The FT is reporting this morning that the latest draft of the Liikanen proposals, which implement bank structural reform within the EU, will be significantly watered down. According to the article, separation will no longer be mandatory and will be less restrictive than previously thought. Wider discretion is also to be given to national competent authorities – not always a good thing – to decide whether certain trading activity constitute a “systemic risk”, based on metrics provided by the European Banking Authority. However, there may be a sting in the tail, with the EU Commission apparently proposing an ‘EU Volcker-Lite’ ban on proprietary trading – but only for the EU’s 30 largest banks.
On 12 December 2013, the European Banking Authority (EBA) published a consultation paper on draft regulatory technical standards (RTS) on the methodology for the identification of global systemically important institutions (G-SIIs) and draft implementing technical standards (ITS) on uniform formats and dates for the disclose of the values of the indicators used for determining the score of G-SIIS. Continue reading
On 12 September 2013, the European Parliament published a press release announcing the adoption of a package of legislative acts to set up a Single Supervisory Mechanism (SSM) for the Eurozone. The SSM legislation was adopted with very large majorities and will bring the EU’s largest banks under the direct oversight of the European Central Bank (ECB) from September 2014.
The SSM legislation consists of a proposed regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions and a proposed regulation amending Regulation 1093/2010 (see this blog post for more details). The European Parliament has also published a document containing the provisional texts adopted which can be found on pages 105 and 50 respectively.
The Regulations will come into force following approval by the EU Council and publication in the Official Journal of the EU. The ECB will assume its supervisory role 12 months later.
On 20 May 2013, the EBA published two consultation papers regarding draft Regulatory Technical Standards (“RTS”) regarding the:
The consultations follow the previous consultation published by the EBA on 11 March 2013 regarding draft RTS on the content of Recovery Plans (see this blog post for more detail) and remain open for comment until 20 August 2013. Final versions of both RTS will be submitted to the European Commission within 12 months of the date on which the “Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”) enters force, but may be amended after the consultation to take into account possible changes to the final RRD.
RTS on the Assessment of Recovery Plans
The draft RTS have been developed pursuant to Article 6(5) of the RRD. Their main objective is to promote harmonisation across the EU regarding the assessment of recovery plans and to facilitate joint assessments of group recovery plans by different supervisory authorities. They outline the three criteria that competent supervisors must take into account when reviewing individual and group recovery plans:
- quality; and
- overall credibility.
The degree of completeness of a recovery plan is to be assessed against the following (non-exhaustive) list of factors:
- whether it covers all the information listed in Section A of the Annex of the RRD (“Information to be Included in Recovery Plans”);
- whether it provides information that is up to date with respect to any material changes to the institution or group to which the recovery plan relates;
- where applicable, an analysis of:
- how and when an institution may apply for the use of central bank facilities; and
- available collateral; and
- whether the recovery plan has been tested against a range of scenarios.
In addition to the information set out above as it applies in a group context, the completeness of group recovery plans is assessed against the following matters:
- the establishment of arrangements for intra-group financial support;
- the identification of obstacles, if any, to the implementation of recovery measures within the group; and
- the identification of substantial practical or legal impediments to:
- the prompt transfer of own funds or
- the repayment of liabilities or assets within the group.
The quality of a recovery plan is assessed against the following (non-exhaustive) list of factors:
- relevance of information;
- comprehensiveness; and
- internal consistency.
Individual Recovery Plans
Overall credibility in the context of individual recovery plans is essentially an assessment of the extent to which:
the implementation of a recovery plan would be likely to restore the viability and financial soundness of the institution in question; and
- the plan or specific options could be implemented effectively in situations of financial stress and without causing any significant adverse effect on the financial system.
‘Restoration of viability and financial soundness’ is assessed against the following (non-exhaustive) factors:
- the level of integration and consistency of the recovery plan with the general corporate governance and risk management framework of the group;
- whether the recovery plan contains a sufficient number of plausible and viable recovery options;
- whether the recovery options included in the recovery plan address the scenarios identified;
- whether the timescale to implement the options is realistic and has been taken into account in the procedures designed to ensure timely implementation of recovery actions;
- the level of the institution`s or group`s preparedness;
- the adequacy of the range of scenarios of financial distress against which the recovery plan has been tested;
- the adequacy of the testing carried out using the scenarios of financial distress;
- the extent to which the recovery options and indicators are verified by the testing carried out using scenarios of financial distress;
- whether the assumptions and valuations made within the recovery plan are realistic and plausible.
