EU Banking Package (CRD VI / CRR III)

The Banking Package comprising Capital Requirements Regulation (CRR III), the Capital Requirements Directive (CRD VI) and a separate legislative proposal to amend the CRR in the area of resolution (the so-called ‘daisy chain’ proposal) was published by the European Commission (EC) on 27 October 2021. 

The EC proposal was subject to extensive negotiations. The European Council (Council) reached its position on the 2021 Banking Package on 8 November 2022, whereas the European Parliament’s (EP) Economics and Monetary Affairs Committee adopted the proposed CRD VI and CRR III on 24 January 2023. Thus, the trilogue discussion with Council and Commission are expected to start in March 2023.

The following blog post provides an overview of the regulatory developments with the respective positions of the EC, the Council and the EP on selected CRR III/CRD VI topics.

Third Country Branches (TCBs)

EC

The EC proposed that third country banks must set up a branch in a Member State and seek authorisation for that branch to commence or continue its activities unless the activities are provided on a reverse solicitation basis (article 21c CRD VI).

In addition, the EC proposed reforms to harmonise the treatment of the TCBs in Europe. Consequently, such branches would be subject to new minimum authorisation and supervision rules (incl. classification) and would be prohibited from conducting cross-border activities across other Member States (no passporting rights).

In terms of capital endowment requirements, the EC proposed the following:  for class 1 TCB - 1% of liabilities or minimum EUR 10 million, for class 2 TCB - EUR 5 million.

Council

The Council has the most relaxed approach to the treatment of TCBs in its proposal. The amendment text deletes article 21c CRD VI on the requirement to establish a branch and respective parts of Article 47 CRD VI on the scope and definitions. Instead, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) must submit a joint report on the merit and modalities of harmonising the conditions under which a third country group may be required to set up a branch in a Member State and obtain authorisation under Title VI of the CRD in order to provide banking services in that Member State.

The capital requirements set by the Council are between those of the EC and the EP: for class 1 TCBs – 2% (the EC proposes 1%) of the average liabilities over three years or a minimum of EUR 10 million and for class 2 TCBs – EUR 5 million.

EP

Overall, the EP’s stance on TBCs is stricter than the Council’s and more in line with the original proposal of the EC. The EP narrows the scope of article 21c CRD VI and excludes MiFID activities. In addition, according to the EP’s proposal, the continuation of activities would also require authorisation. Furthermore, competent authorities should have the power to require TCBs to apply for authorisation as a subsidiary if the branch has aggregate amounts of assets equal to or higher than 40 billion.

The EP level of capital endowment requirements is the highest: for class 1 TCBs – 3% of the average liabilities over three years or minimum EUR 10 million, and for class 2 TCBs – 0.5% of the average liabilities over three years, or minimum EUR 5 million.

Environmental, Social and Governance (ESG)

EC

The EC proposed an amendment in the CRR in order to introduce new harmonised definitions of the different types of risks in the universe of ESG risks. Since a large number of institutions remains outside of the scope of the CRR disclosure rules, article 449a “Disclosure of ESG risks” is therefore amended to extend the requirements related to the disclosure of ESG risks to all institutions, while respecting the proportionality principle. In addition to allow for better supervision of ESG risks, article 430 is amended to require institutions to report their exposure to ESG risks to their competent authorities.

Certain changes are also proposed in the CRD with the objective that short, medium and long-term horizons of ESG risks are included in credit institutions’ strategies and processes for evaluating internal capital needs as well as adequate internal governance.

Furthermore, the Commission proposed that the EBA shall submit a report on the potential Prudential treatment of exposures to environmental and/or social factors by 28 June 2023. 

Council

The Council’s text remains mostly unchanged from the original proposal by the EC. According to the Council, the submission of such a report by the EBA is not sufficient. In addition, the EC should also consider the legislative proposal relating to it.

EP

The EP makes more significant alterations to the EC proposal than the Council. The EP not only broadened the scope of the EBA report but also delayed the deadline to 31 December 2024. In addition, the EP significantly increased the reporting and disclosure requirements for the institutions, including the requirement to disclose information on entities in the fossil fuel sector, their climate targets and transition plans. The EP also instructed the EBA to issue guidelines for determining when a company’s primary source of revenue is from fossil fuels (e.g. exploration, mining, extraction etc.).

Capital requirements for crypto assets

EC and Council

At the time of the release of the EU Banking Package, there was no proposal from the Basel Committee for Banking Supervision (BCBS) on the prudential treatment of crypto assets exposures. The EC was therefore asked by the original proposal and the Council compromise to review whether a prudential treatment of crypto assets is necessary and to adopt a legislative proposal, if appropriate, based on the work of the BCBS.

