Response to consultation on Regulatory Technical Standards on prudent valuation
Question 2. Do you have any comments on the amendments to Article 3 in general, and specifically with regard to the threshold of ten contributors set out in paragraph 2, point (d)? If you consider a different threshold should be applied, please describe how to set it, and provide a rationale and evidence supporting your proposal.
Article 3 (2) (a) exchange prices in a “liquid market”
Where a contract is regularly traded, and in appropriate size, this approach is perfectly reasonable.
However, where a contract has little (or even no) open interest then this approach needs to be carefully considered.
Using other sources of available and reliable data will almost certainly lead to a more accurate and consistent outcome.
In particular OTC quotes and trades can often transact in volumes many times larger than the contracts traded on the exchange.
The proposed approach is also problematic for contracts where there is a timing difference between the exchange close and the closing time for the OTC markets.
We regularly see significant pricing differences between prices and trades submitted at the exchange close compared to those for the OTC market economic end of day (the OTC close). These discrepancies can occur across all asset classes.
Article 3 (2) (c) tradable quotes from brokers and other market participants
Where there are tradable quotes, in reasonable size then these should be included in the range based approach.
However there can be cases where there are tradable quotes but these are well below the standard OTC transaction size and are a significant, and unrealistic, distance away from mid-market.
Reliance on these in the expert approach could produce incorrect measures of market price uncertainty, valuations and ultimately incorrect AVAs.
Article 3 (2) (d) consensus service data where the number of contributors is greater than or equal to 10 and the institution has performed a valuation back testing
If there are more than 10 contributors that are actively trading, the resulting consensus is consistent with valuation back testing and the ranges and thresholds all correspond with expectations, then this approach works well.
However the proposed threshold of 10 contributors could create less than ideal incentives for consensus pricing providers in several areas, as per the examples below.
1: There are 10 contributions but one of them is incorrectly marked - there will be a temptation to create a mechanism so that the contribution is counted, but does not affect the consensus, range and other statistics.
2: A service has 9 submitters – there will be pressure to add an additional contributor; even if they are inactive and will add no value to the process.
3: There are also markets where the number of active participants is well below 10. A consensus formed from a fewer number of active contributors but backed-up by quote and trade data will provide an accurate and reliable valuation.
If an individual submission, and the associated consensus, correlates well to quote and trade data then that is a more desirable outcome than a consensus made up of more contributors that doesn’t display this behavior.
Article 3 (3) (b) indicative broker quotes
A further area of concern is that indicative broker prices are considered for inclusion within the expert-based approach.
Brokers will quote a wide range of prices and some of these will be indicative whilst others will be firm and actionable.
Indicative quotes can give useful information but cannot be consistently relied upon from a valuation perspective. These prices can sometimes be wide, speculative and with no firm interest behind them.
However, actionable quotes will have firm interest behind them and trading can happen within the range of quotes. They can give a reasonable range of exit prices and therefore be relied upon from a valuations perspective.
The role of market makers is to gather all information from quotes, trades and other market data sources and then use this market intelligence to calibrate their models and trading systems. They will execute trades and then mark their books based on these inputs.