Regulatory & ratings updates

Following the meeting of the Eurogroup of 27 January, Jeroen Dijsselbloem (pictured), Dutch finance minister and the Eurogroup’s president, was reported to have said: “On the SRM, our aim is to finalise the negotiations … in time for the April plenary session of the European Parliament, including the intergovernmental agreement on the Single Resolution Fund (SRF). That is currently being prepared and we will come to that in February in the Eurogroup-plus meeting.”

According to a press release of the European Parliament, current negotiations on the Single Resolution Mechanism (SRM) show wide differences with the Council, with the possibility of no deal before the European elections in May. The delay could have negative consequences on the Recovery & Resolution Directive (RRD), scheduled to be voted on in February. In a previous letter to the Greek Presidency of the EU, the ECON committee stated its divergence with the substance of the intergovernmental agreement (IGA) on the functioning of the SRM, due to the following reasons: (1) the lack of a truly single fund which is the cornerstone of the SRM; (2) the infringement of the principle of equal treatment of all banks in the participating Member States, irrespective of their place of establishment (the non-discriminatory use of all the resolutions tools, including use of the single fund, has to be ensured); (3) serious impediments to the speed and efficient functioning of the decision making process.

S&P proposes new bank hybrid rating criteria: Standard & Poor’s published on 6 February a Request for Comment on proposed changes to bank hybrid capital instruments rating criteria. Comments can be submitted in written form by 21 March. The “Equity content” of the instruments is not affected. According to the rating agency, the proposed changes reflect the increasing bail-in risk. The main modification is the concept of “additional notching”, which leads to a greater flexibility on the hands of the rating agency, and will be applied when the standalone credit profile (SACP) or the standard notching do not capture the higher relative risk of a default. This includes one to three notches down for non-payment clauses (e.g. mandatory cancellation linked to distributable items) and further notching or rating caps based on the buffer to going-concern, capital-based triggers (statutory or contractual) resulting in non-payment, write-down, or conversion.

RRD latest compromise text released: The final compromise text released of the Recovery & Resolution Directive (17958/13) confirms the developments already outlined in December. However, the text also shows a new addendum of Art. 43 (Sequence of write-down and conversion in bail-in): “(4b) EBA shall provide guidelines for any interpretation relating to the interrelationship between the provisions laid down in this Directive and those set out in [CRD] and [CRR]”. This could finally address the potential misalignment between the AT1 contractual loss absorption and the statutory application. The Indicative plenary sitting date of the European Parliament on the RRD has been moved to 16 April. The movement likely came on the back of the delay in the finalisation of the SRM regulation, which intertwines with several aspects of the directive.

EBA announces key components of the 2014 EU-wide stress test: On 31 January, the European Banking Authority (EBA) announced the key components of the forthcoming 2014 EU-wide stress test. This exercise will be conducted by all competent authorities across the EU, responsible for assessing the reliability and robustness of banks’ assumptions, data, estimates and results. CRR-complaint trigger-linked Additional Tier 1 and Tier 2 CoCos will be reported as a separate item if the conversion trigger is above the Common Equity Tier 1 ratio in the adverse scenario (>5.5% Transitional CET1).

EU Commission presents banking structural reform draft regulation: On 29 January, the European Commission released the proposed Regulation on structural measures to improve the resilience of EU credit institutions, which follows up the report by the High-Level Group chaired by Finnish central bank governor Erkki Liikanen (pictured), presented in October 2012. The European Banking Federation expressed its discontent with the draft, calling it “an untimely proposal for banks’ structural reform at the expense of financing the economy”.

EBA updates Q&A on grandfathering, and holdings of FI own funds instruments: On 31 January, the EBA provided a new set of answers, including the following:

• Grandfathering of Tier 1 instruments with incentive to redeem post-January 2013 (2013_48): The EBA has clarified that, in order for legacy Tier 1 instruments with an incentive to redeem to be included in fully eligible Tier 2 items after the first call date, the frequency of subsequent calls is not a relevant criterion. This is because a capital instrument with an incentive to redeem is still considered to have an incentive to redeem where it has future calls, even if it is not called at the first call date. Thus, it would not meet all the conditions of Art. 63 of the CRR.
• Holdings of FI own funds instruments (2013_268): Where institutions do not deduct holdings of own funds instruments issued by financial sector entities included in the scope of consolidated supervision as per Art. 49(2) of the CRR, those holdings are risk-weighted in accordance with Art. 49(4). Where those institutions use the standardised approach for credit risk, investments in equity or regulatory capital instruments issued by institutions shall be classified as equity claims and receive a risk weight of 100%, unless they are treated as high risk items in accordance with Art. 128.
• Outflows associated with shorts (2013_189): If an institution has sold short a security on terms requiring delivery within the 30 day horizon, and the institution at the same time owns or has borrowed the very same security for more than 30 days, the institution should not report an outflow as per Art. 423 CRR, provided the security owned or borrowed is not already reported as a liquid asset.

