PS20/26 – Amendments to the Large Exposures Framework – Part 2

2: Overview

2.1 This Prudential Regulation Authority (PRA) policy statement (PS) provides feedback to the responses the PRA received to the following chapters in CP14/24:

• Chapter 2: Calculation of Exposure Value – Securities Financing Transactions;
• Chapter 3: Limits to Large Exposures – Trading Book Exposures; and
• Chapter 4: Calculating the effect of the use of credit risk mitigation techniques.

This PS contains the PRA’s final policy, as follows:

• amendments to the Large Exposures (CRR), Large Exposures, Group Financial Support, and Reporting (CRR) Parts of the PRA Rulebook (Appendix 1);
• amendments to supervisory statement (SS) 16/13 – Large Exposures (Appendix 2); and
• amendments to Annex IX – Instructions for Reporting on Large Exposures and Concentration risk (Appendix 3).

2.2 This PS is structured as follows:

• Chapter 3: Calculation of Exposure Value – Securities Financing Transactions;
• Chapter 4: Limits to Large Exposures – Trading book exposures;
• Chapter 5: Calculating the effect of the use of credit risk mitigation techniques;
• Chapter 6: PRA Rulebook merge and Basel 3.1 consequential changes;
• Chapter 7: Reporting templates and instructions;
• Chapter 8: Implementation timeline and permissions;
• Chapter 9: Additional responses outside the scope of CP14/24; and
• Chapter 10: The PRA’s accountability framework.

2.3 This PS finalises the remaining elements of the package consulted on in CP14/24. Together with PS14/25, it completes the PRA's work to finalise the policy amendments proposed in CP14/24.

2.4 This PS is relevant to PRA-authorised UK banks, building societies, PRA-designated investment firms, PRA-approved holding companies, PRA-designated holding companies and other CRR consolidation entities.

Background

2.5 In CP14/24, the PRA consulted on amendments to the LE framework, taking into consideration internationally agreed Basel standards and their implementation across jurisdictions. The proposals in CP14/24 included the calculation of exposure values for securities financing transactions, the treatment of trading book exposures, intragroup exposure limits and the application of the mandatory substitution approach. This PS sets out the PRA’s final policy following consideration of the responses to the consultation.

2.6 In determining its policy, the PRA considers representations received in response to consultation, publishing an account of them and the PRA's response ('feedback'). The Summary of responses section contains a general account of the representations made in response to CP14/24 and the remaining chapters contain the PRA's feedback.

Summary of responses

2.7 The PRA received a total of 12 responses to CP14/24. Respondents who consented to their names being published are set out in Appendix 4.

2.8 The PRA received substantial feedback on the proposed mandatory substitution approach both in CP responses and at industry roundtables held in December 2024. The Basel LE standards require substitution for all exposures reduced by eligible credit risk mitigation (CRM). When a firm reduces an exposure to a counterparty using eligible CRM, the firm must reassign the reduced portion to the collateral issuer or the protection provider. Respondents raised concerns that mandatory substitution could affect market liquidity and financial stability. They also said it could disproportionately affect smaller firms and create operational and implementation challenges.

2.9 Respondents also raised concerns about the calibration of the proposed Non-Core Large Exposures Group (NCLEG) limits and the removal of the trading book excess allowance for third-party exposures. Respondents also requested a longer implementation period for the most significant changes.

Changes to draft policy

2.10 The PRA welcomes the extensive level of industry engagement on this topic and has carefully considered the feedback and the concerns raised. In reaching its final policy decisions, the PRA has taken this feedback into account. The PRA collected additional data from firms and undertook further analysis to assess the potential impacts of the proposals and inform the final policy. It has also considered how the policy advances the PRA’s objectives and the other matters that it is required to have regard.

2.11 The PRA has made changes in the following areas to finalise the policy proposed in CP14/24:

• Trading book excess allowance for exposures to third parties: the PRA proposed to remove this excess allowance entirely in CP14/24. The final policy retains a materially reduced allowance of up to 85% of Tier 1 capital for a maximum of 10 business days, subject to additional safeguards.
• Trading book excess allowance: clarified the calculation of the additional capital requirement.
• Higher NCLEG permissions: introduced a single higher NCLEG limit of 350% of Tier 1 capital for trading book exposures.
• NCLEG application criteria: amended the proposed approach to be consistent with the Trading Activity Wind-Down (TWD) expectations.
• Implementing the mandatory substitution approach: introduced two exemptions from LE limits for: (1) exposures assigned to a sovereign collateral issuer under a funded credit protection arrangement; and (2) exposures assigned to a collateral issuer arising from a tri-party repurchase agreement facilitated by a tri-party agent.
• Implementation timeline: set the implementation date for the proposed changes to 1 January 2028.
• Minor consequential amendments to the rules required to implement the policy.

2.12 The PRA considers that these changes respond to the most significant concerns raised during consultation while maintaining the core safety and soundness objectives of the proposals. The PRA's reasons for accepting or rejecting specific consultation suggestions are discussed in the following chapters.

Implementation and next steps

2.13 The changes to the PRA Rulebook and related policy materials set out in this PS will take effect on 1 January 2028.

2.14 To facilitate orderly implementation, firms may apply for the new NCLEG permission or higher NCLEG permission from 1 July 2027. Firms seeking to have a permission in place by 1 January 2028 should submit their application allowing sufficient time for the PRA to assess it in line with its usual processes. Where practicable, firms are encouraged to apply as early as possible from 1 July 2027. The PRA intends, where possible, to determine applications before 1 January 2028. Existing NCLEG permissions and modifications will remain valid until they expire. For some firms, the expiry date will be after 1 January 2028. After this date, firms with existing NCLEG permissions and modifications will need to apply for the new permission in the normal course.

