Risk And Regulation Monthly – December 2013

There was a flurry of activity in December for supervisors and legislators, as they looked to honour their 2013 commitments before year-end, with a compromise reached on the Recovery and Resolution Directive and the Deposit Guarantee Scheme Directive in the EU, while in the UK the Banking Reform Bill received Royal Assent and the PRA published its final rules on CRD IV and recovery and resolution planning.

As usual this note is produced for information only on a best efforts basis, and does not constitute advice of any kind.

Capital (including stress testing)

The Prudential Regulation Authority (PRA) published its final rules on implementing the revised Capital Requirements Directive (CRD IV). The publication was a follow-up to a November statement, where the PRA outlined the major changes, such as transitional provisions, and quality of capital for Pillar 2A. The December Policy Statement, which did not differ from the consultation significantly, offered further detail on these issues and on Individual Liquidity Guidance. Importantly, the PRA committed to a number of follow-up activities in 2014, including issuing rules on capital buffers, addressing the remuneration recommendations of the Parliamentary Commission on Banking Standards, and considering its approach to the Liquidity Coverage Ratio given expected EU legislation.

Alongside the final CRD IV rules, the PRA published 14 supervisory statements on areas including stress testing; credit, counterparty credit, market, and operational risk; and large exposures.

In parallel to the PRA publication, the Financial Conduct Authority (FCA) issued its final rules on how CRD IV will be applied to the investment firms under its prudential supervision. In addition to transitional provisions on capital, the FCA paper included a helpful prudential classification of UK investment fund managers. Like the PRA, the FCA will not be issuing rules on capital buffers before HM Treasury (HMT) has made the relevant legal provisions, expected in Q1 2014.

Meanwhile HMT issued its guidance on country-by-country reporting under CRD IV. This sought to explain, in 'layperson's language', the interim and ongoing reporting obligations, the interpretation of key terms and the disclosure provisions.

The Basel Committee on Banking Supervision (BCBS) issued a second consultation paper on revisions to its securitisation framework. Changes were made to the hierarchy of approaches, such that internal ratings-based approaches are permitted for banks with the capacity and supervisory approval to use such an approach, with external ratings then allowed for particular securitisation exposures and the standardised approach to be applied if neither of these approaches is possible. The BCBS also amended its calibration of capital requirements as a result of revisions to some of its modelling assumptions, and proposed a 15% risk-weight floor, rather than the original 20% proposal. The BCBS said its revised approach reflected a desire to balance risk-sensitivity, simplicity and comparability. A further quantitative impact study will also be undertaken.

The BCBS published 'phase two' of its work on the consistency of risk-weighted assets (RWAs) for market risk in the trading book. The initial work was extended to a "more representative and complex" set of trading positions across all major asset classes. The BCBS said the results "broadly confirm" its original finding that the outputs of internal models for market risk vary significantly across banks, and that in addition, variability "typically increases for more complex trading positions". Mooted policy options included improvements to Pillar 3 disclosures, narrower ranges of modelling choices for banks, and further harmonisation of supervisory practices.

The European Banking Authority (EBA) published a series of reports on the comparability of RWAs, including a report on RWAs for market risk, its third interim report on the consistency of RWAs for SME and residential mortgages, and a report focusing on the comparability of supervisory rules and practices in relation to RWAs.

The BCBS finalised its standard on the prudential treatment of banks' investments in the equity of funds. The new framework applies to all banks, irrespective of whether they use the standardised approach or internal models, and will become effective as of January 2017. Among other changes, the new framework sets a 1,250% risk weight for investments for which there is insufficient transparency about the fund's investment activities. The framework creates a hierarchy of approaches for setting capital requirements, with varying degrees of risk-sensitivity depending on the amount of information banks are able to gather about the funds in question.

The EBA published numerous technical standards and guidance, some of which are still consultative, including part three of its standards on own funds; guidance on the treatment of foreign exchange lending to unhedged borrowers; technical standards on the identification of the geographical location of credit exposures; advice on the treatment of unrealised gains; standards on securitisation retention rules; standards on information exchange between home and host supervisors; standards on market risk and CVA risk; standards on joint decisions between home and host supervisors on prudential requirements for individual firms; draft guidelines on significant credit risk transfer for securitisation transactions; on the minimum amount of professional indemnity insurance for mortgage credit intermediaries; and standards on conditions for assessing extensions and changes to internal approaches for credit and operational risk.

The EBA consulted on a methodology for identifying global systemically important institutions as part of CRD IV. The paper set out disclosure requirements for the criteria for these firms, and for other institutions with "exposures" (ie total size) above200bn. The identification methodology and data requests are based on the...