(a)—(b) Not cleared from scrutiny; further information requested; drawn to the attention of the Treasury Committee and the Business, Energy & Industrial Strategy Committee; (c) Cleared from scrutiny
(a) Proposal for a Directive on credit servicers, credit purchasers and the recovery of collateral; (b) Proposal for a Regulation on amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures; (c) Second Progress Report on the Reduction of Non-Performing Loans in Europe
(a) Articles 53 and 114 TFEU; ordinary legislative procedure; QMV; (b) Article 114 TFEU; ordinary legislative procedure; QMV; (c)—
(a) (39588), 7403/18 + ADDs 1–4, COM(18) 135; (b) (39604), 7407/18 + ADDs 1–2, COM(18) 134; (c) (39592), 7410/18 + ADD 1, COM(2018) 133
4.1In several EU countries, banks still have high levels of “bad debt” on their balance sheets. These “non-performing loans” (NPLs) are unlikely to ever be repaid in full, and limit banks’ ability to engage in new lending (as well as posing a risk to financial stability). Although stocks of non-performing loans are decreasing, nine EU countries—not including the UK—still have NPL ratios of more than 10 per cent in their banking sector.
4.2In the summer of 2017 the Member States asked the European Commission to propose a number of policy initiatives to reduce the stock of non-performing loans (NPLs) on the balance sheets of European banks. In January 2018 the European Commission set out the status of its preparations in a first ‘progress report’, followed in March 2018 by concrete proposals for a Directive and a Regulation which would:
4.3We have considered the detail of both proposals, which were accompanied by a second ‘progress report’, in “Background” below. In April 2018 the Economic Secretary to the Treasury (John Glen) told us that the Government “is satisfied that, in their current form, the proposed policy solutions to the NPL problem are targeted at specific problem areas—broad measures aimed at reducing aggregate levels of NPLs in the EU would be disproportionate”.
4.4The Commission’s recent proposals on out-of-court recovery of collateral where businesses fail to repay bank loans and the regulation of debt management companies should be seen in the context of wider efforts within the EU to reduce the prevalence of non-performing loans in a sub-set of Member States. This new legislation is due to take effect on 1 January 2021.
4.5Despite the UK’s low rate of NPLs, and its decision to exit the European Union, it is not yet clear what impact these proposals may have on the regulation of the British banking and debt management industries. As we have noted in relation to other recent EU financial services proposals, the Government has secured a provisional agreement that the UK will stay part of the EU’s economic and regulatory structures—and therefore subject to Single Market law—until the end of 2020. This would provide additional time for the formal negotiation on, and ratification of, a post-Brexit UK-EU trade agreement and for the completion of the UK’s domestic preparations for economic life outside of the Customs Union and Single Market.
4.6However, Ministers have repeatedly refused to rule out the possibility of an extension of that transitional arrangement beyond December 2020. The Government’s view is that the length of the transition “should be determined simply by how long it will take to prepare and implement the new processes and new systems that will underpin the future partnership”. Under the current terms of the transition, any extension would imply the Treasury would be legally required to implement the Commission’s NPL proposals (any amendments introduced by the Council and the Parliament notwithstanding).
4.7As the Directive and the Regulation may have legal effect in the UK, there are some issues of substance that we believe will require careful consideration during the legislative process.
4.8Firstly, the issue of recovery of collateral by banks from business borrowers is highly topical, given the recent controversy over Royal Bank of Scotland’s treatment of its business customers in arrears. We understand the Treasury is undertaking further analytical work to assess the potential impact the requirement to establish an out-of-court procedure for collateral recovery would have on UK law (taking into account the fact that the exact legal provisions are still subject to change). Any new EU rules on out-of-court debt enforcement of secured commercial loans should contain robust protections for borrowers, so that businesses do not see their assets appropriated by banks unnecessarily, or—where enforcement of any collateral is appropriate—for less than their true value.
