Response to consultation on Regulatory Technical Standards on the allocation of off-balance sheet items and UCC considerations
Question 1. Do you have any comment on the non-exhaustive list of examples provided?
The non-exhaustive list of examples of specific off-balance sheet items provided in the draft RTS also mentions “[u]ndrawn amounts of factoring arrangements in the context of commitments to finance the seller of receivables, invoice discount facilities” as off-balance sheet items to be allocated to CCF bucket 3 instead of CCF bucket 5.
Firstly, we wish to clarify that the aforementioned factoring limits (debtor and factoring client limits) can generally not be considered as commitments in the meaning of art. 5 (10) of the CRR and should therefore not be allocated neither to CCF bucket 3 nor 5.
According to art. 5 para. 10 of CRR III, commitments are "any contractual arrangement that an institution offers to a client, and is accepted by that client, to extend credit, purchase assets or issue credit substitutes". With non-recourse factoring, the credit risk lies with the debtor, not with the factoring client, and since debtors are not the clients of factoring companies and generally no contractual arrangements exist between the debtors and the factoring company, debtor limits do not fulfil the aforementioned definition of “commitment”.
Furthermore, debtors cannot even trigger the credit risk, since the realisation of the factoring company’s credit risk mainly depends on the factoring client selling goods or providing services and then selling/assigning the receivables resulting therefrom to the factoring company. This systematic difference is also the reason why in cases of non-recourse factoring, debtor limits need not be reported under AnaCredit (cf. point 5.4.8 of AnaCredit Reporting Manual, Part III – Case studies); similarly, the Deutsche Bundesbank clarified in July 2020 that at least for purposes of reporting loans/credit facilities of a certain amount (Millionenkreditmeldungen), debtor limits in factoring are not considered as commitments. In this context, it should also be noted that for liquidity requirements purposes, art. 411 no. 16 of the current CRR (which remains unchanged by CRR III) defines factoring, but does not classify factoring (limits) as a commitment.
Another reason that factoring limits are not to be considered as commitments is that generally in factoring, all conditions set out in art. 5 para. 10 letters a-e of CRR III are met with:
"(a) ... institution receives no fees or commissions to establish or maintain those contractual arrangements"
The factoring fee and any interest to be paid by the factoring client are only incurred through the purchase, assignment and funding of a receivable and do not serve as consideration for establishing or maintain the factoring agreement as such (in contrast to e.g. commitment fees). In particular the factoring fee is payment for the factoring company’s services to the factoring client in the form of debtor and collection management. This is why the factoring fee is generally also the basis on which VAT is calculated.
“(b) … client is required to apply to the institution for the initial and each subsequent drawdown under those contractual arrangements”
In order to receive liquidity in the form of the receivables purchase price, factoring clients always have to tender the receivable(s) to the factoring company for purchase; the factoring company then decides individually on each purchase and payment. This is therefore the factoring client’s application for each “drawdown”.
“(c) institution has full authority … over the execution of each drawdown” and “(d) institution [assesses] the creditworthiness of the client immediately prior to deciding on the execution of each drawdown"
Factoring agreements generally contain clauses to the effect that debtor/factoring client limits can be cancelled at any time and according to equitable judgment in consideration of the debtor’s creditworthiness. By checking the limit availability prior to each purchase/assignment, this creditworthiness is also assessed with each purchase/assignment, hence giving the factoring company the final say over each purchase/assignment.
“(e) ... offered to a corporate entity, including an SME, ... closely monitored on an ongoing basis"
In addition to the aforementioned checks on limit availability prior to each purchase/assignment, factoring limits and debtors’ creditworthiness are closely monitored on an ongoing basis in factoring, e.g, through regular cross-checks with limits set by credit insurances for the purchased receivables and the debtors, through checks of debtors’ payment behaviours with other factoring clients as well as through the factoring client’s duty to report any negative debtor payment behaviour.
In view of this, neither debtor limits nor factoring client limits are commitments in the meaning of art. 5 para. 10 of the CRR III.
