PwC regulatory roadshow 2016 The next generation of...

PwC regulatory roadshow 2016

The next generation of RWA

www.pwc.com

The original

Luxembourg

17 October 2016

PwC

(Mark Carney, FSB in Handelsblatt of 9.11.2015)

Mirage or phantom menace?

Basel IV is a Mirage

(Felix Hufeld, BaFin President in Börsenzeitungof 25.02.2016)

1 2There is no Basel IV

Basel IV is not under discussion

(Daniele Nouy, EZB in Wirtschaftsblattof 23.03.2016)

3

Please consider a buffer for the additional capital requirements defined under Basel IV in your capital planning by 2018.

(Anonymous ECB-employee to a German SSM-bank)

2

October 2016PwC regulatory roadshow 2016

PwC

Agenda

1 The next generation of RWA

2 Credit risk

3 Market risk

4 Additional risk types

5 IT and data availability

6 Interest rate risk in the banking book

7 ECB Supervision

8 IFRS 9

9 Disclosure

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The next generation of RWA

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Available Capital

Capital Requirements

≥ 100 %

Eligible Own Funds (Tier 1, Tier 2)

Capital Requirements (Credit, Operational, Market) x 12.5

≥ 8 %

From Basel I to Basel II to Basel III to Basel IVPrudential Solvency Ratio

Basel I Basel I.5Basel II

Basel III

Basel IV

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Basel IV in a nutshell

Calculation of the capital ratios according to Basel III/CRR…

Common Equity Tier 1

Additional Tier 1

Tier 2 Instruments

Credit risk

Add. risks

Market risk

OpRisk

> 8% + capital buffer

…and topics covered by Basel IV:

SASecuritis

ationsIRBA SA-CCR CVA

Step-in Risk

FRTB OpRisk

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Indicative impact on RWA

Mirage or phantom menace?

TotalRWA

Distinct increase of CVA Risk Capital Charge

SA new RWA-increase e.g. wrt. institutions, specialized lending, participations

FRTB (Standardized approach)

-10% 40% 150%

-5% 20% 190%

0% 40% 400%

Particular impact on options and credit risks

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Market studies suggest an aggregated increase in RWA of 40% - 65% resulting from ‘Basel IV’

Impact assessment

1) The average STA risk weight for a portfolio within a country (number weighted) is used as the STA reference to apply the floor to. For Specialized Lending, a 100% floor has

been applied to the STA corporates risk weight. Large corporates face an 80% floor, assuming a mix of largest corps and medium sized ones. For Banks, a range of risk weights

between 30% (low impact) and 50% (high impact), to reflect the full reclassification of banks to STA, and the large change in the STA approach for banks.

Sources: Bankenverband, Risk Control Limited, Börsenzeitung, Bloomberg, Deutsche Bank, Reuters, Barclays, PwC Regulatory, Strategy& analysis

Methodology

The RWA and capital impact is estimated on a top-down basis for the key risk types: credit risk, operational risk, market risk and CVA

Starting RWA and capital data has been derived from the published EBA’s transparency exercise 2015 (no internal bank data is used)

The expected impact from Basel IV is derived from studies published by various institutions (incl. BCBS) and professional service firms, where they make top-down indicative estimates of the impact

A likely range of possible impact is defined based on the estimates of 8 independent publications

For credit risk, the impact on the portfolios under the standardized approach is estimated between 10%-30% based on the publications. For the IRB impact, a floor of 60% has been applied to the standardized risk weight for that portfolio1)

Further revisions of the directives may affect these estimates

Estimated impact on RWA Indicative ranges by risk type for “average” banks

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Implying an increase in RWA of €4.4 Tn to €7.4 Tnfor the hundred largest banks in Europe

Aggregated RWA impact estimate in €Tn

Credit risk is the main driver of RWA impact, due to both the size of the portfolio and the height if the impact

Credit risk IRB portfolio increases strongly due to proposed output floors, which are generally binding at 60%

As a result, banks with relatively low risk weights for their IRB portfolios are expected to be at the higher end of this impact range

Similarly, for market risk, the impact of Basel IV will be higher for banks with a high share of trading desks valued with internal models

Next to the output floors, additional restrictions on the application of the A-IRB approach for credit risk is expected to have a significant impact (e.g. mandatory application of F-IRB or STA for corporates)

1) Impact relative to starting value for risk type, impact based on Strategy& perspective on expert estimates

Source: Strategy& analysis

Low impact1) 60% 30%50% 50% 40%10%

90% 65%70% 100% 65%35%High impact1)

Comments

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The credit risk floor is expected to have the highest impact to large corporates and retail mortgages

Impact from Basel IV floors on credit risk by portfolio expected in bn €

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Basel IV significantly affects the capital position of banks and lead to a capital shortfall for almost all banks

Available and (expected) required capitalH1 2015 in €Tn

Combined the capital buffers and the expected increase in RWA due to the current ‘Basel IV’ proposals would approximately double the capital requirements from €1.1 Tn to an expected €1.9 Tn to €2.3 Tn

In spite of the current excess in capital, the current ‘Basel IV’ requirements are expected to lead to a capital shortfall for nearly all banks in scope

On average, banks with a shortfall, would need to raise between €5.0 Bn and €8.5 Bn additional capital which is equivalent to an increase of 30% to 50%1)

The capital shortfall absolutely and relatively increases with the size of the bank, as larger banks tend to rely more on internal models for RWA calculations

1) Number weighted average across all banks which have a shortfall

2) Assuming a current SREP requirement of 10.3% (based on ECB SSM SREP document) and an additional systemic risk and countercyclical buffer of 2.0%

Source: Strategy& analysis

Average bank

shortfall1) - €0.5 Bn €5.0 Bn €8.5 Bn

# banks with

shortfall- 34 87 94

Comments

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Strategy& can support banks to evaluate their business model along four dimensions

Strategic responses to ‘Basel IV’

Asses impact on regulatory requirements and adjust capital plan accordingly

Identify measures to raise capital and/or deleverage balance sheet

Identify strategic impact on business lines and products

Recalibration and optimization of business mix and asset portfolios – increased focus on fee business

Identify key drivers of product specific cost of capital under Basel IV

Restructure products offered and adapt pricing to refelct these drivers

Update models to reflect Basel IV approach Set-up operational prcesses for additional reporting

requirements (e.g. DD)

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Credit risk

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Motivation for a revised standardized approach (SA) for credit risk

1st Consultative Document (BCBS 307)

2nd Consultative Document (BCBS 347)

Consultation

Proposals by the Basel Committee

• Reintroduction of the use of ratings, in a non-mechanistic manner, for exposures to banks, corporates and SL

• Modification of the proposed risk weighting of real estate loans, with loan-to-value ratio as the main risk driver

• Proposals for exposures to multilateral development banks, retail and defaulted exposures, and off-balance sheet items

• Consideration of replacing referencesto external ratings with a limitednumber of risk drivers

• The alternative risk drivers vary based on the particular type of exposure and have been selected on the basis that they are simple, intuitive, readily available and capable of explaining risk across jurisdictions

• Aim to balance risk sensitivity and complexity

• Simple feasibility instead of drawing on internal model-ling

• Cutback of national discretions in order to increase compa-rability in capital requirements

• Introduction of obligatory capital floors based on revised SA frame-works

Reasons for the revision of SA

Insufficient risk sensitivity

1

Dependence onexternal ratings

2

Outdated calibration3

National discretions4

Weaknesses of current SA Basel IV objectives

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Overview of proposed SA modifications 1/3Increase of risk weights for participations and unrated banks

