1
Application and Definitions
1.2
In this Part the following definitions shall apply:
means a relationship where undertakings are linked by a relationship within the meaning of Article 12(1) Directive 83/349/EEC.
means any risk to a firm arising from:
- (1) changes in its business, including:
- (a) the acute risk to earnings posed by falling or volatile income; and
- (b) the broader risk of a firm’s business model or strategy proving inappropriate due to macroeconomic, geopolitical, industry, regulatory or other factors; or
- (2) its remuneration policy.
has the meaning given in point (1) of Article 2 of Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC Derivatives, central counterparties and trade repositories.
has the meaning given in point (14) of Article 2 of Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate.
- (a) who has relationship with A of the kind specified in s. 421 of FSMA;
- (b) who is a member of the same financial conglomerate as A;
- (c) who has a Article 12(1) relationship with A;
- (d) who has a Article 12(1) relationship with any person who falls into (a);
- (e) who is a subsidiary of a person in (c) or (d);
- (f) who is member of the same consolidation group as A; or
- (g) whose omission from an assessment of the risks to A of A's connection to any person coming within (a)-(f) or an assessment of the financial resources available to such persons would be misleading.
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.
means the rules in Chapter 3 (Strategies, processes, and systems), Chapter 12 (Stress test and scenario analysis) and Chapter 13 (Documentation of risk assessments).
means the risk that a firm although solvent, either does not have available sufficient financial resources to enable it to meet its obligations as they fall due, or can secure such resources only at excessive cost.
means the risk that arises from fluctuations in values of or income from assets or in interest or exchange rates.
means (in accordance with point (26) of Article 3(1) of the CRD) a financial holding company which is not itself a subsidiary of an institution authorised in the same EEA State, or of a financial holding company or mixed financial holding company set up in the same EEA State.
means (in accordance with point (24) of Article 3(1) of the CRD) an institution authorised in an EEA State which has an institution or financial institution as subsidiary or which holds a participation in such an institution or financial institution, and which is not itself a subsidiary of another institution authorised in the same EEA State or of a financial holding company or mixed financial holding company set up in the same EEA State.
means (in accordance with point (28) of Article 3(1) of the CRD) a mixed financial holding companywhich is not itself a subsidiary of an institution authorised in the same EEA State, or of a financial holding company or mixed financial holding company set up in the same EEA State.
means:
- (1) the risk to a firm caused by its contractual or other liabilities to or with respect to a pension scheme (whether established for its employees or those of a related company or otherwise); or
- (2) the risk that the firm will make payments or other contributions to or with respect to a pension scheme because of a moral obligation or because the firm considers that it needs to do so for some other reason.
means the risk that credit risk mitigation techniques used by the firm prove less effective than expected.
means the rules in Chapter 4 to Chapter 11 of this Part..
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2
Adequacy of Financial Resources
Overall financial adequacy rule
3
Strategies, Processes and Systems
Overall Pillar 2 rule
3.1
A firm must have in place sound, effective and comprehensive strategies, processes and systems:
- (1) to assess and maintain on an ongoing basis the amounts, types and distribution of financial resources, own funds and internal capital that it considers adequate to cover:
- (a) the nature and level of the risks to which it is or might be exposed;
- (b) the risk in the overall financial adequacy rule in 2.1; and
- (c) the risk that the firm might not be able to meet the obligations in Part Three of the CRR in the future;
- (2) that enable it to identify and manage the major sources of risk referred to in (1) including the major sources of risk in each of the following categories where they are relevant to the firm given the nature and scale of its business:
- (a) credit and counterparty risk;
- (b) market risk;
- (c) liquidity risk;
- (d) operational risk;
- (e) concentration risk;
- (f) residual risk;
- (g) securitisation risk, including the risk that the own funds held by a firm in respect of assets which it has securitised are inadequate having regard to the economic substance of the transaction including the degree of risk transfer achieved;
- (h) business risk;
- (i) interest rate risk in the non-trading book;
- (j) risk of excessive leverage;
- (k) pension obligation risk; and
- (l) group risk.
