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BIPRU 5.1 Application and purpose

Application

BIPRU 5.1.1 R

1 BIPRU 5 applies to a BIPRU firm.

Purpose

BIPRU 5.1.2 G

Pursuant to the third paragraph of article 95(2) of the EUCRR,2BIPRU 5 implements, in part, Articles 78(1) and 91 to 93 and Annex VIII of the Banking Consolidation Directive.

BIPRU 5.1.3 G

BIPRU 5 sets out the principles for the recognition of credit risk mitigation in the calculation of risk weighted exposure amounts for the purposes of the calculation of the credit risk capital component.

BIPRU 5.1.4 G

BIPRU 4.10 implements those parts of Articles 91 to 93 and Annex VIII of the Banking Consolidation Directive which are specific to the recognition of credit risk mitigation by firms using the IRB approach, and modifies the application of the provisions in BIPRU 5 to those firms.

BIPRU 5.1.5 G

In certain cases provisions specific to the IRB approach have been kept in BIPRU 5 in order to reduce duplication. The main examples are certain references to expected loss and references in the IRB approach in the provisions in BIPRU 5.7 about basket CRM techniques.

BIPRU 5.2 The central principles of credit risk mitigation

BIPRU 5.2.1 R

A firm using the standardised approach may recognise credit risk mitigation in accordance with BIPRU 5 in the calculation of risk weighted exposure amounts for the purposes of the calculation of the credit risk capital component.

[Note: BCD Article 91]

BIPRU 5.2.2 R

The technique used to provide the credit protection together with the actions and steps taken and procedures and policies implemented by a lending firm must be such as to result in credit protection arrangements which are legally effective and enforceable in all relevant jurisdictions.

[Note: BCD Article 92(1)]

BIPRU 5.2.3 R

  1. (1)

    A firm must not recognise credit protection as eligible until it has conducted sufficient legal review confirming that the credit protection arrangements are legally effective and enforceable in all relevant jurisdictions in accordance with BIPRU 5.2.2 R.

  2. (2)

    A firm must re-conduct legal reviews as necessary to ensure continuing enforceability and effectiveness.

BIPRU 5.2.4 R

A lending firm must take all appropriate steps to ensure the effectiveness of the credit protection arrangement and to address related risks.

[Note: BCD Article 92(2)]

Funded credit protection

BIPRU 5.2.5 R

In the case of funded credit protection:

  1. (1)

    to be eligible for recognition the assets relied upon must be sufficiently liquid and their value over time sufficiently stable to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk weighted exposure amounts and to the degree of recognition allowed; eligibility is limited to the assets set out in the CRM eligibility conditions; and

  2. (2)

    the lending firm must have the right to liquidate or retain, in a timely manner, the assets from which the protection derives in the event of the default, insolvency or bankruptcy of the obligor - or other credit event set out in the transaction documentation - and, where applicable, of the custodian holding the collateral; the degree of correlation between the value of the assets relied upon for protection and the credit quality of the obligor must not be undue.

    [Note: BCD Article 92(3) and (4)]

Treatment of credit linked notes

BIPRU 5.2.6 G

A credit linked note should be treated, to the extent of its cash funding, as funded credit protection. Therefore the conditions in BIPRU 5 regulating the eligibility of protection providers for unfunded credit protection do not apply. However the other provisions about the requirements for the recognition of unfunded credit protection do apply.

Unfunded credit protection

BIPRU 5.2.7 R

In the case of unfunded credit protection:

  1. (1)

    to be eligible for recognition the party giving the undertaking must be sufficiently reliable, and the protection agreement legally effective and enforceable in the relevant jurisdictions, to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk weighted exposure amounts and to the degree of recognition allowed; and

  2. (2)

    eligibility is limited to the protection providers and types of protection agreement set out in the CRM eligibility conditions.

    [Note: BCD Article 92(5)]

Minimum requirements

BIPRU 5.2.8 R

The minimum requirements set out in BIPRU 5 must be complied with.

[Note: BCD Article 92(6)]

BIPRU 5.2.9 R

A firm must be able to satisfy the appropriate regulator that it has adequate risk management processes to control the 1risks to which the firm may be exposed as a result of carrying out credit risk mitigation. Those processes must include appropriate stress tests and scenario analyses relating to those risks, including residual risk and the risks relating to the intrinsic value of the credit risk mitigation1.

[Note: BCD Annex VIII Part 2 point 1]

1
BIPRU 5.2.10 R

Notwithstanding the presence of credit risk mitigation taken into account for the purposes of calculating risk weighted exposure amounts and as relevant expected loss amounts, a firm must continue to undertake full credit risk assessment of the underlying exposure and must be in a position to demonstrate to the appropriate regulator the fulfilment of this requirement. In the case of repurchase transactions and/or securities or commodities lending or borrowing transactions the underlying exposure must, for the purposes of this rule only, be deemed to be the net amount of the exposure.

[Note: BCD Annex VIII Part 2 point 2]

Calculating the effects of the credit risk mitigation

BIPRU 5.2.11 R

Where the requirements of BIPRU 5.2.2 R to BIPRU 5.2.8 R are met the calculation of risk weighted exposure amounts, may be modified in accordance with BIPRU 5.

[Note: BCD Article 93(1)]

BIPRU 5.2.12 R

No exposure in respect of which credit risk mitigation is obtained may produce a higher risk weighted exposure amount than an otherwise identical exposure in respect of which there is no credit risk mitigation.

[Note: BCD Article 93(2)]

BIPRU 5.2.13 R

Where the risk weighted exposure amount already takes account of credit protection under the standardised approach the calculation of the credit protection must not be further recognised under BIPRU 5.

[Note: BCD Article 93(3)]

BIPRU 5.2.14 R

Subject to BIPRU 5.8, BIPRU 5.9 and BIPRU 5.7.27 R to BIPRU 5.7.28 R, where the CRM eligibility conditions and the CRM minimum requirements are satisfied, the calculation of risk weighted exposure amounts under the standardised approach may be modified in accordance with the provisions of BIPRU 5.

[Note: BCD Annex VIII Part 3 point 1]

BIPRU 5.2.15 R

Cash, securities or commodities purchased, borrowed or received under a repurchase transaction or securities or commodities lending or borrowing transaction must be treated as collateral.

