Response to discussion on the treatment of structural FX under Article 352(2) of the CRR
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In practice, we consider items which revalue periodically for FX as part of the overall net foreign exchange position for capital ratio management purposes.
• Foreign currency non monetary items held at historic FX in a GBP functional currency entity do not revalue for FX and hence are not considered as part of the overall net foreign currency exchange position for capital ratio management purposes.
• However, where the non monetary items are in a non GBP functional currency entity, they are part of the foreign currency net assets which revalue through the currency translation reserve and impacts capital. Hence, we consider these non monetary items for the purpose of the overall net foreign exchange position.
As set out above, for the purpose of capital ratio management, the accounting treatment determines whether we consider these items as sensitive to foreign exchange movements or not. The definition of open position under Article 352 should be interpreted in this spirit.
Finally, certain “equity” accounted capital instruments also result in additional complexity in managing the capital ratios from an FX standpoint and should be considered in any proposed guidance from the EBA. E.g. a EUR contingent capital instrument (CoCos) with no fixed contractual maturity and having discretionary coupons would be “equity” accounted and held at historical cost in the reporting currency (GBP in our case) converted at the FX rate at the time of issuance. The firm may decide to hold the cash raised from this issuance as EUR monetary assets so that it is economically hedged for EUR currency risk (since the CoCo will be redeemed in EUR). However, the accounting mismatch between the CoCo (historical cost) and the EUR monetary assets (daily revaluation) creates volatility in the firm's capital ratio, even though the firm is economically hedged for EUR FX risk. Firms may therefore attempt to neutralise volatility in their capital ratio that occurs on call/redemption of the instruments by running larger EUR open positions prior to call/redemption. These positions should be eligible to be treated as Structural FX positions under CRR Article 352(2).
The hedging strategies used by institutions for structural FX positions are designed and executed with the main purpose of controlling the potential negative effects of exchange-rate fluctuations on capital ratios. The hedging strategies do not distinguish between FX exposures that are subject to the standardized approach or internal model based approaches as both types of exposures generate fluctuations in capital ratios.
Barclays maintains structural FX positions in order to protect its capital ratios from adverse foreign currency movements arising from net investments in foreign branches and subsidiaries. These net investments may comprise both banking as well as trading book items. However, the hedges earmarked as “structural hedges” themselves are managed in the banking book. The objective of these structural hedges is not to take trading positions on foreign currencies, but to protect the firm’s capital ratios from the adverse impact of FX movements.
Consequently, our view is that both banking and trading book positions which form part of the net investments in foreign subsidiaries and branches should qualify for inclusion as structural FX positions.
Although we understand the EBA’s view that only net long FX positions may protect a firm’s capital ratio from adverse foreign exchange movements, it is plausible that a firm may enter into a short position in a foreign currency to economically hedge the net long position in another closely correlated but illiquid foreign currency for which a hedge is not easily available.
Our view is that a firm should be allowed to benefit from CRR Article 352(2) for net short structural FX positions in certain instances provided that it can demonstrate this position is intended to protect the firm’s capital ratios from adverse FX movements.
They include net FX positions ‘deliberately taken’, ‘deliberately not closed’ or ‘maintained’ to protect the firm’s capital ratio from adverse foreign currency movements and arise from unhedged net investments in subsidiaries, branches and from investments in non consolidated associates. Certain foreign currency items such as goodwill and deferred tax assets (which form part of the net assets of foreign currency subsidiaries/branches) are deducted from CET1 create an offsetting position (directionally, just like a hedge) to the revaluing net investments. For capital ratio management purposes all these items are taken into account when determining the structural FX position.
Foreign exchange positions stemming from subsidiaries with a different reporting currency can be seen as ‘deliberately taken to hedge against the adverse effect of FX movements’ on a consolidated level as explained in our response to Question 10.
Currently Barclays manages its structural FX risk with the intention to neutralise the volatility in its capital ratio from any upside or downside FX risk. However, conceptually it may be possible to create a hedge which protects a firm’s capital ratio from any adverse FX movement while still allowing it benefit from any favourable FX movements, although there may be a higher burden of proof for the firm to prove to the competent authority that these hedges are still of a structural nature and eligible for the exemption under CRR Article 352(2). An example of such a situation would be where the bank’s capital ratio is “short” in relation to movements in the foreign currency. In other words, an appreciation of the foreign currency would decrease the capital ratio (see para 33 of EBA consultation where this concept is set out). Here a bank may want to go “long” foreign currency options that pay-off when the foreign currency appreciates in order to protect the bank’s capital ratio.
