Proposal for a Directive of the European Parliament and of the Council amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for re-securitisations, and the supervisory review of remuneration policies SEC(2009) 974 final SEC(2009) 975 final
Date: 2009-07-13
Institutions: European Commission
Subjects: bank, credit, credit institution, economic recession, financial institution, financial market, pay, remuneration of work

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COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 13.7.2009 
COM(2009) 362 final 

2009/0099 (COD) 

Proposal for a 

DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 

amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for 
the trading book and for re-securitisations, and the supervisory review of remuneration 
policies 

SEC(2009) 974 final 

SEC(2009) 975 final 

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EXPLANATORY MEMORANDUM 

1. 

CONTEXT OF THE PROPOSAL 

A  new  capital  requirements  framework,  based  on  the  'Basel-II'  revised  international  capital 
framework,  was  adopted  in  June  2006  as  the  Capital  Requirements  Directive  ('CRD'):  this 
comprises Directive 2006/48/EC relating to the taking up and pursuit of the business of credit 
institutions  (recast)  and  Directive  2006/49/EC  on  the  capital  adequacy  of  investment  firms 
and credit institutions (recast).  

There  is  widespread  recognition  that  further  regulatory  reform  is  needed  to  address 
weaknesses  in  the  regulatory  capital  framework  and  in  the  risk  management  of  financial 
institutions that contributed to the turmoil in global financial markets. As part of its response 
to  the  financial  crisis,  in  November  2008  the  Commission  mandated  a  High  Level  Group 
chaired by Mr. Jacques de Larosière to propose recommendations for reforming the European 
financial  supervision  and  regulation.  The  thirty  one  recommendations1  of  that  Group 
represented  a  comprehensive  set  of  proposals  for  regulatory  and  supervisory  repair.  With 
regard  to  remuneration  structures,  the  Larosière  Report  recommends  that  compensation 
incentives  should  be  better  aligned  with  shareholder  interests  and  long-term  profitability  by 
basing the structure of financial sector compensation schemes on the principles that bonuses 
should  reflect  actual  performance,  should  not  be  guaranteed,  and  that  the  assessment  of 
bonuses should be set in a multi-year framework, spreading bonus payments over the cycle.2

Building  on  the  Group's  recommendations,  in  its  Communication  "Driving  European 
Recovery"  for  the  spring  European  Council  of  March  4,  20093  the  Commission  set  out  an 
ambitious programme of financial services reform. The present proposal is one of the several 
measures that the Commission has already taken to implement that programme. 

The Communication stated that a proposal for the revision of the CRD to be presented by the 
Commission by June 2009 would: 

•  include provisions to reinforce capital requirements for assets that banks hold in the trading 

book for short-term resale; 

•  upgrade the capital requirements for complex securitisations, both in the banking and in the 

trading book; and 

•  enable  supervisory  authorities  to  impose  capital  'sanctions'  on  financial  institutions  the 

remuneration policies of which are found to generate unacceptable risk. 

Similar objectives were also agreed by leaders of the G20 at the meeting in London on 2 April 
2009. The Declaration on Strengthening of the Financial System4 announces an agreement to 
take  action,  once  recovery  is  assured,  to  improve  the  quality,  quantity,  and  international 
consistency  of  capital  in  the  banking  system;  and  to  endorse  and  implement  the  Financial 
Stability  Forum’s  principles  on  pay  and  compensation  and  to  support  sustainable 
compensation schemes.5

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4 
5 

http://ec.europa.eu/internal_market/finances/docs/de_larosiere_report_en.pdf 
Recommendation 11. 
http://ec.europa.eu/commission_barroso/president/pdf/press_20090304_en.pdf 
http://www.g20.org/Documents/Fin_Deps_Fin_Reg_Annex_020409_-_1615_final.pdf 
European leaders expressed their support for these measures at the European Council of March 19-20, 
2009 

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On  the  same  date,  the  Financial  Stability  Forum  ('FSF')  published  a  report  on  Addressing 
Procyclicality in the Financial System and Principles on Sound Compensation Practices in the 
financial industry,6
 aimed at aligning employees' incentives with the long-term profitability of 
the firm. 

The  report  of  the  FSF  on  Addressing  Procyclicality  sets  out  recommendations  to  mitigate 
procyclicality  which  cover  three  areas:  bank  capital  framework,  bank  loan  loss  provisions, 
and  leverage  and  valuation.  The  Basel  Committee  on  Banking  Supervision  has  issued 
Recommendations  intended  to  mitigate  the  risk that  the  regulatory  capital  framework  might 
amplify  the  transmission  of  shocks  between  the  financial  and  real  sectors.  This  includes 
proposals to reduce the reliance on cyclical VAR-based capital estimates and enhance the risk 
coverage  for re-securitization instruments and default and migration risk for non-securitized 
credit  products.  In  support  of  the  recommendations  of  the  FSF  and  the  G20,  the  Basel 
Committee is working on developing more detailed changes to the current rules to a timetable 
set by the G20.  

The  FSF  Principles  on  Sound  Compensation  Practices  call  for  effective  governance  of 
compensation, and for compensation to be adjusted for all types of risk, to be symmetric with 
risk  outcomes,  and  to  be  sensitive  to  the  time  horizon  of  risks.  They  also  recommend  that 
implementation by firms should be reinforced through supervision. 

The  Commission  took  the  first  step  towards  addressing  the  problems  that  arise  from  poorly 
designed compensation structures when, on 30th April 2009, it adopted Recommendations on 
the regime for the remuneration of directors of listed companies7 and on remuneration policies 
in the financial services sector.8 The Communication that accompanied the Recommendations 
indicated that the CRD would be modified to bring the remuneration arrangements of banks 
and investment firms within prudential oversight. 

The Committee of European Banking Supervisors ('CEBS') has also developed principles on 
remuneration policies, which were published on 20th April 2009. The scope of the principles 
covers remuneration policies applying throughout an organisation, and focuses on key aspects 
including  the  alignment  of  company  and  individual  objectives;  governance  with  respect  to 
oversight and decision-making; performance measurement; and forms of remuneration. 

The current proposal is intended to give effect to the commitments set out in the Commission 
Communication  of  4  March,  and  is  consistent  with  the  high  level  international  objectives 
agreed by G20 leaders. 

Finally,  in  accordance  with  the  undertakings  set  out  in  its  Communication  of  4  March,  the 
Commission  will  propose  further  changes  to  the  CRD  in  October  2009  to  address  liquidity 
risk and excessive leverage, introduce provisions for dynamic capital reserving, and remove 
national options and discretions to advance progress towards a common rule book. 

2. 

PUBLIC CONSULTATION 

An open internet consultation on proposed draft revisions to trading book and securitization 
provisions  was  conducted  from  March  25  until  April  29,  2009.  Eighteen  responses  were 
received.  

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http://www.fsforum.org/publications/r_0904a.pdf 
Commission  Recommendation  complementing  Recommendations  2004/913/EC  and  2005/162/EC  as 
regards the regime for the remuneration of directors of listed companies (C(2009)3177/2). 
Commission  Recommendation  on 
(C(2009)3159/2). 

financial  services  sector 

remuneration  policies 

the 

in 

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The responses generally supported the objectives of the Commission's draft proposals. Some 
respondents  expressed  concerns  that  the  approach  to  re-securitisations  was  not  sufficiently 
targeted.  However,  such  concerns  arose  from  an  assumption  that  the  Commission  intended 
what  would  in  effect  be  a  general  ban  by  requiring  the  deduction  from  capital  of  all  re-
securitisations.  This  was  not  the  Commission's  intention,  and  that  has  been  made  clear  by 
modifications which represent a more differentiated approach. 

A separate online public consultation on a proposed draft of remuneration policy provisions 
ran from April 29 until May 6, 2009 on DG MARKT website. Twenty three responses were 
received  from  financial  institutions  and  industry  representatives,  Member  States  and 
regulators. 

The  majority  of  respondents  expressed  support  for  the  principle  that  remuneration  policies 
within the banking sector should be consistent with sound and effective risk management, and 
that this should be brought within the scope of supervisory review under the CRD. 

Some expressed concerns that because remuneration policies and practices are tailored to the 
structure  and  business  model  of  individual  institutions,  the  principles  set  out  in  the  CRD 
should not be too prescriptive. The Commission believes that the text permits the necessary 
flexibility by requiring firms to comply with the principles in a way that is appropriate to their 
size,  internal  organisation  and  nature,  scope  and  complexity  of  their  activities.  In  addition, 
other  respondents  were  concerned  that  including  remuneration  for  employees,  other  than 
executives,  within  the  scope  of  supervisory  review  might  impact  adversely  on  collective 
agreements that banks and investment firms have in place for non-management employees.  

3. 

IMPACT ASSESSMENT  

Altogether,  fourteen  different  policy  options  have  been  assessed.  The  summary  below 
describes the preferred policy option and its expected impact. 

Trading Book 

With  respect  to  capital  requirements  for  bank  trading  books,  the  following  targeted 
amendments, aligned with what is envisaged by the Basel Committee, will be introduced: 

–  Adding  an  additional  capital  buffer  based  on  stress  scenario  VAR  to  the  ordinary  VAR. 

This change is expected to roughly double current trading book capital requirements.  

–  Extending the existing charge for default risk in the trading book to capture losses short of 
issuer default, e.g. rating downgrades, to address the fact that recent losses on traded debt 
most of the time did not involve issuers actually defaulting. The impact of this change will 
depend on the composition of banks' portfolios in the post-crisis environment. 

–  Basing  the  charge  for  securitisation  positions  in  the  trading  book  on  the  existing  simple 
risk  weights  for  the  banking  book.  Again,  the  impact  of  this  change  will  depend  on  the 
composition of banks' portfolios in the post-crisis environment. 

Generally,  banks  tend  to  maintain  capital  levels  that  are  in  line  with  internally  developed 
'targets', and which may lead to higher capital levels than those required by minimum capital 
requirements.  Therefore,  it  is  not  straightforward  to  estimate  how  much  additional  capital 
banks would have to raise in order to comply with the proposed amendments. An increase in 
the  minimum  capital  required  might  be  partially  absorbed  by  existing  capital  buffers.  For 
instance, the overall solvency ratio for large euro-area financial institutions at the end of first 
half of  2008  was  on average 11.4%,  implying an average capital buffer (over the minimum 
capital requirements) of 3.4% of risk-weighted assets.  

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Re-securitizations 

In  line  with  the  approach  developed  by  the  Basel  Committee,  re-securitization  positions 
would  be  assigned  a  higher  capital  requirement  than  other  securitisation  positions  to  reflect 
the higher risk of unexpected impairment losses.  