‘Effective implementation’ is assessed against the following (non-exhaustive) factors:
- whether the range of recovery options sufficiently reduces the risk that obstacles to the implementation of the recovery options or adverse systemic effects arise due to the recovery actions of other institutions or groups being taken at the same time;
- the extent to which the recovery options may conflict with the recovery options of institutions or groups which have similar vulnerabilities and which might implement options at the same time;
- the extent to which implementation of recovery options by several institutions or groups at the same time could negatively affect the impact and feasibility of recovery options.
Group Recovery Plans
Overall credibility in the context of group recovery plans is essentially an assessment of the extent to which:
- the implementation of a recovery plan would achieve the stabilisation of the group as a whole, or any institution of the group; and
- the plan identifies whether, within the group, there are:
- obstacles to the implementation of recovery measures; and
- substantial practical or legal impediments to the prompt transfer of own funds or the repayment of liabilities or assets.
‘Stabilisation’ is assessed against the following (non-exhaustive) factors:
the extent to which the group recovery plan can achieve stabilisation of the group as a whole and any institution of the group;
- the extent to which arrangements included into the group recovery plan ensure coordination and consistency of measures between institutions within the group; and
- the extent to which the group recovery plan provides solutions to overcome:
- obstacles to the implementation of recovery measures; and
- substantial practical or legal impediments to a prompt transfer of own funds or the repayment of liabilities or assets.
RTS specifying the range of scenarios to be used in recovery plans
These draft RTS have been developed pursuant to Articles 5(5) and 5(6) of the RRD. They specify the range of scenarios to be designed by financial institutions when testing their recovery plans. The overriding principle is that scenarios should be based on the events that are the most relevant to the institution or group in terms of activity, size, interconnectedness, business, funding model, etc. Institutions are responsible for selecting an appropriate number of relevant scenarios (taking account of the principle of proportionality within the RRD) and national supervisors are responsible for assessing the adequacy of the chosen scenarios. Each distress scenario should be based on events that are exceptional but plausible and would threaten to cause the failure of the institution or group if recovery measures were not implemented in a timely manner and should cover:
a system wide event;
- an idiosyncratic event; and
- a combination of system wide and idiosyncratic events.
Each distress scenario should also include an assessment of the impact of the events on at least each of the following aspects of the institution or group:
- available capital;
- available liquidity;
- business model;
- payment and settlement operations; and
On 25 April 2013, the Council of the EU published the final compromise texts of a regulation conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions and the proposed regulation amending Regulation 1093/2010 (which established the European Banking Authority). Together these texts establish the EU single supervisory mechanism (SSM).
Broadly, under the new regime, the European Central Bank (ECB) will assume responsibility for the supervision of “significant” credit institutions, with “less significant” credit institutions to remain subject to regulation by national supervisors. “Significance” is to be based on the following criteria:
- importance for the economy of the EU or any participating Member State; and
- significance of cross-border activities.
In addition, any credit institution will be regarded as “significant” if:
- it has total assets of EUR 30 billion or more; or
- the ratio of its total assets to the GDP of the participating Member State of establishment exceeds 20% (unless the total value of its assets is below EUR 5 billion); or
- the ECB considers it to be of significant relevance; or
- it has requested or received public assistance directly from the European Financial Stability Facility or the European Stability Mechanism;
- it ranks amongst the three most significant credit institutions in a participating Member State.
