Explanatory Memorandum to COM(2021)663 - Amendment of Directive 2013/36/EU as regards supervisory powers, sanctions, third-country branches, and environmental, social and governance risks - Main contents
Please note
This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2021)663 - Amendment of Directive 2013/36/EU as regards supervisory powers, sanctions, third-country branches, and environmental, ... |
|---|---|
| source | COM(2021)663  |
| date | 27-10-2021 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
The proposed amendment to Directive 2013/36/EU (the Capital Requirements Directive or CRD) is part of a legislative package that includes also amendments to Regulation (EU) No 575/2013 (the Capital Requirements Regulation or CRR) 1 .
In response to the Great Financial Crisis of 2008-09 (GFC), the Union implemented substantial reforms of the prudential framework applicable to banks in order to enhance their resilience and thus help prevent the recurrence of a similar crisis. Those reforms were largely based on international standards adopted since 2010 by the Basel Committee on Banking Supervision (BCBS) 2 . The standards are collectively known as the Basel III standards, the Basel III reforms or the Basel III framework 3 .
The global standards developed by the BCBS have become increasingly important due to the ever more global and interconnected nature of the banking sector. While a globalised banking sector facilitates international trade and investment, it also generates more complex financial risks. Without uniform global standards, banks could choose to establish their activities in the jurisdiction with the most lenient regulatory and supervisory regimes. This might lead to a regulatory race to the bottom to attract bank businesses, increasing at the same time the risk of global financial instability. International coordination on global standards limits this type of risky competition to a large extent and is key for maintaining financial stability in a globalised world. Global standards also simplify the life of internationally active banks – among which are a good number of EU banks – as they guarantee that broadly similar rules are applied in the most important financial hubs worldwide.
The EU has been a key proponent of international cooperation in the area of banking regulation. The first set of post-crisis reforms that are part of the Basel III framework have been implemented in two steps:
·in June 2013 with the adoption of CRR 4 and CRD IV 5 ;
·in May 2019 with the adoption of Regulation (EU) 2019/876 6 , also known as CRR II, and Directive (EU) 2019/878, also known as CRD V 7 .
The reforms implemented so far focused on increasing the quality and quantity of regulatory capital that banks have to hold to cover potential losses. Furthermore, they aimed at reducing banks’ excessive leverage, increasing banks’ resilience to short-term liquidity shocks, reducing their reliance on short-term funding and their concentration risk, and addressing too-big-to-fail problems 8 .
As a result, the new rules strengthened the criteria for eligible regulatory capital, increased minimum capital requirements, and introduced new requirements for credit valuation adjustment 9 (CVA) risk and for exposures to central counterparties 10 . Furthermore, several new prudential measures were introduced: a minimum leverage ratio requirement, a short-term liquidity ratio (known as the liquidity coverage ratio), a longer-term stable funding ratio (known as the net stable funding ratio), large exposure limits 11 and macro-prudential capital buffers 12 .
Thanks to this first set of reforms implemented in the Union 13 , the EU banking sector has become significantly more resilient to economic shocks and entered the COVID-19 crisis on a significantly more stable footing when compared to its condition at the onset of the GFC.
In addition, temporary relief measures were taken by supervisors and legislators at the outset of the COVID-19 crisis. In its Interpretative Communication on the application of the accounting and prudential frameworks to facilitate EU bank lending supporting businesses and households amid COVID-19 of 28 April 2020 14 , the Commission confirmed the flexibility embedded in the prudential and accounting rules as highlighted by the European Supervisory Authorities and international bodies. On that basis, in June 2020, the co-legislators adopted targeted temporary amendments to specific aspects of the prudential framework – the so-called CRR “quick fix” package 15 . Together with resolute monetary and fiscal policy measures 16 , this helped banks to keep on lending to households and companies during the pandemic. This, in turn, helped mitigate the economic shock 17 resulting from the pandemic.
While the overall level of capital in the EU banking system is now considered satisfactory on average, some of the problems that were identified in the wake of the GFC have not yet been addressed. Analyses performed by the EBA and the ECB have shown that the capital requirements calculated by EU banks using internal models demonstrated a significant level of variability that was not justified by differences in the underlying risks and that ultimately undermines the reliability and comparability of their capital ratios. In addition, the lack of risk sensitivity in the capital requirements calculated using standardised approaches results in insufficient or unduly high capital requirements for some financial products or activities (and hence for specific business models primarily based on them). In December 2017, the BCBS agreed on a final set of reforms 18 to the international standards to address these problems. In March 2018, the G20 Finance Ministers and Central Bank Governors welcomed these reforms and repeatedly confirmed their commitment to full, timely and consistent implementation. In 2019, the Commission announced its intention to table a legislative proposal to implement these reforms in the EU prudential framework. 19
In light of the COVID-19 pandemic, the preparatory work of this proposal has been delayed. The delay reflected the BCBS’s decision of 26 March 2020 to postpone the previously agreed implementation deadlines for the final elements of the Basel III reform by one year. 20
Considering the above, the present legislative initiative has two general objectives: contributing to financial stability and contributing to the steady financing of the economy in the context of the post-COVID-19 crisis recovery. These general objectives can be broken down in four more specific objectives:
to strengthen the risk-based capital framework, without significant increases in capital requirements overall;
to enhance the focus on ESG risks in the prudential framework;
to further harmonise supervisory powers and tools; and
to reduce banks’ administrative costs related to public disclosures and to improve access to banks’ prudential data.
To strengthen the risk-based capital framework
The temporarily stressed economic conditions have not modified the need to deliver on this structural reform. Completing the reform is necessary to address the outstanding issues, to further strengthen EU banks’ financial soundness, putting them in a better position to support economic growth and withstand potential future crises, and to facilitate the comparability of capital levels across banks. The implementation of the final Basel III elements is also necessary to provide institutions with the necessary regulatory certainty, completing a decade-long reform of the prudential framework.
Finally, completing the reform is in line with the EU’s commitment to international regulatory cooperation and the concrete actions some of its partners have announced or have already taken to implement the reform timely and faithfully.
