Consultation

Executive Summary

1. This consultation paper (CP 10) reflects a common understanding among European supervisory authorities of the procedures to be used in processing, assessing, and making decisions on the application of an institution to use an Advanced Measurement (AMA) or an Internal Ratings Based (IRB) approach for regulatory purposes. It also sets out guidance, again based on a common understanding among the supervisory authorities, on the meaning and the implementation of the minimum requirements for using these approaches, as set out in the recast Capital Requirements Directive (CRD).

2. The CRD requires an explicit approval process for the use of AMA and IRB approaches for regulatory purposes. An approval to use an IRB approach can be given only if the competent authority is satisfied that the institution's systems for managing and rating credit risk exposures are sound and implemented with integrity and, in particular, that they meet the requirements listed in Article 84 in accordance with Annex VII, Part 4 of the CRD. Similarly, approval to use an AMA under Article 105 can be only given when institutions satisfy their competent authorities that they meet the qualifying criteria set out in Annex X, Part 3 of the CRD.

3. One of the greatest challenges for supervisors in implementing the CRD is defining under what conditions they will be satisfied with these systems. Supervisors would like these conditions to be convergent across the EU member states, in order to make the playing field as level as possible for institutions using AMA and IRB approaches.

4. When CEBS began working on these guidelines, its aim was to cover a wide range of areas related to AMA and IRB approaches, including the definition of loss and default, requirements for rating obligors and exposures, the estimation and validation of internal risk parameters, stress testing, corporate governance matters, data issues, and the application, assessment and decision processes. The tight time frame imposed on this project made some prioritisation indispensable. These guidelines therefore represent only the first phase of CEBS's work on the implementation, validation, and assessment of AMA and IRB approaches. Nevertheless, they cover a large number of topics, sometimes in a considerable degree of detail, relating to the application, decision, and especially the assessment process.

5. These guidelines are drafted as guidance to supervisors, elaborating on the CRD Articles and Annexes. However, since the guidelines express CEBS's expectations of how national supervisory authorities should deal with the implementation and assessment of AMA and IRB approaches, it is clear that they also affect the institutions intending to use these approaches.

6. The guidelines will be a helpful tool for national supervisors (on-site examiners and off-site inspectors), both in conducting the assessment of an application to use an AMA or IRB approach, and in later examinations or inspections of the approaches applied. They will also reduce the burden on the industry. In particular, the guidelines will streamline the application and decision process according to Article 129(2) of the CRD. To assist in assessing whether an application is complete, the supervisors have agreed on a minimum set of documents to be included in applications, while still leaving each authority the right to require additional documents. Similarly, the guidelines contain a list of areas that the assessment of applications would concentrate on. Therefore, the guidelines should simplify and speed up the approval process.

7. These guidelines do not cover 'explicit' national discretions, that is areas where the CRD presents the competent supervisory authority with an explicit choice of alternatives to apply. This topic has already been addressed by CEBS in the 'national discretions' exercise. For example, no guidance has been given on how supervisory authorities should make use of the explicit discretion on the number of days past due for retail and Public Sector Entities exposures.

8. The guidelines cover a broader concept of validation than that pursued by the Validation Sub-Group of the Basel Committee's Accord Implementation Group (AIG), since assessing the institution's validation of its internal rating systems (IRB) and its operational risk measurement systems (AMA) is only part of the much broader concept of a supervisor's assessment. This difference in focus does not, however, imply any inconsistency with the work of the AIG. To the contrary, consistency with the work of the AIG sub-groups on validation and data issues and the AIG Sub-Group on Operational Risk has been one of the prior goals when drafting these guidelines. Indeed, these guidelines take over the High-Level Principles on Validation of the AIG Sub-Group on Validation and use them as the basis for elaborating further guidance on this subject.

9. CEBS believes that a formal consultation of the Guidelines framework at this stage will benefit both market participants and supervisors. CEBS invites comments on this consultation paper by 30 October 2005 (CP10@c-ebs.org). The comments received will be published on the CEBS website unless the respondent requests otherwise.

Comments are specifically requested on the following general questions:

• Do you think that the proposed guidelines will enhance a regulatory level-playing field for EU institutions using an AMA or IRB approach?
• Do you support the proposed procedures for cooperation between supervisory authorities in the pre-application, approval, and post-approval period, and do these procedures address the need for efficiency, consistency and reduced administrative burden for institutions applying for an AMA or IRB approach?
• Do you think that the areas covered in the guidelines represent a significant and for your purposes useful convergence among supervisors? In which precise areas would this be true?
• Has CEBS focused on the areas of greatest relevance to the industry?
• What other areas of importance should be covered by CEBS in possible future work on AMA and IRB approaches?