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UniCredit Position on CP20 Summary

Core Content

UniCredit Group has provided detailed feedback on the CEBS paper on diversification within the context of Capital Adequacy Assessment. The comments are structured into general remarks and specific section observations, with a focus on improving the clarity, relevance, and practical applicability of the paper for both regulators and financial institutions.

Main Views and Key Points

General Remarks

• Relation to Pillar 2: UniCredit requests clarification on how the paper aligns with the broader scope of Pillar 2, particularly in relation to GL03. It is unclear whether the paper is intended primarily for regulators to harmonise Supervisory Review Process (SRP) or for financial institutions to support Internal Capital Adequacy Assessment Approach (ICAAP).

• Inter vs. Intra Risk Diversification: There is a need for a stronger emphasis on the distinction between inter-risk and intra-risk diversification. UniCredit notes that inter-risk diversification is often more relevant, especially for large, cross-border groups.

• Embedding Diversification in Management: The group highlights the importance of integrating diversification into managerial processes, particularly in the allocation of diversification benefits to business units. This is especially crucial for cross-border entities where business lines operate across multiple jurisdictions.

• Definition of Internal Capital: UniCredit suggests defining internal capital and clarifying its relationship with aggregated economic capital, as the paper currently assumes internal capital without explicit discussion.

Remarks on Specific Sections

• Section 15: The economic capital assessment should be acknowledged as a combination of statistical methods and expert judgment. While statistical testing is valuable, it may not always be feasible, especially when dealing with complex or non-standard assumptions.

• Section 34: For groups that have undergone mergers and acquisitions, consistency across the entire Group should be a key criterion when selecting time series for assessment. Mixing data from previously independent entities can introduce inconsistencies that need to be addressed.

• Section 38: Correlation should not be treated as the sole or interchangeable measure of dependency structure between risk factors. UniCredit points out that correlation can be misleading in the case of heavy-tailed distributions, and that dependency structures may require more sophisticated modeling approaches.

• Section 39: The scope of the section on dependency should be clearly defined, distinguishing between dependencies among risks and among risk factors. The former is considered to be exogenous to business strategy, while the latter is influenced by strategic decisions, such as increasing exposure to large corporate clients, which can affect the correlation between credit and market risks.

• Section 49: Risk management is viewed as a process that includes both models and expert judgment. Expert judgment is essential in overcoming data limitations and incorporating non-quantifiable information. It should be integrated with statistical estimates, such as Bayesian methods, but within a robust framework that includes scenario analysis and back testing.

• Section 58: Stress testing is an important tool for risk management, and UniCredit suggests that stresses on diversification can arise from two sources: changes in the dependency structure (e.g., increased correlation) and changes in the levels of individual risks. Both factors should be considered in assessing the impact on diversification.

• Section 88: The comparison of economic capital to regulatory requirements should take into account that large organizations may have moved away from internal models like IRB or AMA towards standardized approaches. This transition must be reflected in the comparison to ensure accuracy.

• Section 101: Consistency among regulators is essential for achieving a coherent capital adequacy framework. Differences in regulatory requirements across countries could disrupt the consolidated approach that is central to ICAAP, thereby undermining the effectiveness of the capital assessment process.

Conclusion

UniCredit's feedback underscores the importance of aligning the paper with Pillar 2 requirements, clarifying the role of diversification in risk management, and ensuring that the methodologies used are both robust and adaptable to different organizational structures and regulatory environments. The group also emphasizes the need for greater transparency and consistency in both the modeling and regulatory aspects of capital adequacy assessment.