Investment firms regulated by the
Markets in Financial Instruments Directive (MiFID) are subject
to capital requirements under the Capital Requirements Directive
(CRD IV) and Capital Requirements Regulation (CRR).
The framework adopted by both the directive and the regulation,
collectively known as the CRD IV package, presents a single set of
prudential rules establishing capital adequacy requirements with
the aim of ensuring “solvency of financial institutions and
the reduction of systemic risk of failure of financial
The above-mentioned rules capture credit institutions and
investment firms under one and the same regulatory framework, and
consequently, MiFID investment firms are subject to the same
capital adequacy requirements (derived from Basel standards) that
apply to EU credit institutions, including banks.
Definition of investment firms
The CRR determines the exact applicability of the regulation to
investment firms by referring to the definition given in MiFID. The
sole provision of
investment advice or reception and transmission of orders
without holding clients’ money and assets, excludes a firm from
falling within the ambit of the definition of investment firms.
Credit institutions and local firms are also excluded from the
definition. Within the Maltese regulatory context, firms that are
exempt from the provisions of the CRR comprise Category 1
Investment Services licence holders.
The prudential capital requirements
The mitigation of risk of harm to stakeholders has been the
driving force behind the establishment of standard prudential
requirements, thereby promoting the responsible management of
various business risks by firms.
Such requirements for credit institutions and investment firms
are divided into two separate categories: the initial capital
requirements and the own funds requirement, related to solvency,
liquidity and large exposures.
The role of the Fit and Proper Test surely cannot be devalued;
satisfying the three categories of the test cumulatively is crucial
for any prospective licence holder to be granted an investment
services licence by the MFSA.
Solvency is one out of the three criteria comprising the fit and
proper test, and which must be fulfilled on a continuing basis. The
latter criterion is aimed at ensuring that the applicant has proper
control and management of its liquidity and capital while also
having sufficient financial resources to meet the minimum
For the purposes of meeting the minimum regulatory capital, and
hence satisfying the solvency test, an applicant is to hold a
certain amount of initial capital, which constitutes the Capital
Resources Requirement of an investment firm.
The specific amount of initial capital varies according to the
category of investment services licence the applicant is seeking to
obtain. A clear pattern emerges, whereby the initial capital
required by licence holders becomes more onerous as the activities
of the licence become more extensive. Naturally, this reflects the
principle that more capital is required to cater for greater risks
Firms that seek to receive and transmit orders in relation to
one or more instruments provide investment advice and place
instruments without a firm commitment basis, but which do not
intend to hold or control clients’ money or customers’
assets, require a Category 1a licence. The amount of initial
capital required by such firms depends on whether a firm is
registered under the Insurance Meditation Directive, in which case
it would require €25,000. If not registered under this
directive it would require €50,000 as initial capital.
Firms that seek to receive, transmit and/or provide investment
advice and to place instruments without a firm commitment basis
solely for non-private customers, but which do not intend to hold
or control clients’ money or customer assets, will require a
Category 1b licence. If the firm is not registered under the
Insurance Mediation Directive, the initial capital required would
either be €50,000 without Professional Indemnity Insurance
(PII) or €20,000 with PII. If a firm is registered under the
aforementioned directive, its initial capital is limited to
MiFID firms and fund managers require a Category 2 licence, and
an initial capital of €125,000. This licence is required by
firms seeking to provide any investment service and to hold or
control clients’ money or customers’ assets, but not by
firms seeking to operate a multilateral trading facility, deal for
their own account or underwrite or place instruments on a firm
A Category 3 licence allows firms to provide any investment
service and to hold and control clients’ money or customer
assets. To attain this licence, €730,000 is needed as initial
A Category 4a licence is required by firms seeking to act as
trustees or custodians of collective investment schemes, and firms
requiring this licence will need €730,000 as initial
A Category 4b licence, on the other hand, allows licence holders
to act as custodians of AIFs or PIFs which have no redemption
rights exercisable during a five-year period and to act as
custodians to AIFs marketed in Malta. €125,000 is required as
For Category 1a, 1b, and 4b licence holders, the Capital
Resources Requirement will be the higher of the initial capital and
the fixed overheads requirement.
The Capital Resources Requirement applicable to Category 2
licence holders which qualify as fund managers, will be the higher
of the sum of the initial capital of €125,000 and an
additional amount of own funds equivalent to 0.02 per cent of the
amount by which the value of the portfolios under management exceed
€250,000,000 and the fixed overheads requirement.
