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Valuation in resolution – valuation 1,2 and 3

Valuation in resolution – valuation 1,2 and 3

The European Banking Authority (EBA) has issued Regulatory Technical Standards on valuations in the context of resolution.

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Michelle Adcock

Banking prudential, EMA FS Risk & Regulatory Insight Centre

KPMG in the UK

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As a result of the unprecedented impact of Covid-19, the Bank and PRA announced on 7 May 2020 measures to alleviate the operational burden on firms. Amongst these measures, compliance with the Bank’s Statement of Policy on Valuation capabilities to support resolvability has been extended by three months from 1 January 2021 to 1 April 2021. Firms should be compliant with the Valuations Statement of Policy by 1 April 2021 unless otherwise communicated by the Bank. If you wish to discuss the impact of these changes on your ViR programme with our Banking teams please email the following: go-fmemafsriskandreg@kpmg.com

The standards (PDF 485 KB) clarify the basis for three different types of valuation – to inform a decision on whether to put a bank into resolution; to inform the choice of resolution tools and the extent of any bail-in of liabilities; and to determine whether any creditors would have been better off had the bank gone into insolvency.

Valuation 1

The first type of valuation ahead of resolution is to determine whether the conditions for triggering resolution are met. The EBA standards make clear that this type of valuation should follow normal accounting and prudential rules relevant to an assessment of whether a bank meets the conditions for continuing authorisation (so the rules applying to the preparation of financial statements and the calculation of regulatory capital ratios). No account should be taken of any actions that the resolution authority might take if the bank is put into resolution.

Valuation 2

The second type of valuation ahead of resolution is to inform the choice of resolution tools, including the extent of any bail-in of liabilities, and to determine (where relevant) the rate at which non-equity liabilities should be converted into new equity. This valuation may depart from accounting and prudential rules, because potential losses should be assessed using economic values (the present value of future cash flows), in particular where the resolution strategy is based on the sale of businesses or assets within a defined disposal period. In addition, this valuation should be based on prudent assumptions, in an attempt to avoid situations where the eventual losses are not covered by the initial bail-in amount. This may result in the inclusion of a conservative buffer to reflect probable losses that the valuer has not been able to estimate with sufficient accuracy as part of a provisional valuation.

In some cases Valuation 2 may be conducted on a preliminary basis ahead of a bank being out into resolution, but then repeated and finalised at some point after resolution. This will depend on the degree of uncertainty ahead of resolution and the extent to which there is scope to finalise bail-in amounts and conversion rates after resolution.

Valuation 3

Following a resolution, a valuation is required under the “no creditor worse off than under liquidation” (NCWOL) principle, to determine whether any creditor should be compensated. This valuation should be undertaken on a “gone concern” basis, estimating the discounted value of cash flows that could reasonably have been expected to arise under the relevant national insolvency procedures for banks. This counterfactual outcome then needs to be compared with the treatment of creditors and shareholders in resolution.

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