Plan to meet leverage ratio requirement
Extensive new regulations
As a consequence of the financial crisis of 2008/09, a substantial number of initiatives have been undertaken to safeguard long-term global financial stability. In September 2009, a political agreement was reached regarding measures to strengthen the international regulations on the operations of credit institutes. In December 2010, the Basel Committee presented a new set of regulations, Basel III. Subsequently in 2011, the European Commission presented a proposal as to how Basel III should be introduced in the EU, as well as a number of other changes. The European Commission’s proposal consisted primarily of an updated capital coverage directive (CRD IV) and a new supervisory ordinance (CRR). These two new sets of regulations were adopted by the European Parliament and the Council of the European Union on 26 June 2013 and took effect on 1 January 2014. Kommuninvest meets all of the requirements regarding risk-weighted capital adequacy (Core Tier 1 capital ratio, Tier 1 capital ratio, Total capital ratio). Kommuninvest also meets current and future regulation regarding liquidity (Liquidity Coverage Ratio, Net Stable Funding Ratio). There is uncertainty surrounding the introduction of the leverage ratio requirement. For further information, see below.
Increased requirements on capital base
The new regulations entail credit institutes within the EU being required to increase the quality and size of their capital bases. In addition to the capital base requirement for risk-weighted assets, demands have been set on capital buffers (the capital conservation buffer, the countercyclical capital buffer, capital buffers for systemically important institutions and the systemic risk buffer). The capital conservation buffer was introduced in Sweden during 2014, amounts to 2.5 percent of REA and shall be covered by Core Tier 1 capital. For further information see Note 28. The countercyclical capital buffer amounts to 1 percent of REA, is to be introduced as of 13 September 2015 and shall be covered by Core Tier 1 capital. The Company is not required to hold capital against the systemic risk buffer. During 2015, the Swedish Financial Supervisory Authority will resolve whether the Company is to be treated as a systemically important institution. If that is the case, the core Tier 1 capital requirement can be raised with a maximum of 2 percent of the total Risk Exposure Amount.
Leverage ratio – the Company
||Leverage ratio according to CRR
||Leverage ratio including subordinated loan
New, non-risk-weighted capital measure – leverage ratio
Alongside the risk-based capital requirements, a non-risk-weighted capital requirement measure is planned – the leverage ratio. The leverage ratio measure makes no distinction between the risk weights of different assets but is based solely on the size of the Tier 1 capital in relation to total exposures in assets and commitments. It is proposed that a compulsory leverage ratio be introduced from 1 January 2018. The reporting of leverage ratio to the relevant authorities began during 2014. The European Commission is to submit a report to the European Parliament and the Council of the European Union by 31 December 2016 proposing, among other things, the level of the leverage ratio based on different business models reflecting the credit institutes’ risk profiles. Leverage ratio levels between 1.5 and 4.5 percent have previously been discussed. The Company’s plan to meet the leverage ratio requirement is described below.
New requirements to meet short and long-term liquidity needs
The liquidity coverage ratio (LCR) requirement entails companies having sufficient liquid assets to be able to cope with real and simulated outward cash flows over a 30-day period of stress. In Sweden, a liquidity coverage ratio requirement has already been introduced effective from 2013. Equivalent regulations will be introduced in the EU during 2015. Until then, the Swedish regulations apply. As a complement to the liquidity coverage ratio requirement above, a long-term, structural liquidity measure is also being introduced – the net stable funding ratio (NSFR). The purpose of this long-term liquidity measure is for the credit institutes to fund their non-current assets with long-term liabilities to a greater extent. The ambition is for better matching of maturities to contribute to a more robust financial system. It has been proposed that the measure be introduced as of 1 January 2018. Within the EU, reporting commenced effective from 2014. As of 2014, in accordance with the regulatory requirements, Kommuninvest reports calculation data for the NSFR on a quarterly basis.
Management of OTC derivatives
During 2015, new regulations will be introduced regarding the handling of OTC derivatives in accordance with regulation (EU) No. 648/2012 of the European Parliament and of the Council regarding OTC derivatives, central counterparties and trade repositories (EMIR, European Markets Infrastructure Regulation). The regulation serves to reduce dependency between different actors and to thereby increase stability in the market for OTC derivatives, which, during the financial crisis, turned out to represent a major risk for the financial system as a whole. The regulation was to have been introduced in 2014, but is delayed.
New regulations for handling distressed institutes
Financial crises can lead to significant public costs, since access to the financial system’s basic functions – payment services, capital supply and risk management – are essential to the functioning of the economy. To prevent a financial crisis from spreading, states have often been forced to step in and rescue systemically important institutions. Expectations of a government rescue could lead to companies taking greater risks and obtaining cheaper financing, which could, among other things, increase the risk of a future financial crisis. Within the EU there is a political agreement that, when in financial distress, systemically important institutions should be reorganised or liquidated in a manner that does not threaten to trigger a financial crisis and that entails the company’s owners and loan financiers bearing the costs of the situation – this is known as resolution. In 2014, a directive was adopted by the European Parliament and the Council, establishing a framework for the recovery and resolution of credit institutes and securities companies. This directive will be implemented in Swedish law during 2015. In addition, the regulations impose increased demands on corporate governance and risk management. Increased opportunities for sanctions are granted to the appropriate supervisory authority, with the ceiling for the sanction fee being raised and it also being possible to charge the fee to physical persons. Demands are also made that systems and protection be introduced for those who raise the alarm regarding transgressions at their workplaces – whistle-blowers.