To enhance the focus on ESG risks in the prudential framework
Another equally important need for reform stems from the Commission’s ongoing work on the transition to a sustainable economy. The Commission Communication on the European Green Deal (EGD) 21 and Commission Communication on achieving the EU’s 2030 Climate Target (‘Fit for 55’) 22 clearly set out the Commission’s commitment to transform the EU economy into a sustainable economy, while also dealing with the inevitable consequences of climate change. It also announced a Sustainable Finance Strategy 23 that builds on previous initiatives and reports, such as the action plan on financing sustainable growth 24 and the reports of the Technical Expert Group on Sustainable Finance 25 , but reinforces the Commission’s efforts in this area to bring them in line with the ambitious goals of the EGD.
The transition towards the Commission’s sustainability goals requires unprecedented financing efforts to mitigate and adapt to climate change, rebuild natural capital and strengthen resilience and wider social capital. Public finances alone will not be enough. Private investment of the transition to a sustainable, carbon-neutral, circular and just economy needs to scale-up to meet the estimated amount of resources that need to be deployed to achieve these goals. Putting green and sustainable financing at the heart of the financial system is the aim of the Commission’s strategy for green financing. Bank-based intermediation will therefore play a crucial role in financing the transition to a more sustainable economy. At the same time, this transition is likely to entail risks for banks that they will need to properly manage to ensure that risks to financial stability are minimised. This is where prudential regulation is needed and where it can play a crucial role. EU strategy acknowledged this and highlighted the need to include a better integration of environmental, social and governance (ESG) risks into the EU prudential framework. The present legal requirements alone are insufficient to provide incentives for a systematic and consistent management of ESG risks by banks.
To further harmonise supervisory powers and tools
Another area of focus is the proper enforcement of prudential rules. Supervisors need to have at their disposal the necessary tools and powers to this effect (e.g. powers to authorise banks and their activities, assess the suitability of their management, or sanction them in case they break the rules). While the EU legislation ensures a minimum level of harmonisation, the supervisory toolkit and procedures vary greatly across Member States. This fragmented regulatory landscape in the definition of certain powers and tools available to supervisors and their application across Member States undermines the level playing field in the internal market and raises doubts about the sound and prudent management of EU banks and their supervision. This problem is particularly acute in the context of the Banking Union. Differences across 21 different legal systems prevent the Single Supervisory Mechanism (SSM) from performing its supervisory functions effectively and efficiently. Moreover, cross-border banking groups have to deal with a number of different procedures for the same prudential issue, unduly increasing their administrative costs.
To reduce banks’ administrative costs related to public disclosures and improve access to banks’ prudential data.
This proposal is also necessary to further enhance market discipline. This is another important tool in order for investors to exercise their role of monitoring the behaviour of banks. To do so, they need to access the necessary information. The current difficulties related to the access to prudential information deprive market participants from the information they need about banks’ prudential situations. This ultimately reduces the effectiveness of the prudential framework for banks and potentially raises doubt about the resilience of the banking sector, especially in periods of stress. For this reason, the proposal aims to centralise disclosures of prudential information with a view to increase access to prudential data and comparability across industry. The centralisation of disclosures in a single access point established by the EBA is also aimed at reducing the administrative burden for institutions, especially small and non-complex ones.
Another cross-sectoral objective, providing a robust EU framework for third country groups providing banking services in the EU, has taken a new dimension after Brexit. The establishment of third country branches (TCBs) is fundamentally subject only to national legislation and harmonised to a very limited extent by the CRD. The recent report by the EBA 26 to the Institutions shows that the current patchy regulatory landscape offers TCBs significant opportunities for regulatory and supervisory arbitrage to conduct their banking activities on the one hand, whilst leading to a lack of supervisory oversight and increased financial stability risks for the EU on the other hand.
Supervisors often lack the information and powers that they need to properly address those risks. The absence of common prudential, governance and detailed supervisory reporting requirements, as well as the insufficient exchange of information between the authorities in charge of supervising different entities/activities of a third country group leaves blind spots. The EU is the only major jurisdiction where the consolidating supervisor does not have the full picture of the activities of third country groups operating via both subsidiaries and branches. These shortcomings are not only creating risks for the financial stability and market integrity of the EU, but also impacting the level playing field among third country groups operating across different Member States, as well as vis-à-vis banks headquartered in the EU.
• Consistency with existing policy provisions in the policy area
Several elements of the CRD and CRR proposals follow work undertaken at international level, or by the EBA, whilst other adaptations of the prudential framework have become necessary due to the practical experience gained since the national transposition and application of the CRD, including in the context of the Single Supervisory Mechanism.
The proposal introduces amendments to the existing legislation and renders it fully consistent with the existing policy provisions in the area of prudential regulation and supervision of banks. The review of the CRR and of the CRD aims at finalising the Basel III reform implementation in the EU introducing measures that are needed to further strengthen resilience of the banking sector.
• Consistency with other Union policies
Almost ten years passed since the European Heads of State and Governments agreed to create a Banking Union; two pillars of the Banking Union – single supervision and resolution – are in place, resting on the solid foundation of a single rulebook for all EU institutions.
This proposal aims at ensuring a continued single rulebook for all EU institutions, whether inside or outside the Banking Union. The overall objectives of the initiative, as described above, are fully consistent and coherent with the EU’s fundamental goals of promoting financial stability, reducing the likelihood and the extent of taxpayers' support in case an institution is resolved, as well as contributing to a harmonious and sustainable financing of economic activity, which is conducive to a high level of competitiveness and consumer protection.
Lastly, with the recognition of ESG-related risks and the incorporation of ESG elements in the prudential framework, this initiative complements the EU broader strategy for a more sustainable and resilient financial system.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Legal basis
The proposal considers actions to frame the taking up, the pursuit and the supervision of the business of banks within the Union, with the objective of ensuring the stability of the internal market. One of the fundamental components of the Union’s financial system, banking is currently providing the largest part of financing within the internal market. The Union has a clear mandate to act in the area of the internal market and the appropriate legal basis consists of the relevant Treaty Articles 27 underpinning Union competences in this area.
