Proposed Amendment to Market Risk Capital Rules Would Replace References to Credit Ratings | Practical Law

Proposed Amendment to Market Risk Capital Rules Would Replace References to Credit Ratings | Practical Law

The Office of the Comptroller of the Currency, the Federal Reserve Board and the FDIC issued a notice of proposed rulemaking that would remove the references to credit ratings in their market risk capital rules.

Proposed Amendment to Market Risk Capital Rules Would Replace References to Credit Ratings

by PLC Finance
Published on 04 Jan 2012 • USA (National/Federal)
The Office of the Comptroller of the Currency, the Federal Reserve Board and the FDIC issued a notice of proposed rulemaking that would remove the references to credit ratings in their market risk capital rules.
On December 29, 2011, the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (FRB) and the FDIC (collectively, Agencies) announced that they are seeking comment on a notice of proposed rulemaking (NPR) that would revise certain of the Agencies' market risk capital rules to replace references to credit ratings. This NPR revises the January 11, 2011 NPR to include alternatives to the use of credit ratings to determine the capital requirements for certain debt and securitization positions (the Agencies intend to propose additional rules replacing references to credit ratings in their general-risk-based capital regulations and the advanced approaches risk-based capital guidelines in the coming months).
The January 2011 NPR proposed changes to the Agencies' market risk capital rules based on the market risk framework published by the Basel Committee on Banking Supervision (BCBS), but did not include those aspects of the framework that relied on credit ratings (for more on the January 2011 NPR, see Legal Update, Federal Banking Agencies Issue Proposed Rules on Market Risk and on Risk-based Capital Standards under the Dodd-Frank Act). Under the Dodd-Frank Act, all federal agencies must remove references to credit ratings from their regulations and provide alternatives to measuring creditworthiness.
The NPR's alternative creditworthiness standards include that:
  • A bank would determine its specific risk-weighting factors for sovereign debt positions based on the Organization for Economic Cooperation and Development (OECD) Country Risk Classifications (CRCs). The OECD uses the CRC methodology to assess country credit risk, generally to set minimum premium rates for transactions covered by the OECD's Export Credit Agreement. This methodology is also recognized by the BCBS as an alternative to credit ratings.
  • For corporate debt positions that are exposures to a publicly traded entity that is not a financial institution, a bank may create its own methodology to calculate the specific risk-weighting factors that uses market-based information and historical accounting information, such as leverage, cash flow and company stock volatility. For all other corporate debt positions (for example, that represent exposures to financial institutions or companies that are not publicly traded), a specific risk-weighting factor of 8% must be assigned.
    The Agencies alternatively propose that a bank may assign an 8% specific risk-weighting factor to all of its corporate debt positions, instead of creating its own methodology.
  • A bank would use the simplified supervisory formula approach (SSFA), which is based on the Basel II advanced approaches supervisory formula approach, to assign specific risk-weighting factors to securitization and resecuritization positions. If the bank cannot or chooses not to use the SSFA, it must assign a specific risk-weighting factor of 100% to the securitization position.
    Under the new NPR, a bank may no longer model specific risk for securitization and resecuritization positions, with the exception of some correlation trading positions.
The Agencies are seeking comments on, among other things, the new methodologies, as well as on the appropriateness of the new NPR's definition of "financial institution" for these purposes. The Agencies are accepting comments on the new NPR until February 3, 2012.
To learn more about Basel III and the Collins Amendment, see Practice Notes, Basel III: An Overview and Summary of the Dodd-Frank Act: Bank Capital (Collins Amendment). For more on credit ratings under Dodd-Frank and about credit ratings agencies, see Practice Notes, Summary of the Dodd-Frank Act: Credit Rating Agencies and Credit Ratings and Credit Rating Agencies.