Cleared from scrutiny; drawn to the attention of the Treasury Committee
(a) Proposed Directive on loss-absorbing and recapitalisation capacity of credit institutions and investment firms; (b) Proposed Directive as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures; (c) Proposed Regulation concerning aspects of capital requirements
(a) and (c) Article 114 TFEU, ordinary legislative procedure, QMV; (b) Article 53(1) TFEU, ordinary legislative procedure, QMV
(a) (38300), 14777/16 + ADDs 1–2, COM(16) 852; (b) (38303), 14776/16 + ADDs 1–2, COM(16) 854; (c) (38304), 14775/16 + ADDs 1–3, COM(16) 850
4.1The European Commission tabled a technically complex in November 2016 to update the European prudential framework for banks. Known collectively as the “Risk Reduction Measures” (RRM), the proposals would bring the EU’s current legal framework—the and , and the —in line with the most recent international standards set by the Basel Committee on Banking Supervision and the Financial Stability Board. They would, for example, set a leverage ratio limiting the amount of debt banks can take on, and introduce new rules that aim for the orderly winding up of financial institutions at risk of collapse without the need for taxpayer bail-outs.
4.2The RRM proposals are subject to the EU’s ordinary legislative procedure, meaning they must be agreed jointly between the European Parliament (by simple majority) and the Member States in the Council (by qualified majority). As we set out further in paragraphs 10 to 17 below, the legislation—once it takes effect—is likely to have a substantial impact on the British financial services industry despite the UK’s withdrawal from the European Union. We have therefore reported developments in the legislative process to the House on a number of occasions since 2016, most recently .
4.3We set out the substance of the Commission proposals, and how they would impact on the British banking sector, in some detail in our previous Reports (most elaborately in and ). Negotiations between the Parliament and the Member States to finalise the legal texts began in September 2018. Throughout the legislative process, the Treasury has been broadly supportive of the package of reforms contained in the RRM package, but it sought to use the legislative deliberations among Member States within the Council to address concerns over the new moratorium powers to suspend a failing bank’s payment obligation, and the extent to which some Member States were seeking to water down a new international standard of “bail-inable” capital for systemically-important banks to avoid taxpayer bail-outs (the so-called ‘TLAC’ standard).
4.4As we discuss in more detail in paragraphs 10 to 17 below, the RRM legislation is likely to be relevant to the UK despite its planned withdrawal from the European Union. In particular, under the draft Withdrawal Agreement the UK would enter a post-Brexit transitional period from ‘exit day’, during which it would stay part of the Single Market and remain directly bound by EU law as if it were still a Member State. The transition would last until at least 31 December 2020, but potentially even longer. It could therefore be in effect when the new banking rules begin applying across the EU, meaning they would also apply in the UK.
4.5In November 2018, the Minister (John Glen MP) there was a preliminary agreement on the table on the final substance of the RRM package, but “key differences” between the two institutions remained. The following month, progress in the negotiations had led to a political agreement on most of the outstanding issues in the negotiations. Member States, including the UK, also at a meeting of the Council of Ministers on 4 December 2018. By dated 17 December 2018, the Economic Secretary informed us that negotiations between the Parliament and Member States would continue in early 2019 to iron out the remaining differences, which were centred on restrictions on bonus payments at banks and the entry into force of a new leverage ratio to limit banks’ reliance on debt to finance their operations.
4.6On 28 March 2019, the Economic Secretary again to tell us that the European Parliament and the Council had reached their on the new banking legislation earlier in the year. This included a deal on the two outstanding elements he identified in his previous letter. In summary, the Risk Reduction Measures for the banking industry as now agreed will make the following changes:
4.7The summarised the Government’s position on the final RRM package as broadly supportive of the agreement between the Parliament and the Council, even though the UK did not secure all the changes it had sought (especially as regards the restrictions on remuneration, the deferred implementation of the FTRB standard, and the IPU requirement for non-EU banks). He described the final outcome as a “significant step in implementing important international standards” and one that will “[reduce] risk and supports a stable and efficient banking system”. Overall, therefore, the Government expects be able to support the new legislation if it is presented to the Council of Ministers for formal adoption while the UK is still a Member State of the EU.
