7.2.1 Initial capital

251. The applicability of CRD 2013 and the CRR to investment firms (both ‘firms’ and ‘investment firms’ as described in the previous section) is dependent on the investment services and activities, as specified in Annex 1 of MiFID, performed by the investment firm.1 The first requirement to be determined for any investment firm is the initial capital requirement. CRD 2013 assumes that all investment firms have an initial capital requirement of €730,000,2 unless they perform a specific set of investment services. If the investment firm offers certain investment services, the initial capital requirement is reduced in accordance with Articles 29 to 32 of CRD 2013.

252. The investment services and activities not mentioned in Articles 29 to 32 are ‘trading for own account’, ‘operation of a multilateral trading facility’ and ‘underwriting of instruments with or without a firm commitment basis’. As of the entry into force of MiFID II, an operator of an OTF is also subject to the CRD 2013 and CRR requirements. As MiFID II did not amend the CRD 2013 and the CRR for this new investment activity, operating an OTF is, similar to operating an MTF, not mentioned in the CRD 2013 and CRR. For an investment firm that performs these investment services or activities, the CRD 2013 and the CRR assume that these firms have a greater inherent risk and should therefore be subject to more stringent capital requirements. Similarly, a credit institution performing these activities poses a greater risk to its depositors than a credit institution which does not, for instance, deal for own risk and account. Given the assumption in the CRD 2013 that all credit institutions are (or could be) universal banks and the risks to depositors and financial stability posed by activities performed by credit institutions, an investment firm which performs certain investment activities or services which may impact customer interests or financial stability, should face similar stringent capital requirements. This will maintain a level playing field between investment firms and credit institutions performing similar activities. Given the previous discussions on the difference between ‘investment firms’ and ‘firms’, one must realize that Articles 28 and 29 of the CRD 2013 are only intended for those MiFID investment firms which qualify under the CRR definition of investment firm. As a result, the firms which are now excluded from the CRR definition of investment firm are no longer subject to these provisions, but are subject to Article 31 of the CRD 2013.3

253. A CRR investment firm that “does not deal in any financial instruments for its own account or underwrite issues of financial instruments on a firm commitment basis”4 can fall under the scope of Article 29 of CRD 2013. Paragraph 1 of Article 29 subjects CRR5 investment firms that hold client money or securities to an initial capital requirement of €125,000, while the third Paragraph of Article 296 gives European Union member states the option to reduce that amount to €50,000 for those CRR investment firms that are not allowed to hold client money or securities. To qualify under Article 29, a CRR investment firm has to offer one or more of the investment services mentioned in Paragraph 1 of Article 29, namely: ‘execution of orders’, ‘portfolio management’ and ‘order transmission’. With the exception of ‘investment advice’, which is not included in the activities mentioned in Article 29 but is excluded from in the definition of investment firm,7 the services mentioned in Article 29 are the same as those the definition of investment firm as set forth in Article 4 of the CRR.

254. The differences between an investment firm that is excluded from the CRR definition of investment firm in article 4(1)(c) of the CRR and a CRR investment firm that falls within the scope of Article 29 can be minor. The main difference between 4(1)(c) investment firms and CRR investment firms subject to Paragraph 1 of Article 29, is that CRR investment firms falling under the scope of Article 29 can be authorized to hold funds or securities belonging to their clients or perform the ancillary service of safekeeping of financial instruments, whereas 4(1)(c) investment firms are not allowed to do this. The difference between a 4(1)(c) investment firm and a CRR investment firm subject to Paragraph 3 of Article 29 is, however, negligible. The actual activities performed between the 4(1)(c) investment firm and the 29(3) CRR investment firm can, and in some cases will be, similar, with only minor changes in activities resulting in major changes in the applicable supervisory regime. The 4(1)(c) firms are subject to the initial capital requirement8 of Article 31 of the CRD 2013, instead of article 29.

