EBA’s Final Report On Draft Technical Standards On The Identification Of A Group Of Connected Clients – Financial Services

On 20 December 2022, the European Banking Authority
(“EBA”) published the final report on its draft
Regulatory Technical Standards on the identification of a group of
“connected clients” under Article 4(4) of the Capital
Requirements Regulation (Regulation (EU) No 575/2013) (“the
RTS”).

The RTS transfers sections of existing own-initiative EBA
Guidelines (“GL”) (in force since January 2019) into
technical standard format. Those transferred sections essentially
discuss the conditions required to form a group of connected
clients, which concept is used in: the large exposures regime;
categorisation of clients in the retail exposure class for the
purposes of assessing credit risks; rating systems (development and
application); criteria for STS securitisations qualifying for
differentiated capital treatment; the SME supporting factor; and
liquidity reporting in the context of stable funding. The GL will
continue to provide guidance in its existing form on due diligence
and governance expectations and the alternative approach to be used
when the head of the group in question is a central government, as
well as the descriptive examples currently used to assist in
determining whether a connected group has been formed.

This means that the RTS sets out the elements that go towards
creating the interrelationships that lead to the transfer of
financial problems among a group of two or more natural or legal
persons closely linked by idiosyncratic risk factors − that
is, when a group of connected clients is created. In the face of an
absence of industry push-back, these elements are being transferred
without amendment from the GL. They cover how the two types of
interconnectedness − control and economic dependency −
arise and how they can interact. Control continues to arise when
the would-be controller has legally enforceable rights that lead to
a “strong form of financial dependency” which can lead to
a domino effect should the controller encounter financial problems.
Parent-subsidiary relationships and being members of the same
accounting group continue to be strong indicators of the existence
of a connected group. The RTS also provides a non-exhaustive list
of circumstances when control criteria arise and of indicators of a
parent-subsidiary or analogous relationship.

The RTS also sets out circumstances when economic dependency can
connect a group, leading to a significant uptick in the likelihood
of financial difficulties spreading. Economic dependency can be
mutual or one-way and should be looked at from the perspective of
business interconnections in the round. The RTS sets out a
non-exhaustive list of situations in which the spread of financial
difficulties within a connected group can prove problematic for the
full and timely repayment of liabilities. Note that the GL continue
to advise that institutions should investigate the economic
dependencies of particular clients when exposure to an individual
client amounts to more than 5% of Tier 1 Capital.

The next stage for the draft RTS is adoption by the European
Commission, followed by scrutiny from the EU Parliament and Council
and publication in the EU’s Official Journal.

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.