CP8/24 – Definition of Capital: restatement of CRR requirements in PRA Rulebook

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Responses are requested by Thursday 12 December 2024.

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1: Overview

1.1 Sections 1 and 4 of the Financial Services and Markets Act (FSMA) 2023 provide for the revocation and restatement of financial services assimilated law in secondary legislation. This is to give way to a comprehensive FSMA model of regulation, and means that most firm-facing provisions of the Capital Requirements Regulation (CRR) will be replaced by the Prudential Regulation Authority’s (PRA) rules.

1.2 HM Treasury (HMT) has today announced its intention to bring into force the revocation of CRR requirements relating to the definition of own funds. This consultation paper (CP) sets out the PRA’s proposed rules to restate, and in some cases modify, these requirements in the PRA Rulebook.

1.3 The PRA proposes in Proposal 1 to restate the vast majority of the requirements without substantive change. The PRA considers that these requirements advance the PRA’s objectives, including by promoting the safety and soundness of PRA-authorised firms.

1.4 The PRA also proposes to make some minor adjustments to certain requirements. These are designed to enhance the proportionality or transparency of the PRA’s approach and cover the following elements of the definition of own funds framework:

• Proposal 2 – proportionality in the Pre/Post-Issuance Notification (PIN) regime;
• Proposal 3 – inclusion of interim profits in Common Equity Tier 1 (CET1) capital resources;
• Proposal 4 – reduction of Additional Tier 1 (AT1) and Tier 2 instruments;
• Proposal 5 – clarify the regulatory capital treatment of non-CET1 shares;
• Proposal 6 – require PRA permission for additional forms of capital reduction; and
• Proposal 7 – permit the terms governing CET1 instruments to reflect the possibility of (but not commit to) a future capital reduction.

1.5 The proposals in this CP would be implemented through:

• amendments to the Own Funds and Eligible Liabilities (CRR) Part and the Definition of Capital Part of the PRA Rulebook (Appendix 1);
• a draft new statement of policy (SoP) – The PRA’s approach to waivers and permissions under Own Funds (CRR) Part (Appendix 2); and
• amendments to supervisory statement (SS)7/13 – Definition of capital (CRR firms) (Appendix 3).

1.6 The PRA is additionally proposing adjustments relating to the definition of own funds that would form part of the PRA’s Strong and Simple Framework. These adjustments are explained in CP7/24 – The Strong and Simple Framework: The simplified capital regime for Small Domestic Deposit Takers (SDDTs), which has been published simultaneously.^{footnote [1]}

1.7 Some of the draft rules contained in this consultation may need to be updated following the restatement of other CRR provisions in the PRA Rulebook. The PRA will consult on any such changes as part of its consultation on the restatement of those provisions in due course.

1.8 This CP is relevant to banks, building societies, PRA-designated investment firms and PRA-approved, or PRA-designated, financial or mixed financial holding companies. It is not relevant to credit unions or third-country branches.

1.9 The PRA has a statutory duty to consult when introducing new rules or changing existing rules (FSMA s138J). When not making rules, the PRA has a public law duty to consult widely where it would be fair to do so. 

1.10 None of the statutory panels was consulted about the proposals in this CP.

1.11 In carrying out its policymaking functions, the PRA is required to comply with several legal obligations. One such requirement is to have regard to certain matters when developing policy proposals. The analysis in this CP explains how the proposals have had regard to these matters, including an explanation of the ways in which this has affected the proposals.

1.12 The ‘have regard’ considerations that were significant in the PRA’s analysis in this case included the efficient use of PRA resources, the principle that the PRA should exercise its powers proportionately, growth and the ability of CRR firms to continue to provide finance, and smart regulatory reform and the Future Regulatory Framework Review.

1.13 In this CP and the appendices, the term ‘own funds’ is synonymous and used interchangeably with ‘regulatory capital’ or ‘capital’. For example, ‘own funds instruments’ is interchangeable with ‘regulatory capital instruments’. ‘Own funds’ is used in this consultation when referring to material in the draft Rules Instrument, as this term has been used in the Instrument to ensure coherence with the other parts of the CRR. ‘Regulatory capital’ or ‘capital’ is used when referring to material in SS7/13, as these are the terms employed by the PRA in the SS and more generally.

