Response to consultation Paper on Draft Regulatory Technical Standards related to implementation of a new prudential regime for investment firms
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Draft RTS specifying the methods for measuring the K-factors referred to in Article 15 of the IFR - EBA/CP/2020/06
Question 1 – Is the proposed articulation of the K-factors calculation methods, in particular be-tween AUM and CMH and ASA, exhaustive or should any other element be considered?
Treatment of cash trades in bonds
3.30 FIA EPTA members would like to note that there is a discrepancy in the treatment of cash trades in bonds, when compared to bond futures. This is because the bond futures would have their notional amount adjusted for the time to maturity of those contracts, in line with Article 33(2)(b), while the cash bonds would be included in the calculation of K-DTF by the amount paid or received. In addition, we would reiterate that market makers and li-quidity providers, who as firms dealing on own account will be subject to K-DTF, play an important role in improving market quality and lowering execution and risk management costs for retail and institutional end-investors in government bonds, which also benefit the liquidity of EU Member States’ sovereign debt issuance.
3.31 FIA EPTA members also note that the duration adjustment in Article 33(2)(b) of the IFR is only applicable to interest rate derivatives, while the duration adjustment in Article 29(4) of the IFR is applicable to interest rate and credit derivatives. We understand this is because of the additional underlying risk that applies to credit derivatives. However, we note fur-ther that high-quality and EU Member States bonds are subject to a 0% specific risk charge own funds requirement, as per Article 336 of the CRR. Therefore, only the general market risk related to the interest rate applies to these bonds.
3.32 Therefore, FIA EPTA members would ask the EBA to include an additional article in the final RTS specifying that the amount paid or received for trades in government bonds, which are subject to a 0% specific risk own funds requirement according to Article 336 of the CRR, is also adjusted for the time to maturity (in years) of the bond, specified in Article 33(2)(b) of the IFR.
6. Fixed Overheads Requirement (FOR)
Draft RTS to specify the calculation of the fixed overheads requirement and to define the notion of a material change (Article 13(4) of the IFR) –
EBA/CP/2020/06
6.1. FIA EPTA members note that the FOR now applies to all investment firms. This is set as one quarter of the fixed overheads of the previous financial year, and the competent au-thority can adjust this amount if the investment firm materially changes its business during the year. This adjustment could be an increase or a decrease, depending on the business change. FIA EPTA members also note that the FOR calculation is also used for setting li-quidity requirements as one-third of FOR.
6.2. The EBA in its consultation clarifies several points regarding the calculation of FOR, some of which are ambiguous in the current CRD III/CRD IV calculation and adding deductions that are not included in current FOR calculations and in the IFR. FIA EPTA members’ views in the regard are described in the below.
Basis of calculation
6.3. The EBA clarifies that FOR calculations are based on the most recent audited annual finan-cial statements or just annual financial statements, if audited financial statements are not available. Currently, the draft delegated regulation refers to annual financial statements validated by the competent authority. This means that according to the current proposed text, the timing of application of the most recent annual accounts would be unclear.
6.4. FIA EPTA members would ask the EBA to clarify that ‘annual financial statements’ are re-garded as being annual financial statements approved by the directors or other compe-tent body of the investment firm.
Full list of deductions
6.5. FIA EPTA members note that the full list of deductions is not included in either the Level 1 or Level 2 texts (i.e., regulation and delegated regulation). In the delegated regulation, the additional items to deduct are referenced as being added to the items already includ-ed in the regulation. This means that although the reference to ‘net profits’ for bonuses is included in the regulation, all the items in the regulation have been stated as items to be considered. This means that they can be changed if a complete list is included in the dele-gated regulation, making it even more important to have a full list of deductions, with po-tential amendments to the text in IFR, in the delegated regulation.
6.6. FIA EPTA would ask the EBA to include in the delegated regulation a full list of items, to be deducted from total expenses. We would urge that this should also cover the reference to ‘fully discretionary’ staff bonuses be included, rather than the reference to ‘net profits’.
Staff bonuses
6.7. Currently for the purpose of CRR, and in line with delegated regulation (EU) 2015/488, ‘ful-ly discretionary staff bonuses’ are deducted from total expenses for the calculation of the FOR. However, we note that point (a) of paragraph 4 of Article 13 of the IFR instead refers to ‘staff bonuses and other remuneration, to the extent that they depend on the net profit of the investment firm in the respective year’. It is unclear to us why this change has been made, and why there is a need to refer to profits, when in most cases an investment firm has the discretion not to pay any bonuses to staff, even if it is making a profit.
6.8. We note further that the EBA proposes that staff bonuses and other remuneration is de-pendent on net profits of the investment firm if it has been paid to employees in the pre-ceding year of payment, or the payment will have no impact on the firm’s capital position in the year of payment. However, FIA EPTA members observe that the meaning of ‘bonus paid before the year of payment’, is unclear. One possible interpretation could be where the payment has occurred in a year preceding the current year, or year the FOR is being calculated. Consequently, FIA EPTA members would ask for the EBA to delete any link be-tween the ability to deduct staff bonuses, from total expenses, and net profits. Alterna-tively, we would urge the EBA to consider clarifying the meaning of bonus paid in the pre-ceding year of payment.
6.9. In addition, with respect to current year and future years, the ability to deduct staff bo-nuses from total expenses, appears to only be possible where the firm is not obliged to pay unless it makes a net profit in that year. It is important to note that the FOR is normally calculated based on previous years expenses, and what is being proposed, for current and future years, can have a knock-on impact for the calculations of material changes in FOR. As mentioned before, an investment firm may decide not to pay bonuses even it is mak-ing a profit, as bonuses are normally dependent on employees meeting targets, which might not be met, and are normally discretionary.
6.10. Based on the current drafting, the normal calculation of FOR would, in most cases, include a deduction of bonuses. However, the calculation of current and future years FOR would not, if a firm projects to make a profit. This means that the calculation of previous years and current year are technically different. Because of this, investment firms may breach the thresholds in Article 3 of the proposed delegated regulation and may be required by the competent authority to calculate a FOR based on these projected figures, without the ability to deduct staff bonuses from total expenses.
6.11. FIA EPTA would ask the EBA, therefore, to remove this reference to ‘net profits’ and sug-gest to revert to ‘fully discretionary staff bonuses’, where it can be added that the link to net profits can be used as an example where discretion exist, but not as the mandatory condition to meet.
6.12. Finally, we note that this linkage between the deduction of staff bonuses and ‘net profits’ is likely not to have been considered in the EBA impact assessment of the proposed new regime, as this is likely to have considered investment firms’ responses aligned with the current CRR regime that only refers to ‘fully discretionary’ bonuses. We consider that this change can have a material impact that should not be underestimated and, if kept, we urge that it should be reflected in a new impact assessment conducted by the EBA where the CRD III/CRD IV FOR is compared to the IFR FOR.
Deduction of fees only where they are passed on and charged to customers
6.13. FIA EPTA members note that the deduction for trading fees has been restricted to cases where such fees are passed on and charged to customers. We do not support this word-ing and would have the following comments:
• It is not clear what is the intention of this restriction;
• Fees incurred for the purposes of executing, registering or clearing transactions are mostly variable in nature;
• The restrictions create an unlevel playing field between firms subject to CRR and those subject to IFR and also among firms subject to IFR (those with or with-out clients) without an objective justification.
6.14. Furthermore, we consider that it should not matter whether an item is included under total expenses provided that they are accounted for in line with the relevant accounting standards. Some expenses would reduce trading income or be accounted for in a separate expenses line in line with accounting standards. In order to make this clear, we consider that the text should read ‘where they are accounted as an expense in accordance with the relevant accounting standard’.
Additional items to deduction from total expenses
6.15. From the deductions listed in both the regulation and delegated regulation above, and the principles behind the ability to deduct items from total expenses, FIA EPTA members con-sider there is at least one type of deduction that is not included and should be added to the list. These relate to a ‘deduction of expenses related to items that have already been deducted from own funds’. The reason behind this additional deduction is that items such as intangible assets, for example, are deducted from own funds and, as such, any ex-pense recorded related to these, such as impairment or amortisation (acceptable in cer-tain local GAAPs), would have no impact on own funds.
Material change in activities on an investment firm
6.16. FIA EPTA members note that the EBA consultation also proposes a definition of what is considered a material change in the activities of an investment firm. As proposed, material change is considered to have occurred if there is a change in projected fixed overheads of the current year, equal to or greater than:
• 30% of the FOR: or
• EUR 2 million.
6.17. FIA EPTA members note further that the EBA decided to increase the percentual change but kept the same EUR 2 million threshold. It is our view that the EUR 2 million threshold for investment firms with a large FOR is inappropriate. For example, for an investment firm with a FOR of EUR 100 million, a EUR 2 million change in FOR represents only a 2% change in fixed overheads and is not likely to be related to a material change in an invest-ment firm’s activities. Requiring such investment firm to restate its FOR is an unnecessary burden. We would ask the EBA to consider two alternative options:
i. Remove the EUR 2 million condition to determine a material change; or
ii. Include an additional statement clarifying that this condition should be considered in a proportionate manner and not as an automatic approach.
3. K-DTF
Draft RTS to specify adjustments to the K-DTF coefficients (Article 15(5) point c) of the IFR)
Draft RTS specifying the methods for measuring the K-factors (Article 15(5), point a) of the IFR) –
EBA/CP/2020/06
Exchange traded options – (Article 1 of the Draft RTS)
3.1. FIA EPTA members agree with the EBA that the trading and settlement of exchange-listed options is akin to other “cash trades” such as for stocks and should be treated as such for purpose of the K-DTF calculation.
3.2. We support, therefore, the proposal in the draft RTS specifying that exchange-traded op-tions are to be treated as ‘cash trades’ and the premium paid or collected – rather than the notional value of the contract – will be used when measuring DTF.
Stressed market conditions – (Article 2 of the Draft RTS)
3.3. The EBA includes a specific question in this section. As follows:
“Question 3 – Is there any example of situations of market stress which would not been taken into account applying the proposed approach but would be relevant for the meas-urement of the K-DTF?”
3.4. FIA EPTA members consider that there are several examples of situations of market stress which are not covered by the current proposal in the draft RTS. FIA EPTA members are concerned that, as currently proposed, the draft RTS will not be effective in delivering on the objectives as set out in the IFR Level 1 text. We would strongly urge the EBA, there-fore, to reconsider its proposed approach. To this end we suggest the proposed solutions which are described in the following paragraphs.
3.5. The current proposal to allow a coefficient adjustment only when there are “exceptional circumstances” pursuant to point (a) of Article 3 of Commission Delegated Regulation (EU) 2017/578 (MiFID II “RTS 8”) would have a very limited or no impact at all. Empirical feed-back from trading venues confirms that exceptional circumstances almost never occur, or only very rarely for extremely limited periods of time, maybe just a few minutes. It should be noted that even the extreme market volatility during the depth of the COVID-19 crisis in March 2020 did not change this picture. In addition, when exceptional circumstances are called under MiFID II, this is specifically designed to relieve investment firms of their obli-gation to provide liquidity on a regular and predictable basis (i.e., not trade), which means the current proposal does not achieve the objective of incentivising liquidity in the mar-kets as set out in recital 1 of the Draft RTS.
3.6. FIA EPTA members also note that pursuant paragraph 5 of Article 15 of IFR, the EBA was tasked with developing the draft RTS to specify when the K‐DTF coefficient should be ad-justed in the event of ‘situations of market stress’. We note that the current proposal ref-erencing ‘exceptional circumstances’ constitutes a more narrow concept and we consider, therefore, that expanding to a broader concept of situations of market stress would be more aligned with the mandate given to the EBA, and would better achieve the stated ob-jectives.
3.7. FIA EPTA members would strongly recommend, therefore, to the EBA to substitute the approach based on the concept of ‘exceptional circumstances’ for one based on ‘stressed market conditions’.
3.8. In that regard, we would further suggest that an approach based on an objective statistical methodology will most effectively deliver on the targeted objective.
3.9. Below, we propose two alternative statistical solutions which would allow for an objective assessment of the existence of ‘stressed’ vs. ‘normal’ market conditions, based on the comparison of short-term market behaviour vs. longer term historical norms. Either of these would efficiently deliver on the need to determine whether stressed market condi-tions are of a type that should result in a coefficient adjustment for the purposes of K-DTF.
3.10. Further, by way of an additional (although in our view less effective) solution we also sug-gest an alternative approach defining ‘stressed market conditions’ as per MiFID II RTS 8.
3.11. Our suggested solutions are as follows:
Statistical method
3.12. FIA EPTA members believe that, rather than relying on trading venues, a simpler and more objective approach is to take a statistical view of stressed market conditions. This method removes volumes of transactions that are associated with statistically high volatility, high volume and observation days. The great advantage of this method is that it is very simple, using generally available external market data and that the method can be used for every product on every exchange.
