The European Union (EU) has announced its decision to delay the implementation of key provisions of the post-crisis banking reforms, commonly known as the Basel III framework.
This decision, championed by France, comes amid growing concerns over a potential delay in the United States’ own adoption of the Basel Endgame, raising questions about the future alignment of these critical regulatory standards.
The EU’s decision to defer the application of the Fundamental Review of the Trading Book (FRTB) by one year, to January 2026, is driven by a desire to maintain a level playing field for European banks. With indications that US regulators may allow their timeline for Basel implementation to slip, the European Commission has determined that delaying the FRTB’s rollout is necessary to prevent European lenders from being at a competitive disadvantage compared to their American and British counterparts.
Addressing Concerns of European Lenders
Large Eurozone banks have long advocated for a delay in the FRTB rules, arguing that the stricter capital requirements would place them at a disadvantage in the trading business.
Gonzalo Gasos of the European Banking Federation emphasizes this point, stating, “If you can’t offer to corporate clients the same products and conditions from day one, you will lose competitiveness in the trading business.”
The EU’s decision to delay the FRTB has also been influenced by the vocal calls from French President Emmanuel Macron, who recently urged the EU to “revise the application” of Basel, stating that the EU “cannot be the only economic area in the world that applies it.”
The Ripple Effect
While the EU’s decision to delay the FRTB may provide a temporary respite for European banks, it also introduces a new set of challenges that regulators and industry players must navigate.
The complex interconnections between the various components of the Basel III framework mean that a delay in one area can have far-reaching consequences.
One of the primary concerns is the impact of the FRTB delay on the implementation of the new CVA framework. The CVA framework is heavily reliant on the risk-weighted assets derived from the FRTB’s standardized approach, and a misalignment between the two could create significant complications for banks.
Panayiotis Dionysopoulos, head of capital at the International Swaps and Derivatives Association, emphasizes the need for a holistic approach, stating, “Given the interconnection of the CVA framework with the revised market risk framework, we have previously suggested that if the EU considers any kind of change in the timeline, then this needs to be considered holistically.”
Uncertainty Surrounding the Output Floor Calculation
The delay in the FRTB’s implementation also raises questions about the calculation of the output floor, a key component of the Basel III framework. The output floor is meant to ensure that banks’ internally modeled capital requirements are not significantly lower than those generated by the standardized approaches.
A European regulatory source explains the potential complications, stating, “If the whole of CRR III came into force at the same time, banks would have to use the FRTB’s standardized approach to set the floor for the market risk component. If the FRTB gets delayed, however, the European regulatory source says rulemakers would need to clarify what happens to the calculation of market risk for setting the floor.”
Global Misalignment
The EU’s decision to delay the FRTB is not occurring in a vacuum; it is part of a broader global landscape where the implementation of Basel III reforms is unfolding at different paces across various jurisdictions.
The United States, which was initially planning to implement its version of the Basel Endgame rules by July 2025, is now facing growing uncertainty. Jay Powell, the chair of the Federal Reserve, has indicated that “broad and material changes” are likely to be made to the final rule, and has not ruled out a re-proposal of the regulation, which would further delay the process.
The divergent timelines between the EU and the US have raised concerns about the potential for competitive distortions. Mairead McGuinness, the EU Commissioner for Financial Services, emphasizes the need for global alignment, stating, “I would hope that the US and other jurisdictions will adopt the standards faithfully and quickly.”
The asynchronous implementation of Basel III reforms across different jurisdictions also poses challenges for regulatory coordination and cooperation. As the EU, the US, and other global financial centers navigate their own unique paths, the risk of regulatory fragmentation and the potential for regulatory arbitrage increases, potentially undermining the intended objectives of the Basel framework.
Navigating the Complexities of Delayed Implementation
The EU’s decision to delay the FRTB is not a simple matter of postponing a single component of the Basel III framework. Rather, it is akin to performing a complex surgical procedure, where the unintended consequences of the intervention must be carefully considered.
As mentioned earlier, the interconnectedness of the CVA framework with the FRTB means that a delay in the latter could have significant implications for the former.
A senior risk manager at an EU bank warns, “You have to put a boundary down on your desk, which is no longer the old boundary, but a new boundary,” adding that this will continue until the FRTB is implemented, leading to “additional cost” for the effort of redrawing and “optimising” the calculations twice.
The EU’s experience with the implementation of the trading book/banking book boundary in the previous iteration of the Capital Requirements Regulation (CRR II) serves as a cautionary tale. In that instance, the European Banking Authority had to issue a no-action letter to avoid a “two-step implementation” of the new boundary, highlighting the challenges of piecemeal implementation.
As the EU navigates the complexities of delayed implementation, industry experts and regulators alike are looking to the European Banking Authority (EBA) to potentially provide a similar no-action relief for the CVA framework, similar to its intervention on the trading book/banking book boundary.
However, the EBA’s ability to do so may be constrained, as the original legislative intent did not explicitly include the CVA framework within the EC’s powers to delay the FRTB.