Response to discussion on the treatment of structural FX under Article 352(2) of the CRR
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HSBC does not agree with the EBA’s view that the potential exclusion should be acceptable only for long FX hedging positions . It should be sufficient to specify that the structural FX hedge is established to protect a capital ratio. The conclusion that only long FX hedging positions would be required is based upon simple examples presented in the discussion paper in which the capital base is denominated in a single currency. This is not the case in a global subsidiarised bank such as HSBC, and as a consequence structural imbalances between capital and RWAs by currency can and do result in both long and short positions. As such, HSBC requires the ability to enter into both long and short positions to protect capital ratios against currency movements. We can provide examples of this if required.
(The discussion paper uses “long FX” to refer to a hedging position that is long foreign currency vs. domestic currency)
HSBC does not believe it is necessary to limit the types of instrument that could be used to hedge. Historically HSBC has primarily established hedging positions using forward FX transactions, but other instruments (eg. FX options, debt instruments) can be used to establish similar hedging positions. The key criteria is that the hedge is deliberately established to protect a capital ratio.
HSBC is of the view that if the purpose of transacting a hedge is to hedge a solo capital ratio of an operating entity or a consolidated capital ratio (or both) then the market risk exemption should be available.
The primary purpose of a hedge is to protect the ratio against adverse movements. The nature of the instrument used to achieve this determines whether or not potential gains are fully or partially renounced. The decision to adopt a hedging strategy that renounces potential gains should be a matter for the individual firm and should not prevent recognition of the position as a qualifying hedge per Article 352(2), provided that the primary purpose of the hedge is met and the appropriate intent is evident.
The accounting rules (IAS 39, IFRS 9) are of some relevance here. HSBC uses FX forwards to hedge structural FX which are designated as net investment hedges to avoid consolidated p&l volatility. This could not be achieved with an option.
The regulatory risk management of structural FX is concerned with the sensitivity of capital ratios to adverse FX movements. A ‘structural FX position’ is the imbalance between the capital in a particular currency and the capital required to support RWAs denominated in that same currency.
Structural FX positions are subject to a limit monitoring framework as part of HSBC’s broader Enterprise-Wide Risk Management Framework. HSBC’s approach to structural FX is discussed on page 60 of HSBC’s 2016 Pillar 3 disclosures and on pages 78 and 116 of HSBC’s 2016 AR&A. HSBC’s regulators are provided visibility of the Group Structural FX position through ALCO materials and the ICAAP process.
Branches are not in general subject to standalone capital requirements and will be assessed at subsidiary level. There are exceptions in certain jurisdictions (eg. India, Indonesia) where branches are subject to local capital requirements akin to those of full banking subsidiaries.
HSBC is of the view that if the purpose of transacting a hedge is to hedge a solo capital ratio of an operating entity or a consolidated capital ratio (or both) then the market risk exemption should be available.
HSBC does not support limiting of exclusions to the amount of ‘investment in affiliated entities’ or ‘amount of investment in consolidated subsidiaries’. We wonder if this is applying accounting concepts to a regulatory risk issue. If the hedge is suitably designed to protect a capital ratio this should suffice.
HSBC also does not support a requirement that the hedge should ‘remain in place for the life of the assets and other items’, which is not practical given the portfolio nature of the exposure and presence of perpetual instruments (eg. equity).
HSBC does not agree that any exclusion should be limited to own fund requirements disclosed in Article 92(1). See Q7 for further comments.
HSBC agrees that items deducted from capital or subject to a 1250% risk weight should be fully considered when determining a structural FX position. We also agree that balances with the same notional value will generate a different structural FX position depending on whether they are deducted or risk weighted at 1250%.
HSBC agree that assets subject to a 0% risk weight create no structural FX position, as there is no RWA associated with the balance and therefore no imbalance versus capital. However, we note that assets risk weighted at 0% within a Group consolidation are not necessarily risk weighted at 0% within sub consolidations that are subject to local regulatory requirements and vice versa.
HSBC agrees that foreign currency assets held at historic cost that generate RWAs should be fully considered when determining a SFX position (i.e. property plant and equipment).
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?
This is not a significant issue for HSBC as non-monetary items held at historic cost are an immaterial component of HSBC’s balance sheet.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?
HSBC shares the EBA view. The objective should be to isolate a structural FX hedge designed to protect a capital ratio and treat it appropriately. The exemption should be available regardless of the approach for calculation of FX own funds requirements.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.
HSBC does not consider that the ‘structural nature’ wording would limit the application of the structural FX provisions to those items held in the banking book. The objective should be to isolate a structural FX hedge designed to protect a capital ratio and treat it appropriately.HSBC does not agree with the EBA’s view that the potential exclusion should be acceptable only for long FX hedging positions . It should be sufficient to specify that the structural FX hedge is established to protect a capital ratio. The conclusion that only long FX hedging positions would be required is based upon simple examples presented in the discussion paper in which the capital base is denominated in a single currency. This is not the case in a global subsidiarised bank such as HSBC, and as a consequence structural imbalances between capital and RWAs by currency can and do result in both long and short positions. As such, HSBC requires the ability to enter into both long and short positions to protect capital ratios against currency movements. We can provide examples of this if required.
(The discussion paper uses “long FX” to refer to a hedging position that is long foreign currency vs. domestic currency)
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?
