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BIPRU 5.4 Financial collateral

Eligibility

BIPRU 5.4.1R

  1. (1)

    Where the credit risk mitigation used relies on the right of a firm to liquidate or retain assets, eligibility depends upon whether risk weighted exposure amounts, and, as relevant, expected loss amounts, are calculated under the standardised approach or the IRB approach.

  2. (2)

    Eligibility further depends upon whether the financial collateral simple method is used or the financial collateral comprehensive method.

  3. (3)

    In relation to repurchase transactions and securities or commodities lending or borrowing transactions, eligibility also depends upon whether the transaction is booked in the non-trading book or the trading book.

    [Note: BCD Annex VIII Part 1 point 6]

BIPRU 5.4.2R

The following financial items may be recognised as eligible collateral under all approaches and methods:

  1. (1)

    cash on deposit with, or cash assimilated instruments held by, the lending firm;

  2. (2)

    debt securities issued by central governments or central banks which securities have a credit assessment by an eligible ECAI or export credit agency recognised as eligible for the purposes of the standardised approach, which is associated with credit quality step 4 or above under the rules for the risk weighting of exposures to central governments and central banks under the standardised approach;

  3. (3)

    debt securities issued by institutions which securities have a credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of exposures to a credit institution under the standardised approach;

  4. (4)

    debt securities issued by other entities which securities have a credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;

  5. (5)

    debt securities with a short-term credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of short term exposures under the standardised approach;

  6. (6)

    equities or convertible bonds that are included in a main index; and

  7. (7)

    gold.

    [Note: BCD Annex VIII Part 1 point 7 (part)]

BIPRU 5.4.3R

For the purposes of BIPRU 5.4.2 R (2), 'debt securities issued by central governments or central banks' include -

  1. (1)

    debt securities issued by regional governments or local authorities exposures to which are treated as exposures to the central government in whose jurisdiction they are established under the standardised approach;

  2. (2)

    debt securities issued by public sector entities which are treated as exposures to central governments in accordance with BIPRU 3.4.24 R;

  3. (3)

    debt securities issued by multilateral development banks to which a 0% risk weight is assigned under the standardised approach; and

  4. (4)

    debt securities issued by international organisations which are assigned a 0% risk weight under the standardised approach.

    [Note: BCD Annex VIII Part 1 point 7 (part)]

BIPRU 5.4.4R

For the purposes of BIPRU 5.4.2 R (3), 'debt securities issued by institutions' include:

  1. (1)

    debt securities issued by regional governments or local authorities other than those exposures to which are treated as exposures to the central government in whose jurisdiction they are established under the standardised approach;

  2. (2)

    debt securities issued by public sector entities, exposures to which are treated as exposures to a credit institution under the standardised approach;

  3. (3)

    debt securities issued by multilateral development banks other than those to which a 0% risk weight is assigned under the standardised approach.

    [Note: BCD Annex VIII Part 1 point 7 (part)]

BIPRU 5.4.5R

Debt securities issued by institutions which securities do not have a credit assessment by an eligible ECAI may be recognised as eligible collateral if they fulfil the following criteria:

  1. (1)

    they are listed on a recognised investment exchange or a designated investment exchange;

  2. (2)

    they qualify as senior debt;

  3. (3)

    all other rated issues by the issuing institution of the same seniority have a credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weight of exposures to institutions or short term exposures under the standardised approach;

  4. (4)

    the lending firm has no information to suggest that the issue would justify a credit assessment below that indicated in (3); and

  5. (5)

    the firm can demonstrate to the appropriate regulator that the market liquidity of the instrument is sufficient for these purposes.

    [Note: BCD Annex VIII Part 1 point 8]

BIPRU 5.4.6R

  1. (1)

    Units in CIUs may be recognised as eligible collateral if the following conditions are satisfied:

    1. (a)

      they have a daily public price quote;4

    2. (b)

      the CIU is limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R; and4

    3. (c)

      4if the CIU is not limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R, units may be recognised with the value of the eligible assets as collateral under the assumption that the CIU has invested to the maximum extent allowed under its mandate in non-eligible assets. In cases where non-eligible assets can have a negative value due to liabilities or contingent liabilities resulting from ownership, the firm must calculate the total value of the non-eligible assets and must reduce the value of the eligible assets by that of the non-eligible assets in case the latter is negative in total.

