Institutions, in the context of private banking and or corporate banking business, provide liquidity to investor/clients for purposes of their own commercial business (unrelated to the acquisition of the institution’s own shares). This is carried out by providing loans pledged with financial collateral in the form of equity shares, corporate bonds, sovereign debt, term deposits or cash in a sight account.

Under the contractual arrangements of the loan and the pledge, as well as applicable legal regulation in our jurisdiction, in the event of default of the obligor the institution is not allowed to foreclose the financial collateral. Instead, it is allowed to sell the collateral in the market and seize the proceeds. However, the institution is only allowed to sell collateral in the amount that is required settle the debt of the obligor, no more. Financial collateral is valued daily and therefore the institution can sell it in the market until the debt is settled in full. Accordingly, the amount of the synthetic holding should be the accounting value of the pledged shares limited by the limit of the EAD of the loan.

We present below two scenarios where there is overcollateralization.

Scenario 1

The institution grants a loan with the arrangements described above in the amount of 100 monetary units for the financing of the obligor’s commercial activity and the obligor pledges financial collateral in the form of the institution’s own equity shares in the amount of 150 shares that are valued in the market 1 monetary unit each, for a total amount of 150 monetary units. 

The institution would then calculate the amount of the deduction for the synthetic holding of its own shares considering that it can only seize 100 shares to settle the debt and therefore the deduction should be the accounting value of 100 shares as per Q&A 2020_5128.

Is the approach followed by the institution, correct?

Scenario 2

The institution grants a loan with the arrangements described above in the amount of 100 monetary units for the financing of the obligor’s commercial activity and the obligor pledges financial collateral in the form of:

• 100 shares of the institution own shares that are valued in the market 1 monetary unit each, for a total amount of 100 monetary units.
• 100 shares of another company, for the purpose of the scenario is an industrial company, that are valued at 1 monetary unit each, amounting a total of 100 monetary units.

The institution would then calculate the amount of the deduction for the synthetic holding of its own shares considering that it can only seize 100 shares in total and would sell in the market the obligor’s portfolio prorate, i.e. 50 shares of the institution and 50 shares of the shares of the industrial corporate. Accordingly, the deduction would be the accounting value of 50 shares of the institution, in line with Q&A 2020_5128.

Is the approach followed by the institution, correct?