Transcript No Slide Title

Applicability and calibration of the CRD
for commodity firms
CFRC WG meeting
23 November 2005
ISDA
ISDA ®
International Swaps and Derivatives Association, Inc.
Capital Requirements Directive
(CRD)
• Transposes the new Capital Accord into EU law.
Approved on 28 September 2005
• Implementation staggered :
– 1/1/2007 for firms using simple approaches
– 1/1/2008 for firms using sophisticated approaches
2
ISDA ®
CRD
• CRD : 3 Pillar approach :
– Pillar 1 : minimum capital requirements;
– Pillar 2 : supervisory review. May lead to additional
capital requirements
– Pillar 3 : disclosure requirements
• Fundamental question : Is CRD adapted to risks
borne by commodity firms on their derivative
business ?
3
ISDA ®
CRD
• Commodity firms do not pose same risks as financial
institutions :
– NO depositor/investor exposure
– NO systemic risk (Enron failure)
– Risks on the physical side already monitored by physical
regulators
• This has motivated light touch capital regulation in the EU
• And no regulation in other key countries (US, Switzerland)
4
ISDA ®
CRD
• Commodity firms’ special case is acknowledged at
political level in the EU:
• CRD Recital 19 (b) The goal of liberalisation of gas and
electricity markets is both an economically and politically
important goal for the Community. With this in mind, the
capital requirements, and other prudential rules, to be
applied to firms active in those markets need to be
proportionate and should not unduly interfere with
achievement of the goal of liberalisation.”
5
ISDA ®
CRD
• Article 45d of the CAD further institutes a carve-out for
commodity firms, which will become regulated by the
earlier of end 2010 and the time by which the Commission
has proposed an appropriate capital regime.
• Calendar is set by the Commission : industry understands
that they are planning to conduct the capital review in
parallel with the MiFID exemptions review, i.e. conclude
by spring 2008.
6
ISDA ®
CRD
• Conclusion : the case for applying the CRD to commodity
firms has not been made
• Further, even if a CRD type approach were retained, the
target insolvency level may need to be distinct from that
applied to financial institutions.
– Target pursued for financial institutions based on Basel I. No
equivalent regime to Basel I exists for commodity firms.
– If a lower target is retained, e.g. 99th percentile instead of 99.9th,
credit risk and operational risk capital charges are reduced
respectively by 50% and 33%.
QUESTION : DO MEMBERS OF THE CFRC WISH TO ARGUE
FOR A RECALIBRATION OF THE CRD ?
IF SO, WHAT PERCENTILE SHOULD BE USED ?
7
ISDA ®
Credit charge re-calibrated at 99.9th perc.
Comparison of K IRB (99.9%) with K IRB (99%)
Capital charge for Exposure=100
25.0000
99.90%
20.0000
15.0000
99%
10.0000
5.0000
0.0000
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
Probability of default
8
ISDA ®
Credit risk charge re-calibrated at 99th perc.
Equivalent rating
AAA
AA
A
BBB
BB
B
9
PD
0.03%
0.04%
0.06%
0.21%
1.28%
6.69%
K IRB 99.9%
115.5%
137.4%
175.4%
360.6%
803.5%
1328.4%
K IRB 99%
34.0%
41.9%
56.2%
137.3%
405.5%
841.5%
Old Standardised New Standardised
160.0%
80.0%
160.0%
80.0%
400.0%
200.0%
800.0%
400.0%
800.0%
400.0%
1200.0%
600.0%
ISDA ®
Operational risk charge re-calibrated at 99th perc.
• Operational risk charge is intended to represent on average 12% of
total regulatory capital for fis.
• Commodity firms are likely to use the Basic Indicator Approach , i.e.
calculate op risk capital as a fixed percentage, alpha, of average
income.
• Currently, alpha corresponding to a 99.9th worst case op risk scenario,
is 15%.
• We are seeking to re-calibrate alpha at the 99th percentile.
• Assuming a split between the various forms of capital (market, credit
and operational) in firms’ overall reg cap, it is possible to compute the
% of income which the operational risk charge should represent if it
were calibrated at the 99th percentile.
10
ISDA ®
Operational risk charge re-calibrated at 99th perc.
• Assumptions [To be verified, based on metal traders’
experience in the UK, and the EFET hypothetical testing
exercise]:
• Overall cap charge split as follows :
– Market: 30%
– Credit: 58%
– Operational: 12%
• Then, the operational risk charge should be computed as
10% of income under the Basic Indicator Approach,
implying a reduction in alpha value of 1/3.
11
ISDA ®
END
• [email protected]
12
ISDA ®