CP23/23 – Identification and management of step-in risk, shadow banking entities and groups of connected clients

The Prudential Regulation Authority (PRA) has launched a new consultation (CP23/23) on proposed new rules for CRR firms regarding step-in risk assessments and the transfer of two guidelines of the European Banking Authority (EBA), namely those on „limits on exposures to shadow banking entities“ and on „connected clients“, to new PRA supervisory statements. It’s important to note in this context that the new requirements would NOT apply to firms falling under the SDDT (Small Domestic Deposit Taker) regime which provides certain exemptions and reduced regulatory requirements for smaller banks or financial institutions that predominantly focus on domestic deposits and have limited activities outside the UK.
Specifically, in an effort to mitigate step-in risk, which involves a bank or building society providing support to an entity facing stress, even in the absence of explicit contractual obligations, the PRA proposes various new rules to require in-scope firms to establish clear policies and procedures for assessing step-in risk and for evaluating the significance of such risks. The policies and procedures would thereby have to include
– rules for assignment of the task to oversee step-in risk assessments to one person within a firm;
– a description of a firm’s approach towards the assessment of step-in risks (factors it considers in the determination of possible step-in risks for unconsolidated (associated) entities);
– a description of how materiality of such risks are assessed (how likely is the step-in risk to materialize); and
– a description of the process involved in obtaining relevant information for the assessment of step-in risk.
Furthermore, the PRA proposes to set out rules for the identification of entities for which a firm may have to „step-in“, including firms in which the CRR firm may be invested in, has contractual obligations with, or may be sponsor of. A non-exhaustive list of entity types that the PRA expects firms to consider while conducting their step-in risk assessments is included in the [Draft supervisory statement on „Step-in Risk“](https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/consultation-paper/2023/december/cp2323app2.pdf
). However, some firms would be excluded, particularly those, that are – on their own – subject to prudential requirements.
Following the identification of entities posing step-in risk to the CRR firm, the financial institution must assess their materiality. In this context, firms will be required to establish a materiality threshold (e.g., based on capital or total assets), and entities falling below this threshold, both individually and when compared with similar entities, may be excluded from the further assessment. However, these excluded entities should still be reported in the overall step-in risk assessment submitted to the PRA. This ensures transparency in reporting, even for entities deemed immaterial.
Once immaterial entities have been excluded, firms would be required to assess the remaining entities against specific indicators of step-in risk, including – among others – an entity’s purpose, its design, nature of sponsorship, degree of influence over the investee firm, and other relevant considerations that might cause a firm to have to „step-in“ during stressful situations. The assessment outcomes would have to be documented appropriately, both for cases where no step-in risk and cases where step-in risk was identified. Firms would subsequently have to report their assessments to the PRA using the three forms provided for in Appendix 3.
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As far as the above noted transfer of the EBA guidelines is concerned, the PRA proposes to take them over as is, with targeted modifications to remove EU references and provide more clarity on the subject matters.
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The consultation closes on March 5, 2023.