Response to discussion on the treatment of structural FX under Article 352(2) of the CRR

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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?

According to regulations of Financial Supervisory Service(FSS) in Korea, historic rate is used for the accounting purposes. But for the market risk capital calculation, FX non-monetary items are treated as trading positions, which is included in market risk capital calculation.

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?

Agree. Determining the net FX position (as well as determining the structural FX exclusion) is determining the boundary of trading position. The calculation method should be concerned about how to estimate the parameters more effectively, not about what the boundary is. If structural FX exclusion is dependent on the approach, it would cause significant difference between SA banks and IMA banks in market risk capital calculation and possession of capital ratio hedging instruments

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.

Shinhan bank understands that structural FX provision is based on consolidate accounting technique. Therefore, we agree with EBA’s view that structural exposure arises from lending activities in cross-border subsidiaries and branches. But the definition of ‘structural nature’ is not clear (as mentioned in DP), regulatory agency’s authoritative interpretation is desirable.

Agree. Shinhan bank may only use FX long position as a structural FX position. Holding short position might weaken capital adequacy ratio, depending on the FX movement. BCBS documents also explain structural FX with domestic currency short position.

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?

By separating specific transactions(or financial instruments) which has structural nature from other transactions, banks can identify structural FX position properly. For example, if a bank writes foreign currency denominated equity(or Net investments) in specific department’s B/S and recognize FX positions stem from equity(or Net investments) in specific folder(or portfolio), then the bank would identify structural FX position.

Subsidiaries with a different reporting currency should be converted to reporting currency at a settlement term for consolidate accounting purposes. This reporting currency revaluation process produces Currency Translation Adjustment (CTA) , recognized in Other Comprehensive Income (OCI)
Since both sensitivities of RWA and CTA to FX movement have same positive sign, fluctuation of RWA can be erased proportionally by fluctuation of CTA, then total capital ratio finally can be neutralized.
If a bank has FX long positions related to net investments in subsidiaries with a different reporting currency, bank can utilize Currency Translation Adjustment (CTA) effects to stabilize capital ratio.
But If a bank has square positions (or hedged positions) with foreign currency liabilities, CTA effect would be erased by foreign currency liabilities revaluation and could not stabilize capital ratio.
As mentioned above examples, maintaining long positions stem from subsidiaries with a different reporting currency can be interpreted as utilizing CTA effects to stabilize bank’s capital ratio and that means deliberately taken FX long position.

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?

As a structural FX position, identifying specific positions stem from specific financial instruments which have Non-trading and structural nature is desirable. Foreign currency investments in subsidiaries and branches would be an appropriate example

The purpose of a structural FX provision is to stabilize bank’s capital ratio from FX movement. Approval of potential gain from a structural FX position does not match with stabilizing rationale

Symmetric hedge effect of structural FX position would produce “Real” capital ratio, which means the capital ratio that is not contaminated by FX movement effect. (If the domestic currency appreciates, capital ratio would be higher, in spite of taking more risky assets). In this aspect, Symmetric hedge is more desirable.

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.)?

Since there is no precedent of structural FX authorization in Korea, now we do not use structural FX provision in internal capital calculation to align with regulatory capital. We agree with BCBS and EBA’s capital ratio protection concept and plan to get authorization from Korea Financial Supervisory Service (FSS)

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?

Agree. On a conceptual basis, the maximum size of structural FX position should be the size that enables a bank to neutralize its overall capital ratio sensitivity.
Limiting size of structural FX position in Article92(1) means partial hedge of capital ratio. If structural FX provision limits the size of position, the excess capital above the limit (4%,6%,8%) would be exposed to market volatility. The higher the capital ratio is the more volatility a bank is exposed to. Therefore, banks get penalized for maintaining capital ratio high, which can be considered as reverse discrimination.

Question 8: How do you assess the consolidated ratio? How does your treatment differ between subsidiaries and branches?

We calculate all RWAs in consolidate basis including overseas branches and subsidiaries. But there is no precedent in Korea where structural position is used , so we have to calculate all net FX position’s RWAs including structural FX (positions stem from foreign currency investments in overseas branches and subsidiaries which are subject to fixed FX rate)

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?

Structural FX provision in CRR2 limits the maximum size of structural position to the largest amount of subsidiaries or largest amount of affiliates. But in BCBS FRTB, the exclusion is limited to maximum of subsidiaries “and/or” affiliates. We consider that BCBS’s “and/or” condition would be an argument. Because it might lead partial capital ratio hedge. If bank has both overseas subsidiaries and branches with same functional currency, the structural position size would be limited to the largest amount between “subsidiaries and affiliates”. In this aspect EBA’s wording is more clear than BCBS’s

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.

There should be additional discussions on the calculation methodology of optimal structural FX size and relation between CTA and structural FX. Discussions on these two topics would help to clarify the concept of structural FX.

Name of organisation

Shinhan Bank