By its Directive No. 89/647/EEC dated December 18, 1989, the Council of the European Communities had established common standards for the supervision and monitoring of credit risks in credit institutions. This Directive led to the creation of the European Solvency Ratio, and the methods of implementation of such Ratio in France were defined by Regulation No. 91-05 of the French Banking Regulatory Committee.
This Directive did not deal with the ever-increasing problem of market risks. In this context, a new Directive was elaborated by the European Communities Council, dated March 15, 1993. This defines the "common standards for market risks incurred by credit institutions" and provides "a complementary framework for the supervision of the risks incurred by institutions, in particular market risks, and more especially, position risks, counterparty/settlement risks and foreign exchange risks". This position has been taken up at an international level by the Basle Committee.
This new Directive 93/6/EEC specifies that credit institutions must henceforth provide capital which is always more than or equal to the sum of the following:
I) the capital requirements for their trading-book business and the settlement/delivery risks,
ii) the capital requirements relating to foreign exchange positions,
iii) the capital requirements previously imposed by Directive 89/647/EEC for all their business activities.
Furthermore, this Directive specifies that these risks will be analysed on a consolidated basis, respecting the orientations specified by the Council Directive 92/121/EEC on the monitoring and control of large exposures, enforced in France by Regulation No 93-05 of the French Banking Regulatory Committee.
It is important to stress that Member States were to adopt the necessary legal, regulatory and administrative provisions in order to comply with this Directive 93/6/EEC prior to July 1, 1995. These provisions should thus enter into force on December 31, 1995 at the latest.
No text for the application of this Directive has been presented by the French regulatory authorities to date.
In Appendix III, the European Directive 93/6/EEC defines the terms and conditions of determination of the foreign-exchange risk run by a credit institution:
determination of the net open position in each currency, consisting of the sum of elements such as the net spot position, the net forward position, the delta of options, etc.,
determination of the consolidated short and long positions for all currencies, after conversion into the institution's reporting currency. The higher of the two net positions thus obtained shall be the institution's overall net foreign-exchange position.
If the overall net foreign-exchange position thus calculated exceeds 2% of its total capital, the institution shall multiply the excess by 8% in order to calculate its capital requirement for hedging against foreign-exchange risks.
The Directive nevertheless allows Member States to use other methods for determining the overall net foreign-exchange position, in particular by matching positions between currencies which are closely related to each other.
In Appendix I, II and VI, the European Directive 93/6/EEC defines the methods of determination of the capital requirements needed to support the trading-book business. These are based on the existence of a twofold risk:
a specific risk: the risk of a price change in an instrument due to factors related to its issuer,
a general risk: the risk of a price change in an instrument due to a change in the level of interest rates, or a broad equity-market movement unrelated to any specific attributes of individual securities.
For each of these two risks, the Directive thus specifies the capital requirements in light of the net positions of each institution for three categories of instrument: traded debt instruments, equities and underwriting. These complex calculations are based mainly on the concepts of due date and duration and on heavy statistical observations.
It should, however, be stressed that, at the time of the implementation of this Directive, the competent authorities may authorise institutions which are not very active on the market to calculate the capital requirements for their trading-book business in accordance with the Directive 89/647/EEC relating to the European solvency ratio rather than according to the provisions set out above.
The position of the French Banking Regulatory Committee has not yet been made known to date; however, it would appear that, like the Basle Committee, the French authorities will accept the calculation of capital requirements on the basis of internal models which have previously been approved.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about specific circumstances.
For more information, please contact Olivier Drion or Ghislaine Mattlinger on 33-1-42-91-08-16