CH&Cie Regulatory hot topics & perspectives in 2015

CH&Cie Regulatory Market WatchHot topics & Perspectives for Banks in 2015

September 2014

Overview

Stephane Eyraud [email protected]

Benoit Genest [email protected]

Introduction & OverviewA different evolution of banking regulation

Functioning of College of supervisors

RWA Benchmarking

Remuneration benchmarking exercise

Basel IV ?

Op Risk & AMA

Pilar 3 | Countercyclical capital buffer

Model Quality Review

IHC

Securitization True Sale

IFRS 9 | IFRS 13

BCBS 239

IRRBB

Disclosure for Own Funds

SREP | ICAAP | ILAAP

Post AQR CVA | LVA | XVA

1. The early 2000sA more technical regulation is being set up.Financial institutions must meet minimumefficiency criteria and be compliant withstandardized accounting format. (Bâle II forrisks, IFRS pour accounting )

2. Late 2000sThe financial crisis had a huge impact onregulatory change. While existing regulationhas been strengthen, new rules have beenset up to cover risks that had beenneglected by the regulatory body (CVA,Stress effects, etc.)

3. TodayWe are taking a major step toward achievinga new kind of regulation. Now the entiremarket is being assessed and taken intoaccount ; before the risk was only assessedat an institution level.(benchmarking, standardization andcomparability …)

Regulatory change is a winding road that have been marked by several key milestones

Introduction & OverviewFrom a bottom up to a top down regulation

1. ComparabilityNew legal texts take into account the possibility of a retrospective action based on benchmarking. This is a foundingprinciple as other steps are required as a consequence of this point (see below).

2. StandardizationCorep, Finrep, SREP … From regulator’s perspective, Banking risk management should be evaluated automatically anduniformly. This also allows better comparability between banks.

3. TransparencyPublication of internal methods used - not only solvency ratios but also the entire information channel - must allow tounderstand how auditing is performed and eliminate grey areas.

4. PeriodicityHaving a stable legislative control model is critical. AQR exercises and stress testing will become periodic. In the same waywe may experiment rotations (a portfolio that use IRBA could temporary use STD method under certain conditions)

5. Centralized regulation body with extended capacity of actionThe role of national supervisory authorities has also been framed. Local leeway have been reduced and bank lobbying willbe all the more so great (defense of national specificities like in France with Crédit Logement)

6. SanctionsThere is a new kind of possible sanctions like obligation to increase provisions, equity or auditing staff. Sanctions are notonly due to breaking the rules like before but can also be impose for deviating from market average standards.

The supervisory authorities’ power is increasing and taking a new direction.

This can be defined by six main principles

Introduction & OverviewPerspectives

Beyond a strengthening regulation, it’s an effective control by the regulatory body that seems to beappearing.

• Supervisory authorities are now working together and try to establish an automatic control at a more high level (allbanks together) instead of the current individual level of control (bank by bank)

• Banks will have to make sure that they respect laws and regulations. They must also follow market best practices.Deviation from market average will become a new instrument of control for supervisory authorities. This can be ona quantitative (e.g., change in RWA) or a qualitative perspective (type of internal model used, size of internal controlfunctions, etc.)

IllustrationEuropean real estate market study by the EBA

Analysis of individual RW (RiskWeighted) deviation and comparisonof ELR (Experience Loss Rate) levels

Source : EBA data collection (reference date : December 2012), EBA calculation

AGENDA

RWA Benchmarking | Art. 78

Securitization True Sale

IFRS 9 | Provisions

Model Quality Review & Post AQR


IRRBB

Among all the topics that might affect regulatory work for financial institutions during the next months, six of them caught our attention

For each of them we have decided to proceed as follow:1. Context and targets2. Potential impacts and effects3. Challenges and different options

1 32

54

6

AGENDA


Securitization TrueSale

IFRS 9 | Provisions

Model QualityReview & Post AQR


IRBB

1

Partie 1

Benchmarking PortfoliosArticle 78 of Directive

2013/36/EU EBA/CP/2014/07

7

Context & objectives Reduce discrepancies between internal models used for the calculation of funds requirements

EBA aims to reduce inconsistent calculations of risk weighted assets

Following the crisis, multiple capital assessments have shown substantial differences between banks in the calculation of their fund requirements.

Even though differences in risk parameters (PD, LGD, VaR,…) may come from differences in the underlying risks, EBA has come up with a regulatory framework in order to monitor and reduce differences in the calculation of capital needs.

Aiming an implementation by April 2015, the EBA has published two drafts:

The regulatory technical standards, defining the workflow of sharing the yearly assessment with the relevant authorities, and the types of benchmarks used (extreme values, standard deviation of the output modelling values, …)

The implementation technical standards, specifying the reporting templates, the IT solutions and portfolios that will be assessed for each type of risk

Workflow under art. 78

Source : Public Hearing on draft RTS/ITS on Benchmarking under Article 78 CRD

EBA designs the supervisory benchmarking portfolios

1Banks calculate own funds

requirements for the supervisory benchmarking portfolios

2

EBA produces a report containing benchmarks in order

to assist competent authorities

4 Banks report the results to the competent authorities and EBA together

with an explanation of the methodologies used

3

Competent authorities assess the quality of the internal approaches

making use of EBA report

5 Competent authorities investigate the reasons for significant difference of the

institutions from peers results and approaches

6

Competent authorities takecorrective actions if there is a clear

underestimation of own funds

7

Competent authorities share the results of the assessment with the EBA

8

EBA may issue guidelines and recommendations to improve supervisory and banks’ practices

9

• Publication of the CRD including art 78 on the annual supervisory benchmarking of internal approaches for calculating own funds requirements for credit and market risk exposures

June, 26 2013

• Publication of the RTS and ITS drafts, consultation running until August, 19 2014

May, 28 2014

• Benchmarking exercise conducted by the EBA

Ongoing

• Final report on the functioning of the benchmarking of internal models, incl. the scope of the model

April, 2015

Why ? [Origin] : There were significant differences in the denominator of the capital ratios (the capital requirements) stemming from material differences in banks' regulatory parameters

What ? [Perimeter] : Internal Ratings-Based Approach (IRBA) and the Internal Market Risk Model (Op Risk excluded)

How ? [Methodology] : Portfolio replication. Benchmarking of Portfolios

Timeline

8

Art. 78| What kind of impact and challenge expects BanksDirect or indirect effects?

