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    EC Adopts Regulation on Residual Risk Add-On Under FRTB

    August 16, 2022

    EC adopted the Delegated Regulation that sets out the regulatory technical standards that specify exotic underlyings and the instruments bearing residual risks for the calculation of own funds requirements for residual risks. These regulatory standards constitute a further contribution to a smooth and harmonized implementation of the international market risk (or FRTB) standards in the European Union. This regulation, which has not yet been published in the Official Journal of European Union, supplements Article 325u(5) of the Capital Requirements Regulation or CRR (575/2013).

    The regulatory standards laid out in this Delegated Regulation provide technical specifications for the implementation of the certain elements of the alternative standardized approach for market risk. Institutions using the alternative standardized approach are required to compute three separate own funds requirements for market risk: the sensitivities-based method (SbM) own funds requirements, the residual risk add-on (RRAO), and own funds requirements for the default risk (DRC). These final regulatory technical standards specify what an exotic underlying is and which instruments are instruments bearing residual risks (listed in Annex to this regulation), for the purpose of Article 325u(2) of CRR. The standards also specify that longevity risk, weather, natural disasters and future realized volatility should be considered as exotic underlyings. In addition, the standards set out a non-exhaustive list of instruments bearing residual risks and a list of risks that, in themselves, do not constitute residual risks.

    The residual risk add-on is intended to provide a simple and conservative capital treatment for any other risks not covered by the sensitivities-based method or the default risk charge. Thus, the scope of instruments that are subject to the residual risk add-on must not have an impact in terms of increasing or decreasing the scope of risk factors subject to the other standardized approach components. Therefore, instruments exposed to residual risks—that is, instruments referencing an exotic underlying or instruments bearing other residual risks—are subject to the residual risk add-on treatment. The residual risk add-on amounts to 1% or 0.1% of the gross notional amount of the instrument, depending on whether the instrument is an instrument referencing an exotic underlying or an instrument bearing other residual risks, respectively. This Delegated Regulation is based on the draft regulatory technical standards submitted to the European Commission by the European Banking Authority or EBA. 

     

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    Keywords: Europe, EU, Banking, Regulatory Technical Standards, CRR, Basel, Regulatory Capital, Exotic Underlyings, Longevity Risk, EBA, Residual Risk Add on, Market Risk, FRTB, EC

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