Scope of internal hedges

Should transactions between non-trading books and trading books closed through clearing houses as market transactions be treated as external market transactions and therefore should they not be subject to the requirements established in Article 106 CRR?

As stated in the article 106 of the CRR, internal hedges (as defined in Article 4(1)(96) CRR) must be properly documented and not be primarily intended to avoid or reduce own funds requirements. Therefore, institutions should be able to identify9 all internal hedges and should document their treatment for the purpose of calculating own funds requirements for market risk. In addition to this, and in accordance with Article 106(1)(d) CRR, the market risk that is generated by an internal hedge must be dynamically managed in the regulatory trading book within the authorized limits. In the current operating model in most of the financial entities, non-trading book portfolios usually close their market risk with the trading books through internal transactions that are subject to the CRR and competent authorities’ regulation on internal hedges. However, the recent evolution of the financial markets has increased the volumes of OTC derivatives that banks executed through clearing houses, and this is also the case for some transactions between non-trading and trading portfolios within a specific entity. This new operating model, in which deals between non-trading and trading portfolios are executed through clearing houses, will be as follows: • Financial management, responsible for the management of non-trading book portfolios ask for a price in a specific transaction, including as one of the price providers the trader of one of the trading books of the same entity, in addition to other financial institutions. • If the price provided by the trading book is the most competitive, then the deal is closed and they both clear the transaction through a clearing house, which breaks the deal in two transactions and therefore the entity will have two external deals closed with the market. • The trading book will include this transaction in the compression runs they execute periodically, while the non-trading book will maintain the trade as it is. According with the Rule Book LCH, compressions are allowed for each dealer account (BIC Code), reinforcing the idea of independency without any link between original dealers.