Directive 2006/48/EC of the European Parliament and of the council (repealed)Show full title

PART 2 Minimum Requirements

1. The credit institution must satisfy the competent authorities that it has adequate risk management processes to control those risks to which the credit institution may be exposed as a result of carrying out credit risk mitigation practices.

2. Notwithstanding the presence of credit risk mitigation taken into account for the purposes of calculating risk‐weighted exposure amounts and as relevant expected loss amounts, credit institutions shall continue to undertake full credit risk assessment of the underlying exposure and be in a position to demonstrate the fulfilment of this requirement to the competent authorities. In the case of repurchase transactions and/or securities or commodities lending or borrowing transactions the underlying exposure shall, for the purposes of this point only, be deemed to be the net amount of the exposure.

1. FUNDED CREDIT PROTECTION

1.1. On-balance sheet netting agreements (other than master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions and/or other capital market-driven transactions).

3. For on-balance sheet netting agreements — other than master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions and/or other capital market-driven transactions — to be recognised for the purposes of Articles 90 to 93, the following conditions shall be satisfied:

(a)

they must be legally effective and enforceable in all relevant jurisdictions, including in the event of the insolvency or bankruptcy of a counterparty;

(b)

the credit institution must be able to determine at any time those assets and liabilities that are subject to the on-balance sheet netting agreement;

(c)

the credit institution must monitor and control the risks associated with the termination of the credit protection; and

(d)

the credit institution must monitor and control the relevant exposures on a net basis.

1.2. Master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions

4. For master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions to be recognised for the purposes of Articles 90 to 93, they shall:

(a)

be legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or insolvency of the counterparty;

(b)

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; and

(c)

provide for the netting of gains and losses on transactions closed out under a master agreement so that a single net amount is owed by one party to the other.

5. In addition, the minimum requirements for the recognition of financial collateral under the Financial Collateral Comprehensive Method set out in point 6 shall be fulfilled.

1.3. Financial collateral

1.3.1. Minimum requirements for the recognition of financial collateral under all Approaches and Methods

6. For the recognition of financial collateral and gold, the following conditions shall be met.

(a)

Low correlation

The credit quality of the obligor and the value of the collateral must not have a material positive correlation.

Securities issued by the obligor, or any related group entity, are not eligible. This notwithstanding, the obligor's own issues of covered bonds falling within the terms of Annex VI, Part 1, points 68 to 70 may be recognised as eligible when they are posted as collateral for repurchase transactions, provided that the first paragraph of this point is complied with.

(b)

Legal certainty

Credit institutions shall fulfil any contractual and statutory requirements in respect of, and take all steps necessary to ensure, the enforceability of the collateral arrangements under the law applicable to their interest in the collateral.

Credit institutions shall have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions. They shall re‐conduct such review as necessary to ensure continuing enforceability.

(c)

Operational requirements

The collateral arrangements shall be properly documented, with a clear and robust procedure for the timely liquidation of collateral.

Credit institutions shall employ robust procedures and processes to control risks arising from the use of collateral — including risks of failed or reduced credit protection, valuation risks, risks associated with the termination of the credit protection, concentration risk arising from the use of collateral and the interaction with the credit institution's overall risk profile.

The credit institution shall have documented policies and practices concerning the types and amounts of collateral accepted.

Credit institutions shall calculate the market value of the collateral, and revalue it accordingly, with a minimum frequency of once every six months and whenever the credit institution has reason to believe that there has occurred a significant decrease in its market value.

Where the collateral is held by a third party, credit institutions must take reasonable steps to ensure that the third party segregates the collateral from its own assets.

1.3.2. Additional minimum requirements for the recognition of financial collateral under the Financial Collateral Simple Method

7. In addition to the requirements set out in point 6, for the recognition of financial collateral under the Financial Collateral Simple Method the residual maturity of the protection must be at least as long as the residual maturity of the exposure.

