Discover how to turn regulatory constraints into business opportunities with Chappuis Halder

1. How to turn Standards’ constraints into a business generator ?
“Anyone who has never made a mistake has never tried anything new” –Albert Einstein
Benoit Genest
bgenest@chappuishalder.com
Stephane Eyraud
seyraud@chappuishalder.com
Ziad Fares
zfares@chappuishalder.com

2. Context
Principles & objectives of the Standards
Impacts & issues
CH&CieOffer
Agenda
1
2
3
4
2

3. 3
Regulations and standards evolutions are driven by many factors
From a difficult economic context to political and social pressures
1
Context
Context
Financial institutions faced massive losses during the last crisis with dramatic impacts on the overall economy …
•Thesubprimecrisisthattookplacein2007,unleashedaseriesofproblemsthatthreatenedthefinancialbankingsystemandthewholeeconomyaswell
•Fromarealestatecrisis,toafinancialcrisis,toanoveralleconomycrisis,thisdifficultperiodrevealedshortcomingsinidentifying,hedgingandmanagingrisksinthebankingsystem
•Thecausesofthisturbulencewereofdifferentnatures
Aconfidencecrisis
Liquidityandfundingissues
Volatilityandunpredictabilityofmarketparameters
Highlevelofcorrelationbetweenfinancialinstitutionsandsystemicrisks
SignificantincreaseinOTCderivativetransactionvolumes
Raison d’être of Standards
A reaction to shortcomings revealed during the crisis
•Someregulationsevolved,otherswerecreatedinordertocovertheshortcomingsinriskmanagementrevealedduringthecrisis
•Forexample,BaselIIIcameasareactiontoabadcoverageandunderstandingofCounterpartyCreditRiskandliquiditymanagement
A Changing environment
•Today’seconomicenvironmentisonperpetualmotionfromalegislativeframeworkpointofview(geographically, betweentheEUandtheUS)andfromaconvergenceandhomogenizationbetweenregulationandstandards(regulatoryandaccountingstandards)
Political & Social pressure
•Oneoftheobviousraisond’êtreofregulationsisthepoliticalandsocialpressure,inordertoregulateaccuratelythebankingsystemandtoavoidabusesandexcesses

4. Since the last decade, the regulation and the monitoring of the banking system have been subject to sharper focus
•Publication: 2004
•Application date – standardized approach & IRB foundation:2007
•Application date –IRB advanced : 2008
•Objective : Capture and measure CreditRisk, MarketRisk & OperationalRisk
2008
Basel 2
2012
•Publication: 2009
•Amendments:2010
•Application date :2012
•Objective : Strengthen capital requirements for market risk and re-securitization, amend theCompensation Policy towards market participants etc..
Basel 2.5
2013
•Publication: 2010
•Final text:not issued yet
•Application date :2013
•Objective : Enhance Capital Quality, deal with Systemic Risk, increase capital requirements for Counterparty Credit Risk, manage and cover Liquidity Risk
Basel 3
•Publication: 2011
•Application date :2013
•Objective : Give a precise definition of the fair value, define levels in the fair value hierarchy, consider CVA / DVA in the fair value measurement
IFRS 13
•Publication: phase 1 –2009, phase 2 -2011, phase 3 -2012
•Application date :2015
•Objective : Define asset classes (amortized cost vsfair value), introduce a new impairment model (Expected Loss) ensure convergencewith prudential standards
IFRS 9
2015
Prudential standards
Accounting standards
4
1
Context

5. Latest updates and evolutions of Basel III –liquidity ratios
Latestupdates
•Onthe7thofJanuary2013,theBaselcommitteepublishedthelatestevolutionsanddecisionstakentowardsthedefinitionoftheLiquidityCoverageRatio
•Whatchangesinthisnewversion?
Thetimetableandcalendarofapplication
Theperimeterofinstrumentstakenintoaccountwithintheliquiditybuffer
Revisionofoutflowrates
Drawdownratesonoff-balancesheetexposure
Revisionofinflowrates
LCR=
Liquidity buffer
Outflows –min( Inflows ; 75%)
•Thefollowinginstrumentscannowbetakenintoaccountwithintheliquiditybuffer, cappedat15%fromthetotalbuffer
Corporateinvestmentgradebondswitha50%haircut
Someequitiesinmajorstockindices
RMBSwithaminimumgradeofAAwitha25% haircut
•LiquiditylineswithCentralBanksareunderdiscussion, whethertotakethemintoaccountornot
Liquidity buffer
•Outflowrateonnon- operationaldepositsisreducedto40%from75%initially
•Drawdownratesonliquiditylinesisreducedto30%from100%initially
•DrawdownrateonliquidityandcreditlineswithentitiessubmittedtotheLCRisreducedto40%from100% initially
•Thedefinitionofoperationaldepositsbecomesmorestringent
Outflows
•Inflowsarestillcappedat75% oftotaloutflows
•Inflowrateonrevolvinginstrumentsisfixedat0%(noinflowsonrevolvinginstruments)from50%initially
Inflows
Dec2010
1strelease
Jan2013
2ndrelease
Jan2015
LCR>=60% (initially100%)
Jan2016
LCR>=70%
Jan2017
LCR>=80%
Jan2018
LCR>=90%
Jan2019
LCR>=100%
5
1
Context

