MAH, Chartered Accountants

Category: FCA & financial services

  • IFPR own funds and liquid assets

    Summary of the new IFPR rules in relation to own funds and liquid assets

    IFPR relates to the Investment Firms Prudential Regime.

    From 1 January 2022, FCA authorised investment firms which are not MiFID exempt will need to comply with the new rules1 for MIFIDPRU investment firms. So this will affect most current EUR50k, EUR125k and EUR750k firms as well as Exempt CAD firms.

    Firms will need to monitor their level of own funds and ensure that these are higher than their own funds requirements.

    For small firms this is similar to the old capital adequacy rules and ICAAP, but the minimum levels are higher and there are some other differences as well. Exempt CAD firms won’t be able to rely on professional insurance and so their capital requirement will be much higher.

    At least 1/3 of the fixed overhead requirement also has to be held as liquid assets such as cash and trade debtors (with 50% haircut).

    If a firm’s level of own funds drops below 110% of the requirement then this will trigger an early warning with the FCA. If the firm’s own funds or liquid assets fall below a certain level then the firm would need to wind down.

    Own funds

    Own funds mainly relate to the Equity section of a firm’s balance sheet. Most of our clients will typically have common equity tier 1 capital but we don’t expect many to have significant levels of Additional Tier 1 (eg certain types of preference shares) or Tier 2 capital (eg subordinated debt due after 5 years.

    Common equity tier 1 capital

    This is share capital, share premium, retained earnings and other reserves less deductions for losses of the current financial year and certain assets such as intangible assets, deferred tax, pension assets, investments in financial firms and a number of others etc (see FCA handbook MIFIDPRU 3.3.6 for the full list). The FCA’s CP20/24 also has Figure 3:

    It may also be possible to include interim profits and new capital instruments (eg ordinary shares) with permission from the FCA. See FCA handbook MIFIDPRU 3.3.2 and 3.3.3 and for the forms. The FCA handbook mentions they expect to receive a notification at least 20 business days before the issuance.

    The independent auditors would also need to verify the profit and write a letter to confirm the profit figure.

    Own funds requirement

    Firms will have to maintain own funds that at least equal to their own funds requirement. For small investment firms which meet the SNI criteria2 this is the higher of:

    • permanent minimum capital (“PMR”)
    • fixed overheads requirement (“FOR”)

    Permanent minimum capital (“PMR”)

    For most small firms their PMR will be £75,000 if they do not hold client money/securities and are not placing orders on a firm commitment basis. (ie similar to EUR50k firms under old rules)

    If firms hold client money and also cannot operate matched principal trading or dealing on their own account their PMR will be £150,000.

    For other firms their PMR will be £750,000.

    See MIFIDPRU 4.4.1 for full details. There are also transitional arrangements so that the PMR does not need to be held straight away on 1 January 2022. See the FCA Handbook MIFIDPRU TP 2 and also CP20/24 Chapter 6.

    Fixed overheads requirement (“FOR”)

    The FOR is the minimum level a firm would need to absorb losses if it has to wind down or exit the market. Firms will need to consider this in detail in their Internal Capital Adequacy and Risk Assessment (ICARA) process.

    The FOR is calculated as 1/4 of its relevant expenditure in the previous year as per its most recent audited accounts.

    This will exclude fully discretionary expenditure such as as:

    • staff bonuses and variable remuneration
    • non recurring expenses from non-ordinary activities
    • amortisation where intangibles are already deducted from own funds

    See MIFIDPRU 4.5.3 for full details.

    Basic liquid assets requirement

    Firms need to hold in core liquid assets at least 1/3 of their fixed overhead requirement plus 1.6% of the total amount of any guarantees provided to clients.

    Core liquid assets are mainly cash and SNIs can also use short term trade receivables due within 30 days, subject to a 50% haircut (ie like a bad debt provision). The assets also need to be denominated in pound sterling, so this would exclude cash or trade receivables in USD or EUR for example.

    Cash needs to be short term deposits in held at a UK authorised credit institution. Certain money market funds can also be used.

    See MIFIDPRU 6.2.1 onwards.

