8 Financial services
| (30802) 12093/09 + ADDs 1-2 COM(09) 362
| Draft Directive amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for resecuritisations, and the supervisory review of remuneration policies
|
| Legal base | Article 47(2); co-decision; QMV
|
| Document originated | 13 July 2009
|
| Deposited in Parliament | 16 July 2009
|
| Department | HM Treasury |
| Basis of consideration | EM of 24 July 2009
|
| Previous Committee Report | None
|
| To be discussed in Council | Not known
|
| Committee's assessment | Politically important
|
| Committee's decision | Not cleared; further information requested
|
Background
8.1 In June 2006 Directives 2006/48/EC and 2006/49/EC, known together
as the Capital Requirements Directive, were adopted, to be implemented
from 1 January 2008.[25]
The Capital Requirements Directive introduced a new framework
for the prudential supervision of the capital held by banks and
other financial services firms in the Community, which reflected
new standards agreed internationally in the Basel Committee on
Banking Supervision[26]
in 2004.
8.2 In October 2008 the Commission proposed amending
the Capital Requirements Directive in several areas — large
exposures, definition of capital, supervisory arrangements and
securitisations — those amendments were agreed earlier this
year and will come into force on 31 December 2010.[27]
The Document
8.3 With this draft Directive the Commission now
proposes further amendments to the Capital Requirements Directive
in light of the current financial crisis. The overarching aim
of the proposal is to strengthen prudential requirements for trading
risks, align remuneration practices with effective risk management
and improve due diligence and disclosure requirements for re-securitisations.
8.4 For calculation of regulatory capital requirements
firms classify their assets as either banking book (typically
containing medium- and long-term assets) or trading book (consisting
of positions in financial instruments or commodities, held with
the intention of trading). The Capital Requirements Directive
allows a firm to use either standard rules or an internal modelling
approach (subject to strict supervisory criteria and prior approval)
to calculate the capital it is required to hold against its trading
book. However, throughout the current crisis many firms' models
have not coped well with the unusual market conditions —
assumptions around liquidity (the ability to sell assets), volatility
(the rate of change of prices in those assets) and correlation
(the degree to which prices of different assets move in tandem)
have proved to be misleading. Consequently, it is widely agreed
that a significant increase in the level of capital held against
assets in the trading book is required. The Commission proposes
several technical amendments aimed at increasing capital requirements:
- adding an additional capital
buffer, based on using stressed market conditions as an input
to firms' internal models. This is expected to roughly double
current trading book capital requirements;
- extending the requirement for firms to calculate
the additional risk, to the extent it is not captured by their
models, that the issuer of debt held in the trading book defaults,
to capture losses short of issuer default (for example rating
downgrades). This is to address the fact that most recent losses
on traded debt did not involve issuers actually defaulting. The
impact of this change will depend on the composition of banks'
portfolios in the post-crisis environment but is likely to lead
to an increase; and
- requiring firms to make a separate calculation,
based on the existing simple risk weights applied to securitisations
in the banking book, for securitisation positions held in the
trading book. The impact of this change will depend on the composition
of banks' portfolios in the post-crisis environment, but in general
is likely to lead to an increase.
8.5 In a securitisation, a firm packages together
a group of assets (for example a portfolio of loans) and creates
securities to sell to investors. The performance of these securities
depends on the performance of the underlying asset pool. The newly
created securities can be structured to have different risk and
reward characteristics to suit different investors. Re-securitisations
are similar but the underlying assets are themselves securitisations.
They have generally been considered low credit risk by rating
agencies and market participants due to the benefits of diversification.
However, re-securitisations are by their nature more complex than
straight securitisations and the assumptions on the benefits of
diversification in the underlying assets have proved to be overly
optimistic.
8.6 Therefore, the draft Directive has a set of capital
requirements that are higher than for straight securitisation
positions of the same rating. It provides for:
- a strengthened supervisory
process for re-securitisations that are particularly complex;
- compliance with the applicable due diligence
standards to be checked on an investment-by-investment basis by
a bank's supervisory authority;
- the Committee of European Bank Supervisors, a
Lamfalussy Level 3 committee, to converge supervisory practice
by agreeing which types of re-securitisations are "highly
complex"; and
- in exceptional cases, where a bank cannot demonstrate
to its regulator that it has complied with the required due diligence,
a risk weight of 1250% to be applied to the position in that re-securitisation,
that is £1 of capital to be held for every £1 invested
in the re-securitisation significantly in excess of typical capital
requirements).
Additionally the draft Directive enhances disclosure
requirements, in line with internationally agreed standards, in
several areas, such as securitisation exposures in the trading
book.
