EU Banking Package - CRR II and CRD V within sight

On 23 November 2016, the European Commission published proposals for the completion of the banking regulation reform (Capital Requirements Regulation (CRR) II and Capital Requirements Directive (CRD) V plus Bank Recovery and Resolution Directive (BRRD) II and Single Resolution Mechanism Regulation (SRMR) II. The proposals are intended to implement Basel III and parts of Basel IV in EU law (excluding, inter alia, credit risk calculation) as well as autonomous EU regulations (especially in terms of proportionality).

In May 2018 the ECOFIN (Council) published its statement, followed by the ECON (Parliament) releasing its opinion in June 2018. The trialogue negotiations began in early July 2018. On 5 December 2018, European Parliament announced that it had reached an agreement on the banking package with the European Council. On 15 February 2019, an agreement was reached between the Romanian presidency and the Parliament. Parliament and Council will hence be called on to adopt the proposed regulation at first reading. The debate in the EU Parliament is scheduled for mid-April 2019. A publication in the EU Official Journal (OJEU) would then be possible until the end of May 2019. From then on, a transitional period of 18 months respectively two years applies.

The revisions are expected to lead to significant changes in supervisory law by the beginning of the next decade. Accordingly, each bank and financial services company should examine the expected provisions in detail and promptly analyse to what extent transformation projects will be necessary in order to make optimum use of the transformation period.
However, the implementation must consider that the CRR II does not yet address key aspects of Basel IV, in particular the credit risk provisions, which could have a significant impact on regulatory capital. These amendments are likely to be implemented by CRR III.

What makes the prediction on this topic so difficult is the fact that it is not foreseeable whether the EU will deviate from the proposals of the BCBS, as it has already done with this EU banking package, and replace them with its own proposals. This is all the more the case as the Basel proposals would result in a break with the current third rating agency regulation (CRA III), which provides for the withdrawal of external ratings from European banking supervision.

Overview of the amendments

The following is a brief overview of the most important amendments:

Amending capital requirements

New Pillar 1 requirements

CRR ll introduces a binding 3 % leverage ratio for all institutions subject to the CRD that applies in addition to total capital ratio of 8 %, cf. Articles 92, 429 — 429g CRR II. For global systemically important institutions (G-Slls) the Parliament provided for an add-on equaling 50 % of the G-SII buffer (i.e. + 0, 5% to 1,75 %).

The ratio requires institutions to back 3 % of the unweighted total exposure with regulatory core capital (CET 1 and AT 1) in future. The leverage ratio is thus intended to supplement the risk-based capital requirements and, for example, counteract their procyclical effect and potential weaknesses in risk management.

Articles 411 — 430 CRR II roll out a harmonised binding net stable funding ratio (NSFR), set at a minimum level of 100 %. NSFR is that between the available stable funding (ASF) held by an institution and the required stable funding (RSF) that an institution needs over a one-year horizon, calibrated to reflect the presumed degree of stability and liquidity respectively. The Parliament (a) set the RSF calibration for derivatives at 5 %; (b) reduced the asymmetric treatment for repos and reverse repos, by lowering the RSF to 0 % for secured reverse-repos and 5 % for unsecured reverse repos; (c) covered bonds benefit from preferential treatment.

Revised risk-weighting and large exposure standards

CRR II sets out more risk sensitive capital requirements for market risk, cf. Articles 94, 102, 103, 104 — 104b, 325 — 325az, 501b CRR II, that include (a) clearer rules on the scope of application to prevent regulatory arbitrage; (b) making requirements proportionate to reflect the risks to which banks are exposed more accurately; and (c) strengthening the conditions to use internal models to enhance consistency and risk-weight comparability across banks. Banks with small trading books (under €50 million and less than 5 % of total assets) are allowed to apply the treatment of banking book positions to their trading book. Banks with medium-sized activities subject to the market-risk capital requirements (under €300 million and less than 10 % of total assets) may use the simplified standardised approach.

Besides, CRR II improves large exposures prudential treatment, cf. Articles 387 — 403 and Art. 493, 507 CRR II. Currently, those exposures cannot exceed 25 % of the eligible capital. CRR II substantiates the capital that can be taken into account to calculate the large exposures limit (only Tier 1 capital), introduces a lower cap of 15 % for G-Slls' exposures to other G-Slls, , and imposes the use of the standardised approach (SA-CCR, cf. Articles 273 — 282 CRR II) for determining exposures to OTC derivatives, even for banks that have been authorised to use internal models.