[Note: Art 73 (part) of the CRD]
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3.2
As part of its obligations under the overall Pillar 2 rule in 3.1, a firm must identify separately the amount of common equity tier one capital, additional tier one capital and tier two capital and each category of capital (if any) that is not eligible to form part of its own funds which it considers adequate for the purposes described in the overall Pillar 2 rule.
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3.3
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3.4
A firm must:
- (1) carry out regularly the assessments required by the overall Pillar 2 rule in 3.1; and
- (2) carry out regularly assessments of the processes, strategies and systems required by the overall Pillar 2 rule in 3.1 to ensure they remain comprehensive and proportionate to the nature, scale and complexity of the firm’s activities.
[Note: Art 73 (part) of the CRD]
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3.5
- (1) make an assessment of the firm-wide impact of the risks identified in accordance with that rule, to which end a firm must aggregate the risks across its various business lines and units, taking appropriate account of any correlation between risks; and
- (2) take into account the stress tests that the firm is required to carry out under the general stress test and scenario analysis rule in 12.1 and any stress tests that the firm is required to carry out under the CRR.
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4
Credit and Counterparty Risk
4.1
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4.2
A firm must have internal methodologies that:
- (1) enable it to assess the credit risk of exposures to individual obligors, securities or securitisation positions and credit risk at the portfolio level;
- (2) do not rely solely or mechanistically on external credit ratings; and
- (3) where its own funds requirements under Part Three of the CRR are based on a rating by an ECAI or based on the fact that an exposure is unrated, enable the firm to consider other relevant information for assessing its allocation of financial resources and internal capital.
[Note: Art 79(b) of the CRD]
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4.3
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5
Residual Risk
6
Concentration Risk
6.1
A firm must address and control, by means which include written policies and procedures, the concentration risk arising from:
- (1) exposures to each counterparty including central counterparties, groups of connected counterparties and counterparties in the same economic sector, geographic region or from the same activity or commodity;
- (2) the application of credit risk mitigation techniques; and
- (3) risks associated with large indirect credit exposures such as a single collateral issuer.
[Note: Art 81 of CRD]
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7
Securitisation Risk
7.1
A firm must evaluate and address through appropriate policies and procedures the risks arising from securitisation transactions in relation to which the firm is investor, originator or sponsor, including reputational risks, to ensure in particular that the economic substance of the transaction is fully reflected in risk assessment and management decisions.
[Note: Art 82(1) of CRD]
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7.2
A firm which is an originator of a revolving securitisation transaction involving early amortisation provisions must have liquidity plans to address the implications of both scheduled and early amortisation.
[Note Art 82(2) of the CRD]
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8
Market Risk
8.1
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8.2
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8.3
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8.4
A firm which has, in calculating own funds requirements for position risk in accordance with Part Three, Title IV, Chapter 2 of the CRR, netted off its positions in one or more of the equities constituting a stock-index against one or more positions in the stock-index future or other stock-index product, must have adequate financial resources and internal capital to cover the basis risk of loss caused by the future's or other product's value not moving fully in line with that of its constituent equities.
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8.5
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8.6
As part of its obligations under the overall Pillar 2 rule in 3.1, a firm must consider whether the value adjustments and provisions taken for positions and portfolios in the trading book enable the firm to sell or hedge out its positions within a short period without incurring material losses under normal market conditions.
[Note: Art 98(4) of the CRD]
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9
Interest Risk Arising from Non-Trading Book Activities
9.1
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9.2
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9.3
The evaluation under 9.2 must cover the effect of a sudden and unexpected change in interest rates of 200 basis points in both directions.
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9.4
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9.5
A firm must carry out the evaluation under 9.2 as frequently as necessary for it to be reasonably satisfied that it has at all times a sufficient understanding of the degree to which it is exposed to the risks referred to in 9.2 and the nature of that exposure. In any case it must carry out those evaluations no less frequently than once a year.
