The European banking industry fully supports in principle the objective of achieving transparency in this area.
It also agrees with the ESRB that any transparency to be achieved in this area needs (i) to adopt a gradual approach and (ii) to ensure that the level of assets encumbered to central banks, as well as the amount of liquidity assistance given by central banks cannot be detected.
The basic challenge with which the EBA was faced following the ESRB Recommendation was to strike a right balance between the need to achieve transparency (and comparability) whilst maintaining confidentiality on central bank assistance. EBF does not believe that the EBA has been successful in its attempt to reconcile both conflicting objectives considering that it has two basic flaws:
The EBA proposals would make market participants believe that a bank which has pledged all of his assets to its central bank would be in a far better position than a bank that does not at all rely on central bank funding but would instead have engaged in secured funding in private markets. This is clearly unacceptable.
Whilst EBF fully understands the rationale behind the suggestion to use median figures - i.e. to avoid disclosing the risk that sporadic spikes of secured funding are disclosed - the consultation paper fails to explain how banks could possibly manage reconciling median figures with balance sheet figures.
It is crucial, moreover, to highlight that any suspicion that market participants may have concerning a bank’s funding and liquidity position is likely to have a devastating impact. Considering that market participants who wish to enter into transactions have a choice between a broad range of possible counterparties, they will carefully avoid entering into contracts with any counterparty whose reputation concerning its funding position has - rightfully or not – been tainted . Any unfavourable perception that might arise from disclosures that are being imposed will, therefore, be ruthlessly sanctioned by the market: the bank involved will be excluded from market transactions henceforth and, therefore, be obliged to have a recourse to its central bank to secure most of its funding. Cleary, it is absolutely imperative for the asset encumbrance/unencumbrance disclosure framework to avoid creating self-fulfilling prophecies.
As a result, regulators would be well-advised to act in a most diligent way in this regard and avoid venturing into bets on how market participants may possibly react to banks’ disclosures on asset encumbrance/unencumbrance before having gained any experience with possible market reactions. Cleary, this remains unexplored territory. In view of the limited experience in disclosing information on banks’ collateral management and funding practices, we strongly believe that the EBA should restrain from testing the waters by second guessing possible market reactions but rely instead - during a first stage - on those disclosures that market participants have explicitly recognised to be adequate to satisfy their information needs.
This means that the EBA should recognise at this stage of the proceedings that transparency is sufficiently taken care of whenever banks comply with the disclosure requirements imposed by IFRS 7 as supplemented by the FSB sponsored disclosure guidance and best practices recommended by the Enhanced Disclosure Task Force. The Recommendations made by the EDTF align the needs of users with EBA’s reporting requirements and foster a better understanding of the relevancy of the requirements as well as of definitions related to asset encumbrance which in recent years have emerged. The uniformity of the disclosure presentation which the ESRB is looking for is reflected in the example of an asset encumbrance table set forth in the EDTF Report, which the EDTF is in the process of reviewing under the aegis of the FSB. The EDTF Template contributes to implementing the ESRB objective “that the information disclosed to the market is clear, easy to compare and appropriate.”
Adopting such a process would allow the EBA to take stock of experience gained with the way in which market participants have responded to the EDTF disclosure template. Together with additional insight provided by the information which supervisory authorities will have collected on the basis of the Asset Encumbrance Reporting framework in the meantime, this will provide a more solid basis to prepare the next stage of the disclosure framework. We would like to strongly suggest that, during the subsequent process, the industry would also be provided with an opportunity to duly inform the regulatory community on the feedback that their investor relations departments of banks will have received from market participants.
It may be useful adding that, adopting the approach we advocate for, would almost inevitably require the EBA to recognise – at this stage of the proceedings - that the consolidation scope to be applied should not be the prudential scope of consolidation but the IFRS consolidation scope. EBF doe not consider this to be a major flaw. On the contrary even, considering that investors and financial analysts tend to be more familiar with the accounting scope of consolidation. It will, moreover, be much easier for them to understand on that basis the reconciliations to be made with financial statements, which will, therefore, increase transparency even more.
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