The publication of the Prudential Regulation Authority’s (PRA) Business Plan on 9th April recognises that the COVID-19 pandemic and other emerging risks, could cause firms and itself to change priorities in the short term. While the message to firms is that the PRA will be pragmatic, its supervision will continue to require the maintenance of robust prudential standards.
While it may not be explicit from a first reading of the Plan, as part of the focus on robust prudential standards, firms should anticipate regulatory scrutiny on how well their established governance and risk management practices are working under the current crisis, for example:
- Had risks been appropriately identified and assessed in terms of exposures and impacts?
- Are previously established risk appetites, tolerances and mitigations still appropriate?
- Did the stress and scenario framework and scenario analyses adequately capture the impact of current events? Were reverse stress tests severe enough?
- How has the ORSA process coped with rapidly changing circumstances?
- Were individual accountabilities, including those under SM&CR, clear enough?
- How effectively has the Board been engaged so as to both keep it informed and able to make necessary decisions in a timely manner?
- Does the crisis reveal any weaknesses in Board composition, skills experience and culture it sets for the organisation?
The PRA will maintain its policy focus on operational resilience and climate change, and on otherpolicy areas such as financial resilience and recovery and resolution.
In recognition of the current challenges facing banks, the PRA confirms the cancellation of their 2020 annual stress test and the delayed publication of the biennial exploratory scenario (a world-wide slow down). Furthermore, banks can use CRD IV capital buffers during the current crisis. Emphasising its ongoing focus on financial resilience, the PRA has made clear its expectation that all institutions hold on to cash and capital reserves wherever possible. In particular, it does not expect dividends or bonuses to be paid, or share buy-backs undertaken, until the future is clearer.
Although the consultation period on the December 2019 operational resilience paper has been deferred until 1st October, firms should continue to operate and plan on the basis that this will become PRA’s policy. The paper is only one of many published by regulatory bodies around the world and the PRA’s approach will be influenced by its international engagement. Therefore, firms should also monitor papers issued by the Basel Operational Resilience Group, the G7 Cyber Experts Group and others, for example, the recent joint FSB/BIS publication on COVID-19 and operational resilience.
For many institutions, operational resilience will depend on arrangements with outsourcers. Therefore, in reviewing outsourcing arrangements the PRA will expect firms to consider operational resilience together with the various regulatory guidelines on outsourcing published last year.
Recovery & Resolution
For banks, the PRA will continue to assess the credibility of their resolution and recovery plans. For insurance groups, the PRA will concentrate on working with the FSB and the IAIS to develop a common approach. We are already seeing individual PRA supervisors ask insurers for their plans. Whilst the PRA’s initial focus was on the largest insurance groups, we now see this being extended to medium sized and niche insurers.
Robust Prudential Standards
There will continue to be an emphasis on the submission of complete, timely, and accurate regulatory returns. Whilst formal reviews of regulatory returns may be deferred due to COVID-19, recent regulatory fines and the Dear CEO letter issued by the PRA in October 2019 give a clear indication of the standards expected.
Following the Basel Committee’s announcement that it will defer implementation of Basel IV until 1st January 2022, the PRA has confirmed that it will defer changes on IRB models to 2022. However, it will continue to fine tune the prudential regulatory framework for banks, building societies and for credit unions and to review bank’s capital and liquidity resources.
For insurers, attention to exposures to non-traditional and complex products, and complex and illiquid assets, will continue. They will also be expected to have a liquidity risk management policy that complies with SS5/19, issued in September 2019. Additionally, while the PRA proposals on Prudent Person Principle (CP22/19) have not been finalised, that should be referred to when insurers are updating their risk policies.
The Bank of England remains committed to promoting a smooth transition to a low carbon economy. The PRA will continue to assess how banks and insurance firms are including its challenges into their risk management frameworks, their pricing of products and their evaluation of investments. There is continuation of the PRA’s work with the industry through the Climate Financial Risk Forum (CFRF), as well as preparation for the first climate related biennial exploratory scenario in 2021 that will test the resilience of all major UK financial institutions to the physical and transitional risks of climate change.
Transition away from the LIBOR benchmark: The PRA along with the Bank of England and the FCA will continue to support market-led transition, acting to remove barriers when necessary and will step up engagement with firms on this topic.
Encouraging new market entrants: The PRA confirms its support for the New Bank Start-up Unit and the New Insurers Start-up Unit. It will conduct further analysis of barriers to growth for smaller firms together with development of a tailored supervisory approach.
The impact of AI, machine learning and other new technology on financial services, and how that affects the risks to firms’ safety and soundness and their underlying systems and reporting processes.
Preparation for Brexit in accordance with the UK Government timetable and previous PRA communications.
Sicsic Advisory is currently supporting firms on their overall strategic approach to addressing governance, risk management and other challenges and learnings, as described above, in the context of the current crisis.
In addition, it has expertise to assist firms in addressing:
- Climate Change: In partnership with Elseware, we have developed a framework to manage the financial risk related to Climate Change, based on a structured scenario approach in order to meet short- and long-term stress test requirements.
- Operational Resilience: We are able to assess the current operational resilience capabilities of a firm and develop a roadmap to deploy an Operational resilience approach that meets regulatory expectations.