18. 3. 91 Official Journal of the European Communities No C 69/1 
II 
(Preparatory Acts) 
ECONOMIC AND SOCIAL COMMITTEE 
Opinion on the proposal for a Council Directive on capital adequacy of investment firms 
and credit institutions^1) 
(91/C 69/01) 
On 18 June 1990 the Council decided, in accordance with Article 57 (2) of the Treaty 
establishing the European Economic Community, to ask the Economic and Social Committee 
for an Opinion on the abovementioned proposal. 
The Section for Industry, Commerce, Crafts and Services, which was responsible for the 
preparatory work on the matter, adopted its Opinion on 9 January 1991. The Rapporteur 
was Mr R. Pelletier. 
At its 283rd plenary session (meeting of 30 January 1991) the Economic and Social Committee 
adopted unanimously the following Opinion. 
The Committee supports the proposal for a Directive 
and wishes to pay tribute to the quality of the Com­
mission's intellectual analysis of a complex legislative 
area. It would like to take this opportunity to make 
certain remarks which, in its view, have to be made 
and which are intended to be constructive. 
1. Presentation of the Directive 
1.1. Aim of the proposed Directive 
The present proposal for a Directive on the capital 
adequacy of investment firms and credit institutions is 
a necessary follow-up to the proposal for a Directive 
on investment services in the securities field, presented 
by the Commission to the Council on 3 January 1989. 
This proposal is intended to open the way for invest­
ment firms authorized in their home Member States 
to have access to all other Member States' financial 
markets—either by establishing branches, or by provid­
ing services therein—on the basis of certain conditions 
that closely follow those established for credit insti­
tutions in the second banking coordination Directive, 
adopted in December 1989. The aim of this coordination of prudential rules is to 
ensure that both the health of the general financial 
system and individual investors are adequately protect­
ed in the new integrated European market. 
It should also meet three other goals: 
— First, it should establish a broadly level playing field 
between banking and non-banking investment firms 
trading in the securities markets. Consistently with 
this objective, the rules set out in the proposed 
directive should not provide an incentive for an 
investment firm to opt for one institutional struc­
ture, e.g. that of a credit institution rather than 
another. 
— Second, the directive should enhance, or at least not 
impair, the attractiveness of the Community as a 
financial centre. 
— Thirdly, the directive should not restrict access to 
the financial markets in such a manner as to stifle 
competition, innovation and consumer choice. 
1.2. The economic agents concerned 
(!) OJ No C 152, 21. 6. 1990, p. 6. The proposed directive will apply to investment firms 
and credit institutions. 
No C 69/2 Official Journal of the European Communities 18. 3. 91 
1.3. Capital requirements for investment firms which 
are not credit institutions 
The proposal lays down two types of requirements: 
— minimum initial capital requirements for investment 
firms which are not credit institutions, requirements 
for the latter being already fixed by the second 
banking coordination directive, and 
— capital requirements to cover market risks: 
• the first concerning the position risk, 
• the second concerning the foreign exchange risk, 
• the third concerning counterparty/settlement 
risks, and 
• the fourth concerning other risks. 
1.4. Capital requirements for credit institutions 
— For the foreign exchange risk, all credit institutions 
are required to provide additional capital against 
foreign exchange risk if their overall net foreign 
exchange position exceeds 10% of their own funds. 
— As regards market risks, all credit institutions are 
required to set up their own systems to monitor and 
control market risks. 
In addition, as regards market risks, the supervisory 
authorities in each Member State would have to choose 
between two alternative approaches: 
— either to continue to apply the requirements of the 
solvency ratio Directive, 
— or to set capital requirements on the short-term 
'trading books' of credit institutions in accordance 
with the rules for non-credit institutions and in 
substitution for the requirements of the solvency 
ratio Directive. 
Own resources 
For credit institutions the definition of 'own resources' 
is that laid down in Council Directive 89/299/EEC. 
However, Member States may permit credit institutions 
under the 'trading book' option to use an alternative 
definition of 'own resources' which includes a much 
higher proportion of subordinated debt, though a ceil­
ing is laid down with regard to the requirements on 
their trading books. 
