8.3.3 The BRRD requirements and investment firms

322. The BRRD is applicable to all banks within the European Union. However, not all investment firms are subject to the BRRD requirements.1 Article 2(1)(3) of the BRRD defines an investment firm as those firms falling under the definition of investment firm in the CRR,2 but further limits the scope to only those investment firms subject to CRR requirements that are also subject to the initial capital requirement of Article 28(2) of CRD 2013.3 In essence, only those investment firms that have an initial capital requirement of €730,000 are subject to the requirements of the BRRD. This will affect primarily those investment firms that deal on own account, perform underwriting activities on committed basis or operate an MTF or OTF.4

323. The activities of dealing on own account and underwriting are the activities which, within the current prudential regulations in the European Union, lead to the most stringent capital requirements for investment firms, as discussed in Section 7.2.2. Investment firms performing these activities can be subject, more or less, to the same capital requirements as a bank.5 It would thus make sense to also apply the BRRD requirements to this set of investment firms that already have to comply with banking requirements. However, as Section 7.2.2 highlighted, not all investment firms dealing on own account are subject to requirements similar to those applying to banks. Depending on the specific business model of the investment firm, they can be subject to the investment firm-specific prudential regimes included in the CRR.6 This is especially so for those investment firms that operate an MTF or OTF. These investment firms do have an initial capital requirement of €730,000 but are not subject to the same own funds requirements as a bank.7 Other parts of the CRR which are applicable to banks are also not applicable to MTF or OTF operators, such as the liquidity requirements, capital buffers, leverage ratio and large exposure regime.8

324. Furthermore, by simply using the initial capital requirement as a measure to define the scope of application, the European legislator ignored the fact that the supervision of certain large asset management businesses or investment firms that trade in OTC derivatives, either for their own risk and account or (as counterparty) for their clients, might have benefited from the BRRD requirements and the thought processes required from the firm itself and the resolution authority in drawing up their respective recovery and resolution plans. As discussed in Chapter 7, the current CRR and CRD 2013 regimes do not accurately address the actual risk profile of investment firms. Furthermore, as discussed in Section 2.1.4, this scoping of the BRRD does not reflect the possible systemic risks of investment firms. Only using the initial capital requirement as a means of setting the scope of the BRRD ignores this inherent short-coming of the CRD 2013 and CRR regime, which could mean that the BRRD applies to those investment firms for which the BRRD requirements do not add a supervision benefit, whereas other riskier investment firms that do not qualify under the BRRD definition are outside the scope of the BRRD requirements. The scoping of the BRRD for investment firms therefore is overly simplistic and should be revised significantly to better accommodate the actual risk profiles of certain investment firms.9

325. The BRRD does not contain an explanation on why investment firms are subject to the BRRD. The recitals of the BRRD10 mention the provision of investment services and activities, but mainly as one of the indicators that should be considered by the institution or the supervisory authority when drawing up the recovery and resolution plans. The requirements in the BRRD seem to be oriented towards large banks and do not seem to fully reflect the specific risk profile of investment firms or their business models.

326. As discussed in Section 8.1, the prudential requirements for investment firms should be based on a gone-concern approach. The idea of the resolution plans in the BRRD therefore does have merit for investment firms, but it should be further tailored to the specific characteristics of investment firms. The BRRD regime itself, however, is tailored to the specific characteristics of banks and is thus a useful tool for assessing (and ultimately protecting) the vital functions of banks for the financial system. An analysis of what should constitute vital functions of an investment firm is not included in the BRRD, nor in the analysis of the Financial Stability Board (FSB).11 The Single Resolution Board (SRB) has provided some further guidance on how the SRB assesses whether a function is critical.12 The assessment of the potential disruption to the “function of markets, infrastructure and customers”13 caused by the loss of a vital function is particularly relevant to the discussion on the vital functions of an investment firm. “In particular, the assessment may include: the effect on the liquidity of the markets concerned, the impact and extent of disruption to customer business, and short-term liquidity needs; the perceptibility to counterparties, customers and the public; the capacity and speed of customer reaction; the relevance to the functioning of other markets; the effect on the liquidity, operations and structure of another market; the effect on other counterparties related to the main customers and the interrelation of the function with other services”.14 The SRB report, however, focuses primarily on the assessment of the critical functions of banks. A direct application of the principles of the SRB or the BRRD to investment firms is therefore inappropriate as the investment services and activities provided by investment firms, as discussed in Chapter 2, will usually not result in functions resembling the critical functions of banks. These SRB principles could serve as a basis for analysing the critical functions of an investment firm but cannot be used as the sole means for an investment firm specific assessment.

327. The BRRD regime that is intended to protect the vital functions of banks is not suitable for investment firms. However, the rationale behind the BRRD, ex ante assessment of the resolvability of an institution and the necessary actions for achieving an orderly resolution, are useful tools to apply for the investment firm sector. This will be increasingly relevant now that the new prudential regime for investment firms included in the IFR and IFD is more explicitly based on a gone-concern approach.

328. It would be helpful for the prudential regulatory response for investment firms if supervisory authorities were able to use an “asset transfer” or “business transfer” tool. Within the BRRD context, competent supervisory authorities assess the resolvability of a bank by assessing which parts of the bank are vital for financial markets and by analysing whether and how these parts can be protected from the failure of a bank. One of the means to achieve this is to have the ability to sell or transfer these vital parts of a bank to another entity and thus prevent contagion between the “bad” parts of a bank that would cause it to fail, and the vital parts of the bank.15 This ability to transfer parts of a bank could also be very useful for investment firms as, currently investment firms will wind up in national insolvency procedures which could severely affect the ability of competent supervisory authorities to protect vital parts of the investment firm.16

329. An asset transfer or business transfer tool would help supervisory authorities to transfer part of the business of an investment firm to another firm. For instance, if a large asset manager were to fail, the assets it manages for clients and the asset management relationship with those clients should be the vital part of that investment firm. The prudential legislative framework currently does not contain any means for supervisory authorities to force this failing asset manager to transfer its asset management business to a more viable competitor. If that failing asset manager then ended up in an insolvency procedure, the supervisory authorities would have no say in which firm would acquire the asset management relationships and assets under management, as this would then be within the discretion of the curator appointed in the insolvency procedure. The asset/business transfer tool should give supervisory authorities the ability to transfer the vital parts of an investment firm prior to the insolvency procedures becoming effective and thus protect investors or the financial system.

330. So, although in terms of the details of its requirements the BRRD is primarily useful for banks, the concepts and reasoning behind it could and should also be applied to certain investment firms. Considering that the regulatory response for investment firms should be based on a gone-concern approach, the need for an investment firm-specific BRRD increases. However, the scoping of the current BRRD regime seems to ignore the actual risk profile of investment firms, as discussed in Chapter 2. The usefulness of the BRRD would have benefited from an analysis of the systemic risk of investment firms when setting the scope of the BRRD.