We agree that there should be a simplified approach, but we do not agree with the proposition of a threshold related to the volume of an institution’s fair valued positions above which the simplified approach cannot be used for calculating AVAs. In our opinion an institution should have the possibility to apply the simplified approach regardless of the volume of fair valued positions.
If, however, there should be a restriction as regards the use of the simplified approach we believe that this restriction should also consider aspects of complexity of the institution. The suggested threshold only respects the principle of proportionality in terms of size. It is not proportional in terms of the nature, scale and complexity of the risks associated with an institution's business model and activities.
In our view the ability to choose approach is essential in order to avoid disproportionate compliance costs for institutions like Kommuninvest with large balance sheets but low complexity and risks.
Absence of thresholds for the use of a simplified approach would, in addition, be in analogy with the calculation of capital requirements where there are no thresholds for the use of standardised approaches.
If there is a threshold we disagree with the proposition that the threshold should be measured against all fair valued positions. Since AVA treats uncertainty in valuation it would be consistent with the aim of Article 105 that only fair valued positions in valuation level III (or possibly also level II) according to IFRS would be measured against the (appropriately recalibrated) threshold. Alternatively thresholds could be set per valuation level.
If the threshold would be measured against all fair valued positions it is in our opinion too low since specialized institutions with large volume but low risk business models like Kommuninvest might be above the threshold. For institutions like Kommuninvest direct compliance cost will otherwise be substantial in relation to total operational costs.
In our opinion this question would be resolved by keeping the optionality of approach for AVA open to institutions regardless of the volume of their fair valued positions.
In our opinion the first term in the simplified approach, 25% of net unrealized profit, is not appropriate since valuation uncertainty is not per se related to whether there is an unrealized profit or loss attached to it.
We see the outset of the second term of the suggested simplified approach as good but that it needs to be risk adjusted. A simple risk adjusted calculation method could be as follows.
• No, or very low, AVA for Level 1 fair valued positions.
• No, or very low, AVA for derivatives in hedge relationships designated according to IAS39.
• 0.05% of the sum of the absolute value of Level 2 fair valued positions.
• 0.20% of the sum of the absolute value of Level 3 fair valued positions.
If not using fair valuation hierarchies other categories should be part of a technical standard for a simplified approach.
See answer of Q4.
In our view, as stated in the answer of Q2, it is essential in terms of the principle of proportionality that the simplified approach is available for any institution regardless of size. Under that assumption it would be reasonable to impose that any institution that fails to use the core approach on any part of its fair valued positions should use the simplified approach on all of its fair valued positions.
If however there is a threshold above which institutions are obliged to use the core approach we consider the proposed method extremely disproportionate for institutions with large balance sheet and low complexity.
As for the first term, 100% of net unrealized profit, we consider it, for reasons stated in Q4, that such a correction is not appropriate.
As for the second term, 25% of market value of non-derivatives and 10% of notional value of derivatives, we see that it would imply dramatic consequences for any institution above the threshold that is not able to apply all of the AVA methods for even a small fraction of its fair valued positions. It would instead be preferable to impose a stricter version of the simplified approach, i.e. higher factors.
The definition of Article 12 is closely related to trading activity. Some fair valued positions do not fit in a reasonable way in this model.
In our opinion fair valued (non derivative) liabilities should be excluded from this category AVA.
Another example is that Kommuninvest currently has 86 billion SEK of fair valued loans to local governments. Kommuninvest’s loans to local governments are not trading instruments, they are loans that are economically hedged with matching derivatives, therefore to avoid accounting mismatch these loans are accounted at fair value according to IAS 39. Kommuninvest’s business model includes operations that, via longer maturity of funding than lending, assure the capacity of holding the loan portfolio to maturity.
The loans can readily be given fair values from market activity. However the concentration of Kommuninvest’s valuation position in this market is also the raison d’être of the institution, hence exit strategies from this market is the same as strategies for closing down the business.
The outlined definition of Article 12 indicates that Kommuninvest, for sake of prudency, would have to remove a disproportionately large amount from the institutions own funds at the inception of any loan if measured at fair value. If not measured at fair value the same loan would not have any effect on own funds. Thus the effect of concentrated positions AVA is, in our opinion, clearly not that intended by article 105.
In our opinion at least concentrated positions AVA might be zero. See answer of Q8.
We disagree with the conclusions on direct compliance costs in the Draft RTS. In our opinion the complexity of the balance sheet is not reflected in the RTS and hence is not consistent with the proportionality principle. For institutions that are larger in terms of balance sheet, but smaller in terms of activity and complexity direct compliance cost will be significant if obliged to use the core approach.
For Kommuninvest the valuation processes including staff, market data and systems for pricing currently stands for more than 5% of total operational costs. Complying with the core approach would lead to a large increase in these costs and thus to a significant increase in total operational costs.
We also see a risk that the indirect capital costs could be disproportionate for institutions like Kommuninvest. See answer of Q8.