Amended proposal for a European Parliament and Council Directive amending Directive 93/6/EEC on the capital adequacy of investment firms and credit institutions
Date: 1998-02-13
Institutions: European Commission
Subjects: credit guarantee, credit institution, financial solvency, management audit, share capital

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 

8th recital 

Amendment 1 

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 

gold) 

(agricultural 

inc. 

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 • 

, 
In  the  event  of  numerous  overshootings, 
the  competent  authority  shall  revoke  the  model  is  not  sufficiently  accurate,  the 
the 

If numerous overshootings indicate that the 

competent  authorities  shall  revoke 

,  ,, 

... 

.. 

, 

6 

.  . 
model  s  recognition  or  impose  appropriate 

v 

improved  promptly. 
measures  to  ensure  that  the  model 

is 

,1  .  .i 

,  i  •  model's  recognition  or  impose  appropriate 
is 

measures  to  ensure  that  the  model 

& 

r 

rr 

v 

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. 

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 

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