Response to consultation on Regulatory Technical Standards on prudent valuation
If not, please describe the challenges you face with regard to a monthly calculation, and the monthly reporting of fair values and AVAs (e.g. with the COREP templates). Please make clear if those challenges arise in general or with regard to specific positions (e.g. type of instruments), whether they arise for positions assigned to the trading or non-trading book, and whether they arise for positions treated under the simplified or core approach. Please describe any simplifications and/or assumptions you would have to apply to determine fair values and AVAs on a monthly basis.
General comments:
The suggested changes are far reaching and lead to high implementation burden. Therefore, an imple-
mentation period of at least 6 months between publication in the official journal and application should
be foreseen.
Question 1:
The monthly calculation would significantly increase expenses, associated with higher personnel re-
quirements and more challenging substitution arrangements, leading to substantial secondary ex-
penses, especially in times of skilled labour shortages. Moreover, higher costs for market data can be
expected, which now must be obtained much more frequently. An increase in reporting frequency
could cause overlaps in the process chain, potentially extending the process for creating COREP tem-
plates, which currently takes up to 30 working days. Additionally, there is the generally high cost of
collecting data for both trading and non-trading book positions (including extra data for COREP, e.g.,
granular breakdowns) and for preparatory work before the respective reporting date.
To date, fair values, fair value adjustments, nor prudent value adjustments for the total portfolio of
non-trading book positions have been calculated on a monthly basis. Determining these values re-
quires significant effort, particularly for non-trading book institutions, or is initially not feasible, as
some data is only available quarterly, such as for credit and unlisted equity positions, for which fair
values are calculated quarterly for FINREP purposes. A simplification could be the extrapolation of the
quarterly calculated fair values.
Furthermore, the turnover rate for portfolios is sometimes very low for various banks due to their
strategy. In this case, the benefit of more frequent calculation seems limited. The management of val-
uation uncertainty also takes place over a longer term than that of market risks, meaning that
monthly management impulses from prudent valuation would be of little use or even detrimental due
to increased complexity.
The RTS already prescribes stricter regulations that prevent “window dressing,” for example. This ren-
ders monthly reporting redundant for this purpose.
It would be very difficult for banks to calculate AVA for dates in the past. It should therefore be clari-
fied that the regulator can only require banks to calculate AVA on a monthly basis starting from the
date of the request but not retrospectively for dates in the past. Otherwise, banks would need to mod-
ify their infrastructure for such a retrospective calculation what would result in significant costs.
Question 2. Do you have any comments on the amendments to Article 3 in general, and specifically with regard to the threshold of ten contributors set out in paragraph 2, point (d)? If you consider a different threshold should be applied, please describe how to set it, and provide a rationale and evidence supporting your proposal.
The exclusion of indicative broker quotes and consensus service data from the range of market data
sources for the range-based approach would produce significant challenges. The current proposal
would lead to a dominance of the expert-based approach as, for example, proof of tradability for bro-
ker quotes is rarely possible. This would result in significantly increased effort in terms of validation,
back-testing and reporting, which can even pose methodological difficulties.
We do agree that, in terms of data quality and reliability, indicative quotes and consensus data are to
be placed between executable quotes and proxy data. It remains to be decided where to draw the line
between the range-based and the expert-based approach. While it seems plausible to make that deci-
sion based on the perceived quality of the data (one may still argue that indicative quotes are usually
of high quality), we feel that it is more appropriate to make this decision based on the consequences
of that decision. The following examples shall outline these:
Example 1: Consensus data (Totem) is frequently used as source for swaption volatilities. The number
of contributors may occasionally drop below 10 and therefore the data may become expert-based. Ar-
ticle 9, point 9 states that in this case an independent unit “shall verify the adequacy of the assess-
ment made and the methodology applied”. Such an audit seems inappropriate as the consensus data
will be processed in exactly the same way as range-based consensus data.
Example 2: Bonds are traded almost exclusively in an OTC market (the volume traded at exchanges is
usually insignificant by comparison). Market makers provide quotes in this OTC market with the inten-
tion to trade at that price at that point in time. Yet these quotes are not legally binding as brokers pre-
fer to keep a last look option for the very rare case of disruptive external events (like an earthquake).
