In this Consultation Paper (CP), the Prudential Regulation Authority (PRA) sets out its proposed changes to Supervisory Statement (SS) 17/13 ‘Credit risk mitigation’ to clarify expectations regarding the eligibility of financial collateral as funded credit protection under Part Three, Title II, Chapter 4 (Credit risk mitigation) of the Capital Requirements Regulation (575/2013) (CRR).
This CP is relevant to UK banks, building societies and PRA-designated UK investment firms that are subject to the CRR.
The criteria for recognising collateral as eligible for credit risk mitigation (CRM) purposes are set out in CRR Part Three, Title II, Chapter 4 (Credit risk mitigation). Where the collateral is financial collateral, these criteria include that ‘the credit quality of the obligor and the value of the collateral shall not have a material positive correlation’ (CRR Article 207(2)).
In relation to non-recourse loans, in some cases a significant fall in the value of the financial collateral can itself bring about the default of the obligor. As such the creditworthiness of the obligor can depend materially on the value of the financial collateral. The risk mitigation provided by such collateral may be compromised and Article 207(2) is relevant. In the PRA’s view the CRR is clear on this point. However the PRA has identified some variability in how firms interpret and apply the Article 207(2) requirement.
The PRA considers it necessary to clarify both how Article 207(2) applies in such circumstances, and the PRA’s expectations of how firms should treat collateral with a material positive correlation for CRM purposes.
The CP proposes adding a new chapter to SS17/13, set out in the Appendix.
Please note: In February 2018, CP6/18 ‘Credit risk mitigation: Eligibility of guarantees as unfunded credit protection’ proposed adding a Chapter 7 to SS17/13, so this CP proposes adding Chapter 8, subject to the outcome of CP6/18.
Responses and next steps
This consultation closes on Wednesday 10 April 2019. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP1_19@bankofengland.co.uk.