CELEX: 51990PC0141
Language: en
Date: 1990-05-23
Title: PROPOSAL FOR A COUNCIL DIRECTIVE ON CAPITAL ADEQUACY OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS

COMMISSION OF THE EUROPEAN COMMUNITIES
                                          C0MC90) 141 final- SYN'257
                                          Brussels, 23 May 1990
                        Proposal for a
                      COUNCIL DIRECTIVE
                   on capital adequacy of
         investment firms and credit institutions
               (presented by the Commission)
 ---pagebreak---                               EXPLANATORY MEMORANDUM
GENERAL CONSIDERATIONS
1.  The   present   proposal   for   a  Directive  on   the  Capital   Adequacy  of
     Investment Firms and Credit Institutions is a necessary follow-up to the
    proposal for a Directive on Investment Services In the securities field,
    presented by the Commission to the Council on 3 January 1989 (on which
    there is already an amended proposal presented by the Commission on 8
    February   1990 after    the   advice  of  the  European   Parliament  and  the
    Economic and Social Committee).
    The proposal for a directive on Investment Services is intended to open
    the way for investment firms authorized in their home Member States to
    have access to all other Member States' financial markets - either by
    establishing branches, or by providing services, therein - on the basis
    of certain conditions that closely follow those established for credit
    Institutions    In the Second Banking Coordination Directive, adopted        In
    December   1989.   According to the programme set out       In the White Paper
    "Completing   the   Internal  Market",   these freedoms should    be based on
    coordination of key rules as regards the authorization and the on-going
    supervision of financial Institutions.
2.  The coordination must be such as to ensure that the main objective of
    the proposal    - to ensure that both the health of the general financial
    system  and   Individual   investors are adequately     protected   In the new
    Integrated   European market     -  Is achieved.    It should   also meet   two
 ---pagebreak---                                            - 2 -
    other goals.      First, it should establish a broadly            level playing field
    between non-bank investment firms and credit institutions trading In the
    securities markets.        Consistently    with    this objective,      the rules set
   out   In the proposed Directive should not provide an                 incentive for an
    investment firm to opt for one Institutional structure,                 e.g. that of a
   credit    Institution - rather than another.           Second, the Directive should
   enhance, or      at   least   not  Impair,    the attractiveness of         Europe as a
    financial centre.
   Capital     requirements      for    investment    firms     Which    are.   Dût   credit
    Institutions
3. The   proposal     establishes     minimum     Initial   capital     requirements     for
    Investment firms which are not credit Institutions, requirements for the
    latter being already fixed by the Second Banking Directive.                  These have
   been set at levels which ensure that when It starts its activities, an
    Investment firm has sufficient,          Initial financial resources in view of
   the nature of       its business and      second, which do not form unnecessary
   barriers     to  the   entry    Into   the   market   of    new  firms.     Accordingly,
   different     amounts   are established       for  different     kinds of      investment
   firms, taking into account the types of business carried out by them.
4. The    initial    capital    requirements      for   firms    which   are    not   credit
    institutions are lower than those laid down for credit                 institutions in
   the Second Banking        Coordination     Directive.    This    Is for    two reasons.
   First, investment firms which are not credit             Institutions typically are
   more specialized than credit          institutions; the latter engage In a wider
   variety    of activities      and  thus need     higher    initial   capital.     Second,
   under Annex 5 of the present Directive, investment firms which are not
   credit   institutions are also required to hold "base capital" equivalent
   to three months' of their          fixed overheads, a requirement           which   takes
   account of the wide variation in the size of non-bank Investment firms.
5. In order to provide for the ongoing financial soundness of such firms,
   capital requirements are set to cover the market risks to which they are
   exposed.
 ---pagebreak---                                     - 3 -
5.1 The first requirement     is the position risk requirement          (Annexes 1
    and 2 ) . According to the rules proposed, each firm must keep in the
    form   of   capital   a  certain    percentage   of   Its    long   and    short
    positions, after allowance has been made for hedging and netting.
    This percentage varies according to the nature of the Instruments in
    which the firm has a position and according to the credit-standing
    of the issuers concerned.      This requirement is intended to cover the
    risk   of   adverse   price   movements    In  the   underlying     securities
    whatever their cause (e.g. Interest rate risk changes or shifts In
    an issuer's credit worthiness).
5.2 Second, there is a foreign exchange risk requirement which is set In
    relation to a firm's vulnerability to          losses arising purely        from
    adverse exchange rate movements.       This is laid down in Annex 4.
5.3 The third    requirement   relates to unsettled      transactions,      i.e. to
    transactions    in which   one or    other   party  has   not   paid   for   the
    securities it has contracted to buy or not delivered the securities
    it has contracted to sell.        In such a situation, there         is a risk
    that the counterparty will not be able to carry out Its obligations
    and also a risk of a malfunctioning of the settlement system itself;
    In either of these cases the firm may suffer a loss.
5.4 Finally there Is the "base" requirement In Annex 5, under which each
    firm Is required to hold own funds equivalent to one quarter of the
    previous year's fixed overheads.        This requirement      is intended to
    cover all other risks faced by investment firms, e.g.           the risk that
    market   turnover   collapses   reducing   a firm's broking       income   to a
    level insufficient to cover its expenses.
 ---pagebreak---                                         - 4 -
   Capital requirements for credit Institutions
6. The scope of the proposed Directive extends to all credit Institutions,
    including those which are not Investment firms. This is because several
   of the main      risks dealt with by the Directive, such as the risk of
    losses from    Interest rate and exchange rate movements, apply to their
   traditional activities such as deposit taking and lending, as well as to
   their   investment business.      In consequence not only should          the entire
   business of credit Institutions which are Investment firms be supervised
    In respect    of   these  risks,   but   also   that   of   those   which    are   not
    investment firms.
7. As regards provision against market risks on securities positions, the
   Directive has to take account of the capital requirements imposed by the
   Solvency     Ratio    Directive    (Council     Directive      89/647/EEC),      which
    Implicitly make some provision for risks other than credit risks.                   It
   would   thus   be   inappropriate   to   require   credit     institutions     already
   meeting   the   Solvency   Ratio   Directive    to  provide     additional     capital
   against   market     risk  in  general;    to   do   so    would   put   them    at   a
   disadvantage in comparison with non-bank investment firms from elsewhere
   In the Community and in third countries.
8. The Directive therefore offers a choice of two main options in respect
   of   credit    institutions.   Under    both   of   these    options,    alI    credit
   Institutions are required to :-
   (I)       provide    additional   capital   against    foreign exchange       risk   In
             accordance with the rules laid down in Annex 4, unless their
             foreign     currency   open   positions     are    subject   to    a   limit
             calculated as a percentage of their own funds (Article 4 (2)).
             (This    is necessary because the Solvency Ratio Directive does
             not explicitly take account of foreign currency risks);
   (II)      set up their own systems to monitor and control market risks
             (other    than foreign currency risk) on their overall             business
             (Article 4 (3);
 ---pagebreak---                                       - 5 -
9.  However, as regards market risk on open positions in equities and fixed-
    rate   securities  and  counterparty     risk,   Article   4  (4)   allows    the
    supervisory   authorities  in each Member      State  to choose    between    two
    alternative approaches: -
    either    (a)  to continue   to apply     the  requirements  of   the   Solvency
                   Ratlo Direct ive;
    or        (b)  to set  capital   requirements on     the short-term     "trading
                   books" of credit    institutions, calculated      in accordance
                   with the rules for non-credit      institutions as set out in
                   Annexes 1 - 3 of the Directive        In substitution     for the
                   requirements of   the Solvency Ratio Directive.         For   this
                   purpose a definition of the "trading book"          is given    In
                   Article 2 of the Directive.
10. The supervisory authorities of credit institutions may choose either to
    apply one of the options to all the credit Institutions in their charge,
    or  to decide which of    their   credit    Institutions should    apply    which
    system on a case-by-case basis.
11. The provision of the "trading book" option allows credit Institutions to
    have their capital requirements in this area of business measured In the
    same way as Investment firms which are not credit institutions. In this
    way the trading book option is consistent with the goal of ensuring a
    broadly  level playing field between those       investment  firms which are,
    and those which are not, credit     institutions.    It is also desirable on
    prudential grounds, because the requirements in Annexes 1 to 3 provide a
    more comprehensive treatment of the various risks In investment services
    business than the Solvency Ratio Directive, which         is mainly concerned
    with credit, as opposed to market, risks.
