In order to identify the most material risk driver for transactions with more than one material risk driver, the EBF proposes that credit institutions should be free to choose between option 1a and option 1b, as detailed in steps (v) and (vii) of Article 3(b) of the Commission Delegated Regulation.
Scope of the approach 1
In the Basel SA-CCR text, derivatives are mapped to the asset class of its primary risk driver. Banks are required to use sensitivities and volatilities for the determination of the primary risk driver of complex trades that may have multiple risk drivers. Only those complex trades designated by supervisors are to be mapped to more than one asset class.
In the consultation paper, it is said that the method should be “simple for all cases where the primary and only material risk driver of the transaction is immediately discernible from the nature of the transaction”.
We therefore would like the EBA to consider additional products to be covered by the approach 1 which would ensure that the vast majority of transactions are captured by the qualitative approach and not by the approach in Article 3(1)(a).
Transactions with a different currency between settlement and underlying:
Where the only reason to resolve to approach 2 is that the currency of the underlying of the transaction is not the same as the settlement currency of the transaction, the FX risk-category represents only a fraction of the underlying risk-category.
The EBF therefore recommends the removal of the following part of article 1(b): “where the currency of the underlying of the transaction is the same as the settlement currency of the transaction”, since the FX risk concerned here is not material.
Cases where the use of approach 2 lead to the determination of two material risk categories are rare. It would not justify the extra burden to resort to it.
Cross currency swaps:
It can hardly be claimed that common transactions such as cross currency swaps are complex. If clearly they are sensitive to both Foreign Exchange and Interest Rates risk factors, it can be shown (see thereafter) that FX risk is by far the predominant risk driver. This is being recognised in the Basel text which is considering the cross-currency swaps as foreign exchange contracts. Annex II of Regulation (EU) 575/2013 also classifies cross-currency interest swaps as Foreign-exchange contracts.
When applying the approach 2 to all the cross-currency swaps (i.e. at product level), FX risk delta FRTB-SBM capital charge represents about 80% on average of the total for a representative portfolio. This confirms that FX risk is the only material risk factor for this product.
Resettable cross currency swaps are dominant among cross currencies that would be assigned to two risk categories according to the proposed Approach 2. Many of those resettable cross currency swaps would have been mapped to a single risk category had the resettable feature been removed. The FX-reset feature is a risk mitigant, it lowers the FX risk embedded in the transaction while keeping the IR risk unchanged. We do not believe that the purpose of the regulation is to inflate exposure when risks are lowered. Hence, we do not see fit a systemic doubling of the exposure amount based on the sole relative importance of risk drivers. When well identified products can demonstrably been proven of lower risks than other products of identical primary risk driver, it should be mapped to that single primary risk driver.
Furthermore, cross currency swaps are a vanilla flow product, an important one for commercial end users, corporates for example, providing funding in various currencies. Doubling the exposure amount of those transactions will push banks to increase the cost for clients of such products and may, eventually, deter some to hedge their FX risk. This is even truer in Europe given that many of international transactions are denominated in US dollars.
Considering all those facts, we propose to include cross-currency swaps within the Article 1 of the RTS. Exposure for this vanilla product would be the same for every institution and it would ensure a level playing field.
When in approach 2, significant risk category determination
First of all, the EBF would like to repeat that institutions should in general be free to use either internal sensitivities or FRTB sensitivities or SA-CCR add-ons for the assessment of the risk drivers’ materiality.
As a general rule, FRTB sensitivities will only be available for trading book instruments, whereas counterparty credit risk (CCR) is broader, covering banking book instruments as well. According to the draft Delegated Act, the EBF understands that institutions that do not meet the conditions set out in Article 94(1) or Article 325a(1) of Regulation 2019/876 (CRR2), respectively, have two options with respect to the treatment of banking book instruments with more than one material risk driver:
- Either they produce FRTB sensitivities for derivatives in the banking book solely for the purpose of the SA-CCR.
- Or, alternatively, they apply the method set out in Article 3(1)(a) of the draft Delegated Act and consider all identified risk drivers to be material.
The first option might be unnecessarily burdensome. The quantitative approach methodology creates a clear dependency between the Market risk Framework and the Counterparty Credit risk (CCR) framework both in terms of methodology and IT systems. As such, depending of bank internal organization, using sensitivities for the identification of the most material risk driver may be burdensome and technically complicated. Therefore, some banks could end up using the fall-back methodology described in Article 3(1)(a) for a significant part of their portfolio, resulting in an overstatement of the exposure.
Therefore, at least with regard to derivative trades in the banking book, all institutions should be given the possibility to use internal sensitivities to conduct the quantitative assessment according to Article 3(1)(b) or to choose the method set out in Article 3(2) of the draft Delegated Act (materiality assessment using SA-CCR add-ons).
First of all, the EBF supports the idea that an approach is available for banks that do not use sensitivities.
Second, the EBF asks EBA to confirm that the conditions set out in Article 94(1) of Regulation (EU) No 575/2013 or in Article 325a(1) of Regulation (EU) No 2019/876 and in Article 3(2) of the draft Delegated Regulation, can be applied to credit institutions that are independent or the subsidiary of a large banking group.
The EBF agrees with the EBA assessment that it would be preferable to set the threshold at a level where the distortions are reduced to a minimum, which is, as stated by the EBA, in line with the objectives of the BCBS. Therefore, the threshold should be set as low as possible (1bp).
However, the EBF would also like to emphasize that the impact of the different thresholds varies from bank to bank and depends on several factors, such as the directionality of the relevant portfolio. Therefore, the EBF’s recommendation to the EBA would be that the EBA should reassess the impact of the various options based on additional examples and decide on this matter once the assessment has been concluded. The industry would be available for further exchanges on the topic.
In the response to the EBA discussion paper titled “Implementation in the European Union of the revised market risk and counterparty credit risk frameworks”, the EBF has noted that some problems could arise from introducing the λ shift into the formula. Therefore, the EBF would like to restate its preference for slightly adjusting the supervisory volatility parameter σ as follows:
When assuming that (R+λ) is log-normal (instead of R in the initial formula) we should introduce σ’ defined as follows:
We consider that (dR/R+λ) = σ’ dW instead of (dR/R) = σ dW, we can then deduce that σ * R* dW = σ’ * (R+λ) * dW, which means that σ in the formula should be replaced with σ'= σ*R/(R+λ)
However, the EBF is aware that the calculation of the supervisory delta has already reached a situation where it is highly complex. Adjusting the volatility will therefore increase complexity. The new EBA proposal to set the supervisory volatility at 50%, which was not present in the earlier EBA discussion paper, is a welcome contribution to current discussion, because it would help to reduce complexity. Consequently, in order to minimize the operational burden on banks, the EBF proposes that banks should be free to apply the abovementioned proposal for adjusting the supervisory volatility or a fixed 50% supervisory volatility.
The method proposed by EBA for determining whether a transaction is a long or short position in the primary risk driver or in the most material risk driver in a given risk category shall allow the qualitative approach set out in article 6(b) for transaction where the classification is done using article 1. As a consequence, the EBF suggests the removal of the following part of article 6(b) of the draft Delegated Regulation: “where institutions apply the approach set out in Article 3(1)(a)” or an amendment stating the following: “where institutions apply the approach set out in Article 1, Article 3(1)(a) or Article 3(2).” This is needed to reflect the different possibilities of conducting mapping that are proposed in the draft.