Instruction No. 3/2020 on Interest Rate Risk in the Banking Book Reporting

Instruction No. 3/2020 Official Journal No. 1/2020 2nd Supplement • 2020/02/14 .................................................................................................................................................................................................. Topics Supervision :: Prudential Standards Mod. 99999911/T – 01/14

Index Text of the Instruction Annex I – Reporting Models 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 180 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 180 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 180 040 050 060 070 Issued debt securities 085 Deposits with no defined maturity: current retail 095 Deposits with no defined maturity: non-current retail 105 Deposits with no defined maturity: financial wholesalers 115 Deposits with no defined maturity: non-financial wholesalers 120 Deposits with defined maturity 130 Derivatives 140 Others 150 160 Contingent assets 170 Contingent liabilities 180 Annex III – IRRBB measurement methods Annex IV - Sophistication matrix for IRRBB measurement Annex V - Different levels of sophistication for each indicator and quantitative model Annex VI - Scenarios for the application of the "alert signal" outlier test

Text of the Instruction Subject: Update of the reporting of exposure to interest rate risk resulting from activities not included in the trading book and of the results of the 'outlier' tests evaluated by the supervisor.

This Instruction amends Bank of Portugal Instruction No. 34/2018, published in the 2nd Supplement of Official Journal No. 12/2018, of December 26, 2018 (Instruction No. 34/2018), with the objective of updating the standardized reporting of exposure to interest rate risk resulting from activities not included in the trading book and of the impact on economic value and financial margin of a sudden and unexpected change of 200 basis points in the yield curve.

Among other aspects, through this amendment, updates resulting from the European Banking Authority Guidelines on the management of interest rate risk resulting from activities not included in the trading book (previously designated as Guidelines EBA/GL/2015/08 and now designated as Guidelines EBA/GL/2018/02), of July 19, 2018, are implemented.

Considering the provisions of Article 16(3) of Regulation (EU) No 1093/2010 of the European Parliament and of the Council, of November 24, which established the European Banking Authority, it is the responsibility of the Bank of Portugal, as the competent national authority, as well as of institutions, to ensure compliance with the guidelines and recommendations issued by the EBA, notably the aforementioned Guidelines EBA/GL/2018/02.

The provisions provided for in Instruction No. 34/2018 are thus updated for the purposes of applying the provisions of Article 116-A of the General Regime of Credit Institutions and Financial Companies, approved by Decree-Law No. 298/92 (“RGICSF”), which establishes that the Bank of Portugal must analyze the provisions, strategies, processes, and mechanisms applied by institutions to assess the risks to which they are or may be exposed. In particular, paragraph 5 of the same article is highlighted, according to which this analysis and assessment include the exposure of credit institutions to interest rate risk resulting from banking book activities, and measures are necessary, at least in the case of institutions whose economic value suffers a reduction corresponding to more than 20% of their respective own funds, following a sudden and unexpected change in the interest rate of 200 basis points or amplitude provided in guidelines of the European Banking Authority (EBA) on the matter (hereinafter referred to as the "outlier test").

Consequent upon the entry into force of the aforementioned Guidelines, the principles underlying the calculation of the outlier test result are thus updated and new principles are introduced. In particular, a set of principles is clarified, including, among others, the need to calculate the change in economic value by currency, the definition of the associated significant currency, as well as the inclusion of non-performing exposures.

Point changes were also introduced to the reporting parameters, namely through a change in the disaggregation of exposure to deposits with no defined maturity and the introduction of the possibility of reporting exposure by time bands conditional on the scenarios applied to the yield curves, in order to respond to the new risk management requirements introduced by the Guidelines.

The new reporting will also allow institutions to communicate to the Bank of Portugal the result of the application of a second outlier test, designated as the "alert signal" outlier test.

Additionally, the reporting frequency will be changed to quarterly in cases where the institution calculates a variation in the economic value of capital higher than 20% of own funds or 15% of Level 1 own funds, depending on the respective associated outlier test, thus embodying the reporting obligation provided for in the new Guidelines.

