Association for Financial Markets In Europe

This is a bank specific question and therefore we are unable to respond to this question.
We broadly support EBA’s view. All net open FX positions should be considered in the net FX position, whether managed in the trading book or in the banking book. Only the positions that are of a non-trading or structural nature are excluded, whatever the portfolio in which it is booked (banking book or trading book). In our view, 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 standardized approach or an advanced method is used.
We note that hedging strategies are designed and executed with the main purpose of controlling the potential negative effects of exchange-rate fluctuations on capital ratios, considering transactions according to market expectations and their cost. The hedging strategies do not distinguish between exposures that are subject to the standardized approach and exposures that are subject to IRB approach, as both types of exposures can in fact generate fluctuations on capital ratios. In this regard, the determination of the net FX position and structural FX exclusion should not depend on the approach used for the calculation of FX own-funds requirements.
Additionally, while we support EBA’s view on the structural FX exclusion we disagree on the relevance of open net foreign exchange position (ONFEP) as defined in Article 352 for IMA Bank. Indeed, the ONFEP is a standardised metric to be applied to the set of positions generating FX Risk on the balance-sheet (from which structural positions can be carved out subject to permission by the competent authorities). IMA is an alternative and more accurate way of capturing such risk on the same positions. An IMA institution should not be expected to compute ONFEP.
In the case an institution has permission by the competent authority to use internal models to calculate own funds requirements for market risk in accordance with chapter 5 of Title IV of Part three CRR, the risk weighting for currency risk is included. To prevent a double risk weighting for FX risk, these trading book positions should be excluded from the risk weighting in accordance to chapter 3 of Title IV of Part three CRR.
Please note that the pictures/tables are not in our response below. Please consider our full response that was submitted via email.

Structural FX hedges depend on long term choices with the objective to reduce the sensitivity of own funds to FX variations. Structural FX hedges are normally put on considering the aggregate banking book and trading book positions, rather than being limited to banking book.
While banking and trading book risks are considered risks of different nature and are typically managed differently, it may suit some banks to only address banking book open position with structural hedges. It is, however, important to note that the fundamental review of the trading book will modify the way banks classify portfolios. We highlight that the new provisions include standards to assign instruments to the trading book and banking book but these standards may not be fully aligned with the day to day management of the structural FX positions. The possibility to reclassify positions is limited and always subject to supervisory approval. Furthermore, the way FX positions are measured in order to be risk weighted in accordance to chapter 3 of Title IV of Part three CRR, does not make a distinction between trading and banking book positions, consequently banking and trading book positions should both qualify for structural FX positions. Any position in the banking and trading book which is not earmarked as structural is subject to RWA calculation. In this regard, we consider that the concept “structural nature” will have to be sufficiently flexible to ensure that sound structural FX management methods are permissible. Even if they primarily concern banking book positions, they should not in principle be limited to banking book.
In addition, while we agree that the net open structural FX position can only be long, we do not believe that there is a valid reason just to limit the exclusion to long FX hedges. In this regard, we provide examples of short and long hedge positions below, which help to preserve the capital ratio:

Example 1: A European entity invests in a USD entity and fully fund the investment with debt in USD. The FX movements in the investment is tax exempt but the FX movements in the liability is taxable/deductible. If the USD appreciates the bank pays less taxes, if the USD depreciates, the bank pays more taxes. In order to hedge this position, the bank enters into a short USD/EUR FX position. This short position neutralises the CET1 ratio and should be excluded as it is a structural tax position. So, if the tax treatment is different to cover the ratio you need to take an open position (could be long or short). Then the short positions taken in this sense are covering the ratio, so they should be eligible for the exclusion.
Example 2: Short positions on the balance sheet as a result of negative mark to market of cash flow hedge derivatives. This short position is left open (when managing the structural FX position of the bank) because there is a capital filter that eliminates the impact in reserves. This short position should be eliminated from the structural risk position of the bank as it neutralises the capital ratio as a result of the filter.
We have also included in Annex II, as part of the response to Q8 how to assess the consolidated ratio and an example that shows a short structural FX position hedging the capital ratio.
Example 3: Group’s reporting currency (USD) appreciates against all other currencies.
A holding company with USD as functional currency has two subsidiaries A with functional currency EUR and subsidiary B with functional currency GBP. Subsidiary A has all its assets and liabilities in EUR and B in GBP. Therefore, the US holding needs to hedge the RWA in EUR and USD in a manner that the speed of RWA increase or decrease due to an appreciation or depreciation of the EUR/USD or GBP/USD is the same as the speed of the Capital of the US holding due to an appreciation/ depreciation of the EUR/USD or GBP/USD.
This has an adverse impact on the Group’s capital ratio, as capital provided by subsidiaries A and B, denominated in foreign currencies, support both foreign currency and USD RWAs at the consolidated level. If the foreign currency capital depreciates against USD, the foreign currency capital is unable to support the same level of USD RWAs and the Group ratio depreciates. In order to hedge the Group’s capital ratio in this scenario, a short FX position is required for both GBP and EUR (i.e. GBP a EUR are sold for USD).



