Overview
On 24 April 2025, the Financial Conduct Authority (“FCA”) published Consultation Paper CP25/10, which proposes to simplify the regulatory capital regime for FCA investment firms. In a welcome move, the FCA intends to reduce the complexity of its prudential rulebook for MiFID investment firms by consolidating and reducing the length of the existing own funds rules. The FCA will also make targeted amendments to tailor specific rules, including certain deductions and exceptions, which may be beneficial for the affected firms. A number of the provisions will be of interest to firms with market making obligations. This exercise is intended to make the rules more accessible and reduce compliance costs and barriers to entry.
Summary of key changes
The FCA is maintaining the existing capital tiers and structure (Common Equity Tier 1 ("CET1"), Additional Tier 1 ("AT1") and Tier 2 ("T2")), but by simplifying its requirements, intends to refocus attention on the core characteristics of own funds instruments for investment firms. We set out a summary of the key changes below, together with our commentary on the implications for affected firms.
Changes applicable to multiple tiers of capital
- Removing irrelevant material
The FCA proposes to remove cross-references to the UK version of the onshored Capital Requirements Regulation 2013 (“UK CRR”) from the definition of regulatory capital for FCA investment firms. This will make the rules easier to navigate by ensuring that relevant own funds material for FCA investment firms is in one place, in the MIFIDPRU 3 sourcebook in the FCA Handbook, without needing to cross-refer to the UK CRR, which sets out the regulatory capital regime for banks.
In addition, the FCA is proposing to remove provisions that are not relevant to FCA/UK investment firms or that are duplicative of requirements set out elsewhere in the law. This will include the removal of material relating to the special resolution regime, material duplicated across MIFIDPRU 3, the UK CRR, UK company law and/or accounting standards, and prudential filters for regulated covered bonds and securitised assets. The FCA has claimed that this will result in a circa 70 per cent reduction in the volume of the rules.
- Re-organisation of the rules
The FCA intends to re-organise, rather than change the substance of, the rules relating to the eligibility of own funds instruments. This will mean however that firms will need to familiarise themselves with the new layout and wording of the requirements. This may also mean policies, procedures and disclosures need to be reviewed to ensure that any regulatory references remain correct.
The current rules include various modifications for mutual societies. While the FCA is open to discussing modifications to its rules if any mutual societies were to apply to it in the future to become FCA investment firms, as there are currently no such firms, the FCA will be removing these detailed provisions in aid of simplification.
- Changing the prohibition on funding own capital instruments
The FCA will retain the prohibition on FCA investment firms funding the issuance of their own capital instruments, but will simplify the prohibition by removing ‘excessive prescription’ and, subject to certain conditions, introducing a broad exception for funding provided in the ‘ordinary course’ of a firm’s business. This is not intended to enable firms to support their own capital position, but is intended to exempt activities such as the incidental purchase of a firm’s own instruments in the context of its market making operations.
- Deductions for ‘significant’ and ‘non-significant’ holdings of capital instruments of financial sector entities
Under the current regulatory capital regime, firms must make certain deductions from the value of their own funds instruments in order to calculate their regulatory capital. The FCA is proposing to combine the current deductions relating to ‘significant’ and ‘non-significant’ holdings of capital instruments of financial sector entities. This will enable firms with significant investments in financial sector entities held in the trading book to benefit from the exception for trading book positions (thereby potentially increasing relevant firms’ own funds). The FCA will remove the separate exception for underwriting positions held for five working days or fewer, as these can be held in the trading book and therefore can benefit from the exception for trading book positions.
- Identifying and valuing ‘indirect’ and ‘synthetic’ holdings of financial sector entities for deduction purposes
The FCA proposes to replace the current prescriptive, UK CRR-derived requirements for identifying and quantifying indirect and synthetic holdings in financial sector entities (to enable their value to be deducted from own funds), with a less prescriptive, outcomes-focused approach. This is expected to reduce the complexity of calculations firms are required to undertake.
The FCA will also explicitly confirm that it does not generally require firms to ‘look through’ a fund’s investments, recognising the fact that most funds will only have limited exposures to deductible instruments. However, if a fund has a purpose or mandate to invest mainly in the capital instruments of financial sector entities, then the firm must apply the relevant deductions.
- Deduction of qualifying holdings outside of the financial sector
The FCA is proposing minor changes to this deduction to make it easier to apply and more consistent with similar requirements. Shares held in the trading book will benefit from an exception, as opposed to the current approach of excepting shares which are not fixed financial assets.
- New guidance on fully paid-up instruments
The FCA intends to insert guidance aligned with the international Basel Committee on Banking Supervision approach to the definition of ‘fully paid-up’ instruments, clarifying that the requirement for capital instruments to be fully paid up is stricter than the definition of ‘fully paid’ in the Companies Act 2006. The full amount of capital must have been irrevocably received by the firm, and be fully under the firm’s control, without directly or indirectly exposing the firm to the credit risk of the investor.
- Changes in relation to distributions
The FCA proposes to clarify that the provisions governing distributions on CET1 and AT1 instruments must not trigger events including rights of termination for holders, early repayment obligations, additional voting rights for holders, reclassification of the instrument, or other contractual penalties or obligations that would effectively make distributions mandatory. This will be welcome guidance and increase regulatory certainty for firms and investors in relation to the design of regulatory capital instruments.
