27 March 2020
The European Banking Authority (EBA) published today its final draft Regulatory Technical Standards (RTS) on the new Internal Model Approach (IMA) under the Fundamental Review of the Trading Book (FRTB). These technical standards conclude the first phase of the EBA roadmap towards the implementation of the market and counterparty credit risk frameworks in the EU.
These final draft technical standards cover 11 mandates and have been grouped in three different documents: the final RTS on liquidity horizons for the IMA; the final draft RTS on back-testing and profit and loss attribution (PLA) requirements; and the final draft RTS on criteria for assessing the modellability of risk factors under the IMA.
The final draft RTS on liquidity horizons for the IMA clarify how institutions are to map the risk factors to the relevant category and subcategory, along with specifications with respect to the list of currencies and currency pairs that can be mapped to a 10-day liquidity horizon under the interest rate and the foreign-exchange risk category. Finally, they provide a definition of large and small capitalisation reflecting the specificities of the EU equity market.
The final draft RTS on back-testing and PLA requirements specify the elements to be included for the purpose of those tests in the hypothetical, actual, and risk-theoretical P&L (HPL, APL and RTPL respectively). Furthermore, they set all key-elements characterising the PLA requirements: the tests ensuring that HPL and RTPL are sufficiently close, the consequences for institutions with desks where those changes are not close, the frequency at which the assessment of the PLA requirement has to be performed. Finally, they also set the aggregation formula that institutions are to use for aggregating the own funds requirements.
The final draft RTS on criteria for assessing the modellability of risk factors under the IMA set out the criteria for identifying the risk factors that are modellable and that institutions are, therefore, allowed to include in their expected shortfall calculations. The modellability assessment is intended to ensure that only risk factors, which are sufficiently liquid and observable, are included into expected shortfall calculations so that reliable risk measures are calculated. The technical standards also set the frequency under which the modellability assessment should be performed by institutions.
The adoption of those RTS is expected, under the current Capital Requirements Regulation (CRR2), to trigger the three-year period after which institutions with the permission to use the FRTB internal models are required, for reporting purposes only, to calculate their own funds requirements for market risk with those internal models.
In light of the current situation linked to COVID-19, these RTS will not impose a burden on the industry today. On the contrary, the EBA trusts that providing early information to all market participants about key aspects for the EU implementation of the FRTB framework will be beneficial to ensure a smooth and harmonised process.
In this context, the EBA also acknowledges and welcomes the decision by the Group of Central Bank Governors and Heads of Supervision (GHOS) to defer the implementation date of the revised market risk framework by one year to 1 January 2023, which will also allow EU banks to benefit from a longer implementation time.
These final draft RTS have been developed according to Article 325bd(7), 325be(3), 325bf(9), 325bg(4) of Regulation (EU) No 575/2013 (CRR) as amended by Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019.
Article 325bd(7), mandates the EBA to develop RTS to specify: (a) how institutions are to map the risk factors of the positions to broad categories of risk factors and broad sub-categories of risk factors; (b) which currencies constitute the most liquid currencies sub-category of the broad category of interest rate risk factor; (c) which currency pairs constitute the most liquid currency pairs sub-category of the broad category of foreign exchange risk factor; (d) the definitions of small market capitalisation and large market capitalisation for the purposes of the equity price and volatility sub-category of the broad category of equity risk factor.
Article 325be(3), mandates the EBA to develop RTS to specify the criteria to assess the modellability of risk factors and to specify the frequency of that assessment.
Article 325bf(9), mandates the EBA to develop RTS to specify the technical elements to be included in the actual and hypothetical changes to the value of the portfolio of an institution for the purposes of the back-testing.
Article 325bg(4), mandates the EBA to develop RTS to specify: (a) the criteria necessary to ensure that the theoretical changes in the value of a trading desk's portfolio is sufficiently close to the hypothetical changes in the value of a trading desk's portfolio, taking into account international regulatory developments; (b) the consequences for an institution where the theoretical changes in the value of a trading desk's portfolio are not sufficiently close to the hypothetical changes in the value of a trading desk's portfolio; (c) the frequency at which the P&L attribution is to be performed by an institution; (d) the technical elements to be included in the theoretical and hypothetical changes in the value of a trading desk's portfolio for the purposes of the P&L attribution; (e) the manner in which institutions that use the internal model are to aggregate the total own funds requirement for market risk for all their trading book positions and non-trading book positions that are subject to foreign exchange risk or commodity risk, taking into account the consequences referred to in point (b).
The EBA is legally mandated to deliver these mandates by the 28 March 2020.