For Immediate Release, Tuesday, May 31, 2005
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Comment on Application of
The International Swaps and Derivatives Association (ISDA), the Institute of International Finance (IIF), the London Investment Banking Association (LIBA), The Bond Market Association (TBMA) and the International Banking Federation (IBFed) have submitted a detailed commentary on the three strands of the consultative document issued jointly by the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (IOSCO) on the application of Basel II to trading activities and the treatment of double default effects. The response was also endorsed by the Futures and Options Association (FOA).
The Associations are meeting
with a group of banking and securities regulators on June 2 in
Overall, the Associations are
pleased with the proposals put forward in the field of counterparty credit risk
and wish to thank the regulators for the openness and cooperation with which
they have sought to work with the industry. Addressing the three strands of the
consultative document, the Associations noted that the high degree of
engagement with industry has been most pronounced on Strand 1 (counterparty
credit risk), and to a lesser extent,
In their response, the Associations set forth, in the order of their appearance in the consultative document, their key priorities for change:
♦ The counterparty credit risk proposals need refining in a number of respects: some of the operational requirements for Expected Positive Exposure (EPE) modeling are too prescriptive, in particular the suggested maturity bucketing scheme; the floor imposed on own alpha estimates is unjustified; the range of collateral allowed in EPE computation is unduly restrictive; and the definition of Effective Maturity under the Internal Model Method should reference Effective EPE rather than Expected Exposure.
The Associations are disappointed with the proposal in the consultative
document that netting between derivatives and securities financing transactions
(SFTs) should not be recognized for regulatory capital purposes until there is
a consensus among international regulators that cross-product netting has
reached a sufficient level of legal certainty and usage in the industry. The Associations strongly
reject this assertion and believe that it fails to recognize recent legal developments
♦ The Associations are concerned by the calibration of the double default framework: while industry supports the adoption of a more accurate methodology for measuring double default risk, the scope of the Asymptotic Single Risk Framework is too narrowly defined, and the calibration of the model is overly conservative.
♦ The proposals for the new treatment of unsettled transactions and failed trades are of considerable concern. The Associations do not believe that a case has been made for introducing changes that are excessively conservative in scale and disproportionately expensive to implement. The full deduction of positions 4 days post-settlement is unjustified in light of observed losses and the processes for calculating the capital charges will require systems changes for firms that are already heavily burdened with other regulatory initiatives which they believe ought to take priority. The regulators have made proposals based on insufficient information on the markets that will be affected. In order to take the dialogue forward the regulators must clarify the intended scope of application of their proposals.
♦ Certain elements of the Strand 3 proposals warrant a significant revision, in particular the proposed exclusion of certain positions from the trading book treatment and the proposed new standards for measuring default risk, which are at odds with industryís approach to VAR (Value at Risk). The rules, as currently drafted, have the potential to produce increases in regulatory capital which would be disproportionate to the underlying risks. It will be crucial to cast any final rules in such a way that firms may determine the approach most appropriate for their exposures and, crucially, so as to allow for further methodological developments in this area.
ISDA and LIBA, jointly with the European Banking Federation (FBE), have also responded to the parallel consultation launched on the trading book review by the European Commission. The focus of the response has been on the adoption process of the Capital Requirements Directive, as well as factual errors in the draft legislative text.
The time frame for finalizing the Trading Book Review is scheduled for early July. This tight deadline should not however be allowed to impede a proportional and risk-based result. The Associations look forward to having the opportunity to cooperate with the Basel/IOSCO Working Group further in refining the rules over the coming month.