Ring-fencing and proprietary trading activities reviews: HM Treasury update
On 22 December 2020, the House of Commons Treasury Committee published a letter (dated 16 November 2020) it received from John Glen, Economic Secretary to the Treasury, on the upcoming statutory reviews of the ring-fencing regime legislation and banks' proprietary trading activities.
The ring-fencing regime came into effect on 1 January 2019 and was implemented following recommendations of the 2011 Independent Commission on Banking, chaired by Sir John Vickers. HM Treasury is required, by 1 January 2021, to appoint a panel to review the operation of the ring-fencing regime, including Part 9B of the Financial Services and Markets Act 2000 (FSMA) and the ring-fencing rules made by the Prudential Regulation Authority (PRA) or the Financial Conduct Authority (FCA).
The same implementing legislation that requires HM Treasury to appoint an independent panel to review the ring-fencing regime also requires an independent review of firms' proprietary trading activities. The independent review will consider whether it agrees with the conclusions of the PRA's September 2020 report on proprietary trading.
Given the close connection between the ring-fencing objectives and proprietary trading activity, Mr Glen explains that he intends to appoint one panel of six members to conduct both reviews. Mr Glen sets out his intention to appoint Keith Skeoch, outgoing CEO of Standard Life Aberdeen, as chair of the independent panel.
End of Brexit transition period: BoE and SRB cooperation arrangement
The Single Resolution Board (SRB) has announced that the cooperation arrangement between it and the Bank of England (BoE) came into force on 1 January 2021. The SRB explains that the arrangement will help to facilitate bank resolution while maintaining financial stability in the EU and the UK. It sets out the framework for consulting, cooperating and exchanging information when preparing for and implementing bank resolution in the UK and the Banking Union, in line with the rules in both jurisdictions. The arrangement is based on reciprocity and proportionality, and recognises the complex nature of cross-border bank operations.
The SRB and the BoE will continue to work closely together to ensure appropriate arrangements are in place for effective cooperation on the management of the failure of cross-border banks, in the event this is necessary.
The BoE has updated its resolution webpage to refer and link to the arrangement.
The SRB notes that its Brexit expectations position paper covers topics including the minimum requirement for own funds and eligible liabilities (MREL) eligibility, internal loss absorbency, operational continuity and access to financial market infrastructures. In addition, the SRB has communicated its expectations on an individual basis to banks. It has placed an emphasis on issuances under UK law, raising awareness that they may become ineligible for MREL.
The SRB also notes that its Expectations for Banks document and the MREL policy under the Banking Package also set out measures applying to third countries, which now apply to the UK. These include relevant clauses to contracts governed by third country law to ensure eligibility for MREL, enhance cross-border recognition of resolution actions or support operational continuity in resolution.
MREL and resolvability for mid-tier banks: BoE extends deadline
The BoE has published a statement announcing an extension for mid-tier banks to comply with deadlines relating to the MREL and the resolvability assessment framework (RAF).
For these purposes, "mid-tier banks" are UK resolution entities that are not global systemically important banks (G-SIBs) or domestic systemically important banks (D-SIBs) (or their subsidiaries) for which the BoE has set (or has indicated it will set) an MREL in excess of minimum capital requirements. The term also covers UK material subsidiaries of such institutions and certain UK subsidiaries of overseas groups for which the BoE has set internal MREL in excess of minimum capital requirements.
The BoE has extended the deadline for mid-tier banks to comply with their end-state MRELs to 1 January 2023, unless they are already subject to a later deadline. This replaces indicative end-state MREL compliance dates falling before that date that the BoE had previously communicated.
Before 1 January 2023, mid-tier banks are expected to continue to comply with their interim external and internal MRELs, as set in accordance with point b. of para. 9.4(b) of the Statement of Policy on "The BoE's approach to setting a MREL" (the MREL SoP), or as otherwise communicated to them by the BoE. The MREL SoP should be read as amended accordingly.
All other MREL deadlines remain unchanged.
MRELs applicable to all other institutions are unaffected by this announcement. The BoE notes that, as announced in May 2020, it intends to exercise its discretion with respect to the transition time firms are given to meet higher MRELs. Firms that are not currently subject to a leverage-based capital requirement, but which subsequently become subject to one, will be given at least 36 months after that requirement takes effect to meet any higher MREL resulting from it.