For  particularly  complex  re-securitizations,  the  proposals  reinforce  both  the  due  diligence 
requirements  and  the  supervisory  process  to  enforce  them.  For  investments  in  re-
securitizations  of  particularly  high  complexity,  banks  will  have  to  demonstrate  to  their 
supervisor  that  necessary  due  diligence  standards  have  been  met.  If  they  cannot  do  so,  a 
general deduction from capital would apply. In instances where compliance with required due 
diligence is found to be inadequate, institutions would be debarred from future investment in 
such instruments.  

The impact of these measures on the future credit supply – the funding of which is facilitated 
in part by issuance of re-securitizations such as certain collateralized debt obligations (CDOs) 
-  should  be  assessed  in  the  light  of  the  level  of  their  issuance  in  the  post-crisis  market 
environment.  Evidence  shows  that  total  CDO  issuance  in  Europe  contracted  from  €88.7 
billion  in  2007  to  €47. 9  billion  in  2008.  This  contraction  would  have  been  even  more 
pronounced  had  the  European  Central  Bank  and  the  Bank  of  England  not  been  accepting 
securitization as collateral: in 2008, 95% of all securitization issuance was retained by banks 
for  'repo'  purposes,  with  primary  market  remaining  effectively  closed  due  to  significantly 
diminished  investor  appetite  for  these  instruments.  Against  such  trends,  any  incremental 
impact  on  the  CDO  issuance  and  credit  supply  would  appear  to  be  limited.  However,  this 
measure could limit recovery of the secondary market for the affected instruments. 

Disclosure of Securitization Risks 

Disclosure requirements, in line with internationally agreed standards, would be enhanced in 
several  areas  such  as  securitization  exposures  in  the  trading  book  and  sponsorship  of  off-
balance sheet vehicles. 

These changes will improve investor understanding of banks' risk profile and, by enhancing 
transparency,  reinforce  banks'  risk  management.  The  incremental  administrative  burden  for 
the EU banking industry is estimated at €1.3 milli on per year and is expected to fall mostly on 
larger institutions with more advanced approaches to risk management. 

Supervisory Review of Remuneration Policies 

The proposed amendments will impose oblige credit institutions and investment firms to have 
remuneration  policies  that  are  consistent  with  effective  risk  management.  The  relevant 
principles  will  be  set  out  in  the  CRD,  but  will  be  closely  aligned  with  those  set  out  in 
Commission  Recommendation  C(2009)  3159  of  30  April  2009  on  remuneration  policies  in 
the financial services sector.  

Making  the  relevant  principles  of  the  Recommendation  binding  will  increase  the  rate  of 
compliance by credit institutions and investment firms.  

The  proposal  allows  firms  the  flexibility  to  comply  with  the  new  obligation  and  high  level 
principles in a way that is appropriate to their size and internal organisation and the nature, 
scope and complexity of their activities. This approach is likely to minimise the up-front and 
on-going  compliance  costs  for  firms,  and  was  therefore  preferred  over  an  alternative  of 
requiring  a  strict  and  uniform  compliance  by  all  firms,  irrespective  of  their  size,  with  the 
principles  set  out  in  Commission  Recommendation  C(2009)  3159  of  30  April  2009  on 
remuneration policies in the financial services sector. 

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BUDGETARY IMPLICATION 

The proposal has no implication for the Community budget. 

4. 

LEGAL ELEMENTS OF THE PROPOSAL 

Given that changes need to be introduced into an existing Directive, an amending Directive is 
the most appropriate instrument. This amending Directive should have the same legal basis as 
the Directive it amends. Therefore, the proposal is based on Article 47(2) EC, which provides 
the  legal  basis  for  the  harmonisation  of  rules  relating  to  the  taking  up  and  pursuit  of  the 
business of, inter alia, credit institutions.  

In accordance with the principles of proportionality and subsidiarity as set out in Article 5 EC, 
the  objectives  of  the  proposed  action  cannot  be  sufficiently  achieved  by  the  Member  States 
and can therefore be better achieved by the Community. Its provisions do not go beyond what 
it is necessary to achieve the objectives pursued. 

Only  Community  legislation  can  ensure  that  credit  institutions  operating  in  more  than  one 
Member State are subject to the same requirements for prudential supervision, in this case by 
ensuring  that  the  already  harmonised  capital  requirements  framework  for  credit  institutions 
and  investment  firms  is  further  strengthened  by  reinforced  capital  requirements  for  trading 
book  items,  appropriate  due  diligence  and  upgraded  capital  requirements  for  complex  re-
securitisations,  and  the  introduction  of  explicit  rules  and  appropriate  supervisory  measures 
and sanctions with regard to remuneration structures. 

5. 

DETAILED EXPLANATION OF THE PROPOSAL 

5.1. 

Capital requirements for re-securitisation  

(Article 1(1) and (9) and Annex I, paragraph (3)) 

Re-securitisations are securitisations that have underlying securitisation positions, typically in 
order  to  repackage  medium-risk  securitisation  exposures  into  new  securities.  They  have 
generally  been  considered  low  credit  risk  by  rating  agencies  and  market  participants. 
However,  given  their  complexity  and  sensitivity  to  correlated  losses,  such  re-securitisations 
entail  higher  risks  than  straight  securitisations.  Therefore,  this  proposal  comprises  a  set  of 
capital  requirements  that  are  higher  than  for  straight  securitisation  positions  of  the  same 
rating. 

Furthermore,  the  proposal  includes  a  strengthened  supervisory  process  for  re-securitisations 
that  are  particularly  complex.  The  sample-based  supervisory  review  that  applies  to 
securitisations  and  re-securitisations  of  normal  complexity  is  not  sufficiently  rigorous  for 
some re-securitisations, where the high level of complexity of the instrument in question casts 
doubt  on  the  ability  of  the  bank  to  understand  fully  the  nature  and  risks  of  the  underlying 
exposures. The proposal therefore requires that compliance with the applicable due diligence 
standards  for  banks  that  invest  in  such  products  be  checked  for  each  individual  investment 
made. CEBS will converge supervisory practice by agreeing which types of re-securitisations 
are  'highly  complex',  so  that  the  ability  of  institutions  to  perform  proper  due  diligence  in 
relation  to  such  instruments  can  be  verified  by  supervisors  on  a  case-by-case  basis.  In 
exceptional cases where a bank cannot demonstrate to its regulator that it has complied with 
the  required  due  diligence  in  respect  of  a  highly  complex  re-securitisation,  a  risk  weight  of 
1250% will be applied to the position in that re-securitisation. This capital treatment applies to 
new re-securitisations issued after 31 December 2010, and will only apply to an existing re-
securitisation  position  after  31  December  2014  if  new  underlying  exposures  are  added  or 

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substituted  after  that  date.  Accordingly,  the  1250%  risk  weight  cannot  be  applied  to  banks' 
legacy positions in re-securitisations (unless the underlying exposures of those positions are 
changed after the end of 2014). 

5.2. 

Technical changes 

(Article 1(5) and Annex II, point (4); Article 1(7); Article 2(2) and (3); Annex I, point (2) and 
Annex II, point (2)) 

In 2006 the Commission and CEBS set up the Capital Requirements Directive Transposition 
Group (CRDTG) in 2006 to facilitate a coherent implementation and application throughout 
the EU of the CRD. According to the CRDTG, certain technical provisions of that Directive 
need to be further specified. For instance, this directive will clarify that capital requirements 
for settlement risk also apply in the non-trading book. 

5.3. 

Disclosure requirements 

(Article 1(11) and Annex I, point (4)) 

The  existing  disclosure  requirements  in  the  CRD  regarding  institutions'  securitisation 
exposures are strengthened by this proposal. In particular, the disclosure requirements will in 
future  cover  the  risks  not  only  of  securitisation  positions  in  the  non-trading  book,  but  also 
those in the trading book.  

5.4.  Market risk capital requirements for securitisations 

(Article 1(4), (6) and (8); Article 2(1); Annex II, point (1)) 

Capital requirements for securitisations in the trading book are currently calculated as if these 
instruments were normal debt positions. This contrasts with the banking book, where there is 
a  separate,  more  differentiated  and  risk  sensitive  set  of  capital  requirements.  This  proposal 
envisages  that  the  trading  book  capital  requirements  be  based  on  those  for  equivalent 
securities in the banking book. 

5.5. 

Internal models based capital requirements for market risks 

(Annex II, point (3) 

Institutions may currently calculate their capital requirements for market risks in the trading 
book  using  their  own  models  that  estimate  the  potential  losses  from  future  adverse  market 
internal  models  systematically 
movements.  Over  2007-2008, 
underestimated  the  potential  loss  in  stressed  conditions.  This  led  to  inadequate  capital 
requirements and cyclical volatility of banks' capital as the market environment deteriorated. 
Accordingly, this directive will strengthen the capital requirements based on internal models 
in several respects: 

it  became  clear 

that 

•  there will be a requirement to estimate separately the potential losses in a protracted period 
of  adverse  circumstances,  thereby  enhancing  the  resilience  of  models  under  stress 
conditions and reducing their potential for pro-cyclicality; 

•  institutions  will  be  required  to  estimate  not  only  the  risk  of  losses  from  default  of  debt 
items in the trading book, but also the potential losses from deterioration in credit quality 
short of default; 

•  to address doubts about the ability of internal models to adequately capture the particular 
risk  profile  of  securitisation  positions,  institutions  will  be  required  to  assess  a  separate 
standardised capital charge for the risks of securitisation positions in the trading book. 

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5.6 

Remuneration policies 

(Article 1(2) and (3); Annex I, point (1) and point (4)(iii)) 

Under the current European supervisory framework, there is no express requirement that the 
remuneration policies of financial institutions should be subject to supervisory oversight. As a 
result, supervisory authorities have generally not focused on the implications of remuneration 
policies for risk and effective risk management.  

The purpose of this proposed amendment to the CRD is: 

•  to  impose  a  binding  obligation  on  credit  institutions  and  investment  firms  to  have 
remuneration  policies  and  practices  that  are  consistent  with  and  promote  sound  and 
effective risk management, accompanied by high level principles on sound remuneration; 

•  to bring remuneration policies within the scope of the supervisory review under the CRD, 
so  that  supervisors  would  be  able  to  require  the  firm  to  take  measures  to  rectify  any 
problems that they might identify; 

•  to ensure that supervisors may also impose financial or non-financial penalties (including 

fines) against firms that fail to comply with the obligation. 

The  proposed  requirement  will  apply  to  credit  institutions  and,  by  virtue  of  Article  34  of 
Directive 2006/49/EC, to investment firms that are authorised and regulated under Directive 
2004/39/EC on markets in financial instruments. 

