2020 Universal registration document and annual financial report - BNP PARIBAS 287

5risks and CaPital adequaCy Pillar 3

5

Annual risk survey

Systemic risks related to increased debt In many countries, the health crisis is leading to a massive increase in the public deficit and debt ratios, due to the fall in business activity and the exceptional support measures put in place by governments. In mature economies, public debt ratios will have reached in 2020 unprecedented levels. At present, the very low level of interest rates is limiting the cost of debt service. While massive asset purchases by central banks in Europe should continue to moderate this risk in the near future, the risk of rising interest rates will have to be monitored over the medium term in eurozone countries due to fragmented bond markets. In this context, new common issuances at European level (common bonds) were launched in 2020 and will continue in 2021, as part of the SURE programme (Support to mitigate Unemployment Risks in an Emergency).

The Group s exposure in emerging countries is limited. However, the vulnerability of some of these economies could lead to a downgrade of these countries ratings by the agencies, followed by an increase in risk premiums and debt service costs, leading to disruptions in the global financial system. During the first wave of the pandemic, in many advanced and emerging countries, public policy support contributed to additional debt and avoided a wave of bankruptcies. Nevertheless, in the medium term, this increase in debt could lead to a decline in repayment capacity, whilst the simultaneous increase in public debt reduces the ability of governments to support their private sector if the recovery was weak. On the household side, job losses could also affect debt repayment capacity.

It should be noted that debt-related risk could materialise, not only in the event of a sharp rise in interest rates, which is unlikely in the short and medium term, but also with any negative growth shocks.

Risks of regionalisation of international trade from protectionist measures

In the short term, the risks generated by the trade dispute between the United States and China seem less acute. The priority for both economies in 2020 has been to support the recovery. On the other hand, the new US administration may take a less confrontational stance, although disagreements over intellectual property protection, technology transfer or industrial policies may persist. Following the health crisis, a number of mature economies should also try to reduce their dependency on external supplies in certain areas considered strategic, which could lead to trade regionalisation. This has led to both the renegotiation of a number of trade agreements and the establishment of regional agreements (such as the Asia-Pacific Free Trade Agreement).

Tensions related to trade and globalisation are therefore likely to persist in the coming years, which is likely to hold back global growth by weighing on the volumes traded, disrupting production chains and adversely affecting the confidence of agents and financial markets.

Laws and regulations applicable to financial institutions

Recent and future changes in the laws and regulations applicable to financial institutions may have a significant impact on the Bank. Measures that were recently adopted or which are (or whose application measures are) still projects, that have or are likely to have an impact on the Bank notably include:

■ prudential regulations: with the finalisation of Basel 3 published by the Basel Committee in December 2017, supplemented by the fundamental review of the trading book (FRTB) in January 2019 and of CVA risk (Credit Value Adjustment) in July 2020, which introduces a revision of the credit risk, operational risk, market risk and CVA risk measurement in the calculation of risk-weighted assets. The new Basel framework also provides for the gradual introduction of an overall floor which will be based on standardised approaches. These measures are due to come into force once they are transposed into European law. In addition, the application of certain provisions of CRD 5 and CRR 2, voted in May 2019, has not yet been finalised;

■ the Directive of 16 April 2014 related to deposit guarantee systems and its delegated and implementing acts, the Directive of 15 May 2014 (BRRD) and its revision on 20 May 2019 (BRRD 2) establishing a bank recovery and resolution framework and the anticipation of future MREL requirements (see MREL paragraph in section 5.2 Capital Management and capital adequacy), the Single Resolution Mechanism establishing the Single Resolution Council and the Single Resolution Fund;

■ the Final Rule by the US Federal Reserve imposing tighter prudential rules on the US transactions of large foreign banks, notably the obligation to create a separate intermediary holding company in the US (capitalised and subject to regulation) to hold their US subsidiaries;

■ the regulation of over-the-counter derivative activities pursuant to Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the European Market Infrastructure Regulation (EMIR) in Europe, notably margin requirements for non-cleared derivative products, transparency and reporting requirements for derivatives transactions in securities; as well as the obligation to set off certain derivatives traded over the counter by clearing houses;

■ the new regulations on financial instruments MiFID 2 and MiFIR;

■ the General Data Protection Regulation (GDPR), which came into force on 25 May 2018. This Regulation aims to move the European data confidentiality environment forward and improve personal data protection within the European Union. Businesses run the risk of severe penalties if they do not comply with the standards set by the GDPR. This regulation applies to all banks and companies providing services to European citizens.

For a more detailed description, see risk factor 6.1 Laws and regulations adopted in recent years, particularly in response to the global financial crisis, as well as new legislative proposals, may materially impact the BNP Paribas Group and the financial and economic environment in which it operates.