Shearman & Sterling LLP | FinReg | <span >Basel Committee Consults on Proposed Revisions to Minimum Capital Requirements for Market Risk</span >
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  • Basel Committee Consults on Proposed Revisions to Minimum Capital Requirements for Market Risk
    03/22/2018
    The Basel Committee on Banking Supervision has published a consultation on proposed revisions to the standard it published in January 2016 on the minimum capital requirements for market risk. The Basel Committee has been monitoring the implementation of the standard and its impact on banks’ market risk capital requirements since the standard was published and has identified several issues.

    The Basel Committee proposes changes to the measurement of the standardized approach, to enhance its risk sensitivity, including changes to the treatment of liquid FX pairs, revisions to correlation scenarios and revisions to the capital requirements for non-linear instruments (such as options). The Basel Committee also proposes to recalibrate the risk weights used in the standardized approach to reflect general interest rate risk, FX risk and equity risk. Following feedback that the treatment of multi-underlying options and index instruments in the revised standardized approach is unclear, the Basel Committee also proposes revisions that will clarify the treatment.

    For banks using the internal models approach, the Basel Committee proposes revisions to the P&L attribution test, which is the assessment process to determine whether a bank's internal risk management models appropriately measure all the material risks of each individual trading desk to which they are applied. The proposals also clarify the requirements of the “risk factor eligibility test” for identification of risk factors that are sufficiently liquid and observable to be eligible for inclusion in internal models.

    The Basel Committee proposes some clarifications on the scope of exposures that are subject to market risk capital requirements. The standard published in January 2016 included a new definition of the boundary between a bank’s trading book and banking book, specifying those financial instruments that must be in either book. The January 2016 standard also contained additional detail specifying those instruments that are expected to be in a particular book but that, with supervisory approval, could be designated to the other book. The Basel Committee has identified some circumstances in which a financial instrument may appear simultaneously in both the list of instruments that must be in a particular book as well as the list of instruments that are expected to be in the other book. The Basel Committee proposes clarifications to address this and also proposes revisions to clarify the conditions under which equity investments in funds can be included in the trading book.

    The January 2016 standard further contained revisions to the standards for structural FX positions (that is, positions that hedge a bank’s capital ratio and may therefore be exempt from FX capital requirements). The Committee now proposes revisions to base the amount of structural FX positions that can be exempted on the FX risk stemming from the investment, rather than on the amount of the investment. The proposals will also clarify that a structural FX position in a foreign branch of a bank can be included in the scope of the structural FX position.

    Finally, the proposals outline a new simplified alternative to the standardized approach. The Committee consulted on a simplified alternative in June 2017, with the aim of facilitating adoption of the market risk standard for banks other than those that are internationally active. The viable alternatives mooted by the Committee in that consultation were either a reduced form of the January 2016 standard or a recalibrated version of the Basel II standardized approach. Following consultation feedback, the Committee will pursue the second option and sets out proposals for this.

    Comments on the proposals are invited by June 20, 2018. The Group of Governors and Heads of Supervision, which oversees the Basel Committee, has endorsed a deferral of the implementation date for the standard to January 1, 2022. This time extension will allow banks further time to develop the necessary systems infrastructure.

    View the consultation paper