The UK Prudential Regulation Authority’s new PRA110 liquidity framework comes into effect on 1 July 2019. Compared to other liquidity templates, PRA110 is significantly more granular and requires more frequent reporting. Effective implementation, however, offers financial institutions the opportunity to raise their liquidity standards; improve their access to vital data; and add genuine commercial value.
The PRA confirmed its first policy statement for Pillar 2 liquidity in February 2018, finalising the reporting requirements for the new Cashflow Mismatch Risk (CFMR) framework. This included the introduction of the PRA110 return which replaced FSA047/048. It builds upon the EBA C66, aiming to monitor and measure daily cashflow mismatches.
The PRA’s position is that firms must be able to effectively and accurately monitor and report on daily liquidity cashflow mismatches. PRA110 calls for an approach that doesn’t only ensure regulatory compliance but delivers liquidity risk management, as well as a strategic, forward-looking view of the future evolution of the portfolios in both trading and banking books.
So how can firms turn compliance with these new requirements into a business benefit?
Stand ready to update reporting frequency
The new regime drastically increases reporting requirements for affected institutions. Large firms will have to report PRA110 on a weekly basis with a one-day remittance period, while smaller firms must report on a monthly basis with a 15-day remittance period. However, in times of stress, firms must have the capability to report on a daily basis, and should therefore stand ready to increase reporting frequencies to daily for large firms and weekly for small firms, with a one-day remittance period. The PRA110 return is applicable at both individual and consolidated levels, including ring-fenced entities.
The increased reporting frequency might initially appear as a burden, but firms should not forget that although the overall destination is to deliver the data to the PRA for monitoring of key metrics (including survival days, net liquidity position, worst net liquidity position and peak cumulative net outflows), the journey will allow them to identify these metrics on their own account, and embed them into their own systems. This will provide firms with a material advantage when it comes to awareness and advance knowledge of potential issues, threats, or risks to liquidity standards. Used correctly, this awareness has the potential to enhance business value far beyond regulatory compliance.
Gear up for substantial stress testing
Another key requirement of Pillar 2 is the requirement for ongoing stress testing – a trend that is gathering regulatory momentum across the board, incorporated into everything from MiFID II to CRD IV to the continued implementation of Basel III requirements over the next few years. Data from the PRA110 return will be subject to the application of a rigorous set of stress scenarios and tests of different severity and duration, representing distinct lenses through which the PRA will assess if firms are running excessive maturity mismatches or have not adequately considered limits to monetisation.
The PRA has defined a set of monitoring and guidance-setting tools and scenarios that allow banks to better understand their liquidity position.
However, the PRA has noted that only the granular LCR (without the monetisation profile) will be used to inform a firm’s Individual Liquidity Guidance (ILG), while the others will be used solely for monitoring purposes. Taking the term of the stress testing tools in account as well as the 90-day daily breakdown it’s clear that the PRA are setting the survival guidance de-facto standard at 90-days – 3 times greater than the Pillar 1 LCR guidance.
This too should be viewed as an opportunity rather than a chore. Again, while the data must be sent to the PRA, its collection offers the firm the ability to project and monitor its own cash flows to inform its Internal Liquidity Adequacy Assessment Process. Firms will have to update their risk appetite to take into account the new standardised stress testing framework under PRA110. This will provide them with greater insight into their own operations and allow a more accurate forecast of key elements such as viability risk, debt buyback risk, prime brokerage and matched book liquidity risk, and risk from early termination of non-margined derivatives – elements which, if identified correctly, could save substantial cost outlay.
Preparation is key
But are firms prepared to meet these requirements by the deadline? A recent poll conducted by Wolters Kluwer during its March 2019 webinar (‘Beyond The PRA110 – Adopting a strategic approach to liquidity risk management’) found that out of 131 respondents, almost three quarters (71%) had not yet integrated their PRA110 reporting solution into their stress testing framework. This may be an indicator of inefficient more complex internal processes which increase costs and risk miss-reporting which could influence the L-SYSC scalar the PRA will apply to those firms.
That is not to say that firms are not aware of the urgent need for preparation in advance of the deadline. Out of 153 respondents, over a third (36.6%) claimed to have already reached the implementation/build stage of their PRA110 strategy, while 15% were testing their systems and 7.8% were already in production. Just 4.5% had not yet started, although another third (36.1%) were still at the research and design stage.
Now is the time
With less than three months to go before the implementation deadline, time is running out to take advantage of the opportunities offered by the new PRA110 framework.
Firms should focus not only on the compliance aspect, but on the potential to improve operational efficiency and drive a more forward-looking view of the business needed by regulators through the creation of a crucial link between a firm’s risk profile, risk management, risk mitigation systems and its capital and liquidity planning.
Integral to this is the implementation of integrated financial cashflow analytics and liquidity risk management. To achieve this, firms should explore solutions which integrate balance sheet management across capital and liquidity stress testing and planning; and apply strategies to their business evolution to manage monetisation risk under expected and stress time horizons. This includes operational processes such as applying stress on the underlying financial risk factors to evaluate the impact on low point, cliff and cashflow mismatch liquidity risks, as well as calculating liquidity cash ratios at different time horizons (both for the entire firm and/or for specific portfolios).
Comprehensive solutions which combine a risk management/stress engine with a regulatory reporting platform will enable firms to analyse the impact on both their market and funding liquidity for both retail and wholesale portfolios, and assist them to monitor, manage and report their overall liquidity risk.
The level of complexity inherent in PRA110 also makes automation essential. With around 260 rows by 112 columns totalling up to 29,000 data points, the sheer detail will require firms to upgrade and elevate their systems in order to cope – while from a practical perspective, best practice also demands an increasingly streamlined approach combining liquidity and regulatory management, including the alignment of compliance and risk systems to achieve a single end-to-end solution for robust, flexible and futureproof reporting.
A solution which provides standard and customized liquidity projections and reporting (including stress scenarios, static liquidity funding gap calculations, contingency and dynamic gap assessment, cash management and margining assistance, and systematic risk analysis) not only delivers operational efficiency, but offers an integrated, cost-efficient and consistent view for senior executives and board members.