Banking – Q3 2023

This quarter saw the PRA decide to postpone implementation of major capital reforms under the name of Basel 3.1 by 6 months. The PRA also had its secondary competition objective expanded under law with a greater focus on international competitiveness and growth. There was new guidance proposed around the general requirements for securitisation by the regulatory authorities. Finally, the PRA released CP10/23 on orderly solvent exit for non-systemic banks.

As we enter the final quarter of the year there is something to keep an eye on, Sam Woods Mansion House speech in late October, which may provide further insight into the future regulatory landscape.

Timeline of Basel 3.1 Implementation

The PRA announced a delay in the implementation of Basel 3.1 by six months to 1 July 2025. The end-state date is still 1 Jan 2030, which means the transition period will decrease to 4.5 years. This aligns with the US Basel proposals; however, it deviates from EU’s implementation date, 1 Jan 2025.

The PRA’s decision to delay implementation is less a reflection of their intent to align with the US, and more a concession to the level of complexity this transition brings. The PRA received an overwhelming number of responses to CP16/22, and have decided to release near-final policies in two parts:

1. In Q4 2023, the PRA will release near-final rules for market risk, credit valuation adjustment, counterparty credit risk and operational risk.
2. In Q2 2024, the PRA will publish credit risk, output floor and reporting and disclosures near-final rules.

The implementation of Basel 3.1 interacts with other reviews the PRA is conducting. The capital framework for Strong and Simple will depend on the credit risk provisions for Basel 3.1. Similarly, the PRA stated their intention to perform a complete review of the Pillar 2 methodologies by 2024, so Pillar 2 requirements and corresponding reporting requirements will align with the changes in the Pillar 1 framework in Basel 3.1. The PRA is yet to provide any updates on whether timelines for the Strong and Simple framework and Pillar 2 review will change.

PRA’s Approach to Measuring the Contribution of Regulation to Competitiveness and Growth

The Financial Services and Markets Act (FSMA) 2023 has introduced a new secondary objective for the Prudential Regulation Authority (PRA), emphasising the promotion of the country's international competitiveness and long-term growth, while aligning with global standards. However, this objective cannot compromise the primary objectives of safety, soundness, and protection.

This objective will sit alongside the existing secondary objective for the regulation of banks it supervises, to facilitate effective competition between firms.

To implement this new objective, the PRA is working to better understand and measure its progress. They hosted an international conference on 19 September 2023 to explore the core linkages between regulation, competitiveness, and growth, which has been published here. This paper focuses on how to measure the PRA's progress and presents various metrics for consideration.

Metrics should be directly under the PRA's control to ensure accountability. These metrics include:

1. Maintaining trust: Measuring trust in the PRA and the UK's prudential framework through industry feedback and surveys.
2. Effective regulatory processes: Assessing the efficiency and accessibility of regulatory processes, including authorisations, and reducing burdensome data requests.
3. Tailoring rules: Adapting rules to fit the unique circumstances of the UK financial sector, fostering innovation while maintaining safety.
4. Responsible openness: Measuring international engagement through Memoranda of Understanding (MoUs) and meetings with international standard setters.

Our view is that while these metrics are important, there are risks associated with using the "wrong" metrics, such as unintended consequences and conflicts with primary objectives. For example, there is a risk that the PRA relaxes regulation to advance financial firms’ profitability, jeopardising safety and soundness in the process.

Additionally, the paper suggests reporting on broader macro-indicators of competitiveness and growth, although these should not be considered performance metrics. These indicators could provide context for the PRA's functions and include:

1. Foreign bank assets: Metrics related to foreign financial sector assets in the UK.
2. Market share of new banks: Measuring the presence and growth of new banks.
3. Global financial activity: Evaluating the volume of financial activity conducted globally by leading financial firms and the percentage conducted in the UK.
4. Size of financial sector: Measuring the size of the financial sector.
5. Foreign direct investment: Assessing foreign investment in the financial sector.
6. Capital ratios: Examining capital adequacy in financial institutions.
7. Global Financial Centres Index (GFCI): Evaluating the competitiveness of financial centres.

