PRA updates its approach to branch supervision and expectations for booking arrangements

At a glance
 

• The PRA has published a consultation paper (CP11/24) to update its prior supervisory statement (SS5/21) on its approach to branch and subsidiary supervision. The update on branches was triggered by the failure of Silicon Valley Bank (SVB) UK in March 2023. The proposed changes to booking models and front office controls stem from a combination of developments in banks’ booking structures, the increase in number of split desks and industry requests for clarification of the PRA’s expectations.
• The PRA is clear that the proposals in the CP do not alter the overall framework in SS5/21 but are instead targeted updates. Based on available information about the activities of international banks currently operating as branches in the UK, the PRA does not expect that any of the existing branches of third country banks will have to become subsidiaries as a result of its proposals. Furthermore, based on current growth forecasts, no branch is expected to cross the new thresholds within the next three years.
• For branch supervision, the PRA proposes introducing some additional indicative criteria that the PRA will consider when determining whether it would be appropriate for an international bank to operate in the UK as a branch rather than a subsidiary. These include an additional indicative threshold for possible subsidiarisation of £300m of total retail and small company deposits.
• While the PRA’s proposed changes to its risk appetite for accepting branches of third country banks are unlikely to have an immediate impact on existing branches, they do result in a more complex framework for determining when a branch must convert to a subsidiary.  The framework also provides the PRA with wide discretion. Banks and their UK branches will have to factor the PRA’s updated approach into their strategic planning and growth ambitions for the UK.
• For booking arrangements the PRA has developed more granular principles regarding desk structures, fragmentation of risk management, split desks and remote booking.  All the expectations, including the new ones, are applicable to relevant UK banks and designated investment firms, as well as international banks. The new expectations relate to any material changes to banks’ existing booking structures, particularly where they reduce the effectiveness of existing risk management approaches. The PRA is clearly concerned about the fragmentation of the management of risks and is unlikely to find the fragmentation of the management of a bank’s most complex, non-linear risks acceptable.
• The PRA’s proposals for booking models and structures send a clear signal that firms will have to consider very carefully any changes that result in split desks and/or undermine the effectiveness of centralised risk management.  In addition, the proposals reinforce the need for effective oversight and management within the UK entity of risks originated remotely. We expect the PRA to be particularly challenging when it cannot see the economic or business rationale for any changes to booking structures.
• The consultation closes on Wednesday 30 October 2024. The PRA proposes that the changes to SS5/21 resulting from this CP would be implemented during 2025 Q2. The changes to the material relating to branch reporting would be implemented on 31 December 2025. The PRA and the FCA will also consult on the review of the Senior Managers and Certification Regime (SM&CR) in 2024 which will have relevance to SMF7 Group Entity Senior Manager Function.

Section 1: Changes to the supervision of branches
 

The failure of SVB UK (which became a subsidiary in July 2022) and its limited impact on UK financial stability reinforced for the PRA the importance of timely assessment and, where needed, subsidiarisation of branches of third country banks. It also highlighted a gap in the PRA’s criteria for assessment of whether a third country bank should operate as a branch or a subsidiary which currently focuses on the aggregate amount of deposits covered by the Financial Services Compensation Scheme (FSCS). The majority of deposits held by SVB UK were not FSCS-covered – before subsidiarisation, the SVB UK branch held over £4bn of transactional and instant access deposits from small companies and £5bn of deposits from larger companies. A failure of the branch could have disrupted access to these deposits and trapped the working capital of these companies.

To address these gaps the PRA proposes targeted updates to:

1. Total level of retail and small company demand deposits that can be held within a branch.
 

• The PRA proposes to include an additional indicative threshold of £300 million of total retail and small company demand deposits (i.e., including non FSCS-covered deposits). This will be considered on a firm-by-firm basis and is not expected to have a material impact on the existing branch population.
• In relation to high-net-worth individuals (HNWIs), the PRA may consider it appropriate for a third country bank to operate through a UK branch, even if its retail and small company demand deposits are above the indicative thresholds, where this results from HNWI deposits. Affected branches would be expected to provide relevant evidence of their customer profiles. The PRA plans to consider individuals that had financial assets in the last financial year of over £250,000 as a HNWI.
• The wording of the existing £100m threshold for FSCS-covered retail and small company instant-access deposits will be amended to clarify that this relates only to amounts under the FSCS coverage limit, and not to total balances in FSCS-eligible accounts.
• The PRA is currently reviewing the deposit protection limit and will consult later in the year. Future limit changes would affect what deposits in branches count towards the existing indicative thresholds in SS5/21 with respect to FSCS-covered deposits.

2. Level of demand deposits from corporates above the small company threshold.
 

• The PRA will take account of significant demand deposits from larger corporate customers undertaking UK economic activity that are likely to be dependent on a branch as their sole provider of transactional banking. The PRA will not set a quantitative threshold but intends to use supervision to explore this on a case-by-case basis. 
• The PRA will also take into account retail or corporate liabilities originated in the UK branch but booked remotely. Banks are expected to notify the PRA of material deposit activity originated by their UK branch but booked elsewhere.