Most of the actions to be carried out by the banks should be issued by the EBA from its benchmark analysis. Although the results of the application of Article 78 could cause changes in methodologies of risk management and generate model replications.

Governance, processes & IT

Impacts Description Severity

Internal Model

Strengthening of prudential controls

Action

Optimisation of risk management

EBA draft ITS specify the benchmarking portfolios as well as the templates, definitions and IT solutions that should be applied.

Evolution of Information Systems and Database in order to collect data for the different portfolios

Implementation of a reporting tool

Development of IT solutions

Development of Risk model adapted to the benchmarking portfolio

Update of the documentation of internal models

Depending of the results of the exercise EBA may issue guidelines and recommendations

Implementation of guidelines

Annual assessment by competent authorities of regulatory own fund requirements

Comparison of own fund requirements between standardized approach and internal model and between institutions

Monitoring of the evolution of own funds requirements between two exercise

Having a global vision of all internal models used by European institutions could help them to optimize their risk management

This will give new means to European institutions to compare their risk level

Review of internal model

Underestimation of own fund could lead to an external audit

9

Approach & challenges for the FIEverything becomes comparable and may tend toward uniformity

Indirect Control on the EU Core Tier 1

Direct control (and potential sanctions) on

banks at risk

Regulation underlying objectives Implications for the financial institutions

Indirect control on Bank internal Risk

methodologies

Behind the EBA/CP/2014/07, it seems that the regulatorwants to avoid volatility of the RW and any deviation fromthe mean / Benchmark. This should lead banks toharmonize their methods and limits their room fornegotiations (standardizations of their internal models).

Impact on the contra cyclic buffer and Pillar 2 (macro management of Total EU Core Tier 1 by the EBA with indirect impact on some banks)

Reputational risk

Potential regulatory add-on if the bank is not alignedwith the benhmark

Lobying to strenghten (potential difficulties in defending local particularities)

Potential re-design of some internal models

Alignment of internal methodologies with the benchmatk

Anticipation for more conventional risk models (cone

Detection of atypical risk profile areas: /portfolios and justification to be provided

Anticipate prudential add on piecemeal

Anticipate an emphasis on-site audits especially on Basel 2 models already approved

Better reading of risk profile of other European banks

Negotiations with the regulators to be toughest (strengthening lobbying to predict)

Pragmatic approach to adopt

1

2

3

Illustration :

Correlation

between RW

level and RW

sensitivity in the

EU sample

Source : EBA | FOURTH REPORT ON THE CONSISTENCY

OF RISK WEIGHTED ASSETS | 11 june 2014

AGENDA



IFRS 9 | Provisions



IRRBB

2

Partie 2

SREPDraft Guidelines for common

procedures and methodologies

11

Context & objectives Scoring financial institutions by confronting risk processes and methodologies with business models

SREP’s purpose is to enhance transparency in the banking system by scoring the financial institutions on various criteria

Financial institution scoring framework

On 7 July 2014, EBA published a new consultation paper on Guidelines for common procedures and methodologies for the SREP under Article 107 of CRD IV. The consultation closes on 7 October 2014

Guidelines are expected to be applied by 1 January 2016

This regulation proposes a common methodology to assess the viability of financial institutions and the compliance between processes, governance, methodologies, measures, the business models and the environment in which the financial institutions evolve

It aims at enhancing the transparency across the financial system by assessing four major components:

Governance | Analysing consistency in internal governance and controls, procedures and processes, etc…

Business models | Studying the business environment as well as the sustainability of the strategy, financial plans, etc…

Capital adequacy | Assessing risk contributions to capital (Pillar I as well as Pillar II risks) and the consistency of risk measures, etc…

Liquidity and funding| Identifying risks to liquidity, as well as liquidity sources and resources and their capacity to cover liquidity and funding needs in terms of financial and economic distress

1 2 3 4

1. Size of banks, Systemic Banks

2. Business model &Strategy

3. Internal governance & control

4. Individual Risks (credit, market,…)

5. Capital adequacy (ICAAP,..)

6. Individual risk to liq. & funding

7. Liquidity adequacy

Level of risk- +

1

2

2

3

3

2

2

1

2

2

3

3

2

2

1

2

3

4

F

Overall score

What will the categorisation of financial institutions lead to? All categories of financial institutions will be monitored on a quarterly basis based on the key indicators (RWA, LCR, etc…) Systemic / very large institutions will have to submit to the SREP on a yearly basis whereas for smaller institutions, the assessment will be done each 2 / 3

years What the overall score will lead to ?

The overall score will allow comparing the viability of institutions. In other words, knowing the business model and the business environment, are the governance as well as risk metrics and capital resources sufficient to withhold the activity

12

Impacts on the financial institutions More qualitative than quantitative ?

