## Financial Sector Assessment Program — United Kingdom (1gbrea2022002)

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**Canonical URL:** [Financial Sector Assessment Program — United Kingdom (1gbrea2022002)](https://www.imf.org/-/media/files/publications/cr/2022/english/1gbrea2022002.pdf)

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---

### Overall assessment and context
- Strong reputation for quality of oversight and design of the post-GFC financial stability framework.
- Multipronged responses to exit from the EU and the pandemic were effective; financial market infrastructures remained resilient.
- Authorities led the LIBOR transition and reactivated the countercyclical capital buffer as a preemptive macroprudential measure.
- Recovery: "expected to grow by about 7¼ percent in 2021, returning to its pre-pandemic level by end-2021."
- Inflation: "could peak at about 7 percent in early 2022."
- Credit-to-GDP gap: "declined to about zero for the first time in a decade."

### Key ongoing financial stability challenges
- Three overarching challenges:
  - Brexit-related implementation details and EU-U.K. financial services issues remain work-in-progress (Section III-A).
  - Macrofinancial uncertainty from COVID-19 resurgence, supply disruptions, demographic shifts, inflationary pressures, and tightening global financial conditions.
  - Structural transitions and risks from:
    - (i) rising intermediation by nonbank financial institutions (NBFIs);
    - (ii) fintech and product innovation;
    - (iii) full passthrough of the 2019 retail–investment banking separation;
    - (iv) complete switching out of Sterling LIBOR;
    - (v) mitigation of climate-related financial risks;
    - (vi) economic and financial crimes and cyber-attacks.

### Systemic risk, contagion, and cross-border sensitivity
- Contagion across sovereign–nonfinancial–financial channels currently "remain muted."
- U.K. financial stability remains sensitive to exogenous and cross-border channels given the U.K.’s role as a global financial hub:
  - U.K.-based entities involved in "30 to 40 percent of the world’s cross-border credit, currency, and interest rate derivatives contracts."
  - About half of the banking sector’s assets and one third of NBFIs’ assets are offshore.
  - U.K. hosts two global systemically important CCPs (LCH, ICE Clear), and LME Clear.

### Key systemic-risk findings and stress outcomes
- Potential capital impact: "4.9 percentage points under the most severe scenario (Section III-C), and the solvency ratios of a few insurers could fall below the 100-percent threshold (Section III-D)."
- Housing market risks:
  - "Surge in house prices"; house price-to-earnings ratio at "5.6".
  - Under some FSAP stress scenarios, "mortgage arrears could rise sharply and peak at 2.8 percent in 2022."
- Banking sector stress-test highlights (eight largest U.K.-based banks):
  - CET1 ratio projections:
    - Baseline: "increase by 1.9 percentage points by the end of the scenario horizon."
    - Adverse Scenario 1: "reduces to 13.6 percent in 2022."
    - Adverse Scenario 2: "reduces to 10.7 percent in 2022."
  - Under Adverse Scenario 2, two banks fall below hurdle rates with small CET1 shortfalls amounting to "0.08 percent of GDP at the peak (or 0.035 after AT1 conversion)."
  - Loan portfolio: "about 56 percent of total assets."
  - Mortgage loans: "about 54.9 percent of total exposures at default (EAD)."
  - Corporate loans: "32.5 percent of credit exposures."
  - Retail: "12.6 percent of credit exposures."
  - Mortgage PDs:
    - Adverse Scenario 1: domestic mortgage PDs increase by "4pp at the start of 2022."
    - Adverse Scenario 2: domestic mortgage PDs "peak at 7.7 percent by the end of 2023."
    - Foreign mortgage PDs: "peak at 8.1 in 2022 under Adverse Scenario 1 and reach 9.9 percent in 2023 under Adverse Scenario 2."
  - Dynamic feedbacks: macrofinancial feedbacks reduce GDP further; "GDP would be reduced by additional 0.65 p.p. in 2022" and capital ratios fall by about "57 basis points" on average through the horizon.
  - Labor-market impacts: unemployment "higher by 0.24 p.p. in 2022 and 2023"; incremental impact "0.37 p.p. in 2023."

- Insurance sector stress-test highlights (14 larger insurers covering about "70 percent of the market"):
  - Scarring scenario (downward interest rate shift): "two firms would drop below the 100 percent threshold with an aggregated capital shortfall of almost £9 billion."
  - Life insurers more affected than general insurers; life insurers resilient to variation margin calls in interest rate swap portfolios.

### Macroeconomic scenarios used
- Baseline aligned to October 2021 WEO.
- Two adverse scenarios (2021–25):
  - Adverse Scenario 1: "Recession with lasting economic scars from a protracted pandemic."
    - Selected figures: Real GDP growth in 2021 "0.5 (8.9) percent in 2021 under the first (second) adverse scenario"; unemployment "increases to 6.7" under the first adverse scenario; house prices "Drop by -14.6 percent in 2021" under the first adverse scenario; equity prices "Drop by -5 percent in 2021."
  - Adverse Scenario 2: "Surge in global inflation and consequent tightening of global financial conditions."
    - Selected figures: inflation "peaks at 9.8 percent under the second adverse scenario"; house prices "Drop by -9 percent in 2022 and 2023"; equity prices "Drop by -17 and -18.5 percent in 2022 and 2023, respectively."
- Scenario 2 narrative includes rapid central bank rate increases and sterling depreciation.

### Nonbank financial intermediation (NBFI) and market-based finance
- NBFI roles: CRE, SME lending, specific mortgage products, unsecured consumer credit; some segments (e.g., buy-now-pay-later, corporate loans) outside the regulatory perimeter and lacking granular data.
- Interconnectedness:
  - "Deepening interconnectedness. NBFIs are now sizeable credit providers ... already interconnected among themselves and with banks, including cross-border firms and asset managers."
  - Bank and nonbank credit co-movement: "71 percent."
  - Nearly half of funding of U.K. finance companies "comes from banks."
- Market liquidity risk: primary channel is "liquidity mismatches in the internationally active NBFIs."
- Recommendation: consider strengthening backstops and allowing access to some central bank facilities to appropriately regulated, and systemically interconnected NBFIs (BOE) — design principles to minimize moral hazard and require prescriptive liquidity standards.
- Data recommendation: "Accelerate the efforts to close data gaps on NBFI activities ... continue improving flow-of-funds data including all cross-border NBFI exposures."

### Asset management, MMFs, and fund liquidity
- U.K. asset management industry:
  - AUM: "£11 trillion."
  - Employment: "supports 114,000 people, including 42,200 directly employed."
  - Contribution to GDP: "about 1 percent."
- MMF proportional liquidation profile (selected exact figures, April 9, 2021):
  - Total Liquidation Needs: "22.0" (£ billions)
  - Total Asset Government: "9.9" (£ billions)
  - Total Assets Prime: "231.0" (£ billions)
  - Proportional liquidation maturity profile — Total Liquidation Needs by horizon (1 day to 181-365 days): "8.1, 2.0, 2.4, 2.7, 2.8, 3.1, 1.0"
  - Total Asset Prime by horizon (1 day to 181-365 days): "79.0, 21.4, 28.6, 27.8, 28.7, 31.8, 13.8"
  - Liquidation Needs Prime (In percent) by horizon: "9.6, 9.0, 8.3, 9.4, 9.6, 9.6, 7.0"
- Recommendation: calibrate swing pricing and redemption notice periods to underlying asset liquidity; push for consistent use of liquidity management tools.

### Central counterparties (CCPs)
- U.K.-based CCPs (LCH Ltd., ICE Clear Europe Ltd., LME Clear Ltd.):
  - Aggregate initial margin (IM) "close to around 33 percent of total IM collected by CCPs worldwide."
- CCPs proved resilient in March 2020, but spikes in IM and VM exposed varied clearing member capacity.
- Short-term Brexit/C.C.P. notes:
  - Non-EU clearing members account for "over 70 percent of activity and are expected to stay in the United Kingdom at least until 2025."
  - EU equivalence/recognition arrangements temporary with uncertainty beyond June 30, 2022.
- Recommendation: augment BOE supervisory CCP stress testing with greater transparency on stressed margin demands.

### Housing market and commercial real estate (CRE)
- Housing:
  - "House prices have posted the strongest gains since November 2004."
  - House price-to-earnings ratio: "5.6."
  - Share of new mortgages at high-LTV remains low relative to pre-pandemic, but share of new mortgages at high-LTI rising.
  - FPC: LTI flow limit restricts mortgages with LTI ≥ 4.5 to "15 percent of their new mortgage lending."
  - FPC to consult on withdrawing its affordability test in H1 2022; cautioned this requires careful consideration given rising prices and inflation risks.
- CRE:
  - Market "continues to cool down"; slowdown accelerated during the pandemic.
  - BOE considered CRE price fall a vulnerability in December 2019.
  - FSAP sees potential systemic impact of CRE risks as "contained."

### Climate-related financial risks
- Coverage: eight largest banks, eight largest life insurers, seven large general insurers, and a sample of investment and pensions funds.
- Methodologies: NGFS scenarios, GTAP-E sectoral model, and CCA financial model suite; transition and physical risk analyses up to 2050 with valuation impacts assumed to occur within a five-year horizon.
- Transition risk quantitative impacts (selected exact figures):
  - Switch to "1.5°C with Carbon Dioxide Removal":
    - Banks: "credit losses on their corporate loans higher, on average, than 1 percent."
    - Banks’ equity holdings: "3.5 percent on average" market losses.
    - Banks’ corporate bond holdings: "1.6 percent on average" market losses.
    - Insurers: "loss on investments would range between 1 and 3 percent of total investments."
  - Switch to "Net Zero 2050": "For banks, credit losses would more than triple. For banks, market losses would almost double."
- Physical risk impacts:
  - Banks’ sovereign bond portfolios: overall drop of "0.6 percent" in value from chronic physical risk; could rise to "3 percent" if mean temperature increase accompanied by increased variability.
  - Insurers: expected annual losses from natural disasters "would increase by up to 50 percent (before reinsurance)" if frequency and severity increase by 30 percent each; "More than 70 percent of the losses from a 1-in-200-year event would be recovered from (mostly international) reinsurers."
- Recommendation: BOE should "accelerate the development of its own analytical toolkit" and equip itself with in-house macro, sectoral, and micro models to run independent top-down climate scenario analyses.

### Regulatory and supervisory framework, institutional capacity
- FPC: "a world-class macroprudential authority" with robust interagency processes and seamless data-sharing among BOE/PRA and FCA.
- PRA and FCA: sophisticated frameworks for banks and insurers; SMCR producing positive results though PRA has not fully used all powers.
- Operational resilience: cloud outsourcing and third-party providers raise systemic risks; PRA and FCA "lack express statutory authority to directly review and examine any critical services" provided by third parties.
- Recommendation: seek statutory powers for direct supervisory access to critical third-party providers and enhance on-site supervisory verification of cybersecurity controls.
- Insurance supervision: Solvency II framework rigorous; FSAP assessment: "17 ICPs observed, six largely observed, one partly observed."
- Resolution and crisis management:
  - Progress toward making "all eight systemic U.K. banks resolvable" by 2022; Resolvability Assessment Framework (RAF) in place.
  - Special Resolution Regime (SRR) robust but assigns HMT roles that could constrain operational autonomy; recommendation to "eliminate constraints in the rulebook that may limit resolution funding" and "moderate HMT’s involvement in firm-specific resolution decisions."
  - CCP and insurer resolution regimes need legislative and policy acceleration; complement with RAF-like regimes.

