## _cr11230 - Executive Summary

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### Overall assessment
- Authorities have a comprehensive strategy to enhance prudential regulation and supervision and to meld macro prudential (systemic) considerations with micro prudential regulation and supervision.
- Proposals clarify accountabilities and mandates considerably from current arrangements and provide a well-developed framework for coordination and cooperation.
- Mission concurs with authorities’ assessment that implementation risks are "medium-high"; quality of implementation will be essential for success.
- High quality of resources devoted by authorities to developing the policy framework and implementation issues was noted.
- Financial Services Authority (FSA) has a well-developed change management process broadly on track with appropriate project management disciplines.

### Institutional design: U.K. “triple peak” structure and mandates
- The existing tripartite regulatory regime will be dismantled; the FSA will cease to exist in its current form; a "three peak" structure to be put in place by end-2012.
- Components of the new structure:
  - Prudential Regulation Authority (PRA): subsidiary of the Bank of England (BoE), prudential regulation of banks, investment banks, building societies, and insurance companies.
  - Financial Policy Committee (FPC): independent committee at the BoE responsible for stability of the financial system as a whole.
  - Financial Conduct Authority (FCA): responsible for conduct regulation of authorized financial firms, market regulation, and prudential regulation of smaller entities.
- Concerns and recommendations:
  - FCA’s broad remit is subject to some lack of clarity similar to the FSA’s current mandate; authorities should ensure market regulation and supervision, and prudential supervision of FCA firms, do not become diluted.
  - References to "competition and competitiveness" have been significantly reduced or eliminated in mandates; authorities should resist reintroducing such concepts.

### Macro-prudential framework and FPC toolkit
- FPC will have powers over certain prudential tools that are specific, subject to U.K. national discretion under EU directives, and focused on system-wide characteristics.
- Planned toolkit items under consultation include:
  - the countercyclical capital buffer under Basel III,
  - the overall leverage limits,
  - variable risk weights for a class of assets,
  - margin or haircut requirements,
  - possible cyclical changes in minimum liquidity ratios.
- FPC powers and roles:
  - Ability to require the PRA (and the FCA) to undertake systemic stress tests or conduct them itself.
  - Responsibility for making public recommendations to HMT for adjustments in the regulatory perimeter and in the FPC toolkit.
- Recommendation: An interim articulation of the macro prudential risk framework and policy assessment process would be useful; BoE, with support from the PRA and FCA, may set out that framework before finalization.

### Governance, coordination, and culture
- Well-developed framework for cooperation and coordination included; experience suggests need for a forum for formal and/or informal relationship building, cooperation, and coordination, especially for crisis operation.
- A clear locus for all regulatory agencies to interact may assist U.K. engagement with the EFSB and ESAs.
- Success depends on bringing together different cultures of micro- and macro-prudential regulation and supervision in the BoE and the PRA; senior leadership attention is required.
- Practical measures to foster cooperation: inter-agency work teams and inter-agency secondments.

### Supervisory operating model and prudential supervision enhancements
- Authorities developing a revised risk assessment and supervisory model for banking, building on existing and proposed FSA frameworks with added elements such as systemic importance, interconnections, and resolvability assessments.
- FSAP noted additional considerable work needed to implement elements for very-high-impact banks and to extend it to other high-impact banks and insurers.
- FSAP recommendations and suggested supervisory improvements:
  - More frequent detailed in-depth supervisory review work to confirm FSA assessments of inherent risk and quality of risk management and governance.
  - Better focus supervisory activity on major risk areas and risk-management deficiencies.
  - Better integrate specialist and supervisory work.
  - Simplify and enhance usefulness of the ARROW risk model.
  - De-layer and better integrate supervisory processes to free up time for focused supervisory work and clearer messages to bank senior management and boards.
- Moving to a single-purpose prudential organization in the PRA provides an opportunity for more senior management engagement on prudential issues.

### Systemic analysis, resolvability, and the Special Resolution Regime (SRR)
- New macro prudential analysis, resolvability, and the SRR, and the possibility of material capital buffers, do not reduce need for intensified supervision focused on risk management, governance, capital and liquidity.
- Focus on "not yet problem" banks is important to catch early indicators of material future problems.
- Authorities should avoid seeking false precision in new systemic add-ons; frequency of full assessments of systemic modules and cross-system stress tests should be considered realistically.
- Knowledge on network impacts is valuable but not easy to assemble; important international dimensions imply realistic time frames for major enhancements.

### Proactive intervention framework
- Proposals include a proactive intervention framework which the mission supports.
- Framework characteristics:
  - Flexible and promotes early action to reduce likelihood of material problems developing.
  - Deals with action steps in advance of recovery or resolution, including coordination actions by various authorities.
- Recommendation: Legislation should include a reference to proactive early intervention in relevant mandates to support desired supervisory culture.

### Implementation timing and transitional arrangements
- Proposals not finalized at time of mission but expected to be fully in place starting in 2013.
- Timeline details:
  - A further consultation paper with more detail and draft legislation elements released in February 2011.
  - Legislation to be finalized and presented to parliament later in 2011.
  - Target is passage of legislation in 2012 to permit formal implementation at the beginning of 2013.
- Interim preparatory steps:
  - FSA has started implementing internally two interim organizations mirroring expected split into prudential and market conduct regulation, though not fully in place at mission time.
  - An interim FPC has been set up, including appointment of external members, though it had not commenced operating at the time of the mission.
- Observation: Details are specific to U.K. circumstances; other countries may need different approaches to meet G-20 and FSB goals.

### Resources, scope, and sequencing
- Mission recommendations for authorities:
  - Define the desired supervisory operating model.
  - Decide how much more enhanced in-depth supervisory reviews are needed.
  - Determine how the macro-overlay will work.
  - Decide on desired frequency of cross-system stress testing.
  - Determine economies from supervisory process improvement.
  - Focus and form better IT and analysis of more granular data from banks.
- Mission’s sense: Timely completion of planned enhancements, macro prudential initiatives, resolvability assessment, and other recommendations will necessitate enhancement in resources (enhanced skills and/or more persons) beyond that already planned.
- Essential that the macro overlay not draw away resources from needed enhancements in micro prudential supervision.

*Technical note prepared by Nicholas Le Pan and Göran Lind for the IMF Financial Sector Assessment Program (FSAP).*

### Goals of the new arrangements (paragraph 11)
- Create a dedicated focus on macro prudential analysis and action with responsibilities and tools aligned.
- Introduce a more-judgment-based approach to regulation/supervision of individual firms to challenge business models, identify risks and take action to preserve stability.
- Eliminate gaps where responsibilities are unclear.
- Establish a dedicated specialized body with clear objectives and functions for conduct of business/market integrity regulation and supervision with its own culture.

### Implementation risk and leadership (paragraph 12 and context)
- Authorities assessed implementation risk as medium-high.
- Contributing factors:
  - Long and uncertain timing.
  - Uncertainty about how key elements will work in practice.
  - Leadership for effective implementation and change management facing other demands from remedial programs and regulatory policy agenda.
  - Recent resignations of senior, experienced staff leading to uncertainties about full leadership team; progress continued to name individuals to key positions, especially within the shadow PRA.

