IFPR Capital Requirements — A Practical Guide for UK Investment Firms

Overview of the IFPR

The Investment Firms Prudential Regime (IFPR) came into force on 1 January 2022, replacing the previous patchwork of prudential requirements that applied to MiFID investment firms. The IFPR is implemented through the MIFIDPRU sourcebook in the FCA Handbook and applies to all FCA-authorised investment firms that are not banks, building societies or designated investment firms (i.e., those that are not systemically important).

The IFPR is designed to be proportionate — with simpler requirements for smaller firms and more detailed obligations for larger, more complex firms. This guide provides practical guidance on calculating capital requirements and meeting the ongoing prudential obligations.

The Own Funds Requirement

Every investment firm must maintain own funds (broadly, regulatory capital) equal to or exceeding its own funds requirement. The own funds requirement is the highest of three components:

1. Permanent minimum requirement (PMR): - £75,000 — firms that do not hold client money or assets, do not deal on own account and do not underwrite or place on a firm commitment basis - £150,000 — firms that hold client money or assets, or that are limited licence firms under the previous regime - £750,000 — firms that deal on own account or underwrite/place on a firm commitment basis

2. Fixed overheads requirement (FOR): One quarter of the firm's annual fixed overheads from the most recent audited annual financial statements. Fixed overheads include staff costs, rent, IT costs, professional fees and other operating expenses — excluding variable costs such as performance-related bonuses, profit-sharing and brokerage fees paid to tied agents.

The FOR acts as a proxy for the firm's operational scale and ensures it holds capital proportionate to its cost base. For many smaller firms, the FOR exceeds the PMR and sets the binding capital requirement.

3. K-factor requirement (KFR) — non-SNI firms only: The K-factor requirement is the sum of Risk to Client (RtC), Risk to Market (RtM) and Risk to Firm (RtF) K-factor calculations. SNI firms are exempt from K-factor calculations but must still meet the PMR and FOR.

K-Factor Calculations

Risk to Client (RtC) K-factors:

• K-AUM (Assets Under Management): 0.02% of the value of assets managed on a discretionary or non-discretionary basis. This captures the risk of client loss from poor investment management. Calculated as a rolling average over the preceding 15 months (excluding the three most recent months).

• K-CMH (Client Money Held): A percentage of client money held, with the coefficient depending on whether money is held in segregated or non-segregated accounts. K-CMH captures the risk of client loss from the firm's failure while holding client funds.

• K-ASA (Assets Safeguarded and Administered): 0.04% of the value of client assets the firm safeguards or administers. Captures the risk of loss, misuse or mishandling of client assets.

• K-COH (Client Orders Handled): A percentage of the value of client orders executed, with different coefficients for cash trades and derivatives. Captures the risk of poor execution or operational failures in order handling.

Risk to Market (RtM) K-factors:

• K-NPR (Net Position Risk): Calculated using either the standardised approach or (with FCA permission) an internal model approach. K-NPR captures the market risk of the firm's trading book positions.

• K-CMG (Clearing Margin Given): An alternative to K-NPR for firms that clear through a clearing member. K-CMG is calculated as the total initial margin required by the clearing member, multiplied by a coefficient.

Risk to Firm (RtF) K-factors:

• K-TCD (Trading Counterparty Default): Captures the risk of counterparty default in the firm's trading activities. Calculated based on replacement cost and potential future exposure of derivative positions and securities financing transactions.

• K-DTF (Daily Trading Flow): A percentage of the value of transactions the firm executes by dealing on own account. Captures execution and settlement risk.

• K-CON (Concentration Risk): Captures the risk of large exposures to individual counterparties or groups of connected counterparties. Applies where a firm's exposure to a single counterparty exceeds 25% of its own funds.

The ICARA Process

The Internal Capital Adequacy and Risk Assessment (ICARA) is the centrepiece of the IFPR's supervisory framework. Unlike a one-off calculation, the ICARA is an ongoing process that must be embedded in the firm's governance and risk management. Key elements include:

Risk identification and assessment: Identify all material risks the firm faces — including business risk, operational risk, market risk, credit risk, liquidity risk and concentration risk. For each risk, assess the potential impact on the firm, its clients and the market under both normal and stressed conditions.