[Note: BCD Annex VIII Part 3 point 2]

BIPRU 5.3 On balance sheet netting

Eligibility

BIPRU 5.3.1 R

A firm may recognise as eligible the on-balance sheet netting of mutual claims between the firm and its counterparty.

[Note: BCD Annex VIII Part 1 point 3]

BIPRU 5.3.2 R

Without prejudice to BIPRU 5.6.1 R, eligibility is limited to reciprocal cash balances between a firm and a counterparty. Only loans and deposits of the lending firm may be subject to a modification of risk weighted exposure amounts and, as relevant, expected loss amounts as a result of an on-balance sheet netting agreement.

[Note: BCD Annex VIII Part 1 point 4]

Minimum requirements

BIPRU 5.3.3 R

For on-balance sheet netting agreements - other than master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions and/or other capital market-driven transactions - to be recognised for the purposes of BIPRU 5 the following conditions must be satisfied:

  1. (1)

    they must be legally effective and enforceable in all relevant jurisdictions, including in the event of the insolvency or bankruptcy of a counterparty;

  2. (2)

    the firm must be able to determine at any time those assets and liabilities that are subject to the on-balance sheet netting agreement;

  3. (3)

    the firm must monitor and control the risks associated with the termination of the credit protection; and

  4. (4)

    the firm must monitor and control the relevant exposures on a net basis.

    [Note: BCD Annex VIII Part 2 point 3]

Calculating the effects of credit risk mitigation

BIPRU 5.3.4 R

Loans and deposits with a lending firm subject to on-balance sheet netting are to be treated as cash collateral.

[Note: BCD Annex VIII Part 3 point 4]

BIPRU 5.4 Financial collateral

Eligibility

BIPRU 5.4.1 R

  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 5.4.2 R

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 5.4.3 R

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 5.4.4 R

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 5.4.5 R

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 5.4.6 R

  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 5.4.7 R

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 5.4.8 R

  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 5.4.9 R

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 5.4.10 R

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 5.4.11 R

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 5.4.12 R

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 5.4.13 R

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 5.4.14 R

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 5.4.15 R

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 5.4.16 R

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'sIRB 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 5.4.17 R

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 5.4.18 R

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 5.4.19 R

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 5.4.20 R

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 5.4.21 R

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 5.4.22 R

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 5.4.23 R
BIPRU 5.4.24 R

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 5.4.25 R

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 5.4.26 R

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 5.4.27 R

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 5.4.28 R

  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 5.4.29 R

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

BIPRU 5.4.30 R

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 5.4.31 R

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 5.4.32 R

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 5.4.33 R

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

BIPRU 5.4.34 R

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 5.4.35 R

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 5.4.36 R

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 5.4.37 R

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 5.4.38 R

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 5.4.39 R

  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 5.4.40 R

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 5.4.41 R

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 5.4.42 R

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 5.4.43 R

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 5.4.44 R

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 5.4.45 R

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 5.4.46 R

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 5.4.47 R

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 5.4.48 R

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 5.4.49 R

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 5.4.50 R

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

[Note:BCD Annex VIII Part 3 point 47]

BIPRU 5.4.51 R

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 5.4.52 R

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 5.4.53 R

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 5.4.54 R

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 5.4.55 G

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 5.4.56 R

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 5.4.57 R

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 5.4.58 R

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 5.4.59 R

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 5.4.60 R

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 5.4.61 R

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 5.4.62 R

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 5.4.63 R

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 5.4.64 R

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 5.4.65 R

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 5.4.66 R

Under the standardised approachE* 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]

BIPRU 5.5 Other funded credit risk mitigation

Deposits with third parties: Eligibility

BIPRU 5.5.1 R

Cash on deposit with, or cash assimilated instruments held by, a third party institution in a non-custodial arrangement and pledged to a lending firm may be recognised as eligible credit protection.

[Note: BCD Annex VIII Part 1 point 23]

Deposits with third parties: Minimum requirements

BIPRU 5.5.2 R

To be eligible for the treatment set out at BIPRU 5.5.3 R, the protection referred to in BIPRU 5.5.1 R must satisfy the following conditions:

  1. (1)

    the borrower's claim against the third party institution is openly pledged or assigned to the lending firm and such pledge or assignment is legally effective and enforceable in all relevant jurisdictions;

  2. (2)

    the third party institution is notified of the pledge or assignment;

  3. (3)

    as a result of the notification, the third party institution is able to make payments solely to the lending firm or to other parties with the lending firm's consent; and

  4. (4)

    the pledge or assignment is unconditional and irrevocable.

    [Note: BCD Annex VIII Part 2 point 12]

Deposits with third parties: Calculating the effects of the credit risk mitigation

BIPRU 5.5.3 R

Where the conditions set out in BIPRU 5.5.2 R are satisfied, credit protection falling within the terms of BIPRU 5.5.1 R may be treated as a guarantee by the third party institution.

[Note: BCD Annex VIII Part 3 point 79]

Life insurance policies: Eligibility

BIPRU 5.5.4 R

Life insurance policies pledged to a lending firm may be recognised as eligible credit protection.

[Note: BCD Annex VIII Part 1 point 24]

Life insurance policies: Minimum requirements

BIPRU 5.5.5 R

For life insurance policies pledged to a lending firm to be recognised the following conditions must be met:

  1. (1)

    the party providing the life insurance must be subject to the Solvency II Directive2, or is subject to supervision by a competent authority of a third country which applies supervisory and regulatory arrangements at least equivalent to those applied in the Community;1

    12
  2. (2)

    the life insurance policy is openly pledged or assigned to the lending firm;

  3. (3)

    the party providing the life insurance is notified of the pledge or assignment and as a result may not pay amounts payable under the contract without the consent of the lending firm;

  4. (4)

    the surrender value is declared by the company providing the life insurance and1 is non-reducible;

    1
  5. (4A)

    1the surrender value must be paid in a timely manner upon request;

  6. (4B)

    1the surrender value must not be requested without the consent of the lending firm;

  7. (5)

    the lending firm must have the right to cancel the policy and receive the surrender value in a timely way in the event of the default of the borrower;

  8. (6)

    the lending firm is informed of any non-payments under the policy by the policyholder;

  9. (7)

    the credit protection must be provided for the maturity of the loan. Where this is not possible because the insurance relationship ends before the loan relationship expires, the lending firm must ensure that the amount deriving from the insurance contract serves the lending firm as security until the end of the duration of the credit agreement;1 and

  10. (8)

    the pledge or assignment must be legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

    [Note: BCD Annex VIII Part 2 point 13 (part)]

BIPRU 5.5.6 R

Where it is not possible for a firm to meet the condition set out in BIPRU 5.5.5 R (7), because the insurance relationship ends before the loan relationship expires, the firm must ensure that the amount deriving from the insurance contract serves the firm as security until the end of the duration of the credit agreement.

