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BIPRU TP 8 Pre CRD capital requirements applying on a solo basis during 2007: Securities and futures firms

1Application

8.1

R

This section applies to a BIPRU firm that is:

(1)

a securities and futures firm; and

(2)

is applying BIPRU TP 3.4R (Pre CRD capital requirements applying on a solo basis during 2007).

Purpose of this section

8.2

G

BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007) says that during 2007 a firm may apply the credit risk requirements of IPRU instead of the ones in BIPRU. For a securities and futures firm this involves applying the credit risk requirements in chapter 10 of IPRU(INV). BIPRU TP 8 explains how this is done. In particular this section explains:

(1)

which parts of chapter 10 should be treated as credit risk requirements for this purpose;

(2)

what parts of chapter 10 apply during 2007 and what changes are made to chapter 10 for that purpose; and

(3)

what changes are made to GENPRU and BIPRU to reflect the fact that chapter 10 applies in place of parts of GENPRU and BIPRU.

Duration of transitional

8.3

R

BIPRU TP 8 applies until 1 January 2008.

Drafting approach in this section

8.4

G

The purpose of BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007) is that the basic provisions of BIPRU and GENPRU should be in force from 1 January 2007. However a firm should be able to calculate the capital requirements for credit risk under IPRU and use the large exposures requirements in IPRU. This means that a securities and futures firm should slot the credit risk requirements of chapter 10 of IPRU(INV) into the general requirements of GENPRU and BIPRU. A firm that applies BIPRU TP 3.4R should not use chapter 3 as the source of its pre-2007 credit risk requirements even if it was subject to chapter 3 before becoming a BIPRU investment firm.

8.5

G

The capital calculation for credit risk under BIPRU is made up of three elements, which are set out in GENPRU 2.1.51 R (Calculation of the credit risk capital requirement). These are the credit risk capital component, the counterparty risk capital component and the concentration risk capital component. So the approach in BIPRU TP 8.4G involves finding equivalents for these three elements in chapter 10 where possible.

8.6

G

Under GENPRU and BIPRU a firm calculating its capital resources may usually choose between deducting illiquid assets and material holdings. Only if it has a waiver from consolidated supervision need it deduct both. This broadly corresponds to the approach in calculating financial resources under Tables 10-62(2)A to 10-62(2)C.

8.7

G

The financial resources requirements calculations under chapter 10 depend in part on which of the financial resources calculations in Tables 10-62(2)A to 10-62(2)C a firm uses. Where this is the case the firm should use the requirements calculation associated with the version of the tables in 10-62(2) that corresponds to the capital resources calculation the firm uses under GENPRU 2.2 (Capital resources). BIPRU TP 8.33G explains how the capital resources calculations in GENPRU 2.2 map onto Tables 10-62(2)A to 10-62(2)C.

8.8

G

(1)

To make the GENPRU and BIPRU requirements compatible with chapter 10 for the purpose of BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007), this section takes the approach in this paragraph.

(2)

The illiquid assets and material holdings provisions of GENPRU 2.2 (Capital resources) apply.

(3)

The 8% illiquid asset adjustment under IPRU(INV) 10-65 applies to a firm calculating its financial resources under Table 10-62(2)A. It is equivalent to a capital charge for credit risk under BIPRU. Therefore a firm using the capital resources calculation in GENPRU that corresponds to Table 10-62(2)A (GENPRU 2 Annex 4 R (Capital resources table for a BIPRU investment firm deducting material holdings)) should continue to apply that adjustment. It should be included as part of the non-trading book credit risk charge in BIPRU, which is called the credit risk capital component.

(4)

A 100% illiquid asset adjustment under IPRU(INV) 10-65 is equivalent to a deduction of illiquid assets under GENPRU 2.2 (Capital resources). Therefore a firm should not use this adjustment. This is because, as explained in (2), the illiquid assets provisions in GENPRU 2.2 apply. Any item that would have been caught by IPRU(INV) 10-65 but is not caught by the illiquid assets deduction under GENPRU 2.2 should be dealt with under IPRU(INV) 10-66.

(5)

The IPRU(INV) 10-66 liquidity adjustment covers any asset that has not been subject to a liquidity adjustment for illiquid assets under IPRU(INV) 10-65. Therefore (subject to (3)) a firm should calculate the credit risk capital component (the non-trading book credit charge in BIPRU) by applying IPRU(INV) 10-66 to any asset not deducted as an illiquid assets under GENPRU 2.2 (Capital resources).

(6)

The chapter 10 counterparty risk requirement is used to calculate the BIPRU credit risk charge for trading book items, called the counterparty risk capital component.

(7)

The chapter 10 LER calculation is used to calculate the concentration risk capital component.

