Implementation of the new Prudential Regulatory Framework for Investment Firms

Following the implementation of the new prudential regulatory framework for Investment Firms on the 26^th of June 2021 (Investment firms Regulation – IFR and Investment Firms Directive – IFD) and as regards the transposition of the new directive into national Law, the following laws were voted by the Cyprus parliament on the 21^st of October 2021 and published on the 5^th of November 2021 at the Official Gazette of the Republic of Cyprus:

Law 165(I)/2021, The Prudential Supervisions for Investment Firms Law of 2021 (the ‘Law’)
Law 164(I)/2021, amending Law 97(I)/2021, The Capital Adequacy Investment Firms Law of 2021

Timeline of the implementation

The graph below describes the timeline of the implementation of the new prudential regulatory framework to CIFs from the date of publication of the new Regulation and Directive until the transposition date of the IFD:

The new regulatory regime applies to ALL Investment Firms authorised and supervised under the MiFID II (European Directive 2014/65/EU).

The key regulatory changed under the new regime are summarized in the below table:

Scope	Description
Classification	The new regime introduces a new classification system for Investment Firms. Depending on their activities as well as the size of their balance sheet, Investment Firms are categorized as Class 1 which are under the CRR II/CRDV prudential framework and Class 2 and 3 which are under IFR and the Law
Own Funds Requirements	Own Funds requirements are now calculated as the highest of the following components: · The fixed overheads Requirement · The Initial Capital Requirement · The K-factor requirement (applicable only for Class 2 Investment Firms)
Initial Capital Requirement	New initial capital requirements have been introduced under the new framework. The new regulatory requirements are slightly above the existing ones
K-Factor Requirements	Capital requirement from applying K-factors formula (pursuant to Article 15 of the IFR) is the sum of Risk to Customer (‘RtC’), Risk to Market (‘RtM’) and Risk to Firm (‘RtF’) proxies
Fixed Overheads Requirement	Investment firms are required to calculate the Fixed Overheads Requirement as the one quarter (¼) of the previous year fixed expenses (based on audited figures)
Concentration Risk	The limits to shareholders and directors of 2% and 1% of the eligible capital is no longer applicable under the new prudential framework. Also, K-CON replaces the calculation methodology of the additional capital requirements due to large exposures within the trading book, introduced by the new K-Factors methodology applicable to Class 2 CIFs
Liquidity Requirements	Class 2 and 3 Investment Firms must hold an amount of liquid assets equal to at least one third (1/3) of the Fixed overhead requirement
Reporting requirements	Class 2 and 3 Investment Firms are required to report to CySEC on a quarterly and annual basis respectively their: · level and composition of own funds, · own funds requirements, · own funds requirement calculations · level of activity, including the balance sheet and revenue breakdown by investment service and applicable K-factor (Only Class 3) · concentration risk · liquidity requirements
Disclosures	As a Class 2 Investment Firm, the Company is requested to publicly disclose the following items on an annual basis: a) Risk management b) Governance c) Own funds d) Own Funds requirements e) Remuneration f) Investment Policy g) ESG risks() ESG disclosures should be made from 26 December 2022 for firms

*Further details regarding the above amendments can be found in the IFR&IFD article published on our website.

Further to the above regulatory changes, the Law, introduced several amendments with respect to the new initial capital requirements (€75k, €150k and €750k), internal governance arrangements, prudential consolidation supervision, Internal Capital Adequacy and Risk Assessment Process (ICARA process), remuneration policies as well as other prudential requirements for Cypriot Investment Firms.

Additionally, the new law transposed the provisions of IFD regarding the Group Capital Test (GCT) and prudential consolidation. CIFs that are permitted to use GCT will report only on a solo basis, otherwise they will report on both solo and consolidated basis.

Moreover, all CIFs should have in place adequate corporate governance frameworks proportional to their size and type of activities which should include, among others:

clear organizational structure outlining the responsible people;
sufficient procedures for identifying, monitoring and managing risks the CIF is or could be exposed to;
adequate internal control mechanisms (i.e management supervision and internal auditing);
gender neutral policies which should be in line with efficient risk management.

Further to the above and following the transposition of the IFD into Cypriot Law, the parliament voted several amendments to the following prudential related Laws:

1) The Alternative Investment Fund Managers Law of 2021, 157(I)/2021 was amended in order to update the reference to the Law regarding the calculation of the Fixed Overheads Requirement.

2) The Resolution of Credit Institutions and Investment Firms Law of 2021, 158(I)/2021 explicitly categories Investment Firm types and group structures by providing new definitions for CIFs as per the provisions of the new prudential regulatory framework.

3) The Investment activities and operations of regulated markets Law of 2021, 159(I)/2021 ensures that investment operations are regulated upon the basis of activity type and enables the risk mechanisms established to be specifically tailored to the needs of Investment Firms. The law was amended to include the initial capital amendment and granting authorisation to third-country firms for establishment of a branch, provisions of services at the exclusive initiative of the client, and transitional provisions on the authorisation of credit institutions (having total assets higher than €30b assets).

4) The Macroprudential Oversight of Institutions Law of 2021, 161(I)/2021 requires the Central Bank of Cyprus to acquire more indicative action in terms of overseeing institutions activities thoroughly and applying additional requirements on a case-by-case level i.e., systemic buffer applications. The law was amended to reflect the updated Central Bank of Cyprus powers as the designated macroprudential authority for investment firms.

5) The Business of Credit Institutions Law of 2021, 163(I)/2021 incorporates the classification system provisions for credit institutions in terms of their total assets (higher than 30 billion).

Finally, and following all the above regulatory updates with respect to the prudential supervision, all CIFs should be ready to:

establish their data management systems to collect the respective K-Factors data (if applicable)
assess their group structure whether they fall under prudential consolidation
amend their risk management policies and procedures to ensure that the adequate controls and systems are in place to comply with the new prudential regulatory framework
review the new disclosures (Pillar III) requirements
monitor the classification threshold sets by the new regulation (Class 2 or 3 Investment firm)
review their existing ICAAP (ICARA) under the new prudential rules

Please do not hesitate to contact us in case any further clarification/assistance is needed with respect to the above regulatory changes.