CELEX: 51998PC0090
Language: en
Date: 1998-02-13
Title: Amended proposal for a European Parliament and Council Directive amending Directive 93/6/EEC on the capital adequacy of investment firms and credit institutions

COMMISSION OF THE EUROPEAN COMMUNITIES
                                               Brussels, 13.02.1998
                                              COM(1998) 90 final
                                              97/0124 (COD)
AMENDED PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL
   DIRECTIVE AMENDING DIRECTIVE 93/6/EEC ON THE CAPITAL
  ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS
                            (COM(97)71 final
        (presented by the Commission pursuant to Article 189 a (2)
                            of the EC-Treaty)
 ---pagebreak---  ---pagebreak---                              EXPLANATORY MEMORANDUM
I.       INTRODUCTION
The proposal for a Directive concerned by this amended proposal was submitted to
Parliament and the Council on 17 June 1997 pursuant to Articles 189b(2) and 57(2) of the
EC Treaty.
The Economic and Social Committee handed down a favourable opinion at its 349th
plenary session on 29 October 1997. Two of its suggestions (regarding the length of the
transitional period and back-testing) have been incorporated into the amended proposal,
Parliament having adopted an amendment to that effect.
Parliament adopted (first reading) the legislative resolution giving its opinion on the
proposal for a Directive (COM(97)71 final) at its sitting on 18 December 1997.
Parliament's opinion comprises 10 amendments; they have been included in this amended
proposal.
II.      COMMENTS ON THE AMENDMENTS
Parliament called on the Commission to amend nine points in the proposal for a Directive.
The Commission considers the amendments to these points to be acceptable.
     The first and second amendments extend the transitional provisions for the use of
     alternative spread, carry and outright rates for commodities risk until the end of 2006
     (recital 8 and Article. 1, paragraph 5a). The European Parliament has proposed this
     extension in order to give those institutions intending to use internal models for
    commodities risk more time to develop appropriate systems and improve their internal
     control environment. This accords with a suggestion made by the Economic and
     Social Committee in its opinion. The Commission accepts that this extension is
    justified because of the difficulties of introducing internal models for some financial
     institutions trading in commodities.
     The third amendment (Annex VIII, paragraph 3) provides more detail on how back-
     testing should be undertaken. The Commission has accepted these specifications
 ---pagebreak---  propose:! hy the iv-rof/iiin Parliament, because they make the provisions clearer,
. particularly wiîh rentra to the frequency of the back-tests required.
 The f«gjrikffiEBttiiirAh JE rjseRdraces&< (Annex VE!l, paragraph 4a and Annex Vfll 7a &
 [*.) introduce additional, conditions required to permit the use of internal models (or
 calculating regulatory capital (or specific risk as well as additional arrangements
 regarding the multiplication factor in the context of specific risk. The European
 Parliament has proposed these provisions following adoption of such rules by an
 international forum of banking supervisors. The Commission agrees with the inclusion
 of these provisions in order to avoid competitive disadvantages for EU institutions.
 The fifth amestcfraeitt was introduced by Parliament to clarify that institutions whose
 models do not meet the extra conditions with respect to specific risk as introduced by
 the fourth amendment must continue to calculate capital requirements for specific risk
 according to Annex I of the original directive. The Commission agrees that this is a
 helpful clarification.
 Amendments srr, seven znd eight provide further explanation of how back-testing
 should operate in relation to the application of the "plus factor". In particular they
 specify that for the purposes of calculating the "plus factor" back-testing may be done
 on either actual or hypothetical (assuming unchanged end-of-day positions) results and
 that the value-at-risk calculated by the model must correspond to a one day holding
 period for the portfolio. !n addition they provide competent authorities with the option
 to waive the "plus factor" in particular circumstances, they impose sanctions if back-
 testing shows the mode! to be inadequate and they specify reporting requirements.
  These amendments proposed by the Parliament rellect similar recommendations by the
 Economic and Social Committee in its opinion. The Commission considers that the
 clarifications are helpful in substance but has made some minor adaptations to the text
 proposed by the Parliament in order to achieve consistency and notably to avoid
 duplication with parts of amendment 3.
                                          2>
 ---pagebreak---     AMENDED PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL
         DIRECTIVE AMENDING DIRECTIVE 93/6/EEC ON THE CAPITAL
        ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS
                                      (COM(97)71 final
 Original Proposal                             Amended Proposal
                                                Amendment 1
 8th recital                                    8th recital
 Whereas some investment firms dealing Whereas some investment firms dealing
 primarily in commodities and commodity primarily in commodities and commodity
 derivatives may not yet be able to use derivatives may not yet be able to use
 internal models or to comply with the internal models or to comply with the
capital requirements for commodities risk capital requirements for commodities risk
 as laid down in this Directive; whereas it is as laid down in this Directive; whereas it is
expected that appropriate, cost effective       expected that appropriate, cost effective
internal models for investment firms on the internal models for investment firms on the
risk management of commodities and risk management of commodities and
commodities derivatives, in particular for commodities derivatives, in particular for
options, will be available shortly; whereas, options, will be available shortly; whereas,
in order to give those firms sufficient time in order to give those firms sufficient time
to upgrade their risk management systems, to upgrade their risk management systems,
competent     authorities,   under    certain competent       authorities, under    certain
conditions, should not be obliged to conditions, should not be obliged to
prescribe    the    capital   charges     for prescribe      the   capital   charges    for
commodities referred to in Annex VII to commodities referred to in Annex VII to
Directive 93/6/EEC for investment firms Directive 93/6/EEC for investment firms
before 1 January 2000.                          until after 31 December 2006.
