Are UK branches of EU-27 banks ready to become third-country branches?

The UK branches of the EU-27 banks currently benefit from lighter regulatory requirements compared to the third-country branches. However, post-Brexit this distinction will no longer be relevant as all branches will ultimately be subject to the same rules. So, with the increasing odds of a no-deal Brexit, the EU-27 banks operating in the UK as branches should ramp up their preparations and familiarise themselves with the Prudential Regulation Authority's (PRA) approach to the supervision of the third-country branches.

The PRA's expectation from third-country branches is clear. They should focus primarily on wholesale banking activities. What, in practice, this means is that they should not have any retail and small-company deposit-taking activities beyond de minimis level of £100 million of retail and SME balances covered by the Financial Services Compensation Scheme or to have more than 5,000 retail and SME customers. While these numbers do not constitute hard thresholds and the PRA usually consider each case on a firm-by-firm basis, they nevertheless set the regulator's broader rules on the supervision of the third-country branches.

From a supervisory standpoint, the PRA requires the third-country branches to provide clarity over their main areas of business i.e. if they carry out Critical Functions to enable the regulator to determine the materiality of its activities. These include retail banking, corporate banking, payments, clearing, settlement, custody, intra-financial system borrowing and lending, and investment banking. The PRA also expects the arrangements, processes and mechanisms implemented by a third country branch to be comprehensive and proportionate to the nature, scale and complexity of the risks inherent in its business and activities.

What happens if the group has more than one UK branch? In this case, the PRA aggregates the UK footprint of those branches, including any investment firm branches, to assess the significance of the UK branches as a whole. It would be fair to say that the PRA’s supervisory stance will, by and large, depend on the co-operation with or assurances from home state supervisor as well as the systemic importance of the branch. The regulator tailors its approach to the systemic importance of the branch on a case-by-case basis, with a more stringent approach in the case of a systemic wholesale branch, requiring a greater degree of oversight and influence over the wider group, as well as higher levels of supervisory cooperation with the home state regulators.

In the case of branches that perform Critical Functions, the PRA will also seek assurance over their resolution arrangements. The regulator will be checking the group resolution strategy of the branch set by the home resolution authority to ensure it is aligned with its objectives. It will also be checking the credibility and feasibility of the firm’s group resolution strategy, level of assurance provided by the home state supervisor and the home resolution authority, as well as the ability of the PRA and Bank of England to rely on the home state resolution authority to execute the firm’s resolution strategy. The PRA would also expect the home resolution authority to share the group resolution plan if and when requested.

As one might expect, the PRA also requires third-country branches to have appropriate risk management to support the Critical Functions they undertake. But the regulator's approach depends on a broad range of factors including whether the whole firm meets the PRA’s Threshold Conditions, the degree of equivalence of the home state supervisor’s regulatory regime, and the degree of supervisory cooperation with the home state supervisor and resolution authority.

This assessment is based on the size, complexity and interconnectedness of the business undertaken in the branch. Firms should expect the regulator to ask a set of questions during this assessment. These include: Does the branch provide significant operational services? Does it interconnected to a systemically important UK bank? Does it have more than £100 million of retail and SME balances covered by FSCS? Does it have over 5,000 retail and small company customers? Does it have deposits where the total potential liability to the Financial Services Compensation Scheme exceed £500 million? Does it hold more than an average of £15 billion total gross assets including those traded or originated in the UK but booked remotely to another location? and is the branch likely to exceed the threshold of £15 billion in the future?

Firms which have more than one UK branch should note that the PRA will aggregate the UK footprint of those branches to assess the overall significance of the UK branches of the group, including the assets oft he UK branch of an investment firm. If the PRA decided that a branch is systemically important, it will require further assurances over the branch's supervisability. While the PRA would inform a branch if it is determined to be systemically important, and would tailor its approach on a firm-by-firm basis, firms should expect the regulator to focus on the degree of influence and visibility over the supervisory outcomes for the whole group as per its objectives, as well as on the branch’s operational resilience. To assess the systemic importance of a branch, the PRA will also be looking at the operational services that it provides or its interconnecteded to a systemically important UK bank.

The PRA would also seek assurances on the booking arrangements in place at the branch. It will specifically require the branch to have appropriate internal governance to oversee and manage the linkages between the subsidiary and the branch, clear booking arrangements setting out what it will book in each entity, documentation and approval by the appropriate governance body, appropriate risk management systems and controls for the branch's booking activities, alignment of risk and returns, and explicit oversight of booking arrangements in Statements of Responsibilities under the Senior Managers and Certification Regime. The regulator will also require assurances that the booking arrangements at the branch do not impede the firm’s recovery and resolution.

Turning to the governance-related supervisory requirements from the third-country branches, the PRA is also likely to introduce additional requirements including but not limited to additional Senior Management Functions (SMFs) such as Chief Risk Officer, Chief Finance Officer, Chief Operations Officer and a group executive (SMF7), as well as a branch head of risk (SMF4). Firms should also note that in the case of third-country branches the SM&CR will be applied by both the PRA and the Financial Conduct Authority and they will need to have in place a Head of Overseas Branch (SMF19).

If a firms operates in the UK with both a subsidiary and a branch, the PRA expects appropriate governance to oversee and manage the linkages between them. Given a branch forms part of a legal entity incorporated and authorised abroad, it is not required to have its own board. But firms should note that the PRA may require them to set up a separate branch oversight board. It may also introduce additional branch liquidity requirements as well as restrictions on scope and/or volume of business. 

The EU-27 firms should also note that the branches are expected not to undertake the outsourcing of important operational functions and they may be required to submit information regarding operational continuity in resolution and operational resilience. Depending on the nature, scale and complexity of their business, branches may be required to have a separate, permanent and independent compliance function and to establish an independent internal audit function. The PRA may even require the firm to operate as a UK subsidiary rather than a branch.

In the event of any business transfer to the UK branch, the PRA would also be keen to identify if there is any immediate or future change to business model or strategy of the transferor and transferee, as well as if there's any impact to viability or profitability of the former after transfer of business to the branch. Firms also expect increased supervisory scrutiny both during the transfer of business, particularly on booking arrangements and should be prepared to respond to more frequent questions. So they should engage with their supervisors at an early stage prior to finalising their plans to avoid any unexpected last minute complications.

Disclaimer: The views and opinions expressed in this blog are those of the author and do not necessarily reflect the official views and opinions of PwC.