Example 4: Inclusion of trading book positions in structural FX.
To the extent that it can be demonstrated that a trading book FX position is of a “non-trading or structural nature”, it should be permissible to also include trading book FX positions. An illustrative example would be as follows:
In a group structure, the EU parent holds a participation in a US subsidiary denoted in USD. The USD subsidiary operates only a trading book, i.e. there is no banking book, and it is only funded by the USD investment of the parent. The market risk RWA calculation of the consolidated group is performed based on CRR Article 325 (1), i.e. allowing for a netting of positions held in different legal entities. In order to determine the open FX risk position for market risk RWA purposes, a long USD position in the amount of the USD investment in the subsidiary is excluded as a structural FX position.
Note that from the perspective of the consolidated group, this group internal USD investment is replaced by all external assets and liabilities of the US subsidiary as part of the consolidation process. In the illustrative example, the only external assets and liability result from the trading book. Note however that there is no direct link between the USD investments and a specific trading book position. In this scenario, the structural FX position at the consolidated level (in the amount of the USD investment) effectively results from all trading book position. Note however that only an FX position in the amount of the FX investment is classified as structural FX position. Any additional trading book long or short USD position and any non-USD FX position resulting from the consolidation of the US subsidiary are captured in the market risk RWA.
The above example demonstrates that although the structural FX position effectively results from trading book positions (in a consolidated group view) it is of a non-trading and structural nature as
• from a management perspective, it relates to an investment in a subsidiary that clearly is of a non-trading and structural nature, and
• there is clearly no trading intent with respect to the subsidiary but that this FX position arises on consolidated level when we take all trading book positions of the subsidiary into account; and
• any additional open FX position that the USD subsidiary incurs (that then is of a trading nature) is included in the market risk RWA calculation

Please note that the above example was on purpose simplified to stress the argument that trading book positions may qualify as structural FX positions. In all practical cases, the US subsidiary will also operate a banking book and will not only be funded by the USD investment. In such a scenario, it would then not even be possible to trace the structural FX position back to either a trading or a banking book position.
Please note that the pictures/tables/annexes are not in our response below. Please consider our full response that was submitted via email.

The structural FX positions should not be limited to hedging positions but should also be viewed as FX positions maintained from subsidiaries and branches with a view to hedging the capital ratio of the bank. The firm specific current or target value of the capital ratio at a consolidated level should be considered as the starting point from which to define the magnitude of remaining open position to be kept by currency to minimize ratio sensitivity. Such positions mainly stem from subsidiaries and branches, tangible & intangible assets and capital operations.
In this context, we note that the consultative document is focused mainly on hedging the ratio sensitivity by taking (or rather maintaining) unhedged net investment positions in subsidiaries or branches. One must note that even within the main operating entity, firms take long positions in the currencies of the exposures from which capital requirements arise (and running an equivalent short position in the base currency, or another relevant currency). In our view, this is also a valid structural FX position and strategy. This is particularly true when the institution runs significant exposures in foreign currencies along with exposures in the domestic currencies, notably:
• For investment banks, that grant facilities in a number of currencies (notably USD) to corporate clients
• For institutions in emerging countries which seldom have subsidiaries or even branches. For many reasons, a number of transactions in those countries are not denominated in the domestic currency.