1.4. Minimum requirements for the recognition of real estate collateral

8. For the recognition of real estate collateral the following conditions shall be met.

(a)

Legal certainty

The mortgage or charge shall be enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement, and the mortgage or charge shall be properly filed on a timely basis. The arrangements shall reflect a perfected lien (i.e. all legal requirements for establishing the pledge shall been fulfilled). The protection agreement and the legal process underpinning it shall enable the credit institution to realise the value of the protection within a reasonable timeframe.

(b)

Monitoring of property values

The value of the property shall be monitored on a frequent basis and at a minimum once every year for commercial real estate and once every three years for residential real estate. More frequent monitoring shall be carried out where the market is subject to significant changes in conditions. Statistical methods may be used to monitor the value of the property and to identify property that needs revaluation. The property valuation shall be reviewed by an independent valuer when information indicates that the value of the property may have declined materially relative to general market prices. For loans exceeding EUR 3 million or 5 % of the own funds of the credit institution, the property valuation shall be reviewed by an independent valuer at least every three years.

‘Independent valuer’ shall mean a person who possesses the necessary qualifications, ability and experience to execute a valuation and who is independent from the credit decision process.

(c)

Documentation

The types of residential and commercial real estate accepted by the credit institution and its lending policies in this regard shall be clearly documented.

(d)

Insurance

The credit institution shall have procedures to monitor that the property taken as protection is adequately insured against damage.

1.5. Minimum requirements for the recognition of receivables as collateral

9. For the recognition of receivables as collateral the following conditions shall be met:

(a)

Legal certainty

(i)

The legal mechanism by which the collateral is provided shall be robust and effective and ensure that the lender has clear rights over the proceeds;

(ii)

Credit institutions must take all steps necessary to fulfil local requirements in respect of the enforceability of security interest. There shall be a framework which allows the lender to have a first priority claim over the collateral subject to national discretion to allow such claims to be subject to the claims of preferential creditors provided for in legislative or implementing provisions;

(iii)

Credit institutions shall have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions; and

(iv)

The collateral arrangements must be properly documented, with a clear and robust procedure for the timely collection of collateral. Credit institution's procedures shall ensure that any legal conditions required for declaring the default of the borrower and timely collection of collateral are observed. In the event of the borrower's financial distress or default, the credit institution shall have legal authority to sell or assign the receivables to other parties without consent of the receivables obligors.

(b)

Risk management

(i)

The credit institution must have a sound process for determining the credit risk associated with the receivables. Such a process shall include, among other things, analyses of the borrower's business and industry and the types of customers with whom the borrower does business. Where the credit institution relies on the borrower to ascertain the credit risk of the customers, the credit institution must review the borrower's credit practices to ascertain their soundness and credibility;

(ii)

The margin between the amount of the exposure and the value of the receivables must reflect all appropriate factors, including the cost of collection, concentration within the receivables pool pledged by an individual borrower, and potential concentration risk within the credit institution's total exposures beyond that controlled by the credit institution's general methodology. The credit institution must maintain a continuous monitoring process appropriate to the receivables. Additionally, compliance with loan covenants, environmental restrictions, and other legal requirements shall be reviewed on a regular basis;

(iii)

The receivables pledged by a borrower shall be diversified and not be unduly correlated with the borrower. Where there is material positive correlation, the attendant risks shall be taken into account in the setting of margins for the collateral pool as a whole;

(iv)

Receivables from affiliates of the borrower (including subsidiaries and employees) shall not be recognised as risk mitigants; and

(v)

The credit institution shall have a documented process for collecting receivable payments in distressed situations. The requisite facilities for collection shall be in place, even when the credit institution normally looks to the borrower for collections.

1.6. Minimum requirements for the recognition of other physical collateral

10. For the recognition of other physical collateral the following conditions shall be met:

(a)

the collateral arrangement shall be legally effective and enforceable in all relevant jurisdictions and shall enable the credit institution to realise the value of the property within a reasonable timeframe;

(b)

with the sole exception of permissible prior claims referred to in point 9(a)(ii), only first liens on, or charges over, collateral are permissible. As such, the credit institution shall have priority over all other lenders to the realised proceeds of the collateral;

(c)

the value of the property shall be monitored on a frequent basis and at a minimum once every year. More frequent monitoring shall be required where the market is subject to significant changes in conditions;

