PROPOSAL FOR A COUNCIL DIRECTIVE ON CAPITAL ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS
Date: 1990-05-23
Institutions: European Commission
Subjects: credit guarantee, credit institution, financial instrument, financial solvency, management audit, share capital

COMMISSION  OF  THE  EUROPEAN  COMMUNITIES 

C0MC90) 141 final- SYN'257 

Brussels,  23 May  1990 

Proposal  for a 

COUNCIL  DIRECTIVE 

on  capital  adequacy  of 

investment  firms and  credit  institutions 

(presented  by the  Commission) 

EXPLANATORY  MEMORANDUM 

GENERAL  CONSIDERATIONS 

1.  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  (on  which 

there  is  already  an  amended  proposal  presented  by  the  Commission  on  8 

February  1990  after  the  advice  of  the  European  Parliament  and  the 

Economic  and  Social  Committee). 

The  proposal  for  a  directive  on  Investment  Services  is  intended  to  open 

the  way  for  investment  firms  authorized  in  their  home  Member  States  to 

have  access  to  all  other  Member  States'  financial  markets  -  either  by 

establishing  branches, or  by  providing  services,  therein  - on  the  basis 

of  certain  conditions  that  closely  follow  those  established  for  credit 

Institutions  In  the  Second  Banking  Coordination  Directive,  adopted  In 

December  1989.  According  to  the  programme  set  out  In  the  White  Paper 

"Completing  the  Internal  Market",  these  freedoms  should  be  based  on 

coordination  of  key  rules  as  regards  the  authorization  and  the  on-going 

supervision  of  financial  Institutions. 

2.  The  coordination  must  be  such  as  to  ensure  that  the  main  objective  of 

the  proposal  -  to ensure  that  both  the  health  of  the  general  financial 

system  and  Individual  investors  are  adequately  protected  In  the  new 

Integrated  European  market  -  Is  achieved.  It  should  also  meet  two 

-  2  -

other  goals.  First,  it  should  establish  a  broadly  level  playing  field 

between  non-bank  investment  firms  and  credit  institutions  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  structure,  e.g.  that  of  a 

credit  Institution  -  rather  than  another.  Second,  the  Directive  should 

enhance,  or  at  least  not  Impair,  the  attractiveness  of  Europe  as  a 

financial  centre. 

Capital 
Institutions 

requirements  for 

investment  firms  Which  are.  Dût  credit 

3.  The  proposal  establishes  minimum  Initial  capital  requirements  for 

Investment  firms  which  are  not  credit  Institutions,  requirements  for  the 

latter  being  already  fixed  by  the  Second  Banking  Directive. 

These  have 

been  set  at  levels  which  ensure  that  when  It  starts  its  activities,  an 

Investment  firm  has  sufficient,  Initial  financial  resources  in  view  of 

the  nature  of  its  business  and  second,  which  do  not  form  unnecessary 

barriers  to  the  entry  Into  the  market  of  new  firms.  Accordingly, 

different  amounts  are  established  for  different  kinds  of  investment 

firms,  taking  into  account  the  types  of  business  carried  out  by  them. 

4.  The  initial  capital  requirements  for  firms  which  are  not  credit 

institutions  are  lower  than  those  laid  down  for  credit  institutions  in 

the  Second  Banking  Coordination  Directive.  This  Is  for  two  reasons. 

First,  investment  firms  which  are  not  credit  Institutions  typically  are 

more  specialized  than  credit  institutions;  the  latter  engage  In  a  wider 

variety  of  activities  and  thus  need  higher  initial  capital.  Second, 

under  Annex  5  of  the  present  Directive,  investment  firms  which  are  not 

credit  institutions  are  also  required  to  hold  "base  capital"  equivalent 

to  three  months'  of  their  fixed  overheads,  a  requirement  which  takes 

account  of  the  wide  variation  in  the  size  of  non-bank  Investment  firms. 

5.  In  order  to  provide  for  the  ongoing  financial  soundness  of  such  firms, 

capital  requirements  are  set  to cover  the  market  risks  to which  they  are 

exposed. 

-  3  -

5.1  The  first  requirement  is  the  position  risk  requirement  (Annexes  1 

and  2 ).  According  to  the  rules proposed,  each  firm  must  keep  in the 

form  of  capital  a  certain  percentage  of  Its  long  and  short 

positions,  after  allowance  has  been  made  for  hedging  and  netting. 

This  percentage  varies  according  to  the  nature  of  the  Instruments  in 

which  the  firm  has  a  position  and  according  to  the  credit-standing 

of  the  issuers concerned.  This  requirement  is  intended  to cover  the 

risk  of  adverse  price  movements  In  the  underlying  securities 

whatever  their  cause  (e.g.  Interest  rate  risk  changes  or  shifts  In 

an  issuer's  credit  worthiness). 

5.2  Second,  there  is a  foreign  exchange  risk  requirement  which  is set  In 

relation  to  a  firm's  vulnerability  to  losses  arising  purely  from 

adverse  exchange  rate movements.  This  is  laid  down  in Annex  4. 

5.3  The  third  requirement  relates  to  unsettled  transactions,  i.e.  to 

transactions  in  which  one  or  other  party  has  not  paid  for  the 

securities  it  has  contracted  to  buy  or  not  delivered  the  securities 

it  has  contracted  to  sell.  In  such  a  situation,  there  is  a  risk 

that  the  counterparty  will  not  be  able  to  carry  out  Its obligations 

and  also  a  risk of  a malfunctioning  of  the  settlement  system  itself; 

In either  of  these  cases  the  firm  may  suffer  a  loss. 

5.4  Finally  there  Is the  "base"  requirement  In Annex  5,  under  which  each 

firm  Is  required  to  hold  own  funds  equivalent  to one  quarter  of  the 

previous  year's  fixed  overheads.  This  requirement  is  intended  to 

cover  all  other  risks  faced  by  investment  firms, e.g.  the  risk  that 

market  turnover  collapses  reducing  a  firm's  broking  income  to  a 

level  insufficient  to cover  its expenses. 

-  4  -

Capital  requirements  for  credit  Institutions 

6.  The  scope  of  the  proposed  Directive  extends  to  all  credit  Institutions, 

including  those  which  are  not  Investment  firms.  This  is because  several 

of  the  main  risks  dealt  with  by  the  Directive,  such  as  the  risk  of 

losses  from  Interest  rate  and  exchange  rate  movements,  apply  to  their 

traditional  activities  such  as  deposit  taking  and  lending,  as well  as  to 

their  investment  business.  In  consequence  not  only  should  the  entire 

business  of  credit  Institutions which  are  Investment  firms be  supervised 

In  respect  of  these  risks,  but  also  that  of  those  which  are  not 

investment  firms. 

7.  As  regards  provision  against  market  risks  on  securities  positions,  the 

Directive  has  to  take  account  of  the  capital  requirements  imposed  by  the 

Solvency 

Ratio  Directive 

(Council 

Directive 

89/647/EEC), 

which 

Implicitly  make  some  provision  for  risks  other  than  credit  risks.  It 

would  thus  be  inappropriate  to  require  credit  institutions  already 

meeting  the  Solvency  Ratio  Directive  to  provide  additional  capital 

against  market  risk  in  general;  to  do  so  would  put  them  at  a 

disadvantage  in comparison  with  non-bank  investment  firms  from  elsewhere 

In the  Community  and  in third  countries. 

8.  The  Directive  therefore  offers  a  choice  of  two  main  options  in  respect 

of  credit  institutions.  Under  both  of  these  options,  alI  credit 

Institutions  are  required  to  :-

(I) 

provide  additional  capital  against  foreign  exchange  risk  In 

accordance  with  the  rules  laid  down  in  Annex  4,  unless  their 

foreign  currency  open  positions  are  subject  to  a  limit 

calculated  as  a  percentage  of  their  own  funds  (Article  4 (2)). 

(This  is  necessary  because  the  Solvency  Ratio  Directive  does 

not  explicitly  take  account  of  foreign  currency  risks); 

(II) 

set  up  their  own  systems  to  monitor  and  control  market  risks 

(other  than  foreign  currency  risk)  on  their  overall  business 

(Article  4 (3); 

-  5  -

9.  However,  as  regards market  risk on  open  positions  in equities  and  fixed-

rate  securities  and  counterparty  risk,  Article  4  (4)  allows  the 

supervisory  authorities  in  each  Member  State  to  choose  between  two 

alternative  approaches:  -

either 

(a)  to  continue  to  apply  the  requirements  of  the  Solvency 

Ratlo Direct ive; 

or 

(b)  to  set  capital  requirements  on  the  short-term  "trading 

books"  of  credit  institutions,  calculated  in  accordance 

with  the  rules  for  non-credit  institutions  as  set  out  in 

Annexes  1  -  3  of  the  Directive  In  substitution  for  the 

requirements  of  the  Solvency  Ratio  Directive.  For  this 

purpose  a  definition  of  the  "trading  book"  is  given  In 

Article  2 of  the  Directive. 

10.  The  supervisory  authorities  of  credit  institutions  may  choose  either  to 

apply  one  of  the options  to all  the  credit  Institutions  in  their  charge, 

or  to  decide  which  of  their  credit  Institutions  should  apply  which 

system  on  a  case-by-case  basis. 

11. The  provision  of  the  "trading  book" option  allows  credit  Institutions  to 

have  their  capital  requirements  in this  area  of  business  measured  In  the 

same  way  as  Investment  firms  which  are  not  credit  institutions.  In  this 

way  the  trading  book  option  is  consistent  with  the  goal  of  ensuring  a 

broadly  level  playing  field  between  those  investment  firms  which  are, 

and  those  which  are  not,  credit  institutions.  It  is  also  desirable  on 

prudential  grounds,  because  the  requirements  in Annexes  1 to  3 provide  a 

more  comprehensive  treatment  of  the  various  risks  In  investment  services 

business  than  the  Solvency  Ratio  Directive,  which  is  mainly  concerned 

with  credit,  as opposed  to market,  risks. 

-  6  -

Own  Resources 

12.  The  definition  of  "own  resources"  for  credit 

Institutions,  and 

investment  firms  which  are  not  credit  institutions,  is  dealt  with  in 

Annex  6  of  the  Directive.  In  the  case  of  credit  Institutions  the 

definition 

Is  the  same  as  that 

laid  down  in  Council  Directive 

Nfi 89/299/EEC.  This  definition  Is  dictated  by  the  need  to  ensure  the 

long-run  solvency  of  credit  institutions  -  a  need  based  In  part  on  the 

Illiquid  nature  of  most  of  their  assets  -  In  order  to  realize  the 

fundamental  supervisory  goals  of  depositor  protection  and  the  stability 

of  the  financial  system. 

13.  However  Member  States  may  permit  credit  Institutions  under  the  "trading 

book"  option  to  use  an  alternative  definition  of  "own  resources"  with 

regard  to  the  requirements  on  their  trading  books.  This  Includes  a  much 

higher  proportion  of  subordinated  debt  than  In  the  previous  definition, 

though  a  ceiling  is  placed  on  such  debt  so  that  the  key  supervisory 

goals  are  not  compromised.  The  provision  of  the  alternative  definition 

allows  such  credit  institutions  to  more  easily  meet  the  volatile  own 

resources  requirements  associated  with  their  trading  positions,  and 

ensures  that  the  nature  of  their  own  resources  is  broadly  similar  to 

that  for  Investment  firms  which  are  not  credit  institutions  using  the 

"alternative  definition"  described  in paragraph  14. 

