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AFME and ISDA joint response

The industry would support an approach that takes into account economic evolution as well as development of markets instead of relying on the static BCBS list. Notably, the BCBS list excludes major equities markets such as South Korea, Israel and Taiwan and European countries such as Czech Republic and Iceland, which are all included in the IMF’s list of advanced economies. The IMF methodology takes into account factors such as income per capita, export diversification and integration to the global financial system, which are all helpful indicators to identify market specific risks.

With regards to the EU/EEA markets, we believe that the economic integration, advanced common investor protections and disclosure requirements, cross border access and access to a wide range of financial services providers have effectively resulted in a system that can be defined as an advanced economy.
The industry believes that there are no simple econometric methodologies that can be applied in order to achieve a precise definition of an advanced market. Broad factors such as economic integration, rule of law and advanced financial system, combined with more detailed factors such as transparency of disclosures, quality of insolvency laws and availability of hedging products are all important factors that banks consider when offering their clients with investment products in a specific market.

In more detail, because the classification is only used to assign equity risk weights to equity exposures under the standardised approach, the approach should focus on whether the equity capital markets of a country can be classified as advanced versus emerging. There are a number of complementary metrics that may be used to determine volatility and liquidity:
• Outright volatility of the equity market
• Daily turnover of the equity market as a percentage of market capitalisation
• Correlation of the market with G10 countries during time of stress
• Availability of listed hedging and risk management products
• Number of regulated local market makers
• The ratio of foreign to local participants
The following additional factors may be useful to consider on the basis that they provide an indication of the markets ability to function effectively during times of stress:
• Sophistication of the exchange:
o Percentage of the market accessible through electronic trading;
o The settlement mechanism; and
o The ability of the exchange to perform daily margining.
• Number of exchanges (i.e. are there competing exchanges to the main exchange)
• Degree of oversight of the exchanges by the national regulator
• Level of the country’s compliance with Basel regulations
We do not support the use of metrics such as GDP and debt to GDP or inflation as these metrics are more relevant for other asset classes such as interest rate, credit and foreign exchange risk. Similarly, entities holding equities in another country would be required to capitalise for FX risk. As a result, the assessment of the risk weights applicable to equity risk should exclude this impact.
As mentioned in our response to question one, the BCBS list of countries outside the EU/EEA has omitted a few advanced markets, such as South Korea and Taiwan. The industry believes that the EBA should add these countries from the IMF list to the EU framework and continue reviewing the list periodically. This is to ensure that economic advancements are reflected appropriately in the risk weights and economic development is not hampered by higher capital/investment costs.
Jouni Aaltonen