EBA issues methodology for valuation of liabilities arising from derivatives

The European Banking Authority (EBA) published today the final draft Regulatory Technical Standards (RTS) on the methodology for the valuation of derivative liabilities for the purpose of bail-in in resolution. These standards, which have been developed within the framework of the Bank Recovery and Resolution Directive (BRRD) setting procedures for the orderly management of bank failures, provide EU resolution authorities with a methodology for the valuation of derivative liabilities of credit institutions placed under resolution and ensure that the discipline brought in by the new bail-in tool can effectively be extended to these liabilities too.

The EBA provided EU resolution authorities with a series of tools to carry out a swift and objective valuation of derivative liabilities, while minimising risks of breaching the principle that no creditor should be treated worse off than in liquidation. The approach applies a statutory valuation methodology based on the costs or gains that would be incurred by the counterparty in replacing the contract.

Derivative counterparties will be given the opportunity to provide evidence of commercially reasonable replacement trades within a certain deadline; if they do not exercise this option, then resolution authorities will apply a statutory methodology supported by observable market data or other relevant information.

Resolution authorities may establish the value of derivative liabilities as on the close-out date or as on the date when a price is available in the market. For centrally cleared derivatives, the final draft RTS take into account the applicable regulatory framework under the EU Market Infrastructure Regulation (EMIR) and provides for a process that relies in principle on the Central Counterparty (CCP) default and valuation processes.

When adopted by the Commission, these draft RTS will allow resolution authorities to conclude a potential resolution action including derivative liabilities on the basis of a reliable valuation in a short timeframe. In cases of particular urgency, resolution authorities may also apply resolution actions on the basis of provisional valuations.

Legal basis

These draft RTS have been developed according to paragraph 5 of Article 49 of Directive 2014/59/EU (BRRD), which mandates the EBA to develop draft RTS specifying methodologies and principles on the valuation of liabilities arising from derivatives.