As part of the new European regulations on capital resources for banks (CRD IV / CRR), at the end of March 2013, the European Banking Authority (EBA) published its first draft on the supplementary reporting requirements for Asset Encumbrance.
In the meanwhile the rules and reporting templates have been finally adopted.
With this new reporting requirement the legislator wants to give supervisory authorities a greater insight into what assets are actually available for generating liquidity at the institutions. Assets recorded on balance sheets can indeed include, for example, securities that have been lent, margin payments, securities pledged to the Bundesbank, or loans in cover funds. However, in the event of a financial market crisis, in particular, their free use would be severely restricted. It is not uncommon when concluding such transactions (and the accompanying encumbrance of the assets used as collateral/underlying) to enter into related obligations to make additional payments in the event of a fall in value, which is in no way unusual during economically difficult times. Therefore, the new EBA standard accommodates such circumstances in the new reporting requirement by thoroughly taking into account various types of restrictions on the availability of assets.
The first asset encumbrance report, based on the reference date of 31 December 2014, has to be prepared and submitted by the 11 February 2015.
In December 2013, in addition to the quarterly reporting requirements, the EBA presented guidelines on the disclosure of asset encumbrance. The publication of the guidelines is a first step on the road to the harmonisation of disclosure rules that would enable market participants to make comparisons across all institutions. These guidelines will undergo a review in 2015 and, on the basis of the insights thus gained, will be transformed into binding ITS, which the EBA will have to present at the beginning of 2016.
The quantitative disclosures that are required within the scope of the guidelines resemble shortened versions of the "AE-Assets“, "AE-Collateral“ and "AE-Sources“ templates that are used for quarterly asset encumbrance reporting. In the qualitative part of the disclosure, the institutions should describe the influence of their business models on the level of asset encumbrance and explain how important encumbrance is for their refinancing. The formal template that has been provided for this purpose ultimately only has a free text entry field.
As the reporting requirements, including guidelines for disclosure, have been adopted, the banks are primarily concerned with the proper implementation of these. However, in the meanwhile, many are also turning their attention to the qualitative background that underlies the reporting requirement.
Market participants will still be grappling with the following issues in the long term:
- What encumbrance ratio is appropriate for my institution?
- What does the market expect?
- How does asset encumbrance influence product pricing?
- What would be the consequences for a bail in?
- How can I influence the encumbrance ratio and what impact would this have on other ratios (e.g. equity ratio, LCR)?