Netting and Stock Lending - CRR Provision: Difference between revisions
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The amount of regulatory capital that has to be held is expressed as a percentage of the “'''total risk exposure amount'''” (Art. {{crrprov|92(2)}} of | The amount of regulatory capital that has to be held is expressed as a percentage of the “'''total risk exposure amount'''” (Art. {{crrprov|92(2)}} of [[CRR]]). | ||
{{crrsnap|92(2)}} | {{crrsnap|92(2)}} | ||
The '''total risk exposure amount''' includes the counterparty risk associated with | The '''total risk exposure amount''' includes the counterparty risk associated with [[securities lending}} transactions in the trading book (Art. {{crrprov|92(3)(f)}} of {{tag|CRR]]). | ||
{{crrsnap|92(3)(f)}} | {{crrsnap|92(3)(f)}} | ||
Under the standardised approach, the regulatory capital charge is determined by risk weighting the “'''exposure value'''” of the item in question (Art. {{crrprov|113}} of | Under the standardised approach, the regulatory capital charge is determined by risk weighting the “'''exposure value'''” of the item in question (Art. {{crrprov|113}} of [[CRR]]). | ||
{{crrsnap|113}} | {{crrsnap|113}} | ||
The '''exposure value''' of a | The '''exposure value''' of a [[securities lending}} transaction is determined in accordance with '''Chapter 4''' or '''Chapter 6''' of Part 3, Title II (Art. {{crrprov|111(2)}} of {{tag|CRR]]). | ||
{{crrsnap|111(2)}} | {{crrsnap|111(2)}} | ||
The firm can choose which Chapter to apply (Art. {{crrprov|271(2)}} of | The firm can choose which Chapter to apply (Art. {{crrprov|271(2)}} of [[CRR]]) | ||
{crrsnap|271(2)}} | {crrsnap|271(2)}} | ||
Under Chapter 4, the cash received under a | Under Chapter 4, the cash received under a [[securities lending}} transaction is to be treated as collateral (Art. {{crrprov|193(4)}} of {{tag|CRR]]). | ||
{{crrsnap|193(4)}} | {{crrsnap|193(4)}} | ||
Under Chapter 6, the exposure value can be determined by using an internal model, assuming that the firm has regulatory approval for the use of such a model (Art. {{crrprov|273(2)}} of | Under Chapter 6, the exposure value can be determined by using an internal model, assuming that the firm has regulatory approval for the use of such a model (Art. {{crrprov|273(2)}} of [[CRR]]) or by one of the methods set out in that Chapter. | ||
{{crrsnap|273(2)}} | {{crrsnap|273(2)}} | ||
Although not expressly stated in relation to stock loans, these apply certain methodologies to particular “contracts” or “transactions”. | Although not expressly stated in relation to stock loans, these apply certain methodologies to particular “contracts” or “transactions”. | ||
A securities lending transaction is, both legally and economically a single transaction and is treated as such under | A securities lending transaction is, both legally and economically a single transaction and is treated as such under [[CRR}} (see, for example, Art. {{crrprov|92(3)(f)]]). | ||
{{crrsnap|92(3)(f)}} | {{crrsnap|92(3)(f)}} | ||
Where the conditions referred to in Art. {{crrprov|206}} of | Where the conditions referred to in Art. {{crrprov|206}} of [[CRR]] are satisfied, [[netting]] arrangements are recognised. | ||
{{crrsnap|206}} | {{crrsnap|206}} | ||
However, if those conditions are not satisfied, the exposure is calculated without giving effect to any close-out netting agreement that may exists, i.e. each transaction is treated individually. | However, if those conditions are not satisfied, the exposure is calculated without giving effect to any close-out netting agreement that may exists, i.e. each transaction is treated individually. | ||
Latest revision as of 11:46, 13 August 2024
The amount of regulatory capital that has to be held is expressed as a percentage of the “total risk exposure amount” (Art. 92(2) of CRR). 92(2) Institutions shall calculate their capital ratios as follows:
- (a) the Common Equity Tier 1 capital ratio is the Common Equity Tier 1 capital of the institution expressed as a percentage of the total risk exposure amount;
- (b) the Tier 1 capital ratio is the Tier 1 capital of the institution expressed as a percentage of the total risk exposure amount;
- (c) the total capital ratio is the own funds of the institution expressed as a percentage of the total risk exposure amount.
