The attribution of capital to foreign banking permanent establishments in the UK: The approach in determining an adjustment to funding costs - STEP 2: Risk weighting the assets: host v home state regulation
Where a bank carries on a banking business through a permanent establishment (PE) in each of a number of different countries rather than through subsidiaries, then the primary responsibility for regulating the banking business of that bank (including its PE’s) lies with the home state regulator. The host state regulator, that is the regulator in the country in which the PE carries on its activities, will have some oversight function, but this will be limited. It will not extend to setting the capital requirements of the PE. The Financial Services Authority (FSA) has various oversight functions of PE’s in the UK, including liquidity, systems and controls, money laundering and business plans.
Where a group carries on banking activities through subsidiary companies then each company will be regulated by the regulator of the country in which it resides. For example, for a US banking group the US parent bank will be regulated by the US regulator and any UK banking subsidiaries will be regulated by the UK regulator, the FSA.
Whilst a PE carrying on a banking business in the UK would continue to be regulated primarily by its home state regulator, it would, if it were a separate enterprise trading in the UK, be regulated by the FSA. The legislation at CTA09/Part 2/Chapter 4 aims to create a more level playing field between companies carrying on a banking business in the UK and PE’s. In order to achieve this, the regulatory rules that should be applied to the PE are those that would apply to UK corporates - that is the FSA regulatory regime. It should be stressed that this regime is only being applied for the purposes of attributing capital to the PE to arrive at a capital attribution tax adjustment. The regulation of the bank, including its PE’s, remains a matter for the home state regulator.
During consultations about the new legislation, representations were made about the difficulty in applying host state regulatory rules where assets were in actual fact weighted according to the rules of the home state regulator. In order to address some of the concerns it was accepted that, where the regulatory regime of the home state is not materially different to that operated by the FSA, the PE’s assets may initially be risk weighted according to the home state’s rules. However, any major differences between the home state’s rules and those operated by the UK will need to be adjusted for. For example, some regulators allow transactions between separate legal entities in their jurisdiction to be risk weighted at 0% in instances where this would not be permitted by the FSA. If assets of the PE are initially risk weighted on the basis of the home state’s rules then an adjustment would need to be made to reflect the fact that those assets would require a higher risk weighting under UK rules. Whether the outcome of the home state regulation is materially different depends not just on the regulatory rules but on the nature of the PE’s activities. There may be significant differences in the rules for specific types of customers but if the PE does very little business with such groups the outcome may be broadly the same as if it were UK regulated.