Q.1 Credit Derivatives (Credit Spread Options) - Under BSD S 2/04, credit spread options are treated on a case-by-case basis by the Financial Regulator. The CRD makes no reference to the treatment of credit spread options. Clarification is required as to whether the same treatment will be applied to credit spread options under the CRD such that institutions must refer to the Regulator on a case-by-case basis.
A.1 In the context of the question, BSD S 2/04 is still applicable in Ireland, as the requirements of the CRD do not directly supersede it. In this regard, please refer to Section 1.4 of the Financial Regulator’s Notice on the Implementation of the CRD dated 28 December 2006.
Q.2 Credit Derivatives (Protection Seller) - It appears that the only reference in the CRD to the treatment applicable to the protection seller in the context of the Banking Book relates to basket products. Clarification is sought from the Regulator as to whether in all other cases, the treatment, as set out in BSD S 2/04 will continue to apply.
A.2 Please refer to CRDTG Question 198. (Access via CEBS website www.c-ebs.org )
Q.3(a) Trading Book (Specific Risk Charge) - Annex I of Directive 2006/49/EC sets out the position risk charges to apply to credit derivatives. Points 9-11 set out the treatment to apply to the protection buyer. It states, “for the party who transfers credit risk, the positions are determined as the mirror image of the protection seller. With regard to basket products, this would mean that a first-asset-to-default would create a position for the notional amount in an obligation of each reference entity and a second-to-default would create a position for the notional amount of in each reference asset less one. This is contrary to the current treatment, which requires that the buyer take a specific risk charge against only one asset in the basket. Clarification is needed regarding the specific risk charge to apply to the protection buyer with regard to basket products.
A.3(a) The CRD states in effect that a bank must use the new treatment for basket products as set out in Annex 1. This question is under consideration at the CRDTG.
Q.3(b) Trading Book (Specific Risk Charge) - Point 14 of Annex I states that the institution shall assign its net positions in the trading book, as calculated in accordance with point 1, to the appropriate categories in Table 1 on the basis of their issuer/obligor, external or internal credit assessment, and residual maturity, and then multiply them by the weightings shown in that table. We are unclear if this revised treatment can be applied by institutions availing of Article 152 (8) of the CRD on the grounds that the specific risk charge applied is determined by the credit quality step or risk weight that would apply under the Standardised approach, both of which are concepts that do not form part of Directive 2000/12/EC or Directive 93/6/EEC.
A.3(b) As an interim measure, in respect of the question above, credit institutions availing of the provisions of Article 152 (8) should continue to calculate their capital requirements in accordance with the current rules as set out in BSD S 2/04.
Q.3(c) Trading Book (Specific Risk Charge) - Furthermore, point 15 states that “for the purposes of point 14, qualifying items shall include …long and short positions in assets qualifying for a credit quality step corresponding at least to investment grade in the mapping process described in Title V, Chapter 2, Section 3, Sub-section 1 of Directive 2006/48/EC. Again, we are unclear as to how this provision can apply from 1 January 2007 for those institutions availing of Article 152 (8) of the CRD.
A.3(c) Please see the response to 3b.
Q.4(a) Securitisation - Clarification is required as to the treatment of securitised mortgages in IRB PD modelling in terms of whether the PDs of securitised mortgages should be included in the overall portfolio PD satisfy the requirement for significant credit risk transfer}.
A.4(a) If there is a significant credit risk transfer for the securitised exposures, the PDs of the securitised mortgages are not included in the overall portfolio PD as the capital charge for the securitised mortgages is calculated separately from the overall portfolio capital charge.
Q.4(b) Securitisation - A significant degree of detail is required in calculating the regulatory requirements for securitisation positions and the resulting charge may not be substantially lower than the charge that would apply if the assets were not securitised. Clarification is required as to whether institutions could avoid calculating the requirements for the exposures under the securitisation rules if the institution was happy to apply the capital charge that would apply if the exposures were not securitised. Furthermore, when using the Supervisory Formula approach, if an institution was unable to calculate the IRB charge that would be applied had the underlying exposures not been securitised, could this institution use the default risk weight of 7%?
A.4(b) No. The options open to an institution apart from the calculation of the regulatory requirements for securitisation positions are: to apply a risk weight of 1250% to the position or to deduct the exposure value from own funds. (REF: Annex IX, Part 4, Paragraph 41). Note for information: there is a cap that applies when an institution is using the Kirb formula and that is a maximum charge of 8% of the exposures as if they had not been securitised Plus the Expected Loss amounts of those exposures. (REF: Annex IX, Part 4, Paragraph 45)
Q.4(c)Securitisation - The Regulator has recently proposed amended rules to apply to residential and commercial mortgages under the Standardised and IRB Approach under the CRD. Clarification is required as to whether the Regulator intends applying a similar treatment to securitised residential and commercial mortgages.