Article 9, point 10 states that “[institutions] shall notify the competent authority of the methodology
used to determine the largest individual market price uncertainty AVAs under that approach, repre-
senting at least 20% of the total individual AVAs determined on the basis of that approach.” With in-
dicative quotes as expert-based input, this list will often be dominated by government bonds.
Example 3: Especially non-trading book institutions without the capacity to participate in consensus
service data processes would be affected by the proposed adjustments. In such institutions, sources
according to letters (c) and (e) of RTS 2016/101 Art. 3.2 are primarily used in the construction of a
range of quotes. Due to the tradability vs indication fluctuation of a quote throughout the day and in
the absence of a clear and historised flag from market data providers such as Reuters or Bloomberg a
quote would when in doubt be categorised as indicative due to the missing flag whereas it would actu-
ally be tradable. Consequently, this would lead to a significant amount of valuation exposures (even
very liquid and tradable valuation exposures such as EUR ESTR) being allocated to an expert-based
approach.
Based on these examples, we suggest a broader approach towards using indicative broker quotes and
consensus service data for the range-based approach.
The additional obligations that come with the expert-based approach seem most appropriate when ac-
tual expert judgement is employed. This is not the case for consensus data with less than 10 quotes
that is still processed identically to consensus data with more contributors, or for external, indicative
quotes that are not formally binding. At the same time, the additional obligations would increase insti-
tutions’ operational cost and there is a risk that the reporting is diluted.
We particularly propose to include indicative broker quotes in the list of sources of market data listed
in Art. 3.2 for the purposes of the range-based approach. With the additional requirements on market
data sources in Art. 3a, in particular the requirement of regularly updated data in Art. 3a.2a, as well
as the requirement of Art. 3.2 to use reliable market data, we are of the opinion that the accuracy and
reliability of indicative broker quotes is for most cases ensured. For cases where indicative broker
quotes might not meet the criteria they would in most cases be excluded in the process of market
data collection leaving only a very minor portion of quotes that might enter the range-based approach
while being unreliable. In our view this false inclusion of indicative quotes is outweighed by the possi-
bility to apply the range-based approach to a broader range of valuation exposures and limiting the
usage of expert-based approaches.
The classification of historical data that dates back more than 1 month as expert judgement will effec-
tively increase the portion of AVA classified as expert judgement despite the existence of reliable data.
As a consequence, banks are forced to favour non-binding consensus rather than actual traded prices.
Therefore, we propose to allow the use of transaction pricing data for up to 3 months in “Data Range”
approaches with necessary adjustments if market conditions at the reporting date are materially dif-
ferent from those 3 months earlier.
Question 3. Do you have any comments with regard to the requirements proposed in Article 3a? If you consider that some of those requirements should be adjusted, please describe how you would revise them in order to meet the policy objectives that the proposed amendments try to achieve, and provide the rationale supporting your proposal.
Significant additional expenses are to be expected to provide evidence for the use of the expert-based
approach or to prove the absence of relevant market data for the core approach. It might be neces-
sary to license additional market data, the costs of which do not proportionately reflect the quality im-
provement of the AVA calculation. Furthermore, smaller institutions that calculate the AVA using the
core approach are at a significant disadvantage compared to larger institutions with broader access to
market data.
The end of the year, as the most crucial reporting date, coincides with the period of the least liquid
market data. Specifically, here, it seems sensible to rely on data from an alternative cut-off date with-
out the necessity for subsequent adjustments.
This leads to increased expenses due to the obligation for evidence and documentation, potentially
shifting further activities to periods that are already heavily burdened (shortly after the year-end).
We generally request the provision of criteria that would constitute an acceptable (reasonable) effort to
obtain data from sources as per Article 3.2.
Question 4. Do you agree with the proposed amendment to capture valuation risks stemming from fair-valued back-to-back derivative transactions and SFTs? Do you agree that this would restore alignment with the treatment under the core approach? If not, please describe how you would suggest to revise the amendment providing any rationale and supporting evidence.
NA
Question 5. Do you agree with the proposed amendments to the calibration of the fall-back approach? If you consider that a different range of percentages should be considered, or that the AVAs under the fall-back approach should be calculated in a different manner, please suggest a range or a methodology, as applicable, and provide a rationale and evidence supporting your proposal.
