• PRU APP4 PRU APP4 CREDIT RISK

    • PRU A4.1 PRU A4.1 Credit Risk systems and controls

      • Guidance

        1. Depending on an Authorised Person's nature, scale, frequency, and complexity of Credit Risk granted or incurred, the Credit Risk policy of an Authorised Person should address the following elements:
        a. how, with particular reference to its activities, the Authorised Person defines and measures Credit Risk;
        b. the Authorised Person's business aims in incurring Credit Risk including:
        i. identifying the types and sources of Credit Risk to which the Authorised Person wishes to be exposed (and the limits on that Exposure) and those to which the Authorised Person wishes not to be exposed;
        ii. specifying the level of diversification required by the Authorised Person and the Authorised Person's tolerance for risk concentrations and the limits on those Exposures and concentrations; and
        iii. stating the risk-return that the Authorised Person is seeking to achieve on Credit Risk Exposures;
        c. types of facilities to be offered, along with ceilings, pricing, profitability, maximum maturities and maximum debt-servicing ratios for each type of lending;
        d. a ceiling for the total loan portfolio, in terms, for example, of the loan-to-Deposit ratio, undrawn commitment ratio, a maximum dollar amount or a percentage of capital base;
        e. portfolio limits for maximum aggregate Exposures by country, industry, category of borrower/Counterparty (e.g. banks, non-bank Financial Institutions, corporates and retail), product (e.g. property lending), Groups of related parties and single borrowers;
        f. limits, terms and conditions, approval and review procedures and records kept for Connected lending - all Authorised Persons should have a formal policy statement, endorsed by the Governing Body, on such lending covering these matters;
        g. types of acceptable Collateral, loan-to-value ratios and the criteria for accepting guarantees; and
        h. how Credit Risk is assessed both when credit is granted or incurred and subsequently, including how the adequacy of any security and other risk mitigation techniques are assessed;
        i. the detailed limit structure for Credit Risk, which should:
        i. address all key risk factors, including intra-Group Exposures;
        ii. be commensurate with the volume and complexity of activity; and
        iii. be consistent with the Authorised Person's business aims, historical performance, and the level of capital the Authorised Person is willing to risk;
        j. procedures for:
        i. approving new products and activities which give rise to Credit Risk;
        ii. regular risk position and performance reporting;
        iii. limit exception reporting and approval; and
        iv. identifying and dealing with problem Exposures;
        k. the allocation of responsibilities for implementing the Credit Risk policy and for monitoring adherence to, and the effectiveness of, the policy; and
        l. the required information systems, staff and other resources.
        2. The Credit Risk policy should emphasize the principles of prudence and should be enforced consistently. The policy and its implementation should ensure that credit facilities are only granted to credit-worthy customers and that risk concentrations are avoided.
        3. The Credit Risk strategy and policy need to be clearly disseminated to, and understood by all relevant staff.
        4. The Credit Risk policy of an Authorised Person should clearly specify the delegation of its credit approval authorities. Credit authority thus delegated should be appropriate for the products or portfolios assigned to the credit committee or individual credit officers and should be commensurate with their credit experience and expertise. An officer's credit authority may, however, be increased on the basis of his or her track record. An Authorised Person should ensure that credit authority is required for acquiring any types of credit Exposures, including the use of Credit Derivatives for hedging or income generation.
        5. Credit authority delegated to the credit committee and each credit officer should be subject to regular review to ensure that it remains appropriate to current market conditions and the level of their performance.
        6. An Authorised Person's remuneration policies applicable to all staff should be consistent with its Credit Risk strategy.

        The policies should not encourage officers to generate short-term profits by taking an unacceptably high level of risk.

      • Counterparty Risk assessment

        7. The Authorised Person should make a suitable assessment of the risk profile of its Counterparties. The factors to be considered will vary according to both the type of credit and Counterparty such as whether the Counterparty is a company or a sovereign Counterparty and may include:
        a. the purpose of the credit and the source of repayment;
        b. an assessment of the skill, integrity and quality of management and overall reputation of the Counterparty;
        c. the legal capacity of the Counterparty to assume the liability to the Authorised Person;
        d. an assessment of the nature and amount of risk attached to the Counterparty in the context of the industrial sector or geographical region or country in which it operates and the potential impact on the Counterparty of political, economic and market changes; this assessment may include consideration of the extent and nature of the Counterparty's other financial obligations;
        e. the Counterparty's repayment history as well as an assessment of the Counterparty's current and future capacity to repay obligations based on financial statements, financial trends, cash flow projections and the potential impact of adverse economic scenarios;
        f. an analysis of the risk-return trade-off, with regard to the proposed price of the Credit Facility;
        g. the proposed terms and conditions attached to the granting of credit, including on-going provision of information by the Counterparty, covenants attached to the facility, the adequacy and enforceability of Collateral and guarantees; and
        h. the Authorised Person's existing Exposure to the individual Counterparty, sector, country or product and the availability of credit given Exposure limits.
        8. An Authorised Person should document any variation from the usual credit policy.
        9. An Authorised Person involved in loan syndications or consortia should not rely on other parties' assessments of the Credit Risks involved but should conduct a full assessment against its own Credit Risk policy.
        10. An Authorised Person granting credit to obligors in other countries should be cognisant of the additional risks — country risk and transfer risk — involved in such credits. An Authorised Person should therefore consider the environment — economic and political — in the relevant countries, the potential effect of changes thereto on the obligors' ability to service the credit and the contagion effects in regions where economies are closely related.
        11. The exception reporting should be adequately supported by a management reporting system whereby relevant reports on the credit portfolio are generated to various levels of management on a timely basis.
        12. Connected Counterparties should be identified and the procedures for the management of the combined Credit Risk considered. It may be appropriate for Authorised Persons to monitor and report the aggregate Exposure against combined limits in addition to monitoring the constituent Exposures to the individual Counterparties.
        13. An Authorised Person should consider whether it needs to assess the credit-worthiness of suppliers of goods and services to whom it makes material prepayments or advances.