For investment firms the competent authorities may 
apply: 
— either the definition of 'own resources' in Council 
Directive 89/299/EEC, 
— or a definition focused more on liquidity than sol­
vency, with illiquid assets being deducted in full 
from capital but with a greater amount of subordi­
nated debt being allowed. 2. General comments 
The Committee feels that the following points are essen­
tial in connection with the aims set out by the proposal: 
2.1. It is stated that the proposed Directive should 
enhance, or at least not impair, the attractiveness of 
the Community as a financial centre. The bank for 
international settlements is currently looking into the 
exchange risks and market risks of credit institutions. 
The end result should be some convergence between 
the Community and international bodies both as 
regards the content of the rules which will be laid down 
and the date on which they are to come into force. 
2.2. The assessment of risk leads to the question of 
consolidation, which has been the subject of a draft 
Council Directive on the supervision of credit insti­
tutions on a consolidated basis replacing Directive 83/ 
350/EEC. In the Committee's view, the treatment of 
prudential risk should be part of a consolidated 
approach. 
Consolidated supervision would make it possible to: 
— carry out a realistic and overall assessment of the 
risks borne by a group and its own funds, and 
— ensure competition on equal terms between banks 
and non-banks. 
For these reasons, the Committee proposes that Article 
3 of the solvency ratio Directive should be included in 
the present proposal as a new Article 4a, subject to the 
necessary terminological adjustments being made. 
2.3. As the proposal aims to offer equivalent options 
to non-bank investment firms and credit institutions 
[Article 4(4)], it would be desirable for the choice 
between these options to come from the firms them­
selves rather than solely from the supervisory authority. 
2.4. For firms other than credit institutions the plan­
ned initial capital requirements (Article 3) are lower 
than those laid down for credit institutions in the second 
banking coordination Directive. 
As credit institutions are less specialized and their activi­
ties are more varied, their risks are dispersed; the second 
Directive has taken this into account, but all the same 
the initial capital requirements are higher. However, the 
Committee recognizes that for certain Member States 
higher levels of minimum initial capital would place a 
burden on many investments firms in the Community. 
Further, the Committee is concerned that higher levels 
of minimum initial capital in the Community would 
18. 3. 91 Official Journal of the European Communities No C 69/3 
give an advantage to transmitters of orders (brokers, 
investment counsellors) in non-EC markets, e.g. New 
York, which have significantly lower capital require­
ments. 
2.5. Other risks (Annex 5): For certain .operators, 
for whom fixed overheads form a significant part of 
expenses owing to the nature of their business, the 
additional requirement with respect to 'other risks' 
would be an excessive burden and out of all proportion 
to the residual risks involved. Such a requirement 
should be relaxed by modifying the basis of assessment 
and/or reviewing the extent to which it should be added 
to other capital requirements when an investment firm 
has an initial capital of more than ECU 5 million. 
3. Specific comments 
The proposal deals with the following basic risks in 
market dealings: 
— the market position risk (Annexes 1 and 2), 
— the counterparty/settlement risk (Annex 3), 
— the foreign exchange risk (Annex 4), and 
— other risks (Annex 5). 
The Committee considers that the resulting own funds 
requirements must: 
— ensure cover for the actual risks involved, 
— ensure equal treatment for banks and non-banks, 
and 
— be as consistent as possible, from the technical point 
of view, with the risk-monitoring instruments which 
already exist in the institutions. 
The Committee therefore proposes: 
For the foreign exchange risk (Annex 4): 
— a definition of positions different from those in 
the proposal and the taking into account of the 
correlations between currencies; 
For the position risk concerning debt instruments 
(Annexes 1 and 2): 
— an analytical approach to market risks which draws 
an explicit distinction between credit risk and rate 
risk and which may be applied to both banks and 
non-banks; 
— a measure of the credit risk which is compatible 
with that used in the solvency ratio Directive 89/ 
647/EEC; and 
— a measure of the rate risk based on the calculation 
of the real sensitivity of positions to changes in 
interest rates. On each of these risks the Committee suggests a number 
of amendments in line with the remarks which follow: 
3.1. The foreign exchange risk 
The rules drawn up to take account of foreign exchange 
positions do not take into consideration either the pecu­
liarities of structural positions or the correlations 
between currencies, particularly those within the Euro­
pean Monetary System (EMS). 
