EC s Consultation on Counterparty Credit Risk

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1 EU-Commission Division Bank and Insurance Austrian Federal Economic Chamber Wiedner Hauptstraße 63 P.O. Box Vienna T +43 (0) F +43 (0) E bsbv@wko.at W Your reference, Your message of Our reference, contact person Extension Date BSBV 47/Dr.Rudorfer/Na March 2011 EC s Consultation on Counterparty Credit Risk The Bank and Insurance Division of the Federal Economic Chamber representing the entire Austrian Banking Industry appreciates the possibility to comment on the Commission consultation regarding counterparty redit risk : I. Capitalisation of bank exposures to central counterparties As requested in the document the following refers to the specific questions raised within the consultation document. Ad 1: Yes, the two conditions and the outlined approach are appropriate. However if a qualified CCP fulfills all conditions on capitalisation and a definite margin process etc. an additional capital requirement (instead of 0%) would be an overassessment regarding the incurred risk. The second condition should always be fulfilled, since the bank has to have the necessary information to complete capital calculations. Ad 2: Basically yes. Within well functioning markets the outlined approach appears to be reasonable as there will be a self-regulating mechanism where qualifying and non-qualifying CCP s will be available and chosen according to market demands. Within niche markets such a self regulating mechanism might fail. E.g. it might be unattractive for a CCP which offers clearing in niche products to aim for a qualifying status if its business is de facto captive. Certain minimum requirements should always be fulfilled by CCPs, however, the two-tier system allows distinguishing better and worse CCPs. Special care should be taken to keep C:\Documents and Settings\laubale\Local Settings\Temporary Internet Files\OLKB7\ENG ST_Counterparty Credit Risk_ doc - 1 -

2 the right relationship between capital requirements for non-qualifying CCPs and normal non-ccp market participants. Additionally the characteristics of a qualified CCP should be specified and more detailed. Ad 3: No, a single tier system would not be preferable, because a clear distinction between "safe" CCPs and the other types of CCPs is decisive. However it would have to be transparent to the market participants which CCPs are qualifying. Ad 4: No, based on the description of condition 2 we do not see obstacles. Ad 5: The second condition, that the trade must not have been rejected, is questionable. Since, if the trade was rejected, anyway it cannot be cleared with the CCP. It should be specified under which circumstances a CCP has the possibility to reject a transaction (quality of the collateral, inappropriate threshold, transfer amount, creditworthness of the counterparty etc.) as stated in condition 2. Furthermore the definition is unclear. Is it possible to have a non-qualified transaction with a qualified CCP? Otherwise the sense of the last sentence is not clear (p.7...irrespective of the type of CCP used) Ad 6: As a general remark we note that the treatment of indirect members' clients is not mentioned at all. This is relevant because currently the major clearing houses we are aware of do not offer clearing models which would make it feasible for indirect members' clients to fulfil the two conditions. In order to achieve preferential capital treatment such clients would need to become clients of direct members, therefore cementing oligopolistic structures in the clearing arena. The requirement to legally ensure that another CCP member will take over the portfolio if the original clearing member cannot perform does not appear to be reasonable as the consequence of the default of a general clearer would be (depending on the CCP rules) that the (indirect) clients' portfolio would be liquidated (if no other direct clearing member was willing to take the portfolio). The liquidation proceeds would then be paid out to the (indirect) client. While we are aware of the fact that liquidation of the portfolio would be highly undesirable and could result in m-t-m loss, we cannot see how the fact that the portfolio would be liquidated could result in additional counterparty risk to the (direct) clearing member. In this regard we would ask for clarification. Point b) could lead to a problem, since any clearing member would have to accept positions from another clearing member in case the other clearing member is defaulted. Additionally it needs to be clarified who is the legal counterpart of the trades for the CCP and what happens in case of the default of the CCP