      • Risk assessment: Derivative Counterparties

        14. An Authorised Person should include in its Credit Risk policy an adequate description of:
        a. how it determines with which Derivative Counterparties to do business;
        b. how it assesses and continues to monitor the credit-worthiness of those Counterparties;
        c. how it identifies its actual and contingent Exposure to the Counterparty; and
        d. whether and how it uses credit loss mitigation techniques, e.g. margining, taking security or Collateral or purchasing credit insurance.
        15. In assessing its contingent Exposure to a Counterparty, the Authorised Person should identify the amount which would be due from the Counterparty if the value, index or other factor upon which that amount depends were to change.
        16. An Authorised Person should clearly specify the delegation of its credit approval authorities. Credit authority thus delegated should be appropriate for the products or portfolios assigned to the credit committee or individual credit officers and should be commensurate with their credit experience and expertise. An officer's credit authority may, however, be increased on the basis of his her track record. An Authorised Person should ensure that credit authority is required for acquiring any types of credit Exposures, including the use of Credit Derivatives for hedging or income generation.
        17. Credit authority delegated to the credit committee and each credit officer should be subject to regular review to ensure that it remains appropriate to current market conditions and the level of their performance.

      • Credit approval procedures

        18. An Authorised Person should adhere closely to the "Know Your Customer" principle and should not lend purely on name and relationship without a comprehensive assessment of the credit quality of the borrower.
        19. Credit decisions should be supported by adequate evaluation of the borrower's repayment ability based on reliable information. Sufficient and up-to-date information should continue to be available to enable effective monitoring of the account.
        20. All credits should be granted on an arm's length basis. Credits to related borrowers should be monitored carefully and steps taken to control or reduce the risks of Connected lending.
        21. An Authorised Person should not rely excessively on Collateral or guarantees as Credit Risk mitigants. Such Credit Risk mitigants may provide secondary protection to the lender if the borrower defaults, the primary consideration for credit approval should be the borrower's debt-servicing capacity.
        22. An Authorised Person should be sensitive to rapid expansion of specific types of lending. Such trends may often be accompanied by deterioration of credit standards and thus merit increased focus on more marginal borrowers.
        23. An Authorised Person should ensure through periodic independent audits that the credit approval function is being properly managed and that credit Exposures comply with prudential standards and internal limits. The results of such audits should be reported directly to the Governing Body, the credit committee or senior management as appropriate.

      • Risk control

        24. An Authorised Person should consider setting credit limits for maximum Exposures to single and Connected Counterparties, as well as limits for aggregate Exposures to economic sectors, geographic areas, and on total Credit Risk arising from specific types of products. By limiting Exposures in these categories, an Authorised Person can manage credit Exposure more carefully and avoid excessive concentrations of risk.
        25. The Credit Risk policy of an Authorised Person should include a policy to control and monitor Large Exposures and other risk concentrations. An Authorised Person should carefully manage and avoid excessive risk concentrations of various kinds. These include Exposure to:
        a. individual borrowers (in particular Exposure exceeding 10% of the firm's capital base);
        b. Groups of borrowers with similar characteristics, economic and geographical sectors; and
        c. types of lending with similar characteristics (e.g. those based on assets with similar price behaviour).
        26. Notwithstanding the Concentration Risk limit specified as part of the prudential Rules on Large Exposures, Authorised Persons should exercise particular care in relation to facilities exceeding 10% of capital base.
        27. Authorised Persons should recognise and control the Credit Risk arising from their new products and services. Well in advance of entering into business transactions involving new types of products and activities, they should ensure that they understand the risks fully and have established appropriate Credit Risk policies, procedures and controls, which should be approved by the Governing Body or its appropriate delegated committee. A formal risk assessment of new products and activities should also be performed and documented.
        28. An Authorised Person in Category 123A or 5 is also subject to concentration limits and notification requirements as spelt out in Chapter 4.

      • Risk measurement

        29. An Authorised Person should measure its Credit Risk using a robust and consistent methodology, which should be described in its Credit Risk policy. The Authorised Person should consider whether the measurement methodology should be back-tested and the frequency of any such back-testing.
        30. An Authorised Person should also be able to measure its total Exposure across the entire credit portfolio or within particular categories such as Exposures to particular industries, economic sectors or geographical areas.
        31. Where an Authorised Person is a member of a Group, the Group should be able to monitor credit Exposures on a consolidated basis.
        32. An Authorised Person should have the capability to measure its credit Exposure to individual Counterparties on at least a daily basis.
        33. Authorised Persons should analyse their credit portfolios to identify material inter-dependencies which can exaggerate risk concentrations. The importance can be illustrated by the contagion effects that a substantial decline in property or stock prices may have on the default rate of those commercial and industrial loans which rely heavily on such types of Collateral.
        34. Authorised Persons should establish a system of regular independent credit and compliance audits. These audits should be performed by independent parties, e.g. internal audit and compliance, which report to the Governing Body or the audit committee.
        35. Credit audits should be conducted to assess individual credits on a sampling basis and the overall quality of the credit portfolio. Such audits are useful for evaluating the performance of account officers and the effectiveness of the credit process. They can also enable Authorised Persons to take early measures to protect their loans.

