Recent regulatory developments focussing on banking and finance. See also our General regulatory news of relevance to all financial institutions.

Contents

• COVID-19: PRA statement on application of IFRS 9 and capital requirements as mortgage payment deferrals come to an end
• COVID-19: PRA ends temporary approach to VAR back-testing exceptions
• LIBOR transition: RFRWG recommendations on conventions for referencing compounded in arrears SONIA
• "5 conduct questions": FCA 2019/20 wholesale banking industry feedback
• BRRD II: Corrigendum published in OJ
• BRRD: EBA 2019 annual report on resolution colleges
• CRR: EBA opinion on European Commission amendments to final draft RTS relating to economic downturn
• COVID-19: revised EBA 2020 work programme

COVID-19: PRA statement on application of IFRS 9 and capital requirements as mortgage payment deferrals come to an end

On 26 August 2020, the UK Prudential Regulation Authority (PRA) published a statement to clarify its approach to International Financial Reporting Standard 9 (IFRS 9) and regulatory capital requirements.

The PRA statement follows the updated proposals published by the Financial Conduct Authority (FCA) on retail mortgage payment deferrals in light of COVID-19 (see our briefing: Mortgages and COVID-19: FCA draft guidance on further support after payment deferral period ends). The FCA draft guidance states that, at the end of the existing COVID-19 specific payment deferrals, if borrowers are unable to resume payments in full immediately with all deferred sums either paid in full or capitalised, tailored forbearance arrangements provided in accordance with the draft updated guidance should be considered.

The PRA explains that such tailored forbearance arrangements are likely to be as good an indicator of significant increases in credit risk (SICR), credit impairments or defaults as forbearance was before the pandemic. Before COVID-19, loans subject to forbearance would not automatically have been treated as having experienced a SICR or become credit impaired or in default, and that will also be the case with tailored forbearance provided in accordance with the draft updated guidance.

The PRA states that, although in some cases the position will be clear-cut, in other cases a judgment will need to be made. The guidance in the PRA's June 2020 letter on a framework for making holistic assessments of loans subject to payment deferrals for indicators of SICR or credit impairment will be relevant when making that judgment.

The PRA's earlier guidance stating payment deferrals are not necessarily good indicators of SICR, credit impairments or defaults may, however, continue to be relevant to payment deferrals used outside of the UK, depending on the facts and circumstances involved (including the availability of the deferrals and the circumstances in which they are used). The earlier guidance on holistic assessments of loans also continues to be relevant where firms have limited data to assess the individual financial circumstances of the borrower.

The PRA's March and June letters address other matters and some of that guidance also continues to be relevant; in particular, the guidance in the March letter on the treatment of borrowers that breach covenants due to COVID-19, on IFRS 9 expected credit loss (ECL) model risk, and on the need for post-core ECL model adjustments.

The PRA considers the guidance in the statement to be consistent with IFRS 9 and the Capital Requirements Regulation (CRR). However, it is the responsibility of firms to satisfy themselves that they have prepared their annual and interim financial reports in accordance with the applicable reporting frameworks and for auditors to reach their own audit or review conclusions about those reports. Similarly, it is for firms to ensure they comply with the requirements of CRR.

COVID-19: PRA ends temporary approach to VAR back-testing exceptions

On 27 August 2020, the PRA published a statement announcing that, in light of the amendments to the CRR in response to COVID-19 (the CRR "Quick Fix"), the PRA intends to terminate the temporary approach to value-at-risk (VAR) back-testing exceptions it announced in March 2020.

From 1 October 2020 onwards, firms should no longer apply any commensurate reduction in risks-not-in-VAR (RNIV) capital requirements.

For back-testing exceptions that occur between 1 January 2020 and 31 December 2021 that do not result from deficiencies in their internal model, firms should now apply to the PRA in accordance with Article 500c of the CRR to exclude those exceptions from the calculation of their back-testing addend.