  2. (2)

    The use (or potential use) by a CIU of derivative instruments to hedge permitted investments shall not prevent units in that CIU from being eligible.

    [Note: BCD Annex VIII Part 1 point 9]

BIPRU 5.4.7R

In relation to BIPRU 5.4.2 R (2) to (5):

  1. (1)

    where a security has two credit assessments by eligible ECAIs, the less favourable assessment must be deemed to apply;

  2. (2)

    in cases where a security has more than two credit assessments by eligible ECAIs:

    1. (a)

      the two most favourable assessments must be deemed to apply; or

    2. (b)

      if the two most favourable credit assessments are different, the less favourable of the two must be deemed to apply.

      [Note: BCD Annex VIII Part 1 point 10]

BIPRU 5.4.8R

  1. (1)

    In addition to the collateral set out in BIPRU 5.4.2 R to BIPRU 5.4.7 R, where a firm uses the financial collateral comprehensive method, the following financial items may be recognised as eligible collateral:

    1. (a)

      equities or convertible bonds not included in a main index but traded on a recognised investment exchange or a designated investment exchange;

    2. (b)

      units in CIUs if the following conditions are met:

      1. (i)

        they have a daily public price quote; and

      2. (ii)

        the CIU is limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R and the items mentioned in (a); and4

    3. (c)

      if the CIU is not limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R and the items mentioned in (a) of this rule, units may be recognised with the value of the eligible assets as collateral under the assumption that the CIU has invested to the maximum extent allowed under its mandate in non-eligible assets. In cases where non-eligible assets can have a negative value due to liabilities or contingent liabilities resulting from ownership, the firm must calculate the total value of the non-eligible assets and must reduce the value of the eligible assets by that of the non-eligible assets, in case the latter is negative in total.4

  2. (2)

    The use (or potential use) by a CIU of derivative instruments to hedge permitted investments shall not prevent units in that CIU from being eligible.

    [Note: BCD Annex VIII Part 1 point 11]

Minimum requirements

BIPRU 5.4.9R

For the recognition of financial collateral and gold, the following conditions must be met:

  1. (1)

    the low correlation conditions in BIPRU 5.4.10 R;

  2. (2)

    the legal certainty conditions in BIPRU 5.4.11 R; and

  3. (3)

    the operational requirements in BIPRU 5.4.12 R.

    [Note: BCD Annex VIII Part 2 point 6]

BIPRU 5.4.10R

The low correlation conditions referred to in BIPRU 5.4.9 R (1) are as follows:

  1. (1)
    1. (a)

      the credit quality of the obligor and the value of the collateral must not have a material positive correlation; and

    2. (b)

      securities issued by the obligor, or any related group entity are not eligible.

  2. (2)

    notwithstanding (1)(b), the obligor's own issues of covered bonds falling within the terms of BIPRU 3.4.107 R to BIPRU 3.4.109 R may be recognised as collateral for repurchase transactions, provided that (1)(a) is complied with.

    [Note: BCD Annex VIII Part 2 point 6(a)]

BIPRU 5.4.11R

The legal certainty conditions referred to in BIPRU 5.4.9 R (2) are as follows:

  1. (1)

    a firm must fulfil any contractual and statutory requirements in respect of, and take all steps necessary to ensure, the enforceability of the collateral arrangements under the law applicable to its interest in the collateral;

  2. (2)

    in accordance with the general principle in BIPRU 5.2.2 R, a firm must have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions; and

  3. (3)

    a firm must re-conduct such review as necessary to ensure continuing enforceability.

