Explanatory Memorandum to COM(2021)664 - Amendment of Regulation (EU) No 575/2013 as regards requirements for credit risk, credit valuation adjustment risk, operational risk, market risk and the output floor

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dossier COM(2021)664 - Amendment of Regulation (EU) No 575/2013 as regards requirements for credit risk, credit valuation adjustment risk, ...
source COM(2021)664 EN
date 27-10-2021


1. CONTEXT OF THE PROPOSAL

• Reasons for and objectives of the proposal

The proposed amendment to Regulation (EU) No 575/2013 (the Capital Requirements Regulation or CRR) is part of a legislative package that includes also amendments to Directive 2013/36/EU (the Capital Requirements Directive or CRD) 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 are required to have to cover potential losses. Furthermore, they aimed at reducing banks’ excessive leverage, increasing institutions’ 8 resilience to short-term liquidity shocks, reducing their reliance on short-term funding, reducing their concentration risk, and addressing too-big-to-fail problems 9 .

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 10 (CVA) risk and for exposures to central counterparties 11 . 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 12 and macro-prudential capital buffers 13 .

Thanks to this first set of reforms implemented in the Union 14 , 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 15 , 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 16 . Together with resolute monetary and fiscal policy measures 17 , this helped institutions to keep on lending to households and companies during the pandemic. This, in turn, helped mitigate the economic shock 18 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 European Banking Authority (EBA) and the European Central Bank (ECB) have shown that the capital requirements calculated by institutions established in the EU 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. 19 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 20 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. 21

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. 22

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 institutions’ administrative costs related to public disclosures and to improve access to institutions’ prudential data.

To strengthen the risk-based capital framework

The temporarily stressed economic conditions have not altered the need to deliver on this structural reform. Completing the reform is necessary to address the outstanding issues and to further strengthen the financial soundness of institutions established in the EU, putting them in a better position to support economic growth and withstand potential future crises. The implementation of the outstanding elements of the Basel III reform 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) 23 and Commission Communication on achieving the EU’s 2030 Climate Target (‘Fit for 55’) 24 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 Strategy for Financing the Transition to a Sustainable Economy 25 that builds on previous initiatives and reports, such as the action plan on financing sustainable growth 26 and the reports of the Technical Expert Group on Sustainable Finance 27 , but reinforces the Commission’s efforts in this area to bring them in line with the ambitious goals of the EGD.

Bank-based intermediation will play a crucial role in financing the transition to a more sustainable economy. At the same time, the transition to a more sustainable economy is likely to entail risks for institutions 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. The Strategy for Financing the Transition to a Sustainable Economy acknowledged this and highlighted the need to include a better integration of environmental, social and governance (ESG) risks into the EU prudential framework as the present legal requirements alone are deemed insufficient to provide incentives for a systematic and consistent management of ESG risks by institutions.

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 institutions and their activities, assess the suitability of their management, or sanction them in case they break the rules). While Union 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 single market and raises doubts about the sound and prudent management of institutions 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.

Another important issue, namely the lack of 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 mainly subject to national legislation and harmonised to only a very limited extent by the CRD. A recent report by the EBA 28 shows that this scattered prudential landscape provides TCBs with significant opportunities for regulatory and supervisory arbitrage to conduct their banking activities on the one hand, whilst resulting in a lack of supervisory oversight and increased financial stability risks for the EU on the other hand.

Supervisors often lack the information and powers needed to address those risks. The absence of detailed supervisory reporting and 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 negatively impacting the level playing field among third country groups operating across different Member States, as well as vis-à-vis institutions headquartered in the EU.

To reduce institutions’ administrative costs related to public disclosures and improve access to institutions’ 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 institutions. 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 institutions’ prudential situations. This ultimately reduces the effectiveness of the prudential framework for institutions 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 EBA is also aimed at reducing the administrative burden for institutions, especially small and non-complex ones.

• Consistency with existing policy provisions in the policy area

Several elements of the proposals amending the CRR and the CRD follow work undertaken at international level, or by EBA, while other adaptations to 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 SSM.

The proposals introduce amendments to the existing legislation that are fully consistent with the existing policy provisions in the area of prudential regulation and supervision of institutions. The review of the CRR and of the CRD aims at finalising the implementation of the Basel III reform in the EU as well as strengthening and harmonising supervisory tools and powers. These measures 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 single resolution – are in place, resting on the solid foundation of a single rulebook for all EU institutions.

The proposals aim 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. It will contribute the European Green Deal’s objective that climate risks are managed and integrated into the financial system and the strategic areas of action set out in the 2021 Strategic Foresight Report 29 .

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 institutions within the Union, with the objective of ensuring the stability of the single market. The banking sector is currently providing the largest part of financing within the single market, making it one of the fundamental components of the Union’s financial system. The Union has a clear mandate to act in the area of the single market and the appropriate legal basis consists of the relevant Treaty Articles 30 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 the CRR and Article 53(1) TFEU for the proposal for a directive amending the CRD.

• Subsidiarity (for non-exclusive competence)

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 Union 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 – 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 tools and powers disclosures and third country branches, if the initiative is left to be dealt with at national level only, this may result in reduced transparency and increased risk of arbitrage, 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.

Amending 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 single market for banking services. This is particularly important in the banking sector where many institutions operate across the EU single market. Full cooperation and trust within the SSM and within the colleges of supervisors and competent authorities outside the SSM is essential to ensure the effective supervision of 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 presented in several domains and specific options have been analysed aiming at reducing administrative burden and compliance costs for smaller institutions. This is the case, in particular, of the measures in the area of disclosure, where the compliance burden for small and non-complex institutions would be significantly reduced, if not eliminated. Moreover, the disclosure requirements related to the disclosure of ESG risks that are proposed to be applied to all institutions (i.e. beyond large, listed banks to whom the existing requirement will apply from 2022), will be tailored in terms of periodicity and detail to the size and complexity of the institutions, thus respecting the proportionality principle.

• 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

• Stakeholder consultations

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 elements of the Basel III reform 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 institutions’ administrative burden.

A public consultation carried out between October 2019 and early January 2020 31 had been preceded by a first exploratory consultation conducted in spring 2018 32 , seeking first views of a targeted group of stakeholders on the international agreement. In addition, a public conference was organised in November 2019 to discuss the impact and challenges of implementing the finalised Basel III standards in the EU. Annex 2 of the impact assessment provides the summaries of the consultation and the public conference.

Commission services have also repeatedly consulted Member States on the EU implementation of the final elements of the Basel III reform and other possible revisions of the CRR and the CRD in the context of the Commission Expert Group for Banking, Payment and Insurance (EGBPI).

Finally, during the preparatory phase of the legislation, the Commission services have also held hundreds of meetings (physical and virtual) with representatives of the banking industry as well as other stakeholders.

The results of all the above mentioned initiatives have fed into the preparation of the legislative initiative accompanying the impact assessment. They 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.

• Collection and use of expertise

The Commission made use of the expertise of EBA, which prepared an impact analysis on the implementation of the outstanding elements of the Basel III reform 33 . In addition, the Commission services made use of the expertise of the ECB, which prepared a macroeconomic analysis of the impact of implementing those elements. 34

• Impact assessment

For each of the problems identified, the impact assessment 35 considered a range of policy options across four key policy dimensions, in addition to the baseline situation where no Union action is taken.

For what concerns the implementation of Basel III, the analysis and macroeconomic modelling developed in the impact assessment show that implementing the preferred options and taking into account all the measures in the proposal is expected to lead to a weighted average increase in institutions’ 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 EBA, this impact could lead a limited number of large institutions (10 out of 99 institutions in the test sample) to have to raise collectively additional capital amounts of less than EUR 27bn in order to meet the new minimum capital requirements under the preferred option. To put this amount into perspective, the 99 institutions 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.

More generally, while institutions would incur one-off administrative and operational costs to implement the proposed changes in the rules, no significant increases in costs are expected. Furthermore, the simplifications implied by several of the preferred options (e.g. removal of internally modelled approaches, centralised disclosures) are expected to reduce the 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 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 EBA will continue to collect the necessary data for the monitoring of the key metrics (capital ratios, 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, EBA, together with the SSM and the national competent authorities, are developing an integrated reporting tool (EUCLID) which is expected to be a 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 EBA, that monitor the dynamics of institutions’ own funds and liquidity positions, globally and in the EU, respectively.

• Detailed explanation of the specific provisions of the proposal

Contents

1.

Enhanced definitions of entities to be included in the scope of prudential consolidation


Recent events have highlighted the need to clarify the provisions on prudential consolidation to ensure that financial groups that are headed by fintech companies or include, in addition to institutions, other entities that engage directly or indirectly in financial activities are subject to consolidated supervision. To that end, Article 4 is emended to clarify and enhance the definitions of the terms ‘ancillary services undertaking’(ASU), ‘financial holding company’ and ‘financial institution’, which are all key concepts in this regard. ASUs should be considered as financial institutions and hence be included in the scope of prudential consolidation.

