By Michael Beaton

Introduction

On 19 December 2013, the Prudential Regulation Authority (PRA) issued Policy Statement PS8/13 together with two Supervisory Statements, SS18/13 on recovery planning, and SS19/13 on resolution planning.  Together, this guidance details the PRA’s final RRP rules for UK banks, building societies and UK designated investment firms. Their publication follows on from the FSA’s original consultation paper (CP11/16) and Feedback Statement (FS12/1).  The final rules are set out in the PRA Rulebook Recovery and Resolution Instrument 2013 (PRA 2013/37), which is annexed to PS8/13 and come into force 1 January 2014.

Policy Statement PS8/13: Recovery and Resolution Plans

As the title suggests, PS8/13 addresses both recovery planning and resolution planning.  There is a general recognition that regulatory requirements will have to evolve over time so as to ensure continued consistency with the Financial Stability Board’s (FSB) ‘Key attributes of effective resolution regimes’ and the EU Bank Recovery and Resolution Directive (RRD).  Despite this, recovery planning information requirements have not been amended significantly from FS12/1, except that:

• Supervisory Statement SS18/13 emphasises that firms should identify actions necessary to improve the credibility and effectiveness of a recovery plan; and
• The requirement to automatically submit a remediation plan on meeting recovery triggers pre-agreed with the PRA has been removed.

In contrast, resolution planning data requirements have been revised in light of the PRA’s experience over the previous 18 months with a view to being more targeted in nature and proportionate to the size and complexity of the firm in question.

Supervisory Statement SS18/13 Recovery Planning

The purpose of a recovery plan is to enable a firm to recover from a range of severe financial stresses caused by idiosyncratic problems, market-wide stress or both.  Under SS18/13, the key elements of a recovery plan include:

• Confirmation that the firm’s Board (or other appropriate committee) has reviewed and approved the recovery plan;
• A summary of the complete list of recovery options and an overview of further possible options; A description of each recovery option using a consistent framework;
• Ensuring that the recovery plan is embedded into the firm’s risk management framework;
• Identification of a range of plan activation triggers;
• Clear escalation and decision-making processes;
• Operational plans for accessing central bank liquidity; and
• A communication plan.

In all material respects, these requirements mirror Module 2 (Recovery Plan) of FS12/1.  However, some changes have occurred with respect to more detailed data requests, including:

• “Plan for accessing central bank facilities” - previously, firms were required to “consider” the appropriate amount of assets to pre-position within a central bank facility whereas now they are required to actually ensure that an appropriate amount are pre-positioned;
• “Disposals” – firms are now required to consider fair valuation of the balance sheet, data room capabilities and how these impact recovery option creditability in the event that a merger or sale of the whole firm is a relevant recovery option;
• “Remediation measures” - a new subsection 5 is included, requiring firms to identify actions which should be taken to improve recovery plan credibility.

Supervisory Statement SS19/13 Resolution Planning

General

Broadly, resolution planning requires firms to submit ‘packs’ of information which allow authorities to identify appropriate resolution strategies and work to identify and remove barriers to resolution.

SS19/13 is organised in two “phases”.  Phase 1 requires baseline information to be provided by all firms on group structure, significant legal entities[Footnote 1] and a firm’s business model which is used to establish a preferred resolution strategy.  In this sense, it mirrors Modules 3 and 4 of FS12/1.  It is split into two Parts (A and B), with the possibility of ad hoc information requests if required.  First submissions of Phase 1 information must be made within 15 months of the publication of SS19/13.  Thereafter, the PRA will request resubmission of Phase 1 information every two years or following a material change to the firm’s structure or business activities.

Phase 2 applies in circumstances where authorities require further information in support of the preferred resolution strategy.   The exact nature of the information requested will depend on the preferred strategy and the particular circumstances of the firm in question.