    [Note: BCD Annex VIII Part 2 point 6(b)]

BIPRU 5.4.12R

The operational requirements referred to in BIPRU 5.4.9 R (3) are as follows:

  1. (1)

    the collateral arrangements must be properly documented, with a clear and robust procedure for the timely liquidation of collateral;

  2. (2)

    a firm must employ robust procedures and processes to control risks arising from the use of collateral - including risks of failed or reduced credit protection, valuation risks, risks associated with the termination of the credit protection, concentration risk arising from the use of collateral and the interaction with the firm's overall risk profile;

  3. (3)

    a firm must have documented policies and practices concerning the types and amounts of collateral accepted;

  4. (4)

    a firm must calculate the market value of the collateral, and revalue it accordingly, with a minimum frequency of once every six months and whenever the firm has reason to believe that there has occurred a significant decrease in its market value; and

  5. (5)

    where the collateral is held by a third party, a firm must take reasonable steps to ensure that the third party segregates the collateral from its own assets.

    [Note: BCD Annex VIII Part 2 point 6(c)]

BIPRU 5.4.13R

In addition to the requirements set out in BIPRU 5.4.9 R, for the recognition of financial collateral under the financial collateral simple method the residual maturity of the protection must be at least as long as the residual maturity of the exposure.

[Note: BCD Annex VIII Part 2 point 7]

The financial collateral simple method: General

BIPRU 5.4.14R

BIPRU 5.4.17 R - BIPRU 5.4.22 R set out the calculation of the effects of credit risk mitigation under the financial collateral simple method.

BIPRU 5.4.15R

The financial collateral simple method is available only where risk weighted exposure amounts are calculated under the standardised approach to credit risk.

[Note: BCD Annex VIII Part 3 point 24 (part)]

BIPRU 5.4.16R

A firm must not use both the financial collateral simple method and the financial collateral comprehensive method, unless such use is for the purposes of BIPRU 4.2.17 R to BIPRU 4.2.19 R and BIPRU 4.2.26 R, and such use is provided for by the firm's IRB permission. A firm must demonstrate to the appropriate regulator that this exceptional application of both methods is not used selectively with the purpose of achieving reduced minimum capital requirements and does not lead to regulatory arbitrage.4

[Note: BCD Annex VIII Part 3 point 24 (part)]

The financial collateral simple method: Valuation

BIPRU 5.4.17R

Under the financial collateral simple method, recognised financial collateral is assigned a value equal to its market value as determined in accordance with BIPRU 5.4.12 R.

[Note: BCD Annex VIII Part 3 point 25]

The financial collateral simple method: Calculating risk-weighted exposure amounts

BIPRU 5.4.18R

The risk weight that would be assigned under the standardised approach to credit risk if the lending firm had a direct exposure to the collateral instrument must be assigned to those portions of exposure values4 collateralised by the market value of recognised collateral. For this purpose, the exposure value of an off-balance sheet item listed in BIPRU 3.7.2 R must be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R.4 The risk weight of the collateralised portion must be a minimum of 20% except as specified in BIPRU 5.4.19 R to BIPRU 5.4.21 R. The remainder of the exposurevalue4 receives the risk weight that would be applied to an unsecured exposure to the counterparty under the standardised approach.

[Note: BCD Annex VIII Part 3 point 26]

4

The financial collateral simple method: Repurchase transactions and securities lending or borrowing transactions

BIPRU 5.4.19R

A risk weight of 0% must be assigned to the collateralised portion of the exposure arising from transactions which fulfil the criteria enumerated in BIPRU 5.4.62 R or BIPRU 5.4.65 R. If the counterparty to the transaction is not a core market participant a risk weight of 10% must be assigned.

[Note: BCD Annex VIII Part 3 point 27]

The financial collateral simple method: financial derivative instruments subject to daily mark-to-market

BIPRU 5.4.20R

A risk weight of 0% must, to the extent of the collateralisation, be assigned to the exposure values determined under BIPRU 13 for financial derivative instruments and subject to daily marking-to-market, collateralised by cash or cash assimilated instruments where there is no currency mismatch. A risk weight of 10% must be assigned to the extent of the collateralisation to the exposure values of such transactions collateralised by debt securities issued by central governments or central banks which are assigned a 0% risk weight under the standardised approach.

[Note: BCD Annex VIII Part 3 point 28 (part)]

BIPRU 5.4.21R

A 0% risk weight may be assigned where the exposure and the collateral are denominated in the same currency, and either:

  1. (1)

    the collateral is cash on deposit or a cash assimilated instrument; or

  2. (2)

    the collateral is in the form of debt securities issued by central governments or central banks eligible for a 0% risk weight under the standardised approach, and its market value has been discounted by 20%.