Furthermore, it is also proposed to update the definitions of the terms ‘parent undertaking’ and ‘subsidiary’ in line with the applicable accounting standards, and align them with the concept of ‘control’ already provided for in the CRR to avoid inconsistent application of the rules and regulatory arbitrage.

2.

Own Funds


Definitions of ‘indirect holding’ and ‘synthetic holding’

According to Article 72e(1) of the CRR, institutions that are subject to Article 92a of the CRR are required to deduct indirect and synthetic holdings of certain eligible liabilities instruments. However, the current definitions of the term ‘indirect holding’ and ‘synthetic holding’, respectively, capture holdings of capital instruments only. Therefore, those definitions are amended to also capture holdings of relevant liabilities (Article 4(1), points (114) and (126), of the CRR).

3.

Capital instruments of mutuals, cooperative societies, savings institutions or similar institutions


Following the withdrawal of the United Kingdom from the EU pursuant to Article 50 of the Treaty on European Union, Article 27(1), point (a)(v), of the CRR is no longer relevant for institutions established in the Union (it was introduced to cater for the needs of an institution established in the UK). The provision is therefore deleted.

4.

Threshold exemptions from deduction from Common Equity Tier 1 items


For the purposes of applying some of the own funds related deductions set out in the CRR, institutions have to calculate certain thresholds that are based on their Common Equity Tier 1 (CET1) items after applying prudential filters and most CET1 related deductions. In order to keep the calculation of the relevant thresholds coherent, and to avoid an asymmetry in the treatment of certain deductions for the thresholds, the new CET1 related deductions envisaged by Regulation (EU) 2019/630 of the European Parliament and of the Council 36 and by Regulation (EU) 2019/876 also need to be taken into account for the calculation of the relevant CET1 items. Therefore, references to Article 36(1), points (m) and (n), of the CRR are added to Articles 46(1), 48(1), 60(1), 70(1), and 72i(1) of the CRR. At the same time, in order to accommodate the removal of the deductions of equity exposures under an internal models approach, the reference to Article 36(1), point (k)(v), is deleted from those provisions.

5.

Minority interests in the context of third-country subsidiaries


Regulation (EU) 2019/2033 of the European Parliament and of the Council 37 (Investment Firms Regulation) envisaged changes to the terms ‘institution’ and ‘investment firm’ (Article 4(1), points (2) and (3), of the CRR). A new Article 88b is inserted to ensure that subsidiaries that are located in a third country could nevertheless still be considered for the purposes of Part Two, Title II, of the CRR (i.e. determination of minority interests), provided that those subsidiaries would fall under the revised definitions of those terms if they were established in the Union.

Some additional changes are applied to Articles 84(1), 85(1), and 87(1) of the CRR in the context of third-country subsidiaries. These changes do not alter the current calculation of minority interests, but aim at clarifying the legal text as a follow-up to recent answers provided by the Commission via the EBA Single Rulebook Q&A tool.

6.

Output floor


An output floor (OF) to the risk-based capital requirements is introduced through amendments to both the CRR and the CRD. It represents one of the key measures of the Basel III reforms and aims to reduce the excessive variability of institutions’ own funds requirements calculated using internal models, and thereby enhance the comparability of institutions’ capital ratios. It sets a lower limit to the capital requirements that are produced by institutions’ internal models, at 72.5% of the own funds requirements that would apply on the basis of standardised approaches. The decision to introduce the OF is based on analysis revealing that institutions’ use of internal models makes them prone to underestimate risks, and hence own funds requirements.

The calculation of floored risk-weighted assets (RWAs) is set out in Article 92 of the CRR. Specifically, Article 92(3) is amended to specify which total risk exposure amount (TREA) – floored or un-floored – is to be used for the calculation of the minimum (so-called “Pillar 1”) own funds requirements.

The floored TREA, as set out in Article 92(5), is to be used only by the EU parent institution, financial holding company or mixed financial holding company of a banking group for the purposes of the group solvency ratio calculated at the highest level of consolidation in the EU.

By contrast, the un-floored TREA continue to apply to any group entity for the calculation of own funds requirements at individual level, as specified further in Article 92 i.

Every parent institution, financial holding company or mixed financial holding company in a Member State (different form the EU parent’s location) needs to calculate its share of the floored TREA used for the consolidated group own funds requirement by multiplying that consolidated group’s own funds requirement by the proportion 38 of the sub-consolidated RWAs that are attributable to that entity and its subsidiaries in the same Member State, as applicable.

The consolidated group’s RWAs that are attributable to an entity/subgroup are to be calculated in accordance with Article 92(6) as the entity’s/subgroup’s RWAs, as if the OF would apply to its TREA. This would recognise the benefits of risk diversification across the business models of different entities within the same banking group. At the same time, any potential increase in the own funds required due to the application of the OF at consolidated level would have to be distributed fairly across the subgroups which are located in other Member States than the parent, according to their risk profile.

Article 92(7) replicates the provisions of former Article 92 i, clarifying the calculation factors to be applied to the various risk types covered by the own funds requirements.

Credit risk framework – standardised approach

The standardised approach for credit risk (SA-CR) is used by the majority of institutions across the EU to calculate the own funds requirements for their credit risk exposures. In addition, the SA-CR must serve as a credible alternative to internal model approaches and as an effective backstop to them. The current SA-CR has been found to be insufficiently risk-sensitive in a number of areas, leading sometimes to inaccurate or inappropriate measurement of credit risk (either too high or too low) and hence, to inaccurate or inappropriate calculation of own funds requirements.

The revision of the SA-CR increases the risk sensitivity of this approach in relation to several key aspects.

7.

Exposure value of off-balance sheet items


The revised Basel rules text introduced a number of changes to how institutions are to determine the exposure value of off-balance sheet items and commitments on off-balance sheet items.

Article 5 is amended to introduce the definition of the term ‘commitment’ and the derogation of contractual arrangements that meet specific conditions from being classified as commitments.

Article 111 is amended to align the credit conversion factors (‘CCFs’) applicable to off-balance sheet exposures to the Basel III standards, by introducing two new CCF of 40% and 10%, respectively, and removing the 0% CCF. The treatment of the commitments on off balance-sheet items is also clarified with regard to the CCFs applicable to determine their exposure value.

The exemption introduced in Article 5, in accordance with Basel III standards, will allow institutions, however, to continue to apply a 0% CCF to specific contractual arrangements for corporates, including SMEs, that are not classified as ‘commitments’. Furthermore, Article 495d introduces a transitional period whereby institutions are permitted to apply a 0% CCF to unconditionally cancellable commitments until 31 December 2029; after this date, incrementing CCF value will be phased-in over the next three years, with the CCF value at the end of the phasing-in period reaching 10%. This transitional period will allow the EBA to assess whether the impact of a 10% CCF for those commitments would not lead to unintended consequences for certain types of obligors that rely on those commitment as a source of flexible funding. On the basis of that assessment, the Commission will need to decide whether to submit to the European Parliament and to the Council a legislative proposal to amend the CCF to be applied to unconditionally cancellable commitments.

The classification of off-balance sheet items in Annex I is amended in accordance with the revised Basel III standards to better reflect the grouping of those items in buckets based on applicable CCFs.

Article 111 is further amended to introduce a mandate for EBA to specify technical elements that would allow institutions to correctly assign their off-balance sheet exposures to the buckets in Annex I, and hence to correctly calculate the exposure value for these items.

8.

Exposures to institutions


The revised Basel III standards amended the current treatment of exposures to institutions, introducing the Standardised Credit Risk Assessment Approach (SCRA) alongside the existing External Credit Risk Assessment Approach (ECRA). While the ECRA relies on external credit risk assessments (i.e. credit ratings) provided by eligible credit assessment institutions (ECAIs), to determine the applicable risk weights, under the SCRA institutions are required to classify their exposures to institutions into one of three buckets (“grades”).

Article 120 is amended in line with the Basel III standards to lower the risk weight applicable to exposures to institutions for which a credit quality step 2 credit assessment by a nominated ECAI is available, and to include in the scope of short-term exposures those which arise from the movement of goods across national borders with an original maturity of six months or less.

Article 121 is amended to introduce the SCRA provided by the Basel III standards for exposures to institutions for which no credit assessment by a nominated ECAI is available. This approach requires institutions to classify their exposures to these institutions into one of three grades based on several quantitative and qualitative criteria. In order to avoid a mechanistic application of the criteria, institutions are subject to the due diligence requirements set out in Article 79 of the CRD as for exposures to institutions for which a credit assessment by a nominated ECAI is available when assigning the applicable risk weight. This ensures that the own funds requirements appropriately and conservatively reflect the creditworthiness of the institutions’ counterparties regardless of whether the exposures are externally rated or not. In line with the Basel III standards, the current option of risk-weighting exposures to institutions based on their sovereigns’ ratings is removed to break the link between institutions and their sovereigns.

Article 138 is amended in line with the Basel III standards to break the bank-sovereign link also for rated institutions by prohibiting that credit assessments by a nominated ECAI from incorporating assumptions of implicit government support, unless the ratings refer to public sector institutions.

9.

Exposures to corporates


Article 122 is amended in line with the Basel III standards to lower the risk weight applicable to exposures to corporates for which a credit quality step 3 credit assessment by a nominated ECAI is available.

