We find the approach proposed by the EBA complex to implement. We believe that the definition of shadow banking should be based on an explicit list of types of entities or activities, as opposed to a definition by exception.
We also believe the list of excluded undertakings is too restrictive and remains unclear at this stage:
• There is no information on what would be considered “prudential and supervisory requirements that are at least equivalent to those applied in the Union”. Clarification from the EBA on what a regulated entity consists of would be welcome.
• If we refer to the Implementing Decision 2014/908/EU on the equivalence of the supervisory and regulatory requirements of certain third countries and territories, banks from only 17 countries outside the EU (see annex) would be excluded from the scope of shadow banking. This would mean, for example, that Korean banks and Turkish banks would be considered as shadow banking entities. This doesn’t seem justified by any economic investment rationale.
The definition proposed by the EBA does not consider any proportionality in the definition of shadow banking activities (“Shadow banking entities means undertakings that carry out one or more credit intermediation activities”) i.e. : any undertaking carrying these activities on an ancillary basis would be covered by this definition. We assume that this is not in the intention of the EBA to cover such entities. Thus we suggest that the EBA modifies its definition as follows:
“Shadow banking entities means undertakings that carry out, as their main business (…)”
We also suggest the EBA to clarify whether the identification of an activity as shadow banking should include at least one of the four proposed bank-like activities (maturity transformation, liquidity transformation, leverage and credit risk transfer) AND at least one of the eight activities proposed in paragraph 6 of Title I of the draft Guidelines (activities listed in annex I of CRD IV) OR these references are independent.
Indeed during the EBA’s public hearing, participants asked the EBA to explain how Money Market Funds match the proposed shadow banking definition, knowing that a fund (UCITS for instance) is defined as “an undertaking with the sole object of collective investment in transferable securities or in other liquid financial assets (…)” and thus does not meet any of the eight activities of Annex I of CRD IV listed by the EBA in the draft Guidelines. The EBA’s that MMFs meet the definition of shadow banking because they perform “liquidity transformation” as defined in the proposed guidelines. Our understanding is therefore that many other entities could fall in the shadow banking definition (for instance any LBO holding companies because they involve leverage).
Third country banks
Regardless of the country of incorporation, banks are always subject to authorisation and supervision by the local competent authority, hence should not be considered as shadow activities.
According to the definition proposed by the EBA, it is not clear how insurance companies could fall in the definition of shadow banking activities while EU and equivalent third countries insurance are explicitly excluded. The EBA should make clear if non-equivalent third countries insurance companies fall within this definition or not. It should be underlined that a first package of third country equivalence decisions under Solvency II has been adopted by the Commission .
We would rather consider that regardless of the country of incorporation, insurance companies are always subject to authorisation and supervision by the local competent authority, hence should not be considered as shadow activities.
We believe that the treatment of non-UCITS (and MMF) should be consistent throughout the large exposure framework, in particular considering Commission Delegated Act 1187/2014. The latter does not distinguish between UCITS and non-UCITS funds, but funds for which the structure does not add any additional risk to those borne by the funds’ assets.
In terms of challenges to the collection or provision of information to supervisory authorities, most European investment funds, be they UCITS or nationally regulated funds, already provide comprehensive information to the authorities, their investors and the wider public. The Alternative Investment Fund Manager Directive (AIFMD), in force since 2013, brings the quality of supervisory monitoring to an even higher level by imposing ambitious reporting requirements on managers of alternative investment funds:
Supervisory reporting is mandatory for most Alternative Investment Funds (AIFs) on a quarterly basis and includes detailed information on portfolio composition, principal exposures and most significant counterparty concentrations, risk profile and liquidity management.
The AIFMD reporting provides helpful data for assessing the interconnectedness between banks and other financial entities.
These requirements have been developed with the specific aim of enabling supervisory authorities to effectively monitor systemic risks associated with AIF management. Specific reporting is due by AIFs that use significant leverage (commitment in excess of 3 for 1 of capital).
