While some indications have emerged of the U.K. and E.U. collaborating closely on cross-border financial regulations, post-Brexit inconsistencies have already cropped up. Banks hoping to avoid regulatory mismatches will inevitably need to rethink their compliance strategy.
At the beginning of 2021, the U.K. completed its journey out of the E.U. orbit after the transitionary period ended on 31 December 2020. The Prudential Regulation Authority (PRA) has now taken on substantial new rule-making responsibilities and therefore is making policy decisions to support robust standards and implement regulatory reforms.
It is vital for U.K. banks to understand the impact of changing regulatory guidance on their operations in the U.K. and E.U. as they now must follow one more set of regulations. This article throws light on the recent U.K.-E.U. regulatory divergence and its impact on the U.K. banks.
Recent Regulatory Developments
The U.K. and E.U. announced on 29 March 2021 that they have agreed to sign a Memorandum of Understanding (MoU) to continue talks, co-operate on financial services and create a framework for voluntary regulatory cooperation in financial services.
In the context of the U.K.’s new relationship with the E.U., PRA is already working with U.K. government and other regulatory authorities to develop a revised regulatory approach. The FCA (Financial Conduct Authority) and HM Treasury, has published final rules to implement the Capital Requirements Directive V (CRD V) and will publish the Capital Requirements Regulation II (CRR II) in the second half of 2021. PRA is also updating rules for implementation of Basel 3.1 for firms so that the same can be implemented by 1st Jan 2023, as set by the Basel Committee on Banking Supervision (BCBS).
What’s Next for U.K. Banks?
Considering the above revised PRA regulations, the divergence between the regulatory standards between U.K. and E.U. is quite clear and is likely to increase in the future. Divergence likely in both rules and the timings will impose varied obligations on the U.K. banks to meet both domestic and foreign regulatory compliance.
As an example, The CRR II regulation effective date in E.U. was 28 June 2021 while the implementation of the PRA rules released in July 2021 is from 1 January 2022, six months later than the implementation of E.U. CRR2 standards. In view of this, lately U.K. banks with E.U. presence had to rapidly analyze the impact of added divergence of two similar regimes with differing implementation dates.
Increased Divergence – Dual Reporting Scenario
The U.K. banks with E.U. presence had to deliver drastic changes in their IT systems in first quarter this year to implement new CRR II guidelines for E.U. and are now grappling with the analysis of PRA CRR2 divergence so that the reporting compliance of 1 January 2022 can be met for PRA.
Increased Volume of Work
Developments like these will have very real implications for UK banks in future with substantial operations in multiple jurisdictions. With one more regulator to manage, UK banks need more resources and preparations to do so efficiently. The increased work will not only be on the bank risk divisions but also the IT teams supporting the change. Only trained resources across the entire delivery chain will be able to deliver these changes in short span of time.
PRA as of now has postponed the application of the mandatory substitution approach to large exposures that are secured by collateral issued to a third party, pending further consultation and impact assessment. This has led to more ambiguity as Large exposures substitution approach continues to be applicable in EU set of CRR2 rules.
With stringent deadlines from regulators, the temptation of the banks will be to take a tactical short-term approach to meet the regulatory requirements as opposed to a strategic long-term approach. However, the most successful response will involve long-term thinking as to how best a business can meet future regulatory reporting requirements.
Can Technology Help?
In these changing times, a strong and flexible IT systems can keep U.K. banks afloat to meet regulatory reporting under both jurisdictions.
Adoption of Modern Technology
For implementing the regulations quickly, new layers of complexity have been added on to the existing old systems. Though there is recognition that such quick tactical solutions are costly and risky to continue, the solutions get restricted by such legacy problems. Hence, banks need to embrace more agile and modern systems to define new regulatory compliance rules that account for the variations in the U.K. and E.U.
As a result, focus should also be to look at modern and innovative technologies which support risk analytics for better implementation of regulatory rules/laws and supply insights for optimizing regulatory capital. These targeted investments in technology, data integration and modelling should be conducted more rapidly and cost efficiently.
Re-Engineer Business Processes, IT and Infrastructure
Banks also need to re-visit their core business processes, operating model, underlying IT architecture and infrastructure. Data strategies also need to be adapted quickly to support any changes that the divergence may throw up in the future. Moreover, resources both functional and technical need to be trained to oversee and implement various regulations/laws in both the geographies.
Research and Analysis on Possible Regulatory Divergent Area
Bank senior management should create a separate strategy group with a clear mandate to assess the impact of existing and prospective divergence areas. This would not only save time and money but also help in developing greater clarity in rules and regulations which could be utilized in all upcoming PRA legislation changes. The resources with deep expertise, extensive knowledge and experience can help in understanding the current and future divergent areas so that banks can respond to these challenges more quickly.
Post Brexit, U.K. banks still are not in the stable equilibrium and will have to stay abreast with the changing regulatory requirements.