### Brexit exit implementation and market fragmentation
- Exit period ended "without a materialization of risks for financial stability."
- U.K. actions: onshoring EU law, equivalence decisions, temporary permission regimes, MOUs and cooperation with EU authorities.
- As of November 2021, "32 jurisdictions plus the EEA benefit from equivalence decisions under the United Kingdom’s framework."
- Market fragmentation observed in some trading and derivatives migration to EU/U.S. venues; short-term financial stability risks limited but long-term uncertainty remains, particularly regarding EU access to U.K. CCPs.

### FSAP priority enhancements and key recommended measures (summarized)
- Four priority areas:
  - Expand systemic-risk surveillance and close data gaps on market-based finance, private markets, and cross-border channels.
  - Strengthen on-site supervision for digital money, green finance, technology intermediation, AML/CFT, and cross-border risks.
  - Preserve regulatory primacy and accountability of PRA, FCA, and FPC; ensure FRF review does not constrain independence.
  - Maintain capacity and resourcing for systemic risk monitoring and supervision.

- Selected recommended measures (exact titles retained):
  - A.1: "Strengthen backstops ... by considering allowing appropriately regulated and systemically interconnected NBFIs access to repo and/or Gilt purchase operations ... (BOE)" — MT
  - A.2: "Enhance and further strengthen the existing stress testing framework ... run independent full-fledged top-down exercises covering all systemically relevant components ... (BOE/PRA, with FCA)" — MT
  - A.3: "Seek additional statutory powers to review and examine the resilience of all critical services (including, but not limited to, cloud services) ... (BOE/PRA, FCA, and HMT)" — MT
  - B.4–B.6: strengthen on-the-ground reviews, cyber risk technical reviews, and beneficial ownership verification (various agencies) — NT
  - C.7–C.8: continue LIBOR conversion and prepare for diverse failure scenarios; accelerate recovery and resolution planning for insurers and CCPs — NT/MT
  - D.9–D.12: preserve primacy of FPC/PRA/FCA objectives; review workloads and ensure accountability preserves independence — I/NT
  - Cross-border/data: 13–15 include accelerating data gap closure on NBFIs, strengthening third-country information sharing, and maintaining U.K.’s commitment to mutual cooperation with the EU — MT/I

### Data gaps, reporting, and implementation status
- Ongoing efforts to expand core data templates and enhance analytical infrastructure for stress tests; number of core templates increased from 14 in 2019 to 27 in 2020.
- Implementation status of 2016 recommendations: mixture of Implemented, Partly Implemented, Not Implemented; notable items:
  - Extend FPC powers to buy-to-let market: Implemented.
  - Extend stress-test coverage to large foreign subsidiaries: Not Implemented.
  - Complete core data template and concurrent stress-test analytical infrastructure: "Implementation in progress."
  - Develop cross-sector interconnectedness indicators and flow-of-funds: "Implementation in progress."

_Source: EXECUTIVE SUMMARY and excerpts from the IMF staff report (Financial Sector Assessment Program — United Kingdom, 1gbrea2022002)._

### EXECUTIVE SUMMARY __________________________________________________________________________ 9

### EXECUTIVE SUMMARY

### Overall assessment
- The U.K. financial system enjoys a strong reputation for the quality of oversight and the design of the financial stability framework set up after the 2007-09 Global Financial Crisis (GFC).
- The multipronged response to manage the exit from the EU, and the pandemic was effective (Section II-A).
- Financial market infrastructures stood resilient.
- The U.K. authorities demonstrated leadership in the global LIBOR transition, and with the latest reactivation of the countercyclical capital buffer policy as a preemptive macroprudential measure.
- Reforms in the post-Brexit and post-pandemic period must only help strengthen the foundations and ensure that the institutional oversight and regulatory setup remains strong, independent, and efficient.

### Key ongoing financial stability challenges
- The FSAP identifies three key ongoing financial stability challenges:
  - The United Kingdom has addressed risks relating to the exit from the EU dexterously, but some key details regarding the EU-U.K. financial services remain open and are work-in-progress (Section III-A).
  - Economic recovery has resumed, but the macrofinancial outlook is confronting uncertainty, including the resurgence of COVID-19, supply-side disruptions, demographic shifts, inflationary pressures, and tightening of global financial conditions.
  - Ongoing structural shifts and transitional issues including:
    - (i) the rising intermediation by nonbank financial institutions (NBFIs);
    - (ii) the permeation of financial technology and product innovation;
    - (iii) the full passthrough of the 2019 separation between retail and investment banking;
    - (iv) the complete switching out of Sterling LIBOR;
    - (v) the mitigation of climate-related financial risks; and
    - (vi) the handling of the ubiquitous threats from economic and financial crimes, and cyber-attacks.

- Note on terminology: NBFI refers to all types of investment funds, finance companies, broker-dealers, structured finance vehicles, central counterparties, money lenders, captive funds, and bank holding companies. NBFI credit providers comprise investment funds, insurers, pension funds, money lenders, and finance companies.

### Systemic risk and cross-border sensitivity
- While the three challenges intersect and interact, contagion risks across the sovereign-nonfinancial-financial channel remain muted for the present.
- Given the nature of the U.K. financial system, financial stability remains sensitive to exogenous factors and cross-border channels.

### Risks identified for continuing vigilance
- Pandemic-obfuscated financial risks: under FSAP stress scenarios, corporate and household vulnerabilities could materialize. (Section III-B).
- (The source text continues: "Banks’ capital ratios could decline by up to" — text provided ends at that fragment; no further quantitative stress results are supplied in the provided content.)

*Source: EXECUTIVE SUMMARY, Financial Sector Assessment Program — United Kingdom*

### 4.9 percentage points under the most severe scenario (Section III-C), and the solvency ratios of a

### 1gbrea2022002 - 4.9 percentage points under the most severe scenario (Section III-C), and the solvency ratios of a

### Key systemic-risk findings
- Potential capital impact: "4.9 percentage points under the most severe scenario (Section III-C), and the solvency ratios of a few insurers could fall below the 100-percent threshold (Section III-D)." These potential losses are prima facie absorbable in the near term with their current capitalization levels.
- Housing market risks:
  - "Surge in house prices. Imbalances in the housing market are not apparent yet, but prices have continued to rise."
  - Under some FSAP stress scenarios, "mortgage arrears could rise sharply and peak at 2.8 percent in 2022, higher than the GFC levels (Sections III-B and III-I)."
- Nonbank financial intermediation (NBFI) risks:
  - "Deepening interconnectedness. NBFIs are now sizeable credit providers to the real economy, including in riskier market niches less served by banks."
  - NBFIs are "already interconnected among themselves and with banks, including cross-border firms and asset managers (Sections III-E and III-G)."
  - "Active use of financial technology is deepening these linkages, and data gaps preclude identification and a more definitive assessment of such risks."
- Market liquidity risks:
  - "Liquidity in core markets. The risk to core financial markets remains primarily via liquidity mismatches in the internationally active NBFIs."
  - Recommendation: "It is desirable to actively consider strengthening backstops and allowing access to some central bank facilities to appropriately regulated, and systemically interconnected NBFIs (Section III-H)."
- Regulatory and market fragmentation risks:
  - "Regulatory predictability. Market fragmentation risks remain amplified in the areas of derivatives clearing, and international banks and insurers’ choices of post-Brexit operating models."
  - "Uncertainties surrounding the long-term access of EU clearing members to the U.K. CCPs remain a source of market unease, albeit not viewed as a financial stability risk in the short term for the United Kingdom. (Section III-F)."

### Institutional assessment and macroprudential capacity
- Financial Policy Committee (FPC):
  - "On the institutional side, the Financial Policy Committee (FPC) is a world-class macroprudential authority. The FPC runs robust interagency processes to monitor financial stability conditions (Section IV-A)."
  - "The quality of interagency coordination on prudential and related financial policies is thorough."
  - "There is seamless data-sharing within and between the BOE/PRA and the FCA. The United Kingdom also has a transparent approach to macro- and micro prudential, and conduct regulation."
- Financial Services Future Regulatory Review (FRF review):
  - Ongoing governmental review "seeks to redesign the post-Brexit framework for rules, regulations, and regulatory setup."
  - The FSAP cautions to "remain mindful of the ultimate limits of explicit or implicit fiscal support for the financial sector" and to "persevere with their demonstrated commitment, in support of highest standards of prudence and good governance of domestic and international finance."
  - Emphasis: "while maintaining a competitive financial sector is an important policy goal, financial stability should not be compromised for the objectives of competitiveness."

### FSAP priority enhancements (four broad areas)
- Expand systemic-risk surveillance:
  - "Expand the scope of systemic risk surveillance by the FPC on a continuing basis to assess risks from market-based finance, private markets, and cross-border channels (Section IV-A)."
  - "It will be paramount to close the data gaps that limit mapping, identifying, and analyzing such risks (Sections IV-A and VI-B)."
- Strengthen on-site supervision:
  - "More 'on the ground' supervision would provide better assurance that risks arising from digital money, green finance, technology-based intermediation and investment services, and cross-border risks are known early (Section IV-B), including risks from financial crimes (Section V-D)."
- Preserve regulatory primacy and accountability:
  - "Preserve the primacy of PRA and FCA’s objectives of safety and soundness and market integrity, and the FPC’s financial stability objective—in principle and practice—and ensure that the final set of accountability mechanisms adopted under the FRF review poses no constraints for independent and effective oversight of entities and financial markets."
- Maintain capacity and resourcing:
  - "To sustain the intensity and alacrity of oversight, maintain, always, the necessary level of skills and resources for systemic risk monitoring, oversight, and supervision of all systemically important financial firms and the core markets."

