Existing regulator the Financial Services Authority (FSA) and the Bank of England, in which the PRA will be housed, set out their position in a short paper (3-page / 137KB PDF) intended to assist Parliament with its scrutiny of the Financial Services Bill, which will bring the new regime into force from next year.
The Bill, when it becomes law, will give the PRA the power to designate certain investment firms for prudential regulation by itself rather than the new Financial Conduct Authority (FCA). The FCA will still consider conduct and compliance issues for those firms. In January this year the Treasury published a draft order (5-page / 39KB PDF) enabling the PRA to designate those firms with a minimum capital of €730,000 with permission to deal with investments as principal – known as '730K Investment Firms' – where it considered it "desirable" to do so.
"The policy of designation has been drawn up because some investment firms could pose significant risks to the stability of the financial system or to one or more PRA-regulated entities in their group," the FSA and Bank of England said in the paper. "It follows that they should be prudentially supervised by the PRA in pursuance of its objective of promoting the 'safety and soundness' of regulated firms by seeking to minimise any adverse effects of firm failure on the UK financial system."
The draft Treasury order states that when designating, the PRA must have particular regard to the assets of that firm and those of other 730K Investment Firms within its corporate group, whether any other members of that group have been designated and the nature of the firm's activities. However, these criteria are not exhaustive.
The PRA will handle most of the day-to-day regulation and supervision of banks, building societies and insurers under the new financial services regulatory regime, which the FCA will take over consumer credit regulation from consumer protection regulator the Office of Fair Trading (OFT). It will also take on the FSA's current conduct and compliance role. The FSA was recently reorganised internally into a 'twin peaks' model, intended to reflect the new structure. The changes are due to come into force from 2013.
As well as considering the value of the total assets of the firm, the paper said, the PRA will also consider "firms' business models and booking practices" to ensure that the amount of its assets on paper do not give "a distorted view of the firm's business". The PRA may also look at other assessments of asset values "beyond those regularly submitted on a firm's regulatory returns" to ensure that its reported assets provide an accurate representation of the risks that it takes.
Firms may also be designated if they are "part of a group containing other entities subject to PRA supervision", the paper said. The PRA will consider what share of the group's revenues, balance sheet and risk-taking the firm being assessed holds in judging whether that firm is a material part of the group, as well as taking into account the overall structure of the group.
"It will not be possible to structure a group to avoid the designation of an investment firm by simply establishing several investment firms within the same group that individually fall below the total assets threshold, but which are, in aggregate, above the threshold," the report said.
Whatever thresholds and tests are ultimately adopted by the PRA will be "reviewed periodically to ensure that [they] remains an appropriate indicator", the report said, with assets judged based on an average value over a specified period of time. There will normally be a minimum period for which a designated firm will remain supervised by the PRA, it said.