Ring Fencing Risk - Regulatory and professional discipline

The FCA’s approach to the implementation of ring-fencing and ring-fencing transfer schemes: The FCA will be assessing the potential risks posed by the implementation of ring-fencing. In addition, the FCA will consult with the Prudential Regulation Authority (PRA) in relation to transfers of business to achieve ring-fencing purposes and the FCA will assess the potential risks posed by the proposed schemes to its objectives. The FCA has published guidance which sets out its proposed approach to the implementation of ring-fencing and ring-fencing transfer schemes (RFTSs). It also clarifies its approach to applications for authorisations or other regulatory transactions submitted by firms for the implementation of ring-fencing. The FCA notes that its guidance should be read in conjunction with the PRA’s consultation paper CP33/15 setting out the PRA’s proposed approach to RFTSs. 

The PRA has proposed that large UK banks meet a minimum 3% leverage ratio requirement from 1 January 2016. The requirement would apply to banks with more than £50 billion in deposits.

Unlike the Basel III / CRD IV leverage ratio, the PRA’s proposed leverage ratio is layered with additional systemic risk add-ons. This makes the UK requirement more onerous than the EU version of the leverage ratio.

The PRA’s consultation paper proposes that this 3% minimum be supplemented with additional leverage add-ons for banks that are systemically important or that have exposures that are subject to a Countercyclical Capital Buffer (CCB).

When the CRD IV leverage ratio becomes binding in 2018, UK banks will effectively have to comply with two separate (though very similar) leverage requirements. The level of the CRD IV leverage ratio has not yet been finalised but is expected to be 3% - i.e. in line with the Basel Committee’s provisional leverage requirement. The PRA leverage ratio is likely to be more onerous given its additional leverage buffers, detailed below.

The PRA’s definition of ‘Leverage’

The CRD IV ratio won't contain a binding minimum requirement until 2018, whereas the PRA leverage ratio is due to apply to most large banks from 1 January 2016.

The PRA proposes that its UK leverage ratio follow the same definition of ‘total assets’ as the European leverage ratio. The numerator definition is also broadly similar. However, there is a slight technical difference between the numerator definition for the CRD IV leverage ratio and the PRA leverage ratio: In the CRD IV leverage ratio, a certain amount of 'Other Tier 1' items can be grandfathered forward from the previous regime into the current Additional Tier 1 bracket and therefore counted within the numerator, whereas these grandfathered instruments cannot be included in the PRA leverage ratio. So banks that have grandfathered Additional Tier 1 (AT1) capital instruments may have a higher CRD IV leverage ratio than their PRA leverage ratio.

The PRA’s proposed Leverage Ratio ‘add-ons’

The Countercyclical Leverage Buffer (CCLB)

UK banks and building societies may also be subject to a CCLB which the FPC (and other national regulators) can activate if it fears overheating or unsustainable growth in particular sectors of an economy. The CCLB will be set at 35% of the level of any CCB in effect. For example, if the FPC applies a 1% CCB to certain UK exposures then a CCLB rate of 0.35% will apply to those UK exposures. The CCLB applies in addition to the minimum of 3% and any Additional Leverage Ratio Buffer that applies (see below).

Similarly, where regulators in another EU member state or third country decide to apply a CCB in respect of exposures in that country, UK banks will have to hold a CCB and a CCLB in respect of their exposures in that country. As above the CCLB will be calibrated as 35% of the CCB. Currently only Norway, Sweden and Hong Kong have decided to apply a CCB to their exposures.

The Additional Leverage Ratio Buffer (ALRB)

A further requirement, the ALRB, will apply to globally systemically important banks (G-SIBs) and other major domestic UK banks and building societies, including banks that are subject to ring-fencing requirements. The ALRB will be calibrated as 35% of the combined systemic risk buffers that apply to the bank in question.

For example, if a bank is subject to a combined systemic risk buffer of 2% its ALRB will be 0.7%, in addition to the minimum of 3% and any CCLB in effect.

Reporting and disclosure

In addition to the minimum leverage requirements, the PRA is also proposing to introduce a new reporting form (the FSA083) which banks will be required to complete and submit quarterly from 2017. During 2016 the affected banks will be required to complete and submit a transitional form (the FSA084). The new forms will collect data on the banks’ breakdown of assets.

The PRA proposes that banks disclose data on their leverage ratio and the exposure measure on a quarterly basis. Where there are differences between a bank’s PRA leverage ratio and its CRR leverage ratio (e.g. because the PRA leverage ratio does not recognise grandfathered AT1 capital instruments) the bank must explain why this is so.

This presents an additional burden for UK banks compared to their European peers, as they will be required to complete two sets of regulatory reports on leverage (i.e. COREP and PRA reporting) and two sets of leverage ratio disclosures (i.e. CRD IV Pillar 3 leverage data and the PRA quarterly leverage disclosure).

What can firms do to prepare?

This will be the first time in decades that a binding leverage requirement has applied to UK banks so it will be important to implement it accurately. The PRA leverage ratio requirement will be considerably more onerous than the CRD IV leverage ratio in many ways. The timeline for compliance is also very compressed with the requirement applying from 1 January 2016.

Banks must first consider the £50 billion deposit threshold to determine if they are in scope. Banks that are in scope will need to review the PRA’s proposed leverage reporting forms in order to determine if you they will be able to complete these in an accurate and complete way. Affected banks must ensure that they have access to up-to-date data that will enable them to comply with the daily calculation requirement from 2017. Their systems managers  will also need to consider if any of their assets are subject to a CCB requirement, which would also trigger an additional countercyclical leverage requirement. 

 

Ian Kelly - Senior Manager, Banking and Capital Markets, Deloitte