8.7 On remuneration practices the draft Directive
aims to prevent rewarding excessive short-term risk taking, which
subsequently proves to be detrimental to a firm's longer-term
interests. It will:
- impose a binding obligation
on credit institutions and investment firms to have remuneration
policies and practices that are consistent with, and promote,
sound and effective risk management;
- bring remuneration policies within the scope
of the supervisory review, so that supervisors would be able to
require the firm to take measures to rectify any problems that
they might identify; and
- require supervisors to be given the power to
impose financial or non-financial penalties (including fines)
against firms that fail to comply with the obligation.
The Government's view
8.8 The Financial Services Secretary to the Treasury
(Lord Myners) first comments that the policy objective behind
the Banking Consolidation Directive and the Capital Adequacy Directive,
the Capital Requirements Directive, was to modernise and update
the Community legal framework relating to the prudential supervision
of the capital held by banks and other financial institutions
in line with the recommendations from the Basel Committee, and
that the Capital Requirements Directive forms a key part of the
Community's Financial Services Action Plan for developing a single
market in financial services. The Minister then tells us that
the amendments now proposed have the potential to deliver significant
benefits for the UK in terms of:
- strengthened prudential regulations,
through a substantial increase in the level of capital held against
trading risks;
- increased confidence in the re-securitisation
market, through increased capital requirements and due diligence
requirements coupled with regulatory scrutiny;
- improved risk management, through greater transparency
and due diligence requirements for securitisations;
- preventing remuneration policies from encouraging
excess short-term risk taking to the detriment of the long term
health of the bank; and
- strengthened financial stability, contributing
to the Government's ongoing response to the financial market disruption.
The Minister also comments that the high level principles
on remuneration tally with those being established by the Financial
Services Authority for UK firms and that the Government is supportive
of the proposals as they currently stand.
8.9 More generally the Minister says that "the
Government supports the implementation of these amendments and
where appropriate will seek adjustments to further improve outcomes",
adding that proportionate initiatives to improve risk management,
due diligence and transparency should all be welcomed if the UK
is to remain a competitive financial centre.
8.10 The Minister also sends us the Government's
initial Regulatory Impact Assessment. This considers, for each
of the four main areas of revision proposed, two options for the
Government:
- maintain the status quo;
and
- introduce the amendments.
The assessment makes the obvious comment about the
first option — that this would lead to the UK being in breach
of Community obligations and open it to infraction proceedings
and claims for damages. As for the second option, implementing
the provisions of the proposed Directive directly into UK legislation,
the assessment comments that:
"this option is in line with UK Government policy,
which is not to be super-equivalent — that is, not to impose
additional requirements on UK firms above those specified in the
Directive, unless these are justified by rigorous cost-benefit
analysis."
The assessment discusses for each of the four main
areas of revision the possible implications of the second option
and concludes:
"The Proposal has the potential to deliver significant
benefits for the UK in terms of strengthened financial stability,
with banks holding more capital against assets that have shown
to carry greater risk than previously thought. Increased disclosure
of securitisations will also encourage greater market discipline.
Creating a level playing field on the treatment of remuneration
will act to reduce excessive risk taking across the EU and also
to reduce any anti-competitive effects of the UK adopting a unilateral
approach. Therefore the UK supports the implementation of these
Directive amendments and where appropriate will seek adjustments
to ensure a more balanced outcome."
Conclusion
8.11 The draft Directive in this document would
introduce important changes to the Capital Requirements Directive.
We note that the Government supports the proposed amendments,
but "where appropriate will seek adjustments to further improve
outcomes." Before we consider the document further we should
like to know, very soon, what adjustments the Government thinks
necessary and what progress is being made in securing them. Meanwhile
the document remains under scrutiny.
25 (25852) 11545/04 + ADDs 1-3: see HC 42-xxxiii (2003-04),
chapter 2 (20 October 2004) and Stg Co Deb, European Standing
Committee B, 8 November 2004, cols 3-18. Back
26
The Basel Committee is composed of representatives of the supervisory
authorities (and central banks where these are not the same institution)
of Belgium, Canada, France, Germany, Italy, Japan, Luxembourg,
the Netherlands, Spain, Sweden, Switzerland, the United Kingdom
and the United States. The Financial Services Authority and the
Bank of England represent the UK at the Basel Committee. See http://www.bis.org/bcbs/.
Back
27
(30003) 13713/08 + ADDs 1-3: see HC 16-xxxiv (2007-08), chapter
8 (5 November 2008), HC 16-xxxv (2007-08), chapter 1 (12 November
2008) and Stg Co Debs, European Committee, 25 November
2008, cols. 3-24. Back
|
