BVI s position on the Consultative Document of the Basel Committee on Banking Supervision: Capital requirements for banks equity investments in funds
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1 Frankfurt am Main, 4 October 2014 BVI s position on the Consultative Document of the Basel Committee on Banking Supervision: Capital requirements for banks equity investments in funds BVI 1 gladly takes the opportunity to present its views on the proposals of the Basel Committee on Banking Supervision. We would like to draw the attention to our key issues and concerns on the proposed prudential framework for equity investments in funds. Scope of the proposed application We see the necessity to review the risk-based capital requirements for banks exposures to funds acting as shadow banking entities. However, the proposed widening of the scope to all types of funds and the proposed transfer of the shadow banking requirements to lower risk-weighted and strict regulated funds investments is excessive and too far-reaching. In particular, we strongly disagree with the proposed risk weight of 1250% to the exposures of a fund which does not act as a shadow banking entity to other funds. We believe that the risk-weighted approach under the European CRD IV and CRR framework is appropriate for all other types of funds which are not acting as shadow banking entities. For these types of funds the CRD and CRR requirements should be given an adequate amount of time to prove their resilience. EU shadow banking According to the last ESMA Report on Trends, Risks and Vulnerabilities (cf. liabilities of entities regarded as part of the shadow banking sector amounted only to 18% of bank liabilities in the EU, compared with 94% in the US. Moreover, the shadow banking definitions comprise different investments such as in Asset-Backed Securities (ABS) and Asset-Backed Commercial Paper (ABCP), open commercial paper (CP), the repo market, securities borrowed by broker dealers, and liabilities of special types of Money Market Funds (MMF). Therefore, the pro rata share of the banks equity investments in funds regarded as part of the shadow banking sector is rather low in the EU. This should be taken into account when a risk-weighted approach for banks exposures to funds will be discussed. German investment funds are not part of the shadow banking system German investment funds are not part of the shadow banking system. They neither perform unregulated banking activities nor do they pose systemic risks or engage in regulatory arbitrage. Managers of German investment funds are authorised providers of financial services who are subject to extensive regulation and supervision adequate to their business activities. 1 BVI represents the interests of the German investment fund and asset management industry. Its 75 members currently handle assets of EUR 2.0 trillion in both investment funds and mandates. BVI enforces improvements for fund-investors and promotes equal treatment for all investors in the financial markets. BVI`s investor education programmes support students and citizens to improve their financial knowledge. BVI`s members directly and indirectly manage the capital of 50 million private clients in 21 million households. For more information, please visit
2 Seite 2 von 5 BVI members are German asset managers providing management services to regulated and supervised collective investment undertakings (CIUs). The number of CIUs held by banks and other institutions subject to CRD is rather large (around 14 percent of all German investment funds). These CIUs are very much affected by this consultation paper. According to a survey among our members, 37 investment management companies manage about 1600 funds with assets under management totaling 285 billion Euros subject to the Basel III and CRD regimes. These consist of about 720 mutual funds as well as 940 special funds which are only eligible for institutional investors. All figures refer to the total value of the funds assets. In particular, the stake in the mutual funds held by banks or other institutions is much lower because they are eligible for a number of investors (cf. retail or other institutional investors). Number of investment funds Assets (billion Euro) Total Mutual funds Special funds BVI, July 2013 These German investment funds do not engage in credit intermediation. They invest the capital provided by their investors directly in financial instruments and other non-financial assets. In doing so, German investment funds contribute to the financing of the worldwide real economy by investing in either equity or debt instruments. German investment funds do not raise concerns in systemic terms. Fund investments are financed by assets collected from investors who bear in full the associated investment risks. The risk diversification rules applicable to German investment funds prohibit undue concentrations of investments at the portfolio level. Moreover, German investment funds are bound by high standards of liquidity management in order to prevent liquidity shortages in crisis situations. As a last resort measure, redemptions of fund units may be suspended for a certain time period in order to warrant the interests of investors. Temporary suspension of redemptions can be ordered also by the supervisory authority. Managers of German investment funds are not systemically relevant. The major business activity of fund managers is the management of third party assets on behalf and in the sole interest of their clients. Consequently, fund managers act as agents in the broader market and do not engage in any relevant risks on their own account. The balance sheet totals of German fund managers are generally of no importance in systemic terms. Moreover, according to the new AIFMD rules, the fund manager s own funds may be only invested in liquid assets, or assets easily convertible to cash in the short term, and must not include speculative positions. It is erroneous to assume that investments in German investment funds may be used as tools for regulatory arbitrage. German investment funds are subject to one of the strictest regimes on product regulation in worldwide terms. In the retail sector, both the fund manager and each individual fund must obtain authorisation from the competent authority before carrying on any activities in the market. Managers of AIFs targeting professional investors are subject to authorisation and must be fully
