22 March 2016
The European Banking Authority (EBA) launched today a public consultation on draft Guidelines on corrections to modified duration for debt instruments. These Guidelines aim to establish what type of adjustments to the modified duration (MD) - as defined according to the formulas in the Capital Requirements Regulation (CRR) - have to be performed in order to appropriately reflect the effect of the prepayment risk. The consultation runs until 22 June 2016.
The CRR establishes two standardised methods to compute capital requirements for general interest rate risk. One is the so-called maturity-based calculation for general interest risk, while the other one is the duration-based calculation of general risk.
These draft Guidelines are relevant for institutions applying the duration-based calculation, and propose two approaches to correct the modified duration calculation. The first approach treats the instrument with embedded optionality as if it were a combination of a plain vanilla bond and an option whilst the second approach proposes to calculate directly the change in value of the whole instrument subject to prepayment risk. The Guidelines also propose to compute additional adjustments to reflect the negative convexity as well as transaction costs and any relevant behavioural factors that may affect the modified duration of the instrument.
Responses to this consultation can be sent to the EBA by clicking on the "send your comments" button on the consultation page. Please note that the deadline for the submission of comments is 22 June 2016.
A public hearing will take place at the EBA premises on 25 April 2016 from 15:00 to 17:00 UK time.
Legal basis and next steps
The draft Guidelines have been developed according to the last subparagraph of Article 340(3) of Regulation (EU) No575/2013 which mandates the EBA to develop Guidelines to specify how to apply corrections to the calculation of the modified duration to reflect prepayment risk.