CRR III: Appropriateness and Consistency

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

Earlier this week, ISDA hosted a bank capital conference in Brussels and, based on what the keynote speakers and panelists said, we can expect a busy year with legislative proposals for the third Capital Requirements Regulation (CRR III) expected in June.

We made the point that prudential regulators have a challenging balancing act in implementing the final Basel III rules. On the one hand, their primary responsibility is to their own jurisdictions, and they must implement rules that take account of any local specificities. On the other, capital rules are based on a global framework agreed by the Basel Committee on Banking Supervision, and consistency in application is an important Basel principle.

This balance between global and local interests is about to rise up the agenda with publication of the CRR III proposals, which will implement key Basel III standards in the EU, including the Fundamental Review of the Trading Book (FRTB).

Throughout the many rounds of consultation on Basel III, ISDA has always made the case for rules that are both appropriate, risk sensitive and, as far as possible, consistent. The standard setting is now largely complete but, as global standards are transposed into law in Brussels and other legislative centers, our focus remains the same.

The importance of aligning with global standards was recognized by Sean Berrigan, director general of the directorate general for financial stability, financial services and capital markets union (DG-FISMA) at the European Commission, who said at the ISDA event that “we all have a great deal to gain from integrated financial markets based on international standards”.

Consistency in the substance of the rules is important, but it applies equally to timing. When internationally active firms are required to comply with new rules at different points in time, this introduces unnecessary complexity to the regulatory framework, and can also create distortions in cost and risk management. International coordination on this point should continue to be a priority as national regulators plan for implementation in their markets.

One of the most significant changes in this next phase of Basel III will be the reduced use of internal models. A recent survey by the European Central Bank found that only 40% of banks currently using internal models intend to seek approval to continue to use them under the FRTB rules. A further 40% expect to rely entirely on the new standardized approach.

Moving to a world in which only four out of 10 banks in Europe persist in using internal models represents a significant change. It is critical that the new framework for internal model approval is implemented appropriately, but we also need to be ready for the shift to greater use of standardized approaches. For a standardized model to be effective in calculating capital requirements, it needs to be implemented both accurately and comparably across the industry.

In response, ISDA is working with a group of more than 30 banks on a benchmarking initiative to support accurate, efficient and consistent implementation of the FRTB standardized approach. Recognizing the increased importance of standardized approaches, we will look to expand this work to support other parts of the capital framework where standardized models are used. These will include credit valuation adjustment (SA-CVA) and the standardized approach for measuring counterparty credit risk (SA-CCR).

Publication of CRR III will mark the start of an important period of review and consultation to ensure it balances the needs of local markets while aligning with global standards. Throughout this process, ISDA will continue to make a case for rules that are appropriate, risk sensitive and, as far as possible, consistent.

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