June  was a busy month, both for finalizing the appointments of presidents, commissioners and key policymakers across the EU's institutions but also for setting the future course of financial regulatory reform, be it in the Banking and Capital Markets Union projects but also in more international areas, such as completing the implementation of Basel III or the deepening of the Economic and Monetary Union (EMU i.e. the Eurozone) and making the EU's Single Rulebook for financial services more single.1

Surprisingly, despite some very vocal debates about the candidates for top EU jobs and the process in appointing these, the Consilium − i.e. the EU's "other" legislative body, which represents the executive governments of the EU's Member States - managed to push ahead a number of agreements in principle on institutional reforms relevant to the Eurozone and its Banking Union that aim to support the recent legislative reforms in the EU's Banking Package. With a new European Commission President and a raft of Commissioners set to take office and restart existing momentum on a number of priorities affecting market participants, this Client Alert looks at the extent and impact of these changes. 

At these June meetings one of the items that was high on the agenda was an agreement on a term sheet describing features of the Eurozone's budgetary plans – officially "a budgetary instrument for convergence and competitiveness for the Eurozone (BICC)" − which marks a tentative first step towards more of a Eurozone budget, something that not all EU Member States are supportive of. Areas where there is more support included revisions to the treaty on the European Stability Mechanism (ESM) to introduce a common backstop for bank resolution measures as well as the use of precautionary instruments. Other areas garnering support are necessary measures to respond to the International Monetary Fund's "Article IV Consultation" with the Eurozone on economic surveillance. Propelling Christine Lagarde to the head of the ECB as a replacement for outgoing chief Mario Draghi is perhaps not one of those official recommendations, but something that surprised markets, ECB-watchers and the electorate. 

Other Banking Union relevant institutional reforms included updates on the still much resisted (particularly in Germany) European deposit insurance scheme (EDIS) as the third pillar of the Banking Union. Discussions at the EU political level were echoed in a more technical format by EU and national policymakers on June 14, when representatives of different banks and institutions met at a conference organized by the Institute of Law and Finance in Frankfurt to discuss EDIS, NPLs, sovereign debt and safe assets. Some were of the opinion that the discussions around EDIS are reminiscent of the 2015 debate, namely that arguments are put forward on why it cannot work rather than focusing on the steps to implementing it. EDIS was nonetheless seen as a way of withstanding global competition and more importantly as an essential step to creating a functioning Banking Union. 

Against the backdrop of this institutional reform and plan making, June 27 also marked the date when Regulation (EU) 2019/876 (CRR II Regulation)2, Regulation (EU) 2019/877 (SRM II Regulation)3, Directive (EU) 2019/878 (CRD V Directive)4 and Directive (EU) 2019/879 (BRRD II Directive)5 entered into force, collectively the Banking Package, making amendments to, as opposed to replacing, the respective predecessor legislative instruments. All of these changes have an impact on the EU Single Market for financial services but also more specifically for those active in the Banking Union, especially given that the European Central Bank (ECB), in its role at the head of the Single Supervisory Mechanism (SSM), has indicated that it has its own supervisory expectations.

Stocktake from the Eurogroup meetings and the impact for the Banking Union

The planned changes to the ESM treaty dealing with the European Monetary Fund were approved by finance ministers and then a week later by the heads of state. This has started the revision of the ESM Treaty to allow the full package to be agreed by December 2019. Only then can the SRF backstop, in the form of a revolving credit facility, be introduced. The ESM reform is not subject to disputes amongst the members; EDIS, on the other hand, presents a few more problems. 

A High-level Working Group (HLWG) was established in January and it reported on its broader vision of what the key elements of the future "steady state" Banking Union could look like. In the words of Mário Centeno, Eurogroup president and chair of the board of governors of the ESM, "[c]ountries are not yet ready to take a decision on the next steps. More work is needed on this file and we have to define the sequence of the decision-making process. This should include the development of a road map towards beginning political negotiations on a European deposit insurance system (EDIS) and we have mandated the HLWG to report back again in December 2019. The result could then feed in the next institutional cycle." 

Therefore, while one can expect no ground-breaking news on EDIS over the next months the EU Commission is likely to be supportive of continuing to deliver this institutional third pillar to that of the SSM and the Single Resolution Mechanism (SRM), which the EU's Banking Package reforms seek to improve.  

