Changes from report parliamentary committee draft to plenary report

Added(9) To promote certain sectors of the economy, the Basel III standards provide for a supervisory discretion to enable institutions to assign, within certain limits, a preferential treatment to equity holdings made pursuant to ‘legislative programmes’ that entail significant subsidies for the investment and involve government oversight and restrictions on the equity investments. Implementing that discretion in the Union should also help fostering long-term equity investments.

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Added(10) Corporate lending in the Union is predominantly provided by institutions which use the internal ratings based (IRB) approaches for credit risk to calculate their capital requirements. With the implementation of the output floor, those institutions will also need to apply the SA-CR, which relies on credit assessments by external credit assessment institutions (‘ECAI’) to determine the credit quality of the corporate borrower. The mapping between external ratings and risk weights applicable to rated corporates should be more granular, to bring such mapping in line with the international standards on that matter.

RemovedArticle 1 – paragraph 1 – point 1 – point l, Article 4 – paragraph 1 – point 52f: (52f) ‘physical risk’, as part of the overall environmental risk, means the risk of any negative financial impact on the institution stemming from the current or prospective impacts of the physical effects of environmental factors on the institution’s counterparties or invested assets;

Added(11) Most EU corporates, however, do not seek external credit ratings, in particular due to cost considerations. To avoid disruptive impacts on bank lending to unrated corporates and to provide enough time to establish public or private initiatives aimed at increasing the coverage of external credit ratings, it is necessary to provide for a transitional period for such increase in the coverage. During that transitional period, institutions using IRB approaches should be able to apply a favourable treatment when calculating their output floor for investment grade exposures to unrated corporates.▌

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Added(11a) After the transition period, institutions should be able to refer to credit assessments by ECAIs to calculate the capital requirements for a significant part of their corporate exposures. EBA, European Supervisory Authority (European Insurance and Occupational Pensions Authority) (EIOPA) and European Supervisory Authority (European Securities and Markets Authority) (ESMA), should monitor the use of the transitional arrangement and should have regard to relevant developments and trends in the ECAI market. The transition period should be used to significantly expand the availability of ratings for European corporates. To this end, rating solutions beyond the currently existing rating ecosystem should be developed to incentivise especially larger corporates to become rated. Next to the positive externality the rating process generates, a wider rating coverage will foster, inter alia, the capital markets union. Avenues to attain this goal should consider the requirements related to external credit assessments, or the establishment of additional institutions providing such assessments, and might therefore entail substantial implementation efforts. Member States, in close cooperation with their central bank, should assess whether a request for the recognition of their central bank as ECAI in accordance with Article 2 of Regulation (EC) No 1060/2009 of the European Parliament and the Council and the provision of corporate ratings by the central bank for the purposes of this Regulation may be desirable in order to increase the coverage of external ratings.

RemovedArticle 1 – paragraph 1 – point 1 – point l, Article 4 – paragraph 1 – point 52g: (52g) ‘transition risk’, as part of the overall environmental risk, means the risk of any negative financial impact on the institution stemming from the current or prospective impacts of the transition to an environmentally sustainable economy on the institution’s counterparties or invested assets;

Added(11b) To inform any such future initiative on the set-up of public or private rating schemes, the European Supervisory Authorities (ESAs) should be requested to prepare a report on the impediments to the availability of external credit ratings by ECAIs, in particular for corporates, and on possible measures to address those impediments. In the meanwhile, the European Commission stands ready to provide technical support to Member States via its Technical Support Instrument in this area, e.g. to formulate strategies on increasing the rating-penetration of their unlisted corporates or to explore best practices on setting up entities capable of providing ratings or providing related guidance to corporates. The transition period should be extended only if necessary and justified and for four years at the most.

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Added(12) For both residential and commercial real estate exposures, more risk-sensitive approaches have been developed by the Basel Committee to better reflect different funding models and stages in the construction process.

RemovedArticle 1 – paragraph 1 – point 1 – point l, Article 4 – paragraph 1 – point 52h: (52h) ‘social risk’ means the risk of any negative financial impact on the institution stemming from the current or prospective impacts of social factors on its counterparties or invested assets;

Added(13) The financial crisis of 2008-2009 revealed a number of shortcomings of the current standardised treatment of real estate exposures. Those shortcomings have been addressed in the Basel III standards. In fact, the Basel III standards introduced income producing real estate (‘IPRE’) exposures as a new sub-category of the corporate exposure class which is subject to a dedicated risk weight treatment to reflect more accurately the risk associated with those exposures, but also to improve consistency with the treatment of IPRE under the Internal Rating Based Approach (‘IRBA’) referred to in Part III, Title II, Chapter 3 of Regulation (EU) No 575/2013.

