Response to cP on Guidelines on Credit Risk Mitigation for institutions applying the IRB approach with own estimates of LGDs
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1.2 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 single payment is not required by the BCBS in order for a guarantee to meet operational requirements.
1.3 The “new requirement to treat guaranteed exposures under the same approach that the institution applies for direct exposures to the guarantor” should not be applied for exposures of the bank as policyholder to insurance companies, as it is not equivalent exposure, given the priority claim on insurance companies that banks hold as policyholders. 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 paper.
1.4 Paragraph 29a.ii of the Draft Guidelines in the consultation document (p.35; see also paragraph 33 which references “comparable exposure”) states that banks using the substitution approach should substitute both the PD and LGD risk parameters of the underlying exposure with the corresponding PD and LGD of a comparable direct exposure [emphasis added] to the guarantor. However, this does not correctly reflect the exposure of the bank to the protection provider as a policyholder of an insurance policy. The exposure is not comparable to the bank’s exposure as a creditor, as policyholders are in a privileged position compared to unsecured creditors (see Annex B to the LMA response). We also recommend that the EBA reviews the Fitch Report (attached with LMA response).
1.5 As discussed at the public hearing on 15th April, we appreciate that the CRR as currently drafted does not explicitly address credit insurance as CRM and therefore we intend to participate in any public consultation and otherwise will engage with the EU Commission on amendments to the CRR on this point. However, we would ask that the European Banking Authority, in responding to the Call for Advice of May 2018, consider clarifying the recognition of non-payment insurance and its unique characteristics. Paragraph 15 of the Draft Guidelines suggests that “credit insurance [can] effectively [function] like a guarantee or like a credit derivative [emphasis added]. It therefore is logical to provide explicit recognition of credit insurance, which has characteristics of both of the current UCP tools, but also unique advantages (see Annex C of the LMA response).
1.6 The insurance industry would be prepared to work with EBA and European Insurance and Occupational Pensions Authority (EIOPA) and other relevant stakeholders and regulators on this, including on appropriate definitions and guidelines to provide clarity on non-payment insurance as an independent CRM tool.
See Annex A for additional supporting points.
2.3 Paragraph 29a.ii of the Draft Guidelines (p.35; see also paragraph 33 which references “comparable exposure”) states that banks using the substitution approach should substitute both the PD and LGD risk parameters of the underlying exposure with the corresponding PD and LGD of a comparable direct exposure [emphasis added] to the guarantor. However, this should not apply where the exposure of the bank to the protection provider is as policyholder of an insurance policy, as the exposure is not comparable, as policyholders are in a privileged position compared to unsecured creditors, in the same way that depositors have preference over unsecured creditors in a bank structure. Therefore, we request that a lower LGD should be considered where the bank’s exposure is as a policyholder.
2.4 This is also a concern that should 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”.
2.5 Paragraph 35c. of the Draft Guidelines states that “the degree to which the guarantor’s ability to fulfil the contractual obligation under the unfunded credit protection agreement is correlated with the obligor’s ability to repay can only result in a conservative adjustment of the grades, pools or LGD estimates.”. In our view this Guideline should be modified to address situations where the credit protection is provided by non-payment insurance, given insurers are regulated entities whose multi-line liabilities are diverse and whose capital is ring-fenced by regulation in order to meet their obligations to policyholders. The likelihood of correlation with the risk of default by obligors covered under non-payment insurance is therefore very low.
Please see additional points in Annex B.
Question 1: Do you agree with the proposed clarifications on eligibility requirements in accordance with Article 181(1)(f) of the CRR?
NoQuestion 2: Do you agree with the proposed clarifications on the assessment of legal certainty of movable physical collateral? How do you currently perform the assessment of legal effectiveness and enforceability for movable physical collateral?
NoQuestion 2: Do you agree with the proposed clarifications on the assessment of legal certainty of movable physical collateral? How do you currently perform the assessment of legal effectiveness and enforceability for movable physical collateral?
NoQuestion 4: Do you have specific concerns related to the recognition of collateral in the modelling of LGD? How do you currently recognise collateral in your LGD estimates?
NoQuestion 5: What approaches for the recognition of the unfunded credit protection do you currently use? What challenges would there be in applying approaches listed above for the recognition of unfunded credit protection?
No responseQuestion 6: Do you have any specific concerns related to the issues excluded from the scope of the Guidelines?
1.1 Although we understand from discussions at the public hearing on 15th April that clarification on this point may be forthcoming through the Quantitative Impact Assessment process, and we will engage with the European Commission (EC) on this point as well, we would respectfully request that the EBA support amending Article 215 of the CRR (additional requirements for guarantees) to reflect the explicit permission granted in Article 190(a) of the Bank Committee on Banking Supervision’s International Convergence of Capital Measurement and Capital Standards; a Revised Framework for the guarantor to “step into the shoes” of the underlying obligor:1.2 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 single payment is not required by the BCBS in order for a guarantee to meet operational requirements.