The draft of this Instruction was subject to public consultation, in accordance with legal provisions.

In these terms, the Bank of Portugal, in the exercise of the competence conferred upon it by Article 17 of its Organic Law, approved by Law No. 5/98, of January 31, in its current wording, and by the combined provisions of paragraph 1 and paragraph 2 of Article 120, paragraph 1 of Article 121-A, and paragraph 1 of Article 196, all of the RGICSF, approves the following Instruction:

Article 1. Object This Instruction has as its object to amend Bank of Portugal Instruction No. 34/2018, published in the 2nd Supplement of Official Journal No. 12/2018, of December 26 (Instruction No. 34/2018), in order to update the specific rules and procedures applicable to the provision of standardized format information regarding interest rate risk resulting from activities not included in the trading book (also designated as "Interest Rate Risk in the Banking Book" or, abbreviated, "IRRBB").

Article 2. Amendments to Instruction No. 34/2018 1 - Articles 1, 4, 5, 6, 7, 8, and 10 of Instruction No. 34/2018 shall have the following wording:

«Article 1. Object This Instruction establishes the specific rules and procedures applicable to the provision of standardized format information regarding: a) […] b) The impact on economic value resulting from a sudden and unexpected change of 200 basis points in the yield curve ("outlier test"); c) The impact on the expected one-year financial margin resulting from a sudden and unexpected change of 200 basis points in the yield curve; d) The impact on economic value resulting from the application of the scenarios provided for in Annex VI of this Instruction ("alert signal" outlier test).

Article 4. Reporting of the outlier test result and financial margin variation 1 - The entities referred to in paragraph 1 of Article 2 must report to the Bank of Portugal the impact of a sudden parallel variation of +/- 200 basis points (bps) of the yield curve on economic value. 2 - The entities referred to in paragraph 1 of Article 2 must report to the Bank of Portugal the impact of a sudden parallel variation of +/- 200 basis points (bps) of the yield curve on the expected one-year financial margin.

Article 5. Calculation methods 1 - When calculating the impact of the scenarios referred to in Articles 4 and 4-A on economic value according to the previous article, the entities referred to in paragraph 1 of Article 2 must use one of the calculation methods contained in Annexes III and V of this Instruction, according to the entity's level of sophistication, evaluated according to Annex IV of this Instruction. 2 - When calculating the effect of the scenarios referred to in paragraph 2 of Article 4 on the expected one-year financial margin, entities must use one of the calculation methods indicated in Annexes III and V of this Instruction, according to the entity's level of sophistication, evaluated according to Annex IV of this Instruction. 3 – […]

Article 6. Complementary reporting The reports and calculations referred to in Articles 3, 4, and 4-A of this Instruction must be complemented with a report containing the following elements: a) A description of the method or methods used to calculate the impact of interest rate changes on economic value and financial margin, and the respective level of sophistication according to Annexes III, IV, and V of this Instruction; b) The risk-free yield curve(s) considered in letter u) of paragraph 1 of Article 4-B of this Instruction; c) A description of the hypotheses and assumptions assumed, both in the calculation of changes in economic value and in the financial margin resulting from the application of the scenarios provided for in Articles 4 and 4-A, and in particular, regarding: i. The treatment given to elements whose periods of maturity or effective rate repricing diverge from contractual terms and regarding the treatment of elements with no defined contractual term; ii. The treatment of embedded automatic options (possible minimum and maximum limits of specific interest rates to instruments) and explicit automatic options. d) If the institution excludes commercial margins and other spread components in the calculation performed to determine economic value variations in the outlier tests referred to in Articles 4 and 4-A, a description of the methods referred to in letter l) of Article 4-B of this Instruction.