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Added(14) For general residential and commercial real estate exposures, the loan splitting approach in Articles 124-126 of the Regulation should be kept, as that approach is sensitive to the type of borrower and reflects the risk mitigating effects of the real estate collateral in the applicable risk weights, even in case of high ‘loan-to-value’ (LTV) ratios. Its calibration, however, should be adjusted in accordance with the Basel III standards as it has been found to be too conservative for mortgages with very low LTV ratios.

RemovedArticle 1 – paragraph 1 – point 1 – point l, Article 4 – paragraph 1 – point 52i: (52i) ‘governance risk’ means the risk of any negative financial impact on the institution stemming from the current or prospective impacts of governance factors on the institution’s counterparties or invested assets;

Added(15) To ensure that the impacts of the output floor on low-risk residential mortgage lending by institutions using IRB approaches are spread over a sufficiently long period and thus avoid disruptions to that type of lending that could be caused by sudden increases in own funds requirements, it is necessary to provide for a specific transitional arrangement. For the duration of the arrangement, when calculating the output floor, IRB institutions should be able to apply a lower risk weight to the part of their residential mortgage exposures that is considered secured by residential property under the revised SA-CR. To ensure that the transitional arrangement is available only to low-risk mortgage exposures, appropriate eligibility criteria, based on established concepts used under the SA-CR, should be set. The compliance with those criteria should be verified by competent authorities. Because residential real estate markets may differ from one Member States to another, the decision on whether to activate the transitional arrangement should be left to individual Member States. The use of the transitional arrangement should be monitored by EBA. The transition period should be extended only if necessary and justified and for four years at the most.

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Added(16) As a result of the lack of clarity and risk-sensitivity of the current treatment of speculative immovable property financing, capital requirements for those exposures are currently often deemed to be too high or too low. That treatment therefore should be replaced by a dedicated treatment for ADC exposures, comprising loans to companies or special purpose vehicles financing any of the land acquisition for development and construction purposes, or development and construction of any residential or commercial immovable property.

RemovedArticle 1 – paragraph 1 – point 1 – point m, Article 4 – paragraph 1 – point 54: (54) ‘probability of default’ or ‘PD’ means the probability of default of an obligor over a one-year period, and, in the context of dilution risk, the probability of dilution over a one-year period;

Added(17) It is important to reduce the impact of cyclical effects on the valuation of property securing a loan and to keep capital requirements for mortgages more stable. In the case of a revaluation beyond the value at the time of the loan was granted, the property’s value recognised for prudential purposes should therefore not exceed the average value of a comparable property measured over a sufficiently long monitoring period, unless modifications to that property unequivocally increase its value. To avoid unintended consequences for the functioning of the covered bond markets, competent authorities may allow institutions to revalue immovable property on a regular basis without applying those limits to value increases. Modifications that improve the energy efficiency, and performance on improvements to the resilience, protection and adaptation to physical risks of buildings and housing units should be considered as value increasing.

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Added(18) The specialised lending business is conducted with special purpose vehicles that typically serve as borrowing entities, for which the return on investment is the primary source of repayment of the financing obtained. The contractual arrangements of the specialised lending model provide the lender with a substantial degree of control over the assets and the primary source of repayment of the obligation is the income generated by the assets being financed. To reflect the associated risk more accurately, those contractual arrangements should therefore be subject to specific capital requirements for credit risk. In line with the internationally agreed Basel III standards on assigning risk weights to specialised lending exposures, a dedicated specialised exposures class should be introduced under the SA-CR, thereby improving consistency with the already existing specific treatment of specialised lending under the IRB approaches. A specific treatment for specialised lending exposures should be introduced, whereby a distinction should be made between ‘project finance’, ‘object finance’ and ‘commodities finance’ to better reflect the inherent risks of those sub-classes of the specialised exposures class. Like for exposures to corporates, two approaches to assign risk weights should be implemented, one for jurisdictions allowing the use of external ratings for regulatory purposes and one for jurisdictions that do not allow it.