3.13. This approach is justified because during heightened volatility, end users of securities or derivatives increase their demands for liquidity. These periods tend to coincide with high-er than average volume. The current drafting implies that following a period of height-ened volatility, investment firms would be required to account for higher K-DTF. This cre-ates a disincentive to provide liquidity at a point in time when end users most need it.
3.14. To ensure that liquidity providers are not disincentivised through higher K-DTF readings during this time, firms should be allowed to remove volume from the calculation which co-incides with higher than average volume. Specifically, a threshold which defines higher than average volume is required in order to base this calculation.
3.15. The use of price volatility to statistically define ‘stressed markets’ is widely accepted prac-tice. Delegated Regulation (EU) No. 2017/578 places this exact requirement onto trading venues who must set out parameters to identify stressed market conditions in terms of significant short-term changes of price and volume. Trading venues must then consider the resumption of trading after volatility interruptions as stressed market conditions.
3.16. The use of the same approach to identify stressed market conditions for the purposes of adjusting K-DTF seems entirely appropriate and aligns purposefully with the approach taken by exchanges, while ensuring an objective and consistent methodology across ex-changes and financial instruments.
3.17. A percentile approach offers an elegant and scalable approach that should be simple to calculate. A percentile can be defined as the Nth percentile derived from a list of observa-tions sorted from greatest to least. This can be determined as follows:
Cadj = C * (DTFexcl / DTFincl)
Where:
DTFexcl =the daily trading flow (DTF) of derivatives measured in accordance with Article 33 of Regulation (EU) 2019/2033, excluding the value of any trade that oc-curred during periods of extreme volatility stressed market conditions as set out in Article 2a; and
DTFincl =the DTF of derivatives measured in accordance with Article 33 of Regula-tion (EU) 2019/2033, including the value of any trade that occurs during periods of extreme volatility stressed market conditions as set out in Article 2a.
3.18. Article 2 would be deleted and a new Article 2a included to define ‘period of stressed market conditions’.
3.19. We propose two different options, set out below, to define ‘stressed market conditions’, one based on historical volatility and another based on historical volume.
3.20. To ensure consistent outcomes from the calculation, we propose for the statistical meth-od a longer look-back period than 6 months. This is to make sure the measurements can indeed empirically be assessed as substantive outliers over a longer time horizon; based on FIA EPTA members’ quantitative analysis of market behaviour, we suggest to use a 3 year lookback period for this purpose.
3.21. Option 1 – historical volatility:
“Article 2a
Period of stressed market conditions
For the purposes of Article 1, periods of stressed market conditions shall be deter-mined as the trading days where historic volatility is in the highest 10% of the last 3 years for a given market and product.”
3.22. Historical volatility is measured by the difference between the high and low price of a product on a certain day. For derivatives, the price of the underlying product is used for the measurement. FIA EPTA members have analysed the proposed adjusted calculation, using this statistical method, based on Eurostoxx futures data. In doing so, we have used the year 2019 as the base data. When compared to this the calculated value for K-DTF, once March’s volume begins to be included, increases by up to 51% compared to the same period for 2019.
3.23. Using this proposed statistical method, the increase in capital requirements would show an increase of only 5%, rather than the 51% increase. Without this statistical method the year on year changes for K-DTF range from -11% to 51%. With this statistical method the K-DTF value stabilises with the range tightening from -3% to 10% across 2019 and 2020. This achieves the desired effect of not disincentivising investment firms from providing liquidi-ty during periods of market stress.
3.24. Option 2 – historical volume:
“Article 2a
Period of stressed market conditions
For the purposes of Article 1, periods of stressed market conditions shall be deter-mined as the trading days where market volume for that day was in the highest 10% of the last 3 years for a given market and product.”
3.25. FIA EPTA members have analysed the proposed adjusted calculation, using this statistical method, based on Eurostoxx futures data. In doing so, we have used the first 6 months of 2019 as the base data and set this at 100. When compared to this, the volume of transac-tions in the first 6 months of 2020 increased by almost 50%.
3.26. Using this proposed statistical method, the increase in capital requirements would show an increase of only 2%, rather than the 50% increase. For 2019, this statistical method would show a decrease of only 5%. This demonstrates that there is a normalisation of cap-ital requirement, with large increase in trading volumes, without the negative impact on normal times.
MiFID II definition
3.27. ‘Stressed market circumstances’ is a concept used in MiFID II RTS 8 and mandated by Arti-cle 6 of those RTS to be used by all EU exchanges in their market making schemes. This definition may even allow for it to be applicable more generally rather than only EU trad-ing venues.
3.28. When compared to the statistical method, this approach may be more difficult to imple-ment by investment firms. Exchanges publish when stressed market circumstances do oc-cur per product. However, this data is not always available in an easy format to use in K-DTF calculation by investment firms, which may make the calculation quite burdensome from an operational perspective. In addition, the trigger of stressed market conditions is not generic and can differ per exchange and/or product, and while being quite common in equity markets but less common in commodities and interest rates. Consequently, FIA EPTA members would deem this approach, while an improvement on the ‘exceptional cir-cumstances’ approach to be less effective than the statistical approach outline above.
3.29. This approach can be implemented as follows:
Cadj = C * (DTFexcl / DTFincl)
Where:
DTFexcl =the daily trading flow (DTF) of derivatives measured in accordance with Arti-cle 33 of Regulation (EU) 2019/2033, excluding the value of any trade that occurred during periods of extreme volatility stressed market conditions as set out in Article 2a; and
DTFincl =the DTF of derivatives measured in accordance with Article 33 of Regulation (EU) 2019/2033, including the value of any cash trade that occurs during periods of extreme volatility stressed market conditions as set out in Article 2a.
3.30. Article 2 would be deleted and a new Article 2a is included to define ‘period of stressed market conditions’. As follows:
“Article 2a
Period of stressed market conditions
For the purposes of Article 1, periods of stressed market conditions shall be those situations referred to in of point (b) of paragraph 1 Article 6 of Commission Dele-gated Regulation (EU) 2017/578. Their start and end times shall reflect precisely the times when the trading venue communicated the occurrence of such stressed market conditions under paragraph 6 of Article 7 of Commission Delegated Regu-lation (EU) 2017/578.”
Additional prudence
3.31. Although stressed market conditions are quite unique, there could conceivably be a con-cern that such adjustments may lead to a reduction of K-DTF which is deemed too large. It could be an alternative to provide an additional floor to the calculation in such a way that the reduction is not greater than 50%. As follows:
Cadj = Max [0.50 * C ; C * (DTFexcl / DTFincl)]
2. K-CMG
Draft RTS to specify the calculation of the amount of the total margin for the calculation of K-CMG (Article 23(3) of the IFR) –
EBA/CP/2020/06
Scope of K-CMG
2.1. While being conscious of the IFR Level 1 text, FIA EPTA members would like to bring to the EBA’s attention, in the context of this consultation response, that the combination of the definition of ‘clearing member’ in Article 4(1)(3) of the IFR and Article 23 of the IFR limits the use of K-CMG to investment firms where they are direct clients of an EU clearing member. However, it should be noted that alternatively, investment firms can also be cli-ents of direct clients of EU and non-EU clearing members (i.e. indirect clients), or even di-rect members of the CCP (i.e. clearing members). All these cannot benefit from the use of K-CMG, even if the models used to set margin requirements are set at an appropriate level of prudence and meet all conditions in paragraph 1 of Article 23 of the IFR.
2.2. FIA EPTA members are of the view that this limited scope, where the ability to use the total margin requirement as a methodology to set capital requirements to Risk to Markets should focus on the quality of the margin model, may have an undesired and ‘cooling’ ef-fect on competition, as the requirement discriminates against non-EU clearing members and CCPs, which may lead to further concentration of client clearing activity in a limited number of clearing members or CCPs, without the underlying economic rationale. We would argue that K-CMG should be available to investment firms, irrespective of the loca-tion of the clearing member that they use, and if they are direct or indirect clients of a clearing member, or even direct members of the CCP.
Portfolios and trading desks – (Article 1 of the Draft RTS)
2.3. FIA EPTA members support both the alignment of portfolios with trading desks and the definition of ‘trading desk’ itself as proposed by the EBA in the draft RTS. The concept of trading desks in the draft RTS is aligned with how firms operate in practice and is con-sistent with other regulations, among other with the CRR2 amendments. In this regard, FIA EPTA members note that this would allow investment firms to define trading desks depending on their business models and would cover the diversity of their trading strate-gies. As such, and to ensure uniform interpretation across the Union, FIA EPTA members would encourage the EBA to clarify the concept of trading desk further in a Recital to the RTS, along the lines set out below in paragraph 2.4.
2.4. A trading strategy is characterised by a multiple of factors, each equally important, which include the trading objectives, the type of products traded, the maturity of the products and the market traded. It is therefore important that an investment firm is able to treat relevant variation of one of these factors as a different trading strategy, and therefore a different trading desk, as it would give rise to different underlying risks, different risk management techniques and different margin requirements at one or more clearing members.
Calculation of the amount of the total margin required – (Article 2 of the Draft RTS)
2.5. FIA EPTA members note that Article 2(1) of the draft delegated regulation proposes that the amount of the total margin required to be calculated as follows:
“The amount of the total margin referred to in Article 23(2) of Regulation (EU) 2019/2033 shall be the required amount of collateral in the collateral account comprising the initial margin, variation margins and other financial collateral, as required by the clearing mem-ber’s margin model from the investment firm.”
2.6. FIA EPTA members support the objective to define total margin required. However, we would caution that the proposed definition is not aligned with the operational model of clearing members and would , in its current wording, limit the ability for simultaneous use of K-CMG and K-NPR by different trading desks within the same investment firm, which would be at odds with the intention of the Level 1 text. There are several points in the proposed definition that lead to this potential limitation, as follows:
a. Reference to initial and variation margin – the suggested language in the draft RTS appears to be borrowed from CCP requirements in EMIR. However, it should be noted that clearing members apply a variety of proprietary margin models which do not use the CCP terminology. In addition, if the definition already refers to the amount of collateral required to cover for the risks, specific reference to individual components is superfluous as they are understood to be included. We would therefore suggest focussing on an outcome-based approach and to remove the reference to initial margin and variation margin but to include the exposures that must be covered.
b. Reference to collateral account – it should be noted that firms may have more than one collateral account, which may include financial and non-financial collateral. Giv-en that, as currently proposed, the draft definition is not aligned with common market practice, we would therefore suggest removing the reference to ‘the col-lateral account’ and to ‘financial collateral’.
c. Specific reference to portfolios – the use of K-CMG on a trading desk basis is al-lowed under IFR and the proposed delegated regulation. However, the proposed calculation of the total margin required does not specify that the amount of collat-eral is specific for the trading desks subject to K-CMG. For the purpose of clarifying the calculation, and to allow for the simultaneous use of K-NPR and K-CMG meth-odologies on a trading desk basis, we suggest that the calculation of the total mar-gin required make specific reference that it will apply ‘for the trading desks subject to K-CMG’.
d. K-NPR and K-CMG as a proxy for ‘market risk’ – it is understood that K-NPR and K-CMG are designed to capture what is, in the current prudential framework, the ‘market risk’, which in summary captures the risk of loss resulting from fluctuation in the market value of net positions. Based on this, and the fact that K-NPR is pro-posed to use CRR methodologies, we propose that the calculation of total margin required include a reference to ‘exposures resulting from change in the market value of net positions’.
2.7. Based on the above comments, we would suggest the calculation of the total margin re-quired included Article 2(1) of the proposed delegated regulation to be amended as fol-lows:
“The amount of the total margin referred to in Article 23(2) of Regulation (EU) 2019/2033 shall be the required amount of collateral in the collateral account com-prising the initial margin, variation margins and other financial collateral, as re-quired by the clearing member’s margin model from the investment firm, to cover for current and potential future exposures resulting from change in market price of net positions, for the trading desks subject to CMG.”