The scope of the proposed obligation is restricted to remuneration for staff whose professional 
activities  have  a  material  impact  on  the  risk  profile  of  the  bank  or  investment  firm.  This 
targets the remuneration policies for those individuals who take decisions that may affect the 
level of risk assumed by the institution. 

The  proposed  high-level  principles  on  sound  remuneration  are  not  intended  to  prescribe  the 
amount  and  form  of  remuneration,  and  institutions  remain  responsible  for  the  design  and 
application  of  their  particular  remuneration  policy.  Firms  have  flexibility  as  to  how  the 
principles are applied in a way that is appropriate to their size, internal organisation and the 
nature, scope and complexity of their activities. Credit institutions and investment firms carry 
out different activities and have different levels of tolerated risk: remuneration structures and 
application of the principles will vary accordingly. 

Prudential  oversight  in  the  course  of  the  supervisory  review  would  focus  on  whether  the 
remuneration  policies  and  practices  are  consistent  with  sound  risk  management  given  the 
nature of the firm's business. In order to align supervisory assessments, and to assist firms in 
complying  with  the  principles,  the  proposal  requires  CEBS  to  ensure  the  existence  of 
guidelines on sound remuneration policies. 

If a supervisor identifies problems it may require the credit institution or investment firm to 
take  qualitative  or  quantitative  measures  to  address  those  problems.  Those  measures  may 
include  a  ('qualitative')  requirement  for  the  firm  to  rectify  the  situation  by  changing  its 
remuneration  structure  to  reduce  the  inherent  risk  and  –  in  appropriate  cases  –  a 
('quantitative') requirement for the firm to hold additional own funds against the risk. 

In  addition,  competent  authorities  must  also  have  the  power  under  the  CRD  to  impose 
penalties for a breach of any requirement of the Directive (including the proposed requirement 
in  relation  to  remuneration  policies).  This  sanctioning  power  is  separate  from  the  power  to 
require firms to take qualitative or quantitative measures. The proposed amendment to Article 
54 CRD is intended to ensure that supervisors have both financial and non-financial sanctions 
at their disposal, and that such sanctions are effective, proportionate and dissuasive. 

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This  proposed  amendment  of  the  CRD  complements  the  Commission  Recommendation  on 
remuneration policies in the financial services sector. The more detailed principles set out in 
the  Commission  Recommendation,  along  with  the  CEBS  guidelines,  will  be  relevant  to 
compliance  with  the  obligation  under  the  CRD.  They  should  provide  further  guidance  as  to 
how  the  obligation  might  be  met,  and  a  framework  for  regulators  when  assessing  firms' 
remuneration structures. 

5.7 

General clarification of supervisory review under Article 136(2) 

The proposed new sub-paragraph of Article 136(2) is intended to clarify that, when carrying 
out  the  supervisory  review,  competent  authorities  should  take  into  account  both  the 
quantitative  and  the  qualitative  aspects  of  credit  institutions'  assessment  of  internal  capital 
under Article 123, and credit institutions' arrangements, processes, mechanisms and strategies 
under Articles 22. This clarification applies to the entire review process, and is not restricted 
to  the  review  of  the  new  requirement  relating  to  remuneration  policies  and  practices.  The 
objective is to facilitate further convergence of supervisory practices across the EU. 

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2009/0099 (COD) 

Proposal for a 

DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 

amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for 
the trading book and for re-securitisations, and the supervisory review of remuneration 
policies 

(Text with EEA relevance) 

THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN UNION, 

Having regard to the Treaty establishing the European Community, and in particular Article 
47(2) thereof, 

Having regard to the proposal from the Commission, 
Having regard to the opinion of the European Economic and Social Committee9, 
Acting in accordance with the procedure laid down in Article 251 of the Treaty10, 

Whereas: 

(1) 

(2) 

Excessive  and  imprudent  risk-taking  in  the  banking  sector  has  led  to  the  failure  of 
individual financial institutions and systemic problems in Member States and globally. 
While  the  causes  of  such  risk-taking  are  many  and  complex,  there  is  agreement  by 
supervisors and regulatory bodies, including the G20 and the Committee of European 
Banking Supervisors, that the inappropriate remuneration structures of some financial 
institutions  have  been  a  contributory  factor.  Remuneration  policies  which  give 
incentives to take risks that exceed the general level of risk tolerated by the institution 
can  undermine  sound  and  effective  risk  management  and  exacerbate  excessive  risk-
taking behaviour.  

Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 
relating  to  the  taking  up  and  pursuit  of  the  business  of  credit  institutions11  requires 
credit  institutions  to  have  arrangements,  strategies,  processes  and  mechanisms  to 
manage the risks to which they are exposed. By virtue of Directive 2006/49/EC of the 
European Parliament and of the Council of 14 June 2006 on the capital adequacy of 
investment firms and credit institutions12 that requirement applies to investment firms 
within  the  meaning  of  Directive  2004/39/EC  of  the  European  Parliament  and  of  the 
Council  of  21  April  2004  on  markets  in  financial  instruments  amending  Council 
Directives  85/611/EEC  and  93/6/EEC  and  Directive  2000/12/EC  of  the  European 
Parliament and of the Council and repealing Council Directive 93/22/EEC13. Directive 
2006/48/EC  requires  competent  authorities  to  review  those  arrangements,  strategies, 

9 
10 
11 
12 
13 

OJ C , , p. . 
OJ C , , p. . 
OJ L 177, 30.6.2006, p. 1. 
J L 177, 30.6.2006, p.201. 
OJ L 145, 30.4.2004, p.1. 

EN 

10 

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(3) 

(4) 

(5) 

(6) 

(7) 

(8) 

processes and mechanisms, and to determine whether the own funds held by the credit 
institution or investment firm concerned ensure a sound management and coverage of 
the risks  to  which the institution or  firm is or  might  be exposed. That  supervision is 
carried  out  on  a  consolidated  basis  in  relation  to  banking  groups,  and  includes 
financial holding companies and affiliated financial institutions in all jurisdictions. 

In order to address the potentially detrimental effect of poorly designed remuneration 
structures  on  the  sound  management  of  risk  and  control  of  risk-taking  behaviour  by 
individuals, the requirements of Directive 2006/48/EC should be supplemented by an 
express  obligation  for  credit  institutions  and  investment  firms  to  establish  and 
maintain,  for  those  categories  of  staff  whose  professional  activities  have  a  material 
impact  on  their  risk  profile,  remuneration  policies  and  practices  that  are  consistent 
with effective risk management.  

Because excessive and imprudent risk-taking may undermine the financial soundness 
of financial institutions and destabilise the banking system, it is important that the new 
obligation concerning remuneration policies and practices should be implemented in a 
consistent  manner.  It  is  therefore  appropriate  to  specify  core  principles  on  sound 
remuneration  to  ensure  that  the  structure  of  remuneration  does  not  encourage 
excessive  risk-taking  by  individuals  and  is  aligned  with  the  risk  appetite,  values  and 
long-term interests of the institution. In order to ensure that the design of remuneration 
policies  is  integrated  in  the  risk  management  of  the  financial  institution,  the 
management body (supervisory function) of each credit institution or investment firm 
should establish the general principles to be applied, and the policies should be subject 
to at least annual independent internal review. 

Remuneration policy should aim at aligning the personal objectives of staff members 
with the long-term interests of the credit institution or investment firm concerned. The 
assessment of the performance-based components of remuneration should be based on 
longer-term  performance  and  take  into  account  the  outstanding  risks  associated  with 
the  performance.  The  assessment  of  performance  should  be  set  in  a  multi-year 
framework, for example of three to five years, in order to ensure that the assessment 
process  is  based  on  longer  term  performance  and  that  the  actual  payment  of 
performance-based  components  of  remuneration  is  spread  over  the  business  cycle  of 
the firm  

Commission  Recommendation  of  30  April  2009  on  remuneration  policies  in  the 
financial services sector14 also sets out principles on sound remuneration policies as to 
how firms might comply with this obligation, that are consistent with and complement 
the principles set out in this Directive.  

The  provisions  on  remuneration  should  be  without  prejudice  to  the  rights,  where 
applicable, of social partners in collective bargaining. 

In  order  to  ensure  fast  and  effective  enforcement,  competent  authorities  should  also 
have  the  power  to  impose  either  financial  or  non-financial  measures  or  penalties  for 
breach  of  a  requirement  under  Directive  2006/48/EC,  including  the  requirement  to 
have  remuneration  policies  that  are  consistent  with  sound  and  effective  risk 
management.  Those  measures  and  penalties  should  be  effective,  proportionate  and 
dissuasive. 

14 

C(2009) 3159 

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(9) 

(10) 

In order to ensure effective supervisory oversight of the risks posed by inappropriate 
remuneration  structures,  the  remuneration  polices  and  practices  adopted  by  credit 
institutions  and  investment  firms  should  be  included  in  the  scope  of  supervisory 
review under Directive 2006/48/EC. In the course of that review, supervisors should 
assess  whether  those  policies  and  practices  are  likely  to  encourage  excessive  risk-
taking by the staff in question.  

In  order  to  promote  supervisory  convergences  in  the  assessment  of  remuneration 
policies and practices, the Committee of European Banking Supervisors should ensure 
the existence of guidelines on sound remuneration policies in the banking sector. The 
Committee of European Securities Regulators should assist in the elaboration of such 
guidelines  to  the  extent  that  they  also  apply  to  remuneration  policies  for  persons 
involved  in  the  provision  of  investment  services  and  the  carrying  out  of  investment 
activities  by  credit  institutions  and  by  investment  firms  within  the  meaning  of 
Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 
on markets in financial instruments.15 

(11)  Since  poorly  designed  remuneration  policies  and  incentive  schemes  are  capable  of 
increasing  to  an  unacceptable  extent  the  risks  to  which  credit  institutions  and 
investment  firms  are  exposed,  it  is  appropriate  that  competent  authorities  impose 
qualitative  or  quantitative  measures  on  the  relevant  entities  that  are  designed  to 
address problems that have been identified in relation to remuneration policies in the 
Pillar  2  supervisory  review.  Qualitative  measures  available  to  competent  authorities 
include requiring credit institutions or investment firms to reduce the risk inherent in 
their activities, products or systems, including structures of remuneration to the extent 
that  they  are  inconsistent  with  effective  risk  management.  Quantitative  measures 
include a requirement to hold additional own funds. 

(12) 

In order to ensure adequate transparency to the market of their remuneration structures 
and  the  associated  risk,  credit  institutions  and  investments  forms  should  disclose 
information  on  their  remuneration  policies  and  practices  for  those  staff  whose 
professional  activities  have  a  material  impact  on  the  risk  profile  of  the  institution. 
However,  this  obligation  should  be  without  prejudice  to  Directive  95/46/EC  of  the 
European  Parliament  and  of  the  Council  of  24  October  1995  on  the  protection  of 
individuals with the regard to the processing of personal data and the free movement 
of such data.16 

(13)  The review of risks to which the credit institution might be exposed should result in 
effective  supervisory  measures.  It  is  therefore  necessary  that  further  convergence  be 
reached  with  a  view  to  supporting  joint  decisions  by  supervisors  and  ensuring  equal 
conditions of competition within the Community. 