### Key recommended measures (summary of Table 1)
- A. Further Bolster Management of Systemic Risks
  - 1: "Strengthen backstops to the functioning of core markets in times of stress by considering allowing appropriately regulated and systemically interconnected NBFIs access to repo and/or Gilt purchase operations; clearly communicating the objectives, instruments, eligible participants, and the exit criteria. (BOE)" — MT
  - 2: "Enhance and further strengthen the existing stress testing framework by consolidating the internal toolkit and run independent full-fledged top-down exercises covering all systemically relevant components of the financial system. (BOE/PRA, with FCA)" — MT
  - 3: "Seek additional statutory powers to review and examine the resilience of all critical services (including, but not limited to, cloud services) that third parties provide to regulated firms. (BOE/PRA, FCA, and HMT)" — MT
- B. Continue Strengthening Regulation and Supervision
  - 4: "Further develop 'on the ground' reviews of systemically important financial firms’ exposures and risk management practices for early identification and remediation of supervisory issues, including AML/CFT risks, and to also support macroprudential surveillance. (BOE/PRA and FCA)" — NT
  - 5: "Enhance cyber risk technical risk reviews on technology risk management expectations for all financial firms, and by conducting additional cybersecurity control verification activities to complement CBEST security testing. (BOE/PRA, and FCA)" — NT
  - 6: "Enhance entity transparency through improved verification of beneficial ownership information on the PSC Register and augment, as needed, ongoing support to Crown Dependencies and British Overseas Territories in operationalizing similar registers. (HMT, BEIS/Companies House, and FCDO)" — NT
- C. Minimize Potential Risks of Ongoing Transitions and Future Crises
  - 7: "Continue to encourage the conversion of remaining legacy LIBOR exposures of U.K. regulated firms and support foreign efforts to migrate from non-Sterling LIBOR, mindful of the needs of emerging markets users. (FCA, HMT, and BOE)" — NT
  - 8: "Continue preparing for diverse failure scenarios; eliminate rules that may constrain the bank resolution regime; and accelerate and expand the work on recovery and resolution planning for insurers and CCPs. (HMT, BOE/PRA, FCA, and FSCS)" — MT
- D. Secure Institutional Safeguards for Financial Stability and Integrity
  - 9: "Preserve the primacy of the FPC’s financial stability objective and strengthen its focus on global financial standards and cross-border surveillance. (HMT, BOE, PRA, and FCA)" — I
  - 10: "Preserve the primacy of PRA and FCA’s objectives of safety and soundness and market integrity, in principle and in practice, over any secondary objectives and ad hoc policy priorities. (HMT and FPC)" — I
  - 11: "Review and estimate the expected workload in core and new financial stability and supervisory risk areas and determine how to align BOE/PRA and FCA capacity and resources accordingly. (HMT, BOE/PRA, and FCA)" — NT
  - 12: "Ensure that the final accountability and transparency mechanisms adopted under the ongoing FRF review seek to safeguard regulatory independence and pose no constraints for operational and oversight effectiveness. (HMT, PRA, FCA with other agencies)" — NT
- Cross-border and data recommendations (concluded Table 1)
  - 13: "Accelerate the efforts to close data gaps on NBFI activities, including data on all Sterling asset holdings and data needed to improve the management of liquidity demands by fund managers; continue improving flow-of-funds data including all cross-border NBFI exposures. (FPC, BOE/PRA, and FCA)" — MT
  - 14: "Strengthen information sharing with relevant third-country authorities, including reviewing the approach to monitor and supervise hybrid cross-border transactions, private market activities, and internationally active mixed financial groups. (FPC, BOE/PRA, and FCA)" — MT
  - 15: "Maintain the United Kingdom’s commitment to mutual cooperation with the EU, post-Brexit, including intensifying regulatory dialogue to support financial stability and mitigate market fragmentation risks, including the regulatory status of the U.K. CCPs over the long term. (HMT, BOE, and FCA)" — I

### Financial stability context and macrofinancial links
- Pandemic recovery and macro conditions:
  - "The United Kingdom is recovering from an unprecedented pandemic-related contraction."
  - "With comprehensive policy support, vaccinations, and removal of mobility restrictions, the economy is recovering fast and expected to grow by about 7¼ percent in 2021, returning to its pre-pandemic level by end-2021 (Table 2)."
  - "Inflation has been rising markedly recently, spurred by supply bottlenecks and a recovery in demand, and could peak at about 7 percent in early 2022."
- Policy response:
  - Authorities launched "a multipronged response to support financial stability" including direct and indirect budget support and exceptional prudential measures to ensure continued lending.
  - "The BOE, in concert with other central banks, deployed a range of tools to restore market liquidity. The FCA set new reporting thresholds on the shorting of securities."
- Financial conditions:
  - "With swift and strong policy support, financial conditions progressively reversed the initial sudden tightening following the outbreak."
  - "The credit-to-GDP gap declined to about zero for the first time in a decade."
  - "Residential real estate prices rose sharply since mid-2020, although the share of new mortgages issued at high loan-to-value (LTV) ratios remains low relative to the pre-pandemic period (Section III-H)."
- Sovereign–financial–corporate linkages:
  - "A materialization of risks could reverberate through sovereign-financial-corporate linkages, particularly with increased contingent liabilities to the sovereign (Figure 2)."
  - "Banks and insurance companies started the pandemic well capitalized and with sufficient liquidity buffers (Table 3)."
  - The public Debt Sustainability Analysis notes that "higher government financing needs would call for higher demands on NBFIs' and banks' gilt holdings, with implications for crowding out private credits, raising interest rates, and tightening sovereign-financial links."

### United Kingdom’s role in global finance and key statistics
- Global hub metrics:
  - "The United Kingdom remains a vital global financial hub. At end-2020, the United Kingdom was by far the largest trading marketplace for credit, foreign exchange, and interest rate derivatives."
  - "U.K.-based entities are involved in 30 to 40 percent of the world’s cross-border credit, currency, and interest rate derivatives contracts (Table 4)."
- EU linkages:
  - "EU-U.K. financial linkages are strong (Figure 3, Box 1). The EU13 provides approximately between 20 and 60 percent of cross-border funding obtained by the United Kingdom, depending on the type of instrument."
  - For derivatives, "the outstanding volume of cross-border contracts involving an EU-based and a U.K.-based counterpart ranged between 19 percent (for currency derivatives) to 26 percent (for interest rate derivatives) of the United Kingdom’s total cross-border outstanding amounts."
- Structural features:
  - "The U.K. financial system is central to global finance. About half of the banking sector’s assets and one third of NBFIs’ assets are offshore. The United Kingdom is the largest host jurisdiction to foreign financial firms as subsidiaries or branches."
  - "One-third, and sometimes even one-half, of the world’s currencies and derivatives are traded and cleared in London, and most of the global broker dealers are concentrated in the United Kingdom."
  - The United Kingdom hosts "two global systemically important CCPs (LCH, ICE Clear), and LME Clear."

*Source: IMF staff report (FSAP summary excerpts).*

### 6.      The Brexit transition period ended without a materialization of risks for financial stability.

### 6.      The Brexit transition period ended without a materialization of risks for financial stability.

### Exit implementation, equivalence, and cooperation
- The United Kingdom closely monitored risks, engaged with the industry, and provided necessary regulatory certainty in a timely manner.
- The United Kingdom replicated most of the equivalence determinations in respect of overseas jurisdictions made by the European Commission pre-Brexit.
- In November 2020, the United Kingdom granted a package of equivalence decisions in respect of the EEA states.
- As of November 2021, 32 jurisdictions plus the EEA benefit from equivalence decisions under the United Kingdom’s framework.
- An “onshoring” process converted operative EU law into domestic law, with only minor adjustments.
- An extensive network of Memoranda of Understanding (MOUs) was agreed with EU authorities; ongoing authority-level cooperation occurs in a range of forums.
- A Memorandum of Understanding (MOU) providing a cooperation framework was agreed at the technical level but is not signed yet.

### Measures to mitigate exit risks across financial subsectors (U.K. and EU actions)
- Legal Framework
  - U.K. action: Onshoring of EU law into domestic law with minor adjustments.
  - EU action: Not relevant to the EU.
- Cooperation
  - U.K. action: Extensive MOUs and ongoing authority-level cooperation.
  - EU action: See U.K. actions.
- Banking Services
  - Risk: Inability of U.K. and EEA banks to access U.K. and EEA markets.
  - U.K. action: Temporary permission regime for continuity of EU firms’ services while they seek permanent authorization in the United Kingdom.
  - EU action: No EU-level action; some member states introduced temporary regimes.
  - Outcome: Major U.K.-based banks transferred their EU clients to subsidiaries in the EU to continue servicing them.
- Insurance
  - Risk: Inability to service cross-border insurance contracts.
  - U.K. action: Legislation to allow EEA companies to service policies held by U.K. households.
  - EU action: Some member states introduced run-off regimes. EIOPA guidance issued to facilitate servicing of existing contracts.
- Uncleared Derivatives
  - Risk: Inability to perform certain lifecycle events.
  - U.K. action: Legislation to ensure EEA banks can perform lifecycle events on contracts with U.K. firms. U.K. firms repapered clients. ISDA advice issued.
  - EU action: Temporary exemptions to facilitate novation contracts with EEA counterparties without triggering clearing and bilateral margin obligations.
- CCPs
  - Risk: U.K. CCPs unable to provide clearing services to EEA clearing members and vice-versa.
  - U.K. action: Temporary recognition regime allows EEA CCPs to provide services to U.K. clearing members while applying for permanent recognition.
  - EU action: Equivalence and recognition for U.K. CCPs until June 2022. The EU recently provided public reassurance that it will extend the CCPs’ temporary equivalence (details still unknown). ESMA refrained from recommending derecognition and advised mitigation measures.
  - Note: Three U.K. CCPs (two globally systemic) serve EU clearing members based on Commission equivalence and ESMA recognition decisions expiring on June 30, 2022. The EC intends a 3-year extension to June 2025, but details remain unclear.
  - Structural point: Non-EU clearing members account for over 70 percent of activity and are expected to stay in the United Kingdom at least until 2025.
- Asset Management
  - Risk: Inability to market/operate cross-border and to delegate portfolio management to the United Kingdom (vice-versa).
  - U.K. action: Temporary permission regime for marketing of EEA UCITS and AIFs; cooperation agreements between the FCA and EEA National Competent Authorities enable portfolio management delegation and access to the U.K. National Private Placement Regime.
  - EU action: Cooperation agreements; some member states adopted temporary regimes for marketing of U.K. UCITS and AIFs. Recent Commission proposal allows delegation of portfolio management under somewhat stricter reporting rules.
- Personal Data
  - Risk: Transfer of personal data disrupted.
  - U.K. action: Legislation to allow U.K. to EEA transfers and firms put contractual clauses in place to allow transfers from the EU to the United Kingdom. U.K. FCA signed IOSCO-ESMA Administrative Arrangement.
  - EU action: Following the TCA’s “bridging mechanism,” the Commission adopted adequacy decisions for United Kingdom privacy legislation until 2025.
- Central Securities Depositories (CSDs)
  - Risk: CSD cross-border services may have been disrupted.
  - U.K. action: Transitional regime allows CSDs outside the U.K. to continue providing services in the United Kingdom.
  - EU action / outcome: U.K. CSD completed migration of Irish securities to Euroclear Bank in March 2021 after a temporary equivalence decision.

### Current impact on financial stability and market fragmentation
- At the time of the FSAP, the impact of exit from the EU on the U.K. financial system is not creating financial instability, but risks of market fragmentation and uncertainty remain.
- Anticipation of loss of EU passports led some U.K. firms to set up EU establishments or restructure existing ones; relocation of assets and jobs is below initial estimates.
- Market fragmentation observed:
  - EU share trading in the United Kingdom largely migrated to the EU following rules requiring trading on domestic venues or equivalent third-country venues.
  - Some OTC derivatives trading (notably EUR interest rate swaps) shifted to EU and U.S. venues.
- Temporary U.K. relief mitigated the impact of fragmentation on U.K. firms.
- Industry impact: Increased costs due to reallocation of internal capital and cost of new authorizations; firms expect further optimization of EU footprints guided by future U.K. and EU regulatory developments and supervisory expectations.

### CCPs: long-term uncertainty and systemic considerations
- The long-term ability of U.K. CCPs to operate in the EU remains an open issue, especially for some EUR products.
- Short-term: No evident financial stability risks; the United Kingdom expected to remain a primary clearing center given that non-EU clearing members account for over 70 percent of activity and will stay at least until 2025.
- Broader concern: Increased costs to clear derivatives in case of market fragmentation (loss of multi-currency netting, higher margin requirements, concentrations) may create pressures globally to relax the clearing mandate, potentially weakening a key post-GFC reform important for financial stability.

### Prudential cooperation and crisis management
- Cooperation on prudential supervision and resolution of banks functions well via strong cross-border cooperation mandates in U.K. primary legislation and extensive cooperation arrangements with the EU.
- The effectiveness of crisis management arrangements will be tested in times of stress.

