## _cr16166 - INTRODUCTION ## Source details **Canonical URL:** [_cr16166 - INTRODUCTION](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16166.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16166.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16166.pdf.json) --- ### A. Overview and Recent Institutional Reforms - Financial Services Act of 2012: replaced the FSA with a “twin-peak” system—the Prudential Regulation Authority (PRA) (a subsidiary of the Bank of England (BoE)) and the Financial Conduct Authority (FCA). - Financial Policy Committee (FPC): statutory BoE subcommittee; Governor of the BoE named as Chair; primary objective to identify, monitor, and take action to remove or reduce systemic risk. - BoE and Financial Services Act 2016 (provisions not yet in force at time of assessment): - will merge the PRA into the BoE (ending subsidiary status) and create a Prudential Regulatory Committee (PRC); - PRC governance: senior BoE bank officials and an external majority similar to PRA’s existing Board; - seeks to preserve operational independence of prudential supervision and retain funding via levy on supervised firms; - resolution powers to remain separate in BoE’s Resolution Directorate (RD). - Banking Reform Act (BRA) 2013: implemented ring-fencing and the Senior Managers and Certification Regime (SMR) framework. - Ring-fencing: banks preparing plans to ring fence retail banking operations by 2019. - March 2016: SMR replaced APR; firms must certify key staff annually as fit and proper. - PRA defining a ‘target operating model’ (TOM) to operate within a risk appetite and realistic budget. ### B. High-Level Assessment Findings and Supervisory Orientation - Overall compliance: assessors judged the U.K. to be compliant or largely compliant with all BCPs in this assessment. - Shift in supervisory style: - from perceived “light touch” to more rigorous, hands-on, systemically focused supervision by PRA and FCA. - Greater challenge to larger firms, more frequent engagement with Boards’ independent nonexecutive members and external auditors. - Focus and resource allocation: - Authorities prioritized systemic resilience, concentrating attention and resources on the largest, most systemically important firms. - Assessors noted implications for supervision of mid-size and small firms and recommended safeguards given potentially correlated risks among smaller institutions. ### C. Key Aggregate Outcomes and Metrics Preserved Exactly - Aggregate CET1 capital ratio for U.K. banks: just above 12 percent at the beginning of 2015. - Change in CET1 since 2011: 4 percentage points higher than in 2011. - Funding shifts for major U.K. banks since 2008: - Customer deposit funding increased by nearly GBP 250 billion since 2008. - Wholesale funding declined by over GBP 1.3 trillion. (Bank of England, Financial Stability Report, July 2015.) - Major U.K. banks’ positions at end–September 2015: - average CET1 position above 12 percent; - aggregate leverage ratio over 4.7 percent. - Sector scale statistics: - Total assets in the U.K. banking sector: almost 400 percent of nominal GDP in 2014 (excluding derivative exposures and foreign assets and liabilities of foreign branches). - Over 900 banks, building societies and credit unions supervised by the PRA; within total: 150 deposit-taking foreign branches and 98 deposit-taking foreign subsidiaries from 56 different countries. - Combined assets of largest ten foreign subsidiaries in the U.K.: around GBP 2.75 trillion. - Foreign branches account for around 30 percent of total U.K.-resident banking assets and around a third of U.K. interbank lending. - U.K.-resident banks' foreign assets and liabilities: over 350 percent of U.K. GDP. - Financial services trade surplus: over GBP 59 billion in 2013 (ONS). - Financial services industry employment: over a million people; a million more in complementary professional services; two thirds of those two million jobs are outside London. - Government holdings after 2008–9 interventions (end of August 2015): just under 13 percent ownership in Lloyds, and 73 percent in RBS. ### D. Legal Mandates, Powers, and Macroprudential Framework - Legal foundations: Financial Services Act 2012, FSMA 2000, CRD IV/CRR adoption from January 1, 2014 (transition timelines apply). - PRA primary objective: promote safety and soundness of PRA-authorized persons (S2B FSMA); PRA has a secondary competition objective. - FCA strategic objective: ensure relevant markets function well with operational objectives: S1C, S1D, S1E FSMA. - FPC officially established April 1, 2013; primary objective to identify, monitor and take action to remove or reduce systemic risks; FPC sets countercyclical capital buffer (CCB) and has powers over sectoral capital requirements (SCRs), loan-to-value and debt-to-income limits, and leverage ratio tools. - Resolution and crisis management: - BoE is the resolution authority in accordance with the U.K.’s special resolution regime (Banking Act 2009). - MoU sets out who is in charge between HMT and BoE (including PRA) in a financial crisis and focuses on monitoring/managing risks to public funds. ### E. Licensing, Ownership Changes, and Major Acquisitions (selected findings) - Threshold Conditions: firms must meet and continuously uphold Threshold Conditions to engage in deposit-taking regulated activity (FSMA Schedule 6). - Authorization: - PRA is the authorizing agency; PRA approvals often require FCA consent. - Minimum initial capital applied by PRA: GBP 5 million (Art. 12, CRD), with exceptions for “small specialist banks.” - Transfer of significant ownership: - Notification and approval regime under S178 FSMA 2000; criminal offence to acquire or increase control without PRA approval. - Notification thresholds include movement across 20 percent, 30 percent, 50 percent ownership, or becoming parent. - Major acquisitions: - Chapter 2 of PRA Rulebook: firms must notify PRA of restructuring, reorganization or business expansion with a “significant impact” and actions causing a “material change” in capital adequacy or solvency. - PRA may prevent acquisitions under S55M and consult FCA prior to imposing requirements. ### F. Supervisory Approach, SREP, Continuous Assessment, and Tools - PRA CA (Continuous Assessment) framework: - Eight assessment elements grouped into Gross risk, Risk context, Operational mitigation, Financial mitigation, Structural mitigation. - Firms allocated to five ‘categories’ (1–5) by potential impact; Category 1 most significant (19 firms in Category 1 at time of writing). - PIF (Proximity to Failure) with five stages used to express viability risk (Stage 1–5). - Core supervisory cycle: Periodic Summary Meeting (PSM), mid-point reviews; elements reviewed at least twice per year. - Supervisory techniques: - Increased hands-on work and deep dives for largest firms; baseline monitoring and automated offsite monitoring for smaller firms. - Use of “skilled person” S166 reports to supplement supervision; caution against outsourcing prudential supervision. - Model governance and oversight: - Internal models population at assessment: 18 banks with IRB, 15 with IMA market risk, 8 with IMM, 2 with AMA for operational risk. - Assessors expressed concern that PRA model change policy and specialist resource constraints may leave supervisory control over model robustness stretched. ### G. Capital Adequacy, Stress Testing, and Internal Models - CRR/CRD implementation: - Part II of CRR defines own funds and Basel III components; CRR directly applicable in U.K. law. - PRA used conservative national discretions (e.g., AT1 trigger of 7 percent CET1 for U.K. AT1 instruments). - PRA required full application of CET1 filters/deductions from January 1, 2014 (end-point CET1). - Eight largest U.K. banks expected to meet 7 percent CET1 based on end-point definition (SS3/13). - Stress testing: - BoE/PRA CSTs (Concurrent Stress Tests) for major firms; CSTs used to set Pillar 2 capital expectations and PRA buffers. - PRA expects firms’ ICAAPs/ILAAPs to include stress testing; supervisors may impose own stress test results or capital add-ons if firms’ tests are inadequate. - Assessment: Principle 16 — Largely Compliant (assessors noted EU implementation divergences vis-à-vis Basel, RCAP findings, and supervisory emphasis on compensating Pillar 2 measures). ### H. Liquidity, ILAAP/ILAA, LCR and Asset Encumbrance - LCR EU implementation divergences: - EU modified-LCR (DA) effective Oct 1, 2015 included several deviations from BCBS LCR (e.g., treatment of covered bonds, certain claims to central government, inclusion of certain securitizations). - EBA estimate: EU changes increase LCR by 13.9 percent for sample banks (322). - PRA approach: - PRA set initial LCR requirement as of Oct 1, 2015 at 80 percent (higher than EU minimum of 60 percent at that date). - Phase-in schedule for EU LCR: 60 percent from Oct 1, 2015; 70 percent from Jan 1, 2016; 80 percent from Jan 1, 2017; 100 percent from Jan 1, 2018. - PRA issues Individual Liquidity Guidance (ILG) and monitors ILG quarterly for Category 1–3 firms and six-monthly for Category 4 firms. - ILAAP/ILAA: - Firms must prepare annual ILAAP/ILAA; PRA uses these for liquidity SREP (L‑SREP) and to assess CFPs/LCPs; Chapter 12 of the revised PRA Rulebook requires firms to develop an effective LCP and test it at least annually. - Asset encumbrance: - PRA Rulebook requires active management of asset encumbrance; supervisors monitor unencumbered assets and disclosure expectations per EBA guidelines. - Assessment: Principle 24 — Largely Compliant (noting EU LCR elements less stringent than Basel). ### I. Problem Assets, Provisioning, and AQRs - Problem assets and provisioning framework: - Accounting standards at assessment: IFRS IAS 39 (incurred loss approach). - PRA AQR program (introduced Nov 2013) with Levels 1–4; Level 3/4 include transaction testing on loan files. - Coverage and resource constraints: - Detailed AQRs by credit risk specialists since legal cutover: 8 on Category 2 firms and 3 on Category 3 firms; none on Category 4 or 5 banks; no committed timetable for the remainder. - Typical AQR delivery (median impression): staffing around three specialists + one line supervisor; duration less than two weeks; files reviewed around 100 loan files; portfolio share reviewed between 5 percent and 50 percent depending on asset class. - Assessors’ concerns: - Insufficient direct supervisory transaction testing coverage across majority of smaller banks; recommended enhancements include increased loan-level data access and random AQR backstops. - Assessment: Principle 18 — Largely Compliant. ### J. Controls, Audit, Disclosure, and AML/CFT Supervision - Controls and audit: - Increased dialogue with internal and external auditors; PRA relies more on internal auditors’ work for largest firms and engages external auditors on governance matters. - PRA lacks a general power to access auditors’ working papers; mitigated by close cooperation with FRC. - Disclosure: - Recommendations to publish nonconfidential firm-level prudential returns to assist comparative analysis. - BoE intended to begin publishing selected quarterly aggregate regulatory data from COREP submissions beginning Q4 2015. - AML/CFT: - FCA is primary AML/CFT supervisor; MLR 2007 transposes key AML requirements (CDD, beneficial ownership, enhanced due diligence for correspondent banking, SARs reporting, five-year retention). - FCA supervisory model: highest-risk firms receive systematic AML Program; second-highest receive 2–4 day visits every two years; lower-risk firms reviewed via thematic/event-driven work. - SARs: over 350,000 filed with National Crime Agency in 2013–2014; about 290,000 by retail banks and 23,000 by building societies. - Assessment: Principle 29 — Largely Compliant; assessors flagged limited firm-specific evaluation/testing for majority of lower-risk firms and recommended stronger backstops. ### K. Resourcing, Independence, Cooperation, and Grading Highlights - Resourcing and budgets: - Combined cost of ongoing activities in 2013–14: GBP 664 million—GBP 127 million (24 percent) higher than 2012–13 cost of the FSA (NAO finding). - Combined budgets for 2015/16 of the PRA and FCA (based on AFR): GBP 739.4 million. - Specialist staffing noted (from Target Operating Model review): 48 FTE specialists on credit risk, 43 on market and counterparty credit risk, 41 on risk infrastructure and liquidity. - Independence and accountability: - PRA established as company limited by shares with BoE as sole shareholder; FCA established as private company; both funded by industry fees and operationally independent though accountable to HMT/Parliament. - Assessment of Principle 2: Largely Compliant. - Cooperation: - Domestic and international cooperation frameworks well established; MoUs and supervisory colleges in operation. - Assessment of Principle 3: Compliant. - Principal BCP grading snapshots (selected): - Principle 1 — Compliant. - Principle 2 — Largely Compliant. - Principle 3 — Compliant. - Principle 8 — Largely Compliant. - Principle 9 — Largely Compliant. - Principle 16 — Largely Compliant. - Principle 24 — Largely Compliant. - Principle 29 — Largely Compliant. ### L. Key Recommendations (summary) - Reinforce supervision of mid-size and smaller firms: consider safeguards to offset lower levels of attention and correlated risks among smaller institutions (Principles 8, 9, 15, 18, 21). - Improve model oversight: revise model change review policy and ensure specialist resourcing to assure internal model robustness and prevent opportunistic model use (Principle 16). - Enhance asset quality surveillance: increase direct transaction testing/AQR coverage for nonsystemic banks or deploy randomized AQRs and improved loan-level data access (Principle 18, 17). - Strengthen AML/CFT backstops: adopt stronger, more proactive supervisory measures for lower-risk firms to ensure effective implementation of AML/CFT controls (Principle 29). - Supervisory resourcing review: reassess PRA resources and operating model to ensure ongoing effectiveness given statutory objectives and systemic footprint (Principle 2). - Disclosure and market discipline: publish nonconfidential, firm-level prudential returns to improve market understanding of firms’ risk profiles. - Require explicit concentration limits: mandate banks set thresholds for acceptable concentrations of risk and related-party infra-annual reporting for non-FINREP banks (Principles 19, 20). - Continue promoting alignment of EU rules with Basel standards, particularly on liquidity (LCR) and capital treatment discrepancies (Principle 24, Principle 16). *Source: _cr16166 - INTRODUCTION (IMF staff report excerpts; assessment conducted during November 3–19, 2015)._ ### INTRODUCTION _________________________________________________________________________________ 15 ### _cr16166 - INTRODUCTION _________________________________________________________________________________ 15 ### A. Information and Methodology Used for the Assessment - The Basel Core Principles for Effective Banking Supervision (BCP) assessment reflects: - the assessors’ understanding of the current state of the supervisory approach during a period of continuing development and transition; - incorporation, where relevant, of available information about changes expected in the near future. ### B. Institutional and Market Structure—Overview / Recent Reforms - The Financial Services Act of 2012 reformed the U.K.’s institutional regulatory architecture by: - replacing the Financial Services Authority (FSA) with a “twin-peak” supervisory system consisting of the Prudential Regulation Authority (PRA)—a subsidiary of the Bank of England (BoE)—and the Financial Conduct Authority (FCA); - assigning responsibility for financial stability to the Financial Policy Committee (FPC), a statutory subcommittee of the BoE’s Court of Directors; - naming the Governor of the BoE as Chair of the FPC, with the FPC charged with the primary objective of identifying, monitoring, and taking action to remove or reduce systemic risk. - Subsequent and anticipated structural changes noted in the assessment: - Provisions in the BoE and Financial Services Act 2016 (not yet in force at the time of assessment) will merge the PRA into the BoE, ending its status as a subsidiary, and create a Prudential Regulatory Committee (PRC). - The PRC governance will include senior BoE bank officials and an external majority similar to the PRA’s existing Board of Directors. - The Act seeks to preserve the operational independence of the prudential supervisor and retain its power to fund operations through a levy on supervised firms. - Resolution powers will remain separate from the prudential supervisor and will be retained in the BoE’s Resolution Directorate (RD). - “Ring-fencing”: Banks were preparing plans to ring fence their retail banking operations by 2019, expected to: - reduce systemic risk; - improve resolvability and lower risk to the taxpayer by segregating retail deposits from riskier activities; - potentially spur further increases in the capital base of U.K. banks. - A new “senior managers’ regime” (SMR) replaced the Approved Persons Regimes (APR) in March 2016: - SMR reinforces accountability of individuals in the most senior roles on an ongoing and structured basis. - A new certification regime requires firms to ensure other key staff who could cause significant harm are fit and proper; firms will issue such staff an annual certificate deeming them fit and proper to perform their role. - The PRA is defining a ‘target operating model’ (TOM) to specify how it intends to operate within a risk appetite and realistic budget envelope. ### C. Preconditions for Effective Banking Supervision / High-Level Assessment Findings - Overall compliance and supervisory focus: - The assessors judged the U.K. to be compliant or largely compliant with all BCPs in this assessment. - U.K. authorities have adopted a more rigorous, hands-on, and systemically focused approach to banking supervision since the 2011 FSAP. - The supervisory approach is more clearly aligned with the overarching objective of promoting and preserving systemic resilience, with emphasis on: - assessment of risks and on the adequacy of capital and liquidity in supervised entities; - the largest and most systemically important firms, whose severe deterioration or failure could threaten financial stability and broader economic health and growth. - Stress testing: - Stress testing is a critical supervisory tool encouraging firms and supervisors to adopt a more forward-looking view on balance sheet strength and resilience to shocks. - Evidence indicates stress testing has encouraged firms to strengthen internal analytical and risk-management capabilities, and to retain high levels of capital and liquidity. - Aggregate balance sheet outcomes cited: - The aggregate common equity tier 1 capital (CET1) capital ratio for the U.K. banks was just above 12 percent at the beginning of 2015, 4 percentage points higher than in 2011. - For major U.K. banks, funding from customer deposits increased by nearly GBP 250 billion since 2008, while wholesale funding declined by over GBP 1.3 trillion. (Bank of England, Financial Stability Report, July 2015.) - Resource allocation and supervisory tolerance: - U.K. authorities have prioritized systemic resilience, concentrating attention and resources on the largest, most systemically important firms. - This prioritization reflects a policy choice balancing effectiveness and efficiency given finite supervisory resources, but has implications for supervision of mid-size and small firms. - Assessors question assumptions about the scale and depth of risks from mid-sized and smaller, non-systemically significant institutions, noting such institutions may serve particular regions or customer classes and their risks may be correlated. - Supervisors should consider safeguards to offset lower levels of attention on firms that are not among the largest and most systemically important. ### D. Mandate, Independence, Cooperation, Enforcement Powers (CP 1–3, 11) - Legal and mandate foundations: - The Financial Services Act 2012 and subsequent reforms provided an appropriate foundation for mandate, powers, independence, and ability to direct firms to address weaknesses. - The separation of prudential and conduct supervision largely resolved prior concerns about pursuing two mandates within the same agency. - Regulators no longer have a duty to have regard to the desirability of maintaining the United Kingdom’s competitive position. - The law explicitly mentions a ‘no-zero-failure’ policy: the supervisor’s goal is not to prevent failures entirely, only to avoid disorderly failures that could destabilize the U.K. financial system. - Effectiveness versus efficiency trade-offs: - The assessment notes tensions remain regarding balancing effectiveness and efficiency; adequacy of resources depends on supervisory objectives and risk tolerance. - The decision to prioritize large, systemically important firms is legitimate but requires consideration of supervision and safeguards for the remainder of firms. ### E. Licensing, Permissible Activities, Transfer of Ownership, and Major Acquisitions (CP 5–7) - Licensing and oversight tools: - The U.K. supervisory framework includes sound tools for licensing, oversight of changes in control, and major acquisitions. - Many licensing and acquisition decisions require consultation or approval between the PRA and FCA, with evidence of increasing collaboration. - Requirements for firms: - Firms must meet and continuously uphold a set of “Threshold Conditions” to engage in the regulated activity of deposit-taking. - Firms must behave according to “Fundamental Rules” and “Principles for Business” that guide safety, soundness, and fundamental obligations. ### F. Supervisory Approach, Process, and Reporting (CP 8–10) - Supervisory orientation: - The PRA and FCA are adapting approaches post-“twin peaks” implementation; the FCA announced a revised overall strategy in December 2014 to enable a more market-focused approach to identifying risks and supervising firms. - The PRA’s internal considerations (e.g., TOM) revolve around aligning operations with agreed risk appetite, budget constraints, and governance to meet statutory and strategic objectives. ### Key Dates, Numbers, and References Preserved Exactly - Financial Services Act of 2012 - Financial Services Act 2012 - BoE and Financial Services Act 2016 (provisions not yet in force at time of assessment) - Ring-fencing to be implemented by 2019 - March 2016: new senior managers’ regime (SMR) effective - CET1 ratio: just above 12 percent at the beginning of 2015 - Change in CET1: 4 percentage points higher than in 2011 - Deposit funding increase: nearly GBP 250 billion since 2008 - Wholesale funding decline: over GBP 1.3 trillion - December 2014: FCA announced a revised overall strategy - Bank of England, Financial Stability Report, July 2015 - Mark Carney speech, October 24, 2013 *Source: _cr16166 - INTRODUCTION _________________________________________________________________________________ 15* ### 13. Drawing on lessons learned from the financial crisis, U.K. supervisors have made ### _cr16166 - 13. Drawing on lessons learned from the financial crisis, U.K. supervisors have made ### Supervisory approach: from “light touch” to more hands-on supervision - Key finding: The prior supervisory authority’s approach, labeled “light touch” by some, may not have been sufficient to promote the safety and soundness of the supervised entities. - Observed change: The PRA and the FCA have developed far more “hands-on” and rigorous approaches, enabled in large part by the separation of powers between the PRA and the FCA. - Supervisory actions and orientation: - Supervisors are challenging especially larger firms to a greater degree and seeking to test or validate perspectives more frequently than under the legacy approach. - Supervisors are drawing on additional sources for perspectives, engaging more frequently with independent, nonexecutive members of Boards of directors of the largest firms as well as with external auditors. - Threshold Conditions context (as described in the source): - Minimum requirements that firms must meet to be permitted to carry on regulated activities; codified in FSMA. - Broad requirements: appropriate amount and quality of capital and liquidity; appropriate resources to measure, monitor, and manage risk; fit and proper; conduct business prudently. ### Resource constraints, coverage gaps, and risks from scaled supervision - Key findings: - Resource constraints may limit unduly the depth and breadth of critical reviews of the largest banks and reduce attention to mid-sized and smaller firms. - Continuous assessment (CA) of major players may leave insufficient time and resources for regular review of internal models used for capital requirement calculations. - Far less probing and validation appears to take place in firms not among the most systemically important. - Risks: - Undermined credibility of firms’ capital calculations could weaken supervisors’ emphasis on adequacy of banks’ capitalization. - Supervisors may face unexpected challenges more frequently among smaller firms, raising reputational risks. - Risks across smaller firms are more likely to be correlated than across large ones. ### Mitigating actions and limitations - Mitigation approaches observed: - Automated monitoring of mid-sized to small banks is relied upon to a great degree. - Concern: Unclear whether this gives sufficient insight into management, operations, and risks of smaller firms. - Data improvements noted: some improvements stem from changes in the EU reporting framework and creation of a PRA data governance group; still room to develop better data on credit exposures and performance. - Recommended enhancement: Generate comparable, relevant, reliable, and timely data to monitor credit trends and enable offsite analysis of loan portfolios’ performance. - Use of “skilled person” reviews requiring firms to hire external experts for particular reviews. - Benefit: Provide resources, expertise, and focus; can be a powerful tool. - Caution: Supervisors must avoid “outsourcing” prudential supervision or failing to develop key skills in staff. - A “responsive and flexible” supervisory approach for firms considered lower risk to the U.K. financial system, with mechanisms (FPC, PRA, FCA) to spot risks and scale up resources when needed. - Continued reliance on setting supervisory expectations (Threshold Conditions, PRA’s Fundamental Rules, FCA’s Principles for Business) and on firms to inform supervisors when they do not meet expected standards. - IMF view: U.K. supervisors could undertake more independent probing to ensure firms’ prudence and propriety, especially given recent concerns about weaknesses in conduct and culture. ### Consolidated and cross-border supervision (CP 12–13) - Legal/policy enhancements: - The Financial Services Act 2012 provided two new powers over holding companies that are not authorized entities: - (i) power to give directions to the parent organization to undertake or refrain from certain undertakings; - (ii) power to require the parent organization to provide information. - These powers give PRA and FCA more direct access to, and influence over, parent organizations not undertaking regulated activity. - Cross-border engagement: - PRA and FCA are deeply engaged in oversight of U.K. firms’ overseas operations and cooperate with supervisors abroad as home and host supervisors. - Both agencies can share or exchange relevant information with supervisors in other jurisdictions and can play a role in supervisory colleges. ### Corporate governance (CP 14) - Lessons and actions: - Crisis lesson: excessive build-up of risks prior to the financial crisis might be attributable to weak or poor internal governance. - Supervisors have increased their focus on governance within firms. - The UK may already meet some of the Basel Committee’s newly added expectations related to corporate governance. - Forthcoming measures: efforts to attach more personal responsibility to individuals in significant roles, especially through the upcoming introduction of the new Senior Manager Regime (SMR). - Gaps and expectations: - The APR approach to supervising corporate governance left gaps in supervisors’ abilities to hold key individuals accountable. - The new SMR, implemented from March 7, 2016, is expected to address existing weaknesses and reinforce supervisors’ abilities to ascribe accountability to individuals in key roles. ### Risk-management and capital adequacy (CP 15–25) - Framework strength: - U.K. authorities benefit from a comprehensive and well-articulated general framework, especially for the most systemically important firms. - Persistent issues and opportunities: - Supervisors have difficulty keeping pace with reviews of internal models, raising issues for capital planning across many firms. - Opportunities to improve guidance on supervision of credit risk and to increase the application of Asset Quality Reviews (AQR) for smaller firms. - Recommendation: Continue to promote closer alignment of the EU regulatory framework with international standards. ### Controls, audit, accounting, disclosure, and abuse of financial services (CP 26–29) - Controls and audit: - The U.K.’s approach has evolved to encourage greater dialogue with internal and external auditors. - Supervisors have increased oversight of banks’ internal audit functions, allowing greater reliance on internal auditors’ work. - Discussions with external auditors now extend into governance matters; auditors welcomed increased contact, though consistency of engagement could be improved. - Disclosure: - Supervisors are encouraged to publish nonconfidential, firm-level prudential returns to assist comparative analysis of condition and performance. - Greater release of comparable, relevant, reliable, and timely data on balance sheets, income and losses, and off-balance sheet exposures may improve market understanding of firms’ risk profiles. - Anti‑Money Laundering (AML) and supervision of lower-risk firms: - Current procedures may leave large numbers of firms monitored and supervised on a thematic and “responsive” basis. - Reviews for the majority of firms subject to AML regulation are limited to periodic thematic work on specific risks and sectors. - FCA’s thematic reviews have identified significant problems with compliance or internal controls in smaller firms. - Recommendation: Strengthen the “backstop” against abuse of firms thought to be of lower risk and address apparent gaps in supervisors’ coverage of this part of the industry. *Assessment conducted during November 3–19, 2015.