Consultationresponse

EuropeanCommissionconsultationdocument

‐ExploratoryconsultationonthefinalisationofBaselIII

12April2018

TheAssociationforFinancialMarkets inEurope(AFME)andtheInternationalSwapsandDerivativesAssociation(ISDA),collectively‘theAssociations’,welcometheopportunitytocommentontheEuropeanCommission’sExploratoryconsultationonthefinalisationofBaselIII.

AboutAFME

AFMErepresentsabroadarrayofEuropeanandglobalparticipantsinthewholesalefinancialmarkets.Its members comprise pan‐EU and global banks as well as key regional banks, brokers, law firms,investorsandotherfinancialmarketparticipants.Weadvocatestable,competitive,sustainableEuropeanfinancialmarketsthatsupporteconomicgrowthandbenefitsociety.AFMEistheEuropeanmemberofthe Global Financial Markets Association (GFMA) a global alliance with the Securities Industry andFinancialMarketsAssociation(SIFMA)intheUS,andtheAsiaSecuritiesIndustryandFinancialMarketsAssociation(ASIFMA)inAsia.AFMEislistedontheEURegisterofInterestRepresentatives,registrationnumber65110063986‐76. InformationaboutAFMEand itsactivities isavailableon theAssociation'swebsite:www.afme.eu

AboutISDA

Since1985, ISDAhasworkedtomaketheglobalderivativesmarketssaferandmoreefficient.Today,ISDAhasover850Memberinstitutionsfrom66countries.Thesememberscompriseabroadrangeofderivatives market participants, including corporations, investment managers, government andsupranational entities, insurance companies, energy and commodities firms, and international andregional banks. In addition to market participants, members also include key components of thederivativesmarketinfrastructure,suchasexchanges,intermediaries,clearinghousesandrepositories,as well as law firms, accounting firms and other service providers. Information about ISDA and itsactivitiesisavailableontheAssociation'swebsite:www.isda.org

Wesummarisebelowourhigh‐levelresponsetotheconsultation,whichisfollowedbyanswerstotheindividualquestionsraised.

Overview/ExecutiveSummary

Generalquestions:a)Whatareyourviewsontheimpactoftherevisionsonfinancialstability?b)Whatareyourviewsontheimpactoftherevisionsonthefinancingoftheeconomy?

TheAssociations consider it important that the finalBasel III standard is implemented inaway thatdrivesa robustandeffectivebankingsector,whilst supportinggrowthand thereal economysuchasSMEs,fundingofcorporatesandinfrastructure,andresidentialrealestatepropertymarkets.Insodoingwe urge the European Commission to assess proposals against the Basel Committee’s overarchingcommitmenttonotsignificantlyincreasecapitalrequirementsandensuretheEU’simpactanalysisgoesbeyondtheaggregateanalysisundertakenbytheBaselCommittee.Inlinewiththis,theCommissionandthe EBA should consider further review of the Pillar 2 requirements and application following theindication from regulators that Pillar 1 increases could be offset through the Pillar 2 framework,

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especiallyasthisdoesnotappeartobethedirectionoftravelcurrentlybeingadoptedintheongoingCRR2deliberations.Further,thegranularnatureoftheBaselIIIreformswillaffectmanyproductsandeconomies indifferentwaysand itwillbe crucial that theCommissionand theEBAunderstands thepotentialeffectsonMemberStates,specificproductsandthefinancingoftherealeconomy,giventheessentialroleofbankingintheEUeconomy.Inparticular,weurgetheCommissiontobeclearonhowitseestheadoptionofnationaloptionsanddiscretionsandhowthesewillbeincorporatedintoCRR3.

Inansweringthisconsultation,theAssociationswouldliketonotethelimitedone‐monthtimeframetorespond.ThecommentsbelowreflectouranalysisofareasthatwerenotfullyaddressedinthefinalBaselIIIoutputandnewaspectsintroducedatthefinalstagesbythecommitteethathavenotbeensubjecttoimpactanalysis.WhilenotalltheconcernsraisedbyindustrywereaddressedintheBaselconsultationprocesswhichmayhaveanimpactonfinancingtheEUeconomy,wewouldnotethattherewerepositivechanges introduced in theoutcome. Wewill continue toassess the finalBasel III standardsover thecoming months and form our positions more fully. We look forward to continuing this process ofconsultationwith theEUandanopenandconstructivedialoguewith theEuropeanCommissionandEuropeanBankingAuthority.

Internationalconsistency

The Associations consider it important that international standards such as Basel III are appliedconsistentlyacrossjurisdictions,includingintheEU,enablingbankstooperateonagloballevel‐playingfield whilst also reflecting the specific financial and economic circumstances of Europe (e.g. theresidential real estate property markets and higher reliance of corporates on bank funding).Furthermore, it is important for globally active banks that international standards are implementedfollowing a consistent timeline across jurisdictions, including transitional arrangements and with areasonableimplementationperiodforbanksoncethelegislativeprocessisfinalised.IftheEUtimelinefortheprocessofBaselIIIlegislationandimplementation(orpartsofit)bybankslookslikelytoslipbeyondtheinternationallyagreedtimeframe,weurgethecommissiontoleadeffortstoensurearevisionofthetimelineatagloballeveltoensureinternationalalignment.

TheBasel IIIpackagedoesnot fullyaccount forEU specificongoing initiatives strengthening financialstability

SinceBaselIIEUbankshavetakenconsiderablestepstostrengthentheirriskmanagementframeworkthroughlargescaleinvestmentindevelopinginternalmodels.However,theBaselIIIpackageagreedonDecember7,2017marksinmanywaysacompleterethinkoftheapproachtomodelling.Therationalebehind this was to reduce excessive variability of risk‐weighted assets and rebuild trust in banks'reportedrisk‐weightedcapitalratios.Yettheperceivedvariabilityofmodellingpracticesinthepastdoesnotnecessarilyconsiderthatmanyofthedeficiencies intheEUsystemwhicharebeingaddressedtoensuremodeloutputsareadequateandatthesametimerecognisethebenefitofrisk‐sensitivity.Thisincludes for instance the EBA’s comprehensive IRB repair work, mandatory annual internal modelbenchmarking,andtheTRIMframeworkintroducedbytheSSM.Industryisconcernedthereductioninthe scope forAIRBmodellingwould reduce risk sensitivity in the capital framework and potentiallycreateunintendedconsequencesforriskmanagement.

Inaddition,otherEU‐specificlegislativemeasuresareunderwaytofurtherstrengthenthestabilityofthefinancialsystemforinstancetherecentlylaunchedEuropeanCouncil’sactionplantotackleNPLsandtheestablishmentofaCapitalMarketsUnionandBankingUnion.

Regarding models specifically, these are not just used for RWA calculation purposes but also foraccounting(IFRS9implementation)andstress‐testingpurposesandarepartofanoverallModelRiskManagementFrameworkadoptedbyseveralbanksintheEU.Thefar‐reachingproposalsinthisareaarelikely tohave adverseknock‐on effects that only emerge through time, for instance the emphasis onThroughTheCyclemodellingcouldfurtherreducethescopeforAIRB.WethereforeurgetheCommissiontoassesstheimpactoftheDec7packageinthecontextofthewiderreformsalreadyunderwaytosupport

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thefinancialstabilityoftheEUeconomyandgrowth,andthereformsthathavealreadybeenintroducedorarebeingconsideredinCRR2todeliveramoreresilientbankingfinancialsystem.

Theconsequencesofsegmented finalisation:critical interactionsbetweenvariouselementshavenotyetbeenfullyassessed

WefullyappreciateBasel’spost‐Crisisreformpackagewasfinalised,bynecessity,onapiecemealbasisover 2010 – 2017 and that Basel itself recommends a phased implementation globally to lessen theburdenonbanks.ThenumerouselementsoftheBaselIIIpackagearehowevernotindependentfromeach other as several standards refer to requirements set in other part of the overall framework.Unfortunately,thesegmentedapproachtorulemakingmeanselementsoftheBaselIIIpackagewillbeimplementedatdifferentstages indifferent jurisdictions,whichmayresult inunexpected impactsonproductsandbusinesslines.Althoughunderstandablefromapracticalpointofview,thisapproachhasnot allowed policymakers and the industry to date to either develop in‐depth understanding of theinteractionsbetweenthevariouselementsoftheoverallBaselIIIpackagenortoholisticallyassesstheimpactonfinancialstabilityandfinancingtheeconomy.Threespecifictopicsexemplifythisissue.