A.4(c) No. The calculation of capital charges for securitised exposures, whether for residential, commercial mortgages or other asset type will be as outlined under the CRD.
Q.4(d) Securitisation - Clarification is required from the Regulator in terms of the grandfathering, if any, to apply to securitisation positions from January 2007.
A.4(d) The revised rules on securitisation do not apply to institutions that remain on the pre-CRD capital framework in 2007. (See page 6 of the Financial Regulator’s notice re Implementation of the CRD dated 28 December 2006). The CRD securitisation provisions apply when a credit institution changes over to the CRD framework.
Q.5 CRM (Monitoring of Property Values) - The CRD Credit Risk Mitigation requirements on real estate collateral are set out in Annex VIII, Part 2, paragraph 8. Under monitoring of property values, it states that the value of the property shall be monitored on a frequent basis and at minimum once very year for commercial and once every three years for residential. For loans exceeding €3 million or 5% or own funds, an independent valuer shall review the property valuation at least every three years. Could this be a desktop valuation or would an extensive on-site evaluation be required?
A.5 The Financial Regulator will not at this time prescribe the format for monitoring or reviewing property values. Credit Institutions should be mindful in particular of the stipulation in the directive that more frequent monitoring shall be carried out where the market is subject to significant changes in conditions. Credit Institutions should also be in a position to demonstrate to the Financial Regulator if requested that their valuation methodologies comply with the CRD.
Q.6 Operational Risk - The latest regulatory guidance issued by the Financial Regulator on 28 December 2006 indicates that the requirement to calculate regulatory capital for operational risk does not apply to institutions using the current framework during 2007. However, Article 152 (11) seems to read that when an institution is calculating own funds during 2007, the institution can reduce the operational risk capital element by the value of the following ratio: Credit RWA (Basel1)/Total Exposures. Therefore, in order to be able to calculate the value of the deduction, the institution will need to be able to calculate regulatory capital for operational risk according to the Standardised Approach by January 2007.
A.6 As an interim measure, in respect of the question above, credit institutions availing of the provisions of Article 152(8) for all exposures (i.e. remaining entirely on Basel I) should continue to calculate their capital requirements based on the ‘Basel I’ rules.
Q.7 Undrawn Credit Facilities - Annex II of Directive 2006/48 classifies off-balance sheet items into full risk, medium risk, medium/low risk and low risk. One of the categories under the medium risk is “Undrawn credit facilities (agreements to lend..............) with an original maturity of more than one year." Agreements to lend with an original maturity of up to an including one year are categorised as medium/low risk. What does original maturity relate to? Is it a) The period for which the agreement to lend is valid e.g. Customer is approved a mortgage over 25 years and the offer is valid for 3 months. In this case the original maturity is less than 1 year because the offer to lend is only valid for 3 months or b) The term of the facility itself eg. Customer is approved a mortgage over 25 years and the offer is valid for 3 months. In this case the original maturity is greater than 1 year because it is a 25 year facility.
A.7 It would appear that the maturity of the ‘agreement to lend’ would be used to determine the conversion factor implying that the 20% conversion factor would be applied in this case. Once the facility is drawn and went ‘on-balance sheet’ the term of the facility would be used in the risk weight function.
Q.8 Application for National Discretions - Page 5 of CP22 states that if a discretion relates to provisions that come into force automatically from 1 January 2007, institutions should apply for the use of such discretions as soon as possible and in any case, no later than 31 October 2006. Clarification is sought as to whether the discretions relating to the Trading Book provisions of the CRD fall within this scope.
A.8 In the Financial Regulator’s Notice on the implementation of the CRD dated 28 December 2006, where it is flagged that a Type A discretion will be exercised subject to prior written approval from the Financial Regulator, the onus is on the institution to apply for the discretion, or to re-apply for its continued application if the conditions attaching to it have changed. In the majority of cases, this will form part of an institution’s application for use of an internal models approach although there are some discretions that are independent of this and institutions must apply separately for these. Institutions should discuss the particularities of application for use of a discretion with their examiner.
