The EU looks set to abandon plans to more than double capital requirements for some trade finance instruments, delighting banks and corporates who have spent almost a year campaigning against the reforms.

The European Commission proposed in 2021 to lift the credit conversion factor (CCF) – which calculates what a bank might have to pay out and therefore its exposure risk – from 20% to 50% for off-balance sheet products such as performance bonds, technical guarantees, warranties and standby letters of credit.

The plans, part of the bloc’s implementation of the Basel III banking reforms, irked banks and some large corporate clients, who have long argued that such instruments are low-risk and rarely translate into significant balance sheet exposures on the rare occasions banks are called on to honour the guarantee.

Under the auspices of the International Chamber of Commerce (ICC), EU banks have spearheaded a campaign against the mooted CCF hike over the last year, convening a working group and retaining public relations firm Fleishman-Hillard.

Those efforts chalked up a major win in November when the European Council, which represents the governments of EU member states, said it wants the CCF to remain at 20% for the trade finance items.

The Commission has more recently also backed down from its initial plans, telling banks lobbying against the change that it will not object to the capital requirements remaining at their current level. A Commission spokesperson declined to comment “on the ongoing negotiations” when approached by GTR.

The ICC campaign scored another victory when the European Parliament’s Economic and Monetary Affairs Committee voted on January 24 to keep the CCF for the off-balance sheet trade finance instruments at the current level of 20%. The stance is likely to be adopted by the Parliament next month as its official position, a spokesperson for the legislature says.

The Commission, Parliament and Council will then enter negotiations over the total Basel package.

Bankers who led the push to scrap the changes have welcomed the apparent shift in Brussels. “It’s not signed yet, so it can still change. But we believe we are in a good place,” says Bruno Francois, deputy global head of trade finance at BNP Paribas.

BNP Paribas, Santander and Société Générale steered the ICC’s campaign against the CCF increase. Christian Cazenove, group head of trade oversight at Société Générale, says all together around 70 meetings were conducted with the Commission, MEPs and member state representatives.

Cazenove says “we had a lot of sympathy” in those conversations. That was in large part thanks to data from 55 banks, published by the ICC in April last year, which showed that the average real-world CCF over the period for defaulted customers was around 10%, half the current level required by the Capital Requirements Regulation, the law that is being amended to incorporate the Basel III changes.

The ICC figures filled a gaping hole in EU policy-making, bankers involved in the policymaking effort say. Commission officials told the banks they previously did not have data which would justify keeping the capital requirements at their current levels.

In the past, the the ICC Trade Register had been used to supply such data, but regulators had been reluctant to rely on its findings due to its limited data set.

A Freedom of Information disclosure by the UK Prudential Regulation Authority to GTR earlier this month shows the regulator considered the Trade Register, but not the April ICC paper, when formulating its own planned capital requirements hike, which goes further than the Commission proposals by including letters of credit with a maturity of more than one year.

 

A secret weapon

In their fight over the last year to keep the status quo, the banks were arrayed against a powerful nexus comprising the Commission, regulators and member states opposed to any deviation from the Basel framework. But in addition to the new data, the banks had another secret weapon: their corporate clients.

“The politicians were expecting banks to advocate against Basel, so they were really waiting with a fist when the banks arrived,” says Francois, who took part in meetings with officials and lawmakers. “But they did not expect that a corporate will react to Basel, because it’s a banking regulation. So they were a bit surprised.”

Large European corporates who bid for government infrastructure and procurement contracts are heavy users of guarantees and bonds which will be affected by the Commission’s proposed changes. The capital charge on those instruments will jump by 150%, according to an estimate by Scandinavian banking groups, boosting the cost of a €10mn performance guarantee for a corporate from €50,000 to €125,000, for example.

In their meetings with officials, the banking and corporate envoys used the example of constructing a bridge, Francois says, the cost of which could go up as banks pass on the cost of fattening their capital provisions for guarantees for contractors, on top of other price rises fuelled by inflation.

“They were much more receptive to those kinds of arguments than to the classic one of a bank saying ‘you shouldn’t increase my capital requirements’,” Francois tells GTR.

One of the firms to join the ICC effort to lobby Brussels was Airbus, the France-headquartered aviation and space giant. A move to a 50% CCF for trade finance guarantees and similar products “would mean that these instruments probably could become less interesting for the banks to finance, this may limit the lines of credit available”, says Airbus’ Annelise Lethimonnier, “this is worrying for us”.

Lethimonnier, the firm’s public affairs director for trade, finance and strategic issues, says that while Airbus could replace some of the banking products with corporate undertakings made by entities within the Airbus group, the smaller corporates in the firm’s supply chain do not have access to the same luxury.

“So this is where it’s important to have this vision that it’s not only the big companies that are affected, but smaller ones also,” she tells GTR.

By linking the cost of bank-provided technical guarantees to issues currently vexing the EU – such as the energy transition, defence and transportation – “the Council really started to get sympathetic for the topic because they see these kinds of projects and industries are a strategic priority for the European Union”, says Pablo Ballesteros Gómez, Santander’s global head of trade solutions.

“Having the corporates, and not only the banks providing this view, I think that was really critical to get the Council’s support,” he adds.

The banks believe the twin prongs of ICC data and corporate involvement has swung the issue its way. “I do not remember any meeting where we were being really challenged about our position, because of the support of the corporates, the support of the data,” Cazenove says.

But despite their success so far, Lethimonnier remains cautious. “We know in Brussels that things can change quickly,” she says, “we will remain vigilant”.

 

Deviation row

Although EU lawmaking bodies appear to be coalescing around maintaining the current capital requirements, the topic has been thrust into a much bigger EU fight over banking reform.

EU nations are split over whether the post-financial crisis Basel III standards should be implemented to the letter, or if they can be tweaked to account for newer data and market realities.

The European Banking Authority (EBA) and European Central Bank have admonished EU law making bodies and member states for even considering deviations from the Basel standards.

In an article which referenced a possible walk-back of the proposed CCF hike for trade finance, the two regulators said last November they were “very concerned” that “numerous calls have been made to deviate from the international standards”. Straying from the Basel standards “risk[s] undermining global cohesion and weakening the EU’s standing in international negotiations if we do not keep our commitments”, they added.

Asked about its stance on the proposals relating to trade finance, an EBA spokesperson tells GTR that: “if a similar approach on this aspect is not established globally, this will erode the global level playing field” but declined to add more because the issue is in the hands of legislators.

This story previously said that the ICC Trade Register did not focus on the default risks of specific trade finance instruments. It was amended on January 30, 2023 to show that regulators have instead been concerned by the register’s limited data set.