Draft amending Regulatory Technical Standards on standardised approach for counterparty credit risk

General Information

This document is a final report published by the European Banking Authority (EBA) in June 2024. It concerns a draft regulatory technical standards (RTS) amending existing standards related to the standardized approach for counterparty credit risk (SA-CCR) under the Capital Requirements Regulation (CRR). The scope covers the specification of supervisory delta calculation formulas for interest rate and commodity options, compatible with market conditions where interest rates or commodity prices may be negative. The document comprises 20 pages and relies on Articles 277(5) and 279a(3)(a) of the CRR, amended by CRR3 (Regulation (EU) 2024/1623).

Executive Summary

The document addresses the update of regulatory technical standards (RTS) on the standardized approach for counterparty credit risk (SA-CCR), specifically on the supervisory delta calculation formula for interest rate and commodity options in a context of negative rates or prices (p. 3). This update is motivated by the CRR3 amendment extending the EBA's mandate to specify a formula adapted to commodity options, in addition to interest rate options, to reflect atypical market conditions such as negative prices observed notably during the Covid-19 pandemic (p. 4, p. 12). The proposed formula for the supervisory delta of commodity options follows the existing structure for interest rates, with an adjustment by a parameter λ calculated to shift negative prices and strikes into positive territory, according to a specific formula λ = max{-(1 + threshold) × min(P, K), 0} with a threshold set at 0.1 (p. 5). The supervisory volatility retained is 150% for electricity and 70% for other commodities, in line with international standards (p. 5). Furthermore, the RTS text is aligned with CRR3 amendments, notably on references to FRTB-SA exemptions (p. 6). The EBA conducted a public consultation, which received a single response broadly validating the proposed approach, notably the modified λ formula, and confirming the maintenance of volatility levels (p. 16-19). The recommendations are to submit these RTS to the European Commission for adoption, to ensure regulatory consistency and the ability of institutions to correctly calculate the supervisory delta under market conditions with negative prices, thus avoiding inconsistencies or operational disruptions (p. 3, p. 12).

Context and Objectives

SA-CCR, initially adopted in 2019, replaces previous methods for measuring counterparty credit risk. It includes a replacement component and a potential future exposure component, adjusted by an alpha factor. The supervisory delta calculation for options, based on the Black-Scholes model, assumes underlying prices are positive, which poses problems when commodity prices become negative, as observed during the Covid-19 pandemic (p. 12-13). CRR3 extended the EBA's mandate to include commodity options in the specification of formulas compatible with negative prices (p. 4). The objective is to establish a harmonized methodology, compliant with international standards, allowing financial institutions to calculate the supervisory delta under these conditions, thus ensuring consistency, convergence of practices, and comparability of capital requirements within the European Union (p. 12-13). The scope is limited to interest rate and commodity risk categories, excluding other asset classes. The document also specifies the need to align existing RTS with CRR3 amendments (p. 6).

Summary of Key Points by Theme

Supervisory delta formula for commodity options: The proposed formula follows that applied to interest rate options, with a specific λ adjustment to handle negative prices. This λ is calculated by the formula λ = max{-(1 + threshold) × min(P, K), 0}, where P is the spot or forward price and K the strike price, with a threshold set at 0.1 (p. 5). This transactional approach ensures negative prices are brought into positive domain, making the natural logarithm calculation possible. Supervisory volatility: The levels retained are 150% for electricity and 70% for other commodities, consistent with Basel Committee standards and without further adjustment, to maintain operational simplicity and consistency with interest rate options (p. 5, p. 14). Regulatory alignment: The RTS text is amended to reflect CRR3 changes, notably reference to Article 325a on FRTB-SA exemptions (p. 6). Public consultation: A single response was received, validating the general approach but suggesting extending the λ shift to other asset classes, which exceeds the current mandate (p. 16-18). The alternative λ calculation by multiplication was retained for its generality (p. 18-19). Operational impact and costs: The chosen λ option minimizes implementation costs by extending the already known methodology for interest rates to commodities, avoiding fragmentation and additional complexity (p. 13-14).

Main Findings and Lessons Learned

Findings: The Black-Scholes model used for supervisory delta calculation requires positive prices, which poses problems for commodity options in case of negative prices, a phenomenon observed notably during the pandemic (p. 12-13). CRR3 requires the EBA to specify an adapted formula for commodity options under these conditions (p. 4). Assumptions: The chosen λ formula, based on a multiplier of the minimum value between spot price and strike, is assumed to provide a general solution applicable to all commodities, regardless of their magnitude (p. 5, p. 18). Interpretations: The EBA considers maintaining standard supervisory volatility levels (150% for electricity, 70% for others) pragmatic and compliant with international standards, despite remarks on the non-representativeness of current implied volatilities (p. 14, p. 19). Uncertainties: Extension of the λ formula to asset classes other than interest rates and commodities is not envisaged, as it is outside the regulatory mandate (p. 17-18). The precise impact on institutions' capital requirements is not quantified in this document.

Conclusions and Recommendations

The EBA recommends adopting the amended RTS incorporating the supervisory delta calculation formula for commodity options compatible with negative prices, using the formula λ = max{-(1 + 0.1) × min(P, K), 0} and supervisory volatility levels set at 150% for electricity and 70% for other commodities (p. 5, p. 10). The RTS text is also aligned with CRR3 amendments, notably on FRTB-SA exemptions (p. 6, p. 10). These standards must be submitted to the European Commission for adoption, then to the European Parliament and Council for validation, before publication in the Official Journal of the European Union (p. 3, p. 10). This update ensures regulatory consistency, comparability of capital requirements, and operational capacity of institutions to manage risks related to options under atypical market conditions, notably with negative prices. No adjustment of supervisory volatility levels is recommended, to preserve simplicity and international consistency (p. 14, p. 19).