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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The draft version of the Guidelines, however, does not yet meet the objective of strengthening propor-tionality set out in the “Risk Reduction Package Roadmaps” of 21 November 2019.
More specifically, initial starting points for a more streamlined SREP approach are mentioned primarily in paragraphs 54, 56 and 58. These are not sufficient, however, particularly as Table 1 requires an “As-sessment of all SREP elements (at least)” every three years, even for smaller institutions. It remains un-clear which of the numerous individual aspects set out, inter alia, in Titles 5, 6 and 8 (which are expand-ed even further by references to further EBA guidelines), supervisors are permitted to disregard or con-solidate, for example, when assessing category 3 and category 4 institutions. At the very least, clarifica-tion should be included that this refers to the main elements of the SREP and not to all of the individual criteria mentioned in the Guidelines.
In addition, paragraph 54 merely refers to Article 97(4a) CRD V. The EBA was, however, mandated in that Article to define criteria on how supervisory authorities could implement adapted (harmonised) procedures for institutions with a similar risk profile. In our view, this is currently not reflected in the Guidelines.
Most banks have been investing in the reliability of their ICAAPs for decades. Strengthening the institu-tions’ ICAAPs has always been an important goal for the supervisors, which is why the ICAAP should remain the main starting point for the quantification of individual risks and the determination of the P2R. Only overall inadequate and unreliable ICAAPs should be supplemented by supervisory bench-marks. In all other cases, the imprecise nature of benchmarks would lead to overly conservative measures if they were to be introduced. The EBA should therefore describe in detail when ICAAPs are deemed to be generally unreliable and when, as a result, benchmarks are to be introduced, while in all other cases the ICAAP should be the main starting point for the determination of the P2R. As a result, we take the view that the sources of information referred to in paragraph 369 should only be used as supplementary sources; the primary role of the ICAAP should be retained.
In addition, the requirements should make it clearer that a P2R-LR and P2G-LR that is greater than zero does not need to be set by default (e.g. by adding “where necessary / applicable” in paragraphs 394, 398, 404 b, 409 b, 411 and 424).
Paragraph 393:
We do not agree with the vast majority of the proposed examples. Letters a. to d. of paragraph 393 mention a number of “aspects” that are to be taken into account when assessing the “risk of excessive leverage”, even though these aspects have no legal basis. In the relevant Article 4(1) no. 94 CRR, this risk is defined relatively narrowly as follows: “risk of excessive leverage” means the risk resulting from an institution's vulnerability due to leverage or contingent leverage that may require unintended correc-tive measures to its business plan, including distressed selling of assets which might result in losses or in valuation adjustments to its remaining assets.
This definition is based on the central assumption that the observed institution-specific leverage ratio includes the risk that corrective action will be required due to a potential breach of the minimum lever-age ratio requirement of 3%, which could lead to additional (fire sale) losses. Situations in which the institution operates close to the lower limit or has to tolerate a very volatile leverage ratio due to the na-ture of the business model can therefore be identified as causes of the “risk of excessive leverage”. These situations are covered by c. and d. In our opinion, however, neither the three aspects mentioned under a. nor the aspects in point b. can be summarised under the level 1 definition set out above, mean-ing that they have to be removed.
Furthermore, Article 429a CRR explicitly provides for exemptions for authorised exposure. We fear that the exceptions provided for by the legislator will be undermined by these Guidelines. The use of those exceptions cannot be regarded as evidence of a risk of excessive leverage per se. In this context, it must only be verified that the prerequisites for making use of an exception are met. The leverage ratio is a non-risk sensitive measure by nature and the SREP Guidelines should not try to make it risk sensitive by introducing adjustments that were deliberately not taken into account when establishing the leverage ratio.
Setting standardisation objectives aside, however, it is crucial to maintain the individual assessment and diversity of the institutions and business models. Since these can differ from country to country, and to allow National Competent Authorities (NCAs) to adopt a proportionate approach for the smaller institu-tions they supervise, no standardised EU-wide template should be imposed as a requirement and the transparency requirements should be tightened up instead. Best practice examples could also be provid-ed where appropriate to work towards greater convergence and comparability of the SREP throughout the EU.
Furthermore, in the event that an entity is excluded from the supervisory stress test exercise, or does not participate due to its categorisation, how is the consistency of the methodology ensured? How is the P2G determined, is it done through ICAAP?