Cost benefit analysis (CBA)

1.14 The PRA considers that its proposal to largely preserve the existing CRR requirements – Proposal 1 – should not result in material additional benefits or costs.

1.15 Following the publication of policy statement (PS) 22/21 – Implementation of Basel Standards: Final rules, Article 36 of the CRR was restated in the Own Funds and Eligible Liabilities (CRR) Part of the PRA Rulebook. The PRA proposes to restate other own funds-related provisions in the same Part. The PRA considers this should make it easier for firms to access and understand the requirements to which they are subject.

1.16 The PRA has considered the costs and benefits of the policy adjustments set out below. This is relative to the baseline of the relevant existing requirements in the CRR and PRA rules, and the expectations contained in SS7/13. Overall, the PRA expects the following proposals would reduce costs for firms:

• the PRA’s proposed PIN approach in Proposal 2 would not require firms to assemble and submit PINs relating to certain issuances of CET1 instruments. This proposal would reduce compliance costs, particularly for firms that frequently issue CET1 instruments (for example, as part of an employee share purchase programme);
• Proposal 4 would build in flexibility for PRA to permit capital reductions in certain limited circumstances that are not possible under the CRR. The PRA expects that in those cases, firms may benefit from a reduced ‘cost of carry’ of capital instruments;^{footnote [2]} and
• Proposals 5 and 7 on non-CET1 shares and CET1 instruments would clarify CRR requirements in a manner that achieves greater proportionality, making them easier to interpret and apply. This may result in a minor reduction in costs for some firms, in that there could be a lower cost for firms in determining what is required.

1.17 The PRA expects that Proposals 3 and 6 on interim profits and capital reductions would be unlikely to have a material impact on costs.

‘Have regards’ analysis

1.18 In developing these proposals, the PRA has had regard to its framework of regulatory principles. The regulatory principles that the PRA considers are most material to the proposals include:

• The need to use the PRA’s resources in the most efficient and economical way: The overall approach of largely retaining the substance of the CRR’s existing requirements is less resource intensive than the alternative approach of redesigning all such requirements. This should help to support a timely transition to the UK’s new model of regulation. The approaches outlined in Proposal 2 and Proposal 3 on the PIN regime and interim profits would result in the PRA expending fewer resources assessing notifications and applications (respectively) where the PRA considers there generally to be a low risk to its objectives. This should allow the PRA to redeploy resources to higher risk activities.
  
• 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 was guided by the principle of proportionality in deciding the policy adjustments it proposes be made as part of the restatement of CRR requirements in the PRA Rulebook. Of the six proposed policy adjustments:

(a) Five proposals (Proposals 2, 3, 4, 5, and 7) would remove or reduce the impact of CRR requirements on firms. In those cases, based on its experience as a supervisor, the PRA considers adjustment of the policy to be needed to ensure that the cost of the requirements would be commensurate with the prudential benefit. The PRA expects that Proposal 2 would have a particularly beneficial impact for firms that frequently issue CET1 shares, for example as part of an employee share purchase programme.

(b) One proposal (Proposal 6) would extend current CRR requirements to gain prior PRA permission before undertaking capital reductions, but the PRA considers this to be proportionate to the risk posed to its objectives.

• Growth and the ability of CRR firms to continue to provide finance: The majority of the proposed policy adjustments in this CP seek to relieve administrative burden or clarify the nature of the requirement, with no direct impact on these ‘have regards’. However, Proposal 3 may be supportive, insofar as it facilitates the release of unnecessary regulatory capital.
• Smart regulatory reform and the Future Regulatory Framework Review: The proposals support the swift implementation of the outcomes of the Future Regulatory Framework Review.

1.19 The PRA has had regard to all the other ‘have regard’ factors required. Where analysis has not been provided against a ‘have regard’ for this set of proposals, it is because the effect of that ‘have regard’ was not significant for this set of proposals.

