Newsletter EBA Guidelines on SREP FINANCIAL SERVICES July 2014 The EBA Guidelines on SREP Consultation on a holistic approach for the supervisory review and evaluation process Executive summary On 7. July 2014, EBA published the draft guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) for public consultation. The roughly 200 page draft, developed pursuant to Article 107 (3) of Directive 2013/36/EU, is addressed to Competent Authorities of all Member States of the European Union. EBA invites comments on all proposals till 7. October 2014; the guidelines are expected to be applied by January 2016 taking into account the results of the public consultation. The EBA follows a holistic approach to SREP as it is built around the assessment of key indicators, business model, governance, the capital adequacy and liquidity risks. A new key feature in this context is for the individual supervisor to draw its own quantitative picture of the capital and liquidity risk profile of an institution. It is also worth noting, that the EBA guideline is very specific; e.g. the indicators and sources supervisors should use to identify material deteriorations in the risk profile and supporting SREP framework are specified in detail. The elements of the SREP framework are individually assessed and scored and summed to a final overall SREP score. This final overall score is not the simple arithmetic mean of the individual scores, rather the supervisor has the option to deviate and reflect its findings from the previous 12 months here. Content Executive summary Page 1 The SREP approach Page 2 Assessment with respect to the ECB supervisory role Page 4 Implications for your institution Page 4 The implementation of this guideline is severely dependent on the behaviour of the EZB. It already appears certain that the EZB will develop its own SREP approach which will not only be binding for all directly supervised banks, but also for all indirectly supervised banks in accordance with the principle of proportionality. As EBA and ECB both are institutions with a European background and are closely collaborating on the development of such regulatory texts, we assume that the EBA draft SREP guideline gives a good indication of the ECB SREP. We are expecting significant fundamental changes in the SREP from what financial institutions are currently used to, so even though such methodical changes are only broadly defined yet, we especially recommend to banks directly supervised by EZB to prepare for these upcoming changes.
Newsletter SREP-Leitlinie der EBA / Financial Services / Juli 2014 2 The SREP approach The EBA follows a holistic approach in the draft guideline. The prescribed SREP assessments, both in individual risk categories as well as on an overarching level, results in a graded scoring of an institution which ties back to the ongoing supervision on Pillar 2 supervision as addressed in Art. 76 87 and 87 CRD IV, and addressed in Directive 2013/36/EU (CRR), with the determination of whether an institution is 'failing or likely to fail', as addressed in Directive 2014/59/EU (BRRD Bank Recovery and Resolution Directive). In addition to the holistic approach, it needs to be particularly highlighted that the supervisors are supposed to give a quantitative estimate of the capital adequacy and liquidity risks of a financial institution; an approach that has not previously been part of all national review and evaluation processes. The following chart shows an overview of the SREP elements proposed by EBA. Categorisation of Institutions Monitoring of key indicators Business Model Analysis Assessment of internal governance and institution-wide control Assessment of risks to capital (assessment of inherent risks and control; own funds requirement and Stress Testing; capital adequacy assessment) Assessment of risks to liquidity and funding (assessment of inherent risks and control; own funds requirement and Stress Testing; capital adequacy assessment) Overall SREP assessment Supervisory measures (quantitative: capital & liquidity; other measures) Early Intervention Measures Source: EBA/CP/2014/14 The EBA proposes a categorisation of institutions into four distinct categories in line with the concept of proportionality depending on size, structure, internal governance and business model of the institution. The classification includes global systemically relevant banks, local systemically relevant banks and small non-systemically relevant banks. For instance, EBA proposes to complete the SREP on a yearly basis at global systemically relevant banks, bi-yearly at local systemically relevant banks and only every three years at small non-systemically relevant banks. The SREP framework requires quarterly monitoring of key financial and nonfinancial indicators for all financial institutions. The supervisors are supposed to develop control processes to identify unusual changes as well as specify thresholds for the key indicators (comparison to the peer group etc.) The indicators serve as both, the input for the assessment of the capital and liquidity resources to cover these risks and the business model analysis. The proposed
