Stand out for the right reasons Financial Services Risk and Regulation. FSRR Hot Topic

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1 December 2016 Stand out for the right reasons Financial Services Risk and Regulation FSRR Hot Topic CRRII proposes changes to regulatory reporting and Pillar 3 Highlights On 23 November 2016, the European Commission issued proposed amendments to Regulation (EU) No 575/2013 (the Capital Requirements Regulation or CRR ). The amendments form part of a broad legislative package that also includes amendments to the Capital Requirements Directive ( CRD ), the Bank Recovery and Resolution Directive ( BRRD ) and the Single Resolution Mechanism Regulation ( SMR ). The proposal for amendments to the Capital Requirements Directive and Regulation, published on 23 November 2016 by the European Commission ( EC ), applies to all banks, building societies and systemically important investment firms. Leading up to the publication by the EC, market participants dubbed the latest European legislative proposal package as CRD V, with the changes proposed to the detailed regulations branded CRR II. In publishing the package, the EC noted: The present proposals aim to complete the regulatory reform agenda by tackling remaining weaknesses and implementing some outstanding elements of the reform that are essential to ensure institutions' resilience but have only recently been finalised by global standard setters. This briefing forms part of a series of publications that sets out a summary of the CRR II proposals. Specifically, this note covers the proposals relating to regulatory reporting and changes to the Pillar 3 disclosure requirements, together with comparisons to the Pillar 3 revisions issued by the Basel Committee on Banking Supervision ( BCBS ) and some perspectives on their implications for banks. Timeline of developments Global developments In June 2014, the BCBS consulted on its review of Pillar 3 disclosure requirements, proposing a two phase project intended to establish a single, coherent package of disclosure requirements. It was proposed that the first phase would address the areas of credit risk, market risk, counterparty credit risk, equity risk and securitisation, while the second phase would consolidate all disclosure requirements reflected in other standards (such as liquidity and leverage) and address interest rate risk in the banking book, operational risk, hypothetical standardised approach requirements (for firms using internal ratings-based approaches) and key metrics. In January 2015, the BCBS published its final Standards covering the first phase of its Revised Pillar 3 disclosure requirements. The Committee s intent is that, when fully implemented, the revised disclosure requirements will enable market participants to make meaningful comparisons of banks of risk-weighted assets and approaches to risk management. Additionally, the revisions focus on improving the transparency of the internal model-based approaches that banks use to calculate minimum regulatory capital requirements.