The total risk exposure amount includes the counterparty risk associated with [[securities lending}} transactions in the trading book (Art. 92(3)(f) of {{tag|CRR]]).
92(3)(f) the risk weighted exposure amounts determined in accordance with Title II for counterparty risk arising from the trading book business of the institution for the following types of transactions and agreements:
- (i) contracts listed in Annex II and credit derivatives;
- (ii) repurchase transactions, securities or commodities lending or borrowing transactions based on securities or commodities;
- (iii) margin lending transactions based on securities or commodities;
- (iv) long settlement transactions.
Under the standardised approach, the regulatory capital charge is determined by risk weighting the “exposure value” of the item in question (Art. 113 of CRR).
113: Calculation of risk weighted exposure amounts
1. To calculate risk-weighted exposure amounts, risk weights shall be applied to all exposures, unless deducted from own funds, in accordance with the provisions of Section 2. The application of risk weights shall be based on the exposure class to which the exposure is assigned and, to the extent specified in Section 2, its credit quality. Credit quality may be determined by reference to the credit assessments of ECAIs or the credit assessments of Export Credit Agencies in accordance with Section 3.
2. For the purposes of applying a risk weight, as referred to in paragraph 1, the exposure value shall be multiplied by the risk weight specified or determined in accordance with Section 2.
3. Where an exposure is subject to credit protection the risk weight applicable to that item may be amended in accordance with Chapter 4.
4. Risk-weighted exposure amounts for securitised exposures shall be calculated in accordance with Chapter 5.
5. Exposures for which no calculation is provided in Section 2 shall be assigned a risk-weight of 100 %.
6. With the exception of exposures giving rise to Common Equity Tier 1, Additional Tier 1 or Tier 2 items, an institution may, subject to the prior approval of the competent authorities, decide not to apply the requirements of paragraph 1 of this Article to the exposures of that institution to a counterparty which is its parent undertaking, its subsidiary, a subsidiary of its parent undertaking or an undertaking linked by a relationship within the meaning of Article 12(1) of Directive 83/349/EEC. Competent authorities are empowered to grant approval if the following conditions are fulfilled:(a)
the counterparty is an institution, a financial holding company or a mixed financial holding company, financial institution, asset management company or ancillary services undertaking subject to appropriate prudential requirements;
- (b) the counterparty is included in the same consolidation as the institution on a full basis;
- (c) the counterparty is subject to the same risk evaluation, measurement and control procedures as the institution;
- (d) the counterparty is established in the same Member State as the institution;
- (e) there is no current or foreseen material practical or legal impediment to the prompt transfer of own funds or repayment of liabilities from the counterparty to the institution.
Where the institution, in accordance with this paragraph, is authorised not to apply the requirements of paragraph 1, it may assign a risk weight of 0 %.
7. With the exception of exposures giving rise to Common Equity Tier 1, Additional Tier 1 and Tier 2 items, institutions may, subject to the prior permission of the competent authorities, not apply the requirements of paragraph 1 of this Article to exposures to counterparties with which the institution has entered into an institutional protection scheme that is a contractual or statutory liability arrangement which protects those institutions and in particular ensures their liquidity and solvency to avoid bankruptcy where necessary. Competent authorities are empowered to grant permission if the following conditions are fulfilled:(a)
the requirements set out in points (a), (d) and (e) of paragraph 6 are met;
- (b) the arrangements ensure that the institutional protection scheme is able to grant support necessary under its commitment from funds readily available to it;
- (c) the institutional protection scheme disposes of suitable and uniformly stipulated systems for the monitoring and classification of risk, which gives a complete overview of the risk situations of all the individual members and the institutional protection scheme as a whole, with corresponding possibilities to take influence; those systems shall suitably monitor defaulted exposures in accordance with Article 178(1);
- (d) the institutional protection scheme conducts its own risk review which is communicated to the individual members;
- (e) the institutional protection scheme draws up and publishes on an annual basis, a consolidated report comprising the balance sheet, the profit-and-loss account, the situation report and the risk report, concerning the institutional protection scheme as a whole, or a report comprising the aggregated balance sheet, the aggregated profit-and-loss account, the situation report and the risk report, concerning the institutional protection scheme as a whole;
- (f) members of the institutional protection scheme are obliged to give advance notice of at least 24 months if they wish to end the institutional protection scheme;
- (g) the multiple use of elements eligible for the calculation of own funds (hereinafter referred to as ‧multiple gearing‧) as well as any inappropriate creation of own funds between the members of the institutional protection scheme shall be eliminated;
- (h) The institutional protection scheme shall be based on a broad membership of credit institutions of a predominantly homogeneous business profile;
- (i) the adequacy of the systems referred to in points (c) and (d) is approved and monitored at regular intervals by the relevant competent authorities.
