European Commission
CRR - Use of IRB approach - European Commission adopts Delegated Regulation containing RTS on competent authorities’ assessment methodology - 21 October 2021
The European Commission has adopted a Delegated Regulation (C(2021) 7470) which contains regulatory technical standards (RTS) for national competent authorities (NCAs) to use in relation to the assessment of an institution’s compliance with the requirements to use the internal ratings based (IRB) approach under the Capital Requirements Regulation ((EU) No 575/2013) (CRR).
Under the CRR, credit institutions are permitted to use the IRB approach for the purposes of calculating their own fund requirements for credit risk, subject to the approval of NCAs. Articles 144(2), 173(3) and 190(3)(b) of the CRR empower the Commission to adopt RTS specifying the methodology that NCAs must follow when assessing compliance with aspects of the IRB requirements. The current RTS are the result of the European Commission’s proposed amendments to the EBA’s initial draft as well as the EBA’s opinion on these proposed amendments, published in December 2020.
The RTS apply when NCAs are considering credit institutions’ applications:
- initially to use the IRB Approach;
- to extend the IRB Approach;
- to use the IRB Approach for certain types of exposures in accordance with the sequential implementation plan;
- to carry out material changes to the IRB Approach; and
- to return to the use of less sophisticated approaches for calculating credit risk.
The Council of the European Union and the European Parliament will now scrutinise the Delegated Regulation. If approved, the Delegated Regulation will enter into force 20 days after its publication in the Official Journal of the European Union.
Commission Delegated Regulation (EU) …/... supplementing Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to regulatory technical standards for the specification of the assessment methodology competent authorities are to follow when assessing the compliance of credit institutions and investment firms with the requirements to use the Internal Ratings Based Approach (C(2021) 7470)
Webpage
European Parliament
Non-performing loan management - European Parliament adopts text of proposed Directive - 20 October 2021
The European Parliament has adopted the proposed Directive on credit purchasers and servicers (2018/0063A(COD)). The Directive is intended to establish an EU-wide framework to enable credit institutions which issue non-performing loans (NPLs) to outsource the servicing of those loans to specialist credit servicers or to transfer them to credit purchasers that have the necessary risk appetite and expertise to manage them.
The Directive sets out common EU standards to facilitate, and regulate, the transfer of NPLs from credit institutions to credit purchasers by removing impediments to, and laying down safeguards for, such transfers while, at the same time, safeguarding borrowers’ rights. It also sets out provisions for the authorisation and supervision of credit servicers by NCAs.
Political agreement on the Directive was reached in June 2021. The next step is for the Council to adopt the proposed Directive. If adopted, the Directive will enter into force on the 20th day following its publication in the Official Journal of the European Union.
European Parliament legislative resolution of 19 October 2021 on the proposal for a directive of the European Parliament and of the Council on credit servicers, credit purchasers and the recovery of collateral (P9_TA(2021)0424) (COM(2018)0135 – C8-0115/2018 – 2018/0063A(COD))
European Banking Authority
Benchmark rate transition risks - EBA publishes thematic note - 14 October 2021
The European Banking Authority (EBA) has published a thematic note which provides analysis of EU and EEA banking sector exposures linked to benchmark rates and transition risks relating to interbank offered rates. Key points include:
- benchmark rates play a major role in banks' daily business, including in valuation and risk management. Transitioning away from ceasing benchmark rates to new risk-free reference rates (RFRs) poses a potential key risk for financial markets in general and for banks in particular. There are also links to prudential requirements and accounting, as benchmark rate transitions may affect banks' internal market risk models, prudent valuations and the eligibility assessment of capital instruments;
- LIBOR and EONIA are very close to being phased out at the end of 2021. However, while the largest share of benchmark-referenced assets and liabilities of EEA banks are linked to EURIBOR and national benchmark rates, significant exposures remain to LIBOR and EONIA rates. USD LIBOR-linked derivatives’ exposures are particularly high – data as part of an ad-hoc survey indicated that EU banks have exposures of almost EUR57 trillion in LIBOR and EONIA-linked derivatives;
- banks and NCAs are considering, as a key area of concern, legal challenges accompanying the transition of existing business on the assets side, as well as changes in banks' internal operations and systems; and
- despite the major challenges, NCAs generally agree that the ongoing work and general awareness of the banks under their supervision should adequately address and mitigate risks relating to benchmark rate reforms. However, they also identify challenges relating to the renegotiation of existing contracts, on the basis that litigation and conduct risks do not always dissipate even if transitions are well-managed.
