ch&cie - regulatory offer

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 [email protected]

Stephane Eyraud [email protected]

Ziad Fares [email protected]

Context

Principles & objectives of the Standards

Impacts & issues

CH&Cie Offer

Agenda

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Regulations and standards evolutions are driven by many factors From a difficult economic context to political and social pressures

1Context

Context

Financial institutions faced massive losses during the last crisis with dramatic impacts on the overall economy … • The subprime crisis that took place in 2007, unleashed a series of problems that threatened the financial banking system

and the whole economy as well

• From a real estate crisis, to a financial crisis, to an overall economy crisis, this difficult period revealed shortcomings inidentifying, hedging and managing risks in the banking system

• The causes of this turbulence were of different natures A confidence crisis Liquidity and funding issues Volatility and unpredictability of market parameters High level of correlation between financial institutions and systemic risks Significant increase in OTC derivative transaction volumes

Raison d’être of

Standards

A reaction to shortcomings revealed during the crisis • Some regulations evolved, others were created in order to cover the shortcomings in risk management revealed during

the crisis• For example, Basel III came as a reaction to a bad coverage and understanding of Counterparty Credit Risk and liquidity

management

A Changing environment • Today’s economic environment is on perpetual motion from a legislative framework point of view (geographically,

between the EU and the US) and from a convergence and homogenization between regulation and standards (regulatoryand accounting standards)

Political & Social pressure• One of the obvious raison d’être of regulations is the political and social pressure, in order to regulate accurately the

banking system and to avoid abuses and excesses

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 Credit Risk, MarketRisk & Operational Risk

2008

Basel 2

2012

• Publication : 2009•Amendments : 2010•Application date : 2012•Objective : Strengthen capital

requirements for market risk and re-securitization, amend the Compensation 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 vs fair value), introduce a new impairment model (Expected Loss) ensure convergence with prudential standards

IFRS 9

2015

Prudential standards

Accounting standards

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1Context

Latest updates and evolutions of Basel III – liquidity ratios

Latest updates• On the 7th of January 2013, the Basel committee published the latest evolutions

and decisions taken towards the definition of the Liquidity Coverage Ratio• What changes in this new version ?

The timetable and calendar of application The perimeter of instruments taken into account within the liquidity buffer Revision of outflow rates Drawdown rates on off-balance sheet exposure Revision of inflow rates

LCR =Liquidity buffer

Outflows – min( Inflows ; 75%)

• The following instruments cannow be taken into accountwithin the liquidity buffer,capped at 15% from the totalbuffer

Corporate investmentgrade bonds with a50% haircut

Some equities in majorstock indices

RMBS with a minimumgrade of AA with a 25%haircut

• Liquidity lines with CentralBanks are under discussion,whether to take them intoaccount or not

Liquidity buffer

• Outflow rate on non-operational deposits is reducedto 40% from 75% initially

• Drawdown rates on liquiditylines is reduced to 30% from100% initially

• Drawdown rate on liquidity andcredit lines with entitiessubmitted to the LCR isreduced to 40% from 100%initially

• The definition of operationaldeposits becomes morestringent

Outflows

• Inflows are still capped at 75%of total outflows

• Inflow rate on revolvinginstruments is fixed at 0% (noinflows on revolvinginstruments) from 50% initially

Inflows

Dec 20101st release

Jan 20132nd release

Jan 2015LCR >= 60%(initially100%)

Jan 2016LCR >= 70%

Jan 2017LCR >= 80%

Jan 2018LCR >= 90%

Jan 2019LCR >= 100%

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1Context

Regulations and standards are more and more a worldwide concernGlobal benchmark

Basel II

Basel 2.5

Basel 3

IFRS 9

IFRS 13

North America

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

1Context

Context


Impacts & issues

CH&Cie Offer

Agenda

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Prudential standards cover an extensive scope…… encompassing new solutions to cover shortcomings revealed during the 2007 crisis

2Principles & 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

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Each prudential standard meets a specific objectiveFocus on Basel 2 …


