In response to the rapid developments concerning COVID-19, the European Central Bank (ECB) left interest rates untouched whereas the US Federal Reserve and the Bank of England have decreased rates. Despite not cutting rates, the ECB announced a €750 billion Pandemic Emergency Purchase Programme (PEPP). Purchases will be conducted until the end of 2020 and will include all the asset categories eligible under the existing asset purchase programme (APP). Furthermore, the ECB announced that it will provide temporary capital and operational relief in reaction to coronavirus. The ECB will allow banks to operate temporarily below the level of capital as defined by the Pillar 2 Guidance (P2G), the capital conservation buffer (CCB) and the liquidity coverage ratio (LCR).
In a similar move, the Dutch Central Bank (DNB) announced that it will lower bank buffer requirements to support lending. DNB believes that the strong starting position of the Dutch banking sector allows DNB to temporarily give banks additional leeway to continue business lending and absorb potential losses. The following measures are taken by DNB:
• The systemic buffers will be lowered, from its current 3% of global risk-weighted exposures to 2.5% for ING, 2.0% for Rabobank and 1.5% for ABN AMRO.
• The introduction of a floor for mortgage loan risk weighting will be postponed.
Finally, the European Banking Authority (EBA) announced on 12 March that the current EU-wide stress test is postponed to 2021 to allow banks to prioritise operational continuity.
The transition from London inter-bank offered rate (LIBOR) and other interbank offered rates (IBORs) to alternate risk-free rates (RFRs) is a monumental task and it is one of the biggest challenges facing the financial industry. On 12 March the International Swaps and Derivatives Association (ISDA) published a paper which examines several major developments in 2020 related to the adoption of RFRs, including the publication of new benchmark fallbacks for derivatives contracts and central counterparty changes in discounting and price alignment interest for certain currencies.
The Basel Committee on Banking Supervision (BCBS) fully supports the global efforts to strengthen the robustness and reliability of existing IBORs and promote the development of alternative reference rates. As the LIBOR is not expected to exist past year-end 2021, market participants should consider carefully the economic, legal and reputational risks associated with continuing to write new contracts based on LIBOR. The BCBS encourages to include robust fallback language in contracts that determines how the replacement of a discontinued reference rate would be handled.
On 26 February, the Bank of England (BoE) published a market notice. The BoE decided to impose a “haircut add-on” for LIBOR-linked collateral. This will help to accelerate the transition from LIBOR to the Sterling Overnight Index Average (SONIA). The collateral haircut will take effect later this year and will reach 100% by the end of 2021.
On 27 February, the ‘COP26 Private Finance Agenda’ has been launched. The aim is that every professional financial decision needs to take climate change risk into consideration and that by doing so, the transition to net zero carbon dioxide emissions is supported. In order to achieve ‘net zero’, all companies, banks, insurers and investors will need to adapt their business models. In addition, Christine Lagarde, the president of the ECB, again underlined that “central banks need to devote greater attention to understanding the impact of climate change, including its implications for inflation dynamics”.
Finally, during a meeting in February, the Bank for International Settlements (BIS) and representatives of amongst others central banks, supervisory authorities, banks and insurers agreed that the ability to assess climate change-related financial risks and the accuracy of climate change-related loss estimates needs to be improved.
On 17 February, the EBA published its first quantitative Report on minimum requirements for own funds and eligible liabilities (MREL). The MREL was introduced as part of the 2014 Bank Recovery and Resolution Directive (BRRD) to ensure that banks have enough resources to execute a bail-in or a transfer to a healthy acquirer, instead of requiring public money in case of bank’s failure. The report shows that authorities have made progress in agreeing resolution strategies and setting related MREL requirements: resolution plans are now in place for 222 European banks, representing 80% of total assets. This does not mean that all banks are meeting their MREL requirement. On a weighted average basis, MREL requirements range between 26.5% of risk-weighted assets (RWAs) for the global systemically important institutions (G-SIIs) and 19% for smaller banks. Almost half of the banks are meeting their MREL requirement, but the total MREL shortfall is EUR 178 billion, nonetheless. The EBA called upon banks in the report to close MREL shortfalls, taking advantage of positive market conditions. Just a couple of weeks later, this call sounds like a distant past, given the mayhem on the capital markets caused by the coronavirus.
In a report published on 25 February, the Swiss Financial Market Supervisory Authority (FINMA) provided a detailed assessment of the recovery and resolution plans of the systemically important Swiss institutions. FINMA distinguishes between various types of plans: in a recovery plan an institution lists measures to ensure that it can continue its business activities in a crisis without government intervention. An emergency plan on the other hand, lists measures to ensure that their systemically important functions (e.g. payment services) can be continued without interruption. Further, FINMA draws up resolution plans that set out how a systematically important institution can be restructured or liquidated. The report shows that FINMA views the Swiss emergency plans of Credit Suisse and UBS as effective. The emergency plans of PostFinance, Raiffeisen and Zürcher Kantonalbank, however, do not meet the statutory requirements yet. The review is part of the implementation of the Swiss too-big-to-fail regime, which aims to enhance financial stability.