1. SA‐CCRandotherprudentialrules:

SA‐CCRwillbeusedinmanyareasacrosstheprudentialframeworkandwillaffectallbanksandusersofderivatives.TheimpactwillnotberestrictedtothesmallinstitutionsforwhichSA‐CCRwasdesigned.Despitethis,thefullimpactofSA‐CCRhasnotbeenassessedascurrentestimatesdonotconsidertheimpactofSA‐CCR’sinteractionswithotherareasoftheprudentialframeworkincludingthechangestoriskweightsinCRR3.AscurrentlysetoutintheCRR2proposals,SA‐CCRwill:

ReplaceinternalmodelsintheLargeExposureframework.Thiscreatesanun‐levelplayingfield

withtheUSwheretheequivalentUSregime(SingleCounterpartyCreditLimitsorSCCL)currentlyallowsinternalmodels.

ReplaceCEMintheleverageratioandmayaffectthecalibrationoftheleverageratioasanon‐risk‐basedbackstopmeasure.

Be used for the Central Counterparty (“CCP”) hypothetical capital calculation and in thecalculationofexposuresfortheCVAriskcapitalrequirements.

Bepartofanoutputfloorforcapitalrequirements

Todate,noimpactassessmenthasbeenperformedbystandardsettersontheaggregateimpactofSA‐CCRacrossdifferentareasoftheprudentialframework–Basel/EBAexerciseshavebeenlimitedinscopeandnotconsideredtheaggregateimpact.EBA’sreplytoacallforadvicenotesthat“boththeimpactandthescaleofpotentialimplementationissuesmayhavebeenunderestimated.”1Webelievetheimpactissignificantandthatthisimpactwouldhavebeenalleviatedpartiallyorinfullifthecreditrisk‐relatedstandards(SA‐CCRandSA‐CR)aswellastheproposedLargeExposureschangesrelatingtoSA‐CCRwereimplementedsimultaneouslyintheEU.

Noting the challengeswith theEU implementation schedule however,wedonotwish to oppose theimplementationofSA‐CCR, thoughwebelieve it is imperative that the interactions inall areasof theprudentialframeworkarereviewedandafullimpactstudyonthecalibrationandaggregateimpactofSA‐CCR is performed. In the interim,we suggest that institutions should continue to be able to useinternalmodels(aspartofCRRII)formeasuringcounterpartyriskonderivativetransactionswithintheLargeExposuresframework,wheretheimpactsaremostdrastic.

1https://www.eba.europa.eu/documents/10180/1648752/Report+on+SA+CCR+and+FRTB+implementation+%28EBA‐Op‐2016‐19%29.pdf

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2. SA‐CRandotherprudentialrules

InrelationtochangestotheInternalRatings‐Basedapproach(IRB),replacementofEADmodellingwiththeStandardisedCCF’sasproposedbyBaselishighlypenalanddoesnotreflectindustryexperience.ItshouldalsobenotedthattheSACCFsarealsoreferredtointhecalculationoftheleverageratioforthedeterminationoftheleverageexposurefordeterminingoffbalancesheetitems.IncreasingSACCFswilltherefore also impact the leverage ratio and the magnitude of this impact should be reviewed byregulators.Giventheseinterconnectionsacrosstheframework,itwillbeextremelydifficulttocorrectlydesign,calibrateandreflectontheimpactsofoneaspectoftheCCFframeworkwithoutthisholisticviewofthefullsetofproposalsthatrelatetoCCFs.

3. CVAandFRTB

AfurtherexampleisrevisionstothefinalisedCVAframework.TheBCBSlauncheditsreviewoftheCVArisk framework in 2015, with part of the objective being to ensure consistency with the proposedrevisionstothemarketriskframeworkunderFRTB.WhilsttheCVAstandardshavebeenrevisedandfinalised,themarketriskframeworkunderFRTBhasbeenre‐visitedbytheBCBS,withrevisionstotheminimumcapitalrequirementsformarketriskcurrentlyunderconsultation2.TheCVAframeworkwillthereforeneedtoreflectanyconsequentialmisalignmenttotheFRTBarisingfromthechangesproposedintheconsultation.

ImplementationisanopportunitytorethinkEUprudentialapproach

HistoricallytheEuropeanUniontransposedtheBaselstandardsbyapplyingthemtoallEuropeanbanksatsololevel,regardlessoftheirsizeandsystemicimportance.ThisapproachwasunderstandablewheneachMemberStateorganiseditssupervisionandimplementationintonationallawandpractices,butitischallengingandleadstoinefficientallocationofcapitalforbankinggroups.ThishasalreadybecomeapparentinthediscussionontheRiskReductionPackage,wherechangestothewaiverframeworkarebeingdiscussed. Theimplementationofthe finalBasel IIIreformsisanopportunitymorebroadlytothink about how to transpose prudential regulation whilst maintaining high levels of supervisoryoversight. For example, a more proportionate approach would be to apply requirements at aconsolidatedlevelorgreateruseofsololevelcapitalandliquiditywaivers.TheremovalofbarrierstothefreeflowofliquidityandcapitalintheendbenefitsthewiderEUeconomy,allowingbankstodirectfunds to where customers and clients need it. This will contribute to the overall objectives of theEuropeanUnionandshouldbefullyreviewedinthecontextofimplementingCRR3.1.Standardisedapproachforcreditrisk(SA‐CR)Specificquestions:

a) Whatareyourviewsontherevisions?Pleaseprovidedetails.

Overalltherevisionsaremoregranularbutmoreconservative.ThemainconcernforbanksusingIRBapproachesistheinteractionbetweenbanks’internalmodelsandtheintroductionofanoutputfloor.Assuch,weconsiderthattheproposalscouldendupobscuringunderlyingriskratherthanmakingcapitalrequirements more understandable and comparable. The Commission should therefore pay closeattentiontounintendedconsequencesandperformaholisticreviewofhowtheSAandIRBapproachesinteractwiththeoutputfloor.

2https://www.bis.org/bcbs/publ/d436.pdf

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b) Howwouldtherevisionsimpactyou/yourbusiness?Pleasespecifyandproviderelevant

evidence.

Morespecifically:

i. HowdoestherevisedSA‐CRcomparetothecurrentapproachintermsofcapitalrequirements?Pleaseprovideanestimate,ifthepositiveornegativedifferenceissignificantinyourview,andspecifytherelevantrevision(s).

ii. Dotherevisionsaffectcertainassets/exposureclassesmorethanothersand–ifapplicable–whichof theprovisionsof therevised frameworkmaycreate theseeffects?Pleasesupportyourviewwithspecificevidencetotheextentpossible.

TheAssociationsconsiderthereareseveralareaswhichshouldbecarefullyconsideredbytheEuropeanCommissionwithregardtoSA‐CR:Corporatefunding:Fornon‐ratedcorporates,westronglysupportthealignmentofriskweightswithjurisdictionsthatuseSCRAmeaning65%fornon‐ratedCorporatesthatwouldbeinvestmentgrade.Ifnot, important lendingto therealeconomycouldbe impactedasaresultof lowcoverageofexternalratingsofmanycorporates,impactingnotonlyloansbutalsocorporatetreasuryhedges.Forjurisdictionswhereexternalratingsarepermitted,morethan80%ofexposurestoinvestmentgradeobligorsaretounratedcounterparties.

SMEs:WerecommendthattheSMEsupportingfactor,currentlyincludedintheCRR(CRRart501)isretainedintheEUimplementation,orasadoptedinCRR2.

Specialisedlending:Westronglysupportmorerisksensitivityandarecalibrationoftheriskweightsespecially for high quality projects. In particular, we consider the 80% risk weight for high qualityprojectstooconservativeespeciallyconsideringtheverystringentcriteriadefinedbytheBCBStoqualifyashighquality.Forexample,forhighqualityprojectswhicharesecuredwithphysicalassetsbynature,an80%riskweightintoIRB‐Fassuminga20%securedLGD(15%securedLGDdefined§85p69andtakingintoaccounta40%haircutoncollateral§87p69and§75p67),wouldtranslateintoaratingbelowinvestmentgrade.Thiscalibrationseemsinconsistent.Iftheoutputflooristobeappliedtospecializedlendingwiththeselevelsofriskweights,theseactivitieswouldbecomeuneconomicalforEUbanksandwould be very detrimental for the financing of EU infrastructure projects which heavily rely onspecializedlending.Indeed,wenotesupportingEUbankstoundertakemoreinfrastructurelendingisalreadyunder consideration in the currentproposal forCRR2which includesa supporting factor forinfrastructure‐relatedexposures.

Inaddition,werecommendthatthedefinitionofthespecialisedlendingassetclassisalignedacrosstheStandardisedandIRBapproachestoimprovedconsistencyandcomparabilityacrossfirms.