14.  The  competent  authorities may  apply  the  definition  of  "own  resources"  In 

Council  Directive  89/299/EEC  to  this  latter  group,  or  an  "alternative 

definition".  This  alternative  definition  is  focussed  more  on  liquidity 

than  solvency;  thus  Illiquid  assets  are  deducted  in  full  from  capital, 

but  a greater  amount  of  subordinated  debt  is allowed.  The  highly  liquid 

nature  of  such  firms'  assets  means  that  requiring  them  to  provide 

capital  In this  form  against  the  risks  they  run  Is fully  consistent  with 

the  fundamental  objectives  of  securities market  supervisors.  It  is  also 

In  line with  the  approach  adopted  by  US  securities  market  supervisors. 

-  7  -

COMMENTS ON THE INDIVIDUAL  ARTICLES 

Article 1 

15.  This  provides  for  all  investment  firms,  as  defined  in  the  Council 

Directive  on  Investment  Services  (.../...  EEC),  and  for  all  credit 

institutions  subject  to  the  requirements  of  the  Council  Directive  on  a 

Solvency  Ratio  for  Credit  Institutions  89/647/EEC,  to  be  within  the 

scope  of  this  Directive. 

A r t i c le  2 

16.  This  Article  defines  certain  terms  used  in  the  Directive,  which  are  not 

defined  or  explained  in  the  Investment  Services  Directive. 

Article  3 

17.  Levels  of  Initial  and  minimum  capital  are  laid  down  here  for  investment 

firms 

that 

are  not 

credit 

Institutions.  The  purpose  of 

such 

requirements  Is  to  ensure  that  such  firms  have  enough  starting  capital 

to  begin  business  in  the  provision  of  the  services  they  have  been 

authorized  to  supply.  Two  categories  of  such  firms  are,  however, 

excluded 

from 

both 

these  obligations  and 

the 

business-related 

requirements  referred  to  in  Article  4.  These  are  local  firms  and 

investment  advisers.  They  are  excluded  because  their  failure  poses  no 

threat  to  investors,  or  to  the  general  stability  of  the  financial 

system. 

18.  Allowance  is  made  for  firms  in  existence  at  the  time  the  Directive  is 

implemented  which  fail  to meet  the minimum  levels  stipulated  for  them  in 

the  Article,  and  also  for  firms  whose  Initial  capital  falls  short  after 

Its  Implementation  due  to  losses.  These  provisions  broadly  mirror  those 

In  the  Second  Banking  Coordination  Directive,  although  an  additional 

clause  allows  very  small  firms  to  continue  In existence  in  cases  where, 

as  a  result  of  the  death  of  the owner,  control  shifts  to  an  heir. 

Article  4 

19. This  Article  describes  in  general  terms  the  financial  requirements  for 

firms  covered  by  the  Directive.  An  important  distinction  Is  made 

between  those  Investment  firms  which  are  not  credit  Institutions  and 

those  which  are.  The  former  firms  are  required  to  put  up  capital 

against  each  of  the  risks  identified  In  the  Directive,  In  the  manner 

laid  down  in  Annexes  1  to  5.  Their  overall  requirement  is  the  sum  of 

the  requirements  laid  down  in  each  of  these  Annexes. 

20.  The  requirements  for  credit  institutions  differ  in  a  number  of  respects 

from  those  for  non-banks.  First,  by  contrast  to  investment  firms  which 

are  not  credit  Institutions,  they  are  not  required  to  provide  capital 

against  the  'other  risks'  catered  for  in Annex  5,  such  as  the  risk  of  a 

fall  In  general  market  turnover  and  an  Individual  bank's  broking  income 

failing  with  it.  This  exclusion  Is  justified  on  the  basis  that  such 

risks  are  de  minimis  for  most  credit  institutions,  whereas  they  are 

often  of  paramount  importance  for  other  investment  firms.  Second,  in 

regard  to  their  credit  institutions,  Member  States  may  choose  to  impose 

a  limits,  instead  of  a  capital  requirements,  system,  to  protect  against 

foreign  exchange  risk.  The  provision  of  the 

limits  option 

is 

justifiable  because  the  capital  requirements  In  the  Solvency  Ratio 

Directive  already  take  some  account  of  this  risk.  Third,  all  credit 

institutions  are  obliged  to  establish  internal  systems  to  monitor  and 

control  the  market  risks  associated  with  their  business  in  toto,  and  not 

simply  those  associated  with  their  securities  trading  activities. 

Finally,  Member  States  supervisors  are  given  the  choice  of  Imposing 

either  the  Solvency  Ratio  Directive  requirements  to  their  credit 

institutions'  trading  activities  In  bonds  and  equities,  or  the 

requirements  for  non-banks  detailed  in Annexes  1 to  3. 

9 -

A r t i c le  5 

21. A  mark-to-market  valuation  of  positions on  a  daily  basis  is  required  by 

this  Article,  except  in  the  case  of  credit  institutions  which  are 

subject  to  the  Solvency  Ratio  Directive  requirements  on  all  of  their 

bus Iness. 

Article 6, 

22.  This  Article  lays  down  both  the  type,  and  the  frequency,  of  the 

Information  a  firm  must  provide  its competent  authorities. 

Article  7 

23.  Under  this  Article  Member  States  are  required  to  nominate  one  or  more 

authorities  to  grant  authorizations  and  to  carry  out  the  various 

supervisory  tasks  envisaged  by  the  Directive. 

24.  It  stipulates  that  It  is  also  open  to  a  Member  State  to  nominate 

professional  associations  to  act  in  this  role,  provided  that  their 

status  is  recognized  in  the  overall  statutory  scheme  of  supervision  in 

the  country  concerned. 

25. Where  several  authorities  have  been  nominated  in  a  given  Member  State 

for  the  purposes  of  the  Directive  they  are  required  to  cooperate  closely 

In order  to ensure  an  adequate  level  of  supervision. 

Article  8 

26. This  Article  permits  amendments  to  be  made  to  the  Directive's  rules  in 

certain  areas  by  use  of  a  committee  procedure.  It  Is  modelled  upon 

Article  22 of  the  Second  Banking  Directive. 

10 -

THE  ANNEXES 

27.  Annexes  1  to  5  describe  how  the  risks  In  a  firm's  positions,  and  thus 

the  capital  required  to  safeguard  it,  are  to  be  calculated,  while  Annex 

6  deals  with  the  composition  of  the  capital  that  is  to  be  provided. 

Annex 1 

28.  This  Annex  explains  how  firms'  net  positions  are  to  be  measured, 

including  the  conditions  under  which  gross  positions  in  an  Instrument 

may  be  reduced  by  the  holding  of  offsetting  positions  In either  the  same 

Instrument  or  a  derivative  of  It.  Once  measured,  the  net  positions  are 

subject  to  the  capital  requirements  set  out  in Annexes  2 and  4. 

29.  The  Annex  allows  for  a  degree  of  flexibility  in  the  way  in which  options 

and  swaps  are  treated. 

Annex  2 

30.  This  Annex  explains  how  capital  requirements  on  fixed  rate  Instruments 

and  equities  are  to  be  calculated.  Lower  requirements  are  set  on  paper 

Issued  by  'qualifying'  firms  from  the  private  sector  than  on  that  from 

other  firms,  In  view  of  the  lower  price  volatility  of  the  former. 

Qualifying  Issuers  include  credit  institutions,  and  private  sector  firms 

whose  securities  are  listed  on  Member  State,  or  recognized  third 

country, 

stock  exchanges.  This  Annex 

also  permits 

the  use  of 

alternative  systems  for  measuring  capital  requirements  that  are  based 

on  the mathematical  concept  of  duration,  in certain  circumstances. 

-  11  -

Annex  3 

31.  This  Annex  covers  the  risk  to  a  firm  of  a  deal  it  has  entered  Into  not 

being  settled  for  whatever  reason,  for  example  the  counterparty  Involved 

failing  to  meet  its  side  of  the  bargain,  or  a  malfunctioning  of  the 

settlement  system.  It  explains  the 

method  of  calculating  the  capital 

required  to  provide  a buffer  against  the  losses  arising  In such  cases. 

Annex 4 

32.  This  Annex  describes  the  calculation  of  the  foreign  exchange  risk 

requirement.  The  purpose  of  this  requirement  is  to  provide  a  capital 

buffer  against  losses  arising  from  adverse  movements  in  foreign  exchange 

rates  when  the  credit  institution  or  Investment  firm  has  an  open 

position.  The  method  of  calculation  Is also  used  In calculating  foreign 

exchange  limits  for  credit  Institutions  If  the  competent  authorities  so 

require  under  Article  4. 

Annex 5 

33.  Capital  requirements  are  set  in  this  Annex  to  safeguard  firms  against 

the  diverse  risks  that  are  not  addressed  by  Annexes  2  to  4,  for  example 

the  losses  arising  from  a market-wide  fall  in  turnover. 

Annex  6 

34.  Annex  6  Is concerned  with  the  definition  of  this  capital  or  'own  funds'. 

It  gives  the  competent  authorities  in  each  Member  State  the  option  of 

applying  the  definition  of  own  funds  laid  down  in  the  Council  Directive 

on  the  Own  Funds  of  Credit  Institutions  (89/299/EEC)  or  the  alternative 

definition  set  out  in  this  Annex,  to  Investment  firms  which  are  not 

credit  institutions.  Firms  using  the  latter  are  allowed  to  include  a 

-  12  -

larger  amount  of  subordinated  debt  in  their  own  funds  than  under  the 

former  definition,  but,  unlike  credit 

Institutions,  are  strictly 

required  to  deduct  their  illiquid  assets.  Credit  institutions  are 

required  to  apply  the  definition  in Council  Directive  89/299/EEC,  except 

In the  case of  those which  are  required  to meet  the  capital  requirements 

In  Annexes  2  and  3.  In  this  latter  case  the  competent  authorities  may 

permit  an  alternative  definition which  is similar,  though  not  identical, 

to  the  alternative  definition  for  non-banks. 

