COMMON POSITION (EC) No 21/98 adopted by the Council on 9 March 1998 with a view to adopting European Parliament and Council Directive 98/.../EC of ... , amending Council Directive 93/6/EEC on the capital adequacy of investment firms and credit institutions
Date: 1998-03-09
Institutions: Council of the European Union
Subjects: credit guarantee, credit institution, financial instrument, financial solvency, management audit, share capital

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/7

COMMON  POSITION  (EC)  No  21/98

adopted  by  the  Council  on  9  March  1998

with  a  view  to  adopting  European  Parliament  and  Council  Directive  98/. . ./EC  of  . . .  ,
amending  Council  Directive  93/6/EEC  on  the  capital  adequacy  of  investment  firms  and  credit
institutions

(98/C  135/02)

THE  EUROPEAN  PARLIAMENT  AND  THE  COUNCIL  OF
THE  EUROPEAN  UNION,

Having  regard  to  the  Treaty  establishing  the  European
in  particular  the  first  and  third
Community,  and 
sentences  of  Article  57(2)  thereof,

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

Having regard to the opinion of the Economic and Social
Committee (2),

Having  regard  to  the  opinion  of  the  European  Monetary
Institute (3),

Acting  in  accordance  with  the  procedure  laid  down  in
Article  189b  of  the  Treaty (4),

(1)  Whereas  the  risks  associated  with  commodities
trading  and  commodity  derivatives  are  currently
subject  to  Council  Directive  89/647/EEC  of  18
December  1989  on  a  solvency  ratio  for  credit
institutions (5);  whereas,  however,  the  market  risks
associated  with  those  positions  are  not  captured
accurately  by  Directive  89/647/EEC;  whereas  it  is
necessary  to  extend  the  concept  of  the  ‘trading
book’  to  positions  in  commodities  or  commodity
derivatives which are held for trading purposes and
are  subject  mainly  to  market  risks;  whereas
institutions  must  comply  with  this  Directive  as
regards  the  coverage  of  commodity  risks  on  their
overall  business;  whereas  the  perpetration  of
serious fraud by certain commodity futures traders
is  of  growing  concern  to  the  Community  and  a

(1)  OJ  C  240,  6.8.1997,  p.  24.
(2)  OJ  C  19,  21.1.1998,  p.  9.
(3)  Opinion  delivered  on  7  October  1997.
(4)  Opinion  of  the  European  Parliament  of  18  December  1997
(not yet published in the Official Journal), Council Common
Position  of  9  March  1998  and  Decision  of  the  European
in  the  Official
. . .  (not  yet  published 
Parliament  of 
Journal).

(5)  OJ  L  386,  30.12.1989,  p.  14.  Directive  as  last  amended  by
European  Parliament  and  Council  Directive  98/. . ./EC  (see
page  1  of  this  Official  Journal).

threat  to  the  image  and  integrity  of  the  futures
trading  business;  whereas  it  is  desirable  that  the
Commission 
an
appropriate  prudential  framework  in  order  to
prevent  these  fraudulent  practices  in  the  future;

consider 

defining 

should 

institutions;  whereas 

(2)  Whereas  Council  Directive  93/6/EEC  of  15  March
1993  on  the  capital  adequacy  of  investment  firms
and credit institutions (6) lays down a standardised
method  for  the  calculation  of  capital  requirements
for  market  risks  incurred  by  investment  firms  and
credit 
institutions  have
developed  their  own  risk-management  systems
to  measure  more
(internal  models),  designed 
accurately 
the
than 
market  risks  incurred  by  investment  firms  and
credit 
institutions;  whereas  the  use  of  more
accurate  methods  of  measuring  risks  should  be
encouraged;

the  standardised  method 

capital 

calculating 

(3)  Whereas  the  use  of  such  internal  models  for  the
purpose  of 
requirements
requires  strict  internal  control  mechanisms  and
should be subject to recognition and supervision by
the  competent  authorities;  whereas  the  continued
reliability  of  the  results  of  the  internal  model
calculation  should  be  verified  by  a  back-testing
procedure;

(4)  Whereas 

it 

that 

is  appropriate 

competent
authorities  may  allow  margin  requirements  for
exchange-traded  futures  and  options,  and  on  a
transitional  basis 
for  cleared  over-the-counter
derivatives  of  the  same  nature,  to  be  used  as
substitutes  for  the  capital  requirement  calculated
in  accordance  with  this
for  such 
Directive,  provided  that  this  does  not  lead  to  a
capital requirement which is lower than the capital
requirement  calculated  according  to  the  other
methods  prescribed  in  this  Directive;  whereas  the
application  of  this  principle  does  not  require  that

instruments 

(6)  OJ  L  141,  11.6.1993,  p.  1.

C  135/8

EN

Official  Journal  of  the  European  Communities

30.4.98

the  equivalence  between  such  margin  requirements
and  the  capital  requirements  calculated  according
to  the  other  methods  prescribed  in  this  Directive
must  be  continually  verified  by  the  institutions
applying  this  principle;

1.  Article  2  is  amended  as  follows:

(a)  point  6(a)  and  the 

introductory  phrase  and
subpoints  (i)  and  (ii)  of  point  6(b)  shall  be
replaced  by  the  following:

(5)  Whereas 

the 

rules  adopted  at 

the  wider
international level may, in order to encourage more
sophisticated  risk-management  methods  based  on
internal  models,  lower  capital  requirements  for
credit  institutions  from  third  countries;  whereas
those  credit  institutions  compete  with  investment
firms  and  credit  institutions  incorporated  in  the
Member  States;  whereas  for  investment  firms  and
credit  institutions  incorporated  in  the  Member
States,  only  an  amendment  of  Directive  93/6/EEC
can  provide  similar  incentives  for  the  development
and  use  of  internal  models;

(6)  Whereas 

for 

the 

calculating
market-risk-capital  requirements,  positions  in  gold
and  gold  derivatives  should  be  treated  in  a  similar
fashion  to  foreign-exchange  positions;

purpose 

of 

(7)  Whereas the issue of subordinated debt should not
automatically exclude an issuer’s equity from being
included  in  a  portfolio  qualifying  for  a  2 %
specific-risk  weighting  according  to  point  33  of
Annex  I  to  Directive  93/6/EEC;

(8)  Whereas  this  Directive  is  in  accordance  with  the
work  of  an 
international  forum  of  banking
supervisors on the supervisory treatment of market
in  commodities  and
risk  and  of  positions 
commodity derivatives;

(9)  Whereas  it  is  necessary  to  have  a  transitional
capital  regime  on  an  optional  basis  for  investment
firms and credit institutions undertaking significant
commodities  business,  having 
a  diversified
commodity portfolio and being not yet able to use
models 
the
commodities  risk  capital  requirement,  in  order  to
ensure  a  harmonious  application  of  this  Directive;

the  purpose  of  calculating 

for 

(10)  Whereas  this  Directive  is  the  most  appropriate
means  of  attaining  the  objectives  sought  and  does
not  go  beyond  what  is  necessary  to  achieve  those
objectives,

HAVE  ADOPTED  THIS  DIRECTIVE:

Article  1

Directive  93/6/EEC  is  hereby  amended  as  follows:

‘(a)  its 

in 

positions 

proprietary 

financial
instruments,  commodities  and  commodity
derivatives  which  are  held  for  resale  and/or
which  are  taken  on  by  the  institution  with
the  intention  of  benefiting  in  the  short  term
from  actual  and/or  expected  differences
between  their  buying  and  selling  prices,  or
from  other  price  or  interest-rate  variations,
and  positions 
instruments,
commodities  and  commodity  derivatives,
arising  from  matched  principal  broking,  or
positions  taken  in  order  to  hedge  other
elements  of  the  trading  book;

financial 

in 

(b)  the 

to 

(OTC) 

deliveries 

exposures  due 
free 

the  unsettled
and
transactions, 
over-the-counter 
derivative
instruments  referred  to  in  paragraphs  1,  2,  3
and  5  of  Annex  II,  the  exposures  due  to
repurchase  agreements  and  securities  and
commodities  lending  which  are  based  on
securities  or  commodities  included  in  the
trading  book  as  defined  in  (a)  referred  to  in
paragraph 4 of Annex II, those exposures due
repurchase  agreements  and
to 
securities-borrowing 
commodities-
borrowing transactions described in the same
competent
paragraph, 
authorities  so  approve,  which  meet  either
conditions  (i),  (ii),  (iii)  and  (v)  or  conditions
(iv)  and  (v)  as  follows:

provided 

reverse 

and 

the 

(i)  the exposures are marked to market daily
following  the  procedures  laid  down  in
Annex  II;

(ii) the  collateral  is  adjusted  in  order  to  take
account  of  material  changes  in  the  value
of  the  securities  or  commodities  involved
in 
in
question,  according  to  a  rule  acceptable
to  the  competent  authorities’;

the  agreement  or 

transaction 

(b) points  15  and  16  shall  be  replaced  by  the

following:

‘15.  “warrant” shall mean a security which gives
to  purchase  an
the  right 
the  holder 
underlying  at  a  stipulated  price  until  or  at
the  warrant’s  expiry  date.  It  may  be  settled
by the delivery of the underlying itself or by
cash  settlement.

