Response to consultation on Regulatory Technical Standards on CVA risk of securities financing transactions

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Question 1. At which level would you suggest to set the materiality threshold? When providing your answer, please provide any rationale and evidence supporting your proposal.

Suggested Materiality Threshold

Considering the principles of risk accounting, we suggest setting the materiality threshold for CVA risk exposures arising from fair-valued SFTs at 2%.

Rationale and Evidence

  1. Quantitative Precision and Comprehensive Risk Measurement:
    • Risk accounting provides a precise and detailed method for quantifying non-financial risks, including CVA risks.
    • By leveraging Risk Units (RUs) and a standardized Risk Exposure Calculation Method, institutions can achieve a more accurate and granular measurement of their risk exposures, therefore not having to work with potentially misleading proxy parameters.
    • Setting the threshold at 2% balances the need for sensitivity in detecting material risks without overburdening institutions with overly frequent reclassifications of CVA exposures.
  2. Objective and Consistent Methodology:
    • Risk accounting ensures a consistent and objective approach to measuring risk. The use of a standardized framework for quantifying risks across different transactions helps maintain a level playing field among institutions.
    • A 2% threshold allows for a clear and objective criterion that aligns with the precise quantification capabilities of risk accounting, ensuring that only genuinely material risks are flagged.
  3. Alignment with Integrated Risk Management:
    • The integrated nature of risk accounting, which combines financial and non-financial risk assessments, supports a holistic view of an institution’s risk profile.
    • This comprehensive approach helps in accurately determining the materiality of CVA risks within the broader context of the institution’s overall risk management strategy.
    • A threshold of 2% is appropriate to capture significant risks while allowing institutions to integrate this assessment seamlessly into their existing risk management processes.
  4. Historical Data and Trend Analysis:
    • Risk accounting facilitates the tracking of risk exposures over time, allowing for historical trend analysis and the identification of emerging risks or high-risk exposure concentrations. This proactive capability best supports the quarterly assessment frequency proposed in the RTS.
    • By setting the threshold at 2%, institutions can leverage historical data to ensure that the threshold is robust and reflective of actual risk trends, avoiding both underestimation and overestimation of material risks.
  5. Practical Implementation and Regulatory Compliance:
    • A 2% threshold is practical and achievable for institutions, given the detailed risk measurement and reporting infrastructure provided by risk accounting. It avoids the pitfalls of arbitrary thresholds by grounding the decision in a robust, data-driven methodology, allowing also for real-time or near-real-time decision making.
    • This level ensures compliance with regulatory requirements while also enhancing the institution’s internal risk management capabilities.

In our view, setting the materiality threshold at 2% based on the principles of risk accounting provides a balanced, objective, and practical approach to identifying material CVA risk exposures from fair-valued SFTs.

It also ensures that significant risk exposures are appropriately captured, continuously monitored in their dynamic evolution and effectively managed before generating losses, supporting both regulatory compliance and the institution’s overall risk management framework, while providing tangible business value to shareholders.

Question 2. Do you have any additional comments on this consultation paper? If yes, please specify and motivate.

Integration of Risk Accounting Principles

  1. Enhanced Quantification of CVA Risk:
    • The risk accounting method offers a detailed and granular approach to quantifying virtually any type of risks, including CVA risk. By employing Risk Units (RUs) and the Risk Exposure Calculation Model, institutions can achieve a more accurate understanding of their CVA risk exposures. This method ensures that the CVA risk of fair-valued SFTs is measured precisely, reflecting the actual risk profile more accurately than the proposed ratio-based approach alone.
  2. Comprehensive Risk Management Framework:
    • Risk accounting supports an integrated risk management framework that aligns financial and non-financial risk assessments. This holistic approach ensures that CVA risks are not evaluated in isolation but as part of the broader risk exposure landscape of the institution. 
    • Implementing such a framework can enhance the overall effectiveness of risk management practices, providing deeper insights and facilitating better and more timely decision-making.
  3. Consistency, Comparability and Objectivity:
    • The standardized methodology of risk accounting ensures consistency, comparability and objectivity in risk measurement across different institutions.
    • This reduces the potential for subjective interpretations and promotes a level playing field for all market players.
    • The use of objective criteria for assessing materiality, as enabled by risk accounting, aligns with the regulatory goals of transparency and comparability.
  4. Detailed Reporting and Monitoring:
    • Risk accounting provides detailed and continuous reporting capabilities, allowing for real-time monitoring of CVA risk exposure accumulations.
    • This continuous oversight is beneficial for both regulatory compliance and internal risk management.
    • Institutions can generate comprehensive reports that detail risk exposures, trends, and potential future impacts, enhancing the quality of information available for decision-making.
  5. Forward-Looking Risk Assessment:
    • Unlike traditional methods that may focus primarily on historical data, risk accounting incorporates quantitative forward-looking elements.
    • This proactive approach enables institutions to anticipate and mitigate potential risks before they fully materialize, thus preventing or at least minimizing losses.
    • By using risk accounting, institutions can better prepare for future challenges and adjust their strategies accordingly.
  6. Alignment with Regulatory Requirements:
    • The risk accounting method aligns well with the regulatory requirements outlined in the consultation paper.
    • Its emphasis on accurate, continuous, consistent, and comprehensive risk measurement supports the goals of the draft RTS.
    • By integrating risk accounting principles, institutions can enhance their compliance with the CVA risk assessment and reporting requirements.
  7. Adaptability and Flexibility:
    • Risk accounting is adaptable to various risk types and regulatory frameworks.
    • Its flexibility allows institutions to tailor the risk assessment process to their specific needs while maintaining compliance with regulatory standards.
    • This adaptability ensures that the method remains relevant and effective in the face of evolving risk landscapes and regulatory changes.
  8. Improved Governance and Oversight:
    • The detailed and structured approach of risk accounting enhances governance and oversight of risk management practices.
    • By providing clear and quantifiable measures of risk, risk accounting enables boards and senior management to exercise more effective oversight and ensure accountability for risk management decisions.

Specific Recommendations for the Consultation Paper

  1. Incorporate Risk Accounting Metrics:
    • Consider incorporating risk accounting metrics such as RUs into the assessment framework for CVA risk exposures. This would provide a more nuanced and accurate measure of materiality, enhancing the overall effectiveness of the regulatory standards.
  2. Expand Reporting Requirements:
    • Expand the reporting requirements to include detailed risk accounting reports that provide insights into both current and projected CVA risk exposures.
    • This would enhance the transparency and comprehensiveness of risk disclosures and will provide practical mitigating steps and approaches.
  3. Promote Consistency Across Institutions:
    • Encourage the adoption of standardized risk accounting practices across institutions to ensure consistency and comparability of CVA risk assessments.
    • This would support the regulatory objectives of fairness and transparency in the financial sector.
  4. Foster Continuous Improvement:
    • Establish a feedback loop where institutions regularly review and update their risk accounting practices based on new data, emerging risks, and regulatory developments.
    • This continuous improvement process would ensure that risk management practices remain effective and up to date.

Integrating the principles and practices of risk accounting into the framework for assessing CVA risk of SFTs can significantly enhance the accuracy, consistency, and effectiveness of risk management.

By adopting a comprehensive and detailed approach, institutions can better fulfill regulatory requirements, improve their risk oversight, and ensure robust management of CVA risks.

Please find more details and practical examples in the attached document

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Name of the organization

Risk Accounting Standards Board