Current SA (CRR) Revised SA (BCBS 347)Exposure class

• Risk weights based on external ratings

• Sovereign risk weight if no external rating available (at least 20%)

• Risk weights ranging between 20% and 150%

• Risk weights based on external ratings ranging between 20% and 150% (+ due diligence required)

• Unrated institutions: „Standardised Credit Risk Assessment“ using risk weights of 50%, 100% and 150%

• Sovereign risk weights no longer accepted

• 0% risk weight for specific development banks

• Else treated as institutions

• Risk weight = 0% for specific development banks

• Other external ratings between 20% and 150%(unrated: 50%)

• Risk weights based on external ratings ranging between 20% and 150%

• Unrated: 100%

• Multiplier for SME of 0.7619 in order to reduce risk weights

• Risk weights based on external ratings ranging between 20% and 150% as in status quo

• Risk weight of 85% for SME

• Unrated: 100%

• Additional due diligence required

• Risk weight = 75%

• Granularity criterion and low value criterion applicable

• Unchanged risk weight = 75%

• Risk weight = 100% if not all of the criteria (product criterion, low value criterion, granularity criterion)are met

• Risk weight = 100%

• Institutions: Risk weight = 250%/deduction

• Risk weight = 150% for subordinated debt

• Risk weight =250% for equity instruments

Banks(Institutions)

Multilateral development banks

Corporates

Retail

Subordinateddebt, participations

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Overview of proposed SA modifications 2/3LTV based RW and new classes for real estate


• Risk weight: 35 %

• splitting of exposure secured by real estate

• Loan-to-value concept instead of splitting of exposure

• General Treatment:

- Risk weight ranging between 25% and 55% (if LTV ≤ 100%)

- Risk weight of the counterparty if LTV > 100%

- Operational requirements not met: Risk weight = 100%

• New exposure class: Income-producing Real Estate (IPRE)

- Risk weight ranging between 70 % and 120% (LTV dependent)


• New exposure class Land Acquisition, Development and Construction: Risk weight = 150%

• Risk weight: 50 % (national discretion)

• splitting of exposure secured by real estate

• General Treatment

- If LTV ≤ 60%: Risk weight = Min (60% ; RW of the counterparty)

- Risk weight of the counterparty if LTV > 60%

- Operational requirements not met: Risk weight = Max (100% ; RW of the counterparty)

• New exposure class: Income-producing Real Estate (IPRE)

- Risk weight ranging between 80% and 130% (LTV dependent)


• New exposure class Acquisition, Development and Construction: Risk weight = 150%

Residentialreal estate

Commercialreal estate

Operational requirements:

• Finished property

• Legal enforceability

• Claims over the property

• Ability of the borrower to repay

• Prudent value of the property

• Required documentation

Operational requirements:

• Finished property

• Legal enforceability

• Claims over the property

• Ability of the borrower to repay

• Prudent value of the property

• Required documentation

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Overview of proposed SA modifications 3/3Introduction of specialized lending exposures and other changes


• If emission ratings are available and approved: Risk weight ranging between 20% and 150% (analogue corporations)

• If no ratings available dependent on the phase of project financing: 100% to 150%

• Minimum credit conversion factor for off balance sheet positions of 10% + general increase

• Consideration of currency mismatch (credit currency ≠ client‘s main currency)

Specializedlending

Commercialreal estate

• No rules for specialized lending

Regulations for claims against countries, central banks and public institutions are not considered in BCBS 347.

Emission rating is available and applicable

Rating

Risk weight for object-, project- and commodity trade financing

AAA to AA-

A+ to A-BBB+ to

BBB-BB+ to

BB-Below BB-

20 % 100 % 150 %50 % 100 %

Emission rating is not available/applicable

Object- and commodity trade financing

Project financing

120 %

150 %(pre-operational)

100 %(operational)

Risk weights for specialized lending according to BCBS 347

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Proposed SA modifications for real estateIncrease of RWA and significant exposure migration

Pillar I: Credit risk

CRR

BCBS 347

Residential Real Estate IPRE RRE Commercial Real Estate IPRE Comm. ADC

Average change of RWA shown in exemplary calculations for a large bank

Retail Corporates

Since a splitting of exposures secured by real estate is not considered in BCBS 347, exposures are moved from unsecured risk classes (e.g. retail business) to secured risk classes and are treated with a LTW based RW.

Residential RE: + 2,6 %

+ 42 %

CRE: – 62 %

Exposures migrate from the class Commercial Real Estate (CRE) to Income-producing Real Estate (IPRE) and Acquisition, Development and Construction (ADC) significant increase of RWA

Migration effects from the class Residential Real Estate (RRE) ) to Income-producing Real Estate (IPRE) are partially compensated by migrations of uncollateralized exposures to collateralized exposures (for LTV > 80% after splitting of exposures secured by real estate)

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Impact on overall RWAExample calculations show significant increase of RWA

CRR CRR

BCBS 347

BCBS 347

Large universal bank Special institute

+ 27 %+ 110%

Increase of RWA in exposure class banks

• Exposures in unrated banks are the biggest drivers of an increase in RWA

• Risk weights increase from 20% to 50% in case of omission of applicability of the sovereign risk weight

Large universal bank

CRR

+ 150 %

BSBS

347

Increase of RWS in exposure class subordinated debt and participations

• Increase of risk weights from 100% to 250% for participations leads to significant RWA uplift

Large universal bank

+ 36%

Further reasons for an increase in RWA due to BCBS 347

• Implementation of exposure classes IPRE and ADC

• Implementation of exposure class specialized lending

Overall impact on RWA

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Proposed changes to the IRB approachFuture of IRBA & BCBS 362 and TRIM

Future of IRBA

Necessary regulatory action to improve the comparability of IRB models, i.e.:

• Application area of IRB models

• Definition of default and treatment of defaults

• Application of credit risk mitigation techniques

• Calibration and validation of risk parameters

• Treatment of defaulted positions

Implementation due to the end of the year 2020 (Implementation phase 2 – 2.5 years)

Adjustment of definition of default and higher requirements for parameter estimation procedures

Targeted Review of Internal Models

Multi-annual review processes for internal models of ECB supervised institutions as a part of the Single Supervisory Mechanism (SSM).

Main objectives:

• Recovery of trust in IRB models

• Increase of reliability and adequacy of the models

• Increase of comparability and quality improvement of internal models

• Determination of consistent standards and supervision guidelines

On-site review of internal models and data request carried out by the ECB

BCBS 362

Modification proposal of Basel Committee on Banking Supervision (BCBS) concerning the Internal Rating Based Approach (IRBA), both the advanced (A-IRB) and the foundation IRB (F-IRB). The suggested changes of the consultation paper include:

• Reduction of complexity of the regulatory framework and improvement of comparability

• Reduction of excessive variability in capital requirements for credit risk

Elimination of discretions in the IRB approach used for particular risk positions

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Concerns regarding the quality of internal modelsEBA‘s response with Future of IRBA

Overview

• The EBA is mandated via various CRR paragraphs to develop RTS and guidelines regarding the IRBA requirements (CRR mandate).

• EBA’s plans are summarized in the discussion paper “Future of the IRB Approach” as of 4 March 2015 and 4 February 2016.

• The EBA aims to enhance the use of IRB approaches because of their risk sensitivity. The proposed changes are intended to increase harmonization of definitions and regulatory methods.

• The capital requirements are not intended to be increased due to the revised documents.

• Reconciliation of time schedule and implementation plan with the regulatory authorities.