Even though the quantitative side (respecting the regulatory thresholds and ratios) is still a major topic, the qualitative sidemight be more challenging while assessing the SREP

Governance and organisation


Models & methodologies

Data quality and management

Action

Processes & documentation

Once more risks governance will be most challenging. Internal reportings as well as processes must be clearly defined and controls addressed accurately

Finally, senior management involvement and understanding of risks in accordance with the strategy plan will be challenged

Adjust internal governance

Current methodologies and models will be challenged by the regulator which will seek for a EU-harmonization and therefore lead to get rid of specific methodologies / models used so far by the financial institutions

Design new models

The AQR revealed the difficulties for financial institutions to provide accurate data on a granular and detailed level

Data quality and management is definitely a pain point for banks, and within the SREP, we believe that a focus on data quality and lineage is key

Improve Data quality

Documentation is a major point since regulators seek transparency Define new documented processes

13

Approach & challenges for the FISREP induces 3 major challenges for the FI

Governance / capital & liquidity allocation

Methodologies & models

EBA underlying objectives Implications for the financial institutions

Control & processes

New expectations from the local regulator harmonisation of ICAAP / ILAAP framework

Get rid of local specificities of ICAAP / ILAAP framework implementation

Homogenise capital & liquidity measures

Identify methodologies & models

Get rid of specific methodologies and models by comparing the institution’s models with a EU-wide benchmark

Simplification, strengthening and harmonisation of control & monitoring framework

Review of ICAAP & ILAAP framework

Adjustment of risks to capital profile & liquidity and funding risk profile

Less flexibility in terms of capital & liquidity allocation

Challenge of all deviations, exceptions, exemptions validated by the local regulator so far

Potential P & L / Balance Sheet impacts

Less flexibility in terms of methodology / model design

Establish new control processes & monitoring / reporting tools

Improve IS / IT

Launch a gap analysis based on the SREP scoring methodology in order to identify the weaknesses of the financial institution in its capacity to cope with these new requirements

Based in findings & conclusions of the gap analysis, score the institution

Establish a clear work plan with all the stakeholders (top management, risk, finance, compliance) prioritising quick wins while planning medium and long term projects

Launch top priority projects


1

2

3

AGENDA



IFRS 9 | Provisions



IRRBB

3

Partie 3

IRRBB measurement &

managementEBA Consultation Paper on

amendments to Guidelines on

IRRBB (EBA/CP/2013/23)

IRRBB is a complex and often not very well understood risk with divergent practices prevailing among different institutions and regulators across the EU

It is well documented that unexpected changes to IRRBB different components (repricing risk, yield curve risk,basis risk, optionality) can have dramatic consequences on a bank’s profitability and solvency. This is especiallytrue in the current exit phase from monetary easing policies which is an uncharted territory for IRRBB

Currently, institutions are required to manage IRRBB as part of ICAAP / SREP and to report to their supervisors iftheir economic value declines by more than 20% as a result of standard supervisory shocks

However, the existing divergent approaches among regulators/supervisors and institutions produceinconsistent outcomes – both in terms of the management of IRRBB by institutions, and in terms of supervisoryresponses

Context

Objectives

As a consequence, new guidelines proposed by the EBA establish the +/- 200 bp shock as the standard outlier test & require institutions to overhaul their IRRBB management framework The new guidelines will make compulsory the calculation of a harmonized IRRB +/- 200 bp outlier test by

2015-2016

In addition, the new guidelines are focused on five main areas of interest risk assessment/control :

a. the setting up and use of a range of alternative scenarios for stress-testing IRRBB (historical scenarios, simulations)

b. Review of key behavioral assumptions used in IRRBB measurement (accounts with optionality, Non determined maturity products, equity duration)

c. methods of measuring aggregated interest rate risk and IR sub-types / components (repricing, yield curve, basis risk, optionality)

d. the governance of interest rate risk including independent model validation and periodic reporting obligations

e. the identification, calculation and allocation of capital to IRRBB within internal / economic capital models

IRRBB | Institutions must be prepared to comply with upcoming new regulations on IRRBB Piecemeal approaches will have to be replaced by a comprehensive IRRBB management framework

16

IRRBB | Institutions must be prepared to comply with upcoming new regulations on IRRBB The new regulations on IRRBB are not finalized yet due to the complexity of the different subjects

The framework for the management of IRRBB should be proportionate to the nature, scale and complexity of an institution

Institutions & supervisors will need to be confident that the scenarios used for measurement and stress testing identify all material interest rate risks (yield curve risk, basis risk etc.)

Stress testing for IRRBB will have to be more closely integrated in the institution’s overall stress-testing structures and programmes

IRRBB Scenario and Stress-testing

Area Description Regulation maturity

Key behavioural assumptions made by banks in order to assess their IR risk must be verified : accounts with embedded optionality (prepayment options, options to extend duration, options to change the interest rate basis – from fixed rates to variables), accounts without repricing dates, investment term of equity capital.