6. Regulations and standards are more and more a worldwide concernGlobal benchmark
Basel II
Basel 2.5
Basel 3
IFRS 9
IFRS 13
NorthAmerica
Basel II
Basel 2.5
Basel 3
IFRS 9
IFRS 13
South America
Basel II
Basel 2.5
Basel 3
IFRS 9
IFRS 13
Europe
Basel II
Basel 2.5
Basel 3
IFRS 9
IFRS 13
Asia
Basel II
Basel 2.5
Basel 3
IFRS 9
IFRS 13
Africa
In progress
On hold
Completed
6
1
Context

7. Context
Principles & objectives of the Standards
Impacts & issues
CH&CieOffer
Agenda
1
2
3
4
7

8. Prudential standards cover an extensive scope… … encompassing new solutions to cover shortcomings revealed during the 2007 crisis
2
Principles & objectives of the Standards
Pillar I –Solvency Ratios
Capital
RWA
Core Tier 1
Tier 1
Tier 2
Tier 3
Systemic Risk
Leverage ratio
Pillar II –Supervisory Process
Credit
Pillar III –Market Discipline
Standard
IRB -Foundation
IRB -Advanced
Counterparty
Exposure calculation
Default risk
CVA, WWR
Margin period of risk
Market
Standard
Advanced : Stress Var, IRC
Operational
Standard, BIA, AMA
FI correlation
Buffer
countercyclical
conservation
CCP
Capital requirements
Economic capital
ICAAP
Testing
Stress testing
Back testing
Risk
Concentration / liquidity
Reputational / strategic
Liquidity ratios
LCR
NSFR
Compensation policy for maketparticipants
Financial communication
Credit risk
Market risk
Operational risk
Complex instruments
Off-balance sheet expos.
Breakdown by
industry
Geographic area
Approach (IRBA, STD)
Basel 2
Update Basel 2.5
Update Basel 3
Removed in BIII
New in Basel 2.5
New in Basel 3
8

9. Each prudential standard meets a specific objectiveFocus on Basel 2 …
2
Principles & objectives of the Standards
Basel 2
Basel 2.5
Basel 3
1
2
3
Objective
Description
LimitsofBaselI
•ThemaininputforCookesolvencyratioistotalamountofgrantedloans
•Assetweightings-enablingtoconsidertheweightedrisk-didnotreflecttheborrower'srealcreditworthiness
•Inaddition,thematuritiesofcontractswerenotconsideredeither
•Finallyriskmitigation/hedgingtechniques(CDS, securitizations,collateral&nettingagreements)andoperationalriskwerealsonottreatedwithinBaselI
ObjectivesofBaselII
•BaselIIstandardsproposeanapproachallowingtoconsiderthecreditworthinessoftheborrowerviaaninternalratingsystem
•Inaddition,theyenhancemarketriskmeasurement(e.g.throughtheVaR)anddefinetermsfortreatingoperationalrisk
•WithinBaselII,McDonoughratio–replacingCookeratio-considerscredit,market&operationalrisksandaimstostrengthencapitalrequirements
•Moreover,withinPillarII,financialinstitutionsshallalsoassessandensuretheadequacyofregulatorycapitalwitheconomiccapital-whichreflectstherealactivityofaspecificfinancialinstitution
•Finally,financialreporting&communicationaremandatorywithinPillarIII,inordertoenhancetransparencyamongthebankingsystem
CreditRisk
•BaselIIproposesanAdvancedApproachtocapturedefaultriskbasedonaninternalratingsystem
•Aprobabilityofdefault(PD)iscalculatedforeachcounterpartythroughvarioustechniques(statisticalapproach,expertjudgmentetc...)overaone-year- horizon
•ExposureAtDefault(EAD)iscalculatedanddefinedastheasset'sbookvalue
•Finally,DefaultRecoveryRates(RR)aredeterminedviadifferenttechniques(statisticalapproach, historicalapproach…)
•Foreachasset,ariskweightisdeterminedfromthecombinationofPD,LGDandEAD
•Maturitiesimpactandratingmigrationriskistakenintoaccountviaanadjustmentcoefficient
CounterpartyCreditRisk
•BaselIIdefinestechniquesfordeterminingexposuresonderivativesandsecuritiesfinancingtransactions(repo,securitieslending/borrowing)
•Italsodefinestermsfortakingintoaccountriskmitigationtechniques(collateral,nettingagreements,etc…)
Operationalrisk
•Operationalriskisalsoconsideredandevaluationtechniquesarepresented(AMA,BIA,STD..)
MarketRisk
•Itisaboutcapturingriskscomingfrommarketfactorsvolatility(FXrates,interestrates,creditspreads)
9