Story-line

• EBA evolves regulatory requirements for the main aspects of risk models based on the CRR.

• EBA is intended to publish 17 standards and 10 guidelines regarding internal models.

Revised regulatoryrequirements

• EBA is responsible for a yearly benchmarking exercise on internal models.

• If there are significant deviations from peer-group banks and in case of a risk underestimation, corrective actions will be defined.

Benchmarking exercise

• The EBA is about to increase the transparency regarding internal models and their results.

• The EBA acts in three categories: Benchmarking, Disclosure and Supervisory reporting.

Increased transparency

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Future of IRBADetails in discussion

• Materiality limit of 90 days delinquency

• More precise definition of unlikeliness to pay

• Specification of recovery

• Lack of concrete rules for LGD models

• Clarification of EL and its connection to accounting risk provision (i.e. IFRS 9 Impairment)

• Level of conservatism (incl. downturn component)

• Outstanding concerns:definition ‘long-term average’ and ‘cycle’, calculation of default rate and LGD calculation

• Collateral to mitigate credit risk in the Foundation-IRB (F-IRB)

• Definition of Low default portfolios (LDP): quantitative/qualitative criteria

• Data pooling to deal with lack of data

• Use of floors for PD & LGD

• Discrepancies between EU and Non-EU regulators

• Parameter floors, concept of significant credit risk increase (IFRS 9) and pillar 1+ (concentration risk)

• Increase of adaptability ofroll-out-plans

• Five years as the roll-out period

Parameterestimation

Treatmentof defaults

Lowdefault

portfolio

IRBAapplication

Other

Credit riskreduction

Defaultdefinition

8 hot topics

Internalrisk

manage-ment • Impact due to independence of validation

function

• Stresstesting can have extensive consequences for capital requirements

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Concern regarding the quality of internal modelsBCBS 362: The committee´s response

Main contents Next steps

• Consultation ran until 24 June 2016

• QIS has been conducted in 2016 to test the feasibility and sensitivity of proposed changes

• BCBS wants to finalisethe changes until the end of 2016

• Reduction of complexity and increase of comparability

• Reduction of excessive variability of capital requirements

Focus

Floors for model parameter

Implementation of Floors for PD/LGD/EAD in order to ensure a minimum of conservatism for portfolios for which IRB approaches remain allowed

2

Scope of internal models

1

No future use of F-IRB and A-IRB approaches for specific portfolios, if model parameters are not estimated reliably or if modeling requirements not fulfilled

More specifications for parameter estimation methods and treatment of collateral are provided in order to reduce the RWA variability for portfolios for which IRB approaches remain allowed

Methods of parameter estimation

3

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BCBS 362 Prohibition of IRBA for corporations, institutions and SPVs

• IRBA not allowed for (i) banks and other financial institutions, (ii) large corporations (total assets >50bn euro) and (iii) equity instruments

• A-IRB (with estimation of LGD und CCF) not allowed for corporations with revenues >200m euro

• For specialised lending only the standardised approach (SA) or the Supervisory Slotting Criteria Approach (SSCA) are permitted

• So far no changes for exposures to sovereigns, but a prohibition of IRBA is considered

BCBS proposal concerning application area

Corporation Rating RW

A-IRB

RW SA

Bosch AA- 11% 20%

Siemens A+ 14% 50%

BASF A 18% 50%

Daimler A- 23% 50%

Deutsche

Telekom

BBB+ 29% 100%

RWE BBB 35% 100%

Ø Risk weights 22% 62%

SPV Rating RW

IRB

RW

SSCA

RW SA

Renewable

Energies

A- 25% 70% 100%

Ship

financing

CCC 248% 250% 100%

Project

financing

B 151% 115% 150%

Real estate

financing

BB+ 54% 90% 120%

Ø Risk weights 120% 131% 118%

Institutions Rating RW A-

IRB

RW SA

DZ-Bank AA- 17% 20%

MünchenerHyp AA- 17% 20%

DekaBank A 28% 50%

Hypo Real

Estate

A- 35% 50%

Commerzbank BBB+ 44% 50%

HSH Nordbank Baa3 65% 50 %

Ø Risk weights 34% 40%

The partial prohibition of the IRB approach might lead to an increase of RWA by a factor of 2 – 3 for large corporations and to an increase by 20-80% for receivables from banks and shows reverse effects on specialised lending

Expected impact shown in Examples

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BCBS 362A proposed use of Floors for PD, LGD and CCF in the remaining IRBA portfolios

PD LGD EAD/CCF

unsecured secured

Corporates 5bps 25% 0% Financial coll.

15% Receivables

15% CRE/RRE

20% other

collateral

EAD as sum of

I. Balance sheet

exposure and

II. 50% of off

balance sheet

exposures after

use of SA-CCF

Retail

Real estate 5bps – 10%

Credit cards

-balanced-

5bps 50% –

Credit cards

-revolving-

10bps 50% –

Other retail

business

5bps 30% See corporates

1 The Basel committee is cognizant of the fact that a floor based on an unproportionate high calibration could lead to an incentive for risky activities. Therefore it retrieves alternative floor values from QIS 2016

Expected Impact

• Increase of capital requirements where floors for LGD (secured and unsecured) and CCF are applied

• Revision of segmentation criterions for LGD and CCF in order to minimise the effects of new lower bounds

BCBS proposal for parameter floors1

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BCBS 362 Other changes

BCBS proposal for the amendment of risk parameters estimation

• Specifications in order to ensure the consistency between the European institutions (e.g. TTC PD, using the economic downturn data for the calibration)

PD

Expected Impact

• LGD modeling framework adjustments in order to integrate regulatory Floors and possible lower limits for the Downturn-Add-on

• Revision of the scope of application for internal CCF estimates that will be used for a wider range of tasks

• Changes in credit risk mitigation policies, practices and types of eligible collateral

• Review of the product/hedging strategies

• Increasing the haircuts up to 50% for the trade receivables, CRE/RRE and other physical collateral with respect to the F-IRB approach

• No minimum LGD values for the secured claims in the F-IRB approach

• Separate Downturn-Add-on with possible Floor in the A-IRB approach

LGD

• Banks using the F-IRB approach should rely on CCFs specified in SA

• The estimation of CCFs models for non-revolving commitments with the help of internal models according to the A-IRB approach will no longer be allowed

CCF

• The determination of the period in the A-IRB approach is based on the legal maturity date (not using the redemption date)

M

• Conditional guaranties are not allowed in the A-IRB approach

• Internal estimations of haircuts are not allowed in the F-IRB approach

• In the F-IRB approach only complete substitution approach (guarantors PDs) for the recognition of guarantees and credit derivatives is permitted

CRM

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Target Review of Internal Models (TRIM)Anticipation of the announced changes The ECB has identified

2.400 models!

