Prudential regulation of investment firms in the European Union (ZIFO nr. 32) 2021/3.2.2.1:3.2.2.1 Larger broker-dealer investment firms

Prudential regulation of investment firms in the European Union (ZIFO nr. 32) 2021/3.2.2.1

3.2.2.1 Larger broker-dealer investment firms

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147. To begin with, let us look, in Table 2, at the stylised example of an investment firm as drafted by the Joint Forum. It should be mentioned that this stylised example of an investment firm as developed by the Joint Forum appears to be based on the American investment firm market with very large ‘broker-dealer’ type investment firms. These firms have significant trading books and as such have large positions in financial instruments on their balance sheet. This stylised example by the Joint Forum is useful for an initial analysis of the differences between banks and investment firms. However, this does not reflect the majority of investment firms in the European Union. Therefore, following this stylised example of the Joint Forum in Table 2, a balance sheet of a more prototypical European investment firm will be provided and discussed.

Table 2: Stylised balance sheet for an investment firm1

Assets

Liabilities

Asset Class

%

Liability Class

%

Cash and cash equivalents

1.3

Securities sold under repos

10.7

Cash and securities segregated

5.9

Securities loaned

3.2

Securities purchased under repos

12.9

Short-term borrowings

11.6

Securities borrowed

28.4

Payables

32.2

Receivables (1)

14.9

Financial instruments sold, but not yet purchased, at fair value

25.9

Financial instruments owned at fair value

32.9

Long-term borrowings

10.8

Other assets

3.7

Total shareholder equity

5.6

– Common stock

1.6

– Paid-in capital

3.4

– Retained earnings

0.6

Total Assets

100

Total Liabilities

100

Notes to stylised balance sheet:

(1)

Receivables from customers, broker dealers and clearers. Includes debits (receivables) arising from margin accounts and payables for free credit balances and includes receivables (payables) from pending transactions.

148. This stylised example of a broker-dealer investment firm clearly shows a significant difference as compared to the stylised example of a bank, where the asset side of the bank balance sheet primarily consists of loans and the liabilities side primarily consists of deposits. The balance sheet of this type of investment firm primarily consists of securities and financial instruments. The most important difference is that these broker-dealers have no loan portfolio nor any client deposits. Therefore, the balance sheet is focused entirely on the trading book activities and, as such, the risk profile of a broker-dealer is oriented towards market risk, but also systemic risk. A balance sheet resembling this stylised example will be found in those investment firms that perform the investment activities of dealing on own account or underwriting.

149. As noted above, the example of the Joint Forum is based upon a securities’ holding firm in the US and the Joint Forum sees the “primary types of business that an [investment firm] undertakes are investment banking, capital markets, principal transactions (proprietary trading), asset management and commissions”.2 Of these activities, investment banking and proprietary trading will lead to significant balance sheet items as the investment firm is trading for its own account or using its own balance sheet to trade with or for clients.

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