ESBG keeps a close eye on prudential treatment of crypto assets

On 30 September 2022, ESBG responded to the second public consultation of the Basel Committee on Banking Supervision (BCBS) on the prudential treatment of banks' crypto asset exposures, which is built on the proposals in the first consultation issued in June 2021.

The basic structure of the proposal in the first consultation is maintained, with crypto assets divided into two broad groups: Group 1 includes those that are eligible for treatment under the existing Basel Framework with some modifications. Group 2, on the other hand, includes unbacked crypto asset and stable coins with ineffective stabilisation mechanisms, which are subject to a new conservative prudential treatment.

In the response to the second consultation in 2022, we advocated for the removal of the technological risk add-on from the proposed prudential framework.

The first reason for this would be the principle of technological neutrality. The regulation should focus on regulating the services but not the applicable technology in order not to prevent the adoption of a specific technology and to neither prefer nor prejudice a specific business model or service provider. Secondly, technological risk already exists in all asset classes. If persistent technological risks are detected, the supervisor could require actions for their mitigation or apply a Pillar 2 Requirement (P2R) surcharge. Finally, a common surcharge of capital would reduce institutions’ incentives to mitigate inherent risk.

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OCTOBER 2022 | TOPICS: Prudential, Supervision and Resolution | Public Consultation | Crypto Assests | Basel Framework | Technology Neutrality

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ESBG response to the EFRAG consultation on its first set of draft ESRSs calls to ensure levelled global playing field

ESBG submitted its response to the European Financial Reporting Advisory Group (EFRAG) public consultation on the first set of Draft EU Sustainability Reporting Standards (ESRSs) on 4 August. The consultation comes in response the European Commission’s proposal for a Corporate Sustainability Reporting Directive (CSRD) which envisages the adoption of EU Sustainability Reporting Standards (ESRSs). As part of this, the Commission mandated EFRAG to provide technical advice in the form of draft sustainability reporting standards.

In its response, ESBG highlighted the need for consistency between the International Sustainability Standards (ISSB) sustainability disclosures and the EFRAG ESRSs in order to ensure a levelled global playing field. Moreover, ESBG emphasises the lack of proportionality with respect to disclosure requirements, specifically for smaller/unlisted companies and proposes the provision of certain reporting requirements being made optional.

With respect to implementation challenges, ESBG considers that the data availability issue is the most critical challenge for financial institutions. Taking into consideration the above, ESBG proposed two phase-in solutions that are mutually complementary: i) first year reporting on own operations and gradual reporting on information from the value chain and ii) prioritisation of climate topics and gradual consideration of other environmental, social and governance topics.

Furthermore, we believe that there is not enough guidance in the exposure drafts with respect to the application of the double materiality principle (the requirements for companies to disclose not only the risks that affect, but also their impacts on society and on the environment). In this sense, this concept needs to be clarified and more guidance is needed in relation to specific sectors in due time.

ESBG stresses the limitation on disclosing value chain information for companies. We consider it is difficult to obtain information from companies that are not under the control of the institution (e.g. associate companies). We propose that a phase-in period of 2 years must be granted to financial undertakings to allow them to adapt their processes to collect the necessary information from their value chain.

As a next step, ESBG will evaluate if there is interest from members in submitting input into the up-coming EFRAG consultations on SME specific standards as well as on sector specific standards (EFRAG consultations are expected to be published in 2023).

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EU Taxonomy minimum safeguards: Criteria for the application of external checks should be further defined

ESBG submitted its final response to the Platform for Sustainable Finance (PSF) consultation on its draft report on minimum safeguards (MS) on 6 September. In its response, ESBG highlights that assessing whether a company complies with the due diligence processes should, other than relying on external checks as only possibility, be demonstrated by: i) proving that the applicable national legislation provides for sufficient guarantees concerning the specific topic; ii) self-declarations made by the client concerning the specific topic.

ESBG submitted its final response to the Platform for Sustainable Finance (PSF) consultation on its draft report on minimum safeguards (MS) on 6 September.