• The lack of trust in using internal models for regulatory purposes:

- High complexity embedded in the IRB framework (CRD/CRR)

- Regulatory arbitrage (to achieve lower capital requirements)

- Divergent supervisory practices and interpretations in Europe

• The integration of international regulatory developments in order to be in line with future changes

• A connection mechanism for the IRBA-Model Inventory 2015

• Special preparations based on the experience from regulatory supervision

• Integration of the TRIM-related activities (SREP/SSM)

• Restoring the credibility, adequacy and appropriateness by:

- Ensuring the compliance with regulatory requirements and alignment of supervisory practices

- Publication of the regulatory policies and the development of corrective measures

- Improving the work of supervision

Motivation Objectives Key to success

Scope and Schedule

Special focus on credit, market and counterparty risk models

2016 – Review of the methodological alignment 2017 – IT und Data Quality Review

Providing data requirements

Preparation of the regulatory audit

Anticipation of the model approval requests in 2017

Determination of the internal project organisation and resource availability for the TRIM data requirements and for the regulatory audit

Local IT – and Data-Quality-Reviews of approved models

Supervisory onsite examination focused on specific model reviews (2017 und 2018)

Demand for suitable resources for conducting onsite activities incl. modeling experts

Logistic requirements for the onsite teams

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Market risk

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Background and motivationThe new market risk requirements at a glance

Share of instruments designated to banking book over all instruments (TB+BB)

22%

10%

56%

21%16%

0%

10%

20%

30%

40%

50%

60%

Accountingtrading

asset/liability

Marketmakingactivity

Equityinvestment

fund

Listed equity Options

Material weaknesses of current approaches…

Trading book – banking book boundary

Treatment of credit risk in the trading book

Weaknesses of VaR approach

Liquidity of trading book positions

Transparency and comparability of RWA

Hedging and diversification

Total sample: 14 banks; BCBS QIS with reporting date 31.12.2014 and rules based on discussion papers of Oct., 2013 and Dec., 2014 (d346, Nov. 2015)

… require fundamental review

• Banking book/trading book boundary to be more objective

• Additional tools for supervision

• New Standardised approach increases risk sensitivity of RWA calculation

• Marked increase of complexity

• Internal Model Method using ES instead of VaR

• Changes to model approval process

• Floor based on standardised method

2 31

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Portfolio rearrangement according to Basel IVTransaction type and holding purposes in detail

Final paper

Why having a trading book?

• Short-term resale

• Profiting from short-term price movements

• Locking in arbitrage earnings

• Hedging risk that arise from instruments above

• Correlation trading portfolio

• Trading desk (fixed definition)

• Giving rise to a net short credit or equity position in the banking book

MandatoryTrading book instruments

Instruments, which do not requirea trading book treatment

• Accounting trading asset or liability

• Market making activities

• Equity investment (fund) with look-through

• Listed equity

• Options (incl. bifurcated derivatives)

• Unlisted equity

• Positions designated for securitisation („warehousing“)

• Real estate holdings

• retail credits and corporate SME credits

• Funds (no daily look-through possible)

• Derivatives (instruments above)

Banking book instruments

!

Consultation phase

General mapping criteria

• Purpose of a short-term resale

• Earnings from short-term price movements

• Locking in arbitrage earnings

• Hedging of other trading book positions

Particular mapping criterion of the banking book

• Unlisted equity instruments

• Positions designated for securitisation (‘warehousing’)

• Real estate

• Funds with no look-through

• Derivatives (instruments above)

Particular mapping criterion of the trading book

• Accounting trading asset or liability

• Market making and underwriting activities

• Listed equity

• Funds with look-through

• Naked short positions

• Options

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Sensitivities-based approachDefinition of the main concepts (1/3)

• Definition of 7 risk classes for the sensitivities-based approach:Risk class

• Variables (e.g. a given vertex of a given interest rate curve or an equity price) within a pricing function decomposed from trading book instruments

• Risk factors are mapped to a risk class

Risk factor

• Main input that enters the risk charge computation

• Delta and vega risks: sensitivity to a risk factor

• Curvature risk: worst loss of two stress scenarios

Risk position

• Set of risk positions which are grouped together by common characteristicsBucket

• Amount of capital that a bank should hold as a consequence of the risks it takes

• Computed as an aggregation of risk positions first at the bucket level, and then across buckets within a risk class defined for the sensitivities-based approach

Risk charge

GIRR

Equity

Credit spread (non-SEC)

Commodity

CS (SEC) and CS (CTP)

FX

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Sensitivities-based approach

Assign instruments to risk classes and risk factors

1Risk position: Compute sensitivities to risk factors

2Weight net sensitivity by risk weights per bucket

3Risk charge I: Aggregate capital charges within each bucket

4Risk charge II: Aggregate capital charge across buckets within each asset class

5

• Delta: A risk measure based on sensitivities of a bank’s trading book to regulatory delta risk factors.

• Vega: A risk measure that is also based on sensitivities to regulatory vega risk factors to be used as inputs

• A risk measure which captures the incremental risk not captured by the delta risk of price changes in the value of an option.

• A risk measure that captures the jump-to-default risk in three independent capital charge computations

• A risk measure to ensure sufficient coverage of market risks

Delta Risk

Options only

Vega Risk Curvature Risk Default RiskResidual Risk

Add-on

Non-linear riskLinear risk

• Calculation of three risk charge figures, based on three different scenarios on the specified values for the correlation parameter

• The bank must determine each delta and vega sensitivity and curvature scenario based on instrument prices or pricing models that an independent risk control unit within a bank uses

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Default Risk

Residual Risk Add-On

General information

• Aim of the add-on is to cover complex and exotic instruments within the sensitivity-based approach in a simplified and conservative way

• The complexity of the approach is not indented be to increased

Calculation methodology and risk weights

• Simple sum of gross notional amounts of the instruments bearing residual risks multiplied with a regulatory multiplier

• RW = 1.0% for instruments with an exotic underlying (e.g. longevity risk, weather or natural disasters)

• RW = 0.1% for instruments bearing other residual risks

Compute the jump-to-default risk of each instrument separately

Application of offsetting rules, which enables the derivation of “net jump-to-default” (net JTD) risk positions

Risk weighting of the positions

• Computation of the so called jump-to-default risk (default risk)

• Calculation of the capital requirements for the default risk considering hedging effects

1

2

3

2

3

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IMA – New risk measureFrom VaR to Expected Shortfall

• Does not consider tail risks

• Can lead to unwanted incentives for trading desks • Does depend on the full distribution of tail losses.

Value-at-Risk Expected shortfall

• Need to have representative transactions in relevant products with a history of “real” prices

• Capital IMMC(𝐶𝑖) for a single desk calculated with the same ES model as the trading book wide capital IMMC(C). Aggregated as IMMC = 0.5 IMMC C +0.5 𝑖 IMMC 𝐶𝑖

Modellable

• Relevant products very illiquid (less than 24 observations/year or gaps > 1 month)

• Prudent stress scenario must be used

• No diversification may be assumed

• Liquidity horizon required to be smaller than gaps between observed prices

Non-modellable

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PwC

Calibration to stressed market conditionsProxy-based solution to data problem (1/3)

• Ad-hoc treatment of stressed market condition by an additional SVaR term

• At least yearly updates of stressed period

• Double-counting (same scenarios in VaR and SVaR) problematic

• Single calculation ‘calibrated to a period of significant financial stress’

• Stressed period updated at least every month

• Data since 2007 required

Basel III IMA-Trading book

Calculate stressed ES

Identify important risk factors

Scale by the full current

ES

• Find the 12 month period for which the ES calculated with the reduced set of risk factors is the largest. ES𝑅,𝑆

• Use the same set of risk factors with the current 12 month period. ES𝑅,𝐶

• Reduced set of risk factors must explain at least 75% of P&L.

• Full historical data (10Y) must be available.

• Reduced set subject to approval by regulator.

• Calculate ES with all risk factors for the current 12 month periods. ES𝐹,𝐶

• Combine these numbers to the regulatory expected shortfall.

ES = ES𝑅,𝑆 ×ES𝐹,𝐶

ES𝑅,𝐶

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Different liquidity horizonsIlliquid products become very expensive (2/3)

Risk factor categories (selection)

Liquidity horizons

Interest rate (major ccys) 10

Equity vol. 20

Interest rate vol. 40

Credit spread – high yield 60

Credit spread – structured 120

Calculation

4. Add the scaled ES

(see formula).

