Could the EBA advise whether the reference to “provisions” within the answer to Q&A 2014_933 and 2014_950 refers to specific credit risk adjustments (“SCRAs”)? If so, could the EBA advise if there are any restrictions to the application of AVA against EL as the existing text and level 1 text could be read that any AVA on an IRB exposure would be eligible for offset under Article 159.
This question follows on from the clarification provided by EBA in Q&A 2014_933. In the response it states that the intention is to ensure that EL is only deducted to the extent it has not already been reflected through either: “….general and specific credit risk provisions within the financial statements, which are the starting point of the own funds calculation; or - adjustments to these general and specific credit risk provisions, deducted from own funds according to Article 34 to meet prudent valuation requirements of Article 105 of the CRR It is therefore only Additional Value Adjustments deducted from own funds according to Article 34 of the CRR that should be included in this calculation.” Furthermore Q&A 2014_950 was answered as follows “This follows immediately from the restriction of expected loss amounts to those calculated in accordance with Article 158(5), (6) and (10) of the CRR. The whole treatment of expected loss amounts specified by Article 159(1) of the CRR is deliberately restricted to those exposures for which expected loss amounts are calculated in accordance with Article 158(5), (6) and (10) of the CRR. This is the reason why general and specific credit risk adjustments and additional value adjustments in accordance with Articles 34 and 110 and other own funds reductions are taken into account only to the extent they are related to these exposures.” This seems to suggest that AVA on IRB assets for which an EL is calculated may be included within the Article 159 calculation. The restrictions referred to in 2014_950 appear to exclude AVA on non-IRB assets but not set any restriction on what AVA for IRB assets may be included in the calculation as long as that AVA has been deducted from own funds in accordance with Article 34. The prudential valuation requirements apply only to exposures that are fair valued. As the EBA’s RTS 2013/04 credit risk adjustments made clear, fair value changes are not eligible as SCRAs. In addition, items that are fair valued under IFRS do not have accounting impairment applied to them. Rather, any credit risk deterioration is captured within changes to the fair value. The only exception being Available for Sale (AFS) assets whereby if required, a provision is recognised by reclassifying to profit and loss the cumulative loss recorded in the AFS reserve. We do not believe that the intention of the response to question 2014/933 is to limit the use of AVAs to circumstances where there is an “overlap” between the AVA and any SCRA otherwise it is hard to see how this will be achieved; any AVA would be recognised outside the financial accounting regime and would reflect valuation uncertainty. The provision would be the re-characterisation of some (or all) of the AFS write down in the financial accounting regime. Would the AVA recognised for offset under Article 159 need to be restricted to an element of the AVA which is specifically related to the AFS valuation change which had been recycled as a provision? If there is a restriction to the use of AVA recognised in CET1 arising on IRB assets in the Art 159 calculation it is likely that there will be an overlap in the capital requirements on impacted positions as the exposure value under Article 166 “shall be the accounting value measured without taking into account any credit risk adjustments made”. This might result in a capital requirement for the element covered by AVA in excess of 100% CET1.
The term ‘provisions’ in the answer to Q&A 2014_933 refers to general and specific credit risk adjustments as defined by Article 110 of Regulation (EU) No 575/2013 (CRR) and Commission Delegated Regulation (EU) No 183/2014.
As Article 159 CRR applies to credit risk exposures, only AVAs related to credit risk exposures due to counterparty default should be considered for inclusion within the offset defined in this article. This includes AVAs calculated under Article 12 of Commission Delegated Regulation (EU) 2016/101 on instruments to which credit risk impairments have been applied under the applicable accounting framework. Whilst some of these AVAs may arise from market risk they should nevertheless be included because (as confirmed by QA 2013_101) Regulation (EU) No. 183/2014 links the entire fair value change on such instruments to the credit deterioration through recognition as a credit risk adjustment; any AVA on these instruments is thereby related to Credit risk for the purposes of Art 159.
Update 26.03.2021: This Q&A has been reviewed in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR) and continues to be relevant.