A noteworthy shift in bank capital regulation: EU’s CRR3 receives ICC’s applause

The CRR3 builds on the international Basel III agreement’s key principles, such as reducing the excessive variability of risk-weighted assets (RWA).

The International Chamber of Commerce (ICC), the world business organisation, has publicly praised a recent accomplishment by European Union (EU) policymakersthe successful conclusion of negotiations concerning the third revision of the bank capital framework, the Capital Requirements Regulation 3 (CRR3).

Unpacking the Capital Requirements Regulation (CRR)

The journey of the CRR originates from the EU’s proactive measures to guarantee the financial health of its banks, introduced in 2013 following the 2007-2008 global financial crisis.

This regulation outlines the amount of capital banks must hold as a cushion to mitigate against potential risks associated with their assets.

However, as is the low default nature of trade finance landscape, certain problems that were identified in the aftermath of the global financial crisis remained unresolved, even under the CRR’s guidelines. This led to further refinement in the regulation, leading to the inception of CRR3.

What is an output floor?

In simple terms, the Basel III “output floor” is a rule that ensures banks maintain a minimum level of capital to cover potential losses, regardless of how they calculate the riskiness of their assets.

Banks use models to calculate the amount of risk they’re exposed to, and the riskier their assets are perceived to be, the more capital they need to hold. Some large banks use their own sophisticated ‘internal models’ to do this, which can sometimes result in lower risk weightings, and hence lower capital requirements.

The “output floor” of 72.5% was introduced to prevent these banks from underestimating their risks and holding too little capital. It sets a limit to how much a bank’s capital requirements can be reduced by using internal models.

Even if a bank’s internal model says it can hold less, the bank still needs to maintain capital equal to at least 72.5% of what it would have to hold under the standardized approach.

is a simpler, one-size-fits-all method for calculating risk and capital requirements provided by regulators.

CRR3: A synthesis of Basel III principles and unique EU context

The CRR3 builds on the international Basel III agreement’s key principles, such as reducing the excessive variability of riskweighted assets (RWA).

Under Basel III, an output floor was set, determining the minimum amount of capital a bank could draw from the use of internal models to 72.5% of the capital required under the standardised approach.

CRR3 mirrors this approach while accommodating the unique features of the EU’s banking sector.

CRR3: A resilient framework

CRR3 marks a decisive step forward, introducing significant changes that include maintaining a 20% credit conversion factor (CCF) for technical guarantees and recognising effective maturity for short-term trade instruments.

Additionally, CRR3 addresses the need for sustainability in banking, making it necessary for banks to identify, disclose, and manage environmental, social and governance (ESG) risks.

This evolved regulation also introduces stronger enforcement tools—arming supervisors with more robust mechanisms to oversee EU banks—promoting financial stability and resilience.

Decoding the ICC’s perspective

John Denton, the secretary general of ICC, applauded the newly formed agreement. According to Denton, this deal represents a “great outcome for the real economy in Europe.”

Denton affirmed the importance of this balanced and proportionate framework for trade regulation, which, in his view, successfully promotes financial stability without stifling the provision of critical financing to European businesses.

Roadmap to CRR3 implementation

Following a process of legal translation, the revised regulation will now undergo a formal voting process in the European Council and Parliament. This key milestone precedes the expected implementation of CRR3 in 2025, indicating a new phase in the EU’s banking sector.

Highlighting the larger global implications of CRR3, Tomasch Kubiak, policy manager for the ICC’s Global Banking Commission, emphasised the potential of CRR3 to influence banking regulation worldwide.

Kubiak said, “More broadly, we hope that today’s outcome will send a clear signal globally on the imperative to carefully consider the capital treatment of trade assets in a number of important respects – based on robust industry data showing the performance of the asset class.

Our hope is that the provisions secured in CRR3 will become a template for reforms in other major jurisdictions.”

The ICC reiterates its commitment to fostering a collaborative dialogue with regulatory authorities, financial institutions, and businesses.

Are there unintended consequences of CRR3?

While CRR3 brings promising developments, it’s essential to be aware of potential unintended consequences.

The increased capital requirements, for instance, could inadvertently tighten banks’ ability to lend, affecting sectors such as SMEs—particularly in emerging and developing markets—that heavily rely on bank lending.

Moreover, the blanket approach of CRR3, while aimed at promoting a level playing field, could inadvertently stifle innovation and competition. Banks that have robust internal risk management systems might find themselves at a disadvantage with the introduction of uniform regulatory norms.

Furthermore, the implementation costs of the new regulatory changes might disproportionately burden smaller banks, potentially leading to further consolidation in the banking sector and reducing competition.

Level the CRR3 playing field

In the realm of global banking regulations, CRR3 aims to promote a more level playing field by aligning the EU’s banking norms with international standards, such as Basel III.

However, the effectiveness of this alignment will hinge heavily on the specifics of implementation within different jurisdictions.

A look ahead: CRR3 and it’s global impact

In comparison to its predecessor, CRR3 emphasises sustainability risks and introduces the Basel III ‘output floor’ into the EU regulatory framework. This output floor aims to curb the variability of RWAs across banks, thereby increasing the comparability, and ideally, the competitiveness of EU banks in the global market.

However, the ultimate success of this goal will depend heavily on the implementation details and the market participants’ reactions.

As CRR3 navigates its course towards implementation in 2025, the banking world will undoubtedly be watching closely.

DAVID COLLINS Professor of International Economic Law City, University of London

Co-Editor in Chief International Trade Law and Regulation

2.6

In defence of Investor-State Dispute Settlement

Very few aspects of international law cause as much consternation as Investor-State Dispute Settlement (ISDS). It is probably one of the very few features of Free Trade Agreement (FTA) negotiations that generate media headlines which capture the attention of the general public; often sensationalising the ‘secret courts’ entrenching the advantages of greed-driven multinational corporations.

