Significant risk transfer financing

April 2025

The PRA’s 9 April Dear CFO letter on prudential expectations around significant risk transfer financing emphasised the regulator's focus on ensuring that banks adequately capitalise risks. It specifically addressed the potential undercapitalisation of Securities Financing Transactions (SFTs) collateralised by illiquid collateral and highlighted a key consideration in the forthcoming Basel 3.1 changes.

Given PRA scrutiny and the current volatile and rapidly changing environment, it is crucial that firms pay close attention to the points in the letter in the context of their exposures and use of significant risk transfer financing. 

The PRA:

• Expects banks to consider how the concerns highlighted apply to their business and identify any actions required to update practices to address them appropriately.  All relevant financing portfolios should be included;
• Considers that, for certain financing portfolios, banks have adopted an imprudent approach associated with the recognition of collateral for regulatory capital purposes, resulting in potential undercapitalisation of the risks. As an example, the PRA calls out the practice of repackaging illiquid assets into a tradeable format without appropriate supporting evidence to justify regulatory capitalisation under trading book rules;
• Reminds firms that risks should be appropriately capitalised under Pillar 1 of the UK capital framework. SFTs backed by illiquid collateral which fails to meet the requirements for inclusion in the trading book should follow the applicable rules for banking book exposures. Pillar 2A should then be used to capitalise risks that are either not addressed or only partially addressed under Pillar 1; and
• Notes that, where necessary, it will consider exercising its statutory powers to impose requirements to ensure that any shortcomings are adequately addressed.

The expectations set out are aligned with PS9/24 (the second part of the PRA’s Basel 3.1 near-final rules) which introduces additional collateral eligibility requirements for SFTs in the trading book.

The PRA expects banks to:

• Consider the concerns raised and how they may apply to them specifically;
• Consider the policies, procedures and controls they have in place to analyse the characteristics of different collateral types when determining the capital treatment; and
• Where necessary, ensure that associated policies, control frameworks and reporting are enhanced to address any gaps or issues identified.

Some firms will be asked to respond to the letter in writing, by 11 June 2025, setting out:

• Policies and procedures in place to ensure compliance with Article 299(2)(c) UK CRR (collateral eligibility for SFTs in the trading book);
• Any proposed enhancements to policies and procedures in response to the letter, including any resulting changes to the regulatory capital approach for SFTs associated with specific collateral types and the impact of those changes;
• The current regulatory capital approach applied to SFTs for specific collateral types – the PRA notes that this should be sufficiently granular to capture details of the trading book/banking book boundary as currently applied, including any changes set out; and
• Summary metrics (e.g. financing or collateral balances) showing the materiality of each specific collateral type. Highly liquid collateral can be excluded.

KPMG has extensive experience in managing and facilitating regulatory change. Areas where we can assist include:

• Policy review: Our experienced professionals can assist in reviewing and updating your policies to align with the latest regulatory expectations of Article 299(2)(c) UK CRR and leading practices, as well as helping to prepare for the new requirements under PS9/24;
• Controls evaluation : We can evaluate and test your existing control frameworks, identifying areas for improvement and helping to implement effective methodologies in line with leading industry practice;
• Testing: We offer thorough testing services to assess compliance of the capital treatment of impacted trades with regulatory requirements, to check whether the  methodologies used for credit risk mitigation meet the necessary standards;
• Metric assessment: Our experienced professionals can assess the suitability of metrics designed to measure and monitor the associated risks, as well as provide guidance in relation to metric governance, setting appropriate limits and evaluating escalation processes; and
• PRA response: We can assist with drafting responses to the PRA, where required, including collating any supporting information.