According to regulations of Financial Supervisory Service(FSS) in Korea, historic rate is used for the accounting purposes. But for the market risk capital calculation, FX non-monetary items are treated as trading positions, which is included in market risk capital calculation.
Agree. Determining the net FX position (as well as determining the structural FX exclusion) is determining the boundary of trading position. The calculation method should be concerned about how to estimate the parameters more effectively, not about what the boundary is. If structural FX exclusion is dependent on the approach, it would cause significant difference between SA banks and IMA banks in market risk capital calculation and possession of capital ratio hedging instruments
Shinhan bank understands that structural FX provision is based on consolidate accounting technique. Therefore, we agree with EBA’s view that structural exposure arises from lending activities in cross-border subsidiaries and branches. But the definition of ‘structural nature’ is not clear (as mentioned in DP), regulatory agency’s authoritative interpretation is desirable.
Agree. Shinhan bank may only use FX long position as a structural FX position. Holding short position might weaken capital adequacy ratio, depending on the FX movement. BCBS documents also explain structural FX with domestic currency short position.
By separating specific transactions(or financial instruments) which has structural nature from other transactions, banks can identify structural FX position properly. For example, if a bank writes foreign currency denominated equity(or Net investments) in specific department’s B/S and recognize FX positions stem from equity(or Net investments) in specific folder(or portfolio), then the bank would identify structural FX position.
Subsidiaries with a different reporting currency should be converted to reporting currency at a settlement term for consolidate accounting purposes. This reporting currency revaluation process produces Currency Translation Adjustment (CTA) , recognized in Other Comprehensive Income (OCI)
Since both sensitivities of RWA and CTA to FX movement have same positive sign, fluctuation of RWA can be erased proportionally by fluctuation of CTA, then total capital ratio finally can be neutralized.
If a bank has FX long positions related to net investments in subsidiaries with a different reporting currency, bank can utilize Currency Translation Adjustment (CTA) effects to stabilize capital ratio.
But If a bank has square positions (or hedged positions) with foreign currency liabilities, CTA effect would be erased by foreign currency liabilities revaluation and could not stabilize capital ratio.
As mentioned above examples, maintaining long positions stem from subsidiaries with a different reporting currency can be interpreted as utilizing CTA effects to stabilize bank’s capital ratio and that means deliberately taken FX long position.
As a structural FX position, identifying specific positions stem from specific financial instruments which have Non-trading and structural nature is desirable. Foreign currency investments in subsidiaries and branches would be an appropriate example
The purpose of a structural FX provision is to stabilize bank’s capital ratio from FX movement. Approval of potential gain from a structural FX position does not match with stabilizing rationale
Symmetric hedge effect of structural FX position would produce “Real” capital ratio, which means the capital ratio that is not contaminated by FX movement effect. (If the domestic currency appreciates, capital ratio would be higher, in spite of taking more risky assets). In this aspect, Symmetric hedge is more desirable.
Since there is no precedent of structural FX authorization in Korea, now we do not use structural FX provision in internal capital calculation to align with regulatory capital. We agree with BCBS and EBA’s capital ratio protection concept and plan to get authorization from Korea Financial Supervisory Service (FSS)
Agree. On a conceptual basis, the maximum size of structural FX position should be the size that enables a bank to neutralize its overall capital ratio sensitivity.
Limiting size of structural FX position in Article92(1) means partial hedge of capital ratio. If structural FX provision limits the size of position, the excess capital above the limit (4%,6%,8%) would be exposed to market volatility. The higher the capital ratio is the more volatility a bank is exposed to. Therefore, banks get penalized for maintaining capital ratio high, which can be considered as reverse discrimination.
We calculate all RWAs in consolidate basis including overseas branches and subsidiaries. But there is no precedent in Korea where structural position is used , so we have to calculate all net FX position’s RWAs including structural FX (positions stem from foreign currency investments in overseas branches and subsidiaries which are subject to fixed FX rate)
Structural FX provision in CRR2 limits the maximum size of structural position to the largest amount of subsidiaries or largest amount of affiliates. But in BCBS FRTB, the exclusion is limited to maximum of subsidiaries “and/or” affiliates. We consider that BCBS’s “and/or” condition would be an argument. Because it might lead partial capital ratio hedge. If bank has both overseas subsidiaries and branches with same functional currency, the structural position size would be limited to the largest amount between “subsidiaries and affiliates”. In this aspect EBA’s wording is more clear than BCBS’s
There should be additional discussions on the calculation methodology of optimal structural FX size and relation between CTA and structural FX. Discussions on these two topics would help to clarify the concept of structural FX.
Seo YoungDong (Market risk manager of Risk Engineering Department)