 ---pagebreak---                                            - 6 -
    Own Resources
12. The   definition      of   "own    resources"    for    credit     Institutions,    and
     investment   firms which are not credit         institutions,      is dealt with     in
    Annex   6 of    the   Directive.     In the   case    of   credit    Institutions   the
    definition     Is   the   same   as    that   laid   down     in   Council    Directive
    Nfi 89/299/EEC.    This definition       Is dictated by the need to ensure the
     long-run solvency of credit        institutions    - a need based In part on the
     Illiquid   nature of most      of   their  assets -      In order     to realize   the
    fundamental supervisory goals of depositor protection and the stability
    of the financial system.
13. However Member States may permit credit Institutions under the "trading
    book" option to use an alternative definition of "own resources" with
    regard to the requirements on their trading books.               This Includes a much
    higher proportion of subordinated debt than In the previous definition,
    though a ceiling       is placed on such debt so that            the key   supervisory
    goals are not compromised.         The provision of the alternative definition
    allows such credit       institutions to more easily meet           the volatile own
    resources    requirements     associated    with   their    trading    positions,   and
    ensures that the nature of their own resources                is broadly similar     to
    that for    Investment   firms which are not credit          institutions using the
    "alternative definition" described in paragraph 14.
14. The competent authorities may apply the definition of "own resources" In
    Council Directive 89/299/EEC to this latter group, or an "alternative
    definition".     This alternative definition        is focussed more on liquidity
    than solvency; thus Illiquid assets are deducted               in full from capital,
    but a greater amount of subordinated debt is allowed.               The highly liquid
    nature   of   such   firms' assets      means  that    requiring     them  to   provide
    capital   In this form against the risks they run Is fully consistent with
    the fundamental objectives of securities market supervisors.                It is also
    In line with the approach adopted by US securities market supervisors.
 ---pagebreak---                                              - 7 -
                         COMMENTS ON THE INDIVIDUAL ARTICLES
    Article 1
15. This   provides     for   all   investment    firms,    as  defined    in   the   Council
    Directive     on   Investment    Services    (.../... EEC), and        for   all   credit
     institutions subject to the requirements of the Council Directive on a
    Solvency    Ratio    for Credit      Institutions 89/647/EEC,       to be within       the
    scope of this Directive.
    Article 2
16. This Article defines certain terms used in the Directive, which are not
    defined or explained in the Investment Services Directive.
    Article 3
17. Levels of Initial and minimum capital are laid down here for                   investment
    firms    that     are    not    credit     Institutions.    The    purpose      of   such
    requirements Is to ensure that such firms have enough starting capital
    to begin     business     in the provision      of   the   services    they   have   been
    authorized     to   supply.    Two    categories    of   such   firms   are,     however,
    excluded     from     both    these     obligations     and   the     business-related
    requirements      referred    to   in Article     4.   These   are   local    firms   and
    investment advisers.        They are excluded because their failure poses no
    threat   to    investors,    or   to   the  general    stability   of    the    financial
    system.
18. Allowance is made for firms in existence at the time the Directive is
    implemented which fail to meet the minimum levels stipulated for them in
    the Article, and also for firms whose Initial capital falls short after
    Its Implementation due to losses.           These provisions broadly mirror those
    In the Second Banking Coordination             Directive, although       an   additional
    clause allows very small firms to continue In existence in cases where,
    as a result of the death of the owner, control shifts to an heir.
 ---pagebreak---     Article 4
19. This Article describes in general terms the financial requirements for
    firms   covered     by  the   Directive.     An    important   distinction      Is  made
    between those      Investment   firms which are not credit           Institutions and
    those   which   are.    The   former   firms    are   required    to  put   up   capital
    against each of the risks          identified    In the Directive,       In the manner
     laid down   in Annexes 1 to 5.        Their overall requirement         is the sum of
    the requirements laid down in         each of these Annexes.
20. The requirements for credit institutions differ in a number of respects
    from those for non-banks.         First, by contrast to investment firms which
    are not credit      Institutions, they are not required to provide capital
    against the 'other risks' catered for in Annex 5, such as the risk of a
    fall In general market turnover and an Individual bank's broking income
    failing with     it.   This exclusion      Is justified on the basis that such
    risks are de minimis for most credit               institutions, whereas       they are
    often of paramount       importance for other        investment    firms.   Second, in
    regard to their credit institutions, Member States may choose to impose
    a limits, instead of a capital requirements, system, to protect against
    foreign    exchange     risk.    The   provision      of   the    limits    option    is
    justifiable    because    the   capital    requirements     In   the   Solvency    Ratio
    Directive already      take some account of this risk.             Third, all     credit
    institutions are obliged to establish            internal systems to monitor and
    control the market risks associated with their business in toto, and not
    simply   those    associated     with   their    securities     trading    activities.
    Finally, Member      States supervisors       are given    the choice of        Imposing
    either   the   Solvency     Ratio    Directive     requirements     to   their    credit
    institutions'     trading     activities     In    bonds   and    equities,     or   the
    requirements for non-banks detailed in Annexes 1 to 3.
 ---pagebreak---                                             9 -
    Article 5
21. A mark-to-market valuation of positions on a daily basis is required by
     this Article, except       in the   case   of   credit   institutions     which   are
    subject   to the Solvency Ratio Directive requirements on all of their
    bus Iness.
    Article 6,
22. This   Article    lays  down    both  the   type,   and   the    frequency,   of   the
     Information a firm must provide its competent authorities.
    Article 7
23. Under this Article Member States are required to nominate one or more
    authorities    to   grant   authorizations     and   to  carry     out  the   various
    supervisory tasks envisaged by the Directive.
24. It stipulates     that   It   is also open     to a Member       State  to   nominate
    professional    associations     to act   in this     role,   provided   that    their
    status is recognized      in the overall statutory scheme of supervision in
    the country concerned.
25. Where several authorities have been nominated            in a given Member      State
    for the purposes of the Directive they are required to cooperate closely
    In order to ensure an adequate level of supervision.
    Article 8
26. This Article permits amendments to be made to the Directive's rules in
    certain areas by use of a committee            procedure.     It   Is modelled    upon
    Article 22 of the Second Banking Directive.
 ---pagebreak---                                            10 -
                                     THE ANNEXES
27. Annexes 1 to 5 describe how the risks In a firm's positions, and thus
     the capital required to safeguard       it, are to be calculated, while Annex
    6 deals with the composition of the capital that is to be provided.
    Annex 1
28. This   Annex   explains  how   firms'    net   positions   are  to   be   measured,
     including the conditions under which gross positions            in an   Instrument
    may be reduced by the holding of offsetting positions In either the same
     Instrument or a derivative of It.        Once measured, the net positions are
    subject to the capital requirements set out in Annexes 2 and 4.
29. The Annex allows for a degree of flexibility in the way in which options
    and swaps are treated.
    Annex 2
30. This Annex explains how capital       requirements on fixed rate        Instruments
    and equities are to be calculated. Lower requirements are set on paper
    Issued by 'qualifying' firms from the private sector than on that from
    other   firms,   In view of    the   lower   price   volatility   of  the   former.
    Qualifying Issuers include credit institutions, and private sector firms
    whose   securities   are   listed   on   Member    State,  or   recognized    third
    country,    stock   exchanges.    This    Annex    also   permits    the   use   of
    alternative systems     for measuring capital       requirements that are based
    on the mathematical concept of duration, in certain circumstances.
 ---pagebreak---                                        - 11 -
    Annex 3
31. This Annex covers the risk to a firm of a deal         it has entered Into not
    being settled for whatever reason, for example the counterparty Involved
    failing to meet     its side of the bargain, or a malfunctioning of the
    settlement system.     It explains the    method of calculating the capital
    required to provide a buffer against the losses arising In such cases.
    Annex 4
32. This   Annex   describes   the  calculation   of  the   foreign  exchange risk
    requirement.    The purpose of this requirement       is to provide a capital
    buffer against losses arising from adverse movements in foreign exchange
    rates   when   the  credit   institution  or   Investment   firm  has  an open
    position.    The method of calculation Is also used In calculating foreign
    exchange limits for credit Institutions If the competent authorities so
    require under Article 4.
    Annex 5
33. Capital   requirements are set    in this Annex to safeguard firms against
    the diverse risks that are not addressed by Annexes 2 to 4, for example
    the losses arising from a market-wide fall in turnover.
    Annex 6
34. Annex 6 Is concerned with the definition of this capital or 'own funds'.
    It gives the competent authorities in each Member State the option of
    applying the definition of own funds laid down in the Council Directive
    on the Own Funds of Credit Institutions (89/299/EEC) or the alternative
    definition set out      in this Annex, to    Investment   firms which are not
    credit   institutions.    Firms using the latter are allowed to include a
 ---pagebreak---                                 - 12 -
larger   amount of subordinated debt   in their own funds than under the
former   definition,  but,  unlike   credit   Institutions,   are  strictly
required   to  deduct their   illiquid  assets.  Credit   institutions  are
required to apply the definition in Council Directive 89/299/EEC, except
In the case of those which are required to meet the capital requirements
In Annexes 2 and 3.    In this latter case the competent authorities may
permit an alternative definition which is similar, though not identical,
to the alternative definition for non-banks.