Basel 2

Basel 2.5

Basel 3

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2

3

Objective Description

Limits of Basel I• The main input for Cooke solvency ratio is total

amount of granted loans• Asset weightings - enabling to consider the

weighted risk - did not reflect the borrower's realcreditworthiness

• In addition, the maturities of contracts were notconsidered either

• Finally risk mitigation / hedging techniques (CDS,securitizations, collateral & netting agreements) andoperational risk were also not treated within Basel I

Objectives of Basel II• Basel II standards propose an approach allowing to

consider the creditworthiness of the borrower viaan internal rating system

• In addition, they enhance market risk measurement(e.g. through the VaR) and define terms for treatingoperational risk

• Within Basel II, McDonough ratio – replacing Cookeratio - considers credit, market & operational risksand aims to strengthen capital requirements

• Moreover, within Pillar II, financial institutions shallalso assess and ensure the adequacy of regulatorycapital with economic capital - which reflects thereal activity of a specific financial institution

• Finally, financial reporting & communication aremandatory within Pillar III, in order to enhancetransparency among the banking system

Credit Risk• Basel II proposes an Advanced Approach to capture

default risk based on an internal rating system• A probability of default (PD) is calculated for each

counterparty through various techniques (statisticalapproach, expert judgment etc...) over a one-year-horizon

• Exposure At Default (EAD) is calculated and definedas the asset's book value

• Finally, Default Recovery Rates (RR) are determinedvia different techniques (statistical approach,historical approach…)

• For each asset, a risk weight is determined from thecombination of PD, LGD and EAD

• Maturities impact and rating migration risk is takeninto account via an adjustment coefficient

Counterparty Credit Risk• Basel II defines techniques for determining

exposures on derivatives and securities financingtransactions (repo, securities lending / borrowing)

• It also defines terms for taking into account riskmitigation techniques (collateral, nettingagreements, etc…)

Operational risk• Operational risk is also considered and evaluation

techniques are presented (AMA, BIA, STD..)

Market Risk• It is about capturing risks coming from market

factors volatility (FX rates, interest rates, creditspreads)

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Each prudential standard meets a specific objectiveFocus on Basel 2.5 (CRD II / CRD III) …


Basel

Basel 2.5

Basel 3

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2

3


Motives of Basel 2.5• This reform is considered as an enhancement of

Basel 2 and began in 2005• Following the 2007-08 financial crisis, its scope has

been widened• In fact, during the 2007 crisis, in a context of

extreme volatility of market variables, VaR modelsintroduced in Basel II failed to capture such extremesituations

• As a reminder these models estimate potentiallosses of a portfolio via historical scenarios formarket variables

Objectives of Basel 2.5• Following the financial crisis, where situations of

extreme stress and volatility were observed, Basel2.5 has been issued to capture accurately suchextreme events (which were not taken into accountwithin historical scenarios)

• The scope of Basel 2.5 encompasses exclusivelycredit, market and concentration risks

• Its purpose is to meet the following objectives> Capture Losses related to extreme events> Capture Losses due to default and rating

migration> Treat securitizations & re-securitizations> Take into account correlations between

assets of the trading book

Credit Risk (Standardized Approach)• Securitizations & Re-securitizations are treated as

held into the banking book. They are thereforeprocessed in the framework of credit risk policy.This aims to avoid the arbitrage between thetrading and the banking book

• While determining the exposure on securitization,both balance sheet and off-balance sheetcommitments are considered

• New weighting factors must apply on securitizationinstruments

Market Risk (Internal model approach)• Stressed VaR - It is a new VaR model based on

stressed scenarios for market variables in the intentto capture situations of extreme volatility. This VaRis additional to the classical VaR

• Incremental Risk Charge (IRC) - allows to capturedefault and rating migration risks via a VaR (99% ; 1year) model. It is additional to the market riskcapital charge introduced in Basel 2. It is aboutintroducing a “credit risk” based approach forinstruments held in the trading book

• Comprehensive Risk Measure (CRM) - allows tomeasure both the correlation between instrumentsof a portfolio and the volatility as well

Pillar 2 / Pillar 3• Basel 2.5 defines a Compensation Policy for market

participants (deferred bonus distribution,…)• It also handles the management of concentration

risk and enhances financial communication

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Each prudential standard meets a specific objectiveFocus on Basel 3 (CRD IV) …