4.8Once formally approved by the Parliament and Council, the new banking legislation is expected to take effect in stages from late 2020 onwards. Before their entry into force, the European Commission is due to adopt a number of technical Delegated and Implementing Acts—the EU equivalent of statutory instruments—to give full effect to the new prudential requirements. Those will need to be scrutinised by Member States prior to them becoming applicable.
4.9As set out in more detail in our conclusions below, the EU’s RRM legislation is likely to have a domestic impact in the UK beyond the date of its formal withdrawal from the European Union, for several reasons.
4.10The Risk Reduction Measures now informally agreed, and likely to be adopted formally by the EU institutions before the European elections in May 2019, are another important step in the EU’s efforts to build a financial regulatory architecture that would help to prevent a recurrence of the 2008 banking crisis.
4.11We have taken note of the Minister’s assessment of the substance of the final RRM package, where we accept his assurance that the overall outcome—although not perfect—is acceptable and conducive to the health of Europe’s banking sector. However, this new EU legislation also has a direct impact on the UK irrespective of its imminent withdrawal from the European Union. We have drawn attention to this in a number of our previous Reports on the RRM package, as summarised below.
4.12First, the draft Agreement on the UK’s withdrawal foresees a post-Brexit transition during which the UK would remain in the Single Market and continue applying EU law as if it were a Member State. However, the Government would have no right to attend meetings of the Council of Ministers or any of its associated bodies where EU Member States are represented, and by extension lack any right to vote on new EU policy measures. This transitional period would initially last until the end of 2020, but could potentially be extended until 31 December 2022. We note in this regard that the changes contained in the RRM agreement are likely to take effect from 2020 onwards, well within the putative extended transitional period. That means the amendments to the EU’s capital requirements and bank resolution laws would apply to the British financial sector as and when they take effect. The main exception is the application of the IPU requirement for large ‘third country’ banks, which will only directly affect the British financial services sector after the UK has left the Single Market.
4.13The continued supremacy of EU law during the transition would also extend to any regulatory and implementing technical standards which the European Commission is empowered to adopt under the RRM legislation in the coming years. Crucially, however, although any such EU tertiary legislation would be binding on the UK and its banking industry during transitional period, the Treasury and its independent financial regulators would have had no formal role in their formulation insofar as those discussions take place after the UK has ceased to be a Member State. The Financial Conduct Authority has warned such an extension could pose a risk to the UK’s financial services industry, given that regulation affecting one of the world’s largest financial centres would be formulated without its domestic regulators’ input and without voting rights for its Government. This only serves to reinforce the need for continued parliamentary scrutiny of the development of EU laws—including tertiary legislation—during the transitional period.
4.14Secondly, the substance of the Risk Reduction Measures would matter even in a ‘no deal’ scenario—where the Withdrawal Agreement is not ratified—because of the recent Financial Services (Implementation of Legislation) Bill. Under this draft legislation, the Government has proposed to give itself the power to implement a limited number of pending (“in-flight”) EU proposals on financial services which are not yet in effect when the UK leaves the EU—including the RRM package—into domestic law by statutory instrument in the event of a ‘no deal’ Brexit. With respect to the RRM package, we consider that there is a strong case for speedy implementation in UK law in such a scenario: the final substance of the laws is already known and has benefitted from full Treasury input, as described above; the new EU rules to a large extent reflects international standards which the UK would implement in any event; and the laws would have been explicitly endorsed by the Government in the Council of Ministers, subject to the scrutiny of this Committee.