### Macrofinancial linkages, scenarios, and stress testing framework
- The FSAP assessed resilience using a baseline scenario aligned to the October 2021 WEO and two adverse (tail) scenarios over 2021–25; stress tests were built for corporates, households, banks, and insurers (appendices and figures referenced).
- Adverse scenarios:
  - Adverse Scenario 1: Recession with lasting economic scars from a protracted pandemic.
  - Adverse Scenario 2: Surge in global inflation and consequent tightening of global financial conditions.
- Recent developments (as of the FSAP) kept both adverse scenarios very present:
  - Omicron impacting global growth; international supply chains disrupted.
  - Supply-demand mismatches and higher energy/commodity prices could produce inflationary pressures and tighten global financial conditions.
  - The BOE increased its policy rate in December 2021 and announced a Quantitative Tightening strategy; expectations for U.S. policy tightening increased.
  - Current account deficits largely financed by portfolio investment; capital flow volatility is a potential vulnerability.

### Nonfinancial corporate (NFC) vulnerabilities and macrofinancial amplification
- SME vulnerabilities concentrated in sectors hardest hit by the pandemic.
- Baseline projections for SMEs in 2022–23:
  - Liquidity shortfall of 2 percent of turnover.
  - Equity gap of 1.5 percent of turnover.
- In the accommodation sector:
  - Liquidity shortfall reaches 4 percent of turnover.
  - Equity gap reaches 3 percent of turnover.
- BOE analysis referenced: Total debt increase from Dec 2019 to Mar 2021:
  - Large firms: about 2 percent.
  - SMEs: about 25 percent.
- Under the two adverse scenarios:
  - (a) Recession with scarring: share of firms experiencing financial stress would almost double. Public balance sheet would accumulate losses if guaranteed loan defaults increased, public debt would rise, tightening financing and slowing NFC recovery.
  - (b) Inflationary and tightening scenario: impact more concentrated in leveraged firms; higher interest rates and risk premia could outweigh stronger near-term growth. Fiscal financing needs would rise even without guaranteed defaults, private credit would be constrained due to more Gilt purchases and rising NPLs.

### Macroeconomic scenario highlights (selected figures)
- Real GDP growth in 2021: 0.5 (8.9) percent in 2021 under the first (second) adverse scenario.
- Unemployment: increases to 6.7 under the first adverse scenario.
- Inflation: peaks at 9.8 percent under the second adverse scenario.
- Exchange rate: pound appreciates in 2021 then depreciates during following two years of the scenario horizon.
- House prices:
  - Drop by -14.6 percent in 2021 under the first adverse scenario.
  - Drop by -9 percent in 2022 and 2023 under the second adverse scenario.
- Equity prices:
  - Drop by -5 percent in 2021 under the first adverse scenario.
  - Drop by -17 and -18.5 percent in 2022 and 2023, respectively, under the second adverse scenario.

### Household vulnerabilities
- Household indebtedness is a potential source of financial vulnerability; net financial wealth is high but assets are often illiquid and valuation-sensitive.
- Indebtedness largely stems from mortgages; 80 percent of mortgages are lent by banks, making mortgage vulnerabilities primarily relevant for banks.
- FSAP estimates:
  - Average mortgage arrears would increase moderately in 2021 and 2022 under the baseline scenario, remaining comparable with historical averages due to policy support.
  - The bottom quintile income group has the highest average probability of mortgage arrears.
  - Mortgage arrears risk would increase sizably under the inflationary and tightening of financial conditions scenario.

### Banking sector solvency and liquidity: stress-test outcomes
- Stress tests covered the eight largest U.K.-based banks; results suggest resilience to some severely adverse scenarios.
- Individual-level results:
  - Under Adverse Scenario 1, all banks remain above their hurdle rates.
  - Under Adverse Scenario 2, two banks fall below their hurdle rates with very small CET1 shortfalls amounting to 0.08 percent of GDP at the peak (or 0.035 after AT1 conversion).
- Credit risk characteristics:
  - Loan portfolio accounts for about 56 percent of total assets.
  - Mortgage loans account for about 54.9 percent of total exposures at default (EAD).
  - Corporate loans correspond to 32.5 percent of credit exposures.
  - Retail corresponds to 12.6 percent of credit exposures.
- Mortgage PDs:
  - Under Adverse Scenario 1, domestic mortgage PDs increase by 4pp at the start of 2022.
  - Under Adverse Scenario 2, domestic mortgage PDs initially fall and then peak at 7.7 percent by the end of 2023.
  - Foreign mortgage PDs peak at 8.1 in 2022 under Adverse Scenario 1 and reach 9.9 percent in 2023 under Adverse Scenario 2.
- CET1 ratio projections:
  - Under the baseline (October WEO), the CET1 ratio will increase by 1.9 percentage points by the end of the scenario horizon.
  - Under Adverse Scenario 1, the CET1 ratio reduces to 13.6 percent in 2022.
  - Under Adverse Scenario 2, the CET1 ratio reduces to 10.7 percent in 2022.
- Dynamic feedbacks:
  - Factoring in feedback effects, initial macroeconomic shocks could be amplified through weaker credit growth, translating into higher probabilities of default (PDs) and lower capital ratios by about 57 basis points throughout the scenarios’ horizon.
  - Macrofinancial feedbacks would reduce GDP further (GDP would be reduced by additional 0.65 p.p. in 2022, per the FSAP’s macrofinancial feedback analysis).

*Sources: HMT, BOE, and IMF staff.*

### 0.37 p.p. in 2023...

### 1gbrea2022002 - 0.37 p.p. in 2023...

### Banking sector stress testing and capital impacts
- Shock increases the PD of domestic portfolios by 33 and 43 bps in 2022 and 2023, respectively.
- As a result, capital ratios would reduce by 57 bps on average across the scenario horizon.
- Macro labor-market impacts noted: unemployment would be higher by 0.24 p.p. in 2022 and 2023; an incremental impact cited as 0.37 p.p. in 2023.
- Recommendation: The BOE could invest in completing and consolidating in‑house analytics to independently run top‑down stress tests at higher frequency and progressively cover all systemically relevant components and their interactions.

### Liquidity Coverage Ratio (LCR) and liquidity stress findings
- LCRs are currently well above the regulatory minimum of 100 percent for all banks surveyed.
- Stressed LCR simulation (combination of “haircut” and “outflows” scenarios) shows banks generally maintain high “total currencies” liquidity ratios under all scenarios.
- Single-currency analysis reveals potential FX liquidity shortfalls; more granular PRA 110 reporting on liquidity would help quantify FX liquidity gaps.

### Insurance sector — solvency, profitability, and liquidity
- During the pandemic, insurers' balance sheets proved stable; solvency ratios declined only temporarily in February/March 2020.
- Top-down stress test of 14 larger U.K. insurers (covering about 70 percent of the market) shows vulnerabilities from lower interest rates and equity price declines, particularly for life insurers.
- In the “scarring” scenario (downward interest rate shift):
  - Solvency ratios of two firms would drop below the 100 percent threshold with an aggregated capital shortfall of almost £9 billion.
  - Life insurers are considerably more affected than general insurers.
- Under tightening financial conditions scenario, aggregate impact is milder and even positive for life insurers because lower life insurance liabilities compensate for investment losses.
- Life insurers are largely resilient to variation margin calls in their interest rate swap portfolio; analysis of five large life insurers finds even sizable upward shifts in interest rates would not cause systemic liquidity stress.
- Liquidity risk drivers that require more granular monitoring: margin calls, higher outflows following policy surrenders or catastrophe events, and lower premiums.
- Recommendation: The PRA should enhance supervisory reporting and monitor cash pooling arrangements within insurance groups to analyze combined liquidity drains.

### Market-Based Finance and Nonbank Financial Intermediation (NBFI)
- NBFIs play important roles in CRE, SME lending, specific mortgage products, and unsecured consumer credit; some segments (buy-now-pay-later, corporate loans) remain outside the regulatory perimeter and lack granular data.
- Nearly half of funding of U.K. finance companies comes from banks.
- Balance-sheet linkages exist with overseas banks and asset managers.
- Bank and nonbank credit show a high degree of co-movement: 71 percent.
- Under the recessionary “scarring” scenario, nonbank credit contracts less and resumes growth faster than bank credit.
- Under tightening global financial conditions, nonbank lending contracts less and is less procyclical than bank lending.
- Recommendation: Disaggregated data at individual NBFI firm level is needed to capture heterogeneity and inform macroprudential policy.

### Central Counterparties (CCPs)
- U.K.-based CCPs (LCH Ltd., ICE Clear Europe Ltd., LME Clear Ltd.) are among the largest in the world; their aggregate initial margin (IM) is close to around 33 percent of total IM collected by CCPs worldwide.
- CCPs proved resilient in March 2020, but spikes in IM and VM exposed differing abilities by clearing members and clients to cope with higher liquidity needs.
- Recommendation: BOE’s proposed supervisory CCP stress testing framework could be augmented by increasing transparency under stress conditions and reporting stressed margin demands on clearing members and clients (e.g., estimated IM increases under stressed conditions).

### Asset managers and funds sector risks
- U.K. asset management industry AUM: £11 trillion.
- Industry employment: supports 114,000 people, including 42,200 directly employed.
- Contribution to GDP: about 1 percent.
- Global structures and funds domiciled outside the U.K. complicate monitoring; authorities rely on fund surveys and commercial databases.
- Liquidity risk assessment should be fund‑specific (redemptions, increased margins, funding risks, de‑levering).
- Money Market Funds (MMFs):
  - Non-government MMFs faced large withdrawals in March 2020.
  - Using AIFMD data, aggregate expected losses for AIFs in a March 2020-sized shock are limited, though large fund‑level variation exists.
- Recommendation: Continue to push for consistent use of liquidity management tools (enhanced swing pricing, more consistent liquidity classification of funds’ assets); FPC should ensure swing pricing and redemption notice periods are calibrated to underlying asset liquidity.

### MMF proportional liquidation profile (selected table figures)
- MMF portfolio reference date April 9, 2021, values in £ billions.
- Total Liquidation Needs: 22.0
- Liquidation Needs Government: 0.8
- Liquidation Needs Prime: 21.3
- Total Asset Government: 9.9
- Total Assets Prime: 231.0
- Liquidation Needs Government (In percent): entries include 8.9, 7.4, 0.8, 1.7, 7.6 (as reported)
- Liquidation Needs Prime (In percent): entries include 4.8, 6.2, 10.5, 9.3, 8.8, 6.9, 9.3, 6.9, 9.2 (as reported)
- Proportional liquidation maturity profile (selected rows):
  - Total Liquidation Needs by horizon (1 day to 181-365 days): 8.1, 2.0, 2.4, 2.7, 2.8, 3.1, 1.0
  - Total Asset Prime by horizon (1 day to 181-365 days): 79.0, 21.4, 28.6, 27.8, 28.7, 31.8, 13.8
  - Liquidation Needs Prime (In percent) by horizon: 9.6, 9.0, 8.3, 9.4, 9.6, 9.6, 7.0

### Systemic liquidity, BOE response, and policy options
- Pandemic stressed Gilts, FX, and cross‑currency swaps markets; BOE, with other central banks, augmented repo operations and front‑loaded bond purchases to support market liquidity.
- BOE provided FX via expanded and enhanced FX swaps lines in concert with other central banks.
- Government facilities: Covid Corporate Financing Facility (CCFF) and Term Funding Scheme with SME incentives (TFSME) backstopped nonfinancial firms.
- Observation: BOE’s toolkit could be reinforced by including some classes of appropriately regulated NBFIs to improve options in future stresses; focus should be on large, systemically interconnected NBFIs holding significant sterling securities in core markets (Gilts and Gilt repos).
- Design principles for NBFI-accessible facilities:
  - Reflect diverse nature of NBFIs and address moral hazard.
  - Backstops only for adequately supervised entities with prescriptive liquidity requirements.
  - Pricing to link ex‑post support with ex‑ante risk taking and to avoid discouraging market funding.
  - Clearly defined exit criteria communicated ex ante.
  - Foreign NBFIs could be factored in via arrangements with foreign supervisors or information sharing to ensure equivalent standards.