Phase 1, Part A:  Corporate structure and significant legal entity information

In the main, Part A mirrors Module 3 (Group structure and key legal entity information) of FS12/1, although some minor changes have been made with respect to:

• “Group structure”[2] - including a requirement to provide group consolidated P&L and balance sheet data;
• “Core business lines”[3] – including a new requirement on firms to “highlight material participation in specific markets e.g. banking services provided to UK local authorities or particular industries” as well as geographic concentration of lending and deposits;
• “Capital allocation and mobility”[4] – the previous requirement to provide a summary of capital securities in issue being replaced[5] by a new requirement to provide details of material holdings in other financial institutions;
• “Funding”[6] – enhanced data requirements regarding group funding relationships;
• “Intra-group guarantees”[7] – a new requirement for firms to list the entities that use or are sighted in guarantees, as well as the underlying amounts of contracts that contain “Specified Entity” or similar clauses;
• “Encumbrances”[8] – a new requirement to analyse encumbrances on an intra-group or external basis;
• “Activities and Operations”[9] – a new section which seems to replace the information required in FS12/1 regarding FSCS Deposits[10], Booking practices[11], Interbank exposures[12], Derivatives/securities financing[13], Non-financial interdependencies between legal entities[14], and Analysis of key issues in separation of legal entities[15] and requires firms to provide information on:

        > Deposits;
        > Access to Financial Market Infrastructure (FMI);
        > Cash services;
        > Risk management practices;[16]
        > Counterparty risk management; and
        > Critical shared services.[17]

Footnotes for this section:
[1] Larger firms only - as a guide, this should capture approximately 90% of total balance sheet.
[2] PS19/13 Phase 1, Part A1.1 (previously Module 3.1.1 of FS12/1)
[3] PS19/13 Phase 1, Part A2.1 (which seems to have replaced Module 3.1.3 (“Support Functions”) of FS12/1)
[4] PS19/13 Phase 1, Part A3.1
[5] Although this requirement was largely covered by Module 5a of FS12/1 anyway
[6] PS19/13 Phase 1, Part A3.3
[7] PS19/13 Phase 1, Part A3.4
[8] PS19/13 Phase 1, Part A3.6
[9] PS19/13 Phase 1, Part A4
[10] FS12/1 Module 3.4
[11] FS12/1 Module 3.5
[12] FS12/1 Module 3.6
[13] FS12/1 Module 3.7
[14] FS12/1 Module 3.8
[15] FS12/1 Module 3.9
[16] This largely mirrors the requirements of FS12/1 Module 3.5 (“Booking practices”)
[17] This seems to replace and expand upon the requirements of FS12/1 Module 3.8 (“Non-financial interdependencies between legal entities”)


Phase 1, Part B: Economic Functions

Part B of Phase 1 requests information on firms’ economic functions in order to enable authorities to identify those functions which are critical, need to be protected in resolution and retained in post-resolution restructuring.

Although an exact mapping of changes between PS13/8 and FS12/1 is difficult, broadly, there is an increased emphasis on the provision of granular data with respect to retail and SME deposit taking and lending activities, reflecting a desire to protect taxpayers and the real economy.  Informational requirements in relation to “Trade Financing” activities, “General Insurance” and “Life insurance, pensions, investments and annuities” have also increased.  More minor amendments have been implemented with respect to corporate deposit and lending requirements.  Trading Portfolio data requirements now demand the reporting of outstanding notional amounts of derivatives by asset class and RWA usage also becomes a required field.  New forms are provided for reporting note flow statistics and infrastructure in relation to Cash services and for summarising economic functions performed by each legal entity[Footnote 18].  Finally, some activities previously classified as Economic Functions under FS12/1 no longer appear - including Research, Corporate advisory services, Brokerage, Exchange services and Central clearing services.

[Footnote 18] See “Table on economic functions split by legal entities” – broadly this table seems to be a simplified version of that previously required under FS12/1 Module 4.1.2


Phase 2, Part A: Strategy-specific information requests

The requirements of Phase 2, Part A are driven by the preferred resolution strategy for the firm in question.  They are divided into three main categories:

• Bail-in;
• Partial transfer and bridge bank; and
• Bank Insolvency Procedure.

