Response to consultation on Guidelines on specification of types of exposures to be associated with high risk
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The EBA states that the applicable risk weights for the corporates, retail, and equity exposure classes are calibrated as averages, but that there are certainly exposures with higher and lower risks in the exposure classes. To the extent that the “high risk” exposure class isolates certain exposures and assigns them a higher weighting, we take the view that the credit risk in the remaining exposure classes will be lower and the weighting should be correspondingly reduced.
As a general principle, we believe that the rating of high risk exposures for equity investments is already covered by the specific list of exposures in Article 128(2) of the CRR. In our opinion, additional requirements for the equity exposure class go beyond the EBA’s current mandate.
We also wish to draw attention to current developments at the international level: the BCBS’s guidance on the finalisation of Basel III indicates that in future, only the standardised approach will be permitted in future for equity investments. In the wake of this, the standardised risk weight would be increased from currently 100% to at least 150% for most of the exposures in this asset class. The analysis of high risk items in the equity exposure class will therefore no longer be necessary. This is just another argument for not releasing the Guideline.
In practice, the requirement in point 4.2.7 of the EBA GL for an assessment of all exposures to establish whether there are possible additional exposures to the counterparty will lead to a high implementation effort. In addition to the existing risk weight for the exposure, hypothetical exposures outside the equity exposure class would have to be generated and corresponding risk weights would have to be calculated. An in-depth analysis of each loan in this exposure class to establish high risk would unreasonably burden small institutions in particular. The SA already stipulates higher own funds re-quirements than advanced approaches. This should not be undermined by introducing additional analysis requirements in this approach.
In light of the Basel requirements referred to above, the resulting no more than temporary relevance of the requirements of the EBA Guidelines for equity exposures and the high analysis requirements, we wish to argue in favour of deleting point 4.2.7 of the EBA GL.
For the analysis process, the introduction of a de minimis rule could serve as an alternative. This could either refer to certain exposure classes (such as retail) or a quantitative limit.
In addition, we wish to suggest that equity exposures resulting from the restructuring of loan exposures (foreclosed assets) should also be excluded from the analysis of high risk exposures. The initial objective of these investments is to avoid further losses. In the case of a wider interpretation, this also falls under the intention of generating a profit in accordance with EBA GL 4.1.3, which could imply classification as high risk exposures. However, we do not believe that they exhibit the classic features of an investment in private equity. One of the reasons for this is that the transfer prices for transfer-ring the assets/shares in the bank’s balance sheet are normally significantly lower than the loan amounts at which the assets/companies were previously financed. Any necessary impairment losses were already charged to a large extent on the previously existing debt finance. Moreover, the corresponding investments are equity-financed to a particularly strong extent compared with classic investments in private equity. In contrast to classic investments in private equity, high costs of debt due to excessive leverage are therefore not expected and reduce the probability of default. Com-pared with investments in private equity, foreclosed assets are not subject to any fixed deadline requirements for resales, nor are there any requirements for generating a minimum return. In light of this, we do not see any need to classify the exposures as high risk. This should be clarified by the EBA Guidelines.
Question 1: Do you agree with the proposed clarifications in paragraphs 2 and 3? Would you like to bring forward arguments which potentially mitigate the caveats of the alternative approach for defining what constitutes an investment in private equity?
n/aQuestion 2: Do you agree that the identification of high risk items is particularly relevant for some of the existing exposure classes?
The explanations in the Explanatory box on page 14 appear to be contradictory. One the one hand, they state that all types of exposure classes must be considered when identifying “items associated with particularly high risk”. On the other, they expect that corresponding high risk exposures are ex-pected in particular in the “Corporates”, “Equity” and “Other items” exposure classes. We assume that it is not necessary to identify high risk exposures across all exposure classes and hence in all of an institution’s customer segments. The related expense would be unjustifiable.The EBA states that the applicable risk weights for the corporates, retail, and equity exposure classes are calibrated as averages, but that there are certainly exposures with higher and lower risks in the exposure classes. To the extent that the “high risk” exposure class isolates certain exposures and assigns them a higher weighting, we take the view that the credit risk in the remaining exposure classes will be lower and the weighting should be correspondingly reduced.
As a general principle, we believe that the rating of high risk exposures for equity investments is already covered by the specific list of exposures in Article 128(2) of the CRR. In our opinion, additional requirements for the equity exposure class go beyond the EBA’s current mandate.
We also wish to draw attention to current developments at the international level: the BCBS’s guidance on the finalisation of Basel III indicates that in future, only the standardised approach will be permitted in future for equity investments. In the wake of this, the standardised risk weight would be increased from currently 100% to at least 150% for most of the exposures in this asset class. The analysis of high risk items in the equity exposure class will therefore no longer be necessary. This is just another argument for not releasing the Guideline.
In practice, the requirement in point 4.2.7 of the EBA GL for an assessment of all exposures to establish whether there are possible additional exposures to the counterparty will lead to a high implementation effort. In addition to the existing risk weight for the exposure, hypothetical exposures outside the equity exposure class would have to be generated and corresponding risk weights would have to be calculated. An in-depth analysis of each loan in this exposure class to establish high risk would unreasonably burden small institutions in particular. The SA already stipulates higher own funds re-quirements than advanced approaches. This should not be undermined by introducing additional analysis requirements in this approach.
In light of the Basel requirements referred to above, the resulting no more than temporary relevance of the requirements of the EBA Guidelines for equity exposures and the high analysis requirements, we wish to argue in favour of deleting point 4.2.7 of the EBA GL.
For the analysis process, the introduction of a de minimis rule could serve as an alternative. This could either refer to certain exposure classes (such as retail) or a quantitative limit.
Question 3: Do you have any comments or concerns regarding the proposed scope of the exposures at least to be analysed according to paragraph 5? Should more guidance be provided as regards other types of exposures? If yes, please provide specifications.
Strategic investments are correctly excluded from the definition of private equity exposures.In addition, we wish to suggest that equity exposures resulting from the restructuring of loan exposures (foreclosed assets) should also be excluded from the analysis of high risk exposures. The initial objective of these investments is to avoid further losses. In the case of a wider interpretation, this also falls under the intention of generating a profit in accordance with EBA GL 4.1.3, which could imply classification as high risk exposures. However, we do not believe that they exhibit the classic features of an investment in private equity. One of the reasons for this is that the transfer prices for transfer-ring the assets/shares in the bank’s balance sheet are normally significantly lower than the loan amounts at which the assets/companies were previously financed. Any necessary impairment losses were already charged to a large extent on the previously existing debt finance. Moreover, the corresponding investments are equity-financed to a particularly strong extent compared with classic investments in private equity. In contrast to classic investments in private equity, high costs of debt due to excessive leverage are therefore not expected and reduce the probability of default. Com-pared with investments in private equity, foreclosed assets are not subject to any fixed deadline requirements for resales, nor are there any requirements for generating a minimum return. In light of this, we do not see any need to classify the exposures as high risk. This should be clarified by the EBA Guidelines.