HM Treasury has published a consultation paper seeking views on the exercise of its delegated powers under the Financial Services Bill (FS Bill) to ensure the effective implementation of the Investment Firm Prudential Regime (IFPR) and outstanding Basel 3 standards. The consultation also seeks views on the scope of application of the resolution regime for FCA-regulated investment firms.

Overview and next steps

  • Firms which may be affected by the proposals, in particular EUR 730,000 firms which currently benefit from exemptions and derogations, such as matched principal firms, local firms and commodity firms, should consider the proposals regarding the enlarged scope of the UK resolution regime and PRA designation.
  • The proposed changes relating to the alignment of the definition of groups in the Financial Services and Markets Act 2000 (FSMA) with the relationships in scope for prudential consolidation under the Capital Requirements Regulation (CRR) are not discussed in detail in the consultation. Therefore it is unclear precisely what the changes will be and the extent to which they may have consequences, including unintended consequences, beyond prudential consolidation.
  • The government explains two areas where it intends to diverge from the amended Capital Requirements Regulation (CRR2): eligible liabilities for the purposes of total loss absorbing capacity (TLAC) and the equivalence provision regarding exposures to units or shares of a collective investment undertaking (CIU). Both divergence points reflect the UK’s commitment to prioritising alignment with global standards and markets, rather than close alignment with EU rules. As the deadline for entering into a memorandum of understanding on the establishment of a cooperation framework by the UK and EU approaches, the EU will be keeping a close eye on any suggestion of UK divergence from EU requirements. See our briefing ‘Brexit and Financial Services: 2021 Update’ which discusses the current state of play on equivalence and divergence.
  • Responses to the consultation are requested by 1 April 2021. Feedback to the consultation will inform the secondary legislation to be made once the FS Bill receives royal assent.
  • The FCA produced a first consultation paper on the IFPR in December 2020 (CP20/24) (see our briefing here) and will consult on key elements of the IFPR in the first half of 2021. The PRA has published CP5/21 on implementation of Basel standards. Responses to CP5/21 are requested by 3 May 2021.

Summary of HM Treasury proposals

CRR: Use of revocation power under FS Bill to implement Basel 3 standards

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The FS Bill allows HM Treasury to revoke provisions from the Capital Requirements Regulation (CRR) so that the PRA can introduce updated prudential rules for credit institutions and PRA designated investment firms in line with Basel 3 standards (which in the EU will be implemented via CRR2).

The PRA is currently consulting on its proposed rules to replace the gaps left by these revocations.

CRR revocation powers: Clause 3(1) of the FS Bill gives HM Treasury the power to revoke provisions of the CRR relating to the following:

  • deductions from Common Equity Tier 1 items;
  • exposures with particularly high risk (standardised approach to credit risk);
  • exposures in the form of units or shares in collective investment undertakings (standardised approach to credit risk);
  • treatment of expected loss amounts by exposure types (internal ratings based approach to credit risk);
  • own funds requirements for: counterparty credit risk; operational risk; derogations for small trading book business; the trading book; and credit valuation adjustment risk;
  • large exposures;
  • liquidity requirements;
  • leverage ratio;
  • reporting requirements; and
  • disclosure requirements.

Grandfathering of existing capital treatments: Where firms had previously applied to the PRA for specific treatment of their capital requirements, HM Treasury has said that it will make provisions in secondary legislation to ensure that these firms will not need to reapply for these permissions.

Divergence from CRR2: HM Treasury intends to depart from the EU CRR2’s approach in two areas:

TLAC eligible liabilities

  • The government intends to remain aligned with Financial Stability Board standards which provides that external TLAC must be issued and maintained directly by resolution entities.
  • It will therefore not be replicating Article 88a CRR2, which deviates from the FSB TLAC standard by allowing globally systemically important institutions (G-SIIs) to include eligible liabilities issued by one of its subsidiaries to meet its TLAC requirements, where the eligible liabilities are bought by an existing shareholder that is not part of the same resolution group.
  • A similar provision is made for smaller banks in the EU’s Second Bank Recovery and Resolution Directive (BRRDII) and the government has already signalled its intention not to transpose this provision.

