Standardised Approach for Counterparty Credit Risk (SA-CCR)
The EBA's final draft amending RTS on SA-CCR, part of the EU Banking Package, enhances the original Basel Committee framework. Key updates include new formulas for calculating supervisory delta for commodity options, crucial for handling negative prices.
Comprehensive Overview of the Standardised Approach for Counterparty Credit Risk (SA-CCR)
On 24 June 2024, the European Banking Authority (EBA) published its final draft amending regulatory technical standards (RTS) on the Standardised Approach for Counterparty Credit Risk (SA-CCR). This final draft is a critical component of the new roadmap on the EU Banking Package.
SA-CCR: Historical Context and Evolution
The journey of SA-CCR began with the Basel Committee on Banking Supervision (BCBS), which developed this framework to calculate the exposure at default (EAD) for derivative transactions. The European Banking Authority (EBA) adopted SA-CCR, enhancing the methodology with more precise and risk-sensitive measures compared to its predecessors, the Current Exposure Method (CEM) and the Standardised Method (SM).
In December 2019, the EBA finalised and published draft RTS on SA-CCR, which were subsequently published in the Official Journal of the EU (OJ) in March 2021. These RTS are set to be expanded to include specific formulas for calculating the supervisory delta of commodity options, compatible with negative commodity prices, as part of the continuous improvement of the framework.
Source
[1]
Alessandro Micagni
[2]
Alessandro Micagni
Key Components of SA-CCR
SA-CCR encompasses several critical components that contribute to a comprehensive calculation of counterparty credit risk:
- Replacement Cost (RC): Represents the current exposure of a bank's derivative transactions by determining the mark-to-market value of all derivative positions and applying netting agreements.
- Potential Future Exposure (PFE): Estimates the potential increase in exposure over the life of a derivative contract, considering the type of derivative, remaining maturity, and market volatility. PFE is forward-looking and captures the uncertainty in the derivative's value over its life.
- Multiplier: Adjusts the PFE based on collateralization and netting benefits, reflecting the effectiveness of risk mitigation strategies. It reduces the PFE to account for the collateral held against derivative exposures.
- Add-On Factors: Specific factors applied to different asset classes—such as interest rates, commodities, equities, and foreign exchange—to scale the PFE appropriately for each derivative type's characteristics.
Standardised Approach for Counterparty Credit Risk:
Enhancements and Risk Sensitivity
SA-CCR introduces significant enhancements over previous methods by incorporating more risk-sensitive measures and providing a standardized approach aligned with international regulatory standards. Key improvements include:
- Granularity and Precision: Greater differentiation between various types of derivatives and asset classes ensures accurate risk measurement.
- Sensitivity to Market Conditions: The framework adapts to changing market conditions, including scenarios with negative interest rates or commodity prices.
- Regulatory Alignment: Consistency with global regulatory standards set by the BCBS promotes international compliance and enhances global financial stability.
CRR3 and SA-CCR Recent Regulatory Updates
The recent updates under CRR3 and the EBA's adoption of SA-CCR reflect its ongoing evolution to address emerging risks and market developments. Notably, the amendments to the supervisory delta formula for commodity options ensure the framework remains robust against negative pricing scenarios. The comprehensive review and expansion of the existing RTS on SA-CCR demonstrate a commitment to enhancing the precision and effectiveness of counterparty credit risk measurement.
Specifically, the EBA developed the draft RTS on SA-CCR according to Article 277(5) and 279a(3) of the CRR, as amended by CRR3, which mandates the EBA to specify:
- Methods for Identifying Material Risk Drivers: Identifying transactions with one or more material risk drivers and determining the most material of those drivers.
- Formulas for Supervisory Delta Calculation: Calculating the supervisory delta of call and put options mapped to interest rate or commodity risk categories, including scenarios with negative interest rates or commodity prices.
- Determination of Position in Risk Drivers: Methods for determining whether a transaction is a long or short position in the primary or most material risk driver in a given risk category.
The draft RTS will be submitted to the European Commission for endorsement and subsequently scrutinized by the European Parliament and the Council before being published in the Official Journal.