In addition, the proposal adopts a threshold approach. 
This threshold does not represent an exemption limit 
for institutions which have exceeded it. As the own 
resources requirement is based on the position as a 
whole, once the threshold has been exceeded this 
method of calculation introduces a distortion into com­
petition with firms which have not yet exceeded the 
threshold and are therefore exempted from the corre­
sponding own resources requirement. 
3.1.1. Problem of structural positions 
The ratios laid down in the rules make no distinction 
between the structural and the operational position; the 
two are lumped together and treated in the same way. 
The structural position is defined as being that resulting 
from the funds of foreign branches, the securities of 
subsidiaries and holdings expressed in foreign currency 
but financed in domestic currency, and from provisions 
held in domestic currency against claims in foreign 
currency. 
— As regards content, this structural position orig­
inates in durable investments and is therefore made 
up of elements which show real stability in the 
foreign currency. It must therefore be distinguished 
from the operational position, which derives from 
more volatile elements and for which institutions 
lay down risk limits. 
— Besides, funds from branches and holdings in sub­
sidiaries carry a limited risk: 
• in view of the permanence of foreign establish­
ments, 
• to the extent that the value of such funds and 
holdings is based above all on the heritage they 
represent and on their capacity to generate earn­
ings, since any exchange losses on capital funds 
must be offset by the unit's capacity to generate 
more or less significant operating profits in the 
light of local conditions, of which the value of 
the currency is only one factor among others, 
• because such establishments have very often 
invested their own funds in non-monetary assets 
which can provide a sound protection against 
exchange rate developments. 
No C 69/4 Official Journal of the European Communities 18. 3. 91 
Moreover, such treatment of the structural position 
creates distortions of competition at several levels: 
— It penalizes banks with a large international net­
work. 
— It may hamper the development of such a network 
and allow non-European banking competitors to 
close the gap between themselves and European 
banks, as they would not be faced with similar 
constraints. 
— Finally, steps should be taken to avoid both bank 
and non-bank investment firms being faced with 
constraints in their international development that 
they are not faced with in their other sectors of 
activity. 
For all these reasons it seems desirable that the calcu­
lation of the exchange risk should not be applied to 
structural positions. Anyway, the proposed Directive is 
only aimed at market activities i.e. operational positions 
in foreign currency. 
3.1.2. Correlations between currencies 
The method adopted by the Commission holds that 
each currency creates a position and treats all currencies 
in an equivalent manner. 
But there are groups of currencies within which one 
can detect some highly correlated movements. On the 
economic level, therefore, one can consider that there 
are correlations between the currencies in a group which 
generate a lower exchange risk than that between unre­
lated currencies. The main group of currencies that can 
be singled out is that of the EMS, but there are others 
(e.g. the dollar, Canadian dollar group, the yen group, 
etc.). 
Such correlations should be taken into account when 
calculating the exchange risk. 
It is therefore proposed to allow a correlation of 90% 
between the EMS currencies and with the ECU. This 
percentage seems reasonable in view of the fluctuations 
recorded in recent years. 
The directive could also allow the competent authorities 
in the Member States the possibility of replacing the 
flat rates by a correlation rate (or rates) calculated over 
a reasonably long reference period. 
3.1.3. Own funds considered as a refer­
ence for the exchange risk 
It is also necessary that, as regards the exchange risk, 
the competent authorities should be able to authorize 
credit institutions which have to comply with the capital 
requirements corresponding to their exchange risk to use the definition provided for in paragraph 2 of 
Annex 6. 
The Committee therefore proposes that the text be 
changed as follows, as regards the exchange risk: 
Amend the second sentence in Article 4(2) to read: 
'However, Member States may make this require­
ment applicable only to that part of the overall net 
foreign exchange position, calculated in accordance 
with Annex, which exceeds the equivalent of 10% 
of own funds.' 
Add the following to Annex 4: 
— a new paragraph at the end of point 3, reading: 
'However, investments in (i) the funding of branch­
es, (ii) the acquisition of subsidiaries which are 
credit or financial institutions, or (iii) the acquisition 
of holdings in such institutions shall be disregarded.' 