Exposures to units or shares of a CIU

  • UK CRR: Article 132 CRR relates to exposures that banks have in units or shares of a CIU. Article 132(3) provides an equivalence provision for third country CIUs which permits institutions to determine the risk weight for such CIUs in accordance with the look-through or mandate-based approaches.
  • EU CRR2: In the EU, CRR2 implements the latest Basel reforms which includes a default 1250% risk weight for funds where the bank cannot use the look-through or mandate-based approaches. The 1250% risk weight is also applied to investments in overseas funds which have not been deemed equivalent. In addition, CRR2 will attach the current standalone equivalence assessment in Article 132 to the third country passport equivalence assessment under the Alternative Investment Fund Managers Directive (AIFMD). This means that only where a third country has been deemed equivalent under the AIFMD passport regime will it be deemed equivalent in relation to the use of the risk weight approaches under CRR2 referred to above and therefore avoid the 1250% default risk weight.
  • HM Treasury proposal: HM Treasury proposes keeping the existing standalone equivalence provision in Article 132 CRR as it believes it would be ‘disproportionate to introduce the AIFMD third country passport for these purposes’ This will enable the UK to maintain a more open stance on investment in overseas funds, rather than tying the availability of more favourable approaches to standards designed for marketing purposes.
  • Coming up: Responses to PRA’s consultation on implementing Basel 3 reforms (CP5/21) are requested by 3 May 2021. Chapter 7 of the consultation provides further detail on the PRA’s approach to implementing changes to investments in CIUs. HM Treasury intends to introduce a Gibraltar Authorisation Regime (GAR) and is also considering whether further options to mitigate the impact on UK firms regarding their exposures to investments in funds in Gibraltar ahead of the introduction of the GAR would be necessary.
Fundamental review of the trading book (FRTB)

 

 

 

 

 

HM Treasury is proposing to make regulations to give effect to the FRTB Standardised Approach (FRTB-SA) reporting requirement, the first step towards the full implementation of the FRTB framework. In March 2020, the Basel Committee on Banking Supervision (BCBS) delayed the implementation of FRTB, which will replace the current market risk framework, to January 2023.

The new regulations will be in line with EU requirements, although they will follow the UK’s timeline for CRR. The CRR is due to come into force in January 2022, with reporting taking place during the first quarter of 2022. In the EU, the first reference date for FRTB-SA reporting is expected to be 30 September 2021.

Consistency of macroprudential framework with new regime

 

The expected enactment of the FS Bill and associated secondary legislation means certain elements of the macroprudential legislative framework, in relation to the Financial Policy Committee’s (FPC) powers of direction, will need to be amended to reflect the new regime. This will include ensuring that the macroprudential measures appropriately reflect provisions introduced under the FS Bill in relation to holding companies, and that relevant references in legislation are appropriately updated.
Alignment of CRR consolidation with new Part 9C FSMA

 

 

 

 

 

 

 

 

 

 

 

 

 

The government intends to ensure that definitions applicable in the new Part 9C of FSMA cover all relationships currently in scope of prudential consolidation under Article 18 CRR. Proposed in the FS Bill, Part 9C of FSMA will set out the FCA’s new duties to make rules in relation to FCA investment firms and their parent undertakings.

The scope of prudential consolidation under CRR is wider than the definitions applicable to the proposed new Part 9C of FSMA:

  • Under section 143B(1) of Part 9C FSMA, ‘on a consolidated basis’ means ‘as if all members of an FCA investment firm’s group are a single FCA investment firm’. ‘Group’ in this context relies on the definition in section 421 FSMA.
  • The definition of ‘group’ in section 421 FSMA is different in scope to that for prudential consolidation under CRR. For example, under Article 18(6) CRR, competent authorities may determine prudential consolidation where a parent exercises a significant influence over an entity without holding a participation or other capital ties in that entity.

