Documents considered by the Committee on 7 March 2018 Contents

2Banking reform: risk reduction measures

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; but scrutiny waiver granted for general approach at the ECOFIN Council of 13 March 2018; drawn to the attention of the Treasury Committee

Document details

(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

Legal base

(a) and (c) Article 114 TFEU, ordinary legislative procedure, QMV; (b) Article 53(1) TFEU, ordinary legislative procedure, QMV

Department

Treasury

Document Numbers

(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

Summary and Committee’s conclusions

2.1The European Commission tabled a technically complex package of proposals in November 2016 to update the EU’s capital requirements framework for banks. Known collectively as the “Risk Reduction Measures” (RRM), the proposals would bring the current legal framework—the Capital Requirements Directive and Regulation, and the Bank Recovery & Resolution Directive—in line with the most recent international standards. We set out the substance of the proposals in some details in our previous Reports.5

2.2The Government has been broadly supportive of the package,6 but in January 2018 the new Economic Secretary to the Treasury (John Glen) informed us that several areas remained outstanding where the UK was seeking changes to the legal texts.7 Principally, the Government had outstanding concerns over 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 (the TLAC standard).

2.3In addition, the Minister confirmed the Government was actively opposing a proposed new requirement under the Capital Requirements Directive for certain large non-EU banks and investment firms to create an intermediate, independently-capitalised EU-based parent undertaking (IPU) to facilitate group supervision and resolution. Given the dominant position of UK banks within the EU’s financial system, the European Commission has linked this part of its proposal explicitly to the EU’s “preparedness” for Brexit. However, it was not clear how the UK was seeking to amend this requirement, and what level of support it enjoyed among the other Member States.

2.4The Committee considered these outstanding areas of concern at its meeting on 21 February 2018, and decided to retain the RRM package under scrutiny in anticipation of further information from the Minister about developments in the negotiations and the potential repercussions for the UK-headquartered financial services firms of becoming facing additional costs and barriers to trade under the IPU requirement.

2.5By letter of 28 February 2018, the Economic Secretary informed us of progress in the negotiations (see “Background” below for more detail), which we can summarise as follows:

2.6In his letter, the Minister asked the Committee for a scrutiny waiver to enable the UK to vote in favour of the legal text at the ECOFIN meeting if all the Government’s outstanding concerns are addressed in the final text of the General Approach.

2.7The European Parliament’s Economic and Monetary Affairs Committee is due to vote on the RRM proposals in May, which would enable trilogue negotiations between the Council and MEPs to start before the summer recess. It is not yet clear when the proposals could be formally adopted, and consequently when they might take effect. As a result, we cannot yet be certain whether the changes to the prudential framework would apply directly in the UK (which would be the case if they become applicable during the post-Brexit transitional period, during which EU law would continue to apply). Conversely, it is also not clear when the IPU requirement would begin applying to banks and investment firms based in the UK as they would not be considered ‘third country’ institutions for the duration of the transition.

2.8Given the importance of speedy incorporation of new international standards into the EU’s prudential legislation, and in view of the Government’s explanation that most of its concerns about the legal text of the RRM package have been addressed, we are granting the Minister a scrutiny waiver ahead of the proposed agreement of a general approach at the March ECOFIN Council. However, we do so reluctantly, given that we have had little time to scrutinise the implications of the developments described by the Minister in his letter, and not all of the outstanding issues the Government has identified as priorities for the UK have not been entirely resolved (as evidenced by the fact discussions ‘continue at a pace’).

2.9Therefore, the scrutiny reserve will continue to apply after the March ECOFIN Council, and as a condition of the scrutiny waiver we ask the Minister to write to us no later than 23 March with information on the outcome of that meeting.

