Office of the Superintendent of Financial Institutions
OSFI is releasing the final version of the CAR Guideline for implementation in Q1 2019Footnote 1. The main revisions relate to the domestic implementation of the standardized approach to counterparty credit risk (SA-CCR), capital requirements for bank exposures to central counterparties (CCPs) and the securitization framework.
We have also clarified the capital treatment for right-of-use assets resulting from the adoption of IFRS 16 beginning January 1, 2019. This treatment will become effective for institutions upon their adoption of IFRS 16.
In addition to the above changes, the guideline includes the changes to the capital floor that were communicated to industry in January 2018. OSFI has also removed the Credit Valuation Adjustment (CVA) phase-in and other transitional arrangements that conclude at the end of 2018. Further, the guideline now lists Kroll Bond Rating Agency Inc. as an eligible external credit assessment institution (ECAI) for capital purposes, which became effective on July 6, 2018. Finally, we have provided clarifications throughout the Guideline in response to questions received from the industry as part of our regular annual updates.
The attached table in Annex 1 summarizes comments received and provides an explanation of how the comments have been addressed in the Guideline. We thank those who participated in the consultation process.
Questions concerning these changes can be sent to Catherine Girouard, Director, Capital Division by email at email@example.com.
IFRS 16 provides greater transparency to institutions' statement of financial position. Prior to IFRS 16, lease exposures were underrepresented (on the balance sheet) and, in OSFI's opinion, so were the capital requirements. OSFI supports the IFRS 16 approach whereby, from a lessee's perspective, no distinction is made between assets that are leased ("operating leases") and assets that are financed to be owned ("finance leases"). The CAR Guideline reflects this approach by applying the same capital treatment to all leases subject to IFRS 16.
Capital requirements consider the carrying amount of property (i.e., the risk exposure), whether leased or owned. They also capture other types of risk associated with leases (e.g., early cancellation penalties, fluctuating market lease rates, costs associated with renegotiating or finding a new lease, as well as uncertainty in the realizable value of right of use assets in times of stress).
OSFI should consider allowing the use of a 20% risk weight for the calculation of the capital floor for short term exposures to banks, which is consistent with the Basel I approach.
The change from a Basel I based floor to a Standardized Approach based floor, effective in Q2-2018, has significantly impacted trade finance exposures. Under Basel I, the risk weight was generally set at 20% given a carve-out for claims with a residual maturity of less than 365 days. Under the applicable standardized approach, most trade finance exposures receive a 100% risk weight. The new risk weight is out of line with the risk of trade finance, which is widely recognized as a low risk form of financing.
OSFI's approach to the calculation of the capital floor is to use the existing applicable standardized approach for credit risk under the CAR Guideline. Short term bank exposures should not be treated differently solely for the capital floor, and, as such, if changes are made to the treatment of bank exposures, these would apply to both the calculation of the capital floor and to bank exposures under the standardized approach.
Further analysis and broader consultation would be needed to consider changing the treatment of bank exposures.
The SA-CCR is a significantly better measure of counterparty credit risk exposure than the Current Exposure Method. The new method provides better incentives to enter into netting agreement and exchange margin with their counterparties.
In addition, many global peers make use of the internal modeling method (IMM), which allows banks to model their derivative exposure. Canadian banks with large derivative portfolios are eligible to apply to OSFI to use the IMM. This approach has been available to banks for more than five years and places Canadian banks on a level playing field with their global peers.
OSFI recognizes the increased level of risk measurement, monitoring and disclosure being required by the STC criteria and the potential difficulty and/or operational burden for certain securitization transactions to qualify for preferential capital treatment.
As such, OSFI has modified language where possible to reduce the potential operational burden of meeting certain STC requirements while retaining the substance and intent of the particular STC criterion. For example, the guideline now specifies that certain checks may be performed on a representative sample of underlying obligors, that disclosures may be limited to only those items applicable to the securitization transaction, that certain disclosures need only be provided if requested by an investor and in a timely manner as legally permissible, or that, in some cases, tests similar to those specified may be performed provided they adequately measure the relevant risks.
The STC criteria are designed to collectively safeguard the ability of investors in Canadian securitization transactions to properly and conveniently assess the characteristics, ongoing risks and performance of STC securitization transactions. To this end, institutions must meet all criteria in order for an exposure to be deemed STC compliant and receive preferential capital treatment.
That said, several requirements set out within individual criteria have been made subject to materiality and practical judgement when warranted, while preserving the spirit and intent of the criteria.
Further, we have made targeted adjustments to better align STC criteria with characteristics of the Canadian securitization market and the Canadian legal and economic environment.
November 1, 2018 for institutions with an October 31st year end and January 1, 2019 for institutions with a December 31st year end.
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Due to the large number of comments received regarding the significant revisions to the CAR securitization framework, comments and OSFI responses in this area have been summarized according to general themes.
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