### Mandates — general observations (paragraphs 13–16, 26–33)
- Government proposes clarifying mandates; current prudential mandates judged less than clear.
- Legislated mandates (regulatory objectives) are central to performance and accountability in the U.K.
- Proposed PRA objectives:
  - Primary strategic objective: “to contribute to the promotion of the stability of the U.K. financial system.”
  - Operational objective: “promoting the safety and soundness of PRA authorized firms,” including minimizing adverse effects of firm failure on the U.K. financial system (paragraph 26).
- Mission supports clarifying PRA focus on prudential regulation and explicitly recognizing possibility of firm failure and PRA’s role in minimizing disruption.
- Mission notes absence of explicit reference to proactive, timely intervention in proposed legislation; FSB suggests adding such a reference.
- Recommendation: Maintain adequate enforcement capability in the PRA—either relying on FCA enforcement or, more desirably, developing its own reduced permanent enforcement capability (paragraph 33).
- Legislative removal of competitiveness considerations is supported to avoid hampering effective intervention.

### BoE and FPC mandate (paragraphs 17–25)
- Proposed BoE amendment: state “an objective of the Bank is to protect and enhance the stability of the financial system of the United Kingdom.”
- FPC: committee of the court of the bank with a mandate to contribute to the financial stability objective; responsibilities include identifying systemic risk, monitoring and taking action to reduce/remove systemic risks to protect and enhance resilience.
- Systemic risks include structural market features, distribution of risk within financial sector, unsustainable leverage, debt or credit growth.
- FPC tools include specific warnings, regular financial stability reports, recommendations or directions to PRA and FCA; secondary legislation will detail tools such as invoking Basel III counter-cyclical buffer, changing risk weights, and changing leverage limits.
- Government rejected requiring BoE or FPC to balance multiple primary objectives or explicitly have regard to lending to support economic growth; legislation to state FPC functions should not be exercised in ways likely to have a significantly adverse effect on ability of financial sector to contribute to growth over medium or long term.
- FPC will not decide prudential or conduct rules for individual firms; not lead on crisis management or emergency liquidity assistance.
- FPC may deal with more structural macro prudential tools; trade-offs may involve socio-economic policy goals and competitiveness considerations.
- FPC can make recommendations to HMT on regulatory perimeter and toolkit; PRA has authority to veto FCA decisions likely to lead to disorderly failure, with notification to parliament and disclosure in the annual report—expectation is this veto would be rarely used.
- MACRO prudential toolkit should be specific and focused on system-wide aspects; individual directions may nonetheless materially affect firms.
- FPC and MPC separation preserves accountability; governor to chair both with staging of meetings proposed (MPC likely to act last).
- Information flows should be bidirectional between PRA/FCA and FPC; PRA needs sufficient financial stability staff and a limited number should liaise between micro and macro matters.

### FCA mandate and markets regulation (paragraphs 34–35)
- Proposed FCA objective: to protect and enhance confidence in the U.K. financial system.
- Proposed FCA operational objectives: facilitating efficiency and choice in the market for financial services; securing an appropriate degree of protection for consumers; protecting and enhancing integrity of the U.K. financial system.
- FCA intended to intervene earlier in product lifecycles to improve consumer outcomes and to act as a ‘consumer champion’ without becoming an advocate—balancing may be challenging.
- FCA expected to promote competition in pursuing objectives.
- Markets regulation and enforcement functions to be strong; considerations:
  - Explicit mention of markets regulation matters (transparency and integrity) in FCA statutory objectives.
  - Ensure a senior executive clearly responsible for markets regulation and supervision.
  - Ensure markets regulation expertise on the FCA Board.
- FCA will have the U.K. seat on ESMA.
- Risk: role of ‘consumer champion’ may be misinterpreted and market regulation could become the “poor cousin”; ensure FCA involvement in market infrastructure regulation with sufficient statutory basis.

### Governance and Accountability Framework (paragraph 36 and context)
- Design elements:
  - FPC: sub-committee of BoE’s court, chaired by the governor, with independent members (not majority), senior BoE staff, and heads of PRA and FCA.
  - PRA governed by a board chaired by the governor, majority independent members.
  - FCA governed by an independent board with majority independent members.
- Cross-appointments and roles:
  - CEO of the PRA will also be a deputy governor of the BoE and a member of the FPC.
  - CEO of the FCA will also be on the FPC.
  - Deputy governor for financial stability at BoE to remain on PRA Board.
  - Heads of PRA and FCA to be on each other’s boards; CEOs will not have voting authority on firm-specific decisions.
- Independence and accountability concerns:
  - Arrangements may raise questions on PRA independence; future standards assessments will depend on actual practice.
  - PRA operational independence principle: PRA decisions should be taken by the board or under board-delegated authority and only in pursuit of PRA objectives.
- Appointments and governance:
  - PRA Board members will take significant roles in firm-specific decisions and rule setting.
  - Nominations Committee of the Court to advise on executive appointments; PRA Board appointments made by BoE with HMT approval; HMT to name CEOs of PRA and FCA.
- Budget and remuneration:
  - Proposed budget and remuneration of PRA to be set by court of BoE on PRA recommendation.
  - Court contains a majority of non-executive directors, some current industry participants, requiring recusal in case of conflict under BoE Act.
- Monitoring and remediation:
  - HMT as overall “owner” should monitor arrangements and deal with material issues.
- Public reporting and transparency:
  - Financial stability publications and public reporting to continue; FPC directions reported to HMT and parliament; PRA overrides of FCA measures to be reported.
  - MOUs to be published, reviewed annually, and laid before Parliament.
- Regulatory failure reporting:
  - New legislative requirement for regulator to report to HMT where there is a “regulatory failure,” addressing actions, decisions and lessons learned; report to be laid before parliament.

### Framework for Cooperation and Coordination
- Objective: balance enhanced focus of individual authorities with checks and balances and coordination (ongoing and in crisis).
- Coordination challenges:
  - Need ongoing coordination between macro financial stability objectives and PRA/FCA micro prudential operations; actions by one authority could affect the other’s mandate achievement.
  - Coordination in a crisis is distinct and requires clear mechanisms.
- Information sharing:
  - Timely access to each other’s information is essential; managed through legal “gateways” in legislation/regulation.
  - Bias should be for maximum access to preserve flexibility and responsiveness in a crisis.
  - FPC expected to receive information from PRA (including “watch list” trends), FCA (securities market developments), and BoE (market and financial stability developments, payment systems participation, BoE facilities).
- Legislative duty to coordinate and MOUs:
  - Government proposes legislation imposing a general duty to coordinate on all authorities; MOUs to deliver day-to-day coordination and must be published and reviewed annually.
  - HMT paper indicates consultation requirements when actions may ‘materially impact’ another’s objectives, for mutual consultation, and obligations to manage processes congruently and efficiently.
- Cultural and practical enablers:
  - Cooperation requires openness, trust, understanding of mandates, senior leadership time, staff movement between organizations, and inter-agency work teams.
- Risks of diffusion and convening forum:
  - Danger of diffusion of coordination efforts; no single forum identified for all senior regulators to build relationships and identify issues early—such a forum could mirror emerging European stability bodies.
- Specific PRA–FCA mechanisms:
  - PRA veto over FCA actions that would lead to disorderly failure, with parliamentary disclosure; veto expected to be used sparingly and authorities should consider expeditious consultation with FPC before use.
  - Authorization and variation of permissions: both PRA and FCA to provide authorization for dual-regulated firms, each able to vary permissions; PRA may override FCA actions leading to disorderly failure.
  - Split lead responsibilities in dual-regulated firms: PRA lead on prudential matters; FCA lead on customer interface matters; both retain authority to ban approved persons.
  - Consolidation and consolidated supervision: PRA to be consolidated supervisor for major U.K. bank and insurance groups with new directional powers over other supervisors and unregulated holding companies; effective practical arrangements are important for comprehensive consolidated supervision.

