10.4.1 Prudential requirements to mitigate operational risks

509. The way operational risk is measured in the IFR and the IFD is already a significant improvement on the regime included in the CRD 2013 and the CRR. The IFR and the IFD address operational risk using the K-factors of RtC which are based on business models of investment firms. The IFR and IFD also incorporate one requirement of the CRR regime, the fixed overhead requirement, which was also a relatively good proxy for measuring the operational risk of an investment firm as it is based on the total fixed costs of the investment firm. The total fixed costs of an investment firm, or any other business, indicate the size of the business as one would expect a business with a large amount of fixed costs to be bigger (and having more personnel or other expenses). The fixed overhead requirement then assumes that a larger business will thus incur more operational risk.

510. As discussed in Section 9.2.3 when discussing RtC, the manner in which assets under advice are measured should be further thought through. How this “advice of an ongoing nature” should be measured and which aspects of the service investment advice should be included in the K-AUM calculations is not clear. Even though the risk of advising a client to invest in a certain financial instrument appears similar to the risk when the investment firm itself is managing the portfolio, there are differences. Given the discussion in Paragraph 405 on the difficulties of measuring of assets under advice, it would be beneficial to exclude assets under advice from the calculations of K-AUM. This should be part of the review in accordance with Point B of Article 60(1) of the IFR1 The operational risks of investment advice will be limited and can be regulated through the fixed overhead requirement, which itself is a proxy of the operational risk of an investment firm.

511. Furthermore, the manner in which asset segregation is incorporated into the IFR and IFD needs refinement, as discussed in Paragraphs 407-416. This should also be part of the review of Point B of Article 60(1) of the IFR and should better reflect the actual risks of asset segregation, as discussed in Chapter 4.

512. A further aspect where the operational risk measurement framework in the IFR and IFD could also be improved is an analysis of whether the operational risk indeed follows a linear increase as the business grows, as the requirements under RtC now imply, as discussed in Section 2.1.4. Under the RtC requirements, investment firms are required, for instance, to multiply their entire assets under management by a fixed coefficient, meaning that the IFR assumes the same operational risk for every additional euro of assets managed by the investment firm. For all the K-factors under RtC, but also for the fixed overhead requirement, it does seem more logical, however, that the actual additional risk does not increase in a linear relation to the K-factor when the amount measured under the K-factor increases. The operational risk measurement framework would therefore benefit if the impact of an increase in the size of a business were better reflected in the outcome of the operational risk measurement framework.2 This re-assessing of the implications of increased operational risks should be incorporated into the review report based on Point C of Article 60(1) of the IFR3 which entails the coefficients of Article 15 of the IFR. By setting multiple coefficients for a single K-factor that change depending on the size of the underlying K-factor, the European Commission can incorporate these aspects into a revised version of the IFR.