(d)

the loan agreement shall include detailed descriptions of the collateral plus detailed specifications of the manner and frequency of revaluation;

(e)

the types of physical collateral accepted by the credit institution and policies and practices in respect of the appropriate amount of each type of collateral relative to the exposure amount shall be clearly documented in internal credit policies and procedures available for examination;

(f)

the credit institution's credit policies with regard to the transaction structure shall address appropriate collateral requirements relative to the exposure amount, the ability to liquidate the collateral readily, the ability to establish objectively a price or market value, the frequency with which the value can readily be obtained (including a professional appraisal or valuation), and the volatility or a proxy of the volatility of the value of the collateral;

(g)

both initial valuation and revaluation shall take fully into account any deterioration or obsolescence of the collateral. Particular attention must be paid in valuation and revaluation to the effects of the passage of time on fashion- or date-sensitive collateral;

(h)

the credit institution must have the right to physically inspect the property. It shall have policies and procedures addressing its exercise of the right to physical inspection; and

(i)

the credit institution must have procedures to monitor that the property taken as protection is adequately insured against damage.

1.7. Minimum requirements for treating lease exposures as collateralised

11. For the exposures arising from leasing transactions to be treated as collateralised by the type of property leased, the following conditions shall be met:

(a)

the conditions set out in points 8 or 10 as appropriate for the recognition as collateral of the type of property leased shall be met;

(b)

there shall be robust risk management on the part of the lessor with respect to the use to which the leased asset is put, its age and the planned duration of its use, including appropriate monitoring of the value of the security;

(c)

there shall be in place a robust legal framework establishing the lessor's legal ownership of the asset and its ability to exercise its rights as owner in a timely fashion; and

(d)

where this has not already been ascertained in calculating the LGD level, the difference between the value of the unamortised amount and the market value of the security must not be so large as to overstate the credit risk mitigation attributed to the leased assets.

1.8. Minimum requirements for the recognition of other funded credit protection

1.8.1. Cash on deposit with, or cash assimilated instruments held by, a third party institution

12. To be eligible for the treatment set out at Part 3, point 79, the protection referred to in Part 1, point 23 must satisfy the following conditions:

(a)

the borrower's claim against the third party institution is openly pledged or assigned to the lending credit institution and such pledge or assignment is legally effective and enforceable in all relevant jurisdictions;

(b)

the third party institution is notified of the pledge or assignment;

(c)

as a result of the notification, the third party institution is able to make payments solely to the lending credit institution or to other parties with the lending credit institution's consent; and

(d)

the pledge or assignment is unconditional and irrevocable.

1.8.2. Life insurance policies pledged to the lending credit institution.

13. For life insurance policies pledged to the lending credit institution to be recognised the following conditions shall be met:

(a)

the company providing the life insurance may be recognised as an eligible unfunded credit protection provider under Part 1, point 26;

(b)

the life insurance policy is openly pledged or assigned to the lending credit institution;

(c)

the company providing the life insurance is notified of the pledge or assignment and as a result may not pay amounts payable under the contract without the consent of the lending credit institution;

(d)

the declared surrender value of the policy is non-reducible;

(e)

the lending credit institution must have the right to cancel the policy and receive the surrender value in a timely way in the event of the default of the borrower;

(f)

the lending credit institution is informed of any non-payments under the policy by the policy-holder;

(g)

the credit protection must be provided for the maturity of the loan. Where this is not possible because the insurance relationship ends before the loan relationship expires, the credit institution must ensure that the amount deriving from the insurance contract serves the credit institution as security until the end of the duration of the credit agreement; and

(h)

the pledge or assignment must be legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

2. UNFUNDED CREDIT PROTECTION AND CREDIT LINKED NOTES

2.1. Requirements common to guarantees and credit derivatives

14. Subject to point 16, for the credit protection deriving from a guarantee or credit derivative to be recognised the following conditions shall be met:

(a)

the credit protection shall be direct;

(b)

the extent of the credit protection shall be clearly defined and incontrovertible;

(c)

the credit protection contract shall not contain any clause, the fulfilment of which is outside the direct control of the lender, that:

(i)

would allow the protection provider unilaterally to cancel the protection;

(ii)

would increase the effective cost of protection as a result of deteriorating credit quality of the protected exposure;

(iii)

could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original obligor fails to make any payments due; or

(iv)

could allow the maturity of the credit protection to be reduced by the protection provider; and

(d)

it must be legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

2.1.1. Operational requirements

15. The credit institution shall satisfy the competent authority that it has systems in place to manage potential concentration of risk arising from the credit institution's use of guarantees and credit derivatives. The credit institution must be able to demonstrate how its strategy in respect of its use of credit derivatives and guarantees interacts with its management of its overall risk profile.

2.2. Sovereign and other public sector counter‐guarantees

16. Where an exposure is protected by a guarantee which is counter‐guaranteed by a central government or central bank, a regional government or local authority, a public sector entity, claims on which are treated as claims on the central government in whose jurisdiction they are established under Articles 78 to 83, a multi-lateral development bank to which a 0 % risk weight is assigned under or by virtue of Articles 78 to 83, or a public sector entity, claims on which are treated as claims on credit institutions under Articles 78 to 83, the exposure may be treated as protected by a guarantee provided by the entity in question, provided the following conditions are satisfied:

(a)

the counter‐guarantee covers all credit risk elements of the claim;

(b)

both the original guarantee and the counter‐guarantee meet the requirements for guarantees set out in points 14, 15 and 18, except that the counter‐guarantee need not be direct; and

(c)

the competent authority is satisfied that the cover is robust and that nothing in the historical evidence suggests that the coverage of the counter‐guarantee is less than effectively equivalent to that of a direct guarantee by the entity in question.

17. The treatment set out in point 16 also applies to an exposure which is not counter‐guaranteed by an entity listed in that point if that exposure's counter‐guarantee is in turn directly guaranteed by one of the listed entities and the conditions listed in that point are satisfied.

2.3. Additional requirements for guarantees

18. For a guarantee to be recognised the following conditions shall also be met:

(a)

on the qualifying default of and/or non-payment by the counterparty, the lending credit institution shall have the right to pursue, in a timely manner, the guarantor for any monies due under the claim in respect of which the protection is provided. Payment by the guarantor shall not be subject to the lending credit institution first having to pursue the obligor.

In the case of unfunded credit protection covering residential mortgage loans, the requirements in point 14(c)(iii) and in the first subparagraph of this point have only to be satisfied within 24 months;

(b)

the guarantee shall be an explicitly documented obligation assumed by the guarantor; and

(c)

subject to the following sentence, the guarantee shall cover all types of payments the obligor is expected to make in respect of the claim. Where certain types of payment are excluded from the guarantee, the recognised value of the guarantee shall be adjusted to reflect the limited coverage.

19. In the case of guarantees provided in the context of mutual guarantee schemes recognised for these purposes by the competent authorities or provided by or counter‐guaranteed by entities referred to in point 16, the requirements in point 18(a) shall be considered to be satisfied where either of the following conditions are met:

(a)

the lending credit institution has the right to obtain in a timely manner a provisional payment by the guarantor calculated to represent a robust estimate of the amount of the economic loss, including losses resulting from the non‐payment of interest and other types of payment which the borrower is obliged to make, likely to be incurred by the lending credit institution proportional to the coverage of the guarantee; or

(b)

the lending credit institution can demonstrate that the loss-protecting effects of the guarantee, including losses resulting from the non-payment of interest and other types of payments which the borrower is obliged to make, justify such treatment.