-  13 -

Proposal  for a 

COUNCIL  DIRECTIVE 

on  capital  adequacy  of 

investment  firms and  credit  institutions 

THE COUNCIL  OF THE  EUROPEAN  COMMUNITIES, 

Having  regard  to the Treaty  establishing  the  European  Economic  Community, 

and  in particular  the  first  and  third  sentences  of Article  57(2)  thereof, 

Having  regard  to  the proposal  from  the  Commission^1), 

In cooperation  with  the European  Par I lament^2), 

Having  regard  to the opinion  of  the  Economic  and  Social  Committee^3), 

Whereas  Council  Directive  ...  of  ...  on  investment  services  in  the 
securities  fleld^4)  has  as  its  main  objective  that  of  allowing 

Investment  firms  authorized  by  the  competent  authorities  of  their  home 

Member  States  and  supervised  by  those  same  authorities  to  establish 

branches  and  provide  services  freely  in other  Member  States;  whereas  it 

accordingly  provides  for  coordination  of  the  rules  relating  to  the 

authorization  and  pursuit  of  business of  investment  firms; 

(1)  OJ  No 
(2)  OJ  No 
(3)  OJ  No 
(4)  OJ  No 

-  14 -

Whereas  Directive  ....  does  not,  however,  establish  common  standards  for 

the  own  funds  of  investment  firms,  nor  Indeed  does  it  establish  the 

amounts  of  Initial  capital  of  such  firms; whereas  it does  not  establish  a 

common  framework  for  the monitoring  of  market  risks  incurred  by  the  same 

firms;  whereas  Directive 

makes  reference,  in  several  of  its 

provisions,  to another  Community  initiative,  the objective of  which  would 

be  precisely  to adopt  coordinated  measures  in those  fields-, 

Whereas  the  approach  that  has  been  adopted  is  to  achieve  only  the 

essential  harmonization  necessary  and  sufficient  to  secure  the  mutual 

recognition  of  authorization  and  of  prudential  supervision  systems; 

whereas  the  adoption  of  coordination  measures  as  regards  the  definition 

of  own  funds  of  Investment  firms,  the  establishment  of  the  amounts  of 

initial  capital  and  the  establishment  of  a  common  framework  for  the 

monitoring  of  market  risks  of  investment  firms  are  essential  aspects  of 

the  harmonization  necessary  for  the  achievement  of  mutual  recognition  and 

thus  the  completion  of  the  internal  financial  market; 

Whereas  the  Member  States  may  also  establish  rules  stricter  than  those 

provided  for  In the present  Directive; 

Whereas  this  Directive  forms  part  of  the  wider  International  effort  to 

bring  about  approximation  of  the  rules  in  force  in  major  countries 

regarding  the on-going  supervision  of  investment  firms; 

Whereas  common  basic  standards  for  the  own  funds  of  investment  firms  are 

a  key  feature  In  the  creation  of  an  Internal  market  In  the  Investment 

services  sector  since  own  funds  serve  to  ensure  the  continuity  of 

Investment  firms  and  to  protect  investors;  whereas  such  harmonization 

will  strengthen  the  supervision  of  Investment  firms;  whereas  such 

standards  must  apply  to all  investment  firms  in the  Community-, 

-  15  -

Whereas  in  a  common  financial  market  investment  firms,  whether  they  are 

credit  Institutions  or  not,  engage  in  direct  competition  with  one 

another ; 

Whereas  the  criteria  for  determining  the  composition  of  own  funds  must 

not  be  left  to  the  sole  discretion  of  Member  States-, 

Whereas  the  adoption  of  common  basic  standards  on  the  own  funds  of 

Investment  firms  will  be  in  the  best  interests  of  the  Community  in  that 

it  will  prevent  distortions  of  competition  and  will  strengthen  the 

Community  financial  system; 

Whereas  investment  firms  which  are  credit  institutions  already  have  the 

definition  of  own  funds  provided  for  in  the  Council  Directive  89/299/EEC 

of  17 April  1989 on  the own  funds  of  credit  Institutions  C ); 

Whereas,  there  are  reasons  why  the  definition  of  own  funds  of  Investment 

firms  may  be  adapted  from  that  in  Directive  89/299/EEC  In  order  to  take 

account  of  the  particular  characteristics  of  the  activities  of  those 

firms; 

* 

Whereas,  however,  the  basis  for  a  definition  of  own  funds  for  investment 

firms,  which  are  not  credit  Institutions,  should  be  the  definition  of  own 

funds  of  credit  institutions; 

Whereas  it  is  necessary  to  establish  at  Community  level  the  amounts  of 

minimum  initial  financial  resources  that  competent  authorities  must 

require  from  Investment  firms  In order  to grant  them  authorisation-, 

Whereas  these  amounts  should  be  fixed  at  a  level  which  should  ensure  that 

firms  engaging  in  investment  services  have  the  capacity  to  fulfil  their 

obligations  without,  at  the  same  time,  representing  an  inappropriate 

barrier  to entry  In the market  by  new  firms; 

(1)  OJ  No  124, 5.5.1989,  p.  16. 

-  16  -

Whereas  It  Is  appropriate  to  give  Member  States  the  possibility  of 

reducing  these  amounts  In cases where  Investment  firms  are  not  authorized 

to hold  customers' monies or  securities,  nor  to act  as market  makers, nor 

to underwrite,  nor  to  take  positions of  their  own; 

Whereas  existing  investment  firms  should  be  permitted  to  continue  their 

business  even  if  they  do  not  comply  with  the minimum  amount  fixed  for  new 

firms; 

Whereas,  as  regards  Investment  firms  which  are  credit  institutions,  the 

amount  of  minimum  initial  capital  is  already  established  in  the  Second 

Council  Directive  89/646/EEC  of  15 December  1989  coordination  of  laws, 

regulations  and  administrative  provisions  relating  to  taking  up  and 

pursuit  of  the  business  of  credit  Institutions  and  amending  Directive 
77/780/EEC)<1>; 

Whereas  It  Is necessary  to provide  a common  framework  for  the  supervision 

and monitoring  of  market  risks of  investment  firms; 

Whereas  such  a  framework  must  cover  the main  risks  incurred  by  investment 

firms  and,  in particular,  position  risks,  counterparty/settlement  risks, 

interest  rate  risks  and  foreign  exchange  risks; 

Whereas  the  best  approach  to ensure  the  financial  soundness of  investment 

firms  is  to  impose  on  them  the  obligation  to  provide  at  all  times  a 

certain  amount  of  own  funds  to  cover  each  of  the  risks  associated  with 

their  particular  activities; 

(1)  OJ  No  386, 30.12.1989, p.  1. 

-  17  -

Whereas,  for  credit  institutions,  one  main  part  of  the  risk  associated 

with  their  business  is  already  covered  by  the  Council  Directive 

89/647/EEC  of  18  Decmeber  1989  on  a  solvency  ratio  for  credit 
Institutions^2); 

Whereas,  for  that  reason,  It  is  appropriate  to  give  the  competent 

authorities 

the 

possibility 

to 

choose 

between 

either 

applying 

Directive  89/647/EEC  to  the whole  book  of  credit  Institutions  or  applying 

the  framework  provided  for  in  this  Directive  to  their  trading  book; 

Whereas,  in any  case,  credit  Institutions  must  comply  with  the  provisions 

of  this  Directive  as  regards  the  coverage  of  their  foreign  exchange  risk; 

Whereas  the  existence,  in  all  credit  institutions,  of  internal  systems 

for  monitoring  and  controlling  the  market  risks  on  all  their  business  is 

a  particularly 

important  way  of  minimizing  such  risks;  whereas, 

consequently,  It  is  necessary  that  such  systems  be  approved  by  the 

competent  authorities; 

Whereas  technical  modifications  to  the  detailed  rules  laid  down  in  this 

Directive  may  from  time  to  time  be  necessary  to  take  account  of  new 

developments  in  the  investment  services  sector;  whereas  the  Commission 

shall  accordingly  make  such  modifications  as  are  necessary  within  the 

limits  of  the  Implementing  powers  conferred  on  the  Commission  by  the 

Treaty; 

HAS ADOPTED  THIS  DIRECTIVE 

(2)  OJ  No  386,  30.12.1989,  p. 14. 

-  18 

S C O PE 

Art Icle  1 

1.  M e m b er 

S t a t es 

shall 

apply 

the 

r e q u i r e m e n ts 

of 

this 

D i r e c t i ve  to  investment  f i r ms  d e f i n ed  In  a c c o r d a n ce  with 

the  3rd 

Indent  of  A r t i c le  1  of  D i r e c t i ve 

. . . / . . . / E E C, 

[ r e l a t i ng 

to 

investment 

s e r v i c e s] 

and 

to 

credit 

i n s t i t u t i o ns  as  d e f i n ed  in  A r t i c le  2. 

2.  A  M e m b er  S t a te  may  impose  a d d i t i o n al  or  m o re  s t r i n g e nt 

r e q u i r e m e n ts 

on 

the 

investment 

f i r ms 

and 

credit 

i n s t i t u t i o ns  that  it  has  a u t h o r i s e d. 

- 19 -

DEFINITIONS 

ArtIcle 2 

For  the purposes  of  this Directive: 

"credit  Institutions"  means  all  Institutions  meeting  the 

definition  in  the  1st  Indent  of  Article  1  of  the  Council 

Directive 
the 
which 
requirements  arising  from  Council  Directive  89/647/EEC^2) ; 

subject 

77/780/EEC<1> 

are 

to 

the  "trading  book"  of  a  credit  institution  shall  include 

Its  proprietary  positions  in  transferable  securities  or 

derivative  instruments,  which  are  taken  on  by  the  credit 

Institution  In  order  to  benefit  from  actual  or  expected 

differences  between  their  buying  and  selling  prices, or  In 

order  to hedge other  elements  of  the  trading  book; 

"exchange-traded  instruments"  means  instruments  which  are 

traded  on,  or  under  the  rules  of,  a  stock  exchange,  or 

financial  futures  or  options  exchange  established  and 

officially  recognized  in  the  relevant  Member  State,  or 

established  in  a  third  country  and  recognized  by  the 

competent  authorities  of  the  relevant  Member  State. 

Instruments  which  are  traded  on  such  exchanges  and  markets 

shall  be classified  as equities, debt  instruments, futures, 

options,  convertibles  and  warrants,  In this  Directive; 

"over-the-counter 

(OTC)  Instruments"  means 

other 

I nstruments; 

(1) OJ  No L 322, 17.12.1977, p. 30. 
(2) OJ  No L 386, 30.12.1989, p. 14. 

-  20 -

" q u a l i f y i ng  Issuer"  m e a ns 

a  credit  i n s t i t u t i o n,  or  a  firm 

w h o se  s e c u r i t i es  are  listed  on  a  s t o ck  e x c h a n ge  in  a  M e m b er 

S t a t e,  or  In  a  s t o ck  e x c h a n ge  in  a  third  c o u n t ry  w h en  this 

e x c h a n ge  is  r e c o g n i z ed  by  the  c o m p e t e nt  a u t h o r i t i es  of  the 

r e l e v a nt  M e m b er  S t a t e; 

"central  g o v e r n m e n t"  r e f e rs  to  the  c e n t r al  g o v e r n m e nt  or 

c e n t r al  bank  of  M e m b er  S t a t es  and  all  o t h er  c o u n t r i es  w h i ch 

are  m e m b e rs  of  the  O r g a n i z a t i on  for  E c o n o m ic  C o o p e r a t i on 

and  D e v e l o p m e nt  ( O E C D)  and  any  c o u n t ry  w h i ch  has  c o n c l u d ed 

s p e c i al 

lending 

a r r a n g e m e n ts 

with 

the 

I n t e r n a t i o n al 

M o n e t a ry 

Fund 

( I M F) 

a s s o c i a t ed 

with 

the 

IMF 

G e n e r al 

A r r a n g e m e n ts  to  B o r r ow  ( G A B ); 

"other  p u b l ic  s e c t o r"  m e a ns  r e g i o n al  g o v e r n m e n ts  and  local 

a u t h o r i t i es  in  c o u n t r i es  w h i ch  are  m e m b e rs  of  the  O E CD  or 

w h i ch  h a ve  c o n c l u d ed  s p e c i al 

a r r a n g e m e n ts  w i th  the 

IMF 

a s s o c i a t ed  w i th  the  IMF's  G A B; 

" c o n v e r t i b l e"  m e a ns  a  s e c u r i t y,  w h i c h,  at  the  o p t i on  of  the 

h o l d e r,  can  be  e x c h a n g ed  for  a n o t h er  s e c u r i t y,  u s u a l ly  the 

e q u I ty  of  the  i s s u e r; 

" w a r r a n t"  m e a ns  a  s e c u r i ty  w h i ch  g i v es  the  h o l d er  the  right 

to  p u r c h a se  a  number  of  s h a r es  of  c o m m on  s t o c k,  or  b o n d s, 

at  a  s t i p u l a t ed  p r i ce  up  until  the  w a r r a n t 's  e x p i r a t i on 

d a te ; 

" r e p u r c h a se  a g r e e m e n t"  m e a ns  an  a g r e e m e nt  in  w h i ch  a  firm 

s e l ls  s e c u r i t i es  s u b j e ct  to  a  c o m m i t m e nt  to  r e p u r c h a se  them 

(or  s u b s t i t u t ed  s e c u r i t i es  of  the  s a me  d e s c r i p t i o n)  at  a 

s p e c i f i ed 

f u t u re 

time 

and 

p r i c e, 

a c c o r d i ng 

to 

the 

p r o v i s i o ns 
of 
8 6 / 6 3 5 / E E C *1>; 

A r t i c le 

1 2 ( 2)  of 

the 

C o u n c il 

D i r e c t i ve 

(1)  OJ  No  L  3 7 2,  3 1 . 1 2 . 1 9 8 6,  p.  1. 

