BIPRU 10.2 Identification of exposures and recognition of credit risk mitigation1

1Unless BIPRU 10.2.2 R applies, an exposure is:

1. (1)

   any of the items included in BIPRU 3.2.9 R (Exposure classes for the purposes of the standardised approach) or the table in BIPRU 3.7.2 R (Classification of off-balance-sheet items for the purposes of the standardised approach), whether held in the trading book or the non-trading book, without application of the risk weight or degrees of risk there provided for;

   [Note: BCD Article 106(1) first paragraph]

2. (2)

   any exposure arising from financial derivative instruments;

   [Note: BCD Article 106(1) second paragraph (part)]

3. (3)

   any exposure to an individual counterparty that arises in the trading book calculated by summing the following items:

   1. (a)

      the excess - where positive - of the firm's long positions over its short positions in all the CRD financial instruments issued by the counterparty in question, the net position of each of the different CRD financial instruments being calculated in accordance with the relevant method in BIPRU 7;

   2. (b)

      the firm's net underwriting exposure to that counterparty; and

   3. (c)

      any exposure due to the transactions, agreements and contracts referred to in BIPRU 14.2.2 R (List of trading book exposures that give rise to a counterparty credit risk charge).

   [Note: CAD Article 29(1) first paragraph]

An exposure does not include:

1. (1)

   an exposure which is entirely deducted from a firm's capital resources; or1

2. (2)

   in the case of foreign currency transactions, exposures incurred in the ordinary course of settlement during the two business days1 following payment; or

   1
3. (3)

   in the case of transactions for the purchase or sale of securities, exposures incurred in the ordinary course of settlement during the five business days1 following payment or delivery of the securities, whichever is earlier; or1

   1
4. (4)

   1in the case of the provision of money transmission including the execution of payment services, clearing and settlement in any currency and correspondent banking or financial instruments clearing, settlement and custody services to clients, delayed receipts in funding and other exposures arising from client activity which do not last longer than the following business day; or

5. (5)

   in the case of the provision of money transmission including the execution of payment services, clearing and settlement in any currency and correspondent banking, intra-day exposures to institutions providing those services.

   [Note: BCD Articles 106(1) third paragraph and 106(2)]

1Subject to BIPRU 10.2.6 R and BIPRU 10.2.7 R, the value of a firm's exposures, whether in its non-trading book or its trading book, is the amount at risk calculated in line with GENPRU 1.3 (Valuation).

A firm must calculate the value of its exposures in its trading book in the manner laid down in BIPRU 14 (Capital requirements for settlement and counterparty risk) for the calculation of exposure values. For these purposes the reference in BIPRU 14.2.11 R (How to calculate exposure values and risk weighted exposure amounts for the purpose of calculating the counterparty risk capital component) to the provisions of the IRB approach does not apply.

[Note: CAD Article 29(1)(c) (part) and fourth paragraph]

Exposures arising from financial derivative instruments must be calculated in accordance with one of the methods set out in BIPRU 13 (Financial derivatives, SFTs and long settlement transactions). For the purposes of this chapter, BIPRU 13.6.6 R (Scope of CCR internal model method) also applies.

[Note: BCD Article 106(1) second paragraph]

A firm must not offset exposures in the non-trading book and trading book for the purpose of calculating exposures except to the extent permitted under the standardised approach or, if applicable, the IRB approach.

Subject to this section, funded credit protection or unfunded credit protection that complies with the eligibility requirements and other minimum requirements set out in BIPRU 5 (Credit risk mitigation) and, if relevant, BIPRU 4.10 (The IRB approach: Credit risk mitigation) is permitted to be recognised for the purposes of calculating a firm's exposure. A firm utilising the methods below must still report to the FSA the gross value of its exposures.

[Note: BCD Articles 111(1) first paragraph (part) and 112(2)]

For the purposes of this section, the use of own estimates for LGDs and conversion factors under the IRB approach for an IRB exposure class is referred to as the full IRB approach.

A firm may only recognise collateral for the purpose of BIPRU 10.2.9R (Recognition of credit risk mitigation) if the collateral complies with the eligibility requirements and other minimum requirements set out in BIPRU 5 (Credit risk mitigation) for the purposes of calculating the risk weighted exposure amounts under the standardised approach using the financial collateral simple method or, if applicable, the method in BIPRU 5.5 (Other funded credit risk mitigation). In particular a firm may not recognise collateral for that purpose if it is not eligible under the financial collateral simple method or other applicable method.

[Note: BCD Article 112(2) (part)]

A firm which uses the financial collateral comprehensive method (but not under the full IRB approach (see BIPRU 10.2.10R)) may calculate the value of its exposures to a counterparty or to a group of connected clients as being the fully adjusted value of the exposures to the counterparty or group of connected clients3 calculated in accordance with the financial collateral comprehensive method under BIPRU 5 (Credit risk mitigation) and, if relevant, BIPRU 4.10 (The IRB approach: Credit risk mitigation) taking into account the credit risk mitigation, volatility adjustments and any maturity mismatch (E*) in accordance with those rules.