      • Risk monitoring

        36. An Authorised Person should implement an effective system for monitoring its Credit Risk, which should be described in its Credit Risk policy. The system may monitor the use of facilities, adherence to servicing requirements and covenants, and monitor the value of Collateral and identify problem accounts.
        37. An Authorised Person should consider the implementation of a system of management reporting which provides relevant, accurate, comprehensive, timely and reliable Credit Risk reports to relevant functions within the Authorised Person.
        38. Adequacy and sophistication of Credit Risk measurement tools required depends on the complexity and degree of the inherent risks of the products involved. An Authorised Person should have information systems and analytical techniques that provide sufficient information on the risk profile and structure of the credit portfolio. These should be flexible to help Authorised Person to identify risk concentrations. To achieve this, an Authorised Person system should be capable of analysing its credit portfolio by the following characteristics:
        a. size of Exposure;
        b. Exposure to Groups of related borrowers;
        c. products;
        d. sectors, e.g. geographic, industrial;
        e. borrowers' demographic profile for consumer credits, e.g. age or income group, if appropriate;
        f. account performance;
        g. internal credit ratings;
        h. outstandings versus commitments; and
        i. types and coverage of Collateral.
        39. An Authorised Person should have procedures for taking appropriate action according to the information within the management reports, such as a review of Counterparty limits.
        40. Particular attention should be given to the monitoring of credit that does not conform to usual Credit Risk policy, or which exceeds predetermined credit limits and criteria, but is sanctioned because of particular circumstances. Unauthorised exceptions to policies, procedures and limits should be reported in a timely manner to the appropriate level of management.
        41. Individual credit facilities and overall limits and sub-limits should be periodically reviewed in order to check their performance and appropriateness for both the current circumstances of the Counterparty and in the Authorised Person's current internal and external economic environment. The frequency of review will usually be more intense for higher-risk Counterparties or larger Exposures or in fluctuating economic conditions.
        42. An Authorised Person should have in place a system for monitoring the overall quality of its Credit Risk Exposures under normal and stressful conditions. There should also be a reporting system which alerts management to aggregate Exposures approaching various pre-set portfolio limits.
        43. An Authorised Person should be mindful of business and economic cycles and regularly stress-test their portfolios against adverse market scenarios. Adequate contingency planning should be developed in conjunction with stress-testing to address the possibility of crises developing in a very rapid fashion.
        44. Appropriate stress testing of credit Exposures can be an essential part of the credit management process. Examination of the potential effects of economic or industry downturns, market events, changes in interest rates, changes in foreign exchange rates and changes in liquidity conditions can provide valuable information about an Authorised Person's Credit Risk. This information can be utilised to inform the Authorised Person's on-going credit strategy.
        45. As new techniques for Credit Risk management, monitoring and reporting are developed, the Authorised Person should ensure they are tested and evaluated before undue reliance is placed upon them.
        46. Where the account officer for a credit (or customer relationship manager, branch manager or similar) moves on, the incoming officer should carry out a take-over review. The review should cover inter alia the credit-worthiness of the borrowers, the adequacy of the documentation, compliance with covenants, performance of each loan and the existence and value of any Collateral.

      • Problem Exposures

        47. An Authorised Person should have processes for the timely identification and management of problem Exposures. These processes should be described in the Credit Risk policy.
        48 An Authorised Person involved in Providing Credit should establish a dedicated unit to handle the recovery and work-out of problem loans and should establish policies for the referral of loans to this unit.
        49. An Authorised Person should ensure that its loan portfolio is properly classified and has an effective early-warning system for problem loans.
        50. An Authorised Person should develop and implement internal risk rating systems for managing Credit Risk. The rating system should be consistent with the nature, size and complexity of the Authorised Person's activities. In using internal risk ratings, an Authorised Person should seek to achieve a high granularity in the rating system and adopt multiple grades for loans that are not yet irregular and to develop the ability to track the migration of individual loans through the various internal credit ratings.
        51. Depending on the size and nature of the Authorised Person, it may be appropriate for problem Exposures to be managed by a specialised function, independent of the functions that originate the business or maintain the on-going business relationship with the Counterparty.
        52. Exposures identified as problems or potential problems should be closely monitored by management, and an Authorised Person should set out, for example, whether a loan grading system or a watch or problem list is used and, in the latter case, the criteria for adding an asset to or taking an asset off that list.
        53. It is recommended that Authorised Persons establish a dedicated unit to handle the recovery and work-out of problem loans and put in place policies for the referral of loans to this unit.
        54. An Authorised Person should have adequate procedures for recovering Exposures in arrears or those which had provisions made against them. These should allocate responsibility both internally and externally for its arrears management and recovery and define the involvement of the Authorised Person's solicitors.
        55. Requirements relating to provisioning against loss on problem Exposures are covered in Chapter 4.

      • Risk mitigation

        56. Various methods can be used to mitigate Credit Risk, such as taking security or Collateral, obtaining a guarantee from a third party, purchasing insurance or Credit Derivatives. Authorised Persons should view these as complementary to, rather than a replacement for, thorough credit analysis and procedures.
        57. In controlling Credit Risk, an Authorised Person may utilise certain mitigation techniques.

        Normally, they include:
        a. accepting Collateral, standby letters of credit and guarantees;
        b. entering into Netting arrangements;
        c. setting strict loan covenants; and
        d. using Credit Derivatives and other hedging instruments.
        58. In determining which types of credit mitigation techniques should be used, firms should also consider:
        a. their own knowledge and experience in using such techniques;
        b. cost-effectiveness;
        c. type and financial strength of the Counterparties or Issuers;
        d. correlation with the underlying credits;
        e. availability, liquidity and realisability of the credit mitigation instruments;
        f. the extent to which legally recognised documentation, e.g. ISDA Master Agreement, can be adopted; and
        g. the degree of supervisory recognition of the mitigation technique.
        59. While mitigation through Collateral and guarantees is usually dealt with at the time of granting of credits, Credit Derivatives and Netting are often employed after the credit is in place, or used to manage the overall portfolio risk. When the mitigation arrangements are in place they should then be controlled. Authorised Persons should have written policies, procedures and controls for the use of credit mitigation techniques. They should also ensure adequate systems are in place to manage these activities.
        60. Authorised Persons should revalue their Collateral and mitigation instruments on a regular basis.

