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BIPRU TP 9 Pre CRD capital requirements applying on a solo basis during 2007 and capital floors: Personal investment firms

1Application

9.1

R

This section (except BIPRU TP 9.45R) applies to a BIPRU firm that:

(1)

is a personal investment firm; and

(2)

is applying BIPRU TP 3.4R (Use of IPRU on a solo basis during 2007).

9.2

G

BIPRU TP 9.45R applies to a BIPRU firm that:

(1)

is a personal investment firm; and

(2)

applies BIPRU TP 2 (Capital floors for a firm using the IRB or AMA approaches).

Purpose of this section

9.3

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 personal investment firm this involves applying the credit risk requirements in chapter 13 of IPRU(INV). This section explains how this is done. In particular this section explains:

(1)

which parts of chapter 13 should be treated as credit risk requirements for this purpose;

(2)

what parts of chapter 13 apply during 2007 and what changes are made to chapter 13 for that purpose; and

(3)

what changes are made to GENPRU and BIPRU to reflect the fact that chapter 13 applies in place of parts of GENPRU and BIPRU.

9.4

G

This section also explains how the obligation in BIPRU TP 2 (Capital floors for a firm using the IRB or AMA approaches) is applied to a personal investment firm.

Duration of transitional

9.5

R

This section applies until 1 January 2008.

Drafting approach in this section

9.6

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 firm should slot the credit risk requirements of chapter 13 of IPRU(INV) into the general requirements of GENPRU and BIPRU.

9.7

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 9.6G involves finding equivalents for these three elements in chapter 13 where possible.

9.8

G

The general approach to calculating the capital requirements for credit risk in GENPRU and BIPRU is to calculate the overall credit risk capital requirement (which is the sum of the three components listed in BIPRU TP 9.7G) - a monetary amount - and to compare it with capital resources, also a monetary amount. 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.

9.9

G

The drafting approach of chapter 13 to calculating the capital requirement for credit risk is different from the one in GENPRU and BIPRU. A firm calculates financial resources by adjusting the assets in the balance sheet, taking into account liabilities. Financial resources are then used to test compliance with an own funds test, an expenditure based requirement test and a net asset test. The equivalent of a credit risk charge in Chapter 13 is the deduction of an asset as an Illiquid Adjustment or the deduction of a portion of an asset calculated using the Counterparty Risk Adjustment. Both illiquid assets and material holdings in credit institutions, investment firms and insurers are deducted under Chapter 13.

9.10

G

To make the GENPRU and BIPRU requirements compatible with chapter 13 for the purpose of BIPRU TP 3 (Pre CRD capital requirements applying on a solo basis during 2007), this section takes the approach in BIPRU TP 9.11G to BIPRU TP 9.18G.

9.11

G

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

9.12

G

The chapter 13 Illiquid Adjustment and the chapter 13 Counterparty Risk Adjustment are used to calculate the BIPRU credit risk charge for non-trading book items (called the credit risk capital component) and the BIPRU credit risk charge for trading book items (called the counterparty risk capital component).

9.13

G

When this section requires a firm to apply an Illiquid Adjustment to an asset a firm should apply a credit risk charge to that asset equal to the amount of the Illiquid Adjustment under Chapter 13 and include that charge in the calculation of the total credit risk charge. The amount of that credit risk charge will generally be equal to the amount of that asset. This is equivalent to a deduction from capital. A firm should not apply an Illiquid Adjustment to the extent that the asset has already been included as an illiquid asset or material holding and deducted from capital resources under GENPRU 2.2.

9.14

G

The Chapter 13 Position Risk Adjustment no longer applies. If a firm has a trading book, an item in the trading book that would have received a Position Risk Adjustment is subject to a capital charge under BIPRU 7 (Market risk). An item in a firm's non-trading book that would have received a Position Risk Adjustment is subject under this section to an Illiquid Adjustment. A firm should approach its usual supervisory contact at the FSA if it believes that this treatment is disproportionate.

9.15

G

When this section requires a firm to apply a Counterparty Risk Adjustment to an asset a firm should apply a credit risk charge to that asset equal to the amount of the Counterparty Risk Adjustment under Chapter 13 and include that charge in the calculation of the total credit risk charge. The amount of that credit risk charge will generally be equal to the amount of that asset multiplied by the percentage in Table 13.5.4B or 13.5.4C. A firm should not apply a Counterparty Risk Adjustment to the extent that the asset has already been included as an illiquid asset or material holding and deducted from capital resources under GENPRU 2.2.

9.16

G

All non-trading book items are excluded under IPRU(INV) 13.8. This exclusion is incorporated in the calculations under this section as a credit risk charge of 100%. IPRU(INV) 13.8 does not apply if the firm does not have a trading book.

