Explanatory Memorandum to COM(2011)453 - Access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2011)453 - Access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms. |
|---|---|
| source | COM(2011)453  |
| date | 20-07-2011 |
Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions contains provisions closely related to the coordination of national provisions concerning the access to the activity of credit institutions and their supervisory framework (such as provisions governing the authorisation of the business, the the exercise of the freedom of establishment, the powers of supervisory authorities of home and host Member States in this regard, and the supervisory review of credit institutions). However, that Directive, Directive 2006/49/EC and in particular their annexes also set out prudential rules. In order to approximate further the legislative provisions that result from the transposition of Directives 2006/48/EC and 2006/49/EC into national law and in order to ensure that the same prudential rules directly apply to them, which is essential for the functioning of the internal market, these prudential rules are subject of the proposal for a Regulation [inserted by OP], with which this proposal forms a package.
This proposal contains the following new elements: Provisions on sanctions, effective corporate governance and provisions preventing the overreliance on external credit ratings. This memorandum will therefore deal exclusively with these new elements. The other elements of this Directive repeat existing legislation or are adaptations to the proposed Regulation. For sake of clarity, this proposal also unifies provisions on credit institutions and investment firms, the latter of which are dealt with by Directive 2006/49/EC. This is described in more detail in chapter 5 below. Changes related to the Basel III agreement are dealt with by the proposal for a Regulation except for the provisions on capital buffers that are part of this proposal for a Directive. Therefore, only the objectives and legal elements concerning the capital buffers are part of this explanatory memorandum.The general context of Basel III including the results of impact assessment and public consultations is explained in detail in the proposal for a Regulation.
1.1. Reasons for and objectives of the proposal
1.1.1. Sanctions
Effective, proportionate and dissuasive sanctioning regimes are key to ensure compliance with EU banking rules, protect users of banking services and ensure safety, stability and integrity of banking markets.
The analysis of national sanctioning regimes in the areas covered by this Directive and the Regulation has revealed divergences and weaknesses in the legal framework of sanctioning powers and the investigative powers available to national authorities.
Sanctions which are divergent and too weak risk being insufficient to effectively prevent violations of this Directive and the Regulation to ensure effective supervision and the development of a level playing field. The Commission therefore proposes to reinforce and approximate Member States' legal framework concerning administrative sanctions and measures by providing for sufficiently deterrent administrative sanctions applicable to the key violations of this Directive and the Regulation, appropriate personal scope of administrative sanctions, publication of sanctions and mechanisms encouraging the reporting of violations.
1.1.2. Corporate Governance
The collapse of financial markets in autumn 2008 and the credit crunch that followed can be attributed to multiple, often inter-related, factors at both macro- and micro-economic levels, as identified in the Report of the High-Level Group on Financial Supervision in the EU published on 25 February 2009, and in particular to the accumulation of excessive risk in the financial system. This excessive accumulation of risk was in part due to the weaknesses in corporate governance of financial institutions, especially in banks. Whilst not all banks suffered from systemic weaknesses of governance arrangements, the Basel Committee on Banking Supervision (BCBS) referred to 'a number of corporate governance failures and lapses'.
The need for change in this area has been widely recognised. Firms, competent authorities and international bodies (OECD, Financial Stability Board (FSB) and the BCBS) have reviewed their existing practices and guidelines or are in process of doing so. Strengthening corporate governance is a priority for the Commission, especially in the context of its financial markets reform and crisis prevention programme.
1.1.3. Overreliance on external ratings
Overreliance on external credit ratings occurs when financial institutions and institutional investors rely solely or mechanistically on ratings issued by credit rating agencies while neglecting their own due diligence and internal risk management obligations. Overreliance on credit ratings may lead to herding behaviour of financial actors, e.g. parallel selling-off of debt instruments after that instrument has been downgraded below investment grade, which may affect financial stability – in particular when the few big rating agencies err collectively in their assessments.