The ECB will assume responsibility for, inter alia:
- authorisations and withdrawal of authorisations;
- the administration of certain activities currently carried out by home state regulators, such as the establishment of branches in non-participating Member States;
- the assessment of applications for the acquisition and disposal of “qualifying holdings” (i.e. involving 10% or more of capital or voting rights);
- the regulation of own funds requirements, securitisations, large exposure limits, liquidity, leverage, and reporting and public disclosure of information on those matters;
- the enforcement of governance arrangements, risk management processes, internal control mechanisms, remuneration policies and internal capital adequacy assessment processes;
- conducting supervisory reviews and stress testing;
- consolidated supervision where parent companies are established in participating Member States; and
- supervisory tasks in relation to recovery plans, early intervention and structural changes required to prevent financial stress or failure (but excluding any resolution powers).
For those involved in the preparation of RRPs, here is a link to an article on our sister site regarding an EBA consultation paper on asset encumbrance. Given the potential effect asset encumbrance arrangements can have on a firm’s resolvability, this is the type of thing that may well come across your desk in the future.
On 11 March 2013, the European Banking Authority (EBA) published a consultation paper concerning “Draft Regulatory Technical Standards (RTS) on the content of recovery plans under the draft directive establishing a framework for the recovery and resolution of credit institutions and investment firms” (RRD).
The draft RTS have been developed pursuant to Articles 5(7) and 7(4) of the proposed RRD and relate to the information to be contained in recovery plans that are not subject to simplified obligations under Article 4 of the RRD. The consultation itself runs until 11 June 2013. Thereafter, the EBA will submit the final draft RTS to the Commission within twelve months from the date of entry into force of the RRD (expected to be early in 2015), although the EBA acknowledges that the RTS may have to be amended, depending on the final form of the RRD. The regulation will enter into force on the 20th day following that of its publication in the Official Journal of the European Union.
A summary of the requirements is provided below. However, as currently drafted, the requirements of the draft RTS should not be a cause of concern, particularly not for FSA regulated firms already used to complying with FS12/1.
Draft RTS on Recovery Plans
Recovery plans are expected to contain a discussion of at least the following five items (but not necessarily in the following order):
- a summary of the recovery plan;
- a discussion of governance issues;
- a strategic analysis;
- a communication and disclosure plan; and
- an analysis of preparatory measures.
As the name suggests, this section takes the form of a summary of the key elements of the recovery plan, taken from the other sections.
The governance section of a recovery plan should provide a detailed description of:
- how and by whom the recovery plan was developed, the way in which it is integrated into the risk management framework of the firm and processes in place to ensure that it is kept up-to-date;
- the policies and procedures governing plan approval;
- the conditions and procedures necessary to ensure timely implementation of recovery options, including:
- escalation and decision-making processes; and
- indicators which may require plan activation; and
- management information systems.
The strategic analysis section of a recovery plan should provide:
- a description of the institution/group (as applicable), including:
- a mapping of core business lines and critical functions to legal entities and material branches;
- a detailed description of the group’s legal and financial structures, including:
- intra-group legal, operational and financial interconnectedness; and
- external interconnectedness with respect to material branches/legal entities;
- recovery options dealing with a number of stress scenarios and providing the following information with respect to each recovery option:
- a description of the option;
- an impact and feasibility assessment;
- an operational contingency plan, dealing at the very least with the maintenance of:
- operational processes (both for any separated and remaining entities); and
- access to financial market infrastructure; and
- an assessment of the effectiveness of recovery options and adequacy of indicators in a range of scenarios of financial distress so as to facilitate an overall assessment of recovery capacity.
Communication and disclosure plan
A recovery plan should include a detailed communication and disclosure plan which:
- addresses both internal and external communication;
- describes, for each recovery option, how the communication and disclosure plan would be implemented; and
- provides an assessment of the potential impact on the business and on general financial stability.
A recovery plan must include an analysis of any preparatory measures:
- to facilitate the sale of assets/business lines in a timeframe conducive to the restoration of financial soundness; and
- that the institution/group has taken or plans to take in order to facilitate implementation of the recovery plan or improve its effectiveness.
 A “material branch or legal entity‟ is one that:
- substantially contributes to profits/funding or holds an important share of assets, liabilities or capital;
- performs key commercial activities;
- performs key operational, risk or administrative functions centrally;
- bears substantial risks;
- could not be disposed of or liquidated without being likely to trigger a major risk;
- has importance for the financial stability of at least one of the Member States in which it is incorporated or operates.