Since it is not possible to fully hedge both capital ratios and capital at the same time (as capital ratios are the ratio of two items both of which have FX sensitivity) the firm chooses to either hedge the capital or the capital ratio depending upon the materiality of the foreign currency.
For material currencies, the firm manages the sensitivities to a current or near term target capital ratio. The governance process for identification and monitoring of material/non-material currencies and the respective hedging strategies are documented in the firm’s Risk Policies. Senior Management committees within Barclays have oversight of Structural FX risk positions and hedging strategies, under authority delegated by the Board. The governance arrangements and policies/standards are shared with the competent authority (PRA for consolidated supervision) in line with their requirements for CRR Article 352.
The firm’s approach for managing translational foreign exchange exposure is disclosed in the firm’s Pillar 3 disclosures. A snapshot of the gross and net structural foreign currency exposures and related hedges at the report date are also included in the Pillar 3 disclosures.
Though we agree that the aim of the structural positions should be to neutralise sensitivity of the capital ratio to adverse FX movements, it may not be possible to neutralize the risk to zero given the dynamic nature and complexity of the risk. Firm’s should therefore be allowed to maintain structural FX positions such that the capital ratio sensitivity to FX is managed within a range/tolerance agreed with the firm’s Senior Management and Risk.
There are no differences in the FX translation risk associated with a foreign currency subsidiary and foreign currency branch from an accounting perspective. In some jurisdictions, there is no distinction between a branch or subsidiary for regulatory purposes as capital adequacy requirements are applied to both. We therefore believe that there should not be any differences in treatment between net investments in subsidiaries or branches when looking at consolidated capital ratios.
The cap on structural FX positions proposed in Article 325c can be unhelpful e.g. where a firm overhedges due to different tax rates, or where a hedge for neutralising the Group’s capital ratio is maintained at the level of a regulated subsidiary. Any caps/limits on the structural FX positions should therefore be set in relation to the firm’s current or near term target capital ratio.
Structural hedges are measured at a net position level which can include banking book as well as trading book assets and liabilities. As the net positions vary from month to month, we do not believe that the exclusion should be made at least for six months. Banks need to have flexibility in management of the structural FX position.
Furthermore, market movements and strategic decisions can be drivers for changes of the capital ratio composition. Hedges may have to be managed dynamically and may not remain in place for the life of the assets.
We therefore suggest that the EBA should propose deletion of the exclusions in CRR2 Article 325c(1)(a), (b) and (2).
• Open positions that revalue for FX at the consolidated and individual levels could be different. As a result a firm may need to prioritize neutralizing the adverse impact of FX on the capital ratios at one of these levels. This could be driven by several considerations such as a) whether consolidated or individual level is the binding constraint b) whether stress tests are run at consolidated or individual levels c) whether individual ratios are disclosed externally to investors/analysts.
• A key reason for the difference between consolidated and individual FX exposure is the different accounting and regulatory treatments of investments in subsidiaries. At the consolidated level, the net assets of the foreign currency subsidiary revalue for FX (through the currency translation reserve) whereas at the individual level an investment in a subsidiary is held at historic cost and subject to the threshold deduction test. The consolidated group may wish to hedge part/all of the investment in the foreign subsidiary to manage any adverse impact of FX on its capital ratios. However, if this investment is deducted at the individual level, then the hedge (if executed out of that entity) introduces volatility in the capital ratio at the individual level. This is illustrated in example 2.2.1
• When granting a waiver under Article 352, regulators should consider the case by case situation and not expect that group will be able to demonstrate compliance with Article 352 at both the consolidated and individual level. Failure to comply at either of these levels should not result in an own funds requirement at that level.
Question 1: What is your current practice regarding the treatment of FX non-monetary items held at the historic FX? In particular, do you include these items in the overall net foreign exchange position pursuant to Article 352 CRR? If you include them, what value (i.e. historic or last FX rate) do you use for the purpose of computing them? How do you manage such positions from an FX point of view?
We welcome the EBA’s initiative to provide more clarity on inclusion of items subject to certain accounting treatments (such as non-monetary items held at the historic FX) for calculating net FX positions under Article 352.In practice, we consider items which revalue periodically for FX as part of the overall net foreign exchange position for capital ratio management purposes.