The AIFMD reporting requirements are unique in the EU financial sector as regards their frequency and effectiveness.
Should the EBA proposed guidelines remain unchanged, the distribution of AIFs, which serve the purpose of credit institutions’ capital preservation and diversification, hence making them more resilient, would be massively hampered. Furthermore, we see no specific justification for singling out certain closed-ended and unleveraged AIFs, European Venture Capital Funds (EuVECAs), European Social and Entrepreneurial funds (EuSEFs) and European Long Term Investment Funds (ELTIFs). These provide useful and much needed financing to the EU businesses and economies.
As a consequence, except for those funds relying on a significant leverage, AIFs should also be excluded from the scope of shadow banking, as their regulation is now very close to that applicable to UCITS.
In addition, considering the implementation of recent European regulations applicable to Money Market Funds, we believe that these should also be excluded from the perimeter of shadow banking entities. Indeed, the European Parliament reached an agreement on MMFs in April 2015 opening the way to the implementation of a European Money Market funds regulation.
Securitization and asset financing SPV
The perimeter of securitization and SPVs to be integrated in the shadow banking scope also needs to be clarified. We believe the economic activity of the different types of vehicles needs to be the main criteria of analysis.
For example, leasing vehicles are created to detain an asset and are generally fully refinanced by a group of banks or the leaseholder client himself. The use of these SPVs in structured deals presents no regulatory arbitrage and shall not have any systemic effect. The loans granted by each bank to the SPV corresponds to the total risk exposure and the credit risk is calculated on the final client himself and not on the SPV. Therefore leasing vehicles do not belong to the shadow banking scope.
As mentioned in the introduction, the Capital Market Union encourages the development of market-based finance as an alternative to financing by banks, including activities that may be considered by the EBA as shadow banking. In addition, it is worth noting that the ECB has extended its Quantitative Easing policy to securitisation vehicles.
In its “Global shadow banking monitoring report 2014”, the FSB explicitly specifies securitisation and asset financing vehicles as examples of the “securitisation-based credit intermediation and funding of financial entities” performing an economic function.
We would also like to mention a recent EBA initiative related to defining simple and transparent securitisation which should be taken into consideration when defining the scope of shadow banking activities.
Double counting with Commission Delegated Act 1187/2014
The 1187/2014 Delegated Act requires from institutions to apply a look-through approach to:
- Equity investment in funds
- Credit exposure to securitisation structures
Under the 1187/2014 Delegated Act, if a look-through approach is not possible, institutions are requested to report their aggregate exposures to such structures on one single connected client (“unknown customer”). While this Delegated Act does not cover credit exposures to funds (such as loans, derivatives, SFT …), it does cover a part of the definition of the shadow banking, particularly the securitisation and the equity investment in funds parts.
The aim of this Delegated Act is to give an incentive to banks to have a better knowledge of their exposures to such structures and identify possible link between the underlying exposures to its existing customers. Given that the aim of the shadow banking limitation is to prevent systemic risk, the look-through approach and its fall-back (“unknown customer limit”) already cover this requirement by the identification or limitation of connection amongst counterparties.
Exposures to a shadow banking entity
It is not clear whether the 0, 25% threshold applies to a single exposure or to the aggregate exposure to a shadow banking entity. Could the EBA confirm that this limit is to be applied on a single exposure basis?
We share EBA’s view on the principle for effective processes and control mechanisms.
Moreover, Pillar 2 requirements regarding sectorial risk and concentration risk already exist and apply to banks. In fact, in the context of the overall large exposure regime under Part Four of the CRR, Article 395(2) states that the purpose of the guidelines is to set appropriate aggregate limits on large exposures or lower limits on individual exposures to shadow banking entities. However, the draft guidelines plan to set special Pillar 2 requirements which will apply exclusively to exposures to shadow banks. These additional requirements in paragraphs 1 and 2 in Title II are not necessary, in our view, since they are either already legally enshrined in the implementation of the CRD IV rules relating to Pillar 2 or are covered by the EBA’s new SREP guidelines. Moreover, the use of Pillar 2 measures in such a complex context will most probably result in very heterogeneous implementation, thus endangering level playing field among banks operating cross-border.
