9.2.5 Liquidity

454. One new aspect of the IFR regime for investment firms is the liquidity requirement. Under CRR, see also Section 7.2.4, the liquidity requirements were only applicable to investment firms that perform the investment activities of dealing on own account or underwriting.1 The CRR liquidity requirement is based on measuring the inflow and outflow of liquid assets over a certain period. Credit institutions are inherently at risk of having to repay short-term funding (i.e. deposits of customers), while having longer term assets (i.e. loans granted) and thus face liquidity difficulties if the short-term outflow is greater than the long- term inflow at a certain point in time. The CRR liquidity requirement, therefore, firstly quantifies the risk that a credit institution cannot repay its (short-) term funding with the inflow of liquid assets. Secondly, liquidity management is subject to strict qualitative organisational requirements.

455. This timing difference in funding versus assets is usually not present within investment firms. The possible outflow of liquid assets for an investment firm is inherently smaller than that of a credit institution, simply because an investment firm is not allowed to hold deposits from its clients. The European Commission, therefore, introduces a different liquidity requirement for Class 2 and Class 3 investment firms.

456. As Class 1 investment firms will remain within the scope of the CRD 2013 and CRR regime, the liquidity requirements of the CRD 2013 and the CRR will remain applicable to those Class 1 investment firms. Under the IFR, a Class 2 or 3 investment firm should hold one-third of its fixed overhead requirement in liquid assets.2 One important aspect to highlight is that the CRR liquidity requirement was only applicable to certain investment firms, whereas the IFR liquidity requirement is applicable to all Class 2 and Class 3 investment firms. Competent authorities may exempt Class 3 investment firms from the liquidity requirements.3

457. Investment firms will have to look carefully at their own liquidity policies, based on sound management of their company and based on their own risk management, and analyse whether the requirements imposed by the IFR would warrant adjustment in their current policies. As the liquidity requirement in the IFR means that an investment firm only has to hold liquid assets greater than one-twelfth of its annual fixed costs, the effectiveness and impact of this requirement seems questionable. If an investment firm is not able to meet this one-month liquidity requirement, it would mean that the investment firm is also unable to fully pay the wages of its employees, its rent for the office building and its other fixed expenses for that month.4 In order to comply with is legal responsibilities as a statutory director, the management of an investment firm will normally have enough liquid assets to cover the firm’s expenses for at least the following month if not months.

458. As the fixed overhead requirement is based on the assumption that the investment firm should hold enough capital so that a supervisory authority could wind down the investment firm in an orderly fashion, the IFR liquidity requirement would have made more sense if it had utilized the same period as the fixed overhead requirement, so both requirements should have used a three month period. That would also have strengthened the “orderly wind down approach” of the fixed overhead requirement by making sure that a supervisory authority actually winding down that investment firm not only has a sufficient capital buffer, but also has the liquid assets available to pay for that wind-down and the ongoing fixed costs.

459. As mentioned above, the IFR liquidity requirement requires investment firms to “hold a minimum of one third of their fixed overhead requirement in liquid assets at all times”.5 These liquid assets should be calculated by a method similar to that used by banks. This is done by referring to the Delegated Regulation on the Liquidity Coverage Requirement.6 According to the European Commission “those liquid assets should be of high quality and aligned with those listed in Commission Delegated Regulation (EU) 2015/61 on the Liquidity Coverage Ratio together with the haircuts which apply to these assets under that Delegated Regulation”7 (LCR delegated regulation). However, as the European Commission also noted, the risk profiles of banks and investment firms differ, and using solely the LCR delegated regulation will not acknowledge this difference in risk profile. As such, the Commission proposes to allow investment firms to also use “unencumbered short-term deposits at a credit institution”.8 Although credit institutions are allowed to use “coins and bank notes”9 and certain “exposures to central banks”,10 investment firms do have a more lenient approach in that they can use, without restrictions, any unencumbered deposits held at a bank. Furthermore, the IFR also allows certain financial instruments that “are traded on a trading venue and for which there is a liquid market”11 to be used for IFR liquidity requirement. This is also a more lenient approach as compared to the strict calculations of the LCR delegated regulation.

460. Investment firms that qualify as Class 3 investment firms and Class 2 investment firms that are not allowed to deal on own account or perform underwriting services may also include “receivables from trade debtors as well as fees or commissions receivable within 30 days as liquid assets, provided these do not exceed one-third of the minimum liquidity requirement, do not count towards any additional liquidity requirements imposed by the competent authority, and that they are subject to a haircut of 50%”.12 Applying the haircuts to the liquid assets as specified in the Delegated Regulation is a prudential approach to calculating available liquid assets. The haircut implies that not all of the market value of liquid assets is indeed available to cover the liquidity needs of an institution. However, these haircuts are based on an assessment for credit institutions and not for investment firms. It could, therefore, be that certain liquid assets should be subjected to a higher (or lower) haircut specific to the investment firm sector. The liquidity regime in the IFR appears to not be supported by such an assessment and only uses the existing framework for banks.

461. Article 45 of the IFR13 further requires investment firms to increase their liquid assets by 1,6% of the total value of guarantees provided for customers as these guarantees “can give rise to increased liquidity needs if triggered”.14 Why this percentage is applied is not explained by the European legislator. Article 44 of the IFR15 gives investment firms the possibility to reduce the amount of liquid assets held in “exceptional circumstances”. What these exceptional circumstances are is not defined. As this is also an option that the investment firm can utilize on its own without supervisory approval, the possibility of abuse increases. Either the EC has to clearly define what an exceptional circumstance is, or this option needs to require supervisory approval.