[Note: BCD Annex VIII Part 2 point 13 (part)]

Life insurance policies: Calculating the effects of the credit risk mitigation

BIPRU 5.5.7 R
1
  1. (1)

    1Where the conditions set out in BIPRU 5.5.5 R are satisfied, the portion of the exposure collateralised by the current surrender value of credit protection falling within the terms of BIPRU 5.5.4 R must be either:

    1. (a)

      1subject to the risk weights specified in (3) where the exposure is subject to the standardised approach to credit risk; or

    2. (b)

      1assigned an LGD of 40% where the exposure is subject to the IRB approach but not subject to the firm's own estimates of LGD.

  2. (2)

    1In case of a currency mismatch, the current surrender value must be reduced according to BIPRU 5.7.17 R and BIPRU 5.7.18R, the value of the credit protection being the current surrender value of the life insurance policy.

  3. (3)

    1For the purpose of (1)(a), the following risk weights must be assigned on the basis of the risk weight assigned to a senior unsecured exposure to the company providing the life insurance:

    1. (a)

      1a risk weight of 20%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 20%;

    2. (b)

      1a risk weight of 35%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 50%;

    3. (c)

      1a risk weight of 70%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 100%; and

    4. (d)

      1a risk weight of 150%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 150%.

[Note: BCD Annex VIII Part 3 point 80]

Instruments purchased on request: Eligibility

BIPRU 5.5.8 R

Instruments issued by third party institutions which will be repurchased by that institution on request may be recognised as eligible credit protection.

[Note: BCD Annex VIII Part 1 point 25]

Instruments purchased on request: Calculating the effects of the credit risk mitigation

BIPRU 5.5.9 R

Instruments eligible under BIPRU 5.5.8 R may be treated as a guarantee by the issuing institution.

[Note: BCD Annex VIII Part 3 point 81]

BIPRU 5.5.10 R

For the purposes of BIPRU 5.5.9 R, the value of the credit protection recognised is the following:

  1. (1)

    where the instrument will be repurchased at its face value, the value of the protection is that amount; or

  2. (2)

    where the instrument will be repurchased at market price, the value of the protection is the value of the instrument valued in the same way as the debt securities specified in BIPRU 5.4.5 R.

    [Note: BCD Annex VIII Part 3 point 82]

Credit linked notes

BIPRU 5.5.11 R

Investments in credit linked notes issued by a lending firm may be treated as cash collateral.

[Note: BCD Annex VIII Part 3 point 3]

BIPRU 5.6 Master netting agreements

Eligibility

BIPRU 5.6.1 R

  1. (1)

    For a firm adopting the financial collateral comprehensive method, the effects of bilateral netting contracts covering repurchase transactions, securities or commodities lending or borrowing transactions, and/or other capital market-driven transactions with a counterparty may be recognised.

  2. (2)

    Without prejudice to BIPRU 14 to be recognised the collateral taken and securities or commodities borrowed within such agreements must comply with the eligibility requirements for collateral set out at BIPRU 5.4.2 R to BIPRU 5.4.8 R.

    [Note:BCD Annex VIII Part 1 point 5]

Minimum requirements

BIPRU 5.6.2 R

For master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market-driven transactions1 to be recognised for the purposes of BIPRU 5, they must:

  1. (1)

    be legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or insolvency of the counterparty;

  2. (2)

    give the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon the event of default, including in the event of the bankruptcy or insolvency of the counterparty; and

  3. (3)

    provide for the netting of gains and losses on transactions closed out under a master agreement so that a single net amount is owed by one party to the other.

    [Note:BCD Annex VIII Part 2 point 4]

BIPRU 5.6.3 R

In addition the minimum requirements for the recognition of financial collateral under the financial collateral comprehensive method set out in BIPRU 5.4.9 R must be fulfilled.

[Note:BCD Annex VIII Part 2 point 5]

Calculation of the fully adjusted exposure value: the supervisory volatility adjustments approach and the own estimates of volatility adjustments approach

BIPRU 5.6.4 R
BIPRU 5.6.5 R

In calculating the 'fully adjusted exposure value' (E*) for the exposures subject to an eligible master netting agreement covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market-driven transactions, a firm must calculate the volatility adjustments to be applied in the manner set out in BIPRU 5.6.6 R to BIPRU 5.6.11 R either using the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R for the financial collateral comprehensive method. For the use of the own estimates of volatility adjustments approach the same conditions and requirements apply as under the financial collateral comprehensive method.

[Note:BCD Annex VIII Part 3 point 5]

BIPRU 5.6.6 R

A firm must calculate the net position in each type of security or commodity by subtracting from the total value of the securities or commodities of that type lent, sold or provided under the master netting agreement, the total value of securities or commodities of that type borrowed, purchased or received under the agreement.

[Note:BCD Annex VIII Part 3 point 6]

BIPRU 5.6.7 R

For the purposes of BIPRU 5.6.6 R, type of security means securities which are issued by the same entity, have the same issue date, the same maturity and are subject to the same terms and conditions and are subject to the same liquidation periods as indicated in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 7]

BIPRU 5.6.8 R

A firm must calculate the net position in each currency other than the settlement currency of the master netting agreement by subtracting from the total value of securities denominated in that currency lent, sold or provided under the master netting agreement added to the amount of cash in that currency lent or transferred under the agreement, the total value of securities denominated in that currency borrowed, purchased or received under the agreement added to the amount of cash in that currency borrowed or received under the agreement.

[Note: BCD Annex VIII Part 3 point 8]

BIPRU 5.6.9 R

A firm must apply the volatility adjustment appropriate to a given type of security or cash position to the absolute value of the positive or negative net position in the securities of that type.