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/9

16.  “stock  financing”  shall  means  positions
where  physical  stock  has  been  sold  forward
and  the  cost  of  funding  has  been  locked  in
until  the  date  of  the  forward  sale’;

(c)  point 17, first paragraph, shall be replaced by the

following:

‘17.  “repurchase 

securities 

agreement” 

and  “reverse
repurchase  agreement”  shall  mean  any
agreement  in  which  an  institution  or  its
counter-party 
or
transfers 
commodities or guaranteed rights relating to
title to securities or commodities where that
guarantee is issued by a recognised exchange
which  holds  the  rights  to  the  securities  or
commodities  and  the  agreement  does  not
allow  an  institution  to  transfer  or  pledge  a
particular  security  or  commodity  to  more
than  one  counter-party  at  one  time,  subject
to  a  commitment  to  repurchase  them  (or
substituted  securities  or  commodities  of  the
same  description)  at  a  specified  price  on  a
future  date  specified,  or  to  be  specified,  by
the transferor, being a repurchase agreement
for  the  institution  selling  the  securities  or
commodities  and  a  reverse  repurchase
agreement  for  the  institution  buying  them’;

(d) point  18  shall  be  replaced  by  the  following:

or 

collateral 

transaction 

commodities 

‘18.  “securities  or  commodities  lending”  and
“securities or commodities borrowing” shall
mean  any 
in  which  an
its  counter-party  transfers
institution  or 
against
securities 
appropriate 
a
to 
commitment  that  the  borrower  will  return
equivalent securities or commodities at some
future  date  or  when  requested  to  do  so  by
the 
transaction  being
securities  or  commodities  lending  for  the
institution  transferring  the  securities  or
commodities 
securities  or
and  being 
commodities  borrowing  for  the  institution
to  which  they  are  transferred.

transferor, 

subject 

that 

2.  in  Article  4(1),  first  subparagraph,  points  (i)  and  (ii)

shall  be  replaced  by  the  following:

‘(i) the  capital  requirements,  calculated  in  accordance
with  Annexes  I,  II  and  VI  and,  as  appropriate,
Annex  VIII,  for  their  trading-book  business;

(ii) the  capital  requirements,  calculated  in  accordance
with  Annexes  III  and  VII  and,  as  appropriate,
Annex  VIII,  for  all  of  their  business  activities’.

3.  Article  5(2)  shall  be  replaced  by  the  following:

‘2. Notwithstanding  paragraph  1,  those  institutions
which  calculate  the  capital  requirements  for  their
trading-book  business  in  accordance  with  Annexes  I
and  II,  and  as  appropriate  Annex  VIII,  shall  monitor
and  control  their  large  exposures  in  accordance  with
Directive  92/121/EEC  subject  to  the  modifications
laid  down  in  Annex  VI  to  this  Directive’;

4.  Article  7(10)  and  the  introductory  part  of  Article

7(11),  shall  be  replaced  by  the  following:

‘10. Where  the  rights  of  waiver  provided  for  in
paragraphs  7  and  9  are  not  exercised,  the  competent
authorities  may,  for  the  purpose  of  calculating  the
capital  requirements  set  out  in  Annexes  I  and  VIII
and the exposures to clients set out in Annex VI on a
consolidated  basis,  permit  positions  in  the  trading
book  of  one  institution  to  offset  positions  in  the
trading  book  of  another  institution  according  to  the
rules  set  out  in  Annexes  I,  VI  and  VIII.

they  may  allow 

In  addition, 
foreign-exchange
positions  in  one  institution  to  offset  foreign-exchange
positions in another institution in accordance with the
rules  set  out  in  Annex  III  and/or  Annex  VIII.  They
may  also  allow  commodities  positions 
in  one
institution  to  offset  commodities  positions  in  another
institution  in  accordance  with  the  rules  set  out  in
Annex  VII  and/or  Annex  VIII.

the 

11. The  competent  authorities  may  also  permit
the
offsetting  of 
positions,
foreign-exchange 
respectively,  of  undertakings 
third
in 
countries,  subject  to  the  simultaneous  fulfilment  of
the  following  conditions:’.

trading  book  and  of 
commodities 

located 

and 

considered 

to  prudential 

Securities  or  commodities  borrowing  shall
interprofessional
an 
be 
transaction  when 
is
the  counter-party 
subject 
coordination  at
Community  level  or  is  a  Zone  A  credit
in  Directive
defined 
institution 
89/647/EEC or is a recognised third-country
investment  firm  or  when  the  transaction  is
concluded  with  a  recognised  clearing  house
or  exchange’;

as 

5.  Article  8(5)  shall  be  replaced  by  the  following:

‘5. The competent authorities shall oblige institutions
to report to them immediately any case in which their
counter-parties  in  repurchase  and  reverse  repurchase
agreements or securities and commodities-lending and
securities  and  commodities-borrowing  transactions
default  on  their  obligations.  The  Commission  shall
report  to  the  Council  on  such  cases  and  their
implications for the treatment of such agreements and
transactions  in  this  Directive  not  more  than  three
years  after  the  date  referred  to  in  Article  12.  Such

C  135/10

EN

Official  Journal  of  the  European  Communities

30.4.98

report  shall  also  describe  the  way  that  institutions
meet  those  of  conditions  (i)  to  (v)  in  Article  2(6)(b)
that  apply  to  them,  in  particular  condition  (v).
Furthermore it shall give details of any changes in the
relative volume of institutions’ traditional lending and
their  lending  through  reverse  repurchase  agreements
and  securities-borrowing  or  commodities-borrowing
transactions.  If  the  Commission  concludes  on  the
basis of this report and other information that further
safeguards are needed to prevent abuse, it shall make
appropriate  proposals’.

6.  The  following  Article  shall  be  inserted:

‘Article  11a

Until  31  December  2006,  Member  States  may
authorise  their 
institutions  to  use  the  minimum
spread,  carry  and  outright  rates  set  out  in  the
following 
in
paragraphs 13, 14, 17 and 18 of Annex VII provided
that the institutions, in the opinion of their competent
authorities:

instead  of 

indicated 

those 

table 

(i)  undertake  significant  commodities  business,

(ii)  have  a  diversified  commodities  portfolio,  and

(iii)  are  not  yet  in  a  position  to  use  internal  models
the  capital
for 
requirement  on  commodities  risk  in  accordance
with  Annex  VIII.

the  purpose  of  calculating 

Table

Precious
metals
(except
gold)

Spread  rate  (%)

Carry  rate  (%)

1,0

0,3

Base
metals

1,2

0,5

Agri-
cultural
products
(softs)

Other,
including
energy
products

1,5

0,6

1,5

0,6

Member  States  shall  inform  the  Commission  of  the
use  they  make  of  this  Article’.

7.  Annexes  I,  II,  III  and  V  shall  be  amended,  and
Annexes  VII  and  VIII  added  in  accordance  with  the
Annex  to  this  Directive.

