On 23 November 2016, the European Commission published its proposal for a reform package intended to further strengthen the resilience of credit institutions in the EU. The package consists of proposed amendments to CRR, CRD IV, BRRD and the SRM.

The proposals include a variety of topics that not only consist of further tightened requirements but also contain some adjustments to the existing regulatory framework in favour of credit institutions:

Introduction of leverage ratio (LR)

  • Starting most likely in 2019/2020, credit institutions must hold an additional 3 % CET1 of the exposure measure as a leverage ratio requirement.
  • However, the leverage ratio requirement has been adjusted by the Commission’s final proposal: The exposure measure may be reduced by institutions for public lending, public development banks, pass-through promotional loans and officially guaranteed export credits. In addition, institutions are entitled to reduce the exposure measure by the initial margin received from clients for derivatives cleared through CCPs.
  • The LR is intended to strengthen the financial stability of an institution by setting additional capital requirements on the basis of non-risk weighted assets. The LR requirements are aimed at preventing the build-up of excessive leverage during times of economic boom.

SREP / Pillar II capital add-ons

  • To harmonise Pillar II capital add-on requirements throughout the EU, the proposal contains a set of conditions which need to be met in order for such additional capital requirements to be imposed by the competent authority.
  • Pillar II capital requirements shall no longer address systemic risks / macro-prudential issues but shall be limited to micro-prudential issues. Systemic risks are addressed by the already existing combined capital buffer requirements.
  • Introduction of guidance: In addition to Pillar I and Pillar II add-on / SREP capital requirements, an institution may be guided by the competent authority to establish an adequate level of own funds in order to tackle cyclical economic fluctuations and ensure that an institution’s own funds can absorb potential losses identified in a stress-test.

Transposition of TLAC into European framework law / MREL reform

  • The proposal seeks to align the Basel Committee's TLAC (total loss absorbing capacity) standard for Global Systemically Important Institutions (G-SIIs) with the MREL (minimum requirement for own funds eligible liabilities) standard applicable in the EU and contains amendments and clarifications to the current MREL regime.
  • The transposition proposal includes inter alia the following:
    • Introduction of resolution groups within a financial group;
    • Pillar I MREL requirements only for G-SIIs (18 % of risk weighed assets or 6.75 % of leverage ratio exposure measure; with Pillar II MREL add-ons in certain instances) while all other banks are subject to institution specific Pillar II MREL requirements (providing also for proportionality for smaller and less complex institutions);
    • Introduction of "internal MREL" for subsidiaries of resolution entities that are themselves not resolution entities;
    • Harmonisation of eligibility criteria between TLAC and MREL standards;
    • Non-compliance with MREL requirements will inter alia trigger the restrictions of the Maximum Distributable Amount (MDA) under CRR, i.e. profits may only be distributed to shareholders only in a limited number of instances, and
    • Introduction of guidance: An institution may in certain instances be guided by the resolution authority to hold MREL liabilities in excess of the Pillar I and Pillar II MREL requirements.
  • Subordination is generally only required to meet G-SIIs MREL requirements. For non-G-SIIs, the resolution authority may in certain instances require the MREL requirements to be met with subordinated liabilities (notwithstanding that institutions may in any case generally fulfil MREL and G-SIIs MREL requirements with certain non-subordinated debt up to 3.5 % of the risk exposure amount).
  • The amount of MREL liabilities that an institution needs to hold will be measured against the capital requirements under CRR and the newly introduced leverage ratio measure.
  • Please see the details of the Pillar II MREL requirement here