Background and Rationale
The Standardised Approach for Counterparty Credit Risk (SA-CCR) represents a critical evolution in the regulatory frameworks governing the calculation of exposure at default (EAD) for derivative transactions. The inception of SA-CCR by the Basel Committee on Banking Supervision (BCBS) aimed to replace the less risk-sensitive methods such as the Current Exposure Method (CEM) and the Standardised Method (SM) with a more nuanced and accurate system.
Initial RTS on SA-CCR
In December 2019, the European Banking Authority (EBA) finalized and published the draft Regulatory Technical Standards (RTS) on SA-CCR. These standards were subsequently published in the Official Journal in March 2021, marking a significant milestone in the regulation of counterparty credit risk within the European Union. The RTS on SA-CCR outline several critical components and methodologies designed to enhance the precision and reliability of counterparty credit risk assessments.
Identifying Material Risk Drivers: One of the foundational aspects of the RTS is the method for identifying material risk drivers in derivative transactions. Accurate risk category mapping is crucial because it ensures that each derivative is assessed according to its specific risk profile. The RTS provide detailed guidelines on how to discern the primary risk factors driving the value of a derivative. This involves analyzing the underlying assets, the terms of the derivative contract, and the market conditions that could influence its value. By precisely identifying these risk drivers, financial institutions can apply the correct risk weights and calculate a more accurate EAD.
Supervisory Delta Formula: The supervisory delta formula is a critical tool within SA-CCR for calculating the potential future exposure of options. Specifically tailored for the interest rate risk category, this formula is designed to be compatible with scenarios involving negative interest rates. The supervisory delta is a measure of how the value of an option changes with respect to changes in the underlying risk factor. It incorporates the following elements:
- Delta (Δ): Reflects the sensitivity of the option's price to small changes in the underlying asset's price.
- Gamma (Γ): Accounts for the curvature of the option's price with respect to the underlying asset, providing a second-order sensitivity measure.
- Vega (ν): Measures sensitivity to volatility changes in the underlying asset.
The formula is structured to adjust these sensitivities for negative interest rates, ensuring that the calculated exposures remain realistic and conservative even under adverse market conditions.
Position Determination: Another essential component of the RTS is the methodology for determining the direction of the position in a material risk driver. This determination is vital for accurately assessing whether a financial institution holds a long or short position in the risk driver, which directly impacts the calculation of potential future exposure. The RTS outline procedures for:
- Classifying Positions: Establishing whether a derivative transaction represents a long or short exposure to the underlying risk driver.
- Netting Sets: Grouping transactions that can be netted to reduce overall exposure, taking into account legally enforceable netting agreements.
- Collateral Effects: Integrating the impact of collateral posted or received on the net exposure calculation.
These methodologies are designed to ensure that the SA-CCR framework accurately reflects the risk profile of derivative portfolios, considering all relevant factors that can affect exposure.
The development of these RTS under Articles 277(5) and 279a(3) of Regulation (EU) No 575/2013 (CRR), as amended by Regulation (EU) 2019/876 (CRR2), underscores the EBA’s commitment to maintaining robust and adaptive regulatory standards. By providing a detailed and structured approach to identifying and quantifying counterparty credit risk, the RTS on SA-CCR help financial institutions enhance their risk management practices, comply with regulatory requirements, and contribute to the stability of the financial system.
Standardised Approach for Counterparty Credit Risk (SA-CCR): Amendments Under CRR3
The Standardised Approach for Counterparty Credit Risk (SA-CCR) has undergone significant updates with the introduction of Regulation (EU) 2024/1623 (CRR3). These amendments, particularly under Article 279a(3)(a), have expanded the European Banking Authority’s (EBA) mandate to enhance the precision and applicability of SA-CCR. This section delves deeper into these amendments, focusing on the new requirements for calculating the supervisory delta of options in various risk scenarios and the comprehensive review of existing Regulatory Technical Standards (RTS).
