Banking updates:

FSB sets out G20 Istanbul agenda: The Financial Stability Board (FSB) published on 11 February its Letter to G20 Finance Ministers and Central Bank Governors on Financial Reforms.

The document sets out the FSB’s work programme to advance these goals during the Turkish G20 Presidency in 2015, ahead of the February G20 meeting in Istanbul. Among, the main points, the FSB mentioned:

Completion of the capital framework for banks: The Basel Committee will conduct public consultations and quantitative impact assessments to enhance the Basel framework standardised approaches for calculating risk-weighted assets, to be finalised in 2016, and publish measures that address excessive variability in internal model-based approaches to Basel III. In addition, the Basel Committee will continue to work towards agreement of the appropriate standard for the leverage ratio, to be finalised by 2017 at the latest

Ending too-big-to-fail (1/2): The FSB will finalise the international standard for Total Loss-Absorbing Capacity (TLAC) of Global Systemically Important Banks (G-SIBs). The FSB members will take measures to promote industry adoption of contractual provisions recognising temporary stays on the close-out of financial contracts when a firm enters resolution.

Ending too-big-to-fail (2/2): At the same time, progress must be made towards addressing the too-big-to-fail problem in financial institutions other than banks, including insurers, finance companies, market intermediaries, investment funds and critical market infrastructure. Work on methodologies to identify non-bank, non-insurer global systemically important institutions is progressing and, by the Antalya Summit in November, the International Association of Insurance Supervisors (IAIS) will finalise higher loss absorbency requirements for Global Systemically Important Insurers (G-SIIs).

FSB publishes public responses to TLAC consultation: The Financial Stability Board published on 6 February the public responses to the November consultation on the TLAC for G-SIBs. The recurring themes include:

RWA requirement: As expected, participating institutions are generally advocating 16% of Risk Weighted Assets (RWA) as a common Pillar 1 Minimum TLAC requirement;

Leverage ratio: First, responses generally highlighted that the transposition of the leverage ratio from Basel III to the TLAC framework should not be anchored to a “double-of” moving target. Second, respondents are concerned that the leverage ratio as a basis for TLAC calculation could have a disproportionate effect on those banks that have portfolios with low RWA density. In addition, the final TLAC standard should make clear that, as under Basel III, CET1 held toward buffers counts toward the leverage ratio for TLAC purposes;

Gold-plating and Pillar 2 requirements: Respondents underlined that most of the issues that might be considered to justify Pillar 2 TLAC additions are already covered by other regulatory requirements and, especially, the recovery and resolution planning process and resolvability assessments, and G-SIB surcharges. Furthermore, “gold-plating” by national authorities should not be incentivised.

Subordination: The responses highlight the particular difficulties faced by banks that would be subject to both TLAC and the EU Bank Recovery & Resolution Directive (BRRD). More specifically: (1) structural subordination is not available to banks that are structured under an operating parent company; (2) contractual subordination is made difficult by the current wording of the BRRD, which requires a change in the insolvency status; and (3) statutory subordination as a potential way forward may be considered in some jurisdictions, but would require substantial analysis and time for implementation. For European banks, this would require a legal mechanism either at the EU level, via an amendment to the BRRD, or through national legislation, the feasibility of which is not fully established at this juncture.

33% debt requirement: According to the majority of the responses, the expectation that 33% of the requirement should be met with debt may become restrictive if outstanding senior debt cannot be used to fulfil it. Moreover, it was duly noted (e.g. by the Financial Markets Law Committee) that it is not clear whether equity-accounted Additional Tier 1 capital, which is legally a debt, would be permitted to count towards the long term debt requirement if it satisfied all other TLAC eligibility criteria.

