On 12 September 2024, the regulator set out CP7/24, seeking input on the proposed simplified capital regime and additional liquidity simplifications for SDDTs. This aims to simplify all elements of the capital stack (including Pillar 1 and 2), buffers, and the calculation of regulatory capital. The paper follows its policy statement covering SDDT scope criteria, liquidity and disclosure requirements.
Basel 3.1 rules overview
The Prudential Regulation Authority (PRA) published policy statement 9/24 on the same day, setting out the second set of near-final rules on implementing the Basel 3.1 reforms. The first set of rules was issued in December 2023.
Key changes include updates to the credit risk internal ratings-based (IRB) approach, credit risk mitigation, output floor, Pillar 2 and Pillar 3 disclosures, market risk, and credit valuation adjustment.
Pillar 1 aligns with Basel 3.1
In a nutshell, the Pillar 1 framework for SDDT firms will look similar to the Basel 3.1 rules, with some notable exemptions.
Proposed changes:
Within Pillar 1, SDDT firms would need to calculate credit risk risk-weighted assets (RWAs) using the Basel 3.1 credit risk standardised approach (CR SA) and SA credit risk mitigation (CRM) frameworks, with an exemption from the CR SA due diligence requirements. They would also need to apply the Basel 3.1 SA to operational risk.
For market risk capital requirements, the CR SA would be used, effectively treating trading book exposures as banking book exposures.
However, firms would not need to calculate market risk capital for foreign exchange and commodity risk activities. Exemptions would also apply for credit valuation adjustment (CVA) and counterparty credit risk (CCR) for derivatives, with certain exceptions.
Impacts:
While these exemptions are welcome, implementation may still be harder than expected for SDDTs.
Even with the postponement until 2027, existing credit risk frameworks lack sufficient granularity and risk sensitivity, meaning in-scope firms have significant work ahead.
However, for firms that sit close to the threshold and expect a two-stage move from SDDT to Basel 3.1, the similarity in regimes will facilitate an easier transition.
Pillar 2 provides key simplifications
The PRA's proposed Pillar 2 changes offer several key simplifications for firms:
- Removing the use of IRB (Internal Ratings-Based approach) benchmarks; requiring certain SDDTs to provide detailed credit risk assessments using scenarios
- Allowing the replacement of the Herfindahl-Hirschman Index methodology with a simpler approach for concentration risk
- Introducing a bucketing system for operational risk
- Removing market risk methodologies and expectations
Single Capital Buffer
The proposed Single Capital Buffer (SCB) presents an area of significant simplification, replacing the current capital conservation, countercyclical and PRA buffers.
The SCB would be a supervisory expectation rather than a minimum requirement, set at a minimum of 3.5% of risk-weighted assets, and assessed based on stress test impact, risk management and governance, and supervisory judgment. Automatic conservation measures would be removed to improve buffer usability under stress.
Interim Capital Regime
The Interim Capital Regime (ICR) allows SDDT-eligible firms to avoid implementing the more complex Basel 3.1 rules for a single year before the simplified SDDT capital regime takes effect in January 2027.
Firms can apply for the ICR, which runs from January 2026 to December 2026, and continue using capital requirements similar to the current Capital Requirements Regulation (CRR) rules during this period.
However, the PRA plans an ad hoc off-cycle review for ICR firms, with data collection and results delivered before the January 2027 implementation.
Reduced reporting obligations
The PRA wants to reduce reporting obligations by simplifying up to 24, and descoping up to 38, reporting templates to match the broader SDDT changes.
Internal Capital Adequacy Assessment Process (ICAAP) and Internal Liquidity Adequacy Assessment Process (ILAAP) submission frequency would be reduced to a minimum of every two years, except for annual updates to Pillar 2A and 2B elements. Firms should identify overlaps between ILAAP and ICAAP to reduce duplication.
Impacts:
For firms, the new Pillar 2A and 2B framework enhances predictability and provides relief from the volatile countercyclical buffer.
While the PRA believes the benefits of streamlining will eventually outweigh the one-off implementation costs, SDDT-eligible firms still face a considerable workload.
As off-cycle review implications will guide the new supervisory mechanics, full clarity on the SDDT supervisory process may not emerge within the next year.
Proactive regulatory engagement will be crucial to understand the new requirements, especially around non-cyclical scenarios for credit risk Pillar 2A and SCB stress testing.
The PRA is easing capital requirements and delaying implementation to January 2026 for Basel 3.1.
Basel 3.1: PRA eases capital requirements and delays until 2026
SDDT changes: what can you do now?
While the SDDT regime is simpler compared to Basel 3.1, implementation will have strategic implications. As the PRA finalises the capital elements, next steps will become clearer and eligible firms should prepare accordingly.
Larger qualifying firms will need to assess whether leveraging SDDT or moving directly to Basel 3.1 is optimal, noting the PRA's discretion to push firms towards the tighter Basel 3.1 framework.
With such a broad scope, successful implementation relies on finding synergies with other regulatory approaches to reduce duplication and embed lasting change.
To learn more about the Basel 3.1 reforms and the impact on your firm, get in touch with our team: Kantilal Pithia, Ramesh Parmar, Charles Ebienang, Imran Ahmad, Sonam Nawani, or Riad Fawzi.
The PRA has clarified rules on a standardised approach to credit risk under Basel 3.1. We look at the key changes.
Basel 3.1: PRA clarifies a standardised approach to credit risk
