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?
We would like to make the following comments:
- According to the non-exhaustive list of examples “Forward starting loan i.e. loan offer accepted by the client (commitment), where the agreed terms and conditions require that the client must draw certain amounts at certain points in time” is assigned to bucket 1. What would be a treatment of a forward starting loan which has been accepted by a client, however drawing is in the future dependent on e.g. a review of the rating which has to be assigned to a certain grade, thus there is no certainty that the amount is going to be drawn?
2. Another item which is assigned to bucket 1 as per the non-exhaustive list is “Contingent item where the conditional event that prevents exposing the institution to the risk of credit losses in case of a default has not been triggered yet but it is related to credit risk, and the institution’s guarantee is only conditional on a default event for the guaranteed credit obligation”. Following the conditionality principle described in the consultation paper the principle is based on degree of conditional events that trigger on-balance sheet conversion i.e. the higher the number of events the lower the percentages. This should mean in practice that 100% is assigned if the conditionality is only based on a default of obligor only; 50% is assigned if conditionality is based on ability to meet contractual obligation + on a default of obligor. The draft RTS explains this principle in relation to the non-credit risk related event which precedes a default of obligor (i.e. two events – one is non-credit risk related event + the other one is credit risk related event). Taking into consideration the above cited item, does this contingent item represent the situation when there are two events, however both events are credit risk related (whereas the second event is a default) thus the assignment will be always to bucket 1? In other words, does the conditionality principle (described for bucket 2) also apply for a situation when a contractual obligation which must occur before a default has characteristics of credit risk related event?
3. The non-exhaustive list also includes in bucket 3 „Undrawn amounts of factoring arrangements in the context of commitments to finance the seller of receivables, invoice discount facilities, because this is a contractual arrangement to purchase assets, hence falls under the definition of commitment under article 5(9) while not being a credit substitute.“ How should the phrase „while not being a credit substitute“ be interpreted? Is it to be understood that in the case of some constellations an undrawn amount of a factoring arrangement can be regarded as credit substitute? If yes, could you provide any examples? Furthermore, the text is referring to “undrawn amounts of factoring arrangements”. Is the undrawn amount the difference between the limit provided in the factoring contract and already drawn amount or the limit is capped by the total amount of purchased receivables? Example: Factoring contracts include limits for the maximum amount of advance payment to be provided to the clients (seller) on the transferred receivables. In addition, the contract stipulates that that maximum x % of the transferred receivables (usually 80 %) can be drawn by the client as advance payment. The remaining 20% is called retention. So if the limit stipulated in the contract is EUR 10 mill and the total amount of transferred receivables are EUR 6 mill, then at this moment the client can maximum draw min(10, 6 x 80%), which is EUR 4,8 mill. Nevertheless, if the transferred receivables increase to EUR 20 mill in the next month, then the client can maximum draw min(10, 20 x 80%), which is EUR 10 mill.
Question 2. Which is the average period of time given to the client to accept the mortgage loan offer?
The period of time given to the client is 30 days.
Question 3. What is the applicable percentage tht institution currently apply to these commit-ments?
20% (see EBA Q&A 2022_6602, EBA Q&A 2017_3376)
With regard to para. 17 “It is the EBA understanding that the appropriate allocation for the amount that must be drawn would be bucket 1 considering that […] contractual arrangements not yet accepted by the client fall under the scope of commitments and should receive the same treatment as if accepted.” We do not see the argument why this should automatically be bucket 1 (with a resulting CCF of 100%).
Contractual arrangements offered by an institution, but not yet accepted by the client, could be bucket 3 or 5 as well. Contractual arrangements offered by an institution, but not yet accepted by the client, that would become commitments if accepted by the client, shall be treated as commitments and the percentage applicable shall be the one provided for in accordance with paragraph 2.
For arrangements akin to letters of intent (e.g. “Promesse” in Austria), the current applicable percentage would be 50% or 20% according to Annex 1 2 b) ii) or 3 b) i), depending on the original maturity. A promissory note serves to document the bank's basic willingness to grant a loan. It represents a binding, time-limited financing commitment by the bank, which is fulfilled by the subsequent conclusion of a loan agreement. The key details of a subsequent loan agreement are listed in the promissory note. The conclusion of the contract requires the customer to fulfil the conditions stated in the promissory note.
