14 August 2013

EBF response to EBA consultation on the determination of overall exposure in respect of transactions with underlying assets

EBF welcomed EBA's draft RTS based on the CEBS Guidelines and the more recent experience gathered by national supervisory authorities in the application of these Guidelines and other relevant market developments.

If the RTS does not set a granularity threshold for the consideration of underlying assets, the exposure to the unknown client would exceed the 25 per cent limit because of multiple portfolios on which institutions are confident that they are not connected. EBF thinks that 0 per cent granularity for unknown underlying exposures is logically unjustified and will either entail huge additional operating costs and excessive workloads or a large "Single Unknown Client". In finding the right limit for the level of granularity we think it is important to consider what theoretically can happen under the present granularity conditions which are set at 5 per cent and to contrast them to lower levels of granularity thresholds.

Furthermore, it should be noted that there are certain scenarios where the number of unknown clients can logically be reduced as, while the clients as such cannot be identified, they can be differentiated by investment restrictions.

One of EBF's main concerns lies in the non-recognition of credit enhancement to measure the direct exposure on underlying assets. EBA mentions that defaults can happen simultaneously and thus credit enhancement could disappear in a very short timeframe. The assumption behind such a statement is that the purpose of the Large Exposures regime is to set limits on losses that could arise from the joint default of several counterparties or groups of connected clients. This is at odds with the initial Large Exposure regime’s intent “which is to ensure that a bank can absorb losses resulting from the sudden failure of a single counterparty or group of connected counterparties without itself failing”.

Large Exposure reporting is designed to monitor concentration risks on a client or a group of connected clients. The proposed new rules would result in including some transactions with underlying assets which are:

• more exposed to a risk on a sector or a region, and
• by design have a level of underlying granularity that makes it very improbable to be connected to a large exposure. For instance, a structure such as a Residential Mortgage Backed Security (RMBS) stands first for a risk on the real estate sector and by design its level of underlying granularity causes very limited risks connected with large exposures.

As a general comment, EBF expresses its deep concern on this new change in the EU large exposure framework. The CEBS revisited this framework in 2009 and EU banks have spent a lot of money and time to adapt their IT systems and reporting tools to this new environment, which entered into application in December 2010. After less than three years, the EBA is now proposing new rules for the determination of the overall exposure to a client or a group of connected clients with respect to transactions with underlying assets. In parallel, the Basel Committee has started to review its large exposure framework, including new rules for transactions with underlying assets, which differ from the EBA’s proposal. As a result of this fast moving regulatory environment, banks cannot stabilise their risk management procedures and tools and continuously need to dedicate important resources to these new regulations. These resources are very often diverted from other projects which are critical for the improvement of internal risk management.

The draft RTS does not include transitional arrangements:

• The ITS is supposed to come into force on 1 January 2014. However, the rules proposed are complex and institutions will need time to adapt their IT-systems and procedures accordingly. EBF would therefore suggest to introduce adequate phase-in arrangements.
• The CEBS Guidelines of 2009 implied transitional arrangements for transactions bought before 31 January 2010. These transactions are supposed to be treated under the rules valid until 31 December, 2015. For the assurance of confidence we would find it necessary to also include these transitional arrangement in the EBA ITS. Banks can have significant backlogs of transactions that currently benefit from the grandfathering clause. Applying the new rules to all these transactions would be extremely time-consuming and some transitional arrangements are necessary to allow banks to progressively apply the look-through approach to this backlog.

EBF is concerned that according to Article 4 there could be a never ending look through in the case of funds within fund transactions (umbrella funds). The EBF proposes to include a materiality threshold for transactions where no further look through would be required (instead of funds to be considered as a client). A prudent materiality threshold would be 1.25 per cent of eligible capital.

Finally, EBF is concerned that the EBA proposals are materially different from the current Basel consultation on large exposures. Whilst EBF understands the EBA’s rationale that the Basel consultation is at much early stage in order to derive any meaningful direction from the proposals, EBF would caution deviating significantly from the proposals which could potentially lead to inconsistent approaches being applied across different jurisdictions.

Full response

© EBF