With the implementation of the OF, institutions using internal models to calculate own funds requirements for exposures to corporates would also need to apply the SA-CR which relies on external ratings to determine the credit quality of the corporate borrower. Most EU corporates, however, do not typically seek external credit ratings, due to the cost of establishing a rating and other factors. Given that own funds requirements calculated under the SA-CR are, on average, more conservative for unrated corporates than for corporates that have a rating, the implementation of the OF could cause substantial increases in own funds requirements for institutions using internal models. To avoid disruptive impacts on bank lending to unrated corporates and provide enough time to establish public and/or private initiatives aimed at increasing the coverage of credit ratings, Article 465 is amended to provide for a specific transitional arrangement for exposures to unrated corporates when calculating the OF During the transitional period, institutions are allowed to apply a preferential risk weight of 65% to their exposures to corporates that do not have an external rating, provided that those exposures have a probability of default (PD) of less or equal to 0.5% (this corresponds to an ‘investment grade’ rating). This treatment applies to all unrated corporates, irrespective of whether they are listed or not. EBA shall monitor the use of the transitional treatment and the availability of credit assessments by nominated ECAIs for exposures to corporates. EBA will be required to monitor the use of the transitional treatment and prepare a report on the appropriateness of its calibration. On the basis of that report, the Commission will need to decide whether to submit to the European Parliament and to the Council a legislative proposal on the treatment of unrated corporate exposures of high credit quality. .

Measures to improve the availability of external ratings for corporates are proposed through amendments to Article 135.

10.

Treatment of specialised lending exposures


Promoting viable infrastructure projects and other specialised projects is of vital importance for the economic growth of the Union. Specialised lending by institutions is also a defining characteristic of the Union economy, as compared with other jurisdictions where such projects are predominantly financed by capital markets. Large institutions established in the EU are major providers of funding for specialised projects, objects finance and commodities finance, in the Union and globally; as such, they have developed a high level of expertise in those areas. Business is conducted mainly with special purpose entities that typically serve as borrowing entities and for which the return on the investment is the primary source of repayment of the financing obtained.

In line with the Basel III standards, a specialised exposures class as well as two general approaches to determine applicable risk weights for specialised exposures, one for externally rated exposures and one for exposures which are not externally rated, are introduced under the SA-CR in the new Article 122a. Project finance, object finance and commodities finance exposure classes are introduced under the SA-CR, in line with the same three subcategories in the internal ratings-based (IRB) approaches.

Since the new standardised treatment under the Basel III framework for unrated specialised lending exposures is not sufficiently risk-sensitive to reflect the effects of comprehensive security packages usually associated with some object finance exposures in the Union, additional granularity is introduced in the SA-CR for these exposures. Unrated object finance exposures that benefit from a prudent and conservative management of the associated financial risks by complying with a set of criteria capable to lower their risk profile to a standard of “high quality” benefit from a favourable capital treatment when compared to the general treatment of unrated object finance exposures under the Basel III standards. The determination of what constitutes “high quality” for object finance is subject to further specific conditions to be developed by EBA through draft regulatory technical standards.

The preferential treatment introduced in CRR II to foster bank finance and private investment in high quality infrastructure projects (‘infrastructure supporting factor’) provided in Article 501a is maintained under both the SA-CR and the IRB approaches for credit risk with targeted clarifications, resulting in lower own funds requirements for infrastructure projects than the specific treatment provided by the Basel III standards. However, the preferential treatment provided in the new Article 122a for “high quality” project finance exposures will only apply to exposures to which institutions do not already apply the ‘infrastructure supporting factor’ treatment under Article 501a to avoid an unjustified reduction in own funds requirements.

11.

Retail exposures


Article 123 is amended to further align the classification of retails exposures under SA-CR with the classification under the IRB approaches so as to ensure a consistent application of the correspondent risk weights to the same set of exposures. Article 123 is also amended to introduce a preferential risk-weight treatment of 45% for revolving retail exposures that meet a set of conditions of repayment or usage capable to lower their risk profile, defining them as exposures to “transactors”, in line with the Basel III standards. Exposures to one or more natural persons that do not meet all the conditions to be considered retail exposures are to be risk weighted at 100%.

12.

Exposures with currency mismatch


A new Article 123a is inserted to introduce a risk-weight multiplier requirement for unhedged retail and residential real estate exposures to individuals where there is a mismatch between the currency of denomination of the loan and that of the obligor's source of income. As set out in the final Basel III standards, the multiplier is set at the level of 1.5, subject to a cap for the resulting final risk weight of 150%. Where the currency of the exposures is different from the domestic currency of the country of residence of the obligor, institutions may use all unhedged exposures as a proxy.

13.

Exposures secured by real estate


In line with the final Basel III standards, the treatment of the real estate exposure class is amended to increase further the granularity with regard to the inherent risk posed by different types of real estate transactions and loans.

The new risk weight treatment maintains the distinction between residential and commercial mortgages, but adds further granularity according to the type of financing of the exposure (dependent or not on income streams generated by the collateralised property) and according to the phase the property is in (construction phase vs. finalised property).

One novelty is the introduction of a specific treatment of income producing real estate (IPRE) mortgage loans, i.e. that mortgage loans the repayment of which is materially dependent on the cash flows generated by the property securing those loans. Evidence gathered by the Basel Committee shows that those loans tend to be materially riskier than mortgage loans the repayment of which are materially dependent on the underlying capacity of the borrower to service the loan. However, under the current SA-CR, there is no specific treatment for such riskier exposures, even though this dependence on cash flows generated by the property securing the loan is an important risk driver. The lack of a specific treatment may result in insufficient levels of own funds requirements to cover unexpected losses on this type of real estate exposures.

In Article 4, several definitions are amended, replaced or newly inserted to clarify the meaning of the various types of exposures secured by mortgages on immovable property in line with the revised treatments in Part III (points (75) to (75g)).

Article 124 is replaced to set out in paragraphs 1 to 5 the general and some specific requirements for the assignment of risk weights for exposures secured by mortgages on residential immovable property and commercial immovable property, respectively, including for (residential and commercial) IPRE mortgages. Paragraphs 6 to 10 retain the current periodic assessment of the appropriateness of the standard risk weights and the process to increase them at the discretion of the designated authority.

Article 125 is replaced to implement the revised Basel III treatment for exposures secured by mortgages on residential property. While the loan splitting approach, which splits mortgage exposures into a secured and an unsecured part and assigns the corresponding risk weight to each of these two parts, is retained, its calibration is adjusted in line with the Basel III standards whereby the secured part of the exposure up to 55% of the property value receives a risk weight of 20%. This calibration of the risk weight for the secured part addresses the situation where the institution may incur additional unexpected losses even beyond the haircut that is already applied to the value of the property when selling it in case of a default of the obligor. Furthermore, Article 125 provides a more risk-sensitive fall-back treatment depending on the exposure-to-value (ETV) ratio for residential mortgages where the property is not eligible for the loan-splitting (e.g. because it is not finished).

The amended Article 125 also lays down a dedicated and more granular risk weight treatment which applies to residential IPRE exposures unless the so-called “hard test” is met: where the competent authority of the Member State where the property securing the mortgage is located has published evidence showing that the property market is well-developed and long-established with yearly loss rates which do not exceed certain thresholds, the same preferential risk weights may be applied to residential IPRE exposures as for other residential exposures where the risk of the borrower does not materially depend on the performance of the property.

Article 126 is replaced to implement the revised Basel III treatment for exposures secured by mortgages on commercial immovable property. Conceptually, it mirrors the treatment for residential real estate exposures: the well-established loan splitting approach is maintained and its calibration is adjusted in line with the Basel III standards whereby the secured part of the exposure up to a property value of 55% receives a risk weight of 60%. Furthermore, Article 126 provides a more risk-sensitive fall-back treatment depending on the ETV ratio for commercial mortgages where the property is not eligible for the loan-splitting.

A dedicated and more granular risk-weight treatment for commercial IPRE exposures is introduced via amendments to Article 126 while keeping the “hard test”, which allows institutions to apply the same preferential risk weights to income-producing and other commercial real estate exposures secured by property located in markets where the yearly loss rates do not exceed certain thresholds.

Loans financing land acquisition, development or construction (ADC) of any residential or commercial immovable properties incur a heightened risk. That heightened risk is due to the fact that the source of repayment at origination of the loan is either a planned, but uncertain sale of the property, or substantially uncertain cash flows. The current treatment of speculative immovable property financing is based solely on the borrower’s intention to resell the property for a profit, without taking into account to which extent the repayment is actually certain. Therefore, a new definition is introduced in Article 4 and a new Article 126a is inserted to introduce the specific risk weight treatment of 150% provided by the Basel III standards for loans to companies or special purpose vehicles financing ADC of any residential or commercial property. In turn, the current risk weight treatment of 150% for “speculative immovable property financing” is removed as it is solely based on the borrower’s intention to resell the property for a profit, without taking into account to which extent the repayment is actually uncertain. In line with the Basel III standards, Article 126a allows to assign a risk weight of 100% to residential ADC exposures provided that certain risk-mitigating conditions (in terms of underwriting standards, proportion of pre-sale or pre-lease contracts and equity at risk) are met.

