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 note that the EBA has proposed a list of items, while CRR mandate only allows for setting criteria of allocation of off-balance sheet items not listed in Annex I. We want to highlight that no sort of additional binding listing can eventually be legally added in the final RTS in any way. Moreover, in the list of examples provided, the EBA has quoted some items that are already listed in Annex I which is also in breach of the mandate, by way of example:
- Forward starting loans – as detailed by EBA, it is a financing commitment – a commitment non listed in other buckets is to be assigned to bucket 3. Furthermore, most forward starting loans include conditions (named conditions precedents in loan agreements) or financial covenants to be met before drawdown, meaning there is generally no loan agreement with unconditional drawdown. . In any case, mandatory drawdown of the loan is very rare and only for specific forward starting loans, therefore the description made by the EBA of this kind of facility to justify its classification in bucket 1 is not appropriate.
- Documentary credits – these are by definition generally short-term and self-liquidating , whether there is a collateral or not. Bucket 4 of Annex I lists “ Short-term, self-liquidating trade letters of credit arising from the movement of goods, in particular documentary credits collateralised by the underlying shipment, in case of an issuing institution or a confirming institution;” the wording “in particular” does not restrict the eligibility to the 20% CCF to L/C that are collateralized. Therefore non collateralized letters of credit are already listed as eligible for the 20% CCF treatment and should not be transferred to bucket 2.
- Contingent items 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 – this item is misleading; performance bonds are already listed in Annex I Bucket 2/4 : even if the failure in contractual obligation triggering the activation of the guarantee may be linked to credit risk amongst other reasons, the default of the obligor shall not be considered as the only condition and such items not be transferred to bucket 1.
- EBA in its RTS draft has made it is clear that it is mandated to “specify the criteria that institutions shall use to assign off-balance sheet items, with the exception of items already included in Annex I”. Thus, items already mentioned in Annex I of the CRR (clarified/confirmed by ACPR) should not be included in the RTS scope.
Question 2. Which is the average period of time given to the client to accept the mortgage loan offer?
The maximum period of time given to the client to accept the mortgage loan offer is 30 days.
Please note that in France, the client cannot accept the offer until 10 days.
Unlike consumer credits, the borrowers (ie. natural persons), do not have a right of withdrawal (the period during which a borrower may reconsider his decision), but a right of reflection which allows them to examine the credit proposals, compare them with any other proposals and decide in full knowledge of the facts. This legal reflection period is 10 days and the offer cannot be accepted before the termination of this legal period for reflection.
Question 3. What is the applicable percentage tht institution currently apply to these commit-ments?
We understand that EBA proposes an allocation in bucket 1 to contractual arrangements not yet accepted by the client. We believe that undrawn mortgage loans (accepted or not) can’t receive a 100% CCF because clients generally have different offers with legal delays of retractation and because the drawdown is also conditional to the acquisition of the property and therefore is not certain.
Moreover, at the scale of the jurisdiction, this would imply trapping capital within several credit institutions well beyond the risk of loss of a single credit.
Note the EBA Q&A 2022_6602 on ”Estimation of a conversion factor for binding mortgage offers under the IRB Approach” specified that binding mortgage proposals qualify for the creditor as agreements to lend (Medium or Medium/low risk depending on the initial maturity of the offer, that has been merged into bucket 3 – 40% CCF in CRR3). Allocation to bucket 1 would significantly increase the RWA on such items considering current EBA recommendation.
We understand that some Q&As may be considered obsolete with the entry into force of CRR3, but we believe that the arguments developed in the Q&A are still valid in substance; as a consequence, their classification with a CCF of 20%/50 % shall only lead in CRR3 to a new classification for a CCF of 40 %. Modifications brought by CRR3 to Annex I don’t show, in the elements added to bucket 1 (or even 2), any elements assimilated to a mortgage loan offer, confirming that the substance of EBA Q&A is still valid.
On the contrary, the definition of a commitment brought by CRR3 relies on the acceptance of a contractual arrangement by the client and Article 111.4 specifically aims at specifying that, even if not yet accepted by the client, the item should be treated indifferently as a commitment. There is no intent here to impact the CCF that is to be applied to the given type of commitment as per Annex I.
