7.2.2.4 Fixed overhead requirement

274. As stated above, the main difference between the risk exposure calculations included in Articles 96 and 95 as opposed to Article 92 is the calculation of the fixed overhead requirement1 instead of the exposure to operational risk. Operational risk has been defined in various initiatives2 by the Basel Committee on Banking Supervision (BCBS)3 and in the CRR as “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, and includes legal risk”.4 The CRR contains three approaches5 to calculating the operational risk,6 but essentially the operational risk capital charge is a percentage of the gross revenue of the institution.7 The idea behind the operational risk capital charge is that institutions face a risk in their day-to-day operations and that they should have sufficient capital to mitigate the exposures that may affect the running of their business, see Section 5.4.3. Given the above mentioned guiding principles of the CRD,8 the main focus of the CRD is to prevent credit institutions from failing, thereby minimizing the downside effects of a bank-failure for the depositors and the financial system. The goal of supervision for investment firms however, as discussed in Chapter 6, is different. An investment firm should be able to wind down its operations efficiently and with minimal disruption of its services to its clients. The capital charge for operational risk should, for an investment firm, have a different focus than the gross revenue focus it has for (most) credit institutions. Investment firms are therefore subject to the ‘fixed overhead requirement’9 as defined in Article 97 of the CRR. To comply with the fixed overhead requirement, an investment firm needs to determine its total expenses and subtract certain variable expenses10 from that amount. The investment firm should then hold 25% of the amount of fixed costs as determined in accordance with Article 97 of the CRR. The idea behind the fixed overhead requirement is that an investment firm should have sufficient capital to be able to pay for its fixed expenses for three months (or one- quarter of a year).11 In theory the supervisor should be able, in that period, to wind down the operations of the investment firm with minimum disruption of service for the firm’s clients. This theory, however, only applies in those instances where the supervisory authority start the winding down processes for an investment firm. Although the provisions in the CRR seem to imply a gone-concern approach, nowhere is it made explicit in the provisions of the CRR that the fixed overhead solvency capital requirement is indeed only intended to provide for an effective winding down period.

275. Although it is not explicitly stated in the CRR or its predecessors, the fixed overhead requirement can be seen as a proxy for operational risk, albeit measured differently than the approach chosen for credit institutions. Where the operational risk of a credit institution is measured based on its gross revenue as a proxy to estimate the magnitude of losses stemming from operational risk, the operational risk of an investment firm is measured based on its costs. Both measurement approaches try to assess the operational risk of a business based on the size of that business, assuming that with large income (revenues) or large costs, the business itself will be larger and the possibility of operational risks will increase.