Reducing bank failures? PRA consults on how to ensure a solvent exit for non-systemic banks and building societies

On 28 June 2023, the Prudential Regulation Authority (“PRA”) published a consultation paper (“CP 10/23”) which outlines proposals for non-systemic banks and building societies in the UK to be required to prepare for a solvent exit as part of their business-as-usual (“BAU”) activities and, if solvent exit becomes a reasonable prospect, to be able to execute one with a more detailed plan in place.

The focus is to ensure that solvent exits are completed successfully, which in turn will help support an orderly, timely, and ultimately solvent, exit from PRA-regulated activity; in turn, this is meant to reduce the potential for disruption to the wider market and firms’ customers, as well as supporting a well-functioning and competitive market.

The consultation closes on, and responses are required by, Friday, 27 October 2023.

Background

These proposals form part of a long-standing programme of work, the PRA having previously committed (including in its business plan for 2022/23) to focus on facilitating firms’ ability to exit the market in an orderly manner and without having to rely on the “backstop” of an insolvency or resolution processes. Indeed, the events surrounding HSBC’s acquisition of Silicon Valley Bank this year have brought into sharp focus the importance of robust recovery, resolution and solvent exit planning. This consultation paper forms part of a wider response to recent events by the regulators. For example, the Bank of England commenced a potentially broad and far-reaching review of the deposit guarantee scheme (also known as the Financial Services Compensation Scheme or the “FSCS”) and, most recently, there has also been speculation in the financial press about costly and administratively burdensome plans to lower the thresholds requiring international banks with a presence in the UK to set up subsidiaries.

While solvent exits have proved to be the most common exit route for non-systemic firms since the PRA’s inception in 2013, the PRA found some such exits to be challenging and protracted. If enacted, the proposals will require firms to have a clear forward plan in place, which allows them to deliver solvent exists that are more efficient, cost-effective and ultimately more likely to succeed.

The key elements of this policy are outlined next, focusing in particular on the implications that the proposals would have on firms’ governance arrangements and directors’ responsibilities.

The PRA’s proposals

The PRA proposes to introduce new rules (in a new Chapter 7 to the Recovery Plans Part of the PRA Rulebook) and expectations (set out in a new supervisory statement), while also making some consequential changes to the ‘Solvent wind down’ section of SS3/21 (including replacing the phrase “solvent wind down” with “solvent exit”) (see appendices to CP 10/23).

Two preliminary points should be noted. Firstly, CP 10/23 is restricted in scope to non-systemic UK 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 or another systemically important institution; CP10/23 is not relevant to credit unions or branches of third-country groups. Secondly, a “solvent exit” is defined as the process through which a firm ceases to carry on PRA-regulated activities (i.e. deposit-taking) while remaining solvent.

Planning for solvent exit in advance

Regardless of how unlikely or distant the prospect of a solvent exit may be, all firms in scope would be required to prepare for it as part of their BAU activities in order to be able to effect a solvent exit in an orderly manner if the need arises. Under the new rules, firms are required to produce and maintain a solvent exit analysis (which may form part of their existing recovery plan if deemed appropriate) documenting firms’ preparations, which they must be able to provide to the PRA upon request. The rules are fleshed out in Chapter 2 of the draft supervisory statement, which includes the PRA’s expectations on the details of the solvent exit planning exercise, in order to develop firms’ understanding of the rules, guide compliance and ultimately mitigate the risk of firms being unprepared for a solvent exit or unaware of the costs and time involved. Boards of relevant firms will need to familiarise themselves with these requirements, if enacted, and consider how the solvent exit analysis is prepared and kept up to date as the firm’s position changes over time. In particular, entry into new products or markets will require the solvent exit analysis to be revisited to ensure it is still fit for purpose.