[Note: BCD Article 114(1) first paragraph]

For the purposes of BIPRU 10.2.9R (Recognition of credit risk mitigation), a firm may use both the financial collateral comprehensive method and the financial collateral simple method where it is permitted to use both those methods under BIPRU 5.4.16 R.

[Note: BCD Article 117(1) last paragraph]

A firm may only recognise collateral for the purpose of BIPRU 10.2.14R (Financial collateral comprehensive method) if the collateral complies with the eligibility requirements and other minimum requirements set out in BIPRU 5 (Credit risk mitigation) and, if relevant, BIPRU 4.10 (The IRB approach: Credit risk mitigation) for the purposes of calculating risk weighted exposure amounts under the standardised approach or, if applicable, the IRB approach using the financial collateral comprehensive method. In particular a firm may not recognise collateral for that purpose if it is not eligible under the financial collateral comprehensive method.

A firm that uses the full IRB approach (see BIPRU 10.2.10R) may recognise the effects described in (1) in calculating the value of its exposures to a counterparty or to a group of connected clients for the purposes of BIPRU 10.5 (Limits on exposures) if:

1. (1)

   the firm is able to satisfy the FSA that it can estimate the effects of financial collateral on its exposures separately from other LGD-relevant aspects;

2. (2)

   the firm is able to demonstrate the suitability of the estimates produced; and

3. (3)

   the firm's IRB permission specifically allows it (also see BIPRU 4.1.23 R (4)).

   [Note: BCD Article 114(2) first and second paragraphs]

If a firm that uses the full IRB approach (see BIPRU 10.2.10R) uses its own estimates of the effects of financial collateral on its exposures for large exposures purposes, it must do so on a consistent basis and on a basis consistent with the approach adopted in the calculation of capital requirements. A firm may only use one of BIPRU 10.2.14R (Financial collateral comprehensive method under standardised approach and IRB approach) and BIPRU 10.2.19R (Own estimates of effects of financial collateral).

[Note: BCD Article 114(2) third and fourth paragraphs]

If a firm relies on BIPRU 10.2.19R (Own estimates of effects of financial collateral) the recognition of credit protection is subject to the relevant requirements of the IRB approach.

[Note: BCD Article 112(3)]

1. (1)

   A firm which:

   1. (a)

      uses the financial collateral comprehensive method; or

   2. (b)

      calculates the value of its exposures in accordance with BIPRU 10.2.19R (Own estimates of effects of financial collateral);

   must conduct periodic stress tests of its credit risk concentrations including in relation to the realisable value of any collateral taken.

2. (2)

   The stress tests required by this rule must address:

   1. (a)

      risks arising from potential changes in market conditions that could adversely impact the firm's adequacy of capital resources; and

   2. (b)

      risks arising from the realisation of collateral in stressed situations.

3. (3)

   A firm must be able to satisfy the FSA that the stress tests it carries out under this rule are adequate and appropriate for the assessment of such risks.

4. (4)

   In the event that a stress test carried out in accordance with this rule indicates a lower realisable value of collateral taken than would be permitted to be taken into account under BIPRU 10.2.14R (Financial collateral comprehensive method) or BIPRU 10.2.19R (Own estimates of effect of financial collateral) as appropriate, the value of collateral permitted to be recognised in calculating the value of exposures for the purposes of BIPRU 10.5 (Limits on exposures) is the lower value.

5. (5)

   A firm to which this rule applies must include in its strategy to address concentration risk:

   1. (a)

      policies and procedures to address risks arising from maturity mismatches between exposures and any credit protection on those exposures;

   2. (b)

      policies and procedures in the event that a stress test indicates a lower realisable value of collateral than taken into account under BIPRU 10.2.14R (Financial collateral comprehensive method) or BIPRU 10.2.19R (Own estimates of effects of financial collateral); and

   3. (c)

      policies and procedures relating to concentration risk arising from the application of credit risk mitigation techniques, and in particular large indirect credit exposures (for example to a single issuer of securities taken as collateral).

      [Note: BCD Article 114(3)]

Unless, and to the extent, permitted under BIPRU 10.6.3R (11) (Residential mortgages and leasing transactions) or BIPRU 10.6.3R (12) (Commercial mortgages and leasing transactions), a firm must not take into account the following collateral for the purposes of this section:

1. (1)

   amounts receivable linked to a commercial transaction or transactions with an original maturity of less than or equal to one year;

2. (2)

   a physical item of a type other than those types indicated in BIPRU 4.10.6 R to BIPRU 4.10.12 R (Eligibility of real estate collateral); and

3. (3)

   property leased under a leasing transaction.

   [Note: BCD Article 112(4)]