Structured notes: The majority of respondents argued that structured notes should not be arbitrarily excluded from TLAC, as long as they satisfy the key requirements of the final TLAC term sheet. Structured note obligations do not differ conceptually from vanilla instruments that are hedged, and are equally capable of being written down or converted as a vanilla note. Some suggested that they should be permitted to count towards the requirement if the bank can demonstrate that the notes can absorb losses without giving rise to valuation or legal uncertainty, which is closer to the EBA stance and could be a compromise solution;

Internal TLAC: First, many participants concluded that 65%-75% would be a better range within which to fix a requirement for internal TLAC, with a presumption toward 65%. A higher requirement could create a situation where the sum of internal TLAC requirements may become greater than 100% of a group’s consolidated standalone TLAC imposition. Furthermore, many requested the 33% debt expectation not to apply to internal TLAC.

BASEL COMMITTEE

BCBS publishes consultation on accounting for expected credit losses: On 2 February, the Basel Committee on Banking Supervision (BCBS) launched a consultation on guidance on accounting for expected credit losses. Comprising 11 fundamental principles, the guidance sets out supervisory expectations for banks relating to sound credit risk practices associated with implementing and applying an expected credit loss (ECL) accounting framework. The guidance sets forth supervisory expectations that are consistent with the applicable accounting standards established by the International Accounting Standards Board (IASB) and other standard setters. The deadline for comments is 30 April.

BCBS publishes revised Pillar 3 disclosure requirements: The Basel Committee issued on 28 January the final standard for the revised Pillar 3 disclosure requirements. Compared with the consultative version, the key changes involve: (1) rebalancing the disclosures required quarterly, semi-annually and annually; (2) streamlining the requirements related to disclosure of credit risk exposures and credit risk mitigation techniques; and (3) clarifying and streamlining the disclosure requirements for securitisation exposures. The revised disclosure requirements, which will apply from year-end 2016, are meant to enable market participants to compare banks’ disclosures of risk-weighted assets.

BCBS consults on revisions to the standardised approach for credit risk and consults on capital floors: The Basel Committee released on 22 December a consultative document on revisions to the standardised approach for credit risk. Comments on the proposals should be sent by 27 March. The key aspects of the proposals are:

Bank exposures: would no longer be risk-weighted by reference to the bank’s external credit rating or that of its sovereign of incorporation, but would instead be based on two risk drivers: the bank’s capital adequacy and its asset quality.

Corporate exposures: would no longer be risk-weighted by reference to the borrowing firm’s external credit rating, but would instead be based on the firm’s revenue and leverage. Further, risk sensitivity and comparability with the internal ratings-based (IRB) approach would be increased by introducing a specific treatment for specialised lending.

Subordinated debt, equity and other capital instruments: a specific category for all capital and equity instruments, whether issued by banks or corporates, will be introduced. To align the treatment of these exposures with those under IRB, the Committee proposes to apply a 250% risk weight for subordinated debt and capital instruments other than equities; and to use the IRB simple risk weight method for equity exposures (i.e. 300% for publicly-traded equity holdings, and 400% otherwise), unless these exposures are deducted or risk-weighted at 250% according to paragraphs 87 to 89 of the Basel III capital framework.

Retail category: would be enhanced by tightening the criteria to qualify for a preferential risk weight, and by introducing an alternative treatment for exposures that do not meet the criteria.

Residential real estate: would no longer receive a 35% risk weight. Instead, risk weights would be based on two commonly used loan underwriting ratios: the amount of the loan relative to the value of the real estate securing the loan (i.e. the loan-to-value ratio) and the borrower’s indebtedness (i.e. a debt-service coverage ratio).

Commercial real estate: two options are under consideration: (a) treating the exposures as unsecured with national discretion for a preferential risk weight under certain conditions; or (b) determining the risk weight based on the loan-to-value ratio.

Credit risk mitigation: the framework would be amended by reducing the number of approaches, recalibrating supervisory haircuts and updating the corporate guarantor eligibility criteria.