We thus would like to remind to the EBA that in the current Annex I of CRR3 as voted at the EU parliament, mortgage loan offers, cannot be assigned to bucket 1, 2, 4 or 5 since treated as a commitment as per 111.4. It should thus be assigned to bucket 3 “Commitments, regardless of the maturity of the underlying facility, unless they fall under another category;”, i.e.just like where accepted and undrawn mortgage loans are currently assigned by CRR 3 in accordance with Basel statement. Note that this reasoning stands for any type of financing commitments.
Question 4. What is the average acceptance rate by the client of a mortgage loan offered by the bank?
To note that regardless of statistical average, the application of a 100% CCF ahead of acceptance and even ahead of drawing once the mortgage offer is accepted is potentially incompatible with the legal framework of some jurisdictions.
For example, in France as an example of jurisdiction:
i) once the offer is made by the bank, the client has 30 days to accept it (meaning there may also be contingency in relation to the fact that the client does not accept another offer from another bank (as acknowledged by the EBA)
ii) once accepted, the client can still revoke the contractual agreement (without penalty), should the real estate sale not occur.
As such, EBA is going beyond its mandate by contradicting CRR3 that currently allocates mortgage loan offers to the bucket 3, given that in our opinion undrawn mortgage loan accepted by the client already falls into this category.
Question 5. Do you have any comment on the allocation criteria proposed under Article 1?
We consider that financing commitments are already included in Bucket 3 and therefore, out of the mandate of EBA.
We understand that bucket 1 covers those instances where exposing the institution to the risk of credit losses from the off-balance sheet item in case of default of the obligor is not conditional on the occurrence of any non-credit risk related event that still needs to occur. Bucket 1 shall only encompass credit substitutes (ie guarantees) and commitments to purchase assets, hence should never include financing commitments.
Meanwhile, off-balance sheet items not already included in Annex I to Regulation (EU) No 575/2013 shall be assigned to the bucket 2 referred to in that Annex where the institution's exposure to the risk of credit losses in the event of default of the obligor is contingent to at least one non-credit risk related event that has yet to occur.
Also, given the criteria proposed by EBA, we question which commitments would remain eligible to bucket 3. The formulation used in Article 1.1 is too wide as it encompasses any financing commitment including those where the drawdown is not mandatory or whose possible drawdown does not depend on the materialization of a non-credit event. We note that the EBA’s actual policy intention as stated in the background section of the consultation does not seem to align with the drafting of Article 1.1.: the latter (and article 1.2 as well) should only address off balance sheet items in the form of “contingent” commitments with mandatory drawdowns (guarantees), excluding any form of financing commitments.
We therefore suggest EBA to modify Article 1.1 by precising that it applies to contingent commitments and not to any financing commitments.
Similarly, the current phrasing of Article 1.2 would include any financing commitment which drawdown is contingent to the materialization of a non-credit risk related event. Overall, buckets 1 and 2 should not cover financing commitments since they are supposed to fall in the bucket 3.
It should also be clarified that the failure in the fulfilment of a contractual obligation is a first order non-credit risk related event even if it might be concomitant to the default of the obligor. For instance, a performance bond, whereby the issuer insures the due delivery of goods or services to the buyer, can only be called if the seller has failed to properly finalize the production/delivery. This type of items shall remain in bucket 2 (or 4 when relevant) as already included in Annex I, even if this failure could be, amongst other reasons, linked to financial distress.
We suggest the EBA to modify article 1.2 by precising that this article should apply only to contingent commitment and not to any financing commitments.
We would also like to bring to the attention of the regulator that the verification of the occurrence of a contingent event and the reclassification in another off-balance sheet bucket, for each off-balance sheet commitment, contract by contract, is extremely costly operationally.
Moreover, the occurrence of the non-credit-risk-related event will, in most cases, be concomitant with the drawing of the guarantee and a recording, from an accounting perspective, as a balance sheet exposure (and therefore equivalent to the application of a 100% CCF).
The cost-benefit of EBA’s proposal does not seem proportionate as it only relates to remote cases and would be extremely costly on an operational point of view.
When it comes to the Article 1.3. of the RTS proposal, the EBA refers to 100% CCF for “commitments whereby the client must draw certain amounts in the future”. We would like to recall here again that any financing commitment are already listed in Annex I into Bucket 3 in accordance with Basel III finalisation and EBA clearly goes beyond its mandate in our opinion as per the above.
We thus consider that financing commitment shall in any circumstances be allocated to Bucket 3 as defined under the Basel 3 finalisation that has only merged some of the 20% and 50% bucket elements into the 40% CCF bucket (see annex 1).