Basel 2

Basel 2.5

Basel 3

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2

3


Motives of Basel 3• This reform is basically a response to what has been

observed during the 2007 crisis where capitalreserves failed to absorb recorded losses

• Furthermore the 2007 crisis uncovered manyloopholes. For instance, it was noticed that certainrisks were not covered or considered in the previousstandards or by internal risk management models

Objectives of Basel 3• Basel 3 main purpose is to cover shortcomings

identified during the 2007 crisis in terms of riskmanagement

• Basel 3 proposes amendments for existingstandards but also defines a set of new rules andconsequently widens the scope of issues covered byprudential standards

• More precisely, it enables to meet the followingobjectives

> Enhance the quality and the quantity ofcapital reserves

> Regulate the leverage effect by introducinga leverage ratio whose purpose is toincrease capital reserves or reduce assetsvolumes

> Capture systemic risk and the risk ofcontagion from a financial crisis to anoverall economy crisis

> Enhance Counterparty Credit Riskmanagement and frame a policy forliquidity risk

Enhance the capital structure• Tier 3 is removed and Tier 1 is split into Tier 1 and

Core Tier 1. CET 1 increases to 4,5% from 2%previously

• Some securities previously eligible for Tier 1, will bedowngraded to Tier 2

• The Solvency Ratio must be greater than 10,5% (vs.8% previously

Leverage Ratio• It is defined as the ratio between Tier 1 Capital and

non-weighted exposures (on- & off-balance sheet)• This ratio must be greater or equal to 3%. It

whether increases Tier 1 capital reserves or reducesthe size of the balance sheet

Systemic Risk• Correlation coefficient is increased by 25% for

financial institutions to reflect theirinterdependency and the risk of contagion

• Constitution of a Conservation Buffer thatrepresents 2,5% of the Solvency ratio. It is a CET 1extra cushion

• Constitution of a Countercyclical buffer duringperiod of growth, used to absorb losses during adownturn cycle. It is a CET 1 extra cushion

• Calculation of exposures with CCP

Counterparty Credit Risk / liquidity Risk• CVA calculation to capture MtM Losses due to credit

spreads volatility and to consider WWR through thecalculation of stressed EPE

• Implementation of 2 Liquidity Ratios (ST & LT)

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Accounting rules also evolved …… in order to converge and be consistent with regulatory rules


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

CounterCyclical 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

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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


IFRS 9

IFRS 13

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2

Regulation summary Description

Classification & Measurement• IFRS 9 paragraph 3:5 - The ED proposes two primary

measurement categories for financial instruments.A financial asset or financial liability would bemeasured at amortised cost if two conditions aremet: the instrument has basic loan features and theinstrument is managed on a contractual yield basis

• A financial asset or financial liability that does notmeet both conditions would be measured at fairvalue

Impairment rules• IFRS 9 IN5 (b) - the proposed impairment approach

generally would result in earlier recognition ofcredit losses than the incurred loss impairmentmodel in IAS 39 (ie avoid the systematic biastowards late recognition of credit losses). In otherwords, the requirement for an observable loss eventto have occurred before considering the effect ofcredit losses would be removed

• IFRS 9 IN10 - The IASB has continued to stress theimportance of reflecting the relationship betweenthe pricing of financial assets and expected creditlosses

• IFRS 9 IN 11 - The FASB concluded, jointly with theIASB, that an entity should, along with consideringhistorical data and current economic conditions,consider reasonable and supportable forecasts offuture events and economic conditions fordeveloping the entity’s estimate of expected creditlosses

Motivations• Before the last financial crisis, impairments on

assets valued using the amortized cost method,were calculated using the “incurred loss” method

• This means that impairments exist only if a lossevent occurs

• During the financial crisis, a huge number of lossevents occurred, and the impairment stockincreased drastically, which meant that reservesalready in place failed to absorb current losses

Objectives• The incurred loss model suffered from shortcomings

which led to propose another model• In fact, it recognizes expected losses lately waiting

for a credit event to occur. It also overestimatedinterest income because interest rates didn’tinclude a risk premium related to the creditworthiness of counterparties

• Consequently, impairment under IFRS 9 are to becomputed using an Expected Loss model, whichmeans that reserves are to be built up before acredit event occurs

