Prudential Regulation Authority Rulebook

3.1

This chapter sets out the PRA’s expectations for:

• the development of the TWD option;
• scenario testing;
• the flexibility of the recovery plan in the context of the TWD option; and
• TWD firms’ execution of the TWD option.

3.2

As with any recovery option, a TWD firm’s TWD option should set out the actions, arrangements, and measures that the TWD firm would implement in a scenario of severe macroeconomic and financial stress relevant to the TWD firm’s specific conditions.^{[12 ]}These actions, arrangements, and measures should allow a TWD firm to reduce risk and leverage, and wind down its trading activities in an orderly manner.^[13] A TWD firm should also ensure that the actions, arrangements and measures would be effective in post-resolution restructuring and should identify alternative actions, arrangements, and measures if they are not. Box 1 sets out the actions, arrangements, and measures a firm might identify when developing the TWD option.

3.3

The TWD option should be explained in the TWD firm’s recovery plan, including the playbook where relevant, such that the TWD option would be easily implemented in a stress. The quantification of the costs of the wind-down, set out in more detail in Chapter 4, and any impacts on the TWD firm’s projected capital and liquidity resources throughout the period from the time at which the TWD option is executed to the time at which the TWD firm’s trading activities have been wound down (hereinafter referred to as the ‘wind-down period’), should also be set out in the TWD firm’s recovery plan.^[14] The wind-down period can be split into the period from the time at which the TWD option is executed to the time at which the TWD firm has exited all the positions it can exit without incurring undue costs (hereinafter referred to as the ‘active wind-down period’); and the rest of the wind-down period, during which the firm hedges the exposures of the remaining ‘rump’ positions (insofar as this is possible) until they expire (hereinafter referred to as the ‘passive wind-down period’).

3.4

TWD firms should consider the information that should be provided to support the viability and credibility of the TWD option in recovery. In addition, TWD firms should be able to provide further information and analysis on the viability and credibility of the TWD option in the context of a post-resolution restructuring.^[15]

Box 1 Actions, arrangements, and measures in the context of the TWD option

3.5

The Resolution Assessment Part of the PRA Rulebook and SS4/19 ‘Resolution assessment and public disclosure by firms’ contain, respectively, rules (requiring firms to assess their preparations for resolution, submit a report of their assessment, and publish a summary of their report) and, in SS4/19, expectations on how firms should comply with the rules. The Bank’s Approach to Assessing Resolvability SoP sets out, amongst other things, the outcomes firms must, as a minimum, be able to achieve to be considered resolvable. This SS should be read in conjunction with the Resolution Assessment Part of the PRA Rulebook, SS4/19 and the Bank’s Approach to Assessing Resolvability SoP.

3.6

Under existing recovery planning requirements, a recovery plan must contemplate a range of scenarios of severe macroeconomic and financial stress relevant to the firm’s specific conditions including system-wide events and stress specific to individual legal persons and to groups. SS9/17 sets out that global systemically important institutions (G-SIIs) and O-SIIs should include analysis of at least four scenarios that are:

• relevant to the firm’s business model;
• sufficiently severe to test the plan; and
• designed to take the firm to the point of near failure if recovery measures were not implemented in a timely manner, with the firm defining and justifying its point of near failure.^[16] 

3.7

These stress scenarios must involve severe macroeconomic and financial stress, including system-wide events, legal entity-specific stress, and group-wide stress.^[17] The PRA expects that for TWD firms, at least one of the four scenarios should be used to develop and test the TWD option (the TWD scenario, see paragraph 1.13 above).

3.8

The PRA expects a TWD firm to include a baseline set of factors when designing the TWD scenario. This baseline set of factors should include, at a minimum:

• factors relating to the stage of firm-specific stress;
• factors relating to market-wide stresses; and
• factors relating to the full or partial wind-down of trading activities.

3.9

This baseline set of factors is set out in more detail below. A TWD firm should identify additional factors as appropriate, to ensure that the TWD scenario is relevant to the TWD firm’s specific circumstances.

3.10

In a firm-specific stress, a TWD firm’s capital and liquidity positions may be deteriorating quickly, potentially due to issues unrelated to its trading activities. The TWD firm may need to execute the TWD option in order to reduce its risk and prevent its capital and liquidity positions from deteriorating further.

3.11

The actions, arrangements, and measures a TWD firm chooses when developing the TWD option should be appropriate to the points at which a TWD firm would expect to execute the TWD option, given the TWD scenario. This may be at an early stage while the firm is a going concern, as the TWD firm approaches the point of failure, or as a gone concern in post-resolution restructuring.

