The Bank of England Act 1998 (Macro-prudential Measures) (No.2) Order 2015

Explanatory Note

(This note is not part of the Order)

The Financial Policy Committee is responsible for monitoring and addressing systemic risks which threaten the stability of the United Kingdom's financial system. One tool available to the FPC is the power to issue directions to the Prudential Regulation Authority and the Financial Conduct Authority (together the regulators). The Financial Policy Committee can only issue directions in relation to macro-prudential measures which have been prescribed by HM Treasury.

The Basel III accord included proposals for capital adequacy standards based on an assessment of financial institutions leverage position (which treats all exposures equally, regardless of their estimated risk). These leverage requirements are designed to strengthen the capital position of financial institutions and to mitigate the risk of future financial crises. The Basel proposals included a minimum standard for all financial institutions with the possibility of additional “buffers” for particular classes of financial institutions, in particular those which are systemically important. These proposals are designed to ensure that financial institutions maintain a minimum amount of capital to absorb losses regardless of the risk profile of their assets.

This Order prescribes four macro-prudential measures for the purposes of section 9H of the Bank of England Act 1998 (c.11) (“the 1998 Act”) (power of the Financial Policy Committee of the Bank of England to direct the Financial Conduct Authority and the Prudential Regulation Authority).

The first measure allows the Financial Policy Committee to give a direction to specify a minimum leverage ratio which will apply to all UK banks and PRA regulated UK investment firms (“investment firms”). This will mean that UK banks and investment firms will need to maintain a minimum amount of capital which will be calculated by reference to the amount of their assets and certain off-balance sheet items.

The second measure allows the Financial Policy Committee to give a direction which will secure that institutions which are subject to a systemic risk buffer will ordinarily maintain an additional capital buffer. This requirement will only be engaged if the PRA has set a strategic risk buffer for individual institutions pursuant to Chapter 2 of Part 5A of Capital Requirements (Capital Buffers and Macro-prudential Measures) Regulations 2014, which does not come in to force until 1st January 2019. Accordingly article 4(b) of this Order, which contains the measure for specifying the SRB leverage ratio, also comes into force on 1st January 2019.

The third measure allows the Financial Policy Committee to give a direction that will secure that globally systemically important institutions will ordinarily hold sufficient capital necessary to maintain a G-SII additional leverage buffer.

Finally, the fourth measure allows the Financial Policy Committee to give a direction which will secure that UK banks and UK investment firms will ordinarily hold sufficient capital to maintain a countercyclical leverage buffer. The countercyclical leverage ratio buffer will ensure that UK banks and UK investment firms will ordinarily maintain sufficient capital to satisfy the specified ratio during the upturn in the economic cycle, ensuring that they are not over-extended during a stressed period. The Financial Policy Committee may specify that the countercyclical leverage buffer can be calculated by reference to the countercyclical capital buffer rates

Article 5 provides that where the Financial Policy Committee gives a direction which secures that that UK banks and investment firms ordinarily hold an amount of capital to satisfy a countercyclical leverage ratio buffer and this buffer is to be calculated by reference to countercyclical capital buffer rates and subsequently gives another direction which is identical in substance to the first direction except that it changes a specified value, and where this change is implemented by the PRA by way of new rules issued pursuant to Part 9A of the Financial Services and Markets Act 2000, then if the rules are issued by the PRA then it need not comply with the obligations under sections 138J and 138Kof the Financial Services and Markets Act 2000. However, Article 5 does require the PRA to undertake, and publish alongside any new rules, a cost-benefit analysis of any change in rules.

A full regulatory impact assessment of the effect that this instrument will have on the costs of business and the voluntary sector is available on the HM Treasury website and is annexed to the Explanatory Memorandum which is available alongside the instrument on the OPSI website.