The proposed amendments are built on the same legal basis as the legislative acts that are being amended, i.e. Article 114 TFEU for the proposal for a regulation amending CRR and Article 53 i TFEU for the proposal for a directive amending CRD.
• Subsidiarity (for non-exclusive competence)
The legal basis falls within the internal market area, which is considered a shared competence, as defined by Article 4 TFEU. Most of the actions considered represent updates and amendments to existing Union law, and as such, they concern areas where the Union has already exercised its competence and does not intend to cease exercising such competence. A few actions (particularly those amending the CRD) aim to introduce an additional degree of harmonisation in order to achieve consistently the objectives defined by that Directive.
Given that the objectives pursued by the proposed measures aim at supplementing already existing EU legislation, they can be best achieved at EU level rather than by different national initiatives. National measures aimed at, for example, implementing rules that have an inherent international footprint elements – such as a global standard like Basel III or better tackling ESG-related risks - into applicable legislation would not be as effective in ensuring financial stability as EU rules. In terms of supervisory measures, disclosures and third country branches, if the initiative is left at national level only, this may result in reduced transparency and increased arbitrage costs, leading to potential distortion of competition and affecting capital flows. Moreover, adopting national measures would be legally challenging, given that the CRR already regulates banking matters, including risk weights, reporting and disclosures and other CRR-related requirements.
The amendment of the CRR and the CRD is thus considered to be the best option. It strikes the right balance between harmonising rules and maintaining national flexibility where essential, without hampering the single rulebook. The amendments would further promote a uniform application of prudential requirements, the convergence of supervisory practices and ensure a level playing field throughout the internal market for banking services. This is particularly important in the banking sector where many credit institutions operate across the EU internal market. Full cooperation and trust within the single supervisory mechanism (SSM) and within the colleges of supervisors and competent authorities outside the SSM is essential to ensure the effective supervision of credit institutions on a consolidated basis. National rules would not achieve these objectives.
• Proportionality
Proportionality has been an integral part of the impact assessment accompanying the proposal. The proposed amendments in different regulatory fields have been individually assessed against the proportionality objective. In addition, the lack of proportionality of the existing rules has been assessed in several domains and specific options have been analysed aiming at reducing administrative burden and compliance costs for smaller institutions.
For instance, the amendments introducing ex-ante notification requirements for banks on events with prudential relevance are subject to materiality thresholds, below which events need not be notified. Under the new third country branch framework, those branches that qualify as small and less risky (class 2 third country branches) are subject to comparably less stringent prudential and reporting requirements. Lastly, the new requirements for ex-ante fit-and-proper assessment have been calibrated to target only large financial institutions.
• Choice of the instrument
The measures are proposed to be implemented by amending the CRR and the CRD through a Regulation and a Directive, respectively. The proposed measures indeed refer to or further develop already existing provisions inbuilt in those legal instruments (i.e. the framework for calculating risk-based capital requirements, powers and tools made available to supervisors across the Union).
Some of the proposed CRD amendments affecting sanctioning powers would leave Member States with a certain degree of flexibility to maintain different rules at the stage of their transposition into national law.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Ex-post evaluations/fitness checks of existing legislation
The Commission has taken several steps and carried out various initiatives in order to assess whether the current banking prudential framework in the EU and the implementation of the outstanding international standards are adequate to contribute to ensuring that the EU banking system is stable and resilient to economic shocks and remains a sustainable source of steady funding for the EU economy.
The Commission gathered stakeholders’ views on specific topics in the areas of credit risk, operational risk, market risk, CVA risk, securities financing transactions, as well as in relation to the output floor. In addition to these elements related to the Basel III implementation, the Commission has also consulted on certain other subjects with a view to ensuring convergent and consistent supervisory practices across the Union and alleviating the institutions’ administrative burden.
A public consultation carried out between October 2019 and early January 2020 28 had been preceded by a first exploratory consultation conducted in spring 2018 29 , seeking first views of a targeted group of stakeholders on the international agreement. The results of the two consultations have fed into the preparation of the legislative initiative accompanying the impact assessment.
All the initiatives mentioned above have provided clear evidence of the need to update and complete the current rules in order to i) further reduce the risks in the banking sector, and ii) enhance the ability of institutions to channel adequate funding to the economy.
Annex 2 of the impact assessment provides a summary of the consultation.
• Collection and use of expertise
The Commission made use of the expertise of the EBA, which prepared an impact analysis on the implementation of Basel III reform finalisation 30 . In addition, the Commission services considered the ECB macroeconomic analysis. This is presented in the impact assessment and updates the previous macroeconomic analysis published in December 2019.
• Impact assessment 31
The impact assessment considered a range of policy options across four key policy dimensions, in addition to the baseline situation where no Union action is taken. As shown by the simulation analysis and macroeconomic modelling developed in the impact assessment, implementing the preferred options and taking into account all the measures in the proposal is expected to lead to a weighted average increase in EU banks’ minimum capital requirements of +6.4% to +8.4% in the long term (by 2030), after the envisaged transitional period. In the medium term (in 2025), the increase is expected to range between +0.7% and +2.7%.
According to estimates provided by the EBA, this impact could lead a limited number of large EU banks (10 out of 99 banks in the test sample) to have to raise collectively additional capital amounts (less than EUR 27bn for the 10 banks) in order to meet the new minimum capital requirements under the preferred option. To put this amount into perspective, the 99 banks in the sample (representing 75% of EU banking assets) held a total amount of regulatory capital worth EUR 1414bn at the end of 2019 and had combined profits of EUR 99.8bn in 2019.
While banks would incur one-off administrative and operational costs to implement the changes in the rules, the simplifications implied by several of the preferred options (e.g. removal of internally modelled approaches) are expected to reduce the recurring costs compared to today.
• Regulatory fitness and simplification
This initiative is aimed at completing the EU implementation of the international prudential standards for banks agreed by the BCBS between 2017 and 2020. It would complete the EU implementation of the Basel III reform that was launched by the Basel Committee in the wake of the GFC. That reform was in itself a comprehensive review of the prudential framework that was in place before and during the GFC, namely the Basel II framework (in the EU that framework was implemented through Directive 2006/48/EC, i.e. the original CRD). The Commission used the results of the comprehensive review by the BCBS of the prudential framework, together with input provided by the EBA, the ECB and other stakeholders, to inform its implementation work. Pending the implementation of the final Basel III reforms in the EU, a fitness check or refit exercise has not been carried out yet.