Method of calculation of K-CMG in case of multiple clearing members – (Article 3 of the Draft RTS)
2.8. FIA EPTA members note that Article 3 of the draft delegated regulation proposes that:
“For the purposes of calculating the K-CMG as referred to in Article 23(2) of Regulation (EU) 2019/2033, where an investment firm makes use of the services of more than one clearing member, the investment firm shall calculate the K-CMG by first determining the third high-est amount of total margins required on a daily basis by each clearing member separately over the preceding three months, then adding those amounts and multiplying the out-come by 1.3”
2.9. FIA EPTA members do not support the proposed approach of first determining the third highest amount by each clearing member separately and then adding those amounts. It is our view that the proposed approach does not reflect how the underlying risk is managed in practice by firms and is therefore overly conservative. In addition, the proposed calcula-tion of K-CMG, before adding this additional component where there are several clearing members, already includes a high degree of prudence that does not need to be further increased. In this regard, we suggest the following for consideration by the EBA:
a. Risk management – investment firms manage risks based on the positions they have on a specific day and do not operate a risk management framework based on risks being added up across different days.
b. Third highest margin requirement ¬– it is understood that the use of the third high-est total margin required is to embed a degree of prudence; in combination with other components in the calculation (as set out below) this should be sufficient to ensure an appropriate level of prudential confidence. It is worth noting that the internal models approach in CRR uses an averaging of outcomes over a period. The use of the third highest margin requirement, which is based on the margining model of the clearing member for the same type of risks, is already a more con-servative approach.
c. Multiplying factor – The K-CMG calculation includes a 1.3 multiplying factor which provides for an additional degree of prudence. Our members have assessed that the use of the third highest per clearing member in the manner currently pro-posed by the draft RTS would further increase capital requirements by an addi-tional 10% to 20%, at the very minimum, depending on the number of clearing members which the firm uses. This would seem disproportionate given all other prudential safeguards in place.
d. Double counting – in cases where an investment firm switches a trading desk be-tween clearing members or methodologies (K-NPR and K-CMG), this may lead to a double counting of certain requirements due to the way margin requirements are proposed to be aggregated. Using the aggregation based on days-only would miti-gate such effect.
e. Inconsistent outcomes – the proposed approach may lead to inconsistent out-comes between different investment firms where firm A uses one clearing mem-ber and firm B uses more than one clearing member. For example, even in the case that risks are the same in two investment firms, an investment firm that uses only one clearing member will have lower capital requirements than the one that uses more than one clearing member, for no other reason other than the way margin requirements are added up across multiple clearing members.
f. Concentration risk – the proposed approach would incentivise investment firms to use only one clearing firm, which may lead to further concentration of client clear-ing activity in a more limited number clearing members or CCPs, without any un-derlying economic rationale. This in would increase the risk to the firm, in case of a clearing member’s failure, and the risk to financial stability.
g. Market liquidity and impact assessment – the proposed calculation can lead to an impact on the level of liquidity that investment firms would be able to provide to the market. We would be interested in understanding if the EBA has undertaken any data analysis to assess the impact of the cumulative effect of these proposed rules, which include the third highest, multiplier and aggregation per clearing member. If not, we would urge the EBA to do so and share the outcome with firms.
2.10. Based on the above comments, we suggest the calculation of K-CMG in case of multiple clearing members included in Article 3 of the proposed delegated regulation to be amended as follows:
“For the purposes of calculating the K-CMG as referred to in Article 23(2) of Regula-tion (EU) 2019/2033, where an investment firm makes use of the services of more than one clearing member, the investment firm shall calculate the K-CMG by first adding up, across all clearing members used, the margins for each day, determin-ing the third highest amount of total margins required on a daily basis by each clearing member separately over the preceding three months, then adding those amounts and multiplying the outcome by 1.3”
Prevention of arbitrage – (Article 4 of the Draft RTS)
2.11. The EBA includes a specific question in this section. As follows:
“Question 4 – What would be appropriate thresholds or events that should trigger the comparison between the calculation under the K-CMG compared to the one under the K-NPR?”
2.12. FIA EPTA members fully support the prevention of regulatory arbitrage that can under-mine the stability of the financial market. However, FIA EPTA members do not support the current wording of Article 4 of the proposed delegated regulation and would like to pro-vide feedback on these points and recommend amendments to further improve the cur-rent text.
2.13. The current structure of Article 4, although covering the different points on the mandate that has been given to the EBA, is not entirely clear, which may lead to divergent imple-mentation and supervisory practice across Member States. The conditions that need to be met for a competent authority to grant permission for the use of K-CMG are determined in the IFR. However, it is unclear at what point in time which conditions need to be met and what general non-arbitrage clauses apply. (For example, the requirement to keep consistent methodologies for a period of two years).
2.14. FIA EPTA members observe that the currently proposed drafting of Article 4 appears to mix different types of conditions together. Based on the objectives which Article 4 of the proposed delegated regulation is meant to achieve, we would suggest that it would be more clear if Article 4 were to capture separately the different types of conditions that are captured in Article 23(1)(e) IFR. Consequently, the structure of Article 4 of the Draft RTS should in our view reflect the following three types of conditions (a-c below):
a. Conditions at point of granting permission – this is understood to be the condi-tions that are set in paragraph 1 of Article 4 of the proposed delegated regulation. In general, FIA EPTA members support the text in points (a) to (d) of this para-graph.
However, regarding point (e) of this paragraph (comparison of K-CMG with K-NPR), and the factors described in paragraph 3 of Article 4, FIA EPTA members have a number of concerns, as follows:
i. The text should reflect that certain trading strategies are expected to give rise to an inherently large difference between K-NPR and K-CMG, due to the nature of how standardised approaches to market risk in CRR interact with the structural characteristics of certain financial instruments, for ex-ample, the enhanced maturity ladder for general interest rate risk in the case of short term interest rates (e.g., for STIR exchange traded deriva-tives (ETDs). However, such a difference should in itself not prevent the use of K-CMG as a more appropriate methodology to capture risk to mar-ket.
The more so, as the margin models of clearing members are regarded as prudentially sound. These have undergone extensive testing to ensure their efficacy and accuracy and they are subject to stringent governance criteria.
Therefore, the following amendment is proposed, by adding a point to paragraph 3 of Article 4:
“(f) some trading strategies are expected to give rise to a large dif-ference between K-NPR and K-CMG. A difference between K-NPR and CMG, even if large, should not be sufficient to prevent the use of K-CMG provided that K-CMG meets Article 23 of Regulation (EU) 2019/2033 and is assessed by competent authority as pruden-tially sound”
ii. Two of the points included in paragraph 3 of Article 4 have no relationship with any potential justification of a difference between K-NPR and K-CMG as they are completely independent of any of these.
For example, a calculation of capital requirements based on FOR or other K-factors is not relevant for the purpose of justifying the correct approach to calculate capital requirements for Risk to Market.
Similarly, the level of own funds and the excess over capital requirements is not relevant for this justification. To note that it is ultimately an invest-ment firm’s responsibility to decide the best use for the excess capital it holds, and it should retain the ability to retain control over the use of its excess capital. As such, FIA EPTA members propose the deletion of points (c) and (e) of paragraph 3 of Article 4 of the Draft RTS.
b. General no arbitrage conditions – FIA EPTA members understand this is provided in point (a) of paragraph 2 of Article 4 of the proposed delegated regulation. In-vestment firms will have to conduct an annual assessment of their capital adequa-cy and risks. We believe that an approach to these general no-arbitrage criteria would be more appropriate if aligned with this risk assessment requirement. As such, we propose that the period of ‘at least 24 months’ is replaced by a period of ‘at least 12 months’.
In addition, point (6) in the Recital references that an investment firm will have to make continuous use of the K-CMG method for a trading desk. It also refers to ex-ceptional circumstances where an investment firms may switch methods. Howev-er, the Articles in the delegated regulation do not cover these exceptional circum-stances. Therefore, FIA EPTA members would suggest to the EBA to cover these exceptional circumstances and provide more detail regarding such conditions.
c. Regular assessment of conditions – FIA EPTA members understand this is provid-ed in point (b) of paragraph 2 of Article 4 of the proposed delegated regulation. In answering to Question 4, regarding appropriate thresholds or events that should trigger the comparison between the calculation under the K-CMG compared to the one under the K-NPR, FIA EPTA members do not support the proposed ap-proach. As presented, it is unclear what are the key criteria that trigger the re-quirement to compare K-CMG and K-NPR, and whether this encompasses qualita-tive or quantitative criteria.
In addition, the proposed approach appears to be an automatic trigger. In FIA EP-TA members’ view, these triggers should be used as indicators for competent au-thorities then to make a subsequent judgement whether or not to require a com-parison between K-CMG and K-NPR.
FIA EPTA members would support an approach which aligns these triggers with the regular assessments that have to be conducted by competent authorities and would urge to the EBA to clarify this in the final RTS, in line with the suggested ap-proach outlined below, in which:
i. Competent authorities should assess the qualitative criteria proposed, in-cluding material change in the margin model or in trading strategies, and whether these lead to material changes in relation to K-CMG.
ii. Based on the assessment under point i. above, competent authorities should then determine if there are any reasons to require a comparison between K-NPR and K-CMG capital requirements.
iii. Based on the outcome of the comparison under point ii. above, determine whether the firm’s permission to use K-CMG is kept or revoked.
Double counting
2.15. The EBA includes a specific question in this section, as follows:
“Question 5 – Which other conditions should be considered to avoid double counting or to prevent regulatory arbitrage in the use of the K-CMG approach?”
2.16. FIA EPTA members welcome the objective to understand and avoid cases of double counting and as noted above, we also support the objective to avoid regulatory arbitrage. Double counting may arise in some situations where for example a trading desk is moved from one clearing member to another, or when a firm changes from K-CMG to K-NPR for a trading desk (for example, it has assessed that the other methodology was more appro-priate to reflect the underlying risk of the portfolio).
2.17. FIA EPTA members would suggest that the amendments proposed in paragraphs 2.7 and 2.10 above offer an effective solution to mitigate the occurrence of double-counting.
“Question 5 – Which other conditions should be considered to avoid double counting or to prevent regulatory arbitrage in the use of the K-CMG approach?”
2.16. FIA EPTA members welcome the objective to understand and avoid cases of double counting and as noted above, we also support the objective to avoid regulatory arbitrage. Double counting may arise in some situations where for example a trading desk is moved from one clearing member to another, or when a firm changes from K-CMG to K-NPR for a trading desk (for example, it has assessed that the other methodology was more appro-priate to reflect the underlying risk of the portfolio).
2.17. FIA EPTA members would suggest that the amendments proposed in paragraphs 2.7 and 2.10 above offer an effective solution to mitigate the occurrence of double-counting.
4. Classification
Draft RTS on the information to be provided for the authorisation of investment firms as credit institutions (Article 8a (6) point a) of the CRD)
Draft RTS on the calculation of the threshold referred to in Article 4(1)(1b) CRR (Article 8a(6) point b) of the CRD) –
EBA/CP/2020/06
Overview
4.1. FIA EPTA members would like to raise a concern regarding the potential consequences of the implementation of the proposed delegated regulation in its current form and as cur-rently drafted. As it stands, we are concerned that the currently considered approach will effectively put a disproportionate hard-cap on the size of European investment firms, making it very difficult for them to compete with banks that are not so encumbered. We believe that an alternative approach should be considered which would be more in line with the Level 1 text while enabling larger EU investment firms to compete on a level play-ing field, aligned with the underlying objectives of the Capital Markets Union (CMU) pro-ject of which IFR/IFD is a part. We would strongly urge the EBA to consider such an alter-native approach.
4.2. In the following paragraphs, FIA EPTA members propose an approach which looks to clari-fy more clearly the calculation of the threshold values, and closer to align the methodolo-gy to the intention of the IFR Level 1 text.
4.3. Firstly, is FIA EPTA members’ view that the Draft Regulatory Technical Standard on the cal-culation of the threshold referred to in Article 4(1)(1b) CRR (Article 8a(6) point b) of the CRD) as currently proposed by the EBA is inconsistent with the intention of the European Commission proposal for the IFR and the subsequent discussions held by the co-legislators in finalising such legislation.
4.4. The proposed delegated regulation could lead to an unintentional classification and sub-sequent authorisation of certain European investment firms as Credit Institutions under CRD/CRR and subsequent direct supervision by the Single Supervisory Mechanism (SSM).
4.5. Secondly, FIA EPTA members seek clarification from the EBA as to the intended method-ology to be used in the calculation of total assets as detailed in Article 3, sub-paragraph 2 of the draft RTS. FIA EPTA members’ interpretation of the intended calculation methodol-ogy is detailed in sub-section ‘Total value of assets’.
1. IFD/IFR rules on classification of large investment firms
4.6. We note that the IFD/IFR introduces a number of amendments to CRD and CRR including:
• Extending the definition of ‘credit institution’ in CRR so as to include certain entities carrying out the activities of dealing on own account or underwriting or placing on a firm commitment basis (‘specified activities’) if their total assets reach or exceed a EUR 30 billion threshold (new point (1)(b) of Article 4(1) CRR).
• Adding new provisions to the CRD requiring EU entities that fall within the extend-ed definition to submit an application for authorisation as a credit institution when their assets reach or exceed a similar (but not identically defined) EUR 30 billion threshold calculated on an average basis over a 12 month period (new Article 8a(1) of CRD).
