British Bankers' Association

There are numerous examples of entities where control relationship implied by share ownership may not translate into direct risk. These include Ringfenced Bank entities, dedicated securitisation conduits, SPVs used for Asset Backed Lending (e.g. Ship Finance, Aircraft Finance, Rolling Stock, etc), passive investment JVs, separate CRE investment SPVs, Commodity/Trade Finance dedicated flow bankruptcy remote structures, receivables warehousing SPVs, structured leasing SPVs in Aircraft/Ship/Rolling stock finance and structured finance vehicles (including Private Equity Investment Vehicles) and others.
The need for exceptional disaggregation will always be present in relation to dedicated conduit/securitisation/asset backed lending and other bankruptcy remote/leasing structures. The impact of managing disaggregation by exception should not affect the costs further if the rules allowing exceptions and limitations to the treatment of conduits, BCBS Specialised Lending SPVs, structured leasing SPVs, JVs, etc are principles and analyst judgment based. Furthermore, we believe that to remove risk of overstatement and duplication analyst judgment should be:

- Applied across all three (Control, Economic, Funding) types of aggregation of connected entities and not just for Control aggregation a per current CP wording,

- Be allowed for disaggregation by product type.
We do not see any need for further clarification from an accounting and accounting standard perspective. However, we recommend that EBA clearly allows for partial aggregation where the analyst deems it more appropriate.
We do not recommend any additional triggers and recommend that aggregation is decided on principles based judgement by the analyst who will consider likelihood of direct economic/cash/risk transmission between entities as basis for aggregating. In this way the analyst can include all appropriate existing and/or future product types, structures and relationships between the different entities.
Whilst in isolation the cost of assessing control relationships (including non-consolidated subsidiaries per individual client) should not be different from those that currently apply, the overall cost of assessment is expected to increase materially due to the overall approach, which includes:

- More entities being brought into the scope of assessment as the reporting trigger is reduced to 2% of Eligible capital vs. 2% of Own Funds under the CEBS current treatment and 5% under BCBS;

- The holistic assessment for each exposure which would under the proposal also include cost of additional Funding and Economic consolidation assessment, often including entities that are not clients (thus not obliged to provide data). This would in turn increase analyst time needed for the assessment (proportional to complexity of the entities). These costs would be material and numbered in weeks of analyst engagement for large complex clients (e.g. major manufacturers, energy or mining companies, transport companies, large funds and insurers, etc) that will have multiple touchpoints, sophisticated balance sheet and liquidity management and multiple supplier/investor/off-taker touch points;

- All of these would draw further on highly qualified analyst resource which is costly and scarce in the market.

For this reason we recommend that implementation takes a measured and phased approach allowing banks to gradually upscale teams allowing them sufficient time to optimise their processes.
While the guidance is clear in the majority of cases, it does not appear to provide clear guidance on how to treat Public-Private-Investment contracts/concessions, which have both exposure to private sector contractors (e.g. performance bonds/undertakings, maintenance undertakings, etc) and public (for payments for delivery of service/infrastructure). We recommend that this is expanded on while highlighting the evident need that overall decision is based on analyst judgment, including level (and appropriateness) of full or partial aggregation.
We do not support the trigger being defined as “repayment difficulties”. This is too broadly drawn and may be interpreted to mean, (a) any delay in payments or (b) constraint to ongoing liquidity through higher usage of working capital financing caused by an issue with a supplier/off-taker/option or liquidity provider. The currently proposed approach disregards the reality that such events happen frequently in the normal course of business and are often mitigated by change in suppliers, counterparty, off-taker/sale on market, purchase of risk protection and/or change of financing provider, none of which are sufficiently severe as to trigger default. Maintaining the definition as proposed would thus disproportionally increase the scope of aggregation and analyst time used without a commensurate improvement in identifying true contagion risks. It is also very possible that it will be interpreted differently across the Union. Hence we recommend that trigger wording is changed to one that references the degree of ‘difficulty’ required by linking to the risk of an event of default. The following wording is suggested, “material repayment difficulties, caused by direct economic and cash transmission links, that would make default highly probable”.
The introduction of a prescriptive 50% threshold unhelpful, if used as a prescriptive trigger for mandatory aggregation. Rather, we would consider it to be a positive addition if the 50% threshold, including all other triggers listed under 23 a-j, are presented as triggers for considering consolidation, with the decision to aggregate (or not as the case may be) remaining subject to analyst judgment.

