Prudential consolidation and derogations applicable to investment firms

However, in recognition of the principle of proportionality, a new prudential regime was introduced in the EU. This regime consists of Regulation (EU) 2019/2033, known as the Investment Firms Regulation (IFR) and Directive (EU) 2019/2034, known as the Investment Firms Directive (IFD).

The implementation of these new regulations aims to enhance fairness and transparency in the EU market while ensuring that non-complex firms, which pose minimal risk, are not excessively burdened. Additionally, the regime provides guidance and legislation concerning the prudential consolidation of investment firms and their respective groups.

There are three entities that may serve as the consolidating or union parent undertaking, as detailed in Section 2.2.2 of the Final Report on Draft RTS on the Scope and Method of Consolidation of an Investment Firm Group. These entities, as defined in the IFR, are as follows:

1. Union parent investment firm
   An investment firm based in an EU Member State that is part of an investment firm group, holding a subsidiary investment firm or financial institution, or a participation in such firms. It must not itself be a subsidiary of another investment firm, investment holding company or mixed financial holding company in any Member State.
   
    
2. Union parent investment holding company:
   An investment holding company based in an EU Member State that is part of an investment firm group, which is not a subsidiary of an investment firm or another investment holding company within the EU.
   
    
3. Union parent mixed financial holding company:
   A parent undertaking of an investment firm group classified as a mixed financial holding company.

These consolidating entities carry out the consolidation of four types of undertakings, which, in accordance with the definition of an ‘investment firm group’ in Article 4(1)(25) of the IFR, must be subsidiaries of the union parent undertaking:

• Investment firms
• Financial institutions
• Ancillary services undertakings
• Tied agents of an investment firm

Summary of the type of entities within the scope or consolidation of an investment firm group

As outlined in Article 2.25 of the final report, unless a prudential waiver is granted, the IFR applies to investment firms both individually and on a consolidated basis. The general rule for preparing the consolidated situation for prudential purposes is 'full' consolidation. However, under Article 6(2) of the draft RTS, in certain cases and subject to the group supervisor’s approval, the aggregation method may be used for consolidating these entities.

Methodology for the consolidation of capital requirements

Investment firms must consolidate capital requirements using the following methodology:

1. Permanent Minimum Capital Requirement (PMCR)
   This is the sum of the PMCR of the union parent investment firms at individual level and at the individual level of the investment firms that are consolidated, the initial capital of the consolidated asset management companies, initial capital of the consolidated payment institutions and the initial capital of the consolidated electronic money institutions.
2. Group Fixed Overhead Requirement (FOR)
   The FOR must follow a hierarchical approach using either the consolidated expenditure account or the sum of individual FORs.
3. K-factor Consolidation
   The sum of different K-factors, calculated on a consolidated basis.

All three components must be consolidated before determining the highest figure, which will represent the group’s capital or own funds requirement.

The Group Capital Test (GCT)

The European Banking Authority (EBA) closed a consultation paper on 25 October 2023, aimed at clarifying the application process for the Group Capital Test (GCT). This paper is of particular interest to investment firm groups, as it outlines the criteria for obtaining a derogation from the general prudential requirements.

Competent authorities may grant a derogation when an investment firm's own funds ratio is equal to or exceeds 125%, among other criteria. Firms granted the derogation can apply the Group Capital Test, rather than following individual requirements on a consolidated basis. This derogation is available to firms deemed sufficiently simple and that do not pose a threat to clients or the market. Further details regarding the Group Capital Test can be found here.

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