*Source: BOE, FINREP, COREP, and IMF staff calculations.*

### 37.      The continued surge in house prices warrants closer monitoring (Figure 21). House

### 37.      The continued surge in house prices warrants closer monitoring (Figure 21).

### Housing market developments and vulnerabilities
- House prices have posted the strongest gains since November 2004.
- The house price-to-earnings ratio, at 5.6, surpassed historical highs from 2007.
- The house price increase is more pronounced outside London.
- The share of new mortgage lending at high-LTI ratios also continues to rise.
- Booming transactions reflect support measures and other factors:
  - Stamp Duty Land Tax (SDLT)
  - Mortgage Guarantee Scheme (MGS)
  - larger household savings
  - demand for additional space
  - lower construction activity
  - advantageous financing conditions
- The share of new mortgages issued at high-LTV ratios remains low relative to the pre-pandemic period.
- In December 2021, the FPC judged that the LTI flow limit—which restricts the number of mortgages that lenders can extend at LTI ratios of 4.5 or higher to 15 percent of their new mortgage lending—plays a strong role in guarding against unsustainable household indebtedness through the housing market cycle.
- In the first half of 2022, the FPC will therefore consult on withdrawing its affordability test, noting that the FCA’s Mortgage Conduct of Business Framework still plays an important role.
- Any removal of the FPC’s affordability test, at this juncture, will require careful consideration, as housing prices have been rising markedly and inflation risks loom.
- The FCA’s Mortgage Conduct of Business Framework still requires that in many cases mortgage providers stress interest rates over a minimum five-year horizon.

### Commercial Real Estate (CRE)
- The CRE market continues to cool down.
- The CRE market slowed sharply following Brexit.
- The BOE recognized a potential fall in CRE prices as a domestic financial stability vulnerability in December 2019.
- The slowdown in the CRE market has accelerated during the pandemic.
- The BOE considered the risk of a potential third decline in CRE prices in its 2021 stress test.
- The FPC concluded that the banking sector is resilient to the overall stress scenario, including the sharp decline in CRE prices.
- The FSAP sees the potential systemic impact of CRE risks as contained.

### Climate-related vulnerabilities: scope of assessment
- Coverage: eight largest banks, eight largest life insurers, seven large general insurers, and a sample of investment and pensions funds.
- Methodologies:
  - Scenario-based analysis for transition risk.
  - Sensitivity analyses for physical risks.
- Transition risk source: a policy change that switches expectations from a low and relatively flat carbon price path to a high and steep one, in the United Kingdom and globally.

### Transition risk: scenario design and horizon
- Evolution of relevant risk factors was simulated up to 2050.
- Impacts are estimated based on a revision of asset valuations and risk repricing, assumed to occur within a five-year horizon.
- Models and scenarios used:
  - Sectoral model: GTAP-E.
  - Financial model suite for climate risks: CCA.
  - NGFS scenarios: “National Determined Contributions” (status quo), “1.5°C with Carbon Dioxide Removal”, and “Net Zero 2050”.
- The difference in valuations between the status quo and alternative scenarios represents the potential asset price correction affecting all marketable assets and the probabilities of default of companies.

### Transition risk: quantitative impacts (FSAP analysis)
- Under a switch from “National Determined Contributions” to “1.5°C with Carbon Dioxide Removal”:
  - Banks would suffer credit losses on their corporate loans higher, on average, than 1 percent.
  - Market losses on banks’ equity holdings: 3.5 percent on average.
  - Market losses on banks’ corporate bond holdings: 1.6 percent on average.
  - For insurers, the loss on investments would range between 1 and 3 percent of total investments.
  - Losses would be modest for U.K.-domiciled investments funds and defined benefit pension schemes.
- Under a switch to “Net Zero 2050” (orderly scenario with higher carbon price path and more dispersion across industries):
  - For banks, credit losses would more than triple.
  - For banks, market losses would almost double.
- Losses would be expected to be even higher under a switch to a disorderly transition scenario.

### Physical risk: quantitative impacts
- Chronic physical risk (reduction in GDP levels and growth because of global warming) sensitivity on banks’ sovereign bond portfolios:
  - Change in credit spreads could determine an overall drop of 0.6 percent in the aggregate value of banks’ sovereign bond portfolios.
  - If the increase in mean temperature is accompanied by an increase in its variability, the average impact could rise to 3 percent.
- Acute physical risk (intensification of natural disasters) sensitivity on general insurers’ technical reserves:
  - U.K. insurers are materially exposed to U.S. hurricanes, European windstorms, and domestic floods; reinsurers—mostly located outside the United Kingdom—provide effective risk mitigation.
  - Expected annual losses from natural disasters would increase by up to 50 percent (before reinsurance) if frequency and severity were to increase by 30 percent each.
  - More than 70 percent of the losses from a 1-in-200-year event would be recovered from (mostly international) reinsurers.

### Methodological approaches and sector coverage (summary)
- Scenario-based analysis (NGFS 'Phase I' and 'Phase II' + GTAP + CCA) used for:
  - Banks: corporate loan portfolio, securities portfolio (stocks, corporate bonds), and sovereign bonds (for physical risk).
  - Life insurers: securities portfolio (stocks, corporate bonds, funds).
  - General insurers: securities portfolio and technical reserves (physical risk).
  - U.K.-domiciled funds and pension funds: securities' holdings.
- Sensitivity analysis applied to mortgage LGD by U.K. region based on carbon price paths and buildings' Energy Performance Certificates (EPCs).

### Policy recommendation: BOE analytical capacity
- To retain leadership on climate-related risk analyses, the BOE should accelerate the development of its own analytical toolkit.
- Suggested enhancements:
  - Equip the BOE with a full-fledged suite of in-house models (macro, sectoral, micro) to run independent (top-down) scenario-based analyses of climate-related risks on financial institutions.
  - Deepen understanding of how financial firms’ climate-related risks will be influenced by public policies, particularly:
    - Transition risks (e.g., use of revenues from carbon taxes, energy efficiency measures, other decarbonization policies).
    - Physical risks (e.g., future role of Flood Re and general disaster prevention policies).

*Source: IMF staff analysis as presented in the United Kingdom FSAP chapter.*

### 52.      The United Kingdom operates a sound and transparent regulatory and supervisory

### The United Kingdom operates a sound and transparent regulatory and supervisory framework for banks and insurers

### Regulatory and supervisory framework — overall findings and recommendations
- The PRA uses an array of tools and techniques to implement its risk-based approach and has increased the intensity of supervision on non-systemic smaller banks.
- The regulatory framework for insurance supervision is sophisticated and the United Kingdom are leaders in supervisory techniques.
- The joint PRA-FCA Senior Manager and Certification Regime (SMCR) rolled out from 2016 is producing positive results, but the PRA has not yet used the full range of powers provided by the framework.
- Recommendation: Adopt a stronger ‘on-the-ground’ focus on individual banks, insurers and other systemically important financial firms and their activities, increasing use of the full range of existing tools more frequently, conducting in-depth investigations, and providing timely and substantive feedback to firms.
- Recommendation (banking supervision): Use the Section 166 Skilled Persons Review (S-166 Review) authority in a more proactive supplemental manner while the PRA increasingly develops more competencies internally; the S-166 Review should not be a long-term solution to inadequate resourcing.

### Operational resilience, cloud outsourcing, and third-party oversight
- Regulators have implemented reforms to enhance firms’ operational resilience.
- Cloud outsourcing raises operational (and potentially systemic) risks given the relatively small number of providers involved.
- Finding: The PRA and FCA lack express statutory authority to directly review and examine any critical services from cloud and other third-party providers to regulated entities.
- Recommendation: Seek legislation granting direct supervisory access to third-party providers.
- Recommendation (cyber resilience): Complement existing supervisory practices with onsite activities to verify operational effectiveness of cybersecurity controls and to capture cyber incident underreporting; consider specific resilience standards for systemically important third parties and their inclusion in resilience testing.

### Climate-related financial risks
- The PRA set a deadline of end-2021 for firms to have fully embedded supervisory expectations for the management of climate-related financial risks.
- In June 2021, the PRA launched a Climate Biennial Exploratory Scenario exercise to explore the resilience of major U.K. banks, insurers, and the financial system to these risks.
- The Climate Change Adaptation Reports published by the U.K. financial regulators conclude that financial institutions have made tangible progress against supervisory expectations on climate, but more remains to be done, especially regarding firms’ risk management and scenario analysis capabilities.
- Finding: Banks’ climate disclosures remain incomplete despite tangible progress.
- Recommendation: As proposals advance, U.K. authorities should specify regulatory standards and guidance with sufficiently detailed requirements and expectations, building on existing work and in accordance with international standards being developed.

### Banking-specific issues
- International banking activities are a major regulatory and supervisory responsibility of the United Kingdom; international banks, including G-SIBs undertaking corporate and investment banking (CIB) activities, can operate in the United Kingdom as either subsidiaries or branches.
- Finding: The United Kingdom’s entity-neutral approach is largely unique and presents limitations and practical challenges in the case of branches.
- Recommendation: The PRA should further enhance cooperation with relevant third-country home authorities to maximize information sharing and supervisory collaboration and review regularly whether the approach to supervising international banking firms delivers expected supervisory outcomes and preserves financial stability.
- Post-Brexit challenge: Streamline the prudential framework while continuing to meet internationally agreed standards; the post-Brexit regulatory structure is relatively complex, integrating EU legislation into a multilayered mix.
- PRA intention: Introduce proportionality measures into the prudential framework for banks that are neither systemically important nor internationally active.
- Principle: Non-internationally active banks must remain subject to rigorous prudential standards, broadly consistent with the Basel framework.

### Insurance-specific issues
- The United Kingdom has a highly developed framework for insurance supervision implemented by highly sophisticated regulators.
- FSAP detailed assessment outcome: 17 ICPs were found to be observed, six largely observed, and only one partly observed.
- The Solvency II framework is a rigorous prudential framework; conduct requirements are similarly robust.
- Recommendation: Post-Brexit, avoid reducing high standards while tailoring adopted European requirements to domestic and international aspects of the insurance market.
- Lloyds and London Market: The PRA should consider setting up a platform for supervisory cooperation for Lloyds to allow interactions with supervisors where Lloyds operates both regulated operations and in markets without physical operations.
- Institutional governance: Preserve the independence of the PRA and FCA; ensure requests for advice from HMT are made transparently and that PRA can provide independent and transparent advice.
- Recommendation: HMT and BOE/PRA should proceed with development of a resolution regime for insurers; currently no dedicated insurer resolution regime exists.
- Finding: The United Kingdom is assessed as partly observed for ICP 12 (exit from the market).