(14)  There should be a separate capital treatment for securitisations which re-package other 
securitisations  and  are  subject  to  a  higher  credit  risk  than  normal  securitisations  and 
provides  credit  institutions  and  investment  firms  with  clear  disincentives  against 
investment in securitisations of particularly high complexity and risk. 

(15)  Banks  investing  in  re-securitisations  are  required  under  Directive  2006/48/EC  to 
exercise due diligence also with regard to the underlying securitisations and the non-
securitisation  exposures  ultimately  underlying  the  former.  Depending  on  the 

15 
16 

OJ L 145, 30.4.2004, p.1. 
OJ L 281, 23.11.95, p.31. 

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complexity of the layers of securitisation structures and depending on the complexity 
and the diversity (or both) of the non-securitisation exposures that ultimately underlie 
the re-securitisations, the required due diligence may be impossible or uneconomical 
(or  both)  to  carry  out.  This  is  in  particular  the  case  where  the  ultimate  underlying 
exposures are, for example, leveraged buy-out or project finance debt. In these cases, 
institutions should not invest in such highly complex re-securitisations. In their review 
of the required due diligence, competent authorities should devote particular attention 
to  such  highly  complex  securitisations  and  require  their  full  deduction  from  capital, 
unless  it  has  been  convincingly  demonstrated  to  their  satisfaction  that  in  each 
individual  case  of  highly  complex  re-securitisation  exposures,  the  institution  has 
performed the due diligence required by Directive 2006/48/EC, including with regard 
to the ultimate underlying exposures. 

(16) 

In  order  to  promote  the  convergence  of  supervisory  practices  with  regard  to  the 
supervision  of  due  diligence  for  highly  complex  re-securitisations,  the  Committee  of 
European  Banking  Supervisors  should  establish  guidelines,  which  should  include  a 
definition of or criteria for the types of re-securitisations that should be considered as 
'highly complex' for this purpose. That definition or those criteria should be adapted to 
developments in market practices. 

(17)  The  provisions  on  prudent  valuation  in  Directive  2006/49/EC  should  apply  to  all 
instruments measured at fair value, whether in the trading book or non-trading book of 
institutions.  It  should  be  clarified  that,  where  the  application  of  prudent  valuation 
would  lead  to  a  lower  carrying  value  than  actually  recognised  in  the  accounting,  the 
absolute value of the difference should be deducted from own funds. 

(18) 

Institutions should have a choice whether to apply a capital requirement to or deduct 
from own funds those securitisation positions that receive a 1 250 % risk weight under 
this  Directive,  irrespective  of  whether  the  positions  are  in  the  trading  or  the  non-
trading book. 

(19)  Capital requirements for settlement risks should also apply to the non-trading book. 

(20)  Originator or sponsor institutions should not be able to circumvent the prohibition of 
implicit support by using their trading books in order to provide such support. 

(21)  Without  prejudice  to  the  disclosures  explicitly  required  by  this  Directive,  the  aim  of 
the disclosure requirements should be to provide market participants with accurate and 
comprehensive  information  regarding  the  risk  profile  of  individual  institutions. 
Therefore  institutions  should  be  required  to  disclose  additional  information  not 
explicitly listed in this Directive if necessary to meet this objective. 

(22) 

In order to ensure a coherent implementation throughout the Community of Directive 
2006/48/EC,  the  Commission  and  the  Committee  of  European  Banking  Supervisors 
set  up  a  working  group  (Capital  Requirements  Directive  Transposition  Group  - 
CRDTG) in 2006, entrusted with the task of discussing and resolving issues related to 
the  implementation  of  that  Directive.  According  to  the  CRDTG,  certain  technical 
provisions of Directives 2006/48/EC and 2006/49/EC need to be further specified. It is 
therefore appropriate to adjust those provisions. 

(23)  Where  an  external  credit  assessment  for  a  securitisation  position  incorporates  the 
effect  of  credit  protection  provided  by  the  investing  institution  itself,  the  institution 
should not be able to benefit from the lower risk weight resulting from that protection. 
This  should  not  lead  to  the  deduction  from  capital  of  the  securitisation  if  there  are 

EN 

13 

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other ways to determine a risk weight in line with the actual risk of the position, not 
taking into account such credit protection. 

(24) 

In  the  field  of  securitisation,  disclosure  requirements  of  institutions  should  be 
considerably strengthened. They should in particular also take into account the risks of 
securitisation positions in the trading book. 

(25)  Specific  risk  charges  for  securitisation  positions  should  be  aligned  with  the  capital 
requirements in the banking book since the latter provide for a more differentiated and 
risk-sensitive treatment of securitisation positions. 

(26)  Given recent weak performance, the standards for internal models to calculate market 
risk  capital  requirements  should  be  strengthened.  In  particular,  their  capture  of  risks 
should  be  completed  regarding  credit  risks  in  the  trading  book.  Furthermore,  capital 
charges should include a component adequate to stress conditions to strengthen capital 
requirements  in  view  of  deteriorating  market  conditions  and  in  order  to  reduce  the 
potential  for  pro-cyclicality.  Given  the  recent  particular  difficulties  of  treating 
securitisation positions using approaches based on internal models, institutions' ability 
to model securitisation risks in the trading book should be limited and a standardised 
capital  charge  for  securitisation  positions  in  the  trading  book  should  be  required  by 
default. 

(27)  Directives 2006/48/EC and 2006/49/EC should therefore be amended accordingly, 

HAVE ADOPTED THIS DIRECTIVE: 

Directive 2006/48/EC is amended as follows: 

(1) 

In Article 4, the following points (40a) and (40b) are inserted: 

Article 1 

"(40a) 're-securitisation' means a securitisation where one or more of the underlying 

exposures meet the definition of a securitisation position; 

(40b) 're-securitisation position' means an exposure to a re-securitisation;" 

(2) 

Article 22 is amended as follows: 

(a) 

 Paragraph 1 is replaced by the following: 

"1.  Home  Member  State  competent  authorities  shall  require  that  every  credit 
institution  have  robust  governance  arrangements,  which  include  a  clear 
organisational  structure  with  well-defined,  transparent  and  consistent  lines  of 
responsibility, effective processes to identify,  manage, monitor and report the 
risks  it  is  or  might  be  exposed  to,  adequate  internal  control  mechanisms, 
including  sound  administration  and  accounting  procedures,  and  remuneration 
policies and practices that are consistent with and promote sound and effective 
risk management." 

(b) 

 The following paragraph 3 is added: 

"3.  The Committee of European Banking Supervisors shall ensure the existence of 
guidelines  on  sound  remuneration  policies  which  comply  with  the  principles 
set  out  in  point  22  of  Annex  V.  The  Committee  of  European  Securities 
Regulators  shall  cooperate  closely  with  the  Committee  of  European  Banking 
Supervisors  in  ensuring  the  existence  of  guidelines  on  remuneration  policies 
for  categories  of  staff  involved  in  the  provision  of  investment  services  and 

EN 

14 

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activities meaning of Directive 2004/39/EC of the European Parliament and of 
the Council of 21 April 2004 on markets in financial instruments. 

(3) 

In Article 54, the following paragraph is added: 

"Member States shall ensure that, for the purposes of the first paragraph, their 
respective competent authorities have the power to impose financial and non-
financial penalties or measures. Those penalties or measures must be effective, 
proportionate and dissuasive." 

(4) 

Article 57 is amended as follows: 

(a) 

In the first paragraph, point (r) is replaced by the following: 

"(r) the exposure amount of securitisation positions which receive a risk weight 
of 1 250 % under Annex IX, Part 4 and the exposure amount of securitisation 
positions  in  the  trading  book  that  would  receive  a  1  250%  risk  weight  in  the 
same credit institutions non-trading book.  

(b) 

The following paragraph is added: 

For  the  purposes  of  point  (r),  exposure  amounts  shall  be  calculated  in  the 
manner specified in Annex IX, Part 4." 

(5) 

In Article 64, the following paragraph 5 is added: 

"5. Credit institutions shall apply the requirements of Part B of Annex VII to 
Directive  2006/49/EC  to  all  their  assets  measured  at  fair  value  when 
calculating  the  amount  of  own  funds  and  shall  not  include  in  the  amount  of 
own funds any amounts necessary as adjustments under those requirements." 

(6) 

Article 66(2) is replaced by the following: 

"2. The total of the items in points (l) to (r) of Article 57 shall be deducted half 
from the total of the items in points (a) to (c) minus (i) to (k) of that Article, 
and  half  from  the  total  of  the  items  in  points  (d)  to  (h)  of  that  Article,  after 
application of the limits laid down in paragraph 1 of this Article. To the extent 
that  half  of  the  total  of  the  items  in  points  (l)  to  (r)  exceeds  the  total  of  the 
items in points (d) to (h) of Article 57, the excess shall be deducted from the 
total of the items in points (a) to (c) minus (i) to (k) of that Article.  

Items in point (r) of Article 57 shall not be deducted if they have been included 
for  the  purposes  of  Article  75  in  the  calculation  of  risk-weighted  exposure 
amounts  as  specified  in  Annex  IX,  Part  4  or  in  the  calculation  of  capital 
requirements as specified in Annex I to Directive 2006/49/EC." 

(7) 

In Article 75, point (c) is replaced by the following: 

"(c)  in  respect  of  all  their  business  activities,  for  foreign  exchange  risk,  for 
settlement risk and for commodities risk, the capital requirements determined 
according to Article 18 of Directive 2006/49/EC;" 

(8) 

Article 101(1) is replaced by the following: 

"1.  The  following  shall  not,  with  a  view  to  reducing  potential  or  actual  losses  to 
investors,  provide  support  to  the  securitisation  beyond  its  contractual 
obligations: 

(a) 

any originator credit institution which, in respect of a securitisation, has 
done any of the following:  

EN 

15 

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(i)  made use of Article 95 in the calculation of risk-weighted exposure 

amounts;  

(ii) 

sold instruments from its trading book to an SSPE to the effect that 
it  does  not  hold  capital  for  the  specific  risk  of  these  instruments 
anymore; 

(b) a sponsor credit institution." 

(9) 

The following Article 122b is inserted after Article 122a: 

"Article 122b 

1.  Notwithstanding  the  risk  weights  for  general  re-securitisation  positions  in 
Annex IX, Part 4, the competent authorities shall require that credit institutions 
apply  a  1250  %  risk  weight  to  positions  in  highly  complex  re-securitisations, 
unless  the  credit  institution  has  demonstrated  to  the  competent  authority  for 
each  such  re-securitisation  position  concerned  that  it  has  complied  with  the 
requirements set out in Article 122a(4) and (5). 