Bail-in

Information requests regarding bail-in are clearly informed by recent developments in thinking regarding ‘single point of entry’ versus ‘multiple point of entry’ approaches to resolution and the impact this may have on loss-absorbing capacity.  Broadly, they replace Module 5a of FS12/1.  In addition, more robust information requirements have been implemented with respect to:

• Intra-group exposures;[Footnote 19]
• Contract documentation; and
• Operational shared services.

[Footnote 19] In form, this is not too dissimilar to the interbank exposure reporting under FS12/1


Partial transfer and bridge bank

Information provided in relation to this section will enable authorities to assess the feasibility of grouping and separating a firm’s functions into viable business units.  It is sub-divided into 3 sections:

• Effecting a transfer: involving a strategy and business model analysis, asset valuations and identification of barriers to separation;
• Operational shared services – partial transfer/bridge bank: an analysis of critical internal or external operational shared services; and
• Continuity: an assessment of the level of continuity of critical functions provided when executing a transfer of assets and liabilities to a private sector purchaser or bridge bank.

Bank Insolvency Procedure

Most of the information required to assess the feasibility of executing a Bank Insolvency Procedure is already provided to authorities through business as usual regulatory reporting and the information provided in Phase 1.

Phase 2 Part B: Critical function information requests

Any requirements for further information pursuant to this section will depend on the complexity of the individual firm and its preferred resolution strategy.  Tables are provided with respect to the following potential areas of enquiry:

• Payments, clearing and settlement: focussing on critical FMIs;
• Trading book analysis: focussing on the firm’s booking model, trade documentation and operational continuity;
• Cash services: focussing on the scope, scale and operational continuity of cash services;
• Custody services: focussing on the scope, scale and operational continuity of custody services.

Phase 2 Part C:  Additional information requests

To facilitate resolution planning, authorities may require firms to prepare additional information on:

• Business reorganisation plans: restructuring options considered in advance in order to facilitate the timely production of an effective reorganisation plan in the event of resolution;
• Operational continuity: a breakdown of high level costs, split by legal entity and business line as well as an analysis of any group service company model;
• Liquidity: an analysis of funding requirements by and across legal entities and by currency together with information on intraday liquidity;
• Valuation: identification of equity value, quantum of losses or an insolvency counterfactual valuation.

Chapter 3 – Contingent information requests

As they become more stressed or approach resolution, firms should expect to receive requests from the PRA to provide, at short notice, additional or refreshed information relating to:

• Deposit-taking activities;
• Bail-in loss-absorbing capacity;
• Liquidity;
• Collateral assessment; and/or
• Cash services.

Conclusion

In PS8/13, the PRA has clearly both learned the lessons from the first generation of RRPs and raised the bar in terms of informational demands.  Data requirements are more granular and focussed, but also more flexible in nature, reflecting the need to create a consistent benchmark between firms whilst recognising that there is no ‘one size fits all’ policy to the production of a living will.

However, despite the obvious progress, it remains questionable whether as an industry, European banks are any closer to being truly resolvable.  At a macro level, resolution decision making processes under the Single Resolution Mechanism look set to be cumbersome and time-consuming, involving up to 9 committees and 143 votes[Footnote 20].  At a micro level, the requirement under SS19/13 to submit data in (essentially) paper form every two years[21] does nothing to enhance basic resolvability.  Moreover, the RRD, set to be finalised later this month, seems unlikely to address the root cause of the problem.

Fundamentally, resolvability is not about a firm’s ability to muster resource in an effort to meet a bi-annual request for information.  Rather, it is about a firm’s innate ability to generate and refresh new and existing resolution data on request and with minimal effort.  Whilst the result is fundamental system redesign, the trigger will require firms to embrace a culture which places data at the heart of the business, emphasising data integrity, security and flexibility.  Only then will it be possible to aggregate and generate the various view of data necessary in order identify the most appropriate resolution plan, execute it at speed and adapt it as and when necessary, all within the context of the market stress and instability that is likely to accompany the resolution of any global systemically important bank.  The Basel Committee’s recent progress report on the adoption of the Principles for effective data aggregation and risk reporting is arguably a better barometer of bank resolvability.  Even though this is a case of banks marking their own homework, it would suggest that there is a significant amount of work remaining before it is really possible to say that the question of ‘too big to fail’ has been adequately addressed.