On 23 January 2013, the European Banking Authority (EBA) published its recommendation on the development of recovery plans.
The recommendation is a follow-up to the EBA’s Discussion Paper on recovery plans published on 15 May 2012 and is primarily for the benefit of national competent authorities pending the finalisation of the EU directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”). It aims to ensure consistency and convergence on highest standards across the EU.
The requirement to complete the template recovery plan outlined in the recommendation applies to a list of 39 banks, as detailed in Schedule 1 to this article. The template itself must be completed no later than 31 December 2013.
Summary of Recovery Plan Template
The template recovery plan itself is divided into three sections:
- General overview – providing background information on the structure of the group and the governance processes supporting the recovery plan;
- Core of recovery plan – dealing with the design and implementation of credible recovery options; and
- Follow-up – addressing the measures that can be taken to optimise successful resolution strategies.
A more detailed summary of the requirements is provided in Schedule 2 to this article.
The Data Challenge
Whilst much inevitably depends on the specific drafting of an individual group’s recovery plan, the EBA template does raise the prospect that a number of EU banks will be required to effectively produce two recovery plans. Taking the UK as an example, broadly speaking, banks preparing recovery plans pursuant to FS12/1 will find that they have already undertaken most of the analysis necessary in order to produce an EBA compliant recovery plan. Thankfully, much of the required data will have been generated as part of their Module 2 (Recovery Plans) submissions. However, firms may need to look further afield into Modules 3, 4 and 5 in order to meet certain other requirements of the EBA template, such as those regarding:
- group legal structure diagrams;
- functional mappings;
- intra-group dependencies; and
- information management processes.
In addition, certain other aspects of the EBA template are not specifically addressed under FS12/1. This includes the requirement to produce an “Operational Contingency Plan” explaining in detail how internal operations and access to market infrastructure will be maintained during the implementation of a recovery option.
The practical difficulties presented by the EBA template recovery plan are symptomatic of a wider issue hampering the ability of firms to meet the RRP needs of regulators. This stems from the absence of any kind of real agreement amongst national regulators as to the set of information to be generated by firms in support of their RRPs. Unfortunately, current indications are that any chance of uniformity with respect to RRP data requirements is actually receding yet further, with authorities in jurisdictions such as Canada and Hong Kong largely declining to follow earlier precedents set by regulators such as the FSA. Given the administrative and financial burden associated with RRP production, the challenge to firms in the future will be to find a way to create a flexible enough view of underlying data so as to avoid having to completely reinvent the wheel for each regulator. A technology led solution would seem to be the answer and is long overdue.
List of Banks Subject to the EBA Recommendation on Recovery Plans
Summary of EBA Template Recovery Plan
The EBA template is divided into three main sections, as detailed below.
1. General Overview
This should include at least:
- the key elements presented in each section of the plan;
- the main changes since the last update, if applicable;
- an overview of the steps to be taken before finalisation/update of the plan.
1.2 Description of the group
This section should provide a:
- general overview of the institution’s:
- legal structure (including significant branches);
- business model;
- activities and jurisdictions in which it is active;
- main core business lines; and
- mapping of:
- legal and operational structures i.e.:
- significant legal entities and branches;
- activities conducted;
- business units; and
- employees by business unit;
- legal and financial structures i.e.:
- significant legal entities and branches;
- cash flows;
- liquid assets;
- funding needs;
- large exposures;
- Tier 1 capital;
- legal and operational structures i.e.:
- description of:
- intra-group financial links, including:
- material intra-group exposures;
- material intra-group funding relationships;
- capital mobility; and
- intra-group guarantees;
- critical or systemically relevant group functions, including:
- external functions:
- payment systems;
- services provided to other institutions;
- centralised functions
- collateral management;
- access to market infrastructures;
- external functions:
- intra-group financial links, including:
1.3 Discussion of internal governance
This section addresses internal governance issues regarding the design of the recovery plan, providing a summary of:
- how the plan was developed, including:
- identification of persons responsible for the different sections; and
- discussion of how the plan is integrated into corporate governance and risk management frameworks;
- by whom the plan was approved, including:
- involvement of senior management;
- whether the plan was presented to internal/external auditors;
- whether the plan was presented to the risk committee; and
- confirmation of approval by Board of Directors and/or Supervisory Board;
- the governance of recovery options during a crisis, including:
- a description of escalation processes; and
- the decision making process surrounding plan activation;
- how the plan is to be updated, including:
- responsible individuals;
- frequency of updating; and
- a description of the updating process in response to material changes affecting the institution or its environment.