RealEstate:TheAssociationssupportkeepingtheloanapproachandloansplitting,inparticularforthetreatmentontheportionoftheloanbelow55%ofthepropertyvalue.Furthermore,applicationofloan‐splitting techniques should be kept at the discretion of the institution, not at the national level. It isimportantthatabankcandeterminethemostappropriateapproachfortheirownexposures.Inaddition,granularityofriskweightsforloansplittingshouldbeincreasedtothatofexposuresnotsubjecttoloansplitting.

Residentialrealestateproperty:WealsoconsideritveryimportantfortheCommissiontoreflectonthewidevariancesintheresidentialrealestatepropertyevenwithintheEU,forinstanceinsomeMemberStatesLTVisnotconsideredintheborrowers’repaymentcapacity,ratheritistheloantoincomeratio.Itwillalsobeimportantfortheactualvaluationofthemortgagevaluetobeadequatelyreflectedinthe

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risk‐weightingasitchangesovertime.Inrespectof§60oftheBCBSagreementon‘finishedproperty’should also be closely reviewed on the impact for EU markets where banks finance a significantproportionofpropertyunderconstruction.

Leasing:Astudyregardingleasingactivities(CapitalRequirementsforLeasing:AProposalAdjustingforLowRisk,AreportpreparedforLeaseEuropebytheUniversityofCologne),hasexploredtheimpactsontheseactivitiesandhassuggestedthataleasingfactorcouldbemultipliedtotheStandardisedApproachrisk weights to more accurately reflect leasing risk. A leasing factor of 0.6177 ensures capitalrequirementsthataresufficientlyconservativeandstillabovetheA‐IRBApproachcapitalrequirements.

Equityexposures:TheCommissionshouldcarefullyconsidertheimpactofthe400%RWintroducedforspeculativeunlistedequitywhichdoesnotappeartoalignwithcurrenttreatmentofprivateequityinCRR,whichwasdesignedtopromotefinancingoftheeconomy.WerecommendtheCRRtreatmentofprivateequitywithaspecificrisk‐weightof190%shouldbemaintained.

UnconditionallyCancellableCommitments – the current 0%CCF should bemaintained subject tosupervisoryoversight/approval.Theriskthatabankdoesnotreviewitscommitmentandpaysoutfundsunintentionally is in an operational riskwhich is captured elsewhere. Similarly, the risk that severalclientsdrawontheirfacilitiesatthesametimeiscaughtvialiquidityrules,aswellassectorlimits.WethereforeseenorationalebehindtheBaselCommittee’sdecisiontoseta10%CCFforUCCs.TheAssociationsconsiderUCCsessential inthefinancingoftherealeconomy.UCCarrangementsarecommonlyputinplacewithcorporatesandSMEsandarecloselyandcontinuouslymonitoredwithbanksbeingabletounilaterallycancelorlimitadditionaldrawdownsforinstancewhentheyidentifyanysignofdeteriorationinthecreditworthinessofborrower.SomeexamplesofUCCsareasfollows:

Undrawncommitmentstofinancereceivableswherecustomerfacilitydocumentationallowsthereductionorcancellationoffurtherdraw‐downsorrequiresrepaymentofexistingdraw‐downs;

Trade and commodity product customer limits that apply to trade and commodity financeinstrumentssuchaslettersofcreditsandguaranteesadvisedtocustomersbutthathavenotyetbeenutilized.Forexample,ifaletterofcredit(L/C)facilityisuncommitted,thismeansthebankhasnoobligationtoissueanyL/Cthecustomerasksittoissue.Thebankcanrefusetoissueforanyreasonandwithoutanyobligationtogivereasons.Any"limits"statedinthedocumentationfor this type of facility are not amounts up towhich the bank has committed to provide thefacilitiesbutanindicationofthebank'smaximumpotentialappetiteforprovidingthattypeoffacilitytothatcustomer.Theydonotbindthebankinanyway.

Retailcreditcardcommitmentswhereconsumerprotectionlawsandregulationsthatgovernthelender’sabilitytorestrictacustomer’srighttodrawontheunusedportionofacreditcardlinerequireonlythatthelenderprovideafter‐the‐factnoticethatcustomer’slinehasbeencancelledorreduced;

Creditfacilitiesgrantedtohighnetworthindividualsaretypicallysecuredbyeligiblecollateralandcancompriseportfoliofinancefacilities.Thesecanincluderealestatemortgageloanfacilities,lifeinsurancepremiumfinancingfacilitiesandstandbyletterofcreditfacilities.Thetermsandconditionsofthesecreditfacilitiestypicallyallowafirmtounconditionallycancelandwithdrawanyfacilityorundrawnportionofafacilityatanytime.Thefirmreservestherighttodeclineanyrequesteddrawdownandmay at any time andwithoutpriornotice terminate facilities at itsdiscretion.

Transaction‐relatedcontingentitems:AsproposedinBaseltheCCFfortheseoff‐balancesheetitemswouldincreasefrom20%asitisinthecurrentCRR(medium/lowriskitemsAnnex1)to50%.Thiscoversbondsandguaranteesthatsupporttradefinance.TheCommissionshouldcarefullyconsiderwhethera50%CCFisjustifiedbytheunderlyingrisksandtheimpactthiscouldhaveontheprovisionoftrade‐relatedfinance.

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SecuritiesFinancingTransactions:Webelieve thatdisregardingall collateral receivedand treatingexposuresasunsecuredwherehaircutsarelowerthanthefloorsisdisproportionateandoutoflinewiththeeconomicriskandlegalposition.WealsobelievetherecouldbeunintendedconsequencesfromtheimplementationoftheminimumhaircutfloorsforSFTsbecausetheentitieswithinthescopeoftherulecouldbemuchbroaderthanintended.Theintentoftheminimumhaircutfloorsframeworkistopreventunsustainable financing to unregulated counterparties and to reduce leverage of unregulatedcounterpartiesbytargetinginsufficientlycollateralisedlendingagreements.Giventhescopedefinedinthe Basel 3 finalisation package includes counterparty terminology different to that in the EU (seereference to counterparties are considered to be “supervised by a regulator that imposes prudentialrequirementsconsistentwithinternationalnorms”inpara180),andinordertoalignwiththeintentofthe rule, the framework should be appropriately and carefully scoped so as to be applicable only totransactionswheretheintentistoprovidefinancingtounregulatedcounterparties.

c) Wheredoyouexpectparticularimplementationchallengesandwhy?Pleasespecify.

Oneimplementationchallengewillbeforbanksusingapprovedmodelstocalculatecapitalrequirementsto build the capability to also generate capital requirements under the SA and disclose it. It will benecessaryforbankstobegivenadequatetimetorunandthencomparethetwooutputs(SAvs.model)beforebeingrequiredtodisclose.

Furthermore, lackofeligiblecollateral, i.e. receivablesandphysical collateral (other thanrealestate)under the SA for leasing, factoring and other lending activities secured by such types of collateral iscounterproductiveintermsofsupportingfinancetotherealeconomy&doesnotappropriatelyreflectunderlyingrisk.ThesetypesofcollateralarehoweverrecognisedundertheF‐IRBthroughreductionsinsupervisoryLGD levels.We thereforerecommendSAallowingrecognitionofnon‐realestatephysicalcollateral,commoditiesandreceivablesunderthestandardisedapproachasitisundertheF‐IRB.ThiscanbedonethoughlowerRWsunderSAforthesesecuredtransactions.GiventhattheeffectofLGDsonRWsislinear,theselowerRWscouldbecalibratedintheproportionsassproposedfortheIRBFintheBasel362consultationdocument:i.e.a56%reductioninRW(for200%collateralisationor50%LTV,theprescribedLGDgoesfrom45%to20%).

AfurtherchallengeforsmallSAbanksisthatofdatacollection,forinstancegettingdetaileddataonrealestatecollateral.InthisrespectwewouldurgetheCommissiontoconsiderhowsomeofthisdatacouldbepooledastheBaselCommitteeisnowconsideringforNMRFsinthecontextoftheFRTBandconsiderdevelopingspecificprinciplesapplicabletodatapooling.AnadditionaldatacollectionchallengeisthatspecificdatarequiredforbanksascounterpartiesisnotconsistentlyavailableforbanksthathavenotyetadoptedBasel3.

Anotherissueishowtheimplementationoftherevisedstandardisedapproachwillrequiresignificantchangestodatainfrastructure.Forexample,thenewtransactorvs.revolverlogicwillrequirehistoricalpaymentbehaviourstobeanalysedandappropriatedataflowstobeestablishedforthisdatatobepassedintotheregulatoryreportingsystem.

Finally,wewouldnotetheriskweightadd‐onforcurrencymismatchandoriginalvaluationrequirementsformortgageandretailexposureproductswillrequiredatathatisnotcurrentlycapturedoravailabletobefedintoregulatoryreportingsystems.