IRRBB Measurement assumptions

Institutions should use a variety of quantitative tools and models to measure the various aspects of interest rate risk, taking into account the limitations of each tool

An institution should be aware of the risks arising as a consequence of the accounting treatment of transactions in the banking book (i.e. rules on hedge accounting)

IRRBB Measurement methods

Institutions should define their overall risk tolerance limits to IRRBB and to each of its sub-types and components. The management body is responsible for setting and reviewing these limits

Institutions should validate their IRRBB models and related IT systems by a suitably qualified and independent function

IRRBB Governance

Internal capital should be allocated to reflect any open IR positions within the banking book, taking into account an institution’s risk appetite and the governance/control structure

Internal capital should be calculated based of stated risk limits (not actually used risk limits)IRRBB Capital

allocation

17

IRRBB | Institutions must be prepared to comply with upcoming new regulations on IRRBB Compliance with the new regulations will require extensive adaptation work and dedicated resources

EBA underlying objectives Implications for the financial institutions

Revise and overhaul their IRRBB measurement and management process by addressing currently identified loopholes

Establish a clear work plan with all the stakeholders (top management, risk, finance, compliance) prioritising quick wins while planning medium and long term projects

Anticipate for new regulation standards in term of harmonized risk calculation


IRRBB Scenario and Stress-testing

Adaption of IT systems and procedures for stress-testing IR scenarios for the standardized outlier test and other scenarios : non parallel shifts/tilts/changes in the shape of the yield curve, historical scenarios, simulation of interest rate paths

Review of the general stress-testing frameworks to integrate IRRBB with other risks with proper estimation of correlations & dependencies across multiple risk types

1

IRRBB Measurement assumptions

Adaptation of IR models and measurement procedures to accommodate for changing behavioural assumptions (including sensitivity analysis, back-testing of model results and conservation margins)

Development of appropriate pricing and risk mitigation strategies

2

IRRBB Measurement methods

Adaptation of risk management systems to include different measures of IRRB and its different components with both an earnings perspective and an economic value perspective

Compliance of banks’ accounting practices to the new rules on IR hedge accounting contained in IFRS 9 following their expected transposition by the European Commission in 2015 or 2016

3

IRRBB Governance

Validation of IRRBB models should be included in the general model validation framework and planning of the institutions

Internal reporting procedures on IRRBB should be formalized and management should be responsible of the overall IRRBB governance process

4

IRRBB Capital allocation

Potential move of IRRBB from Pillar 2 to Pillar 1 (on-going discussion between the industry and different regulators)

Economic capital models should include capital charges for IRRBB

5

AGENDA



IFRS 9 | Provisions



IRRBB

4

Partie 4

Provisions & ReservesIFRS 9

19

Context & objectives Improve accounting for financial instruments by amending the classification and measurement requirements and adding a new expected credit losses model

The major change for the banking industry will be driven by the impact the new EL impairment model

IFRS9 new forward looking expected loss impairment model philosophy

The IASB published the final version of IFRS 9 Financial Instruments in July 2014

The new standard will come into effect on 1 January 2018 with early application permitted

The improvement introduced by IFRS9 includes:

1. A logical model of classification and measurement driven by cash flow characteristics and the business model in which an asset is held. This single, principle-based approach replaces existing rule-based requirements that are complex and difficult to apply

2. A forward looking expected loss impairment model: During the financial crisis, the delayed recognition of credit losses on loans was identified as a weakness in existing accounting standards. IFRS 9 introduces a new, expected loss impairment model that will require more timely recognition of expected credit losses

3. A substantially-reformed model for hedge accounting with enhanced disclosures about risk management activity. The new model represents a substantial overhaul of hedge accounting that aligns the accounting treatment with risk management activities, enabling entities to better reflect these activities in their financial statements

What will the adjusted classification and measurement of asset lead to? Adjusted valuation methodologies Potential impacts on Balance Sheet and P&L

What will the new expected loss impairment model lead to? New provisioning principles New models & provisioning methodologies Impact on provision stock and therefore the P&L

Objective :

smooth

effects of the

credit cycle

Objective :

Coverage of

know risk

Coverage of risks

Credit cycle(7 to 10 years)

Specific

provisionning

Collective

provisionning

Bottom of

provision

cycle

Peak of the

provision

cycle

Pro-cyclicity

Pro-cyclicity effect

mitigation

Floor (12-

months EL)

x

0 Time

20

Impacts on the financial institutions Whether in terms of risk management or in terms of models & methodologies, the IFRS 9 impacts are significant

IFRS 9 will have 2 major impacts : A potentially negative impact on the stock of provision Reshape all current provisioning methodologies and models through new expected loss impairment models

Governance & organisation


Risk management

Models & methodologies

Action

Data & IT

Impact on the current governance in terms of provisions management• Will lead to a new governance at a group level aiming to manage more closely provisions at a

consolidated level and the potential links / impact on the capital allocation & management

Impact on decision making process from the risk manager to the top management for release / charge for impairment

New provisioning principles and associated governance

Increase of the stock of provisions, especially the new stock of provision for the good book

Impact of new asset valuation model on the balance-sheet

Financial planning

Arbitrage

Need of homogenisation of valuation & provisioning models

Need of new expected loss impairment models

Need of new valuations models

New methodologies & model design

“Historical information is always considered to be an important anchor or base from which to measure expected credit losses”

Provide accurate data for the process of valuation of assets and the expected loss impairment models

Reinforce data quality and management

Data gathering & cleaning

Align IT strategy

21

Approach & challenges for the FI3 years to close the gap…

Risk management

Methodologies & model design

IFRS9 underlying objectives Implications for the financial institutions

Harmonisation of specific & collective provisions variation

The compensation of the fluctuations inherent in specific provisioning

Smooth the Cost of Risk over time

Provision coverage rate optimization

Better anticipation of crisis & economic trends

Consistency with Basel II / III methodologies

Design of models based on market best practices and homogenisation within a group

P&L Impact on Cost of Risk of the financial institution and therefore the RoE, RoRWA

Balance sheet adjustment (impact of asset valuation)

Impact on prudential requirement including the solvency ratio (EL-provision gap)

