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CH&Cie - Regulatory Offer

This document discusses regulations and standards that govern the banking system. It provides context on factors that drive regulations, including the 2007-2008 financial crisis which revealed shortcomings in risk management. Major standards discussed include Basel II, Basel 2.5, Basel III, IFRS 9, and IFRS 13. Each standard addresses specific objectives like strengthening capital requirements, managing liquidity risk, and increasing transparency. The document also outlines the principles and objectives of the various standards, with a focus on Basel II, Basel 2.5, and how they aim to improve risk measurement and management.

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How to turn Standards’ constraints into a business generator ? “Anyone who has never made a mistake has never tried anything new” –Albert Einstein Benoit Genest bgenest@chappuishalder.com Stephane Eyraud seyraud@chappuishalder.com Ziad Fares zfares@chappuishalder.com
Context Principles & objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 2
3 Regulations and standards evolutions are driven by many factors From a difficult economic context to political and social pressures 1 Context Context Financial institutions faced massive losses during the last crisis with dramatic impacts on the overall economy … •Thesubprimecrisisthattookplacein2007,unleashedaseriesofproblemsthatthreatenedthefinancialbankingsystemandthewholeeconomyaswell •Fromarealestatecrisis,toafinancialcrisis,toanoveralleconomycrisis,thisdifficultperiodrevealedshortcomingsinidentifying,hedgingandmanagingrisksinthebankingsystem •Thecausesofthisturbulencewereofdifferentnatures Aconfidencecrisis Liquidityandfundingissues Volatilityandunpredictabilityofmarketparameters Highlevelofcorrelationbetweenfinancialinstitutionsandsystemicrisks SignificantincreaseinOTCderivativetransactionvolumes Raison d’être of Standards A reaction to shortcomings revealed during the crisis •Someregulationsevolved,otherswerecreatedinordertocovertheshortcomingsinriskmanagementrevealedduringthecrisis •Forexample,BaselIIIcameasareactiontoabadcoverageandunderstandingofCounterpartyCreditRiskandliquiditymanagement A Changing environment •Today’seconomicenvironmentisonperpetualmotionfromalegislativeframeworkpointofview(geographically, betweentheEUandtheUS)andfromaconvergenceandhomogenizationbetweenregulationandstandards(regulatoryandaccountingstandards) Political & Social pressure •Oneoftheobviousraisond’êtreofregulationsisthepoliticalandsocialpressure,inordertoregulateaccuratelythebankingsystemandtoavoidabusesandexcesses
Since the last decade, the regulation and the monitoring of the banking system have been subject to sharper focus •Publication: 2004 •Application date – standardized approach & IRB foundation:2007 •Application date –IRB advanced : 2008 •Objective : Capture and measure CreditRisk, MarketRisk & OperationalRisk 2008 Basel 2 2012 •Publication: 2009 •Amendments:2010 •Application date :2012 •Objective : Strengthen capital requirements for market risk and re-securitization, amend theCompensation Policy towards market participants etc.. Basel 2.5 2013 •Publication: 2010 •Final text:not issued yet •Application date :2013 •Objective : Enhance Capital Quality, deal with Systemic Risk, increase capital requirements for Counterparty Credit Risk, manage and cover Liquidity Risk Basel 3 •Publication: 2011 •Application date :2013 •Objective : Give a precise definition of the fair value, define levels in the fair value hierarchy, consider CVA / DVA in the fair value measurement IFRS 13 •Publication: phase 1 –2009, phase 2 -2011, phase 3 -2012 •Application date :2015 •Objective : Define asset classes (amortized cost vsfair value), introduce a new impairment model (Expected Loss) ensure convergencewith prudential standards IFRS 9 2015 Prudential standards Accounting standards 4 1 Context
Latest updates and evolutions of Basel III –liquidity ratios Latestupdates •Onthe7thofJanuary2013,theBaselcommitteepublishedthelatestevolutionsanddecisionstakentowardsthedefinitionoftheLiquidityCoverageRatio •Whatchangesinthisnewversion? Thetimetableandcalendarofapplication Theperimeterofinstrumentstakenintoaccountwithintheliquiditybuffer Revisionofoutflowrates Drawdownratesonoff-balancesheetexposure Revisionofinflowrates LCR= Liquidity buffer Outflows –min( Inflows ; 75%) •Thefollowinginstrumentscannowbetakenintoaccountwithintheliquiditybuffer, cappedat15%fromthetotalbuffer Corporateinvestmentgradebondswitha50%haircut Someequitiesinmajorstockindices RMBSwithaminimumgradeofAAwitha25% haircut •LiquiditylineswithCentralBanksareunderdiscussion, whethertotakethemintoaccountornot Liquidity buffer •Outflowrateonnon- operationaldepositsisreducedto40%from75%initially •Drawdownratesonliquiditylinesisreducedto30%from100%initially •DrawdownrateonliquidityandcreditlineswithentitiessubmittedtotheLCRisreducedto40%from100% initially •Thedefinitionofoperationaldepositsbecomesmorestringent Outflows •Inflowsarestillcappedat75% oftotaloutflows •Inflowrateonrevolvinginstrumentsisfixedat0%(noinflowsonrevolvinginstruments)from50%initially Inflows Dec2010 1strelease Jan2013 2ndrelease Jan2015 LCR>=60% (initially100%) Jan2016 LCR>=70% Jan2017 LCR>=80% Jan2018 LCR>=90% Jan2019 LCR>=100% 5 1 Context
Regulations and standards are more and more a worldwide concernGlobal benchmark Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 NorthAmerica Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 South America Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 Europe Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 Asia Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 Africa In progress On hold Completed 6 1 Context
Context Principles & objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 7
Prudential standards cover an extensive scope… … encompassing new solutions to cover shortcomings revealed during the 2007 crisis 2 Principles & objectives of the Standards Pillar I –Solvency Ratios Capital RWA Core Tier 1 Tier 1 Tier 2 Tier 3 Systemic Risk Leverage ratio Pillar II –Supervisory Process Credit Pillar III –Market Discipline Standard IRB -Foundation IRB -Advanced Counterparty Exposure calculation Default risk CVA, WWR Margin period of risk Market Standard Advanced : Stress Var, IRC Operational Standard, BIA, AMA FI correlation Buffer countercyclical conservation CCP Capital requirements Economic capital ICAAP Testing Stress testing Back testing Risk Concentration / liquidity Reputational / strategic Liquidity ratios LCR NSFR Compensation policy for maketparticipants Financial communication Credit risk Market risk Operational risk Complex instruments Off-balance sheet expos. Breakdown by industry Geographic area Approach (IRBA, STD) Basel 2 Update Basel 2.5 Update Basel 3 Removed in BIII New in Basel 2.5 New in Basel 3 8