4.9Secondly, the proposed EU-wide regulatory approach to ‘credit servicers’ has implications for consumers and businesses alike because it appears to open up the UK’s market for debt management to overseas companies. The Government’s sale of Northern Rock’s loan-book of distressed mortgages to a private equity firm in 2015 sparked concerns about the protection available to borrowers whose loans were sold. Similar issues could arise if the new EU ‘passport’ for credit servicers would allow a bank to have its loan agreements managed more easily by a third party that may not even have a domestic presence, or be subject to the supervision of a UK-based regulator like the Financial Conduct Authority. In this regard, we would like the Minister to write to us as soon as possible to clarify:
4.10After the UK leaves the Single Market, credit servicing companies based in the EU would no longer have a right to ‘passport’ their activities into the UK domestic market (and vice versa for British debt management agencies). At that point, UK-based credit servicers would only be able to operate within the Single Market if they establish a separate legal entity in an EU country, subject to authorisation and supervision by that country’s domestic regulator. Similarly, once the UK is a ‘third country’ vis-à-vis the Single Market, British firms would not be able to purchase loan agreements from EU banks unless they appointed a legal representative within the EU (and this representative must, in turn, engage an EU-based bank or credit servicing company to actually manage the loans).
4.11In anticipation of further information from the Treasury about developments in the legislative process in the coming months, we retain both legislative proposals under scrutiny and draw them to the attention of the Treasury Committee. We also consider that the Directive on credit servicing and out-of-court enforcement of collateral may be of interest to the Business, Energy & Industrial Strategy Committee in view of its scrutiny of Government policy that affects businesses and consumers. We are content to clear the second NPL progress report from scrutiny.
(a) Proposal for a Directive on credit servicers, credit purchasers and the recovery of collateral: (39588), 7403/18 + ADD 1–4, COM(18) 135; (b) Proposal for a Regulation on amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures: (39604), 7407/18 + ADD 1–2, COM(18) 134; (c) Communication from the European Commission—Second Progress Report on the Reduction of Non-Performing Loans in Europe: (39592), 7410/18, COM(18) 133.
4.12In several EU countries, national banking sectors continue to hold unsustainably high levels of “bad debt”: non-performing loans (NPLs) that are unlikely to ever be repaid in full. These constitute a drag on bank capital and resources, hindering new lending to fuel the economy, as well as potentially posing a risk to financial stability if banks cannot absorb the losses incurred on loans that will never be repaid.
4.13In June 2017 EU Finance Ministers explicitly called for a package of measures, at both EU and national level, to help reduce overall stocks of NPLs and to ensure banks have sufficient capital to deal with the financial consequences of bad loans. This Council ‘Action Plan’ outlined the need for a number of policy initiatives, including:
4.14A progress report published by the Commission in January 2018 set out at high level the specific policy initiatives it intended to propose to fulfill the requirements of the Council Action Plan. In addition to guidance and support for both banks and regulators, these included legislative proposals to facilitate a secondary markets where banks could sell ‘bad’ loans to new creditors; a new prudential requirement for banks to cover the risk of new loans becoming distressed (‘provisioning’); and the availability of out-of-court collateral recovery mechanisms for banks if borrowers fail to repay secured loans. At the time, the Economic Secretary to the Treasury (John Glen) told us that the proposed policies are “unlikely to affect the UK” as it has “very low levels of NPLs”. However, the Government supports the EU’s efforts to reduce stocks of bad loans, as long as the new policies do not trigger “additional economic or market risk” and “address specific problem areas and [will] not solely be aimed at reducing aggregate NPL levels across the EU as a whole”.
4.15When we considered the Commission progress report in February 2018, we concluded that—the UK’s exit from the EU and its low stock of bad loans notwithstanding—it was not yet possible to assess the potential implications of the proposed NPL initiatives for the UK, particularly as regards the legislation being prepared by the Commission, because the Government had provisionally agreed with the EU that the UK would stay part of the Single Market—including EU financial services legislation—until at least the end of 2020. Depending on the timetable for the adoption of the Commission’s proposals by the Member States and the European Parliament, the new capital requirements and statutory out-of-court recovery mechanism could therefore apply to the British banking sector, if they were to take effect while Single Market legislation is still binding on the UK.
4.16The European Commission published two legislative proposals to address non-performing loans in the EU banking sector on 18 March 2018, accompanied by a second progress report on related non-regulatory measures.
4.17The proposed legislation consists of:
4.18The objective of the Directive is to prevent excessive future build-up of NPLs on banks’ balance sheets. Fundamentally, it aims to do so in two separate ways:
4.19The Economic Secretary to the Treasury (John Glen) submitted an Explanatory Memorandum on the proposals on 16 April 2018. We have described the substance of the proposed legislation, and the Government’s views thereon, in more detail below.
4.20The bulk of the proposed Directive is focused on the development of a more efficient secondary market for non-performing loans, which relies on banks being able to sell NPLs to specialist credit purchasers (who would then become the creditor, removing the loan from the bank’s balance sheet) or outsource management of the debt recovery process to a credit servicing company. The latter can carry out tasks such as monitoring the performance of loan agreements, communicating with the borrower, and enforcing or renegotiating the creditor’s rights. Banks make use of this secondary market where they themselves are unable to effectively manage bad loans.