Manage the increase of the stock of provision through financial planning

Arbitrage of provisions-consuming portfolios / counterparties

Design of a dynamic provisioning model

• Consistency between collective / specific provisioning

• “independency vis-à-vis the economic cycle” = Through the cycle provisioning

• Transparency / manageability

Based on common principles, align all the methodologies & models

Launch fist IRFS 9 impact analysis on provisioning level

Establish a first estimate of the gap between current level and target level of provision

Define provisioning principles at a Group level

Map & segment the provisions

Define the target modelling scope and the number / type of new models to design


1

2

AGENDA



IFRS 9 | Provisions



IRRBB

5

Partie 5

True Sale SecuritizationA leveraged approach for long-

term balance sheet performance

23

True Sale Securitization | A renewed hot topic for financial institutionsAfter some less appealing time, securitization is coming back

1

• The Originate-to-Distribute (OTD) model was deployed after 2008 across banks as regulatory requirements pressured senior management to act on their (off) balance sheet exposures. The expected benefits were initially:

• Deleveraging| For the originator, lighten the balance sheet and associated capital usage

• Diversification benefits| For the investor, access specific layers of risk and yields

• Regulatory pressure | For the regulator, less leveraged financial institutions under control

Chappuis Halder & Cie Can help identify opportunities? We think the context of 2014/2015 should see the resurgence of TS securitization, as rating agencies are scrutinizing and investors are looking for yield across the curve. We can leverage our state-of-the-art Regulatory Watch and our first class accounting and CIB experience to identify efficient and bespoke TS Securitization opportunities

TS Securitization backed by strong

rationale…

superseded as rates

environment subsided…

but is gaining some momentum

with regional specificities

• As market rates subsided and investors hesitated further on investing in ABS, other vehicles were preferred to OTD, soon redefined as Originate-to-Hold:

• Covered bonds | Offered diversification opportunities for investors seeking asset recourse in case of default

• Synthetic securitization | Namely via Total Return Swaps to relieve temporarily On and Off balance sheet exposures. TRS offers a temporary transfer of risk to the swap counterparty, obliging the original issuer in return to increase counterparty risk and taking back a future asset on its balance sheet

• Market and regulatory environment favour a come back to TS Securitization

• US and Europe | European and US banks are deploying a new set of true sale securitization, amid upcoming rate hike, accounting pressures, profit-making positions and fast-approaching capital and liquidity metrics as well as a request for Asset Quality Review from the ECB.

• Asia| Chinese regulators are now preparing to expand from WMP requiring no regulatory approval to western-style securitization in the onshore market, including credit card and auto-loan

2

1

24

True Sale Securitization | The strategic impacts of True Sale SecuritizationA competitiveness vector in a cloudy market and regulatory environment

In today’s global regulatory environment (Basel III, BIS asset encumbrance, ECB’s AQR), banks are incentivized to increase their capital buffers, be it for regulatory compliance or internal performance targets such as ROE, Liquidity and funding cost.

• As opposed to synthetic securitization and covered bond issuances, a true sale achieves an effective and full transfer of a bank’s (the originator) targeted pool of selected assets from its balance sheet to a Special Purpose Entity.

• Although this technique is not new and was at the center of excessive risk assimilation and transfer, the recent market levels, ahead of a potential US rate hike, allow for asset sale at decent, possibly positive MtM.

• This activity allows to operate in compliance with global and local regulations, while improving balance sheet performance and ROE.

An incentive to deleverage

Impacts Description Key advantages

A need to improve performance

A compelling obligation to act

• Decreases asset encumbrance levels TS allows banks to decrease asset encumbrance levels and therefore the need for additional collateral. TS generates a virtuous funding circle as the cash generated from the true sale can be used to fund bank’s

activities and removes the need to use retained assets as collateral to source central bank funding.

• Reduces funding costs With less assets on balance sheet, the cost of funding is minimized as the need for collateral is lowered. This also removes the future risks of increased funding costs incurred in the event of a difficult access to

funding (downgrade, liquidity crisis, increased regulatory buffers…).

• Increases competitiveness Banks with lightened BS are more agile and can benefit from preferential funding costs as credit

worthiness is improved. Extra cash generated by the true sale can be reused to support other ailing businesses

• In periods of financial stress, when risk appetite falls sharply due to increased counterparty risk and market conditions are stressed, assets are likely to be sold at a discount (depreciated and illiquid).

• However, with a true sale, once assets have been securitized, the level of profits has been locked in and cash is immediately available to the bank.

• Lightens bank’s balance sheet from non/low-performing assets, long maturities, risks no more acceptable due to high capital consumption or risk tolerance breach; an opportunity to improve assets’ quality

• Means to source top quality and liquid equity capital, reducing regulatory capital obligations, improving leverage, capital and liquidity metrics

• Builds a less risky profile and reduces need for heavy collateralization

• Reduces the total amplification of market volatility on the bank’s balance sheet

• Reduces funding costs charge by treasury department on assets

• More agile and cost-effective businesses

• Central but also potentially regional / local, when necessary

• Positioning for the upcoming rate hike and fast-approaching capital and liquidity constraints

• Locking in potential profits in a still low rate/vol environment

• Potential future legal constraints would hinder such risk transfer

An efficient technique for banks to turn these regulatory constraints into business opportunities is to raise cash by selling assets held on balance sheet via TS securitization

25

True Sale Securitization |Disruptive approach for a lasting effort“Regulators look ahead to 'Basel 4'”

ECB aims to complete the AQR task before it takes over direct responsibility for supervision of significant banks from 4 November 2014

EBA’s CRR/Basel III milestone for early 2015

• Introduction of the LCR: Initial introduction of the Liquidity Coverage Ratio (LCR), with a requirement of 60%. This will increase by ten percentage points each year until 2019.