• Fundamental rights
The EU is committed to high standards of protection of fundamental rights and is signatory to a broad set of conventions on human rights. In this context, the proposal is not likely to have a direct impact on these rights, as listed in the main UN conventions on human rights, the Charter of Fundamental Rights of the European Union, which is an integral part of the EU Treaties and the European Convention on Human Rights (ECHR).
4. BUDGETARY IMPLICATIONS
The proposal does not have implications for the Union budget.
5. OTHER ELEMENTS
• Implementation plans and monitoring, evaluation and reporting arrangements
It is expected that the proposed amendments will start entering into force in 2023 at the earliest. The amendments are tightly inter-linked with other provisions of the CRR and the CRD that are already in force and have been monitored since 2014 and, with respect to the measures introduced by the risk reduction measures package, since 2019.
The BCBS and the EBA will continue to collect the necessary data for the monitoring of the key metrics (capital rations, leverage ratio, liquidity measures). This will allow for the future impact evaluation of the new policy tools. Regular Supervisory Review and Evaluation Process (SREP) and stress testing exercises will also help monitoring the impact of the new proposed measures on affected institutions and assessing the adequacy of the flexibility and proportionality provided to cater for the specificities of smaller institutions. Additionally, the EBA, together with the SSM and the national competent authorities, are developing an integrated reporting tool (EUCLID) which is expected to be an useful instrument to monitor and evaluate the impact of the reforms. Finally, the Commission will continue to participate in the working groups of the BCBS and the joint task force established by the European Central Bank (ECB) and by the EBA, that monitor the dynamics of institutions’ own funds and liquidity positions, globally and in the EU, respectively.
• Explanatory documents (for directives)
No explanatory documents are considered necessary.
• Detailed explanation of the specific provisions of the proposal
Contents
- Independence of competent authorities
- Supervisory powers
- Clarification of the interplay between the failing or likely to fail declaration (FOLTF) and the withdrawal of authorisation
- Environmental, social and governance (ESG) risks
- Direct provision of banking services in the EU by third country undertakings
- Third country branches (TCBs)
- Source: EBA Report on Third Country Branches
- Current challenges
- Harmonised TCBs framework
- Impact of the new framework
- Review of the administrative sanctioning regime
- Review of the composition of Pillar 2 requirements
- Adjustments accompanying the introduction of the output floor
- Disclosure
- Supervisory benchmarking of approaches for calculating own funds requirements
Recent developments showed the need for clearer and more operational provisions on the principle of independence of competent authorities. Therefore, Article 4 is amended to clarify how Member States must ensure that the independence of competent authorities, including their staff and governance bodies, is preserved. Minimum requirements are introduced to prevent conflicts of interests in the supervisory tasks of competent authorities,their staff and governance bodies, and EBA is mandated to develop guidelines in that regard, taking into account international best practices.
For it to be efficient, the Banking Union relies on the convergence of supervisory practices and, ultimately, on a sufficient degree of harmonisation of the various national rules framing the supervisory action. A certain number of discrepancies between Member States are, in this regard, considered as very detrimental to the proper functioning of the Banking Union. This is, in particular, the case of supervisory powers. While the CRD lists a minimum set of supervisory powers that must be available to competent authorities across the Union, some of them are already in place in many Member States while missing in others. This situation leads to an uneven playing field and, potentially, to regulatory arbitrage. It also makes impossible for some competent authorities to intervene in certain transactions conducted by a supervised entity that may raise strong prudential and/or money laundering/terrorism financing concerns.
To remedy this situation, the Commission’s proposal expands the list of supervisory powers available in the CRD to competent authorities to cover operations such as acquisitions by a credit institution of a material holding in a financial or non-financial entity (new Chapter 3 in the current Title III), the material transfer of assets or liabilities (new Chapter 4) and merger or divisions (new Chapter 5). These supervisory powers will ensure that competent authorities are notified in advance (Articles 27a, 27f and 27j), have at their disposal all the necessary information to perform a prudential assessment of these operations, and can ultimately oppose to the completion of operations (Articles 27b, 27g and 27k) detrimental to the prudential profile of the supervised entities undertaking them.
These new supervisory powers are framed in order stay proportionate, and more specifically to avoid undue additional administrative burden for supervised entities and competent authorities. First of all, powers related to acquisition by credit institutions of qualifying holdings and transfers of assets and liabilities only apply in case of transactions deemed material. A tacit approval mechanism is provided for, similar to the one in place for the acquisition of material holdings in credit institutions, in order to give legal certainty to supervised entities and to prevent that competent authorities be obliged to engage in a standard procedure of adoption of decisions where these are not necessary. Only in the case of mergers and divisions, a prior approval from competent authorities is imposed in all cases (unless the operation is internal to a group), as long as it does not lead to a situation where the new entity stemming from the merger of the division would need to seek an authorisation as a credit institution or an approval as a financial holding company.
In addition, in order to ensure a proper articulation between the various assessments (possibly involving multiple competent authorities) that could have to be undertaken for one single operation, a close cooperation between the competent authorities involved is expected, and framed by requirements to cross notifications and information sharing (Articles 27c, 27h and 27k). To facilitate this cooperation, but also to ensure a proper streamlining of the notification and assessments processes and to avoid undue administrative burden for both supervised entities and competent authorities, a certain number of EBA mandates are proposed to supplement the legal framework envisaged in the CRD for these new supervisory powers. These mandates concern matters such as the information to be sent to the competent authorities, the assessment process, added detail on the relevant assessment criteria, or the cooperation between the various competent authorities which may be involved.
These amendments were subject to dedicated discussions within the Expert Group on Banking, Payments and Insurance.