10. Each prudential standard meets a specific objectiveFocus on Basel 2.5 (CRD II / CRD III) …
2
Principles & objectives of the Standards
Basel
Basel 2.5
Basel 3
1
2
3
Objective
Description
MotivesofBasel2.5
•ThisreformisconsideredasanenhancementofBasel2andbeganin2005
•Followingthe2007-08financialcrisis,itsscopehasbeenwidened
•Infact,duringthe2007crisis,inacontextofextremevolatilityofmarketvariables,VaRmodelsintroducedinBaselIIfailedtocapturesuchextremesituations
•Asareminderthesemodelsestimatepotentiallossesofaportfolioviahistoricalscenariosformarketvariables
ObjectivesofBasel2.5
•Followingthefinancialcrisis,wheresituationsofextremestressandvolatilitywereobserved,Basel2.5hasbeenissuedtocaptureaccuratelysuchextremeevents(whichwerenottakenintoaccountwithinhistoricalscenarios)
•ThescopeofBasel2.5encompassesexclusivelycredit,marketandconcentrationrisks
•Itspurposeistomeetthefollowingobjectives
>CaptureLossesrelatedtoextremeevents
>CaptureLossesduetodefaultandratingmigration
>Treatsecuritizations&re-securitizations
>Takeintoaccountcorrelationsbetweenassetsofthetradingbook
CreditRisk(StandardizedApproach)
•Securitizations&Re-securitizationsaretreatedasheldintothebankingbook.Theyarethereforeprocessedintheframeworkofcreditriskpolicy. Thisaimstoavoidthearbitragebetweenthetradingandthebankingbook
•Whiledeterminingtheexposureonsecuritization, bothbalancesheetandoff-balancesheetcommitmentsareconsidered
•Newweightingfactorsmustapplyonsecuritizationinstruments
MarketRisk(Internalmodelapproach)
•StressedVaR-ItisanewVaRmodelbasedonstressedscenariosformarketvariablesintheintenttocapturesituationsofextremevolatility.ThisVaRisadditionaltotheclassicalVaR
•IncrementalRiskCharge(IRC)-allowstocapturedefaultandratingmigrationrisksviaaVaR(99%;1year)model.ItisadditionaltothemarketriskcapitalchargeintroducedinBasel2.Itisaboutintroducinga“creditrisk”basedapproachforinstrumentsheldinthetradingbook
•ComprehensiveRiskMeasure(CRM)-allowstomeasureboththecorrelationbetweeninstrumentsofaportfolioandthevolatilityaswell
Pillar2/Pillar3
•Basel2.5definesaCompensationPolicyformarketparticipants(deferredbonusdistribution,…)
•Italsohandlesthemanagementofconcentrationriskandenhancesfinancialcommunication
10