    Overall financial adequacy rule

    Firms would need to assess various business risks in detail as part of the ICARA process. This is a very complex and wide area, and only covered briefly here.

    A firm needs to hold sufficient own funds and liquid assets for the firm to remain financially viable throughout the economic cycle and to allow it to be wound down in an orderly manner, if needed.

    The amount of own funds needed is the:

    • amount of own funds needed to fund ongoing business and cope with periods of stress; and
    • the amount of own funds needed to allow it to wind down in an orderly manner

    The own funds threshold requirement is the amount of own funds needed to enable a firm to comply with the overal financial adequacy rule.

    FCA Handbook MIFIDPRU 7.6.4 also has this picture:

    The amount of liquid funds needed is the basic liquid assets requirement plus the higher of:

    • an amount of liquid assets needed to fund ongoing business and cope with periods of stress
    • additional amount of liquid assets needed to allow it to wind down in an orderly manner

    It can also include non-core liquid assets in the calculation, see MIFIDPRU 7.7.8.

    Notfying the FCA & Triggers

    Firms must notify the FCA if the liquid assets or own funds fall below certain limits. A wind down would also be triggered if they fall too low.

    CP21/7 has the following table which summarises the rules:

    Early warning indicator and other intervention points

    1Where can we find the rules?

    The easiest place to start is the FCA Handbook MIFIDPRU Prudential Sourcebook for MiFID Investment Firms.

    There are also further explanations in the FCA’s consultation and policy papers on IFPR CP20/24, CP21/7 and PS21/17.

    The FCA Handbook often refers to “UK CRR”. CRR stands for Capital Requirements Regulations and was originally EU legislation. After Brexit the UK has its own version.

    UK CRR is the UK version of Regulation of the European Parliament and the Council on prudential requirements for credit institutions and investment firms (Regulation (EU) No 575/2013) and amending Regulation (EU) No 648/2012, which is part of UK law by virtue of the EUWA, read together with any CRR rules as defined in section 144A of the Act.

    As a starting point, the EU CRR Articles define the types of capital and then the adjustments required can generally be found in the FCA Handbook.

    The actual UK legal instruments are also noted on the FCA’s website about IFPR.

    2SNI firms

    There are a number of conditions, but the main ones are:

    • average assets under management less than £1.2 billion
    • client orders handled are less than £100m per day for cash trades and £1 billion per day for derivatives
    • does not have permission to deal on its own account
    • balance sheet total (including off balance sheet items) less than £100m
    • annual revenue is less than £30m
  • MiFID II and VAT on Research – still in the dark!

    MiFID II and VAT on Research – still in the dark!

    MiFID II

    31 October 2017

    Although the MiFID II regulation has been published since 2014 (delayed implementation date – 3rd January  2018), it is surprising that H M Revenue & Customs has not yet provided any firm guidance on the VAT treatment of research work.

    Recent press states that HMRC is now meeting with industry groups and is set to publish guidance on the VAT treatment of research work carried out from 3 January 2018 onward under MiFID II.

    Commission sharing agreements  (CSA)

    Currently, any research work paid via a CSA is potentially an exempt supply for VAT purposes as it is normally bundled with a payment for execution services. Execution commissions are exempt supplies for VAT and if research is part and parcel of the execution services, then the bundled research services are also exempt from VAT. MiFID II seeks to separate research from commissions as part of a larger aim to reduce the research data being fed to fund managers.

    Fund managers

    Firms that manage funds are generally not eligible to register for VAT as they mainly deal in financial products, which are exempt from VAT.

    MiFID II requires that the payment for research work is done separately and independently from the payment of commissions for execution services. Research Payment Accounts (RPA) are now going to be used by many fund managers.

    VAT position after MiFID II?

    If research is to be identified as a separate supply from that of execution services, HMRC rules could deem the supply of research services as VATable services at the standard rate of 20%.

    HMRC

    The disadvantage here would be felt by research providers as:

    • Fund managers will not be willing to increase their budgets for research given that they are unable to reclaim any VAT suffered on research costs,
    • Research providers would be pricing themselves out of market (against providers outside Europe) should they try and increase their prices by 20% in order to accommodate the possible new VAT burden, and
    • as a result, UK based research providers will be forced to absorb the 20% VAT burden and accept lower fees than what they are receiving now.