Waivers from capital and liquidity

CRR II provides for more flexibility regarding waivers from capital and liquidity requirements, cf. Articles 4, 7 and 8 CRR II. So far, waivers can only apply at individual level for subsidiaries within the same Member State that are overseen on a consolidated basis by the same supervisor. The Commission argued that where the same competent authority supervises parents and subsidiaries established in different Member States participating in the banking union, it should be able to waive the application of own funds and liquidity requirements. Parliament, however, reduced the scope, by providing that capital waivers cannot apply to subsidiaries exceeding the threshold qualifying an institution as 'significant' according to the Single Supervisory Mechanism Regulation (SSMR) and that capital waivers cannot exceed 25 % of the subsidiaries' minimum own funds requirements.

This limits the possibility of granting large exposures, which will tend to make them more expensive

Proportionality

CRR II calibrates reporting and disclosure requirements for small, non-complex banks, cf. Articles 94, 99, 273a„ 325a, 430a — 451a CRR II. The absolute threshold to define 'small, non-complex institutions' was raised to €5 billion. In the existing framework, banks have to report according to uniform reporting requirements that include information about institutions' solvency, the overall financial situation, leverage, large exposures and liquidity. At the same time, disclosure requirements apply at 'consolidated (group) level'. For both kind of requirements, the Commission put forward amendments in the CRR (and the CRD) aimed at enhancing proportionality and reducing compliance costs for institutions.

CRR II also adjusts the SME supporting factor. Currently, banks receive a capital charge reduction of 23,81 % for SME lending under €1,5 million. The proposal widens this 'SME supporting factor' to €3 million and extends its scope with no upper limit, i.e. above the limit specified above, a 15 % reduction for the remaining part of the exposure would apply, cf. Article 501 CRR II.

This is intended to reduce the cost of lending to SMEs.

To encourage private investments in infrastructure projects, the Commission laid down a more risk-sensitive regulatory environment being able to promote high quality infrastructure projects and reduce risks for investors, cf. Article 501a CRR II. Similar to what is envisaged for insurance undertakings, capital charges for exposures to infrastructure projects would be reduced (factor of 0,75), provided those projects comply with a set of criteria capable of lowering their risk profile and enhancing the predictability of their cash flows.

The aim is to promote private financing for infrastructure projects that contribute to strengthening European competitiveness and stimulating the labour market.

Finally, the Commission proposes a targeted amendment to address problems that emerged in the application of the CRD requirements to pay out part of the variable managers' remuneration in instruments and to defer the payment over time, and another targeted amendment aimed at allowing listed institutions to use share-linked instruments to meet those requirements, cf. Articles 92, 94 CRD V.

The EU Commission thus underlines that these regulations in particular can only be applied to a limited extent to small and less complex institutions or to employees with low variable remuneration. Accordingly, the application may be waived if certain thresholds are not reached (value of assets under €5 billion or the annual variable remuneration does not exceed €50,000).

Resolution framework

CRR II also implements the TLAC standard, cf. Articles 72a — 721, 92a, 104a and 104b CRR II, and 131(1) CRD V. It introduces a Pillar 1 MREL requirement for G-Slls to hold minimum levels of capital and other instruments which bear losses in resolution, in compliance with the TLAC standard. This requirement contains a risk-based ratio (at least 18 %) and a non-risk-based ratio (at least 6,75 %); a similar requirement applicable at subsidiary level is set out for subsidiaries of non-EU G-Slls. A new Chapter 5a on eligible liabilities is introduced in the CRR II.

Pillar 2 capital requirements

The CRD V settles the conditions for imposing additional own funds requirements (Pillar 2 capital add-ons), cf. Articles 104, 104a, 104b, 141, 141a CRD V. The proposal also clarifies the interaction between the Pillar 2 add-ons, the Pillar 1 requirements, the own funds and eligible liabilities requirement, the MREL and the combined buffers ('stacking order'). For details, please refer to the relevant EBA paper. In addition, the proposal constrains competent authorities' discretion when imposing additional reporting and disclosure obligations on institutions under Pillar 2.