4.15Lastly, the shape of the RRM package is likely to be important post-Brexit in the context of any future trade agreement on financial services between the UK and the EU. This new banking legislation will form part of the EU regulatory baseline, which will underpin negotiations on any future market access agreement for UK banks wanting to operate in the EU when they lose their Single Market ‘passporting’ rights. The Political Declaration on the future UK-EU relationship states that any such preferential access to markets for financial services between the UK and the EU is to be governed by ‘equivalence’, a legal mechanism that allows the EU to decide that the supervisory system of a ‘third country’ for a particular financial sector achieves the same regulatory outcomes as its own.
4.16Although the ‘equivalence’ provisions of the Capital Requirements Regulation for market access by non-EU banks are extremely limited compared to some other financial sector regulated by European law, it is possible for EU-based financial institutions to obtain prudential reliefs for exposures to banks in third countries considered equivalent in this way. The assessments of whether the UK’s prudential regime achieves the same outcomes as that of the EU will be affected by the amendments to Europe’s banking rules as discussed in this Report, and may therefore need to be reflected in UK law in the long term if the Government wants to maintain any equivalence arrangements (including those elements with which the UK disagreed). Efforts to maintain equivalence would be facilitated by the Treasury’s regulation-making powers described in paragraph 14, since there would be no need for primary legislation to align UK law with the amended version of the Capital Requirements Directive and Regulation even when the UK has become a ‘third country’.
4.17In light of the imminent adoption by the Council of these new EU banking laws, we are content to now clear the RRM proposals from scrutiny. We also again draw the attention of the Treasury Committee to these developments, given the potential consequences of the new EU banking legislation for UK law (either during the post-Brexit transitional period, or if it is implemented domestically in a ‘no deal’ scenario under the Financial Services (Implementation of Legislation) Bill).
(a) Proposed Directive on loss-absorbing and recapitalisation capacity of credit institutions and investment firms: (38300), + ADDs 1–2, COM(16) 852; (b) Proposed Directive as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures: (38303), + ADDs 1–2 COM(16) 854; (c) Proposed Regulation concerning aspects of capital requirements: (38304), + ADDs 1–3, COM(16) 850.
Twenty-fifth Report HC 71–xxiii (2016–17), (22 February 2017); First Report HC 301–i (2017–19), (13 November 2017); Fifteenth Report HC 301–xv (2017–19), (27 February 2018); Seventeenth Report HC 301–xvii (2017–19) (7 March 2018); Twenty-eighth Report HC 301–xxvii (2017–19), (16 May 2018); and Fiftieth Report HC 301–xlix (2017–19), (9 January 2019).(11 January 2017); Thirty-second Report HC 71–xxx (2016–17),
14 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms.
15 on prudential requirements for credit institutions and investment firms.
16 establishing a framework for the recovery and resolution of credit institutions and investment firms.
17 The RRM package included a fourth proposal, related to the resolution powers of the European Central Bank over banks within the Eurozone. We cleared this from scrutiny , as it had no direct impact on UK banks. Similarly, the elements of the proposals relating to a new accounting standard on calculating banking losses and rules on creditor hierarchy in the event of bank failure were fast-tracked and have already been adopted (see our ).
18 See for example our Reports of and .
19 The Member States adopted their ‘general approach’, the basis for the negotiations, . The European Parliament’s Economic and Monetary Affairs Committee adopted its position on the RRM proposals the following month.
20 submitted by HM Treasury (20 December 2016).
21 Moratoria powers related to bank recovery and resolution allows the authorities to suspend (contractual) payments by a bank in crisis. The rationale is that such moratoria allow an appropriate resolution strategy to be implemented, including the bail-in of a bank’s assets. The Commission proposed a new moratorium tool allowing resolution authorities to suspend the payment obligations of a failing bank for a short period of time during the early intervention (pre-resolution) phase (when a bank might still recover). It also wanted to expand an existing in-resolution moratorium power (when a bank is already no longer viable). The UK consistently opposed this element of the proposal, amid concerns that an extended moratorium could have a significant economic impact (by interfering with financial markets and disrupting cash flows to a bank’s counterparties) and “risks undoing international progress to address the risk of cross-border termination of contracts in resolution”, such as the Universal Stay Protocol established by the Financial Stability Board.
