CP10/23 – Solvent exit planning for non-systemic banks and building societies

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Responses are requested by Friday 27 October 2023.

Please address any comments or enquiries by email to: CP10_23@bankofengland.co.uk.

Alternatively, please address any comments or enquiries to:

Paulius Martuzevicius (Recovery and Resilience Team)

Bank of England,

Threadneedle Street,

London,

EC2R 8AH

1. Overview

1.1 This consultation paper (CP) outlines the Prudential Regulation Authority’s (PRA) proposals for non-systemic banks and building societies in the UK to prepare, as part of their business-as-usual (BAU) activities, for an orderly ‘solvent exit’; and if needed, to be able to execute one. The PRA identified in 2021,^{footnote [1]} and confirmed in its business plan for 2022/23, that it would do more in the coming years to increase confidence that firms can exit the market with minimal disruption, in an orderly way, and without having to rely on the backstop of an insolvency or resolution process. This CP is part of that long-standing programme of work.

1.2 The proposals in this CP will, if implemented, add a new chapter (Chapter 7) to the Recovery Plans Part of the PRA Rulebook (Appendix 1) and introduce a new supervisory statement (SS) (Appendix 2) applicable to firms that are in scope of the proposed new rule.

1.3 The proposals in this CP include:

• new rules and expectations stating that firms must prepare for a solvent exit as part of their BAU activities, and that firms must document those preparations in a solvent exit analysis;
• new expectations, which would apply only if solvent exit became a reasonable prospect for a firm, on how firms should: (i) prepare a detailed solvent exit execution plan, and (ii) monitor and manage a solvent exit; and
• consequential changes to SS3/21 – Non-systemic UK banks: The Prudential Regulation Authority’s approach to new and growing banks by amending the ‘Solvent wind down’ section in that SS.

1.4 The proposals aim to increase the likelihood that a firm can execute a solvent exit successfully. They would result in solvent exit policy being formalised within the PRA policy framework; solvent exit would sit alongside recovery and resolution as a possible route for non-systemic firms facing stress or wishing to exit from PRA-regulated activity for any reason. Figure 1 depicts those three outcomes alongside relevant PRA policies. The proposed changes would help support an orderly and timely exit from PRA-regulated activity, reducing the potential for disruption to the wider market and to the firm’s customers. Increasing the ease with which firms can cease PRA-regulated activity would also support a well-functioning and competitive market, where new firms can enter, and unviable firms can more easily leave.

1.5 The proposals in this CP would result in consequential changes to SS3/21 – Non-systemic UK banks: The Prudential Regulation Authority’s approach to new and growing banks by amending the ‘Solvent wind down’ section in that SS. Firms in scope of SS3/21 would be subject to the proposed new Chapter 7 of the Recovery Plans Part and the new expectations proposed in the draft SS – Solvent exit planning for non-systemic banks and building societies. For the avoidance of doubt, the proposals would replace the phrase ‘solvent wind-down’ (when describing a solvent cessation of PRA-regulated activities) with ‘solvent exit’.

1.6 The CP is relevant to UK banks and building societies to which Chapter 7 of the Recovery Plans Part applies (henceforth ‘firms’). Specifically, this means UK-incorporated banks and building societies which are: (a) not subject to the Operational Continuity Part of the PRA Rulebook, or (b) not members of a group which is a global systemically important institution (G-SII) or an other systemically important institution (O-SII). It is not relevant to credit unions or branches of third-country groups.

1.7 A solvent exit means the process through which a firm ceases PRA-regulated activities (deposit-taking) while remaining solvent throughout.^{footnote [2]} The firm should transfer^{footnote [3]} or repay (or both) all deposits as part of its solvent exit.^{footnote [4]} Once the firm has transferred and/or returned all deposits, a solvent exit will end with the removal of the firm’s Part 4A PRA permission.^{footnote [5]}

1.8 The PRA has a statutory duty to consult when introducing new rules (FSMA s138J) or new standards instruments (FSMA s138S). The PRA has assessed the potential costs and benefits of these proposals. While there will be some costs to firms to implement these proposals, the PRA estimates that they would be outweighed by the benefits. Details of the PRA’s analysis of the potential costs and benefits are covered in the cost-benefit analysis section below.

1.9 In carrying out its policy-making functions, the PRA is required to comply with several legal obligations. Appendix 4 lists the statutory obligations applicable to the PRA’s policy development process. The analysis in this CP explains how the proposals have had regard to the most significant matters, including an explanation of the ways in which having regard to these matters has affected the proposals.