Impact on mutuals

1.20 The PRA considers that the impact of the proposed rule changes on mutuals would generally not be significantly different from that on other firms. Proposal 5 on non-CET1 shares may have less impact on mutuals owing to the nature of their capital structures.

Equality and diversity

1.21 In developing its proposals, the PRA has had due regard to the equality objectives under s.149 of the Equality Act 2010. The PRA has not identified a link between definition of capital and equality and diversity.

Structure of the CP

1.22 The replacement of assimilated law on Definition of Capital would require the creation of new or amendment of existing policy as follows:

• Chapter 2 summarises the effects of the proposed rules. These consist of new rules to replace relevant provisions in the CRR, to be included in the renamed Own Funds (CRR) Part of the Rulebook, and consequential amendments to some existing rules in the Definition of Capital Part;
• Chapter 3 sets out consequential amendments to SS7/13; and
• Chapter 4 sets out a proposal for a new statement of policy on the PRA’s approach to Definition of Capital-related permissions.

Implementation

1.23 The PRA intends to consult on the implementation date for these proposals when it consults on restating other CRR provisions in due course.

Responses and next steps

1.24 This consultation closes on Thursday 12 December 2024. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP8_24@bankofengland.co.uk.

1.25 When providing your response, please tell us whether or not you consent to the PRA publishing your name, and/or the name of your organisation, as a respondent to this CP.

1.26 Please also 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.

1.27 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 [3]}

2: Restating relevant CRR provisions in the PRA Rulebook

2.1 This chapter sets out the PRA’s proposed new rules on own funds. These are intended to be located in the Own Funds and Eligible Liabilities (CRR) Part of the PRA Rulebook, to be renamed the Own Funds (CRR) Part, and in the Definition of Capital Part.

Proposal 1: general approach

2.2 The own funds provisions of the CRR implement the Basel CAP standard that helps to ensure the high quality of firms’ capital bases. The PRA’s proposed general approach under Proposal 1 would largely restate in PRA rules the current CRR requirements in this area. As part of this restatement, the PRA proposes to make some modifications compared to the assimilated requirements to ensure their operability in the PRA Rulebook, and to omit some provisions that are not necessary or relevant for UK firms. The PRA also proposes to remove from existing rules a provision that will no longer be necessary.^{footnote [4]}

2.3 Provisions concerning eligible liabilities items or instruments do not fall within the scope of this consultation. The Bank of England (‘the Bank’), as the UK resolution authority, is preparing changes to its MREL statement of policy to take account of the Government’s intended revocation of these provisions. The Bank will consult on its approach to these provisions in due course. The PRA may consult on consequent changes to linked provisions.

2.4 In addition to the general approach of Proposal 1, there are six provisions that the PRA proposes to restate with substantive policy modifications; these modifications are set out below in Proposals 2 – 7. The PRA proposes not to restate Article 31, ‘Capital instruments subscribed by public authorities in emergency situations’. This reflects the introduction of significant relevant reforms since the global financial crisis.

PRA objectives analysis

2.5 The PRA considers that its proposed general approach under Proposal 1 would advance the PRA’s general objective of promoting the safety and soundness of PRA-authorised persons. This is because the relevant requirements of the CRR seek to ensure that firms’ regulatory capital is of sufficient quality and is available to absorb losses, thereby helping to ensure their resiliency.

2.6 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) competition; and (ii) competitiveness and growth. Notwithstanding that current requirements would largely be preserved, the PRA considers that there would likely be some positive impact on both secondary objectives:

• restating requirements into the PRA Rulebook would make it easier for firms to access and understand the provisions that apply to them. This is relative to the alternative, under which a greater number of the requirements to which firms are subject would be divided between assimilated legislation and the Rulebook. The PRA considers that the proposed approach would therefore help to further the aims of reducing barriers to entry, facilitating effective competition, and making it more attractive to operate in the UK;
• moving obligations from legislation into the PRA Rulebook would allow the PRA to be more responsive and flexible in adjusting requirements to address emerging risks or future innovation. It is more straightforward for the PRA to amend its rules than for legislation to be amended; and
• limiting substantive changes to existing requirements would minimise adjustment costs for firms.

