Guidance

SoP – The PRA’s methodologies for setting Pillar 2 capital

Chapter

Group Risk, including RFB group risk

Printed on: 01/11/2024

Rulebook at: 29/04/2024

8A

Group Risk, including RFB group risk

8A.1

This chapter sets out the methodology the PRA uses to inform the setting of a firm’s Pillar 2A capital requirement for group risk, including RFB group risk, where groups contain an RFB sub-group.

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Definition and scope of application

8A.2

Group risk, as defined in the PRA Rulebook,[18] means the risk that the financial position of a firm may be adversely affected by its relationships (financial or non-financial) with other entities in the same group or by risk which may affect the financial position of the whole group, including reputational contagion.

  • 18. Internal Capital Adequacy Assessment 1.2.
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Methodology

8A.2A

The PRA’s assessment of group risk will be informed by the following:

  • the extent to which the allocation of the total amount of financial resources, own funds and internal capital between different parts of the consolidation group adequately reflects the nature, level and distribution of the risks to which the consolidation group is subject;
  • the extent to which, for any given risk type, the minimum requirements applied to an entity established outside the United Kingdom, on an individual or sub-consolidated basis, exceed the entity’s share[19] of the consolidated group requirements for the same risk. When making this assessment, the PRA would not generally take into account requirements that are attributable to risks that:
      1. (i) are already mitigated through the risk based capital framework[20] or by other means;[21] or
      2. (ii) net off in consolidation (for example, intragroup risks and offsetting positions); and
  • where a firm is a member of a group in which a qualifying parent undertaking[22] has a double leverage ratio above 100%, or is projecting one above 100%, the firm’s approach to managing the risks of double leverage, including the cash flow risks, and the credibility of its related stress testing and scenario analysis. For this purpose, the double leverage ratio is defined as a parent company’s common equity capital investment in its subsidiaries[23] divided by its own common equity capital.[24]
  • 19. An entity’s share of a particular consolidated group capital requirement can be determined by multiplying that consolidated group capital requirement by the proportion of the consolidated group’s Pillar 1 RWAs that are attributable to that entity. The consolidated group’s RWAs that are attributable to an entity is calculated as the entity’s Pillar 1 RWAs, calculated on the same basis as the group RWAs, minus the risk-weighted exposures of the entity to other group entities.
  • 20. For example, a PRA authorised firm may have permission to use an IRB model to calculate consolidated capital requirements in respect of a portfolio of credit risk exposures. If its overseas subsidiary is required to use a standardised approach for the same portfolio of credit risk exposures (on an individual or sub-consolidated basis), and as a result, it is subject to higher requirements in respect of that portfolio, the PRA would not take the difference into account in its assessment of group risk.
  • 21. For example, the risk of a local entity might be mitigated at the group level through risk management processes or internal control mechanisms established at the group level.
  • 22. Section 192B FSMA.
  • 23. As defined in paragraph 3.29A of SS 31/15.
  • 24. As defined in paragraph 3.29A of SS 31/15.
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8A.2B

Supervisory judgement is used to determine:

  • the amount of firm-specific Pillar 2A capital requirements for group risk; and
  • any steps that need to be taken in respect of any double leverage being used or proposing to be used by a firm’s qualifying parent undertaking. Such steps may include, for example, imposing a specific limit on the amount of double leverage a firm’s qualifying parent undertaking can use.[25]
  • 25. For example, by exercising the PRA’s power of direction under Section 192C of the Financial Services and Markets Act (Power of Direction over Qualifying Parent Undertakings).
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RFB group risk

8A.3

RFB group risk means, in relation to a consolidation group containing an RFB sub-group,[26] the risk that the financial position of a firm on a consolidated basis may be adversely affected by the minimum capital and buffers applicable at the level of the RFB sub-group, such that there is insufficient capital within (or an inappropriate distribution of capital across) the consolidated group to cover the risks of the consolidated group.

