Understanding the New Investment Prudential Regime – K-Factors & Capital Calculations

By Kyte Ekstrom | Compliance, FCA Regulation, FinTech, Investment, Investment Advisor, Investment Funds, Investment Manager | 0 Comments

The new regime has thrown a spanner in the works of all investment firms regulated by the FCA as it brings about BIG changes.

The new requirements, which came into force on the 1st January 2022, seek to capture the potential harm posed by firms to their clients and the markets in which they operate. It also considers the amount of capital and liquid assets FCA investment firms should hold so that if the firm does have to wind-down, it can do so in an orderly way.

Firm Categorisation

Firstly, and most importantly, a firm needs to ascertain whether they are a small and non-interconnected firm (SNI) or a non-SNI. To be considered an SNI firms must meet all the threshold conditions below:

  • Assets under Management of under £1.2 billion
  • Client cash orders of under £100 million per day
  • Client derivative orders of under £1 billion per day
  • The firm does not safeguard assets
  • The firm does not hold client money
  • On and off-balance sheet total of less than £100 million
  • Total annual gross revenue from investment services and activities of less than £30 million.

SNI firms would qualify for certain benefits such as some capital and reporting requirements. For example, an SNI firm would not have to calculate their capital requirements with regard to the K-Factors.

However, the capital requirements for all investment firms will be changing, whether the K-Factors apply or not. The idea for this regime is to include the 3 options for the capital requirement whereby a firm will have to determine their requirement, whichever one is the highest out of the permanent minimum requirement (PMR), fixed overhead requirement, and the K-Factor requirements.

Permanent Minimum Requirement (PMR)

This requirement could change with other factors like overheads and K-Factors. The overheads requirement is simply 3 months of relevant expenditure.

K-Factors

K-Factors aim to calculate ongoing capital requirements based on several capital factors. It aims to measure the risks posed by a firm to its customers, to the market generally and to the firm itself. The FCA’s expectation is that all firms will be expected to consider the relevant K-factors as part of their internal and supervisory discussions for monitoring sources of harm, even if firms are categorised as a SNI. The relevancy of K-Factors will depend on the firm status as an SNI, and the activities conducted. SNI’s will NOT have to deal with K-Factors when calculating their capital requirement.

There are several K-factors, and some or all may apply to a Non-SNI firm. Many firms that historically have been classified as a ‘BIPRU’ firm or an ‘Exempt CAD’ firm are likely to be subject to one of more of the following K-factors:

  • K-AUM requirement (assets under management) – 0.02% of the firm’s average AUM; and
  • K-COH requirement (client orders handled) – 0.1% of average COH attributable to cash trades and 0.01% of average COH attributable to derivatives trades.

For reference see the full list of K-factors below:

In conclusion, the capital requirements have been intensified and, in most cases, will require a specialist compliance team to deal with it. It must be noted that K-Factors will need to be calculated regardless but will only be required within capital calculation if it is the highest of the three between PMR, fixed overheads and K-Factors.

Confused about K-factors, have questions or need help managing the new Investment Prudential Regime? Then get in touch and our team of experienced compliance experts will be on hand to help.

Need compliance support? Take a look at our ongoing retainer services. Our retainer services start from 1 day a month.

Understanding the New Investment Prudential Regime

Written By

Ammad Aqeel

Tags: , ,