PRA published a statement that sets out its approach to calculate exposure for counterparty credit risk, or CCR, under the internal models method (IMM). It published another statement that sets out its approach for the Value-at-Risk (VAR) back-testing, with this temporary approach being relevant for firms experiencing an elevated level of VAR back-testing exceptions. Both these statements have been published in light of the COVID-19 outbreak.
Statement on exposure value for counterparty risk under IMM
The Capital Requirements Regulation (CRR) does not preclude firms using the IMM to measure the exposure value, including collateral which has not yet settled at the time of calculation. Where a shortfall between the collateral for which a firm has called and the collateral which has settled arises as a result of the ordinary collateral settlement cycle, including this shortfall in the calculation of exposure may lead to unwarranted volatility in the exposure value and therefore unwarranted volatility in risk-weighted assets. Firms with permission under CRR Article 285 are required to capture the effects of margining within the calculation of Effective Expected Positive Exposure, which is derived from the profile of estimated Expected Exposure. PRA considers that firms are not required to estimate the initial Expected Exposure recognizing only collateral that has settled at the time of calculation. According to PRA, a firm which calculates the initial Expected Exposure on the basis of collateral that has not yet settled would be expected to monitor the impact of this modeling choice on an ongoing basis and hold capital against any understatement of economic risk. Firms would not be expected to recognize collateral in the initial Expected Exposure which has been called for but disputed by the counterparty.
If a firm makes a change to any IMM model as a result of this guidance then this would constitute a post-approval model change requiring post-notification as per Section 6.16 of PRA Supervisory Statement SS12/13, unless the impact of that change exceeded the materiality threshold as set out in Section 6.10(b) of the statement, in which case it would require pre-notification as set out in Section 6.15.
Statement on temporary approach to VAR back-testing exceptions
PRA mentioned that the exceptional levels of market volatility over the past few weeks have led to an elevated level of VAR back-testing exceptions across the industry. To mitigate the possibility of excessively pro-cyclical market risk capital requirements through the automatic application of a higher VAR multiplier, PRA will allow firms—on a temporary basis—to offset increases due to new exceptions through a commensurate reduction in risks-not-in-VAR (RNIV) capital requirements. The statement notes that the baseline number of back-testing exceptions to be used, which will determine the point at which the RNIV reduction starts, should be agreed with PRA at the outset. Firms are expected to continue to monitor and analyze exceptions during this temporary period and, when the situation returns to normal (that is, after the end of the temporary period), PRA will consider which (if any) of the exceptions can reasonably be discounted (per section 6 of PRA supervisory statement on market risk). This approach will be reviewed by PRA after six months—that, is in September 2020.
Keywords: Europe, UK, Banking, Value-at-Risk, COVID-19, CRR, Counterparty Credit Risk, Back-Testing, Risk-Weighted Assets, Regulatory Capital, Internal Models, PRA
PRA, via the consultation paper CP12/20, proposed changes to its rules, supervisory statements, and statements of policy to implement certain elements of the Capital Requirements Directive (CRD5).
EIOPA published the financial stability report that provides detailed quantitative and qualitative assessment of the key risks identified for the insurance and occupational pensions sectors in the European Economic Area.
EBA published its risk dashboard for the first quarter of 2020 together with the results of the risk assessment questionnaire.
EBA announced that the next stress testing exercise is expected to be launched at the end of January 2021 and its results are to be published at the end of July 2021.
PRA published the consultation paper CP11/20 that sets out its expectations and guidance related to auditors’ work on the matching adjustment under Solvency II.
MAS published a statement guidance on dividend distribution by banks.
APRA updated its capital management guidance for banks, particularly easing restrictions around paying dividends as institutions continue to manage the disruption caused by COVID-19 pandemic.
FSB published a report that reviews the progress on data collection for macro-prudential analysis and the availability and use of macro-prudential tools in Germany.
EBA issued a statement reminding financial institutions that the transition period between EU and UK will expire on December 31, 2020; this will end the possibility for the UK-based financial institutions to offer financial services to EU customers on a cross-border basis via passporting.
SRB published guidance on operational continuity in resolution and financial market infrastructure (FMI) contingency plans.