Each prudential standard meets a specific objectiveFocus on Basel 2 … 2 Principles & objectives of the Standards Basel 2 Basel 2.5 Basel 3 1 2 3 Objective Description LimitsofBaselI •ThemaininputforCookesolvencyratioistotalamountofgrantedloans •Assetweightings-enablingtoconsidertheweightedrisk-didnotreflecttheborrower'srealcreditworthiness •Inaddition,thematuritiesofcontractswerenotconsideredeither •Finallyriskmitigation/hedgingtechniques(CDS, securitizations,collateral&nettingagreements)andoperationalriskwerealsonottreatedwithinBaselI ObjectivesofBaselII •BaselIIstandardsproposeanapproachallowingtoconsiderthecreditworthinessoftheborrowerviaaninternalratingsystem •Inaddition,theyenhancemarketriskmeasurement(e.g.throughtheVaR)anddefinetermsfortreatingoperationalrisk •WithinBaselII,McDonoughratio–replacingCookeratio-considerscredit,market&operationalrisksandaimstostrengthencapitalrequirements •Moreover,withinPillarII,financialinstitutionsshallalsoassessandensuretheadequacyofregulatorycapitalwitheconomiccapital-whichreflectstherealactivityofaspecificfinancialinstitution •Finally,financialreporting&communicationaremandatorywithinPillarIII,inordertoenhancetransparencyamongthebankingsystem CreditRisk •BaselIIproposesanAdvancedApproachtocapturedefaultriskbasedonaninternalratingsystem •Aprobabilityofdefault(PD)iscalculatedforeachcounterpartythroughvarioustechniques(statisticalapproach,expertjudgmentetc...)overaone-year- horizon •ExposureAtDefault(EAD)iscalculatedanddefinedastheasset'sbookvalue •Finally,DefaultRecoveryRates(RR)aredeterminedviadifferenttechniques(statisticalapproach, historicalapproach…) •Foreachasset,ariskweightisdeterminedfromthecombinationofPD,LGDandEAD •Maturitiesimpactandratingmigrationriskistakenintoaccountviaanadjustmentcoefficient CounterpartyCreditRisk •BaselIIdefinestechniquesfordeterminingexposuresonderivativesandsecuritiesfinancingtransactions(repo,securitieslending/borrowing) •Italsodefinestermsfortakingintoaccountriskmitigationtechniques(collateral,nettingagreements,etc…) Operationalrisk •Operationalriskisalsoconsideredandevaluationtechniquesarepresented(AMA,BIA,STD..) MarketRisk •Itisaboutcapturingriskscomingfrommarketfactorsvolatility(FXrates,interestrates,creditspreads) 9
Each prudential standard meets a specific objectiveFocus on Basel 2.5 (CRD II / CRD III) … 2 Principles & objectives of the Standards Basel Basel 2.5 Basel 3 1 2 3 Objective Description MotivesofBasel2.5 •ThisreformisconsideredasanenhancementofBasel2andbeganin2005 •Followingthe2007-08financialcrisis,itsscopehasbeenwidened •Infact,duringthe2007crisis,inacontextofextremevolatilityofmarketvariables,VaRmodelsintroducedinBaselIIfailedtocapturesuchextremesituations •Asareminderthesemodelsestimatepotentiallossesofaportfolioviahistoricalscenariosformarketvariables ObjectivesofBasel2.5 •Followingthefinancialcrisis,wheresituationsofextremestressandvolatilitywereobserved,Basel2.5hasbeenissuedtocaptureaccuratelysuchextremeevents(whichwerenottakenintoaccountwithinhistoricalscenarios) •ThescopeofBasel2.5encompassesexclusivelycredit,marketandconcentrationrisks •Itspurposeistomeetthefollowingobjectives >CaptureLossesrelatedtoextremeevents >CaptureLossesduetodefaultandratingmigration >Treatsecuritizations&re-securitizations >Takeintoaccountcorrelationsbetweenassetsofthetradingbook CreditRisk(StandardizedApproach) •Securitizations&Re-securitizationsaretreatedasheldintothebankingbook.Theyarethereforeprocessedintheframeworkofcreditriskpolicy. Thisaimstoavoidthearbitragebetweenthetradingandthebankingbook •Whiledeterminingtheexposureonsecuritization, bothbalancesheetandoff-balancesheetcommitmentsareconsidered •Newweightingfactorsmustapplyonsecuritizationinstruments MarketRisk(Internalmodelapproach) •StressedVaR-ItisanewVaRmodelbasedonstressedscenariosformarketvariablesintheintenttocapturesituationsofextremevolatility.ThisVaRisadditionaltotheclassicalVaR •IncrementalRiskCharge(IRC)-allowstocapturedefaultandratingmigrationrisksviaaVaR(99%;1year)model.ItisadditionaltothemarketriskcapitalchargeintroducedinBasel2.Itisaboutintroducinga“creditrisk”basedapproachforinstrumentsheldinthetradingbook •ComprehensiveRiskMeasure(CRM)-allowstomeasureboththecorrelationbetweeninstrumentsofaportfolioandthevolatilityaswell Pillar2/Pillar3 •Basel2.5definesaCompensationPolicyformarketparticipants(deferredbonusdistribution,…) •Italsohandlesthemanagementofconcentrationriskandenhancesfinancialcommunication 10
Each prudential standard meets a specific objectiveFocus on Basel 3(CRD IV) … 2 Principles & objectives of the Standards Basel 2 Basel 2.5 Basel 3 1 2 3 Objective Description MotivesofBasel3 •Thisreformisbasicallyaresponsetowhathasbeenobservedduringthe2007crisiswherecapitalreservesfailedtoabsorbrecordedlosses •Furthermorethe2007crisisuncoveredmanyloopholes.Forinstance,itwasnoticedthatcertainriskswerenotcoveredorconsideredinthepreviousstandardsorbyinternalriskmanagementmodels ObjectivesofBasel3 •Basel3mainpurposeistocovershortcomingsidentifiedduringthe2007crisisintermsofriskmanagement •Basel3proposesamendmentsforexistingstandardsbutalsodefinesasetofnewrulesandconsequentlywidensthescopeofissuescoveredbyprudentialstandards •Moreprecisely,itenablestomeetthefollowingobjectives >Enhancethequalityandthequantityofcapitalreserves >Regulatetheleverageeffectbyintroducingaleverageratiowhosepurposeistoincreasecapitalreservesorreduceassetsvolumes >Capturesystemicriskandtheriskofcontagionfromafinancialcrisistoanoveralleconomycrisis >EnhanceCounterpartyCreditRiskmanagementandframeapolicyforliquidityrisk Enhancethecapitalstructure •Tier3isremovedandTier1issplitintoTier1andCoreTier1.CET1increasesto4,5%from2% previously •SomesecuritiespreviouslyeligibleforTier1,willbedowngradedtoTier2 •TheSolvencyRatiomustbegreaterthan10,5%(vs. 8%previously LeverageRatio •ItisdefinedastheratiobetweenTier1Capitalandnon-weightedexposures(on-&off-balancesheet) •Thisratiomustbegreaterorequalto3%.ItwhetherincreasesTier1capitalreservesorreducesthesizeofthebalancesheet SystemicRisk •Correlationcoefficientisincreasedby25%forfinancialinstitutionstoreflecttheirinterdependencyandtheriskofcontagion •ConstitutionofaConservationBufferthatrepresents2,5%oftheSolvencyratio.ItisaCET1extracushion •ConstitutionofaCountercyclicalbufferduringperiodofgrowth,usedtoabsorblossesduringadownturncycle.ItisaCET1extracushion •CalculationofexposureswithCCP CounterpartyCreditRisk/liquidityRisk •CVAcalculationtocaptureMtMLossesduetocreditspreadsvolatilityandtoconsiderWWRthroughthecalculationofstressedEPE •Implementationof2LiquidityRatios(ST&LT) 11
Accounting rules also evolved … … in order to converge and be consistent with regulatory rules 2 Principles & objectives of the Standards IFRS 9 IFRS 13 Phase 1 – Classification & Measurement Phase 2 –Impairment rules Phase 3 –Hedging account Evaluation method Amortized Cost Incurred Loss model Expected Loss model Risk exposure Bad Book / good Book EL calculation methodology Maturity / Horizon Counter Cyclical effects Accounting Specific / Collective 1–Fair Value Instruments Classification 2–CVA / DVA impairment Fair value hierarchy Level 1 –Quoted Prices Level 2 –Prices computed with observable parameters Level 3 –Prices computed with non observable parameters Fair value Definition Calculation methodology Expected Loss –standard / advanced approach Shifting curve CDS Spreads Risk exposure / perimeter Valuation techniques Methodology Reporting Suppresion No regulatory guidelines Regulatory guidelines 12 Fair Value through P&L Historical cost Other methods Classification Held to maturity Intent to be sold