2. Core of recovery plan
This section requires firms to provide a “menu of recovery options” enabling an institution to respond to financial stress, whether idiosyncratic or systemic, and to assess the feasibility and impact of each option. At a minimum, the information detailed below is to be provided.
2.1 General overview of recovery options
Firms are required to provide a general description of:
- all available recovery options; and
- the actions that would be taken to enable timely execution of each option.
2.2 Recovery indicators
Recovery indicators determine the point at which, in a given situation, an institution starts to consider appropriate recovery options. They are both quantitative and qualitative in nature and tend to relate to the solvency and liquidity of the institution in question under stressed scenarios. However, they do not automatically activate a specific recovery option, instead acting as an early identification of the best way forward. This part of the recovery plan should detail how recovery indicators:
- are incorporated into an institution’s risk management framework;
- align with liquidity or capital contingency plan triggers;
- align with the institution’s risk appetite framework.
2.3 Assumptions and scenarios
The objective of this section is to define a set of stress scenarios (idiosyncratic, systemic and a combination of the two) under which the efficiency of the different recovery options can be assessed by reference to their impact on such factors as:
- profitability; and
2.4 Recovery options
Recovery options are extraordinary in nature and can include:
- external recapitalisation;
- divestment of assets, subsidiaries or business units (or the whole institution);
- voluntary restructuring of liabilities;
- reduction of balance sheet;
- strengthening of liquidity position.
With respect to each recovery option, a firm is required to perform:
- an impact assessment, addressing:
- financial and operational impact; and
- external impact;
- a risk assessment, addressing:
- feasibility i.e. the risk that an option cannot be implemented; and
- systemic consequences i.e. the risks resulting from implementation; and
- a decision making process regarding implementation of recovery options.
2.5 Operational contingency plan
For each recovery option an institution is expected to provide an operational contingency plan detailing the way in which its operations can be maintained following implementation of a recovery option. This includes at least an analysis of:
- internal operations. e.g.:
- IT systems;
- Suppliers; and
- HR operations; and
- access to market infrastructure, e.g.:
- clearing and settlement facilities;
- payment systems; and
- additional requirements in terms of collateral.
2.6 Communication plan
Firms are expected to provide a detailed communication plan regarding both internal and external stakeholders, addressing:
- implementation of the communication plan under each recovery option; and
- the potential impact on the business and on general financial stability.
2.7 Information management
Firms are required to describe general policy with respect to information management together with an analysis of specific information needs in relation to each recovery option. Furthermore, each institution must be able to demonstrate an ability to satisfy not only its own information needs under each recovery option, but also the needs of its regulators. Information required by a regulator would include:
- intra-group exposures;
- trades booked on a back-to-back basis;
- amounts of liquid assets in parent banks and subsidiaries;
- off balance sheet activities; and
- large exposures.
Follow-up measures focus primarily on:
- preparations that can be taken in advance of the implementation of a recovery option; and
- areas for improvement.
On 21 December 2012, the European Banking Authority (EBA) published its response to the EU Commission’s “Consultation on a Possible Recovery and Resolution Framework for Financial Institutions Other Than Banks”.
In general, the EBA believes it important that RRP regimes should be harmonised so as to avoid regulatory arbitrage across borders and between industries such as banking and insurance. Clear guidance should also be provided on the circumstances and extent to which FMIs which also hold banking licences will be subject to bank or non-bank resolution proposals. Ultimately, it may be necessary to extend the non-bank RRP proposals to include ‘shadow banking’ entities such as money market funds and hedge funds.