Thematic note: Benchmark rate transition risks - analysis of the EU/EEA banking sector’s exposures linked to benchmark rates and transition risks relating to interbank offered rates (EBA/REP/2021/30)
Press release
European Central Bank
Economy-wide climate stress test - ECB publishes letter to CEOs of significant institutions - 18 October 2021
The European Central Bank (ECB) has published a letter sent to chief executive officers (CEOs) of significant institutions setting out information on participation in the ECB’s 2022 climate risk stress test (2022 CST). The 2022 CST is for banks in the Single Supervisory Mechanism that the ECB supervises and aims to identify vulnerabilities, industry best practices and the challenges faced by banks.
The 2022 CST will comprise several phases, including data collection, quality assurance and the computation of results. It will include three modules:
- module 1: an overarching questionnaire to assess how banks are building their climate stress test capabilities for use as a risk management tool;
- module 2: a peer benchmark analysis to compare banks across a common set of climate risk metrics; and
- module 3: a bottom-up stress test targeting transition and physical risks.
The letter also contains a link to the methodology for the 2022 CST which explains how institutions should conduct the exercise.
The stress test will take place between March – July 2022 and scenarios used in it will be based on the ECB’s 2021 CST, which was the first climate risk stress test to be carried out and the results of which were published in September 2021.
The output of the 2022 CST will be integrated into the Supervisory Review and Evaluation Process (SREP) using a qualitative approach. The ECB will conduct the 2022 CST alongside other ECB supervisory initiatives and environmental risk in 2022, including a thematic review of bank’s climate-related and environmental risk management practices, the results of which will be included in the SREP.
Letter to banks: Information on participation in the 2022 ECB Climate Risk Stress Test
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Banking supervision - ESG-related requirements - ECB publishes speech - 20 October 2021
The European Central Bank (ECB) has published a speech, given by ECB Executive Board Member and Supervisory Board Vice-Chair, Frank Elderson, which covers three main areas:
1. Banks’ progress in meeting ECB supervisory expectations
The ECB has been taking steps to increase understanding of the impact of the climate crisis from a financial risk perspective and ensure that banks have a comprehensive, strategic and forward-looking approach to disclosing and managing all climate-related and environmental (C&E) risks. The ECB's review of banks’ self-assessment as to their progress in meeting the ECB’s supervisory expectations shows that, while banks have started reflecting C&E risks in their current structures and some have taken steps such as measuring and disclosing the carbon emissions linked to their loan books, the banks themselves deem 90% of their practices to be only partially or not at all compliant with the ECB’s supervisory expectations. The ECB’s review of banks’ C&E disclosure and risk management practices suggests that, as things stand, European banks may be largely misaligned with the economic transition path towards carbon neutrality by 2050.
2. Mandatory requirement for transition plans
Given these findings, the legislative initiatives currently under way and the industry’s own acknowledgement of the importance of moving to transition-robust business models, Mr Elderson proposes that there should be a mandatory requirement on banks to develop transition plans compatible with EU policies implementing the Paris Agreement. The transition plans should include concrete intermediate milestones from now until 2050 and the associated key performance indicators. Banks should also be required to disclose progress towards these goals on an annual basis so that banks’ management and national competent authorities (NCAs) can understand the risks arising from a possible misalignment with the transition path. If banks fail to meet these milestones, NCAs will be expected to take appropriate measures to ensure that this failure does not result in financial risks.