1.1.4. Pro-cyclicality of institution lending
Pro-cyclicalityeffects are defined as those which tend to follow the direction and amplify the economic cycle. One feauture of current-risk based capital requirements is that they vary over the economic cycle. Provided that credit institutions could meet them there is no explicit regulatory constraint on the amount of risk they can take on, and then on their leverage.
1.2. General context
1.2.1. Sanctions
In its 2010 Communication 'Reinforcing sanctioning regimes in the financial sector' i the Commission has envisaged EU legislative action to set minimum common standards on certain key issues of sanctioning regimes, to be adapted to the specifics of the different sectors.
First, sanctions applicable for key violations of the CRD, such as authorisation requirements, prudential obligations and reporting obligations, vary across Member States and do not seem always appropriate to ensure sanctions are sufficiently effective, proportionate and dissuasive.
Second, a certain divergence exists in the level of application of sanctions in different Member States, including those having banking sectors of similar size and in some Member States no sanctions have been applied for more than one year, which could be symptomatic of a weak enforcement of EU rules.
1.2.2. Corporate Governance
In its Communication of 4 March 2009 i, the European Commission announced that it would (i) examine corporate governance rules and practice within financial institutions in the light of the financial crisis, and (ii) where appropriate, make recommendations, or propose regulatory measures, in order to remedy any weaknesses in the corporate governance system in this important sector of the economy.
In June 2010, the Commission published a Green Paper on corporate governance in financial institutions and remuneration policies i and an accompanying staff working document i which analysed the deficiencies in corporate governance arrangements in the financial services industry and proposed possible ways forward.
The results of this public consultation demonstrated a broad consensus on the deficiencies identified, receiving support from different public authorities and Member States. The European Parliament has also recognised the importance of strengthening corporate governance standards and practices in financial institutions in its Report on remuneration of directors of listed companies and remuneration policies in the financial services sector i. Economic and Social Committee in its opinion on the Green Paper - Corporate governance in financial institutions and remuneration policies i welcomes the Commission Green Paper and supports the proposed action.
1.2.3. Overreliance on external ratings
At the international level, the FSB recently issued principles to reduce authorities’ and financial institutions’ reliance on external ratings i. The principles call for removing or replacing references to such ratings in legislation where suitable alternative standards of creditworthiness are available and for requiring banks to make their own credit assessments. The proposed provisions are in line with the FSB principles.
1.2.4. Capital buffers:
Capital conservation and most especially countercyclical buffers are meant to attenuate the risk of pro-cyclicality and the risk of excessive leverage referred to in 1.1.4 above.
1.3. Existing Community provisions in this area
Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions requires credit institutions to have robust governance arrangements. However, it did not specify what the governance arrangements should look like in detail.
In order to reduce reliance on external ratings, an obligation for banks to undertake own due diligence regarding the underlying assets of securitisation exposures has been introduced into Directive 2006/48/EC.
1.4. Consistency with other policies
In the context of the reform of the European supervisory architecture, the enhancement of capital requirements and crisis management and resolution, the proposed reform of corporate governance in credit institutions is an integral part of an overall reform of the financial services sector. Corporate governance reform should also be seen in the context of the recent Commission Communication on reinforcing sanctioning regimes in the financial services sector.
The Commission has launched a horizontal initiative to encourage industry to increase the representation of women on boards, that after one year it will assess whether self-regulatory initiatives have had the desired effect and if not it will consider legislative approaches. Given that the impact assessment shows that this issue is pertinent for the banking sector, the approach taken at this stage is consistent with a bottom up approach. However, if the wider evaluation in one year finds that there is a need to legislate, then the approach taken in this sector will need to be adapted.
Contents
2.1. Consultation with interested parties
2.1.1. Sanctions
The Commission carried out a public consultation ending on 19 February 2011 on the measures envisaged to reinforce and approximate sanctioning regimes in the financial sector i, including on the issues relevant in the banking sector, as identified on the basis of a study carried out by the European Committee of Banking Supervisors on national sanctioning regimes in this sector i.
The Commission received comments from a variety of respondents, including a significant number of stakeholders in the banking sector (supervisory authorities, central banks, banks and associations of bankers), which provided comments on the need for EU action in this field, the level of harmonisation warranted, the specific actions suggested and their potential benefits or disadvantages.