1. Calculate 10-day ES

with all risk factors .

2. Calculate 10-day ES with risk

factors based on 𝑛 ≥ 20.

3. Scale the result with

the 𝑇-rule.

5. Repeat from2. with

𝑛 ≥ 40, 60, 120.

ES = ES(𝑄)2 + 𝑗≥2

(ES(𝑄𝑗) (𝑛𝑗 − 𝑛𝑗−1)/10

2

ES Q : 10-day ES with all risk factors

ES 𝑄𝑗 : 10-day ES with risk factors with liquidity horizons larger than 𝑛𝑗

𝑛𝑗: j-th largest liquidity horizon

Holding Period in ES Calculation

• In the Basel III framework, a 10-day VaR was used for the entire trading book portfolio.

• In FRTB, there are various holding periods (also called ‘liquidity horizons’

• Doubling the liquidity horizon increases the capital requirement by roughly 40%.

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Model approval process The approval process contains further uncertainty (3/3)

Is an unambiguously defined group of traders or trading accounts reportingto a head trader.

Definition of Trading Desks

Evaluation of model on trading desk level

If the desk is not approved, the SA must be used

Th

ree

crit

erio

ns

Has a well defined business strategy including a list of allowed activities.

Has a clear risk management structure. Provides P&L-reports at least weakly.

Tra

din

g d

esk

s p

rop

ose

d b

y

inst

itu

tio

n

Mu

st b

e a

pp

rov

ed b

y

sup

erv

iso

rs

Back testing performed for1-day VaR at 97,5% and 99% quantile

P&L attribution: Comparison of the risk P&L with the actual and hypothetical P&L

More than 30 (97,5%) and 12 (99%) violations

Unexplained P&L > 10% or ratio of variance > 20%

• The new model approval rules lead to significant amount of new work to be done.

• Model approval process requires a wide range of skills.

- Regulatory

- Quant

- IT

- Processes

• Impact studies are required to assess for which desks to seek model approval and for which to use the standardized approach.

1

2

3

1

2

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PwC

Conclusion final FRTB frameworkThe implementation of FRTB is a comprehensive project

The final FRTB framework will have a huge impact on financial institutions

Not only higher capital charges are expected, but also adjustments of the IT-infrastructure in order to ensure the reporting quality.

Extensive challenges especially for small institutions

The new criteria could have various impacts depending on the business model and size of the institution. Small institutions might find that they have a trading desk according to the new definition.

Distinction of standardized and internal models

A straight ‘distinction’ between the standardized approach and the internal model gets lost, because the required sensitivities are calculated based on mathematical valuation methods, which are currently prescribed in internal models by the supervisors.

Challenges in terms of risk control and capital allocation

Challenges for the risk control especially due to new liquidity horizons for portfolios with less liquid positions and increased requirements in back-testing and model validation.

Position management and adjustment of trading strategy

Necessity of an early impact analysis to examine the effects of the revised trading book definition and to make strategic decisions in the field of rededications.

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Additional risk types

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The new standardized approach for calculating counterparty credit risk (SA-CCR)

Calculation of EAD using SA-CCR𝐸𝐴𝐷𝑆𝐴−𝐶𝐶𝑅 = alpha x (RC + Multiplier x AddOn)

The aim of the SA-CCR is to provide an approach,

Which can be used for various types of derivatives (secured/unsecured + bilateral/cleared)1

Which is suitable for a simple and reliable implementation2

Which accounts for the well known shortcomings of the CEM and SM 3

Which draws on approaches already known in the Basel framework4

Which minimizes the discretion of national supervisors and banks5

Which improves the risk sensitivity of the calculations without generating additional complexity6

The introduction of SA-CCR replaces CEM and SM!!!

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PwC

SA-CCR in detail

Alpha

Replacement cost

Multiplier

AddOn

PF

E

• Alpha = 1,4

• Supervisory factor

• Analogue IMM

• Current replacement costs

• Calculation depends on secured/unsecured transactions

• Considering parameters of collateral agreements for secured transactions

• Accounts for over-collateralization and negative mark to market values

• Reduces add-on in these cases

𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = 𝑀𝐼𝑁 1; 𝐹𝑙𝑜𝑜𝑟 + 1 − 𝐹𝑙𝑜𝑜𝑟 × 𝑒𝑥𝑝𝑉 − 𝐶

2 × 1 − 𝐹𝑙𝑜𝑜𝑟 × 𝐴𝑑𝑑𝑂𝑛𝑎𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒

• Potential future increase of current exposure

• Depends on volatility of the underlying

No collateralRC = MAX [V – C; 0]

collateralRC = MAX [V – C; TH + MTA – NICA; 0]

Calculation of EAD using SA-CCR𝐸𝐴𝐷𝑆𝐴−𝐶𝐶𝑅 = alpha x (RC + Multiplier x AddOn)

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The data requirements of SA-CCR cause in significant challenges

• Mapping of positions to netting sets and collateral required

• Indication of the so-called "Margin Period of Risk" necessary

• Distinction of transactions with cash and physical settlement

• Data requirements for basis swaps (reference rate)

• Query of notional values for derivatives with varying denominations

• Ratings for reference obligations of (basket) credit derivatives

• Strike price of options and market value of underlying assets required

• Exercise date of Bermuda options required

• ….

SA-CCRChallenges and implications

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0 - 100% 100 -200%

200 -300%

300 -400%

400 -500%

500 -600%

> 600%

Changes of EAD by SA-CCR1

1Real portfolio of >5.000 derivative positions

• EAD change from CEM to SA-CCR in % of EAD using CEM

• partly disproportionate increase of RWA

• key drivers of EAD increase under SA-CCR: non-existing netting agreements and a lack in data availability

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Objectives of the revised CVA risk capital charge framework

Consideration of exposure component in the CVA exposure component is an important driver of the CVA

Alignment to accounting best practices in connection with the accounting CVA Development of ‘Best Practices’ for the determination of the accounting CVA (IFRS 13)

Alignment to Trading Book Review market risks determine the amount of derivative exposure (consideration in regulatory market risk)

Background of the revised CVA risk capital charge framework

Components of the revised CVA risk capital charge framework

FRTB-CVA framework Basic CVA (BA-CVA) framework

IMMBalance

sheetIMM

Balance sheet

IMM SA-CCR

Assessment base

IMA-CVA SA-CVA BA-CVA

Named after FRTB toreflect consistency

Deleted after consultation

1

2

3

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PwC

The new basic CVA approach is an improved version of the current standardized approach

The capital requirement (𝑲) of the new basic CVA approach (BA CVA) is composed of a component for the counterparty credit spread risk (𝑲_𝒔𝒑𝒓𝒆𝒂𝒅) and a second component for the exposure risk (𝑲_𝑬𝑬). Only single-name, single-name contingent and index CDS are allowed as hedges for counterparty credit spread component.