Similarly, the concept ‘deliberately taken’, also include ‘deliberately not closed’ or ‘maintained’. Banks’ internal specific processes are designed to determine the amount of positions that are deliberately maintained in order to protect the capital ratio. These decisions are agreed in the Asset and Liability Management Committee (ALCO) and formally documented. The ALCO process could be used/leveraged also for regulatory purposes.
Please find in annex I three simplified examples based on an accounting point of view (i.e. IFRS). These examples aim to show how one could define ‘deliberately taken in order to hedge the ratio’ at the consolidated and at the individual level. As these examples proof, one cannot hedge the consolidated ratio and similarly the induvial ratio or vice versa.
We are of the view that hedging the ratio in particular situations can only be done at a consolidated level and that hedging the ratio at consolidated level could conflict with the ratio at individual level. Suppose that the ultimate EUR mother company does not have branches and has a 100% stake in a EUR sub-holding. When this sub holding holds all subsidiaries in a foreign currency, the individual mother company does not have any foreign currency positions on its individual balance sheet that can be hedged but nonetheless runs a currency risk. The currency risk is included in the EUR net asset value of the EUR sub-holding and therefore affects the CET 1 of the mother company in its individual balance sheet. In this case the consolidated company however has currency positions that can be hedged under article 352.2 CRR. Therefore, we are of the view that article 6 of the CRR cannot solely be applied to Chapter 3 of Title IV of Part three CRR. We also refer to this issue in our answer to question 9.
The structural FX treatment should be understood as being applicable for “positions” (that can stem from hedging through various FX instruments, including options, with a view to protect the firms’ capital ratio from adverse FX movements). The industry believes that both long and short positions are economically acceptable.
No industry response to this question.
Please note that the pictures/tables/annexes are not in our response below. Please consider our full response that was submitted via email.

