Regulators said they envisage new specific treatment for resecuritizations, and expect an interim treatment until banks are fully integrated to the new Basel accord.
These changes in the Basel II landscape will see increased capital requirements for resecuritizations and conduit facilities. This is a result of the consensus that more capitalization is needed under the new regime, said regulators who spoke on a panel at the recent Information Management Network's second annual European CLO, Structured Credit Products and Credit Derivatives Summit.
"In terms of the process consultation, the comment period is out until Oct. 15," said a Financial Services Authority (FSA) official speaking at the conference. "We understand there is still work to do, but the expectation is that there will be a final proposal at the end of the year. The aim is to have a better grasp on what is really happening in this structure."
In October 2007, the Basel Committee consulted on proposed guidelines for computing capital for incremental default risk, or the risk that is incremental to the default risk already reflected in a bank's value-at-risk (VaR) model. The application of such an incremental default risk charge, however, would not have captured recent losses in CDOs of ABS and other resecuritizations held in the trading book.
One challenge the accounting rules face are issues that can become systematic and thus apply to all transactions, like the SIV asset fire sales and CDO event of defaults. It's likely that the framework will change to better accommodate the way macro issues affect micro markets. The Basel Committee decided to expand the scope of the capital charge to capture not only price changes due to defaults, but also other sources of price risk, such as those reflecting credit migrations and significant moves in credit spreads and equity prices. The decision was taken as a response to recent credit market turmoil, where a number of major banking organizations have suffered large losses. Most losses were sustained in banks' trading books.
The majority of those losses were not captured in the 99%/10-day VaR. "Since the losses have not arisen from actual defaults, but rather from credit migrations combined with the widening of credit spreads and loss of liquidity, applying an incremental risk charge covering default risk only would not appear adequate," said the Basel Committee on Banking Supervision in a statement released at the end of July. "For example, the incremental default risk charge would not have captured recent losses in CDOs of ABS and other re-securitizations held in the trading book."
These losses that have materialized during the last 14 months have not arisen from actual defaults, but - again, as the Basel Committee stated above - from credit migrations combined with the widening of credit spreads and loss of liquidity. As such, most of the losses were not captured in the 99%/10-day VaR. "Banks that hold ABS need not over-rely on ratings they need to demonstrate a level of risk management position to maintain changes to [their] trading book," said the official representing the FSA.
Since the losses did not result from actual defaults, applying an incremental risk charge covering default risk only is not adequate.
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