• The main objectives of this model are Building up reserves to absorb losses if a

downturn in the economy occurs(countercyclical effect)

Converge with Basel II definition ofexpected loss

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IFRS 13 provides more precision on fair value definition…but banks concerns are more focused on CVA / DVA computation


IFRS 9

IFRS 13

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2

Regulation summary Description

Fair value hierarchy• IFRS 13:72 - The hierarchy gives the highest priority

to quoted prices in active markets and the lowestpriority to unobservable inputs

Fair value definition• IFRS 13:Appendix A - The price that would be

received to sell an asset or paid to transfer a liabilityin an orderly transaction between marketparticipants at the measurement date (i.e exit price)

Valuation techniques• IFRS 13:62

market approach – uses prices andinformation generated by markettransactions

cost approach – current replacement cost income approach – discounted cashflows

CVA / DVA impairment• IAS 39.AG67 - Fair value reflects the credit quality of

the instrument• IAS 39.AG28 (b) - An appropriate technique for

estimating the fair value of a particular financialinstrument would incorporate credit risk

• IFRS 13.42 - The fair value of a liability reflects non-performance risk. Non-performance risk includes,but may not be limited ton an entity’s own creditrisk

Motivations• One of the major motivations of IFRS 13 is the

convergence of accounting standards, byestablishing a set of accounting rules that will beused generally and by reducing the gap between USGAAP and IFRS

• IFRS 13 was designed in order to give one cleardefinition of fair value measurement as well asenhancing clarity by standardizing elements ofreporting and valuation techniques

• Moreover, during the crisis of 2007, MtM losseswere of phenomenal amounts which led to defineclearly fair value and how it must be measured

Objectives• IFRS 13 establishes a single framework for all fair

value measurement but does not change when fairvalue must apply

• But rather describes how to measure fair value• Moreover, IFRS 13 clearly stipulates that fair value

must reflect losses due to counterparty credit risk(CVA) as well as gains due to an entity’s own creditrisk (DVA)

• Nonetheless, IFRS 13 doesn’t define how CVA andDVA are to be computing which means thatcalculation methodology are one of the major issuesfor banks under IFRS 13

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Context


Impacts & issues

CH&Cie Offer

Agenda

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2

3

4

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Regulatory requirements and constraints have multi-dimensionnal impacts… from financial impacts, to more operational and IT concerns, then business issues (1/3)

3Impacts & issues

Bâle 2

Subjects Financial Orga MethodologyBusiness Hot Topic?

Credit Risk - RWA computation• Standard approach

• IRB Foundation

• Advanced (PD, LGD,EAD, CCF modeling)

CCR – exposure computation• Current Exposure

Method (add-on)

• Internal-basedmodel approach(EPE)

Market Risk – RWA computation• Standard approach

• Internal approach(VaR models, MonteCarlo simulation…)

Pillar II & Pillar III• ICAAP

• Back testing / stress

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3Impacts & issues

Bâle 2.5

Subjects Hot Topic?

Market Risk – RWA computation• Stress VaR

• IRC / CRM

Basel 3

Capital structure• Tier 1 / Tier 2

CCR - CVA• Standard approach

• Advanced approach

Systematic risk• Correlation

coefficient for FI

• Capital buffers

• CCP

Leverage Ratio

Liquidity ratios• LCR

• NSFR

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Financial Orga MethodologyBusiness


3Impacts & issues

IFRS 9

Subjects Hot Topic?

Phase 1 - Classification & Measurement • Classification

• Measurement

Phase 2 – Impairment rules• Expected Loss

impairment

IFRS 13

Fair Value Instruments Classification • Hierarchy

• Valuationtechniques

CVA / DVA impairment• Methodology and

calculation

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Financial Orga MethodologyBusiness

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

LoansLoans

Rever. ReposRever. Repos

SecuritizationSovereign sec.

