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EBA Consults on Asset Encumbrance Reporting

Introduction

On 26 March 2013 the European Banking Authority (EBA) published a consultation paper on Draft Implementing Technical Standards (ITS) on Asset Encumbrance Reporting under the draft Capital Requirements Regulation (CRR).  The deadline for comments is 24 June 2013.

The EBA believes that increasing levels of asset encumbrance may pose risks to individual institutions and/or to the whole financial system as a result of:

  • increasing structural subordination of unsecured creditors and depositors;
  • increasing funding and liquidity risks (since institutions with encumbered balance sheets may have fewer assets eligible for encumbrance);
  • increasing sensitivity of liquidity profiles to market value of collateral; and
  • the pro-cyclical nature of asset encumbrance during times of financial stress.

In light of this, the ITS provides supervisory authorities with information on the level and nature of asset encumbrance in institutions. This will facilitate comparison of the reliance on secured funding and the degree of structural subordination of unsecured creditors and depositors across institutions.  It will also enable supervisors to assess the ability of institutions to manage funding stress and to assess the amount of assets available within a resolution situation.

The draft ITS is comprised of three parts:

  • a legal text which defines the reporting framework, introducing a definition of “asset encumbrance” and outlining the frequency of reporting;
  • reporting templates and instructions; and
  • a Data Point Model and validation rules, defining technical specifications so as to promote harmonisation of reporting.

The Legal Text

Meaning of ‘Asset Encumbrance’

An asset is considered encumbered if “it has been pledged or if it is subject to any form of arrangement to secure, collateralise or credit enhance any transaction from which it cannot be freely withdrawn”.  As such, assets which are placed with an institution, are not used and can be freely withdrawn are not considered to be encumbered.  The explanatory guidance accompanying the draft ITS explains that the definition of “encumbered” is not based on an explicit legal definition, such as title transfer, but rather on economic principles. However, the definition is closely linked to contractual conditions and the EBA regards the following types of contracts as being covered:

  • secured financing transactions, including:
    • repos and reverse repos;
    • securities lending; and
    • other forms of secured lending;
  • various collateral agreements, such as those used for the collateralisation of derivatives transactions;
  • financial guarantees that are collateralised;
  • collateral placed at clearing systems, CCPs and other financial market infrastructures as a condition for access to service e.g. default funds and initial margin;
  • central bank facilities, but not including pre-positioned assets which can be withdrawn without prior approval;
  • underlying assets from securitisation structures, where the financial assets have not been de-recognised from the institution’s financial assets; and
  • assets in cover pools used for covered bond issuance, except in certain situations where the institution holds the corresponding covered bonds (‘own issued bonds’).

The Reporting Templates

General

Annex I to the ITS details the reporting templates which must be completed and submitted to supervisory authorities.  The Annex is split into five parts (A-E), as detailed below.

Part A: Overall Asset Encumbrance

This template requires firms to provide information regarding the accounting value and fair value of both encumbered and unencumbered assets, split by asset class.  Furthermore, it draws a distinction between unencumbered assets which are actually or potentially “available for encumbrance” and those which, whilst unencumbered, are “non-available for encumbrance” (i.e. where they have been taken as collateral but the reporting institution is not permitted to sell or re-pledge the collateral, except in the case of a default by the collateral owner).

Part B: Maturity Data

This template requires firms to provide a general overview of the amount of encumbered assets and collateral received which is re-used, split by reference to maturity buckets.

Part C: Contingent Asset Encumbrance

The template on Contingent Asset Encumbrance details two scenarios that attempt to define extreme but plausible stress the reporting institution might experience:

  • a 30% decrease in the fair value of encumbered assets; and
  • a 10% depreciation in significant currencies.

In completing the template, firms are asked to calculate the additional amount of assets that would become encumbered due to legal, regulatory or contractual provisions that could be triggered in the event that either of the above scenarios occur, again split by asset class.

Part D: Covered Bond Issuance

The reporting template for covered bonds programmes is designed to promote a harmonised regime with respect to the supervision of asset encumbrance in relation to cover bond issuance, regarded as necessary due to the belief that:

  • covered bonds programmes constitute one of the main drivers of assets encumbrance;
  • asset encumbrance in covered bonds programs is mainly long-term (in contrast to, say, encumbrance generated by repo financing and securities lending); and
  • asset encumbrance profiles within covered bonds programs are particularly difficult to compare across institutions and Member States due to differing national regulatory and credit rating requirements, as well as issuer strategies in terms of voluntary collateralisation buffers.

As such, this template focuses on liabilities associated with covered bond issuances as compared to collateral coverage, both measured over time.

Part E: Advanced Data

The format of this reporting template is similar to that of Part A, but requires data at a much more granular level, seeking information about the value of encumbered assets, split by asset class and ‘source of encumbrance’ i.e.:

  • central bank funding;
  • exchange traded derivatives;
  • over the counter derivatives;
  • repos;
  • collateralised deposits;
  • covered bonds;
  • ABS;
  • debt securities other than covered bonds and ABS; and
  • other.

Reporting Frequency

The reporting frequency associated with each part of the Annex is as detailed below:

Annex 1

Description

Reporting Frequency

Part   A

Information on overall asset encumbrance

Quarterly

Part   B

Information on maturity of asset encumbrance

Quarterly

Part   C

Information on contingent   asset encumbrance

Annual

Part   D

Information on covered bond asset encumbrance

Quarterly

Part   E

Information on detailed asset encumbrance

Semi-annual

Exemptions

In order to limit the administrative burden associated with reporting, smaller institutions  with total assets below EUR 1 billion will only be required to report in respect of Part A.  In addition, institutions that do not issue covered bonds are not required to report the information under Part D.  Finally, institutions are not required to report under Parts B, C or E if in the preceding two years they have had:

  • total assets of less than EUR 30 billion; and
  • asset encumbrance levels (measured as the ratio between encumbered assets and total assets) below 5%.

Conclusion

Once enacted, the asset encumbrance ITS promises to be another in a long line of administratively burdensome reporting requirements.  It will require a ‘deep-dive’ into both collateral management systems and the contractual arrangements associated with a wide variety of asset classes and transaction types in order to understand existing levels of encumbrance, the nature and amount of assets available to be encumbered and their associated values, with a view to generating detailed information on the liquidity and funding profile of the firm.  On the plus side, understanding the nature of asset encumbrance arrangements is a valuable exercise in its own right, and many banks may be able to leverage off experience of conducting similar exercises such as understanding the impact of credit ratings downgrades on collateral posting requirements.  In addition, FSA regulated banks may already have addressed some of the issues raised in the ITS in relation to their Module 3.3 (“Encumbrances”) RRP submissions.  Nonetheless, system upgrades, business process changes and resourcing requirements will undoubtedly result from the new guidelines and, even at this early stage in their development, firms should be considering the details requirements of the draft ITS in the forward planning of their regulatory reporting frameworks.

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