* ### 34. The Financial Services Act 2012 established a new framework for financial regulation ### _cr16166 - 34. The Financial Services Act 2012 established a new framework for financial regulation ### Framework and institutional responsibilities - The Financial Services Act 2012 gave responsibility for financial stability to the newly established FPC of the BoE. - The BoE Act 1998, as amended by the Financial Services Act 2012, gives the FPC responsibility to identify, assess, monitor, and take action in relation to financial stability risk across the whole financial system, including addressing risks arising in the nonbank financial system (including institutions and markets). - The Act gives the FPC the power to make recommendations to Her Majesty’s Treasury (HMT) on regulated activities, and general powers in respect of information gathering. - Responsibility for the overall regulatory framework and the protection of the public finances rests with HMT and the Chancellor of the Exchequer. ### New regulatory architecture (PRA, FCA, BoE functions) - The Financial Services Act 2012 transferred prudential regulation of deposit-takers, insurers and the largest investment firms to a new microprudential supervisor, the PRA, a subsidiary of the BoE. - Responsibility for regulating conduct of business was given to the FCA, with the mandate and tools to protect consumers and market participants, including through the promotion of competition. - The PRA and FCA started to operate in April 2013. - The BoE is the resolution authority responsible for preparing and responding to the failure of banks, building societies, certain investment firms and central counterparties in accordance with the U.K.’s special resolution regime. The BoE is also responsible for the regulation of systemically important firms supporting the clearing, payment and settlement infrastructure in the United Kingdom. ### Regulatory perimeter and nonbank system - Most U.K. financial institutions are regulated in some form, although not all activities undertaken by these institutions are subject to regulation. - Finance company regulatory treatment depends on ownership and activity: - owned by banks → PRA and FCA regulated; - nonbanks providing residential mortgages or consumer credit → FCA regulated; - nonbanks undertaking business lending (for amounts exceeding GBP 25,000) or providing certain types of buy to let mortgages → unregulated. - Securitization special purpose vehicles (SPVs) may be regulated depending on whether they are part of a banking group. - The FPC has a statutory power to make recommendations to HMT in relation to the boundaries between and within regulated and non-regulated sectors (the 'regulatory perimeter'). The FPC committed to hold a discussion on the regulatory perimeter at least annually. - In July 2015 the FPC considered channels through which stress in key parts of the nonbank financial system could impact U.K. financial stability and, based on its current assessment, did not see a case for recommending changes to the regulatory framework but would return to the issue on an annual basis, or sooner, if risks were identified. ### Banking Reform Act (BRA) 2013 and governance of firms - The Banking Reform Act (BRA) 2013 implemented the final ring-fencing recommendations of the independent commission on banking (ICB), separating retail banking from wholesale or investment banking within banking groups to isolate activities vital to the economy and customers. - The BRA implemented recommendations by the PCBS on culture and standards, and put in place the legal framework for the “Senior Managers and Certification Regime” to strengthen regulation of individuals in the U.K. banking sector. - The BRA makes available to the BoE a stabilization option (the “bail-in option”) under part 1 of the BRA 2009. ### BoE and Financial Services Act (pending provisions) - Parliament passed a new BoE and Financial Service Act; most provisions had not come into force at the time of this assessment. Key reforms set out in the Act include: - Bringing the PRA within the BoE (ending subsidiary status) and creating a new committee of the BoE to be known as the PRC, while retaining PRA independence in rules, policies and supervisory decisions; - Reinforcing accountability of the PRC and the CEO for the BoE's prudential regulation functions, with updated reporting requirements; - Updating resolution planning and crisis management arrangements between the Treasury and the BoE, including strengthened requirement for the BoE to provide the Treasury with information on risks to public funds; - Making the court of directors a smaller, unitary Board; - Placing the new deputy governor for banking and markets in legislation, adding the position to the court of directors and the FPC; - Adjusting the statutory basis of the FPC from a subcommittee of the court to a statutory committee of the BoE; - Bringing the BoE within the purview of the National Audit Office (NAO); - Strengthening coordination arrangements between the Treasury and the BoE in protecting taxpayers and the wider economy from bank failures; and - Extending the Senior Managers and Certification Regime to all financial services firms and implementing a fairer system by introducing a ‘duty of responsibility’ (superseding the previously proposed ‘reverse burden of proof’). ### EU regulatory context (CRD IV, BRRD, DGSD) - As a member of the EU, the United Kingdom adheres to the European ‘single Rulebook,’ with the backbone represented by the 2013 CRD and Regulation (the ‘CRD IV package’), implementing Basel III capital and liquidity standards and corporate governance rules. The Regulation and Directive came into force from January 1, 2014, with transition time for member states. - The CRD IV package is a ‘going concern’ framework designed to ensure banks are adequately capitalized in normal times to absorb losses and pay obligations in a stress, and have adequate governance, systems and controls. - The 2014 Banking Recovery and Resolution Directive (BRRD) applies to non-viable banks and introduced a harmonized set of resolution tools to protect critical functions, limit contagion, and avoid taxpayer bail-outs. - The 2014 Deposit Guarantee Scheme Directive (DGSD) harmonizes deposit protection at EUR 100,000 per depositor per bank, mandates protection for temporary high balances, and requires member states to ensure ex ante funding equivalent to 0.8 percent of covered deposits is available. ### Scale and structure of the U.K. banking sector (key statistics) - Total assets in the U.K. banking sector were almost 400 percent of nominal GDP in 2014, excluding derivative exposures and foreign assets and liabilities of foreign branches. - There are over 900 banks, building societies and credit unions supervised by the PRA. Within the total of 900 there are 150 deposit-taking foreign branches and 98 deposit-taking foreign subsidiaries in the United Kingdom from 56 different countries. - Foreign banks constitute around half of U.K. banking sector assets on a residency basis, with the combined assets of the largest ten foreign subsidiaries in the United Kingdom (including their non deposit-taking entities) totaling around GBP 2.75 trillion. - Foreign branches account for around 30 percent of total U.K.-resident banking assets and around a third of U.K. interbank lending. - Nearly a fifth of global banking activity is booked in the United Kingdom, and U.K.-resident banks' foreign assets and liabilities account for over 350 percent of U.K. GDP. - Financial services contributed a trade surplus of over GBP 59 billion in 2013 according to the Office for National Statistics (ONS). - The financial services industry employs over a million people; a million more are employed in complementary professional services. Two thirds of those two million jobs are outside London. - Government holdings following the 2008–9 interventions: at the end of August 2015 government holdings stood at just under 13 percent ownership in Lloyds, and 73 percent in RBS. ### Capital positions, stress testing, and asset quality work - Major U.K. banks reported an average CET1 position above 12 percent and an aggregate leverage ratio over 4.7 percent at end–September 2015. - In November 2012, the FPC recommended that the FSA "takes action to ensure that the capital of U.K. banks and building societies reflects a proper valuation of their assets, a realistic assessment of future conduct costs and prudent calculation of risk weights." - In March 2013, the FPC judged that the immediate objective should be to achieve a CET1 ratio, based on Basel III definitions and after the required adjustments, of at least 7 percent of risk-weighted assets (RWA) by end 2013. - Stress tests are used primarily to assess the amount of capital a bank might require in the event of an adverse shock; AQRs help ensure reported capital positions are stated accurately. ### Preconditions for effective supervision, macroeconomic policy, and the FPC - The Government's economic policy objective is to achieve strong, sustainable and balanced growth more evenly shared across the country and between industries, recognizing prior unbalanced growth driven by private and public sector debt. - The BoE’s monetary policy objective is to deliver price stability (low inflation) and, subject to that, to support the government's economic objectives including growth and employment; the inflation target is set by the government at 2 percent. - The Government's economic strategy consists of four key pillars: - a) monetary activism and credit easing; - b) deficit reduction; - c) completing reform of the financial system and improving the regulatory framework; and - d) a comprehensive package of structural reforms, rebalancing and strengthening the economy for the future. - The FPC was officially established on April 1, 2013. Its primary objective is identifying, monitoring and taking action to remove or reduce systemic risks to protect and enhance the resilience of the U.K. financial system; its secondary objective is to support the economic policy of the government. The FPC publishes a record of formal policy meetings and is responsible for the BoE’s bi-annual Financial Stability Report (FSR). - The FPC is a statutory subcommittee of the BoE’s Court. Its members include: the governor; three deputy governors (financial stability, prudential regulation, and monetary policy); the chief executive of the FCA; the BoE’s executive director for Financial Stability Strategy and Risk (FSSR); four external members appointed by the Chancellor; and a nonvoting member from HMT. - The FPC has responsibility for setting the countercyclical capital buffer (CCB) and powers of direction over sectoral capital requirements (SCRs), loan-to-value and debt-to-income limits in respect of owner-occupied lending, and in relation to leverage ratio tools. There is a statutory requirement for the FPC to prepare and maintain a general statement of policy for the powers of Direction it is given under legislation. ### Public infrastructure, payment systems, and legal/framework strengths - The United Kingdom ranks 6th in the World Bank ‘Ease of Doing Business’ classification at international level for both 2015 and 2016. - Medium-high score for strength of insolvency framework; maximum score for depth of credit information; very high ranking (4th) for protection of minority investors. - Payment, clearing and settlement systems are well regulated; basic economic, financial and social statistics are publicly available. ### Financial safety nets and crisis management - The Financial Services Compensation Scheme (FSCS) is the U.K.'s compensation fund of last resort for customers of authorized financial services firms; it covers business conducted by firms authorized by the PRA and FCA and may cover European firms authorized by their home state regulator operating in the United Kingdom. FSCS protects: deposits; insurance policies; insurance broking (for business on or after January 14, 2005), including connected travel insurance where the policy is sold alongside a holiday or other related travel (for business on or after January 1, 2009); investment business; and home finance (for business on or after October 31, 2004). - The FSCS is independent of the government and the financial industry, was set up under the Financial Services and Markets Act (FSMA) 2000, and became operational on December 1, 2001 (although it still covers claims from before this date). It may pay compensation if a firm is unable, or likely to be unable, to pay claims against it; the FSCS does not charge individual consumers for using the service. - The key principle of financial crisis management is to make clear who is in charge of what, and when: the BoE has primary operational responsibility for financial crisis management; the Chancellor and HMT have sole responsibility for any decision involving public funds. When the BoE has formally notified the Treasury of a material risk to public funds, and either there is a serious threat to financial stability, or public funds are already committed by the Treasury to resolve or reduce such a serious threat and it would be in the public interest to do so, the Chancellor may use powers to direct the BoE. *Source: _cr16166 - 34. The Financial Services Act 2012 established a new framework for financial regulation* ### 62. The Financial Crisis Management Memorandum of Understanding (MoU) sets out who ### 62. The Financial Crisis Management Memorandum of Understanding (MoU) sets out who ### Crisis management and MoU - The MoU sets out who is in charge of what and when between HMT and the BoE (including the PRA) in a financial crisis. - The MoU has a particular focus on monitoring and managing potential risks to public funds. ### PRA preparedness, authority, and supervisory requirements - Core aspect: the PRA aims at ensuring preparedness for recovery or resolution of a failing firm. - The PRA has authority to set rules and supervisory requirements for: - financial holding companies (FHCs), - mixed financial holding companies (MFHCs), - mixed activity FHCs, - banks, - building societies, and - PRA-designated investment firms. - The PRA's rules require supervised entities to: - be better prepared for future financial stress through credible and robust recovery planning (identification of options to recover financial strength in stress situations); - provide information (‘resolution packs’) to help the BoE in its role as the resolution authority; and - ensure the feasibility of bailing-in creditors, in the case of cross-border firms, by adopting contractual recognition of bail-in. ### Market discipline and disclosure - An extensive set of institutional investors, major rating agencies and analysts are active in the United Kingdom. - Well-developed mechanisms support market discipline, including a system of regular disclosure by public companies. - Required disclosures for banks have been materially enhanced through the additional annual disclosures based on Pillar 3 of the Basel III global regulatory framework. - Some banks make quarterly financial disclosures and some half-yearly. - Regular financial statement disclosures relate to market risk, liquidity risk and credit concentrations. - The FPC of the BoE prepares and publishes a FSR twice per calendar year. - The FSR sets out the FPC's view of the outlook for U.K. financial stability, including its assessment of the resilience of the U.K. financial system and the current main risks to financial stability, and the action it is taking to remove or reduce those risks. ### Post-crisis reforms and market maturity - Since the financial crisis the United Kingdom has fundamentally reformed its financial sector and has pushed for international reforms to help end too-big-to fail and ensure effective market discipline. - The United Kingdom has well established and mature markets which have effective mechanisms for ensuring market discipline. ### Corporate governance and takeover regulation - The FRC sets governance guidelines for listed companies with premium listing through the U.K. Corporate Governance Code. - The U.K. Corporate Governance Code operates on the principle of 'comply or explain.' - It sets out good practice covering issues such as Board composition and effectiveness, the role of Board committees, risk management, remuneration and relations with shareholders. - The Code has been instrumental in spreading best Boardroom practice throughout the listed sector since it was first issued in 1992. - In November 2012, the government published its response to the 17 specific recommendations of an independent review of U.K. equity markets. - The review aimed to ensure that U.K. equity markets continue to benefit both companies and investors. - The Panel on Takeovers and Mergers (the "Panel"): - established in 1968; - issues and administers the City Code on Takeovers and Mergers (the "Code"); - supervises and regulates takeovers and other matters to which the Code applies; - designated as the supervisory authority to carry out certain regulatory functions in relation to takeovers pursuant to the Directive on Takeover Bids (2004/25/EC) (the "Directive"); - statutory functions are set out in and under Chapter 1 of Part 28 of the Companies Act 2006. - The Code is designed to ensure shareholders are treated fairly, afforded equivalent treatment by an offeror, and have an opportunity to decide on the merits of a takeover; it provides an orderly framework for takeovers and is designed to promote the integrity of the financial markets. ### Government shareholdings and asset management (UKFI and UKAR) - The U.K. Financial Investments (UKFI) was created in November 2008 as part of the U.K.'s response to the financial crisis. - UKFI is a Companies Act Company, with HMT as its sole shareholder, and operates at arm's-length from government. - UKFI is responsible for managing the Government's shareholdings in the RBS Group plc and the Lloyds Banking Group plc. - UKFI's overarching objective is to manage these shareholdings commercially to create and protect value for the taxpayer as shareholder. - UKFI aims to devise and execute a strategy for realizing value for the government's investments in an orderly and active way over time within the context of protecting and creating value for the taxpayer as shareholder, paying due regard to the maintenance of financial stability and acting in a way that promotes competition. - UKFI is also responsible for managing the Government's 100 percent shareholding and loans in U.K. Asset Resolution Limited ("UKAR") and its subsidiaries. - UKAR: - was formed during 2010 to integrate the activities of Northern Rock (asset management) plc and Bradford & Bingley Plc. - UKFI managed the government's 100 percent shareholding in Northern Rock plc from Northern Rock plc's formation on January 1, 2010 up to its sale to Virgin Money on January 1, 2012. ### Consumer protection and retail deposits - One of the FCA’s central responsibilities is to protect consumers from the firms and individuals in the financial industry that may cause them harm. - The FCA expects firms to provide customers with appropriate products and services. - The FCA evaluates firms’ abilities to meet relevant supervisory requirements before they are authorized. - The FCA supervises authorized firms and prevents those that are not meeting standards from carrying out regulated activities. - FCA interventions include imposing penalties, stopping firms from carrying out certain types of business, requiring improvements in controls or management, or securing redress. - With respect to retail deposits, U.K. legislation and FCA rules set down a conduct regime for banks and other account providers covering: - the provision of appropriate information, such as on terms and conditions, before an account is opened; - the ongoing provision or availability of information to customers about the activity on the account, such as through regular statements, as well as changes to terms and conditions such as notifications when the rate of interest applied to the balance on the account changes; - the making and receipt of payments on the account, and the related protections against issues such as unauthorized transactions; - deposit protection; and - the provision of overdrafts. ### Other measures - In 2013, the government launched the 'Current Account Switch Service.' It lets consumers safely and reliably switch their accounts between banks in seven days, with a guarantee that they will be fully protected against any financial loss during the transfer. *Source: _cr16166 - 62. The Financial Crisis Management Memorandum of Understanding (MoU) sets out who* ### 77. Compliance of each principle will be made based on the following four-grade scale: ### _cr16166 - 77. Compliance of each principle will be made based on the following four-grade scale: ### Grading scale and applicability - Four-grade scale: compliant, largely compliant, materially noncompliant, and noncompliant. A “not applicable” grading can be used under certain circumstances. - Compliant: - A country will be considered compliant with a Principle when all essential criteria applicable for this country are met without any significant deficiencies. - Note: “There may be instances ... where a country can demonstrate that the Principle has been achieved by other means. Conversely ... the essential criteria may not always be sufficient ... other measures may also be needed ...” - Largely compliant: - A country will be considered largely compliant whenever only minor shortcomings are observed that do not raise concerns about the authority’s ability and clear intent to achieve full compliance within a prescribed period. - Can be used when the system does not meet all essential criteria, but overall effectiveness is sufficiently good and no material risks are left unaddressed. - Materially noncompliant: - A country will be considered materially non‑compliant whenever there are severe shortcomings, despite formal rules, and evidence that supervision has clearly not been effective or practical implementation is weak. - Acknowledges the “gap” between “largely compliant” and “materially non‑compliant” is wide and forces assessors to make a clear statement. - Noncompliant: - A country will be considered non‑compliant whenever there has been no substantive implementation of the Principle, several essential criteria are not complied with, or supervision is manifestly ineffective. - Footnote 11: For grading, references to “essential criteria” in this para. include additional criteria if a country volunteered to be assessed and graded against additional criteria. *Italic: UNITED KINGDOM — INTERNATIONAL MONETARY FUND (extracted content)* ### Principle 1 — Responsibilities, objectives, and powers (overview) - Principle statement: An effective system of banking supervision has clear responsibilities and objectives for each authority involved in the supervision of banks and banking groups. A suitable legal framework provides necessary legal powers to authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns. - Assessment of Principle 1: Compliant. ### Essential Criteria and key findings (EC 1 – EC 7) EC 1 — Responsibilities and objectives publicly defined - Legal/regulatory basis: - CRD requires MSs to ensure National Competent Authorities (NCAs) assess compliance with CRD and CRR (Arts. 4–7) and separate resolution functions (Art. 4). Art. 5 requires internal coordination if more than one NCA. Art. 6 requires NCAs cooperate within ESFS and ESRB. - U.K. institutional structure: - The PRA and FCA are the NCAs for the United Kingdom. - PRA: prudential matters; supervises around 1,700 firms and groups, including over 900 deposit-takers and nearly 700 insurers of all sizes. - FCA: conduct supervisor for approximately 56,000 firms across all industry sectors (including all deposit-takers) and prudential supervisor for approximately 24,000 firms not regulated by the PRA. - Legal foundation: - Responsibilities/objectives of PRA and FCA set out in FSMA 2000 (public). - PRA general objective: promote the safety and soundness of PRA-authorized persons (S2B FSMA). - PRA Fundamental Rules are in the PRA Rulebook and express expectations on conduct, financial resources, risk strategy, organization and control, openness, and preparedness for resolution. - PRA has a secondary competition objective. - FCA strategic objective: ensure that relevant markets function well. FCA operational objectives: - Securing an appropriate degree of protection for consumers (S1C FSMA); - Protecting and enhancing the integrity of the U.K. financial system (S1D FSMA); - Promoting effective competition in the interests of consumers (S1E FSMA). - Coordination and rulemaking: - FSMA establishes coordination mechanisms for PRA and FCA, with hard requirements to cooperate (e.g., duties to consult on rules S138I and S138J; imposition of a requirement S55L and S55M; “appropriate regulator” S204A). - Macroprudential overlay: - FPC established April 1, 2013 on statutory basis; primary objective to contribute to BoE’s financial stability objective. - FPC powers: make Recommendations (comply or explain) to PRA and FCA; give directions to PRA and FCA to deploy specific macroprudential tools prescribed by HMT (CCB, SCR, limits on residential mortgage lending including loan-to-value and debt-to-income). - BoE is the U.K. resolution authority for banks, building societies, CCPs and certain investment firms; Banking Act sets roles and powers. - EU roles: - EBA is competent authority for functioning of colleges of supervisors (no supervisory responsibilities). European Commission handles regulatory matters for EU (no supervisory powers). EC 2 — Primary objective of supervision - PRA is assigned the primary objective of promoting the safety and soundness of PRA-authorized persons (S2B FSMA). - PRA’s secondary competition objective does not conflict with or override the primary objective. EC 3 — Power to set and enforce prudential standards and increase requirements by risk/systemic importance - Authorization and Threshold Conditions: - Banks must meet Threshold Conditions (FSMA Schedule 6) and comply with PRA/FCA rules to be/continue authorized; Threshold Conditions impose obligations on the regulator and form basis/trigger for resolution. - Capital setting: - PRA routinely sets Pillar 2A capital for credit, market, counterparty, operational risks; sets Pillar 2A for IRRBB, credit concentration risk, pension obligation risk; may set capital for other risks. - The sum of Pillar 1 and Pillar 2A represent the individual capital guidance (ICG). - PRA expects banks to meet Pillar 2A with at least 56 percent of CET1 and no more than 25 percent of Tier 2 Capital. - PRA buffer (Pillar 2B) and interaction with CRD buffers: - Firms may be expected to hold additional Pillar 2B capital (PRA buffer) to ensure compliance during a stressed period (informed by CST or own stress tests). - PRA may set buffer to cover RM&G weaknesses or severe stress losses; may consider systemic importance. - PRA buffer generally set as the excess, if any, above CRD buffers. - Rulemaking and enforcement powers: - PRA and FCA can alter/revoke/modify/waive rules (FSMA S138A). Draft rules require cost-benefit analysis and public notice (S138I). - Strong enforcement powers include unlimited financial penalties and public censure (S66; Part XIV FSMA S205 and S206). EC 4 — Law/regulations updated and subject to public consultation - CRD/CRR framework: - Current CRD/CRR framework adopted in 2013; prior iterations in 2006, 2009 (CRD II) and 2010 (CRD III), each following public consultation. - EBA technical standards/guidelines are subject to formal public consultations. - PRA/FCA rule updates: - PRA and FCA update rules and guidance regularly; significant portions of prudential framework are direct EU Regulations (CRR) applied directly. - Draft rules must be accompanied by cost-benefit analysis and explanation for public consultation (S138I FSMA). EC 5 — Information and investigatory powers; group and branch supervision; supervision of foreign banks - Legal basis: - CRD Art. 65 requires MSs to provide NCAs information gathering and investigatory powers; Art. 97 expects NCAs to conduct supervisory review/evaluation. - PRA/FCA powers: - Full access to Board, management, staff, records via S165 FSMA and powers to appoint investigators under S167 and S170 FSMA. - PRA Fundamental Rule 7: firms must deal with regulators openly/cooperatively and disclose matters PRA reasonably expects notice of. - Failure to provide required information can be punished as contempt of court; knowingly providing materially false/misleading information is a criminal offence; destroying/concealing relevant documents can be a criminal offence (S177 and S398 FSMA). - Warrants to enter premises and obtain documents where noncompliance suspected (S176 FSMA). - Scope across entities and jurisdictions: - Powers apply to U.K. incorporated firms, U.K. subsidiaries of overseas firms, and U.K. branches of overseas firms (subject to home/host allocation for EEA firms). - Investigatory powers can, in principle, be used in other jurisdictions but enforcement may be limited by overseas laws. EC 6 — Power to take corrective action, impose sanctions, revoke license, and cooperate on resolution - EU framework references: - CRD: NCAs expected to withdraw authorization (Art. 18), impose penalties (Art. 64), require corrective actions (Art. 102 and Art. 104). - EU resolution: BRRD establishes framework. - Corrective action and revocation (domestic powers): - Regulators may change a bank’s permission on their own initiative under S55J FSMA (OIVOP), including withdrawing authorization and limiting deposit acceptance. - FCA or PRA may impose requirements on banks (S55L and S55M FSMA). - Sanctions available (Part XIV FSMA): - Suspending permission to carry on regulated activity for a specified period; - Imposing limitations or restrictions on regulated activities during suspension; - Publishing a statement of public censure; - Imposing a financial penalty. - Resolution process: - BoE is the designated resolution authority. - Two key conditions for resolution: - Firm must be failing, or likely to fail (assessed by prudential supervisor—PRA, or FCA where applicable—having consulted the BoE). - It must not be reasonably likely that action outside resolution will result in firm no longer failing (assessed by BoE as resolution authority, having consulted PRA or FCA, and HMT). EC 7 — Power to review parent and affiliated companies’ activities - CRD requirements: - CRD Art. 4 requires MSs to empower NCAs to monitor activities and obtain information from FHCs and MFHCs; CRD provides legal framework for consolidated supervision (Arts. 111–127). - PRA approach: - PRA supervises large complex groups on a consolidated basis, including where holding company not a regulated legal entity. - Parent companies that are holding companies fall outside CRR; Financial Services Act 2012 gave PRA and FCA powers over ‘qualifying parent undertakings’ (FSMA S192B and S192C): - Power to give directions to qualifying parent undertakings to take or refrain from specific actions; - Power to make rules requiring qualifying parent undertakings to provide information/documents of a specified description. - PRA has issued policy statements on use of directions over qualifying parent undertakings. - PRA’s direction powers can require information/documents concerning activities of affiliated companies; PRA may also use information‑gathering powers over the regulated entity (Rule 4.1 Information Gathering Part of PRA Rulebook). ### Assessment of Principle 1 — Comments (selected) - Financial Services Act 2012: - Formally separated prudential (PRA) and conduct (FCA) supervision functions; assigns PRA a clear primary objective of safety and soundness. - PRA must act to facilitate effective competition as a secondary objective; where conflict occurs, primary objective takes precedence. - PRA orientation and supervisory approach: - PRA expresses a ‘no zero‑failure’ policy and emphasizes minimizing the adverse effect of failure on U.K. financial stability—hence prioritizes supervision of largest systemic banks, potentially at expense of medium/small banks’ intrusiveness. - PRA’s Target Operational Model, risk appetite, oversight and mitigation were under review (announced in 2015 annual report, p. 21). - Macroprudential implementation: - Since April 2013 FPC is statutory macroprudential authority; powers include CCB, SCR, and mortgage limits. - Deployment experience is limited: countercyclical and sectoral buffers not activated yet; mortgage limits applied in limited form (mortgage lenders required to limit proportion of mortgages at loan-to-income multiples of 4.5 and above to no more than 15 percent of new mortgages). - Limited evidence about effectiveness and operational burden so far; cooperation between BoE and PRA is favoring dialogue and synergies (e.g., running CSTs). - Powers over parent undertakings: - 2012 powers appear broadly adequate to assess impact of non-regulated parent/affiliated companies on banks, though some regulatory tools (e.g., APR and SMR) may not apply to non-regulated holding directors unless they have roles in the regulated entity. - Residual concerns: - Prioritization toward systemic banks sensible for financial stability but may raise reputational risk if perceived insufficiently intrusive on mid-size failures. - CST is absorbing significant time/resources; further evolution may stress microprudential supervision without adequate recruiting, staff retention, and training. ### Principle 2 — Independence, accountability, resourcing and legal protection (selected ECs) EC 1 — Operational independence, accountability and governance - Legal/regulatory basis: - Independence, governance and accountability arrangements for PRA and FCA set out in FSMA 2000 and articles of association (publicly disclosed). - Structures and funding: - PRA established as company limited by shares with BoE as sole shareholder; majority of Board members are independent nonexecutives; Court of the BoE approves PRA’s budget. - FCA established as private company; has operational independence though ultimately accountable to government and parliament. - Both funded by fees levied on industry by statute (subject to consultation); neither subject to central government budgetary control. PRA must publish budget and variations and is responsible for annual reporting. - Government directions: - HMT has limited powers to direct regulators in specified circumstances: - a) consider firms’ compliance with rules about remuneration and resolution plans; - b) take action where competition authorities advise regulation is distorting competition and are not content with regulator’s response; - c) ensure U.K.’s compliance with EU law and international obligations; - d) technical directions re annual reports, accounts, and payment of penalty income to HMT; - e) technical directions to FCA about criminal prosecution; - f) directions relating to investigations under the Financial Services Act 2012. - Financial Services Act 2012 investigation