FCA proposes simplification of UK capital rules for investment firms

The Financial Conduct Authority (FCA) released a consultation paper (CP25/10) on 24 April on the definition of capital for investment firms that outlines plans to simplify and consolidate the rules on what qualifies as regulatory capital and to make these easier to understand. 

The proposals are in line with the UK financial regulator's broader aims to make rules more accessible and proportionate, to avoid unnecessary complexity and to support the government's growth "mission".

The substance of the rules remain largely unchanged, however, and the FCA does not expect firms to amend capital arrangements because of the simplification measures.

The consultation closes on 12 June and the FCA plans to publish final rules in the second half of the year and bring them into force on 1 January 2026.

Rationale for changes

The FCA plans to remove all references to the retained EU law version of the UK Capital Requirements Regulation (CRR) (575/2013) –  that is, technically, to the UK CRR as it stood on 1 January 2022 – from the definition of regulatory capital (or "own funds") applicable to investment firms under the Markets in Financial Instruments Directive Prudential Rules (MIFIDPRU) 3.

It has pointed out that the UK CRR was designed for banks, which typically have more complex capital structures than investment firms. This has made its rules a poor match for how investment firms really operate, with capital typically made up of ordinary shares and retained earnings. By removing references to the UK CRR and writing simpler equivalents into MIFIDPRU directly, the FCA hopes to make the rules easier for firms to follow.

The FCA has implied that it only cross-referred to the UK CRR to deliver the investment firms prudential regime on time, and points to the Treasury's announcement last year that the UK CRR will be revoked as "further impetus" for this change.

Longer-term, the FCA plans to produce an integrated sourcebook covering core capital requirements across firms it prudentially regulates. Tidying MIFIDPRU, it suggests, could be a step towards this goal.

Implementation of proposals

The substantive requirements for firms are broadly unchanged. The three tiers of capital – Common Equity Tier 1 (CET1), Additional Tier 1 and Tier 2 – remain, as do the amounts and proportions in which these must be held. Eligible items for the different tiers and required deductions are essentially the same.

The changes the FCA proposes aim instead to remove irrelevant materials (for example, duplication of accounting standards) and unnecessary prescription (for example, replacing calculation methodologies with principles-based rules) and to introduce clarifications (for example, on the meaning of "fully paid up" instruments).  

There is a helpful change to the rules on CET1 instruments, so that an eligible CET1 share can now rank parri passu with other non-CET1 shares on a liquidation. This should help start-up firms with different share classes or employee incentive arrangements, although liquidation "waterfalls" are likely to remain problematic. 

Further simplifications include interim profits (to count as CET1) requiring FCA notification rather than permission and trading firms that repurchase their capital instruments for "market making" no longer needing permission or to notify.

Rules are not always relaxed and some disclosure requirements will be enhanced. An objective test will be introduced concerning cross-holdings and some rarely used options will be removed, with the FCA suggesting firms can apply for a waiver instead.

However, the substantive changes are minor and driven by the need for simplicity. The FCA's view is that if a firm's own funds meet current requirements then they will likely under the revised rules too. The changes are more relevant to new firms or those wanting to change their capital structure.

Osborne Clarke comment

The FCA's growth objective comes through clearly in the consultation paper – three of the four stated outcomes for this proposal are accessibility, efficiency and proportionality.  However, since this is a simplification and consolidation exercise with substantive capital requirements largely unchanged, it is unclear how much, in practice, it will lighten the load on firms or contribute to growth in the sector. The FCA has implied that it only referred to UK CRR because it was pressed for time and is simply redrafting MIFIDPRU the way it should have been. 

In practice, it is unlikely that investment firms with simple capital structures were closely examining UK CRR requirements and firms, if they now come across a "thorny" question that the simplified rules do not answer, can still – as they previously could – turn to the UK CRR and European "questions and answers" for a steer. Moreover, if, as the FCA suggests, the UK CRR is overly complex for investment firms, the proposed simplification hardly breaks new ground.

However, given the length and complexity of the FCA Handbook as it has evolved over time, the regulator's move to make rules clearer and more accessible are a step in the right direction; if done well and across different sourcebooks, this could reduce compliance costs to some extent.