2 In March 2016, the BCBS consulted on the second phase of Pillar 3 revisions. In addition to the June 2014 proposals, it proposed that institutions will be required to report hypothetical standardised approach requirements for market risk, counterparty credit risk and securitisation. In light of other policy developments, disclosure requirements were also incorporated for total lossabsorbing capacity (TLAC) and revisions made for operational risk and market risk. A key component of the new Pillar 3 regime is to introduce a series of fixed-format quantitative tables and flexible-format qualitative templates to drive uniform, consistent Pillar 3 disclosure across banks internationally. European developments In June 2016, the European Banking Authority ( EBA ) published a consultation paper setting out Guidelines on disclosure requirements (the EBA Guidelines ) under the Pillar 3 regime enforced through Part Eight of the CRR. The scope of the EBA Guidelines broadly align with the BCBS phase 1 revisions and seek to ensure that the revised framework can be implemented in a consistent way throughout the European Union. In addition to introducing certain modifications to align individual disclosure tables and templates with the CRR, two notable departures from the BCBS revised Pillar 3 requirements included: i. Timing While the BCBS called for implementation of the first phase of Pillar 3 requirements for financial years ending 2016, the EBA proposed application for year-end 2017 ; and ii. Scope In its view, the EBA noted that the comprehensiveness of the guidance has led the EBA to limit, at this early stage, its scope of application to Globally and Other Systemically Important Institutions (G-SII and O-SIIs), and any other institution opted-in these Guidelines on the basis of a supervisory decision. All institutions (meeting the requirements of Articles 6, 10 and 13 of the CRR) remain subject to disclosure rules set out in Part Eight. Other developments In parallel to the significant Pillar 3 disclosure developments at the global and European levels, a number of key developments regarding regulatory reporting in the UK have taken place during These included: i. Heightened supervisory focus on regulatory reporting As we outlined in a recent blog, in an October 2016 speech at Mansion House, the PRA CEO revealed his preference for firms to publish their regulatory returns and committed to establishing a dialogue with industry and other stakeholders regarding exploring further this potentially significant development. The Mansion House speech was the culmination of a year in which the PRA sharpened its focus on the quality of firms regulatory reporting through a series of dear CEO letters to a group of firms announcing intentions to launch a thematic review of the completeness and accuracy of their Common Reporting (COREP) returns. This development prompted a number of firms to commission reviews on their regulatory reporting, revealing their own concerns around matters of technical judgement and interpretation, or detailed calculation and disclosure errors, within their regulatory reporting templates. ii. Assurance over RWAs and bank capital ratios Market and supervisory focus on regulatory capital ratios have long been a key factor underpinning confidence in firms capital positions and the resilience of the banking system. While the importance of high quality reported regulatory information has never been in debate, UK bank capital ratios unlike some international territories are not subject to external assurance, either within COREP, other regulatory or financial reporting or Pillar 3. Consequently, the drivers for exploring options for assurance over regulatory ratios are multiple Including, among others: escalating supervisory concern over the integrity of regulatory reporting as highlighted above; individual accountability under the Senior Manager s Regime; changes to the Pillar 3 disclosure framework to subject to the same level of internal review and internal control processes as the information provided for financial reporting ; and other regulatory changes including BCBS 239 confirmations that aggregated and reported risk data is relevant and appropriate, in terms of both amount and quality. In July 2015, the Institute of Chartered Accountants in England and Wales ( ICAEW ) published a Discussion Paper which set out potential benefits, considerations and issues involved in designing an assurance engagement on capital ratios and related information. This was followed in November 2016 with a consultation paper setting out a proposed framework for providing assurance (both internal and external) over banks RWAs and capital ratios. While the consultation does not call for a requirement for regulatory ratios to be audited or subject to external assurance, it does provide a coherent framework and a set of key considerations that could be used in designing assurance activity in these areas. 3 Hot Topic Financial Services Risk and Regulation

3 Summary of the key CRR II proposals Given multiple drivers at the global, European and UK levels and escalating focus from a range of stakeholders regarding reported regulatory information, the CRR II proposals in the areas of disclosure and regulatory reporting are significant Albeit somewhat beneficial for smaller firms. Key revisions in the proposals include: EBA to undertake assessment of regulatory reporting burden Various provisions have been added or amended in the CRR and the CRD to enhance proportionality and reduce costs on firms in the overall regulatory reporting framework. Reporting on large exposures will be simplified, while small institutions (a defined term) will only be required to submit regulatory reports on an annual basis as opposed to semi-annually or more frequently for all other firms. Additionally, the legislation gives a mandate to the EBA to deliver a report to the European Commission on the cost of regulatory reporting by 31 December The mandate sets out a very precise methodology for the EBA to evaluate the reporting burden on firms and obliges the EBA to make recommendations on ways to simplify reporting for small institutions through amendments to existing EBA reporting templates. Uniform Pillar 3 disclosure formats Consistent with the BCBS proposals and EBA Guidelines discussed above, CRR II empowers the EBA to develop draft implementing technical standards specifying uniform disclosure formats and instructions with which firms will need to publish their Pillar 3. These disclosure formats should convey sufficiently comprehensive and comparable information for users to assess risk profiles of firms and their degree of compliance with CRR. It will be important for firms to follow how the EBA Guidelines translate into implementing technical standards given that the required end-users for the latter will be all CRR-firms, which is much broader than just the G-SIIs and O-SIIs currently envisaged in the EBA Guidelines. Proportionality and scope A key feature across the CRD V/CRR II package is the introduction of greater proportionality A theme which has carried through into the proposed Pillar 3 requirements. New provisions are added to provide for a more proportionate disclosure regime that takes into account the relative size and complexity of firms. Firms will now be classified into defined categories based on size, with a further distinction between those that are listed and nonlisted. Disclosure requirements will apply to each category of institutions on a sliding scale basis, with differentiation in the substance and frequency of. At the upper end of the scale, large institutions with listed securities will be required to provide annual of all the information required under Part Eight of the CRR, plus of selected information on a semiannual and quarterly basis, including a key prudential metrics table. At the lower end, small non-listed firms will only be required to make selected of governance, remuneration and risk management information and the key metrics table on an annual basis. These proposals across the various defined categories of firms are summarised in the table below: Annual Semi-annual Quarterly Large institution (G-SIIs) 1 All All LCR and NSFR and eligible liabilities individual risk types, CRM and Leverage Key metrics Results of ICAAP, if required 2 on credit quality and provisions Large institution (non-g-siis, listed) 1 All All LCR and NSFR individual risk types, CRM and Leverage Key metrics Results of ICAAP, if required 2 on credit quality and provisions 4 Hot Topic Financial Services Risk and Regulation

