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Summary of EBA Roadmap for the New Market and Counterparty Credit Risk Approaches

Core Content

The European Banking Authority (EBA) has outlined a roadmap for the implementation of the new market risk and counterparty credit risk frameworks in the EU, specifically the Standardised Approach for Counterparty Credit Risk (SA-CCR) and the Fundamental Review of the Trading Book (FRTB). This roadmap is based on the EBA's Discussion Paper (DP) published on 18 December 2017 and takes into account the responses from industry stakeholders and the European Commission's CRR2 legislative proposal.

The EBA's approach is structured into four phases, prioritising the implementation of essential elements of the framework first, followed by more complex regulatory deliverables that require feedback and experience from early stages.

Main Views and Concerns

1. SA-CCR – Mapping of Derivatives Transactions to Risk Categories

• Respondents supported the idea of identifying transactions with clear risk categories.
• There was a preference for including interest rate forwards on investment grade and non-investment grade bonds, as well as commodity swaps, dividend swaps, and FX fader options.
• A cap on the number of risk categories per derivative transaction was suggested, with a preference for a maximum of two categories.

2. SA-CCR – Corrections to Supervisory Delta

• The λ shift adjustment was proposed to account for negative interest rates.
• Respondents preferred allowing institutions to reflect the market convention for λ at the subportfolio level.
• The shifted lognormal model was discussed as an alternative, with the formula: min(P + λ, K + λ) = 1%.
• A simple and conservative approach was welcomed for institutions unable to perform quantitative calculations.

3. FRTB – Trading Book Boundary

• A flexible framework was preferred, with "trading intent" as the key criterion for determining trading book status.
• There was a call to differentiate between automatic reallocations and those initiated by the institution.
• Supervisory approval should not be required for automatic reallocations that reduce capital requirements.

4. FRTB – Treatment of Non-Trading Book Positions Subject to FX or Commodity Risk

• Most respondents believed that these positions were not material in terms of market risk capital requirements.
• Concerns were raised regarding the valuation of non-fair-valued positions and the frequency of revaluation.
• A minimum number of notional trading desks was not supported, though some suggested one desk per asset class.
• Backtesting and P&L attribution requirements were generally not applicable to non-daily or non-fair-valued positions.

5. FRTB – Residual Risk Add-on (RRAO)

• Respondents supported the general definitions of instruments with residual risk.
• A principles-based approach was preferred over a list-based approach.
• Concerns were raised about the inclusion of instruments like variance swaps and those without optionality but with vega risk.
• Some suggested that RRAO should apply only in cases where the uneconomic exercise of options leads to increased duration or losses.

6. FRTB – IMA Liquidity Horizons

• Respondents supported the proposed approach for mapping risk factors to liquidity horizons.
• Concerns were raised about the potential for capital benefits and differences in capital requirements due to varying mapping rules.
• A single liquidity horizon of 10 days for all currencies was suggested.
• The three-year revision period for liquidity horizons was questioned, with some preferring a yearly update.

7. FRTB – Backtesting and P&L Attribution Requirements

• The composition of the hypothetical P&L (HPL) was a major point of discussion.
• Some respondents preferred excluding valuation adjustments (VAs) from the HPL, while others supported including them.
• A general consensus was that VAs should only be included in HPL at the top of the house.
• The time/theta effect was supported as part of the P&L, with a preference for a more generic definition.
• The risk-theoretical P&L was seen as consistent with the HPL criteria.
• The EBA's proposed fallback approach for non-modellable risk factors was welcomed, though concerns were raised about the conservativeness of the method.

8. FRTB – Non-Modellable Risk Factor (NMRF) Stress Scenario Risk Measure

• The 1-year stress period for modellable risk factors was considered suitable for NMRFs.
• Data types were proposed to be consistent with those used for modellable risk factors.
• A fallback solution was preferred, with a specific range of stress scenarios.
• The SA risk weights were considered too high for the purpose of stress scenarios under this fallback approach.

Key Implementation Issues

• Operational burden: The EBA acknowledged concerns regarding the implementation of the IMA and its supervisory approval processes.
• Regulatory certainty: Institutions require legal clarity to invest in system upgrades and process improvements.
• Harmonisation: Technical standards should align with international norms to ensure a level playing field.
• Confidentiality: Some stakeholders requested confidentiality for their responses.
• Thresholds: The EUR 500 million threshold for reporting requirements was accepted, though some questioned the recalibration of the standardised approach below this threshold.

Regulatory Deliverables and Deadlines

• The SA-CCR is fully incorporated into CRR2 and is expected to apply from 2 years after its entry into force (2021).
• The reporting requirement for FRTB is expected to come into force by 31 December 2019.
• The full implementation of the FRTB framework, including capital requirements, is expected to follow through a legislative proposal by the Commission by 30 June 2020.

EBA Commitment

• The EBA is committed to addressing implementation challenges and ensuring a smooth transition.
• Stakeholder input has been integrated into the development of regulatory deliverables.
• The EBA will continue to refine its approach based on feedback and evolving standards.

Conclusion

The EBA's roadmap aims to ensure a structured and consistent implementation of the new market and counterparty credit risk frameworks in the EU. By prioritising key elements and addressing concerns raised by stakeholders, the EBA seeks to balance regulatory rigor with operational feasibility.