Banking Package reforms

While the making of the Banking Package and the relevant reforms began in earnest in November 2016, the publication and entry into force of the various requirements mark an important milestone for legislative policymakers' delivery of international standards agreed by the Basel Committee, the Financial Stability Board (FSB) and the G20. These standards may be further revised and streamlined by the ECB-SSM. 

The main purpose of the BRRD II Directive and SRM II Regulation is to implement in the EU the FSB's total loss absorbing capacity (TLAC) standard.6 The BRRD II Directive revises the existing MREL regime, aligning it with the TLAC standard. It also advances reforms and amends some issues that have not worked so well such as the contractual recognition of bail-in, as set out in Article 55 of the BRRD, as well as introducing new moratorium powers for resolution authorities and requirements on the contractual recognition of resolution stay powers. The concepts of "resolution entity" and "resolution group" are also introduced. Resolution entities refers to the entities to be resolved, meaning the entities to which resolution actions could be applied, while resolution groups refers to the aforementioned entities together with their subsidiaries. 

As said above, the BRRD II Directive also allows resolution authorities to suspend certain contractual obligations of institutions and entities for a maximum of two days. Further, the Directive revises Article 55, so that it now addresses instances where it is impracticable for BRRD institutions to include contractual recognition clauses in liability contracts, i.e. the requirement for banks to include in their contracts governed by the law of a third country a clause by which the creditor recognizes the bail-in power of the EU authorities. For many firms this change may be very welcome, even if further clarity is needed from the EBA, as the authority mandated to specify the conditions under which it would be impracticable to include such recognition clauses. 

The SRM II Regulation introduces amendments such as changing the minimum requirement for the own funds and eligible liabilities (MREL) requirement for banks and globally systemically important banks (G-SIBs), to measure it as a percentage of the total risk-exposure amount and of the leverage ratio exposure measure of the relevant institution. As a brief recap, the BRRD and SRM require institutions to meet MREL at all times, which has to be determined by the resolution authority, in order to secure the effectiveness of the bail-in tool and other resolution tools. The European Banking Authority (EBA) developed regulatory technical standards for MREL, which were formally adopted by the European Commission in May 2016. While there are conceptual differences between TLAC and MREL, both standards are concerned with banks holding a sufficient amount of loss-absorbing liabilities to ensure a credible resolution of failing institutions. Also, under the BRRD II Directive, the Pillar 2 requirement will be maintained for non G-SIBs, to be extended to the institution-specific add-on for G-SIBs (if Pillar 1-MREL is not sufficient to absorb losses and recapitalize the G-SIB).

The CRR II Regulation and CRD V Directive on the other hand have other areas of focus. The CRR II Regulation contains reforms to the CRR relating to international prudential standards, particularly those set by the Basel Committee on Banking Supervision (BCBS), following on from the Basel III standards agreed in December 2010. It should be remembered that after the G20 summit in April 2009 the European Commission developed rules to strengthen the regulations of the banking sector using Basel III as a basis, meaning the ramifications from that still run deep. 
The CRR II Regulation contains provisions implementing the FSB's TLAC standard. To elaborate on the TLAC changes, a Pillar 1 MREL requirement for G-SIIs is introduced, in compliance with the TLAC standard. This contains a risk-based ratio and a non risk-based ratio. Under the new Article 141a CRD V Directive, breaches of Pillar 1-MREL and Pillar 2-MREL may lead to a breach of the combined buffer requirement and consequently trigger restrictions on discretionary payments to the holders of regulatory capital instruments and for variable remuneration purposes. The transitional TLAC requirement of the higher of 16% of RWA or 6% of the leverage ratio exposure measure applies immediately, while the higher requirement will come into effect at the beginning of 2022. It should also be remembered that earlier in the year7 a MREL subordination policy in several steps was revealed, where a new category of large banks with a balance sheet size greater than €100 billion was created. 

The CRR II Regulation also sets out more risk-sensitive capital requirements for market risk and introduces a binding 3% leverage ratio for all institutions subject to the CRD. The leverage ratio relating to public lending by public development banks, officially guaranteed export credits and the provision of central clearing services by firms to clients is further adjusted. The leverage ratio buffer for G-SIBs is also amended. The buffer is set at 50% of a G-SIB's risk-weighted higher loss absorbency requirements and must be met with Tier 1 capital. In the event that the G-SIB does not meet its leverage ratio buffer requirement, it becomes subject to capital distribution constraints. 

