Chapters 2 and 3 of PRA Consultation Paper 37/15: The implementation of ring-fencing: prudential requirements, intragroup arrangements and use of financial market infrastructures (CP37/15) set out proposals relating to the prudential regime applicable to ring-fenced banks (RFBs).
The following is a summary of the key points arising in these chapters.
The overall key messages are:
- PRA not consulting on the Leverage Ratio or Net Stable Funding Ratio (NSFR) as these are still subject to international agreement;
- PRA proposes to require RFBs to meet prudential requirements on the basis of the sub-group of entities which includes the RFB i.e. sub-consolidation of prudential requirements;
- RFB sub-group is a sub-set of related group entities, within a consolidation group; and
- RFB sub-group must meet prudential requirements on a sub-consolidated basis, as well as on the solo and consolidated bases.
Requiring the RFB to comply with prudential requirements on the basis of RFB sub-group ‘will allow the PRA to assess whether an RFB, together with the other entities in its RFB sub-group, has sufficient resources to meet the requirements arising from the risks in its RFB sub-group without relying on other group entities outside the sub-group, in particular excluded activity entities’.
Once the determination of the RFB sub-group is made, and a requirement imposed under s.55M, Financial Services and Markets Act 2000 (as amended) (FSMA) the sub-group must meet the requirements of Parts 2-4 and 6-8 Capital Requirements Regulation (CRR) on the basis of its sub-consolidated group.
RFB must ‘manage the risks of its RFB sub-group within its risk appetite under business-as-usual and stress conditions’.
RFB must ‘ensure the RFB sub-group has sufficient capital to meet the capital requirements under the business-as-usual and stress conditions, including capital to cover its exposures to entities outside its RFB sub-group.’
Intra-group exposures to entities outside the RFB sub-group should be viewed as equivalent to third party exposures.
Calculations of concentration risk under Pillar 2 currently exclude intra-group exposures. As a result of the change above, intragroup exposures should now be included in calculations of single name, sector and geographic concentration risk.
Determining RFB sub-group
Notable points include:
- the PRA will consider the following requirements when deciding if it is appropriate to constitute an RFB sub-group, for the purposes of applying prudential requirements on a sub-consolidated basis:
- size of subs/sister companies;
- size of sub-group relative to UK consolidated group; and
- nature of activities of subs/sister companies and risks they pose to RFB.
- in determining composition of prospective RFB sub-group the PRA will assess the appropriateness of the inclusion of each legal entity that could be included in the sub-group. Assessment undertaken in advance of composition of sub-group;
- the PRA expects that the composition of an RFB sub-group will align to legal entity structure around the RFB. ‘This means that an RFB sub-group must be coherent and contain entities that share a common parent’;
- the PRA expects that an RFB sub-group will be headed by an RFB. However, >1 RFB, then may be headed by intermediate holding company. RFB sub-group could include PRA authorised person, which is not an RFB (though unlikely);
- the PRA expects that the legal entity structure of the RFB sub-group should be aligned with the governance and management arrangements that apply to RFB sub-group.
- the RFB sub-group not to contain an ‘excluded activity entity’;
- an entity in which RFB may not have ownership rights or holdings of capital instruments should not be included in the sub-group. Similarly, entities that may not have ownership rights/holdings of capital instruments in RFB should not be included in the sub-group. And, ‘where the inclusion of an entity could affect adversely the continuity of provision of core services by the RFB, it should not be included in the sub-group’;
- greater complexity of RFB sub-group = greater scrutiny by PRA;
- the PRA may require legal entities to be removed from sub-group structure if ‘inappropriate’ for them to be included in RFB sub-group; and
- the PRA may use s.55M/s.192C FSMA powers, where the situation falls of short being ‘inappropriate’.
Liquidity management function to remain within the RFB. However, the management of liquidity and funding should be on both individual and sub-consolidated basis.
Intragroup liquidity concessions would not be available to wider group.
Intragroup concessions permit PRA-authorised firms to apply beneficial treatment to certain intragroup transactions/arrangements for the purpose of calculating capital or liquidity requirements under CRR.
Intragroup concessions only applicable to members of RFB sub-group.
To permit otherwise, would mean increased risk that the RFB’s ability to carry on core activities could be adversely affected by the acts or omissions of other group members, and the RFB would depend on resources which are provided by a group member which could cease to be available on insolvency of that group member.
Core UK Group/Non-core UK Group large exposure permissions not available to the RFB’s with respect to exposures to wider group. Permitted only for the RFB sub-group.
Distributions by the RFB and entities in the RFB sub-group forbidden unless ‘reasonable notice has been given to the PRA of the intention to make the distribution’. Notice to include information supporting the RFB’s ability to maintain sufficient capital resources post distribution. Notice signed off by senior management function.
PRA expects that UK parents of RFBs would not make use of double leverage to fund investment in RFB capital. However it is possible. PRA to assess extent to which double leverage would affect safety/soundness of RFB/RFB sub-group.
Holding of capital
The PRA has clarified that, the requirement that an RFB should not have ownership interest in any ‘excluded activity entity’ extends to all classes of capital instruments, and includes all members of RFB sub-group within scope of these expectations.