• Foreign currency non monetary items held at historic FX in a GBP functional currency entity do not revalue for FX and hence are not considered as part of the overall net foreign currency exchange position for capital ratio management purposes.
• However, where the non monetary items are in a non GBP functional currency entity, they are part of the foreign currency net assets which revalue through the currency translation reserve and impacts capital. Hence, we consider these non monetary items for the purpose of the overall net foreign exchange position.
As set out above, for the purpose of capital ratio management, the accounting treatment determines whether we consider these items as sensitive to foreign exchange movements or not. The definition of open position under Article 352 should be interpreted in this spirit.
Finally, certain “equity” accounted capital instruments also result in additional complexity in managing the capital ratios from an FX standpoint and should be considered in any proposed guidance from the EBA. E.g. a EUR contingent capital instrument (CoCos) with no fixed contractual maturity and having discretionary coupons would be “equity” accounted and held at historical cost in the reporting currency (GBP in our case) converted at the FX rate at the time of issuance. The firm may decide to hold the cash raised from this issuance as EUR monetary assets so that it is economically hedged for EUR currency risk (since the CoCo will be redeemed in EUR). However, the accounting mismatch between the CoCo (historical cost) and the EUR monetary assets (daily revaluation) creates volatility in the firm's capital ratio, even though the firm is economically hedged for EUR FX risk. Firms may therefore attempt to neutralise volatility in their capital ratio that occurs on call/redemption of the instruments by running larger EUR open positions prior to call/redemption. These positions should be eligible to be treated as Structural FX positions under CRR Article 352(2).
Question 2: Do you share the EBA’s view that there is no clear risk justification for making the determination of the net FX position as well as of the structural FX exclusion dependent on the approach for the calculation of FX own funds requirements?
We support the EBA’s view that the exemption for structural FX positions should be available regardless of whether an institution uses the Standardised approach or the Internal Models approach to capitalise its foreign currency risk as the underlying risks are essentially the same.The hedging strategies used by institutions for structural FX positions are designed and executed with the main purpose of controlling the potential negative effects of exchange-rate fluctuations on capital ratios. The hedging strategies do not distinguish between FX exposures that are subject to the standardized approach or internal model based approaches as both types of exposures generate fluctuations in capital ratios.
Question 3: Do you consider that the ‘structural nature’ wording in the CRR would limit the application of the structural FX provision to those items held in the banking book? Do you agree with the EBA’s view that the potential exclusion should be acceptable only for long FX positions? If you consider that it should be allowed for short positions please provide rationale and examples.
We do not believe that the ‘structural nature’ wording in the CRR would limit the application of the structural FX provision to those items held in the banking book.Barclays maintains structural FX positions in order to protect its capital ratios from adverse foreign currency movements arising from net investments in foreign branches and subsidiaries. These net investments may comprise both banking as well as trading book items. However, the hedges earmarked as “structural hedges” themselves are managed in the banking book. The objective of these structural hedges is not to take trading positions on foreign currencies, but to protect the firm’s capital ratios from the adverse impact of FX movements.
Consequently, our view is that both banking and trading book positions which form part of the net investments in foreign subsidiaries and branches should qualify for inclusion as structural FX positions.
Although we understand the EBA’s view that only net long FX positions may protect a firm’s capital ratio from adverse foreign exchange movements, it is plausible that a firm may enter into a short position in a foreign currency to economically hedge the net long position in another closely correlated but illiquid foreign currency for which a hedge is not easily available.
Our view is that a firm should be allowed to benefit from CRR Article 352(2) for net short structural FX positions in certain instances provided that it can demonstrate this position is intended to protect the firm’s capital ratios from adverse FX movements.
Question 4: How should firms/regulators identify positions that are deliberately taken in order to hedge the capital ratio? What types of positions would this include? Do you consider that foreign exchange positions stemming from subsidiaries with a different reporting currency can be seen (on a consolidated level) as ‘deliberately taken to hedge against the adverse effect of FX movements’? If yes, how do you argue that this is the case?
