COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 13.02.1998 
COM(1998) 90 final 
97/0124 (COD) 
AMENDED PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL 
DIRECTIVE AMENDING DIRECTIVE 93/6/EEC ON THE CAPITAL 
ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS 
(COM(97)71 final 
(presented by the Commission pursuant to Article 189 a (2) 
of the EC-Treaty) 

EXPLANATORY MEMORANDUM 
I. INTRODUCTION 
The proposal for a Directive concerned by this amended proposal was submitted to 
Parliament and the Council on 17 June 1997 pursuant to Articles 189b(2) and 57(2) of the 
EC Treaty. 
The Economic and Social Committee handed down a favourable opinion at its 349th 
plenary session on 29 October 1997. Two of its suggestions (regarding the length of the 
transitional period and back-testing) have been incorporated into the amended proposal, 
Parliament having adopted an amendment to that effect. 
Parliament adopted (first reading) the legislative resolution giving its opinion on the 
proposal for a Directive (COM(97)71 final) at its sitting on 18 December 1997. 
Parliament's opinion comprises 10 amendments; they have been included in this amended 
proposal. 
II. COMMENTS ON THE AMENDMENTS 
Parliament called on the Commission to amend nine points in the proposal for a Directive. 
The Commission considers the amendments to these points to be acceptable. 
The first and second amendments extend the transitional provisions for the use of 
alternative spread, carry and outright rates for commodities risk until the end of 2006 
(recital 8 and Article. 1, paragraph 5a). The European Parliament has proposed this 
extension in order to give those institutions intending to use internal models for 
commodities risk more time to develop appropriate systems and improve their internal 
control environment. This accords with a suggestion made by the Economic and 
Social Committee in its opinion. The Commission accepts that this extension is 
justified because of the difficulties of introducing internal models for some financial 
institutions trading in commodities. 
The third amendment (Annex VIII, paragraph 3) provides more detail on how back-
testing should be undertaken. The Commission has accepted these specifications 
propose:! hy the iv-rof/iiin Parliament, because they make the provisions clearer, 
. particularly wiîh rentra to the frequency of the back-tests required. 
The f«gjrik ffiEBtt iiirAh JE rjseRd races &< (Annex VE!l, paragraph 4a and Annex Vfll 7a & 
[*.) introduce additional, conditions required to permit the use of internal models (or 
calculating regulatory capital (or specific risk as well as additional arrangements 
regarding the multiplication factor in the context of specific risk. The European 
Parliament has proposed these provisions following adoption of such rules by an 
international forum of banking supervisors. The Commission agrees with the inclusion 
of these provisions in order to avoid competitive disadvantages for EU institutions. 
The fifth amestcfraeitt was introduced by Parliament to clarify that institutions whose 
models do not meet the extra conditions with respect to specific risk as introduced by 
the fourth amendment must continue to calculate capital requirements for specific risk 
according to Annex I of the original directive. The Commission agrees that this is a 
helpful clarification. 
Amendments srr, seven znd eight provide further explanation of how back-testing 
should operate in relation to the application of the "plus factor". In particular they 
specify that for the purposes of calculating the "plus factor" back-testing may be done 
on either actual or hypothetical (assuming unchanged end-of-day positions) results and 
that the value-at-risk calculated by the model must correspond to a one day holding 
period for the portfolio. !n addition they provide competent authorities with the option 
to waive the "plus factor" in particular circumstances, they impose sanctions if back-
testing shows the mode! to be inadequate and they specify reporting requirements. 
These amendments proposed by the Parliament rellect similar recommendations by the 
Economic and Social Committee in its opinion. The Commission considers that the 
clarifications are helpful in substance but has made some minor adaptations to the text 
proposed by the Parliament in order to achieve consistency and notably to avoid 
duplication with parts of amendment 3. 
