EU regulatory focus on non-performing loans

While the effects of the COVID-19 pandemic on banks’ assets quality have not been as pronounced as initially feared, EU regulators remain concerned that a new wave of non-performing loans (NPLs) could still arise. A broad range of EU regulatory initiatives are on-going in anticipation of rising NPL levels in 2022.

In December 2020, the European Commission published its Action Plan on tackling NPLs in the aftermath of the COVID-19 pandemic. The plan introduced a broad range of policy initiatives to be implemented at the EU level. One key area of focus is the further development of secondary distressed debt markets. In this article, we discuss recent progress with some of these regulatory initiatives.

The EU Directive on NPLs (PDF 933 KB) is expected to enter into force shortly, to be transposed into national laws within two years. The Directive aims to further harmonise the regulation of Europe’s secondary NPL markets while protecting borrowers’ rights. Credit purchasers will not need special authorisation to acquire loans, but will have to comply with borrower protection rules. Credit servicers will need authorisation and be subject to supervision by national competent authorities. All credit purchasers of consumer portfolios will need to appoint a credit servicer in the host country. Third country credit purchasers of SME portfolios will also have to appoint a credit servicer to protect entrepreneurs.

This harmonisation of approaches between EU jurisdictions is a welcome step towards increasing the cross-border operations of NPLs purchasers and servicers while protecting borrowers. However, the Directive is not expected to fundamentally change how the industry operates. One of the main reasons for heterogeneity between EU jurisdictions is the significant variation between national enforcement and insolvency frameworks. The European Commission (EC) is considering how to increase the standardisation of enforcement, but convergence is not expected any time soon due to the complexity this entails.

Improving the availability, quality, and comparability of NPL data has been identified as a critical step in the development of Europe’s secondary NPL markets. Ongoing initiatives in this area include setting minimum data standards for NPL transactions, adding new NPL Pillar 3 disclosure requirements, and possibly creating a pan-EU NPL data hub.

The EBA NPL Templates as the required minimum data set for transactions

As part of the NPL Action Plan, the European Banking Authority (EBA) was invited to review the “EBA NPL templates” it produced in 2017/18 – a request reiterated in the Directive. The templates are being improved and streamlined with a view to transposing them into implementing technical standards (ITS) for credit institutions.

The templates are expected to evolve from a voluntary tool into a required, defined data format for sales of non-performing credit agreements to third party investors and for transactions between credit institutions. Some exceptions will apply, and a level of proportionality will apply depending on the nature and size of the loans being transacted.

The consultation (PDF 1.5 MB) period for the review of the EBA NPL Templates ended on 31 August 2021, and the EBA is now reviewing the industry feedback. It is not expected that the new ITS will enter into force before 2022. Nor is it yet known how this might impact compulsory minimum data requirements for NPL sales.

Increasing the quantity, quality, and comparability of NPL data

In parallel with the EBA’s work, on 8 September 2021 the EC completed its targeted consultation (PDF 305 KB) on improving the transparency and efficiency of secondary NPL markets. The proposal consists of:

• Introducing additional Pillar 3 disclosure requirements for NPLs under the Capital Requirements Regulation (CRR); and
• Creating a central EU data hub to act as a data repository for the NPL market.

The aim of these initiatives is to increase the quantity, quality and comparability of NPL data available to market participants, facilitating price discovery and NPL transactions.

The additional Pillar 3 disclosure requirements would focus on providing a more complete picture of NPL portfolios, possibly adding data points such as recovery rates, time to recovery and judicial costs. Since this disclosure would only apply to credit institutions, there could also be new disclosure requirements introduced for credit purchasers and/or credit servicers operating in secondary NPL markets. In time, this would provide more extensive data on the performance of NPL portfolios, both pre- and post-transaction. It would also complement the additional disclosure requirements for NPL data for securitisation which entered force last year.

A pan-European data hub would act as a central data repository, providing access to anonymised data and information on realised NPL transactions and post-transaction performance. The data could be used to create better portfolio insights, allowing buyers and sellers to make granular portfolio comparisons using various indicators and based on diverse factors such as region, sectors, and asset classes. This would ultimately support more accurate pricing and encourage new entrants to the market.

In theory, more standardised rules around NPL transactions and servicing, and greater access to NPL data, should foster better functioning secondary NPL markets. The coming months will be crucial to deciding how these initiatives can be implemented in a practical and optimal manner. For this purpose, the EC has recently appointed a group of experts to form an NPL Advisory Panel tasked with supporting the implementation of the NPL Action Plan.

In the meantime credit institutions, as sellers of NPLs, should be alert to the upcoming changes. The proposed new data requirements could impact how banks prepare for NPL sales, and new disclosure requirements would also require new post-trade actions from NPL purchasers and servicers. More broadly, greater transparency is likely to boost competition in European NPL markets, attract new entrants and sharpen pricing. This could ultimately move European markets closer to their US counterparts, where investors predominantly compete on the internal rate of return (IRR) rather than access to information. In short, changing regulations could have far-reaching consequences for the buyers and sellers of European NPLs.