2.4. Additional requirements for credit derivatives

20. For a credit derivative to be recognised the following conditions shall also be met:

(a)

subject to point (b), the credit events specified under the credit derivative shall at a minimum include:

(i)

the failure to pay the amounts due under the terms of the underlying obligation that are in effect at the time of such failure (with a grace period that is closely in line with or shorter than the grace period in the underlying obligation);

(ii)

the bankruptcy, insolvency or inability of the obligor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; and

(iii)

the restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that results in a credit loss event (i.e. value adjustment or other similar debit to the profit and loss account);

(b)

where the credit events specified under the credit derivative do not include restructuring of the underlying obligation as described in point (a)(iii), the credit protection may nonetheless be recognised subject to a reduction in the recognised value as specified in point 83 of Part 3;

(c)

in the case of credit derivatives allowing for cash settlement, a robust valuation process shall be in place in order to estimate loss reliably. There shall be a clearly specified period for obtaining post-credit-event valuations of the underlying obligation;

(d)

if the protection purchaser's right and ability to transfer the underlying obligation to the protection provider is required for settlement, the terms of the underlying obligation shall provide that any required consent to such transfer may not be unreasonably withheld; and

(e)

the identity of the parties responsible for determining whether a credit event has occurred shall be clearly defined. This determination shall not be the sole responsibility of the protection provider. The protection buyer shall have the right/ability to inform the protection provider of the occurrence of a credit event.

21. A mismatch between the underlying obligation and the reference obligation under the credit derivative (i.e. the obligation used for the purposes of determining cash settlement value or the deliverable obligation) or between the underlying obligation and the obligation used for purposes of determining whether a credit event has occurred is permissible only if the following conditions are met:

(a)

the reference obligation or the obligation used for purposes of determining whether a credit event has occurred, as the case may be, ranks pari passu with or is junior to the underlying obligation; and

(b)

the underlying obligation and the reference obligation or the obligation used for purposes of determining whether a credit event has occurred, as the case may be, share the same obligor (i.e., the same legal entity) and there are in place legally enforceable cross-default or cross-acceleration clauses.

2.5. Requirements to qualify for the treatment set out in Annex VII, Part 1, point 4

22. To be eligible for the treatment set out in Annex VII, Part 1, point 4, credit protection deriving from a guarantee or credit derivative shall meet the following conditions:

(a)

the underlying obligation shall be to:

• a corporate exposure as defined in Article 86, excluding insurance and reinsurance undertakings;

• an exposure to a regional government, local authority or Public Sector Entity which is not treated as an exposure to a central government or a central bank according to Article 86; or

• an exposure to a small or medium sized entity, classified as a retail exposure according to Article 86(4);

(b)

the underlying obligors shall not be members of the same group as the protection provider;

(c)

the exposure shall be hedged by one of the following instruments:

• single-name unfunded credit derivatives or single-name guarantees,

• first-to-default basket products — the treatment shall be applied to the asset within the basket with the lowest risk‐weighted exposure amount, or

• n^th-to-default basket products — the protection obtained is only eligible for consideration under this framework if eligible (n-1)th default protection has also be obtained or where (n-1) of the assets within the basket has/have already defaulted. Where this is the case the treatment shall be applied to the asset within the basket with the lowest risk‐weighted exposure amount;

(d)

the credit protection meets the requirements set out in points 14, 15, 18, 20 and 21;

(e)

the risk weight that is associated with the exposure prior to the application of the treatment in Annex VII, Part 1, point 4, does not already factor in any aspect of the credit protection;

(f)

a credit institution shall have the right and expectation to receive payment from the protection provider without having to take legal action in order to pursue the counterparty for payment. To the extent possible, a credit institution shall take steps to satisfy itself that the protection provider is willing to pay promptly should a credit event occur;

(g)

the purchased credit protection shall absorb all credit losses incurred on the hedged portion of an exposure that arise due to the occurrence of credit events outlined in the contract;

(h)

if the payout structure provides for physical settlement, then there shall be legal certainty with respect to the deliverability of a loan, bond, or contingent liability. If a credit institution intends to deliver an obligation other than the underlying exposure, it shall ensure that the deliverable obligation is sufficiently liquid so that the credit institution would have the ability to purchase it for delivery in accordance with the contract;

(i)

the terms and conditions of credit protection arrangements shall be legally confirmed in writing by both the protection provider and the credit institution;

(j)

credit institutions shall have a process in place to detect excessive correlation between the creditworthiness of a protection provider and the obligor of the underlying exposure due to their performance being dependent on common factors beyond the systematic risk factor; and

(k)

in the case of protection against dilution risk, the seller of purchased receivables shall not be a member of the same group as the protection provider.