UK: Foreign Bank Branches In The UK | The PRA Approach

Last Updated: 4 March 2014
Article by Kai Kohlberger and John Andrews

Most Read Contributor in UK, August 2017

The Prudential Regulation Authority's (PRA) new supervisory approach to foreign bank branches "is expected to require some branches to either exit the market or become a subsidiary", according to a new consultation paper released today.

The paper sets out the PRA's proposed approach to supervising international banks, largely focusing on branches of non-European Economic Area (EEA) firms. While the paper provides new details and explanations, it largely confirms the recent experiences of firms seeking to set up (particularly retail) branch operations. A number of things jump out from the paper:

  • The PRA's concerns are greatest with respect to retail banking activity conducted through branches, rather than wholesale activities – the PRA expects new non-EEA branches to focus on wholesale, and to do so at a level that is not critical to the UK economy; high volumes of retail business in branches of non-EEA banks will require "a very high level of assurance" over resolution;
  • Resolution is absolutely central to the PRA's approach, and a new resolution requirement is set to be tied closely to threshold conditions for authorisation;
  • All deposit-takers and designated investment firms operating through branches will be required to complete a new data collection return beginning in 2015, with a pilot to be conducted with a sub-set of branches in 2014.

Focus on Non-EEA branches

Three criteria will be used when determining the PRA approach to non-EEA branches: home-state supervisory equivalence; critical economic functions (CEFs) conducted in the UK; and the adequacy of resolution arrangements.

Home-state supervisory equivalence

For non-EEA branches, the PRA's threshold conditions apply to the bank as a whole, and not just the UK branch. This means that the quality of home-state supervision is critical, and as such the PRA will conduct an equivalence assessment. This will cover a wide range of areas, with assessments set to be broader where a branch conducts CEFs. Importantly, the PRA's standards and process will not be set down in rules, giving the PRA broad discretion here, and the ultimate division of prudential responsibilities will be the subject of bilateral agreements.

Where home state arrangements are not deemed equivalent, either generally or in relation to specific activities, a branch will fail to satisfy the threshold conditions for authorisation, and would be required to operate in the UK as a subsidiary.

Critical economic functions – retail under the spotlight

The PRA will look to understand the nature of the business undertaken through branches, as well as the materiality of that activity to the UK economy. It will look across several categories of activities: retail banking; corporate banking; payments, clearing and settlement; custody; intra-financial system transactions; and investment banking.

The PRA will be looking at whether the extent of a branch's activities in these areas could affect the stability of the UK financial system, or interrupt critical services. There are two main concerns here: continuity of access to accounts for depositors; and the potential for the firm to create a liability to the UK deposit guarantee scheme, the FSCS. These are notably retail-centric issues, and the PRA makes it clear that it will only be content to let non-EEA branches conduct retail banking activities beyond as-yet-unspecified de minimis levels where there is "a very high level of assurance" in relation to resolution. Clearly the PRA's decision on where to set this level will be a crucial determinant of how individual banks are affected.

Resolution centre stage

Resolution "will be a key deciding factor" in the PRA's stance towards a non-EEA branch. This means both the equivalence of home-state resolution regimes and the credibility of the individual bank's resolution plan will be examined. There will be a new rule in place which requires non-EEA firms to "take all steps within their control" to have adequate resolution arrangements in place for UK branches. Crucially, any firm failing to satisfy this requirement "would likely fail to satisfy" threshold conditions for authorisation.

When it comes to assessing resolution regimes as a whole, the PRA will take into account international standards (i.e. the Financial Stability Board's 'Key Attributes'), although how exacting the PRA will be in this regard is unclear –at the extreme, full compliance line-by-line against the Key Attributes could be a significant challenge, irrespective of how much work an individual bank does within the constraints of its domestic law.

Assessments will be conducted on a case-by-case basis, and the more significant the branch, the more assurance the PRA will seek, particularly if the branch conducts CEFs.

How will branches actually be supervised?

The PRA will look to have firm-specific agreements in place with home supervisors. They will be looking at several areas: business risks; liquidity; capital; risk management; and management and governance. Some of these are the responsibility of the home-state supervisor (notably consolidated capital requirements), but in others there is a bigger role for the PRA. In particular, the PRA will expect a senior individual in the UK management team to be responsible for an annual attestation of compliance with Senior Management Arrangements, Systems and Controls (SYSC) requirements. Senior individuals will also require approval by the PRA.

What about banks with both a branch and subsidiary in the UK?

While in general the paper has less to say on the supervision of subsidiaries (on account of the PRA having a broader suite of powers over such entities already), one area of interest for some large global banks will be the relationship between their UK branches and subsidiaries. The PRA says it will expect "appropriate governance" to oversee and manage the links between the two entities, and in particular they will expect a clear booking model to be in place, including setting out what will be booked in each entity, and how application of the policy will be verified.

Data collection

A new rule requires all deposit-taking branches and designated investment firms to submit a set of data twice a year. This will allow the PRA to assess the potential impact that branches could have on UK financial stability, with a view to designating certain branches as "significant". The PRA says that it intends this regular requirement to reduce the number of ad hoc requests for information. This will begin in 2015 for all branches (whether EEA or non-EEA), with a pilot to be conducted in 2014 with an unspecified sub-set of branches.

Summary and implications

The explanation of the PRA's stance will be useful for banks with existing branches and those looking to set up new branches in the UK. We would not expect there to be significant changes between the text of the consultation and the final policy statement, given that in our view the document reflects a policy approach which is already largely in place.

The PRA notes that the UK is "by far the most open developed financial market for international banks to operate branches" and emphasises that its new approach is not intended to change this. Nonetheless, it is clear that openness will turn heavily on the potential for branches to harm the UK financial system, particularly in relation to retail banking. It is also clear that the PRA is retaining discretion in places – it will not formally enshrine processes and standards in rules, and will exercise its judgment. This is consistent with its more general shift towards judgment-based supervision.

The PRA's statement that some branches may have to subsidiarise (or presumably otherwise exit the market in at least some business lines) is a live issue for non-EEA banks which currently take sizeable volumes of retail deposits through UK branches. Such banks will need to examine these issues closely, recognising that continuing to conduct their retail activities through a branch will require a higher level of assurance, particularly in relation to resolution.

There are several things banks with UK branches can immediately consider with respect to their own situation. For instance, how far advanced is the home resolution regime? Does the bank have a group-wide resolution plan in place, and are the branch and its UK CEFs dealt with explicitly in that plan? What is the branch's operating model, and to what extent does it rely on services and data provided by the parent? What arrangements are there in place to ensure the continuity of these services in a stress scenario? All these things point to a focus on the relationship between the parent bank and branch – any work which goes into clarifying that relationship will not be work wasted.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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