                                              k
 ---pagebreak--- Original Prtip-es&l Amended Proposal
                    Amendment 2
                     Article t, paragraph 5a (new)
                     Article Ha is inserted:
                                     "Article 11a
                     Up to 31 December 2006, Member States
                    may authorize their institutions to use the
                     minimum spread, carry and outright rates
                     indicated in the following table rather than
                    those indicated in Annex VII. 13, 13.a, 16
                    and 16.a, provided that those institutions,
                    in the opinion of the competent authorities:
                    - carry out a significant        volume of
                    transactions in commodities;
                         have    a   diversified   portfolio   of
                    commodities;
                    - are not yet in a position to employ
                    internal models as part of their risk
                    management system for the calculation of
                    the capital requirements in relation to their
                    commodities position in accordance with
                    Annex VIII.
                     t>
 ---pagebreak--- Minimum spread, carry and outright rates
           Precious Nase       Perishable    Other
                    r
           mclals    JltL1!Ls goods          goods
           (exccrtl            (agricultural inc.
            gold)               products)     energy
                                             products
Spread        1.0       1.2       1.5          ]_.5
Rale (%)
Carry rate    03 •      05        06             06
m
Outright       8         \0        \1             \5
Rate (%)
Member States applying this Article shall
provide the Commission with the necessary
information."
 ---pagebreak--- Original Proposal                             Amended Proposal
                                              Amendment 3
Annex VIII, paragraph 3                        Annex VIII, paragraph 3
3. The competent authorities shall also be 3. The institution          shall   monitor   the
satisfied    that the  institution's  models accuracy and performance of its model by
continue to be reasonably accurate, as conducting a back-testing programme. The
evidenced      by  a  regular    back-testing back-testing has to provide          for each
programme       to be conducted      by the business day a comparison of the one day
institution.                                   value-at-risk measure generated by the
                                               institution's model for the portfolio's end-
                                               of-day positions with the one day change of
                                              the portfolio's value by the end of the
                                               subsequent     business   day.     Competent
                                               authorities shall monitor the development
                                               by institutions of the capability to perform
                                               back-testing     on    both     actual   and
                                               hypothetical changes in the portfolio's
                                               value.    Back-testing    on     hypothetical
                                              changes in the portfolio's value is based
                                              upon a comparison between the portfolio's
                                              end-of-day value and, assuming unchanged
                                              positions, its value at the end of the
                                              subsequent day.
                                               ^r
 ---pagebreak--- Origmal Proposal Amended Proposal
                 Amendment 4
                  Annex VIII, paragraph 4a (new)
                  4a. l;or the purpose of calculating capita 1
                  requirements for specific risk associated
                  with traded debt and equity positicns_the
                  competent authorities may recognise the
                  use of an institution's internal model if in
                  addition to compliance with the conditions
                  in the remainder of this Annex the model:
                  - explains the historical price variation in
                  the portfolio,
                 -    captures   concentration    in terms  of
                  magnitude and changes of composition of
                 the portfolio,
                 - is robust to an adverse environment, and
                 - is validated through back-testing aimed at
                 assessing whether specific risk is being
                 accurately      captured.     If    competent
                  authorities allow this back-testing to be
                  performed on the basis of relevant sub-
                  portfolios these must be chosen in a
                  consistent manner.
                 t
 ---pagebreak--- Original Proposai                               Amended Proposal
                                                Amendment 5
Annex VIII, paragraph 5                          Annex VIII, paragraph 5
5.     Notwithstanding       ruimgraph _     l_, 5. Institutions using internal models which
institutions using models shall be subject to are not in accordance with paragraph 4a
a separate capital charge to cover the shall be subject to the separate capital
specific risk of traded debt instruments and charge in respect of the specific risk
equities as described in Annex 1 to the calculated according to Annex I.
extent that the competent          authorities
consider that this risk is not incorporated
sufficiently    into   their   models.   The
competent authorities shall in any case set a
minimum specific risk charge of 50% of
the charge as calculated according to
Annex I for institutions using models.
