7.2 Determining additional own funds requirement

Competent authorities should determine additional own funds requirement for material risks and elements of risks stemming from the investment firm’s activities, considering all situations listed in Article 40(1) of Directive (EU) 2019/2034, including:

• a. risks or elements of risks the investment firm is exposed to or poses to others are not covered or not sufficiently covered by adequate amounts, types and distribution of capital in accordance with Part Three or Four of Regulation (EU) 2019/2033;
• b. deficiencies in the investment firms’ arrangements, processes, mechanisms and strategies, if such deficiencies cannot be resolved within an appropriate timeframe;
• c. deficiencies in the investment firm’s adjustments in relation to the prudent valuation of the trading book enabling it to sell or hedge out its positions within a short period without incurring material losses under normal market conditions;
• d. investment firm’s non-compliance with the requirement for the application of the permitted internal models leading to inadequate levels of capital; and
• e. investment firm’s repeated failure to establish or maintain an adequate level of additional own funds, as set out in Article 41 of Directive (EU) 2019/2034.

The total amount of additional own funds requirement should be the sum of any additional own funds requirement determined by competent authorities covering all situations listed in the preceding paragraph.

7.2.1 Determining additional own funds to cover risks or elements of risks not covered or not sufficiently covered by Part Three or Four of Regulation (EU) 2019/2033

Competent authorities are required to set the level of additional own funds requirement to cover risks or elements of risks that are not covered or not sufficiently covered by Part Three and Four of Regulation (EU) 2019/2033 further specified by the delegated regulation adopted in accordance with Article 40(6) of Directive (EU) 2019/2034 and following the risk assessment performed under Title 6.

Competent authorities should rely on the following sources of information for the identification, assessment, and quantification of such risks or elements of risks:

• a. for investment firms that do not meet the criteria for qualifying as small on non-interconnected investment firm set out in Article 12(1) of Regulation (EU) 2019/2033, investment firms groups, and for investment firms that meet those criteria where the competent authority deems it appropriate, the ICARAP or the consolidated ICARAP in the case of an investment firm groups, and more specifically its ICAAP component, and the outcomes of its assessment by the competent authority, including the ICAAP calculations, where deemed reliable or partially reliable in accordance with paragraphs 279 to 282;
• b. for investment firms subject to Directive 2014/59/EU, the recovery plan and the outcomes of its assessment by the competent authority, considering requirements for the recovery plans applicable to the investment firm under review;
• c. supervisory reporting;
• d. the outcomes of the supervisory assessment and any benchmark calculations;
• e. the outcomes of any relevant previous supervisory activities; and
• f. any other relevant inputs, including those arising from interactions and dialogues with the investment firm, public market studies or sectoral and portfolio views.

As referred in paragraph 276, point (a), the ICAAP and outcomes of its assessment should be taken into account by competent authorities as one of key inputs for the identification and assessment of risks and elements of risks, stemming from both non-regulated and regulated businesses, the investment firm is exposed to or poses to clients and markets. The quantification of the amount of capital considered adequate and eventually additional own funds requirement should take into account, among other inputs, the ICAAP calculations if deemed reliable or partially reliable.

As referred to in paragraph 276, point (b), where appropriate, the recovery plan and its assessment should be taken into account by competent authorities to support the determination of capital considered adequate to orderly wind-down, as further specified by means of the delegated regulation adopted in accordance with Article 40(6) of Directive (EU) 2019/2034. More specifically, the competent authority should use the recovery plan’s inputs to identify key business lines and critical functions, recovery actions, governance arrangements, operational steps, and scenarios. They may leverage on the scenarios used in the recovery plan by increasing their level of severity to achieve a wind-down scenario.

ICAAP calculations

Competent authorities should assess whether the ICAAP is covering both:

• a. the risks or elements of risks the investment firm or the investment firm group is exposed to or poses to others stemming from its businesses and operations either regulated or non-regulated; and
• b. the necessary steps and resources but also the risks or elements of risks that might arise from an orderly wind-down process.

Competent authorities should assess the reliability of the ICAAP calculations related to paragraph 279, points (a) and (b), by assessing whether they are sufficiently:

• a. consistent: the quantified risks should be commensurate with the business model, composition of the portfolio and trading strategy of the investment firm;
• b. granular: the ICAAP methodologies should allow the calculations to be broken down at least by risk category²³ , where possible broken-down risk-by-risk, rather than presenting a single (economic capital) calculation covering all risks;
• c. credible: the calculations/methodologies used should demonstrably cover the risks they are looking to address and should be based on the investment firm’s knowledge and experience, or, where applicable, on appropriate models and prudent assumptions;
• d. understandable: the underlying drivers of the calculations/methodologies should be clearly specified. A ‘black box’ calculation should not be acceptable; and
• e. comparable: competent authorities should consider the ICAAP’s risk measurement methodologies, adjusting, or requiring the investment firm to adjust them to facilitate comparability with peers and supervisory benchmark estimations.

