Calculation of K-COH

Should the transactions relating to managing the delegated investment funds’ portfolios be included into COH of the investment firms?

It is common that investment fund management companies delegate a management of some of their investment funds’ portfolios to an investment firm. I.e., the investment firm offers portfolio management service in Annex 1 Section A of (EU) 2014/65 to an investment fund management company (an asset manager). The investment firm and the asset manager do not often belong to the same financial group. Hence, there is no risk for the double accounting from the IFR/D sense. Paragraph 2 in Article 17 of IFR (EU 2019/2033) states that assets formally delegated by another financial entity to the investment firm should not be included to the AUM of the investment firm. This is well-founded because the entity who has done the delegation of the management of the assets is responsible for those assets to the external clients. Hence, the investment firm to whom an asset manager has delegated the management the portfolio of their investment fund should not include the assets of that investment fund in their AUM under IFR. However, should the transactions relating to managing the delegated investment funds’ portfolios be included into COH of the investment firms? Paragraph 2 in Article 20 of IFR defines which transactions should be included and which excluded in COH of an investment firm. COH shall include transactions executed by investment firms providing portfolio management services on behalf of investment funds (the third subparagraph). Do these transactions include the transactions described above, i.e., those transactions that occurred when an investment firm manages assets in the portfolio of an investment fund delegated by an asset manager, i.e., when an investment firm provides portfolio management service under (EU) 2014/65 to an asset manager? Additionally, the third subparagraph states that it should apply “without prejudice to the fifth subparagraph”, i.e., it does not limit what is said in that subparagraph. The fifth subparagraph states that those transactions handle by the investment firm that arise from the servicing of a client’s investment portfolio where it already calculates AUM shall be excluded (the first part). This is well-founded because the risk here is already considered under AUM.  However, the latter part of the fifth subparagraph is contradicting towards the first part of the subparagraph and the third subparagraph. Where that activity relates to the delegation of management of assets to the investment firm not contributing to the AUM of that investment firm by virtue of Article 17(2), COH shall exclude the transactions. Hence, if a financial entity has formally delegated the management of assets to the investment firm, those assets should not be considered in AUM of the investment firm nor the transaction relating management of these delegated assets in COH of the investment firm. Therefore, the delegated management of another financial entity’s assets does not have any effect to the investment firm’s prudential K-factor requirements under IFR. Is this the case? If the offering of portfolio management service under MiFiD to an asset manager, i.e, managing a delegated asset portfolio a behalf of an asset manager, is not consider under AUM or COH, some investment firms have no K-factor requirement under IFR regardless how significant the magnitude of the service provided is. There is a significant risk for downwards biased prudential requirements because these investment firms rarely how significant fixed overheads.