Response to consultation on Regulatory Technical Standards on prudent valuation
If not, please describe the challenges you face with regard to a monthly calculation, and the monthly reporting of fair values and AVAs (e.g. with the COREP templates). Please make clear if those challenges arise in general or with regard to specific positions (e.g. type of instruments), whether they arise for positions assigned to the trading or non-trading book, and whether they arise for positions treated under the simplified or core approach. Please describe any simplifications and/or assumptions you would have to apply to determine fair values and AVAs on a monthly basis.
NA
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.
The threshold of ten contributors appears arbitrary. As some products may not have so many active market participants, data from less than ten contributors does not necessarily mean that it is less reliable.
I would like to draw your attention to derivatives. The RTS may not have considered market data aspects that are impactful to the valuation review of derivatives.
The valuation review of derivatives, e.g. European Swaptions, requires a significant amount of prices. The market data set needs to be covered by instruments with varying expiries, underlying tenors and strikes. This large set of prices needs to be coherent (consistent to each other). Individual prices may not be meaningfully useful - see question 8 and model calibration.
Valuation risk requires the distribution of that coherent set of prices as of a given day/time to be available. It is likely that only consensus services and/or brokers can deliver that information. Both sources would need a special place in the market data hierarchy.
Question 3. Do you have any comments with regard to the requirements proposed in Article 3a? If you consider that some of those requirements should be adjusted, please describe how you would revise them in order to meet the policy objectives that the proposed amendments try to achieve, and provide the rationale supporting your proposal.
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Question 4. Do you agree with the proposed amendment to capture valuation risks stemming from fair-valued back-to-back derivative transactions and SFTs? Do you agree that this would restore alignment with the treatment under the core approach? If not, please describe how you would suggest to revise the amendment providing any rationale and supporting evidence.
NA
Question 5. Do you agree with the proposed amendments to the calibration of the fall-back approach? If you consider that a different range of percentages should be considered, or that the AVAs under the fall-back approach should be calculated in a different manner, please suggest a range or a methodology, as applicable, and provide a rationale and evidence supporting your proposal.
NA
Question 6. Do you have any comments in relation to the positions proposed to be subject to the fall-back approach? If you consider a different treatment should be applied to these positions, please describe how you would treat them in order to meet the intended policy objectives, and provide the rationale and any evidence supporting your proposal.
NA
Question 7. Are the requirements included in Article 8 clear? If you consider them to be not clear or to be particularly challenging to meet in specific circumstances, please describe the issue you encounter and how you would address it in order to meet the intended policy objectives, and provide the rationale and any evidence supporting your proposal.
NA
Question 8. Do you have any comments with regard to the amendments to Article 9, 10 and 11? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
Comments to Article 9 MPU
I am referring here to a large and important trade population that may requrie a different treatment, namely derivatives that are actively traded.
The IPV of derivatives, like European Swaptions, is performed in two steps; (1) model re-calibration to the coherent set of prices, (2) quantification of the valuation impact. Referring to (1), the model inputs are adjusted so as, together with the model, (reasonably) reproduce the set of target prices.
The requirement
“Where institutions use a valuation model to determine the exit price of the valuation position, they shall calculate individual market price uncertainty AVAs on valuation exposures related to each valuation input that the institutions used in the relevant valuation model to determine that exit price. Each of the valuation inputs shall be treated separately. Where a valuation input consists of a matrix of parameters, every parameter in the matrix shall be considered as a separate valuation input”
would materially overstate MPU as the (potentially several) valuation parameter values are determined by the price of the product. Moreover, distributions of the valuation inputs do not necessarily exist, only the distribution of prices. The valuation inputs may only have a meaning together with the model and their output (the price).
The requirement
“(i) where institutions use a valuation model to determine the exit price of the valuation position, as referred to in paragraph 1, second subparagraph, they shall multiply the difference between the value of the valuation input as used to determine the reference fair value of the valuation position and the prudent value of that valuation input estimated in accordance with point (a), by the sensitivity of the valuation position to that valuation input”
would materially overstate MPU. It is very unlikely that, say the prudent 2 year swap rate is x basis points higher than its fair value and that the 3 year swap rate is y basis points lower than its fair value. Prudency would, likely be interpreted to be the valuation input value that reduces the book valuation for each valuation input. However, the market data implied by that impact would not be plausible.
Model re-calibration to market data prices that have been modified through the above type of adjustments may fail, as the set of prices may have lost its coherence. The alternative would be to re-calibrate the model to a coherent set of 10th percentile and 90th percentile prices respectively. The resulting valuation impact would be more realistic.
The requirement
“Institutions shall perform the variance ratio test separately for each valuation input that consists of a matrix of parameters.”
is not necessary and likely impossible to perform as distributions of the valuation inputs do not necessarily exist, only the distribution of prices. The valuation inputs may only have a meaning together with the model and their output (the price).
Comments to Article 10 - CoC
As the requirements on MPU and CoC are similar and determined by the focus on “each valuation input” my comments on Article 9 apply to Article 10 too.
Another way to see that the approach based on “each valuation input” very likely overstates valuation risk can be seen by contrasting AVAs to fair VAs. Let us take as example the VAs needed to move mid-levels to exit-levels. Not reducing the risk dimension would lead to an AVA that is many several times larger than the fair VA. Such a large AVA would not be credible as the amount required to achieve a 90% confidence level.
Question 9. Do you have any comments with regard to the amendments to Article 12? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
NA
Question 10. Do you have any comments with regard to the amendments to Article 14 and 15? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
NA
Question 11. Do you agree with the requirements set out in Article 19a and Article 19b? If you do not agree, please describe how you would suggest to revise those Articles and address the mandate on extraordinary circumstances outlined in Article 34 CRR. When giving your answer, please provide the rationale and any relevant evidence supporting your proposal.
NA
Question 12. Which of the two options presented do you consider more appropriate for the purposes of addressing concentration of UCS AVAs? When giving your answer, please provide the rationale and any relevant evidence supporting your proposal.
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Question 13. Do you have any comments with regard to the amendments introduced in the Annex? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
NA
Question 14. Do you have any other comments on this consultation paper? If you do not agree with any of the proposed requirements, please describe how you would adjust or design them in order to meet the policy objectives that the proposals try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
NA