Specialised lending is defined as an exposure which possess the following characteristics (CRR Art 147(8)):

(a) the exposure is to an entity which was created specifically to finance or operate physical assets or is an economically comparable exposure;

(b) the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate;

(c) the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise. 

In the context of financing aircrafts, an entity is typically created to acquire the aircrafts which then funds such purchase through the receipt of financing from third parties (e.g. banks) which is secured against the aircraft and the repayment of such financing is through the income generated by the aircraft. Therefore, such financing together with the fact that the entity does not have the independent capacity of a broader commercial enterprise would meet the requirements (a) to (c) and hence the financing would be seen as a specialised lending exposure (i.e. object finance). 

However, where the income generated from the aircrafts is through financial leasing instead of operating leases (this is typical of leases entered into with large commercial airlines), then such entity whilst specifically set up to finance physical assets could be interpreted to meet the definition of a financial institution as its primary activity could be considered to be financial leasing and hence the entity would then be seen as a financial sector entity (FSE). Therefore, should an exposure which meets the specialised lending definition (for example object finance) also be seen to be an exposure to an FSE?  If so then does CRR Art 153(2) apply to such an exposure? 

The definition of a financial institution under CRR article 4(1)(26) is as follows:

“an undertaking other than an institution and other than a pure industrial holding company, the principal activity of which is to acquire holdings or to pursue one or more of the  activities listed in points 2 to 12 and point 15 of Annex I to Directive 2013/36/EU, including an investment firm, a financial holding company, a mixed financial holding company, an investment holding company, a payment institution within the meaning of Directive (EU) 2015/2366 of the European Parliament and of the Council, and an asset management company, but excluding insurance holding companies and mixed-activity insurance holding companies as defined in points (f) and (g) of Article 212(1) of Directive 2009/138/EC” 

and financial leasing is point 3 of Annex I to Directive 2013/36/EU

An SPV established solely to perfect security over a physical asset which is leased under a financial leasing agreement should not be deemed to meet the definition of a financial institution. 

If the entity classification as FSE were to apply, then under CRR 3 which is due to become effective from 1 Jan 2025, an exposure which meets the definition of specialised lending exposure would not benefit from the transitional arrangements for specialised lending exposures under CRR 3 Art 495b(1) as the loss given default (LGD) in accordance with CRR 3 Art. 151(8) would need to be based on those set out in CRR 3 Art 161(1). 

Capturing a specialised lending entity as a FSE does not appear to be the intention of the regulatory framework as this would result in an arbitrary capital treatment based on, for example, the use of financial leasing rather than operating leasing of aircrafts by entities within the aviation market.  Furthermore, whilst not directly relevant to the application of own estimates of LGD.  Further support that leasing activity in the context of object finance exposures (e.g. aviation financing) should not constitute financial sector related activity and hence such entity not being a FSE is based on a description of sources of income within Article 1(3) of the Delegated Regulation 2021/598.  In particular it states, “Where the purpose of a specialised lending exposure is to finance the acquisition of physical assets, including in particular ships, aircraft, satellites, railcars, and fleets, and the income to be generated by those assets is lease or rental payments obtained from one or several third parties (‘object financing exposures’).”

The global commercial aircraft leasing market size was valued at USD 154bn in 2023 so the potential impact of such a treatment would likely have a very material impact on the industry as a whole.