Question ID:
2020_5567
Legal Act:
Regulation (EU) No 575/2013 (CRR)
Topic:
Own funds
Article:
36; 37
Paragraph:
1b; a
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations:
Not applicable
Article/Paragraph:
Not applicable
Disclose name of institution / entity:
No
Type of submitter:
Competent authority
Subject Matter:
Interplay between Article 13a of Commission Delegated Regulation (EU) No 241/2014 as regards the deduction of software assets from Common Equity Tier 1 (CET1) items and Article 37(a) of Regulation (EU) No 575/2013 (CRR)
Question:

Would it be possible that the application of Article 37(a) of the CRR in conjunction with the new deduction rules established in Article 13a of the Commission Delegated Regulation (EU) No 241/2014 could lead to:
• A negative deduction, i.e. an addition, of software assets when it comes to the determination of CET1 items, and/or
• A non-adequate amount to be risk weighted?

Background on the question:

The following legal provisions apply to this question:

  • Article 36(1)b) of the CRR lays down that institutions shall deduct from CET1 items their ‘intangible assets with the exception of prudently valued software assets the value of which is not negatively affected by resolution, insolvency or liquidation of the institution’.
  • Article 37(a) of the CRR lays down that ‘the amount to be deducted shall be reduced by the amount of associated deferred tax liabilities that would be extinguished if the intangible assets became impaired or were derecognised under the applicable accounting framework’.

Before Article 13a of Commission Delegated Regulation (EU) No 241/2014 became applicable, software assets were fully deducted from CET1 items. Thus, the application of Article 37(a) of the CRR could never lead to a negative amount to be deducted from CET1 items, i.e. to an addition to CET1 capital.

When Article 13a started to apply, the amount to be deducted could be zero or lower than the carrying amount of the software asset concerned. This means that applying Article 37(a) of the CRR together with Article 13a of the Delegated Regulation (EU) No 241/2014 could technically lead to a negative amount to be deducted, i.e. to an addition to the CET1 capital.

This is illustrated in the example below, where it is assumed that Bank A invests in 100 of software assets as of 31 December of year T, with an accounting useful life of 4 years. The applicable tax rate is 25%. The statements for these software assets would be as follows:

 

Year end

T

T+1

T+2

T+3

T+4

Gross Book Value (GBV)

100

100

100

100

100

Accounting Amortisation

0

25

25

25

25

Accounting Accumulated Amortisation (A)

0

25

50

75

100

Net carrying amount (B)

100

75

50

25

0

DTLs (C = 25%*B)

25

18.75

12.50

6.25

0

 

When applying the prudential treatment according to Article 13a, a maximum of three years of software useful life would be applicable, with the following prudential amortisation schedule:

 

Year end

T

T+1

T+2

T+3

Prudential Gross Book Value

100

100

100

100

Prudential Amortisation

0

  33.33

  33.33

  33.33

Prudential Accumulated Amortisation. (D)

0

33.33

66.67

100

Prudential Net carrying amount (E)

100

66.67

33.33

0

 

The CET1 deduction amount following Article 13a would correspond to 8.33 in T+1 and to 16.67 in T+2 (i.e. D-A) respectively, while the amount to be risk-weighted at 100% would be 66.67 in T+1 and 33.33 in T+2 respectively.

 

Nonetheless, when Article 37(a) of the CRR is considered, the amount of intangible assets (including software) deducted from CET1 items ’shall be reduced by the amount of associated deferred tax liabilities that would be extinguished if the intangible assets became impaired or were derecognised under the applicable accounting framework’. Therefore, in Year T+1 of the example above, a negative amount of 10.42 (i.e. D minus A minus C) would be deducted from CET1, leading to a CET1 benefit of the same amount and to an amount of 85.42 of software to be risk weighted (i.e. B minus10.42) that is higher than the respective net carrying amount recognised in the institution’s balance sheet (i.e. 75).

Date of submission:
20/10/2020
Published as Final Q&A:
26/02/2021
EBA Answer:

Article 37(a) of Regulation (EU) No 575/2013 (CRR) was adopted in a context where all intangible assets (including software) were fully deducted from CET1 items pursuant to Article 36(1)(b) of the CRR.

However, following the changes introduced by Regulation (EU) 2019/876, Article 36(1)(b) of the CRR has been amended and an exception from the deduction of intangible assets from Common Equity Tier 1 (CET1) items for ‘prudently valued software assets the value of which is not negatively affected by resolution, insolvency or liquidation of the institution’ was introduced. Moreover, Commission Delegated Regulation (EU) 2020/2176, amending Delegated Regulation (EU) No 241/2014 as regards the deduction of software assets from CET 1 items , has introduced a prudential treatment of software assets, which is based on their amortisation for prudential purposes over a period of maximum three years.

Therefore, having regard to the revised treatment of software assets set out in Article 13a of Delegated Regulation (EU) No 241/2014 and Article 37(a) CRR, the amount of software assets to be deducted from CET1 items shall be reduced only by the corresponding portion of the associated deferred tax liabilities (DTLs) and not by the full amount of DTLs related to the software assets at stake. The remaining portion of DTLs related to software assets may, instead, be used to reduce the amount of the deferred tax assets (DTAs) of the institution that rely on future profitability, if the conditions established in Article 38(3) and (4) of the CRR are met.

As regards the amount of software to be risk weighted pursuant to Articles 113(5) and 156 of the CRR, it shall be determined for each software asset as the difference between:

  1. The net carrying amount of the software asset into question, recognised in the financial statement of the institution; and
  2. The amount to be deducted from CET1 items according to Article 13a(5) of Delegated Regulation (EU) No 241/2014, but  without considering the effects related to the application of the treatment established in Article 37(a) of the CRR, with reference to the DTLs associated to those software assets.

Therefore, in the example submitted, with specific reference to the year T+1:

  • the amount to be deducted from CET1 items following the application of the provisions of Article 37(a) of the CRR would be 6.25, equal to the amount of software to be deducted in accordance with the abovementioned Article 13a(5) of Delegated Regulation (EU) No 241/2014 (i.e. 8.33), reduced by the corresponding portion of DTLs associated to the concerned software asset (i.e. 2.08, equal to 25%*8.33);
  • the amount of software assets to be risk weighted pursuant to Articles 113(5) and 156 of the CRR would be 66.67, equal to the difference between the net carrying amount of the software asset at stake (75) and the amount to be deducted in accordance with Article 13a(5) of Delegated Regulation (EU) No 241/2014 (8.33).

In light of the above, the application of Article 13a of Delegated Regulation (EU) No 241/2014 and the provisions of Article 37(a), CRR must not lead to a negative CET1 deduction for the software asset in question, nor to an amount to be risk weighted that is higher than its net carrying amount.

Status:
Final Q&A
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