4.21The proposal would create a common set of rules that third party credit servicers need to abide by in order to operate, to ensure their proper conduct and supervision across the Union, while allowing greater competition among servicers in harmonising the market access across Member States. This will lower the cost of entry for potential loan purchasers by increasing the accessibility and reducing the costs of credit servicing. More purchasers on the market should, everything else being equal, ease the way for a more competitive market with a larger number of buyers, leading to higher demand and higher transaction prices.
4.22The harmonised standards for credit servicing companies (i.e. debt management agencies) would be:
4.23Where a credit servicing company obtains authorisation to operate from the national regulator of any EU country, it would be able to:
4.24The supervision of credit servicing companies would primarily be the responsibility of the regulator that authorised its operations, even where it provides services in another EU country. The draft Directive would allow the authorities of ‘host’ Member States to “conduct checks, inspections and investigations in respect of credit servicing activities provided within their territory by a credit servicer authorised in [another] Member State” at their own initiative. However, they could not bar a company authorised elsewhere in the EU from operating, unless its ‘home’ regulator withdraws its licence. It is unclear if Member States could require a credit servicing company authorised in another EU country from establishing a physical presence in their territory.
4.25The proposed legislation does not contain any mechanism for the operation of non-EU credit servicing companies in the EU, for example by way of a decision recognising a third country’s regulatory regime as ‘equivalent’ to the rules laid down in the Directive.
4.26The Economic Secretary’s Explanatory Memorandum on the proposed rules for credit servicers states that the Government “is satisfied that, in their current form, the proposed policy solutions to the NPL problem are targeted at specific problem areas—broad measures aimed at reducing aggregate levels of NPLs in the EU would be disproportionate”.
4.27The proposal also contains several provisions relating to credit purchasing, where a company buys a loan book from a bank and becomes the creditor vis-à-vis the borrower. It would sets out minimum disclosure requirements by the bank towards the prospective buyer of a loan agreement, as well as requiring the sale to be notified to the financial regulator.
4.28Credit purchasers based outside the European Union would need to appoint a designated representative within the EU before they could purchase a credit agreement involving an EU-based borrower. This representative, in turn, would have to engage an EU bank or credit servicing company to manage loan agreements with consumers. That requirement does not apply to commercial loans, or where the purchasing company is based in the EU. Credit purchasers or their representatives would also have various obligations to relay information on their activities to their ‘home’ regulator within the European Union.
4.29The second part of the Directive relates to the enforcement of collateral by banks when a borrower is not making sufficient loan repayments. While banks can enforce collateral under national insolvency and debt recovery frameworks, it argues that this process “can often be slow and unpredictable”, keeping the banks capital tied up and preventing it from engaging in new lending. Examples of inefficiencies in the debt recovery process are ‘collateral meltdown’ (the simultaneous sale of collateral by all lenders leads to a sharp fall in asset prices, and therefore a lower likelihood the collateral will cover the outstanding debt), and court congestion (when the judicial system of a Member State is unable to process legal debt recovery actions expeditiously).
4.30The proposed Directive would therefore require each Member State to establish, in law, a “more efficient” method to banks and credit purchasers to recover money from secured loans to business borrowers without recourse to legal action in court. Recovery of the collateral under this so-called “accelerated extrajudicial collateral enforcement procedure” (AECE) would take the form of a public auction, private sale, or outright appropriation of the asset by the creditor (in which case it would be free to keep the asset or sell it as it wishes). AECE be available only when agreed on in advance by means of the loan agreement between the lender and the borrower, and could not be used in relation to secured consumer credit agreements, such as residential mortgages.
4.31In order to ensure fair treatment of the business whose collateral is subject to recovery, the Directive would require the creditor to have the assets independently valuated to determine the appropriate reserve price for auction or private sale (or its value to the bank in case of appropriation). The valuer would have to be appointed by common consent of both lender and borrower, and the collateral could only exceptionally be sold for less than the reserve price (and never for less than 80 per cent of the estimated value). Any positive difference between the selling price and the outstanding debt would revert to the borrower.
