Response to consultation on Regulatory Technical Standards that specify material changes and extensions to the Internal Ratings Based approach
Question 1. Do you have any comments on the clarification of the scope of the revised draft regulatory technical standards to specify the conditions for assessing the materiality of the use of an existing rating system for other additional exposures not already covered by that rating system and changes to rating systems under the IRB Approach?
Paragraph 8 on page 6 states that 'based on the approved methods, processes, controls, data collection and IT systems, should not be considered to fall within the scope of this RTS', and paragraph 9 states that 'Updates to the data used in the development and calibration of the rating systems should therefore be covered by this Regulation.'
It's good to clarify whether the updates to the data used in the development and calibration of the rating system based on approved methods also is in scope of this regulation or not.
Question 2. Do you have any comments on the clarifications and revisions made to the qualita-tive criteria for assessing the materiality of changes as described in the Annex I, part II, Section 1 and Annex I, part II, Section 2?
Paragraph 16 of the consultation paper clarifies on what constitutes a material change while assessing changes in validation methodology and/or validation processes. It is noted that such a change is considered material only if the change leads to a more lenient judgement within the institution towards accuracy and consistency of the estimation of the relevant risk parameter. Other changes would not be deemed material, but constitute an ex-ante notification. However the magnitude of change has not been addressed. Hence, consider the following scenario:
A change in validation methodology leads to a minor improvement in the accuracy and consistency of the estimation of the relevant risk parameters. Given that this constitutes a lenient judgement, would it be appropriate to classify this as a material change? It would be our understanding that the existing distinction between material and non-material changes based on the magnitude of the change will remain relevant under the new RTS but now only in the “more lenient direction”. The idea that any lenient judgement, irrespective of magnitude of change, constitutes a material change would be disproportional in our view, and would in fact lead to many more material change applications than in the past.
Question 3. Do you have any comments on the clarifications and revisions made to the qualita-tive criteria for assessing the materiality of extensions and reductions as described in the Annex I, Part I, Section 1 and Annex I, Part I, Section 2?
No comment.
Question 4. Do you have any comments on the introduced clarification on the implementation of the quantitative threshold described in Article 4(1)(c)(i) and 4(1)(d)(i)?
The proposed adjustments in the RTS entail that the quantitative threshold should be assessed at an aggregated level if a change impacts multiple rating systems. In this case, there is a possibility that impact on one system might offset impact on other system (the release of RWA in one rating system compensates for the allocation in another). If the impact on one system is above the threshold and the impact on the aggregated level is below, should it be considered as a material change or not? Additionally, at what level do institutions have to report the RWA impact? Combined or individual rating system level?
Question 5. Do you have any comments on the revised 15% threshold described in Article 4(1)(d)(ii) related to the materiality of extensions of the range of application of rating systems?
It's understood that the EBA introduces a new threshold for extensions. There might be cases where performance measures in terms of ranking ability remain satisfactory and the extension is representative of the rating system. Classifying this type of extension as material would be excessive. Therefore, these arguments can be added to support materiality classification even if RWA increases. Additionally, the newly introduced ratio could result in counterintuitive outcomes. Instead of the direct ratio, as pointed out in the consultation box, the relative difference (i.e., calculating the numerator as the difference between the RWEA assigned by the extended rating system and the RWEA assigned to the set of exposures before the extensions) could be used for materiality assessment in line with paragraph 2 of Article 4.
Question 6. Do you have any comments on the documentation requirement for extensions that require prior notification?
Paragraph 32 stipulates that for an extension, all documentation referred to in Article 8(1) should be submitted, which includes the assessment report of the validation function. However, this can lead to impractical scenarios where the institution has to perform an off cycle periodic review/ validation activity to align with the extension notification. In this regard, would it not be more effective to perform an ad hoc review of the materiality assessment without performing a detailed validation of the scope change itself? This would also be in line with Paragraph 120 of the ECB Guide which stipulates that the assessment and classification should be confirmed by an unit independent of the one responsible for the assessment and classification of the change/ extension (“four-eyes principle”). Moreover, having a review from the validation function solely on the materiality of change classification would also serve the purpose of the new RTS to ensure quality assurance of the notification type and therefore limit the number of (misclassified) material changes.
The scope change itself is also expected to be looked at by other departments in the bank like the relevant Business and Risk Management teams who need to provide their sign-off before implementation. The validation function would subsequently assess the scope change during the next periodic review, which could still lead to timely follow-up actions for further improvement.
Article 8 point 1-e requires that institution's assess the model performance of the rating system after the change. It's good to clarify in the RTS for which kind of changes the model performance report would be required as not all changes have an impact on the model performance.