    We are keenly following this issue for our clients. If you require any assistance with your company’s VAT or tax position in respect of work in the Financial Services industry, please contact us.

    Also read…

    VAT and financial services

    Financial services

  • 6 ways to legally boost your balance sheet permanently

    We use our expertise to help clients maximise their assets where legally possible in accordance with UK GAAP or IFRS. This is especially useful for companies who need to meet gross asset or capital requirements such as FCA firms or raising bank loans or complying with bank or investor covenants. However, the methods below are not always possible and there will also be tax consequences.

    The methods below are of a permanent or long term nature and do not involve window dressing or other short term methods, so the accounts should still be true and fair and have a clean audit report if all the relevant criteria are met.

    1) Recognise intangible assets

    If your company has spent time or money developing intellectual property then the chances are that it can be capitalised on the balance sheet if certain criteria are met.

    For example, one of our clients spent £200k developing an online payments platform as well as other mobile apps. We reviewed the contracts and looked at how the systems worked and after discussions with management were able to confirm that an intangible asset had been created. One of the main factors in particular was that the platform was already generating significant revenue, however, even if a company is loss making or a startup it may still be able to capitalise intangibles depending on their profit forecasts.

    Staff time can also be capitalised. For example on an FCA client, we looked at how much time a director and his staff spent on building and developing  a complex quantitative model to monitor financial trading signals as opposed to maintaining it and fixing bugs. We were then able to advise on the percentage of staff costs that could potentially be capitalised.

    Intangible assets such as those above can also qualify for tax relief on amortisation.

    We also found that a mining client had spent significant amounts on legal fees and we were able to capitalise these as exploration and evaluation assets.

    2) Turn tax losses into a deferred tax asset

    If its probable that the company will generate sufficient profits in the future to utilise tax losses then the future tax benefit can be recognised as an asset.

    This one is often tricky to convince auditors (such as ourselves!) but at the end of the day, if cashflow forecasts are good enough to satisfy going concern, then they could potentially support a deferred tax asset especially if a company is beginning to turn a corner and is close to generating profits.

    3) Make sure all income has been accrued

    If you bill clients at the end of a job then you could potentially have work in progress at the end of the year which has a value. This will often have to be brought into your revenue stream anyway to ensure that income is recognised in the period in which it is generated.

    Some companies may have intercompany fees, licences or royalties charged to foreign subsidiaries or connected companies. For example, one of our clients has a UK system and we helped them to setup a licencing fee to a foreign company under an intercompany agreement. This will increase turnover and assets as long as the debt is recoverable. For a profit making group this won’t be a problem, however, if there is no chance that the subsidiary or connected company can pay the fees in future, then the debt will need to be written off or impaired.

    4) Convert debt to equity (or subordinate it)

    If directors have used their own funds to finance a company then this will be a liability on the balance sheet. One simple way to boost the balance sheet and to reduce creditors is by issuing shares to the director in exchange for writing off the debt. This would also avoid a tax bill which could occur if the debt was written off to the profit and loss. If the shares are issued at market value then this will also avoid income tax for the director.

    FCA firms can also subordinate the debt for at least 5 years to include it in their capital calculations and we can advise on how to do this using a subordinated loan agreement.

    One of our clients tried to do this using preference shares, however, care needs to be taken because if they are redeemable preference shares then the debt component still needs to be presented as a liability on the balance sheet.

    5) Revalue property

    If your company owns its own premises or has investment properties then these can usually be revalued upwards based on management’s estimates. A more formal independent valuation may also be required in certain circumstances.

    6) Issue shares!

    We left this one till last as it sounds a bit obvious but many of our clients have raised funding from investors, for example £100k-£200k from angel/seed investors, £0.5m from VCs and £m’s from AIM. If you’re unsure of the process, we can help you to prepare a pitch deck and financial projectors and help you to approach potential investors.