22 TLAC stands for Total Loss-Absorbing Capacity.
23 Article 132 of the Withdrawal Agreement allows for the transition to be extended until 31 December 2022 by mutual agreement between the UK and the EU.
24 In particular, at that stage those included whether to fully implement the new international standards on market risk (the FRTB) at this stage or at some point in the next decade; the rules governing subordination of bail-in assets in the event of a bank failure; the flexibility for national regulators to impose additional micro- and macro-prudential requirements on their domestic banking industry above and beyond the statutory minimum (Pillar 2); and the asset threshold for the requirement for large ‘third country’ banks—including UK ones after its withdrawal from the Single Market—to establish an IPU in the EU for supervision purposes.
25 Elements of the proposals relating to a new accounting standard on calculating banking losses and rules on creditor hierarchy in the event of bank failure were fast-tracked and have already been adopted (see our Report of 13 November 2017).
26 See ““ (4 December 2018). The Government supported this political endorsement without seeking clearance from the European Scrutiny Committee in advance. The Minister for this subsequently, noting that the Austrian Presidency of the Council had amended the agenda for the meeting “unexpectedly” and that “not supporting the compromise would likely have isolated the UK and we could have been viewed as an impediment to progressing risk reduction measures in the EU”. The UK was by Mark Bowman, Director-General for International and EU affairs at HM Treasury.
27 The minimum leverage ratio is calculated by dividing a bank’s core capital by its debt exposures. The relative exposure would be limited to three per cent, with the aim of preventing banks from excessively increasing their debt levels, for example to compensate for low profitability, which could turn them insolvent during an economic downturn. The main area contention between MEPs and Member States in this regard was whether this new requirement should apply from 1 January 2020 (the Parliament’s position) or from two years after the new Capital Requirements Regulation takes effect, most likely in early 2021 (the Council’s position). The final agreement was a vindication of the Council’s position, setting the date of application of the leverage ratio two years after the new CRR enters into force.
28 The new, binding net stable funding ratio (NSFR) will establish a harmonised standard for how much stable, long-term sources of funding a bank needs in order to weather periods of market and funding stress. The NSFR is calculated as the ratio of an institution’s amount of available stable funding (ASF) to its amount of required stable funding (RSF).
29 The FRTB is an international standard that aims to reduce market risk by establishing more risk-sensitive “own funds” prudential requirements for institutions that have substantial exposure to securities and derivatives. In this context, ‘own funds’ refers to funds available to a bank that allows it to absorb losses in a going or in a gone concern situation. The Capital Requirements Regulation (CRR) sets out the characteristics and conditions for own funds, backed up by further regulatory technical standards developed by the European Banking Authority.
30 For example, the Fundamental Review of the Trading Book (FRTB), a new approach to reducing market risk in the banking sector, will not be incorporated into EU law at this point, to take into account recent changes to the international standard. Instead, the European Commission will present a further proposal to amend the EU’s capital requirements legislation “as soon as [the FRTB is] finalised at international level. See for more information , p. 9. This proposal, which is intended to be published by June 2020, would be subject to the ordinary legislative procedure between the Council and the Parliament in its own right.
31 TLAC stands for “Total Loss-Absorbing Capacity”.
32 MREL stands for “minimum requirement for own funds and eligible liabilities”.
33 One of the key differences between the TLAC and MREL standards is that the former applies only to the largest (systemically-important) banks, whereas the latter—an EU legal concept—apply to all banks.
34 With respect to the proposed moratoria powers, the Government’s priority was to limit “the length of suspension and avoiding the consecutive application of moratoria”. The Minister told us in December 2018 that these objectives had been achieved in the final compromise, “as the moratorium power lasts for two business days” (compared to the original proposal of five business days) and “cannot be applied consecutively with existing moratorium and stays powers”. This, he added, “aligns with Bank of England policy, and with international standards”.
35 An example of a Pillar 2 requirement in the UK is the Financial Policy Committee’s mandatory for residential mortgages, implemented by the Bank of England and the Financial Conduct Authority.
