Response to cP on Guidelines on Credit Risk Mitigation for institutions applying the IRB approach with own estimates of LGDs

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Question 1: Do you agree with the proposed clarifications on eligibility requirements in accordance with Article 181(1)(f) of the CRR?

No

Question 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?

No

Question 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?

No

Question 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?

No

Question 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?

NA

Question 6: Do you have any specific concerns related to the issues excluded from the scope of the Guidelines?

Firstly, as noted in our comments in the attached full response, we would support measures to better outline the quality and status of credit insurance as a CRM, including recognising insurance as a separate UCP category.

Secondly, we would favour 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. This ability is a core function of the credit insurance product, so EBA backing for aligning the CRR approach with the BCBS operational requirements to permit either one lump sum payment or assume the future payment obligations would be beneficial.

Thirdly, we submit that the “new requirement to treat guaranteed exposures under the same approach that the institution applies for direct exposures to the guarantor” should not apply for exposures of the bank as policyholder to insurance companies. This is because it is not equivalent exposure, given the priority claim on insurance companies that banks hold as policyholders (as compared to unsecured creditors). The banks should be able to recognise (depending on the jurisdiction and its respective insurance regulations) the improved LGD of its exposure as a policyholder, based on the risk differentiators noted above.

Finally, insurers’ ringfencing of assets for the benefit of banks as policyholders should be recognised. For example, the 45% LGD under paragraph 70 of the Basel III: Finalising post-crisis reforms (p.66) should be modified to recognise the benefit to banks as policyholders, rather than unsecured creditors, of an insurer.

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?

NA

Question 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?

We would suggest that the Draft Guidelines are unclear on this point and that further clarification would be useful. Additionally, we would raise that both Option 1 and 2 presented in paragraph 34 (and Figure 1) of the Draft Guidelines are in conflict with the normal contractual arrangements regarding the allocation of cashflows from the obligor between insurers and banks using credit insurance for UCP. The approaches presented may therefore require added consideration and we would be happy to provide added information on this if needed.

Question 9: Do you agree with the proposed rules for the application of the modelling approach?

NA

Question 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?

NA

Question 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?

We would argue that banks should be permitted further discretion on LGD for exposure to insurance companies. Paragraph 29a.ii of the Draft Guidelines requires that banks using the substitution approach should substitute both the PD and LGD risks parameters with the PD and LGD of a “comparable direct exposure 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. Consequently, we think a lower LGD should be considered where the bank’s exposure is as policyholder.

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”.

We would make a further point in relation to Paragraph 35c. of the Draft Guidelines, “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.” We submit that this should beamended to address situations where the credit protection is provided by non-payment insurance, given insurers are highly regulated entities with diverse liability portfolios, stringent solvency requirements and ringfenced capital to guarantee policyholder protection, allied to low correlation risk with the default of the obligor.

Question 12: Do you consider portfolio guarantees as a form of eligible UFCP? Do they include cases where the guarantee contract sets a materiality threshold on portfolio losses below or above which no payment shall be made by the guarantor? Do they include cases where two or more thresholds (caps) either expressed in percentages or in currency units are set to limit the maximum obligation under the guarantee? How do you recognise the portfolio guarantees’ credit risk mitigation effects in adjusting risk parameters?

NA

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Name of organisation

International Underwriting Association of London (IUA)

Contact name

No

Phone number

No