Capital requirement of BA-CVA: 𝐊 = 𝐊𝐬𝐩𝐫𝐞𝐚𝐝 + 𝐊𝐄𝐄

• No hedge for CVA-Risk:

𝑲𝒔𝒑𝒓𝒆𝒂𝒅𝒖𝒏𝒉𝒆𝒅𝒈𝒆𝒅

= 𝝆 𝒄𝑺𝒄

𝟐

+ 𝟏 − 𝝆𝟐 𝒄𝑺𝒄𝟐

• With single-name or index CDS as hedge:

𝑲𝒔𝒑𝒓𝒆𝒂𝒅 = 𝝆 𝒄

𝑺𝒄 − 𝒊𝑺𝒊𝒊𝒏𝒅

𝟐

+ 𝟏 − 𝝆𝟐 𝒄

𝑺𝒄𝟐 +

𝒄

𝒉∈𝒄𝟏 − 𝒓𝒉𝒄

𝟐 𝑺𝒉𝑺𝑵 𝟐

;

𝑺𝒄 ≔ 𝑺𝒄 − 𝒉∈𝒄

𝒓𝒉𝒄𝑺𝒉𝑺𝑵

• 𝑲𝑬𝑬 calculates by a scaling of

𝑲𝒔𝒑𝒓𝒆𝒂𝒅𝒖𝒏𝒉𝒆𝒅𝒈𝒆𝒅

with 𝜷:

𝑲𝑬𝑬 = 𝜷 𝝆 𝒄𝑺𝒄

𝟐

+ 𝟏 − 𝝆𝟐 𝒄𝑺𝒄𝟐

• Without hedges, especially the regulatory ES for CVA (𝑺𝒄) ) and the regulatory correlation (𝝆) are relevant, analogous to 𝑲𝑬𝑬

• 𝑺𝒊𝒊𝒏𝒅 and 𝑺𝒉

𝑺𝑵 designate the regulatory ES for the price of the index Hedge 𝒊 or from

single-name Hedge 𝒉

• 𝒓𝒉𝒄 is the regulatory correlation between the credit spreads of counterparty 𝒄 and single-name hedge 𝒉. Depending on the type of single-name hedges, 𝒓𝒉𝒄 is either 50%, 80% or 100%

• 𝑺𝒄 designates the regulatory ES for CVA for counterparty c

• 𝝆 is the regulatory correlation between the counterparty credit spread and the systematic factor

• 𝜷 denotes the variability EE multiplier, it is: 𝜷 = 𝟎. 𝟓

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Revised securitization framework

Implementation:

• New hierarchy for the application of the calculation methods

• Introduction of new calculation approaches

• Introduction of a risk-weight floor of 10% for all calculation approaches

• Considering multiple risk drivers

• One rating will be sufficient

• For re-securitizations still only the standard approach is allowed

• No consideration of granularity when using external ratings

Reduction of mechanistic reliance on external ratings1

Strengthening of risk sensitivity2

Reduction of cliff effects3

Higher risk weights for higher rated senior tranches4

Decreased risk weights for lower rated senior tranches5

Aim:

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PwC

New calculation methods and requirements for STS securitizations

Assessment approaches for the determination of risk weights

SEC-Internal Ratings Based Approach

SEC-Standardized Approach

SEC-External Ratings Based Approach

Simple, transparent, standardized securitizations

Simplicity

Standardisation

Transparency

• Legal enforceability of the sale of positions

• No further encumbrance

• Defined recognition criteria

• No portfolio management

• …

• Risk retention

• Reduction of interest and currency risks

• Market rates

• …

• Investor access to information about the historical, static and dynamic performance with respect to defaults and losses

• …

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PwC

Standardized Measurement Approach (SMA)Uniform calculation approach for OpRisk

Calculation approach for operational risk: SMA

Basic calculation methodology of SMA

• Combining the previous standard approaches (BIA and STA)

• Revision of the weaknesses identified by a newly developed calculation method

• Abolition of the AMA due to the inherent complexity of the measurement approach and a lack of comparability

• QIS in 2016 to ensure a stable capital requirements for operational risks

• The greatest impact on the capital requirements are expected for those banks currently using the AMA

• The SMA is based on the fundamental principle of the business indicator (BI) in combination with bank-specific internal loss data

• Calculation of capital requirement by bucket separation

• depending on the level of the BI/Buckets, internal loss data is taken into account when calculating the capital requirement

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PwC

Standardized Measurement Approach (SMA)Calculation of business indicator

Services component

• Introducing a uBI parameter (adjusted business indicator)

• Addressing the problem of an improper calculation of risk for banks with a provision focused business model

Business indicator

Financial component

• Considering the absolute net result of trading and banking book

Interest-, operating lease- and dividend component

• Criticism that banks with a high net interest margin must hold relatively high capital requirements

• Considering interest-bearing assets in the calculation

Capital Requirement acc. SMA

The capital requirement acc. SMA for pillar 1 is always binding, regardless of whether the OpRisk value is smaller in Pillar 2, equal to or greater.

Bucket 1

Bucket 2 – 5

• The capital requirement equals the BI multiplied by a factor

• Smaller banks (BI up to €1 billion) don‘t have to evaluate loss data for the time being

• Capital requirements result from the multiplication of the BI component with a multiplier of internal losses (MIV)

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Step-in risk

BanksEntities out of the scope of regulatory/accounting

consolidationShadow banks/Non-Bank-Financials

Beyond or in the absence of any contractual obligations Step-in risk

Contractual obligations/Legally binding businesses RWA

Pr

ima

ry

ind

ica

tor Upfront

facilitiesDecision making

Majority Only provider of facilities

1 full

2 partial Or

3 partial

4 partial Or

5 partial

6 none

Pr

ima

ry

in

dic

ato

r Capital ties Influence on Management

7 >50%

Or none But dominant

8 >20% and <50% But significant

9 <20% But significant

10 credit rating based on a bank's own rating

11 Exclusive critical services provider

Mapping of primary indicators with measurement approaches

Full consolidation approach

Primary indicators 1, 2, 7 and 10

Full consolidation or conversion approach

Primary indicators 3, 4, 5 and 6

Conversion approach

Primary indicators 8, 9 and 11

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PwC

Leverage ratio

Cash Pooling

Disclosure of gross amounts in ‘Notional Cash Pooling’, disclosure of net amounts in ‘Physical Cash Pooling’.

Securities financing transactions (SFTs)

An account of ‘Open repos’ is not allowed. Cash assets and liabilities with the same counterparty may be netted.

Impairment

Balance sheet non-derivative exposure can be further reduced by general credit risk adjustments.

Derivatives

Introduction of a modified version of theSA-CCR and additional requirements on the treatment of written credit derivatives.

Securitization

The two possible interpretations are based on an exclusion or an account in the overall measure of risk.

Financial assets

Two different treatments of standard market purchases and sales of financial assets are possible, if it is accounted for on the settlement date or trade date either.

Credit conversion factors (CCFs)

In the future the CCFs for off-balance sheet positions will correspond to those of the revised credit risk standardized approach.

Impairment SFTs

Securiti-sation

CCFs

Financialassets

DerivativesCash

pooling

Leverageratio

Disclosure

Disclosure

The requirements are published separately.

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IT and data availability

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PwC

Data, their availability, readability, quality and flexibility will become more and more important

AnaCredit, BCBS 239, SREP and the current disclosure requirements underline the importance of data in the reporting of Institutions

Expected impact

• Tendency of European supervision

- Calls for granular data

- Judges and rates data quality

→ Quantitative supervision

• Increase in stress tests and ad hoc queries

Internal drivers

• Control relevance of reporting data

- Capital planning

- Convergence Pillar 1 & 2

- Impact analysis/portfolio management

• Convergence of financial, risk and regulatory reporting function

101001001010

010010010011

010011 11 1

00010 00 1

10011 11 1

10 00 01 0

11 1 1

0 0 1

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PwC

Regulatory tools can be used for various applications

Even if the data is available in a high degree of maturity, the right tools are essential for many applications

Ongoing business Ad Hoc Strategic

Impact analysis/capital planning

Plausibility checks(e.g. FINREP/COREP)

Trading & Treasury impact analysis

Automated disclosure

Backup/measuring data quality

Support of stress tests

QIS support

Advanced analytics

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The reporting software leads the threads together

The reporting software must meet a variety of challenges and must be embedded within the Bank’s overall architecture

Data collection/-harmonization

Central location for all reporting-relevant data, harmonized across different source systems.