To reduce the impact of cyclical effects on the valuation of property securing a loan and to keep own funds requirements for mortgages more stable, the final Basel III standards cap the value of the property recognised for prudential purposes at the value measured at loan origination, unless modifications “unequivocally” increase the value of the property. At the same time, the standards do not oblige banks to monitor the development of property values. Instead, they only require adjustments in case of extraordinary events. By contrast, the current SA-CR applicable in the EU requires institutions to regularly monitor the value of property pledged as collateral. Based on this monitoring, institutions are required to make upwards or downwards adjustments to the property (irrespective of the property value at loan origination). Article 208 is amended to reduce the impact of cyclical effects on the valuation of property securing loans and to keep own funds requirements for mortgages more stable. In particular, the current requirement for frequent monitoring of property values is kept, allowing for upwards adjustment beyond the value at loan origination (unlike the Basel III standards), but only up to the average value over the last three years in case of commercial immovable property and over the last six years in case of residential immovable property. For immovable property collateralising covered bonds, it is clarified in Article 129 that competent authorities may allow institutions to use the market value or the mortgage lending value without limiting increases in the property value at the average over the last three or six years, respectively. Furthermore, it is clarified in Article 208 that modifications made to the property that improve the energy efficiency of the building or housing unit must be considered as unequivocally increasing its value. Finally, institutions are allowed to carry out the valuation and revaluation of properties by means of advanced statistical or other mathematical methods, developed independently from the credit decision process, subject to the fulfilment of a number of conditions, which are based on EBA Guidelines on loan origination and monitoring (EBA/GL/2020/06), and subject to supervisory approval.

Article 465 is amended to provide for a specific transitional arrangement for low-risk exposures secured by mortgages on residential property when calculating the output floor. During the transitional period Member States may allow institutions to apply a preferential risk weight of 10% to the secured part of the exposure up to 55% of the property value, and a risk weight of 45% to the remaining part of the exposure up to 80% of the property value, provided certain conditions are met aimed at ensuring that they are low risk, and verified by the competent authority. EBA will be required to monitor the use of the transitional treatment and prepare a report on the appropriateness of its calibration. On the basis of that report, the Commission will need to decide whether to submit to the European Parliament and to the Council a legislative proposal on low-risk exposures secured by mortgages on residential property.

14.

Subordinated debt exposures


Article 128 is replaced to implement the revised treatment for exposures to subordinated debt provided by the final Basel III standards (i.e. a risk weight of 150%).

15.

Equity exposures


Article 133 is replaced to implement the revised treatment for equity exposures under the final Basel III standards. The scope of the equity exposure class is clarified by providing a definition of equity exposures and specifying which other instruments are to be categorised as equity exposures for the purpose of calculating the risk weighted assets for credit risk.

To increase the risk-sensitivity of the SA-CR, the revised risk weights reflect the higher loss risk of equity compared to debt exposures via a risk weight of 250% and differentiate between long-term and riskier speculative investments which are assigned a risk weight of 400%. In order to avoid unwarranted complexity, the classification of long-term exposures refers to the holding period approved by the institution’s senior management as central criterion.

Equity exposures incurred under legislative programmes to promote specified sectors of the economy that provide significant subsidies for the investment to the institution and involve some form of government oversight may be assigned a risk weight of 100% subject to a threshold of 10% of the institution’s own funds and supervisory approval. Such subsidies may also be in the form of general guarantees by multilateral development banks, public development credit institutions and international organisations. This is to reflect the fact that the European Investment Bank Group, multilateral development banks, public development credit institutions and Member States are setting up such ‘legislative programmes’, often based on general public guarantees and linked to financial recovery and resilience plans, to mobilise private capital, including to support strategic businesses.

Equity exposures to central banks remain subject to a risk weight of 100%.

Finally, Article 133 provides a floor for equity exposures that are recorded as a loan but arise from a debt/equity swap made as part of the orderly realisation or restructuring of the debt: in line with the Basel III standard, the applicable risk weight must not be lower than the risk weight that would apply if the holdings remained in the debt portfolio.

Many EU banks hold long-standing, strategic equity participations in financial and non-financial corporates. The Basel III standards increase the RWs for all kinds of equity exposures over a 5-year transition period without providing a specific treatment for strategic equity investments. Applying the more conservative approach embedded in the Basel III standards to the whole stock of existing equity holdings could jeopardise the economic viability of existing strategic relationships.

In view of this, Article 49 is amended to set the risk weight applicable to equity exposures to financial sector entities included in the same scope of prudential consolidation (group) or – subject to supervisory approval – to institutions falling within the same institutional protection scheme at 100% thereby preserving the current treatment for most entities concerned.

Furthermore, a new Article 495a is inserted to set out a gradual phasing-in of the new risk weights applicable to equity exposures. Furthermore, the new Article provides for a grandfathering of the current treatment of historic and strategic equity investments that have been holding by an institution over the last ten years in entities, including in insurance undertakings, over which it exercises significant influence.

16.

Defaulted exposures


Article 127 is amended to clarify the risk weight treatment of discounts on purchases of non-performing exposures (NPEs), as announced in the Communication on “Tackling non-performing loans in the aftermath of the COVID-19 pandemic”. To this end, the proposal clarifies that institutions can take into consideration the discount on purchased defaulted assets when determining the appropriate risk-weight to be applied to defaulted exposure. This complements EBA’s ongoing work aimed at amending the RTS on credit risk adjustments.

Further amendments to Article 127 align the language with the one used in the revised Basel III standards.

17.

Use of credit assessments by External Credit Assessment Institutions and mapping


To inform any future initiative on the set-up of public or private rating schemes, Article 135 is amended to mandate the European Supervisory Authorities (ESAs) to prepare a report on the impediments to the availability of external credit ratings by ECAIs, in particular for corporates, and on possible measures to address them.

Credit risk framework – internal ratings-based approaches

18.

Reduction of the scope of internal rating based approaches


Own funds requirements for credit risk that are based on institutions’ internal models have important benefits in terms of risk sensitivity, institutions’ understanding of their risks as well as the level playing field between among institutions across the Union. However, the financial crisis highlighted important deficiencies in the IRB approaches. A range of studies conducted at both international and EU level found an unacceptably wide variation in capital requirements across institutions that cannot be explained solely by differences in the riskiness of institutions’ portfolios. This hinders the comparability of capital ratios and it impacts the level playing field among institutions. Also, the crisis has revealed instances where the losses incurred by institutions on some portfolios were significantly higher than the model predictions, which resulted in insufficient levels of capital held by individual institutions.

Institutions have done so because the applicable framework contained insufficient limits as regards the availability of IRB approaches for exposures classes that are difficult to model, and because the framework in principle compelled those institutions that intended to use the IRB approach for some of their exposures to roll it out to all exposures

Articles 150 and 151(8) are amended to limit the exposures classes for which internal models can be used to calculate own funds requirements for credit risk, implementing the Basel III standards. Specifically, the use of the advanced IRB (A-IRB) approach, which allows the modelling of all risk parameters, is only allowed for those exposure classes for which robust modelling is possible whereas other exposure classes are “migrated” to less sophisticated approaches:

·for exposures to corporates with total consolidated annual sales greater than EUR 500 million or belonging to a group where the total annual sales for the consolidated group is more than EUR 500 million (‘large corporates’), for exposures to institutions and to other financial sector entities (including those treated as corporates), the use of the advanced IRB approach is no longer available – for those exposures, institutions can use the foundation IRB (F-IRB) approach and hence only model the PD;

·for equity exposures, the IRB approach is no longer available - for those exposures, institutions must use the SA-CR.

Limiting the use of advanced modelling approaches is expected to remove an important source of undue variability in RWAs and thereby improve the comparability of own funds requirements. In addition, it will remove a source of unnecessary complexity from the framework.

19.

New exposure class for regional governments and local authorities as well as public sector entities


Currently, exposures to public sector entities (PSEs) and to regional governments and local authorities (RGLAs) can be treated either as exposures to central governments or as exposures to institutions. Those treated as exposures to institutions would need to be migrated to the F-IRB approach under the revised Basel III standards and hence be subject to the modelling constraints, whereas exposures treated as exposures to central governments would not. To reduce undue complexity in the framework, ensure a consistent treatment of exposures to PSEs and RGLAs and avoid unintended variability in the related own funds requirements, it is proposed to create a new ‘PSE-RGLA’ exposure class in Article 147(2), to which all exposures to those entities will be assigned (irrespective of their current treatment as sovereign exposures or as institution exposures), and to apply to this new exposure class the same rules that are applicable to the general corporates exposure class, as provided in a new Article 151(11). In particular, the input floors applicable to corporate exposures would apply in the same manner to exposures belonging to the PSE-RGLA exposure the Basel III class.

20.