### Macroprudential framework and challenges (paragraphs 56–61)
- Having BoE and FPC macro financial stability insights available to micro supervisors could contribute effectively to micro prudential work; authorities plan to retain reduced financial stability expertise.
- Key design and implementation challenges:
  - Use of systemic risk measures expected to be infrequent, complicating timing and effectiveness assessment.
  - Systemic risk analysis often concerns tail outcomes which models handle poorly.
  - Period of experimentation needed before identifying ranges and thresholds for action.
  - Staff should be encouraged to focus on tail risks and fault lines.
  - Analysis of available tools may depend on what prudential measures under EU rules are subject to national discretion.
- Communication: ongoing communication needed to keep macro prudential expectations reasonable; stability communication itself is a tool and may be coupled with FPC-controlled measures.
- Recommendation (paragraph 61): Markets, governments, and U.K. authorities would benefit from greater interim articulation of the macro prudential risk framework and monitoring process; BoE (with PRA and FCA support) could set out an interim framework prior to finalization to aid clarity and transparency.

### Interaction between macro and micro prudential measures (paragraph 58)
- Proposals aim to separate responsibilities: micro prudential in PRA, macro prudential with FPC, while locating both in the same institutional structure to underpin interaction.
- Dividing line likely to be less clear in practice, especially where a few banks dominate market share and their reactions to measures are key.
- Material micro prudential measures directed at large banks could have macro aspects requiring consideration.
- Countercyclical measures must be symmetric (buffers should go both up and down); timing, interpretation of reductions, and communication are important.
- Authorities designed formal coordination and decision-making measures; consensus building is important to maximize effectiveness.

### Implementation needs and near-term actions (paragraph 60)
- Work to design implementation details must involve:
  - enhanced data collection and analysis, including data from outside the regulated sector;
  - an enhanced analytical framework, including a macro risk assessment framework;
  - development of a suite of indicators, including administrative and market data;
  - thinking on thresholds for judgments on possible actions;
  - an effective communication approach to support market reactions as intended;
  - thinking on how BoE and FPC will provide macro prudential and market analysis to PRA and FCA and integrate it into supervisory frameworks;
  - active monitoring of unique issues, such as risk build ups in CCPs and their risk management capability.
- Near-term recommendation: BoE with PRA and FCA support could set out an interim macro prudential framework that will evolve with operation and international progress.

### Supervisory operating model for banking prudential supervision (paragraphs 62–68)
- Authorities developing a revised model to deliver a more judgment-based, proactive, early intervention regime focusing on safety, soundness, and financial stability.
- ARROW to be replaced by a new PRA risk model focused on system impact of firm failure; model to be simpler and allow significant supervisory judgments.
- SEP and CPP are starting points, with additions for systemic impact and resolvability assessments; proposed new initial module to assess gross system impact of a firm’s failure based in part on recovery and resolution plan analysis and inter-linkages.
- Recovery and resolution planning assessments have started and can help identify vulnerabilities; effectiveness of new resolution tools for major banks may be untested for some time.
- Resource realism:
  - Authorities should avoid false precision in systemic add-ons at expense of core supervision enhancements.
  - Frequency of full assessments of systemic modules and cross-system stress tests should be considered pragmatically.
  - New model requires considerable work identifying interconnections; network impact analysis has important international dimensions and realistic time frames for enhancements.
- Roles and accountability:
  - Bringing macro analysis into risk assessment diffuses responsibility; achieving constructive bottom-up and top-down assessments with constructive challenge is crucial.
  - Senior leadership of BoE and PRA must actively monitor the new risk assessment and intervention system early in implementation.
- Continued need for intensified supervision: macro prudential tools and SRR do not replace intensified supervision focused on risk management, governance, capital and liquidity.

### Supervisory operating model for insurance prudential supervision (paragraphs 69–73)
- Revised risk assessment and supervisory model for insurers intended; U.K. to implement Solvency II.
- For very-high-impact insurers, model will use parts of CPP supplemented with resolvability analysis; smaller insurers supervised via monitoring/outlier analysis with occasional in-depth reviews; medium-size insurers likely intermediate intensity with more frequent detailed reviews.
- Systemic risks in insurance differ from banks but failures could be locally systemic; large insurer failure could destabilize markets via asset-side actions or anticipation effects.
- Traditional view that insurance cannot suffer liquidity runs may not be wholly accurate due to certain liabilities; balance sheets can contain liquidity and market risk comparable to banks.
- Supervision benefits from co-located banking and insurance supervision; mission supports assigning insurers to PRA.
- Resolution framework:
  - SRR does not currently apply to insurers; applying SRR to insurers is being considered.
  - Resolving a major insurer likely to be complex and challenging.
- Supervision tools and model risk:
  - Effective supervision requires risk specialists and actuarial analysis; business model and stress testing important; attention to risk management and governance quality essential.
  - Enhanced use of models under Solvency II poses challenges; qualitative conditions for model use must be emphasized.
  - U.K. needs to preserve ability to use individual capital guidance (Pillar II) for insurers.
  - A robust resolvability regime and Pillar II cannot substitute for adequate supervision.

### Proactive intervention framework (paragraphs 74–76)
- Authorities intend to implement a proactive intervention regime; mission supports it. It will not be referred to in legislation; authorities may want to revisit including such a reference as recommended by the FSB.
- Scope and rationale:
  - Early intervention operates at various stages of a firm’s evolution and should cover all stages.
  - Early stages: business elements with actual or potential inherent risks not sufficiently appreciated by the firm, beyond firm’s risk management capability, or inconsistent with financial cushions—regulatory action early can reduce likelihood and severity of problems.
  - Stress testing may not reveal these weaknesses; deep dives may be necessary.
- Later stages and coordination:
  - Later stages are closer to potential demise and benefit from coordinated timely actions and support to act.
  - Supervisors need to judge credibility of firms’ plans to restore health.
  - Early intervention model should include guidance on when different responsible authorities, including the FSCS, should be informed.

*Source: IMF staff commentary in the cited section of the PDF chapter.*

### Executive Summary ......................................................................................................

### _cr11230 - Executive Summary ......................................................................................................

### Overall assessment
- The authorities have a comprehensive, considered strategy for a new structure of accountabilities and authorities to enhance prudential regulation and supervision, and for melding macro prudential (systemic) considerations with micro prudential regulation and supervision.
- The proposals clarify accountabilities and mandates considerably from those in place currently, put forward a well-developed framework for coordination and cooperation, and go farther than in many other jurisdictions to determine how to meld macro- and micro prudential regulation and supervision.
- The mission concurs with the authorities’ assessment that the risks in the plan are "medium-high"; quality of implementation will be essential for success.
- The mission was impressed by the high quality of resources being devoted by all the authorities to developing a coherent policy framework and sorting out implementation issues.
- There is a well-developed change management process in place at the Financial Services Authority (FSA), which is broadly on track and includes appropriate project management disciplines.