     

    We can give you tailored advice to boost your balance sheet

    As you can see we use our specialist expertise in a joined up way to think about accounting and tax requirements. The above examples can sometimes get quite tricky so its definitely worthwhile seeking professional advice. You can contact us here for further information.

  • BREXIT: A GUIDE FOR SMALL BUSINESSES

    BREXIT: A GUIDE FOR SMALL BUSINESSES

    DOWNLOAD THE FULL BREXIT REPORT HERE

    Background

    As readers are no doubt aware the UK voted to leave the EU in June 2016. We were shocked that Brexit actually happened and were worried about the impact on our clients.

    The long lasting effects are unknown and much will depend on the negotiation of trade agreements with the EU. Some commentators have suggested that the UK could be in recession for many months whilst others have suggested that this will all blow over and the UK will rapidly recover.

    We have attempted to evaluate the worst case scenarios and impact on our small business clients.

    We all need to be aware of the potential threats to the UK economy and our clients/customers and take appropriate steps in order to survive and to thrive.

    Summary

    The Bank Of England is likely to cut interest rates and provide liquidity facilities to banks in order to prevent another credit crisis and to calm the markets. Financial markets could be due to political or financial/economic reasons and its too early to predict what could happen in the future.

    However, there is a potential risk of recession due to the fall in exchange rates, inflationary pressure and uncertainties affecting business and consumer confidence. Foreign investment may also fall.

    The full impact of Brexit is not yet known and one of the key factors will be the negotiations of a new trade agreement with the EU. If the Norway/Swiss models are followed and UK businesses can access the Single Market for imports/exports and financial passporting then the impact of Brexit may be limited.

    However, we have considered the worst case scenarios for our core sectors:

    Financial services: In the short term, FCA firms should re-check financial forecasts, risk assessments and capital adequacy requirements. In the medium/long term they will need to consider whether they will need to migrate to the EU or setup a subsidiary to ensure passporting.

    Tech startups: In the short term, cash burn and forecasts should be re-assessed as it could potentially become more difficult to raise finance if investors are nervous about the UK economy. In the long term, restrictions on movement of labour could reduce the talent pool and some of the infrastructure and benefits of operating in the UK.

    Fintech: Could suffer the same problems as tech startups but could also be affected by lack of passporting or reduced demand from the financial services sector if they are suffering from Brexit.

    Import / Export: Amazon sellers could suffer from double layers of taxation and tariffs if they’ll now have to export goods to both the UK and EU separately, depending on how trade agreements are negotiated. Foreign goods could also become more expensive to UK customers, reducing to demand.

    Contractors: Economic uncertainty could increase demand for temporary contracts if businesses are adverse to hiring new permanent staff. However, financial services could potentially suffer from job losses and temporary staff could also be affected. EU citizens need to check if they can stay in the UK and may be able to apply for permanent residence.

    AIM/ISDX plcs: Equity markets have suffered and existing plcs may find it difficult to raise new capital. If the credit crisis of 2007-08 can be used as a guide then it may be difficult for new firms to list or to reverse in the near future, as many deals collapsed after the credit crisis.

    DOWNLOAD THE FULL BREXIT REPORT HERE

  • VAT and financial services

    VAT and financial services:

    Are you losing out on VAT?

    VAT and financial services is a very tricky area and this video presentation gives a brief overview:

    https://www.youtube.com/watch?v=IaYzGej4p0c

    The main points covered are:

    1) VAT and financial services exemptions under VAT Act 1994 Schedule 9 Group 5 (eg money, loans, securities, advising collective investment scheme)

    If a firm is making exempt sales, then it doesn’t have to pay any VAT on income to HMRC, however it also cannot reclaim VAT on its expenses.

    2) Standard rated items, mainly looking investment management/advisory. If  a firm is providing advice or is using its discretion to manage investments or funds and isn’t merely executing transactions according to clients’ instructions, then these services are taxable at 20%. Either the client has to pay an extra 20%, of the firm has to take a hit of 20% on its fees.

    This may be avoided by carefully structuring the services with an SPV so that the investment manager has an interest in the trading profits of the fund, as a principal. Therefore, its share of profits would be exempt.

