Prudential Regulation Authority Annual Report 2022

1 March 2021 to 28 February 2022

Presented to Parliament pursuant to paragraph 19(4) of Schedule 1ZB of the Financial Services and Markets Act 2000 as amended by the Financial Services Act 2012 and the Bank of England and Financial Services Act 2016.The Annual Report also includes the Annual Competition Report and the Annual Report of the Prudential Regulation Committee to the Chancellor of the Exchequer on the adequacy of the Prudential Regulation Authority (PRA) resource and the independence of the PRA functions.

This report is made by the Prudential Regulation Authority (PRA) under the Financial Services and Markets Act 2000 (FSMA) as amended by the Financial Services Act 2012 and the Bank of England and Financial Services Act 2016. It is made to the Chancellor of the Exchequer and covers the year ended Monday 28 February 2022.

The report covers the requirements of paragraph 19 of schedule 1ZB of FSMA.

The Bank of England Annual Report and Accounts for the year ending Monday 28 February 2022 is available on the Bank of England’s (the Bank’s) website. The PRA’s audited accounts for the reporting year ending Monday 28 February 2022 are set out on pages 206-215 of the Bank of England Annual Report and Accounts. HM Treasury (HMT) has issued an accounts direction; disclosures relating to this can be found on pages 208-210 of the Bank’s Annual Report and Accounts.

Additional material can be found on the PRA section of this website.

Any enquiries related to this publication should be sent to us at praannualreport@bankofengland.co.uk.

Consultation

Members of the public are invited to make representations to the PRA on the:

• PRA Annual Report;
• way in which the PRA has discharged its functions during the period to which the report relates; and
• extent to which, in their opinion, the PRA’s objectives have been advanced and the PRA has considered the regulatory principles to which it must have regard when carrying out certain of its functions (contained in section 3B of FSMA), and facilitated effective competition in the markets for services provided by PRA-authorised firms in carrying on regulated activities in accordance with section 2H of FSMA.

Please address any comments or enquiries to praannualreport@bankofengland.co.uk, or by post to:

PRA Communications

Prudential Regulation Authority

20 Moorgate

London

EC2R 6DA

The consultation closes on Monday 19 September 2022.

Privacy and limitation of confidentiality notice

By providing representation to the PRA on this Annual Report, you provide personal data to the Bank of England. This may include your name, contact details (including, if provided, details of the organisation you work for), and opinions or details offered in the representations.

The representations will be assessed to inform our further work as a regulator. We may use your details to contact you to clarify any aspects of your response.

Your personal data will be retained in accordance with the Bank’s records management schedule. To find out more about how we deal with your personal data, your rights, or to get in touch please visit our privacy webpage.

Information provided in response to this report, including personal information, may be subject to publication or disclosure to other parties in accordance with access to information regimes including under the Freedom of Information Act 2000 or data protection legislation, or as otherwise required by law or in discharge of the Bank’s functions.

Please indicate if you regard all, or some of, the information you provide as confidential. If the Bank of England receives a request for disclosure of this information, we will take your indication(s) into account, but cannot give an assurance that confidentiality can be maintained in all circumstances. An automatic confidentiality disclaimer generated by your IT system on emails will not, of itself, be regarded as binding on the Bank of England.

Foreword by the Chair

Andrew Bailey
Governor
Chair of the Prudential Regulation Committee

2021/22 has again demonstrated the importance of strong standards and robust supervision, most recently in the context of the impact of Covid-19, and the conflict in Ukraine, but also the default of Archegos Capital Management earlier in the year. I am encouraged that the International Monetary Fund (IMF) has recognised in its five yearly Financial Sector Assessment Program (FSAP) the extensive actions taken to increase resilience in the UK financial system and the effectiveness of the prudential and supervisory frameworks in helping to support the safety and soundness of the banking and insurance system. As Sam says in his foreword, we now have a key responsibility to maintain the levels of resilience built up in the financial system through the post-financial crisis reforms we, and other UK and international authorities, have spent over a decade implementing.

To do this we must also have an eye on the horizon, scanning for new and emerging risks. Events like Archegos have played out against a backdrop of major shifts happening in the financial services landscape, demonstrating the continued need for the PRA to be swift on its feet in pursuit of its objectives, and the benefit of being part of the wider Bank in doing so. As you will see in the report, there has been a significant programme of work in the PRA.

