CP16/22 – Implementation of the Basel 3.1 standards: Output floor

Overview

9.1 This chapter sets out the Prudential Regulation Authority’s (PRA) proposals to implement the Basel 3.1 standards for the output floor with respect to firms’ calculation of own funds requirements.

9.2 The PRA understands that HM Treasury (HMT) intends to revoke Article 92 of the Capital Requirements Regulation (CRR). Accordingly, this chapter proposes to introduce a new Required Level of Own Funds (CRR) Part of the PRA Rulebook to reflect the implementation of the output floor.

9.3 The PRA proposes to implement the output floor as follows:

• to introduce a floor on risk-weighted assets (RWAs) that would require relevant firms with internal model (IM) permissions to calculate RWAs as the higher of: (i) the total RWAs calculated using all approaches that they have supervisory approval to use (including IM approaches); or (ii) 72.5% of RWAs calculated using only standardised approaches (SAs) (where the latter is called ‘the output floor’ or ‘floored RWAs’);
• to apply the requirement to UK firms that are not part of a group headquartered overseas. For those firms, the output floor would be applied on a consolidated basis at the level of the UK consolidation group where such a group exists, or on an individual basis where the firm is not part of a group. In addition, where a firm is a ring-fenced body (RFB), the output floor would be applied on a consolidated basis at the level of the ring-fenced sub-group, or on an individual basis where the RFB is not part of a ring-fenced sub-group;
• to require those firms to apply floored RWAs in the calculation of all own funds requirements and buffers when becoming bound by the output floor;
• to require that IM firms apply the PRA’s proposed implementation of the SA in the same manner as for firms without permission to use IMs; and
• to apply the transitional arrangements for the output floor, consistent with the Basel 3.1 standards regarding the length of transition period, beginning on 1 January 2025.

9.4 The PRA allows firms to measure risk and calculate associated RWAs in two different ways, depending on the risk concerned: the SAs, in which the PRA determines the risk weights that should be applied to different exposures and risks; and IM approaches, where the PRA allows firms with the requisite permissions to model certain parameters. The output floor, a central new element in the Basel 3.1 standards, aims to ensure that RWAs for firms with IM permissions do not fall below a defined percentage of the RWAs calculated under the SAs. The output floor is intended to promote the safety and soundness of firms with IM permissions, and to facilitate competition between SA and IM firms.

9.5 The Basel Committee on Banking Supervision (BCBS) has noted concerns with the excessive variability and lack of comparability of modelled risk weights, and stated an intention to restore the credibility of the risk-weighted regulatory capital framework by constraining the RWA impact of IM approaches. The BCBS has indicated specific concern that IM approaches, at an aggregate level, fail to adequately capture relevant risks. This is because the modelling of relatively rare events is often uncertain, and so the output floor imposes a ‘backstop’ to guard against risk weights falling excessively low, as well as guarding against excessive variability in risk weights. The PRA shares these concerns.

9.6 The proposals set out in this chapter regarding the output floor requirements are relevant to UK-headquartered groups that are within scope of the proposals in this CP (see Chapter 2 – Scope and levels of application).^{footnote [1]} In addition, the section below on ‘Output floor – scope and levels of application’ is also relevant to UK-based subsidiaries of foreign firms with permission to use IM approaches, which the PRA does not propose to include in the output floor requirement, but which may be subject to ad hoc data requests.

Implementation of an output floor

9.7 In line with the Basel 3.1 standards, the PRA proposes to implement an output floor. The proposed output floor would aim to address identified shortcomings in the use of IMs, and support the restoration of credibility in the risk-weighted regulatory capital framework. The PRA considers this proposal critical to the overall implementation of the Basel 3.1 standards, as it complements and supports refinements to the SA and IM regimes, and promotes the enhancement of risk-sensitivity.

9.8 The PRA proposes that a firm within the scope of the output floor would be required to calculate RWAs, for the purposes of compliance with own funds requirements and buffers, as the higher of: (i) the total RWAs calculated using all approaches which it has supervisory approval to use (including IM approaches); or (ii) 72.5% of RWAs calculated using only standardised approaches, using the following calculation: ^{footnote [2]}

9.9 The PRA’s proposals for the scope and levels of application of the proposed output floor, as well as the SAs required and the proposed five-year transition period, are addressed in more detail later in this chapter.