EP

In the meantime, on 16 December 2022 the BCBS published the final version of the rules for the prudential treatment of crypto asset exposures to be implemented by 1 January 2025. On this basis, the EP amendment text requests the EC to present more details regarding the implementation of a dedicated prudential treatment for exposures to crypto assets, taking international standards and MiCA requirements into consideration, by 30 June 2023.

In addition, the EP draft legislation includes a single clause relating to crypto assets, requiring one euro of balance sheet capital for each euro of every crypto asset held (the 1-for-1 capital clause). This requirement is a transitional measure, which will apply until 30 December 2024. Specifically, institutions must apply a 1250% risk weight to their exposures to crypto assets in the calculation of their own funds’ requirements.

Furthermore, the EP proposal includes a new article on the disclosure of exposures to crypto assets and related activities.

Other key CRR III/CRD VI changes

Output floor

The output floor (OF) for risk-based capital requirements is a key part of the Basel III reforms and is a major point of disagreement among co-legislators. The EC’s original proposal for reducing the effect of the OF on the increase in the capital requirements involved OF calculation at the highest level of consolidation and proportional distribution across entities of the group. The EP supports the EC and the Basel committee, while the Council proposes calculation and application at all levels of consolidation, which is a politically sensitive issue.

Fit & proper

The EP’s stance on the fit & proper requirements is closer to the EC’s original proposal, while the Council simplifies the requirements by introducing a new article for key function holders. Despite simplification, the Council still allows competent authorities to remove management body members who do not meet the requirements. The EP suggests consulting anti-money laundering (AML) authorities for verification of the management body members.

Liquidity waivers

The EP has added a new element, namely a report by the EC on the possibility of allowing the application of the cross-border liquidity waivers. This was not included in the EC’s original proposal or in the Council’s compromise. The topic has caused battles in past negotiations of the previous Banking Package.

Specialised lending

The Basel III framework for unrated specialised lending exposures does not reflect the effects of security packages usually associated with some object finance exposures in the Union. For this reason, the EC introduced additional granularity in the standardised approach for credit risk (SA-CR). The original proposal offers a favourable capital treatment for ‘high quality’ unrated object finance exposures that comply with specific criteria. The determination of ‘high quality’ is subject to further conditions from the EBA. The EP supports the EC’s proposal of a ‘high quality object finance’ with 80% risk weight, while the Council proposes a report from the EBA on the definition and specific prudential treatment of a ‘high quality object finance’ subgroup and assigns a specific prudential treatment.

Unrated corporates

The EC’s proposal for a specific transitional arrangement for exposures to unrated corporates when calculating the OF to avoid disruptive impacts on bank lending to unrated corporates is kept in place by the Council and the EP. The Council has only slightly redrafted the text and left the transitional provision for unrated corporates for the calculation of the OF unchanged. The EP has kept the idea of the transitional period but proposed a higher risk weight of 70% in the last two years of the transitional period (2031-2032), instead of 65%.

Transitionals

The Council introduced the greatest number of transitional arrangements (nine) compared to the EC and EP (six). Four of the transitional provisions are presented in all three texts (implementation of the OF, unrated corporates for the calculation of the OF, equity exposures, and specialised lending exposures).

Credit risk, CCFs

The Council and the EP redrafted the CRR to increase the risk sensitivity of the SA-CR approach by aligning the credit conversion factors (CFFs) for off-balance sheet exposures to the Basel III standard. Off-balance sheet exposures will be split into five buckets with varying CCF percentages. The Council and EP moved trade finance off-balance sheet items from 50% CCF treatment to 20% to avoid a significant increase in the capital charge for this category.

Market risk

The CRR proposal introduces binding own funds requirements for market risk in line with the revised Basel fundamental review of the trading book (FRTB) standards, which are agreed upon by co-legislators. The Council agrees to the EC’s mandate to adopt delegated acts to amend the approaches for calculating the own funds requirements for market risk and to align with international developments. The EP provides a longer term for the delegated act (three years) and foresees a legislative proposal for a level playing field with third countries.

Securities financing transactions (SFTs)

The Council and EP have added mandates for EBA and EC on the prudential treatment of securities financing transactions (SFTs) in their texts.

Operational risk

The EC’s proposal for the calculation of the minimum own funds requirements for operational risk has been accepted by the Council and the EP. The proposal disregards historical operational loss data for all institutions to ensure a level playing field and simplify the calculation of operational risk capital, in accordance with the revised Basel standard.

Impact on Swiss financial institutions

The proposed changes in the Third Country Branches regime might have a significant impact on Swiss banks servicing clients in the European Union on a cross-border basis as well the ones that have a branch in the European Union.

In addition, banking groups operating in the European Union might be further affected by the estimated increase in the capital requirements.

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