Fit & Proper
The fit-and-proper framework is one of the least harmonised areas in EU bank supervisory law and, accordingly, amendments to the CRD are deemed necessary to ensure a more consistent, efficient and effective supervision of members of the management body and of key function holders. Despite the efforts made by regulators and supervisors 32 to ensure further supervisory convergence, legislative modifications are necessary to improve their oversight. The current framework for board members, based on national laws implementing the CRD, is largely principle-based and therefore does not detail how and when supervisors should conduct fit-and-proper assessments. As regards key function holders, the absence of a definition and a framework in the CRD has led some supervisors to not properly identify them and therefore to not carry out an assessment of their suitability to perform their duties, while others do it in a variety of ways. This fragmented regulatory landscape is an acute problem, particularly in the Banking Union. Therefore, in addition to the fit-and-proper criteria in Article 91, Articles 91a and 91b are introduced to clarify the role of banks and competent authorities for checking the compliance of board members, including the timing of such assessment. Articles 91c and 91d are added to set minimum requirements for key function holders.
To ensure financial stability, in urgent situations of removal or replacement of members of the management body or senior management in the context of application of early intervention measures or implementation of resolution action by the competent authorities and resolution authorities, the fit-and-proper assessment should be carried out after those persons have taken up their duties.
Clarification of the interplay between the failing or likely to fail declaration (FOLTF) and the withdrawal of authorisation
Article 18 is amended in order to clarify that where a credit institution is declared failing or likely to fail (FOLTF) by the competent authority or by the resolution authority, the competent authority is empowered to withdraw of the banking authorisation.
Some recent cases highlighted a suboptimal alignment between the prudential and the resolution frameworks. To make an example, under the Union’s bank resolution framework, not only actual insolvency or actual illiquidity, but also likely insolvency and likely illiquidity constitute grounds for determining that a credit institution is FOLTF. Instead, national insolvency laws usually require actual insolvency and/or actual illiquidity to occur before an insolvency proceeding can be opened. Some of the elements which are embedded into the national legislative framework for insolvency cannot be addressed via changes to the CRD. However, it is proposed to clarify in Article 18, point (g) that in case a credit institution is FOLTF and, at the same time, it does not meet the other conditions to enter resolution (presence of public interest, absence of a market driven alternative to resolve the crisis), it should discontinue the banking business and be liquidated under national laws.
New provisions are introduced and adjustments made to several Articles in the CRD and in the CRR in order to address the significant risks that credit institutions will face due to climate change and the profound economic transformations that are needed to manage this and other ESG risks. The provisions in Article 133 on the systemic risk buffer (SyRB) framework may already be used to address various kinds of systemic risks, which may include risks related to climate change. The relevant competent or designated authorities, as applicable, may require credit institutions to maintain a systemic risk buffer to address risks with the potential to have serious negative consequences for the financial system and the real economy in Member States, where imposing a systemic risk buffer rate is deemed effective and proportionate to mitigate the risk. According to Article 133(5), measures taken by the relevant competent or designated authorities under Article 133 can be applied across certain sets or subsets of exposures, for instance those subject to physical and transition risks related to climate change. The suitability of the macroprudential framework for dealing with such risks will be assessed in a comprehensive and structured way in the 2022 review of the macroprudential framework.
Article 73 and Article 74 of the CRD are amended to require that short, medium and long-term horizons of ESG risks be included in credit institutions’ strategies and processes for evaluating internal capital needs as well as adequate internal governance.
A reference to the current and forward-looking impacts of ESG risks and a request for the management body to develop concrete plans to address these risks are also introduced in Article 76.
Article 87a of the CRD introduces a sustainability dimension in the prudential framework to ensure a better management of ESG risks and incentivise a better allocation of bank funding across sustainable projects, thus helping the transition to a more sustainable economy. Article 87a also enables competent authorities to review banks’ alignment with the relevant Union policy objectives or broader transition trends relating to ESG factors and banks’ management of ESG risks over the short, medium and long term, leading to an improved understanding of these risks and enabling competent authorities to address financial stability concerns that could arise from credit institutions’ continuing to misprice ESG risks. To ensure the consistency of ESG risk assessments, Article 87a mandates the EBA to specify further the criteria for the assessment of ESG risks, including how they should be identified, measured, managed and monitored as well as how credit institutions should draw concrete plans to address and internally stress test resilience and long-term negative impacts to the ESG risks.
As regards the supervisory review and evaluation process (SREP), the EBA is given the power in Article 98 to issue guidelines on the uniform inclusion of ESG risks in the SREP.
In light of the relevance of future-looking stress tests for gauging environment-related as well as other ESG risks in the review and evaluation process (SREP) under Article 97, Article 100 is amended to enable the EBA together with the other ESAs to develop consistent standards for methodologies to stress test these risks, giving priority to environment-related risks as ESG risk data and methodologies evolve to capture the other factors.
To facilitate the SREP of the credit institutions’ exposures, governance and management of ESG risks, Article 98 is amended to require competent authorities to assess the adequacy of institutions’ exposures as well as of the arrangements, strategies, processes and mechanisms to manage these risks in their review and evaluation.
In order to facilitate the possibility for competent authorities to address ESG risks affecting the prudential situation of the bank over the short, medium and long term, and to reflect the specificities of these category of risks, a concrete supervisory power to address ESG risks is added in Article 104.
Credit institutions are subject to prudential regulation and supervision to minimise the risk of failure and, when it occurs, to manage that failure to prevent that it may spread in a disorderly manner to other credit institutions and market players and lead to the collapse of the financial system (contagion risk). Hence, one of the main purposes of prudential regulation and supervision is to protect the financial stability of the Union and its Member States.
Taking into account this objective, it is essential to prevent that areas or segments in the markets may fall outside the scope or reach of the system of prudential regulation and supervision, as in this scenario risks could build up in those segments in an unchecked fashion and spread to other parts of the financial system with very damaging effects. This is particularly important for those parts of the financial markets where credit institutions are closely involved.
The financial crisis of 2008-2009 is the latest historical precedent which underlines how small market segments may become the source of significant threats to the financial stability of the Union and its Member States if left outside the scope of prudential regulation and supervision.
