Response to consultation on draft RTS on the identification of a group of connected clients (GCC)
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The burden of the proof is on the credit institution’s side (not on the authority’s side) that can cause demands/requirements which are hard to fulfill.
Moreover, we consider the implementation into the management and systems of section 7 of EBA Guidelines of Group of Connected Clients now transposed in Art 3 of the draft RTS is challenging as interconnectedness due to economic dependency has to be identified between subsidiaries considering:
- Economic dependency relationships, as opposed to information from control relationships, require quite granular information, which may not be obtainable. In the case of economic dependencies such as supply chain links or dependence on large customers, it is a commercially sensitive inside information. Generally, the information to identify economic interconnectedness has to be available in relevant entities. It is difficult to identify this type of interconnectedness for small subsidiaries due to the lack of information.
Another issue is that in our experience in the application of the current guidelines, centralized databases are not available. Because of that, the procedures are very extensive and granular. It entails high costs and time regarding managing changeable information. Moreover, it is possible that different institutions will arrive at different results when analysing the same entities. The process is operationally complex and very burdensome, and manual routines are required with higher workload in the form of a more detailed analysis and more subjectivity.
- Assuming the information to identify economic dependency for relevant entities is available, the economic dependency will impact at Group level. Therefore, the identification of economic dependencies at Group level would simplify the process.
- In addition, when identifying an economic dependency at subsidiary level, we are of the view that the potential support of each Group to its subsidiaries in case of financial difficulties should be considered.
The guideline isn’t clear about whether or not pure natural persons without any commercial business that are interconnected to another natural person without any commercial business like husband and wife are in scope. Please see also our remarks on question 5.
More specifically, we consider the following cases to warrant further clarification:
- In the cases where the sum of all exposures to one individual client doesn't exceed 5% of Tier 1 capital, we consider that banks should just use readily available information with a proportionate approach, as it is stated in the current guidelines.
- There are aspects which might benefit from further guidance. Examples mentioned in the consultation document are comprehensive but universal. More detailed examples of group of connected clients in different industries would be beneficial. In terms of clarification, it is imperative for institutions to give due emphasis to the clause (cannot be replaced in a timely manner without excessively increased costs) – as, it could still be possible for the entity to easily (i.e., in a timely manner without excessively increased costs) find a replacement or to compensate for any losses (or foregone profits) inflicted by the party in financial difficulties without experiencing own repayment difficulties; in which case the institution does not need to consider these companies / persons as a single risk.
- In addition, it would be useful to have more information about the control and management procedures for identifying connected clients. For example, to what extent and at what point it is expected to collect data from large entities (several subsidiaries and sub-group parent companies). Bank’s KYC-procedure is already extensive, and the backgrounds are examined in connection with granting of credit. Also, often banks´ own guidelines instruct to form a group of connected clients even before granting credit. However, EBA’s guideline only talks about exposures (credit).
- Banks have many customers in different industries and of different sizes and partially therefore the group of connected clients has been perceived as complex. Sometimes it can be difficult to assess the significance of economic dependencies and/or control. From time to time some cases must be assessed case-by-case basis by interpreting the EBA guideline.
- Finally, we like to emphasize that when the RTS become effective, article 6 CRR make this RTS also compulsory for the large exposure regime at the individual bank basis. However, the Basel Large Exposure Framework is written from a consolidated view (see SCO10.1). However, Europe also applies the Large Exposure framework at the individual level. From the more than 70 paragraphs, the consultation paper only addresses in one paragraph (i.e. paragraph 22) that the draft RTS will also be applicable at intra group exposures of banking groups.
Therefore, it addresses the issues at a consolidated basis, but there is no extensive elaboration how the “consolidated” large exposure rules can also be applied on an individual basis toward subsidiaries and if this is the case, what issues emerge when looking at the group of connected clients. We are of the view that also in the cost benefit analysis EBA has not looked at this framework from the individual perspective. On page 35 of the consultation paper EBA writes that it only has performed the cost benefit analysis at the highest level of consolidation.
