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EBA Final Draft Regulatory Technical Standards on Prudent Valuation

Core Content

The EBA Final Draft Regulatory Technical Standards (RTS) on prudent valuation under Article 105(14) of Regulation (EU) No 575/2013 (CRR) aim to ensure that fair-valued positions in the trading book and banking book are adjusted to achieve an appropriate degree of certainty. These adjustments, known as Additional Valuation Adjustments (AVAs), are designed to reflect the prudential soundness of institutions and the dynamic nature of trading book positions.

The RTS introduce two approaches for calculating AVAs: the simplified approach and the core approach. The simplified approach is intended for institutions with limited exposure to fair-valued positions, while the core approach is a more detailed and consistent framework that applies to all institutions, including those below the threshold, if necessary.

Main Views and Key Information

Simplified Approach

• Threshold: Institutions with a total of fair-valued assets and liabilities below EUR 15 billion may apply the simplified approach.
• Calculation: AVAs are calculated as 0.1% of the aggregate absolute value of fair-valued positions.
• Exclusions: Exactly matching, offsetting positions are excluded from the calculation.
• Proportionality: Only positions that impact CET1 capital are considered.
• Consolidation: If the threshold is breached on a consolidated basis, the core approach is mandatory for all entities within the group.

Core Approach

• Framework: Provides a consistent and detailed method for calculating AVAs.
• Certainty Target: Institutions should aim for a target level of certainty of 90%.
• AVAs Calculation:
  • Market Price Uncertainty AVA: Calculated based on a range of plausible values and the 90% certainty level.
  • Close-out Costs AVA: Calculated using market data and the 90% certainty level.
  • Model Risk AVA: Calculated using an expert-based approach with defined key factors.
• Aggregation:
  • For market price uncertainty, model risk, and close-out costs, AVAs are aggregated as 50% of the sum of individual AVAs.
  • For other categories, AVAs are simply summed.
• Diversification Benefits: Applied to certain AVAs to reflect the benefits of diversification, especially for instruments not related to expected exit costs.
• Data Sources: Institutions must use market data, including exchange prices, trades, broker quotes, and consensus data. For instruments without reliable market data, proxy data or prudent shifts may be used.

Systems, Controls, and Documentation

• Institutions must maintain systems, controls, and documentation to support the prudent valuation process.
• Documentation should ensure that competent authorities can verify the correct application of AVA requirements.

Future Review of the RTS

• The EBA will review the RTS if future accounting requirements change the approach to determining fair value.
• This ensures the RTS remain aligned with evolving standards and continue to support prudential objectives.

Scope of the Prudent Valuation Standards

• The standards apply to all fair-valued positions, regardless of whether they are in the trading or banking book.
• The term 'positions' refers to financial instruments and commodities.

Impact of AVAs

• AVAs affect CET1 capital but not own funds requirements (unless the small trading book derogation applies).
• The QIS and stakeholder feedback were used to refine the draft RTS and ensure proportionality and operational feasibility.

Aggregation of AVAs

• Simplified Approach: No aggregation is required.
• Core Approach:
  • For market price uncertainty, model risk, and close-out costs, AVAs are aggregated as 50% of the sum of individual AVAs.
  • For other categories, AVAs are aggregated as a simple sum.
  • The total AVA is the sum of all category-level AVAs.

Proportionality and Threshold Considerations

• The threshold for the simplified approach is applied at the individual and consolidated levels.
• Institutions that fail to meet the threshold for two consecutive quarters must notify the competent authority and transition to the core approach within two quarters.

Conclusion

The EBA's final draft RTS provide a structured and proportionate framework for calculating AVAs under Article 105(14) of the CRR. The two approaches—simplified and core—allow for flexibility depending on the size and complexity of an institution’s fair-valued positions. The RTS emphasize the importance of certainty, diversification benefits, and proportionality, while also ensuring transparency, consistency, and compliance with prudential requirements.