IFRS 9 changes the way of measuring impairments…as a consequence of the last financial crises 2 Principles & objectives of the Standards IFRS 9 IFRS 13 1 2 Regulation summary Description Classification&Measurement •IFRS9paragraph3:5-TheEDproposestwoprimarymeasurementcategoriesforfinancialinstruments. Afinancialassetorfinancialliabilitywouldbemeasuredatamortisedcostiftwoconditionsaremet:theinstrumenthasbasicloanfeaturesandtheinstrumentismanagedonacontractualyieldbasis •Afinancialassetorfinancialliabilitythatdoesnotmeetbothconditionswouldbemeasuredatfairvalue Impairmentrules •IFRS9IN5(b)-theproposedimpairmentapproachgenerallywouldresultinearlierrecognitionofcreditlossesthantheincurredlossimpairmentmodelinIAS39(ieavoidthesystematicbiastowardslaterecognitionofcreditlosses).Inotherwords,therequirementforanobservablelosseventtohaveoccurredbeforeconsideringtheeffectofcreditlosseswouldberemoved •IFRS9IN10-TheIASBhascontinuedtostresstheimportanceofreflectingtherelationshipbetweenthepricingoffinancialassetsandexpectedcreditlosses •IFRS9IN11-TheFASBconcluded,jointlywiththeIASB,thatanentityshould,alongwithconsideringhistoricaldataandcurrenteconomicconditions, considerreasonableandsupportableforecastsoffutureeventsandeconomicconditionsfordevelopingtheentity’sestimateofexpectedcreditlosses Motivations •Beforethelastfinancialcrisis,impairmentsonassetsvaluedusingtheamortizedcostmethod, werecalculatedusingthe“incurredloss”method •Thismeansthatimpairmentsexistonlyifalosseventoccurs •Duringthefinancialcrisis,ahugenumberoflosseventsoccurred,andtheimpairmentstockincreaseddrastically,whichmeantthatreservesalreadyinplacefailedtoabsorbcurrentlosses Objectives •Theincurredlossmodelsufferedfromshortcomingswhichledtoproposeanothermodel •Infact,itrecognizesexpectedlosseslatelywaitingforacrediteventtooccur.Italsooverestimatedinterestincomebecauseinterestratesdidn’tincludeariskpremiumrelatedtothecreditworthinessofcounterparties •Consequently,impairmentunderIFRS9aretobecomputedusinganExpectedLossmodel,whichmeansthatreservesaretobebuiltupbeforeacrediteventoccurs •Themainobjectivesofthismodelare Buildingupreservestoabsorblossesifadownturnintheeconomyoccurs(countercyclicaleffect) ConvergewithBaselIIdefinitionofexpectedloss 13
IFRS 13 provides more precision on fair value definition…but banks concerns are more focused on CVA / DVA computation 2 Principles & objectives of the Standards IFRS 9 IFRS 13 1 2 Regulation summary Description Fairvaluehierarchy •IFRS13:72-Thehierarchygivesthehighestprioritytoquotedpricesinactivemarketsandthelowestprioritytounobservableinputs Fairvaluedefinition •IFRS13:AppendixA-Thepricethatwouldbereceivedtosellanassetorpaidtotransferaliabilityinanorderlytransactionbetweenmarketparticipantsatthemeasurementdate(i.eexitprice) Valuationtechniques •IFRS13:62 marketapproach–usespricesandinformationgeneratedbymarkettransactions costapproach–currentreplacementcost incomeapproach–discountedcashflows CVA/DVAimpairment •IAS39.AG67-Fairvaluereflectsthecreditqualityoftheinstrument •IAS39.AG28(b)-Anappropriatetechniqueforestimatingthefairvalueofaparticularfinancialinstrumentwouldincorporatecreditrisk •IFRS13.42-Thefairvalueofaliabilityreflectsnon- performancerisk.Non-performanceriskincludes, butmaynotbelimitedtonanentity’sowncreditrisk Motivations •OneofthemajormotivationsofIFRS13istheconvergenceofaccountingstandards,byestablishingasetofaccountingrulesthatwillbeusedgenerallyandbyreducingthegapbetweenUSGAAPandIFRS •IFRS13wasdesignedinordertogiveonecleardefinitionoffairvaluemeasurementaswellasenhancingclaritybystandardizingelementsofreportingandvaluationtechniques •Moreover,duringthecrisisof2007,MtMlosseswereofphenomenalamountswhichledtodefineclearlyfairvalueandhowitmustbemeasured Objectives •IFRS13establishesasingleframeworkforallfairvaluemeasurementbutdoesnotchangewhenfairvaluemustapply •Butratherdescribeshowtomeasurefairvalue •Moreover,IFRS13clearlystipulatesthatfairvaluemustreflectlossesduetocounterpartycreditrisk(CVA)aswellasgainsduetoanentity’sowncreditrisk(DVA) •Nonetheless,IFRS13doesn’tdefinehowCVAandDVAaretobecomputingwhichmeansthatcalculationmethodologyareoneofthemajorissuesforbanksunderIFRS13 14
Context Principles & objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 15
Regulatory requirements and constraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (1/3) 3 Impacts & issues Bâle 2 Subjects Financial Orga Methodology Business Hot Topic? Credit Risk -RWA computation •Standardapproach •IRBFoundation •Advanced(PD,LGD, EAD,CCFmodeling) CCR –exposure computation •CurrentExposureMethod(add-on) •Internal-basedmodelapproach(EPE) Market Risk –RWA computation •Standardapproach •Internalapproach(VaRmodels,MonteCarlosimulation…) Pillar II & Pillar III •ICAAP •Backtesting/stress     16
Regulatory requirements and constraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (2/3) 3 Impacts & issues Bâle 2.5 Subjects Hot Topic? Market Risk –RWA computation •StressVaR •IRC/CRM     Basel 3 Capital structure •Tier1/Tier2 CCR -CVA •Standardapproach •Advancedapproach Systematic risk •CorrelationcoefficientforFI •Capitalbuffers •CCP LeverageRatio Liquidity ratios •LCR •NSFR    17 Financial Orga Methodology Business
Regulatory requirements and constraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (3/3) 3 Impacts & issues IFRS 9 Subjects Hot Topic? Phase 1 -Classification & Measurement •Classification •Measurement Phase 2 –Impairment rules •ExpectedLossimpairment IFRS 13  Fair Value Instruments Classification •Hierarchy •Valuationtechniques CVA / DVA impairment •Methodologyandcalculation  18 Financial Orga Methodology Business
Banks will face great challenges in putting in place regulations… with an impact on balance sheet’s structure and P&L Direct impact on capital structure 2% 4.50% 2% 1.50% 3% 2% 1% 2.50% 2.50% Basel 2/2.5 Basel 3 Countercyclical buffer Conservation buffer Tier 3 Tier 2 Additional Tier 1(hybrid) CET 1 + 63% Impact on balance sheet -Assets Impact on balance sheet -liabilities Other Other Fees Fees Loans Loans Rever. Repos Rever. Repos Securitization Sovereignsec. Securities Securities Cash Cash Derivatives Derivatives Today With Basel III Unsec. funding Unsec.funding Deposit Deposit Secu. Funding short term Secu. Funding short term Interbank borrowing Interbank bor. Derivatives Derivatives. Capital Capital Today With Basel III NSFR & leverage ratio LCR buffer CVA impact LCR buffer NSFR & LCR Trust crisis, collat. Correlation coeffic. Capital struct. & buffers Trust crisis, collat. Impact on P&L –Cost of risk CVA / DVA (IFRS 13) No CCR impairment Expected Loss (IFRS 9) Incurred Loss •CCRimpairment–SubstantialimpactontheP&Lbecauseofderivativesandrepotransactionvolumes •ExpectedLossimpairment–Comparedtotheincurredlossmodel,theimpactontheP&Lisgreaterbecauseimpairmentarebuiltupbeforeacrediteventoccurs 19 3 Financial impacts
Banks will face great challenges in putting in place regulations… with an impact on processes and organization Regulatory CVA –Basel III Leverage Ratio –Basel III Liquidity Ratios –Basel III Central Counterparty Clearing House –Basel III •EPE/StressedEPE–OneofthemainchallengesforCVAcomputationunderBaselIII(Advancedapproach)istobuiltuppricingmodelsandscenariogenerators •HedgingCVA&interactionswithCVAdesks–ItisimportantthatprocessesforcomputingCVAcapitalrequirements,CVAimpairmentandCVAdesksmustbeoptimized •RequiresahighcomputingcapacitywithoptimizedmodelsforMTsimulations •RequiresagoodunderstandingofprocessesaswellasallCVAcomponents •IdentificationoftransactionswithCCP–WithinBaselII,transactionswithCCPhadanEAD=0,whichmeantthatthesetransactionswerenotidentifiedseparately •Margincallsandcollateralmanagement–WithEMIRregulation, thevolumeoftransactionwithCCPwillincreasessignificantly •DefaultFund–BaselIIIdefinescapitalrequirementsforbalanceandoff- balancesheetdefaultfunds •RequireshighgranularitywithinITsystems&anewmethodologyforEADcalculus •RequiresoptimizedprocesseswithBOcollateralmanag. unit •RequiresoptimizedprocesseswithRisk&Financialfunctions •Reposandderivativestreatment– Oneoftheinputstotheratioisrepotransactionswithanettingbetweencashlegandsecuritiesleg •Reconciliationbetweenriskandfinancefunction–Theinputstotheleverageratioareof2natures:Risk& finance.Riskinputsarereposandderivativestreatment.Financeinputsarecapitalinformation •Requiresthecapacityofidentifyingtoeachbalancesheetexposure,itsoff- balancesheetleg •RequiresoptimizedprocesseswithRisk&Financialfunctions •Liquiditybuffer–isconstitutedofcash, centralbankreserves,liquidsecuritiesetc… •Identificationofencumberedassets– Assetsusedascollateral(forsecuritizationforinstance)mustbeidentifiedandtreateddifferentlyintermsofliquiditywithintheNSFR •RequireshighgranularitywithinALMcalculator& optimizedprocesseswiththetreasurer •RequiresoptimizedprocesseswithBOcollateralmanag. Unit 20 3 Organizational impacts
