Prudential Regulation Authority ("PRA") supervision of international banks

The current use of UK branches and subsidiaries by foreign banks

The UK is home to one of the world’s largest wholesale banking markets and this is reflected in the policy towards foreign banks operating here. The PRA describes its policy towards branches of foreign banks as being relatively open, compared to that of some other national authorities (which are more restrictive and more likely to require the establishment of a separate locally incorporated/regulated subsidiary).

There are a large number of foreign banks operating in the UK and they are significant providers to the UK economy. Many of these banks operate via a UK branch and these tend to be used for wholesale banking activities. It is not uncommon for a foreign bank group to operate via both a UK branch (for wholesale business) and a UK/EEA subsidiary (for retail business). In many cases a non-EEA bank group will establish a subsidiary within the EEA (often in the UK) and this may operate by braches in other EEA countries.

UK retail deposit taking by foreign groups is often conducted through a local UK (or EEA) subsidiary but this is not always the case and UK branches of EEA banks (operating under the passport regime) are also used.

Use of a branch has benefits for the foreign bank because there is greater flexibility to move funds in and out of the UK/branch and this reduces funding costs. There is less flexibility to move funds in and out of the UK with a subsidiary and this model may therefore be used where local deposits will fund local lending,

Regulating branches and subsidiaries – the legal position faced by PRA

The flexibility and attraction for foreign banks of a UK branch model (compared to a UK subsidiary) is matched by increased risks for PRA and UK financial stability. Essentially, PRA must rely to a large degree on the home state, whereas, if a UK subsidiary is established, the full UK regime will apply.

Will PRA allow a foreign bank to establish a UK branch?

As explained above, PRA authorisation is not required for UK branches of EEA banks.

For non-EEA banks, PRA will refuse authorisation unless –

• The Home State Supervisor (HSS) is judged to be equivalent AND
• The HSS will accept responsibility for the branch AND
• Either the branch does not/will not conduct CEFs AND there is an appropriate level of assurance over resolution

OR

• (where CEFs are involved) There is a high level of assurance over resolution AND an agreed split of supervisory responsibilities and focus on UK financial stability, such that the risk to UK financial stability is within PRA’s risk appetite.

The assessment of the HSS equivalence is an internal PRA procedure relating to the home state and not the bank in question. The frequency of these assessments (which are based on international peer reviews) depends on the number of banks from a particular country. As will be seen from the above criteria, some banks from a country with HSS equivalence may be permitted to operate via a branch whilst others may not.

A CEF/Critical Economic Function is ‘a function whose disruption or withdrawal could have an adverse material impact on financial stability in the UK’. PRA will consider the materiality of activities in retail banking, corporate lending, payments, clearing and settlement, custody, intra-financial system borrowing and lending and investment banking. PRA says that it expects new non-EEA bank branches to focus on wholesale activities and at a level that is not critical to the UK economy. PRA has particular concerns over retail banking and about non-EEA bank branches undertaking this activity other than on a de minimis basis. This is because of concerns about the impact of the failure/resolution of the bank on

• The continuity of access to transactional bank accounts – PRA mentions a bench mark limit of up to 5,000 retail and SME customers with less than £100 million covered transactional or instant access account balances

AND

• The impact on the UK if the FSCS were to be unable to recover its liabilities (to eligible depositors) in the bank insolvency

In all cases, ‘resolution’ will be a key factor. PRA will be guided by factors which may include the home state resolution regime, international standards, assurances from the HSS and understanding the bank’s own resolution planning. There will be much greater scrutiny and a higher threshold, where CEFs are involved (such as non-de minimis retail deposit taking).

How will this policy impact existing UK branches of foreign banks?

This policy will impact the existing branches of non-EEA banks. For existing non-EEA branches, supervisory focus will be on whether the branch undertakes CEFs, and on working with the HSS to gain adequate assurance over how those functions could be resolved in line with the PRA’s objectives. Concerns will be raised with the HSS and ultimately might lead to PRA exercising powers over the branch or revoking the branch authorisation (leaving open the possibility that the bank would apply for authorisation of a UK subsidiary).