4.7. FIA EPTA members support the threshold in place, to ensure that investment firms of suf-ficient size and European importance are proportionately regulated within the European Union, and welcomes the standalone ‘solo test’. However, FIA EPTA members have con-cerns regarding the calculation of the ‘group test’ threshold in article 8a(1)(b) CRD (and thus article 4(1)(1)(b)(ii) and (iii) CRR) as set out in the proposed delegated regulation and its alignment with the intentions of the IFR/IFD level 1 text.
4.8. Within the proposed delegated regulation, there is a distinction between an investment firm headed by an ‘EU parent undertaking’ and an investment firm headed by a ‘non-EU parent undertaking’. This distinction seems to be an incorrect interpretation of the intent of the Level 1 Legislation.
4.9. According to articles 8 and 9 of the proposed delegated regulation, the investment firm must calculate ‘total assets’ for the purposes of the ‘group test’ in point 8a(1)(b) CRD as follows:
a. “the aggregation of the assets of both EU and non-EU entities carrying out speci-fied activities where they are part of a group headed by an EU parent undertaking (an EU group) - but only the assets of EU entities (so carrying on specified activities where they are part of a group headed by a non-EU parent undertaking (a third-country group); and
b. that aggregation to use the individual (i.e., unconsolidated) balance sheets of those group companies (with some adjustments for intercompany items).”
Legal background
4.10. Originally the proposed text of the ‘group test’ required only the aggregation of the total assets shown on individual balance sheets of EU entities which were part of the group, re-gardless of the location of the parent entity. The group test in the original proposal made no distinction between EU groups and third-country groups and it would have been clearly disproportionate to treat smaller EU firms which are subsidiaries of third country groups as credit institutions simply because the third-country group also includes large non-EU enti-ties that carry on specified activities outside the EU.
4.11. Subsequent changes by the co-legislators were made as a response of the opinion of the ECB of 22 August 2018. In that opinion the ECB recommended the following:
“the proposed regulation should provide clarification as to how the assets are to be calcu-lated, i.e. including the assets of Union branches of third country groups and third coun-try subsidiaries of undertakings in the Union arising from their consolidated balance sheet.” (emphasis added)”
4.12. The response to the ECB’s remarks resulted in the following proposed rewording of the original legislative document:
a. a provision to widen the scope of ‘individual assets’ to include branches of non-EU entities within third country groups; and
b. a provision to focus on the (sub-)consolidated assets of the entities already en-compassed by point (1)(b) of article 4(1) CRR and 8a(1) CRD. (i.e. EU entities that carry out specified activities).
4.13. A key principle of the IFR, and wider European banking regulation, is to prevent the ability for regulated entities to take advantage of regulatory arbitrage across the Union, and pre-vent the risk of circumvention of the requirement for entities to be authorised as credit institutions by structuring their EU activities in such a way that allows EU activities to be excluded from the calculation of ‘total assets’. As such, the ‘group test’ should be focused on EU activities, as opposed to activities conducted outside of the EU.
Other thresholds in IFD/IFR apply only to EU assets
4.14. During the legislative process, the co-legislators added a provision to IFR that was not in-cluded in the legislative proposal and that was designed to ensure that larger investment firms not treated as credit institutions would still be subject to supervision under CRR/CRD (Article 1(2) IFR). This provision includes a solo and group test structured in a similar way to the solo and group tests under CRR/CRD, but with a size threshold of EUR 15 billion and subject to wording excluding from the calculations of the threshold "the individual assets of any subsidiaries established outside the Union that carry on any of the [specified activi-ties]" (see points (a) and (b) of Article 1(2) IFR).
4.15. However, the starting point for the solo and group test under this provision should be un-derstood as being consistent with the correct methodology discussed above. Article 1(2)(a) and (b) of the IFR should be understood as focusing on the consolidated assets of EU enti-ties that carry on specified activities, but then excluding the assets of non-EU subsidiaries of those EU entities when calculating the consolidated assets of those EU entities if those non-EU subsidiaries carry on specified activities. Thus, the intention appears to have been to apply an approach closer to the originally proposed text of point (1)(b) of Article 4(1)(1) CRR and Article 8a(1) CRD.
Proposed solution to the ‘group test’
4.16. FIA EPTA asks the EBA to amend its proposed delegated regulation so that it aligns the method for applying the thresholds in Article 8a(1) CRD with an approach which is con-sistent with an understanding of point (1)(b) of Article 4(1) CRR, based on its legislative history and the apparent reading of the ECB on this issue.
4.17. FIA EPTA proposes a calculation of the ‘group test’, which is believed to meet the original intent of the Level 1 co-legislators as well as providing a level playing field for European in-vestment firms who have managed to create large businesses outside of the EU, while ensuring that once the assets held by that investment firm reach certain thresholds within the EU, they are subject to the appropriate regulatory regime. The calculation should con-tain the following:
a. A provision making clear that the threshold in point (a) of Article 8a(1) CRD is de-termined by reference to the total value of the consolidated assets of an EU entity that carries on specified activities; and
b. A provision making clear that the threshold in point (b) of Article 8a(1) CRD is de-termined by:
i. identifying all the EU entities in a group that carry out specified activities (step 1);
ii. eliminating those EU entities identified at step 1 which are subsidiaries of another entity identified at step 1 (to prevent double counting);
iii. calculating the consolidated assets of each of the remaining entities identi-fied at step 1 (including the assets of their EU and non-EU subsidiaries);
iv. eliminating those EU entities identified at step 1 whose consolidated assets are equal to or greater than EUR 30bn (consistently with the requirements of point (1)(b)(ii) of Article 4(1) CRR and point (b) of Article 8a(1) CRD);
v. summing the total consolidated assets of the remaining entities identified at step 1;
vi. for third-country groups, adding to that sum the assets of EU branches of non-EU entities (for consistency with the requirements of point (1)(b)(ii) of Article 4(1) CRR).
2. Total value of assets
4.18. Article 3 of the regulatory technical standards for the calculation of the threshold referred to in Article 8a(6)(b) of the CRD describes how to calculate the total value of assets for rel-evant institutions. Three possibilities are provided, firstly a prudential approach, secondly the use of IFRS and finally the use of an applicable national accounting law.
4.19. FIA EPTA members consider the EUR 30 billion threshold aims to capture whether or not an investment firm is running a large or similar risk profile as a significant credit institution. It is FIA EPTA members’ opinion that total asset value from an accounting standards per-spective is a poor metric for determining the risk profile of an investment firm, and it wel-comes the introduction of the ability to use a prudential approach in measuring total as-sets, as a fairer representation of total assets for investment firms. This is mainly due to the strict netting pre-requisites under (IFRS) accounting standards, which particularly pe-nalises investment firms with active trading portfolios.
4.20. In Part7 of CRR – ‘Leverage’, the regulator prescribes an exposure measure methodology for the use of calculating the total exposure of the institution for the purpose of measur-ing the total leverage used by the institution. The methodology used to calculate the ‘total exposure measure’ is the sum of the following:
• Total Assets as reported in the financial statement and securities financing trans-actions; excluding derivatives.
• Total Derivatives Exposure using the SA-CCR methodology
• Add-ons for Securities Financing Transactions
• Off-Balance Sheet Items
• Certain Outstanding settlements
4.21. FIA EPTA members support the use of the prudential measures, as prescribed within the Leverage Ratio calculations, to determine total assets and would strongly urge the EBA to clarify in the final RTS that such can indeed be applied in this manner. They will meet the methodology prescribed within Article 3, sub-paragraph 2 of the proposed delegated reg-ulation on the calculation of total assets. Using the approach taken in the calculation of the ‘total exposure measure’ and applying it to calculate the ‘total assets’, the investment firm would exclude the off-balance sheet, SFTs, add-ons and outstanding settlements. The calculation of ‘total assets’ would be the sum of the following:
• Total Assets as reported in the financial statement; excluding derivatives.
• Total Derivatives Exposure using the SA-CCR methodology.
4.22. Finally, FIA EPTA members take from the wording of paragraphs 3 and 4 of Article 3 of the RTS that there is a hierarchy in the three different methods in subsections (2), (3) and (4). FIA EPTA members understand that there is a hierarchy proposed between (3) and (4) so that IFRS is to be preferred over other national accounting standards, but we fail to see the logic for a hierarchical order between subsection (2) on the one hand and (3) and (4) on the other. Therefore, we would suggest to the EBA to provide firms with optionality between using (2) prudential individual reporting, and (3) IFRS, and only allow (4) other national accounting laws, if (2) and (3) cannot be determined.
Draft RTS on prudential consolidation of investment firms groups (Article 7(5) of the IFR) – EBA/CP/2020/06
5.1. FIA EPTA members are of the view that the draft RTS is unnecessarily complex, mainly be-cause of a number of cross-references. We would suggest to the EBA that it would be helpful if the text could be clarified and simplified. We note that Class 2 investment firms, including principal trading firms, are relatively simple and straight-forward and the current drafting of the RTS does not seem to take into account this type of uncomplicated struc-tures.
5.2. FIA EPTA members note that the extraterritorial application and aggregation of the K-factors is troublesome for three reasons:
i. Third-country regimes applicable to investment firms do not have such extraterri-torial application, which creates an unlevel playing field;
ii. The K-factors are explicitly not calibrated for market circumstances in third coun-tries, which if applied would cause disproportionately high capital requirements for third-country operations, likewise resulting in an unlevel playing field; and
iii. The wide scope of consolidation may lead to a consolidated capital requirement where the sum is larger than the individual parts. We believe that applying the consolidation provisions to third-country subsidiaries is unnecessary as these are subject to their own capital requirements, consistent with their local environment and market structure. This would also level the playing field, leading to an in-creased attractiveness and competitiveness of principal trading firms with sub-stantial operations or structures in the Union.
Question 9 – The methods for calculating the K-factors in a consolidated situation may allow for further specifications. Is there any K-factor for which the calculation in the context of the consoli-dated basis would require further specifications? What aspects should be considered?
5.3. Additionally, in response to Question 9, FIA EPTA members would welcome a confirmation in the final RTS that, for the purpose of consolidated K-factor own-funds requirements, activities or exposures would be disregarded as a matter of principle, for all K-factors, in line with a consolidation approach. This would be in line with the language in Article 11 (3)(b). This is clear in Article 11(3) for K-NPR, K-TCD and K-DTF but should be clarified in the RTS for all other K-factors that may be affected by intragroup positions and transactions.
Draft RTS on prudential consolidation of investment firms groups (Article 7(5) of the IFR) – EBA/CP/2020/06
5.1. FIA EPTA members are of the view that the draft RTS is unnecessarily complex, mainly be-cause of a number of cross-references. We would suggest to the EBA that it would be helpful if the text could be clarified and simplified. We note that Class 2 investment firms, including principal trading firms, are relatively simple and straight-forward and the current drafting of the RTS does not seem to take into account this type of uncomplicated struc-tures.
5.2. FIA EPTA members note that the extraterritorial application and aggregation of the K-factors is troublesome for three reasons:
i. Third-country regimes applicable to investment firms do not have such extraterri-torial application, which creates an unlevel playing field;
ii. The K-factors are explicitly not calibrated for market circumstances in third coun-tries, which if applied would cause disproportionately high capital requirements for third-country operations, likewise resulting in an unlevel playing field; and
iii. The wide scope of consolidation may lead to a consolidated capital requirement where the sum is larger than the individual parts. We believe that applying the consolidation provisions to third-country subsidiaries is unnecessary as these are subject to their own capital requirements, consistent with their local environment and market structure. This would also level the playing field, leading to an in-creased attractiveness and competitiveness of principal trading firms with sub-stantial operations or structures in the Union.
Question 9 – The methods for calculating the K-factors in a consolidated situation may allow for further specifications. Is there any K-factor for which the calculation in the context of the consoli-dated basis would require further specifications? What aspects should be considered?
5.3. Additionally, in response to Question 9, FIA EPTA members would welcome a confirmation in the final RTS that, for the purpose of consolidated K-factor own-funds requirements, activities or exposures would be disregarded as a matter of principle, for all K-factors, in line with a consolidation approach. This would be in line with the language in Article 11 (3)(b). This is clear in Article 11(3) for K-NPR, K-TCD and K-DTF but should be clarified in the RTS for all other K-factors that may be affected by intragroup positions and transactions.
Is the proposed articulation of the K-factors calculation methods, in particular between AUM and CMH and ASA, exhaustive or should any other element be considered?
We refer to section 3 of our attached consolidated responseDraft RTS specifying the methods for measuring the K-factors referred to in Article 15 of the IFR - EBA/CP/2020/06
Question 1 – Is the proposed articulation of the K-factors calculation methods, in particular be-tween AUM and CMH and ASA, exhaustive or should any other element be considered?