Banks will face great challenges in putting in place regulations… with an impact on models and methods CVA Impairment –IFRS 13 Expected Loss model -IFRS 9 •CVA/DVAmethodology–OneofthemainchallengesforCVAimpairmentisputtinginplaceamethodology(knowingthatitisnotspecifiedinIFRSrules) •Benchmarkofmethodologiesthatcanbeused •ExpectedLossmethodology–TheExpectedLosswithinIFRS9hasthesamedefinitionastheexpectedlosswithinBaselII.ThechallengeforbanksistocalibratetheELcorrectlytoavoidoverlapwiththeULwithinBaselII.Thispointwillbedetailedinpartn°5 ExpectedLossmodel 1 ShiftingCurves 2 CDS spreads 3 •CVA=PDxLDGxEAD •PD-Inpriority,considerobservablecreditspreads.Ifnotavailable,useregulatory1-yearPD,anddeterminePDtillmaturityusingincrementalPDformula •EAD Inastandardizedmethod,usetheCurrentExposureMethod(MtM+Add-on)usingregulatoryadd-onfactors Inanadvancedapproach,useEPEmodels •LGD-Inpriority,considerobservableLGD(ratingagencies, etc…).Ifnotavailable,useregulatoryLGD •CVA=PresentValue1(RiskFree)–PresentValue2(+riskpremium) •Cashflowsarediscountedusingzero-couponcurves,thenzero-coupon+creditspreads •CVA=EADx(creditspreadxduration)xLGD •CVAiscomputedasafunctionofcreditspread 21 3 Methodology impacts
Understanding the dynamic of interactions between regulations… is about identifying the synergies and optimizing potential overlap (1/2) Synergies Basel II – IFRS 9 What is the issue ? How to optimize? Basel II 99,9% EL (Basel II) UL (Basel II) Loss Probability Bad EL 1y (IFRS) calibration •ELwithinBaselIIisdefinedasPDxLGDxEADona1yearhorizon •ELwithinIFRS9isalsodefinedasPDxLGDxEAD.Though,iftheparametersusedaresignificantlydifferentfromthoseusedinbasel2,thiscanleadto: Abadcoverageofexpectedlosses(case1) Overlapbetweenimpairmentandcapital(case2) 1 2 •ThebestwaytocalibratecorrectlyandefficientlytheELwithinIFRSistouseBaselIIparametersandcapitalizeonwhatisprovidedforregulatoryintent Basel II -EL Basel II –PD (TTC) Basel II -LGD Basel II -EAD IFRS –PD (PIT) IFRS -LGD IFRS -EAD 1y maturity Economic LGD Regulatory EAD Basel II -EL 1y for bucket 1 Until maturity for bucket 2,3 PIT Not economic,PIT Regulatory EAD Same risk bases Synergies Basel II – Basel III LossesduetoratingmigrationsarealreadycapturedwithinBaselII Maturity adjustment coefficient, function of PD •ThematurityadjustmentcoefficientintroducedwithinBaselIIhasadualpurpose Thelongerthematurityis,thehighertheriskis ItisafunctionofPD,andcapturesratingmigrations •ThepurposeofCVAunderBaselIIIistocapturelossesduetoratingvolatilityandmigration Analysisoftheb(PD)term Itisanadditionalcapitalrequirementforratingmigrations.RatingMigrationsaremorelikelytohappenforlowerPDandhighermaturities •ForBaselIII-CVAundertheIRBapproach,thematurityadjustmentcoefficientmaybesetto1(whichmeanscapturingdefault-onlyrisk)ifthebankcandemonstratethatratingmigrationandrisksarecorrectlyandefficientlycapturedinthespecificVaRmodel PD 22 3 Methodology impacts
MtM EL (Basel III) Understanding the dynamic of interactions between regulations… is about identifying the synergies and optimizing potential overlap (2/2) Synergies Basel III – IFRS 13 What is the issue ? How to optimize? EL (IFRS 13) UL (Basel II) Loss due to counterparty default Probability CVAunderBaselIIIvsCVAunderIFRS13:2differentdefinitionsfordifferentpurposes •CVAunderBaselIIIcoversMtMlossesduetoratingmigrationandvolatility,withoutcounterparty’sdefault.Itisaone-yearhorizonVaRwith99%confidencelevel.ItincorporatesULandELaswell •CVAunderIFRS13coversexpectedlossesonderivativesandreposstyletransactionsduetocounterpartydefault Yet,thereismuchincommonbetweenthem •Eventhoughtheyareusedfordifferentpurposes,itisimportanttocalibratethemcorrectlytoavoidoverlapsknowingthattheysharethesameinputsandperimeter UL (Basel III) MtMLoss due to rating volatility Therearetwomainaxesforoptimization:Methodologyandperimeterofapplication •Methodology&inputs–MeasuringCVAunderIFRSasanExpectedLossmodelwillallowtocapitalizeonBaselIIparameters(PD,LGD,EAD)andusethemasinputstothemodel.TheseinputsarealsousedforCVAcomputationunderBaselIII •Perimeterofapplication–CVAunderBaselIIIandIFRS13arecomputedonallnon-defaultedderivativesandrepostyletransactions.Onetheperimeterisidentified,regulatoryEADcanbeusedforIFRS13purposes,afterreconciliatingMtMusedforregulatorypurposesandMtMusedforaccountingpurposes Methodology& inputs 1 MethodologyunderBasel3 •PD–PriorizingexternalPD,theninternalPD,thenbydefaultvalue •LGD-PriorizingexternalLGD,theninternalLGD,thenbydefaultvalue •EAD–Determinedusingadd-onmethod(MtM+add-on) orusingEPEmodels Same methodology, rules and inputs can be used for IFRS 13 Perimeter 2 Riskbases Non defaultedderivatives Basel III EAD Add- on Reconciliation IFRS 13 EAD AccountingMtM 23 3 Methodology impacts
Context Principles & objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 24
CH&Cie Regulatory offer and scope of interventionDelivering solutions at all levels 4 CH&Cie Offer Interpretation of Standards •CH&Ciehasbuiltupanexpertisecenterconstitutedofexpertsinregulatoryandaccountingstandards •Wehelpourcustomersininterpretingcorrectlythenormsaswebeneficiatefromalargebenchmarkaswellasexperienceandexpertise •Ourinterpretationisconductedinatwo-wayapproach Interpretationandimpactsfromourclient’senvironmentandbusinessperspective Amoremacro-levelanalysis Advice at an expertise-level Implementation 1 2 3 •MorethanjustinterpretingtheStandards,wedeliverandprovideexpertise-leveladviceby Identifyinghowandwherethestandardswillhaveasignificantimpactforourclients Stayingup-to-datewiththebestpracticesonaworld-widelevel Capitalizingonourknow-howandknowledgeatbothRegulationsandriskmanagementlevel •Wealsodeliversolutionsintermsofimplementingthestandardsby Managingandsteeringprojectsinordertoputinplacethestandardswithhotdeadlines Providingassistanceonamoretechnicalpointofview(simulation, testing,…) Offeringsimpleguidanceandorientationonadailybasis Follow-up on evolving standards •Inacomplexandchangingenvironment, wherestandardsandregulationsaredrivenbypoliticalandsocialpressure,standardsareevolvingcontinuously •Ourexpertisecenterisup-to-datetothelatestandupcomingstandards’evolutions Optimization Assistance and help for third parties 4 5 6 •Weprovidesolutionstohelpourcustomersoptimizetheimpactsofthestandardsby Helpingtobettercalibratemodelsandoptimizetheirefficiency(example–optimizingratingscales) Identifyingsynergiesbetweenthestandardswhichallowtocapitalizeandenhancewhatisalreadyinuse Simulatingimpacts&realizingsensitivitiestests.Forexample, StandardizedCVAformulaunderBIIIishighlysensitivetomaturities •Wealsoprovideassistanceandhelponhottopicsfor Centralbanksandlocalregulators Auditors Internalcontrolfunctions 25
MONTREAL 12F –1819 BdRene Levesque O. Montreal, Quebec, H3H2P5 PARIS 20 Rue de la Michaudière 75002, Paris, France NIORT 19 avenue Bujault 79000 Niort, France NEW YORK 1441, BroadwaySuite 3015, New YorkNY 10018, USA SINGAPORE Level 25, North Tower, One Raffles Quay, Singapore 048583 HONG KONG 9/F, KinwickCentre 32 Hollywood Road, Central, Hong Kong LONDON 50, Great Portland Street London EC3V 9EA, UK GENEVA Rue de Lausanne 80CH 1202 Genève, Suisse 26

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CH&Cie - Regulatory Offer

  • 1.