    [Note: BCD Annex VIII Part 3 point 29]

BIPRU 5.4.22R

For the purposes of BIPRU 5.4.20 R and BIPRU 5.4.21 R 'debt securities issued by central governments or central banks' must include:

  1. (1)

    debt securities issued by regional governments or local authorities exposures to which are treated as exposures to the central government in whose jurisdiction they are established under the standardised approach;

  2. (2)

    debt securities issued by multilateral development banks to which a 0% risk weight is assigned under or by virtue of the standardised approach; and

  3. (3)

    debt securities issued by international organisations which are assigned a 0% risk weight under the standardised approach.

    [Note: BCD Annex VIII Part 3 point 28 (part)]

The financial collateral comprehensive method: General

BIPRU 5.4.23R
BIPRU 5.4.24R

In valuing financial collateral for the purposes of the financial collateral comprehensive method, volatility adjustments must be applied to the market value of collateral, as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R, in order to take account of price volatility.

[Note: BCD Annex VIII Part 3 point 30]

BIPRU 5.4.25R

Subject to the treatment for currency mismatches in the case of financial derivative instrument set out in BIPRU 5.4.26 R, where collateral is denominated in a currency that differs from that in which the underlying exposure is denominated, an adjustment reflecting currency volatility must be added to the volatility adjustment appropriate to the collateral as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 31]

BIPRU 5.4.26R

In the case of financial derivative instrument covered by netting agreements recognised under BIPRU 13, a volatility adjustment reflecting currency volatility must be applied when there is a mismatch between the collateral currency and the settlement currency. Even in the case where multiple currencies are involved in the transactions covered by the netting agreement, only a single volatility adjustment may be applied.

[Note: BCD Annex VIII Part 3 point 32]

BIPRU 5.4.27R

In the case of a firm using the financial collateral comprehensive method, where an exposure takes the form of securities or commodities sold, posted or lent under a repurchase transaction or under a securities or commodities lending or borrowing transaction, and margin lending transactions the exposure value must be increased by the volatility adjustment appropriate to such securities or commodities as prescribed in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Article 78(1), third sentence]

The financial collateral comprehensive method: Calculating adjusted values

BIPRU 5.4.28R

  1. (1)

    The volatility-adjusted value of the collateral to be taken into account is calculated as follows in the case of all transactions except those transactions subject to recognised master netting agreements to which the provisions set out in BIPRU 5.6.5 R to BIPRU 5.6.29 R are to be applied:

    CVA = C x (1-HC-HFX)

  2. (2)

    The volatility-adjusted value of the exposure to be taken into account is calculated as follows:

    EVA = E x (1+HE), and in the case of financial derivative instruments EVA = E.

  3. (3)

    The fully adjusted value of the exposure, taking into account both volatility and the risk-mitigating effects of collateral is calculated as follows:

    E* = max {0, [EVA - CVAM]}

    Where:

    1. (a)

      E is the exposure value as would be determined under the standardised approach if the exposure was not collateralised.

    2. (b)

      EVA is the volatility-adjusted exposure amount.

    3. (c)

      CVA is the volatility-adjusted value of the collateral.

    4. (d)

      CVAM is CVA further adjusted for any maturity mismatch in accordance with the provisions of BIPRU 5.8.

    5. (e)

      HE is the volatility adjustment appropriate to the exposure (E), as calculated under BIPRU 5.4.30 R to BIPRU 5.4.65 R.

    6. (f)

      HC is the volatility adjustment appropriate for the collateral, as calculated under BIPRU 5.4.30 R to BIPRU 5.4.65 R.

    7. (g)

      HFX is the volatility adjustment appropriate for currency mismatch, as calculated under BIPRU 5.4.30 R to BIPRU 5.4.65 R.

    8. (h)

      E* is the fully adjusted exposure value taking into account volatility and the risk-mitigating effects of the collateral.

  4. (4)

    For the purpose of (3)(a), for a firm calculating risk weighted exposure amounts under the standardised approach the exposure value of an4 off-balance sheet items listed in BIPRU 3.7 must be 100% of its value rather than the exposure value4 indicated in BIPRU 3.2.1 R and BIPRU 3.7.2 R.