255. Article 30 of CRD 2013 governs “local firms”.9 These firms qualify as MiFID investment firms but are excluded from the CRR definition of investment firm. Under the CRR definition a local firm is a firm which “deals for its own account on markets in financial futures or options or other derivatives and on cash markets for the sole purpose of hedging positions on derivatives markets, or dealing for the accounts of other members of those markets and being guaranteed by clearing members of the same markets, where responsibility for ensuring the performance of contracts entered into by such a firm is assumed by clearing members of the same markets”10 and is excluded from the scope of the CRR and the CRD 2013. The CRD 2013, however, does place an initial capital requirement of €50,000 on local firms “insofar as they benefit from the freedom of establishment or to provide services”.11 Because local firms only deal on own account, do not have (external) clients and may not perform services for (external) clients and their activities are guaranteed by their clearing member, the inherent risks of these local firms for investors or the financial system are reduced, so the CRD 2013 and the CRR regime does not apply. Only if these local firms intend to perform their activities in member states of the European Union other than that in which the local firm has its registered office, will they become subject to an initial capital requirement under Article 30 of the CRD 2013.

256. The firms which are excluded from the CRR definition of investment firm in Point c of Article 4(1)(2) of the CRR are subject to the initial capital requirements12 of Article 31 of CRD 2013. Besides containing an initial capital requirement, Article 31 of the CRD 2013 primarily describes the manner in which the capital requirement should be maintained. The first paragraph states that firms excluded from the CRR definition of investment firm should have an initial capital of €50,000, a professional indemnity insurance or any combination of those.13 This is a significant easing of the requirements compared to the original text of the CRD 2006, especially for those firms which are excluded of the CRR, but which were investment firms under the previous definition in the CRD 2006. Under the CRD 2006, these firms were obliged to provide a regulatory capital of €50,000 or €125,000 by actual equity endowment. Under the CRD 2013, they can replace the €50,000 with a professional indemnity insurance.

257. If the firm excluded from the CRR definition is also registered under the IMD, the initial capital requirement will be reduced to €25,000, a professional indemnity insurance or any combination of those.14 This reduced capital requirement is possible because firms registered as (re)insurance intermediaries under the IMD must also have a professional indemnity insurance as described in Article 4, Paragraph 3 of the IMD.15 The combination of the professional indemnity insurance under the IMD and the capital requirement or professional indemnity insurance under Article 31, Paragraph 2 of the CRD 201316 provides for an increase compared to the requirements for investment firms not registered under the IMD and falling under the first Paragraph of Article 31 of the CRD 2013.17

258. Investment firms which perform the investment service of ‘placing of financial instruments without a firm commitment basis’ can be subject to different initial capital requirements. If the investment firm performs this investment service in conjunction with the investment services with which it could qualify under Article 29 of the CRD 2013,18 it would have an initial capital requirement of €125,000 or €50,000. If the investment firm only performs this investment service, it does not meet the conditions of Article 29, Paragraph 1, and can therefore only be subjected to the initial capital requirement of Article 28 of the CRD 2013,19 which means an initial capital requirement of €730,000. This results in investment firms with a relatively low risk profile (i.e. the investment firm is primarily a sales office and does not face the risk of a failed placing, see also the section on underwriting and placing of financial instruments in Section 2.1.2) being subject to the most stringent initial capital requirement. When this activity of placing without a firm commitment basis is combined with one or more of the activities mentioned in Paragraph 1 of Article 29 of the CRD 2013,20 the CRD apparently considers the activity less risky. It therefore seems that the European legislator has omitted to include a specific initial capital requirement for firms only placing instruments without a firm commitment basis and which are not involved in the provision of any other investment services.

259. With regard to the impact of the change in the CRR definition of investment firm, the initial capital requirements are a clear example of the changes this brings for the supervisory practice. Whereas under the CRD 2006 definition a majority of Dutch investment firms would fall under the initial capital requirement of € 125.000 or € 50.000 of Article 29 of the CRD 2013, under the CRR definition most MiFID investment firms in the Netherlands fall under the initial capital requirements of € 50.000 or a professional indemnity insurance of Article 31 of the CRD 2013. The professional indemnity insurance which is allowed under Article 31 of CRD 2013 may mean a reduction in the quality of capital which is required for investment firms as the loss-absorbing capacity of a professional indemnity insurance is dependent on the characteristics and the coverage of the insurance itself. For capital instruments, these (loss absorption) criteria are described in detail in Part Two of the CRR and any capital instrument which does not comply with the criteria in the CRR cannot be used to fulfil the capital requirement. The CRR and the CRD 2013 do not contain any (loss absorption) criteria for a professional indemnity insurance whatsoever.