On 18 December 2019, the Prudential Regulation Authority CEO and Deputy Governor of the Bank of England, published a letter to the Working Group on Sterling Risk-Free Reference Rates in response to the Working Group’s previous letter on Regulatory Capital impediments to Interbank Offered Rates.

The letter states that the ‘PRA’ has been working on the potential link between the Prudential Framework and Benchmark Rate Reform, both during the transition period and in a ‘steady state’. The ‘CEO also highlights the need for the Working Group to engage with Non-UK Authorities, as issues raised need to be addressed at the European or Global Level, whilst the ‘PRA’ will continually raise the issues at the Basel Committee on Banking Supervision.

The letter specifically responds to the main themes raised by the Working Group:

• Additional Tier 1 and Tier 2 Capital : Capital Instruments that currently reference ‘LIBOR’ will require amendment for a new Reference Rate, which may make them fall short of the Capital Requirements Regulation eligibility, resulting in an unplanned reduction in a Bank’s Capital Position. The ‘PRA’ does not consider it is necessary to reassess the eligibility of Instruments, where the amendments are solely to replace the Benchmark Reference Rate.
• Bilateral Margin Requirements for Non-Cleared Derivatives: The letter provides assurance that International Regulators have clarified that the new requirements are not intended to apply to legacy contracts where they were amended solely to deal with Interest Rate Benchmark Reforms.
• Rules related to Resolution: The ‘PRA’ is considering possible implications of Benchmark Rate Reform on a Contractual Recognition of ‘Bail-In’ and ‘Stay In’ Resolution Rules and plans to provide an update in Spring 2020.
• Counterparty Credit Risk, Market Risk, and Interest Rate Risk in the Banking Book: The letter advises Firms to take consequent reduction in liquidity into account when planning their ‘LIBOR’ Transition Programme. The letter recognises the challenges in addressing basis Risks and Model Changes as a result of changes in Benchmark Rate.

The ‘PRA’ plans to meet with major Firms in the first Quarter of 2020 to discuss approaches to managing the aforementioned risks. Supervisors will also write to Firms with Internal Model Method (‘IMM’) and Internal Model Approach (‘IMA’) Model approvals to ask them to identify the number and type of Models that will require amendment and the expected timelines for submission of Model Changes for pre-approval. Based on the responses and feedback, the ‘PRA’ will look to communicate its plans for Model Review in the second quarter of 2020.

Banks’ Senior Management, Finance, Change Management and Audit / Risk Committees and Board Members need to remain closely engaged with the risks mentioned above (and others as they emerge) to ensure that they are addressed, seeking input from Risk and Compliance, Finance and Operations Teams.

In 2020, Regulatory Supervisors will be engaging regularly with affected Firms to foster participation and commitment of Market Participants with a view to developing new Market Structures, Technologies, Standards and Solutions to address the Transition Challenges.

Further information:
To read more, please follow this link:
https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2019/prudential-regulatory-framework-and-libor-transition.pdf?la=en&hash=55018BE92759217608D587E3C56C0E205A2D3AF4

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Prudential Regulation Authority publishes ‘Dear CEO’ Letter

Please Note: This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.

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