    If the investment manager is an external entity providing services as an agent, then even if its consideration is contingent eg 20% of trading profit if hurdles met etc, then they would still be subject to VAT

    3) The place of supply rules need to be checked. If the client is located outside of the UK, then the sales may be outside the scope of VAT. In this case, no VAT is due on sales and the firm may be able to reclaim VAT on its expenses if the sales would normally have been subject to VAT if supplied in the UK.

    Contact us

    This is a brief summary. VAT and financial services is a very complex area and we can discuss your circumstances and look at your contracts, as well as the legislation and VAT cases to design a VAT strategy. Please contact us for a free, no obligation consultation to discuss your requirements. Our base at Liverpool Street is within easy reach of the City, Canary Wharf or Mayfair or we could also visit you at your offices.

  • FCA audit

    FCA audit

    FCA audit:

    Do you need an FCA audit?

    Under the Companies Act 2006 (or as applied to LLPs) a business will normally need an audit if it is fairly large and exceeds 2 out of the 3 size limits of a small firm:

    • assets > £3.26m (£5.1m from 1/1/16)
    • turnover > £6.5m (£10.2m from 1/1/16)
    • employees > 50

    However, an FCA registered firm which is an MiFID investment firm is likely to require an FCA audit even if it would otherwise be a small firm (see notes below)*.

    FCA registered

    “FCA registered” refers to financial firms registered and authorised by the Financial Conduct Authority which is one of the successor bodies to the Financial Services Authority (FSA).

    FCA registered firms come under intense scrutiny and so it is vital that they only engage auditors with the skills and resources to ensure that their financial affairs are in order. This is also mentioned in the FCA handbook:

    [quote style=”boxed”]SUP 3.4.2R: Before a firm, to which SUP 3.3.2 R applies, appoints an auditor, it must take reasonable steps to ensure that the auditor has the required skill, resources and experience to perform his functions under the regulatory system[/quote]

    How we can help

    We have experience of auditing FCA registered firms and use all of our skills, resources and experience to ensure that the audit goes smoothly. Some of the key aspects of our work specific to an FCA audit are:

    1. checking your FCA permissions and capital requirements in detail;
    2. obtaining a full understanding of your business and systems;
    3. understanding your key risks and the controls to mitigate them;
    4. recalculating fees/commissions/brokerage;
    5. reconciling open positions, trading balances and fund/managed accounts to 3rd party reports;
    6. checking if you have held client assets or money;
    7. investigating any regulatory breaches;
    8. working fast and efficiently to meet your audit deadline;
    9. submitting client asset reports to the FCA upon completion

    Expertise

    Despite our small size we are highly skilled auditors. For example, we were invited to respond to the FRC’s new draft standard about FCA client asset audits. In fact, we were the only firm to participate not ranked in the Top 10 audit firms:

    MAH response to FRC consulation

    Are you paying too much for your audit?

    Some firms may ratchet up their prices as soon as they hear “FCA”, however we prepare our quotes on a fair basis and will normally be able to offer very competitive prices.

    *Detailed notes about the audit exemptions for MiFID firms

    Under s.478b(i) of the Companies Act 2006 MiFID investment firms are not exempt from an audit, even if they would otherwise be small companies.

    s.539 explains that an “MiFID investment firm” means an investment firm within the meaning of Article 4.1.1 of Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments, other than—
    (a) a company to which that Directive does not apply by virtue of Article 2 of that Directive,
    (b) a company which is an exempt investment firm within the meaning of regulation 4A(3) of the Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2007, and
    (c) any other company which fulfils all the requirements set out in regulation 4C(3) of those Regulations;

    We can review your situation to check if your firm meets any of the exemptions under Articles 2 and 3 of Directive 2004/39/EC. If it doesn’t, Title II of Directive 2004/39/EC is likely to apply under 4A(3) of FSMA 2000 (MiFID) 2007. This means that your firm could be an MiFID investment firm which doesn’t appear to meet any of the exemptions in s.539 (a,b,c) , and therefore, required to have an audit.

    Want to find out more?

    Please contact us for a free, no obligation consultation to discuss your requirements.