As the proposed changes have not been published yet, it is unclear at the moment precisely what these changes will mean and the extent to which they may have consequences beyond prudential consolidation.  HM Treasury has stated that it intends to rely on its delegated powers to preserve alignment with Article 18 CRR, and does not plan to ‘go beyond what is currently applicable (or indeed go beyond the scope of the EU’s Investment Firms Regulation (IFR), which also mirrors Article 18 CRR)’ and that ‘for the avoidance of doubt, this wider definition of group would not affect existing definitions of group in any other part of FSMA or elsewhere in the statute book’.

Consequential amendments to the PRA RAO reflecting new initial capital levels for investment firms

 

 

 

 

 

 

 

 

 

 

 

 

 

The EU Investment Firms Directive (IFD) amends the levels of initial capital requirements (ICR) for the authorisation of investment firms. The FCA is consulting on whether to introduce similar ICR levels in the IFPR.

References to obsolete ICR levels will need to be deleted. In particular, the government intends to delete references to EUR 730,000 ICR level (expected to be updated with ICR level of GBP 750,000 in the IFPR) in the Financial Services and Markets Act (PRA-Regulated Activities) Order 2013 (PRA RAO) and the Banking Act 2009 (Exclusion of Investment Firms of a Specified Description) Order 2014 (Banking Act Order) – see below.

Article 3 PRA RAO sets out the conditions under which the PRA may designate certain investment firms for prudential supervision by the PRA. Broadly, a firm with permission to deal in investments as principal and which has an ICR set at EUR 730,000 is currently eligible for designation as a PRA investment firm, although it will only be designated as such if it meets certain size and activity thresholds, consistent with the PRA’s statement of policy on designation of investment firms.

HM Treasury is proposing to amend Article 3 PRA RAO by removing the existing reference to EUR 730,000 so that all firms that are authorised to deal as principal, irrespective of their ICR, will fall within scope of the PRA RAO.

This could result in a larger population of PRA investment firms. Firms which deal as principal but which are currently exempt from the EUR 730,000 ICR, including ‘local’ firms and exempt matched principal firms (but excluding commodity firms as the FS Bill provides that such firms cannot be designated firms for the purposes of the CRR), may in future be designated for prudential supervision by the PRA. In practice, however, the need to meet certain systemic criteria in order to qualify for PRA designation is likely to mean that the overall population of such firms remains small.

Application of the UK resolution regime in Part 1 of the Banking Act 2009 to FCA investment firms

 

 

 

 

 

 

 

In the UK, investment firms with a EUR 730,000 ICR are, together with banks and building societies, subject to the resolution regime under the Banking Act 2009 (UK resolution regime). Currently, EUR 730,000 investment firms which benefit from exemptions and derogations, such as matched principal firms, local firms and commodity firms, are not subject to the UK resolution regime.

In the EU, the IFD amends the Bank Recovery and Resolution Directive (BRRD) so that all investment firms with a new ICR of EUR 750,000 will come into scope of the resolution regime.

The government is seeking views on whether or not it should follow the EU’s approach. If the government follows the EU’s approach, more FCA investment firms (such as the types of firms referred to above which currently benefit from exemptions and derogations) will be brought within scope of the UK resolution regime. These firms will likely become subject to more requirements, including information provision requirements and those found in Chapter 11 of the FCA’s Prudential Sourcebook for Investment Firms (IFPRU).

Other transitional consequential changes to statute book

 

Implementing the new IFPR will require other transitional and consequential changes to be made to primary and secondary legislation, as well as retained EU law. HM Treasury plans to make these other changes at the same time as the amendments discussed in this consultation, but does not plan to consult separately as they are not expected to be substantive.

 

 

Clive Cunningham

Clive Cunningham
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Katherine Dillon

Katherine Dillon
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Patricia Horton
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