Fitch: Draft Encumbrance Reporting Falls Short When Most Needed

Thu Mar 20, 2014 1:32pm EDT

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(The following statement was released by the rating agency) LONDON, March 20 (Fitch) The European Banking Authority's (EBA) draft guidelines for encumbrance reporting miss vital disclosure as liquidity risk rises, Fitch Ratings says. A shortfall in the proposed requirements means that unencumbered assets disclosed might not actually be available for funding purposes. The proposals include specific dispensation such that emergency liquidity assistance given by central banks would not be disclosed. Paradoxically, the likelihood of unreported central bank support will increase as liquidity risk rises. This will limit the usefulness of the information, particularly under stress conditions, and means that the draft reporting is unlikely to provide a complete picture of liquidity risk. The absence of disclosure on emergency liquidity assistance is likely, in Fitch's view, to encourage investors to withdraw funds sooner than they would do if transparency was provided at a time of crisis, because they would be forced to make conservative assumptions. The proposals also allow for timing delays and do not require frequent reporting. It would help to boost confidence in bank disclosure if additional reporting could be reconciled to reported financial statements. But this is not part of the EBA's proposal. In addition, information disclosed may not be sufficiently granular to answer all of the questions that investors might have. The draft EBA rules require assets to be split only into headline categories, such as equity instruments or debt securities, rather than into the specific asset types required under supervisory reporting. Greater granularity around credit quality would be useful, for example showing broad rating categories or even splitting assets between investment grade and non-investment grade. Best practice would show asset and secured liability types separately as well. These include repos, securitised loans, cover pool assets and outstanding covered bonds, particularly if these can be reconciled back to the balance sheet. This might be addressed with more extensive EBA disclosure requirements due to be agreed by 2016. On a weighted average basis, Spanish, Swedish, German and Portuguese banks are at the top of a sample of 135 covered bond issuers (101 banking groups) worldwide rated by Fitch, with asset encumbrance from cover pools ranging from 28% to 12% at end-2012. But there are several sources of bank asset encumbrance beyond cover pools. Although many banks have enhanced their reporting of encumbrance in recent years, information still varies and is often spread out in different parts of the financial statements. European banks currently report assets pledged as collateral, transferred assets and collateral held under International Financial Reporting Standards but usually only on an annual basis. Some also follow the recommendations of the Enhanced Disclosure Task Force (EDTF) - a body comprised of representatives from global banks, investors, analysts and external auditors - to disclose a table analysing total assets into encumbered and unencumbered portions. But these recommendations do not have mandatory force and are not applied by all institutions. The draft rules make encumbrance disclosures mandatory and enforce a common template. Despite the shortfalls, it should aid comparisons between institutions, allowing investors to assess more easily banks' reliance on secured funding and their degree of structural subordination. They would be helpful in extending the availability of encumbrance information, as well as providing additional details in some areas, building on recommendations for voluntary disclosure in this important area by the EDTF and required accounting disclosures. The guidelines for encumbrance reporting, issued by the EBA, have been open for comment until today. A final version is expected to be published by the end of June 2014. Contact: John Boulton Director Credit Policy - Accounting +44 20 3530 1673 Fitch Ratings Limited 30 North Colonnade London E14 5GN Bridget Gandy Managing Director Financial Institutions +44 20 3530 1095 Cynthia Chan Senior Director Fitch Wire +44 20 3530 1655 Media Relations: Hannah Huntly, London, Tel: +44 20 3530 1153, Email: hannah.huntly@fitchratings.com. 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