EUROPEAN COMMISSION PROPOSAL FOR REVIEW OF

UNCLAS SECTION 01 OF 02 BRUSSELS 001657

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E.O. 12958: N/A
TAGS: EFIN ETRD ECON EUN
SUBJECT: EUROPEAN COMMISSION PROPOSAL FOR REVIEW OF
CAPITAL REQUIREMENT DIRECTIVES


1. SUMMARY. On October 1, 2008, the European
Commission unveiled its proposal to amend the
Capital Requirement Directives (2006/48/EC and
2006/49/EC) through a combination of co-decision and
comitology proposals. The Co-decision proposal
contains the more fundamental changes that must
receive approval from the European Parliament and
the Council. Under the proposed rules: 1) banking
institutions will be required to hold a higher
amount of capital to protect themselves against the
risk of default; 2) ad-hoc Colleges of Supervisors
will supervise banks with cross-border operations;
and 3) financial institutions that originate
securitized products will be required to keep five
percent of the securities.

DETAILS OF THE PROPOSALS
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2. MANAGEMENT OF LARGE EXPOSURES: Banks will be
required to limit their exposure to a client or a
group of connected clients to twenty five percent of
their Tier 1 capital (or 150 million, whichever is
higher). Some exceptions remain, such as exposures
to sovereign and regional governments, local
authorities, cooperative banks and others detailed
in the Directive.


3. SUPERVISION OF CROSS-BORDER BANKING GROUPS:
QColleges of SupervisorsQ will be established for
banking groups that operate in multiple EU
countries. Each banking group will be supervised by
an adQhoc college whose composition will vary
depending on the cross-border nature of the group.
Decisions on key supervisory aspects will be jointly
agreed upon by the consolidating (lead) supervisor
and the host supervisors, with the final say for the
consolidating supervisor (and a mediation mechanism
in case of disagreement). This will affect the
current supervisory architecture, the so-called
Pillar 2. Colleges of supervisors will also
coordinate the liquidity risk management of banking
groups that operate in multiple EU countries.


4. QUALITY OF BANK CAPITAL. There will be clear
EU-wide criteria for assessing whether 'hybrid'
capital is eligible to be counted as part of a
bank's overall capital. (There is currently no EU-
wide legislation defining what types of hybrid
capital can be counted.) For hybrid capital to be
recognized as Qoriginal own fundsQ (i.e. Tier I
capital),it needs to: be able to absorb losses,
allow the cancellation of payment in times of
stress, be deeply subordinated during liquidation
and must be permanently available, i.e. either
undated or with an original maturity longer than 30
years. Hybrid capital can, however, be callable
earlier, but only at the initiative of the issuer,
with supervisory approval and if it is replaced with
capital of the same quality. The proposal also sets
quantitative limits on the use of hybrid capital to
discourage institutions from relying extensively on
it to the detriment of QcoreQ capital.


5. RISK MANAGEMENT FOR SECURITIZED PRODUCTS: Rules
on securitized debt will be tightened. Originators
will be required to retain some risk exposure to
these securities (no less than five percent of the
total originated) while firms that purchase the
securities will be allowed to do so only after
conducting comprehensive due diligence. If they
fail to do so, they will be subject to significant
capital penalties. The proposal also lowers the
capital requirements for less risky assets held by
Collective Investment Undertakings (CIU) but
maintains high capital charges where the assets are
either high risk or the actual risk is not known.


6. In addition to the above co-decision proposal,
the Commission also plans to introduce certain
technical changes that were approved by the European
Banking Committee and have been submitted to the
European Parliament for scrutiny. These technical
changes address inconsistencies that have been
identified during the transposition phase of the
CRD, and that must be resolved to ensure that the

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effectiveness of the CRD is not compromised.

OUTLOOK FOR THE PROPOSAL
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7. The European Parliament will now examine the
proposal and vote on a report in the Economic and
Monetary Affairs Committee. The designated
rapporteur, who will lead the parliamentary
scrutiny, is Austrian Conservative MEP Ottmar Karas.
He will hold a preliminary exchange of views within
the ECON Committee on November 4th and 5th. In order
for the proposal to be adopted before the end of the
current parliamentary legislature (spring 2009),the
report will have to be adopted by the plenary no
later than January 2009.

SILVERBERG