It is worth noting that whilst the level of detail in the solvent exit analysis is meant to be proportionate to the nature, scale and complexity of the firm, Chapter 2 of the supervisory statement does include a list of minimum content requirements. Among other things, firms are required to set up clear governance arrangements, with a named executive accountable for each stage of the process, being: (i) the firm’s BAU preparations for a solvent exit, including the review and approval of the solvent exit analysis; (ii) escalation and decision-making regarding a solvent exit, including whether a solvent exit execution plan should be produced and a solvent exit initiated (as further detailed below); and (iii) monitoring the execution of a solvent exit, including whether further action is needed or a solvent exit is no longer feasible. The accountable executive is also required to confirm that the firm meets the expectations in the supervisory statement albeit that it is expressly acknowledged that these expectations can be met also by adopting the governance arrangements developed under the PRA’s recovery planning expectations. These requirements will need to be factored into firms’ existing governance arrangements and statements of responsibilities, and added to regular board meeting cycles as required.

Producing a solvent exit execution plan and executing a solvent exit

If solvent exit becomes a “reasonable prospect” for a firm, the PRA expects the firm to produce a solvent exit execution plan, within a reasonable amount of time, once it begins to consider a solvent exit or if so requested by the PRA. Not much detail is provided at this stage as to the meaning of a “reasonable prospect”, albeit that it is noted that a firm’s evaluation could be informed by the firm’s solvent exit indicators, which are required to be included in its solvent exit analysis. It is interesting to note that this is the same standard as for wrongful trading, which could potentially aid in the interpretation of this threshold. The firm must provide the plan to the PRA in an appropriate timescale and must include sufficient detail in it to inform itself and the PRA of how it will complete the cessation of its PRA-regulated activities, with Annex A to the supervisory statement setting out a non-exhaustive list of minimum contents. We would expect this plan (as its name indicates) to focus on the execution of the exit – i.e. the method of placing the firm in a position to be able to repay depositors or transfer deposits to another regulated firm.

Among other things, the PRA expects that the solvent exit execution plan should include actions and timelines for the solvent exit, from the point of initiation to the removal of the firm’s Part 4A PRA permission, which must include transfer and/or repayment of all deposits. Firms are therefore likely to need to give some thought in the solvent exit analysis as to what a hypothetical “playbook” might look like and what barriers might emerge, much as the larger firms do in the context of planning for the Resolution Assessment Framework. Furthermore, the solvent exit execution plan is also expected to set out the details of governance arrangements, including roles and responsibilities in formally deciding to initiate the solvent exit, as well as in managing and executing it. It is expected that a firm’s board, or another appropriate senior governance committee or group, should provide sufficient challenge on the firm’s solvent exit execution plan, and review and approve it. As with the exit analysis, this requirement will need to be factored into firms’ existing governance arrangements and statements of responsibilities.

During the execution of a solvent exit, it is expected that firms keep the PRA informed, in particular if there are any risks to or concerns about its successful completion. In practice, we would expect firms executing a solvent exit to be in regular dialogue with all their regulators, not just the PRA. The PRA expects firms to continually assess whether a solvent exit is likely to succeed, and whether it remains feasible and appropriate (and the frequency of such “continual” assessment will need to be identified by firms). This requirement, however, does need to be placed in the context of the duties owed by directors to a company and its creditors under statute and at common law (and to avoid any liability for wrongful or fraudulent trading), which essentially require them to determine whether and when formal insolvency procedures should be triggered (and the PRA expects this to be the case “when it appears to the firm that a solvent exit will no longer be successful”).

Lastly, once the solvent exit is complete, the firm must also submit an application to the PRA to have its Part 4A PRA permission cancelled (as well as considering, if appropriate, whether any other regulatory approvals/ notifications may be required).

Conclusion

The proposals in CP 10/23 would provide welcome clarification regarding the PRA’s expectations around solvent exits of certain non-systemic firms. While it is foreseen that their implementation would entail both one-off costs (for example, as regards the feasibility studies for certain scenarios, setting up internal governance and putting together the first solvent exit analysis and any related playbooks) and ongoing costs (incurred in updating the solvent exit analysis, playbooks and monitoring the solvency indicators), the expected benefits are far-reaching and include minimising disruption to the wider market and reducing the burden on the FSCS. Finally, the proposals have proportionality built in them and are also intended to allow firms, where appropriate, to make use of the work, analysis and governance that they already have in place for recovery planning, which is expected to significantly reduce costs.