The implementation of the final Basel III reforms may be dogged by uncertainty and delay, but 2023 promises to deliver much-needed progress in some advanced economies.
By the middle of the year, the EU is expected to complete trilogue negotiations to determine its final regulatory stance, while the US looks set to publish its initial proposals within a similar timeframe. The UK, meanwhile, will see the Prudential Regulation Authority’s (PRA) consultation period for its proposals terminate in March 2023, before it finalises its approach in the following months.
These developments will clarify how the rules will be applied in some of the world’s largest and most complex financial services markets. Yet the early signs are not promising. Though the Covid-19 pandemic has contributed to a delay in global go-live dates, the health crisis has little to do with growing signs of divergence that, for some market participants, represents a clear trend towards regulatory fragmentation.
“There’s a patchwork quilt being assembled, when you look globally,” says Jared Chebib, partner in consultancy EY’s UK financial services practice. As Mr Chebib has previously noted, this lack of regulatory consistency will deliver few positives for the market or financial sector stability, as the friction and costs of doing business across borders increases.
Distinct approaches
The differences between jurisdictions have been underscored by the publication of specific proposals. The UK’s PRA published its approach to the final rules in November 2022, more than a full year after the European Commission’s proposals in October 2021.
Though both the EU and the UK are largely faithful to the Basel III regime, and will ultimately achieve the objective of regulatory stability, critics have identified differences in their approach that raise potential questions over the relative competitiveness of their respective internationally active banks.
There’s a patchwork quilt being assembled, when you look globally
One point of contention involves the EU’s somewhat staggered implementation of the output floor, which gives banks eight years to apply this rule to unrated corporates, low-risk mortgages and derivatives, according to research from EY.
In addition, internal ratings based (IRB) firms are, according to EY, granted “transitional preferential treatment” in the case of residential mortgages and unrated corporates to 2032. Further and associated delays are proposed under the EU’s retail credit risk approach.
These, and other differences, have prompted accusations that the EU is pursuing a relatively less stringent approach vis-à-vis the UK. In January 2023, law firm Linklaters published a briefing in which it blamed lobbying on the part of EU banks for these divergences: “The [UK] Prudential Regulation Authority continues to strive for full implementation of the Basel 3.1 standards, with certain deviations and clarifications. This contrasts with the less stringent EU approach, which as a result of lobbying by EU banks introduces significant deviations.”
Even so, this view is not shared universally. Caroline Liesegang, head of prudential regulation at the Association for Financial Markets in Europe, believes the differences between the UK and EU approach to Basel III are less consequential in light of what they aim to achieve.
“The UK and EU proposals are not that different after all. What matters is the outcome in terms of systemic regulatory stability and both frameworks will provide that. While the legislative and regulatory systems show different characteristics, we certainly do not see a ‘race to regulatory bottom’ between the jurisdictions – and that is preferable in the medium to long term,” says Ms Liesegang.
Further off the beaten track
What is clear, however, is that the US will deviate from the final Basel III reforms to an even greater extent than either the UK or the EU. In a December 2022 speech, the vice-chair for supervision at the US Federal Reserve, Michael S. Barr, emphasised his plan to conduct a “holistic review” of capital standards imminently.
“The bit that we haven’t seen yet is where the US stands. The unfortunate likelihood is that it will diverge even more from the final Basel III reforms. There’s a strong view in the market that the US will in fact remove all credit modelling approaches as options for global banks,” says Mr Chebib.
In any case, time is running out for global regulatory authorities. Despite the welcome clarity that 2023 will bring, there is little time left for any finalised proposals to be implemented. With the likes of the UK and the EU deferring their go-live dates to January 1, 2025, regulators and banking systems alike will have to move quickly to adjust to the new rules in order to meet the deadline.
“In most cases these reforms are set for a go-live deadline of January 2025 – that is cutting it fine,” says Mr Chebib.
