Response to consultation Paper on draft RTS and ITS on benchmarking portfolios
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Whilst Barclays agree that ‘outliers’ do require further enquiries and analysis, it should not be the case that outliers are automatically deemed to be unjustified as an outlier may result from a firm specific difference, and be justified. For example, for HDP portfolios the proposed benchmarking exercise is to identify which portfolios are “outliers” and worthy of further review. However this will be a matter of judgement rather than a mechanistic approach.
In addition to using quartiles, Barclays considers that it would also be useful to look at a number of dispersion type metrics, for example the use of a normalised average (or mean) of a group of peers as the optimal comparison level, as opposed to using quartiles as an indication of significant differences between bank portfolios and low / high diversity in own fund requirements or the firm’s ratio to average (mid to median), the number of standard deviations from mean.
In terms of the suggested criteria Barclays is not convinced that assessment against the standardised results is appropriate. Barclays experience is that depending on the asset class most (if not all AIRB firms) are either above or below the standardised risk weights,
Barclays is unclear as to how the use of “outturns” would be used in the assessment of the level of capital. Barclays considers that it is appropriate that supervisors should endeavour to understand how much of a potential divergence in capital is attributed to poorly performing models and how much is based on justifiable differences. However, Barclays has a concern that a full run of the full front-to-back capital solution, using different inputs, may not be something that firms are able to do easily (if at all).
In addition, the RTS also proposes the use of a binomial back test. It is not clear what this is and Barclays would welcome further clarification.
As Barclays recommendation is that only high level information is provided, consistent with previous RWA exercises, rather than disclosure of firm specific results, the emphasis on the assessment of the results should be on the dispersion of results (“quartile approach”…) and an acceptable range of outcomes, and that this could vary through time.
Barclays understanding is that Article 78 does not require that thresholds are established upfront and it may not actually be of assistance to the benchmarking exercise to do so at this stage. Barclays would suggest the following:
i. The EBA should consider disregarding the fourth quartile as this is not necessary given the Directive remit of paying particular attention to approaches where there is a significant and systematic under-estimation of own funds requirements (Article 78.3b).
ii. The Standardised Rules should not be used as a “benchmark” as these tend not to be risk sensitive and are not necessarily a conservative benchmark (e.g. sovereigns in Market Risk where standardised rules are likely to underestimate risk given 0% risk weights).
The use of Standardised rules as a ‘benchmark’ may also not be the most appropriate anchor when many of these are being revised (e.g. SA-CCR, Sensitivity Based Approach (SBA), etc).
iii. The definition of outturns in a Market Risk context requires further clarification. Barclays assumes that this refers to the use of a one year ‘P&L’ vector for Market Risk to allow variability from the choice of modelling assumptions to be identified (e.g. differences in the length of time series, weightings and data). However, it should be noted that this data will not be readily available for all firms if they are not using an historical simulation model. Further, in this situation, the resulting VaR would not be relevant for the benchmark as the model would not be in use and will affect the accuracy of the benchmarking results.
iv. The use of comparison between estimates and outturns may not be beneficial in instances where the actual internal default experience of the firm for the relevant portfolio is limited (e.g. the Barclays Hedge Fund portfolio has limited internal default experience compared to the industry-wide default experience).
v. For HDP it is likely that each national regulator will only have a limited number of AIRB firms to benchmark and the review process is likely to be far more subjective. In addition, across HDP and Market risk, this may not be proportionate as some firms will be required to build new models that will be solely used for the exercises. As such, we consider that it should a targeted submission, used selectively where there are material concerns over the variability in RWAs, for which such an approach may be proportionate.
vi. Barclays is unclear of the use of outturns and binomial back testing in establishing benchmarks against which to assess capital requirements and would welcome further clarification on this proposal.
The benchmarks in (i) are the approaches that are most appropriate for market risk although the assessment of dispersion should be more sophisticated than just using the first and fourth quartiles. (See question 2).
For HDP, the key issue is defining the portfolios for which data is requested so that regulators have the best chance of being able to compare “like with like”. The benchmarks would then simply identify which firms merit further investigation. In this regard, benchmarking is less important than the provision of data for identified portfolios and any subsequent investigation/challenge.
Barclays agrees with the draft ITS that the Basel portfolios should be used as an initial starting point. However, in principle Barclays could also migrate to the EBA portfolios with the addition of more complex products over time, as capacity and infrastructure is developed to run HPEs.
