A new regime for the prudential regulation of investment firms in Europe should be developed, so that regulators can apply rules that distinguish between the industry’s handful of major players and the smaller, non-systemic firms that make up the bulk of the industry, European financial regulators say.
In a report published on Monday by the European Securities and Market Authority (ESMA) and the European Banking Authority (EBA), the regulators recommend the creation of a tiered capital regime, with distinct rules for major investment firms that are critical to the overall financial system, and smaller, firms that aren’t important to overall systemic stability.
The report, which is being published in response to a request from the European Commission on the prudential requirements for investment firms, recommends that firms be categorized to distinguish between systemic, ‘bank-like’ firms that should face tougher prudential rules; non-systemic firms that should have a more limited set of requirements; and, very small firms with ‘non-interconnected’ services. This approach would make the capital rules more proportional to different sorts of firms, the report says, and it would clarify certain supervisory requirements.
Only a handful of firms engage in ‘bank-like’ intermediation businesses, and take on substantial underwriting risks, that exposes these firms to credit risk, primarily in the form of counterparty risk, and market risk, the report notes. However, for most other investment firms, “a less complex prudential regime seems appropriate to address the specific risks that investment firms pose to investors and to other market participants,” the report says.
Small, non-interconnected firms “warrant a very simple regime to wind them down in an orderly manner”, the report says. “Such a regime could be based mainly on fixed overhead requirements that fulfil the objective of setting aside sufficient capital for ensuring safe and sound management of their risks. These firms could also be subject to simplified reporting obligations,” the report adds.
The report calls for the development of a prudential regime for ‘non-systemic’ investment firms that would include specific rules for their credit, market, operational and liquidity risks. The EBA indicates that it is prepared to collect the data to support these policy developments.
The report also recommends that the exemption from the EBA’s capital rules for commodity trading firms be extended until Dec. 31, 2020. The current exemption is set to expire at the end of 2017. The EBA suggests that this exemption should be extended until a new regime has been adopted or, at the latest, until the end of 2020. “This extension would allow for the possible development of a prudential regime for investment firms as a follow-up to the policy options and additional work of the EBA,” the report says.