Feedback Statement: Proposed Basel III-related changes to bank disclosure requirements

Ref #5188912 March 2013 Feedback Statement: Proposed Basel III-related changes to bank disclosure requirements 1 Introduction 1 We issued the consultation paper “Registered bank disclosure requirements: Basel III updates” on 15 November 2012 and asked for comments by 14 December 2012. We received 15 responses in total, including from most of the locally-incorporated banks and the overseas bank branches, and also from the Financial Markets Authority (FMA) and one individual. 2 We implemented the Basel III enhancements of the capital adequacy requirements of New Zealand-incorporated registered banks with effect from 1 January 2013. These changes necessitated changes in banks’ disclosure of their capital adequacy positions, in time for the next reporting date after 1 January 2013, namely 31 March 2013. At the minimum, revisions were needed to the disclosure of the composition of bank capital, of details of the individual instruments that comprise capital, and of the summaries of capital ratios. 3 We also require branches of overseas-incorporated registered banks to disclose a limited amount of information on the capital adequacy of the bank as a whole and its banking group, under their home country supervisory regime. This disclosure also required minor changes to allow for the possibility of home country implementation of Basel III. 4 Our consultation paper included proposed revised text for the disclosure Orders in Council to take effect from 31 March 2013. It also included options for taking into account the Basel Committee’s expanded approach to disclosure of a bank’s capital base, set out in its paper of June 2012 entitled “Composition of capital disclosure requirements” (the “Basel paper”). 5 Revised versions of the disclosure Orders in Council have now been made: these are “Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order 2013” (“the local Order”), and “Registered Bank Disclosure Statements (Overseas Incorporated Registered Banks) Order 2013” (“the branch Order”). This paper explains the policy decisions reached in getting to this point in light of the feedback we received, and

2 Ref #5188912 also our conclusions on possible further changes to the disclosure requirements discussed in the consultation paper. 2 Composition of capital 6 Existing full-year and half-year disclosure requirements cover the instruments and reserves that make up the different categories of capital, along with the deductions from each category. Basel III changes both some of the high level categories of capital, and some of the details of the components of capital and deductions from it. 7 The Basel paper mandates comprehensive additional disclosure arising from the Basel III enhancements to the definition of capital. It includes a detailed template approach for presenting the components of capital. We proposed the alternatives of either updating our disclosure requirements in line with our existing style to incorporate the Basel III capital concepts, or implementing the full template approach set out in the Basel paper. 8 There was very little support for the full template option. Most responses made the general point that an update in line with the existing approach would continue disclosure that is easier to understand and provides adequate comparability between NZ banks. 9 Other more specific points against the Basel template approach were: • It is likely that APRA, as a Basel Committee member, will implement the Basel III template approach for major Australian banking groups. However, none of the New Zealand subsidiaries of the big four Australian groups saw material benefits from being subject to the same disclosure approach as that applying to their parent groups. • The Basel III approach would be less clear and useful for New Zealand readers. The Basel template numbering would need explaining, as would the gaps from “not applicable” rows. One respondent also noted the complexity arising from the adjustments that would need to be made to a few of the components of capital defined in our capital adequacy regime, to allow some of the rows of the template to be filled in. • Updating within the current style of disclosure would meet the spirit of the Basel III requirements by allowing readers to see clearly how banks’ capital is made up. • One respondent thought that while the Basel Committee’s objective of greater international comparability is desirable in principle, it is probably not achievable in practice given the differences in the accounting and legal frameworks, and in the way that other aspects of capital adequacy are implemented. Suggesting that capital ratios are exactly comparable may be misleading. • The FMA cited the principle from their “Effective Disclosure” guidance that disclosure should be “clear, concise and effective”, in favour of a pragmatic update of disclosure for the Basel III changes, that is, not following the letter of the Basel paper. 10 Only two respondents recognised some benefits of detailed Basel compliance, from improved international comparability and from the potential reputation benefit for New

