Response to consultation on Guidelines on limits on exposures to shadow banking
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Moreover, Pillar 2 requirements regarding sectorial risk and concentration risk already exist and apply to banks. In fact, in the context of the overall large exposure regime under Part Four of the CRR, Article 395(2) states that the purpose of the guidelines is to set appropriate aggregate limits on large exposures or lower limits on individual exposures to shadow banking entities. However, the draft guidelines plan to set special Pillar 2 requirements which will apply exclusively to exposures to shadow banks. These additional requirements in paragraphs 1 and 2 in Title II are not necessary, in our view, since they are either already legally enshrined in the implementation of the CRD IV rules relating to Pillar 2 or are covered by the EBA’s new SREP guidelines. Moreover, the use of Pillar 2 measures in such a complex context will most probably result in very heterogeneous implementation, thus endangering level playing field among banks operating cross-border.
We believe the proposed Guidelines should only apply at consolidated level –our rationale is threefold:
- Usual large exposures limits set out in the CRR already apply to exposures to all types of counterparties and therefore include any counterparty that would be considered to be a “shadow bank” under the EBA’s proposed definition. These rules already apply at both solo and consolidated levels, hence a sufficient backstop already exists within the current framework. The enhanced protection against single name concentration risk that would be provided by the EBA Guidelines can still be achieved by applying it at the consolidated level.
- Applying the Guidelines at consolidated level only would make it easier for firms to manage them within the ICAAP process as individual legal entities may have only a partial view of shadow banking activities existing within a banking group. Consequently, the risk management process aimed at increasing senior management awareness would be effective only when performed at consolidated level (group view). This is also in line with the Pillar II approach.
- The burden of infrastructure, systems and processes that firms would need to put in place to comply with the Guidelines would be less onerous if applied at the consolidated level only.
We oppose the view to use the large exposure framework to set sectorial limits, all the more considering the proposed definition of the shadow banking sector which puts together all sorts of entities (asset financing entities, unregulated entities, etc…) which may not present any financial link to one another.
Indeed, there will be no interconnectedness between a US hedge fund, a Korean leasing company and a European Money Market Fund. An aggregate limit would be totally disconnected from the effective risk borne by institutions in relation to these counterparties.
In addition, we do not see the added value of the current individual limit proposal. Such practice is already implemented in all banks, based on their respective business model and risk appetite, irrespective of whether the counterparties would be considered shadow banking entities or not. Moreover, individual exposures are already subject to the large exposure limit, including in the specific case of the “unknown client” as defined in the Commission’s Delegated Act 1187/2014.
Our question concerning individual limits, is rather to understand the meaning of “tighter limits”. Clarification would be needed to explain “tighter than what?”
Measurement of the exposure
The setting of internal limits for OTC derivatives implies using internal metrics (Potential Future Exposure, or other internally modelled exposure measurement), which are not equivalent to those used for the purpose of large exposures measurement (currently: the Effective Expected Positive Exposure times a multiplier, or Current Exposure Method; in the future framework: the SA CCR).
We would like the EBA to confirm that internal limits for OTC derivatives as required by the proposed guidelines under the principal approach should not be set and measured by using large exposure framework metrics but by using internal metrics, in order to avoid unduly burdensome double calculations on these transactions.
We consider that all measures that encourage institutions to resort to look-through approaches are more relevant in terms of risk monitoring.
Our preferred approach is option 2. However, we believe that it should be clarified as it is not properly calibrated as currently drafted. Please see our comments below.
The large exposures framework applies to a client or a group of connected clients. As explained before, we do not believe the proposed definition of shadow banking entities would result in defining a set of shadow banking entities that are interconnected. On the contrary, most of them will be totally disconnected given the wide range of heterogeneous businesses they represent.
The figure has no rationale and is not commensurate with general activities run by banks with such different entities, in fact, we find it surprising that EBA is of the opinion that an aggregate limit of 25 % would be appropriate. As a reminder, CRD II carried an aggregate limit for all large exposures (exposures exceeding the 10%-threshold) of 800 % of own funds. On this basis, the proposed limit of 25% is far too low and obviously disconnected from the reality of actual volumes of transactions involved and business practices.
2. Do you agree with the approach the EBA has proposed for the purposes of establishing effective processes and control mechanisms? If not, please explain why and present possible alternatives.
We share EBA’s view on the principle for effective processes and control mechanisms.Moreover, Pillar 2 requirements regarding sectorial risk and concentration risk already exist and apply to banks. In fact, in the context of the overall large exposure regime under Part Four of the CRR, Article 395(2) states that the purpose of the guidelines is to set appropriate aggregate limits on large exposures or lower limits on individual exposures to shadow banking entities. However, the draft guidelines plan to set special Pillar 2 requirements which will apply exclusively to exposures to shadow banks. These additional requirements in paragraphs 1 and 2 in Title II are not necessary, in our view, since they are either already legally enshrined in the implementation of the CRD IV rules relating to Pillar 2 or are covered by the EBA’s new SREP guidelines. Moreover, the use of Pillar 2 measures in such a complex context will most probably result in very heterogeneous implementation, thus endangering level playing field among banks operating cross-border.