power: - FCA and PRA required to investigate and make a report to the Treasury where there has been a serious failure in the system of financial regulation and certain conditions are met. - Treasury may direct regulators that conditions for an investigation appear to have been met; may direct an investigation solely on public interest grounds even without regulator investigation. - Historical use: Treasury announced one intended use in November 2013 (independent investigation into events at the Co‑op BoE) but delayed to avoid prejudicing FCA/PRA enforcement investigations. No HMT investigation had started at time of assessment. - Interpretation: instrument seen as ex-post accountability rather than ex-ante interference. EC 2 — Appointment and removal transparency (beginning of description) - Schedule 1ZB of FSMA requires the BoE’s Governor to be Chair of the PRA and the Deputy Governor for Prudential Regulation to be Chief Executive of the PRA. - Both the governor and deputy governor for Prudential Regulation are appointed by the Queen under [text continues in source beyond excerpt]. *Italic: Excerpted from document — UNITED KINGDOM — INTERNATIONAL MONETARY FUND* ### Section 1(2) of the BoE Act 1998, on the recommendation of the Prime Minister and Chancellor. ### _cr16166 - Section 1(2) of the BoE Act 1998, on the recommendation of the Prime Minister and Chancellor. ### Appointment and removal of PRA and FCA leaders and board members - The governor and deputy governors for Prudential Regulation and Financial Stability are members of the PRA Board ex officio and can be removed from office by the BoE, with the consent of the Chancellor of the Exchequer, if considered unable or unfit to discharge their functions as members. - All appointed members of the PRA Board must be appointed by the court of directors of the BoE with the approval of HMT (para. 6 of Schedule 1ZB FSMA). - Grounds for removal of an appointed PRA Board member are set out in FSMA (para. 14 of Schedule 1ZB) and include incapacity, serious misconduct, and significant conflicts of interest. - Schedule 1ZA of FSMA sets out the FCA’s constitution; para. 2 of Schedule 1ZA requires the chairman and other members of the FCA’s governing body to be appointed, and be liable to removal from office, by the Treasury (two members are required to be jointly appointed by the Treasury and the Secretary of State). - Para. 4 Schedule 1ZA details circumstances in which the Treasury may remove the chairman or other members from office; grounds include incapacity, serious misconduct, and significant conflicts of interest. - From April 1, 2013, the Treasury appoints the Chairman of the FCA for a minimum term of five years and the CEO for a minimum term of three years. - According to the BoE Act, the Chair of the PRA (BoE Governor) is appointed by the Queen for a term of eight years (though the current governor has indicated he intends to serve for five years). - The CEO of the PRA is appointed by the Queen for a term of five years from April 1, 2013. - There are no legal provisions requiring that the reason(s) for removal of the head(s) of the supervisory authorities be disclosed. - Appointed members of the Boards of both organizations are generally appointed for a standard minimum term of three years; initial appointments have sometimes been for less than three years to stagger changes in nonexecutive membership. ### EC 3 — Publication of objectives and accountability framework - The PRA and FCA objectives are set out in legislation as summarized in EC 3 of Principle 1. - The PRA’s approach to supervision is published. - HMT has the power to appoint an independent person to review the economy, efficiency and effectiveness with which the PRA has used its resources in discharging its functions (S20). This power had never been used by the Treasury at the time of the assessment. - HMT can require the PRA to undertake an investigation into any “relevant events” where HMT considers it to be in the public interest and the PRA has not undertaken, or is not undertaking, an investigation already (S77 of the Financial Services Act 2012). An investigation of this kind has been announced and immediately suspended to wait for the outcome of investigations to be conducted by the PRA and FCA. - FSMA requirements for the PRA include: - At least once a year make a report to the Treasury on, amongst other things, the discharge of its functions. HMT is required to lay a copy of each such report received before parliament (FSMA Schedule 1ZB para. 19). - Invite representations from the public about its annual report, the way it has discharged its functions and the extent to which its objectives have been advanced (Schedule 1ZB para. 20). - Be subject to full audit by the NAO and the NAO is able to launch Value for Money Studies of the PRA (Schedule 1ZB para. 23). - Maintain effective arrangements for consulting practitioners on the extent to which its general policies and practices are consistent with its general duties under S2B to 2H (S2L of FSMA). - Make arrangements for the investigation of complaints arising in connection with the exercise of, or failure to exercise, any of its relevant functions (Part 6 of the Financial Services Act 2012). - Make a report to HMT, to be laid before parliament, where there has been regulatory failure (S74 of the Financial Services Act 2012). HMT has power to order an independent inquiry into regulatory failure, carried out by a third party (S68 and S69 of the Financial Services Act 2012). - FSMA requirements for the FCA include: - At least once a year make a report to HMT on, amongst other things, the discharge of its functions. The Treasury is required to lay a copy of each such report received before parliament (FSMA Schedule 1ZA para. 11). - Hold an annual public meeting to discuss its annual report (Schedule 1ZA para. 12). - Be subject to full audit by the NAO and the NAO is able to launch Value for Money studies of the FCA (Schedule 1ZB para. 15). - Consult practitioners and consumers on the extent to which its general policies and practices are consistent with its general duties under S1B (S1M of FSMA). - Make arrangements for the investigation of complaints arising in connection with the exercise of, or failure to exercise, any of its relevant functions (Part 6 of the Financial Services Act 2012). - HMT power to appoint an independent person to review the economy, efficiency and effectiveness with which the FCA has used its resources in discharging its functions (S1S of FSMA). - Make a report to HMT, to be laid before parliament, where there has been regulatory failure (S73 of the Financial Services Act 2012) and HMT may order an independent inquiry (S68 and S69 of the Financial Services Act 2012). - HMT power to require the FCA to undertake investigations into “relevant events” (S77 of the Financial Services Act 2012); HMT may direct the FCA to take certain actions (e.g., to consider whether firms’ remuneration policies comply with the regulator’s rules (S137I(3), FSMA)). - HMT may specify the boundary between the FCA and PRA responsibilities (S3G, FSMA). - The Treasury Select Committee of the House of Commons periodically considers PRA and FCA performance and requires senior executives to appear before it. - Recipients of PRA and FCA decisions may challenge those decisions before the Upper Tribunal where expressly stated by FSMA, or otherwise via judicial review. ### EC 4 — Internal governance and decision-making processes - The PRA’s supervisory internal governance operates through the PRA Regulatory Decision Making Framework Guide, providing staff with information on relevant processes and guidance on decision levels; updates are communicated to all staff. - The PRA has a dedicated Secretariat that supports internal governance and associated committees, schedules decisions in a centralized forward agenda, and arranges ad-hoc meetings or written procedures for emergency decisions. - The PRA Board reserves certain decisions to itself, including supervisory decisions for the largest and most systemically significant firms, and delegates other decisions to the CEO, advised by the Supervision, Risk and Policy Committee. Details are set out in “Delegations and Matters Reserved to the Board”. - The PRA policy on conflict of interest of the “appointed members” of the PRA Board is public. - The FCA has an escalation process for supervisory decisions with published criteria available to all Supervisors and a framework for business as usual (BAU) supervisory decisions (e.g., Firm Evaluation sign-off, Interim Review, Deep Dives findings letters, Risk Mitigation Programs). - Non-BAU supervisory decisions escalate to the Divisional Supervisory Risk Committee (DSRC), a subcommittee of the Executive Regulatory Issues Committee (ERIC), and may escalate to the FCA’s Executive Committee (ExCo), the FCA’s final decision-making body. - ExCo comprises nine members, including CEO, COO, director of supervision and authorization, director of enforcement and market oversight, and director of strategy and competition; ExCo implements Board strategy and is informed of certain decisions for further sign-off. - Directors must declare conflicts of interest (S175 of the Financial Services Act 2012); an interested director absents from related discussions and reviews. ### EC 5 — Professionalism, integrity, and conflict of interest rules - All PRA staff are covered by the BoE’s Code of Conduct, rolled out in June 2015, consolidating and updating existing policies; the Code includes records management, Information security, and policies on conflict of interest and impartiality. - The FCA’s Code of Conduct is public. ### EC 6 — Resources, financing, and capabilities for effective supervision - The PRA and FCA have powers to require payment of fees; the cost of banking supervision is met by an annual fee (authorization charged separately). Fee-charging powers are set out in FSMA (PRA para. 31 of Schedule 1ZB; FCA para. 23 of Schedule 1ZA). Rulemaking must follow consultation procedures in S138I and M138J of FSMA. - Budget and business planning are annual. The PRA budget includes technology provision divided into ongoing support costs and investment in new technology, much targeted at adoption and implementation of European and national legislation. - Travel budgets support onsite work, cross-border cooperation, and participation in domestic and international meetings, targeted at high-travel areas such as Policy and International Banking. - FSMA (S166) gives PRA and FCA power to require a regulated firm or group member to provide a report by a skilled person; the PRA commissions the report and the firm pays for the skilled person. - The skilled person regime provides specialist resources and expertise to review firm activities and remedial actions; the Reports by Skilled Persons Supervisory Statement 7/14 sets out policy and expectations. - The PRA’s pay policy aims to pay median against the private sector and upper quartile against the public sector; salary scales are reviewed every two years. - Skills identification and gap-rectification are conducted annually via: - A training needs analysis facilitated by the central learning and development team with input from supervision business areas. - Learning and development analysis by individual supervisors and team managers through performance management and technical competencies. - The PRA introduced developmental reviews for senior leaders, reviewed succession planning, updated leadership training, and introduced 360 feedback for managers; work is ongoing to articulate technical and managerial career paths. - Internal promotion is the core route; a promotion framework for experts applies where longer tenure and deep technical experience are required. - FCA recent consultation (CP 15/14) proposed fees to raise the FCA’s Annual Funding Requirement (AFR) for 2015/16; the FCA’s 2015/16 Business Plan set out the AFR use and included budgets to: - Recruit, retain and train sufficient skilled staff; - Cover travel expenses for onsite work; - Provide technology systems to support supervisors. - The 2014/15 FCA Annual Report (Appendix 1) sets out skilled person reviews undertaken, appointments, and costs. - FCA budget and planning determine: - The overall total performance award for the following year to attract and retain staff and distribution across staff. - The overall total training budget; supervisory function represented on the ‘FCA Academy’ Advisory Group directing investment in learning. - Assessors perceived and found evidence of strain for staff, especially specialist resources. ### EC 7 — Workforce planning and skills development - PRA bridges skill gaps through central learning and development provision and local team-level training frameworks; skills identification and remedial activity are annual and include central training needs analysis and individual performance-based learning plans. - FCA’s Annual Planning cycle includes people capability plans for short- and medium-term needs; the supervisory function is represented on the ‘FCA Academy’ Advisory Group. ### EC 8 — Risk-based allocation of supervisory resources - PRA supervisory frequency and intensity vary by firm, reflecting judgment of potential impact on financial stability, proximity to failure, and resolvability. - The PRA allocates firms to five ‘categories’ of impact 1 to 5, with 1 representing most significant firms and 5 representing firms with capacity to cause almost no disruption. - The firm’s proximity to failure is captured in its PIF; supervisors assess firms against the PRA risk model to determine overall assessment and relative PIF rating. - Additional work is performed where necessary, considering firm resilience, resolvability, market and economic conditions, and business model; supervisory concerns influence future supervisory programs, including attitudes to growth or appointments to significant influence functions (SIF). - The FCA defines risk as combination of impact and probability, combining them to measure overall risk to statutory objectives and to prioritize regulatory response and resource allocation. - Firms are allocated a conduct categorization C1 to C4 by impact score; resources are allocated based on conduct classification. For banks and building societies impact scores are driven by total assets and liabilities and number of depositors, with sector weighting (e.g., retail banks have higher impact score than investment banks). - C1 and C2 firms are allocated to dedicated supervisory teams with proactive supervision; supervisory strategy is set at firm-specific level annually or bi-annually. - C3 and C4 firms do not have a named supervisor and are supervised on a cluster or thematic basis and when risks crystallize. - Banking and insurance groups with the largest retail customer footprint are rated C1; there are normally between 10 and 12 C1 groups. - In December 2014 the FCA announced a revised supervisory strategy to enable a more market-focused approach to identifying risks and supervising firms (see CP 8–EC 1). ### EC 9 — Legal protection and indemnification for supervisors and staff - FSMA provides that the PRA, FCA and any person who is, or is acting as, a member, officer, or member of staff of either body is not liable in damages for anything done or omitted in the discharge, or purported discharge, of the PRA’s or FCA’s functions (para. 25 of Schedule 1ZA and para. 33 of Schedule 1ZB). - No examples exist where PRA staff have been liable for damages. - Protection does not apply if the act or omission is shown to have been in bad faith, or unlawful as the result of S6(1) of the Human Rights Act (HRA) 1998. - Regulators cover legal costs of defending staff in legal actions related to their work as PRA or FCA employees. - Both regulators have the power to require payment of fees to cover costs of defending their actions. ### Assessment outcome - Assessment of Principle 2: Largely Compliant *Source: _cr16166 - Section 1(2) of the BoE Act 1998, on the recommendation of the Prime Minister and Chancellor.* ### 2000. It is composed of a series of sections that have the effect of codifying the protections in the European ### _cr16166 - 2000. It is composed of a series of sections that have the effect of codifying the protections in the European Convention on Human Rights into U.K. law. ### Supervisory independence, accountability, and resourcing - Assessment: U.K. framework compliant with requirements of independence, accountability and legal protection for supervisors. - HMT powers of direction do not appear to affect day-to-day supervision and no evidence they have constrained supervisory independence. - Removal of the head of supervisory authorities: no legal requirement to disclose motivation for removal, but intense public scrutiny expected in the U.K. system. - Resourcing: element of limited compliance identified, especially for the PRA. - Evidence of strain on staff, particularly specialist resources (e.g., see CP 16). - Causes of strain: convergence of new projects (preparatory works for structural reform—ring-fencing policy—and the SMR) and implementation of post-crisis regulatory reform agenda. - London’s status as a global financial marketplace intensifies resource strain (frontier financial innovation, evolving firm risks). - Ongoing and emerging demands expected to continue: ordinary supervisory schedule, new activities (e.g., the CST, especially if extended), and emergence of new risks (e.g., cyber risk). - High competition for skilled recruits; PRA policy to pay median against private sector is reasonable but may not ensure retention. - Observed consequences: high churn rate, frequent rotation of main counterparts (e.g., lead supervisors), low relative seniority of PRA personnel at some meetings (e.g., senior managers with five or less years of experience). - Cost and budgets: - Reported NAO finding: “combined cost of their ongoing activities in 2013–14 is GBP 664 million–GBP 127 million (24 percent) higher than the 2012–13 cost of the FSA.” - Combined budgets for 2015/16 of the PRA and FCA (based on AFR) is GBP 739.4 million. - For the PRA, much of the increase is due to fees linked to special projects (e.g., structural (ring-fencing) reform). - PRA budget stance and implications: - PRA committed to set its budget at a level “no higher than the flat real cost of operation.” - Commitment entails constant resource optimization and risk of potentially weakening supervisory action. - Raises question whether flat real cost is compatible with prudential supervision of hundreds of firms, including four global systemically important banks, amid a perceived financial sector growing in real terms. - PRA revising its Target Operating Model to address tensions. - IT and data capabilities: - Within limited observation window, IT systems generally satisfactory. - Perceived difficulty in flexibly aggregating data to respond to relatively simple requests; potential weakness in flexible analytical capacity to feed management information (MI). *Assessment note*: issue of resources is complex, globally systemic given size and centrality of U.K. financial sector. ### Principle 3 — Cooperation and collaboration (framework and performance) - Principle summary: Laws, regulations, or arrangements provide a framework for cooperation and collaboration with domestic authorities and foreign supervisors; arrangements reflect need to protect confidential information. - Assessment of Principle 3: Compliant. - Domestic cooperation (EC 1): - Legal basis: Art. 5 CRD requires MSs to have coordination measures with domestic supervisory authorities; FSMA provides coordination mechanisms between PRA and FCA: - Cross-membership of Boards between the PRA and FCA (Schedule 1ZA and 1ZB). - Duty to coordinate exercise of their functions (S3D). - Requirement to establish a MoU setting out delivery of the duty (S3E). - Veto mechanism for the PRA over FCA action to reduce risk to financial stability or disorderly failure (S3I). - Both required to publish an account of coordination in annual reports (Schedule 1ZA and 1ZB). - PRA has never exercised its veto power over FCA action to date. - Specific FSMA requirements on coordination and consultation where both authorities involved; policy coordination committee meets quarterly. - Series of MoUs in place (examples listed): BoE–FCA on markets and market infrastructure; FCA–PRA co-ordination; FCA–PRA supervision of with-profits policies; FSCS–PRA; international MoUs; CMA–FCA; FOS–FCA; FSCS–FCA. - Overarching MoU requires domestic supervisory colleges for individual dual-regulated firms and groups (Section 25 of FCA/PRA MoU). - Directors of FCA and PRA meet quarterly; both report on performance against MoU quarterly (most recent conducted in July 2015). - FCA/PRA firm classifications: minimum frequency of colleges based on higher of FCA and PRA classifications unless agreed otherwise. - PRA and FCA cooperate with BoE and HMT; statutory cooperation with BoE (S3Q) to support BoE’s financial stability objective. - Many PRA firm regulatory data still collected by FCA (e.g., reporting via FCA’s GABRIEL system, controllers and close links reports). - Coordination assisted by CEOs’ cross-board membership and joint membership on FPC; dedicated teams coordinate analysis across FPC, FCA, PRA. - MoU between HMT, BoE, and PRA on coordination in relation to financial stability or public interest (S65 Financial Services Act 2012). - International coordination MoU on engagement in international organizations (S66 Financial Services Act 2012). - Market participants reported overall positive opinion on domestic coordination; PRA–FCA coordination perceived better than initially expected. - International cooperation (EC 2): - CRD Arts. 6, 7, 50, 55, 56, 57, 112, 115, 116 provide EU legal bases for cooperation, coordination, information exchange, and colleges of supervisors. - Level 2 measures: EBA/EC instruments (Regulation 524/2014; Implementing Regulation 620/2014); EBA RTS and ITS on colleges (published December 2014, not yet approved by EC). - PRA and FCA require confidential information sharing with overseas authorities only where professional secrecy obligations are equivalent to certain EU Directives. - PRA/FCA party to MoUs and Exchange of Letters (EoLs) with overseas authorities; under transitional provisions, legacy FSA MoUs continue with successor authorities. - FCA active in international committees (IOSCO, FSB, IAIS, FATF), member of ESMA, engages with EBA and EIOPA in coordination with PRA. - FCA has MoUs with many supervisors worldwide and participates in supervisory colleges for global groups. - Confidentiality and information sharing (EC 3 and EC 4): - CRD Arts. 53–62 address exchange of information and professional secrecy. - Art. 53: confidential information disclosure restrictions, exceptions for criminal law and bankrupt banks in civil/commercial proceedings. - Art. 55: cooperation with non-member countries only if professional secrecy equivalent to EU. - Arts. 56–57: allowed exchange when secrecy maintained with specified recipients; authorities must communicate to EBA names of authority recipients. - Art. 54: recipients must use information only in course of duties and for enumerated supervisory purposes. - Art. 59: transmission to parliamentary enquiry committees/courts of auditors under conditions (mandate, need to know, secrecy, originating NCA agreement); onsite inspection information requires express consent of inspecting NCA. - U.K. domestic law: - Confidential information restrictions in S348 FSMA; S349 FSMA and FSMA (disclosure of confidential information) Regulations (SI 2001/2188) provide statutory “gateways” for lawful disclosure to specified persons/bodies. - PRA and FCA may disclose to EEA and non-EEA regulatory authorities only for regulatory functions; must ascertain recipient will only use information for those purposes. - Confidentiality restrictions in S348 FSMA apply to recipients (restrictions “follow the information around”). - For non-EEA authorities, MoUs typically stipulate supervisory-purpose-only use and confidential treatment by recipient. - Disclosure practice: - PRA and FCA make public regulatory information subject to exemptions: personal data (Data Protection Act 1998) and information subject to statutory restrictions (e.g., confidential regulatory information per S348 FSMA). - FSMA and Regulations do not impose obligation to disclose particular information to other bodies (except when regulatory action or litigation under FSMA). Statutory duty to cooperate with overseas regulators and persons in prevention/detection of financial crime. - Regulation 4 permits disclosure for criminal proceedings/investigations; Regulation 5 permits disclosure in civil proceedings where related to statutory functions. - PRA would strongly resist disclosure and, where appropriate, notify originating supervisory authority when information disclosed; for EEA-sourced information, notification of onward disclosure falls within Art. 117 CRD cooperation obligation. - Where required to disclose, PRA can request information be heard by the court in camera. - Recovery and resolution support (EC 5): - BRRD framework governs recovery planning, resolution planning, early intervention, assessment of conditions for resolution, notification obligations, and resolution colleges (Arts. 6, 8, 11, 14, 27, 32, 81, 88). - Cooperation with nonmembers: Art. 88 allows third-country resolution authorities to be invited as observers to resolution colleges if confidentiality requirements equivalent to EEA apply; Art. 90 restricts onward transmission without consent; Arts. 93–98 and Art. 97 set non-binding cooperation frameworks with third countries and notification obligations to EBA. - EU may refuse to recognize non-EU resolution proceedings if adverse to EU financial stability, fiscal effects, or unequal depositor treatment (Art. 95). - U.K. implementation: - BRRD requirements implemented from January 1, 2015. - BoE is U.K. resolution authority under Banking Act 2009 for failing banks, building societies, and certain investment firms/their groups. - Resolution regime covers PRA-regulated firms and certain FCA-regulated investment firms incorporated in the U.K. - Act sets BoE objectives and formal responsibilities to consult PRA, FCA, and HMT when placing a firm into resolution and choosing tools. - Practical roles and cooperation: - PRA and BoE coordinate development of resolution plans; PRA reviews Phase 1 submissions and, with BoE, determines preferred resolution strategy and information requests for the firm. - Prudential supervisor (PRA for banks) responsible for ongoing supervision; PRA judgement about proximity to failure captured in PIF and triggers supervisory actions and BoE/Treasury engagement. - PRA and BoE decide to put a firm into the resolution regime, having consulted HMT and FCA (Banking Act 2009). - BoE decides and conducts resolution tools (except temporary public ownership and public equity support tool). - HMT decides on temporary public ownership or public equity injection and conducts the resolution with BoE. - FSCS pays out or funds transfer of deposits protected by deposit guarantee scheme up to prescribed limits. - PRA approach: ensure preparedness for recovery or resolution; PRA rules require firms to provide key data used in resolution plans. - MoU reviewed by assessors: facilitates rapid information exchange/cooperation in crisis/emergency situations between supervisory authorities for recovery and resolution planning; mutual support in supervision of branches and home state supervision of recovery and resolution plans. ### Principle 4 — Permissible activities - Assessment: Compliant. - EC 1 (definition of “bank”): - Legislation does not define the term “bank”. - FSMA 2000 (Regulated Activities) Order 2001 defines activities subject to regulation, including acceptance of deposits. - PRA Rulebook Glossary defines a bank as: - “(i) a firm with a part 4A permission to carry on the regulated activity of accepting deposits and is a credit institution, but is not a credit union, friendly society, or a building society; or (ii) an EEA bank.” - EC 2 (permissible activities clearly defined): - FSMA 2000 (Regulated Activities) Order 2001 defines activities subject to supervision, including acceptance of deposits. - PRA supervises all banks and building societies under same prudential regulatory regime, with some differences (e.g., special prudential regime for credit unions in Credit Union Sourcebook). - EC 3 (use of the word “bank” controlled): - Companies Act 2006 and “Company, Limited Liability Partnership and Business Names (Sensitive Words and Expressions) Regulation” 2014 require FCA review of any use of “bank” or derivative; FCA can reject a name if it could create confusion for the public. - EC 4 (taking deposits reserved): - All institutions able to accept deposits are subject to PRA supervision. - Any institution seeking to take deposits from the public must receive permission under Part IV of FSMA 2000 or be exempt (e.g., EEA-chartered banks using passporting). - EC 5 (public list of licensed banks): - PRA and FCA maintain the Financial Services Register as a public record of regulated firms, individuals and other bodies. - PRA publishes lists of banks, building societies, and branches of foreign banks monthly on its website. - Comment: Although “bank” not defined in U.K. laws, name usage and related concepts are strictly controlled; accepting deposits is clearly identified as an activity requiring authorization. ### Principle 5 — Licensing criteria and authorization process - Assessment: descriptive findings on licensing framework and criteria. - EC 1 (authority responsible for licensing): - PRA is the authorizing agency and lead regulator; applicants for regulated activity must apply to the PRA under S55A (2) of FSMA 2000. - PRA can approve an applicant only with FCA consent; application managed jointly by both agencies. - Since legal cutover (April 1, 2013), 13 banks have received either authorization as new banks or variations; of these, three were authorizations for non-U.K. banks to establish branches in the U.K. - Exception: EEA banks operate via passport and are automatically authorized once notification procedure completed (Schedule 3 to FSMA 2000). - As part of authorization, PRA or FCA may impose binding conditions or limitations at point of authorization. - After authorization, PRA and FCA can remove or amend a firm’s Part 4A permission to receive deposits; conditions/limitations exercisable after consultation. Part XIII FSMA 2000 provides separate regime for passported firms (generally limited by home state regulator responsibilities). - EC 2 (criteria for licensing and rejection/removal powers): - Applicants for Part 4A permission must meet five PRA “Threshold Conditions” and four FCA “Threshold Conditions”; together these form licensing criteria. - PRA Threshold Conditions (paras. 5A–F Part 1E Schedule 6 of FSMA 2000): 1) Legal status—deposit-takers must be bodies corporate or partnerships; 2) Location of offices—U.K.-incorporated corporate bodies must maintain head offices and, if one exists, registered offices in the United Kingdom; 3) Prudent conduct of business—applicant must conduct business prudently, including appropriate financial (capital, liquidity) and nonfinancial resources (skills, experience to manage risk, ability to comply with non-financial requirements enforced by the PRA and any other relevant factors); 4) Suitability—applicant must satisfy PRA that it is a “fit and proper” person with regard to all circumstances to conduct a regulated activity (supervisors consider connections to other persons; nature of regulated activity; and need to ensure applicant can conduct activities soundly and prudently); 5) Effective supervision—applicant must be capable of being supervised by the PRA. - FCA Threshold Conditions for banks: 1) Effective supervision—applicant’s corporate structure, “close links,” and controllers do not impede effective supervision; 2) Appropriate resources—applicant’s corporate governance and risk-management arrangements are in place and appropriate; 3) Suitability—management have adequate skills, experience, and integrity (“fit and proper” test); firm has appropriate policies/procedures and manages conflicts of interest; 4) Business model—applicant firm’s strategy is suitable for regulated activities sought and does not pose risk to FCA objectives. - Some overlap exists between PRA and FCA criteria; FCA approach considers statutory objectives: protect consumers; protect and enhance integrity of U.K. financial system; promote effective competition in interest of consumers. - If application information is knowingly false, the PRA can cancel a firm’s authorization (text truncated at this point in source). *Italic source attribution: IMF staff report content unit _cr16166 - 2000.