1.3 The “new requirement to treat guaranteed exposures under the same approach that the institution applies for direct exposures to the guarantor” should not be applied for exposures of the bank as policyholder to insurance companies, as it is not equivalent exposure, given the priority claim on insurance companies that banks hold as policyholders. 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 paper.
1.4 Paragraph 29a.ii of the Draft Guidelines in the consultation document (p.35; see also paragraph 33 which references “comparable exposure”) states that banks using the substitution approach should substitute both the PD and LGD risk parameters of the underlying exposure with the corresponding PD and LGD of a comparable direct exposure [emphasis added] to the guarantor. However, this does not correctly reflect the exposure of the bank to the protection provider as a policyholder of an insurance policy. The exposure is not comparable to the bank’s exposure as a creditor, as policyholders are in a privileged position compared to unsecured creditors (see Annex B to the LMA response). We also recommend that the EBA reviews the Fitch Report (attached with LMA response).
1.5 As discussed at the public hearing on 15th April, we appreciate that the CRR as currently drafted does not explicitly address credit insurance as CRM and therefore we intend to participate in any public consultation and otherwise will engage with the EU Commission on amendments to the CRR on this point. However, we would ask that the European Banking Authority, in responding to the Call for Advice of May 2018, consider clarifying the recognition of non-payment insurance and its unique characteristics. Paragraph 15 of the Draft Guidelines suggests that “credit insurance [can] effectively [function] like a guarantee or like a credit derivative [emphasis added]. It therefore is logical to provide explicit recognition of credit insurance, which has characteristics of both of the current UCP tools, but also unique advantages (see Annex C of the LMA response).
1.6 The insurance industry would be prepared to work with EBA and European Insurance and Occupational Pensions Authority (EIOPA) and other relevant stakeholders and regulators on this, including on appropriate definitions and guidelines to provide clarity on non-payment insurance as an independent CRM tool.
See Annex A for additional supporting points.
Question 7: Do you agree with the proposed clarification regarding the parallel treatment of ineligible UFCP and ineligible FCP? How do you currently monitor the cash flows related to ineligible unfunded credit protection and how do you treat such cash flows with regard to the PD and LGD estimates?
No responseQuestion 8: Do you agree with the proposed rules for the application of the substitution approach? Do you see any operational limitations in excluding the guaranteed part of exposure to which substitution approach is applied from the scope of application of the LGD model for unguaranteed exposures?
2.1 We feel that the GL are unclear on this point and warrant clarification. In addition, it is important to note that neither of the two options presented are consistent with/both the options presented conflict with the normal contractual arrangements with regard to the allocation of cashflows from the obligor between insurers and banks using credit insurance for UCP.Question 9: Do you agree with the proposed rules for the application of the modelling approach?
No responseQuestion 10: What challenges would you envisage for back-testing the substitution approach? Do you agree that the back-testing should be performed rather at Expected loss level? Do you have any approach currently in place for the back-testing of substitution approach?
No responseQuestion 11: Do you agree with the proposed guidance for the estimation of the LGD of comparable direct exposure towards the guarantor? What concerns would you have about the calculation of the risk weight floor?
2.2 Due to strength of insured policyholders’ claims compared to unsecured creditors, we advocate that the EBA guidance should explicitly permit banks to recognise their priority claim as policyholder in their LGD calculations.2.3 Paragraph 29a.ii of the Draft Guidelines (p.35; see also paragraph 33 which references “comparable exposure”) states that banks using the substitution approach should substitute both the PD and LGD risk parameters of the underlying exposure with the corresponding PD and LGD of a comparable direct exposure [emphasis added] to the guarantor. However, this should not apply where the exposure of the bank to the protection provider is as policyholder of an insurance policy, as the exposure is not comparable, as policyholders are in a privileged position compared to unsecured creditors, in the same way that depositors have preference over unsecured creditors in a bank structure. Therefore, we request that a lower LGD should be considered where the bank’s exposure is as a policyholder.
2.4 This is also a concern that should 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”.
2.5 Paragraph 35c. of the Draft Guidelines states that “the degree to which the guarantor’s ability to fulfil the contractual obligation under the unfunded credit protection agreement is correlated with the obligor’s ability to repay can only result in a conservative adjustment of the grades, pools or LGD estimates.”. In our view this Guideline should be modified to address situations where the credit protection is provided by non-payment insurance, given insurers are regulated entities whose multi-line liabilities are diverse and whose capital is ring-fenced by regulation in order to meet their obligations to policyholders. The likelihood of correlation with the risk of default by obligors covered under non-payment insurance is therefore very low.
Please see additional points in Annex B.