36 Under Article 92(2) of the Capital Requirements Directive, the remuneration restrictions can be applied by Member States to banks ‘in a manner and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities’. In practice, this has meant that most Member States in their territory with a balance sheet below a certain threshold (which varies country-by-country). The Commission’s original proposal contained provisions aimed at eliminating divergent practices and setting a common threshold for the waiver.
37 In its general approach, the Council largely retained the status quo, given individual Member States the ability to raise or lower the asset threshold below which the restrictions would not apply (with a maximum of €15 billion). The European Parliament’s position was to fix that threshold at €8 billion (£7.2 billion) in assets, with no flexibility for individual EU countries to vary it.
38 For banks within scope of the bonus cap, variable remuneration for individual employees is capped at a maximum of 200% of fixed pay (if shareholders approve).
39 These restrictions include, for example, deferral of bonuses, claw-back and pay-out in shares or other financial instruments to discourage excessive short-term risk-taking.
40 In his letter, the Economic Secretary explains that the impact of the new pay restrictions would be “manageable” for smaller banks, because they are less likely to pay bonuses in excess of the legal cap or which take overall pay packets above the new €50,000 threshold. The Minister also notes that the recently-agreed Investment Firm Review will take smaller investment banks outside of the scope of the Capital Requirements Regulation altogether by creating a new, standalone prudential framework for the investment services sector.
41 Although the UK opposed this in view of its impact on British banks after Brexit, both the remaining Member States and European Parliament agreed there should be such a requirement. However, they had different views on its scope and the date it should take effect. The Parliament had wanted it to apply to banking groups with €30 billion or more in assets held in the EU, versus €40 billion for the Council. The Parliament also wanted the IPU requirement to apply to any G-SIIs with two or more subsidiaries in the EU, irrespective of their total assets. The Council called for a four year transitional period for the IPU requirement after the amended Capital Requirements Directive has begun to apply, which itself would be 18 months after it is formally adopted by the Parliament and Council.
42 The Economic Secretary told us in December 2018 that this arrangement “significantly increases the proportionality and operability of the measure” compared to the Commission’s original proposal, although it would still affect a sizable number of UK-based banks following Brexit.
43 Delegated Acts can be vetoed by the European Parliament or the Council. Implementing Acts must be actively approved by Member States, with no formal decision-making role for the Parliament.
44 (29 November 2018).
45 2017–2019. After the Report stage for the Bill was delayed by the Government on 4 March 2019, it is not yet clear when the legislation is likely to complete its passage through Parliament.
46 The same cannot be said for a number of other pending EU proposals which the Treasury could also implement via statutory instrument under the Bill, which we believe require further detailed scrutiny by Parliament because their substance is still being negotiated at EU-level. Some of the EU proposals included in the scope of the Bill, including on the supervision of Central Counterparties and the powers of the European Supervisory Authorities—are still subject to intensive negotiations at EU-level, meaning it is far from clear what the eventual substance of those laws will be.
47 Where an ‘equivalence’ determination is made, firms from that non-EU country typically either gain preferential market access rights or (as is more common) become more attractive for EU-based financial services providers to do business with (from a regulatory and prudential perspective). Decisions taken by the European Commission relating to equivalence need to be approved by a qualified majority of Member States. Equivalence is also applied entirely unilaterally by the EU, with no right of appeal for the Government if it is not granted or withdrawn.
48 There is no ‘equivalence’ mechanism that gives non-EU banks the right to provide banking services, even wholesale, into the EU as a whole on a cross-border basis, although individual Member States may permit it based on local legislation. This is in contrast to the investment services sector, where such equivalence can be—but has not been—granted under the Markets in Financial Instruments Regulation.
49 See Articles 107(4), 114(7), 115(4), 116(5) and 142(2) of the . EU banks can generally hold less capital against exposures to other banks in ‘equivalent’ jurisdictions. See for more information ““ by UK Finance (accessed 20 December 2018).
Published: 30 April 2019