Secondly, if factoring limits were to be viewed as commitments (despite all of the aforementioned arguments), they should at least be considered as unconditionally cancellable commitments since they fulfil the corresponding prerequisites of art. 5 para. 10 of the CRR III:
Factoring companies generally have binding internal guidelines that limits are to be cancelled in the case of critical deteriorations in creditworthiness. These guidelines ensure that, in the event of a relevant deterioration in creditworthiness, limits are cancelled without further discretion and therefore “automatically”, as foreseen in art. 5 para. 10 of the CRR III. Furthermore, such limit cancellations do generally not have to be announced to the factoring client before they take effect, and in contrast to other commitments, there is also no increased probability that the factoring limit will be utilised if the factoring client's financial/economic situation deteriorates. This applies all the more when focusing on the party with the relevant default risk in non-recourse factoring, namely the debtor.
Taking art. 2 of the draft RTS into consideration (cf. also question 7 below), there are also no factual reasons to maintain the factoring limit despite creditworthiness doubts. The cancellation of limits due to a deterioration in the creditworthiness of a debtor is completely standard practice in factoring and is actually inherent to the structure of the factoring business, so that it is quite inconceivable that a corresponding cancellation of limits could have e.g. reputational consequences for the factoring company or negatively influence the perception of the factoring company in the market. Similarly, maintaining factoring limits for fear of legal disputes is also hardly conceivable: Legal disputes, in particular with the debtors of purchased/assigned receivables, are part of the debtor management and collection aspect of non-recourse factoring and hence quite normal.
Thirdly, even if factoring limits were to be classified as commitments, an allocation of all factoring limits into bucket 3 (instead of bucket 5) is uncalled for, inadequate and disproportionate.
A CCF of 40% by no means appropriately reflects the probability with which it may be reasonably in factoring expected that undrawn limits are converted into actual credit risk exposures or positions. Factoring clients are generally obliged to tender all of their receivables against the relevant debtors to the factor. Generally applying a CCF of 40% would therefore effectively mean that factoring clients are expected to increase their turnover (!) on average by 40%, based on the undrawn debtor limits. It goes without saying that this assumption is untenable.
Moreover, a comparison with the other examples provided for bucket 3 clearly demonstrates that undrawn factoring limits show systematically fundamental differences from a risk perspective which do not justify the application of the same CCF. While a CCF of 40% may well be appropriate for granting revolving overdraft limits on current accounts (cf. example 3 of the consultation paper) because there is a corresponding probability of drawdown (especially if the customer's financial situation deteriorates), the same cannot be said of factoring limits due to the systematic differences already mentioned. In factoring, the debtor cannot trigger the credit risk being assumed by the factoring company. For the factoring client, on the other hand, to trigger said credit risk, the factoring client must first carry out a real economy transaction, which then triggers the conditions for the factor's purchase of the hereby generated receivables. In addition, a factoring client facing economically hard times in no way increases the probability of a sale of goods / services and thus (theoretically) a corresponding exposure or credit risk on the debtor. On the contrary: With economically challenging times, experience shows that factoring clients face a higher probability of sales difficulties due to e.g. shortages in material and dwindling confidence on the debtor side, i.e. factoring clients confronted with economic challenges are likely to generate less receivables that can be sold/assigned to factoring companies in return for liquidity in the form of the purchase price.
A comparison with example 1 regarding bucket 3 as stated in the draft RTS also shows fundamental differences to non-recourse factoring. In this example 1, the institution has submitted a takeover bid with a recognisable price offer, which will lead to an increased likelihood of the transaction being implemented and thus the emergence of a corresponding credit/default risk. In contrast to factoring, the institution itself has the sole power to let such a situation arise in the first place by setting the parameters of the offer, which in turn may justify a corresponding CCF of 40%.
As stated above, the sum of undrawn factoring limits are usually 5 to 7 times higher than the average utilization. Allocating factoring limits to bucket 3 in this scenario would hence effectively entail higher capital requirements for “undrawn” factoring limits than for the actual risk weighted assets following the purchase and assignment of receivables against debtors, even if the factoring companies were to lower their limits considerably. A (conservative) example calculation with a factoring limit only 5 times higher than the actual utilisation can easily illustrate this:
Debtor limit for an SME corporate factoring client: 1 million Euro
Utilisation: 200.000 Euro
800.000 Euro off-balance sheet exposure, risk weight with 40% credit conversion factor (CCF) due to allocation to bucket 3 results in 320.000 Euro and a capital requirement (13-15%) of 41.600-48.000 Euro (theoretical risk), while the actual utilisation of 200.000 Euro only requires 21.000 Euro regulatory capital. In cases where the limit is 7 times higher than the actual utilisation, this difference is obviously higher still.
