ERM in Financial Services - PRA Rulebook

Question 1

What is the Overall Pillar 2 Rule in the PRA Handbook on ICAAP?

Answer 1

A firm must have in place sound, effective and comprehensive strategies, processes and systems:

1. to assess and maintain on an ongoing basis the amounts, types and distribution of financial resources, own funds and internal capital that it considers adequate to cover.

(a) the nature and level of the risks to which it is or might be exposed;

(b) the risk in the overall financial adequacy rule in 2.1; and

(c) the risk that the firm might not be able to meet the obligations in Part Three of the CRR in the future;

2. that enable it to identify and manage the major sources of risk referred to in (1) including the major sources of risk in each of the following categories where they are relevant to the firm given the nature and scale of its business:
3. to ensure that the firm’s own funds can absorb potential losses resulting from stress scenarios, including those identified under the supervisory stress test.

Question 2

What is the Overall Financial Adequacy Rule?

Answer 2

A firm must at all times maintain overall financial resources, including own funds and liquidity resources, which are adequate both as to amount and quality, to ensure there is no significant risk that its liabilities cannot be met as they fall due.

Question 3

What elements of ERM are in the Pillar 2 rule?

Answer 3

As part of its obligations under the overall Pillar 2 rule in 3.1, a firm must:

(1) make an assessment of the firm-wide impact of the risks identified in accordance with that rule, to which end a firm must aggregate the risks across its various business lines and units, taking appropriate account of any correlation between risks; and

(2) take into account the stress tests that the firm is required to carry out under the general stress test and scenario analysis rule in 12.1 and any stress tests that the firm is required to carry out under the CRR.

Question 4

What is the Solvency 2 PRA rule that contains the elements of ERM?

Answer 4

(1) A firm must have in place an effective risk-management system comprising strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report on a continuous basis the risks, at an individual and at an aggregated level, to which it is or could be exposed, and their interdependencies.

(2) That risk-management system must:

(a) be effective and well integrated into the organisational structure and decision-making processes of the firm with proper consideration of the persons who have key functions;

(b) cover the risks to be included in the calculation of the SCR as set out in Solvency Capital Requirement - General Provisions 3.3(1), as well as the risks which are not, or not fully, included in the calculation thereof; and

Question 5

What are the risks that the PRA Solvency 2 rule says the calculation of the SCR should cover?

Answer 5

(i) underwriting and reserving;
(ii) asset-liability management;
(iii) investment, in particular derivatives, quasi-derivatives and similar commitments;
(iv) liquidity risk and concentration risk management;
(v) operational risk management;
(vi) reinsurance and other risk-mitigation techniques.

Question 6

What does the PRA Solvency 2 rulebook say the ORSA must cover?

Answer 6

a) the firm’s overall solvency needs taking into account the specific risk profile, approved risk tolerance limits and the business strategy of the firm;

(b) the compliance, on a continuous basis, with:
(i) the SCR and MCR; and
(ii) the requirements regarding technical provisions, as set out in Technical Provisions; and
(c) the significance with which the risk profile of the firm deviates from the assumptions underlying the SCR.