The report is intended to provide advice on the application of the minimum safeguards which bring a social and governance component to the EU Taxonomy. The report looks at human rights including workers’ rights and consumers´ rights, bribery/corruption, taxation and fair competition as core substantive topics for which compliance with minimum safeguards has to be defined. The draft report proposes a two-pronged approach for identifying non-compliance with MS, namely one related to adequate due diligence processes implemented in companies (internal checks) and the other related to the actual outcome of these processes or the company’s performance (external checks).

In its response, ESBG highlights that assessing whether a company complies with the due diligence processes should, other than relying on external checks as only possibility, be demonstrated by: i) proving that the applicable national legislation provides for sufficient guarantees concerning the specific topic; ii) self-declarations made by the client concerning the specific topic.

Moreover, ESBG emphasises that gravity thresholds for non-compliance should be defined, so that not every minor violation (e.g. of taxation or work laws) leads to the establishment of an external check.

Furthermore, when assessing compliance with MS, the report recommends that the focus should be on assessing the human rights due diligence processes of a company, rather than on controversy checks e.g. media coverage (currently employed by ESG ratings agencies), as it is considered that the latter is based on value judgement and is sometimes difficult to justify. ESBG believes that the administrative cost derived from direct analysis of due diligence processes would be too burdensome for institutions and emphasizes that they should rely on ESG ratings agencies in order to not impair financial activity.

Finally, ESBG calls for further clarifications on the level of application of MS in particular cases, e.g. an exposure to a company active in sectors that by definition do not fulfil the minimum safeguards to be taxonomy-eligible or -aligned, even if the specific transaction finances activities that fulfil all requirements.

As a next step, the Platform will analyse the feedback received and prepare the final report. ESBG will continue to monitor this very important topic, with the possibility to get involved at a later stage.

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Reducing the scope of the EBA NPLs data templates

On 5 September 2022, ESBG responded to the EBA consultation on the draft non-performing loans (NPL) transaction data templates, which seek to improve the functioning of secondary markets for NPLs.

The number of data fields in the proposed templates (especially those marked as “mandatory”) is significantly higher than what has historically been proven necessary to close voluntary NPL deals from a market standards perspective and it should therefore be reduced. Such a high number of data fields would in fact bring a significant costs increase for sellers and may jeopardise the development of NPL secondary markets.

In addition to the fact that most of the required information is too detailed and not relevant for the purposes of loan valuations, the data is also not always available within the banking system. This could lead to a counter-productive effect where sellers could renounce to sales they could execute due to constraining mandatory fields.

Another main impediment for this template to be useful is the issue of data consistency. The template would mainly be populated with management data and internal methodologies that can use different calculations and logics leading to incomparable information among portfolios.

Furthermore, it makes no sense to have common templates for single names or reduced portfolios of single names and massive portfolios of NPLs. Exposures to one single debtor or to a reduced number of corporates or SMEs have historically needed a different set of information, as their potential purchasers perform a deeper financial and legal analysis of the exposures rather than a statistical analysis, which is more adequate for massive portfolios.

Overall, the remaining fields compared to the original templates from 2017 still contain significantly more information than market standards require. For a well-functioning secondary market it is currently possible to sell NPLs by providing mainly 20 data fields.

Against this background, we request that the EBA further streamlines the templates, aiming at simpler, more balanced and effective design in order to achieve a broader application and increase transparency in the NPL market, without having a detrimental impact on EU NPL deals.

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FATF revision of Recommendation 25

The Financial Action Task Force (FATF) aims to better meet its objective of preventing the misuse of legal arrangements for money laundering and terrorist financing (ML/TF) and therefore conducts a review of its Recommendation 25 (R.25) and the Interpretive Note on their transparency and beneficial ownership (BO).