PRA objectives analysis

9.10 The PRA considers that the proposed output floor would reduce excessive cyclicality in RWAs, enhance comparability of RWAs among firms, and protect against model risk, promoting the credibility of the risk-weighted regulatory capital framework. The PRA also considers that the proposed output floor would reduce undercapitalisation due to uncaptured model risk. By implementing an output floor, the PRA aims to promote safety and soundness by providing a robust and transparent backstop to the use of IM approaches, addressing concerns shared by the BCBS and the PRA (see cost benefit analysis section of Chapter 1 – Overview, and Appendix 7).

9.11 In addition, IM approaches often generate significantly lower risk weights than the SAs for similar exposures. The PRA considers that the proposed output floor, by applying the same SA methodologies to SA and IM firms, would support competition by narrowing and stabilising the gap in risk weights between them.

‘Have regards’ analysis

9.12 In developing these proposals, the PRA has had regard to the FSMA regulatory principles, the aspects of the Government’s economic policy set out in the HMT recommendation letter from 2021 and the supplementary recommendation letter sent April 2022. The PRA has also taken into consideration the matters for which it is required to when proposing changes to CRR rules (as defined in section 144A of FSMA). The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposals:

1. Proportionality (FSMA regulatory principles):

• The PRA considers that the proposed output floor represents a proportionate response to shortcomings in IM approaches. The proposal would most directly impact firms with IM permissions, which are typically larger and more complex.
• The PRA considers that the 72.5% multiplier would allow the output floor to function as a supportive backstop, without removing incentives to pursue IM approval.

2. Finance to the real economy (FSMA CRR rules) and sustainable growth (FSMA regulatory principles and HMT recommendation letter):

• By improving the credibility of the risk-weighted regulatory capital framework, the PRA considers that the proposed output floor would support the UK’s position as a global financial centre, in turn supporting the provision of finance to the real economy. The PRA also considers that the proposal would support the sustainable provision of finance to the real economy by introducing a backstop against model risk, supporting financial stability in the case of unanticipated and extreme market outcomes.
• By reducing the cyclicality of RWAs, the PRA considers that the proposed output floor would promote smoother lending throughout the business cycle and potentially reduce buffer requirements, also supporting sustainable growth.

3. Relevant international standards (FSMA CRR rules):

• The proposed output floor, including the use of the 72.5% multiplier, aligns with the Basel 3.1 standards.

4. Relative standing of the UK as a place to operate (FSMA CRR rules) and competitiveness (HMT recommendation letter):

• The proposed implementation of the output floor, and alignment with the 72.5% multiplier, aligns with the phased-in implementation of the Basel 3.1 standards proposed by regulators in other jurisdictions. Some international peers have proposed to alter the SA methodologies on a transitional basis for the purposes of the calculation of the output floor,^{footnote [3]} effectively creating an alternative set of SAs and reducing the overall estimated impact of the output floor. However, the PRA considers that implementing a common and consistent SAs framework for all firms would best promote safety and soundness and the competition benefits of the output floor. By responding appropriately to identified gaps in risk capture, the PRA considers that the proposed output floor would promote competitiveness by supporting the international reputation of the UK.

Scope and levels of application

9.13 The output floor within the Basel 3.1 standards is intended to apply to ‘internationally-active banks’ that use IMs, including to relevant entities within their groups. The output floor primarily aims to address issues of cyclicality, accuracy, and consistency in RWAs at a broad level rather than activity by activity. Therefore, the PRA considers that the proposed output floor would perform its intended functions most effectively and proportionately as a consolidation level measure.

9.14 The PRA also considers the output floor an aggregate measure most effectively applied at the consolidated level, to allow the recognition of diversification between risks and reduce the potential impact on specific business activities. The PRA considers that application at the consolidation level would protect against disproportionate impacts for more specialist entities.

9.15 The proposed output floor would apply to firms in scope of the PRA’s CRR requirements in the following way:

• on a consolidated basis only, at the UK consolidation level (ie the ultimate UK group level) of UK-headquartered groups;
• on an individual basis to UK stand-alone firms; and
• on a sub-consolidated basis for RFB sub-groups, or individual basis where the RFB is not part of a ring-fenced sub-group.