Both sets of portfolios have their own advantages and disadvantages which we have summarised in the table below:
Advantages Disadvantages
EBA • Vanilla
• More readily replicated
• Easier to isolate drivers of variability due to incremental addition of risks • New
• More aggregation increases operational risks
Basel • Familiarity
• More representative of current trading book • ‘Exotic’ portfolios create greater potential for variability
• More difficult to assess diversification
It is also important that only exposures in the same legal jurisdiction are compared. Most AIRB banks will have exposures across many countries and it is important that these are separated out. For example the European economic downturn may mean that risk weights in some countries are high relative to others. These portfolios should be disaggregated.
• Instruments 1-9, 11 and 13 include the term ‘OTC’ but are exchange-traded instruments.
• Instruments 59 and 60 do not include an indication of the notional.
• Instruments 1-3 don’t have an exact end date, unlike Instruments 3-14.
• Instrument 28, doesn’t indicate which reference rate to use for the spot rate, Barclays assume this would be the ECB reference rate, but this should be clarified. Similarly the end of day three month EUR/USD forward rate and if a cross currency spread should be booked.
In the TBG type portfolios:
• Portfolio 27 – it needs to be made clear whether short index put means short receiver.
• Position seniority should be confirmed
• US names now trade NORE instead of MODRE, this should be clarified.
• For portfolio 14, the notional amount in USD is variable and resets at the beginning of each interest period, but it doesn’t specify the source or time of that spot rate
Whichever portfolios are used, we would encourage the used of standardised confirmations to minimise potential ambiguities.
i. It is unclear what Option (c) adds to Option (a) and Option (b).
ii. If regulatory approval has not been given, it is unclear whether firms should be submitting results where the model is used for internal purposes only as these might distort the results, as the model could diverge from regulatory requirements further than when only considering those used for both regulatory and internal purposes.
i. Consideration should be given to including a materiality threshold with exemptions for portfolios that fall below the threshold. For example, this could be defined as either a % of a firms’ RWAs, or as a % of a market, or for mortgage books greater than Euro X bn etc.
Imposing a materiality threshold would also recognise that the work associated with including smaller insignificant portfolios in the HPE is not proportionate and will not yield results of significance to justify their inclusion and the associated time and resource required to do so. In these cases, supervisory oversight could take other forms, e.g. internal validation reporting.
ii. It is not clear whether the exemptions from reporting will also include portfolios which have supervisory floors / add-ons, as well as slotting for in-scope property exposures, etc. Barclays would recommend that consideration is given to exempting such portfolios from reporting because by definition the risk weights should be the same.
Q2. Do you consider that the benchmarks outlined in the RTS are sufficiently proportionate and flexible? Do you have any alternative benchmark proposals? If yes, please provide details.
Given potential limitations in the study, Barclays considers that the benchmarks need to be more flexible than are currently proposed.Whilst Barclays agree that ‘outliers’ do require further enquiries and analysis, it should not be the case that outliers are automatically deemed to be unjustified as an outlier may result from a firm specific difference, and be justified. For example, for HDP portfolios the proposed benchmarking exercise is to identify which portfolios are “outliers” and worthy of further review. However this will be a matter of judgement rather than a mechanistic approach.
In addition to using quartiles, Barclays considers that it would also be useful to look at a number of dispersion type metrics, for example the use of a normalised average (or mean) of a group of peers as the optimal comparison level, as opposed to using quartiles as an indication of significant differences between bank portfolios and low / high diversity in own fund requirements or the firm’s ratio to average (mid to median), the number of standard deviations from mean.
In terms of the suggested criteria Barclays is not convinced that assessment against the standardised results is appropriate. Barclays experience is that depending on the asset class most (if not all AIRB firms) are either above or below the standardised risk weights,
Barclays is unclear as to how the use of “outturns” would be used in the assessment of the level of capital. Barclays considers that it is appropriate that supervisors should endeavour to understand how much of a potential divergence in capital is attributed to poorly performing models and how much is based on justifiable differences. However, Barclays has a concern that a full run of the full front-to-back capital solution, using different inputs, may not be something that firms are able to do easily (if at all).
In addition, the RTS also proposes the use of a binomial back test. It is not clear what this is and Barclays would welcome further clarification.
Q3. What limitations do you see in relation to the use of the proposed benchmarks, i.e., (i) first and the fourth quartiles; (ii) comparison between own funds under the internal models and the standardised approach; and (iii) comparison between estimates and outturns?