Prospective Category 2 MiFID firms, Category 3 or Category 4a
licence holders must satisfy a CET1 capital ratio of 4.5 per cent,
Tier 1 capital ratio of six per cent and a total capital ratio of
eight per cent.
Investment firms must be well-equipped to cater for situations
in which they might incur a loss. More specifically, firms must
have own funds in sufficient quantity for immediate use, enabling
them to absorb losses and thus be in a position to cover capital
requirements for instances of Credit Risk, Operational Risk as well
as Market Risk.
Under the CRR, the own funds of an institution consist of the
sum of its Tier 1 capital and Tier 2 capital.
Moreover, the CRR obliges investment firms to maintain the own
funds requirement at least equal to or in excess of its capital
resources requirement, throughout the firm’s entire business
operations. The licence holder’s own funds may not fall below
the amount of initial capital required at the time of its
authorisation. Under the MFSA rules, the own funds constitute the
financial resources requirement of an investment firm.
Capital requirements for MiFID Firms – Proposed
Through its Report on Investment Firms, the European Banking
Authority criticises the current prudential framework and in turn
proposes significant changes to the EU’s regulatory capital
rules for MiFID investment firms. Owing to its overly complex
nature, the prudential regime in place for MiFID firms has become
excessively burdensome for non-bank investment firms. In this
regard, the authority envisions a shift from the current framework,
which is primarily designed for banks, to a system that is simpler,
more proportionate, and which above all, addresses the specific
risk profiles of investment firms, unlike the fixed initial capital
requirements currently set out in the CRD IV regime.
The EBA outlines a three-tier approach aimed at determining the
systemic significance of investment firms and the extent to which
such firms absorb bank-related risks. The EBA’s three-tier
approach categorises investment firms into bank-like (systematic)
investment firms, non-systematic investment firms and small,
MiFID firms, which are deemed systemic and which run bank-like,
conducting large-scale intermediation and undertaking substantial
underwriting activities, expose them significantly to credit risk,
involving counterparty risk and market risk for positions taken on
own account (irrespective of whether it is for the sake of external
clients or not). The full set of CRD IV/CRR rules apply to such
systemically important firms.
On the other hand, a less burdensome prudential regime is more
appropriate to non-bank-like investment firms, enabling such firms
to address the specific risks posed to investors and market
participants with respect to investment business risks, such as
credit, market, operational and liquidity risk.
However, a simpler regime would apply for small and
non-interconnected firms. The basis of the regime would be focused
mainly on fixed overheads and large exposure requirements with
the objective of setting aside sufficient capital for ensuring safe
and sound management of their risks.
This approach essentially necessitates the development of a
separate and specific prudential regime for non-systemic and
non-interconnected firms. The regime must be such as to address the
risks associated with holding client money and
Market participants have welcomed the EBA’s invitation to
comment on its discussion paper issued on November 4. While there
is general consensus on the need to implement a more adequate
prudential system that addresses the specific risk requirements of
investment firms, some participants still deem the EBA’s
propositions as far too intricate to be applied on a practical
The allocation of investment firms according to their systemic
activities, as a matter of fact, has not been favoured by certain
participants who consider the number of actual systemic or
bank-like firms as being highly marginal, particularly in light of
the fact that investment firms, unlike banks, do not take deposits
from clients. Also based on the latter, the fact that investment
firms cannot take deposits necessitates more clarification of what
the term ‘bank-like’ means.
The latter participants have alternatively proposed to classify
investment firms in a more proportionate manner, allocating
investment firms to different risk categories, namely complex, for
investment firms carrying out bank-like activities, medium risk,
for investment firms which should be in the scope of some
prudential requirements above a basic requirement, and low risk,
for any other MiFID firm that would not fall under the scope of the
CRR or the scope of prudential consolidation. The low risk category
would include MTFs and also OTFs.
On the other hand, some positive points in relation to the
discussion paper were also mentioned. The discretion afforded to
national regulators in defining certain thresholds (e.g. number,
size and activity of investment firms) was well received by market
participants, seeing that national markets vary greatly in the
various jurisdictions of the EU. Having a minimum level of
assessment criteria while allowing a margin of appreciation to
regulators was deemed to be an appropriate compromise.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.