It's important to note that these indicators provide a broader context for the PRA's work but are not direct measures of its performance.

CP15/23 – Securitisation: General requirements

CP15/23 presents the PRA’s proposed rules to replace relevant EU provisions within the Securitisation Regulations, Risk Retention Technical Standards and Disclosure Technical Standards. The proposed implementation date for the PRA changes is 2024, dependent on the progress of the draft Securitisation Regulations Document 2023.

1. The proposals for replacing requirements in the Securitisation Regulation are as follows:

• Clarification of requirements: The PRA intends to provide clarity on the requirements for securitisation manufacturers and investors. A crucial aspect of this clarification is ensuring that ‘one-off’ securitisations are included in the regulatory framework.
• Principles-based approach: Adoption of a principles-based approach, particularly in terms of verifying disclosures by UK manufacturers and non-UK manufacturers subject to PRA rules. This approach focuses on ensuring the availability of sufficient, specific, and ongoing information to assess risks comprehensively.
• Delegation of due diligence: Clarification of provisions related to the delegation of due diligence to a managing party helping to determine the responsibility of the delegating party in cases where due diligence obligations are assigned to a managing party.
• Non-Performing Exposures (NPEs): The PRA proposes allowing a reduction in the value of securitised exposures for NPEs using the Non-refundable purchase price discount (NRPPD) to closer align with the market.
• Timelines: The PRA will specify timelines within which manufacturers must provide certain information, such as underlying documentation, to enhance transparency in securitisation transactions.

2. Proposals for replacing relevant requirements in the Risk Retention Technical Standards are as follows:

• Risk retention: Permittance of a change of retainer if an insolvency situation arises.
• 'Sole purpose test’: To prevent 'shell' companies from acting as risk retainers, the PRA propose considering factors such as business strategy, payment capacity, management experience, and corporate governance arrangements when reviewing specification.
• Resecuritisations: Clarification that in cases where resecuritisations are permitted, retainers generally must maintain a material net economic interest for each transaction.
• Exemption for certain firms: PRA-authorised CRR and Solvency II firms may be exempt from the requirement of full cash collateralisation and segregation for synthetic or contingent retention.
• Asset comparability: The proposed rules apply eligibility criteria to assets on the balance sheet, focusing on expected performance and future performance indicators.

3. The PRA replacements of relevant provisions in the disclosure technical standards will preserve the substance of the current requirements and does not replace the EU Securitisation Regulation 2017’s directions to firms. The PRA may change this in the future.

CP 10/23 – Solvent Exit Plan 

In June 2023, the PRA published CP10/23 (CP)which covers proposals for in-scope firms to prepare (and where necessary, execute) an ‘orderly solvent exit’. This is an extension of the PRA’s positioning in its 2022/23 business plan to do more to promote confidence in the ability of firms to exit the market with minimal disruptions to the wider market.

A solvent exit is the process by which firms discontinue PRA-regulated activities (deposit taking) while remaining solvent. Firms will be required to transfer or repay (or both) all deposits as part of their solvent exit which will end with the removal of the firm’s Part 4A PRA permission. Its scope is restricted to:

• Firms are not subject to the OCIR.
• Firms that are not members of a group which is a G-SII or O-SII.
• Firms that are not credit unions or branches of third-country groups.

Impact on firms

The CP proposes two thresholds (reasonable prospect of solvent exit and commencement of solvent exit) for firms within its scope. Firms would be expected to:

• Maintain a solvent exit plan (and solvent exit analysis) as BAU.
• Produce a detailed plan demonstrating how solvent exits would be executed when it becomes a reasonable prospect.
• Develop frameworks for monitoring and managing solvent exits.

The proposals in the CP provide an opportunity to bridge the gap between recovery planning and resolution (insolvency). Solvent exit would sit alongside recovery and resolution, as a route for non-systemic firms facing stress or wishing to exit from PRA-regulated activity for any reason (forced, or strategic). Such firms would be expected to test their solvent exit analysis against a range of idiosyncratic and market-wide scenarios. This is similar to expectations under the recovery regime and is intended to help firms understand the behaviour of customer deposits and enhance the overall resolution capabilities.