[Note: BCD Annex VIII Part 3 point 9]

BIPRU 5.6.10 R

A firm must apply the foreign exchange risk (fx) volatility adjustment to the net positive or negative position in each currency other than the settlement currency of the master netting agreement.

[Note: BCD Annex VIII Part 3 point 10]

BIPRU 5.6.11 R

E * must be calculated according to the following formula:

E * = max {0, [(∑(E) -∑ (C)) + ∑ (|net position in each security| x Hsec) + (∑|Efx| x Hfx)]}

where:

  1. (1)

    (where risk weighted exposure amounts are calculated under the standardised approach) E is the exposure value for each separate exposure under the agreement that would apply in the absence of the credit protection;

  2. (2)

    C is the value of the securities or commodities borrowed, purchased or received or the cash borrowed or received in respect of each such exposure;

  3. (3)

    ∑(E) is the sum of all Es under the agreement;

  4. (4)

    ∑(C) is the sum of all Cs under the agreement;

  5. (5)

    Efx is the net position (positive or negative) in a given currency other than the settlement currency of the agreement as calculated under BIPRU 5.6.8 R;

  6. (6)

    Hsec is the volatility adjustment appropriate to a particular type of security;

  7. (7)

    Hfx is the foreign exchange volatility adjustment; and

  8. (8)

    E* is the fully adjusted exposure value.

    [Note: BCD Annex VIII Part 3 point 11]

Calculation of the fully adjusted exposure value: the master netting agreement internal models approach

BIPRU 5.6.12 R
BIPRU 5.6.13 G

A firm that wishes to use the master netting agreement internal models approach will need to apply to the appropriate regulator for a master netting agreement internal models approach permission. BIPRU 1.3 sets out the requirements and procedures relating to those applications.

BIPRU 5.6.14 G

A master netting agreement internal models approach permission will amend, to the extent set out in the master netting agreement internal models approach permission, BIPRU 5.6.1 R so as to provide that, with the exceptions provided in BIPRU 5.6, a firm must use the master netting agreement internal models approach for the purposes of the calculations specified in BIPRU 5.6.

BIPRU 5.6.15 G

A firm which has been granted a VaR modelwaiver will still need to make an application to the appropriate regulator for a master netting agreement internal models approach permission. However, the application should generally be straightforward as a firm which is able to satisfy the requirements for a VaR modelwaiver should usually also be able to satisfy the requirements for a master netting agreement internal models approach permission.

[Note: BCD Annex VIII Part 3 point 14]

BIPRU 5.6.16 R

The master netting agreement internal models approach1 is an alternative to using the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach in calculating volatility adjustments for the purpose of calculating the 'fully adjusted exposure value' (E*) resulting from the application of an eligible master netting agreement covering repurchase transactions, securities or commodities lending or borrowing transactions and/or other capital market-driven transactions other than derivative transactions. The master netting agreement internal models approach takes into account correlation effects between security positions subject to a master netting agreement as well as the liquidity of the instruments concerned. The internal model used for the master netting agreement internal models approach must provide estimates of the potential change in value of the unsecured exposure amount (∑E -∑C).

[Note: BCD Annex VIII Part 3 point 12 (part)]

BIPRU 5.6.17 R

A firm may also use the internal model used for the master netting agreement internal models approach1 for margin lending transactions if the transactions are covered under the firm'smaster netting agreement internal models approach permission and the transactions are covered by a bilateral master netting agreement that meets the requirements set out in BIPRU 13.7.

[Note: BCD Annex VIII Part 3 point 12 (part)]

BIPRU 5.6.18 R

A firm may use the master netting agreement internal models 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 uses the master netting agreement internal models approach, it must do so for all counterparties and securities, excluding immaterial portfolios where it may use the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 13]

BIPRU 5.6.19 R
  1. (1)

    A firm must be able to satisfy the appropriate regulator that the firm's risk management system for managing the risks arising on the transactions covered by the master netting agreement is conceptually sound and implemented with integrity and that, in particular, the minimum qualitative standards in (2) - (11) are met.

  2. (2)

    The internal risk-measurement model used for calculation of potential price volatility for the transactions is closely integrated into the daily risk-management process of the firm and serves as the basis for reporting risk exposures to senior management of the firm.

  3. (3)

    The firm has a risk control unit that is independent from business trading units and reports directly to senior management. The unit must be responsible for designing and implementing the firm's risk-management system. It must produce and analyse daily reports on the output of the risk-measurement model and on the appropriate measures to be taken in terms of position limits.

  4. (4)

    The daily reports produced by the risk-control unit are reviewed by a level of management with sufficient authority to enforce reductions of positions taken and of overall risk exposure.

  5. (5)

    The firm has sufficient staff skilled in the use of sophisticated models in the risk control unit.

  6. (6)

    The firm has established procedures for monitoring and ensuring compliance with a documented set of internal policies and controls concerning the overall operation of the risk-measurement system.

  7. (7)

    The firm's models have a proven track record of reasonable accuracy in measuring risks demonstrated through the back-testing of its output using at least one year of data.

  8. (8)

    The firm frequently conducts a rigorous programme of stress testing and the results of these tests are reviewed by senior management and reflected in the policies and limits it sets.

  9. (9)

    The firm must conduct, as part of its regular internal auditing process, an independent review of its risk-measurement system. This review must include both the activities of the business trading units and of the independent risk-control unit.

  10. (10)

    At least once a year, the firm must conduct a review of its risk management system.

  11. (11)

    The internal model used for the master netting agreement internal models approach1 must meet the requirements set out in BIPRU 13.6.65 R to BIPRU 13.6.67 R.

    [Note: BCD Annex VIII Part 3 point 16]

BIPRU 5.6.19A G

2This paragraph provides guidance in relation to BIPRU 5.6.19R (8). In carrying out the stress testing programme, a firm should evaluate the simultaneous impact of individual stress scenarios on its counterparty exposures, its positions and the aggregate amount of margin calls that it would receive. A firm's stress scenarios should take into account the possibility that the liquidation period may be substantially longer than 5 days for repurchase transactions and securities lending or borrowing transactions, and 10 days for other types of securities financing transactions.