Kommuninvest and leverage ratio
Through a number of unique circumstances, the Company has been able to operate with a leverage ratio that has historically been below 0.5 percent, while nonetheless remaining sufficiently well capitalised to cover the risks in its operations: All of the Company’s obligations are guaranteed by the members of the Society by means of a joint and several guarantee. This approach means that all members provide the ultimate guarantee for the Company’s operations. Since municipalities and county councils/regions cannot be declared bankrupt and cannot cease to exist, and the state bears the overarching responsibility for the activities of the municipalities and county councils/regions, the members’ guarantee for all of the Company’s obligations is perceived as very strong. The Company lends solely to Swedish municipalities and county councils/regions who are members of the Society and their majority-owned companies. Loans to Swedish municipalities and county councils/regions have a low risk profile, with a 0 percent risk weight according to applicable capital coverage rules. The Company also has a low risk profile in its liquidity reserve and the members of the Society guarantee the Company’s exposures towards derivative counterparties. However, the leverage ratio requirement does not generally take the risks in the operations into account. Leverage ratio is defined as the Tier 1 capital divided by total exposures in assets and liabilities. To meet the requirement, the capital bases of both the Group and the Company need to be increased. In accordance with the Society’s owner directives, capital in the Company is being built up over the long term through profit accumulation. From 2011, the build-up of capital has involved profit accumulation, although it may in the future also involve direct capital contributions from members of the Society and other forms of capital.
Capital plan regarding leverage ratio
The Society bears the principal responsibility for the Group’s capitalisation. The Society’s plan is based on the capitalisation of the Group and the Company being raised to a level corresponding to a leverage ratio of 1.5 percent. At its Annual General Meeting on 10 April 2014, the Society made decisions regarding matters including a raised minimum contribution for existing members, as well as the possibility of making extra contributions. A second decision by the 2015 Annual General Meeting is required for the decisions to become binding. In the event that the final leverage ratio requirement is set higher than 1.5 percent, the Society, as the first priority, plans to issue additional Tier 1 capital instruments to members or actors affiliated with the Society, such as the Company’s customers, municipalities and county councils/regions that are not members of the Society, or other local government actors. Provided approval is given by the Annual General Meeting, Tier 1 capital instruments may also be issued to other capital market actors.
Leverage ratio 2014
On 31 December 2014, the Company’s leverage ratio1, reported according to CRR, was 0.76 (0.57) percent. Including the SEK 1 billion subordinated loan issued in 2010 to the Society, the leverage ratio amounte to 1.09 (0.91) percent. However, the loan terms for the subordinated loan are such that the loan is not eligible for inclusion as Tier 1 capital according to CRR. The Company intends to replace the existing subordinated loan with a new one or with another capital form that is eligible for inclusion as Tier 1 capital well in advance of year-end 2017. For further details, see Note 29.
On 31 December 2014, the Group’s leverage ratio1, reported according to CRR, was 0.79 (0.58) percent. Including the SEK 1 billion subordinated loan issued in 2010 to the Society’s members, the leverage ratio amounted to 1.10 (0.97) percent. On 31 December 2014, the Company’s leverage ratio1, reported according to CRR, was 0.76 (0.57) percent. Including the SEK 1 billion subordinated loan issued in 2010 to the Society, the leverage ratio amounted to 1.09 (0.91) percent.
However, the loan terms for the subordinated loans are such that they are not eligible for inclusion as Tier 1 capital according to CRR. The Group intends to replace the existing subordinated loans with new ones or with other capital forms that are eligible for inclusion as Tier 1 capital well in advance of yearend 2017. For further details, see Note 35 of the Kommuninvest Cooperative Society annual report 2014.
1) Leverage ratio is defined as the Tier 1 capital divided by total exposures in assets and liabilities. Regarding the lending portfolio and the liquidity reserve the exposure equals the book value. For derivatives assets the exposure is calculated by totalling all exposures in individual netting agreements with derivatives counterparties. To this exposure amount is added a possible future exposure amount calculated according to the standardised method (the market valuation method) established in the EU Capital Requirements Regulation, CRR. Off-balance sheet commitments are also assigned an exposure value. The exposure amount is calculated based on the probability that the commitment will be utilised. Applicable commitments for Kommuninvest are committed undisbursed loans. The reported leverage ratios for 2013 differ from what was reported in the 2013 Annual Report, due to a change in calculation methods. As of 2014, Kommuninvest calculates leverage ratio as the simple arithmetic mean of the monthly leverage ratios over a quarter.