Input floors under the A-IRB approach


Articles 160(1), 161 i, 164 i, and 166(8c) are amended to introduce minimum values for institutions’ own estimates of IRB parameters that are used as inputs to the calculation of RWAs (‘input floors’). These input floors act as safeguards to ensure that own funds requirements do not fall below sufficiently prudent levels, mitigating model risk, measurement error, data limitations, and improving the comparability of capital ratios across institutions.

Concerning the PD risk parameter, the existing input floors are slightly increased (from 0.03% under Basel II to 0.05% under Basel III). For the loss given default (LGD) and CCF risk parameters, on the other hand, the input floors are new requirements, calibrated in a prudent manner. The LGD input floor for unsecured corporates exposures is set at 25%, and for unsecured general retail exposures at 30%. A formula including conservative haircuts by collateral type is provided for secured exposures, while the IRB-specific CCF input floor are set according to the 50% of the applicable standardised approach CCF.

21.

Treatment of sovereign exposures


A new Article 159a is added to specify in line with the Basel III standards that the new input floors (described under the previous section) applicable to institutions’ own PD, LGD and CCF estimates are not applicable to sovereign exposures.

Deletion of the “1,06 scaling factor” in the risk weight formula

In line with the Basel III standards, Articles 153(1) and 154(1) are amended to delete the “1,06 scaling factor” that applies to the risk weighted exposure amounts for credit risk under the IRB approaches thereby simplifying the calculation and cancelling the 6% calibration increase in the IRB risk weights that apply under the current framework.

Removal of the “double default” treatment

Articles 153(3), 154(2), 202 and 217 are amended to remove the double default method applicable to some guaranteed exposures, leaving only one general formula for the calculation of risk weights and simplifying the framework, as provided by the Basel III standards. With fewer embedded options, the revised calculation ensures greater comparability of RWAs across institutions and a reduction of undue variability.

22.

Roll-out of the IRB approaches and the permanent partial use


Under the final Basel III standards, the adoption of the IRB approaches for one exposure class by an institution is no longer conditioned to the fact that all the exposure classes of its banking book should eventually be treated under the IRB approach (‘IRB roll out’) except for those exposures for which a permanent partial use (PPU) of the SA-CR is permitted by the rules and approved by the competent authority. This new principle is implemented in Articles 148 and 150, allowing institutions to apply the IRB approaches selectively.

In order to provide a level playing field between those institutions which are currently treating their exposures under one of the IRB approaches and those which are not, transitional arrangements are set out in a new Article 494d which allow institutions to revert to the SA-CR during a three year period subject to competent authorities’ approval under a simplified procedure.

23.

Revised risk parameter under the foundation IRB approaches


Article 161(1) is amended to implement the recalibrated LGD values for senior unsecured exposures to corporates (LGD of 40% instead of 45%). The LGD value for dilution risk of purchased corporate receivables is also amended so as to be aligned with the Basel treatment.

24.

Revised scope and calculation methods for own estimates of credit conversion factors


Article 166(8), (8a), (8b) and (8d) and Article 182 are amended to revise the scope and calculation methods for the computation of own estimates of CCFs which are used to determine the exposure value of off-balance sheet items other than derivatives contracts. In particular, the new provisions require the use of a fixed period of 12 months prior to default to estimate own estimates of CCFs, and allow the use of own estimates only for specific commitments for which the corresponding standardised CCF is lower than 100%.

25.

Guarantees provided by protection providers treated under a less sophisticated approach


The Basel III standards have significantly revised the methodologies that institutions are allowed to use to recognise the risk mitigating effects of eligible guarantees with the view to, among others, limit the range of approaches and therefore reduce the variability of own funds requirements. To this end, the Basel III standards generally provide for the risk-weight to be applied to the secured part of the exposure to be the one that should be computed according to the approach applied to comparable direct exposures to the protection provider. Where an exposure which is treated under the A-IRB approach is guaranteed by a guarantor which is treated under the F-IRB approach or the SA-CR, recognition of that guarantee leads to the guaranteed exposure to be treated under the F-IRB or the SA-CR, respectively. Recognition of guarantees in the A-IRB approach will need to be done through the use of one of the following approaches:

·the substitution of the risk weight approach, substituting the risk weight of the obligor by the risk weight of the guarantor if comparable direct exposures towards the guarantor are treated under the SA-CR (Article 235a);

·the substitution of risk parameters approach, substituting the risk parameters of the obligor by the risk parameters associated to comparable direct exposures to the guarantor if comparable direct exposures towards the guarantor are treated under the IRB approach (Article 236a); or

·the adjustment of the LGD or of both PD and LGD estimates (Article 183); under this approach, the proposal clarifies that the recognition of a guarantee should never lead to a risk-weight applicable to the guaranteed exposure, which is lower than that of a approach comparable direct exposure to the guarantor. This is intended to safeguard the consistency of the framework in terms of risk assessment, avoiding the situation that an indirect exposure to a particular protection provider could benefit from a lower risk weight than a comparable direct exposure where that same protection provider is the obligor.

26.

Specialised lending exposures under the A-IRB approach


The new modelling restrictions under the Basel III standards are relatively limited as regards the treatment of specialised lending exposures under the IRB approaches. While parameter floors do apply, the A-IRB approach remains available independently of the size of the obligor, unlike the treatment applicable to other corporate exposures. However, the new parameter floors applicable to corporate exposures also apply to specialised lending exposures without giving recognition to the specific lending practices which entail security arrangements to mitigate the credit risk.

Therefore, a new Article 495b is inserted to phase-in the new floors, starting with a 50% discount factor which increases gradually to 100% over a 5-year period. Furthermore, the Article mandates EBA to assess the adequacy of the PD and LGD input floors applicable to specialised lending exposures and empowers the Commission to revise the parameters by a delegated act based on EBA’s assessment..

27.

Enabling clauses for leasing exposures and credit insurance


A high level of expertise and risk management has been developed by institutions in the EU in the area of leasing, as well as in the use of credit insurance, in particular for trade finance purposes. In the absence of sufficient data, it remains unclear whether the new risk parameters are calibrated appropriately to reflect the risk mitigating effect of leasing collateral and, respectively, which features credit insurance policies must possess to be recognised as eligible credit protection.

Therefore, a new Article 495c is inserted mandating EBA to assess the appropriateness of the Basel III risk calibration of the parameters applicable to leasing exposures, in particular the new collateral haircuts (‘volatility adjustments’) and regulatory values for secured LGD. The Commission is empowered to revise the calibration via a delegated act, if appropriate, taking into account EBA’s report. In the meantime, a 5-year phasing-in applies to the new risk parameters under the A-IRB approach.

Furthermore, a new Article 495d is inserted mandating EBA to report to the Commission on the eligibility and the use of credit insurance as a credit risk mitigation technique and on the appropriate risk parameters they should be associated with under the SA-CR and foundation IRB approach. Based on that report, the Commission is required to submit, if appropriate, a legislative proposal on the use of credit insurance as a credit risk mitigation technique.

Credit risk framework – credit risk mitigation techniques

Articles 224 to 230 are amended to implement the Basel III rules and methods for taking into account collateral and guarantees under both the SA-CR and the F-IRB approach. In particular, the supervisory haircuts applicable to financial collateral under the financial collateral comprehensive method have been revised, and so have the values of secured LGDs and collateral haircuts applicable to exposures treated under the F-IRB.

Article 213(1), point (c)(iii), and Article 215(2) are amended to clarify the eligibility criteria for guarantees and, respectively, guarantees provided in the context of mutual guarantee schemes or provided by or counter-guaranteed by some entities. Those clarifications should notably provide further clarity on the eligibility as credit risk mitigation techniques of public guarantee schemes set up in the context of the COVID-19 crisis.

28.

Market risk framework


In 2016, the BCBS published a first set of revised market risk standards, known as the fundamental review of the trading book (FRTB) in order to address identified deficiencies of the market risk capital requirements framework for trading book positions. In the course of monitoring the impact of the FRTB standards, the BCBS identified a number of issues with the FRTB standards and, as a result, published revised FRTB standards in January 2019.

In November 2016, the Commission originally proposed to introduce binding own funds requirements based on the FRTB standards as part of the CRR II to address the deficiencies of the market risk framework. However, given the BCBS’s subsequent decision to revise those standards, with timelines incompatible with the milestones in the CRR II negotiation process, the European Parliament and the Council agreed to implement the FRTB standards in the CRR II only for reporting purposes. The introduction of own funds requirements based on the FRTB standards was left for later, by way of adoption of a separate legislative proposal.

In order to introduce binding own funds requirements for market risk in line with the revised FRTB standards, a number of amendments are made to the CRR.

29.

Subject matter, scope and definitions


Article 4 is amended to clarify the definition of trading desk.

30.

Elements of own funds


Article 34 is amended to include a derogation allowing institutions to reduce the total additional value adjustments under extraordinary circumstances, based on an opinion provided by EBA, in order to address the pro-cyclicality embedded in the additional value adjustments deducted from CET1 capital.

31.