Background

1.10 In 2021, the PRA committed to focus on increasing the ease with which non-systemic firms can, where necessary, exit in an orderly manner from PRA-regulated activities, without having to rely on the backstop of insolvency.^{footnote [6]} Such ‘solvent exits’ have proved to be the most common exit route for non-systemic firm's since the PRA’s inception in 2013, particularly in cases where firms or the PRA have concluded that a firm’s business model is no longer viable or sustainable.

1.11 While many solvent exits have concluded without issue, the PRA has found that some exits of non-systemic firms have been challenging and protracted. Often, potential barriers to an orderly exit are only identified once detailed solvent exit execution planning is already underway. In some cases, these issues have taken many months to address. The PRA considers that solvent exit would be more efficient, more cost-effective, and more likely to succeed (as opposed to ending in insolvency proceedings) with improved forward planning by the firms in scope. A clear published policy on how firms should prepare in advance for a solvent exit should help deliver better and more consistent outcomes.

1.12 The PRA considers that greater preparedness by firms for a solvent exit would support the PRA’s statutory objectives and should benefit firms and the wider market. Uncertain and overly protracted exits pose a risk to financial stability and the wider market by increasing the likelihood that a firm’s exit is disorderly. The work needed to remove barriers to an orderly exit can consume significant resources of both the firm in question and the PRA. A lack of preparedness can also increase the risk of an initially solvent exit ending in resolution, with associated risks to depositors, creditors, and other key stakeholders of the firm.

1.13 The PRA recognises that solvent exits may not always be the most appropriate exit route, for example in a ‘fast-failure’ scenario. However, in scenarios where there is more time for a firm and the PRA to prepare for an orderly solvent exit, greater advance planning would help ensure that the firm is better prepared to execute such an exit. Figure 1 provides an overview of how the proposed solvent exit planning policy would fit in with other relevant policies for both systemic and non-systemic firms.

Implementation

1.14 The PRA proposes that the implementation date for the changes resulting from this CP would be Q3 2025.

Responses and next steps

1.15 This consultation closes on Friday 27 October 2023. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP10_23@bankofengland.co.uk. Please indicate in your response if you believe any of the proposals in this consultation paper 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.

1.16 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.

2. The PRA’s proposals

Solvent exit planning for non-systemic firms

Planning for a solvent exit as part of BAU activities

2.1 The PRA proposes new rules and expectations to help firms prepare for solvent exit as part of their BAU activities. These would apply to all firms in scope, regardless of how unlikely or distant a prospect solvent exit may seem. Where appropriate, firms may use their work under existing recovery planning policy to meet, or begin to meet, the proposed rules and expectations. The PRA’s proposals for BAU preparations include new PRA rules (Appendix 1 to this CP) in Chapter 7 of the Recovery Plans Part that require firms to prepare for a solvent exit and to produce and maintain a solvent exit analysis, and new expectations on solvent exit planning during BAU (Chapter 2 of draft SS – Solvent exit planning for non-systemic banks and building societies) to guide firms’ compliance.

2.2 The proposed rules would require firms to prepare for a solvent exit as part of their BAU activities, so that, if needed, a firm can cease PRA-regulated activities in a timely and orderly manner. The rules would require firms to produce and maintain a solvent exit analysis (which may form part of a firm’s existing recovery plan if the firm finds it appropriate) documenting a firm’s preparations, which the firm must be able to provide to the PRA upon request.

2.3 Chapter 2 of the draft SS on solvent exit planning provides details on how the PRA expects firms to meet the requirements in the proposed rules. A firm would be expected to provide, in its solvent exit analysis, evidence that it meets all the expectations in Chapter 2. A list of the minimum contents that a firm should set out in its solvent exit analysis is provided in the ‘Preparing for a solvent exit in advance’ section of that draft SS.

2.4 The proposed expectations are intended to develop firms’ understanding of how they would exit from PRA-regulated activities while still solvent, the main barriers and risks they may face doing so, and how they would make timely and effective decisions concerning a solvent exit. They should help mitigate the risk of firms being unprepared for a solvent exit or unaware of the costs and time involved.