Creation of new senior asset class

  • The Commission's proposal now seeks to create a new category of senior class instruments that are eligible for MREL purposes ("non-preferred senior").
  • Non-preferred senior liabilities are supposed to rank between senior unsecured liabilities and capital instruments (CET1, AT1, Tier 2, Subordinated debt) of an institution. Thus, non-preferred senior liabilities will be subject to bail-in after capital instruments but before senior unsecured liabilities.
  • Non-preferred senior instruments will satisfy the subordination requirements under the MREL eligibility criteria (see above for more details on subordination requirements).
  • The proposal does not intend to affect existing debt instruments issued prior to the date of application of the amended provisions.
  • The proposal is intended to close a gap in the existing MREL provisions of BRRD which are intended to provide for a liability structure of credit institutions that allows for an effective application of the bail-in tool. Unlike the Basel Committee's TLAC proposal for G-SIIs, the existing MREL rules of the BRRD, which apply to all credit institutions and not only G-SIIs, do not generally require that a liability eligible for MREL is subordinated.
  • As a result, liabilities eligible for MREL could rank in insolvency pari passu with non-eligible liabilities. As a core principle of the BRRD, creditors may not be treated in a manner which leaves them worse-off than would be the case in normal insolvency proceedings. Consequently, under the current MREL regime, creditors of MREL eligible liabilities could potentially have a compensation claim against the resolution fund, thereby circumventing the goal of bail-in.

Contractual bail-in clauses

  • According to the Commission, the current framework for contractual bail-in clauses has proven impractical. This is because the inclusion of bail-in clauses was required for essentially all agreements even if, in practice, these could not be subject to a bail-in.
  • Resolution authorities shall now be allowed to grant a waiver from the requirement to include contractual bail-in clauses in certain agreements. Liabilities under agreements for which a resolution authority granted relief are, however, not eligible for MREL purposes.

Introduction of Net Stable Funding Ratio (NSFR)

  • The proposal to introduce a NSFR (most likely in 2019) seeks to ensure that an institution has available stable funding relative to the required stable funding it needs over a one-year period.
  • The NSFR is set at 100 %. In order to determine the amount of stable funding available to an institution, the institution’s liabilities and regulatory capital is multiplied by certain factors. Those factors shall reflect the funding’s degree of reliability over a period of one year in both normal and stress situations.
  • The Commission’s proposal contains certain adjustments from the Basel Committee’s standard and easements for inter alia pass-through models (in particular of relevance for covered bonds), trade financings, residential guaranteed loans, credit unions, certain CCPs or derivatives.

SME and infrastructure financing

  • The existing easements for SME financings in Art 501 CRR will be extended.
  • For the first EUR 1.5 million, the current capital reduction of 23.81 % shall be maintained, while for amounts exceeding EUR 1.5 million (with no upper limit) a capital reduction of 15 % shall be applied.
  • Investments in infrastructure projects are proposed to be subject to reduced capital requirements, provided that such projects meet certain quality and eligibility criteria.

Proportionality

In an attempt to ease certain regulatory requirements for less complex banks, the Commission proposes certain adjustments to the current framework:

  • In particular, regulatory reporting shall become less strict for small banks, e.g. less frequent capital reports or removing certain reporting items.
  • Also, disclosure requirements shall be adjusted to reflect a more proportionate approach.
  • Small and non-complex institutions (up to EUR 5 billion assets over the last preceding four financial years) and staff receiving low variable remuneration (up to EUR 50,000 provided that this is less than 25 % of the staff’s total remuneration) shall in principle be exempt from the rules on deferral and pay-out of variable remuneration in instruments issued by the institution; and
  • Listed institutions shall be able to effect pay-out of variable remuneration not only in shares but also in share-linked instruments.

Fundamental Review of the Trading Book (FRTB)

  • In order to address issues with the market risk capital requirements (eg risk for regulatory arbitrage by institutions choosing the most favourable treatment between the trading book and the banking book), the Commission proposes to implement the Basel Committee’s FRTB standard, starting most likely in 2020. As of 2020, the new requirements will be phased-in over a three year period.
  • Contrary to the Basel Committee, however, the Commission proposes a proportionate approach: (i) banks with small trading books (under EUR 50 million and less than 5 % of an institution’s total assets) are entitled to apply the treatment of the banking book to the trading book and (ii) banks with medium-sized trading books that are subject to market risk capital requirements (less than EUR 300 million and less than 10 % of an institution’s total assets) are entitled to apply a simplified standard approach.

Derivative exposures

  • Exposures to OTC derivative transactions shall be calculated in accordance with SA-CCR methods (standardised approach for counterparty credit risk) even for banks that have been authorised to use internal models.

Large exposure

Large exposure limits are decreased from 25 % to 10 % for G-SIIs’ exposures towards other G-SIIs.