Integrated data base

• Base for calculations and analysis

• Central starting place for tools and quality assurance

Back channel for communication with the supervisory…

…and thus more than just a data warehouse

Standardization

Reduction of customized solutions for regulatory reporting in order to optimize costs and response times due to regulatory changes.

Delivery Models

• Buy vs.

• Rent vs.

• SaaS

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We therefore recommend an integrated project approach,…

…that combines the technical analysis directly with the viewing of data, tools and future reporting software.

• Use of synergies in the implementation of data quality and data governance

• Integration of Pillar 1 & 2

• Preparation for the regulatory requirements resp. granularity and quality

Integration in data-related projects (as BCBS 239)

• Early preparation and analysis of the impact of new regulatory requirements

• Derivation of strategic decisions (for example, in portfolio management)

• Speeding up implementation of projects

Use of tools for preliminary analysis

• Use of reporting data for controlling

• Increasing the consistency of data between Accounting and Risk

• Long-term planning for the further development of the overall architecture

Consideration of risk and financial architecture

• Identification of the individual requirements of the regulatory reporting

• Comparison of existing market solutions, incorporating best practices

• Qualified make-or-buy decision

Software selection and preliminary studies

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Interest rate risk in the banking book

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PwC

Interest Rate Risk in the Banking Book (IRRBB)History of the revisions

Financial and economic crisis

BaFin RS 11/2011 (BA) – ZÄR imAnlagebuch

EBA Guideline (GL/2015/08) IRRBB

VeröffentlichungBCBS 368 Standard zuIRRBBEntry into

force SREP (Supervision)

• Amendment due to the changes in the markets (financial crisis) and the supervision (SREP).

• Currently no comparability between banks possible. Therefore requirements for identifying, measuring, monitoring and controlling IRRBB were developed.

Sept. 2008 9th November 2011 April 28th 201622nd May 2015 January 1st 2016

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EBA Guideline 2015/08*Significant effects for banks

• Examination of the components of IRRBB

• Implementation of static and dynamic scenarios

• Both P&L-related (NII) and present value (EV) related measures

• Conservative regimes relating to the assumptions regarding customer behavior, exercise of options, dealing with interest-free positions (reserves/own funds)

• Expansion of the documentation and validation requirements

• Consideration and ensure consistency of strategy, risk appetite and business activities of the institution

• Impact on the risk-bearing capacity (ICAAP) through provision of internal capital and considering the quality of capital

Impact

Measurement/systems

Assumptions/policies

Risk-bearing capacity/capital

* Valid since 01 January 2016; BaFin has notified to the EBA "comply", thus implementing the requirements

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BCBS 368*Significant effects for banks

* Initially addressing to international banks/implementation deadline 2018th

Detail compared to the EBA Guideline low, but additional requirements are included:

Implementation of a validation framework and model risk management: Review of the validity of the concept, ongoing model monitoring, performance analysis (backtesting of internal parameters, eg stability of deposits).

Disclosure under a standardized format(Qualitative and quantitative information).

Detailed requirements for dealing with the establishment of modelingassumptions for the following products: Fixed rate loans with early repayment risk, loan commitments, non-maturity deposits, redemption of term deposits (mitigation compared with consultation paper).

Impact

Reporting

Risk-bearing capacity/capi-tal

Validation

Principle 10-12 requirements for supervision: Threshold for identifying "outlier" banks will be reduced from 20% to 15%; Increased supervision and capital requirements if necessary

Assumptions/policies

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Outlook

• Uncertainty regarding the risk profile score – is determined individually – no uniform standard

• Impact on the risk-bearing capacity of banks

• Expected increased demands for "outlier" banks

EBA/GL/2015/08

BaFin RS2nd half of 2016

BCBS 368

• Capital charges via SREP capital fixing for institutions that are considered still in 2016

• For the remaining institutions the general decree of BaFin(publication expected 2nd half 2016) will apply –"transitional" to the SREP capital fixing

Fixing of the capital requirement based on the Basel interest rate shock + individual qualitative risk

profile score (amongst others review of the quality of risk management)

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ECB Supervision

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PwC

One and a half year of SSM: Key lessons learnedMore intensive, intrusive and demanding supervision

Regulation across the EU remains diverse and fragmented, meaning more harmonization is needed in many areas

Banks are genuinely trying to adapt the new regime

Costs of compliance have emerged as a further concern for banks

The SSM continues to face very high expectations

Setting up the SSM has been a significant achievement

The prospect of increased regulation, supervision and costs under the SSM has

prompted a legal challenge

SSM touches behavior and culture through governance and risk

appetite review

Ongoing work on business models and profitability

drivers needed

Banks are concerned in regard to the new regime’s clarity,

transparency and governance

No single interpretation of CRD IV and CRR regulations, given national options

and discretions

The first one and a half year of SSM:

lessons learned

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PwC

Priorities of the ECB for 2016 and 2017

Business model analyses

Internal Governance (RIGA)

Guidelines on risk appetite

ICAAP and Stress Testing

Data Quality, Governance and Reporting

TRIM AnaCreditBCBS 239

Non-performing Loans

IFRS 9ILAAPAQR2.0

Options and discretions(O&Ds)

Cyber Security & Resilience

Operational and Conduct Risk

SREP for LSIs

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Options and discretionsECB Regulation (EU) 2016/445

The CRR contains numerous discretions which may be exercised by the competent authority

As the competent authority of SSM banks the ECB is responsible for the exercise of these discretions

Own funds

Own funds requirements

Large exposures

Liquidity

Transitional arrangements

1

2

3

4

5

• Treatment of qualifying holdings outside the financial sector

• Default definition: 90 days past due

• Preferential treatment of i.e. covered bonds, holdings

• Level 2B liquid assets, outflows from trade finance

• Transitional adjustments for unrealized gains and losses, pension obligations, insurance companies, and others

The ECB requirements are partially contrary to the national implementation in the member states

Entry into force: in principle October 1, 2016; definition of default from December 31, 2016; Determination for the outflows from stable retail deposits from January 1, 2019

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More regulatory changes at a glance

LCR andALMM

Prudent Valuation

Shadow Banking

MREL + TLAC

AnaCredit

• Publication of the LCR Reporting Templates (D-VO 2016/322); valid from the reporting date 30.09.2016; Deadline of 30 calendar days for the first 6 reporting dates

• Publication of ALMM reporting templates (D-VO 2016/313); valid from the reporting date 30.04.2016; extended deadline analog LCR; no reporting of reporting template C66

• January 2016: Final RTS to account for uncertainties in all fair value positions by calculating AVAs published in OJEU

• Start of the consultation on the significant expansion of the corresponding CoRep reporting obligations (esp. breakdown enhancement when using core approach)

• EBA guidelines (EBA/GL/2015/20) to limit exposures to shadow banks

• Target: limiting the activities of the financial sector with shadow banking companies

• Institute specific individual/overall limits; Internal management/monitoring processes

• Target: framework to ensure the resolvability of all banks

• Central mechanism: direct participation of investors in losses in the event of a bank resolution (‘bail-in’)

• Introduction of minimum rates & ongoing reporting and disclosure requirements from 2016

• Granular central credit registry of the ECB and the national central banks from 2018

• Credit institutions incl. worldwide branches report on individual transaction level 95 attributes for loans, certain (capitalized) deposits and reverse repurchase agreements with legal entities from a commitment of EUR 25,000 per customer

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IFRS 9

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IFRS 9 – Classification and measurement

Business model ‘hold to collect’?