We believe the proposed Guidelines should only apply at consolidated level –our rationale is threefold:
- Usual large exposures limits set out in the CRR already apply to exposures to all types of counterparties and therefore include any counterparty that would be considered to be a “shadow bank” under the EBA’s proposed definition. These rules already apply at both solo and consolidated levels, hence a sufficient backstop already exists within the current framework. The enhanced protection against single name concentration risk that would be provided by the EBA Guidelines can still be achieved by applying it at the consolidated level.
- Applying the Guidelines at consolidated level only would make it easier for firms to manage them within the ICAAP process as individual legal entities may have only a partial view of shadow banking activities existing within a banking group. Consequently, the risk management process aimed at increasing senior management awareness would be effective only when performed at consolidated level (group view). This is also in line with the Pillar II approach.
- The burden of infrastructure, systems and processes that firms would need to put in place to comply with the Guidelines would be less onerous if applied at the consolidated level only.
We share EBA view on the principle for oversight arrangements.
Any aggregate limit should be set on homogeneous group of entities and according to the EBA’s mandate should not be set in addition to “tighter individual limits”.
We oppose the view to use the large exposure framework to set sectorial limits, all the more considering the proposed definition of the shadow banking sector which puts together all sorts of entities (asset financing entities, unregulated entities, etc…) which may not present any financial link to one another.
Indeed, there will be no interconnectedness between a US hedge fund, a Korean leasing company and a European Money Market Fund. An aggregate limit would be totally disconnected from the effective risk borne by institutions in relation to these counterparties.
In addition, we do not see the added value of the current individual limit proposal. Such practice is already implemented in all banks, based on their respective business model and risk appetite, irrespective of whether the counterparties would be considered shadow banking entities or not. Moreover, individual exposures are already subject to the large exposure limit, including in the specific case of the “unknown client” as defined in the Commission’s Delegated Act 1187/2014.
Our question concerning individual limits, is rather to understand the meaning of “tighter limits”. Clarification would be needed to explain “tighter than what?”
Measurement of the exposure
The setting of internal limits for OTC derivatives implies using internal metrics (Potential Future Exposure, or other internally modelled exposure measurement), which are not equivalent to those used for the purpose of large exposures measurement (currently: the Effective Expected Positive Exposure times a multiplier, or Current Exposure Method; in the future framework: the SA CCR).
We would like the EBA to confirm that internal limits for OTC derivatives as required by the proposed guidelines under the principal approach should not be set and measured by using large exposure framework metrics but by using internal metrics, in order to avoid unduly burdensome double calculations on these transactions.
The fall-back approach, in particular in option 1, seems arbitrary, very punitive, and with no incentive to implement proper policy: one single anomaly, regardless materiality or qualitative motivation, would have a detrimental effect on the whole population.
We consider that all measures that encourage institutions to resort to look-through approaches are more relevant in terms of risk monitoring.
Our preferred approach is option 2. However, we believe that it should be clarified as it is not properly calibrated as currently drafted. Please see our comments below.
The 25% limit seems arbitrary and, as an aggregate and sectorial limit, is not comparable to the current limit in the large exposures framework.
The large exposures framework applies to a client or a group of connected clients. As explained before, we do not believe the proposed definition of shadow banking entities would result in defining a set of shadow banking entities that are interconnected. On the contrary, most of them will be totally disconnected given the wide range of heterogeneous businesses they represent.
The figure has no rationale and is not commensurate with general activities run by banks with such different entities, in fact, we find it surprising that EBA is of the opinion that an aggregate limit of 25 % would be appropriate. As a reminder, CRD II carried an aggregate limit for all large exposures (exposures exceeding the 10%-threshold) of 800 % of own funds. On this basis, the proposed limit of 25% is far too low and obviously disconnected from the reality of actual volumes of transactions involved and business practices.