Amended proposal for a European Parliament and Council Directive amending Directive 93/6/EEC on the capital adequacy of investment firms and credit institutions
COMMISSION OF THE EUROPEAN COMMUNITIES Brussels, 13. 02. 1998 COM(1998) 90 final 97/0124 (COD) AMENDED PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL DIRECTIVE AMENDING DIRECTIVE 93/6/EEC ON THE CAPITAL ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS (COM(97)71 final (presented by the Commission pursuant to Article 189 a (2) of the EC-Treaty) EXPLANATORY MEMORANDUM I. INTRODUCTION The proposal for a Directive concerned by this amended proposal was submitted to Parliament and the Council on 17 June 1997 pursuant to Articles 189b(2) and 57(2) of the EC Treaty. The Economic and Social Committee handed down a favourable opinion at its 349th plenary session on 29 October 1997. Two of its suggestions (regarding the length of the transitional period and back-testing) have been incorporated into the amended proposal, Parliament having adopted an amendment to that effect. Parliament adopted (first reading) the legislative resolution giving its opinion on the proposal for a Directive (COM(97)71 final) at its sitting on 18 December 1997. Parliament's opinion comprises 10 amendments; they have been included in this amended proposal. II. COMMENTS ON THE AMENDMENTS Parliament called on the Commission to amend nine points in the proposal for a Directive. The Commission considers the amendments to these points to be acceptable. The first and second amendments extend the transitional provisions for the use of alternative spread, carry and outright rates for commodities risk until the end of 2006 (recital 8 and Article. 1, paragraph 5a). The European Parliament has proposed this extension in order to give those institutions intending to use internal models for commodities risk more time to develop appropriate systems and improve their internal control environment. This accords with a suggestion made by the Economic and Social Committee in its opinion. The Commission accepts that this extension is justified because of the difficulties of introducing internal models for some financial institutions trading in commodities. The third amendment (Annex VIII, paragraph 3) provides more detail on how back- testing should be undertaken. The Commission has accepted these specifications propose:! hy the iv-rof/iiin Parliament, because they make the provisions clearer,. particularly wiîh rentra to the frequency of the back-tests required. The f«gjrik ffiEBtt iiirAh JE rjseRd races &< (Annex VE!l, paragraph 4a and Annex Vfll 7a & [*. ) introduce additional, conditions required to permit the use of internal models (or calculating regulatory capital (or specific risk as well as additional arrangements regarding the multiplication factor in the context of specific risk. The European Parliament has proposed these provisions following adoption of such rules by an international forum of banking supervisors. The Commission agrees with the inclusion of these provisions in order to avoid competitive disadvantages for EU institutions. The fifth amestcfraeitt was introduced by Parliament to clarify that institutions whose models do not meet the extra conditions with respect to specific risk as introduced by the fourth amendment must continue to calculate capital requirements for specific risk according to Annex I of the original directive. The Commission agrees that this is a helpful clarification. Amendments srr, seven znd eight provide further explanation of how back-testing should operate in relation to the application of the "plus factor". In particular they specify that for the purposes of calculating the "plus factor" back-testing may be done on either actual or hypothetical (assuming unchanged end-of-day positions) results and that the value-at-risk calculated by the model must correspond to a one day holding period for the portfolio. !n addition they provide competent authorities with the option to waive the "plus factor" in particular circumstances, they impose sanctions if back- testing shows the mode! to be inadequate and they specify reporting requirements. These amendments proposed by the Parliament rellect similar recommendations by the Economic and Social Committee in its opinion. The Commission considers that the clarifications are helpful in substance but has made some minor adaptations to the text proposed by the Parliament in order to achieve consistency and notably to avoid duplication with parts of amendment 3. 