Moreover, we would like to add the following comments:
Title 7.7.1:
When it comes to P2G-LR it is rather unclear how the static balance sheet assumption as given in the EU-wide stress test could form a proper basis for the exploration of a leverage ratio under stress, which would already be misleading from a theoretical point of view.
There is no clear guidance for setting a P2G-LR. We suspect that the LR-related risk is overestimated and that, in consequence, the P2G-LR is set too high. Paragraph 423 states that the “level of P2G-LR should protect against the breach of TSLRR in the adverse scenario”. On the other hand, paragraph 429 sets out that the P2G should cover at least the maximum stress impact. Regardless of how far the start-ing point was above the minimum requirements or how far the minimum requirements were exceeded in the stress scenario, the outcome would be very different.
We ask that it be clarified that there is generally no room for (non-institution specific) minimum (floor) P2G and P2G-LR.
Paragraph 437:
In our view, keeping the provision introduced in 2018, stating that the P2G is to be met using CET1, is not permissible. The wording of Article 104b CRD V adopted in 2019 only focuses on own funds over-all. Working papers on the CRD review reveal that the majority of member states had favoured the in-troduction of a “soft” recommendation with regard to the P2G. As a result, an expectation to meet P2G with CET1 only within the SREP Guidelines is not consistent with the intention of the EU legisla-tor and is lacking any legal basis. This tightened requirement should be deleted and the wording should be based on own funds in line with the CRD V.
• The disclosure of buckets or “ranges of P2G add-ons” by the supervisory authority could make sense in principle as a way of communicating to the markets. Such publications by the supervisory authorities should, however, be limited to large, capital market-oriented institutions. In any case, we do not encourage that individual results of single institutions be published.
• Our view is that extending the disclosure requirements for institutions with regard to individual P2G would clearly not make sense, which is why we reject such a proposal. The disclosure re-quirements have only just been revised extensively and in full as part of the CRR II in conjunction with Implementing Regulation 2021/637, meaning that they reflect the current needs from a Pillar 3 perspective. Small and non-complex, as well as non-capital market-oriented other institutions were granted considerable relief by law as part of this process, as the disclosed data is generally not accessed (cf. EP, 2016/0360A(COD) of 11 December 2017). With this in mind, we also consider the disclosure regulations in the CRR II to be entirely sufficient.
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?
ESBG welcomes the EBA initiative to revise the SREP GLs in order to align them with the existing regulations. The current structure of the guidelines should be preserved as it is in line with the SREP process. However, ensuring the consistency and compatibility of all introduced changes with the logic of the guidelines would be highly appreciated.The draft version of the Guidelines, however, does not yet meet the objective of strengthening propor-tionality set out in the “Risk Reduction Package Roadmaps” of 21 November 2019.
More specifically, initial starting points for a more streamlined SREP approach are mentioned primarily in paragraphs 54, 56 and 58. These are not sufficient, however, particularly as Table 1 requires an “As-sessment of all SREP elements (at least)” every three years, even for smaller institutions. It remains un-clear which of the numerous individual aspects set out, inter alia, in Titles 5, 6 and 8 (which are expand-ed even further by references to further EBA guidelines), supervisors are permitted to disregard or con-solidate, for example, when assessing category 3 and category 4 institutions. At the very least, clarifica-tion should be included that this refers to the main elements of the SREP and not to all of the individual criteria mentioned in the Guidelines.
In addition, paragraph 54 merely refers to Article 97(4a) CRD V. The EBA was, however, mandated in that Article to define criteria on how supervisory authorities could implement adapted (harmonised) procedures for institutions with a similar risk profile. In our view, this is currently not reflected in the Guidelines.
Question 2: Do you think that the proposed overall framework for setting additional own funds requirements appropriately incorporates the ICAAP information and estimates?
Based on the current draft, we believe that unfortunately only a loose connection between the ICAAP, as the basis for the supervisory analysis, and the final P2R would remain. The idea currently is for the ICAAP to also serve as a quantitative basis for the SREP. From our perspective, this sort of fundamen-tal approach still makes sense (see also our additional comments on Title 6).Most banks have been investing in the reliability of their ICAAPs for decades. Strengthening the institu-tions’ ICAAPs has always been an important goal for the supervisors, which is why the ICAAP should remain the main starting point for the quantification of individual risks and the determination of the P2R. Only overall inadequate and unreliable ICAAPs should be supplemented by supervisory bench-marks. In all other cases, the imprecise nature of benchmarks would lead to overly conservative measures if they were to be introduced. The EBA should therefore describe in detail when ICAAPs are deemed to be generally unreliable and when, as a result, benchmarks are to be introduced, while in all other cases the ICAAP should be the main starting point for the determination of the P2R. As a result, we take the view that the sources of information referred to in paragraph 369 should only be used as supplementary sources; the primary role of the ICAAP should be retained.