Article  2

1. Member  States  shall  bring  into  force  the  laws,
regulations  and  administrative  provisions  necessary  to
comply with this Directive not later than 24 months after
the  date  of  its  entry  into  force.  They  shall  forthwith
inform  the  Commission  thereof.

When  Member  States  adopt  these  measures,  they  shall
contain  a  reference  to  this  Directive  or  shall  be
accompanied  by  such  reference  on  the  occasion  of  their
official  publication.  The  methods  of  making  such
reference  shall  be  laid  down  by  Member  States.

2. Member States shall communicate to the Commission
the  text  of  the  main  provisions  of  domestic  law  which
they  adopt  in  the  field  governed  by  this  Directive.

Article  3

This  Directive  shall  enter  into  force  on  the  day  of  its
publication  in  the  Official  Journal  of  the  European
Communities.

Article  4

This  Directive  is  addressed  to  the  Member  States.

Done  at  . . .

Outright  rate
(%)

8

10

12

15

For  the  European  Parliament

For  the  Council

The  President

The  President

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/11

ANNEX

1.  Annex  I  is  amended  as  follows:

(a)  In  Paragraph  4,  the  last  sentence  is  deleted  and  the  following  subparagraph  is  added:

‘The  competent  authorities  may  allow  the  capital  requirement  for  an  exchange-traded  future  to  be
equal  to  the  margin  required  by  the  exchange  if  they  are  fully  satisfied  that  it  provides  an  accurate
measure of the risk associated with the future and that it is at least equal to the capital requirement
for a future that would result from a calculation made using the method set out in the remainder of
this  Annex  or  applying  the  internal  models  method  described  in  Annex  VIII.  Until  31  December
2006  the  competent  authorities  may  also  allow  the  capital  requirement  for  an  OTC  derivatives
contract of the type referred to in this paragraph cleared by a clearing house recognised by them to
be  equal  to  the  margin  required  by  the  clearing  house  if  they  are  fully  satisfied  that  it  provides  an
accurate  measure  of  the  risk  associated  with  the  derivatives  contract  and  that  it  is  at  least  equal  to
the capital requirement for the contract in question that would result from a calculation made using
the method set out in the remainder of this Annex or applying the internal models method described
in  Annex  VIII’.

(b) In  paragraph  5,  the  third  subparagraph  is  replaced  by  the  following:

‘The  competent  authorities  shall  require  that  the  other  risks,  apart  from  the  delta  risk,  associated
with options are safeguarded against. The competent authorities may allow the requirement against a
written exchange-traded option to be equal to the margin required by the exchange if they are fully
satisfied that it provides an accurate measure of the risk associated with the option and that it is at
least  equal  to  the  capital  requirement  against  an  option  that  would  result  from  a  calculation  made
using  the  method  set  out  in  the  remainder  of  this  Annex  or  applying  the  internal  models  method
described  in  Annex  VIII.  Until  31  December  2006  the  competent  authorities  may  also  allow  the
capital requirement for an OTC option cleared by a clearing house recognised by them to be equal to
the  margin  required  by  the  clearing  house  if  they  are  fully  satisfied  that  it  provides  an  accurate
measure of the risk associated with the option and that it is at least equal to the capital requirement
for  an  OTC  option  that  would  result  from  a  calculation  made  using  the  method  set  out  in  the
remainder  of  this  Annex  or  applying  the  internal  models  method  described  in  Annex  VIII.  In
addition  they  may  allow  the  requirement  on  a  bought  exchange-traded  or  OTC  option  to  be  the
same as that for the instrument underlying it, subject to the constraint that the resulting requirement
does not exceed the market value of the option. The requirement against a written OTC option shall
be  set  in  relation  to  the  instrument  underlying  it’.

(c)  Paragraph  6  is  replaced  by  the  following:

‘6.  Warrants  relating  to  debt  instruments  and  equities  shall  be  treated  in  the  same  way  as  options

under  paragraph  5’.

(d) Paragraph  33(i)  is  replaced  by  the  following:

‘(i)  the  equities  shall  not  be  those  of  issuers  which  have  issued  only  traded  debt  instruments  that
currently  attract  an  8 %  requirement  in  Table  1  appearing  in  paragraph  14  or  that  attract  a
lower  requirement  only  because  they  are  guaranteed  or  secured’.

2.  Annex  II  is  amended  as  follows:

(a)  Paragraph  1  is  replaced  by  the  following:

‘1. 

In  the  case  of  transactions  in  which  debt  instruments,  equities  and  commodities  (excluding
repurchase  and  reverse  repurchase  agreements  and  securities  or  commodities  lending  and
securities  or  commodities  borrowing)  are  unsettled  after  their  due  delivery  dates,  an  institution
must  calculate  the  price  difference  to  which  it  is  exposed.  This  is  the  difference  between  the
agreed settlement price for the debt instrument, equity or commodity in question and its current
market value, where the difference could involve a loss for the institution. It must multiply this
difference by the appropriate factor in column A of the table appearing in paragraph 2 in order
to  calculate  its  capital  requirement’.

C  135/12

EN

Official  Journal  of  the  European  Communities

30.4.98

(b) Paragraphs  3.1  and.  3.2  are  replaced  by  the  following:

‘3.1.  An  institution  shall  be  required  to  hold  capital  against  counterparty  risk  if:

(i)  it has paid for securities or commodities before receiving them or it has delivered securities

or  commodities  before  receiving  payment  for  them

and

(ii) in  the  case  of  cross-border  transactions,  one  day  or  more  has  elapsed  since  it  made  that

payment  or  delivery.

3.2.  The  capital  requirement  shall  be  8 %  of  the  value  of  the  securities  or  commodities  or  cash
owed  to  the  institution  multiplied  by  the  risk  weighting  applicable  to  the  relevant
counterparty’.

(c)  The  heading  before  paragraph  4.1  and  the  first  subparagraph  of  paragraph  4.1  are  replaced  by  the

following:

‘Repurchase  and  reverse  repurchase  agreements,  securities  or  commodities  lending  and  borrowing

4.1. 

In the case of repurchase agreements and securities or commodities lending based on securities
or  commodities  included  in  the  trading  book  the  institution  shall  calculate  the  difference
between  the  market  value  of  the  securities  or  commodities  and  the  amount  borrowed  by  the
institution or the market value of the collateral, where that difference is positive. In the case of
reverse  repurchase  agreements  and  securities  or  commodities  borrowing,  the  institution  shall
calculate the difference between the amount the institution has lent or the market value of the
collateral  and  the  market  value  of  the  securities  or  commodities  it  has  received,  where  that
difference  is  positive’.

3.  Annex  III  is  amended  as  follows:

(a)  Paragraph  1  is  replaced  by  the  following:

‘1. 

If  the  sum  of  an  institution’s  overall  net  foreign-exchange  position  and  its  net  gold  position,
calculated in accordance with the procedure set out below, exceeds 2 % of its total own funds,
it shall multiply the sum of its net foreign-exchange position and its net gold position by 8 %
in  order  to  calculate  its  own-funds  requirement  against  foreign-exchange  risk.

Until  31  December  2004,  the  competent  authorities  may  allow  institutions  to  calculate  their
own-funds  by  multiplying  by  8 %  the  amount  by  which  the  sum  of  the  overall  net
foreign-exchange  position  and  the  net  gold  position  exceeds  2 %  of  the  total  own  funds’.