2.Internalratings‐based(IRB)approachesforcreditriskSpecificquestions:

a) Whatareyourviewsontherevisions?Pleaseprovidedetails.

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ItisnotclearwhethertheproposedBaselrevisionstoIRBstriketheappropriatebalancebetweenreducingunwarrantedvariabilityandreducingrisksensitivity.TheAssociationsconsidertheshiftfromA‐IRBtoIRB‐Faregressivestepintermsofassessingrisk,especiallygiventheEBA’sworkonIRB repair and the SSM’sTRIMexercise.The limited ability to recognise thebenefits for securedlendingduetoLGDfloorsiscounterintuitiveandwillhaveanegativeimpactonlending,specificallytoemergingmarketswheresecuredlendingisprevalent.

TheAssociationshavebeenverysupportiveoftheEBAIRBrepairprogrammewhichisathoughtful,bottom‐upanalysisofthevarianceinIRBriskweightedassets.TheEBA’sapproachisthebestwaytodealwithunwarrantedRWAvariability. TheEBAroadmapon the futureof the IRBapproach,focusedonthreekeyareas:reviewoftheIRBregulatoryframework,supervisoryconsistencyandincreasedtransparency.

Supervisoryconsistencyandincreasedtransparencyhaspartlybeenaddressedthroughtheannualinternal model benchmarking requirement. These studies have helped to identify unwarranteddivergenceswhicharisefrombank’sinternalbusinesspracticeincludingharmonisingthedefinitionofdefault,suchasthedayspastduecriterionfordefaultidentification,indicationsofunlikelinesstopay,conditionsforthereturntonon‐defaultedstatusandtreatmentofdefaultedassets.

Thefirstbenchmarkingexerciseindicatedthat75%ofthedeviationinriskweightedassetsforlowdefault portfolios (sovereigns, large corporates and institutions) can be explained by the samedrivers. These include differences in (i) the share of the defaulted assets, (ii) geography andassociatedmacroeconomicconditionsand(iii)portfoliomix. Theremaining25%ofvariability ismainlyduetodifferencesinbank‐specificfactors,suchasriskmanagementpractices. Webelievethat in Europe supervisory have the appropriate tools to deal with outlier banks and manageunwarrantedRWAvariability.

Overall,therefore,ourMemberswouldsupportanapproachmorealignedtothatsetoutintheEBA’sworkonthefutureoftheIRBapproachandforquantitativeanalysisbasedontherevisedmodelstobeundertaken.

b) Howwouldtherevisionsimpactyou/yourbusiness?Pleasespecifyandproviderelevantevidence.

Morespecifically:i. HowdotherevisedIRBapproachescomparetothecurrentapproachesintermsof

capital requirements? Please provide an estimate, if the positive or negativedifferenceissignificantinyourview,andspecifytherelevantrevision(s).

ii. Dotherevisionsaffectcertainassets/exposureclassesmorethanothersand–ifapplicable–whichof theprovisionsof therevised frameworkmaycreate theseeffects?Pleasesupportyourviewwithspecificevidencetotheextentpossible.

TheactivitiesmostimpactedbytherevisionstotheIRBapproachareasfollows:

For exposures to Large Corporate and Financial Institutions: application of a F‐IRB LGDs for

institutionspreviouslyapplyingAIRBLGDs(45%/40%LGDsinthefutureframeworkcomparedtointernalLGDlevels)

AlimitedrecognitionofcollateralinF‐IRBapproach AnincreaseoftheexposureduetomodificationofCCFsandtheirapplicationonUCCs TheapplicationofafixedmaturityinF‐IRBinsteadoftheactualmaturity

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Theapplicationofinputfloorsonanoverallbasisandfloorsonhaircuts,especiallyforsecuredfinancing

Indetail:

The commission should strongly consider the impact on large corporates and financial institutions.AlthoughLargeCorporateshaveeasieraccesstomarketstofinancetheirdebt,theystillneedbankingservicesforthepurposeoftheirday‐to‐dayactivitysuchas:

Revolvingcreditfacilities,overdraft,(i.e.:undrawncreditlines) Back‐upliquiditylinesforCommercialPapersissuedbythecorporate Performance bonds, Stand‐by letters of Credit, and all other banking facilities needed by the

commercialactivitiesofcorporates Cashmanagementfacilities(notionalandcashpooling) Factoring HedgingwithOTCDerivatives

Alargepartoffinancingproductsprovidedtolargecorporatesismadeofundrawncreditfacilitiesthatcannotbereplacedbyanycapitalmarketissuance.

OneareaoftheBaselagreementtheCommissionshouldconsiderinparticularistheinteractionbetweentheshiftfromA‐IRBtoF‐IRBforlargecorporates,especiallywheresubsidiariesarebroughtintoscopewhichmayotherwisehavebeentreatedasan individualentity.Thisassumesthat thesubsidiariesoflargecorporategroupsbenefitfromanimplicitsupportofthegroupwhichmakesthem“lowdefault”,yetitisnotprovenandcouldleadtodifferentcapitaltreatmentofentitiesofthesamecreditqualitybasedonwhether theyareaffiliated toawidergroup.Furthermore, this sameprinciplecould impactuponlending to specialised lending structures undertaken by large corporates. Consequently, the Baselpackagepenalizesmorethecorporates,mid‐corporatesandSMEsbelongingtogroupvis‐à‐visthestand‐aloneones,creatingacompetitivedisadvantagefortheformer.Inthecaseofunratedlocallegalentitiesof largegroups, thisprovisionwould indeed likely increase their costof financing (mostof themareunrated) with unintended consequences for the real economy as these counterparties typicallysignificantlyrelyonbanklendingandhavemorelimitedaccesstocapitalmarkets.

Asregardstheintroductionof40/45%LGDriskparameters,theCommissionshouldalsocloselyconsidertheimpactforbanksrequiredtomovefromtheA‐IRBtotheF‐IRB.AnyadoptionofsuchparametersshouldbedonealongsidewithadetailedimpactanalysisontheseassetclassesforinstitutionsmovingfromA‐IRBtoF‐IRB.LGDparametersunderminetheprincipleofrisk‐sensitivitybuiltupthroughyearsof investment in IRBmodelsanddonotreflectexperienceddistributionofLGDs,aswellas thewidevariety of activities which are central to the financing of financial institutions and large corporates.Moreover,suchgranularF‐IRBLGDparametersconcernallassetclassesinCRR,notjustthoseapplicabletofinancialinstitutionsandlargecorporates.

InrelationtoCRM,theAssociationsconsidertherecognitionandapplicabilityofcollateralmitigationshouldaligntheF‐IRBapproachwiththeAIRBasthisusesthemostadequatemethodologieswhichtakeintoaccountguaranteesandsecuritiesinthetransactionasopposedtofullyunsecuredloans(thereforewithnoguarantee).MorethoroughstudiesinvolvingtheindustryshouldbeundertakentoimprovethecurrentCRMframework(seeEBAReportonCreditRiskMitigationframework).

TheAssociationsconsiderthefinalinputfloorsandhaircutsonriskparameterstobeoverlyconservativeandrecommendtheCommissionassessifthesehaveduplicativeimpactwhenconsideredalongsidetheEBA’s futureof the IRBapproach. Such floors could introduceperverse incentivesbypenalisinghighquality exposures and again encourage focus on higher risk activities and reducing transparency.Furthermore,thefloorappliedonhaircutscouldcreateastrongdisincentiveforbankstomodelinternalhaircuts,giventhatthecollateralsubjecttolargestdevaluationwouldbepenalizedwhilebetterqualitycollateral could not benefit from it (given that input floors are applied at single transaction level).

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EssentiallythismeansthatbanksareencouragedtoapplythestandardizedandFIRBparameterforthecollateralevaluationevenunderAIRBapproach.

In theF‐IRBapproach thematurity is fixedat2.5years,withanationaldiscretion for supervisors torequireinstitutionstoapplythecashflowmethodologyinstead.Theapplicationofthefixedmaturityreduces the risk sensitivity of the IRB approach significantly. The Commission should maintain thenationaldiscretionandwiththattheuseoftheactualmaturityforportfoliostreatedundertheF‐IRB,asiscurrentlypossibleinCRR.

ReplacementofEADmodellingwiththeStandardisedCCF’sasproposedbyBaselishighlypenalanddoesnot reflect of industry experience. In our view, the scope ofmodelling available for CCFs should beconsistentwiththatofLGDs.AssuchwerecommendthatCCFmodellingberetainedinparticular forcorporates, including fornon‐revolvingproducts, aswell as for trade financeandspecialised lendingexposures.Moreover,theyshouldnotbesubjecttotheproposedfloor.ItshouldalsobenotedthattheSACCFsarealsoreferredto inthecalculationoftheleverageratio forthedeterminationoftheleverageexposure for determining off balance sheet items. Increasing SA CCFswill therefore also impact theleverageratioandthemagnitudeofthisimpactislikelytobesignificant.Inaddition,clientsthatrelyonthearrangementstowhichthenewCCFregimewillapplywillfindtheavailabilityoraccessibilityofsuchproductsrestrictedthroughincreasedcostsofpaymentandfinancingfacilities.WewouldassumethatthespreadchargedtotheborrowerwouldfollowtheleveloftheproposedCCFslinearly.