Question 4. What is the average acceptance rate by the client of a mortgage loan offered by the bank?
n.a.
Question 5. Do you have any comment on the allocation criteria proposed under Article 1?
The rationale for Art. 1 (1) and (2) is not clear, particularly in the articulation of the non-credit risk related events.
In relation to the conditionality principle and contingent items, we would like to point out that even when the claim exists it does not necessarily mean that the claim must be paid. The claim is in most cases withdrawn by the beneficiary after the applicant/corporate client is willing to extend the said instrument to the benefit of the respective transaction and hence possibility to heal and improve the underlying service and/or perfect the delivery of goods. Moreover, the claim is also subject to a possible injunction and therefore will be decided by a court ruling before payment is affected. Furthermore, under letters of credit, presentation of documents might be discrepant with the underlying letter of credit, i.e. payment is not triggered until the issuing bank and/or applicant is confirming the acceptance of such. In the guarantee business, payment claims are technical in nature, specifically very short in nature, on average between 5 and 10 days, and moreover such drawdowns are always documented by an approved guarantee facility credit line.
In addition to the re-classification of contingent items can EBA specify under which item in bucket 1 re-classified off-balance sheet items should be subsumed (e.g. Other off-balance sheet item constituting a credit substitute where not explicitly included in any other category)?
According to the draft RTS a commitment that is not a credit substitute may be assigned to bucket 3 or bucket 5, depending on whether it meets the definition of unconditionally cancellable commitment. Following this wording, it could be said that the commitments can be only assigned to bucket 1, 3 and 5. What is unclear is how to treat commitments related to trade-finance facilities. Example: a commitment to open short-term self-liquidating trade letters of credit arising from the movement of goods. The item does not have characteristics of a credit substitute and it is also not unconditionally cancellable. Based on the formulation of the draft RTS such items should be assigned to bucket 3 (40%), however such treatment would be more prudent than with the given instrument i.e. with open short-term self-liquidating letter of credit which should be assigned to bucket 4 with a 20%. Can EBA clarify a treatment of commitments related to trade finance facilities?
What concerns the treatment of contractual arrangements offered by an institution, but not yet accepted by the client, where the client must draw a certain amount in the future (for example a mortgage loan offer) EBA proposes that such commitments should get the same treatment as if accepted (100%). The assignment to 100% is linked to the fact that the client must draw a certain amount in the future. However, at the time when the offer has not been accepted by the client yet, there is no certainty that the amount will be drawn in the future. A client can even reject the offer in the period, which was given to the client, thus in such case there is no drawing.
We would propose to include a grandfathering provision for the existing instruments (already given) assigned to a sub-category “Other off-balance sheet items carrying similar risk and as communicated to EBA” which would allow to treat such instruments in the respective bucket as per the communication towards EBA.
Question 6. Do you have any suggestion regarding allocation criteria for buckets 4 and 5?
We propose to include in bucket 5: “Facility allowing for a rejection of any utilization of the line without any given reason even though the line is formally provided for optional utilization”.
Although Annex I CRR requires for the assignment to bucket 4 that the documentary credits are collateralized by the underlying shipment (in case of an issuing institution or a confirming institution) we would like to point out that confirmed letters of credit to the benefit of the beneficiary/corporate client whereas goods are delivered to the applicant of such letter of credit can only be evidenced by the underlying transport documents which are usually issued in the name of such applicant or the issuing bank. For the confirming bank a documentary credit is not collateralized by the underlying shipment. Following the above stated, we would like to propose to include in bucket 4 also documentary credits evidenced by the underlying transport documents, to especially also accommodate shipping routes via truck and railways as these documents do not represent title documents.
Question 7. Do you have any comment on the factors that may constrain unconditionally cancel-lable commitments proposed under Article 2?
Art. 2 (a) appears inappropriate/redundant as a credit institution with deficiencies in the risk management procedures, including shortcomings in the credit risk monitoring framework and in the IT systems and processes would already be facing questions and enhanced scrutiny by the competent authority, at least in the SREP.
Explicitly envisaging this as a factor that may constrain the institutions’ ability to cancel UCCs would leave the scope of potential cases largely undefined. Introducing considerations of proportionality, and especially of materiality it is key to establish the relevance of such deficiencies if the EBA intends to maintain this factor under the RTS. Moreover, we would emphasise that such deficiencies would certainly lead to P2R/P2G or other supervisory measures that are more targeted to address and remedy identified shortcomings.