    How to turnStandards’ constraints into a business generator ? “Anyone who has never made a mistake has never tried anything new” –Albert Einstein Benoit Genest bgenest@chappuishalder.com Stephane Eyraud seyraud@chappuishalder.com Ziad Fares zfares@chappuishalder.com
  • 2.
    Context Principles &objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 2
  • 3.
    3 Regulations andstandards evolutions are driven by many factors From a difficult economic context to political and social pressures 1 Context Context Financial institutions faced massive losses during the last crisis with dramatic impacts on the overall economy … •Thesubprimecrisisthattookplacein2007,unleashedaseriesofproblemsthatthreatenedthefinancialbankingsystemandthewholeeconomyaswell •Fromarealestatecrisis,toafinancialcrisis,toanoveralleconomycrisis,thisdifficultperiodrevealedshortcomingsinidentifying,hedgingandmanagingrisksinthebankingsystem •Thecausesofthisturbulencewereofdifferentnatures Aconfidencecrisis Liquidityandfundingissues Volatilityandunpredictabilityofmarketparameters Highlevelofcorrelationbetweenfinancialinstitutionsandsystemicrisks SignificantincreaseinOTCderivativetransactionvolumes Raison d’être of Standards A reaction to shortcomings revealed during the crisis •Someregulationsevolved,otherswerecreatedinordertocovertheshortcomingsinriskmanagementrevealedduringthecrisis •Forexample,BaselIIIcameasareactiontoabadcoverageandunderstandingofCounterpartyCreditRiskandliquiditymanagement A Changing environment •Today’seconomicenvironmentisonperpetualmotionfromalegislativeframeworkpointofview(geographically, betweentheEUandtheUS)andfromaconvergenceandhomogenizationbetweenregulationandstandards(regulatoryandaccountingstandards) Political & Social pressure •Oneoftheobviousraisond’êtreofregulationsisthepoliticalandsocialpressure,inordertoregulateaccuratelythebankingsystemandtoavoidabusesandexcesses
  • 4.
    Since the lastdecade, the regulation and the monitoring of the banking system have been subject to sharper focus •Publication: 2004 •Application date – standardized approach & IRB foundation:2007 •Application date –IRB advanced : 2008 •Objective : Capture and measure CreditRisk, MarketRisk & OperationalRisk 2008 Basel 2 2012 •Publication: 2009 •Amendments:2010 •Application date :2012 •Objective : Strengthen capital requirements for market risk and re-securitization, amend theCompensation Policy towards market participants etc.. Basel 2.5 2013 •Publication: 2010 •Final text:not issued yet •Application date :2013 •Objective : Enhance Capital Quality, deal with Systemic Risk, increase capital requirements for Counterparty Credit Risk, manage and cover Liquidity Risk Basel 3 •Publication: 2011 •Application date :2013 •Objective : Give a precise definition of the fair value, define levels in the fair value hierarchy, consider CVA / DVA in the fair value measurement IFRS 13 •Publication: phase 1 –2009, phase 2 -2011, phase 3 -2012 •Application date :2015 •Objective : Define asset classes (amortized cost vsfair value), introduce a new impairment model (Expected Loss) ensure convergencewith prudential standards IFRS 9 2015 Prudential standards Accounting standards 4 1 Context
  • 5.
    Latest updates andevolutions of Basel III –liquidity ratios Latestupdates •Onthe7thofJanuary2013,theBaselcommitteepublishedthelatestevolutionsanddecisionstakentowardsthedefinitionoftheLiquidityCoverageRatio •Whatchangesinthisnewversion? Thetimetableandcalendarofapplication Theperimeterofinstrumentstakenintoaccountwithintheliquiditybuffer Revisionofoutflowrates Drawdownratesonoff-balancesheetexposure Revisionofinflowrates LCR= Liquidity buffer Outflows –min( Inflows ; 75%) •Thefollowinginstrumentscannowbetakenintoaccountwithintheliquiditybuffer, cappedat15%fromthetotalbuffer Corporateinvestmentgradebondswitha50%haircut Someequitiesinmajorstockindices RMBSwithaminimumgradeofAAwitha25% haircut •LiquiditylineswithCentralBanksareunderdiscussion, whethertotakethemintoaccountornot Liquidity buffer •Outflowrateonnon- operationaldepositsisreducedto40%from75%initially •Drawdownratesonliquiditylinesisreducedto30%from100%initially •DrawdownrateonliquidityandcreditlineswithentitiessubmittedtotheLCRisreducedto40%from100% initially •Thedefinitionofoperationaldepositsbecomesmorestringent Outflows •Inflowsarestillcappedat75% oftotaloutflows •Inflowrateonrevolvinginstrumentsisfixedat0%(noinflowsonrevolvinginstruments)from50%initially Inflows Dec2010 1strelease Jan2013 2ndrelease Jan2015 LCR>=60% (initially100%) Jan2016 LCR>=70% Jan2017 LCR>=80% Jan2018 LCR>=90% Jan2019 LCR>=100% 5 1 Context
  • 6.
    Regulations and standardsare more and more a worldwide concernGlobal benchmark Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 NorthAmerica Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 South America Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 Europe Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 Asia Basel II Basel 2.5 Basel 3 IFRS 9 IFRS 13 Africa In progress On hold Completed 6 1 Context
  • 7.
    Context Principles &objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 7
  • 8.
    Prudential standards coveran extensive scope… … encompassing new solutions to cover shortcomings revealed during the 2007 crisis 2 Principles & objectives of the Standards Pillar I –Solvency Ratios Capital RWA Core Tier 1 Tier 1 Tier 2 Tier 3 Systemic Risk Leverage ratio Pillar II –Supervisory Process Credit Pillar III –Market Discipline Standard IRB -Foundation IRB -Advanced Counterparty Exposure calculation Default risk CVA, WWR Margin period of risk Market Standard Advanced : Stress Var, IRC Operational Standard, BIA, AMA FI correlation Buffer countercyclical conservation CCP Capital requirements Economic capital ICAAP Testing Stress testing Back testing Risk Concentration / liquidity Reputational / strategic Liquidity ratios LCR NSFR Compensation policy for maketparticipants Financial communication Credit risk Market risk Operational risk Complex instruments Off-balance sheet expos. Breakdown by industry Geographic area Approach (IRBA, STD) Basel 2 Update Basel 2.5 Update Basel 3 Removed in BIII New in Basel 2.5 New in Basel 3 8
  • 9.
    Each prudential standardmeets a specific objectiveFocus on Basel 2 … 2 Principles & objectives of the Standards Basel 2 Basel 2.5 Basel 3 1 2 3 Objective Description LimitsofBaselI •ThemaininputforCookesolvencyratioistotalamountofgrantedloans •Assetweightings-enablingtoconsidertheweightedrisk-didnotreflecttheborrower'srealcreditworthiness •Inaddition,thematuritiesofcontractswerenotconsideredeither •Finallyriskmitigation/hedgingtechniques(CDS, securitizations,collateral&nettingagreements)andoperationalriskwerealsonottreatedwithinBaselI ObjectivesofBaselII •BaselIIstandardsproposeanapproachallowingtoconsiderthecreditworthinessoftheborrowerviaaninternalratingsystem •Inaddition,theyenhancemarketriskmeasurement(e.g.throughtheVaR)anddefinetermsfortreatingoperationalrisk •WithinBaselII,McDonoughratio–replacingCookeratio-considerscredit,market&operationalrisksandaimstostrengthencapitalrequirements •Moreover,withinPillarII,financialinstitutionsshallalsoassessandensuretheadequacyofregulatorycapitalwitheconomiccapital-whichreflectstherealactivityofaspecificfinancialinstitution •Finally,financialreporting&communicationaremandatorywithinPillarIII,inordertoenhancetransparencyamongthebankingsystem CreditRisk •BaselIIproposesanAdvancedApproachtocapturedefaultriskbasedonaninternalratingsystem •Aprobabilityofdefault(PD)iscalculatedforeachcounterpartythroughvarioustechniques(statisticalapproach,expertjudgmentetc...)overaone-year- horizon •ExposureAtDefault(EAD)iscalculatedanddefinedastheasset'sbookvalue •Finally,DefaultRecoveryRates(RR)aredeterminedviadifferenttechniques(statisticalapproach, historicalapproach…) •Foreachasset,ariskweightisdeterminedfromthecombinationofPD,LGDandEAD •Maturitiesimpactandratingmigrationriskistakenintoaccountviaanadjustmentcoefficient CounterpartyCreditRisk •BaselIIdefinestechniquesfordeterminingexposuresonderivativesandsecuritiesfinancingtransactions(repo,securitieslending/borrowing) •Italsodefinestermsfortakingintoaccountriskmitigationtechniques(collateral,nettingagreements,etc…) Operationalrisk •Operationalriskisalsoconsideredandevaluationtechniquesarepresented(AMA,BIA,STD..) MarketRisk •Itisaboutcapturingriskscomingfrommarketfactorsvolatility(FXrates,interestrates,creditspreads) 9
  • 10.