Inthewordsof theAssociationofCorporateTreasurers“workingcapitalmanagement isvital for thegenerationofsustainablecashflowandsurvivalofallcompanies”.Commitmentsandcontingentfacilitiesareanimportanttoolforcorporatetreasurerstomanagetheirliquidityanddealwithunexpecteddelaysordemands inpayments. If credit conversion factorsno longer reflect the real likelihoodofusageofcommitments,theywillbemispricedandthereforereducetheirusefulnessasatoolforcorporates.Inourview,thiswillbedamagingtothewiderfinancialstability,asitwillmakepooreconomicperformancemorelikely,whichinturnmayleadtoanincreaseinrisksfacedbybanks.Wearealsonotconvincedthatitwouldbeeconomicallylikelyfornon‐bankstoprovideanalternativetothesebankingservices.Unlikealoan,whereunregulatedactivitiescanplayarole,thecostoftheriskmanagementofliquidityriskissomethingthatonlythebankingsectorcanefficientlybear.Itwouldthereforebeperverseifregulatorschoosetomisallocateriskinanareathatshouldbethecoreroleofthebankingsystem.c)Wheredoyouexpectparticularimplementationchallengesandwhy?Pleasespecify.TheAssociationsconsidertheretobesignificantimplementationissuesinthefollowingareas

Theintroductionofparameterfloorsaddsasignificantincreaseinoperationalcomplexity,andthere remain a number of areas where more clarity and certainty need to be provided,particularlyinregardsnationaldiscretionsandpracticalapplicationofthresholds.Forexample,the application of the LGD floors for AIRB will result in institutions having to run threecalculationsatanygiventime(internalAIRBmodels,thecalculationwiththefloorsandtheactualFIRBcalculation).

Significant implementation issues in regards the application of the revenue threshold forconsolidated corporate groups in terms of information availability and monitoring of thethreshold.

SignificantimplementationissuesinregardtosystemschangesrelatingtothereviseddefinitionforrecognisingcommitmentsandassessinganyimpactonEADmodelestimates.

SomeLGDandEADmodelsareusedforportfoliosthatcontaincustomerswhichwillhavetheirAIRBpermissionsremoved(e.g.CorporateLGDmodels).Thesewillrequirere‐validationontheremainingpopulation, andquitepossibly regulatorypre‐approvalorpre‐notification for theircontinueduse.ThisactivitywouldcoincidewiththealreadychallengingtimelinesfortheEBA’sIRBworkprogramme;whichbanksarerequiredtocomplywithby1stJanuary2021.

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Theway in which Large Corporates with consolidated revenues above 500M€ are identifiedneedstobeclarifiedforLargeCorporateandwillbeanissueforcorporateforwhichrevenuesarenotavailableonaregularbasis(SME,funds….).

Regarding CRM framework, it remains unclear how institutions should handle the mix ofregulatoryapproaches theywill be facedwith. For instance, for bank guaranteeswhichare acommontypeofCRMoftenprovidedinsupportofmidcapcorporates,weunderstandthattheuseofF‐IRBapproachwillmean thatCRMcannotbe reflected inamodelledLGDona corporateexposureundertheA‐IRBA.

Acommonlyusedformofcollateralsuchasa“pledgeonallassets”whichprovideseffectiverisk‐mitigationeffectmightbedifficulttorecognizeunderF‐IRBgoingforward,asitdoesnotreflectonthespecificcapturingandupdatingofindividualassetvaluations.I.e. inordertobeabletoapply F‐IRB (particularly where we are newly required to do so) and recognize additionalcollateral,wholecollateralvaluationprocessesandinfrastructurewillneedtobebuilt.

Theinteractionwiththeoutputfloor.3.CVAriskframework

a)Whatareyourviewsontherevisions?Pleaseprovidedetails.

Whilst there are some improvements in relation to non‐internal model approaches, we oppose thecompleteremovaloftheuseofanyinternalmodel.

Furthermore, therevisedCVA frameworkhasonlybeensubject toasingleconsultation. Webelieve,therefore,thatfurtherimpactstudiesarerequiredtoreliablyassessthecalibrationandtheimpactsofthefinalframework.Specifically,wewouldliketofocusonthefollowingelements:

1. GapbetweenaccountingCVAandregulatoryCVA

WerecognizethatthegapbetweenregulatorycapitalCVAandaccountingCVAwasnarrowedcomparedtotheoriginalproposal.However,significantdifferencesstillremain,andbanksmayhavetomaintaintwoseparatemodelstocomplywiththerevisedcapitalregulationsaswellaslocalaccountingstandards,whichriskdistortingtheessential linkbetweeneconomicriskandcapital. In this respect, CVA remains the onlymarket risk in the Basel frameworkwhere theaccountingmeasureisnotusedasaninputtothecapitalrequirementcalculation.

ThemainsourcesofdivergencebetweenaccountingCVAandregulatoryCVAare:

SecuritiesFinancingTransactions(SFTs)

InthefinalBaselstandard,fair‐valuedSFTsareincludedintherevisedCVAcapitalchargeonamandatorybasis[BCBSd424,§3].SFTsandotherformsofcollateralisedborrowing should not be included in the CVA regulatory framework. Theseinstruments are not necessarily captured in accounting CVA. The credit valuationcomponentofSFTsisembeddedinthevaluationbase,muchlikeatradedbond.Ontheonehand,thevariationsoffairvalueofaSFTareessentiallydrivenbyvariationsof repo rates.On theotherhand, the IMMmetric capturesMTMvariationsdue tovariationsintheSFTcollateralvalue.

Inaddition,asonlyfair‐valuedSFTsaresubjecttotheCVAcapitalcharge,differentaccounting policies across jurisdictions could lead to varying capital requirementsdependingonthereportingentity’sjurisdiction.

MarginPeriodofRisks

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The final Basel standard imposes a regulatory CVA based on “9+N business days”marginperiodofrisk(MPoR)whereNistheremarginingperiod.SuchMPoRcouldresult in becoming overly conservative and not commensuratewith the risk trulyincurrednorconsistentwithaccountingCVApractices.

LossGivenDefault

Weacknowledgethere isabroad‐basedadoptionofmarket‐impliedparameters inaccountingCVA includingPDs, recovery rates anddiffusionparameters.TheBaselCommitteelogicallyimposesaregulatoryCVAbasedonmarket‐impliedparameters.WenotethatsomeflexibilityisgrantedtousedifferentLGDsinspecificcaseswhere“thebankcandemonstratethattheseniorityofthederivativeexposurediffersfromtheseniorityofseniorunsecuredbonds”[BCBSd424§30].WeadvocatethatbanksshouldbeabletousedifferentLGDsforcertainspecifictypeofexposurese.g.becausetheyare secured (such as coveredbonds, fundsorproject finance vehicles) or becausetheirnaturedoesnotpermittherelianceonthecreditmarket(seeforinstancetheuncertainty around political intervention in the context of sovereign exposures),subject tobeingable todemonstrate that theuseof suchparametersareproperlygovernedandvalidatedwithinthefirm.

CounterpartieswithperfectCSAs3.

Suchcounterpartiesraiseaparticularconcern.Indeed,itisexpectedthatcalculatingSA‐CVAsensitivities forsuchcounterpartieswillbecomputationallyvery intensiveyet accounting CVA on such counterparties is immaterial. The proliferation ofmandatoryInitialMargin(IM)requirementsonbilateralOTCderivativenettingsetswill further accentuate this trend. Therefore, consistency could be put at risk byincludingnettingsetssubjecttoperfectCSAandIMrequirementsintherevisedCVAcapitalcharge.

2. Calibrationofthenewframework

TheBaselCommitteeconsultativepaperonRevisionstotheminimumcapitalrequirementsformarketrisk4outlinedrevisedriskweightsfortheFRTBstandardizedapproach.TheCommitteeproposestoreducetheriskweightsforthegeneralinterestrateriskclassby20–40%,andequityandFXriskclassesby25–50%.TheCommitteenotesthat“Uponfinalisationofanyrecalibratedriskweights,theCommitteemayalsoconsidermakingcorrespondingchangestoriskweightsusedinthestandardisedapproachtocreditvaluationadjustmentrisk(SA‐CVA)giventhatSA‐CVAriskweightswerebasedupontheriskweightsincludedintheJanuary2016marketriskstandard.”WestronglyrecommendthatsuchchangestotheriskweightsaresubjecttoadequatereviewandincorporatedintheSA‐CVAframework.