2> 
AMENDED PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL 
DIRECTIVE AMENDING DIRECTIVE 93/6/EEC ON THE CAPITAL 
ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS 
(COM(97)71 final 
Original Proposal Amended Proposal 
Amendment 1 
8th recital 8th recital 
Whereas some investment firms dealing Whereas some investment firms dealing 
primarily in commodities and commodity primarily in commodities and commodity 
derivatives may not yet be able to use derivatives may not yet be able to use 
internal models or to comply with the internal models or to comply with the 
capital requirements for commodities risk capital requirements for commodities risk 
as laid down in this Directive; whereas it is as laid down in this Directive; whereas it is 
expected that appropriate, cost effective expected that appropriate, cost effective 
internal models for investment firms on the internal models for investment firms on the 
risk management of commodities and risk management of commodities and 
commodities derivatives, in particular for commodities derivatives, in particular for 
options, will be available shortly; whereas, options, will be available shortly; whereas, 
in order to give those firms sufficient time in order to give those firms sufficient time 
to upgrade their risk management systems, to upgrade their risk management systems, 
competent authorities, under certain competent authorities, under certain 
conditions, should not be obliged to conditions, should not be obliged to 
prescribe the capital charges for prescribe the capital charges for 
commodities referred to in Annex VII to commodities referred to in Annex VII to 
Directive 93/6/EEC for investment firms Directive 93/6/EEC for investment firms 
before 1 January 2000. until after 31 December 2006. 
k 
Original Prtip-es&l Amended Proposal 
Amendment 2 
Article t, paragraph 5a (new) 
Article Ha is inserted: 
"Article 11a 
Up to 31 December 2006, Member States 
may authorize their institutions to use the 
minimum spread, carry and outright rates 
indicated in the following table rather than 
those indicated in Annex VII. 13, 13.a, 16 
and 16.a, provided that those institutions, 
in the opinion of the competent authorities: 
- carry out a significant volume of 
transactions in commodities; 
have a diversified portfolio of 
commodities; 
- are not yet in a position to employ 
internal models as part of their risk 
management system for the calculation of 
the capital requirements in relation to their 
commodities position in accordance with 
Annex VIII. 
t> 
Minimum spread, carry and outright rates 
Precious Nase Perishable Other 
mclals rJltL1!Ls goods goods 
(exccrtl (agricultural inc. 
gold) products) energy 
products 
Spread 1.0 1.2 1.5 ]_.5 
Rale (%) 
Carry rate 03 • 05 06 06 
m 
Outright 8 \0 \1 \5 
Rate (%) 
Member States applying this Article shall 
provide the Commission with the necessary 
information." 
Original Proposal Amended Proposal 
Amendment 3 
Annex VIII, paragraph 3 Annex VIII, paragraph 3 
3. The competent authorities shall also be 3. The institution shall monitor the 
satisfied that the institution's models accuracy and performance of its model by 
continue to be reasonably accurate, as conducting a back-testing programme. The 
evidenced by a regular back-testing back-testing has to provide for each 
programme to be conducted by the business day a comparison of the one day 
institution. value-at-risk measure generated by the 
institution's model for the portfolio's end-
of-day positions with the one day change of 
the portfolio's value by the end of the 
subsequent business day. Competent 
authorities shall monitor the development 
by institutions of the capability to perform 
back-testing on both actual and 
hypothetical changes in the portfolio's 
value. Back-testing on hypothetical 
changes in the portfolio's value is based 
upon a comparison between the portfolio's 
end-of-day value and, assuming unchanged 
positions, its value at the end of the 
subsequent day. 
^r 
Origmal Proposal Amended Proposal 
Amendment 4 
Annex VIII, paragraph 4a (new) 
4a. l;or the purpose of calculating capita 1 
requirements for specific risk associated 
with traded debt and equity positicns_the 
competent authorities may recognise the 
use of an institution's internal model if in 
addition to compliance with the conditions 
in the remainder of this Annex the model: 
- explains the historical price variation in 
the portfolio, 
- captures concentration in terms of 
magnitude and changes of composition of 
the portfolio, 
- is robust to an adverse environment, and 
- is validated through back-testing aimed at 
assessing whether specific risk is being 
accurately captured. If competent 
authorities allow this back-testing to be 
performed on the basis of relevant sub-
portfolios these must be chosen in a 
consistent manner. 
t 
Original Proposai Amended Proposal 
Amendment 5 
Annex VIII, paragraph 5 Annex VIII, paragraph 5 
5. Notwithstanding ruimgraph _ l_, 5. Institutions using internal models which 
institutions using models shall be subject to are not in accordance with paragraph 4a 
a separate capital charge to cover the shall be subject to the separate capital 
specific risk of traded debt instruments and charge in respect of the specific risk 
equities as described in Annex 1 to the calculated according to Annex I. 
extent that the competent authorities 
consider that this risk is not incorporated 
sufficiently into their models. The 
competent authorities shall in any case set a 
minimum specific risk charge of 50% of 
the charge as calculated according to 
Annex I for institutions using models. 
