PRA's review of ring-fencing rules: potential for relaxation in key pain points

30/01/2024

On 25 January 2024, the Prudential Regulation Authority (PRA) published a report setting out its conclusions following the PRA’s review of its ring-fencing rules undertaken during the course of 2023. This marks the first review carried out by the PRA since the ring-fencing regime became effective on 1 January 2019, delivering on its statutory duty to review its ring-fencing rules every five years from the regime’s inception.  

The PRA review only covered the ring-fencing regime in so far as it is contained in the rules and associated guidance within the PRA Rulebook and any supplementary Supervisory Statements. The review therefore did not extend to parts of the regime found in legislation, which has been subject to separate review and, more recently, consultation by HM Treasury in September 2023.

While the PRA reports its satisfaction with the bulk of the ring-fencing rules, it has identified several specific and discrete areas where improvement to the rules and associated guidance could be made. This indicates a welcome move towards potential reform in respect of some of the “pain points” that have been the focus of the banking industry over the last few years. However, any change will require the PRA to further consult on the specific rule changes before it can take effect and, as such the banking industry will continue to engage with the PRA and HMT on this topic.

Rules relating to the provision of services to RFBs from non-ringfenced parts of a banking group

The first area relates to Rule 9 within the RFB Part of the PRA Rulebook (Continuity of Provision of Services). The PRA reports that it has granted no modifications or waivers in respect of this rule, though has acknowledged it is the rule which is most breached. Rule 9 was designed to ensure an RFB does not become reliant on certain services provided by a non-ring-fenced body (NRFB) within its group, with the aim of safeguarding the RFB from being put at risk in the event of the NRFB failing.

Despite additional guidance on what services fall under scope of Rule 9 being provided, the PRA received significant feedback on this rule, with a clear focus on Rule 9.1 in terms of clarity and potential overlap with the Operational Continuity in Resolution and Operational Resilience regime (OpRes). Rule 9.1 is drafted widely to capture “services” or “facilities” that it requires on a “regular basis” from an entity within its group, which is open to interpretation and creates operational complexity for banking groups. Despite a non-exhaustive list of ‘services and facilities’ being included in SS8/16, there is still a risk that Rule 9.1 could be interpreted to cover front office business support, for example, which is not the intention. 

As a result, the PRA has confirmed that a consultation on Rule 9.1 will be carried out and indicated an openness to modifying Rule 9.1 to better target the intended spirit of the ring-fencing regime. Suggestions on how to do this include integration of Rule 9.1 with other regimes such as OpRes; allowing modifications; updating guidance; or even reconsidering the language of the rule itself. This is a welcome indication of flexibility from the PRA in relation to one of the key “pain points” for most large banking groups.  

Rules relating to arm’s length transactions

Rule 12 of the RFB Part of the PRA Rulebook, which details the requirement for RFBs to contract with group members outside the ring-fence on an arm’s length basis, similarly attracted substantial feedback. This focused on concerns around the frequency at which firms are required to review their arm’s length policies (currently on an annual basis). The PRA confirmed that it intends to consult on this rule to potentially reevaluate the frequency of review, recognising that requiring this to be done on an annual basis may be disproportionate.  

RFBs’ access to Financial Market Infrastructures

The PRA is not considering any significant changes to its rules or guidance in relation to RFBs’ access to Financial Market Infrastructures (FMIs). The PRA has stated that the rules in this respect appear up to date and proportionate and instead is only considering a minor technical change to reflect the UK’s departure from the EU.

Rule 16 of the RFB Part of the PRA Rulebook governs how RFBs must access and ensure their positions and assets are held separately from those of other users of Central Counterparties (CCPs) and Central Security Depositories (CSDs). The rule is supplemented by guidance within SS8/16 which clarifies the PRA’s expectation that firms should generally access CCPs and CSDs directly, rather than via third-party intermediaries, to mitigate any operational risk the RFB would be exposed to if an intermediary was to fail.

Rule 16 was updated following Brexit to distinguish UK FMIs from non-UK FMIs, the references previously being to European Economic Area (EEA) FMIs and non-EEA FMIs. The PRA has acknowledged the benefit of carrying this change over to SS8/16, which was not amended at the same time as Rule 16, noting that such amendment is already under consultation.

Data reporting requirements

In its review, the PRA also considered the adequacy of the specific data reporting requirements imposed under the ring-fencing regime which allow it to supervise compliance of affected banks. In reviewing the various template ring-fencing reports, the PRA paid consideration to RFB005 (Joint and Several Liabilities Arising from Taxes: reports on VAT and bank levy data for group and RFB). The PRA identified that the tax liability captured within this report are immaterial compared with the Tier 1 Capital of the firms in scope and that therefore the removal of the same would pose limited prudential risk. Accordingly, the PRA confirmed its intention to consult on removing the reporting obligations for RFB005.

The PRA also recognised that there might be inconsistencies on how Rule 12.7 of the Notifications Part of the PRA Rulebook may be applied. Under this rule, firms are required to notify the PRA within 30 days of a certain category of breach (including relevant financial institution (RFI) exposures, where the counterparty only became aware of an RFI after exposure was incurred). The PRA clarified that in these instances, the requirement is to notify within 30 days and that this supersedes the requirement to notify immediately under Rule 2.4 of the Notifications Part of the PRA Rulebook.

Is substantive change on the horizon?

The PRA’s report by no means suggests a fundamental overhaul of the rules on ring-fencing - the majority of the rules, such as those surrounding intragroup arrangements and internal auditing requirements, have been determined as necessary, sufficient and relevant to the intentions of the ring-fencing regime. However, the report is a welcome indication that the PRA is prepared to be more flexible on particular pain points like services across the ring-fence, offering hope to firms which have been grappling with the operational rigidity of those rules since their introduction.  

 

This article was originally published in Reuters Regulatory Intelligence.