Updated Mandate for Supervisory Delta Calculation Under the revised mandate, the EBA is now required to develop and specify formulas for calculating the supervisory delta of options mapped to both interest rate and commodity risk categories. This expansion is particularly crucial in scenarios where prices may turn negative, as experienced during extraordinary market conditions such as the Covid-19 pandemic. The supervisory delta formula is essential for determining the sensitivity of options to changes in underlying risk factors, ensuring that the calculated exposures remain robust and accurate under a wide range of market conditions.
Interest Rate and Commodity Risk Categories The amendments necessitate distinct approaches for interest rate and commodity options, considering their unique market dynamics:
- Interest Rate Options: The supervisory delta formula for interest rate options must accommodate scenarios where interest rates fall below zero. Negative interest rates, once a theoretical anomaly, have become a reality in several major economies, requiring precise adjustments in risk calculations.
- Commodity Options: For commodities, the challenge lies in dealing with negative prices, which have occurred in extreme market conditions. The updated mandate requires the EBA to incorporate adjustments that ensure the delta calculations remain valid and reliable even when commodity prices enter negative territory.
Supervisory Volatility Adjustments The EBA must also ensure that the supervisory volatility used in these calculations is appropriate and reflective of current market conditions. Supervisory volatility is a critical component in the delta calculation, representing the potential variability in the price of the underlying asset. The amendments call for a reassessment and potential adjustment of these volatility parameters to maintain consistency with international standards and enhance the accuracy of risk assessments.
Expansion and Review of Existing RTS In addition to updating the supervisory delta formulas, the EBA is tasked with a comprehensive review and expansion of the existing RTS on SA-CCR. This review aims to ensure that the standards align with the revised CRR text as amended by CRR3, providing a cohesive and updated regulatory framework. The key aspects of this review include:
- Inclusion of Commodity Options: The expansion will explicitly incorporate a supervisory delta formula for commodity options that can handle negative prices. This inclusion addresses the gap identified during recent market upheavals and ensures that the SA-CCR framework remains comprehensive and applicable to a broad range of derivative instruments.
- Alignment with CRR3: The review will ensure that all RTS are fully aligned with the updated Capital Requirements Regulation, reflecting the latest regulatory requirements and best practices. This alignment is crucial for maintaining regulatory coherence and facilitating the smooth implementation of SA-CCR across financial institutions.
Submission Deadline The legal deadline for the submission of the draft RTS is 10 July 2025. This deadline underscores the urgency and importance of these updates in enhancing the regulatory framework for counterparty credit risk. By this date, the EBA is expected to finalize and submit the expanded and revised RTS for endorsement, ensuring that financial institutions can promptly incorporate these changes into their risk management practices.
Detailed Amendments to SA-CCR: Supervisory Delta Formula for Commodity Risk Category
The detailed amendments to the Standardised Approach for Counterparty Credit Risk (SA-CCR) introduce a refined supervisory delta formula for commodity options, ensuring consistency with the methodologies applied to negative interest rates. This comprehensive approach aims to maintain robust and accurate calculations even under adverse market conditions, such as negative pricing scenarios, enhancing the reliability of risk assessments.
Supervisory Delta Formula for Commodity Options
The supervisory delta formula for commodity options is meticulously crafted to handle the complexities of negative price environments. The formula is:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
This formula ensures the supervisory delta calculations are robust, accounting for negative price movements by incorporating a shift parameter, λ\lambdaλ, that adjusts the prices into positive territory. The parameter λ\lambdaλ is critical in scenarios where either the current price (P) or the strike price (K) is negative, thereby avoiding undefined logarithmic calculations.
Key Elements of the Formula:
- Sign: Indicates the direction (positive or negative) of the option's exposure.
- Type: Reflects whether the option is a call or a put.
- Natural Logarithm (ln): Ensures the ratio remains positive, which is essential for the logarithmic function.
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
- Volatility (σ): Set at a supervisory level to standardise the calculation across different commodities.
Adjustments Based on Feedback in SA-CCR
The initial proposal included three threshold levels (EUR 0.1, EUR 1, and EUR 10), but these were found inadequate. Feedback from the consultation process led to the adoption of a more generalized solution for the λ\lambdaλ shift:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max \left( -(1 + \text{threshold}) \cdot \min(P, K), 0 \right)$$
Where the threshold is set at 0.10. This alternative formulation addresses the feedback that a one-size-fits-all threshold was not suitable for all commodities, providing a flexible yet robust adjustment mechanism.
