CP13/22 - Amendments to the PRA's approach to identifying other systemically important institutions (O-SIIs)

1. Overview

1.1 This Consultation Paper (CP) sets out the Prudential Regulation Authority’s (PRA) proposed changes to the criteria and scoring methodology it uses to identify other systemically important institutions (O-SIIs). O-SIIs are firms that are systemically important in a domestic context. The PRA is required to identify and publish a list of O-SIIs under Article 32 of the ‘Capital Requirements (Capital Buffers and Macro-prudential Measures) Regulations 2014’ (the Capital Buffers Regulations). The criteria for O-SII identification are derived from Article 31 of the Capital Buffers Regulations.

1.2 The proposals in this CP would result in changes to the Statement of Policy (SoP) on ‘The PRA’s approach to identifying other systemically important institutions (O-SIIs)’ (Appendix 1). The proposals would also result in an amendment to the SoP on ‘Interpretation of EU Guidelines and Recommendations: Bank of England and PRA approach after the UK’s withdrawal from the EU’ (Appendix 2).

1.3 The CP is relevant to credit institutions, investment firms, and parent (mixed) financial holding companies incorporated in the UK. The proposals contained in this consultation do not apply to third-country branches operating in the UK.

1.4 The purpose of these proposals is to streamline the PRA’s approach to identifying O-SIIs following the UK’s withdrawal from the EU. The PRA considers its proposals would reduce the cost of the annual O-SII identification process, both for the PRA and for firms, while continuing to achieve the intended outcome of identifying firms whose distress or failure would have a systemic impact on the UK economy or financial system. The PRA does not expect firms would incur additional costs as a result of the proposals.

1.5 The PRA has considered the interaction between its primary and secondary objectives and the ‘have regards’. The PRA considers that its proposals would advance its primary objective by ensuring it uses a clear approach, consisting of a single refined scoring mechanism, to identify O-SIIs. These changes would reduce complexity in the O-SII identification approach, by removing the need to carry out two parallel scoring methodologies, and would ensure the PRA’s approach more accurately identifies firms whose distress or failure would have a systemic impact on the UK economy or financial system, by ensuring that the methodology captures, and puts sufficient weight on, key activities for the real economy, such as retail banking and payments. The proposals would also promote the efficient use of the PRA’s resources and enhance proportionality for regulated firms, by simplifying the O-SII identification process and ensuring this relies solely on existing regulatory returns, reducing complexity and burden on firms.

Background

1.6 The Financial Stability Board has recommended^{footnote [1]} that national authorities identify domestic systemically important banks (D-SIBs), and take measures to reduce the probability and impact of their distress or failure – including higher loss absorbency requirements, intensive supervision, and resolution requirements. The Basel Committee on Banking Supervision has established a framework for D-SIBs.^{footnote [2]}

1.7 In the UK, the Capital Buffers Regulations contain the implementation of these accords in provisions regarding O-SIIs (the equivalent of D-SIBs under UK legislation) and the O-SII buffer.

1.8 The PRA’s approach to identifying O-SIIs currently follows the European Banking Authority’s (EBA) ‘Guidelines on criteria to assess other systemically important institutions (O-SIIs)’ (the EBA Guidelines).^{footnote [3]} The EBA Guidelines set out a two stage process for O-SII identification. The first stage is a minimum mandatory framework, which consists of a prescribed set of criteria, indicators, and weights that authorities should use to identify the institutions that must be designated as O-SIIs. The second stage offers authorities the discretion to overlay the mandatory part of the framework, in order to better reflect the specificities of the national banking sector, and if appropriate, designate additional firms as O-SIIs. The PRA uses its own scoring methodology under this stage.

1.9 The PRA identifies O-SIIs in the UK each year in accordance with this process, and publishes the outcome of the annual O-SII identification assessment, including a list of firms identified as O-SIIs (O-SII designation).

1.10 Institutions designated as O-SIIs are subject to enhanced supervision by the PRA, including recovery and resolution planning. This is in line with the PRA’s approach to banking supervision^{footnote [4]} and reflects these firms’ potential impact on the stability of the UK financial system.