    [Note: BCD Annex VIII Part 3 point 33]

    4

The financial collateral comprehensive method: Calculation of volatility adjustments to be applied: General

BIPRU 5.4.29R

BIPRU 5.4.30 R - BIPRU 5.4.65 R set out the calculation of volatility adjustments under the financial collateral comprehensive method.

BIPRU 5.4.30R

Volatility adjustments may be calculated in two ways: the supervisory volatility adjustments approach and the own estimates of volatility adjustments approach.

[Note: BCD Annex VIII Part 3 point 34]

BIPRU 5.4.31R

A firm may choose to use the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach independently of the choice it has made between the standardised approach and the IRB approach for the calculation of risk weighted exposure amounts. However, if a firm seeks to use the own estimates of volatility adjustments approach, it must do so for the full range of instrument types, excluding immaterial portfolios where it may use the supervisory volatility adjustments approach.

[Note: BCD Annex VIII Part 3 point 35 (part)]

BIPRU 5.4.32R

Where the collateral consists of a number of recognised items, the volatility adjustment must be

(H = ∑i αi Hi)

where:

  1. (1)

    ai is the proportion of an item to the collateral as a whole; and

  2. (2)

    Hi is the volatility adjustment applicable to that item.

    [Note: BCD Annex VIII Part 3 point 35 (part)]

The financial collateral comprehensive method: Supervisory volatility adjustments approach

BIPRU 5.4.33R

BIPRU 5.4.34 R - BIPRU 5.4.43 R set out the calculation of volatility adjustments under the supervisory volatility adjustments approach.

BIPRU 5.4.34R

The volatility adjustments to be applied under the supervisory volatility adjustments approach (assuming daily revaluation) are those set out in the tables in BIPRU 5.4.35 R - BIPRU 5.4.38 R.

[Note: BCD Annex VIII Part 3 point 36]

Table: Volatility adjustments for debt securities described in BIPRU 5.4.2R(2) and (3) - (4)

BIPRU 5.4.35R

This table belongs to BIPRU 5.4.34 R.

Credit quality step with which the credit assessment of the debt security is associated

Residual Maturity

Volatility adjustments for debt securities issued by entities described in BIPRU 5.4.2 R (2)

Volatility adjustments for debt securities issued by entities described in BIPRU 5.4.2 R (3) and (4)

20 day liquidation period (%)

10 day liquidation period (%)

5 day liquidation period (%)

20 day liquidation period (%)

10 day liquidation period (%)

5 day liquidation period (%)

1

≤ 1 year

0.707

0.5

0.354

1.414

1

0.707

> 1 ≤ 5 years2

2.828

2

1.414

5.657

4

2.828

> 5 years

5.657

4

2.828

11.314

8

5.657

2-3

≤ 1 year

1.414

1

0.707

2.828

2

1.414

> 1 ≤ 5 years

4.243

3

2.121

8.485

6

4.243

> 5 years

8.485

6

4.243

16.971

12

8.485

4

≤ 1 year

21.213

15

10.607

N/A

N/A

N/A

> 1 ≤ 5 years

21.213

15

10.607

N/A

N/A

N/A

> 5 years

21.213

15

10.607

N/A

N/A

N/A

Table: Volatility adjustments for debt securities described in BIPRU 5.4.2R(5)

BIPRU 5.4.36R

This table belongs to BIPRU 5.4.34 R.

Credit quality step with which the credit assessment of a short term debt security is associated

Volatility adjustments for debt securities issued by entities described in BIPRU 5.4.2 R (2) with short-term credit assessments

Volatility adjustments for debt securities issued by entities described in BIPRU 5.4.2 R (3) and (4) with short-term credit assessments

20 day liquidation period (%)

10 day liquidation period (%)

5 day liquidation period (%)

20 day liquidation period (%)

10 day liquidation period (%)

5 day liquidation period (%)

1

0.707

0.5

0.354

1.414

1

0.707

2-3

1.414

1

0.707

2.828

2

1.414

Table: Volatility adjustments for other collateral or exposure types

BIPRU 5.4.37R

This table belongs to BIPRU 5.4.34 R.