BCBS releases capital planning guidelines: The Basel Committee has issued guidelines to foster overall improvement in banks’ capital planning practices. Some of the observed weaknesses reflected processes that were not sufficiently comprehensive, appropriately forward-looking or adequately formalised. According to the Basel Committee, some banks underestimated the risks inherent in their business strategies and, in turn, misjudged their capital needs.

FPC publishes policy statement on powers to supplement capital requirements: The UK Financial Policy Committee (FPC) released a Policy Statement describing the countercyclical capital buffer (CCB) and sectoral capital requirements (SCR) tools, the core indicators with respect to each tool and their likely impact on financial stability and growth. More specifically: (1) the SCR tool allows the FPC to change capital requirements, over and above their microprudential level, on exposures to specific sectors judged to pose a risk to the system as a whole; (2) the CCB tool allows the FPC to change capital requirements, over and above their microprudential level, in relation to all loans made by banks to borrowers in the UK. The Government previously stated its intention to use the flexibility in the legislation to give the FPC powers over the CCB as soon as practicable after 1 January 2014.

EBA RTS on Own Funds officially adopted by Council: The Council of the EU has officially adopted the Regulatory Technical Standards (RTS) on Own Funds. The text will be applicable after the publication in the EU Journal.

Basel III leverage ratio framework, disclosure requirements issued: The Basel III Committee refined its leverage ratio definition to “overcome differences in national accounting frameworks” and amend several controversial aspects of its June 2013 proposals.

Key takeaways include:

• Minimum requirement (Tier 1 divided by total exposures) remains 3%.
• On-balance sheet exposures: Instead of using a uniform 100% credit conversion factor (CCF), the leverage ratio will use the same CCFs that are used in the Basel framework’s Standardised Approach for credit risk under the risk-based requirements, subject to a floor of 10%.
• Written credit derivatives: The effective notional amounts included in the exposure measure may be capped at the level of the maximum potential loss, with netting permitted where the bank purchases credit protection on the same reference name and assuming: (a) the credit protection purchased is pari passu or senior to the written obligation; and (b) the remaining maturity of credit protection purchased is greater than the remaining maturity of the written credit derivative.
• Central clearing: To avoid double-counting of exposures, a clearing member’s trade exposures to qualifying central counterparties (QCCPs) associated with client-cleared derivatives transactions may be excluded when the clearing member does not guarantee the performance of a QCCP to its clients.
• Securities financing transactions (SFTs) (ie, repos): Limited netting with the same counterparty is now allowed (under the usual conditions such as legally enforceable right to set off, intention to net settle or net settlement mechanism in place).
• Implementation schedule: 1) publication from January 2015, 2) Final calibration by 2017, and 3) Pillar 1 from January 2018.

Basel Committee issued proposed revisions to the Basel framework’s Net Stable Funding Ratio (NSFR). The revisions include:

• Reducing cliff effects within the measurement of funding stability;
• Improving the alignment of the NSFR with the Liquidity Coverage Ratio (LCR);
• Altering the calibration of the NSFR to focus greater attention on short term, potentially volatile funding sources.

The Committee has issued final requirements for banks’ LCR-related disclosures. These requirements will improve the transparency of regulatory liquidity requirements and enhance market discipline. Banks will be required to comply with these disclosure requirements from the date of the first reporting period after 1 January 2015.

EBA publishes final draft RTS on market risk and CVA risk: On 20 December the EBA published its final draft RTS on the definition of market and its final draft RTS on Credit Valuation Adjustment (CVA) risk. The latter is supplemented by an Opinion on CVA risk, which further elaborates on the approach taken by the EBA in determining a proxy spread.

BCBS publishes revised framework for equity investments in funds: On 13 December the Basel Committee published a final standard that revises the treatment of banks’ equity investments in all funds that are not held for trading purposes. The revised policy framework is scheduled to take effect from January 2017.

UK PRA releases final implementation of CRD IV: The UK Prudential Regulation Authority (PRA) published the final statement of policy (PS 7/13), rules and supervisory statements required to implement CRD IV in the UK, also providing feedback on the responses to Consultation Paper 5/13. In particular, on Pillar 2:

• The PRA has decided that Pillar 2A risks should be met with the same quality of capital as Pillar 1 risks, ie, with at least 56% in CET1, no more than 44% in AT1 and at most 25% in Tier 2 capital;
• The PRA is currently reviewing its approach to setting Pillar 2A capital and, as part of that review, the PRA will consider whether and, if so, to what extent firms should disclose Pillar 2A;
• Individual Capital Guidance (ICG) may be set on an individual basis where firms are not able to demonstrate that capital is adequately allocated between the different parts of the group or where there are impediments to the transfer of capital within the group;
• The PRA expects to consult on its approach to Pillar 2 during the course of 2014. The consultation will also cover the transition to the PRA buffer and the relationship between the PRA buffer and the concurrent stress-testing exercise proposed by the FPC in March 2013.

Banking Reform Bill receives Royal Assent: The UK Banking Reform Bill has received Royal Assent, now becoming an Act of Parliament. It implements the recommendations of the Independent Commission on Banking.