Response to consultation on draft Regulatory Technical Standards (RTS) on prudent valuation
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We see the outset of the second term of the suggested simplified approach as good but that it needs to be risk adjusted. A simple risk adjusted calculation method could be as follows.
• No, or very low, AVA for Level 1 fair valued positions.
• No, or very low, AVA for derivatives in hedge relationships designated according to IAS39.
• 0.05% of the sum of the absolute value of Level 2 fair valued positions.
• 0.20% of the sum of the absolute value of Level 3 fair valued positions.
If not using fair valuation hierarchies other categories should be part of a technical standard for a simplified approach.
If however there is a threshold above which institutions are obliged to use the core approach we consider the proposed method extremely disproportionate for institutions with large balance sheet and low complexity.
As for the first term, 100% of net unrealized profit, we consider it, for reasons stated in Q4, that such a correction is not appropriate.
As for the second term, 25% of market value of non-derivatives and 10% of notional value of derivatives, we see that it would imply dramatic consequences for any institution above the threshold that is not able to apply all of the AVA methods for even a small fraction of its fair valued positions. It would instead be preferable to impose a stricter version of the simplified approach, i.e. higher factors.
In our opinion fair valued (non derivative) liabilities should be excluded from this category AVA.
Another example is that Kommuninvest currently has 86 billion SEK of fair valued loans to local governments. Kommuninvest’s loans to local governments are not trading instruments, they are loans that are economically hedged with matching derivatives, therefore to avoid accounting mismatch these loans are accounted at fair value according to IAS 39. Kommuninvest’s business model includes operations that, via longer maturity of funding than lending, assure the capacity of holding the loan portfolio to maturity.
The loans can readily be given fair values from market activity. However the concentration of Kommuninvest’s valuation position in this market is also the raison d’être of the institution, hence exit strategies from this market is the same as strategies for closing down the business.
The outlined definition of Article 12 indicates that Kommuninvest, for sake of prudency, would have to remove a disproportionately large amount from the institutions own funds at the inception of any loan if measured at fair value. If not measured at fair value the same loan would not have any effect on own funds. Thus the effect of concentrated positions AVA is, in our opinion, clearly not that intended by article 105.
For Kommuninvest the valuation processes including staff, market data and systems for pricing currently stands for more than 5% of total operational costs. Complying with the core approach would lead to a large increase in these costs and thus to a significant increase in total operational costs.
We also see a risk that the indirect capital costs could be disproportionate for institutions like Kommuninvest. See answer of Q8.
Do you agree with the proposed simplified approach? Do you think the risk sensitiveness of the approach is appropriate? Are there alternative approaches that you believe would be more appropriate? State your reasons.
In our opinion the first term in the simplified approach, 25% of net unrealized profit, is not appropriate since valuation uncertainty is not per se related to whether there is an unrealized profit or loss attached to it.We see the outset of the second term of the suggested simplified approach as good but that it needs to be risk adjusted. A simple risk adjusted calculation method could be as follows.
• No, or very low, AVA for Level 1 fair valued positions.
• No, or very low, AVA for derivatives in hedge relationships designated according to IAS39.
• 0.05% of the sum of the absolute value of Level 2 fair valued positions.
• 0.20% of the sum of the absolute value of Level 3 fair valued positions.
If not using fair valuation hierarchies other categories should be part of a technical standard for a simplified approach.
Could a differentiated treatment for some asset/liability classes be considered, for example with regard to their liquidity? Please state the pros and cons of such a differentiation. How would you define the degree of liquidity of an asset/liability class (e.g. fair value hierarchy, eligibility for the LCR, other)?
See answer of Q4.Do you agree with the approach defined above to calculate an AVA where the approaches in Article 8 and 9 are not possible for a valuation exposure? If not, what other approach could be prescribed? Explain your reasoning.
In our view, as stated in the answer of Q2, it is essential in terms of the principle of proportionality that the simplified approach is available for any institution regardless of size. Under that assumption it would be reasonable to impose that any institution that fails to use the core approach on any part of its fair valued positions should use the simplified approach on all of its fair valued positions.If however there is a threshold above which institutions are obliged to use the core approach we consider the proposed method extremely disproportionate for institutions with large balance sheet and low complexity.
As for the first term, 100% of net unrealized profit, we consider it, for reasons stated in Q4, that such a correction is not appropriate.
As for the second term, 25% of market value of non-derivatives and 10% of notional value of derivatives, we see that it would imply dramatic consequences for any institution above the threshold that is not able to apply all of the AVA methods for even a small fraction of its fair valued positions. It would instead be preferable to impose a stricter version of the simplified approach, i.e. higher factors.
Do you agree with the approaches defined in Articles 11 to 16 to calculate the various categories of AVAs? If not, what other approach could be prescribed for each AVA? State your reasons.
The definition of Article 12 is closely related to trading activity. Some fair valued positions do not fit in a reasonable way in this model.In our opinion fair valued (non derivative) liabilities should be excluded from this category AVA.
Another example is that Kommuninvest currently has 86 billion SEK of fair valued loans to local governments. Kommuninvest’s loans to local governments are not trading instruments, they are loans that are economically hedged with matching derivatives, therefore to avoid accounting mismatch these loans are accounted at fair value according to IAS 39. Kommuninvest’s business model includes operations that, via longer maturity of funding than lending, assure the capacity of holding the loan portfolio to maturity.
The loans can readily be given fair values from market activity. However the concentration of Kommuninvest’s valuation position in this market is also the raison d’être of the institution, hence exit strategies from this market is the same as strategies for closing down the business.
The outlined definition of Article 12 indicates that Kommuninvest, for sake of prudency, would have to remove a disproportionately large amount from the institutions own funds at the inception of any loan if measured at fair value. If not measured at fair value the same loan would not have any effect on own funds. Thus the effect of concentrated positions AVA is, in our opinion, clearly not that intended by article 105.
Are there cases where the above AVAs may have a zero value that could be defined in the RTS? If yes, please specify.
In our opinion at least concentrated positions AVA might be zero. See answer of Q8.Do you agree with our analysis of the impact of the proposals in this CP? If not, can you provide any evidence or data that would explain why you disagree or might further inform our analysis of the likely impacts of the proposals?
We disagree with the conclusions on direct compliance costs in the Draft RTS. In our opinion the complexity of the balance sheet is not reflected in the RTS and hence is not consistent with the proportionality principle. For institutions that are larger in terms of balance sheet, but smaller in terms of activity and complexity direct compliance cost will be significant if obliged to use the core approach.For Kommuninvest the valuation processes including staff, market data and systems for pricing currently stands for more than 5% of total operational costs. Complying with the core approach would lead to a large increase in these costs and thus to a significant increase in total operational costs.
We also see a risk that the indirect capital costs could be disproportionate for institutions like Kommuninvest. See answer of Q8.