Although paragraph 5 of the draft ITS states that in exceptional cases no single risk prevails despite the paragraph 1, 2 or 4 of article 1, we considered it necessary that this is further explained and provided for with examples in the guideline and the wording in article 1 of the RTS.
For the individual Large Exposure analysis of EU banking groups, related policies and reports, adoption of this draft RTS without modification, would mean that almost the entire Banking Group (all direct and indirect subsidiaries of the ultimate mother that are in the IFRS consolidation), have to be considered as a single risk and therefore as one group of connected clients. Although the CRR leaves room for fully or partially exemption from the LE upper limit (25% of T1), we foresee increased:
o Compliance cost to identify all relevant exposures for the individual large exposure reporting
o Complications in the analysis on the possibility of exemptions and fulfilling the conditions for exemptions
o Risk of restrictions in intra group funding due to restriction set by the large exposure regime.
Without clear and sound guidance, the application of the large exposure rules at the individual basis could imply significant costs for large institutions in the Union with subsidiaries outside their own Member State.
In any case, we understand that the exemptions in articles 400 and 493 are not affected by paragraph 22, as is also suggested by footnote 6 of the consultation paper.
- Moreover, we believe that the relationship between General Partners / SGRs and Funds they manage as well as between Funds (including Private Equity Funds) and their related companies (SPVs / subsidiaries) deserve further explanation. Please see the the attached document and the annex in there for further elaboration.
Therefore, we would welcome the inclusion of those structures where risk is segregated (in addition to SPVs) and clarity in which cases it can be refuted to consider these exposures as single risks.
In addition, in paragraph 2 the ability to demonstrate no single risk may be challenging to implement in practice, especially if this would mean e.g. an audit trail for each decision. It should be possible for banks to implement these rules in their framework applying a rule based setup, built on the list in this Article and complemented with internal expertise on where applicable.
Article 2-1 j) should not apply to borrowers which benefit from a structuring enabling to isolate the borrower from the risk of bankruptcy of its shareholders, like in the case of specialized lending.
Hence, even if a 50% threshold would allow for more homogeneity of the identification criteria for economic dependents across the banking industry. We are of the view that, in addition to any quantitative analysis/threshold, a qualitative analysis should be carried out in the identification of economic dependency relationships.
As the industry concluded also in the GL consultation in 2017, a quantitative threshold restricts the tailored approach needed for adequately capturing the different qualitative angles and the different business models of a bank’s clients.
It is important to make a comprehensive case-by-case analysis, including the assessment of potential losses and their significance as well as how easy it is to replace the funding, in case of funding problems (if the economic dependency is based on funding source, the criteria of identification of economic dependents based on concentration of revenues or expenditures in one group will not be applied).
Question 1. Could you please indicate, if the approach of sections 4, 6 and 7 of the existing EBA guidelines, now transposed in the Articles of the draft RTS, remains sound and is implementable with no major challenge or unduly high costs. Please elaborate.
In general, guidelines leave too much discretion and too much room for interpretation to the authority, especially when considering economic dependency.The burden of the proof is on the credit institution’s side (not on the authority’s side) that can cause demands/requirements which are hard to fulfill.
Moreover, we consider the implementation into the management and systems of section 7 of EBA Guidelines of Group of Connected Clients now transposed in Art 3 of the draft RTS is challenging as interconnectedness due to economic dependency has to be identified between subsidiaries considering:
- Economic dependency relationships, as opposed to information from control relationships, require quite granular information, which may not be obtainable. In the case of economic dependencies such as supply chain links or dependence on large customers, it is a commercially sensitive inside information. Generally, the information to identify economic interconnectedness has to be available in relevant entities. It is difficult to identify this type of interconnectedness for small subsidiaries due to the lack of information.
Another issue is that in our experience in the application of the current guidelines, centralized databases are not available. Because of that, the procedures are very extensive and granular. It entails high costs and time regarding managing changeable information. Moreover, it is possible that different institutions will arrive at different results when analysing the same entities. The process is operationally complex and very burdensome, and manual routines are required with higher workload in the form of a more detailed analysis and more subjectivity.
