The 2020 European financial services outlook
For all financial services practitioners, 2020 will be a year of dynamic developments.
International banks can operate in the United Kingdom (UK) either as subsidiaries or branches1. Data from the Prudential Regulation Authority (PRA) currently shows that there are 160 branches of international banks operating in the UK, of which 77 are from European Economic Area (EEA) banks operating under passporting arrangements.
A key question for these UK branches of EEA banks has been the approach the PRA (and the FCA) will take in relation to their authorisation and supervision once the UK leaves the EU and no longer has Single Market access. In our earlier joint survey with the Association of Foreign Banks (AFB) it was noted that requiring UK branches of EEA banks to subsidiarise post Brexit was a clear ‘red line’ on the basis of increased capital and liquidity requirements, and an uplift in costs of doing business generally.
Following our joint AFB survey, the PRA has provided some clarity on its future approach to the authorisation and supervision of international banks by publishing Consultation Paper 29/17: International banks: the PRA’s approach to branch authorisation and supervision (CP29/17) and a Dear CEO letter entitled Firms’ preparations for the UK’s withdrawal from the EU: planning assumptions (Dear CEO letter).
In this briefing note we describe the key points set out in CP29/17 and the Dear CEO letter.
Whilst accepting that a branch offers less supervisory control than a subsidiary, the PRA acknowledges in CP29/17 that, if done safely, the ability of international banks to branch into other countries is “an important component of an open world economy that benefits the UK economy.” The PRA adds that this is especially true “where those international banks meet the same prudential standards as the UK headquartered banks.” However, the PRA also notes that there would be risks to UK financial stability if it is unable to supervise international banks branching into the UK in a way that promotes safety and soundness of the firms it supervises.
In CP29/17 the PRA takes a two-step approach to the authorisation and supervision of UK branches of international banks. The first step focuses on the PRA’s general objectives2 and its assessment of a range of factors including the equivalence and the supervisability of the international bank which proposes to have a branch in the UK. Importantly, the PRA asserts that its authorisation framework applies to the whole international bank, of which the branch is part, rather than just the branch itself. The second step comprises additional requirements where the branch is seeking to conduct significant retail activities in the UK or where it is considered by the PRA to be a systemically important wholesale branch.
The PRA explains in CP29/17 that its proposed general approach to branch authorisation and supervision is “anchored” in its general objectives and an assessment of a range of factors including regulatory equivalence and the supervisability of an international bank that operates in the UK through a branch, including:
Having an appropriate degree of supervisory cooperation with the home state supervisor is important in that it enables the PRA to understand the nature and extent of the risks facing the bank. The PRA will also seek to be able to provide ‘appropriate’ input into the supervisory strategies of the home state supervisor. The more important a branch is to UK financial stability, the higher the PRA’s standard of supervisory cooperation and standards.
In performing its general assessment, the PRA will balance the overall supervisability against the nature and scale of the banking activities that the firm proposes to carry out, including those through its UK branch.
The PRA states in CP29/17 that it would be unlikely to be prepared to host a branch in circumstances where:
The PRA would expect branches of international banks operating in the UK to focus primarily on wholesale banking activities. However, it has additional expectations where such branches are systemically important.
In assessing whether a branch is systemically important, the PRA looks at whether the overall UK footprint of the branch exceeds an average of £15 billion total gross assets. In calculating this footprint, the PRA will take account both of assets booked onto the balance sheet of the branch and assets traded or originated in the UK but booked remotely to another jurisdiction. The PRA mentions that the £15 billion threshold is “only indicative” and that its determination will also take into account the scale of provision of critical functions (as described in PRA Supervisory Statement 10/14 as “critical economic functions”) the branch undertakes and links to other PRA-regulated firms.
In addition to the regulatory equivalence and supervisability considerations mentioned above, the PRA would also assess the degree of influence and visability that it has over the supervisory outcomes for the bank as a whole and the wider group. This factor becomes more important where group structures become more complex.
Where the PRA is not satisfied as to the degree of supervisability of the branch, or it does not have the necessary degree of influence and visability it needs to achieve its general objectives it can apply specific regulatory requirements on the branch on a case-by-case basis. The PRA states in CP29/17 that such requirements would be intended to ensure that there are sufficient financial and operational resources, and appropriate governance, at the UK branch level.
However, in instances where exercising such powers would still not allow the PRA to achieve its general objectives the bank would be outside the PRA’s risk appetite for branches and the regulator would likely require the bank to establish a subsidiary in the UK.
The PRA also has additional expectations for international banks that propose to undertake significant retail banking activities. Where significant retail banking activities are proposed the PRA would expect them to be carried out by a subsidiary rather than a branch. The PRA considers retail banking activities to be significant where a bank:
The PRA states in CP29/17 that the position for non-EEA banks remains unchanged. The PRA states:
“On the basis of their existing business structures and current degree of supervisability, including the level of supervisory cooperation already in place, the PRA does not expect the new approach to affect any of the non-EEA international banks currently authorised to operate in the UK through branches.”
The Dear CEO letter contained a number of key messages from the PRA but perhaps the following are the most important:
CP29/17 and the Dear CEO letter are welcome publications for EEA banks that passport into the UK. They reduce some of the uncertainty that Brexit has created, allowing authorisation planning to be undertaken with more confidence. In particular, the PRA appears to have settled the red line issue of subsidiarisation, taking a fairly pragmatic stance by limiting it to two specific instances and even then, in the instance of a UK branch conducting wholesale business and being systemically important, it is first prepared to use its powers and apply specific regulatory requirements on a case by case basis.
EEA banks operating in the UK would also be wise to pay attention to the PRA’s warning that the “authorisation challenge is significant” and if they have not already done so engage in pre-application discussions with the PRA without delay.
“This briefing was first published on Thomson Reuters Regulatory Intelligence on 20 January 2018.”
This assumes that applicable exclusions under the Regulated Activities Order, like the overseas persons’ exclusion, are not available.
In the context of banks see section 2B of the Financial Services and Markets Act 2000. The PRA has a general objective of “promoting the safety and soundness of PRA authorised firms." The PRA advances this objective by seeking to: (i) ensure that the business of PRA authorised firms is carried on in a way which avoids any adverse effect on the stability of the UK financial system; (ii) minimise the adverse effect that the failure of the PRA authorised firm could be expected to have on the stability of the UK financial system and in particular, adverse effects resulting from the disruption of the continuity of financial services.
The PRA’s Threshold Conditions can be found in Part 1E of Schedule 6 to the Financial Services and Markets Act 2000.
For all financial services practitioners, 2020 will be a year of dynamic developments.
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