[Note: Art 98(5) of the CRD]
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10
Operational Risk
10.1
A firm must implement policies and processes to evaluate and manage the exposure to operational risk, including model risk and to cover low-frequency high severity events. Without prejudice to the definition of operational risk, a firm must articulate what constitutes operational risk for the purposes of those policies and procedures.
[Note: Art 85(1) of the CRD]
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11
Risk of Excessive Leverage
11.1
A firm must have in place policies and procedures for the identification, management and monitoring of the risk of excessive leverage.
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11.2
Those policies and procedures must include, as an indicator for the risk of excessive leverage, the leverage ratio determined in accordance with Article 429 of the CRR and mismatches between assets and obligations.
[Note: Art 87(1) of the CRD]
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11.3
A firm must address the risk of excessive leverage in a precautionary manner by taking due account of potential increases in that risk caused by reductions of the firm's own funds through expected or realised losses, depending on the applicable accounting rules. To that end, a firm must be able to withstand a range of different stress events with respect to the risk of excessive leverage.
[Note: Art 87(2) of the CRD]
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12
Stress Tests and Scenario Analysis
General stress test and scenario analysis rule
12.1
As part of its obligation under the overall Pillar 2 rule in 3.1, a firm must, for the major sources of risk identified in accordance with that rule, carry out stress tests and scenario analyses that are appropriate to the nature, scale and complexity of those major sources of risk and to the nature, scale and complexity of the firm's business.
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12.2
In carrying out the stress tests and scenario analyses in 12.1, a firm must identify an appropriate range of adverse circumstances of varying nature, severity and duration relevant to its business and risk profile and consider the exposure of the firm to those circumstances, including:
- (a) circumstances and events occurring over a protracted period of time;
- (b) sudden and severe events, such as market shocks or other similar events; and
- (c) some combination of the circumstances and events described in (a) and (b), which may include a sudden and severe market event followed by an economic recession.
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12.3
In carrying out the stress tests and scenario analyses in 12.1, the firm must estimate the financial resources that it would need in order to continue to meet the overall financial adequacy rule in 2.1 and the obligations laid down in Part Three of the CRR under the adverse circumstances being considered.
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13
Documentation of Risk Assessments
13.1
A firm must make a written record of the assessments required under this Part. These assessments must include assessments carried out on a consolidated basis and on an individual basis. In particular it must make a written record of:
- (a) the major sources of risk identified in accordance with the overall Pillar 2 rule in 3.1;
- (b) how it intends to deal with those risks; and
- (c) details of the stress tests and scenario analyses carried out, including any assumptions made in relation to scenario design, and the resulting financial resources estimated to be required in accordance with the general stress test and scenario analysis rule in 12.1.
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14
Application of this Part on an Individual Basis, a Consolidated Basis and a Sub-Consolidated Basis
The ICAAP rules
14.1
A firm that is neither a subsidiary of a parent undertaking incorporated in or formed under the law of any part of the UK nor a parent undertaking must comply with the ICAAP rules on an individual basis.
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14.2
A firm that is not a member of a consolidation group must comply with the ICAAP rules on an individual basis.
[Note: Art 108(1) of the CRD]
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14.3
A firm which is a parent institution in a Member State must comply with the ICAAP rules on a consolidated basis.
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14.4
A firm controlled by a parent financial holding company in a Member State or a parent mixed financial holding company in a Member State must comply with the ICAAP rules on the basis of the consolidated situation of that holding company, if the PRA is responsible for supervision of the firm on a consolidated basis under Article 111 of the CRD.
[Note: Art 108(2) and 108(3) of the CRD]
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14.5
A firm that is a subsidiary must apply the ICAAP rules on a sub-consolidated basis if the firm, or the parent undertaking where it is a financial holding company or mixed financial holding company, have an institution or financial institution or an asset management company as a subsidiaryin a third country or hold a participation in such an undertaking.
[Note: Art 108(4) of the CRD]
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14.6
If the ICAAP rules apply to a firm on a consolidated basis or on a sub-consolidated basis the firm must carry out consolidation to the extent and in the manner prescribed in Articles 18(1), 18(8), 19(1), 19(3), 23 and 24(1) of the CRR and Groups 2.1-2.3.
