Implementing the Basel 3 final reforms in the EU: the European Council agrees its General Approach

This blog was published on 28 November 2022. Our latest analysis of the EU Banking Package state of play can be found here.

At a glance:

• The European Council has agreed its General Approach on the legislation that will implement the final Basel 3 framework in the EU.
• This is an important milestone in the EU’s long negotiations to implement Basel 3. The Council’s agreement on any legislative file is usually a good indicator of the EU’s final position.
• The Council’s text makes a number of important amendments to the Commission’s proposal, including a significant change to the application of the Standardised Output Floor (OF).
• Overall, however, the Council has kept the bulk of the Commission’s proposed approach. As a result, the EU continues to look likely to implement a version of Basel 3 that diverges substantially from the international standard.
• Banks should now update their assessment of the EU’s approach to Basel implementation and its likely impact on their business models and compliance programmes.
• This blog assesses what has been agreed by the Council, how it differs from the European Commission’s 2021 proposal, and what the next steps are in the path to finalisation and implementation.

Relevant to:

Board members, executives, risk and finance leads, heads of capital planning, heads of Basel implementation programmes at banks operating in the EU.

Background

On 8 November, the European Council (European Finance Ministers meeting as Ecofin) formally agreed its negotiating position on the “Banking Package” legislative file ahead of forthcoming negotiations between EU Member States and the European Parliament. This is a critically important milestone in the EU’s adoption of the final Basel 3 framework as the Council’s “General Approach” represents a compromise reached by all 27 EU Member States and is therefore very influential in shaping what the final law will look like.

The Council’s General Approach follows the European Commission’s proposal of the Banking Package, published in 2021, which contained amendments to the EU Capital Requirements Regulation and Capital Requirements Directive (the amending proposals are known as CRD6/CRR3).

While negotiations with the European Parliament will result in further changes being made, the Council’s General Approach is now the best available indication of the EU’s likely implementation of the Basel 3 framework.

Part I: Our assessment of the Council’s position

The document linked to this blog provides our more in-depth assessment of the Council’s General Approach. It is organised around our “5D” analytical framework that assessed the deviations made by the European Commission in its 2021 proposal – namely, the Delays, Deferrals, Divergences, Directions and Differences between the BCBS framework and the proposed EU legislation.

The European Council’s position retains most of the deviations from the BCBS’s framework that the Commission proposed, including:

• preferential treatment of investment-grade exposures to unrated corporates under the OF;
• lower capital requirements for some low-risk exposures to residential mortgages under internally modelled approaches; and,
• retaining the SME and infrastructure supporting factors and exemptions from the CVA framework for transactions with certain counterparties, despite calls from some EU regulators (including the EBA and the ECB) to remove them.

The Council has, however, reversed some high-profile policy decisions from the Commission’s proposals, including:

• agreeing that the OF be applied at all levels of consolidation (unless host supervisors decide to waive the requirement), in contrast to the Commission’s proposal to apply the OF only at the consolidated group level;
• reversing a preferential approach for unrated specialised lending facilities allowing for lower risk weights for certain object finance exposures, instead requesting that the European Banking Authority (EBA) assess the appropriateness of a preferential treatment by 2026; and
• reversing a requirement for third country banks to establish a branch or a subsidiary in an EU Member State in order offer banking services to clients located there (except in the case of reverse solicitation) (CRD6 Art. 21(c)).

The Chair of the EBA, José Manuel Campa, as well as the Chair of the European Central Bank’s Single Supervisory Mechanism, Andrea Enria, published a statement this month calling for EU legislators to adhere closely to the timing and content of the BCBS Basel framework in the implementation of the Banking Package. While the Council’s General Approach represents, in common with the Commission’s 2021 proposal, a substantial deviation from the Basel standard, some Council amendments represent a tightening that either brings the text closer to the original Basel standards or increases the likely capital impact of the rules. This reflects a careful balance of views among EU Member States between wanting to adhere to international banking standards while also seeking to manage the expected capital impact of the Basel 3 reforms on economic activities that are important in Europe.

Part II: Implementation timing

The European Council’s General Approach leaves mostly unchanged the Basel 3 implementation timing approach proposed by the European Commission last year. This consists of:

•  An implementation date of 1 January 2025 for most elements of the Basel 3 reforms (two years later than the BCBS target of 1 January 2023)
•  A five-year phasing-in of the Standardised Output Floor from 1 January 2025 to 1 January 2030 (ending two years later than the BCBS phase-in target of 1 January 2028).
• A mechanism to delay the implementation of revised Market Risk requirements by up to two years if other jurisdictions do not implement their respective rules on time.
•  An 18-month transposition and application deadline for the Directive (CRD6), which itself contains a 24-month implementation period for provisions related to the Third Country Branch framework following application.

This re-confirms the intention of EU legislators to implement the Basel 3 framework without further delays to the timeline. This timing will nevertheless be very tight and is likely to provide only one year between when the law is expected to be finalised (by end 2023) and when it must be initially implemented by banks. This compares to a two-year general implementation period that was used for the CRR2 package finalised in 2019.
Other major financial services jurisdictions, including the UK and the US, have said that they are also targeting 1 January 2025 to implement Basel 3. Given the intense focus on having a common implementation date across major BCBS members, we expect EU policymakers will try to maintain the current implementation timing: this will, however, depend on negotiations continuing to progress smoothly and, potentially, on regulators in the US and UK proceeding to plan.

Part III: Next steps in the negotiations

The Council now awaits the finalisation of the European Parliament’s negotiating position (expected early 2023) on the Banking Package, before inter-institutional negotiations (called “trilogues”) begin on the file.

Trilogue negotiations on a legislative package of this complexity and importance can be a prolonged process. The Parliament is likely to have substantial differences with the Council, and there is some indication that its negotiating text could be more aligned in certain areas to the BCBS standards, so difficult trade-offs will need to be made. In previous CRD/CRR negotiations, however, the Council has made comparatively fewer concessions to the Parliament’s position than vice versa and therefore the Council’s General Approach has often been the best indication of the direction of travel on a legislative file.

We expect that EU negotiators will aim to conclude trilogue negotiations by Q4 2023 and have the revised CRD6 and CRR3 texts enter EU law before the end of 2023. This would allow for the one-year implementation period mentioned earlier. This short implementation timeline underlines the importance of the banking sector taking early action where it is possible to do so – including allocating sufficient resources to Basel programme activity areas such as preparing for the application of the OF. Using the Council’s General Approach as the basis for reasonable assumptions about the final state of the EU’s Basel 3 approach is a good place to begin.