11. Each prudential standard meets a specific objectiveFocus on Basel 3(CRD IV) …
2
Principles & objectives of the Standards
Basel 2
Basel 2.5
Basel 3
1
2
3
Objective
Description
MotivesofBasel3
•Thisreformisbasicallyaresponsetowhathasbeenobservedduringthe2007crisiswherecapitalreservesfailedtoabsorbrecordedlosses
•Furthermorethe2007crisisuncoveredmanyloopholes.Forinstance,itwasnoticedthatcertainriskswerenotcoveredorconsideredinthepreviousstandardsorbyinternalriskmanagementmodels
ObjectivesofBasel3
•Basel3mainpurposeistocovershortcomingsidentifiedduringthe2007crisisintermsofriskmanagement
•Basel3proposesamendmentsforexistingstandardsbutalsodefinesasetofnewrulesandconsequentlywidensthescopeofissuescoveredbyprudentialstandards
•Moreprecisely,itenablestomeetthefollowingobjectives
>Enhancethequalityandthequantityofcapitalreserves
>Regulatetheleverageeffectbyintroducingaleverageratiowhosepurposeistoincreasecapitalreservesorreduceassetsvolumes
>Capturesystemicriskandtheriskofcontagionfromafinancialcrisistoanoveralleconomycrisis
>EnhanceCounterpartyCreditRiskmanagementandframeapolicyforliquidityrisk
Enhancethecapitalstructure
•Tier3isremovedandTier1issplitintoTier1andCoreTier1.CET1increasesto4,5%from2% previously
•SomesecuritiespreviouslyeligibleforTier1,willbedowngradedtoTier2
•TheSolvencyRatiomustbegreaterthan10,5%(vs. 8%previously
LeverageRatio
•ItisdefinedastheratiobetweenTier1Capitalandnon-weightedexposures(on-&off-balancesheet)
•Thisratiomustbegreaterorequalto3%.ItwhetherincreasesTier1capitalreservesorreducesthesizeofthebalancesheet
SystemicRisk
•Correlationcoefficientisincreasedby25%forfinancialinstitutionstoreflecttheirinterdependencyandtheriskofcontagion
•ConstitutionofaConservationBufferthatrepresents2,5%oftheSolvencyratio.ItisaCET1extracushion
•ConstitutionofaCountercyclicalbufferduringperiodofgrowth,usedtoabsorblossesduringadownturncycle.ItisaCET1extracushion
•CalculationofexposureswithCCP
CounterpartyCreditRisk/liquidityRisk
•CVAcalculationtocaptureMtMLossesduetocreditspreadsvolatilityandtoconsiderWWRthroughthecalculationofstressedEPE
•Implementationof2LiquidityRatios(ST&LT)
11

12. Accounting rules also evolved … … in order to converge and be consistent with regulatory rules
2
Principles & objectives of the Standards
IFRS 9
IFRS 13
Phase 1 – Classification & Measurement
Phase 2 –Impairment rules
Phase 3 –Hedging account
Evaluation method
Amortized Cost
Incurred Loss model
Expected Loss model
Risk exposure
Bad Book / good Book
EL calculation methodology
Maturity / Horizon
Counter
Cyclical effects
Accounting Specific / Collective
1–Fair Value Instruments Classification
2–CVA / DVA impairment
Fair value hierarchy
Level 1 –Quoted Prices
Level 2 –Prices computed with observable parameters
Level 3 –Prices computed with non observable parameters
Fair value Definition
Calculation methodology
Expected Loss –standard / advanced approach
Shifting curve
CDS Spreads
Risk exposure / perimeter
Valuation techniques
Methodology
Reporting
Suppresion
No regulatory guidelines
Regulatory guidelines
12
Fair Value through P&L
Historical cost
Other methods
Classification
Held to maturity
Intent to be sold

13. IFRS 9 changes the way of measuring impairments…as a consequence of the last financial crises
2
Principles & objectives of the Standards
IFRS 9
IFRS 13
1
2
Regulation summary
Description
Classification&Measurement
•IFRS9paragraph3:5-TheEDproposestwoprimarymeasurementcategoriesforfinancialinstruments. Afinancialassetorfinancialliabilitywouldbemeasuredatamortisedcostiftwoconditionsaremet:theinstrumenthasbasicloanfeaturesandtheinstrumentismanagedonacontractualyieldbasis
•Afinancialassetorfinancialliabilitythatdoesnotmeetbothconditionswouldbemeasuredatfairvalue
Impairmentrules
•IFRS9IN5(b)-theproposedimpairmentapproachgenerallywouldresultinearlierrecognitionofcreditlossesthantheincurredlossimpairmentmodelinIAS39(ieavoidthesystematicbiastowardslaterecognitionofcreditlosses).Inotherwords,therequirementforanobservablelosseventtohaveoccurredbeforeconsideringtheeffectofcreditlosseswouldberemoved
•IFRS9IN10-TheIASBhascontinuedtostresstheimportanceofreflectingtherelationshipbetweenthepricingoffinancialassetsandexpectedcreditlosses
•IFRS9IN11-TheFASBconcluded,jointlywiththeIASB,thatanentityshould,alongwithconsideringhistoricaldataandcurrenteconomicconditions, considerreasonableandsupportableforecastsoffutureeventsandeconomicconditionsfordevelopingtheentity’sestimateofexpectedcreditlosses
Motivations
•Beforethelastfinancialcrisis,impairmentsonassetsvaluedusingtheamortizedcostmethod, werecalculatedusingthe“incurredloss”method
•Thismeansthatimpairmentsexistonlyifalosseventoccurs
•Duringthefinancialcrisis,ahugenumberoflosseventsoccurred,andtheimpairmentstockincreaseddrastically,whichmeantthatreservesalreadyinplacefailedtoabsorbcurrentlosses
Objectives
•Theincurredlossmodelsufferedfromshortcomingswhichledtoproposeanothermodel
•Infact,itrecognizesexpectedlosseslatelywaitingforacrediteventtooccur.Italsooverestimatedinterestincomebecauseinterestratesdidn’tincludeariskpremiumrelatedtothecreditworthinessofcounterparties
•Consequently,impairmentunderIFRS9aretobecomputedusinganExpectedLossmodel,whichmeansthatreservesaretobebuiltupbeforeacrediteventoccurs
•Themainobjectivesofthismodelare
Buildingupreservestoabsorblossesifadownturnintheeconomyoccurs(countercyclicaleffect)
ConvergewithBaselIIdefinitionofexpectedloss
13

