Regarding the first question, we do not consider that the ‘structural nature’ wording in the CRR would limit the application of the structural FX provision to those items held in the banking book. In many practical situations, the structural FX position is arising due to foreign subsidiaries. From the group point of view, the positions in foreign subsidiaries can be managed in its entirety; not differentiating between positions in the banking book and the trading book.
Regarding the second question, we do not agree with EBA's view that the potential exclusion should be acceptable only for long FX positions. There are situations when the exemption of a short structural FX position is the only way to close an open FX position for regulatory purposes. Therefore, the exemption of short positions should be permitted. A practical but rather complex example follows.
Background for the example:
- A financial holding company registered in EU is a member of a regulated group.
- The functional currency of the financial holding company and the regulated group is euro.
- The financial holding company owns a foreign subsidiary in a third country (outside of EU). The investment into the foreign subsidiary is the only asset of the financial holding company and it is fully financed by the equity.
- The foreign subsidiary is a financial institution but not a credit institution in the third country (for example consumer finance company).
- The foreign subsidiary has all its assets and liabilities in its local currency, which is its functional currency. From the local point of view of the foreign subsidiary, the FX position of the subsidiary is closed.
- The foreign subsidiary is subject to a local regulation, which prohibits any open positions in foreign currencies. This is a simplification. In reality, the positions in foreign currencies are limited rather than forbidden completely.
- For simplification, we assume no operational risk, no counterparty credit risk, no CVA risk, and no market risk beside the FX.
- The capital requirement for the credit risk of the foreign subsidiary is assumed equal to 60 % of its NAV.
Analysis of the FX position:
- For EU regulatory purposes, the foreign subsidiary exhibits a long position in its local currency on individual level.
- The long position of the foreign subsidiary equals to its net asset value (NAV, assets - liabilities).
- The financial holding exhibits no FX position. Its investment into the foreign subsidiary is booked at historical costs.
- The group FX position is the sum of the position in the foreign subsidiary and the position in the financial holding company. The group FX position is long and it is equal to the NAV of the foreign subsidiary.
Hedging of the FX position:
- The group wants to hedge the FX risk to stabilize its total capital ratio.
- 60 % of the FX position is identified as structural. The structural position is equal to the capital requirement for the credit risk in the foreign subsidiary. This is fully in line with the logic of the illustrative example 4.3 and point 61 in the discussion paper.
- 40 % of the FX position is identified as the position, which should be closed.
- In theory, the hedge can be done either in the foreign subsidiary or in the financial holding company. The regulatory consequences of both alternatives are analyzed below.
Regulatory consequences of the hedging in the foreign subsidiary:
- The hedging in the foreign subsidiary means a reduction of the long position in the local currency and replacement of this by a long position in euro.
- Any euro position in the foreign subsidiary means an open FX position from the local regulatory point of view. Thus, it is prohibited by the local regulation.
- Conclusion: the hedging in the foreign subsidiary is not feasible.
Regulatory consequences of the hedging in the financial holding company:
- Hedging in the financial holding company means a short position in the local currency of the foreign subsidiary.
- The hedging transaction can be easily done and there are no restrictions in EU.
- From the economic point of view, the FX position is effectively closed. In fact, this is very common type of hedge. There is even special type of accounting treatment permitted for such hedge (Hedges of a Net Investment in a Foreign Operation).
- However, for the calculation of the net position at the group level for the regulatory purposes, the positions in the financial holding company and the foreign subsidiary cannot be netted. A netting cannot be even approved by the competent authorities because the conditions in Article 325 (3) of the CRR are not met (the foreign subsidiary is not a credit institution). Therefore, the group still exhibits a long position in the local currency. The position generates a capital requirement even if it is closed. On top of the long position, the group exhibits also a short position in the local currency.
- The only way how to make the hedge effective for the regulatory purposes is to exempt both the long and the short positions from the calculation of the FX positions using Article 352 (2) of the CRR (subject to the regulatory approval).
- Conclusion: the hedging at the financial holding company level is feasible but it is ineffective unless a short position is exempt from the FX positions.
- There are situations when the exemption of a short structural FX position is the only way to close an open FX position. Therefore, the exemption of short positions in the Article 352 (2) shall be permitted.
Regarding the application of the structural FX treatment to specific instruments, we do not agree with the approach. As described in the answer to question 3, the FX position is usually managed in its entirety.
Regarding the potential gains, it is acceptable to renounce the potential gains in order to protect the ratio from potential losses. Even if we consider both types of hedges as acceptable from the economic point of view, the hedging with options is very expensive and thus rare; especially in case of structural FX positions which are of long term nature.
We do share the EBA’s view that the maximum FX position that could be considered structural should be the position that would ideally neutralise the sensitivity of the capital ratio to FX movements.
We do not agree fully with the statement that the size of the structural position should be limited by the minimum capital ratios established in Article 92(1) of CRR. In our view, additional capital requirements as specified in Article 128 of CRD and ICAAP add-ons (CRD Article 104(1) (a)) should be reflected in the ratio. In all circumstances, the actual total capital ratio of an institution should be a floor for the ratio used to identify the structural FX position. This approach to the structural FX position stabilizes the total capital ratio much better than using 4.5 %, 6.0 %, or 8 .0 % from Article 92(1) if CRR.
We welcome the clarification as proposed in Article 325c.
We have two concerns regarding the Article 325c:
1) The wording of point 1 may imply that the size of the structural position should be limited by the minimum capital ratio levels in Article 92(1). This should not be the case, see our answers for question 7 and 8. On the other hand, entities should be allowed to have a choice to hedge CET1, Tier 1, and total capital ratio.
2) The wording of point 3 requires an explicit regulatory approval of any subsequent changes of the excluded amounts. This is very restrictive. This approach is not practical in situations when the structural FX amount is based on a calculation (for example percentage of credit risk weighted assets denominated in a foreign currency). A re-approval might be needed every month. An alternative wording might be considered:
Competent authorities shall approve any subsequent changes by the institution to the methodology to calculate the amounts that shall be excluded from the own funds requirements for market risks in accordance with paragraph 1.
This approach is in line with other areas, where the competent authorities approve the models not the particular results of the models.
We do agree with the analysis in the simplified statements. We are not aware of additional elements which should be considered in the simplified analysis.