2.15 The PRA is continuing to assess several consequential LE framework changes arising from the implementation of Basel 3.1, including the treatment of certain off-balance sheet items and other areas affected by changes to the underlying credit risk framework. The PRA will consider these issues separately from this PS next year.

3: Calculation of Exposure Value – Securities Financing Transactions

3.1 In CP14/24, the PRA proposed to remove the option for firms to use internal models to calculate exposure values for Securities Financing Transactions (SFTs).

3.2 The PRA did not receive any objections to this proposal. Some respondents agreed with the rationale and considered it to be generally in line with the design of the LE framework as a sufficiently conservative backstop.

3.3 Most of the responses covering this proposal focused on the impact on the size of intragroup exposures. Five respondents raised concerns that exposure values calculated using the Financial Collateral Comprehensive Method (FCCM) could be materially higher than those calculated using internal models. They explained that this could affect firms with centralised booking models and significant intragroup SFT activity.

3.4 Five respondents were concerned that the calibration of the higher NCLEG limit of 250% and the additional capital requirement applying to the trading book excess allowance would not absorb the impact without significant changes to their business-as-usual operating model. They also argued that this methodology change could place UK firms at a competitive disadvantage as some jurisdictions have retained the option to use internal models. Therefore, some respondents requested that the higher NCLEG limit be recalibrated to provide sufficient capacity for firms to absorb the increase in the exposures due to this methodology change.

3.5 Having considered these responses, the PRA has decided to remove the option to use internal models for calculating exposure value on SFTs, as proposed in CP14/24. This is consistent with the role of the LE framework as a simple, transparent and comparable backstop to risk-sensitive capital requirements. Allowing firms to use internal models would make the measurement of concentration risk dependent on firm-specific modelling choices. This would be inconsistent with the purpose of the LE framework. The change would enable firms to measure SFT exposures prudently and consistently.

3.6 To give full effect to this policy, the PRA has decided to delete the provision in Article 390(4) that permits a firm with Internal Model Method permission under the counterparty credit risk framework to use the same method to calculate exposure values on SFTs. CP14/24 did not propose to delete this provision. The PRA considers that its deletion is a consequential amendment that aligns the final rules with the proposal set out in CP14/24. It does not represent a change to the policy consulted on.

3.7 The PRA recognises that, for some firms, this methodology change could increase exposures to entities within the same banking group without increasing the volume of transactions or the underlying risk. After considering industry feedback, the PRA undertook further analysis of regulatory data and additional firm submissions to refine its assessment of the impact. Considering this analysis, the PRA has increased the higher NCLEG limit to 350%. Full details are set out in Chapter 4.

4: Limits to Large Exposures – trading book exposures

4.1 The LE framework limits a firm’s exposure to a single counterparty, or a group of connected counterparties (GCC), to 25% of its Tier 1 capital or £130 million, whichever is greater. For the purposes of this PS, ‘LE limits’ refers to these limits. Currently, a firm can exceed the LE limits for exposures to each counterparty or GCC in the trading book by up to 500% of its Tier 1 capital. Any excesses to all counterparties or GCCs that have persisted for more than 10 days may not, in aggregate, exceed 600% of the firm’s Tier 1 capital. We refer to this allowance as the trading book excess allowance.

Trading book exposures to third parties

4.2 In CP14/24, the PRA proposed to remove the trading book excess allowance for firms’ exposures to third parties. The PRA explained in the Cost Benefit Analysis chapter of CP14/24 that the impact of this proposed change was expected to be limited. Firms should be able to manage LE limit breaches in exceptional circumstances in accordance with Article 396 of the Large Exposures (CRR) Part of the PRA Rulebook. This provides an established mechanism for firms to address temporary breaches arising from exceptional circumstances.

4.3 Two respondents recognised the PRA’s prudential concerns about the scale of the existing trading book excess allowance, which can permit exposures substantially above the LE limits. However, seven respondents requested that the PRA retain the trading book excess allowance for third parties as it offers flexibility for firms to accommodate short-term volatility.

4.4 Six respondents argued that trading book exposures can increase rapidly due to short-term volatility in the financial market. Breaches are usually driven by market price factors outside of a firm’s control. Without an allowance, firms would have to maintain large risk appetite buffers to operate below the LE limits to avoid accidental breaches driven by temporary market volatility. These risk appetite buffers could reduce firms’ activities, which may detract from market liquidity. One respondent highlighted that this flexibility is particularly important for smaller trading banks.

4.5 Some of these respondents did not consider the existing Article 396 process for addressing LE limit breaches an adequate alternative to the trading book excess allowance. They argued that there was insufficient clarity about what would be considered ‘exceptional circumstances’. They also noted supervisory implications where breaches occur for reasons outside a firm’s control. They suggested a grace period of 10 business days in which firms could reduce their trading book exposures. Some of these respondents also suggested an additional capital requirement could apply to the excess exposures during that period.

4.6 The PRA judges the existing calibration of the trading book excess allowance to be imprudent. It could expose a firm to significantly greater losses if a single counterparty or GCC failed unexpectedly. This could hinder the firm’s ability to continue operating as usual in a stress and increase contagion risk in the financial system. However, the PRA accepts that short-term flexibility could support firms’ sound risk management during periods of market stress and volatility. In CP14/24, the PRA noted that firms had rarely relied on the trading book excess allowance and therefore expected its removal to have limited practical impact. However, subsequent engagement has highlighted that the existence of the allowance itself can support firms' risk management during periods of market stress and volatility, even where it is infrequently used. Without this flexibility, firms may maintain larger risk-appetite buffers than necessary or reduce activity to minimise temporary breaches, which could affect market functioning.

4.7 Therefore, in a change from the proposal in CP14/24, the PRA has decided to retain a modest and time-limited trading book excess allowance for firms’ trading book exposures to third parties.

