A. We understand from discussions at the public hearing on 15 April 2019 that clarification on issues outside the scope may be forthcoming through the Quantitative Impact Assessment process. We would, however, request that the European Banking Authority support the amendment of Article 215 of the Capital Requirements Regulation (CRR) (additional requirements for guarantees), in order to reflect the explicit permission granted in Article 190(a) of the BCBS’s International Convergence of Capital Measurement and Capital Standards; a Revised Framework for the guarantor to “step into the shoes” of the underlying obligor:
• Article 190(a) permits the guarantor to either make one lump sum payment or “assume the future payment obligations of the counterparty covered by the guarantee” so a cash payment is not necessarily required by the BCBS in order for a guarantee to meet operational requirements.
B. Specifically for private sector insurers: The “new requirement to treat guaranteed exposures under the same approach that the institution applies for direct exposures to the guarantor” discussed in Section 2.4.5 of the Call for Advice should not be applied for exposures of the bank as policyholder to insurance companies, as it is not “comparable” exposure, given the priority claim on insurance companies that banks hold as policyholders in the same way that depositors have preference over unsecured creditors in a bank structure. Policyholders are in a privileged position compared to unsecured creditors. The banks should be allowed to recognise (depending on the jurisdiction and its respective insurance regulations) the improved LGD of its exposure as policyholder, based on the risk differentiators set forth in this note.
• Paragraph 29a.ii of the Draft Guidelines (p.35; see also paragraph 33 which references “comparable exposure”) requires that the PD and LGD of a “comparable direct exposure to the guarantor” be applied. As said, this should not apply where the exposure of the bank to the protection provider is as holder of an insurance policy.
C. Specifically for public sector insurers (ECAs): As per Article 4 (81) in conjunction with Article 201 of the CRR, officially supported export credits are provided either directly or indirectly by the respective government to the export financing bank. The loan is, therefore, secured by either (i) a direct claim against the state (Ministry of Finance or a special government body), or (ii) a 'public sector entity' (in terms of Article 8 (4) CRR), which in turn avails of a binding undertaking or guarantee by its respective government to ensure compliance with any claim payment obligations. Hence, the treatment of the risk under these officially supported export credits is somewhat different from insurance provided by the private sector, as central governments receive preferential treatment under CRR. A claim under an officially supported export credit therefore benefits from the same credit treatment as exposure to the central government in cases of (i) or (ii) above (provided that the public sector entity is meeting the requirements of Article 116 (4) CRR).
D. As discussed at the public hearing on 15 April 2019, we appreciate that the CRR as currently drafted does not explicitly address credit insurance as Credit Risk Mitigation. In this context, we would ask EBA, in responding to the Call for Advice of May 2018, for clarification to existing requirements that acknowledge credit insurance characteristics under the category of Unfunded Credit Protection based on the following:
• Non-payment insurance provides effective credit risk mitigation able to support bank lending and associated trade and investment in emerging markets where credit derivatives are rarely available and for complex transactions not easily covered by other CRM tools.
• Paragraph 15 of the Draft Guidelines suggests that “credit insurance [can] effectively [function] like a guarantee or like a credit derivative [emphasis added]. It would be useful to clarify the acknowledgment of credit insurance as a CRM tool, which has characteristics of both of the current UCP tools, but also unique advantages.
• It is important to distinguish between guarantees issued for the purposes of enhancing the credit of the borrower (those issued by parent companies or by the sovereign owners of public-sector borrowers, and bank guarantees or stand-by letters of credit issued by a borrower’s bank) and guarantees managing the lender’s exposure (these include unfunded risk participations, credit insurance and credit derivatives). Credit enhancement guarantees are arranged by the borrower and issued by a guarantor with a close commercial relationship with the borrower and (i) are specifically issued as an inducement to lending; (ii) present a correlated credit risk between borrower and guarantor, and (iii) on payment by the guarantor, the borrower’s default is cured and its obligation to the lender is discharged. The exposure management guarantees, at the other hand, are arranged and paid for by the lender and (i) are usually issued by a guarantor/insurer who regards the lender as its client, and who has no relationship with the borrower (indeed the guarantee is often silent to them); (ii) the credit risk of the borrower and guarantor are not correlated; and (iii) on payment by the guarantor, the borrower’s default is not cured and its obligations to the lender (or its assignee, i.e. the insurer) remain unaltered.