It shouldalsobenoted that thebasicapproach (BA_CVA)still showshighriskweightsand isexpectedtoincreasecapitalbymultiplesandshouldalsobesubjecttoreview.

Inaddition,indexhedgesandproxyhedgesarenotsufficientlyrecognized.Weobserveinpracticethat index hedges, because theymust be decomposed into constituents, tend to increase thecapitalchargecreatingawrongincentiveforbanksandfurtherwideningthegapbetweensoundriskmanagementpractices and capitalization rules.The sameapplies toproxyhedgesdue todiversificationbeingaccountedforthroughaquadraticformulawithpenalizingcorrelations.

3PerfectCSA:CSAwith0threshold,anddailymargincalls4https://www.bis.org/bcbs/publ/d436.pdf

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Inbothinstances,werecommendallowingpartialnettingofriskweightedCounterpartycreditspreadsensitivitieswithrelatedproxyhedges.Thelevelofnettingallowancewoulddependonthequalityoftheproxyhedging.

3. SelectionofCVAeligiblehedges

WearesupportiveoftheinclusionofgenericmarketriskhedgesinthenewCVAframework(andnotjustcreditriskhedges),butweexpectconsiderableinfrastructurechallengestoidentifywhattheCVAeligiblehedgesareunderthenewscope.

While the selection of credit risk hedges (CDS/Index) is already in practice, selectingRates/FX/CommoditiesorothertypeofgenericmarketriskhedgeswillbechallengingforXVAdesksthatmanagetheserisksholisticallyatportfoliolevelacrossvariousvaluationadjustments.Furthermore, theadditional requirement– forCVAhedgeswithcurvatureriskordefault riskcharge ‐ to identifymatching external trades in themain front officedesk,will bedifficult toimplementanditislikelytoresultinnointernalCVAhedgeswithcurvatureriskordefaultriskchargebeingclassifiedaseligible.

Onamoregenericlevel,theCVAcapitalframeworkremainsdisjointedfromthegenericmarketrisk capital framework, instead of being integrated into the Trading book and capitalisedcomprehensively.

4. TradesasclientsofclearingmemberofaQualifyingCCP(QCCP)

The lack of clarity relating to the treatment of tradeswhen institutions are clients of a clearmemberofaQualifyingCCP,whicharecurrentlyexemptedunderCRR,isaconcernformembers.Weadvocate that these trades should continue to remainexempt,not just the tradesdirectlyfacingaQCCP.

b) Howwouldtherevisionsimpactyou/yourbusiness?Pleasespecifyandproviderelevantevidence.

Morespecifically:

i. How does the current CVA framework compare to the revised one in terms ofcapital requirements? Please provide an estimate, if the positive or negativedifferenceissignificantinyourview,andspecifytherelevantrevision(s).

Asapreliminaryremark,werecall that theBaselCommitteeonlyperformedonequantitative impactstudyonfullbanks’portfoliosinFebruary2016priortofinalisationoftherevisedCVAframework.Atthetime,theimpactstudyrevealedthattherevisedframeworkwouldleadtoasurgeinCVARWAs.

FirmsareinthecourseofassessingtheimpactoftherevisedBaselstandardaspartoftheDecember2017Basel3Monitoringexercise5.PreliminaryresultsonthesameperimeterofFebruary2016providesomeindicationsthattherevisedownfundrequirementsforCVAriskwouldstillbeamultipleofcurrentownfundsrequirements,despiteimprovementscomparedtoFebruary2016proposal6.

Weanticipateapotentialincreaseincapitalconsumptionwhichwouldincreasethecostofhedgingforclients.Thiswouldbealongsideasubstantialincreaseinoperationalandinfrastructurecoststocomply

5Furthermore,anIndustryQISiscurrentlyongoing(coordinatedbytheAssociations).6It’sexpectedthataccuratefigures(derivingfromtheIndustryQIS)willbeavailablebeginningofMay,2018.

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withtherules. For instance,throughfor instancehavingto includeSFTswhicharefair‐valuedinthecomputation.

Wealsoexpecttherequirementtohedgenon‐lineartradeswithanexternalcounterpartywouldincreasethecostofhedgingforaninstitutionasawhole,asbanks’practiceisoftentohedgeCVAnon‐creditrisksinternally.TherequirementtohaveamatchingexternaltradeinthefrontofficedeskwillbeachallengingrequirementfortheinfrastructureandcouldleadtheCVAdeskstohedgetheserisksexternallyinordertoobtaincapitalrecognition(amoreexpensiveandinefficientwayofhedgingforbanksoverall).InternalCVAhedgesofFX/Rates/Commodities/Equitiesriskshouldbeconsideredeligible.

WewouldthereforewelcomefurtherworkinassessingtheimpactsbyEuropeanbodiesinthisarea.

RegardingSA‐CVAspecifically,wereiteratethatusualaccountingCVACCRproxyhedges(indexhedgesandsinglenameproxy)areoverallinefficientandcanevenleadtoanincreaseincapitalrequirements.

c) Wheredoyouexpectparticularimplementationchallengesandwhy?Pleasespecify.

We are concerned that time constraints could jeopardise the building of a sound and consistentframework. The target deadline set by the Basel Committee – January 2022 – seems extremelychallenging,especiallyinacontextwherethetranspositioncalendarinEuropeisunknownandtheECBhasnotyetdiscloseditsexpectationsintermsofSA‐CVAapprovalprocess.

Asunderlinedabove,themajorimplementationchallengeistodevelopthecapacitytocomputeSA‐CVAsensitivities on at least a monthly basis. In that respect, we note that the final standard is ratherprescriptiveinthewaysuchsensitivitiesmustbecomputed(bumpingapproach).

Wereiteratetheneedtograntbanktheflexibilitytocarveoutfromagivennettingset,transactionsthatthebank is not able tomanageunderSA‐CVAand to capitalize such transactionsunderBA‐CVA in adistinctnettingset.

SignificantimplementationchallengesarelikelytoarisefromhavingtoincludeSFTsinthecomputationandinidentifyingeligibleCVAhedgesunderthenewscope.

While the selection of credit risk hedges (CDS/Index) is already in practice, selectingRates/FX/Commodities/EquitiesorothertypeofmarketriskhedgeswillbeverychallengingforXVAdesksthatmanagetheserisksholisticallyatportfoliolevelacrossmultiplevaluationadjustments(FVA,CVA,DVA,CTDVAandothers).BankscouldimplementtoolstooptimisecapitalbyisolatingCVA‐onlyhedges,butthatcouldleadtomisrepresentationofactualrisksmanagedbytheCVAdesks.

Asalreadyhighlighted,anotherchallengewillbetoidentifyhedgeslikeswaptions(orothertypeofnon‐lineartrades)wheretheinfrastructureshouldbeabletolook‐throughatthefront‐officetradingdesktobeabletodeterminewhethertheCVAhedgeisultimatelyhedgedexternallyornot.

Another important challenge to highlight, is the requirement tomodel the dependency between theexposureofatradeandthecreditqualityofthecounterparty,inordertousetheinternalCVAmodelforSA‐CVA application. In practice,modelling thiswrong‐way risk behaviorwill be very challenging forbanks and the modelling itself will be subject to very different assumptions (correlation used forexample)bydifferentbanks.WewouldadvisetoremovethisasarequirementtobeabletouseSA‐CVAmodel.

Finally,inthelightofaboveconsiderations,weurgetheEuropeanCommissiontoproposeasustainableEuropeanimplementationtimelineoftherevisedCVAstandardsuchthatallparties(banksforvalidationandECBforvalidation)havesufficienttimetoadapt.

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d) Whatareyourviewson the revisedCVA framework to captureCVA risksarising fromcounterpartiescurrentlyexemptedfromtheownfundrequirementsforCVArisksunderArticle382oftheCRR?

WhenBaselIIIwastransposedintoEuropeanlegislationviatheCRDIVpackagetheEuropeanlegislatordecidedtoexcludeCVAcapitalchargesonthecounterpartyriskarisingfromderivativetransactionswith“end‐users”,i.e.non‐financialcounterparties(NFC),sovereignandpensionfunds,whichusederivativestohedgeagainstpotentialadversemovesincurrencies,interestratesorotherfinancialvariables.TheEuropeanlegislatorbelievedendusersofderivativesshouldn’thavetoincurhighercoststohedgerisksbecausetheywereunabletocollateralizetheirderivativestransactionsduetosignificantinfrastructurecostsorlackofaccesstoliquidassets.ThiswasalsorecognizedintheEuropeanMarketInfrastructureRegulation(EMIR)thatexemptscorporatesbelowathresholdfromtheclearingobligationforderivativecontracts.

