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CEBS Consultation Paper Summary on Large Exposures Rules (2007)

Core Content

CEBS issued a second consultation paper on the review of the Large Exposures (LE) rules on December 7, 2007, and invited feedback by February 22, 2008. This paper outlines proposed changes to the LE framework, aiming to enhance risk management and harmonize regulations across the EU. Deutsche Bank has provided its input, highlighting both the positive aspects and concerns regarding the complexity and scope of the proposed reforms.

Main Points and Key Issues

1. Definition of Large Exposures and Interconnectedness

• CEBS retains the current definition of large exposure as 10% of own funds but expands the concept of "connected clients".
• Examples of financial dependency include:
  • Exposure to a commercial property and its tenant.
  • Exposure to a sole producer and its sole buyer.
  • Exposure to a producer and its vendors.
  • Entities with identical customer bases.
  • Entities with overlapping management.
• Deutsche Bank believes the current German framework is sufficient and that the proposed interpretation lacks clear and measurable criteria.

2. Internal Models Method (IMM)

• CEBS acknowledges the use of exposure values from the IMM for large exposures, but introduces a conflicting requirement in §113(3) that exposure values must be consistent with the internal approach for limit setting.
• Deutsche Bank uses PFE (Potential Future Exposure), not EPE (Expected Positive Exposure), for limit setting.
• It argues that the use test for IMM should align with solvency regulations and not be an additional hurdle.

3. Risk Mitigation and Exposure Value Calculation

• CEBS retains the conflicting definitions of exposure from the CRD, mixing EAD (Exposure at Default) with LGD (Loss Given Default).
• Deutsche Bank suggests that the LE regime should focus only on EAD, with collateralised exposures treated with exceptions.
• CEBS proposes to apply unfunded protection in a manner similar to minimum capital rules, including PD (Probability of Default) of protection sellers, which adds unnecessary complexity.

4. Intra-group Exposures

• CEBS has not yet decided on the appropriate treatment for intra-group exposures.
• Deutsche Bank supports the current German approach, which excludes subsidiaries from LE reporting unless they are consolidated.
• It questions the rationale for applying a stricter 20% limit to non-consolidated subsidiaries compared to third-party groups.

5. Trading Book Exposures

• CEBS recognizes the blurring lines between trading and banking books, which may lead to regulatory arbitrage.
• It supports the idea of amending the trading book LE regime in light of incremental default risk capital charges.
• Deutsche Bank highlights the inconvenience of applying banking book rules to trading book exposures, which could hinder investment services.

6. Breach of Limits

• CEBS outlines three possible supervisory responses to breaches:
  1. Not accepting the breach and requiring corrective actions.
  2. Allowing an adjustment period with conditions on own funds.
  3. Permitting a longer breach period with a minimum capital level and coverage of the excess.
• Deutsche Bank is open to any approach as long as it is consistently applied across Europe.

7. Reporting Requirements

• CEBS suggests that regular reporting of large exposures is necessary but not burdensome.
• Deutsche Bank finds the Pillar 3 reporting of large exposures to be highly undesirable due to customer privacy and operational burden.
• It prefers reporting based on gross exposure values and independent reporting from regulators.

8. Market Failure and Advanced Institutions

• CEBS acknowledges that large banks can diversify better and are more subject to market discipline.
• However, its analysis shows that the 25% limit can be restrictive even for large banking groups in some countries.
• It emphasizes that the LE regime is a backstop for unforeseen events, not an exemption for advanced institutions.

Conclusion

While the CEBS consultation paper represents a step in the right direction, it is criticized for maintaining unnecessary complexity, conflicting definitions, and lack of clarity in key areas such as interconnectedness, exposure value calculation, and reporting. Deutsche Bank supports the idea of harmonization but urges for simplification and consistency in the implementation of the new LE regime. The paper also fails to address the non-bank group limit issue, which could lead to unequal treatment of subsidiaries. Overall, the document highlights the need for prudential alignment, operational feasibility, and clear regulatory guidelines.