4.8 The final policy permits firms to have trading book exposures to third parties up to 85% of their Tier 1 capital for no more than 10 business days. The policy is 10 business days rather than 10 days to ensure firms have a consistent opportunity to reduce excess exposures, irrespective of when the excess arises. This is particularly important as the period now determines whether a firm is in breach of the LE limit, rather than only the application of a capital requirement.

4.9 The excess exposure would be subject to non-trading book exposures not exceeding usual LE limits and an additional capital requirement, as suggested by respondents. The 85% is substantially lower than the current allowance and aligns with the intragroup trading book excess allowance (see next section). It balances the prudential purpose of the LE framework, with providing sufficient headroom to manage short-term market volatility.

4.10 The PRA has decided to retain the requirement for firms to report each time the limit is exceeded to the PRA without delay. Firms must report the amount of the excess and the name of the client or GCC concerned. The PRA has also amended Article 398 of the Large Exposures (CRR) Part of the PRA Rulebook. This prevents firms from deliberately circumventing the 10 business day restriction by transferring exposures or creating artificial transactions.

Trading book exposures to intragroup entities

Trading book excess allowance for intragroup exposures

4.11 In CP14/24, the PRA proposed to keep the trading book excess allowance for intragroup exposures. These include exposures to specified parent undertakings (including through participations or other kinds of holdings), other subsidiaries of that parent undertaking or to its own subsidiaries and qualifying holdings. The PRA proposed to reduce the allowance to 85% of a firm’s Tier 1 capital. This more conservative allowance was proposed to balance the risk of excessive intragroup contagion risk with the benefits of effective risk management and control practices. The PRA also proposed to simplify the calculation of the additional capital requirement that applies to the trading book excess allowance.

4.12 The PRA received little feedback on the proposal to reduce the size of the trading book excess allowance for intragroup exposures. One respondent noted that this is helpful for firms’ booking and risk management structures. Three respondents requested clarification on the additional capital requirement calculation.

4.13 The PRA has decided to reduce the trading book excess allowance to intragroup entities to 85% of a firm’s Tier 1 capital, as consulted in CP14/24. This is subject to a firm’s non-trading book exposures meeting the LE limits and an additional capital requirement on the excess exposure.

4.14 In response to feedback, the PRA has amended the rules to clarify the calculation of the additional capital requirement. The amended rules make it clear that a 100% risk weight applies to the part of the exposure that exceeds LE limits. Firms are not required to hold additional own funds equal to the full amount of that excess exposure. These amendments clarify the policy intention consulted on in CP14/24 and do not change the policy.

Consolidation of NCLEG permissions

4.15 The simplified framework removed the need for separate NCLEG permissions for the non-trading book and trading book. The PRA therefore proposed to replace the separate NCLEG permissions with a single NCLEG permission, with no change to the conditions a firm must meet to be granted the permission. The PRA did not receive any feedback and therefore, it has decided to implement this as proposed.

4.16 NCLEG permissions granted under the existing framework will continue to be recognised as legacy NCLEG permissions and may continue to be used in accordance with their existing terms until they expire or are replaced by a permission granted under the revised rules.

Changes to NCLEG limits for intragroup exposures

4.17 In CP14/24, the PRA proposed to allow firms meeting enhanced risk management and control requirements, including the expectations in SS1/22 – Trading activity wind-down, to apply for a new firm-specific higher NCLEG permission. Subject to PRA approval, this new permission would allow firms to have trading book exposures to certain group entities outside of UK up to 250% of their Tier 1 capital.

4.18 Five respondents welcomed the proposal. However, some of these respondents argued that the proposed 250% cap would be insufficient to absorb the increase in exposures when removing the option to use internal models to measure exposures on SFTs. Some respondents provided relevant estimates and additional data. Three respondents also noted that some other jurisdictions exempt intragroup exposures or permit higher limits. They argued this could influence firms’ booking arrangements and the attractiveness of the UK as a location for international financial activity.

4.19 Respondents put forward several suggestions. Four suggested a higher standard cap of at least 350%. Two preferred a firm-specific limit to reflect differences in their booking models and group structures. Two respondents requested more information about how the PRA would grant a firm-specific limit between 100% and 250%. They explained that uncertainty about the calibration process would make it difficult for them to gauge the level of NCLEG limit they would need and the effect of the policy on their capital position.

4.20 The PRA has considered industry responses and analysed further data submitted by respondents. The analysis indicates that removing the option to use internal models to measure SFTs exposures could increase some firms’ intragroup exposures more than anticipated at the time of consultation. As explained in CP14/24, the purpose of introducing the higher NCLEG limit is to offset increased measured exposures arising solely from this methodology change. This would enable firms to maintain existing booking arrangements, risk management and control practices. The PRA concluded that a higher limit of 250% would likely not fully achieve that objective for some firms.

4.21 The PRA has therefore decided to introduce a higher NCLEG permission as proposed, covering both trading and non-trading book exposures. The higher NCLEG limit for trading book exposures will be increased to 350% of a firm’s Tier 1 capital.

4.22 The PRA has also decided to apply the 350% limit to all firms granted a higher NCLEG permission. This is a change from the firm-specific approach proposed in CP14/24. The PRA recognises that a firm-specific approach may reduce transparency, predictability and increase the risk of inconsistent outcomes. The PRA therefore considers that a single standard limit is more appropriate as it provides greater certainty for firms and promotes a clear and consistent LE framework.

Trading Activity Wind-Down (TWD) expectations

4.23 In CP14/24, the PRA proposed that firms applying for the new higher NCLEG permission must demonstrate that they have robust plans in place to ensure a solvent wind-down and that they meet all the expectations in SS1/22.

4.24 Three respondents asked for clarification on how the TWD expectations will be considered in the PRA’s assessment of firms’ applications for higher NCLEG permissions. They interpreted the consultation proposal as making compliance with the relevant TWD expectations a prerequisite for obtaining a higher NCLEG permission.