 ---pagebreak---                                         - 13 -
                                  Proposal for a
                                COUNCIL DIRECTIVE
                             on capital adequacy of
                  investment firms and credit institutions
THE COUNCIL OF THE EUROPEAN COMMUNITIES,
Having regard to the Treaty establishing the European Economic Community,
and in particular the first and third sentences of Article 57(2) thereof,
Having regard to the proposal from the Commission^ 1 ),
In cooperation with the European Par I lament^ 2 ),
Having regard to the opinion of the Economic and Social Committee^ 3 ),
Whereas  Council  Directive     ... of    ... on     investment   services    in the
                    4
securities   fleld^ )    has   as    its   main    objective    that  of    allowing
Investment firms authorized by the competent authorities of their home
Member  States  and   supervised    by   those   same   authorities   to   establish
branches and provide services freely in other Member States; whereas it
accordingly  provides    for   coordination     of   the  rules   relating   to  the
authorization and pursuit of business of investment firms;
(1)  OJ No
(2)  OJ No
(3)  OJ No
(4)  OJ No
 ---pagebreak---                                          - 14 -
Whereas Directive .... does not, however, establish common standards for
 the own    funds of    investment   firms, nor      Indeed  does    it establish    the
 amounts of Initial capital of such firms; whereas it does not establish a
 common framework for the monitoring of market risks incurred by the same
 firms;   whereas    Directive           makes    reference,     in   several   of   its
provisions, to another Community initiative, the objective of which would
be precisely to adopt coordinated measures in those fields-,
Whereas    the   approach    that  has  been   adopted     is to    achieve   only  the
essential    harmonization necessary       and sufficient     to secure     the mutual
recognition     of   authorization    and   of  prudential     supervision     systems;
whereas the adoption of coordination measures as regards the definition
of own funds of       Investment  firms, the establishment of the amounts of
 initial   capital   and   the establishment     of    a common    framework   for  the
monitoring of market risks of investment firms are essential aspects of
the harmonization necessary for the achievement of mutual recognition and
thus the completion of the internal financial market;
Whereas the Member States may also establish rules stricter                 than those
provided for In the present Directive;
Whereas this Directive forms part of the wider              International effort to
bring   about   approximation of      the   rules    in force    in major     countries
regarding the on-going supervision of investment firms;
Whereas common basic standards for the own funds of investment firms are
a key feature      In the creation of an Internal market            In the   Investment
services    sector    since   own  funds   serve    to   ensure   the   continuity   of
Investment    firms and to protect        investors; whereas such        harmonization
will   strengthen     the   supervision    of   Investment     firms;    whereas   such
standards must apply to all investment firms in the Community-,
 ---pagebreak---                                         - 15 -
 Whereas in a common financial market       investment firms, whether they are
 credit   Institutions   or  not,   engage    in  direct   competition    with    one
 another ;
Whereas the criteria for determining the composition of own funds must
 not be left to the sole discretion of Member States-,
Whereas    the adoption   of  common   basic   standards on    the own     funds of
 Investment firms will be in the best interests of the Community             in that
 it will    prevent  distortions   of   competition    and  will    strengthen    the
Community financial system;
Whereas investment firms which are credit         institutions already have the
definition of own funds provided for in the Council Directive 89/299/EEC
of 17 April 1989 on the own funds of credit Institutions           C);
Whereas, there are reasons why the definition of own funds of Investment
firms may be adapted from that in Directive 89/299/EEC In order to take
account   of   the particular   characteristics of      the activities of      those
firms;
                                                   *
Whereas, however, the basis for a definition of own funds for            investment
firms, which are not credit Institutions, should be the definition of own
funds of credit institutions;
Whereas   it is necessary to establish at Community         level the amounts of
minimum    initial  financial   resources    that   competent   authorities     must
require from Investment firms In order to grant them authorisation-,
Whereas these amounts should be fixed at a level which should ensure that
firms engaging in investment services have the capacity to fulfil their
obligations without,     at  the same    time,   representing    an   inappropriate
barrier to entry In the market by new firms;
(1)   OJ No 124, 5.5.1989, p. 16.
 ---pagebreak---                                        - 16 -
Whereas    It   Is appropriate   to give Member    States  the possibility    of
 reducing these amounts In cases where Investment firms are not authorized
 to hold customers' monies or securities, nor to act as market makers, nor
 to underwrite, nor to take positions of their own;
Whereas existing investment firms should be permitted to continue their
business even if they do not comply with the minimum amount fixed for new
firms;
Whereas, as regards Investment firms which are credit        institutions, the
amount of minimum      initial capital  is already established   in the Second
Council Directive 89/646/EEC of 15 December        1989 coordination of    laws,
regulations     and  administrative  provisions   relating  to  taking  up   and
pursuit of the business of credit        Institutions and amending    Directive
              1
77/780/EEC)< >;
Whereas It Is necessary to provide a common framework for the supervision
and monitoring of market risks of investment firms;
Whereas such a framework must cover the main risks incurred by investment
firms and, in particular, position risks, counterparty/settlement risks,
interest rate risks and foreign exchange risks;
Whereas the best approach to ensure the financial soundness of investment
firms   is to    impose on them the obligation to provide at all       times a
certain amount of own funds to cover each of the risks associated with
their particular activities;
(1)   OJ No 386, 30.12.1989, p. 1.
 ---pagebreak---                                             - 17 -
Whereas, for credit        institutions, one main part of the risk associated
with    their   business      is  already    covered    by  the    Council    Directive
89/647/EEC     of    18   Decmeber    1989    on   a  solvency    ratio    for   credit
 Institutions^ 2 );
Whereas,    for   that    reason,   It   is appropriate     to   give   the   competent
authorities      the     possibility     to    choose    between    either     applying
Directive 89/647/EEC to the whole book of credit Institutions or applying
the framework provided for in this Directive to their trading book;
Whereas, in any case, credit Institutions must comply with the provisions
of this Directive as regards the coverage of their foreign exchange risk;
Whereas the existence, in all credit             institutions, of    internal   systems
for monitoring and controlling the market risks on all their business is
a   particularly      important    way    of   minimizing    such    risks;    whereas,
consequently,     It    is necessary    that   such   systems  be    approved   by  the
competent authorities;
Whereas technical modifications to the detailed rules laid down in this
Directive may     from    time to time be necessary        to take account      of  new
developments    in the     investment services sector; whereas the Commission
shall   accordingly make such modifications as are necessary within                 the
limits of    the   Implementing    powers conferred on the Commission           by  the
Treaty;
HAS ADOPTED THIS DIRECTIVE
(2)   OJ No 386, 30.12.1989, p. 14.
 ---pagebreak---                                                  - 18
SCOPE
Art Icle 1
1.   Member           States       shall      apply        the    requirements        of   this
     Directive            to   investment        firms      defined    In   accordance     with
     the      3rd        Indent     of    Article       1    of  Directive       .../.../EEC,
     [relating              to      investment          services]         and     to     credit
     i n s t i t u t i o n s as d e f i n e d  in A r t i c l e 2.
2.   A    Member          State    may      impose    additional       or    more    stringent
     requirements               on      the       investment         firms      and      credit
     institutions            that    it has     authorised.
 ---pagebreak---                                   - 19 -
DEFINITIONS
ArtIcle 2
For the purposes of this Directive:
     "credit   Institutions" means        all   Institutions   meeting   the
    definition    in the 1st     Indent of Article 1 of the Council
    Directive     77/780/EEC<1>        which     are    subject    to    the
                                                                        2)
    requirements arising from Council Directive 89/647/EEC^                 ;
    the   "trading   book" of a credit         institution   shall  include
     Its  proprietary    positions      in   transferable    securities    or
    derivative    instruments, which        are taken on by the credit
     Institution   In order     to benefit      from  actual   or  expected
    differences between their buying and selling prices, or In
    order to hedge other elements of the trading book;
    "exchange-traded     instruments" means        instruments which     are
    traded   on, or    under   the   rules of, a stock        exchange, or
    financial    futures    or   options      exchange    established    and
    officially    recognized     in   the    relevant   Member   State, or
    established     in  a  third     country     and  recognized    by   the
    competent    authorities      of     the    relevant    Member   State.
