In November 2016, the European Commission published proposals for the revised Capital Requirements Directive, known as CRD V. These proposals represent the EU’s attempt to legislate for rules being globally agreed at the Basel Committee for Banking Supervision. The proposal will likely lead to a substantial increase of capital requirements, particularly for large banks, and will require huge efforts at implementation.
So what do the proposals mean for firms and how should they take steps to prepare? Tessa Norman, Hortense Huez, Luis Prazeres and Ben Higgin from our Financial Services Risk and Regulation practice discuss this and more in our video.
Watch it and find out:
Hello and thanks for joining us for this Being better informed video from the Financial Services Risk and Regulation Centre of Excellence team. I am joined by Ben Higgin, Luis Prazeres and Hortense Huez.
Today we will cover the European Commissions’ proposals for the revised Capital Requirements Directive, known as CRD5. So Ben, first off were there any surprises in the package?
So the package was largely as we were expecting with one last minute addition and that’s a requirement for non EU groups that have two or more subsidiaries within the EU to now have an EU parent company. That entity needs to be authorised and it needs to be subject to all the prudential requirements. Now you could see this as a response to the US where they have got a similar regime or indeed in response to Brexit – either way it’s quite a big thing for non EU firms to factor into their plans and it makes the situation even more complex for those firms that are thinking about restructuring as a result of Brexit.
OK, and how does the proposals compare to the current CRD4 and Basel framework?
Largely similar – one main difference is proportionality – so they have introduced a simpler compliance and reporting regime for smaller firms which should be good news to them. There are also some EU specific nuances, so for example in things like the leverage ratio where they’ve excluded public lending from public development banks etc. So there are a couple of other changes that people just need to watch out for.
OK, and Luis, apart from the new proposals around parent companies, what else do firms need to think about in terms of their implementation plans?
OK, so in terms of FRTB the changes are really fundamental, they are really deep and wide across banks, for example there is a move within the internal models approach from VAAR to short fall. And that is really fundamental because it’s a new way of calculating risk and the new measure and is more aligned with individuality because it’s based on the tail risk. Other changes, we have a couple of tests that the banks need to pass in order to keep that…the IMA approach which is the back testing and the P&L attribution. If you fail that you default to the standardised approach which is a risk sensitivity based approach, there is a new methodology so we have challenges in terms of data and infrastructure and systems and processes within the bank. Also you have a very strict boundary between the trading and banking book and you have issues with the broken hedges, you are restricted in terms of internal risk transfers, which is another issue that banks are dealing with. And, finally, this is all desk based so you need to have a very specific approval for each desk across the trading book and that’s fundamental changes for banks.
OK, so lots for firms to be thinking about. And finally Hortense what other areas do firms need to focus on at the moment?
So, CRD5 focuses on a lot of different areas, so firms will have to think about the interactions between the different requirements. One area where firms will need to spend time is the Net Stable Funding Ratio otherwise known as NSFR, in this a specific topic is the treatment of derivatives which is a bit more beneficial than Basel 4 but something to watch out for. The other area is the standardised approach to counter party credit risk, because this will be used also in the leverage ratio requirement, the large exposure and also in an NSFR where depending on whether you can use it, it could be beneficial or not – firms will have to figure that out. So overall the package shows a lot of additional complexity compared to the current rules and lots of risk factors that firms will have to look at and refine and I think firms will need to look at their infrastructure, their data granularity processes and controls and see whether they are fit for purpose. Also, another area is looking at their project mix and how it fares when you look at the regulatory requirements, the profitability and the cost in a balance. OK?
Thank you all. If you would like to find out more about the steps you need to take to prepare for this banking reform package please get in touch with us. You can also read our Hot Topics on CRD5 for a more detailed analysis.
Director, Financial Services Risk and Regulation, PwC United Kingdom
Tel: +44 (0)20 7804 5421