        The method and frequency of revaluation depends on the nature of the hedge and the products involved.
        61. If an Authorised Person takes security or Collateral, on credit facilities, appropriate policies and procedures should be documented covering:
        a. the types of security or Collateral considered;
        b. procedures governing the valuation and revaluation of security or Collateral including the basis of valuation;
        c. policies governing the taking of security or Collateral, including obtaining appropriate legal title; and
        d. policies governing possession of security or Collateral.
        62. The value of security and Collateral should be monitored at an appropriate frequency. For example, commercial property might be revalued annually, whereas Securities provided as Collateral should be marked to market usually on a daily basis. Residential property may not need to be revalued annually, but information should be sought as to general market conditions.
        63. When taking Collateral in support of an Exposure, an Authorised Person should ensure that legal procedures have been followed, to ensure the Collateral can be enforced if required.
        64. An Authorised Person should consider the legal and financial ability of a guarantor to fulfil the guarantee were it called upon to perform its obligations as guarantor.
        65. An Authorised Person should analyse carefully the protection afforded by risk mitigants such as Netting agreements or Credit Derivatives, to ensure that any residual Credit Risk is identified, measured, monitored and controlled.
        66. An Authorised Person providing mortgages at high loan-to-value ratios should consider the need for alternative forms of protection against the risks of such lending, including mortgage indemnity insurance, to protect against the risk of a fall in the value of the property.

      • Record keeping

        67. The Authorised Person should maintain appropriate records of:
        a. credit Exposures, including aggregations of credit Exposures, by:
        i. Groups of Connected Counterparties; and
        ii. types of Counterparty as defined, for example, by the nature or geographical location of the Counterparty;
        b. credit decisions, including details of the facts or circumstances upon which a decision was made; and
        c. information relevant to assessing current credit quality.
        68. Credit records should be retained for at least six years, subject to any requirement in the Rules requiring such records to be kept for a longer period.
        69. It is important that sound and legally enforceable documentation is in place for each credit agreement as this may be called upon in the event of a default or dispute. An Authorised Person should therefore consider whether it is appropriate for an independent legal opinion to be sought on documentation used by the Authorised Person. Documentation should be in place before the Authorised Person enters into a contractual obligation or releases funds.

      • Country and transfer risk Exposure

        70. Chapter 4 does not provide limits on the size of an Authorised Person's Exposure to a particular country or region. However, an Authorised Person which has Large Exposures in a country or region should include in its Credit Risk policy:
        a. the geographical areas in which the Authorised Person does or intends to do business;
        b. its definition of Credit Risk Exposure and transfer risks (such as exchange restrictions) associated with doing business in each country or region;
        c. how to measure its total Exposure in each country or region and across several countries or regions;
        d. the types of business the Authorised Person intends to undertake in each country or region;
        e. limits on Exposures to an individual country or region which the Authorised Person deals with, and sub-limits for different types of business if appropriate;
        f. the procedure for setting and reviewing country or regional limits; and
        g. the process by which the Authorised Person's actual country or regional Exposures will be monitored against limits and the procedure to be followed if the limits are breached.
        71. When setting country or regional limits, an Authorised Person should consider:
        a. the economic and political circumstances prevailing in the country or region;
        b. the transfer risks associated with any particular country or region;
        c. the type and maturity of business undertaken by the Authorised Person in a particular country or region;
        d. the Authorised Person's existing concentration of country or regional risk;
        e. the source of funding for the country or regional Exposure; and
        f. sovereign or other guarantees offered.

      • Provisioning

        72. Depending upon the nature of the Authorised Person and its business, the Authorised Person's provisioning policy should set out:
        a. who has responsibility for reviewing the provisioning policy and approving any changes;
        b. how frequently the policy should be reviewed;
        c. when the review will take place, including the circumstances in which a review might be more frequent;
        d. who has primary responsibility for ensuring the provisioning policy remains appropriate, including any division of responsibilities;
        e. the areas of its business to which the provisioning policy relates — it should include both on balance sheet and off balance sheet Exposures and assets;
        f. where it takes different approaches to different lines of its business and the key features of those differences;
        g. who has responsibility for monitoring its asset portfolio on a regular basis in order to identify problem or potential problem assets and the factors it takes into account in identifying them;
        h. whether a loan grading system or a watch or problem list is used and, in the latter case, the criteria for adding an asset to or taking an asset off that list;
        i. the extent to which the value of any Collateral, guarantees or insurance which the Authorised Person holds affects the need for or size of provision;
        j. on what basis the Authorised Person makes its provisions, including the extent to which the level of provisioning is left to managerial judgement or to a committee or involves specified formulae and the methodologies or debt management systems and other formulae used to determine provisioning levels for different business lines and the factors applied within these methodologies;
        k. who is responsible for ensuring that the Authorised Person's provisioning policy is being implemented properly, and the measures the Authorised Person has in place if its provisioning polices are not adhered to;
        l. who is responsible for the regular reviews of the Authorised Person's specific and general provisions and who decides whether provision levels are satisfactory. The reviews should take account of changes in the status of the Exposures and potential losses and changes in the conditions associated with them;
        m. the reports used to enable management to ensure that the Authorised Person's provisioning levels remain satisfactory, the frequency and purpose of those reports and their circulation;
        n. the procedures for recovering Exposures in arrears or Exposures which have had provisions made against them, including who has responsibility both internally and externally for its arrears management and recovery and the involvement of the Authorised Person's solicitors;
        o. the procedures and methodologies for writing off and writing back provisions, including treatment of interest and who has the relevant responsibility for determining these;
        p. the frequency of any review of its write off experience against provisions raised; such a review can help identify whether an Authorised Person's policies result in over or under provisioning across the business cycle, and contribute to a general review of an Authorised Person's provisioning policy and the design of any loan grading systems, Credit Risk models, and risk pricing; and
        q. the Authorised Person's procedures and methodologies for calculating and raising provisions for contingent and other liabilities, how frequently they should be reviewed and who has the relevant responsibilities. Other liabilities include the crystallisation of contingent liabilities such as acceptances, endorsements, guarantees, performance bonds, indemnities, irrevocable letters of credit and the confirmation of documentary credits.
        73. Provisions may be general (against the whole of a given portfolio) or specific (against particular Exposures identified as bad or doubtful), or both. The Regulator expects contingent liabilities and anticipated losses to be recognised in accordance with the applicable accounting standards.
        74. Appropriate systems and controls for provisions vary with the nature, scale and complexity of the credit granted. An Authorised Person for which the extension of credit is a substantial part of its business is expected to have greater regard to developing, implementing and documenting a provisioning policy than an Authorised Person for which Credit Risk is incidental to the operation of its business.
        75. The Regulator recognises that the frequency with which an Authorised Person reviews its provisioning policy once it has been established will vary from firm to firm. However, the Regulator expects an Authorised Person to review its policy to ensure it remains appropriate for the business it undertakes and the economic environment in which it operates. The provisioning policy should be reviewed at least annually by the Governing Body.