The expansion of the scope and the calibration of the charge result in various issues. For instance, the
notional-related charges for derivatives are not reflective of the actual economic risk. Moreover, the
framework lacks the concept of significance for risks that could not be independently verified / price-
tested and thus removes banks’ ability to assess & capitalise the economic risk. Moreover, the range of
charges (1-15%) is not consistent with the FRTB RRAO (0.1%-1%) for derivatives.
Question 6. Do you have any comments in relation to the positions proposed to be subject to the fall-back approach? If you consider a different treatment should be applied to these positions, please describe how you would treat them in order to meet the intended policy objectives, and provide the rationale and any evidence supporting your proposal.
NA
Question 7. Are the requirements included in Article 8 clear? If you consider them to be not clear or to be particularly challenging to meet in specific circumstances, please describe the issue you encounter and how you would address it in order to meet the intended policy objectives, and provide the rationale and any evidence supporting your proposal.
A major existing shortcoming of the core approach is the partial double counting of risks with respect
to Day One Profit Deferrals under IFRS. We urge the EBA to rectify this issue by allowing a partial off-
set subject to the following safeguards:
• Banks need to map the deferred Day One Profit reserves directly to the corresponding AVA for
the respective valuation uncertainty drivers.
• The amount that can be offset is generally capped at the AVA.
The requirement of Art. 8.7 of inclusion of convexity and cross-order effects is challenging and re-
quires significant effort of implementation and introduces a significant layer of computational burden
with limited expected effect from a mostly plain vanilla portfolio. Gamma/x-gamma risks require large
moves to become material, which is more relevant for VaR / stressed VaR calculations rather than val-
uation uncertainty. Therefore, this requirement should be dropped.
In case this requirement is not dropped, could the EBA please elaborate in which manner a demon-
stration might be achieved and how frequent such demonstration would be required? Please also pro-
vide guidance if such cross-order effects in sensitivities should be recognized solely in the VRT or in
the AVA calculation itself when using a sensitivity-based approach.
The requirement to calibrate end-of-day models quarterly means an unnecessary operational burden,
as institutions already use these models to demonstrate marking to market (Fair Value). We propose
to drop this requirement.
Question 8. Do you have any comments with regard to the amendments to Article 9, 10 and 11? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
Significantly higher expenses are anticipated in the determination of the MPU and the chain of cus-
tody. Regarding the market data utilized (in accordance with Article 3/3a), the expert-based approach
is predominantly applied. This leads to substantially increased efforts in terms of validations, verifica-
tions (e.g., conservatism), documentation, and the establishment of an additional independent unit for
the annual validation of the methodology. (Points 9, 10, 11)
Concerning the penalization of the used market data (indicative broker quotes), this may result in the
elimination of various zero AVA positions, thus leading to an unjustifiably significant increase in the
MPU (CoC). (Point 3)
In model-based approaches with a reduced parameter set, significantly higher expenses are incurred
due to verifications, validations, variance ratio tests, and the establishment of an additional independ-
ent unit. (Points 7, 8)
Additionally, this results in the loss of the diversification factor, leading to significantly higher AVAs.
(Annex 2(a)(ii)(2))
The changes with regard to the Variance Ratio Test disincentivise hedging because they penalises
hedging strategies not matching exactly end-of-day risk buckets. This increases dispersion of capital
across banks, subject to each bank's risk bucket definition and choice of hedges. Moreover, it is Incon-
sistent with other capital requirement measures (e.g. FRTB NMRF), where the prescribed bucket re-
duction does not penalise aggregation. Therefore, we suggest to remove the alpha factor requirement
and instead introduce targeted restrictions on the VRT application:
• Minimum number of buckets, e.g. no fewer buckets than the amount used for the purpose of
determination of corresponding liquidity adjustments.
• Requirement of liquidity of selected buckets and replicating instruments to be supported by
market data.
The proposal to make Fair Value reserves subject supervisors horizontal reviews expand prudential su-
pervisory discretion to accounting Fair Value although proper accounting practice is a responsibility of
the bank and its auditors enforced by ESMA. Banks are penalised if they do not attribute their Fair
Value based on the ECB’s view. Reducing alpha for the entire AVA category to zero seems too punitive,
given the fact that the problem above will most likely affect a small part of the portfolio. Moreover, the
framework/principles required to ensure no adjustment to alpha factor are unclear and, thus, banks
will have to assume the worst case in pricing, increasing competitiveness gap versus banks from third
countries. We propose to drop this requirement or at least consider scaling the alpha reduction accord-
ing to some estimate of the extent of the actual problem.