Within Barclays, the structural FX positions taken to hedge the capital ratio can be easily identified as they are recorded in a separate books delineated from other trading activity of the firm and are subject to appropriate Senior Management oversight as guided by the supervising authority (PRA’s) regime for application of CRR Article 352(2).They include net FX positions ‘deliberately taken’, ‘deliberately not closed’ or ‘maintained’ to protect the firm’s capital ratio from adverse foreign currency movements and arise from unhedged net investments in subsidiaries, branches and from investments in non consolidated associates. Certain foreign currency items such as goodwill and deferred tax assets (which form part of the net assets of foreign currency subsidiaries/branches) are deducted from CET1 create an offsetting position (directionally, just like a hedge) to the revaluing net investments. For capital ratio management purposes all these items are taken into account when determining the structural FX position.
Foreign exchange positions stemming from subsidiaries with a different reporting currency can be seen as ‘deliberately taken to hedge against the adverse effect of FX movements’ on a consolidated level as explained in our response to Question 10.
Question 5: Do you consider that the structural FX treatment could be applied to specific instruments instead of being understood as being applicable for ‘positions’? Taking into account the risk rationale of hedging the capital ratio, do you consider that it is acceptable to renounce to potential gains in order to protect the ratio from potential losses? Do you consider that both types of hedging (i.e. reducing the sensitivity of the ratio to movements of FX in both directions, or only if the movement produces losses) are acceptable from an economic perspective? If so, do you consider that both approaches would be acceptable under Article 352?
Structural FX treatment should be applied to net open positions rather than being instrument specific as volatility in capital ratios may arise from and are managed on a “net open currency positions” basis. Where specific hedges are used to manage structural FX risk, these hedges should also be included in the treatment.Currently Barclays manages its structural FX risk with the intention to neutralise the volatility in its capital ratio from any upside or downside FX risk. However, conceptually it may be possible to create a hedge which protects a firm’s capital ratio from any adverse FX movement while still allowing it benefit from any favourable FX movements, although there may be a higher burden of proof for the firm to prove to the competent authority that these hedges are still of a structural nature and eligible for the exemption under CRR Article 352(2). An example of such a situation would be where the bank’s capital ratio is “short” in relation to movements in the foreign currency. In other words, an appreciation of the foreign currency would decrease the capital ratio (see para 33 of EBA consultation where this concept is set out). Here a bank may want to go “long” foreign currency options that pay-off when the foreign currency appreciates in order to protect the bank’s capital ratio.
Question 6: If ‘structural FX’ is used conceptually internally within your organisation (e.g. in risk policies, capital policies, risk appetite frameworks, etc.), how do you define the notion of ‘structural FX position’ and ‘structural hedge’? Please describe how any ratio-hedging strategies are mandated within your organisation. Are ratio-hedging strategies prescribed in risk policies approved by the board? How do you communicate structural FX risk and position taking to your external stakeholders (e.g. in Pillar 3 reports, or reporting to regulators, investors, etc.)?
Barclays maintains structural FX positions in order to protect its capital ratios from adverse FX movements.Since it is not possible to fully hedge both capital ratios and capital at the same time (as capital ratios are the ratio of two items both of which have FX sensitivity) the firm chooses to either hedge the capital or the capital ratio depending upon the materiality of the foreign currency.
For material currencies, the firm manages the sensitivities to a current or near term target capital ratio. The governance process for identification and monitoring of material/non-material currencies and the respective hedging strategies are documented in the firm’s Risk Policies. Senior Management committees within Barclays have oversight of Structural FX risk positions and hedging strategies, under authority delegated by the Board. The governance arrangements and policies/standards are shared with the competent authority (PRA for consolidated supervision) in line with their requirements for CRR Article 352.
The firm’s approach for managing translational foreign exchange exposure is disclosed in the firm’s Pillar 3 disclosures. A snapshot of the gross and net structural foreign currency exposures and related hedges at the report date are also included in the Pillar 3 disclosures.
Question 7: Do you share the EBA’s view that the maximum FX position that could be considered structural should be the position that would ideally neutralise the sensitivity of the capital ratio to FX movements? Alternatively, in the light of the reference to Article 92(1), do you consider that the size of the structural position should be limited by the minimum capital ratio levels? If this is the case, which one of the three levels established in Article 92(1) do you apply?
