The Prudential Regulation Authority has published a letter addressed to the Chair of the Working Group on Sterling Risk-Free Reference Rates. The letter responds to the Working Group's letter in October 2019 requesting regulatory forbearance or clarification from regulators on the impact that the LIBOR transition is likely to have on the prudential requirements for banks. The main issues raised by the Working Group include: (i) the potential for certain capital instruments to no longer qualify as regulatory capital; (ii) the potential for securitizations and MREL-eligible instruments to be considered as "new contracts" as a result of changes to contractual terms, leading to the need to insert bail-in or other bank recovery contractual terms; and (iii) that many banks will need to obtain regulatory approvals for alterations to the models used to determine their regulatory capital arising from their exposures and risks.

The PRA states the following in response:

  • The PRA's view is that the eligibility of regulatory capital instruments should not be reassessed where amendments are made solely to replace the benchmark reference rate. The PRA has raised the issue at the Basel Committee on Banking Supervision and an internationally consistent response is in progress.
  • The PRA supports the view of the European Supervisory Authorities (and other regulators) that new requirements are not intended to apply to legacy uncleared derivatives contracts where amendments are made solely to replace the benchmark reference rate.
  • The PRA's rules on contractual recognition of bail-in and stay in resolution are relevant where legacy contracts may be deemed to be materially amended. The PRA intends to provide an update in spring 2020 on the implications arising from the LIBOR transition.
  • The PRA will meet with major firms in Q1 2020 to discuss how a consistent approach can be adopted for managing counterparty credit risk, market risk and interest rate risk in the banking book. Firms will be requested to identify the number and type of models that will need amending and to inform the PRA as to when they expect to submit model changes for approval. The PRA will communicate further on its plans for model review in Q2 2020, however, the PRA indicates the pre-approvals for model changes for any material change are likely to still be required.

Finally, the PRA stresses that it is important for banks' senior management to stay closely engaged on these issues and the risks. The PRA suggests that the Working Group and the PRA meet in spring 2020 to consider how work on regulatory issues arising from the benchmark reforms is progressing.