Response to consultation Paper on draft RTS on back-testing and PLA attribution requirements
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Day-one Profits/Losses correspond to the gains or losses at inception. It is measured as the difference between the transaction price and the fair value at initiation (fair value is generally observed at the end of the day, as a consequence day-one P&L includes intraday volatility between transaction time and closing time).
IFRS 13 requires day-one gains and losses to be recognized in P&L unless another IFRS specifies otherwise. IAS 39 and IFRS 9 prohibit the recognition of Level 3 day-one P&L (instruments for which valuation techniques rely on non-observable market data). As a consequence, on Level 3 instruments, the common practice is to calculate a day-one Profits/Losses Reserve (for accounting purposes only): Day-one Profits/losses is reserved and released through the life of the trade. Given that this reserve is not in the scope of market risk, it is not included in backtesting P&Ls.
Day-one P&L is generally split into:
• Trading Margin: hedge cost required by the trading;
• Client Margin: Margin at inception of the trade on top of trading margin;
• Market volatility between trade time and EOD (i.e. End-Of-Day).
Quantifying precisely each of the 3 elements above would require a closing valuation at the precise trade time. Given that such practice is unrealistic, industry members generally quantify client margins on a declaratory basis. On the other hand day-one P&L is generally computed as the difference between the fair value (observed at the closing time) and the trade price. Neither client margin nor day-one P&L is considered as commission.
Intraday trading as well as new and modified deals should be included in the Actual P&L. As a consequence, day-one P&L is included in the Actual P&L.
New trades are not part of the Hypothetical P&L. Hence, day-one P&L is not included in the Hypothetical P&L.
Client Margin is part of the day-one P&L and is consequently included in the Actual P&L and excluded in the Hypothetical P&L.
The inclusion (respectively exclusion) of day-one P&L and Client Margin in the Actual P&L (respectively Hypothetical P&L) is clear and does not need to be clarified further in Articles 1 to 4.
The example provided in the consultation paper (i.e. case 2 in page 19) clarifies the conditions under paragraph 2 of Article 15 may apply. However, French institutions believe that the application criteria should cover situations where the risk factors for the HPL are transformed into equivalent risk factors in RTPL, yet represented differently, for the purpose of risk modelling.
Typically, it is common practice to transform observations of IR futures contract with fixed maturity date (used for HPL), into equivalent price of “synthetic instruments” with fixed time-to-maturity (used in the RTPL) to exclude time decay effects from the calibration of risk factors and thus enable consistent shock distributions in the risk engine.
The industry considers that data alignment should be allowed in such situation as long as institutions can justify to the satisfaction of supervisory authorities that these inherent transformations of market data, performed for the purpose of risk modelling, neither reduce the granularity of risk factors nor distort the representation/dynamic of the PL function, and provide documentation thereof as required in Article 16(2).
Q5. Do you agree with the criteria in paragraph 5 allowing institutions to exclude an adjustment from the changes in the trading desk’s portfolio value? Are there any other criteria you deem useful for this purpose?
We agree with the criteria listed in paragraph 5 of Article 1.Q6.How do institutions identify client margins and day-one profits/losses in the systems (e.g. as commissions, margins)? Please specify if currently they are taken into account in the end-of-day valuation process, in the actual P and L and in the hypothetical P and L.
As specific terminology may differ across the Industry, French institutions propose the following definition to answer this question:Day-one Profits/Losses correspond to the gains or losses at inception. It is measured as the difference between the transaction price and the fair value at initiation (fair value is generally observed at the end of the day, as a consequence day-one P&L includes intraday volatility between transaction time and closing time).
IFRS 13 requires day-one gains and losses to be recognized in P&L unless another IFRS specifies otherwise. IAS 39 and IFRS 9 prohibit the recognition of Level 3 day-one P&L (instruments for which valuation techniques rely on non-observable market data). As a consequence, on Level 3 instruments, the common practice is to calculate a day-one Profits/Losses Reserve (for accounting purposes only): Day-one Profits/losses is reserved and released through the life of the trade. Given that this reserve is not in the scope of market risk, it is not included in backtesting P&Ls.