Parts of chapter 10 of IPRU(INV) that apply in 2007

8.9

R

The parts of chapter 10 of IPRU(INV) that do and do not apply during the period that BIPRU TP 3.4R applies are as set out in BIPRU TP 8.11R.

8.10

G

The table in BIPRU TP 8.11R assumes that the firm is not applying the IRB approach. BIPRU TP 8.35R to BIPRU TP 8.38R deal with a firm that does apply the IRB approach.

8.11

R

Table: Parts of chapter 10 of IPRU(INV) that apply in 2007

This table belongs to BIPRU TP 8.9R

Chapter 10 rule

A Y denotes that the provision does apply

An N denotes that it does not apply

Remarks

10-A (Application of Chapter 10 Glossary)

Y

See BIPRU TP 8.32R

10-B (Application)

N

BIPRU TP 8.1R applies instead

10.10 to 10.12 (Record keeping and Reconciliations)

N

Applied in part under BIPRU TP 23 (Record keeping transitionals)

10-32 (Defaulting repo counterparty and LE Notification Requirements)

N

10-41 (Repo and Valuation)

N

10-60 to 10-63 (Initial Capital and Financial Resources)

N

10-64 to 10-68 (Liquidity Adjustments, Charged Assets and Contingent Liabilities)

10-64(2) (Intangible assets)

N

GENPRU 2.2 (Capital resources) applies instead

10-65(12) (Material holdings)

N

GENPRU 2.2 applies instead

The rest

Y

See BIPRU TP 8.13R to BIPRU TP 8.19G. The requirement in 10-64(1)(c) for an illiquid asset adjustment for commodities to be calculated under appendix 6 (the PRR charge for commodities) does not apply

10-69 (Deficiencies in subsidiaries)

N

10-70 (Calculation of financial resources requirement)

N

10-71 (Primary requirement)

N

10-72 (Base requirement)

N

10-73 (Expenditure requirement)

N

10-74 (Secondary requirement)

Y

BIPRU TP 3.10R and the table in BIPRU TP 8.34G explain how the terms used in rule 10-74 are to be interpreted

10-80 to 10-120 (PRR)

N

But see BIPRU TP 8.29R to BIPRU TP 8.31G

10-170 to 10-176 (CRR)

10-170(3) and (9) (Valuation) and 10-173(8) (Daily valuation)

N

The rest

Y

See BIPRU TP 8.20R to BIPRU TP 8.25R

10-190 to 10-196 (Large exposures)

10-190(1) (Application)

N

BIPRU TP 10 (Pre CRD capital requirements applying on a consolidated basis during 2007) deals with consolidation

The rest

Y

See BIPRU TP 8.26R to BIPRU TP 8.28R

10-200 to 10-204 (Consolidated supervision)

N

10-300 (ACMPs)

Y

Applies to the extent relevant to the parts of chapter 10 that apply under BIPRU TP 8

Appendix 1 (Glossary of Terms for IPRU(INV) 10)

Y

See BIPRU TP 8.32R

Appendices 4 to 11 (PRR)

Appendix 4 43R to 47R (Specific risk portion of the interest rate PRR)

Y

The rest of Appendices 4 to 11

N

Appendix 20 (Guidance notes on reconciliation of firm's balances with a counterparty which is a member of an exchange (rule 10-11(4))

N

Appendix 21 (Note on the valuation of positions)

N

Appendix 43 (Guidance note on the financial resources and accounting treatment of soft commission agreements (rule 10-73 and 10-175))

Y

Applies so far as relevant to CRR

Appendix 47 (Counterparty weights to be applied in calculating liquidity adjustment and CRR (rules 10-64 to 10-68, and 10-172 to 10-176))

Y

Appendix 48 (Securities and Futures firms: Guidance notes on the secondary requirement)

Y

Appendix 55 (Guidance notes on the application of adequate collateral or acceptable collateral to reduce counterparty exposures)

Y

Appendix 56 (Guide to Adequate Credit Management Policy (ACMP) (rules 10-172 to 10-175, 10-300 and "ACMP"))

Y

See remarks for 10-300

Appendix 57 (List of exchanges and clearing houses recognised for the purposes of IPRU(INV))

Y

Appendix 58 (Verification of interim profits by external auditors)

N

Appendix 59 (List of regulators for the purposes of the definition of recognised third country investment firms)

Y

Appendix 62 (Netting)

Y

Appendix 63 (Guidance on Credit derivatives)

Y

(1) Applies so far as relevant to CRR.

(2) Applies so far as relevant to liquidity adjustments.

(3) Does not apply so far as relevant to the PRR.

(4) If the firm is the protection seller in relation to a credit derivative in the non-trading book it must apply the treatment in IPRU(BANK).