We share the EBA’s view that the size of the structural positions should not be limited by the minimum capital ratio levels. Instead, the size of the structural positions should be determined by the firm’s current or near term target capital ratio which also takes into account factors such as the Pillar 2 add-ons, regulatory buffers and other capital planning assumptions including voluntary buffers. This is consistent with the overall objective of managing FX sensitivity on the current or near term capital ratios rather than the minimum capital ratios as prescribed under Article 92(1) of CRR.Though we agree that the aim of the structural positions should be to neutralise sensitivity of the capital ratio to adverse FX movements, it may not be possible to neutralize the risk to zero given the dynamic nature and complexity of the risk. Firm’s should therefore be allowed to maintain structural FX positions such that the capital ratio sensitivity to FX is managed within a range/tolerance agreed with the firm’s Senior Management and Risk.
Question 8: How do you assess the consolidated ratio? How does your treatment differ between subsidiaries and branches?
Structural FX positions are often taken/maintained to manage the FX sensitivity on capital ratios at a consolidated level. There could be differences between the consolidated capital ratio and the capital ratios of individually regulated entities in the group. This is addressed further in question 10.There are no differences in the FX translation risk associated with a foreign currency subsidiary and foreign currency branch from an accounting perspective. In some jurisdictions, there is no distinction between a branch or subsidiary for regulatory purposes as capital adequacy requirements are applied to both. We therefore believe that there should not be any differences in treatment between net investments in subsidiaries or branches when looking at consolidated capital ratios.
Question 9: What are your views on the CRR2 text of the structural FX article? What significant impacts might this have on your current hedging strategies?
As mentioned in response to Question 7 above, the amount of structural FX hedge that firms are allowed to take should be determined in reference to their current or near term capital ratio taking into account firm specific circumstances and capital planning.The cap on structural FX positions proposed in Article 325c can be unhelpful e.g. where a firm overhedges due to different tax rates, or where a hedge for neutralising the Group’s capital ratio is maintained at the level of a regulated subsidiary. Any caps/limits on the structural FX positions should therefore be set in relation to the firm’s current or near term target capital ratio.
Structural hedges are measured at a net position level which can include banking book as well as trading book assets and liabilities. As the net positions vary from month to month, we do not believe that the exclusion should be made at least for six months. Banks need to have flexibility in management of the structural FX position.
Furthermore, market movements and strategic decisions can be drivers for changes of the capital ratio composition. Hedges may have to be managed dynamically and may not remain in place for the life of the assets.
We therefore suggest that the EBA should propose deletion of the exclusions in CRR2 Article 325c(1)(a), (b) and (2).
Question 10: Do you agree with the analysis in the simplified assessment, from both an individual and a consolidated perspective, of the various elements discussed in this Annex of the DP or do you have any comments? In particular, do you have comments regarding the analysis of: o the actual level of the capital ratio o the effect of items deducted from capital / subject to a 1.250% RWA / subject to a 0% RWA o the effect of items held at the historical FX rate? Are there any additional elements, not included in the simplified examples, which should be considered in the analysis, both from an individual and a consolidated perspective? Please provide simple examples to illustrate them.
We agree with the EBA’s simplified assessment. The examples set out in Annex 1 of the EBA’s discussion paper illustrate the key principles (particularly example 2.2.1 and 2.2.2). We summarize some of the key points below:• Open positions that revalue for FX at the consolidated and individual levels could be different. As a result a firm may need to prioritize neutralizing the adverse impact of FX on the capital ratios at one of these levels. This could be driven by several considerations such as a) whether consolidated or individual level is the binding constraint b) whether stress tests are run at consolidated or individual levels c) whether individual ratios are disclosed externally to investors/analysts.
• A key reason for the difference between consolidated and individual FX exposure is the different accounting and regulatory treatments of investments in subsidiaries. At the consolidated level, the net assets of the foreign currency subsidiary revalue for FX (through the currency translation reserve) whereas at the individual level an investment in a subsidiary is held at historic cost and subject to the threshold deduction test. The consolidated group may wish to hedge part/all of the investment in the foreign subsidiary to manage any adverse impact of FX on its capital ratios. However, if this investment is deducted at the individual level, then the hedge (if executed out of that entity) introduces volatility in the capital ratio at the individual level. This is illustrated in example 2.2.1
• When granting a waiver under Article 352, regulators should consider the case by case situation and not expect that group will be able to demonstrate compliance with Article 352 at both the consolidated and individual level. Failure to comply at either of these levels should not result in an own funds requirement at that level.