    • PRU A4.2 PRU A4.2 Credit conversion factors (CCFs) for calculating Exposures

      • CCFs for off-balance sheet CR Exposures

        • PRU A4.2.1 PRU A4.2.1

          The applicable CCFs for off-balance sheet CR Exposures are provided in the table below.

            Description of Off-balance Sheet Item CCF
          (a) Direct credit substitutes 100%
          (b) Transaction-related contingent items 50%
          (c) Short-term self-liquidating trade-related contingent items (applicable to both issuing and confirming banks) and commitments to underwrite debt and equity Securities 20%
          (d) Note issuance facilities and revolving Underwriting facilities 50%
          (e) Transactions, other than SFTs, involving the posting of Securities held by the Authorised Person as Collateral 100%
          (f) Asset sales with recourse, where the Credit Risk remains with the Authorised Person 100%
          (g) Other commitments with certain drawdown 100%
          (h) Other commitments
          (i) with an Original Maturity of more than one year
          (ii) with an Original Maturity of one year or less
          (iii) which are unconditionally cancellable at any time by the Authorised Person without prior notice, or that effectively provide for automatic cancellation due to deterioration in an obligor's creditworthiness
          50%

          20%

          0%

          • Guidance

            1. In cases where there is an undertaking to provide a commitment on another off-balance sheet Exposure, an Authorised Person should apply the lower of the applicable CCFs. Examples of direct credit substitutes include general guarantees of indebtedness, standby letters of credit serving as financial guarantees for loans and Securities, and acceptances (including endorsements with the character of acceptances). Examples of transaction-related contingent items include performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions.
            2. Documentary credits collateralised by the underlying shipments are an example of short-term self-liquidating trade-related contingent items. In respect of item (f) in the table above, the terms of the agreement should be such that there is no substantial transfer of all risks and rewards of ownership to the Counterparty. Other commitments with certain drawdown would include forward purchase, forward Deposits and partly paid Securities. Formal standby facilities and credit lines are examples of other commitments, referred to in item (h) of the table above.
            3. In respect of item (h)(iii) in the table above, an Authorised Person, if required to by the Regulator, should be able to demonstrate that it actively monitors the financial condition of the obligor, and that its internal control systems are such that it is able to cancel the facility upon evidence of a deterioration in the credit quality of the obligor.

      • CCFs for off-balance sheet SE Exposures

        • PRU A4.2.2 PRU A4.2.2

          (1) The applicable CCFs for off-balance sheet SE Exposures are provided in the table below.

            Description of off-balance sheet item CCF
          (a) Unrated eligible liquidity facilities 50%
          (b) Eligible Servicer cash advance facilities 0%
          (c) Others 100%
          (2) An Authorised Person must notify the Regulator if it intends to provide eligible Servicer cash advance facilities and when there is a drawdown.

          • Guidance

            Eligible Servicer cash advance facilities refers to undrawn Servicer cash advances or facilities that are contractually provided for and unconditionally cancellable without prior notice, so long as the Servicer is entitled to full reimbursement and this right is senior to other claims on cash flows from the underlying Exposures.

    • PRU A4.3 PRU A4.3 Collateral calculations and haircuts

      • Core market participants

        • PRU A4.3.1

          For the purposes of this Section, "core market participant" means:

          (a) any central government or Central Bank;
          (b) any PSE;
          (c) any qualifying MDB;
          (d) any banking institution or Securities firm;
          (e) any Financial Institution eligible for a 20% risk weight under Section 4.12;
          (f) any central counterparty;
          (g) any regulated mutual fund that is subject to capital or leverage requirements; or
          (h) any regulated pension fund.

      • Calculation of E* for collateralised transactions other than OTC Derivative transactions and long settlement transactions

        • PRU A4.3.2

          An Authorised Person using the FCCA to calculate E* must adjust both the amount of the Exposure to the Counterparty and the value of any Collateral received in support of that Counterparty to take into account possible future fluctuations in the value of either due to market movements, by using the methods and haircuts set out in Rules A4.3.6 to A4.3.29.

        • PRU A4.3.3

          An Authorised Person must calculate the appropriate haircuts to be applied using one of the following methods:

          (a) standard supervisory haircuts; or
          (b) own-estimate haircuts.

        • PRU A4.3.4

          [Reserved]

        • PRU A4.3.5 PRU A4.3.5

          (1) As an alternative to the use of standard supervisory haircuts or own-estimate haircuts, an Authorised Person may, subject to the Regulator's approval, use VaR models to reflect the price volatility of the Exposure and Collateral for SFTs which are covered by a qualifying bilateral Netting agreement. The requirements relating to the use of this approach are set out in Section A4.5.
          (2) An Authorised Person may seek the Regulator's approval referred to in (1) only if it has already received the Regulator's approval to use the internal models approach for calculating the Market Risk Capital Requirement.

