Review of CP4/23 – The Strong and Simple Framework: Liquidity and Disclosure Requirements

• Average total assets under £20 billion.
• Trading business equal to or less than 5% of total assets and £44 million.
• Net foreign exchange position less than 2% of firm’s own funds.
• No holdings of commodities or commodities derivatives.
• No IRB approvals.
• The firm does not provide certain clearing, settlement, and custody services.
• The firm is not an operator of a payments system.
• At least 75% of the firm’s assets are located domestically in the UK.

Firms are expected to meet these criteria at the individual level and consolidated level, if part of a consolidated group. However, there is one notable exception. UK Subsidiaries of foreign firms are not eligible for the simpler regime, due to their international activity. If they meet all other simpler-regime criteria (on an individual and group level), firms can apply for a modification or waiver, that will allow them to be treated as Simpler-regime firms, however total group assets would need to be less than £20m.

The PRA published CP 4/23 in Q1 2023, which sets out a number of simplified liquidity, disclosure and reporting measures previously discussed in DP 1/21 that’ll apply to simpler regime firms. In summary, the PRA is proposing that:

• NSFR will be disapplied where banks where retail funding accounts for >50% of their total funding.
• Pillar 3 disclosures will be disapplied for unlisted banks and streamlined for listed however, banks would still be allowed to make voluntary disclosures if they so wish.
• Some ALMM reporting requirements are set to be removed.
• Pillar 2a add-ons are set to be removed, but supervisors will retain discretion on this matter.

In addition, the PRA intends to consider possible further changes to liquidity reporting requirements as part of implementing the Bank of England’s (‘the Bank’) plan for transforming data collection. From a liquidity perspective, the overall benefit to firms of these changes does appear to be, on balance, positive.

But what looks like “deregulation” is perhaps not what it says on the tin. For instance, the PRA is proposing that NSFR (the key regulatory ratio) need not be calculated by firms that have >50% of their funding from retail deposits – but these firms would already have a structurally high NSFR due to their retail funding. Further, the PRA is proposing to remove Pillar 2a add-ons (thereby reducing liquidity coverage requirements), but only a tiny fraction of smaller firms have this add on. Therefore, these proposals are essentially a drive to remove redundant requirements, which should ease the operational and financial burden on smaller firms without taking away the benefits of post-crisis reforms.

Retail Deposit Ratio

The PRA proposes to introduce a new calculation of liquidity, the ‘Retail Deposit Ratio’ (RDR) for Simple Regime Firms (SRF). This will replace the requirement for Strong and Simple firms to calculate NSFR as part of their regulatory requirements.

RDR (%) = Total Retail Deposits / Total Funding 

• total retail deposits = the sum of liabilities to natural persons, and certain liabilities to SMEs with an aggregate limit on SME deposits of £880,000
• total funding = the sum of liabilities that do not qualify as retail funding.

The PRA has set an “RDR Condition” of 50%. It covers 4 quarters to avoid fluctuations in and out of scope of NSFR, and that disapplication of NSFR is done too prematurely. Firms must notify the PRA immediately if they cease to meet the RDR condition.

Given that NSFR is now embedded in risk management and governance, firms may experience a little short-term pain to move away from that calculation and towards the new RDR. However, in the long run this is likely to be a net benefit for several banks.

Firms experiencing changes to their liquidity funding mix, potentially due to alternations in their business model or because they are new banks with high growth models, will have to carefully review the forward looking finding projections of their funding mix.

Pillar 2 Liquidity

The PRA is proposing to amend the SoP ‘Pillar 2 Liquidity’ and SS24/15 approach to supervising liquidity and funding risk. They do not plan to apply Pillar 2 Liquidity guidance to Simpler-regime Firms, except where warranted due to idiosyncratic risks.

The PRA is also proposing the introduction of a new ILAAP template that could be used as a guide by SRFs when producing ILAAPs. The new template merges sections of the previous template that could be duplicative for Simpler regime Firms; it reorders the overall template, placing greater emphasis on stress testing and qualitative information for all the 12 sub-categories of liquidity risk; and includes guidance on how Simpler-regime Firms can conduct their risk assessment proportionately in the context of their business model.

Pillar 2 liquidity add-ons were not in place for many firms. Supervisory discretion appears very similar to the current regime, so it does not appear that much will substantively change.

While reductions in the scale and scope of ILAAPs for SRFs are welcomed, for several firms, stress testing was the most complicated element. Placing more emphasis on this section may mean more work for firms. Banks will also have to carefully consider how they identify, measure, manage and monitor liquidity risks at a more granular level, as this information will not need to be disclosed in the ILAAP.

Banks will need to monitor publication of the final policy closely because the Bank of England wording on this topic of material significance remains very high level at this time.

Liquidity Returns

ALMM returns are liquidity risk monitoring tools that measure dimensions of the liquidity risk profile not captured by the LCR or NSFR. The PRA proposes the exclusion of the following returns from the requirement of the SRFs:

• C67 – concentration of funding by counterparty
• C69 – prices for various lengths of funding
• C70 – roll-over of funding
• C71 – concentration of counterbalancing capacity

This decision was based on the extent to which these returns can be used to promote Safety and Soundness of SRFs, the nature of the risks SRFs are exposed to, reporting costs and the approach to supervision and other sources of information available to the PRA.

Perhaps the most significant change is the exemption from C70 'Roll-over of funding'; this section requires pertinent data to be extracted, cleansed, and populated for each day of the reporting period, providing the basis for funding roll-over calculations not utilised elsewhere.

Overall, ALMM's monthly schedule and unique data demands mean that the proposed changes should result in SRFs seeing a reduction in the amount of time and effort expended on liquidity reporting. However, given that subsidiaries of most international firms may not quality for the simpler regime, there is a question about whether all small firms in the UK can benefit from such reductions.