Q.9 Definition of Retail - Section 6.6 of CP 22 states that the Financial Regulator will not be asking standardised institutions to provide their own definitions of what constitutes a retail exposure. Instead, the Regulator expects institutions to adopt a more common sense approach. Clarification is sought as to the overlap between an institutions’s own definition of retail and the criteria as set out in Article 79(2) of the CRD.
A.9 With respect to the above question, credit institutions’ definition of retail should comply with Article 79(2).
Q.10 Number of days past due - With regard to counting the number of days past due, clarification is sought in terms of cases where part payments are made. It is stated that “so long as money is incoming always and everywhere to extinguish a debt before it becomes 90 days past due, an institution is free to record this in its systems as delinquent rather than in default”. Clarification is specifically sought as to whether a materiality threshold will apply in such cases.
A.10 The Financial Regulator does not propose to define a materiality threshold at this point in time. Credit institutions should refer to Appendix 3 of the Financial Regulator’s Notice on the implementation of the CRD dated 28 December 2006.
Q.11 Pillar 3 - Paragraph 6 of Annex XII, Part 2 outlines the information to be disclosed regarding the credit institution’s exposure to credit risk and dilution risk. Reference is made to value adjustments and provisions as part of this requirement. Clarification is sought as to the distinction between ‘value adjustments’ and ‘provisions’.
A.11 Please refer to CRDTG Question 130 (Access via the CEBS website www.c-ebs.org)
Q.12 Standardised Approach - Paragraph 7 of Annex XII, Part 2 refers to information to be disclosed by credit institutions adopting the Standardised Approach to Credit Risk, as set out in Articles 78-83. Point (c) of this paragraph requires that credit institutions provide “a description of the process used to transfer the issuer and issue credit assessments onto items not included in the trading book”. Clarification is sought as to the meaning of this requirement.
A.12 Please refer to CRDTG Question 139 (access via the CEBS website www.c-ebs.org)
Q.13 Annex XII Part 3 Para 1 - Part (iii) of Paragraph 1(e) of Annex XII, Part 3 states that credit institutions shall disclose “the exposure-weighted average risk weight” …..“for each of the exposure classes; central governments and central banks, institutions, corporates and equity….”Clarification is sought as to the meaning of the phase “exposure-weighted average risk weight”.
A.13 For each of the specified exposure classes, an institution needs to disclose the average risk weight for the exposure class. This involves multiplying the exposure values by the relevant risk weight, summing the answers and dividing by the total exposure values. This provides the average risk weight for the particular portfolio.
Q.14 Disclosure of rating decisions - Article 145(4) requires institutions to explain their rating decisions to SME and other corporate applicants for loans, if requested. The explanation must be provided in writing. Clarification is sought as to the level of detail the Regulator envisages being provided.
A.14 Institutions should take a pragmatic and common sense approach when dealing with these requests. The Financial Regulator does not seek to be prescriptive in this area and will keep the matter under review.
Q.15 ICAAP Submission timing - What is the timing of ICAAP submission in 2007?
A.15 Credit Institutions licensed under the Central Bank Act, 1971 that adopt the CRD standardised approach to credit risk in 2007 shall submit ICAAP data to the Financial Regulator through the appropriate template 6 months prior to the date they use the approach for the calculation of regulatory capital.Credit institutions licensed under the Central Bank Act, 1971 that adopt an IRB approach to credit risk in 2007 and for which the Financial Regulator is their consolidating supervisor, shall submit ICAAP data to the Financial Regulator through the appropriate template at the same time as their IRB model application submission. Credit institutions licensed under the Central Bank Act, 1971 that adopt an IRB approach to credit risk in 2007 but for which the Financial Regulator is not their consolidating supervisor, shall submit ICAAP data to the Financial Regulator through the appropriate template at the same time as their parent submits their IRB model application. Investment firms are required to have an ICAAP in place at the firm’s adoption of the CRD capital framework. Investment firms are not required to submit the ICAAP template prior to the switchover.
Q.16 What is the Financial Regulator's Guidance on IRBA (Internal Ratings Based Approach) Stress Testing?
A.16 View the Guidance on IRBA Stress Testing. (Section 3.1.15 of CRD-VR-1.X IRBA Stress Testing) (Link to doc in Regulatory Requirements & Guidance Section)
Q.17 Transitional Arrangements and Capital Floors - When applying the capital floors throughout 2007, 2008 and 2009, would it suffice to calculate the capital that would apply under Basel 1 on a Quarterly basis when submitting the COREP?