          • Guidance

            Approval for the use of the internal model approach is governed by Section 5.11 of Chapter 5 (Market Risk).

        • PRU A4.3.6 PRU A4.3.6

          An Authorised Person using standard supervisory haircuts or own-estimate haircuts under the FCCA must calculate E* for any collateralised transaction not covered by a qualifying bilateral Netting agreement or a qualifying cross-product Netting agreement other than OTC Derivative transactions or long settlement transactions, using the following formula:

          E* = max {0, [E (or EAD)(1 + HE) - C(1 - HC - HFX)]}

          where;

          E* = Exposure value after risk mitigation;

          E = fair value of the Exposure calculated in accordance with Section 4.9;

          HE = haircut appropriate to the Exposure;

          C = fair value of the eligible financial Collateral received;

          HC = haircut appropriate to the Collateral, or if the Collateral is a basket of assets, the weighted sum of the haircuts appropriate to the assets in the basket where each weight is the proportion of the asset in the basket in units of currency; and

          HFX = haircut appropriate for currency mismatch between the Collateral and Exposure.

          • Guidance

            Where the residual maturity of the Collateral is shorter than the residual maturity of the Exposure, the Authorised Person must substitute PA calculated in accordance with Rules 4.13.14 to 4.13.16 for C(1 - HC - HFX).

        • PRU A4.3.7

          An Authorised Person using standard supervisory haircuts or own-estimate haircuts under the FCCA must calculate E* for any collateralised transaction covered by a qualifying bilateral Netting agreement or qualifying cross-product Netting agreement other than OTC Derivative transactions or long settlement transactions, using the following formula:

          𝐸 = Max {0, [∑(𝐸) − ∑(𝐶) + add-on]}

          where:

          E* = Exposure value after risk mitigation;

          E = fair value of the Exposure calculated in accordance with Section 4.9 of these Rules;

          C = fair value of eligible financial Collateral received; and

          add-on = the add-on amount to reflect the market price volatility and foreign exchange volatility, calculated in accordance with Rule A4.3.8 below.

        • PRU A4.3.8 PRU A4.3.8

          An Authorised Person must calculate the add-on using one of the following approaches:

          (a) the approach according to the following formula:

          add-on = ∑(𝐸𝑆 . 𝐻𝑆 ) + ∑(𝐸𝐹𝑋. 𝐻𝐹𝑋)

          where:

          ES = absolute value of the net position in a given Security;

          HS = haircut appropriate to ES

          EFX = absolute value of the net position in a currency different from the settlement currency; and

          HFX = haircut appropriate for currency mismatch between the Collateral and Exposure;

          or
          (b) the approach using VaR models, provided the Authorised Person has received approval from the Regulator as referred to in Rule A4.3.5.

          • Guidance

            Approval for the use of the internal model approach is governed by Section 5.11 of Chapter 5.

        • PRU A4.3.9

          Subject to Rules A4.3.10 to A4.3.12, an Authorised Person must determine HE, HC, HS and HFX referred to in Rules A4.3.6 to A4.3.8, in accordance with the standard supervisory haircuts in the table forming part of Rule A4.3.13.

        • PRU A4.3.10

          An Authorised Person may calculate HE, HC, HS and HFX using own-estimate haircuts in accordance with Rules A4.3.17 to A4.3.23 if it has received approval from the Regulator to use the internal models approach for calculating the Market Risk Capital Requirement. If the Authorised Person chooses to use own-estimate haircuts, it must do so consistently for determining haircuts for all eligible financial Collateral and all portfolios, except that it may, with the approval of the Regulator, use the standard supervisory haircuts in Rules A4.3.13 to A4.3.16 for any portfolio which is immaterial in size and risk profile.

        • PRU A4.3.11

          An Authorised Person may apply a value of zero to HE, HC and HS in the case of a qualifying SFT with a core market participant. This approach is not available to an Authorised Person using VaR models in accordance with Section A4.5 to calculate E*.

        • PRU A4.3.12

          An Authorised Person may apply a value of zero to HE, HC and HS in the case of an SFT where both the Exposure and Collateral are Securities issued by central governments where a value of zero has been prescribed by the banking regulator of that jurisdiction and Exposures to the central government of that jurisdiction have a Credit Quality Grade of 1 as set out in the table Rule 4.12.4.

      • Standard supervisory haircuts

        • PRU A4.3.13 PRU A4.3.13

          The standard supervisory haircuts, HE, HC and HS referred in Rules A4.3.6 to A4.3.8 (assuming daily remargining, daily revaluation and a ten-business day holding period), are subject to Rule A4.3.14, as follows:

          Debt security:
          Credit Quality Grade
          of issue – long-term
          Residual Maturity Standard Supervisory Haircut
          (%)
          Issuer
          Central
          government
          or central bank
          Other
          1 ≤ 1 year 0.5      1     
          > 1 year and ≤ 5 years 2      4     
          > 5 years 4      8     
          2 or 3,
          and unrated bank
          securities as defined
          in Rule 4.13.5(d)
          ≤ 1 year 1      2     
          > 1 year and ≤ 5 years 3      6     
          > 5 years 6      12     
          4 All 15      n/a     

           

          Debt security:
          Credit Quality Grade of issue
          – short-term
          Standard Supervisory Haircut
          (%)
          Issuer
          Central
          government
          or central bank
          Other
          I 0.5      1     
          II or III,
          and unrated bank securities as
          defined in Rule 4.13.5(d)
          1      2     

           

          Other collateral or exposure type

          Standard Supervisory Haircut
          (%)
          Gold 15     
          Any equity (including a convertible bond) included in a main index 15     
          Any equity (including a convertible bond) traded on a regulated exchange 25     
          Any unit in a Collective Investment Fund Highest haircut
          applicable to any
          Security in which
          the Fund can invest
          Cash in the same currency as the underlying exposure 0     
          Instruments in the Trading Book other than those listed (for pre-settlement Counterparty Exposures arising from SFTs included in the Trading Book). 25     

          • Guidance

            1. The Credit Quality Grade for a debt security is that associated specifically with that debt security issue.
            2. PSEs and MDBs should be treated as equivalent to central governments for the purpose of this table.

