PRA issues a Consultation Paper (CP14/24) on Large Exposures

What does this mean?

The consultation includes a number of proposals from the PRA including: 

1. Mandatory Substitution Approach for Credit Risk Mitigation (CRM): Under the proposals firms are required to reassign the reduced portion of exposures, achieved through CRM, to the collateral issuer or protection provider (guarantor).
2. Removing Internal Model Methods for Securities Financing Transactions (SFTs): Firms would no longer be permitted to use internal model methods to calculate exposure values for SFTs. Instead, they would  be required to use the Financial Collateral Comprehensive Method (FCCM).
3. Amendments to Large Exposure (LE) Limits: The PRA is proposing that the option for firms to exceed LE limits for third-party trading book exposures should  be removed. However, exceeding LE limits for intra-group exposures will still be permitted.
4. Removal of certain exemptions and stricter requirements: The PRA is also proposing to  remove the exemption from LE limits for exposures to the UK deposit guarantee scheme (DGS) and  stricter requirements on exposures to certain French counterparties due to decisions made by the French authorities.
5. Merging LE Rules: The Large Exposures (CRR) and the Large Exposures Parts of the PRA Rulebook will be merged to improve accessibility.

What do firms need to do?

If the PRA chooses to proceed with its proposals as consulted on there will be a range of implications for firms. These include: 

Mandatory Substitution Approach for Credit Risk Mitigation (CRM):

• Risk management functions will need to update internal policies and procedures to reflect the new requirements before proceeding with the necessary system enhancements. Risk management and reporting systems will need to  be modified to capture and report the recognised amounts, which are the reduced portions of exposures to collateral issuers and guarantors.
• Exposure calculation models will need to be updated to accurately calculate the recognised amounts. The calculation must differentiate between scenarios involving collateral issuers (both considering and not considering haircuts) and those involving guarantors.
• Once the required system and model changes have been implemented, banks will need to assess the impact on their existing business-as-usual (BAU) processes and procedures. This will include determining whether any redesign of internal reporting templates is required to incorporate the recognised amounts and other relevant information.

Removing Internal Model Methods for Securities Financing Transactions (SFTs):

• As banks already run the FCCM calculation for derivatives the impact of this change may be limited.
• FCCM uses standardised haircuts and volatility adjustments, which may lead to higher exposures.  

Amendments to Large Exposure (LE) Limits:

• Banks may need to update their systems to ensure real-time monitoring and reporting of LE limits for both third-party and intragroup exposures. Although the PRA states that limit excesses were rarely used, banks previously had the flexibility to exceed limits for third-party exposures, which may have resulted in less stringent monitoring. However, with the new requirements, banks will need to closely monitor these limits in real time. This may require technology investment.
• Process Redesign: Internal processes for managing and approving large exposures will need to be redesigned to align with the new limits and capital requirements. This includes updating risk management frameworks and approval workflows.
• Limiting the ability to exceed LE limits for third-party exposures could impact the liquidity of certain market segments. Banks may be less willing to take on large positions, hence stricter trade requirements may need to be introduced. 

Removal of Certain Exemptions and Stricter Requirements:

• Removal of the DGS will result in adjustments to risk models and updates to various systems.
• Relaxed reporting requirements in dealing with certain French counterparties.

Next steps

The consultation is open until Friday 17 January 2025. During this time, the PRA invites feedback on the proposals set out in the consultation paper (CP).

After considering the responses, the PRA will publish a final policy statement. This statement will outline the final rules and any amendments made in light of the feedback.