3 Ref #5188912 Zealand. But both also agreed on balance that the existing approach is better suited to New Zealand, and allows readers to understand more easily how capital is made up. 11 Our consultation included detailed text to update the local Order under either option, and banks were happy with the proposed text, subject to minor drafting comments. 12 Given the near-unanimity of this feedback we decided to update the detailed disclosure of the composition of capital in keeping with the current style of presentation. 13 In the “off-quarters” (the first and third quarter of the financial year) banks are currently required to disclose a brief summary of the main components of capital. This is outside the scope of the Basel template. We proposed to keep this disclosure as a brief summary, updated as necessary for the Basel III changes. This was agreed unanimously, and we have implemented it accordingly. 3 Terms and conditions of capital instruments 14 Banks are currently required to disclose the key terms and conditions of each instrument included in their capital base, and what category of capital it qualifies for. 15 The Basel paper includes another template, covering all possible features of capital instruments, set out in a standardised way. Under the approach set out in the Basel paper, each bank would disclose a “main features report” summarising all of its capital instruments in accordance with this template, and would also publish on its website the full terms and conditions of each capital instrument. These disclosure items are meant to be updated any time there is a new issue, redemption or other trigger event. 16 We put forward detailed drafting proposals for how we would adapt our existing disclosure of terms and conditions of capital instruments to reflect the new Basel III categories and criteria, which we labelled Option 1. We also put forward three alternatives for how we could implement the full Basel III approach (Options 2(1), 2(2) and 2(3)). Table 1 (below) summarises these options. 17 Five respondents preferred Option 1. One respondent could see pros and cons in all four options. One respondent preferred Option 2(1), and one other preferred either Option 2(1) or 2(2). 18 Some key points made were: • The legal processes around director sign-off and publication are a major consideration for some banks. Options 2(1) and 2(2) would both require additional disclosure statements published outside the current quarterly cycle. There are real practical challenges and compliance costs in setting up the new processes. • It was generally felt that publication of the details of a new instrument on the day of its issue is not feasible. One bank suggested that publication within 10 working days might be feasible.

4 Ref #5188912 Table 1: Summary of options for revised disclosure of instrument terms and conditions Component Option Summary description (updated from our current approach) Basel template of main features Full terms and conditions of each instrument Option 1 (Non-Basel) Full-year and half-year DS: summary of all existing instruments. Off-1/4 DS: summary of any new instruments issued during latest quarter. None. None. Option 2 (1) Full-year and half-year DS only: summary of all existing instruments. Main features report for all instruments published separately on the bank’s website: updated on new issue or redemption of any instrument. For each new instrument issued: published on the bank’s website in a new PDF on the day it is issued. Option 2 (2)

Full-year and half-year DS only: summary of all existing instruments. For each new instrument issued: published separately on the bank’s website on the day it is issued, in a new PDF also including the full terms. See column to left: published on website on issue date, in the same PDF as the template of main features. Option 2 (3) None: replaced in DSs by template. Full-year and half-year DS only: main features report for all instruments currently issued. Off-1/4 DS: template for any new instrument issued during latest quarter. For each new instrument issued: published on the bank’s website in a new PDF on the day it is issued. Key: (Each colour represents a separate disclosure document.) Part of existing quarterly disclosure statement. Separate disclosure statement containing main features report for all instruments. Separate disclosure statement for each capital instrument.

5 Ref #5188912 • Option 2(3) was viewed as less burdensome for the banks than Options 2(1) or 2(2), since it avoids the problem of setting up additional sign-off dates for directors. However, some responses liked Option 2(3) least because it is the one that would add most “clutter” to the existing disclosure statement. • One respondent suggested that if anyone was really interested in the full detail of a capital instrument they could get hold of the issue documents themselves. Another felt that no-one would have an interest in seeing the full terms and conditions of a capital instrument that is issued 100 percent to the parent bank of the registered bank. • One respondent objected to the duplication involved in options 2(1) and 2(2), in that the current summary description is retained in the existing DS at the same time as the full detail is added in separate new DSs. But other respondents take the opposite view: they envisage the main DS as the only document that most readers will refer to, and therefore favour keeping the summary terms there to allow readers to see the whole picture in one place, while relegating the detail to separate documents. • One respondent favoured Option 2(1), in view of the benefits for the New Zealand banking industry of following the Basel Committee’s rules (the same respondent was nevertheless against the Basel template approach for the composition of capital). They also suggested a lower-burden variant on this option: when a new capital instrument is issued (for instance), the main features report would be updated and the instrument’s terms would be published, but not until the next publication date for the quarterly DS. 19 The balance of the feedback is thus against the Basel template approach under any of the three options proposed. However, the suggested variant on Option 2(1) would still broadly implement the Basel template, but in a way that would address the concerns about adding wholly new and separate director sign-off and publication processes. It would also keep the main disclosure statement as straightforward as possible. 20 But given that we have decided against using the Basel template for the composition of capital, any reputation benefit of following the Basel rules in this one area would be limited. We also agree with some of the respondents that the inherent value of this additional disclosure is limited, in the sense that it is hard to see who would ever need to obtain more information on a bank’s capital instruments than that already summarised in the existing DS. The cost to banks, even reduced as suggested, would not be negligible. 21 We have therefore decided to implement Option 1. This entails continuing with our current style of description of the terms of each capital instrument, and adding a requirement in the off-quarter DS to summarise the terms of any new instrument issued since the last reporting date. This has been implemented, to take effect from 31 March 2013. 22 This also means that we will not be consulting again on the additional disclosure statements that would have been needed under any of the full Basel options.

