On 11 October 2019, the European Commission launched a public consultation on the implementation in the European Union of the December 2017 Basel Committee on Banking Supervision (BCBS) standard (Basel III: Finalising post-crisis reforms). The consultation document addresses the key elements of the BCBS standard, including revisions to the Basel III standards on credit risk, and operational risk, the introduction of minimum haircut floors for non-centrally cleared securities financing transactions (SFTs), amendments to the credit valuation adjustment (CVA) risk framework and the introduction of a new output floor (please see a more detailed overview below). In addition to these “core” elements of the Basel III reform the European Commission has identified additional issues on which it seeks stakeholder views in the ongoing consultation, and including:

  • Possible centralisation of Pillar 3 disclosures at the level of the European Banking Authority (EBA);
  • Consideration whether further measures, if any, could be taken to incorporate environmental, social and governance (ESG) risks into prudential regulation “without pre-empting ongoing work to this effect”; and
  • Possible changes to the existing regime for the assessment of the suitability of members of the management body of financial institutions (“fit and proper” regime).

The consultation document includes 212 questions, grouped into nine main sections. These address the following key issues (non-exhaustive):

Credit risk (Qs 1 – 111)

The Commission seeks stakeholder views on, among others, some of the key elements of the revised standardised approach to credit risk (SA-CR). This includes consideration of relative costs and benefits of the external credit risk assessment approach (ECRA) and the standardised credit risk assessment approach (SCRA), and in particular how the two regimes compare in terms of risk-sensitivity, impact on risk-weighted assets (RWAs) and operational burden. The Commission also asks for industry input on costs and benefits of the implementation of the enhanced due diligence requirements to be performed by institutions. In relation to SCRA specifically, the Commission seeks views on the costs and benefits of implementing the definition of grades under SCRA and whether the quantitative and qualitative criteria for the classification of counterparties into grades are sufficiently clear. In respect of exposures to corporates, the Commission focuses on the treatment of exposures to unrated corporates and, among others, questions whether the definition of “investment grade” corporate requires further adjustments for the purpose of implementation in Union law. Finally, in relation to specialised lending (including project finance, object finance and commodities finance), views are sought on the costs and benefits of implementing the specific treatment thereof, and whether any further adjustments to the specialised lending regime are required for the purpose of its implementation in the EU. Last but not least, the Commission seeks input on the new credit conversion factors (CCFs) within the off-balance sheet (OBS) framework.

Securities Financing Transactions (SFTs) (Qs 112 – 122)

The Commission seeks stakeholder views on how they assess the potential effectiveness of the BCBS-prescribed minimum haircut floors for SFTs, and whether further clarifications in respect of scope of the haircuts application or the formulas that identify in-scope SFTs non-compliant with the haircut floor, would be required for the purpose of application in Union law. The Commission also considers an alternative approach to implementing minimum haircut floors for in-scope SFTs, i.e. implementation via market – as opposed to prudential – regulation. In respect of other revisions to the calculation of the exposure at default for SFTs, the Commission seeks views, among others, on the expected effects of these revisions with regard to risk-sensitivity, recognition of netting, impact on RWAs and comparability across institutions.

Operational risk (Qs 123 – 145)

In respect of operational risk, the Commission seeks views on, among others, how exercising the discretion to set Internal Loss Multiplier (ILM) equal to 1, would affect the link between the capital incentives and management of operational risks, and whether it would be necessary to mitigate possible cliff-effects that might derive from the introduction of an institution-specific ILM. Views are also sought on the discretion to increase the loss data threshold to EUR 100,000, the discretion to use the ILM for bucket 1 institutions, the discretion to request institutions to use less than five years when the ILM is greater than 1, the exclusion of certain operational risk loss events and other operational risk topics (including governance and organisational requirements thereof).

Market risk (Qs 146 – 158)

In respect of the market risk issues, the Commission seeks views on, among others, converting the reporting requirement currently existing in EU law (the “FRTB framework”) into an own fund requirement, and on an introduction of the simplified standardised approach. Other issues on which views are sought include the treatment of investments in collective investment undertakings (CIUS), date of application of new own fund requirements for market risk and implementation challenges and administrative burden.