4 Annual Semi-annual Quarterly Large institution (non G-SIIs, non-listed) 1 All Key metrics N/A Small institution (listed) on Risk Management and Governance All Remuneration All LCR and NSFR Results of ICAAP, if required 2 individual risk types, CRM and Leverag Key metrics N/A Small institution (non-listed) Key metrics on Risk Management and Governance All Remuneration N/A N/A Other institutions (listed) All Key metrics N/A Other institutions (non-listed) All Risk Management, Governance and Remuneration All LCR and NSFR Results of ICAAP, if required 2 individual risk types, CRM and Leverage Key metrics N/A 1. Includes subsidiaries of institutions meeting the 'large institution' definition. 2. ICAAP related information to be disclosed only if required by the competent authority. Changes to technical criteria Various amendments have been proposed to the detailed disclosure requirements to better align with international standards, and the European Commission has been empowered to amend the disclosure requirements to reflect developments or amendments of international standards on. In particular, the amendments are intended to reflect new or amended Pillar I requirements to be introduced as part of the CRD V/CRR II package which include on Total Loss Absorbing Capacity ( TLAC ) and eligible liabilities, the new Standardised Approaches to Counterparty Credit Risk (SA-CCR), market risk and liquidity requirements (the LCR and NSFR). Some of the more notable technical changes include: i. Risk Management In addition to various enhanced risk management, firms will need to disclose information on intra-group transactions and transactions with related parties that may have a material impact on the risk profile of the consolidated group. 5 Hot Topic Financial Services Risk and Regulation

5 ii. Risk weighted exposure amounts Specific disclosure requirements are introduced for risk weighted exposure amounts for each category of specialised lending and for categories of equity exposures. Additionally, explanations for variations in risk weighted exposure amounts between the current and previous reporting period will need to be supplemented by an outline of key drivers explaining those variations. iii. Counterparty credit risk Additional collateralrelated disclosure requirements which require the amount of segregated and unsegregated collateral received and posted, per collateral type, further broken down between collateral used for derivatives and securities financing transactions (SFTs). For SFTs, firms will need to disclose exposure values before and after the effect of credit risk mitigation. Firms will also need to disclose the amount of collateral they would have to provide as a result of downward migration in its own credit rating. iv. Operational risk management Disclosure requirements relating to operational risk have been significantly expanded and will now require extensive loss disclosure Including total operational risk losses over the last ten years, a breakdown of historical losses by year, separate identification of losses exceeding EUR 1 million and the number of such losses, as well as the total amounts of the five largest losses. To align with Pillar I Operational Risk revisions, firms will also have to disclose the indicators and components for the calculation of their own fund requirements, broken down per relevant business indicator. v. Interest Rate Risk in the Banking Book To align with the Pillar I revisions to Interest Rate Risk in the Banking Book ( IRRBB ), the Article relating to interest rate risk disclosure has been significantly enhanced to capture a range of IRRBB concepts. These include descriptions of key modelling and parametric assumptions used in internal measurements systems, explanations of significant interest rate risk measures and descriptions of how firms define, measure, mitigate and control their banking-book activities for interest rate risk purposes. vi. Key metrics Consistent with the BCBS Revised Pillar 3 framework, a new Article has been introduced to require firms to disclose certain specified key metrics in a tabular format. Given the new Pillar 3 proportionality / sliding-scale concept which places emphasis on the key metrics table over other more prescriptive and granular for smaller firms, the key metrics table will represent a significant focal point for the of all firms irrespective of size. Among others, disclosure of specified key metrics will need to include: Composition of capital resources and disclosure of capital requirements Total risk weighted exposure amount Combined buffer requirements Leverage ratio LCR and NSFR Own funds and eligible liabilities broken down at the level of each resolution group. vii. Significant investments Disclosure requirements have been included regarding investments in insurance undertakings that a competent authority has authorised not to be deducted from supplementary own fund requirements of financial conglomerates. viii. Remuneration Clarifications have been made to the remuneration and a disclosure requirement is introduced concerning the use of derogations from the remuneration rules of CRD. 6 Hot Topic Financial Services Risk and Regulation

