Response to consultation on revised draft Guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) and supervisory stress testing
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In addition, we would like to point out that the exemptions in 429a(1)(d) ('claims on central governments, regional governments, local authorities or public sector entities in relation to public sector investments and promotional loans') are conditional on an institution fulfilling the criteria of a public development credit institution. Hence, the risk of not meeting the criteria to apply the exemption is directly linked to the business model. The assessment of the risk should be in line with the assessment of the business model risk and careful consideration should be taken to avoid any double counting.
According to Art. 104a, competent authorities may impose additional own funds requirements to address risks of excessive leverage not sufficiently covered by point (d) of Article 92(1) of Regulation (EU) No 575/2013 (CRR II).
In the draft EBA Guideline it is proposed that the Competent Authority should focus on potentially elevated vulnerabilities, not captured by the own funds requirements as set out in CRR Art. 92(1) d that may require corrective measures to the business activities of the institution, that were not envisaged in the business plan. EBA goes on to propose elements that the competent authority should consider when determining if there are such risks.
The leverage ratio is meant to function as a backstop to risk weighted capital requirements. According to CRR Art. 429, the leverage ratio shall be calculated as an institution's capital measure divided by that institution's total exposure measure and shall be expressed as a percentage. Pursuant to CRR Art. 111(1) the total exposure measure consists of all assets according to CRR Art. 429(4), primarily according to their accounting values.
Since the leverage ratio includes the total exposure measure, the EAPB as a matter of principle considers it conceptually difficult to see risks of leverage, aside from risks, if any, from the excluded items according to CRR Art. 429a, that might be considered not covered by the pilar 1 requirement. Given the pilar 1 calibration at 3 pct. (plus G-SIFI buffer if applicable) as an appropriate backstop level and a prudent level of leverage for institutions, it is furthermore unclear under what circumstances it would be justified to consider the institution not sufficiently “backstopped” at this level. The EAPB does not consider this to be properly addressed by the proposals in the consultation document.
The EAPB emphazises that it is the responsibility of institutions to address situations where the leverage ratio might be reduced too close to the backstop level, and to ensure compliance at all times with the minimum requirement as necessary, e.g. by reducing their exposures or increasing their capital to avoid breaches. If the institutions manage the risks prudently and avoid breaching the requirement, the backstop has served its purpose, and it would in EAPB’s opinion for this reason not be justified to impose a Pillar 2 requirement based on the volatility of the leverage ratio as mentioned in paragraph 393 (c) and the explanatory box on p. 156.
From this perspective the EAPB’s opinion is that, this and several of the other dimensions considered by EBA go beyond the scope of the authority to impose additional own funds requirements under Art. 104a insofar as they seem to primarily address risks of non-compliance with the Pillar 1 requirement rather than risks of excessive leverage that are not sufficiently covered by the Pillar 1 requirement. Whilst the EAPB does not in principle consider it irrelevant to consider what would be the appropriate level of a backstop for a given business model, and to consider if specific business models might be exposed to vulnerabilities at a 3 pct. backstop level that it would be appropriate to address with a regulatory requirement, it is the EAPB view that the level of such regulatory requirement properly belongs in a discussion of the level of the Pillar 1 requirement. The appropriate harmonized backstop level at 3 pct has been adopted in CRR at the EU level with relevant adaptions and exclusions etc. as set out in CRR Part 7, and reflects what has been internationally agreed as the appropriate level for a backstop in the Basel Committee. The level of the Pillar 1 requirement ensures a level playing field between institutions and member states and globally, and ensures that equal risks are treated equally across business models (as appropriately modified by the provisions of CRR Part 7).
Risks associated with non-compliance with the Pillar 1 requirements should be addressed with specific measures to ensure compliance rather than Pillar 2 requirements that would double count risks already covered by the Pillar 1 requirement. As examples, risks of regulatory arbitrage/optimization as mentioned in paragraph 393 (a)(i) in EAPBs view properly belongs in a discussion of the Pillar 1 treatment of exposures that have a more favourable treatment in the calculation of the leverage ratio, but if a risk of excessive leverage is identified beyond what is considered covered by the Pillar 1 requirement as a result, for example, of extensive use of collateral swaps, a pilar 2 requirement should instead be considered with reference to the insufficient treatment of collateral swaps when calculating the exposure measure, if a material risk, and not with reference to the institution’s legitimate choice of using such instruments in the business instead of SFTs. Similarly, for paragraph 393 (a)(ii), compliance with the Pillar 1 leverage ratio requirement at all times would require that any optimization did not reduce the leverage ratio to below 3 % outside of the reporting dates. Operating at a minimum level of 3 pct. (with the appropriate administrative margin that the institution might deem necessary to ensure compliance at all times) should be considered legitimate, even if the institutions report a higher level than 3 pct. at the reporting dates. Obviously, non-compliance outside the reporting dates should be addressed with supervisory measures to enforce appropriate compliance at all times rather than by imposing a Pillar 2 requirement.