### Institutional design: U.K. “triple peak” structure and mandates
- The existing tripartite regulatory regime will be dismantled; the FSA will cease to exist in its current form; and a "three peak" structure will be put in place by end-2012.
- Components of the new structure:
  - Prudential Regulation Authority (PRA): a subsidiary of the Bank of England (BoE), carrying out prudential regulation of financial firms, including banks, investment banks, building societies, and insurance companies.
  - Financial Policy Committee (FPC): an independent committee at the BoE responsible for regulation of stability of the financial system as a whole.
  - Financial Conduct Authority (FCA): responsible for regulation of conduct of authorized financial firms providing services to consumers, market regulation, and prudential regulation of smaller entities.
- The new Financial Conduct Authority (FCA), with its broad remit, is subject to some of the lack of clarity present in the current mandate of the FSA; the authorities should find ways to ensure that market regulation and supervision, and prudential supervision of FCA firms, do not become diluted.
- The authorities have appropriately reduced significantly, or eliminated, references in the mandates of the various prudential bodies to "competition and competitiveness"; the authorities should resist calls to reintroduce such concepts as the package proceeds to adoption.

### Macro-prudential framework and FPC toolkit
- The FPC will have powers over certain prudential tools that are specific, subject to U.K. national discretion under EU directives, and focused on system-wide rather than firm-specific characteristics.
- The current plan proposed for consultation includes:
  - the countercyclical capital buffer under Basel III,
  - the overall leverage limits,
  - variable risk weights for a class of assets,
  - margin or haircut requirements,
  - possible cyclical changes in minimum liquidity ratios.
- The FPC will be able to require the PRA (and the FCA) to undertake systemic stress tests or conduct them itself.
- The FPC will have responsibility for making public recommendations to HMT for adjustments in the regulatory perimeter and in the FPC toolkit.
- Recommendation: An interim articulation of the macro prudential risk framework and policy assessment process would be useful; it may be desirable for the BoE, with support from the PRA and FCA, to set out that framework even before it is final, understanding it will evolve.

### Governance, coordination, and culture
- The proposals include a well-developed framework for cooperation and coordination; however, experience in other countries suggests the need for a forum for formal and/or informal relationship building, cooperation, and coordination, especially for crisis operation.
- A clear locus for all regulatory agencies to interact might assist the United Kingdom in interacting with the European Financial Stability Board (EFSB) and the European Supervisory Authorities (ESAs).
- Success will depend on bringing together different cultures of micro- and macro-prudential regulation and supervision in the BoE and the PRA; senior leadership attention is required to promote and model desired interactions, cooperative behavior, division of responsibilities in practice, and constructive challenge.
- Practical measures to foster cooperation: inter-agency work teams on specific issues and inter-agency secondments.

### Supervisory operating model and prudential supervision enhancements
- The authorities are developing a revised risk assessment and supervisory model for banking, building on existing and proposed FSA frameworks with added elements such as systemic importance, interconnections to risk assessments, and assessing resolvability.
- This approach is a continuation of the more-intensive approach already being implemented for major banks by the FSA.
- The FSAP noted additional considerable work needed to implement elements of the existing framework for very-high-impact banks and the need to extend it to other high-impact banks and insurers.
- The FSAP recommended that detailed in-depth supervisory review work to confirm FSA assessments of inherent risk and quality of risk management and risk governance be more frequent.
- Suggested supervisory improvements:
  - Better focus supervisory activity on major areas of potential risk and risk-management deficiencies.
  - Better integrate specialist and supervisory work.
  - Simplify and enhance the usefulness of the ARROW risk model.
  - De-layer and better integrate various supervisory processes to free up more time for focused supervisory work and clearer messages to bank senior management and boards.
- Moving to a single-purpose prudential organization in the PRA provides an opportunity for more senior management engagement on prudential issues on an ongoing basis.

### Systemic analysis, resolvability, and the Special Resolution Regime (SRR)
- The new approach to macro prudential analysis, resolvability, and the new Special Resolution Regime (SRR)—as well as the possibility of requiring material capital buffers—does not reduce the need for intensified supervision that focuses on effectiveness of risk management and governance, as well as on capital and liquidity.
- The focus on "not yet problem" banks is important to increase the chance of catching early indicators of material future problems that might otherwise test the capital, liquidity, and resolution regime.
- Authorities should avoid seeking false precision in new systemic add-ons; frequency of full assessments of systemic modules and frequency of cross-system stress tests should be considered realistically.
- Knowledge and information on network impacts are valuable but not easy to assemble or analyze; an important international dimension is being considered by other bodies, implying a realistic time frame for major enhancements.

### Proactive intervention framework
- The proposals include a proactive intervention framework which the mission supports.
- Characteristics of the framework:
  - Flexible and promotes early action to reduce likelihood of material problems developing.
  - Deals with action steps in advance of the time for recovery or resolution, including coordination actions by the various authorities that need to be involved.
- Recommendation: Legislation should include a reference to proactive early intervention in relevant mandates to support the supervisory culture desired.

### Implementation timing and transitional arrangements
- The proposals were not finalized at the time of the mission but are expected to be fully in place starting in 2013.
- Timeline details:
  - A further consultation paper containing more detail and elements of draft legislation was released in February 2011.
  - Legislation will be finalized and presented to parliament later in 2011.
  - The target is passage of legislation in 2012, in time to permit formal implementation at the beginning of 2013.
- Interim preparatory steps:
  - The FSA has started to implement internally two interim organizations mirroring the expected split of its functions into prudential and market conduct regulation and supervision, though implementation was not fully in place at the time of the mission.
  - An interim FPC has been set up, including appointment of external members, though it had not commenced operating at the time of the mission.
- Observation: Important details of the proposed structure are specific to U.K. circumstances and other countries may need different approaches to meet G-20 and FSB goals.

### Resources, scope, and sequencing
- The mission discussed resource requirement issues as part of the FSAP and recommends the authorities:
  - Define the desired supervisory operating model.
  - Decide how much more enhanced in-depth supervisory reviews are needed to gain adequate assurance.
  - Determine how the macro-overlay will work.
  - Decide on the desired frequency of cross-system stress testing.
  - Determine economies from supervisory process improvement.
  - Focus and form better IT and analysis of more granular data from banks.
- The mission’s strong sense is that timely completion of already-planned enhancements, the new initiatives from macro prudential overlay, assessing resolvability, and other recommendations (such as more frequent, proactive detailed supervisory reviews) will necessitate enhancement in resources (some combination of enhanced skills and more persons) beyond that already planned.
- It is essential that the new macro overlay not draw away resources from needed enhancements in micro prudential supervision, which have been identified but not yet fully implemented.

