Directive 2006/48/EC of the European Parliament and of the council (repealed)Show full title

1.4. Financial collateral

1.4.1. Financial Collateral Simple Method

24. The Financial Collateral Simple Method shall be available only where risk‐weighted exposure amounts are calculated under Articles 78 to 83. A credit institution shall not use both the Financial Collateral Simple Method and the Financial Collateral Comprehensive Method.

Valuation

25. Under this method, recognised financial collateral is assigned a value equal to its market value as determined in accordance with Part 2, point 6.

Calculating risk‐weighted exposure amounts

26. The risk weight that would be assigned under Articles 78 to 83 if the lender had a direct exposure to the collateral instrument shall be assigned to those portions of claims collateralised by the market value of recognised collateral. The risk weight of the collateralised portion shall be a minimum of 20 % except as specified in points 27 to 29. The remainder of the exposure shall receive the risk weight that would be assigned to an unsecured exposure to the counterparty under Articles 78 to 83.

Repurchase transactions and securities lending or borrowing transactions

27. A risk weight of 0 % shall be assigned to the collateralised portion of the exposure arising from transactions which fulfil the criteria enumerated in points 58 and 59. If the counterparty to the transaction is not a core market participant a risk weight of 10 % shall be assigned.

OTC derivative transactions subject to daily mark-to-market

28. A risk weight of 0 % shall, to the extent of the collateralisation, be assigned to the exposure values determined under Annex III for the derivative instruments listed in Annex IV and subject to daily marking-to-market, collateralised by cash or cash‐assimilated instruments where there is no currency mismatch. A risk weight of 10 % shall be assigned to the extent of the collateralisation to the exposure values of such transactions collateralised by debt securities issued by central governments or central banks which are assigned a 0 % risk weight under Articles 78 to 83.

For the purposes of this point debt securities issued by central governments or central banks shall include: –

(a)

debt securities issued by regional governments or local authorities exposures to which are treated as exposures to the central government in whose jurisdiction they are established under Articles 78 to 83;

(b)

debt securities issued by multilateral development banks to which a 0 % risk weight is assigned under or by virtue of Articles 78 to 83; and

(c)

debt securities issued by international organisations which are assigned a 0 % risk weight under Articles 78 to 83.

Other transactions

29. A 0 % risk weight may be assigned where the exposure and the collateral are denominated in the same currency, and either:

(a)

the collateral is cash on deposit or a cash assimilated instrument; or

(b)

the collateral is in the form of debt securities issued by central governments or central banks eligible for a 0 % risk weight under Articles 78 to 83, and its market value has been discounted by 20 %.

For the purposes of this point ‘debt securities issued by central governments or central banks’ shall to include those indicated under point 28.

1.4.2. Financial Collateral Comprehensive Method

30. In valuing financial collateral for the purposes of the Financial Collateral Comprehensive Method, ‘volatility adjustments’ shall be applied to the market value of collateral, as set out in points 34 to 59 below, in order to take account of price volatility.

31. Subject to the treatment for currency mismatches in the case of OTC derivatives transactions set out in point 32, where collateral is denominated in a currency that differs from that in which the underlying exposure is denominated, an adjustment reflecting currency volatility shall be added to the volatility adjustment appropriate to the collateral as set out in points 34 to 59.

32. In the case of OTC derivatives transactions covered by netting agreements recognised by the competent authorities under Annex III, a volatility adjustment reflecting currency volatility shall be applied when there is a mismatch between the collateral currency and the settlement currency. Even in the case where multiple currencies are involved in the transactions covered by the netting agreement, only a single volatility adjustment shall be applied.

(a) Calculating adjusted values

33. The volatility-adjusted value of the collateral to be taken into account is calculated as follows in the case of all transactions except those transactions subject to recognised master netting agreements to which the provisions set out in points 5 to 23 are applied:

C_VA = C x (1-H_C-H_FX)

The volatility-adjusted value of the exposure to be taken into account is calculated as follows:

E_VA = E x (1+H_E), and, in the case of OTC derivative transactions, E_{VA =} E.