BIPRU 5.6.20 R

The calculation of the potential change in value must be subject to the following minimum standards:

  1. (1)

    at least daily calculation of the potential change in value;

  2. (2)

    a 99th percentile, one-tailed confidence interval;

  3. (3)

    a 5-day equivalent liquidation period, except in the case of transactions other than securities repurchase transaction or securities lending or borrowing transactions where a 10-day equivalent liquidation period should be used;

  4. (4)

    an effective historical observation period of at least one year except where a shorter observation period is justified by a significant upsurge in price volatility; and

  5. (5)

    three-monthly data set updates.

    [Note: BCD Annex VIII Part 3 point 17]

BIPRU 5.6.21 R

The internal risk-measurement model must capture a sufficient number of risk factors in order to capture all material price risks.

[Note: BCD Annex VIII Part 3 point 18]

BIPRU 5.6.22 R

A firm may use empirical correlations within risk categories and across risk categories provided that it is able to satisfy the appropriate regulator that the firm's system for measuring correlations is sound and implemented with integrity.

[Note: BCD Annex VIII Part 3 point 19]

BIPRU 5.6.23 G

The appropriate regulator will not grant a master netting agreement internal models approach permission if it is not satisfied that the standards in BIPRU 5.6.19 R to BIPRU 5.6.22 R are met.

BIPRU 5.6.24 R

The fully adjusted exposure value (E*) for a firm using the master netting agreement internal models approach must be calculated according to the following formula:

E * = max {0, [(∑E -∑C) + (VaR output of the internal models)]}

where

  1. (1)

    (where risk weighted exposure amounts are calculated under the standardised approach) E is the exposure value for each separate exposure under the agreement that would apply in the absence of the credit protection;

  2. (2)

    C is the value of the securities borrowed, purchased or received or the cash borrowed or received in respect of each such exposure;

  3. (3)

    ∑ (E) is the sum of all Es under the agreement; and

  4. (4)

    ∑ (C) is the sum of all Cs under the agreement.

    [Note: BCD Annex VIII Part 3 point 20]

BIPRU 5.6.25 R

In calculating risk weighted exposure amounts using the master netting agreement internal models approach, a firm must use the previous business day's model output.

[Note: BCD Annex VIII Part 3 point 21]

BIPRU 5.6.26 G

No changes should be made to the internal model used for the master netting agreement internal models approach1 unless the change is not material. Material changes to such a model will require a variation of the master netting agreement internal models approach permission. Materiality is measured against the model as it was at the time that the master netting agreement internal models approach permission was originally granted or, any later date set out in the master netting agreement internal models approach permission for this purpose. If a firm is considering making material changes to such a model then it should notify the appropriate regulator at once.

BIPRU 5.6.27 G

If a firm ceases to meet the requirements of BIPRU 5 in relation to the master netting agreement internal models approach, the firm should notify the appropriate regulator at once.

BIPRU 5.6.28 G

Calculation of risk weighted exposure amounts under the standardised approach

BIPRU 5.6.29 R

  1. (1)

    A firm must under the standardised approach calculate risk weighted exposure amounts for repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market-driven transactions covered by master netting agreements under this rule.

  2. (2)

    E* as calculated under BIPRU 5.6.5 R to BIPRU 5.6.25 R must be taken as the exposure value of the exposure to the counterparty arising from the transactions subject to the master netting agreement for the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R.

    [Note: BCD Annex VIII Part 3 point 22]

BIPRU 5.7 Unfunded credit protection

Eligibility

BIPRU 5.7.1 R

The following parties may be recognised as eligible providers of unfunded credit protection:

  1. (1)

    central governments and central banks;

  2. (2)

    regional governments or local authorities;

  3. (3)

    multilateral development banks;

  4. (4)

    international organisationsexposures which are assigned a 0% risk weight under the standardised approach;

  5. (5)

    public sector entities, claims on which are treated as claims on institutions or central governments under the standardised approach;

  6. (6)

    institutions;

  7. (7)

    other corporate entities, including parent undertakings, subsidiary undertakings and affiliate corporate entities of the firm, that have a credit assessment by an eligible ECAI associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporates under the standardised approach.

    [Note: BCD Annex VIII Part 1 point 26]

Types of credit derivatives

BIPRU 5.7.2 R

The following types of credit derivatives, and instruments that may be composed of such credit derivatives or that are economically effectively similar, may be recognised as eligible;

  1. (1)

    credit default swaps;

  2. (2)

    total return swaps; and

  3. (3)

    credit linked notes to the extent of their cash funding.

    [Note: BCD Annex VIII Part 1 point 30]

BIPRU 5.7.3 R

Where a firm buys credit protection through a total return swap and records the net payments received on the swap as net income, but does not record offsetting deterioration in the value of the asset that is protected (either through reductions in fair value or by an addition to reserves), the credit protection must not be recognised as eligible.

[Note: BCD Annex VIII Part 1 point 31]

Internal hedges

BIPRU 5.7.4 R

When a firm conducts an internal hedge using a credit derivative - i.e. hedges the credit risk of an exposure in the non-trading book with a credit derivative booked in the trading book - in order for the protection to be recognised as eligible for the purposes of BIPRU 4.10 or BIPRU 5 the credit risk transferred to the trading book must be transferred out to a third party or parties. In such circumstances, subject to the compliance of such transfer with the requirements for the recognition of credit risk mitigation set out in BIPRU 4.10 or BIPRU 5, the rules for the calculation of risk weighted exposure amounts and expected loss amounts where unfunded credit protection is acquired set out in BIPRU 4.10 or BIPRU 5 must be applied.

[Note: BCD Annex VIII Part 1 point 32]

Minimum requirements: General

BIPRU 5.7.5 R

BIPRU 5.7.6 R to BIPRU 5.7.10 R deal with requirements common to guarantees and credit derivatives.

