IFD/IFR – Analysis of Class 2 Firms and their Capital Requirement Calculations
Introduction
In our previous article (can be found here) we analyzed the categorization of investment firms in accordance with the new Prudential Regulation and Directive (IFR/IFD).
Class 2 investment firms will be subject to new risk-based regulatory capital requirements, assessed as the higher of the sum of their ‘K-factor’ requirements, one quarter of their annual fixed overheads and their initial capital requirement.
What are K-Factors?
K-factors are quantitative indicators that aim to identify risks that an investment firm may pose to clients, markets or liquidity, as well as to the firm itself.
Specifically, K-factors are divided in the IFR into three groups and they aim to capture the risks the firms may be exposed to:
Risk to Client
Risk to Market
Risk to Firm
|
Category |
K-factor |
|
Co-efficient (or method) |
|
Risk to Client |
Assets under management (discretionary and ongoing non-discretionary advisory) |
K-AUM |
0.02% |
|
Client money held (on segregated or non-segregated basis) |
K-CMH |
0.4% (segregated |
|
|
0.5% (non-segregated) |
|||
|
Assets under safeguarding and administration |
K-ASA |
0.04% |
|
|
Client orders handled (cash trades and derivatives) |
K-COH |
0.1% (cash trades) |
|
|
0.01% (derivatives) |
|||
|
Risk to Market |
Net position risk on own account trading book positions (unless K-CMG applies) |
K-NPR |
N/A (capital as per CRR simplified or standardised approach) |
|
Total margins required by firm’s clearing member (if permitted by competent authority) |
K-CMG |
N/A(capital=3rd highest total daily margin requirement over last 3 months) |
|
|
Risk to Firm |
Trading Counterparty default (own account trading book exposures) |
K-TCD |
N/A (capital = ∑1.2 x exposure value x risk factor x CVA) |
|
Daily trading flow for cash trades or derivatives (trading book own account transactions + transactions executed for clients in firm’s name). |
K-DTF |
0.1%(cash trades) |
|
|
0.01%(derivatives) |
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|
Concentration risk on own account trading book transactions. |
K-CON |
N/A (capital = ∑[exposure capital requirement/ exposure value] x exposure value excess) |
The overall K-factor position is a sum of the K-factors in respect of the three areas of risk outlined (RtC, RtM and RtF) as outlined in Article 15 of the IFR.
The K-factors and coefficients that are applied to each factor are outlined in the table above.
How can we help?
Our experienced Risk Management Team can help you to prepare for the submission of reporting forms related to IFR/IFD. Do not hesitate to contact us for more information at: [email protected]