4.25 In light of the responses, the PRA has clarified its approach. A firm will not be required to demonstrate that it meets the TWD expectations as a standalone condition for granting the permission. When assessing an application, the PRA will consider the firm’s relevant TWD practices, alongside its booking arrangements, risk-management framework, systems and controls, and other relevant factors. The PRA has updated SS16/13 accordingly.

Non-trading book intragroup exposures

4.26 The proposals in CP14/24 to introduce a higher NCLEG permission only applied to trading book intragroup exposures.

4.27 Four respondents requested that the higher NCLEG limit also apply to non-trading book exposures. They explained that firms may have substantial intragroup SFT activities in the non-trading book for liquidity and treasury management purposes. Removing the option to use internal models would also increase the exposure value of these transactions. One respondent requested a non-trading book limit of at least 150% of a firm’s Tier 1 capital.

4.28 The PRA has decided not to extend the higher trading book NCLEG limit to non-trading book intragroup exposures. Under a higher NCLEG permission, firms may continue to exempt both trading book and non-trading book intragroup exposures up to 100% of a firm’s Tier 1 capital. However, only trading book exposures may benefit from the higher limit above 100% of Tier 1 capital. The PRA considers there is insufficient evidence to justify permitting a higher limit for non-trading book exposures. Analysis of regulatory data submitted by firms indicated that the impact of the methodology change would be limited and firms would be unlikely to exceed the existing limit of 100% of a firm’s Tier 1 capital.

5: Calculating the effect of the use of credit risk mitigation techniques

Mandatory substitution

5.1 In CP14/24, the PRA proposed to make the substitution approach mandatory, as consulted in CP5/21 – Implementation of Basel standards. CP14/24 also included additional proposals to clarify how the substitution approach should work.

5.2 Overall, 10 respondents addressed this proposal. Respondents generally supported the application of the substitution approach to unfunded CRM. However, five respondents argued that applying the substitution approach to funded CRM would be disproportionate. They argued that collateral differs from unfunded credit protection because it is held by the firm, marked to market and generally capable of being replaced.

5.3 Five respondents argued that implementing mandatory substitution is disproportionate to the risk it seeks to address. They argued that the possibility for firms to suffer losses would generally require the failure of both the original counterparty and the collateral issuer. In addition, aggregating multiple exposures to the same collateral issuer received from multiple unconnected counterparties did not recognise diversification provided by these counterparties. They also argued that mandatory substitution is not needed because concentration risk of this nature is already captured and addressed in the Pillar 2A and stress testing frameworks.

5.4 Five respondents raised concerns about the potential impact of the substitution approach on repo markets and smaller firms. Two respondents also raised concerns regarding tri-party collateral arrangements. These issues are discussed further below.

5.5 The PRA has considered the responses to the consultation, subsequent industry feedback and further analysis based on regulatory data and additional information collected from firms. To advance its primary objective of safety and soundness, the PRA has decided to make the substitution approach mandatory for all firms. Under the current LE framework, firms may reduce an exposure to reflect the effect of CRM, including collateral. They can choose not to apply the substitution approach to recognise a corresponding increase in exposure to the collateral issuer or protection provider, or not to apply it consistently across all exposures. Material concentrations arising from applying CRM techniques can therefore build up within firms and across the wider financial system without being fully recognised, monitored or constrained.

5.6 The PRA recognises that indirect exposures arising through CRM differ from direct exposures, because losses may depend on both the original counterparty and the collateral issuer or protection provider. The PRA also recognises respondents' concerns regarding double default and diversification. However, where firms recognise the risk-mitigating effect of CRM elsewhere in the prudential framework, the PRA considers that the resulting concentration to the collateral issuer or protection provider should also be recognised within the LE framework. Without mandatory substitution, firms can obtain the benefit of CRM while material concentrations to protection providers remain outside the LE framework.

5.7 The PRA therefore considers that concentrations arising through CRM remain relevant prudential risks that should be recognised and subject to LE limits. Making the substitution approach mandatory addresses a gap in the current PRA prudential framework by ensuring these concentrations are recognised, monitored and constrained in a consistent manner. Mandatory substitution is also part of the Basel LE standard and has been implemented by other major Basel-compliant jurisdictions. Implementing it in the UK therefore brings the PRA's LE framework into closer alignment with the Basel LE standards and their implementation in comparable jurisdictions.

5.8 The PRA recognises the difference between funded credit protection, where collateral is held against an exposure, and unfunded credit protection, where a promise is made from a third party to pay when a borrower defaults. Funded credit protection is secured by collateral already held by the firm, which is typically margined and can be replaced if the credit quality deteriorates. Those features reduce risk but do not eliminate it entirely. A firm may still develop concentrations to a collateral issuer by relying on securities issued by the same entity across many unrelated transactions, and replacement may become difficult or costly when that issuer is under stress. The PRA does not consider that a firm’s internal risk management, stress testing or Pillar 2 requirements provide the same consistent counterparty-level measurement and hard backstop that would be delivered by mandatory substitution.

5.9 The PRA has also decided to finalise the policy with two targeted exemptions where the impact is assessed as disproportionate. See the Sovereign exposure exemption and Tri-party repo exemption sections below. Both exemptions represent a change from the PRA’s proposal in CP5/21 and CP14/24.

Sovereign exposure exemption

5.10 In CP14/24, the PRA proposed that an exposure assigned to a sovereign collateral issuer or protection provider through substitution would be exempt from LE limits where the sovereign is assigned a 0% risk weight for credit risk purposes. This is consistent with the wider LE framework.

5.11 Four respondents argued that the proposed exemption was too restrictive, noting the broader sovereign exemption provided in the Basel LE standards. They questioned how the ‘funded and denominated’ condition, which is used to determine certain sovereign risk weights, should be applied to the exposures to sovereign collateral issuers. They explained that firms may not be able to identify how collateral posted by a counterparty was funded and that the currency of their liabilities does not affect their ability to liquidate the collateral following a counterparty default.