Extrapolating this to the overall factoring turnover in 2023 in Germany of more than 384 billion Euro, this could mean additional capital requirements for (theoretical) factoring limits of factoring companies of around 11-16 billion Euro.
If factoring limits were to be allocated to bucket 3, the theoretical, not materialised credit risk would require a multiple of the amount of regulatory capital for the utilised, materialised credit risk (even more so where credit insurances are used for credit risk mitigation purposes in accordance with CRR, thus lowering regulatory capital requirements for actually purchased receivables). This is inadequate and disproportionate. In this context, we also wish to point out that since particularly national civil law influences how factoring is executed and factoring contracts (including limits) are drafted, such national differences need to be taken more into consideration in order to maintain a level playing field.
Considering the low-risk nature and history of factoring (limits), the very widespread use of credit risk protection through credit insurances in factoring (who in turn also follow capital requirements) and since the wording of the draft RTS implies that the examples given for allocation into bucket 3 are non-exclusive, i.e. that an allocation to bucket 5 remains possible (“…unless assigned to bucket 1 or bucket 5…”), we therefore advocate to make this distinction clearer in order to allocate factoring limits to bucket 5 at most, should they still be considered as (unconditionally cancellable) commitments.
For further details, please refer to our position paper in response to this consultation which we have also uploaded.
Question 2. Which is the average period of time given to the client to accept the mortgage loan offer?
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Question 3. What is the applicable percentage tht institution currently apply to these commit-ments?
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Question 4. What is the average acceptance rate by the client of a mortgage loan offered by the bank?
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Question 5. Do you have any comment on the allocation criteria proposed under Article 1?
Please refer to our answer to question 7 as well as to our position paper in response to this consultation which we have also uploaded.
Question 6. Do you have any suggestion regarding allocation criteria for buckets 4 and 5?
NA
Question 7. Do you have any comment on the factors that may constrain unconditionally cancel-lable commitments proposed under Article 2?
The factors presented in art. 2 and referenced to in art. 1 of the draft RTS may in theory lead to an unconditionally cancellable commitment not being cancelled, but this is rarely (if ever) the case in practice, especially not in factoring (if factoring limits were to be considered as commitments, cf. our response to question 1). In factoring, there are no factual reasons to maintain the factoring limit despite creditworthiness doubts or deteriorations. The cancellation of limits due to a deterioration in the creditworthiness of a debtor is completely standard practice in factoring and is actually inherent to the structure of the factoring business. Hence, it is quite inconceivable that a corresponding cancellation of limits could have e.g. reputational consequences for the factoring company or negatively influence the perception of the factoring company in the market and that this is turn would influence the decision or hinder the factoring company’s ability to cancel a commitment. Similarly, maintaining factoring limits for fear of legal disputes is also hardly conceivable: Legal disputes, in particular with the debtors of purchased/assigned receivables, are part of the debtor management and collection aspect of non-recourse factoring and hence quite normal.
The consequence resulting from the (in practice unlikely) constraining factors in art. 2 is that unconditionally cancellable commitments are allocated to bucket 3 according to art. 1, i.e. with a CCF of 40% instead of 10%. Due to this significant and considerable consequence and given the difficulty of proving the absence of/non-decisive influence of factors presented in art. 2, the exceptional nature of cases where the factors mentioned in art. 2 of the draft RTS may actually play a decisive role should be better reflected in the wording of arts. 1 and 2, e.g. by adding “… may in few cases constrain…” to art. 2 and “”is actually constrained” in art. 1.
For further details, please refer to our position paper in response to this consultation which we have also uploaded.
Question 8. Do you have any comment on the notification process proposed under Article 3?
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What is the materiality in your institution of the off-balance sheet items that would fall under the categories “Other off-balance sheet items carrying similar risk and as commu-nicated to EBA” listed in each bucket of Annex I?
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Do you identify any specific item you may hold off-balance sheet that is currently classi-fied as “Other off-balance sheet items carrying similar risk and as communicated to EBA” and that may experience a change in bucket allocation based on the criteria listed in Ar-ticle 1 of these RTS? What would be the related change in the associated percentage as per article 111(2)?
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