IFR/IFD: Practical implications of a new prudential regime for principal trading firms

Abstract

The Investment Firm Regulation and Directive package (IFR/IFD) presents a unique opportunity to design a bespoke European prudential regime for investment firms, including principal trading firms. Principal trading firms trade financial instruments for their own account and own risk and do not hold or manage client assets or money. The current Capital Requirements Regulation and Directive (CRR/CRDIV) were designed for banks and incorrectly assess risks connected to investment firms (such as trading firms). These types of firms have fundamentally different balance sheets, portfolios, holding periods and business models to which current metrics are not very well attuned. Although IFR’s methodologies are quite elegant in prescribing required capital for an incredibly diverse population of over 6,500 investment firms in Europe, there remain quite a few issues to be resolved. This is important because if metrics are implemented incorrectly, they may limit liquidity provision and risk transfer in the financial markets, thus affecting stability. Addressing these key elements will bring IFR/IFD closer to the policy intent to simplify and better tailor capital requirements, and other prudential requirements, to investment firms in order to make European markets more secure and more competitive.