WSBI-ESBG response to the public consultation
General position
• The fragmented regulatory landscape is an issue for obtaining information from other jurisdictions.
• Guidance for implementing R.25 rules would improve the timely availability and accuracy of BO information.
• Resourcing and funding of the implementation of the R.25 requirements pose potential challenges.
Scope of legal arrangements, risk assessment and foreign trusts
• Regarding the potential limitation of the scope of risk assessment and mitigation obligation to such legal arrangements that have sufficient links with the countries, a sectoral risk assessment for legal persons and arrangements should be considered as a “sufficient link”.
• The new suggested risk assessment allows for the application of enhanced due diligence measures and also provides for how best to mitigate risks associated with different products and services.
Obligations of trustees under R.25
• When extending the requirement to obtain and hold information on beneficiaries or classes of beneficiaries to objects of powers of discretionary trusts, who may derive a benefit form a trust in the future, it should be referred to professional service providers such as lawyers, notaries, accountants, etc.
• Regarding the nexus of such obligations based on residence of trustees or location where the trusts are administered, it would be difficult to verify or authenticate information provided by trustees from other jurisdictions. Some trustees may reside from high-risk jurisdictions.
Definition of beneficial owners
• A standalone definition for BO in the context of legal arrangements might create a clear distinction between a BO for legal arrangements and for legal persons, but could lead to confusion. For a harmonised definition, the interpretive note should provide clarifications on, e.g., the element of “control” in a trust.
• Information regarding beneficiaries should be publicly available to promote transparency.
Obstacles to transparency
• Trusts that are owned or controlled by a company with various directors or nominee shareholders in different jurisdictions could be used to obscure ownership in legal arrangements.
• Flee/flight clauses are used as a protective mechanism for members and the interest of the trust. The enforceability of such clauses might be challenging.
• Key obstacles to transparency of trusts and other legal arrangements are the lack of uniform know-your-customer (KYC) standards as well as the use of professional intermediaries. Furthermore, the identification of BO of nominee shareholders, directors or various stocks can be difficult.
Approach in collecting beneficial ownership information
• Incomplete mandatory KYC information collected by other agents or service providers incl. trust and company service providers are observed to be an issue, as well as a fragmented regulatory landscape.
• A multi-pronged approach should be followed for accessing BO information of legal arrangements.
Adequate, accurate and up-to-date information
• The notion of “independently sourced/obtained documents, data or information” in the definition of accurate information poses an issue for the private sector as it is difficult to obtain adequate information

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State Aid rules for banks in difficulty

The European Savings and Retail Banking Group (ESBG) welcomes the initiative of the European Commission to launch a targeted consultation aiming at reviewing the State Aid rules for banks in difficulty.

The potential revision will assess the fitness of the current rules regarding burden-sharing, market discipline, financial stability, and the protection of taxpayers among other things. The modernized framework should ensure that the State Aid rules are applied proportionally, are adapted to the crisis management and deposit insurance (CMDI) legislation and are specifically targeted at different kinds of bank crises.

ESBG argues that all DGS measures available under the CMDI framework applied in accordance with the rules established by the DGSD and the BRRD/SRMR, regardless of national specificities in the design, the governance, and the functioning of DGSs, should be exempted from the application of the regular State Aid control rules. It should be made clear that when DGS funds are used for support measures, State Aid rules should not be applicable and no notification to the Commission be required. Exempting the application of the State Aid rules on actions under the CMDI framework will allow the effective and undisturbed use of measures foreseen under DGSD/BRRD/SRMR.
Furthermore, and until such improvements are effectively achieved, ESBG finds it important to avoid any increase in contributions to the national DGS and to the Single Resolution Fund (SRF).

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International Sustainability Standards Board consultation on Sustainability Disclosures

The International Sustainability Standards Board (ISSB) has been established at COP26 with the purpose of developing a comprehensive global baseline of sustainability disclosures for the capital markets. The purpose of the consultation is to develop a comprehensive global baseline of sustainability disclosures designed to meet the information needs of investors in assessing enterprise value.