General requirements, valuation and reporting


Article 102 is amended to introduce the FRTB approaches for the purpose of the calculation of own funds requirements. Article 104 is replaced to revise the criteria used to assign positions to the trading book or to the non-trading book (i.e. the banking book); it introduces also a derogation which allows an institution to assign to the non-trading book specific instruments that would otherwise be assigned to the trading book; the derogation is subject to very strict conditions and to an approval by the institution’s competent authority. Article 104a is amended to further specify the conditions that need to be used for reclassifying an instrument between the two books. Article 104b is amended to introduce a derogation that allows institutions to create dedicated trading desks to which institutions can allocate exclusively non-trading book positions subject to foreign exchange risk and commodity risk. Article 104c is introduced to specify the treatment of hedges of foreign exchange risk in capital ratios, which allows institutions to exclude, under certain conditions, some positions from the calculation of the own funds requirements for foreign exchange risk. Article 106 is amended to clarify to the existing provisions on internal risk transfers.

32.

General provisions


Article 325 is amended to introduce binding own funds requirements for market risk based on the FRTB approaches set out in Chapters 1a (alternative standardised approach or A-SA), 1b (alternative internal model approach or A-IMA) and 2 to 4 (simplified standardised approach or SSA), as well as conditions for their use and the frequency of calculation of the own funds requirements. A derogation for institutions from calculating own funds requirements for positions subject to foreign exchange risk that are deducted from their own funds is also introduced.

Article 325a is amended to introduce the eligibility criteria for using the SSA.

Article 325b clarifies the calculation of own funds requirements for market risk on a consolidated basis.

33.

The alternative standardised approach


Article 325c is amended to introduce additional qualitative requirements related to the validation, documentation and governance of the A-SA.

Article 325j is amended to clarify certain elements of the final FRTB standards with regards to the treatment of investments in funds (i.e. collective investment undertakings or CIUs) and to introduce some targeted adjustments to the calculation of the own funds requirements for these positions to ensure that the treatment of CIUs under the standardised approach does not disproportionately increase the complexity of the calculation and is less penalising, given that CIUs play a crucial role in facilitating the accumulation of personal savings, whether for major investments or for retirement. These objectives are addressed by specifying that institutions should apply the look-through approach with a monthly frequency for those positions in CIUs concerned by that approach, and by allowing institutions, under specific conditions, to use data provided by relevant third-parties in the calculation of the own funds requirements under the look-through approach. In addition, under the mandate-based approach, Article 325j introduces a mandate for the EBA to further specify the technical elements that the institutions must use to build up the hypothetical portfolio used in the calculation of the own funds requirements.

Article 325q is amended to clarify the treatment of foreign exchange vega risk factors.

Article 325s is amended to adjust the formula for vega risk sensitivities.

Article 325t is amended to further align the sensitivities used for the calculation of own funds requirements with the ones used for the risk management of the institution.

A provision related to traded non-securitisation credit and equity derivatives is moved from Article 325ab to the more relevant Article 325v.

Articles 325y, 325am, 325ah and 325ak are amended similarly to clarify the assignment of credit quality categories under the A-SA.

Article 325ae is modified to clarify the treatment of the inflation risk factor and of cross currency basis risk factors.

Articles 325ah and 325ak are amended to clarify the risk weights of covered bonds (both externally rated and unrated).

Article 325ai and 325aj are amended to clarify the value of correlation parameters.

Article 325as is modified to introduce a lower risk weight for the commodity delta risk factor related to carbon trading emissions. Under the final Basel III standards, emission allowances are assimilated to electricity contracts, which could be considered too conservative in light of historical data relevant to the EU market for emission allowances. Indeed, the creation of the Market Stability Reserve by the Commission in 2015 has stabilised the volatility of the price of Emissions Trading System (ETS) allowances. This justifies creating a specific risk category for ETS allowances under the A-SA, distinct from electricity, with a lower risk weight equal to 40% to better reflect the actual price volatility of this EU-specific commodity.

Article 325ax is amended to clarify the risk weights for sensitivities to vega risk factors.

34.

The alternative internal model approach


Article 325az is amended to clarify the conditions that the institutions must comply with in order to be granted the permission to use the A-IMA for the calculation of own funds requirements for market risk.

Article 325ba is amended to introduce the formula for the aggregation of the own funds requirements calculated under the A-IMA.

Article 325bc is amended to introduce a RTS mandate for EBA to specify the criteria for the use of data inputs in the risk-measurement model.

Article 325be is amended to specify new powers for the competent authorities with regards to the assessment of the modellability of the risk factors performed by institutions using the A-IMA.

Article 325bf is amended to introduce new powers for competent authorities to address model deficiencies and with respect to the back-testing requirements performed by institutions using A-IMA.

Article 325bg is amended to introduce binding requirements on P&L attribution performed by institutions using the A-IMA.

Article 325bh is amended to introduce adjustments for calculating the own fund requirements for market risk for CIUs positions under the A-IMA, in particular to ensure that more CIUs could be eligible under the approach. Similarly to the amendments made to the CIU treatment under the A-SA, institutions are allowed, under specific conditions, to use data provided by relevant third-parties in the calculation of the own funds requirements under the look-through approach, and are required to apply the look-through approach with a minimum weekly frequency.

Article 325bi is amended to clarify the responsibilities of the risk control unit and the validation unit with respect to the risk management system.

Article 325bp is amended to further clarify the situations in which institutions are permitted to use an IRB model to estimate default probabilities and loss given default for the calculation of the own funds requirement for default risk.

Article 337, Article 338, Article 352 and Article 361 are amended to replace, or delete, provisions that are no longer relevant for using the SSA.

35.

Use of internal models to calculate own funds requirements


Chapter 5 is deleted since the current internal model approach (IMA) used to calculate the own funds requirements for market risk is replaced by the A-IMA set out in Chapter 1b.

36.

Delegated and Implementing acts


Given the uncertainty of whether major jurisdictions will deviate from the final Basel III standards in their implementation of FRTB and the importance of ensuring a level playing field in practice between institutions established in the Union and their international peers, Article 461a empowers the Commission to adopt delegated acts to amend the approaches to calculate the own funds requirements for market risk, and to amend the date of entry into application of these approaches in order to align them with international developments.

37.

Credit valuation adjustment (CVA) risk framework


The credit valuation adjustment (CVA) is a fair-value accounting adjustment to the price of a derivative transaction, aiming to provision against potential losses due to the deterioration in the creditworthiness of the counterparty to that transaction. During the GFC, a number of systemically important banks incurred significant CVA losses on their derivatives portfolios because of the deterioration of many of their counterparties’ creditworthiness at the same time. As a result, the BCBS introduced in 2011, as part of the first set of Basel III reforms, new standards to calculate capital requirements for CVA risk to ensure that banks’ CVA risk would be covered with sufficient capital in the future. These Basel standards were transposed in Union law in 2013 through the CRR.

However, concerns were raised by banks and supervisors that the 2011 standards did not appropriately capture the actual CVA risk banks were exposed to. In particular, three specific criticisms were raised with respect to those standards: i) that the approaches set out in those standards lack risk-sensitivity, ii) that they do not recognise CVA models developed by banks for accounting purposes, and iii) that the approaches set out in those standards do not capture the market risk embedded in the derivative transactions with the counterparty. To address those concerns, the BCBS published revised standards in December 2017, as part of the final Basel III reforms, and further adjusted their calibration in a revised publication in July 2020. In order to align it with the 2020 BCBS standards, a number of amendments are made to the CRR.

In Article 381, a definition of the meaning of CVA risk is introduced to capture both the credit spread risk of an institution’s counterparty and the market risk of the portfolio of transactions traded by that institution with that counterparty.

Article 382 is amended to clarify which securities financing transactions are subject to the own funds requirements for CVA risk. In addition, a new provision requiring institutions to report the results of the calculation of the own funds requirements for CVA risk for transactions exempted in accordance with that Article is introduced. It is additionally specified that institutions that hedge the CVA risk of those exempted transactions have the discretion to calculate own funds requirement for CVA risk for those transactions, taking into account the eligible hedges concerned. Finally, new mandates for the EBA are introduced to develop guidelines to help supervisors to identify excessive CVA risk and to develop an RTS to specify the conditions for assessing the materiality of CVA risk exposures arising from fair-valued securities financing transactions.

Article 382a is inserted to set out the new approaches institutions should use to calculate their own funds requirements for CVA risk, as well as the conditions for using a combination of those approaches.

Article 383 is replaced to introduce the general requirements for using the standardised approach for calculating the own funds requirements for CVA risk, as well as the definition of regulatory CVA for that purpose. Articles 383a to 383x are inserted to further specify the technical elements of the standardised approach.

Article 384 is replaced to introduce the basic approach for calculating the own funds requirements for CVA risk, in line with the Basel III standards.

Article 385 is replaced to introduce the simplified approach for calculating the own funds requirements for CVA risk, as well as the eligibility criteria for the use of simplified approach.

Finally, Article 386 is amended to reflect the new requirements applicable to eligible hedges for the purposes of the own fund requirements for CVA risk.

38.