Supervisory Volatility Adjustments
Supervisory volatility (σ\sigmaσ) plays a crucial role in the delta calculation, reflecting the expected variability in the price of the underlying commodity. The supervisory volatility levels are set to ensure consistency with Basel standards and are specified as follows:
- Electricity: 150%
- Other Commodities: 70%
These levels ensure that the volatility adjustments are appropriate for the specific risk characteristics of different commodities, thereby enhancing the precision of the risk calculations.
Ensuring Robust Calculations in Negative Price Scenarios
The enhancements to the supervisory delta formula ensure that calculations remain valid even when commodity prices turn negative, which was a significant challenge highlighted during market disruptions like the Covid-19 pandemic. By adjusting both the price (P) and the strike price (K) through the λ\lambdaλ parameter, the formula maintains its integrity and avoids undefined operations, such as the logarithmic term becoming negative.
Other Amendments to Existing RTS on SA-CCR
Amendments to Article 4(4)
The amendments to Article 4(4) of the Regulatory Technical Standards (RTS) on the Standardised Approach for Counterparty Credit Risk (SA-CCR) are significant, reflecting changes in the broader regulatory environment. Article 4(4) originally referenced Article 325a of the Capital Requirements Regulation (CRR), which identified institutions exempted from Fundamental Review of the Trading Book - Standardised Approach (FRTB-SA) reporting requirements. However, with the implementation of CRR3, the FRTB-SA has transitioned to become capital requirements. This regulatory shift necessitates an update in the wording of Article 4(4) to align with the new regulatory framework.
The revision of Article 4(4) ensures that the SA-CCR framework remains consistent with the latest regulatory mandates. It is essential for financial institutions to be aware of these changes to maintain compliance. The updated wording now clearly defines the institutions subject to the FRTB-SA capital requirements under CRR3, thereby eliminating any ambiguity that existed under the previous regulation. This clarity helps financial institutions better understand their obligations and ensures that their risk management practices are in line with the current regulatory standards.
Amendments to Article 5
Article 5 has undergone amendments to enhance the precision and applicability of supervisory delta calculations, particularly in scenarios where interest rates or commodity prices might be negative. The need for such amendments arose from the challenges experienced during market disruptions, such as those seen during the Covid-19 pandemic, where certain commodity prices turned negative.
The updated wording in Article 5 specifies the calculation method for the supervisory delta (δ\deltaδ) of call and put options in these negative scenarios. This update is critical for ensuring that the supervisory delta calculations remain accurate and reflective of market realities, even under adverse conditions.
The amendments include:
- Enhanced Clarity: The revised wording removes ambiguities, making the calculation methods more transparent and easier to implement.
- Negative Price Handling: The updated Article 5 explicitly addresses how to handle scenarios where underlying prices or interest rates are negative, ensuring that the calculations are robust and applicable in all market conditions.
- Calculation Method: The specific method for calculating the supervisory delta (δ\deltaδ) of call and put options now accounts for negative pricing, incorporating adjustments to maintain accuracy. This includes the use of a shift parameter (λ\lambdaλ) to move negative prices into a positive range, ensuring the logarithmic functions in the delta calculations are always defined.
These amendments are crucial for financial institutions that manage a portfolio of derivatives, as they must ensure their models accurately reflect the risk exposure in all market conditions. By updating their internal systems to align with these revised standards, institutions can maintain robust risk management practices and remain compliant with regulatory requirements.
Standardised Approach for Counterparty Credit Risk (SA-CCR): Updated Table of Supervisory Volatility
The recent amendments to Article 5(3) of the Regulatory Technical Standards (RTS) on the Standardised Approach for Counterparty Credit Risk (SA-CCR) include significant updates to the table of supervisory volatility. These updates are crucial for accurately reflecting the risk associated with various underlying instruments in different risk categories. The updated table now specifies the supervisory volatility for interest rates and commodities, ensuring that financial institutions can better gauge potential future exposure and adjust their risk management strategies accordingly.