The Basel Committee also on 22 December published a consultative paper on the design of a capital floor framework based on standardised, non-internal modelled approaches. The consultative paper is part of a range of policy and supervisory measures from the Committee that aim to enhance the reliability and comparability of risk-weighted capital ratios. The floor is meant to mitigate model risk and measurement error stemming from internally-modelled approaches, and would also enhance the comparability of capital outcomes across banks. Nevertheless, the floor’s calibration was not included within the scope of this consultation. The Committee will instead consider it alongside its work on finalising the revised standardised approaches to credit risk, market risk and operational risk, taking into account its ongoing review of the capital framework and its balance of simplicity, comparability and risk sensitivity. Comments on this proposal should also be sent by 27 March.

BCBS publishes assessment of Basel capital regulations in the EU: The Basel Committee published on 5 December a report assessing the implementation of the Basel capital framework in the nine EU Member States that are members of the Basel Committee. The main findings are the following:

• The assessment concluded that 8 of the 14 components meet all minimum provisions of the relevant Basel standards and these were therefore graded as “compliant”. Four of the components were assessed as “largely compliant”, reflecting the fact that most but not all provisions of the global standard were satisfied;
• The calculation of minimum capital requirements and definition of capital, which include the Danish Compromise, was considered “largely compliant”. In this regard, the BCBS Assessment Team acknowledged that the current EU rules were formulated “in good faith” and were overtaken by the Basel Committee FAQ on consolidation vs. deduction published in December 2011. On the one hand, the Assessment Team is of the view that the FAQ is an agreed Basel Committee policy and should therefore be respected. On the other, EU authorities believe that the FAQ goes beyond an interpretation of Basel III and introduced additional requirements outside the due process for new Basel standards;
• The IRB approach for credit risk was assessed as “materially non-compliant” and pertained primarily to the treatment of exposures to SMEs, corporates and sovereigns;
• The EU’s counterparty credit risk framework, which provides an exemption from the Basel framework’s credit valuation adjustment (CVA) capital charge for certain derivative exposures, was also found to be “non-compliant”.

COMMISSION, COUNCIL, PARLIAMENT

EU Council decided not to object to the adoption of EBA RTS on Own Funds pt. IV: At the ECOFIN meeting of 17 February, the EU Council decided not to object to the adoption by the Commission of a Delegated Act amending Delegated Regulation (EU) No 241/2014, which supplements the CRR with regard to RTS for Own Funds requirements. The regulation, which derives from EBA RTS on Own Funds pt. IV, specifies whether and when multiple distributions would create a disproportionate drag on capital. It also clarifies the meaning of preferential distributions, namely preferential rights to payments of distributions and order of payments of distribution. The act will provide institutions with an alternative way to build CET1 capital.

ECON considers Hökmark Report on Bank Structural Reform: The ECON committee officially considered the Hökmark Report on “Structural measures improving the resilience of EU credit institutions” at its 21 January meeting. The report, presented by MEP Gunnar Hökmark and published on 7 January, drifts away from the original proposal, made in January 2014, which was in turn largely based on the Liikanen report. Following the release of the document, the European Banking Federation stated that it “shares banks’ concerns by acknowledging the importance of preserving vital liquidity-generating functions for economic growth whilst maintaining cost effective financial services for SMEs”. According to the British Bankers’ Association, the report offers “a neat solution for the UK, giving a de facto exemption for ring-fenced banks which can’t engage in such activity under the Vickers rules and thereby avoiding the consequence of them having to ‘double-separate’”. In addition, “it also broadly captures the French and German regimes in a way that the original derogation did not, perhaps with the exception of underwriting securities”. A vote was scheduled for 23 March, while the European Parliament indicative plenary sitting date was set for 28 April.

Leverage Ratio Delegated Regulations published in the Official Journal: On 12 January, the European Parliament and the Council gave their backing to Commission Delegated Regulation amending Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to the Leverage Ratio. The Regulation was published in the Official Journal of the EU on 17 January.

Council adopts Regulation on SFR contributions and appoints members of the SRB: The Council adopted on 19 December a decision appointing the chairperson, vice-chairperson and four other full time members of the Single Resolution Board (SRB), along with a regulation determining the contributions to be paid by banks to the EU’s Single Resolution Fund (SRF).