Where the institution, in accordance with this paragraph, decides not to apply the requirements of paragraph 1, it may assign a risk weight of 0 %.
The exposure value of a [[securities lending}} transaction is determined in accordance with Chapter 4 or Chapter 6 of Part 3, Title II (Art. 111(2) of CRR). 111(2). The exposure value of a derivative instrument listed in Annex II shall be determined in accordance with Chapter 6 with the effects of contracts of novation and other netting agreements taken into account for the purposes of those methods in accordance with Chapter 6. The exposure value of repurchase transaction, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions may be determined either in accordance with Chapter 6 or Chapter 4.
The firm can choose which Chapter to apply (Art. 271(2) of CRR) {crrsnap]] Under Chapter 4, the cash received under a [[securities lending}} transaction is to be treated as collateral (Art. 193(4) of {{tag|CRR]]). 193(4). Institutions shall treat cash, securities or commodities purchased, borrowed or received under a repurchase transaction or securities or commodities lending or borrowing transaction as collateral.
Under Chapter 6, the exposure value can be determined by using an internal model, assuming that the firm has regulatory approval for the use of such a model (Art. 273(2) of CRR) or by one of the methods set out in that Chapter. 273(2). Where permitted by the competent authorities in accordance with Article 283(1) and (2), an institution may determine the exposure value for the following items using the Internal Model Method set out in Section 6:
- (a) the contracts listed in Annex II;
- (b) repurchase transactions;
- (c) securities or commodities lending or borrowing transactions;
- (d) margin lending transactions;
- (e) long settlement transactions.
Although not expressly stated in relation to stock loans, these apply certain methodologies to particular “contracts” or “transactions”. A securities lending transaction is, both legally and economically a single transaction and is treated as such under [[CRR}} (see, for example, Art. {{crrprov|92(3)(f)]]).
92(3)(f) the risk weighted exposure amounts determined in accordance with Title II for counterparty risk arising from the trading book business of the institution for the following types of transactions and agreements:
- (i) contracts listed in Annex II and credit derivatives;
- (ii) repurchase transactions, securities or commodities lending or borrowing transactions based on securities or commodities;
- (iii) margin lending transactions based on securities or commodities;
- (iv) long settlement transactions.
Where the conditions referred to in Art. 206 of CRR are satisfied, netting arrangements are recognised.
Article 206 Requirements for master netting agreements covering repurchase transactions or securities or commodities lending or borrowing transactions or other capital market driven transactions
Master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions or other capital market driven transactions shall qualify as an eligible form of credit risk mitigation where the collateral provided under those agreements meets all the requirements laid down in Article 207(2) to (4) and where all the following conditions are met:
- (a) they are legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or insolvency of the counterparty;
- (b) they give the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon the event of default, including in the event of the bankruptcy or insolvency of the counterparty;
- (c) they provide for the netting of gains and losses on transactions closed out under an agreement so that a single net amount is owed by one party to the other.
However, if those conditions are not satisfied, the exposure is calculated without giving effect to any close-out netting agreement that may exists, i.e. each transaction is treated individually.
This is to be expected because netting arrangements are only recognised if they are legally enforceable. If they are not, the counterparties may have a gross exposure to each other due to the fact that an insolvency official may be able to “cherry pick” between individual transactions, i.e. disclaim unprofitable transactions while enforcing profitable ones.
- It would be very unusual for an insolvency official to be able to cherry pick individual rights and obligations within a single transaction. I am not aware of any jurisdiction in which this is possible and certainly it is not possible under English law.
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