1.11 Institutions designated as O-SIIs may be subject to higher loss absorbency requirements in the form of an O-SII buffer. Article 34 of the Capital Buffer Regulations restricts the application of the O-SII buffer to ring-fenced bodies (RFBs) and large building societies.^{footnote [5]} As per the Capital Buffer Regulations Article 34ZB, the Financial Policy Committee (FPC) maintains a framework for setting O-SII buffer rates.^{footnote [6]} The PRA has set out its approach in applying the FPC’s framework.^{footnote [7]}

Summary of proposals

1.12 The policy proposals included in this CP are amendments to SoP ‘The PRA’s approach to identifying other systemically important institutions (O-SIIs)’ and to SoP ‘Interpretation of EU Guidelines and Recommendations: Bank of England and PRA approach after the UK’s withdrawal from the EU’. The proposed amendments involve:

• the removal of the EBA’s scoring methodology from the O-SII identification process, and deletion of the EBA Guidelines, such that O-SII identification is based solely on the PRA’s scoring methodology; and
• updates to specific indicators and weights in the PRA’s scoring methodology for O-SII identification.

Implementation

1.13 The PRA proposes that the implementation date for the changes resulting from this CP would be on the date of publication of the final revised SoP. The PRA, therefore, expects to carry out the 2022 O-SII designation process under the revised approach. In line with the SoP, the PRA will publish the list of firms designated as O-SIIs under this process by Thursday 1 December 2022.

Responses and next steps

1.14 This consultation closes on Thursday 22 September 2022. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP13_22@bankofengland.co.uk. Please indicate in your response if you believe any of the proposals in this CP are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

1.15 References related to the UK’s membership of the EU in the SoPs covered by this CP have been updated as part of these proposals to reflect the UK’s withdrawal from the EU. Unless otherwise stated, any remaining references to EU or EU-derived legislation refer to the version of that legislation which forms part of retained EU law.^{footnote [8]}

2. Proposals

Amendments to SoP ‘The PRA’s approach to identifying other systemically important institutions (O-SIIs)’ and to SoP ‘Interpretation of EU Guidelines and Recommendations: Bank of England and PRA approach after the UK’s withdrawal from the EU’

2.1 The UK’s withdrawal from the EU presents an opportunity for the PRA to review its approach to identifying O-SIIs. The PRA proposes to streamline its approach by removing the EBA’s scoring methodology from the O-SII identification process, and instead use solely the scoring methodology currently carried out as part of supervisory overlay. The PRA also proposes specific updates to this methodology.

2.2 The PRA has always placed emphasis on its scoring methodology under supervisory overlay in designating O-SIIs. The PRA’s scoring methodology measures activities that are critical to the UK economy and financial system, in line with the PRA’s focus on the risk of disruption to the continuity of supply of critical economic functions. The PRA considers that the removal of the EBA’s scoring methodology would simplify the O-SII identification process, while continuing to achieve the intended outcome of identifying firms whose distress or failure would have a systemic impact on the UK economy or financial system. The proposal to remove the EBA’s scoring methodology would remove the need to carry out two parallel scoring methodologies. The proposal would also remove the need for any ad hoc data requests from firms for the purposes of O-SII identification, relying fully on regulatory data already provided by firms as part of ongoing supervisory activities.

2.3 Consistent with the rationale described above, in addition to amending its SoP ‘The PRA’s approach to identifying other systemically important institutions (O-SIIs)’, the PRA proposes an amendment to SoP ‘Interpretation of EU Guidelines and Recommendations: Bank of England and PRA approach after the UK’s withdrawal from the EU’. Specifically, the PRA proposes to delete the following Guidelines to reflect that they are no longer relevant: ‘Guidelines on criteria to assess other systemically important institutions (O-SIIs)’. This does not alter the PRA’s expectation that firms continue to comply with the other Guidelines and Recommendations included in the Appendices of the abovementioned SoP, to the extent that they remain relevant.