RemovedArticle 1 – paragraph 1 – point 1 – point m, Article 4 – paragraph 1 – point 55: (55) ‘loss given default’ or ‘LGD’ means the ratio of the loss on an exposure related to a single facility due to the default of an obligor or facility to the amount outstanding at default, and, in the context of dilution risk, the loss given dilution meaning the ratio of the loss on an exposure related to a purchased receivable due to dilution, to the amount outstanding of the purchased receivable;

Added(19) While the new standardised treatment for unrated specialised lending exposures laid down in Basel III standards is more granular than the current standardised treatment of exposures to corporates under this Regulation, the former is not sufficiently risk-sensitive to reflect the effects of comprehensive security packages and pledges usually associated with these exposures in the Union, which enable lenders to control the future cash flows to be generated over the life of the project or asset. Due to the lack of external rating coverage of specialised lending exposures in the Union, the treatment for unrated specialised lending exposures laid down in Basel III standards may also create incentives for institutions to stop financing certain projects or take on higher risks in otherwise similarly treated exposures which have different risk profiles. Whereas the specialised lending exposures are mostly financed by institutions using the IRB approach that have in place internal models for these exposures, the impact may be particularly significant in the case of ‘object finance’ exposures, which could be at risk for discontinuation of the activities, in the particular context of the application of the output floor. To avoid unintended consequences of the lack of risk-sensitivity of the Basel treatment for unrated object finance exposures, object finance exposures that comply with a set of criteria capable to lower their risk profile to ‘high quality’ standards compatible with prudent and conservative management of financial risks, should benefit from a reduced risk weight. EBA shall be entrusted to develop draft regulatory technical standards specifying the conditions for institutions to assign an object finance specialised lending exposure to the ‘high quality’ category with a risk weight similar to ‘high quality’ project finance exposures under the SA-CR. Institutions established in jurisdictions that allow the use of external ratings should assign to their specialised lending exposures the risk weights determined only by the issue-specific external ratings, as provided by the Basel III framework.

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Added(20) The classification of retail exposures under the SA-CR and the IRB approaches should be further aligned to ensure a consistent application of the correspondent risk weights to the same set of exposures. In line with the Basel III standards, rules should be laid down for a differentiated treatment of revolving retail exposures that meet a set of conditions of repayment or usage capable to lower their risk profile. Those exposures shall be defined as exposures to ‘transactors’. Exposures to one or more natural persons that do not meet all the conditions to be considered retail exposures should be risk weighted at 100% under the SA-CR.

RemovedArticle 1 – paragraph 1 – point 1 – point m, Article 4 – paragraph 1 – point 56: (56) ‘conversion factor’ or ‘credit conversion factor’ or ‘CCF’ means the ratio of the currently undrawn amount of a commitment from a single facility that could be drawn from a single facility before default and that would therefore be outstanding at default to the currently undrawn amount of the commitment from that facility, the extent of the commitment being determined by the advised limit, unless the unadvised limit is higher;;

Added(21) Basel III standards introduce a credit conversion factor of 10% for unconditionally cancellable commitments ('UCC') in the SA-CR. This is likely to result in a significant impact on obligors that rely on the flexible nature of the UCC to finance their activities when dealing with seasonal fluctuations in their businesses or when managing unexpected short-term changes in working capital needs, especially during the recovery from the COVID-19 pandemic. It is thus appropriate to provide for a transitional period during which institutions will continue to apply a null credit conversion factor to their UCC, and, afterwards, to assess whether a potential gradual increase of the applicable credit conversion factors is warranted to allow institutions to adjust their operational practices and products without hampering credit availability to institutions’ obligors. That transitional arrangement should be coupled with a report prepared by EBA.

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Added(22) The financial crisis of 2008-2009 has revealed that, in some cases, credit institutions have also used IRB approaches on portfolios unsuitable for modelling due to insufficient data, which had detrimental consequences for the robustness of the results and thus, for the financial stability. It is therefore appropriate not to oblige institutions to use the IRB approaches for all of their exposures and to apply the roll-out requirement at the level of exposure classes. It is also appropriate to restrict the use of IRB Approaches for exposure classes where robust modelling is more difficult to increase the comparability and robustness of capital requirements for credit risk under the IRB approaches.

RemovedArticle 1 – paragraph 1 – point 1 – point s, Article 4 – paragraph 1 – point 75a: (75a) ‘commercial immovable property’ means any immovable property that is not residential property;

Added(23) Institutions’ exposures to other institutions, other financial sector entities and large corporates typically exhibit low levels of default. For such low-default portfolios, it has been shown that it is difficult for institutions to obtain reliable estimates of a key risk parameter of the IRB approach, the loss given default (‘LGD’), due to an insufficient number of observed defaults in those portfolios. This difficulty has resulted in an undesirable level of dispersion across credit institutions in the level of estimated risk. Institutions should therefore use regulatory LGD values rather than internal LGD estimates for those low-default portfolios.

