Background
The FCA's rules on what counts as the different categories1 of regulatory capital ("own funds") for investment firms are spread across a patchwork quilt of sources: MIFIDPRU 3 and its annexes, plus the time-frozen requirements in UK CRR (assimilated law) and related technical standards. The rules are user-unfriendly and (being based on the bank regime) overly complex (and prescriptive) for investment firms. The UK CRR will also be phased out under HM Treasury plans.
The FCA recognises these weaknesses. In its consultation paper on the definition of capital for FCA investment firms (CP25/10), the FCA sets out its proposals to unify all the rules within MIFIDPRU 3; and simplify them in several areas.
The FCA does not expect firms will need to make any changes to their existing capital arrangements as a result of the proposals. In our view, however, some of the changes may be relevant for firms when they change their capital structure or reduce capital, particularly those (such as start-ups) with more complex capital structures such as share classes with varying rights. There are also some additional changes to the general requirements on own funds (MIFIDPRU 3.6) wrapped in.
This exercise is about making the rules more proportionate to investment firms, easier to navigate and up to date. According to the cost benefit analysis (CBA), the FCA does not see this as having UK growth and competitiveness benefits.
The response deadline is 12 June 2025.
Quick read
Firms impacted
FCA-only regulated MIFIDPRU investment firms (and their UK consolidated parent entity, if MIFIDPRU consolidation applies).
Rules architecture
- All rules defining what qualifies as eligible own funds (CET1, AT1 and T2), deductions and related requirements to be in one revised source: MIFIDPRU 3. EU-derived sources (UK CRR etc) will be deleted.
- Newly drafted complete sections in MIFIDPRU 3.
- Structure of new rules is intended to be more logical and user-friendly.
Rules content
- Simplification of several rules across all three tiers of capital, intended to make them more proportionate for investment firms.
- Extra clarificatory guidance added.
- No change in the fundamental approach to the characteristics required for each tier of qualifying regulatory capital.
Possible 1 January 2026 implementation.
Key proposals at a glance
The table below is a simplified summary of the main elements of the FCA proposals.
| Area | Change | ||
|---|---|---|---|
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Rules architecture |
Consolidation of all requirements into a single source: MIFIDPRU 3 Removal of all UK CRR and related technical standards material - by deletion of MIFIDPRU 3 Annex 7R (Additional provisions relating to own funds) and Annex 8R (Prudent valuation and additional valuation adjustments) Removal of material which does not apply to FCA investment firms or is not practically relevant to their business models or duplicates other material, e.g. material about the bank recovery and resolution regime; and material which duplicates company law/accounting standards (see table on page 17 of CP25/10) |
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Composition of total own funds requirement |
No change The maximum amount of CET1, AT1 and T2 that contribute to the total own funds requirement remains the same, i.e.:
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Qualifying capital conditions - prohibition on funding your own capital instruments |
Simplified - new exception Introduction of broad exception for funding provided in the ordinary course of a firm's business (e.g. a market maker providing margin lending that happens to involve its own shares) |
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Qualifying conditions - "fully paid up" instruments |
Additional guidance on what constitutes "fully paid up" (based on Basel Committee guidance) |
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Qualifying conditions - eligibility criteria for CET1 and AT1 |
Simplified conditions relating to:
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Deductions -significant and non-significant holdings in capital instruments of financial sector entities |
Simplified Combined into one single category of deduction |
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Deductions -indirect holdings and synthetic holdings |
Simplified Clarification that the FCA does not generally require firms to "look through" a fund's investments - firms can treat the fund itself as a non-financial entity |
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Deductions -cross holdings |
Simplified Changed to an objective test (with specific indicators) instead of an FCA opinion |
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CET1 changes |
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Qualifying conditions -permanence of instrument |
New guidance CET1 instruments must be "permanent" to qualify. However, that does not mean a firm can never reduce its regulatory capital. New guidance proposed, to clarify that a firm can nevertheless acknowledge that it is able to reduce capital (e.g. under its articles), but that it should not create any expectation that it might do so |
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Qualifying conditions -existence of non-CET1 shares as well |