Minimum haircut floor framework for SFTs


Securities financing transactions (SFTs) play an essential role in the financial system of the Union by allowing financial institutions to manage their own liquidity position and support their securities market-making activities. SFTs are also important for central banks as those transactions enable them to transmit, via financial institutions, their monetary policy plans to the real economy. SFTs can, however, also enable market participants to recursively leverage their positions by reinvesting cash collateral and re-using non-cash collateral, respectively. To address the risk of a build-up of excessive leverage outside the banking sector, the Financial Stability Board (FSB) published in 2013 a recommendation 39 to its member jurisdictions to introduce minimum collateral haircuts for some non-centrally cleared SFTs traded between banks and non-banks. According to that recommendation, such minimum collateral haircuts should be introduced, at the discretion of each jurisdiction, either directly via a market regulation, or indirectly via a more punitive capital requirement; the latter was developed by the BCBS in 2017 as part of the final Basel III reforms.

The recommendations of EBA in its dedicated report 40 on the implementation of the minimum haircut floors framework for SFTs in Union law and of ESMA in its report 41 on SFTs and leverage in the EU, pointed out, however, that it was not clear what impact the application of such framework would have on institutions. Those recommendations also expressed concerns that the application of that framework to certain types of SFTs could create undesirable consequences to those financial activities. In addition, it is not yet clear whether it would be more appropriate to apply the framework to institutions as a more punitive own funds requirement, or rather as a market regulation. Applying the framework to institutions as a more punitive own funds requirement would allow institutions that would not comply with those minimum haircut floors to pursue those financial activities, subject to a penalty. Alternatively, applying the framework as a market regulation would ensure a level-playing field for all market participants should the Union decide to introduce a similar market regulation for relevant SFTs between non-banks, as also recommended by the FSB in its above mentioned 2013 report.

Against this background, Article 519c introduces a mandate for EBA to report, in close cooperation with ESMA, to the Commission on the appropriateness of implementing in the Union the minimum haircut floors framework applicable to SFTs. On the basis of this report, the Commission will, if appropriate, submit a legislative proposal to the European Parliament and to the Council.

39.

Operational risk


New standardised approach to replace all existing approaches for operational risk

The BCBS has revised the international standard on operational risk in order to address weaknesses that emerged in the wake of the 2008-2009 financial crisis. Besides the lack of risk-sensitivity in the standardised approaches, a lack of comparability arising from a wide range of internal modelling practices under the advanced measurement approaches (AMA) was identified. Against this background, and in order to enhance the simplicity of the framework, all existing approaches for the calculation of the own funds requirements for operational were replaced by a single, non-model-based approach to be used by all institutions. Although the use of models, such as those developed under the AMA, is no longer possible under this new framework to determine own funds requirements for operational risk, institutions will still have the discretion to use those models for the purpose of the internal capital adequacy assessment process (ICAAP).

The new standardised approach is implemented in the Union by replacing Part Three, Title III, of the CRR. In addition, further adjustments are made to several other articles in the CRR, mainly i) to introduce clear and harmonised definitions related to operational risk (Article 4(1), points (52a), (52b), and (52c)), as recommended by the EBA in its reply 42 to the Commission’s 2019 Call for Advice, and ii) to reflect the replacement of Title III throughout the CRR (for instance, former references to Title III in Article 20 are deleted). Lastly, the EBA is mandated to report to the Commission on the use of insurance in the context of the revised operational risk framework (Article 519d). That report is needed as some concerns have emerged in the supervisory community as to whether the new standardised approach for operational risk may allow for regulatory arbitrage through the use of insurance.

40.

Calculation of own funds requirements for operational risk


According to the final Basel III standards, the new standardised approach combines an indicator that relies on the size of the business of an institution (Business Indicator Component or BIC) with an indicator that takes into account the loss history of that institution. The revised Basel standard envisages a number of discretions on how the latter indicator may be implemented. Jurisdictions may disregard historical losses for the calculation of operational risk capital for all relevant institutions, or may take historical loss data additionally into account for institutions below a certain business size. For the calculation of the minimum own funds requirements, in order to ensure a level playing field within the Union and to simplify the calculation of operational risk capital, those discretions are exercised in a harmonised manner by disregarding historical operational loss data for all institutions.

The calculation of the BIC is set out in the new Chapter 1 of Title III (new Articles 312 to 315). In the Union, the minimum own funds requirements for operational risk will be solely based on the BIC (Article 312). The calculation of the BIC, which is based on the so-called business indicator, is set out in Article 313, while the determination of the business indicator, including its components and possible adjustments due to mergers, acquisitions or divestments, is set out in Articles 314 and 315.

41.

Data collection and governance


The new Chapter 2 (new Articles 316 to 323) provides for the rules on data collection and governance. As a matter of proportionality, those requirements are split into rules that apply to all institutions, such as the provisions on the operational risk management framework (Article 323), and rules that are only relevant for institutions that also have to disclose historical loss data (Article 446(2)) and thus have to maintain a loss data set (Article 317). In the Union, in line with the EBA reply to the Commission’s 2019 Call for Advice, all institutions with a business indicator equal to or above EUR 750 million will be required to maintain a loss data set and to calculate their annual operational risk losses for disclosure purposes. To ensure that the new framework remains proportionate, competent authorities will be able to grant a waiver from that requirement, unless the business indicator of an institution exceeds EUR 1 billion (Article 316). With a view to ensure a certain stability over time, in particular to avoid that temporary drops in the size of the business indicator unduly affect that assessment, the relevant business indicator will be the highest business indicator reported over the last two years.

Elements that are relevant for the calculation of the annual operational risk loss are further specified in Articles 318 to 321. Article 318 sets out the determination of the ‘gross loss’ and the ‘net loss’ and Article 319 contains the relevant loss data thresholds of EUR 20 000 and EUR 100 000. Certain exceptional operational risk events that are no longer relevant to an institution’s risk profile may be disregarded, provided that all related conditions are met and the institution’s supervisor has granted the permission to do so (Article 320). In the same vein, an institution may have to include additional losses, for instance, related to acquired or merged entities (Article 321).

The accuracy and comprehensiveness of an institutions loss data are essential. Therefore, supervisors will have to periodically review the quality of the loss data (Article 322).

42.

Leverage ratio


Calculation of the exposure value of derivatives

Since the adoption of Regulation (EU) 2019/876, the BCBS has further revised one specific aspect of its leverage ratio framework. To facilitate the provision of client-clearing services, the treatment of client-cleared derivatives for leverage ratio purposes was amended in June 2019 43 . Under the revised rules, the treatment of those derivatives is generally aligned with the treatment envisaged under the standardised approach for counterparty credit risk (SA-CCR) in the risk-based framework. In its February 2021 report on the leverage ratio 44 , the Commission concluded that it was appropriate to adjust the calculation of the total exposure measure to align the treatment of client-cleared derivatives with the internationally agreed standards. Therefore, Article 429c is amended accordingly.

43.

Calculation of the exposure value of off-balance-sheet items


In light of the proposed amendments to Articles 4 and 111(1) of the CRR, there is no need any more to set out a minimum conversion factor of 10% for certain off-balance-sheet items in the leverage ratio framework. Therefore, the derogation set out in Article 429f(3) is deleted.

44.

Regular way purchases and sales awaiting settlement


The provisions related to regular-way purchases and sales awaiting settlement are amended to better align those rules with the Basel III standards, notably by clarifying that those provisions apply to financial assets, rather than to securities only. Articles 429(6) and 429g(1) of the CRR are amended accordingly.

45.

Environmental, social and governance risks (ESG risks)


Institutions play an instrumental role in the ambition of the Union to promote a long-term transition to sustainable development in general and, in particular, to support a just transition towards net-zero greenhouse gas emissions in the economy of the Union by 2050. That transition entails new risks that need to be understood and appropriately managed at all levels.

The accelerated transition towards a more sustainable economy may have a considerable impact on companies, increasing the risks to institutions individually and to the overall financial stability. Human behavioural impacts on climate, like the emissions of greenhouse gases, or the continuation of unsustainable economic practices, are drivers of physical risks potentially exacerbating the likelihood of environmental hazards and their socio-economic impacts. Institutions are also exposed to those physical risks, which hold a trade-off relationship with transition risks as, all other things being equal, physical risks are expected to decrease when transition policies are implemented. However, the opposite may occur when no action is taken, meaning, when the transition risk is low and the implementation of transition-related policies takes longer, the more physical risks will increase.

To promote an adequate understanding and management of the sustainability risks, commonly referred as environmental, social and governance (ESG) risks, institutions established in the Union need to identify systematically, disclose and manage those risks at their individual level. The relative novelty of ESG risks and their specificities mean that the understanding of those risks can differ significantly across institutions.

Therefore, Article 4 is amended to introduce new harmonised definitions of the different types of risks in the universe of ESG risks (Article 4(1), points 52d to 52i). The definitions are aligned with those proposed by EBA in its report dedicated to ESG risks.

To allow for better supervision of ESG risks, Article 430 is amended to require institutions to report their exposure to ESG risks to their competent authorities.

