European Savings and Retail Banking Group (ESBG)

Yes, in every case where the financing is a ring-fenced structure that does not impact any related entity. Typical examples are project financing.

Similarly, every situation where a controlling entity makes it explicit that it does not exercise its formal control rights and there is no risk of default contagion, does not constitute a single risk from a counterparty credit risk management perspective.

Furthermore, this might be the case in situations where another party has such control as described in paragraph 13c (page 31), e.g. management rights based on contractual conditions, clauses, etc. Such types of control do not necessarily have an impact on financial difficulties, etc.
The impact is positive. It permits more accurate counterparty credit risk underwriting and steering by not mixing cash flows that should not be related.
It is our assessment that this is not a significant issue. Given the requirements for internal controls and procedures in general to identify individual customers for grouping, there are barely any significant additional costs either, in ESBG’s view.
Yes, as long as there are no conditions in the regulations in order to apply this alternative approach and, above all, as long as the actual exemption for exposures to central governments is maintained pursuant to Art 400(1) CRR. The outlined structures determine multiple counting of risk positions to both central governments and controlled entities, since they can be included in different groups of connected clients.
First of all, ESBG would like to stress that when repayment difficulties are assessed the materiality of the impact on the level of credit risk for the bank as a result of the repayment problem should be taken into consideration.

Also, since the identification and grouping based on economic dependency is typically manual, the new and stricter formulation will increase the manual routines in order to identify “groups of connected clients” based on economic dependency.

We consider that the concept of “repayment difficulties” is to some extent a vague concept that would even make it more difficult for institutions to identify and delimit to what extent the economic dependencies would lead to contagion effect chains. A broader definition of entities constituting groups of connected clients would determine greater volatility in the composition of groups, with unintended effects in terms of operating costs and impact on credit risk management practices.

In any case, a more precise definition of “repayment difficulties” would help in order to specify that client likeliness to repay should be seriously impaired and lead to the event of default of the counterparty. ESBG therefore invites the EBA to maintain the existing reference to substantial, existence-threatening repayment difficulties (although we took good note of the EBA justifying in paragraph 23 of Section 3 the reason why the term of the 2009 CEBS Guidelines “substantial, existence-threatening repayment difficulties” is proposed to be replaced). Switching from the restrictive concept of 'default contagion' (“substantial existence-threatening repayment difficulties”) to the less restrictive concept of 'repayment difficulties' is counterproductive and effectively prevents proper counterparty risk assessment and risk steering. By removing the crucial qualification that economic dependence exists only in case of 'default contagion', entire value chains may or must be connected. This creates artificial groupings that cannot be managed with the tools of counterparty credit risk management any more (financial analysis, counterparty rating…) and significantly deteriorates the quality of credit risk management in a bank. In ESBG’s opinion, the further clarification provided by paragraphs 24 and 25 (page 16) does not remove this fundamental problem of the proposed modification to the current definition.

What is more, we generally doubt whether individual loan officers and relationship managers have the soft information needed to identify connected clients according to the new guideline (paragraph 34, page 23). To fulfil these extended requirements, banks could be forced to take additional external data providers to closely monitor their business relationships of the clients.

Economic dependence is an extremely important criterion for determining single risks that, by its very nature, can and should only be established based on a thorough case-by-case assessment. Except for point k), any of the criteria listed in paragraph 23 (page 35) may indicate economic dependence, but does not conclusively define it. The case-by-case assessment must be conducted by adequately skilled professionals familiar with the individual case. Defining any list of criteria may – and in practice does – lead to situations where the formation of a group of connected clients is done algorithmically by IT processes or by back-office functions not familiar with the particular case. This creates groupings that may not constitute a single risk, which undermines the very concept and usefulness of a group of connected clients.

In relation to the case explained by the EBA, the financial difficulties of the guarantor would not imply financial difficulties for the unrelated clients, in ESBG’S opinion, unless an economic dependency exists between the guarantor and the clients that could be analysed with the guidelines provided in paragraph 23. The same applies to potential effects between the unrelated clients that are guaranteed by the same guarantor.

As a matter of fact, in our experience, this is quite an exceptional case. As the likelihood of simultaneous claims under guarantees to unrelated counterparties seems to be fairly low, ESBG would not qualify such clients as connected. The situation described in the explanatory box on page 35 would be an exaggerated interpretation of the term “single risk”.
Generally speaking, the relation between interconnectedness through control and interconnectedness through economic dependency will be difficult to assess as the approach foreseen requires different steps that have to be taken.

Moreover, the implementation of the envisaged measures is likely to determine in many cases multiple counting of risk positions to clients that should be included in different groups of connected clients. As stated before (please see the answer to question 6), we deem that double counting of exposures (due to entities being included in different groups of connected clients) is not desirable. In fact, this would lead to the double counting of the bank exposure to the client in the bank records aimed at supervisory reporting. Consequently (unless the bank creates a double-track management system detaching the credit risk management from supervisory evidences), the double counting would affect the monitoring of bank exposure to the client for risk management purposes, in terms of determining credit limits and allocating credit decisions.
European Savings and Retail Banking Group (ESBG)