9.17

G

The calculation of the capital requirements for credit risk in GENPRU and BIPRU is based on applying a capital charge to the firm's assets. The credit risk charge in GENPRU and BIPRU in broad terms reflects the risk to a firm that it will suffer loss because its counterparties do not pay what they owe to the firm. Thus generally it is not necessary to continue the requirement in Table 13.5.4 to deduct liabilities. However it is still necessary to include other liabilities deducted as part of the calculation of financial resources under Chapter 13 if they are of the type listed in section 4 of Chapter BC of IPRU(BANK). This is because the Directive provisions that allow pre-2007 credit risk requirements to be used during 2007 require a capital charge for this type of item. In practice it is unlikely that these items will be relevant to a personal investment firm except for guarantees.

9.18

G

The chapter 13 Large exposure Adjustment is used to calculate the concentration risk capital component. This is only relevant to a firm with a trading book.

Parts of chapter 13 of IPRU(INV) that apply in 2007

9.19

R

The parts of chapter 13 of IPRU(INV) that do and do not apply during the period that BIPRU TP 3.4R applies are set out in BIPRU TP 9.21R.

9.20

G

The table in BIPRU TP 9.21R assumes that the firm is not applying the IRB approach. BIPRU TP 9.41R to BIPRU TP 9.44R deal with a firm that does apply the IRB approach.

9.21

R

Table: Parts of chapter 13 of IPRU(INV) that apply in 2007

This table belongs to BIPRU TP 9.19R

Chapter 13 rule

A Y denotes that the provision does apply

An N denotes that it does not apply

Remarks

13.1 (Application)

N

BIPRU TP 9.1R and BIPRU TP 9.2R apply instead

13.1.2 (General requirements)

N

13.1.3 to 13.1.6 (Professional Indemnity insurance)

N

13.1.7 to 13.1.9 (Notification)

N

13.1.10 to 13.1.17 (Record keeping)

N

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

13.2 (Financial Resources Tests)

N

13.3 (Financial Resources Test 1 - Own funds)

N

13.4 (Financial resources Test 1A - Adjusted net current assets)

N

13.5.1R to 13.5.3AG (Expenditure-based Requirement)

N

13.5.4 (Calculation of financial resources to meet Tests 1, 1A or 2)

Y

Only applies for the purpose of deciding whether Table 13.5.4(1) or Table 13.5.4(2) applies

13.5.4A (Obligation to identify trading book items and special adjustments)

Y

Does not apply to special adjustments that do not apply under this section

Part I of Tables 13.5.4(1) and (2) (Net assets requirement for firms in Category A): (Assets calculation)

Illiquid Adjustment

Y

See BIPRU TP 9.23R to BIPRU TP 9.26G

Counterparty Risk Adjustment

Y

See BIPRU TP 9.23R to BIPRU TP 9.31G

Position Risk Adjustment

N

If an exposure in the non-trading book would have been subject to a Position Risk Adjustment a firm must apply an Illiquid Adjustment to it.

Large exposure Adjustment

Y

See BIPRU TP 9.34R

Part II of Tables 13.5.4(1) and (2) (Net assets requirement for firms in Category A): (Liabilities calculation)

Counterparty Risk Adjustments

Y

See BIPRU TP 9.23R to BIPRU TP 9.31G

Liabilities if they are listed in section 4 of Chapter BC of IPRU(BANK) and are in the firm's non-trading book

Y

(1) This applies whether they are on or off balance sheet.

(2) A firm must include liabilities under a credit derivative.

(3) See BIPRU TP 9.23R

Position Risk Adjustment

N

If an exposure in the non-trading book would have been subject to a Position Risk Adjustment a firm must apply an Illiquid Adjustment to it.

The rest

N

Table 13.5.4A (Position risk)

N

Table 13.5.4B (Unsettled securities transactions)

N

See BIPRU TP 9.28R

Table 13.5.4C (Counterparty risk)

Y

See BIPRU TP 9.23R to BIPRU TP 9.31G

Table 13.5.4D (Over the counter derivatives)

Y

See BIPRU TP 9.26G and BIPRU TP 9.30R to BIPRU TP 9.31G

Table 13.5.4E (Foreign exchange risk)

N

13.5.5 to 13.5.5C (Subordinated debt)

N

13.6 (Large exposures)

Y

See BIPRU TP 9.32R to BIPRU TP 9.34R

13.7 (Consolidated Supervision of Group Companies)

N

13.8 (Trading book)

Table 13.8(1) (Definition of trading book)

N

The rest

Y

See BIPRU TP 9.23R and BIPRU TP 9.38R

13.9 to 13.9.12 (Financial resources tests for Category B firms)

N

Glossary for chapter 13

Y

See BIPRU TP 9.38R

Categorisation

9.22

R

Each firm is a Category A firm for the purposes of chapter 13 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 13 Illiquid Adjustment and the Counterparty Risk Adjustment