²³ Risk categories cover the risks associated to an orderly wind-down, risk-to-clients, risk-to-markets, risk-to-firms and other risks further specified by means of the delegated regulation adopted in accordance with Article 40(6) of Directive (EU) 2019/2034.

Competent authorities should further assess the reliability of the ICAAP calculations by comparing them against the outcome of the supervisory benchmarks for the same risks or, if sufficiently comparable, the same risk categories, and other relevant inputs.

An ICAAP calculation should be considered partially reliable where, despite not meeting all the above criteria, the calculation still seems highly credible, though this should be on an exceptional basis and accompanied by steps to improve deficiencies identified in the ICAAP calculation.

Supervisory benchmarks

Competent authorities should develop and apply risk-specific supervisory benchmarks as a means to challenge ICAAP calculations for those material risks, or elements of such risks, that are not covered or not sufficiently covered by Part Three and Four of Regulation (EU) 2019/2033, or to further support the determination of risk category-by-risk category and preferably of risk-by-risk additional own funds requirement where ICAAP calculations for those material risks, or elements of such risks, are deemed unreliable or are unavailable.

The supervisory benchmarks should be developed, taking into account the implementation burden on competent authorities, where prudent, consistent, transparent and comparable measure can be provided to compare across investment firms the capital considered adequate for a given category or element of risk.

Given the variety of different business models operated by, size and complexity of investment firms, the outcome of the supervisory benchmarks may not be appropriate in every instance for every investment firm. Competent authorities should address this by using the most appropriate benchmark where alternatives are available, and by applying judgment to the outcome of the benchmark to account for business-model-specific and investment firm-specific considerations.

When competent authorities take supervisory benchmarks into consideration for the determination of additional own funds requirement, as part of the dialogue, they should explain to the investment firm the rationale and general underlying principles behind the benchmarks.

Other relevant inputs

Competent authorities should use other relevant inputs to support the determination of risk category-by-risk category or risk-by-risk additional own funds requirement. Other relevant inputs may include peer-group comparisons, or other relevant reports and studies.

Other relevant inputs should prompt competent authorities to reassess the appropriateness/reliability of an ICAAP/benchmark calculation for a specific risk or category of risk, and/or make adjustments to the outcome, where they prompt doubts about its accuracy.

To ensure consistency in determining additional risk category-by-risk category or risk-by-risk own funds requirement, competent authorities should use the same peer groups established to analyse risks to capital as specified in Title 6.

When competent authorities take other relevant inputs into consideration for the determination of additional own funds requirement, as part of the supervisory dialogue, they should explain to the investment firm the rationale and general underlying principles behind the inputs used .

7.2.2 Determining own funds or other measures to cover deficiencies in models used for regulatory purposes

If, during the ongoing review of internal approaches pursuant to the requirements of Article 37 of Directive (EU) 2019/2034, competent authorities identify model deficiencies that could lead to underestimation of the minimum own funds requirements set out in Regulation (EU) 2019/2033, they should set additional own funds requirement for such deficiencies, where this is determined to be more appropriate than other supervisory measures, such as requiring investment firms to adjust their models. Such additional own funds requirement should only be set as an interim measure while the deficiencies are addressed.

7.2.3 Determining own funds or other measures to cover deficiencies in adjusting the prudent valuation of the trading book

If during their reviews pursuant to Article 36 of Directive (EU) 2019/2034, and following the risk assessment performed under Title 6, competent authorities identify deficiencies in the prudent valuation of the investment firm’s trading book positions that could lead to underestimation of the K-NPR requirement set out in Article 22 of Regulation (EU) 2019/2033, they should set additional own funds requirement to cover such deficiencies. Such additional own funds requirement should only be determined if more appropriate than any other supervisory measures and should be maintained only as an interim measure until the deficiencies are addressed.

7.2.4 Determining own funds or other measures to cover other deficiencies

Competent authorities should set additional own funds to cover deficiencies in governance arrangements, processes, mechanisms and strategies or other deficiencies – identified following the risk assessment outlined in Titles 4 to 6 – where other supervisory measures are considered insufficient or not appropriate to ensure compliance with requirements. Competent authorities should only set such additional own funds requirement as an interim measure while the deficiencies are addressed.

Where an investment firm that does not meet the conditions for qualifying as small and non-interconnected set out in Article 12(1) of Regulation (EU) 2019/2033, repeatedly fails to establish or maintain an adequate level of own funds to cover the guidance on additional own funds communicated in accordance with Article 41(1) of Directive (EU) 2019/2034, competent authorities should set additional own funds requirement to cover that additional risk not later than two years after the breach of guidance. Competent authorities may postpone that decision where they allow the investment firm to operate below the level of guidance due to cyclical economic fluctuations or other firm-specific circumstances.