5.12 Three respondents raised concerns that the proposed exemption could reduce the use of sovereign collateral where the relevant sovereign issuers’ credit ratings are mapped to below CQS1 in the credit risk framework. This could affect the liquidity in the repo market and the use of sovereign collateral in emerging market activities. They also raised concerns that following a sovereign downgrade, firms may experience cliff-edge effects, as the sovereign exposure would no longer be exempt. The proposed exemptions could also incentivise firms to accept lower-quality collateral or conduct transactions on an unsecured basis.

5.13 Having considered industry feedback, the PRA has decided to apply a broader exemption for sovereign exposures arising from the substitution approach. The PRA’s further analysis suggested that the consultation proposal could constrain the use of eligible sovereign collateral for some firms more than anticipated by CP14/24. A sovereign downgrade from CQS1 to CQS2 could make a firm’s aggregated exposures to that collateral issuer immediately subject to LE limits. Firms might then need to reduce their use of the affected collateral or other exposures to the same sovereign. The proposal could also encourage firms to concentrate collateral use in a narrower set of CQS1 sovereigns. Therefore, the PRA’s final policy, reflected in Article 400(1)(m), exempts from LE limits exposures to all issuers of sovereign collateral received as funded credit protection. This is a change from the sovereign exemption proposed in CP14/24.

5.14 The PRA is mindful that this broader exemption will include some collateral that it does not consider to be risk free, as reflected in the credit risk framework. On balance, the PRA considers this inconsistency acceptable because the exemption addresses areas where mandatory substitution could have a disproportionate effect.

5.15 The PRA has decided that this broader exemption will not extend to unfunded credit protection, such as sovereign guarantees. The PRA judges that this different treatment is justified because replacing or liquidating unfunded credit protection could be more difficult. Therefore, the PRA has decided to keep its CP14/24 proposal that unfunded credit protection provided by sovereign protection providers would be exempt from LE limits only where the sovereign protection provider is assigned a 0% risk weight for credit risk purposes.

5.16 The final rules and reporting instructions require firms to report all indirect exposures arising through substitution, including those that are exempt from the LE limits. Firms should aggregate indirect exposures to the same collateral issuer or protection provider. They should report those exposures on a separate line from any direct exposures to that counterparty, including where the indirect exposure is exempt. This is consistent with the approach for reporting direct exposures, which are aggregated by counterparty.

Corporate collateral and market functioning

5.17 In CP14/24, the PRA proposed to make the substitution approach mandatory where firms use eligible CRM to reduce an exposure, including where firms receive corporate collateral. Several respondents argued that making substitution mandatory for corporate collateral could reduce firms' willingness to accept corporate bonds and other non-sovereign collateral in repo and collateralised derivatives transactions. They said that the use of non-cash corporate collateral had increased following periods of market stress and that restricting it could reduce collateral diversity and increase reliance on sovereign collateral.

5.18 Four respondents also raised concerns about repo and corporate bond market liquidity. They argued that mandatory substitution could reduce a firm’s capacity to intermediate collateral, shift activity to overseas or non-bank entities, and adversely affect market functioning during periods of stress. Some of these respondents also argued that these effects could be inconsistent with broader developments in the Bank of England’s Sterling Monetary Framework.

5.19 The PRA has decided to make substitution mandatory for corporate collateral as consulted. The PRA, together with other colleagues from the Bank of England, has considered the responses and undertaken further analysis. This analysis did not indicate that applying the substitution approach to corporate collateral would create material cliff-edge effects or require significant changes to firms' collateral management practices. The PRA therefore does not consider that the proposal would materially constrain firms' use of corporate collateral or impair market functioning. The prudential benefits of recognising concentration risk to corporate collateral issuers justify making substitution mandatory.

Impact of mandatory substitution on small firms

5.20 Five respondents argued that mandatory substitution could have a disproportionate effect on smaller firms because their smaller capital bases result in lower nominal LE limits. They also argued that smaller firms may have fewer alternatives for diversifying collateral exposures or accessing Qualifying Central Counterparties (QCCPs). They therefore requested a more proportionate treatment, including exempting smaller firms from mandatory substitution or, alternatively, exempting firms using tri-party repo arrangements from the requirement.

5.21 The PRA has decided to make the substitution approach mandatory for all firms as consulted. The PRA considers that small firms can be vulnerable to concentration risk, and that the LE framework has an important backstop role in ensuring their resilience. However, targeted exemptions that may benefit smaller firms are discussed and adopted in the Sovereign exposure exemption and Tri-party repo exemption sections.

Tri-party repo exemption

5.22 Several respondents raised concerns about monitoring compliance with LE limits for exposures secured through tri-party collateral agreements. A firm may control the transaction terms and eligibility criteria but have limited day-to-day control over the specific collateral accepted. As set out in Article 403(3), firms may calculate exposures using contractual collateral-issuer limits agreed with the tri-party agent. However, they argued that mandatory substitution and automated collateral substitution would make large exposure monitoring materially more complex. They said this would require significant systems investment and could constrain tri-party repo, collateral eligibility and secured financing activity.

5.23 Having considered these responses, the PRA agrees and has decided to exempt exposures to issuers of collateral received under tri-party repurchase agreements facilitated by tri-party agents from LE limits. Although the exemption applies to all firms, it is expected to be particularly beneficial to smaller firms that are more likely to rely on tri-party agents and may have fewer alternatives for managing collateral exposures. Firms will still be required to continue to identify and report exposures, or relevant limits, arising from tri-party repo. In its final rules, the PRA introduced this exemption in Article 400(1)(n) and as a result, the PRA has also deleted Article 403(3)(e) as this condition is no longer required.