9.23

R

A firm must calculate the sum of the credit risk capital component and the counterparty risk capital component as being equal to the sum of the following:

(1)

the amount of the Illiquid Adjustments under chapter 13 of IPRU(INV) so far as they are in force under BIPRU TP 9.21R;

(2)

the amount of any non-trading book assets that would be excluded under rule 13.8.2 of chapter 13 of IPRU(INV) (exclusion of non-trading book items from financial resources calculations);

(3)

the amount in relation to unsettled securities transactions (Cash against documents) specified in BIPRU TP 9.28R;

(4)

the amount in relation to unsettled securities transactions (Free deliveries) specified in BIPRU TP 9.29R;

(5)

the amount of the Counterparty Risk Adjustments under whichever is applicable of point 22 of Part II of Table 13.5.4(1) and point 22 of Part II of Table 13.5.4(2) of chapter 13 of IPRU(INV) (Liabilities adjustments relating to OTC derivatives for calculating financial resources);

(6)

the amount of the other Counterparty Risk Adjustments under whichever is applicable of Part I of Table 13.5.4(1) and Part I of Table 13.5.4(2) of chapter 13 of IPRU(INV) (Assets adjustments for calculating financial resources); and

(7)

the amount of any other liabilities under whichever is applicable of Part II of Table 13.5.4(1) and Part II of Table 13.5.4(2) of chapter 13 of IPRU(INV) but only to the extent provided by BIPRU TP 9.21R.

9.24

R

A firm must not apply a credit risk charge to an exposure under BIPRU TP 9.23R to the extent that it has already been deducted as an illiquid asset or a material holding under GENPRU 2.2 (Capital resources).

9.25

R

If it is necessary to distinguish between the credit risk capital component and the counterparty risk capital component a firm must allocate:

(1)

any amount calculated for an exposure in the non-trading book to the credit risk capital component; and

(2)

any amount calculated for an exposure in the trading book to the counterparty risk capital component.

9.26

G

A firm may still apply the netting provisions for OTC derivatives in chapter 13 even though the OTC derivative calculation is split between the credit risk capital component and the counterparty risk capital component under BIPRU TP 9.25R. The net amount should be allocated to the credit risk capital component if the gross value of the non-trading book derivatives is bigger and to the counterparty risk capital component if the gross value of the trading book derivatives is bigger.

Adjustments to the Counterparty Risk Adjustments calculations: General

9.27

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 9.28R to BIPRU TP 9.31G is to reflect those cases in which the Directive requires the new requirements to apply from 1 January 2007.

Adjustments to the Counterparty Risk Adjustments calculations: Unsettled Securities Transactions

9.28

R

(1)

The calculation of the credit risk charge for unsettled securities transactions is based on the Counterparty Risk Adjustment for such transactions adjusted in accordance with this rule.

(2)

Subject to the rest of this rule, the amount of the credit risk charge is equal to the Counterparty Risk Adjustment under paragraphs (a) and (b) in the unsettled securities transactions sections of Table 13.5.4(1) or (2).

(3)

The credit risk charge applies where the firm is exposed to loss if the counterparty does not perform.

(4)

A firm must calculate the Counterparty Risk Adjustment for an unsettled securities transaction in the trading book under BIPRU 14.3 (Unsettled transactions) rather than under chapter 13 of IPRU(INV).

Adjustments to the Counterparty Risk Adjustments calculations: Free deliveries

9.29

R

(1)

The calculation of the credit risk charge for a free delivery is based on the Counterparty Risk Adjustment for such transactions adjusted in accordance with this rule.

(2)

Subject to the rest of this rule, the amount of the credit risk charge is equal to the Counterparty Risk Adjustment under paragraphs (a) and (b) in the free delivery sections of Table 13.5.4(1) or (2).

(3)

A firm must include foreign currency and commodity for the purpose of trading book calculations.

(4)

The capital treatment in the table in BIPRU 14.4.3 R (Capital treatment for free deliveries) applies for the purpose of trading book calculations. But when the capital treatment in that table is that the firm must treat the transaction as an exposure, the firm must calculate a credit risk charge equal to the amount in (2).

Adjustments to the Counterparty Risk Adjustments calculations: Derivative transactions

9.30

R

A firm must treat a credit derivative in the trading book as a derivative to which paragraph 22 of Part II of Table 13.5.4(1), paragraph 22 of Part II of Table 13.5.4(2) and table 13.5.4D of chapter 13 of IPRU(INV) (Over the counter derivatives) apply.

9.31

G

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

How to use the chapter 13 large exposure rules

9.32

R

Section 13.6 of chapter 13 of IPRU(INV) (Large exposures) applies in place of BIPRU 10 (Concentration risk).

