BIPRU 12.5 Individual Liquidity Adequacy Standards

In conducting its ILAA, a firm is obliged to comply with the stress testing and related requirements which appear in this section. The rules in this section also provide that in its ILAA a firm must include an assessment of the firm's compliance with the standards set out in BIPRU 12.3 and BIPRU 12.4.

A firm should carry out an ILAA at least annually, or more frequently if changes in its business or strategy or the nature, scale or complexity of its activities or the operational environment suggest that the current level of liquidity resources is no longer adequate. A firm should expect that its usual supervisory contact at the appropriate regulator will ask for the ILAA to be submitted as part of the ongoing supervisory process.

The appropriate regulator will review the results of a firm's ILAA, including the results of the stress tests required by BIPRU 12.5.6R, as part of its Supervisory Liquidity Review Process (SLRP). The appropriate regulator's review of the stress test results will assist it assessing the adequacy of a firm's liquidity resources relative to other ILAS BIPRU firms and, consequently, in calibrating the individual liquidity guidance that it gives to that firm. BIPRU 12.9.2G sets out the appropriate regulator's approach to assessing the adequacy of a firm's liquidity resources and indicates that, among other factors, it will have regard to the firms ILAA. It is not, therefore, the case that the amount of liquidity resources advised to the firm as being adequate in its individual liquidity guidance will necessarily equate to the amount needed to meet its liabilities as they fall due in the stresses required by BIPRU 12.5.6R. The appropriate regulator will assess the adequacy of a firm's liquidity resources on a case-by-case basis and, accordingly, the amount of liquidity resources judged as adequate in the firm's individual liquidity guidance might be either above or below the amount needed to survive the stresses required by BIPRU 12.5.6R.

For the purpose of BIPRU 12.5.8R (4), a firm should consider the effect of credit rating downgrades of varying degrees of severity. In doing so, it should also consider the cumulative effect of successive credit rating downgrades to its long-term credit rating.

In assessing how its liabilities behave under stress, the firm should categorise its liabilities according to value, maturity and estimated speed of outflow. The firm should bear in mind that wholesale funding risk may crystallise as an acute loss of funds in the short term, or as a longer-term gradual leakage of funds, or as both.

In the appropriate regulator's view, Type A wholesale funding is likely to include at least funding which:

1. (1)

   is accepted from a credit institution, local authority, insurance undertaking, pension fund, money market fund, asset manager (including a hedge fund manager), government-sponsored agency, sovereign government, or sophisticated non-financial corporation; or

2. (2)

   is accepted through the treasury function of a sophisticated non-financial corporation which may be assumed to respond swiftly to negative news about a firm's credit-worthiness; or

3. (3)

   is accepted on wholesale market terms as a part of a firm's money market operations; or

4. (4)

   is accepted from a depositor with whom a firm does not have a long-established relationship or to whom a firm does not supply a range of services; or

5. (5)

   is accepted from overseas counterparties (other than those in the country or territory of incorporation of a firm's parent undertaking1); or

6. (6)

   is obtained through unsecured debt instruments (such as certificates of deposit, medium-term notes and commercial paper); or

7. (7)

   is not obtained through repo against assets of the type described in BIPRU 12.7.2R (1) or BIPRU 12.7.2R (2); or

8. (8)

   is obtained from counterparties with a relatively low creditor seniority on the liquidation of the firm.

In general, the appropriate regulator expects a firm's retail funding to be less responsive than its wholesale funding to actual or perceived changes in the firm's credit-worthiness. However, a firm should nevertheless make its own assessment of the relative responsiveness of its wholesale and retail funding.

For the purposes of assessing behaviour under stress, a firm should categorise its retail liabilities according to: value, maturity, estimated speed of outflow, product type, interest rate applied and any other factor that it considers relevant to its retail deposit structure.

A firm should also be mindful that its retail funding profile is unlikely to be constant. In carrying out its ILAA, a firm should have regard to any changes to its retail funding profile since the previous ILAA and also to the possible impact of any future changes on its ability to maintain retail funding during periods of stress. In its ILAA submission to the appropriate regulator, a firm should include an analysis of:

1. (1)

   its retail funding profile as at the date of its ILAA;

2. (2)

   its retail funding profile over the twelve months preceding its ILAA;

3. (3)

   its projected retail funding profile over the twelve months following the date of its ILAA; and

4. (4)

   its approach to assessing which of its retail funding it has classed as Type A retail funding and which as Type B retail funding.

