HM Treasury consultation on IFPR implementation and Basel 3 standards

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.

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.

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’.

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.

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).