    Each prudential standardmeets a specific objectiveFocus on Basel 2.5 (CRD II / CRD III) … 2 Principles & objectives of the Standards Basel Basel 2.5 Basel 3 1 2 3 Objective Description MotivesofBasel2.5 •ThisreformisconsideredasanenhancementofBasel2andbeganin2005 •Followingthe2007-08financialcrisis,itsscopehasbeenwidened •Infact,duringthe2007crisis,inacontextofextremevolatilityofmarketvariables,VaRmodelsintroducedinBaselIIfailedtocapturesuchextremesituations •Asareminderthesemodelsestimatepotentiallossesofaportfolioviahistoricalscenariosformarketvariables ObjectivesofBasel2.5 •Followingthefinancialcrisis,wheresituationsofextremestressandvolatilitywereobserved,Basel2.5hasbeenissuedtocaptureaccuratelysuchextremeevents(whichwerenottakenintoaccountwithinhistoricalscenarios) •ThescopeofBasel2.5encompassesexclusivelycredit,marketandconcentrationrisks •Itspurposeistomeetthefollowingobjectives >CaptureLossesrelatedtoextremeevents >CaptureLossesduetodefaultandratingmigration >Treatsecuritizations&re-securitizations >Takeintoaccountcorrelationsbetweenassetsofthetradingbook CreditRisk(StandardizedApproach) •Securitizations&Re-securitizationsaretreatedasheldintothebankingbook.Theyarethereforeprocessedintheframeworkofcreditriskpolicy. Thisaimstoavoidthearbitragebetweenthetradingandthebankingbook •Whiledeterminingtheexposureonsecuritization, bothbalancesheetandoff-balancesheetcommitmentsareconsidered •Newweightingfactorsmustapplyonsecuritizationinstruments MarketRisk(Internalmodelapproach) •StressedVaR-ItisanewVaRmodelbasedonstressedscenariosformarketvariablesintheintenttocapturesituationsofextremevolatility.ThisVaRisadditionaltotheclassicalVaR •IncrementalRiskCharge(IRC)-allowstocapturedefaultandratingmigrationrisksviaaVaR(99%;1year)model.ItisadditionaltothemarketriskcapitalchargeintroducedinBasel2.Itisaboutintroducinga“creditrisk”basedapproachforinstrumentsheldinthetradingbook •ComprehensiveRiskMeasure(CRM)-allowstomeasureboththecorrelationbetweeninstrumentsofaportfolioandthevolatilityaswell Pillar2/Pillar3 •Basel2.5definesaCompensationPolicyformarketparticipants(deferredbonusdistribution,…) •Italsohandlesthemanagementofconcentrationriskandenhancesfinancialcommunication 10
  • 11.
    Each prudential standardmeets a specific objectiveFocus on Basel 3(CRD IV) … 2 Principles & objectives of the Standards Basel 2 Basel 2.5 Basel 3 1 2 3 Objective Description MotivesofBasel3 •Thisreformisbasicallyaresponsetowhathasbeenobservedduringthe2007crisiswherecapitalreservesfailedtoabsorbrecordedlosses •Furthermorethe2007crisisuncoveredmanyloopholes.Forinstance,itwasnoticedthatcertainriskswerenotcoveredorconsideredinthepreviousstandardsorbyinternalriskmanagementmodels ObjectivesofBasel3 •Basel3mainpurposeistocovershortcomingsidentifiedduringthe2007crisisintermsofriskmanagement •Basel3proposesamendmentsforexistingstandardsbutalsodefinesasetofnewrulesandconsequentlywidensthescopeofissuescoveredbyprudentialstandards •Moreprecisely,itenablestomeetthefollowingobjectives >Enhancethequalityandthequantityofcapitalreserves >Regulatetheleverageeffectbyintroducingaleverageratiowhosepurposeistoincreasecapitalreservesorreduceassetsvolumes >Capturesystemicriskandtheriskofcontagionfromafinancialcrisistoanoveralleconomycrisis >EnhanceCounterpartyCreditRiskmanagementandframeapolicyforliquidityrisk Enhancethecapitalstructure •Tier3isremovedandTier1issplitintoTier1andCoreTier1.CET1increasesto4,5%from2% previously •SomesecuritiespreviouslyeligibleforTier1,willbedowngradedtoTier2 •TheSolvencyRatiomustbegreaterthan10,5%(vs. 8%previously LeverageRatio •ItisdefinedastheratiobetweenTier1Capitalandnon-weightedexposures(on-&off-balancesheet) •Thisratiomustbegreaterorequalto3%.ItwhetherincreasesTier1capitalreservesorreducesthesizeofthebalancesheet SystemicRisk •Correlationcoefficientisincreasedby25%forfinancialinstitutionstoreflecttheirinterdependencyandtheriskofcontagion •ConstitutionofaConservationBufferthatrepresents2,5%oftheSolvencyratio.ItisaCET1extracushion •ConstitutionofaCountercyclicalbufferduringperiodofgrowth,usedtoabsorblossesduringadownturncycle.ItisaCET1extracushion •CalculationofexposureswithCCP CounterpartyCreditRisk/liquidityRisk •CVAcalculationtocaptureMtMLossesduetocreditspreadsvolatilityandtoconsiderWWRthroughthecalculationofstressedEPE •Implementationof2LiquidityRatios(ST&LT) 11
  • 12.
    Accounting rules alsoevolved … … in order to converge and be consistent with regulatory rules 2 Principles & objectives of the Standards IFRS 9 IFRS 13 Phase 1 – Classification & Measurement Phase 2 –Impairment rules Phase 3 –Hedging account Evaluation method Amortized Cost Incurred Loss model Expected Loss model Risk exposure Bad Book / good Book EL calculation methodology Maturity / Horizon Counter Cyclical effects Accounting Specific / Collective 1–Fair Value Instruments Classification 2–CVA / DVA impairment Fair value hierarchy Level 1 –Quoted Prices Level 2 –Prices computed with observable parameters Level 3 –Prices computed with non observable parameters Fair value Definition Calculation methodology Expected Loss –standard / advanced approach Shifting curve CDS Spreads Risk exposure / perimeter Valuation techniques Methodology Reporting Suppresion No regulatory guidelines Regulatory guidelines 12 Fair Value through P&L Historical cost Other methods Classification Held to maturity Intent to be sold
  • 13.
    IFRS 9 changesthe way of measuring impairments…as a consequence of the last financial crises 2 Principles & objectives of the Standards IFRS 9 IFRS 13 1 2 Regulation summary Description Classification&Measurement •IFRS9paragraph3:5-TheEDproposestwoprimarymeasurementcategoriesforfinancialinstruments. Afinancialassetorfinancialliabilitywouldbemeasuredatamortisedcostiftwoconditionsaremet:theinstrumenthasbasicloanfeaturesandtheinstrumentismanagedonacontractualyieldbasis •Afinancialassetorfinancialliabilitythatdoesnotmeetbothconditionswouldbemeasuredatfairvalue Impairmentrules •IFRS9IN5(b)-theproposedimpairmentapproachgenerallywouldresultinearlierrecognitionofcreditlossesthantheincurredlossimpairmentmodelinIAS39(ieavoidthesystematicbiastowardslaterecognitionofcreditlosses).Inotherwords,therequirementforanobservablelosseventtohaveoccurredbeforeconsideringtheeffectofcreditlosseswouldberemoved •IFRS9IN10-TheIASBhascontinuedtostresstheimportanceofreflectingtherelationshipbetweenthepricingoffinancialassetsandexpectedcreditlosses •IFRS9IN11-TheFASBconcluded,jointlywiththeIASB,thatanentityshould,alongwithconsideringhistoricaldataandcurrenteconomicconditions, considerreasonableandsupportableforecastsoffutureeventsandeconomicconditionsfordevelopingtheentity’sestimateofexpectedcreditlosses Motivations •Beforethelastfinancialcrisis,impairmentsonassetsvaluedusingtheamortizedcostmethod, werecalculatedusingthe“incurredloss”method •Thismeansthatimpairmentsexistonlyifalosseventoccurs •Duringthefinancialcrisis,ahugenumberoflosseventsoccurred,andtheimpairmentstockincreaseddrastically,whichmeantthatreservesalreadyinplacefailedtoabsorbcurrentlosses Objectives •Theincurredlossmodelsufferedfromshortcomingswhichledtoproposeanothermodel •Infact,itrecognizesexpectedlosseslatelywaitingforacrediteventtooccur.Italsooverestimatedinterestincomebecauseinterestratesdidn’tincludeariskpremiumrelatedtothecreditworthinessofcounterparties •Consequently,impairmentunderIFRS9aretobecomputedusinganExpectedLossmodel,whichmeansthatreservesaretobebuiltupbeforeacrediteventoccurs •Themainobjectivesofthismodelare Buildingupreservestoabsorblossesifadownturnintheeconomyoccurs(countercyclicaleffect) ConvergewithBaselIIdefinitionofexpectedloss 13
  • 14.
