EBA Peer Review finds credit valuation adjustment risk is overall supervised sufficiently and recommends some follow-up measures to further strengthen supervision

The European Banking Authority (EBA) published today its Peer Review on excluding transactions with non-financial counterparties established in a third country from credit valuation adjustment (CVA) risk. The Review found that the competent authorities targeted in this review assessed CVA risk sufficiently although some elements of such an assessment were missing. The EBA, therefore, has set out a series of follow-measures to address these deficiencies.

The financial crisis 2007-2008 revealed that CVA risk was a source of unexpected losses. Robust CVA risk management mitigates against losses and helps ensure the soundness of an institution. It is, therefore, important to ensure effective supervision of the requirements in this area. This Peer Review analysed the effectiveness of competent authorities’ supervisory practices regarding their assessment of CVA risk of the institutions under their supervision with a view to strengthening consistency and effectiveness of supervision in this area.

In particular, the peer review focused on the transactions exempted from own funds requirements for CVA risk specified in Article 382(4) of the Capital Requirements Regulation (CRR), and more specifically, on the procedures for excluding transactions with non-financial counterparties established in a third country from the own funds requirement for CVA risk. Reviewing this area is important in ensuring alignment of treatment of non-financial counterparties established in a third country with those established in the EU, taking into account the global nature of derivative markets.

The Peer Review focused on four competent authorities and found that, overall, they assessed CVA risk sufficiently, using different approaches which were fit for purpose in satisfying the regulatory requirements and the EBA Guidelines on Supervisory Review and Evaluation Process (SREP). However, the Review also highlighted some areas where supervision could be strengthened by all competent authorities. For that, the EBA has adopted follow-up measures for competent authorities which it will review in two years’ time. These follow-up measures relate, in particular, to the need to:

• review their resource allocation to ensure that CVA risk is properly supervised at all times and for all institutions under their supervision;
• monitor the intrinsic risk and potential capital impact of the CVA exemptions, assess the CVA risk stemming from securities financing transactions (SFTs) and develop criteria/benchmarks to determine their incorporation in the own funds requirements for CVA risk
• ensure that they fully apply the EBA’s SREP Guidelines by having supervisory engagement with all institutions in relation to CVA risk;
• ensure that they have performed a review of compliance with the requirements of the technical standards in this area, and continue to perform such a review with a frequency consistent with that set out in the EBA SREP Guidelines.

The Review also identified best practices developed by some competent authorities that might be of benefit for other competent authorities to adopt. These include best practices in relation to keeping institutions informed regarding any supervisory expectations on the management of CVA risk and actions to address possible deficiencies that may have been identified. They also cover the supervision of CVA risk, which ensures a holistic view of the risk by taking into account risks of a similar nature, such as market and counterparty credit risk, and interaction with valuation practices, accounting rules and other types of adjustments, such as xVAs.

Legal basis and background

Article 30 of the EBA Regulation requires the EBA to periodically conduct peer reviews of some or all of the activities of competent authorities within its remit, to further strengthen consistency and effectiveness in supervisory outcomes. Peer reviews identify follow-up measures to achieve this, together with best practices seen in competent authorities. After two years, the EBA is required to assess the adequacy and effectiveness of actions taken by competent authorities in response to the follow-up measures.

The peer review has been performed by an ad hoc Peer Review Committee of EBA and competent authorities’ staff in accordance with the EBA peer review work plan for 2022-2023 and following the process in Article 30 of the EBA Regulation and the EBA peer review methodology.

The exercise covered four competent authorities: the ECB/SSM for institutions under its direct supervision and Sweden, Denmark and Hungary for institutions under their supervision. It assessed competent authorities’ supervisory practices in relation to CVA risk and how they verify the compliance by institutions with the conditions which are required under the Regulation for the purpose of excluding transactions with non-financial counterparties established in a third country from the own funds requirements for CVA risk in accordance with point (a) of Article 382(4) of Regulation (EU) No 575/2013.