The European Banking Authority (EBA) has launched its public consultation on draft Regulatory Technical Standards (RTS) defining the valuation of derivative liabilities for the purpose of bail-in in resolution. The consultation will run until 13 August 2015.

The framework proposed in the EBA standards will allow resolution authorities and independent evaluators to effectively conduct a reliable valuation in a short timeframe. 

In cases of particular emergency constraints, resolution authorities will also be able, under certain conditions, to apply resolution actions on the basis of preliminary valuations and even before pricing is available in the market.

The EBA says that this should only happen in "very exceptional circumstances" where central counterparties (CCPs) do not deliver a close-out amount or do not apply default procedures within an agreed deadline.

Developed as part of the Bank Recovery and Resolution Directive (BRRD), the draft RTS suggest a methodology for valuing credit institution's derivative liabilities placed under resolution and ensure that the discipline brought in by the new bail-in tool will be effectively extended to these liabilities.

The draft RTS give resolution authorities a series of tools to enact a swift and objective valuation of derivative liabilities while avoiding discrepancies with the insolvency counterfactual which could lead to breach the non-creditor-worse-off principle.

This means, in the event of resolution, a statutory valuation methodology will be based on the costs or gains that would be incurred by the counterparty in replacing the contract. Derivative counterparties will be able to have input into determining the close out amount within a certain deadline.

However, if no feedback is received, the resolution authorities will independently apply this valuation method based on mid-market prices and bid-offer spreads. 

In order to make a final valuation within a matter of days with maximum accuracy, the draft standards also specify that resolution authorities should establish the value of derivative liabilities at the date of close-out or when a price is available in the market for the contract or the underlying assets.

Early terminations of derivatives may bring specific additional costs. To allow for this, the RTS have stated circumstances in which resolution authorities might exempt contracts from close-out and bail-in. This would happen where the application of the bail-in tool is likely to bring destruction in value exceeding the bail-in potential of the corresponding liabilities.

The standards take into account the specific regulatory framework applicable to centrally cleared derivatives, and rules and procedures for valuing derivatives in resolution that already exist under Emir.