MIFIDPRU 2.6 The group capital test

1The definition of ‘own funds instruments’ for the purpose of MIFIDPRU 2.6.2R ensures that significant investments in common equity tier 1 instruments, additional tier 1 instruments and tier 2 instruments of financial sector entities in the investment firm group do not need to be deducted by a parent undertaking when applying the group capital test. This is to avoid ‘double counting’ of those investments.

1MIFIDPRU 3.7 contains rules and guidance on the composition of capital for parent undertakings subject to the group capital test.

1. (1)

   1Each GCT parent undertaking in the investment firm group must satisfy the group capital test. The group capital test can therefore apply at each level within the group structure. This mitigates the risk of leverage or capital gearing being introduced at levels underneath the UK parent entity.

2. (2)

   The requirement in MIFIDPRU 2.6.5R only applies to GCT parent undertakings. However, MIFIDPRU 2.6.7R imposes obligations on GCT parent undertakings in relation to their subsidiaries that are:

   1. (a)

      parent undertakings established in a third country; or

   2. (b)

      parent undertakings incorporated in, or with their principal place of business in, the UK that are not GCT parent undertakings.

3. (3)

   This prevents leverage and capital gearing being introduced into the investment firm group through:

   1. (a)

      intermediate parent undertakings established in a third country; or

   2. (b)

      intermediate parent undertakings in the UK to which the group capital test does not directly apply.

1. (1)

   1The effect of MIFIDPRU 2.6.7R is shown through the example below of a hypothetical investment firm group that contains the following undertakings:

   1. (a)

      a UK parent entity (“A”);

   2. (b)

      an intermediate investment holding company (“B”), that is incorporated in the UK and is a direct subsidiary of A;

   3. (c)

      an undertaking established in a third country (“C”) that would be an investment holding company if it were established in the UK and that is a direct subsidiary of B;

   4. (d)

      an undertaking established in a third country (“D”) that would be a MIFIDPRU investment firm if it were established in the UK and that is a direct subsidiary of C;

   5. (e)

      a MIFIDPRU investment firm (“E”) that is a direct subsidiary of D;

   6. (f)

      a tied agent (“F”) that is established in the UK and that is a direct subsidiary of B;

   7. (g)

      an undertaking established in a third country (“G”) that would be a financial institution if it were established in the UK and that is a direct subsidiary of C;

   8. (h)

      an intermediate holding company (“H”) that is incorporated in the UK and is a direct subsidiary of A; and

   9. (i)

      an authorised payment institution (“I”) that is incorporated in the UK and is a direct subsidiary of H.

2. (2)

   The group capital test:

   1. (a)

      applies directly to A and B because they are both GCT parent undertakings;

   2. (b)

      applies only indirectly to C and D, through the obligations imposed on the responsible UK parent, because C and D are parent undertakings established in a third country;

   3. (c)

      applies only indirectly to H, through the obligations imposed on A in its capacity as the responsible UK parent, because H is not a GCT parent undertaking; and

   4. (d)

      does not apply to E, F, G or I because they are not parent undertakings.

3. (3)

   1In this example, B is a responsible UK parent because:

   1. (a)

      B has two subsidiaries (a direct subsidiary, C, and an indirect subsidiary, D) that are both parent undertakings established in a third country and that would be relevant financial undertakings if they were established in the UK; and

   2. (b)

      B does not have a subsidiary in the UK that is the parent undertaking of C or D. (Although F is a UK subsidiary of B, F is not a parent undertaking.) This means that there is no intermediate parent undertaking in the UK between B and either of C or D.

4. (4)

   A is not a responsible UK parent in relation to C and D. This is because A has a subsidiary, B, that is a parent undertaking of C and D and that is incorporated in the UK. B is therefore an intermediate parent undertaking in the UK between A on the one hand and C and D on the other.

5. (5)

   B is a responsible UK parent in relation to C and D. Note that B is the responsible UK parent of both C and D, even though D is only an indirect subsidiary of B. This is because there is no parent undertaking between C and D that is established in the UK and the definition of a subsidiary includes subsidiaries of subsidiaries.

6. (6)

   Under MIFIDPRU 2.6.7R(2), B therefore has the choice of whether to:

   1. (a)

      ensure that both C and D comply with the requirements of the group capital test as it would apply to them if they were established in the UK; or

   2. (b)

      hold own funds instruments that are sufficient to cover the sum of the requirements of the group capital test that apply to B and would apply to C and D if they were established in the UK.

7. (7)

   If B chooses the approach in (6)(a), B must:

   1. (a)

      hold sufficient own funds instruments to cover the sum of B’s holdings in, and contingent liabilities in favour of, C and F;

   2. (b)

      ensure that C holds sufficient own funds instruments to cover the sum of C’s holdings in, and contingent liabilities in favour of, D and G; and

   3. (c)

      ensure that D holds sufficient own funds instruments to cover the sum of D’s holdings in, and contingent liabilities in favour of, E.

8. (8)

   If B chooses the approach in (6)(b), B must hold sufficient own funds instruments to cover the sum of:

   1. (a)

      B’s holdings in, and contingent liabilities in favour of, C and F;

   2. (b)

      C’s holdings in, and contingent liabilities in favour of, D and G; and

   3. (c)

      D’s holdings in, and contingent liabilities in favour of, E.

9. (9)

   A is, however, a responsible UK parent in relation to H. This is because A is a GCT parent undertaking that is the parent undertaking of H. H is a relevant financial undertaking (being a holding company, and therefore a financial institution) and a parent undertaking. H is not a GCT parent undertaking because H is not an authorised person and does not have a MIFIDPRU investment firm as a subsidiary. There is also no intermediate GCT parent undertaking between A and H.

10. (10)

    In a similar way to B above, A therefore has a choice under MIFIDPRU 2.6.7R(2) of whether to:

    1. (a)

       ensure that H complies with the requirements of the group capital test as if it applied directly to H; or

    2. (b)

       hold own funds instruments that are sufficient to cover the sum of the requirements of the group capital test that apply to A and would apply to H.

11. (11)

    If A chooses the approach in (10)(a), A must:

    1. (a)

       hold sufficient own funds instruments to cover the sum of A’s holdings in, and contingent liabilities in favour of, B and H; and

    2. (b)

       ensure that H holds sufficient own funds instruments to cover the sum of H’s holdings in, and contingent liabilities in favour of, I.

12. (12)

    If A chooses the approach in (10)(b), A must hold sufficient own funds instruments to cover the sum of:

    1. (a)

       A’s holdings in, and contingent liabilities in favour of, B and H; and

    2. (b)

       H’s holdings in, and contingent liabilities in favour of, I.

1UK investment holding companies and UK mixed financial holding companies are included in the FCA’s supervision of compliance with the group capital test where they are GCT parent undertakings.