How will PRA supervise a UK branch of a non-EEA bank?

PRA will seek clear acceptance from the HSS

• of its prudential responsibilities for the UK branch
• confirmation that the bank as a whole meets PRA’s Threshold Conditions
• firm-specific split of responsibilities for prudential supervision of the branch and information sharing

PRA supervision will focus on understanding the branch’s activities, financial strength and resolvability and–

• business risks
• liquidity – branch ‘self-sufficiency’ (which is the default position) or ‘whole firm liquidity’ with regular provision of information to PRA (discretionary). Note: PRA will consult on this as part of CRD[1] liquidity provisions.
• Capital
• Risk management, systems and controls
• Management and governance

Regulation of individuals – attestation and the new Senior Management Regime

In addition to being notified of any breaches of the Senior Management Arrangements, Systems and Controls (SYSC) Sourcebook, PRA also expects senior individuals (who should be part of the management team) to annually attest compliance with SYSC. The attestation should refer to areas of SYSC that deal with branches and the attestation should follow standard wording as stated in the supervisory statement. The first attestation should be sent to the relevant supervisory team by 31 March 2015.

Although PRA recognises that several people may be responsible for compliance with SYSC, it requires one person alone to give the attestation and to be responsible for it.

The new Senior Management Regime (SMR).

The new SMR will replace the old Approved Persons Regime (APER) – for deposit takers and PRA-regulated investment firms.

HM Treasury (HMT) is still consulting on whether and how to apply the SMR to branches of non-EEA firms. FCA and PRA published a consultation on the new regime in July. To read more about the new SMR you can read our report here.

Contingent on the outcome of the HMT consultation, PRA proposes to apply the Senior Manager Function to branches of non-EEA firms. Thus these banks would have to put forward an individual for approval under the Senior Manager Function, which PRA sees as being similar to the role of CEO of the branch. This person would be subject to full personal regulation by PRA under SMR, with the personal liabilities and responsibilities that the new senior manager regime involves. In some cases PRA can envisage requiring a second SMF to ensure the most senior person is brought within the SMR regime.

How will PRA supervise a UK branch of an EEA bank?

Whilst PRA’s role in the supervision of UK branches of EEA banks is limited, it does have certain powers and responsibilities. Until the liquidity requirements of CRR[2] are implemented, PRA is responsible for the supervision of branch liquidity. Beyond this, PRA will be concerned about the impact on UK financial stability and will work with the HSS on any issues arising. In extremis PRA will refer the issue to the European Banking Authority (EBA) and PRA also points to its emergency powers under Articles 43 and 44 of CRD.

If the PRA has material concerns about a firm’s viability or a branch’s activities which the HSS is not addressing, it will refer the issue to the EBA.

How will PRA supervise a UK banking subsidiary of a foreign bank?

A UK subsidiary of an international bank requires its own governance and risk management, and must comply with UK capital and liquidity requirements. The PRA supervises subsidiaries of international banks broadly under the same framework as for UK-headquartered firms, focusing on three key elements:

(i) The potential impact a firm could have on financial stability through its business or in the event of failure;

(ii) How a firm’s external context and the business risks it faces might affect its viability; and

(iii) Mitigating factors such as a firm’s management, financial strength (in particular capital and liquidity) and resolvability.

The PRA will work with the HSS to assess the links between the UK subsidiary and the wider consolidated group as well as the group’s recovery and resolution plans, and may limit the links between the UK subsidiary and the group.

Where firms have both a subsidiary and a branch in the UK, the PRA expects appropriate governance to oversee the links between the two entities. Firms will also be expected to have a clear booking model in place setting out what they will book in each entity and how its application will be verified.

[1] Capital Requirements Directive 2013/36/EU on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms (CRD IV)

[2] Capital Requirements Regulation (EU) No 575/2013 on prudential requirements for credit institutions and investment firms (CRR).