* ### Part 4A permission under S55J(1)(c)(ii) FSMA 2000. ### _cr16166 - Part 4A permission under S55J(1)(c)(ii) FSMA 2000 ### Overview of authorization process and documentation - Assessors reviewed: - two examples of the FCA’s communications to the PRA providing consent to approve applicants’ authorizations, including an example of FCA consent subject to specific conditions or limitations; - an internal PRA document outlining a new bank authorization and summarizing the PRA’s and the FCA’s analysis; - examples of actual Approved Persons Assessments and Recommendations Memos for firms seeking authorization. - These documents indicated that the PRA and FCA rely on the criteria outlined in the report when evaluating applications. ### EC 3 — Consistency of licensing criteria with ongoing supervision - Legal basis: - Under FSMA S513(3), firms must meet the Threshold Conditions when first seeking authorization and then on an ongoing basis. - Documentation reviewed: - New Bank and New Branch Authorization Assessments and Recommendation Papers detailing the PRA’s internal review, including assessing compliance with the PRA’s Threshold Conditions and noting FCA’s conclusions. ### EC 4 — Assessment of organizational and group structures - Licensing authority determines that structures will not hinder effective supervision (solo and consolidated) and, where appropriate, that structures will not hinder effective implementation of corrective measures. - PRA and FCA Threshold Conditions require satisfaction in respect of controllers and “close links” and that those close links do not prevent effective supervision on either a solo or consolidated basis. - The EBA is developing regulatory standards to specify what obstacles constitute a barrier to effective supervision, as required under Art. 8(2) of CRD IV. - Reference: CRR Art. 4(38) definition of “close links.” ### EC 5 — Suitability and transparency of major shareholders and ultimate beneficial owners - EBA guidance: - EBA guidelines address suitability of major shareholders in paras. 1–2 of Art. 14 of CRD IV. - Major shareholders defined as qualifying holdings or, if none, the twenty largest shareholders. - U.K. practice: - “Threshold Conditions” require assessment of controllers and “close links” to evaluate ownership transparency. - Neither the EBA nor U.K. supervisors have issued guidance specific to suitability of ultimate beneficial owners; evaluation references CRD and future RTS requirements for major shareholders that could include ultimate beneficial owners. - If a major shareholder or beneficial owner does not meet criteria, they may not maintain a controlling interest and the firm may fail to meet Threshold Condition para. 5E. - Assessors reviewed licensing applications containing analysis of controllers and close links, intelligence information on applicants, and analysis of origin/source of capital resources. ### EC 6 — Minimum initial capital - PRA applies minimum required capital of GBP 5 million (Art. 12, CRD), with limited exceptions for “small specialist banks.” ### EC 7 — Fit and proper assessment of Board and senior management - Licensing authority evaluates Board members and senior management for expertise and integrity (fit and proper), conflicts of interest, and collective sound knowledge of intended activities and risks. - Under Threshold Conditions, PRA and FCA must be satisfied that non-financial resources (e.g., Board members) possess requisite skills, knowledge, and experience relative to the business model. - FSMA S59 requires certain individuals in SIF roles to seek approval before taking position; approval granted only if both PRA and FCA are satisfied fit and proper. - PRA SIF roles include all members of a firm’s Board, and heads of finance, risk, and internal audit functions. - Fit and proper criteria for Approved Persons (as set out in the PRA Rulebook): 1) Honesty, integrity and reputation — includes criminal proceedings and regulatory judgments. 2) Competence and capability — includes relevant experience, time to perform role, and identification of potential conflicts of interest. 3) Financial soundness — includes bankruptcy history. - Reference: FSMA S61 powers to dictate fitness and propriety factors, statements of principle, and Code of practice; draft SS consultation May 2015, final version March 2016. ### EC 8 — Review of strategic and operating plans, governance, risk management, AML, and outsourcing - PRA and FCA require submission of a 5-year business plan. - Supervisors consider proposed outsourcing arrangements and controls placed over those arrangements. - FCA assesses controls and systems, competence of management, and adequacy of AML policies and procedures. ### EC 9 — Financial projections and adequacy - Supervisors require: - 5-year financial forecasts; - own assessments of capital required (stress testing); - source of funds to support business activities; - liquidity needs; - financial information on principal shareholders. ### EC 10 — Host and home supervisor interactions for foreign banks - PRA and FCA have full powers and responsibilities over subsidiaries of overseas firms (EEA and non-EEA); such firms must meet all Threshold Conditions. - EEA bank branches can “passport” deposit-taking activities into the United Kingdom without U.K. authorization; the authorized firm must inform its home country supervisor, which may object within three months. - For U.K. branches of non-EEA banks, the PRA evaluates equivalence of home country regulator; if not equivalent, PRA will refuse authorization for a branch; if equivalent, PRA collaborates via supervisory colleges. - Annual updates are required on applicant’s ability to meet prudential standards. ### EC 11 — Monitoring progress of new entrants and supervision intensity - Firms must continue to meet Threshold Conditions and other PRA Handbook and Rulebook requirements. - Supervision can be intensive and not risk-based for up to five years. - FCA supervision approach is judgment-based and pre-emptive with three pillars: 1) Proactive firm supervision — identify and mitigate key drivers of poor conduct, minimize risk to market integrity, and not impede effective supervision. 2) Event-driven reactive supervision — deal with emerging or crystallized unforeseen issues. 3) Issues and products supervision — analyze whole sectors for current events and potential drivers of poor outcomes for consumers and markets. ### Assessment — Principle 5 (Licensing) - Assessment result: Compliant - Comments: - Based on U.K. and EBA self-assessments, follow-up questions, and review of sample licensing evaluations and decisions, U.K. supervisors are compliant with Principle 5 regarding licensing. - Although no specific guidance on ultimate beneficial owners, licensing applications reviewed showed analysis is adequately deep and thorough (see EC 5). ### Principle 6 — Transfer of significant ownership - EC 1 — Definitions: - EU/CRR: qualifying holding defined as direct or indirect holding of 10 percent or more of capital or voting rights or enabling significant influence (Art. 4(1)(36) Regulation EU/575/2013). - UK: FSMA 2000 defines “significant ownership” and “controlling interest” based on: 1) A owns 10 percent or more of shares in B; 2) A owns 10 percent or more of voting power in B; 3) A owns sufficient shares or voting power in B to exercise significant influence. - EC 2 — Notification and approval requirements for changes in ownership: - Under S178 FSMA 2000, a person deciding to acquire or increase control over an authorized firm must give PRA notice of intention and obtain approval before acquisition or increase of control. - Notification covers changes in beneficial ownership and voting rights, directly or indirectly. - It is a criminal offense to fail to obtain approval prior to acquisition. - Notification thresholds requiring approval as ownership increases from one category to the next: 1) <20 percent to >20 percent 2) <30 percent to >30 percent 3) <50 percent to >50 percent 4) Or A becomes `parent of B - Assessors reviewed PRA “Change in Control: Assessment and Recommendation Memos” evidencing the process. - EC 3 — Power to reject or reverse changes in significant ownership: - PRA may object under S186 FSMA 2000 to acquisition or ongoing ownership (holdings above 10 percent or via significant influence) by a “controller” on grounds including: 1) reputation of proposed controller; 2) reputation and experience of persons directing the business; 3) financial soundness of proposed controller; 4) whether firm will be able to comply with prudential requirements under proposed control; 5) whether group structure permits effective supervision and clarity of regulatory responsibilities and exchange of information; 6) reasonable grounds to suspect money laundering or terrorist financing or an increased risk thereof. - FCA evaluates effects on customers to ensure appropriate customer contact and interactions. - False information underlying change in control may be deemed evidence of lack of required reputation. - EC 4 — Reporting and identification of significant shareholders and beneficial owners: - Annual reporting required of all controllers and close links and regarding possible changes. - Neither EBA nor U.K. supervisors have issued guidance specific to ultimate beneficial owners; requirements in CRD and future RTS apply to major shareholders and could include beneficial owners. - Banks must notify PRA when aware of potential changes in controllers or close links. - Assessors found evidence of PRA analysis drilling down into legal structure up to ultimate legal owners and verifications from open and closed sources. - EC 5 — Powers to address unauthorized changes of control: - Under S191A FSMA 2000, PRA may object to a person’s control and may launch criminal proceedings for failures to seek approval, acquiring control after a warning notice, or breaching an interim order. - PRA has power under S191B to issue a “restriction notice” modifying how control is exercised (e.g., prohibit voting, payment of dividends, or disposal of shares). - PRA can apply to the court for an order for sale of shares following objection under S191C. - It is a criminal offence under S191F to acquire or increase control without notifying the PRA first. - EC 6 — Duty of banks to notify supervisors of material information affecting suitability of major shareholders: - Under “Fundamental Rule” 7, firms must deal with the supervisor in an open and cooperative way and must disclose anything the PRA would “reasonably expect” notification of; similar rule applies to the FCA. - Assessment — Principle 6: - Assessment result: Compliant - Comments: - Based on U.K. authorities’ self-assessment, discussions with authorities, and review of sample analyses, U.K. authorities comply with core principle regarding transfer of significant ownership. - As per Principle 5, ultimate beneficial owners lack specific guidance, but PRA requires adequate information about all persons and entities able to exercise control. ### Principle 7 — Major acquisitions (introductory material) - Principle 7 grants supervisor power to approve/reject and impose prudential conditions on major acquisitions or investments by a bank, including cross-border operations, and to determine that affiliations/structures do not expose the bank to undue risks or hinder effective supervision. - Essential criteria EC 1 (beginning): laws/regulations should define types and amounts of acquisitions/investments requiring prior approval versus cases where notification after acquisition suffices. *Italic source attribution: Part 4A permission under S55J(1)(c)(ii) FSMA 2000 (document content provided).* ### Chapter 2 of the Notifications Part of the PRA Rulebook requires that a firm give the PRA notice ### Chapter 2 of the Notifications Part of the PRA Rulebook requires that a firm give the PRA notice ### Notification requirements and PRA/FCA powers - Firms must notify the PRA of: - “any proposed restructuring, reorganization or business expansion which could have a significant impact on the firm’s risk profile or resources, including, but not limited to: (a) setting up a new undertaking within a firm’s group, or a new branch (whether in the U.K. or not)...” - “any action which a firm proposes to take which would result in a material change in its capital adequacy or solvency, including, but not limited to: (a) any action which would result in a material change in the firm’s financial resources or financial resources requirement.” - Failure to notify the PRA of an acquisition of another operating entity is likely to contravene the general notification requirements by analogy to establishment of a new undertaking. - Following notification, the PRA can prevent an acquisition or investment by imposing requirements (S55M and S55N(1)(b) of FSMA). Under S55M(7) the PRA must consult the FCA before imposing or varying a requirement. - The PRA can prevent an acquisition/investment where it would likely lead to failure to meet any Threshold Condition or where preventing it would advance any PRA statutory objective (including safety and soundness). Similar powers exist for the FCA under S55L. - If the target entity is a bank, the acquirer must also obtain prior approval (see CP 6). ### Supervisory criteria and Threshold Conditions (Principle 7 summary) - U.K. supervisors use Threshold Conditions 3, 4, and 5 to judge proposed acquisitions/investments: - Threshold Condition 3: business must be conducted in a prudent manner. - Threshold Condition 4: firm must be fit and proper. - Threshold Condition 5: firm is able to be supervised effectively. - PRA must determine adequacy of financial and non-financial resources to meet Threshold Condition 3 (prudence). - PRA can prohibit major acquisitions/investments (including cross-border operations) where host-country laws prevent information flows necessary for consolidated supervision. - Assessment: Principle 7 — Compliant. - Comment summary: - Notification requirements expansive: firms must notify any proposed business expansion with a “significant impact” and any action causing a “material change” in capital adequacy or solvency. - Authorities have powers (via Threshold Conditions) to approve or reject major acquisitions for risk or supervision concerns. - Supervisors must review major acquisitions/investments by other entities in a banking group to ensure no undue risks or impediments to supervision. ### PRA supervisory approach and risk methodology (Principle 8) - PRA CA (continuous assessment) risk framework: three focus areas 1. Potential impact on financial stability (EC 1(b)) 2. Risk context (external environment and business risks) 3. Mitigating factors (governance, financial strength, resolvability) - PRA scores 8 elements (generally on a scale of 1 to 10) grouped into five considerations: - Gross risk: 1. Potential impact on financial stability — firms assigned to categories 1 to 5; “Category 1” = largest/systemically important. At time of writing: 19 firms in Category 1, about two-thirds international banking groups. - Risk context: 2. External context (macroeconomic, political, legislative, catastrophe risks) 3. Business risks (business model viability and structure) - Operational mitigation: 4. Management and governance structure 5. Risk-management and control infrastructure (Risk Assessment Framework, EWRM, operational controls) - Financial mitigation: 6. Capital (quantity, quality, location) 7. Liquidity (ability to meet liabilities, buffers of high quality unencumbered assets) - Structural mitigation: 8. Resolvability (likelihood failure will be orderly; resolution preparedness under Fundamental Rules) - Supervisory cycle: - Periodic Summary Meeting (PSM) — scores reviewed and capital/liquidity guidance set. - Mid-point review for Category 1–4 firms. - All elements reviewed at least twice per year (PSM and mid-year), but detailed assessment of all eight elements may not occur annually. - FCA supervisory categorization and approach: - At time of submission, FCA had 4 impact categories; late 2015 changed to 2 categories: - “Fixed portfolio” — FCA appoints a named supervisor; at assessment time: 26 banks out of approximately 110 firms in the fixed portfolio. - “Flexible portfolio” — majority of firms; supervised via thematic work, education/engagement, baseline monitoring, and reactive work. - FCA firm evaluation covers 10 underlying risk groups. - Assessment: Principle 8 — Largely Compliant. - Key comments: - Emphasis on closer oversight of largest systemically important firms and heightened expectations for capital and liquidity. - Resource constraints have led to more intensive supervision for Category 1 firms and a more responsive, automated approach for smaller firms. - Potential gaps: limited frequency/depth in some risk areas (e.g., operational risk reviews can require up to three years for a large firm), reliance on automated triggers for smaller firms, and inconsistent communication of supervisory expectations in some teams. - Mitigants include higher capital/liquidity buffers, business model assessments, Threshold Conditions and Fundamental Rules, SMR (replacing APR), and the PIF with five stages. ### PIF, escalation, and resolvability (EC 6–7 under Principle 8) - PRA uses the PIF to express judgment on firm viability with five stages: - Stage 1 and 2: lowest to moderate risk to viability. - Stage 3: risk to viability without firm action. - Stage 4: imminent risk to viability. - Stage 5: resolution phase. - For firms in PIF Stages 3 or 4: BoE’s Resolution Directorate (RD) adds them to a watch list and assesses barriers to resolution; in Stage 4 RD generates solutions. - Two key conditions to place a firm into resolution: 1. Firm is failing or likely to fail (e.g., failing to meet Threshold Conditions). 2. It is reasonably likely no action outside resolution will prevent failure. - Use of stabilization tools requires public interest test and consultation with PRA, FCA, and HMT. - PRA assessing PIF to ensure compliance with Early Intervention Measures under BRRD. ### Supervisory techniques and tools (Principle 9) — on-/off-site mix and procedures - PRA supervisory model: - Annual review cycle with PSM and mid-year review. - Onsite and offsite work coordinated by dedicated teams for largest firms. - For largest firms, reviews of some risk elements (e.g., operational risk) can take up to three years. - Baseline monitoring is primary tool for smaller firms (Categories 3–5). - FCA supervisory pillars: - Pillar 1: proactive engagement (meetings with senior management) - Pillar 2: reactive work - Pillar 3: thematic/cross-firm work - Use of third parties: - PRA/FCA can require “skilled person” S166 reports under FSMA 2000; skilled-person panel established from April 1, 2013. - PRA’s SS 7/14 sets expectations for skilled persons, including communication to PRA. - Assessment: Principle 9 — Largely Compliant. - Key comments: - Greater use of hands-on work at largest firms, but some onsite testing appears cursory (e.g., AQRs with limited loan file reviews). - Reliance on skilled persons can supplement expertise but risks substituting for in-house capacity; supervisors caution against outsourcing prudential responsibilities. - Supervisory resources concentrated on largest firms; smaller firms receive more reactive supervision via automated monitoring. ### Supervisory reporting and data (Principle 10) - Legal and reporting framework: - Art. 65(3) CRD requires NCAs to have information-gathering powers. - EU harmonized supervisory reporting: COREP and FINREP (EBA ITS on supervisory reporting; Commission Implementing Regulation (EU) No. 680/2014). - COREP must be reported on both solo and consolidated basis; FINREP mandatory only for IFRS institutions at consolidated level (solo level reporting remains national discretion). - PRA powers: S165 and S165A FSMA; SUP 16.12 (PRA Handbook) governs regulatory returns; S55M may impose reporting requirements. - Scope of supervisory reports includes: - Solvency, on-/off-balance sheet assets/liabilities, P&L, capital adequacy, liquidity (LCR, NSFR, AMM), LE and concentration, asset encumbrance, leverage ratio, loss data, supervisory benchmarking. - Frequency and proportionality: - Reporting frequency varies (monthly liquidity, quarterly capital/FINREP, semiannual/annual templates). - PRA may require additional/more frequent reporting (e.g., Capital+ monthly for highest impact firms; liquidity weekly for some). - Proportionality: reduced reporting for smaller firms (materiality thresholds); SUP 16.12 sets frequencies. - Validation and data quality: - Validation rules from EBA ITS apply at submission; PRA RDG performs plausibility checks and automated alerts (Alert Manager System). - Alerts require supervisors to evaluate issues and document decisions within 10 days. - PRA may use S166 reviews for persistent/serious quality issues. - PRA is undertaking a data stock-take to rationalize collections, reduce duplication, and align definitions (completion expected by 2016). - Assessment: Principle 10 — Compliant. - Comments: - Harmonized EU reporting improved supervisory data consistency. - Opportunities remain to develop better data on credit exposures and performance. ### Corrective and sanctioning powers (Principle 11) - Legal basis and tools: - FSMA 2000 provides PRA and FCA powers to impose requirements, intervene early, vary permissions (S55J, S55L, S55M, S55N). - CRD/BRRD also provide powers for early intervention and remedial measures (CRD Arts. 102–106; BRRD Art. 27). - Threshold Conditions Order (FSMA 2000 Order 2013) sets Threshold Conditions. - PRA processes: - “PRA Regulatory Decision-Making Framework” sets decision-making steps for corrective actions and sanctions; more senior review required for statutory notices. - PIF formalizes expected supervisory responses across five stages. - Sanctions can apply to firms and individuals (approved persons), including withdrawal of approval, fines, suspension, public statements. - PRA has powers to ring-fence or impose requirements on parent undertakings (S192C) and to limit intra-group transfers or activities. - Assessment: Principle 11 — Compliant. ### Consolidated supervision and group oversight (Principle 12) - PRA supervises groups on consolidated basis in accordance with CRR/CRD (Parts 2, 3, 4, 6, 7 application per CRR Arts. 6 and 11 as appropriate). - PRA collects consolidated and solo information (COREP templates COR001–004; Capital+ reporting). - PRA exercises powers over qualifying parent undertakings and can direct unregulated parents under FS Act 2012 and subsequent rulemaking (including ring-fencing and facilitating resolution). - PRA conducts onsite visits of foreign operations, uses supervisory colleges and bilateral engagement, and coordinates with FCA on conduct issues that may affect prudential standing. - Assessment: Principle 12 — Compliant. ### Home-host cooperation and colleges (Principle 13) - EU legal framework: - CRD/CRR/BRRD set requirements for consolidating supervisors, colleges, JRADs, and resolution colleges. - EBA RTS/ITS provide operational rules for colleges and information exchange. - PRA’s college and crisis arrangements: - Well-established bank-specific colleges for materially cross-border U.K. groups (HSBC, SCB, Barclays, RBS). - Multiple college types for largest banks: Core College (twice a year + quarterly teleconferences), General College (annual), Global College (annual), regional core colleges, and CMGs for resolution. - JRAD process used to compile SREP input and Pillar 2 proposals; PRA coordinates inputs and drafts JRAD documents for college discussion/approval. - MOUs in place with most host regulators in core colleges; PRA publishes MoUs and follows equivalence/materiality/reliance criteria for non-EEA MoUs. - Information exchange and joint work: - PRA schedules regular teleconferences, consults host regulators on college agendas, and seeks to incorporate non-EEA regulator views where material. - PRA participates in joint supervisory reviews and onsite visits with host supervisors. - Crisis cooperation and resolution planning: - PRA and BoE RD establish CMGs and coordinate on resolvability, group resolution plans, and RAP assessments. BoE leads resolution strategy; PRA contributes via supervisory data and verification. - PRA notifies resolution authority when early intervention triggers met or if firm is failing/likely to fail. - Host access and inspections: - PRA has protocol to notify host supervisors of intended foreign onsite visits and invites participation. - PRA requires firms to provide access to business premises under PRA rules. - Assessment: Principle 13 — Compliant. *Source: _cr16166 - Chapter 2 of the Notifications Part of the PRA Rulebook requires that a firm give the PRA notice* ### Chapter 3 of the Information Gathering Part of the PRA Rulebook. ### Chapter 3 — Information Gathering Part of the PRA Rulebook ### Supervision of booking offices, shell banks, and home-host cooperation (EC 10 / Principle 13) - Reviewers were given access to confidential papers that set out PRA expectations regarding supervision of booking offices. - Shell banks are effectively prevented from operating in the U.K. through S16 Money Laundering Regulations (MLR) 2007 whereby, they are not able to obtain banking relationships with credit institutions. - The approach taken by the PRA’s predecessor organization, the FSA, was recognized by the financial action task force (FATF) in the mutual evaluation follow-up report (December 2009) and the position has not changed in the new regulatory structure now in place. - EC 10: A supervisor that takes consequential action on the basis of information received from another supervisor consults with that supervisor, to the extent possible, before taking such action. - EU-wide legislation on home-host relationships: - Art. 117 of CRD requires competent authorities to consult each other before taking a decision (or immediately inform each other, after having taken the decision, in case of urgency or if a consultation could jeopardize the effectiveness of the measure decided) regarding: - Changes in the shareholder, organizational, or management structure of a bank; and - Significant penalties or exceptional measures, including the imposition of a specific capital requirement or of a limitation in the use of advanced measurement approaches (AMA) for the calculation of capital requirements. - RTS and ITS on colleges of supervisors require competent authorities participating in a college plan and coordinate their supervisory activities both in going-concern situations and during emergency situations. - For information received from non-EU authorities, ex-ante consultation or ex-post information on supervisory actions taken on the basis of such information are contained in some MoUs signed with non-EU authorities and represent an established working modality for U.K. authorities. - Assessment of Principle 13: Compliant. - Comment: U.K. authorities, as both home and host supervisors of cross-border banking groups, regularly share information and cooperate with foreign authorities. Foreign banks operating in the United Kingdom are subject to the same standards as domestic banks. ### Corporate governance (Principle 14) — EC1–EC9, AC1; Assessment: Largely Compliant - Principle 14 summary: Supervisor determines banks and banking groups have robust corporate governance policies and processes commensurate with risk profile and systemic importance; covers strategic direction, group and organizational structure, control environment, responsibilities of Boards and senior management, and compensation. - Key legal and regulatory bases cited: - S172 of the Companies Act 2006: director must act in good faith to promote company success for members as a whole. - Art. 88(1) of CRD IV and GOR 5.1: management body defines, oversees, and is accountable for governance arrangements. - FCA listing rules require compliance statements with the U.K. Corporate Governance Code (FRC); see GOR 5.4/5, 2.1, 2.8, 4.1, and 3.1/2 from the PRA Rulebook. - APR historically used to ensure fitness and propriety of individuals; replaced in March 2016 by SMR (Senior Managers Regime). - EC1 (Board and senior management responsibilities, guidance): - Description and findings: Authorities cited laws/guidance (Companies Act, CRD IV, FCA listing rules); PRA uses internal guidance including “the Supervision Approach to Management and Governance” (issued in final form in November 2015) to map evaluation territory including collective Board effectiveness and “culture.” - Supervisory letters to Boards often identify concerns (Board composition, committee structures, Board appointments, control function challenge) and follow-up meetings clarify expected actions. - EC2 (regular assessment and correction of deficiencies): - PRA assesses “management & governance” within its risk model, refreshes views in PSM and mid-year review; periodic governance reviews and “deep dives” for largest firms recommended every two to three years; corporate governance reviews expanding to Category 2 banks. - FCA focus on conduct-related risks, uses liaison with Board members, focused reviews, and Board materials. - Examples: letters requiring changes to remuneration policies; S166 skilled persons reviews including governance focus. - EC3 (nomination/appointment processes; NEDs and committees): - CRD IV Art. 88(2) requires nomination committees for significant firms; Chairs of Board committees are NEDs performing controlled functions and require PRA approval. - PRA expectations for audit, risk, and remuneration committees set out (SS21/15 on internal governance; Art. 76(3), Art. 95(1) of CRD IV). - Historically reliance on supervisory dialogue and “soft power” to influence nominations and training. - EC4 (duty of care and loyalty; suitability): - S172 Companies Act and S64(1A) FSMA 2000 statement of principles for “approved persons” (integrity, due skill and care). - PRA disciplinary powers under S66 FSMA 2000 for noncompliance. - PRA and FCA interviews/analyzes used to determine “fit and proper” under legacy APR. - EC5 (Board oversight of strategy, risk appetite, culture): - PRA supervisors meet regularly with Boards of Category 1 and 2 firms, review Board packs, codes of conduct, training materials; FCA seeks “tone from the top” and uses Board liaison, reviews, and incident handling assessments. - EC6 (fit and proper standards, succession planning, oversight of management execution): - APR used until March 2016; PRA uses PSM assessments, reviews of Board documentation and scorecards, annual remuneration round review, and specific supervisory letters; PRA annual reviews of Board effectiveness and succession planning examined. - EC7 (compensation oversight and alignment with prudent risk-taking): - Remuneration Part of the PRA Rulebook requires firms to discourage excessive risk-taking; rules introduced in 2009, effective January 2010; rules jointly owned by PRA and FCA. - Level one remuneration firms (total assets over GBP 50 billion over an average of three years) must submit remuneration policy statements for supervisory review. - Level two (total assets over GBP 15 billion but less than GBP 50 billion averaging over three years) and level three (total assets less than GBP 15 billion) must complete statements and make available on request. - Malus and clawback: supervisors consider annual reports on application; in serious failures malus or clawback may be imposed at any point in the year. - EC8 (understanding operational structure and opaque structures): - PRA expects comprehensive control frameworks, EWRM reviews, specialist reviews, and SS9/13 expectations on governance for significant risk transfer through securitization. - EC9 (power to require changes in Board composition): - S61(1) and S63(1) FSMA 2000: PRA may approve or remove an individual subject to fit and proper assessment; PRA can require hiring of additional Board members for identified skill gaps. - Supervisory correspondence and internal analyses evidence interventions and recommendations to withdraw candidates. - AC1 (notification of material information affecting fitness and propriety): - SUP 10B.12.18 R and SUP 10B.13 require firms to inform the PRA as soon as practicable about material information affecting an approved person’s fitness and propriety; SUP 10A.14.17R requires the same for the FCA. Failure to disclose may be a criminal offence under S398 FSMA 2000. - Overall assessment and commentary: - Assessment of Principle 14: Largely Compliant. - Rationale: Authorities have a multi-pronged supervisory approach, new SMR (replacing APR in March 2016) designed to strengthen individual accountability via Statements of Responsibilities and powers of conditional approval; however, APR weaknesses and concentration of governance reviews on Category 1 firms leave further supervisory work to expand beyond largest firms. Effectiveness of SMR could not be evaluated at time of assessment. ### Risk management process (Principle 15) — EC1–EC13; supervisory tools and practices - Principle 15 summary: Supervisor determines banks have comprehensive risk management processes to identify, measure, evaluate, monitor, report, and control or mitigate all material risks, including contingency arrangements and recovery plans; commensurate with risk profile and systemic importance. - Legal and supervisory frameworks and guidance: - CRD Arts. 74, 76, 77–86 (credit, residual, concentration, securitization, market, interest rate in non-trading book, operational, liquidity, excessive leverage). - EBA guidelines on internal governance (GL 44), and EBA SREP guidelines on common procedures and methodologies for SREP. - PRA Fundamental Rules: Fundamental Rule 5 (effective risk strategies and risk-management systems); Fundamental Rule 6 (responsible organization and controls). - PRA “approach to banking supervision document”: expects prudent management, risk-aware culture, effective three lines of defense, ICAAP and proportional risk frameworks. - EC1 (Board-approved strategies and risk appetite; culture; limits; senior management monitoring): - PRA expects Boards to set risk appetite, embed safety and soundness in culture, and ensure effective three lines of defense. - Ongoing reforms: PRA consulting on CP 18/15 (Board responsibilities) to require Boards to evidence sustainable business model, measurable risk appetite, and active oversight of risks. - Supervision structure and tools (applied proportionately by firm category): - Firms categorized in 5 categories based on size, interconnectedness, complexity and business type (see BCP 8 and BCP 9 referenced). - Key supervisory tools: - CA (Continuous Assessment) meetings: regular meetings (monthly, quarterly) with risk managers across business lines to challenge risk-management, risk appetite, limits, risk culture, and measurement. - Annual PSM (Periodic Supervisory Meeting) and mid-year HoD (Head of Department) review to set supervisory strategy and review progress. - Management Information (MI) review: supervisors receive risk committee packs and regulatory returns; frequency and granularity depend on firm size and complexity. - Deep-dive reviews with SRS (Supervisory Risk Specialists) for key risks or concentrated portfolios (e.g., AQRs, model reviews, IRB, governance reviews). - EWRM (Enterprise-Wide Risk-Management) reviews: top-down and bottom-up assessment of risk framework, CRO capability, lines of defense, and linkage to remuneration; for Category 1 firms, typically every 2–3 years. - S166 skilled persons reports commissioned when specific issues arise. - Category-specific supervisory practices: - Category 1 (major U.K. and international firms): highest intensity — monthly/quarterly CA meetings, quarterly specialist visits on traded risk, PSMs, deep-dive reviews, enterprise-wide reviews, regular CRO meetings. - Category 2–4 banks and building societies: same tools applied with lower intensity proportional to risk-impact methodology; annual visits to review capital adequacy and liquidity/treasury in alternate years; specialists deployed in alternate years; for Category 3–4 lower-risk firms specialist reviews at least every 4 years. - Building societies: SS20/15 provides specific expectations on risk-management for lending and treasury; societies must inform supervisors before changes representing more than 5 percent of capital or 10 percent of future revenue. - EC2–EC4 (comprehensiveness, adequacy, documentation, communication, MI quality): - PRA Rulebook requires management bodies to approve and periodically review strategies and policies (Art. 2.3 of risk control section implementing Art. 76(1) CRD). - Supervisors assess comprehensiveness via CA meetings, CRO liaison, deep-dive reviews, MI analysis, stress testing, and SREP. - Supervision expects firms to have MI of appropriate quality, integrity, and completeness; PRA assesses internal MI quality during deep-dive reviews and EWRM reviews and feeds back required improvements. - EC5 (ICAAP/ILAAP and supervisory review of capital and liquidity adequacy): - BIPRU 12.2.1R on liquidity resources; Threshold Condition 5D requires prudent business and appropriate capital and liquidity; BIPRU 2.2.4G highlights firm/regulator assessment via ICAAP and SREP. - Supervision regularly reviews ICAAPs/ILAAPs; SREP cycle is risk-based with supervision and SRS specialists; peer comparisons used; PSM sets ICG and/or ILG where appropriate. - EC6 (models governance, validation, supervisory oversight): - PRA implements Arts. 77–78 CRD on internal approaches and supervisory benchmarking; firms submit RWAs and methodologies at least annually. - PRA expectations: prudent use of models, independent validation, senior management understanding of model limitations; semiannual reviews for traded risk models; risk-based oversight for IRB models; annual attestations by a SIF to compliance (SS11/13–14/13). - PRA participates in EBA benchmarking exercises. - EC7 (information systems and risk data aggregation): - EBA guidelines and SREP require effective and reliable information systems that support risk data aggregation in normal and stressed conditions. - Supervision reviews information systems via CA meetings, SRS IT reviews, reconciliation with BoE data and regulatory returns, and may commission S166 skilled person reports for deficiencies. - Firms expected to work towards BCBS PERDARR principles. - EC8 (new products and material changes): - EBA internal governance guidelines require documented new product approval policies approved by management body; independent risk function role specified. - Supervision assesses new product approval policies during CA meetings, deep-dive reviews, EWRM; PRA reviews examples and may require improved Board information and challenge. - Building societies: SS20/15 requires consultation with supervisors for initiatives > 5 percent of capital or 10 percent of future revenue. - FCA expects customer-centric product design, suitability, stress testing, and senior management oversight; conducts firm-specific and thematic work. - EC9–EC10 (risk management function, CRO role, independence, notification on removal): - PRA Rulebook (Rule 3.4 risk control part transposing Art. 76(5) CRD) requires an independent risk-management function with sufficient authority, resources, and Board access. - Under SMR, prescribed responsibilities for senior managers to safeguard independence of the risk function for larger firms (assets of more than GBP 250 million). - SYSC Rule 21.1 (PRA expectations for CRO) and SYSC 21.1.4G require CRO approval and that CRO may not be removed without governing body approval; CROs are preapproved CF28s under APR and are SMF4/3.4 under SMR; firms must notify PRA if CRO dismissed using Form C. - Supervision questions independence, resourcing, and access of risk functions during CA meetings and deep-dive reviews; internal audit reviews of risk function are regularly considered. - Proportionality: smaller firms may not have fully independent risk functions but must demonstrate segregation of duties and “four eyes” coverage. - EC11 (standards for specific risk types): - CRD articles for specific risk types enumerated: Art. 79 (Credit), Art. 80 (Residual), Art. 81 (Concentration), Art. 82 (Securitization), Art. 83 (Market), Art. 84 (Interest in non-trading book), Art. 85 (Operational), Art. 86 (Liquidity), Art. 87 (Excessive leverage). - EBA SREP guidelines provide supervisory assessment criteria; U.K. implementation referenced in consultation papers CPs 17, 22, 23, 24, and 25. - EC12 (contingency arrangements, recovery plans, coordination with resolution authorities): - Art. 74 CRD requires recovery plans proportional to size and complexity; NCAs cooperate closely with resolution authorities. - BRRD drives recovery and resolution planning since January 1, 2015; PRA recovery and resolution framework in place since January 1, 2014; PRA rules and SS18/13 incorporate BRRD requirements. - Recovery plans must include at least three severe scenarios (system-wide and idiosyncratic); G-SIIs required to include at least four scenarios. - Supervisors notify firms of material deficiencies and/or impediments; firms have two months (extendable to three) to address deficiencies. - PRA uses PIF (Proximity to Failure) scoring within supervisory assessment framework; PIF considers external context, business risk, management and governance, risk-management and controls, and capital and liquidity. - PRA coordinates with RD (Resolution Directorate) and notifies RD when a firm is failing or likely to fail. - Supervisory practice: Category 2–4 firms’ recovery plans reviewed during annual capital and liquidity visits; supervisors identify common deficiencies (overoptimistic recoveries, insufficient buyer identification, limited indicators) and require remediation. - EC13 (stress testing and integration into decision-making): - CRD Arts. 97–99 set basis for supervisory evaluation of stress testing and inclusion in SREP. - EBA SREP and GL 32 on stress testing provide supervisory assessment criteria. - PRA Rulebook SYSC 20.2.1R requires stress tests and reverse stress testing; reverse stress tests documented, reviewed and approved at least annually (SYSC 20.2.3R), and updated as appropriate. - PRA SS6/13 (stress testing, scenario analysis, and capital planning) sets expectations on governance, scenario design, management actions, and integration into planning. - BoE CST (Concurrent Stress Testing) framework supports understanding of feedback effects and qualitative review of firms’ stress testing capabilities and Board engagement. - Supervisory SREP reviews of ICAAPs incorporate firm stress testing and PRA supervisory models; sequential stress testing previously used and now superseded by CST. *Source: Chapter 3 of the Information Gathering Part of the PRA Rulebook (as contained in the supplied PDF content).* ### 1. The identification and quantification of risks to which a firm is exposed, including an ### 1. The identification and quantification of risks to which a firm is exposed, including an ### SREP / Supervisory Review and Evaluation Process (SREP) and Continuous Assessment (CA) - SREP work reflects the scale and complexity of firms supervised by the PRA and is supplemented with targeted, deeper reviews (e.g., interest rate risk on the banking book). - SREP reviews combine desk-based reviews of firms’ documentation and on-site interviews of staff from the governing body to analysts. - The PRA expects firms to carry out ICAAPs annually and reserves the right to call in any year (e.g., if the firm changes its business model via acquisition). - The PRA has an ongoing CA cycle for major firms that includes: - monthly meetings that involve discussion of key exposures with management; - semiannual visits to review and assess firms’ traded risk-management controls/frameworks; - review of stress testing frameworks and stress test outputs (for example, through regular reviews of MI and discussion of risk-management/mitigation actions taken by the firm). - Targeted deeper reviews address individual risks or capital management and stress testing processes. ### Category 1–4 Banks and Building Societies: Intensity and Frequency of Review - Category 1 (major) banks: highest intensity of CA and specialist reviews. - Category 2–4 firms: PRA operates a CA process to review and provide feedback on effectiveness of risk-management with intensity scaled to PRA’s risk impact methodology. - Core supervisory process applied to all firms includes an annual visit to review, in alternate years, capital adequacy as part of a comprehensive SREP process; the visit includes detailed review of the firms’ ICAAPs and stress testing. - For smaller firms, PRA models for specific portfolios exist to benchmark outcomes of individual firms’ stress tests. - For Category 3 and 4 firms judged lower risk: - specialist review of capital takes place at least every four years; - a biennial supervisory review will take place in intervening years. - For Category 2–4 firms, specialist capital and treasury resources are available and deployed in alternate years for larger/more complex firms. ### Stress Testing, Scenarios, and Capital Planning - The PRA/FPC publishes standards scenarios intended to “anchor” the stress testing performed by firms, ensuring scenarios are of adequate relevance and intensity. - Firms are expected to develop and use their own scenarios that specifically test vulnerabilities of their business models. - For banks not taking part in the CST, the scenario is provided as a guide to calibrating their own scenarios for Pillar 2 stress testing purposes. - Responsibility for developing scenarios for Pillar 2 purposes lies with firms; the ‘anchor’ scenario helps calibrate the severity. - Supervisors review firms’ stress testing outcomes and underlying assumptions; firms are expected to use stress scenarios relevant to their business model and operations. - Where supervisors consider firms’ stress testing insufficiently rigorous, they require improvements either immediately or at the next iteration, depending on materiality. - Results of stress testing are expected to be integrated with the firm’s corporate plan and ICAAP, and to inform: - level of any P2A add-ons (where stress testing suggests that the P1 charge is insufficient); - the capital planning buffer (CPB) (now PRA buffer). - If a firm has not performed an adequate stress test, the PRA will use results of its own stress test or add an amount for conservatism pending provision of more credible numbers and will expect the firm to improve stress testing capability within a defined period. - The results of reviews in terms of supervisory judgments on the level of CPB required are presented to a PSM for each firm, at which ICG+CPB is set and key issues are agreed for feedback to the firm; the PSM process allows independent review to achieve consistency and a sense check on judgment. ### Qualitative Assessment of Risk-Management Practices - SREP includes a qualitative assessment of risk-management practices underpinning risk-identification, capital planning, and stress testing processes, and how these link with firms’ day-to-day business operations. - Supervisors assess whether banks appropriately account for risks (including liquidity impacts) in internal pricing, performance measurement, and new product approval processes for all significant business activities (EC 14). ### Findings from Funding Transfer Pricing (FTP) and Pricing Reviews - In 2014, SRS conducted a cross-firm FTP review on seven Category 1 U.K. banks focusing on a representative set of retail and corporate banking products to understand pricing structures and implications for business models and the financial system. - FTP components assessed included fees/cash backs, liquidity costs, interest rate hedging costs, securitization credits (for certain types, e.g., mortgages), commercial margin, and management overlays. - The review concluded that firms had made some developments regarding FTP frameworks but weaknesses remained: - The accuracy of cost data feeding the FTP model; - A failure to embed costs at product line level; - An inability to distinguish between long- and short-dated risk; - A propensity to credit short-term wholesale funding, which may be flighty in stress. - Messages from the review were fed back to firms in subsequent face-to-face meetings; where risks were considered material they were incorporated into the firms’ CA schedule. ### Governance and Product Approval Processes - Supervision and SRS question firms on many aspects of products during deep-dive reviews, including the new product approval process and pricing of risk. - As part of the CA process and monthly trading book reviews, supervision asks for information about new products and significant new transactions and how liquidity and credit risk are taken into account when originating deals and in risk management approvals. - The supervisory review focuses on: - how the Board sets and propagates risk appetite via limits and controls; - firms’ capacity (skills and capabilities) to operate to chosen risk appetite; - effectiveness of risk control systems in practice; - extent to which potential credit costs are factored into product pricing, the approval process for new products, and FTP arrangements to ensure correct pricing signals. ### Building Societies and Proportionality - For building societies, PRA expectations of appropriate risk-management for different business model levels are set out in SS20/15, focusing on lending and treasury activities. - All building societies are expected to align to the most appropriate risk approach and supervisors assess capability to operate safely at the chosen approach level. - SS20/15 includes expectations on pricing activities; these are due to be expanded in an updated version planned for consultation later in 2015. ### Additional Criteria — AC1 (Other Material Risks) - Supervisor requires banks to have policies/processes for assessing material risks not directly addressed in subsequent Principles, such as reputational and strategic risks. - SREP guideline requires NCAs to assess key vulnerabilities to which an institution’s business model and strategy are or may be exposed, including: - Poor expected financial performance. - Reliance on an unrealistic strategy. - Excessive concentrations or volatility. - Excessive risk-taking. - Funding structure concerns. - Significant external structures. - SREP includes consideration of sustainability of an institution’s strategy and the risk level of the strategy. - BIPRU 9.1.6R requires risks arising from securitization transactions (investor, originator, sponsor), including reputational risks, to be evaluated and addressed through appropriate policies and procedures so economic substance is reflected in risk assessment and management decisions. - GOR Part 5.1 of the PRA Rulebook requires management body approval and oversight of the firm’s strategic objectives, risk strategy and internal governance. - GOR 2.1 requires robust governance arrangements including clear organizational structure, defined lines of responsibility, effective processes to identify, manage, monitor, and report risks, and internal control mechanisms. ### Supervisory Assessment and Conclusions (Principle 15) - Supervision conducts regular analyses of firms’ business models and reviews firms’ P&L accounts to identify quality and sustainability of income streams. - Assessment of Principle 15: Compliant - Comments: - PRA has a comprehensive and articulated framework for supervision of banks’ risk-management systems allowing breadth and depth of analyses and reviews beyond the previous BCP assessment. - Review of banks’ EWRM via combined top-down/bottom-up perspective is integral to the CA for the largest banks. - Introduction of the CST for major U.K. banks has significantly raised the standard of risk-management practices inside the banks (per major banks’ CROs). - Smaller institutions receive lower degree of attention and are rarely examined by SRS, raising legitimate questions elaborated elsewhere (see CP 8 and 9). - Competing requests on a fixed pool of skilled specialist resources impose frequent reprioritizations; interpretation of PRA oversight should be read jointly with other aspects of PRA’s operating model (CP 2 and CP 16). ### Introductory Note on Principle 16 — Capital Adequacy - Principle 16 statement: - "The supervisor sets prudent and appropriate capital adequacy requirements for banks that reflect the risks undertaken by, and presented by, a bank in the context of the markets and macroeconomic conditions in which it operates. The supervisor defines the components of capital, bearing in mind their ability to absorb losses. At least for internationally active banks, capital requirements are not less than the applicable Basel standards." - Essential criteria EC 1 begins: - Laws, regulations or the supervisor require banks to calculate and consistently observe prescribed capital requirements, including thresholds by reference to which a bank might be subject to supervisory action. Laws, regulations or the supervisor define the qualifying components of capital, ensuring emphasis on elements permanently available to absorb losses on a going concern basis. *International Monetary Fund — United Kingdom assessment (excerpts).* ### Part II of CRR defines the components of own funds following Basel capital tier structure, ### _cr16166 - Part II of CRR defines the components of own funds following Basel capital tier structure, ### Part II CRR and Basel III implementation - Part II of CRR defines the components of own funds following Basel capital tier structure, which reflect varying degrees of loss absorption capacity. - CRD introduced a ‘capital conservation buffer’ (Art. 129) and related capital conservation measures (Art. 141) that restrict distribution of dividends, payments of variable remuneration, payments on additional tier 1 instruments whenever such dividends and/or payments would result in a breach of the combined buffer requirement. - Art. 54 CRR provides for the write down or conversion of additional tier 1 instruments when the CET1 ratio of a bank falls below 5.125 percent. - CRR is directly applicable in U.K. law; all banks are required to comply with CRD/CRR which set out minimum capital requirements and qualifying components of capital. - EBA RTS complement CRR/CRD on own funds. ### PRA national discretions and supervisory choices - The PRA has used certain discretions in the CRR to ensure outcomes consistent with Basel III, for example: - Requires banks to deduct significant investments in insurance entities, subject to Threshold Conditions, rather than risk weight such investments. - All AT1 instruments issued externally by U.K. banks have a trigger of 7 percent CET1 rather than the CRR minimum of 5.125 percent. - Grandfathered certain state owned ordinary shares for one bank until December 31, 2017, notwithstanding they do not fully comply with CET1 criteria. - The PRA’s PS 7/13 supplements the CRR with additional rules in the PRA Rulebook (connected funding of a capital nature, connected transactions, preissuance notification regime, implementation of national discretions and transitional provisions). - The PRA required institutions to apply all filters and deductions from CET1 in full from January 1, 2014 (end-point definition of CET1), not exercising discretion to phase in certain requirements more slowly (e.g., full deduction of DTAs relying on future profitability (Rule 10.7) and equity holdings in insurance/reinsurance/insurance holding companies subject to threshold (Rule 10.8)). - As a consequence, the PRA estimated that the average CET1 ratio for the largest four U.K. banks in 2015 would be almost 2 percent lower under the U.K. implementation, compared with the minimum transitional path allowed under the CRR. - The eight largest U.K. banks (Barclays, Cooperative Bank, HSBC, Lloyds Banking Group, Nationwide Building Society, Royal Bank of Scotland, Santander U.K., and Standard Chartered) are held to a higher standard: expected to meet a 7 percent CET1 ratio, based on end-point definition of CET1 (SS3/13). ### Assessment against Basel standards (EC 2) - For internationally active banks, the definitions of capital, risk coverage, method of calculation, and thresholds are not lower than applicable Basel standards. - Basel Committee RCAP (December 2014) assessment of EU implementation found: - Materially noncompliant overall. - Compliant: scope of application, transitional arrangements, capital buffers, IMA for market risk, operational risk, supervisory review process, disclosure requirements. - Largely compliant: definition of capital, standardized approach for credit risk, securitization framework, standardized approach for market risk. - Materially noncompliant: IRB approach for credit risk. - Noncompliant: counterparty credit risk framework. - Certain divergences have limited materiality (within 10 bps of CET1 capital ratio overestimation): e.g., SME multiplier; absence of 1.06 scaling factor for non-IRB formula exposures. - Broader range of counterparts exempted from the CVA requirement under CRR (versus Basel) determines an impact on CET1 capital ratios significantly larger than 10 bps in all cases. - U.K. exercise of conservative national discretions is likely partially to compensate, though not precisely quantifiable, for apparent capital ratio increases from EU/Basel divergences. ### Supervisor powers and capital adequacy (EC 3 and EC 4) - Art. 104 CRD: supervisors can require banks to hold own funds in excess of minimum capital requirements; restrict or limit business; request divestment; require reduction of risk in activities/products/systems. - Art. 5 CRR: exposures for credit risk capital requirements include assets and off-balance-sheet items. - PRA can apply Pillar 2 capital add-ons for risks not captured under Pillar 1 (examples: defined benefit pension risk, IRRBB, concentration risk, governance and risk management, conduct risk). - All firms required to hold additional capital under Pillar 2, with some partial exceptions (e.g., banks subject to international sanctions not subject to a Pillar 2B add-on). - PRA updated methodology for setting Pillar 2 capital in July 2015. - Art. 131 CRD: capital surcharge for global and other systemically important institutions. - Art. 130+ CRD: bank-specific CCB depends on weighted average of CCB rates applied in jurisdictions of a bank’s credit exposures. - Art. 133 CRD: supervisors can impose a systemic risk buffer up to 3 percent (or 3–5 percent with EC opinion) on exposures, with notification and review processes involving EC, ESRB, EBA. - Art. 458 CRR: macroprudential authority of a Member State may enact stricter national measures subject to notification and potential council rejection procedures. - Arts. 429–430 CRR: introduce a leverage ratio (reporting requirement, disclosure obligation from 1/1/2015). - Large U.K. banks and building societies expected to meet a 3 percent Tier 1 leverage ratio (SS3/13). On July 1, 2015 the FPC directed PRA to implement a 3 percent Tier 1 minimum leverage ratio for these firms ahead of Basel III/CRR timelines. - FPC’s leverage ratio framework introduces two leverage ratio buffers: countercyclical leverage ratio buffer and supplementary leverage ratio buffer; PRA intends to implement framework from January 1, 2016. - FPC proposes extending minimum leverage ratio requirement to all PRA-regulated banks, building societies and investment firms from 2018, subject to a 2017 review. - FPC macroprudential powers allow direction of two capital buffer tools: CCB and SCR. SCRs can be set on exposures to residential property, commercial property, and other financial sector parts, and more granular subsectors. CCB and SCRs apply to all U.K. incorporated banks, building societies and large investment firms. ### Internal models: approval, oversight, and powers (EC 5) - EU framework requires internal models (IRB, IMA, AMA, IMM) to adhere to qualifying standards as rigorous as Basel, except for exceptions identified in RCAP (especially IRB). - Prior permission required for reverting from IRB/AMA/IMM to standardized methods; no explicit CRR requirement for supervisor permission to revert from IMA to standardized for market risk, though practice and monitoring constrain this. - Material modifications to IRB/AMA/IMA require prior supervisory approval; IMM lacks explicit legal requirement for supervisor approval of material changes. - Art. 101 CRD: supervisors must regularly review internal models, ensure material deficiencies are addressed or impose higher multiplication factors, capital add-ons, or other measures. - Art. 101 CRD allows revocation of permission to use an internal approach where noncompliance cannot be restored within an appropriate deadline. - As of assessment: - 18 banks in the U.K. with IRB approved models (9 AIRB, 5 FIRB, 4 retail only). - 15 with IMA permission for market risk. - 8 with IMM permission for counterparty credit risk. - 2 with AMA permission for operational risk. - PRA model oversight practices: - Risk specialists division reviews first-time IRB notifications. - Risk-based approach with classification of model changes as “material,” “intermediate,” or “immaterial.” - Desktop reviews, on-site visits, mandatory Q&A challenge, final decision through PRA decision-making framework. - PRA relies on firms’ self-assessments and annual attestations for less material models/changes. - The prioritization approach could permit significant model changes at smaller banks without full PRA review under resource constraints. - The PRA conducts thematic reviews and uses EBA benchmarking (Art. 78 RTS) to identify outliers. - For market/counterparty risk: - Technical panel recommendations from SRS, supervision decision committees, monitoring via back-testing, capital trends, internal risk-MI quarterly for 9 firms with most material trading books. - Cross-firm comparisons and thematic reviews (examples: IMM exposures to CCPs and ETDs; initial margin models; IMA back-testing and CVA/specific risk models). - For operational risk: - AMA qualifying standards in draft RTS (CRR Art. 312.4(a)); no recent AMA applications; compliance assessed in periodic supervision. - PRA does not formally assess TSA users against Basel paras. 660–663 and CRR Art. 320; institutions must notify competent authorities prior to using TSA. - Powers to impose conditions and reporting: - PRA cannot add conditions at grant stage where CRR conditions are unequivocally met, but can use S55M FSMA to impose requirements related to permissions (e.g., reporting). - PRA can impose reporting requirements or conditions on ongoing model use; may impose capital add-ons for risks not captured in VaR. - Revocation and remediation: - CRD IV Art. 101.4 permits revocation where firm unlikely to restore compliance; PRA has removed model approvals and imposed significant capital add-ons in practice. - PRA can revoke AMA permission or require standardized/basic indicator approach; remediation programs used to restore compliance. ### Forward-looking capital management and stress testing (EC 6) - Art. 177 CRR: IRB banks must have sound stress testing processes for capital adequacy assessment. - Art. 296 CRR: IMM banks must have comprehensive stress testing for counterparty credit risk capital requirements assessment. - Art. 368 CRR: IMA banks must frequently conduct rigorous stress testing addressing a number of possible shocks. - EBA SREP guidelines require supervisors to regularly assess banks’ stress testing programs as part of ICAAP review, including: - Assess stress testing impact on credit risk provisioning. - Consider interest rate risk in the banking book stress test results. - Verify stress testing for operational events and secondary effects (liquidity, funding costs). - Supervisors should require credible capital plans ensuring ability to meet total capital ratio or other target ratio over assumed horizon. - Major U.K. firms are subject to CST (Common Scenario Testing); outputs used to assess system and individual firm vulnerabilities and to set additional capital buffers. - PRA uses an in-house model to benchmark smaller banks’ mortgage book stress-testing; PRA may use its numbers to derive capital buffers if firms’ results are materially lower. - Firms’ ICAAP must include forward-looking assessment over 3–5 years; PRA reviews these and can set additional capital buffers where capital resources insufficient. - PRA issues scenarios indicating severity expectations for firms’ corporate plan stress tests; expects firms to run PRA scenarios as part of regular stress testing. - PRA powers (Section 55M FSMA and S137G FSMA) can require contingency arrangements and recovery plans; PRA has required submission of capital-strengthening plans (example: 2013 capital shortfall exercise required three firms to submit plans). - PRA notifies firms of a PRA buffer amount over minimum requirements and CRD4 buffers; PRA buffer based on firm-specific supervisory assessment and reflects systemic importance. Firms using PRA buffer face supervisory consequences and must prepare capital restoration plans if breached. - BoE publishes a hurdle rate framework for CSTs with a strong presumption of action if a bank falls below key thresholds; supervisory response less intensive for projected breaches of buffers than for minimum capital breaches. - Example: One participating firm in 2014 required to submit a revised capital plan which was accepted by the PRA. ### Group capital allocation and solo consolidation (AC1 and AC2) - CRD and CRR apply to all credit institutions and investment firms in the EU, irrespective of size or international activity. - PRA applies capital requirements (definition, risk coverage, method, scope) equally to non-internationally active banks and internationally active banks. - U.K. credit unions are exempt from CRD and supervised under PRA specialist sourcebook with simple capital and liquidity regimes; regulatory capital includes audited reserves, interim net profits, shares, subordinated debt (subject to conditions) and revaluation reserves (subject to conditions and not exceeding 25 percent of total capital). - CRD/CRR applied both on standalone and consolidated basis (Art. 7 CRR exceptions subject to conditions). - Art. 73 CRD requires banks to maintain internal capital amount, type and distribution consistent with risk nature and level. - PRA exercises Art. 49(2) CRR discretion to deduct from own funds, on a standalone basis, significant investments in financial entities included in consolidated group to ensure adequate capital in all regulated entities. - Art. 9 CRR allows PRA to waive standalone requirements on a case-by-case basis (“solo consolidation”) if no material impediment to prompt transfer of own funds; around 40 banks have permission to use solo consolidation. - PRA does not use the more general Art. 7 CRR derogation to waive standalone supervision. ### Assessment and conclusion (Assessment of Principle 16) - Assessment: Largely Compliant. - Key summary findings: - CRD and CRR implement Basel capital standards in the EU and are complemented by EBA RTS on own funds. - Basel Committee RCAP (December 2014) assessed EU implementation as materially noncompliant, notably due to IRB misalignments and counterparty credit risk framework issues. - Some divergences have limited materiality (within 10 bps CET1 overestimation); CVA exemptions under CRR have impacts significantly larger than 10 bps on CET1 in all cases. - U.K. authorities have tended to adopt conservative national discretions, partially compensating for some divergences. - PRA’s requirement to apply end-point CET1 filters/deductions from January 1, 2014 represents “super-equivalence” and was estimated to reduce average CET1 for largest four banks by almost 2 percent in 2015 versus minimum CRR transitional path. - Possible compensating effects (understatement vs. overstatement of CET1) exist but are based on separate calculations and different samples and will diminish as the transitional period ends. - Overall, assessors could not ensure sufficient comfort to reach a definitive fully compliant judgment across all aspects. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### conclusion about the net impact of these two effects, but, given the inherent uncertainties, ### _cr16166 - conclusion about the net impact of these two effects, but, given the inherent uncertainties, ### Supervisory approach to internal models and specialist resource constraints - Assessors do not consider the U.K. implementation of the EU capital framework as fully compliant with Basel; deviations give rise to deficiencies in Pillar 2 requirements that should be compensated by specific Pillar 2 add-ons. - U.K. authorities are awaiting indications from the EBA Guidelines on the treatment of CVA risk under SREP (in consultation at the time of the assessment) before addressing lower capital requirements stemming from noncompliance with the Basel rules for CVA capital charges. - Assessors found PRA internal policy on review of banks’ internal models (credit, market, operational, and counterparty credit risk) not entirely reassuring in terms of supervisory control over model robustness and in preventing opportunistic behaviors by banks. - Model change policy appears reflective of a broader PRA phenomenon: growing IRB permission demand (particularly from mid-size and small banks) may increase demand for specialist resources. - Specialist resources increasingly under pressure and unable to meet concurrent requests. Evidence includes: - A specialist team reducing scope of an internal model examination due to insufficient time to review documentation in full. - Internal PRA debate exploring solutions that risk diminished assurance (e.g., model change policy) or impervious alternatives such as external validation that could outsource prudential responsibilities (potential violation of CP 9–EC 11). - Staffing reported in the review of the Target Operating Model: 48 FTE specialists on credit risk, 43 on market and counterparty credit risk, 41 on risk infrastructure and liquidity. - Given the large number of banks with approved internal models and the centrality of high capitalization measured against RWA, assessors view assuring model robustness and preventing opportunistic use as an absolute priority for the PRA. - Considerations and suggested complementary tools: - CSTs (Comprehensive Stress Tests) engagement of supervisors, specialists, and financial stability experts raises banks’ risk-management standards more effectively than usual model reviews and creates stronger recurring incentives on banks. - CST could complement or partially substitute intensive model review programs but would not likely reduce demand on skilled resources. - Hypothetical portfolio exercises (HPE) planned jointly with EBA, and potentially run independently in interim periods, could better tailor exercises to U.K. market. - Benchmarking exercises (e.g., cross-comparison of IRB banks’ parameters on portfolios of common obligors) based on regular collection of exposures and parameters from banks with approved models. ### Principle 17 — Credit risk: findings, tools, and assessment - Principle 17 status: Largely Compliant. - Key supervisory expectations and sources: - CRD Articles transposed into PRA Rulebook: Art. 76 (risk-management and risk-management function) and Art. 79 (internal methodologies to assess credit risk at obligor and portfolio level). - EBA guidelines on SREP (applying from January 2016) set expectations on internal credit risk processes (paras. 180, 182). PRA and FCA committed to comply with the guidelines. - PRA supervisory approach: - Delivered through supervisors maintaining an up-to-date view via a rolling program of supervisory assurance work (core and discretionary elements) supported by inhouse credit risk specialist resources. - CA (continuous assessment) work program agreed annually at firm’s periodic PSM; supported by targeted technical risk reviews, AQRs, and thematic reviews. - Specialist resources focused primarily on Category 1 firms; asset quality and other reviews at smaller banks (Category 2–4) depend on key risks and resource availability. - Examples of targeted reviews: SME and commercial real estate portfolios, an AQR at a branch of an EU bank, underwriting procedures in an investment bank, cross-firm CRE lending and slotting procedures, retail credit reviews. - Gaps in supervisory guidance (assessors’ identification): - Lack of explicit supervisory expectations in PRA guidance on: - EC 5: that banks make credit decisions free of conflicts of interest and on an arm’s length basis. - EC 4: that banks monitor significant unhedged credit risk. - EC 6: that credit policy prescribes major credit risk exposures exceeding a certain amount or percentage of the bank’s capital be decided by the Board or senior management. - PRA expectations on credit risk-management are often general and less articulated than EBA SREP guidelines. - Data and monitoring: - PRA receives loan-level data via Mortgage Product Sales Data report (managed by FCA) including loan characteristics and, since 2015, credit impairment; coverage limited to mortgages and only recently accumulating default information. - FX lending is a small share of U.K. banks’ total assets: around 11 percent at the time of an ESRB assessment; PRA judged low FX lending exposure for the U.K. - Supervisory tools and stress testing: - All U.K. banks must include credit exposures in ICAAP stress testing; ICAAPs reviewed proportionate to firm materiality. - PRA conducts regular CST of largest U.K. banks (currently the largest seven) to estimate potential losses and capital/liquidity requirements under FPC/PRA Board scenarios. - PRA credit and traded risk specialists and BoE financial stability team jointly challenge firms’ loss projections; adjustments to firms’ forecasts may be made by BoE where warranted. - If stress-test results show a firm under-capitalized, PRA may request increased capital resources. - Recommendations/highlights: - PRA could strengthen oversight by enhancing access to broader loan-level data (e.g., credit reference agency databases) to improve offsite monitoring and early detection of weakening underwriting standards, especially for medium-small banks. ### Principle 18 — Problem assets, provisions, and reserves: findings and assessment - Principle 18 status: Largely Compliant. - Accounting and supervisory framework: - U.K. accounting standards (IFRS IAS 39; U.K. GAAP FRS 102) require regular assessment of impairment for loans and assets at amortized cost; incurred loss approach in place at assessment time. - EBA Guidelines on SREP (and ITS on supervisory reporting) set expectations for NPLs, forbearance, provisioning, and reporting. - PRA relies on banks’ Boards and external auditors as primary responsibilities for problem asset identification and provisioning; PRA complements via dialogue with auditors and supervisory reviews. - PRA practices by firm category: - Category 1 U.K.-headquartered firms: - CA framework: PRA discusses troubled assets, portfolio risks, MI, and engages with Board risk committee chairs, CROs, and front office. - PRA meets auditors several times per year and receives audit reports relevant to provisioning assessment; accounting specialists support supervisors in challenging provisioning. - AQR program (introduced November 2013) assesses adequacy of accounting provisions and Pillar 1/2A capital via four levels of granularity (Level 1–4); Level 3/4 include transaction testing on loan files. - Seven Category 1 U.K.-headquartered firms are subject to CST. - PRA can set Pillar 2 additional capital for balance-sheet concentrations or deficiencies in risk management (e.g., inappropriate collateral valuations, overly benign credit grades). - Branches/subsidiaries of overseas-headquartered banks: similar asset quality work by International Banking Directorate, without PRA credit risk specialists for AQRs. - Smaller banks and building societies: - Most are required to submit twice-yearly detailed loan book data (product, indexed LTV, arrears, provisions) used to monitor risk migration and discussion with banks/auditors. - Building societies comply with SS 20/15 expectations; internal audit reviews found deficiencies in setting and monitoring risk appetite limits. - Credit unions: - Required provisions: 35 percent of balances for loans in arrears 3–12 months; 100 percent for loans in arrears 12 months or more. Category 4 credit unions visited once a year. - AQR coverage and resource constraints: - Since legal cutover (two and a half years prior to assessment), Level 3/4 detailed AQRs by credit risk specialists on smaller banks numbered: 8 on Category 2 firms and 3 on Category 3 firms; none on Category 4 or 5 banks. - No committed timetable to subject remaining smaller banks to similar detailed reviews. - AQR delivery observations (median impression from assessors): - Staffing: around three specialists plus one line supervisor. - Duration: less than two weeks. - Files reviewed: around 100 loan files. - Portfolio share reviewed: between 5 percent and 50 percent depending on asset class. - Supervisory powers and remediation: - PRA lacks formal powers over provisioning in banks’ financial statements; common approaches to insufficient provisions include persuading directors to adjust provisioning, making deductions from capital in CST starting points, or factoring extra provisions into Pillar 2A. - Historical example: FPC request in 2013 led PRA to identify an aggregate shortfall of around GBP 13 billion (net of actions already planned) in capital of eight major U.K. banks and building societies; firms invited to take additional actions to close shortfalls. - Earlier FPC/FSA exercise estimated possible overstatement of major U.K. banks’ and building societies’ capital positions by GBP 30–40 billion (unrecognized expected loan losses), GBP 10–20 billion (unrecognized conduct costs), and some GBP 20 billion (imprudent risk weighting). - Coverage of off-balance sheet exposures and valuation: - IRB banks required to categorize and measure off-balance sheet items appropriately; supervisors check evolution of off-balance sheet commitments as part of AQR and quarterly C&C meetings. - IFRS/FRS 102 treatment: derivatives at fair value; loan commitments and guarantees subject to provisioning where appropriate; IFRS 9 expected credit loss approach forthcoming. - Classification, forbearance, and default definitions: - EBA ITS on supervisory reporting: default occurs when institution considers obligor unlikely to pay in full or obligor is past due more than 90 days; IRB may allow 180 days for certain retail exposures/SME residential/commercial real estate and PSEs. - ITS sets conditions for discontinuation of nonperforming and forborne classifications (paras. 156–157). - System-wide monitoring and concentration risk: - PRA supervisors and SRS credit team perform cross-firm reviews (collections & recoveries, asset quality). - FPC monitors system-level build-up of risk and recommends action; examples include 2012 action on provisioning shortfalls and later actions addressing high loan-to-income mortgage lending. - Credit Risk Forum coordinates assessment across BoE/PRA directorates and supports systemic monitoring (examples: U.K. CRE lending and slotting, Mid Corporate/SME, mortgage collections and recoveries). - Assessors’ key recommendations and observations: - While PRA engages intensively with external auditors and uses AQRs, assessors see insufficient direct supervisory transaction testing coverage across the broader population of smaller banks, which may allow creeping deterioration of underwriting standards to go undetected for prolonged periods. - To mitigate resource constraints and broaden direct supervisory scrutiny, PRA could: - Increase reliance on line supervisors for conducting loan-file based AQRs (with enhanced training and on-the-job support from specialists). - Consider random AQR backstops for smaller banks to reduce expectation of prolonged light-touch intrusive supervision. - Assessors conclude PRA approach to problem assets and provisioning is not fully compliant but not materially non-compliant, noting current benign environment (NPL ratios near historical lows) mitigates some concerns but urging PRA to address inherent limits. *International Monetary Fund — assessment content as provided in the source text* ### Part IV of the CRR (Arts. 387–403) contains a comprehensive regime for the treatment of LE, ### _cr16166 - Part IV of the CRR (Arts. 387–403) contains a comprehensive regime for the treatment of LE, ### Large exposures and concentration risk — legal and supervisory framework - Part IV of the CRR (Arts. 387–403) covers on-balance sheet exposures, off-balance sheet exposures and contingent liabilities. - Banks must have sound administrative and accounting procedures and adequate internal control mechanisms for identifying, managing, monitoring, reporting and recording all LE and subsequent changes (Art. 393). - Art. 81 of CRD — transposed into PRA Rulebook ICAA 6 — requires firms to establish written policies and procedures to address and control concentration risks, including concentration arising from: - exposures to each counterparty including central counterparties, groups of connected counterparties and counterparties in the same economic sector, geographic region or from the same activity or commodity; - the application of CRM techniques; and - risks associated with large indirect credit exposures such as a single collateral issuer. - Definition guidance: CRR Art. 4(39) defines ‘group of connected clients’ (points (a) and (b)) with a possible exception for natural and legal persons connected with the government. - The CEBS “Guidelines on the revised LE regime” provide supervisory guidance on applying the definition of groups of connected clients; in cases of divergence the competent authority decides. ### Large exposures — quantitative thresholds, limits, and exemptions - Any exposure to a client or group of connected clients equal to or greater than 10 percent of a firm’s eligible capital is to be considered a LE (Art. 392). - CRR Art. 395: LE limits at 25 percent of a bank’s eligible capital, after CRM. - If the client is a credit institution or investment firm, the limit is the largest between 25 percent and EUR 150 million; exposures must not exceed a “reasonable limit” determined by the institution’s internal policies and procedures, which must not exceed 100 percent of the institution's eligible capital. - CRR Art. 6: LE limits must be complied with on both individual and consolidated basis. - Exemptions under CRR Art. 400: - Core U.K. group permission (related to CRR Art. 113(6) 0 percent risk weight) leading to full exemption from LE limit (CRR Art. 400(1)(f)). - Noncore LE group permission (CRR 400(2)(c)) allows full or partial exemption for intragroup exposures up to 100 percent of firm eligible capital under certain conditions. - At time of assessment there were 13 core U.K. group permissions and 20 noncore LE group permissions in force. ### Reporting, monitoring and supervisory tools for LE and concentration - CRR Art. 394 sets out reporting requirements for LE and certain largest exposures (identification of client or group, exposure value before CRM, type of credit protection, expected run-off). - EBA COREP templates and Commission's Implementing Regulation (EU) No 680/2014 Annex VIII and IX include LE reporting (sector identification, NACE codes). - PRA collects LE and capital adequacy information quarterly via COREP template ‘COR002’. Geographical breakdown via ‘COR001’. Currency exposures via liquidity templates ‘COR003’ and ‘COR004’. - FINREP reporting templates F20.01–20.07 (and F31 for related parties) capture concentration and related party information for firms subject to FINREP. - PRA performs plausibility checks (RDG) on returns and uses MI and ad-hoc requests to assess LE and risk concentrations. ### Supervisory assessment, stress testing, and Pillar 2 treatment - Market risk concentrations addressed under Pillar II: banks required to hold additional capital for market risks underestimated or not covered under Pillar 1. - PRA assesses and scores institutions’ management of credit concentration risk via the PRA risk model and SREP; a revised methodology was finalized and to be implemented in January 2016. - PRA’s SREP methodology generates suggested capital add-ons for single-name, sectoral and geographic concentration risk separately. - Supervisory stress testing examples: - 2014 CST focused on a U.K. downturn with emphasis on residential mortgage valuations (geographic and product concentration impacts). - 2015 CST focused on an Asian stress with combined trading book shock; firms had to identify top ten Asian trading book exposures and default at least the two most vulnerable counterparties. - PRA may require skilled person reviews under S166 FSMA 2000 if information systems are inadequate; PRA has used S166 in the last five years for large firms. ### Assessors’ conclusions on LE and concentration (Principle 19) - Assessment: Compliant. - Comments: - EU LE regime broadly aligned with Basel 2014 LE framework, but gaps exist (wider exemptions under CRR Art. 400, more generous treatment for certain asset classes such as covered bonds and exposures to G-SIBs). - CRR uses 0 percent CCF for some low-risk exposures, while Basel LE framework applies a 10 percent CCF floor. - No stricter LE limit for G-SIBs in EU regime as per Basel. - Some divergences deemed unlikely to be material for U.K. banks (e.g., covered bond concentrations). - Main notable divergence: PRA does not require banks to set explicit internal thresholds/limits for acceptable concentrations (EC 3) — recommended that authorities introduce and enforce this requirement explicitly; partially compensated by Pillar 2 capital buffer methodology. --- ### Related party transactions — definitions, controls and supervisory powers (Principle 20) - PRA Rulebook defines “related parties” comprehensively (controls, affiliates, controllers, directors, senior management, key employees, close family members, direct/related interests, subsequent relatedness after a transaction). - PRA Rulebook requires transactions with related parties to be at market value or on terms no more favorable than with non-related counterparties; exception for beneficial terms that are part of overall remuneration packages (e.g., staff loans). - Building Societies Act (BSA) 1986 contains requirements and restrictions around directors and connected persons (S63–S69). - PRA Rulebook requires firms to set a ‘materiality threshold’ above which related-party transactions (including write-offs) require prior management-body approval and to prevent related parties participating in decisions on those transactions. - Firms must record and monitor related-party transactions using an independent credit review or audit process; exemptions must be reported to senior management/management body. - Reporting: - LE reporting (COREP) and FINREP template F31 capture related-party exposures (FINREP semiannual; COREP quarterly). - For many U.K. banks (not in FINREP population), transactions with related parties reported only in annual reports unless they qualify as LE. - Supervisory powers: under Part 4A FSMA 2000 PRA can set limits on exposures to any persons, deduct related-party exposures from capital, or require collateralization; PRA has used supervisory ring-fences and specific measures when needed. - Assessment: Compliant. - Comments and recommendations: - PRA Rulebook aligns with BCP definitions and sets most requirements. - Gaps: absence of regular infra-annual reporting of related-party transactions for the majority of banks — assessors recommend authorities introduce regular infra-annual reporting and routine monitoring applicable to generality of banks. --- ### Country and transfer risk — supervisory expectations (Principle 21) - PRA handbook/rules require firms to identify, measure, evaluate, monitor, report and control or mitigate country risk and transfer risk; firms must report country risk limits and exposures to the PRA quarterly and notify breaches. - Supervisory practice: - SRS conducts periodic reviews (two per year) of Category 1 firms’ management of country and transfer risk; fewer resources for lower-category firms. - Larger firms’ country risk analysis occurs as part of technical risk reviews or AQRs; other firms typically reviewed at least quarterly in connection with COREP COR001 and COR002 returns. - PRA can require increased Pillar 2A capital where provisions or capital are inadequate for country/transfer risk. - SRS has conducted overseas AQRs to validate provisioning and capital in foreign jurisdictions. - Assessment: Compliant. - Comments: - Supervisory engagement appropriate for Category 1 firms; limited specialist resources for smaller firms may constrain proactive oversight of potentially significant international exposures. --- ### Market risk — governance, models, valuation and supervisory practice (Principle 22) - Legal basis: - Art. 83 CRD requires policies/processes for identification, measurement and management of market risks. - Art. 368 CRR governance for banks using internal models for market risk. - Art. 105 CRR requires valuation adjustments for valuation/exit-price uncertainty (market liquidity risk). - EBA SREP Guidelines and draft RTS (model assessment RTS per Art. 363[4]) define supervisory elements for market risk, governance, resources and internal models. - Supervisory coverage: - Nine banks with largest trading books assessed on continuous basis (CA); other banks receive reviews within supervisory cycle. - Monthly data pack and structured capital report submissions for large banks; quarterly submissions on risk profiles and semiannual IMA review visits for banks with internal models. - PRA conducts ad-hoc reviews for market events (e.g., Swiss Franc de-peg) and thematic reviews (e.g., credit valuation adjustments). - SRS division provides detailed half-yearly reviews and cross-firm analyses. - Valuation and controls: - CRR Art. 105: revalue trading positions at least daily; independent price verification; model assumptions assessed by independent parties; procedures for valuation adjustments. - PRA requires reporting of valuation adjustments quarterly in accordance with PRA GENPRU S1.3. - Pillar 2 and stress testing: - Pillar 2 capital for illiquid or concentrated positions not adequately captured by VaR models; methodology stresses exposures for a one-year holding period at 99.9 percent confidence interval to compute Pillar 2 capital charge (offsets for mitigants deducted). - Art. 100 CRD mandates annual SREP stress tests; Art. 368(1)(g) CRR requires frequent stress tests for institutions using internal models for market risk. - PRA and EBA stress tests cover market risk; PRA conducts additional stress exercises including “dark corners” scenario starting in 2016, every other year. - Assessment: Compliant. --- ### Interest rate risk in the banking book (IRRBB) — requirements, measurement, and supervision (Principle 23) - CRD/CRR and PRA implementation: - Art. 98 CRD requires supervisor review of IRRBB exposures; mitigation (including capital) if economic value declines by more than 20 percent of own funds from a sudden 200 basis points interest rate change or as per EBA guidelines. - PRA Rulebook ICAAP rules (Art. 9.1–9.5) require firms to evaluate IRRBB, apply +/–200 basis points shock, notify PRA if economic value decline > 20 percent of own funds, and conduct assessments at least annually. - Firms must keep written records of IRRBB assessments (Art. 13.1). - Data collection and supervisory methodology: - Large firms provide IRRBB data via FDSF; all banks provide FSA017 returns showing +/-200bp shock outcomes and behavioral assumptions. - PRA’s July 2015 Statement of Policy “The PRA’s methodologies for setting Pillar 2 capital” (S7) details Pillar 2 assessment methodology for IRRBB. - EBA guidelines on IRRBB published May 2015; entry into force January 2016. - Governance, models and validation: - PRA expects ICAAP to be Board-owned and approved; SS31/15 requires management body responsibility and approval for ICAAP (including IRRBB). - PRA does not have a formal requirement for internal or external validation of IRRBB models but expects firms to be conservative and for PRA to investigate model structure and governance (SS 5/13). - Stress testing: - PRA requires firms to apply a 200 basis point shock in both directions; PRA will test wider range of shocks and currency-specific yield curve volatility parameters (S7.10). - Firms must monitor earnings volatility over a 3–5 year timeframe as part of assessments. - Assessment: Compliant. - Comments: - EBA guidelines coming into force January 2016; PRA adjusting data collection to implement EBA requirements (modifying FSA017 and consolidating returns). - Basel Committee review of IRRBB may introduce standardized methodology — PRA may update Pillar 2 treatment accordingly. --- ### Liquidity risk — LCR, ILG/OLAR, ILAA and supervisory approach (Principle 24) - LCR implementation and EU divergences: - EU modified-LCR (Art. 412 CRR and delegated Act 2015/61) effective from October 2015 with several divergences from BCBS LCR (often less conservative): - inclusion of covered bonds meeting requirements to Level 1 HQLA with 7 percent haircut and cap of 70 percent (DA Art. 10); - inclusion of nonexternally rated covered bonds into Level 2BV HQLA (DA Art. 12); - inclusion of claims to central government/central bank/regional governments/local authorities/PSEs to Level 1 HQLA even if not marketable (DA Art. 10); - securitization of auto, SME and consumer loans to Level 2B HQLA (DA Art. 13). - More conservative EU treatments include 15–20 percent run-off rates for certain retail deposits (DA Art. 25 (2) (3)) and limitation on stable retail deposit outflow rate during phase-in. - EBA calculation: changes increase LCR by 13.9 percentage points for sample banks (322) and reduce bank failures to meet 100 percent LCR from 74 to 17. - Phase-in schedule for LCR: - 60 percent from 1 October 2015, - 70 percent from January 1, 2016, - 80 percent from January 1, 2017, and - 100 percent from January 1, 2018. - PRA approach and ILG/OLAR: - PRA set transition path requiring firms to meet 100 percent LCR by January 1, 2018, but set initial LCR requirement as of October 1, 2015 at 80 percent. - OLAR: firms must maintain adequate liquidity resources in amount and quality to ensure no significant risk that liabilities cannot be met as they fall due; PRA issues ILG (Individual Liquidity Guidance) on amount, quality and funding profile expectations. - ILG monitored quarterly for Category 1–3 firms and six-monthly for Category 4 firms; supervisors review returns (FSA047, FSA048) biweekly or monthly for larger firms. - Until an L-SREP under new regime, PRA carries forward ILG add-on as interim Pillar 2 liquidity buffer to capture risks not in LCR (e.g., intraday risk, concentration of funding). - Liquidity monitoring tools and metrics: - EBA final draft ITS on additional liquidity monitoring metrics (AMM) to form PRA liquidity monitoring when in force. - PRA maintained existing maturity ladder in parallel with new one during transition (PRA ladder shorter horizon: 5 years vs >10 years in new). - Stress testing and ILAA: - Firms must document ILAA; stress testing must consider institution-specific, market-wide and combined scenarios, analyze 14 sources of liquidity risk and net outflows before management actions (PRA Rulebook ILAA S11.5 and Rule 11.3–11.5). - L-SREP assesses liquidity profile and required improvements, informs ILG; frequency 1–3 years according to systemic importance, full-scope L-SREP at least every three years for most systemically important firms. - Supervisory discretion and past actions: - PRA responded to FPC recommendations: allowed use of collateral prepositioned for BoE discount window to meet up to 10 percentage points of ILG (Sept 2012) and up to 40 percent during 2013 FPC phase-in recommendation (subject to capital). - PRA retains ability to set higher liquidity levels for individual firms where appropriate. - Assessment: (implicit in text) PRA approach aligns with EBA and Basel frameworks with transitional and national discretions; PRA set more stringent initial LCR of 80 percent as of Oct 1, 2015. *International Monetary Fund — staff report content unit as provided* ### Annex 1. This template includes sections, which detail the firm’s liquidity risk-management ### Annex 1. This template includes sections, which detail the firm’s liquidity risk-management framework, policies, processes, and stress testing. ### ILAAP / ILAA framework and supervisory use - The PRA Rulebook Chapter 13 requires firms to update their ILAAP annually for approval from its management body. - The firm must regularly carry out an internal assessment of the adequacy of its liquidity and funding in accordance with its ILAAP. - The PRA will use the firm’s ILAAP to form the basis of their liquidity assessment. - The PRA will use the evidence contained in the ILAAP in line with SS24/15 paras. 3.5–3.8, to assess whether the strategies, policies, processes, and systems that enable it to identify, measure, manage, and monitor liquidity risk are comprehensive and bank-wide. This will inform the PRA’s judgment of the qualitative aspect of “ILG.” - Past regime references: - BIPRU 12.4 (in particular BIPRU 12.4.