The EBA agrees that the objectives of a resolution regime for FMIs should be aligned with those of banks, namely the continuation of critical functions and the maintenance of financial stability. Cross-border co-ordination in the form of supervisory Resolution Colleges should also be encouraged.
With respect to resolution tools, the EBA supports the proposal concerning the transfer of critical functions of a failing FMI to a surviving FMI. In order to facilitate such a transfer, the EBA suggests that ex-ante operational arrangements between FMIs should be established and specifically endorses the actions referred to in the FSB “Key Attributes” paper, namely:
- A centralised repository for all FMI membership agreements;
- Standardised documentation for payment services;
- Draft transition services agreement; and
- A ‘purchasers’ pack’ including key information on payment operations and credit exposures, and lists of key staff.
With respect to loss-allocation tools, specifically the haircutting of margin held on behalf of clearing members of a failing FMI, the EBA believes that more consideration should be given to the specific circumstances of the clearing member and their ability to actually absorb losses so as to avoid the possibility of financial contagion. Moreover, any loss-allocation mechanism which goes beyond normal pre-funded loss mutualisation measures (i.e. the guarantee fund) should be closely coordinated with authorities responsible for the supervision and oversight of the clearing members.
On the subject of group resolution of FMIs, the EBA is of the opinion that any recovery and resolution framework should aim to maintain the ‘healthy’ parts of the FMI in question. In order to protect these ‘healthy’ parts, it may be necessary to wind up or even ‘tear up clearing’ of specific instruments. In addition, it may be prudent to allow for one part of an FMI group to provide temporary financial support to an FMI in difficulty, provided that this does not risk contagion or involve lending to an insolvent entity.
On 14 December 2012, the European Banking Authority (“EBA”) published its opinion on the recommendations of the High-level Expert Liikanen Group on reforming the structure of the EU banking sector.
The final report of the Liikanen Group was published on 2 October 2012 and made the following recommendations:
mandatory separation of proprietary trading and other high-risk trading activities to the extent exceeding a threshold;
- possible additional separation of activities conditional on an institution’s resolvability;
- possible amendments to the use of bail-in as a resolution tool;
- review of the capital requirements on trading assets and real estate loans; and
- strengthening banks’ governance and controls.
In general, the EBA considers that the Liikanen proposals strike an appropriate balance between protecting the core features of the universal banking model and strengthening the resilience of the financial sector. However, it believes that an impact assessment is required in order to properly be able to evaluate the potential benefits and cost of the proposals.
Aware that several Member States are considering structural change to national banking industries, the EBA emphasises the need to ensure consistency across the EU so as to protect the operation of the Single Market. To this end, it states that clear criteria must be established in relation to such issues as:
- the situations where separation is mandatory;
- parameters that apply to exceptions such as the provision of “hedging services to non-banking clients”; and
- the provision of financial support between deposit banks and trading entities pursuant to the proposed bank recovery and resolution directive (the “RRD”).
Banks’ compliance with the proposals should also be subject to periodic review and macro-prudential monitoring to avoid structural arbitrage. In addition, any structural changes must be consistent with existing legislation, such as the RRD and the large exposures regulation, but should not be viewed as a substitute for adequate supervision.
The EBA considers that there is a need to further develop the bail-in framework in the RRD in order to improve its legal and operational certainty and so avoid possible destabilising effects. The EBA repeats its preference for a two-tier bail-in regime. Under such a regime, bail-in would initially be applied to a targeted category of debt instruments. This targeted approach would, it is hoped, avoid the risk that a wide ex ante bail-in regime turns out to be of limited value once resolution actually occurs. Only if the targeted approach proved insufficient, would remaining creditors be bailed-in within a proper administrative resolution procedure.
In addition, banks would be required to issue and hold a minimum percentage of their liabilities as “bail-inable” debt. It is anticipated that this would create a market in bail-in debt, encourage the standardisation of contracts and incentivise rating agencies to focus on the rating of bail-in instruments. However, the EBA supports the proposal that such debt should be held outside of the banking system, suggesting that penal risk-weightings could be introduced in order to discourage acquisition of such securities by the banking sector. It also welcomes the suggestion to use bail-in instruments in remuneration schemes for top management and as part of bonus schemes.