Technical clarifications

Measuring exposures under the substitution approach

5.24 In CP14/24, the PRA proposed clarifications on how exposures should be calculated under the substitution approach, including how the calculation interacts with the methodologies used to recognise CRM under the credit risk framework and to calculate exposure values under the counterparty credit risk framework, and on the treatment of overcollateralisation.

5.25 Several respondents requested further clarifications on the calculation of recognised amounts under the substitution approach. They asked how volatility adjustments should be reflected when determining the amount assigned to the collateral issuer under the FCCM and how the calculation applies under the Standardised Approach for Counterparty Credit Risk (SA-CCR). Some asked whether the exposures substituted should be capped at the market value of the collateral received. Others sought clarification on the treatment of overcollateralisation and the allocation of exposures across multiple items in the same collateral pool.

5.26 Having considered the consultation responses, the PRA has clarified the calculation of exposures under the substitution approach in its final rules (Article 403(1A)) and SS16/13. The final rules require firms to determine the exposure to the collateral issuer using the relevant methodologies in the credit risk or counterparty credit risk framework, as applicable. The exposure to the collateral issuer is the lower of the amount by which the original exposure is reduced and the market value of the collateral. The PRA considers this approach appropriate and proportionate as it maintains consistency with the credit risk framework and the counterparty credit risk framework. It ensures that overcollateralisation and the application of the alpha factor in SA-CCR do not overstate the size of the exposure.

5.27 In SS16/13, the PRA has also clarified the allocation of exposures for SA-CCR, where the effect of collateral is measured in aggregate and reflected in the size of the multiplier. In this case, firms should assign the substituted exposure to each of the collateral issuer on a pro-rata basis, based on the market value of the collateral. This is a change from the proposal consulted on in CP14/24.

Measuring exposures under the substitution approach for transactions in a master netting agreement

5.28 Four respondents requested clarification of how to calculate the indirect exposure for SFTs covered by a master netting agreement, including security-for-security transactions. They argued that recognising only securities received, without taking account of securities posted or the netting effects of the agreement, could overstate the economic risk.

5.29 Having considered consultation responses and compared the effects of potential policy options, the PRA recognises the challenge in prescribing an approach that would work in all cases. There are many factors to consider, such as the composition and characteristics of the netting set and the relative size of individual transactions in the netting set. There are also operational implications for firms. As a result, the PRA has decided not to prescribe an approach at this stage and firms have the flexibility to adopt an approach that works for them, as long as it is prudent and applies consistently. The PRA intends to revisit this treatment in the future.

Netting of exposures

5.30 One respondent asked whether indirect exposures assigned to a collateral issuer under the substitution approach could be netted with direct short exposures or with posted and received securities from the same issuer.

5.31 The PRA considers that firms should recognise netting only where the existing prudential framework permits it, including under qualifying master netting agreements for SFTs. Where no recognised netting arrangement exists, the PRA does not consider it appropriate for firms to offset direct and indirect exposures to the same issuer. Firms may not be able to realise such offsets in practice. They should therefore aggregate these exposures when determining total exposure to the relevant counterparty or group of connected counterparties.

The treatment of exposures from applying the substitution approach where the original exposure is exempt

5.32 Three respondents requested clarification on whether indirect exposures recognised through substitution should be included in LE limit calculations where the underlying exposure is exempt from the LE limits. They argued that recognising an indirect exposure in these circumstances could undermine the purpose of the exemption applied to the original exposure and create unnecessary calculation and reporting burden.

5.33 The PRA considers, as a general principle, that exposures to collateral issuers and protection providers arising from the use of credit risk mitigation should be included in LE limit calculations, even where the original exposure is exempt from LE limits. In finalising its rules, the PRA has introduced specific exemptions where it considers proportionate. This includes the targeted exemptions on sovereign exposures and tri-party repo. The PRA has also clarified the treatment of QCCP related transactions.

Collateral not recognised for regulatory purposes

5.34 One respondent requested clarification on whether the substitution approach would apply to collateral that is accepted for commercial or risk-management purposes but not used as a form of credit risk mitigation for regulatory capital purposes.

5.35 The PRA considers it is important to maintain consistency between the recognition of CRM for the original exposure and substitution of the resulting exposure to the collateral issuer or protection provider. In the LE framework, firms may not reduce an exposure to a client where collateral has not been recognised in determining the exposure under the credit risk or counterparty credit risk methodology. The substitution approach therefore does not apply, and the firm must recognise the full exposure to the client.

Qualifying central counterparties (QCCP) related transactions

5.36 Two respondents requested clarification on the interaction between mandatory substitution and the existing exemption for QCCPs related transactions. They argued that, where the direct exposure to a QCCP is exempt, collateral associated with the transaction should not result in an indirect exposure under the substitution approach.

5.37 The PRA’s LE rules exempt certain QCCP related exposures from LE limits. These include clearing a member firm’s trade exposures and default fund contributions to QCCPs, as well as a client firm’s trade exposures to clearing members on QCCP related transactions. Article 400(1)(j) and Article 400(1)(l) of the Large Exposures (CRR) Part of the PRA Rulebook specify these exemptions. The PRA considers that subjecting exposures to issuers of associated collateral arising from the substitution approach to LE limits would be inconsistent with the purpose of these exemptions. The PRA has therefore decided to exempt from LE limits these indirect exposures by amending Article 400(1)(j) and Article 400(1)(l). Firms must identify and report these indirect exposures through supervisory reporting. Other direct or indirect exposures from QCCP related transactions that do not qualify for the exemptions under Article 400(1)(j) and (l) remain subject to LE limits.

Cash collateral

5.38 Three respondents requested clarification that receipt of cash collateral does not create an indirect exposure under the substitution approach. The PRA agrees with this treatment. The substitution approach is not designed to capture cash collateral. It is designed to address the potential risks of excessive concentration to collateral issuers and protection providers. The PRA has amended Article 403(1) of the Large Exposures (CRR) Part of the PRA Rulebook to exclude cash collateral from the scope of the substitution approach.