(b) Paragraphs  3.1  and  3.2  are  replaced  by  the  following:

‘3.1.  Firstly,  the  institution’s  net  open  position  in  each  currency  (including  the  reporting  currency)
and in gold shall be calculated. This position shall consist of the sum of the following elements
(positive  or  negative):

—  the net spot position (i. e. all asset items less all liability items, including accrued interest, in

the  currency  in  question  or,  for  gold,  the  net  spot  position  in  gold),

—  the net forward position (i. e. all amounts to be received less all amounts to be paid under
forward  exchange  and  gold  transactions,  including  currency  and  gold  futures  and  the
principal  on  currency  swaps  not  included  in  the  spot  position),

—  irrevocable  guarantees  (and  similar  instruments)  that  are  certain  to  be  called  and  likely  to

be irrecoverable,

—  net  future  income/expenses  not  yet  accrued  but  already  fully  hedged  (at  the  discretion  of
the reporting institution and with the prior consent of the competent authorities, net future
income/expenses not yet entered in accounting records but already fully hedged by forward
foreign-exchange transactions may be included here). Such discretion must be exercised on
a  consistent  basis,

—  the  net  delta  (or  delta-based)  equivalent  of  the  total  book  of  foreign-currency  and  gold

options,

—  the  market  value  of  other  (i. e.  non-foreign-currency  and  non-gold)  options,

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/13

—  any  positions  which  an  institution  has  deliberately  taken  in  order  to  hedge  against  the
adverse  effect  of  the  exchange  rate  on  its  capital  ratio  may  be  excluded  from  the
calculation  of  net  open  currency  positions.  Such  positions  should  be  of  a  non-trading  or
structural  nature  and  their  exclusion,  and  any  variation  of  the  terms  of  their  exclusion,
shall  require  the  consent  of  the  competent  authorities.  The  same  treatment  subject  to  the
same conditions as above may be applied to positions which an institution has which relate
to  items  that  are  already  deducted  in  the  calculation  of  own  funds.

3.2.  The competent authorities shall have the discretion to allow institutions to use the net present

value  when  calculating  the  net  open  position  in  each  currency  and  in  gold’.

(c)  Paragraph  4,  first  sentence,  is  replaced  by  the  following:

‘4. 

Secondly, net short and long positions in each currency other than the reporting currency and
the  net  long  or  short  position  in  gold  shall  be  converted  at  spot  rates  into  the  reporting
currency’.

(d) Paragraph  7  is  replaced  by  the  following:

‘7. 

Secondly,  until  31  December  2004,  the  competent  authorities  may  allow  institutions  to  apply
an  alternative  method  to  those  outlined  in  paragraphs  1  to  6  for  the  purposes  of  this  Annex.
The capital requirement produced by this method must be sufficient to exceed 2 % of the net
open  position  as  measured  in  paragraph  4  and,  on  the  basis  of  an  analysis  of  exchange-rate
movements  during  all  the  rolling  10-working-day  periods  over  the  preceding  three  years,  to
exceed  the  likely  loss  99 %  or  more  of  the  time.

The  alternative  method  described  in  the  first  subparagraph  may  only  be  used  under  the
following  conditions:

(i)  the  calculation  formula  and  the  correlation  coefficients  are  set  by  the  competent

authorities,  based  on  their  analysis  of  exchange-rate  movements;

(ii) the  competent  authorities  review  the  correlation  coefficients  regularly  in  the  light  of

developments  in  foreign-exchange  markets’.

4.  Annex  V  is  amended  as  follows:

(a)  Paragraph  2,  first  sentence,  is  replaced  by  the  following:

‘Notwithstanding  paragraph  1,  the  competent  authorities  may  permit  those  institutions  which  are
obliged  to  meet  the  own-funds  requirements  laid  down  in  Annexes  I,  II,  III,  IV,  VI,  VII  and  VIII  to
use  an  alternative  definition  when  meeting  those  requirements  only’.

(b) Paragraph  4  is  replaced  by  the  following:

‘4.  The  subordinated  loan  capital  referred  to  in  paragraph  2(c)  may  not  exceed  a  maximum  of
150 % of the original own funds left to meet the requirements laid down in Annexes I, II, III,
IV,  VI,  VII,  and  VIII  and  may  approach  that  maximum  only  in  particular  circumstances
acceptable  to  the  relevant  authorities’.

(c)  Paragraphs  6  and  7  are  replaced  by  the  following:

‘6.  The competent authorities may permit investment firms to exceed the ceiling for subordinated
loan capital prescribed in paragraph 4 if they judge it prudentially adequate and provided that
the  total  of  such  subordinated  loan  capital  and  the  items  referred  to  in  paragraph  5  does  not
exceed  200 %  of  the  original  own  funds  left  to  meet  the  requirements  imposed  in  Annexes  I,
II, III, IV, VI, VII and VIII or 250 % of the same amount where investment firms deduct item
2(d)  referred  to  in  paragraph  2  when  calculating  own  funds.

7. 

The  competent  authorities  may  permit  the  ceiling  for  subordinated  loan  capital  prescribed  in
paragraph  4  to  be  exceeded  by  a  credit  institution  if  they  judge  it  prudentially  adequate  and
provided  that  the  total  of  such  subordinated  loan  capital  and  the  items  referred  to  in
paragraph  5  does  not  exceed  250 %  of  the  original  own  funds  left  to  meet  the  requirements
imposed  in  Annexes  I,  II,  III,  VI,  VII  and  VIII’.

C  135/14

EN

Official  Journal  of  the  European  Communities

30.4.98

5.  The  following  Annexes  are  added:

‘ANNEX  VII

COMMODITIES  RISK

1.  Each position in commodities or commodity derivatives shall be expressed in terms of the standard
unit  of  measurement.  The  spot  price  in  each  commodity  shall  be  expressed  in  the  reporting
currency.

2.  Positions  in  gold  or  gold  derivatives  shall  be  considered  as  being  subject  to  foreign-exchange  risk
and  treated  according  to  Annex  III  or  Annex  VIII,  as  appropriate,  for  the  purpose  of  calculating
market  risk.

3.  For  the  purposes  of  this  Annex,  positions  which  are  purely  stock  financing  may  be  excluded  from

the  commodities  risk  calculation  only.

4.  The interest-rate and foreign-exchange risks not covered by other provisions of this Annex shall be
included  in  the  calculation  of  general  risk  for  traded  debt  instruments  and  in  the  calculation  of
foreign-exchange  risk.

5.  When the short position falls due before the long position, institutions shall also guard against the

risk  of  a  shortage  of  liquidity  which  may  exist  in  some  markets.

6.  For the purpose of paragraph 19, the excess of an institution’s long (short) positions over its short
(long)  positions  in  the  same  commodity  and  identical  commodity  futures,  options  and  warrants
shall  be  its  net  position  in  each  commodity.  The  competent  authorities  shall  allow  positions  in
derivative  instruments  to  be  treated,  as  laid  down  in  paragraphs  8,  9  and  10,  as  positions  in  the
underlying  commodity.

7.  The  competent  authorities  may  regard  the  following  positions  as  positions  in  the  same

commodity:

—  positions  in  different  sub-categories  of  commodities  in  cases  where  the  sub-categories  are

deliverable  against  each  other,

and

—  positions  in  similar  commodities  if  they  are  close  substitutes  and  if  a  minimum  correlation  of
0,9  between  price  movements  can  be  clearly  established  over  a  minimum  period  of  one  year.

Particular  instruments

8.  Commodity  futures  and  forward  commitments  to  buy  or  sell  individual  commodities  shall  be
incorporated  in  the  measurement  system  as  notional  amounts  in  terms  of  the  standard  unit  of
measurement and assigned a maturity with reference to expiry date. The competent authorities may
allow the capital requirement for an exchange-traded future to be equal to the margin required by
the  exchange  if  they  are  fully  satisfied  that  it  provides  an  accurate  measure  of  the  risk  associated
with the future and that it is at least equal to the capital requirement for a future that would result
from  a  calculation  made  using  the  method  set  out  in  the  remainder  of  this  Annex  or  applying  the
internal  models  method  described  in  Annex  VIII.  Until  31  December  2006  the  competent
authorities  may  also  allow  the  capital  requirement  for  an  OTC  commodity  derivatives  contract  of
the type referred to in this paragraph cleared by a clearing house recognised by them to be equal to
the  margin  required  by  the  clearing  house  if  they  are  fully  satisfied  that  it  provides  an  accurate
measure  of  the  risk  associated  with  the  derivatives  contract  and  that  it  is  at  least  equal  to  the
capital requirement for the contract in question that would result from a calculation made using the
method set out in the remainder of this Annex or applying the internal models method described in
Annex  VIII.

