Non-paper on K-factors for Risk to Market (RtM) from NL and CZ. Introduction

Transcription

1 Non-paper on K-factors for Risk to Market (RtM) from NL and CZ Introduction The European Commission s proposal for the Investment Firm Regulation (IFR) provides in Article 21 that the Risk to Market (RtM) K-factor requirement for an investment firm dealing on own account shall be the higher of K-NPR (net position risk) or K-CMG (clearing member guaranteed). For the purpose of calculating K-NPR, the proposed Article 22 of IFR sets out three methods, being (i) the simplified standardised approach for market risk under current CRR, (ii) the standardised approach under the new CRR2 (i.e. the Fundamental Review of the Trading Book FRTB), or (iii) the internal model approach for market risk set out in the CRR. The calculation of K-CMG is set out by the proposed Article 23 of IFR, subject to supervisory approval and a number of conditions. This non-paper contains a number of drafting suggestions for revisions in order to make the RtM K-factors more appropriate and more proportionate for investment firms dealing on own account under the responsibility of a clearing member. This will make the RtM capital requirements more reflective of actual risks and less burdensome. The most important revision is the removal of the words the higher of (K- NPR or K-CMG) in Article 21 of IFR, such that K-CMG becomes a fourth and full alternative method to calculate the RtM capital requirement. Also, some amendments are proposed to further ensure the prudency and appropriateness of this capital requirement. Making K-CMG a full alternative for calculating the RtM capital requirements It is recognised that the standardised approach for market risk in CRR allows for limited netting of hedged positions. This is amongst others due to the fact that netting is only allowed if products are traded on the same market or if it concerns off-setting positions in identical underlying securities of derivatives. This makes K-NPR less appropriate for trading firms with high trading volumes that continuously hedge their market risk by taking off-setting positions. These investment firms often play an important role in the capital markets as market makers or liquidity providers. For these trading firms the CRR capital requirements for market risk would be too high, as they lead to a capital charge for both legs of a hedged position, even though trading positions are economically hedged and the net market risk is very low or close to zero. This explains the need for an alternative method to calculate the capital requirement for Risk to Market, being K-CMG. Trading firms with high trading volumes often use a clearing member to finance their trading positions, with the underlying trading portfolio serving as collateral. The clearing member calculates a haircut for this collateral, to take account of the risks the clearing member faces in relation to these trading positions. The clearing member s haircut mainly considers market risk by calculating the maximum potential adverse market value change of the trading portfolio under a set of stress scenarios. This haircut equals the minimum total margin requirement that the investment firm has to post in liquid assets (including cash) with the clearing member. The clearing member ensures that it sets its margin requirements prudently, in order to protect itself against the risk exposure in relation to the trading positions of the trading firm. To ensure its prudency, an important condition in the EC s proposal for the use of K-CMG is that the margin model of the clearing member meets criteria that are equivalent to the requirements for margin models of central counterparties (CCPs) in EMIR 1. The margins required by the clearing member from the trading firm are based on proper netting and off-setting, and are therefore adequately reflecting the actual risk. As such, K-CMG is a prudent and tailored approach for measuring RtM for the investment firm concerned, bearing in mind that K-CMG requires the trading firm to hold capital that is equal in amount to the total margin requirement set by the clearing member. 1 This will be assessed by the investment firm s competent authority, which may consult the clearing member s competent authority if needed (and where that is a different authority).

