Introduction
The European Banking Authority (EBA) recently organised a public hearing on two important topics in banking supervision: the Regulatory Technical Standards (RTS) on the Fundamental Review of the Trading Book Framework (FRTB) and the Standardized Approach for measuring Counterparty Credit Risk exposures (SA-CCR). The proposed amendments are part of the roadmap on the EU Banking Package and aim to align the existing RTS with the Capital Requirements Regulation 3 (CRR3). The deadline to respond to the consultation was March 14, 2024.
Content of the Consultation Paper
In the context of the CRR3, several changes have been made to the FRTB. These include mandates to the EBA to revise the existing RTS to ensure compatibility with the new Level 1 text. The changes primarily relate to the treatment of FX and commodity risk in the banking book under Article 325 CRR3, as well as the profit and loss attribution requirements under Article 325bg CRR3 and the risk factor modellability assessment under Article 325be CRR3. The primary objective of these revisions is to synchronise these standards with the CRR3 and thereby promote a stable regulatory environment.
With respect to the RTS on profit and loss attribution requirements, the Consultation Paper proposes amendments, that reflect the new wording in Article 325bg CRR and remove the formulas for aggregating capital requirements for market risk from the delegated regulation, as they are now included directly in Article 325ba CRR.
In relation to the RTS on modellability assessment, the Consultation Paper proposes changes including documentation requirements to assist the competent authority which may allow institutions to use third-party market data to perform the modellability assessment. This has been introduced in line with the new provision in Article 325be, which states that the competent authority may allow institutions to use market data from third-party vendors to perform the modellability assessment.
In relation to the RTS on FX and Commodity Risk in the Banking Book, the Consultation Paper proposes amendments including requirements to ensure that institutions can identify positions that are exposed to FX risk only because of the translation risk resulting from the consolidation process, and to ensure that the institution has clear policies in place to clarify which positions are managed by traditional trading desks and which are instead managed in the context of a notional position.
A notable amendment under the CRR3 is the extension of the EBA's mandate under Article 279a(3)(a) regarding SA-CCR. This includes the specification of formulas for the calculation of the supervisory delta for interest rate options, which now includes negative interest rate scenarios, and the extension of this approach to commodity options in the context of negative commodity prices, a scenario that occurred during the COVID-19 pandemic. The existing RTS on SA-CCR, which already specify the supervisory delta formula for interest rate options compatible with negative interest rates, should therefore be expanded to specify the formula to be used to calculate the supervisory delta of commodity options compatible with negative commodity prices (and the corresponding supervisory volatility). The proposed supervisory delta formula suitable for negative commodity prices is the same as that set out in Article 279a(1)(a) of the CRR, but it additionally includes a 𝜆 shift to the terms 𝑃 and 𝐾 to bring them into positive territory when they are negative. The value of the 𝜆 shift is set so that a certain threshold is not exceeded on the smallest (i.e., more negative) term between 𝑃 and 𝐾. The formula is applied at the transaction level. This approach is consistent with the approach for interest rate options in the existing RTS. The existing RTS on SA-CCR will also be revised to maintain consistency with the text of the CRR as amended by CRR3.
Implication for banks
The implications of the changes of the RTS on FRTB should be limited in addition to the changes made in the CRR3 since they mostly reflect those changes but do not introduce new significant requirements. In addition, the changes mostly affect Alternative Internal Model Approach (A-IMA) banks. Nevertheless, these changes need to be reflected in the governance and processes for market risk.
The implications of the changes of the RTS on SA-CCR are wider. The adoption of the new method provided for calculating deltas for options mapped to the commodity risk category will require additional model development, implementation, and potential validation efforts. For example, banks will need to
- Amend model governance documents and implementation relating to the calculation of supervisory delta for commodity risk mapped options including the additional regulatory variable λ,
- Conduct independent validation of the amended model, and
- Revise data quality processes and remove potentially existing own makeshift remedies relating to negative commodity prices (e.g., flooring)
Meanwhile, impact on numbers is expected to be small as shifts will only apply under negative commodity prices.
Conclusion
In conclusion, the EBA's public hearing on the RTS on FRTB and SA-CCR highlights the regulator's focus on enhancing risk management practices in the banking sector. Banks should closely monitor the developments in these standards and prepare for the upcoming compliance requirements. It is recommended that banks review their risk management frameworks, assess the impact of the proposed amendments, and take necessary actions to enable compliance. Additionally, banks should stay informed about future trends and upcoming changes in this specific area of banking supervision to proactively adapt their risk management practices.
Contact us