The EAPB for these reasons disagrees with the approach taken by the EBA. We would encourage the EBA to take an approach to what risks might be considered not covered or not sufficiently covered by the Pillar 1 requirement that is both more principles based and more specific, and set out a more detailed methodology to measure any such risks and its relation to the potential for causing excessive leverage. A more appropriate approach might for instance be to specify to what extent additional own funds requirements might be required to cover material risks of excessive leverage that have not been contemplated under the provisions of CRR (noting as mentioned in the response to question 3 above that exemptions under Art 429a have deliberately been provided for by the legislator and that this should be taken carefully into consideration) and/or that might be excluded or reduced in value under the applicable accounting framework (to the extent not already included as off balance exposures under the total exposure measure). If the administrative margins set by the institution are considered insufficient to cover volatility or other dimensions that might affect the risks of excessive leverage, the EAPB would in any case consider it more appropriate to offer supervisory guidance on the appropriate level of administrative margins rather than to impose a Pillar 2 requirement.
It is not fully clear whether disclosure is limited to the institution or that the aim is also to disclose it to the public. Therefore, we would like to stress that it is very important that the P2G is not made public. The disclosure would be in contradiction to the nature of P2G, being a bilateral supervisory tool between the supervisor and the institution to express non-binding supervisory expectations. Public disclosure would render it a binding requirement.
Question 1: How could the guidelines be further simplified in a way that appropriate focus of assessment is allowed while preserving the comprehensiveness of the assessment and ensuring that all aspects are sufficiently covered?
N/AQuestion 2: Do you think that the proposed overall framework for setting additional own funds requirements appropriately incorporates the ICAAP information and estimates?
We note that paragraph 361 included in the previous Guidelines has been removed from the current draft proposal. In our view, the dialogue between the supervisor and the financial institution on the ICAAP outcomes as an element to take into account in determining the additional own funds requirements as provided by this paragraph should be kept.Question 3: Do you agree with the proposed clarifications on the assessment of the risk of excessive leverage?
Paragraph 393(b) of the Guidelines states that in assessing the risk of excessive leverage competent authorities should take into account elements of risk of excessive leverage that are explicitly excluded from or not explicitly addressed by the leverage ratio own funds requirement, including due to the exclusions listed in Article 429a of Regulation (EU) No 575/2013. This risks that exemptions deliberately provided for by the legislator will be overwritten by this guideline. In our view, focus should be on the risk of compliance with the necessary conditions for the use of the exemptions.In addition, we would like to point out that the exemptions in 429a(1)(d) ('claims on central governments, regional governments, local authorities or public sector entities in relation to public sector investments and promotional loans') are conditional on an institution fulfilling the criteria of a public development credit institution. Hence, the risk of not meeting the criteria to apply the exemption is directly linked to the business model. The assessment of the risk should be in line with the assessment of the business model risk and careful consideration should be taken to avoid any double counting.
Question 4: Do you think that the assessment of dimensions and indicators described in this explanatory box would also be relevant for the assessment of the risk of excessive leverage? Are there any other elements / indicators that you are using in the assessment of this risk?
Answers to questions 3 and 4:According to Art. 104a, competent authorities may impose additional own funds requirements to address risks of excessive leverage not sufficiently covered by point (d) of Article 92(1) of Regulation (EU) No 575/2013 (CRR II).
In the draft EBA Guideline it is proposed that the Competent Authority should focus on potentially elevated vulnerabilities, not captured by the own funds requirements as set out in CRR Art. 92(1) d that may require corrective measures to the business activities of the institution, that were not envisaged in the business plan. EBA goes on to propose elements that the competent authority should consider when determining if there are such risks.
The leverage ratio is meant to function as a backstop to risk weighted capital requirements. According to CRR Art. 429, the leverage ratio shall be calculated as an institution's capital measure divided by that institution's total exposure measure and shall be expressed as a percentage. Pursuant to CRR Art. 111(1) the total exposure measure consists of all assets according to CRR Art. 429(4), primarily according to their accounting values.
Since the leverage ratio includes the total exposure measure, the EAPB as a matter of principle considers it conceptually difficult to see risks of leverage, aside from risks, if any, from the excluded items according to CRR Art. 429a, that might be considered not covered by the pilar 1 requirement. Given the pilar 1 calibration at 3 pct. (plus G-SIFI buffer if applicable) as an appropriate backstop level and a prudent level of leverage for institutions, it is furthermore unclear under what circumstances it would be justified to consider the institution not sufficiently “backstopped” at this level. The EAPB does not consider this to be properly addressed by the proposals in the consultation document.