*Technical note prepared by Nicholas Le Pan and Göran Lind for the IMF Financial Sector Assessment Program (FSAP).*

### 11.      The specific goals of the new arrangements are to:

### _cr11230 - 11.      The specific goals of the new arrangements are to:

### Goals of the new arrangements (paragraph 11)
- Create a dedicated focus on macro prudential analysis and action with responsibilities and tools aligned.
- Introduce a new more-judgment-based approach to regulation/supervision of individual firms capable of challenging business models, identifying risks and taking action to preserve stability.
- Eliminate gaps in which responsibilities are unclear.
- Establish a dedicated specialized and focused body with clear objectives and functions for conduct of business/market integrity regulation and supervision (including its own culture distinct from other U.K. bodies).

### Implementation risk and leadership (paragraph 12 and context)
- The authorities assessed the risk in implementation of these proposals to be medium-high.
- Contributing factors to medium-high implementation risk:
  - Long and uncertain timing.
  - Uncertainty about how key elements will work in practice.
  - Leadership for effective implementation and change management facing other demands from remedial programs already started and from the domestic U.K. and international regulatory policy agenda.
  - Recent resignations of some senior, experienced staff leading to uncertainties about the full leadership team, though progress continued to name individuals to key positions, especially within the shadow PRA.

### Mandates — general observations (paragraphs 13–16, 26–33)
- The government proposes to clarify the mandates of the various authorities; standards assessments for this FSAP found the current prudential mandates to be less than clear (paragraph 13).
- Clear mandates link to internal and external performance measures and accountability; in the United Kingdom the legislated mandates (called the regulatory objectives) play a more important role in performance than in other countries (paragraph 14).
- The FSA mandate did not explicitly mention prudential supervision; this is much more clearly set out in the proposed mandate of the PRA (paragraph 15).
- The mission concurs that lack of clarity in mandates and expectations contributed to regulatory failure leading up to the crisis; mission supports the proposed mandate changes but notes features that need consideration to maximize likelihood of success (paragraph 15).
- Legislated mandates can help parliament recognize what authorities cannot be expected to achieve; failures of financial institutions do not automatically mean the regulatory or supervisory system has failed (paragraph 16).
- For the PRA, proposed primary strategic objective: “to contribute to the promotion of the stability of the U.K. financial system”; proposed operational objective: “promoting the safety and soundness of PRA authorized firms.” Legislation will make clear this includes minimizing adverse effects of firm failure on the U.K. financial system (paragraph 26).
- Mission supports two major thrusts for the PRA changes:
  - Make clear the PRA’s focus on prudential regulation and supervision.
  - Explicitly recognize possibility of failure of firms and the PRA’s role in minimizing disruption, without treating firm failure per se as evidence of PRA failure (paragraph 27).
- The mission notes no explicit reference to proactive, timely intervention in the legislated mandate as proposed; the FSB suggests such a reference is desirable and authorities should consider adding it (paragraph 28).
- Early intervention requires more than a prompt intervention regime; it requires a mindset and culture of supervision and regulation and high-level parliamentary recognition of early intervention can be important to credibility (paragraph 29).
- The initial HMT consultation asked about keeping ‘have regards’ related to impact of regulation on innovation or competitiveness; mission concurs with government that removing competitiveness factors from the legislation is strongly supported to avoid lack of clarity and possible hampering of effective intervention (paragraphs 30–31).
- Regulatory principles such as economical and efficient use of resources and proportionality are understandable, but proportionality should not lead to inadequate supervision of smaller firms or non-systemic firms (paragraph 32).
- PRA should maintain adequate enforcement capability—either relying on FCA enforcement or (more desirably) developing its own reduced permanent enforcement capability that can draw on outside resources as necessary (paragraph 33).

### Bank of England (BoE) and Financial Policy Committee (FPC) mandate (paragraphs 17–25)
- Proposed amendment: BoE’s existing financial stability mandate to state “an objective of the Bank is to protect and enhance the stability of the financial system of the United Kingdom.” Legislation will make clear that, in pursuing this objective, the BoE shall aim to work with HMT, the PRA (part of the BoE group), and the FCA (paragraph 17).
- FPC will be a committee of the court of the bank with a mandate to contribute to the achievement of the financial stability objective of the bank; legislative responsibility focused on identification of systemic risk, monitoring of and taking action to reduce or remove systemic risks, with a view to protecting and enhancing the resilience of the U.K. financial system (paragraph 17).
- Systemic risks include: structural features of the financial markets (including the payments infrastructure), distribution of risk within the financial sector, and unsustainable levels of leverage, debt or credit growth (paragraph 17).
- FPC tools and powers:
  - Tools such as specific warnings, regular publication of financial stability reports, and making recommendations or directions to the PRA and FCA.
  - Secondary legislation will detail specific tools such as invoking the Basel III counter-cyclical capital buffer, changing risk weights, and changing leverage limits (paragraph 17).
- Government rejected requiring BoE or FPC to balance several primary objectives or to explicitly have regard to lending to support economic growth; legislation will make clear financial stability mandate “does not require or authorize the FPC to exercise its functions in a way that would, in its opinion, be likely to have a significantly adverse effect on the ability of the financial sector to contribute to growth over the medium or long term.” This recognizes financial stability and sustained economic growth are not necessarily opposed (paragraph 18).
- The proposed approach avoids over-precision about the role of the FPC/BoE and allows for future flexibility and further detail (paragraph 19).
- Decision-making delineation: decisions on prudential or conduct rules and individual supervisory decisions are responsibility of the PRA or FCA respectively, not the FPC; FPC not involved with individual decisions on emergency liquidity assistance (ELA) or use of resolution tools—thus FPC will not be lead on crisis management (paragraph 20).
- FPC goal includes dealing with more structural (rather than cyclical) macro prudential tools (paragraph 21). Structural tools examples: moving certain derivative products onto exchanges; adjustments in capital requirements for high-LTV lending.
- Trade-offs for structural tools may involve socio-economic policy goals and cost competitiveness; effective consultation with economic policy makers and industry is recommended; waiver of normal consultation possible when very quick implementation is required (paragraph 21).
- FPC will have powers of recommendation or direction to PRA and FCA; for recommendations the other authority must comply or explain in writing why it has not done so (paragraph 22).
- FPC can make recommendations to HMT on regulatory perimeter, dividing line between PRA and FCA, and FPC’s toolkit (paragraph 22).
- PRA will have authority to veto FCA decisions it considers likely to lead to disorderly failure of a firm or wider financial instability; PRA must notify parliament of use of this power and set them out in the annual report (paragraph 22). It is expected this power would be rarely, if ever, used (paragraph 22).
- Acknowledged responsibility and accountability issues and unintended consequences inherent in FPC’s directive power over PRA and FCA; government proposes macro prudential toolkit be specific and focused on system-wide aspects rather than individual firms, though individual directions may materially affect firms (paragraph 23).
- Macro prudential policy and monetary policy may interact and in short run there may be trade-offs; separation of FPC from MPC is understandable to avoid blurring accountability, but FPC and MPC should be aware of each other’s thinking; governor to chair both and staging of meetings proposed with MPC likely to act last (paragraphs 24–25).
- Information flows may be bidirectional between PRA/FCA and FPC; PRA and FCA should be encouraged to raise macro prudential or systemic issues and seek FPC support; PRA needs sufficient financial stability staff to participate effectively and a limited number of PRA financial stability staff should liaise between micro and macro prudential matters (paragraph 25).