Transaction-specific treatment

5.39 Three respondents requested exclusions or alternative treatments for a range of transaction structures, including overnight stock borrowing, collar-financing transactions, bankruptcy-remote arrangements, intercompany collateral movements and sub-participations. One also requested that firms should be allowed to recognise hedges against indirect LE exposures.

5.40 The PRA has not introduced transaction-specific exemptions or alternative treatments beyond those set out in this PS. Respondents provided limited evidence that the treatment of the specific transaction structures identified would result in disproportionate or unintended outcomes under the substitution approach. The PRA considers that mandatory substitution should operate as a simple and consistent backstop whenever eligible CRM reduces a regulatory exposure, unless a specified exemption applies. Creating bespoke treatments for particular transaction structures could significantly increase complexity and reduce the consistency and comparability of the framework. The PRA therefore considers it more appropriate to maintain a principles-based approach than to prescribe treatment for individual transaction types.

6: PRA Rulebook merge and Basel 3.1 consequential changes

6.1 In CP14/24, the PRA proposed to merge the Large Exposures Part of the PRA Rulebook with the Large Exposures (CRR) Part of the PRA Rulebook. As part of this consolidation, the PRA proposed to move the existing exemption for certain intragroup resolution exposures from the Large Exposures Part to Article 400 of the Large Exposures (CRR) Part, alongside the other exemptions from LE limits. The proposal was intended to consolidate the LE requirements into a single Part. This included transferring provisions relating to the NCLEG framework and associated notification requirements, the treatment of existing sovereign large-exposure permissions, and the exemption for certain intragroup resolution exposures into the Large Exposures (CRR) Part. The PRA also noted that Basel 3.1 could have consequential implications for the LE framework, including from the revised FCCM.

6.2 The PRA did not receive any responses on the proposed PRA Rulebook merge. On Basel 3.1 consequential changes, some respondents highlighted additional areas where the Basel 3.1 package could have implications and requested clarity on the interactions. Respondents highlighted potential consequential effects from Basel 3.1 changes to the credit risk framework, including for the treatment of off-balance-sheet exposures and the associated LE rules and reporting requirements.

6.3 The PRA has decided to finalise the rulebook merge consulted on in CP14/24 by deleting the Large Exposures Part of the PRA Rulebook and transferring provisions in this Part to the Large Exposures (CRR) Part. In doing so, the PRA has sought to preserve the existing policy in the transferred provisions, limiting changes to those necessary to give effect to the policy decisions set out in this PS. Accordingly, except where provisions are new or have been amended as part of the policy changes set out in this PS, the final rules have not been fully reviewed to reflect changes arising from the implementation of Basel 3.1. The PRA applied the same approach when updating SS16/13 and the LE reporting instructions, preserving the existing policy and guidance except where amendments were needed to reflect the policy changes set out in this PS or the consolidation of the PRA Rulebook.

6.4 Given the close relationship between the LE framework and the PRA’s wider risk-based framework (eg credit risk), the PRA recognises the need to assess the broader implications of Basel 3.1 on LE rules. This PS addresses a number of these, including the revised FCCM under Basel 3.1 to measuring SFT exposures. However, further assessment is required. This includes considering whether additional amendments are needed to reflect Basel 3.1 changes elsewhere in the PRA Rulebook and related policy materials. The PRA intends to undertake further analysis during 2027 and consult on any consequential changes where appropriate in due course.

7: Reporting templates and instructions

7.1 In CP14/24, the PRA proposed no amendments to the reporting templates because of mandatory substitution. However, the PRA explained that consequential changes to reporting requirements and instructions would be required. Draft reporting instructions published with CP14/24 set out the detailed changes. These included clarifications on how firms should report exposures arising under the substitution approach and updates to align the instructions with the PRA Rulebook.

7.2 Two respondents requested revisions to the LE reporting templates and instructions. They explained that the existing design did not clearly distinguish exposures arising from substitution of CRM from other types of indirect exposure, including exposures to underlying instruments of derivatives.

7.3 The PRA has decided to keep the existing LE reporting templates unchanged. The PRA considers that although the existing templates do not distinguish exposures under the substitution approach from other indirect exposures, they should be sufficient to capture the relevant information needed for supervisory monitoring and assessment purposes. The PRA has amended the relevant reporting instructions to reflect the final policy and clarify how firms should report exposures under the substitution approach.

8: Implementation timeline and permissions

Implementation timeline

8.1 In CP14/24, the PRA proposed to implement the vast majority of the proposals soon after publishing the policy statement, with the removal of IM methods to take effect on 1 January 2026. Due to the large number of industry responses received, the finalisation of CP14/24 was delayed, allowing further industry engagement and policy development.

8.2 Four respondents raised concerns about the proposed timeline given the scale of the operational work required to implement mandatory substitution. They highlighted the need for systems development, reporting changes, operational adjustments and changes to client legal arrangements. Respondents also noted challenges associated with identifying collateral issuers, monitoring frequently changing collateral pools, calculating indirect exposures and ensuring ongoing compliance with LE limits. Several respondents requested additional implementation time, with some supporting at least 12 months between publication of the final policy and implementation, and others requesting alignment with the timing of Basel 3.1 implementation on 1 January 2027.

8.3 The PRA recognises that the final policy, particularly mandatory substitution, will require firms to make changes to their systems and controls. The changes to the LE framework will take effect on 1 January 2028.

NCLEG permissions

8.4 In CP14/24, the PRA proposed that the revised NCLEG framework would take effect shortly after publication of the final PS. The PRA proposed transitional arrangements until March 2026 for affected firms whose existing permissions would cease to have effect, allowing them time to apply for a higher NCLEG permission. Existing NCLEG trading book and non-trading book permissions granted before implementation would remain in place.