Categorisation

8.12

R

Each firm is a Category A firm for the purposes of chapter 10 of IPRU(INV) as applied by BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007) and this section.

How to use the chapter 10 liquidity adjustment rules

8.13

R

A firm must calculate the credit risk capital component by adding together the deductions under the liquidity adjustment rules that apply under BIPRU TP 8.11R.

8.14

R

The 100% liquidity adjustment in IPRU(INV) 10-65 (Liquidity adjustment on illiquid assets) does not apply.

8.15

G

The reason for BIPRU TP 8.14R is explained in BIPRU TP 8.8G.

8.16

R

IPRU(INV) 10-65 (Illiquid assets) only applies to a firm calculating capital resources under GENPRU 2 Annex 4 R (Capital resources table for a BIPRU investment firm deducting material holdings).

8.17

G

The reason for BIPRU TP 8.16R is explained in BIPRU TP 8.8G.

8.18

R

A firm must calculate the credit risk charge for commodities in the non-trading book as a liquidity adjustment under IPRU(INV) 10-64(1)(c) in accordance with the CRR rules in Chapter 10. A firm must include that amount in the calculation of the credit risk capital component.

8.19

G

A firm may still apply the CRR netting provisions for commodities in chapter 10 even though the calculation is split between the credit risk capital component and the counterparty risk capital component under BIPRU TP 8.18R and BIPRU TP 8.20R. The net amount should be allocated to the credit risk capital component if the gross value of the non-trading book commodities is bigger and to the counterparty risk capital component if the gross value of the trading book commodities is bigger.

How to use the chapter 10 CRR rules

8.20

R

Subject to BIPRU TP 8.18R, a firm must calculate the counterparty risk capital component as being equal to the capital charge under the CRR rules that apply under BIPRU TP 8.11R.

Adjustments to the CRR calculations: General

8.21

G

Broadly speaking the Directive transitional provisions that allow pre-2007 credit risk rules to be used in 2007 cover all credit risk rules. However the transitional provisions for trading book credit risk (Annex II of the Capital Adequacy Directive, which is implemented in BIPRU 14 (Capital requirements for settlement and counterparty risk)) is not quite as straightforward as that. In some cases pre-2007 requirements can be used. In others they cannot. The purpose of BIPRU TP 8.22R to BIPRU TP 8.25R is to reflect those cases in which the Directive requires the new requirements to apply from 1 January 2007.

Adjustments to the CRR calculations: Free deliveries

8.22

R

(1)

The calculations under rule 10-172 of IPRU(INV) (Free deliveries) are amended in accordance with this rule.

(2)

A firm must include foreign currency transactions.

(3)

The capital treatment in the table in BIPRU 14.4.3 R (Capital treatment for free deliveries) applies. But when the capital treatment in that table is that the firm must treat the transaction as an exposure, the firm must apply the treatment in rule 10-172 rather than BIPRU 14 (Capital requirements for settlement and counterparty risk).

Adjustments to the CRR calculations: Derivative transactions

8.23

R

A firm must treat a credit derivative in the trading book as a derivative to which rule 10-174 of IPRU(INV) (Derivative transactions) applies.

8.24

G

The capital treatment for credit derivatives set out in BIPRU 14.2.5 R - BIPRU 14.2.8 R (Capital treatment for credit derivatives) does not apply.

Adjustments to the CRR calculations: Cash against documents

8.25

R

A firm must include foreign currency transactions in the calculations under 10-171 of chapter 10 of IPRU(INV) (Cash against documents transactions).

How to use the chapter 10 large exposure rules

8.26

R

10-190 to 10-196 of chapter 10 of IPRU(INV) (Large exposures requirement) apply in place of BIPRU 10 (Concentration risk).

8.27

R

A firm must calculate the concentration risk capital component as being equal to the capital charge under the LER rules that apply under BIPRU TP 8.11R.

8.28

R

BIPRU 10.5.2 R to BIPRU 10.5.5 R (Capital resources for concentration risk purposes) apply in place of the corresponding provisions of chapter 10.

Specific risk calculations

8.29

R

A firm must use chapter 10 of IPRU(INV) as it applies under BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007) and this section to calculate the specific risk portion of the interest rate PRR under BIPRU 7.2 (Interest rate PRR) to the extent that the relevant rules in BIPRU 7.2 require the use of the standardised approach to credit risk.

8.30

R

Any reference to a qualifying debt security or qualifying equity in a part of BIPRU that applies during 2007 must be interpreted in accordance with the definition in the Glossary to chapter 10 of IPRU(INV). However BIPRU 7.2.50 R (Must not apply qualifying debt security treatment to risky assets) also applies.