Newsletter SREP-Leitlinie der EBA / Financial Services / Juli 2014 3 indicators cover all of the regulatory Pillar 1 and Pillar 2 ratios (all ratios from external reporting, reorganisation and winding-up of credit institutions, etc.) as well as market indicators (share price, CDS-Spreads, etc.). The centre of the SREP focuses on the following four analyses that result in the overall SREP assessment. For each individual analysis, EBA suggests a numerical scoring between the values 1 (best result) and 4 (worst result). The final overall SREP result is not the simple arithmetic mean of the four individual scores; rather, the supervisors have some leeway in the evaluation process and weight assignments. The business model analysis supports the other elements of the SREP. Focus are the business and strategic risks and is used to evaluate the sustainability and risk bearing ability of an institution. Therefore, EBA proposes that supervisors should not only focus on current business models, but also evaluate the forwardlooking strategy and financial planning of the financial institution to identify shortcomings. For this purpose, supervisors should use a number of institution specific internal sources (strategic plan, reorganisation and winding-up concept, external and internal reporting) as well as external sources (financial stability reports, rating reports). The assessment of the governance and control arrangements should encompass the entire internal governance framework and institution-wide control arrangements of a financial institution; this includes the corporate and risk culture as well as the risk management framework, including ICAAP (Internal Capital Adequacy Assessment Process) and the new ILAAP (Internal Liquidity Adequacy Assessment Process), remuneration policies and practices, and the recovery planning arrangements. The overall assessment of the internal governance and institution-wide controls should enable the supervisors to verify whether these measurements are adequate to the risk profile, business model, size and complexity of the financial institution, and to what degree the institution adheres to the requirements and standards of good internal governance and risk controls arrangements. In the assessment of the risks to capital, EBA identifies credit and counterparty risk, market risk, operational risk, and interest rate risk from non-trading activities (IRRBB). While evaluating the risks that have been identified as material for the financial institution, competent authorities should also evaluate the corresponding risk management and control processes; hereby using a broad basis of information such as standard and ad-hoc reporting, internal risk reports, risks identified in the institution s ICAAP, communications to investors, rating agencies etc. The subsequent SREP capital assessment not only consists of the assessment weather the own funds held by the institution ensure a sound coverage of risks to capital to which the institution is or might be exposed (e.g. impact on own funds from model risks or from control, governance or other deficiencies), but also of the risks from excessive leverage and an assessment whether the capitalization is adequate given the economic cycle. Lastly, the liquidity and funding risk requires its own quantitative assessment from the local supervisor. There are two main components in the liquidity and funding risk that need to be evaluated; first, the assessment whether the current liquidity buffer can cover intra-day, short- and medium-term outflows in a normal and a stress scenario (including an evaluation of the LCR implementation) and second, an assessment of the medium- and long-term funding risk via analysis of the institution s funding profile as well as the evaluation of risks to the stability of the funding profile. EBA also requires competent authorities to take into account possible concentration risks, expected changes in the funding risk based on the institution s funding plan, and finally, an assessment of the funding market available to the institution. As was the case in the capital assessment, the SREP liquidity assessment is the basis for the competent authority to take measures
Newsletter SREP-Leitlinie der EBA / Financial Services / Juli 2014 4 (e.g. higher LCR requirement, longer time horizon for inflows to exceed outflows, differing composition of liquidity buffer, etc.) The prudential assessment criteria shown in SREP are only broadly defined and include, in addition to the core measures (liquidity and capital requirements) further requirements in the risk management processes, adjustments to the business model and even so called early intervention measures (this early intervention is part of the BRRD and covers the transition between solvent and insolvent institutions). The SREP could also result in a financial institution being identified as failing or likely to fail, an assessment that would result in further procedures in the scope of the BRRD (reorganisation and winding-up of credit institution). The SREP does not intend to be exhaustive and gives leeway to competent authorities to take into account other additional criteria that may be deemed relevant according to their experience and the specificities of the institution. Assessment with respect to the ECB supervisory role One could argue that the guideline currently is in draft status only and hence will be subject to future revisions and that the national implementations will add another level of uncertainty suggesting to wait for finalization before any relevant actions from the financial industry. In this context we would like highlight the fact that the ECB will take on the supervisory responsibility from November of this year onwards. Already as of today it is known that the ECB is