UK: Asset Encumbrance Disclosures: Navigating The Maze

Last Updated: 9 February 2015
Article by Enrique Benito and Aniq Ahmed

Despite the increasing scrutiny by regulators and market participants on banks' asset encumbrance levels, these remain poorly understood. With the objective of increasing market transparency on this area, a number of initiatives have been developed by regulators and standard setters. These include the recommendations to enhance the risk disclosures by banks published by the Enhanced Disclosure Taskforce (EDTF) and requirements to publicise asset encumbrance information within Pillar 3 disclosures, in addition to existing accounting requirements in IFRS 7.

In this post we explore these initiatives and discuss how firms can prepare to comply with the existing disclosure requirements. If you are looking for some background information on the topic of Asset Encumbrance, we invite you to read our previous post: Asset encumbrance: The elephant in the room?.

IFRS Disclosures

IFRS 7 requires institutions to provide information related to collateral and pledged assets in their financial statements, including:

  • the carrying amount of the financial assets that have been pledged as collateral for their liabilities or contingent liabilities, and the carrying amount or fair value of transferred assets that have not been derecognised (IFRS 7.14); and
  • the fair value of collateral held (financial or non-financial) that the institution is permitted to sell or repledge in the absence of default by the owner of the collateral, and the amount that has been sold or re-pledged (IFRS 7.15).

EDTF Recommendations

In October 2012, the EDTF, set up by the Financial Stability Board (FSB), published a report including 32 recommendations on how banks could enhance their risk disclosures. These recommendations were developed with large international banks in mind and are not of mandatory implementation.

Recommendation 19 refers to asset encumbrance and requires that in order to facilitate an understanding of available and unrestricted assets to support potential funding and collateral needs, banks need to 'summarise encumbered and unencumbered assets in a tabular format by balance sheet categories, including collateral received that can be re-hypothecated or otherwise redeployed'. The proposed tabular template is provided in figure 5 of the appendix to section 5 of the EDTF report.

Interestingly, on its 2014 Progress Report, the EDTF highlighted that banks reported less progress in implementing recommendations that have the potential to conflict with forthcoming regulatory requirements or templates, and particularly recommendation 19, due to anticipation of forthcoming requirements such as the Pillar 3 disclosure requirements (see below).

Pillar 3 disclosure requirements

In addition to regulatory reporting requirements issued by the European Banking Authority (EBA) which require the provision of up to nine templates, with submissions commencing on February 2015, firms subject to disclosure requirements in Part 8 of the Capital Requirements Regulation (CRR) will also need to start publicly disclosing asset encumbrance information within their Pillar 3 disclosures, in accordance with the EBA 'Guidelines on Disclosure of Encumbered and Unencumbered Assets'.

There are four templates in total, requiring the following information:

  • Template A: encumbered and unencumbered assets in carrying and fair value amounts by broad categories of asset type;
  • Template B: collateral received by an institution, by broad categories of product type;
  • Template C: carrying amount of encumbered assets/collateral received and associated liabilities; and
  • Template D: business commentary on the impact of the business model on encumbrance levels and relevance of encumbrance on the funding model.

This information needs to be disclosed at least annually, based on median values of at least quarterly data, on a rolling basis over the last 12 months preceding the Pillar 3 disclosure reference date.

The expectation is that final Binding Technical Standards (BTS) will be issued by the EBA in 2016. Until then, European regulatory authorities have the option to implement the EBA provisions into their local jurisdiction. So far, most authorities have confirmed full compliance with the EBA guidelines, including the Prudential Regulation Authority (PRA) through the publication of Supervisory Statement SS11/14, and the Financial Conduct Authority (FCA) through the publication of a statement on Disclosure of encumbered and unencumbered assets.

The EBA Guidelines provide the option for regulatory authorities to waive publication of template B if they consider that its disclosure may allow the detection of liquidity assistance by central banks. UK regulated firms have the possibility to obtain such waiver if they meet at least one of the following conditions at the reporting reference date:

  • the firm meets the conditions in Article 94(1) of the Capital Requirements Regulation (CRR) relating to the size of on and off balance sheet trading book business;
  • the fair value of collateral received by the firm in the form of debt securities has not exceeded £100 billion for any single reporting reference date over the last 12 months preceding the Pillar 3 disclosure reference date; or
  • the arithmetic mean of the fair value of collateral received by the firm in the form of debt securities – calculated using monthly data on a rolling basis over the last 12 months preceding the Pillar 3 disclosure reference date under the Guidelines – is less than £100 billion.

Whereas the PRA has stated that it expects firms to disclose median values of monthly data on a rolling basis over the previous twelve months (including for the first disclosure) unless volatility in the level of encumbered assets month to month is not deemed to be significant, firms regulated by the FCA are given the option to disclose median values of monthly (instead of quarterly) data, as well as use data as at 31 December 2014 for the first Pillar 3 disclosure.

The expectation is that the disclosures would be published no more frequently than annually, and both the PRA and the FCA have confirmed that they expect the concept of materiality in article 432 of the CRR to apply to these disclosures.

How firms can prepare

Firms will need to consider consistency between different instances of data provision relating to asset encumbrance, such as the different market disclosures in annual accounts and Pillar 3, regulatory reporting and internal risk management information.

Firms should also consider the overlap with wider disclosure and reporting requirements in FINREP and COREP, including the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) as instances of cross-validation and common approaches to data, reporting and IT implications need to be taken into account.

Firms will need to make sure that any enhancements to their risk management and reporting systems are robust and enable compliance with the new disclosure and regulatory reporting requirements, ensuring consistency with their internal risk management approach for asset encumbrance as mandated in BIPRU 12.

Data challenges also need to be addressed early in order to meet the disclosure and reporting deadlines. Appropriate timescales for any enhancements necessary to comply with rules and guidance need to be discussed and agreed with the firm's supervisors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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