2.4 In addition to the removal of the EBA’s scoring methodology, the PRA proposes some further amendments to SoP ‘The PRA’s approach to identifying other systemically important institutions (O-SIIs)’. The PRA proposes specific updates to some of the indicators and weights in the scoring methodology under the current supervisory overlay, in order to ensure that the methodology captures, and puts sufficient weight on, key activities for the real economy. These updates reflect how banking services and the reporting of these activities to the PRA have changed since the methodology was last updated. In particular, the PRA proposes to:

• increase the weight of the ‘retail banking’ category to 150%, reflecting the importance of this category to the UK economy and financial system;
• increase the sub-category weight of ‘corporate lending’ to 60%, and conversely reduce the weight of ‘corporate deposits’ to 40%, reflecting the importance of the former to the real economy; and
• add two new indicators to capture Faster Payments transactions and the volume of debt instruments traded. The PRA considers these additions would capture relevant key metrics in the current banking market, given, for example, the growth in the number of entrants and associated transactions through the Faster Payments scheme. The data for these two new indicators is already available to the PRA, so there would be no additional cost in collecting this data.

2.5 The PRA considers the proposals would advance the PRA’s primary objective by ensuring the PRA uses a clear approach to identify O-SIIs, consisting of a single refined scoring mechanism, thus better enabling the PRA to identify firms whose distress or failure would have a systemic impact on the UK economy or financial system. The PRA further considers the proposals would reduce costs for firms by removing the need for any ad hoc data requests for the purposes of O-SII identification. The PRA considers that its proposed revised approach to identifying O-SIIs would continue to advance its secondary objective, as it would enable the PRA to identify and apply enhanced supervision to those firms whose distress or failure would have a systemic impact on the UK economy or financial system.

2.6 The PRA has considered the interaction of this proposal with have regards. The PRA considers that the proposals promote the efficient and economic use of the PRA’s resources and enhance proportionality by simplifying the O-SII identification process and ensuring this relies solely on existing regulatory returns from firms.

3. The PRA’s duty to consult

3.1 The PRA fulfils its statutory obligations and public law duties by providing the following in relation to the proposed policy:

1. a cost benefit analysis;
2. compatibility with the PRA’s objectives: an explanation of the PRA’s reasons for considering that making the proposed policy is compatible with the PRA’s duty to act in a way that advances its general objective,^{footnote [9]} insurance objective^{footnote [10]} (if applicable), and secondary competition objective;^{footnote [11]}
3. FSMA regulatory principles: an explanation of the ways in which having regard to the regulatory principles has affected the proposed policy;^{footnote [12]}
4. impact on mutuals: a statement as to whether the impact of the proposed policy will be significantly different to mutuals than to other persons.^{footnote [13]}
5. HM Treasury (HMT) recommendation letter: the Prudential Regulation Committee (PRC) should have regard to aspects of the Government’s economic policy as recommended by HMT;^{footnote [14]} and
6. equality and diversity: the PRA is also required by the Equality Act 2010^{footnote [15]} to have due regard to the need to eliminate discrimination and to promote equality of opportunity in carrying out its policies, services, and functions.^{footnote [16]}

3.2 Appendix 3 lists the statutory obligations applicable to the PRA’s policy development process. The analysis in this chapter explains how the proposals have had regard to the most relevant matters listed in paragraph 3.1, including an explanation of the ways in which having regard to these matters has affected the proposals.

Amendments to SoP ‘The PRA’s approach to identifying other systemically important institutions (O-SIIs)’ and to SoP ‘Interpretation of EU Guidelines and Recommendations: Bank of England and PRA approach after the UK’s withdrawal from the EU’

3.3 The PRA proposes to streamline its approach to identifying O-SIIs by removing the EBA’s scoring methodology from the O-SII identification process, and deleting the EBA Guidelines. The PRA also proposes to update specific indicators and weights in its scoring methodology for O-SII identification.

3.4 The PRA considers that the proposed changes in its approach to identifying O-SIIs would advance its primary objective, promote the efficient and economic use of the PRA’s resources, and enhance proportionality.