8.5 Four respondents requested that existing NCLEG permissions or modifications remain available until the revised framework takes effect, to avoid the need for repeated applications over a relatively short period. Respondents also sought further clarity on the process and timing for applying for the new NCLEG and higher NCLEG permissions.

8.6 Having considered firm responses, the PRA decided that firms may apply for the new NCLEG or higher NCLEG permissions before 1 January 2028 (when the policy changes in this PS come into force). The PRA intends to process applications before that date where possible. Firms may apply from 1 July 2027. This supports timely assessment while ensuring that applications use reasonably up-to-date information. It should enable firms to have permissions in place when the policy changes take effect.

8.7 Existing NCLEG permissions and modifications will remain valid until they expire, including where this is after 1 January 2028. After this date, firms with existing NCLEG permissions and modifications will need to apply for the new permission in the normal course.

9: Additional responses outside the scope of CP14/24

9.1 Three respondents requested the removal or amendment of notification requirements applying to intragroup exposures. They argued that these notifications duplicate information available through regulatory reporting and requested either a higher notification threshold or clarification of their frequency.

9.2 Some respondents provided broader comments on the LE framework. One suggested that the framework may no longer operate as a simple prudential backstop and could constrain banks' capacity to intermediate in financial markets. Another requested further work on the commercial effects of the framework, particularly for internationally active UK-headquartered firms. One respondent requested that firms should be able to apply the LE framework at subgroup level, rather than at the level of individual entities within the subgroup.

9.3 Two respondents requested that the PRA apply the preferential exposure value available for certain covered bonds in the Basel LE standard. One respondent also requested that firms be permitted to look through covered bonds and securitisations to underlying assets where those instruments are received as collateral.

9.4 The PRA has considered these responses. As these comments did not relate directly to the proposals consulted on in CP14/24, the PRA has not provided detailed feedback on them in this PS but may consider them in future policy work.

10: The PRA’s accountability framework

10.1 Before making any proposed rules, the PRA is required to have regard to any representations made to it in response to the consultation, and to publish an account, in general terms, of those representations and its feedback to them.^{footnote [1]}

10.2 This PS takes account of how the policy advances the PRA objectives and of significant matters that the decision maker had regard to.

10.3 In CP14/24, the PRA explained how it had regard to the matters that were significant to the proposals. That analysis remains appropriate except where set out below. In developing the final policy, the PRA has considered the responses to the consultation and undertaken further analysis. In particular:

• Proportionality: The PRA considers that the final policy is proportionate. In response to consultation feedback, the PRA has introduced targeted exemptions for exposures arising from substitution of funded sovereign collateral and tri-party repo arrangements. These changes reduce the costs and potential market impacts of mandatory substitution where these would be disproportionate to the prudential benefits. The approach continues to capture other material concentrations to collateral issuers and protection providers. The PRA has also increased the higher NCLEG limit to 350% of Tier 1 capital, providing firms with greater flexibility to maintain existing booking arrangements following the changes to exposure measurement. The PRA has retained a materially reduced and time-limited trading book excess allowance for third-party exposures, providing limited flexibility to manage short-term volatility while materially reducing the scale of the existing allowance.
• Sustainable growth and finance for the real economy: The PRA considers that the final policy supports sustainable growth while maintaining the safety and soundness benefits of the LE framework. The targeted exemptions address concerns raised during consultation about potential effects on sovereign bond and repo markets and reduce the potential impact on firms' use of collateral. The PRA considers that the remaining elements of the final policy are unlikely to have a material impact on finance for the real economy.
• Efficient and economic use of PRA resources: The PRA considers that the final policy supports the efficient and economic use of its resources. In particular, replacing firm-specific higher NCLEG limits with a single 350% limit simplifies the application and assessment process. The final policy also simplifies the calculation of the additional capital requirement associated with the trading book excess allowance.
• Different business models and competition: The PRA has considered the effects of the final policy across different business models. The targeted exemptions for indirect exposures arising under the substitution approach apply irrespective of firm size, but may particularly benefit firms that have fewer alternatives for managing collateral arrangements. The PRA considers that these changes reduce potential disproportionate impacts while maintaining a consistent prudential framework across firms.
• International standards and competitiveness and growth: The final policy brings the PRA's LE framework into closer alignment with the Basel LE standards, while reflecting features of the UK financial system and evidence received during consultation. The PRA considers that the changes made following consultation, including the targeted exemptions for indirect exposures arising under the substitution approach and revised treatment of trading book and intragroup exposures, reduce potential impacts on firms' booking arrangements, collateral use and market activity while maintaining the prudential objectives of the LE framework.

10.4 Where the PRA considers that the final rules differ significantly from CP14/24, section 138J(5) of the Financial Services and Markets Act 2000 (FSMA) requires the PRA to publish:

• details of the differences together with an updated cost benefit analysis; and
• a statement setting out in the PRA’s opinion whether the impact of the final rules on mutuals is significantly different from the impact that the:
  • draft rule would have had on mutuals; or
  • final rule will have on other PRA-authorised firms.

10.5 The PRA has considered the changes to the draft rules set out in this PS and does not consider that they differ significantly from the proposals consulted on for these purposes. The PRA has therefore not produced an updated cost benefit analysis. Similarly, the PRA does not consider that the impact of the final rules on mutuals is significantly different from the impact that the draft rules would have had on mutuals, or from the impact that the final rules will have on other PRA-authorised firms.

10.6 When making CRR rules or rules applying to certain holding companies, the PRA must also publish a summary of the purpose of the proposed rules. This is set out in Chapters 2, 3 and 4 of CP14/24.

10.7 The PRA has also considered, and consulted HM Treasury on, the likely effect of the rules on relevant equivalence decisions, in accordance with section 144C(3) FSMA. The PRA does not consider that the final rules will have a material impact on relevant equivalence decisions.