Supervisory Volatility Explained
Supervisory volatility is a critical component in the calculation of the potential future exposure (PFE) of derivative transactions. It represents the standard deviation of changes in the price of the underlying instrument, which is essential for estimating the range of possible future values of the derivative. By incorporating supervisory volatility into the SA-CCR framework, regulators ensure that financial institutions account for market volatility in their risk assessments, leading to more accurate and reliable exposure calculations.
Detailed Breakdown
The updated table in Article 5(3) provides specific supervisory volatility percentages for different risk categories, reflecting the distinct characteristics and historical volatility of each asset class. These updates are designed to align with current market conditions and regulatory standards, thereby enhancing the robustness of the SA-CCR framework.
Interest Rate Risk Category:
- Underlying Instrument: All
- Supervisory Volatility: 50%For the interest rate risk category, the supervisory volatility is set at 50%. This uniform volatility measure is applied to all interest rate derivatives, ensuring consistency in the calculation of PFE across different interest rate products. The 50% volatility factor takes into account the historical fluctuations in interest rates, providing a balanced approach to estimating future exposure.
Commodity Risk Category:
- Underlying Instrument: Electricity
- Supervisory Volatility: 150%The supervisory volatility for electricity is significantly higher at 150%. This reflects the high volatility and price fluctuations characteristic of the electricity market. The elevated volatility factor ensures that the potential future exposure calculations for electricity derivatives are adequately conservative, capturing the inherent risks associated with this commodity.
- Underlying Instrument: Other commodities
- Supervisory Volatility: 70%For other commodities, a supervisory volatility of 70% is applied. This category includes commodities such as oil, natural gas, metals, and agricultural products. The 70% volatility factor balances the diverse volatility profiles of these commodities, ensuring that the SA-CCR framework remains robust and comprehensive.
The updates to the supervisory volatility table in Article 5(3) have several implications for financial institutions:
- Enhanced Risk Sensitivity: By aligning supervisory volatility factors with current market conditions, the updated table enhances the sensitivity of the SA-CCR framework to market fluctuations. This allows institutions to better capture the risk profile of their derivative portfolios.
- Improved Accuracy in PFE Calculations: The specified volatility factors for different asset classes improve the accuracy of PFE calculations, leading to more reliable estimates of exposure at default (EAD). This is crucial for ensuring that capital requirements are reflective of the actual risk.
- Regulatory Compliance: Adhering to the updated supervisory volatility factors ensures that financial institutions remain compliant with the latest regulatory standards under CRR3. This compliance is essential for maintaining regulatory approval and avoiding potential penalties.
- Strategic Risk Management: Institutions can leverage the updated volatility factors to refine their risk management strategies. By understanding the specific volatility profiles of different asset classes, they can make more informed decisions regarding hedging, capital allocation, and risk mitigation.
Accompanying Documents
Draft Cost-Benefit Analysis / Impact Assessment
A comprehensive draft cost-benefit analysis and impact assessment accompany the amendments to the Standardised Approach for Counterparty Credit Risk (SA-CCR), underscoring the necessity and benefits of these changes within the regulatory framework. The Basel Committee's final standard on SA-CCR, published in March 2014, introduced a novel methodology for quantifying counterparty credit risk exposures, supplanting previous non-internal model approaches such as the Current Exposure Method (CEM) and the Standardised Method (SM). This updated SA-CCR framework incorporates two primary components: replacement cost (RC) and potential future exposure (PFE), with an alpha factor applied to their sum to calculate the exposure at default (EAD).
SA-CCR Framework: Problem Identification
The SA-CCR framework was devised to address the limitations and inadequacies of earlier methodologies in capturing the true risk associated with derivative transactions. However, the Covid-19 pandemic exposed a significant vulnerability in the supervisory delta adjustment for options. Specifically, some commodity prices turned negative, rendering the natural logarithm term ln(PK)\ln \left( \frac{P}{K} \right)ln(KP) undefined. This issue necessitated immediate regulatory attention and adjustments to maintain the integrity and applicability of the SA-CCR framework under such extreme market conditions.