2 The balance sheet below illustrates CMG in a simplified form. Stylised balance sheet of a trading firm Assets mio Liabilities mio Trading portfolio (e.g. securities/derivatives) Margins posted at clearing member (= encumbered cash/liquid assets) Unencumbered cash/liquid assets 100 Asset-backed loan (= loan due to clearing member) Equity 15 5 In this example, the trading firm has a trading portfolio with a mark-to-market value of 100 mio, which is fully financed by the clearing member. This trading portfolio serves as collateral for this loan, which is therefore asset-backed. The clearing member calculates a haircut of 10 mio, implying that the net collateral value is 90 mio. As a consequence, the trading firm has to post additional cash or liquid assets (i.e. margins or encumbered cash) of at least 10 mio at the clearing member, being total margins required. Subsequently, K-CMG requires that the trading firm holds an amount of capital that is at least equal to this total margin requirement of 10 mio, which effectively means that the investment firm has to fully capitalise the margins required by its clearing member. The trading firm in this example also holds unencumbered cash or liquid assets of 5 mio which could be used for instance if additional margins are required. It is further recognised that the words the higher of in the proposed Article 21 of IFR create inefficiencies and administrative burdens. In its current form, this provision requires trading firms to continuously calculate two K-factors (both K-NPR and K-CMG) for the same trading positions, regardless of which K-factor is ultimately applied for the capital requirements for RtM. Because K-CMG is more appropriate and creates less administrative burdens, K-CMG should be a separate and fourth alternative method to calculate the RtM capital requirement for trading firms with cleared positions, subject to prior approval by the competent authority and to a number of conditions (see next). This can be achieved by simply replacing the words the higher of [K-NPR or K-CMG] in Article 21 of IFR by either [K-NPR or K-CMG]. More stringent and appropriate conditions on the use of K-CMG The EC s proposal for the IFR already establishes that the use of K-CMG is subject to prior approval by the competent authority and a number of conditions. Most importantly, the third condition for the use of K-CMG is that a margin model of the trading firm s clearing member meets criteria that are equivalent to the requirements for margin models of CCPs under EMIR. This non-paper proposes some amendments to the conditions in Article 23 of IFR, to make the use of K-CMG more prudent and appropriate: In the EC s proposal for K-CMG, reference is made to initial margin posted [to the clearing member]. In order to make this more prudent, this should be replaced by total margin required [by the clearing member]. After all, the clearing member does not distinguish between initial and variation margin (like CCPs do), but requires total margins which mainly consider the market risk associated with financing the trading positions of the investment firm (which take place under the responsibility of that clearing member). To offer more flexibility it should be allowed to use K-CMG on a portfolio basis, such that investment firms that use this margin approach for specific portfolios can apply K-CMG as well, whilst still calculating the RtM capital requirement for their unmargined portfolios by applying one (or more) of the three alternative methods for K-NPR.

3 With regard to the condition on the supervisory assessment of the clearing member s margin model, we propose a technical change. Instead of cross-referring to Article 41 of EMIR (that is addressed to CCPs) it is proposed to copy in the relevant parts of that EMIR provision into Article 23(1)(c) of IFR, so as to make this condition more appropriate for trading firms and their clearing members. In addition, some minor technical amendments are proposed with regard to the RtM K-factors, including: It is proposed to delete the EUR 300 million threshold for the use of the FRTB method, in order to align with the developments in the in the CRD/CRR Review package and keep FRTB in as an option, instead of a mandatory method for larger trading firms. It is proposed to rename the K-factor to clearing margin given as this is more consistent with the content of this K-factor. Proposed amendments The following pages include drafting suggestions for the methodologies to calculate K-NPR and K-CMG. Bold and underlined are the drafting suggestions. Highlighted in [yellow] are comments regarding proposed changes.