- Assuming the information to identify economic dependency for relevant entities is available, the economic dependency will impact at Group level. Therefore, the identification of economic dependencies at Group level would simplify the process.
- In addition, when identifying an economic dependency at subsidiary level, we are of the view that the potential support of each Group to its subsidiaries in case of financial difficulties should be considered.
The guideline isn’t clear about whether or not pure natural persons without any commercial business that are interconnected to another natural person without any commercial business like husband and wife are in scope. Please see also our remarks on question 5.
Question 2. Have you identified any additional aspect(s) that would require clarification? In this vein, would you see the need for further illustrative examples (and if yes, on which precise situation or specific case)? Please elaborate.
Overall, we would prefer that the guidelines strike a good balance between rule-based guidance on economic dependencies and at the same time provide appropriate flexibility. The previous, and currently proposed, EBA approach based on a broader set of principles and examples, with a heavy emphasis on analysis and interpretation, requires a lot of manual work and may lead to differing outcomes in institutions, without a clear benefit.More specifically, we consider the following cases to warrant further clarification:
- In the cases where the sum of all exposures to one individual client doesn't exceed 5% of Tier 1 capital, we consider that banks should just use readily available information with a proportionate approach, as it is stated in the current guidelines.
- There are aspects which might benefit from further guidance. Examples mentioned in the consultation document are comprehensive but universal. More detailed examples of group of connected clients in different industries would be beneficial. In terms of clarification, it is imperative for institutions to give due emphasis to the clause (cannot be replaced in a timely manner without excessively increased costs) – as, it could still be possible for the entity to easily (i.e., in a timely manner without excessively increased costs) find a replacement or to compensate for any losses (or foregone profits) inflicted by the party in financial difficulties without experiencing own repayment difficulties; in which case the institution does not need to consider these companies / persons as a single risk.
- In addition, it would be useful to have more information about the control and management procedures for identifying connected clients. For example, to what extent and at what point it is expected to collect data from large entities (several subsidiaries and sub-group parent companies). Bank’s KYC-procedure is already extensive, and the backgrounds are examined in connection with granting of credit. Also, often banks´ own guidelines instruct to form a group of connected clients even before granting credit. However, EBA’s guideline only talks about exposures (credit).
- Banks have many customers in different industries and of different sizes and partially therefore the group of connected clients has been perceived as complex. Sometimes it can be difficult to assess the significance of economic dependencies and/or control. From time to time some cases must be assessed case-by-case basis by interpreting the EBA guideline.
- Finally, we like to emphasize that when the RTS become effective, article 6 CRR make this RTS also compulsory for the large exposure regime at the individual bank basis. However, the Basel Large Exposure Framework is written from a consolidated view (see SCO10.1). However, Europe also applies the Large Exposure framework at the individual level. From the more than 70 paragraphs, the consultation paper only addresses in one paragraph (i.e. paragraph 22) that the draft RTS will also be applicable at intra group exposures of banking groups.
Therefore, it addresses the issues at a consolidated basis, but there is no extensive elaboration how the “consolidated” large exposure rules can also be applied on an individual basis toward subsidiaries and if this is the case, what issues emerge when looking at the group of connected clients. We are of the view that also in the cost benefit analysis EBA has not looked at this framework from the individual perspective. On page 35 of the consultation paper EBA writes that it only has performed the cost benefit analysis at the highest level of consolidation.
Although paragraph 5 of the draft ITS states that in exceptional cases no single risk prevails despite the paragraph 1, 2 or 4 of article 1, we considered it necessary that this is further explained and provided for with examples in the guideline and the wording in article 1 of the RTS.
For the individual Large Exposure analysis of EU banking groups, related policies and reports, adoption of this draft RTS without modification, would mean that almost the entire Banking Group (all direct and indirect subsidiaries of the ultimate mother that are in the IFRS consolidation), have to be considered as a single risk and therefore as one group of connected clients. Although the CRR leaves room for fully or partially exemption from the LE upper limit (25% of T1), we foresee increased:
o Compliance cost to identify all relevant exposures for the individual large exposure reporting
o Complications in the analysis on the possibility of exemptions and fulfilling the conditions for exemptions
o Risk of restrictions in intra group funding due to restriction set by the large exposure regime.
