11 January 2013

Industry response to EBA's discussion paper on Draft RTS on prudent valuation under Article 100 of the draft CRR

This letter contains the response of ISDA, AFME and BBA to the EBA's Discussion Paper on "Draft Regulatory Technical Standards on prudent valuation under Article 100 of the draft Capital Requirements Regulation (CRR)" of November 2012.

The Industry agrees with the need to specify how to apply the prudent valuation requirements in Article 100 of the draft CRR consistently and believes these aims are achievable. It recognises the importance of having both a comparable starting point for the calculation of regulatory capital resources, and confidence in the realisability of the valuations used within that calculation. However it does not believe the approaches currently laid out achieve this, and in fact they are likely to worsen comparability as discussed further below. The Industry therefore proposes a consultation group, comprising industry, regulators and auditors, be set up to explore how these aims can be achieved.

The predominant concern with the proposal is that it attempts to address a perceived inconsistency in fair value (which is backed by trade levels, market quotes and supplemented by well defined price verification and auditor review) with a confidence level approach that is not backed by any of these, and as such it is unrealistic to believe that improved consistency can be achieved at a threshold that is significantly less well defined. The proposed regulations would increase subjectivity and reduce comparability across firms.

The Industry’s preferred option is for an approach that supports and enhances the existing valuation methodologies and practices rather than creating a new and independent set of processes. The Industry believes that the Competent Authorities should work with the institutions in assessing the quality of their practices and methodologies around the implementation, governance, validation and degree of challenge of the valuations process. Where these are viewed as insufficient to achieve the desired confidence around the prudence of the valuation further AVA’s should be taken to achieve the desired confidence and to act as an encouragement to improve processes.

The Industry believes the current proposals are unnecessarily prescriptive and formulaic for liquid positions and offer little guidance particularly for illiquid and complex positions which involve a greater level of judgement and subjectivity. The Regulatory Technical Standards (RTS) should recognise the necessary balance between judgement and science in this area. Judgement is needed by firms, and by a supervisor assessing whether a firm is being sufficiently prudent. No formulaic approach can substitute for the use of judgement and a less prescriptive general approach, without a formulaic confidence level, should be proposed instead.

For liquid positions where a more prescriptive and formulaic approach is possible to implement, there is very limited analytical benefit and impact to capital of applying the approach proposed in the Paper. Liquid positions, where fair value is not materially different from prudent value, should be excluded from the full rigours of the proposed approach. Incorporating liquid assets in the framework will divert resources and attention that would be better spent on assessing the prudence of valuations for more complex and illiquid assets.

Full letter

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