The deadline for mid-tier banks to implement the Statement of Policy on "The BoE's Approach to Assessing Resolvability" and to achieve the three resolvability outcomes has been extended from 1 January 2022 to 1 January 2023.
The BoE emphasises that it remains important for boards and senior management of mid-tier banks to take responsibility for their firm’s resolvability and to continue to take steps to assure themselves that they have the necessary arrangements in place to achieve, and continue to achieve, the three resolvability outcomes by 1 January 2023. The BoE intends to continue to engage with those firms on the implementation of the RAF ahead of the revised deadline.
The extension of MREL and RAF deadlines will enable the BoE to engage with interested parties on the issues set out in its MREL discussion paper published on the same day (see below) and to complete its review of the MREL framework in 2021 considering that engagement.
MREL: BoE discussion paper
The BoE has published a discussion paper as part of its review of the UK’s framework for the MREL The discussion paper is the first part of the BoE's review, which will consider, among other things, resolution strategy thresholds, the calibration of MREL, instrument eligibility and the application of MRELs within banking groups.
The deadline for responses is 18 March 2021. The BoE intends to publish a consultation paper in summer 2021, setting out any proposed changes to its MREL framework, and to make any policy changes by the end of 2021.
CRR prudential treatment of software assets: PRA statement
The PRA has published a statement on the requirement on the prudential treatment of software assets under Article 36(1)(b) of the Capital Requirements Regulation (CRR). Article 36(1)(b) of the CRR became effective on 23 December 2020 (including in the UK) and exempts software assets from the deduction requirement for intangible assets from common equity tier 1 (CET1). This revised regulatory treatment of software assets does not derive from the Basel Standards and is specific to the CRR.
Concerned that this could undermine the safety and soundness of UK firms, the PRA plans to consult to maintain the earlier position whereby all software assets continue to be fully deducted from CET1 capital. Firms should take this into account when making capital management and other decisions, which may be impacted by this change.
While the revised EU requirement applies to PRA-regulated firms, the PRA recommends firms do not base their distribution or lending decisions on any capital increase arising from this requirement. They should also consider any significant software assets included in their regulatory capital in making capital management decisions.
CRD V implementation and designation of firms within certain consolidation groups: PRA PS29/20
The PRA has published a policy statement, PS29/20, setting out its final policy on the implementation of the Capital Requirements Directive V (CRD V) and its final policy on the designation of firms within certain consolidation groups. The policy statement is relevant to UK banks, building societies and PRA-designated investment firms, as well as UK financial holding companies and UK mixed financial holding companies.
PS29/20 follows the PRA's consultation in CP22/20, on its proposed approach to designating entities within certain banking UK consolidation groups as responsible for ensuring that consolidated prudential requirements are met during a transitional period, and policy statement, PS26/20, setting out near-final versions of rules instruments, statements of policy, supervisory statements, model requirements and templates relating to the proposals consulted on in CP12/20 and CP17/20. The PRA did not make the final versions of these documents at that time because its power under the CRD V EU Exit Regulations to make rules imposing consolidated or sub-consolidated requirements on holding companies could not be exercised before 28 December 2020.
The PRA also published additional rulebook instruments and supervisory statements where it considers that certain policies would need to be amended under the European Union (Withdrawal) Act 2018 (EUWA) to make the legislation operable following the end of the Brexit transition period.
There are 33 appendices to PS29/20, including links to the rulebook instruments, updated Supervisory Statements, Statements of Policy, etc.
International banks: PRA CP2/21 on approach to branch and subsidiary supervision
The PRA has published a consultation paper, CP2/21, setting out its proposed approach to supervising the UK activities of PRA-authorised banks and designated investment firms that are headquartered outside of the UK, or are part of a group based outside of the UK (referred to as "international banks"). The term includes those firms operating in the UK through a branch. It also proposes expectations for receiving information concerning risks in the wider group, and for cooperation from regulated entities and their supervisors, in order that it can be satisfied that firms are meeting threshold conditions.
