The European Commission adopted today a delegated act that postpones by one year (i.e. until 1 January 2026) the date of application of the Basel III fundamental review of the trading book (FRTB) standards in the EU for the banks’ calculation of their own funds requirements for market risk.
1. Can you explain what will apply for banks on 1 January 2025, and what the Commission proposes to delay?
The EU has agreed on a review of banking rules (the Capital Requirements Regulation and the Capital Requirements Directive), that completed the implementation of Basel III in Europe. This package of reforms is set to enter into application from 1 January 2025. This package also implements the market risk prudential requirements (‘the Fundamental Review of the Trading Book’ or ‘FRTB’) introduced by Basel III, that incorporate more sophisticated risk measurement techniques and aim to align capital charges more closely to the actual risks banks are facing in their activities in capital markets.
An international level playing field is particularly important for these activities. Competition between internationally active banks is very intense in this area, due to the ease with which market activities can be conducted across jurisdictions (including between Member States and third countries or through branches). To prevent any distortions of the playing field, the implementation of the FRTB rules should therefore converge as much as possible across jurisdictions.
The Council and the European Parliament mandated the European Commission to monitor the international implementation of the FRTB standards across jurisdictions and empowered the Commission to adopt delegated acts to ensure an international level playing field, should significant deviations in implementation by third countries be identified, either in terms of timeline or requirements (Article 461a of the Capital Requirements Regulation III (CRR3)). The empowerment allows the Commission to adopt successive delegated acts, in case allowing the Commission to take further action in 2025.
The Commission’s ongoing monitoring of the implementation across jurisdictions indicates that a number of them have already implemented the standards or are in the process of doing so, in line with their international commitments. However, other major jurisdictions, for which level playing field considerations are very relevant, have yet to finalise their rules or communicate on a definite timeline for implementation. More specifically, the United States has not yet provided clarity on when and how it would finalise its implementation of the Basel III standards. The implementation date in the US is now likely to be in January 2026 at the very earliest.
As a result, the Commission considers it necessary, to fulfil the mandate entrusted by the European co-legislators and to preserve the level playing field for the trading activities of European banks, to postpone by one year, until 1 January 2026, the date of application of the FRTB standards in the EU for banks’ calculation of own funds requirements for market risk.
A delegated act has been adopted today to that effect. Subject to the scrutiny of the European Parliament and Council for a period of 3 months, the delegated act should enter into application on 1 January 2025, as the remainder of the banking package.
Postponing the application of the new market risk rules for the calculation of banks’ own funds requirements means that banks will continue to calculate the related own funds requirements during 2025 under the current rules (Capital Requirements Regulation (CRR) - 575/2013/EU).
During this period, the Commission will continue to monitor the FRTB implementation in other jurisdictions and assess necessary measures in case of additional delays.
2. What are the implications for the banks and the implementation of the related prudential rules?
A number of related operational and technical aspects must also be clarified, so that banks and supervisors have a consistent approach to the implementation of the requirements.
Market risk reporting requirements
The Capital Requirements Regulation (CRR2) introduced specific reporting requirements for credit institutions based on the FRTB framework. The objective of those reporting requirements was to ensure that institutions adequately prepare for the implementation of the FRTB framework as binding capital requirements.
During the one-year postponement period, institutions will continue to use their current (pre-FRTB) methodologies to calculate their own funds requirements for market risk. In parallel, the FRTB Standardised Approach will be used for the output floor calculation. These elements therefore need to continue to be reported to competent authorities based on the current reporting requirements.
Concretely, it means that the existing reporting templates for market risk, as they are laid down in Commission Implementing Regulation (EU) 2021/451 and Implementing Regulation (EU) 2021/453, will continue to apply until 1 January 2026.
Market risk disclosure requirements
The banking package introduces specific disclosure requirements for the own funds requirements for market risk, tailored to the FRTB framework. Considering the decision to postpone the application of the FRTB requirements by one year, the Commission considers that the new disclosure requirements should equally be postponed by one year, until 1 January 2026. The Commission is working closely with the EBA to fully reflect this approach in the implementing technical standards that specify the applicable disclosure framework.
As institutions will continue to calculate their own funds requirements for market risk using the current (pre-FRTB) methodologies as available under CRR2 during that period, information on those methodologies and on relevant own funds requirements must continue to be made available to market participants, in line with the existing disclosure requirements. These are key contributions to preserve a robust market discipline and correctly inform the investment decisions.
