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EBA Consultation Paper Summary: Draft Regulatory Technical Standards for CVA Risk

Core Content

This document outlines the European Banking Authority's (EBA) draft Regulatory Technical Standards (RTS) related to the calculation of credit valuation adjustment (CVA) capital charges. The RTS are based on the proposed Capital Requirements Regulation (CRR) and revised Capital Requirements Directive (CRD IV) by the European Commission, which aim to align EU banking regulations with the Basel III framework. The EBA seeks feedback from stakeholders on how to implement these standards, particularly on the methodology for determining a proxy spread and the specification of a limited number of smaller portfolios.

Main Features of the Draft RTS

• Proxy Spread Determination: The EBA proposes a methodology to determine proxy spreads for CVA risk, especially when no credit default swap (CDS) is available for a counterparty. This includes:

  • Using a proxy spread based on rating, industry, and region.
  • Applying a pre-determined framework for aggregating data.
  • Ensuring that all inputs are based on reliable data from a liquid two-way market.
  • Allowing for interpolation and extrapolation of data, provided it is conceptually sound.

• Portfolio Size and Number Limits:

  • The number of non-IMM portfolios (excluding single transaction portfolios) must not exceed 15% of the total number of portfolios.
  • The size of non-IMM portfolios (including single transaction portfolios) must not exceed 10% of the total size of all portfolios.
  • These limits are to be monitored regularly, and permission to use the advanced method may be withdrawn if limits are breached for two consecutive quarters.

• Definitions:

  • A portfolio is defined as a netting set used for regulatory purposes.
  • A non-IMM portfolio is one where the Internal Model Method (IMM) is not applied.
  • A single transaction portfolio includes only one transaction and is not subject to a legally enforceable netting agreement.
  • The size of a portfolio can be defined using three options:
    1. Exposure at default calculated using the mark-to-market method.
    2. Current exposure, defined as the larger of zero and the market value of a transaction or portfolio upon counterparty default.
    3. Standardised CVA capital charge calculated in accordance with Article 374 of the CRR.

Key Questions for Consultation

1. Q1: Does the VaR proxy methodology always take into account rating, region, and industry when determining the proxy spread for CVA risk? Will the minimum prescribed granularity for these factors, if applied to Article 4.1, impact current proxy spread modelling methodologies?

2. Q2: Will the proposed use of the extended VaR proxy methodology and/or the minimum prescribed granularity for rating, industry, and region when determining a proxy spread for CVA risk impact institutions' current methodologies for proxy spread modelling?

3. Q3: Please provide information and data concerning the availability of CDS data relevant to the intersection of sub-categories ("rating", "industry", and "region") and the application of the aggregation rules specified in Article 5.8.

4. Q4: Please provide any information as to the difference in own funds requirements for the portfolio of counterparties following the application of the approach set out in Article 5.8 and Article 5.9 or the alternative policy options here described.

5. Q5: Do the proposed thresholds of 15% for the number and 10% for the size of smaller portfolios, together with the definitions, provide an incentive for institutions to limit their portfolio exposures not covered by the Internal Model Method (IMM)?

6. Q6: Will 15% and/or 10% cause any impact for your institution? If there will be an impact, please specify and assess the overall effect on the institution.

7. Q7: Which of the three definitions of 'size of portfolio' as defined in Article 2(4) would you use to determine the 10% size ratio? Please provide reasons for the selected definition and details of any alternative options you would propose.

Key Information

• The draft RTS are intended to be submitted to the European Commission by 1 January 2013.
• The RTS aim to ensure a level-playing field by preventing divergent national requirements and facilitating cross-border financial services.
• The EBA has conducted public consultations and considered stakeholder opinions, including those from the Banking Stakeholder Group.
• The use of a proxy spread is necessary when no reliable market data is available, and institutions must use a method that is consistent with the standardised approach when no suitable data exists.
• The EBA expects that most of its RTS will be adopted as Commission Regulations, which are binding and directly applicable in all Member States.

Purpose and Rationale

• The purpose of the draft RTS is to implement the CRR's provisions on CVA risk, particularly Article 373(6), which requires the EBA to specify how proxy spreads should be determined and how the limited number of smaller portfolios should be defined.
• The rationale is to enhance the resilience of the banking sector by improving the accuracy and consistency of capital requirements for CVA risk, while also ensuring that institutions have clear guidelines and that there is no undue burden on them.
• The EBA aims to provide a transparent, consistent, and proportionate approach to the calculation of CVA capital charges, based on reliable market data and appropriate methodologies.

Conclusion

The EBA's draft RTS on CVA risk are designed to provide detailed guidance on the determination of proxy spreads and the specification of a limited number of smaller portfolios. These standards are essential for implementing the CRR and aligning EU banking regulations with the Basel III framework. They seek to ensure consistency, transparency, and fairness across the EU banking sector, while also allowing for flexibility in the application of methodologies depending on the availability of data. The consultation process is critical to refining these standards based on stakeholder input and ensuring that they are practical and effective in real-world scenarios.