Response to consultation Paper on draft RTS on the treatment of non-trading book positions subject to foreign-exchange risk or commodity risk

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Q1. Do you agree with the approach in relation to the use of the accounting value and alternatively the fair value as a basis for computing the own funds requirements for foreign exchange risk, or do you think that institutions should be requested to use e.g. only the accounting value? Please elaborate.

We agree with the proposal (To use either accounting value or fair value) but some of our members prefer to use the accounting value (see also answer to Question 3).

Q2. Do you agree that institutions should be requested to update on a daily basis only the foreignexchange risk component of banking book instruments? Please elaborate.

We agree with the proposal.

Q3. Could you please describe the current risk-management practices that institutions use for managing the foreign-exchange risk stemming from banking book positions, e.g. whether the accounting or the fair-value is used as a basis for determining the exposure in a currency, the frequency at which banking book positions are fully revalued, the frequency at which the foreignexchange component is updated?

In general, the accounting values are used for determination of the exposures of banking book positions. Although in some special cases fair values for certain type of instruments (e.g. bonds) are taken into account in Pillar 2 framework (even if treated at amortized costs) we think that the accounting value is the best common basis for the Pillar 1 framework of banking book positions.

Accounting values are updated at least monthly. Fair Value calculation of banking book positions de-pends on the type of instrument. For traded instruments like bonds, the fair values are generally updated daily, but at least monthly. For non-traded instrument like loans and deposits, a fair value calculation is following the quarterly IFRS reporting frequency.

The foreign exchange component is updated on a daily basis.

Q4. Do you agree with the proposed methodology for capturing the foreign-exchange risk stemming from non-monetary items at historical cost under the standardised approach? Do you have any other proposal for capturing the foreign-exchange risk stemming from non-monetary items at historical cost that would be prudentially sound while fitting within the standardised approach framework? Please elaborate.

ESBG thinks that the inclusion of items at historic costs as a Delta 1 positions is in general overly con-servative. As these positions do not revalue with FX-movements, an efficient hedge for risk weighted assets (RWAs) generated from historic costs item is impossible. Impairments due to FX movements depend on many parameters and the risk of impairment due to FX movements may be remote.

In addition, the Delta 1 approach is in contradiction to the proposed treatment under the internal model approach where the risk of impairment due to FX should be modelled by the bank, see also Question 9.

Inclusion of items at historic cost is directly connected to the EBA Draft Guidelines on the treatment of structural FX under 352 (2) of the CRR. Regulatory approval for exclusion of items at historic costs generate an overly complex, resource and time consuming process.

Additionally, we see a possible overlap between inclusion of subsidiaries at historic costs and systemic risk buffer and O-SII buffer that would lead to double coverage of the same risks.

Finally, we would recommend allowing the full exclusion of items at historic costs or to establish criteria for reduced risk weights depending on probability for FX induced impairment.

Q5. How are you currently treating, from a prudential perspective, non-monetary items at historical cost that may be subject to an impairment due to a sharp movement in the foreign-exchange rate? In which currency are those items treated from an accounting perspective?

We would like to point out that items at historic costs are currently not included in Pillar 1 capital re-quirements. These items are included in the Pillar 2 framework.

Q6. Could you please provide an estimate of the materiality of non-monetary items that are held at historical cost for your institution (e.g. size of the non-monetary items at historical cost with respect to the institution’s balance sheet)? Please elaborate.

For some of our members, at consolidated level the items in FX held at historical costs are not material. Whereas at solo level participations in subsidiaries held at historical costs are material (between 5-10% of solo balance sheet).

Q8. Do you agree that, with respect to the valuation of foreign-exchange and commodity positions held in the banking book, the provisions applicable in the context of the alternative standardised approach (Article 1 paragraphs 1 and 2) should also apply in the context of the alternative internal model approach (Article 3 paragraphs 1 and 2)? Please elaborate.

ESBG agrees with the proposal.

Q9. Do you agree with the provision requiring institutions to model the risk that non-monetary items at historical cost are impaired due to changes in the relevant exchange rate or do you think that the RTS should be more prescribing in this respect? Please elaborate.

We agree that a risk adjusted treatment for historic cost items in the internal model approach is a suita-ble framework for fostering management of this risk type. Despite the fact it is increasing the complexity of the internal model it is still superior to a Delta 1 approach as foreseen for the standardized approach. See also the answer to Question 4.

Q12. Do you agree with the definitions of hypothetical and actual changes in the portfolio’s value deriving from non-trading book positions that have been included in the proposed draft RTS?

ESBG agrees.

Q11. Do you think that the requirement to capture the impairment risk in the risk-measurement model for institutions using the internal model approach is less or more conservative than the requirement proposed for institutions using the standardised approach? Please elaborate.

Given the lack of detailed analysis at this stage we cannot give a detailed estimate However, we expect that the standardized approach is in general more conservative than an internal model approach. Delta 1 approach will result in more conservative exposures in the standardized approach and, in addition, the diversification benefits between currencies might be more pronounced in the internal model.

Q10.How institutions would capture the risk of an impairment in their risk-measurement model? Would the definition of impairment used in the internal model be identical to the one proposed in the accounting standards? Please elaborate.

There is no detailed concept available, but we think that the accounting standards are the basis for such a model. We expect that the model can be based on similar techniques as currently applied for event-driven tail risk quantification.

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Name of the organization

European Savings and Retail Banking Group (ESBG)