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PERG 13.6 The recast Capital Adequacy Directive

PERG 13.6

Q54. What is the purpose of this section?

This section is designed to help UK investment firms consider:

  • • whether the recast CAD , as implemented in the UK, applies to them;
  • • if so, which category of firm they are for the purposes of the FSA's base capital resources requirements made under the recast CAD, for example whether they are a BIPRU 50K firm, a BIPRU 125K firm, a BIPRU 730K firm, a UCITS investment firm, an exempt CAD firm or a firm falling within the transitional regime for certain commodity brokers and dealers; and
  • • how the recast CAD otherwise impacts on their business, by explaining when a firm will be a limited licence firm, a limited activity firm or a full scope BIPRU investment firm.

    This section is intended to provide a general summary of these issues and not a detailed or exhaustive explanation of the

    recast CAD as implemented in the UK.

Q55. Are we subject to the recast CAD?

Only investment firms subject to the requirements of MiFID are subject to the requirements of the recast CAD. This includes UCITS investment firms (see Q6 and Q63).

Despite being subject to the requirements of MiFID, broadly speaking, if you are one of the following investment firms our implementation of the recast CAD will only apply to you in a limited way:

  • • a firm whose main business consists exclusively of providing investment services or activities in relation to commodity derivatives or C10 derivatives, or both, and to whom the ISD would not have applied. If you fall into this category, you will fall within a transitional regime under which you will not be subject to the capital requirements of the recast CAD but will be subject to other requirements (see Q57); or
  • • a firm that is only authorised to provide investment advice or receive and transmit orders, or both, without holding client money or securities . If you fall into this category, you will be an exempt CAD firm and only subject to base capital requirements under the recast CAD (see Q58 and Q59 below) .

If you are an investment firm to which an exemption in either article 2 or article 3 MiFID applies (see PERG 13.5 and PERG 13 Annex 1 flow chart 2), you are not subject to the recast CAD. However, if you potentially fall within the article 3 exemption, but decide to opt into MiFID regulation, for instance to acquire passporting rights (see Q52), you are subject to the recast CAD. If you do so, you are an exempt CAD firm (see Q58 and Q59).

There is also a special exemption under the recast CAD for locals that do not fall within the exemption for local firms under MiFID (see Q47). However, we do not think that UK regulated firms that were subject to the regulatory regime for locals prior to MiFID implementation are likely to fall within the exemption under the recast CAD. This is because they are likely to fall within article 2.1(l) MiFID.

Q56. We are an investment firm to which MiFID applies and do not fall into one of the limited categories described above. How does the recast CAD apply to us?

You are a CAD investment firm. Broadly speaking, you should go through an initial two-stage process in considering how the recast CAD will apply to you:

You are either a BIPRU 50K firm (subject to a base capital requirement of euro 50,000) (see Q60), a BIPRU 125K firmIFPRU 125K firm (subject to a base capital requirement of euro 125,000) (see Q61), a BIPRU 730K firm (subject to a base capital requirement of euro 730,000) (see Q62) or a UCITS investment firm (see Q63). Your base capital requirement depends essentially on the scope of your permission and any limitations or requirements placed upon it.

If you are a CAD investment firm, in essence the scope of your permission and any limitations or requirements placed upon it also dictate whether you are a limited licence firm, a limited activity firm or a full scope BIPRU investment firm. Broadly speaking, the benefit of being a limited licence firm or a limited activity firm (see Q64 and Q65) is that you are exempt from minimum own funds requirements to hold capital to cover operational risk, although you are subject to the requirements to hold own funds calculated by reference to credit risk, market risk and fixed overheads (see GENPRU 2.1.45 R).

If you are a full scope BIPRU investment firm, you are subject to the full range of recast CAD risk requirements (see Q66). See, generally, GENPRU 2.1.45 R in relation to the calculation of capital resources requirements for limited licence firms, limited activity firms and full scope BIPRU investment firms.

The question of whether you are a limited licence firm or a limited activity firm may also be relevant to capital treatment at a group level. This is outside the scope of this guidance which focuses only on the application of the recast CAD at the level of the individual firm, although you may find the decision tree at BIPRU 8 Annex 5 helpful in considering these issues.

Q57. How do we know if we are a firm to which the transitional regime for certain commodity brokers and dealers applies?

You are a firm to which the transitional regime applies if:

  • • you are a firm to which the ISD did not or would not have applied on 31 December 2006; and
  • • your main business consists exclusively of the provision of investment services or activities in relation to financial instruments set out in C5, 6, 7, 9 and 10 of Annex 1 of MiFID. See BIPRU TP 15 .