### Crosscutting challenges to financial stability
- LIBOR transition:
  - Most LIBOR settings ceased in December 2021 and all will end by June 2023, creating urgency to rebase contracts to risk-free rates (RFRs).
  - A voluminous stock of legacy contracts amounting to around U.S.$14 trillion needs transition, mainly in U.S. dollars.
  - Finding: Transition is well advanced in Sterling markets; progress is less advanced in key U.S. dollar markets traded in the United Kingdom, risking fragmentation.
  - Recommendation: End production of new LIBOR exposures, actively convert legacy instruments, and develop a forward-looking oversight regime to prevent re-emergence of LIBOR-like risks.
- Open Banking and crypto assets:
  - Open Banking launched in 2018 to increase competition; banks’ income from payment services is about 0.8 percentage points of return on equity and uptake has been slow.
  - Entry of platform-based technology companies could bring opportunities and risks; gradual process recommended to contain risks.
  - Finding: The United Kingdom has a proactive approach to crypto asset policy and risk tracking; regulations for crypto assets exist and regulations for stable coins are being developed following international guidance.
  - Recommendation: Maintain nimble policy and regulatory frameworks and allocate resources appropriately and timely to react quickly and prevent rapid buildup of risks to financial stability.
- Cybersecurity:
  - FPC set out a strategy in June 2017 to withstand and recover from cyber incidents.
  - The CBEST program (simulated attacks) is the cornerstone of testing strategy.
  - Recommendation: Complement supervisory practices with onsite verification of cybersecurity controls and consider statutory powers and standards for critical third-party providers.
- Combating financial crimes and safeguarding financial integrity:
  - The U.K. AML/CFT regime is among the most effective worldwide.
  - Tools: FCA modular/thematic supervision and data analysis; People with Significant Control (PSC) Register provides public access to beneficial ownership.
  - Recommendation: Leverage technology tools (e.g., machine learning) to enhance FCA’s risk-based supervision; use properly supervised “skilled persons” to supplement oversight for low-risk entities; have OPBAS conduct direct AML/CFT supervision for low-capacity or high-risk PBS; progress proposed legislation to improve verification in the PSC register and establish a beneficial ownership register for foreign entities owning U.K. properties.
  - Recommendation: Continue use of unexplained wealth orders to confiscate illicit assets and generate financial intelligence for cross-border investigations.
  - Reference: 2019–22 Economic Crime Plan.

### Preparing for future crises — resolution framework and crisis readiness
- Progress: Many 2016 FSAP recommendations on the financial safety net and crisis management have been followed.
- Objective: The United Kingdom is working towards the 2022 deadline to make all eight systemic U.K. banks resolvable.
- Tooling: A comprehensive Resolvability Assessment Framework (RAF) supports authorities and firms in meeting this commitment; material foreign subsidiaries and some mid-tier banks are subject to the RAF, except for reporting and disclosure requirements.
- Crisis readiness: BOE revamped crisis readiness governance, including a Heightened Contingency Framework Project; HMT advanced its Professionalizing Crisis Management Project; similar developments are ongoing at the FCA and the FSCS.
- Recommendation: Continue preparing for diverse failure scenarios, including fast-fail resolutions and concurrent failures of multiple systemic and mid-tier banks; continue testing and updating crisis readiness individually and collectively, including with U.S. and EU counterparts.

*International Monetary Fund.*

### 74.      The special resolution regime (SRR) for banks appears robust but assigns HMT a

### 1gbrea2022002 - 74.      The special resolution regime (SRR) for banks appears robust but assigns HMT a

### Special resolution regime (SRR) for banks — findings and recommendations
- Findings:
  - The SRR includes modified insolvency regimes for banks, building societies, and investment firms.
  - The BOE plays a crucial role in the court-based insolvency proceedings.
  - Under certain conditions, HMT can play a critical role in elements of firm-specific resolution decisions, including cross-border cases, although this remains untested.
  - Certain parts of the U.K. resolution regime that were introduced or maintained to comply with EU rules may constrain resolution funding.
- Policy recommendations:
  - Eliminate constraints in the rulebook that may limit resolution funding.
  - Review and explain measures to moderate HMT’s involvement in firm-specific resolution decisions, focusing HMT intervention on cases where public funds are at risk.
  - Strengthen the operational autonomy of the BOE where public funds are not at risk and of the FSCS regarding funding.
  - Ensure the BOE undertakes resolvability assessments of banks with a high degree of autonomy.

### Resolution regimes for CCPs and insurers
- Findings:
  - With modifications for CCP characteristics, the SRR applies to the three recognized U.K. CCPs, aiming to achieve objectives similar to the banks’ SRR under similar conditions and with similar powers.
  - The existing CCP regime predates pertinent international guidance issued since 2012 and predates implementation of the EU CCP RRP regime.
  - HMT is considering statutory changes for an expanded CCP resolution regime with more powers for BOE.
  - HMT, alongside the BOE, is considering an SRR for insurers; the PRA, together with the BOE, is developing an RRP approach for insurers.
- Policy recommendations:
  - Accelerate legislative and policy efforts for CCP and insurer resolution regimes.
  - Complement these efforts with a RAF-like regime.

### Internationally active mixed financial groups — risks and recent incidents
- Findings:
  - Internationally active financial groups seek arbitrage advantages via demand-side and technology-based shifts, diverting risk to jurisdictions with looser data, reporting, and oversight.
  - These entities include hybrid structures, finance companies, family offices, and other non-traditional forms; some are counterparties to CIB banks and some are supervised in the United Kingdom.
  - Recent high-profile cases involved excessive leverage in unregulated or lightly regulated entities and limited disclosure requirements.
  - Global supervisors later described the incidents as ‘nonsystemic’, but they highlighted neglected cross-border NBFI risks that could have become systemic under different circumstances.
  - Several banks and CIB branches lacked appropriate governance and risk management to monitor and mitigate risks from these activities.
  - Supervisors did not systematically monitor these positions in real time nor were they aware of common exposures across banks globally.
  - Elements in domestic regimes, such as the U.K.’s approach to “appointed representatives,” helped keep risks off supervisors’ radar.
  - Such entities are not subject to detailed regulatory public disclosure requirements; ongoing technology transformation could amplify arbitrage and bypassing of financial stability oversight.

### Data gaps, supervisory cooperation, and recommended actions
- Findings:
  - The United Kingdom is considering measures to address data gaps, but effective reform requires international cooperation due to the cross-border nature of activities.
- Policy recommendations:
  - Expand BOE biannual survey of prime brokers to include more granular cross-border, cross-market, and cross-product exposures.
  - Consider expanding oversight over internationally active NBFIs operating in the United Kingdom to include additional monitoring criteria.
  - Take a closer look at unregulated entities within mixed cross-border groups to evaluate their impact on regulated entities and potential systemic implications.
  - Review whether existing supervisory cooperation arrangements provide sufficient information-sharing for effective systemic risk monitoring.
  - Consider fundamental changes in the appointed representative regime.

### Agency independence, mandates, and resource needs
- Findings:
  - U.K. financial regulators have separate mandates focused on financial stability, safety and soundness, and market integrity; they also have secondary objectives to facilitate effective competition and support the government’s economic policy.
  - Since 2015, “Competitiveness” has been listed in Remit Letters by the Chancellor as an aspect the FPC and PRA should have regard to.
  - The Financial Services Act of 2021 introduced additional considerations that the PRA must have regard to when making rules implementing Basel III standards, including the international competitiveness of the U.K. financial sector.
  - HMT’s Financial Services Future Regulatory Review (FRF review) proposes empowering regulators to set regulatory and supervisory requirements while subject to enhanced accountability; it introduces a statutory secondary objective for the FCA and PRA to “facilitate the long-term growth and international competitiveness of the U.K. economy.”
  - Certain measures could constrain U.K. regulators’ ability to discharge new rulemaking responsibilities if not carefully designed.
- Policy recommendations:
  - Preserve the primacy of U.K. regulators’ general objectives in principle and practice.
  - Design proposals to avoid proliferation of wider financial services policy priorities that could divert focus from financial stability.
  - Ensure enhanced accountability and transparency mechanisms preserve regulators’ independence and operational effectiveness.
  - Maintain robust, high-quality regulatory standards that encourage investment and growth.

### Resourcing, capabilities, and technological leverage
- Findings:
  - Current resource levels are fully deployed given the range and nature of tasks outlined in the FSAP report.
  - New demands will arise from post-Brexit prudential rulemaking responsibilities, an increased number of firms to be supervised after Brexit, more intrusive supervisory practices, new climate change responsibilities, rapid technological change, major U.K. financial sector projects, and participation in international standard setting bodies.
- Policy recommendations:
  - BOE/PRA and FCA should carefully evaluate and maintain the level of resources required to deliver objectives for regulated firms.
  - Continue to pursue staffing resources for resolution and crisis management commensurate in quantity and quality with increasing demands.
  - Leverage technologies (big data and machine learning) and explore further data and platform synergies between the BOE/PRA and the FCA to support timely identification of risks and maximize oversight efficiencies.
  - Assign resources to complete implementation of FSAP recommendations where action has been initiated but work is underway.

### Authorities’ views — summary
- The authorities:
  - Welcomed the FSAP, agreed with much of the assessment, and found conclusions broadly reasonable.
  - Welcomed the positive endorsement of the U.K.’s financial stability framework, prudential policies, and the U.K.’s role as a global financial center.
  - Stressed commitment to high regulatory and supervisory standards and international cooperation.
  - Indicated intent to assess and follow up on FSAP recommendations and agreed to publish the FSSA and FSAP Technical Notes and the Detailed Assessment Report (DAR).
  - Welcomed IMF feedback on mitigation of financial stability risks from the end of the Brexit transition period and the U.K. response to the pandemic.
  - Emphasized intent to be at the forefront of global work on NBFI risks and acknowledged that modern finance complexities require stronger global cooperation.

### Selected stress-test framework and numeric details
- Market share: Approximately 75 percent of PRA-regulated banks’ lending to the United Kingdom real economy.
- Effective date (top-down baseline): end-December 2020.
- Stress test horizon: 5 years (2021-2025).
- Sample scope: Eight major banks and building societies included.
- Data sources: Banks’ submissions as part of the Annual Cyclical Scenario (ACS), FINREP, COREP, HBRD.
- Scenario information:
  - Three macroeconomic scenarios (baseline and two adverse) agreed with the authorities.
  - Baseline scenario based on the October 2021 WEO projections.
  - Scenario 1: Adverse with scarring — describes pandemic receding in first half of 2021, emergence of new variants, pandemic under control not earlier than late 2022 for advanced economies including The United Kingdom., and by the end of 2023 for the rest of the world; real GDP growth of only 0.5 percent (scenario narrative truncated in source).

*Source: 1gbrea2022002 (excerpts from IMF FSAP chapter).*

### 2021. Amid the intensifying pandemic real GDP recovers by only

### 1gbrea2022002 - 2021. Amid the intensifying pandemic real GDP recovers by only

### One macroeconomic scenario and adverse scenario used for 2021 solvency stress test
- The adverse scenario covers 2021–25 and is a severe path layered on the COVID shock of 2020, broadly consistent with the ‘double-dip’ scenario from the FPC’s reverse stress test of August 2020.
- The scenario represents an intensification of macroeconomic shocks seen in 2020.
- The traded risk stress is aligned with the macroeconomic scenario; there is no separate traded risk scenario.
- The global stress leads to higher perceived risk, lower risk appetite, and rising credit risks in several markets.
- Participating banks are required to submit stressed misconduct costs for known issues.
- Medium-term scarring: lower potential output growth by 0.3 percent relative to the pre-COVID period and a higher natural unemployment rate.
- Real GDP recovers by only 1.6 percent in 2022.