2> AMENDED PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL DIRECTIVE AMENDING DIRECTIVE 93/6/EEC ON THE CAPITAL ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS (COM(97)71 final Original Proposal Amended Proposal 8th recital Amendment 1 8th recital Whereas some investment firms dealing Whereas some investment firms dealing primarily in commodities and commodity primarily in commodities and commodity derivatives may not yet be able to use derivatives may not yet be able to use internal models or to comply with the internal models or to comply with the capital requirements for commodities risk capital requirements for commodities risk as laid down in this Directive; whereas it is as laid down in this Directive; whereas it is expected that appropriate, cost effective expected that appropriate, cost effective internal models for investment firms on the internal models for investment firms on the risk management of commodities and risk management of commodities and commodities derivatives, in particular for commodities derivatives, in particular for options, will be available shortly; whereas, options, will be available shortly; whereas, in order to give those firms sufficient time in order to give those firms sufficient time to upgrade their risk management systems, to upgrade their risk management systems, competent authorities, under certain competent authorities, under certain conditions, should not be obliged to conditions, should not be obliged to prescribe the capital charges for prescribe the capital charges for commodities referred to in Annex VII to commodities referred to in Annex VII to Directive 93/6/EEC for investment firms Directive 93/6/EEC for investment firms before 1 January 2000. until after 31 December 2006. k Original Prtip-es&l Amended Proposal Amendment 2 Article t, paragraph 5a (new) Article Ha is inserted: "Article 11a Up to 31 December 2006, Member States may authorize their institutions to use the minimum spread, carry and outright rates indicated in the following table rather than those indicated in Annex VII. 13, 13. a, 16 and 16. a, provided that those institutions, in the opinion of the competent authorities: - carry out a significant volume of transactions in commodities; have a diversified portfolio of commodities; - are not yet in a position to employ internal models as part of their risk management system for the calculation of the capital requirements in relation to their commodities position in accordance with Annex VIII. t> Minimum spread, carry and outright rates Precious Nase Perishable Other mclals rJltL1!Ls goods goods (exccrtl gold) (agricultural inc. products) energy products Spread 1. 0 1. 2 1. 5 ]_. 5 Rale (%) Carry rate 03 • 05 06 06 m Outright 8 \0 \1 \5 Rate (%) Member States applying this Article shall provide the Commission with the necessary information. " Original Proposal Amended Proposal Amendment 3 Annex VIII, paragraph 3 Annex VIII, paragraph 3 3. The competent authorities shall also be 3. The institution shall monitor the satisfied that the institution's models accuracy and performance of its model by continue to be reasonably accurate, as conducting a back-testing programme. The evidenced by a regular back-testing back-testing has to provide for each programme to be conducted by the business day a comparison of the one day institution. value-at-risk measure generated by the institution's model for the portfolio's end- of-day positions with the one day change of the portfolio's value by the end of the subsequent business day. Competent authorities shall monitor the development by institutions of the capability to perform back-testing on both actual and hypothetical changes in the portfolio's value. Back-testing on hypothetical changes in the portfolio's value is based upon a comparison between the portfolio's end-of-day value and, assuming unchanged positions, its value at the end of the subsequent day. ^r Origmal Proposal Amended Proposal Amendment 4 Annex VIII, paragraph 4a (new) 4a. l;or the purpose of calculating capita 1 requirements for specific risk associated with traded debt and equity positicns_the competent authorities may recognise the use of an institution's internal model if in addition to compliance with the conditions in the remainder of this Annex the model: - explains the historical price variation in the portfolio, - captures concentration in terms of magnitude and changes of composition of the portfolio, - is robust to an adverse environment, and - is validated through back-testing aimed at assessing whether specific risk is being accurately captured. If competent authorities allow this back-testing to be performed on the basis of relevant sub- portfolios these must be chosen in a consistent manner. t Original Proposai Amended Proposal Amendment 5 Annex VIII, paragraph 5 Annex VIII, paragraph 5 5. Notwithstanding ruimgraph _ l_, 5. Institutions using internal models which institutions using models shall be subject to are not in accordance with paragraph 4a a separate capital charge to cover the shall be subject to the separate capital specific risk of traded debt instruments and charge in respect of the specific risk equities as described in Annex 1 to the calculated according to Annex I. extent that the competent authorities consider that this risk is not incorporated sufficiently into their models. The