• We would be prepared to work with EBA and other relevant stakeholders and regulators on this, including on appropriate definitions and guidelines to provide clarity on credit insurance as a CRM tool.
In addition to the above, we would like to provide the following supporting arguments:
1. Key risk differentiators that should be permitted to be taken into account in modelling the PD and LGD of banks’ claims as policyholders
1.1. Since the confirmation by both the BCBS (FAQ6, QIS3) and the EBA (Single Rulebook 2014_768 and Assessment of the Current CRM Framework (19 March 2018), paragraph 36, page 15) that non-payment insurance can function as an effective credit risk mitigant, the product has evolved to align with the operational requirements of CRM whilst remaining a policy of indemnity offered (i) under tested insurance law and (ii) by highly regulated private, public or multilateral insurers with diverse portfolios, strong credit ratings, and based in legal jurisdictions where effective enforcement against the insurer is practicable.
1.2. The fact that the non-payment product is not correlated with either insurers’ other exposures or liabilities (if any) nor with the insured banks’ exposure to the underlying obligor substantially lowers systemic risk:
1.2.1. In the case of private insurers, regulatory and reserving requirements ensure liquid, callable capital is available to pay claims to policyholders. In the case of public and multilateral insurers, government regulations, government ownership and/or being part of the government allows for sufficient capital to pay claims to policyholders, and typically a claim on the government itself.
1.2.2. The ability of Berne Union private, public and multilateral members to absorb large losses is well tested: The figure paid by our members since the global financial crisis in 2008 and subsequent years – the most severe test of the non-payment product to date – was over USD 50 billion.
1.3. Insurers do not present the same risks for financial stability as banks (which are often the counterparties for credit derivatives). For instance, they do not typically undertake maturity transformation and so are less vulnerable to sudden losses of confidence, ‘runs’, and contagion than banks.
1.3.1. One of the cornerstone principles for providers of non-payment insurance is that the bank retain a meaningful share of the risk covered: this focus on products that have meaningful risk-sharing features is viewed favourably by rating agencies (e.g., S&P Insurers: Rating Methodology dated 7 May 2013, p. 9).
1.4. Under the Solvency II Directive , regulated insurers must have a high quality of capital. To ensure that the capital required to be held by insurers is directly relevant to policyholders, insurers’ capital is located where it is needed.
1.5. According to the 2017 XLCatlin Global Credit Insurance Monitor , credit insurance was seen by the policyholders polled as “the most efficient, transparent and acknowledged way to manage credit risk and to comply with corporate governance requirements”.
2. Non-payment insurance would benefit from an acknowledgement or a clarification to existing requirements given its characteristics, particularly when compared to credit derivatives
2.1. Unlike credit default swaps, non-payment insurance policies are personal contracts with a direct relationship between the covered loss and the actual risk.
2.2. Claims performance within the control of the bank: A recent survey of the top 9 brokers of non-payment transactional insurance for regulated financial institutions over the period 2007-2017 reported that 97% of claims made were paid on time/in full; the remainder were “compromised” due to operational failures on the part of the insured financial institution – and yet 44% of the “compromised” amounts claimed were still paid in settlement agreements.
2.3. The insurance claim process is much more in the control of the bank than a CDS settlement:
2.3.1. CDS settlement only occurs once consensus has been reached (1) that a credit event has been called and has occurred and (2) as to the value of the CDS, determined through an auction process, the framework of which has to be specifically established. Only once the auction has been completed does a settlement obligation exist, at which point payment is made relatively quickly via the clearing houses.
2.3.2. In addition, a CDS default trigger is potentially different to that of the insurance product in a default process: a restructuring enabled via a consensual route may not result in CDS triggering until the terms of the restructuring have been agreed. This can literally be months or years after a non-payment insurance policy has already triggered and paid.
2.3.3. Depending on the structure of the company, not all entities would be covered by a CDS; the bank’s specific exposure may not be covered (“basis risk”) .
2.3.4. In contrast, the claims process under an insurance policy operates differently:
22.214.171.124. The policy is already tailored to the specific exposure the bank is running and the bank has a direct relationship with the insurer, allowing communication and certainty during the claims process.