Treatment of cash trades in bonds
3.30 FIA EPTA members would like to note that there is a discrepancy in the treatment of cash trades in bonds, when compared to bond futures. This is because the bond futures would have their notional amount adjusted for the time to maturity of those contracts, in line with Article 33(2)(b), while the cash bonds would be included in the calculation of K-DTF by the amount paid or received. In addition, we would reiterate that market makers and li-quidity providers, who as firms dealing on own account will be subject to K-DTF, play an important role in improving market quality and lowering execution and risk management costs for retail and institutional end-investors in government bonds, which also benefit the liquidity of EU Member States’ sovereign debt issuance.
3.31 FIA EPTA members also note that the duration adjustment in Article 33(2)(b) of the IFR is only applicable to interest rate derivatives, while the duration adjustment in Article 29(4) of the IFR is applicable to interest rate and credit derivatives. We understand this is because of the additional underlying risk that applies to credit derivatives. However, we note fur-ther that high-quality and EU Member States bonds are subject to a 0% specific risk charge own funds requirement, as per Article 336 of the CRR. Therefore, only the general market risk related to the interest rate applies to these bonds.
3.32 Therefore, FIA EPTA members would ask the EBA to include an additional article in the final RTS specifying that the amount paid or received for trades in government bonds, which are subject to a 0% specific risk own funds requirement according to Article 336 of the CRR, is also adjusted for the time to maturity (in years) of the bond, specified in Article 33(2)(b) of the IFR.
Are the requirements for notion of segregated accounts sufficient? Are there issues on segregated accounts which need to be elaborated further?
We refer to Section 6 of our attached consolidated response. These are comments in relation to:6. Fixed Overheads Requirement (FOR)
Draft RTS to specify the calculation of the fixed overheads requirement and to define the notion of a material change (Article 13(4) of the IFR) –
EBA/CP/2020/06
6.1. FIA EPTA members note that the FOR now applies to all investment firms. This is set as one quarter of the fixed overheads of the previous financial year, and the competent au-thority can adjust this amount if the investment firm materially changes its business during the year. This adjustment could be an increase or a decrease, depending on the business change. FIA EPTA members also note that the FOR calculation is also used for setting li-quidity requirements as one-third of FOR.
6.2. The EBA in its consultation clarifies several points regarding the calculation of FOR, some of which are ambiguous in the current CRD III/CRD IV calculation and adding deductions that are not included in current FOR calculations and in the IFR. FIA EPTA members’ views in the regard are described in the below.
Basis of calculation
6.3. The EBA clarifies that FOR calculations are based on the most recent audited annual finan-cial statements or just annual financial statements, if audited financial statements are not available. Currently, the draft delegated regulation refers to annual financial statements validated by the competent authority. This means that according to the current proposed text, the timing of application of the most recent annual accounts would be unclear.
6.4. FIA EPTA members would ask the EBA to clarify that ‘annual financial statements’ are re-garded as being annual financial statements approved by the directors or other compe-tent body of the investment firm.
Full list of deductions
6.5. FIA EPTA members note that the full list of deductions is not included in either the Level 1 or Level 2 texts (i.e., regulation and delegated regulation). In the delegated regulation, the additional items to deduct are referenced as being added to the items already includ-ed in the regulation. This means that although the reference to ‘net profits’ for bonuses is included in the regulation, all the items in the regulation have been stated as items to be considered. This means that they can be changed if a complete list is included in the dele-gated regulation, making it even more important to have a full list of deductions, with po-tential amendments to the text in IFR, in the delegated regulation.
6.6. FIA EPTA would ask the EBA to include in the delegated regulation a full list of items, to be deducted from total expenses. We would urge that this should also cover the reference to ‘fully discretionary’ staff bonuses be included, rather than the reference to ‘net profits’.
Staff bonuses
6.7. Currently for the purpose of CRR, and in line with delegated regulation (EU) 2015/488, ‘ful-ly discretionary staff bonuses’ are deducted from total expenses for the calculation of the FOR. However, we note that point (a) of paragraph 4 of Article 13 of the IFR instead refers to ‘staff bonuses and other remuneration, to the extent that they depend on the net profit of the investment firm in the respective year’. It is unclear to us why this change has been made, and why there is a need to refer to profits, when in most cases an investment firm has the discretion not to pay any bonuses to staff, even if it is making a profit.
6.8. We note further that the EBA proposes that staff bonuses and other remuneration is de-pendent on net profits of the investment firm if it has been paid to employees in the pre-ceding year of payment, or the payment will have no impact on the firm’s capital position in the year of payment. However, FIA EPTA members observe that the meaning of ‘bonus paid before the year of payment’, is unclear. One possible interpretation could be where the payment has occurred in a year preceding the current year, or year the FOR is being calculated. Consequently, FIA EPTA members would ask for the EBA to delete any link be-tween the ability to deduct staff bonuses, from total expenses, and net profits. Alterna-tively, we would urge the EBA to consider clarifying the meaning of bonus paid in the pre-ceding year of payment.
6.9. In addition, with respect to current year and future years, the ability to deduct staff bo-nuses from total expenses, appears to only be possible where the firm is not obliged to pay unless it makes a net profit in that year. It is important to note that the FOR is normally calculated based on previous years expenses, and what is being proposed, for current and future years, can have a knock-on impact for the calculations of material changes in FOR. As mentioned before, an investment firm may decide not to pay bonuses even it is mak-ing a profit, as bonuses are normally dependent on employees meeting targets, which might not be met, and are normally discretionary.
6.10. Based on the current drafting, the normal calculation of FOR would, in most cases, include a deduction of bonuses. However, the calculation of current and future years FOR would not, if a firm projects to make a profit. This means that the calculation of previous years and current year are technically different. Because of this, investment firms may breach the thresholds in Article 3 of the proposed delegated regulation and may be required by the competent authority to calculate a FOR based on these projected figures, without the ability to deduct staff bonuses from total expenses.
6.11. FIA EPTA would ask the EBA, therefore, to remove this reference to ‘net profits’ and sug-gest to revert to ‘fully discretionary staff bonuses’, where it can be added that the link to net profits can be used as an example where discretion exist, but not as the mandatory condition to meet.
6.12. Finally, we note that this linkage between the deduction of staff bonuses and ‘net profits’ is likely not to have been considered in the EBA impact assessment of the proposed new regime, as this is likely to have considered investment firms’ responses aligned with the current CRR regime that only refers to ‘fully discretionary’ bonuses. We consider that this change can have a material impact that should not be underestimated and, if kept, we urge that it should be reflected in a new impact assessment conducted by the EBA where the CRD III/CRD IV FOR is compared to the IFR FOR.
Deduction of fees only where they are passed on and charged to customers
6.13. FIA EPTA members note that the deduction for trading fees has been restricted to cases where such fees are passed on and charged to customers. We do not support this word-ing and would have the following comments:
• It is not clear what is the intention of this restriction;
• Fees incurred for the purposes of executing, registering or clearing transactions are mostly variable in nature;
• The restrictions create an unlevel playing field between firms subject to CRR and those subject to IFR and also among firms subject to IFR (those with or with-out clients) without an objective justification.
6.14. Furthermore, we consider that it should not matter whether an item is included under total expenses provided that they are accounted for in line with the relevant accounting standards. Some expenses would reduce trading income or be accounted for in a separate expenses line in line with accounting standards. In order to make this clear, we consider that the text should read ‘where they are accounted as an expense in accordance with the relevant accounting standard’.
Additional items to deduction from total expenses
6.15. From the deductions listed in both the regulation and delegated regulation above, and the principles behind the ability to deduct items from total expenses, FIA EPTA members con-sider there is at least one type of deduction that is not included and should be added to the list. These relate to a ‘deduction of expenses related to items that have already been deducted from own funds’. The reason behind this additional deduction is that items such as intangible assets, for example, are deducted from own funds and, as such, any ex-pense recorded related to these, such as impairment or amortisation (acceptable in cer-tain local GAAPs), would have no impact on own funds.
Material change in activities on an investment firm
6.16. FIA EPTA members note that the EBA consultation also proposes a definition of what is considered a material change in the activities of an investment firm. As proposed, material change is considered to have occurred if there is a change in projected fixed overheads of the current year, equal to or greater than:
• 30% of the FOR: or
• EUR 2 million.
6.17. FIA EPTA members note further that the EBA decided to increase the percentual change but kept the same EUR 2 million threshold. It is our view that the EUR 2 million threshold for investment firms with a large FOR is inappropriate. For example, for an investment firm with a FOR of EUR 100 million, a EUR 2 million change in FOR represents only a 2% change in fixed overheads and is not likely to be related to a material change in an invest-ment firm’s activities. Requiring such investment firm to restate its FOR is an unnecessary burden. We would ask the EBA to consider two alternative options:
i. Remove the EUR 2 million condition to determine a material change; or
ii. Include an additional statement clarifying that this condition should be considered in a proportionate manner and not as an automatic approach.
Is there any example of situations of market stress which would not been taken into account applying the proposed approach but would be relevant for the measurement of the K-DTF?
We refer to section 3 of our attached consolidated response3. K-DTF
Draft RTS to specify adjustments to the K-DTF coefficients (Article 15(5) point c) of the IFR)
Draft RTS specifying the methods for measuring the K-factors (Article 15(5), point a) of the IFR) –
EBA/CP/2020/06
Exchange traded options – (Article 1 of the Draft RTS)
3.1. FIA EPTA members agree with the EBA that the trading and settlement of exchange-listed options is akin to other “cash trades” such as for stocks and should be treated as such for purpose of the K-DTF calculation.
3.2. We support, therefore, the proposal in the draft RTS specifying that exchange-traded op-tions are to be treated as ‘cash trades’ and the premium paid or collected – rather than the notional value of the contract – will be used when measuring DTF.
Stressed market conditions – (Article 2 of the Draft RTS)
3.3. The EBA includes a specific question in this section. As follows:
“Question 3 – Is there any example of situations of market stress which would not been taken into account applying the proposed approach but would be relevant for the meas-urement of the K-DTF?”
3.4. FIA EPTA members consider that there are several examples of situations of market stress which are not covered by the current proposal in the draft RTS. FIA EPTA members are concerned that, as currently proposed, the draft RTS will not be effective in delivering on the objectives as set out in the IFR Level 1 text. We would strongly urge the EBA, there-fore, to reconsider its proposed approach. To this end we suggest the proposed solutions which are described in the following paragraphs.
3.5. The current proposal to allow a coefficient adjustment only when there are “exceptional circumstances” pursuant to point (a) of Article 3 of Commission Delegated Regulation (EU) 2017/578 (MiFID II “RTS 8”) would have a very limited or no impact at all. Empirical feed-back from trading venues confirms that exceptional circumstances almost never occur, or only very rarely for extremely limited periods of time, maybe just a few minutes. It should be noted that even the extreme market volatility during the depth of the COVID-19 crisis in March 2020 did not change this picture. In addition, when exceptional circumstances are called under MiFID II, this is specifically designed to relieve investment firms of their obli-gation to provide liquidity on a regular and predictable basis (i.e., not trade), which means the current proposal does not achieve the objective of incentivising liquidity in the mar-kets as set out in recital 1 of the Draft RTS.
3.6. FIA EPTA members also note that pursuant paragraph 5 of Article 15 of IFR, the EBA was tasked with developing the draft RTS to specify when the K‐DTF coefficient should be ad-justed in the event of ‘situations of market stress’. We note that the current proposal ref-erencing ‘exceptional circumstances’ constitutes a more narrow concept and we consider, therefore, that expanding to a broader concept of situations of market stress would be more aligned with the mandate given to the EBA, and would better achieve the stated ob-jectives.
3.7. FIA EPTA members would strongly recommend, therefore, to the EBA to substitute the approach based on the concept of ‘exceptional circumstances’ for one based on ‘stressed market conditions’.
3.8. In that regard, we would further suggest that an approach based on an objective statistical methodology will most effectively deliver on the targeted objective.
3.9. Below, we propose two alternative statistical solutions which would allow for an objective assessment of the existence of ‘stressed’ vs. ‘normal’ market conditions, based on the comparison of short-term market behaviour vs. longer term historical norms. Either of these would efficiently deliver on the need to determine whether stressed market condi-tions are of a type that should result in a coefficient adjustment for the purposes of K-DTF.
3.10. Further, by way of an additional (although in our view less effective) solution we also sug-gest an alternative approach defining ‘stressed market conditions’ as per MiFID II RTS 8.
3.11. Our suggested solutions are as follows:
Statistical method
3.12. FIA EPTA members believe that, rather than relying on trading venues, a simpler and more objective approach is to take a statistical view of stressed market conditions. This method removes volumes of transactions that are associated with statistically high volatility, high volume and observation days. The great advantage of this method is that it is very simple, using generally available external market data and that the method can be used for every product on every exchange.