2.10We also note the Minister’s reference to the need for a “long transition period” with respect to the new IPU requirement for large non-EU banks, which he says was necessary to “reduce uncertainty and complexity for firms who already must manage challenges with post-Brexit restructuring”. In light of this, we also ask him to clarify:

2.11More generally, we note that any improvements to the legal texts of the RRM package secured by the Government prior to the ECOFIN Council will also need to have the support of the European Parliament in the next stage of the legislative process. Given the inter-institutional negotiations are unlikely to begin before May, we are concerned that any delays in the process could push back formal adoption of the RRM package until after the UK loses its vote within the Council next year. The Committee expects to be kept informed of the likely timetable for next steps, and will keep a close eye on the extent to which the Government is able to protect any concessions won at this stage as the UK’s formal withdrawal from the EU approaches.

2.12Given that substantial questions remain outstanding about the implications of the proposals for the UK banking industry and about the wider impact of Brexit on flows of financial services between the UK and the EU, we draw these developments to the attention of the Treasury Committee.

Full details of the documents

(a) Proposed Directive on loss-absorbing and recapitalisation capacity of credit institutions and investment firms: (38300), 14777/16 + 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), 14776/16 + ADDs 1–2 COM(16) 854; (c) Proposed Regulation concerning aspects of capital requirements: (38304), 14775/16 + ADDs 1–3, COM(16) 850.

Background

2.13Since November 2016 the EU has been discussing a package of complex technical proposals on risk reduction measures (RRM) for the banking sector. These aim to bring the EU’s capital requirements for banks in line with international standards, and update its legal framework for the recovery and resolution of failing banks. The Committee set out the detail of the RRM package in some detail in Reports of November 2017 and February 2018.

2.14The Government has been broadly supportive of the package, especially where it incorporates global prudential standards into EU law. In January, the Economic Secretary to the Treasury (John Glen) informed us that several areas of contention remained in the negotiations between the Member States in the Council, namely:

2.15The Committee retained the proposals under scrutiny, in view of the fact that the UK may have to apply the new banking legislation during the post-Brexit transitional period and given that certain elements apply to British banks with operations within the Single Market when the UK becomes a “third country” vis-à-vis the Single Market. We also asked the Minister to provide more information on the outstanding areas of contention, and in particular the possible implications of the IPU requirement for the UK financial services industry after Brexit.

The Minister’s letter of 28 February 2018

2.16On 1 March, the Economic Secretary to the Treasury (John Glen) wrote to us9 to confirm the Bulgarian Presidency was seeking to obtain a general approach at the meeting of the ECOFIN Council on 13 March. He added that, from the Government’s perspective, “there is a pathway to reaching a compromise on the outstanding issues that meets our negotiating objectives”, namely that:

2.17The Minister notes that, as of early March, negotiations at official level “continue at a pace”, with the following developments having taken place since his predecessor’s letter of 23 January:10

Pillar 2 requirements

2.18Under so-called “Pillar 2” requirements, Member State regulators have the ability to impose additional prudential requirements beyond the statutory minimum (the Pillar 1 requirements). The European Commission had proposed to reduce national flexibility where Pillar 2 were used to achieve macro-economic rather than firm-specific risk management objectives, but the Member States wanted to retain a measure of flexibility. As a result:

Intermediate parent undertakings for non-EU banks

2.19The Minister says the Government has made “significant progress” with respect to the proposals to require certain large non-EU banks to establish an intermediate parent undertaking (IPU) within the EU (which obviously could affect UK firms after Brexit).

2.20The UK’s concerns related primarily to the “disproportionate impact of these new requirements and the approach taken by the Commission”, which did not conduct an impact assessment or “appropriate discussions” with Member States ahead of their publication. In particular, the Government is of the view that the European Commission’s initial proposal would have conflicted with third country legal frameworks for banks that require a separation of retail activities from wholesale banking (such as ring fencing in the UK or the Volcker Rule in the US) “and could be impossible, or at least incredibly costly, for firms to meet”.

