Following the end of the Brexit Transition Period, the Prudential Regulation Authority (PRA) has set out in a consultation paper and draft supervisory statement how it proposes to approach supervision of international bank branches and subsidiaries in the UK. The key message is that the UK banking system is open for business. The PRA continues to be open to allowing banks to operate in the UK through a branch or subsidiary, and in principle to hosting subsidiaries that operate a highly integrated global business model, especially highly integrated investment banking and trading businesses and custody activities. Banks need to meet certain conditions in return, with an emphasis on providing sufficient management information to supervisors and establishing adequate governance and controls in order to give the PRA assurance that risks are being appropriately managed.
These proposals are relevant to all international banks that have – or are planning to establish – operations in the UK, whether through a branch or subsidiary. (Banks that are currently operating within the deemed authorisations under the Temporary Permissions Regime will not need to meet the proposals immediately, but will have to do so as soon as practicable and in any event by the time they are authorised.) The proposals will be of interest from the perspective of both planning day-to-day supervisory interactions and legal entity and operating structure optimisation.
According to the PRA, the proposals simply restate existing practices, some of which were set out in its 2018 Supervisory Statement on branch authorisation and supervision. David Bailey, Executive Director International Banks Supervision, however, noted in a speech that accompanied publication of the proposals that the proposals have: “…not all been written down in this way before”. This is an important consideration. We think the proposals contain important points of detail and clarification, not all of which will be familiar to all banks, and therefore require careful study.
On booking models, the PRA expects to ask banks to complete a self-assessment against its proposals in the near future. For a small number of banks, the PRA also expects to receive better information and have greater visibility of risks going forward, and plans to discuss this with the banks concerned.
Expectations for effective supervision
The PRA’s starting position is that the UK operations of international bank branches and subsidiaries can in principle be highly integrated with the parent banking group. This is in contrast to supervisors in some other jurisdictions whose default position is to expect branches and subsidiaries to operate on a more or less standalone basis.
The PRA though expects certain conditions to be met, and it will adapt its supervisory approach to the specific risks and challenges posed by the business strategy and operating model of each bank. The more closely the PRA’s expectations on effective supervision are met, the more it will be content for an entity in the UK to be highly integrated with the wider group. Conversely, if the PRA does not receive sufficient information or is not satisfied with the degree of cooperation it has with a bank, or if it feels that the controls over risks to the UK business are inadequate, it will be less accommodating.
Put differently, acceptance of a high degree of integration comes with a price to be paid – particularly in the form of the provision of frequent and detailed management information (MI) about the rest of the group and dialogue and co-operation with the home supervisor.
In a number of respects the PRA’s policy is unchanged from what has been published before. This includes, for example, its expectation of sufficient home supervisor equivalence and cooperation; the importance of resolvability and cooperation from the home resolution authority; and the fact that its approach varies according to the size and systemic importance of business in the UK. Expectations with respect to size thresholds to take into account when assessing the appropriate operating structure, cooperation with group, and controls for an entity are also unchanged from the PRA’s previous policy.
- Booking arrangements
The PRA continues to expect booking arrangements to be transparent, coherent and underpinned by an effective control framework to ensure that approved booking practices are adhered to. The PRA’s definition of booking arrangements captures activities from origination through to back-office settlement. This definition is potentially wider in scope than many banks have considered to date, and banks may need to recalibrate their existing booking model documentation and associated controls.
The PRA provides further detail on its expectations for risk management and controls across the front-to-back trade lifecycle, including emphasising the importance of local risk management capabilities, an appropriate balance of preventative and detective controls, and comprehensive MI.
The proposals clarify that these expectations apply to branches as well as subsidiaries and emphasise the importance of supervisors having adequate visibility of UK booking arrangements in the context of group risks. The PRA sets additional requirements for the booking arrangements of highly integrated entities, with specific expectations outlined for remote booking and back-to-back booking models.
- Other considerations
Two points stand out from the proposals for us related to ensuring the viability of UK entities. First, the PRA’s focus on the structural profitability of subsidiaries. Subsidiaries should be on a path to being structurally profitable on a standalone basis (or else, the group’s viability should depend on supporting the UK operations). This is not a new consideration for the PRA but the emphasis on the extent to which the profitability of the UK subsidiary is supported by cross-subsidy from the rest of the group will require careful consideration by banks as well as detailed MI (some of which may not be readily available). Second, the role of parental support. The PRA may request evidence that parental support will be provided. And echoing the consideration of the importance of UK entities to the profitability of the group, the proposal notes that “the more important the international bank is to the wider group, the more likely it is that its survival is essential to the group’s resolution”.
Significant weight is placed on the information that is provided to the PRA. The information the PRA expects to have access to will be proportionate, varying according to the risk that the bank poses. The proposals set out the baseline information expected from all banks, and additional information expected for highly integrated or systemically significant businesses (so entities do not necessarily need to be big to be asked to provide additional information). Information required above the baseline will include, for example, further details of where risk is managed within the UK and group, and of performance of the UK entity and group.
In terms of governance, whilst the proposals do not introduce new requirements, further details are provided of the PRA’s expectations. There is an emphasis in particular on ensuring that individuals responsible for governance of UK entities are appropriately independent of the parent, whilst at the same time having sufficient credibility and influence with the group’s wider management to be able to ensure that the interests of the UK entities are considered. The PRA expects banks to allocate responsibility for overseeing the firm’s booking arrangements to a Senior Management Function (SMF) holder.
The proposals remind banks that take retail deposits of the need to comply with requirements related to the single customer view, through which data can be provided for depositor payout in the event of resolution. Banks also need to ensure that they follow the PRA’s rules on operational resilience and on outsourcing. Even where functions are outsourced to other group entities outside the UK and/or group-wide policies are being applied, the PRA expects that UK entities also specifically ensure compliance with UK legal and regulatory requirements.
When the PRA’s expectations are not met
Where the PRA does not have sufficient information or is not satisfied with the degree of cooperation is has, or if the controls over risks appear to be inadequate, it will explore potential mitigants. One option will be for a UK entity to become more independent of the overseas business. The degree of integration – or separation – will be considered across several dimensions, including governance; capital and liquidity; booking risk management; operational resilience; resolution strategy; and structural profitability. The PRA notes that a small number of banks that previously operated in the UK via EEA branches have now established subsidiaries in the UK. The establishment of a subsidiary to replace an existing third-country branch may indicate that - at least in some cases - the PRA has already taken decisions along these lines.
Although the PRA indicates that these proposals restate existing policy, many international banks that currently have a subsidiary or branch in the UK will find it instructive to review their existing practices against the requirements that have been set out. For international banks considering establishing a new subsidiary or branch in the UK, the proposals provide an important framework for planning the legal entity and operating model structure.
"By international standards the UK is very open to financial services, and we will continue to put a huge effort into making this work safely for us and the rest of the world, including those in the EU who want to do business with the UK", Sam Woods, Deputy Governor for Prudential Regulation and CEO, Prudential Regulation Authority