BIPRU 5.7.6 R

Subject to BIPRU 5.7.9 R, for the credit protection deriving from a guarantee or credit derivative to be recognised the following conditions must be met:

  1. (1)

    the credit protection must be direct;

  2. (2)

    the extent of the credit protection must be clearly defined and incontrovertible;

  3. (3)

    the credit protection contract must not contain any clause, the fulfilment of which is outside the direct control of the lender, that:

    1. (a)

      would allow the protection provider unilaterally to cancel the protection;

    2. (b)

      would increase the effective cost of protection as a result of deteriorating credit quality of the protected exposure;

    3. (c)

      could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original obligor fails to make any payments due; or

    4. (d)

      could allow the maturity of the credit protection to be reduced by the protection provider; and

  4. (4)

    it must be legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

    [Note: BCD Annex VIII Part 2 point 14]

BIPRU 5.7.7 G

For the purposes of BIPRU 5.7.6 R (3)(a), payment of premiums and other monies due under the contract is within the control of the lending firm. So a clause that allows the protection provider unilaterally to cancel the contract after a reasonable period due to non payment of such monies will not mean that the condition in that rule is not met.

Minimum requirements: Operational requirements

BIPRU 5.7.8 R

A firm must be able to satisfy the appropriate regulator that it has systems in place to manage potential concentration of risk arising from the firm's use of guarantees and credit derivatives. The firm must be able to demonstrate how its strategy in respect of its use of credit derivatives and guarantees interacts with its management of its overall risk profile.

[Note: BCD Annex VIII Part 2 point 15]

Minimum requirements: Sovereign and other public sector counter-guarantees

BIPRU 5.7.9 R

Where an exposure is protected by a guarantee which is counter-guaranteed by a central government or central bank, a regional government or local authority or a public sector entity claims on which are treated as claims on the central government in whose jurisdiction they are established under the standardised approach, a multilateral development bank or an international organisation,1to which a 0% risk weight is assigned under or by virtue of the standardised approach, or a public sector entity,1 claims on which are treated as claims on credit institutions under the standardised approach, the exposure may be treated as protected by a guarantee provided by the entity in question provided the following conditions are satisfied:

  1. (1)

    the counter-guarantee covers all credit risk elements of the claim;

  2. (2)

    both the original guarantee and the counter-guarantee meet the requirements for guarantees set out in BIPRU 5.7.6 R, BIPRU 5.7.8 R and BIPRU 5.7.11 R, except that the counter-guarantee need not be direct; and

  3. (3)

    the firm is able to satisfy the appropriate regulator that the cover is robust and that nothing in the historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct guarantee by the entity in question.

    [Note: BCD Annex VIII Part 2 point 16]

BIPRU 5.7.10 R

The treatment of BIPRU 5.7.9 R applies, also, to an exposure which is not counter-guaranteed by an entity listed in that rule if the exposure's counter-guarantee is in its turn directly guaranteed by one of the listed entities and the conditions listed in BIPRU 5.7.9 R are satisfied.

[Note: BCD Annex VIII Part 2 point 17]

Additional requirements for guarantees

BIPRU 5.7.11 R

For a guarantee to be recognised the following conditions must also be met:

  1. (1)

    on the qualifying default of and/or non-payment by the counterparty, the lending firm must have the right to pursue, in a timely manner, the guarantor for any monies due under the claim in respect of which the protection is provided;

  2. (2)

    payment by the guarantor must not be subject to the lending firm first having to pursue the obligor;

  3. (3)

    in the case of unfunded credit protection covering residential mortgage loans, the requirements in BIPRU 5.7.6 R (3)(c) and in this rule have only to be satisfied within 24 months;

  4. (4)

    the guarantee must be an explicitly documented obligation assumed by the guarantor;

  5. (5)

    subject to (6), the guarantee must cover all types of payments the obligor is expected to make in respect of the claim; and

  6. (6)

    where certain types of payment are excluded from the guarantee, the recognised value of the guarantee must be adjusted to reflect the limited coverage.

    [Note: BCD Annex VIII Part 2 point 18]

BIPRU 5.7.12 R

In the case of guarantees provided in the context of mutual guarantee schemes recognised for these purposes by another EEA competent authority under a CRD implementation measure with respect to point 19 of Part 2 of Annex VIII of the Banking Consolidation Directive or provided by or counter-guaranteed by entities referred to in BIPRU 5.7.9 R, the requirements in BIPRU 5.7.11 R (1) - (3) will be satisfied where either of the following conditions are met:

  1. (1)

    the lending firm has the right to obtain in a timely manner a provisional payment by the guarantor calculated to represent a robust estimate of the amount of the economic loss, including losses resulting from the non-payment of interest and other types of payment which the borrower is obliged to make, likely to be incurred by the lending firm proportional to the coverage of the guarantee; or

  2. (2)

    the lending firm is able to demonstrate to the appropriate regulator that the loss-protecting effects of the guarantee, including losses resulting from the non-payment of interest and other types of payments which the borrower is obliged to make, justify such treatment.

    [Note: BCD Annex VIII Part 2 point 19]

Additional requirements for credit derivatives

BIPRU 5.7.13 R

For a credit derivative to be met the following conditions must also be met.

  1. (1)

    Subject to (2), the credit events specified under the credit derivative must at a minimum include:

    1. (a)

      the failure to pay the amounts due under the terms of the underlying obligation that are in effect at the time of such failure (with a grace period that is closely in line with or shorter than the grace period in the underlying obligation);

    2. (b)

      the bankruptcy, insolvency or inability of the obligor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; and

    3. (c)

      the restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that results in a credit loss event (i.e. value adjustment or other similar debit to the profit and loss account).

  2. (2)

    Where the credit events specified under the credit derivative do not include restructuring of the underlying obligation as described in (1)(c), the credit protection may nonetheless be recognised subject to a reduction in the recognised value as specified in BIPRU 5.7.16 R.

  3. (3)

    In the case of credit derivatives allowing for cash settlement a robust valuation process must be in place in order to estimate loss reliably. There must be a clearly specified period for obtaining post-credit-event valuations of the underlying obligation.

  4. (4)

    If the protection purchaser's right and ability to transfer the underlying obligation to the protection provider is required for settlement, the terms of the underlying obligation must provide that any required consent to such transfer may not be unreasonably withheld.

  5. (5)

    The identity of the parties responsible for determining whether a credit event has occurred must be clearly defined. This determination must not be the sole responsibility of the protection provider. The protection buyer must have the right/ability to inform the protection provider of the occurrence of a credit event.