Significantly higher efforts are incurred by the model AVAs due to additional annual verifications and
submissions to the supervisory authority regarding the adequacy of the models used.
Banks are forced to book all IPV variances to avoid punitive AVA outcome, resulting in:
• Removing the concept of risk appetite for valuation uncertainty.
• Removing the 1st Line / 2nd Line segregation of duties for Fair Value Recognition in P&L of ad-
justments linked to subjective or uncertain pricing sources, potentially reducing the quality of
reported earnings.
In order to avoid these unintended consequences, we suggest to maintain the 0.5 aggregation factor
capitalise for Group level net aggressive unadjusted IPV variance for reliable independent pricing
sources identify via a systematic assessment the unreliable subset where the asymmetric approach is
to be followed for subjective independent pricing sources.
Question 9. Do you have any comments with regard to the amendments to Article 12? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
Significant expenses will be incurred, especially in the analysis and implementation of the newly added
requirements related to model risk and MPU, but increased expenses are also expected in ongoing op-
erations. In particular, the CVA scope extension to Fair Value SFTs is disproportionate. FV CVA is not
relevant when trading SFTs and no accounting adjustments for CVA are applicable. Moreover, the
scope extension is inconsistent with other capital measures: FRTB CVA allows for the exemption of FV
SFTs subject to materiality considerations. US NPR exempts all SFTs and UK PRA significantly limits
the scope. Therefore, the CVA scope should not be extended.
Also, the alignment of the MPOR to be used with that used for regulatory is inappropriate and will lead
to unjustified additional conservatism. There is no evidence corroborating such an alignment. Moreo-
ver, it is inconsistent with the definition of the prudent value:
“[…] the value at which institutions are 90% confident that they will exit a position based on the appli-
cable market conditions at the time of the assessment […]”
Using a floored MPOR in in contradiction to applicable market conditions and adds a further layer of
conservatism that is also not justified from a conceptual point of view in our opinion.
Another driver of unjustified operational burden is the requirement to take into account CVA correla-
tions due to the prescribed granularity of application, without a necessarily meaningful change in out-
comes. This requirement should be dropped as well.
Question 10. Do you have any comments with regard to the amendments to Article 14 and 15? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
Question 10:
While requirements of Art. 15.1 letters (b) to (d) are clear, the EBA is asked to provide guidance on an
applicable criterion for market price uncertainty, close-out cost and concentrated positions AVAs to be
considered fully exiting the exposure in light of requirement in letter (a) of mentioned article.
All non-linear positions are impacted, including liquid vanilla options. Additional charges will occur,
even if the backtesting of PruVal charges is successful. In addition to that, the discounting rate will be
disconnected from the cost of capital. We suggest to remove this requirement if PruVal is successfully
backtested and to limit the application to portfolios with products that are in scope of the RRAO. More-
over, the discount rate should be linked to the cost of equity of the institution.
Article 17 – OpRisk AVAs:
The AVA size is not a good indicator of Operational Risk. As the AVA is applicable to all products, re-
gardless of their complexity, it penalises conservative business models such as market making. There-
fore, we suggest to limit the application to desks/books where operational losses linked to valuation
processes have occurred during the last 5 years.
Question 11. Do you agree with the requirements set out in Article 19a and Article 19b? If you do not agree, please describe how you would suggest to revise those Articles and address the mandate on extraordinary circumstances outlined in Article 34 CRR. When giving your answer, please provide the rationale and any relevant evidence supporting your proposal.
The proposed relief measure will only be applicable in the event of a major market stress but there is
no provision for market dislocations on significant, short-term market stress events (e.g. CS/SVB,
Russia/Ukraine war), We propose to introduce a relief measure for significant but not yet major mar-
ket stress events with an alpha factor set at 0.58%.
Question 12. Which of the two options presented do you consider more appropriate for the purposes of addressing concentration of UCS AVAs? When giving your answer, please provide the rationale and any relevant evidence supporting your proposal.
