Why is the FCA consulting on capital adequacy for investment firms? Is it a drive to enhance London’s appeal?
Peter Scott · Posted on: June 23rd 2025 · read
Peter Scott, Audit Partner at MHA, the UK member firm of the Baker Tilly international network and a specialist in audit and assurance for investment funds, offers insight into the FCA's consultation (CP25/10) and its underlying rationale.
The Financial Conduct Authority (FCA) has published a consultation paper (CP25/10) outlining proposed amendments to the definition of "own funds" (regulatory capital) for FCA investment firms. The existing regulations are based on the UK Capital Requirements Regulation (UK CRR), which incorporates Basel Committee banking standards.
The FCA has acknowledged that the current capital adequacy requirements are unduly complex, a factor which this consultation seeks to address, in alignment with the UK government's broader objective to bolster the City of London’s attractiveness to global investors. The complexity arises because the UK CRR was primarily formulated for banks, whose capital structures are typically more intricate than those of investment firms.
Banks frequently employ sophisticated financial instruments, necessitating complex capital calculations. Conversely, investment firms generally maintain simpler capital structures, largely consisting of ordinary shares and retained earnings. Furthermore, the UK CRR contains provisions, such as those pertaining to bank resolution, which are irrelevant to FCA investment firms, thus imposing unnecessary regulatory burdens.
In a move intended to streamline the regulatory landscape and enhance the City's competitive edge, the FCA proposes to remove all references to the UK CRR from the definition of regulatory capital within MIFIDPRU 3. This will involve consolidating the requirements directly into MIFIDPRU 3, eliminating irrelevant provisions, and improving the clarity and accessibility of the rules.
The FCA estimates that this simplification will reduce the volume of legal text by approximately 70%.
The primary impetus behind these reforms is to establish a more proportionate and standalone prudential framework for investment firms, a key component of the government's strategy to make the UK a more attractive destination for investment. The FCA contends that the current reliance on the UK CRR is inefficient, as these rules are not appropriately tailored to the business models of investment firms. By simplifying the rules, the FCA aims to reduce compliance costs, minimise the risk of misinterpretation, and ensure that firms hold the appropriate level of high-quality capital, thereby fostering a more business-friendly environment.
It is important to emphasise that these proposals do not entail any changes to the levels of regulatory capital that firms are required to hold. Firms will not be obliged to adjust their capital arrangements as a direct consequence of these reforms. Rather, the emphasis is on simplifying and clarifying the rules to enhance ease of understanding and application, aligning with the government's objective of reducing regulatory complexity to attract investment.
There is also some new guidance on rules surrounding the return of capital. Essentially, on issuance of a capital instrument, a firm must not create the expectation that it would carry out a reduction of capital at some future point (3.3A.12G), for example, by creating an economic incentive for the firm to do so. This may particularly affect firms that are LLPs. Furthermore, there will no longer be a requirement to get FCA permission to include interim profits (although they must still be independently verified). This will be advantageous as it removes the delay of waiting for the FCA to approve interim profits.
It will also no longer be required for an unregulated parent subject to a group capital test to get FCA permission to include new capital issuances or interim profits in regulatory capital.
The FCA intends to publish the final rules in a Policy Statement in the latter half of 2025, with the new framework expected to be implemented on 1 January 2026, contingent upon feedback received during the consultation period. The consultation paper also signals a longer-term ambition to establish an integrated sourcebook for prudential requirements, potentially extending the simplified own funds rules to other sectors in due course, further demonstrating the UK's commitment to regulatory efficiency.
In conclusion, the proposed changes are good in that they simplify regulation and the removal of the requirement to have the FCA approve profit verifications which will make that process a lot more dynamic. The additional clarity on under what terms tier 1 capital can be returned or repaid is also welcome, although it may cause issues for firms who are LLPs who will need to review their capital agreements.