9.  Commodity  swaps  where  one  side  of  the  transaction  is  a  fixed  price  and  the  other  the  current
market price shall be incorporated into the maturity ladder approach as a series of positions equal
to the notional amount of the contract, with one position corresponding with each payment on the
swap  and  slotted  into  the  maturity  ladder  set  out  in  the  table  appearing  in  paragraph  13.  The
positions  would  be  long  positions  if  the  institution  is  paying  a  fixed  price  and  receiving  a  floating
price  and  short  positions  if  the  institution  is  receiving  a  fixed  price  and  paying  a  floating  price.

Commodity  swaps  where  the  sides  of  the  transaction  are  in  different  commodities  are  to  be
reported  in  the  relevant  reporting  ladder  for  the  maturity  ladder  approach.

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/15

10.  Options  on  commodities  or  on  commodity  derivatives  shall  be  treated  as  if  they  were  positions
equal in value to the amount of the underlying to which the option refers, multiplied by its delta for
the  purposes  of  this  Annex.  The  latter  positions  may  be  netted  off  against  any  offsetting  positions
in the identical underlying commodity or commodity derivative. The delta used shall be that of the
exchange  concerned,  that  calculated  by  the  competent  authorities  or,  where  none  of  those  is
available  or  for  OTC  options,  that  calculated  by  the  institution  itself,  subject  to  the  competent
authorities’  being  satisfied  that  the  model  used  by  the  institution  is  reasonable.

However, the competent authorities may also prescribe that institutions calculate their deltas using
a  methodology  specified  by  the  competent  authorities.

The  competent  authorities  shall  require  that  the  other  risks,  apart  from  the  delta  risk,  associated
with  commodity  options  are  safeguarded  against.  The  competent  authorities  may  allow  the
requirement for a written exchange-traded commodity option to be equal to the margin required by
the  exchange  if  they  are  fully  satisfied  that  it  provides  an  accurate  measure  of  the  risk  associated
with the option and that it is at least equal to the capital requirement against an option that would
result from a calculation made using the method set out in the remainder of this Annex or applying
the  internal  models  method  described  in  Annex  VIII.  Until  31  December  2006  the  competent
authorities  may  also  allow  the  capital  requirement  for  an  OTC  commodity  option  cleared  by  a
clearing house recognised by them to be equal to the margin required by the clearing house if they
are  fully  satisfied  that  it  provides  an  accurate  measure  of  the  risk  associated  with  the  option  and
that  it  is  at  least  equal  to  the  capital  requirement  for  an  OTC  option  that  would  result  from  a
calculation made using the method set out in the remainder of this Annex or applying the internal
models  method  described  in  Annex  VIII.  In  addition  they  may  allow  the  requirement  on  a  bought
exchange-traded  or  OTC  commodity  option  to  be  the  same  as  that  for  the  commodity  underlying
it,  subject  to  the  constraint  that  the  resulting  requirement  does  not  exceed  the  market  value  of  the
option.  The  requirement  for  a  written  OTC  option  shall  be  set  in  relation  to  the  commodity
underlying  it.

11.  Warrants  relating  to  commodities  shall  be  treated  in  the  same  way  as  commodity  options  under

paragraph 10.

12.  The transferor of commodities or guaranteed rights relating to title to commodities in a repurchase
agreement  and  the  lender  of  commodities  in  a  commodities  lending  agreement  shall  include  such
commodities  in  the  calculation  of  its  capital  requirement  under  this  Annex.

(a) Maturity  ladder  approach

13.  The  institution  shall  use  a  separate  maturity  ladder  in  line  with  the  following  table  for  each
commodity.  All  positions  in  that  commodity  and  all  positions  which  are  regarded  as  positions  in
the same commodity pursuant to paragraph 7 shall be assigned to the appropriate maturity bands.
Physical  stocks  shall  be  assigned  to  the  first  maturity  band.

Maurity  band

(1)

0  #  1  month
.  1  #  3  months
.  3  #  6  months
.  6  #  12  months
.  1  #  2  years
.  2  #  3  years
.  3  years

Spread  rate
(in  %)
(2)

1,50
1,50
1,50
1,50
1,50
1,50
1,50

14.  Competent authorities may allow positions which are, or are regarded pursuant to paragraph 7 as
positions in the same commodity to be offset and assigned to the appropriate maturity bands on a
net  basis  for:

—  positions  in  contracts  maturing  on  the  same  date

and

C  135/16

EN

Official  Journal  of  the  European  Communities

30.4.98

—  positions  in  contracts  maturing  within  10  days  of  each  other  if  the  contracts  are  traded  on

markets  which  have  daily  delivery  dates.

15.  The institution shall then work out the sum of the long positions and the sum of the short positions
in each maturity band. The amount of the former (latter) which are matched by the latter (former)
in  a  given  maturity  band  shall  be  the  matched  positions  in  that  band,  while  the  residual  long  or
short  position  shall  be  the  unmatched  position  for  the  same  band.

16.  That part of the unmatched long (short) position for a given maturity band that is matched by the
unmatched  short  (long)  position  for  a  maturity  band  further  out  shall  be  the  matched  position
between  two  maturity  bands.  That  part  of  the  unmatched  long  or  unmatched  short  position  that
cannot  be  thus  matched  shall  be  the  unmatched  position.

17.  The  institution’s  capital  requirement  for  each  commodity  shall  be  calculated  on  the  basis  of  the

relevant  maturity  ladder  as  the  sum  of  the  following:

(i) 

the sum of the matched long and short positions, multiplied by the appropriate spread rate as
indicated in the second column of the table appearing in paragraph 13 for each maturity band
and  by  the  spot  price  for  the  commodity;

(ii)  the  matched  position  between  two  maturity  bands  for  each  maturity  band  into  which  an
unmatched position is carried forward, multiplied by 0,6 % (carry rate) and by the spot price
for  the  commodity;

(iii)  the residual unmatched positions, multiplied by 15 % (outright rate) and by the spot price for

the  commodity.

18.  The institution’s overall capital requirement for commodities risk shall be calculated as the sum of

the  capital  requirements  calculated  for  each  commodity  according  to  paragraph  17.

(b) Simplified  approach

19.  The  institution’s  capital  requirement  for  each  commodity  shall  be  calculated  as  the  sum  of:

(i)  15 %  of  the  net  position,  long  or  short,  multiplied  by  the  spot  price  for  the  commodity;

(ii) 3 %  of  the  gross  position,  long  plus  short,  multiplied  by  the  sport  price  for  the  commodity.

20.  The institution’s overall capital requirement for commodities risk shall be calculated as the sum of

the  capital  requirements  calculated  for  each  commodity  according  to  paragraph  19.

ANNEX  VIII

INTERNAL  MODELS

1.  The  competent  authorities  may,  subject  to  the  conditions  laid  down  in  this  Annex,  allow
institutions  to  calculate  their  capital  requirements  for  position  risk,  foreign-exchange  risk  and/or
commodities  risk  using  their  own  internal  risk-management  models  instead  of  or  in  combination
with  the  methods  described  in  Annexes  I,  III  and  VII.  Explicit  recognition  by  the  competent
authorities  of  the  use  of  models  for  supervisory  capital  purposes  shall  be  required  in  each  case.