There are amendments made to the net stable funding ratio (NSFR) too. Credit institutions and systemic investment banks will now be required to finance their long-term activities with stable sources of funding. The CRR II Regulation sets the NSFR at a minimum level of 100%, meaning that an institution will hold enough stable funding to meet its needs over a one-year period both under normal and stressed conditions. 

In terms of market risk, the CRR II Regulation introduces the BCBS FRTB standards as a reporting but not a binding capital requirement. These standards relate to large exposures, exposures to central counterparties, exposures to collective investment undertakings, counterparty credit risk and interest rate risk. More specifically, the CRR II Regulation amends the CRR to introduce the standard approach to counterparty credit risk (SA-CCR) and introduces a simplified version of it for certain firms where the approach would be too complex or burdensome to implement. The new regulation also introduces the use of a single method for determining the own funds requirements for exposures due to default fund contributions. With regards to large exposures, the CRR II Regulation limits the capital that can be taken into account to calculate the large exposures limit to Tier 1 capital, and introduces the lower limit of 15% for G-SIBs' exposures to other G-SIBs.

We have already provided coverage8 on the CRD V Directive's changes for financial holding companies and mixed financial holding companies and the requirements for licensing and how to prepare for these9 but, as a recap, non-EU entities/groups that either qualify as a globally systemically important bank or which have EU firms with total assets in excess of €40 billion in their group are now required to set up an intermediate parent undertaking to allow for supervision of their activities.  Entities that meet the group asset value tests on June 27, 2019, will have until December 30, 2023, to set-up an appropriate permissioned EU-domiciled intermediate parent undertaking. 

The Banking Package also refines the reporting and disclosure requirements for small banks. The CRR II Regulation and the CRD V Directive also contain reforms to the CRR and the CRD IV Directive that do not relate directly to any international prudential standards. A number of these reforms reflect the findings of the Commission's review of the impact of CRD IV on banks' financing of the EU economy and its general call for evidence on the EU regulatory framework for financial services. The CRD V Directive also makes a specific mention of the anti-money laundering and combatting terrorist financing measures that competent authorities should take. The CRR Regulation lowered the capital requirements for credit risk on exposures to SMEs of up to €1.5 million by 23.81%. The CRR 2 Regulation keeps the percentage reduction but extends it to exposures of up to €2.5 million. The rise of sustainable finance is also taken into account as the EBA is mandated to report on how individual regulators incorporate environmental, social and governance risks into the supervisory process. 

As a whole, the legislative instruments aim to allow financial institutions to address long-term funding risk and reduce excessive leverage. The proportionality of the prudential framework for institutions is enhanced, and the loss absorption and recapitalization capacity of G-SIBs is increased. 


The long-awaited regulations and directives of the Banking Package, while now finally published, will start applying in 2020 and 2021. Whether they will have the desired effects remains to be seen, however one thing is certain, this legislative effort is a significant step in harmonizing the rules and closing the gaps exposed by the global financial crisis. These changes aim to support the EU's Single Market for financial services and beyond, but also push ahead implementation of the spirit of global principles, some of which have yet to be fully finalized internationally.

As always, firms are encouraged to keep a close eye on the ECB-SSM requirements and are reminded to track their progress through the implementation of policies and procedures in order to stay in "good graces" with regulators, especially as the ECB-SSM has indicated that its supervisory priorities over the 2019-2021 multiannual supervisory work program will continue to include scrutiny of compliance with the CRR/CRD IV chapters of the EU's Single Rulebook as well as adding its own twist.

Our Eurozone Hub lawyers are assisting a number of firms in understanding how these reforms, as well as specific requirements and expectations from the Eurozone's Banking Union, may affect their compliance requirements in documentation and non-documentation workstreams. If you would like to receive further analysis on any other issues raised herein, please contact one of our Eurozone Hub key contacts on the right. 


1 For further background information readers may turn to the following contributions from the European Parliament's Economic Governance Support Unit, which provides in-depth analysis to MEPs and is useful in terms of framing issues that MEPs are considering. These contributions show the policy directions that are likely to be set by the European Commission and DG-FISMA's priorities for the 2019-2024 legislative cycle:

  1. Banking Union: what next?
  2. Banking Union: Completing the Single Rulebook?
  3. Banking Union: Defusing the home/host state debate

2 See full text here.

3 See full text here.

4 See full text here.

5 See full text here.

6 See our dedicated coverage on MREL and TLAC from January 2019 here.

7 See coverage here.

8 Available here.

9 Available here.

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