6 What does this mean for firms? Having accumulated considerable momentum since the BCBS publication of the first phase of the Revised Pillar 3 requirements, the direction of travel regarding the nature and extent of firms risk, capital, leverage and liquidity Together with supervisory expectations around those is clear. While the timeline for the first set of revised for the largest firms at the European level may still be at least 12 months away, all firms, irrespective of size, can now be certain of what the future reporting landscape looks like. It will be a future requiring more granular and uniform public disclosure, the integrity of which will need to be attested to by senior management. This attestation will need to be supported by a robust system of internal controls over regulatory reporting, at a level likely similar to internal controls over financial reporting. With greater consistency between firms through uniform disclosure templates, a key consideration for firms will be how their Pillar 3 under the new regime will influence the way the firm is judged by financial markets. With other regulatory change programmes Including regulatory stress testing, BCBS 239 and IFRS 9 Competing for resource over recent years, it will now also be important for firms to look at how to turn investment in new risk and capital evaluation capabilities into a more informed basis for decisionmaking. Leading firms will draw on the new and more detailed data that will need to be made available once the new Pillar 3 requirements are implemented. Firms will have to start considering how to gain comfort around the numbers they will be expected to disclose as the revised Pillar 3 framework is fully implemented. While some of the information that will be required to be disclosed may already be generated for statutory or regulatory reporting purposes, or used in internal management evaluations, many of these pieces of information would not have been attested to in writing or publicly disclosed before. There is little doubt that supervisory and market focus on banks prudential will continue to escalate. Those firms who are proactive and approach their responses to the new disclosure regime in a deliberate and structured way will find opportunities not only through accessing richer data and enhanced internal controls, but will be able to craft a compelling and complete narrative that can shape market perceptions. Contacts Nigel Willis E: nigel.willis@pwc.com T: +44 (0) Peter El Khoury E: peter.elkhoury@pwc.com T: +44 (0) Paul Parsons E: paul.parsons@pwc.com T: +44 (0) Rivaan Roopnarain E: r.roopnarain@pwc.com T: +44 (0) Martin Neisen E: martin.neisen@de.pwc.com T: Abdellah M barki E: abdellah.mbarki@nl.pwc.com T: Hot Topic Financial Services Risk and Regulation

7 Stand out for the right reasons Financial Services Risk and Regulation Financial services risk and regulation is an opportunity At PwC we work with you to embrace change in a way that delivers value to your customers, and long-term growth and profits for your business. With our help, you won t just avoid potential problems, you ll also get ahead. We support you in four key areas. By alerting you to financial and regulatory risks we help you to understand the position you re in and how to comply with regulations. You can then turn risk and regulation to your advantage. Even the best processes or products sometimes fail. We help repair any damage swiftly to build even greater levels of trust and confidence. Working with PwC brings a clearer understanding of where you are and where you want to be. Together, we can develop transparent and compelling business strategies for customers, regulators, employees and stakeholders. By adding our skills, experience and expertise to yours, your business can stand out for the right reasons. For more information on how we can help you to stand out visit We help you to prepare for issues such as technical difficulties, operational failure or cyber attacks. By working with you to develop the systems and processes that protect your business you can become more resilient, reliable and effective. Adapting your business to achieve cultural change is right for your customers and your people. By equipping you with the insights and tools you need, we will help transform your business and turn uncertainty into opportunity. This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, "PwC" refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details JD-OS