29 November 2010

Joint AFME and ISDA response to European Commission Consultation on Countercyclical Buffers

 The Association for Financial Markets in Europe (AFME) and the International Swaps and Derivatives Association (ISDA) welcome the opportunity to comment on the consultation on countercyclical buffers (the Consultation) and would like to express their support for the European Commission’s (the Commission’s) furtherance of the debate on the reforms in this area. The consultation on countercyclical buffers serves as a helpful addition to the Commission’s on-going dialogue with the industry on capital measures. We particularly welcome the willingness of the Commission to seek and address industry views on the Basel proposals, as this has been absent from the discussions on this topic so far.


The main concerns resulting from the consultation on countercyclical buffers are as
follows:

o Level of cyclicality in the Pillar 1 requirements. The extent of cyclicality introduced by the CRD is not yet known owing to the paucity of data. The framework was implemented in the EU at the end of 2006 and is currently undergoing radical change, so the implications, both in terms of the cyclicality of the new requirements and the impact on the wider economy, are difficult to determine. While AFME and ISDA understand the political imperative for delivering a regime that addresses excessive procyclicality, it is difficult to identify the appropriate level for any buffers until the detail of the Pillar 1 requirements are set out and the implications of these new rules for cyclicality have been fully understood. To the extent that procyclicality in capital requirements is deemed to exist and at a level that is detrimental to financial stability, any implementation prior to a full cycle of all major countries adopting Basel III should be modest in scale.

o Macro-prudential toolbox. Further articulation of the full range of macro-prudential tools and how they would be used is required. The countercyclical buffer is only one of the available macro-prudential tools and it is difficult to comment on the consultation without understanding how it would work in the context of the wider macro-prudential debate. Very little research has been undertaken to assess the applicability of the range of macro-prudential tools; the likely interaction of the countercyclical buffer with other policy tools; and the implications of using various combinations of measures. In order to fully assess the suitability of the countercyclical buffer proposals put forward by the Commission and other relevant bodies, more work needs to be done to examine the practical and quantitative implications of using the countercyclical buffer as part of a broader macro-prudential toolbox.

o Interaction with other parts of the framework, including Pillar 2. AFME and ISDA would like to understand how the proposal for countercyclical buffers is intended to operate with the other measures that are being considered to address procyclicality. For example, forward looking provisioning is likely to reduce the need for a buffer by bringing forward recognition of losses and thus will have a countercyclical effect by putting aside profits. In addition, the extent to which firms’ internal rating systems adopt a ‘Through the Cycle’ approach and the use of downturn parameters will also reduce the need for countercyclical buffers. Further, we would like to understand how the buffer interrelates with other measures already within the framework to address procyclicality, such as stressed Value at Risk (VaR) and stress testing in the banking book. While we understand the authorities’ desire to ensure that firms are adequately capitalised when entering a downturn we remain concerned by the potential for duplication of capital requirements for this risk.

o International consistency. AFME and ISDA are very supportive of the consideration of other alternatives to the proposals in BCBS 172 in addressing issues raised by the industry participants. The majority of their Members prefer Commission Option A (bank specific approach under Pillar 2), although they recognise that it does not align with that proposed in BCBS 172. AFME and ISDA continue to believe that international consistency is very important and would therefore urge the Commission to raise Option A with the Basel Committee and encourage its adoption as the global standard. If the Basel Committee does not endorse Option A then a further reflection in light of the ongoing concern in relation to international consistency is needed.

o Timing of proposed measures. AFME and ISDA urge the Commission to take sufficient time to develop detailed recommendations regarding countercyclical buffers. It is vital that proposals taken forward are workable and proportionate in relation to the risks posed. Ambitious deadlines should not take priority over delivering a countercyclical buffer proposal that can be implemented in an operationally efficient manner. AFME and ISDA therefore think that countercyclical buffers should not be included within the CRD 4 proposal, but within a subsequent amendment to the CRD.

o Practicality/application. AFME and ISDA are very concerned that the proposal based on BCBS 172 gives rise to significant operational challenges for the firms in implementation. They appreciate the introduction of two further options for consideration that may address some of the problems, particularly the bank specific buffer approach. However such an approach will create issues for supervisors in terms of delivering a ‘level playing field’ across institutions.

o Release of the buffer. The use of the buffer is one of the core concerns, and one that is considered not to be dealt with in insufficient detail. Whilst AFME and ISDA recognise that the Commission states that the buffer should only be deployed when certain conditions are in place, the criteria are unclear. In the absence of more detailed guidance around release the Commission runs the risk of the
countercyclical buffer being perceived as a new minimum requirement. This could in turn have serious consequences in the event of the buffer being released and the message it sends to the market.

o Roles of regulatory bodies. Whilst AFME and ISDA agree with the Commission’s broad outline for a pan-European coordination and consistency of buffer decision, they urge the Commission to ensure that the respective roles of the ESRB, the EBA, and the national regulators are clearly defined and do not overlap. They urge the Commission to apply the following principles in developing the detailed descriptions of roles to be played by the aforementioned bodies: clear segregation of responsibilities; certainty and finality of decision-making; and clear and efficient three-way communication process. To the extent that standards are developed we also urge that effective policy making processes, including proper consultation, are put in place.

Full paper

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