        • PRU A4.3.14

          The standard supervisory haircut, HE, for transactions in which an Authorised Person lends instruments that do not qualify as eligible financial Collateral (e.g. corporate debt Securities with a Credit Quality Grade of 4 or worse) is 25%.

        • PRU A4.3.15

          The standard supervisory haircut, HFX, for currency mismatch where Exposure and Collateral are denominated in different currencies based on a ten-business day holding period and daily revaluation is 8%.

        • PRU A4.3.16

          Where the minimum holding period, frequency of remargining or revaluation assumptions set out for eligible financial Collateral in Rule A4.3.13 differ from those of the Authorised Person, the Authorised Person must adjust HE, HC and HS using the formulae in Rules A4.3.25 to A4.3.26.

      • Own-estimate haircuts

        • PRU A4.3.17

          (1) An Authorised Person must apply for approval from the Regulator if it intends to use own-estimate haircuts.
          (2) An Authorised Person must not use own-estimate haircuts unless it has received approval to adopt the internal models approach to calculate the Market Risk Capital Requirement.
          (3) The Regulator may grant approval for an Authorised Person to use own-estimate haircuts subject to such conditions or restrictions as the Regulator may impose.

        • PRU A4.3.18

          If An Authorised Person becomes aware after it has received approval to use own-estimate haircuts that it no longer complies with any of the requirements in Rules A4.3.17 to A4.3.23 or any of the conditions or restrictions imposed by the Regulator pursuant to Rule A4.3.17 or no longer meets the Rules, it must

          (a) inform the Regulator as soon as practicable;
          (b) assess the effect of the situation in terms of the risk posed to the Authorised Person;
          (c) prepare a plan to rectify the situation and inform the Regulator of its plan as soon as practicable; and
          (d) undertake prompt corrective action within a reasonable time in accordance with the plan prepared pursuant to (c).

        • PRU A4.3.19

          If An Authorised Person fails to comply with Rule A4.3.18, the Regulator may revoke its approval for the Authorised Person to use own-estimate haircuts. The Authorised Person may also be required to revise its estimates for the purpose of calculating regulatory Capital Requirements if its estimates of E*, does not adequately reflect its Exposure to Counterparty Credit Risk.

      • Requirements for use of own-estimate haircuts

        • PRU A4.3.20

          An Authorised Person using own-estimate haircuts must estimate the volatility for each individual instrument that is taken as eligible financial Collateral. In estimating such volatility, the Authorised Person must not take into account the correlations between unsecured Exposures, Collateral and exchange rates. Where there are Maturity Mismatches, the Authorised Person must apply Rules 4.13.14 to 4.13.16.

        • PRU A4.3.21

          An Authorised Person must ensure that the model used to estimate volatilities captures all the material risks run by it.

        • PRU A4.3.22 PRU A4.3.22

          In calculating the haircuts using internal estimates of volatilities, an Authorised Person must:

          (a) use a 99th percentile, one-tailed confidence interval;
          (b) use the minimum holding period and remargining or revaluation conditions according to the type of transaction as set out in Rules A4.3.24 to A4.3.26. Where the minimum holding period, remargining or revaluation conditions used by an Authorised Person differ from those set out above, it must adjust the haircuts using the formulae in Rules A4.3.25 to A4.3.26;
          (c) use a historical observation period (i.e. sample period) of at least one year.

          Where the Authorised Person uses a weighting scheme or other methods for the historical observation period, the "effective" observation period must be at least one year (i.e. the weighted average time lag of the individual observations must not be less than six months);
          (d) update its data sets at least once every three months and recalculate haircuts at least once every three months. The Regulator may require more frequent updates whenever there is an increase in volatility in market prices of the Collateral; and
          (e) use the estimated volatility data in the day-to-day risk management process of the Authorised Person and if the Authorised Person is using a longer holding period for risk management compared to the ones prescribed in Rules A4.3.24 to A4.3.26., then the longer holding period must also be applied for the calculation of haircuts.

          • Guidance

            1. An Authorised Person should:
            a. take into account the illiquidity of lower quality Collateral and should adjust the holding period upwards in cases where such a holding period would be inappropriate given the liquidity of the Collateral; and
            b. identify where historical data may understate potential volatility (e.g. a pegged currency);
            and deal with such cases by subjecting the data to stress testing.
            2. An Authorised Person, when considering the market liquidity of a Collateral, should consider four dimensions:
            a. immediacy, which refers to the speed with which a trade of a given size at a given cost is completed;
            b. depth, which refers to the maximum size of a trade for any given bid-ask spread;
            c. tightness, which refers to the difference between buy and sell prices; and
            d. resiliency, which refers to how quickly prices revert to original or fundamental levels after a large transaction.
            3. The Authorised Person should have experienced Persons familiar with the relevant market for the Collateral to judge the market liquidity of the Collateral and determine if the minimum holding period is sufficient for any given Collateral. The holding period should be deemed to be insufficient if the value of the Collateral would move by more than 1% should the Collateral be liquidated within the minimum holding period in these Rules, taking into account the immediacy, depth, tightness and resiliency of the market. In such a situation, the holding period should be adjusted upwards, such that the Collateral can be safely liquidated within the period, without causing a price movement of more than 1% relative to the value after the haircut.
            4. An Authorised Person should aim to update its data sets daily in line with industry practice. If the Authorised Person updates its data sets less than once every three months, it should be able to demonstrate to the Regulator that the volatilities of the market prices are stable. In addition, where the updating of data sets is less frequent, the Regulator will normally expect compensating controls in the form of stress testing.