The primary problem identified was the supervisory delta adjustment's failure under negative price scenarios. This gap highlighted the need for a robust mechanism capable of accommodating extreme market volatilities, ensuring that the risk measures remain accurate and effective even when prices deviate significantly from historical norms.
Policy Objectives
The draft amending RTS aims to establish a harmonised methodology for computing the supervisory delta adjustment for options under the SA-CCR framework, specifically addressing scenarios where commodity prices are negative. The key policy objectives of these amendments include:
- Consistency Across Regulatory Frameworks: By aligning the supervisory delta adjustment methodology with the provisions for interest rate options, the amendments promote uniformity across different risk categories. This consistency is crucial for ensuring that financial institutions apply a standardized approach to risk assessment, enhancing the comparability of their capital requirements.
- Enhanced Comparability of Own Funds Requirements: The harmonized methodology facilitates a more accurate and comparable determination of own funds requirements across financial institutions. By addressing the discrepancies caused by negative price scenarios, the amendments ensure that the capital requirements reflect the true risk exposure, supporting a more level playing field within the banking sector.
- Support for Effective Functioning of the EU Banking Sector: The updated SA-CCR framework, with its robust provisions for negative price scenarios, supports the resilience and stability of the EU banking sector. By mitigating the impact of extreme market volatilities on risk calculations, the amendments help financial institutions maintain their capital adequacy and risk management standards, even during periods of significant market stress.
Technical Specifications and Adjustments
The technical specifications in the draft amending RTS include detailed methodologies for calculating the supervisory delta adjustment for options under negative commodity prices. These methodologies ensure that the calculations remain robust and accurate, preserving the integrity of the SA-CCR framework.
- Revised Supervisory Delta Formula: The revised formula incorporates a lambda (λ\lambdaλ) shift to ensure that the terms PPP (price) and KKK (strike price) remain positive, maintaining the validity of the natural logarithm term. This adjustment addresses the previously identified issue of undefined values in negative price scenarios.
- Supervisory Volatility Adjustments: The supervisory volatility (σ\sigmaσ) values for different commodities have been updated to reflect their inherent market volatilities accurately. For instance, the volatility for electricity has been set at 150%, while other commodities have a volatility of 70%. These adjustments align with the CRR2 and Basel standards, ensuring that the volatility measures are realistic and reflective of current market conditions.
- Feedback Incorporation: The consultation process revealed inadequacies in the initially proposed threshold levels (EUR 0.1, EUR 1, EUR 10). In response, a more general solution was adopted, using the formula
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max \left( - (1 + \text{threshold}) \cdot \min (P, K), 0 \right)$$
Options Considered, Cost-Benefit Analysis, and Preferred Options
Value of λ Shift
In refining the supervisory delta formula under the Standardised Approach for Counterparty Credit Risk (SA-CCR), several options were considered for implementing the lambda (λ) shift to address negative commodity prices. These options aim to ensure the accuracy and robustness of the supervisory delta calculations, critical for maintaining effective risk management practices.
- Option 1a: Using a Simple Threshold-Based FormulaThe first option utilizes a straightforward approach:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max(\text{threshold} - \min(P, K), 0)$$
Here, the threshold represents a predefined value, and PPP and KKK are the current price and strike price, respectively. While this method is simple, it may not sufficiently capture the complexities and variations in commodity price movements, leading to potential inaccuracies in extreme market conditions.
- Option 1b: Applying a Proportional Adjustment FormulaThe second option, which is preferred, uses a proportional adjustment formula:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max(- (1 + \text{threshold}) \cdot \min(P, K), 0)$$
with a threshold of 0.1, this formula offers a more flexible and adaptive solution. It adjusts the lambda shift based on the proportionate relationship between the price and strike price, independent of their absolute values. This approach ensures a more accurate and stable supervisory delta calculation across varying market conditions, including negative price scenarios.
- Option 1c: Alternative MethodologiesThe third option involves exploring alternative methodologies, such as those based on market conventions or other statistical models. While potentially innovative, these methods may introduce additional complexity and variability, making them less consistent and harder to standardize across different financial institutions.
