The PRA has published SS5/19, which is effective immediately, and represents a significant strengthening in the PRA’s expectations regarding the liquidity risk framework of all insurers, not just those which have obvious liquidity risk exposures.
We expect that all PRA-regulated insurers will need to amend their liquidity risk management frameworks in order to demonstrate that they reflect the scale, nature and complexity of their business in a manner which meets the PRA’s expectations.
Updates to the Consultation Paper (CP4/19)
The PRA does not consider that the substance of its expectations has altered from the proposals it communicated within CP4/19 which we discussed in depth within a previous blog. There are however a number of material amendments in SS5/19 which firms should note:
- The role of the Board in assessing and managing liquidity risk
As per CP4/19, the PRA expects the Board to own and set an overarching liquidity risk appetite, which is sufficiently granular to meet the PRA’s detailed expectations. However, SS5/19 adds granularity regarding the Board’s role in the day-to-day management of liquidity risk, explicitly noting that the oversight of liquidity risk can be delegated to a Board risk committee. Regardless of whether it is the Board or Board risk committee, SS5/19 is clear that insurers must:
- have systems in place which produce regular reporting to allow for identification, measurement and management of liquidity risks, and
- establish and evidence a clear escalation process for issues related to liquidity risk to be raised to the Board.
- Escalation of breaches in liquidity risk appetite
Within the escalation process for issues related to liquidity risk, SS5/19 introduces a new requirement for firms to inform the PRA if it breaches, or is going to breach, its liquidity risk appetite.
This reflects the PRA’s view that “liquidity risk is a fast-moving risk” and brings the PRA’s expectations regarding liquidity risk in line with those regarding solvency capital risk appetites – highlighting the increased importance it is placing on liquidity risk management within insurers.
- Liquidity risk assessment
SS5/19 emphasises the PRA’s expectation that insurers need to identify all material sources of liquidity risk they are exposed to, in order to inform the development of a proportionate risk management framework. In particular, and in line with the PRA’s recently published proposals relating to the Prudent Person Principle (CP22/19), prominence is given to firms needing to ‘look-through’ into money market funds and other pooled asset vehicles.
- Definition of risk limits within the liquidity risk appetite framework
SS5/19 is not prescriptive regarding the limits which firms need to set to allow monitoring of liquidity risk exposures. This reflects the fact that liquidity risk is not a homogenous exposure, and the PRA’s clear expectation is that each firm must define limits which are appropriate to their business and based on their liquidity risk assessment. There are a range of potential limits and metrics which may be appropriate, and risk limits will differ between firms in both their form, time horizon and quantum.
- Liquidity Risk Management frameworks within Groups and ring-fenced funds
SS5/19 strengthens CP4/19’s message that liquidity risk management frameworks should be fit for purpose across individual legal entities and parent Groups; and in particular should not contradict each other. Firms should thus ensure that stress testing, metrics and contingency planning focuses on both solo entities, and broader groups, as well as individual ring-fenced funds if they exist.
Other Updates to the CP:
- Stress testing horizon: Liquidity risk can emerge over various time horizons and SS5/19 is clear that liquidity stress tests should cover a variety of time horizons. In line with the rest of the supervisory statement, firms will need to demonstrate the appropriateness of their stress testing horizons to their business.
- Intra-day risk: Whilst most insurers typically have minimal exposure to intra-day risk in a BAU scenario, SS5/19 highlights a concern that there are a number of potential ‘silent’ exposures which may emerge over this timeframe in a stress. As such, SS5/19 explicitly notes that most firms should conduct stress testing, and have appropriate systems to monitor exposure, over this time horizon.
- Liquidity buffers: SS5/19 provides further guidance regarding the function and characteristics of the liquidity buffer. Broadly the liquidity buffer should be the quantity of ‘primary’ and ‘secondary’ liquidity which will be required to meet plausible cash flow needs over one, or many, time horizons.
- Documentation: The PRA expects firms to demonstrate their liquidity risk management framework, strategy and policies with sufficient prominence and ease to effectively allow their effective oversight and implementation. In particular, SS5/19 notes an expectation that “all related documentation is accessible from one place” and we expect that most insurers will need to develop standalone Liquidity Contingency Plan documents, in addition to ensuring that existing documents collate liquidity considerations in all required areas.
What should you do next?
We anticipate that the PRA is expecting the majority of insurers to reconsider the way that liquidity risk is perceived, monitored and managed. In particular, SS5/19 has significant impacts for firms that are part of larger groups, especially those headquartered overseas.
At the very least, all PRA-regulated insurers should perform a gap analysis of their liquidity risk frameworks against the requirements of SS5/19 in order to specifically address the issues raised by the PRA, and evidence proactive good practice to the regulator.
Our expectation is that PRA supervisors will shortly want to see evidence of liquidity risk given more prominence by Boards and senior managers of insurers than it historically has been, and evidence that firms have integrated changes into risk management frameworks and governance arrangements.
Deloitte’s liquidity risk experts have vast experience in helping clients develop proportionate liquidity risk management frameworks in line with regulatory expectations. If you would like to discuss the PRA’s approach or best practice in this area, please get in touch with the contacts noted below.