Following its previous work on a new “strong and simple” prudential framework for non-systemic UK banks and building societies (see our previous blog post for more information on the initial work), the Prudential Regulation Authority (PRA) published its consultation paper CP4/23 on 27 February 2023 setting out its proposals for the first substantive phase of the new simplified regime. CP4/23 calls for stakeholder views on “Liquidity and Disclosure requirements for Simpler-regime Firms”, making up part of the proposed reforms for the smallest UK firms.
The proposals in the consultation paper will be of interest not only to smaller firms which expect to fall within the scope of the definition of “simpler-regime firm” (see CP5/22), but also to a wider range of firms as the PRA intends to engage with relevant stakeholders during the course of this year on whether and how to build out further layers of the proposed “strong and simple” framework to larger firms that are not internationally active.
The broader context
The UK’s financial services regulators have launched a number of reviews of existing laws since Brexit as they seek to identify ways to enhance competition in the retail banking sector and encourage new entrants to the UK market. The proposals announced by PRA CEO, Sam Woods, in November 2020 on simplified prudential rules for small UK banks and building societies form part of those efforts and denote a key area of divergence from the existing prudential rules in Europe.
The objectives of these “strong and simple” reforms include simplifying the prudential framework for in-scope firms, whilst maintaining their resilience and the stability of the UK financial sector. The PRA’s intention is to tailor the relevant rules more precisely to the risks which in-scope firms face. The end goal is a set of layered regimes, with increasingly more sophisticated requirements to reflect the increasing size or complexity of in-scope firms.
Recognising that these proposals will take a while to draw up and implement, the PRA has first turned to developing a regime for the smallest UK banks and building societies, which likely struggle the most with the complexity and costs of the existing regime (referred to as the “simpler regime”).
The PRA’s work on this simpler regime is taking place in three parts. A consultation paper (CP5/22) on scope was released in April 2022. Consultation on substantive prudential rules is in turn split into two parts, with Phase 1 focused on non-capital related measures and Phase 2 on capital-related rules. This phased approach is designed to facilitate faster progress towards proportionality, as firms can start to benefit from simpler-regime efficiencies before the entire package of rules is finalised.
Other separate, but related regulatory work is taking place in parallel, including a consultation on the PRA’s implementation of Basel 3.1 standards of prudential regulation (CP16/22), which firms in the simpler regime would not be required to apply, and a consultation published alongside CP4/23 on remuneration rules applicable to small firms (CP5/23).
The consultation paper
CP4/23 kicks off Phase 1 of the PRA’s work on the substantive prudential rules for the simpler regime, focusing on non-capital related rules which will apply to the smallest banks and building societies (referred to as “simpler-regime firms”).
The simpler regime proposals set out in CP4/23 include the following measures, which simpler-regime firms could opt to apply:
- Net stable funding ratio (NSFR): The NSFR measures firms’ funding profile in relation to the composition of their assets. Certain simpler-regime firms could instead apply a “Retail Deposit Ratio” (RDR), a simpler measure based on data points which firms already gather as part of their liquidity reporting. Firms for which the RDR is at least 50% for four consecutive quarters could apply this measure instead of the NSFR. The PRA estimates that nearly all firms within the proposed scope of the regime would currently meet this RDR condition.
- Pillar 2 liquidity: The PRA considers that simpler-regime firms are generally unlikely to have material Pillar 2 risks as compared to their Pillar 1 risks. As such, it is proposing that Pillar 2 liquidity guidance only be applied to simpler-regime firms where this is justified based on a firm’s material idiosyncratic risks. A firm’s supervisor may choose to review the firm for Pillar 2 risks having reviewed the firm’s Internal Liquidity Adequacy Assessment Process (ILAAP) document. Additionally, simpler-regime firms could base their ILAAP document on a proposed simplified, more tailored template.
- Liquidity reporting: The additional liquidity monitoring metric (ALMM) returns which firms must complete aim to measure various dimensions of a firm’s liquidity and funding risk profile that are not otherwise captured by the liquidity coverage ratio or NSFR. The PRA is proposing to exclude simpler-regime firms from having to provide four of the five ALMM returns; only the return on concentration by product type would be required. This return would also be amended so as to require firms to report liabilities arising from all product types (removing the need for firms to check whether each product type exceeds the threshold) in order to simplify the reporting process. Supervisors could request information which would otherwise be covered by the other four ALMM returns from specific simpler-regime firms if this would facilitate the effective supervision of the firm.
- Pillar 3 disclosures: Pillar 3 disclosure requirements would be amended or removed for simpler-regime firms, given their lower capacity to cause significant financial disruption. Firms with listed financial instruments would be subject only to a requirement to disclose key metrics and an overview of risk weighted exposure amounts. This would enable market participants to continue to apply market discipline to such firms, but would make the costs of disclosure more proportionate. Non-listed firms would be exempt from Pillar 3 requirements. The Pillar 3 rules for small and non-complex institutions would be abolished, with such firms thereafter disclosing under either the simpler regime or rules applying to ‘other’ institutions.
Impact of reforms in CP4/23
The PRA considers that these reforms will have a variety of beneficial effects for the UK financial system without compromising its safety and soundness objective, including:
- reduced compliance costs;
- a stronger banking sector. The PRA believes that the reforms could encourage a dynamic and diverse banking sector without making the sector more fragile, supporting sustainable economic growth and improving financial resilience;
- enhancing the attractiveness of the UK as a place for banking groups to do business, potentially promoting inward investment;
- improved competition and lower barriers to entry. Firms standing to benefit from simpler-regime rules (around 30 banks and 33 building societies, in the PRA’s estimation) could use their improved financial position to compete more effectively with bigger players; and
- resource efficiencies for the PRA.
Firms which are close to the threshold of being a “simpler-regime firm”, as well as UK domestic firms falling outside the scope of the simpler regime, may want to engage with the PRA over the course of this year as it considers whether to introduce further layers of simplification.
There is still a significant way to go before we know what the full “strong and simple” framework will look like, but the smallest UK banks and building societies may not have to wait too long to start experiencing the benefits of this reform:
- a policy statement on the scope of the simpler regime is expected later this year;
- the consultation period for CP4/23 is open until 30 May 2023, with the implementation of Phase 1 rules for the simpler regime planned for early H2 2024; and
- a consultation on Phase 2 of the simpler regime, focused on simplifications to Pillar 2 and buffer requirements, is expected in H1 2024.
The PRA’s timeline on further layers of the graduated prudential regime is not yet fully known, but the regulator is planning to engage with stakeholders on this topic during 2023. It is, as yet, unclear how many layers of simplified prudential regulation there will be or exactly which firms will be in scope but there is plenty by way of further PRA materials to look forward to.