3.12

The actions, arrangements, and measures a TWD firm chooses as part of the TWD option should be appropriate to the anticipated market-wide stresses and other issues that occur when trading becomes difficult. TWD firms should include the following minimum baseline set of factors when designing the TWD scenario:

• duration of market-wide stress;
• the TWD scenario should have two phases: a stressed phase in which risk premia and market volatility increase significantly and market liquidity is significantly reduced; and a phase in which markets return to normal (scenario dynamics); 
• severity of credit downgrade of the TWD firm, and severity of general credit downgrade as part of the macroeconomic scenario;
• barriers to over the counter (OTC) derivative market access;
• barriers to the sale of portfolios during market-wide stress; and
• funding sensitivities to full or partial closure of secured funding markets and foreign exchange markets.

3.13

The actions, arrangements, and measures a TWD firm chooses when developing the TWD option should be appropriate as to whether the TWD firm is planning to conduct a full or partial wind-down of its trading activities, given the TWD scenario.

3.14

A TWD firm may consider the wind-down of part of its trading activities based on the geographic location of those activities, or the asset classes that make up those activities, when developing the TWD option. A TWD firm winding down its UK equities business, but not its European fixed-income business, would be an example of a partial wind-down of a TWD firm’s trading activities.

3.15

This does not impact the expectation (set out in more detail in Chapter 4) that a TWD firm’s TWD capabilities should be built on the basis of the full wind-down of its trading activities.

3.16

The PRA expects the actions, arrangements, and measures set out in a TWD firm’s recovery plan to be appropriate with reference to the TWD firm’s business model and anticipated or real-life circumstances.^[18]

3.17

A TWD firm’s recovery plan should be sufficiently flexible to anticipate the need to make different decisions and use different actions, arrangements, and measures depending on prevailing market conditions.

3.18

A TWD firm should be able to flexibly amend the actions, arrangements, and measures to demonstrate that the TWD option is credible, to improve the consistency of different parts of the TWD firm’s recovery plan, and to demonstrate that the plan is credible as a whole. The actions, arrangements, and measures should be tailored to the TWD scenario, and relevant to the TWD firm’s specific conditions.^[19]

3.19

This is particularly important in the context of the TWD option, as the real-life circumstances in which a TWD firm may need to execute the TWD option are difficult to predict in advance, and can change rapidly. TWD firms should use the most up to date information available to them when selecting which actions, arrangements, and measures to use.

3.20

In developing the TWD option, a TWD firm should seek to conserve both capital and liquidity, and adopt a prudent approach to risk management. In selecting the actions, arrangements, and measures that make up part of the TWD firm’s recovery plan, the TWD firm may choose, within an overall prudent approach, whether it wants to prioritise capital conservation or liquidity conservation, given the TWD scenario.

3.21

In either case (whether a TWD firm chooses to prioritise capital or liquidity conservation), the TWD firm should be able to set out which different actions, arrangements, and measures it would select if it were to alter its approach.^[20] For example, a TWD firm that prioritised capital conservation should be able to set out how it might change the selection of actions, arrangements, and measures set out in its recovery plan, should it change to prioritise liquidity conservation. It could do this, for example, by changing the order in which portfolios are sold, accepting haircuts or accelerating portfolio sales to conserve liquidity.

3.22

The PRA expects TWD firms to execute their TWD option in line with expectations for the execution of recovery options set out in SS9/17.

3.23

For example, the PRA expects firms to leverage their indicator framework (paragraphs 2.45- 2.52 of SS9/17) to identify emerging signs of firm-specific and/or market-wide stress, and to indicate different stages of stress as implied by a particular metric. The calibration of indicators should be sufficiently sensitive to alert the firm to stress and sufficiently forward-looking to allow time for the TWD option to be executed.

3.24

As set out in SS9/17, the use of this indicator framework may trigger the convening of a senior decision-making committee. To allow firms flexibility in their response, the trigger of an indicator should not be used as an automatic trigger for a predefined set of management actions.

3.25

Similarly, firms should include in their recovery plans a sufficiently clear description of escalation and decision-making processes relevant to the recovery plan, as part of the firm’s wider risk management framework. Firms should detail who is responsible for taking what decisions and when. This should ensure effective action is taken in a timely manner and should include procedures to be followed during recovery, including identification of the key people involved and their roles and responsibilities.^[21]

3.26

TWD firms should use relevant information produced using their TWD capabilities (see Chapter 4) in order to feed into decision-making throughout a wind-down of their trading activities, as appropriate. This information should have a bearing on the parts of a TWD firm’s recovery plan playbook that are relevant to the TWD option. 

3.27

As set out by the Bank in its SoP on Restructuring Planning, TWD firms should be able to determine and describe how they would execute their TWD option in post-resolution restructuring, and should be able to describe their TWD option in sufficient detail for the TWD option to be actionable by the firm and to be deemed credible by the Bank. TWD firms should also consider the extent to which the description of the TWD option in their recovery plans could be relied on for this purpose, and what detail may be needed beyond what is provided in their recovery plans.^[22]

3.28

The interaction between the expectations set out in this SS, other PRA policies, and the Bank’s RAF policies, is set out in more detail in the Trading activity wind-down SoP.