It is our interpretation that the prudential filter established in CRR Article 33(1) applies only to unrealised capital gains and losses, since:

• Article 33 – 1 establishes prudential filters for items that while included in shareholders’ equity from an accounting perspective should not be included in prudential own funds, including in (a) the fair value reserves related to gains and losses on cash-flow hedges of financial instruments that are not valued at fair value, including projected cash flows. Points (b) and (c) of the same article include fair value changes from changes in the own credit standing of the institution and gains and losses from the institutions own credit risk related to derivative liabilities;

• Once a gain or loss has been realised and settled it is no longer subject to economic fluctuations in value, regardless of the subsequent accounting treatment. While realised gains and losses from cash-flow hedges are amortised through P&L during the projected life of the original hedged cash-flows, the contribution to shareholders’ equity and, therefore, to own funds, remains unchanged from the date in which the gains or losses were realised. The same is true for items described in (b) and (c), for which the recognition in P&L occurs immediately upon realisation;

- The CRR, in article 35, recognises that the prudential filters established in article 33 refer to unrealised gains and losses when it states that “Except in the case of the items referred to in Article 33, institutions shall not make adjustments to remove from their own funds unrealised gains and losses on their assets and liabilities measured at fair value.”;

- The EBA recognises in “Technical advice to the Commission on possible treatments of unrealised gains measured at fair value under Article 80 of the Capital Requirements Regulation (CRR)” paragraph 9 (page 11) that “The CRR also retains a prudential filter for unrealised gains and losses arising from cash flow hedges and for changes in the value of liabilities (debt instruments and derivatives) due to changes in own credit risk (Article 33 CRR). The first filter was introduced in the CRR in order to take into account the asymmetry in the accounting treatment of cash flow hedge transactions between the hedging instrument and the hedged item. The second is necessary to avoid the counter-intuitive effect that the level of own funds is conversely proportional to the credit quality of the institution itself. As these filters are prescribed by the CRR, the EBA has excluded them from the scope of the technical advice.”;

- The Basel Committee, in Working Paper 28, when discussing prudential filters for regulatory capital (section 4.3, page 17) explicitly states that “Following this agreement, the EU Capital Requirements Regulation, which came into force in January 2014, disposes of nearly all prudential filters for the calculation of own funds, and in particular the one referring to unrealised gains and losses which are recognised in the revaluation reserve. It retains, however, a prudential filter for unrealised gains and losses arising from cash flow hedges and for the changes in the value of liabilities (debt instruments and derivatives) due to changes in own credit risk”;

- Such understanding is, in our view, the only one consistent with underlying economic substance as it reflects crystalised gains or losses immediately in own funds. It is prudent because  realised gains and losses are no longer uncertain or subject to changes in value and, from a prudential standpoint, in case of realised losses in the Cash Flow Hedges, such immediate recognition ensures the most conservative assessment of own funds, as the alternative would result in an overstatement of regulatory own funds.