A.17 In section 1.5.2 of the Implementation of the CRD Notice, dated 28 December 2006, the Financial Regulator's position on the operation of capital floors vis-à-vis the calculation of banks' capital requirements under CRD compared with what their capital requirements would have been pre-CRD, is outlined as follows: "During these years (i.e.2007, 2008, 2009) institutions shall compare on an ongoing basis their capital requirements under the revised capital adequacy framework and their capital requirements under the existing capital adequacy framework." This means that, from a systems' perspective, institutions must retain the capability to calculate capital requirements under the basis of the pre-CRD Directive until the end of 2009. A simplified example on how capital floors can be calculated was also included in the consultation paper CP22 under part A. Within the COREP framework, the CA template under row 2.6.1 allows for "Complements to overall floor for Capital Requirements". Consequently, from a reporting perspective, calculation of what a bank's capital requirements would have been pre-CRD, for the most part, is implicitly reported on a quarterly basis until the end of 2009. This does not, however, negate an institution’s requirement to calculate and compare on an ongoing basis their capital requirements under the revised capital adequacy framework and their capital requirements under the existing capital adequacy framework.
Q.18 Specific Risk Charge on CDS - Annex I of Directive 2006/49/EC, paragraph 8 states that a credit default swap does not create a position for general market risk for the protection seller. However, for the purposes of specific risk, if premium or interest payments are due under the product, these cash flows must be represented as notional positions in government bonds. Our understanding is that a long position in the reference asset is created for Specific Risk and that premium / interest payments are represented as notional positions in government bonds for the calculation of General Interest Rate Risk. Therefore the derivative itself does not create a position for general interest rate risk but interest / premium payments do. As such, there is no change to existing rules, which states the following for general interest rate risk [BSD S 2/04, pg24]. Clarification on this would be appreciated.
A.18 The position risk treatment of credit default swaps will be as set out in Annex I, Paragraph 8 of Directive 2006/49 and not BSD S 2/04.
Q.19 Real Estate Collateral 1 - One of the conditions to be met for real estate collateral to be recognised as eligible collateral is as follows;"the risk of the borrower is not materially dependent upon the performance of the underlying property or project, but rather on the underlying capacity of the borrower to repay the debt from other sources. As such, repayment of the facility does not materially depend on any cash flow generated by the underlying property serving as collateral" Many real estate loans relate to income-generating property assets, which have collateral underpinning the loan which is independent of the borrower’s own repayment capacity. Can the underlying real estate underlying such loans still qualify for credit risk mitigation purposes?
A.19 Eligible real estate collateral should comply with the minimum requirements set out in Annex VIII, Part 2, Section 1.4 and the eligibility requirements for real estate collateral as set out in Annex VIII, Part 1, Section 1.3.3. . In addition the bank must comply with the valuation criteria for real estate collateral as set out in Annex VIII, Part 3, Section 1.5.1. In this regard the value of the real estate collateral should take account of any prior claims on the property. Banks operating under the IRB Approach should note that certain types of income-producing Real Estate financing may be classified as ‘specialised lending’ exposures if they possess the characteristics outlined in Article 86(6) of Directive 2006/48 (Regulation 31(7) of SI 661)
Q.20 Real Estate Collateral 2 - Part 1 Annex VIII, Paragraph 13 states residential real estate may be recognised as eligible collateral where…."the risk of the borrower is not materially dependent upon the performance of the underlying property or project, but rather on the underlying capacity of the borrower to repay the debt from other sources”. Does this, as it appears to, invalidate the impact of real estate collateral as credit risk mitigation on LGDs unless the borrower is, independently of the underlying property, capable of repaying the debt?
A.20 Eligible real estate collateral should comply with the minimum requirements set out in Annex VIII, Part 2, Section 1.4 and the eligibility requirements for real estate collateral as set out in Annex VIII, Part 1, Section 1.3.3. . In addition the bank must comply with the valuation criteria for real estate collateral as set out in Annex VIII, Part 3, Section 1.5.1. In this regard the value of the real estate collateral should take account of any prior claims on the property. Banks operating under the IRB Approach should note that certain types of income-producing Real Estate financing may be classified as ‘specialised lending’ exposures if they possess the characteristics outlined in Article 86(6) of Directive 2006/48 (Regulation 31(7) of SI 661)
Q.21 Gross Income Figures and Op. Risk Charges - For the Basic Indicator Approach [BIA] and the Standardised Approach [TSA] to operational risk, gross income is used as the exposure indicator. For the TSA for example, the average of the annual gross income for each of the previous three years is used.It is our working assumption that the gross income figures are not required to be audited. The resulting operational risk charge would however be subject to review by the person /body that undertakes a review of the ‘Self Assessment’.Is this in line with the Regulator’s thinking or should the gross income figures by extracted from the audited accounts? If this is the case, for the 2008 charge, the figures from 2004, 2005 & 2005 would be used (2007 would not be audited until Q1 2008).