In the appropriate regulator's view Type A retail funding is likely to include at least funding which:

1. (1)

   has been accepted through the internet; or

2. (2)

   is considered to have a more than average sensitivity to interest rate changes (such as a deposit whose acceptance can reasonably be attributed to the use of price-focused advertising by the firm accepting the deposit); or

3. (3)

   in relation to any individual depositor exceeds to a significant extent the amount of that individuals deposits with the accepting firm that are covered by a national deposit guarantee scheme; or

4. (4)

   is not accepted from a depositor with whom the firm has had a long relationship; or

5. (5)

   is accepted from retail depositors who can access their deposits before their residual contractual maturity subject to a loss of interest or payment of another form of early access charge (as a general proposition, the behaviour of liabilities to retail depositors is likely to depend in part on the contractual terms and conditions which give rise to those liabilities); or

6. (6)

   is not held in an account which is maintained for transactional purposes.

For the purpose of calculating the net amounts of collateral and cash under BIPRU 12.5.26R, a firm should separately analyse:

1. (1)

   the amounts of collateral and cash needed in relation to both its own payments and those of its customers; and

2. (2)

   the intra-day timing of the payment of cash and the posting of the collateral, including the time at which the demand for its collateral and cash is greatest.

For the purpose of BIPRU 12.5.26R, a firm should ensure that it takes into account, in both normal financial conditions and in periods of stress, the effect of:

1. (1)

   other participants in a payment system withholding some or all of the payments expected from them; and

2. (2)

   its customers increasing either or both the volume and value of their payments.

For the purpose of BIPRU 12.5.29R, a firm should assume that the effect of that default is that the exposure is rolled overnight.

For the purpose of BIPRU 12.5.31R, the appropriate regulator would expect a firm, in relation to each payment or settlement system in which it participates directly, to provide details of:

1. (1)

   that firm's charges for providing intra-day credit;

2. (2)

   any collateral requirements which it applies to its customers;

3. (3)

   the credit limits that it imposes (and the circumstances, if any, in which credit may be provided notwithstanding a limit breach);

4. (4)

   the extent to which the customers of that firm make use of the credit extended to them; and

5. (5)

   where relevant, the points during the day at which a customer is required to settle, or provide assets as collateral to cover, that firm's credit exposure to it.

As part of its ILAA submission to the appropriate regulator, a firm to which BIPRU 12.5.33R applies should include:

1. (1)

   details of any alternative arrangements that it has in place to ensure that it continues to be able to meet its liabilities as they fall due in the circumstances set out in BIPRU 12.5.34R; and

2. (2)

   details of the policies governing the use of intra-day credit provided to it by a firm which is a direct participant in a given payment or settlement system, including details of the criteria against which that participant will decide whether to reduce or cease the provision of intra-day credit.

For the purpose of BIPRU 12.5.36R, a firm should consider the full range of legal and regulatory restrictions on the availability to it of liquidity support from other members of its group. A firm should ensure that it understands restrictions in force in other jurisdictions, as well as the potential for such restrictions to be imposed in the future, as to the allowable size of intra-group exposures. A firm should also consider the circumstances in which it may find itself obliged to transfer liquidity resources to other entities in its group.

In relation to derivatives positions, a firm should:

1. (1)

   assess the effect on its cash flows arising from the maturity, exercise and repricing of derivatives in which it holds a position, including the impact of counterparties:

   1. (a)

      who may require the posting of additional margin or collateral in the event of a decline in that firm's credit rating;

   2. (b)

      who may require the posting of additional margin or collateral (or the return to them of margin or collateral) in the event of a change in the value of a derivative or of the posted collateral;

   3. (c)

      who (in the case of those that are any of a recognised investment exchange, a designated investment exchange or a recognised clearing house) may require the posting of additional margin in volatile market conditions;

   4. (d)

      who may choose to terminate an OTC derivative which they have entered into with the firm rather than post additional margin or collateral;

   5. (e)

      who, in periods of name-specific liquidity stress experienced by the firm, may choose to terminate out of the money derivatives which they have entered into with that firm; and

   6. (f)

      who, in periods of stress, may choose to post less liquid collateral than would likely be the case in normal financial conditions; and

2. (2)

   assume that under the stresses required by BIPRU 12.5.6 R there may be uncertainty as to the accuracy of the valuation attributed to a derivative contract.

In relation to its contingent liabilities, a firm should:

1. (1)

   calculate the impact on its cash flows of those of its contingent obligations that will be triggered in normal financial conditions; and

2. (2)

   estimate the impact on its cash flows of those of its contingent obligations that may be triggered under the liquidity stresses required by BIPRU 12.5.6 R.

