PRA statement on credit risk mitigation (CRM) eligibility, risk-based capital treatment, and leverage ratio treatment of guarantees under the Energy Markets Financing Scheme (EMFS)

Statement

On Monday 17 October, HM Treasury and the Bank of England (‘the Bank’) launched the Energy Markets Financing Scheme (EMFS) to address the extraordinary liquidity requirements faced by energy companies operating in UK wholesale physical gas and/or electricity markets. This statement sets out the Prudential Regulation Authority’s (PRA) observations on the capital requirements relating to firms’ exposures under the scheme, particularly eligibility for recognition as unfunded credit risk mitigation (CRM) under the UK Capital Requirements Regulation (CRR). The statement also sets out observations on the treatment of exposures under the UK leverage ratio framework.

The statement does not provide a comprehensive description of the EMFS. It does not provide an exhaustive description of the prudential requirements that apply to credit facilities extended by firms to energy companies under the scheme, nor is it a comprehensive description of the regime under which CRM techniques impact the calculation of risk weighted exposure amounts. Firms should assess the exposures against the relevant articles of the CRR, and any relevant PRA rules and expectations (including expectations set out in Supervisory Statement (SS) 17/13 ‘Credit risk mitigation’. Where necessary, firms should seek independent advice to confirm that all the applicable requirements and expectations have been satisfied.

CRM eligibility of EMFS guarantees

A guarantee is one form of unfunded credit protection which, where it meets the conditions in Articles 194 and 213-215 of the CRR, may allow a firm to adjust their capital requirements.

The PRA considers that the terms of the guarantee provided under the scheme do not contain features that would render the guarantee ineligible for recognition as unfunded credit risk protection under the CRR, and the effects of the guarantee would appear to justify such treatment.

Observation on the EMFS scope of protection

The EMFS guarantee excludes cover for default interest and some fees owed by a borrower to a lender. Firms recognising the EMFS guarantee as eligible unfunded credit protection in relation to an exposure are required to adjust the value of the guarantee to reflect these limitations of the coverage, consistent with CRR Article 215.1c(ii).

The EMFS guarantee does not cover funds advanced after the lender learns of a use of funds previously advanced for a non-scheme purpose, or of a downgrade in the borrower’s credit rating to below the scheme minimum.^{footnote [1]}  Sums advanced in these circumstances are consequently not guaranteed and should be assigned the risk weight of the obligor. There is an exception for further advances made in these circumstances with the guarantor’s consent.

Firms applying the Standardised Approach (SA) for credit risk

The portion of an exposure benefiting from the protection of a guarantee provided by the Bank under the EMFS should be assigned the relevant central bank risk weight prescribed by the SA (the value of the guarantee recognised should be adjusted under relevant CRM provisions for any payment types excluded under the guarantees). Any residual part of the exposure that is not covered by the guarantee should be assigned the SA risk weight that would apply if the exposure were not guaranteed.

Firms applying an Internal Ratings Based (IRB) approach for exposures to the obligor, with a Permanent Partial Use (PPU) exemption for exposures to the guarantor

The portion of an exposure benefiting from the protection of a guarantee provided by the Bank under the scheme should be assigned the relevant central bank risk weight prescribed by the SA (the amount of guarantee recognised should be adjusted under relevant CRM provisions for any payment types excluded under the guarantees). Any residual part of the exposure that is not covered by the guarantee should be risk weighted according to the relevant approved IRB approach as if the exposure were not guaranteed.

Firms applying an IRB approach for exposures to the obligor and for exposures to the guarantor

Firms should adopt an approach to reflect the effect of the guarantee provided by the Bank that is consistent with their approved IRB models and their IRB permissions.

Leverage ratio treatment of exposures under the scheme

Firms should include exposures relating to the scheme in their leverage ratio total exposure measure, as calculated in accordance with the Leverage Ratio (CRR) Part of the PRA Rulebook.