9.16 The PRA proposes to apply the output floor to all UK-headquartered groups within the scope of the PRA’s CRR requirements. The PRA proposes to exclude UK-based subsidiaries of banking groups headquartered overseas (‘international subsidiaries’) that are subject to group consolidation outside the UK. The PRA expects that the floor would be applied to the overseas group or parent company on a consolidation level in its home jurisdiction.

9.17 The PRA may consider extending the output floor requirement to such international subsidiaries if it considers there to be a prudential case to do so (eg if the floor is not implemented, or not implemented in line with international standards, in home jurisdictions). In support of this, the PRA may request international subsidiaries with approval to use an IM to provide data on an ad hoc basis to support the PRA’s understanding of the potential impact of application of the floor. This is set out in more detail below (see paragraphs 9.21 – 9.23).

9.18 For RFBs, the PRA proposes to implement the output floor both at the UK consolidation level and at the level of the ring-fenced sub-group (or individual RFB if there is no sub-group). This reflects the prudential function of the ring-fence (ie treating the ring-fenced sub-group as equivalent to the UK consolidation level, within the ring-fence).

9.19 The PRA considers that applying the output floor as set out above would allow firms to benefit from diversification within a group structure, while still being held to a robust and transparent backstop. Extending the floor to RFBs would be consistent with this approach, while also facilitating competition for firms concentrated in residential retail mortgages.

9.20 Proposed reporting requirements for firms within scope of the output floor are covered in Chapter 12 – Reporting.

Data gathering for IM firms excluded from scope

9.21 The PRA does not propose to introduce a requirement for international subsidiaries that are excluded from the scope of application of the output floor (as set out above) to provide data on a regular basis. However, the PRA may request firms excluded from the scope of the PRA’s output floor to participate in ad hoc data gathering exercise(s) on the impact of the output floor, including international subsidiaries.

9.22 The PRA considers that using ad hoc exercise(s) would allow required on-going impact assessment of the proposed scope and levels of application of the output floor to be carried out in a proportionate way. This analysis would also support the PRA in any potential adjustment of the scope of the output floor in the future, subject to further consultation.

9.23 The PRA would ask IM firms not subject to the output floor to participate in any ad hoc exercises to the fullness of their capacity, and provide high-quality data. If responses of an insufficient quantity or quality were received, the PRA would consider the extension of the requirements set out in Chapter 12 to firms otherwise not subject to the output floor. This would reflect the fact that a minimum level of information would be required by the PRA in order to quantitatively assess and justify its decision to exclude these firms from the scope of the floor, where they are otherwise subject to PRA requirements for IM firms.

PRA objectives analysis

9.24 The PRA considers that the consolidation level (including the RFB sub-group level as per paragraph 9.18) is the most appropriate basis on which to apply the output floor as a prudential backstop, advancing the safety and soundness of firms by addressing a gap in risk capture, while continuing to support specialisation within well-diversified groups.

9.25 With regards to the secondary competition objective, the PRA’s proposal aims to facilitate competition between subsidiaries by applying the output floor consistently at the consolidation level only. By extending the scope of the floor to the consolidation level for RFBs, the proposal also aims to treat RFBs consistently with the intentions of the ring-fence requirements by treating RFBs as independent of their wider consolidated groups, while also supporting a level playing field in the provision of finance by firms to the UK domestic retail market.

‘Have regards’ analysis

9.26 In developing these proposals, the PRA has had regard to the FSMA regulatory principles, the aspects of the Government’s economic policy set out in the HMT recommendation letter from 2021 and the supplementary recommendation letter sent April 2022. The PRA has also taken into consideration the matters for which it is required to when proposing changes to CRR rules (as defined in section 144A of FSMA). The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposals:

1. Proportionality (FSMA regulatory principles):

• As the output floor is an aggregate measure, the PRA considers it most proportionate to propose application at the consolidated level, where diversification can be taken appropriately into account and excessive impact on more specialised subsidiaries avoided.
• The PRA considers that applying the floor at the RFB level aligns with this approach and the intentions of the ring-fencing regime, as it treats RFBs as independent of their wider consolidated groups.
• The proposed scope and levels of application would balance these concerns with the need to provide a robust and consistent backstop against model risk.

