The European Banking Authority (EBA) has initiated a public consultation regarding its draft Regulatory Technical Standards (RTS) focused on the criteria for identifying hedging instruments that mitigate residual risk.
This move is a critical component of the EBA’s comprehensive strategy to implement the EU banking package, particularly in managing market risks. Stakeholders have until 3 May 2024 to share their insights on these proposed standards.
At the heart of the EBA’s latest initiative is the introduction of the residual risk add-on (RRAO) within the standardized approach of the Fundamental Review of the Trading Book (FRTB) framework.
The Capital Requirements Regulation (CRR3) has been updated to allow certain exemptions from the RRAO charge. Specifically, instruments that carry residual risks, if used to hedge against similar risks, might not be subject to the RRAO. The EBA’s mandate includes developing RTS to clarify when an instrument effectively serves as a hedge, thereby qualifying for this exemption.
The proposed RTS outline a methodology for financial institutions to assess whether the RRAO charge from which they seek exemption is linked to a risk factor not included in the Sensitivity-based Method (SbM) or if the exemption is sought for other reasons. If the RRAO charge is exclusively related to a non-SbM risk factor, the standards provide a framework to ensure that the hedge significantly reduces the sensitivity to that specific risk factor.
Conversely, if the RRAO charge arises from factors other than non-SbM risk factors, the RTS stipulate that the hedging instrument can only be recognized as a hedge—and thus exempt from the RRAO charge—if it entirely neutralizes the risk from the hedged instruments.
The EBA has opened the floor for comments through their consultation page, encouraging feedback until the 3 May 2024 deadline. Additionally, a public hearing will be conducted via conference call on 6 March 2024, offering stakeholders a platform to discuss the draft RTS in detail. Registration for the event is required by 4 March 2024.
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