RRM – and its impact on the banks’ regulatory duties in the EU
The “Risk Reduction Measures” (RRM) package was approved by the EU Commission on 15.04.2019 and show the regulatory path for the next 3 years for the banks operating within the EU. They will be published beginning of July 2019. The regulations are expected to be transferred into local laws by the end of the year, and applicable latest by 31.12.2020. Some, like FRTB and TLAC (see below) with immediate effect.
Let’s outline the key topics of the package.
- CRR II ( Capital Requirements Regulation): For a start, CRR II finalizes those measures that were already in place when the CRR I entered into force and resulted from Basel III requirements. These essentially include the requirements for limiting the leverage ratio as well as the net stable funding ratio. Both have been in force as reporting obligations in the EU since 2014 and will now be binding minimum ratios.
- Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR):
TLAC (“Total Loss Absorbing Capacity”) describes liability of shareholders and the rules on the subordination of Minimum Requirement for own funds and Eligible Liabilities (MREL) instruments are tightened and a new category of large banks, the so-called “top-tier banks” with a balance sheet size greater than EUR 100bn, is introduced. Basel III is only partially implemented here as the new global standards of Basel III were published shortly after the RRM.
- Market risk: The Fundamental Review of the Trading Book (FRTB) framework as adopted by the BCBS in 2017 has been explicitly excluded from the scope of the banking package. Instead, the co-legislators adopted a reporting requirement, which will be applicable once the elements reviewed at international level are introduced via a number of delegated acts.
- Proportionality: The disclosure requirements become more proportionate for smaller and less complex banks. In addition, small banks will benefit from more simple and conservative prudential standards plus a reduction of reporting efforts, notably for market risk, the NSFR, counterparty credit risk, interest rate risk in the banking book, and remuneration. Please note further comments on SA-CCR under point 8).
- Sustainable finance: The EBA obtained a mandate to investigate on how to incorporate environmental, social, and governance (ESG) risks into the supervisory process and what the prudential treatment of assets associated with environmental or social objectives should look like. ESG-related risks will also need to be publicly disclosed by large institutions.
- Anti-Money Laundering (AML) rules: The cooperation and exchange of information obligations between prudential and AML authorities is reinforced and an explicit AML dimension is added to several key prudential instruments, such as authorization, fit and proper tests and the supervisory review and evaluation process.
- IPU : This is a change in the supervision of groups based in a third country outside the EU. An Intermediate Parent Unit (IPU) will have to be set up in the future, which will form the base for this group’s banking activities in the EU and under which all relevant units will be consolidated. This obligation starts with a combined balance sheet volume of more than EUR 40 billion, which also includes dependent branches within the EU.
- The implementation of the Standardized Approach for Counterparty Credit Risk (SA-CCR) , they are result of the Basel standards BCBS 279, but still, in addition, introducing a simplified version of the SA-CCR for smaller, less complex banks, while also allowing some banks to use the even simpler Original Exposure Method. Also, it introduces a higher quality of capital as the capital base for the calculation of the large exposures limit; exposures to credit derivatives to be calculated using the SA-CCR; and exposures between G-SIBs are reduced to 15 percent.
These are the main points, but what we see in general: the regulations demand a fine net of controls, rules, documentation, analysis woven into a coherent, diligent and transparent data universe. Now the NSFR and Leverage Ratio are binding, a lot of the reported values and returns are more significant, with a direct impact on the balance sheet, and the overall financial situation.
The same binding and significance is valid for the use of standard model and internal model methods. As there are too many details left for that special area to mention here specifically (note: it will be discussed in the next article, coming end soon).
The banks need to concentrate on establishing highest data and risk management standards, when they have to implement all these directives and measures in time; this horizon is set to be 18 to 24 months. Most likely your bank has to be ready by Q1 2021.
The regulatory reporting change projects need to be shaped and initiated right now, if it has not been yet done.
Outlook after RRM
And, dear reader – without a doubt – the next package is on its way, CRR3 and collecting the rest of the Basel 3 plus the full Basel 4 considerations, that are already on the table. This is expected to arrive in 2022.