The fully adjusted value of the exposure, taking into account both volatility and the risk‐mitigating effects of collateral is calculated as follows:

E* = max {0, [E_{VA -} C_VAM]}

Where:

E is the exposure value as would be determined under Articles 78 to 83 or Articles 84 to 89 as appropriate if the exposure was not collateralised. For this purpose, for credit institutions calculating risk‐weighted exposure amounts under Articles 78 to 83, the exposure value of off-balance sheet items listed in Annex II shall be 100 % of its value rather than the percentages indicated in Article 78(1), and for credit institutions calculating risk‐weighted exposure amounts under Articles 84 to 89, the exposure value of the items listed in Annex VII, Part 3, points 9 to 11 shall be calculated using a conversion factor of 100 % rather than the conversion factors or percentages indicated in those points.

E_VA is the volatility-adjusted exposure amount.

C_VA is the volatility-adjusted value of the collateral.

C_VAM is C_VA further adjusted for any maturity mismatch in accordance with the provisions of Part 4.

H_E is the volatility adjustment appropriate to the exposure (E), as calculated under points 34 to 59.

H_C is the volatility adjustment appropriate to the collateral, as calculated under points 34 to 59.

H_FX is the volatility adjustment appropriate to currency mismatch, as calculated under points 34 to 59.

E* is the fully adjusted exposure value taking into account volatility and the risk‐mitigating effects of the collateral.

(b) Calculation of volatility adjustments to be applied

34. Volatility adjustments may be calculated in two ways: the Supervisory volatility adjustments approach and the Own estimates of volatility adjustments approach (the ‘Own estimates’ approach).

35. A credit institution may choose to use the Supervisory volatility adjustments approach or the Own estimates approach independently of the choice it has made between the Articles 78 to 83 and Articles 84 to 89 for the calculation of risk‐weighted exposure amounts. However, if credit institutions seek to use the Own estimates approach, they must do so for the full range of instrument types, excluding immaterial portfolios where they may use the Supervisory volatility adjustments approach.

Where the collateral consists of a number of recognised items, the volatility adjustment shall be , where a_i is the proportion of an item to the collateral as a whole and H_i is the volatility adjustment applicable to that item.

(i) Supervisory volatility adjustments

36. The volatility adjustments to be applied under the Supervisory volatility adjustments approach (assuming daily revaluation) shall be those set out in Tables 1 to 4.

VOLATILITY ADJUSTMENTS

Table 1

Credit quality step with which the credit assessment of the debt security is associated	Residual Maturity	Volatility adjustments for debt securities issued by entities described in Part 1, point 7(b)			Volatility adjustments for debt securities issued by entities described in Part 1, point 7(c) and (d)
		20-day liquidation period ( %)	10-day liquidation period ( %)	5-day liquidation period ( %)	20-day liquidation period ( %)	10-day liquidation period ( %)	5-day liquidation period ( %)
1	≤ 1 year	0,707	0,5	0,354	1,414	1	0,707
	>1 ≤ 5 years	2,828	2	1,414	5,657	4	2,828
	> 5 years	5,657	4	2,828	11,314	8	5,657
2-3	≤ 1 year	1,414	1	0,707	2,828	2	1,414
	>1 ≤ 5 years	4,243	3	2,121	8,485	6	4,243
	> 5 years	8,485	6	4,243	16,971	12	8,485
4	≤ 1 year	21,213	15	10,607	N/A	N/A	N/A
	>1 ≤ 5 years	21,213	15	10,607	N/A	N/A	N/A
	> 5 years	21,213	15	10,607	N/A	N/A	N/A

Table 2

Credit quality step with which the credit assessment of a short term debt security is associated	Volatility adjustments for debt securities issued by entities described in Part 1, point 7(b) with short-term credit assessments			Volatility adjustments for debt securities issued by entities described in Part 1, point 7(c) and (d) with short-term credit assessments
	20-day liquidation period ( %)	10-day liquidation period ( %)	5-day liquidation period ( %)	20-day liquidation period ( %)	10-day liquidation period ( %)	5-day liquidation period ( %)
1	0,707	0,5	0,354	1,414	1	0,707
2-3	1,414	1	0,707	2,828	2	1,414

Table 3

Other collateral or exposure types
	20-day liquidation period ( %)	10-day liquidation period ( %)	5-day liquidation period ( %)
Main Index Equities, Main Index Convertible Bonds	21,213	15	10,607
Other Equities or Convertible Bonds listed on a recognised exchange	35,355	25	17,678
Cash	0	0	0
Gold	21,213	15	10,607

Table 4

Volatility adjustment for currency mismatch
20‐day liquidation period ( %)	10‐day liquidation period ( %)	5‐day liquidation period)
11,314	8	5,657

37. For secured lending transactions the liquidation period shall be 20 business days. For repurchase transactions (except insofar as such transactions involve the transfer of commodities or guaranteed rights relating to title to commodities) and securities lending or borrowing transactions the liquidation period shall be 5 business days. For other capital market driven transactions, the liquidation period shall be 10 business days.