3.13. This approach is justified because during heightened volatility, end users of securities or derivatives increase their demands for liquidity. These periods tend to coincide with high-er than average volume. The current drafting implies that following a period of height-ened volatility, investment firms would be required to account for higher K-DTF. This cre-ates a disincentive to provide liquidity at a point in time when end users most need it.
3.14. To ensure that liquidity providers are not disincentivised through higher K-DTF readings during this time, firms should be allowed to remove volume from the calculation which co-incides with higher than average volume. Specifically, a threshold which defines higher than average volume is required in order to base this calculation.
3.15. The use of price volatility to statistically define ‘stressed markets’ is widely accepted prac-tice. Delegated Regulation (EU) No. 2017/578 places this exact requirement onto trading venues who must set out parameters to identify stressed market conditions in terms of significant short-term changes of price and volume. Trading venues must then consider the resumption of trading after volatility interruptions as stressed market conditions.
3.16. The use of the same approach to identify stressed market conditions for the purposes of adjusting K-DTF seems entirely appropriate and aligns purposefully with the approach taken by exchanges, while ensuring an objective and consistent methodology across ex-changes and financial instruments.
3.17. A percentile approach offers an elegant and scalable approach that should be simple to calculate. A percentile can be defined as the Nth percentile derived from a list of observa-tions sorted from greatest to least. This can be determined as follows:
Cadj = C * (DTFexcl / DTFincl)
Where:
DTFexcl =the daily trading flow (DTF) of derivatives measured in accordance with Article 33 of Regulation (EU) 2019/2033, excluding the value of any trade that oc-curred during periods of extreme volatility stressed market conditions as set out in Article 2a; and
DTFincl =the DTF of derivatives measured in accordance with Article 33 of Regula-tion (EU) 2019/2033, including the value of any trade that occurs during periods of extreme volatility stressed market conditions as set out in Article 2a.
3.18. Article 2 would be deleted and a new Article 2a included to define ‘period of stressed market conditions’.
3.19. We propose two different options, set out below, to define ‘stressed market conditions’, one based on historical volatility and another based on historical volume.
3.20. To ensure consistent outcomes from the calculation, we propose for the statistical meth-od a longer look-back period than 6 months. This is to make sure the measurements can indeed empirically be assessed as substantive outliers over a longer time horizon; based on FIA EPTA members’ quantitative analysis of market behaviour, we suggest to use a 3 year lookback period for this purpose.
3.21. Option 1 – historical volatility:
“Article 2a
Period of stressed market conditions
For the purposes of Article 1, periods of stressed market conditions shall be deter-mined as the trading days where historic volatility is in the highest 10% of the last 3 years for a given market and product.”
3.22. Historical volatility is measured by the difference between the high and low price of a product on a certain day. For derivatives, the price of the underlying product is used for the measurement. FIA EPTA members have analysed the proposed adjusted calculation, using this statistical method, based on Eurostoxx futures data. In doing so, we have used the year 2019 as the base data. When compared to this the calculated value for K-DTF, once March’s volume begins to be included, increases by up to 51% compared to the same period for 2019.
3.23. Using this proposed statistical method, the increase in capital requirements would show an increase of only 5%, rather than the 51% increase. Without this statistical method the year on year changes for K-DTF range from -11% to 51%. With this statistical method the K-DTF value stabilises with the range tightening from -3% to 10% across 2019 and 2020. This achieves the desired effect of not disincentivising investment firms from providing liquidi-ty during periods of market stress.
3.24. Option 2 – historical volume:
“Article 2a
Period of stressed market conditions
For the purposes of Article 1, periods of stressed market conditions shall be deter-mined as the trading days where market volume for that day was in the highest 10% of the last 3 years for a given market and product.”
3.25. FIA EPTA members have analysed the proposed adjusted calculation, using this statistical method, based on Eurostoxx futures data. In doing so, we have used the first 6 months of 2019 as the base data and set this at 100. When compared to this, the volume of transac-tions in the first 6 months of 2020 increased by almost 50%.
3.26. Using this proposed statistical method, the increase in capital requirements would show an increase of only 2%, rather than the 50% increase. For 2019, this statistical method would show a decrease of only 5%. This demonstrates that there is a normalisation of cap-ital requirement, with large increase in trading volumes, without the negative impact on normal times.
MiFID II definition
3.27. ‘Stressed market circumstances’ is a concept used in MiFID II RTS 8 and mandated by Arti-cle 6 of those RTS to be used by all EU exchanges in their market making schemes. This definition may even allow for it to be applicable more generally rather than only EU trad-ing venues.
3.28. When compared to the statistical method, this approach may be more difficult to imple-ment by investment firms. Exchanges publish when stressed market circumstances do oc-cur per product. However, this data is not always available in an easy format to use in K-DTF calculation by investment firms, which may make the calculation quite burdensome from an operational perspective. In addition, the trigger of stressed market conditions is not generic and can differ per exchange and/or product, and while being quite common in equity markets but less common in commodities and interest rates. Consequently, FIA EPTA members would deem this approach, while an improvement on the ‘exceptional cir-cumstances’ approach to be less effective than the statistical approach outline above.
3.29. This approach can be implemented as follows:
Cadj = C * (DTFexcl / DTFincl)
Where:
DTFexcl =the daily trading flow (DTF) of derivatives measured in accordance with Arti-cle 33 of Regulation (EU) 2019/2033, excluding the value of any trade that occurred during periods of extreme volatility stressed market conditions as set out in Article 2a; and
DTFincl =the DTF of derivatives measured in accordance with Article 33 of Regulation (EU) 2019/2033, including the value of any cash trade that occurs during periods of extreme volatility stressed market conditions as set out in Article 2a.
3.30. Article 2 would be deleted and a new Article 2a is included to define ‘period of stressed market conditions’. As follows:
“Article 2a
Period of stressed market conditions
For the purposes of Article 1, periods of stressed market conditions shall be those situations referred to in of point (b) of paragraph 1 Article 6 of Commission Dele-gated Regulation (EU) 2017/578. Their start and end times shall reflect precisely the times when the trading venue communicated the occurrence of such stressed market conditions under paragraph 6 of Article 7 of Commission Delegated Regu-lation (EU) 2017/578.”
Additional prudence
3.31. Although stressed market conditions are quite unique, there could conceivably be a con-cern that such adjustments may lead to a reduction of K-DTF which is deemed too large. It could be an alternative to provide an additional floor to the calculation in such a way that the reduction is not greater than 50%. As follows:
Cadj = Max [0.50 * C ; C * (DTFexcl / DTFincl)]
What would be appropriate thresholds or events that should trigger the comparison between the calculation under the K-CMG compared to the one under the K-NPR?
We refer to Section 2 of our attached consolidated response2. K-CMG
Draft RTS to specify the calculation of the amount of the total margin for the calculation of K-CMG (Article 23(3) of the IFR) –
EBA/CP/2020/06
Scope of K-CMG
2.1. While being conscious of the IFR Level 1 text, FIA EPTA members would like to bring to the EBA’s attention, in the context of this consultation response, that the combination of the definition of ‘clearing member’ in Article 4(1)(3) of the IFR and Article 23 of the IFR limits the use of K-CMG to investment firms where they are direct clients of an EU clearing member. However, it should be noted that alternatively, investment firms can also be cli-ents of direct clients of EU and non-EU clearing members (i.e. indirect clients), or even di-rect members of the CCP (i.e. clearing members). All these cannot benefit from the use of K-CMG, even if the models used to set margin requirements are set at an appropriate level of prudence and meet all conditions in paragraph 1 of Article 23 of the IFR.
2.2. FIA EPTA members are of the view that this limited scope, where the ability to use the total margin requirement as a methodology to set capital requirements to Risk to Markets should focus on the quality of the margin model, may have an undesired and ‘cooling’ ef-fect on competition, as the requirement discriminates against non-EU clearing members and CCPs, which may lead to further concentration of client clearing activity in a limited number of clearing members or CCPs, without the underlying economic rationale. We would argue that K-CMG should be available to investment firms, irrespective of the loca-tion of the clearing member that they use, and if they are direct or indirect clients of a clearing member, or even direct members of the CCP.
Portfolios and trading desks – (Article 1 of the Draft RTS)
2.3. FIA EPTA members support both the alignment of portfolios with trading desks and the definition of ‘trading desk’ itself as proposed by the EBA in the draft RTS. The concept of trading desks in the draft RTS is aligned with how firms operate in practice and is con-sistent with other regulations, among other with the CRR2 amendments. In this regard, FIA EPTA members note that this would allow investment firms to define trading desks depending on their business models and would cover the diversity of their trading strate-gies. As such, and to ensure uniform interpretation across the Union, FIA EPTA members would encourage the EBA to clarify the concept of trading desk further in a Recital to the RTS, along the lines set out below in paragraph 2.4.
2.4. A trading strategy is characterised by a multiple of factors, each equally important, which include the trading objectives, the type of products traded, the maturity of the products and the market traded. It is therefore important that an investment firm is able to treat relevant variation of one of these factors as a different trading strategy, and therefore a different trading desk, as it would give rise to different underlying risks, different risk management techniques and different margin requirements at one or more clearing members.
Calculation of the amount of the total margin required – (Article 2 of the Draft RTS)
2.5. FIA EPTA members note that Article 2(1) of the draft delegated regulation proposes that the amount of the total margin required to be calculated as follows:
“The amount of the total margin referred to in Article 23(2) of Regulation (EU) 2019/2033 shall be the required amount of collateral in the collateral account comprising the initial margin, variation margins and other financial collateral, as required by the clearing mem-ber’s margin model from the investment firm.”
2.6. FIA EPTA members support the objective to define total margin required. However, we would caution that the proposed definition is not aligned with the operational model of clearing members and would , in its current wording, limit the ability for simultaneous use of K-CMG and K-NPR by different trading desks within the same investment firm, which would be at odds with the intention of the Level 1 text. There are several points in the proposed definition that lead to this potential limitation, as follows:
a. Reference to initial and variation margin – the suggested language in the draft RTS appears to be borrowed from CCP requirements in EMIR. However, it should be noted that clearing members apply a variety of proprietary margin models which do not use the CCP terminology. In addition, if the definition already refers to the amount of collateral required to cover for the risks, specific reference to individual components is superfluous as they are understood to be included. We would therefore suggest focussing on an outcome-based approach and to remove the reference to initial margin and variation margin but to include the exposures that must be covered.
b. Reference to collateral account – it should be noted that firms may have more than one collateral account, which may include financial and non-financial collateral. Giv-en that, as currently proposed, the draft definition is not aligned with common market practice, we would therefore suggest removing the reference to ‘the col-lateral account’ and to ‘financial collateral’.
c. Specific reference to portfolios – the use of K-CMG on a trading desk basis is al-lowed under IFR and the proposed delegated regulation. However, the proposed calculation of the total margin required does not specify that the amount of collat-eral is specific for the trading desks subject to K-CMG. For the purpose of clarifying the calculation, and to allow for the simultaneous use of K-NPR and K-CMG meth-odologies on a trading desk basis, we suggest that the calculation of the total mar-gin required make specific reference that it will apply ‘for the trading desks subject to K-CMG’.
d. K-NPR and K-CMG as a proxy for ‘market risk’ – it is understood that K-NPR and K-CMG are designed to capture what is, in the current prudential framework, the ‘market risk’, which in summary captures the risk of loss resulting from fluctuation in the market value of net positions. Based on this, and the fact that K-NPR is pro-posed to use CRR methodologies, we propose that the calculation of total margin required include a reference to ‘exposures resulting from change in the market value of net positions’.
2.7. Based on the above comments, we would suggest the calculation of the total margin re-quired included Article 2(1) of the proposed delegated regulation to be amended as fol-lows:
“The amount of the total margin referred to in Article 23(2) of Regulation (EU) 2019/2033 shall be the required amount of collateral in the collateral account com-prising the initial margin, variation margins and other financial collateral, as re-quired by the clearing member’s margin model from the investment firm, to cover for current and potential future exposures resulting from change in market price of net positions, for the trading desks subject to CMG.”