4 Part A Proposed amendments to the Recitals of the Investment Firm Regulation (IFR) (20) The K-factor under RtM captures net position risk (K-NPR) in accordance with the market risk provisions of CRR or, where permitted by the competent authority for specific types of investment firms which deal on own account through clearing members, based on total margins posted with required by an investment firm s clearing member (K-CMG). (24) The K-factor for RtM for investment firms which deal on own account is based on the rules for market risk for positions in financial instruments, in foreign exchange, and in commodities in accordance with Regulation (EU) No 575/2013 as amended [footnote 7]. This allows investment firms to choose to apply either the standardised approach under Regulation (EU) No 575/2013 (simplified standardised approach under Regulation (EU) No 575/2013 as amended), if their assets are below EUR 300 million or the revised standardised approach under Regulation (EU) No 575/2013 as amended, or as well as the option to use internal models. In the two last cases of the revised standardised approach, the resulting capital requirement may be decreased to 65%, making permanent the possibility under Regulation (EU) No 575/2013 as amended to apply this on a temporary basis for three years, in order to take account of investment firms overall lower prudential relevance. Alternatively, the capital requirement of trading firms whose business is centrally cleared should with positions that are subject to clearing may, subject to the approval of the competent authority and a number of conditions, be equal to the amount of total margins posted with required by their clearing member. The investment firm s competent authority may also allow the investment firm to make partial use of the K-CMG approach, such that this margin approach is used for portfolios that are subject to clearing, whilst using one or more of the three alternative methods for K-NPR for portfolios that are not subject to clearing. (39) In order to ensure the harmonised application of this Regulation, EBA should be charged with drafting technical standards to specify the calculation of fixed overheads, the calculation for setting capital requirements equal to the initial margin posted with total margin required by clearing members, and the templates for the public disclosures and regulatory reporting required under this Regulation. Part B Proposed amendments to the Investment Firm Regulation (IFR) Article 4 Definitions 1. For the purpose of this Regulation, the following definitions shall apply: [ ] (30) K-CMG or K-factor in relation to clearing margin given member guarantee (CMG) means the capital requirement equal to the amount of initial margins posted with total margin required by a clearing member, where the execution and settlement of transactions of an investment firm dealing on own account takes place under the responsibility of a general clearing member; [It is proposed to rename the K-factor to clearing margin given as this is more consistent with the content of this K-factor. The capital requirement under CMG is calculated as the amount of total margins required to be posted (or given ) to the investment firm s clearing member.] (XX) positions held with trading intent means positions held with trading intent as defined in point (85) of Article 4 of Regulation (EU) No 575/2013; [For clarity, reference to the definition of positions held with trading intent in CRR is made]

5 (YY) clearing member means a clearing member as defined in point (14) of Article 2 of Regulation (EU) No 648/2012; [For clarity, reference to the definition of clearing member in EMIR is made] CHAPTER 3 RtM K-Factors Article 21 RtM K-factor requirement The RtM K-factor requirement for the trading book positions held with trading intent of an investment firm dealing on own account, whether for itself or on behalf of a client, shall be the higher of either K-NPR calculated in accordance with Article 22 or K-CMG calculated in accordance with Article 23. [The words held with trading intent are inserted to make clear that only positions held with trading intent are in scope for the RtM capital requirements. Therefore, positions held with the sole purpose of meeting liquidity requirements should be excluded.] Article 22 Calculating K-NPR 1. For the purposes of K-NPR, the capital requirement for the trading book positions held with trading intent of an investment firm dealing on own account, whether for itself or on behalf of a client shall be calculated using one or more of the following approaches: [Adding one or more is important because of the use of different methods for RtM, including the use of margins, for specific portfolios.] (a) the [simplified standardised] approach set out in Chapters 2 to 4 of Title IV of Part Three of Regulation (EU) No 575/2013 where the investment firm's trading book business is equal to or less than EUR 300 million; [The standardised approach for market risk under the CRR2 (i.e. the FRTB methodology) will likely not be mandatory for banks, as it is expected to be introduced only as a monitoring and reporting requirement in the CRD/CRR Review package. In contrast, the EUR 300 million threshold in the EC s proposal effectively makes the FRTB the mandatory standardised approach for investment firms with large trading books. This is inconsistent and therefore it is proposed to delete the EUR 300 million threshold.] (b) the standardised approach set out in [Chapter 1(a) of Title IV of Part Three of the Regulation No (EU) No 575/2013, in accordance with Article 1(84) of the Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012] [The standardised approach for market risk under the CRR2 (i.e. the FRTB methodology) may, conceptually, be more suitable for some trading firms, albeit the initial calibrations are focused on banks. It may therefore continue to be included as an option, even though the SA-CRR2 is likely to be introduced only as a monitoring and reporting requirement in the CRD/CRR Review package.];

