On 16 November 2020, the PRA published a Dear Chief Financial Officer (CFO) letter concerning remediation of prudential treatment of legacy instruments before the Capital Requirements Regulation I (CRR I) transition period ends.
The Dear CFO letter follows an earlier opinion from the European Banking Authority on the prudential treatment of legacy instruments, and communicates the PRA’s position and asks CFOs to take certain action to address issues arising from the planned treatment of their firm’s affected legacy instruments.
Key points in the Dear CFO letter include:
- As explained in Supervisory Statement 7/13, the PRA expects firms to avoid complex features and capital structures that may complicate prudential assessment and may also undermine capital instruments’ loss-absorbing properties and CRR I compliance. The PRA notes that firms are responsible for compliance with applicable regulations, such as the CRR I and binding technical standards, taking into account relevant guidance.
- The PRA refers firms to the Bank of England’s (BoE) minimum requirement for own funds and eligible liabilities (MREL) Statement of Policy (SoP). Paragraph 5.10 of the MREL SoP sets out the BoE’s view that firms should consider whether having non-Common Equity Tier 1 (CET1) own funds instruments that do not meet the relevant eligibility criteria for MREL resources could create difficulties for resolution. The BoE may consider the challenges to resolvability presented by such instruments as part of assessing firms’ resolvability.
- The PRA expects affected firms to undertake a risk-based approach and assess appropriate remedial actions before the end of the CRR I transition period. A firm’s choice of remedial action may depend on a number of factors, including call options, governing law, issuing entity, and market conditions. Firms are requested to share an action plan with their usual supervisory contact by 31 March 2021. If a firm intends to keep affected legacy instruments as non-regulatory capital, and non-eligible liability instruments beyond the end of the CRR I transition period, the action plan should include a reasoned analysis of any prudential risks, including concerns for resolvability or insolvency, and potential actions to mitigate those risks.