2. Sustainable growth (FSMA regulatory principles and HMT recommendation letter) and finance to the real economy (FSMA CRR rules):

• The PRA considers that the proposed scope and levels of application of the output floor would contribute towards sustainable growth and the sustainable provision of finance to the real economy by ensuring IM firms are adequately capitalised against model risk, avoiding as far as possible imposing costs directly on specialised subsidiaries or business lines.
• The PRA also considers that the proposed scope and levels of application would support sustainable growth by reducing the cyclicality of risk weights for UK headquartered firms at the aggregate level, while not restricting more specialised business models within diversified groups.

3. Relevant international standards (FSMA CRR rules):

• The PRA considers that the proposed scope and levels of application are broadly aligned with international standards, by ensuring that ‘internationally active banks’ are subject to the output floor on a consolidated basis.

4. Relative standing of the UK as a place to operate (FSMA CRR rules) and competitiveness (HMT recommendation letter):

• The PRA considers that the proposed scope and levels of application would support competitiveness by promoting regulatory consistency and the ease of doing business across borders. By proposing not to apply the output floor directly to either international or domestic subsidiaries, where they are similarly subject to group consolidation and supervision for the purposes of the application of the output floor, the PRA considers the proposal would be supportive of the competitiveness of the UK as a place to do business.

5. Mutuals (FSMA obligation):

• The PRA considers that mutuals with IM permissions may experience a relatively higher impact from the output floor, to the extent that internal ratings based (IRB) approaches continue to produce lower average risk weights relative to the SA, following the proposed changes to Supervisory Statement (SS) 11/13 – ‘Internal Ratings Based (IRB) approaches’ set out Policy Statement (PS) 13/17 – ‘Residential mortgage risk weights’, PS11/20 – ‘Credit risk: Probability of Default and Loss Given Default estimation’,^{footnote [4]} and the proposed implementation of the Basel 3.1 standards.
• The PRA has considered this impact, and reached the view that a prudential case nonetheless exists to apply the output floor to mutuals, in line with the proposed approach to IM groups and RFBs. While mutuals may be more impacted by the proposed floor due to operating with legal constraints on their capacity to diversify, the PRA considers that this does not reduce their exposure to model risk, which may be amplified by specialisation in residential retail mortgages, and less diversified model use. The PRA considers that the impact of the output floor on mutuals may also be smaller when considered alongside the combined impact of other elements of the capital framework eg firm-specific buffers (see Chapter 10 – Interactions with the PRA’s Pillar 2 framework).
• From the perspective of competition, the PRA also considers that this approach would result in mutuals being treated consistently with RFBs, which are similarly concentrated in residential retail mortgage lending.
• However, in recognition of the constraints on the business models of mutuals and the potential high impact due to their concentration in residential retail mortgages, the PRA welcomes specific responses from mutuals on the impact of the output floor as proposed.

Question 49: Do you support the scope and levels of application of the PRA’s proposed output floor? Do you have any additional evidence on the potential impact of these proposals with respect to different activities or particular business lines? 

Application of the output floor to minimum requirements and buffers

9.27 As set out in the PRA Rulebook and SS16/16 – ‘The minimum requirement for own funds and eligible liabilities (MREL) – buffers and Threshold Conditions’, firms must meet the following own funds requirements at all times:

• Common Equity Tier 1 (CET1) must be at least 4.5% of RWAs;
• Tier 1 capital must be at least 6.0% of RWAs;
• Total capital (Tier 1 capital and Tier 2 capital) must be at least 8.0% of RWAs;
• where relevant, firm-specific Pillar 2A; and
• where relevant, minimum requirement for own funds and eligible liabilities (MREL).

9.28 In addition to the regulatory minima set out above, firms are expected^{footnote [5]} to also meet all relevant buffers, including:

• the capital conservation buffer (CCoB), set at 2.5% of RWAs, and countercyclical capital buffer (CCyB)^{footnote [6]} when relevant;
• higher loss absorbency requirements for systemic firms, ie for firms identified as global systemically important banks (G-SIBs) or other systemically important institutions (O-SIIs); and
• the PRA buffer (also referred to as Pillar 2B), where relevant.

9.29 The PRA proposes that when the output floor is ‘activated’ (ie when 72.5% of RWAs calculated using SAs exceed RWAs calculated using IM approaches), ‘floored’ RWAs would be used as the applicable RWAs wherever relevant in all elements of the capital stack, including the requirements set out above.