8.31

G

The effect of BIPRU TP 8.29R and BIPRU TP 8.30R is that a firm should apply rules 43R to 47R of Appendix 4 of Chapter 10 of IPRU(INV) (Specific risk portion of interest rate PRR) instead of BIPRU 7.2.43 R to BIPRU 7.2.49 R (Specific risk portion of interest rate PRR). The reason for this is that the calculation of the specific risk portion of the interest rate PRR under BIPRU 7 (Market risk) involves the use of the standardised approach to credit risk. The specific risk rules therefore need to be adjusted for a firm that is not using the standardised approach to credit risk in 2007 so as to apply the pre-2007 method of calculating specific risk. The definition of qualifying equity also depends in part on the standardised approach to credit risk.

Definitions

8.32

R

The definitions of trading book, non-trading book, commodity, financial institution, illiquid asset and material holding in the Glossary to chapter 10 of IPRU(INV) are replaced by the corresponding definitions in the Glossary.

Mapping GENPRU and BIPRU concepts onto IPRU

8.33

G

Some of the parts of chapter 10 of IPRU(INV) that apply in 2007 refer to parts of IPRU that do not apply. BIPRU TP 3.10R explains that where this happens a firm should interpret that cross-reference in accordance with the provision in BIPRU or GENPRU that corresponds to the IPRU provision that does not apply in 2007. A firm should refer to IPRU in the case of cross-references in GENPRU and BIPRU to provisions in GENPRU and BIPRU that do not apply in 2007. BIPRU TP 8.34G sets out how certain concepts in chapter 10 of IPRU(INV) correspond to ones in GENPRU and BIPRU. The purpose of the table is to help firms to interpret such cross-references.

8.34

G

Table: Mapping GENPRU and BIPRU concepts onto ones in chapter 10 of IPRU(INV)

This table belongs to BIPRU TP 8.33G

GENPRU and BIPRU

Chapter 10 of IPRU(INV)

Calculations of counterparty risk capital component and calculations under BIPRU 14 (Capital requirements for settlement and counterparty risk)

Calculation of CRR

Illiquid asset

Illiquid asset

Deduction from capital resources as an illiquid assets

100% liquidity adjustment

Calculation of the credit risk capital component

8% liquidity adjustment

Concentration risk capital component

LER

Unsettled transaction under BIPRU 14.3

Cash against documents (IPRU(INV) 10-171)

Free deliveries under BIPRU 14.4

Free deliveries (IPRU(INV) 10-172)

Calculation of PRR or of the market risk capital requirement

Calculation of PRR and the foreign exchange requirement

Capital resources calculations under GENPRU 2 Annex 4 R

Financial resources calculation under table 10-62(2)A

Capital resources calculations under GENPRU 2 Annex 6 R

Financial resources calculation under table 10-62(2)B

Capital resources calculations under GENPRU 2 Annex 5 R respectively

Financial resources calculation under table 10-62(2)C

Investment firm consolidation waiver

Exemption from consolidated supervision

Commodity extended maturity ladder approach

Modified maturity ladder approach (relevant to the CRR calculation - see 10-174)

The table in BIPRU 7.8.28 R (Net underwriting position reduction factors)

Table 27R of Appendix 7 (Net underwriting position reduction factors)

Consolidated supervision in accordance with rules 10-200 to 10-203 (see for example the reference in rule 10-192(1)(g))

Consolidated supervision under BIPRU 8 (Group risk - consolidation)

Initial capital

Initial capital

Tier one capital resources plus tier two capital resources after deductions (stage N of the capital resources table)

Own funds

Capital resources

Financial resources (as referred to for example in rule 10-74)

Externally verified interim net profits and losses and partners' capital as referred to in GENPRU 2.2.102 R

Interim profit and loss account (as referred to in rule 10-74)

Trading book concentration risk excess

Excess D under rule 10-194(3)

Risk weight

Counterparty weight.

Firms using the IRB approach during 2007: General

8.35

R

BIPRU TP 8.36G to BIPRU TP 8.38R only apply to a firm that is applying the IRB approach under BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007) as well as using IPRU.

8.36

G

The effect of BIPRU TP 3.17G (Pre CRD capital requirements applying on a solo basis during 2007 for firms also using the IRB approach) is that neither the illiquid asset adjustment nor the CRR requirements of chapter 10 apply to an exposure to which the firm applies the IRB approach. The IRB approach requirements in BIPRU apply instead. The main requirements are listed in BIPRU TP 3.17G.

8.37

R

A firm must apply BIPRU 7.2.45 R - 7.2.47R (Using internal ratings to calculate specific risk and treatment of securitisations) to calculate the specific risk portion of the interest rate PRR to the extent that the obligor or exposure in question comes within the scope of its IRB permission.

8.38

R

The definitions of qualifying debt security and qualifying equity in the Glossary apply if the security or obligor in question comes within the scope of a firm's IRB permission.