4.32The Commission says the proposal is designed “so as to not affect preventive restructuring or insolvency proceedings and not to change the hierarchy of creditors in insolvency”, as “restructuring and insolvency processes prevail over the accelerated extrajudicial collateral enforcement procedure set out with this proposal”. The Minister’s Explanatory Memorandum does not explain whether the UK, should it be under an obligation to transpose the Directive into domestic law, would have to make any substantial changes to existing means of extra-judicial enforcement of collateral.
4.33The second legislative proposal of the March 2018 NPL package deals with banks’ prudential treatment of new lending, to ensure they maintain sufficient liquidity even when loans are not fully repaid.
4.34The proposal would amend the Capital Requirements Regulation (CRR) to create a ‘prudential backstop’: a requirement for banks to make “time-bound prudential deductions from own funds”. This, the Commission says, would reduce financial stability risks arising from high levels of insufficiently covered NPEs, by avoiding the build-up or increase of such NPEs with spill-over potential in stressed market conditions; and ensure that institutions have sufficient loss coverage for NPEs, hence protecting their profitability, capital and funding costs in times of stress. In turn, this would ensure that stable, less pro-cyclical financing is available to households and businesses.
4.35Concretely, the proposed amendment to the CRR would require all banks to have sufficient liquid funds to cover the incurred and expected losses on new loans once such loans become non-performing, up to a common minimum level (the ‘minimum coverage requirement’), made up of provisions recognised by the applicable accounting framework. Where an institution does not meet the minimum coverage requirement, the prudential ‘backstop’ would apply: a bank would have to deduct the difference between the level of the actual coverage and the minimum coverage from its statutory Common Equity Tier 1 (CET1) prudential capital.
4.36Under the Commission proposal:
None, as these are new proposals for legislation. However, we previously considered EU policy on non-performing loans in February 2018. See: Fifteenth Report HC 301–xv (2017–19),(28 February 2018).
40 Bulgaria, Croatia, Cyprus, Greece, Hungary, Ireland, Italy, Portugal and Slovenia. The UK, along with Luxembourg, Sweden and Finland, has one of the lowest levels of NPLs in the EU.
41 The overall stock of bad loans across the EU—amounting to €950 billion (£842 billion)—is also still higher than it was before the financial crisis.
42 (Council conclusions, 11 July 2017).
43 See our for more information on the first NPL progress report.
44 submitted by HM Treasury (16 April 2018).
45 This is because the Directive as currently drafted requires Member States to transpose the Directive into national law by 31 December 2020. Those provisions are to apply in domestic law from 1 January 2021.
46 See for example our Report of 2 May 2018 on a new EU Crowdfunding Regulation.
51 (Council conclusions, 11 July 2017).
52 See our for more information on the NPL progress report.
53 submitted by HM Treasury (1 February 2018).
54 submitted by HM Treasury (16 April 2018).
55 ‘Passporting’ into another Member State under the Directive would be subject to the debt management company having informed its domestic regulator of its intention do so in advance (after which this information would be communicated to the regulators of the other Member States in question).
56 Article 4 of the Directive requires credit servicing companies to apply for authorisation in an EU Member State before commencing operations, and article 5 restricts such applications to EU-based natural and legal persons.
57 Commission Impact Assessment .
58 For ‘social considerations’, it can also not be applied to the main residence of a business owner who takes out a commercial loan.
59 Where the two parties cannot agree upon the appointment of a valuer, one would be appointed by a decision of a court in the Member State in which the business borrower is established or domiciled.
60 Sale for less than the reserve price would only be possible where no buyer has been found willing to pay the full value, and there is a “threat of imminent deterioration of the asset”.
61 Or the valuation, in case of appropriation of the asset.
62 Article 32 of the draft Directive provides that “where insolvency proceedings are initiated in respect of a business borrower, the realisation of collateral pursuant to national laws transposing this Directive is subject to a stay of individual enforcement actions in accordance with applicable national laws”.
63 CET1 regulatory capital consists primarily of a bank’s common stock.
64 The definition is based on the concept of NPE in Commission Implementing Regulation (EU) No 680/2014, which is already commonly applied for supervisory reporting purposes. This definition includes, among others, defaulted exposures as defined for the purposes of calculating own funds requirements for credit risk and exposures impaired pursuant to the applicable accounting framework. The amendment would also introduce strict criteria on the conditions to discontinue the treatment of an exposure as non-performing as well as on the regulatory consequences of refinancing and other forbearance actions.
65 However, if the collateral against a secured loan has not been enforced after a number of years after the loan became non-performing, the credit protection would not be seen as effective and full coverage of the exposure amount would be deemed necessary.
Published: 8 May 2018