126.96.36.199. A claim can be made if the work-out has not been agreed by the time the cure/claim settlement period has elapsed (although, as noted above, the preferred course is normally that the policy is restructured to follow the work-out for the reasons detailed above).
188.8.131.52. The claims payment process is highly prescribed and includes a detailed timeframe and specifies the steps and information the bank must take or provide to successfully conclude the process.
184.108.40.206. The insured’s rights under the contract, including damages for late payment, are protected by law and precedent.
220.127.116.11. The policy allows for active engagement by the insured bank to ensure its claim is processed in an acceptable manner.
2.4. Both export credit insurance and export credit guarantees are conditional. In practice, however, these conditions are under the control of the covered banks themselves and not related to the payment risk. One such condition is e.g. that the bank must monitor the risk and remind the borrower of his obligation to pay. In the decades' long history of cover provided to banks, we are not aware of a rejection of a claim due to a breach of a condition over which the bank had control, except for very exceptional circumstances such as fraudulent action on part of the bank.
Berne Union response:
A. Due to strength of policyholder compared to unsecured creditors, we recommend to explicitly clarify favourable treatment for exposures to insurance companies where the bank is policyholder of a non-payment insurance policy.
B. And/or allow banks some discretion on LGD for exposure to insurance companies
• The argumentation is provided in our response to Question 6 under B and C.
• This is also a concern that should in our view be addressed by the EBA in responding to the Call for Advice of May 2018 (Section 2.4.5), regarding the “new requirement to treat guaranteed exposures under the same approach that the institution applies for direct exposures to the guarantor”.
In addition to the above, we would like to provide the following supporting arguments:
3. Privileged position of policyholders
3.1. There is further evidence of the banks’ privileged position as a policyholder compared to unsecured creditors’ claims in the unlikely event of the bankruptcy of, in particular, a private insurer. Regulated insurance companies have minimal, if any, preferential debt. In addition, borrowings by insurance groups are done at the holdings level, outside the regulated entity which holds the capital and thus are structurally subordinated: the debt ratings of insurance groups are lower than the claims paying rating of an insurer, as reflected in ratings of insurers published by credit rating agencies.
3.2. In the case of officially supported export credits, government regulations, government ownership and/or being part of the central government allows for sufficient capital to pay claims to policyholders, and typically a claim on the central government itself.
3.3. As a policyholder of a multilateral insurer, the banks’ position is even more privileged, given the extremely unlikely scenario of the multilateral’s insolvency, as the shareholders are multiple sovereign states.
3.4. Article 275 of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009:
“1. Member States shall ensure that insurance claims take precedence over other claims against the insurance undertaking in one or both of the following ways: (a) with regard to assets representing the technical provisions, insurance claims shall take absolute precedence over any other claim on the insurance undertaking; or (b) with regard to the whole of the assets of the insurance undertaking, insurance claims shall take precedence over any other claim on the insurance undertaking with the only possible exception of the following: (i) claims by employees arising from employment contracts and employment relationships; (ii) claims by public bodies on taxes; (iii) claims by social security systems; (iv) claims on assets subject to rights in rem.”
3.5. While not directly secured with collateral, claims of banks as policyholders benefit from ringfencing of assets to secure outstanding liabilities to policyholders at the operating company level in circumstances where the obligor is in distress by provisioning required by insurance regulators for exposures where the insurer has a potential claim liability. This ringfencing of assets for the benefit of banks as policyholders should be recognised, and therefore the 45% LGD under paragraph 70 of the Basel III: Finalising post-crisis reforms (p.66) should be modified to acknowledge this benefit to banks as policyholders, rather than creditors, of an insurance undertaking.
3.6. Fitch Ratings, having established the value available to creditors and the approximate scale of creditors at each level of priority, applies a waterfall to determine estimated recovery ratios, based on the expected relative recovery characteristics of an obligation upon curing of a default, emergence from insolvency, or following the liquidation or termination of the obligor or its associated collateral. According to Fitch Ratings , the typical order of seniority of creditors at operating company level is as follows:
1. Policyholder obligations with seniority (for example, life insurance policyholders in certain jurisdictions)
2. Policyholder obligations without seniority
3. Secured debt
4. Unsecured senior debt
5. Subordinated debt