9.30 Firms within scope of the leverage ratio framework would also remain subject to leverage ratio requirements.

9.31 The PRA has considered the possibility of double-counting in developing this proposal, and considers that no material methodological overlap would exist between the proposed output floor and the PRA’s Pillar 2 methodologies. While Pillar 2 covers a range of risks not addressed under Pillar 1, model risk is not captured specifically. As set out in Chapter 10, to the extent that the proposals in this CP would as a whole improve risk capture in Pillar 1, Pillar 2A capital requirements would be revised to account for duplication of risk capture.

9.32 However, the PRA considers that the interaction between the output floor and the own funds requirements and buffers set out above may be complex, as explained in more detail in Chapter 10. The PRA would monitor the interactions between the output floor, Pillar 2A, and the capital buffer framework, and provide additional guidance on appropriate methodologies and calculations should it consider this necessary. The PRA welcomes responses, including evidence, regarding the impact of these issues, and regarding where additional guidance on potential interactions would support implementation.

PRA objectives analysis

9.33 In light of the PRA’s support for the prudential purposes of the output floor, the PRA considers that the application of floored RWAs through the whole capital stack would be the most consistent, conceptually sound, and simple approach to implementing the output floor. The proposed approach minimises the potential for undercapitalisation due to uncaptured model risk, advancing the PRA’s objective of safety and soundness.

9.34 By ensuring G-SIBs’ and O-SIIs’ buffer requirements reflect the output floor, supporting the comprehensibility and comparability of total RWAs across firms and closing the gap between SA and IM firms, the proposed approach would advance the PRA’s secondary competition objective.

‘Have regards’ analysis

9.35 In developing these proposals, the PRA has had regard to the FSMA regulatory principles, the aspects of the Government’s economic policy set out in the HMT recommendation letter from 2021 and the supplementary recommendation letter sent April 2022. The PRA has also taken into consideration the matters for which it is required to when proposing changes to CRR rules (as defined in section 144A of FSMA). The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposals:

1. Proportionality (FSMA regulatory principles):

• The PRA considers that the proposed application of floored RWAs for the purposes of meeting all regulatory minima and relevant buffers represents the most proportionate approach to implementation of the output floor. This aims to ensure consistency in calculations and limits the complexity of the capital stack, as well as appropriately managing the potential impact of model risk. The PRA has considered the possibility of double-counting, and does not consider that double-counting would arise as a result of this proposal.

2. Sustainable growth (FSMA regulatory principles and HMT recommendation letter) and finance to the real economy (FSMA CRR rules):

• The PRA considers that the proposed approach would support sustainable growth and provision of finance to the real economy by ensuring risk-sensitive adjustments to risk-weighting methodologies are reflected wherever total RWAs are used. The PRA considers this would address shortcomings in the existing framework and reduce cyclicality, promoting sustainable lending to the real economy through the cycle.

3. Relative standing of the UK as a place to operate (FSMA CRR rules) and competitiveness (HMT recommendation letter):

• The proposed approach of applying floored RWAs for the calculation of own funds requirements and buffers is materially aligned with the proposals set out by international peers, and therefore supports the UK’s attractiveness as a place to do business. Jurisdictions that consider their approach to Pillar 2A may capture firm-specific model risk (such as the EU) have proposed to review approaches to additional own funds requirements on a firm-by-firm basis at the point when a firm is bound by the floor. The PRA does not address model risk in its Pillar 2A methodologies, but nevertheless would consider any potential interaction between the output floor and its approach to Pillar 2 through its upcoming review of Pillar 2A (to be completed by 2024).

4. Relevant international standards (FSMA CRR rules):

• The proposed approach of applying floored RWAs for the calculation of own funds requirements and buffers aligns with the proposals set out by the Basel 3.1 standards, and would promote enhanced risk-sensitivity in requirements for international firms subject to relevant buffers (ie G-SIBs).

Question 50: Do you have any comments on the PRA’s proposal that when the output floor is activated, ‘floored’ RWAs should be used wherever relevant in all elements of the capital stack? Do you have any additional evidence that is relevant to this proposal to inform the PRA’s analysis? 