— a new point 3a: 
'Only 10% of the net open position in ECU or any 
currency belonging to the EMS shall be taken into 
consideration.' 
3.2. Position risks 
3.2.1. Debt instruments 
3.2.1.1. Position risk on debt instruments 
The calculation of positions as proposed in Annex 2 
could be improved for institutions which can use a 
system reflecting duration, on condition that this system 
takes account of the counterparty risks. 
The weights used in paragraph 2, which add together 
the credit and rate risks for the same maturity give rise 
to artificial positions for rate risks, for the following 
reasons (see numbered Annex): 
— hedges are heavily penalized and do not reflect 
the object of rate hedging operations which are 
performed on the markets, 
— the application of weights gives rise to very different 
capital requirements for a same group of operations 
each hedging each other, depending on which oper­
ation is taken to be the hedge. 
For these reasons it seems desirable that, as a comp­
lement to the method proposed in paragraph 2 of Annex 
2, the option which is described in paragraph 4 of 
Annex 2 should be set out in greater detail, with the 
rate risk being separated from the credit risk. 
18. 3. 91 Official Journal of the European Communities No C 69/5 
The method adopted would separate clearly the credit 
risk from the rate risk. 
The credit risk would be calculated on the basis of the 
weights adopted by the solvency ratio. 
The total of the weighted amounts would be covered 
by a capital amount of 2%. 
The rate risk would be based on a calculation of the 
sensitivity of market instruments to two variations in 
rates: the first variation would be of 1% and concern 
positions with a residual life of less than one year, while 
the second variation would be of 0,25% and concern 
positions with a residual life of more than one year. 
The aggregates of the rate risks in the different currenc­
ies would be the subject of partial setting-off for cur­
rencies belonging to the same currency area (EMS cur­
rency). 
3.2.1.2. Number of maturities in the formula for calcu­
lating positions on debt instruments 
For both options there seems to be too many maturities 
without any corresponding improvement in risk assess­
ment. A reduction in the number of maturities seems 
desirable, especially as each passage from one band to 
another leads to disparities when calculating capital 
requirements. 
3.2.2. Equities (Annex 2, paragraphs 5 and 6) 
3.2.2.1. More explanation must be given of the way 
in which account is taken of operations to hedge equity 
portfolios through index contracts or index options. 
Full authorization should be given to hedging using 
instruments derived from equities and to operations 
involving convertible bonds. 
3.2.2.2. Units in unit trusts and mutual investment 
funds in currencies or bonds basically hold assets which 
are sensitive to variations in rates. Such instruments 
are treated as shares in the proposal, which seems 
economically illogical. They should be given special 
treatment, as the risk to be assessed is one of rates. 3.3. Underwriting of debt and equity instruments and 
risk concentration (Annex 2, paragraphs 7, 8 
and 9) 
Capital requirements should be reduced so as not to 
discourage the guarantees of the primary market (para­
graph 8). 
The present wording of paragraph 9 should be 
improved by taking into account the quality of the 
issuers. It also seems essential to exempt from this 
rule issues by Member States of the Organization for 
Economic Co-operation and Development (OECD) and 
those by countries which have concluded special loan 
agreements with the International Monetary Fund 
(IMF) within the framework of the general agreements 
to borrow (GAB) of the IMF. 
3.4. Counterparty/settlement risk (Annex 3, para­
graph 4) 
This risk must not apply to OTC derivative instruments 
as it has already been taken into account in the weights 
for market risks. 
3.5. Own funds requirement 
3.5.1. The foreign exchange risk (Annex 4) 
The 8% capital requirement laid down in paragraph 1 
of Annex 4 is not based on a statistical study of the 
daily variation of parities, but seems to be taken over 
from the solvency ratio, which concerns the credit risk 
more than the exchange risk. The figure of 8% seems 
far too high for the risk involved if one considers 
positions which are re-assessed daily. The European 
standard which is to be laid down will, whatever hap­
pens, have to be internationally accepted. 
