Consolidated and Enhanced Framework
The promotion of transparency and market discipline through Pillar 3 regulatory disclosure requirements have always been key tenets in the Basel framework. The purpose of these requirements is to make key information available about a bank’s capital and risk exposures in order to inform market participants. During the financial crisis, it became apparent that the existing Pillar 3 framework did not provide sufficient information to enable market participants to compare a bank’s overall capital adequacy with that of peer banks.
This weakness led to the Basel Committee Banking Supervision (BCBS) issuing a series of new standards for revised Pillar 3 disclosures, which are reflected at a European level in the EBA’s Guidelines on disclosure requirements under Part Eight of Regulation (EU) No. 575/2013 (the “Guidelines”). The revised framework represents a significant step towards enhancing the consistency and comparability of banks’ regulatory disclosures and ultimately towards promoting the transparency agenda.
The Guidelines do not change the substance of the Pillar 3 requirements contained in the CRR and supplement existing information already provided under delegated or implementing regulations or guidelines. Notwithstanding this, the impact of the revised Pillar 3 disclosures framework for banks is very significant. The volume and detail required has increased substantially and is far more prescriptive than before.
The Guidelines state that institutions identified as either global systemically important institutions (G-SIIs) or other systemically important institutions (O-SIIs) should apply the Guidelines in full. However, the Central Bank of Ireland has indicated that the Guidelines apply to all credit institutions and that disclosures should be made in accordance with Article 6, Article 10 and Article 13 of CRR. The Guidelines took effect from the end of December 2017.
BCBS has set out five guiding principles for banks’ Pillar 3 disclosures, namely that disclosures should be clear, comprehensive, meaningful to users, consistent over time and comparable across banks. As such, disclosures are extensive, data intensive and partially prescriptive in format. They need to be made in accordance with varying timelines and include the following:
Prescriptive fixed form templates are used for quantitative information that is considered essential for assessing a bank’s regulatory capital adequacy. The strict format aims at ensuring that all information is provided in a single media or location and enables meaningful comparisons to be made with other banks. Templates with a more flexible format have been developed for information which is considered meaningful to the market but is not central for analysis purposes. Therefore banks may provide the information in a form better suited to their institution.
The information in the tables and templates is far-reaching and covers general disclosures, risk management, scope of application, capital requirements, credit risk, counterparty credit risk and market risk. Securitisation and requirements, such as own funds and the leverage ratio, are excluded as they are already covered by delegated or implementing regulations or guidelines.
Proportionality is embedded in the different disclosure templates and tables. Smaller, less complex institutions are expected to have a lower risk profile and are not subject to all the disclosure requirements.
There is no doubt that the regulatory reporting load has snowballed over the past few years. Banks can no longer view Pillar 3 reporting as a one-off, annual exercise but rather should incorporate it into a holistic, integrated, business-as-usual approach to regulatory reporting, which will present all the typical challenges regulatory reporting presents – data production and quality, governance and adequacy of skilled resources.
In terms of Pillar 3 qualitative disclosures, a particular concern has arisen in relation to the greater level of detail required around the bank’s business model and its risk profile and whether or not those disclosures effectively amount to revealing the bank’s strategy.
In terms of the Pillar 3 quantitative disclosures, the prescriptive nature of the templates is burdensome, in that there is more room for error in reporting, as Pillar 3 disclosures are not currently mapped to regulatory reporting systems and therefore manual reporting solutions are being used until a more sustainable reporting solution is developed. When building this more sustainable solution, banks must have a robust risk and control framework in place and consider the alignment of the financial statements and existing regulatory reports with the periodic disclosures being made in the Pillar 3 reports.
The Guidelines also contain a requirement that banks should have a policy on the verification of disclosures and that this verification of the information in the disclosures should, at a minimum, be subject to the same level of review as information disclosed as part of the management report. This requirement places a huge emphasis on the importance of a formal governance process and an internal control structure on the Pillar 3 reporting process.
The evolution of this framework continues with BCBS having just issued further proposed revised standards in a consultation paper following on from the finalisation of the Basel III post crisis regulatory reforms in December 2017. In this consultation, BCBS has proposed revised disclosures to the following elements of the framework - credit risk, operational risk, the leverage ratio and the CVA and RWA templates and new disclosures for asset encumbrance and capital distribution constraints.
Although the BCBS standards are not binding immediately on banks, they do provide insights into supervisory expectations of best practice and these recent proposals from the BCBS will ultimately inform the EU rule makers and will result in changes to the current Guidelines.
Domestically significant institutions have already been carrying out gap analyses to see what new reporting capabilities they need to have in place as well as assessing the draw on resources required to produce these disclosures on a quarterly basis. The first of the new submissions have been made but the work is far from over with the next disclosure only ever being three months away. Institutions will have to ensure that whatever process is in place is sustainable, controlled and fully governed. There is also a need for ownership of Pillar 3 reporting and clearly defined roles and responsibilities. The increase in the regulatory reporting burden has meant that finding qualified staff to carry out the work is getting increasingly difficult.
In addition to the challenges faced by the larger institutions set out above, less significant institutions now face the challenge of “catch-up” given that they may not have been expecting, and therefore not preparing, to be making these additional disclosures. The drain on resources may be felt even more acutely in these smaller institutions given they probably lack the scale of larger institutions to absorb a new quarterly reporting requirement.
All institutions, irrespective of size, at a minimum need to;
Most importantly banks should be aware that the Pillar 3 framework continues to evolve with further revisions and new disclosures in the pipeline. Banks need to actively track these changes and incorporate them into the bank’s Pillar 3 policy and approach.