Original Proposal Amended Proposal 
Amendment 6 
Annex VIII, paragraph 7 - second sub- Annex VIII, paragraph 7- second sub­
paragraph paragraph 
The value-at-risk number calculated by The value-at-risk number calculated by 
means of the model shall be compared with means of the model shall be compared with 
the actual change in value of the portfolio, the actual change in value of the portfolio. 
Rack-testing shall be carried out daily on Back-testing shall be carried out daily on 
the basis of both effective and, assuming the basis of actual or, assuming unchanged 
unchanged end-of-day positions, hypo- end-of-day positions, hypothetical changes 
thetical changes in the portfolio value. in the portfolio value. The value-at-risk 
number subject to the backtesting must 
correspond to a holding period of one day. 
Before using an internal model to 
determine its own funds, the institution 
shall also obtain the approval of the 
competent authorities, inter alia, for the 
type of changes (actual or hypothetical) to 
be used in its backtesting. The institution 
must also apply the method selected 
consistently. 
>o 
Original Proposal Amended Proposal 
Amendment 7 
Annex VIII, paragraph 7 - second sub- Annex VIII, paragraph 7- third sub­
paragraph paragraph 
If the change in portfolio value exceeds the If the change in portfolio value exceeds the 
value-at-risk calculated using the model, value-at-risk calculated using the model, 
the target has been overshot. The number the target has been overshot. The number 
of overshoot ings, as set out in table 5, shall of overshootings, as set out in Table 5, 
be based on a spot check of 250 values. shall be based on a statistical sample of 
daily values covering the 250 most recent 
working days. 
For the purpose of determining the 'plus' 
factor, the number of overshootings shall 
be determined at least quarterly 
Original Proposal Amended Proposal 
Amendment 8 
Annex VIII, paragraph 7 - last three Annex VIII, paragraph 7- last three 
sub-paragraphs sub-paragraphs 
The competent authorities can, in "The competent authorities can, in 
individual cases, waive the requirement to individual cases, waive the requirement to 
add a plus factor if, owing to an increase the multiplication factor by the 
exceptional situation, an increase in the "plus'Maetor in accordance with 'Table 5 if 
multiplication factor would be unjustified the institution has demonstrated to the 
and the model is basically sound. In this satisfaction of the competent authorities 
context, the institution has lo prove that an that such an increase is unjustified and that 
increase would be unjustified. the model is basically sound. 
, ., . p • , .. If numerous overshootings indicate that the 
In the event of numerous overshootings, 6 
the competent authority shall revoke the model is not sufficiently accurate, the 
, ,, ... . . competent authorities shall revoke the 
model s recognition or impose appropriate v 
,1 . .i , i • model's recognition or impose appropriate 
measures to ensure that the model is & r rr v improved promptly. 
The institution is to record all 
overshootings ascertained by back-testing, 
together with the reasons for them, and to 
notify the competent authorities 
immediately of the extent of the 
overshootings and the reasons for them. measures to ensure that the model is 
improved promptly. 
The institution is to record all 
overshootings ascertained by back-testing, 
together with the reasons for them, and to 
notify the competent authorities, without 
undue delay, and in any case no later than 5 
working days after the day on which the 
error was noted. 
Original Proposal Amended Proposal 
Amendment 9 
Annex VIII, paragraph 7a & b (new) 
7a. If for the purpose of calculating capital 
requirements for specific risk the 
institution's model is recognised by the 
competent authorities in accordance with 
paragraph 4a, the multiplication factor to 
be applied to the specific risk portion of the 
institution's value-at-risk measure shall be 
increased to 4. If the institution's back-
testing indicates that the model does not 
sufficiently accurately capture specific risk 
the competent authorities shall revoke the 
model's recognition for the purpose of 
calculating capital requirements for 
specific risk or impose appropriate 
measures to ensure that the model is 
improved promptly. 
7b. The competent authorities may waive 
the requirement pursuant to paragraph 7a. 
for an increase of the multiplication factor 
to 4 if the institution demonstrates that in 
line with agreed international standards its 
model adequately captures also, inter alia, 
the event and default risk for its traded debt 
and equity positions. 
i3> 

ISSN 0254-1475 
COM(98) 90 final 
DOCUMENTS 
EN 09 08 10 
Catalogue number : CB-CO-98-095-EN-C 
ISBN 92-78-31196-0 
Office for Official Publications of the European Communities 
L-2985 Luxembourg 
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