The actions envisaged to approximate and reinforce sanctioning regimes were also discussed with Member States in the meeting of the Financial Services Committee held on 17 January 2011.
2.1.2. Corporate Governance
The initiative and impact assessment is the result of an extensive and continuous dialogue and consultation with all major stakeholders, including securities regulators, market participants (issuers, intermediaries and investors), and consumers.
Questionnaires on their corporate governance practices were sent to a diverse cross-section of 10 major listed banks or insurance companies established in the EU. The questionnaires were augmented by 30 follow-up interviews with Board members, company secretaries, chief financial officers, chief risk officers, internal controllers.
A questionnaire on their views and role regarding corporate governance of financial institutions was also sent to the European banking supervisors. Similarly, a cross-section of major European institutional investors and shareholders' associations received a questionnaire on their practices and expectations regarding corporate governance of financial institutions. A follow-up meeting with about 30 investors was held on 2 February 2010.
The Green Paper finally launched a public consultation from 2 June 2010 to 1st September 2010 on the possible ways forward to deal with failures in corporate governance in financial institutions. The responses and their analysis can be consulted on the Commission website i.
2.1.3. Overreliance on external ratings
The Commission conducted a public consultation on issues concerning external ratings which also covered overreliance on them. The consultation closed on 7 January 2011 and attracted 93 responses. Several options were proposed, ranging from incentivising the use of internal models to requiring firms to carry out their own risk management without relying exclusively or mechanistically on external ratings. The responses and their analysis can be consulted on the Commission website i.
2.1.4. Capital Buffers
Capital Buffers are part of the BCBS 2010 agreement and as such they were consulted extensively both within the Basel framework and in the framework of the Commission's specific consultations
2.2. Collection and use of expertise
2.2.1. Sanctions
The study carried out by the European Committee of Banking Supervisors in 2008 i provided information concerning the administrative sanctions laid down in national legislation and the actual use of sanctions by banking supervisors. In 2011, additional information has been collected by the Commission on sanctions provided for in national legislation for key violations of the CRD.
The measures proposed are based on this information and the responses to the public consultation.
2.2.2. Corporate Governance
As part of the consultation process, and in the course of preparation of the Green Paper, the Commission services also organised on 12 October 2009 a public conference, a number of stakeholders participated. Discussion focused on the role and competence of the Board of directors, governance issues related to internal control and risk management, the respective role of shareholders, supervisors and statutory auditors.
The Green Paper is also based on the analysis and studies that have been performed or are still carried out by public or private organisations, at the international level as well as the European and national levels. In their work, the Commission staff benefited from the advice of the European Corporate Governance Forum (ECGF) and of the ad hoc advisory group on corporate governance composed of some members of the ECGF and other renowned corporate governance specialists.
2.2.3. Overreliance on external ratings
The Commission is actively participating in the work of the FSB referred to above. Furthermore, it participates in the BCBS that is also undertaking work to reduce reliance on ratings in its Working Groups on Liquidity and on Ratings and Securitisation.
2.2.4. Capital Buffers
Sub-groups of the Capital Requirements Directive Working Group, whose members are nominated by the European Banking Committee, have also conducted work at a technical level concerning capital buffers.
2.3. Impact assessment
2.3.1. Sanctions
The Communication on 'Reinforcing sanctioning regimes in the financial sector' was accompanied by an impact assessment analysing the main policy options for approximating and strengthening sanctioning regimes for violations of financial services rules including in the banking sector. A second impact assessment accompanies this proposal, examining the specific problems in the capital requirements area in more detail.
