UK regulatory reform: Consultation on the policy for the designation of investment firms for prudential supervision by the PRA

The Bank of England has published for consultation the draft policy about the designation of investment firms for supervision by the Prudential Regulation Authority (PRA) where they are considered to be systemically important/relevant. 

Under the proposed PRA Regulated Activities Order - currently under consultation until 24 December - the PRA will be able to designate certain firms for prudential supervision by the PRA. It may only do so if the conditions set out in article 3(2) and (3) of the PRA Regulated Activities Order must be satisfied. These are (likely to be) that the person:

• has, or has applied for, permission to deal in investments as principal; and
• has, or would have if it were authorised, a minimum capital of EUR 730,000, or is a broadly analogous European Economic Area (EEA) passporting firm or non-EEA firm.

The proposed test is quantitative: the PRA will have regard to each of the following factors in determining whether an Eligible Investment Firm should be designated:

• whether the firm’s balance sheet exceeds an average of £15 billion total gross assets over four quarters, as reported on regulatory returns; and/or
• whether the sum of the balance sheets of all Eligible Investment Firms in a group exceeds an average of £15 billion total gross assets over four quarters; and/or
• where the firm is part of a PRA group, whether the firm’s revenues, balance sheet and risk-taking is significant relative to the group’s revenues, balance sheet and risk-taking.

Although the consultation acknowledges that an individual firm’s impact on the financial system is not only a function of its size, but also the complexity of its operations, the substitutability of the services it provides and its connectedness with the rest of the system, the first condition is purely quantitative - as the draft PRA Regulated Activities Order envisages - so designation of firms which are members of non-financial groups would be made simply on the basis of their assets.

The PRA is required to keep all designations under review, and aims to guard against volatility in designation - it is for this reason that the value of total assets is averaged over four quarters.  PRA staff will review the eligible population of firms against the designation criteria on a periodic basis to consider whether any additional firms should be designated, or their designation withdrawn.  The decision-making body of the PRA will receive a summary of this analysis, together with any designation recommendations.

The PRA must consult the Financial Conduct Authority (FCA) before making (or withdrawing) a designation.

If the PRA proposes to designate a firm, it will issue a notice setting out its reasons, and the firm will normally be given 28 days to make representations.  The notice will state the date that the designation decision would take effect which will usually be three months from the date of the notice being issued.  The firm will have the right to refer matters to the Upper Tribunal.

These procedural arrangements will be modified for the first designation decisions which will take effect at legal cut-over (when the PRA assumes its responsibilities for prudential regulation - currently envisaged to be 1 April 2013). Although firms will still have the opportunity to make representations on proposed designation decisions, this is likely to be subject to an accelerated timetable.  The FSA has tried to ensure that the firms that it considers are most likely to be designated by the PRA are supervised by the Prudential Business Unit within the FSA, under the internal ‘twin peaks’ model. The PRA will, however, make the formal designation decision.

In considering withdrawal of PRA designation, the PRA will have regard to the same factors as it does when deciding to designate an Eligible Investment Firm, but would not normally withdraw a designation unless the firm had been subject to prudential supervision by the PRA for at least one year after designation (except where there is a de-merger or a sale).   The PRA would follow the procedure for warning notices and decision notices. If designation is withdrawn, prudential supervision of the firm passes to the FCA.

The Bank and the FSA invite comments on the proposed policy by 4 January 2013 and are particularly interested in views on the proposed communication of designation decisions and the 3-month period which a firm would have to prepare for a change in its regulator as a result of a designation decision.