The Prudential Regulation Authority (PRA) has written to Chief Financial Officers at regulated firms highlighting supervisory concerns about illiquid and structured financing portfolios, drawing on observations from significant risk transfer (SRT) financing activities. The PRA expects banks to ensure the regulatory capital approach reflects the substance of transactions, including the liquidity of underlying collateral, and to apply the feedback to all relevant financing portfolios. The letter focuses on potential weaknesses in firms’ assessment of collateral eligibility for securities financing transactions (SFTs) in the trading book, particularly under Article 299(2)(c) of the UK Capital Requirements Regulation (UK CRR). It identifies cases where collateral has been recognised in a way the PRA views as imprudent, potentially leading to undercapitalisation, and notes that repackaging illiquid assets into a tradeable format is not, without supporting evidence, sufficient to justify trading book capital treatment for associated SFTs. Firms are expected to capitalise these risks appropriately under Pillar 1, treat SFTs backed by illiquid collateral that is not eligible for the trading book under the banking book rules, and use Pillar 2A for risks not, or only partly, captured in Pillar 1. The PRA also links these expectations to near-final Basel 3.1 implementation changes that add further trading book SFT collateral eligibility requirements, including expectations on demonstrating secondary market liquidity under stressed conditions and on the ability to value collateral, including daily mark-to-market or robust mark-to-model approaches. Supervisors will contact relevant firms to request a written response by Wednesday 11 June 2025 setting out existing policies and procedures for compliance with Article 299(2)(c), any enhancements planned in response (including changes to capital approaches and their impact), and a granular view of current capital treatment by collateral type with summary metrics on materiality, excluding highly liquid collateral. The PRA will use responses to determine whether further bilateral or cross-firm engagement is needed.
Prudential Regulation Authority 2025-04-09
UK's Prudential Regulation Authority raises concerns over illiquid collateral in trading book securities financing transactions and requests responses by 11 June 2025
The Prudential Regulation Authority (PRA) has raised concerns about illiquid and structured financing portfolios, urging banks to ensure regulatory capital approaches reflect transaction substance and collateral liquidity. The PRA warns against imprudent collateral recognition in securities financing transactions (SFTs) under UK regulations, which could lead to undercapitalisation. Firms must align with Basel 3.1 changes, ensuring appropriate capitalisation and demonstrating secondary market liquidity and robust collateral valuation methods.