The main objective of the measures proposed is to ensure better compliance with EU banking rules by increasing effectiveness and dissuasiveness of national sanctioning regimes. This requires the achievement of the following operational objectives:
· Reinforcement and approximation of the legal framework concerning sanctions by ensuring
– Appropriate administrative sanctions for the key violations of CRD
– Appropriate personal scope of administrative sanctions
– Publication of sanctions
· Reinforcement and approximation of the mechanisms facilitating detection of violations by ensuring
– Effective mechanisms encouraging the reporting of misconducts
2.3.2. Corporate Governance
The overarching goal of this initiative is to ensure that the effectiveness of risk governance in European credit institutions and investment firms is strengthened. The measures envisaged should help avoid excessive risk-taking by individual credit institutions and ultimately the accumulation of excessive risk in the financial system. In order to achieve this goal, this initiative focuses on the following operational objectives:
– increasing the effectiveness of risk oversight by Boards;
– improving the status of the risk management function; and
– ensuring effective monitoring by supervisors of risk governance.
To achieve these objectives, the Commission has chosen to improve the existing legal framework.
The requirements regarding Board composition and selection of Board members will ensure more appropriate behaviours, competencies, time commitment and increased accountability. Well-informed, competent Boards and a strong risk management function will increase the ability of credit institutions to identify and manage emerging risks thereby reducing excessive risk-taking. Disclosure requirements will support increased transparency, leading to a more informed market and improved market discipline.
Opening the Board to more diverse candidates might give opportunity to people who were for the time being absent from Board rooms to become members of the Board. It would enlarge the pool of suitable candidates for board membership and improve expertise. Therefore, any potential negative impact on the pool of suitable candidates of the proposal should not be significant.
More stringent requirements at European level could have a negative impact on the competitiveness of European credit institutions at international level. However, the possible decrease in competitiveness due to more stringent requirements should be mitigated by a positive impact on investors, depositors and other stakeholders. Improved risk governance would contribute to the resilience of the banking sector.
The proposal would neither entail significant costs for credit institutions nor have a significant impact on lending activities.
2.3.3. Overreliance on external ratings
A general part on overreliance covering the proposed elements will be included in the forthcoming impact Assessment on the new initiative on credit rating agencies (expected beginning of July 2011).
2.3.4. Capital Buffers
As Capital Buffers are part of the Basel agreement their impact assessment is made together with all the other measures and detailed in the Regulation accompanied this Directive.
The proposal has no implications for the EU budget.
4.1. Legal basis
The legal basis for this proposal is Article 53 i TFEU. Directives 2006/48/EC and 2006/49/EC, which would be replaced by this Directive and the proposed regulation [inserted by OP], constitute an essential instrument for the achievement of the Internal Market from the point of view of both the freedom of establishment and the freedom to provide financial services, in the field of credit institutions and investment firms. This proposal replaces Directives 2006/48/EC and 2006/49/EC with regard to the coordination of national provisions governing the authorisation of the business, the acquisition of qualifying holdings, the exercise of the freedom of establishment and of the freedom to provide services, the powers of supervisory authorities of home and host Member States in this regard and the provisions governing the initial capital and the supervisory review of credit institutions and investment firms. The main objective and subject-matter of this proposal is to coordinate national provisions concerning the access to the activity of credit institutions and investment firms, the modalities for their governance, and their supervisory framework. The proposal is therefore based on Article 53 i TFEU.
This proposal is complementary to the proposed regulation [inserted by OP], establishing uniform and directly applicable prudential requirements for credit institutions and investment firms, since such requirements are closely related to the functioning of financial markets in respect of a number of assets held by credit institutions and investment firms, and is based on Article 114 TFEU.
4.2. Subsidiarity
In accordance with the principles of subsidiarity and proportionality set out in Article 5 TFEU, the objectives of the proposed action cannot be sufficiently achieved by the Member States and can therefore be better achieved by the EU. Its provisions do not go beyond what is necessary to achieve the objectives pursued. Only EU action can ensure that credit institutions and investment firms operating in more than one Member State are subject to the same requirements and thereby ensure a level playing field, reduce regulatory complexity, avoid unwarranted compliance costs for cross-border activities, promote further integration in the EU market and contribute to the elimination of regulatory arbitrage opportunities. EU action also ensures a high level of financial stability in the EU.