competent authorities shall in any case set a minimum specific risk charge of 50% of the charge as calculated according to Annex I for institutions using models. Original Proposal Amended Proposal Amendment 6 Annex VIII, paragraph 7 - second sub- Annex VIII, paragraph 7- second sub paragraph paragraph The value-at-risk number calculated by The value-at-risk number calculated by means of the model shall be compared with means of the model shall be compared with the actual change in value of the portfolio, the actual change in value of the portfolio. Rack-testing shall be carried out daily on Back-testing shall be carried out daily on the basis of both effective and, assuming the basis of actual or, assuming unchanged unchanged end-of-day positions, hypo- end-of-day positions, hypothetical changes thetical changes in the portfolio value. in the portfolio value. The value-at-risk number subject to the backtesting must correspond to a holding period of one day. Before using an internal model to determine its own funds, the institution shall also obtain the approval of the competent authorities, inter alia, for the type of changes (actual or hypothetical) to be used in its backtesting. The institution must also apply the method selected consistently. >o Original Proposal Amended Proposal Amendment 7 Annex VIII, paragraph 7 - second sub- Annex VIII, paragraph 7- third sub paragraph paragraph If the change in portfolio value exceeds the If the change in portfolio value exceeds the value-at-risk calculated using the model, value-at-risk calculated using the model, the target has been overshot. The number the target has been overshot. The number of overshoot ings, as set out in table 5, shall of overshootings, as set out in Table 5, be based on a spot check of 250 values. shall be based on a statistical sample of daily values covering the 250 most recent working days. For the purpose of determining the 'plus' factor, the number of overshootings shall be determined at least quarterly Original Proposal Amended Proposal Amendment 8 Annex VIII, paragraph 7 - last three Annex VIII, paragraph 7- last three sub-paragraphs sub-paragraphs The competent authorities can, in "The competent authorities can, in individual cases, waive the requirement to individual cases, waive the requirement to add a plus factor if, owing to an increase the multiplication factor by the exceptional situation, an increase in the "plus'Maetor in accordance with 'Table 5 if multiplication factor would be unjustified the institution has demonstrated to the and the model is basically sound. In this satisfaction of the competent authorities context, the institution has lo prove that an that such an increase is unjustified and that increase would be unjustified. the model is basically sound. ,. p • , In the event of numerous overshootings, the competent authority shall revoke the model is not sufficiently accurate, the the If numerous overshootings indicate that the competent authorities shall revoke , ,,. , 6. model s recognition or impose appropriate v improved promptly. measures to ensure that the model is ,1. i , i • model's recognition or impose appropriate is measures to ensure that the model & r rr v The institution is to record all overshootings ascertained by back-testing, together with the reasons for them, and to notify the competent authorities immediately of the extent of the overshootings and the reasons for them. improved promptly. The institution is to record all overshootings ascertained by back-testing, together with the reasons for them, and to notify the competent authorities, without undue delay, and in any case no later than 5 working days after the day on which the error was noted. Original Proposal Amended Proposal Amendment 9 Annex VIII, paragraph 7a & b (new) 7a. If for the purpose of calculating capital requirements for specific risk the institution's model is recognised by the competent authorities in accordance with paragraph 4a, the multiplication factor to be applied to the specific risk portion of the institution's value-at-risk measure shall be increased to 4. If the institution's back- testing indicates that the model does not sufficiently accurately capture specific risk the competent authorities shall revoke the model's recognition for the purpose of calculating capital requirements for specific risk or impose appropriate measures to ensure that the model is improved promptly. 7b. The competent authorities may waive the requirement pursuant to paragraph 7a. for an increase of the multiplication factor to 4 if the institution demonstrates that in line with agreed international standards its model adequately captures also, inter alia, the event and default risk for its traded debt and equity positions. i3> ISSN 0254-1475 COM(98) 90 final DOCUMENTS EN 09 08 10 Catalogue number : CB-CO-98-095-EN-C ISBN 92-78-31196-0 Office for Official Publications of the European Communities L-2985 Luxembourg « *•