To this end, the consultation includes proposed standards on general sustainability-related disclosure requirements as well as on climate-related disclosure requirements |Position – Executive summary | August 2022 |

CONSISTENCY BETWEEN ISSB STANDARDS AND EFRAG ESRSs
WSBI-ESBG believe that it is crucial to achieve consistency of sustainability reporting at global level and especially a full alignment of reporting requirements between ISSB standards and EFRAG European Sustainability Reporting Standards (ESRSs) to ensure a global playing field in terms of sustainability reporting. This convergence between both standards will address the risk of additional disclosures.

DOUBLE MATERIALITY
WSBI-ESBG highlight that the IFRS sustainability standards are based on an ‘enterprise value creation’ or financial materiality approach, in which sustainability impacts are measured in terms of impacts on the financial position and prospects of the company itself. On the other hand, the EFRAG ESRSs are being developed based on the ‘double materiality’ principle, where disclosure is required both from the point of view of financial impact on the company and on the impact of the company on society and the environment.

TRANSITION PLANS
WSBI-ESBG notes that the EFRAG ESRSs make a clearer reference to alignment with limiting global warming to 1.5°C in line with the Paris Agreement. On the other hand, IFRS sustainability standards allow the entity to choose its own target. By way of consequence, WSBI – ESBG requests that the ISSB takes into consideration including a clear reference to the 1.5°C target of the Paris Agreement in order to ensure comparability between the two standards.

BOUNDARIES AND VALUE CHAIN
Although, WSBI – ESBG considers it essential that sustainability reporting should capture the entire value chain, we ask for clearer and more defined boundaries as it is considered difficult and complicated to obtain information from companies that are not under the control of a financial institution, especially regarding scope 3 GHG emissions.

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For a single market for data to push growth and innovation

ESBG submitted its response to the European Commission (EC) targeted consultation on an Open Finance Framework and data sharing in the financial sector on 15 July.

ESBG and its members highlighted that they share the objectives of the EC’s data strategy and the commitment to create a single market for data that will constitute a potential source of growth and innovation.

A European approach to data is essential to ensure competitiveness, avoid fragmentation, benefit from an effect of scale and guard against windfall effects from which certain non-European players could benefit. A flourishing data-driven market should be based on principles of mutual benefits and right incentives for all market participants. Therefore, a fair share of value and risk is a fundamental prerequisite for the success of data sharing.

In an open finance framework, the principle “same activity/data, same risks, same rules” shall apply to all actors, including third party providers, ESBG said in its response. To ensure customer’s trust, every third party accessing customer data shall ensure privacy rights and data protection in compliance with all applicable rules. As such, we suggest third party within the financial sector be subject to the same licensing requirements and to supervision by competent authorities.

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PSD2 review must seek fair distribution of value and risk among all market participants

ESBG submitted its response to the European Commission (EC)’s targeted consultation on the review of the revised payment services Directive (PSD2) on 15 July. In it, ESBG and its members stated that the core principle of PSD2 – access to data free of charge – did not foster the best outcome and that the PSD2 implementation has been a highly complicated and costly process for the whole market.

For banks, in particular, the investments required for the implementation of PSD2 have been unproportionally high without a chance of a return. More in general, the significant investment levels do not match the limited economic benefits for the market and the end-consumer.

Therefore, the review of the PSD2 should seek a more balanced approach, with a fair distribution of value and risk among all market participants.

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On the EU Commission consultation on Distance Marketing in Financial Services Directive review

The publication of the European Commission proposal amending Directive 2011/83/EU and repealing Directive 2002/65/EC, follows the public consultation carried out last year. The Distance Marketing in Financial Services Directive (DMFSD) has historically provided a legal basis for the distance selling of financial products and a minimum safety net for consumers, when there is no specific text (for example, when new products are introduced or for products outside the scope of a specific directive).

ESBG supports the scenario chosen by the Commission for its proposal to retain the relevant and still valid elements of the DMFSD by integrating them into a broader directive (the Consumer Rights Directive 2011/83/EU which is not currently concerning financial products) and to make some adjustments. Thus, a specific chapter dedicated to “Financial services contracts concluded at a distance” has been added to this directive, making it possible to retain the specificities of the DMFSD.

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