The purpose of the proposals in CP2/21 is to provide clarity to international banks on the implications for them of the different ways they may choose to structure their operations. The proposals also aim to explain how the PRA would assess these firms against its threshold conditions, particularly the condition relating to the effective supervision of firms, when a firm belongs to a group based outside the UK.
The proposals would result in a new Supervisory Statement (SS) "International banks: The PRA's approach to branch and subsidiary supervision", which will supersede SS1/18 "International banks: the Prudential Regulation Authority’s approach to branch authorisation and supervision".
The PRA states that the proposed expectations on subsidiaries and systemic wholesale branches in the proposed SS are consistent with the PRA's existing supervisory approach and are intended to provide clarity to firms on what they need to do to meet the PRA threshold conditions. It notes that this clarification is particularly timely given the changes in the population of firms that the PRA supervises and the associated changes in firms' operating structures.
The consultation period ends on 11 April 2021. The PRA intends to implement the final policy in Q2 2021.
The PRA has also published a speech by David Bailey, BoE Executive Director Financial Market Infrastructure, in which he further sets out the PRA's approach to supervising international banks. Among other things, he covers what is meant by "responsible openness", cooperation with home state supervisors, information sharing and governance. He also discusses booking arrangements for trading activity and having robust and proportionate requirements in place for international firms.
End of Brexit transition period: FCA guidance on approach to interpreting reporting and disclosure requirements under CRD and CRR BTS
The FCA has published guidance setting out the approach it expects firms to take when interpreting EU-based references found in reporting and disclosure templates and associated instructions in binding technical standards (BTS) relating to the CRD and CRR. The guidance is necessary following the expiry of the implementation period under the UK-EU Withdrawal Agreement.
The FCA has not made line-by-line changes to reporting or disclosure templates or instructions as a result of Brexit. Instead, it expects firms to interpret EU references in those requirements in accordance with this guidance.
Transposing BRRD II: PRA PS28/20
The PRA has published a policy statement, PS28/20, on transposing the Bank Recovery and Resolution Directive (BRRD) II (BRRD II) which amends the BRRD. The UK was required to transpose the BRRD II Directive by 28 December 2020. HM Treasury's statutory instrument (SI) transposing the BRRD II Directive was made on 3 December 2020 and amends primary legislation that will affect the Contractual Recognition of Bail-in and Stay in Resolution Parts of the PRA Rulebook. In PS28/20, the PRA sets out its final rules concerning the impact of BRRD II on these Parts.
To comply with the PRA's obligation to transpose BRRD II, most of the elements of the SI that are relevant to these Parts came into force on 28 December 2020, but subsequently ceased to have effect at the end of the transition period. The PRA rulebook instruments followed a similar approach.
LIBOR transition: Working Group paper on credit adjustment spread methods for active transition GBP LIBOR referencing loans
The Working Group on Sterling Risk-Free Reference Rates has published a paper highlighting the key methodologies emerging in the loan market on credit adjustment spreads for active transition from LIBOR to SONIA, and how these compare to the approaches taken in the bond and derivatives markets.
The Working Group encourages loan market participants to consider which methodology is appropriate to calculate the credit adjustment spreads for active transition. Based on historic loan transactions and approaches taken in the bond and derivatives markets, two key methodologies have emerged and are considered by the paper:
- five-year historical median approach; and
- forward approach (based on the forward-looking swap market).
The Working Group also published a set of slides outlining an indicative path towards its recommended milestone to cease issuance (by the end of March 2021) of sterling LIBOR-based loan products maturing beyond the end of 2021.
SSM banks: ECB guide on supervisory approach to consolidation
The European Central Bank (ECB) has published a guide on its supervisory approach to consolidation for banks in the single supervisory mechanism (SSM). The aim of the guide is to clarify the principles underpinning the prudential supervisory approach the ECB follows when determining whether the arrangements implemented by a credit institution resulting from a consolidation ensure the sound management and coverage of its risks.
The ECB has also published a feedback statement, which provides an overview of the comments received to its preceding consultation, together with the ECB's response and explanation of any subsequent amendments made to the guide.
SRB permission regime for reduction of eligible assets: SRB communication
The Single Resolution Board (SRB) has published a communication on the SRB permission regime on the reduction of eligible assets.
