Capital Requirements Directive IV Framework …

1 Capital Requirements Directive IV Framework European Additions to basel III. Allen & Overy Client Briefing Paper 17 | January 2014. 2 CRD IV Framework : European Additions to basel III| January 2014. CRD IV Framework : European Additions to basel III. This briefing paper is part of a series of briefings on This briefing is for general guidance only and does the implementation of basel III in Europe via the not constitute definitive advice. Capital Requirements Directive IV1 (CRD IV). NOTE: In relation to the topics discussed in this and the Capital Requirements Regulation2 (CRR), briefing, CRD IV and the CRR contain a number of replacing the Banking Consolidation Directive3 and discretions for Member States in relation to national Capital Adequacy The legislation is implementation. The regime may therefore differ highly complex: these briefings are intended to provide a across Member States in a number of respects. high-level overview of the architecture of the regulatory Capital and liquidity Framework and to draw attention to This briefing paper is based on information available the legal issues likely to be relevant to the in-house lawyer.

2 As of 17 January 2014. Background and scope Sources CRD IV and the CRR recast and replace the Capital Requirements Corporate Governance, Systems and Controls: Directive (ie the Banking Consolidation Directive and Capital CRD IV ( Directive 2013/36/EU): Articles 76 - 91;. Adequacy Directive 2006/48/EU and 2006/49/EU) (CRD) and apply CRR (Regulation 575/2013): Article 435. from 1 January 2014. Whilst they primarily represent the European Recovery and resolution planning: CRD IV. Commission's implementation of the revisions to the basel Accord ( Directive 2013/36/EU): Article 74. known as basel III, they also introduce a number of important changes to the banking regulatory Framework that were not provided Disclosure: CRD IV ( Directive 2013/36/EU): Articles 89-90. for under the basel proposals. Remuneration: CRD IV ( Directive 2013/36/EU): Articles 92-95;. In addition to these changes, the CRR also provides for a single CRR (Regulation 575/2013): Article 450.

3 Rulebook' in that it produces, for the first time, a single set of Reliance on external credit ratings: CRD IV ( Directive 2013/36/EU): prudential rules for credit institutions and investment firms Article 77 ; CRR (Regulation 575/2013): Articles 111-141. (together, firms) that are directly applicable in member states. Credit risk adjustments: CRR (Regulation 575/2013): Article 110. The intention behind this is to ensure uniform application of basel III in Europe. The new rules in the CRR remove a significant Supervisory reporting Requirements : CRR (Regulation 575/2013): number of national options and discretions from the current CRD. Articles 99, 100, 101 and 394. They allow member states to apply stricter Requirements only Sanctions: CRD IV ( Directive 2013/36/EU): Articles 64-72. where these are justified by national circumstances, needed on UK Financial Conduct Authority (FCA) Policy Statement (PS13/10). financial stability grounds or because of a firm's specific risk profile.

4 CRD IV for Investment Firms (December 2013). This briefing summarises the new rules on corporate governance, UK Prudential Regulation Authority (PRA) Policy Statement (PS7/13). systems and controls, recovery and resolution planning, disclosure, Strengthening Capital Standards: Implementing CRD IV, feedback remuneration, reliance on external credit ratings, credit risk adjust- and final rules (December 2013) (the PRA Policy Statement). ments, supervisory reporting Requirements and sanctions under CRD IV and the CRR. PRA Supervisory Statement (SS16/13) Large Exposures (December 2013) (the PRA Supervisory Statement on Large Exposures). PRA Supervisory Statement (SS10/13) Credit Risk Standardised Approach (December 2013) (the PRA Policy Statement on Credit Risk Standardised Approach). 1_2013/36/EU. 2_Regulation 575/2013. 3_2006/48/EU. 4_2006/49/EU. Allen & Overy LLP 2016. 3. Corporate governance, systems and controls The corporate governance provisions found within CRD IV Members are required to commit sufficient time to and the CRR build upon work already undertaken by perform their functions with limits being placed on the European Commission and are designed to further the number of directorships and non-executive reduce excess risk taking by firms.