For the purpose of BIPRU 12.5.46G, a firm should therefore assess the impact on its cash flows of the triggering of contingent obligations contained in all contractual documentation to which it is party, including: acceptances, endorsements, guarantees, underwriting agreements, standby letters of credit, documentary credits, warrants, indemnities, undrawn note issuance facilities and other revolving credit facilities. A firm should also assess the degree of concentration in its total contingent liabilities as respects obligations arising from particular types of contract, counterparty and market sector.

In relation to its commitments (other than liquidity facilities to support securitisation programmes)), a firm should:

1. (1)

   calculate its maximum contractual exposure arising from those commitments;

2. (2)

   calculate the effect on its cash flows of the drawing of those commitments in normal financial conditions; and

3. (3)

   estimate the effect on its cash flows of the drawing of those commitments under the liquidity stresses required by BIPRU 12.5.6 R.

For the purpose of BIPRU 12.5.48G, a firm should:

1. (1)

   consider its contractual exposure to the following types of commitment: committed funding facilities, undrawn loans and advances to wholesale counterparties, mortgages that have been agreed but not yet been drawn down, credit cards, overdrafts (and other retail lending facilities);

2. (2)

   ensure that its analysis of each type of commitment is sufficiently granular to enable that firm to:

   1. (a)

      assess the circumstances in which counterparties will draw down;

   2. (b)

      identify the extent of any correlations as between counterparties in deciding whether or not to draw down;

   3. (c)

      identify the extent to which decisions by the firm's counterparties to draw down may be correlated to a decline in the firm's own liquidity resources; and

   4. (d)

      assess the proportion of its total commitments attributable to particular counterparties; and

3. (3)

   assess the extent to which draw down requires the counterparty in question to deliver to the firm collateral in the form of marketable assets, while also assessing the anticipated effect of such a requirement on:

   1. (a)

      the likelihood that the counterparty in question will draw down; and

   2. (b)

      the firm's liquidity position if the counterparty in question delivers collateral on draw down; and

4. (4)

   assess the impact on its cash flows of its commitment counterparties experiencing liquidity stress at the same time as that firm is subject to the stresses required by BIPRU 12.5.6 R.

In relation to liquidity facilities to support securitisation programmes, a firm should:

1. (1)

   assess the extent of its contractual obligations to provide liquidity support to sponsored and third-party structured vehicles;

2. (2)

   identify the circumstances in which support will, or is likely to, be called; and

3. (3)

   assess the impact on that firm's cash flows of such support being called:

   1. (a)

      in normal financial conditions; and

   2. (b)

      under the liquidity stresses required by BIPRU 12.5.6R.

For the purpose of BIPRU 12.5.50G (2), a firm should consider the impact of the following events on the likelihood of a call for liquidity support: inability of a vehicle to roll over commercial paper (due either to disruption in the CP market or to concern as to the quality of the assets securitised) and, in relation to sponsored vehicles, concern as to the solvency of that firm as sponsor and, separately, the possibility of draw down of undrawn commitments entered into by the sponsored vehicle in its own right.

Franchise-viability risk is the risk that in the stresses required by BIPRU 12.5.6R a firm may not have sufficient liquidity resources to maintain its core business franchise and reputation.

In complying with BIPRU 12.5.52R, a firm should assess the extent to which it can and realistically will:

1. (1)

   restrict new retail lines without significantly damaging customer relationships;

2. (2)

   restrict new wholesale lending without significantly damaging its ability to resume such lending following the period of stress in question;

3. (3)

   cease to provide liquidity support to its sponsored vehicles;

4. (4)

   decline to exercise call options whose effect if not exercised might be to cause market participants to question the firm's ability to continue to meet its liabilities as they fall due; and

5. (5)

   continue any regular programme of buying back its issued debt.

For the purpose of BIPRU 12.5.54G (5), a firm may wish to continue repurchasing its debt to help demonstrate that a two-way market continues to be made in its paper and, more generally, in order to maintain the long-term viability of its debt issuance programme. Equally, a firm may wish to continue repaying retail depositors before the contractual maturity of those deposits in order to maintain confidence in its ability to continue to meet its liabilities as they fall due.

In complying with BIPRU 12.5.56R, a firm should consider all marketable assets which count towards its liquidity resources for the purposes of meeting the overall liquidity adequacy rule. A firm should therefore include in this assessment any assets that it holds in its liquid assets buffer.

The appropriate regulator regards as marketable those of a firm's assets that it is able to sell outright or repo. For liquidity management purposes, a firm would ordinarily expect to hold a stock of assets of this kind in order to reduce the likelihood that it may need to borrow unsecured at short notice. To the extent that these assets may behave differently under stress conditions than under normal financial conditions, a firm is subject to marketable assets risk.

As a general proposition, the speed with which a firm may be able to realise a marketable asset, and the price impact of doing so, will depend to a significant extent on the volume of those assets which that firm wishes to realise and the market conditions prevailing at the time.