21  -

" r e v e r se  r e p u r c h a se  a g r e e m e n t"  m e a ns  an  a g r e e m e nt  in  w h i ch 

a  firm  b u ys  s e c u r i t i es  from  a  c o u n t e r p a r ty  and  a g r e es  to 

sell 

them 

(or 

s u b s t i t u t ed 

s e c u r i t i es 

of 

the 

same 

d e s c r i p t i o n)  back 

to  that 

c o u n t e r p a r ty 

at  a 

s p e c i f i ed 

f u t u re  time  and  p r i c e,  a c c o r d i ng 

to  the  p r o v i s i o ns  of 

A r t i c le  1 2 ( 2)  of  D i r e c t i ve  8 6 / 6 3 5 / E E C; 

" c l e a r i ng  m e m b e r"  m e a ns  a  m e m b er  of  both  the  e x c h a n ge  and 

the 

c l e a r i ng 

h o u s e, 

thus 

h a v i ng 

a  d i r e ct 

c o n t r a c t u al 

r e l a t i o n s h ip 

w i th 

the 

c e n t r al 

c o u n t e r p a r ty 

(market 

g u a r a n t o r ). 

N o n - c l e a r i ng  m e m b e rs  must  h a ve  their 

t r a d es 

r o u t ed  t h r o u gh  a  c l e a r i ng  m e m b e r; 

"local  f i r m"  m e a ns  a  firm  d e a l i ng  o n ly  for  Its  own  a c c o u nt 

on  a  f i n a n c i al 

f u t u r es  or  o p t i o ns  e x c h a n ge  or  for  the 

a c c o u n ts  o f,  or  m a k i ng  a  p r i ce  to,  o t h er  m e m b e rs  of  the 

s a me  e x c h a n g e,  w h i ch  is  g u a r a n t e ed  by  a  c l e a r i ng  m e m b er  of 

the  s a me  e x c h a n g e,  w i th  this  g u a r a n t ee  b e i ng  t a k en 

Into 

a c c o u nt 

in 

the 

s e t t i ng 

of 

the 

g u a r a n t o r 's 

c a p i t al 

r e q u i r e m e n t s; 

" d e l t a"  m e a ns  the  e x p e c t ed  c h a n ge  in  an  o p t i on  p r i ce  as  a 

p r o p o r t i on  of  a  small  c h a n ge  in  the  p r i ce  of  the  i n s t r u m e nt 

u n d e r l y i ng  the  o p t i o n; 

for  the  p u r p o s es  of  Point  5  of  A n n ex  1, 

"long  p o s i t i o n" 

m e a ns  a  p o s i t i on  in  w h i ch  a  firm  has  fixed  the  interest 

rate  it  will  r e c e i ve  at  s o me  time  In  the  f u t u r e,  and  "short 

p o s i t i o n"  m e a ns  a  p o s i t i on 

in  w h i ch 

It  has  fixed 

the 

Interest  r a te  It  will  pay  at  s o me  time  in  the  future-, 

- 22 -

"own  funds"  means  own  funds  as  defined  In  Directive 

89/299/EEC.  However  this  definition  may  be  modified,  for 

credit  Institutions,  In  the  circumstances  described  in 

Point  2  of  Annex  6.  In  the  case  of  Investment  firms  which 

are  not  credit  Institutions,  the  competent  authorities  may 

use  the  definition  set  out  In  Point  4  of  Annex  6  instead; 

"initial  capital"  means  capital  as  defined  In  Points  (1) 

and  (2) of  Article  2(1)  of  Directive  89/299/EEC.  The  paid-

up  share  capital  component  of  this  shall  comprise  all 

amounts  regardless  of  their  actual  designations,  which,  in 

accordance  with  the  legal  structure  of  the  Institution 

concerned,  are  regarded  under  national 

law  as  equity 

capital  subscribed  and  paid  by  the  shareholders  or  other 

proprletors. 

INITIAL  CAPITAL  AND  DEROGATIONS  FROM  CAPITAL  REQUIREMENTS 

ArtIcle  3 

1.  References  to  investment  firms  In  Articles  3  to  6  denote 

only  those  investment  firms  which  are  neither  credit 

Institutions,  nor  local  firms,  nor  firms  engaged  purely  in 

the  business  of  supplying  investment  advice. 

2.  Investment  firms  shall  have  initial  capital  of  at  least 

ECU 500 000. 

3.  Member  States  may  reduce  this  amount  to  ECU 50 000  where  a 

firm  is  neither  authorised  to  hold  customers'  monies  or 

securities,  nor  to  act  as  a market  maker,  nor  to  underwrite 

except  where  the  firm  is  involved  only  in  the  distribution 

of  issues  on  a  best  efforts  basis. 

-  23 -

4.  M e m b er 

S t a t es  may  r e d u ce  the  a m o u nt 

In  p a r a g r a ph  2  to 

ECU  100 000 

In  the  case  of  f i r ms  w ho  hold  cl l e n t s'  m o n i es 

or  s e c u r i t i es  in  a c t i ng  as  a g e n ts  or  p o r t f o l io  m a n a g e r s, 

but  w ho  do  not  hold  t r a d i ng  p o s i t i o ns  of  their  o w n. 

5.  N o t w i t h s t a n d i ng  p a r a g r a p hs  2,  3  and  4,  M e m b er  S t a t es  may 

c o n t i n ue  the  a u t h o r i s a t i on  of  investment  f i r ms  in  e x i s t e n ce 

b e f o re  this  D i r e c t i ve  is  i m p l e m e n t e d,  w h o se  own  f u n ds  are 

less  than  the  initial  capital 

levels  s p e c i f i ed 

in  those 

p a r a g r a p h s.  The  own  f u n ds  of  such  f i r ms  shall  not  fall 

b e l ow 

the 

h i g h e st 

level 

r e c o r d ed 

after 

the 

d a te 

of 

n o t i f i c a t i on  of  t h is  D i r e c t i v e. 

6. 

If  c o n t r ol  of  an  investment  firm  f a l l i ng  w i t h in  p a r a g r a ph  5 

Is  t a k e n,  o t h er  than  t h r o u gh  i n h e r i t a n c e,  by  a  n a t u r al  or 

legal 

p e r s on  o t h er 

than 

the  p e r s on  w ho 

c o n t r o l l ed 

it 

p r e v i o u s l y,  the  own  f u n ds  of  that  i n s t i t u t i on  must  a t t a in 

at 

least 

the  a p p r o p r i a te 

level 

p r e s c r i b ed 

for 

initial 

c a p i t al  In  p a r a g r a p hs  2,  3  and  4. 

7.  H o w e v e r,  in  c e r t a in  s p e c i f ic  c i r c u m s t a n c es  and  w i th  the 

c o n s e nt  of  the  c o m p e t e nt  a u t h o r i t i e s,  w h e re  t h e re 

Is  a 

m e r g er  of  two  or  m o re  Investment  f i r m s,  the  own  f u n ds  of 

the  firm  r e s u l t i ng  from  the  m e r g er  need  not  a t t a in  the 

level  of  initial  capital  r e f e r r ed  to  in  p a r a g r a p hs  2,  3  and 

4. 

H o w e v er  the  own  f u n ds  of  the  new  Investment  firm  may 

not  fall  b e l ow  the  total  own  f u n ds  of  the  m e r g ed  f i r ms  at 

the  time  of  the  m e r g e r,  as  long  as  the  a p p r o p r i a te  levels 

p u r s u a nt  to  p a r a g r a p hs  2,  3  and  4  have  not  been  a t t a i n e d. 

8.  An  investment 

f i r m 's  own  f u n ds  may  not  fall  b e l ow 

the 

amount  of  initial  capital  r e q u i r ed  u n d er  p a r a g r a p hs  2,  3 

and  4  or  the  a m o u n ts  of  own  f u n ds  r e q u i r ed  u n d er  p a r a g r a p hs 

5,  6  and  7.  H o w e v e r, 

if,  In  the  c a s es  r e f e r r ed  to  in 

p a r a g r a p hs  2 , 3 , 4 ,5  and  7  the  own  f u n ds  s h o u ld  be  r e d u c e d, 

the  c o m p e t e nt 

a u t h o r i t i es  m a y,  w h e re 

the 

c i r c u m s t a n c es 

j u s t i fy  It,  a l l ow  an  investment  firm  a  limited  p e r i od  in 

w h i ch  to  r e c t i fy  its  s i t u a t i on  or  c e a se  Its  a c t i v i t i e s. 

- 24 -

PROVISION  AGAINST  RISKS 

Art icle  4 

1. 

Investment  firms  shall  provide  at  all  times  a  certain 

amount  of  own  funds  to  cover  each  of  the  various  risks 

associated  with  their  particular  activities.  The  sum  of 

these  amounts, which  shall  be  calculated  in  accordance 

with  the  methods  outlined  in  paragraph  5  below  and 

Annexes  1  to  5,  shall  be  their  overall  own  funds 

requirement.  They  shall  ensure  that  their  overall  own 

funds  requirement  is  lower  than  or  equal  to  the  own 

funds  that  they  hold. 

2. 

Credit  institutions  shall  provide,  in  addition  to  the 

requirements  set  in  Directive  89/647/EEC  and  any  set  in 

paragraphs  4  and  5  below,  own  funds  to  cover  their 

foreign  exchange  risk-,  this  amount  shall  be  calculated 

in  accordance  with  the  method  outlined  in  Annex  4. 

Pending  further  harmonisation  however,  Member  States 

may  waive  the  application  of  this  requirement  in 

relation  to  credit  institutions  whose  business  is 

limited  as  follows:  their  overall  net  foreign  exchange 

position,  calculated  in  accordance  with  Annex  4,  must 

not  exceed  the  equivalent  of  10%  of  own  funds. 

The 

competent 

authorities 

shall 

require 

credit 

institutions  to  set  up  systems,  which  need  to  be 

approved  by  the  competent  authorities,  to  monitor  and 

control 

the 

interest 

rate, 

equity 

price 

and 

counterparty/settlement  risks  on  all  of  their  business. 

- 25 -

The 

competent 

authorities 

shall 

require 

credit 

institutions  -  either 

on 

a  general,  or 

on 

an 

individual  basis  -  to  meet  the  capital  requirements 

set  out  in  Directive  89/647/EEC  on  all  of  their 

business,  or  may,  instead  of  this,  require  them  to  meet 

the  capital  requirements  laid  down  in  Annexes  2  and  3 

hereto  on  their  trading  books,  and  the  requirements  of 

Directive  89/647/EEC  on  the  rest  of  their  business. 