developing an own approach to SREP, which will be application right away to those institutes directly supervised by the ECB. It also will by the principle of proportionality also to apply to those banks only indirectly supervised by the ECB. As EBA and ECB both are institutions with a European background and are closely collaborating on the development of such regulatory texts, we assume that the EBA draft SREP guideline gives a good indication of the ECB SREP. Implications for your Institution The EBA draft guideline indicates fundamental changes to the SREP and to the methods banks need to employ for quantification of their economic capital adequacy as well as their liquidity risks. As the future methods are yet to be defined in more detail during national implementation, we would currently not propose to perform premature changes to internal methods and approaches. Nonetheless we strongly advise banks, especially those to be in the future directly supervised by the ECB, to start preparing for the imminent change process. At least the following steps should be addressed: Establish a Single Point of Contact for the SREP process: the national supervisor or the ECB will employ the SREP process in order to achieve a holistic view on an institution which covers the business model, the risk bearing capacity, the funding situation and last but not least the status of recovery planning. In the supervised bank responsibility for those elements typically is distributed across various organizational units. We propose to decide in a timely manner on a central unit to manage the SREP process both from a process and content perspective in a role of a Single Point of Contact in order to prevent frictions, inefficiencies and inconsistencies. Analyse readiness for the new SREP process: the future SREP process comprises new and also quantitative analyses by the regulators. Especially in the review of the internal approaches (ICAAP and ILAAP) we expect a strong standardization, e.g. by in a clear definition of risk types as well as comparisons and reconciliations against Pillar 1 figures and top-down models produced by the regulators. A consolidation of data sources and definitions between the Pillar 1 and Pillar 2 approaches will be necessary in order to support the standardization. We expect that the ECB will employ the new
Newsletter SREP-Leitlinie der EBA / Financial Services / Juli 2014 5 process at least partially already in 2015 and recommend to identify potential impediments and gaps which might reduce the ability of an institution to optimally support the SREP process. Here we would like to stress that this ability will also enter the score a bank will attain with respect to quality of governance and control. Impact analysis on capital needs: some of the emerging methodological changes directly impact the economic capital adequacy. We do expect that the risk bearing capacity also in Pillar 2 will focus on the equity components prescribed by Pillar 1. Additionally Pillar 1 capital needs per risk category will form a floor for the respective economic capital needs while diversification effects will in future be at least to a large extent - disregarded. We recommend to start to perform recurring impact analyses on the resulting changes in capital needs in order to identify potential gaps in the capitalization as soon as possible. Identify requirements to enhance internal management processes: the future SREP process will lead to fundamental changes both in the analysis of the capital adequacy as well as in liquidity risk management. This comprises a continuous monitoring and active management of the key indicators as defined by the regulators. This fact in turn will need to be reflected in the business and risk strategies and might impact certain business models. We recommend to analyse the current portfolio of business plans and projects with regard to compatibility with the future SREP process in order to prevent misguided investments.
Newsletter SREP-Leitlinie der EBA / Financial Services / Juli 2014 6 Contact KPMG AG Wirtschaftsprüfungsgesellschaft THE SQUAIRE Am Flughafen 60549 Frankfurt am Main Ulrich Pukropski Partner, Head of Financial Services T +49 69 9587-1717 upukropski@kpmg.com Dr. Matthias Mayer T + 49 89 9282-1433 matthiasmayer@kpmg.com Daniel Quinten T +49 69 9587-1600 dquinten@kpmg.com Dr. Heiko Carstens T +49 89 9282-4715 hcarstens@kpmg.com Dr. Holger Spielberg T + 49 89 9282-4870 hspielberg@kpmg.com Marc Schäfer T + +49 621 4267-707 mschaefer@kpmg.com Die enthaltenen Informationen sind allgemeiner Natur und nicht auf die spezielle Situation einer Einzelperson oder einer juristischen Person ausgerichtet. Obwohl wir uns bemühen, zuverlässige und aktuelle Informationen zu liefern, können wir nicht garantieren, dass diese Informationen so zutreffend sind wie zum Zeitpunkt ihres Eingangs oder dass sie auch in Zukunft so zutreffend sein werden. Niemand sollte aufgrund dieser Informationen handeln ohne geeigneten fachlichen Rat und ohne gründliche Analyse der betreffenden Situation. 2014 KPMG AG Wirtschaftsprüfungsgesellschaft, eine Konzerngesellschaft der KPMG Europe LLP und Mitglied des KPMG-Netzwerks unabhängiger Mitgliedsfirmen, die KPMG International Cooperative ( KPMG International ), einer juristischen Person schweizerischen Rechts, angeschlossen sind. Alle Rechte vorbehalten. Der Name KPMG, das Logo und cutting through complexity sind eingetragene Markenzeichen von KPMG International Cooperative.