[Footnote 20] See the FT, EU ministers set to define banking union
[21] See SS19/13, page 5, paragraph 13

December 2013

Copyright © Derivatives Risk Solutions LLP 2013

Michael  Beaton is a lawyer and managing partner of Derivatives Risk Solutions LLP. 


Email: drs@drsllp.com
Web: www.drsllp.com
Blogs: www.recoveryandresolutionplans.wordpress.com
www.regulatoryreform.wordpress.com

By Michael Beaton

On 10 July 2013, the EU Commission proposed a Single Resolution Mechanism (SRM), a complement to the Single Supervisory Mechanism (SSM) and one of the building blocks of EU Banking Union.  The SRM is designed to ensure that the resolution of a failing banks can be managed efficiently with minimal costs to taxpayers and the real economy.

The proposed SRM would apply the substantive rules of the Recovery and Resolution Directive (RRD). The EU's Council of Finance Ministers reached agreement on a general approach to the RRD on 27 June and the EU Parliament’s Committee on Economic and Monetary Affairs adopted its report on 20 May. Negotiations between the Council and the European Parliament are due to start soon with the aim of reaching final agreement on the RRD in autumn 2013.  At its recent meeting, the EU Council of Ministers set themselves the target of reaching agreement on the SRM by the end of 2013 so that it can be adopted before the end of the current European Parliament term in 2014. This would enable it to apply from January 2015, together with the RRD.

Under the SRM:

• the European Central Bank (ECB) would signal when a bank in the euro area or established in a Member State participating in the Banking Union was in severe financial difficulties and needed to be resolved;
• a Single Resolution Board, consisting of representatives from the ECB, the EU Commission and the relevant national authorities, would prepare the resolution of a bank;
• a Single Bank Resolution Fund, funded by contributions from the banking sector and replacing national resolution funds, would be set up under the control of the Single Resolution Board;
• on the basis of the Single Resolution Board's recommendation, or on its own initiative, the EU Commission would decide whether and when to place a bank into resolution and would set out a framework for the use of resolution tools and the Single Bank Resolution Fund; and
• under the supervision of the Single Resolution Board, national resolution authorities would be in charge of the execution of a resolution plan.

Many countries have yet to give their regulators important powers over recovery and resolution planning, according to the first Peer Review report from the Financial Stability Board (FSB).

"While major legislative reforms have already been undertaken by some FSB jurisdictions (particularly those directly affected by the financial crisis) to develop new, or revise existing, resolution regimes, it is clear that implementation is still at an early stage", says the report.

The FSB also points out that regulatory regimes are generally better developed for banks than for other financial institutions.

A PDF copy of the full report is available here.

by Michael Beaton

On 8 March 2013, the EU Commission published a summary of the responses (67 in total) it received to its October 2012 consultation on a possible recovery and resolution framework for financial institutions other than banks.  

There is also a set of links to individual responses.

The summary addresses views expressed on the three categories of financial Institutions considered in the consultation, being:

• financial market infrastructures (“FMI”) i.e. central counterparties (“CCP”) and central securities depositories (“CSD”);
• insurance companies; and
• other non-bank entities and institutions e.g. payment systems.

Financial Market InfrastructuresThere was general agreement on the need for recovery and resolution plans (“RRP”) for FMIs, due to their systemic importance.  Although resolution measures for all FMIs should focus on ensuring the continuity of essential services, the RRP regimes for CCPs and CSDs should be tailored, reflecting the general view that CCPs are more systemically important than CSDs.  Both the RRP regimes for CCPs and CSDs should be different from the current proposals regarding RRP for banks, although powers to transfer operations of a failing FMI to a purchaser or bridge entity would still be required.  There was little common ground on the application of loss allocation to FMI beyond the need for predictability, clarity, preciseness, transparency and parity.