Both options have methodological weaknesses and lead to inappropriate UCS AVAs. Isolated UCS AVAs
do not seem to be appropriate to measure diversification in general throughout all AVA components.
For example, an institution with many counterparties with collateral and only a few without would be
negatively impacted by the proposed options compared to institutions with many counterparties with-
out collateral, which seems an unintentional outcome.
Specific issued with the two proposed options are:
• In Option 1 the whole portfolio gets an alpha of 0 if one counterparty has a weight of above
10%, but this counterparty is uncorrelated with the other counterparties in the portfolio which
might be perfectly diversified. One counterparty (that might even oscillate around 10%) influ-
encing all other positions seems unreasonable.
• In Option 2, even if the portfolio is perfectly diversified the top 5 counterparties receive an al-
pha of 0, which is also not appropriate and could, for example, lead to mismanagement espe-
cially if the list of top 5 counterparties changes regularly.
In order to account for concentrated positions, we propose to set alpha to 0 only for those counterpar-
ties that have a weight above a certain threshold (e.g. 10%).
Furthermore, the use of a portfolio-based approach for components of UCS AVAs would lead to exces-
sive burdens for such banks in both cases as they would have to redistribute the portfolio-based com-
ponents to individual counterparties. A diversification factor of 0 for individual counterparties would be
impossible to implement under such circumstances both technically and functionally. Hence, we ask to
take into account such portfolio-based approaches in case of a revision of these options.
Question 13. Do you have any comments with regard to the amendments introduced in the Annex? If you do not agree with the amendments, please describe how you would adjust or design the requirements to meet the policy objectives that the amendments try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
In light of the amendments to the aggregation factor for MPU- and COC-AVA the EBA is asked to clar-
ify whether the implied amendments to the aggregation factor affect the aggregation factor of AVAs
calculated according to Art. 12 and 13 (Unearned Credit Spread and Investing and Funding Costs) as
well due to the implied reference of Art. 12 and 13 to Art. 9 and 10 whereby, in case amendments are
considered to be applicable for Art. 12 and 13 as well, the implication would be that a fair value ad-
justment (e.g. COC) to a fair value adjustment (e.g. CVA) should be estimated which is not considered
market practice or required in current accounting standards.
Question 14. Do you have any other comments on this consultation paper? If you do not agree with any of the proposed requirements, please describe how you would adjust or design them in order to meet the policy objectives that the proposals try to achieve. When giving your answer, please provide the rationale and relevant evidence supporting your proposal.
Significant expenses are expected to increase due to the proposed regulations. This is partly due to
the monthly determination and partly due to the significantly heightened requirements for providing
evidence, validations, documentation, etc., which are largely attributable to a penalization of the mar-
ket data to be used (especially consensus data and indicative broker quotes) and a resulting more
dominant expert-based approach.
In the section 'Absence of fair value adjustments for market price uncertainty and close-out costs',
noted from paragraph 23 onwards, an unequal treatment is discussed that ostensibly arises if no fair
value adjustments are made for an AVA category. This also refers to paragraph 88 in IFRS 13. It is
suggested that the aggregation factor 'alpha' be set to zero if no corresponding fair value adjustment
exists.
We particularly do not understand the rationale behind the use of an additional market price uncer-
tainty discount in the context of fair value measurement.
Normally, fair value is considered a price that a third party is willing to pay. In practice, within the
context of fair value, when using a market parameter, either an average value or a median is em-
ployed. The most favourable (in terms of the most aggressive) liquid market parameter for the institu-
tion at the time of measurement is not used as a basis, implying that a certain type of market price
uncertainty is already included in the model value.
As we understand, paragraph 88 of IFRS 13 refers to Level 3 inputs, that is, unobservable inputs. De-
pending on the significance of this parameter for the measurement of an instrument, this leads to the
categorization of the entire instrument as Level 3 and thus also to the creation of an additional Day
One P&L.
With the additional consideration of a market price uncertainty discount, we see the risk that aspects
of prudent valuation are already included in the accounting, which are not reflected in the 'fair' pricing
of a transaction.
In absence of clear guidance from accounting standards the EBA is asked to propose the scope, pur-
pose and extend an MPU fair value adjustment should fulfill to be an eligible fair value adjustment.