Novi-o seeks to broaden op risk scope

LONDON - Novi-o, the operational risk sub-group of the Committee of European Banking Supervisors' expert group on prudential regulation, held a public hearing on its 'Compendium of supplementary guidelines on implementation issues of operational risk', where European supervisors and industry representatives aired their opinions.

The main concerns of the panel addressed issues relating to the scope of operational risk and the allocation of capital under the advanced measurement approach (AMA) to operational risk under the Capital Requirements Directive (CRD). The compendium seeks to ensure that supervisory guidelines evolve with the discipline of operational risk and understands the definition of what constitutes an operational risk needs to be readdressed, particularly in the new market environment, which has demonstrated much blurring of the boundaries between risk types. Moreover, the CRD and the Basel II Accord do not include any guidance on how to distinguish between operational risk and market risk boundary events, or clarify the scope of operational risk loss, which remains open to interpretation - and in flux given the current crisis situation. The Novi-o paper proposes to clarify these aspects. But supervisors remain concerned that the draft clarifications do not go far enough. Many were anxious to see more examples of strategic or marker risks to be able to identify such risks from op risks more confidently. Equally, losses from op risks events such as pending losses, near misses and timing impacts, remain unclearly defined for most present at the hearing, with calls for more examples of what exactly should be included in the scope of op risk losses for management as well as for measurement purposes. Some pending losses, for example, might not show for several years, particularly in some litigation cases, and including this in the op risk measurement is not only difficult to monitor, but it could cause instability in the capital model, said one attendee.

One of the most prevalent concerns relates to the changes to the allocation limitations on the diversification effect, which the paper says needs to be reviewed so the allocation mechanism takes into account the operational risk of the subsidiaries concerned. Supervisors at the meeting commented that this should be a Pillar II issue and doubted that risk-sensitive allocation could exist, and if it could, it would be imprecise. The group is collecting comments until the end of March and plans to issue final guidance later in the year.

Novi-o is also drafting supplementary guidelines on operational risk-transfer mechanisms, which aim to introduce some general conditions on operational risk-transfer instruments and guidelines for the recognition of insurance in the AMA calculation. One issue under consideration is whether firms should have experience of such products before they can be used with the AMA to enable firms to gather data on the certainty and timeliness of payment. The paper is due to be published for consultation soon.