On 12 August 2020, the European Banking Authority (EBA) published a consultation paper on draft guidelines that clarify the conditions to be met by the data related to modellable risk factors, which institutions should use in their expected shortfall (ES) calculations. The guidelines clarify that the data used to compute the ES risk measure should be: (i) accurate, (ii) appropriate, (iii) frequently updated, and (iv) complete and overall consistent in its use in the ES risk measure.
The revised Capital Requirements Regulation (CRR2) implements in EU legislation, inter alia, the revised framework for minimum capital requirements for market risk (also known as the Fundamental Review of the Trading Book – FRTB), developed by the Basel Committee and published in its final version in January 2019. One of the novelties introduced by the FRTB and included in the CRR2 is the alternative internal model approach, specifically revised to overcome the identified drawbacks in the Basel 2.5 internal model approach.
The alternative internal model approach is designed to capture market risks taking into account tail risks, risk of market illiquidity and the default risk through the sum of three components: i) the expected shortfall risk measure, which determines capital requirements for those risk factors for which a sufficient amount of observable data is available (modellable risk factors), ii) the stress scenario risk measure for risk factors with limited observable data (non-modellable risk factors), and iii) the own funds requirement for default risk associated with credit and equity positions.
Article 325bh(3) of the CRR gives the mandate to the EBA to develop guidelines specifying the criteria for the use of data inputs referred to in Article 325bc of the CRR and used in calculating the partial expected shortfall in accordance with the same article. The guidelines should clarify the qualitative conditions that the data related to modellable risk factors should meet to be used in the institution’s expected shortfall calculations.
The deadline for comments on the consultation paper is 12 November 2020.