PRA consults on implementation of Basel III standards in the UK

On 12 February 2021, the Prudential Regulation Authority (PRA) published Consultation Paper (CP5/21) on the implementation of the Basel III standards into UK law (CP). This is the first major PRA publication after the end of the Brexit transitional period. The draft rules are generally closely aligned (but not identical) to the corresponding requirements under the EU’s CRR II.

Stakeholders may provide their feedback to the Consultation by Monday 3 May 2021.

Background

CRR II implements the remaining Basel III standards (which were not covered by the Capital Requirements Regulation (EU) No 575/2013 (CRR)) into EU law. However, given that most of the CRR II provisions come into force on 28 June 2021 (i.e. after the end of the Brexit transitional period) they have not been transposed into UK law. Instead, the remaining Basel III standards will be implemented into UK law through the Financial Services Bill, which will give the PRA the power to adopt relevant rules. 

In general, the PRA has used CRR II as an initial basis for the UK framework, but also proposing to take a different approach where this is deemed necessary in order to achieve closer alignment with the Basel III standards, enhance proportionality of the UK regime and ensure consistency with the existing UK rules. For the most part, the new UK prudential framework will apply from 1 January 2022.

The Consultation does not cover amendments to the UK’s leverage ratio regime, which will be considered separately by the Financial Policy Committee (FPC) and Prudential Regulation Committee (PRC).

Overview of key proposals

• Definition of capital / deduction of software assets from CET1: A main area of divergence between the EU and the UK concerns the capital treatment of certain software assets. Generally, under the Basel III standards ‘intangible assets’ must be deducted from Common Equity Tier 1 (CET1) capital, on the basis that they are not sufficiently loss absorbent on a going concern basis. The EU CRR II rules exclude certain software assets from the requirement for CET1 deduction. The PRA has previously expressed concerns with the EU approach. Therefore, the draft UK rules require that all intangible assets (including software assets that qualify as intangible assets under International Financial Reporting Standard (IFRS) or the applicable accounting standards) should be fully deducted from CET1, with no exception. The PRA intends to implement the relevant changes as soon as possible.
• Counterparty credit risk: The PRA proposes to introduce a new standardised approach for measuring counterparty credit risk exposures (SA-CCR) for firms that are not permitted to use the internal model method (IMM) and a revised framework for firms’ exposures to central counterparties (CCPs). The PRA also proposes to introduce a simpler, more conservative SA-CCR approach for certain smaller firms. This forms part of a series of draft measures that aim to make the UK prudential framework more proportionate, particularly for smaller institutions.
• Market risk: The Consultation includes changes to the requirements for the trading book, particularly regarding the requirements on prudent valuation. In addition, the PRA proposes to amend the eligibility requirements for derogation for small trading book business by increasing the relevant thresholds, thereby allowing more firms with limited trading activities to be exempt from certain market risk requirements. In particular, the PRA proposes to replace the relevant thresholds under the EU CRR with a threshold of 5% of a firm’s total assets and an absolute threshold of GBP44 million (which is more than twice as high compared to the current EU absolute threshold).
• Operational risk: The draft rules aim to clarify certain ambiguities that have been identified regarding the method of calculation used for the basic indicator approach (BIA), in particular by making explicit the treatment of leasing assets.
• Large exposures: The CP implements the Basel III standards’ revised large exposures framework, which will generally be aligned to the CRR II relevant framework.
• Liquidity rules: In addition to implementing the Basel III standards on the Net Stable Funding Ratio (NSFR), the draft rules introduce a simplified (but at least as conservative) version of the NSFR that small and non-complex firms may choose to apply. With regards to the Liquidity Coverage Ratio (LCR), the PRA intends to replicate the relevant requirements under the CRR and the relevant Delegated Acts into the PRA rules, but also clarify certain definitions.
• Exposures to Collective Investment Undertakings (CIUs): The draft rules revise the prudential requirements applicable to CIU exposures by introducing an updated hierarchy of approaches to determine relevant capital requirements: (i) a revised look through approach (LTA), that can be used where a firm has sufficient information on the underlying exposures of the CIU, and the information is verified by a third party; (ii) a mandate based approach (MBA) and (iii) a fall back approach (FBA) which can be used when the LTA and MBA are not feasible and under which a 1,250% risk weight would apply. The PRA intends to allow firms to apply a combination of the three approaches to their CIU exposures, provided the relevant conditions for their use are met.
• Currency denomination of thresholds and monetary values: As a general rule, the PRA intends to redenominate thresholds and monetary values included in the proposed PRA rules from Euros (EUR) into Pound Sterling (GBP) (with the exception of the thresholds for disclosure of the number individuals that receive remuneration of EUR1 million or more per financial year).
• Updates to supervisory reporting: Among other things, the PRA proposes to update the UK version of COREP and FINREP and intends to use as basis version 3.0 of the European Banking Authority’s (EBA) reporting taxonomy, which has also been updated recently to in light of the Basel III standards.
• Pillar 3 disclosure: The relevant proposals aim to align the Pillar 3 disclosures of UK firms to the relevant Basel III requirements and improve the comparability, quality, and consistency of firms’ regulatory disclosures.