 ---pagebreak--- Original Proposal                            Amended Proposal
                                             Amendment 6
Annex VIII, paragraph 7 - second sub- Annex VIII, paragraph 7 - second sub-
paragraph                                     paragraph
The value-at-risk number calculated by        The value-at-risk number calculated by
means of the model shall be compared with     means of the model shall be compared with
the actual change in value of the portfolio,  the actual change in value of the portfolio.
Rack-testing shall be carried out daily on    Back-testing shall be carried out daily on
the basis of both effective and, assuming     the basis of actual or, assuming unchanged
unchanged    end-of-day    positions, hypo- end-of-day positions, hypothetical changes
thetical changes in the portfolio value.      in the portfolio value. The value-at-risk
                                              number subject to the backtesting must
                                              correspond to a holding period of one day.
                                              Before    using   an    internal model    to
                                              determine its own funds, the institution
                                              shall also obtain the approval of the
                                              competent authorities, inter alia, for the
                                              type of changes (actual or hypothetical) to
                                              be used in its backtesting. The institution
                                              must also apply       the method   selected
                                              consistently.
                                              >o
 ---pagebreak--- Original Proposal                               Amended Proposal
                                                Amendment 7
Annex VIII, paragraph 7 - second sub- Annex VIII, paragraph 7- third sub-
paragraph                                       paragraph
If the change in portfolio value exceeds the If the change in portfolio value exceeds the
value-at-risk calculated using the model, value-at-risk calculated using the model,
the target has been overshot. The number the target has been overshot. The number
of overshoot ings, as set out in table 5, shall of overshootings, as set out in Table 5,
be based on a spot check of 250 values.         shall be based on a statistical sample of
                                                daily values covering the 250 most recent
                                                working days.
                                                For the purpose of determining the 'plus'
                                                factor, the number of overshootings shall
                                                be determined at least quarterly
 ---pagebreak---  Original Proposal                                     Amended Proposal
                                                       Amendment 8
Annex VIII, paragraph 7 - last three Annex VIII, paragraph 7- last three
sub-paragraphs                                          sub-paragraphs
 The     competent       authorities       can,     in "The     competent     authorities     can,  in
individual cases, waive the requirement to individual cases, waive the requirement to
add a plus factor             if,    owing to an increase the multiplication factor by the
exceptional situation, an increase in the "plus'Maetor in accordance with 'Table 5 if
multiplication factor would be unjustified              the institution has demonstrated to the
and the model is basically sound. In this satisfaction of the competent authorities
context, the institution has lo prove that an that such an increase is unjustified and that
increase would be unjustified.                          the model is basically sound.
, .,            . p•                       , ..         If numerous overshootings indicate that the
                                                                                 6
In the event of numerous overshootings,
the competent authority shall revoke the                model is not sufficiently accurate, the
    , ,,           ...                            . .   competent authorities shall revoke the
                                                             v
model s recognition or impose appropriate
                             ,1 . .i           , i •    model's recognition
                                                        measures   to& ensureorthat
                                                                                 impose
                                                                                      the appropriate
                                                                                            model    is
improved promptly.
measures      to ensure that the model is                                           r      rr    v
                                                        improved promptly.
 The     institution      is      to    record     all
                                                         The   institution    is   to    record    all
overshootings ascertained by back-testing,
                                                        overshootings ascertained by back-testing,
together with the reasons for them, and to
                                                        together with the reasons for them, and to
notify       the       competent          authorities
                                                        notify the competent authorities, without
immediately        of    the       extent   of    the
                                                        undue delay, and in any case no later than 5
overshootings and the reasons for them.
                                                        working days after the day on which the
                                                        error was noted.
 ---pagebreak--- Original Proposal  Amended Proposal
                  Amendment 9
                    Annex VIII, paragraph 7a & b (new)
                    7a. If for the purpose of calculating capital
                    requirements       for   specific   risk   the
                    institution's model is recognised by the
                    competent authorities in accordance with
                    paragraph 4a, the multiplication factor to
                    be applied to the specific risk portion of the
                    institution's value-at-risk measure shall be
                   increased to 4. If the institution's back-
                   testing indicates that the model does not
                   sufficiently accurately capture specific risk
                   the competent authorities shall revoke the
                    model's recognition for the purpose of
                   calculating       capital   requirements    for
                    specific    risk    or   impose    appropriate
                    measures to ensure that the model is
                    improved promptly.
                   7b. The competent authorities may waive
                   the requirement pursuant to paragraph 7a.
                   for an increase of the multiplication factor
                   to 4 if the institution demonstrates that in
                   line with agreed international standards its
                   model adequately captures also, inter alia,
                   the event and default risk for its traded debt
                   and equity positions.
                  i3>
 ---pagebreak---  ---pagebreak---                                                                     ISSN 0254-1475
                                                             COM(98) 90 final
                                              DOCUMENTS
EN                                                                 09 08     10
                                    Catalogue number : CB-CO-98-095-EN-C
                                                              ISBN 92-78-31196-0
Office for Official Publications of the European Communities
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