The behaviour of a firm's marketable assets under conditions of stress is likely to depend on a number of different factors, including:

1. (1)

   the depth and competitiveness of the market for the marketable asset in question, the size of the bid-offer spread, the presence of committed market-makers, the nature of the information available to potential counterparties, the degree of structural complexity of the assets in question and the assets eligibility in central bank market operations and liquidity facilities; and

2. (2)

   that firm's operational capability to generate funding from those assets in a timely manner.

In considering its operational capability to generate funding from assets, a firm should be aware that its capability in this regard is likely to depend on:

1. (1)

   whether it has in place arrangements for repo;

2. (2)

   the extent to which that firm already holds a significant proportion of the market for the marketable asset in question;

3. (3)

   the extent to which that firm periodically realises some or all of its holdings of that asset; and

4. (4)

   that firm's accounting treatment and valuation of that asset.

In complying with BIPRU 12.5.63R, a firm should consider all non-marketable assets which count towards its liquidity resources for the purposes of meeting the overall liquidity adequacy rule.

BIPRU 12.2.5 G notes that a firm should include in its liquidity resources sufficient assets which are marketable or otherwise realisable. The appropriate regulator considers those assets which are capable of realisation, but other than through repo or outright sale, as non-marketable assets. To the extent that these assets may behave differently under stress conditions than under normal financial conditions, a firm is subject to non-marketable assets risk. Different forms of non-marketable assets risk arise, particularly in relation to:

1. (1)

   retail loans; and

2. (2)

   unsecured wholesale assets.

In addition to realising a firm's marketable assets, a firm can meet its outflows in part by expected inflows from maturing non-marketable assets such as retail loans. Inflows from these assets (principal and interest) may in stressed conditions be affected by counterparty behaviour, exposing that firm to non-marketable assets risk.

For the purpose of the assessment in BIPRU 12.5.67R, a firm should ensure that it assesses repayment behaviour at a level of granularity sufficient to enable it to draw informed conclusions about its liquidity exposure. The appropriate regulator would expect a firm's assessment to analyse separately the non-marketable assets risk associated with each of its relevant products and with each type of counterparty from whom it is expecting repayments.

For the purpose of the assessment in BIPRU 12.5.67R, a firm should in particular have regard to the risk associated with:

1. (1)

   repayment defaults; and

2. (2)

   exercise by its counterparties of contractual rights to repay before the expected maturity date or to delay repayment beyond that date.

A firm may also use its unsecured wholesale assets to generate liquidity, otherwise than by outright sale or repo. A firm may, for example, choose to generate funding from some of the assets included in its liquidity resources by using them in securitisation or covered bond programmes. Assets that are typically used to raise liquidity in this manner include residential mortgage loans; commercial mortgage and other loans; credit card and automobile receivables, which have been packaged for the wholesale markets. To the extent that the ability to fund from these non-marketable assets may be limited under stressed conditions, a firm may be exposed to non-marketable assets risk.

The assessment required by BIPRU 12.5.63R is particularly important for a firm which:

1. (1)

   ordinarily does not raise funding from its non-marketable assets in this way; or

2. (2)

   places proportionately greater reliance on securitisation programmes as compared to other funding strategies to generate liquidity.

A firm which chooses to warehouse assets in the way described in BIPRU 12.5.72R should consider the particular risks that arise from the method of financing that it uses to pre-fund those assets. For example, financing of warehoused assets by means of short-term (rather than long-term) funding is more likely to put that firm under liquidity pressure in the event that its proposed securitisation is not completed (either at all, or at the expected date).

A firm with a sufficiently flexible funding strategy should be able to reduce its liquidity risk by diversifying its liquidity resources.

For the purpose of BIPRU 12.5.75R, a firm should take into account the extent to which its liquidity resources are diversified according to:

1. (1)

   type of instrument and product;

2. (2)

   currency;

3. (3)

   counterparty;

4. (4)

   liability term structure; and

5. (5)

   market for their realisation (provided that such market is open to the firm as counterparty).

A firm should be aware that the degree of diversification in its liquidity resources can be compromised, particularly in periods of stress, by a number of factors, including:

1. (1)

   reduced or terminated funding provision from some counterparties as a result of that firm's credit-rating being downgraded or its financial condition deteriorating;

2. (2)

   disputes over the terms of legally binding commitments to lend which delay the provision of funding;

3. (3)

   markets previously used by the firm for raising funding ceasing to be open or operating but at reduced capacity;

4. (4)

   reliance on a small number of brokers to access funding sources; and

5. (5)

   positive correlations in the behaviour of different instruments and products.