Solely payments of principal and interest?

Fair value option applied?

Amortised cost

FVPLFVOCI

(with recycling)FVOCI

(no recycling)

Business model ‘hold & sell’?

YesNo

Yes

Yes

No Yes

Yes

Yes

No

No

NoTrading?

FVOCI 0ption applied?

No

No

Yes

Caption: SPPI = Solely Payments of Principal & Interest

FVOCI = Fair Value through Other Comprehensive Income

FVPL = Fair Value through Profit & Loss

Debt instruments DerivativesEquity

instruments

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General model: The three stages – Decision tree

Absolute credit quality Does the financial asset meet the definition of ‘low credit risk’ at the reporting date?

Credit-impaired

Does the financial asset meet the credit-impaired definition (same definition as in IAS 39)?

Performing

12-Months-EL (interest revenue on gross basis)

Significant increase of credit risk

EL over Lifetime (interest revenue on gross basis)

Credit-impaired

EL over Lifetime (interest revenue on net basis)

1 2 3

No

Yes

Yes

Relative credit quality

Has the credit risk increased significantly since initial recognition?

Assessment based on payment status:

If more than 30 days overdue yes (rebuttable presumption)

No

No Yes

Change in credit quality since initial recognition

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Significant effects at a glance

• Differences between CR-SA and IRBA

- CR-SA: impairments have to be considered in the exposure value

- IRBA: Comparison of impairments with Expected Loss (EL)

• IAS 39 value as assessment base under static consideration of changes

• Elimination of AFS category under IFRS 9

• Financial assets of category FVOCI are not subject to requirements of prudential filters

• Impact on operational requirements of Art. 417 CRR due to the business model, ‘Hold’ under IFRS 9

• Changes in FINREP templates due to IFRS 9 → final version of the template depends on the IFRS 9 endorsement

• IFRS 9 may lead to different classification of assets compared to IAS 39

- Previously measured at fair value; can possibly be valued at cost and vice versa → this leads to new assets subject to Prudent valuation

Treatment of loan loss provisions and expected losses

Prudential filters

Prudent valuation

Liquidity buffer

FINREP

Treatment at implementation date

• Changes in the assessment base (book value) IFRS 9 for RWA, the leverage ratio, large exposure and own funds (deductions)

Market risk • New classification criteria, limiting the possibility of switching positions between banking and trading book for reasons of regulatory arbitrage

Definition of default • Regulatory requirements for the determination of past due must be procedurally included in the guideline.

0

1

2

3

4

5

6

7

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Disclosure

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Overview of disclosure requirements of phase I (BCBS 309) und phase II (BCBS 356)

Text

BCBS 356 (phase II)

+ Regulatory ratios

+ Prudent valuation

+ TLAC (Total loss absorbing capacity)

+ Hypothetical RWA

+ Countercyclical capital buffer

+ Changes in market- and operational risks

Credit risk

Counter-party

credit risk

Securiti-zations

Market risk

Accounting and

RWARemune-ration

Capital components

Encumbrance

Liquidity risk

Operational risk

G-SIB

BCBS 309(Phase I)

(Phase II)

BCBS 255 (G-SIB)

BCBS 197 (Remuneration)

BCBS 221 (Capital)

BCBS 270 (LR)

BCBS 272 (LCR)

BCBS 295 (NSFR)

BCBS 107 (Basel II: OpRisk)

BCBS 368 (Interest rate risk)

Interest rate risk in the banking

book

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According to BCBS, Pillar III actions are divided into three phases

Pillar 3 Disclosure requirements over time2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 …

Phase I

• Establishment of 5 principles for the disclosure in the following areas:

– Credit risk

– Counterparty credit risk

– Securitization

– Market risk

– Holdings

• Establishing uniform table formats, independent Pillar 3 report, disclosure frequency and timing, adoption by date 31/12/2016

• Harmonization of disclosure requirements including the unrevised parts of phase I and new areas:

– previous BCBS papers that were not included in phase I: G-SIB, Remuneration, Capital, LR, LCR, NSFR, OpRisk, Interest rate risk

– New areas included in phase II: TLAC, countercyclical buffer, hypothetical RWA, regulatory ratios, prudent valuation, changes to market risk and OpRisk

• Consultation until June 10, 2016

• Harmonization of disclosure requirements, Pillar I requirements, which relate directly to pillar 3

• Consultation paper to be published until end of June 2017

Phase II Phase III

Phase III

BCBS 107

BCBS 157

BCBS 158

CRD III CRR

CRD IV

BCBS286

BCBS309

BCBS356

BCBS368

BCBS 255

BCBS 197

BCBS 221

BCBS 270

BCBS 272

BCBS 296

Phase II

Phase I

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New disclosure requirements at a glance

The Basel Committee bundles and complements existing proposals for disclosure in an comprehensive consultation paper (BCBS 365)

Existing papers Phase I (BCBS 309) Phase II (BCBS 365) Entry into force

Capital

LCR

NSFR

Leverage Ratio

Remuneration

G-SIB indicators

Risk Management& RWA

Reconciliation balance sheet to regulatory

Credit risk

Counterparty credit risk

Securitizations

Key Metrics

Floor

Prudent Valuation

TLAC

Countercyclical capital buffer

Market risk

OpRisk

Interest rate risk in the banking book

2016 – 2019

open

2016/2017

2017/2019

2017

2017/2016

2017/2016

2018/2016/2019

2017/open

openHypothetical RWA

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Revised Pillar 3 Disclosure Requirements: Challenges and conclusions

Scope of disclosure

Significant subsidiaries will probably have to meet a lot of the disclosure requirements also on single entity level

Disclosure intervals

In addition to the annual disclosure a lot of data must be disclosed every half year or quarterly

Reconciliation of balance sheet and regulatory exposure

• Annual reconciliation from accounting to regulatory consolidation

• Annual detailed reconciliation of balance sheet values (exact balance sheet classification, book values) to regulatory risk types and reconciliation of carrying amounts to regulatory exposure values for CR SA and IRBA

• Balance sheet and regulatory information for each individual transaction required

• Other challenges particularly in risk provisioning, off-balance sheet derivatives, balance sheet netting and collateral, prudent valuation ...

Extent of disclosure

The number of disclosure tables and forms increases with phase II to 67 tables (instead of 40 tables in Phase I)

• Banks must ensure more frequent disclosure in time with the publication of annual reports and are obliged to make the disclosure in a single document

• In particular, the objectives of transparency, comparability and coordination are in focus of the revisions

• Comparability should be ensured between the institutions by specifying formatting templates

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PwC

Thank you for your attention!

Martin Neisen

Partner – Global Basel IV Leader

Phone: +49 69 9585 3328

Mobile: +49 151 5380 0865

E-Mail: [email protected]

Jean-Philippe Maes

Partner – Financial Services Risk Consulting

Phone: +352 49 48 48 2874

Mobile: +352 621 33 2874

E-Mail: [email protected]

PwC Regulatory Management – Solutions for a regulatory world

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This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the

information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the

accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PwC does not accept or assume any liability,

responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication

or for any decision based on it.

© 2016 PwC. All rights reserved. “PwC” refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see

www.pwc.com/structure for further details.

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