FCA paper published on market risk capital requirements for investment firms

The current regime for market risk capital requirements is largely inherited from frameworks originally designed for banks, notably the UK Capital Requirements Regulation (UK CRR) as it stood on 31 December 2021. Although the Investment Firms Prudential Regime (IFPR) implemented in 2021 marked a step towards a more tailored approach, significant elements—including the calculation of capital for market risk—still rely on bank-centric rules. The FCA recognises that investment firms typically pose less systemic risk in failure than banks, given their smaller size, lack of deposit-taking, and often more liquid balance sheets. As such, there is a commercial imperative to ensure capital requirements do not unduly restrict trading activity or innovation, particularly as the market landscape evolves with new asset classes and trading technologies.

The paper highlights several design considerations for the review:

• Proportionality and market integrity: Striking a balance between robust capital requirements to protect market integrity and avoiding excessive barriers to entry or growth for investment firms.
• Alignment with internal risk management: Ensuring regulatory capital requirements are not materially out of line with firms’ own risk management practices, to avoid regulatory capital becoming a mere compliance exercise. 
• Coverage of new asset classes: The framework must be adaptable to emerging asset classes and trading techniques, including crypto assets and tokenised securities. 
• International comparisons: The FCA notes that other jurisdictions often apply net capital rules (NCR) rather than bank-style frameworks, which may offer alternative models for the UK to consider. 

The engagement paper sets out a range of possible approaches for reform and invites industry feedback on the following:

• Amend the Standardised Approach: Under this option, the FCA proposes to amend the standardised approach to market risk by updating the existing K-NPR method and incorporating the requirements directly into the FCA Handbook, removing the cross-references to the ‘frozen-in-time’ UK CRR. This would be particularly beneficial for specialised trading firms that rely on the standardised approach, which currently does not reflect the effect of hedging or diversification. As an alternative to, or alongside, amendments to the standardised approach, the FCA is also considering the application of discount factors – primarily for firms without retail or professional clients or clearing business – to better align capital requirements with firms’ underlying risk profiles.  
• Margin-Based Approach: Under this option, the FCA is considering whether the alternative to the K-NPR calculation of market risk capital can be utilised, the K-CMG which is based on clearing margins. Under the K-CMG method, firms may seek permission to set capital requirements for cleared portfolios using the third-highest daily total margin over the preceding 3 months. Firms are required to satisfy governance and control requirements to obtain permission for this approach, as K-CMG effectively relies on margins calculated by CCPs and clearing members supervised by banking regulators. The current scope only covers centrally cleared or DvP-settled positions, but the FCA is exploring whether a margin-based approach could be extended to uncleared OTC derivatives or certain cash products, whilst considering how diversification or hedging could be reflected. 
• Internally modelled approach: Under MIFIDPRU 4.12.4R, firms may seek permission to use an internal model approach to calculate market risk capital for equities, debt, FX and commodities, as an alternative to the standardised approach method. The internal model approach is based on a value-at-risk method and is designed to align capital with the economic risks of a trading portfolio. However, no FCA investment firms currently use it, citing high operational and governance burdens. As such, the FCA is considering whether to amend the approach to make it more proportionate and risk-sensitive. 
• Net capital rule (NCR) approach: Under this option, the FCA proposes to replace the current market risk capital framework with an NCR approach, under which firms maintain specified minimum levels of net liquid assets to ensure they can wind down their balance sheets without causing customer losses. The approach applies haircuts to different asset classes and may include limits on trading book leverage. While broadly similar in outcome to the Basel-standardised approach, adopting an NCR could require wider changes to how capital adequacy is calculated for investment firms and may allow optional use of VaR-based internal models for setting haircuts. 
• Sensitivities-based method: This option would involve a review of whether aspects of Basel’s Fundamental Review of the Trading Book (FRTB) could be adapted for FCA investment firms, focusing on the revised standardised approach. The FRTB framework increases risk sensitivity by using a sensitivities-based method which captures changes in instrument values under stressed market conditions, and adds in default risk and residual risk components. It also incorporates liquidity horizons to reflect sudden market shocks. Whilst this approach could provide a more precise measure of market risk, it is complex and could discourage participation in less liquid markets, potentially conflicting with the FCA’s aim to support wholesale trading, market liquidity, and entry for specialised trading firms. 
• Repurposing K-TCD for exposure to price risk: Another option would be to repurpose the existing K-TCD framework, currently used to capture counterparty default risk to calculate market risk capital. This would involve measuring replacement cost and potential future exposure for positions, adapting these concepts to reflect price risk. Significant revisions would be needed to cover different asset classes, hedged or offsetting exposures, and the appropriate net / gross treatment. While this approach could leverage familiar regulatory metrics, it would still rely on standardised charges that may not fully capture the true risk of loss for all positions. 
• Weighted liquid exposure method: This option proposes a weighted liquid exposure methodology, under which firms assess the time required to unwind positions without affecting market prices and apply a capital charge based on the overall weighted liquidity profile of the asset class or portfolio. Whilst this approach may not capture all risk characteristics, it offers a way to account for less liquid instruments, provided they do not constitute a material portion of the trading book.