SecuritiesSecurities

Cash

CashDerivatives

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

• CCR impairment – Substantial impact on the P&L because ofderivatives and repo transaction volumes

• Expected Loss impairment – Compared to the incurred lossmodel, the impact on the P&L is greater because impairmentare built up before a credit event occurs

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3Financial 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 / Stressed EPE – One of the mainchallenges for CVA computation underBasel III (Advanced approach) is to builtup pricing models and scenariogenerators

• Hedging CVA & interactions with CVAdesks – It is important that processesfor computing CVA capitalrequirements, CVA impairment andCVA desks must be optimized

• Requires a highcomputingcapacity withoptimized modelsfor MT simulations

• Requires a goodunderstanding ofprocesses as wellas all CVAcomponents

• Identification of transactions with CCP– Within Basel II, transactions with CCPhad an EAD = 0, which meant thatthese transactions were not identifiedseparately

• Margin calls and collateralmanagement – With EMIR regulation,the volume of transaction with CCP willincreases significantly

• Default Fund – Basel III defines capitalrequirements for balance and off-balance sheet default funds

• Requires highgranularity within ITsystems & a newmethodology forEAD calculus

• Requires optimizedprocesses with BOcollateral manag.unit

• Requires optimizedprocesses with Risk& Financial functions

• Repos and derivatives treatment –One of the inputs to the ratio is repotransactions with a netting betweencash leg and securities leg

• Reconciliation between risk andfinance function – The inputs to theleverage ratio are of 2 natures : Risk &finance. Risk inputs are repos andderivatives treatment. Finance inputsare capital information

• Requires the capacityof identifying to eachbalance sheetexposure, its off-balance sheet leg

• Requires optimizedprocesses with Risk& Financial functions

• Liquidity buffer – is constituted of cash,central bank reserves, liquid securitiesetc…

• Identification of encumbered assets –Assets used as collateral (forsecuritization for instance) must beidentified and treated differently interms of liquidity within the NSFR

• Requires highgranularity withinALM calculator &optimized processeswith the treasurer

• Requires optimizedprocesses with BOcollateral manag.Unit

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3Organizational 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 / DVA methodology – One of the main challenges for CVAimpairment is putting in place a methodology (knowing that it isnot specified in IFRS rules)

• Benchmark of methodologies that can be used

• Expected Loss methodology – The Expected Loss within IFRS 9 hasthe same definition as the expected loss within Basel II. The challengefor banks is to calibrate the EL correctly to avoid overlap with the ULwithin Basel II. This point will be detailed in part n°5

ExpectedLoss model

1

ShiftingCurves

2

CDS spreads

3

• CVA = PD x LDG x EAD• PD - In priority, consider observable credit spreads. If not

available, use regulatory 1-year PD, and determine PD tillmaturity using incremental PD formula

• EAD In a standardized method, use the Current

Exposure Method (MtM + Add-on) usingregulatory add-on factors

In an advanced approach, use EPE models• LGD - In priority, consider observable LGD (rating agencies,

etc…). If not available, use regulatory LGD

• CVA = Present Value 1 (Risk Free) – Present Value 2 (+ riskpremium)

• Cashflows are discounted using zero-coupon curves, thenzero-coupon + credit spreads

• CVA = EAD x (credit spread x duration) x LGD• CVA is computed as a function of credit spread

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3Methodology 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

• EL within Basel II is defined as PD x LGD x EAD on a 1 yearhorizon

• EL within IFRS 9 is also defined as PD x LGD x EAD. Though, ifthe parameters used are significantly different from thoseused in basel 2, this can lead to :

A bad coverage of expected losses (case 1) Overlap between impairment and capital (case 2)

1

2

• The best way to calibrate correctly and efficiently the EL within IFRSis to use Basel II parameters and capitalize on what is provided forregulatory intent

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

Losses due to rating migrations are alreadycaptured within Basel II

Maturity adjustment

coefficient, function

of PD

• The maturity adjustment coefficient introduced within Basel IIhas a dual purpose

The longer the maturity is, the higher the risk is It is a function of PD, and captures rating migrations

• The purpose of CVA under Basel III is to capture losses due torating volatility and migration

Analysis of the b(PD) term

It is an additional capitalrequirement for ratingmigrations. Rating Migrationsare more likely to happen forlower PD and highermaturities

• For Basel III-CVA under the IRB approach, the maturity adjustmentcoefficient may be set to 1 (which means capturing default-onlyrisk) if the bank can demonstrate that rating migration and risks arecorrectly and efficiently captured in the specific VaR model