6 (c) the internal model approach set out in [Chapter 1(b) of Title IV of Part Three of the Regulation No (EU) No 575/2013 in accordance with Article 1(84) of the Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012]. 2. K-NPR calculated under the approaches specified under points (b) and (c) shall be multiplied by a factor of 65%. [There is no justification to apply a permanent scaling factor on the outcome of the internal model approach, as an approved internal model should be the best estimate of market risk for an individual investment firm. This is also reflected by the first proposed amendment to Recital (24) of IFR.] 2. For the purposes of the second sentence of point (a) of paragraph 1, an investment firm shall calculate the size of on- and off- balance sheet business in accordance with [paragraphs 2 to 7 of Article 325a of Regulation No (EU) No 575/2013]. [If the 300 million threshold is removed from paragraph 1 there is no need to clarify in a second paragraph how the size of the trading business should be calculated.] Article 23 Calculating K-CMG 1. By way of derogation from For the purposes of Article 22 21, the competent authority may allow an investment firm, for all positions held or on a portfolio basis, to calculate K-CMG for transactions and positions that are centrally cleared subject to clearing, subject to the following conditions: [It is proposed to replace transactions and positions that are centrally cleared by positions that are subject to clearing as K-CMG captures market risk for trading positions (as it is K-DTF that deals with the risk of large volumes of transactions).] (a) the investment firm is not part of a group containing a credit institution; (b) the execution clearing and settlement of the transactions of the investment firm that are centrally cleared subject to clearing take place under the responsibility of a clearing member and the transactions are either guaranteed by that clearing member centrally cleared by a qualifying CCP or otherwise settled on a delivery-versus-payment basis; [The trading firms concerned have their transactions settled under the responsibility of a clearing member. That clearing member normally clears and settles transactions through qualifying CCPs (QCCPs) or may settle on a delivery-versus-payment (DVP) basis.] (c) the calculation of the initial margin posted by the investment firm to total margin required by the clearing member is based on an internal a margin model of the clearing member. An assessment of the competent authority confirms that this margin model lead to margin requirements that are reflective of the risk characteristics of the products the investment firm trades and takes into account the interval between margin collections, market liquidity and the possibility of changes over the duration of the transaction. The margin requirements shall be sufficient to cover losses that may result from at least 99% of the exposures movements over an appropriate time horizon with at least a two-business days holding period;

7 [Instead of cross-referring to EMIR, the most relevant parts of Article 41 EMIR are copied in here.] (d) the clearing member is a credit institution. 2. K-CMG shall be the highest total amount of initial margin posted to total margin required, on a daily basis, by the clearing member by from the investment firm over the preceding 3 months. [The words on a daily basis are inserted as the EC s proposal leaves the frequency of measurement of the total margin required unspecified. Since clearing members tend to calculate margins required once a day, it is proposed to set the frequency at a daily basis.] EBA, in consultation with ESMA, shall develop draft regulatory technical standards to specify the calculation of the amount of the initial total margin required as referred to in paragraph 1(c) 2. [Building on the proposed amendment for point (c) of Article 23(1) of IFR, the mandate under this new paragraph 3 for Level 2 technical standards from EBA/ESMA could be further specified, e.g. by adding: taking into account the regulatory technical standards developed under paragraph 5 of Article 41 of Regulation (EU) No 648/2012 and paragraph 4 of Article 49 of Regulation (EU) No 648/ ] The EBA shall submit those draft regulatory technical standards to the Commission by [nine months from the date of entry into force of this Regulation]. Power is delegated to the Commission to adopt the revised regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/ Commission Delegated Regulation (EU) No 153/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on requirements for central counterparties (OJ L 052 of ), as amended by Commission Delegated Regulation (EU) 2016/822 of 21 April 2016 (OJ L 137).

8 Part C Proposed amendments to the Recitals of the Investment Firm Directive (IFD) (7a) An investment firm may trade via a clearing member in another Member State. In such a situation, there needs to be a mechanism for sharing information between the relevant competent authorities in the different Member States on the model and parameters used for the calculation of the margin requirements of the investment firm where this is used as the basis for the investment firm s capital requirements. [This new recital covers the cooperation between competent authorities for the purpose of assessing margin models] Part D Proposed amendment to the Investment Firm Directive (IFD) Article 11 Cooperation between competent authorities of different Member States 5a. For the purposes of assessing the condition in point (c) in paragraph 1 of Article 23 of Regulation (EU) ---/----[IFR], the competent authority of an investment firm s home Member State may request to the competent authority of a clearing member s home Member State information relating to the margin model and parameters used for the calculation of the margin requirement of the relevant investment firm. [To facilitate cooperation and information sharing between the investment firm s competent authority and the clearing member s competent authority (if these are different authorities) for the purposes of an assessment of the clearing member s margin model, a new paragraph 5a to Article 11 is proposed. Article 5 of IFD already covers such cooperation where both competent authorities are within the same Member State.] * * *