Response to consultation on draft RTS on Pillar 2 add-ons for investment firms
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Justification for the introduction of this floor seems to be given in recital 10, where it stated “To ensure that additional own funds requirements remain adequate over time, it is necessary to adjust them proportionally to any significant increase of own funds requirements […]”. This ‘floor’ is then to remain in place at least until the a new SREP assessment has taken place.
EBA seems to assume that own funds requirements can only ever increase for an investment firm. That is not necessarily the case for investment firms, and in particular for principal trading firms. In particular trading firms with market making obligations may see their own fund requirements both increase and decrease in relative short periods of time, depending on market circumstances – in particular trading volumes and volatility.
By way of example – during the 2020 Covid induced market volatility many market makers remained in the market to provide liquidity. The increase in trading activities of these firms led to a significant increase in own fund requirements from k-factors such as K-DTF, K-NPR and K-CMG. If a floor for additional pillar two requirements would have been in place in the Spring of 2020 these market making firms would have been faced with much higher capital requirements, until long after the markets calmed and own fund requirements from these K-factors would have come down again.
As an alternative we propose the NCA may either decide to apply a fixed amount or – ideally – fix the ratio to the additional own fund requirements of a firm.
We do not support the inclusion (in article 3 of the Draft RTS) of ICT risks in risk that are not sufficiently covered in any own funds requirements set out in Article 11.
As explained in our comments to question 5 on the EBA guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) under IFD, DTF was intended in the level 1 text to cover operational risks resulting from a trading activity (recital 26) with no distinction of the type of operational risks and no specific exclusion. However, in line with the framework as envisaged by Level 1, investment firms will include these risks when making their assessment and compare it with DTF. Only in cases where Pillar 1 does not adequately cover these risks would additional P2R measures be warranted.
In summary, we cannot support the EBA methodology that presupposes that risk arising from ICT are not covered by the own funds requirements. Additional P2R measures would be warranted only in cases where Pillar 1 does not adequately cover operational risks, including ICT risk, resulting from trading on own account. We would therefore suggest to move the reference to ICT risk from article 3(2)(a) to article 2 paragraph 3.
The risks identified in the discussion paper as candidates for a Pillar 2 addition are already covered by K-NPR, K-CMG and K-DTF. NCAs and firms should only have to identify Pillar 2 requirements in case risks are not, or inadequately, covered by Pillar 1.
Question 1. Do you have any comments on the structure and elements included in this Consultation Paper for the computation of Pillar 2 add-ons?
NB. This answer has been coordinated with FIA EPTA. We are concerned about the fact that art. 4(2) of the draft Delegated Regulation effectively creates a floor with respect to the additional Pillar 2 requirements. This is the result of the fact that the additional own funds requirements as calculated in art. 4(1) are to expressed both (1) as an absolute amount, as well as (2) as the ratio of that amount to own funds requirements. The second paragraph of art. 4(2) subsequently states that where the level of the own funds requirements varies, the level of additional own fund requirements shall at all times be the highest of the absolute amount and the amount necessary to satisfy the ratio.Justification for the introduction of this floor seems to be given in recital 10, where it stated “To ensure that additional own funds requirements remain adequate over time, it is necessary to adjust them proportionally to any significant increase of own funds requirements […]”. This ‘floor’ is then to remain in place at least until the a new SREP assessment has taken place.
EBA seems to assume that own funds requirements can only ever increase for an investment firm. That is not necessarily the case for investment firms, and in particular for principal trading firms. In particular trading firms with market making obligations may see their own fund requirements both increase and decrease in relative short periods of time, depending on market circumstances – in particular trading volumes and volatility.
By way of example – during the 2020 Covid induced market volatility many market makers remained in the market to provide liquidity. The increase in trading activities of these firms led to a significant increase in own fund requirements from k-factors such as K-DTF, K-NPR and K-CMG. If a floor for additional pillar two requirements would have been in place in the Spring of 2020 these market making firms would have been faced with much higher capital requirements, until long after the markets calmed and own fund requirements from these K-factors would have come down again.
As an alternative we propose the NCA may either decide to apply a fixed amount or – ideally – fix the ratio to the additional own fund requirements of a firm.
We do not support the inclusion (in article 3 of the Draft RTS) of ICT risks in risk that are not sufficiently covered in any own funds requirements set out in Article 11.
As explained in our comments to question 5 on the EBA guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) under IFD, DTF was intended in the level 1 text to cover operational risks resulting from a trading activity (recital 26) with no distinction of the type of operational risks and no specific exclusion. However, in line with the framework as envisaged by Level 1, investment firms will include these risks when making their assessment and compare it with DTF. Only in cases where Pillar 1 does not adequately cover these risks would additional P2R measures be warranted.
In summary, we cannot support the EBA methodology that presupposes that risk arising from ICT are not covered by the own funds requirements. Additional P2R measures would be warranted only in cases where Pillar 1 does not adequately cover operational risks, including ICT risk, resulting from trading on own account. We would therefore suggest to move the reference to ICT risk from article 3(2)(a) to article 2 paragraph 3.
The risks identified in the discussion paper as candidates for a Pillar 2 addition are already covered by K-NPR, K-CMG and K-DTF. NCAs and firms should only have to identify Pillar 2 requirements in case risks are not, or inadequately, covered by Pillar 1.