Why should the Basel Committee review the SA-CCR?

The Basel Committee on Banking Supervision (BCBS) Standardized Approach to Counterparty Credit Risk (SA-CCR) has been introduced to improve the risk sensitivity of the capital framework for derivative transactions without creating undue complexity for banks. One of the main objectives of the Committee when formulating the SA-CCR standard was to design an approach that would be applicable to a wide variety of derivatives, including margined and non-margined, as well as bilateral and cleared transactions.

Prior to SA-CCR, which was finalized in 2014, banks were required to determine the exposure amount of derivative contracts in their portfolios using either an internal model method (IMM) or one of two model methods. not internal, namely the current exposure. standardized method (CEM) and the standardized method (SM). As is known, non-IMMs have been widely used by banks, either in their entirety or for selected derivative portfolios to calculate their risk-weighted assets (RWA) for credit risk exposures of counterpart.

SA-CCR was the first of the Basel III standardized approaches to be finalized by the BCBS and remains one of the most critical elements of banking prudential regulation, impacting not only RWAs for counterparty credit risk, but also credit valuation adjustment risk, production floor RWAs, leverage ratio and calculations of large exposures. For Global Systemically Important Banks (G-SIBs), this also has important implications for the calculation of the G-SIB capital supplement.

The SA-CCR standard was specifically designed to address the shortcomings of non-internal model approaches, replacing them with a more risk-sensitive approach to counterparty exposures. As is known, the CEM had been severely criticized for a number of significant shortcomings. For example, he did not distinguish between trades with and without margin. It was also criticized on the grounds that the prudential add-on factor did not sufficiently capture the level of volatility observed during periods of high financial market stress. Banks also complained that accounting for netting benefits was overly simplistic and insensitive to the relationships between derivative positions. Accordingly, a key element of the SA-CCR has been to introduce higher levels of risk sensitivity, while retaining some useful conceptual design features of the CEM.

SM, on the other hand, has also been criticized for several weaknesses, even though it has been proposed by the BCBS as a more risk-sensitive approach than CEM. Banks have complained that the SM does not distinguish between margined and unmargined trades or sufficiently capture the level of volatility seen during times of stress. Some banks also complained that the SM was not a non-IMM alternative for calculating exposure at default, as it relied on IMM to calculate delta equivalents for non-linear transactions. Regarding the complexity of the SM, some banks were also concerned that defining the hedging set would cause them undue operational difficulties and that only current exposure or potential future exposure would be capitalized.

The SA-CCR standard sought to address these criticisms by introducing a simpler approach to calculating RWAs for counterparty credit risk associated with OTC derivatives, exchange-traded derivatives and long settlement transactions. The new approach naturally had significant implications for banks from an operational perspective with respect to derivative positions in their banking and trading books. As a result, while the main intention of the Basel Committee was to reduce complexity, the reality has been different in practice.

Regarding its capital implications, the impact of SA-CCR on capital requirements could vary significantly from bank to bank depending on their derivatives portfolios and netting positions. In more practical terms, while SA-CCR could lead to a decrease in capital for a diversified and perfectly matched trading portfolio of derivatives, it could also lead to an increase in capital requirements for derivatives portfolios composed mainly of non-diversified products, borderless and borderless. cleared transactions.

From a strategic perspective, this has made optimizing portfolio positions for banks more critical than ever. Since the capital impact of the SA-CCR standard is not generalizable, it does not necessarily create a burden from a capital management perspective. Given the more risk-sensitive nature of SA-CCR compared to CEM, in practice banks whose portfolios of derivatives in netting sets refer to the same asset classes are rewarded through cross-class netting of assets.

However, this does not mean that the SA-CCR is a perfectly proportionate framework in terms of compliance burden. Although SA-CCR represents a radical change in the methodology for calculating EAD for the derivatives portfolio, it requires complex input parameters. It also requires granular datasets across industries, with increasing complexity, especially in the case of more complex derivative products. The new approach not only comes with complicated calculation requirements, but also complex data attributes, which has become a major challenge, especially for smaller banks whose risk and/or funding functions are not not sufficiently equipped to manage risk sensitivities.