     Instruments which are traded on such exchanges and markets
    shall be classified as equities, debt instruments, futures,
    options, convertibles and warrants, In this Directive;
    "over-the-counter      (OTC)      Instruments"     means          other
     I nstruments;
(1) OJ No L 322, 17.12.1977, p. 30.
(2) OJ No L 386, 30.12.1989, p. 14.
 ---pagebreak---                                                     - 20 -
     "qualifying              Issuer" m e a n s           a credit        institution,         or    a  firm
    whose securities                 are      listed on a s t o c k e x c h a n g e          in a M e m b e r
    S t a t e , or       In a s t o c k        exchange         in a third       country       when     this
    exchange           is r e c o g n i z e d     by    the c o m p e t e n t  authorities           of   the
     relevant         Member       State;
     "central          government"             refers        to    the    central      government          or
    central         bank of M e m b e r          S t a t e s and all       other    countries          which
    are      members          of   the       Organization             for    Economic        Cooperation
    and      Development            ( O E C D ) and       any    country      which    has      concluded
    special             lending           arrangements               with      the      International
    Monetary             Fund       (IMF)         associated            with     the      IMF      General
    Arrangements              to B o r r o w      (GAB);
    "other        public        sector"         means       regional       governments         and     local
    authorities              in c o u n t r i e s     which       are    members    of     the    OECD     or
    which        have        concluded           special         arrangements         with        the     IMF
    associated            with     the      IMF's      GAB;
    " c o n v e r t i b l e " m e a n s a s e c u r i t y , w h i c h , at       the o p t i o n of       the
    holder,         can      be e x c h a n g e d     for    another       security,       usually        the
    e q u I t y of      the     i ssuer;
    "warrant" means a security                           which gives         the h o l d e r   the     right
    to    purchase           a number          of    shares       of   common     stock,       or    bonds,
    at     a    stipulated            price        up     until      the    warrant's         expiration
    date ;
    "repurchase              agreement"           means       an   agreement       in w h i c h     a   firm
    sells securities                 subject         to a c o m m i t m e n t  to r e p u r c h a s e   them
    (or      substituted            securities             of    the    same    description)           at   a
    specified               future         time        and       price,       according           to      the
    provisions              of    Article            12(2)       of     the    Council          Directive
                          1
    86/635/EEC* >;
(1) OJ No L 3 7 2 , 3 1 . 1 2 . 1 9 8 6 , p . 1.
 ---pagebreak---                                                   21 -
"reverse           repurchase            agreement"         means      an    agreement       in   which
a    firm       buys      securities           from      a    counterparty           and   agrees     to
sell          them         (or        substituted             securities           of      the      same
description)                back        to    that      counterparty             at    a    specified
future          time       and       price,       according           to     the    provisions        of
Article          1 2 ( 2 ) of D i r e c t i v e     86/635/EEC;
"clearing            member"         means     a member           of   both     the   exchange       and
the        clearing           house,         thus      having         a     direct       contractual
relationship                  with         the      central            counterparty            (market
guarantor).               Non-clearing             members          must     have     their     trades
routed         through        a clearing          member;
"local         firm"      means        a firm      dealing         only    for    Its own      account
on      a    financial            futures        or     options         exchange        or   for     the
accounts           of,     or     making       a   price         to,   other      members      of    the
same       exchange, which                 is g u a r a n t e e d   by a c l e a r i n g   member     of
the       same      exchange,            with     this      guarantee          being     taken      Into
account             in      the        setting        of        the      guarantor's           capital
requirements;
"delta"          means       the     expected        change         in an     option     price     as a
p r o p o r t i o n of a small             change       in the p r i c e of         the    instrument
underlying             the    option;
for      the      purposes          of    Point     5 of        Annex      1,    "long      position"
means        a    position           in   which      a    firm       has    fixed     the    interest
rate       it will        r e c e i v e at s o m e     time       In the f u t u r e , and      "short
position"             means        a    position          in     which       It   has     fixed      the
Interest          rate      It will        pay at s o m e time            in the future-,
 ---pagebreak---                                        - 22 -
     "own   funds"    means     own     funds      as   defined       In    Directive
    89/299/EEC.     However     this    definition        may   be   modified,     for
    credit    Institutions,        In    the    circumstances         described      in
    Point   2 of Annex 6.        In the case of          Investment      firms which
    are not credit      Institutions, the competent               authorities      may
    use the definition set out            In Point 4 of Annex 6 instead;
    "initial    capital"     means    capital       as  defined      In   Points   (1)
    and (2) of Article 2(1) of Directive 89/299/EEC.                       The paid-
    up   share   capital     component        of    this     shall    comprise     all
    amounts   regardless of their          actual      designations, which, in
    accordance    with    the     legal     structure        of  the     Institution
    concerned,     are   regarded        under      national       law    as   equity
    capital   subscribed      and   paid     by    the   shareholders       or  other
    proprletors.
INITIAL CAPITAL AND DEROGATIONS FROM CAPITAL                   REQUIREMENTS
ArtIcle 3
1.  References    to   investment       firms     In Articles       3 to 6     denote
    only   those     investment       firms      which      are   neither      credit
    Institutions, nor       local    firms, nor       firms engaged        purely   in
    the business of supplying           investment advice.
2.  Investment    firms    shall     have     initial      capital     of   at   least
    ECU 500 000.
3.  Member   States may    reduce this amount            to ECU 50 000        where a
    firm   is  neither    authorised        to    hold    customers'      monies    or
    securities, nor to act as a market maker, nor to underwrite
    except where the firm         is involved only           in the    distribution
    of  issues on a best efforts basis.
 ---pagebreak---                                                 - 23 -
4. Member        States       may       reduce       the      amount         In    paragraph          2    to
   ECU 100 000            In the       case     of    firms       who     hold     cl l e n t s '   monies
   or   securities            in    acting       as    agents         or    portfolio          managers,
   but w h o do not           hold      trading      p o s i t i o n s of     their      own.
5. Notwithstanding              paragraphs           2,    3    and      4,   Member        States       may
   continue         the a u t h o r i s a t i o n of      investment          firms      in     existence
   before       this     Directive           is   implemented,             whose     own       funds     are
    less    than       the     initial         capital        levels        specified           in   those
   paragraphs.           The      own      funds     of     such        firms      shall        not    fall
   below        the      highest          level       recorded            after       the        date     of
   notification           of t h i s      Directive.
6.  If c o n t r o l   of an      investment         firm      falling within              paragraph        5
    Is t a k e n ,    other      than      through        inheritance,            by   a natural          or
    legal      person       other         than      the      person         who      controlled           it
   previously,           the    own      funds     of    that       institution           must      attain
   at    least        the     appropriate             level        prescribed            for       initial
   capital        In p a r a g r a p h s   2, 3 and        4.
7. However,          in   certain         specific         circumstances              and      with      the
   consent        of     the     competent          authorities,              where       there       Is    a
   merger       of    two    or    more       Investment          firms,        the    own      funds     of
   the    firm       resulting           from     the     merger         need      not     attain        the
   level of         initial      capital        referred         to    in p a r a g r a p h s    2, 3 and
   4.    However         the    own      funds     of     the      new     Investment           firm    may
   not   fall       below     the      total     own     funds       of    the    merged        firms     at
   the   time       of   the    merger,         as    long     as     the    appropriate            levels
   pursuant        to p a r a g r a p h s    2, 3 and 4 have not                 been      attained.
8. An    investment           firm's        own     funds        may      not     fall       below      the
   amount       of     initial       capital        required          under      paragraphs           2,    3
   and 4 or        the a m o u n t s of own          funds required              under       paragraphs
   5,   6    and      7.    However,           if,     In    the       cases      referred          to    in
   paragraphs          2,3,4,5        and     7  the    own      funds       should       be     reduced,
   the    competent           authorities            may,        where        the     circumstances
   justify        It,    allow       an     investment          firm      a   limited         period      in
   which     to r e c t i f y    its s i t u a t i o n or c e a s e         Its    activities.
 ---pagebreak---                                       - 24 -
PROVISION AGAINST RISKS
Art icle 4
1.     Investment    firms     shall    provide   at   all    times    a   certain
      amount of own funds to cover each of the various                        risks
      associated with their particular             activities. The sum of
      these amounts, which           shall be calculated          in accordance
      with   the   methods      outlined      in  paragraph        5   below    and
      Annexes    1   to    5,    shall     be  their     overall      own     funds
      requirement.      They    shall    ensure   that    their     overall     own
      funds   requirement        is   lower   than   or    equal     to   the   own
      funds that they hold.
