Changes to the Capital Requirements Directive (11/47)

16 November 2011

Who does this concern?

This will apply mainly to Banks, Building Societies and some investment firms who are caught by the CRD and to their advisers. It may well be of interest to shareholders, creditors and firms other than stakeholders, as well as trade associations and consumer groups.

Introduction and Background

The aim of the CRD is to ensure the financial soundness of credit institutions, essentially banks and building societies and some investment firms. It lays down the financial resources that such firms must hold in order to cover their risks. This is a legal framework that has been updated and improved by a series of packages which the European Commission has numbered to avoid confusion and generally for ease of reference. There was a consultation by the FSA in 2009 (CP09/29). Feedback on this consultation was published in 2010 in CP10/17. In 2011 in CP 11/9 the FSA consulted on the remaining elements of CRD 3, as well as, clarifying Changes to the Capital Requirements Directive.

The financial crisis demonstrated that the current market risk framework was inadequate when it came to capturing some key risks on a firms’ trading books. Thus the Basel Committee on Banking Supervision (BCBS) decided that it was necessary to increase the risk capture of both credit risk and illiquidity in the trading book as well as the relevant capital requirements. The current CRD changes implement these requirements in Europe and will result in higher market risk capital under both the internal models methods and standardised rules.

The financial crisis also showed that the CRD capital requirements for re-securitisations were inadequate and CRD3 introduces higher capital requirements for such positions in both the trading book and non-trading book. This PS reports on the main issues raised by firms in response to Consultation Paper 11/9 Strengthening Capital Standards 3 – further consultation on CRD3 and publishes final rules.

Structure of the Policy Statement PS 11/12

As noted the rules and guidance included in this document will come into force into force on 31 December this year (2011). Changes to reporting data will take effect for periods ending on or after that date. The PS provides a summary and discussion of the responses FSA received to CP11/9. The rest of the paper is structured as follows:

Strengthening capital requirements in the trading book
Higher capital requirements for re-securitisations
Other CRD changes viz: Pillar 3, prudent valuation and technical amendments.
Cost Benefit Analysis (integrated in relevant chapter rather than addressed in a separate chapter)

Trading Book Amendments

With regard to Trading Book Amendments the changes in CRD3 set out to:

increase the level of capital held against trading book risks;
reduce the relative cyclicality of the market risk capital requirements;
reduce the opportunity for arbitrage between the non-trading and the trading books; and
improve the capture of credit risk and illiquidity in the trading book.

Stressed Value at Risk (VaR)

The CRD3 package will introduce a stressed VaR measure – a one-tailed 99% confidence interval 10-day VaR measure with model inputs calibrated to historical data from a continuous 12-month period of financial stress. FSA consulted on the draft Handbook text for this element in CP09/29 and provided feedback in CP11/9.

The Incremental Risk Charge (IRC)

The IRC model aims to improve the risk capture of the market risk framework by requiring firms to hold capital for the default and migration risk of traded debt instruments incremental to that captured by their VaR model. FSA consulted on the draft Handbook text for this element in CP09/29 and provided feedback in CP11/9.

Applying the standardised measure to securitisations

The CRD3 package seeks to address the possibility for arbitrage between the non-trading and the trading book for securitisation positions by aligning the capital charges for securitisations in the trading book under the standardised method.

What next?

The changes in this PS will come into effect on 31 December 2011 and firms within the scope of the CRD will need to be compliant at that date. If your firm falls under the scope of the CRD it will need to ensure its systems and finances are ready in advance of the changes.

This is a lengthy and complex Policy Statement and those firms interested or affected by it should read the full document here and/or speak with their CPA Account Manager.

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