Furthermore, although the SA-CCR standard was intended to minimize the discretion used by national authorities and banks, keeping abreast of its adoption at the jurisdictional level has been an ongoing challenge for large international banks, where regional variations , implementation delays and inconsistencies have caused a major headache for their risk and finance functions, not to mention the various complexities they have also created for other functions such as legal, operations, compliance, data, reporting and IT.

While it is absolutely true that SA-CCR is a much more risk-sensitive approach to calculating exposure-at-default for counterparty credit risk compared to CEM, the industry believes there are still aspects of the standard that the BCBS should review. Banks are particularly concerned that, as it stands, SA-CCR leads to excessive risk exposure with an associated impact on capital management and end-user costs. The industry attributes this overall to a lack of thought about structural changes in the derivatives market and overall regulatory framework since the introduction of the SA-CCR standard by the BCBS in 2014, as well as a lack of sensitivity at risk in its calibration.

In the European Union (EU), in order to ease the compliance burden on smaller and less complex banks, the revised Capital Requirements Directive and Regulation (CRD 5 and CRR 2) have made significant changes to the SA-CCR, allowing the use of a less complex approach subject to certain conditions. In line with the Basel IV framework, CRR 2 adopts a new SA-CCR, which is a more risk-sensitive measure of counterparty risk reflecting the benefits of clearing, hedging and collateral, while being better calibrated to volatilities observed. The final framework also adopts a simplified SA-CCR and retains the initial exposure method for small banks.

Going further than the Basel IV framework, CRR 2 also includes a simplified approach for banks that meet predefined eligibility criteria with respect to contract netting arrangements. More specifically, the use of this approach is subject to an on-balance sheet and off-balance sheet derivative activity size equal to or less than 10% of the institution’s balance sheet total and €300m, which makes the approach simplified accessible to banks that have more on- and off-balance sheet derivatives activity than originally proposed in 2016. use of the simplified SA-CCR too restrictive to set up.

The SA-CCR was then introduced as part of the capital production floor under CRR 3, which aims to ensure full implementation of the Basel IV standards in the EU. On the other hand, the 2021 Banking Package aligned the classification of retail customer exposures under SA-CR with those of the internal ratings-based approach. Departing from the Basel IV standards, it also introduced a number of EU-specific provisions for the definition of exposure classes and the assignment of respective risk weights, .

With respect to the United States (US), “Standardized Approach for Calculating the Exposure Amount of Derivative Contracts”, which was published in November 2019, included certain modifications aimed at mitigating the associated regulatory capital costs, introducing a significant degree of fragmentation between the EU and the United States. This has raised concerns that further weakening of Basel IV standards in the US could result in US banks receiving an unfair regulatory advantage, giving them an unfair advantage over EU banks.

Concerned about potential inconsistencies regarding the implementation of the SA-CCR standard in various jurisdictions, the International Swaps and Derivatives Association (ISDA), the Institute of International Finance and the Global Financial Markets Association recently asked the Basel Committee to reconsider the SA-CCR standard. CCR standard due to excessive risk exposures with associated impact on capital and end-user costs. While the BCBS should consider this request, the outcome remains uncertain.

Market fragmentation is indeed a significant risk and inconsistent application of the SA-CCR may jeopardize the post-crisis reform efforts of the BCBS. The calibration of the SA-CCR must be reviewed quickly to take into account recent market developments. In particular, the increase in collateral through initial margin requirements for non-centrally cleared derivatives should be duly accounted for as an important risk mitigant. The BCBS should also take into account the recent ISDA master netting agreement, which establishes new rules for the calculation of exposure for secured financing transactions and derivatives. In addition, the BCBS should also redesign certain aspects of the SA-CCR to adapt to new digital asset classes.

A comprehensive review of the SA-CCR at the BCBS level is needed to ensure more consistent and faster implementation of the standard, achieve greater harmonization of national banking regulations, close gaps between different jurisdictions and reduce the need future country-specific measures that could lead to further fragmentation between regions.

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