### FCA mandate and markets regulation (paragraphs 34–35)
- Proposed FCA objective: to protect and enhance confidence in the U.K. financial system.
- Proposed FCA operational objectives: facilitating efficiency and choice in the market for financial services, securing an appropriate degree of protection for consumers, and protecting and enhancing the integrity of the U.K. financial system (paragraph 34).
- FCA intended to be more willing to intervene in early stages of a product lifecycle to deliver improved outcomes for consumers and is designed to be a ‘consumer champion’ (without becoming an advocate for consumers)—a balance that may prove challenging in practice (paragraph 34).
- FCA expected to take action to promote competition in pursuing its objectives (paragraph 34).
- FCA intended to have strong markets regulation and enforcement functions; consideration advised for:
  - Explicit mention of markets regulation matters (transparency and integrity) in FCA statutory objectives.
  - Ensuring a senior executive clearly responsible for markets regulation and supervision.
  - Ensuring markets regulation expertise on the FCA Board (paragraph 35).
- Markets regulation and enforcement functions will largely be carried over from the FSA; FSA’s credible deterrence approach and enhanced use of specialist resources expected to be continued in the FCA (paragraph 35).
- FCA will have the U.K. seat on the European Securities and Markets Authority (ESMA) (paragraph 35).
- It is essential that the wholesale market integrity mandate be well executed and properly resourced; IOSCO assessment broadly concluded that was the case currently, though there are some areas for improvement (paragraph 35).
- Risk noted that the role of ‘consumer champion’ may be misinterpreted for markets and that market regulation risks becoming the “poor cousin” in the new arrangements; ensure FCA involvement in market infrastructure regulation (led by BoE) with respect to market integrity matters and with sufficient statutory basis to ensure workability (paragraph 35).

*Source: _cr11230 - 11.      The specific goals of the new arrangements are to:*

### 36.      At the time of the mission, thinking was understandably at an early stage on how

### 36.      At the time of the mission, thinking was understandably at an early stage on how

### Governance and Accountability Framework
- Design:
  - FPC to be a sub-committee of the BoE’s existing court, chaired by the governor, with independent members (not in the majority), senior BoE staff, and the heads of the PRA and FCA.
  - PRA to be governed by a board, chaired by the governor, with membership from the BoE, and with a majority of independent members.
  - FCA to be governed by an independent board, similar to the current FSA arrangements, with a majority of independent members.
- Cross-appointments and roles:
  - CEO of the PRA will also be a deputy governor of the BoE and a member of the FPC.
  - CEO of the FCA will also be on the FPC.
  - Deputy governor for financial stability at the BoE will continue as a member of the PRA Board.
  - Heads of the PRA and FCA will be on each other’s boards.
  - CEOs will not exercise voting authority on firm-specific decisions.
- Independence and accountability concerns:
  - These arrangements may raise questions on the degree of independence and separate accountability of the PRA; future standards assessments will depend heavily on actual practice in judging operational independence.
  - Participation on other authorities’ boards, often with independent members, may not substitute for a locus where formal and informal cooperation and coordination can be encouraged.
- PRA operational independence principle:
  - PRA decisions should be taken by the board or under board-delegated authority and only in pursuit of PRA objectives.
  - A challenge exists to make closer macro–micro prudential cooperation operational in a model where the PRA is a ‘semi-autonomous’ subsidiary of the BoE with senior staff holding multiple formal roles.
  - Success depends on clear, understood, and respected roles, contributions, and accountabilities; individuals must be mindful of the capacity in which they are acting.
- PRA Board composition, roles, and appointments:
  - Government indicates PRA Board members (including non-executives) will take significant roles in critical firm-specific decisions, in addition to setting rules.
  - Nominations Committee of the Court will advise on executive appointments.
  - Appointments to the PRA Board will be made by the BoE with the approval of HMT.
  - HMT will name the CEOs of the PRA and FCA.
- Budget and remuneration issues:
  - Proposed that the budget and remuneration of the PRA be set by the court of the BoE, on the recommendation of the PRA, to ensure efficient use of the wider Bank Group’s resources.
  - International standards expect the agency with supervisory accountability to have adequate resources and sound governance; the parent–subsidiary analogy is not fully analogous for regulatory agencies.
  - Court contains a majority of non-executive directors, some current financial industry participants, creating possible real or perceived conflict and independence issues; BoE Act requires recusal in case of conflict.
  - Unclear how non-executive directors’ governance roles (including approving PRA rule changes and assessing PRA decisions) will work in practice without assuming executive supervisory roles.
- Senior executives’ time allocation:
  - Governor to chair the FPC, MPC, and the PRA Board; cross-appointments help legitimacy but require sufficient time allocation for all duties.
- Monitoring and remediation:
  - If coordination is not working, regulators responsible for working it out; HMT as overall “owner” should monitor new arrangements and deal with material issues, involving a few senior people maintaining close links.
- Public reporting and transparency:
  - Financial stability publications and existing public reporting (strategic/business plans and priorities statements) will continue.
  - Directions of the FPC will be reported to HMT and to parliament, as will PRA overrides of FCA measures.
  - Public consultation on PRA/FCA initiatives will continue, including macro prudential measures implemented at the recommendation of the FPC.
  - Additional flexibility proposed for FPC-directed actions, including FPC policy statements and possibility of HMT modifying consultation requirements; FPC must be seen as transparent in decision framework and possible use of tools.
- Regulatory failure reporting:
  - New legislative requirement for the regulator to report to HMT where there is a “regulatory failure,” addressing actions, decisions and lessons learned for both firms and the regulator; report to be laid before parliament.
  - Authorities recognize that not all institutional failures represent a regulatory failure and that the difference should be better understood.

