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

Go back

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: The consultation paper proposes setting the materiality threshold in the range of 1% to 5. Based on international best practices and the rationale provided in the paper, I suggest setting the threshold at 1%

Rationale: 

Other regulatory frameworks, such as Basel III, emphasize the importance of risk sensitivity. In the Basel framework, materiality thresholds are often set at lower levels (around 1% to 2%) to ensure early risk identification and mitigation. A threshold of 1% would align with these standards and ensure that institutions with significant CVA risk exposures are identified early, minimizing systemic risk. 

According to data provided in the Basel III monitoring exercise, 19 institutions, representing 13% of the sample, exceed the 1% threshold. By setting the threshold at 1%, the EBA ensures that a significant portion of institutions with notable CVA risk are included, thus improving the robustness of the financial system. 

A lower threshold like 1% captures a broader set of institutions without unduly burdening smaller institutions. While setting a higher threshold (e.g., 5%) may reduce administrative complexity, it could exclude institutions with growing risks, which is counterproductive to the goal of comprehensive risk management. 

US Regulations (Dodd-Frank Act): The US sets stringent thresholds for capital requirements and risk assessments, with capital stress tests designed to be sensitive to small risk exposures. A 1% threshold aligns with the spirit of these regulations, which focus on proactive risk management. 

UK Prudential Regulation Authority (PRA): The PRA often recommends conservative risk measures to ensure stability. For instance, under CRD IV, the PRA has consistently emphasized the importance of strict thresholds to ensure that institutions maintain adequate capital buffers. 

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

  1. Inclusion of Mixed Qualitative and Quantitative Approaches: While the paper predominantly recommends a quantitative approach, a mixed approach could offer flexibility. Institutions that have relatively lower computational capabilities might benefit from a qualitative overlay. For example, the Canadian Office of the Superintendent of Financial Institutions (OSFI) combines qualitative risk assessments with quantitative thresholds in assessing market and credit risks, ensuring a more comprehensive risk management strategy. 
  2. Frequency of Assessment: The proposal to assess CVA risk on a quarterly basis is reasonable and aligns with existing reporting cycles such as COREP reporting. However, institutions that experience significant volatility in their CVA risk should be allowed to opt for monthly assessments. This would provide real-time adjustments to capital requirements and ensure a more dynamic risk management approach. 
  3. Cliff Effect Mitigation: The proposal to use ratios over the last four quarters to determine materiality is a good step towards avoiding cliff effects, where institutions rapidly move in and out of capital requirements. However, introducing more gradual capital adjustments or transitional arrangements could help mitigate the impact of sudden changes in the financial environment. In Australia, for example, the Australian Prudential Regulation Authority (APRA) adopts such transitional measures to ensure stability in capital requirements. 
  4. Legislative and Regulatory Context : While the RTS addresses CVA risk in SFTs, it is essential to emphasize the broader regulatory landscape to ensure that this draft is fully aligned with other ongoing legislative reforms. For instance, inconsistencies with the Basel Committee on Banking Supervision’s (BCBS) guidelines or SFTR’s transparency requirements could create compliance challenges. Harmonization and clarity in relation to Basel III and Basel IV should be made explicit in the RTS. 

  5. Exemption of SFTs:  The exemption of centrally cleared SFTs from CVA charges seems appropriate, as clearing through CCPs effectively reduces counterparty credit risk, which aligns with the EU's commitment to promoting central clearing. However, for non-centrally cleared SFTs, the proposed methodologies for calculating CVA risk need to balance between precision and practicality, particularly for smaller institutions. We recommend exploring simplified methodologies or offering proportionality measures for small- to medium-sized institutions (SMEs) with limited exposure, to avoid undue regulatory burden. 

  6. Hedging Strategies for CVA Risk: The inclusion of hedging techniques is critical, but there is a need for greater clarity on what qualifies as eligible hedges. Our recommendation would be to ensure that the criteria for hedging effectiveness are clear and not overly restrictive, as this might discourage institutions from using legitimate hedging mechanisms. Furthermore, clarification is needed on how frequently the effectiveness of these hedging techniques will need to be assessed, as overly frequent assessments could lead to operational complexities.\ 

  7. Standardized vs. Advanced CVA Approaches: The RTS specifies that institutions must use either the standardized approach or the advanced approach (if internal models are approved) for CVA charge calculation. While the distinction between the standardized and advanced approaches is necessary, we note that institutions face significant operational hurdles in obtaining approval for internal models under the advanced approach. We recommend that the EBA provide clear guidance on the approval process for internal models to ensure a fair and efficient process. Moreover, smaller institutions may lack the resources to develop and maintain these advanced models, and a less burdensome alternative for such firms should be considered. 

  8. Interaction with SFTR and Other Regulations : The RTS must align with the Securities Financing Transactions Regulation (SFTR) and its transparency and reporting requirements. The RTS should not impose redundant obligations on institutions already complying with SFTR.The interaction between SFTR and the RTS on CVA risk is crucial. Institutions already face significant reporting and transparency requirements under SFTR, and it will be important to ensure that the CVA risk management requirements are streamlined to avoid duplicative or conflicting obligations. For example, CVA exposure calculations should be compatible with the data that institutions already gather under SFTR, making compliance more efficient. 

  9.  Reporting and Disclosure Requirements: The draft mandates regular reporting on CVA risk exposures to national competent authorities. Institutions must also disclose their CVA risk management practices to the public. The reporting and disclosure requirements should be harmonized with existing frameworks, particularly the European Market Infrastructure Regulation (EMIR) and SFTR, to avoid overlapping obligations. We recommend that the EBA streamline the CVA reporting requirements with these other regulatory frameworks, making sure that the reporting timelines and formats are consistent and avoid duplicative efforts. Moreover, there should be consideration of a phase-in period for smaller institutions to comply with the new reporting obligations. 

 

Final Recommendations 

Clarify Exemptions and Simplified Treatment: Provide clearer guidance on proportionality and how smaller institutions or low-risk transactions can qualify for simplified or exempt treatment. 

Harmonize with SFTR and EMIR: Ensure alignment between the RTS requirements and existing regulations such as SFTR and EMIR, particularly in the areas of reporting and CVA exposure calculations. 

Encourage Proportional Application: Recommend proportionality in the application of internal model validation requirements to avoid overburdening smaller institutions. 

Simplified Hedging Rules: Offer more detailed guidance on the qualification and assessment of hedging techniques to provide legal certainty for institutions. 

Clear Approval Processes: Establish clearer and faster processes for the approval of internal models, especially under the advanced approach, to reduce operational burdens. 

Name of the organization

With Law ( law firm )