The proposals follow recent criticism of the supervisory authorities' handling of additional capital requirements from the Supervisory Review and Evaluation Process (SREP); the relevant requirements are hence further specified.

Exemptions regime

CRD V also tailors the exemptions regime. Some public development banks and credit unions in certain Member States are currently exempted from the CRD IV / CRR framework. To ensure one level playing field, the CRD V proposal provides for an additional exemption for similar institutions in other Member States. The criteria take account of the features of entities on the list of entities exempted from CRD / CRR, i.e. promotional and development banks without cross-border activities and not exceeding the significance threshold in size set by the SSMR; as well as limited size credit unions without cross-border activities.

However, since most cooperative banks do not only offer their products to members and also distribute other products, they are generally not eligible for the exemption.

Intermediate parent undertaking

The proposed EU intermediate holding structure, which would affect many non-European banks, especially in the context of the Brexit, is attracting considerable interest. Article 21b CRD V (in conjunction with Article 4 No. 137 CRR II) requires two or more institutions established in the EU belonging to the same parent institution in a third country to establish an intermediate EU parent undertaking in the form of a holding company (cf. Article 21a CRD V) or an EU institution that requires a supervisory approval (license). The requirement is limited to third country groups that are considered non-EU-G-SII or that have institutions in the EU with total assets of €40 billion or more (paragraph 3). This is intended to ensure a complete group and single supervision of all undertakings domiciled within the EU (cf. Articles 8 and 21b CRD V). The ECB even calls for extension to branches.

Amending bank resolution framework

MREL

The following is an overview of the planned MREL framework (cf. European Commission):

Resolution entity and resolution group

BRRD II adopts the concept of the "resolution entity" and the "resolution group" (from the TLAC standard of the FSB) in order to take into account the two most important settlement procedures used, namely the Single Point of Entry (SPE) and the Multiple Point of Entry (MPE) (amended Articles 2, 12, 13). In the SPE strategy, only one group entity (usually the parent undertaking) is liquidated, while other (subsidiary) group entities are not liquidated but their losses are transferred to the liquidated entity. The MPE strategy allows more than one entity to be liquidated.

The amendments create more legal clarity with regard to individual definitions and the institutions affected accordingly.

Third country provisions

BRRD II addresses the need for proportionality of bail-in related rules by revising Article 55 under which banks have to include in contracts that are governed by the law of a third country a clause by which the creditor recognises the bail-in power of the EU resolution authorities.

This contractual recognition requirement is designed to ensure the effectiveness of the bail-in tool in a cross-border resolution and to promote equal treatment between EU and third-country creditors. In this case, the relevant contractual documentation must be properly drafted respectively adapted.

However, it is questionable to what extent (existing) liabilities are subject to the bail-in powers of the EU resolution authorities under English law within the framework of Brexit. This must be analysed in detail in each individual case.

Creditor hierarchy

Some Member States have amended the insolvency ranking of certain bank creditors under their national insolvency law; unsecured debt holders and other creditors of banks can be treated differently from one Member State to another. The proposal amends Article 108 BRRD by partially harmonising the creditor hierarchy in case of bank insolvency, as regards the priority ranking of holders of bank senior unsecured debt eligible to meet the BRRD rules. It intends to create a new asset class of 'non-preferred' senior debt that should only be bailed-in in resolution after other capital instruments, but before other senior liabilities.

This is deemed to comply with the subordination requirement for inclusion in TLAC and MREL (but not in own funds). This should help banks to meet their MREL requirements once these are specified by the Single Resolution Board (SRB) and by national resolution authorities.

SRMR II mirrors BRRD II

The SRMR II deals with the institution-specific add-on for G-Slls and the general requirements applicable to banks established in the banking union. The proposal mirrors the modifications in the BRRD and introduces a number of targeted amendments to the existing SRMR: It changes the MREL' requirement for banks and G-Slls under the scope of the SRB (taking over TLAC, Articles 12a-j SRMR II) from being measured as a percentage of the total liabilities of the institution into a percentage of the total risk-exposure amount, and of the leverage ratio exposure measure of the relevant institution. The amendments also introduce an internal MREL requirement (Articles 12g and 12h) which, in line with the TLAC standard, allows the recapitalisation of a resolution group entity without placing it into formal resolution.