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14.7
For the purpose of the ICAAP rules as they apply on a consolidated basis or on a sub-consolidated basis:
- (1) the firm must ensure that the consolidation group has the processes, strategies and systems required by the overall Pillar 2 rule in 3.1;
- (2) the risks to which the overall Pillar 2 rule in 3.1 and the general stress test and scenario analysis rule refer are those risks as they apply to each member of the consolidation group;
- (3) the reference in the overall Pillar 2 rule in 3.1 to amounts and types of financial resources, own funds and internal capital (referred to in this rule as resources) must be read as being to the amounts and types that the firm considers should be held by the members of the consolidation group;
- (4) other references to resources must be read as being to resources of the members of the consolidation group;
- (5) the reference in the overall Pillar 2 rule in 3.1 to the distribution of resources must be read as including a reference to the distribution between members of the consolidation group;
- (6) the reference in the overall Pillar 2 rule in 3.1 to the overall financial adequacy rule in 2.1 must be read as being to that rule as adjusted under 14.14-14.16 (level of application of the overall financial adequacy rule);
- (7) a firm must be able to explain how it has aggregated the risks referred to in the overall Pillar 2 rule in 3.1 and the financial resources, own funds and internal capital required by each member of the consolidation group; and
- (8) in particular, to the extent that the transferability of resources affects the assessment in (2), a firm must be able to explain how it has satisfied itself that resources are transferable between members of the group in question in the stressed cases and the scenarios referred to in the general stress test and scenario analysis rule in 12.1.
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14.8
A firm must allocate the total amount of financial resources, own funds and internal capital identified as necessary under the overall Pillar 2 rule in 3.1 (as applied on a consolidated basis or on a sub-consolidated basis) between different parts of the consolidation group.
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14.9
The firm must carry out the allocation in 14.8 in a way that adequately reflects the nature, level and distribution of the risks to which the consolidation group is subject.
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14.10
A firm must also allocate the total amount of financial resources, own funds and internal capital identified as necessary under the overall Pillar 2 rule in 3.1 as applied on a consolidated basis or on a sub-consolidated basis between each firm which is a member of the consolidated group on the following basis:
- (a) the amount allocated to each firm must be decided on the basis of the principles in 14.9; and
- (b) if the process in (a) were carried out for each group member, the total so allocated would equal the total amount of financial resources, own funds and internal capital identified as necessary under the overall Pillar 2 rule in 3.1 as applied on a consolidated basis or on a sub-consolidated basis.
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The risk control rules
14.11
The risk control rules apply to a firm on an individual basis whether or not they also apply to the firm on a consolidated basis or sub-consolidated basis.
[Note: Art 109(1) (part) of the CRD]
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Level of application of the overall financial adequacy rule
14.12
Where a firm is a member of a consolidation group, the firm must ensure that the risk management processes and internal control mechanisms at the level of the consolidation group of which it is a member comply with the obligations set out in the risk control rules on a consolidated basis (or a sub-consolidated basis).
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14.13
Compliance with the obligations referred to in 14.12 must enable the consolidation group to have arrangements, processes and mechanisms that are consistent and well integrated and that any data relevant to the purpose of supervision can be produced.
[Note: Art 109(2) (part) of the CRD]
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14.14
The overall financial adequacy rule in 2.1 applies to a firm on an individual basis whether or not it also applies to the firm on a consolidated basis or sub-consolidated basis.
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14.15
The overall financial adequacy rule in 2.1 applies to a firm on a consolidated basis if the ICAAP rules apply to it on a consolidated basis and applies to a firm on a sub-consolidated basis if the ICAAP rules apply to it on a sub-consolidated basis.
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14.16
When the overall financial adequacy rule in 2.1 applies on a consolidated basis or sub-consolidated basis, the firm must ensure that at all times its consolidation group maintains overall financial resources, including own funds and liquidity resources, which are adequate, both as to amount and quality, to ensure that there is no significant risk that the liabilities of any members of its consolidation group cannot be met as they fall due.
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