Method of calculation of K-CMG in case of multiple clearing members – (Article 3 of the Draft RTS)
2.8. FIA EPTA members note that Article 3 of the draft delegated regulation proposes that:
“For the purposes of calculating the K-CMG as referred to in Article 23(2) of Regulation (EU) 2019/2033, where an investment firm makes use of the services of more than one clearing member, the investment firm shall calculate the K-CMG by first determining the third high-est amount of total margins required on a daily basis by each clearing member separately over the preceding three months, then adding those amounts and multiplying the out-come by 1.3”
2.9. FIA EPTA members do not support the proposed approach of first determining the third highest amount by each clearing member separately and then adding those amounts. It is our view that the proposed approach does not reflect how the underlying risk is managed in practice by firms and is therefore overly conservative. In addition, the proposed calcula-tion of K-CMG, before adding this additional component where there are several clearing members, already includes a high degree of prudence that does not need to be further increased. In this regard, we suggest the following for consideration by the EBA:
a. Risk management – investment firms manage risks based on the positions they have on a specific day and do not operate a risk management framework based on risks being added up across different days.
b. Third highest margin requirement ¬– it is understood that the use of the third high-est total margin required is to embed a degree of prudence; in combination with other components in the calculation (as set out below) this should be sufficient to ensure an appropriate level of prudential confidence. It is worth noting that the internal models approach in CRR uses an averaging of outcomes over a period. The use of the third highest margin requirement, which is based on the margining model of the clearing member for the same type of risks, is already a more con-servative approach.
c. Multiplying factor – The K-CMG calculation includes a 1.3 multiplying factor which provides for an additional degree of prudence. Our members have assessed that the use of the third highest per clearing member in the manner currently pro-posed by the draft RTS would further increase capital requirements by an addi-tional 10% to 20%, at the very minimum, depending on the number of clearing members which the firm uses. This would seem disproportionate given all other prudential safeguards in place.
d. Double counting – in cases where an investment firm switches a trading desk be-tween clearing members or methodologies (K-NPR and K-CMG), this may lead to a double counting of certain requirements due to the way margin requirements are proposed to be aggregated. Using the aggregation based on days-only would miti-gate such effect.
e. Inconsistent outcomes – the proposed approach may lead to inconsistent out-comes between different investment firms where firm A uses one clearing mem-ber and firm B uses more than one clearing member. For example, even in the case that risks are the same in two investment firms, an investment firm that uses only one clearing member will have lower capital requirements than the one that uses more than one clearing member, for no other reason other than the way margin requirements are added up across multiple clearing members.
f. Concentration risk – the proposed approach would incentivise investment firms to use only one clearing firm, which may lead to further concentration of client clear-ing activity in a more limited number clearing members or CCPs, without any un-derlying economic rationale. This in would increase the risk to the firm, in case of a clearing member’s failure, and the risk to financial stability.
g. Market liquidity and impact assessment – the proposed calculation can lead to an impact on the level of liquidity that investment firms would be able to provide to the market. We would be interested in understanding if the EBA has undertaken any data analysis to assess the impact of the cumulative effect of these proposed rules, which include the third highest, multiplier and aggregation per clearing member. If not, we would urge the EBA to do so and share the outcome with firms.
2.10. Based on the above comments, we suggest the calculation of K-CMG in case of multiple clearing members included in Article 3 of the proposed delegated regulation to be amended as follows:
“For the purposes of calculating the K-CMG as referred to in Article 23(2) of Regula-tion (EU) 2019/2033, where an investment firm makes use of the services of more than one clearing member, the investment firm shall calculate the K-CMG by first adding up, across all clearing members used, the margins for each day, determin-ing the third highest amount of total margins required on a daily basis by each clearing member separately over the preceding three months, then adding those amounts and multiplying the outcome by 1.3”
Prevention of arbitrage – (Article 4 of the Draft RTS)
2.11. The EBA includes a specific question in this section. As follows:
“Question 4 – What would be appropriate thresholds or events that should trigger the comparison between the calculation under the K-CMG compared to the one under the K-NPR?”
2.12. FIA EPTA members fully support the prevention of regulatory arbitrage that can under-mine the stability of the financial market. However, FIA EPTA members do not support the current wording of Article 4 of the proposed delegated regulation and would like to pro-vide feedback on these points and recommend amendments to further improve the cur-rent text.
2.13. The current structure of Article 4, although covering the different points on the mandate that has been given to the EBA, is not entirely clear, which may lead to divergent imple-mentation and supervisory practice across Member States. The conditions that need to be met for a competent authority to grant permission for the use of K-CMG are determined in the IFR. However, it is unclear at what point in time which conditions need to be met and what general non-arbitrage clauses apply. (For example, the requirement to keep consistent methodologies for a period of two years).
2.14. FIA EPTA members observe that the currently proposed drafting of Article 4 appears to mix different types of conditions together. Based on the objectives which Article 4 of the proposed delegated regulation is meant to achieve, we would suggest that it would be more clear if Article 4 were to capture separately the different types of conditions that are captured in Article 23(1)(e) IFR. Consequently, the structure of Article 4 of the Draft RTS should in our view reflect the following three types of conditions (a-c below):
a. Conditions at point of granting permission – this is understood to be the condi-tions that are set in paragraph 1 of Article 4 of the proposed delegated regulation. In general, FIA EPTA members support the text in points (a) to (d) of this para-graph.
However, regarding point (e) of this paragraph (comparison of K-CMG with K-NPR), and the factors described in paragraph 3 of Article 4, FIA EPTA members have a number of concerns, as follows:
i. The text should reflect that certain trading strategies are expected to give rise to an inherently large difference between K-NPR and K-CMG, due to the nature of how standardised approaches to market risk in CRR interact with the structural characteristics of certain financial instruments, for ex-ample, the enhanced maturity ladder for general interest rate risk in the case of short term interest rates (e.g., for STIR exchange traded deriva-tives (ETDs). However, such a difference should in itself not prevent the use of K-CMG as a more appropriate methodology to capture risk to mar-ket.
The more so, as the margin models of clearing members are regarded as prudentially sound. These have undergone extensive testing to ensure their efficacy and accuracy and they are subject to stringent governance criteria.
Therefore, the following amendment is proposed, by adding a point to paragraph 3 of Article 4:
“(f) some trading strategies are expected to give rise to a large dif-ference between K-NPR and K-CMG. A difference between K-NPR and CMG, even if large, should not be sufficient to prevent the use of K-CMG provided that K-CMG meets Article 23 of Regulation (EU) 2019/2033 and is assessed by competent authority as pruden-tially sound”
ii. Two of the points included in paragraph 3 of Article 4 have no relationship with any potential justification of a difference between K-NPR and K-CMG as they are completely independent of any of these.
For example, a calculation of capital requirements based on FOR or other K-factors is not relevant for the purpose of justifying the correct approach to calculate capital requirements for Risk to Market.
Similarly, the level of own funds and the excess over capital requirements is not relevant for this justification. To note that it is ultimately an invest-ment firm’s responsibility to decide the best use for the excess capital it holds, and it should retain the ability to retain control over the use of its excess capital. As such, FIA EPTA members propose the deletion of points (c) and (e) of paragraph 3 of Article 4 of the Draft RTS.
b. General no arbitrage conditions – FIA EPTA members understand this is provided in point (a) of paragraph 2 of Article 4 of the proposed delegated regulation. In-vestment firms will have to conduct an annual assessment of their capital adequa-cy and risks. We believe that an approach to these general no-arbitrage criteria would be more appropriate if aligned with this risk assessment requirement. As such, we propose that the period of ‘at least 24 months’ is replaced by a period of ‘at least 12 months’.
In addition, point (6) in the Recital references that an investment firm will have to make continuous use of the K-CMG method for a trading desk. It also refers to ex-ceptional circumstances where an investment firms may switch methods. Howev-er, the Articles in the delegated regulation do not cover these exceptional circum-stances. Therefore, FIA EPTA members would suggest to the EBA to cover these exceptional circumstances and provide more detail regarding such conditions.
c. Regular assessment of conditions – FIA EPTA members understand this is provid-ed in point (b) of paragraph 2 of Article 4 of the proposed delegated regulation. In answering to Question 4, regarding appropriate thresholds or events that should trigger the comparison between the calculation under the K-CMG compared to the one under the K-NPR, FIA EPTA members do not support the proposed ap-proach. As presented, it is unclear what are the key criteria that trigger the re-quirement to compare K-CMG and K-NPR, and whether this encompasses qualita-tive or quantitative criteria.
In addition, the proposed approach appears to be an automatic trigger. In FIA EP-TA members’ view, these triggers should be used as indicators for competent au-thorities then to make a subsequent judgement whether or not to require a com-parison between K-CMG and K-NPR.
FIA EPTA members would support an approach which aligns these triggers with the regular assessments that have to be conducted by competent authorities and would urge to the EBA to clarify this in the final RTS, in line with the suggested ap-proach outlined below, in which:
i. Competent authorities should assess the qualitative criteria proposed, in-cluding material change in the margin model or in trading strategies, and whether these lead to material changes in relation to K-CMG.
ii. Based on the assessment under point i. above, competent authorities should then determine if there are any reasons to require a comparison between K-NPR and K-CMG capital requirements.
iii. Based on the outcome of the comparison under point ii. above, determine whether the firm’s permission to use K-CMG is kept or revoked.
Double counting
2.15. The EBA includes a specific question in this section, as follows:
“Question 5 – Which other conditions should be considered to avoid double counting or to prevent regulatory arbitrage in the use of the K-CMG approach?”
2.16. FIA EPTA members welcome the objective to understand and avoid cases of double counting and as noted above, we also support the objective to avoid regulatory arbitrage. Double counting may arise in some situations where for example a trading desk is moved from one clearing member to another, or when a firm changes from K-CMG to K-NPR for a trading desk (for example, it has assessed that the other methodology was more appro-priate to reflect the underlying risk of the portfolio).
2.17. FIA EPTA members would suggest that the amendments proposed in paragraphs 2.7 and 2.10 above offer an effective solution to mitigate the occurrence of double-counting.
Which other conditions should be considered to avoid double counting or to prevent regulatory arbitrage in the use of the K-CMG approach?
We refer to Section 2 of our attached consolidated response“Question 5 – Which other conditions should be considered to avoid double counting or to prevent regulatory arbitrage in the use of the K-CMG approach?”
2.16. FIA EPTA members welcome the objective to understand and avoid cases of double counting and as noted above, we also support the objective to avoid regulatory arbitrage. Double counting may arise in some situations where for example a trading desk is moved from one clearing member to another, or when a firm changes from K-CMG to K-NPR for a trading desk (for example, it has assessed that the other methodology was more appro-priate to reflect the underlying risk of the portfolio).
2.17. FIA EPTA members would suggest that the amendments proposed in paragraphs 2.7 and 2.10 above offer an effective solution to mitigate the occurrence of double-counting.
Do you have any comment on the elements included in this Consultation Paper for the application of the aggregation method?
We refer to our comments in section 4 of our consolidated response. These comments are in relation to:4. Classification
Draft RTS on the information to be provided for the authorisation of investment firms as credit institutions (Article 8a (6) point a) of the CRD)
Draft RTS on the calculation of the threshold referred to in Article 4(1)(1b) CRR (Article 8a(6) point b) of the CRD) –
EBA/CP/2020/06
Overview
4.1. FIA EPTA members would like to raise a concern regarding the potential consequences of the implementation of the proposed delegated regulation in its current form and as cur-rently drafted. As it stands, we are concerned that the currently considered approach will effectively put a disproportionate hard-cap on the size of European investment firms, making it very difficult for them to compete with banks that are not so encumbered. We believe that an alternative approach should be considered which would be more in line with the Level 1 text while enabling larger EU investment firms to compete on a level play-ing field, aligned with the underlying objectives of the Capital Markets Union (CMU) pro-ject of which IFR/IFD is a part. We would strongly urge the EBA to consider such an alter-native approach.
4.2. In the following paragraphs, FIA EPTA members propose an approach which looks to clari-fy more clearly the calculation of the threshold values, and closer to align the methodolo-gy to the intention of the IFR Level 1 text.
4.3. Firstly, is FIA EPTA members’ view that the Draft Regulatory Technical Standard on the cal-culation of the threshold referred to in Article 4(1)(1b) CRR (Article 8a(6) point b) of the CRD) as currently proposed by the EBA is inconsistent with the intention of the European Commission proposal for the IFR and the subsequent discussions held by the co-legislators in finalising such legislation.
4.4. The proposed delegated regulation could lead to an unintentional classification and sub-sequent authorisation of certain European investment firms as Credit Institutions under CRD/CRR and subsequent direct supervision by the Single Supervisory Mechanism (SSM).
4.5. Secondly, FIA EPTA members seek clarification from the EBA as to the intended method-ology to be used in the calculation of total assets as detailed in Article 3, sub-paragraph 2 of the draft RTS. FIA EPTA members’ interpretation of the intended calculation methodol-ogy is detailed in sub-section ‘Total value of assets’.
1. IFD/IFR rules on classification of large investment firms
4.6. We note that the IFD/IFR introduces a number of amendments to CRD and CRR including:
• Extending the definition of ‘credit institution’ in CRR so as to include certain entities carrying out the activities of dealing on own account or underwriting or placing on a firm commitment basis (‘specified activities’) if their total assets reach or exceed a EUR 30 billion threshold (new point (1)(b) of Article 4(1) CRR).
• Adding new provisions to the CRD requiring EU entities that fall within the extend-ed definition to submit an application for authorisation as a credit institution when their assets reach or exceed a similar (but not identically defined) EUR 30 billion threshold calculated on an average basis over a 12 month period (new Article 8a(1) of CRD).