The  competent  authorities 

in  Member  States  shall 

require  that  investment  firms  have  adequate  own  funds 

to  cover  the  risks  arising  in  connection  with  business 

that  is  outside  the  activities  listed  in  Council 

Directive  ../.../EEC  [relating  to  investment  services]. 

In  addition  they  shall  ensure  that  the  own  funds  of 

investment  firms,  and  those  credit  institutions  that 

are  required  to  meet  the  capital  requirements  in 

Annexes  2  and  3  hereto,  protect  them  against  the  risks 

In  those  Instruments  that  fall  within  the  activities  of 

Council  Directive  ../.../EEC  (relating  to  investment 

services]  but  which  are  not  explicitly  catered  for  in 

this  Directive,  and,  in  the  case  of  such  credit 

Institutions,  are  within  the  trading  book. 

All  cases 

covered  by  this  paragraph  shall  be  reported  to  the 

Commission  by  the  relevant  competent  authorities. 

EVALUATION  OF  POSITIONS  FOR  REPORTING  PURPOSES 

ArtIcle  5 

1. 

Positions  shall  be  marked  to  market  daily  by  investment 

firms  and  credit  institutions  unless  Annexes  2,  3  and  5 

hereto  do  not  appSy  to  them. 

- 26 

In  the  absence  of  readily  available  market  prices 

e.g.  In  the  case  of  dealing  in  new  issues  on  the 

primary 

markets,  the 

authorities 

may 

waive 

the 

requirement  under  paragraph  1,  and  require  firms  to 

use  alternative  methods  of  evaluation  provided  that 

these  methods  are  sufficiently  prudent,  and  have  been 

approved  by  the  competent  authorities. 

REPORTING  REQUIREMENTS 

Art icle  6 

Member  States  shall  require  that  investment  firms  and 

credit  Institutions  provide  the  competent  authorities 

of  the  home  Member  State  with  all  the  information 

necessary  to  assess  their  compliance  with  the  rules 

adopted  In  accordance  with  this  Directive.  Member 

States  shall  also  ensure  that  investment  firms'  and 

credit  Institutions'  internal  control  mechanisms  and 

administrative  and  accounting  procedures  permit  the 

verification  of  their  compliance  with  such  rules  at  all 

t imes. 

- 27 -

2. 

Investment  firms  which  are  not  credit 

institutions 

shall 

be 

obliged 

to 

report 

to 

the 

competent 

authorities  in  the  manner  specified  by  the  latter  at 

least  once  every  month  In  the  case  of  firms  which  are 

authorised  to  deal  as  principal,  at  least  once  every 

three  months  in  the  case  of  those  firms  described  in 

Article  3 ( 4 ), and  at  least  once  a  year  In  the  case  of 

those  firms  covered  by  Article  3 ( 3 ).  Such  reports  must 

be  received  by  the  competent  authorities  within  two 

weeks  of  the  end  of  the  reporting  period. 

3. 

Credit  institutions  shall  be  obliged  to  report  in  the 

manner  specified  by  the  competent  authorities 

at  the 

same  time  as  they  are  obliged  to  report  under  Directive 

89/647/EEC,  and  at  more  frequent  intervals  if  the 

competent  authorities  so  request. 

COMPETENT  AUTHORITIES 

ArtIcle  7 

1. 

Member  States  shall  designate  the  authorities  which  are 

to  carry  out  the  duties  provided  for  in  this  Directive. 

They  shall  Inform  the  Commission  thereof,  indicating 

any  division  of  duties. 

2. 

The  authorities  referred  to  in  paragraph  1  must  be 

public  authorities  or  bodies  officially  recognized  by 

national  law  or  by  public  authorities  to  be  part  of  the 

supervisory  system  prevailing  in  the  relevant  Member 

State. 

3. 

The  authorities  concerned  must  be  granted  all  the 

powers  necessary  to  carry  out  their  tasks. 

-  28  -

The  competent  authorities  of  different  Member  States 

shall  collaborate  closely  to  carry  out  the  duties 

provided  for  In  this  Directive,  particularly  when 

investment  services  are  provided  on  a  services  basis  or 

by  the  establishment  of  branches  In  one  or  more  Member 

States.  They  shall  supply  one  another  on  request  with 

all  information  likely  to  facilitate  the  supervision  of 

the  capital  adequacy  of  investment  firms  and  credit 

Institutions  and  particularly  the  verification  of  their 

compliance  to  the  rules  laid  down  in  this  Directive. 

Any 

exchange 

of 

Information 

between 

competent 

authorities  which  Is  provided  for  in  this  Directive  in 

respect  of  Investment  firms  shall  be  subject  to  the 

obligation  of  professional  secrecy  as  set  out  in 

Article  20  of  Directive 

.../.../EEC 

[Felating  to 

investment 

services] 

and, 

in 

respect 

of 

credit 

Institutions,  subject  to  the  obligation  set  out  in 

Article  12  of  Council  Directive  77/780/EEC. 

COMMITTEE 

Art icle  8 

1. 

The  technical  amendments  to  be  made  to  this  Directive 

In  the  following  areas  shall  be  adopted  In  accordance 

with  the  procedure  laid  down  In  paragraph  2: 

-  definitions  in Article  2; 

-  Initial  capital  requirements  in 

-  ArtIcle  3; 

-  ceiling  referred  to  In Article 4 ( 2 ); 

-  treatment  of  Instruments  within  the 

scope  of 

Directive 

../.../EEC 

relating 

to 

Investment 

services  , but  not  covered  In  this  Directive; 

-  calculation  of  net  open  positions  In  Annex  1; 

-  Annex  2; 

-  29  -

-  c o u n t e r p a r t y / s e t t l e m e nt  risk  w e i g h ts  in  Annex  3-, 

-  f o r e i gn  e x c h a n ge  risk  w e i g h ts  in  A n n ex  4-, 

-  time  p e r i od  used  in  Annex  5; 

-  d e f i n i t i on  of  own  f u n ds  in  P o i n ts  2,  4  and  5  of 

A n n ex  6. 

2. 

W h e n e v er  the  technical  a m e n d m e n ts  r e f e r r ed  to  in  the 

first  p a r a g r a ph  are  to  be  m a de  to  this  D i r e c t i v e, 

A r t i c le 

2 3 ( 2 ), 

of 

Council 

D i r e c t i ve 

. . / . . . / E EC 

[relating  to  investment  s e r v i c e s]  shall  a p p l y. 

FINAL  P R O V I S I O NS 

Art Icle  9 

1. 

M e m b er 

S t a t es 

shall 

bring 

into 

force 

the 

laws, 

r e g u l a t i o ns  and  a d m i n i s t r a t i ve  p r o v i s i o ns  n e c e s s a ry  to 

c o m p ly  with  this  D i r e c t i ve  by  1  J a n u a ry  1993  at  the 

latest.  They  shall 

f o r t h w i th 

inform 

the 

C o m m i s s i on 

t h e r e o f. 

The  p r o v i s i o ns  a d o p t ed  p u r s u a nt  to  the  first  p a r a g r a ph 

shall  m a ke  e x p r e ss  r e f e r e n ce  to  this  D i r e c t i v e. 

2. 

Member  S t a t es  shall  c o m m u n i c a te  to  the  C o m m i s s i on  the 

texts  of  the  m a in  laws,  r e g u l a t i o ns  and  a d m i n i s t r a t i ve 

p r o v i s i o ns  w h i ch  they  adopt  in  the  field  c o v e r ed  by 

this  D I rect I v e. 

Art icle  10 

T h is  D i r e c t i ve  is  a d d r e s s ed  to  the  Member  S t a t e s. 

D o ne  at  B r u s s e l s, 

For  the  C o u nc iI 

The  P r e s i d e nt 

- 30 -

ANNEX  1 

CALCULATION  OF  NET  OPEN  POSITIONS 

Equity  and  debt  Instruments 

1. 

The  firm's  long  and  short  positions  In  the  same  equity, 

debt  and  convertible 

issues  shall  be  netted.  In 

calculating  the  net  position  the  competent  authorities 

may  allow  positions  in  derivative  instruments  to  be 

treated 

as 

the 

underlying 

(or 

notional) 

security/securities.  The  competent  authorities  shall 

allow  the  netting  of  identical  financial  futures, 

options  and  warrants,  contracts. 

2. 

Debt  Instruments  denominated  in  the  same  currency  shall 

be  grouped  by  maturity  (according  to  Annex  2)  in 

reflection  of  the  residual  maturity  of  fixed  rate 

Instruments,  and  the  period  to  repricing  of  other 

Instruments. 

3. 

Debt  Instruments  shall  be  categorised  by  issuer  as 

follows:  central  government,  other  public  sector, 

qualifying  and  other. 

Convert IbI es 

4. 

No 

netting 

is  allowed 

between 

convertibles 

and 

offsetting  positions 

in  the  underlying 

Instrument 

Itself,  unless  the  competent  authorities  adopt  an 

approach  under  which  the  likelihood  of  a  particular 

convertible  being  converted  is  taken  Into  account,  or 

have  a  capital  requirement  to  cover  any  potential  loss 

which  could  be  incurred  on  conversion. 

-  31  -

O t h er  I n s t r u m e n ts 

5. 

Interest 

r a te 

f u t u r es 

and 

f o r w a rd 

r a te 

a g r e e m e n ts 

( F R A s)  w h i ch  are  not  b a s ed  on  an  u n d e r l y i ng  I n s t r u m e n t, 

will 

be  t r e a t ed  as  c o m b i n a t i o ns  of 

long  and 

short 

p o s i t i o n s.  T h us  a  long  f u t u r es  p o s i t i on  will  be  t r e a t ed 

as 

a  c o m b i n a t i on 

of 

a  b o r r o w i ng 

m a t u r i ng 

on 

the 

d e l i v e ry  d a te  of  the  f u t u r es  c o n t r a ct  and  a  h o l d i ng  of 

an  a s s et  m a t u r i ng  on  the  e x p i r a t i on  d a te  of  the  f u t u r e. 

T he  o p p o s i te  h o l ds  for  a  short 

p o s i t i o n.  B o th 

the 

b o r r o w i ng  and  asset  h o l d i ng  will  be  i n c l u d ed 

in  the 

c e n t r al  g o v e r n m e nt  c o l u mn  of  T a b le  1  In  A n n ex  2.  A 

f u t u re  or  a  f o r w a rd  w h i ch  is  b a s ed  on  an  u n d e r l y i ng 

debt  i n s t r u m e nt  will  be  t r e a t ed  as  e i t h er  a  long  or 

short 

p o s i t i on 

in 

the 

u n d e r l y i ng 

I n s t r u m e n t. 

Its 

m a t u r i ty  will  be  t a k en  to  be  the  p e r i od  until  d e l i v e ry 

or  e x e r c i se  of  the  c o n t r a c t,  p l us  the 

life  of 

the 

u n d e r l y i ng  s e c u r i t y,  o r,  If  the  life  of  the  u n d e r l y i ng 

s e c u r i ty  e x c e e ds  a  y e a r,  as  t h is 

life 

i t s e l f. 

The 

c o m p e t e nt  a u t h o r i t i es  may  a l l ow  the  r e q u i r e m e nt  for  an 

e x c h a n g e - t r a d ed  f u t u re  to  be  equal  to  the  m a r g in  held 

at  the  e x c h a n ge  if  they  are  f u l ly  s a t i s f i ed  that  it 

p r o v i d es  an  a c c u r a te  m e a s u re  of  the  risk 

a s s o c i a t ed 

w i th  the  f u t u r e. 