    [Note: BCD Annex VIII Part 2 point 20]

BIPRU 5.7.14 R

A mismatch between the underlying obligation and the reference obligation under the credit derivative (i.e. the obligation used for the purposes of determining cash settlement value or the deliverable obligation) or between the underlying obligation and the obligation used for purposes of determining whether a credit event has occurred is permissible only if the following conditions are met:

  1. (1)

    the reference obligation or the obligation used for purposes of determining whether a credit event has occurred, as the case may be, ranks pari passu with or is junior to the underlying obligation; and

  2. (2)

    the underlying obligation and the reference obligation or the obligation used for purposes of determining whether a credit event has occurred, as the case may be, share the same obligor (i.e., the same legal entity) and there are in place legally enforceable cross-default or cross-acceleration clauses.

    [Note: BCD Annex VIII Part 2 point 21]

Unfunded credit protection: Valuation

BIPRU 5.7.15 R

BIPRU 5.7.16 R to BIPRU 5.7.19 R set out the provisions applying to the valuation of unfunded credit protection.

BIPRU 5.7.16 R

  1. (1)

    The value of unfunded credit protection (G) is the amount that the protection provider has undertaken to pay in the event of the default or non-payment of the borrower or on the occurrence of other specified credit events.

  2. (2)

    In the case of credit derivatives which do not include as a credit event restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that result in a credit loss event (e.g. value adjustment, the making of a value adjustment or other similar debit to the profit and loss account):

    1. (a)

      where the amount that the protection provider has undertaken to pay is not higher than the exposure value, the value of the credit protection calculated under (1) must be reduced by 40%; or

    2. (b)

      where the amount that the protection provider has undertaken to pay is higher than the exposure value, the value of the credit protection must be no higher than 60% of the exposure value.

      [Note: BCD Annex VIII Part 3 point 83]

BIPRU 5.7.17 R

Where unfunded credit protection is denominated in a currency different from that in which the exposure is denominated (a currency mismatch) the value of the credit protection must be reduced by the application of a volatility adjustment HFX as follows:

G* = G x (1-HFX)

where:

  1. (1)

    G is the nominal amount of the credit protection;

  2. (2)

    G* is G adjusted for any foreign currency risk; and

  3. (3)

    Hfx is the volatility adjustment for any currency mismatch between the credit protection and the underlying obligation.

    [Note: BCD Annex VIII Part 3 point 84 (part)]

BIPRU 5.7.18 R

Where there is no currency mismatch:

G* = G

[Note: BCD Annex VIII Part 3 point 84 (part)]

BIPRU 5.7.19 R

The volatility adjustments to be applied for any currency mismatch may be calculated based on the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 85]

Calculating risk weighted exposure amounts and expected loss amounts

BIPRU 5.7.20 R

BIPRU 5.7.21 R to BIPRU 5.7.28 R set out the provisions applying to the calculation of risk weighted exposure amounts.

Calculating risk weighted exposure amounts: Partial protection - tranching

BIPRU 5.7.21 R

Where a firm transfers a part of the risk of a loan in one or more tranches, BIPRU 9 applies. Materiality thresholds on payments below which no payment shall be made in the event of loss are considered to be equivalent to retained first loss positions and to give rise to a tranched transfer of risk.

[Note: BCD Annex VIII Part 3 point 86]

Calculating risk-weighted exposure amounts : The standardised approach

BIPRU 5.7.22 R

BIPRU 5.7.23 R to BIPRU 5.7.25 R set out the provisions applying to the calculation of risk weighted exposure amounts under the standardised approach in the case of unfunded credit protection.

Calculating risk weighted exposure amounts: standardised approach: Full protection

BIPRU 5.7.23 R

For the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R, g shall be the risk weight to be assigned to an exposure, the exposure value (E) of1 which is fully protected by unfunded credit protection (GA), where:

  1. (1)

    g is the risk weight of exposures to the protection provider as specified under the standardised approach;

    1
  2. (2)

    GA is the value of G* as calculated under BIPRU 5.7.17 R further adjusted for any maturity mismatch as laid down in BIPRU 5.8; and1

  3. (3)

    1E is the exposure value according to BIPRU 3.2.1 R to BIPRU 3.2.3 R and BIPRU 13; for this purpose the exposure value of an off-balance sheet item listed in BIPRU 3.7.2 R shall be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R.

    [Note: BCD Annex VIII Part 3 point 87]

Calculating risk weighted exposure amounts: Standardised approach: Partial protection - equal seniority

BIPRU 5.7.24 R

Where the protected amount is less than the exposure value and the protected and unprotected portions are of equal seniority - i.e.1 the firm and the protection provider share losses on a pro-rata basis, proportional regulatory capital relief is afforded. For the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 Rrisk weighted exposure amounts must be calculated in accordance with the following formula:

(E-GA) x r + GA x g

where:

1
  1. (1)

    E is the exposure value; according to BIPRU 3.2.1 R to BIPRU 3.2.3 R and BIPRU 13; for this purpose, the exposure value of an off-balance sheet item listed in BIPRU 3.7.2 R shall be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R;1

  2. (2)

    GA is the value of G* as calculated under BIPRU 5.7.17 R further adjusted for any maturity mismatch as laid down in BIPRU 5.8;

  3. (3)

    r is the risk weight of exposures to the obligor as specified under the standardised approach; and

  4. (4)

    g is the risk weight of exposures to the protection provider as specified under the standardised approach.

    [Note: BCD Annex VIII Part 3 point 88]

Calculating risk weighted exposure amounts: standardised approach: Sovereign guarantees

BIPRU 5.7.25 R

A firm may apply the treatment provided for in BIPRU 3.4.5 R to BIPRU 3.4.7 R to exposures or parts of exposures guaranteed by the central government or central bank, where the guarantee is denominated in the domestic currency of the borrower and the exposure is funded in that currency.

[Note: BCD Annex VIII Part 3 point 89]

Calculating risk-weighted exposure amounts and expected loss amounts: Basket CRM techniques

BIPRU 5.7.26 R

BIPRU 5.7.27 R to BIPRU 5.7.28 R set out the provisions applying to the calculation of risk weighted exposure amount and expected loss amounts where basket credit risk mitigation techniques are used.