Once solvent exit is a reasonable prospect

2.5 The PRA proposes to clarify its expectations of firms for whom solvent exit has become a reasonable prospect. The proposed expectations cover (i) producing a detailed solvent exit execution plan^{footnote [7]} and (ii) executing and monitoring a solvent exit. These are outlined in Chapter 3 of the draft SS – Solvent exit planning for non-systemic banks and building societies.

2.6 Under the proposals, firms would be expected to produce a detailed solvent exit execution plan, within a reasonable amount of time, once a firm begins to consider a solvent exit or if a PRA supervisor informs the firm that they should prepare for one. A firm would need to provide its solvent exit execution plan to the PRA. The plan should contain sufficient detail to demonstrate whether the firm could successfully execute a solvent exit. Annex A of the draft SS – Solvent exit planning for non-systemic banks and building societies sets out a list of the minimum contents that a firm should set out in its solvent exit execution plan.

2.7 During the execution of a solvent exit, firms would be expected to keep the PRA, and other stakeholders as appropriate, informed throughout the execution of a solvent exit. Firms would also need to continually monitor the execution of the solvent exit.

2.8 These proposals would help to facilitate more timely and useful solvent exit execution plans, which underpin a successful solvent exit. They should also support clearer decision-making and communication during a solvent exit, and better monitoring of the solvent exit as it progresses. On that basis, the proposals would help to ensure that any solvent exit that is started has a higher likelihood of completing successfully – in an orderly, timely, and ultimately solvent manner.

Proposals for consequential changes to SS3/21

2.9 The proposals in this CP would result in consequential changes to SS3/21 – Non-systemic UK banks: The Prudential Regulation Authority’s approach to new and growing banks. The PRA proposes to replace the term ‘solvent wind-down’ with ‘solvent exit’ when referencing or describing a solvent cessation of PRA-regulated activities, and to delete the ‘Solvent wind down’ section. The objective of this proposal is to introduce greater clarity and accuracy in the language associated with ceasing PRA-regulated activities while solvent.

PRA objectives analysis

2.10 In discharging its general functions, the PRA must, so far as reasonably possible, act in a way that advances its general objective to promote the safety and soundness of PRA-authorised persons. The proposals in this CP would advance the PRA’s general objective to promote the safety and soundness of firms it regulates, by helping firms to develop a clear and considered route for an orderly and timely solvent exit. Such an exit should reduce risks to the firm, as well as to the UK’s financial stability.

2.11 These proposals would also advance the PRA’s secondary objective to facilitate effective competition. Ensuring firms can solvently exit PRA-regulated activity with minimal disruption to the market is fundamental to a well-functioning and dynamic market. It allows new entrants in and non-viable firms out. It would also provide some assurance to investors that an exit route exists that does not rely on insolvency procedures.

2.12 The Financial Services and Markets Bill 2022 (the FSM Bill)^{footnote [8]} includes measures to amend the PRA’s objectives by introducing a new secondary competitiveness and growth objective. At the point that those measures come into force, this new secondary objective would require the PRA (in discharging its general functions in a way that advances its primary objectives and so far as reasonably possible) to act in a way that facilitates (subject to aligning with relevant international standards): (a) the international competitiveness of the economy of the UK (including, in particular, the financial services sector through the contribution of PRA-authorised persons); and (b) its growth in the medium to long term.

2.13 Bearing this in mind and the proposed implementation date for the changes proposed in this CP, the PRA has considered whether the proposals set out in this CP would facilitate the international competitiveness of the UK economy and its growth in the medium to long term. The PRA considers the changes proposed in this CP are unlikely to have a material impact on UK growth or international competitiveness. The PRA considers that firms’ increased preparedness for solvent exit, and the prevention of disorderly exits, would reinforce strong prudential standards and effective competition, which are key to instilling trust and confidence among investors, firms, and other regulators. Therefore, the PRA considers the proposals would have a positive impact on ensuring that the UK remains competitive and attractive as a place to do business, with a robust, effective, and trusted regulatory regime.

Cost benefit analysis (CBA)

Benefits

2.14 Increased likelihood of a successful solvent exit: Preparing for a solvent exit as part of BAU (ie before the need to execute one arises) increases the likelihood that a firm can initiate and complete a solvent exit successfully. The focus in the proposals on timely decision-making, informed by clear and forward-looking indicators, and overseen by appropriate governance, would make it more likely that a solvent exit is started when it has a higher probability of being completed successfully. Several studies of the banking sector in the US suggest that firms incur an average loss of 20% of total asset value from failure and insolvency.^{footnote [9]} An increased likelihood of a successful solvent exit should therefore help reduce the risk of losses to firms. Improving the chances of a solvent exit could also have benefits for several market stakeholders, such as depositors, shareholders, and creditors (if the firm is also being wound up as a legal entity), who would be more likely to receive their funds in full and in a timely manner.