### Framework for Cooperation and Coordination
- Overall design and objective:
  - Balancing enhanced focus of individual authorities with checks and balances and coordination (ongoing and in a crisis) is key.
  - Greater clarity and accountability about specific powers and responsibilities; FPC as a new body focusing on financial stability more broadly.
- Coordination challenges:
  - Need ongoing coordination between macro financial stability objectives and micro prudential operations of the PRA and FCA; both may be involved in particular files (e.g., approvals of transactions or SIFI approvals).
  - Actions of one authority could affect the other’s ability to achieve its mandate, though such occurrences are likely rare.
  - Coordination in a crisis is a distinct issue.
- Information sharing:
  - Timely access to each others’ information is essential; managed through legal “gateways” specified in legislation and regulations.
  - Bias should be for maximum access to each other’s information to preserve flexibility and responsiveness in a crisis and foster mutual trust.
  - FPC expected to receive information and analysis from the PRA (including trends in “problem” or “watch list” institutions), information on securities market developments from the FCA, and BoE information on market and financial stability developments, banks’ participation in payment clearing and settlement systems, and BoE facilities.
- Legislative duty to coordinate and MOUs:
  - Government proposes legislation imposing a general duty to coordinate on all authorities (preferable to statutory requirements to take others’ mandates into account).
  - MOUs to deliver the duty to coordinate and day-to-day coordination will be in legislation; MOUs must be published, reviewed annually, and laid before Parliament.
  - Cross-appointments and legal requirements for coordination to be built into certain processes (approvals and rule-making).
  - HMT paper indicates the legislative requirement to consult will have three main elements:
    - where the PRA or FCA are considering action that may ‘materially impact’ on the other’s achievement of its objectives, they must consult;
    - the PRA and FCA must consult to take advantage of each other’s expertise;
    - both the PRA and FCA will be under obligation to manage their processes congruently and efficiently.
  - Details to be left to expected high degree of cooperation and proposed MOUs; heads of the PRA and FCA could consider a periodic process to assess how arrangements work in practice, with input from regulated firms.
- Cultural and practical enablers:
  - Cooperation requires openness, trust, understanding and respect of mandates, and willingness to find solutions meeting as many needs as possible.
  - Significant investment of time by senior leaders and setting the tone for others is required; movement of people between organizations and inter-agency work teams can assist in building cooperation culture.
- Risks of diffusion and need for a convening forum:
  - Danger of diffusion of coordination and communication efforts; unclear what formal or informal coordination mechanism involving all authorities will be in normal times and in a crisis.
  - A crisis management MOU is planned; an MOU on coordination of international activities is planned.
  - No single forum identified where all key senior regulatory decision makers can focus on relationship and trust building and early identification of issues; such a forum need not be formal and could mirror emerging European financial stability bodies and ESAs.
- Specific PRA–FCA coordination mechanisms:
  - PRA would be able to veto actions by the FCA that would lead to the disorderly failure of a firm or wider financial instability (both PRA and FCA have authority to wind up an authorized firm, though only the PRA can trigger the special resolution regime); the fact of the veto would have to be disclosed to parliament.
  - Such a veto expected to be used very sparingly; authorities should consider requiring that any potential veto be consulted on an expeditious basis with the FPC before issuance.
  - Authorization and variation of permissions:
    - For firms both PRA- and FCA-regulated, government proposes both must provide necessary authorization, but mentions other options and coordination mechanisms to minimize inefficiencies.
    - Each authority to retain power to vary its permission; PRA would have authority to override FCA actions where they would lead to disorderly failure.
    - Future standards assessments will ensure each regulator can meet mandates and standards requirements.
  - Split lead responsibilities in dual-regulated firms:
    - PRA lead on functions related to prudential matters; FCA lead on matters relating to interface with customers.
    - Lead would consult with the other in areas of interest but would have the final say.
    - Both regulators retain authority to ban an approved person working in a regulated firm.
    - Possible alternative: system of dual approval for certain key positions with coordinated and harmonized information requests and assessment processes.
  - Consolidation and consolidated supervision:
    - PRA to be the consolidated supervisor for major U.K. bank and insurance groups.
    - Where supervision of authorized entities is split between PRA and FCA, they will be expected to coordinate.
    - New powers of direction by the consolidated supervisor over other supervisors with respect to authorized entities they supervise and over unregulated holding companies of groups.
    - Important that arrangements work effectively in practice to allow comprehensive consolidated regulation and supervision, including access by the group supervisor to all entities in the group for assessing safety and soundness.

*Source: IMF staff commentary in the cited section of the PDF chapter.*

### 56.      Having the macro financial stability insights of the BoE and FPC available to

### _cr11230 - 56.      Having the macro financial stability insights of the BoE and FPC available to

### Macroprudential framework and challenges
- Paragraph 56: Having the macro financial stability insights of the BoE and FPC available to micro supervisors could contribute effectively to the micro prudential work. The authorities plan to retain their own (reduced) financial stability expertise so they can effectively pull together their micro prudential information in ways that inform their own mandates and the FPC.
- Paragraph 57: Key design and implementation challenges:
  - Use of systemic risk measures can be expected to be infrequent, thus complicating the assessment of appropriate timing and effectiveness (it is difficult to calibrate measures based on experience).
  - Systemic risk analysis is often about the tails of the distribution of outcomes, which models have a great deal of difficulty in handling and which tend not to be the focus of other macro-economic or monetary policy work.
  - There will need to be a period of experimentation before ranges of variables and thresholds for possible action can be identified.
  - Staff responsible for macro prudential risk analysis will need to be encouraged to focus on tail risks and fault lines, not just on higher-probability risks.
  - For the United Kingdom, the analysis of available tools may be dependent on what prudential measures under EU rules will be subject to national discretion.
- Paragraph 59: Communication is required on an ongoing basis to keep macro prudential expectations reasonable; stability communication itself becomes a tool and may be coupled with measures controlled by the FPC.

### Interaction between macro and micro prudential measures
- Paragraph 58: Interaction issues and institutional arrangements:
  - Proposals aim to separate responsibilities: micro prudential matters in the PRA and macro prudential matters with the FPC.
  - The FPC and the PRA are designed to be in the same institutional structure to help underpin the interaction between macro and many micro-prudential issues.
  - The dividing line is likely to prove less clear-cut in practice, especially where only a few banks account for a large share of the market and their reaction to macro prudential measures is key.
  - Material micro prudential measures directed at large banks could have macro aspects that need consideration.
  - Countercyclical measures must be symmetric (for example, additional buffers—should go both up and down); timing and interpretation of reductions, and communication, are important so they are not seen to undercut prudential goals.
  - Various, relatively-formal, coordination and decision-making measures have been designed to address macro-micro interaction; authorities should promote consensus building to maximize effectiveness.
  - Discussions suggested a good degree of cooperation in thinking through issues such as use of tools, data, and risk analysis at this early stage.

### Implementation needs and near-term actions
- Paragraph 60: Work to design implementation details will need to involve:
  - enhanced data collection and analysis, including data from outside the regulated sector;
  - an enhanced analytical framework, including a macro risk assessment framework;
  - the development of a suite of indicators, including administrative and market data that are monitored;
  - thinking on thresholds for making judgments on possible actions;
  - an effective communication approach that supports markets reacting to possible macro prudential measures in the way intended;
  - thinking on how the BoE and FPC will provide macro prudential and market analysis to the PRA and FCA and how this analysis will be integrated into their supervisory frameworks;
  - active monitoring of unique issues, such as risk build ups in CCPs and their risk management capability.
- Paragraph 61: Near-term recommendation:
  - Markets, governments, and the various U.K. authorities would benefit from greater interim articulation of the macro prudential risk framework and monitoring process.
  - The BoE (with support from the PRA and the FCA) could consider setting out that framework even before it is final, on the understanding that it will evolve with operation and international progress.
  - Greater articulation of the interim framework to be used by the FPC might help clarify macro-micro interaction in practice, increase transparency, and lessen the need for early discrete action by the FPC.