2. 

Paragraph 1 shall apply in respect of positions in new re-securitisations issued 
after  31  December  2010.  In  respect  of  positions  in  existing  re-securitisations, 
paragraph  1  shall  apply  from  31  December  2014  where  new  underlying 
exposures are added or substituted after that date." 

In Article 136(2), the following paragraph is added: 

"For  the  purposes  of  determining  the  appropriate  level  of  own  funds  in  the 
supervisory review process carried out in accordance with Article 124, the competent 
authorities shall assess whether any imposition of a specific own funds requirement 
in  excess  of  the  minimum  level  is  required  to  capture  risks  to  which  a  credit 
institution might be exposed, taking into account the following: 

(a) 

the  quantitative  and  qualitative  aspects  of  credit  institutions'  internal  capital 
assessment referred to in Article 123; 

(b)  the  credit  institutions'  arrangements,  processes  and  mechanisms  referred  to  in 

Article 22; 

(c) 

the outcome of the supervisory review process carried out in accordance with 
Article 124." 

(10)  Article 145(3) is replaced by the following: 

"3.  Credit  institutions  shall  adopt  a  formal  policy  to  comply  with  the  disclosure 
requirements laid down in paragraphs 1 and 2, and have policies for assessing 
the  appropriateness  of  their  disclosures,  including  their  verification  and 
frequency.  Credit  institutions  shall  also  have  policies  for  assessing  whether 
their  disclosures  convey  their  risk  profile  comprehensively  to  market 
participants.  

Where  those  disclosures  do  not  convey  the  risk  profile  comprehensively  to 
market  participants,  credit  institutions  shall  publicly  disclose  the  information 
necessary in addition to that required according to paragraph 1. However, they 
shall  only  be  required  to  disclose  information  which  is  material  and  not 
proprietary or confidential according to the technical criteria set out in Annex 
XII, Part 1." 

EN 

16 

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(11)  The Annexes are amended as set out in Annex I to this Directive: 

Directive 2006/49/EC is amended as follows: 

Article 2 

(1) 

In the first subparagraph of Article 3(1), the following point (t) is added: 

"(t)  'securitisation  position'  and  're-securitisation  position'  mean  securitisation 
position and re-securitisation position as defined in Directive 2006/48/EC." 

(2) 

In Article 17(1), the introductory phrase is replaced by the following: 

"Where an institution calculates risk-weighted exposure amounts for the purposes of 
Annex  II  to  this  Directive  in  accordance  with  Articles  84  to  89  of  Directive 
2006/48/EC, then for the purposes of the calculation provided for in point 36 of Part 
1 of Annex VII to Directive 2006/48/EC, the following shall apply:" 

(3) 

In Article 18(1), point (a) is replaced by the following: 

"(a) 

the  capital  requirements,  calculated  in  accordance  with  the  methods  and 
options  laid  down  in  Articles  28  to  32  and  Annexes  I,  II,  and  VI  and,  as 
appropriate,  Annex  V,  for  their  trading  book  business,  and  points  1  to  4  of 
Annex II for their non trading book business." 

(4) 

The Annexes are amended as set out in Annex II to this Directive 

Article 3 

Transposition 

1. 

Member  States  shall  bring  into  force  the  laws,  regulations  and  administrative 
provisions  necessary  to  comply  with  this  Directive  by  31  December  2010  at  the 
latest.  They  shall  forthwith  communicate  to  the  Commission  the  text  of  those 
provisions and a correlation table between those provisions and this Directive. 

When  Member  States  adopt  those  provisions,  they  shall  contain  a  reference  to  this 
Directive  or  be  accompanied  by  such  a  reference  on  the  occasion  of  their  official 
publication. Member States shall determine how such reference is to be made. 

2. 

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

Article 4 

Entry into force 

This Directive shall enter into force on the twentieth day following that of its publication in 
the Official Journal of the European Union. 

EN 

17 

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Article 5 

Addressees 

This Directive is addressed to the Member States. 

Done at Brussels, 

For the European Parliament 
The President 

For the Council 
The President 

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18 

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ANNEX I 

Annexes V, VI, IX and XII to Directive 2006/48/EC are amended as follows: 

(1) 

In Annex V, the following Section 11 is added: 

"11.  REMUNERATION POLICIES 

22.  When establishing and applying the remuneration policies for those categories 
of  staff  whose  professional  activities  have  a  material  impact  on  their  risk 
profile, credit institutions shall comply with the following principles in a way 
that is appropriate to their size, internal organisation and the nature, the scope 
and the complexity of their activities: 

(a) 

(b) 

(c) 

(d) 

the  remuneration  policy  is  consistent  with  and  promotes  sound  and 
effective  risk  management  and  does  not  encourage  risk-taking  that 
exceeds the level of tolerated risk of the credit institution; 

the remuneration policy is in line with the business strategy, objectives, 
values and long-term interests of the credit institution; 

the  management  body  (supervisory  function)  of  the  credit  institution 
establishes  the  general  principles  of  the  remuneration  policy  and  is 
responsible for its implementation;  

the  implementation  of  the  remuneration  policy  is,  at  least  annually, 
subject  to  central  and  independent  internal  review  for  compliance  with 
policies  and  procedures  for  remuneration  defined  by  the  management 
body (supervisory function); 

(e)  Where  remuneration  is  performance  related,  the  total  amount  of 
remuneration  is  based  on  a  combination  of  the  assessment  of  the 
performance of the individual and of the business unit concerned and of 
the overall results of the credit institution; 

(f)  Fixed  and  variable  components  of  total  remuneration  are  appropriately 
balanced;  the  fixed  component  represents  a  sufficiently  high  proportion 
of the total remuneration to allow the operation of a fully flexible bonus 
policy, including the possibility to pay no bonus; 

(g)  payments  related 

termination  of  a  contract  reflect 
performance achieved over time and are designed in a way that does not 
reward failure; 

the  early 

to 

(h) 

the  measurement  of  performance  used  to  calculate  bonuses  or  bonus 
pools  includes  an  adjustment  for  current  and  future  risks  and  takes  into 
account the cost of the capital and the liquidity required; 

(i) 

payment  of  the  major  part  of  a  significant  bonus  is  deferred  for  an 
appropriate period and is linked to the future performance of the firm. 

(2) 

Annex VI, Part 1 is amended as follows: 

(a) 

Point 8 is replaced by the following: 

"8.  Without  prejudice  to  points  9,  10  and  11,  exposures  to  regional 
governments  and  local  authorities  shall  be  risk  weighted  as  exposures  to 
institutions , subject to point 11a. This treatment is independent of the exercise 

EN 

19 

   EN 

 
of discretion as specified in Article 80(3). The preferential treatment for short-
term exposures specified in points 31, 32 and 37 shall not be applied." 

(b) 

The following point 11a is inserted: 

"11a.  Without  prejudice  to  points  9,  10  and  11,  exposures  to  regional 
governments  and  local  authorities  of  the  Member  States  denominated  and 
funded  in  the  domestic  currency  of  that  regional  government  and  local 
authority shall be assigned a risk weight of 20%." 

(3) 

Annex IX is amended as follows: 

(a) 

In Part 3, point 1, the following point (c) is added: 

"(c)  The  credit  assessment  shall  not  be  based  or  partly  based  on  unfunded 
support provided by the credit institution itself." 

(b) 

Part 4 is amended as follows: 

(i) 

In point 5, the following sentence is added: 

"Where no credit assessment of a nominated ECAI can be used for a position in 
asset backed commercial paper because of the requirement set out in point 1(c) 
of Part 3, the credit institution may use the risk-weight assigned to a liquidity 
facility  in  order  to  calculate  the  risk-weighted  exposure  amount  for  the 
commercial  paper  if  the  commercial  paper  of  an  ABCP-program  and  the 
liquidity facility form overlapping positions." 

(ii)  Point 6 is replaced by the following: 

"6.  Subject  to  point  8,  the  risk-weighted  exposure  amount  of  a  rated 
securitisation or re-securitisation position shall be calculated by applying to the 
exposure  value  the  risk  weight  associated  with  the  credit  quality  step  with 
which  the  credit  assessment  has  been  determined  to  be  associated  by  the 
competent authorities in accordance with Article 98 as laid down in Table 1." 

(iii)  Table 1 is replaced by the following: 

Table 1 

Credit  Quality 
Step 

1 

2 

3 

for 

other 

all 
quality steps 

credit 

(only 

4 
credit 
assessments 
other 
short-term 
credit 
assessments) 

than 

Securitisation 
positions 

Re-securitisation 
positions 

20% 

50% 

100% 

350% 

40% 

100% 

225% 

650% 

1250% 

1250% 

(iv)  Table 2 is deleted. 

EN 

20 

   EN 

 
 
(v)  Point 46 is replaced by the following: 

"46. Under the Ratings Based Method, the risk-weighted exposure amount of a 
rated securitisation position or re-securitisation shall be calculated by applying 
to  the  exposure  value  the  risk  weight  associated  with  the  credit  quality  step 
with which the credit assessment has been determined to be associated by the 
competent authorities in accordance with Article 98, as set out in the Table 4, 
multiplied by 1,06." 

(vi)  Table 4 is replaced by the following: 

Table 4 

Credit Quality Step 

Securitisation Positions 

Re-securitisation 
Positions 

Credit 
assessments 
other 
than 
short term 

term 

Short 
credit 
assessments 

A 

B 

C 

D 

E 

1 

2 

3 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

11 

7% 

8% 

12% 

15% 

10% 

18% 

12% 

20% 

20% 

35% 

35% 

50% 

60% 

75% 

100% 

250% 

425% 

650% 

20% 

25% 

35% 

20% 

25% 

35% 

40% 

60% 

30% 

40% 

50% 

65% 

100% 

100% 

150% 

150% 

225% 

200% 

350% 

300% 

500% 

500% 

650% 

750% 

850% 

all other and unrated 

1250% 

(vii)  Point 47 is replaced by the following: 

"47.  The  weightings  in  column  C  of  table  4  shall  be  applied  where  the 
securitisation position is not a re-securitisation position and where the effective 
number  of  exposures  securitised  is  less  than  six.  For  the  remainder  of  the 
securitisation positions that are not re-securitisation positions, the weightings in 
column B shall be applied unless the position is in the most senior tranche of a 

EN 

21 

   EN 

 
 
 
 
 
 
 
 
 
 
 
 
securitisation, in which case the weightings in column A shall be applied. For 
re-securitisation  positions  the  weightings  in  column  E  shall  be  applied  unless 
the  re-securitisation  position  is  in  the  most  senior  tranche  of  the  re-
securitisation  and  none  of  the  underlying  exposures  were  themselves  re-
securitisation  exposures,  in  which  case  column  D  shall  be  applied.  When 
determining whether a tranche is the most senior, it is not required to take into 
consideration amounts due under interest rate or currency derivative contracts, 
fees due, or other similar payments." 

