EBA Issues Standards to Determine Indirect Exposures from Derivatives
EBA published the final draft regulatory technical standards that present a methodology for the calculation of indirect exposures for different categories of derivative contracts and credit derivative contracts with a single underlying debt or equity instrument. Specifically, the standards cover the calculation of indirect exposures for options on debt and equity instruments, credit derivative contracts, and other derivatives that have a debt or equity as the underlying instrument. The draft regulatory standards were issued in line with the revised Capital Requirements Regulation (CRR2) and are intended to facilitate consistency through different pieces of the regulatory framework for calculation of large exposures.
The regulatory standards provide a separate methodology for the calculation of exposures stemming from contracts with multiple underlying reference names. The proposed methodologies are expected to be easy to implement and applicable by all institutions in a standardized manner. The final draft standards have been developed in a way to ensure that they are compatible with the jump-to-default (JTD) approach under the Fundamental Review of the Trading Book (FRTB) and the CRR and the corresponding draft regulatory standards on JTD that the EBA is developing. The basis of both draft regulatory technical standards is the variation in price that would stem from the default of an issuer. Post a three-month EBA consultation on the draft regulatory standards, EBA clarified the treatment of derivatives and credit derivatives allocated to the trading book or non-trading book. Furthermore, the draft regulatory standards have been amended to align the proposed rules applicable to multi-underlying derivatives with a structure (that is, an index and collective investment undertakings) or without a structure, as well as the introduction of a partial look-though approach for this type of derivatives.
For large exposures purposes, under the CRR, an institution shall calculate the exposures to a client or group of connected clients by adding the direct and indirect exposures in the trading book and in the nontrading book. The indirect exposure to the issuer of the underlying instrument of a derivative contract shall be calculated as the loss that would result from the default of the issuer itself. The draft regulatory technical standards propose a methodology for the calculation of such exposures. The draft regulatory standards thus build on the BCBS framework on large exposures with the intention of being consistent with market risk rules for the calculation of exposures from (credit) derivatives, complemented where needed by specificities or objectives stemming from the large exposures framework. These regulatory technical standards are part of the EBA roadmap on risk-reduction measures package that was published in November 2019. The final draft technical standards will be submitted to EC for adoption. Following submission, the technical standards will be subject to scrutiny by the European Parliament and the Council before being published in the Official Journal of the European Union.
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Keywords: Europe, EU, Banking, Indirect Exposures, Derivatives, Large Exposures, CRR2, Basel, Regulatory Technical Standards, Credit Risk, Market Risk, Concentration Risk, EBA
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