HSBC’s structural FX hedges are subject to robust internal governance that clearly demonstrates the intent of the hedge, and the exemption requires approval by the PRA. This might be instructive in establishing the appropriate threshold to meet the requirement.HSBC does not believe it is necessary to limit the types of instrument that could be used to hedge. Historically HSBC has primarily established hedging positions using forward FX transactions, but other instruments (eg. FX options, debt instruments) can be used to establish similar hedging positions. The key criteria is that the hedge is deliberately established to protect a capital ratio.
HSBC is of the view that if the purpose of transacting a hedge is to hedge a solo capital ratio of an operating entity or a consolidated capital ratio (or both) then the market risk exemption should be available.
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?
HSBC believes that the structural FX treatment should be based on the intent to protect a capital ratio rather than the hedging instrument, and should therefore be based on ‘position’.The primary purpose of a hedge is to protect the ratio against adverse movements. The nature of the instrument used to achieve this determines whether or not potential gains are fully or partially renounced. The decision to adopt a hedging strategy that renounces potential gains should be a matter for the individual firm and should not prevent recognition of the position as a qualifying hedge per Article 352(2), provided that the primary purpose of the hedge is met and the appropriate intent is evident.
The accounting rules (IAS 39, IFRS 9) are of some relevance here. HSBC uses FX forwards to hedge structural FX which are designated as net investment hedges to avoid consolidated p&l volatility. This could not be achieved with an option.
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.)?
HSBC distinguishes the accounting definition of structural FX from the regulatory risk perspective of structural FX. From an accounting perspective, HSBC defines that ‘Structural FX exposures represent net investments in subsidiaries, branches and associates, the functional currencies of which are currencies other than the US dollar’ (2016 Annual Report and Accounts (“AR&A”) p78). Exchange differences on structural exposures are recognised in “Other Comprehensive Income”, and within shareholders equity as part of “Other reserves”. HSBC’s structural exposures are quantitatively disclosed on P116 of the 2016 AR&A.The regulatory risk management of structural FX is concerned with the sensitivity of capital ratios to adverse FX movements. A ‘structural FX position’ is the imbalance between the capital in a particular currency and the capital required to support RWAs denominated in that same currency.
Structural FX positions are subject to a limit monitoring framework as part of HSBC’s broader Enterprise-Wide Risk Management Framework. HSBC’s approach to structural FX is discussed on page 60 of HSBC’s 2016 Pillar 3 disclosures and on pages 78 and 116 of HSBC’s 2016 AR&A. HSBC’s regulators are provided visibility of the Group Structural FX position through ALCO materials and the ICAAP process.
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?
HSBC does not believe that the Basel Framework limits the structural position to minimum ratios, but instead ‘allows banks to protect their capital adequacy ratio’ against the adverse effect of exchange rates in totality. We note that encouraging banks to hedge the actual ratio promotes financial stability by reducing the probability that a combined shock across FX and other market variables erodes the buffer held in excess of regulatory minimum. Limiting the structural position to a 4.5%, 6% or 8% minimum provides only a partial hedge of the actual ratio and will not neutralise or remove ratio volatility.Question 8: How do you assess the consolidated ratio? How does your treatment differ between subsidiaries and branches?
HSBC’s treatment of structural FX is the same at consolidated and subsidiary level, including branches. The structural FX position is the imbalance between the capital in a particular currency and the capital required to support RWAs denominated in that same currency at the current capital ratio.Branches are not in general subject to standalone capital requirements and will be assessed at subsidiary level. There are exceptions in certain jurisdictions (eg. India, Indonesia) where branches are subject to local capital requirements akin to those of full banking subsidiaries.
HSBC is of the view that if the purpose of transacting a hedge is to hedge a solo capital ratio of an operating entity or a consolidated capital ratio (or both) then the market risk exemption should be available.
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?
HSBC is concerned that the CRR 2 wording is significantly more restrictive than the current wording per CRR article 352(2), and if adopted would not provide the necessary flexibility required by global banks to fully manage structural FX positions without generating additional RWAs.HSBC does not support limiting of exclusions to the amount of ‘investment in affiliated entities’ or ‘amount of investment in consolidated subsidiaries’. We wonder if this is applying accounting concepts to a regulatory risk issue. If the hedge is suitably designed to protect a capital ratio this should suffice.
HSBC also does not support a requirement that the hedge should ‘remain in place for the life of the assets and other items’, which is not practical given the portfolio nature of the exposure and presence of perpetual instruments (eg. equity).
HSBC does not agree that any exclusion should be limited to own fund requirements disclosed in Article 92(1). See Q7 for further comments.
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.
HSBC agrees that the actual level of the capital ratio is a key structural FX consideration. Where a bank intends to protect its current ratio, the position needed to neutralise FX volatility must reference the current ratio.HSBC agrees that items deducted from capital or subject to a 1250% risk weight should be fully considered when determining a structural FX position. We also agree that balances with the same notional value will generate a different structural FX position depending on whether they are deducted or risk weighted at 1250%.
HSBC agree that assets subject to a 0% risk weight create no structural FX position, as there is no RWA associated with the balance and therefore no imbalance versus capital. However, we note that assets risk weighted at 0% within a Group consolidation are not necessarily risk weighted at 0% within sub consolidations that are subject to local regulatory requirements and vice versa.
HSBC agrees that foreign currency assets held at historic cost that generate RWAs should be fully considered when determining a SFX position (i.e. property plant and equipment).