LIBOR transition: RFRWG recommendations on conventions for referencing compounded in arrears SONIA

The Working Group on Sterling Risk-Free Reference Rates (RFRWG) has published a statement of recommendations on standard market conventions to support the use of SONIA in loan markets for Sterling Bilateral and Syndicated Facilities, including Multicurrency Syndicated Facilities where there is a sterling currency option.

SONIA compounded in arrears is the RFRWG's recommended alternative to Sterling LIBOR. The recommendations (which are non-binding) aim to enable and expedite the transition away from the use of LIBOR.

In summary, the recommendations are:

• SONIA remains the RFRWG's recommended alternative to Sterling LIBOR, implemented via a compounded in arrears methodology, and loan markets should now move consistently towards this;
• use of a five banking days' lookback without observation shift. This aligns with the approach recommended by the Alternative Reference Rate Committee for US dollar loan markets and is most likely to be made rapidly available. While this approach is the recommendation, where lenders are also able to offer lookback with an observation shift this remains a viable and robust alternative;
• where an interest rate floor is used, the RFRWG recognises that it may be necessary to apply the floor to each daily interest rate before compounding; and
• accrued interest should be paid at the time of principal prepayment.

"5 conduct questions": FCA 2019/20 wholesale banking industry feedback

The FCA has published its report, "5 Conduct Questions: Industry Feedback for 2019/20". The five conduct questions form part of the FCA's strategy for supervising wholesale banks.

Key messages from the report include:

• conduct and culture change programmes are having a positive effect;
• while awareness of conduct risk is higher, skills to identify these risks must improve. This is especially important in the evolving "work from home" operating model predominately in use;
• psychological safety for day-to-day "speaking up and challenge" still needs attention from staff at all levels;
• remuneration strategies that focus on the "how" as well as the "what" are a positive development but more can be done to fully harness strategic benefits; and
• corporate purpose and principles have become confused. CEOs and line managers can help clarify how these terms link to individual roles and responsibilities

The FCA states that COVID-19 has created new and greater conduct risks. It will be important for firms to engage staff at home in the effort to identify potential sources of harm in their individual environments.

BRRD II: Corrigendum published in OJ

A corrigendum to the English version of Directive (EU) 2019/879 amending the Bank Recovery and Resolution Directive (2014/59/EU) (BRRD II) has been published in the Official Journal of the EU (OJ).

The Corrigendum amends the references to Article 12 of the Capital Requirements Regulation (CRR) in Article 45h(2) of BRRD II to Article 12a of the CRR.

BRRD: EBA 2019 annual report on resolution colleges

The European Banking Authority (EBA) has published its 2019 annual report on resolution colleges. Resolution colleges are required under the Bank Recovery and Resolution Directive (BRRD). The report sets out the EBA's observations of the efficiency, effectiveness and consistency of the functioning of resolution colleges during 2019.

CRR: EBA opinion on European Commission amendments to final draft RTS relating to economic downturn

The EBA has published an opinion on the European Commission's amendments relating to the EBA's final draft regulatory technical standards (RTS) on the specification of the nature, severity and duration of an economic downturn under Articles 181(3)(a) and 182(4)(b) of the CRR.

The EBA's opinion identifies three substantive changes introduced by the Commission. These relate to:

• the deletion of the requirement stating that the economic indicators relating to one downturn period should be significantly correlated. The EBA is of the view that this requirement should be re-introduced;
• the introduction of a proportionality principle for the cost of data (Recital 10 and Article 2), which alters the agreed policy. The EBA suggests some re-drafting to clarify the relevant data sources; and
• removing the possibility of considering a shorter time series than 20 years for economic indicators relating to an EU member state that joined the EU less than 20 years ago. The EBA agrees to the Commission's proposal, despite the substantive nature of the change.

In addition, the EBA has identified a number of non-substantive and drafting changes that, in its view, may unintendedly hamper the clarity of the text. Therefore, the EBA is proposing alternative drafting suggestions.

COVID-19: revised EBA 2020 work programme

On 14 August 2020, the EBA published a revised work programme for 2020, which it has amended to reflect the projects it has postponed due to COVID-19. The EBA also summarises the actions it has taken in response to COVID-19.

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