In July 2017, the Bank of England’s Prudential Regulation Authority (PRA) released its “Pillar 2 Liquidity – CP13/17” publication discussing liquidity measures for a range of market factors. The paper builds on previous research from the agency’s CP21/16 publication. The comment period for input on measures affecting a range of market liquidity aspects in the UK is open until October 13 and the PRA plans to publish a third consultation paper presenting the market findings.

Liquidity management is a key aspect of global risk calculations and is broadly used across the market. The “Pillar 2 Liquidity – CP13/17” publication discusses firm liquidity risks and liquidity management in securities finance.

Liquidity management in banking capital planning

Liquidity management in banking capital planning is a topic that has been closely scrutinized following the 2008 financial crisis also bringing about numerous other liquidity requirements for the financial markets. The PRA’s objective in identifying new Pillar 2 guidelines for the UK is to promote the safety and soundness of banking operations in the region.

The PRA’s Pillar 2 liquidity guidelines focus on the daily management of liquidity and will integrate stress testing around cashflow mismatch risk (CFMR) and liquidity coverage requirements (LCR). According to the consultation paper the PRA also proposes to institute a new reporting template for liquidity oversight that would require weekly submission for large firms and monthly submission for small firms. This would be created in conjunction with legislation under PRA110. The PRA expects for new Pillar 2 liquidity guidelines to begin taking affect in early 2018.

CFMR, LCR and PRA110

The PRA has reported that the development of its new liquidity standards which encompass CFMR and LCR will be closely linked to the implementation of the new PRA110 legislation. The CFMR testing will include scenarios of varying severity and duration. These scenarios will take into account four main risks: low point risk, HQLA monetization risk, cliff risk and FX mismatch risk. Guidance around qualifying levels of liquidity for CFMR will be defined by the PRA’s new Pillar 2 guidelines. Additionally Pillar 2 will consider the LCR which is a measure of a firm’s cumulative liquidity position over a 30-day period. The PRA is developing its testing for CFMR and LCR in conjunction with PRA110 which is slated for implementation in January 2019 and includes documentation templates that facilitate the liquidity tests.

Liquidity management for securities finance

In addition to new guidelines for reporting firm liquidity and capital planning the PRA’s proposal also directs a focus to liquidity for securities finance. The PRA’s 2017 consultation paper takes the position that securities financing margin liquidity risk assessments should be based on historical margin posted, with a stress uplift applied. This position is reinforced throughout the “Pillar 2 Liquidity – CP13/17” publication.

In comments regarding the stress uplift the PRA says it will be subject to supervisory judgement and based on information from a firm’s intraday liquidity management systems. The PRA will also take into consideration the sophistication of the payment and securities settlement systems used by the firm. Furthermore, the PRA has stated that it is important to consider additional potential outflows relating to margin requirements on securities transactions that may be required when the credit quality of the collateral has deteriorated which will also be a factor considered for the designated stress uplift.

Industrywide changes for liquidity management

Overall, ongoing consultation is expected to take place in regards to liquidity planning and securities finance liquidity guidelines for the UK. These guidelines will build on previously initiated efforts primarily around PRA110 and will likely include CFMR and LCR testing. The comment period on “Pillar 2 Liquidity – CP13/17” closes on October 13 and the PRA expects to issue a third consultation paper followed by guidelines regarding implementation of Pillar 2 in early 2018 which will come before the legislation and changes currently being enacted under PRA110. All changes being enacted will be integrated with the industry’s liquidity management services. Liquidity management service providers will support new processes through customer service and liquidity management reporting.