FSA sets out further capital requirements proposals

Mar 01 2006 Martin Coyle

The Financial Services Authority has said that its proposals for implementing the Capital Requirements Directive passed a cost-benefit analysis and should attract broad industry acceptance. Consultation paper 06/3 sets out the FSA's full set of draft Handbook rules and guidance for implementing the regime, which is designed to introduce a risk-sensitive prudential framework for credit institutions and investment firms in the European Union. The CRD, which takes effect in January 2007, was developed in line with the Basel II capital accord, which takes effect in 2008.

The FSA said that it had a major challenge in the area of super-equivalence. Previously, the FSA and the Treasury said they would not attempt to be "super-equivalent" with the UK implementation of EU directives. The paper notes that it intends to defer the new requirements for capital definition and large exposures until the EU and Basel Committee complete their reviews of these areas at the end of 2007. The FSA has also gone further in the areas of economic stress testing and diversification benefits.
The regulator said stress testing should be used as a starting point for a discussion with firms as to whether they had adequate contingency plans to manage their capital, relative to the pillar one capital requirements, through a recession. If firms were found to have an inadequate capital management contingency plan, the stress test would be used to impose an additional capital requirement on them.
The FSA said that its revised approach to firms' claims for diversification benefits under pillar two were significantly more liberal than the approach taken in its previous consultation. The paper noted that the data and analytical tools to support this aspect of pillar two were not yet fully developed or agreed upon internationally. Because of this, the FSA said it would consider firms' claims for additional diversification benefits under pillar two in the long term, where they could be justified. In the short term, the FSA said it would apply components of pillar one as a minimum.

Applying for waivers

The paper noted that firms attempting to apply for waivers under the internal ratings-based approach and advanced measurement approaches would be subject to rigorous challenges by FSA staff.

"We will expect firms to acknowledge frankly any shortcomings and to take a conservative approach while making improvements. If necessary, we will not approve waiver applications where insufficient progress has been made in important qualitative areas, such as the 'use test' or senior management governance. Nor will we agree waiver applications where there are clear shortcomings in modelling parameters which have a significant impact on capital levels, unless the firm proposes appropriate conservatism to compensate," the paper stated.

The paper emphasised the importance of its proposals for senior management governance of IRB waiver applications. It said that the FSA would not, at present, include additional guidance in the Handbook. It will take account of expected guidance from the Committee of European Banking Supervisors, however, and include a definition of "designated committee" in the Handbook glossary. On the CEBS front, the FSA warned firms that the organisation's guidelines did not lend themselves to a "copy out" within a principles-based approach.

Home-host requirements

The FSA said that it had been working closely with other regulators to develop relevant principles and guidance to put in place home-host requirements for advanced approach applications.

The FSA said it would take the lead when home supervisor by coordinating with other supervisors and involving firms in college presentations. It would also liaise with firms when drawing up action plans for dealing with their applications. The FSA added that it would liaise closely with the home supervisor and seek reassurances that it was comfortable with the application. This was consistent with CEBS guidelines, the FSA noted.

The regulator said it would deem as valid any preparatory work that firms undertook in anticipation of the final text, provided that they complied with the FSA's "policy baseline". Firms should also discuss with the FSA an appropriate individual timetable for making changes, as required by the final CRD text and Handbook rules.

The FSA plans to publish a feedback statement on the paper in July. The Handbook rules and guidance will be finalised in October.

The paper follows CP05/3, which was published in January 2005. The consultation period ends on April 28.

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