2.  Recognition  shall  only  be  given  if  the  competent  authority  is  satisfied  that  the  institution’s
risk-management  system  is  conceptually  sound  and  implemented  with  integrity  and  that,  in
particular,  the  following  qualitative  standards  are  met:

(i) 

(ii) 

the  internal  risk-measurement  model  is  closely  integrated  into  the  daily  risk-management
process  of  the  institution  and  serves  as  the  basis  for  reporting  risk  exposures  to  senior
management  of  the  institution;

the  institution  has  a  risk  control  unit  that  is  independent  from  business  trading  units  and
reports  directly  to  senior  management.  The  unit  must  be  responsible  for  designing  and
implementing  the  institution’s  risk-management  system.  It  shall  produce  and  analyse  daily
reports on the output of the risk-measurement model and on the appropriate measures to be
taken  in  terms  of  trading  limits;

30.4.98

EN

(iii) 

Official  Journal  of  the  European  Communities

C  135/17

the  institution’s  board  of  directors  and  senior  management  are  actively  involved  in  the
risk-control process and the daily reports produced by the risk-control unit are reviewed by a
level  of  management  with  sufficient  authority  to  enforce  both  reductions  of  positions  taken
by  individual  traders  as  well  as  in  the  institution’s  overall  risk  exposure;

(iv) 

the institution has sufficient numbers of staff skilled in the use of sophisticated models in the
trading,  risk-control,  audit  and  back-office  areas;

(v) 

the  institution  has  established  procedures  for  monitoring  and  ensuring  compliance  with  a
documented  set  of  internal  policies  and  controls  concerning  the  overall  operation  of  the
risk-measurement  system;

(vi) 

the  institution’s  models  have  a  proven  track  record  of  reasonable  accuracy  in  measuring
risks;

(vii)  the  institution  frequently  conduct  a  rigorous  programme  of  stress  testing  and  the  results  of
these  tests  are  reviewed  by  senior  management  and  reflected  in  the  policies  and  limits  it
sets;

(viii)  the  institution  must  conduct,  as  part  of  its  regular  internal  auditing  process,  an  independent
review  of  its  risk-measurement  system.  This  review  must  include  both  the  activities  of  the
business  trading  units  and  of  the  independent  risk-control  unit.  At  least  once  a  year,  the
institution  must  conduct  a  review  of  its  overall  risk-management  process.  The  review  must
consider:

—  the  adequacy  of  the  documentation  of  the  risk-management  system  and  process  and  the

organisation  of  the  risk-control  unit,

—  the  integration  of  market  risk  measures  into  daily  risk  management  and  the  integrity  of

the  management  information  system,

—  the  process  the  institution  employs  for  approving  risk-pricing  models  and  valuation

systems  that  are  used  by  front  and  back-office  personnel,

—  the  scope  of  market  risks  captured  by  the  risk-measurement  model  and  the  validation  of

any  significant  changes  in  the  risk-measurement  process,

—  the  accuracy  and  completeness  of  position  data,  the  accuracy  and  appropriateness  of
volatility  and  correlation  assumptions,  and  the  accuracy  of  valuation  and  risk  sensitivity
calculations,

—  the verification process the institution employs to evaluate the consistency, timeliness and
reliability of data sources used to run internal models, including the independence of such
data  sources

and

—  the  verification  process  the  institution  uses  to  evaluate  back-testing  that  is  conducted  to

assess  the  model’s  accuracy.

3.  The  institution  shall  monitor  the  accuracy  and  performance  of  its  model  by  conducting  a
back-testing programme. The back-testing has to provide for each business day a comparison of the
one-day  value-at-risk  measure  generated  by  the  institution’s  value  by  the  end  of  the  subsequent
business  day.  Competent  authorities  shall  examine  the  institution’s  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  on  a  comparison  between  the  portfolio’s
end-of-day  value  and,  assuming  unchanged  positions,  its  value  at  the  end  of  the  subsequent  day.
Competent  authorities  shall  require  institutions  to  take  appropriate  measures  to  improve  their
back-testing  programme  if  deemed  deficient.

4.  For the purpose of calculating capital requirements for specific risk associated with traded debt and
equity positions, 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,

—  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.

C  135/18

EN

Official  Journal  of  the  European  Communities

30.4.98

5. 

Institutions using internal models which are not recognised in accordance with paragraph 4 shall be
subject  to  a  separate  capital  charge  for  specific  risk  as  calculated  according  to  Annex  I.

6.  For  the  purpose  of  paragraph  10(ii)  the  results  of  the  institution’s  own  calculation  shall  be  scaled

up  by  a  multiplication  factor  of  at  least  3.

7.  The multiplication factor shall be increased by a plus-factor of between 0 and 1 in accordance with
the  following  table,  depending  on  the  number  of  overshootings  for  the  most  recent  250  business
days  as  evidenced  by  the  institution’s  back-testing.  Competent  authorities  shall  require  the
institutions  to  calculate  overshootings  consistently  on  the  basis  of  back-testing  either  on  actual  or
on  hypothetical  changes  in  the  protfolio’s  value.  An  overshooting  is  a  one-day  change  in  the
portfolio’s  value  that  exceeds  the  related  one-day  value-at-risk  measure  generated  by  the
institution’s  model.  For  the  purpose  of  determining  the  plus-factor  the  number  of  overshootings
shall  be  assessed  at  least  quarterly.

Number  of  overshootings

Plus-factor

Fewer  than  5
5
6
7
8
9
10  or  more

0,00
0,40
0,50
0,65
0,75
0,85
1,00

The competent authorities can, in individual cases and owing to an exceptional situation, waive the
requirement to increase the multiplication factor by the plus-factor according to the above table, if
the  institution  has  demonstrated  to  the  satisfaction  of  the  competent  authorities  that  such  an
increase  is  unjustified  and  that  the  model  is  basically  sound.

If  numerous  overshootings  indicate  that  the  model  is  not  sufficiently  accurate,  the  competent
authorities shall revoke the model’s recognition or impose appropriate measures to ensure that the
model  is  improved  promptly.

In  order  to  allow  competent  authorities  to  monitor  the  appropriateness  of  the  plus-factor  on  an
ongoing basis, institutions shall notify promptly, and in any case no later than within five working
days, the competent authorities of overshootings that result form their back-testing programme and
that  would  according  to  the  above  table  imply  an  increase  of  a  plus-factor.

8. 

If the institution’s model is recognised by the competent authorities in accordance with paragraph 4
for the purpose of calculating capital requirements for specific risk, the institution shall increase its
capital requirement calculated pursuant to paragraphs 6, 7 and 10 by a surcharge in the amount of
either:

(i) 

the  specific  risk  portion  of  the  value-at-risk  measure  which  should  be  isolated  according  to
supervisory  guidelines;  or,  at  the  institution’s  option,

(ii)  the  value-at-risk  measures  of  sub-portfolios  of  debt  and  equity  positions  that  contain  specific

risk.

Institutions  using  option  (ii)  are  required  to  identify  their  sub-portfolio  structure  beforehand  and
should  not  change  it  without  the  consent  of  the  competent  authorities.

9.  The  competent  authorities  may  waive  the  requirement  pursuant  to  paragraph  8  for  a  surcharge  if
the  institution  demonstrates  that  in  line  with  agreed  international  standards  its  model  accurately
captures  also  the  event  risk  and  default  risk  for  its  traded  debt  and  equity  positions.

10.  Each  institution  must  meet  a  capital  requirement  expressed  as  the  higher  of:

(i) 

its previous day’s value-at-risk number measured according to the parameters specified in this
Annex;

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/19

(ii)  an  average  of  the  daily  value-at-risk  measures  on  each  of  the  preceding  60  business  days,
multiplied  by  the  factor  mentioned  in  paragraph  6,  adjusted  by  the  factor  mentioned  in
paragraph 7.

11.  The  calculation  of  value-at-risk  shall  be  subject  to  the  following  minimum  standards:

(i)  at  least  daily  calculation  of  value-at-risk;

(ii)  a  99th  percentile,  one-tailed  confidence  interval;

(iii)  a  10-day  equivalent  holding  period;

(iv)  an  effective  historical  observation  period  of  at  least  one  year  except  where  a  shorter

observation  period  is  justified  by  a  significant  upsurge  in  price  volatility;

(v)  three-monthly  data  set  updates.

12.  The  competent  authorities  shall  require  that  the  model  captures  accurately  all  the  material  price
risks  of  options  or  option-like  positions  and  that  any  other  risks  not  captured  by  the  model  are
covered  adequately  by  own  funds.