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Added(24) Institutions that use internal models to estimate the own funds requirements for credit risk for equity exposures typically base their risk assessment on publically available data, to which all institutions can be assumed to have identical access. Under those circumstances, differences in own funds requirements cannot be justified. In addition, equity exposures held in the banking book form a very small component of institutions’ balance sheets. Therefore, to increase the comparability of institutions’ own funds requirements and to simplify the regulatory framework, institutions should calculate their own funds requirements for credit risk for equity exposures using the SA-CR, and the IRB approach should be disallowed for that purpose.

RemovedArticle 1 – paragraph 1 – point 1 – point s, Article 4 – paragraph 1 – point 75b: (75b) ‘income-producing real estate exposure’ or ‘IPRE exposure’ means an exposure secured by one or more residential or commercial immovable properties where the fulfilment of the credit obligations related to the exposure materially depends on the cash flows generated by those immovable properties securing that exposure, rather than on the capacity of the obligor to fulfil the credit obligations from other sources; the primary source of such cash flows would be lease or rental payments, or proceeds from the sale of the residential property;

Added(25) It should be ensured that the estimates of the probability of default (‘PD’), the LGD and the credit conversion factors (‘CCF’) of individual exposures of institutions that are allowed to use internal models to calculate capital requirements for credit risk do not reach unsuitably low levels. It is therefore appropriate to introduce minimum values for own estimates and to oblige institutions to use the higher of their own estimates of risk parameters and those minimum values. Such risk parameters’ ‘input floors’ should constitute a safeguard to ensure that capital requirements do not fall below prudent levels. In addition, they should mitigate model risk due to such factors as incorrect model specification, measurement error and data limitations. They would also improve the comparability of capital ratios across institutions. In order to achieve those results, input floors should be calibrated in a sufficiently conservative manner.

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Added(26) Risk parameter floors that are calibrated too conservatively may indeed discourage institutions from adopting the IRB approaches and the associated risk management standards. Institutions may also be incentivised to shift their portfolios to higher risk exposures to avoid the constraint imposed by the risk parameter floors. To avoid such unintended consequences, risk parameter floors should appropriately reflect certain risk characteristics of the underlying exposures, in particular by taking on different values for different types of exposure where appropriate.

RemovedArticle 1 – paragraph 1 – point 1 – point s, Article 4 – paragraph 1 – point 75e: (75e) ‘exposure secured by residential property’, or ‘exposure secured by a mortgage on residential property’, or ‘exposure secured by residential property collateral’, or ‘exposure secured by residential immovable property’, means an exposure secured by residential immovable property;

Added(27) Specialised lending exposures have risk characteristics that differ from general corporate exposures. It is thus appropriate to provide for a transitional period during which the LGD input floor applicable to specialised lending exposures is reduced. The transition period should be extended only if necessary and justified and for four years at the most.

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Added(28) In accordance with the Basel III standards, the IRB treatment for the sovereign exposure class should remain largely untouched, due to the special nature and risks related to the underlying obligors. In particular sovereign exposures should not be subject to the risk parameters input floors.

RemovedArticle 1 – paragraph 1 – point 1 – point s, Article 4 – paragraph 1 – point 75f: (75f) ‘exposure secured by commercial immovable property’, or ‘exposure secured by a mortgage on commercial immovable property’, or ‘exposure secured by commercial immovable property collateral’ means an exposure secured by commercial immovable property;

Added(29) To ensure a consistent approach for all RGLA-PSE exposures, a new RGLA-PSA exposure class should be created, independent from both sovereign and institutions exposure classes▌.

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Added(30) It should be clarified how the effect of a guarantee could be recognised for a guaranteed exposure where the underlying exposure is treated under the IRB approach under which modelling for PD and LGD is allowed but where the guarantor belongs to a type of exposures for which modelling the LGD, or the IRB approach is not allowed. In particular, the use of the substitution approach, whereby the risk parameters of the underlying exposures are substituted with the ones of the guarantor, or of a method whereby the PD or LGD of the underlying obligor are adjusted using a specific modelling approach to take into account the effect of the guarantee, should not lead to an adjusted risk weight that is lower than the risk weight applicable to a direct comparable exposure to the guarantor. Consequently, where the guarantor is treated under the SA-CR, recognition of the guarantee under the IRB approach should lead to assigning the SA-CR risk weight of the guarantor to the guaranteed exposure.