Banks can opt for different kind of strategies when dealing with the FX risk, the amount of the structural position to be excluded depends on the strategy followed in terms of the capital ratio. When the capital ratio is fully neutralized to movements in the foreign exchange risk, the amount to be excluded should be the maximum FX position that that would ideally neutralise the sensitivity of the capital ratio post tax effects to FX movements but when the ratio is not fully but partially neutralized, the amount to be excluded should be limited to the amount that would act as a hedge of the capital ratio, meaning partially reducing its sensitivity (Examples explained in Annex IV) with no change in sign.
In the case where the tax rules in a country imply that revaluations of the hedging instrument (i.e. short currency positions) are being taxed, but the revaluation of the (long) net investment is tax exempted, an institution needs to ‘over-hedge’ with the factor of the tax rate in order to achieve a perfect hedge that neutralises the capital ratio. (See annex III for example).
We believe that in identifying the ratio, the ALCO process and initial supervisory approval are sufficient and should be subject to periodic (at least quarterly, as per the COREP reporting frequency) reviews to assess if the exempted hedges remain appropriate for managing the exposure. An over-hedge identified in the ALCO and supervisory review process that is not related to tax effects should incur a capital charge.
With regards to minimum capital ratios, we strongly believe that their use for determining the right ratio would be sub-optimal. This does not enable banks to neutralise the sensitivity of the current (or target) capital ratio, which is more appropriate economically. In practice, hedges are not put on in reference to minimum ratios, but rather to the actual or target capital ratio. Therefore, we do not support limiting the size of the structural hedge to minimum capital ratio levels as it would fail the objective of neutralization of the own funds to FX movements. In fact, it would penalise banks that hedge structural FX risk prudently.
We would in addition propose to add the leverage ratio to the group of ratios which qualify for hedging by structural FX positions, particularly if that is the binding capital constraint to the bank. Out of such a group of ratios, one ratio would be the key ratio to be hedged. This ratio limits the amount for the maximum FX position. The other solvency ratios can be over- or under-hedged driven by the maximum FX position.
Please note that the pictures/tables/annexes are not in our response below. Please consider our full response that was submitted via email.
We interpret the first part of the question is institution specific question and therefore limit our comments to that which is consistent across our members, namely that structural FX issues must be assessed at different levels, including the minority interest perspective. To this end, we include a worked example in Annex II, to highlight some possible considerations to take into account.
In relation to the latter question, we do believe branches and subsidiaries should be treated equally and set out our reasoning below:
Firstly, the structural FX positions are often taken to cover the own funds’ sensitivity at a consolidated level (an open position at the level of the mother company can be compensated by an open position at the level of the subsidiary or the branch), as can be seen from the examples in annex I. Therefore, we believe that there should not be any difference on capital/dotation hedging between subsidiaries and branches.
Secondly, there are some jurisdictions where there is no distinction between a branch and a subsidiary. In India for example, branches in are required to meet capital adequacy requirements which are at par with requirements for subsidiaries in the jurisdiction. Effectively a branch in this jurisdiction is expected to operate with the same level of capital as a subsidiary.
Bearing these in mind, the structural FX treatment at a consolidated level for investment in branches are no different to investment in subsidiaries. Additionally, from an accounting perspective, dependent on the Generally Accepted Accounting Rules used, there is not any difference between subsidiary and branch which means consolidated group is the same regardless of legal structure. We would therefore request that branches and subsidiaries be treated at par from a structural FX perspective.
The hedge eligibility according to the CRR II definition appears to be much more restrictive than the existing structural FX hedge limitations. While this is to a large extent reflecting the BCBS’s standard in the Fundamental Review of the Trading book, in our view this issue has not been addressed adequately during the consultation process and we believe it needs to be reviewed and aligned with the broader open position terms as described in the discussion paper and in our response above. We do not believe that the restrictions are required from a supervisory viewpoint nor do we believe that they result in more efficient hedging practices. On the contrary, it may result in structural management and level playing field issues between banks depending on their organisational structure.
We also believe that the word “amount of investment” should be clarified and it should be defined how to perform its calculation. At the individual basis, the ‘hedge’ is actually the position which is maintained; the investment. At the consolidated basis, once the elimination of the investment versus equity has taken place, the assets/liabilities stemming from the subsidiary are integrated with the parent’s. In this vein, the concept “investment” is not applicable at consolidated basis.
It is not clear why the amount of investment should be limited to consolidated subsidiaries. Banking groups which operate through a different legal structure in form of a branch system should have the same possibilities to define structural FX positions. Hence, the definition of “investment” should comprise subsidiaries and branches. Furthermore, items resulting in a capital deduction (e.g. goodwill) should be included as well since they provide a natural hedge to the capital ratios. These items are already included in the capital calculation and including them in the RWA calculation would result in double-counting.
More specifically, we believe that while article 325 c, (1) a (i and ii) limits the exclusion to the largest of the two options, it should be instead aggregated across 1) Subsidiaries 2) affiliated entities 3) branches 4) strategic equity stakes. The FX position to be considered “structural” can be a partial or the maximum FX position that reduces or neutralises the sensitivity of the current or target capital ratio to FX movements, taking into account firm specific circumstances and capital planning.
Secondly, we do not believe that the exclusion should be made at least for six months. Both RWA’s and own funds calculations vary from month to month and thus the calculation of the structural FX exposure as well. Markets can potentially move even more and banks need to have flexibility in management of the structural FX position. Therefore, it is more economically sound to also update the amount of the ‘exclusion’ on a monthly basis.
Thirdly, in regard of the exclusion of the hedge there is a new requirement that it must remain ‘in place for the life of the assets or other items’. Equities, by definition, do not have a maturity. As we have mentioned before, structural FX position is defined on a higher balance sheet composition level and therefore it would be inappropriate to tag balance sheet items against the open FX position as they may vary (see our previous answers) and contain trading book as well as banking book assets and liabilities. Furthermore, market movements, strategic ALM decisions, local political circumstances etc. can all be drivers for changes of the capital ratio composition and therefore the hedges have to be managed dynamically.
Consequently, we strongly believe that requiring supervisory approval for individual hedging transactions is overly burdensome and could disincentivise prudent structural FX management. Therefore, we recommend that these requirements are reviewed during the completion of the CRR2 and further aligned more closely with the existing structural FX management and ALCO processes.
We note that participations denominated in foreign currencies which are accounted at historic cost should not bear any capital charge.
Finally, and as also addressed in our answer to question 4, we like to ask your attention for the fact that article 6 CRR is in our view incorrectly applicable to chapter 3 of Title IV of Part three CRR. We like to make you aware that the BCBS stated on page 6 of its revisions of the minimum capital requirements for market risk as issued in January 2016 that their concept is designed for reporting at the consolidated level. They literally state “supervisory authorities will retain the right to continue to monitor the market risks of individual entities on a non-consolidated basis to ensure that significant imbalances within a group do not escape supervision”. The BCBS does not give guidance how supervisory authorities should do this. We therefore believe, in the case article 6 CRR is not adapted in a manner that article 6 is not applicable to chapter 3 of Title IV of Part three CRR, EBA should be mandated by the legislator to provide in an RTS how supervisors should cope with this market risks of individual entities. One option could be to include this in pillar 2.
No industry response.
Jouni Aaltonen
A