CVA risk (Qs 159 – 176)

In relation to the revised CVA framework, the Commission seeks views on the costs and benefits of implementing thereof in the EU and in particular, how the approaches provided by the final Basel III standards compare with the current approach of the Capital Requirements Regulation (CRR) in terms of impacts on RWAs and operational burden. Notably, the Commission notes that while the final Basel III standards do not exempt any particular transaction from the calculation of the capital requirement for CVA risk, the CRR provides a number of exemptions from the CVA framework that mostly cover derivative transactions with counterparties that were exempted from the clearing/margining requirements under the European Market Infrastructure Regulation (EMIR). Noting that the CVA risk of the exempted counterparties under the CRR may still be a source of significant risk for some of the institutions that benefit from those exemptions, the Commission seeks views on how institutions currently manage the CVA risks arising from the counterparties exempted and what would be the potential impact of removing the existing exemptions. In addition, the Commission calls for industry input on the issues relating to proportionality in the CVA framework, internal CVA under the SA-CVA, fair-value SFTs under the CVA framework and implementation challenges and administrative burden.

Output floor (Qs 177 – 187)

The Commission seeks stakeholder views on the material scope of the new output floor application, and in particular on the costs and benefits of including in the calculation of the output floor more own funds requirements than those explicitly mentioned in the Basel III standards. Also, the Commission considers whether further adjustments would be necessary in respect of the material scope of the output floor implementation, and if so, what would be their prudential rationale. Finally, the Commission seeks views on the relative costs and benefits of applying the output floor at all levels of the banking group or solely at the highest level of consolidation in the EU, and on the application of the BCBS-prescribed five-year transitional measures for the purpose of implementation of the new output floor requirements in the EU.

Centralised supervisory reporting and disclosures (Qs 188 – 190)

In respect of the centralised supervisory reporting and Pillar 3 disclosures, the Commission notes that under a current framework, institutions need to process the same data according to two separate schemes (one for supervisory reporting and one for disclosures). It also notes that currently the EBA works to create the European Centralised Infrastructure for Supervisory Data (EUCLID), expected to become operational at the end of 2020. In this context, the Commission seeks views whether obligation to centrally disclose the information obtained from all institutions established in the EU, should be transferred to the EBA.

Sustainable finance (Q 191)

The Commission notes three actions that have been identified by the co-legislators in the course of the recent legislative review of amendments to CRR and CRD IV, and which included – (1) a mandate for the EBA to assess the inclusion of the ESG risks in the supervisory review and evaluation process (SREP), (2) a requirement for large, listed institutions to disclose ESG risks, including physical and transition risks, and (3) a mandate for the EBA to assess on the basis of available data and the findings of the Commission High-Level Expert Group on Sustainable Finance, whether a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental and/or social objectives would be justified. In this context, the Commission notes what – if any – further measures could be taken to incorporate ESG risks into prudential regulation, without pre-empting the ongoing work stemming from earlier mandates.

Fit and proper (Qs 192 – 212)

The last part of the Commission’s consultation document addresses issues relating to the “fit and proper” regime for key function holders. The Commission notes that CRD IV does not provide for an assessment by competent authorities of the suitability of individuals other than members of the management body and holding positions of responsibility. The Commission therefore considers potential expansion of the competent authorities’ role in fit and proper assessment to include assessment of some key function holders. Views are sought, among others, on what would be the benefits and drawbacks of such expansion, whether it would be useful to identify key function holders in a descriptive manner and/or to specify certain roles as belonging to the set of key function holders. In addition, the Commission seeks views on the competent authorities’ assessment of the suitability of members of the management body, including supervisory procedure, proportionality, roles of the management body, individual and collective suitability, as well as cultural factors influencing conduct.

In terms of next steps, the Commission will hold a public conference on 12 November 2019 to discuss the impact and challenges of implementing the final Basel III reforms in the EU. The deadline to submit comments to the ongoing consultation is 03 January 2020. Legislative proposals introducing the final Basel III standard in Union law, in the form of amendments to CRR and CRD IV legislation, are expected to be published by the Commission in mid-2020.