-2R) required firms to be able to withstand a range of different stress events while conforming with the liquidity risk appetite approved by the firm’s governing body. - BIPRU 12.3.4R supplemented by BIPRU 12.3.5R required the firm to ensure it has a comprehensive bank-wide view of liquidity risk consistent with its risk profile and systemic importance. - Evidence of implementation observed by assessors included ILAAP/ILAA documentation and PRA-focused reviews for a major U.K. bank, a building society, and U.K. branch and subsidiary of an international bank, spanning differing business models and liquidity risk-management approaches. Reviews were thorough, detailed, tailored to bank characteristics and systemic importance, and included supervisory follow-up. ### EC 4 — Liquidity strategy, policies and processes - EC 4 statement: - The supervisor determines that banks’ liquidity strategy, policies and processes establish an appropriate and properly controlled liquidity risk environment including: - a) clear articulation of an overall liquidity risk appetite that is appropriate for the banks’ business and their role in the financial system and that is approved by the banks’ Boards; - b) sound day-to-day, and where appropriate intraday, liquidity risk management practices; - c) effective information systems to enable active identification, aggregation, monitoring and control of liquidity risk exposures and funding needs (including active management of collateral positions) bank-wide; - d) adequate oversight by the banks’ Boards in ensuring that management effectively implements policies and processes for the management of liquidity risk in a manner consistent with the banks’ liquidity risk appetite; and - e) regular review by the banks’ Boards (at least annually) and appropriate adjustment of the banks’ strategy, policies and processes for the management of liquidity risk in the light of the banks’ changing risk profile and external developments in the markets and macroeconomic conditions in which they operate. - Description and findings re EC 4: - EBA SREP guidelines (apply from January 1, 2016) recommend supervisors assess: - a) liquidity risk strategy and tolerance established and approved by management body (para. 400 a); tolerance appropriate considering business model, overall risk tolerance, role, financial condition and funding capacity (para. 400 d). - b) limit and control framework adequacy for complexity, size, business model, reflecting material drivers of liquidity risk (para. 414 a); limits regularly reviewed and clearly communicated (para. 414 b); procedures for monitoring limits and handling breaches (para. 414 f). On intraday liquidity: monitor and control cash flows and forecasts (para. 406 a); adequate intraday stress testing (para. 406 b). - c) appropriate framework and IT systems for identifying and measuring liquidity and funding risk, including all material legal entities, branches, subsidiaries (para. 404 c); understanding access to financial instruments given legal, regulatory and operating restrictions, including asset inaccessibility due to encumbrance (para. 404 d). Reporting: MI and internal information flows should be understandable, accurate and usable (para. 405 b). - d) management body discusses and reviews governance and policies for managing liquidity and funding risk (para. 401 a); senior management ensures decisions of management body are monitored (para. 401 c). Specific reports and documentation with comprehensive and accessible liquidity risk information submitted regularly (para. 405 c). - e) liquidity risk strategy and tolerance updated by management body (para. 400 a). - U.K. context: - a) PRA Rulebook ILAA Chapters 3 and 4 require robust liquidity strategies, policies and processes, clear articulation of liquidity risk appetite, approval by the firm’s management body, and reflection of the firm’s importance in each country of operation. Banks recommended to refer to EBA SREP Guidelines as outlined in SS 24/15, Annex 1. - b) PRA Rulebook Chapter 3 requires robust day-to-day liquidity strategies; Chapter 5 sets intraday liquidity active management requirements. PRA assesses through ILAA/ILAAP and CA engagement. - c) PRA Rulebook Chapters 3 and 4 require bank-wide identification, measurement, management and monitoring of liquidity and funding risk. Chapter 7 requires active management of collateral positions, distinguishing pledged and unencumbered assets. SS 24/15, Annex 1 provides ILAAP template for framework and IT systems. PRA assesses ILAA/ILAAP and CA engagement for effectiveness of bank-wide information systems. - d) Chapter 13 requires management body approval of ILAAP; assessment and approval must include review of methodologies and assumptions for risk measurement and liquidity management. Supervisor assesses management body oversight via ILAA/ILAAP and CA engagement. - e) Chapter 13 requires management body to review and approve ILAAP regularly, at least annually. SS 24/15, Annex 1 contains strategy, policies, processes sections; Chapter 4 requires liquidity risk appetite appropriate for business strategy. Supervisor determines whether management body regularly reviews and adjusts strategy, policies and processes, and expects firms to update ILAA/ILAAP when risk profile or external conditions change. ### EC 5 — Funding strategies, policies and processes - EC 5 statement: - The supervisor requires banks to establish, and regularly review, funding strategies and policies and processes for the ongoing measurement and monitoring of funding requirements and the effective management of funding risk. Policies and processes include consideration of how other risks (e.g., credit, market, operational and reputation risk) may impact the bank’s overall liquidity strategy, and include: - a) an analysis of funding requirements under alternative scenarios; - b) the maintenance of a cushion of high quality, unencumbered, liquid assets that can be used, without impediment, to obtain funding in times of stress; - c) diversification in the sources (including counterparties, instruments, currencies and markets) and tenor of funding, and regular review of concentration limits; - d) regular efforts to establish and maintain relationships with liability holders; and - e) regular assessment of the capacity to sell assets. - Description and findings re EC 5: - Legal and regulatory references: - Art. 413 CRR requires firms to ensure their long term obligations are adequately met with a diversity of stable funding instruments under both normal and stressed conditions. - Art. 86(1) CRD mandates competent authorities to ensure firms have robust strategies, policies, processes and systems for identification, measurement, management, and monitoring of liquidity risk over appropriate time horizons, including intraday, to ensure adequate liquidity buffers. - Art. 86(4) CRD mandates competent authorities to ensure firms develop methodologies for identification, measurement, management and monitoring of funding positions, including current and projected material cash-flows, off-balance-sheet items and possible impact of reputational risk. - EBA SREP guidelines (apply from January 1, 2016) recommend supervisors assess whether funding plan is feasible and appropriate relative to nature, scale, complexity, current and projected activities and liquidity and funding profile (para. 420). Interactions between funding risk and other risks should be recognized (para. 404 b). - On specific EC elements the guidelines recommend supervisors assess: - a) whether funding plan supports projected business activities under adverse scenarios (para. 420 a). - b) adequacy of controls regarding the liquid assets buffer, including timely monitoring and immediate availability to the group entity using the assets (para. 416). - c) whether limit and control framework ensures availability of diversified funding structure (para. 414 f). - d) approach to developing relationships with funding providers to lower access reduction risk (para. 403 b). - e) approach to maintaining ongoing market presence and testing market access (para. 403 a). - On (b) guidelines require supervisors assess adequacy of institution’s liquidity buffer and counterbalancing capacity to meet liquidity needs (para. 388). - PRA expectations: - Firms to detail compliance in their ILAA/ILAAP submissions; supervisor will review ILAA/ILAAP and CA engagement consistent with PRA’s L-SREP approach as detailed in SS 24/15 section 3. - Once EBA ITS on AMM under CRR Art. 415(3)(b) adopted by the EC, supervisor will be able to monitor diversification of funding in part through the C.76.00 AMM return. - PRA consistent with EBA SREP guidelines. - Specific supervisory rules and tools: - PRA Rulebook, ILAA Rule 2.2: firms must hold liquidity resources containing an adequate buffer of high quality, unencumbered assets and maintain a prudent funding profile. - PRA Rulebook Rules 7, 8, and 10: manage funding needs, collateral and asset encumbrance to ensure timely use of assets in times of stress. - Rule 9: ensure access to funding adequately diversified by source and tenor. - SS 24/15 Para. 2.20: expectations on analysis of the ten key risk drivers mentioned in EC 2. - LCR requires firms to build liquidity buffers adequate to face imbalance between inflows and outflows in gravely stressed conditions over 30 days. - DA Art. 8(1): PRA may set requirements to enforce increased diversification of the HQLA buffer or restrict holdings of particular asset classes; under CRD Art. 103 PRA may restrict holdings if several firms exposed to common risk factors. - DA requires firms to regularly, and at least annually, monetize a sufficiently representative sample of their holdings of liquid assets. - PRA expects larger firms to consider absolute size of HQLA holdings and ability to monetize without compromising speed of disposal or price, and consider market and financial stability impacts. - Supervisor will monitor diversification of funding in part through C76.00 CM return, in addition to ILAAP documents. - The EBA’s ITS on AMM C76.00 return will allow supervisor to monitor diversification of funding. ### EC 6 — Contingency funding plans (CFPs) - EC 6 statement: - The supervisor determines that banks have robust liquidity contingency funding plans (CFPs) to handle liquidity problems. The CFP must be formally articulated, adequately documented and set out the bank’s strategy for addressing liquidity shortfalls in a range of stress environments without placing reliance on lender of last resort support. CFP must establish clear lines of responsibility, include clear communication plans (including communication with the supervisor) and be regularly tested and updated to ensure operational robustness. Supervisor assesses feasibility in light of bank’s risk profile and systemic importance and requires bank to address deficiencies. - Description and findings re EC 6: - Art. 86(10) and (11) CRD mandate competent authorities to ensure firms develop CFPs to address possible liquidity shortfalls which are tested at least annually and approved by senior management. - EBA SREP Guidelines (apply from January 1, 2016) recommend supervisors assess whether LCP: - specifies policies, procedures and action plans for responding to severe potential disruptions to funding ability (para. 417); - contains feasible actions relative to stress scenarios (para. 418); - has appropriate escalation and prioritization procedures detailing when and how actions can and should be activated (para. 419 a); - has adequate policies and procedures for communication within the institution and with external parties (para. 419 b); - appropriately addresses assumption regarding role of central bank funding in the institution’s LCP (para. 417 f). *International Monetary Fund — UNITED KINGDOM. Annex 1, liquidity risk-management framework, ILAAP/ILAA, EC 4, EC 5, EC 6, SS24/15 references and PRA Rulebook requirements.* ### Chapter 12 of the revised PRA Rulebook’s ILAA Section requires firms to develop an effective ### _cr16166 - Chapter 12 of the revised PRA Rulebook’s ILAA Section requires firms to develop an effective ### Liquidity Contingency Plans (LCP) and Contingency Funding Plans (CFP) - Chapter 12 of the revised PRA Rulebook’s ILAA Section requires firms to develop an effective LCP taking account the outcome of the stress tests. - Firms are required to test their LCP at least annually. - Further guidance for firms is provided in SS 18/13 with SS 24/15, Annex 1 recommending that firms cross reference the relevant section of the recovery and resolution plan in the ILAAP document. - Supervisor responsibilities and expectations: - The supervisor will comply with paras. 417 to 419 of the EBA SREP Guidelines and will ensure that compliance with the requirements of the revised PRA Rulebook Chapter 12 are addressed in the ILAAP document and through the CA engagement. - Review coverage will include, but not be limited to, ensuring the firm’s CFP is formally articulated, adequately documented, and sets out the bank’s strategy for addressing liquidity shortfalls in a range of stress environments reflecting the liquidity risk profile of the firm. - The actions outlined in the LCP should be in line with the firm’s overall risk strategy and liquidity risk tolerance. - The supervisor will assess whether the LCP establishes clear lines of responsibility, includes clear communication plans (including communication with the supervisor) and is regularly tested and updated to ensure it is operationally robust. - Joint assessment for recovery plans: - For reviewing recovery plans, supervisors and the supporting recovery and resolution team undertake a joint assessment of issues arising from the CFP/LCP set out in the firm’s recovery plan. - Supervisors and recovery and resolution experts review the stress scenarios in the recovery plan to identify whether or not liquidity recovery options generate sufficient benefit to the firm in the event a liquidity stress causes the firm to invoke their recovery plan. - L-SREP review: - For the LCP and CFP review for the L-SREP, supervisors, along with liquidity experts in the SRS’ teams will assess the CFP/LCP to review firms’ arrangements and how these are informed by the results of firms’ liquidity stress testing. ### Stress Testing: Rules, Expectations, and Use of Results - Rule and guidance references: - Chapter 11 of the PRA Rulebook’s ILAA Section outlines the PRA rules a firm must follow with regards to stress testing in line with the relevant requirements of CRD Art. 86. - The rules require firms to conduct stress tests on a regular basis (11.3), across institution-specific, market-wide, and combined alternative scenarios across different time periods (11.4). - Assumptions must be appropriate (11.5), reviewed by its management body (11.6), and the results used for risk-management purposes and the development of LCPs (11.7). - SS24/15, para. 2.18 to 2.22 sets the PRA expectation of the minimum considerations firms should undertake for a set of liquidity risk drivers in their stress testing program. - SS24/15, para. 2.23 to 2.24 set PRA expectations that firms will consider intraday risk within their stress testing program. - Supervisor expectations and EBA SREP alignment: - The supervisor requires banks to include a variety of short-term and protracted bank-specific and market-wide liquidity stress scenarios (individually and in combination), using conservative and regularly reviewed assumptions, into their stress testing programs for risk management purposes. - The supervisor determines that the results of the stress tests are used by the bank to adjust its liquidity risk management strategies, policies and positions and to develop effective CFPs. - Arts. 86(8), (9) and (10) CRD mandate competent authorities to ensure firms consider alternative scenarios on liquidity positions and risk mitigations at least annually, covering institution-specific, market-wide, and combined alternative scenarios across different time periods and varying degrees of stress; outcomes should inform development of effective LCPs. - The EBA SREP guidelines (para. 408, 410, 412, 413) recommend supervisors assess adequacy of liquidity-specific testing, consideration of short-term/prolonged and institution-specific/market-wide scenarios, conservative assumptions, regular review of assumptions/scenarios, and integration of outcomes into strategic planning and LCPs. - PRA expectations for ILAAP submissions: - The PRA expects firms to detail in their ILAAP submission their compliance with the rules and expectations detailed above. - The supervisor will ensure, through review of the ILAAP document and CA engagement consistent with the PRA’s approach to conducting an L-SREP as detailed in SS24/15 S3, that the firm uses the results of the stress tests to adjust risk-management strategies, policies and positions, and to develop effective LCPs. - Historical regime: - The previous PRA liquidity regime (BIPRU 12.4.10 to 12.4.16 and BIPRU 12.4.3) already stipulated requirements for CFPs, regular testing, update based on mandatory stress tests, governing body reporting/approval, inclusion of a variety of time horizons, and annual review of assumptions. ### Foreign Currency Liquidity (EC 8) - Supervisor requirements: - The supervisor identifies banks carrying out significant foreign currency liquidity transformation. - Where a bank’s foreign currency business is significant, or the bank has significant exposure in a given currency, the supervisor requires the bank to undertake separate analysis of its strategy and monitor liquidity needs separately for each significant currency. - This includes using stress testing to determine appropriateness of mismatches in that currency and, where appropriate, setting and regularly reviewing limits on the size of cash flow mismatches for foreign currencies in aggregate and for each significant currency individually. - The supervisor monitors the bank’s liquidity needs in each significant currency and evaluates the bank’s ability to transfer liquidity from one currency to another across jurisdictions and legal entities. - Legal and reporting requirements: - CRR Art. 415 (2) requires an institution to report LCR separately in the currencies in which it has more than 5 percent of the total liability or it has a significant branch in a MS using a different currency. - DA Art. 4 (5) requires institutions to also observe the LCR requirement in these currencies. - Art. 8(6) requires firms to ensure that the currency denomination of their liquid assets is consistent with the distribution by currency of their net liquidity outflows and grants competent authorities the power to restrict currency mismatches. - PRA Rulebook coverage: - The PRA Rulebook ILAA section Rules 3.1, 3.2, 5.2(3), 8, 11(5), 11(7) and 12.4 cover foreign currency liquidity transformation and significant currency exposures. - Rule 3.1: robust strategies, policies, processes, and systems to identify, measure, manage, and monitor liquidity and funding risks, including tailoring to currencies and legal entities. - Rule 8: actively manage liquidity risk exposures and related funding needs taking account of currencies and limitations to potential transfers of liquidity among entities, both within and outside the EEA. - Rule 5.2(3): measure, monitor, and deal with intraday liquidity risk for currencies with significant positions. - Rules 11(5) and 11(5)(2): stress test cross currency funding risk and report vulnerabilities and proposed mitigating actions to the management body. - SS24/15, para. 2.20 sets expectations on analysis of key risk drivers, particularly para. 2.20(iii), 2.20(vii), and 2.20(viii). - PRA powers and monitoring: - The PRA can currently set ILG by currency where a firm has significant (greater than 20 percent) liabilities in a particular currency. - The interim LCR reporting requirement will be on an all currency basis though DA Art. 8 (6) grants competent authorities the power to restrict currency mismatches. - When the EBA’s ITS on AMM under CRR Art. 415(3)(b) is adopted by the EC, the PRA will monitor currency mismatches in part through the C.67.00 and C71.00 AMM returns. - Transitional arrangements: during the transition between the BIPRU 12 regime and the EU LCR, submission of legacy PRA returns (FSA047 and FSA048) was maintained to allow monitoring of liquidity position in each significant currency of bank subsidiaries. - Noted shortcoming: - The PRA does not set an explicit rule requiring firms to regularly review the limits on the size of cash flow mismatches for foreign currency. ### Asset Encumbrance (AC1) - Supervisor requirements and expectations: - The supervisor determines that banks’ levels of encumbered balance-sheet assets are managed within acceptable limits to mitigate risks posed by excessive encumbrance on cost of funding and sustainability of long-term liquidity. - The supervisor requires banks to commit to adequate disclosure and to set appropriate limits to mitigate identified risks. - EBA and disclosure framework: - EBA SREP Guidelines recommend supervisors, when assessing risks to sustainability of funding profile from concentration in funding sources, take into account that asset encumbrance may adversely affect market appetite for unsecured debt (para. 396 b). - Following CRR Art. 443, the EBA published guidelines on disclosure of encumbered and unencumbered assets; guidelines published in June 2014 will be reviewed and form the basis for binding technical standards to be developed by 2016. - Guidelines recommend supervisors assess whether the limit and control framework helps ensure availability of sufficient and accessible liquid assets (para. 414 f). - PRA rules and expectations: - Rule 3.4 of the PRA Rulebook’s ILAA section requires firms to have risk-management policies to define their approach to asset encumbrance, and procedures and controls to identify, monitor, and manage collateral management and asset encumbrance risks. - Chapter 10 details PRA rules on management of asset encumbrance: firms must actively manage encumbrance including amount of unencumbered assets available in stress and impediments to encumbering assets in stress. - Firms must actively manage encumbrance proportionate to business model, funding markets, and macroeconomic situation, with the management body informed in a timely manner of appropriate detail on encumbrance levels and credit quality. - The PRA expects firms to detail compliance in their ILAAP submission; supervisors will ensure levels of unencumbered assets are managed within acceptable limits via ILAAP review and CA engagement. - PRA transition and monitoring: - The PRA’s approach to asset encumbrance supervision will be further detailed in L-SREP guidelines effective October 1, 2015, including metrics quality, deterrence to potential investors, and granularity of limits to ensure sufficient free assets are available to fund previously unsecured funding in stress. - The PRA will monitor asset encumbrance levels through submissions aligned with EBA published guidelines on reporting of asset encumbrance. - Historical requirements: - Previous PRA regime (BIPRU 12.3.33, 12.3.34, 12.3.22, 12.3.23) required active management of encumbrance, distinction of unencumbered assets at all times including in stress, and understanding impediments to encumbering assets in stress. ### Assessment of Principle 24 and Overall Observations - Assessment outcome: - Assessment of Principle 24: Largely Compliant. - Key observations: - The mission previously observed that the new comprehensive liquidity regimen and supervisory program put in place would be a strong base for U.K. supervisors to assess banks’ liquidity management strategies, including prudent policies and processes to identify, measure, monitor, and control liquidity risk. - Post-crisis evolution in the U.K. supervisory framework placed U.K. authorities at the front edge on liquidity risk supervision; the PRA has a liquidity risk framework that is overall robust, structured, and consistently implemented. - At the time of assessment the PRA was transitioning from BIPRU12 to the EU version of the LCR standard (October 2014). BIPRU12 was ‘switched off’ though part of preexistent reporting was provisionally maintained to allow the PRA adequate sight during transition. - Assessors were not positioned to verify implementation of the new regime but noted comprehensiveness of rules (sometimes beyond EBA guidelines) and consistent implementation before and after the regime through analysis of ILAAP and supervisory documents. - No substantial deviations from Principle 24 requirements in the PRA framework for liquidity risk were identified. - Notable exception: - The main notable exception is the LCR requirement: the LCR adopted in the EU has elements less stringent than the Basel agreed rule, most notably a wider definition of HQLA. Given EC 1 states that for internationally active banks the prescribed liquidity requirement should not be lower than the applicable Basel standard, the EU regulatory framework’s compliance with EC 1 is problematic. - In 2014 the EBA performed a comparison between the Basel and EU versions of the LCR and found that the EU implementation of LCR determined an average increase of banks' LCR by *Source: _cr16166 - Chapter 12 of the revised PRA Rulebook’s ILAA Section requires firms to develop an effective* ### 13.9 percent, with a significant dispersion of results. It also stated that "large, internationally ### _cr16166 - 13.9 percent, with a significant dispersion of results. It also stated that "large, internationally ### Principle 25 — Operational risk - Overall assessment: Compliant. - Findings on liquidity framework context: - The PRA set the initial LCR requirement as of October 1, 2015 at 80 percent, which is greater than the 60 percent mandated by the EU regulatory standard and will ensure a higher LCR floor for the U.K. banks until January 2017. - The PRA maintains that most of the increase in LCR ratios was driven by the assumption made regarding level 2B assets. - Because the EU LCR is less stringent in important respects than the applicable Basel standard, the assessors deem the overall U.K. supervisory framework for liquidity risk largely compliant. - EC 1 (legal/regulatory requirements): - Banks must comply with CRD IV/CRR standards for operational risk, and Section 10.1 of the ICAAP rules in the PRA Rulebook requires policies/processes to evaluate and manage operational risk (including model risk and low-frequency, high severity events (Art. 85(1) of the CRD)). - PRA requires Category 1 firms to have operational risk-management frameworks commensurate with scale, nature and complexity and meeting qualitative standards applicable to AMA. - Supervisory approach and implementation (EC 2–EC 7): - Board oversight: PRA Handbook SYS21.1.2 specifies CRO reporting to governing body on exposures relative to risk appetite; Board approval of risk appetite is expected though not a formal requirement. - Supervisory verification: supervisors assess implementation via management reporting, governance committee minutes, discussions with CRO and Internal Audit. - Deep-dives: PRA aims to complete about 10-12 deep-dives in aggregate related to operational risk across all Category 1 firms each year; often two deep-dives in aggregate per year across all Category 2 firms each year. For Category 1 firms, usually about two to four aspects of operational risk are evaluated through deep-dives, implying comprehensive assessment over about three years per firm. - Evolution: PRA moved from high-level framework reviews to targeted reviews of individual types of operational risk (internal memos cited: December 17, 2014; March 19, 2014). - Business continuity and DR (EC 4): firms must comply with EBA guidance on SREP and PRA Rulebook SYSC 4.1.6 and SYSC 4.1.7; PRA reviewed offshore processing center arrangements across major 12 firms in 2014; supervisors review Category 1–4 recovery and resolution plan documents annually. - IT and data (EC 5–EC 6): Fundamental Rule 5 and FCA SYSC 3.1.1 require effective risk-management systems and controls; CRR Art. 320 and 321 apply for standardized and AMA firms; SRS periodically assesses effectiveness of operational risk reporting. - Reporting to supervisor (EC 7): Fundamental Rule 7 requires openness; since start of 2015 PRA requires Category 1 firms to provide quarterly operational risk data through the FDSF (including loss events, top risks, scenarios, emerging risks). SRS presents overviews to supervisory teams every six months. - Outsourcing (EC 8): SYSC 4.1.1R requires effective processes for identifying/managing outsourcing risks; SYSC 8.1.8(9)R requires access to data and premises of service provider for PRA and competent authorities. - Additional criteria AC1 (common points of exposure): - Market-wide exercises: 2013 cybersecurity exercise across twenty firms including six FMIs; BoE launched CBEST in June 2014 to conduct penetration tests and expected to report in summer of 2016. - Supervisory comments and observations: - PRA has customized operational risk reviews for largest firms; strategic use of several deep-dives spread over three years may provide confidence but uncertainty remains whether pace is sufficient given rapid innovations in operational risk management. - PRA developed operational risk dashboards comparing firms’ self-assessments with PRA supervisors’ views; currently three dashboards for (i) Category 1 U.K. international firms; (ii) Category 1 international Banks; and (3) Category 1 U.K. domestic firms. - Operational risk specialists are expected to allocate around 10 percent of their time to ongoing contacts with firms’ operational risk functions in Category 2 firms. - PRA increased allocation of operational risk and IT risk resources to smaller banks from less than 10 percent in 2014 to around 20 percent in the second part of 2015. - Recommendation: supervisors may wish to consider ways to monitor and evaluate with potentially greater frequency the most important advances in operational risk-management and look horizontally across major firms to ensure they keep pace. ### Principle 26 — Internal control and audit - Overall assessment: Compliant. - EC 1 (internal control framework): - GOR 2.1–2.3 of the PRA Rulebook implements CRD Art. 74.1 and requires robust governance arrangements, clear organizational structure, effective processes to identify/manage/report risks, and internal control mechanisms including sound administrative and accounting procedures and effective control and safeguard arrangements for information processing systems. - GOR 2.7: firms must establish accounting policies/procedures to deliver timely financial reports reflecting a true and fair view on request by the PRA. - SKE rules require arrangements concerning segregation of duties and prevention of conflicts of interest. - EC 2 (balance of skills/resources in control functions): - SKE part of PRA Rulebook sets requirements to ensure staff have appropriate skills, knowledge and experience (SKE 2.1); employees not given conflicting multiple tasks (SKE 3.1). - PRA meets regularly with heads/chairs of audit, compliance, risk committees for Category 1 firms more than once per year; annual meetings for lower categories. - Expectation that independent control functions (risk, finance, compliance, internal audit) are in place and have access to Board and committees. - EC 3–EC 5 (compliance and internal audit functions): - Compliance and Internal Audit parts of PRA Rulebook require a permanent, effective and independent compliance function (2.3–2.4) with necessary authority, resources and expertise. - Internal audit: Compliance and Internal Audit 3.1 requires a separate and independent internal audit function where appropriate and proportionate; internal audit must implement an audit plan and verify compliance with recommendations. - Internal audit is part of systems and control controlled function (CF 28) and the head of internal audit is a SIF requiring PRA approval. - PRA assesses internal audit effectiveness through ongoing supervision, review of internal audit reports and audit committee materials, and meetings with heads of internal audit and audit committee chairs (Category 1 and 2 at least annually). - Outsourcing of internal audit: outsourcing rules require firms to retain necessary expertise to supervise outsourced functions (Outsourcing part 2.6 (3)). - Supervisory powers and practice: - PRA can require skilled person reports (FSMA S166) to cover effectiveness of internal audit if needed. - Supervisory comments: - PRA’s supervisory approach expects separate risk-management and control functions proportionate to the firm’s nature/scale/complexity. - Transition from APR to SMR (came into force March 2016) will be evaluated in the next FSAP regarding fit-and-proper individuals and accountability. - For smaller firms, PRA may have fewer touch points beyond PSM and midyear review; supervisors rely on firms’ compliance with fundamental rules and threshold conditions. ### Principle 27 — Financial reporting and external audit - Overall assessment: Compliant. - EC 1–EC 3 (financial statements, auditor opinion, valuation practices): - Regulation 2002/1606 (Arts. 4 and 5) requires IFRS for consolidated financial statements of EU listed companies; U.K. credit institutions prepare statements in IFRS as endorsed in EU, FRS 101, or FRS 102. - Arts. 74 and 88 of the CRD require institutions to have robust governance including sound accounting practices. - U.K. law (Companies Act 2006, BSA 1986, Friendly Societies Act 1968) requires maintenance of books/records and audited financial statements. - Auditing standards: audits conducted in accordance with ISAs (U.K. and Ireland) issued by the FRC; Practice Notes PN 19 (banks and building societies) and PN 27 (credit unions) provide guidance. - Valuation: Art. 24 and Art. 105 of the CRR require valuations in accordance with applicable accounting framework and systems/controls for prudent valuation adjustments; EBA draft RTS on prudent valuation exists and PRA expects firms to apply it already. - PRA supervisors assess governance, independent verification/validation, and prudent valuation adjustments, focusing on major trading firms and benchmarking against EBA draft RTS. - EC 4–EC 7 (audit scope, expertise, rotation): - Audit scope set by law and ISAs; ISAs require risk and materiality based approach (ISA 315, 330, 540 referenced). - PRA meets regularly with external auditors of Category 1 firms and liaises with auditors of other credit institutions; PRA can require skilled person work under S166/S167 of FSMA. - PRA has powers under S55M of FSMA to impose requirements that can result in rescinding or terminating an auditor appointment; PRA must be notified of new appointments (Part Auditors 2.1(5)). - PRA can disqualify/fine/publicly censure an audit firm under S345A of FSMA. - Audit partner rotation: FRC’s ethical standards require rotation of audit engagement partner at least every five years for listed companies (with exceptions up to seven years under safeguards); proposed EU Audit Directive implementation expected to require change of external auditor every ten years (with tender options to extend to 20 years) from June 2016. - EC 8–EC 9 (supervisor engagement with auditors and duty to report): - FSMA S339 requires at least annual bilateral meetings between external auditors and supervisors of largest U.K. credit institutions; PRA Code mandates at least annual bilaterals for largest firms and often more frequent meetings. - PRA and FRC engage in twice-yearly bilateral meetings with big audit firms; PRA reviews external auditors’ management letters and audit committee material. - Duty to report: CRD Art. 63(1) establishes duty to report material breaches; FSMA 2000 (communications by auditors) regulations 2001 impose legal duty to report to the PRA certain contraventions; FSMA S 342(3) and S343(5) provide protection for auditors reporting to PRA in good faith. - Additional criteria AC1 (access to working papers): - PRA does not have a general power to access auditors’ working papers unless issued to the client as reports; S165 of FSMA gives PRA access to supervised firm’s documents including reports from the auditor to the firm. - FRC’s audit quality review team (AQRT) has right of access to auditors’ working papers for public interest entity audits; PRA works closely with FRC and can notify recognized supervisory bodies for other audits. - PRA proposed CP 8/15 (Feb 2015) to require external auditors to prepare written reports to the PRA on specified matters; PRA considering comments with decision expected later in 2015. - Supervisory comments: - Legal framework requires financial statements and adequate records; FCA enforces listed institutions’ reporting; PRA reviews firms’ ability to produce adequate and reliable data. - Lack of formal PRA power to access auditors’ working papers mitigated by close collaboration with FRC; deficiency considered immaterial. - Expectation of increased auditor supervision and interaction; forthcoming EU requirements on audit rotation noted. ### Principle 28 — Disclosure and transparency - Overall assessment: Compliant. - EC 1–EC 3 (disclosure requirements and scope): - Three broad disclosure sources: 1. CRR Pillar III reports (Art. 431) including EBA binding technical standards for templates/instructions (own funds, leverage ratio, CCB, G-SIB indicators, encumbered/unencumbered assets). 