3. ECB’s climate strategy – next steps
The ECB will continue to roll out other elements of its climate strategy, including:
- conducting a supervisory stress test with a focus on C&E risks;
- carrying out a full supervisory review of banks’ practices in relation to the incorporation of C&E risks into their risk frameworks; and
- gradually rolling out a dedicated Supervisory Review and Evaluation Process (SREP) methodology that will eventually influence banks’ minimum capital requirements.
Speech by Frank Elderson: Overcoming the tragedy of the horizon: requiring banks to translate 2050 targets into milestones
HM Treasury
Buy now pay later products - HM Treasury publishes Consultation Paper - 21 October 2021
HM Treasury has published a Consultation Paper on the regulation of interest-free buy now pay later (BNPL) products. The Consultation Paper calls for feedback on the scope and form of the regulatory proposals, which are designed to address the risks highlighted in the Woolard Review. As previously reported in this Bulletin, the Woolard Review, a review of change and innovation in the unsecured credit market, included the recommendation that all BNPL should be regulated by the FCA to prevent risks of potential consumer harm from crystallising.
The regulatory changes proposed include topics such as:
- changes to the way BNPL products should be advertised;
- requiring BNPL firms to communicate with the customer more clearly that they are entering into a credit agreement and the associated features and risks;
- requiring BNPL firms to take more steps to protect borrowers in financial difficulty, including the potential application of provisions in the Consumer Credit Act 1974 (CCA);
- bringing BNPL firms and products within the ambit of the Financial Ombudsman Service (FOS);
- requiring creditworthiness assessments for BNPL products in line with current FCA rules; and
- bringing BNPL firms within the scope of the statutory buyer protection scheme under section 75 of the CCA.
The consultation paper notes the importance of such regulatory changes being proportionate to ensure that consumers are given appropriate protections without unduly limiting the availability and cost of useful financial products.
The consultation closes on 6 January 2022.
HM Treasury consultation paper: ‘Regulation of Buy-Now Pay-Later’
Webpage
Prudential Regulation Authority
Non-performing exposures - PRA publishes Policy Statement - 21 October 2021
The PRA has published a Policy Statement (PS 24/21) entitled ‘Implementation of Basel standards: Non-performing loan securitisations’. The Policy Statement discusses responses to the PRA’s earlier Consultation Paper (CP 10/21) on the draft rules for calculation capital requirements on exposures to Non-Performing Exposure (NPE) securitisations and sets out the PRA’s final policy.
The Policy Statement indicates that one change has been made to the draft rules as published in Consultation Paper, namely that the definition of ‘NPE securitisation’ has been amended to add “any other relevant reason”. The new definition will read: “securitisation backed by a pool of non-performing exposures the nominal value of which makes up not less than 90% of the entire pool’s nominal value at the time of origination and at any later time where assets are added to or removed from the underlying pool due to replenishment or restructuring or any other relevant reason.” Minor changes have also been made to Supervisory Statement ‘Securitisation: General requirements and capital framework’ (SS10/18) to reflect Brexit and improve clarity.
The PRA states PS 24/21 is relevant to UK banks, building societies, PRA-designated investment firms, and UK financial holding companies (FHCs) and UK mixed financial holding companies (MFHCs) of certain PRA-authorised firms.
The final rules are contained in a new NPE Part to the PRA Handbook (Appendix 1 of the Policy Statement) and an updated version of SS10/18 (Appendix 2). The changes will take effect from 1 January 2022.
PRA Policy Statement: ‘Implementation of Basel standards: Non-performing loan securitisations’ (PS 24/21)
Webpage
New NPE Part to the PRA Handbook: CRR Firms: Non-Performing Exposures Securitisation (CRR 2 Modifications) Instrument 2021
Updated PRA Supervisory Statement: ‘Securitisation: General requirements and capital framework’ (SS 10/18)
Credit unions - PRA updates webpage and publishes letters on annual assessment - 18 October 2021
The PRA has updated a webpage with information on the letters sent to directors of credit unions, setting out the findings of its 2021 annual assessment of these firms.