3 Seite 3 von 5 relicensed under AIFMD until July 2014 at the latest. Professional AIFs must be notified to the authorities as part of the manager s authorisation and separately, for marketing purposes. In substantive terms, German fund managers must observe strict requirements for the management of risks, including liquidity risks, inherent in managed funds. Potential conflicts of interest must be capaciously identified, managed by internal arrangements and if not fully eliminated, disclosed to investors. For UCITS and other retail investment funds, there are extensive provisions in place regarding assets deemed eligible for fund investments as well as applicable investment limits in terms of issuer and counterparty risks in addition to the restrictions on leverage mentioned below. German investment funds provide extensive transparency to the authorities and the public concerning both product features and target investments. Especially, under AIFMD a new quality of supervisory monitoring will be achieved. Supervisory reporting shall be mandatory for most funds on a quarterly basis and encompasses nineteen pages of details on portfolio composition, principal exposures and most important concentrations, risk profile and liquidity management. The AIFMD reporting will also provide helpful data for assessing the interconnectedness between banks and other financial institutions as it comprises identification of the top five counterparties to which a fund has the greatest credit exposure and which have the greatest credit exposure to the fund respectively for each individual AIF. Moreover, German UCITS are already under the obligation to submit regular reports to the authorities concerning their use of derivative instruments over the entire reporting period. The extension of regulatory measures addressed to shadow banking entities to other investment funds than MMFs should be conditional on the existing potential for systemic risk or regulatory arbitrage assessed on the basis of the applicable regulation and state of the relevant market. Under this assumption, there is no shadow banking potential discernible in German investment funds. German investment funds are bound by high regulatory standards on securities lending and repos. These standards aim in the first place at mitigating potential risks from these investment techniques by imposing counterparty risk limits and defining high standards for collateral. These existing national rules should be taken into account by the Basel Committee when assessing the need for further regulatory measures. The proposed look-through approach As stated above, we strongly disagree with the proposed risk weight of 1250% on the exposures to a fund which does not act as a shadow banking entity to other funds (cf. Paragraph 14 of the Consultation Paper). According to a survey among our members, they manage about 750 funds with assets under management totaling more than 100 billion Euros which invest in other (target) funds. These target funds are themselves regulated under the UCITS or AIFM regimes and are not part of the shadow banking system. The regulation provide for strict limits for investments in other (target) funds. German mutual or special funds may acquire other (target) fund units only if no more than 10 percent of the value of the target funds assets may in aggregate be invested in units of other funds. In the majority of cases, the investment management company which manages the fund of funds requires information about the composition of the underlying assets of the target funds from the investment management companies which manage the target funds.
4 Seite 4 von 5 Moreover, under the CRR regime (cf. Article 128 of the CRR), institutions shall assign a 150 % risk weight to exposures, including exposures in the form of shares or units in a CIU that are associated with particularly high risks, where appropriate. However, this provision will not apply to banks investments in UCITS or AIFs where the mandate of the fund does not allow leverage higher than that required under Article 51(3) of the UCITS Directive. In case of such fund investments, an exposure shall be assigned with a risk weight of 100 %, unless the look-through approach or other conditions are met (cf. Article 132 of the CRR). This approach takes into account in an appropriate manner the risks of banks investments in funds which do not act as shadow banking entities. Therefore, we propose to implement the same approach under the revision of the capital requirements for equity investments in funds. Furthermore, in general, we support the approach that banks may rely on third-party calculations for determining the risk weights associated with their equity investments in funds if they do not have adequate data or information to perform the calculations themselves (cf. Paragraph 16 of the Consultation Paper). However, we strongly disagree with the proposal that in such cases the applicable risk weight would be one risk weight notch higher than the one that would be applicable if the exposure was held directly by the bank. It is incomprehensible why the calculation conducted by a third party (such as the investment management company) should lead to a higher risk weight, in particular for funds which do not act as shadow banking entities. Therefore, we request