure etc,  

Firms should complete a comprehensive analysis of all relevant aspects of the IFR/IFD and identify how it will impact the respective firm’s business model.  Some of the larger class two firm will require more comprehensive implementation projects than smaller class three firms.

There are a series of new regulatory reports for both Class 2 and Class 3 firms.  Key questions for firms to ask themselves relate to whether they have reviewed the requirements set out in the draft regulatory reports and whether they have access to all the data points.

There will also be threshold reporting for Class 3, Class 2 and Class 1 minus firms, where they are required to report on the total value of consolidated assets on a solo or group basis.  This reporting will commence for all impacted firms in Q1 2022.

I would also like to remind firms that the EBA has a Q&A tool on it’s website to promote consistent application of IFR and IFD.  We encourage you to use this.      


In conclusion, the new prudential requirements for investment firms, a bespoke regime for investment firms rather than one primarily designed for banks, will strengthen the financial resilience of and consumer protections offered by MiFID investment firms.

On the whole we expect the increased resilience and risk-readiness of investment firms arising from the introduction of this new regime to bring greater investor confidence.  The tailoring of capital requirements to the exact business of the individual investment firm is a very positive development.

As I end today I would like to thank you for your time this afternoon.  I am confident that the introduction of this new prudential regime will enhance our collective objectives of having a strong investment firm community in Ireland.

Thank you

My thanks to Niamh Lynn, Suzanne Power, Peter McDermott, Ross Kinsella, Ruth Hogan-Davis, Geraldine McWeeney, and Adrian O’Mahony for their contributions to this speech.


[1] de Guindos, L. (2020). "Europe’s role in the global financial system" Speech delivered at at the SUERF/De Nederlandsche Bank Conference “Forging a new future between the UK and the EU”, on 8 January 2020. 

[2] As reported to the Central Bank of Ireland through the Transaction Reporting Portal

[3] Official Journal of the European Union (2017). "Commission delegated regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards specifying the organisational requirements of investment firms engaged in algorithmic trading"

[4] MIFID activities 3 and 6 – Own account trading and underwriting on a firm commitment basis.

[5] This threshold is set out in Article 4(1)(1) of Regulation (EU) No 575/2013.

[6] CRD V amends CRD IV and entered into force in December 2020.  However the application of the amendments in so far as they relate to investment firms has been postponed until 26 June 2021.  The current CRR will be amended by CRR II which will enter into force in May 2021.

[7]  Firms with EU consolidated assets of greater than €15bn are required to apply the CRR prudential regime.  There is a competent authority discretion to require firms with consolidated assets of greater than €5 bn to apply the CRR regime provided certain other criteria are met.

[8] The CAR is contained in Part 6 of the Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1)) (Investment Firms) Regulations 2017 (S.I. No. 604 of 2017).

[9] This threshold may be increased by the exercise of a Member State discretion.