Other collateral or exposure types

20 day liquidation period (%)

10 day liquidation period (%)

5 day liquidation period (%)

Main index equities, main index convertible bonds

21.213

15

10.607

Other equities or convertible bonds listed on a recognised investment exchange or designated investment exchange

35.355

25

17.678

Cash

0

0

0

Gold

21.213

15

10.607

Table: Volatility adjustments for currency mismatch

BIPRU 5.4.38R

This table belongs to BIPRU 5.4.34 R.

Volatility adjustment for currency mismatch

20 day liquidation period (%)

10 day liquidation period (%)

5 day liquidation period (%)

11.314

8

5.657

BIPRU 5.4.39R

  1. (1)

    For secured lending transactions the liquidation period is 20 business days.

  2. (2)

    For repurchase transactions (except insofar as such transactions involve the transfer of commodities or guaranteed rights relating to title to commodities) and securities lending or borrowing transactions the liquidation period is 5 business days.

  3. (3)

    For other capital market-driven transactions1, the liquidation period is 10 business days.

    [Note: BCD Annex VIII Part 3 point 37]

BIPRU 5.4.40R

In the tables in BIPRU 5.4.35 R - BIPRU 5.4.38 R and in BIPRU 5.4.41 R to BIPRU 5.4.43 R, the credit quality step with which a credit assessment of the debt security is associated is the credit quality step with which the external credit assessment is associated under the standardised approach. For the purposes of this rule, BIPRU 5.4.7 R also applies.

[Note: BCD Annex VIII Part 3 point 38]

BIPRU 5.4.41R

For non-eligible securities or for commodities lent or sold under repurchase transactions or securities or commodities lending or borrowing transactions, the volatility adjustment is the same as for non-main index equities listed on a recognised investment exchange or a designated investment exchange.

[Note: BCD Annex VIII Part 3 point 39]

BIPRU 5.4.42R

For eligible units in CIUs the volatility adjustment is the weighted average volatility adjustments that would apply, having regard to the liquidation period of the transaction as specified in BIPRU 5.4.39 R, to the assets in which the fund has invested. If the assets in which the fund has invested are not known to the firm, the volatility adjustment is the highest volatility adjustment that would apply to any of the assets in which the fund has the right to invest.

[Note: BCD Annex VIII Part 3 point 40]

BIPRU 5.4.43R

For unrated debt securities issued by institutions and satisfying the eligibility criteria in BIPRU 5.4.5 R the volatility adjustments are the same as for securities issued by institutions or corporates with an external credit assessment associated with credit quality steps 2 or 3.

[Note: BCD Annex VIII Part 3 point 41]

The financial collateral comprehensive method: Own estimates of volatility adjustments approach: General

BIPRU 5.4.44R

BIPRU 5.4.45 R - BIPRU 5.4.60 R deal with the calculation of volatility adjustments under the own estimates of volatility adjustments approach.

BIPRU 5.4.45R

A firm complying with the requirements set out in BIPRU 5.4.50 R to BIPRU 5.4.60 R may use the own estimates of volatility adjustments approach for calculating the volatility adjustments to be applied to collateral and exposures.

[Note: BCD Annex VIII Part 3 point 42]

BIPRU 5.4.46R

When debt securities have a credit assessment from an eligible ECAI equivalent to investment grade or better, a firm may calculate a volatility estimate for each category of security.

[Note: BCD Annex VIII Part 3 point 43]

BIPRU 5.4.47R

In determining relevant categories, a firm must take into account the type of issuer of the security the external credit assessment of the securities, their residual maturity, and their modified duration. Volatility estimates must be representative of the securities included in the category by the firm.

[Note: BCD Annex VIII Part 3 point 44]

BIPRU 5.4.48R

For debt securities having a credit assessment from an eligible ECAI equivalent to below investment grade and for other eligible collateral the volatility adjustments must be calculated for each individual item.

[Note: BCD Annex VIII Part 3 point 45]

BIPRU 5.4.49R

A firm using the own estimates of volatility adjustments approach must estimate volatility of the collateral or foreign exchange mismatch without taking into account any correlations between the unsecured exposure, collateral and/or exchange rates.