Volatility Adjustment
The supervisory volatility (σ\sigmaσ) values are crucial for accurately reflecting market conditions in the SA-CCR framework. Two main options were evaluated:
- Option 2a: No Adjustment to Supervisory VolatilityThis option retains the existing supervisory volatility values, which are standardized across different asset classes. The primary advantage of this approach is the reduction in operational burden, as it maintains consistency with the framework for interest rate options. This option is preferred because it simplifies the implementation process and ensures alignment with established regulatory standards, thereby enhancing comparability across institutions.
- Option 2b: Adjustment to Supervisory VolatilityAlternatively, adjusting the supervisory volatility values to better reflect current market conditions was considered. While this approach might improve the accuracy of risk assessments, it would increase the complexity of implementation and potentially reduce comparability across institutions. Given these trade-offs, this option was not favored.
Preferred Options and Rationale
The preferred options, combining the proportional adjustment formula (Option 1b) and no adjustment to supervisory volatility (Option 2a), offer a balanced approach. The proportional adjustment formula provides a robust and adaptive method for calculating the lambda shift, ensuring that the supervisory delta remains accurate even in negative price scenarios. Meanwhile, retaining the existing supervisory volatility values simplifies the implementation process and maintains consistency with the established SA-CCR framework.
By adopting these preferred options, the SA-CCR framework enhances its ability to manage counterparty credit risk effectively. These adjustments ensure that financial institutions can accurately calculate their exposure at default (EAD) for derivative transactions, even under extreme market conditions. This contributes to the overall stability and resilience of the financial system, aligning with the regulatory objectives of promoting sound risk management practices and ensuring a level playing field across the banking sector.
Cost-Benefit Analysis
The cost-benefit analysis of these options underscores the trade-offs between implementation complexity and risk assessment accuracy. The preferred options minimize operational burdens while ensuring robust and consistent risk calculations. This balance is crucial for maintaining the effectiveness and efficiency of the SA-CCR framework, ultimately supporting the stability and resilience of financial institutions.
Standardised Approach for Counterparty Credit Risk (SA-CCR): Feedback from Public Consultation
Summary of Responses and EBA's Analysis
The European Banking Authority (EBA) conducted a comprehensive public consultation on the draft Regulatory Technical Standards (RTS) for the Standardised Approach for Counterparty Credit Risk (SA-CCR). This consultation spanned three months and concluded on 14 March 2024. The feedback from this consultation was meticulously analyzed, and several key issues were identified, leading to significant amendments in the draft RTS.
Key Issues Raised
- Supervisory Delta for Commodity OptionsOne of the primary issues highlighted was the need to adapt the supervisory delta formula to handle negative prices effectively. Respondents generally supported the application of the λ shift in the formula, which adjusts the price and strike price terms to ensure they remain positive, thus maintaining the integrity of the supervisory delta calculation even in adverse market conditions.Feedback Analysis:
- Respondents endorsed the λ shift mechanism for its ability to make the supervisory delta formula robust against negative prices.
- There was a strong recommendation to extend this λ shift application beyond commodity options to other asset classes to ensure consistency and robustness across all derivatives.
- Threshold Levels for λ ShiftThe proposed threshold levels (EUR 0.1, EUR 1, EUR 10) for the λ shift were found inadequate by many respondents. They argued that these fixed thresholds might not be suitable for all commodities due to the diverse nature of commodity prices and their volatilities.
- Feedback Analysis:
- Respondents suggested a more generalized approach, proposing a formula that dynamically adjusts based on the relationship between the current price (P) and strike price (K).
- The preferred formula provided by respondents was:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max(-1.1 \cdot \min(P, K), 0)$$
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max(-1.1 \cdot \min(P, K), 0)$$
- Supervisory VolatilityAnother critical issue raised was the use of supervisory volatilities, which some respondents argued do not reflect current market conditions accurately. They advocated for the use of implied volatilities, which are derived from market prices and thus provide a more accurate representation of expected future volatility.
- Feedback Analysis:
- While the preference for implied volatilities was noted, the EBA maintained that using standardized supervisory volatilities ensures consistency and comparability across institutions and aligns with international regulatory standards.
