EBA publishes final guidelines on modified duration for debt instruments

The EBA has published final guidelines on corrections to modified duration for debt instruments. The guidelines are intended to establish adjustments to the modified duration that have to be performed in order to appropriately reflect the effect of the prepayment risk as outlined in the Capital Requirements Regulation (CRR). The guidelines are also intended to contribute to the implementation of the EU Commission's securitisation package under the Capital Markets Union reform programme.

The guidelines establish two approaches to correct the modified duration calculation:

• treat the instrument with embedded optionality as if it were a combination of a plain vanilla bond and an option; and
• calculate directly the change in value of the whole instrument subject to prepayment risk.

Additionally, the guidelines also request additional elements to the correction to reflect the negative convexity as well as transaction costs and, where relevant, behavioural factors that may affect the modified duration of the instrument.

The guidelines apply from 1 March 2017.