8.5 Conclusions

343. This Chapter discussed the relevance of going-concern versus gone-concern regulation, the usefulness of a ‘Volcker rule’ type rule for investment firms and the applicability of the BRRD for investment firms. The prudential regulation of investment firms should focus on an orderly wind-down, and as such be based upon the gone-concern principles. This approach to prudential supervision is enhanced by the already applicable asset segregation requirements, which give an additional protection of client’s assets as compared to the banking sector. A failure of an investment firm will thus not directly impact the assets and funds belonging to its clients. Those assets and funds of the client can be indirectly impacted if the investment firm (for instance an asset manager) were to end up in an insolvency procedure in which the asset manager is no longer able to actually manage the assets of its clients. This could mean that the investment firm is not able to respond to market changes that affect the value of the client’s assets. To prevent this indirect effect, investment firms should hold enough capital to facilitate an orderly wind-down.

344. To establish what the required amount of capital is to facilitate the orderly wind down, supervisory authorities responsible for the supervision of investment firms should draw up a resolution plan, similar to the BRRD requirements for banks. This resolution, or ‘orderly wind down plan’ should be further tailored to consider the specific risks, business models and specific characteristics of investment firms. The requirements of the BRRD could serve as a template for the development of these investment firm specific resolution requirements.

345. When discussing the Volcker rule and its possible application in a prudential regime for investment firms, this study concluded that the need for such a requirement was not that profound for the investment firm sector. Both through the asset segregation requirements and the gone-concern prudential approach, trading activities of investment firms should not have an impact on or be funded by client funds or assets. Furthermore, by requiring investment firms to be capitalised to such a level that facilitates an orderly wind-down, the risks to the financial system should be limited as that will lead to a solution “without harming public interest and causing financial instability”.1 The investment firm should still be able, in the orderly wind-down phase, to execute the functions that might disrupt the financial markets if that investment firm were to enter insolvency procedures. It is therefore essential to further align national insolvency procedure with an investment firm-specific resolution regime. Under national insolvency regimes, it might prove difficult for the investment firm to execute its vital functions in order to prevent disruptions in the financial markets, as national insolvency procedures might require the insolvent firm to cease operations.2 If a supervisory authority, in its role within the investment firm resolution regime, deems that certain functions of an investment firm are critical or vital for financial markets, one could argue that this should prevail over normal insolvency procedures or that the investment firm resolution regime should precede an insolvency procedure.

346. The need to protect depositors or to safeguard the financial system against the risks in banks’ trading activities, which prompted the discussions on the Volcker rule in the USA and drove the Liikanen report in the EU, is not present within the investment firm sector. Therefore, there is no need to separate trading and client activities. Ultimately, the investment firm sector is already subject to a partial separation of trading and client activities through the asset segregation requirements, which create a separation between the client assets and investment firm assets and thus should prevent contagion between the assets of the investment firm and the assets of its clients.

347. Investment firms can be systemically important. The methods used for assessing this systemic relevance used by the FSB and the EBA, however, appear to be based on the business models of banks and as such do not provide for an adequate methodology to assess if an investment firm might be systemically important. To fully assess the systemic relevance of an investment firm the following criteria should be used: 1) the systemic importance of the investment firm and 2) the complexity of the investment firm. The systemic importance of an investment firm is influenced by its importance for the economy in a specific country. Furthermore, the substitutability and interconnectedness of the investment firm is relevant when assessing systemic relevance. An investment firm can be very important for the economy of a specific country, but when its functions can be easily replaced by other firms operating on the financial markets, the investment firm will most likely not be systemically relevant. An investment firm that is not of economic importance, but is not easily replaced by other financial market participants, will most likely also not be systemically relevant as the failure of that investment firm will not cause severe distress on financial markets.

348. The complexity of an investment firm is influenced by its organisational structure, by the types of financial instruments it invests in (either for itself of for its clients), but can also be influenced by the funding profile of that investment firm. The complexity of the organisational structure of the investment firm or the complexity of the assets the investment firm manages will impact the resolvability of that investment firm and will thus impact the manner in which supervisory authorities will be able to perform an orderly wind-down scenario. Furthermore, a “bank-like” investment firm that is funded through (short-term) wholesale markets might be more complex and its possible wind-down is more complex as the funding needed to wind down its business needs to be attracted through the financial markets. An investment firm going through financial difficulties (and a possible wind-down scenario) will most likely have difficulties in accessing this wholesale funding and will thus be exposed to a possible disorderly wind-down.