14. IFRS 13 provides more precision on fair value definition…but banks concerns are more focused on CVA / DVA computation
2
Principles & objectives of the Standards
IFRS 9
IFRS 13
1
2
Regulation summary
Description
Fairvaluehierarchy
•IFRS13:72-Thehierarchygivesthehighestprioritytoquotedpricesinactivemarketsandthelowestprioritytounobservableinputs
Fairvaluedefinition
•IFRS13:AppendixA-Thepricethatwouldbereceivedtosellanassetorpaidtotransferaliabilityinanorderlytransactionbetweenmarketparticipantsatthemeasurementdate(i.eexitprice)
Valuationtechniques
•IFRS13:62
marketapproach–usespricesandinformationgeneratedbymarkettransactions
costapproach–currentreplacementcost
incomeapproach–discountedcashflows
CVA/DVAimpairment
•IAS39.AG67-Fairvaluereflectsthecreditqualityoftheinstrument
•IAS39.AG28(b)-Anappropriatetechniqueforestimatingthefairvalueofaparticularfinancialinstrumentwouldincorporatecreditrisk
•IFRS13.42-Thefairvalueofaliabilityreflectsnon- performancerisk.Non-performanceriskincludes, butmaynotbelimitedtonanentity’sowncreditrisk
Motivations
•OneofthemajormotivationsofIFRS13istheconvergenceofaccountingstandards,byestablishingasetofaccountingrulesthatwillbeusedgenerallyandbyreducingthegapbetweenUSGAAPandIFRS
•IFRS13wasdesignedinordertogiveonecleardefinitionoffairvaluemeasurementaswellasenhancingclaritybystandardizingelementsofreportingandvaluationtechniques
•Moreover,duringthecrisisof2007,MtMlosseswereofphenomenalamountswhichledtodefineclearlyfairvalueandhowitmustbemeasured
Objectives
•IFRS13establishesasingleframeworkforallfairvaluemeasurementbutdoesnotchangewhenfairvaluemustapply
•Butratherdescribeshowtomeasurefairvalue
•Moreover,IFRS13clearlystipulatesthatfairvaluemustreflectlossesduetocounterpartycreditrisk(CVA)aswellasgainsduetoanentity’sowncreditrisk(DVA)
•Nonetheless,IFRS13doesn’tdefinehowCVAandDVAaretobecomputingwhichmeansthatcalculationmethodologyareoneofthemajorissuesforbanksunderIFRS13
14

15. Context
Principles & objectives of the Standards
Impacts & issues
CH&CieOffer
Agenda
1
2
3
4
15

16. Regulatory requirements and constraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (1/3)
3
Impacts & issues
Bâle 2
Subjects
Financial
Orga
Methodology
Business
Hot Topic?
Credit Risk -RWA computation
•Standardapproach
•IRBFoundation
•Advanced(PD,LGD, EAD,CCFmodeling)
CCR –exposure computation
•CurrentExposureMethod(add-on)
•Internal-basedmodelapproach(EPE)
Market Risk –RWA computation
•Standardapproach
•Internalapproach(VaRmodels,MonteCarlosimulation…)
Pillar II & Pillar III
•ICAAP
•Backtesting/stress




16

17. Regulatory requirements and constraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (2/3)
3
Impacts & issues
Bâle 2.5
Subjects
Hot Topic?
Market Risk –RWA computation
•StressVaR
•IRC/CRM




Basel 3
Capital structure
•Tier1/Tier2
CCR -CVA
•Standardapproach
•Advancedapproach
Systematic risk
•CorrelationcoefficientforFI
•Capitalbuffers
•CCP
LeverageRatio
Liquidity ratios
•LCR
•NSFR



