On May 26, 2016, the European Commission published a consultation paper on proposed options for implementing principles of proportionality in the upcoming capital requirements framework, to review the Original Exposure Method and replace the current standardized approached for counterparty credit risk with a new standardized approach. The consultation looks at the potential introduction of new standards for market risks in the prudential framework as it provides an opportunity to reassess the issue of proportionality for smaller or simpler financial institutions. The current risk framework contained in the CRR establishes some principles of proportionality but there is no derogation for small trading book businesses which would allow firms with non-significant trading activities to use a simplified prudential framework to calculate requirements for their trading exposures. The proposed Basel Committee for Banking Supervision standardized approach would bring significant modifications to the current approach in the CRR, making it more risk sensitive and better suited for complex financial instruments. The Commission is considering whether to implement a simplified version of the new standardized approach or to keep the current standardized approach.

The Commission is mandated to submit a report to the European Parliament by December 31, 2016, on the use of the Original Exposure Method under the CRR. The OEM is a standardized approach used to calculate the exposure values of derivative contracts, but only firms that can benefit from the derogation for small trading book businesses can use it. Numerous limitations on the application of the OEM have been identified: in particular, its simple design renders it difficult accurately to capture the exposure value of derivative transactions. The Commission is proposing three options: (i) keep the OEM in its current form; (ii) modify it in order to ensure its consistency with the Standardized Approach for Counterparty Credit Risk; or (iii) remove it and replace it the with the Basel Committee Standardized Approach for Counterparty Credit Risk.

Responses to the consultation are due by June 24, 2016.

The consultation paper is available at:

http://ec.europa.eu/finance/bank/docs/regcapital/crr-crd-review/20160526-trading-book-consultation_en.pdf