2.    Credit   institutions        shall    provide,     in addition        to  the
      requirements set        in Directive 89/647/EEC and any set in
      paragraphs     4   and    5   below,    own   funds     to    cover     their
      foreign   exchange      risk-, this amount       shall     be   calculated
      in  accordance       with     the   method   outlined        in   Annex    4.
      Pending    further     harmonisation        however,      Member      States
      may   waive     the    application       of    this     requirement        in
      relation     to    credit       institutions      whose      business      is
      limited   as follows: their overall             net   foreign      exchange
      position,    calculated        in accordance      with    Annex     4, must
      not exceed the equivalent of 10% of own funds.
      The    competent        authorities        shall       require        credit
      institutions       to    set    up   systems,     which      need     to   be
      approved    by   the competent        authorities,       to monitor       and
      control      the      interest        rate,     equity         price      and
      counterparty/settlement risks on all of their business.
 ---pagebreak---                                      - 25 -
      The    competent        authorities          shall      require        credit
      institutions       -    either      on     a    general,       or     on    an
      individual     basis     -   to   meet     the   capital      requirements
     set    out    in   Directive        89/647/EEC        on    all    of     their
     business, or may, instead of this, require them to meet
      the capital      requirements       laid down       in Annexes       2 and   3
      hereto on their       trading books, and           the requirements of
     Directive 89/647/EEC on the rest of their business.
     The    competent       authorities         in    Member      States       shall
     require    that    investment      firms     have    adequate     own     funds
     to cover    the risks arising           in connection with           business
     that    is outside      the   activities        listed     in Council
     Directive    ../.../EEC        [relating to investment services].
      In  addition     they    shall    ensure      that    the   own    funds    of
      investment    firms,      and   those     credit      institutions        that
     are    required      to    meet    the     capital       requirements        in
     Annexes 2 and 3 hereto, protect                them against       the     risks
      In those   Instruments that fall within the activities of
     Council    Directive        ../.../EEC        (relating     to   investment
     services]    but    which    are not      explicitly      catered      for   in
     this    Directive,       and,     in    the     case    of    such      credit
     Institutions, are within            the trading        book.      All    cases
     covered    by    this    paragraph       shall    be    reported       to   the
     Commission by the relevant competent                  authorities.
EVALUATION OF POSITIONS FOR REPORTING                PURPOSES
ArtIcle 5
1.   Positions shall be marked to market daily by                     investment
     firms and credit        institutions unless Annexes 2, 3 and 5
     hereto do not appSy to them.
 ---pagebreak---                                       - 26
       In  the    absence      of    readily     available      market    prices
      e.g.   In    the   case    of    dealing      in   new   issues    on   the
      primary       markets,       the    authorities        may    waive     the
      requirement       under    paragraph      1,    and   require   firms    to
      use   alternative       methods      of   evaluation      provided     that
      these   methods      are  sufficiently       prudent, and      have    been
      approved by the competent            authorities.
REPORTING    REQUIREMENTS
Art icle 6
      Member    States     shall    require    that    investment    firms    and
      credit    Institutions        provide    the    competent    authorities
      of   the    home    Member     State    with     all   the   information
      necessary      to   assess     their    compliance      with   the    rules
      adopted      In   accordance       with     this    Directive.      Member
      States    shall     also    ensure    that     investment    firms'     and
      credit     Institutions'        internal     control     mechanisms     and
      administrative        and    accounting       procedures     permit     the
      verification of their compliance with such rules at all
      t imes.
 ---pagebreak---                                     - 27 -
2.    Investment       firms    which     are   not    credit      institutions
     shall     be      obliged       to     report      to     the    competent
     authorities        in  the   manner     specified     by   the   latter   at
      least once every         month    In the case of        firms which     are
     authorised       to   deal   as   principal,     at     least  once    every
     three   months       in the    case   of   those    firms    described     in
     Article    3 ( 4 ) , and at     least once a year         In the case of
     those firms covered by Article 3 ( 3 ) .               Such reports must
     be   received       by  the    competent      authorities      within    two
     weeks of the end of the reporting               period.
3.   Credit    institutions        shall   be obliged       to report     in the
     manner   specified       by   the   competent     authorities       at   the
     same time as they are obliged to report under                    Directive
     89/647/EEC,        and    at   more    frequent       intervals     if   the
     competent authorities so request.
COMPETENT   AUTHORITIES
ArtIcle 7
1.   Member States shall designate the authorities which are
     to carry out the duties provided               for   in this Directive.
     They   shall      Inform    the   Commission      thereof,      indicating
     any division of duties.
2.   The   authorities        referred     to    in  paragraph      1  must    be
     public   authorities        or   bodies    officially      recognized     by
     national    law or by public authorities to be part of the
     supervisory       system     prevailing      in  the     relevant    Member
     State.
3.   The   authorities        concerned       must   be    granted     all    the
     powers necessary to carry out their tasks.
 ---pagebreak---                                      - 28 -
      The   competent       authorities      of   different     Member     States
      shall    collaborate        closely     to    carry    out    the    duties
      provided      for     In   this    Directive,       particularly       when
       investment services are provided on a services basis or
      by the establishment of branches                In one or more       Member
      States.    They    shall    supply    one   another    on   request    with
      all   information      likely to facilitate the supervision of
      the   capital     adequacy      of   investment      firms    and    credit
       Institutions and particularly            the verification of their
      compliance      to   the   rules    laid   down    in  this    Directive.
      Any     exchange        of     Information        between        competent
      authorities which         Is provided      for   in this Directive       in
      respect    of    Investment      firms    shall    be   subject     to  the
      obligation      of     professional       secrecy     as    set    out   in
      Article     20    of     Directive      .../.../EEC        [Felating     to
      investment       services]        and,     in    respect      of     credit
      Institutions,        subject     to   the    obligation      set   out   in
      Article 12 of Council Directive               77/780/EEC.
COMMITTEE
Art icle 8
1.    The  technical      amendments      to be made      to   this   Directive
      In the    following      areas   shall    be adopted      In   accordance
      with the procedure         laid down     In paragraph 2:
      - definitions       in Article 2;
      -  Initial capital        requirements in
      - ArtIcle 3;
      - ceiling referred to In Article 4 ( 2 ) ;
      - treatment      of    Instruments      within    the     scope     of
         Directive        ../.../EEC         relating        to      Investment
         services    , but not covered         In this Directive;
      - calculation of net open positions                In Annex    1;
      - Annex 2;
 ---pagebreak---                                                - 29 -
        - counterparty/settlement                   risk w e i g h t s    in Annex 3-,
        - foreign exchange               risk w e i g h t s   in A n n e x 4-,
        - time p e r i o d used           in Annex     5;
        -   definition         of     own      funds    in    Points       2,    4   and    5  of
           Annex     6.
2.      Whenever        the    technical          amendments        referred        to   in   the
        first      paragraph          are      to   be   made       to    this      Directive,
        Article          23(2),         of       Council       Directive            ../.../EEC
         [relating       to   investment          services]      shall     apply.
FINAL     PROVISIONS
Art Icle 9
1.      Member       States        shall         bring       into      force       the     laws,
        regulations          and   administrative            provisions        necessary       to
        comply      with      this     Directive        by    1 January         1993    at    the
        latest.        They      shall        forthwith       inform       the      Commission
        thereof.
        The  provisions           adopted       pursuant      to    the   first      paragraph
        shall    make express           reference       to this       Directive.
2.      Member     States       shall       communicate        to    the    Commission        the
        texts of        the m a i n     laws, r e g u l a t i o n s  and     administrative
        provisions          which     they       adopt    in    the     field      covered     by
        this D I rect I v e .
Art icle    10
This Directive           is a d d r e s s e d   to the Member         States.
D o n e at B r u s s e l s ,                                For    the C o u n c iI
                                                            The    President
 ---pagebreak---                                      - 30 -
                                    ANNEX 1
                 CALCULATION OF NET OPEN POSITIONS
Equity and debt     Instruments
1.   The firm's     long and short positions           In the same equity,
     debt    and    convertible         issues    shall     be    netted.     In
     calculating      the net     position     the competent       authorities
     may   allow    positions       in   derivative     instruments      to   be
     treated        as        the       underlying         (or       notional)
     security/securities.           The    competent     authorities      shall
     allow     the   netting       of    identical     financial      futures,
     options and warrants, contracts.
2.   Debt   Instruments denominated           in the same currency        shall
     be   grouped      by    maturity      (according     to    Annex    2)   in
     reflection      of    the    residual      maturity     of   fixed     rate
     Instruments,       and     the    period    to   repricing      of   other
     Instruments.
3.   Debt    Instruments       shall     be   categorised      by   issuer    as
     follows:      central       government,      other     public      sector,
     qualifying and other.