the Basel Committee to implement the same procedure which applies under Article 132(5) of the CRR according to which banks, the depository institution or the CIU management company may calculate an average risk weight for banks exposures in funds without any additional risk weights. In this context, the last sentences of Paragraph 16 of the Consultation Paper should be deleted according to which a 1250 % risk weight is applied whenever the risk weights of underlying exposures cannot be determined. In our view, a standard risk weight approach should be determined for all cases. Irrespective of the risk-weighted look-through approach, we propose that an annual confirmation of external audits on the accuracy of the data used for the purposes of applying a look-through approach should be considered as an alternative approach (cf. Paragraph 13 of the Consultation Paper). This should apply in cases where the investment management company manages more than one fund with different financial years for various funds because there is an ongoing audit process in place. We also disagree with the proposed ratings-based approach for securitisation positions (cf. Paragraph 15 of the Consultation Paper). We understand that this approach shall also be an obligation for investment management companies which manage the banks funds investments as an outflow of the look-through approach. An internal rating-based approach for securititsation positions does not apply to investment management companies. Implementation of such internal rating processes for securititsation position would lead to significant additional burden or significant additional cost. Therefore, we propose that only the standard risk-weighted approach under the CRD IV and CRR shall apply. The proposed mandate-based approach and fall-back approach As stated above and for the same reasons, we strongly disagree with the proposed risk weight of 1250% to a fund s exposures to other funds under the other approaches described under Paragraphs 19 and 20 of the Consultation Paper.
5 Seite 5 von 5 The proposed leverage adjustment We disagree with the proposed leverage definition under Paragraph 21 of the Consultation Paper according to which the ratio of total assets over total equity should be multiplied with a risk weight with a cap of 1250 %. We understand the proposed leverage definition in such a manner that total equity means all kinds of financial leverage measures. These would also include short-term borrowings, backto-back loans or borrowings held for the purpose for bridging liquidity shortfall to ensure redemption policies of the funds. The EU regulator has already specified that such borrowings are not apt to increase the exposure of a fund. Therefore, we request the Basel Committee to clarify that only the methods of increasing the exposure of an AIF under the AIFMD should be considered under the leverage definition, in particular only the methods defined in Annex I of the Delegated Regulation (EU) No 231/2013 should be taken into account. However, the leverage definition of the Basel Committee should apply only when an investment management company manages a fund which employs leverage on a substantial basis. According the AIFMD, a fund with a leverage ratio calculated in accordance with the commitment method (cf. Article 7 of the Delegated Regulation (EU) No 231/2013) of more than three times its net asset value would be considered as employing leverage on a substantial basis. The EU regulator supposes that, a fund could cause systemic risks only in cases where this limit is exceeded. Moreover, there are strict limits on the level of leverage that may be employed by German mutual and special funds in which banks are invested. The global exposure of UCITS relating to derivative instruments may not exceed the total NAV of the fund; UCITS direct borrowings are reduced to a negligible size (10% of the fund assets and only on a temporary basis). Managers of alternative investment funds (AIFs) falling under the new AIFMD regime, on the other hand, are under the obligation to define the maximum level of leverage for each AIF and to report on its implementation to investors and competent authorities. Additional regulatory limits apply to AIFs which are being distributed to the retail public. However, we prefer Option 1 for incorporation of leverage into the calculation of risk weighted assets because equity investment can be most appropriately taken into consideration. Alternative approach: In our view, the Basel Committee should take into account that under the AIFMD regime the manager of AIFs is obliged to demonstrate that the leverage limits for each AIF it manages are reasonable, and that the AIFM complies with those limits at all times. Where the stability and integrity of the financial system may be threatened, the competent authorities of the EU home member state of the AIFM are able to impose limits to the level of leverage that an AIFM can employ in AIFs under its management (cf. Article 25 of the AIFMD). This ex ante monitoring approach appears to be a suitable and reasonable method of considering leverage without implementing a multiplication factor for the leverage ratio of funds which do not act as shadow banking entities. Transitional arrangements Finally, in cases that the Basel Committee will maintain on the proposed approach for funds acting as shadow banking entities or for all types of funds, a reasonable transitional period must be granted to allow for implementation of the necessary adjustements to systems and operations. Therefore, we propose a transitional period which starts only after the full implementation of the Basel III and CRD frameworks in 2019.
Before turning to detailed remarks on the questions for consultation, we would like to draw EBA s attention to our key issues and concerns.
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