Documents considered by the Committee on 16 May 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 25 May 2018

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 Directive6 and Regulation,7 and the Bank Recovery & Resolution Directive8—in line with the most recent international standards. We set out the substance of the proposals in some details in our previous Reports.9

2.2The Government has been broadly supportive of the package of reforms,10 but it has sought to use the legislative deliberations among Member States within the Council to address 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 the context of the UK’s exit from the EU, the Government has also actively opposed a proposed new requirement for large non-EU banks and investment firms with operations in more than one Member State to create an intermediate, independently-capitalised EU-based parent undertaking (IPU) to facilitate group supervision and resolution.11 This would have a direct impact on UK banks, whose operations within the Single Market would require a larger (and therefore more costly) presence in the EU after the UK loses its ‘passporting’ rights for financial services when it becomes a “third country” (either on 29 March 2019 or at the end of the post-Brexit transitional period).

2.4We last considered the RRM package in March, when the Bulgarian Presidency had hoped to broker a general approach among Member States at the ECOFIN Council.12 Such agreement did not in the end materialise because “further work was needed” to overcome the remaining areas of contention, namely:13

2.5By letter of 2 May 2018, the Economic Secretary (John Glen) informed us that the Bulgarian Presidency of the Council is again seeking adoption of a general approach at the next meeting of EU Finance Ministers (on 25 May 2018) pending full resolution of the outstanding matters described above.18 From his letter, it is clear that the above issues mostly remain to be resolved, and as a result negotiations within the Council working party are likely to continue right up to the ECOFIN meeting:

2.6The Minister has also again asked the Committee for a scrutiny waiver to enable the Government to vote in favour of a legal text at the ECOFIN meeting which “meets UK objectives”, as he believes “there is a pathway to reaching a compromise on these outstanding issues that meets our negotiating objectives”. The European Parliament’s Economic and Monetary Affairs Committee is due to vote on the RRM proposals in June, which would enable trilogue negotiations between the Council and MEPs to start shortly before or just after the 2018 summer recess. It is not yet clear when the proposals could be formally adopted, and consequently when they might take effect, but the Minister has previously told he is “confident that formal adoption of the Risk Reduction Measures package will be met before the UK’s withdrawal from the EU”.

2.7Once the finalised RRM package is published in the Official Journal, it will be possible to assess whether the new legislation, or parts thereof, will take effect during the post-Brexit transitional period (during which EU law would continue to apply in the UK). Under the current draft of the Article 50 Withdrawal Agreement, this transition is due to last until 31 December 2020 (just after the date when all Member States would have had to have transposed the new Capital Requirements Directive into domestic law under the current timetable).21

2.8By extension, until the amendment to the Capital Requirements Directive is formally adopted, it is also unclear when exactly non-EU banks within the scope of the new IPU requirement (including the 17 UK banks and investment firms identified by the Treasury) would have to establish a holding company within the EU: under the terms of the Council’s approach, this would not become a binding obligation until seven years after the new legislation is adopted.22

2.9In light of the Minister’s assurance that the EU Finance Ministers are expected to agree on the incorporation of new international prudential standards into EU law—in line with the UK’s objectives as set out in his letters of 28 February23 and 21 March 201824—and given the seven-year transitional period before the IPU requirement would concretely affect UK banks as ‘third country’ firms after the RRM package is formally adopted,25 we are content to grant him a scrutiny waiver ahead of that ECOFIN Council meeting on 25 May 2018. This will allow the Government to endorse the Member States’ common position if it considers it appropriate to do so.

2.10The long transitional period for the entry into force of the IPU requirement notwithstanding, we remain concerned about its costs for the UK banks within its scope after our exit from the Single Market (either on 29 March 2019 or at the end of any subsequent transitional period). The precise impact of this new obligation on the British banking industry cannot be known, as it is inextricably tied to the wider uncertainty around bilateral access for UK and EU financial services providers to each other’s markets after the UK becomes a ‘third country’ for the purposes of EU law. As we have described in our other recent Reports on EU financial services policy,26 a severe reduction in cross-border market access for UK firms to the EU market is the default result of the UK’s exit from the Single Market. There is no indication that the remaining Member States are willing to consider the Government’s proposal of market access based on mutual recognition of regulatory standards, but without a common rulebook or enforcement structures.

2.11In light of this, the default presumption must be that UK banks will be treated as ‘third country’ institutions from the moment of our exit from the Single Market. That underlines the importance of the Government maximising its input into the RRM package while it still retains representation within the EU institutions. The Minister’s reassurances about the speedy adoption of the legislation notwithstanding, we are concerned that any delays in the process could push back formal adoption of the RRM legislation until after the UK loses its vote within the Council in March 2019. The Committee will therefore keep a close eye on the likely timetable for formal adoption of the RRM package and the extent to which the UK’s priorities for this file are preserved in the Presidency’s negotiations with the European Parliament on the final legal texts. In light of this, we emphasise that the scrutiny reserve will continue to apply after the May ECOFIN Council.

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.

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); Fifteenth Report HC 301–xv (2017–19), chapter 1 (27 February 2018); and Seventeenth Report HC 301–xvii (2017–19) chapter 2 (7 March 2018).


6 Directive 2013/36/EU on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms.

7 Regulation 575/2013 on prudential requirements for credit institutions and investment firms.

8 Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment firms.

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

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

11 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.

13 See letter from John Glen to Sir William Cash (21 March 2018).

14 The Bank of England currently requires full subordination of MREL for firms with a bail-in resolution strategy.

15 Market risk prudential requirements mean banks have to hold more regulatory capital to compensate for any substantial exposure to securities and derivatives.

16 In the UK, exempted institutions include credit unions and municipal banks. The current discussions do not affect the existing derogations so the impact on the UK is minimal.

17 The transition period would grant affected non-EU banks seven years after the Directive comes into force before the IPU requirement becomes binding. So the IPU requirement would become effective in early 2026.

18 Letter from John Glen to Sir William Cash (2 May 2018).

19 MREL subordination enables ‘bail-inable’ resources of a bank to rank below (and therefore absorb losses before) liabilities related to day-to-day operations and critical economic functions of a bank in the case of its insolvency. The Bank of England currently requires full subordination of MREL for firms with a bail-in resolution strategy.

20 However, the Minister notes that UK banks with existing holding companies in the EU may not “necessarily structure themselves under those holding companies to meet an IPU requirement”.

21 The transposition date would be 18 months after formal adoption of the Directive, which would be in early 2019. That puts the deadline for transposition into domestic law in late 2020.

22 The transitional period before the IPU requirement takes effect still needs to be agreed with the European Parliament. The impact the IPU obligations could have on British banks will also depend on the precise relationship between UK and EU banking legislation after the end of the transition, which remains to be negotiated as part of the broader UK-EU trade agreement.

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

24 Letter from John Glen to Sir William Cash (21 March 2018).

25 Any future UK-EU agreement on financial services which may exempt UK institutions from this requirement notwithstanding. This is the Government’s objective, but there has been no indication the EU is willing to concede such status for a financial services industry not bound by the EU’s financial services rulebook, regulatory oversight and jurisdiction of the Court of Justice of the EU.

26 See for example our recent Reports on delegation in the asset management industry; prudential requirements for investment firms; and the Crowdfunding Regulation.




Published: 22 May 2018