Without clear and sound guidance, the application of the large exposure rules at the individual basis could imply significant costs for large institutions in the Union with subsidiaries outside their own Member State.
In any case, we understand that the exemptions in articles 400 and 493 are not affected by paragraph 22, as is also suggested by footnote 6 of the consultation paper.
- Moreover, we believe that the relationship between General Partners / SGRs and Funds they manage as well as between Funds (including Private Equity Funds) and their related companies (SPVs / subsidiaries) deserve further explanation. Please see the the attached document and the annex in there for further elaboration.
Question 3. After considering the circumstances set out in Article 1 that constitute a single risk by means of control, could you please indicate if the described circumstances are sufficiently clear? Please elaborate.
In paragraph 3 – natural persons wouldn’t have “management”. We suggest clarifying the wording in this regard.Question 4. Is the additional Scenario C 0 related to the determination of a group of connected clients by means of control, listed in Section 3.4.1 (Groups of connected clients based on a control relationship), sufficiently clear? Would you see need for further illustrative examples of a control relationship?
We would see need for additional examples considering there are structures different than SPVs, where the risk is segregated and there's no risk of contagious even though the control relationship exits.Therefore, we would welcome the inclusion of those structures where risk is segregated (in addition to SPVs) and clarity in which cases it can be refuted to consider these exposures as single risks.
Question 5. After considering the circumstances set out in Article 2 that constitute a single risk by means of economic dependency, could you please indicate if the described circumstances are sufficiently clear? Please elaborate.
The wording would suggest that groups need to be formed also for households. This should be clarified going forward.In addition, in paragraph 2 the ability to demonstrate no single risk may be challenging to implement in practice, especially if this would mean e.g. an audit trail for each decision. It should be possible for banks to implement these rules in their framework applying a rule based setup, built on the list in this Article and complemented with internal expertise on where applicable.
Article 2-1 j) should not apply to borrowers which benefit from a structuring enabling to isolate the borrower from the risk of bankruptcy of its shareholders, like in the case of specialized lending.
Question 6. In point (c) of Article 2(1), would you prefer following a quantitative approach by replacing the term “significant part” with a threshold of “50% or more” as envisaged in point 1 of LEX 10.16? What would be the advantages or disadvantages? Please elaborate.
We consider it is important to flag that the identification of economic dependencies is supported by a qualitative and quantitative approach. For this reason, we believe the replacement of the term “significant part” with a threshold of “50% or more” could weaken the comprehensive character of the analysis banks are pursuing on both ends as the focus will shift to the quantitative angle. As outlined in Article 2 of the RTS, economic dependency should be assessed according to various perspectives for determining the underlying dependency of a bank on an individual natural or legal person, such as (a) the risk of insolvency of the counterparty, the significance of the part of (b) guarantee, (c) funding, (d) supply or (e) receivables or liabilities of an entities, where (f) repayment risks may arise, (h) funding may not be replaced in a timely manner without excessively increased costs, (i) unified management basis and (j) administrative management decision may fall together with a major part of the same person.Hence, even if a 50% threshold would allow for more homogeneity of the identification criteria for economic dependents across the banking industry. We are of the view that, in addition to any quantitative analysis/threshold, a qualitative analysis should be carried out in the identification of economic dependency relationships.
As the industry concluded also in the GL consultation in 2017, a quantitative threshold restricts the tailored approach needed for adequately capturing the different qualitative angles and the different business models of a bank’s clients.
It is important to make a comprehensive case-by-case analysis, including the assessment of potential losses and their significance as well as how easy it is to replace the funding, in case of funding problems (if the economic dependency is based on funding source, the criteria of identification of economic dependents based on concentration of revenues or expenditures in one group will not be applied).