Entry into force of the new regulatory provisions applicable to investment firms

In order to provide investment firms with a dedicated framework, which is better suited and harmonised, the IFD package introduces a new classification methodology, defines new prudential requirements and a new reporting framework and reforms certain rules regarding governance.

New regulatory provisions applicable to investment firms entered into force following:

• the publication of the Law of 21 July 2021 amending the Law of 5 April 1993 on the financial sector (the “LFS”) in order to transpose, among others, Directive (EU) 2019/2034 of the European Parliament and of the Council of 27 November 2019 on the prudential supervision of investment firms and amending Directives 2002/87/EC, 2009/65/EC, 2011/61/EU, 2013/36/EU, 2014/59/EU and 2014/65/EU (the “IFD”); and
• the entry into force of Regulation (EU) 2019/2033 of the European Parliament and of the Council of 27 November 2019 on the prudential requirements of investment firms and amending Regulations (EU) No 1093/2010, (EU) No 575/2013, (EU) No 600/2014 and (EU) No 806/2014 (the “IFR”) on 26 June 2021.

The IFD and the IFR together constitute the “IFD package” whose aim is to subject investment firms to a dedicated framework, which is better suited and harmonised at European level with respect to the prudential supervision.

Three classes of investment firms

The IFD package categorises investment firms into three different classes. The so-called “class 1” investment firms which, due to their size or their activities, are considered as systemic and/or are assimilated to credit institutions. The latter do not fall within the scope of the IFD package and remain subject to banking regulations.

Consequently, the IFD package applies to the so-called “class 2” and “class 3” investment firms. While “class 2” investment firms are entirely subject to the new regime, the small and non-interconnected investment firms defined in Article 12 of the IFR, the so-called “class 3” investment firms, benefit from a simplified supervisory framework in accordance with the principle of proportionality.

Following the mapping performed by the CSSF, about one third of the investment firms incorporated under Luxembourg law belong to “class 2”, the remainder being “class 3” investment firms. No “class 1” investment firm has been identified so far.

New requirements regarding own funds

As regards prudential requirements, which apply in principle at individual and consolidated level, the IFD package introduces notably new permanent minimum capital requirements, determined according to the investment service or activity provided and which range between EUR 75,000 and EUR 750,000.

“Class 2” investment firms establish their general own funds requirement as the highest amount deriving from the comparison of three indicators, namely their fixed overheads requirement, their permanent minimum capital requirement and their “K-factor” requirement. “K factors” are indicators which allow assessing the risks arising from the activity for the clients, for the market and for itself.

“Class 3” investment firms determine their own funds requirement as the highest amount among two indicators only, namely their fixed overheads requirement and their permanent minimum capital requirement.

The IFD package defines also the liquidity requirements, whose compliance is mandatory for “class 2” investment firms and optional for “class 3” investment firms, as well as the requirements with respect to concentration risk monitoring for all investment firms.

In order to facilitate a phased-in compliance for existing investment firms with the new own funds requirements, the IFD package defines the rules intended to mitigate the effects of an increase in own funds requirements during a five-year period as from 26 June 2021.

“Class 2” investment firms must formally implement and document their internal assessment process, called “Internal Capital Adequacy and Risk Assessment” or “ICARA”, in order to assess and permanently maintain levels of internal capital and liquid assets they consider adequate to cover their risks. The requirement applies in an alleviated manner to “class 3” investment firms which must possess robust processes and systems to manage the risks for their clients and for themselves in terms of own funds and liquidity. However, they are not subject, in principle, to a formal documentation obligation as is the case for “class 2” investment firms.

The investment firms’ adequacy of the internal measures and levels of own funds and liquidity will be periodically assessed by the CSSF in the framework of the Supervisory Review and Evaluation Process (“SREP”). The content, intensity and frequency of the SREP will be determined by way of joint guidelines which are being drafted by the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA).

A new European reporting framework

Following the communication regarding the regulatory reporting format applicable to investment firms of February 2021, the IFD package introduces a European prudential reporting framework (the “IFR reporting”) to report information regarding the level, composition, requirements and calculation of the requirements of own funds, the level of activity, the concentration risk and the liquidity requirements. This framework will be formalised in draft technical standards specifying the formats as well as the dates, definitions and instructions regarding these reports, drawn up by the EBA in consultation with ESMA. With reference to the principle of proportionality, “class 2” investment firms are subject to a quarterly IFR reporting as from 30 September 2021, whereas “class 3” investment firms are subject to an annual IFR reporting as from 31 December 2021.

The CSSF will publish shortly a “Reporting Handbook” containing instructions for the transmission of the new IFR reporting to the CSSF. Concomitantly, the national and ad hoc prudential reporting obligations, defined notably in Circular CSSF 05/187 remain applicable for all investment firms. At a later stage, it is however envisaged to reform the content of the national and ad hoc reporting tables to be prepared by investment firms so as to have a better alignment with the European reporting.

Specific requirements regarding governance…

The IFD package outlines specific requirements regarding governance and in particular regarding the remuneration policy for “class 2” investment firms whose aggregate value of the balance sheet total and off-balance sheet assets exceed EUR 100 million. These investment firms must establish a remuneration committee at the level of the management body in its supervisory function. They must also comply with certain rules regarding the composition of a variable remuneration. The payment of variable remunerations must be partially subject to a deferral over a three- to five-year period as appropriate and, where applicable, to a contraction where the financial performance of the investment firm is subdued or negative.

… and regarding transparency

To ensure transparency vis-à-vis their investors and, more broadly, the markets, “class 2” investment firms must publish their level of own funds, their own funds requirements, their governance arrangements and their remuneration policies and practices. In line with the new requirements regarding Environmental, Social, and Governance (ESG) risks, they must also publish a report on ESG risks on a half-yearly basis as from 26 December 2022. “Class 3” investment firms shall in principle not be subject to publication requirements.

A new approach for the authorisation of investment firms

In addition to the amendments of the LFS due to the IFD, the Law of 21 July 2021 amends, among others, the provisions regarding the authorisation of investment firms and repeals the investment firm statuses. This amendment reflects the increasing harmonisation of the European rules applicable to investment firms. It entails also that the authorisation as investment firm is henceforth granted by the CSSF with reference to the investment activities and services as laid down in Directive 2014/65/EU, called “MiFID II”.

This amendment does not nullify the authorisations of investment firms previously authorised with reference to investment firm statuses. However, with a view to complying with the new legal provisions, an updated version of the articles of incorporation, reflecting the corporate objects that have been amended to be in line with the new provisions of the LFS, must be filed with the RCS.