Publication alert: EBA - Final draft RTS on the IMA under the FRTB and Roadmap for market and CCR approaches
We communicate that the European Banking Authority (EBA) has published the following documents:
- Final draft RTS on Liquidity Horizon for the IMA
- Final draft RTS on Backtesting and PLA requirements
- Final draft RTS on Risk factor modellability
1. Context
In January 2019, the BCBS finalised and published standards on Minimum capital requirement for market risk (revised FRTB), which replaces the previous minimum capital requirements for market risk in the global regulatory framework, implemented in the EU via the CRR. Further, in June 2019 the European Parliament (EP) and the Council issued CRR II introduces reporting requirements under FRTB IMA (June 2023) and FRTB SA (March 2021). The European Commission (EC) is expected to present a legislative proposal in June 2020 detailing how this regulation will be implemented. However, key parts of the framework relating to the FRTB revisions will be implemented through a Commission Delegated Act and EBA technical standards.
In this context, and after the publication of the consultation papers in June 2019, the EBA has published three Final drafts on RTS on the new internal model approach (IMA) under the FRTB in order to specify essential aspects of the IMA and contribute to a smooth and harmonised implementation of the FRTB in the EU. In particular, these documents are the Final draft on RTS on liquidity horizons, the Final draft on RTS on back-testing and profit and loss attribution (PLA) requirements and, the Final draft on RTS on criteria for assessing the modellability of risk factors under the IMA.
2. Main points
Final draft RTS on liquidity horizons for the IMA
- Scope. According to the CRR II, institutions are required to map each risk factor to one of the risk factor categories and to one of the risk factor subcategories listed (e.g. most liquid currencies and domestic currency, or volatility for interest rate risk factor’s category) for the purpose of identifying the relevant liquidity horizon under the IMA.
- Content. This document specifies the following aspects:
- Mapping of risk factors to risk factor categories and subcategories, by providing ad hoc treatments for some specific risk factors as well as a general approach for the majority of cases.
- Definition of most liquid currencies for interest rate risk, by establishing that those currencies are defined considering the Triennial Central Bank Survey Over the Counter (OTC) interest rate derivatives turnover compiled by the Bank of International Settlements (BIS).
- Most liquid currency pairs for FX risk, by defining them also considering the Triennial Central Bank Survey foreign exchange turnover compiled by BIS.
- Definition of a small and large capitalisation for equities:
- It is considered a large capitalization a market capitalisation equal to or greater than EUR 1.75 billion and equities in indices listed in the ESMA ITS which its components are all quoted in the EU.
- It is considered a small capitalization all capitalisation that does not fall within the scope of large capitalisation.
Final draft RTS on back-testing and profit and loss attribution (PLA) requirements
- Scope. According to the CRR II, credit institutions should use an IMA that is reliable in determining capital requirements relative to the Profit & Loss (P&L) of the institution. To this end, two ways of assessing that a model is reliable are the regulatory backtesting programme and the PLA test.
- Content. This document specifies the following aspects:
- Definition of actual and hypothetical P&L, for the purpose of both backtesting performed at trading desk level and backtesting performed on the portfolio of all positions attributed to these trading desks.
- The PLA test, by providing:
- The criteria ensuring that theoretical changes in a trading desk portfolio’s value are sufficiently close to the hypothetical changes.
- The consequences for an institution with one (or multiple) trading desk(s) with theoretical and hypothetical changes in the portfolio(s) value(s) not sufficiently close.
- The frequency at which the P&L attribution test should be performed.
- The definition hypothetical P&L and risk-theoretical P&L (RTPL).
- The way institutions using the internal model for some desks have to aggregate the total own funds requirement for market risk of all their trading book positions and non-trading book positions bearing FX or commodity risk.
Final draft RTS on criteria for assessing the modellability of risk factors under the IMA
- Scope. According to the CRR II, institutions shall assess the modellability of all the risk factors of the positions assigned to the trading desks for which they have been granted permission or are in the process of being granted such permission.
- Content. This document specifies the following aspects:
- The methodology of the modellability assessment of a risk factor by:
- Identification at a minimum of 24 verifiable prices which are representative for the risk factor over the preceding 12-months, without any period of 90 days or longer with less than four verifiable prices which are representative for the risk factor.
- Identification at a minimum of 100 verifiable prices which are representative for the risk factor over the preceding 12-months.
- The requirements a price should satisfy to be verifiable and the representativeness of verifiable prices for risk factors.
- The methodology of the modellability assessment of a risk factor by:
3. Next steps
- The adoption of these RTS is expected, under CRR II, to trigger the three-year period after which institutions with the permission to use the FRTB internal models are required to calculate their own funds requirements for market risk with those internal models.