13.  The  competent  authorities  shall  require  that  the  risk-measurement  model  captures  a  sufficient
number  of  risk  factors,  depending  on  the  level  of  activity  of  the  institution  in  the  respective
markets.  As  a  minimum,  the  following  provisions  shall  be  respected:

(i) 

for  interest  rate  risk,  the  risk-measurement  system  shall  incorporate  a  set  of  risk  factors
corresponding  to  the  interest  rates  in  each  currency  in  which  the  institution  has  interest  rate
sensitive  on-  or  off-balance  sheet  positions.  The  institution  shall  model  the  yield  curves  using
one  of  the  generally  accepted  approaches.  For  material  exposures  to  interest-rate  risk  in  the
major currencies and markets, the yield curve shall be divided into a minimum of six maturity
segments,  to  capture  the  variations  of  volatility  of  rates  along  the  yield  curve.  The
risk-measurement  system  must  also  capture  the  risk  of  less  than  perfectly  correlated
movements  between  different  yield  curves;

(ii)  for  foreign-exchange  risk,  the  risk-measurement  system  shall 

incorporate  risk  factors
corresponding  to  gold  and  to  the  individual  foreign  currencies  in  which  the  institution’s
positions  are  denominated;

(iii)  for equity risk, the risk-measurement system shall use a separate risk factor at least for each of

the  equity  markets  in  which  the  institution  holds  significant  positions;

(iv)  for  commodity  risk,  the  risk-measurement  system  shall  use  a  separate  risk  factor  at  least  for
each  commodity  in  which  the  institution  holds  significant  positions.  The  risk-measurement
system must also capture the risk of less than perfectly correlated movements between similar,
but  not  identical,  commodities  and  the  exposure  to  changes  in  forward  prices  arising  from
maturity mismatches. It shall also take account of market characteristics, notably delivery dates
and  the  scope  provided  to  traders  to  close  out  positions.

14.  The competent authorities may allow institutions to use empirical correlations within risk categories
and  across  risk  categories  if  they  are  satisfied  that  the  institution’s  system  for  measuring
correlations  is  sound  and  implemented  with  integrity’.

C  135/20

EN

Official  Journal  of  the  European  Communities

30.4.98

STATEMENT  OF  THE  COUNCIL’S  REASONS

I. 

INTRODUCTION

1.  On 17 June 1997 the Commission forwarded to the Council a proposal for a Directive
amending Council Directive 93/6/EEC on the capital adequacy of investment firms and
credit institutions, based on Article 57(2), in particular the first and third sentences, of
the  EC  Treaty.

The  Economic  and  Social  Committee  and  the  European  Parliament  delivered  their
opinions  on  29  October  1997  and  18  December  1997  respectively.  The  European
Monetary  Institute  gave  its  opinion  on  7  October  1997.

Following  the  European  Parliament’s  opinion,  the  Commission  submitted  an  amended
proposal  on  13  February  1998.

2.  On 9 March 1998, the Council adopted its common position pursuant to Article 189b

of  the  Treaty.

II.  OBJECTIVE

The  primary  purpose  of  the  common  position  is  to  amend  Council  Directive  93/6/EEC  on
capital  adequacy  of  investment  firms  and  credit  institutions  with  respect  to  the  use  of
internal  risk-management  models  for  calculating  capital  requirements  of  market  risks  and
the  inclusion  of  measures  to  have  appropriate  capital  available  to  cover  the  market  risks
inherent in commodities and commodity derivatives. The common position further aims at
updating  and  adjusting  Directive  93/6/EEC  to  take  account  of  recent  developments  on  the
financial  markets  and  of  developments  in  international  banking  supervision.

III.  ANALYSIS  OF  THE  COMMON  POSITION

1.  The  enacting  terms  of  the  Directive  (Article  1  of  the  common  position)

The  enacting  terms  of  the  Directive  in  the  common  position  are  almost  unchanged
compared to the Commission proposal. The drafting of paragraph 4 (amending Article
7(10)) has been slightly changed to align all language versions of the original Directive
and  to  make  the  text  of  the  first  and  second  indent  of  the  provision  consistent.

In Article 1 the common position takes over, almost verbatim, amendment 20 proposed
by  the  European  Parliament  (amendment  2  in  the  amended  Commission  proposal),
concerning  the  introduction  of  a  new  Article  11a  on  a  transitional  regime  for
commodities  business.

In  the  common  position  the  implementation  date  has  been  fixed  as  not  later  than  24
months  after  the  entry  into  force  of  the  Directive  in  order  to  give  all  Member  States
sufficient  time  to  implement  the  provisions.

2.  The  annex  to  the  common  position

(a)  Annex  I  to  Directive  93/6/EEC  (paragraph  I  of  the  annex  to  the  common

position)

Paragraph  1(a)  and  (b)  of  the  common  position  (amending  Annex  I  to  Directive
93/6/EEC paragraphs 4 and 5) concerning exchange-traded futures and options, and

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/21

the  new  Annex  VII  paragraphs  8  and  10  concerning  exchange-traded  commodities
futures  and  options,  contain  a  provision  allowing  the  capital  requirements  for  an
exchange-traded  instrument  to  be  equal  to  the  margin  required  by  the  exchange.
The  common  position  here  changes  the  drafting  of  the  Commission  proposal  to
make  it  clear  that  the  margin  must  be  at  least  equal  to  the  capital  requirement  for
the  instrument  in  question  which  would  result  from  a  calculation  made  using  the
standard  method  set  out  in  Annex  I  or  VII  respectively  or  applying  the  internal
models  method  described  in  Annex  VIII.

Similar  provisions  have  been 
introduced  concerning  over-the-counter  (OTC)
derivatives contracts in order to take into account the clearing of OTC contracts by
a  recognised  clearing  house,  as  provided  in  particular  in  Sweden.  Member  States
may  until  31  December  2006,  allow  the  capital  requirements  for  such  contracts  to
be equal to the margin required by the clearing house under the same conditions as
laid  down  for  exchange-traded  futures  and  options  (paragraph  1(a)  and  (b)
concerning  exchange-traded  futures  and  options,  and  new  Annex  VII  paragraphs  8
and  10  concerning  exchange-traded  commodities  futures  and  options).  These
changes are consistent with the related provisions (Article 2(3)b) and Article 3(2)) in
the  common  position  which  amends  the  Second  Banking  Directive,  the  Solvency
Ratio  Directive  and  also  the  Capital  Adequacy  Directive (1).

The remainder of the provisions relating to Annex I to Directive 93/6/EEC has been
maintained  as  proposed  by  the  Commission.

(b) Annex  II  to  Directive  93/6/EEC  (paragraph  2  of  the  annex  to  the  common

position)

The  common  position  maintains  the  provisions  relating  to  Annex  II  to  Directive
93/6/EEC  as  proposed  by  the  Commission.

(c)  Annex  III  to  Directive  93/6/EEC  (paragraph  3  of  the  annex  to  the  common

position)

The  new  paragraph  1  of  Annex  III  (paragraph  3(1)  of  the  common  position)
introduces  more  stringent  capital  requirements  by  converting  the  2 %  ‘free  zone’
into a 2 % ‘threshold’. In order to facilitate the implementation of this provision the
common position allows Member States to permit institutions to calculate their own
funds  requirements  according  to  the  existing  rules  until  31  December  2004.

The  new  paragraph  7  of  Annex  III  (paragraph  3(d)  of  the  common  position)
amends the alternative method of calculating foreign exchange positions. To ensure
a  uniform  approach  in  the  future  the  common  position  introduces  an  expire  date,
31  December  2004,  for  the  use  of  the  alternative  method.

The  remainder  of  the  provisions  relating  to  Annex  III  to  Directive  93/6/EEC  has
been  maintained  as  proposed  by  the  Commission.

(1)  Common  Position  No  23/98  adopted  by  the  Council  on  9  March  1998  with  a  view  to  adopting
European Parliament and Council Directive 98/. . ./EC amending, Article 12 of Directive 77/780/EEC on
the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit
of  the  business  of  credit  institutions,  Articles  2,  5,  6,  7  and  8  and  Annexes  II  and  III  to  Directive
89/647/EEC on a solvency ratio for credit institutions and Article 2 and Annex II to Directive 93/6/EEC
on  the  capital  adequacy  of  investment  firms  and  credit  institutions  (see  page  32  of  this  Official
Journal).

C  135/22

EN

Official  Journal  of  the  European  Communities

30.4.98

(d) Annex  V  to  Directive  93/6/EEC  (paragraph  4  of  the  annex  to  the  common

position)

The  common  position  maintains  the  provisions  relating  to  Annex  V  to  Directive
93/6/EEC  as  proposed  by  the  Commission.