Category 5 firms are those firms that the PRA has assessed as having no capacity individually to cause disruption to the UK financial system by failing or by carrying on their business in an unsafe manner. It further sub-divides these firms into two peer groups: (i) category 5 credit unions with total assets above £15 million or with more than 10,000 members; and (ii) category 5 credit unions with total assets of less than £15 million and fewer than 10,000 members (small).
The PRA has sent a tailored letter to each group which:
- emphasise the need for all credit unions to co-operate with the PRA in the event that their prudential position deteriorates, whether as a result of COVID-19 or otherwise;
- set out frequent issues with credit unions’ Single Customer View (SCV) files and remind all credit unions to routinely check their SCV;
- recommend that credit unions with total assets above £15 million and with more than 10,000 members undertake proportionate scenario testing to enable them to manage and control the incidences of loan delinquency, impairment and arrears; and
- remind credit unions with total assets of less than £15 million and/or less than 10,000 members of the PRA rule modification by consent, which reduces the minimum provisioning requirement for bad debt in accordance with the PRA’s directions.
Webpage
PRA letter to directors of credit unions which are part of a group with total assets below £15 million and fewer than 10,000 members
PRA letter to directors of credit unions which are part of a group with total assets above £15 million and/or with more than 10,000 members
Credit risk - PRA publishes final policy on identifying economic downturns for IRB models (PS23/21) - 20 October 2021
The PRA has published a Policy Statement which sets out its final policy on credit risk and the identification of the nature, severity and duration of an economic downturn for the purposes of internal ratings based (IRB) models (PS23/21). The Policy Statement follows the PRA’s Consultation Paper CP7/21, published in April 2021, and includes its feedback to the consultation responses received.
Under Articles 171(1)(b) and 182(1)(b) of the UK Capital Requirements Regulation (575/2013/EU), as amended by the Capital Requirements (Amendment) (EU Exit) Regulations 2018 (SI 2018/1401) (together, the UK CRR), firms are required to use loss given default (LGD) and conversion factor (CF) estimates that are appropriate for an economic downturn if those are more conservative than the respective long-run average. The European Banking Authority (EBA) has produced draft regulatory technical standards (RTS) specifying the economic downturn conditions according to which firms must estimate the downturn LGDs and CFs.
The Policy Statement confirms PRA’s final policy as follows:
- a new UK Technical Standard Instrument (UKTSI) which introduces requirements for identifying economic downturn to ensure that downturn estimates of LGDs and exposures at default reflect consistent and sufficiently severe downturn scenarios, and that the selected downturn period is long enough to capture the economic impact of a particular downturn event (Appendix 1);
- an updated Supervisory Statement ‘Internal ratings based (IRB) approaches’ (SS11/13) which makes minor amendments to the Statement to reflect the new Technical Standard and the end of the Brexit transition period; and
- versions of the relevant EBA guidelines as they stood at the end of the transition period (Appendices 3-5).
In light of the consultation responses received, the PRA has amended the UKTSI set out in CP7/21 to clarify that:
- in respect of the indicators specified in the UKTSI, firms must use levels, absolute changes in levels, or percentage changes of levels of economic indicators, depending on which gives the best indicator of economic conditions; but
- firms may additionally use other measures of those, or any other relevant indicators, where these are also explanatory variables for the economic cycle.
The Policy Statement is relevant to UK banks, building societies and PRA-designated UK investment firms. The policy changes will be implemented on 1 January 2022.