Astheindustryhasstatedbefore,applicationoftheexemptionscouldbereviewedonlywhentheBaselstandardprovedtobecorrectlyamended,i.e.improvementsmadetotheIMAapproachamongstothers.Now that the IMA approach has been removed, the industry continues to believe that the mis‐specification of CVA risk capital could lead to an overall increase in costs derivatives for end users(corporates and sovereigns counterparties) and creates a disincentive for end users to use theseinstrumentsforhedgingpurposes.Therefore,unlessathoroughanalysisshowsthattheimpactonend‐usersisnotsignificant,webelievethattheexemptionsshouldremaininplace.4.Operationalriskframeworka)Whatareyourviewsontherevisions?Pleaseprovidedetails.

The InternalLossMultipliershouldbesetequal to1when therevisedBasel III framework istransposed into theCRR, inorder to avoidheterogeneous treatmentsbetweenEuropean countries,dependingonnationalsupervisors.AnILMlevelwhichdeviatesfrom1wouldraisethequestionofthecorrespondingimpactonownfundsrequirements inEuropeandcouldunderminethe“no‐significantcapitalincrease”principleofthenewBaselframework.Inaddition,settingtheILMat1wouldalsomakeupfortheshortcomingsoftheSMA.

ItshouldbemadeclearforthepurposeofPillar2riskchargesinanyfuturerevisionstoArticle104aCRD,thatforthepurposeofpoint(a)ofparagraph1,theapplicationofanILMat1sufficientlycoverstherisk.ThiswillhelpensureconsistentapplicationofthemultiplieracrosstheEU.

Notallowingtherecognitionoftorecognizeanyforward‐lookingmitigationisalsoconsideredamajorflaw of the new methodology, which could jeopardise the management of operational risk itself.InsuranceisnotencompassedintheSMAapproach,despiteourstrongviewthatthepossibilitytouseitasanactiveoperationalriskmanagementtoolshouldbemaintained.Effectivelyapplyinganinsuranceschemehasmultiplepositiveaspectsandallowsthe“pricing”ofoperationalriskagainstathirdpartywith opposite economic incentives (i.e. buyer and seller). The recognition of insurance recoveries innettingoperationallossesdoesnotaddresstheabove‐mentionedaimasitresultsinonlytheexpectedlossesbeingconsideredratherthantakingintoaccounttherisktransferallowedbyaneffectiveinsuranceframework.

b) Howwould the revisions impact you/your business? Please specify and provide relevantevidence.

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On an individual bank level, for institutions using the Advanced Measurement Approach (AMA), asproposedbytheCRR,tomeasureoperationalrisk,institutionsarecurrentlyprovidingimpactsfortheBaselQISandimpactstudieshavebeenmadebytheEBA.

BasedonastudybytheORX(tobepublished)7,morethan75percentofparticipatingEuropeanbankswouldhavehighercapitalincomparisontocurrentPillarIlevelsunderthenewSMA.Inaverage(median)termstheimpactisanincreaseof+22.5percentSeetablebelow).

Uncertaintyinimpact

Supervisorshavediscretiontomodifytheroleofthelossmultiplierwithinthecapitalcalculation.InthefollowinganalysistheORXassessesthreepossibleimplementations.

1.Capital=BICxILM(withlosses>€20k)–thedefaultapproach

2.Capital=BICxILM(withlosses>€100k)

3.Capital=BIC(noILM)

BynotincludingtheILM(option3),incomparisontocurrentlevelscapitalwouldincreaseinEurope+28percent,butdownfrom+36per‐centwhenlossesareused.

7StudydonebyORX,viewsexpressedbyAFME.24banksparticipatedfromtheEU,USandSwitzerlandandthesurveywasconductedanonymously.

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Thedefault(option1)andBICdriven(option3)arecomparedabove.ThisshowstheILMcanhaveasignificantinfluenceonoutcome,givinganincreaseof+34.7%whencapitalisconsideredasapercentageof income(Figure4).By lookingat thedifferencebetweenthelargestandsmallest impactsperbankacrossthethreeapproaches,theORXseesvariabilityexceeding30percent(Figure5)formorethanhalfofEuropeanbanks.Therefore,toaccuratelyassessimpact,thereisaclearneedforgreaterclarityfromsupervisorsontheirexpectedimplementation.Supervisorscanalsoincreasethelosscollectionthresholdto€100kfrom€20k.Thisresultsinarelativelyminorreductionincapital(20.3per‐centdownfrom22.5per‐cent)Figure6.

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SeparatelytotheORXstudy,ourworkingassumptionisthatforthoseinstitutionsthatdonotcurrentlyusetheAMA,theexpectationisthatregulatorswouldensurethatthecumulativePillar1+Pillar2chargeremainsconstant,withanyincreaseinPillar1beingoffsetbyacommensuratereductioninthePillar2charge.WewouldwelcomeiftheCommissioncouldclarifythisassumption.c)Wheredoyouexpectparticularimplementationchallengesandwhy?Pleasespecify.

Implementationchallengeswilloccurduetothechangefromanadvancedmeasurementapproachtoastandardizedapproach.Thestandardizedapproachwillchangethecontributionofeachbusinesslinetotheoperationalriskcapitalrequirements,comparedtothecurrentapproach.Institutionswillfaceanewchallengetoproperlyallocatethesechargesinternally.Iftheinternalallocationoftheoperationalriskchargestothebusinesslinesisbasedontheircontribution,theROEmaybesignificantlyaffectedforsomebusinesslines.

Withparticularregardtomodelapproval,EUlegislationshouldclarifywhethersupervisoryapprovalwillbenecessaryfortheintroductionoftheSMA,whichreplacesallotherexistingapproaches.Ifsupervisoryapproval were to be necessary, EU legislation should set a realistic timeline and standardise therequirementsbysupervisors.Inasimilarvein,theEuropeanCommissionshouldclarifytheinteractionwith the recently‐adopted RTS (Delegated Regulation C(2018)1446) on the supervisors’ assessmentmethodologyforAMApermissiontofirms(n.b.theDelegatedActisexpectedtoenterintoforceinlate2018). It requires firms to update their approach and especially disuse Gaussian & Normal‐likedistributionswithintwoyears,i.e.bylate2020.

Finally,weareconcernedwiththepublicdisclosurerequirements.Giventhevariedrangeofthequalityandquantityofbanks’lossinformation,theextenttowhichthemeaningfulsector‐widecomparisonofthedata ismeaningful isquestionable.Therawdatarequiredcould lead tomisinterpretationandanunlevelplayingfield.

Inaddition,itisnotclearhowexternalpartieswillbeabletoassessatotallossfiguretodeterminethequalityofORriskmanagementasthisfigurecoversverydifferentaspectsoftheevolutionoftheloss(additionallossesonpastincidents,newlosses,recoveries,adjustmentofprovisions…).

Alternatively, it would be preferable andmore informative of a bank’s actual riskmanagement andoperationalrisktobreakdownlossesbycategories,andshowapercentagebreakdownofriskcategories,ratherthangivingabsoluteamounts.Adoptingpercentagesandtrends,ratherthanabsoluteamounts,wouldbemoreusefulandlesslikelytoraiseproblemsofconfidentiality.

Thereisalsotheconcernthatsomeoperationalrisklossessuchaspendinglitigationsandsettlementsmaybesubjecttoconfidentialityandnotallowforreportingoftheseincidents(includingtheonesforwhichexclusionisrequested).

ThecommissionshouldconsiderifdetailedqualitativeandquantitativeinformationaboutlossesshouldonlybeprovidedtoEuropeanSupervisors.

Inshort,ourconcernsareasfollows:

Therelevanceofthecomparisonbetweenbanksofhistorical lossdata‐Giventhatthe

definitionsofloss(includingthenationaldiscretionsonthethreshold),theeffectivenessoflossdatacollectionprocess,andtheaccountingstandardsvaryacrossbanks,thelossdataisnotcomparableandcanbemisleading.

The usefulness to historical loss data ‐ Capital adequacy should bemeasured againstfuture projected loss considering the bank’s current operational risk managementframework,insteadofjustlookingathistoricallossdatawhichcannotbesimplysaidtobedirectlyrelevanttofuturelosses.

5.Outputfloor

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a)Whatareyourviewsontherevisions?Pleaseprovidedetails.