Opt Ions  on  Interest  r a t e s,  debt  i n s t r u m e n t s,  e q u i t i e s, 

f i n a n c i al  f u t u r e s,  s w a ps  and  f o r e i gn  c u r r e n c i e s,  are 

t r e a t ed 

as 

If 

they 

w e re 

p o s i t i o ns 

in 

the 

d e l ta 

m u l t i p l i ed  by  the  a m o u nt  of  the  u n d e r l y i ng 

i n s t r u m e nt 

to  w h i ch  the  o p t i on  r e f e r s.  The  d e l ta  u s ed  s h o u ld  be 

that  of  the  e x c h a n ge  c o n c e r n e d,  o r,  w h e re  t h is  Is  not 

a v a i l a b le  or  for  O TC  o p t i o n s,  that  c a l c u l a t ed  by  the 

firm  I t s e l f,  s u b j e ct  to  the  c o m p e t e nt  a u t h o r i t i es  b e i ng 

s a t i s f i ed 

that 

the 

model 

used 

by 

the 

firm 

is 

r e a s o n a b l e.  T he  c o m p e t e nt 

a u t h o r i t i es 

shall 

r e q u i re 

that 

the  o t h er 

r i s k s,  apart 

from 

the  d e l ta 

r i s k, 

a s s o c i a t ed  w i th  o p t i o ns  are  s a f e g u a r d ed  a g a i n s t. 

The 

c o m p e t e nt  a u t h or 11les  may  a I I ow  the  r e q u I r e m e nt  a g a I n st 

-  32 -

a  w r i t t e n,  e x c h a n g e - t r a d ed  o p t i on  to  be  equal  to  the 

m a r g in  held  at  the  e x c h a n ge  if  they  are  f u l ly  s a t i s f i ed 

that 

it  p r o v i d es 

an  a c c u r a te 

m e a s u re 

of 

the 

risk 

a s s o c i a t ed  w i th  the  o p t i o n,  and  for  the  r e q u i r e m e nt  on 

a  b o u g h t,  e x c h a n g e - t r a d ed  or  O TC  o p t i on  to  be  the  s a me 

as  for  the  i n s t r u m e n ts  u n d e r l y i ng  It,  s u b j e ct  to  the 

c o n s t r a i nt 

that 

the  r e s u l t i ng 

r e q u i r e m e nt 

d o es 

not 

e x c e ed  the  m a r k et  v a l ue  of  the  o p t i o n. 

T he  r e q u i r e m e nt 

a g a i n st  a  w r i t t en  O TC  o p t i on  will  be  set  in  r e l a t i on  to 

the  I n s t r u m e nt  u n d e r l y i ng  it. 

7. 

S w a ps  will  be  t r e a t ed  for  Interest  rate  risk  p u r p o s es 

on  the  s a me  b a s is  as  o n - b a l a n ce  sheet  i n s t r u m e n t s.  T h us 

an 

interest 

rate  s w ap  u n d er  w h i ch  a  firm 

r e c e i v es 

f l o a t i ng  rate  interest  and  p a ys  f i x ed  r a te 

interest 

will  be  t r e a t ed  as  e q u i v a l e nt  to  a  long  p o s i t i on  in  a 

f l o a t i ng  rate  I n s t r u m e nt  of  m a t u r i ty  e q u i v a l e nt  to  the 

p e r i od  until 

the  next 

interest  f i x i n g,  and  a  short 

p o s i t i on 

in  a  fixed 

rate 

i n s t r u m e nt 

w i th 

the 

s a me 

m a t u r i ty  as  the  s w ap  i t s e l f. 

C o m p e t e nt  a u t h o r i t i es  may 

h o w e v er  set  a l t e r n a t i ve  r e q u i r e m e n ts  to  t h e se  for  f i r ms 

u s i ng  s w ap  m o d e ls  w h i ch  p r o v i d e,  to  the  s a t i s f a c t i on  of 

the  c o m p e t e nt  a u t h o r i t i e s,  a  m o re  a c c u r a te  m e a s u re  of 

the  r I sks  In  s w a p s. 

8. 

W a r r a n ts  shall  be  t r e a t ed  in  the  s a me  way  that  o p t i o ns 

are  t r e a t ed  In  p a r a g r a ph  6. 

C u r r e n cy  c o n v e r s i on 

9. 

All  net  p o s i t i o n s,  i r r e s p e c t i ve  of  their  s i g n,  must  be 

c o n v e r t ed  on  a  d a i ly  b a s is  Into  the  f i r m 's  r e p o r t i ng 

c u r r e n cy  at  the  p r e v a i l i ng  spot  e x c h a n ge  rate  b e f o re 

the Ir  a g g r e g a t I on . 

-  33 -

A N N EX  2 

P o s i t i on  risk 

1. 

Investment  firms  shall  c a l c u l a te  their  net  p o s i t i o ns  as 

def i ned  In  Annex  1 . 

2. 

Investment  f i r ms  will  apply  the  w e i g h ts  s h o wn  in  T a b le 

1  to  their  n e t,  fixed  interest  rate  p o s i t i o n s,  w h e t h er 

In  their  own  or  f o r e i gn  c u r r e n c i e s, 

as  c a l c u l a t ed  in 

Annex 

1, 

and 

thus 

c a l c u l a te 

their 

w e i g h t ed 

long 

p o s i t i o ns  and  their  w e i g h t ed  short  p o s i t i o n s. 

Table 1 

Residual 
maturity 

Central 
Central 
government 
and European 
Commun i ty 

3 months 

up to 
more than  3 up to  6 months 
more than  6 up to 12 months 
more than  1 up to  2 years 
more than  2 up to  5 years 
more than  5 up to 10 years 
more than 10 up to 20 years 
Over 20 years 

X 
0.3 
0.3 
0.5 
0.5 
1.0 
1.0 
1.6 
1.6 
2.9 
2.9 
3.8 
3.8 
4.8 
4.8 
5.8 
5.8 

tc sector 
Other public sector 
Other 
llfylng 

publ 
I qua 

and 

X 
0.5 
0.5 
1.0 
1.0 
1.6 
1.6 
3.6 
3.6 
4.9 
4.9 
5.8 
5.8 
6.8 
6.8 
7.8 
7.8 

Other 

X 
8.0 
8.0 
8.0 
8.0 
10.0 
15.0 
15.0 
15.0 

3. 

T he  capital  r e q u i r e m e nt  will  be  : 

p l us 

less 

the  sum  of  the  w e i g h t ed  long  p o s i t i o ns 

the  sum  of  the  w e i g h t ed  short  p o s i t i o ns 

any  h e d g i ng  a l l o w a n c e s,  c a l c u l a t ed  as  f o l l o w s: 

1 5 0%  of  any  w e i g h t ed  long  (or  s h o r t)  p o s i t i on  in 

central  g o v e r n m e nt  b o n ds  w h i ch  can  be  o f f s et 

in 

part  or  fully  against  a  w e i g h t ed  short  (or  long) 

p o s i t i on  in  central  g o v e r n m e nt  b o n ds  In  the  same  or 

an  a d j a c e nt  m a t u r i ty  b a n d; 

-  34 -

1 0 0%  of  any  w e i g h t ed  long  (or  s h o r t)  p o s i t i on  in 

central  g o v e r n m e nt  b o n ds  w h i ch  can  be  offset 

in 

part  or  fully  against  a  w e i g h t ed  short  (or  long) 

p o s i t i on  in  central  g o v e r n m e nt  b o n ds  in  the  n e x t-

b u t - o ne  m a t u r i ty  band; 

In  the  case  of  h e d g es  b e t w e en  p o s i t i o ns 

in  the 

'other  p u b l ic  sector  and  q u a l i f y i n g'  b o n ds  (the 

second 

c a t e g o ry 

in 

T a b le 

1 ),  the 

r e s p e c t i ve 

p e r c e n t a g es  are  1 2 0%  and  8 0 %,  rather  than  the  1 5 0% 

and  1 0 0%  used  for  central  g o v e r n m e nt  b o n d s. 

In  the  case  of  a  hedge  b e t w e en  a  p o s i t i on 

in 

central  g o v e r n m e nt  b o n ds  and  a  p o s i t i on  in  'other 

p u b l ic  sector  and  q u a l i f y i n g'  b o n d s,  the  r e s p e c t i ve 

p e r c e n t a g es  are  also  1 2 0%  and  8 0 %. 

(Note  that  the  u n u s ed  p o r t i on  of  p a r t i a l ly  offset 

w e i g h t ed 

p o s i t i o ns 

can 

be 

e m p l o y ed 

in 

this 

p r o c e s s .) 

Durât ion 

4. 

C o m p e t e nt 

a u t h o r i t i es 

in  a  Member 

S t a te  may  use  a 

system 

for 

a p p l y i ng 

capital 

r e q u i r e m e n ts 

to 

the 

interest  rate  d e p e n d e nt  b u s i n e ss  of  investment  f i r m s, 

w h i ch  r e f l e c ts  d u r a t i o n,  instead  of  the  r u l es  set  out 

in  p a r a g r a p hs  2  to  3  a b o v e,  so  long  as  the  r e q u i r e m e n ts 

e m a n a t i ng 

from 

it  are  b r o a d ly  e q u i v a l e nt 

to 

those 

r e s u l t i ng 

from 

the 

a p p l i c a t i on 

of 

the 

rules 

in 

p a r a g r a p hs  2  to  3. 

E q u I t l es 

5. 

The  capital  required  against  a  long  or  a  short  equity 

p o s i t i on  shall  be  1 0%  of  its  value  in  the  case  of  a 

q u a l i f y i ng  equity  and  2 5%  for  any  other  e q u i t y. 

-  35 -

6. 

T he  c o m p e t e nt  a u t h o r i t i es  may  a l l ow  a  r e d u c t i on  in  the 

r e q u i r e m e nt 

for 

any 

r e d u c t i on 

in 

risk 

due 

to 

d i v e r s i f i c a t i o n,  w h e t h er  t h r o u gh  the  i n v e s t m e nt 

firm 

h o l d i ng  a  large  number  of  long,  or  s h o r t,  p o s i t i o ns  in 

e q u i t i es  or  e q u i t i es  d e r i v a t i v e s,  or  from  Its  h o l d i ng 

long  and  short  p o s i t i o ns 

in  d i f f e r e nt  e q u i t i es  and 

e q u i t i es  d e r i v a t i v e s.  H o w e v er  any  such  r e d u c t i on  shall 

o n ly  be  a l l o w ed  on  the  b a s is  that  the  r e s u l t i ng  capital 

r e q u i r e m e nt  is  s u f f i c i e nt  to  cover  the  firm  a g a i n st  a 

1 0%  c h a n ge  in  the  g e n e r al  level  of  e q u i ty  p r i c es  on  its 

ma I n  m a r k e t s. 

U n d e r w r i t i ng  of  debt  and  e q u i ty  I n s t r u m e n ts 

7. 

In  the  case  of  u n d e r w r i t i ng  of 

issues  of  debt  and 

e q u i ty  i n s t r u m e n t s,  the  c o m p e t e nt  a u t h o r i t i es  may  a l l ow 

the  w e i g h ts  r e f e r r ed  to  in  p a r a g r a p hs  2  and  5  a b o ve  to 

be  r e d u c ed  by  6 0%  d u r i ng  the  first  w e e k,  by  3 5%  d u r i ng 

the  s e c o nd  w e e k,  and  by  2 0%  d u r i ng  the  third  w e ek 

f o l l o w i ng 

the 

day 

on  w h i ch 

the 

u n d e r w r i t i ng 

firm 

e n t e r ed  Into  an  i r r e v o c a b le  c o m m i t m e nt  to  p u r c h a se  the 

s e c u r i t i e s,  p r o v i d ed  that  the  s e c u r i t i es  in  q u e s t i on 

are  to  be  traded  on  a  r e g u l a t ed  m a r k et  r e c o g n i s ed  by 

the  c o m p e t e nt  a u t h o r i t i e s. 