• Leverage ratio, Parallel run II: The leverage ratio and its components will be tracked and disclosed but not mandatory.

• Minimum capital requirements: Higher minimum capital requirements are fully implemented.

Uncertainty about future market conditions makes it worth implementing in the nearest future.

Change drivers Urgency

Performance

Regulatory

True Sale

Securitization

AGENDA



IFRS 9 | Provisions



IRRBB

6

Partie 6

Asset Quality Review A challenge still in stake

27

Context & objectives Model Quality Review : Consequences of the asset quality review exercise

1 2

MQR’ purpose will be to homogenise the credit risk models … by complying the EBA’ recommendations

• This regulation will suggest a common guidelines to assess the compliance of the Basel 2 models management

• It would aim at enhancing the transparency across the quality of models procedure and risk management by assessing four major components:

• Data quality | Analysing data’ pertinence in the models design

• Guidelines| Homogenization of the models compliance assessment (within Basel 2 regulatory requirements)

• Crisis anticipation| To have robust models which will respond to crisis’ hypothesis

• Consistency of the European banks’ processes | To assume a common and compliant risk management through the different banks of the European Union

• The models compliancy will be assessed based on the review of a set of dimensions :

1 2 3 4

1. Portfolio coverage

2. Internal governance

3. Methodology

4. Risk management

5. Internal ratings system

6. Capital equity

Cost of impact- +

What will be the scope of banks for the models review ? The IRB-A compliant banks and the ongoing certification banks

What the models compliance will lead to ? The overall models compliance will allow to assess the suitability of the Basel 2 models across institutions and thus, the optimal Risk Weight estimation

28

Model Quality ReviewThe ongoing challenge for the European banks

Even the IRB-A’ banks will have to prove the relevancy of their models and the adequacy of the risk management

Governance


Data quality and management

Methodology

Action

Capital equity and prudence margin

The internal and external validation processes as well as the provided documents, certifications reports and follow-up will be challenged

A referential of all the validated models (and ongoing validation models) will be monitored

• The “no compliance” of the banks’ governance should implied limits in the models validation status

Adjust internal governance

A road map of all the Basel models

Following the AQR, the risk management should monitored the different steps of the modelling data feed

The focus will also be done on the specifics treatment for the model construction and the pertinence of the whole Basel 2 indicators calculation process

• An inadequacy data process will imply a huge work of adjustment and modifications for banks

Homologate the data feed process

Assess the suitability of regulatory indicators (impacting the RW)

The models methodology will reveal the capacity of the banks to use a relevant and Basel 2 compliant model to estimate the credit risk

An inadequacy of the methodology (comparing to the European benchmark and guidelines) will lead to a weak in the RW estimation

• The banks will have to update their methodology if using specific one (not compliant with the best practice)

Homogenise and improve the methodology (internal models)

Identify the limits

Additionally to the re-estimation of the Basel 2 parameters (in case of inadequacy of the models or methodologies), the challenge for the banks will also be to keep in line with the global benchmark of prudential margin

• An underestimate prudential margin will lead to a re-estimation of the RW and thus, the capital equity

Adjust the RW

Measure the impact on the capital equity

29

Approach & challenges for the banksHow to be prepared ?

MQR| How to be prepared ?

Methodologies & models

EBA underlying objectives Implications for the banks

Control & processes

The availability of a global governance framework in the bank and its subsidiaries will provide the high level of Basel 2 compliancy and transparency

The suitability of each validation steps will assess the stability of the models’ robustness and reinforce the clients confidence

A global methodology of models deployment will be a guarantee to the Basel compliance of the banks

The identification of the banks exemption to the global methodology will be measured and supervised

An adequacy of the RW estimations (PD, LGD & CCF)

An optimal prudence margin assessment

A benchmark of RWA density for all the banks

To summarize and update the relevant documents

To prepare the suitability of the RW estimation process

To expose the action plan, alerts and adjustment planned in the whole RW estimation process

Challenge of all deviations, exceptions, exemptions validated by the local regulator so far

To monitor the models’ robustness and adaptability within the economic cycle reality

To monitor within a long cycle the credit risk level and thus to ensure the optimal prudence margin (adjustment…) of the RW estimation

This review will follow the AQR’ results planned in Autumn’ 2014. The limits revealed by the AQR’ review will highlight the focusses point for the MQR exercise

The huge work can be done as a pre-request

The information to provide and the tests to proceed can be listed and done as of today (for a better anticipation)


1

2

3

AGENDA



IFRS 9 | Provisions



IRRBB

APPENDICES

31

AppendixSREP

A. SREP Framework

B. Overall SREP Score presentation

32

SREP Framework

A – Categorisation of institutions

B – Monitoring of key indicators

C – Business model AnalysisD – Assessment of internal governance and institution-

wide controls

F – Assessment of risks to liquidity & funding

E – Assessment of risks to capital

Assessment of inherent risks and controls

Determination of own funds requirements & stress testing

Capital adequacy assessment

Assessment of inherent risks and controls

Determination of liquidity requirements & stress testing

Liquidity adequacy assessment

G – Overall SREP assessment & Overall SREP score

H – Supervisory measures

Other supervisory measuresQuantitative liquidity measuresQuantitative capital measures

I – Early intervention measures

33

SREP Score presentation

Risks to liquidity and funding scores

Credit score

Market score

Operational score

Interest rate score

Risks to capital scores

Overall SREP score

SREP liquidity

Additional own funds

Macro-prudential requirements

TSCR and OCR

economic cycle

SREP Capital score

leverage

Liquidity risk score

Funding risk score

Funding & liquidity adequacy

Overall assessment of liquidity

Identification of specific liquidity req.