The FCA is also proposing to tweak one of the eligibility requirements for AT1 and T2 instruments so that the level of distributions cannot change in a way that is linked to the credit standing of the firm or a member of its group. This would replace the previous, more complex regime which allowed firms to use a broad market index as one of the bases for determining the level of distributions.
The FCA is removing the requirement to obtain permission to pay distributions in a form other than cash or own funds instruments, as no firm has ever applied for that permission. Were a firm to want to introduce an alternative distribution structure in the future, they would need to apply to the FCA for a waiver of the retained rules, which require all distributions to be paid in cash or own funds instruments.
- Objective test for cross holdings
The FCA is introducing an objective test for deducting cross holdings which are designed to artificially inflate own funds, introducing new guidance as to when such deductions should be made.
- Index holdings of capital instruments
The FCA will be maintaining the ability for firms to net off holdings via indices, while simplifying the provisions by removing the detailed stipulations around internal control processes and the requirement for the FCA to assess these processes annually. Any such netting would continue to be subject to general risk management and internal control requirements.
The FCA is proposing to introduce an exception to the requirement to obtain prior FCA permission for a reduction of capital, where capital instruments are repurchased for market making purposes.
In other cases where FCA permission and notification is required, the FCA will require firms to satisfy a new objective standard that ‘the firm will continue to exceed its own funds threshold requirement by a margin sufficient to ensure adequate financial resilience for the foreseeable future’. This will replace the current test which requires firms to exceed the applicable capital requirements ‘by a margin that the FCA considers necessary’, in practical effect more fully transferring the onus of making this judgement on to firms.
The FCA will introduce two examples in Handbook guidance to demonstrate the application of new, simplified provisions on the deduction of minority interests.
Changes to the CET1 capital framework
- Permanence of CET1 instruments
A fundamental feature of CET1 instruments is that they are permanent. That being said, in certain circumstances, firms may be permitted to reduce their own funds under the capital rules and the terms of such instruments (for example, a firm’s articles of association) may also permit such reductions. The FCA is proposing new guidance which recognises a firm’s residual discretion in this respect, while maintaining the expectation that firms must not indicate, expressly or implicitly, that the principal amount of the instrument would or might be repaid, except in the context of liquidation.
- New disclosure requirements in relation to more complex structures involving non-CET1 shares
In a helpful clarification echoing proposed changes to the PRA rules for banks, the FCA will make it explicit that more complex capital structures involving non-CET1 shares, including non-CET1 shares that carry a liquidation preference, will not preclude the eligibility of CET1 shares by their mere existence in the capital stack. This will be helpful for earlier stage investment firms and should also facilitate private equity investment in the sector. However, new disclosure requirements will apply to firms with non-CET1 instruments that rank equally with CET1 instruments, which are intended to ensure appropriate transparency. This will require affected firms to publish a disclosure in the prescribed format, clearly identifying which instruments rank equally, explaining how losses would be absorbed and shared between equally ranked instruments, specifying the proportion of residual assets that each instrument is entitled to claim and referring to the provisions in the firm’s constitution that establish these arrangement.
Firms will be able to recognise interim profits in their CET1 capital resources without prior FCA permission, instead being required to notify the FCA. However, certain conditions must be met, including the deduction of foreseeable charges and dividends on a prudent basis.
- Valuation adjustment for trading book positions
The FCA is proposing to remove most of the legacy requirements relating to additional valuation adjustments to positions in the trading book. Firms must continue to adopt a standardised 0.1 per cent adjustment to trading book positions.
Changes to the AT1 capital framework
- Conversion or write down of AT1 instruments
When the FCA implemented the MIFIDPRU rules post-Brexit, it simplified the AT1 rules for investment firms, only permitting a ‘full’ (rather than ‘partial’) conversion or write down on the occurrence of a trigger event. The FCA is now proposing to remove certain legacy requirements which do not make sense in this context, for example, the requirement for an independent review of the amount to be written down or converted, which is unlikely to be necessary when the only option is ‘full’ write down or conversion.
Changes to the T2 capital framework
The FCA is not proposing any specific material policy changes in relation to T2 capital instruments.
Concluding commentary
CP25/10 proposes a significant streamlining of the regulatory capital framework for FCA investment firms. Though a welcome change, the proposed rules would only apply to MIFIDPRU investment firms, UK parent entities that are required to comply with MIFIDPRU 3 on the basis of their consolidated situation and parent undertakings subject to the group capital test. Further work is needed to simplify the legacy rules for less risky firms that are not in-scope of MiFID and therefore do not benefit from these changes.
Similarly, while the FCA has indicated that it will further tailor the rules for market making/principal trading firms, the FCA has recently confirmed that the initial discussion and engagement process on that workstream will not start until 2026.
Next steps
The FCA invites feedback from firms and stakeholders on the proposals outlined in CP25/10. The deadline for comments is 12 June 2025. The final rules are expected to be published in a Policy Statement in the second half of 2025, with the new framework expected to come into force on 1 January 2026.
Firms will need to consider their capital structures and their capital policies, procedures and disclosures to identify whether any changes are required in light of the proposed changes. For example, firms with non-CET1 shares will need to comply with new disclosure requirements. Firms with trading books and/or that undertake market making activities should review the proposed changes carefully.
If you would like to discuss any of the above, please contact any of the contacts listed, or your regular CMS contact.
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