Credit risk mitigation: Eligibility of financial collateral

Policy Statement 14/19 | Consultation Paper 1/19

Published 23 July 2019

Credit risk mitigation: Eligibility of financial collateral – PS14/19

Overview

This Prudential Regulation Authority (PRA) Policy Statement (PS) provides feedback to responses to Consultation Paper (CP) 1/19 ‘Credit risk mitigation: Eligibility of financial collateral’. It contains the updated Supervisory Statement (SS) 17/13 ‘Credit risk mitigation’ (Appendix).

This PS is relevant to UK banks, building societies and PRA-designated UK investment firms that are subject to the Capital Requirements Regulation (575/2013) (CRR). It is not relevant to UK branches of firms in other European Economic Area (EEA) countries and non-EEA countries, or to insurance firms.

Background

In CP1/19 the PRA consulted on clarifications to expectations regarding the eligibility of financial collateral as funded credit protection under Part Three, Title II, Chapter 4 (Credit risk mitigation) of the CRR.

The PRA received three responses to the CP. In a number of areas respondents welcomed the PRA’s clarifications regarding the eligibility of financial collateral. However, respondents raised concerns regarding the proposals and their impact on certain types of transactions. Some respondents also requested further clarification on certain aspects of the proposals. The PRA’s feedback to these responses, and final policy decisions, are set out in Chapter 2.

Changes to draft policy

Following consideration of responses, the PRA has made a number of minor changes to the draft policy as set out in the CP. These changes clarify:

  • that where the obligor and the collateral issuer share the same country this does not automatically imply there is a material positive correlation;
  • what assets the PRA would consider relevant when it refers to ‘all of the assets to which the lender has legal recourse’; and
  • how the PRA’s expectations apply when firms have recourse to a financial collateral asset that is an index instrument.

Further details on these are set out in Chapter 2.

The PRA considers that the changes will not have a significant impact on firms (including mutuals) and will not have a significantly different impact on mutuals than for other firms. As a result, the cost benefit analysis in respect of these changes has not been updated.

Implementation

The changes to SS17/13 will be effective on publication of this PS. If firms have concerns about their ability to comply with these expectations, they should get in touch with their usual supervisory contacts.

The policy set out in this PS has been designed in the context of the current UK and EU regulatory framework. The PRA has assessed that the proposals will not be affected in the event that the UK leaves the EU with no implementation period in place.

PDF Policy Statement 14/19


Published 10 January 2019

Credit risk mitigation: Eligibility of financial collateral - CP1/19

Overview

In this Consultation Paper (CP), the Prudential Regulation Authority (PRA) sets out its proposed changes to Supervisory Statement (SS) 17/13 ‘Credit risk mitigation’ to clarify expectations regarding the eligibility of financial collateral as funded credit protection under Part Three, Title II, Chapter 4 (Credit risk mitigation) of the Capital Requirements Regulation (575/2013) (CRR).

This CP is relevant to UK banks, building societies and PRA-designated UK investment firms that are subject to the CRR. 

Background

The criteria for recognising collateral as eligible for credit risk mitigation (CRM) purposes are set out in CRR Part Three, Title II, Chapter 4 (Credit risk mitigation). Where the collateral is financial collateral, these criteria include that ‘the credit quality of the obligor and the value of the collateral shall not have a material positive correlation’ (CRR Article 207(2)).

In relation to non-recourse loans, in some cases a significant fall in the value of the financial collateral can itself bring about the default of the obligor. As such the creditworthiness of the obligor can depend materially on the value of the financial collateral. The risk mitigation provided by such collateral may be compromised and Article 207(2) is relevant. In the PRA’s view the CRR is clear on this point. However the PRA has identified some variability in how firms interpret and apply the Article 207(2) requirement.

The PRA considers it necessary to clarify both how Article 207(2) applies in such circumstances, and the PRA’s expectations of how firms should treat collateral with a material positive correlation for CRM purposes.

The CP proposes adding a new chapter to SS17/13, set out in the Appendix.

Please note: In February 2018, CP6/18 ‘Credit risk mitigation: Eligibility of guarantees as unfunded credit protection’ proposed adding a Chapter 7 to SS17/13, so this CP proposes adding Chapter 8, subject to the outcome of CP6/18.

Responses and next steps

This consultation closed on Wednesday 10 April 2019. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP1_19@bankofengland.co.uk.

PDFConsultation Paper 1/19

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