A.21 In respect of gross income:Annex X, Part 1, para 3, in relation to the Basic Indicator Approach, states, “The three year average is calculated on the basis of the last three twelve-monthly observations at the end of the financial year. When audited figures are not available business estimates may be used”. Annex X, Part 2, para 2, in relation to the Standardised Approach, states, “The three year average is calculated on the basis of the last three twelve-monthly observations at the end of the financial year. When audited figures are not available, business estimates may be used”. Therefore as stated above, audited figures should be used when calculating the operational risk charge and if audited figures are not available, business estimates may be used. The purpose of the self assessment for the use of the Standardised Approach to operational risk is to ensure that the qualifying criteria in Annex X, Part 2, para 12 along with the general criteria in Article 22 and Annex V have been implemented in the credit institution at the time that the institution moves on to the CRD.
Q.22 Article 89(7) - Institutions adopting the Standardised Approach to Credit Risk may avail of Article 80(7) which allows for a zero risk weight for intra-group exposures, provided the following conditions are met:
- The counterparty is an institution or financial holding company, financial institution, asset management company or ancillary services undertaking subject to appropriate prudential requirements,
- The counterparty is included in the same consolidation as the credit institution on a full basis,
- The counterparty is subject to the same risk evaluation, measurement and control procedures as the credit institution
- The counterparty is established in the same Member State as the credit institution and
- There is no current or foreseen material, practical or legal impediments to the prompt transfer of own funds of repayment of liabilities from the counterparty to the credit institution.
The Irish Regulator will be applying this discretion subject to prior written approval. The fifth condition noted above suggests that while qualification for the amended-solo provision does not guarantee qualification for this provision, the entity must qualify for the amended solo provision to qualify for this provision (given that this requirement must also be satisfied for the amended-solo provision). Is this correct? If this is the case, does this mean that institutions should hold-off submitting their applications until the amended-solo issue is resolved?
A.22 It may cause confusion to directly link the fifth condition listed here with the qualification for amended solo reporting under Article 70. As the criteria for each are different both discretions will be examined separately. Therefore banks wishing to avail of this discretion should apply through their line examiners in the normal way. As noted in the Financial Regulator’s CRD Implementation notice, application for use should be made six months before an institutions adoption of the CRD capital framework and should set out the entities to which they wish the treatment to apply and how in each case the relevant criteria of Article 80(7) are met. When applying for the Article 80(7) discretion, the Financial Regulator will require a cover letter signed by a member of the Board that clearly confirms that the criteria in Article 80(7) are satisfied
Q.23 Specific Risk Charge using the IRB Approach - Annex I of Directive 2006/49/EC, paragraph 14 states: “debt securities issues or guaranteed by central governments, issued by central banks, international organizations…..which would qualify under credit quality step 1 or which would receive a 0% risk weight under the rules for the risk weighting of exposures under Articles 78-83 of Directive 2006/48/EC. Clarification is sought as to how this can apply where an institution is applying the IRB approach to credit risk.
A.23 Annex 1, Paragraph 14 of 2006/49/EC further advises that: For institutions which apply the rules for the risk weighting of exposures under Articles 84 to 89 of Directive 2006/48/EC, to qualify for a credit quality step the obligor of the exposure shall have an internal rating with a PD equivalent to or lower than that associated with the appropriate credit quality step under the rules for the risk weighting of exposures to corporates under Articles 78 to 83 of that Directive.
Q.24 Original Effective Maturity - Annex VI: Part 1, paragraph 28 states that exposures to institutions with an original effective maturity of three months or less shall be assigned a risk weight of 20%. Is effective maturity determined by the original maturity of the exposure, the residual maturity of the exposure or the remaining maturity as of when the reporting institution acquired the exposure? For example, on 31/12/06, Bank A buys a 10 yr bond with 2 years left to maturity. If the bank is reporting for 31/03/07 what is the “original effective maturity” of the exposure
- 10 yrs; i.e. the original maturity of the bond
- 21 months i.e. the residual maturity
- 2 yrs; i.e. the maturity of the bond as of when it was purchased by Bank A
A.24 Please refer to answers given to Questions 149 and 150 of the CRD TG.