Proposal 2: proportionality in the PIN regime

2.7 The current approach to the notification and approval of new or amended capital instruments is set out both in the CRR and in the PRA’s PIN rules.^{footnote [5]}

2.8 The PRA proposes to modify the requirements such that:

• firms would not need to submit a notification to the PRA when issuing CET1 on terms identical to those that the PRA has previously approved; and
• firms would be able to notify the PRA of CET1 and AT1 transactions^{footnote [6]} on terms that are ‘substantially the same’ as those the PRA has previously reviewed as soon as practicable after they have taken place, rather than beforehand.^{footnote [7]}

2.9 To put this proposal into effect, the PRA would make changes to the current CRR text,^{footnote [8]} as well as the existing PIN rules^{footnote [9]} and SS7/13.^{footnote [10]}

PRA objectives analysis

2.10 The PRA views the PIN regime as an essential tool to ensure the quality of firms’ capital, and therefore their safety and soundness. The PRA considers that the proposal would result in a regime that is more proportionate, while continuing to ensure that CET1 and AT1 instruments that meet the relevant minimum requirements are recognised in firms’ resources.

2.11 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) effective competition; and (ii) competitiveness and growth. The PRA expects that the proposal would not have any implications for effective competition. The PRA expects that the proposal would have a minor positive impact on competitiveness and growth via a reduction in compliance costs for firms.

Proposal 3: inclusion of interim profits in CET1

2.12 The CRR requires firms to obtain PRA permission before including interim profits in their CET1 capital resources. The interim profits must first be independently verified by firms’ auditors and reduced by any foreseeable charge or dividend for the period.^{footnote [11]}

2.13 In restating this requirement in PRA rules, the PRA proposes to modify it to require firms to submit a notification after they include any verified interim profits in CET1, rather than apply for prior permission. The PRA’s view is that the requirement for independent verification of the interim profits provides adequate assurance that the profits have been evaluated in accordance with the principles set out in the applicable accounting framework.^{footnote [12]}

PRA objectives analysis

2.14 The prudential rationale for controls on the inclusion of interim profits in CET1 is to provide safeguards against the potential overstatement of those profits, and therefore the firm’s available CET1 resources. The quantity and quality of capital available to absorb losses is fundamental to a firm’s safety and soundness. The PRA considers that the proposal to retain the requirement for independent verification, but replace the permission requirement with a notification requirement, is a proportionate approach that supports safety and soundness by continuing to apply a requirement for assurance through independent verification.

2.15 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) effective competition; and (ii) competitiveness and growth. The PRA expects that the proposal would be unlikely to have any implications for effective competition. On competitiveness and growth, the PRA notes that a similar approach is taken in the Basel CAP standard. CAP provides for the possibility that national authorities put in place appropriate audit, verification or review procedures before interim profits may be included in capital resources, without specifying that any such procedures are required.^{footnote [13]} The proposal would therefore comply with CAP in a more proportionate way, which could have a minor positive effect on competitiveness and growth. The PRA does not expect Proposal 3 would result in a material reduction in compliance costs for firms given that they would still be required to obtain verification and submit a notification.

Proposal 4: reduction of AT1 and Tier 2 instruments

2.16 Under CRR, the repurchase of AT1 and Tier 2 instruments within five years of their issuance is prohibited other than in prescribed circumstances.^{footnote [14]} This aims to ensure that capital has an appropriate degree of permanence and is available to absorb losses when needed. However, the PRA considers there to be a narrow set of exceptional circumstances in which it could also be prudent and proportionate for firms to repurchase AT1 or Tier 2 within five years of issuance.

2.17 The PRA proposes to permit firms to repurchase AT1 and Tier 2 instruments within five years of their issuance where the PRA considers that it would materially enhance the safety and soundness of the firm.^{footnote [15]}

PRA objectives analysis

2.18 The PRA considers that allowing AT1 and Tier 2 instruments to be repurchased within 5 years of issuance in certain exceptional circumstances could both promote firms’ safety and soundness and be proportionate.

