Further details on the liquidity transfer pricing systems

Minimum Requirements for Risk Management (MaRisk) Protocol of the Meeting of the MaRisk Expert Committee on 18.06.2013 in Bonn (BaFin) Topic: Liquidity Transfer Pricing Systems

1. Welcome The supervisor welcomes the participants and provides a brief overview of the topics of the expert committee, which are summarized below.

2. Allocation Systems in Smaller Institutions Smaller institutions are mostly still in the phase of creating a concept for the use of allocation systems. Liquidity costs and benefits are partially already processed in the area of calculation. Furthermore, there is usually no quantification of liquidity costs and benefits in the institutions' procedures, i.e., the price of the expected liquidity binding is not shown separately and charged or remunerated. Internal liquidity management often takes place via volume limits rather than internal transfer prices. Thus, the establishment of an allocation system is not rendered unnecessary. The discussion also deals with the allocation of liquidity costs and benefits and the use of contribution margin accounting in the context of post-calculation. If an institution uses contribution margin accounting for post-calculation, the supervisor will generally include this in the examination of an allocation system.

3. Consideration of the Costs of the Liquidity Buffer and Other Equity Instruments The discussion in the expert committee shows that the costs of the liquidity buffer are difficult to delineate. The liquidity buffer of an institution depends on its individual risk appetite and thus consists of different components depending on the institution. Consequently, the corresponding opportunity costs cannot be determined uniformly. Among the associations of smaller institutions, there are different approaches regarding the consideration of indirect costs from the liquidity buffer. The indirect costs are currently either not considered or the costs of the liquidity buffer are allocated. Furthermore, the treatment of equity instruments that do not count towards the liquidity buffer must be discussed further. This appears appropriate, as these can be assets of lower quality with higher liquidity risks that must be adequately considered. The mixing of liquidity and credit risks is viewed as problematic in this context. Participants note that the decomposition of spreads into individual components (creditworthiness and liquidity) is difficult. So far, smaller institutions regularly neglect the liquidity risks of their equity instruments.

4. Liquidity Transfer Pricing Systems in Larger Institutions The individual participants report on how far they have progressed with the creation of the concept for the liquidity transfer pricing system and its corresponding implementation. In particular, the treatment of liquidity costs and the steering effect or incentive setting of the systems are addressed. It shows that the developments of liquidity transfer pricing systems and their implementations at larger institutions have progressed further than those of allocation systems at smaller institutions. In some cases, the systems used at larger institutions have already been in place for years.

5. Miscellaneous Participants welcome the transparency of liquidity costs and benefits through a liquidity transfer pricing system or allocation system. Problems still exist regarding the consideration of liquidity risks. In this context, the supervisor points out that a blanket view of liquidity costs and benefits at the business level, e.g., solely distinguishing between private and corporate customers, is not useful with regard to the steering impulse and cannot meet the requirement for cause-related internal allocation according to BTR 3.1 Para. 5 MaRisk. The differentiation must be more granular at this point. A view at the transaction level in the allocation of liquidity costs, benefits, and risks is not strictly required in every case for an allocation system. However, in a liquidity transfer pricing system, allocation should take place at the transaction level as much as possible. If no allocation takes place at the transaction level, a meaningful aggregation must be found, whereby products and transactions with similar liquidity characteristics can be aggregated.

6. Questions from Participants The wording of BTR 3.1 Para. 7 MaRisk ("The responsibility for the development and quality as well as the regular review of the liquidity transfer pricing system is to be exercised in a unit independent of the market and trading.") is discussed regarding whether methodological responsibility and development may be located in Treasury, although Treasury generally does not operate independently of the market and trading. In this context, the supervisor clarifies that the term "Treasury" does not have a universally valid definition. Due to its differently structured functions and tasks in practice, Treasury can be located in trading or, for example, in the finance department. At this point, it can generally be stated that the process of developing and regularly reviewing a liquidity transfer pricing system must be monitored by risk controlling. Risk controlling can draw on the expertise of Treasury. To this extent, the supervisor does not follow the analogous application of the concept of "material plausibility check" for purposes of method development proposed during the meeting in this context.

7. Implementation of Requirements All institutions must create a concept for a liquidity transfer pricing system or allocation system by the end of 2013 at the latest. However, the implementation period is granted to all institutions beyond the end of the year, i.e., the supervisor will exercise discretion in the supervisory assessment, provided that delays in individual cases are not due to shortcomings of the institution. Nevertheless, the supervisor expects that institutions review mechanisms already in place and make improvements to their systems and procedures as soon as possible, insofar as this appears possible and sensible.

8. Concluding Remarks The discussion in the expert committee shows that the use of liquidity transfer pricing systems or allocation systems is at different stages of progress in the institutions. It becomes clear that, depending on the complexity of business activities, various approaches and designs can meet the supervisory goal of using such a system. Liquidity transfer pricing systems or allocation systems should not only aim for the cause-related internal allocation of the respective liquidity costs, benefits, and risks and the associated transparency, but also to provide institutions with a steering instrument with which "silo thinking," which was particularly evident in the financial crisis, can be overcome. Further, initially also bilateral, exchange on the topic appears advisable.