The European Union’s Capital Requirements Regulation – CRR defined under Regulation No 575/2013 – defines the requirements relating to prudent valuation (PRUVAL) adjustments of banks’ fair-valued positions. The purpose of the regulation is to mandate banks to set capital aside for the “uncertainty” of valuations that are inherent in the mark-to-market and mark-to-model approaches used by trading institutions.
Regulation becomes law
The regulation became law in Q1, 2016. Banks are now expected to comply with the Regulatory Technical Standard (RTS) that the EBA published on the back of the regulation. But the bank of England thinks the industry is not up to standard yet.
In proposing the regulation, the various bodies responsible for regulating the banking industry rightly concluded that the use of
- a single mid price or
- a single bid-offer spread or
- a single valuation produced by a model
does not capture the uncertainty inherent in valuations. The RTS, therefore, mandated a number of approaches under which banks would calculate ‘Additional Valuation Adjustments’, which in aggregate would determine each bank’s PRUVAL capital charge. The approaches required the use of the distribution of prices or rates available for each position in order to determine AVAs, which, to the 90% confidence level, would capture uncertainty associated with the use of a single mid price or a single bid-offer price. All this requires ongoing availability of the right data.
Reviewing the process
In June, 2016, the Bank of England’s Prudential Regulation Authority (PRA) produced a paper entitled “Regulatory Update on Current Valuation Topics”. One of the themes of this paper was that while firms are for the most part are complying with the RTS, many of them have PRUVAL processes in place that are very manual. A lack of interconnectedness between PRUVAL processes was also a theme. For the PRA to have confidence that a bank’s PRUVAL is being applied accurately and consistently the underlying data sources, processes and calculations need to be auditable. Manual approaches, while getting banks across the Jan 1st regulatory finish line, are not seen as a sustainable way forward.
Keys to success
As firms look to move from manual, operationally risky processes to more automated, robust and efficient frameworks, GoldenSource has identified the key data capabilities required for success:
- risk sensitivity storage and aggregation
- multi-source and type pricing, rates and curve data availability
- price, curve and surface time series data with supporting market data manipulation capabilities
- AVA calculations for Market Price Uncertainty, Close Out Costs and Unearned Credit Spreads
- easy integration with security master and customer master systems
- an industry standard data model underlying all the systems and calculations
This adds to the list of financial data capabilities needed to comply with regulations and operational business as usual. There will certainly be new regulations and also internal demands for deeper analytics, faster reporting and improved governance. It is critical from a data management perspective to keep a forward view on the quality, availability and preparation of integrated data around securities, products, customers, accounts, entities, transactions and corporate actions.
PRUVAL is one of many regulatory data challenges that can be accommodated within a strategic data management approach. Banks that assess the totality of their financial/reference/market/risk data needs can then make tactical adjustments or additions to a strategic capability, gaining incremental benefit as they go. This avoids the need to reconcile cross-regulatory and cross-departmental data at various stages during transaction, compliance, reporting and disclosure processes, which is disruptive to operations and reduces efficiency.
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