3 It has to be feared that transaction costs for small and medium-sized market participants being reliant on an indirect access are systemically higher compared to those for direct market participants. This results in a massive discrimiation for small and medium-sized market participants. Ad 7: Please refer to Question 6 If there would be a possibility of a so-called client- to client clearing (a clearing for indirect member s clients) the approach would make sense for those client s client accounts. Ad 8: The outlined approach for non-qualifying CCP s raises the question why only the standardised approach can be applied? Since trades with a CCP are in general over collateralized, this will lead to an exposure which is larger than necessary. Therefore the risk weight should be even smaller than 2%. Ad 9: It would make sense to extend the treatment of bankruptcy-remote collateral to nonqualifying CCPs in order to reduce capital requirements also for this type of CCP Ad 10: We agree with the proposed treatment. Ad 11: It certainly can be improved, e.g. by using the internal model method for calculating the hypothetical capital. Additionally the 20% risk weight should be replaced by a more diversified approach. Ad 12: Yes. Ad 15: If CCPs do the calculation there should be an independent unit checking the results. Ad 16: We agree, but the risk weight should be less than 1250%, which means that the risk weights in scenario 3 is too high because it does not take into account the rating of the clearing members. II. Treatment of incurred credit valuation adjustments (CVA) Recognition of CVA via reduced exposure or via provisions/increase of available capital Ad 17: There is no special treatment for counterparty risk exposures. Exposures from derivatives against a counterparty are aggregated together with all other type of exposures and contribute to the expected loss calculation. Any CVA adjustment reduces the EAD

4 The treatment in internal capital assessment is similar to regulatory capital treatment. a) Currently not considered in the regulatory capital. b) Currently not considered in the internal capital. Ad 18: We simulate 40 time gridpoints in the future. For the EAD calculation we take the grid points in the first year, for the CVA calculation we take the average till the end of the trade. Ad 19: The reduction of the exposure amount is the more straightforward way and emphasizes that CVA is a price correction. However, in this case the capital is deducted for each counterpart separately, while in the other case with the provision, the provision is calculated for all customers and losses are deducted from there. Additionally, the provision method might be more consistent with the credit risk framework. Recognising CVA via provisions/increase of capital seems to be the more adequate procedure. As a loss is already taken into P/L a bank that has a conservative CVApolicy would see a benefit from recycling the difference to capital vis-a-vis competitors that have a less conservative approach. Reducing the exposure amount only would resemble more a trading book style approach where a full negative price development is taken to P/L and capital requirements are calculated on the current market value of the position. Ad 20: Reducing the exposure amount is the more consistent with the treatment of other trading book risks however it should be done with CVA divided by LGD. Recognising CVA via provisions/increase of capital seems to be the more in line with the credit risk framework. Ad 21: The loss in case of default is NPV CVA NPV*R = (NPV CVA/LGD)*LGD, therefore the exposure should be reduced by CVA/LGD. Ad 22: The CVA excess over the EL should be treated as Tier 1 capital which supports the counter cyclicality and it could be incorporated in the forthcoming provisioning procedure. (Excess over EL as Tier 1 only) B. The incurred CVA should be compared to the total EL from credit risk and counterparty risk. Restricting to a specific netting set or specific asset would not reflect the fact that fundamentally there is no difference between expected loss from counterparty credit risks to other risk. C. As we think, that incurred CVA should be measured compared to total credit risk we find it appropriate that no further restriction to the current Basel II level should be applied. D. a special risk weight if the CVA was taking into account depending from the percentage of - 4 -

5 provisioning Ad 24: We do not suggest an alternative treatment Ad 25: We do not consider them unsuitable, but think that the reduction of the exposure amount is the most straightforward one, where least additional calibration has to be done. Ad 26: The reduction of the exposure amount will not lead to a significant change in the capital requirements as the CVA is much smaller than the EAD and additionally they are multiplied by the risk weight and 8%. Ad 27: Unexpected losses from CVA should be covered by capital charge that recognizes already incurred losses by reducing the exposure amount. As remarked also in Question 19 the capital charge should be based on the future downside risk. Any loss taken into account in the CVA calculation reduces the downside risk and therefore should be fully factored in the capital requirements by reducing EAD. Ad 28: For a stand-alone consideration of the derivatives business the CVA-capital charge the impact is significant leading to multiple of 3-5 times the current capital requirements. Therefore we consider it as important that double counting of already incurred CVA-losses in the capital treatment is avoided. As derivatives exposure contribute only to a small extent to total risk weighted assets and capital requirements, the overall impact of CVA-capital requirements are limited. Kindly give our comments due consideration. Yours sincerely, Dr. Herbert Pichler Managing Director Division Bank and Insurance - 5 -

Public ConsultationEffective Resolution of Systemically Important Financial Institutions 19 July 2011

Public ConsultationEffective Resolution of Systemically Important Financial Institutions 19 July 2011 fsb@bis.orgbaselcommittee@bis.org Division Bank and Insurance Austrian Federal Economic Chamber Wiedner Hauptstraße 63 P.O. Box 320 1045 Vienna T +43 (0)5 90 900-DW F +43 (0)5 90 900-272 E bsbv@wko.at