Despite the widespread ‘backlash’ against ISDS, originating primarily in academia, ISDS offers important procedural protections for foreign investors and should be retained in Free FTAs. On balance, it is an advantageous system that is conducive to foreign investment.

Simply put, ISDS enables legal claims to be brought by foreign firms against the states in which they do business. Such claims are typically based on rights created through international investment treaties (or the investment chapters of FTAs), such as guarantees against discrimination or full compensation in the event that the host state expropriates the investors’ assets.

The availability of ISDS remains central to many firms’ decisions to invest in particular countries, particularly those where the rule of law is, or is perceived to be, weak or where courts lack independence.

What is ISDS?

„ ISDS allows foreign firms to bring legal claims against host states in which they do business,

„ Claims are based on rights established in international investment treaties or investment chapters of Free Trade Agreements (FTAs),

„ ISDS provides procedural protections for rights such as guarantees against discrimination and compensation for the expropriation of investors’ assets.

„ Modelled on international commercial arbitration, with arbitrators chosen by the parties and rendering legally binding decisions,

„ ISDS offers advantages such as neutrality, cost- effectiveness, and faster resolution compared to traditional court procedures.

„ It also provides confidentiality, allowing firms and states to avoid unwanted media attention.

„ Awards are enforceable in courts around the world, enabling investors to use local legal systems to seize assets in the event of non-payment

Modelled on international commercial arbitration, ISDS rests on the consent of the parties who choose arbitrators who render legally binding decisions. This is in contrast to conventional national courts where judges are appointed by states, in some cases lacking independence or sufficient expertise in international commerce.

ISDS has been around for more than fifty years, originally created as a tool of economic development to mitigate risks of economic activity in politically unstable countries. It gained momentum in the late 1990s and by the first decades of this century, several hundred claims had been brought against host states by investors. ISDS appears in most of the many thousand investment treaties, although this trend appears to be reversing. Unfortunately, ISDS is now being extricated from FTAs.

Why use ISDS?

In addition to its neutrality, as with most forms of arbitration, ISDS is usually cheaper and faster than normal civil court procedures. It also offers confidentiality, enabling firms (and states) to escape some of the harsh consequences of unwanted media attention. The arbitration awards are enforceable in courts around the world, which is not always the case for civil judgments, many of which have no legal significance in foreign courts. It is no surprise that ISDS has become so popular for internationally mobile firms.

Critics of ISDS point to the high value of awards issued by tribunals, in some cases, placing burdens on host governments which must pay them. They further assert that the legal costs of ISDS are too high, often because of the long time frames of the cases, foreclosing the ability of smaller firms to use the system. The system is regularly accused of lacking transparency, essential due to the public nature of the claims brought as a consequence of government decisions.

This backlash against ISDS is often grounded in broader criticisms of international investment treaties themselves. These instruments historically granted rights to investors with no corresponding obligations. Protections have been based on vague standards, limiting governments’ capacity to regulate in the public interest for fear of claims adjudicated by international tribunals without any role for their own domestic courts. Many accuse ISDS tribunals of being biased against states, particularly those in the developing world.

While these assessments have some merit, many of these problems are exaggerated, or are manageable. Reforms to ISDS, instigated by UNCITRAL, ICSID and other bodies, have augmented the transparency and streamlined procedural rules with a view to reducing time frames and costs.

New codes of conduct for arbitrators should help ensure that ISDS adjudicators are impartial, helping contribute to legally sound and consistent awards. Statistically, there is no evidence that arbitrators are biased in favour of investors. On the substantial elements of investment treaties, modern instruments have pulled back on protections for investors and enlarged the policy space of host states.

Perhaps the greatest indictment of ISDS has been its one-sided nature – it is traditionally only available to investors who bring claims against states, not viceversa. This appears to represent an inherent flaw in the system – reinforcing its illegitimacy as a forum of international law.

It is important to point out that the availability of counter-claims by host states is increasing. New treaties have the capacity to impose environmental and social governance obligations on firms which could be actionable through ISDS.

More crucially, though, is the reality that host states are already in a position of dominance over foreign investors. For many businesses, it can take decades of costly investment before profits begin to appear. This is especially true in the extractive sector where mineral resources may not become profitable for twenty years or more, with sunk costs representing huge financial exposure.

During this time, investors are incredibly vulnerable, subject to the whims of often volatile local governments where corruption or worse, political upheaval are endemic. While ISDS’ are admittedly unequal, they are designed precisely to rectify this imbalance.

ISDS in developing and developed countries

While these risks are not as prevalent in developed countries because of a more stable political environment and robust independent court systems, the risks still exist.

Investors may be as vulnerable to the vagaries of municipal or regional courts and governments in developed states, which may lack the rigour or integrity of their federal equivalents. Moreover, the time and expense of civil courts, particularly in advanced Western countries with a strong culture of combative litigation, can be prohibitive for smaller firms seeking to gain a foothold against larger market incumbents. ISDS, particularly with its recent reforms designed to lower costs, is well-suited to address these challenges, levelling the playing field and encouraging risk-taking enterprise.

Time and again investors have indicated that they value ISDS, especially in unsafe countries with untapped resources. Removing it from new FTAs, as has been the case for example in the USMCA, is likely to be a mistake.

Moving forward, it would be advantageous that countries revisit the recent antipathy towards ISDS, and instead listen to the needs of the business community upon which the economy, and by extension society at large, relies for continued prosperity.

BRIAN CANUP Assistant Editor