Whilst we are supportive of the overarching objective to increase the resilience of the EU's financial system, we do not agree with the approach the EBA has proposed for the purposes of defining shadow banking entities. The Consultation has defined shadow banking entities as entities that:
Carry out credit intermediation activities, defined as bank-like activities involving maturity transformation, liquidity transformation, leverage, credit risk transfer or similar activities; and are not within the scope of prudential consolidation nor subject to solo prudential requirements under specified EU legislation (or equivalent third country legal frameworks). Entities referred to in Article 2(5) and Article 9(2) of Directive 2013/36/EU (CRD) are also not to be regarded as shadow banking entities.
Whilst we support the move away from the FSB paper on shadow banking, which attempts to categorise by vehicle type rather than the activity it carries out, we still have the following additional concerns:
a) the EBA has defined shadow banking entities too broadly and without an adequate assessment of which activities fall within the definition. We are specifically concerned that this definition would capture any entity whose business happens to include lending or credit, regardless of whether this is the entity's main business;
b) the general reference to bank-like activities" is overly broad as it could be seen to cover any entity whose activities involve "maturity transformation" and/or "leverage". Although it appears that for the purpose of the guidelines these activities must be "bank-like", further clarification is required as to exactly what this means; and
c) the EBA lists examples of entities that carry out credit intermediation and this includes a broad list, for example special purpose vehicles. We would stress the importance that shadow banking should be identified by reference to economic activity and not vehicle type. It should be noted that the same sort of "entity" for labelling purposes can pose very different levels of risk. In addition, entities that do not feature in a pre-determined list could carry out the same activity as one that does. Simply regulating entities by way of vehicle categorisation is potentially dangerous, and could lead to unintended consequences for low risk investment vehicles. Furthermore, we consider that it would be very difficult to categorise shadow banking entities accurately, particularly given the rate of financial product/vehicle evolution, which could potentially render any definitions outdated within a short space of time.
As a result, we do not consider the definition, as currently drafted, is workable in practice particularly because corporates, borrowing through their Treasury companies could be captured. This reduces these entities' access to credit with an ultimate cost to employment and growth.
Furthermore, banks will be required to make a determination on a borrower-by-borrower basis as to whether that borrower falls within this definition. Assuming that it will not be permissible simply to accept a borrower's undertaking that it does not engage in these activities, it will therefore be necessary for each bank to establish a set of metrics to classify borrowers. Such metrics will presumably have to be objective rather than judgement-based, and (presumably) based on publicly available data. It is almost impossible to envisage such a system not coming up with significant unintended consequences; the most important of which is that commercial businesses whose data inadvertently contravenes such metrics may find themselves cut off from the banking system as a whole as a source of finance. Given the number of borrowers this could capture, this will be an extremely difficult task to manage. It seems to us that the "definition" contained in the consultation paper is not capable of being reduced to easily applicable metrics, and is in fact designed primarily as a guide to the application of expert judgement. If this is the case, such judgement should be exercised by the public sector, and not be left to individual banks.
In order to mitigate these concerns, it is our view that a concept of materiality should be introduced at the very least. The LMA raised a similar point when it responded on CRD IV in May 2012, which related to the drafting/interpretation of the legislation and its possible impact for the syndicated loan market. In the end, the following definitions were included in Article 142(5):
‘unregulated financial sector entity’ means an entity that is not a regulated financial sector entity but that performs, as its main business, one or more of the activities listed in Annex I to Directive 2013/36/EU or in Annex I to Directive 2004/39/EC"
and, with respect to Article 411(1):
‘financial customer’ means a customer that performs one or more of the activities listed in Annex I to Directive 2013/36/EU as its main business, or is one of the following .... ".
In our view, by adding a concept of materiality will mean that companies, which carry out these activities as an ancillary part of their business, are not caught by the legislation. It also permits institutions to carry out a practical and meaningful assessment as to whether an entity falls within these definitions."