However, the use of the FRTB Standardised Approach for the purpose of the output floor requires elements of its calculation to be provided in the context of the disclosure framework applicable to the output floor. These elements are not affected by the empowerment for the delegated act under Article 461a of the CRR3. These have already been specified in the context of the implementing technical standards developed by the EBA.
Output floor
The output floor is a key element of the Basel reform. It works as a lower limit (‘floor’) determined on the basis of standardised approaches on the capital requirements (‘output’) that banks calculate using their internal models. The output floor is introduced to constrain the ability of banks to excessively reduce their capital requirements by using internal models and mitigate the excessive variability of the requirements. It is a backstop measure whose aim is to enhance the confidence in risk-based capital requirements and to improve the solidity of banks that make use of internal models, increasing the comparability of capital requirements across banks.
It is therefore an essential element of the banking package that needs to be introduced across all risks. Its application should however be made consistent with the one-year postponement of the FRTB implementation. The application of the current standardised approach is however not advisable as it would require banks that are under the internal models-based approach to implement a new methodology for one year.
Thanks to the current interim reporting requirements, EU banks are already well-advanced in their developments of the FRTB Standardised Approach. Therefore, in line with the backstop nature of the output floor and to maintain an adequate incentive structure towards a full implementation of the FRTB standards, the Commission expects that EU banks currently using an internal model approach for capital purposes calculate the output floor for the market risk component of the own funds requirements on the basis of the comparison between the outcomes of the current Internal Model-based Approach and the FRTB Standardised Approach. EU banks that are currently using the standardised approach for capital purposes would similarly compare its outcome with the FRTB Standardised Approach unless they are not subject to the current interim reporting requirements (this calculation is in line with Articles 92(4), point (b)(i) and 92(5), point (b)(i), of CRR as amended by CRR3).
While following this approach may result in different impacts on own funds requirements across banks depending on the characteristics inherent to their trading book activities, these effects are deemed appropriately mitigated by the progressive phasing-in of the output floor.
The Commission is working with EBA so that it provides any necessary clarification to the banking sector in this area.
Trading book / non-trading book boundary requirements
The new requirements introduced by the banking package on the non-trading book / trading book boundary will become applicable from 1 January 2025. However, the delay of the FRTB requirements for the calculation of own funds requirements implies that banks would be required to implement the boundary conditions in the context of pre-FRTB approaches, potentially leading to unintended consequences. Therefore, the Commission considers that EU regulators and supervisors should take action in this area to avoid a staggered implementation of the different elements of the FRTB framework.
EBA will provide guidance to supervisors in this area, as it had done so in past situations.
Capital requirements for credit valuation adjustment (CVA) risk
Credit valuation adjustment (CVA) risk can be defined as the risk of losses arising from changing CVA values in response to movements in counterparty credit spreads and market risk factors that drive prices of derivative transactions and securities financing transactions. This risk needs to be adequately capitalised by banks.
The new approaches introduced under CRR3 to calculate the own funds requirements for CVA risk are based, to a certain extent, on the design and calibration of the FRTB Standardised Approach. However, the provisions relating to the new CVA requirements are not included into the scope of the empowerment granted to the Commission under Article 461a of the CRR3. In addition, the Commission considers that the level playing field issues are less relevant for the calculation of the own funds requirements for CVA risk, given the way the EU is implementing this part of the standard.
Therefore, the Commission considers that the prudential requirements for CVA risk must be applied by banks from 1 January 2025 as foreseen under CRR3.
Profit and loss attribution test (PLAT)
CRR3 contains a transitional treatment allowing banks to continue using internal models for trading desks that do not meet the PLAT conditions for another year. That treatment is set to expire on 31 December 2025. The aim of this transitional treatment was to provide specific flexibility to banks using internal models, in accordance with a similar provision in the Basel standards.
The adoption of the delegated act, postponing by one year the date of application of the FRTB rules in the EU, makes this provision de facto obsolete as the transitional treatment would expire before the PLAT requirements are into application for capital requirements purposes. In addition, the provision setting out the transitional treatment for the PLAT is not covered by the empowerment for the delegated act under Article 461a of the CRR3.
As part of the monitoring of the international developments, the Commission will reassess the situation, including the need for another transitional measure or other adaptations to the PLAT requirements.
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Details
- Publication date
- 24 July 2024
- Author
- Directorate-General for Financial Stability, Financial Services and Capital Markets Union