Basel heading for ‘rotten’ compromise, warns EU lawmaker

US commitment to FRTB is essential to persuade Europe to adopt a 72.5% output floor

European Parliament building in Strasbourg
European Parliament could derail Basel III implementation if enough believe the compromise puts Europe's banks at a disadvantage to US counterparts

European lawmakers are likely to give a hostile reception to a possible compromise deal at the Basel Committee on Banking Supervision, after regulators indicated they were close to agreeing to set a floor for internal capital models at 72.5% of the standardised approaches.

“The compromise that is emerging in the Basel Committee is a rotten one,” says Markus Ferber, vice-chair of the European Parliament’s economic and monetary affairs (Econ) committee, and a German member of the largest parliamentary grouping, the European People’s Party.

The Basel Committee is due to meet on December 12–13 to thrash out the final piece of the Basel III package that has been delayed since January this year. If the latest talks are successful, the governors and heads of supervision who oversee the committee are likely to sign off and publish the final standards in January 2018.

While European negotiators have pushed for a floor set at 70% or lower, the US side has pressed for 80% or higher. In a meeting on June 14–15, European nations reportedly rejected a proposal that would have floored modelled capital at 75% of the standardised approaches. US rules under the Dodd-Frank Act – known as the Collins Amendment – impose a de facto 100% floor on credit and market risk, so the Basel output floor would have little impact on US banks’ capital requirements.

“If you look where Europe was coming from and where we are about to end up with regards to the output floors, this looks like a clear victory for US banks, while the EU banking sector will lose out. The European banking sector will pay a dear price for the inability of EU negotiators to co-ordinate properly and hold a firm line,” adds Ferber. The Econ committee will be responsible for transposing any Basel deal into European law.

In a speech on November 14, German Bundesbank board member Andreas Dombret said that a 72.5% floor “is anything but the result Germany had been hoping for” but also that it would be wrong to allow “negotiations to founder over 2.5 percentage points” – a reference to the EU’s original demand that the floor should not exceed 70%.

Ferber’s reaction to the compromise, however, threatens to derail Basel III implementation in Europe if enough MEPs are convinced a 72.5% output floor puts European banks at a disadvantage relative to US peers. The European People’s Party alone comprises 215 of the parliament’s 750 MEPs, while Germany has 96.

“In my opinion, we now have to have a close look at the eventual compromise and see if it really makes sense to transpose it one-to-one into European law. That is even more so given the poor transposition record other jurisdictions have for previous Basel packages,” he says.

US FRTB trade-off

Ferber’s warning about other jurisdictions’ poor transposition records echoes concerns expressed by Dombret in his speech. The Bundesbank regulator insisted the US must commit to implementing other parts of Basel III that have already been agreed – especially the Fundamental Review of the Trading Book (FRTB) – in order for Europe to sign up to the output floor.

“The United States, too, must implement Basel III without qualification – every part of the reform. Which is to say including the complete revision of the trading book rules,” said Dombret.

French central bank governor François Villeroy de Galhau took a similar line in a speech on November 6. In his speech, de Galhau made a direct link between US FRTB implementation and Europe accepting a model output floor in Europe, but without referencing the 72.5% figure specifically.

“First, the agreement must be fair – it must be applied by all jurisdictions, in all its components, including by the Americans in the measurement of market risks, ie the FRTB. Second, the agreement must be reasonable, in terms of the increased capital requirements that will apply to French and European banks – including through the introduction of the so-called ‘output floor’ on capital requirements for banks that use internal models,” de Galhau said.

Markus Ferber
The European banking sector will pay a dear price for the inability of EU negotiators to co-ordinate properly and hold a firm line
Markus Ferber, European Parliament economic and monetary affairs committee

A US Treasury report published in June following an executive order on regulation by president Donald Trump recommended “delaying the domestic implementation of the NSFR [net stable funding ratio] and FRTB rules until they can be appropriately calibrated and assessed”.

One regulatory expert at a US bank says European Union policymakers have repeatedly voiced concern that the FRTB will not be applied in the US, despite the US Treasury report not specifically ruling it out.

“The Treasury report didn’t say it’s not introducing FRTB, but EU policymakers throw this in our face all the time. It’s an easy argument. We don’t believe the US is not going to do this, but it may be re-evaluating which banks it will apply to,” says the regulatory expert.

He adds: “We think the Treasury is pausing on this in order to remove the community and savings banks from the Basel rules, not the very large Wall Street banks. It’s very much like raising the threshold for designation as a US systemically important bank up from $50 billion, that’s never going to let Goldman or JP Morgan off the leash.”

By contrast, the European Commission has already published proposals in November 2016 that would implement both FRTB and the NSFR. This package – the second Capital Requirements Regulation (CRR II) is now due for discussion in the European Parliament and the Council of the EU.

The US regulatory expert believes the EU is unlikely to proceed with CRR II until the Basel Committee reaches its deal on the final tranche of the Basel III package. Even then, the EU risks falling out of kilter with the rest of the world on Basel implementation if CRR II rules are adopted without waiting for the US to finalise FRTB.

“As a US bank we only apply EU rules for our EU entities, which affects us, but nowhere near as much as a BNP Paribas or Deutsche Bank. When Basel announces an agreement [on the floor], the EU will put a date in the timetable, but I’m sure this will have to be delayed,” he says.

For the EU to implement the capital floor, he adds, there will need to be amendments to CRR II, or more likely fresh legislation at a later date.

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