    IFRS 13 providesmore precision on fair value definition…but banks concerns are more focused on CVA / DVA computation 2 Principles & objectives of the Standards IFRS 9 IFRS 13 1 2 Regulation summary Description Fairvaluehierarchy •IFRS13:72-Thehierarchygivesthehighestprioritytoquotedpricesinactivemarketsandthelowestprioritytounobservableinputs Fairvaluedefinition •IFRS13:AppendixA-Thepricethatwouldbereceivedtosellanassetorpaidtotransferaliabilityinanorderlytransactionbetweenmarketparticipantsatthemeasurementdate(i.eexitprice) Valuationtechniques •IFRS13:62 marketapproach–usespricesandinformationgeneratedbymarkettransactions costapproach–currentreplacementcost incomeapproach–discountedcashflows CVA/DVAimpairment •IAS39.AG67-Fairvaluereflectsthecreditqualityoftheinstrument •IAS39.AG28(b)-Anappropriatetechniqueforestimatingthefairvalueofaparticularfinancialinstrumentwouldincorporatecreditrisk •IFRS13.42-Thefairvalueofaliabilityreflectsnon- performancerisk.Non-performanceriskincludes, butmaynotbelimitedtonanentity’sowncreditrisk Motivations •OneofthemajormotivationsofIFRS13istheconvergenceofaccountingstandards,byestablishingasetofaccountingrulesthatwillbeusedgenerallyandbyreducingthegapbetweenUSGAAPandIFRS •IFRS13wasdesignedinordertogiveonecleardefinitionoffairvaluemeasurementaswellasenhancingclaritybystandardizingelementsofreportingandvaluationtechniques •Moreover,duringthecrisisof2007,MtMlosseswereofphenomenalamountswhichledtodefineclearlyfairvalueandhowitmustbemeasured Objectives •IFRS13establishesasingleframeworkforallfairvaluemeasurementbutdoesnotchangewhenfairvaluemustapply •Butratherdescribeshowtomeasurefairvalue •Moreover,IFRS13clearlystipulatesthatfairvaluemustreflectlossesduetocounterpartycreditrisk(CVA)aswellasgainsduetoanentity’sowncreditrisk(DVA) •Nonetheless,IFRS13doesn’tdefinehowCVAandDVAaretobecomputingwhichmeansthatcalculationmethodologyareoneofthemajorissuesforbanksunderIFRS13 14
  • 15.
    Context Principles &objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 15
  • 16.
    Regulatory requirements andconstraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (1/3) 3 Impacts & issues Bâle 2 Subjects Financial Orga Methodology Business Hot Topic? Credit Risk -RWA computation •Standardapproach •IRBFoundation •Advanced(PD,LGD, EAD,CCFmodeling) CCR –exposure computation •CurrentExposureMethod(add-on) •Internal-basedmodelapproach(EPE) Market Risk –RWA computation •Standardapproach •Internalapproach(VaRmodels,MonteCarlosimulation…) Pillar II & Pillar III •ICAAP •Backtesting/stress     16
  • 17.
    Regulatory requirements andconstraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (2/3) 3 Impacts & issues Bâle 2.5 Subjects Hot Topic? Market Risk –RWA computation •StressVaR •IRC/CRM     Basel 3 Capital structure •Tier1/Tier2 CCR -CVA •Standardapproach •Advancedapproach Systematic risk •CorrelationcoefficientforFI •Capitalbuffers •CCP LeverageRatio Liquidity ratios •LCR •NSFR    17 Financial Orga Methodology Business
  • 18.
    Regulatory requirements andconstraints have multi-dimensionnalimpacts… from financial impacts, to more operational and IT concerns, then business issues (3/3) 3 Impacts & issues IFRS 9 Subjects Hot Topic? Phase 1 -Classification & Measurement •Classification •Measurement Phase 2 –Impairment rules •ExpectedLossimpairment IFRS 13  Fair Value Instruments Classification •Hierarchy •Valuationtechniques CVA / DVA impairment •Methodologyandcalculation  18 Financial Orga Methodology Business
  • 19.
    Banks will facegreat challenges in putting in place regulations… with an impact on balance sheet’s structure and P&L Direct impact on capital structure 2% 4.50% 2% 1.50% 3% 2% 1% 2.50% 2.50% Basel 2/2.5 Basel 3 Countercyclical buffer Conservation buffer Tier 3 Tier 2 Additional Tier 1(hybrid) CET 1 + 63% Impact on balance sheet -Assets Impact on balance sheet -liabilities Other Other Fees Fees Loans Loans Rever. Repos Rever. Repos Securitization Sovereignsec. Securities Securities Cash Cash Derivatives Derivatives Today With Basel III Unsec. funding Unsec.funding Deposit Deposit Secu. Funding short term Secu. Funding short term Interbank borrowing Interbank bor. Derivatives Derivatives. Capital Capital Today With Basel III NSFR & leverage ratio LCR buffer CVA impact LCR buffer NSFR & LCR Trust crisis, collat. Correlation coeffic. Capital struct. & buffers Trust crisis, collat. Impact on P&L –Cost of risk CVA / DVA (IFRS 13) No CCR impairment Expected Loss (IFRS 9) Incurred Loss •CCRimpairment–SubstantialimpactontheP&Lbecauseofderivativesandrepotransactionvolumes •ExpectedLossimpairment–Comparedtotheincurredlossmodel,theimpactontheP&Lisgreaterbecauseimpairmentarebuiltupbeforeacrediteventoccurs 19 3 Financial impacts
  • 20.
    Banks will facegreat challenges in putting in place regulations… with an impact on processes and organization Regulatory CVA –Basel III Leverage Ratio –Basel III Liquidity Ratios –Basel III Central Counterparty Clearing House –Basel III •EPE/StressedEPE–OneofthemainchallengesforCVAcomputationunderBaselIII(Advancedapproach)istobuiltuppricingmodelsandscenariogenerators •HedgingCVA&interactionswithCVAdesks–ItisimportantthatprocessesforcomputingCVAcapitalrequirements,CVAimpairmentandCVAdesksmustbeoptimized •RequiresahighcomputingcapacitywithoptimizedmodelsforMTsimulations •RequiresagoodunderstandingofprocessesaswellasallCVAcomponents •IdentificationoftransactionswithCCP–WithinBaselII,transactionswithCCPhadanEAD=0,whichmeantthatthesetransactionswerenotidentifiedseparately •Margincallsandcollateralmanagement–WithEMIRregulation, thevolumeoftransactionwithCCPwillincreasessignificantly •DefaultFund–BaselIIIdefinescapitalrequirementsforbalanceandoff- balancesheetdefaultfunds •RequireshighgranularitywithinITsystems&anewmethodologyforEADcalculus •RequiresoptimizedprocesseswithBOcollateralmanag. unit •RequiresoptimizedprocesseswithRisk&Financialfunctions •Reposandderivativestreatment– Oneoftheinputstotheratioisrepotransactionswithanettingbetweencashlegandsecuritiesleg •Reconciliationbetweenriskandfinancefunction–Theinputstotheleverageratioareof2natures:Risk& finance.Riskinputsarereposandderivativestreatment.Financeinputsarecapitalinformation •Requiresthecapacityofidentifyingtoeachbalancesheetexposure,itsoff- balancesheetleg •RequiresoptimizedprocesseswithRisk&Financialfunctions •Liquiditybuffer–isconstitutedofcash, centralbankreserves,liquidsecuritiesetc… •Identificationofencumberedassets– Assetsusedascollateral(forsecuritizationforinstance)mustbeidentifiedandtreateddifferentlyintermsofliquiditywithintheNSFR •RequireshighgranularitywithinALMcalculator& optimizedprocesseswiththetreasurer •RequiresoptimizedprocesseswithBOcollateralmanag. Unit 20 3 Organizational impacts
  • 21.