Risk  c o n c e n t r a t i on 

8. 

An  Investment  firm  w h i ch  h a s,  or  is  c o m m i t t ed  to,  a 

long  or 

short 

p o s i t i on 

in  a  p a r t i c u l ar 

issue 

of 

s e c u r i t i es  w h i ch  e x c e e ds  2 5%  of  the  total  i s s u e,  shall 

meet  an  a d d i t i o n al  capital  r e q u i r e m e nt  e q u i v a l e nt  to 

1 0 0%  of  the  r e q u i r e m e nt  a g a i n st  the  u n h e d g ed  p o s i t i on 

set  out  in  p a r a g r a p hs  2  and  5  a b o v e. 

-  36 -

An  Investment  f i r m 's  total  e x p o s u re  to  an  issuer  cannot 

e x c e ed  2 5%  of  its  own  f u n ds  w i t h o ut  the  investment  firm 

n o t i f y i ng  the  c o m p e t e nt  a u t h o r i t i e s:  the  firm  shall 

meet  an  a d d i t i o n al  capital  r e q u i r e m e nt  a g a i n st 

such 

e x p o s u r e s, 

c a l c u l a t ed 

by 

s u m m i ng 

the 

r e q u i r e m e n ts 

a g a i n st  each  u n h e d g ed  p o s i t i on  In  the  o v e r a ll  e x p o s u r e. 

-  37 -

ANNEX  3 

C o u n t e r p a r t y / s e t t l e m e nt  risk 

In  the  case  of  t r a n s a c t i o ns  In  which  b o n ds  and  e q u i t i es 

( e x c l u d i ng 

r e p u r c h a se 

and 

r e v e r se 

r e p u r c h a se 

a g r e e m e n t s)  are  u n s e t t l ed 

after 

their  due 

d e l i v e ry 

d a t e s,  a  firm  must  c a l c u l a te  the  p r i ce  d i f f e r e n ce  to 

w h i ch  It  is  e x p o s e d.  T h is  is  the  d i f f e r e n ce  b e t w e en  the 

agreed  s e t t l e m e nt 

p r i ce  for  the  bond  or  e q u i ty 

In 

q u e s t i o n,  and 

its  current  market 

v a l u e,  w h e re 

the 

d i f f e r e n ce  could  involve  a  loss  for  the  firm.  It  must 

m u l t i p ly  this  d i f f e r e n ce  by  the  a p p r o p r i a te  factor  in 

C o l u mn  A  of  T a b le  1  in  order  to  c a l c u l a te  Its  capital 

r e q u I r e m e n t. 

N o t w i t h s t a n d i ng 

p a r a g r a ph 

1, 

a 

firm 

c a n, 

at 

the 

d i s c r e t i on  of  its  competent  a u t h o r i t i e s,  c a l c u l a te  its 

capital 

r e q u i r e m e n ts 

by 

m u l t i p l y i ng 

the 

agreed 

s e t t l e m e nt 

p r i ce 

of 

every 

t r a n s a c t i on 

w h i ch 

is 

u n s e t t l ed  b e t w e en  5  and  45  days  after  its  due  d a t e,  by 

the  approprI ate  factor  in  C o l u mn  B  of  T a b le  1.  From  45 

or  m o re  days  after  the  due  date  It  shall  take  the 

r e q u i r e m e nt  to  be  1 0 0%  of  the  price  d i f f e r e n ce  to  which 

it  Is  e x p o s e d,  as  in  C o l u mn  A. 

Table  1 

Number  of  days  after 

due  s e t t l e m e nt  date 

5-15 

1 6 - 30 

3 1 - 45 

46  +more 

C o l u mn  A 

C o l u mn  B 

8% 

5 0% 

7 5% 

0 . 2 5% 

0 . 5% 

2 . 0% 

1 0 0% 

see  p a r a.  2 

-  38  -

R e p u r c h a se  and  r e v e r se  r e p u r c h a se  a g r e e m e n ts 

3. 

In  the  c a se  of  r e p u r c h a se  a g r e e m e n ts  the  firm  shall  put 

up  the  d i f f e r e n ce 

b e t w e en 

the  m a r k et 

v a l ue  of 

the 

s e c u r i t i e s,  and  the  a m o u nt  b o r r o w ed  by  the  firm  ( w h i ch 

is  their  o r i g i n al  s a le  v a l u e)  w h e re  this  d i f f e r e n ce  Is 

p o s i t i v e.  In  the  c a se  of  r e v e r se  r e p u r c h a se  a g r e e m e n ts 

the  firm  shall  put  up  the  d i f f e r e n ce  b e t w e en  the  a m o u nt 

It  has  lent  p l us  a c c r u ed  i n t e r e s t,  and  the  m a r k et  v a l ue 

of  the  s e c u r i t i es 

it  has  r e c e i v ed 

( w h i ch 

Is  their 

o r i g i n al  s a le  v a l ue  p l us  a c c r u ed  i n t e r e s t)  w h e re  this 

d i f f e r e n ce  is  p o s i t i v e. 

In  the  c a se  of  both  r e p u r c h a se 

a g r e e m e n ts 

and 

r e v e r se 

r e p u r c h a se 

a g r e e m e n ts 

the 

c o m p e t e nt  a u t h o r i t i es  may  r e d u ce  the  r e q u i r e m e nt  to  the 

e x t e nt  that  the  b o r r o w er  p r o v i d es  the  lender  w i th  the 

m a r g in 

that 

is  n o r m a l ly 

r e q u i r ed 

in  the  m a r k et 

in 

quest  Ion. 

O TC  d e r i v a t i ve  I n s t r u m e n ts 

4. 

T he  r e q u i r e m e nt  shall  be  c a l c u l a t ed  as  f o l l o w s:  first 

the 

firm  will 

sum 

(I)  the 

total 

r e p l a c e m e nt 

cost 

( o b t a i n ed  by  m a r k i ng  to  m a r k e t)  of  ail  Its  c o n t r a c t s, 

I n c l u d i ng 

b o u g ht 

e q u i ty 

o p t i on 

c o n t r a c t s, 

w i th 

p o s i t i ve  v a l u es  and  ( i i ),  in  the  c a se  of  interest  rate 

and  e x c h a n ge  rate  c o n t r a c t s,  an  a m o u nt  for  p o t e n t i al 

f u t u re  c r e d it  e x p o s u r e,  c a l c u l a t ed  by  m u l t i p l y i ng  the 

total  n o t i o n al  p r i n c i p al  a m o u nt  of  its  c o n t r a c ts  by  the 

f o l l o w i ng  w e i g h t s,  as  a p p r o p r i a t e: 

Res IduaI  m a t ur I ty 

Interest  rate 

E x c h a n ge  rate 

c o n t r a c ts 

cont r a c ts 

less  than  o ne  year 

o ne  year  and  over 

0 . 5% 

1 . 0% 

5 . 0% 

-  39 -

The  capital  requirement  will  be  4%  of  the  sum  of  (I)  and 

(II)  w h e re  the  c o u n t e r p a r ty 

Is  in  the  n o n - b a nk 

p r i v a te 

s e c t o r,  2%  of  the  sum  w h e re  it  is  in  the  b a n k i ng  sector 

and/or  In  the  regional  g o v e r n m e nt  or  local  a u t h o r i ty  s e c t o r, 

and  zero  if  it  Is  the  central  g o v e r n m e n t. 

-  40 -

A N N EX  4 

F o r e i gn  e x c h a n ge  risk 

1. 

The  o v e r a ll  net  f o r e i gn  e x c h a n ge  p o s i t i o n,  c a l c u l a t ed 

In  a c c o r d a n ce  with  the  p r o c e d u r es  set  out  b e l o w,  shall 

be  a s s i g n ed  an  8%  capital  r e q u i r e m e n t. 

2. 

A  t w o - s t a ge  c a l c u l a t i on  shall  be  u s e d. 

3. 

F i r s t,  the  f i r m 's  net  o p en  c u r r e n cy  p o s i t i on  in  each 

c u r r e n cy  ( I n c l u d i ng  the  r e p o r t i ng  c u r r e n c y)  shall  be 

c a l c u l a t e d.  T h is  p o s i t i on  shall  c o n s i st  of  the  a d d i t i on 

of  the  f o l l o w i ng  e l e m e n ts  ( p o s i t i ve  or  n e g a t i v e ): 

the  net  spot  p o s i t i on  ( I . e.  all  asset  items  less  ail 

l i a b i l i ty 

items,  including  a c c r u ed 

i n t e r e s t, 

in  the 

c u r r e n cy  in  q u e s t i o n ); 

the  net 

f o r w a rd 

p o s i t i on 

( i . e.  all 

a m o u n ts 

to  be 

r e c e i v ed 

less  all  a m o u n ts  to  be  paid  under 

f o r w a rd 

e x c h a n ge  t r a n s a c t i o n s,  Including  c u r r e n cy  f u t u r es  and 

the  p r i n c i p al  on  c u r r e n cy  s w a ps  not  Included  in  the 

spot  p o s 11 ion) ; 

g u a r a n t e es  (and  s i m i l ar  i n s t r u m e n t s)  that  are  c e r t a in 

to  be  caI led ; 

net  f u t u re  I n c o m e / e x p e n s es  (at  the  d i s c r e t i on  of  the 

r e p o r t i ng  i n s t i t u t i o n;  w h en  this  d i s c r e t i on  has  been 

u s e d,  It  may  not  be  c h a n g ed  w i t h o ut  the  prior  a p p r o v al 

of  the  c o m p e t e nt  a u t h o r i t i e s ); 

the  net  d e l ta  (or  d e l t a - b a s e d)  e q u i v a l e nt  of  the  total 

book  of  f o r e i gn  c u r r e n cy  o p t i o n s. 

-  41  -

S e c o n d,  net  short  and  long  p o s i t i o ns  in  each  c u r r e n cy 

o t h er  than  the  r e p o r t i ng  c u r r e n c y,  shall  be  c o n v e r t ed 

at  spot  r a t es  Into  the  r e p o r t i ng  c u r r e n c y.  T h ey  shall 

then  be  summed  s e p a r a t e ly  to  form  r e s p e c t i v e ly 

the 

total  of  the  net  short  p o s i t i o ns  and  the  total  of  the 

net  long  p o s i t i o n s.  The  higher  of  t h e se  two  t o t a ls  will 

be  the  f i r m 's  o v e r a ll  net  f o r e i gn  e x c h a n ge  p o s i t i o n. 

Net  p o s i t i o ns  In  c o m p o s i te  c u r r e n c i es  may  be  d e c o m p o s ed 

into  the  c o m p o n e nt  c u r r e n c i es  a c c o r d i ng  to  the  q u o t as 

In  f o r c e. 

- 42 -

ANNEX  S 

Other  risks 

Investment  firms,  excluding  credit  institutions,  shall 

be  required  to  hold  own  funds  equivalent  to  one  quarter 

of  their  previous  year's  fixed  overheads.  The  competent 

authorities  may  adjust  this  requirement  in  the  event  of 

a  material  change  to  a  firm's  business  since  the 

previous  year.  When  the  firm  has  not  completed  a 

year's  business,  Including  on  the  day  it  starts  up,  the 

requirement  will  be  a  quarter  of  the  fixed  overheads 

figure  projected 

in  its  business  plan,  unless  an 

adjustment  to  this  plan  Is  required  by  the  authorities. 