Finally, in order to better align the timelines of any changes to the prudential rules that may be needed, Article 501c is amended to advance the deadline for EBA to deliver its report on the prudential treatment of these exposures from 2025 to 2023. Within the mandate in Article 501c, the EBA should assess exposures to assets and activities in the energy and resource efficiency sectors, as well as in the infrastructure and transport fleets sectors. The assessment should also cover the possibility of a targeted calibration of a risk weights for items associated with particularly high exposure to climate risk, including assets or activities in the fossil fuel sector and in high climate impact sectors. If found to be justified, the report by the EBA should describe a range of options for applying a dedicated prudential treatment of exposures subject to impacts from environmental and social factors.

46.

Integrated supervisory reporting system and data sharing


Since 2018, the EBA, in cooperation with the ECB and national competent authorities, has been working on the creation of the European Centralised Infrastructure for Supervisory Data (EUCLID) to aggregate in a centralised integrated system the reporting information shared by supervisors on the largest institutions established in the Union. This system will be particularly useful to feed public reports and analysis with aggregated data and risk indicators on the overall EU banking sector. Article 430c currently mandates the EBA to prepare a feasibility study for the development of a consistent and integrated system for collecting statistical, resolution and prudential data, as well as to involve the relevant authorities in the preparation of the study. In March 2021, the EBA published a discussion paper on that feasibility study, seeking stakeholders’ input by 11 June 2021. In accordance with Article 430c(3), once the feasibility study is finalised by EBA, the Commission will assess whether to introduce at a later stage potential amendments to the reporting requirements mandated in Part Seven A of the CRR.

47.

Disclosures


Enhanced transparency and proportionality in disclosure requirements

In view of the changes made to the CRR to implement the final Basel III standards, as well as the need to further reduce the administrative costs related to disclosures and to facilitate the access to information disclosed by institutions, several changes are made to Part Eight of the CRR.

Article 433 is amended to empower the EBA to centralise the publication of annual, semiannual and quarterly institutions’ prudential disclosures. This proposal aims to make prudential information readily available through a single electronic access point, thus addressing the current fragmentation with a view to increase transparency and comparability of disclosures to the benefit of all market participants. EBA’s centralised publication would take place at the same time the institutions publish their financial statements or reports, or as soon as possible thereafter. This proposal is fully consistent with the Capital Market Union Action Plan and it is an intermediary step towards the future development of an EU-wide single access point for companies’ financial and sustainable investment-related information.

Article 434 is amended to reduce the administrative burden related to disclosures, especially for small and non-complex institutions. The rationale of this provision leverages on the progress made by the EBA and the competent authorities in the creation of an infrastructure that aggregates supervisory reporting (EUCLID). The proposal enhances proportionality mandating the EBA to publish disclosures of small and non-complex institutions based on supervisory reporting information. This way, small and non-complex institutions are only required to report to their supervisors, and not to publish relevant disclosures.

Articles 438 and 447 are amended to include disclosures obligations for institutions that use internal model and thus need to disclose the total risk exposures amounts calculated according to the full standardised approach as compared to the actual risk-weighted assets at the risk level, and for credit risk at asset class and sub-asset class level. This implements the relevant Basel III standard that requires banks to compare modelled and standardised RWA at risk level. Articles 433a, 433b and 433c concerning the frequency of disclosures are amended accordingly.

Articles 433b and 433c are amended to include the obligation for small and non-complex institutions, as well as for other non-listed institutions, to disclose on an annual basis information on the amount and quality of performing, non-performing and forborne exposures for loans, debt securities and off-balance-sheet exposures, and information on past due exposures. The proposed amendments are in line with the 2017 Council action plan on NPLs 45 , which invited the EBA to implement by the end of 2018 enhanced disclosure requirements on asset quality and non-performing loans for all institutions. In addition, the changes would ensure full consistency with the Communication on “Tackling non-performing loans in the aftermath of the COVID-19 pandemic” 46 . The extension of the disclosure requirements in Article 442, points (c) and (d), to small and non-complex institutions and to other non-listed institutions does not create any additional burden for these institutions for two reasons. First, these institutions are already disclosing NPLs related information based on the EBA Guidelines on NPLs disclosure 47 , which followed the 2017 Council action plan and, currently, are reflected in the Commission Implementing Regulation (EU) 2021/637 of 15 March 2021 48 . Second, once the centralisation of disclosures through the EBA web-platform is in place, information on NPLs could be extracted from supervisory reporting, thus reducing the burden for all institutions and eliminating any burden for small and non-complex ones.

Articles 445 and 455 introduce new disclosure requirements the institutions calculating their own funds requirements for market risk using one of the standardised approaches and, respectively, the A-IMA, need to comply with.

Article 445a is inserted to introduce new disclosure requirements for own funds requirements for CVA risk.

Article 446 is amended to introduce the revised disclosure requirements for operational risk.

In the area of disclosures, the CRR II already introduced provisions aimed at improving the capture of ESG risks. In this regard, large institutions with publicly listed issuances will start disclosing information on ESG risks from June 2022 onwards. However, the immediate effectiveness of these provisions is limited, as a large number of institutions remains outside of the scope of the CRR disclosure rules. Article 449a is therefore amended to extend the requirements related to the disclosure of ESG risks to all institutions, while respecting the proportionality principle.

48.

Empowerments to EBA


The proposal expands the scope of the existing EBA mandate under Article 434a. In addition to establish and develop uniform disclosure formats, the proposed amendments to Article 434a require EBA to set up a policy on disclosures’ resubmissions and on the necessary IT solutions for centralising the disclosures.

Definition of ‘small and non-complex institution’

The proposal amends the definition of the term ‘small and non-complex institution’, set out in Article 4(1), point (145), by allowing institutions to exclude derivatives transactions concluded with non-financial clients and derivatives transactions used to hedge those transactions, subject to a limit.

49.

CIUs with an underlying portfolio of euro area sovereign bonds


Article 506a of Regulation (EU) 2021/558 mandated the Commission to publish by 31 December 2021 a report assessing whether it is necessary to make changes to the regulatory framework “to promote the market for, and bank purchases of, exposures in the form of units or shares in CIUs with an underlying portfolio consisting exclusively of sovereign bonds of Member States whose currency is the euro, where the relative weight of each Member States’ sovereign bonds in the total portfolio of the CIU is equal to the relative weight of each Member States’ capital contribution to the ECB”.

Article 132 i of the CRR provides for a “look-through approach”, whereby the investor institution may “look through to the underlying exposures [of a CIU] in order to calculate an average risk weight for its exposures in the form of units or shares in the CIUs” in accordance with the methods set out in the CRR. This is subject to the condition that the investor institution be “aware” of the CIU’s underlying exposures.

Hence, the current regulatory regime allows investor institutions to apply to the units or shares in the CIU the same risk weights that would apply to a direct investment in the sovereign bonds of Member States. Given that such sovereign exposures already attract a beneficial regulatory capital treatment, it does not seem necessary to make changes to the prudential framework to promote the market for CIUs with this type of underlying or, in particular, to accommodate the specific structure referred by Article 506a of Regulation (EU) 2021/558.

Furthermore, with the recent and planned issuance of bonds under the NextGenerationEU programme, it would appear there is no longer an immediate need for the creation of the abovementioned structure.

50.

Additional supervisory powers to impose restrictions on distributions by institutions


Pursuant to Article 518b, the Commission is required to report to the European Parliament and to the Council by 31 December 2021 on whether exceptional circumstances that trigger serious economic disturbance in the orderly functioning and integrity of financial markets justify during such periods, granting additional binding powers to competent authorities to impose restrictions on distributions by institutions.

In response to the economic and financial distress caused by the COVID-19 pandemic, the Commission, the EBA, the ECB, the ESRB and most national competent authorities urged institutions to refrain from dividend distribution or share buy-backs and to adopt a conservative approach to variable remunerations. Preserving capital resources to support the real economy and absorb losses has been the common objective during the exceptional circumstances in 2020 and 2021.

The recommendations issued by authorities across the Member States in line with agreed EU stances have led to the desired effects and channelled capital resources in ways that help the banking system to support the real economy, as recent analysis by the ECB and a stock-take by EBA suggest. Consequently, when asked on whether the considered they would need additional powers in the area restrictions on distributions, competent authorities were of the view that the powers they currently have at their disposal are sufficient.

At the current juncture, the Commission therefore does not see a need for additional supervisory powers to be granted to the competent authorities to impose restrictions on distributions by institutions in exceptional circumstances. The issue of macroprudential oversight and coordination of such restrictions in exceptional circumstances in the future will be considered in the forthcoming review of the macroprudential framework.

51.

Prudential treatment of crypto assets


In recent years, financial markets have witnessed a rapid increase in activity related to so-called crypto assets and a progressively increased involvement of institutions in that activity. While crypto assets share certain common characteristics with more traditional financial assets, some of their features are significantly different. As a consequence, it is unclear whether the existing prudential rules would adequately capture the risks inherent in those assets. Since the BCBS only recently started exploring the question of whether a dedicated treatment should be developed for those assets, and if so, what should that treatment be, it was not possible to include specific measures on this topic in this proposal. Instead, the Commission is asked to review whether a dedicated prudential treatment for crypto assets would be needed and to adopt, if appropriate, a legislative proposal to this end, taking into account the work undertaken by the BCBS.