The Prudential Regulation Authority is consulting on its expectations regarding the eligibility of guarantees as unfunded credit protection for the purposes of a firm's Pillar 1 regulatory capital requirements. The PRA is intending to add a new section to the Supervisory Statement 'Credit risk mitigation'.
The EU Capital Requirements Regulation allows firms to recognize certain forms of credit risk mitigation when calculating their regulatory capital requirements. Unfunded credit protection can be attained through a guarantee where a third party becomes obliged to pay out in the event of non-payment or default of the credit obligor. The CRR sets out the eligibility criteria for a guarantee to qualify for CRM.
The PRA is seeking to clarify which contracts and obligations meet the CRR eligibility criteria so that capital relief from guarantees is obtained only where the risk has been effectively transferred to the guarantor. The consultation paper sets out the PRA's proposed guidance on some of the eligibility criteria, namely, the criteria that stipulate that the guarantee must:
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be legally effective and enforceable in all relevant jurisdictions and supported by an independent, written and reasoned legal opinion;
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be clearly defined and incontrovertible;
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not include any clauses, the fulfilment of which is outside the direct control of the lender, that could render the contact ineligible for CRM; and
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cover all types of payments the obligor is expected to make.
The proposed guidance relates to the recognition of guarantees for capital relief under the substitution approach available to exposures on the standardized approach and foundation internal ratings based approach. Guarantees recognized under the advanced internal ratings based approach are out of scope of the consultation.
The PRA is seeking feedback on the proposals, in particular, the nature of existing guarantee arrangements for CRM and the impact of the proposals on a firm's existing CRM practices. The consultation closes on May 16, 2018.
View the consultation paper.
View the existing Supervisory Statement 'Credit risk mitigation'(SS 17/13).