### Supervisory operating model for banking prudential supervision
- Paragraph 62: Authorities are developing a revised risk assessment and supervisory model for banking, building on existing and proposed FSA frameworks with addition of systemic elements; it is designed to deliver a more judgment-based, proactive, early intervention regime focusing on safety and soundness, and financial stability.
- Paragraph 63: FSAP recommendations and model evolution:
  - Detailed in-depth supervisory review work to confirm FSA assessments of inherent risk and quality of risk management and risk governance should be more frequent.
  - Opportunities exist to better focus supervisory activity on major risk areas, integrate specialist and supervisory work, simplify and enhance the usefulness of the ARROW risk model, and de-layer and better integrate supervisory processes.
  - Moving to a single-purpose prudential organization in the PRA provides an opportunity for more senior management engagement on prudential issues.
  - ARROW is intended to be replaced by a new PRA risk model focusing on the impact on the stability of the system of firm failure; forward-looking analysis on the basis of a balance of risks will be a core of the model; the model will be simpler than ARROW and allow significant space for supervisory judgments.
- Paragraph 64: The new supervisory model base and additions:
  - Starting point: new Supervisory Enhancement Program (SEP) and Core Prudential Program (CPP), currently being implemented in the FSA over the next 18–24 months, with additions for systemic impact assessment and an explicit resolvability assessment.
  - Proposed addition: a new initial module that assesses the gross impact on the system of a firm’s failure, based in part on recovery and resolution plan analysis and assessment of inter-linkages between the firm and the wider financial system.
- Paragraph 65: Recovery and resolution planning:
  - Assessment of banks’ recovery and resolution plans has started and can help identify vulnerabilities and measures to improve resolvability.
  - Effective partnership between macro and micro prudential staff is required.
  - The effectiveness of new resolution tools for major banks may be largely untested for some time.
  - Additional modules are likely to be resource-intensive and will involve various specialist resources working with supervision teams.
  - Authorities plan to revisit layered supervisory processes and the ARROW framework with the objective of simplification to support a judgment-based approach.
- Paragraph 66: Resource and realism considerations:
  - Authorities need to avoid seeking false precision in systemic add-ons at the expense of implementing core supervision enhancements in a timely way.
  - Frequency of full assessments of systemic modules and initiatives such as cross-system stress tests should be considered.
  - New model implies considerable work identifying interconnections between firms and between firms and markets; network impacts knowledge is not easy to assemble/analyze and has an important international dimension; authorities should be realistic about time frames for major enhancements.
- Paragraph 67: Roles, accountability, and monitoring:
  - Responsibility and accountability for risk assessment and supervisory planning are being diffused as more macro analysis is brought into the current risk-assessment model.
  - Relevant roles include the supervisor, the risk group in the FSA that specifies “standard factors” in risk-assessment models, and BoE macro prudential staff.
  - Achieving constructive bottom-up and top-down risk assessments with constructive challenges will be very important.
  - Active monitoring of the new risk assessment and intervention system by senior leadership of the BoE and the PRA early in implementation will be essential.
- Paragraph 68: Continued need for intensified supervision:
  - The new approach to macro prudential analysis, resolvability, and the new SRR (as well as the possibility of requiring material capital buffers) does not reduce the need for intensified supervision that focuses on effectiveness of risk management and governance as well as capital and liquidity.
  - Focus on “not yet problem” banks is important to catch early indicators of material future problems.

### Supervisory operating model for insurance prudential supervision
- Paragraph 69: Reform intentions and Solvency II:
  - A revised risk assessment and supervisory operating model for prudential supervision of insurance is intended.
  - BoE and the FSA are considering what elements of insurance are potentially systemic and the place for prudential insurance regulation and supervision in that regard.
  - The United Kingdom will implement the Solvency II directive.
  - For very-high-impact insurers, the model will use parts of the CPP (with less-formal emphasis on the risk management/governance module), supplemented with a resolvability analysis.
  - Smaller insurers: supervisory operating model likely based more on monitoring and outlier analysis with occasional in-depth focused reviews.
  - Medium-size insurers: likely an intermediate intensity model with more frequent detailed reviews than for smaller insurers; the proactive intervention framework will apply.
- Paragraph 70: Nature of systemic risks in insurance:
  - Systemic aspects of insurers are different from and likely less than for banks, but failures could be locally systemic if insurance concentration is high.
  - Failure of a large insurer could temporarily destabilize markets through actions on the asset side (such as semi-forced asset sales) and anticipation of such actions could affect markets.
  - Traditional view that insurance cannot suffer liquidity runs may not be wholly accurate because of certain insurance liabilities or quasi-insurance liabilities.
  - Within insurance or reinsurance groups, liabilities may be as potentially volatile in certain markets as equivalent liabilities of banks.
  - Balance sheets of major insurance groups and reinsurance groups can contain liquidity risk and market risk as material and complex as that for a commercial or investment bank.
  - There may be risk transfer between banks and insurers and opportunities for arbitrage.
- Paragraph 71: Supervisory benefits of co-located supervision and staffing implications:
  - It may be easier to assess systemic aspects and take advantage of supervisory expertise across both sectors if supervision of major banking and insurance groups are in the same authority.
  - The mission supports continuing to assign regulation and supervision of insurers to the PRA.
  - As insurance is to be part of the PRA, the BoE will need to enhance its expertise on insurance matters and consideration should be given to having some insurance expertise on the FPC.
- Paragraph 72: Resolution framework for insurers:
  - The FSA and the BoE are examining the framework for resolving insurance companies and this may lead to changes in legislation.
  - The SRR does not now apply to insurers, either on a stand-alone basis or on those that are part of banking groups.
  - Resolving insurers through solvent run-off will need to be supplemented by the ability to “close” or restructure insurers that have breached capital thresholds (using existing or new tools); applying the SRR to insurers is being considered.
  - Resolving a major insurer is likely to be very complex and challenging, with considerable uncertainty.
- Paragraph 73: Supervision tools and model risk:
  - Effective supervision requires risk specialists (market, credit, operational risks) in addition to actuarial analysis.
  - Business model analysis and financial risk assessment, including stress testing, are important, but assessment of risk management and governance quality is also essential.
  - Enhanced use of models under Solvency II poses challenges; qualitative conditions for model use (such as sound risk management and governance) must receive adequate attention.
  - The United Kingdom needs to preserve its ability to use individual capital guidance (Pillar II) as a regulatory tool for insurers.
  - A robust resolvability regime and Pillar II cannot be a perfect substitute for adequate supervision to reduce risks and impact of unanticipated or disorderly failures.

### Proactive intervention framework
- Paragraph 74: Authorities intend to implement a proactive intervention regime; the mission supports this. It will not be referred to in legislation. Authorities may want to revisit including some reference in the legislated mandate for early intervention, as recommended by the FSB.
- Paragraph 75: Scope and rationale:
  - Early intervention regime operates at various stages of the evolution of a bank and all stages should be covered.
  - Early stages involve business elements with actual or potential inherent risks not sufficiently appreciated by the firm, beyond the firm’s risk management/governance capability, or inconsistent with the firm’s financial cushions.
  - Action by the regulator at early stages can significantly reduce likelihood/severity of ensuing problems and reduce risk of surprises.
  - Stress testing may not reveal these weaknesses; deep dives may be necessary.
- Paragraph 76: Later stages and coordination:
  - Latter stages of early intervention are closer to potential demise of a firm and benefit from coordination of timely actions and support the will to act.
  - Supervisors often need to judge credibility of firms’ plans to restore health.
  - Closer to serious problem stage, coordination of authorities (e.g., supervisor and resolution authority) is desirable.
  - Early intervention model should include guidance as to when different responsible authorities, including the FSCS, should be informed.

*IMF staff report text (paragraphs 56–76).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11230.pdf_