Analysis

The European Commission takes key steps towards a CRD6/CRR3 legislative proposal in 2020

Implementing the final elements of the Basel III framework in the European Union

Preparing for the CRD6/CRR3 legislative proposal

The European Commission is now preparing the European Union’s next bank capital legislative package, the sixth Capital Requirements Directive and the third Capital Requirements Regulation (CRD6/CRR3). This legislative proposal is expected to be published in mid-2020 and will implement the final elements of the Basel III framework agreed in December 2017 by the Basel Committee on Banking Supervision (often referred to by industry as “Basel IV”).

The CRD6/CRR3 package will be wide-ranging, but is expected to include core Basel III components as well as market risk. However, the Commission consultation also raises the prospective of further initiatives being included in the package, including:

  • Streamlining regulatory reporting;
  • Reflecting environmental, social and governance (ESG) risks in the capital framework; and
  • Enhancing the fit-and-proper requirements in the CRD to strengthen bank governance.

Six themes we’ll be following closely

As part of this preparatory work, the European Banking Authority provided the Commission with technical advice on the implementation of Basel III in August this year, and is expected to publish a second report with further advice by year-end. The Commission also issued a public consultation and held a day-long public hearing in Brussels on 12 November to debate the EU’s approach to implementing the Basel framework. The discussion brought to the fore six important themes:

  • Timing of implementation: the European Commission is committed to implementing the revised Basel III rules in line with the BCBS target date of 1 January 2022, with a five-year implementation period for the standardised output floor (running to 1 January 2027). However, there are growing doubts on the ability to meet this deadline given the complexity and importance of the package, and the likelihood of around two years of political negotiations for completion and an associated implementation period.
  • Faithful implementation of Basel standards: despite the determination of EU regulators to stick to the rules agreed by the BCBS, there is mounting pressure for the EU to modify the Basel III framework in implementation in order to mitigate the expected capital impact of the revised rules. Much of this debate centres on the calibration of the standardised output floor, which is intended to set a floor in capital requirements calculated by banks using internal models at 72.5% of those required under standardised approaches for calculating capital requirements for Pillar 1 risks. The intention here is to create a level playing field among banks and to increase trust in the robustness of internal models. Regulators are concerned that modifying this calibration may put at risk the international consensus achieved thus far, but the EBA recently issued a report projecting this calibration will generate a 24.4% increase in minimum capital requirements for EU banks, shaping this to be one of the most controversial points in the CRD6/CRR3 debate.
  • Reflecting European specificities: discussion has also centred on potential areas where the rules may need to be modified to suit the EU market, particularly those that are backed by strong evidence. A case in point is the treatment of exposures to unrated corporates under the revised standardised approach for credit risk. Several parties have argued that this penalises European banks, as EU SMEs are much less likely than their US counterparts to have a credit rating.
  • Proportionality: there is ongoing debate as to whether it is appropriate for the EU to apply the full BCBS bank capital framework to all banks, or whether a more proportional or tiered approach to implementation could be pursued. So far the feedback has been mixed, with officials at the European Commission arguing that since, in their view, smaller banks are not inherently less risk, they cannot justify applying relaxed prudential standards to them, although there may be ways to reduce the administrative burden of regulatory implementation.
  • Fragmentation in the EU banking market: there is continued concern about fragmentation of the EU banking market and the implications that this may have on cross-border consolidation and the financial efficiency of groups. This may lead the European Commission to make another attempt to allow home supervisors to waive sub-consolidated capital and liquidity requirements for Eurozone subsidiaries of Eurozone parent entities, though this attempt had failed in the CRR2 discussions.
  • More evidence from industry: the European Commission has launched a fresh consultation exercise (open for input until 3 January), and is keen to collect further evidence about the potential impact of the Basel III framework on European banks. This could strengthen its hand when making the case for deviations from the BCBS standards.  

Expected next steps in the proposal of CRD6/CRR3

The six areas of discussion outlined above will be central in determining the shape of the legislation that the Commission will propose next year, which will be very much aligned to the following work plan:  

  • The EBA is due to report back to the European Commission by year-end with its second impact assessment and technical advice on implementing the Basel III framework.
  • The European Commission will then draft the CRD6/CRR3 legislation implementing Basel III and carry out its own impact assessment.
  • CRD6/CRR3 is due to be proposed by the Commission in June 2020, although this depends on the speed of the legislative drafting process.
  • The proposal will then go through detailed legislative negotiations in both the European Parliament and the European Council before it can become law.

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