Today, 9 April 2018, the Prudential Regulatory Authority (PRA) has published its Business Plan 2018/19. The Business Plan sets out:
- An overview of the PRA’s responsibilities and approach;
- The PRA strategy;
- Business Plan 2018/19; and
- Budget 2018/19.
Alongside the Business Plan, the PRA has published:
- CP7/18 Regulated fees and levies: rates proposals 2018/19; and
- Letter from the Prudential Regulation Committee to the Chancellor, and its report on the adequacy of PRA resources and the independence of PRA functions.
In the summer, the PRA will publish its Annual Report for the year ended 28 February 2018.
Foreword from Sam Woods, Chief Executive:
- Woods highlights that the regulators are approaching full implementation of post-crisis reforms.
- For the first time since concurrent stress testing began in 2014, none of the large banks have need to improve their capital position following the 2017 results.
- Firms are on track to implement ringfencing.
- Focus is on ensuring that new reforms work, including the SMCR and its extension to insurers towards the end of 2018.
- The PRA will remain “vigilant for any sign of ‘regulatory arbitrage’ (behaviour that is intended to comply with the letter but defy the spirit of the rules)”.
- Woods acknowledges that in exercising supervision, the PRA will sometimes come into conflict with firms, but notes that this is “inherent in a system in which the regulator is charged with pursuing the public interest through the activities of privately-owned firms.”
- While the PRA is “prepared to seek improvements – in ways consistent with international standards – where the rules clearly do not work as intended. But we are not going to go soft: we will maintain a level of resilience that is at least as great as that currently planned.”
- On Brexit, the PRA is working with government to ensure that withdrawal is orderly.
- Woods also notes the need to focus on cyber security/resilience. Noting that there is no overarching prudential standard for operational resilience, Woods highlights that this will be a priority in developing the PRA’s supervisory approach.
Overview of responsibilities and approach
- With 1,425 staff, the PRA supervises circa 1500 firms and groups, including c 900 banks, building societies and credit unions, and 600 plus insurers.
- Over half of UK banking sector assets are from branches and subsidiaries of foreign banks, totalling around £7.4 trillion.
- The UK insurance sector is the largest in Europe, and fourth largest in the world.
The PRA Strategy
- “The PRA’s strategy is to deliver a resilient financial sector by seeking: an appropriate quantity and quality of capital and liquidity; effective risk management; robust business models; and sound governance including clear accountability of firms’ management. This supports our pursuit of our primary safety and soundness, policyholder protection, and secondary competition statutory objectives.”
- The PRA’s strategic goals for 2018/19 are to:
- have in place robust prudential standards comprising the post-crisis regulatory regime (pages 10-11); delivery of this objective includes:
- implementation of structural reform/ringfencing in the UK by 1 January 2019, with a move to testing the effectiveness of arrangements (including policies, governance and control arrangements) in 2018;
- refining the PRA’s approach to Solvency II, including delivering a series of improvements such as finalising policy on the matching adjustment, internal model change processes and reporting requirements. Further consultation on removing the requirement for the external audit of Solvency and Financial Condition Reports for small firms from 2019; and the modelling of ‘dynamic’ volatility adjustment for internal model firms will take place in April 2018. The PRA is considering ways to simplify the recalculation of the transitional measure on technical provisions. The PRA finds that the Solvency II risk margin is too sensitive to interest rates and therefore too large in the current low rate environment (particularly for long-dated annuity business) and will act to tackle this; and
- continuing to contribute to financial stability through policy development and implementation.
- continue to adapt to changes in the external market and to hold regulated firms, and those who run them, accountable for meeting our standards (pages 11-12); the PRA notes the following areas of interest:
- changes in the behaviour or structure of firms which seek to take advantage of regulatory arbitrage;
- new firms seeking authorisation to operate in the United Kingdom. In the next three years, the PRA expects around 20-30 new banks. It will review how the current authorisation process may be improved to facilitate the entry of new insurers;
- firms seeking permissions to conduct new business, such as through the introduction of the new framework to facilitate the issuance of Insurance Linked Securities (ILS) through ISPVs;
- changes to business structures in the banking and insurance sectors as a result of regulation (e.g., ring-fencing), the search for profitability in a low interest rate environment, and wider issues such as EU withdrawal;
- use of financial technologies (FinTech) by banks and other financial services providers;
- on accountability, the PRA says it will finalise policy, including the extension of the SMCR to insurers; it will also continue to review firms’ governance arrangements in areas such as remuneration practices, dividend distributions, and corporate governance at board level.
- ensure that firms are adequately capitalised, and have sufficient liquidity, for the risks they are running or planning to take (pages 12-14); in the coming year, the PRA will:
- assess the adequacy of capital and liquidity resources of firms in the banking sector through a range of measures;
- assess credit risk and asset quality and to consider the level and drivers of risk-weighted assets
- finalise its groups policy, including the approach to supervising double leverage;
- monitor the implementation of the Basel III reform package;
- continue to progress work on how banks are implementing IFRS9;
- across the insurance sector, focus on core balance sheet risks arising from complex products and asset exposures and monitor business models;
- be involved in the conduct of the EIOPA 2018 stress test exercise from May to November;
- review life insurers’ risk management and governance of illiquid assets, focusing on firms with large and complex exposures; and
- consult on a supervisory statement on the Prudent Person Principle (Solvency II).
- develop our supervision of operational resilience in order to mitigate the risk of disruption to the provision of critical economic functions (pages 14-15); the PRA will:
- publish a joint paper with the Bank and FCA on the supervisory approach to operational resilience; and
- run another sector-wide exercise to assess the response to major disruption.
- ensure that banks and insurers have credible plans in place to enable them to recover from stress events, and that we have a credible resolution strategy to manage a firm’s failure – proportionate to the firm’s size and systemic importance – in an orderly manner (pages 15-16); the PRA notes:
- the importance of the minimum requirements for own funds and eligible liabilities (MREL);
- the role of structural reform (ringfencing);
- that the coming year will see the completion of Phase 3 of its solvent wind down work with Category 1 investment banking subsidiaries with material trading activities, continued progress on earlier phases of work with UK banks, and ongoing collaboration with international regulators; and
- for insurers it will continue to work on resolution plans for G-SIIs and will continue to make the case for an insurer resolution regime.
- facilitate effective competition by actively considering the proportionality of our approach as it contributes to the safety and soundness of the UK financial system (page 16); 2018/19 activities will include:
- assessing the competition implications of PRA policies;
- implementing policies to facilitate internal-rating based model applications from smaller banks, and refining the Pillar 2A capital framework;
- facilitating market entry in the banking sector through the joint PRA/FCA New Bank Start-up Unit, and reviewing how the current authorisation process might be improved to facilitate the entry of new insurers;
- building on the successful implementation in 2017 of the new UK regime for Insurance Linked Securities (ILS);
- making sure that stand-alone ring-fenced banks are not unduly burdened compared to those that form parts of universal banking groups; and
- mitigating the risk that the implementation of IFRS 9 in January 2018 unduly penalises small firms.
- deliver a smooth transition to a sustainable and resilient UK financial regulatory framework following the UK’s exit from the European Union (page 17);
- operate effectively by ensuring that resources are allocated to work that best advances our strategy and reduces the greatest risks to the delivery of our statutory objectives (page 18-19).
PRA Budget 2018/19
- The PRA’s budget for 2018/19 is £275 million, including implementation, project and transaction fees of £22 million, which is a decrease of £13 million on the 2017/18 budget.
Cat DankosConsultant, London
+44 20 7466 7494