Introduction

The Prudential Regulation Authority (PRA) has published Consultation Paper 4/14 - Supervising international banks: the PRA’s approach to branch supervision (the CP).1

The CP proposes new rules and includes a draft supervisory statement, in which the PRA sets out its proposed approach to supervising international banks. The scope of the supervisory statement covers both UK branches and UK subsidiaries2 of banks incorporated elsewhere in, and outside of, the EEA.

A summary of the PRA’s proposals is set out at the end of this note. The headline points of the CP do not come as a particular surprise and reiterate, develop, or are foreshadowed by, the PRA’s inaugural Approach to Banking Supervision paper, published in April of last year and by PRA CEO Andrew Bailey’s speech to the BBA on 17 October 2013.

Themes

The CP draws upon a number of themes that have had a prominent place in UK and global regulatory and economic debates during and since the global financial crisis: the tension between fostering the UK as a global banking hub and protecting UK depositors and tax payers; the testing of the ability and willingness of regulators from different jurisdictions to work together; and the so-called balkanisation or subsidiarisation of banks and other financial institutions.

These debates and tensions are far from resolved (and are perhaps irresolvable) as demonstrated in the last few months in and outside the UK by, for example, the differences in (or tensions between) the stated or implied views of UK Chancellor George Osborne and Andrew Bailey on the establishment of UK branches by Chinese Banks that were evident last autumn and the approval last month by the US Federal Reserve of rules enhancing prudential standards for non-US banking organisations.

Nonetheless there are a few interesting new developments in the detail of such proposals.

Home State Equivalence and Threshold Conditions

The PRA’s key regulatory tool, in the context of authorising and supervising the branches of non-EEA banks will be its assessment of whether such banks’ Home State Supervisors (HSS) (i.e. the regulators in their countries of origin) meet the PRA’s standards of equivalence. The focus on regulatory equivalence is not unexpected – it was discussed in the PRA’s Approach to Banking Supervision paper and can be seen as part of a general trend towards assessing international regulatory equivalence (most notably in the context of EU regimes such as EMIR, AIFMD and MiFID II). What is notable, is the fact that the PRA makes an explicit link between such equivalence assessment and its Threshold Conditions. Threshold Conditions are hard-wired into the UK regulatory regime as conditions that must be met not only by an applicant for a banking licence, but also on an on-going basis by all regulated firms.

The PRA states that “firms which are from countries whose regulators are assessed not to be equivalent will fail the Threshold Condition… [and will not] be authorised.” Similarly, it notes that “if the assessment of the equivalence of a HSS changes, the firm can have its [regulatory] permission varied or cancelled”. On one reading of the draft supervisory statement, the logical conclusion – which the PRA does not make explicit – would be that if, in the course of determining a new branch application, the PRA determines that the applicant’s HSS is not equivalent and that therefore such applicant has failed the Threshold Condition then all existing branches of other banks from the same home state would also fail their Threshold Conditions. This would mean that, regardless of how well run and capitalised such other banks are, their UK branch permissions may need to be varied or cancelled – or the branches pushed into subsidiaries (or out of the UK altogether).

Therefore the PRA may find that it is binding its own hands in that, if it is faced with an application for a branch from a bank that it would like to reject (and feels that it could do so on the grounds of the HSS regime) it may have to choose between two undesirable positions: blocking the application of the new branch (and therefore effectively declaring all existing branches from the same home state in breach of their Threshold Conditions) or allowing the application through, unless it can find some other cause or reject it, in order to avoid the political and economic fallout that would arise from the former route.

The PRA could revise its policy statement in order more clearly to provide that its assessment of HSS equivalence for the purposes of determining compliance with Threshold Conditions will somehow be linked with equivalence of the HSS regime in the specific context of each particular bank’s business and risks, rather than uniformly applicable to all banks from the same home state. Of course, this raises the risk that the PRA’s policy and the application thereof is claimed to be arbitrary and discriminatory.

In fairness to the PRA, it presumably has taken the view that making this connection between the assessment of HSS equivalence and the Threshold Conditions is the only certain way that it can achieve its policy objective within the scope of existing legislation and that the alternative would involve seeking the passing of new legislation by Parliament (which would be a difficult, uncertain, lengthy and potentially politically embarrassing process, over which the PRA would have no control).

Interaction with EEA Regulators

The PRA is more restricted, by virtue of EU requirements (in particular CRD IV), in its treatment of UK branches of EEA banks. Even so, the PRA seems to be signalling that it is intending to take as active a role in the prudential regulation of EEA banks with branches in the UK as it is able. The PRA expresses willingness to refer matters to the EBA and cites articles 43 and 44 of the CRD IV Directive3 as grounds for it to take emergency precautionary measures where it believes that another EEA state has failed to take appropriate action in respect of its banks with branches in the UK.

Depositor Preference

It is also worth noting that non-EEA depositor preference regimes seem to be back on the UK regulatory agenda. In 2012, the FSA published a consultation paper on this subject. The FSA’s (now the PRA’s) conclusions have been constantly pushed back – many thought indefinitely. The PRA has now promised to publish more information later this year. In the meantime, there is little one can glean from the latest CP as to the direction that the PRA will take; other than that “the minimum outcome the PRA would seek to achieve is to ensure that the branch’s UK creditors and depositors are treated equally with their domestic equivalents”. This is broadly the same position espoused by the FSA in its consultation paper and so it remains to be seen whether the PRA will indeed push forward this issue.

The deadline for comments on the CP is 27 May 2014.

Headlines of CP 4/14

Branches of Non-EEA Banks

  • The PRA’s approach to authorisation of branches of non-EEA branches is centred on an assessment of the equivalence of the home state’s supervision of the bank as a whole and the level of assurance that the PRA gains from the HSS over resolution of banks.
  • The PRA will also need have agreed with the relevant HSS the split of prudential responsibilities for branches of non-EEA banks between the two regulators.
  • The PRA will only be content for UK branches of non-EEA banks to undertake retail banking beyond de minimis levels where there is a very high level of assurance from the HSS over resolution.
  • The PRA will expect new branches of non-EEA banks to operate at a level that is not critical to the UK economy
  • In supervising existing branches of non-EEA banks, the PRA will focus on whether each branch undertakes critical economic functions and will work with the HSS to gain assurance over how, if things go wrong, such functions would be resolved.

Branches of EEA banks

  • As with branches of non-EEA banks, the PRA will focus on whether branches of EEA banks undertakecritical economic functions and will work with home state regulators to ensure that the home state regulators’ resolution strategy for such banks will take into account the impact on the UK to agree how the PRA can support prudential supervision.
  • Where the PRA has material concerns about a bank’s viability or activities, which the home state regulator is not addressing, it may refer the issue to the EBA and may take further emergency action in accordance with the CRD IV Directive.

UK subsidiaries

  • The PRA will work with HSS of the parent bank to assess linkages between a UK subsidiary banks and the wider bank group and will seek to limit linkages between the UK subsidiary and wider group.
  • Where a bank has both a branch and subsidiary in the UK, the PRA will expect the group to have appropriate goverance arrangements to manage the links between the two and to ensure clarity around which products and exposures are booked to the subsidiary and which to the branch/non-UK bank.

Draft Rules

The CP  proposes new PRA rules - specifically:

  • a rule that UK branches of non-EEA banks must ensure that the (bank-wide) resolution plan provides adequately for the resolution of the UK branch.
  • a rule requiring UK branches of EEA and non-EEA banks to submit twice yearly branch data collection returns. The form of the return is appended to the CP.