Barclays support the EBA’s comments that in principle the exercise should not lead to standardisation, preferred methods or encourage some bias towards an ‘acceptable’ range, particularly if specific results are disclosed.As Barclays recommendation is that only high level information is provided, consistent with previous RWA exercises, rather than disclosure of firm specific results, the emphasis on the assessment of the results should be on the dispersion of results (“quartile approach”…) and an acceptable range of outcomes, and that this could vary through time.
Barclays understanding is that Article 78 does not require that thresholds are established upfront and it may not actually be of assistance to the benchmarking exercise to do so at this stage. Barclays would suggest the following:
i. The EBA should consider disregarding the fourth quartile as this is not necessary given the Directive remit of paying particular attention to approaches where there is a significant and systematic under-estimation of own funds requirements (Article 78.3b).
ii. The Standardised Rules should not be used as a “benchmark” as these tend not to be risk sensitive and are not necessarily a conservative benchmark (e.g. sovereigns in Market Risk where standardised rules are likely to underestimate risk given 0% risk weights).
The use of Standardised rules as a ‘benchmark’ may also not be the most appropriate anchor when many of these are being revised (e.g. SA-CCR, Sensitivity Based Approach (SBA), etc).
iii. The definition of outturns in a Market Risk context requires further clarification. Barclays assumes that this refers to the use of a one year ‘P&L’ vector for Market Risk to allow variability from the choice of modelling assumptions to be identified (e.g. differences in the length of time series, weightings and data). However, it should be noted that this data will not be readily available for all firms if they are not using an historical simulation model. Further, in this situation, the resulting VaR would not be relevant for the benchmark as the model would not be in use and will affect the accuracy of the benchmarking results.
iv. The use of comparison between estimates and outturns may not be beneficial in instances where the actual internal default experience of the firm for the relevant portfolio is limited (e.g. the Barclays Hedge Fund portfolio has limited internal default experience compared to the industry-wide default experience).
v. For HDP it is likely that each national regulator will only have a limited number of AIRB firms to benchmark and the review process is likely to be far more subjective. In addition, across HDP and Market risk, this may not be proportionate as some firms will be required to build new models that will be solely used for the exercises. As such, we consider that it should a targeted submission, used selectively where there are material concerns over the variability in RWAs, for which such an approach may be proportionate.
vi. Barclays is unclear of the use of outturns and binomial back testing in establishing benchmarks against which to assess capital requirements and would welcome further clarification on this proposal.
Q4. What in your view is the most appropriate benchmark and/or approach for the assessment of the level of potential underestimation of own funds requirements?
A combination of approaches should be considered as opposed to a ‘one size fits all’ approach e.g. the use of a normalised average (or mean) of a group of peers as the optimal comparison level; other percentiling approaches (rather than using quartiles only).The benchmarks in (i) are the approaches that are most appropriate for market risk although the assessment of dispersion should be more sophisticated than just using the first and fourth quartiles. (See question 2).
For HDP, the key issue is defining the portfolios for which data is requested so that regulators have the best chance of being able to compare “like with like”. The benchmarks would then simply identify which firms merit further investigation. In this regard, benchmarking is less important than the provision of data for identified portfolios and any subsequent investigation/challenge.
Q5. Which set of market risk portfolios do you consider more appropriate for the initial exercise conducted under Article 78?
Barclays supports use of a single set of portfolios to be used across different exercises (whether instigated by Basel or the EBA), and encourage a unified approach. If further RWA variability studies are to be conducted by Basel, Barclays would encourage these to be aligned to the EBA to make use of the same portfolios. Where Basel is proposing to use different portfolios to those selected by the EBA, Barclays would encourage the EBA to adopt use of the BCBS portfolio version 2.Barclays agrees with the draft ITS that the Basel portfolios should be used as an initial starting point. However, in principle Barclays could also migrate to the EBA portfolios with the addition of more complex products over time, as capacity and infrastructure is developed to run HPEs.
Both sets of portfolios have their own advantages and disadvantages which we have summarised in the table below:
Advantages Disadvantages
EBA • Vanilla
• More readily replicated
• Easier to isolate drivers of variability due to incremental addition of risks • New
• More aggregation increases operational risks
Basel • Familiarity
• More representative of current trading book • ‘Exotic’ portfolios create greater potential for variability
• More difficult to assess diversification
Q6. As explained in the background section, do you consider the approach proposed by the EBA appropriate for future annual exercises?