4.3. Compliance with Articles 290 and 291 TFEU
On 23 September 2009, the Commission adopted proposals for Regulations establishing EBA, EIOPA, and ESMA i. In this respect the Commission wishes to recall the Statements in relation to Articles 290 and 291 TFEU it made at the adoption of the Regulations establishing the European Supervisory Authorities according to which: 'As regards the process for the adoption of regulatory standards, the Commission emphasises the unique character of the financial services sector, following from the Lamfalussy structure and explicitly recognised in Declaration 39 to the TFEU. However, the Commission has serious doubts whether the restrictions on its role when adopting delegated acts and implementing measures are in line with Articles 290 and 291 TFEU.'
5.1. Interaction and consistency between elements of the package
This Directive forms a package with the proposed Regulation [inserted by OP]. This package would replace Directives 2006/48/EC and 2006/49/EC. This means that both the Directive and the Regulation would each deal with both credit institutions and investment firms. Currently, the latter are merely annexed to Directive 2006/48/EC by Directive 2006/49/EC. A large part of it merely contains references to Directive 2006/48/EC. Joining provisions applicable to both businesses in the package would therefore improve the readability of provisions governing them. Moreover, the extensive annexes of both Directives would be integrated into the enacting terms, hereby further simplifying their application.
Prudential regulations directly applicable to banks and investment firms are set out in the proposal for a Regulation. In the proposal for a Directive remain provisions concerning the authorisation of credit institutions and the exercise of the freedom of establishment and the free movement of services. This would not concern investment firms, as the corresponding rights and obligations are regulated by Directive 2004/39/EC ('MiFiD'). General principles of the supervision of credit institutions and investment firms, which are addressed to Member States and their competent authorities, would also remain in the Directive. This encompasses in particular the exchange of information, the distribution of tasks between home and host country supervisors and the exercise of sanctioning powers (which would be newly introduced). The Directive would still contain the provisions governing the supervisory review of credit institutions and investment firms by the competent authorities of the Member States. These provisions supplement the general prudential requirements set out in the Regulation for credit institutions and investment firms by individual arrangements that are decided by the competent authorities as a result of their ongoing supervisory review of each individual credit institution and investment firm. The range of such supervisory arrangements would be set out in the Directive since the competent authorities should be able to exert their judgment as to which arrangements should be imposed. This includes the internal processes within a credit institution or investment firm notably concerning the management of risks and the corporate governance requirements that are newly introduced.
5.2. Sanctions
Member States should provide that appropriate administrative sanctions and measures can be applied to breaches of the banking legislation. To this end, the Directive will require them to comply with the following minimum rules.
First, administrative sanctions and measures should apply to those natural or legal to credit institutions and to individuals responsible for a breach. This would include credit institutions, investment firms and individuals, where appropriate.
Second, in the case of a breach of key provisions of this Directive and the Regulation, a minimum set of administrative sanctions and measures should be available to competent authorities. This includes withdrawal of authorisation, cease and desist orders, public statement, dismissal of management, administrative pecuniary sanctions.
Third, the maximum level of administrative pecuniary sanctions laid down in national legislation should exceed the benefits derived from the violation if they can be determined and, in any case, should not be lower than the level provided for by the Directive (10% of the total annual turnover of the institution concerned in the case of a legal person, 5 millions euros or 10% of the annual income of an individual in the case of a natural person).
Fourth, the criteria taken into account by competent authorities when determining the type and level of the sanction to be applied in a particular case should include at least the criteria set out in the Directive (eg. benefits derived from the violation or losses caused to third parties, cooperative behaviour of the responsible person, etc).
Fifth, sanctions and measures applied should be published, as provided in this Directive.
Finally, appropriate mechanism should be put in place to encourage reporting of breaches within credit institutions and investment firms.
Criminal sanctions are not covered by this proposal.
5.3. Corporate Governance
The management body of a credit institution or investment firm as a whole should at all times commit sufficient time and possess adequate knowledge, skills and experience to be able to understand the business of the credit institution and its main risk exposures. All members of the management body should be of sufficiently good repute and possess individual qualities and independence of mind which enable them to constructively challenge and oversee the decisions of the management. To avoid group think and facilitate critical challenge, management boards of credit institutions should be sufficiently diverse as regards age, gender, geographical provenance, educational and professional background to present a variety of views and experiences. Gender balance is of particular importance to ensure adequate representation of demographical reality.