The SRF was established by a Regulation adopted in July 2014; it will be applicable from 1 January 2016. It will be built up over a period of eight years to reach a target level of at least 1% of the amount of covered deposits of all credit institutions authorised in all the participating member states.

ECB

ECB issues recommendation on dividend distribution policies: On 28 January, the European Central Bank (ECB) adopted a recommendation on dividend distribution policies (where dividends are defined as any type of cash pay-out that is subject to the approval of the General Assembly) targeting entities supervised by the Single Supervisory Mechanism (SSM). In addition, it is also addressed at the national competent and designated authorities with regard to less significant supervised entities and less significant supervised groups. The content of the ECB recommendations are based on the following categories:

Category 1: institutions that satisfy the applicable Pillar 1 and supervisory review and evaluation process (SREP) Pillar 2 capital requirements, and that have already reached their fully-loaded CET1, Tier 1 and Total Capital ratios, should only distribute their net profits in dividends in a conservative manner to enable them to continue to fulfil all requirements even in the case of deteriorated economic and financial conditions;

Category 2: institutions that satisfy the applicable Pillar 1 and SREP Pillar 2 capital requirements, but that have not reached their fully loaded CET1, Tier 1 and Total Capital ratios, should only distribute their net profits in dividends in a conservative manner to enable them to continue to fulfil all requirements, even in the case of deteriorated economic and financial conditions. In addition, they should in principle only pay out dividends to the extent that, at a minimum, a linear path towards the required fully-loaded ratios is secured;

Category 3: Credit institutions that under the 2014 Comprehensive Assessment have a capital shortfall that would not be covered by capital measures by 31 December 2014, or credit institutions in breach of the Pillar 1 or SREP Pillar 2, should in principle not distribute any dividend.

Danièle Nouy hints at possible capital requirements for sovereign exposures: Danièle Nouy, chair of the supervisory board of the SSM at the ECB, said during an interview on 28 January that there should be capital requirements for sovereign debt holdings. According to Bloomberg reports, Nouy stated the following: “It was confirmed during the crisis that there are no risk-free assets, so there should be a risk weight, capital requirements for sovereign exposures.” However, she added that “probably at the end of the day … the capital requirement will be limited, because on average those exposures are of good quality, but indeed, what is not risk-free should have a capital requirement”.

EBA

EBA consults on MREL criteria: On 27 February a public consultation closed on European Banking Authority (EBA) draft Regulatory Technical Standards (RTS) further specifying the criteria to set the Minimum Requirement for Own Funds & Eligible Liabilities (MREL) laid down in the Bank Recovery & Resolution Directive (BRRD). The BRRD does not establish a common minimum MREL, but actual levels should be adapted to reflect the resolvability, risk profile, systemic importance and other characteristics of each institution. These RTS aim to further specify these minimum criteria in order to achieve an appropriate degree of convergence in how they are applied and interpreted across Member States, and ensure that similar levels of MREL can be set for similar institutions.

The consultation was launched on 28 November. As per the BRRD, the EBA is expected to submit the final draft RTS to the European Commission by 3 July.

EBA advises on the definition of eligible capital: The EBA published on 17 February its opinion on the review of the appropriateness of the definition of “eligible capital”, in response to a call for advice received from the European Commission in December 2013 in accordance with Article 517 of the Capital Requirements Regulation (CRR). From 1 January 2014, the eligible capital definition specified in Article 4(1)(71) of the CRR replaced the “own funds” definition for defining “large exposures” and setting large exposures limits. The definition is also used to determine the capital requirements applicable to investment firms with limited investment services and to determine the prudential treatment for qualifying holdings outside the financial sector. The difference between the two definitions is that the amount of Tier 2 capital recognised as eligible capital may not exceed one-third of Tier 1 capital whereas there was no limit for the inclusion of Tier 2 capital in the own funds definition. The EBA suggested conducting a comprehensive review of the EU large exposures regime at an appropriate point in time, in order to align it with the Basel Committee standards on the supervisory framework for measuring and controlling large exposures.