The first Resolvability Assessment Framework (RAF) submissions were received from major UK banks and building societies in 2021. The RAF is designed to make the resolution process more transparent, better understood, and therefore successful when it is needed. Those submissions mark an important milestone in increasing confidence that firms can exit the market in an orderly way without disturbing it.

With the transformation of the role of the PRA, following the UK’s exit from the European Union (EU), comes new opportunities. We now have the opportunity to tailor rules more effectively to the UK market and the firms we regulate, while maintaining strong standards.

We are making good progress in this area, for instance through the joint review of the Solvency II framework for insurers with HMT, and our work to develop a ‘strong and simple’ regulatory framework for non-systemic banks and building societies, which aims to reduce complexity and barriers to growth for these firms.

I give my sincere thanks to PRA staff for their drive and determination during this demanding year, and to the members of the PRC for their expertise and the valuable perspective they bring to our decision-making.

Foreword by the Chief Executive

Sam Woods
Deputy Governor, Prudential Regulation,
Chief Executive of the PRA

2021/22 was another busy year for the PRA, but we also undertook a strategic review to see what lessons could be learned from the organisation’s first eight years in existence. Having moved beyond implementing the post-financial crisis reforms, we identified the need to respond to new and emerging risks resulting from technological and wider societal developments. That review resulted in recommendations to strengthen our approach in a number of areas, which we have started work on in the past year and will continue to take forward into the coming year. These include working with the government to ensure the UK’s financial services regulatory framework is fit for the future, supporting the Bank in assessing the regulatory impacts of new forms of digital money, a particular focus on firms’ operational and cyber resilience, and working to mitigate new and emerging financial risks such as climate change. Ahead of all of this, however, we have a key responsibility to maintain the levels of resilience built up through the post-financial crisis reforms.

There has been significant work around the transformation of the role of the PRA following the UK’s exit from the EU, our enhanced role as a host supervisor, and the need to work out how we make policy when we have greater control of the rulebook. I have said before that we are getting on with important reforms while the wider debate around the roles of Parliament, the Government, and regulators unfolds. In April 2021, we published proposals for a new ’strong and simple’ regulatory framework for non-systemic banks and building societies. This aims to tackle the complexity and barriers to growth challenges faced by these firms. We published a policy statement (PS) on the implementation of Basel standards in October, and are currently designing policy on the final set of Basel III standards (known as Basel 3.1). Additionally, at the end of 2021 we finalised Phase 1 changes to the Solvency II reporting requirements and expectations, as part of wider work on the Review of Solvency II being undertaken with HMT. On the ground, we are authorising growing numbers of EU firms as they emerge from the Temporary Permissions Regime (TPR).

The last year has seen significant work to strengthen management practices, in particular following the default of Archegos Capital Management in March 2021. In December, we wrote to banks to outline deficiencies stemming from a flawed risk culture, in which frontline business executives failed to take accountability for risk and from independent risk functions lacking sufficient standing within firms, and senior management incentives which failed to promote sustainable longer-run outcomes. We reminded firms of the importance of investing in their risk management frameworks and controls infrastructure. There will be more on this in the coming months.

Changes to how we do our job as the prudential regulator are playing out against the backdrop of major shifts in the financial services landscape. During the Covid-19 pandemic, there have been rapid innovations in how people make payments, and the Bank and PRA need to stay ahead of these trends in order to ensure the opportunities they afford are realised in a safe way, and without compromising financial stability. We have helped the Bank with its discussion paper (DP) on new forms of digital money, which lays the groundwork for the regulation of systemic stablecoins. We have also written to firms setting out how they should identify, measure, and mitigate risks associated with crypto activities. Our work to integrate cryptoassets into a resilient regulatory framework continues.

A very different disruptive force we are having to contend with is climate change, and the risks it may pose to monetary and financial stability. The past year has seen us engage closely with regulated firms on their progress to embed supervisory expectations in this area, and we issued the climate biennial exploratory scenario in order to explore the resilience of major UK banks, insurers, and the financial system to climate-related risks. We also began to embed climate change into our own supervisory approach.

As we emerge from the uncertainty of Covid, we are facing new challenges that will shape our role as regulator in the years to come – from the way we make policy, to the need to ensure that the financial system remains resilient as emerging technologies make their mark on the sector and the wider economy.