6 Ref #5188912 4 Capital reconciliation table 23 The Basel III disclosure rules include a requirement to show a reconciliation between the value of each capital instrument as disclosed in the banking group’s financial statements, and the amount that the instrument contributes to regulatory capital. This is not part of our existing capital adequacy disclosure, but it seemed to us a potentially worthwhile addition, particularly in light of the greater complexity of the adjustments that can be needed to calculate the contribution to capital of non-CET1 instruments. 24 The Basel III paper does not set out a detailed template for this reconciliation. Our proposal for implementing this was therefore to add a brief instruction to the local Order to show such a reconciliation, with the intention that this would allow relatively “free-form” disclosure, in line with our existing style of disclosure. We intended that this reconciliation would also show the effect of the Basel III transitional arrangements for capital instruments, as we have implemented them in New Zealand. 25 The feedback on this proposal was as follows: • The FMA and five of the banks thought such a reconciliation would be useful. However, one bank thought that it would only be helpful for more sophisticated readers, and would be confusing for others. Another bank suggested having the option of a “nil return” in cases where it is easy to see how regulatory capital is derived from financial statement values. • Three banks felt that this reconciliation would be of minimal benefit and would add length and complexity to the disclosure statement. Two of them believe that the Basel Committee’s main objective was to deal with cases where the scope of consolidation of the banking group for capital adequacy purposes is different from that for financial statement purposes (under GAAP): this situation does not currently arise in New Zealand. • Two banks had helpful suggestions on the detail of how the information would be presented, which we will bear in mind in our further work on this disclosure. • Two responses agreed with our proposal that annual disclosure would be sufficient, and none disagreed. • It was generally felt that our draft new text for the local Order did not provide enough detail. It was suggested that we would need to spell out our expectations more explicitly, particularly to get consistent disclosure of the impact of transitional phasing out. 26 Unlike the previous two items, this proposal would not update an existing requirement that is rendered out of date by Basel III, and so it does not drive an essential need for an amendment to be in place by 31 March 2013. In light of the feedback, we therefore decided to defer a final decision on this proposal. 27 Opinion appears divided on how material are the reconciling amounts that this disclosure would show, and on how useful readers would find the information. We therefore plan to request information from all New Zealand-incorporated banks in respect of the earliest

7 Ref #5188912 feasible reporting date that reflects Basel III capital adequacy, to find out what banks’ reconciliation tables would actually reveal. If this exercise suggests that this disclosure is worth having, we will consult banks again with revised and expanded text for the requirement, reflecting what the data-gathering exercise shows us and spelling out more clearly what we expect banks to disclose. 5 Other disclosure changes consulted on 28 Comments were generally in favour of our proposed updates to the summary table of capital ratios. Some banks felt this table would no longer be necessary if we adopted the full Basel template for the composition of capital, but as noted above, we have decided against that. 29 If a locally-incorporated bank is a subsidiary of an ultimate parent bank, it must currently disclose various information on the capital position of its ultimate parent bank and/or banking group, and on the nature of the Basel capital regime applied by the home country supervisor. Analogous disclosure applies to branches in respect of the registered bank as a whole, and/or its group. We proposed some minor changes to this disclosure, needed to allow banks to refer to the Basel III framework and its new categories of capital. Banks raised a few detailed drafting comments on these proposals, which we have addressed in finalising the changes. 30 Banks were unanimously in favour of the “wait and see” approach we proposed for disclosing exposures to qualifying central counterparties. Such exposures will therefore be handled within existing disclosure requirements. 6 Information on costs and benefits 31 We requested data on the relative costs and benefits of the different options, but most banks were unable to give us any hard figures. There were a number of comments that the information required to be disclosed under any of the options is mostly available in any case. Consistent with this, the recurring costs of updating the existing disclosure in line with our current approach were generally felt to be immaterial. On the other hand, there were some comments that the cost of establishing additional forms of disclosure statement would be material. 32 The recurring costs of the changes we have implemented with effect from 31 March 2013 therefore appear minimal. Banks expected to incur some minor implementation costs.