RemovedArticle 1 – paragraph 1 – point 1 – point s, Article 4 – paragraph 1 – point 75g: (75g) ‘exposure secured by immovable property’, or ‘exposure secured by a mortgage on immovable property’, or ‘exposure secured by immovable property collateral’ means an exposure secured by residential or commercial immovable property;

Added(30a) In the context of removing unwarranted variability in capital requirements, existing discounting rules applied to artificial cash flows should be clarified in order to remove any unintended consequences. A mandate should be given to EBA to update its guidelines by 31 December 2025.

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Added(30b) The introduction of the output floor could have a significant impact on own funds requirements for securitisation positions held by institutions using the Securitisation Internal Ratings Based Approach(SEC-IRBA). Although such positions are generally small relative to other exposures, the introduction of the output floor could affect the economic viability of the securitisation operation because of an insufficient prudential benefit of the transfer of risk. This would come at a juncture where the development of the securitisation market is part of the action plan on capital markets union and also where originating banks might need to use securitisation more extensively in order to manage more actively their portfolios if they become bound by the output floor. A mandate should be given to EBA to report to the Commission on the need to eventually provide for a specific arrangement increasing the risk-sensitivity of the standardised approach of the purpose of the calculation of the output floor.

RemovedArticle 1 – paragraph 1 – point 1 – point t, Article 4 – paragraph 1 – point 78: (78) ‘one-year default rate’ means the ratio between the number of obligors or facilities that have defaulted during a period that starts from one year prior to a date of observation T, and the number of obligors, or the number of facilities where the classification as defaulted is applied at facility level pursuant to the second subparagraph of Article 178(1), assigned to this grade or pool one year prior to that date of observation T;

Added(31) Regulation (EU) 2019/876 of the European Parliament and of the Council amended Regulation (EU) No 575/2013 to implement the final FRTB standards only for reporting purposes. The introduction of binding capital requirements based on those standards was left to a separate ordinary legislative initiative, upon the assessment of their impacts for Union banks.

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Added(32) In order to complete the reform agenda introduced after the financial crisis of 2008-2009 and to address the deficiencies in the current market risk framework, binding capital requirements for market risk based on the final FRTB standards should be implemented in Union law. Recent estimates of the impact of the final FRTB standards on Union banks have shown that the implementation of those standards in the Union will lead to a large increase in the own funds requirements for market risk for certain trading and market making activities which are important to the EU economy. To mitigate that impact and to preserve the good functioning of financial markets in the Union, targeted adjustments should be introduced to the transposition of the final FRTB standards in Union law.

RemovedArticle 1 – paragraph 1 – point 1 – point v a (new), Article 4 – paragraph 1 – point 139: (va) point (139) is replaced by the following: / (139) ‘securities financing transaction’ means a transaction such as repurchase agreement, reverse repurchase agreement, security lending and borrowing, or margin lending transaction, where the value of the transition depends on market valuations and the transaction may be subject to margin agreements;

Added(33) As requested under Regulation (EU) 2019/876, the Commission should take into account the principle of proportionality in the calculation of the capital requirements for market risk for institutions with medium-sized trading book businesses, and calibrate those requirements accordingly. Therefore, institutions with medium-sized trading books should be allowed to use a simplified standardised approach to calculate own funds requirements for market risk, in line with the internationally agreed standards. In addition, the eligibility criteria to identify institutions with medium-sized trading books should remain consistent with the criteria set out in Regulation (EU) 2019/876 for exempting such institutions from the FRTB reporting requirements set out in that Regulation. A derogation is included to allow the banks to classify several types of instruments usually held in the trading book (including listed equities) as banking book positions, subject to the approval of the competent authority and when that position is not held with trading intent or does not hedge positions held with trading intent.

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Added(34) Institutions’ trading activities in wholesale markets can easily be carried out across borders, including between Member States and third countries. The implementation of the final FRTB standards should therefore converge as much as possible across jurisdictions, both in terms of substance and timing. If that would not be the case, it would be impossible to ensure an international level playing field for those activities. The Commission should therefore monitor the implementation of those standards in other BCBS member jurisdictions and, where necessary, should take steps to address potential distortions of those rules.

RemovedArticle 1 – paragraph 1 – point 1 – point w a (new), Article 4 – paragraph 1 – point 145 – point c: (wa) in point 145, point c is replaced by the following: / (c) it is subject to simplified obligations, in relation to recovery and resolution planning in accordance with Article 4 of Directive 2014/59/EU;