Article 7. Reporting models 1 – The information required in Article 3, as well as the information from the calculations provided for in Articles 4 and 4-A, is provided according to the reporting models indicated below, contained in Annex I to this Instruction: a) […] b) […] c) IRRBB 03.00 – Results of the outlier test and application of the standard 200 bps shock on the expected one-year financial margin; d) IRRBB 04.00 – Results of the "alert signal" outlier test.

Article 8. Frequency 1 - Entities must report to the Bank of Portugal the information mentioned in Articles 3, 4, 4-A, and 6 of this Instruction, with a frequency: a) Quarterly, with reference to March 31, June 30, September 30, and December 31, if the calculation performed by the entity results in a negative variation in economic value higher than: i. 20% of own funds, according to paragraph 1 of Article 4, or ii. 15% of Level 1 core own funds, according to Article 4-A. b) Semi-annual, with reference to June 30 and December 31, if none of the thresholds referred to in the previous letter are exceeded. 2 – […] 3 – The information with reference to: a) March 31 must be reported by May 31 of the same year; b) June 30 must be reported by August 30 of the same year; c) September 30 must be reported by November 30 of the same year; d) December 31 must be reported by February 28 of the following year. 4 – In order to ensure adequate monitoring of the evolution of interest rate risk exposure in the banking book of entities that exceed the thresholds referred to in letter a) of paragraph 1 of this article, the quarterly reporting obligation only ceases after 2 consecutive quarters in which the referred thresholds are not met.

Article 10. Request for exemption for investment firms 1 – […] 2 – […] 3 – This exemption does not apply in cases where entities exceed the limits provided for in letter a) of paragraph 1 of Article 8, applying the reporting obligations provided for in that article.»

2 - Annexes I, II, III, IV, and V published in Instruction No. 34/2018 shall have the wording given in Annexes I, II, III, IV, and V to this Instruction, respectively.

Article 3. Additions to Instruction No. 34/2018 1 – Articles 4-A and 4-B are added to Instruction No. 34/2018, with the following wording:

«Article 4-A. Reporting of the "alert signal" outlier test results The entities referred to in paragraph 1 of Article 2 must report to the Bank of Portugal the impact of sudden variations in the yield curve resulting from the application of scenarios 1 to 6 on economic value as established in Annex V of this Instruction.

Article 4-B. Principles underlying the calculation of outlier tests 1 - When calculating the impact of sudden variations in the yield curve on economic value according to Articles 4, paragraph 1, and 4-A, entities must take into consideration, in particular, the following: a) All positions of instruments sensitive to interest rates must be included; b) Operations in small trading portfolios, according to Article 94 of Regulation No. 575/2013 of the European Parliament and of the Council, of June 26, 2013, on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, must be included, except if their interest rate risk is captured in another risk indicator; c) All Level 1 core own funds instruments and other perpetual own funds instruments without call dates must be excluded from the calculation; d) Entities must reflect automatic and behavioral options in the calculation, adjusting the main behavioral modeling assumptions to the characteristics of the different interest rate scenarios; e) Obligations regarding pension plans and pension plan assets must be included, except if their interest rate risk is captured in another risk indicator; f) Cash flows resulting from interest rate sensitive instruments must include any capital repayment, any capital repricing, and any interest payments; g) Entities with a gross ratio of non-performing exposures higher than 2% must include non-performing exposures as interest rate sensitive instruments, net of impairments; h) The gross ratio of non-performing exposures referred to in the previous letter must correspond to the total gross of debt securities and loans and advances considered non-performing, according to Commission Implementing Regulation (EU) No 680/2014, of April 16, 2014, establishing implementing technical standards with regard to reporting by institutions in accordance with Regulation (EU) No 575/2013 of the European Parliament and of the Council, on the total gross of debt securities and loans and advances; i) The modeling of non-performing exposures should reflect the expectation regarding the amount of future cash flows and their timing; j) Entities must take into account possible minimum and maximum limits of specific interest rates to instruments; k) The treatment of commercial margins and other spread components that make up interest rates relative to the risk-free interest rate,