This exemption is only relevant if you are a firm to which MiFID applies, that is, you do not fall within the exemptions in articles 2 or 3 of MiFID (see Q55). Although you are exempt from the capital requirements of the recast CAD, you are subject to risk management and other systems and control requirements in the form of SYSC (see BIPRU TP 15.11G). You may also be subject to the requirements of chapter 3 of IPRU(INV).

In our view, your main business for the purposes of this exemption is the main business to which MiFID applies.

Q58. How do we know whether we are an exempt CAD firm and what does this mean in practice?

This category may be relevant to you if you have permission to advise on investments or arrange deals in investments in relation to MiFID financial instruments but fall outside the article 3 MiFID exemption (for example, because you choose to opt out of the exemption or because you transmit orders to persons not listed in the exemption or provide services in relation to derivatives that are not transferable securities). You can be an exempt CAD firm if you:

  • • are not authorised to hold client money in relation to MiFID business;
  • • do not have a safeguarding and administering investments (without arranging) permission in relation to MiFID financial instruments; and
  • • have a requirement on your permission so that the only MiFID investment services and activities you can perform are reception and transmission of orders or investment advice or both.

Where you hold client money for purposes unconnected with providing investment advice or receiving and transmitting orders in relation to MiFID financial instruments, in our view you can still be an exempt CAD firm. This might include, for instance, when you hold money or securities for clients to whom you only provide services that do not constitute investment services and therefore fall outside the scope of MiFID.

The conditions relating to the article 3 MiFID exemption look similar to those for an exempt CAD firm. There are important differences, however, between the two:

  • • the article 3 MiFID exemption (see Q49) extends only to services provided in relation to transferable securities and units in collective investment undertakings, whereas no such restriction applies to exempt CAD firms; and
  • • the article 3 MiFID exemption requires orders to be transmitted to certain persons only (see Q49 and Q50), whereas no such restriction arises in the case of exempt CAD firms.

If you are an exempt CAD firm , you are subject to base capital requirements which comprise the following broad options:

  • • base capital of euro 50,000; or
  • • professional indemnity insurance of euro 1,000,000 for any one claim and euro 1,500,000 in aggregate; or
  • • a combination of base capital and professional indemnity insurance resulting in an equivalent level of coverage to the options above.

For the rules transposing these requirements and supporting guidance, see IPRU(INV)2and in particular sections 13.1 and 13.1A and chapter 9. You will be subject to the relevant ongoing requirements in the Interim Prudential Sourcebook for Investment Businesses relating to1 personal investment firms and securities and futures firms1, as appropriate (see IPRU(INV) 13.1A.13R1 and IPRU(INV) 9.2.9R1).

If you are an exempt CAD firm which has opted into MiFID legislation (see Q52), you will need to consider whether you are subject to the audit requirements of companies legislation (see Part VII of the Companies Act 1985 and Part 16 of the Companies Act 2006). You can benefit from the auditing exemption for small companies in companies legislation if you fulfil the conditions of regulation 4C(3) of the Financial Services and Markets Act 2000 (Markets in Financial Instruments Regulations) 2007. In other words, if you continue to meet the conditions of the article 3 MiFID exemption (notwithstanding that you are an exempt CAD firm), you can benefit from the auditing exemption for small companies, as provided for in companies legislation. For further details, see The Markets in Financial Instruments Directive (Consequential Amendments) Regulations 2007 (SI 2007/2932) . The same regulations also contain a transitional regime which has the effect of exempting exempt CAD firms from statutory audit requirements in relation to a financial year beginning before 1 November 2007 and ending on or after that date, where the exempt CAD firm was not an ISD investment firm.1

Q59. If we are subject to the Insurance Mediation Directive , does this make any difference to the requirements which apply?

Yes. If the only investment services that you are authorised to provide are investment advice or receiving and transmitting orders or both, without holding client money or securities, you can still be an exempt CAD firm. However, you are subject to different base capital requirements. Broadly speaking, article 8 recast CAD requires you to have professional indemnity insurance of euro 1,000,000 for any one claim and euro 1,500,000 in aggregate (this is the IMD requirement), plus coverage in one of the following forms:

  • • base capital of euro 25,000; or
  • • professional indemnity insurance of euro 500,000 for any one claim and euro 750,000 in aggregate; or
  • • a combination of base capital and professional indemnity insurance resulting in an equivalent level of coverage to the options above.

For the rules transposing these requirements and supporting guidance, see the final paragraph of the answer to Q58.

As mentioned in Q58, when you hold client money or securities for purposes unconnected with providing investment advice or receiving and transmitting orders in relation to MiFID financial instruments, in our view you can still be an exempt CAD firm. This might include, for instance, when you hold client money for those to whom you provide insurance mediation services.