5 CRD IV contains directorships a member of the management body additional Requirements on the nature and composition can hold. For significant firms , there are explicit of management bodies and risk management arrangements limits on the combination of directorships. whereas the CRR requires firms to make increased The management body is responsible for the Pillar Three disclosures. implementation of effective and prudent governance Although CRD required firms to have robust arrangements which consider the segregation of duties governance arrangements in place and at least two within the firm and the prevention of conflicts of interest. experienced individuals effectively directing the business, the Significant firms must establish a nomination European Commission believes that weaknesses in corporate committee. When recruiting members to the governance contributed to the financial crisis. Of particular management body, firms must consider a broad range concern was the perceived failure by boards to exercise of qualities and competencies, including diversity.

6 Sufficient risk oversight and establish appropriately strong The European Commission believes that diversity in risk management functions this, in their view, was board composition will provide a broader range combined with supervisors being incapable of identifying of views and opinions and therefore avoid the weaknesses within the risk governance frameworks. phenomenon of group think .5. In order to combat these concerns, CRD IV introduces new Requirements in relation to management bodies In relation to risk management arrangements, which include: CRD IV requires that: All members of the management body must be of The management body be responsible for the firm's sufficiently good repute and in possession of adequate overall risk strategy and for the adequacy of the firm's knowledge, skills and experience not only to perform risk management system, and must devote sufficient time their duties but also to ensure the independence of mind to risk issues.

7 Necessary to constructively challenge and oversee the Significant firms establish a separate risk committee, decisions of management. Members must act with composed of non-executive members, who advise the honesty, integrity and independence. The combined management body on the firm's overall current and future management body will be required to possess adequate risk appetite and strategy and assist in the risk oversight collective knowledge and skills to enable it to understand role although the management body will remain the main risks arising from activities across the firm as a ultimately accountable. Non- significant firms may whole. The firm must devote adequate resources to the combine the risk committee with the audit committee. induction and training of the management body. 5_European Commission: Capital Requirements CRD IV/CRR Frequently Asked Questions. 4 CRD IV Framework : European Additions to basel III| January 2014.

8 Firms establish a risk management function that is Supervisors assess whether firms have implemented independent from operational functions and has been policies and processes to evaluate and manage the granted sufficient authority, stature, resources and access exposure to risks such as operational risk, concentration to the management body. In significant firms , risk, credit and counterparty risk, market risk, liquidity the risk management function must be headed by risk and risk of excessive leverage. New Requirements an independent senior manager who has distinct apply in respect of systems and controls on liquidity risk responsibility for that function. profiles, credit risk, market risk and leverage risk. Recovery and resolution planning Article 74(4) of CRD IV requires the generation of recovery The requirement is tempered by the principle of and resolution plans. Recovery plans fall to the firm: proportionality: the Requirements may be reduced if resolution plans to the competent authorities.

9 The authorities consider that the firm is non-systemic. Disclosure CRD IV seeks to improve the transparency of firm activities disclosures in relation to their risk management objectives by requiring annual disclosure of profits, taxes and subsidies and policies (for each separate category of risk) and their in different jurisdictions from 1 January 2015. It also requires enhanced governance arrangements, including the policy disclosure of return on assets in the annual report. on diversity and the existence of a separate risk committee (where applicable). It also mandates disclosure of firms'. The CRR supports the strengthened governance provisions leverage ratios from 2015. by also requiring firms to make increased Pillar Three Allen & Overy LLP 2016. 5. Significant firms the Capital conservation buffer and the counter-cyclical Capital buffer;. additional obligations and scope the scope of liquidity reporting on an individual basis.

10 A number of CRD IV Requirements are limited in scope to the scope of liquidity reporting on a consolidated significant firms . These include Requirements regarding: basis; and the requirement to establish an independent remuneration disclosure. risk committee;. the requirement to establish an independent CRD IV does not specify what amounts to a nominations committee; significant firm for these purposes. In the UK. the PRA has provided guidance that firms within its the requirement to separate the CEO and chairperson role, and limitations on the number of directorships impact categories 1 or 2 are significant for this purpose. an individual may hold; The FCA has set out in IFPRU section tests to assess what classes of investment firms will be the requirement to establish an independent remuneration committee; significant . These are based on quantitative tests of balance sheet assets, liabilities, annual fee and supervisory stress testing.