3.5.2. Own funds used for calculating 
market risks (Annex 6, paragraph 2) 
The rule in paragraph 5(2) of Annex 6 stipulating that 
subordinated debt may not be repaid if such repayment 
would mean that the own funds of the firm in question 
would then stand at below 120% of the firm's overall 
requirement should be deleted. Such wording, if it were 
applied to all the own funds requirements of credit 
institutions (the solvency ratio), would nullify the pro­
visions of paragraph 2 in Annex 6, the aim of which is 
to align the definitions of own funds for investment 
firms with those for credit institutions. 
No C 69/6 Official Journal of the European Communities 18.3.91 
In addition, in paragraph 2 of Annex 6, the limit of 
25% of the total amount of own funds which would 
result from applying Council Directive 89/299/EEC is 
too low. 
4. Conclusion 
The completion of the Single Market in the financial 
sector, which is scheduled for the end of 1992, requires the harmonization of the basic elements of the pruden­
tial rules in the different Member States. 
In view of the differences in status of investment firms, 
the Committee considers it essential that the proposed 
capital adequacy Directive respect this principle: the 
same type of activities lead to the same type of risk, and 
must be governed by the same prudential requirements. 
This is the spirit behind the Committee's suggestions. 
Done at Brussels, 30 January 1991. 
The Chairman 
of the Economic and Social Committee 
Francois STAEDELIN 
APPENDIX 
EXAMPLE 
The penalties imposed on hedging operations are very heavy and are out of keeping with the aim of hedging 
in markets. 
The proposed directive lays down a capital requirement even though the rate risk is fully covered. 
Let us take the following example: 
'A portfolio of transactions made up of 1) a five-year government bond for ECU 100 million covered 
rate-wise by a short position in a futures contract for ECU 100 million (taken out with a credit institution 
for 5 years) and 2) a position in negotiable securities to the value of ECU 100 million covered by an 
interest rate swap of ECU 100 million (taken out with another credit institution for a period of 5 years)'. 
Calculation in accordance with the proposed capital adequacy directive 
Government loan 2,9% of 100 
Notional futures (*) contract 2,9% of 100 
Negotiable security 4,9% of 100 
Interest rate swap 4,9% of 100 
Reduction of total own funds requirement due to hedging 
Government loan by futures contract: 150% of 2,9 = 4,35 
Negotiable asset by interest rate swap: 120% of 4,9 = 5,88 
Total own funds requirement: (2 x 2,9) + (2 x 4,9) - 4,35 - 5,88 = 5,37. 
N.B.: According to the solvency ratio, the calculation would be as follows: 
Government loan and futures contract 
Negotiable assets [(100 x 20%) x 8%] 
Swap for 5 years [(100 x 20% x 4%) x 8%] x 50% 0 
1,6 
0,032 
1,632 
(*) Notional contract refers to a standardized fictitious fixed-
rate government debt issue 
18. 3. 91 Official Journal of the European Communities No C 69/7 
Swap operations are heavily penalized 
In the case of a swap backed by another swap, for which there is no interest rate risk, the text calls for a 
large amount of capital to cover market risk. 
Thus 2 back-to-back swaps for ECU 100 million concluded with two companies in the column 'other public 
sector and qualifying'. 
Calculation in accordance with the proposed capital adequacy directive (millions of ECU) 
1. Position risk 
Payer of fixed rate swap 100 x 6,8% 6,8 
Receiver of fixed rate swap 100 x 6,8% 6,8 
13,6 
Cover 
Swap 100 x 6,8 x 120% 8,16 
Own funds requirement 13,6 — 8,16 5,44 
2. Settlement-delivery risk 
Assuming that the market value of two rate swaps is identical (except for their signs being opposite) and 
equal to ECU 6,8 million (sensitivity of two rate swaps to a rate variation of 1%): 
[6,8 x (0,5 x 100)] x 2% = 0,146 
Therefore the total cost in own funds is: 
5,44 + 0,146 = 5,586. 
N.B.: According to the solvency ratio, the calculation would be as follows: 
2 (100 x 9 x 20%) x 8% x 50% = 0,144. 
Difference between the two methods: 
To cover solely a counterparty risk, the proposed capital adequacy directive would require additional own 
funds of: 
(5,586 - 0,144) = 5,442 for ECU 200 million. 
which means that the gap is proportional to the nominal amount of the back-to-back rate swaps and penalizes 
institutions indirect proportion to the rate swaps in their portfolios.