First-to-default credit derivatives

BIPRU 5.7.27 R

Where a firm obtains credit protection for a number of exposures under terms that the first default among the exposures will trigger payment and that this credit event will terminate the contract, the firm may modify the calculation of the risk weighted exposure amount and, as relevant, the expected loss amount of the exposure which would in the absence of the credit protection produce the lowest risk weighted exposure amount under the standardised approach or the IRB approach as appropriate in accordance with BIPRU 4.10 or BIPRU 5, but only if the exposure value is less than or equal to the value of the credit protection.

[Note: BCD Annex VIII Part 6 point 1]

Nth-to-default credit derivatives

BIPRU 5.7.28 R

Where the nth default among the exposures triggers payment under the credit protection provided by a credit derivative, a firm purchasing the protection may only recognise the protection for the calculation of risk weighted exposure amounts and, as relevant, expected loss amounts if protection has also been obtained for defaults 1 to n-1 or when n-1 defaults have already occurred. In such cases the methodology must follow that set out in BIPRU 5.7.27 R for first-to-default derivatives appropriately modified for nth-to-default products.

[Note: BCD Annex VIII Part 6 point 2]

BIPRU 5.8 Maturity mismatches

BIPRU 5.8.1 R

For the purposes of calculating risk weighted exposure amounts, a maturity mismatch occurs when the residual maturity of the credit protection is less than that of the protected exposure. Protection of less than three months residual maturity, the maturity of which is less than the maturity of the underlying exposure, must not be recognised.

[Note: BCD Annex VIII Part 4 point 1]

BIPRU 5.8.2 R

Where there is a maturity mismatch the credit protection must not be recognised where the original maturity of the protection is less than 1 year.

[Note: BCD Annex VIII Part 4 point 2 (part)]

Definition of maturity

BIPRU 5.8.3 R

Subject to a maximum of 5 years, the effective maturity of the underlying is the longest possible remaining time before the obligor is scheduled to fulfil its obligations. Subject to BIPRU 5.8.4 R, the maturity of the credit protection is the time to the earliest date at which the protection may terminate or be terminated.

[Note: BCD Annex VIII Part 4 point 3]

BIPRU 5.8.4 R

Where there is an option to terminate the protection which is at the discretion of the protection seller, the maturity of the protection must be taken to be the time to the earliest date at which that option may be exercised. Where there is an option to terminate the protection which is at the discretion of the protection buyer and the terms of the arrangement at origination of the protection contain a positive incentive for the firm to call the transaction before contractual maturity, the maturity of the protection must be taken to be the time to the earliest date at which that option may be exercised; otherwise such an option may be considered not to affect the maturity of the protection.

[Note: BCD Annex VIII Part 4 point 4]

BIPRU 5.8.5 R

Where a credit derivative is not prevented from terminating prior to expiration of any grace period required for a default on the underlying obligation to occur as a result of a failure to pay the maturity of the protection must be reduced by the amount of the grace period.

[Note: BCD Annex VIII Part 4 point 5]

Valuation of protection: Transactions subject to funded credit protection - financial collateral simple method

BIPRU 5.8.6 R

BIPRU 5.8.7 R sets out the calculation for the valuation of transactions subject to funded credit protection under the financial collateral simple method.

BIPRU 5.8.7 R

Where there is a mismatch between the maturity of the exposure and the maturity of the protection, the collateral must not be recognised.

[Note: BCD Annex VIII Part 4 point 6]

Valuation of protection: Transactions subject to funded credit protection - financial collateral comprehensive method

BIPRU 5.8.8 R

BIPRU 5.8.9 R sets out the calculation for the valuation of transactions subject to funded credit protection under the financial collateral comprehensive method.

BIPRU 5.8.9 R

  1. (1)

    The maturity of the credit protection and that of the exposure must be reflected in the adjusted value of the collateral according to the following formula:

    CVAM = CVA x (t-t*)/(T-t*)

    where:

    1. (a)

      CVA is the volatility adjusted value of the collateral as specified in BIPRU 5.4.28 R or the amount of the exposure, whichever is the lowest;

    2. (b)

      t is the number of years remaining to the maturity date of the credit protection calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or the value of T, whichever is the lower;

    3. (c)

      T is the number of years remaining to the maturity date of the exposure calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or 5 years, whichever is the lower; and

    4. (d)

      t* is 0.25.

  2. (2)

    CVAM must be taken as CVA further adjusted for maturity mismatch to be included in the formula for the calculation of the fully adjusted value of the exposure (E*) set out at BIPRU 5.4.28 R.

    [Note: BCD Annex VIII Part 4 point 7]

Valuation of protection: Transactions subject to unfunded credit protection

BIPRU 5.8.10 R

BIPRU 5.8.11 R sets out the calculation for the valuation of transactions subject to unfunded credit protection.

BIPRU 5.8.11 R

  1. (1)

    The maturity of the credit protection and that of the exposure must be reflected in the adjusted value of the credit protection according to the following formula:

    GA = G* x (t-t*)/(T-t*)

    where:

    1. (a)

      G* is the amount of the protection adjusted for any currency mismatch;

    2. (b)

      GA is G* adjusted for any maturity mismatch;

    3. (c)

      t is the number of years remaining to the maturity date of the credit protection calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or the value of T, whichever is the lower;

    4. (d)

      T is the number of years remaining to the maturity date of the exposure calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or 5 years, whichever is the lower; and

    5. (e)

      t* is 0.25.

  2. (2)

    GA is then taken as the value of the protection for the purposes of BIPRU 5.7.16 R to BIPRU 5.7.25 R.

    [Note: BCD Annex VIII Part 4 point 8]

BIPRU 5.9 Combinations of credit risk mitigation in the standardised approach

BIPRU 5.9.1 R

In the case where a firm calculating risk weighted exposure amounts under the standardised approach has more than one form of credit risk mitigation covering a single exposure (e.g. a firm has both collateral and a guarantee partially covering an exposure), the firm must subdivide the exposure into parts covered by each type of credit risk mitigation tool (e.g. a part covered by collateral and a portion covered by guarantee) and the risk weighted exposure amount for each portion must be calculated separately in accordance with the provisions of the standardised approach and BIPRU 5.

[Note: BCD Annex VIII Part 5 point 1]

BIPRU 5.9.2 R

When credit protection provided by a single protection provider has differing maturities, a similar approach to that described in BIPRU 5.9.1 R must be applied.

[Note: BCD Annex VIII Part 5 point 2]