4.5 Analysis of the current business model

To understand the means and methods used by an investment firm to operate and generate profits, competent authorities should undertake quantitative and qualitative analyses.

4.5.1 Quantitative analysis

Competent authorities should undertake both a static and trend analysis of key quantitative features of the investment firm’s current business model to understand its financial performance and the degree to which this is driven by its risk appetite being higher or lower than peers.

Areas for analysis by competent authorities may include:

• a. profit and loss: competent authorities may assess the underlying profitability of the investment firm (after exception items and one-offs), the breakdown of income streams, the breakdown of costs, impairment provisions and key ratios (including cost/income net profit margin, net cash-flow);
• b. the balance sheet: competent authorities may assess the asset and liability mix, the funding structure, the change in the own funds and own funds requirements, and key ratios (including return on equity, Core Tier 1, funding gap);
• c. concentrations: competent authorities may assess concentrations in the P&L and balance sheet related to customers, sectors and geographies; and
• d. risk appetite: competent authorities may assess the formal limits put in place by the investment firm (notably trading limits) and its adherence to them to understand the risks that the investment firm is willing to take to drive its financial performance.

4.5.2 Qualitative analysis

Competent authorities should undertake an analysis of qualitative features of the investment firm’s current business model to understand its success drivers and key dependencies.

Areas for analysis by competent authorities may include:

• a. key external dependencies: competent authorities may determine the main exogenous factors that influence the success of the business model; these may include third-party providers, intermediaries and specific regulatory drivers;
• b. key internal dependencies: competent authorities may determine the main endogenous factors that influence the success of the business model; these may include the quality of IT platforms and operational and resource capacity; and even key people;
• c. franchise: competent authorities may determine the strength of relationships with customers, suppliers and partners; this may include the investment firm’s reliance upon its reputation, the effectiveness of branches, the loyalty of customers and the effectiveness of partnerships; and
• d. areas of competitive advantage: competent authorities may also determine the areas in which the investment firm has a competitive advantage over its peers; these may include any of the above, such as the quality of the investment firm’s IT platforms, or other factors such as the investment firm’s global network, the scale of its business or its product proposition.
• e. ML/TF risks: in the analysis, competent authorities should consider any indications that the business model and activities give rise to increased ML/TF risks, including cash transactions or establishment or use of legal entities in high-risk third countries, as identified in accordance with Article 9 of Directive (EU) 2015/849. Where present, these indications should be complemented by quantitative analysis, as appropriate, focusing in particular on the materiality of the revenues and the income from operations run in such high risk third countries, the concentrations of exposures to customers for which the investment firms apply enhanced customer due diligence as set out in Chapter II, Section 3 of Directive 2015/849.