Including updates on CRD IV, financial transaction tax and resolution plans


Staying on top of hot topics: FTT and CRD IV

The UK launched a legal challenge to the EU financial transaction tax (FTT) on 18 April 2013 amid mounting concerns about the extra territorial impacts of the tax. It is believed the UK Government is challenging the use of the enhanced cooperation procedure to introduce the FTT. Whilst the motives of the UK Government are currently unclear, it appears that they are seeking to obtain changes to the structure of the proposed EU FTT regime, rather than to derail the proposals entirely. However, significant questions persist about the viability of the tax in its current guise. In our Global FS Tax Newsflash we set out the background to this challenge, its implications for the EU FTT and what institutions affected by the EU FTT should be doing now.


The European Parliament approved the Capital Requirements Directive (CRD) IV package on the 16 April 2013. The process bringing it into force is complex and depends on when the package is published in the Official Journal. To stay on top of CRD IV businesses will need to keep an eye on the bigger picture whilst delivering a complex technical programme with national flexibility. So now is the time to review and refresh CRD IV programmes to ensure they have the rigour and flexibility to respond to these challenges. In our Hot Topic we explain the legal and technical process and how some states will struggle to implement the directive in time meaning the same rules will not necessarily apply across the EU from 1 January 2014.


Managing intraday liquidity

The Basel Committee released the final version of its report on Monitoring tools for intraday liquidity management on 11 April 2013, following a consultation in July 2012. The paper outlines a set of intraday liquidity indicators to help supervisors monitor how well banks manage intraday liquidity risk.

The report stresses that no single indicator can provide supervisors with sufficient information on intraday liquidity risks or on how well risks are managed. In all there are seven primary intraday liquidity tools, not all of which will be applicable to all banks at all times:

  • daily maximum intraday liquidity usage
  • available intraday liquidity at the start of the business day
  • total payments
  • time-specific obligations
  • value of payments made on behalf of correspondent banking customers
  • intraday credit lines extended to customers
  • tool applicable to reporting banks which are direct participants
  • intraday throughput.

The Basel Committee outlines the reporting requirements of each indicator and supporting regulatory requirements. Although the indicators will apply specifically to internationally active banks, they have been designed equally to apply to all banks, including those that access payment and settlement systems indirectly via the services of a correspondent bank.

The crisis demonstrated the importance of understanding and managing the liquidity inflows in banks but what is the rationale for further guidance on intraday liquidity? The Basel III liquidity framework is centred upon two new minimum liquidity standards: the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio. Although the LCR is designed to promote the short term resilience of a bank’s liquidity profile, it does not currently include intraday liquidity within its calibration. The Basel Committee highlighted this weakness when the liquidity framework was first devised and later approved.

These indicators, if used and handled correctly, should give supervisors a better take on banks’ ability to meet payment and settlement obligations on a timely basis, both in normal times and in stressed conditions. The crisis demonstrated the importance of managing liquidity positions and the risks of meeting payment to meet payment and settlement obligations on a timely basis under stressed conditions are serious. Given the close relationship between the management of banks’ intraday liquidity risk and the smooth functioning of payment and settlement systems, the indicators are also likely to benefit those who oversee payment and settlement systems.


Europe and the US lag behind others in Basel III implementation

While the banking crisis was primarily a failure of the orthodox US and Western European banking model, the rest of the world is leading the way in implementing the package of reforms designed to make the banking system a safer place to do business.

Since October, eight more members have issued final Basel III-based capital regulations, bringing the total to 14. Eleven Basel Committee member countries now have final Basel III capital rules in force: Australia, Canada, China, Hong Kong, India, Japan, Mexico, Saudi Arabia, Singapore, South Africa and Switzerland. Three Basel Committee member countries – Argentina, Brazil and Russia – have issued final rules and will bring them into force by end 2013. The rest have also missed the 1 January 2013 deadline for issuing final regulations: EU members (nine countries), Indonesia, Korea, Turkey and the US.