(e) Annex  VI  to  Directive  93/6/EEC  (paragraph  5  of  the  annex  to  the  common

position)

The Council considers that large exposures in the trading book should be calculated
according to the standardised method and not to the model approach. The common
position  therefore  does  not  amend  Annex  VI  to  Directive  93/6/EEC  and  Annex  I
paragraph  5  of  the  Commission  proposal  has  been  deleted.

(f)  The  new  Annex  VII

The drafting of paragraphs 7, 13 and 17 of the common position (paragraphs 7, 13
and  16  in  the  Commission  proposal)  has  been  amended  and  three  new  paragraphs
14,  18  and  20  have  been  added.  These  changes  aim  only  at  making  the  text  more
transparent  and  no  change  in  substance  of  the  provisions  is  intended.

Paragraphs  8  and  10  of  the  common  position  have  been  changed  to  include  OTC
derivatives  cleared  by  a  clearing  house  as  has  been  described  above  in  point  (a).

The  remainder  of  Annex  VII  is  maintained  as  proposed  by  the  Commission.

(g) The  new  Annex  VIII

In  paragraph  1  of  Annex  VIII  the  common  position  substitutes  the  term
‘recognition’  for  the  term  ‘approval’,  and  aims  at  making  the  text  more  clear  by
stipulating  that  the  recognition  shall  be  for  supervisory  capital  purposes.

Paragraph 2 which set out the qualitative standards for the risk-management system
which  have  to  be  met  before  the  use  of  models  by  an  institution  can  be  recognised
by  the  competent  authorities,  is  maintained  as  proposed  by  the  Commission.  since
an  independent  review  of  the  risk-measurement  system,  as  set  out  in  the
Commission  proposal  paragraph  4,  is  an  indispensable  element  of  a  sound
risk-management  system  the  common  position  incorporates  paragraph  4  of  the
Commission  proposal  as  a  new  paragraph  2(viii)  without  other  changes  to  the
drafting.

Paragraph  3  in  the  common  position  concerning  back-testing  incorporates  fully
amendment 2 proposed by the European Parliament (amendment 3 in the amended
Commission  proposal)  with  only  a  few  minor  drafting  amendments  which  do  not
change  the  substance  of  the  paragraph.  in  this  manner  the  common  position  also
incorporates  the  main  part  of  the  substance  of  amendment  4  (amendment  6  in  the
amended  Commission  proposal),  since  the  two  amendments  over  the  same  subject.
The remainder of amendment 4 is included in paragraph 7, see below. The Council
shares  the  concerns  expressed  by  the  European  Parliament  by  the  requirement  in
amendment 4 that an institution needs the approval of the competent authorities for
the  type  of  changes  to  be  used  in  its  back-testing.  Rather  than  requiring  a  prior
approval, the common position, in the last sentence of paragraph 3, explicitly states
that  the  competent  authorities  shall  require  institutions  to  take  appropriate
measures  to  improve  their  back-testing  programme  if  deemed  deficient.  The
common  position  thus  includes  the  substance  of  amendment  4  proposed  by  the
European Parliament.

30.4.98

EN

Official  Journal  of  the  European  Communities

C  135/23

Paragraphs 4 and 5 in the common position incorporate fully amendments 3 and 16
proposed  by  the  European  Parliament  (amendments  4  and  5  of  the  amended
Commission  proposal),  which  update  the  provisions  in  the  original  Commission
proposal  on  specific  risk,  to  bring  them  in  line  with  recent  developments  on
international  level  in  the  Basle  Committee  on  Banking  Supervision.

The  common  position  maintains  paragraph  6  as  proposed  by  the  Commission,  but
it  has  been  made  clear  that  the  multiplication  factor  of  3  is  to  be  understood  as  a
minimum  by  adding  the  words  ‘at  least’.

Paragraph  7  in  the  common  position  concerning  the  calculation  of  the  plus-factor
redrafts  paragraph  7  of  the  original  Commission  proposal  with  a  view  to  making
the  text  more  precise.  It  includes  fully  amendments  5  and  6  proposed  by  the
European  Parliament  (amendments  7  and  8  of  the  amended  Commission  proposal)
in a slightly different wording. Compared to the Commission proposal the common
position  aims  at  making  the  text  more  flexible  by  requiring  only  the  reporting  of
overshootings  that  would  imply  an  increase  of  a  plus-factor.  Two  elements
contained  in  amendment  4  proposed  by  the  European  Parliament  are  included  in
paragraph  7,  namely  the  choice  of  back-testing  method  for  calculating  the
plus-factor  and  the  requirement  that  the  chosen  method  be  applied  consistently.

The new paragraphs 8 and 9 concerning the surcharge for institutions using models
for the calculation of capital requirements for specific risk, incorporate amendments
7  and  8  proposed  by  the  European  Parliament  (amendment  9  in  the  amended
Commission  proposal).  The  drafting  of  paragraph  8  has  been  changed  to  align  it
closer with the text agreed on international level in the Basle Committee on Banking
Supervision.

Paragraph  10  sets  out  the  calculation  of  the  capital  requirement  and  is  unchanged
compared to paragraph 8 of the original Commission proposal. It must be recalled,
however, that the surcharge set out in paragraph 8 is additional to the requirements
set  out  in  paragraph  10.  or,  in  other  terms,  the  total  capital  requirement  is  the
higher  of:

(i)  previous  day’s  VARtotal  +  surcharge,  or

(ii) 60-day  average  VARtotal  *  (3  +  plus-factor)  +  surcharge

surcharge  =  VARspec.risk  of  whole  portfolio,  or

VARtotal  of  sub-portfolios  containing  specific  risk

(applies  only  to  specific  risk  models  which  do  not  capture  event  and  default
risk)

plus-factor =  depends  on  number  of  overshootings  in  back-testing  of  VARtotal

(applies  only  if  there  are  overshootings)

If models are not recognised for specific risk at all, the capital charge for specific
risk  according  to  Annex  I  to  Directive  93/6/EEC  has  to  be  added.

Paragraphs 11, 12 and 13 of the common position (paragraphs 9, 10 and 11 of the
Commission  proposal)  essentially  follow  the  Commission  proposal  except  for
certain  minor  adjustments:

—  in  paragraph  11(iv)  the  common  position  requires  a  shorter  observation  period

where  this  is  justified  by  a  significant  upsurge  in  price  volatility,

C  135/24

EN

Official  Journal  of  the  European  Communities

30.4.98

—  in  paragraph  12  it  is  made  clear  that  any  price  risks  of  options  and  option-like
positions  not  captured  by  the  model  must  be  covered  adequately  by  own
funds,

—  the wording of paragraph 13(i) has been changed slightly to make the text more

clear,

—  the  wording  of  paragraph  13(ii)  has  been  changed  to  make  it  clear  that  gold  is

considered  similar  to  foreign  exchange.

3.  Recitals

The  recitals  have  been  adapted  following  the  changes  made  to  the  Commission
proposal.

Recital  1  which  sets  out  the  need  for  covering  market  risks  associated  with
commodities 
the
Commission should consider defining an appropriate prudential framework in order to
prevent  fraudulent  practices  by  certain  commodities  futures  traders.

trading  and  commodities  derivatives 

indicates 

further 

that 

The  last  two  recitals  have  been  deleted  as  unnecessary  from  a  legal  point  of  view.

The  substance  of  amendment  19  proposed  by  the  European  Parliament  (amendment  1
in  the  amended  Commission  proposal)  concerning  recital  8  is  included  in  the  new
Article  11a  which  lays  down  the  expiry  date  for  the  transitional  period,  but  since  the
drafting of recital 9 (recital 8 in the Commission proposal) has changed amendment 19
is  not  included  explicitly  in  the  recitals.

IV.  CONCLUSION

The  Council  considers  that  all  amendments  made  to  the  Commission  proposal  are
completely in line with the objectives of the proposed Directive. The common position fully
includes  the  substance  of  all  amendments  proposed  by  the  European  Parliament  and
subsequently included in the amended Commission proposal. The most significant changes
in  the  common  position  compared  to  the  original  Commission  proposal,  the  introduction
of  the  transitional  provisions  for  commodities  business  and  the  updating  of  the  provisions
on  internal  models  in  Annex  VIII,  follow  directly  from  amendments  proposed  by  the
European Parliament.