Convert IbI es
4.   No    netting       is     allowed      between     convertibles        and
     offsetting      positions         in   the    underlying       Instrument
      Itself,    unless       the   competent      authorities       adopt    an
     approach     under     which     the   likelihood    of    a   particular
     convertible      being     converted     is taken    Into    account, or
     have a capital       requirement       to cover    any potential       loss
     which could be incurred on conversion.
 ---pagebreak---                                               - 31 -
Other    Instruments
5.     Interest           rate      futures         and      forward         rate       agreements
      ( F R A s ) w h i c h are not b a s e d on an u n d e r l y i n g                Instrument,
      will        be     treated        as    combinations            of       long     and      short
      p o s i t i o n s . T h u s a long f u t u r e s p o s i t i o n will             be    treated
      as      a      combination          of      a     borrowing          maturing          on     the
      delivery          d a t e of     the   futures        contract        and     a holding        of
      an a s s e t m a t u r i n g on the e x p i r a t i o n          d a t e of     the     future.
      The       opposite          holds      for      a   short       position.           Both      the
      borrowing            and     asset     holding         will     be      included         in   the
      central          government          column        of    Table       1    In    Annex      2.   A
      future         or    a    forward      which        is    based      on     an    underlying
      debt        instrument          will    be     treated        as    either        a    long    or
      short          position          in    the       underlying             Instrument.           Its
      maturity          will     be    taken     to be      the p e r i o d      until      delivery
      or     exercise           of    the    contract,           plus      the      life      of    the
      underlying            security,       or,      If the       life of        the    underlying
      security           exceeds        a   year,        as     this      life       itself.        The
      competent           authorities         may      allow     the    requirement            for   an
      exchange-traded                future      to    be    equal     to     the    margin       held
      at     the      exchange         if   they      are     fully      satisfied          that     it
      provides           an    accurate        measure         of    the      risk      associated
      with      the     future.
      Opt Ions on            Interest      rates,        debt     instruments,            equities,
      financial            futures,       swaps        and     foreign        currencies,           are
      treated           as      If     they     were        positions            in    the       delta
      multiplied            by    the    amount       of    the    underlying            instrument
      to     which       the     option      refers.        The    delta        used     should      be
      that       of    the     exchange       concerned,          or,    where       this      Is   not
      available           or     for    OTC    options,         that     calculated           by    the
      firm       Itself, subject            to the c o m p e t e n t       authorities           being
      satisfied              that      the      model         used      by       the       firm      is
      reasonable.              The     competent          authorities            shall        require
      that        the      other       risks,       apart        from      the      delta        risk,
      associated            with     options        are     safeguarded            against.         The
      c o m p e t e n t a u t h o r 11les may a I I ow the r e q u I r e m e n t a g a I n s t
 ---pagebreak---                                              - 32 -
      a  written,        exchange-traded                option       to   be   equal      to     the
      margin    held at        the e x c h a n g e      if they are f u l l y         satisfied
      that    it     provides          an      accurate          measure       of    the       risk
      associated        with      the o p t i o n ,     and     for   the    requirement          on
      a bought,        exchange-traded              or O T C o p t i o n     to be     the     same
      as  for    the      instruments           underlying           It,   subject        to    the
     constraint          that       the      resulting           requirement         does       not
     exceed    the m a r k e t      v a l u e of     the o p t i o n .     The    requirement
     against     a w r i t t e n O T C o p t i o n will           be set     in r e l a t i o n   to
      the  Instrument          underlying           it.
7.   Swaps    will      be    treated         for     Interest        rate    risk     purposes
     on the s a m e b a s i s as o n - b a l a n c e sheet               instruments.          Thus
     an    interest         rate      swap       under        which      a   firm      receives
     floating        rate      interest         and       pays     fixed      rate     interest
     will   be    treated         as   equivalent            to   a   long    position        in a
     floating       rate      Instrument          of    maturity        equivalent        to    the
     period     until        the      next      interest          fixing,      and     a    short
     position        in    a     fixed        rate       instrument        with      the       same
     maturity      as the s w a p         itself.          Competent       authorities          may
     however     set a l t e r n a t i v e     requirements           to t h e s e   for     firms
     using swap models which                   p r o v i d e , to the s a t i s f a c t i o n     of
     the   competent          authorities,             a more       accurate       measure        of
     the r I sks       In s w a p s .
8.   Warrants       shall      be    treated        in the       same    way    that     options
     are t r e a t e d   In p a r a g r a p h    6.
Currency   conversion
9.   All   net    positions,           irrespective            of   their     sign,     must      be
     converted        on    a    daily       basis       Into     the    firm's      reporting
     currency       at    the      prevailing           spot      exchange       rate     before
     the Ir a g g r e g a t I o n .
 ---pagebreak---                                              - 33 -
                                           ANNEX     2
                                      Position       risk
1.      Investment       firms shall          calculate       their     net   positions      as
       def i ned      In Annex       1 .
2.      Investment       firms       will     apply    the w e i g h t s s h o w n  in T a b l e
       1 to their         net,     fixed      interest      rate     positions,       whether
        In   their     own     or   foreign      currencies,           as   calculated       in
       Annex       1,    and       thus      calculate         their      weighted       long
       positions       and their w e i g h t e d       short     positions.
   Table 1
   Residual                         Central           Other public
                                                            publ tc sector
                                                                    sector                Other
   maturity                         government           andI quallfylng
                                   and European
                                     Commun i ty
                                        X                           X                       X
   up to       3 months                  0.3                       0.5                      8.0
   more than 3 up to 6 months            0.5                       1.0                      8.0
   more than 6 up to 12 months           1.0                       1.6                      8.0
   more than 1 up to 2 years             1.6                       3.6                      8.0
   more than 2 up to 5 years             2.9                       4.9                     10.0
   more than 5 up to 10 years            3.8                       5.8                     15.0
   more than 10 up to 20 years          4.8                        6.8                     15.0
   Over 20 years                         5.8                       7.8                     15.0
3.     T h e capital      requirement          will    be :
              the sum of the w e i g h t e d         long     positions
 plus         the sum of the w e i g h t e d         short     positions
 less        any h e d g i n g    allowances, calculated               as   follows:
              150%    of    any    weighted        long     (or    short)      position      in
             central       government          bonds     which       can    be   offset      in
             part     or    fully     against       a   weighted        short     (or   long)
             position        in central        government       bonds      In the same or
             an a d j a c e n t   maturity       band;
 ---pagebreak---                                                - 34 -
               100%      of    any    weighted         long     (or   short)       position       in
               central        government           bonds     which      can     be   offset       in
              part       or    fully     against        a  weighted         short     (or     long)
               position         in   central        government       bonds       in   the    next-
              but-one maturity               band;
               In     the     case     of    hedges       between        positions        in    the
               'other        public      sector        and     qualifying'          bonds      (the
              second          category          in     Table       1),      the      respective
              percentages           are    1 2 0 % and 8 0 % , rather           than    the    150%
              and 1 0 0 % used         for central         government         bonds.
               In     the     case     of     a     hedge      between       a    position       in
              central         government         bonds     and    a position          in    'other
              p u b l i c sector       and q u a l i f y i n g ' b o n d s , the     respective
              percentages           are also 1 2 0 % and 8 0 % .
              (Note       that     the    unused       portion      of    partially        offset
              weighted           positions            can     be     employed          in      this
              process.)
Durât ion
4.    Competent            authorities            in   a   Member       State       may    use     a
      system           for      applying          capital        requirements            to     the
      interest           rate    dependent          business      of     investment        firms,
      which        reflects        duration,          instead     of   the     rules     set    out
      in p a r a g r a p h s 2 to 3 a b o v e , so           long as the          requirements
      emanating            from      it    are       broadly      equivalent          to     those
      resulting             from      the       application          of      the      rules      in
      p a r a g r a p h s 2 to 3.
EquItles
5.   The      capital         required       against       a    long   or    a short       equity
     position            shall     be   10%      of    its   value      in    the    case    of   a
     qualifying            equity     and 2 5 % for any other                equity.
 ---pagebreak---                                                      - 35 -
6.        The      competent           authorities          may    allow       a reduction            in  the
          requirement                for       any       reduction             in      risk         due    to
          diversification,                   whether        through        the       investment          firm
          holding         a    large number           of     long, or        short,        positions        in
          equities          or     equities         derivatives,            or    from        Its    holding
           long       and      short        positions          in   different             equities        and
          equities          derivatives.             However       any     such      reduction          shall
          o n l y be a l l o w e d on the b a s i s that                 the r e s u l t i n g       capital
          requirement              is s u f f i c i e n t    to   cover       the     firm      against      a
          10% change            in the g e n e r a l        level of e q u i t y         p r i c e s on   its
          ma I n m a r k e t s .
