European Banking Authority Refines Market Risk Rules
The European Banking Authority (EBA) has unveiled amendments to its regulatory technical standards (RTS) on market risk, a move that could ripple through the operations of corporate treasury departments across Europe and beyond.
The changes, detailed in a report released August 13, are designed to align existing regulations with the recently enacted Capital Requirements Regulation 3 (CRR3). While technical in nature, these adjustments may have far-reaching implications for how banks manage risk—and by extension, how they interact with corporate clients.
The EBA’s amendments focus on three key areas: profit and loss attribution requirements, risk factor modellability assessment, and the treatment of foreign exchange and commodity risk in the non-trading book. These changes stem from the need to align the existing RTS, which were developed under CRR2, with the new provisions introduced in CRR3.
In a move aimed at ensuring regulatory stability, the EBA has chosen to limit the amendments to what is strictly necessary to fit with the new CRR3 text. This approach recognizes that many institutions have already implemented the provisions included in the existing delegated regulations and have used them to obtain approval from competent authorities to use the internal model approach for computing own funds requirements for market risk.
One of the most significant changes relates to the profit and loss attribution (PLA) requirements. The amendments clarify that trading desks classified as “green” under the existing regulations are considered to have theoretical changes in portfolio value close to the hypothetical changes. Similarly, “yellow” desks are deemed to have theoretical changes sufficiently close, but not identical, to hypothetical changes. Conversely, “orange” and “red” desks are considered to have theoretical changes neither close nor sufficiently close to hypothetical changes.
This classification system is crucial for determining whether a trading desk meets the PLA requirements and can continue using internal models for calculating market risk capital requirements. For corporate treasurers, this could impact how their banking partners structure their trading operations and potentially influence the pricing of treasury products.
Another key change is the removal of the formulae for aggregating the own funds requirements for market risk from the delegated regulation. This formula has now been included directly in Article 325ba(3) of the CRR3, simplifying the regulatory landscape but requiring careful attention from both bank and corporate treasury departments to ensure compliance.
The amendments also introduce new documentation requirements for banks using market data from third-party vendors in their risk factor modellability assessments. Institutions will now need to document the number of risk factors classified as modellable based on verifiable prices provided by each third-party vendor, along with a materiality assessment of those risk factors. This change could impact the models banks use to price various financial instruments, a development that corporate treasurers should monitor closely.
In the realm of foreign exchange and commodity risk, the amendments require institutions to identify positions included in their foreign exchange risk exposure due to translation risk when calculating own funds requirements for market risk on a consolidated basis. This is particularly relevant for multinational corporations managing currency exposures across different jurisdictions.
Furthermore, institutions must now document in their internal policies whether non-trading book positions subject to foreign exchange or commodity risk are assigned to trading desks managing exclusively non-trading book positions or to desks managing both trading and non-trading book positions. Where assignments differ, institutions must specify the criteria and rationale for these assignments. This increased transparency could provide corporate treasurers with valuable insights into how their banking partners manage these risks.
The EBA’s cautious approach—limiting changes to only those necessary for CRR3 alignment—aims to minimize disruption. However, corporate treasurers should remain vigilant as these changes could indirectly affect their operations through altered bank risk management practices and potentially revised pricing of financial products and services.
While these regulations primarily target banks and financial institutions within the European Union, their impact may extend beyond EU borders. U.S. corporate treasurers, particularly those of multinational corporations or those working with European banks, should also take note. As global banking standards continue to evolve, similar changes could appear in other jurisdictions. Moreover, these changes reflect ongoing developments in global banking standards, which could indirectly impact operations or relationships with European financial institutions.
The amendments aim to harmonize the implementation of profit and loss attribution requirements, standardize criteria for assessing risk factor modellability, and establish common requirements for calculating own funds requirements for certain non-trading book positions. This harmonization is expected to create a more level playing field, promote convergence of institutions’ practices, and enhance comparability of own funds requirements across the EU.
For corporate treasuries, these regulatory changes could have several implications. The refinements in how banks calculate capital requirements could influence their appetite for certain types of transactions or relationships, potentially affecting corporate treasuries’ banking arrangements and financial strategies.
Additionally, the changes related to profit and loss attribution, risk factor modellability, and treatment of foreign exchange and commodity risk in non-trading books could influence how banks manage and price these risks, potentially affecting corporate treasuries’ risk management strategies and the costs of hedging activities.
As regulators continue to refine the post-crisis regulatory framework, the interplay between banking rules and corporate treasury operations grows ever more complex. The EBA’s latest move underscores the need for corporate treasurers to stay informed and agile in an evolving regulatory landscape.
The EBA conducted a public consultation on these amendments, which lasted for three months and ended on March 14, 2023. Only one response was received, which was largely supportive of the proposed changes. This feedback led to minor adjustments in the final draft, particularly regarding the applicability of certain requirements to banks using the standardized approach.
The new standards are expected to take effect later this year, following a formal adoption process by the European Commission. As these changes roll out, corporate treasurers would be well-advised to engage proactively with their banking partners to understand how these regulatory shifts might affect their financial operations and strategies.