Article 78a of the CRR, which was introduced by CRR II, requires institutions to obtain permission from their resolution authorities to call, redeem, repay or repurchase eligible liabilities instruments before these instruments reach their contractual maturity. The effect of the Single Resolution Mechanism (SRM) II Regulation, which applies from 28 December 2020, is to expand the scope of liabilities subject to the permission regime to all liabilities eligible for the MREL (including senior unsecured liabilities and internal MREL eligible liabilities).
The purpose of the communication is to inform institutions of the impact on the SRB's current permission regime procedure of the application of the SRM II Regulation and the regulatory technical standards (RTS) on the procedure applicable to early redemptions under Article 78a(3) of the CRR currently under development by the EBA.
The SRB sets out how it will transition from its current procedure for assessing prior permission applications to 1 January 2022, which is the deadline for institutions to comply with the intermediate MREL targets set under the SRM II Regulation. The SRB emphasises the importance of building up and maintaining an adequate MREL stock, warning of the potential consequences of having a MREL shortfall on 1 January 2022.
BRRD: EBA second report on simplified obligations and waivers
The European Banking Authority (EBA) has published its second report on the application of simplified obligations and waivers in recovery and resolution planning in accordance with Article 4 of the Bank Recovery and Resolution Directive (BRRD). The report presents an overview of how competent and resolution authorities have applied the principle of proportionality in recovery and resolution planning, based on data collected in December 2019. The EBA published its first report in December 2017.
BRRD: EBA final report on RTS on estimating Pillar 2 and combined buffer requirements for setting MREL
Following its July 2020 consultation, the EBA has published a final report on its draft RTS specifying the methodology to be used by resolution authorities to estimate the Pillar 2 and combined buffer requirements at resolution group level. This is for the purpose of setting the MREL under the BRRD.
BRRD: EBA final report on ITS on reporting by resolution authorities of MREL decisions
Following a consultation launched in July 2020, the EBA has published a final report on draft implementing technical standards (ITS) specifying uniform reporting templates, instructions and methodology for the identification and transmission by resolution authorities to the EBA of information on MREL. The purpose of the ITS is to replace the existing ITS on MREL reporting by resolution authorities that are set out in Commission Implementing Regulation (EU) 2018/308, which supplements the BRRD. Article 45j(2) of the BRRD, as amended by BRRD II, gave the EBA a mandate to produce new ITS on MREL reporting by resolution authorities to reflect the new framework introduced by BRRD II.
The ITS set out minimum procedural obligations covering reporting periods and submission dates, as well as templates to be used by resolution authorities when informing the EBA of the MREL requirements they have set. Annex I to the ITS set out the templates that should be used by resolution authorities and Annex II contains the instructions for completing the templates. The ITS will also repeal Commission Implementing Regulation (EU) 2018/308.
BRRD: EBA final report on RTS and ITS on impracticability of contractual recognition of bail-in
Following its July 2020 consultation, the EBA has published a final report on draft RTS and draft ITS on the impracticability of contractual recognition of write-down and conversion powers and related notifications under Articles 55(4) and 55(8) of the BRRD.
BRRD II amends Article 55 to address the scenario where it is impracticable for institutions and entities subject to the BRRD to include bail-in contractual recognition clauses in liability contracts. The new Articles 55(6) and 55(8) give the EBA a mandate to draft RTS specifying conditions under which it would be legally, contractually or economically impracticable to include contractual recognition clauses and ITS to specify uniform formats and templates for notifying resolution authorities concerning impracticable clauses.
The draft ITS specify uniform formats and templates for the notification to resolution authorities of contracts meeting the conditions of impracticability defined in the draft RTS. The EBA has published Annex I (templates) and Annex II (instructions) to the draft ITS separately.
COVID-19: EBA report on implementation of selected COVID-19 policies: December 2020
On 21 December 2020, the EBA published an updated version of its report on the implementation of selected COVID-19 policies. The aim of the report is to provide a follow-up on the implementation issues around COVID-19 credit risk policy relief measures, particularly the EBA's guidelines on moratoria, and to monitor how such measures are implemented. The report also contains FAQs on the implementation of the requirements set out in the EBA's guidelines on COVID-19 reporting and disclosure.
The EBA may update the report in the future to reflect further issues that may arise in the context of its monitoring of the implementation of COVID-19 policies.