Day-one P&L is generally split into:
• Trading Margin: hedge cost required by the trading;
• Client Margin: Margin at inception of the trade on top of trading margin;
• Market volatility between trade time and EOD (i.e. End-Of-Day).
Quantifying precisely each of the 3 elements above would require a closing valuation at the precise trade time. Given that such practice is unrealistic, industry members generally quantify client margins on a declaratory basis. On the other hand day-one P&L is generally computed as the difference between the fair value (observed at the closing time) and the trade price. Neither client margin nor day-one P&L is considered as commission.
Intraday trading as well as new and modified deals should be included in the Actual P&L. As a consequence, day-one P&L is included in the Actual P&L.
New trades are not part of the Hypothetical P&L. Hence, day-one P&L is not included in the Hypothetical P&L.
Client Margin is part of the day-one P&L and is consequently included in the Actual P&L and excluded in the Hypothetical P&L.
The inclusion (respectively exclusion) of day-one P&L and Client Margin in the Actual P&L (respectively Hypothetical P&L) is clear and does not need to be clarified further in Articles 1 to 4.
Q7. Paragraph 4 requires institutions to compute (for the purpose of the backtesting) the value of an adjustment (that is included in the changes in the portfolio’s value) performing a stand-alone calculation, i.e. considering only the positions in trading desks that are calculating the own funds requirements using the internal model approach (i.e. desks meeting all conditions in article 325az(2)). Do you agree with the provision? Do you consider the provision clear?
Please see our answer to question 4 of this consultation (EBA/CP/2019/06).Q8. Do you agree with the possibility outlined in paragraph 5 to include in the portfolio’s changes the value of an adjustment stemming from the entire portfolio of positions subject to own funds requirements (i.e. both positions in standard-approach desks and positions in internal model approach desks)? Or do you think it would not be overly burdensome for institutions to compute adjustments on the positions in trading desks that are calculating the own funds requirements using the internal model approach only?
The French Banking Federation considers as overly burdensome the possibility to include in the portfolio’s changes the value of an adjustment stemming from the entire portfolio of positions, as outlined in paragraph 5 of Article 2 of the draft Regulatory Technical Standards.Q8. Do you agree with the possibility outlined in paragraph 5 to include in the portfolio’s changes the value of an adjustment stemming from the entire portfolio of positions subject to own funds requirements (i.e. both positions in standard-approach desks and positions in internal model approach desks)? Or do you think it would not be overly burdensome for institutions to compute adjustments on the positions in trading desks that are calculating the own funds requirements using the internal model approach only?
The French Banking Federation considers as overly burdensome the possibility to include in the portfolio’s changes the value of an adjustment stemming from the entire portfolio of positions, as outlined in paragraph 5 of Article 2 of the draft Regulatory Technical Standards.Q9. Do you agree with the criteria outlined in this article for the alignment of input data? Please provide some examples where an institution could use the provision set out in paragraph 2.
The French Banking Federation welcomes that the alignment of input data, introduced in paragraph MAR32.31 of the Basel standard, has been transposed in Article 15 of the draft Regulatory Technical Standards.The example provided in the consultation paper (i.e. case 2 in page 19) clarifies the conditions under paragraph 2 of Article 15 may apply. However, French institutions believe that the application criteria should cover situations where the risk factors for the HPL are transformed into equivalent risk factors in RTPL, yet represented differently, for the purpose of risk modelling.
Typically, it is common practice to transform observations of IR futures contract with fixed maturity date (used for HPL), into equivalent price of “synthetic instruments” with fixed time-to-maturity (used in the RTPL) to exclude time decay effects from the calibration of risk factors and thus enable consistent shock distributions in the risk engine.
The industry considers that data alignment should be allowed in such situation as long as institutions can justify to the satisfaction of supervisory authorities that these inherent transformations of market data, performed for the purpose of risk modelling, neither reduce the granularity of risk factors nor distort the representation/dynamic of the PL function, and provide documentation thereof as required in Article 16(2).