2.19 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) effective competition; and (ii) competitiveness and growth. The PRA expects that the proposal would be unlikely to have any implications for effective competition. The PRA expects that the proposal may have a small positive effect on competitiveness and growth, as it may allow some firms to allocate capital more efficiently than they can today. The PRA notes that the relevant CAP standard prohibits calling capital instruments within five years of their issuance (subject to certain exemptions) but does not prohibit their repurchase, provided that supervisory approval is granted.^{footnote [16]}

Proposal 5: clarify the regulatory capital implications of non-CET1 shares

2.20 The PRA proposes to clarify certain CRR wording on the interaction between CET1 and non-CET1 shares.^{footnote [17]}

2.21 The PRA proposes to clarify explicitly in PRA rules that the eligibility of capital instruments for CET1 would not be precluded by the existence of non-CET1 shares that confer on the holder a claim:

• that ranks in insolvency or liquidation equal to, or better than, that of a CET1 instrument holder; or
• on a prescribed percentage of the firm’s residual assets.

PRA objectives analysis

2.22 The PRA considers this proposal to be consistent with its safety and soundness objective. Clarifying that non-CET1 shares may rank pari passu with CET1 shares is proportionate and does not undermine the strength of the capital base. The PRA considers that clarifying that the presence of non-CET1 shares that carry a claim on a given proportion of residual assets does not undermine the quality of CET1 as CET1 shareholders’ potential return would remain unlimited and they could still lose the full amount of their investment.

2.23 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) effective competition; and (ii) competitiveness and growth. The PRA expects that the proposal would be unlikely to have any implications for its secondary objectives.

Proposal 6: require PRA permission for additional forms of capital reduction

2.24 The CRR specifies that permission is required before effecting the ‘call, redemption, repayment or repurchase’ of an AT1 or Tier 2 instrument prior to its contractual maturity.^{footnote [18]} It omits from the list of items requiring permission other transaction types that may result in a reduction of capital.

2.25 The PRA addressed this omission explicitly in SS7/13. The SS sets an expectation that firms obtain prior permission before undertaking any other form of transaction that would have the effect of reducing regulatory capital instruments and related share premiums (for example, de-recognising an instrument as regulatory capital).^{footnote [19]} In order to ensure that a consistent approach is taken, the PRA proposes to specify this as a requirement in PRA rules.^{footnote [20]}

PRA objectives analysis

2.26 The PRA views the capital reduction permissions regime as essential for advancing its primary objective of promoting the safety and soundness of firms. The proposal to elevate the PRA’s expectations into the rules reinforces the importance of the permission requirement and would help to ensure that firms do not reduce their capital without such permission.

2.27 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) effective competition; and (ii) competitiveness and growth. The PRA expects that the proposal would be unlikely to have any implications for its secondary objectives, given that it already expects firms to apply for a permission in relevant circumstances.

Proposal 7: permit the terms governing CET1 instruments to reflect the possibility of a future capital reduction

2.28 The PRA proposes to clarify that the possibility of a future reduction to an instrument does not render that instrument ineligible as CET1.

2.29 CRR allows CET1 instruments to be reduced at the firm’s discretion, with prior PRA permission.^{footnote [21]} Separately, CRR prohibits CET1 instruments’ terms indicating that they would or ‘might be’ reduced, other than at liquidation.^{footnote [22]} This could cause uncertainty as to whether, for example, CET1 terms could provide for the firm to conduct discretionary share repurchases.

2.30 The PRA proposes to restate these CRR provisions with a modification to clarify that the possibility of a future reduction would not of itself undermine an instrument’s permanence. Any such capital reductions would be subject to prior PRA permission.

PRA objectives analysis

2.31 The PRA considers that the proposal would not undermine the achievement of the PRA’s primary safety and soundness objective, and would be more consistent with a framework that permits capital reductions with PRA prior permission.

2.32 The PRA has assessed whether this proposal facilitates its secondary objectives of: (i) effective competition; and (ii) competitiveness and growth. The PRA expects that the proposal would be unlikely to have any implications for its secondary objectives.