Question 3: Do you agree with the proposed clarifications on the assessment of the risk of excessive leverage?
We agree only partly with the proposed clarifications on the assessment of the risk of excessive leverage. We recommend that the supervisory authorities adopt a pragmatic approach to assessing risks of exces-sive leverage. In our view, the business models and business activities of the vast majority of institutions do not entail such risks and imposing a P2R-LR and/or a P2G-LR should ultimately only be necessary in singular cases. Additional information requirements, a separate supervisory leverage ratio stress test or similar measures are only likely to be necessary – if at all – for institutions if the supervisory assessment flags up material indications pointing to risks of excessive leverage. For all other institutions, the re-quirements relating to the leverage ratio should be implemented as part of a system that is as streamlined as possible so as not to produce any unnecessary additional work for supervisory authorities and institu-tions alike. The reference in paragraph 397 to the fact that available sources of information should be used should be positioned more prominently within the text and, where appropriate, further information should be added on proportionate implementation options.In addition, the requirements should make it clearer that a P2R-LR and P2G-LR that is greater than zero does not need to be set by default (e.g. by adding “where necessary / applicable” in paragraphs 394, 398, 404 b, 409 b, 411 and 424).
Paragraph 393:
We do not agree with the vast majority of the proposed examples. Letters a. to d. of paragraph 393 mention a number of “aspects” that are to be taken into account when assessing the “risk of excessive leverage”, even though these aspects have no legal basis. In the relevant Article 4(1) no. 94 CRR, this risk is defined relatively narrowly as follows: “risk of excessive leverage” means the risk resulting from an institution's vulnerability due to leverage or contingent leverage that may require unintended correc-tive measures to its business plan, including distressed selling of assets which might result in losses or in valuation adjustments to its remaining assets.
This definition is based on the central assumption that the observed institution-specific leverage ratio includes the risk that corrective action will be required due to a potential breach of the minimum lever-age ratio requirement of 3%, which could lead to additional (fire sale) losses. Situations in which the institution operates close to the lower limit or has to tolerate a very volatile leverage ratio due to the na-ture of the business model can therefore be identified as causes of the “risk of excessive leverage”. These situations are covered by c. and d. In our opinion, however, neither the three aspects mentioned under a. nor the aspects in point b. can be summarised under the level 1 definition set out above, mean-ing that they have to be removed.
Furthermore, Article 429a CRR explicitly provides for exemptions for authorised exposure. We fear that the exceptions provided for by the legislator will be undermined by these Guidelines. The use of those exceptions cannot be regarded as evidence of a risk of excessive leverage per se. In this context, it must only be verified that the prerequisites for making use of an exception are met. The leverage ratio is a non-risk sensitive measure by nature and the SREP Guidelines should not try to make it risk sensitive by introducing adjustments that were deliberately not taken into account when establishing the leverage ratio.
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?
No. In our view, further indicators do not seem to be appropriate. As a result, we welcome the fact that the examples discussed in the explanatory box are not included in the draft SREP Guidelines, as none of them can be summarised under the authoritative definition of “risk of excessive leverage” provided in Article 4(1) no. 94 CRR. In our opinion, a link to “leverage risk” based on the CRR definition cannot be meaningfully drawn in these examples. What is more, the aspects mentioned are already taken into ac-count elsewhere.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?
The proportion of CET1 for the P2R specified in Article 104a CRD V and the requirements for the P2R-LR comply with the requirements set out in Article 92 CRR. In our opinion, more stringent re-quirements (i.e. higher CET1 ratios) are generally not necessary and should be limited to justified indi-vidual cases, as provided for in the wording of the Directive. We do not believe that there are any gen-erally applicable examples of situations or that there is any need for more detailed regulations.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?