Regulators should agree one common benchmarking exercise. The co-ordination of this data gathering exercise should be compared to other such initiatives already in place e.g. how does this proposed EBA annual exercise differ to the LDP / Group Template exercise submitted to the PRA annually? Is there an initiative to determine differences / similarities between the two exercises in order to reduce duplication and ensure consistency in data provided?Q7. Do you have any alternative proposals? If yes, please provide details.
As indicated under Q6, it would be helpful to synchronise the EBA exercise with other initiatives already in place by the PRA / EBA / BCBS.Q8. Which of the two options for phasing-in do you consider preferable?
Option 2 (defining ‘all’ portfolios and including provisions in the ITS that specify the phasing-in of portfolios over time i.e. institute a rotation process requiring banks to submit LDP portfolios in the even years and other portfolios in odd years) is preferable as providing the necessary information on a rotational basis would ease the implementation issues for both firms and competent authorities.Q9. Do you see any potential ambiguities in the credit risk portfolios defined in Annex I? Please identify the relevant portfolio providing details and any suggestions that would eliminate these ambiguities.
The corporate vs. retail definition should align with firm’s existing regulatory reporting and not inadvertently create additional or different reporting groupings.Q10. Do you have any suggestions for additional credit risk portfolios? Please provide details.
The credit risk portfolios should be identified to increase the possibility of “like being compared with like”. This may be most easily achieved by using key risk drivers. For example, for mortgage portfolios, it is right that LTV is identified. However, portfolio risk profile can also vary according to many other factors such as (a) time on book and (b) degree of delinquencyIt is also important that only exposures in the same legal jurisdiction are compared. Most AIRB banks will have exposures across many countries and it is important that these are separated out. For example the European economic downturn may mean that risk weights in some countries are high relative to others. These portfolios should be disaggregated.
Q11. Do you see any potential ambiguities in the market risk portfolios defined in Annexes VII.a and VII.b? Please identify the relevant portfolio providing details and any suggestions that would eliminate these.
In the EBA portfolios:• Instruments 1-9, 11 and 13 include the term ‘OTC’ but are exchange-traded instruments.
• Instruments 59 and 60 do not include an indication of the notional.
• Instruments 1-3 don’t have an exact end date, unlike Instruments 3-14.
• Instrument 28, doesn’t indicate which reference rate to use for the spot rate, Barclays assume this would be the ECB reference rate, but this should be clarified. Similarly the end of day three month EUR/USD forward rate and if a cross currency spread should be booked.
In the TBG type portfolios:
• Portfolio 27 – it needs to be made clear whether short index put means short receiver.
• Position seniority should be confirmed
• US names now trade NORE instead of MODRE, this should be clarified.
• For portfolio 14, the notional amount in USD is variable and resets at the beginning of each interest period, but it doesn’t specify the source or time of that spot rate
Whichever portfolios are used, we would encourage the used of standardised confirmations to minimise potential ambiguities.
Q12. Do you have any suggestions for additional market risk portfolios? Please provide details.
See above comments on EBA portfolios in Q5.Q13 Do you agree with the possibility of allowing firms to refrain from reporting portfolios if one of the conditions stated in Article 3 is met?
Broadly, yes though with two caveats:i. It is unclear what Option (c) adds to Option (a) and Option (b).
ii. If regulatory approval has not been given, it is unclear whether firms should be submitting results where the model is used for internal purposes only as these might distort the results, as the model could diverge from regulatory requirements further than when only considering those used for both regulatory and internal purposes.
Q14 Do you have any suggestion about additional exemptions from reporting? If yes, please provide details.
Barclays would suggest that the following additional exemptions are made from reporting:i. Consideration should be given to including a materiality threshold with exemptions for portfolios that fall below the threshold. For example, this could be defined as either a % of a firms’ RWAs, or as a % of a market, or for mortgage books greater than Euro X bn etc.
Imposing a materiality threshold would also recognise that the work associated with including smaller insignificant portfolios in the HPE is not proportionate and will not yield results of significance to justify their inclusion and the associated time and resource required to do so. In these cases, supervisory oversight could take other forms, e.g. internal validation reporting.
ii. It is not clear whether the exemptions from reporting will also include portfolios which have supervisory floors / add-ons, as well as slotting for in-scope property exposures, etc. Barclays would recommend that consideration is given to exempting such portfolios from reporting because by definition the risk weights should be the same.