Quantification of specific liquidity req.

Articulation of specific liquidity req.

Governance framework

Corporate and risk culture

Orga and functioning of the Mgt body

Remuneration policies and practices

Governance score

2

Business environment

Business model

Strategy and financial plans

Business model viability

Business model score

1

Sustainability of the strategy

Sustainability of the strategy

Risk management framework

Internal control framework

IS and business continuity planning

Recovery planning

Capital Liquidity & Funding

3 4

34

AppendixIRRBB

A. Alternative methods for IRRBB measurement

B. Key challenges and success factors of a stress-testing exercise

35

Earn

ing

mea

sure

s

Quantitative tools and models

Appendix 1 | Tools for measuring different components of IRRBB

Source : EBA/CP/2013/23

Eco

no

mic

val

ue

mea

sure

s

Earnings at risk

Modified duration of equity and PV01 of equity

Partial modified durations and partial PV01

Effective duration of equity

Capital at Risk / Economic Value of Equity

Capital at Risk / Economic Value of Equity

Description Advantages and limitations

Repricing risk

Potential risk types

Repricing risk Yield curve Basis risk Option risk

Repricing risk

Yield curve risk

Repricing risk Option risk



Gap analysis measures the arithmetic difference between the nominal amounts ofinterest-sensitive assets and liabilities of the banking book in absolute terms. Itallocates all relevant interest-sensitive assets and liabilities into predefined timebands according to their next contractual repricing date or behavioral assumptionsregarding the maturity

Simplicity Static model that does not take account of the interest

sensitivity of the optionality parameters Yield curve and/or basis risk cannot be analyzed adequately

EaR measures the loss of net interest income over a particular time horizon (1y/5y) resultingfrom interest rate movements, either gradual or as a one-off large interest rate shock. EaR isthe difference in net interest income between a base scenario and alternative scenario. Withproperly designed comprehensive stress test scenarios it is a dynamic method that takesaccount of all components of the interest rate sensitivity

Analyze the interest rate risk profile of the banking book Good indication for the short-term effects of convexity and yield curve

risk Highly sensitive to assumptions about customer behavior and

management responses to different scenarios Changes in earnings outside the observation period are ignored

Modified duration shows the relative change in the market value of a financial instrumentcorresponding to marginal parallel shifts of the yield curve.PV01 of equity expresses the absolute change of the equity value resulting from a one basispoint (0.01%) parallel shift of the yield curve

Analyze the economic value impact of a given change in interest ratesrelating to a particular class of assets and liabilities or the balancesheet as a whole

Large movements in interest rates can’t be measured accurately Does not take account of the interest sensitivity of the optionality

parameters.

These partial measures show the sensitivity of the market value of the banking book to amarginal parallel shift of a yield curve in particular maturity segments. To each sub-portfolio’spartial measure a different magnitude of a parallel shift can be applied by which the effect ofthe change of the shape of the yield curve can be computed for the entire portfolio.

Analyze the impact of the changes of yield curve shapes on theeconomic value of the banking book

Only applies to marginal shifts of the yield curve within each segment Does not take account of the interest sensitivity of the optionality

parameters

Effective duration measures value changes due to marginal parallel shifts of the yield curve. Anexample is the modified duration that additionally arises from the interest rate sensitivity ofembedded optionality.

Analyze the economic value impact of a given change in interest ratestaking account of the option risk

Only applies to marginal shifts of the yield curve within each segment

CaR/EVE measures the theoretical change in the net present value of the balance sheet andtherefore of its equity value resulting from an interest rate shock. Account needs to be takenof the fact that size and timing of the cash flows may differ under the various scenarios as aresult of customer behaviour. This measure is designed to account also for basis risk and it canestimate the long-term effect of a change of a yield curve shape if alternative scenarios areadequately designed.

Comprehensive measure of interest rate risk that takes account of allcomponents of interest rate risk.

Heavily dependent upon assumptions made as to timing of cash flowsand the discount rate used.

The method may underestimate the short-term effect of convexityand yield curve risk on the solvency of the institution.

The VaR method measures the expected maximum loss of market value that can be incurredunder normal market circumstances over a given time horizon and subject to a givenconfidence level. The VaR approach covers three different techniques: Historical simulation,Variance-covariance matrix and Monte Carlo simulation.The extent to which different interest rate risk types are measured depends on the modeldesign and scenarios used.

Takes account of the historical volatility of prices, interest rates anddiversification effects in or between portfolios or balance sheetpositions

Does not adequately cover the tail risk Method less appropriate for portfolios with high optionality Very demanding in terms of technology and computation.

Static models Dynamic models

Gap analysis

36

Successful completion of a stress-testing

process

Data, systems & disclosures

Project implementation

Resources and capabilities

Methodology

Governance & communication

The limited period allowed for the exercises, require a very efficient project management to meet regulatory tight deadlines

Tasks need to be clearly defined, streamlined and rigorously monitored

Supervisors assess results as well as the way they are produced

Completeness, consistency (e.g. finance vs. risk data) and (more importantly) quality

Massive data from different sources Compliance with stress test

requirements (e.g. AQR results used as inputs)

Consistency with external definitions (e.g. EBA definitions) and accounting principles in force

Heavy documentation, flexibility to answer additional data requests from supervisors

Stress-testing is a very burdensome process.. Recent CCAR exercises suggest that banks will need more people dedicated to the process

The increased complexity and scope require a mix of quantitative, financial, IT and/or economic skills

Excellent capacity for the analysis of regulatory guidelines and identify which texts apply to the bank

Flexibility in incorporating new approaches in ST framework is key

Optimize internal modeling since supervisors increasingly rely on internal models and assess their quality

Translate macro-scenarios into risk factors Leverage on benchmark Detailed documentation of modeling

approaches used by the bank

More integrated approach across all areas and business lines of the bank (front office, finance, risk, etc.)