4.7. FIA EPTA members support the threshold in place, to ensure that investment firms of suf-ficient size and European importance are proportionately regulated within the European Union, and welcomes the standalone ‘solo test’. However, FIA EPTA members have con-cerns regarding the calculation of the ‘group test’ threshold in article 8a(1)(b) CRD (and thus article 4(1)(1)(b)(ii) and (iii) CRR) as set out in the proposed delegated regulation and its alignment with the intentions of the IFR/IFD level 1 text.
4.8. Within the proposed delegated regulation, there is a distinction between an investment firm headed by an ‘EU parent undertaking’ and an investment firm headed by a ‘non-EU parent undertaking’. This distinction seems to be an incorrect interpretation of the intent of the Level 1 Legislation.
4.9. According to articles 8 and 9 of the proposed delegated regulation, the investment firm must calculate ‘total assets’ for the purposes of the ‘group test’ in point 8a(1)(b) CRD as follows:
a. “the aggregation of the assets of both EU and non-EU entities carrying out speci-fied activities where they are part of a group headed by an EU parent undertaking (an EU group) - but only the assets of EU entities (so carrying on specified activities where they are part of a group headed by a non-EU parent undertaking (a third-country group); and
b. that aggregation to use the individual (i.e., unconsolidated) balance sheets of those group companies (with some adjustments for intercompany items).”
Legal background
4.10. Originally the proposed text of the ‘group test’ required only the aggregation of the total assets shown on individual balance sheets of EU entities which were part of the group, re-gardless of the location of the parent entity. The group test in the original proposal made no distinction between EU groups and third-country groups and it would have been clearly disproportionate to treat smaller EU firms which are subsidiaries of third country groups as credit institutions simply because the third-country group also includes large non-EU enti-ties that carry on specified activities outside the EU.
4.11. Subsequent changes by the co-legislators were made as a response of the opinion of the ECB of 22 August 2018. In that opinion the ECB recommended the following:
“the proposed regulation should provide clarification as to how the assets are to be calcu-lated, i.e. including the assets of Union branches of third country groups and third coun-try subsidiaries of undertakings in the Union arising from their consolidated balance sheet.” (emphasis added)”
4.12. The response to the ECB’s remarks resulted in the following proposed rewording of the original legislative document:
a. a provision to widen the scope of ‘individual assets’ to include branches of non-EU entities within third country groups; and
b. a provision to focus on the (sub-)consolidated assets of the entities already en-compassed by point (1)(b) of article 4(1) CRR and 8a(1) CRD. (i.e. EU entities that carry out specified activities).
4.13. A key principle of the IFR, and wider European banking regulation, is to prevent the ability for regulated entities to take advantage of regulatory arbitrage across the Union, and pre-vent the risk of circumvention of the requirement for entities to be authorised as credit institutions by structuring their EU activities in such a way that allows EU activities to be excluded from the calculation of ‘total assets’. As such, the ‘group test’ should be focused on EU activities, as opposed to activities conducted outside of the EU.
Other thresholds in IFD/IFR apply only to EU assets
4.14. During the legislative process, the co-legislators added a provision to IFR that was not in-cluded in the legislative proposal and that was designed to ensure that larger investment firms not treated as credit institutions would still be subject to supervision under CRR/CRD (Article 1(2) IFR). This provision includes a solo and group test structured in a similar way to the solo and group tests under CRR/CRD, but with a size threshold of EUR 15 billion and subject to wording excluding from the calculations of the threshold "the individual assets of any subsidiaries established outside the Union that carry on any of the [specified activi-ties]" (see points (a) and (b) of Article 1(2) IFR).
4.15. However, the starting point for the solo and group test under this provision should be un-derstood as being consistent with the correct methodology discussed above. Article 1(2)(a) and (b) of the IFR should be understood as focusing on the consolidated assets of EU enti-ties that carry on specified activities, but then excluding the assets of non-EU subsidiaries of those EU entities when calculating the consolidated assets of those EU entities if those non-EU subsidiaries carry on specified activities. Thus, the intention appears to have been to apply an approach closer to the originally proposed text of point (1)(b) of Article 4(1)(1) CRR and Article 8a(1) CRD.
Proposed solution to the ‘group test’
4.16. FIA EPTA asks the EBA to amend its proposed delegated regulation so that it aligns the method for applying the thresholds in Article 8a(1) CRD with an approach which is con-sistent with an understanding of point (1)(b) of Article 4(1) CRR, based on its legislative history and the apparent reading of the ECB on this issue.
4.17. FIA EPTA proposes a calculation of the ‘group test’, which is believed to meet the original intent of the Level 1 co-legislators as well as providing a level playing field for European in-vestment firms who have managed to create large businesses outside of the EU, while ensuring that once the assets held by that investment firm reach certain thresholds within the EU, they are subject to the appropriate regulatory regime. The calculation should con-tain the following:
a. A provision making clear that the threshold in point (a) of Article 8a(1) CRD is de-termined by reference to the total value of the consolidated assets of an EU entity that carries on specified activities; and
b. A provision making clear that the threshold in point (b) of Article 8a(1) CRD is de-termined by:
i. identifying all the EU entities in a group that carry out specified activities (step 1);
ii. eliminating those EU entities identified at step 1 which are subsidiaries of another entity identified at step 1 (to prevent double counting);
iii. calculating the consolidated assets of each of the remaining entities identi-fied at step 1 (including the assets of their EU and non-EU subsidiaries);
iv. eliminating those EU entities identified at step 1 whose consolidated assets are equal to or greater than EUR 30bn (consistently with the requirements of point (1)(b)(ii) of Article 4(1) CRR and point (b) of Article 8a(1) CRD);
v. summing the total consolidated assets of the remaining entities identified at step 1;
vi. for third-country groups, adding to that sum the assets of EU branches of non-EU entities (for consistency with the requirements of point (1)(b)(ii) of Article 4(1) CRR).
2. Total value of assets
4.18. Article 3 of the regulatory technical standards for the calculation of the threshold referred to in Article 8a(6)(b) of the CRD describes how to calculate the total value of assets for rel-evant institutions. Three possibilities are provided, firstly a prudential approach, secondly the use of IFRS and finally the use of an applicable national accounting law.
4.19. FIA EPTA members consider the EUR 30 billion threshold aims to capture whether or not an investment firm is running a large or similar risk profile as a significant credit institution. It is FIA EPTA members’ opinion that total asset value from an accounting standards per-spective is a poor metric for determining the risk profile of an investment firm, and it wel-comes the introduction of the ability to use a prudential approach in measuring total as-sets, as a fairer representation of total assets for investment firms. This is mainly due to the strict netting pre-requisites under (IFRS) accounting standards, which particularly pe-nalises investment firms with active trading portfolios.
4.20. In Part7 of CRR – ‘Leverage’, the regulator prescribes an exposure measure methodology for the use of calculating the total exposure of the institution for the purpose of measur-ing the total leverage used by the institution. The methodology used to calculate the ‘total exposure measure’ is the sum of the following:
• Total Assets as reported in the financial statement and securities financing trans-actions; excluding derivatives.
• Total Derivatives Exposure using the SA-CCR methodology
• Add-ons for Securities Financing Transactions
• Off-Balance Sheet Items
• Certain Outstanding settlements
4.21. FIA EPTA members support the use of the prudential measures, as prescribed within the Leverage Ratio calculations, to determine total assets and would strongly urge the EBA to clarify in the final RTS that such can indeed be applied in this manner. They will meet the methodology prescribed within Article 3, sub-paragraph 2 of the proposed delegated reg-ulation on the calculation of total assets. Using the approach taken in the calculation of the ‘total exposure measure’ and applying it to calculate the ‘total assets’, the investment firm would exclude the off-balance sheet, SFTs, add-ons and outstanding settlements. The calculation of ‘total assets’ would be the sum of the following:
• Total Assets as reported in the financial statement; excluding derivatives.
• Total Derivatives Exposure using the SA-CCR methodology.
4.22. Finally, FIA EPTA members take from the wording of paragraphs 3 and 4 of Article 3 of the RTS that there is a hierarchy in the three different methods in subsections (2), (3) and (4). FIA EPTA members understand that there is a hierarchy proposed between (3) and (4) so that IFRS is to be preferred over other national accounting standards, but we fail to see the logic for a hierarchical order between subsection (2) on the one hand and (3) and (4) on the other. Therefore, we would suggest to the EBA to provide firms with optionality between using (2) prudential individual reporting, and (3) IFRS, and only allow (4) other national accounting laws, if (2) and (3) cannot be determined.
Do you have any comments on the conditions established in this Consultation Paper to apply proportional consolidation to investment firms groups under Regulation (EU) No 2019/2033?
We refer to section 5 of our consolidated responseDraft RTS on prudential consolidation of investment firms groups (Article 7(5) of the IFR) – EBA/CP/2020/06
5.1. FIA EPTA members are of the view that the draft RTS is unnecessarily complex, mainly be-cause of a number of cross-references. We would suggest to the EBA that it would be helpful if the text could be clarified and simplified. We note that Class 2 investment firms, including principal trading firms, are relatively simple and straight-forward and the current drafting of the RTS does not seem to take into account this type of uncomplicated struc-tures.
5.2. FIA EPTA members note that the extraterritorial application and aggregation of the K-factors is troublesome for three reasons:
i. Third-country regimes applicable to investment firms do not have such extraterri-torial application, which creates an unlevel playing field;
ii. The K-factors are explicitly not calibrated for market circumstances in third coun-tries, which if applied would cause disproportionately high capital requirements for third-country operations, likewise resulting in an unlevel playing field; and
iii. The wide scope of consolidation may lead to a consolidated capital requirement where the sum is larger than the individual parts. We believe that applying the consolidation provisions to third-country subsidiaries is unnecessary as these are subject to their own capital requirements, consistent with their local environment and market structure. This would also level the playing field, leading to an in-creased attractiveness and competitiveness of principal trading firms with sub-stantial operations or structures in the Union.
Question 9 – The methods for calculating the K-factors in a consolidated situation may allow for further specifications. Is there any K-factor for which the calculation in the context of the consoli-dated basis would require further specifications? What aspects should be considered?
5.3. Additionally, in response to Question 9, FIA EPTA members would welcome a confirmation in the final RTS that, for the purpose of consolidated K-factor own-funds requirements, activities or exposures would be disregarded as a matter of principle, for all K-factors, in line with a consolidation approach. This would be in line with the language in Article 11 (3)(b). This is clear in Article 11(3) for K-NPR, K-TCD and K-DTF but should be clarified in the RTS for all other K-factors that may be affected by intragroup positions and transactions.
The methods for calculating the K-factors in a consolidated situation may allow for further specifications. Is there any K-factor for which the calculation in the context of the consolidated basis would require further specifications? What aspects should be considered?
We refer to section 5 of our consolidated responseDraft RTS on prudential consolidation of investment firms groups (Article 7(5) of the IFR) – EBA/CP/2020/06
5.1. FIA EPTA members are of the view that the draft RTS is unnecessarily complex, mainly be-cause of a number of cross-references. We would suggest to the EBA that it would be helpful if the text could be clarified and simplified. We note that Class 2 investment firms, including principal trading firms, are relatively simple and straight-forward and the current drafting of the RTS does not seem to take into account this type of uncomplicated struc-tures.
5.2. FIA EPTA members note that the extraterritorial application and aggregation of the K-factors is troublesome for three reasons:
i. Third-country regimes applicable to investment firms do not have such extraterri-torial application, which creates an unlevel playing field;
ii. The K-factors are explicitly not calibrated for market circumstances in third coun-tries, which if applied would cause disproportionately high capital requirements for third-country operations, likewise resulting in an unlevel playing field; and
iii. The wide scope of consolidation may lead to a consolidated capital requirement where the sum is larger than the individual parts. We believe that applying the consolidation provisions to third-country subsidiaries is unnecessary as these are subject to their own capital requirements, consistent with their local environment and market structure. This would also level the playing field, leading to an in-creased attractiveness and competitiveness of principal trading firms with sub-stantial operations or structures in the Union.
Question 9 – The methods for calculating the K-factors in a consolidated situation may allow for further specifications. Is there any K-factor for which the calculation in the context of the consoli-dated basis would require further specifications? What aspects should be considered?
5.3. Additionally, in response to Question 9, FIA EPTA members would welcome a confirmation in the final RTS that, for the purpose of consolidated K-factor own-funds requirements, activities or exposures would be disregarded as a matter of principle, for all K-factors, in line with a consolidation approach. This would be in line with the language in Article 11 (3)(b). This is clear in Article 11(3) for K-NPR, K-TCD and K-DTF but should be clarified in the RTS for all other K-factors that may be affected by intragroup positions and transactions.
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