    Banks will facegreat challenges in putting in place regulations… with an impact on models and methods CVA Impairment –IFRS 13 Expected Loss model -IFRS 9 •CVA/DVAmethodology–OneofthemainchallengesforCVAimpairmentisputtinginplaceamethodology(knowingthatitisnotspecifiedinIFRSrules) •Benchmarkofmethodologiesthatcanbeused •ExpectedLossmethodology–TheExpectedLosswithinIFRS9hasthesamedefinitionastheexpectedlosswithinBaselII.ThechallengeforbanksistocalibratetheELcorrectlytoavoidoverlapwiththeULwithinBaselII.Thispointwillbedetailedinpartn°5 ExpectedLossmodel 1 ShiftingCurves 2 CDS spreads 3 •CVA=PDxLDGxEAD •PD-Inpriority,considerobservablecreditspreads.Ifnotavailable,useregulatory1-yearPD,anddeterminePDtillmaturityusingincrementalPDformula •EAD Inastandardizedmethod,usetheCurrentExposureMethod(MtM+Add-on)usingregulatoryadd-onfactors Inanadvancedapproach,useEPEmodels •LGD-Inpriority,considerobservableLGD(ratingagencies, etc…).Ifnotavailable,useregulatoryLGD •CVA=PresentValue1(RiskFree)–PresentValue2(+riskpremium) •Cashflowsarediscountedusingzero-couponcurves,thenzero-coupon+creditspreads •CVA=EADx(creditspreadxduration)xLGD •CVAiscomputedasafunctionofcreditspread 21 3 Methodology impacts
  • 22.
    Understanding the dynamicof interactions between regulations… is about identifying the synergies and optimizing potential overlap (1/2) Synergies Basel II – IFRS 9 What is the issue ? How to optimize? Basel II 99,9% EL (Basel II) UL (Basel II) Loss Probability Bad EL 1y (IFRS) calibration •ELwithinBaselIIisdefinedasPDxLGDxEADona1yearhorizon •ELwithinIFRS9isalsodefinedasPDxLGDxEAD.Though,iftheparametersusedaresignificantlydifferentfromthoseusedinbasel2,thiscanleadto: Abadcoverageofexpectedlosses(case1) Overlapbetweenimpairmentandcapital(case2) 1 2 •ThebestwaytocalibratecorrectlyandefficientlytheELwithinIFRSistouseBaselIIparametersandcapitalizeonwhatisprovidedforregulatoryintent Basel II -EL Basel II –PD (TTC) Basel II -LGD Basel II -EAD IFRS –PD (PIT) IFRS -LGD IFRS -EAD 1y maturity Economic LGD Regulatory EAD Basel II -EL 1y for bucket 1 Until maturity for bucket 2,3 PIT Not economic,PIT Regulatory EAD Same risk bases Synergies Basel II – Basel III LossesduetoratingmigrationsarealreadycapturedwithinBaselII Maturity adjustment coefficient, function of PD •ThematurityadjustmentcoefficientintroducedwithinBaselIIhasadualpurpose Thelongerthematurityis,thehighertheriskis ItisafunctionofPD,andcapturesratingmigrations •ThepurposeofCVAunderBaselIIIistocapturelossesduetoratingvolatilityandmigration Analysisoftheb(PD)term Itisanadditionalcapitalrequirementforratingmigrations.RatingMigrationsaremorelikelytohappenforlowerPDandhighermaturities •ForBaselIII-CVAundertheIRBapproach,thematurityadjustmentcoefficientmaybesetto1(whichmeanscapturingdefault-onlyrisk)ifthebankcandemonstratethatratingmigrationandrisksarecorrectlyandefficientlycapturedinthespecificVaRmodel PD 22 3 Methodology impacts
  • 23.
    MtM EL (BaselIII) Understanding the dynamic of interactions between regulations… is about identifying the synergies and optimizing potential overlap (2/2) Synergies Basel III – IFRS 13 What is the issue ? How to optimize? EL (IFRS 13) UL (Basel II) Loss due to counterparty default Probability CVAunderBaselIIIvsCVAunderIFRS13:2differentdefinitionsfordifferentpurposes •CVAunderBaselIIIcoversMtMlossesduetoratingmigrationandvolatility,withoutcounterparty’sdefault.Itisaone-yearhorizonVaRwith99%confidencelevel.ItincorporatesULandELaswell •CVAunderIFRS13coversexpectedlossesonderivativesandreposstyletransactionsduetocounterpartydefault Yet,thereismuchincommonbetweenthem •Eventhoughtheyareusedfordifferentpurposes,itisimportanttocalibratethemcorrectlytoavoidoverlapsknowingthattheysharethesameinputsandperimeter UL (Basel III) MtMLoss due to rating volatility Therearetwomainaxesforoptimization:Methodologyandperimeterofapplication •Methodology&inputs–MeasuringCVAunderIFRSasanExpectedLossmodelwillallowtocapitalizeonBaselIIparameters(PD,LGD,EAD)andusethemasinputstothemodel.TheseinputsarealsousedforCVAcomputationunderBaselIII •Perimeterofapplication–CVAunderBaselIIIandIFRS13arecomputedonallnon-defaultedderivativesandrepostyletransactions.Onetheperimeterisidentified,regulatoryEADcanbeusedforIFRS13purposes,afterreconciliatingMtMusedforregulatorypurposesandMtMusedforaccountingpurposes Methodology& inputs 1 MethodologyunderBasel3 •PD–PriorizingexternalPD,theninternalPD,thenbydefaultvalue •LGD-PriorizingexternalLGD,theninternalLGD,thenbydefaultvalue •EAD–Determinedusingadd-onmethod(MtM+add-on) orusingEPEmodels Same methodology, rules and inputs can be used for IFRS 13 Perimeter 2 Riskbases Non defaultedderivatives Basel III EAD Add- on Reconciliation IFRS 13 EAD AccountingMtM 23 3 Methodology impacts
  • 24.
    Context Principles &objectives of the Standards Impacts & issues CH&CieOffer Agenda 1 2 3 4 24
  • 25.
    CH&Cie Regulatory offerand scope of interventionDelivering solutions at all levels 4 CH&Cie Offer Interpretation of Standards •CH&Ciehasbuiltupanexpertisecenterconstitutedofexpertsinregulatoryandaccountingstandards •Wehelpourcustomersininterpretingcorrectlythenormsaswebeneficiatefromalargebenchmarkaswellasexperienceandexpertise •Ourinterpretationisconductedinatwo-wayapproach Interpretationandimpactsfromourclient’senvironmentandbusinessperspective Amoremacro-levelanalysis Advice at an expertise-level Implementation 1 2 3 •MorethanjustinterpretingtheStandards,wedeliverandprovideexpertise-leveladviceby Identifyinghowandwherethestandardswillhaveasignificantimpactforourclients Stayingup-to-datewiththebestpracticesonaworld-widelevel Capitalizingonourknow-howandknowledgeatbothRegulationsandriskmanagementlevel •Wealsodeliversolutionsintermsofimplementingthestandardsby Managingandsteeringprojectsinordertoputinplacethestandardswithhotdeadlines Providingassistanceonamoretechnicalpointofview(simulation, testing,…) Offeringsimpleguidanceandorientationonadailybasis Follow-up on evolving standards •Inacomplexandchangingenvironment, wherestandardsandregulationsaredrivenbypoliticalandsocialpressure,standardsareevolvingcontinuously •Ourexpertisecenterisup-to-datetothelatestandupcomingstandards’evolutions Optimization Assistance and help for third parties 4 5 6 •Weprovidesolutionstohelpourcustomersoptimizetheimpactsofthestandardsby Helpingtobettercalibratemodelsandoptimizetheirefficiency(example–optimizingratingscales) Identifyingsynergiesbetweenthestandardswhichallowtocapitalizeandenhancewhatisalreadyinuse Simulatingimpacts&realizingsensitivitiestests.Forexample, StandardizedCVAformulaunderBIIIishighlysensitivetomaturities •Wealsoprovideassistanceandhelponhottopicsfor Centralbanksandlocalregulators Auditors Internalcontrolfunctions 25
  • 26.
    MONTREAL 12F –1819BdRene Levesque O. Montreal, Quebec, H3H2P5 PARIS 20 Rue de la Michaudière 75002, Paris, France NIORT 19 avenue Bujault 79000 Niort, France NEW YORK 1441, BroadwaySuite 3015, New YorkNY 10018, USA SINGAPORE Level 25, North Tower, One Raffles Quay, Singapore 048583 HONG KONG 9/F, KinwickCentre 32 Hollywood Road, Central, Hong Kong LONDON 50, Great Portland Street London EC3V 9EA, UK GENEVA Rue de Lausanne 80CH 1202 Genève, Suisse 26