For sake of clarity, we propose the following amendments:
Article 1
- Off-balance sheet items not already included in Annex I to Regulation (EU) No 575/2013, excluding financing commitments shall be assigned to the bucket 1 referred to in that Annex where the institution's exposure to the risk of credit losses in the event of default of the obligor is not contingent to any non-credit risk related event.
- Off-balance sheet items not already included in Annex I to Regulation (EU) No 575/2013, excluding financing commitments shall be assigned to the bucket 2 referred to in that Annex where the institution's exposure to the risk of credit losses in the event of default of the obligor is contingent to at least one non-credit risk related event.
Question 6. Do you have any suggestion regarding allocation criteria for buckets 4 and 5?
We would welcome EBA to provide more guidance on non transactional guarantees and more generally on allocation to buckets 4 and 5, for the “other off-balance sheet items carrying similar risks” allocated to those buckets.
Question 7. Do you have any comment on the factors that may constrain unconditionally cancel-lable commitments proposed under Article 2?
Indeed, the CRR3 mandate in article 111(8) requires the EBA to develop draft regulatory technical standards to specify “(…) (b) the factors that may constrain the institutions’ ability to cancel the unconditionally cancellable commitments referred to in Annex I”. However, it appears that RTS as drafted, results in the introduction of factors (reputational risks, risk management capabilities) that would require banks to increase the CCF from 10% to 40%. These factors were already identified by the Basel Committee to justify the CCF increase from 0% to 10%[1].
By proposing, not only the same factors as the one used by the Basel Committee to justify the increase from 0% to 10%, to justify the CCF increase from 10% to 40% (which constitutes some kind of double-counting), but also the applicable CCF when these factors are met, the EBA makes strategic decisions and policy choices in contradiction with EU law and in particular its founding regulation.
The 2 factors linked to risk management deficiencies and reputational risk (already mentioned by the Basel committee) should therefore be removed from the list of Article 2.
As regards the risk of litigation, banks are always under threat of litigation even if a claim is unfounded. Since there is always a possibility of litigation, none of our commitments could be qualified as UCC.
Moreover, we believe that these factors are discretionary and subjective, and potentially institutions will never be able to demonstrate that they objectively don’t exist, which creates regulatory uncertainty for institutions in case of disagreement with their supervisors. For example, we wonder how to justify that we never run a reputational risk when we unilaterally cancel a product. Similarly, it is clear that our business relationship with the client can always suffer in case of cancellation of commitments.
We therefore suggest EBA to clarify that its expectations are not that banks should demonstrate, for a given facility or type of facility, that these factors don’t exist but instead banks would have to consider assigning a UCC facility to a higher bucket if they identify that these factors exist and are material.
Regarding the detection of risk management deficiencies, one could set some criteria linked to the risk management processes that would allow (or not) to fall in the UCC category of items that effectively provides for automatic cancellation due to deterioration in client’s creditworthiness. For instance, any credit facility that meets the following conditions shall remain allocated to bucket 5:
- it contractually provides for cancellation in case of client’s creditworthiness deterioration and
- is subject to a risk management process which allows that the credit deterioration is detected in a timely manner and that there is no substantial time lag between the observed deterioration and the cancellation of the line.
Finally, we ask the EBA some clarifications on the process of assessment and documentation of these factors.
[1] BCBS consultative document, revisions to the standardised approach 2014: “Commitments that a bank may cancel unconditionally and at any time without prior notice, or that effectively provide for automatic cancellation due to the deterioration in a borrower’s creditworthiness, currently receive a 0% CCF. However, consumer protection laws, risk management capabilities and reputational risk considerations may constrain banks’ ability to cancel such commitments. For this reason, the
Committee believes a 0% CCF is inappropriate and proposes a new CCF of 10% for such exposures.”
Question 8. Do you have any comment on the notification process proposed under Article 3?
Currently, each bank reports its ‘other' off-balance sheet items to its competent authority together with a rationale why this product is assigned to this bucket and the competent authority reports all those type of ‘other’ off-balance sheet items to the EBA.
Once a year, the EBA should publish the assignment of all ‘other’ off-balance sheet items reported to them with their view for the right assignment.
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?
In France, all technical guarantees generating exposure to credit losses conditional to the non-fulfilment of contractual obligations that are today listed by ACPR as of similar risk of trade finance exposure would fall into 50% bucket based on article 1 and as mentioned the EBA mandate is not to change all the rules of the game.
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)?
We have no comments.