PRA objectives

3.5 The proposals in this CP would advance the PRA’s primary objective by ensuring the PRA uses a clear approach, consisting of a single refined scoring mechanism, in identifying O-SIIs. The PRA considers its proposed changes would better enable the PRA to identify firms whose distress or failure would have a systemic impact on the UK economy or financial system.

1. The removal of the EBA’s scoring methodology and deletion of the EBA Guidelines would reduce complexity in the O-SII identification approach, by removing the need to carry out two parallel scoring methodologies, and would reduce costs for firms, by removing the need for any ad hoc data requests for the purposes of O-SII identification.
2. Updates to the PRA’s scoring methodology would ensure that the methodology captures, and puts sufficient weight on, key activities for the real economy, such as retail banking and payments.

3.6 The PRA considers that its proposed revised approach to identifying O-SIIs would continue to facilitate effective competition, as it would enable the PRA to identify and apply enhanced supervision to those firms whose distress or failure would have a systemic impact on the UK economy or financial system. By identifying O-SIIs and making them subject to enhanced supervision, including recovery and resolution planning, the PRA would ensure that O-SIIs compete in a way that does not compromise their safety and soundness, and thereby have adverse effects on other financial institutions and the real economy.

Have regards

FSMA regulatory principles

3.7 In developing these proposals, the PRA has had regard to the regulatory principles. The following three of the principles are of particular relevance:

1. The principle that a burden or restriction which is imposed on a person should be proportionate to the benefits which are expected to result from the imposition of that burden: The PRA’s proposal to remove the EBA’s scoring methodology would avoid any ad hoc data requests from firms for the purposes of O-SII identification, while continuing to achieve the intended outcome.
2. The need to use the PRA’s resources in the most efficient and economic way: The PRA’s proposal to remove the need to carry out two parallel scoring methodologies for the purposes of O-SII identification would reduce burden on the PRA’s resources.
3. The principle that the PRA should exercise its functions transparently: The PRA’s proposal to use a single scoring mechanism would enhance transparency in how it designates O-SIIs. The PRA will continue to publish the list of O-SIIs and their respective scores on an annual basis.

3.8 The PRA has considered the remaining FSMA regulatory principles (see references in Appendix 3), and considers that they are not relevant to this proposal.

Impact on mutuals

3.9 The PRA considers that the impact of the proposed rule changes on mutuals is expected to be no different from the impact on other firms.

HMT recommendation letter

3.10 HMT has made recommendations to the PRC about aspects of the Government’s economic policy to which the PRC should have regard when considering how to advance the PRA’s objectives and apply the regulatory principles.

3.11 Competition: The PRA has considered competition as detailed in paragraph 3.6 above.

3.12 The PRA has considered the remaining aspects of government economic policy as laid out in the HMT recommendation letter (see references in Appendix 3), and considers that they are not relevant to this proposal.

Equality and diversity

3.13 The PRA considers that the proposals do not give rise to equality and diversity implications because they are designed to streamline the PRA’s approach to identifying O-SIIs, and should not unfairly disadvantage any one group or characteristic.

Cost benefit analysis

3.14 The PRA considers that the removal of the EBA’s scoring methodology would simplify the O-SII identification process, while continuing to achieve the intended outcome of identifying firms whose distress or failure would have a systemic impact on the UK economy or financial system. The PRA considers that the updates to its scoring methodology, particularly the higher weights attributed to retail banking and corporate lending, and tracking Faster Payments, would improve the PRA’s ability to capture key activities for the real economy, and thus identify firms with the highest potential to adversely affect the stability of the system.

3.15 The PRA considers the proposals in this CP would reduce costs for firms by removing the need for any ad hoc data requests from the PRA to firms for the purposes of O-SII identification. The extent of this cost reduction would depend on firms’ ongoing marginal costs in providing to the PRA the data required under the EBA’s scoring methodology that could not be sourced from regulatory returns, which may vary by firm. The data for the two proposed new indicators under the PRA’s scoring methodology is already available to the PRA, so there would be no additional cost for firms in collecting this data.