On 9 February the Internal Market and Services Directorate General of the European Commission launched a public consultation seeking stakeholders' views on proposed measures to strengthen bank capital requirements for counterparty credit exposures arising from derivatives, repo and securities financing activities. The measures are based on the work of the Basel Committee on Banking Supervision, and will form part of the Commission's upcoming legislative proposal to implement Basel III reforms into EU law. Interested parties are invited to send their opinions by 9 March 2011.

The financial crisis highlighted that banks massively underestimated the level of counterparty credit risk associated with over-the-counter (OTC) derivatives. This prompted G20 leaders at the September 2009 Pittsburgh summit to call for more OTC derivatives to be cleared through a Central Counterparty (CCP), and also ask that OTC derivatives that could not be cleared centrally be subjected to higher capital requirements in order to properly reflect the higher risks associated with them. Following the G20 leaders' call, the Basel Committee on Banking Supervision (BCBS) started to review the regulatory capital treatment for counterparty credit risk. The BCBS identified insufficiencies and that CCPs were not widely used to clear derivatives trades.

The purpose of the public consultation on possible measures to strengthen bank capital requirements for counterparty credit risk is to gather stakeholders' views on two specific issues in the area of counterparty credit risk:

• Capitalisation of bank exposures to central counterparties (CCPs)
• Treatment of incurred credit valuation adjustments (CVA)

The proposed measures form an integral part of the Commission's efforts to ensure efficient, safe and sound derivatives markets, in line with the recent consultation on central securities depositories. They will strengthen the capital requirements for counterparty credit exposures arising from institutions’ derivatives, repo and securities financing activities and will create the right incentives for banks to use CCPs wherever practicable.

Measures aim specifically to raise the amount of capital backing credit risk exposures, reduce procyclicality which means reducing the impact of economic fluctuation throughout the cycle and provide additional incentives to move OTC derivative contracts to central counterparties and, finally, helping to reduce systemic risk across the financial system.

These measures would complement the Commission's other regulatory initiatives in this area, including the Regulation of OTC derivatives, central counterparties and trade repositories. The consultation's feedback and the ongoing Quantitative Impact Study being conducted by the Basel Committee will both be essential for finalising the Commission's legislative proposal which is due for summer 2011.