2.15 More efficient and less costly exits for firms: Based on its experience, the PRA considers that solvent exit planning in BAU would help reduce the time and costs involved in any solvent exits that do occur, as firms would have already established their governance procedures, considered potential risks, and understood the timings for possible actions needed to complete a solvent exit. The proposed SS – Solvent exit planning for non-systemic banks and building societies is intended to provide firms with a better understanding of the PRA’s expectations when executing a solvent exit, so that they are more able to meet those expectations in a timely manner. This should facilitate a more efficient, less costly, exit for firms.

2.16 Reduced disruption to the wider market: The PRA considers that the increased likelihood of a successful solvent exit that the proposals support helps reduce the risk of disruption to the wider market that may arise from disorderly market exits. By helping to ensure that solvent exits are well thought through, well communicated, and executed in an orderly, timely, and clear manner, the proposals should help reduce uncertainty across the wider market and the potential risk of contagion.

2.17 Potential to reduce costs of exit being borne by industry through the Financial Services Compensation Scheme (FSCS): When a firm successfully completes a solvent exit, deposits are repaid in full or transferred, ie a solvent exit should not involve recourse to FSCS pay-outs. This helps to avoid the costs of an insolvency being passed on to other firms, who may fund the FSCS.

2.18 A more dynamic and competitive market: The PRA considers that solvent exit planning would support a well-functioning and competitive market by increasing the likelihood of a successful and orderly solvent exit. The proposals should help provide confidence to firms, and the wider market, that there exists a well understood route to exit, and should enable less efficient firms to exit more easily. Solvent exit planning may also provide potential investors with the assurance that they could access their funds if the firm were to become non-viable.

Costs

Costs to firms

2.19 The PRA considers that there would be costs to firms to implement and continually comply with the proposals. Two fundamental aspects of the proposals should significantly reduce the costs for firms. First, the proposals are clear that firms would be able to leverage and adapt their existing work under recovery planning for solvent exit purposes. They also have proportionality built into them, for example by stating that a firm’s BAU planning should be appropriate to the nature and scale of the firm’s activities. The PRA’s estimate of the costs to firms is provided below.

Estimating costs to firms

2.20 Affected firms: As set out in Chapter 1, this CP is relevant to UK-incorporated banks and building societies which are: (a) not subject to the Operational Continuity Part of the PRA Rulebook, or (b) not members of a group which is a G-SII or an O-SII. The analysis of costs considers the impacts across this cohort of firms based on PRA records from 2022. The number of firms affected is 144, consisting of 107 banks and 37 building societies.

2.21 Operational compliance costs to firms: The incremental operational compliance costs to affected firms arise from the requirement on firms to implement a framework for preparing for solvent exit, to produce and maintain a solvent exit analysis, and to embed solvent exit planning into BAU. To estimate these costs, the PRA gathered input from PRA supervisors on the additional amount of time and effort they expect firms under their review to expend to comply with the new requirements. The PRA also reviewed previous CBAs to help inform this input. The PRA then conducted desk-based analysis using this input along with salary data from the 2023 Robert Walters Salary Guide on key staff and job roles expected to undertake the incremental work.^{footnote [10]}

2.22 Table 1 reports the estimated one-off and ongoing operational compliance costs for in-scope firms individually and in aggregate based on this analysis. Given the uncertainty around the estimates, the table reports indicative ranges (lower and upper estimates) for each measure. In summary, the PRA estimates:

• one-off implementation costs of between £25,000 and £75,000 per firm (between £4 million and £10 million for all in-scope firms)
• ongoing costs of between £10,000 and £25,000 per firm (between £2 million and £4 million for all in-scope firms) annually
• total discounted present value costs of between £325,000 and £775,000 per firm (between £50 million and £110 million for all in-scope firms)

Table 1: Estimate of operational compliance costs per firm and for all affected firms^(a)

2.23 One-off costs to firms: The PRA anticipates additional time would be spent by firms to familiarise themselves with the proposals, conduct a gap analysis, set up internal governance, and put together the first solvent exit analysis. The PRA estimates that this incremental time would be roughly equivalent to one full-time equivalent (FTE) staff, depending on the complexity of the firm’s business model and the extent to which it may be able to leverage and adapt its existing infrastructure around recovery planning for solvent exit purposes. The PRA considers that the additional tasks would be completed by a variety of staff across several different job categories, and that direct one-off implementation costs would range between £25,000 and £75,000 per firm, or between £4 million and £10 million in aggregate.