17
Financial
Orga
Methodology
Business

18. Regulatory requirements and constraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (3/3)
3
Impacts & issues
IFRS 9
Subjects
Hot Topic?
Phase 1 -Classification & Measurement
•Classification
•Measurement
Phase 2 –Impairment rules
•ExpectedLossimpairment
IFRS 13

Fair Value Instruments Classification
•Hierarchy
•Valuationtechniques
CVA / DVA impairment
•Methodologyandcalculation

18
Financial
Orga
Methodology
Business

19. Banks will face great challenges in putting in place regulations… with an impact on balance sheet’s structure and P&L
Direct impact on capital structure
2%
4.50%
2%
1.50%
3%
2%
1%
2.50%
2.50%
Basel 2/2.5
Basel 3
Countercyclical buffer
Conservation buffer
Tier 3
Tier 2
Additional Tier 1(hybrid)
CET 1
+ 63%
Impact on balance sheet -Assets
Impact on balance sheet -liabilities
Other
Other
Fees
Fees
Loans
Loans
Rever. Repos
Rever. Repos
Securitization
Sovereignsec.
Securities
Securities
Cash
Cash
Derivatives
Derivatives
Today
With Basel III
Unsec. funding
Unsec.funding
Deposit
Deposit
Secu. Funding short term
Secu. Funding short term
Interbank borrowing
Interbank bor.
Derivatives
Derivatives.
Capital
Capital
Today
With Basel III
NSFR & leverage ratio
LCR buffer
CVA impact
LCR buffer
NSFR & LCR
Trust crisis, collat.
Correlation coeffic.
Capital struct. & buffers
Trust crisis, collat.
Impact on P&L –Cost of risk
CVA / DVA (IFRS 13)
No CCR impairment
Expected Loss (IFRS 9)
Incurred Loss
•CCRimpairment–SubstantialimpactontheP&Lbecauseofderivativesandrepotransactionvolumes
•ExpectedLossimpairment–Comparedtotheincurredlossmodel,theimpactontheP&Lisgreaterbecauseimpairmentarebuiltupbeforeacrediteventoccurs
19
3
Financial impacts

20. Banks will face great challenges in putting in place regulations… with an impact on processes and organization
Regulatory CVA –Basel III
Leverage Ratio –Basel III
Liquidity Ratios –Basel III
Central Counterparty Clearing House –Basel III
•EPE/StressedEPE–OneofthemainchallengesforCVAcomputationunderBaselIII(Advancedapproach)istobuiltuppricingmodelsandscenariogenerators
•HedgingCVA&interactionswithCVAdesks–ItisimportantthatprocessesforcomputingCVAcapitalrequirements,CVAimpairmentandCVAdesksmustbeoptimized
•RequiresahighcomputingcapacitywithoptimizedmodelsforMTsimulations
•RequiresagoodunderstandingofprocessesaswellasallCVAcomponents
•IdentificationoftransactionswithCCP–WithinBaselII,transactionswithCCPhadanEAD=0,whichmeantthatthesetransactionswerenotidentifiedseparately
•Margincallsandcollateralmanagement–WithEMIRregulation, thevolumeoftransactionwithCCPwillincreasessignificantly
•DefaultFund–BaselIIIdefinescapitalrequirementsforbalanceandoff- balancesheetdefaultfunds
•RequireshighgranularitywithinITsystems&anewmethodologyforEADcalculus
•RequiresoptimizedprocesseswithBOcollateralmanag. unit
•RequiresoptimizedprocesseswithRisk&Financialfunctions
•Reposandderivativestreatment– Oneoftheinputstotheratioisrepotransactionswithanettingbetweencashlegandsecuritiesleg
•Reconciliationbetweenriskandfinancefunction–Theinputstotheleverageratioareof2natures:Risk& finance.Riskinputsarereposandderivativestreatment.Financeinputsarecapitalinformation
•Requiresthecapacityofidentifyingtoeachbalancesheetexposure,itsoff- balancesheetleg
•RequiresoptimizedprocesseswithRisk&Financialfunctions
•Liquiditybuffer–isconstitutedofcash, centralbankreserves,liquidsecuritiesetc…
•Identificationofencumberedassets– Assetsusedascollateral(forsecuritizationforinstance)mustbeidentifiedandtreateddifferentlyintermsofliquiditywithintheNSFR
•RequireshighgranularitywithinALMcalculator& optimizedprocesseswiththetreasurer
•RequiresoptimizedprocesseswithBOcollateralmanag. Unit
20
3
Organizational impacts