38. In Tables 1 to 4 and in points 39 to 41, the credit quality step with which a credit assessment of the debt security is associated is the credit quality step with which the credit assessment is determined by the competent authorities to be associated under Articles 78 to 83. For the purpose of this point, Part 1, point 10 also applies.

39. For non-eligible securities or for commodities lent or sold under repurchase transactions or securities or commodities lending or borrowing transactions, the volatility adjustment is the same as for non-main index equities listed on a recognised exchange.

40. For eligible units in collective investment undertakings the volatility adjustment is the weighted average volatility adjustments that would apply, having regard to the liquidation period of the transaction as specified in point 37, to the assets in which the fund has invested. If the assets in which the fund has invested are not known to the credit institution, the volatility adjustment is the highest volatility adjustment that would apply to any of the assets in which the fund has the right to invest.

41. For unrated debt securities issued by institutions and satisfying the eligibility criteria in Part 1, point 8 the volatility adjustments shall be the same as for securities issued by institutions or corporates with an external credit assessment associated with credit quality steps 2 or 3.

(ii) Own estimates of volatility adjustments

42. The competent authorities shall permit credit institutions complying with the requirements set out in points 47 to 56 to use their own volatility estimates for calculating the volatility adjustments to be applied to collateral and exposures.

43. When debt securities have a credit assessment from a recognised ECAI equivalent to investment grade or better, the competent authorities may allow credit institutions to calculate a volatility estimate for each category of security.

44. In determining relevant categories, credit institutions shall take into account the type of issuer of the security the external credit assessment of the securities, their residual maturity, and their modified duration. Volatility estimates must be representative of the securities included in the category by the credit institution.

45. For debt securities having a credit assessment from a recognised ECAI equivalent to below investment grade, and for other eligible collateral, the volatility adjustments must be calculated for each individual item.

46. Credit institutions using the Own estimates approach must estimate volatility of the collateral or foreign exchange mismatch without taking into account any correlations between the unsecured exposure, collateral and/or exchange rates.

Quantitative Criteria

47. In calculating the volatility adjustments, a 99th percentile one-tailed confidence interval shall be used.

48. The liquidation period shall be 20 business days for secured lending transactions; 5 business days for repurchase transactions, except insofar as such transactions involve the transfer of commodities or guaranteed rights relating to title to commodities and securities lending or borrowing transactions, and 10 business days for other capital market driven transactions.

49. Credit institutions may use volatility adjustment numbers calculated according to shorter or longer liquidation periods, scaled up or down to the liquidation period set out in point 48 for the type of transaction in question, using the square root of time formula:

where T_M is the relevant liquidation period;

H_M is the volatility adjustment under T_M and

H_N is the volatility adjustment based on the liquidation period T_N.

50. Credit institutions shall take into account the illiquidity of lower-quality assets. The liquidation period shall be adjusted upwards in cases where there is doubt concerning the liquidity of the collateral. They shall also identify where historical data may understate potential volatility, e.g., a pegged currency. Such cases shall be dealt with by means of a stress scenario.

51. The historical observation period (sample period) for calculating volatility adjustments shall be a minimum length of one year. For credit institutions that use a weighting scheme or other methods for the historical observation period, the effective observation period shall be at least one year (that is, the weighted average time lag of the individual observations shall not be less than 6 months). The competent authorities may also require a credit institution to calculate its volatility adjustments using a shorter observation period if, in the competent authorities' judgement, this is justified by a significant upsurge in price volatility.

52. Credit institutions shall update their data sets at least once every three months and shall also reassess them whenever market prices are subject to material changes. This implies that volatility adjustments shall be computed at least every three months.

Qualitative Criteria

53. The volatility estimates shall be used in the day-to-day risk management process of the credit institution including in relation to its internal exposure limits.

54. If the liquidation period used by the credit institution in its day-to-day risk management process is longer than that set out in this Part for the type of transaction in question, the credit institution's volatility adjustments shall be scaled up in accordance with the square root of time formula set out in point 49.

55. The credit institution shall have established procedures for monitoring and ensuring compliance with a documented set of policies and controls for the operation of its system for the estimation of volatility adjustments and for the integration of such estimations into its risk management process.