U n d e r w r i t i n g of debt           and e q u i t y     Instruments
7.         In     the     case        of     underwriting           of      issues        of      debt    and
          equity        i n s t r u m e n t s , the c o m p e t e n t    a u t h o r i t i e s may      allow
          the w e i g h t s       referred        to     in p a r a g r a p h s   2 and        5 above     to
          be    reduced         by 6 0 % d u r i n g      the    first      w e e k , by       35%    during
          the      second         week,        and    by      20%    during         the       third      week
          following             the       day     on     which       the       underwriting              firm
          entered         Into an          irrevocable         commitment           to p u r c h a s e    the
          securities,             provided          that      the    securities              in    question
          are      to    be    traded         on   a   regulated         market         recognised         by
          the c o m p e t e n t       authorities.
Risk      concentration
8.        An     Investment            firm      which      has,     or      is    committed          to,    a
          long        or     short          position         in    a     particular              issue     of
          securities           which        exceeds       2 5 % of    the      total       issue,      shall
         meet        an    additional            capital        requirement             equivalent         to
          100%      of     the     requirement           against        the     unhedged           position
          set out         in p a r a g r a p h s   2 and 5 a b o v e .
 ---pagebreak---                                  - 36 -
An  Investment     f i r m ' s total  exposure     to an    issuer    cannot
exceed   2 5 % of  its own f u n d s w i t h o u t the  investment      firm
notifying      the   competent       authorities:      the       firm  shall
meet   an    additional        capital   requirement        against     such
exposures,       calculated        by   summing      the      requirements
against   each u n h e d g e d  position    In the o v e r a l l   exposure.
 ---pagebreak---                                                - 37 -
                                              ANNEX     3
                           Counterparty/settlement                  risk
       In the case of t r a n s a c t i o n s            In which      b o n d s and     equities
       (excluding               repurchase              and        reverse            repurchase
      agreements)             are      unsettled          after     their        due     delivery
      dates,          a  firm     must      calculate        the    price       difference       to
      which        It   is e x p o s e d . T h i s    is the d i f f e r e n c e    between     the
      agreed          settlement          price       for     the    bond       or   equity      In
      question,           and      its      current        market      value,        where      the
      difference           could       involve       a   loss    for   the      firm.     It   must
      multiply          this     difference          by    the    appropriate          factor    in
      Column         A of     Table      1   in order       to c a l c u l a t e    Its    capital
      requIrement.
      Notwithstanding                paragraph           1,     a    firm       can,      at    the
      discretion          of     its competent            authorities,          calculate       its
      capital            requirements             by       multiplying             the      agreed
      settlement             price         of     every        transaction            which      is
      unsettled          between       5 and      45 days after            its due d a t e ,     by
      the approprI ate factor                   in C o l u m n B of T a b l e       1.    From   45
      or     more       days     after       the     due     date     It    shall       take    the
      requirement           to be 1 0 0 % of the price d i f f e r e n c e               to which
      it     Is e x p o s e d ,  as     in C o l u m n  A.
Table 1
Number    of days        after                               Column A                   Column B
due s e t t l e m e n t  date
        5-15                                                      8%                      0.25%
      16-30                                                      50%                      0.5%
      31-45                                                     75%                       2.0%
      46     +more                                             100%               see p a r a . 2
 ---pagebreak---                                                 - 38 -
Repurchase      and    reverse         repurchase         agreements
3.      In the c a s e of r e p u r c h a s e        agreements          the    firm    shall    put
       up   the     difference             between        the     market        value       of   the
       securities,         and     the     amount       borrowed        by    the   firm      (which
        is their     original          sale      value) where            this    difference        Is
       positive.       In the        case      of    reverse       repurchase         agreements
       the firm shall           put up the d i f f e r e n c e           between      the     amount
        It has   lent p l u s a c c r u e d         interest,        and     the m a r k e t   value
       of   the     securities             it     has    received           (which       Is    their
       original      sale       value       plus     accrued        interest)        where      this
       difference        is p o s i t i v e .       In the c a s e of both            repurchase
       agreements          and        reverse          repurchase             agreements         the
       competent      a u t h o r i t i e s may      reduce      the r e q u i r e m e n t   to  the
       extent     that     the      borrower         provides         the     lender     with    the
       margin      that       is     normally          required          in    the    market      in
       quest Ion.
OTC derivative         Instruments
4.     The   requirement           shall        be   calculated           as   follows:        first
       the    firm     will         sum      (I)      the     total        replacement          cost
       (obtained      by     marking          to m a r k e t )   of     ail    Its    contracts,
       Including          bought            equity         option           contracts,          with
       positive     values         and     ( i i ) , in the       c a s e of     interest       rate
       and   exchange         rate       contracts,         an     amount       for     potential
       future    credit        exposure,            calculated         by    multiplying         the
       total   notional         principal           amount     of    its c o n t r a c t s   by  the
       following      w e i g h t s , as      appropriate:
 Res IduaI m a t u r I ty            Interest        rate                   Exchange        rate
                                        contracts                              cont r a c t s
 less than o n e      year                                                               1 .0%
 o n e year   and   over                      0.5%                                       5.0%
 ---pagebreak---                                   - 39 -
The  capital    requirement    will  be  4%   of  the   sum  of  (I)  and
(II)   where    the   counterparty    Is   in   the   non-bank   private
sector,    2%  of   the  sum  where   it  is   in   the  banking   sector
and/or   In the regional     government  or   local   authority  sector,
and zero    if it   Is the central   government.
 ---pagebreak---                                              - 40 -
                                            ANNEX     4
                              Foreign exchange                 risk
1.  The     overall        net     foreign        exchange           position,      calculated
    In a c c o r d a n c e    with      the p r o c e d u r e s     set    out   below,     shall
    be a s s i g n e d    an 8 % capital           requirement.
2. A two-stage calculation                      shall      be     used.
3. First,         the     firm's       net     open      currency         position      in   each
   currency            (Including          the    reporting            currency)      shall     be
   c a l c u l a t e d . T h i s p o s i t i o n shall         consist       of  the   addition
   of the f o l l o w i n g e l e m e n t s        ( p o s i t i v e or     negative):
   the     net       spot    position          (I.e.      all      asset      items    less   ail
    liability           items,        including          accrued          interest,      in    the
   currency           in q u e s t i o n ) ;
   the      net        forward        position          (i.e.         all    amounts      to    be
   received            less    all      amounts         to     be     paid     under    forward
   exchange           transactions,             Including          currency       futures     and
   the      principal          on    currency         swaps         not     Included     in   the
   spot      p o s 1 1 ion) ;
   guarantees            (and     similar        instruments)             that    are   certain
   to be caI led ;
   net     future         Income/expenses              (at      the     discretion       of   the
   reporting            institution;           when      this       discretion        has    been
   used,       It may      not     be c h a n g e d    without          the   prior    approval
   of the c o m p e t e n t        authorities);
   the net         delta     (or     delta-based) equivalent                    of  the     total
   book of f o r e i g n c u r r e n c y         options.
 ---pagebreak---                                       - 41 -
Second,      net      short    and      long    positions           in each     currency
other    than       the   reporting          currency,           shall    be   converted
at  spot      rates      Into    the      reporting          currency.       They     shall
then    be     summed       separately            to     form      respectively         the
total    of    the     net   short       positions           and   the   total      of  the
net  long p o s i t i o n s . The higher              of t h e s e    two t o t a l s  will
be the f i r m ' s o v e r a l l     net     foreign exchange              position.
Net p o s i t i o n s   In c o m p o s i t e  c u r r e n c i e s may be      decomposed
into   the     component         currencies           according         to   the     quotas
In f o r c e .
 ---pagebreak---                             - 42 -
                           ANNEX S
                         Other    risks
 Investment   firms, excluding       credit   institutions, shall
be required to hold own funds equivalent             to one quarter
of their previous year's fixed overheads. The competent
authorities may adjust this requirement             in the event of
a   material    change    to    a   firm's   business    since   the
previous    year.    When    the    firm   has   not   completed   a
year's business, Including on the day            it starts up, the
requirement    will   be   a quarter     of  the   fixed   overheads
figure    projected     in   its    business     plan,   unless   an
adjustment   to this plan      Is required by the authorities.
For   firms   that   are   starting     up,  own   funds   shall  be
greater    than   or   equal    to   this   amount,    and   initial
capital at    least equal    to the requirements       laid down in
Art icle 3.