For that reason, the provision of banking services in the Union requires having a physical presence in a Member State through a branch or a legal person, as only through such physical presence credit institutions may be subject to effective prudential regulation and supervision in the Union. A sensu contrario, the provision of banking services in the Union without a branch or a legal person established in a Member State contributes to creating such type of market segments that fall outside the scope and reach of the Union’s prudential regulation and supervision, where risks may build up unchecked and eventually threaten the financial stability of the Union or its Member States.
Hence, undertakings in third countries must set up a branch in a Member State and seek authorisation under Title VI of the CRD for that branch as a condition for being allowed to start conducting banking activities in that Member State. Article 21c is inserted in the CRD to set this requirement explicitly.
However, this requirement need not apply to cases where such third country undertakings engage in the provision of banking services with clients and counterparts in a Member State through reverse solicitation of services, as in such cases it is the relevant client or counterpart that approaches the undertaking in the third country to solicit the provision of the service.
Overview of TCBs in the EU 33
As of 31 December 2020, there were 106 TCBs in the EU distributed across 17 Member States. The aggregate amount of total assets held by them on that date was just over EUR 510 billion, 86% of which was concentrated in only four Member States (Belgium, France, Germany and Luxembourg).
There seems to be a trend towards an increasing use of TCBs to access Member States’ banking markets, insofar as the total number of TCBs went up by 14 and the amount of assets held by them by EUR 120.5 billion in 2020 relative to 2019.
While a majority of TCBs (70 out of 106) held less than EUR 3 billion in assets, there were two individual TCBs holding assets in excess of EUR 30 billion, and another 14 TCBs held assets in an amount between EUR 10 billion and EUR 30 billion (compared to 6 on the same date of the previous year).
As of 31 December 2020, TCBs established in the EU originated from 23 third countries, the most numerous being from China (18), UK (15), Iran (10), USA (9) and Lebanon (9). Several third country groups (23) have TCBs in more than one Member State. In addition, some of those third country groups also have one or more subsidiaries in the EU. For instance, 14 third country groups have both a TCB and a subsidiary in the same Member State. Of these, 9 third country groups have one subsidiary and two or more TCBs in the EU. Two third country groups have a double presence comprising a TCB and a subsidiary in more than one Member State. The largest 15 third country groups operating in the EU hold more than ¾ of their EU assets via TCBs. As regards the impact of TCBs’ presence in the EU, it can be measured using the following two metrics:
(a)the ratio of TCBs’ aggregate total asset amount per Member State as at 31 December 2019 against the size of the national banking system 34 . This ratio is lower than 1% in 7 Member States, between 1% and 10% in 6 Member States and increases to over 25% in 1 Member State.
(b)the ratio of TCBs’ aggregate total asset amount per Member State as at 31 December 2019 against the size of the national GDP. This ratio is lower than 1% in 7 Member States, between 1% and 10% in 6 Member States and increases to over 25% in 1 Member State.
As for business models and based on available information, 50 TCBs operate as universal banks, while 48 operate only as wholesale banks. Only 4 TCBs operate as retail banks.
As shown in the preceding section, the footprint of TCBs in the EU is already highly significant. In various cases, TCBs hold collectively a very material amount of assets relative to the size of the GDP of their Member State of establishment and of the banking sector of that same Member State. For some TCBs, the individual asset size exceeds the threshold that would make them qualify as significant institutions under the direct supervision of the European Central Bank (ECB) in the context of the Single Supervisory Mechanism (SSM). However, TCBs remain outside the scope of the SSM and not subject to the supervisory requirements laid down in the CRD as they are not credit institutions authorised under Chapter 1 of Title III of that Directive.
In contrast to such background, the establishment of TCBs to provide banking services 35 in the EU is essentially subject to national legislation, as only high level information obligations in relation to them have recently been harmonised as part of CRDV. This creates a patchy regulatory landscape that gives rise to disparate requirements on TCBs in each Member State and to significant challenges for competent authorities to monitor properly the risks that result from the activities they conduct in the EU. For instance:
(a)given the complete absence of a common prudential or governance regulatory framework on TCBs, some of them are subject to only limited requirements in certain Member States;
(b)current EU-wide supervisory cooperation mechanisms do not capture TCBs, which creates blind spots insofar as TCBs generate risks that can spill over in an unfettered fashion to other group entities or to the market. For example, as there is no requirement for competent authorities to exchange comprehensive information on TCBs, authorities supervising a third country group in one Member State lack sufficient information on the TCBs of the same group in another Member State and, by the same token, they also lack adequate tools to deal with such potential spill-over risks;
(c)several third country groups use complex legal structures through a mix of subsidiaries and branches or, depending on the services provided, cross-border operations, to conduct their activities in the EU. Such complex structures can be opaque and very difficult for competent authorities to properly supervise given the different and disjointed set of requirements that apply to each of those. For example, double-hatting of board members can lead to conflicts of interest, while flexible booking and accounting may lead to shifting risk from one entity to the other;
(d)while TCBs should provide services only in the Member States where they are established 36 , enforcing compliance with this requirement is not only difficult, but made almost impossible under the current framework due to the growing trend of financial services’ digitalisation.
TCBs also raise regulatory arbitrage concerns. Where the Member State of establishment imposes low prudential standards, TCBs may effectively allow third country groups to undercut EU banking requirements where their head office is subject to less stringent prudential or supervisory standards in the relevant third country.
Given the material footprint that TCBs already have in EU banking markets and the currently scattered and disjointed prudential and supervisory requirements that they are subject to, there are obvious risks to the financial stability and market integrity of the EU, as well as opportunities for regulatory arbitrage that need addressing through a new harmonised TCBs framework.
While maintaining the status quo is not a desirable option, subjecting TCBs to the full set of prudential and supervisory requirements that apply to credit institutions under the CRR and the CRD might be disproportionate, as it would not cater appropriately for their distinct features relative to credit institutions with their head office in the EU, and would have a material detrimental effect on such TCBs.
Instead, a more appropriate way forward would be to create an ad hoc set of minimum-harmonising requirements that builds on existing national frameworks of Member States currently in force and ensures minimum standards and consistent requirements throughout the Union . Such framework would provide the necessary clarity, predictability and transparency for third country undertakings wishing to conduct banking services through branches in one or various Member States. It would also align the EU requirements on TCBs with prevailing international practices, insofar as numerous third countries apply similar or equivalent requirements to branches of foreign banks active in their territories.
