Tighter capital rules for UK banks: other firms beware

17 March 2020

In a week that saw HM Treasury confirm that it would bring EU regulatory capital standards into UK law (including those in the Investment Firms Directive and the Investment Firms Regulation), the Prudential Regulation Authority (PRA) issued its pre-issuance notification (PIN) requirements for banks.

The PIN regime gives the PRA an opportunity to comment on the eligibility of any proposed capital instrument with its Common Equity Tier (CET1) rules.

Together with the European Banking Authority’s July 2019 report on CET1 instruments which makes ordinary shares the only type of eligible CET1 instruments, the revised PIN regime will create hurdles for banks looking to share structures that, for example, incentivise management.

Basic changes to the regime

  1. The requirement for a properly reasoned independent legal opinion and auditor opinion for new CET1 issuances where a bank makes a PIN. Currently, an independent legal opinion is only required for Alternative Tier 1 and Tier 2 issuances, while CET1 issuances only require a self-assessment form.
  2. An amendment to Supervisory Statement SS7/13 on CRD IV and capital. The amendment clarifies the PRA’s expectations on complex capital structures that firms refrain from employing complex capital structures that complicate prudential assessment. The PRA prefers vanilla share structures consisting of only one class of share that is fully subordinated to all other capital and debt, and that has full voting rights and equal rights across all shares in respect to dividends and rights in liquidation.
  3. Expectations that a Senior Manager sign a declaration confirming that the capital instruments meet the relevant eligibility criteria. This enhanced liability for the individual in question is in keeping with the focus of the Treasury, PRA and FCA on individual accountability.

Noteworthy areas of impact

  1. A minimum period for the PRA to consider a CET1 instrument. This is specified as of at least one month in advance of the intended date of issuance of a CET1 instrument, with "more time" necessary for an instrument with "complex feature(s)". In addition to the effort of having to procure the legal and auditor opinions, firms will now be time constrained in how quickly they can move in implementing any capital arrangement, a potentially important factor in any transaction timetable. 
  2. The replacement of "connected transactions" with "side agreements" in the PRA Capital Rules. Firms now have a duty to send any side agreement to the PRA at least one month before the agreement. The  undefined and broader side agreement will allow the PRA more visibility and power to challenge a greater number of side arrangements. Previously, the connected transaction formulation gave firms and its advisers more room to argue that something, when taken together with the item of capital, would not cause it not to display the characteristics of CET1 and was hence not for the PRA’s eyes.

Other financial services firms, such as investment managers, should also take note as the Financial Conduct Authority (FCA) is likely to follow the PRA's lead. The FCA handbook contains near identical provisions for IFPRU firms and the rules for BIPRU firms contain a provision dealing with the effects of "other transactions" but no requirement to share side agreements with the FCA. While the changes may not be identical, it is difficult to see FCA firms escaping these types of change.

View HM Treasury’s policy statement

View the PRA’s update to (PIN) requirements