Eu Abandons The Overhaul Of Trade Finance Capital Requirements

The EU has scrapped the plan to hike capital requirements for trade finance instruments, sources report, making a victory for banks who vigorously oppose the changes.

The European Commission proposed to bolster the capital treatment of trade finance products such as technical guarantees in 2021, performance bonds and standby letters of credit to comply with the final tranche of Basel standards on international banking regulation.

Banks complained about the move that would push up the costs of providing trade finance which would later be passed on to European customers. They enlisted corporates in a comprehensive lobbying campaign which is designed to thwart the plans.

The European Commission, Parliament and Council made a deal on the new EU capital requirements regulation (CRR) including the abandonment of the plan to lift the capital requirements for trade finance instruments, on June 27.

The credit conversion factor (CCF) calculates the exposure risk and the amount that the bank has to pay as it will remain at the current level of 20% for technical guarantees reported by the sources. The technical guarantees include warranties such as standby letters of credit, tender, and performance bonds along with the associated advance payment and retention guarantees.

As per the indications by the sources, the final CRR text will recognise “Effective maturity” for the instruments of trade finance in place of the proposed wording which would have imposed 2.5-year maturity on instruments such as letters of credit which are then provided to large corporates. 

The European Parliament and Council announced on the morning of 27th June that the deal has reached in statements which did not mention the treatment of trade finance. A draft text for the legislation hasn’t been published and it still needs formal approval by the EU’s three lawmaking bodies. The critics of the plans say that the committee’s treatment of trade finance is based on the decade’s-old data and the credit risk posed by the trade finance products.

The advocacy campaign of the bank led by the International Chamber of Commerce (ICC), leaned heavily on the recent data that shows low default rates for guarantees and similar products. 

Tomasch Kubiak, Policy manager for the ICC Global Banking Commission says, “We thank the members of the bank and corporates that have worked with us extensively over the 18 months to provide data and market insights that were needed to secure the agreement adopted today. This has been a remarkable collaborative effort to preserve the viability of trade business in the EU.”

Sean Edwards the chairman of the International Trade and Forfaiting Association says, “The body is very pleased to read that the EU has decided to grant a 20% CCF for performance and related guarantees. This is based on the forensic data presented to the European Authorities showing low loss rates for these products which has justified lower conversion factor.”

Technical guarantees are widely used by large European firms to secure high-value overseas contracts including infrastructure and defence. French lenders and corporate giants such as BNP Paribas, Societe Generale, Airbus, and Engie were particularly outspoken in their opposition to tougher requirements for the products.

Financial institutions also argue against the stricter capital treatment of banks’ exposures to insurance providers under the revised CRR (inherited from the Basel network) which they say will harm the effectiveness and cost of credit insurance.

Edward says that “The EU’s decision is a sort of constructive dialogue and pragmatic decision-making that all industry participants welcome from their regulators and the ongoing discussions are other regulators, we hope for a similar approach especially when this would be based on the same data.”

The broader deal of the implementation of Basel 3.1 includes the implementation of the so-called output floor at limiting the use of banks’ internal risk calculation models, it is a harmonised “fit and proper” framework for the senior executives and streamlined requirements for branches of third-country banks.

Swedish finance minister Elisabeth Svantesson says that “After intense negotiations, we have reached an agreement on updated rules which we believe will boost the strength and resilience of banks operating in the Union”.

This step will ensure that the European banks can continue to operate also in light of external shocks, crises or disasters. The swift implementation of global standards is also an important signal for our international partners along with the EU’s continued commitment to international cooperation and multilateralism.

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