(viii)  Point 48 is deleted: 

(ix)  Point 49 is replaced by the following: 

"49.  In  calculating  the  effective  number  of  exposures  securitised  multiple 
exposures  to  one  obligor  must  be  treated  as  one  exposure.  The  effective 
number of exposures is calculated as: 

(

N

=

EAD
i

2)

EAD
i

2

i

∑
∑

i

where EADi represents the sum of the exposure values of all exposures to the 
ith  obligor.  If  the  portfolio  share  associated  with  the  largest  exposure,  C1,  is 
available, the credit institution may compute N as 1/C1." 

(x)  Point 50 is deleted. 

(xi)  Point 52 is replaced by the following: 

"52. Subject to points 58 and 59, under the Supervisory Formula Method, the 
risk weight for a securitisation position shall be the risk weight to be applied in 
accordance with point 53. However, the risk weight shall be no less than 20% 
for  re-securitisation  positions  and  no  less  than  7%  for  all  other  securitisation 
positions." 

(xii)  In point 53, the sixth paragraph is replaced by the following: 

"N is the effective number of exposures calculated in accordance with point 49. 
In the case of re-securitisations, the credit institution must look at the number 
of  securitisation  exposures  in  the  pool  and  not  the  number  of  underlying 
exposures  in  the  original  pools  from  which  the  underlying  securitisation 
exposures stem." 

(12) 

(4) 

Annex XII, Part 2 is amended as follows: 

(a) Points 9 and 10 are replaced by the following: 

The  credit 

institutions  calculating 

in 
"9. 
accordance  with  points  (b)  and  (c)  of  Article  75  shall  disclose  those 
requirements  separately  for  each  risk  referred  to  in  those  provisions.  In 
addition, the capital requirement for specific interest rate risk of securitisation 
positions shall be disclosed separately. 

their  capital  requirements 

10. 
The following information shall be disclosed by each credit institution 
which  calculates  its  capital  requirements  in  accordance  with  Annex  V  to 
Directive 2006/49/EC: 

(a) for each sub-portfolio covered: 

EN 

22 

   EN 

 
 
(i) 

the characteristics of the models used; 

(ii) 

for the incremental risk capital charge the methodologies used and 
the risks measured through the use of an internal model including a 
description  of  the  approach  used  by  the  credit  institution  to 
determine  liquidity  horizons,  the  methodologies  used  to  achieve  a 
capital  assessment  that  is  consistent  with  the  required  soundness 
standard and the approaches used in the validation of the model; 

(iii)  a description of stress testing applied to the sub-portfolio; 

(iv)  a description of the approaches used for back-testing and validating 
the accuracy and consistency of the internal models and modelling 
processes; 

(b) 

the scope of acceptance by the competent authority; 

(c) 

a  description  of  the  extent  and  methodologies  for  compliance  with  the 
requirements set out in Annex VII, Part B to Directive 2006/49/EC; 

(d) 

the highest, the lowest and the mean of the following: 

(i) 

(ii) 

the  daily  value-at-risk  measures  over  the  reporting  period  and  as 
per the period end; 

the stressed value-at-risk measures over the reporting period and as 
per the period end; 

(iii) 

the incremental risk capital charge over the reporting period and as 
per the period-end; 

the  amount  of  capital  for  incremental  risk,  together  with  the  weighted 
average liquidity horizon for each sub-portfolio covered; 

a comparison of the daily end-of-day value-at-risk measures to the one-
day changes of the portfolio's value by the end of the subsequent business 
day  together  with  an  analysis  of  any  important  overshooting  during  the 
reporting period." 

(e) 

(f) 

(b) Point 14 is replaced by the following: 

"14.  Credit  institutions  calculating  risk  weighted  exposure  amounts  in 
accordance with Articles 94 to 101 or capital requirements according to point 
16a  of  Annex  I  to  Directive  2006/49/EC  shall  disclose  the  following 
information, where relevant separately for their trading and non-trading book: 

(a) 

(b) 

(c) 

a  description  of  the  credit  institution's  objectives  in  relation  to 
securitisation activity; 

the  nature  of  other  risks  including  liquidity  risk  inherent  in  securitised 
assets; 

the  type  of  risks  in  terms  of  seniority  of  underlying  securitisation 
positions  and  in  terms  of  assets  underlying  these  latter  securitisation 
positions assumed and retained with re-securitisation activity; 

(d) 

the  different  roles  played  by  the  credit  institution  in  the  securitisation 
process; 

EN 

23 

   EN 

 
(e) 

(f) 

(g) 

(h) 

(i) 

an indication of the extent of the credit institution's involvement in each 
of them; 

a  description  of  the  processes  in  place  to  monitor  changes  in  the  credit 
and market risk of securitisation exposures including, how the behaviour 
impacts  securitisation  exposures  and  a 
of 
description of how those processes differ for re-securitisation exposures; 

the  underlying  assets 

a  description  of  the  credit  institution's  policy  governing  the  use  of 
hedging  and  unfunded  protection  to  mitigate  the  risks  of  retained 
securitisation  and  re-securitisation  exposures,  including identification  of 
material hedge counterparties by relevant type of risk exposure; 

the  approaches  to  calculating  risk  weighted  exposure  amounts  that  the 
credit  institution  follows  for  its  securitisation  activities  including  the 
types of securitisation exposures to which each approach applies; 

the  types  of  SSPEs  that  the  credit  institution,  as  sponsor,  uses  to 
securitise third-party exposures including whether and in what form and 
to  what  extent  the  credit  institution  has  exposures  to  these  SSPEs,  both 
on- and off-balance sheet exposure; 

(j) 

a summary of the credit institution's accounting policies for securitisation 
activities, including: 

(i)  whether the transactions are treated as sales or financings; 

(ii) 

the recognition of gains on sales; 

(iii) 

(iv) 

the  methods  and  key  assumptions  and 
securitisation positions; 

inputs  for  valuing 

the  treatment  of  synthetic  securitisations  if  this  is  not  covered  by 
other accounting policies; 

(v)  how assets awaiting securitisation are valued and whether they are 
recorded  in  the  credit  institutions  non-trading  book  or  the  trading 
book; 

(vi)  policies  for  recognising  liabilities  on  the  balance  sheet  for 
arrangements  that  could  require  the  credit  institution  to  provide 
financial support for securitised assets; 

(k) 

the names of the ECAIs used for securitisations and the types of exposure 
for which each agency is used; 

(l)  where  applicable,  a  description  of  the  Internal  Assessment  Approach  as 
set  out  in  Annex  IX,  Part  4  including  the  structure  of  the  internal 
assessment process and relation between internal assessment and external 
ratings,  the  use  of  internal  assessment  other  than  for  IAA  capital 
purposes,  the  control  mechanisms  for  the  internal  assessment  process 
including  discussion  of  independence,  accountability,  and  internal 
assessment  process  review;  the  exposure  types  to  which  the  internal 
assessment process is applied and the stress factors used for determining 
credit enhancement levels, by exposure type; 

(m)  an  explanation  of  significant  changes  to  any  of  the  quantitative 

disclosures in points (i) to (l) since the last reporting period; 

EN 

24 

   EN 

 
(n) 

separately  for  the  trading  and  the  non-trading  book,  the  following 
information broken down by exposure type: 

(i) 

(ii) 

the total amount of outstanding exposures securitised by the credit 
institution,  separately  for  traditional  and  synthetic  securitisations 
and  securitisations  for  which  the  credit  institution  acts  only  as 
sponsor; 

the aggregate amount of on-balance sheet securitisation exposures 
retained  or  purchased  and  off-balance  sheet  securitisation 
exposures; 

(iii) 

the aggregate amount of assets awaiting securitisation; 

(iv) 

for securitised facilities subject to the early amortisation treatment, 
the  aggregate  drawn  exposures  attributed  to  the  seller’s  and 
investors’ interests respectively, the aggregate capital requirements 
incurred  by  the  credit  institution  against  its  retained  (the  seller’s) 
shares of the drawn balances and undrawn lines and the aggregate 
capital  requirements  incurred  by  the  credit  institution  against  the 
investor’s shares of drawn balances and undrawn lines; 

(v) 

the amount of securitisation exposures that are deducted from own 
funds or risk-weighted at 1 250%; 

(vi)  a  summary  of  current  year’s  securitisation  activity,  including  the 
amount  of  exposures  securitised  and  recognised  gain  or  loss  on 
sale; 

(o) 

separately  for  the  trading  and  the  non-trading  book,  the  following 
information: 

(i) 

(ii) 

the  aggregate  amount  of  securitisation  exposures  retained  or 
purchased  and  the  associated  capital  requirements,  broken  down 
between  securitisation  and  re-securitisation  exposures  and  further 
broken  down  into  a  meaningful  number  of  risk-weight  or  capital 
requirement bands, for each capital requirements approach used; 

the  aggregate  amount  of  re-securitisation  exposures  retained  or 
purchased broken down according to the exposure before and after 
hedging/insurance and the exposure to financial guarantors, broken 
down  according  to  guarantor  credit  worthiness  categories  or 
guarantor name; 

(p) 

(q) 

for  the  non-trading  book  and  regarding  exposures  securitised  by  the 
credit institution, the amount of impaired/past due assets securitised and 
the  losses  recognised  by  the  credit  institution  during  the  current  period, 
both broken down by exposure type; 

for  the  trading  book,  the  total  outstanding  exposures  securitised  by  the 
credit  institution  and  subject  to  a  capital  requirement  for  market  risk, 
broken down into traditional/synthetic and by exposure type." 

(c) The following point 15 is added: 

the 
"15.  The 
remuneration policy and practices of the credit institution for those categories 

information  shall  be  disclosed 

following 

regarding 

EN 

25 

   EN 

 
of  staff  whose  professional  activities  have  a  material  impact  on  their  risk 
profile: 

(a) 

the  decision-making  process  used 

information  concerning 
for 
determining the remuneration policy, including if applicable, information 
about the composition and the mandate of a remuneration committee, the 
name  of  the  external  consultant  whose  services  have  been  used  for  the 
determination  of  the  remuneration  policy  and  the  role  of  the  relevant 
stakeholders; 

(b) 

information on link between pay and performance; 

(c) 

(d) 

(e) 

information  on  the  criteria  used  for  performance  measurement  and  the 
risk adjustment; 

information  on  the  performance  criteria  on  which  the  entitlement  to 
shares, options or variable components of remuneration is based; 

the  main  parameters  and  rationale  for  any  bonus  scheme  and  any  other 
non-cash benefits." 

