EU Prudential Banking Package 2021 get ready for significant changes
25 November 2021
25 November 2021
The European Commission has published a legislative package containing significant proposals to the existing EU prudential framework concerning (among other things): third country branches; Fundamental Review of the Trading Book; credit risk; and the Fit and Proper framework. This briefing takes a look at the main details.
The 2021 EU Prudential Banking Package introduces significant proposals in a number of areas including:
Proposals in this area include amendments to reflect changes made to the standardised approach for credit risk (SA-CR) by the Basel Committee in relation to determining the exposure value of off-balance sheet items and commitments on off-balance sheets. Other proposals include; aligning the classification of retail exposures under SA-CR with the classification under the Internal Ratings Based approach so as to ensure consistent application of risk weights to the same set of exposures; introducing more granularity in relation to the risks posed by different types of real estate transactions and loans; and amendments to implement the revised treatment for equity exposures under the final Basel III standards.
Credit risk mitigation
Proposals in this regard include clarifications on the eligibility criteria for guarantees and guarantees provided in the context of mutual guarantee schemes. These clarifications are intended to provide clarity on the eligibility of credit risk mitigation techniques of COVID 19 public guarantee schemes
FRTB
Proposals include an amendment to clarify the definition of a trading desk; revising the criteria used to assign positions to the trading book or the banking book; a derogation permitting institutions to assign to the banking book specific instruments that would otherwise be assigned to the trading book (subject to certain conditions and to approval from the NCA);a derogation to allow firms to create a dedicated trading desk where they can allocate exclusively non-trading book positions subject to foreign exchange risk and commodity risks; and introducing binding own funds requirements for market risk based on the FRTB approaches; introducing alternative qualitative requirements relating to validation, documentation and governance of the alternative standardised approach.
Credit Valuation Adjustment
Proposals include: introducing a definition of the meaning of CVA risk to encompass both the credit spread risk of an institution’s counterparty and the market risk of the portfolio of transactions traded by that institution with the counterparty; provisions clarifying which securities financing transactions are subject to the own funds requirements for CVA risk (including EBA mandates to issue RTS); introducing general requirements for using the standardised approach for calculating the own funds requirements for CVA risk, as well as the definition of regulatory CVA in this regard; introducing a basic approach for calculating own funds requirements for CVA risks, in line with Basel III; and introducing a simplified approach for calculating own funds requirements for CVA risk, as well as eligibility criteria for the use of the simplified approach.
Securities Financing Transactions
The proposals include a mandate for the EBA to report, in cooperation with ESMA, on adoption of the FSB recommendations for introduction of minimum collateral haircuts for some non-centrally cleared SFT trades between banks and non-banks.
Operational risk
CRR III introduces a new standardised approach to replace all existing approaches for operational risks (firms can still use models for the purpose of the internal capital adequacy assessment process). This follows the introduction by the Basel Committee of a single non-model based approach for calculating own fund requirements. Part Three, Title III of the CRR is to be replaced and harmonised with definitions relating to operational risk to be introduced.
ESG
Disclosures on exposures to ESG risks are to apply to all institutions (i.e. not just large, listed ones as is currently the case), in a proportionate way. CRR III accelerates the deadline for the EBA to report on the potential prudential treatment of ESG exposures from 2025 to 2023. CRR III introduces harmonised definitions for environmental risks, social risks, governance risks. Institutions will be required to have robust governance arrangements and concrete plans signed off by the management body to deal with ESG risks.
Prudential treatment of cryptoassets
CRR III provides that the European Commission should review whether a dedicated prudential treatment for cryptoassets would be needed and to adopt if appropriate legislative proposals, taking into account the work of the Basel Committee (which issued a consultation on the topic earlier this year).
Fit and Proper Test
Under the existing Fit and Proper framework, banks' board members and managers are required to demonstrate that they have necessary qualities to exercise their duties. Proposed amendments include: requiring that board members will not be able to take up their positions until firms check if they have the qualities necessary to perform their duties; for large banking groups, prior assessment is to be carried out by national competent authorities in relation to board members with roles in holding companies of banking groups; and a requirement for institutions to assess “key function holders" to ensure they have all the relevant qualities needed to carry out their functions.
Classification
The proposals introduce a new regime for TCBs whereby TCBs are categorised as Class 1 (larger and riskier) and Class 2 (smaller) with requirements adjusted accordingly.
The proposed regime acknowledges that, while subjecting TCBs to the full set of prudential and supervisory requirements under CRR and CRD would be too burdensome, a consistent framework made of the elements stated below is required for TCBs at an EU level.
A TCB will be deemed Class 1 if either of the following criteria is met:
Reauthorisation
TCBs must meet certain conditions for authorisation and the minimum regulatory requirements such as: capital endowment requirements (to be maintained at all times); liquidity requirements (depending on the classification of the TCB as Class 1 or Class 2); internal governance and risk control requirements; booking arrangements requirements (to track assets and liabilities linked to the business carried out by the TCB in a Member State); and reporting requirements. All existing TCBs are required to be reauthorised following a 12 months transitional period from transposition.
Power to subsidiarise
NCAs can require TCBs established in their territory to apply for authorisation as a subsidiary under the CRD where the TCB engages in transactions or business with counterparts in other Member States in contravention of the internal market rules. The power is also available for use in cases where a TCB poses risks to the financial stability of the relevant Member State or of the EU.
Assessment of systemic importance and restructuring
Where TCBs have assets on their books in an amount equal to or higher than EUR 30 billion, NCAs must assess on a regular basis whether such TCBs pose a level of risk to the financial stability of the respective Member State and of the EU that is analogous to institutions defined as “systemic” under the CRR and the CRD. NCAs, after a comprehensive assessment and calculation exercise, may decide either to require the TCBs to restructure their activities or assets so that that they cease to meet the criteria of systemic importance or the EUR 30 billion threshold; or to impose additional Pillar 2 requirements on the third country group’s TCBs and subsidiaries in the EU.
Resolution: MREL
The proposals introduce:
The European Commission is proposing that the measures would apply, for the most part, from January 2025.
Co-authors: Bisola Williams and Pablo Asensio
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.