2. Accounting standards and national legislation (Companies Act). 3. Transparency Directive 2004/109 and Markets Abuse Directive 2003/6/EC. - CA2006 and BSA specify form/content of financial statements; listed firms required to prepare consolidated financial statements in accordance with IFRS. - Disclosures must be material, reliable and include comparative information. - EC 2 (qualitative and quantitative disclosures): - IFRS and FRS 102 require qualitative and quantitative disclosures on financial performance, position, risk exposures, and risk-management policies (IFRS 7, FRS 102 S11/S34). - Related party disclosures required (IAS 24, FRS 102.33.5–14, CA2006 sections 409/401, CAR Schedules, BSA Schedules). - PRA supports voluntary disclosure initiatives; seven of largest 21 banks voluntarily report under British Bankers Association Code for Financial Reporting Disclosure. - FPC recommended full implementation of Enhanced Disclosure Task Force (2012); compliance deemed sufficient for FPC to declare implementation. - EC 4 (enforcement of disclosure standards): - EBA benchmarking and Pillar 3 reviews assist competent authorities; PRA participates in EBA-led assessments. - FRRP (part of FRC) ensures annual accounts of public companies and large private companies comply with CA2006/BAS; can ask firms to correct or require remedial action. - PRA and FRC MoU for cooperation and information exchange. - EC 5 (system-wide publications): - FPC required to publish Financial Stability Report (FSR) twice per year covering aggregate capital ratios, balance sheet composition and related data. - BoE published CST results in December 2014 including projected firm-level CET1 ratios and aggregate projected capital ratios; BoE publishes a range of monetary and financial statistics. - Prior recommendation to publish non-confidential firm-level prudential returns remains; BoE intends beginning Q4 2015 to publish quarterly selected aggregate regulatory data from firms’ COREP submissions. - Additional criteria AC1 (period-average exposures and disclosures over reporting period): - CRR and IFRS include requirements or guidance for using average or median values where end-period values are unrepresentative (examples: Art. 42 C) exposures after accounting offsets; Art. 449 n) iv) securitization activity; Art. 443 encumbered assets median values; IFRS 7.IG.20 guidance on highest/lowest/average exposures). - Draft EBA ITS on leverage ratios requires disclosure as simple arithmetic mean of monthly leverage ratios over a quarter. - Supervisory comments: - Combined CRR, U.K. financial reporting guidelines and audit frameworks support accessible and fair consolidated/solo reporting. - Some EU rule changes reduce mandatory quarterly financial statements to semi-annual; most Category 1 firms expect to continue quarterly voluntarily. - Recommendation repeated: U.K. authorities should continue to consider publishing nonconfidential firm-level prudential returns (balance sheet/income, loan/investment sectors, asset quality, funding and capital structure, off-balance sheet exposures). - Benchmarking exercises and increased supervisory engagement with external auditors (Category 1 and 2 supervisors to meet at least once per year with external auditor and one additional meeting per year around annual audit) noted. ### Principle 29 — Abuse of financial services (AML/CFT) - EC 1 (legal/regulatory supervisory duties): - FCA is primary U.K. supervisor for combating abuse of financial services; FSMA 2000 sets FCA operational objective to protect/enhance integrity of U.K. financial system (S1B(3)(b) and S1D(2)(b)). - FCA has power to make rules, supervise compliance, and enforce breaches; supervises firms subject to MLR 2007. FCA estimates 15,000 firms subject to MLR, of which 900 are deposit-taking institutions. - FCA provides guidance (e.g., “financial crime guide: a guide for firms”) and operates integrated and dedicated financial crime supervision strategies. - EC 2 (bank policies/processes and supervisory approach): - FCA categorizes firms by perceived financial crime risk; categories not strictly size-based. - New authorizations include review of AML policies; applications assessed against Threshold Conditions including AML/compliance. - Supervision assesses effectiveness in practice: culture, governance, oversight, training, escalation criteria. - High-risk firms: SAMLP assessments on a four-year rolling cycle; onsite portion lasts about three months with detailed testing/interviews (includes operations of U.K. incorporated banks outside EEA). - Next-highest risk firms: site visits on a two-year cycle, two to four days. - Lower-risk firms: thematic reviews and responsive/event-driven supervision; the supervisory approach to lower-risk firms is relatively new (first adopted in 2014) and coverage data over multi-year periods is limited. - EC 3 (reporting to FIU and to supervisor when material to bank safety/soundness): - FCA principles require firms to deal with regulators openly; FCA rules require reporting of “significant fraud” to appropriate regulator immediately, considering size of monetary loss or potential monetary loss. - PRA Fundamental Rule 7 requires firms to disclose to PRA anything of which PRA would reasonably expect notice; scope is wide enough to cover reporting of fraud material to safety, soundness or reputation. - SARs statistics: over 350,000 suspicious activity reports filed with National Crime Agency from 2013-2014; about 290,000 filed by retail banks and 23 thousand filed by building societies. - National Risk Assessment noted complaints about SAR filing process (need to overhaul IT and concerns about overly formulaic reporting); authorities had not finished public consultation on measures at time of writing. - EC 4 (supervisor sharing information with FIU/other authorities): - MLR requires FCA and other AML supervisory authorities to promptly inform the National Crime Agency if they know or suspect money laundering or terrorist financing. - BoE policy: meet legal obligations under POCA 2002, MLR, and Terrorism Act 2000; BoE appointed an MLRO. - FCA MLRO function: FCA appointed MLRO with two deputies; FCA ran awareness program to improve FCA-wide suspicious activity reporting and mandatory financial crime training modules for supervisors. - EC 5 (CDD policies and program elements): - MLR prohibits firms from establishing relationships or carrying out transactions if unable to apply CDD measures. - CDD program essential elements described: customer acceptance policy; identification/verification including beneficial ownership; ongoing monitoring; enhanced due diligence for high-risk accounts and PEPs; recordkeeping with at least five year retention. - Supervisory observations and coverage gaps: - The FCA’s intensive supervisory approach to highest-risk firms is robust; coverage of lower-risk firms relies on thematic reviews, complaints, whistleblowers, and event-driven exercises. - The relative newness of the lower-risk supervisory approach and lack of multi-year coverage data leave questions about adequacy of coverage for lower-risk firms that assessors and authorities should address in the next FSAP cycle. *Italic: Extracted from the IMF assessment contained in the provided source content.* ### part 2 and part 3 of the legislation. The MLR require banks to identify and verify the ### _cr16166 - part 2 and part 3 of the legislation. The MLR require banks to identify and verify the customer’s identity, identify any beneficial owner who may not be the customer, obtain information on the purpose and intended nature, conduct on-going monitoring of the business relationship, and ensure that documents are kept up to date, among other responsibilities. ### MLR requirements and bank responsibilities - Banks must identify and verify the customer’s identity, identify any beneficial owner who may not be the customer, obtain information on the purpose and intended nature of the business relationship, conduct on-going monitoring of the business relationship, and ensure that documents are kept up to date, among other responsibilities. - Banks must establish and maintain “appropriate and risk-sensitive” policies and procedures to identify and scrutinize: - complex or unusually large transactions; - unusual patterns of transactions which have no apparent economic or visible legal purpose; - any other activity that a bank regards as particularly likely to be related to money laundering or terrorist financing. - A senior manager at an appropriate level of authority must approve the initiation of a business relationship with a politically exposed person. - Certain senior managers can become criminally liable where the bank commits an offense under the MLR. - Under the FCA’s existing rules, a director or senior manager is held personally responsible for ensuring that the bank has effective AML systems and controls in place. - Banks must retain copies of the evidence of the customer’s identity for five years after a business relationship ends. ### Enhanced due diligence and correspondent banking (EC 6) - The MLR require banks that have, or propose to enter into, a correspondent banking relationship to apply enhanced due diligence measures to mitigate money laundering and terrorist financing risk. - Banks are required to gather sufficient information from correspondents to understand the nature of their business and assess the respondent’s AML and terrorist financing controls. - The MLR prohibit banks from entering into, or continuing, a correspondent banking relationship with a shell bank or a bank that is known to permit its accounts to be used by a shell bank, and require appropriate measures to prevent this. ### Supervisory approach to AML/CFT compliance testing - The FCA applies a risk-based supervisory approach, with more intrusive testing concentrated on the highest risk firms: - The most intrusive approach is limited to the highest risk firms, especially those in the top risk category, and to a lesser degree firms in the second highest risk category. - For firms in the lower risk categories, the FCA relies on thematic reviews, monitoring of regulatory returns, complaints, whistleblowers, media reports, law enforcement and other partners, and “event-driven” supervisory exercises when potential AML issues come to light or risks crystallize. - Supervisory activities described: - systematic AML Program for highest risk firms—detailed testing of firms’ AML controls in their U.K. operations and, where relevant, important or high risk overseas operations; - firms in the second highest risk category receive two to four day visits from FCA supervisors every two years; - firms in the lower risk categories are monitored by risk alerts, event-driven supervision, and thematic sector-wide reviews. ### Controls, internal audit, compliance officers, and staff policies (EC 7, EC 9, EC 10, EC 11) - The MLR require banks to establish and maintain appropriate and risk-sensitive policies and procedures relating to internal controls to prevent activities related to money laundering and terrorist financing. - FSMA 2000 and FCA handbooks: - FSMA gives the FCA power to compel information or documentation reasonably required (S165). - FSMA 2000 sets out duties and powers of auditors and their authority to provide information to the FCA (S340–346); FSMA 2000 also gives the FCA the power to require banks to appoint an auditor and sets out qualifications and rights and duties of the auditor. - The FCA’s “senior management arrangement, systems, and controls Handbook” requires banks to carry out regular assessments of the adequacy of their AML systems and controls. - Banks must appoint a MLR officer, who may also be the nominated officer required under POCA; the nominated officer receives internal reports under POCA and the Terrorism Act 2000. The FCA requires the officer to have a level of authority and independence sufficient to carry out his/her functions effectively. - Hiring and training requirements: - Banks are required to put in place systems and controls that promote high ethical and professional standards when hiring staff, including adequate employee vetting procedures as reflected in the FCA’s Threshold Conditions. - The MLR require that banks make their staff aware of the law on money laundering and terrorist financing and regularly provide training in how to recognize and deal with transactions and other activities that may be related to money laundering or terrorist financing. - Reporting protections: - POCA 2002 allows banks to disclose information that meets defined criteria; the Serious Crime Act 2015 amended POCA and introduced a specific exemption from civil liability for money laundering disclosures. - The Terrorism Act 2000 and the Data Protection Act 1998 provide similar exemptions regarding relevant disclosures. ### Supervisory powers and cooperation (EC 8, EC 12) - The FCA’s powers under FSMA include: - compel information or documentation (S165); - vary or cancel a bank’s permissions to carry on regulated activities for various reasons, including failure to satisfy Threshold Conditions or to advance FCA objectives; - issue private censures and impose unlimited financial penalties. - FSMA 2000 establishes a duty on the FCA to take steps appropriate to cooperate with other persons (in the United Kingdom or elsewhere) with similar functions in relation to the prevention or detection of financial crime, and permits disclosure to equivalent supervisory authorities to enable or assist them to discharge their supervisory functions. - The FCA provides the secretariat for the financial crime information network, a forum for intelligence-sharing on financial crime issues with 110 representatives from central government, law enforcement agencies, and regulatory bodies around the world. ### Supervisory resources, expertise, and outreach (EC 13) - The FCA maintains in-house specialist expertise: - 23 staff serving on its specialist intelligence services team supporting fitness and propriety assessments; - financial crime department consists of 42 staff, which includes a financial crime specialist supervision team (27 staff) and the financial crime policy and risk team (9 staff). - All supervisors are required to complete compulsory financial crime online training, supplemented with targeted training sessions and wider briefings. - FCA outreach includes publishing thematic reviews on AML and financial abuse issues, participation in industry conferences, relationship managers for higher risk firms, publication of “financial crime: a guide for firms,” webinars, and speeches. ### Assessment of Principle 29 — Findings and concerns - Assessment: Largely Compliant. - Observations and findings: - U.K. supervisors have an appropriate legal framework and appropriate policies to oversee regulated firms’ compliance with AML/CFT laws and regulations. - Questions remain about the depth and frequency of supervisory coverage across all supervised firms—particularly whether sufficient testing is done to ensure policies, procedures, controls, and training are developed and implemented by all deposit-takers and not solely the highest risk firms. - The FCA segregated supervised firms into categories in 2014 to align monitoring with assessed risk: - 14 investment banks and retail banks identified as being in the highest risk category receive the greatest degree of supervisory scrutiny, including the systematic AML Program. - 75 firms of varying size (63 of which are banks) are in the second highest risk group; these firms are subject to a visit of two to four days every two years, led by three to four specialists who will review 20–25 customer files representing a mix of high risk customers plus a random sample. - The majority of banking organizations are in the lower risk categories and are subject mainly to thematic reviews, event-driven supervision, and monitoring of regulatory returns and external intelligence (whistleblowers, media, law enforcement, other partners). - Thematic reviews typically involve two to three day visits to a sample of 20–30 firms to evaluate a particular risk-related issue; published thematic reviews have identified a range of weaknesses in compliance, including some “particularly serious” requiring supervisory action. - Key concern: - The limited firm-specific evaluation and testing for the majority of lower risk firms raises the question of whether supervisors are ensuring that all banks effectively implement AML/CFT obligations (ECs 2, 5, 6, 7, 9, 10). - U.K. supervisors should consider additional means to ensure that firms assessed as lower risk are effectively managing risks against financial abuse; prior FSAP concerns about “pockets of financial activities that receive less than adequate supervision” remain relevant. *Source: IMF staff assessment text contained in the provided content unit.* ### 1. Responsibilities, objectives, and ### 1. Responsibilities, objectives, and ### Key findings on regulatory architecture and prudential focus - The new financial regulatory architecture addresses most findings of the previous FSAP: unclear and ultimately unbalanced allocation of effort and resources between the prudential and conduct macro-objectives; the reference to principles of ‘good regulation’ potentially weakening the supervisor’s focus on prudential issues; the lack of powers over parent undertakings. - The new macroprudential framework, centered on the FPC, has yet to reach its operating speed and it is still unclear, at this stage, whether it could divert resources from effective core supervision. ### Independence, accountability, resourcing, and legal protection for supervisors (CP 2) - Grade: LC - Considering the size, complexity and systemic footprint of the U.K. financial system, supervisory resources, in their current configuration, might be overstretched, potentially weakening the supervisory action. ### Cooperation and collaboration (CP 3) - Grade: C - Domestic institutional arrangements promote cooperation among domestic authorities. - International cooperation (both bilateral and multilateral) appears well established and evolving. ### Permissible activities and licensing (CP 4–6) - CP 4 Grade: C - The name “bank” is not defined in U.K. laws, but use of this name and the related concept of “building society” are strictly controlled through legislation and the PRA’s and FCA’s rules. - Accepting deposits is clearly identified as an activity requiring authorization, and only firms authorized to accept deposits may use the name “bank” or “building society.” - CP 5 Grade: C - Through application of the U.K.’s “Threshold Conditions,” the U.K.’s licensing criteria appears to ensure that a firm once authorized can be supervised effectively. - CP 6 Grade: C - While neither the EBA nor the U.K. supervisors have issued guidance regarding ultimate beneficial owners, the EBA and U.K. supervisory agencies reference requirements regarding major shareholders or any entity or individual who is to become a shareholder, which would include ultimate beneficial owners. - Consequently, beneficial owners would be subject to scrutiny similar to other shareholders in evaluations regarding the transfer of significant ownership. ### Major acquisitions and supervisory approach (CP 7–9) - CP 7 Grade: C - U.K. legislation does not define ‘major acquisition,’ but notification requirements create an expansive definition covering any proposed business expansion with a potentially significant impact on the firm’s risk profile, resources, capital adequacy or solvency. - U.K. authorities have powers to approve or reject major acquisitions that raise supervisory concerns. - CP 8 Grade: LC - Important progress toward a more rigorous, “hands-on” approach, especially for the most systemically important firms. - Opportunities remain to undertake more testing and probing, even in the largest firms. Offsite monitoring remains the primary means for less systemically important firms. - CP 9 Grade: LC - Supervisors apply a range of tools more actively for systemically important firms, but reliance on skilled persons and “deep dives” still does not achieve the benefits of onsite supervision including transaction testing and greater probing. ### Supervisory reporting and corrective powers (CP 10–11) - CP 10 Grade: C - Thanks to the EU-harmonized reporting framework, a wide range of data is collected; degree of detail generally adequate, though opportunities remain to develop better data on credit exposures and performance. - CP 11 Grade: C - Creation of the PRA’s proactive intervention framework (PIF), with five explicitly defined stages, provides supervisors with a more formal early intervention process and tools. ### Group supervision and home-host relationships (CP 12–13) - CP 12 Grade: C - U.K. authorities supervise banking groups on a consolidated basis; prudential standards imposed at different consolidation levels; supervisors analyze consolidated and solo data. - CP 13 Grade: C - U.K. authorities regularly share information and cooperate with foreign authorities; foreign banks in the U.K. are subject to same standards as domestic banks. ### Governance, risk management, and model oversight (CP 14–16) - CP 14 Grade: LC - Weaknesses in APR may be addressed through the new SMR to identify individual accountability. - Corporate governance reviews have focused on Category 1 firms; PRA released guidance to evaluate governance across all supervised firms. - CP 15 Grade: C - PRA has a comprehensive framework for supervision of banks’ risk-management systems; introduction of the CST for major U.K. banks raises risk-management standards. - Smaller institutions receive less attention and are rarely examined by risk specialists. - CP 16 Grade: LC - Current model change review policy does not ensure adequate scrutiny of internal model banks’ capital requirement calculations. - Some elements of non-compliance of EU legislation/regulation on capital with the Basel standard (as revealed by the December 2014 RCAP) are relevant for the U.K., though U.K. implementation is more conservative for other aspects. ### Credit, problem assets, concentration, related parties, and country risk (CP 17–21) - CP 17 Grade: LC - Lack of explicit supervisory guidance on credit risk management for the generality of banks. - CP 18 Grade: LC - AQRs at nonsystemic banks are too sporadic to ensure adequate scrutiny of asset classification and provisioning. - CP 19 Grade: C - EU framework for LE not aligned with the Basel standard; misalignment will take effect only from January 2019. - Overall robust framework for concentration risk, advanced for credit risk concentration under Pillar 2; less structured but effective for other forms. - CP 20 Grade: C - PRA Rulebook complies with BCP definitions; aggregate related-party transactions obtained semi-annually via FINREP. Non-FINREP banks provide this information annually, which may not ensure adequate supervision at medium and small banks. - CP 21 Grade: C - PRA engages more on country and transfer risk with the largest firms; more work could be done for smaller firms. ### Market, interest-rate, liquidity, operational risk, and controls (CP 22–26) - CP 22 Grade: C - PRA periodically reviews banks’ market risk-management processes against risk profile and capital strength. - CP 23 Grade: C - Continued weaknesses in measures and comparability of IRRBB across firms; forthcoming EU and BCBS changes may remediate prior suggestions. - CP 24 Grade: LC - PRA has a robust liquidity risk framework consistently implemented. The EU Regulation on liquidity is not aligned with the Basel standard. - CP 25 Grade: C - Supervisors customize operational reviews for largest firms; strategic use of several deep dives over three years for largest firms may raise questions about review pace. - CP 26 Grade: C - Engagement with control functions and auditors strengthened for largest firms; fewer touch points in smaller firms. ### Reporting, transparency, financial crime (CP 27–29) - CP 27 Grade: C - Law requires banks to prepare financial statements and maintain books and records. FCA enforces listed banks’ requirements; PRA reviews firms’ ability to produce adequate data. - Lack of formal powers to access auditors’ working papers mitigated by PRA collaboration with FRC. - CP 28 Grade: C - CRR, U.K. financial reporting guidelines and audit frameworks help ensure accessible and fair reporting on consolidated and solo basis. - CP 29 Grade: LC - Testing of management and control of exposure to financial crime and abuse is limited; pockets of financial activities receive less than adequate supervision. ### Recommended Actions to improve compliance with the BCP (summary) - Principle 1: PRA to incorporate into its approach to risk an explicit consideration of reputational risk, including related to the possible failure of nonsystemic banks. - Principle 2: Reevaluate the adequacy of PRA resources and of its operating model for the overall effectiveness of its supervisory activity. - Principle 8: Evaluate adequacy of supervision, especially of less systemically important firms, and whether current arrangements provide sufficient testing to ensure all firms operate safely, soundly and in compliance. - Principle 9: Seek more ways to validate and probe statements in banks. Evaluate whether “deep-dives” provide sufficient ongoing insight into major firms, and whether key skills need to be developed within staff. - Principle 14: Promote efforts to make managers in financial institutions more accountable; ensure corporate governance is appropriately supervised beyond the largest firms, including via recently released supervisory guidance. - Principle 16: Revise the model change review policy to ensure reliability of large banks’ capital requirement calculations is adequately scrutinized. - Principle 17: Provide more explicit guidance on supervisors’ expectations to the generality of banks. Consider establishing regular access to (and elaborations from) broad databases with loan level information. - Principle 18: Devise operational enhancements to secure a minimum level of direct scrutiny of asset classification and provisioning for nonsystemic banks. Require banks to set and periodically review an appropriate threshold for significant exposures. - Principle 19: Require banks to set thresholds for acceptable concentrations of risk. - Principle 20: Introduce regular infra-annual reporting of transactions with related parties for non-FINREP banks. Ensure regular monitoring of compliance with related-party rules for all banks. - Principle 21: Consider how to mitigate risks of missing issues in mid and small banks. - Principle 24: Continue to promote closer alignment of the EU regulatory framework with international standards. - Principle 25: Evaluate assumptions underlying deployment of SRS with regard to operational risk to ensure all firms, not solely systemically important ones, manage this risk appropriately. - Principle 29: Propose stronger and more proactive backstops for evaluating banks in the lowest risk categories more frequently to assess quality of controls and risk-management to avoid exposures to financial crime. ### Authorities’ response (summary) - Paragraph 78: U.K. authorities welcome and support the IMF’s comprehensive review and acknowledge significant progress since the last FSAP in 2011 through adoption of a more rigorous, hands-on and systemically focused approach. - Paragraph 79: The U.K. authorities’ ambition is for the U.K. financial services sector to be the best regulated in the world, aligning competitive and innovative markets of unquestioned integrity with the highest standards of conduct. Steps taken include: - i. continuing to be a leading advocate for tough capital and leverage requirements and liquidity standards; - ii. introducing a robust resolution regime and adopting total loss absorbency standards, a bail in tool and structural reform of the banking system; - iii. putting in place the Senior Managers and Certification Regime to ensure strong governance, better accountability of senior executives and higher standards of conduct in the banking sector; - iv. ensuring better alignment of financial incentives of senior risk takers with the longer term financial soundness of their firms; and - v. prioritizing a high degree of protection for consumers of financial services, improving standards across the industry and taking tough enforcement action against those who do not meet them. - Paragraph 80: The U.K.’s approach is centered on forward looking, judgment based prudential and conduct regulation; it does not seek a ‘zero failure’ regime but aims to ensure failures do not cause significant disruption to critical services or material negative impact on consumers. Resources are devoted where risk to financial stability is greatest; authorities consider current scrutiny of smaller firms appropriate, proportionate and in line with statutory objectives. - Paragraph 81: U.K. authorities welcome IMF findings on AML/CFT supervision and recognition of progress since 2011. - Paragraph 82: FCA’s AML supervision is risk-based and outcome focused; resources targeted at banks and activities giving rise to high money laundering risk. Supervision of lower risk banks via thematic reviews, event-driven supervision and alerts from domestic/overseas authorities is considered proportionate and effective. - Paragraph 83: U.K. authorities express support for the role of the FSAP and look forward to continuing dialogue with the IMF and global counterparts to improve stability and supervision of the global financial system. *IMF Financial Sector Assessment: Core Principles chapter (excerpts).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16166.pdf_