The EAPB emphazises that it is the responsibility of institutions to address situations where the leverage ratio might be reduced too close to the backstop level, and to ensure compliance at all times with the minimum requirement as necessary, e.g. by reducing their exposures or increasing their capital to avoid breaches. If the institutions manage the risks prudently and avoid breaching the requirement, the backstop has served its purpose, and it would in EAPB’s opinion for this reason not be justified to impose a Pillar 2 requirement based on the volatility of the leverage ratio as mentioned in paragraph 393 (c) and the explanatory box on p. 156.
From this perspective the EAPB’s opinion is that, this and several of the other dimensions considered by EBA go beyond the scope of the authority to impose additional own funds requirements under Art. 104a insofar as they seem to primarily address risks of non-compliance with the Pillar 1 requirement rather than risks of excessive leverage that are not sufficiently covered by the Pillar 1 requirement. Whilst the EAPB does not in principle consider it irrelevant to consider what would be the appropriate level of a backstop for a given business model, and to consider if specific business models might be exposed to vulnerabilities at a 3 pct. backstop level that it would be appropriate to address with a regulatory requirement, it is the EAPB view that the level of such regulatory requirement properly belongs in a discussion of the level of the Pillar 1 requirement. The appropriate harmonized backstop level at 3 pct has been adopted in CRR at the EU level with relevant adaptions and exclusions etc. as set out in CRR Part 7, and reflects what has been internationally agreed as the appropriate level for a backstop in the Basel Committee. The level of the Pillar 1 requirement ensures a level playing field between institutions and member states and globally, and ensures that equal risks are treated equally across business models (as appropriately modified by the provisions of CRR Part 7).
Risks associated with non-compliance with the Pillar 1 requirements should be addressed with specific measures to ensure compliance rather than Pillar 2 requirements that would double count risks already covered by the Pillar 1 requirement. As examples, risks of regulatory arbitrage/optimization as mentioned in paragraph 393 (a)(i) in EAPBs view properly belongs in a discussion of the Pillar 1 treatment of exposures that have a more favourable treatment in the calculation of the leverage ratio, but if a risk of excessive leverage is identified beyond what is considered covered by the Pillar 1 requirement as a result, for example, of extensive use of collateral swaps, a pilar 2 requirement should instead be considered with reference to the insufficient treatment of collateral swaps when calculating the exposure measure, if a material risk, and not with reference to the institution’s legitimate choice of using such instruments in the business instead of SFTs. Similarly, for paragraph 393 (a)(ii), compliance with the Pillar 1 leverage ratio requirement at all times would require that any optimization did not reduce the leverage ratio to below 3 % outside of the reporting dates. Operating at a minimum level of 3 pct. (with the appropriate administrative margin that the institution might deem necessary to ensure compliance at all times) should be considered legitimate, even if the institutions report a higher level than 3 pct. at the reporting dates. Obviously, non-compliance outside the reporting dates should be addressed with supervisory measures to enforce appropriate compliance at all times rather than by imposing a Pillar 2 requirement.
The EAPB for these reasons disagrees with the approach taken by the EBA. We would encourage the EBA to take an approach to what risks might be considered not covered or not sufficiently covered by the Pillar 1 requirement that is both more principles based and more specific, and set out a more detailed methodology to measure any such risks and its relation to the potential for causing excessive leverage. A more appropriate approach might for instance be to specify to what extent additional own funds requirements might be required to cover material risks of excessive leverage that have not been contemplated under the provisions of CRR (noting as mentioned in the response to question 3 above that exemptions under Art 429a have deliberately been provided for by the legislator and that this should be taken carefully into consideration) and/or that might be excluded or reduced in value under the applicable accounting framework (to the extent not already included as off balance exposures under the total exposure measure). If the administrative margins set by the institution are considered insufficient to cover volatility or other dimensions that might affect the risks of excessive leverage, the EAPB would in any case consider it more appropriate to offer supervisory guidance on the appropriate level of administrative margins rather than to impose a Pillar 2 requirement.
Question 5: Can you provide examples of situations which in your view might require CET1 instead of other capital instruments to cover potential losses in relation to P2R and P2R-LR?
In Pillar 1 the own funds requirement for leverage is expressed as a Tier 1 requirement. As such, we would suggest that the P2R-LR should be composed of Tier 1 capital.Question 6: Would you consider the introduction of a standardised template for the communication to the supervised institution of the outcome of the SREP to be beneficial?
We welcome a common template for the communication of P2R, P2R-LR, P2G and P2G-LR. The main purpose of the template should be transparency. That said, the template should be flexible enough to be in line with the spirit of Pillar 2 being an institution specific risk assessment.It is not fully clear whether disclosure is limited to the institution or that the aim is also to disclose it to the public. Therefore, we would like to stress that it is very important that the P2G is not made public. The disclosure would be in contradiction to the nature of P2G, being a bilateral supervisory tool between the supervisor and the institution to express non-binding supervisory expectations. Public disclosure would render it a binding requirement.