Art. 2 (b) to d) may be relevant but lay in the sphere of business policy decisions of the credit institutions. Consumer protection rules have to be taken into account in any case.
We understand that if the institution is experiencing any issue which is mentioned on this list of the factors, such off-balance sheet item has to be assigned to the bucket 3 (40%), irrespective whether the contract itself allows to be cancelled unconditionally. The factors proposed in Article 2 are too generic due to which it can be difficult to prove an absence of the factors, which means that it basically prevents an institution to assign an unconditionally cancellable commitment to bucket 5. This seems to be in contradiction with Level 1 text (CRR) which specifically lists as one of the buckets bucket 5 for unconditionally cancellable commitments. We propose to remove reputational and litigation risk from the list of factors.
Furthermore, please note the potential interplay with IFRS 9 B 5.5.39 & 40, in the sense that those unconditionally cancellable commitments (hence, having by definition a “contractual maturity” of 0-1 days) in respect of which that unconditional cancellability may not be de facto applied would meet the criterion (b) in B 5.5.39 and, assuming the other two criteria (a) and (c) are also normally fulfilled, they would fall under the accounting requirement of B 5.5.40, namely a so-called “behavioural maturity” would need to be estimated (in absence of a higher than 0 “contractual maturity”) for the purpose of applying the IFRS 9 impairment requirements on such off-balance exposures (the newly applicable “bucket 3” CCF being of course another factor in the related credit loss allowance calculation). It further means that the factors drafted in Article 2 would presumably become a practical “application guidance” for IFRS accountants, in distinguishing between (a) unconditionally & immediately cancellable (hence: 0 contractual maturity) loan commitments subject to “behavioural maturity”- based loss allowance calculation requirements of IFRS 9 (hence: still falling under “loan commitments” for IFRS accounting purposes), i.e. those UCCs allocated to bucket 3 due to falling under Article 2 and (b) unconditionally & immediately cancellable loan commitments not subject to “behavioural maturity”-based loss allowance calculation requirements of IFRS 9 (hence: not falling under “loan commitments” for IFRS accounting purposes, but as IAS37 governed “contingent liabilities”, hence: not subject to any provisioning unless non-performing), i.e. those UCCs allocated to bucket 5 due to not falling under Article 2. In respect of (b) above, please further note that the newly applicable CCF of 10% might result in CRR-based FINREP provisioning of such exposures, whilst for IFRS purposes such provisions would need to be reversed (based on IAS 37), unless the related client is non-performing.
Question 8. Do you have any comment on the notification process proposed under Article 3?
To ensure improved readability and compliance, it would be helpful to clarify the specific references to Implementing Regulation (EU) 2021/451 Article 3. Moreover Implementing Regulation (EU) 2021/451 does not seem to fit at all.
What concerns the notification process for “Other off-balance sheet items carrying similar risk and as communicated to EBA” EBA proposes to notify such items through regular reporting in accordance with Regulation 2021/451. Following the current version of respective Regulation, including the recently proposed amendment, it does not appear that templates for COREP would have any specific section which would address such notification process. In FINREP-templates such items are simply subsumed under “Other commitments”, so it is unclear how exactly the information about certain off-balance sheet items (the ones which are not listed in Annex I or not mentioned in the example list provided in the draft RTS) is supposed to be communicated to EBA through supervisory reporting regulation.
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?
n.a.
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)?
As per the notification which was submitted in the past to communicate “Other off-balance sheet items carrying similar risk” there are instruments (in form of guarantees) in the portfolio which have characteristics of trade finance, however the maturity of such instruments is longer than one year. Although such instruments have a longer maturity, ICC statistics show, that there is no material difference in related draw down risk for guarantees with a tenor of more than 1 year and with a tenor of less than 1 year. As the risk deriving from trade related off-balance sheet items doesn´t depend of whether its term is longer or shorter than one year, but rather of the close connection to the underlying trade transaction and as the restriction to maximum tenor for trade finance doesn´t reflect correctly the structure of trades, we treat such off-balance sheet items (as per the notification letter) in bucket 4 (20%) under “Other off-balance sheet items carrying similar risk and as communicated to EBA”.
In this respect, the understanding is that the treatment for “Other off-balance sheet items carrying similar risk” notified in the letter is valid also under CRR3.