EU CAD beta lowered – but only for some

UK and European op risk executives were shocked when a EU Commission official revealed that although the beta for the trading and sales business line would be lowered to 15% from 18% in the EU's Capital Adequacy Directive, this benefit would only be available to some institutions.

Michel Martino, an official in the Banking and Financial Conglomerates Unit in the Internal Market Directorate at the EU Commission, told a London conference at the beginning of July that the beta for the trading and sales business line would be “transitionally” lowered to 15% until 2012. This benefit would be available to investment firms, as defined under EU legislation. However, banks could only qualify for this lower beta if 50% or more of their income came from their trading and sales business line.

“This was one of the outcomes of our different impact studies, where there is clear evidence that there is a strong impact on institutions that primarily engage in trading and sales business,” said Martino. “So the decision was taken to allow them to use a lower beta factor – 15% instead of 18% for the trading and sales business until the end of 2012.”

But more surprises were on the way. The income number used to calculate capital under the basic indicator approach will be linked to the definition of income in existing EU legislation on accounting. As a result, firms that are publicly listed will have to use the International Accounting Standard definition of accounting, while private firms will be left with using the definition of income that their home accounting body advocates.

Martino also indicated that it would probably be 12 to 18 months before the proposed amendments to the Capital Adequacy Directive (CAD) and the Codified Banking Directive were accepted by the EU parliament. On top of this, it would be a further 12 months before member countries adopt the rules via their own legislature or regulatory processes. As a result, banks and investment firms in the EU won’t have final rules to work with until the third or fourth quarters of 2006.

He added that the final EU CAD text published in July would probably not contain a final implementation deadline for the industry, although text might suggest a split implementation date in line with Basel II. “There are mixed views on the implementation,” said Martino. “Basically there are two schools of thought. About half would prefer the new rules to apply only at the end of 2007, in departure from the Basel II implementation date. All approaches would be available at the same time. While the other half prefers the same implementation dates as Basel II.” He noted that big international banks prefer the first approach, while some smaller banks advocate the second, because of the level of investment they have made so far in their models and framework. The problem is that the implementation deadline is part of the text, which must be passed by the EU parliament – and so the deadline will not be finalised until the parliament has approved the directive. With a chuckle, Martino said: “In about 18 months, you will know the implementation deadline for sure.”

Operational Risk