3. Group resolution strategy of a branch.
 

• When making a determination about its branch risk appetite against the criteria relating to demand deposit activity, the PRA will take account of the efficacy of the group and its home resolution authority’s arrangements for resolution. 
• The PRA suggests that when the home resolution arrangements are comparable to the BoE’s (SoP on BoE’s approach to assessing resolution), it may allow a third country bank to provide demand deposit services to UK customers through a branch, even when the scale of the branch activities exceeds the PRA’s risk appetite.

Section 2: PRA’s expectations regarding booking arrangements
 

The PRA has developed more granular principles regarding desk structures. The principles focus on the risk management and control of firms’ derivative activity and reflect changes observed in firms’ booking structures. These changes originate from PRA close engagement with the ECB’s desk-mapping review but are of wider application. The PRA proposes extending the scope of application of these booking expectations to include those PRA-authorised banks and designated investment firms that are headquartered in the UK or are part of a group based in the UK, with investment banking or sales and trading activities in both the UK and overseas.

• The PRA puts greater emphasis on firms notifying the PRA of any planned material booking model changes. The PRA will need to understand the rationale for changes when firms move away from a centralised risk management structure, particularly where risk management is being fragmented, and the mitigants that a firm is putting in place. In any proposed changes, firms should ensure that the changes do not undermine the effectiveness of risk management. Proposals to fragment risk management of the most complex non-linear risks are unlikely to be acceptable to the PRA. 
• Firms need to ensure that any proposal to split desks firms is justified by the volume of activity in the “new” jurisdiction, that traders are aligned with the proportion of activity, there is a single business head accountable for consolidated management of split desks across entities, there is a single consolidated independent risk management oversight and firms can reduce offsetting inventory positions and pool collateral between entities.
• In any move to increase remote booking, firms should consider liquidity, market or counterparty risk that may be left behind. A structure with all traders in different locations to the risk hub is unlikely to be acceptable to the PRA. 
• Firms should ensure they have a sound economic rationale for any proposed change such as location of market liquidity or distribution of client activity. The PRA does not view the underlying currency of denomination of an instrument as a sufficient rationale to warrant fragmentation of risk. 
• The PRA is giving more clarity in relation to front office controls including on various types of booking practices, definitions and pre- and post-trade controls and elevating the status of management information on booking to make it clear that the PRA considers it an essential element of ‘controls’. The PRA is placing more emphasis on documentation and senior governance approval of controls themselves in addition to associated booking arrangements. 
• Existing control weaknesses should be remediated before further booking changes can be proposed. 
• The PRA expects firms to meet the expectations in this section within a reasonable timeframe and should provide supervisors with their plans.

Section 3: Amendments to the PRA branch return and other changes
 

The proposed changes in relation to branch supervision will require amendments to Branch Return reporting which will need to include (semi-annually) data on total retail and small company deposits held in transactional accounts or instant access accounts, instant access non-financial corporate deposits and the number of HNWIs. 

In addition, the PRA proposes to add a new part to the PRA Branch Return Form to collect whole-bank liquidity data from third-country banks to gather information on the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR). They will be required to report semi-annually on a number of metrics relevant for the LCR and NSFR (e.g., 30-day net outflows, available and required stable funding). The PRA is willing to update SS34/15 to allow for collection of more frequent liquidity data of third-country banks, especially during stress periods.

The PRA expects branches to comply with the new reporting requirements without any significant additional effort since they relate closely to information branches already provide in the branch return. Where new information is to be provided to the PRA (e.g. in relation to branch HNWI deposits) it is expected to be based on information banks already produce for their own purposes so the cost should not be material.

In the consultation, the PRA has also clarified:

• The Role of Deposit Aggregators - use of third parties to source deposits will be taken into consideration when assessing the deposit-taking activity of a bank branch.
• The PRA’s process on equivalence assessments – basing the PRA’s equivalence assessments on reputable third-party sources (e.g. the IMF) where appropriate and available but utilising other sources as necessary.
• Expectations for international banks will be aligned with the PRA’s previous statement on innovations in the use by deposit-takers of deposits, e-money and regulated stablecoins. In practice this means that international banks should only provide innovations in digital money in a way that meets the eligibility rules for deposit protection under the FSCS. eligibility rules for deposit protection under the FSCS. 

Conclusion
 

As the PRA suggested, the proposed changes are targeted and do not alter the overall framework for supervising UK branches of third country banks. The new indicative threshold for retail and small company demand deposits and additional considerations for larger corporate and HNWI will subject branches that have such depositors to greater supervisory scrutiny. 

Firms will also need to prepare rigorously when considering or requesting approval for any changes in booking arrangements having particular regard for remote booking, split desk governance, fragmented risk management, and ensuring they provide sufficient justification for any changes.