56. An independent review of the credit institution's system for the estimation of volatility adjustments shall be carried out regularly in the credit institution's own internal auditing process. A review of the overall system for the estimation of volatility adjustments and for integration of those adjustments into the credit institution's risk management process shall take place at least once a year and shall specifically address, at a minimum:

(a)

the integration of estimated volatility adjustments into daily risk management;

(b)

the validation of any significant change in the process for the estimation of volatility adjustments;

(c)

the verification of the consistency, timeliness and reliability of data sources used to run the system for the estimation of volatility adjustments, including the independence of such data sources; and

(d)

the accuracy and appropriateness of the volatility assumptions.

(iii) Scaling up of volatility adjustments

57. The volatility adjustments set out in points 36 to 41 are the volatility adjustments to be applied where there is daily revaluation. Similarly, where a credit institution uses its own estimates of the volatility adjustments in accordance with points 42 to 56, these must be calculated in the first instance on the basis of daily revaluation. If the frequency of revaluation is less than daily, larger volatility adjustments shall be applied. These shall be calculated by scaling up the daily revaluation volatility adjustments, using the following ‘square root of time’ formula:

where:

H is the volatility adjustment to be applied

H_M is the volatility adjustment where there is daily revaluation

N_R is the actual number of business days between revaluations

T_M is the liquidation period for the type of transaction in question.

(iv) Conditions for applying a 0 % volatility adjustment

58. In relation to repurchase transactions and securities lending or borrowing transactions, where a credit institution uses the Supervisory Volatility Adjustments Approach or the Own Estimates Approach and where the conditions set out in points (a) to (h) are satisfied, credit institutions may, instead of applying the volatility adjustments calculated under points 34 to 57, apply a 0 % volatility adjustment. This option is not available in respect of credit institutions using the internal models approach set out in points 12 to 21:

(a)

Both the exposure and the collateral are cash or debt securities issued by central governments or central banks within the meaning of Part 1, point 7(b) and eligible for a 0 % risk weight under Articles 78 to 83,

(b)

Both the exposure and the collateral are denominated in the same currency,

(c)

Either the maturity of the transaction is no more than one day or both the exposure and the collateral are subject to daily marking-to-market or daily remargining,

(d)

It is considered that the time between the last marking-to-market before a failure to remargin by the counterparty and the liquidation of the collateral shall be no more than four business days,

(e)

The transaction is settled across a settlement system proven for that type of transaction,

(f)

The documentation covering the agreement is standard market documentation for repurchase transactions or securities lending or borrowing transactions in the securities concerned,

(g)

The transaction is governed by documentation specifying that if the counterparty fails to satisfy an obligation to deliver cash or securities or to deliver margin or otherwise defaults, then the transaction is immediately terminable, and

(h)

The counterparty is considered a ‘core market participant’ by the competent authorities. Core market participants shall include the following entities:

• the entities mentioned in point 7(b) of Part 1 exposures to which are assigned a 0 % risk weight under Articles 78 to 83;

• institutions;

• other financial companies (including insurance companies) exposures to which are assigned a 20 % risk weight under Articles 78 to 83 or which, in the case of credit institutions calculating risk‐weighted exposure amounts and expected loss amounts under Articles 83 to 89, do not have a credit assessment by a recognised ECAI and are internally rated as having a PD equivalent to that associated with the credit assessments of ECAIs determined by the competent authorities to be associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporates under Articles 78 to 83

• regulated collective investment undertakings that are subject to capital or leverage requirements;

• regulated pension funds; and

• recognised clearing organisations.

59. Where a competent authority permits the treatment set out in point 58 to be applied in the case of repurchase transactions or securities lending or borrowing transactions in securities issued by its domestic government, then other competent authorities may choose to allow credit institutions incorporated in their jurisdiction to adopt the same approach to the same transactions.

(c) Calculating risk‐weighted exposure amounts and expected loss amounts

Standardised Approach

60. E* as calculated under point 33 shall be taken as the exposure value for the purposes of Article 80. In the case of off-balance sheet items listed in Annex II, E* shall be taken as the value at which the percentages indicated in Article 78(1) shall be applied to arrive at the exposure value.

IRB Approach

61. LGD* (the effective LGD)calculated as set out in this point shall be taken as the LGD for the purposes of Annex VII.

LGD* = LGD x (E*/E)

where:

LGD is the LGD that would apply to the exposure under Articles 84 to 89 if the exposure was not collateralised;

E is the exposure value as described under point 33;

E* is as calculated under point 33.