New guidance CET1 instruments must rank below all other claims in liquidation (first loss absorbing). New guidance proposed, to clarify that shares can still meet this condition where there are other shares which rank equally to the CET1 shares but do not themselves qualify as CET1 But there will be extra disclosure requirements (MIFIDPRU 8 Annex 1R) to inform the market about such arrangements |
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Inclusion of interim profits as CET1 |
Simplified - notification instead of prior FCA approval Streamlined process: removing the requirement to obtain FCA permission. Notification based system instead |
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Adjustments for trading book positions |
Simplified Removal of legacy requirements in MIFIDPRU 3 Annex 8R. Standard adjustment (0.1% of trading book) remains |
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Deductions -qualifying holdings outside the financial sector |
Simplified Replacement of the exception for shares which are not fixed assets with a new carve out for shares held in trading book Removal of exception for short term underwriting positions |
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AT1 changes |
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Loss absorption mechanism -conversion or write down |
Simplified Simplification of requirements that the full amount of the AT1 instrument must be written down/converted on trigger event, e.g. removal of requirement for independent review |
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Deductions |
Simplified Alignment of relevant AT1 deduction rules with (new) approach to CET1 deductions (see above) - deduction of holdings of own AT1; cross-holdings; AT1 of financial sector entities; excess T2; and AT1 related foreseeable tax charges |
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T2 changes |
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Maturity and amortization |
Simplified Different formula for calculating amortization when a T2 instrument has a residual maturity of five years or less |
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Deductions |
Simplified Alignment of equivalent T2 deduction rules with (new) approach to CET1 /AT1 deductions (above) - deduction of holdings of own T2; and T2 of financial sector entities |
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Other changes to general requirements (MIFIDPRU 3.6) |
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Distributions - in a form other than cash/own fund instruments |
Simplified - removal of FCA permission requirement Article 73 UK CRR prohibition will be kept, but in a simplified version. Existing IFPR regulatory permission for this is considered redundant and will be removed. Firms can still apply for a waiver if necessary |
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Distributions - use of broad market indices (AT1 and T2) |
Simplified Removal of rules allowing firms to use broad market indices to determine distribution levels (where no correlation to the firm/group credit standing). Considered unnecessarily complex. Replaced by tweak to one of the eligibility requirements, to prohibit instruments with distribution linked to credit standing |
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Reductions in capital - requirement to obtain FCA permission |
Simplified and new exception for market making Retained, but:
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Netting of index holdings (in capital instruments) |
Simplified - removal of FCA permission requirement
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Consolidated groups - minority interests (i.e. capital of a subsidiary which is contributed by an external investor) |
Simplified - broader eligibility requirements for minority interests
Focus only on the contribution which that subsidiary makes to the consolidated capital requirement of the MIFIDPRU group |
What does this mean for firms?
The FCA's messaging focuses on the benefits to MIFIDPRU firms (and their consolidation groups) of the proposed simplification and streamlining of these rules on "what counts as regulatory capital".
Pros:
- Generally, more user-friendly rules and more clarificatory guidance.
- Some of the substantive changes may have practical benefits for firms in some situations – such as, for example:
- When applying for FCA permission to reduce capital, the condition relating to the adequacy of post-reduction regulatory capital levels is potentially more objective (i.e. less subject to the FCA's discretionary judgement).
- Interim profits can be included in CET1 without prior FCA approval.
- More certainty on what must be deducted from own funds.
Cons:
- Much of the MIFIDPRU 3 text is newly drafted (including some new definitions). Firms will need to familiarise themselves with the new version and check the detail. In its CBA, the FCA has assumed that firms will need to review 45 pages of CP text, but the draft new rules alone (including annexes) are 80 pages and no comparison against the existing sources is provided.
- Additional market disclosure is required where a firm has equal-ranking CET1 qualifying shares as well as non-CET1 shares.
1 CET1 (common equity tier 1), AT1 (additional tier 1) and T2 (tier 2).
Key contacts
Disclaimer
The articles published on this website, current at the dates of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.