### Scenario 2 — Adverse with sudden tightening of global financial conditions
- Global recovery dynamics:
  - Consumer spending picks up supported by drawdown of pandemic savings for continuously employed workers and gradually receding government support for affected workers.
  - Low investment during the pandemic, business failures, and skill mismatches reduce global spare capacity.
  - Energy and commodity prices rise on a sustained basis as recovery proceeds.
  - Localization of key value chains reduces globalization’s role in productivity gains and disinflation.
- Monetary and financial conditions:
  - Major central banks accommodate near-term inflation; the Fed shows greater inflation tolerance under its new framework.
  - Policy rates remain near zero initially, but term premia rise sharply as markets revisit inflation expectations, increasing corporate and sovereign borrowing costs.
  - Central banks raise short-term rates rapidly by 2022/2023; uncertainty about quantitative tightening creates upwards pressure on term premia and long-term rates.
  - Equity prices are flat in the near term, then decline as policy tightening becomes inevitable.
  - In the United Kingdom, reduced foreign investor risk appetite leads to sterling depreciation and further goods price inflation.
- Real economy:
  - Intensifying supply-side snags prevent full recovery of potential output to the pre-COVID path despite easing pandemic-related supply restrictions.
  - Unemployment remains elevated despite some initial improvement.

### Risks and buffers — positions / risk factors assessed for banks
- Credit risk (provision costs):
  - Estimated according to Basel III framework.
  - Includes lending risk from exposures to sovereigns, public entities, financial institutions, corporates, mortgage-related lending, cross-border loan exposures, and retail lending.
- Sovereign risk:
  - Mark-to-market valuation of securities (trading book and AFS/FVO) linked to macro scenario shocks to interest rates and credit spreads.
- Market risk other than sovereign risk:
  - Stress from shocks to interest rates, credit spreads, exchange rates, commodities, and equity prices.
- Profits:
  - Interest income declines from lost income on defaulted loans.
  - Interest expenses increase due to rising funding costs with empirically estimated pass-through.
  - Net fee and commission income, other income and non-interest expense evolve with macroeconomic conditions.
  - No change in business models (no portfolio rebalancing) in some assumptions; banks’ submissions should reflect corporate plans and be adjusted for stress.
- Behavioral and balance sheet assumptions:
  - Loan portfolios assumed to grow uniformly at the nominal GDP growth rate of the scenarios, with no composition change except for new NPLs.
  - Balance sheet composition remains constant over the stress horizon in baseline assumptions; alternative approach allows dynamic balance sheets reflecting corporate plans.
  - Banks can only accumulate capital through retained earnings.
  - Maturing assets are replaced by exposures of the same type and risk.
  - Statutory/effective tax rates applied.
  - Dividend policy: under positive profits and capital ratios above hurdle rates, payout set at 30 percent; otherwise no dividend payout.
  - If capital ratios fall below regulatory minimum, no prompt corrective action is assumed.
  - Management actions are not incorporated under some assumptions; other approaches allow business-as-usual and strategic management actions.
- Reporting and linkage:
  - No mechanical link between stress test results and setting of capital buffers; the Bank will consider each bank’s capital low point against hurdle rates.

### Regulatory and market-based standards and parameters
- PDs and LGDs:
  - Point-in-Time (PiT) PDs and LGDs for expected losses (numerator of capital ratio) and Through-the-Cycle (TtC) PDs and LGDs for RWA (denominator).
  - Transition rates between IFRS 9 stages 1-2-3 inferred from available information.
  - Domestic Corporate PDs derived from corporate stress test output as a robustness check.
  - PDs and LGDs evolve with macroeconomic and financial variables of the scenario.
- Capital definition and hurdle rates:
  - Capital defined according to Basel III/PRA rulebook, including CET1, Tier 1, and total CAR.
  - Hurdle rates: Pillar 1 and 2A CET1 Requirements plus systemic buffers (G-SIB, O-SII, and SRB); leverage ratio requirements.
  - Results reported on a fully loaded basis; IFRS 9 transitional arrangements are not accounted for.
  - Banks required to apply IFRS 9 in starting position and throughout projection period.
  - Hurdle rates/reference points include Pillar 1 and 2A CET1 Requirements plus systemic buffers (G-SIB and SRB).

### Reporting format for results (banks)
- Outputs:
  - Evolution of CET1, Tier 1, and CAR for the aggregate banking system.
  - Decomposition of key drivers to aggregate net profits and aggregate CET1 capital ratios.
  - Cumulative impairment charges by bank for The United Kingdom and other specific countries impacted by the scenario.
  - Number of banks and share of total assets below hurdle rates.
- Publication timeline:
  - Individual firm-by-firm results from the stress test will be published in Q4 2021.
  - Aggregate information will also be published in Summer 2021.
  - Q4 publication will include decomposition of drivers to aggregate changes in CET1 and Tier 1 leverage ratio and details of aggregate impairments by asset class and geography.
- Note:
  - Refers to the 2021 Solvency Stress Test exercise rather than Annual Cyclical Scenario (ACS); key differences include that ACS includes baseline projections and a different approach to traded risk.

### Top-Down IMF insurance sector solvency risk (summary)
- Institutional perimeter:
  - 8 life insurance groups.
  - 6 general insurance groups.
  - Market share: Life: 71 percent (gross premiums written); Non-life: 70 percent (gross premiums written).
  - Consolidation: Group level. Data from regulatory reporting. Reference date: December 31, 2020.
- Methodology and time horizon:
  - Investment assets: market value changes after price shocks affecting solvency.
  - Insurance liabilities: change in best estimate via discount rate changes; risk margin proportionately changed.
  - Required capital after stress approximated by Solvency II standard formula also for internal model users.
  - Time horizon: Instantaneous shock.
- Tail shocks — Scarring scenario (selected exact shocks):
  - Risk-free interest rates (without volatility adjustment): -29 bps (1y GBP), -139 bps (10y GBP); -44 bps (1y EUR), -180 bps (10y EUR); -12 bps (1y USD), -143 bps (10y USD).
  - Sovereign bond spread: +80 bps (domestic), +70 bps (other low-yield AEs), up to +160 bps (EMDEs).
  - Stock prices: -19.5 percent (domestic), -25.0 percent (United States and Euro area), -15.0 percent (other advanced economies), -25.0 percent (emerging and developing economies).
  - Property prices: -14.6 percent (domestic, residential), -29.7 percent (domestic, commercial), -10.0 percent (foreign, residential), -18.0 percent (foreign, commercial).
  - Corporate bond spreads: between +70 bps (AAA, non-financials) and +290 bps (B and lower, non-financials); between +85 bps (AAA, financials) and +320 bps (B and lower, financials).
- Tail shocks — Tightening of financial conditions (selected exact shocks):
  - Risk-free interest rates: +462 bps (1y GBP), +111 bps (10y GBP); +335 bps (1y EUR), +61 bps (10y EUR); +240 bps (1y USD), +68 bps (10y USD).
  - Sovereign bond spread: +50 bps (domestic), +30 bps (other low-yield AEs), up to +180 bps (EMDEs).
  - Stock prices: -15.8 percent (domestic), -15.0 percent (United States and Euro area), -15.0 percent (other advanced economies), -30.0 percent (emerging and developing economies).
  - Property prices: -8.4 percent (domestic, residential), -20.1 percent (domestic, commercial), -6.0 percent (foreign, residential), -8.2 percent (foreign, commercial).
  - Corporate bond spreads: between +40 bps (AAA, non-financials) and +320 bps (B and lower, non-financials); between +70 bps (AAA, financials) and +360 bps (B and lower, financials).
- Sensitivity analysis:
  - Default of largest financial counterparty.
- Risks and buffers:
  - Market risks: interest rates, share prices, property prices, credit spreads.
  - Credit risks: default of largest financial counterparty.
  - Summation of risks; no diversification effects.
  - Buffers: Solvency II long-term guarantee measures and transitionals including Matching Adjustment (MA) and Transition on Technical Provisions (TMTP); unit-linked life insurance losses borne by policyholders.
  - Behavioral adjustments: None.
- Reporting outputs:
  - Impact on valuation of assets and liabilities.
  - Impact on solvency ratios (including and excluding long-term guarantee measures and transitionals).
  - Contribution of individual shocks to changes of eligible own funds.
  - Dispersion measures of solvency ratios.
  - Capital shortfall and possible de-risking of investment assets to re-establish full coverage of solvency requirements.

### Top-Down IMF insurance sector liquidity risk (summary)
- Institutional perimeter:
  - 5 life insurance groups: Aviva Group, Legal & General Group, M&G Group, Royal London Group, Scottish Widows Group.
  - Market share: Life: 51 percent (balance sheet assets). Data from regulatory reporting. Reference date: December 31, 2020.
- Methodology and time horizon:
  - Revaluation of derivative positions after interest rate shock.
  - Time horizon: Instantaneous (1 day, 5 days).
- Scenario analysis:
  - None.
- Sensitivity analysis:
  - Parallel shift of interest rate term structure for all currencies: +25 bps, +50 bps, +100 bps.
- Risks and buffers:
  - Liquidity risk: Margin calls for interest rate swaps.
  - Buffers: None.
  - Behavioral adjustments: None.
- Reporting outputs:
  - Total amount of variation margin calls.
  - Variation margin as percent of cash holdings.
  - Variation margin as percent of high-quality liquid assets.

### Risks — Likelihood and expected impact (selected entries)
- Global resurgence of the COVID-19 pandemic:
  - Likelihood: Medium.
  - Expected impact: Demand for contact-intensive sectors remains low; prolonged production cost increases; corporate bankruptcies and longer-term unemployment increase; bank losses on domestic and cross-border exposures; banks’ capital declines and weaker credit growth (second-round effects).
- Disorderly transformations (reshoring and global value chain shifts):
  - Likelihood: Medium.
  - Expected impact: Increased production costs and inflation; reduced potential output; prolonged unemployment and corporate insolvencies weighing on banks’ asset quality.
- De-anchoring of inflation expectations in the U.S.:
  - Likelihood: Medium.
  - Expected impact: Fast demand recovery plus supply constraints leads to sustained above-target inflation; Fed tightens earlier; front-loaded tightening of financial conditions and higher risk premia; higher debt service and refinancing costs causing defaults and credit losses; severe real estate price correction leading to loan losses and mark-to-market losses on debt securities.
- Rising commodity prices amid bouts of volatility:
  - Likelihood: Medium.
  - Expected impact: Persistent rise in import prices passes through to U.K. domestic inflation; volatility in financial markets and higher risk premia increases debt service burdens and leads to losses in banks’ bond portfolios.

*Source: 1gbrea2022002 - 2021. Amid the intensifying pandemic real GDP recovers by only*

### Appendix I

### Appendix I

### Structural Risks — FSAP Risk Assessment Matrix
- Cyber-attacks on critical infrastructure, institutions, and financial systems trigger systemic financial instability or widespread disruptions in socio-economic activities and remote work arrangements. Risk rating: Medium.
  - Disruptions in the real economy and in financial services undermine consumer and business confidence and negatively affect asset quality. Amid concerns about counterparty risk, funding market freeze and risk premia spike.
- Higher frequency and severity of natural disasters related to climate change cause severe economic damage to smaller economies susceptible to disruptions and accelerate emigration from these economies. A sequence of severe events in large economies reduces global GDP and prompts a recalculation of risk and growth prospects. Disasters hitting key infrastructure or disrupting trade raise commodity price levels and volatility. Risk rating: Medium.
  - Damages from increasingly frequent and severe hazards (esp. floods in The United Kingdom) and from increasing surface temperatures and extreme weather events (out of The United Kingdom) affect the probabilities of default of corporates and households and the value of their collateral, leading to an increase in banks’ credit losses.
- The global policy response to mounting evidence of climate change impact on the economy leads to a sharp acceleration of the transition to a low-carbon economy, determining a drastic reassessment of asset values and causing significant losses in equity and bond portfolios with large concentrations in high-carbon sectors.
- Stronger impact from Brexit. Greater implementation disruptions in the short term, and greater trade frictions with the EU (due to perceived regulatory divergence and EU location policies) and loss of financial and professional service business in the medium term. Risk rating: Medium.
  - Market fragmentation increases the cost of financial services and the continuing uncertainty about the adjustment path leads to a decrease in business investment and weighs on potential growth.

