Regarding the interpretation of Article 500(1) of the Regulation (EU) 2019/876 amending Regulation (EU) No 575/2013 (hereafter “Regulation (EU) No 575/2013 as amended”), do we understand it correctly that:
the adjustment based on Article 500 for all disposed exposures cannot lead to an estimate of average losses for the disposed assets that is lower than the estimated LGD calculated under point (a) above?
Article 181(1)(a) of Regulation (EU) No 575/2013 already requires banks to estimate LGDs using all observed defaults. According to our understanding banks need to include also incomplete cases in this calculation and thus they need to incorporate an adjustment for incomplete recovery processes, as also explained in paragraphs 158 and 159 of EBA/GL/2017/16. By definition, exposures in scope of a disposal are incomplete workout cases prior to the disposal, so institutions already need, for the purposes of obtaining the long-run average LGD, to estimate future costs and recoveries for the incomplete recoveries processes based on comparable cases.
It should be highlighted that this interpretation significantly simplifies the implementation of this article, as it reduces the implementation to the new use of existing methodologies/approaches already required by other articles of Regulation (EU) No 575/2013.
In accordance with Article 500(1) of the Regulation (EU) No 575/2013 as amended by Regulation (EU) 2019/876, subject to conditions specified in points (a) to (c) of that article and by way of derogation from Article 181(1)(a), institutions may adjust their LGD estimates “by partly or fully offsetting the effect of massive disposals of defaulted exposures on realised LGDs”. Consequently, in order to derive adjusted LGD estimates, institutions should adjust the realised LGDs on disposed exposures, which were included in the massive disposal plan. Such adjustment should reflect exclusively the impact on the obtained sale price of the assets due to the massive nature of the disposal, which may have led to a larger than usual discount, but it should not affect any other elements; in particular, it should not offset the impact of economic conditions. For this purpose only the cash flows directly related to the massive disposal can be adjusted, and any recoveries, costs or discounting effects realised on these exposures before the sale must remain unchanged.
Institutions should use the method or methods for adjusting realised LGDs, which are the most appropriate for the portfolio subject to the massive disposal, taking into account the principles and objectives described above. Possible methods for LGD adjustment to be considered include inter alia the following two methods:
Different methods may be appropriate for different sales or parts of portfolios subject to the massive disposal.
The answers clarify provisions already contained in the applicable legislation. They do not extend in any way the rights and obligations deriving from such legislation nor do they introduce any additional requirements for the concerned operators and competent authorities. The answers are merely intended to assist natural or legal persons, including competent authorities and Union institutions and bodies in clarifying the application or implementation of the relevant legal provisions. Only the Court of Justice of the European Union is competent to authoritatively interpret Union law. The views expressed in the internal Commission Decision cannot prejudge the position that the European Commission might take before the Union and national courts.