[Note: BCD Annex VIII Part 3 point 46]

The financial collateral comprehensive method: Own estimates of volatility adjustments approach: Quantitative Criteria

BIPRU 5.4.50R

In calculating the volatility adjustments, a 99th percentile one-tailed confidence interval must be used.

[Note: BCD Annex VIII Part 3 point 47]

BIPRU 5.4.51R

The liquidation period is 20 business days for secured lending transactions; 5 business days for repurchase transactions except insofar as such transactions involve the transfer of commodities or guaranteed rights relating to title to commodities and securities lending or borrowing transactions; and 10 business days for other capital market-driven transactions1.

[Note: BCD Annex VIII Part 3 point 48]

BIPRU 5.4.52R

A firm may use volatility adjustment numbers calculated according to shorter or longer liquidation periods, scaled up or down to the liquidation period set out in BIPRU 5.4.51 R for the type of transaction in question, using the square root of time formula:

(HM = HN )√TM/TN)

where:

  1. (1)

    TM is the relevant liquidation period;

  2. (2)

    HM is the volatility adjustment under TM ; and

  3. (3)

    HN is the volatility adjustment based on the liquidation period TN.

    [Note: BCD Annex VIII Part 3 point 49]

BIPRU 5.4.53R

A firm must take into account the illiquidity of lower-quality assets. The liquidation period must be adjusted upwards in cases where there is doubt concerning the liquidity of the collateral. A firm must also identify where historical data may understate potential volatility, e.g. a pegged currency. Such cases must be dealt with by means of stress scenario assessments3.

[Note: BCD Annex VIII Part 3 point 50]

3
BIPRU 5.4.54R

The historical observation period (sample period) for calculating volatility adjustments must be a minimum length of one year. For a firm that uses a weighting scheme or other methods for the historical observation period, the effective observation period must be at least one year (that is, the weighted average time lag of the individual observations must not be less than 6 months).

[Note: BCD Annex VIII Part 3 point 51]

BIPRU 5.4.55G

The appropriate regulator may also require a firm to calculate its volatility adjustments using a shorter observation period if, in the appropriate regulator's judgement, this is justified by a significant upsurge in price volatility.

BIPRU 5.4.56R

A firm must update its data sets at least once every three months and must also reassess them whenever market prices are subject to material changes. This implies that volatility adjustments must be computed at least every three months.

[Note: BCD Annex VIII Part 3 point 52]

The financial collateral comprehensive method: Own estimates of volatility adjustments approach: Qualitative Criteria

BIPRU 5.4.57R

The volatility estimates must be used in the day-to-day risk management process of a firm including in relation to its internal exposure limits.

[Note: BCD Annex VIII Part 3 point 53]

BIPRU 5.4.58R

If the liquidation period used by a firm in its day-to-day risk management process is longer than that set out in BIPRU 5.4 for the type of transaction in question, the firm's volatility adjustments must be scaled up in accordance with the square root of time formula set out in BIPRU 5.4.52 R.

[Note: BCD Annex VIII Part 3 point 54]

BIPRU 5.4.59R

A firm must have established procedures for monitoring and ensuring compliance with a documented set of policies and controls for the operation of its system for the estimation of volatility adjustments and for the integration of such estimations into its risk management process.

[Note: BCD Annex VIII Part 3 point 55]

BIPRU 5.4.60R

An independent review of a firm's system for the estimation of volatility adjustments must be carried out regularly in the firm's own internal auditing process. A review of the overall system for the estimation of volatility adjustments and for integration of those adjustments into the firm's risk management process must take place at least once a year and must specifically address, at a minimum:

  1. (1)

    the integration of estimated volatility adjustments into daily risk management;

  2. (2)

    the validation of any significant change in the process for the estimation of volatility adjustments;

  3. (3)

    the verification of the consistency, timeliness and reliability of data sources used to run the system for the estimation of volatility adjustments, including the independence of such data sources; and

  4. (4)

    the accuracy and appropriateness of the volatility assumptions.