Standardised approach methodologies used in the calculation of the output floor

9.36 The PRA considers that a robust and consistent application of SA methodologies by IM firms subject to the floor is necessary to achieve the prudential objectives of the output floor. The PRA considers this is appropriate given the PRA’s proposals would enhance risk-sensitivity in the SA. The PRA proposes that when applying the output floor, IM firms would apply the PRA’s proposed implementation of the SA, in the same manner as for firms without permission to use IM.

9.37 The PRA proposes to implement the following SA methodologies:

• credit risk: the SA for credit risk (see Chapter 3 – Credit risk – Standardised approach, and Chapter 5 – Credit risk mitigation). Credit risk mitigation (CRM) eligibility requirements and techniques that are only available under Foundation IRB or Advanced IRB, and not under the SA, would not be used for the purposes of the output floor;
• counterparty credit risk: when calculating the exposure for derivatives, firms would use the SA for counterparty credit risk (SA-CCR) as set out in the Counterparty Credit Risk Part, subject to the proposed adjustment to those rules set out in Chapter 7 – Credit valuation adjustment and counterparty credit risk. This approach would be combined with the relevant borrower risk weights from the SA for credit risk (as proposed in Chapter 3);
• credit valuation adjustment (CVA) risk: the SA for CVA (SA-CVA), the Basic Approach for CVA (BA-CVA), or 100% of the counterparty credit risk capital requirements (‘AA-CVA’), as set out in Chapter 7, depending on which of these approaches is used by the firm for CVA risk;
• securitisation: the external ratings-based approach (SEC-ERBA), the SA (SEC-SA), or a risk weight of 1250% as set out in the CRR, as applied by Article 92 of the Required Level of Own Funds (CRR) Part for the purposes of the output floor. The SAs for securitisation are an area the PRA intends to keep under review and may consult on separately in due course (see Box 1 below);
• market risk: the SA for market risk (see Chapter 6 – Market risk), using the approaches for securitisations set out above when determining the default risk charge component for securitisations held in the trading book; and
• operational risk, settlement risk, dilution risk, market risk for items in the non-trading book and requirements for large exposures: the relevant SA, as per part 3 of Article 92 of the Required Level of Own Funds (CRR) Part.

PRA objectives analysis

9.38 The PRA considers that the proposed approach would support the safety and soundness of firms by ensuring that the output floor is a consistent and transparent backstop to modelled risk weights.

9.39 The proposed approach would also support the PRA’s secondary competition objective by holding IM firms to a consistent standard in the application of the SA methodologies, enhancing comparability and levelling the playing field between SA and IM firms.

‘Have regards’ analysis

9.40 In developing these proposals, the PRA has had regard to the FSMA regulatory principles, the aspects of the Government’s economic policy set out in the HMT recommendation letter from 2021 and the supplementary recommendation letter sent April 2022. The PRA has also taken into consideration the matters for which it is required to when proposing changes to CRR rules (as defined in section 144A of FSMA). The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposals:

1. Finance to the real economy (FSMA CRR rules) and sustainable growth (FSMA regulatory principles and HMT recommendation letter):

• The PRA considers the proposed approach to SA methodologies for the calculation of the output floor would provide the most robust and transparent backstop, ensuring the risk-weighting framework would appropriately capture the true risks faced by firms, and so enabling them to support sustainable growth in the long-term. This would be supported by the revisions to the SAs proposed elsewhere in this CP, which aim to improve risk-sensitivity.
• The PRA also considers that applying the SA methodologies faithfully would reduce the pro-cyclicality of risk weights for IM firms, which would better enable firms to provide finance to the real economy through the cycle and therefore support stable and sustainable growth.

2. Relative standing of the UK as a place to operate (FSMA CRR rules) and competitiveness (HMT recommendation letter):

• The PRA considers that by aligning with the end state approaches proposed by international peers,^{footnote [7]} the proposed application of the output floor supports the competitiveness of the UK. As noted above, the PRA considers that implementing a common and consistent application of the SAs would most effectively promote the safety and soundness and competition benefits of the output floor, ultimately benefiting the competitiveness of the UK by supporting the international reputation of the UK and its regulatory authorities.
• To the extent that any of the PRA’s proposals with regards to the SA calculations affect competitiveness, these are considered in the relevant risk chapters (eg information regarding the proposed SA to unrated corporates may be found in Chapter 3).
• With regards to the PRA’s proposal to implement the output floor for securitisations, the PRA is aligned with the Basel 3.1 standards and the European Commission’s October 2021 proposals, but would continue to monitor approaches in other international jurisdictions and would take into account competitiveness in finalising the proposals set out in this CP.