EN 

26 

   EN 

 
Annexes I, II, V and VII to Directive 2006/49/EC are amended as follows: 

ANNEX II 

(1) 

Annex I is amended as follows: 

(a)  Point 14 is amended as follows: 

(i)  The first paragraph is replaced by the following: 

"14.  The  institution  shall  assign  its  net  positions  in  the  trading  book  in 
instruments  that  are  not  securitisation  positions  as  calculated  in  accordance 
with  point  1  to  the  appropriate  categories  in  Table  1  on  the  basis  of  their 
issuer/obligor, external or internal credit assessment, and residual maturity, and 
then  multiply  them  by  the  weightings  shown  in  that  table.  It  shall  sum  its 
weighted positions resulting from the application of this point and of point 16a 
(regardless  of  whether  they  are  long  or  short)  in  order  to  calculate  its  capital 
requirement against specific risk." 

(ii)  The fourth paragraph is deleted. 

(b)  The following point 16a is inserted: 

"16a. The institution shall calculate the capital requirement for its net positions 
in  the  trading  book  in  instruments  that  are  securitisation  positions  as 
follows: 

(a) 

(b) 

that  would  be  subject 

for  securitisation  positions 
the 
Standardised Approach for credit risk in the same institution's non-
trading book, 8% of the risk-weighted exposure amounts under the 
Standardised  Approach  as  set  out  in  Part  4  of  Annex  IX  to 
Directive 2006/48/EC; 

to 

for  securitisation  positions  that  would  be  subject  to  the  Internal 
Ratings Based Approach in the same institution's non-trading book, 
8%  of  the  risk-weighted  exposure  amounts  under  the  Internal 
Ratings  Based  Approach  as  set  out  in  Part  4  of  Annex  IX  to 
Directive 2006/48/EC. The Supervisory Formula Method may only 
be  used  with  supervisory  approval  by  institutions  other  than  an 
originator  institution  that  may  apply  it  for  the  same  securitisation 
position  in  its  non-trading  book.  Where  relevant,  estimates  of  PD 
and  LGD  as  inputs  to  the  Supervisory  Formula  Method  shall  be 
determined  in  accordance  with  Articles  84  to  89  of  directive 
2006/48/EC  or  alternatively  and  subject  to  separate  supervisory 
approval, based on an approach as set out in point 5a of Annex V; 

(c)  Paragraphs  (a)  and  (b)  notwithstanding,  for  re-securitisation 
positions that would be subject to a 1 250 % risk weight according 
to  Article  122b(1)  of  Directive  2006/48/EC  if  they  were  in  the 
same  institutions  non-trading  book,  8%  of  the  risk-weighted 
exposure amount according to that Article." 

(c)  Point 34 is replaced by the following: 

"34.  The  institution  shall  sum  all  its  net  long  positions  and  all  its  net  short 
positions  in  accordance  with  point  1.  It  shall  multiply  its  overall  gross 
position  by  8%  in  order  to  calculate  its  capital  requirement  against 
specific risk." 

EN 

27 

   EN 

 
(d)  Point 35 is deleted. 

(2) 

In Annex II, point 7, the second paragraph is replaced by the following: 

"However, in the case of a credit default swap, an institution the exposure of 
which arising from the swap represents a long position in the underlying shall 
be permitted to use a figure of 0% for potential future credit exposure, unless 
the credit default swap is subject to closeout upon insolvency of the entity the 
exposure  of  which  arising  from  the  swap  represents  a  short  position  in  the 
underlying,  even  though  the  underlying  has  not  defaulted,  in  which  case  the 
figure for potential future credit exposure of the institution shall be limited to 
the amount of premia which are not yet paid by the entity to the institution." 

(3) 

Annex V is amended as follows: 

(a)  Point 1 is replaced by the following: 

"1. The competent authorities shall, 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  IV.  Explicit  recognition  by  the  competent 
authorities  of  the  use  of  models  for  supervisory  capital  purposes  shall  be 
required in each case." 

(b) 

In point 4, the second paragraph is replaced by the following: 

"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.  At  a  minimum,  competent  authorities 
shall  require  institutions  to  perform  back-testing  on  hypothetical  (using 
changes  in  portfolio  value  that  would  occur  were  end-of-day  positions  to 
remain unchanged) outcomes." 

(c)  Point 5 is replaced by the following: 

"5.  For  the  purpose  of  calculating  capital  requirements  for  specific  risk 
associated  with  traded  debt  and  equity  positions,  the  competent 
authorities shall recognise the use of an institution's internal model if, in 
addition  to  compliance  with  the  conditions  in  the  remainder  of  this 
Annex, the internal model meets the following conditions: 

(a) 

(b) 

(c) 

(d) 

it explains the historical price variation in the portfolio; 

it  captures  concentration  in  terms  of  magnitude  and  changes  of 
composition of the portfolio; 

it is robust to an adverse environment; 

it  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; 

EN 

28 

   EN 

 
(e) 

it  captures  name-related  basis  risk.  This  means  that  institutions 
shall  demonstrate  that  the  internal  model  is  sensitive  to  material 
idiosyncratic  differences  between  similar  but  not 
identical 
positions; 

(f) 

it captures event risk. 

The institution's internal model shall conservatively assess the risk arising from 
less  liquid  positions  and  positions  with  limited  price  transparency  under 
realistic market scenarios. In addition, the internal model shall meet minimum 
data  standards.  Proxies  shall  be  appropriately  conservative  and  may  be  used 
only where available data is insufficient or is not reflective of the true volatility 
of a position or portfolio. 

The institution may choose to exclude from the calculation of its specific risk 
capital requirement using an internal model those positions for which it meets a 
capital requirement for position risks according to point 16a of Annex I. 

As techniques and best practices evolve, institutions shall avail themselves of 
these new techniques and practices." 

(d)  The following points 5a to 5k are inserted: 

"5a.  Institutions  subject  to  point  5  for  traded  debt  instruments  shall  have  an 
approach  in  place  to  capture,  in  the  calculation  of  their  capital 
requirements, the default and migration risks of its trading book positions 
that are incremental to the risks captured by the value-at-risk measure as 
specified  in  point  5.  An  institution  shall  demonstrate  that  its  approach 
meets soundness standards comparable to the approach set out in Articles 
84  to  89  of  Directive  2006/48/EC,  under  the  assumption  of  a  constant 
level  of  risk,  and  adjusted  where  appropriate  to  reflect  the  impact  of 
liquidity, concentrations, hedging and optionality. 

Scope 

5b.  The approach to capture the incremental default and migration risks shall 
cover all positions subject to a capital charge for specific interest rate risk 
but shall not cover those subject to the specific treatment of point 16a of 
Annex  I.  Subject  to  supervisory  approval,  the  institution  may  choose  to 
consistently  include  all  listed  equity  positions  and  derivatives  positions 
based on listed equities for which such inclusion is consistent with how 
the  bank  internally  measures  and  manages  risk.  The  approach  must 
reflect the impact of correlations between default and migration events. It 
must  not  reflect  the  impact  of  diversification  between  default  and 
migration  events  on  the  one  hand  and  other  market  risk  factors  on  the 
other hand. 

Parameters 

5c.  The approach to capture the incremental risks must measure losses due to 
default  and  internal  or  external  ratings  migration  at  the  99,9  % 
confidence interval over a capital horizon of one year. 

Correlation  assumptions  shall  be  supported  by  analysis  of  objective  data  in  a 
conceptually sound framework. The approach to capture the incremental risks 
shall  appropriately  reflect  issuer  concentrations.  Concentrations  that  can  arise 

EN 

29 

   EN 

 
within  and  across  product  classes  under  stressed  conditions  shall  also  be 
reflected. 

The approach shall be based on the assumption of a constant level of risk over 
the  one-year  capital  horizon,  implying  that  given  individual  trading  book 
positions  or  sets  of  positions  that  have  experienced  default  or  migration  over 
their  liquidity  horizon  are  re-balanced  at  the  end  of  their  liquidity  horizon  to 
attain  the  initial  level  of  risk.  Alternatively,  an  institution  may  chose  to 
consistently use a one-year constant position assumption. 

5d.  The liquidity horizons shall be set according to the time required to sell 
the  position  or  to  hedge  all  material  relevant  price  risks  in  a  stressed 
market,  having  particular  regard  to  the  size  of  the  position.  Liquidity 
horizons  shall  reflect  actual  practice  and  experience  during  periods  of 
both systematic and idiosyncratic stresses. The liquidity horizon shall be 
measured  under  conservative  assumptions  and  shall  be  sufficiently  long 
that the act of selling or hedging, in itself, would not materially affect the 
price at which the selling or hedging would be executed.  

The determination of the appropriate liquidity horizon for a position or set of 
positions is subject to a floor of three months. 

The determination of the appropriate liquidity horizon for a position or set of 
positions  shall  take  into  account  an  institution’s  internal  policies  relating  to 
valuation  adjustments  and  the  management  of  stale  positions.  When  an 
institution  determines  liquidity  horizons  for  sets  of  positions  rather  than  for 
individual positions, the criteria for defining sets of positions shall be defined 
in  a  way  that  meaningfully  reflects  differences  in  liquidity.  The  liquidity 
horizons  shall  be  greater  for  positions  that  are  concentrated,  reflecting  the 
longer  period  needed  to  liquidate  such  positions.  The  liquidity  horizon  for  a 
securitisation  warehouse  shall  reflect  the time  to  build,  sell  and  securitise  the 
assets, or to hedge the material risk factors, under stressed market conditions. 

5e.  Hedges may be incorporated into an institution’s approach to capture the 
incremental  default  and  migration  risks.  Positions  may  be  netted  when 
long and short positions refer to the same financial instrument. Hedging 
or  diversification  effects  associated  with  long  and  short  positions 
involving different instruments or different securities of the same obligor, 
as  well  as  long  and  short  positions  in  different  issuers,  may  only  be 
recognised by explicitly modelling gross long and short positions in the 
different instruments. Institutions shall reflect the impact of material risks 
that could occur during the interval between the hedge’s maturity and the 
liquidity  horizon  as  well  as  the  potential  for  significant  basis  risks  in 
hedging  strategies  by  product,  seniority  in  the  capital  structure,  internal 
or  external  rating,  maturity,  vintage  and  other  differences  in  the 
instruments. An institution shall reflect a hedge only to the extent that it 
can be maintained even as the obligor approaches a credit or other event. 