Board and senior management need to be involved in the development and operation of the stress-testing : close oversight and communication throughout the process

Failure to pass the tests, and the way to process the stress exercise, can lead to an unexpectedimpact on the firm’s reputation vis–à-vis the market or investors

Appendix 2 | Key challenges and success factors of a stress-testing process

37

ProjectImplementation/Governance/

Resources

Scenarios

Results/Documentation

Data

Risk modeling

• What processes? How to ensure involvement of the top management in the end-to-end process?

• What is the optimal mix of competences?

• What coverage of risks? Which portfolios? Which entities?

• What scenarios to be used? At which level of severity? What is the planning horizon?

• What models? What parameters to be stressed? How to translate macro-scenarios into risk factors? What level of sophistication? How to value capital impact?

• How to leverage on existing documentation? What are the new requirements?

• How to align the task of documentation with actual performance of the test? How to dot it on time ?

• What data are necessary inputs for scenarios and stress-tests? How to respond to additional data requests from regulators?

• What level of industrialization achieved by implementing (or not) a stress library?


38

Successful completion of a stress-testing

process

Data, systems & disclosures

Project implementation

Resources and capabilities

Methodology

Governance & communication

The limited period allowed for the exercises, require a very efficient project management to meet regulatory tight deadlines

Tasks need to be clearly defined, streamlined and rigorously monitored

Supervisors assess results as well as the way they are produced

Completeness, consistency (e.g. finance vs. risk data) and (more importantly) quality

Massive data from different sources Compliance with stress test

requirements (e.g. AQR results used as inputs)

Consistency with external definitions (e.g. EBA definitions) and accounting principles in force

Heavy documentation, flexibility to answer additional data requests from supervisors

Stress-testing is a very burdensome process.. Recent CCAR exercises suggest that banks will need more people dedicated to the process

The increased complexity and scope require a mix of quantitative, financial, IT and/or economic skills

Excellent capacity for the analysis of regulatory guidelines and identify which texts apply to the bank

Flexibility in incorporating new approaches in ST framework is key

Optimize internal modeling since supervisors increasingly rely on internal models and assess their quality

Translate macro-scenarios into risk factors Leverage on benchmark Detailed documentation of modeling

approaches used by the bank

More integrated approach across all areas and business lines of the bank (front office, finance, risk, etc.)

Board and senior management need to be involved in the development and operation of the stress-testing : close oversight and communication throughout the process

Failure to pass the tests, and the way to process the stress exercise, can lead to an unexpectedimpact on the firm’s reputation vis–à-vis the market or investors


39

AppendixIFRS 9

A. Classification and measurement

The classification and measurement approach

B. Expected loss impairment model

Overview of the impairment requirements

C. Hedge accounting

Fundamental review of hedge accounting Aspects reconsidered

40

The classification and measurement approach

IFRS 9 applies one classification approach for all types of financial assets, including those that contain embedded derivative features. Financial assets are therefore classified in their entirety rather than being subject to complex bifurcation requirements

Two criteria are used to determine how financial assets should be classified and measured:a) the entity’s business model for managing the financial assets; andb) the contractual cash flow characteristics of the financial asset

Process for determining the classification and measurement of financial assets

Held to collect contractualcash fl ows only?

Instruments within thescope of IFRS 9

Contractual cash flows are solelyprincipal and interest?

Fair value option?

Fair value throughprofit or loss

Amortisedcost

Fair value option?

Fair value through othercomprehensive income

YES

NO

YES

YES YES

NO

YES

NO

NO

NO

Held to collect contractualcash flows and for sale?

Classification and measurement 1

41

Overview of the impairment requirements

As soon as a financial instrument is originated or purchased, 12-month expected credit losses are recognised in profit or loss and a loss allowance is established

This serves as a proxy for the initial expectations of credit losses

For financial assets, interest revenue is calculated on the gross carrying amount (ie without adjustment for expected credit losses)

Stage 1

Impairmentrecognition

Interest revenue

12-monthexpected

credit losses

Effective intereston gross carrying

amount

Stage 2

If the credit risk increases significantly and the resulting credit quality is not considered to be low credit risk, full lifetime expected credit losses are recognised

Lifetime expected credit losses are only recognised if the credit risk increases significantly from when the entity originates or purchases the financial instrument

The calculation of interest revenue on financial assets remains the same as for Stage 1

Lifetimeexpected

credit losses

Effective intereston gross carrying

amount

Stage 3

If the credit risk of a financial asset increases to the point that it is considered credit-impaired, interest revenue is calculated based on the amortised cost (ie the gross carrying amount adjusted for the loss allowance)

Financial assets in this stage will generally be individually assessed

Lifetime expected credit losses are still recognised on these fi nancialassets

Lifetimeexpected

credit losses

Effective intereston amortised cost

Description

Expected loss impairment model 2

42

Fundamental review of hedge accounting Aspects reconsidered

Hedgeaccounting

Objective

Alternatives tohedge

accountingHedged items

Presentation and

disclosure

Hedginginstruments

Groups and netpositions

Effectivenessassessment

Discontinuationand rebalancing

Hedge accounting 3

Economy & Finance

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