2.24 Ongoing costs to firms: The PRA anticipates ongoing costs for firms to review their solvent exit analysis and make any necessary changes, as well as monitor relevant indicators. The additional time needed will depend on the complexity of firms’ business models (and the possibility that a firm may change its business model throughout its life). To account for this, the PRA has provided a range of the estimated on-going compliance costs. The PRA estimates annual, incremental time would be equivalent to less than one FTE, and assumes additional tasks would be fulfilled by staff across a variety of job categories. On this basis, annual ongoing compliance costs would range between £10,000 and £25,000 per firm (or between £300,000 and £700,000 in present value terms). Aggregate ongoing costs would amount to between £2 million and £4 million annually (or between £45 million and £100 million in present value terms).

2.25 Total costs to firms: Combining one-off and ongoing costs, the PRA estimates the present value of total direct compliance costs would be between £325,000 and £775,000 per firm (between £50 million and £110 million in aggregate).

Costs to the PRA

2.26 There would be additional costs to the PRA for supervising against the proposed rules and expectations on solvent exit. Supervisory time and resource will be required to review and engage with firms regarding their solvent exit documentation. The PRA expects that some of this cost will be offset by improved efficiency of any solvent exits that do occur.

Overall assessment of costs against benefits

2.27 The PRA considers that the cost to firms from these proposals would not be excessive and would be outweighed by the benefits. The proposals would allow firms to, where appropriate, make use of the work, analysis, and governance that they already have in place for recovery planning, which would significantly reduce costs. The proposals are also designed to apply proportionately to the nature and scale of a firm’s activities. The expected benefits of the proposals are far-reaching, including minimising disruption to the wider market and reducing the burden on FSCS funds (and hence avoiding additional costs to the industry).

2.28 Overall, the PRA views the costs to firms and the PRA itself to be outweighed by the long-term benefits to financial stability, firms, and the PRA.

‘Have regards’ analysis

2.29 In developing these proposals, the PRA has had regard to the FSMA regulatory principles, and the aspects of the Government’s economic policy set out in the HMT letter from December 2022. The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposal:

• Proportionality (FSMA regulatory principles and Legislative and Regulatory Reform Act 2006): The proportionality principle is embedded within the proposed rules and expectations by stating that a firm’s BAU solvent exit planning should be appropriate to the nature and scale of the firm’s activities. In addition, and where appropriate, firms may use their work under existing recovery planning requirements to meet, or begin to meet, some of the proposals.
• The need to use the resources of each regulator in the most efficient and economic way (FSMA regulatory principles): The proposals would support more timely and orderly solvent exits. Such an outcome should decrease how much PRA resource is required to oversee or facilitate such exits.
• Better outcomes for consumers (HMT recommendation letter): An orderly solvent exit should result in improved outcomes for depositors (when compared with an excessively protracted exit or insolvency). As part of a solvent exit, firms would repay (or transfer) deposits in full and in a timely manner, without recourse to the FSCS.
• Transparent exercise of PRA’s functions (FSMA regulatory principles and Legislative and Regulatory Reform Act 2006): The proposals include the creation of new rules that would help ensure clarity for firms on what is required of them and how to best prepare themselves for a potential solvent exit.

2.30 The PRA has had regard to other factors as required. Where analysis has not been provided against a ‘have regard’ for these proposals, it is because the PRA considers that ‘have regard’ to not be a significant factor for this proposal.

Impact on mutuals

2.31 FSMA requires that the PRA assesses whether, in its opinion, the impact of the proposed rules on mutuals will be significantly different from the impact on other firms. While the PRA does not consider the impact to be different, it notes that the Building Societies Act 1986 provides options for how the dissolution of a building society may be executed. The PRA is considering whether publishing guidance on these options may be helpful in assisting building societies with their planning to meet the PRA’s rules on solvent exit.

Equality and diversity

2.32 The PRA has assessed whether the proposal gives rise to equality and diversity implications, and considers that, given the nature of the changes proposed, there is no impact.