2.21However, in light of changes to the legal text, the Minister believe the UK will be able to support the outcome of negotiations “in the interest of a balanced overall compromise that delivers appropriate levels of international harmonisation and supervisory flexibility”. These changes include:

Remuneration requirements

2.22The Commission had proposed to lift some of the EU’s rules on remuneration for bankers, relating to deferral of bonuses and pay-out in instruments, for companies with less than €5 billion (£4.5 billion) in assets or for staff in any firm with relatively low bonus payments. Individual Member States would retain the flexibility to impose the full restrictions if they so choose. The Minister now explains:

Net Stable Funding Ratio, Leverage Ratio and Market Risk

2.23With respect to the proposals to update the Capital Requirements Directive and Regulation, the Minister explains that, as the Committee had been previously informed, the Member States are set to endorse bringing EU law in line with new international standards:

Bank recovery and resolution

2.24The RRM package also amends the EU’s Bank Recovery & Resolution Directive (BRRD).

2.25The underlying objective of the 2014 Bank Recovery and Resolution Directive is that the cost of bank failures should be borne primarily by shareholders and creditors (a “bail-in”), not taxpayers (a “bail-out”). The Directive therefore established the “Minimum Requirement for [own funds and] Eligible Liabilities” (MREL). This requires national resolution authorities to fix a firm-specific level of liabilities that can be readily “bailed-in”, such as deposits, to absorb losses based on their firm-specific risk profile. The RRM package seeks to incorporate into EU law a new international bail-in standard for the largest banks (the TLAC standard).13

2.26The Minister notes that:

Contractual recognition of bail-in

2.27The requirement for MREL to include contractual recognition of bail-in—i.e. that creditors could face a haircut in the event of a resolution—has been removed, as the Member States considered it “unnecessary and is inconsistent with the broad statutory bail-in power which already exists”.

2.28Similarly, the Minister explains there is “broad consensus” to amend requirements for the contractual recognition of bail-in in contracts governed by non-EU law, “which addresses industry concerns there may be circumstances where compliance is impracticable”. The UK is seeking technical amendments to this aspect of the legislation “to ensure operability”.

Moratorium powers

2.29Regarding the introduction of new moratorium powers, which freeze the flow of payment and delivery obligations for a bank, the Minister says the UK has “made progress to reduce economic and financial stability risks […] by limiting the powers”:

Previous Committee Reports

Twenty-fifth Report HC 71–xxiii (2016–17), chapter 6 (11 January 2017); Thirty-second Report HC 71–xxx (2016–17), chapter 6 (22 February 2017); First Report HC 301–i (2017–19), chapter 19 (13 November 2017); and Fifteenth Report HC 301–xv (2017–19), chapter 1 (27 February 2018).


5 See for example our Reports of 13 November 2017 and 21 February 2018.

6 Explanatory Memorandum submitted by HM Treasury (20 December 2016).

7 Letter from John Glen to Sir William Cash (23 January 2018).

8 Two elements of the RRM package, relating to bank creditor hierarchy and a new accounting standard to calculate bank losses, were fast-tracked and have already been adopted. See our Report of 21 February 2018 for more information.

9 Letter from John Glen to Sir William Cash (28 February 2018).

10 Letter from John Glen to Sir William Cash (23 January 2018).

11 Branches vs subs.

12 The so-called “bonus cap”, which limits bankers’ bonuses to 200 per cent of their fixed salary, would not have been affected by this new exemption.

13 The Financial Stability Board (FSB) developed the international Total Loss-Absorption Capacity (TLAC). This sets an 18 per cent minimum proportion of the risk-weighted assets of global systemically-important banks (“G-SIIs”) that must be readily bail-inable in the event of bank failure. As TLAC and MERL have the same regulatory objective, the Commission proposed to incorporate the TLAC standard into EU law by requiring EU-based G-SIIs to hold a statutory (Pillar 1) minimum MREL equivalent to the TLAC standard. It would also allow national resolution authorities to impose firm-specific additional (Pillar 2) MREL requirements on G-SIIs. The existing MREL requirements for other (smaller) banks would remain substantially the same.

14 The Minister also notes that the level of MREL subordination is separate to the issue of the UK’s approach to structural subordination, which was covered in previous correspondence on the Bank Creditor Hierarchy Directive and which the Committee referred to in its recent Banking Reform Report.




9 March 2018