Planning for Solvent Exit – SS2/24

In March 2024, the Prudential Regulation Authority (PRA) finalised its policy on solvent exit planning and it is largely unchanged from the 2023 consultation paper (CP), which was covered in our previous blog. This blog explores some of the more practical issues that the PS5/24 and SS2/24 may raise.

The Role of Solvent Exit

Within the realm of recovery and resolution planning for the non-systemic sector, solvent exit sits in between the recovery phase and the invocation of the bank insolvency process (BIP), with the expectation that it can be used when recovery is no longer a realistic prospect, but when there are still sufficient resources available to avoid insolvency. As such, it shares characteristics in its purpose with both recovery planning (i.e. actions to avoid insolvency) and the BIP (i.e. the firm ceases to be a deposit-taker). Solvent exit could also be used to support a strategic exit from the banking market when the firm is not under any stress – it is still important to demonstrate that this can be done without an adverse impact on the PRA’s statutory objectives.

Experience suggests that where banks have pursued a solvent exit strategy, there has been minimal adverse impact, whereas insolvency is more likely to lead to contagion and adverse prudential and consumer outcomes.

Solvent exit is therefore entirely consistent with PRA’s statutory objectives, but is also consistent with the FCA’s objectives of achieving good outcomes for customers.

The Solvent Exit Analysis (SEA) and Solvent Exit Execution Plan (SEEP)

The supervisory statement provides guidance on the minimum detail to be included in these documents, but some firms will be wondering what is the “proportionate” level of detail required by non-systemic banks and building societies is for these documents, especially the SEA which is due by October 2025. The SEEP by contrast, only needs to be prepared if solvent exit becomes a “reasonable prospect.”

There is naturally no simple answer to this – firms’ size, business and operating model will all be factors to take into account. However, there are useful lessons to be learned from FCA wind-down planning and the weaknesses commonly identified in them. A particular theme is that these plans are not actionable. Unsurprisingly, preparation is key – and this is the purpose of the SEA.

It is important to remember that a SEEP will most likely need to be produced quickly in response to a stress event, when the firm is pre-occupied with executing the recovery plan and dealing with concerned stakeholders, and therefore may have limited time and resources available for producing the SEEP. It is also possible that the request to prepare the SEEP will come directly from the PRA, potentially for submission within 30 days of the request.

The fact that the PRA lays this out as a two-step process suggests that it does not expect the SEA to be a large, all-encompassing document that will suit any eventuality. However, the SEEP will need to contain some complex information, such as a detailed action plan in response to the prevailing circumstances, updated financial and non-financial resources required to execute the plan, as well as going through senior review and governance. It will be challenging for a non-systemic firm with limited resources to deliver the SEEP in a short timeframe if it has not already laid the foundations in the SEA.

Therefore, the more that these elements of the solvent exit plan are “on the shelf” in the SEA, the better, so that they can be rapidly configured for the scenario, reducing the likelihood of a failed solvent exit and disorderly failure. It may be necessary to prepare a skeleton SEEP as part of the SEA, with a clear idea of what contents would need to be produced, by whom and how quickly. This could be supplemented by a SEEP production ‘playbook.’

Areas of focus

There are a wide range of areas that need to be covered, and some of these are listed in SS2/24 and some of which will allow firms to leverage work done on recovery planning.  Below we provide some thoughts on a few of the factors that firms will need to consider.

Trigger framework

The identification and calibration of a trigger framework for decision-making tends to be a challenging area for firms, even where there are a wide range of metrics in place in the risk monitoring framework. The requirements stress the importance of implementing solvent exit indicators, suitably calibrated to allow sufficient time to prepare the SEEP and then subsequently execute it, if necessary. The calibration of the trigger to develop the SEEP should therefore be separate from, and much earlier than, the trigger point at which a decision on commencing solvent exit becomes necessary.

The existing risk monitoring framework should form the foundation, but there are some points that it would be sensible to consider:

• Appropriate calibration of existing indicators, beyond the point of simply indicating entry into recovery, and to the point at which orderly solvent exit would be triggered.
• Entry into recovery is likely to be a trigger to commence preparation of the SEEP. Even if this is not a trigger in the framework, it would likely to be a trigger for the authorities to formally request it.
• Forward-looking indicators to provide an idea of when resolution may become necessary and therefore the time and financial resources available to execute the plan.
• It should include non-financial and qualitative indicators.

Customer outcomes

The PRA is the prudential regulator and, therefore, it is not directly focused on FCA priorities and achieving good customer outcomes. However, it is important that in preparing both an SEA and SEEP, good customer outcomes are given the appropriate level of focus. The FCA will inevitably be interested in seeing that the approach does not treat customers unfairly. This may cover factors such as not providing insufficient support to vulnerable customers or providing poor service during exit (e.g. insufficient call centre staff), leading to poor outcomes.

The SEEP should also demonstrate that other stakeholders are treated fairly – liabilities are paid on time and suppliers have their contracts honoured. A well-managed solvent exit will almost certainly be better for stakeholders than the BIP.

Third-party purchasers

The scope of solvent exit involves the cessation of all regulated activities of the firm and it is likely that assets or even whole business lines will be sold to third parties during solvent exit. In which case, it is important that firms leverage their approach to disposals options in recovery plans and related documents, by including evidence of conservative pricing assumptions, the steps and timelines to execution and also identify potential purchasers. Disposals during a stressed exit will likely achieve realisations at the lower end of the range of pricing expectations and firms may want to consider what is the lowest end of the valuation range that would allow the successful execution of the SEEP. Firms should also consider that it might not be possible to sell certain assets and would need to be held for longer, potentially until maturity.

Modelling

The SEA will need to be accompanied by a financial forecast of the solvent exit, showing cash flows as well as an evolution of the P&L, balance sheet, capital and liquidity levels and any customer assets over the entire period. This should be appropriately detailed and flexible enough to be updated in response to changes in the proposed solvent exit approach, timings and levels of stress. While firms will be able to leverage existing forecasting models, they should factor in additional costs that are likely to be incurred, such as redundancies and external advisors and support, as well as the capital impact of disposals. Most importantly, financial forecasts should be able to demonstrate both to the Board and regulators that the firm has sufficient capital and liquidity to manage a solvent exit from the point that it triggers solvent exit. The cost of solvent exit vs available assets will be a critical factor in deciding the timing of the decision to formally enter solvent exit.

Conclusion and next steps

There are a wide range of factors that non-systemic banks and building societies in scope for SS2/24 need to take into account, which will involve both leveraging existing processes but also developing new approaches. Whilst the regulatory deadline of October 2025 is some way off, experience suggests that preparation of such plans can be time consuming and it is wise for firms to consider how they will tackle this regulation. Prior to commencing preparation of the SEA, there are activities that firms can initiate now as part of their planning process:

• Determining the “owner” of the SEA production process
• Planning the timeline to produce the SEA ahead of October 2025
• A high-level project plan
• A skeleton of what the SEA output will look like
• A gap assessment of required information compared to what information is currently available
• Estimate of the resources required to prepare the SEA