CRR: European Commission adopts Implementing Regulation on ITS on supervisory reporting
The European Commission has adopted an Implementing Regulation containing ITS on supervisory reporting requirements for institutions under the CRR that repeals and replaces Commission Implementing Regulation (EU) 680/2014. It has published the Annexes to the Implementing Regulation separately.
The purpose of the Implementing Regulation is to set out all the ITS on supervisory reporting under the CRR in a single place. It reflects additional reporting requirements introduced by CRR II, including new requirements on counterparty credit risk and the net stable funding ratio, and changes to existing areas of reporting, including own funds, credit risk, large exposures, the leverage ratio and global systemically important institution (G-SII) indicators. It also reflects amendments to the CRR made by Regulation (EU) 2019/630, which established a prudential backstop for non-performing loans.
The Implementing Regulation will enter into force on the day following that of its publication in the Official Journal of the European Union (OJ). It will apply from 28 June 2021, except for the requirements for reporting on the leverage ratio buffer requirement for institutions identified as G-SIIs, which will apply from 1 January 2023. Articles 9 and 10, which contain reporting requirements for groups that consist only of investment firms, will cease to apply on 26 June 2026.
CRR: Delegated Regulation on prudential treatment of software assets
Delegated Regulation (EU) 2020/2176, which amends Delegated Regulation (EU) 241/2014 as regards the deduction of software assets from CET 1 items, has been published in the OJ. The Delegated Regulation sets out RTS specifying the application of the deductions of software assets that are classified as intangible assets for accounting purposes under Article 36(1)(b) of the CRR.
The Delegated Regulation entered into force on 23 December 2020.
CRD: EBA consults on amendments to ITS on benchmarking of internal models
The EBA has published a consultation paper on draft ITS amending Commission Implementing Regulation (EU) 2016/2070 with regard to benchmarking of internal models.
Commission Implementing Regulation (EU) 2016/207016, which reflects a mandate under Article 78(8) of the CRD, contains ITS specifying the information that institutions have to report to the EBA and to competent authorities to monitor the range of risk weighted exposure amounts or own funds requirements for the exposures or transactions in the benchmark portfolio resulting from the internal approaches of those institutions and to assess those approaches.
For the 2022 benchmarking exercise, the EBA is proposing to amend Commission Implementing Regulation (EU) 2016/207016 to make changes to the reporting templates and instructions relating to market risk, credit risk and IFRS 9. The proposed revisions to the Annexes have been published separately in a zip file on the webpage for the draft ITS.
The deadline for responses is 15 February 2021.
CRD: EBA report on methodology for calibrating O-SII buffer rates
The EBA has published a report on the appropriate methodology to calibrate other systemically important institution (O-SII) buffer rates.
CRD V makes extensive amendments to the framework for capital buffers for firms identified as O-SIIs as set out in the CRD. Competent authorities will have the discretion to subject each O-SII to a buffer of up to 3% of their total risk exposure amount (TREA). It also mandated the EBA to produce a report on the appropriate methodology for the design and calibration of O‐SII buffer rates, as there is currently is no harmonised methodology at EU level for calibrating these rates.
In the report, the EBA recommends that a floor methodology should apply for the calibration of O-SII buffer rates ideally by the year 2022. The methodology should be based on the O‐SII scores that result from the first stage of the process for identifying O-SIIs. Competent authorities will still retain the ability to set higher O-SII buffer rates than the prescribed floor and are encouraged to do so where appropriate.
The EBA suggests that it should be given a legal mandate in future revisions to the CRD to prescribe the floor methodology for calibrating O-SII buffer rates in the form of technical standards. This mandate might also extend to the process for identifying O-SIIs, which is currently set out in EBA guidelines published in December 2014.
Eurosystem plans for digital euro: ECB letter
The European Central Bank (ECB) has published a letter it has sent, responding to a letter from the European Parliament, on plans for a digital euro. Among other things, the ECB explains that the Eurosystem is currently conducting conceptual analysis and practical experimentation on the technical solutions that might support the issuance of a digital euro in the future. It also outlines the role of commercial banks in a digital euro system, and the possible impact on their provision of credit.
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Authored by Yvonne Clapham