April 8, 2024

Ann E. Misback
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue N.W.
Washington, D.C. 20551

James P. Sheesley
Assistant Executive Secretary
Attention: Comments/Legal OES (RIN 3064-AF29)
Federal Deposit Insurance Corporation
550 17th Street N.W.
Washington, D.C. 20429

Chief Counsel’s Office
Attention: Comment Processing
Office of the Comptroller of the Currency
400 7th Street S.W.
Suite 3E-218
Washington, D.C. 20219

Re: Regulatory capital rule: Amendments applicable to large banking organizations and to banking organizations with significant trading activity – Addendum

Federal Reserve: Docket No. R-1813, RIN 7100-AG64
FDIC: RIN 3064-AF29
OCC: Docket ID OCC-2023-0008

Dear Sir/Madam,

We appreciate the opportunity to provide further clarifications to our letter submitted to the Agencies on January 16th, 2024 (“January Letter”)1 in relation to the above-referenced proposal (the “Proposed Rulemaking”).2 Specifically, below we provide additional information and clarifications on our comments relating to the following aspects of the Proposed Rulemaking:

• Equity Investment in Funds (Index Bucket Approach)
• Industry QIS Results (FRTB SA RWA Impact)

I. Equity Investment in Funds (Index Bucket Approach)

The proposed capitalization approaches for equity investments in funds under the SBM framework in FRTB-SA would not be implementable or would be extremely punitive, resulting in capital requirements disproportionate to the inherent risk of the fund positions.

The Associations are concerned that the capital treatment of equity investments in funds (EIIFs) remains very problematic under the FRTB-SA. Although the FRTB IMA in the Proposed Rulemaking contains some improvements for the treatment of EIIFs, the FRTB-SA treatment is excessively conservative and will substantially increase capital requirements. The main challenge for banking organizations is the limitation in the availability of data. The look through approach (LTA) requires fund managers to publish all of their underlying fund holdings on a frequent basis and banks to translate this into the relevant risk measures under FRTB-SA. Firstly, for a substantial portion of funds, in particular mutual funds, fund holding reporting on such a frequent basis is not available. Secondly, banking organizations will face significant challenges in implementing the necessary infrastructure and computational enhancements due to their scale and complexity. This is due to the size of fund holdings for which risk data needs to be generated when those holdings are not on the balance sheet and therefore not subject to the standard data checks.

Moreover, the index tracking bucket approach as prescribed in FRTB-SA would not be implementable for most mutual funds given that most of them are not passive index trackers. Consequently, banking organizations would be forced to apply the punitive “fallback method”3 for the vast majority of the fund population. This “fall back method”, as currently defined, is overly conservative and insufficiently risk sensitive with respect to the underlying risk of the fund positions.4

The significance of the impact from the use of the fall back method can be seen in the most recent Basel III monitoring report5. It was noted that several G-SIBs reported conservative assumptions for the capitalization of EIIFs under the revised market risk framework. The high capital charge is driven by the application of the fall back method instead of the other available methods such as index tracking or hypothetical portfolio approach. The Associations note that 80% of the reported capital charge was excluded due to the pervasive use of the fall back method. Given how FRTB-SA is specified currently, the Associations cannot see how such an adjustment from the Basel Committee in the Basel III monitoring report provides an accurate and representative impact estimate.

In the January Letter, the Associations proposed enhancing the currently defined index buckets in the FRTB-SA framework to include EIIFs as well6. We note that the standard initial margin model (“SIMM”) methodology already incorporates the use of index buckets for funds into its standardized calculations. This treatment should be extended to the FRTB-SA capitalization of funds to ensure a more risk sensitive capitalization even when the LTA or index tracking approach is not possible or practical. The selection of the appropriate fund bucket could be based on a fund’s prospectus or mandate. For example, if a mutual fund’s prospectus specifies that it will primarily invest in U.S. large-cap equity securities, then a position in that mutual fund should be capitalized by assigning it to the “large cap and liquid economy funds” bucket per
Table 1 below.

The Associations have produced additional recommendations for a methodology similar to the index bucket approach, encompassing an approach for determining appropriate risk weights. The approach for a banking organization to allocate a fund to an appropriate fund bucket without any requirement to look through the fund is a key component of the new methodology. A banking organization should be allowed to map its fund exposure to one of the proposed buckets (see below) based on the banking organization’s internal policy and procedures. The approach to map fund exposures to the proposed buckets should consider whether the fund meets the criteria for “well diversified”, the fund’s main investment strategy, and available information on the fund’s actual holdings.

1 Letter from ISDA and SIFMA to the Agencies (January 16, 2014), available at https://www.isda.org/a/1ElgE/ISDA-and-SIFMA-Response-to-US-Basel-III-NPR.pdf

2 Regulatory Capital Rule: Large Banking Organizations and Banking Organizations With Significant Trading Activity, 88 Fed. Reg. 64,028 (Sept. 18, 2023)

3 § _.205(e)(3)(iii)

4 Many of these points are made on pages 34-35 in the letter from ISDA and SIFMA to the Agencies (January 16, 2014), available at https://www.isda.org/a/1ElgE/ISDA-and-SIFMA-Response-to-US-Basel-III-NPR.pdf

5 Basel III Monitoring Report: https://www.bis.org/bcbs/publ/d570.pdf

6 See page 34 in the letter from ISDA and SIFMA to the Agencies (January 16, 2014), available at https://www.isda.org/a/1ElgE/ISDA-and-SIFMA-Response-to-US-Basel-III-NPR.pdf