Title VI of the CRD is, therefore, amended to include provisions on the following:
(a)authorisation: the establishment of TCBs is subject to an explicit authorisation procedure and minimum requirements. Those requirements must include cooperation and information arrangements whereby the competent authorities of the TCBs i) have access to enough information on the undertaking in the third country that is the branch’s head office (the TCB’s “head undertaking”) and ii) are able to cooperate with the supervisory authorities of the head undertaking insofar as necessary or relevant to effectively supervise the TCB in the Member State;
(b)minimum regulatory requirements: these comprise obligations on TCBs to:
(i)maintain a minimum capital endowment, calculated as a percentage of the branch’s liabilities for larger and riskier TCBs (class 1) or a fixed amount for smaller TCBs (class 2);
(ii)comply with a liquidity requirement, which for class 1 TCBs must be the same as the liquidity coverage requirement that applies to credit institutions in accordance with Commission Delegated Regulation (EU) 2015/61;
(iii)meet internal governance and risk control requirements, and to implement booking arrangements in order to track the assets and liabilities linked to the business conducted by the TCB in the Member State.
(c)reporting requirements: TCBs are required to report regularly to their competent authorities i) information on their compliance with the requirements laid out in the CRD and in national law and ii) financial information in relation to the assets and liabilities on their books;
(d)supervision: competent authorities are required to conduct regular reviews of TCBs’ compliance with their regulatory requirements, including for AML purposes, and take supervisory measures to ensure or restore compliance with those requirements. Competent authorities of class 1 TCBs are required to include them in the colleges of supervisors of the relevant group, where one already exists, or otherwise set up an ad hoc college for class 1 TCBs of the same group operating in more than one Member State.
For reasons of proportionality, and in particular to avoid any unnecessary additional administrative burden for small(er) TCBs, the scope and level of prudential requirements is modulated to differentiate between class 1 and class 2 TCBs. The former class comprises the larger TCBs (i.e. those holding assets equal to or in excess of EUR 5 billion), as well as TCBs authorised to take deposits from retails customers and TCBs considered “non-qualifying”, the latter two regardless of their size. Class 2 comprises all TCBs not classified as class 1.
A TCB is considered ‘qualifying’ where its head office is established in a country i) that has in place a supervisory and regulatory framework for banks and confidentiality requirements that have been assessed as equivalent to those in the Union and ii) that is not listed as a high-risk third country that has strategic deficiencies in its regime on anti-money laundering and counter terrorist financing.
Member States must ensure that their competent authorities have the necessary powers to require TCBs established in their territory to apply for authoritisation as subsidiary institutions under the CRD in specific cases (power to subsidiarise). For instance, this power must be capable of being used on a TCB that engages in transactions or business with counterparts in other Member States in contravention of the internal market rules. Moreover, the same power must also be available for using in cases where a TCB poses risks to the financial stability of the relevant Member State or of the EU, taking into account certain systemic risk indicators laid down in the CRD and further detailed in regulatory technical standards.
Where TCBs have assets on their books in an amount equal to or higher than EUR 30 billion, competent authorities 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 (assessment of systemic importance). The EUR 30 billion threshold must be calculated taking into account the assets booked by all the TCBs belonging to the same third country group in the EU, whether in a single or in various Member States, and measured either as an average over a period of three consecutive years or as a minimum absolute threshold reached for at least 3 years over a period of 5 consecutive years. For the purposes of carrying out the systemic importance assessment, competent authorities must have regard to the systemic risk indicators referred to in the preceding paragraph. Where, in the light of those indicators, competent authorities conclude that the relevant TCBs are systemic, they may require such TCBs to apply for authoritisation as subsidiary institutions under the CRD in order to continue conducting banking activities in the Member State and the EU (requirement to subsidiarise). Alternatively, competent authorities may decide either (i) 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 30bn threshold (requirement to restructure); or (ii) to impose additional Pillar 2 requirements on the third country group’s TCBs and subsidiary institutions in the EU (e.g. additional capital, liquidity, reporting or disclosure requirements), where those Pillar 2 requirements are appropriate and sufficient to mitigate potential risks to financial stability (Pillar 2 requirements). Competent authorities may only decide not to impose any of the above requirements on the TCBs where they can justify that the risks that such TCBs pose to financial stability and market integrity would not significantly increase in the absence of those requirements (decision to defer). Competent authorities must reassess their decision to defer within one year from the date the decision was made.
The assessment of systemic importance of TCBs belonging to a third country group with branches and subsidiaries across the EU must be led by (i) the consolidating supervisor of the relevant group in the Union, where Article 111 of the CRD applies; (ii) the competent authority that would become the consolidated of the group in the EU in accordance with that Article if the TCBs were treated as subsidiary institutions; or (iii) EBA, where the lead competent authority has not commenced the assessment or the hypothetical consolidated supervisor has not been determined within a period of three months. The decision whether to impose any of the above-referred requirements or to defer imposing such requirements on TCBs assessed as systemic, must be taken as a joint decision by the lead competent authority and the competent authorities responsible for supervising the TCBs and subsidiaries of the same third country group.
Furthermore, the new TCB framework does not supersede or prevent any discretion that Member States may currently have to impose a requirement of general application on undertakings established in certain third countries to conduct banking activities in their territory through subsidiaries authorised in accordance with Chapter 1 of Title III of the CRD.
Under the proposed new framework, TCBs currently operating in the EU will need to be re-authorised. However, the compliance and transitional costs associated with this authorisation and on-going operation would be significantly mitigated by the following circumstances:
(a)TCBs will have a transitional period of 12 months following the 18 months transposition period of the Directive to obtain the authorisation and, therefore, will be able to spread out the transitional costs over that period;
(b)the authorisation and prudential requirements are largely based on existing national requirements in various Member States and, since the new framework contains requirements very similar to those, TCBs would only need to incur limited costs to adapt;
(c)based on 31 December 2020 data, up to 40 out of 106 TCBs authorised to operate in various Member States would have qualified as class 2 and, hence, those 40 would be subject to comparatively less stringent prudential and reporting requirements under the new framework;
(d)based on the same data and as of that date, only 3 TCBs had assets on their books in excess of EUR 30 billion and, thus, would be subject to the assessment of systemic importance.