EBA publishes revised version of its final draft RTS on prudent valuation: The EBA released on 23 January a specific and limited amendment to its final draft RTS on Prudent Valuation published on 31 March 2014. As a consequence of this decision, all occurrences of “volatility” in Article 9 and Article 10 of the final draft RTS published on 31 March 2014 should be replaced by “variance” for the purposes of computing market price uncertainty and close-out costs additional valuation adjustments (AVAs). This amendment, which affects only institutions using the Core approach, will result in a slight relaxation of the calibration of the volatility test performed under these two articles, thus avoiding unwanted side-effects in the already challenging first year implementation of the Core approach.

EBA consults on procedures, forms and templates for resolution planning: The EBA launched on 14 January a public consultation on draft Implementing Technical Standards (ITS) on procedures, forms and templates for resolution planning, part of the BRRD secondary legislation. The proposed draft ITS develop in detail the procedure that should be followed when resolution authorities require information about an institution for the purpose of drawing up a resolution plan. The deadline for the submission of comments is 14 April.

EBA updates list of CET1 capital instruments: The EBA published on 23 December an updated list of capital instruments that Competent Supervisory Authorities across the EU have classified as Common Equity Tier 1 (CET1). This list is compiled in accordance with Article 26 of CRR and is updated on a regular basis. Since the publication of the first list, Finland’s non-voting cooperative shares, Portugal’s participation units and the UK’s deferred shares were assessed and evaluated as compliant with the CRR.

EBA publishes criteria to assess O-SIIs: The EBA issued on 16 December its final Guidelines defining the criteria that EU competent authorities will use to identify institutions that are systemically important either at Union or Member State level, Other Systemically Important Institutions (O-SIIs). In line with the provisions laid down in the CRD, competent authorities can require O-SIIs to hold an additional buffer of up to 2% of CET1. These Guidelines aim at setting uniform parameters at EU level while taking into account specificities of Member States’ individual banking sectors, so as to achieve an appropriate degree of convergence in the identification process as well as at ensuring a comparable, clear and transparent assessment of systemically important institutions in the EU. For this purpose, the Guidelines envisage a two-step process for the identification of O-SIIs:

• In the first step, on the basis of mandatory quantitative indicators (related to size, interconnectedness, relevance for the economy, complexity), competent authorities will obtain scores indicating the systemic importance of each bank;
• In the second step of the process, competent authorities can still qualify banks scoring between the lower and upper thresholds as O-SIIs, by using their supervisory judgment, but only on the basis of a closed list of optional indicators set forth in the Guidelines;
• Finally, to reduce the reporting burden for small institutions, competent authorities may decide to exclude very small institutions from the identification process, if they assess that they are unlikely to pose systemic threats to the domestic economy.

EBA Q&A

2014_1382 relating to short positions in financial institution capital instruments: The EBA published on 20 February a new set of answers to the Q&A tool. In particular, question 2014_1382 relates to short positions in financial institution capital instruments, more specifically whether a guarantee or CDS over an item treated as a financial institution capital instrument can be considered a short position for the purposes of Articles 45(a), 59(a) or 69(a) of the CRR. According to the EBA response, a derivative or a guarantee provided for a capital instrument in which an institution directly holds a long position in respect of the underlying exposure may only be treated as an offsetting short position for the purposes of Articles 45(a), 59(a) or 69(a) of CRR if such a derivative is provided by an entity outside the accounting and prudential scope of consolidation of the institution at all levels of consolidation, and if the derivative is such that it fully and promptly offsets any changes in value arising in the long position in the own funds instrument. However, a derivative that would cover only losses occurring after a default has occurred would not comply with this treatment, and therefore may not be treated as an offsetting short position.