Policy Statement: Credit Risk: The identification of the nature, severity and duration of an economic downturn for the purposes of IRB models (PS23/21)
Annex 1: PRA Standards Instrument: Technical Standards (Economic Downturn) Instrument 2021
Annex 2: Supervisory Statement: Internal Ratings Based approaches (SS11/13)
Annex 3: Guidelines for the estimation of LGD appropriate for an economic downturn (‘Downturn LGD estimation’)
Annex 4: Guidelines on the application of the definition of default under Article 178 of Regulation (EU) No 575/2013
Annex 5: Guidelines on PD estimation, LGD estimation and the treatment of defaulted exposures
Updated webpage
Financial Conduct Authority
LIBOR transition - FCA publishes new webpage on UK BMR - 15 October 2021
The FCA has published a new webpage containing questions and answers (Q&As) on its new powers under the onshored Benchmarks Regulation ((EU) 2016/1011) (UK BMR). The Financial Services Act 2021 amended UK BMR to provide the FCA with enhanced powers to organise an orderly wind-down of LIBOR and other benchmarks. The Q&As have been prepared to help manage that wind-down and cover several topics, including:
- the impact of wind-down on contractual provisions;
- the use of synthetic LIBOR after the end of 2021; and
- how to implement the synthetic LIBOR solution.
FCA webpage: LIBOR and the FCA’s new powers under the UK BMR: questions and answers
Payment Systems Regulator
APP Scams - Confirmation of Payee - PSR publishes Response Paper - 21 October 2021
The Payment Systems Regulator (PSR) has published a Response Paper (RP21/1) following its Consultation Paper (CP21/6) which was published in May 2021 on the second phase of delivering Confirmation of Payee (CoP). As previously reported in this Bulletin, CoP is a name-checking service designed to prevent Authorised Push Payment (APP) scams and misdirected payments, and is already offered by the UK’s six largest banking groups.
The Response Paper concludes that Phase 1 of delivering CoP has had a positive impact in reducing APP scams and mitigating risk. The PSR also summarises its findings from the call for views and concludes that further work is needed to ensure a greater number of institutions use CoP so that more consumers are protected. With this in mind, the Paper sets out the PSR’s next steps in relation to the implementation of CoP, which include:
- monitoring the progress of Phase 1 participants who will enter Phase 2 by the end of 2021;
- beginning a consultation in December 2021 on terminating the dual running of Phase 1 and 2 and revoking Specific Direction 10 by March 2022; and
- issue a further consultation in March 2022 (if appropriate) to direct non-participant Payment System Providers (PSPs) to offer CoP and/or secure the delivery of the secondary reference data (SRD) capability.
PSR Response Paper: Confirmation of Payee (RP21/1)
Webpage
United Nations Environment Programme Finance Initiative
Responsible Banking Principles - UNEP FI publishes report on PRB implementation - 15 October 2021
The United Nations Environment Programme Finance Initiative (UNEP FI) has published its report on progress made by the banks that have signed up to the Principles for Responsible Banking (PRBs), launched in September 2019, on their implementation of the Principles. 250 banks representing over 40% of banking assets worldwide have so far signed up to them.
The report assesses progress in three key areas: (i) the banks’ current impact on people and planet; (ii) their follow-on prioritisation and setting of targets in the areas where their businesses have the most significant impact; and (iii) the achievement of public reporting on their progress within 18 months of signing up to the PRBs, and, by year four, achieving third party verification of that reporting. The banks must implement all steps within their first four years of signing up to the PRBs and the report captures their progress as at March 2021. The report is intended to set the first baseline to measure future progress beyond that point.
Key findings from the report show that, while progress differs widely, current implementation has already shown early signs of collective progress, including 94% of banks identifying sustainability as a strategic priority for their organisation, 93% analysing the environmental and social impacts of their activities, and 30% setting targets with a strong focus on climate and financial inclusion. The report finds early indications of impact on the real economy, with banks’ mobilising USD2.3 trillion of sustainable finance so far.
That said, the report indicates that continued and accelerated action is needed from the banks, including enhancing the availability and quality of data, setting targets in line with improved impact analysis and increasing action on critical sustainability issues such as equality, biodiversity loss and human rights.
Insights from the report will be used by the UNEP FI to further develop the work programme to support banks in scaling up their progress and addressing these key challenges. The next progress report is scheduled for 2023.
UNEPFI: Responsible Banking: Building Foundations: The first collective progress report of the UN Principles for Responsible Banking signatories
Executive summary
Press release
Webpage
See the General section for an item on the Climate Financial Risk Forum’s second set of guides on climate-related financial risk management.
