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CEBS Technical Advice on the Review of Large Exposures Rules Summary

Core Content

The CEBS technical advice to the European Commission on the review of the Large Exposures (LE) rules is structured into two parts, with the first part focusing on the objectives and purposes of the LE regime, and the second part addressing various regulatory tools and policy options. The advice is based on a comprehensive market failure and regulatory failure analysis, and considers stakeholder feedback and ongoing cost-benefit analysis.

Main Objectives of the Large Exposures Regime

CEBS identifies the following as the key objectives of a large exposures regime:

• Contain negative externalities from large exposures to individual counterparties or groups of connected counterparties, which could threaten financial stability and public confidence.
• Minimise moral hazard arising from safety net arrangements such as deposit insurance and lender of last resort (LOLR).
• Ensure public authorities have the necessary tools to monitor prudential principles continuously.
• Use appropriate and proportionate tools for intervention, if necessary, to achieve the stated objectives.

CEBS believes that large exposures can lead to traumatic losses due to "unforeseen events", such as unexpected government actions, loss of major customers, or breakdowns in business models. These events can cause unexpected defaults and systemic risk, even if the institution is adequately capitalised at the portfolio level.

Policy Options Considered

CEBS evaluated several policy options for regulating large exposures, including:

2.1 No Specific Regime

• Removing the current LE rules, allowing institutions to manage exposures internally.
• CEBS argues this would not ensure risks are kept to an acceptable level and may lead to imprudent exposures in certain cases.

2.2 Pillar 2 Approach

• Removing the current LE limits, allowing institutions to set their own internal limits.
• CEBS is concerned that Pillar 2 may not be sufficient to address systemic risk and moral hazard due to:
  • The complexity and transitory nature of large exposures.
  • Inconsistent implementation across Member States.
  • Uncertainty about acceptable exposure levels.
  • The risk of crowding out in Pillar 2 discussions.

2.3 Pillar 3 Disclosure

• Requires institutions to disclose large exposures to the market.
• CEBS acknowledges the potential for market discipline but highlights challenges:
  • Confidentiality concerns for certain exposures.
  • High frequency of disclosure needed.
  • Cost of analysis for market participants.

Key Findings and Recommendations

• CEBS proposes an amended limit-based "back-stop" regime, which is a simple and easy-to-understand tool, avoiding the need for complex models.
• The 800% aggregate limit is considered to provide a harmonised minimum standard, ensuring portfolio granularity and limiting losses not covered under Pillar 1.
• Compliance with the 800% limit should not replace the need for managing concentration risk under Pillar 2.
• CEBS suggests a prudent approach for off-balance sheet items, with a 100% conversion factor for most items, except low-risk ones (0% conversion factor).
• CEBS will further examine which transactions can be exempted from these flat conversion factors.

International Comparison

• Other jurisdictions also impose limits on large exposures to individual counterparties or groups.
• The EU regime is not necessarily stricter than others, but some specific transactions are treated more strictly.
• CEBS highlights the Fiat example as evidence that the current limit-based regime can be effective in enforcing lending discipline.

Further Work and Considerations

• CEBS outlines the areas to be considered in the second part of its advice, including:
  • Connected clients
  • Intra-group exposures
  • Inter-bank exposures
  • Trading book
  • Investment managers
  • One size fits all approach
  • Credit risk mitigation (CRM)

Key Challenges and Concerns

• The risk of traumatic loss due to unforeseen events remains a concern, even with current limits.
• Market failures such as negative externalities, moral hazard, and information asymmetry justify regulatory intervention.
• Regulatory failures could arise from interventions, including those related to safety nets and other measures.

Conclusion

CEBS concludes that while institutions may generally act prudently, market failures due to large exposures persist and require regulatory intervention. The advice advocates for a limit-based back-stop regime that is simple, clear, and proportionate, ensuring that the core aim of the LE regime is to protect against traumatic losses from single counterparty defaults. CEBS also acknowledges the need for further work on the implementation of principles-based approaches and the potential for differentiated treatment based on institutional sophistication and activities.