You should also bear in mind that if you are a firm to whom article 2 or article 3 MiFID applies (see PERG 13.5), you are not subject to the recast CAD.

Q60. Are we a BIPRU 50K firm?

This category may be relevant to you if you are not an exempt CAD firm and have one or more of the following permissions in relation to MiFID financial instruments:

provided that you are not authorised to:
  • • hold client money in relation to MiFID business or safeguard and administer (without arranging) MiFID financial investments; or
  • • deal on own account in, or underwrite on a firm commitment basis, issues of MiFID financial instruments (if you have a dealing in investments as principal permission in relation to MiFID financial instruments, you need a limitation or requirement on your permission to this effect).

Q61. Are we a BIPRU 125K firm?

This category may be relevant to you if you would have been a BIPRU 50K firm but for the fact that you are entitled to hold client money in relation to MiFID business or hold MiFID financial instruments.

You may also be a BIPRU 125K firm if you meet the conditions of article 5.2 recast CAD. Broadly speaking, this applies to investment firms which execute investors' orders and hold financial instruments for their own account provided that:

  • • such positions arise only as a result of the firm's failure to match investors' orders precisely;
  • • the total market value of all such positions is subject to a ceiling of 15% of the firm's initial capital;
  • • the firm meets the requirements laid down in articles 18, 20 and 28 recast CAD (including own funds requirements in respect of position risk, settlement and counterparty credit risk and large exposures); and
  • • such positions are incidental and provisional in nature and strictly limited to the time required to carry out the transaction in question.

If you meet the conditions of article 5.2 recast CAD and are not authorised to hold client money in relation to MiFID business or safeguard and administer (without arranging) MiFID financial instruments, you will be a BIPRU 50K firm.

Q62. Are we a BIPRU 730K firm?

If you are a CAD investment firm and you are neither a BIPRU 50K firm nor a BIPRU 125K firm nor a UCITS investment firm (see Q63), you will be a BIPRU 730K firm.

Q63. We are a UCITS investment firm. How will the recast CAD apply to us?

UCTIS investment firms (UCITS management companies that are authorised to perform the additional services of portfolio management, investment advice and safeguarding and administration of units) are subject to the recast CAD in parallel with the capital requirements in the UCITS Directive.

If you are a UCITS investment firm, your base capital requirement is contained in GENPRU 2.1.48 R (which refers to UPRU 2.1.2 R (1)) and in summary is:

  • • a minimum base capital requirement of euro 125,000; and
  • • an additional amount of own funds equal to 0.02% of the amount by which the value of the portfolios under management exceeds euro 250,000,000 (subject to an overall maximum base capital requirement of euro 10,000,000).

In our view, a UCITS investment firm should be a limited licence firm, as the UCITS Directive prevents it from dealing on own account outside its scheme management activities. As a result, where a UCITS investment firm has a dealing in investments as principal permission, this should be limited to box management activities where MiFID financial instruments are concerned. In our view, a UCITS investment firm which has this limitation and complies with it will not be dealing on own account for the purposes of the MiFID and the recast CAD.

Q64. Are we a limited licence firm?

A limited licence firm is one that is not authorised to:

  • • deal on own account (see Q16); and
  • • underwrite and/or place financial instruments on a firm commitment basis (see Q22).

You can be a limited licence firm if you are either:

Generally, you cannot be a limited licence firm if you are a BIPRU 730K firm. However, you may be a limited licence firm if you operate a multilateral trading facility (and therefore are a BIPRU 730K firm) and do not have a dealing in investments as principal permission enabling you to deal on own account or to underwrite or place financial instruments on a firm commitment basis.

For calculation of the variable capital requirement for a BIPRU limited licence firm (including a UCITS investment firm), see GENPRU 2.1.45 R.

Q65. Are we a limited activity firm?

A limited activity firm is a BIPRU 730K firm that deals on own account only for the purpose of:

  • • fulfilling or executing a client order; or
  • • gaining entrance to a clearing and settlement system or a recognised exchange when acting in an agency capacity or executing a client order.

If you wish to be a limited activity firm, you should apply for a limitation on your dealing in investments as principal permission reflecting these conditions.

There is also a category for certain firms which, among other things, do not hold client money or securities and have no external customers. We do not think that any UK regulated firms are likely to fall within this third category of limited activity firm.

Q66. What is the effect of being a CAD investment firm which is neither a limited licence firm nor a limited activity firm?

You will be a full scope BIPRU investment firm, subject to the full range of recast CAD risk requirements.

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