Own funds requirement: fixed overheads and the permanent minimum.

The three floors

Regulation (EU) 2019/2033 sets the own funds requirement as the highest of three amounts: the permanent minimum capital requirement, the fixed overheads requirement, and the K-factor requirement. Firms that meet the conditions to be small and non-interconnected do not calculate the third, so for them the requirement is the higher of the first two.

All three are calculated. The requirement is the maximum, but a supervisor expects to see each of them derived, not only the one that ended up binding.

Calculating the fixed overheads requirement

The requirement is one quarter of the fixed overheads of the preceding year. The starting point is total expenditure for that year from the most recent audited annual financial statements, or unaudited statements where audited ones are not available. Variable and discretionary items are then deducted to leave the costs that would continue if the firm stopped writing new business.

Firms without a full preceding year of operation — newly authorised firms — use the projected fixed overheads from their authorisation, until an actual year exists to calculate from.

Which costs may be deducted

The deductible items are defined, not a matter of judgement about what feels variable. The categories that recur in practice:

• Fully discretionary staff bonuses and other discretionary remuneration, where the firm is genuinely free not to pay them.
• Employees’, directors’ and partners’ shares in net profits, to the extent they are fully discretionary.
• Shared commission and fees payable that are directly related to commission and fees receivable and included in total revenue, where payment is contingent on actual receipt.
• Fees and commission paid to clearing organisations, exchanges and brokers for executing, registering or clearing transactions.
• Interest paid to customers on client money, where the firm has no obligation to pay it.
• Non-recurring expenses from non-ordinary activities, which is narrower than it appears — a cost is not non-recurring merely because it has not happened before.
• Tax expenditure falling due in respect of annual profits.
• Losses from trading on own account.

Where the firm uses tied agents, expenditure relating to their activity is brought into the calculation, since the firm carries responsibility for the business they write.

The permanent minimum

The permanent minimum capital requirement is a fixed amount determined by what the firm is authorised to do, with higher amounts for firms that deal on own account or underwrite on a firm commitment basis, and lower amounts for firms whose permissions do not extend to holding client money or assets. It is the floor that binds newly authorised firms and firms whose cost base is small relative to their permissions.

Two points are easy to miss. The amount follows the permissions held, not the activities currently carried on — a permission that is dormant still counts. And a change in permissions changes the requirement immediately, without waiting for a reporting cycle.

Which floor binds

Where the calculation goes wrong

• Treating every variable cost as deductible. The list is closed. A cost that varies with revenue is not deductible unless it falls within a defined category.
• Discretionary in name only. A bonus the firm has always paid, or is contractually committed to, is not fully discretionary.
• Using management accounts. The basis is the annual financial statements, audited where available.
• Ignoring a material change. The most common supervisory challenge, and the easiest to pre-empt by documenting the annual reassessment.
• Omitting tied agent expenditure where the firm uses them.

REGREP is an independent software provider. This record explains a reporting framework in plain language and is not legal, tax or regulatory advice. Confirm scope, thresholds and submission dates with your competent authority before you file.