Regardingkeyfeature5.1(applicationoftheoutputfloor):

Itisworthlegislatorsspecifyingthattheoutputfloorshouldnotgobeyondatthe72.5%levelsetatBasel,especiallygivenbanksarealsosubjecttotheleverageratiominimumrequirementsasbackstoptotheinternalmodels.Thiswillbeaconstrainttothedevelopmentofmarketactivitiesanddiversifiedbusinessmodels.Thiscanbeachievedby:

applyingasfavourablyaspossiblemanyofthenationaldiscretionsthatrelatetothestandardised

approaches; ensuringthattheflooriscalculatedattheaggregateRWAlevel,ratherthanonarisk‐typebyrisk‐

typebasis;and applyingthefloorattheleveloftheglobalconsolidatedgrouponly.Banksmaychoose,orare

being obliged, to arrange their businesses in such a way that lower risk activities, such asresidentialpropertylending,areheldinonesubsidiarywhilsthigherriskactivities,suchasinthetradingbook,areinseparatesubsidiaries.Anaggregatefloorthatisappliedattheregulatedlegalentitylevelmayresultinthecapitalfloorbitingatanindividualsubsidiarylevel,whenitisnotanissueattheconsolidatedlevel.Shouldtherebeconstraintsondoubleleverage,thecapitalisationofthesubsidiariesdrivenbythecapitalfloorsmaybecomethedeterminingfactorintheoverallcapitalisationofabankinggroup.

Beforeanyfloorcanbeimplemented,thereareareasofthecapitalfloor,suchasthetreatmentofcapitaldeductions,wherefurtherEuropean‐specificguidanceisrequired.Forexample,intheEU,afirmisabletodeductsecuritisationpositionsriskweightedat1250%fromcapital,whereas there isnochoice inBasel.Ifafirmhaselectedsuchanapproach,therulesneedtoconsiderhowthiswillapplyinthecontextofafloor,whereunderSEC‐IRBAitmayriskweightedand,underthefloor,itmaybededucted(orviceversa).Thesameistrueofthecurrentprovisionrules,whereunderthereisadifferenceintreatmentbetweenstandardisedandIRB,whichneedsfurtherguidance.ThiscouldbefurtherexacerbatediftheCommissionproceedswithitsplantodeducttheunprovidedforelementofnon‐performingloans.

Theimplementationofthefloorshouldwaituntilthefullroll‐outoftherevisionstoBaselIIIhasbeencompleted.Itshouldnotbeimplementedinapiece‐mealapproach,astheelementsofCRR2andCRR3arefinalised,sincethisisinconsistentwiththecalculationitself.Furthermore,thetimingshouldfactorinotherelementsoftheregimewhichremainoutstanding,suchasthetimingofsecondarylegislationunderregulatorytechnicalstandards.Inaddition,itshouldincludeareasthatareoutsideoftheBaselrevisions, butwhichmay have an impact upon Pillar 1 RWAs, such as the proposals to introduce aprudentialbackstopfornon‐performingloans.

This will also allow for alignment with Basel’s output floor, with the following six risk types beingincludedintheimplementationoftheoutputfloorintheEU:credit,counterparty,CVA,securitisation,marketandoperationalrisks.

Regardingkeyfeature5.2(disclosureofRWAs/outputfloor):

TheEuropeanjurisdictionisfacinglargePillarIIIrequirements.WeacknowledgetheworkoftheEBAandtheECBinthisfield,whichalreadyrequireextensivedisclosuretemplateregardinginternalmodels.Theexistingmeasuresensuretheappropriateandtransparentuseofmodels,whicharesufficientfortheregulatorandsupervisortohaveabroadunderstandingofbanks’frameworks.Generally,regardingthistopic, we favour striking a balance regarding the density of disclosure, in order to avoidcounterproductivemeasures,redundancyandundulyburdensomerequirements.

TheproposeddisclosurebytheBaselCommitteecouldmisleadinglyestablishthestandardisedapproachas the true capital requirement. It will wrongly lead investors to judge banks with respect to the

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standardisedapproach, considered as the “correctmeasure andbenchmark”, thereforeusing amuchrougherandless‐risksensitivemeasure.Itwillimplicitlyrequirethemtohaveadditionalownfunds.Thissituationhasoccurredinthepast,wheninvestorsdidnotconsiderphase‐inrequirements(CET1,LCR…),expectingfinancialinstitutionstohavefully‐phasedrequirementsaheadoftheregulatorycalendar.Withthebenchmarkingofinternalmodelsagainstthestandardisedapproach,marketexpectationswouldbepermanent, creating undesirable incentives and negative externalities (e.g. on financial stability andcreditsupply).Ontopofthat,suchdisclosurewillunderminethelevelplayingfieldbypushingbanksusingstandardisedapproachtooptimizetheirexposurestocomplywiththisapproach,whichisnotthecaseforbanksusingmostlyinternalmodels.

Also,disclosuresbytypeofrisksortypeofassetscoulddentanygainfromthephasingoftheoutputflooruntil 2027. With such disclosures, starting 2022, the analysts and rating agencies would be able tocompare and restate the capital requirements of the banks that are using internal models intostandardizedapproach,withoutanyfloor.

Moreover,HypotheticalRWAunderstandardisedapproachwouldprovideneithermoretransparencyoninternalmodelsnormoreunderstandingofinternalmodels.Itwouldnotreflecttheriskprofileofbankusing internallymodelledRWA.Toprovide informationonhypotheticalRWAunder thestandardisedapproachwouldbringmore complexity in reading thePillar3data. Itwouldbedifficult forusers tounderstandtherelevanceofthestandardRWAcomparedtointernalmodelsbasedRWA.b) Howwould the revisions impact you/your business? Please specify and provide relevantevidence.Morespecifically:

i.Whatwouldbetheimpactoftherevisedoutputfloorintermsofcapitalrequirementswhencomparedtotheapplicationoftherevisedinternallymodelledapproaches?Pleaseprovide an estimate, if the impact is significant in your view, and specify the relevantdriver.

WewelcomefurtherworkbyEuropeanbodiestoassesstheimpactinthisarea.

TheCommissionshoulddeterminewhetherthefloorisappropriatelycalibratedinaEuropean‐specificcontextviaaquantitativeimpactstudy,theresultsofwhichshouldbepublished.Thisshould considernotwhether the floordrives capital; but also the situationswherebanksareconstrainedbyaproximitytothe floor.Anyanalysisshouldalsotake intoaccountthe impactuponMREL.ii.Doestheapplicationoftherevisedoutputflooraffectcertainassets/exposureclassesmorethanothersand–ifapplicable–whichoftheprovisionsoftherevisedframeworkmaycreate theseeffects?Pleasesupportyourviewwithspecificevidence to theextentpossible.

Theapplicationoftherevisedoutputflooroncertainassets/exposureclassesisdifficulttoassessastheoutputflooriscalculatedatanaggregateRWAlevel.Thisiscompoundedbytheneedtospecifyhowthenationaldiscretionswithintheframeworkwillbeexercised,thefinalcalibrationof the market risk and standardised CVA frameworks becoming known, and any European‐specificamendmentstotheBaselframeworkbeingagreed.Furthermore,assetoutabove,thelevelofapplicationwithinagroupisalsomaterial.AllofthesemayaffecttherelativebalancebetweenmodelledandstandardisedRWAs.Asaresult,beforetheEuropeanversionoftheBaselIIIamendmentsareagreed,aquantitativeimpactstudyshouldbeperformed.

c)Wheredoyouexpectparticularimplementationchallengesandwhy?Pleasespecify.

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Theimplementationofthisproposedfloorregimeforbanksutilisinginternallymodelledapproachesisaconsiderableundertaking:banksdonotrunboththestandardisedandthemodelledapproachesagainsttheirfullportfoliostoday.Thiswillinvolvesignificantinfrastructure,dataandreportingenhancementsand require long lead times tomake the necessary changes across almost all elements of the RWAframework.

Onceimplemented,theimpositionofthecapitalfloorswillleadtoagreaterpressureonprocessingtimes.Thiswillaffectboththe timingofdeliveryofreturnsandthe frequency inwhichfirmschoosetorunadditionalcalculations.

Inordertoensurethatfirmsareabletobuildeffectivereportingsystemsandprocessesattheoutset,itisimportantthatanyregulatorytechnicalstandards,orchangestothereporting(CoRep)templatesanddisclosureframeworksarefinalisedassoonaspossible.Delaystothereportingframeworkmaycreateadditionalburdenonfirmsinthelong‐run.

In the casewhere theaggregateoutput floor is binding, institutionswill face a challenge toproperlyallocatetheRWAsurchargebetweenbusinesslinesinternally.Abindingleverageratiowilllikelyleadtocliff effects and volatility of capital allocation,whichmay be detrimental to long‐term financing andgrowth,andleadtogreatervolatilityandprocyclicality.

KindRegards,

ConstanceUsherwood

Director,PrudentialRegulation

KindRegards,

NicolaMariano

AssistantDirector,RiskandCapital