For  firms  that  are  starting  up,  own  funds  shall  be 

greater  than  or  equal  to  this  amount,  and  initial 

capital  at  least  equal  to  the  requirements  laid  down  in 

Art icle  3. 

- 43 -

ANNEX  6 

Own  funds 

1. 

The  own  funds  of  credit  Institutions  shall  be  defined 

In  accordance  with  Council  Directive  89/299/EEC. 

2. 

Notwithstanding  paragraph  1,  the  competent  authorities 

may  permit  those  credit  institutions  which  are  obliged 

to  meet  the  capital  requirements  on  their  trading  book 

that  are  laid  down  in  Annexes  2  and  3,  to  use  an 

alternative  definition  of  own  funds  when  meeting  these 

requirements.  This 

alternative 

definition 

shall 

include  share  capital  and  reserves  as  defined  in  Points 

(1)  and  (2) Article  2(1) of  Council  Directive  89/299/EEC, 

and  subordinated  loan  capital  subject  to  the  following 

conditions.  First,  this  subordinated 

loan 

capital 

shall  not  exceed  250% of  the  share  capital  and  reserves 

Included  in  this  definition.  Second,  the  use  of  this 

alternative  definition  shall  not  result  in  adding  more 

than  25%  to  the  total  amount  of  own  funds  which  would 

result  from  applying  Council  Directive  89/299/EEC  to 

the 

credit 

Institution 

as 

a  whole.  Third, 

the 

conditions  laid  down  in  5(2)  below  must  apply  to  this 

subordinated  loan  capital. 

3. 

The  own  funds  of  investment  firms  which  are  not  credit 

Institutions  shall  be  defined 

in  accordance  with 

Council  Directive  89/299/EEC. 

4(1)  Notwithstanding  the  requirements  of  paragraph  3,  the 

competent  authorities  may  permit  investment  firms  which 

are  not  credit  institutions  an  alternative  definition 

of  own  funds.  This  shall  include: 

(2)  share  capital  and  reserves  as  defined  in  1(1)  and  1(2) 

of  Article  2 of  Council  Directive  89/299/EEC-, 

44 -

(3)  m i n us  intangible  a s s e ts  w i t h in  the  m e a n i ng  of  A r t i c le 

4 ( 9)  ('assets')  of  Council  D i r e c t i ve  8 6 / 6 3 5 / E E C; 

(4)  plus  net  p r o f i ts  (or  m i n us  net  losses)  after  a l l o w a n ce 

for  all  a n t i c i p a t ed  tax  l i a b i l i t i e s; 

(5)  plus 

s u b o r d i n a t ed 

loan 

capital 

subject 

to 

the 

c o n d i t i o ns  set  out  In  p a r a g r a ph  5 ( 2 ); 

(6)  m i n us  illiquid  a s s e t s. 

5 ( 1)  Firms  shall  be  required  to  satisfy  their  a u d i t o rs  and 

competent  a u t h o r i t i es  that  they  have  a d e q u a te  s y s t e ms 

to  c a l c u l a te  with  r e a s o n a b le  a c c u r a cy  at  any  time  the 

financial  p o s i t i on  of  the  firm. 

(2)  The  s u b o r d i n a t ed  loan  capital  referred  to  in  4 ( 5)  shall 

have  an  Initial  m a t u r i ty  of  at  least  two  y e a r s. 

It 

shall  be  fully  p a i d - up  and  the  loan  a g r e e m e nt  shall  not 

Include 

any 

clause 

p r o v i d i ng 

that, 

in 

s p e c i f i ed 

c i r c u m s t a n c e s, 

other 

than 

the 

w i n d i n g - up 

of 

the 

investment  firm,  the  debt  will  become  r e p a y a b le  before 

the  agreed 

repayment 

d a t e,  u n l e ss 

the 

s u p e r v i s o ry 

a u t h o r i t i es  agree  to  it  having  been  given  two  d a y s' 

n o t i c e.  S u b o r d i n a t ed  debt  may  not  be  repaid  if  such 

repayment  would  mean  that  the  own  funds  of  the  firm  in 

q u e s t i on  would  then  stand  at  below  1 2 0%  of  the  firm's 

overall  r e q u i r e m e n t. 

(3)  The  s u b o r d i n a t ed  loan  capital  referred  to  in  4 ( 5)  may 

not  exceed  a  m a x i m um  of  2 5 0%  of  the  sum  total  of  items 

4 ( 2)  plus  4 ( 4)  less  4 ( 3)  and  should  only  a p p r o a ch  this 

m a x i m um  in  p a r t i c u l ar  c i r c u m s t a n c es  a c c e p t a b le  to  the 

relevant  competent  a u t h o r i t i e s. 

-  45  -

( 4)  i l l i q u id  a s s e ts  i n c l u d e: 

fixed  a s s e ts  (except  to  the  e x t e nt  that  land  and 

b u i l d i n gs 

are  a l l o w ed 

to  count 

a g a i n st 

s e c u r ed 

l o a n s ); 

I n v e s t m e nt 

in 

c o n n e c t ed 

c o m p a n i es 

if 

t h e se 

c o m p a n i es  are  s u b s i d i a r i es  or  if  the  s h a r es  are  not 

r e a d i ly  r e a l i s a b le  i n v e s t m e n t s; 

d e p o s i ts  m a d e,  o t h er  than  t h o se  w h i ch  are  w i th  a 

c r e d it 

i n s t i t u t i o n, 

local 

a u t h o r i ty 

or 

r e g i o n al 

g o v e r n m e nt 

and 

a v a i l a b le 

for 

r e p a y m e nt 

w i t h in 

n i n e ty  d a y s,  and  a l so  e x c l u d i ng  m a r g in  p a y m e n ts  in 

c o n n e c t i on 

w i th 

f u t u r es 

or 

w r i t t en 

o p t i o ns 

c o n t r a c ts -, 

g u a r a n t e es  g i v e n; 

d e f i c i e n c i es  In  s u b s i d i a r i e s; 

all  o t h er  a s s e ts  ( i n c l u d i ng  p h y s i c al  s t o c k s)  u n l e ss 

they  a re  s u b j e ct  to  the  c a p i t al  r e q u i r e m e n ts  set 

out  in  t h is  D i r e c t i v e,  or  p u r s u a nt  to  A r t i c le  4 ( 5 ). 

-  46 -

COMPETITIVENESS AND  EMPLOYMENT  IMPACT  STATEMENT 

PROPOSAL  FOR  A COUNCIL  DIRECTIVE ON CAPITAL  ADEQUACY 
OF  INVESTMENT  FIRMS AND  CREDIT  INSTITUTIONS 

I. 

What  Is the main  reason  for  introducing  the  measure? 

The main  reason  for  Introducing  the measure  is to ensure  that 
consumers  of  financial  services  are  adequately  protected  by  imposing 
minimum  capital  requirements  on  investment  firms. 

I I. 

Features of  the  businesses  In  question 

The  scope  of  the  proposal  covers  credit  Institutions and  non-
bank  investment  firms  which  are  dealers  or  brokers  in securities,  as 
well  as portfolio managers  and  investment  advisers. 

a) 

b) 

There  are many  SMEs, mainly  in the United  Kingdom. 

There  is no  particular  regional  concentration. 

-  47  -

III. 

What 

direct  OPl IgatlQns  does  this  measure 

impose  on 

businesses? 

Businesses  are  required  to  comply  with  requirements  relating 

to  minimum  start-up  capital  which  varies  with  the  type  of  risk 

resulting  from  the  activities  the  firm  is carrying  out. 

For  low-risk  activities,  such  as  investment  advice  only  or 

"locals",  there  Is  no  initial  or  on-going  capital  requirement. 

(Locals  are  members  of  financial  futures  or  options  exchanges  whose 

transactions  are  guaranteed  by  other  member  firms  of  the  exchange.) 

The  general  start-up  capital  Is  set  at  ECU  500 000.  Member  States 

may  reduce  this  requirement  to  ECU  50  000  for  firms which  do  not  hold 

customers' money  or  securities, or  to  ECU  100  000  for  brokerage  firms 

which  hold  customers' money  or  securities  but  who  do  not  take  trading 

positions  for  their  own  account.  Firms  already  In  existence  before 

implementation  of  the  directive  may  be  granted  an  exemption 

(grandfathering  clause)  from  these  initial  capital  requirements. 

Firms  will  also  have  to  meet  on-going  capital  requirements 

based  on  an  expenditure  measure  and  on  their  position  risk, 

counterparty  risk  and  foreign  exchange  risk.  These  risks  are 

strictly  proportional  to  the  size of  each  business  and  to  the  size  of 

the  risk  taken. 

IV. 

What 

indirect  obligations  are  local  authorities 

likely  to  impose  on  businesses? 

None 

-  48  -

V. 

Are  there  anv  special  measures  In respect  of  SMEs? 

Implicitly  SMEs  will  be  the  main  bénéficiaires  of  the 

"grandfathering  clause"  concerning  Initial  capital, as well  as of  the 

exception  for  "locals" and  pure  Investment  advisers. 

VI. 

What  Is the  ilkeiv  effect  on: 

a)  the competitiveness of  businesses? 

Investment  firms'  own  funds  should  reflect  the  risks  taken 

and  the  size  of  their  transactions.  This  should  improve  their 

performance  and  reduce  their  failure  rate. 

b)  employment? 

Because  of  the  "grandfathering  clause"  there  should  be  no 

reduction  In  the  number  of  already  existing  firms.  There  Is  likely 

to  be  some  reduction  In  the  number  of  new  entrants  as  not  all 

candidates  would  be  able  to  meet  the  initial  capital  requirement  of 

ECU  50 000  or  ECU  100 000.  This  effect  might,  however,  well  be 

compensated  for  by  the  fact  that  all  authorised  firms  could  engage  In 

securities  business  throughout  the  Community  on  the  basis  of  home 

country  authorisation  and  supervision.  In  addition,  consumers  of 

financial  services  should  have  more  confidence  in  small  and  medium-

sized 

Investment  firms,  knowing  that  they  are  likely  to  be 

sufficiently  capitalized  in  relation  to  the  size  of  their  business. 

The  survival  rate of  new  entrants  should  increase  because  of  a  larger 

capacity  to absorb  losses. 

49 -

VII. 

Have  both  sides of  Industry  been  consulted? 

There  have  been  no  consultations  with  representatives  of 

employees. 

As  far  as  the  business  sector  is concerned,  there  have  been 

requests  made  to  the  Commission  by  representatives  of  the  financial 

futures  and  options  exchanges  in  France,  the  Netherlands  and  the 

United  Kingdom  in favour  of  "locals".  These  demands  have  been met  by 

the  exclusion  of  "locals"  from  initial  and  on-going  capital 

requirements. 

In  addition,  there  have  been  requests  made  by  FIMBRA 

concerning  the  level  of  the  Initial  start-up  requirements.  These 

demands  have been met,  as  far  as compatible  with  consumer  protection, 

by  excluding  pure  investment  advisers  from  any  capital  requiremnets, 

by providing  an  Intermediate  level  of  start-up  capital  of  ECU  100 000 

for  brokers  who  do  not  take  positions,  and  by  the  "grandfathering 

clause"  for  existing  firms. 

ISSN 0254-1475 

COM (90) 141  final 

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