For  trading  book  positions  that  are  hedged  via  dynamic  hedging  strategies,  a 
rebalancing  of  the  hedge  within  the  liquidity  horizon  of  the  hedged  position 
may  be  recognised  provided  that  the  institution  (i)  chooses  to  model 
rebalancing  of  the  hedge  consistently  over  the  relevant  set  of  trading  book 
positions, (ii) demonstrates that the inclusion of rebalancing results in a better 
risk  measurement,  and  (iii)  demonstrates  that  the  markets  for  the  instruments 

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serving as hedges are liquid enough to allow for this rebalancing even during 
periods of stress. Any residual risks resulting from dynamic hedging strategies 
must be reflected in the capital charge. 

5f.  The approach to capture the incremental default and migration risks must 
reflect the nonlinear impact of options, structured credit derivatives and 
other  positions  with  material  nonlinear  behaviour  with  respect  to  price 
changes.  The  institution  shall  also  have  due  regard  to  the  amount  of 
model  risk  inherent  in  the  valuation  and  estimation  of  price  risks 
associated with such products. 

5g.  The approach to capture the incremental default and migration risks shall 

be based on objective data. 

Validation 

5h.  As part of the independent review of their risk measurement system and 
the  validation  of  their  internal  models  as  required  in  this  annex, 
institutions  shall,  with  a  view  to  the  approach  to  capture  incremental 
default and migration risks, in particular: 

(i) 

validate  that  its  modelling  approach  for  correlations  and  price 
changes  is  appropriate  for  its  portfolio,  including  the  choice  and 
weights of its systematic risk factors; 

(ii)  perform a variety of stress tests, including sensitivity analysis and 
scenario  analysis,  to  assess  the  qualitative  and  quantitative 
reasonableness  of  the  approach,  particularly  with  regard  to  the 
treatment  of  concentrations.  Such  tests  shall  not  be  limited  to  the 
range of events experienced historically; 

(iii)  apply appropriate quantitative validation including relevant internal 

modelling benchmarks.  

The  approach  to  capture  the  incremental  risks  must  be  consistent  with  the 
institution’s 
identifying, 
measuring, and managing trading risks. 

risk  management  methodologies 

internal 

for 

Documentation 

5i.  An  institution  shall  document  its  approach  to  capturing  incremental 
default  and  migration  risks  so  that  its  correlation  and  other  modelling 
assumptions are transparent to competent authorities. 

Internal approaches based on different parameters 

5j. 

If  the  institution  uses  an  approach  to  capturing  incremental  default  and 
migration risks that does not comply with all requirements of this point 
but  that  is  consistent  with  the  institution’s  internal  methodologies  for 
identifying,  measuring,  and  managing  risks 
to 
demonstrate  that  its  approach  results  in  a  capital  requirement  that  is  at 
least as high as if it was based on an approach in full compliance with the 
requirements  of 
review 
compliance with the previous sentence at least yearly. The Committee of 
European  Banking  Supervisors  shall  monitor  the  range  of  practices  in 
this area and draw up guidelines in order to secure a level playing field. 

this  point.  Competent  authorities  shall 

it  shall  be  able 

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Frequency of calculation 

5k.  An  institution  shall  calculate  the  approach  to  capture  the  incremental 

risks at least weekly. 

(e)  Point 7 is replaced by the following: 

"7.  For  the  purposes  of  points  10b(a)  and  10b(b),  the  results  of  the 
institution's own calculation shall be scaled up by a multiplication factor 
(m+) of at least 3." 

(f) 

In Point 8, the first paragraph is replaced by the following: 

"For  the  purposes  of  point  10b(a)  and  10b(b),  the  multiplication  factor  (m+) 
shall be increased by a plus-factor of between 0 and 1 in accordance with Table 
1, depending on the number of overshootings for the most recent 250 business 
days as evidenced by the institution's back-testing of the value-at-risk measure 
as  set  out  in  point  10.  Competent  authorities  shall  require  the  institutions  to 
the  basis  of  back-testing  on 
calculate  overshootings  consistently  on 
hypothetical  changes  in  the  portfolio'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." 

(g)  Point 9 is deleted. 

(h)  Point 10 is amended as follows: 

(i) 

Point (c) is replaced by the following: 

 "(c) a 10-day holding period;" 

(ii) 

Point (e) is replaced by the following: 

"(e) monthly data set updates." 

(i)  The following points 10a and 10b are inserted: 

"10a. In addition, each institution shall calculate a ‘stressed value-at-risk’ based 
on  the  10-day,  99th  percentile,  one-tailed  confidence  interval  value-at-risk 
measure of the current portfolio, with value-at-risk model inputs calibrated to 
historical data from periods of significant financial stress relevant to the firm’s 
portfolio.  The  choice  of  such  historical  data  shall  be  subject  to  yearly  review 
and  approval  by  competent  authorities.  The  Committee  of  European  Banking 
Supervisors  shall  monitor  the  range  of  practices  in  this  area  and  draw  up 
guidelines  in  order  to  ensure  convergence.  Institutions  shall  calculate  the 
stressed value-at-risk at least weekly. 

10b.  Each  institution  must  meet,  on  a  daily  basis,  a  capital  requirement 

expressed as the sum of: 

(a)  The higher of (1) its previous day’s value-at-risk number measured 
according  to  point  10  (VaRt-1);  and  (2)  an  average  of  the  daily 
value-at-risk  measures  according  to  point  10  on  each  of  the 
preceding  sixty  business  days  (VaRavg),  multiplied  by 
the 
multiplication factor (m+); 

plus 

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(b)  The higher of (1) its latest available stressed-value-at-risk number 
according to point 10a (sVaRt-1); and (2) an average of the stressed 
value-at-risk  numbers  calculated  in  the  manner  and  frequency 
specified  in  point  10a  during  the  preceding  sixty  business  days 
(sVaRavg), multiplied the multiplication factor (m+); 

plus 

(c)  The  sum  of  its  weighted  positions(regardless  of  whether  they  are 
long or short) resulting from the application of point 16a of Annex 
I; 

plus 

(d)  The  higher  of  the  institution's  most  recent  and  the  institution's  12 
weeks  average  measure  of  incremental  default  and  migration  risk 
according to point 5a." 

(j) 

In Point 12, the first paragraph is replaced by the following: 

"The risk-measurement model shall capture a sufficient number of risk factors, 
depending on the level of activity of the institution in the respective markets. 
Where a risk factor is incorporated in the institution's pricing model but not in 
the  risk-measurement  model,  the  institution  must  be  able  to  justify  this 
omission  to  the  satisfaction  of  the  competent  authority.  In  addition,  the  risk-
measurement model shall capture nonlinearities for options and other products 
as  well  as  correlation  risk  and  basis  risk.  Where  proxies  for  risk  factors  are 
used  they  shall  show  a  good  track  record  for  the  actual  position  held.  In 
addition, the following shall apply for individual risk types:" 

(4) 

Annex VII, Part B is amended as follows: 

(a) 

In point 2, point (a) is replaced by the following: 

"(a)  documented  policies  and  procedures  for  the  process  of  valuation.  This 
includes  clearly  defined  responsibilities  of  the  various  areas  involved  in  the 
determination  of  the  valuation,  sources  of  market  information  and  review  of 
their  appropriateness,  guidelines  for  the  use  of  unobservable  inputs  reflecting 
the institution’s assumptions of what market participants would use in pricing 
the  position,  frequency  of  independent  valuation,  timing  of  closing  prices, 
procedures  for  adjusting  valuations,  month  end  and  ad-hoc  verification 
procedures;" 

(b)  Point 3 is replaced by the following: 

"3.  Institutions  shall  mark  their  positions  to  market  whenever  possible. 
Marking  to  market  is  the  at  least  daily  valuation  of  positions  at  readily 
available  close  out  prices  that  are  sourced  independently.  Examples  include 
exchange  prices,  screen  prices,  or  quotes  from  several  independent  reputable 
brokers." 

(c)  Point 5 is replaced by the following: 

"5. Where marking to market is not possible, institutions must conservatively 
mark  to  model  their  positions/portfolios  before  applying  trading  book  capital 
treatment.  Marking  to  model  is  defined  as  any  valuation  which  has  to  be 
benchmarked, extrapolated or otherwise calculated from a market input." 

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(d) 

In point 6, point (a) is replaced by the following: 

"(a) senior management shall be aware of the elements of the trading book or 
of  other  fair-valued  positions  which  are  subject  to  mark  to  model  and  shall 
understand the materiality of the uncertainty this creates in the reporting of the 
risk/performance of the business;" 

(e)  Points 8 and 9 are replaced by the following: 

"Valuation adjustments 

8. Institutions shall establish and maintain procedures for considering valuation 
adjustments. 

General standards 

9. The competent authorities shall require the following valuation adjustments 
to be formally considered: unearned credit spreads, close-out costs, operational 
risks, early termination, investing and funding costs, future administrative costs 
and, where relevant, model risk." 

(f) 

Points 11 to 15 are replaced by the following: 

"11.  Institutions  shall  establish  and  maintain  procedures  for  calculating  an 
adjustment  to  the  current  valuation  of  less  liquid  positions.  Such  adjustments 
shall where necessary be in addition to any changes to the value of the position 
required  for  financial  reporting  purposes  and  shall  be  designed  to  reflect  the 
illiquidity  of  the  position.  Under  those  procedures,  institutions  shall  consider 
several factors when determining whether a valuation adjustment is necessary 
for less liquid positions. Those factors include the amount of time it would take 
to hedge out the position/risks within the position, the volatility and average of 
bid/offer  spreads,  the  availability  of  market  quotes  (number  and  identity  of 
market  makers)  and  the  volatility  and  average  of  trading  volumes  including 
trading  volumes  during  periods  of  market  stress,  market  concentrations,  the 
aging  of  positions,  the  extent  to  which  valuation  relies  on  marking-to-model, 
and the impact of other model risks. 

12.  When  using  third  party  valuations  or  marking  to  model,  institutions  shall 
consider whether to apply a valuation adjustment. In addition, institutions shall 
consider the need for establishing adjustments for less liquid positions and on 
an ongoing basis review their continued suitability. 

13.  When  valuation  adjustments  give  rise  to  material  losses  of  the  current 
financial year, these shall be deducted from an institution's original own funds 
according to point (k) of Article 57 of Directive 2006/48/EC. 

14.  Other  profits/losses  originating  from  valuation  adjustments  shall  be 
included in the calculation of ‘net trading book profits’ mentioned in point (b) 
of  Article  13(2)  and  be  added  to/deducted  from  the  additional  own  funds 
eligible to cover market risk requirements according to such provisions. 

15.  Valuation  adjustments  which  exceed  those  made  under  the  accounting 
framework  to  which  the  institution  is  subject  shall  be  treated  in  accordance 
with point 13 if they give rise to material losses, or point 14 otherwise." 

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