2015_1791 relating to the repurchase of own funds instruments for market-making purposes: The EBA added a new answer to the Q&A tool on 13 February relating to the timing applicability of the waiver for the repurchase of own funds instruments for market-making purposes. According to the EBA, having regard to the aim and nature of market-making activities and the limits set out in Article 29(3) of Regulation (EU) No 241/2014 (RTS on own funds parts 1 and 2), competent authorities may permit institutions to repurchase Additional Tier 1 or Tier 2 instruments for market-making purposes from the date of issuance in accordance with the conditions stipulated by this Regulation and Q&A 2014_1352. The latter previously noted that the predetermined amount for which the competent authority has given its permission should be deducted from the moment the authorisation is granted.

EBA launches Q&A Tool on BRRD: As anticipated, the EBA updated on 30 January its online Single Rulebook Q&A Tool with the inclusion of the BRRD. The authority has already released several answers. Two of the most relevant answers are:

2015_1779 The question relates to the application of bail-in to liabilities guaranteed by third parties. According to the EBA, guarantees or liabilities guaranteed by a third party are not considered as secured liabilities in the meaning of Article 43(2)(b) of the BRRD because that concept must be interpreted as covering only liabilities secured/guaranteed by assets of the institution under resolution;

2015_1784 The question relates to the use of Deposit Guarantee Scheme (DGS) contributions towards the 8% requirement. According to the EBA, Article 44(5)(a) subjects the use of the resolution fund to a prior contribution of 8% of total liabilities including own funds, to be made by shareholders, holders of other instruments of ownership, holders of relevant capital instruments and of other eligible liabilities. The definition of eligible liabilities in Article 2 (71) excludes explicitly liabilities that are excluded from the scope of the bail in; this is the case of covered deposits. Therefore, if the bail-in of shareholders and eligible liabilities does not reach 8%, resort to the resolution fund is, in principle, not possible and the DGS will step in for covered deposits.

UK

PRA consults on the assessment of capital adequacy under Pillar 2: The UK Prudential Regulation Authority (PRA) launched on 19 January a new consultation paper (CP1/15) on the assessment of capital adequacy under Pillar 2. The CP1/15 sets out proposed changes to the PRA’s Pillar 2 framework for the banking sector, including changes to rules, and supervisory statements. It also introduces the content of a new statement of policy, the “PRA’s methodologies for setting Pillar 2 capital”, which sets out the practices that the PRA proposes to use to inform its setting of firms’ Pillar 2A capital requirements. The release also complements the EBA SREP guidelines launched on 19 December 2014.

The FCA publishes Policy Statement on BRRD implementation: The UK Financial Conduct Authority (FCA) published on 16 January a Policy Statement (PS15/2) containing the final rules to transpose the BRRD into the UK regulatory regime. The document also reports on the main issues arising from Consultation Paper CP14/15, originally published on 1 August 2014. The rules on recovery and resolution entered into force in the UK on 19 January, with the exception of the rules on the contractual recognition of bail-in, which will come into force on 1 January 2016.

Amendment to the Capital Requirements Regulation laid before UK Parliament: The UK Capital Requirements (Capital Buffers & Macro-prudential Measures) (Amendment) Regulations 2015 were laid before Parliament on 13 January. These Regulations implement Articles 133 and 134 of CRD IV, introducing a Systemic Risk Buffer in the UK legislation. The buffer will be applicable from 1 January 2019. The UK intends to use the systemic risk buffer to implement the recommendation made by the Independent Commission on Banking in 2011, and subsequently agreed by HM Treasury in its 2012 White Paper, that ring-fenced banks and large building societies hold additional capital due to their relative importance to the UK economy. The Bank of England’s Financial Policy Committee (FPC) will be responsible for setting out the framework for determining which institutions should hold the buffer and, if so, how large the buffer should be.

BoE publishes approach to resolving failed institutions: The Bank of England on 8 December published in its Quarterly Bulletin an article by Andrew Gracie, Lucy Chennells and Mark Menary on the Bank of England’s approach to resolving failed institutions. According to Bloomberg reports, Gracie stated that the TLAC framework will be finalised by November 2015 at a conference in December.