More than 8,200 European banks will need to hold more and better capital to resist future shocks, as part of a package of long-awaited proposals known as Capital Requirement Directive IV (CRD IV) outlined by the European Commission’s (EC) on 20 July 2011. These proposals translate the Basel III accord into draft European legislation and will supersede the existing Capital Requirements Directive. While the introduction of CRD IV will challenge EU banks’ resources, these proposals are designed to offer “a more solid foundation to ensure financial stability” and will further level the playing field for banks across the EU.
CRD IV contains two parts: a Directive, governing deposit-taking activities, and a Regulation, containing the detailed prudential requirements for credit institutions and investment firms. The Directive covers:
The main elements to the Regulation are:
The proposed Regulation reflects the introduction of a single set of harmonised prudential rules for banks and investment firms, meaning that national options and discretions will be removed and Member States only permitted to apply stricter requirements where justified by national circumstances, financial stability grounds, or a bank's specific risk profile.
However, the Regulation is flexible enough to allow national supervisors respond to their national specificities by setting additional capital requirements for banks at the appropriate levels. Michel Barnier, Member of the EC responsible for Internal Market and Services, said that national supervisors will be able to set the parameters applicable to some specific risks (e.g. real-estate credit) and the exact level of the counter-cyclical security buffer according to the local economic situation. Barnier believes that a single rule book was the only answer, as any national approach to reinforce bank stability would be - “illusory” in a Single Market.
Judgments about the impact of CRD IV on the total additional capital required by banks, and then the follow-through impacts of the rules on the volume and pricing of bank lending to non-financials, will be critical to assessing whether the Directive will achieve its stated aims.
The European Securities and Markets Authority (ESMA) is consulting on a series of guidelines, which if adopted, will clarify trading platforms and investment firms’ organisational requirements in relation to a highly automated trading environment under existing regulations. The guidelines are designed to reduce the risks that arise from highly automated trading under three areas: electronic trading systems, fair and orderly trading and market abuse.
ESMA proposes that trading platforms and investment firms should have governance arrangements to ensure effective monitoring of IT systems and trading controls in a highly automated trading environment: a clear process for accountability; communication of information and signoff for initial deployment; subsequent updates and resolution of problems identified through monitoring. To ensure markets have fair and orderly trading, trading platforms should have appropriate and proportionate organisational arrangements that reduce the possibility of orders reaching the marketplace that are unauthorised, in breach of risk management thresholds, erroneous or disruptive. Generally, trading facilities should have the ability to prevent access to their platforms and to cancel, amend or correct a transaction. For investment firms’ trading systems, ESMA’s guidance suggests that firms should generally block or cancel trades that:
Trading platforms will need to put in place sophisticated systems with capacity to accommodate high frequency generation of orders and transactions, to monitor orders entered and transactions undertaken and any other behaviour which may involve market abuse. Guidelines on investment firms are centred on both monitoring the activities of individuals/algorithms trading and training staff responsible for trading and compliance on market abuse.
ESMA expects to adopt final guidelines at the end of 2011. The guidelines will sit under the existing legal framework provided by MiFID and Markets Abuse Directive (MAD) which are currently under review, and so commentators need to consider them in that context. ESMA will revisit the guidelines when MiFID and MAD are finalised to consider whether they need to be adapted in the light of the new legislative framework.
In response to concerns about the risks of Exchange Traded Funds (ETFs), ESMA published a discussion paper on 22 July 2011, looking at the way to reduce the risks for retail investors and highlighting the potential systemic risk caused by ETFs and their impact on financial stability.
ESMA is seeking feedback on the following policy orientations for UCITS ETFs:
In relation to structured UCITS, ESMA sets out proposals on total return swaps and strategy indices.
Comments can be made on the discussion paper until 22 September 2011.
Systemically important financial institutions (SIFIs) will need to complete the first drafts of their recovery plans in less than five months and their resolution plans in less than 11 months, according to proposed timelines set by the Financial Stability Board (FSB). Supervisors and SIFIs are currently working closely together to create appropriate recovery and resolution plans for each firm. By December 2012, both the recovery plans and the resolution plans should be completed by firms and approved by supervisors.
Currently, resolution arrangements for firms vary greatly across jurisdictions. According to the FSB, an effective resolution regime should be built on a number of interdependent components:
The resolution authority should prevent any unnecessary losses in the value of assets and contagion across the financial system. This may require the difficult and time consuming task of extracting and preserving systemically important operations.
The FSB believes that an interim solution, such as a “bridge bank”, may be required in such cases, where the resolution authority could tap in to additional powers necessary to operate and resolve the firm including powers to terminate contracts and replace management and directors if necessary.
The Basel Committee on Banking Supervision produced a consultation report detailing the assessment methodology underpinning calculations on additional capital SIFIs will be required to hold under FSB proposals. The methodology for SIFIs is based on an indicator approach and comprises of five board categories:
The additional loss absorbency requirements range from 1-2.5% of Common Equity Tier 1, depending on the bank’s importance. The higher capital requirements will be introduced in parallel with Basel III capital conservation and countercyclical buffers and will be fully effective on 1 January 2019.
The EC wants every EU citizen to have access to a basic, affordable bank account irrespective of their financial position. Currently, Member States do not guarantee the availability of essential banking services and an estimated 30 million EU citizens over the age of 18 have no bank account. The EC is seeking to reduce this figure by establishing EU-wide principles giving customers the right to open and use a bank account with a number of basic features, such as ability to withdraw and lodge money and execute payment transactions. Access to such accounts will not be conditional on the purchase of additional services and the EC is quite explicit that banks should not offer any overdraft facilities in connection with these accounts.
At least one bank will be required to offer these basic payment accounts in each jurisdiction and the application process must be “transparent, fair and reliable”. Fees associated with the account should either be free or at a “reasonable charge”. Member States must ensure that appropriate and effective complaints and redress procedures are in place for the out-of-court settlement of disputes concerning rights and obligations and a competent authority is made responsible for monitoring effective compliance with these principles.
The financial industry generally opposes a binding EU instrument in this field, arguing that each country should develop its own solutions in light of its individual circumstances. However, the Commission believes that pan-European regulation is justified on social and financial grounds.
At present, ten EU countries have either regulatory codes (Belgium, France, Finland, Denmark, Sweden, and Netherlands) or voluntary codes (Germany, Slovenia, Italy, and UK) in place.