 ---pagebreak---                                  - 43 -
                                ANNEX 6
Own funds
1.   The own    funds of    credit    Institutions       shall    be   defined
      In accordance with Council Directive 89/299/EEC.
2.   Notwithstanding     paragraph     1, the competent          authorities
     may permit    those credit      institutions which          are   obliged
     to meet    the capital    requirements on their           trading     book
     that   are   laid   down    in   Annexes    2    and   3,    to   use   an
     alternative    definition of own funds when meeting                  these
     requirements.      This      alternative         definition         shall
      include share capital      and reserves as defined            in Points
     (1) and (2) Article 2(1) of     Council   Directive    89/299/EEC,
     and subordinated      loan capital      subject     to the     following
     conditions.     First,    this     subordinated          loan     capital
     shall not exceed 250% of the share capital                and   reserves
     Included    in this definition.         Second,      the use     of   this
     alternative    definition     shall   not   result     in adding      more
     than  25% to the total        amount   of own     funds which       would
     result   from   applying     Council    Directive       89/299/EEC      to
     the    credit     Institution      as    a     whole.      Third,      the
     conditions    laid down     in 5(2) below must          apply    to   this
     subordinated    loan capital.
3.   The own funds of      investment     firms which are not           credit
     Institutions      shall    be    defined      in    accordance        with
     Council Directive 89/299/EEC.
4(1) Notwithstanding      the  requirements       of    paragraph      3,   the
     competent authorities may permit           investment firms which
     are  not   credit   institutions      an  alternative        definition
     of own funds. This shall         include:
 (2) share capital     and reserves as defined           in 1(1) and       1(2)
     of Article 2 of Council Directive 89/299/EEC-,
 ---pagebreak---                                                      44 -
  (3) m i n u s       intangible            assets     within        the    meaning       of    Article
         4 ( 9 ) ('assets') of Council                     Directive         86/635/EEC;
  (4) plus        net      profits          (or m i n u s   net      losses) after          allowance
         for all        anticipated            tax    liabilities;
  (5) plus           subordinated                 loan       capital          subject         to     the
        c o n d i t i o n s set out           In p a r a g r a p h 5 ( 2 ) ;
  (6) m i n u s     illiquid          assets.
5 ( 1 ) Firms       shall        be     required       to     satisfy       their      auditors      and
        competent            authorities            that     they     have      adequate       systems
        to     calculate           with      reasonable          accuracy        at   any    time    the
        financial           p o s i t i o n of the        firm.
  (2) The s u b o r d i n a t e d          loan capital          referred       to    in 4 ( 5 ) shall
        have       an     Initial          maturity        of     at   least       two    years.      It
        shall       be fully p a i d - u p and the                 loan a g r e e m e n t   shall    not
        Include            any       clause         providing           that,        in     specified
        circumstances,                   other       than        the     winding-up           of     the
        investment            firm,        the debt       will     become       repayable        before
        the       agreed          repayment          date,        unless        the      supervisory
        authorities              agree       to    it    having       been      given      two    days'
        notice.           Subordinated             debt     may      not    be    repaid      if    such
        repayment           would       mean     that     the own       funds of        the    firm   in
        question          would        then     stand     at     below     1 2 0 % of     the    firm's
        overall         requirement.
 (3) The        subordinated               loan    capital        referred        to    in 4 ( 5 )   may
        not     exceed        a maximum          of 2 5 0 % of       the sum       total     of    items
        4 ( 2 ) plus 4 ( 4 )           less 4 ( 3 ) and         should     only     approach        this
        maximum          in    particular           circumstances            acceptable         to   the
        relevant          competent          authorities.
 ---pagebreak---                                          - 45 -
(4) illiquid      assets         include:
        fixed        assets        (except        to    the      extent   that      land     and
        buildings              are   allowed           to     count    against         secured
         loans);
         Investment               in    connected               companies        if      these
        companies            are s u b s i d i a r i e s or      if the s h a r e s are     not
        readily          realisable         investments;
        deposits           made,     other        than      those    which     are     with     a
        credit           institution,            local        authority     or       regional
        government              and     available              for   repayment          within
        ninety         d a y s , and    also excluding              margin    payments        in
        connection               with       futures             or    written          options
        c o n t r a c t s -,
        guarantees             given;
        deficiencies              In s u b s i d i a r i e s ;
        all     other       assets     (including            physical    stocks)        unless
        they       are      subject      to     the      capital      requirements          set
        out     in t h i s D i r e c t i v e , or p u r s u a n t      to A r t i c l e 4 ( 5 ) .
 ---pagebreak---                                        - 46 -
            COMPETITIVENESS AND EMPLOYMENT IMPACT STATEMENT
         PROPOSAL FOR A COUNCIL DIRECTIVE ON CAPITAL ADEQUACY
              OF INVESTMENT FIRMS AND CREDIT INSTITUTIONS
I.               What Is the main reason for introducing the measure?
        The main reason for Introducing the measure is to ensure that
consumers of financial services are adequately protected by imposing
minimum capital requirements on investment firms.
I I.             Features of the businesses In question
        The scope of the proposal covers credit Institutions and non-
bank investment firms which are dealers or brokers in securities, as
well as portfolio managers and investment advisers.
        a)       There are many SMEs, mainly in the United Kingdom.
        b)       There is no particular regional concentration.
 ---pagebreak---                                                  - 47 -
 III.   What     direct      OPl IgatlQns    does   this    measure     impose   on
businesses?
        Businesses are required to comply with requirements relating
to minimum    start-up      capital   which   varies with      the  type   of  risk
resulting from the activities the firm is carrying out.
        For   low-risk activities, such as investment advice only or
"locals",   there     Is   no   initial   or   on-going    capital    requirement.
(Locals are members of financial futures or options exchanges whose
transactions are guaranteed by other member firms of the exchange.)
The general start-up capital          Is set at ECU 500 000.        Member   States
may reduce this requirement to ECU 50 000 for firms which do not hold
customers' money or securities, or to ECU 100 000 for brokerage firms
which hold customers' money or securities but who do not take trading
positions for their own account.           Firms already     In existence before
implementation     of    the    directive    may   be   granted     an   exemption
(grandfathering clause) from these initial capital requirements.
        Firms will also have to meet on-going capital                 requirements
based  on   an    expenditure      measure    and  on    their    position    risk,
counterparty    risk     and    foreign   exchange    risk.     These   risks   are
strictly proportional to the size of each business and to the size of
the risk taken.
IV.                What     indirect    obligations    are    local    authorities
                   likely to impose on businesses?
                   None
 ---pagebreak---                                               - 48 -
V.                 Are there anv special measures In respect of SMEs?
          Implicitly   SMEs  will    be  the   main   bénéficiaires    of   the
"grandfathering clause" concerning Initial capital, as well as of the
exception for "locals" and pure Investment advisers.
VI.               What Is the ilkeiv effect on:
                  a) the competitiveness of businesses?
          Investment  firms' own funds should reflect the risks taken
and   the   size  of  their   transactions.    This   should   improve    their
performance and reduce their failure rate.
                  b) employment?
          Because of the    "grandfathering clause" there should         be no
reduction In the number of already existing firms.           There Is likely
to be some     reduction   In the   number   of  new entrants    as not     all
candidates would be able to meet the initial capital requirement of
ECU 50 000    or  ECU 100 000.    This  effect   might,   however,   well    be
compensated for by the fact that all authorised firms could engage In
securities business throughout       the Community on the basis of home
country    authorisation  and   supervision.    In addition,    consumers    of
financial services should have more confidence in small and medium-
sized    Investment   firms,   knowing    that   they   are   likely    to   be
sufficiently capitalized in relation to the size of their business.
The survival rate of new entrants should increase because of a larger
capacity to absorb losses.
 ---pagebreak---                                                  49 -
VII.    Have both sides of Industry been consulted?
        There   have   been  no consultations with      representatives of
employees.
        As far as the business sector        is concerned, there have been
requests made to the Commission by representatives of the financial
futures and options exchanges       in France, the Netherlands and       the
United Kingdom in favour of "locals".       These demands have been met by
the  exclusion    of   "locals"   from    initial   and   on-going   capital
requirements.
         In addition,     there  have   been    requests   made  by   FIMBRA
concerning  the   level of   the  Initial   start-up   requirements.   These
demands have been met, as far as compatible with consumer protection,
by excluding pure investment advisers from any capital requiremnets,
by providing an Intermediate level of start-up capital of ECU 100 000
for brokers who do not take positions, and by the "grandfathering
clause" for existing firms.
 ---pagebreak---                                                                                  ISSN 0254-1475
                                                                  COM (90) 141 final
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