In order to have an effective risk oversight and control, the management body should be responsible and accountable for the overall risk strategy of the credit institution or investment firm and for the adequacy of the risk management systems, taking into account the credit institution's risk profile. Given the importance of sound risk management in credit institutions, the management body in its supervisory function should set up a separate risk committee to deal specifically with risk issues and prepare management body decisions on risk issues. The risk committee should assist the management body in its risk oversight role but the management body should remain finally accountable for risk strategy.
In order to provide a complete view on risk to senior management and to the management body, credit institutions and investment firms should have an independent risk management function which should be able to form an effective and holistic view of the whole range of risks in a credit institution. Risk management function should possess sufficient stature and authority to influence strategic risk-management decisions and have direct access to the management body.
5.4. Overreliance on external ratings
Credit institutions and investment firms are required to have their own sound credit granting criteria and credit decision processes in place. This applies irrespective of whether institutions grant loans to customers or whether they incur securitisation exposures. External credit ratings may be used as one factor among others in this process but shall not prevail. In particular, internal methodologies shall not rely solely or mechanistically on external ratings.
For the specific purposes of calculating regulatory bank capital requirements, rating agency assessments are, in certain instances, applied as a basis for differentiating capital requirements according to risks and not for determining the minimum required quantum of capital itself. The CRD framework as a whole provides banks with an incentive to use internal rather than external credit ratings even for purposes of calculating regulatory capital requirements.
The proposed provision would require credit institutions and investment firms with material credit risk exposure or a significant number of counterparties to develop and use internal models rather than the standardized approach which is relying on external ratings.
In addition, it is proposed that EBA publicly discloses, on an annual basis, information on the steps taken by institutions and by supervisory authorities to reduce overreliance on external ratings and reports on the degree of supervisory convergence in this regard.
5.5. Capital buffers
On the basis of Basel III, this proposal introduces two capital buffers on top of the requirements: a Capital Conservation Buffer and a countercyclical capital buffer.
The Capital Conservation Buffer amounts to 2,5% of risk weighted assets, applies at all times and has to be met with capital of highest quality.
It is aimed at ensuring institutions' capacity to absorb losses in stressed periods that may span a number of years. Institutions would be expected to build up such capital in good economic times. Those credit institutions that fall below the buffer target will face constraints on discretionary distributions of earnings until the target is reached.
The Countercyclical Capital buffer is intended to achieve the broader macro-prudential goal of protecting the banking sector and the real economy from the system-wide risks stemming from the boom-bust evolution in aggregate credit growth and more generally from any other structural variables and from the exposure of the banking sector to any other risk factors related to risks to financial stability. It will be applied by adjusting the size of the buffer range established by the conservation buffer by up to additional 2.5%.
The Countercyclical Capital Buffer is set by national authorities for loans provided to natural and legal persons within their Member State. It can be set between 0% and 2.5% of risk weighted assets and has to be met by capital of highest quality likewise. If justified, authorities can even set a buffer beyond 2.5%. The Countercyclical Capital Buffer will be required during periods of excessive credit growth and released in a downturn. The ESRB could issue recommendations for the buffer settings by national authorities and its monitoring, including instances where the buffer exceeds 2.5%. So long as the Countercyclical Capital Buffer is set below 2.5%, Member States have to mutually recognise and apply the capital charge to banks in their Member State. For parts of the buffer exceeding 2.5%, authorities can choose if they accept the judgement of their peers and apply the higher rate or leave it at 2.5% for institutions authorised in their Member State.
Credit institutions and investment firms whose capital falls below the buffers will be subject to restrictions on the distribution of profits, payments on Additional Tier 1 instruments and the award of variable remuneration and discretionary pension benefits. In addition, these institutions will have to submit capital conservation plans to the supervisory authorities to ensure a swift replenishment of the buffers.