21. Banks will face great challenges in putting in place regulations… with an impact on models and methods
CVA Impairment –IFRS 13
Expected Loss model -IFRS 9
•CVA/DVAmethodology–OneofthemainchallengesforCVAimpairmentisputtinginplaceamethodology(knowingthatitisnotspecifiedinIFRSrules)
•Benchmarkofmethodologiesthatcanbeused
•ExpectedLossmethodology–TheExpectedLosswithinIFRS9hasthesamedefinitionastheexpectedlosswithinBaselII.ThechallengeforbanksistocalibratetheELcorrectlytoavoidoverlapwiththeULwithinBaselII.Thispointwillbedetailedinpartn°5
ExpectedLossmodel
1
ShiftingCurves
2
CDS spreads
3
•CVA=PDxLDGxEAD
•PD-Inpriority,considerobservablecreditspreads.Ifnotavailable,useregulatory1-yearPD,anddeterminePDtillmaturityusingincrementalPDformula
•EAD
Inastandardizedmethod,usetheCurrentExposureMethod(MtM+Add-on)usingregulatoryadd-onfactors
Inanadvancedapproach,useEPEmodels
•LGD-Inpriority,considerobservableLGD(ratingagencies, etc…).Ifnotavailable,useregulatoryLGD
•CVA=PresentValue1(RiskFree)–PresentValue2(+riskpremium)
•Cashflowsarediscountedusingzero-couponcurves,thenzero-coupon+creditspreads
•CVA=EADx(creditspreadxduration)xLGD
•CVAiscomputedasafunctionofcreditspread
21
3
Methodology impacts

22. Understanding the dynamic of interactions between regulations… is about identifying the synergies and optimizing potential overlap (1/2)
Synergies Basel II – IFRS 9
What is the issue ?
How to optimize?
Basel II 99,9%
EL
(Basel II)
UL
(Basel II)
Loss
Probability
Bad EL 1y (IFRS) calibration
•ELwithinBaselIIisdefinedasPDxLGDxEADona1yearhorizon
•ELwithinIFRS9isalsodefinedasPDxLGDxEAD.Though,iftheparametersusedaresignificantlydifferentfromthoseusedinbasel2,thiscanleadto:
Abadcoverageofexpectedlosses(case1)
Overlapbetweenimpairmentandcapital(case2)
1
2
•ThebestwaytocalibratecorrectlyandefficientlytheELwithinIFRSistouseBaselIIparametersandcapitalizeonwhatisprovidedforregulatoryintent
Basel II -EL
Basel II –PD (TTC)
Basel II -LGD
Basel II -EAD
IFRS –PD (PIT)
IFRS -LGD
IFRS -EAD
1y maturity
Economic LGD
Regulatory EAD
Basel II -EL
1y for bucket 1
Until maturity for bucket 2,3
PIT
Not economic,PIT
Regulatory EAD
Same risk bases
Synergies Basel II – Basel III
LossesduetoratingmigrationsarealreadycapturedwithinBaselII
Maturity adjustment coefficient, function of PD
•ThematurityadjustmentcoefficientintroducedwithinBaselIIhasadualpurpose
Thelongerthematurityis,thehighertheriskis
ItisafunctionofPD,andcapturesratingmigrations
•ThepurposeofCVAunderBaselIIIistocapturelossesduetoratingvolatilityandmigration
Analysisoftheb(PD)term
Itisanadditionalcapitalrequirementforratingmigrations.RatingMigrationsaremorelikelytohappenforlowerPDandhighermaturities
•ForBaselIII-CVAundertheIRBapproach,thematurityadjustmentcoefficientmaybesetto1(whichmeanscapturingdefault-onlyrisk)ifthebankcandemonstratethatratingmigrationandrisksarecorrectlyandefficientlycapturedinthespecificVaRmodel
PD
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3
Methodology impacts