3. Proportionality (FSMA regulatory principles):

• The PRA considers that consistent application of the SAs for the implementation of the output floor is proportionate as this would limit potential complexity by avoiding the introduction of an additional methodology for the calculation of risk weights specific to the floor.

Transition period

9.41 The PRA proposes to apply the transitional arrangements for the output floor, aligning with the Basel 3.1 standards regarding the length of the proposed transition period. This transition period would begin on 1 January 2025, in line with the PRA’s proposed overall implementation date (see Chapter 1 – Overview). The transition period is intended to support the implementation of the floor in an orderly manner, and reduce potential cliff edges in own funds requirements.

9.42 For the purposes of the transition period, the output floor would be calibrated as set out below:

Multipliers for the output floor

9.43 The PRA does not propose to implement the transitional cap, a national discretion given in the Basel 3.1 standards whereby jurisdictions may cap the incremental increase in RWAs as a result of application of the output floor at 25% for the duration of the transition period. While it may provide some relief from the impact of the floor for the purposes of the transition period for any firm substantially impacted, the PRA considers that the cap would create a cliff-edge when removed, by introducing additional volatility in the short- to medium-run, undermining the benefits of the output floor to safety and soundness.

PRA objectives analysis

9.44 The PRA considers that implementing the full transition period, without a transitional cap, would support the safety and soundness of firms by reducing potential cliff-edges in own funds requirements, and allow firms to adjust to changes in own funds requirements in an orderly manner.

9.45 The PRA also considers that implementing the full transition period would facilitate competition by ensuring that all firms have sufficient time to implement the output floor in an orderly manner, in particular those facing a higher fully phased-in impact from the floor.

‘Have regards’ analysis

9.46 In developing these proposals, the PRA has had regard to the FSMA regulatory principles, the aspects of the Government’s economic policy set out in the HMT recommendation letter from 2021 and the supplementary recommendation letter sent April 2022. The PRA has also taken into consideration the matters for which it is required to when proposing changes to CRR rules (as defined in section 144A of FSMA). The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposals:

1. Proportionality (FSMA regulatory principles) and finance to the real economy (FSMA CRR rules):

• The PRA considers that the proposal to implement the full transition period is proportionate and consistent with the proposals set out in this chapter, as it aims to allow firms sufficient time to adjust to any changes in own funds associated with the output floor. In this way, the PRA considers that an orderly transition over a long transition period would support the provision of sustainable finance to the real economy. The PRA considers its proposal not to implement the RWA cap proportionate, given the potential risk of cliff-edges in own funds requirements and ratios.

2. Relative standing of the UK as a place to operate (FSMA CRR rules) and competitiveness (HMT recommendation letter):

• The proposed approach aligns with the overall timeline of other jurisdictions, based on the PRA’s current understanding of such timelines.
• In light of its objectives and other have regards, the PRA has considered the potential impact of implementing transitional adjustments to the calibration of SA methodologies used for the calculation of the output floor as proposed in other jurisdictions. While there may be a short-term competitiveness impact to not aligning with other jurisdictions during the transition period, implementing the full transition period is the PRA’s preferred approach to supporting firms in adjusting to any changes in own funds requirements that may arise from the proposed output floor, due to concerns regarding introducing alternative SA methodologies set out above. The PRA considers that its proposed approach would best advance the PRA’s objectives, while ensuring relative consistency over time and reduces the risk of cliff-edges in methodologies or own funds requirements.
• The PRA has also considered competitiveness in the calibration of SAs at the asset class level, and this analysis may be found in the relevant chapters.

3. Mutuals (FSMA obligation):

• The PRA considers that the proposed approach would support mutuals with IM permissions, which may face higher impacts due to constraints on their capacity to diversify at the consolidation level (as set out above), to adjust to and implement the output floor without disrupting their routine business.

Question 51: Do you have any comments on the PRA’s proposed transitional arrangements including the proposal to not apply the discretionary transitional cap?