We believe that the current proposal would greatly benefit if it were clear that the principle of aggregation to be followed in the event of the triggers listed in a) to k) is that “direct cash/economic/risk transmission is likely between entities which would make default of the dependent party highly probable”.

We also believe that further detail is needed to cover situations relating to:

- Infrastructure/Project financing;

- Trade Finance SPVs;

- Leasing;

- CRE Propco’s (individual asset holding SPVS) ;

- Conduits;

- An asset that may be 100% linked to a single supplier/off-taker, but where their failure would not lead to transmission of default across the group due to:

o the nature of the asset and/or existence of a market for its expedient sale/conversion to cash, or,

o inclusion of appropriate market norm clauses in legal arrangements, allowing to replace the off-taker/supplier in case of failure to meet obligations.

Paragraph 26 in section 3.2.3 of the background and rationale makes it clear that the guidance regarding common sources of funding remains the same as the original 2009 guidance. Some national supervisors have issued earlier more detailed guidance regarding the application of the 2009 guidance as it relates to SPVs that are connected to the firm itself. In order to avoid an expectation that national guidelines may require further review or revision we would welcome a confirmation in the final issued guidelines that none of the latest content further develops or alters the principles or detail espoused in 2009.
Financial, ownership and especially economic relationships between entities are often bespoke, subject to specific contractual and/or regulatory arrangements and as such providing a prescriptive list of obligatory triggers (even more so if the list is expanded) could only lead to either lack (or overstatement) of aggregation. We recommend that an overarching change to the proposal is made with a clear principles based approach (see answer to Question 7 above) anchored by a list of examples and/or triggers that should launch consideration of aggregation (leaving the final decision on analyst judgment of the likelihood of default).
Guidance on Control grouping is clearer than others, although we again restate need for:

- More clarity on approach to bankruptcy remote (or shared ownership) vehicles

- Assuring that the level of aggregation (or decision not to), regardless of if it is on Ownership, Funding, Economic (or combination thereof) basis, remains on analyst judgment and is not prescriptive, instead a list of triggers for considering aggregation should be provided (leveraging on proposal from this draft guidance)

- Defining limitations/exclusions on bankruptcy remote SPVs/conduits/securitisations

- Amending the wording of trigger from “repayment difficulties” to one focused on materiality of risk of default – see response to Question 7 above

The background and rationale comments in section 3.2.5 recognise the inherent difficulties of exhaustively researching the economic connection between clients and, particularly, non-clients. The emphasis on taking reasonable steps to extract this information, where it is already known, is not however reflected in the guidelines in section 8 paras 33 to 38. For example

• Para 35 suggests “intensive” investigation should be “to the extent possible” which does not make clear that firms are likely to be limited in their information bases for different groups (and particularly non clients).

• Para 36 require the use of “all available” information, which can be read as meaning information that is available outside of the core credit process must be obtained without regard to cost or value, or potentially the robustness of the information.

There are significant concerns regarding the burden of collection which will fall upon customers who are likely to be the principal source of information, collecting them from their suppliers or offtakers (if and where possible). Firms will require quite granular information in order to be able to identify common sources of contagion in their datasets robustly. The transient nature of much of this information exacerbates this burden, and the cost of maintaining the data to a reliable standard. Furthermore, for commercial reasons, this information may not be obtainable as it is likely that customers’ off-taker or supplier may refuse to provide commercially sensitive inside information, as they are not a direct client of a firm and not legally/contractually obliged to), making the exercise fraught and potentially with limited/no benefit if interpreted as mandatory. It may also lead to unwillingness of firms’ direct customers to disclose further commercially sensitive information as the process becomes overly intrusive and exceeds contractual and legal obligations between customers and firms.

We recommend recognition of the difficulty of investigating and collecting non client information with it being amended so that the wording clearly recommends (rather than mandates) to include non-client information that is publicly available, or where that is not possible to what a firm can reasonably obtain directly from their customers or from the core credit process
Without such recognition the impact of this guidance is expected to bring a noticeable increase in costs which will be further exacerbated by reducing the increased due diligence threshold to 2% of Eligible capital rather than 2% of Own funds under current CEBS guidance or the 5% BCBS trigger. The divergence from BCBS trigger would also lead to different treatment between banks operating across different markets/having more than one regulator, increasing complexity and costs. As such we also strongly recommend that the new standards are aligned to the BCBS trigger ratio.

For further information on this submission please contact Nemanja Eckert, Policy Director, BBA.
British Bankers' Association