While TCBs may be subject to additional costs to comply with the new reporting requirements, these would be justified in order to meet the objective of enhancing the protection of financial stability and market integrity.
Periodic penalty payments are introduced as a new enforcement tool aimed at ensuring that credit institutions swiftly comply with the prudential rules. In addition, a clear distinction is made between periodic penalty payments and administrative penalties. The list of breaches subject to administrative penalties and sanctions is supplemented with prudential requirements currently missing on the list of sanctionable breaches under article 67 of the CRD. Articles 66 and 67 of CRD are amended to clarify the definition of “total annual net turnover” and define it by reference to the business indicator in the new Article 314 of the CRR.
To ensure a level playing field in the field of sanctioning powers, Member States are required to provide for administrative penalties, periodic penalty payments and other administrative measures in relation to breaches of national provisions transposing the CRD and the CRR. In addition, procedural safeguards are introduced for the effective application of penalties especially in the case of accumulation of administrative and criminal penalties on the same breach. To this end, Article 70 of CRD is amended to require Member States to lay down rules on the cooperation between competent authorities and judicial authorities in cases of duplication of criminal and administrative proceedings and penalties on the same breach. These rules are intended to provide for a sufficient level protection for the natural or legal person subject to this duplication of proceedings in accordance with the “ne bis in idem principle”.
In order to enhance the internal coherence of the regulatory framework, CRD V aligned the nature of regulatory capital that banks must hold to meet the Pillar 2 capital requirement with the minimal capital composition of the Pillar 1 capital requirement. By derogation from the general rule set out in Article 104a i of the CRD, supervisors have the discretion to decide, on a case by case basis, to impose Pillar 2 capital requirements with a higher share of Tier 1 capital or CET 1 capital. This new treatment has been implemented only recently during the COVID-19 crisis. While it is still too early for comprehensive conclusions on the recent alignment, a first review has confirmed the usefulness of a consistent standard composition of minimum (Pillar 1) and additional (Pillar 2) capital requirements.
The introduction of the output floor (OF) in the calculation of the total risk exposure amount (TREA) as set out in Article 92 of the CRR will have an impact on those own funds requirements set out in the CRD the calculation of which depends on TREA. Those requirements are the capital conservation buffer (CCB) requirement, the countercyclical capital buffer (CCyB) requirement, the buffer requirements for global systemically-important and other systemically-important institutions (G-/O-SIIs), the systemic risk buffer (SyRB) requirement, and – to the extent a competent authority uses an approach that sets it as a percentage of TREA from the outset 37 – the institution-specific Pillar 2 requirement (P2R).
Two of those requirements, namely the P2R and the SyRB, can be used to address risks that are similar in nature to those addressed by the OF. Consequently, there is a possibility that certain risks (e.g. model risk 38 ) could be double-counted once the OF starts to apply. This needs to be avoided. The EBA's advice on the Basel III finalisation includes a specific recommendation on this issue and calls, more generally, on competent and designated authorities to reconsider the appropriate level of P2R and the SyRB, respectively, once the OF will start to apply.
In view of the above, the proposal amends Articles 104a and 133 of the CRD - setting out the rules on the P2R and the SyRB, respectively - by introducing safeguards aimed at preventing unjustified increases in the P2R and the SyRB requirement following an institution becoming bound by the OF 39 :
·the P2R and the SyRB requirement will be “frozen” to avoid automatic (also referred to as “arithmetic”) increases in the amount of regulatory capital required under those two requirements. This safeguard is justified by the fact that the increase in RWAs due to the institution becoming bound by the OF is, all else being equal, purely arithmetic and is not reflective of an actual increase in risks that would justify requiring additional capital from the institution;
·the institution’s competent authority will be required to review the calibration of the P2R and the competent or designated authority, as applicable, will be required to review the calibration of the the SyRB requirement, respectively, to establish whether double-counting of risk is present, and if so, to re-calibrate those requirements to avoid such double-counting;
·the two requirements will remain frozen until the respective reviews will be concluded and the relevant decisions on the appropriate calibration of the requirements will be announced 40 .
Articles 104a and 133 of the CRD are also amended to clarify that the P2R and the SyRB requirement cannot be used to cover risks that are already fully covered by the OF.
Finally, Article 131 is amended to require competent or designated authorities, as applicable, to review the calibration of the O-SII buffer requirement of an O-SII when that O-SII becomes bound by the OF, to make sure that the calibration remains appropriate.
Article 106 is amended to allow Member States to grant supervisors the power to require institutions to submit information to the EBA within a deadline. This follows the changes made to Articles 433 and 434 of the CRR, which require EBA to centralise the publication of institutions’ disclosures. In addition, the proposal enables supervisors to allow institutions to use specific media and locations for publications other than the EBA website. This is in line with the proposed change to the CRR according to which, in addition to the centralised EBA’s publication, institutions remain free to publish their own disclosures via other means.
Article 78 is amended to add two types of approaches to calculate own funds requirements to the approaches included in the scope of the supervisory benchmarking, namely:
(a)modelling approaches used to calculate expected credit risk losses both under International Financial Reporting Standard (IFRS) 9 and under national accounting standards; and
(b)the alternative standardised approach for market risk set out in Part Three, Title IV, Chapter 1a of the CRR given that institutions can model certain parameters under that approach.
Since the approaches used to calculate expected credit risk losses can also be used by institutions using the standardised approach for credit risk set out in Part Three, Title II, Chapter 2 of the CRR, those institutions are also included in the scope of the supervisory benchmarking exercise. However, the EBA is required to decide which of those institutions must be included, taking into account the principle of proportionality.
Article 78 is also amended to allow for the possibility of reducing the frequency of the benchmarking exercises from annual to biennial in recognition of the fact that after a certain number of exercises are been carried out, a lower frequency is likely to be sufficient to monitor the outcomes of institutions’ approaches. This will also reduce the administrative burden for institutions using the benchmarked approaches.