3: Consequential amendments to SS7/13

Proposal 8: amend SS7/13 to facilitate other proposals

3.1 In order to give effect to the changes detailed in Proposals 2 and 6 above on the PIN regime and capital reductions, it would be necessary to make certain consequential amendments to SS7/13:

• the proposed improvements to the PIN regime set out in Proposal 2 would require corresponding changes to the supervisory statement. For example, it would no longer be necessary for the PRA to set out its interpretation of the CRR term ‘sufficiently in advance’, which appears in the context of firms being required to notify the PRA of upcoming issuances of CET1 instruments. This term would not appear in the PRA Rulebook, because relevant issuances would either be moving to a post-notification regime, or would not be subject to a PIN requirement at all; and
• SS7/13 currently includes an expectation that firms seek prior permission for any form of reduction of regulatory capital instruments. This expectation would no longer be required if, per Proposal 6, there is a rule for the same purpose.

3.2 The PRA additionally proposes some drafting changes to aid readability and reduce the length and complexity of the SS.

PRA objectives analysis

3.3 The PRA considers the proposed amendments to SS7/13, in themselves, to be neutral with respect to both its primary and secondary objectives. The impact of the relevant proposals is explored in paragraphs 2.10 – 2.11 and 2.26 – 2.27 of the CP.

4: Draft new statement of policy on approach to own funds permissions

4.1 Sometimes it may be appropriate for rules to vary if the PRA is satisfied that a firm meets specific criteria. This is achieved through permissions, modifications, or waivers.

4.2 FSMA 2023 gives the PRA a new power. Section 138BA of FSMA allows the PRA, on application or with the consent of a person who is subject to the PRA rules, to give the person a permission that enables them not to apply the rules, or to apply the rules with a modification specified in the permission.^{footnote [23]} This new power is available in relation to PRA rules specified by HMT. HMT has specified that the power will be available in relation to most rules made by the PRA.^{footnote [24]} The PRA proposes to use this power to give effect to the permission requirements in the own funds provisions of the CRR. In order to ensure continuity, HMT has announced that it intends to introduce legislation to ‘save’ all Definition of Capital-related permissions granted under the CRR.

Proposal 9: set out the criteria for own funds-related permissions in a statement of policy

4.3 The own funds provisions of the CRR contain a number of permission requirements. For example, firms are required to apply to the PRA for permission to reduce capital instruments.^{footnote [25]} The CRR specifies the conditions that the PRA must consider when assessing these applications.

4.4 In line with the approach to s138BA proposed in CP3/24, the PRA proposes to publish a SoP (see Appendix 2) to set out the criteria or factors that the PRA will consider in deciding whether to grant own funds-related permissions in the PRA Rulebook. In all but one case, these reflect the existing conditions in the CRR. The exception relates to Proposal 4 in Chapter 2 above, where the PRA proposes to revise the conditions that are currently set out in Article 78(4) to provide further flexibility regarding the repurchase of capital instruments within five years of issuance.

PRA objectives analysis

4.5 The PRA’s analysis of the effect of its overall approach to permissions is set out in CP 3/24.

4.6 The PRA considers that its proposed approach of largely preserving the own funds-related permissions criteria from the CRR when replacing them with PRA rules would advance the PRA’s general objective of promoting the safety and soundness of PRA-authorised persons. This is because the relevant criteria help to ensure that firms’ regulatory capital is of sufficient quality and will be available to absorb losses, thereby protecting depositors and other senior creditors. Where the criteria would be adjusted to facilitate the repurchase of capital instruments within five years of their issuance, this would be limited to situations in which the repurchase would materially enhance the safety and soundness of the firm.

4.7 The PRA has assessed whether this proposal would advance its secondary objectives of: (i) competition; and (ii) competitiveness and growth. The PRA considers that the proposed SoP would be neutral insofar as the relevant criteria from the CRR are preserved. As set out in paragraph 2.19 of the CP, the PRA considers that adjusting the criteria for capital reduction permissions may have a small positive effect on competitiveness and growth.