- The decision to retain supervisory volatilities is aimed at maintaining a level playing field and reducing the operational burden on institutions.
Amendments Based on Feedback
After carefully considering the feedback, the EBA made several amendments to the draft RTS:
- Adoption of the Alternative Formula for the λ Shift:
- The EBA adopted the suggested formula:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max(-1.1 \cdot \min(P, K), 0)$$
- Reaffirmation of Supervisory Volatility:
- Despite the push for implied volatilities, the EBA decided to retain the supervisory volatility values. This decision ensures the framework remains consistent and manageable across various institutions, facilitating smoother implementation and regulatory oversight.
Amendments to the Draft RTS
Adoption of the Alternative Formula for the λ Shift
In response to the feedback received during the public consultation, the European Banking Authority (EBA) has adopted a more flexible and adaptive approach for the λ shift in the supervisory delta formula. The new formula is as follows:
$$\delta = \text{sign} \cdot N \left( \text{type} \cdot \ln \left( \frac{P + \lambda}{K + \lambda} \right) + 0.5 \cdot \sigma^2 \cdot T \right) \cdot \frac{1}{\sigma \cdot \sqrt{T}}$$
Where:
$$\lambda = \max \left( \text{threshold} - \min(P, K), 0 \right)$$
$$\text{threshold} = 0.10\%$$
Additionally:
$$\frac{P + \lambda}{K + \lambda}$$
$$\frac{K + \lambda}{P + \lambda}$$
Also:
$$\lambda = \max(-1.1 \cdot \min(P, K), 0)$$
This formula dynamically adjusts the λ shift based on the relationship between the current price (P) and the strike price (K). By applying a factor of -1.1 to the minimum of these two values, the formula ensures that the terms remain positive, thereby maintaining the robustness of the supervisory delta calculation even in negative price scenarios. This method was preferred because it offers a general solution that is independent of the absolute value of commodity prices, making it versatile and applicable across various market conditions.
Next Steps
The draft Regulatory Technical Standards (RTS) incorporating these amendments will be submitted to the European Commission for endorsement. Following this, the draft RTS will undergo scrutiny by the European Parliament and the Council before being published in the Official Journal of the European Union. The legal deadline for submission is 10 July 2025. This rigorous process ensures that the updated SA-CCR framework is thoroughly vetted and aligned with broader regulatory objectives within the EU.
Implications for Financial Institutions: SA-CCR framework
Compliance and Risk Management
Financial institutions must take proactive steps to align their internal models and systems with the updated SA-CCR framework. This alignment is crucial for maintaining compliance with the new regulatory standards and optimising risk management practices. Key areas that require updates include:
- Adjusting Transaction Identification Processes:
- Institutions need to refine their processes for identifying transactions to accurately determine material risk drivers. This involves implementing systems that can dynamically apply the updated supervisory delta calculations, especially for commodity options.
- Revising Capital Requirement Calculations:
- The updated RTS necessitates revisions in how capital requirements are calculated. Institutions must incorporate the new supervisory delta formulas and ensure their models reflect these changes accurately.
Strategic Adjustments
The amendments to the SA-CCR framework have strategic implications for financial institutions, particularly regarding their portfolios and risk management strategies. Institutions should consider the following adjustments:
- Portfolio Reassessment:
- Institutions may need to reassess their portfolios to identify transactions that are significantly impacted by the updated supervisory delta calculations. This is especially relevant for portfolios with a high concentration of commodity options and other derivatives with complex risk profiles.
- Enhanced Risk Management Practices:
- Effective implementation of the updated SA-CCR framework can lead to enhanced capital efficiency and stronger risk management practices. Institutions should leverage these changes to optimize their risk exposure and improve their overall financial stability.
- Training and Development:
- Staff training programs should be updated to ensure that personnel are well-versed in the new regulatory requirements and capable of implementing the updated models and systems effectively.
- Technological Upgrades:
- Investing in advanced technological solutions that can handle the increased complexity of the new SA-CCR calculations will be crucial. These upgrades can streamline compliance processes and improve the accuracy of risk assessments.
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