As a business owner, director, or investor of a UK holding company with regulated investment firms, compliance with the Investment Firms Prudential Regime (IFPR) is crucial to avoiding disciplinary measures or sanctions by the Financial Conduct Authority (FCA). If companies have acquired subsidiaries over time, compliance with liquidity requirements can be challenging, since often significant goodwill appears on the balance sheet. In this blog post, we will explore the impact of goodwill on IFPR compliance and provide possible solutions to ensure your UK holding company and its regulated investment firms meet the FCA's prudential requirements at a group level.
What is goodwill, and why does it matter for IFPR compliance?
Goodwill is an intangible asset that represents the excess of the purchase price of an acquired company or business over its fair value. It arises when a company buys another company and pays more than the fair value of its net assets, such as its property, plant, and equipment, and inventory. Goodwill reflects the value of the acquired entity's reputation, customer relationships, brand name, and other intangibles that can generate future economic benefits for the acquiring company.
While goodwill is an essential component of many M&A transactions, it can pose challenges for IFPR compliance. Under the IFPR, a UK holding company with regulated investment firms must maintain adequate capital resources, liquidity, and risk management systems at a group level. The FCA's prudential requirements are designed to ensure that the group can withstand severe financial stress scenarios and continue to operate and meet its obligations to clients and counterparties.
However, significant goodwill on the balance sheet can make it challenging to meet these requirements. Goodwill is unlikely to generate cash flows, and therefore, it cannot be used to support the group's capital resources or liquidity. Moreover, if the UK holding company is required to write down the value of its goodwill, this could lead to a breach of the FCA's capital adequacy requirements, triggering disciplinary measures, or sanctions.
EXCEPTIONS TO IFPR REQUIREMENTS
While IFPR compliance is mandatory, some exceptions apply. Article 3 exempt MIFID firms, insurers, and certain collective investment undertakings may be carved out from these requirements. However, it is crucial to assess whether your UK holding company and its regulated investment firms qualify for these exemptions and the potential implications of not complying with IFPR requirements.
POSSIBLE SOLUTIONS FOR GOODWILL IMPAIRMENT
If your UK holding company has significant goodwill on its balance sheet and struggles to meet IFPR requirements, you have several possible solutions to consider:
CAPITALISATION OF PARENT
When a UK holding company boasts an ample stash of liquid assets or cash, the notion of capitalising the parent may cross their minds. This process involves investing funds into the group or re-investing pre-existing profits in a move to improve the group's capital, thereby enhancing its adherence to the IFPR regulations.
Consider this situation: a UK holding company purchases an investment firm valued at £50 million, including a goodwill of £10 million. In its balance sheet, the parent company boasts £100 million cash, alongside a regulatory capital requirement of £70 million. In an attempt to augment the group's capital, the holding company's decision to inject £20 million into the group bumps up its capital to a healthy £120 million.
REORGANISATION OF GROUPS
If a UK-based holding company possesses several subsidiaries under its umbrella, it becomes essential to restructure the group to ensure compliance with IFPR regulations. This may involve merging or consolidating subsidiaries to reduce the impact of regulatory capital constraints, or perhaps transferring some subsidiaries to a subsidiary overseas to take advantage of more favourable regulatory regimes.
For instance, take a UK-based holding company with two subsidiaries: one in the UK and the other in the EU. The subsidiary located in the EU is subjected to fewer regulatory capital requirements than its UK-based counterpart. Consequently, the holding company could relocate some of its investment firms from its UK subsidiary to the EU subsidiary, which would enable them to avoid stringent regulatory capital demands while still operating in full compliance with relevant laws and regulations.
DIVESTMENT OF INVESTMENT COMPANY
When a UK holding company finds itself with significant goodwill impairments that hinder its compliance with the IFPR, divestment may be advisable. This strategic move not only optimizes the group's capital and liquidity but also enhances its risk management system. Furthermore, it mitigates the potential risks involved in the investment firm's operations, resulting in a more advantageous business outlook for the holding company.
If a UK holding company acquired an investment firm with £20 million in goodwill, only to discover that the latter's operations were incompatible with the group's strategic goals or objectives, divesting the company is a potential solution. As a consequence, regulatory capital requirements would decrease, and the group would be better equipped to respond to market trends. The holding company can, therefore, open itself up to new and profitable ventures, unburdened by the struggling investment firm.
CHANGES TO REGULATORY PERMISSIONS
The challenge of meeting IFPR compliance requirements for a UK holding company is an issue that may arise due to the activities of its regulated investment firms. In such cases, the company may choose to explore options for modifying its regulatory permissions. This can be achieved by strategically adjusting the investment firms' activities to better align with the group's capabilities, reducing the regulatory capital requirements, or submitting requests for exemptions from specific IFPR requirements.
For instance, take a regulated investment firm of a UK holding company engaged in high-risk trading activities, leading to a significant increase in regulatory capital requirements. In that case, the company may apply for a change in regulatory permissions. By doing so, the company can achieve a better alignment between the investment firms' activities and the group's capabilities, thereby reducing the regulatory capital requirements and ultimately ensuring IFPR compliance.
Conclusion
IFPR compliance for a UK holding company can be difficult to maintain. However, there are several strategies that may help the business achieve this goal. These include capitalising the parent by injecting funds into the group or re-investing existing profits; reorganising groups by merging or consolidating certain subsidiaries and transferring investment firms overseas; divestment of an investment firm with significant goodwill impairments; as well as changing regulatory permissions in order to better align activities with capabilities and reduce regulatory capital requirements. By taking these steps, companies can ensure they remain compliant with IFPR regulations while also being open to new profitable ventures.
Originally published 23 May 2023.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.