### Implementation Status of 2016 Key Recommendations — Overview
- Status as of November 2021 (Implemented, Partly Implemented, Not Implemented).
- Interim Status reported in the 2018 Article IV Consultation – IMF Country Report No. 18/316. This Appendix reports developments as of end June 2021.

### Financial stability policy framework — Key Recommendations and Statuses
1. Recommendation: Extend the Financial Policy Committee’s (FPC) powers of direction to the buy-to-let market. [Her Majesty’s Treasury (HMT)] (¶4, ¶21)
   - Time Frame: Near term
   - Status: Implemented. Legislation came into force in early 2017.

2. Recommendation: Extend perimeter of concurrent stress tests to cover large foreign subsidiaries. [BOE, PRA] (¶41)
   - Time Frame: Medium term
   - Status: Not Implemented.
     - The BOE reviewed the perimeter as part of updating its approach to stress testing and decided not to include these banks in the concurrent stress test at this time.
     - Rationale: A stress test of the United Kingdom entity alone is likely to be less informative than a group-level test and could provide false comfort if the legal entity is able to survive the stress test, but the group would not be able to survive a comparable stress event.
     - For U.K. subsidiaries of foreign-owned banks that do not participate in the concurrent stress test, the BOE’s supervisory approach is to focus on working with home supervisory authorities to assess parent group support to U.K. operations in a stress.

3. Recommendation: Complete core data template and enhance analytical infrastructure for concurrent stress tests. [BOE, PRA] (¶41)
   - Time Frame: Medium term
   - Status: Implementation in progress.
     - The number of core data templates increased from 14 in 2019 to 27 in 2020.
     - BOE in final stages of comprehensive review of data firms need to report from the 2022 stress test onwards.
     - Nearly all templates will be core, with integrated definitions and data quality rules; templates reviewed no more frequently than every three years.
     - BOE aims to migrate all core data templates onto a common data format, with integrated data controls, by 2022.
     - Model development: new models of Net Interest Income (NII)—including modelling of lending and deposit rates—and a granular model of large U.K. corporate impairments are at an advanced stage; enhanced toolkit for modelling financial market stresses including U.K. government bond securities and repo markets; model governance framework updated. Model development continues.

4. Recommendation: Develop a set of cross-sector interconnectedness indicators using flow of funds data, cross sector exposures, market-based indicators, and information produced by thematic analyses. [BOE, FCA] (¶15)
   - Time Frame: Medium term
   - Status: Implementation in progress.
     - BOE collects granular data from banks involved in annual concurrent stress test including borrowing and lending exposures to other financial institutions and granular data on tradeable asset holdings.
     - Enhanced Financial Accounts project: ONS published over 30 articles and experimental statistics by 2019, published experimental flow of funds matrix and “whom-to-whom” data for MMFs; non-MMF funds; OFIs; financial auxiliaries; captive financial institutions and money lenders; insurance corporations and pension funds.
     - October 2020: ONS published experimental balance sheet statistics for many financial sectors outside banking, investment funds, insurance, and pensions.
     - August 2020 FSR: FPC welcomed FSB mapping of critical connections in non-bank sectors with BOE and FCA participation.
     - BOE published Financial Stability Paper 42 and extended models in Staff Working Paper 803 and Staff Working Paper 809 on system-wide stress simulation.
     - Solvency II regulatory reporting and PRA ad-hoc reporting used to identify interconnectedness (Insurance Stress Test 2019), calibrate system-wide stress test models, identify potential liquidity strains and market impacts from fire sales, and identify insurers’ dependencies during COVID stresses.

### Financial sector oversight — Key Recommendations and Statuses
5. Recommendation: Increase the supervisory intensity on less systemically important banks (more frequent onsite inspections and greater scrutiny of asset classification and provisioning). [PRA] (¶27)
   - Time Frame: Near term
   - Status: Implementation in progress.
     - PRA senior leadership strengthened: four Head of Divisions overseeing non-systemic firms.
     - PRA shifted 6 percent of supervisory resource from large to non-systemic firm supervision over the past two years.
     - Risk specialist teams bolstered by three new senior technical specialist roles.
     - 2018/19 thematic review of fast-growing firms completed.
     - 2020: BOE undertook desk-based stress test of all non-systemic U.K. banks and building societies (over 100) during COVID-19.
     - Number of non-systemic firms considered higher risk more than doubled over the past five years to be 19 firms today.
     - Enhanced data collection (Branch Return) and development of analytical tools and dashboards for internationally headquartered groups’ non-systemic firms.
     - Financial Resources and Credit pool established for International Banks Directorate (IBD) to conduct CSREP and LSREP work and credit reviews.
     - Since 2017, PRA senior leadership meets three times a year to scan the horizon for emerging and evolving risks.

6. Recommendation: Extend, if legally possible, the scope of transparency reporting under the Alternative Investment Fund Managers Directive (AIFMD) to cover non-EEA managers and funds, where relevant for systemic risk monitoring, and strive for enhanced international exchange of information. [HMT and FCA] (¶34)
   - Time Frame: Near term
   - Status: Implemented.
     - Since July 2017, the FCA has obtained information from:
       - (1) Non-EEA AIFMs on their quarterly-reporting non-EEA master funds if the corresponding feeder funds are marketed in The United Kingdom
       - (2) U.K. AIFMs on all their non-EEA funds not marketed in the EEA.

7. Recommendation: Ensure that Broker Crossing Networks’ (BCNs) activities are sufficiently supervised and monitored. [FCA] (¶33)
   - Time Frame: Near term
   - Status: Implemented.
     - FCA completed a review of the structure of the equity market in 2019 including visits to firms operating as Systematic Internalisers (SI) and previously operating BCNs.
     - Review assessed trading models and systems and controls for pre-trade transparency and conflicts of interest; feedback provided and ongoing supervision of SI activities according to FCA supervision model.

8. Recommendation: Broaden the review of bank internal models to cover a greater sample of less material models and models of smaller banks. [PRA] (¶28)
   - Time Frame: Medium term
   - Status: Implemented in progress.
     - PRA seeks to review at least 60 percent of firms’ modelled credit risk RWAs.
     - Commencing comprehensive cross-firm review of all IRB models (material and less material) to meet new regulatory standards in Policy Statements 7/19 (definition of default) and 11/20 (PD and LGD estimation).
     - Expectation that firms reduce unwarranted variability in IRB model-driven RWAs; all firms using IRB for mortgage exposures, whatever their size, will need to use a hybrid model by end January 2022.
     - Programme for mortgage exposures due to be completed by 2021 and by 2022 for other asset classes.

9. Recommendation: Introduce agreements like those under the European Insurance and Occupational Pensions Authority (EIOPA) requirements for colleges for insurers with significant business outside the EEA. [PRA, FCA] (¶31)
   - Time Frame: Medium term
   - Status: Implemented.
     - PRA supervisory practices aligned to IAIS ICP25 requirements including ComFrame.
     - Supervisory colleges in place for all significant groups supervised by PRA; supervisory coordination arrangements for small groups with limited international footprint.
     - PRA organises and chairs colleges when it is the home supervisor; FCA participates based on risk assessment and remit.

### Financial market infrastructures — Key Recommendations and Statuses
10. Recommendation: Consider alternative structures for the oversight and management of risk within The United Kingdom High-Value Payments system (HVPS) and finalize the self-assessment of the Real Time Gross Settlement System (RTGS) infrastructure against the Principles for Financial Markets Infrastructures. [BOE] (¶38)
    - Time Frame: Near term
    - Status: Implemented.
      - April 2017: FPC agreed financial stability risks from current HVPS delivery structure and welcomed BOE’s proposed move to direct delivery.
      - November 2017: BOE completed transfer to direct delivery, becoming HVPS scheme operator (previously CHAPS Co) alongside operating RTGS.
      - Self-assessment of RTGS infrastructure against the Principles for Financial Markets Infrastructures completed and published.

11. Recommendation: Continue with the de-tiering project for payment systems and EUI and consider, as part of the RTGS review, increasing settlement in central bank money for CCP-embedded payment system transactions by increasing the number of CCP members that are also members of the HVPS. [BOE] (¶37)
    - Time Frame: Medium term
    - Status: Partly implemented/Underway.
      - Firm-specific actions promoting de-tiering and opening access to payment systems taken; number of CHAPS and Faster Payments Services direct participants increased significantly between 2016 and 2020.
      - As part of RTGS review, BOE engaged with CCPs and clearing members on benefits of direct CHAPS membership and features of a rebuilt RTGS to promote broader clearing usage.
      - Further de-tiering work likely a medium-term deliverable given RTGS rebuild and new policy challenges.

### Crisis Management and Resolution — Key Recommendations and Statuses
12. Recommendation: Build on current arrangements to develop operating principles for funding of firms in resolution. [HMT, BOE, and the FSCS] (¶51)
    - Time Frame: Near term
    - Status: Implemented.
      - 2017: U.K. authorities set up a flexible Resolution Liquidity Framework (RLF) for banks, building societies, and investment firms.
      - RLF offers liquidity support to entities or their holding company in a BOE-led resolution.
      - RLF complements Sterling Monetary Framework facilities and Emergency Liquidity Assistance, available before and after resolution provided firms qualify and meet requirements.

13. Recommendation: Work with international partners to develop an effective resolution regime for insurance firms that could be systemically significant at the point of failure. [HMT, BOE, PRA] (¶47)
    - Time Frame: Medium term
    - Status: Not implemented.
      - The United Kingdom has not yet implemented a comprehensive insurer resolution regime.
      - Participated in IAIS developments that enhanced ICP 12 requirements.
      - 2021 Detailed Assessment Report found that the United Kingdom only partly observes ICP 12 in its updated form.
      - United Kingdom needs to focus on implementing a comprehensive insurer resolution regime that meets ICP 12 and considers the FSB’s Key Attributes Assessment Methodology for the insurance sector.

14. Recommendation: Establish an approach for engaging with countries that are not members of CMGs but where U.K. banks and CCPs have a systemic presence. [BOE] (¶39, ¶52)
    - Time Frame: Medium term
    - Status: Partially Implemented.
      - No regular (e.g., annual) process to identify and engage with non-CMG host jurisdictions where U.K. GSIBs have a systemic presence.
      - U.K. authorities engage with non-CMG host authorities through: (i) a regional CMG in Asia for one U.K. GSIB, (ii) regional and non-core supervisory colleges, and (iii) SRB-led resolution colleges for major EU banks.
      - BOE monitors U.K. GSIBs’ global operations to determine CMG composition adjustments; composition has been adjusted in Asia for one GSIB.
      - For systemic CCPs, the CPMI-IOSCO ‘SI>1’ process helps identify host jurisdictions where the two U.K. global systemically important CCPs have a systemic presence; over three-quarters of these jurisdictions are members of the CCPs’ CMGs; all jurisdictions are represented at the FSB fmiCBCM, providing a platform to engage with non-CMG jurisdictions.

_Appendix I — Implementation Status of 2016 Key Recommendations (Status as of November 2021; developments reported as of end June 2021)._

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1gbrea2022002.pdf_