ESBG believes that competent authorities should be encouraged to provide a structured template for the communication of P2R, P2R-LR, P2G and P2G-LR. The main driver of the structure of such tem-plates should be transparency. Institutions need detailed information on the basis/methods for deter-mining the Pillar 2 capital requirements imposed so they can address them appropriately. That is, institu-tions must be informed which risk types, deficiencies, benchmarks, etc. contribute to the given determi-nation of P2R, etc. and to what extent. In this context, a list of all items/risks examined (including refer-ences) would increase comparability and traceability for institutions. Overall, benchmarking across insti-tutions, where performed, and benchmarking results should be made more transparent.Setting standardisation objectives aside, however, it is crucial to maintain the individual assessment and diversity of the institutions and business models. Since these can differ from country to country, and to allow National Competent Authorities (NCAs) to adopt a proportionate approach for the smaller institu-tions they supervise, no standardised EU-wide template should be imposed as a requirement and the transparency requirements should be tightened up instead. Best practice examples could also be provid-ed where appropriate to work towards greater convergence and comparability of the SREP throughout the EU.
Question 7: What are your views on the guidance for setting P2G and P2G-LR? Is it sufficiently clear?
The guidance is not sufficiently clear for P2G-LR. Within paragraph 436 only P2G setting is mentioned (to be met with CET1 eligible own funds) while P2G-LR is not mentioned. In paragraph 440 both P2G and P2G-LR are mentioned as CET1 denominated while in the explanatory text box for Pillar2 guid-ance it is mentioned that “keeping consistency within the leverage ratio stack based on a Tier 1 compo-sition of P2G-LR would leave the calculation coherent and straightforward. Nonetheless competent authorities may still need to require institutions to cover P2G-LR with CET1 eligible own funds based on institution-specific considerations.”Furthermore, in the event that an entity is excluded from the supervisory stress test exercise, or does not participate due to its categorisation, how is the consistency of the methodology ensured? How is the P2G determined, is it done through ICAAP?
Moreover, we would like to add the following comments:
Title 7.7.1:
When it comes to P2G-LR it is rather unclear how the static balance sheet assumption as given in the EU-wide stress test could form a proper basis for the exploration of a leverage ratio under stress, which would already be misleading from a theoretical point of view.
There is no clear guidance for setting a P2G-LR. We suspect that the LR-related risk is overestimated and that, in consequence, the P2G-LR is set too high. Paragraph 423 states that the “level of P2G-LR should protect against the breach of TSLRR in the adverse scenario”. On the other hand, paragraph 429 sets out that the P2G should cover at least the maximum stress impact. Regardless of how far the start-ing point was above the minimum requirements or how far the minimum requirements were exceeded in the stress scenario, the outcome would be very different.
We ask that it be clarified that there is generally no room for (non-institution specific) minimum (floor) P2G and P2G-LR.
Paragraph 437:
In our view, keeping the provision introduced in 2018, stating that the P2G is to be met using CET1, is not permissible. The wording of Article 104b CRD V adopted in 2019 only focuses on own funds over-all. Working papers on the CRD review reveal that the majority of member states had favoured the in-troduction of a “soft” recommendation with regard to the P2G. As a result, an expectation to meet P2G with CET1 only within the SREP Guidelines is not consistent with the intention of the EU legisla-tor and is lacking any legal basis. This tightened requirement should be deleted and the wording should be based on own funds in line with the CRD V.
Question 8: What are your views on possible disclosures, which may be attached to P2G and/or ranges of buckets in case they are identified?
It is not clear from the question which type of disclosure is meant here. As a result, we will address sev-eral potential aspects:• The disclosure of buckets or “ranges of P2G add-ons” by the supervisory authority could make sense in principle as a way of communicating to the markets. Such publications by the supervisory authorities should, however, be limited to large, capital market-oriented institutions. In any case, we do not encourage that individual results of single institutions be published.
• Our view is that extending the disclosure requirements for institutions with regard to individual P2G would clearly not make sense, which is why we reject such a proposal. The disclosure re-quirements have only just been revised extensively and in full as part of the CRR II in conjunction with Implementing Regulation 2021/637, meaning that they reflect the current needs from a Pillar 3 perspective. Small and non-complex, as well as non-capital market-oriented other institutions were granted considerable relief by law as part of this process, as the disclosed data is generally not accessed (cf. EP, 2016/0360A(COD) of 11 December 2017). With this in mind, we also consider the disclosure regulations in the CRR II to be entirely sufficient.