PD

22


MtMEL

(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

CVA under Basel III vs CVA under IFRS 13 : 2different definitions for different purposes• CVA under Basel III covers MtM losses due to rating

migration and volatility, without counterparty’s default. Itis a one-year horizon VaR with 99% confidence level. Itincorporates UL and EL as well

• CVA under IFRS 13 covers expected losses on derivativesand repos style transactions due to counterparty default

Yet, there is much in common between them• Even though they are used for different purposes, it is

important to calibrate them correctly to avoid overlapsknowing that they share the same inputs and perimeter

UL

(Basel III)

MtM Loss due to rating volatility

There are two main axes for optimization : Methodologyand perimeter of application• Methodology & inputs – Measuring CVA under IFRS as an Expected

Loss model will allow to capitalize on Basel II parameters (PD, LGD,EAD) and use them as inputs to the model. These inputs are alsoused for CVA computation under Basel III

• Perimeter of application – CVA under Basel III and IFRS 13 arecomputed on all non-defaulted derivatives and repo styletransactions. One the perimeter is identified, regulatory EAD can beused for IFRS 13 purposes, after reconciliating MtM used forregulatory purposes and MtM used for accounting purposes

Methodology& inputs

1 Methodology under Basel 3• PD – Priorizing external PD, then internal PD, then by

default value• LGD - Priorizing external LGD, then internal LGD, then by

default value• EAD – Determined using add-on method (MtM + add-on)

or using EPE models

Same methodology, rules and inputs can be used for IFRS 13

Perimeter

2 Risk bases

Non defaulted

derivatives

Basel III

EADAdd-

on

Reconciliation

IFRS 13

EAD

AccountingMtM

23


Context


Impacts & issues

CH&Cie Offer

Agenda

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2

3

4

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CH&Cie Regulatory offer and scope of interventionDelivering solutions at all levels

4CH&Cie Offer

Interpretation of Standards

• CH&Cie has built up an expertise centerconstituted of experts in regulatory andaccounting standards

• We help our customers in interpretingcorrectly the norms as we beneficiate from alarge benchmark as well as experience andexpertise

• Our interpretation is conducted in a two-wayapproach

Interpretation and impacts from ourclient’s environment and businessperspective

A more macro-level analysis

Advice at an expertise-level Implementation1 2 3

• More than just interpreting the Standards, wedeliver and provide expertise-level advice by

Identifying how and where thestandards will have a significantimpact for our clients

Staying up-to-date with the bestpractices on a world-wide level

Capitalizing on our know-how andknowledge at both Regulations andrisk management level

• We also deliver solutions in terms ofimplementing the standards by

Managing and steering projects inorder to put in place the standardswith hot deadlines

Providing assistance on a moretechnical point of view (simulation,testing, …)

Offering simple guidance andorientation on a daily basis

Follow-up on evolving standards

• In a complex and changing environment,where standards and regulations are driven bypolitical and social pressure, standards areevolving continuously

• Our expertise center is up-to-date to thelatest and upcoming standards’ evolutions

Optimization Assistance and help for third parties4 5 6

• We provide solutions to help our customersoptimize the impacts of the standards by

Helping to better calibrate modelsand optimize their efficiency (example– optimizing rating scales)

Identifying synergies between thestandards which allow to capitalizeand enhance what is already in use

Simulating impacts & realizingsensitivities tests. For example,Standardized CVA formula under BIIIis highly sensitive to maturities

• We also provide assistance and help on hottopics for

Central banks and local regulators

Auditors

Internal control functions

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MONTREAL

12F – 1819 Bd Rene

Levesque O.

Montreal, Quebec,

H3H2P5

PARIS

20 Rue de la

Michaudière

75002, Paris, France

NIORT

19 avenue Bujault

79000 Niort, France

NEW YORK

1441, Broadway

Suite 3015, New York

NY 10018, USA

SINGAPORE

Level 25, North

Tower,

One Raffles Quay,

Singapore 048583

HONG KONG

9/F,

Kinwick Centre 32

Hollywood Road,

Central, Hong Kong

LONDON

50, Great Portland

Street

London EC3V 9EA, UK

GENEVA

Rue de Lausanne 80

CH 1202 Genève,

Suisse

26

ch&cie - regulatory offer

Economy & Finance