Despite some delays in implementing Basel III regulations, global banks are making steady progress in strengthening their capital base to meet the new Basel III standards. The latest data collected by the Basel Committee indicate that, for the 12 months ending June 2012, on average large internationally active banks raised their capital ratios. For example, the average Common Equity Tier 1 (CET1) of capital ratios rose from 7.1% to 8.5% of risk-weighted assets at large global banks. For those banks that do not yet meet the fully-phased in requirements, CET1 capital shortfalls fell from roughly €450 billion to €200 billion. This is a sign that US and European banks are pushing ahead with implementing Basel III and not waiting for the final rules to be in place.

While the progress is positive, inconsistencies persist in how Basel III is implemented from country to country (e.g. definition of capital). This will undoubtedly generate opportunities for regulatory arbitrage as banks search for less onerous regulatory regime. This presents a significant challenge for the Basel Committee. A single rule book across global financial markets is unworkable, given the heterogeneous nature of markets. In some respects inconsistencies are good if they are tailored to the unique characteristics of the individual financial market and not motivated on competitiveness grounds. But even if done with the best of intensions, inconsistencies may result in risks building-up in certain regions and spilling over elsewhere. These problems are part and parcel of implementing regulations across international borders. The Basel Committee needs to be the forum where countries can debate these issues and work in tandem to mitigate any externalities which may arise.


The long road to resolution

The FSB published a Thematic Review on Resolution Regimes Peer Review Report on 12 April 2013 as it reviews compliance with its Key Attributes for Effective Resolution Regimes for Financial Institutions (October 2011).

The review found that some FSB countries (e.g. UK, US) have undertaken major reforms to their resolution regimes since the crisis. The implementation of the Key Attributes, however, is still at an early stage and legislative action is necessary to fully align resolution regimes in FSB jurisdictions to that standard.

In many countries, resolution authorities currently lack important powers needed to resolve systemic institutions, such as bail-in powers. In terms of the scope of the regime, most national authorities lack powers to take control of the parent company or affiliates of a failed financial institution, and do not have the authority and powers to resolve non-bank institutions that could be systemic upon failure.

Few countries currently have expedited procedures for giving effect to foreign resolution actions or have clear and dedicated statutory provisions for domestic authorities to share confidential information and cooperate for resolution purposes with foreign authorities. Finally, the FSB reports that most of its members lack a statutory resolution planning requirement or the power to require firms to make changes to their organisational and financial structures in order to improve their resolvability.

In Europe we are still waiting on political agreement on the Recovery and Resolution Directive (RRD), also known as the Bank Crisis Management Directive, which will introduce a harmonised approach to recovery and resolution in Europe. On 8 May 2013, the EU Council published a note on the state of play of discussions in the Council on RRD. The Council produced the note ahead of an ECOFIN meeting on 14 May 2013 at which the RRD will be discussed.

The note demonstrates that significant work is needed before the Directive is finalised. For example, the approach to bail-in, which the Council views as being central, is still undecided. The note sets out three possible approaches for the design of the tool:

  • A harmonised approach: derivatives would be the sole class of creditors that could be excluded from bail-in on a discretionary basis. This approach would also allow for insured depositor preference.
  • A discretionary approach: resolution authorities would have discretion on which liabilities should be excluded from bail-in.
  • A mixed approach: this approach would allow for a number of defined exclusions and a small number of discretionary exclusions.

It is hoped that discussions in ECOFIN on 14 May will facilitate the advancement of the Council negotiations. An integral part of banking union, the adoption of the Directive in advance of the launch of the single supervisory mechanism in the summer 2014 will create, in conjunction with CRD IV, the fundamental underpinning to the new supervisory regime. The Council has reiterated on a number of occasions the need to finalise negotiations on this legislation by June this year. Assuming the ECOFIN meeting does provide momentum through clarifying the direction of travel on this key issue, the Council may be in a position to confirm its approach to future negotiations with the Commission and EP (in trilogue) before the end of the Irish Presidency. Final agreement could then be expected in the fourth quarter of this year. Clarity on the way forward with regards to this Directive is also likely to influence the progress of the upcoming Commission proposal on a single resolution mechanism.