Assessment of own funds adequacy: Determine whether the firm's own funds (calculated under MIFIDPRU) are adequate to absorb potential losses from the identified risks. Where the firm concludes that its own funds requirement does not adequately capture a material risk, it must hold additional own funds — the "own funds threshold requirement."

Assessment of liquid assets adequacy: Separately assess whether the firm holds sufficient liquid assets to meet its obligations as they fall due, including under stress scenarios. The basic liquid assets requirement is one third of the FOR, but firms must assess whether a higher amount is needed.

Wind-down planning: Every investment firm must prepare a wind-down plan as part of its ICARA. The plan must estimate the costs and timeline for an orderly wind-down of the firm's business, including: - Ongoing fixed costs during the wind-down period - Costs of completing or transferring client mandates - Costs of returning client money and assets - Staff costs (including retention payments for key personnel) - Legal and professional fees - Potential claims or litigation costs

The firm must hold liquid assets sufficient to fund the wind-down without requiring additional capital or relying on revenue generated during the wind-down period.

Stress testing: The ICARA must include stress testing across a range of scenarios relevant to the firm's business model. Scenarios should include: - Severe market downturns affecting revenue and asset values - Loss of key clients or revenue streams - Operational failures (IT outages, fraud, key person risk) - Regulatory changes that materially affect the business model

Governance: The ICARA must be owned by the firm's governing body (typically the board or management committee). The board must review and approve the ICARA at least annually and whenever there is a material change in the firm's risk profile or business model. The FCA expects evidence of genuine board engagement — not merely a rubber-stamping exercise.

FCA Supervisory Expectations

The FCA has published its expectations for ICARA quality through supervisory statements and multi-firm reviews. Common areas of supervisory focus include:

• Quality of risk identification — the FCA expects firms to identify risks specific to their business model, not merely reproduce generic risk taxonomies
• Calibration of stress scenarios — scenarios must be severe but plausible, and must reflect the firm's actual business activities and vulnerabilities
• Wind-down planning realism — the FCA has criticised firms for overly optimistic wind-down timelines and underestimated costs. Wind-down plans should be based on conservative assumptions
• Integration with business decisions — the ICARA should inform strategic decisions, not be a standalone compliance document. The FCA expects to see evidence that capital and liquidity considerations are factored into business planning

Common Compliance Challenges

FOR calculation errors: The most common errors include incorrectly classifying costs as variable (when they should be fixed), using unaudited figures and failing to annualise costs for firms with a short trading history. The FCA expects firms to err on the side of caution when classifying costs.

K-factor data quality: Accurate K-factor calculation depends on reliable data — particularly for K-AUM, K-CMH and K-COH. Firms must establish robust data governance to ensure the inputs to K-factor calculations are complete, accurate and timely.

ICARA as a box-ticking exercise: The FCA has warned that some firms treat the ICARA as an annual compliance document rather than an ongoing risk management process. The ICARA should be a living document that is updated whenever material changes occur — not drafted once and filed away.

Insufficient wind-down liquidity: Many firms underestimate the time and cost required for an orderly wind-down. The FCA expects wind-down plans to assume conservative timelines (typically 6–12 months for investment managers, longer for firms with complex client mandates) and to include contingency buffers.

Practical Recommendations

Invest in your ICARA from day one. For newly authorised firms, the ICARA should be developed as part of the authorisation process — not as an afterthought. The FCA will assess the quality of your ICARA approach during the application.

Automate K-factor calculations. Manual spreadsheet-based calculations are error-prone and difficult to audit. Invest in systems that calculate K-factors automatically from your operational data, with clear audit trails and exception reporting.

Engage your board meaningfully. The board must understand the ICARA, challenge its assumptions and use it to inform strategic decisions. Consider dedicating a board meeting (or a standing agenda item) to ICARA review and risk appetite discussion.

Plan for FCA engagement. The FCA may request your ICARA at any time and may set individual capital or liquidity guidance based on its assessment. Be prepared to discuss and defend your ICARA methodology, assumptions and conclusions.