I want to thank PRA staff for all their hard work over the last year, and for embracing new challenges and opportunities that will keep us regulating financial firms in a dynamic and effective way.

The PRC is the body within the Bank responsible for exercising the Bank’s functions as the PRA as set out in the Bank of England Act 1998 and the Financial Services and Markets Act 2000 (FSMA). The PRC is on the same legal footing as the Monetary Policy Committee and the Financial Policy Committee.

The PRC’s terms of reference provide for 12 members. Five members are Bank staff: the Governor and four Deputy Governors. The Committee also includes the Chief Executive of the Financial Conduct Authority (FCA), and at least six members appointed by the Chancellor of the Exchequer.

• The PRC is independent in all its decision-making functions, including making rules and the PRA’s most important supervisory and policy decisions.
• The PRA’s functions are exercised by the Bank and are funded by PRA fees, with the PRC responsible for consulting on and setting the level of those fees.
• The PRC is required to report annually to the Chancellor of the Exchequer on the adequacy of resources allocated to the PRA functions and the extent to which the exercise of those functions is independent of the exercise of the Bank’s other functions (further information available under ‘The extent to which the exercise of PRA functions is independent of other Bank functions’ chapter).
• Since February 2016, the Bank has indemnified members of the PRC against personal civil liability on the same terms as the members of Court.^{footnote [1]}

The PRA’s statutory objectives, which underpin its forward-looking, judgement based approach to supervision are:

• a general objective to promote the safety and soundness of the firms it regulates;
• specifically for insurers, to contribute to the securing of an appropriate degree of protection for those who are, or may become insurance policyholders; and
• a secondary objective to, so far as is reasonably possible, act in a way which facilitates effective competition in the markets for services provided by PRA authorised persons in carrying on regulated activities.

On 23 March 2021, HMT issued ‘Recommendations for the Prudential Regulation Committee’. This letter was updated on 7 April 2022. This sets out aspects of the government’s economic policy to which the PRC should have regard when considering how to advance its objectives, and when considering the application of the regulatory principles in FSMA.

FSMA also requires the PRA to review, if necessary revise, and publish annually its strategy in relation to how it will deliver its statutory objectives. The strategy is set by the PRC, in consultation with the Bank’s Court of Directors. The PRA’s strategy was published in the PRA Business Plan 2022/23, in April 2022.

Annual report of the PRC to the Chancellor of the Exchequer

The adequacy of resources allocated to the performance of PRA functions and the extent to which the exercise of PRA functions is independent of other Bank functions.

This is the Annual Report by the PRC to the Chancellor of the Exchequer under paragraph 19 of Schedule 6A to the Bank of England Act 1998 (as amended). It relates to the period of 1 March 2021 to 28 February 2022. The PRA publishes this report as part of its commitment to transparency.

Background

Since 1 March 2017, the PRA has been part of the legal entity of the Bank of England. The PRC is a statutory committee of the Bank and is responsible for the exercise of the Bank’s functions as the PRA. The PRC is on the same statutory footing as the Bank’s Monetary Policy Committee (MPC) and the Financial Policy Committee (FPC). The PRA Annual Report summarises the PRC’s responsibilities and the statutory framework under which the PRA operates. Under this statutory framework, the PRC is responsible for strategy, policy, and rule making, and the adoption (with the approval of the Bank’s Court of Directors) of the budget for the PRA. These functions cannot be delegated.

The performance of PRA functions

The PRA has published two approach documents setting out how it advances its statutory objectives: the PRA’s approach to banking supervision and the PRA’s approach to insurance supervision. The PRA does not seek to operate a zero-failure regime. This is a key principle underlying the PRA’s approach to supervision. Each year, the PRC sets the PRA strategy and business plan, and adopts the PRA’s budget. These are based on the PRA’s approach to supervision, the PRA’s operating model, and its risk tolerance, all agreed by the PRC.

The adequacy of resources

The PRA is fully funded by fees paid by regulated firms. The PRA consults each year on the allocation of fees among firms and has the ability, after consultation, to raise additional funds during the year for material changes. The PRA received four responses to its fees consultation proposals in 2021/22, which did not result in changes to the proposals.