Insurance and Reinsurance FirmsThere was a wide-spread recognition that insurance companies are less systemically important that banks and that Solvency II will enhance supervisors’ powers of intervention.  Nonetheless, except amongst insurers, there was general support for further investigation into the scope for resolution tools which could protect policyholders as well as financial stability in the event of an insurer’s failure. However, even outside of the insurance industry, there was no conclusive support as to the need for a detailed RRP framework.  The insurance industry objected to insurance-specific RRP proposals, arguing at a high-level that there is no evidence that RRP is needed and specifically that:

• as yet, no sources of systemic risk in insurance have been identified;
• consistency with international developments must be ensured before the EU legislates;
• the current framework is sufficient, particularly in light of Solvency II; and
• bank RRP is not suited to the insurance industry.

Other non-bank financial institutionsThe majority of respondents expressed the view that payment systems currently do not require further consideration from an RRP perspective due to the fact that they are subject to central bank oversight.

By Michael Beaton

As previously reported, on 20 February 2013 the FSA published an update to its Recovery and Resolution Planning guidance.  It was announced that, in the future, firms will not have to update their resolution information pack (RRP Modules 3-6) on an annual basis as a matter of process.  Instead, they will only be required to respond to requests for resolution planning information from their supervisors.

It seems difficult to reconcile the FSA’s new position with other RRP guidance.  The FSB’s “Key Attributes” document states clearly[1] that “supervisory and resolution authorities should ensure that RRPs are updated…at least annually or when there are material changes to a firm’s business or structure”, a requirement which is echoed in the draft Recovery and Resolution Directive[2] (RRD).  More generally, given the enormous amount of data processing effort that goes into updating a resolution plan in practice, it is difficult to see how any firm which does not follow processes designed to facilitate the periodic updating of a resolution plan could ever be taken to be in compliance with the “Key Attributes” requirements that it must be able to demonstrate an ability to produce the essential information needed to implement a resolution plan within 24 hours[3] or be capable of delivering sufficiently detailed, accurate and timely information to support an effective resolution[4].

Firms would also be forgiven for being confused as to how best to react to this guidance in light of other regulatory developments which offer incentives for those who are prepared to constantly seek to optimise their resolvability, including:

• the additional loss-absorbency requirements of Basel III for Global Systemically Important Banks;
• the Liikanen proposal that structural separation above and beyond that relating to ‘significant’ trading activities should be dependent on the robustness of RRPs; and
• the Vicker’s recommendation that an additional levy of up to 3% of equity capital be required of a UK banking group that is judged “insufficiently resolvable to remove all risk to the public finances”.

Enhancing resolvability demands a proactive, rather than a reactive, approach to RRP legislation.  By its nature, the assimilation of resolution information is not a process that can be easily mothballed and simply dusted-down as and when required, particularly for firms operating in multiple jurisdictions.  Rather, if it is to mean anything, optimising resolvability requires huge commitment and continued cooperation on the part of both firms and authorities.  In light of the drafting of the “Key Attributes” document and particularly the RRD, it is at least questionable whether the new FSA guidance will survive the test of time.  The message to firms must surely be to note the FSA’s new guidance with interest but to continue on a ‘business as normal’ footing with their RRP preparations.

[1] “Key Attributes”, paragraph 11.10

[2] Article 9(3)

[3] “Key Attributes”, paragraph 12.2(iii)

[4] “Key Attributes”, Annex II, paragraph 4.14

The lack of certainty around regulation of insurers is holding back the sector, according to a new report from Standard & Poors.

The report, Global Insurance Key Risks And Credit Trends Dominated By Low Interest Rates And Regulation Issues, identifies some of the key risks and comments on IAIS's identification of Globally Systemically Important Insurers (see our previous article on this topic).

"The consequences of being designated as a G-SII are unclear", says the report, "It will certainly involve a greater level of oversight, coordinated by the group's lead supervisor. It may also involve a capital buffer (as for G-SIBs), but in the absence of a global capital standard, the basis for such a buffer is questionable." (our italics).

The report also notes that insurers are "pleading" with IAIS to ringfence the systemically risky activities rather than apply heightened supervision and capital buffers to the whole G-SII group.

The final IAIS  list of 'too big to fail' G-SIIs is due to be published in April.