    [Note: BCD Annex VIII Part 3 point 56]

The financial collateral comprehensive method: Scaling up of volatility adjustments

BIPRU 5.4.61R

The volatility adjustments set out in BIPRU 5.4.34 R to BIPRU 5.4.43 R are the volatility adjustments to be applied where there is daily revaluation. Similarly, where a firm uses its own estimates of the volatility adjustments in accordance with BIPRU 5.4.45 R to BIPRU 5.4.60 R, these must be calculated in the first instance on the basis of daily revaluation. If the frequency of revaluation is less than daily, larger volatility adjustments must be applied. These must be calculated by scaling up the daily revaluation volatility adjustments, using the following 'square root of time' formula:

(H = HM√(NR + (TM - 1))/(TM)))

where:

  1. (1)

    H is the volatility adjustment to be applied;

  2. (2)

    HM is the volatility adjustment where there is daily revaluation;

  3. (3)

    NR is the actual number of business days between revaluations; and

  4. (4)

    TM is the liquidation period for the type of transaction in question.

    [Note: BCD Annex VIII Part 3 point 57]

The financial collateral comprehensive method: Conditions for applying a 0% volatility adjustment

BIPRU 5.4.62R

In relation to repurchase transaction and securities lending or borrowing transactions, where a firm uses the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach and where the conditions set out in (1) - (8) are satisfied, a firm may, instead of applying the volatility adjustments calculated under BIPRU 5.4.30 R to BIPRU 5.4.61 R, apply a 0% volatility adjustment:

  1. (1)

    both the exposure and the collateral are cash or debt securities issued by central governments or central banks within the meaning of BIPRU 5.4.2 R (2) and eligible for a 0% risk weight under the standardised approach;

  2. (2)

    both the exposure and the collateral are denominated in the same currency;

  3. (3)

    either the maturity of the transaction is no more than one day or both the exposure and the collateral are subject to daily marking-to-market or daily remargining;

  4. (4)

    it is considered that the time between the last marking-to-market before a failure to remargin by the counterparty and the liquidation of the collateral is no more than four business days;

  5. (5)

    the transaction is settled across a settlement system proven for that type of transaction;

  6. (6)

    the documentation covering the agreement is standard market documentation for repurchase transactions or securities lending or borrowing transactions in the securities concerned;

  7. (7)

    the transaction is governed by documentation specifying that if the counterparty fails to satisfy an obligation to deliver cash or securities or to deliver margin or otherwise defaults, then the transaction is immediately terminable; and

  8. (8)

    the counterparty is a core market participant.

    [Note: BCD Annex VIII Part 3 point 58 (part)]

BIPRU 5.4.63R

The option in BIPRU 5.4.62 R is not available in respect of a firm using the master netting agreement internal models approach.

[Note: BCD Annex VIII Part 3 point 58 (part)]

BIPRU 5.4.64R

Core market participant means the following entities:

  1. (1)

    the entities mentioned in BIPRU 5.4.2 R (2) exposures to which are assigned a 0% risk weight under the standardised approach to credit risk;

  2. (2)

    institutions;

  3. (3)

    other financial companies (including insurance companies) exposures which are assigned a 20% risk weight under the standardised approach;

  4. (4)

    regulated CIUs that are subject to capital or leverage requirements;

  5. (5)

    regulated pension funds; and

  6. (6)

    a recognised clearing house or designated clearing house.

    [Note: BCD Annex VIII Part 3 point 58 (part)]

BIPRU 5.4.65R

If under the CRD implementation measure for a particular EEA State with respect to point 58 of Part 3 of Annex VIII of the Banking Consolidation Directive (Conditions for applying the 0% volatility adjustment) the treatment set out in that point is permitted to be applied in the case of repurchase transactions or securities lending or borrowing transactions in securities issued by the domestic government of that EEA State, then a firm may adopt the same approach to the same transactions.

[Note: BCD Annex VIII Part 3 point 59]

Financial collateral comprehensive method: Calculating risk-weighted exposure amounts

BIPRU 5.4.66R

Under the standardised approach E* as calculated under BIPRU 5.4.28 R must be taken as the exposure value for the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R. In the case of off-balance sheet items listed in BIPRU 3.7, E* must be taken as the value to which the percentages indicated in BIPRU 3.2.1 R and BIPRU 3.7.2 R must be applied to arrive at the exposure value.

[Note: BCD Annex VIII Part 3 point 60]