The UK’s financial regulatory framework has historically aligned capital requirements for firms regulated by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The PRA’s adoption of Basel 3.1 therefore introduces a significant shift, creating a clear divergence between the two regimes for the first time, significantly altering how PRA-regulated firms calculate their capital requirements.
However, on 17 January the PRA announced a six month delay in implementing these new rules. While this delay directly affects PRA-regulated firms, it also provides an opportunity to examine the broader implications for FCA-regulated firms. In this article, we will explore this in more detail – specifically, we will look at what some of the areas are where the divergence may cause challenges for FCA-regulated firms and consider how the newly announced delay could best be used to address some of these.
First, some context
Under the UK’s “twin peaks” regulatory model, financial oversight is shared between the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The PRA is responsible for prudential regulation of systemically important, dual-regulated firms under the Capital Requirements Regulation (CRR), while the FCA focuses on conduct regulation for all financial services firms and serves as the sole prudential regulator for smaller investment firms under the Investment Firms Prudential Regime (IFPR). Historically, CRR has provided a unified framework for assessing capital and liquidity across both regulatory regimes.
However, the adoption of Basel 3.1 introduces a significant shift. Driven by the PRA’s objectives to enhance competitiveness, support economic stability, and align with international regulatory standards, the new framework requires PRA-regulated firms to calculate capital using the Advanced Standardised Approach (ASA). This marks a substantial evolution of the existing Standardised Approach (SA), which FCA-regulated firms will continue to use, creating a clear divergence between the two regimes.
Impact on capital requirements
ASA introduces a more risk-sensitive methodology for calculating risk-weighted assets (RWAs), offering greater precision in firms capital calculations. This shift moves PRA-regulated firms away from internal models and toward a simplified yet more accurate framework for assessing capital requirements.
This change in approach could disadvantage FCA regulated firms. Whilst we don’t yet know the full impacts, it is likely that they will have to hold a higher level of capital for the same trading activities given a less granular model.
Impact on perception of risk
Secondly, the more granular and risk-sensitive ASA framework under Basel 3.1 could lead to a perception that FCA-regulated firms are subject to less rigorous standards. This may result in counterparties and customers viewing FCA firms as riskier, potentially impacting their ability to attract business. Such concerns are exacerbated by the fact that the FCA’s capital framework, which relies on K-factor calculations, will no longer be internationally aligned.
Potential consequences
For FCA-regulated firms, this will likely present competitive challenges. Many FCA firms operate in sectors where they directly compete with PRA-regulated counterparts. In the FinTech space, for example, Revolut competes with traditional banks in payments and foreign exchange, while Wise challenges banks in cross-border payments. Similarly, investment firms like Hargreaves Lansdown, Nutmeg, and XTX Markets compete with large banks for institutional and retail clients’ savings.
With the majority of growth and innovation expected to come from the smaller, more agile firms that would traditionally fall under the FCA’s remit, this should be a concern. Especially so considering the FCA’s secondary objective, and the wider UK government’s desire for growth driven by innovation.
So what now?
The implications of Basel 3.1 for FCA firms remains uncertain, but the potential for regulatory arbitrage is high. One reassuring factor is the FCA’s clear commitment to fostering UK growth and competition. If the new regulations are found to negatively impact the firms it oversees, the FCA is likely to act decisively to address those challenges.
However, the FCA so far has remained silent on the PRA’s reforms, leaving some FCA-regulated firms questioning whether these changes might eventually even extend to them – a big concern! With the FCA facing some headwinds lately, we expect the FCA to want to stay out of further potential flashpoints. But that unfortunately is also exactly the problem here.
For now, the industry has been given breathing space to try to assess the full consequences of how these changes may unfold in the UK’s financial landscape – we hope the twin regulators equally use this opportunity to consider the consequences of the divergence between the two regimes.
