An update on the forthcoming CRD IV rules

On 27th March 2013, the Permanent Representatives Committee approved the compromise text on the Capital Requirements Directive, better known as the “CRD 4” package proposed to amend and replace the existing rules on capital requirements, applicable to banks and certain investment firms. The new proposals come in the form of a Directive that governs access to deposit-taking activities and a Regulation that establishes the prudential requirements that institutions need to respect.

The Directive

The Directive shall be transposed into national law be each Member State. This Directive has sought to address the following:

Capital buffers

Capital Conservation Buffer (applicable for all Banks) – The introduction of additional requirements for a Capital Conservation Buffer of CET 1 capital amounting to 2.5% of total risk exposure.

Counter-Cyclical Buffer (Institution-specific) – The introduction of a counter-cyclical capital buffer of up to 2.5%; hence the national Authority shall be responsible for setting the rate and financial institutions shall set their buffer on the basis of their credit exposure to various jurisdictions.

Systemic Risk buffer – This buffer, composed of additional CET 1 capital, may be introduced by Member States subject to certain limits, beyond which the Commission’s approval would have to be sought. In addition, buffer requirements specific to global systemically important institutions (SIIs) shall be mandatory, whilst these shall be voluntary for other (e.g. EU and domestic) SIIs.

Bankers’ bonuses

As from 2014, Bankers’ bonuses in relation to performance carried out in 2014, shall be no greater that their fixed salary that is 1:1 fixed to variable remuneration. This ratio may be raised to a maximum of 2:1 subject to a number of pre-defined conditions being met. The European Banking Authority shall also be issuing the necessary guidelines, and will also work closely with the Commission to review and report on these provisions bearing in mind their impact on financial stability and competitiveness.

Governance and Transparency

Institutions shall be required to publically disclose the number of employees per institution in the group and their net banking income, as from 1st January 2014. Other stringent and more onerous disclosures shall apply to Global and Other systemically important institutions as from 2015, subject to the Commission’s decision.

The expiry of this provision, commonly referred to as a “sunset” clause may apply should such provision be dealt with in the forthcoming Accounting Directive.

The Regulation

The Regulation will become binding on all Member States once it enters into force. The main areas bringing substantial changes address the following:

Capital requirements

Banks and Investment firms are to hold increased Common Equity Tier 1 (CET 1 – subject to pre-defined criteria) capital from 2% to 4.5% of risk weighted assets (i.e. between 4% to 4.5% until December 2014). The quality of the CET 1 instruments shall be monitored by the European Banking Authority.

Liquidity requirements – Liquidity Coverage Ratio (LCR)

Institutions shall be required to hold liquid assets amounting to no less than the net liquidity outflows the institution might experience during a 30-day stressed period, and during which time such institutions may utilise their liquid assets to cover their net liquidity outflows. Liquidity inflows are also limited to 75% of liquidity outflows in order for institutions not to rely on expected inflows so as to meet their outflows, but rather hold a minimum amount of liquid assets equivalent to 25% of their outflows.

Following an initial observation period, the LCR shall be introduced in 2015 starting at 60% and reaching 100% in 2018; until such time, member states may continue to adopt or introduce their own liquidity requirements.

Net stable funding ratio (NSFR)

The Commission will submit a legislative proposal by 31st December 2016 in terms of the NSFR which shall addresses longer term funding.

Leverage ratio

The leverage ratio being a non-risk based measure shall be introduced from 1st January 2018 once agreed upon by the Council and Parliament on the basis of a report that is envisaged to be drafted by the Commission by 31st December 2016, following an observation period whereby institutions shall be required to disclose their leverage ratio as from 1st January 2015, on the basis of their respective business models.

National flexibility: Macro-prudential powers

For up to two years, the respective Member States’ regulators are allowed to enforce stricter macro-prudential requirements for domestically licensed financial institutions in order to better address risks to financial stability, subject to the Council’s approval. These requirements include:

• The level of own funds
• Liquidity requirements
• Large Exposures requirements
• The level of the capital conservation buffer
• Public disclosure requirements
• Intra-financial sector exposures
• Property Assets Risk Weights

Finally, following the 27th March 2013 approval of the comprise text, it is expected that once the European Parliament approves these texts, the Council will also approve the same without further discussion, that have been on-going since May 2012. Therefore, these rules will apply from 1st January 2014 if publication within the Official Journal takes place by 30th June 2013.