[Banking] The PRA’s new liquidity regime

In October 2014, the European Commission published the Delegated Act to supplement EU Regulation 575/2013 (CRR) on the liquidity coverage ratio (LCR) and on the circumstances under which specific inflow and outflow levels should be imposed to cover institutions’ specific liquidity risks.

The legislation will become effective on 1 October 2015 in the UK and will be applicable to all firms under the Capital Requirements Directive IV (CRD IV). In November 2014 the PRA issued a consultation paper (CP27/14) to explain the proposed changes to the liquidity rules. The consultation period finished in February 2015. The PRA published its policy statement (PS11/15) with the final rules on 8 June 2015.

In PS 11/15, the PRA announced that full implementation of the LCR will be phased in as follows: 80% requirement from 1 October 2015, 90% requirement from 1 January 2017, and 100% requirement from 1 January 2018. The LCR applies to all European institutions in a standardised way and seeks to ensure the adequacy of a bank’s stock of unencumbered High Quality Liquid Assets (HQLA) – that is cash or assets that can be converted into cash at little or no loss of value in private markets to meet liquidity needs for a 30 calendar day liquidity stress scenario¹. The LCR could therefore fail to capture some firms’ specific liquidity risks and it does not provide any information on the adequacy of systems and processes for managing liquidity risk. For these reasons, institutions will be required to continue to comply with the PRA’s Overall Liquidity Adequacy Rule (OLAR) which requires banks to ensure that their liquidity and funding risks are comprehensively identified and managed.

In revising its approach to liquidity regulation, the PRA will revoke its current Prudential sourcebook on Liquidity Standards for banks, building societies and investment firms (BIPRU 12) when the LCR comes into effect on 1 October 2015. As a consequence, the simplified Individual Liquidity Adequacy Standards regime and the standardised stress tests requirement outlined in BIPRU 12 will be switched off. Additionally, the following modifications will be discontinued:

• the intragroup liquidity modification, which allows UK-incorporated, PRA-regulated firms to rely on liquidity support from elsewhere in their group; and
• the whole firm liquidity modification, which allows the UK branches of overseas banks to rely on available liquidity from elsewhere in the firm.

However, since the EU regulation on liquidity will apply from 1 October 2015, institutions that rely on the intragroup liquidity modification can apply for a similar permission under CRR Article 8.²

The rules on OLAR, liquidity risk management, stress tests, Internal Liquidity Adequacy Assessment (ILAA) and asset encumbrance, which are included in BIPRU 12, will be addressed in the new part of the PRA’s Rulebook focused on liquidity. Existing individual liquidity guidance (ILGs) and liquidity add-ons that cover firm-specific risks not captured by the LCR will be considered as interim Pillar 2 fixed add-ons and they will be based on their absolute amounts as at 30 September 2015. During the summer of 2015, the PRA will communicate firm-specific add-on levels to the firms with existing add-ons. The Pillar 2 fixed add-ons should be covered by HQLA whose specific types are defined in Title II of the Delegated Act. Pre-positioned assets at the Bank of England not eligible for inclusion in the HQLA buffer cannot be used to comply with the PRA’s liquidity guidance.

In terms of reporting, the European Banking Authority (EBA) is currently revising the COREP LCR templates to implement the Delegated Act requirements through additional monitoring metrics returns (AMMs).³ Tight deadlines might be faced in completing them. The PRA expects firms with balance sheets above £5 billion to have systems and controls in place to submit the COREP LCR, the contractual maturity ladder (AMM C66.00) and Rollover (AMM C70.00) returns daily in case of stressed conditions. In order to facilitate the supervision of liquidity, the PRA will maintain the existing FSA047 (daily flows) and FSA048 (enhanced mismatch) for at least one year from the introduction of the full suite of COREP templates. The PRA will assess the progress in implementing the equivalent AMM C66.00 (maturity ladder) return in the first half of 2016 and will review this requirement accordingly.

Following the application of the LCR, the PRA will no longer be responsible for the supervision of branches of EU credit institutions and will therefore stop collecting liquidity reports in relation to these branches from 1 October 2015. UK branches of third-country firms and of EEA firms with a head office outside the EU will cease to submit the existing regulatory returns when the LCR will come into effect. From that day, they will report on liquidity on a whole firm basis through their home state liquidity reporting regime. The PRA will confirm specific details at a future date.

_{[1] The LCR is calculated as the ratio of the liquidity buffer (HQLA) and the net liquidity outflows over a 30 calendar day stress period.}

_{[2] CRR Article 8 allows competent authorities to supervise an institution and all or some of its subsidiaries in the EU as a single liquidity sub-group under certain conditions.}

_{[3] Annex A of PS 11/15 provides the equivalent AMM returns for the existing FSA templates (where applicable).}