Response to consultation on Guidelines on limits on exposures to shadow banking
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We broadly agree with this approach. With regard to point (b), however, reference to “the total exposure to regulated financial sector entities” is somewhat misleading as it implies that these regulated financial sector entities are distinct from shadow banking entities – the corollary being that shadow banking entities are unregulated. However, MMFs and AIFs (registered under the EU Alternative Investment Fund Managers Directive) are subject to product-level regulation, as noted elsewhere. Therefore, it may be more appropriate to refer to “the size of current exposures to shadow banking entities relative to its total exposures and relative to other entities within the scope of the CRR” in place of “regulated financial sector entities.”
Taking account of interconnectedness within the process for setting aggregate exposure limits (as well as for setting individual limits) is appropriate but may be difficult to quantify in practice depending on the availability of data. We acknowledge that this situation is accounted for under para. 1.e of the principles (“implement a robust process for determining interconnectedness between shadow banking entities, and between shadow banking entities and the institution. This process should in particular address situations where interconnectedness cannot be determined, and set out appropriate mitigation techniques to address potential risks stemming from this uncertainty.”) It may be helpful to provide more detailed guidance to firms regarding the measurement of interconnectedness and how to apply the guidance where interconnectedness cannot be reasonably quantified.
The criteria listed for the determination of individual exposure limits appear reasonable.We also broadly support the EBA’s proposed approach of requiring firms to use the principal approach (i.e. the application of the criteria listed in the guidance) to determine exposure limits, and to only use the fallback approach (applying an aggregate exposure limit of 25% of eligible capital to shadow banking entities) where it is not possible to apply the principal approach due to either insufficient information on shadow banking entities or a lack of effective processes to use that information.
We acknowledge the EBA’s stated preference for option 1 on the basis that it is simpler to apply and is more conservative. However, in our view, option 2 makes better use of available information on shadow banking entities and activities and thus provides for the possibility of more appropriate and realistic exposure limits than option 1. We agree with the EBA that both options provide incentives to firms to gain sufficient information about shadow banking exposures under the principal approach (to avoid being subject to a potentially more conservative limit of 25% of eligible capital under the fallback approach); however, to a certain extent, this incentive may be stronger under option 2 by rewarding the collection and use of pertinent data with appropriate exposure limits.
2. Do you agree with the approach the EBA has proposed for the purposes of establishing effective processes and control mechanisms? If not, please explain why and present possible alternatives.
The proposed list of principles for establishing effective processes and control mechanisms appears reasonable and CFA Institute has no further comments.3. Do you agree with the approach the EBA has proposed for the purposes of establishing appropriate oversight arrangements? If not, please explain why and present possible alternatives.
The proposed list of principles for establishing appropriate oversight arrangements appears reasonable and CFA Institute has no further comments.4.Do you agree with the approaches the EBA has proposed for the purposes of establishing aggregate and individual limits? If not, please explain why and present possible alternatives.
In determining the aggregate exposure limit, the EBA proposes that each firm takes account of (a) its business model and risk management framework, (b) the size of its current exposures to shadow banking entities relative to its total exposures and relative to its total exposure to regulated financial sector entities, and (c) interconnectedness.We broadly agree with this approach. With regard to point (b), however, reference to “the total exposure to regulated financial sector entities” is somewhat misleading as it implies that these regulated financial sector entities are distinct from shadow banking entities – the corollary being that shadow banking entities are unregulated. However, MMFs and AIFs (registered under the EU Alternative Investment Fund Managers Directive) are subject to product-level regulation, as noted elsewhere. Therefore, it may be more appropriate to refer to “the size of current exposures to shadow banking entities relative to its total exposures and relative to other entities within the scope of the CRR” in place of “regulated financial sector entities.”
Taking account of interconnectedness within the process for setting aggregate exposure limits (as well as for setting individual limits) is appropriate but may be difficult to quantify in practice depending on the availability of data. We acknowledge that this situation is accounted for under para. 1.e of the principles (“implement a robust process for determining interconnectedness between shadow banking entities, and between shadow banking entities and the institution. This process should in particular address situations where interconnectedness cannot be determined, and set out appropriate mitigation techniques to address potential risks stemming from this uncertainty.”) It may be helpful to provide more detailed guidance to firms regarding the measurement of interconnectedness and how to apply the guidance where interconnectedness cannot be reasonably quantified.
The criteria listed for the determination of individual exposure limits appear reasonable.We also broadly support the EBA’s proposed approach of requiring firms to use the principal approach (i.e. the application of the criteria listed in the guidance) to determine exposure limits, and to only use the fallback approach (applying an aggregate exposure limit of 25% of eligible capital to shadow banking entities) where it is not possible to apply the principal approach due to either insufficient information on shadow banking entities or a lack of effective processes to use that information.
5. Do you agree with the fallback approach the EBA has proposed, including the cases in whichit should apply? If not, please explain why and present possible alternatives. Do you think that Option 2 is preferable to Option 1 for the fallback approach? If so, why? In particular: Do you believe that Option 2 provides more incentives to gather information about exposures than Option 1? Do you believe that Option 2 can be more conservative than Option 1? If so, when? Do you see some practical
CFA Institute believes that option 2 (applying the fallback approach only to those shadow banking exposures to which the principal approach cannot be applied) is preferable to option 1 (applying the fallback approach (aggregate 25% exposure limit) to all exposures when the institution cannot apply all of the criteria of the principal approach to all exposures).We acknowledge the EBA’s stated preference for option 1 on the basis that it is simpler to apply and is more conservative. However, in our view, option 2 makes better use of available information on shadow banking entities and activities and thus provides for the possibility of more appropriate and realistic exposure limits than option 1. We agree with the EBA that both options provide incentives to firms to gain sufficient information about shadow banking exposures under the principal approach (to avoid being subject to a potentially more conservative limit of 25% of eligible capital under the fallback approach); however, to a certain extent, this incentive may be stronger under option 2 by rewarding the collection and use of pertinent data with appropriate exposure limits.