EBF publishes response to EBA consultation on prudent valuation under article 105(14) of CRR

16 October 2013

The EBF notes many areas of positive developments, but calls for clarification of the scope and would argue that it would make more sense that the scope of prudential valuation be limited to the trading book.

The EBF notes many areas of positive developments in the guidance provided in the consultation paper, in particular the recognition of a diversification factor of 50 per cent as a standard measure and the fact that liquidity risk is excluded from the category of adjustments to be done for AVA computation.

As regards the current draft RTS, the main concern lies with the definition of scope. EBF members have serious concerns as to the impact of such a wide scope, as all items at fair value would have in operational terms and in the capital requirements of banks.

The EBF defends that instruments of own funds and own debt should be excluded from prudent valuation as there is no intent of trading. Furthermore, EBF would urge the EBA to consider the combined effect of the prudent valuation proposed in this consultative paper and the discussion paper on possible treatments of unrealised gains measured at fair value under Article 80 of the Capital Requirements Regulation (CRR) in order to avoid double deduction from own funds.

The EBF calls for clarification of the scope and would argue that it would make more sense that the scope of prudential valuation be limited to the trading book. The EBF observes that trading book is the scope envisaged in the Capital Requirements Regulation (CRR), article 105, while article 35 could be considered as an emphasis.

Should the EBA determine that this is not the CRR intention, the EBF would argue that the RTS should clarify that article 35 relates to financial instruments in the accounting sense, and include specific provisions for non-trading exposures. In particular, EBF draws the EBA attention to the following issues:

• The instruments used as hedges, notably of interest rate risk, of loans and receivables in the banking book are not intended for immediate realization or necessarily available for such realization. It is EBF’sview that while estimating a close out cost for these instruments in isolation makes little economic sense, the inclusion of value in the scope of Prudent Valuation goes beyond the scope of articles 35 and 105, and does not correspond to realistic close out scenario. This ambiguity calls at least for clarification of the CRR intention with regard to derivatives used as interest rate hedge of loans and receivables portfolios,
• In application of IFRS13, EU banks are required to factor their own credit risk when measuring the fair value of derivatives and of own debt designated at fair value. The article 33 of the CRR states that the gains and losses arising from changes of own credit risk should be deducted from the own funds. Therefore, EBF believes that the RTS should also explicitly exclude these from the scope of prudent valuation framework. The EBF would argue that own credit risk, as a risk factor, should be scoped out of the RTS.
• In the view of the same article 33, EBF believes that EBA should explicitly clarify that cash flow hedges targeted by the prudential filter in paragraph 1 (a) are also scoped out.
• Assets that are deducted from own funds according to articles 36, 56 and 66 of the CRR should be scoped out of prudential valuation. Including such assets within the scope of prudential valuation would clearly amount to double counting of deductions.
• Finally, EBF would argue that the application of the prudent valuation requirements should be aligned with the phasing of the prudential filter related to the AFS portfolio. The EBF would argue that the simplest approach is to exempt the AFS portfolios during the phasing period.

As to the trading book positions, the EBF would welcome further simplification with regard to the zero AVA provisions. The EBF argues that instruments that are eligible liquid assets and are classified as level 1 in the accounting fair value hierarchy should be assigned zero market price uncertainty AVA and zero close out cost AVA. The EBF further suggests that instruments traded in exchanges, and meeting the requirements of article 338 of the CRR should attract zero Close out cost AVA with no further documentation of the 90% confidence interval (art 9.3 of the RTS).

The EBF also has significant concerns with the back-testing requirements within Article 8 paragraph 4 (b) and Article 9 paragraph 5 (b) which EBF does not believe will achieve consistency in risk aggregation across the industry. The reasons why it is not believed that these paragraphs would lead to consistent reduction in parameters is that the calculation is dependent upon an institution’s position at the point in time that the ratio is calculated. The guidance as currently drafted would also enable institutions to select any reduced set of parameters that pass the stipulated test in order to optimise their uncertainty calculations, even where this is not reflective of the market structure or risk management practices. In addition, EBF also believes this guidance to be extremely onerous given that detailed calculations would need to be performed for each set of parameters each period.

Regarding the timing, it is important to note that it could take at least nine to 12 months for banks to upgrade their internal control frameworks. This entails implementing and upgrading valuation policies and price test departments and the IT infrastructure that should support the process proposed. As IT applications can only be designed using detailed and specific instructions, the analysis of the upgrade can only start the moment the final RTS is available. After the RTS is available banks need to study it, discuss it with IT developers who need to convert it into IT specifications and finally it needs to be programmed and tested. This process will last at least nine to 12 months. Consequently, EBF advises EBA to include in its RTS that banks will have maximum 12 months to fully implement the requirements and how to cope with prudent valuation as from 1 January 2014 before it has been fully implemented.

Full response

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