The PRC seeks to ensure that the PRA’s financial and non-financial resources are appropriately allocated to the work that best advances its objectives. In making judgements on the allocation of resources, the PRC takes into account a wide range of relevant considerations. These include the wider legislative and policy framework under which the PRA operates, including the duty to have regard to certain factors under FSMA, the Legislative and Regulatory Reform Act (LARA) and the Financial Services Act effective 1 March 2022. The PRC also takes into account HMT’s recommendation letter, which was updated on 7 April 2022 (more information available on the Prudential Regulation Committee page), and contains aspects of the government’s economic policy to which the PRC should have regard when considering how to advance the PRA’s objectives, and the application of the regulatory principles set out in FSMA.

The PRC oversees the allocation of its resources to a combination of assurance work on individual firms and sectors, sectoral stress testing, policy making, and investment in multi-year programmes that respond to changes in the external environment and risk profile of regulated firms. Work on multi-year programmes can span a range of areas, such as operational resilience, the Future Regulatory Framework (FRF), and the review of Solvency II insurance regulation.

The PRC also receives and reviews regular updates on the PRA’s performance and on how the PRA’s financial and non-financial resources are allocated and monitored, as well as how any resource risks are being mitigated through performance and assurance reporting, discussions of papers prepared by staff, and PRC members’ regular interaction with the PRA, including meetings with senior management and other staff. In particular, the regular reporting to PRC covers: progress against strategic aims; budget and headcount position; staff turnover; technology availability; and the PRA’s risk profile. The reports and other evidence provided to the PRC during the year indicate whether the PRA has used its financial and non-financial resources to deliver its functions, in line with its business plan.

The Bank’s internal control functions are also applied within the PRA. This includes the Bank’s risk management framework, compliance function, internal audit function, and the Audit and Risk Committee of Court. In addition, PRC members have the benefit of their own engagement with industry through meetings and events across the year.

The PRA made substantive progress against its strategic priorities in its 2021/22 Business Plan, reprioritising as necessary in response to Covid-19. As set out in the 2022/23 Business Plan, it will aim to increase resources in the current year due to the increase in responsibilities related to rule-making. Further investment in technology is also required to maintain and improve its operational effectiveness.

In 2021/22, the PRA underspent by £3.5 million, principally due to lower than assumed expensed project costs, reduced travel, and operating under headcount during the year. Due to additional income received in the year, the PRA will return £7.2 million to firms (2.4% of the PRA’s total budget), as explained within the 2022/23 fee rates consultation.

The extent to which the exercise of PRA functions is independent of other Bank functions

The PRA has a number of safeguards in place to ensure that it retains sufficient operational independence, including the independence of the PRC, and the funding and reporting arrangements set out in FSMA and the Bank of England Act 1998.

The PRC is independent in all its decision-making functions, which include making rules and the PRA’s most important supervisory and policy decisions. The PRC also maintains its independence by ensuring that actual and potential conflicts of interest across its members are identified and managed on a continual basis, and by having its own internal infrastructure and processes that supplement Bank-wide arrangements. PRC members’ remuneration is determined by the Bank’s Remuneration Committee.

The PRA is located within the Bank, and contributes to effective policymaking on financial stability. Roles and responsibilities of the Bank and PRA are distinct, and functions are discharged in line with the Basel Core Principles. For example, the Bank has legislation-driven arrangements in place to ensure that its functions as the UK’s resolution authority, and its supervisory functions (which are exercised in its capacity as the PRA) are operationally independent from one another, and has issued a statement setting out these arrangements.

The PRC is structurally separated from the FPC and MPC by having different external memberships. The PRC and FPC hold all meetings separately, except those to discuss matters of mutual interest (for example, the annual concurrent stress test). The FPC has specific powers of direction over prescribed macroprudential measures, and can make recommendations to anyone with the purpose of reducing risks to financial stability, including the PRA. This can sometimes mean that the FPC takes decisions that constrain the actions determined by the PRC.

The fee income generated from regulated firms can only be used for the functions covered by the statutory framework that the PRA operates within. The PRA’s budget covers its direct costs, as well as indirect costs charged by the Bank, including those for central functions such as technology, finance, and human resources. The Bank’s external auditors review the allocation of indirect costs charged by the Bank, and provide external assurance that costs have been allocated appropriately.