23. MtM
EL
(Basel III)
Understanding the dynamic of interactions between regulations… is about identifying the synergies and optimizing potential overlap (2/2)
Synergies Basel III – IFRS 13
What is the issue ?
How to optimize?
EL
(IFRS 13)
UL
(Basel II)
Loss due to counterparty default
Probability
CVAunderBaselIIIvsCVAunderIFRS13:2differentdefinitionsfordifferentpurposes
•CVAunderBaselIIIcoversMtMlossesduetoratingmigrationandvolatility,withoutcounterparty’sdefault.Itisaone-yearhorizonVaRwith99%confidencelevel.ItincorporatesULandELaswell
•CVAunderIFRS13coversexpectedlossesonderivativesandreposstyletransactionsduetocounterpartydefault
Yet,thereismuchincommonbetweenthem
•Eventhoughtheyareusedfordifferentpurposes,itisimportanttocalibratethemcorrectlytoavoidoverlapsknowingthattheysharethesameinputsandperimeter
UL
(Basel III)
MtMLoss due to rating volatility
Therearetwomainaxesforoptimization:Methodologyandperimeterofapplication
•Methodology&inputs–MeasuringCVAunderIFRSasanExpectedLossmodelwillallowtocapitalizeonBaselIIparameters(PD,LGD,EAD)andusethemasinputstothemodel.TheseinputsarealsousedforCVAcomputationunderBaselIII
•Perimeterofapplication–CVAunderBaselIIIandIFRS13arecomputedonallnon-defaultedderivativesandrepostyletransactions.Onetheperimeterisidentified,regulatoryEADcanbeusedforIFRS13purposes,afterreconciliatingMtMusedforregulatorypurposesandMtMusedforaccountingpurposes
Methodology& inputs
1
MethodologyunderBasel3
•PD–PriorizingexternalPD,theninternalPD,thenbydefaultvalue
•LGD-PriorizingexternalLGD,theninternalLGD,thenbydefaultvalue
•EAD–Determinedusingadd-onmethod(MtM+add-on) orusingEPEmodels
Same methodology, rules and inputs can be used for IFRS 13
Perimeter
2
Riskbases
Non defaultedderivatives
Basel III
EAD
Add- on
Reconciliation
IFRS 13
EAD
AccountingMtM
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3
Methodology impacts

24. Context
Principles & objectives of the Standards
Impacts & issues
CH&CieOffer
Agenda
1
2
3
4
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25. CH&Cie Regulatory offer and scope of interventionDelivering solutions at all levels
4
CH&Cie Offer
Interpretation of Standards
•CH&Ciehasbuiltupanexpertisecenterconstitutedofexpertsinregulatoryandaccountingstandards
•Wehelpourcustomersininterpretingcorrectlythenormsaswebeneficiatefromalargebenchmarkaswellasexperienceandexpertise
•Ourinterpretationisconductedinatwo-wayapproach
Interpretationandimpactsfromourclient’senvironmentandbusinessperspective
Amoremacro-levelanalysis
Advice at an expertise-level
Implementation
1
2
3
•MorethanjustinterpretingtheStandards,wedeliverandprovideexpertise-leveladviceby
Identifyinghowandwherethestandardswillhaveasignificantimpactforourclients
Stayingup-to-datewiththebestpracticesonaworld-widelevel
Capitalizingonourknow-howandknowledgeatbothRegulationsandriskmanagementlevel
•Wealsodeliversolutionsintermsofimplementingthestandardsby
Managingandsteeringprojectsinordertoputinplacethestandardswithhotdeadlines
Providingassistanceonamoretechnicalpointofview(simulation, testing,…)
Offeringsimpleguidanceandorientationonadailybasis
Follow-up on evolving standards
•Inacomplexandchangingenvironment, wherestandardsandregulationsaredrivenbypoliticalandsocialpressure,standardsareevolvingcontinuously
•Ourexpertisecenterisup-to-datetothelatestandupcomingstandards’evolutions
Optimization
Assistance and help for third parties
4
5
6
•Weprovidesolutionstohelpourcustomersoptimizetheimpactsofthestandardsby
Helpingtobettercalibratemodelsandoptimizetheirefficiency(example–optimizingratingscales)
Identifyingsynergiesbetweenthestandardswhichallowtocapitalizeandenhancewhatisalreadyinuse
Simulatingimpacts&realizingsensitivitiestests.Forexample, StandardizedCVAformulaunderBIIIishighlysensitivetomaturities
•Wealsoprovideassistanceandhelponhottopicsfor
Centralbanksandlocalregulators
Auditors
Internalcontrolfunctions
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26. MONTREAL
12F –1819 BdRene Levesque O.
Montreal, Quebec, H3H2P5
PARIS
20 Rue de la Michaudière
75002, Paris, France
NIORT
19 avenue Bujault
79000 Niort, France
NEW YORK
1441, BroadwaySuite 3015, New YorkNY 10018, USA
SINGAPORE
Level 25, North Tower,
One Raffles Quay, Singapore 048583
HONG KONG
9/F,
KinwickCentre 32 Hollywood Road,
Central, Hong Kong
LONDON
50, Great Portland Street
London EC3V 9EA, UK
GENEVA
Rue de Lausanne 80CH 1202 Genève, Suisse
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