  • 26. An RFB sub-group is a sub-set of related group entities within a consolidation group, consisting of one or more RFBs and other legal entities, which is established when the PRA gives effect to Article 11(5) of the CRR. See SS8/16 ‘Ring fenced bodies (RFBs)’ for more detail.
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Methodology

8A.4

Where minimum capital (Pillar 1 or Pillar 2A) of the RFB sub-group for an identified risk is higher than the RFB sub-group’s share of the minimum capital for that risk on a consolidated basis, the difference will usually be reflected in Pillar 2A capital requirements on a consolidated basis to reflect the associated RFB group risk at the consolidated group level.

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8A.5

The PRA’s assessment of the total amount of the Pillar 2A capital requirement for RFB group risk will be informed by the following, to the extent not already captured by the assessment of other elements of the capital framework:

  • the difference between:
  1. (i) the amount of capital applicable at the RFB sub-group level to cover credit concentration risk identified on a sub-consolidated basis; and
  2. (ii) the RFB sub-group’s share of the capital held by the consolidated group to cover credit concentration risk identified for the consolidation group.

The share referred to in point (ii) above will be calculated as:

  1. (a) the amount of capital applicable at the level of the consolidated group to cover the credit concentration risk identified for the consolidation group, multiplied by
  2. (b) the proportion of the consolidated group’s credit risk RWAs that are attributable to the RFB sub-group;[27]
  • any minimum capital applicable at the level of the RFB sub-group that is attributable to risk-weighted exposures of the RFB sub-group to group entities that are not members of the RFB sub-group (to the extent RFB group risk in relation to those exposures is not already captured by the assessment of other aspects of RFB group risk covered in this paragraph); and
  • as appropriate, the amount by which the minimum capital applicable at the RFB sub-group level to cover any other risk exceeds the amount of minimum capital applicable at the consolidated group level to cover the same risk. (This could include, for example, interest rate risk in the banking book, operational risk or the risk of a consolidation group being undercapitalised following the application of PRA rules on deduction of significant investments in financial sector entities at the level of the RFB sub-group.)[28]
  • 27. The proportion of the consolidated group’s credit risk RWAs that are attributable to the RFB sub-group is calculated as the RFB sub-group’s credit risk RWAs (calculated on a sub-consolidated basis) minus the risk-weighted exposures of the RFB subgroup to group entities that are not members of the RFB sub-group.
  • 28. See paragraphs 2.1 and 2.2 in the Definition of Capital Part of the PRA’s Rulebook.
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Pension obligation risk

8A.6

As set out in SS8/16 ‘Ring-fenced bodies (RFBs)’,[29] the PRA expects an RFB to ensure it has fully and appropriately considered group risk arising in respect of its pension arrangements when conducting its assessment of pension obligation risks at the level of the RFB sub-group. The PRA expects an RFB to consider all relevant factors when performing its assessment, including, but not limited to, its current share of consolidated group pension obligations, and its expected future share where it is making changes to its pension arrangements. An RFB’s assessment should not be limited to a simple allocation of a share of the consolidated group’s pension obligation risk. A full assessment may therefore result in a higher capital requirement than if the RFB were to apply a ‘share-of-group’ approach, particularly in the period prior to 1 January 2026. The PRA also expects to apply its existing policy, as set out in SS31/15 ‘The Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP)’,[30] when assessing the pension obligation risk of a consolidated group containing an RFB. The PRA expects the assessment of RFB group risk at group level to be unaffected by the assessment of the pension obligation risk for the RFB sub-group given:

  • the transitional nature of the risk; and
  • assuming the sum of the amount of pension risks at the level of the RFB sub-group and group entities that are not members of the RFB sub-group is not expected to increase to a level above that of the consolidated group in the event that the RFB will have to assume the pension liabilities of group entities that are not members of the RFB sub-group.

This exception only applies to the assessment of pension risk and should not be taken to mean that other risks with proportionately higher requirements should not be included in the assessment of RFB group risk.

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Reporting

8A.7

Firms are required to submit data in respect of the Pillar 2A RFB group risk add-on in FSA071 ‘Firm Information and Pillar 2 Summary’ template.[31]

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