9.33

R

The following adjustments are made to section 13.6 of chapter 13 of IPRU(INV) (Large exposures):

(1)

BIPRU 10.5.2 R to BIPRU 10.5.5 R (Capital resources for concentration risk purposes) apply in place of the definition of own funds that applies under section 13.6 of chapter 13 of IPRU(INV);

(2)

rule 13.6.2B (Excess over EBR should not be excluded) does not apply; and

(3)

BIPRU 10.5.14 R (Notification) applies instead of the notification requirement in 13.6.

9.34

R

A firm must calculate its concentration risk capital component as being equal to the sum of the Large exposure Adjustments under whichever is applicable of Part I of Table 13.5.4(1) and Part I of Table 13.5.4(2) of chapter 13 of IPRU(INV) (Assets adjustments for calculating financial resources).

Specific risk calculations

9.35

R

A firm must calculate the specific risk portion of the interest rate PRR in accordance with BIPRU TP 8.29R (Pre CRD interest rate PRR for securities and futures firms).

9.36

R

Any reference to a qualifying debt security in a part of BIPRU that applies during 2007 must be interpreted in accordance with the definition in the Glossary to chapter 13 of IPRU(INV). However BIPRU 7.2.50 R (Must not apply qualifying debt security treatment to risky assets) also applies. Any reference to a 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).

9.37

R

The reason for BIPRU TP 9.35R and BIPRU TP 9.36R 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. However chapter 13 does not distinguish between specific risk and general market risk. The nearest equivalent is in chapter 10 of IPRU(INV) (Securities and futures firms). The definition of qualifying equity also depends in part on the standardised approach to credit risk.

Definitions

9.38

R

The definition of trading book is replaced with the definition in the Glossary. Section 13.8 of chapter 13 of IPRU(INV) (Trading book) and the definition in the Glossary to chapter 13 are amended accordingly.

Mapping GENPRU and BIPRU concepts onto IPRU

9.39

G

Some of the parts of chapter 13 of IPRU(INV) that apply in 2007 refer to parts of chapter 13 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 chapter 13 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 9.40G sets out how certain concepts in chapter 13 of IPRU(INV) correspond to ones in GENPRU and BIPRU. The purpose of the table is to help firms to interpret such cross-references.

9.40

G

Table: Mapping GENPRU and BIPRU concepts onto ones in chapter 13 of IPRU(INV)

This table belongs to BIPRU TP 9.39G

GENPRU and BIPRU

Chapter 13 of IPRU(INV)

See BIPRU TP 9.10G to BIPRU TP 9.17G

Illiquid Adjustment

See BIPRU TP 9.10G to BIPRU TP 9.17G

Counterparty Risk Adjustment

See BIPRU TP 9. 18G

Large exposure Adjustment

Material holding

The nearest equivalent is point 13 of Part I of Table 13.5.4(1) and (2) (All other assets)

Unsettled transaction under BIPRU 14.3

Cash against documents

Free deliveries under BIPRU 14.4

Free deliveries

Market risk capital requirement

The Position Risk Adjustment and the Foreign Exchange Risk Adjustment

Trading book concentration risk excess

Excess X in Table 13.6.2(2)

A firm should use the specific risk portion of the relevant PRR charge under BIPRU 7 (Market risk) (subject to the other provisions of this section about specific risk) where Chapter 13 as applied by this section requires the firm to apply position risk discounts.

Position risk discounts (particularly relevant for the purposes of Table 13.6.2(2))

Risk weight

Where Chapter 13 requires an asset to be deducted from capital that is equivalent to applying a risk weight of 1250%. Applying the 1.6% adjustment under Table 13.5.4C is equivalent to applying a 20% risk weight under BIPRU together with the standard 8% BIPRU credit risk charge. The "NIL" adjustment under that table is equivalent to applying a 0% risk weight.

Firms using the IRB approach during 2007: General

9.41

R

BIPRU TP 9.42G to BIPRU TP 9.44R 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.

9.42

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 the Counterparty Risk Adjustments do not 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. The same applies to the Illiquid Adjustments although illiquid assets or material holdings will still have to be deducted under GENPRU 2.2 (Capital resources).

9.43

A firm must apply BIPRU 7.2.45 R - BIPRU 7.2.47 R (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.

9.44

R

The definition 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.

Calculation of capital floors under BIPRU TP 2

9.45

R

(1)

This paragraph sets out how the obligation in BIPRU TP 2 (Capital floors for a firm using the IRB or AMA approaches) is applied to a personal investment firm.

(2)

A firm must apply Financial Resources Test 2 (Expenditure-based Requirement) for the periods specified in BIPRU TP 2 by multiplying the Expenditure-based Requirement by the percentage figure in BIPRU TP 2.8R or BIPRU TP 2.9R.

(3)

BIPRU TP 2 does not apply to Financial Resources Test 1 (Own funds) or Financial Resources Test 1A (Adjusted net current assets).