From the French banking sector’s point of view, the accounting treatment doesn’t impact the Foreign Exchange (FX) non-monetary items’ treatment, especially the capacity to exclude them from FX positions pursuant to article 352 of the CRR.
Foreign exchange (FX) non-monetary positions held at historic cost should be included in the overall net foreign exchange position and computed at the last FX rate for each quarterly revaluation.
It is worth reminding that the FX position that is subject to a capital requirement may arise from banking book positions (e.g. accrued income or provisions in currencies that are not the base currency) as well as positions resulting from a trading intent.
Only the positions that are of a “non-trading or structural” nature are excluded. The position that is of a non-trading or structural nature depends on a management choice realised by the top management of the bank, independently from whether the portfolios embedding the positions are from a trading or banking nature or from whether the standardized approach or an advanced method is used
However, we disagree on the relevance of computing net FX positions, as defined in article 352, for books managed under IMA (internal model approach). The IMA positions are subject to specific methodologies for globally computing the various risk factors (including FX risk) and calculating corresponding own funds’ requirements.
Structural FX positions depend on long term choices with the objective to reduce the sensitivity of own funds to FX variations. Indeed, ‘durable’ and ‘non-trading’ (as a reference to the intent, not the capital treatment) are more adequate terms to describe such positions.
We share EBA’s view that the potential exclusion should only be acceptable for net long FX positions.
Cf. more details regarding “positions” in question 5.
FBF members believe that FX positions taken in order to hedge the ratio do not only result from hedging derivatives but cover a much larger scope. As such, FX positions stemming from subsidiaries with a different reporting currency can be seen (on a consolidated level) as ‘deliberately taken to hedge against the adverse effect of FX movements’.
Furthermore, regulators should be aware that the ratio’s neutralization against FX movements depends on (i) the consolidation level and (ii) the ratio (CET1 or Tier 1) considered. A FX position taken in order to hedge the local Tier 1 ratio could increase the ratio’s FX sensitivity at the group (ie. consolidated) level for example. As such, the Management must decide how to allocate the hedging positions across the various relevant entities.
Such hedging positions are mainly stemming from subsidiaries/branches, tangible & intangible assets, capital operations. However, hedging positions may also include long net positions taken in an operating entity that cannot isolate in dedicated branches or subsidiaries its business denominated in currencies other than its base currency or even positions taken to tackle specific situations such as tax drag (notably with respect to the revaluation of participations or branches).
The structural FX treatment should be understood as being applicable for “positions”.
It should be possible to hedge the capital ratio in both directions i.e. benefit from potential gains or protect the ratio from potential losses. Therefore, both types of derivatives (FX forward as well as options) could be traded.
The Management should be free to choose the most adequate hedging strategy.
However, from a management perspective, it could make sense to choose to renounce to potential gains to protect the ratio from potential losses.
For “Structural FX”, please see our answer to Questions n°3 & 5.
At least annually, the sensitivity of own funds to FX variations may be estimated and presented to the Management of the credit institution. FX risk policy is described in the Risk Appetite Statement approved by the Management. It mentions the ratio-hedging strategy.
FX risk position is internally reported to the Management through financial committees. Externally this is reported to the regulators. In the annual report, the CET1 sensitivity to major currencies (e.g USD, GBP) is disclosed.
The maximum FX position that can be considered as “structural” is the maximum FX position that would ideally neutralise the sensitivity of the current or target capital ratio to FX movements.
The use of a minimum capital ratio is not optimal in our sense as it would not enable to neutralise the sensitivity of the current (or target) capital ratio (CET 1 for instance). The use of a minimum capital ratio would fail the objective of neutralization of the own funds to FX movements. In addition, the minimum required capital ratio is generally much higher than the minimum Pillar 1 ratio due to the required various buffers (including Pillar 2 buffers).
FBF members consider that the assessment of the structural FX position should be the same between subsidiaries, branches, and more generally any operating entities (including those without branches or subsidiaries) since structural FX positions are appreciated at a consolidated level.
The structural FX positions are taken at any relevant level (mostly but not exclusively at consolidated level) with a view to reduce the sensitivity of the consolidated ratios and when possible the other relevant ratios (sub-consolidated or even solo).
FBF members consider that article 325c of the CRR2 is much more restrictive than the current article 352(2) of CRR. The current wording raises several issues:
- The assessment of exclusions by the supervisor on a case by case basis would be impossible to manage for credit institutions (article 325c(2));
- Members do not understand why the exclusion should be limited to the maximum amount between investments in non-consolidated affiliated entities and investments in consolidated subsidiaries. Total amount of exclusions should take into account both kind of investments and even other entities (article 325c(1)(a));
- The current wording implies that a credit institution with no branch or subsidiary is not allowed to protect its ratios from FX movement with a FX position (article 325c(1)(a)) which can be extremely detrimental when a significant part of the business is carried in currencies other than the local currency;
- Members do not understand the economic rationale behind the 6 month time period (article 325c(1)(b));
More generally speaking, the evaluation of structural hedges of FX risk should be assessed through a flexible framework that allows credit institutions to adopt for the most appropriate general FX policy.
We believe that the simplified examples are useful and should be maintained but not binding as it is not reflecting every possible use case.
FBF members agree with the simplified examples although more complex situations need to be assessed such as:
- Fiscal issues related to the revaluation of retained earnings or reserves within subsidiaries;
- Issues related to minority interests denominated in foreign currencies.