We believe the proposed Guidelines should only apply at consolidated level –our rationale is threefold:
- Usual large exposures limits set out in the CRR already apply to exposures to all types of counterparties and therefore include any counterparty that would be considered to be a “shadow bank” under the EBA’s proposed definition. These rules already apply at both solo and consolidated levels, hence a sufficient backstop already exists within the current framework. The enhanced protection against single name concentration risk that would be provided by the EBA Guidelines can still be achieved by applying it at the consolidated level.
- Applying the Guidelines at consolidated level only would make it easier for firms to manage them within the ICAAP process as individual legal entities may have only a partial view of shadow banking activities existing within a banking group. Consequently, the risk management process aimed at increasing senior management awareness would be effective only when performed at consolidated level (group view). This is also in line with the Pillar II approach.
- The burden of infrastructure, systems and processes that firms would need to put in place to comply with the Guidelines would be less onerous if applied at the consolidated level only.
3. Do you agree with the approach the EBA has proposed for the purposes of establishing appropriate oversight arrangements? If not, please explain why and present possible alternatives.
We share EBA view on the principle for oversight arrangements.4.Do you agree with the approaches the EBA has proposed for the purposes of establishing aggregate and individual limits? If not, please explain why and present possible alternatives.
Any aggregate limit should be set on homogeneous group of entities and according to the EBA’s mandate should not be set in addition to “tighter individual limits”.We oppose the view to use the large exposure framework to set sectorial limits, all the more considering the proposed definition of the shadow banking sector which puts together all sorts of entities (asset financing entities, unregulated entities, etc…) which may not present any financial link to one another.
Indeed, there will be no interconnectedness between a US hedge fund, a Korean leasing company and a European Money Market Fund. An aggregate limit would be totally disconnected from the effective risk borne by institutions in relation to these counterparties.
In addition, we do not see the added value of the current individual limit proposal. Such practice is already implemented in all banks, based on their respective business model and risk appetite, irrespective of whether the counterparties would be considered shadow banking entities or not. Moreover, individual exposures are already subject to the large exposure limit, including in the specific case of the “unknown client” as defined in the Commission’s Delegated Act 1187/2014.
Our question concerning individual limits, is rather to understand the meaning of “tighter limits”. Clarification would be needed to explain “tighter than what?”
Measurement of the exposure
The setting of internal limits for OTC derivatives implies using internal metrics (Potential Future Exposure, or other internally modelled exposure measurement), which are not equivalent to those used for the purpose of large exposures measurement (currently: the Effective Expected Positive Exposure times a multiplier, or Current Exposure Method; in the future framework: the SA CCR).
We would like the EBA to confirm that internal limits for OTC derivatives as required by the proposed guidelines under the principal approach should not be set and measured by using large exposure framework metrics but by using internal metrics, in order to avoid unduly burdensome double calculations on these transactions.
5. Do you agree with the fallback approach the EBA has proposed, including the cases in whichit should apply? If not, please explain why and present possible alternatives. Do you think that Option 2 is preferable to Option 1 for the fallback approach? If so, why? In particular: Do you believe that Option 2 provides more incentives to gather information about exposures than Option 1? Do you believe that Option 2 can be more conservative than Option 1? If so, when? Do you see some practical
The fall-back approach, in particular in option 1, seems arbitrary, very punitive, and with no incentive to implement proper policy: one single anomaly, regardless materiality or qualitative motivation, would have a detrimental effect on the whole population.We consider that all measures that encourage institutions to resort to look-through approaches are more relevant in terms of risk monitoring.
Our preferred approach is option 2. However, we believe that it should be clarified as it is not properly calibrated as currently drafted. Please see our comments below.
6. Taking into account, in particular, the fact that the 25% limit is consistent with the currentlimit in the large exposures framework, do you agree it is an adequate limit for the fallback approach? If not, why? What would the impact of such a limit be in the case of Option 1? And in the case of Option 2?
The 25% limit seems arbitrary and, as an aggregate and sectorial limit, is not comparable to the current limit in the large exposures framework.The large exposures framework applies to a client or a group of connected clients. As explained before, we do not believe the proposed definition of shadow banking entities would result in defining a set of shadow banking entities that are interconnected. On the contrary, most of them will be totally disconnected given the wide range of heterogeneous businesses they represent.
The figure has no rationale and is not commensurate with general activities run by banks with such different entities, in fact, we find it surprising that EBA is of the opinion that an aggregate limit of 25 % would be appropriate. As a reminder, CRD II carried an aggregate limit for all large exposures (exposures exceeding the 10%-threshold) of 800 % of own funds. On this basis, the proposed limit of 25% is far too low and obviously disconnected from the reality of actual volumes of transactions involved and business practices.