        • PRU A4.3.23 PRU A4.3.23

          An Authorised Person must have robust and effective processes in place for ensuring compliance with documented internal policies, controls and procedures concerning the operation of the risk measurement system to support the use of own-estimate haircuts.

          • Guidance

            In order to demonstrate compliance with Rule A4.3.23, an Authorised Person should give due regard to the following expectations of the Regulator:

            (a) the risk measurement system should be used in conjunction with internal Exposure limits;
            (b) the risk management processes of an Authorised Person relating to the use of own-estimate haircuts should be subject to internal audit at least once a year, covering the following areas:
            (i) the integration of risk measures into daily risk management;
            (ii) the validation of any significant change in the risk management process;
            (iii) the accuracy and completeness of position data;
            (iv) the verification of the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources; and
            (v) the accuracy and appropriateness of volatility assumptions.
            (c) such internal audits referred to in (b) are not to be confused with an internal validation of the risk management systems surrounding the use of own-estimate haircuts. All significant risk models employed to support the use of own-estimate haircuts should be validated at least once a year. The internal audits serve as an independent process check to help ensure that the validation is sufficiently robust and effective.

      • Minimum holding periods, remargining or revaluation conditions

        • PRU A4.3.24

          The following table sets out the minimum holding periods and remargining or revaluation conditions for different types of transactions where an Authorised Person uses own-estimate haircuts:

          Transaction type Minimum holding period Remargining/ Revaluation Condition
          Repos, reverse repos, Securities or commodities lending or Securities or commodities borrowing transactions Five business days daily remargining
          OTC Derivative transactions and margin lending transactions Ten business days daily remargining
          Exposures secured by eligible financial Collateral 20 business days daily revaluation

        • PRU A4.3.25

          Where the assumed minimum holding period is not met or remargining or revaluation conditions are not fulfilled, an Authorised Person must calculate the applicable haircut using the following formula:

          H = HM √{[NR + (TM - 1)]/ TM}


          where -

          "H" refers to the haircut;

          "HM" refers to the haircut under the minimum holding period;

          "TM" refers to the minimum holding period for the type of transaction or eligible financial Collateral; and

          "NR" refers to the actual number of business days between remargining or revaluation, as the case may be.

        • PRU A4.3.26

          When an Authorised Person uses a holding period, TN, which is different from the specified minimum holding period, TM, the Authorised Person must calculate HM using the following formula:

          HM = HN√(TM/TN)

          where -

          "TN" refers to the holding period used by the Authorised Person for deriving HN; and

          "HN" refers to the haircut based on the holding period TN.

      • Recognition of eligible financial Collateral under FCSA

        • PRU A4.3.27

          Subject to A4.3.28, an Authorised Person which has taken eligible financial Collateral for a CR Exposure and is using the FCSA may recognise the effects of CRM of the eligible financial Collateral as follows:

          (a) break down the Exposure into -
          (i) a collateralised portion with E equal to the latest fair value of the eligible financial Collateral; and
          (ii) an uncollateralised portion with E equal to the E of the CR Exposure less the latest fair value of the eligible financial Collateral;
          and
          (b) for the purposes of calculating the Credit RWA amount pursuant to Rule 4.8.3, use:
          (i) for the collateralised portion, the CRW that is applicable to the eligible financial Collateral as though the Authorised Person had a direct Exposure to that Collateral; and
          (ii) for the uncollateralised portion, the CRW that is applicable to the obligor.

        • PRU A4.3.28

          If the CRW determined in accordance with A4.3.27(b)(i) is less than 20%, an Authorised Person must apply a CRW of 20% to the collateralised portion of the CR Exposure, except in the following cases:

          (a) a qualifying SFT where the Counterparty in the transaction is a core market participant, in which case the Authorised Person may apply a risk weight of 0%;
          (b) a qualifying SFT where the Counterparty in the transaction is not a core market participant, in which case the Authorised Person may apply a risk weight of 10%;
          (c) an OTC Derivative transaction subject to daily mark-to-market that is collateralised by cash, and where there is no currency mismatch, in which case the Authorised Person may apply a risk weight of 0%;
          (d) an OTC Derivative transaction subject to daily mark-to-market that is collateralised by Exposures to central governments, Central Banks or PSE or a combination thereof qualifying for a 0% risk weight in accordance with the Rules in Chapter 4, and where there is no currency mismatch, in which case the Authorised Person may apply a risk weight of 10%; and
          (e) a transaction where there is no currency mismatch and the Collateral comprises -
          (i) cash on Deposit as set out in Rule 4.13.5(a); or
          (ii) Exposures in the central government and Central Bank asset class or in the PSE asset class or a combination thereof qualifying for a 0% risk weight under the Rules in Section 4.12, and the latest fair value of such Collateral has been discounted by 20% for the purposes of determining the value of the collateralised portion of the CR Exposure in accordance with Rule A4.3.27(a)(i), in which case the Authorised Person may apply a CRW of 0%.

        • PRU A4.3.29

          An Authorised Person which is using FCSA must not recognise the effects of CRM of any Collateral with a Maturity Mismatch.

    • PRU A4.4 PRU A4.4 Qualifying Securities Financing Transactions (SFTs)

      • PRU A4.4.1

        A qualifying SFT must comply with the following requirements:

        (a) both the Exposure and the Collateral are cash, or a Security issued by a central government or Central Bank qualifying for a 0% risk weight under the Rules in Section 4.12;
        (b) both the Exposure and the Collateral are denominated in the same currency;
        (c) either the transaction is overnight or both the Exposure and the Collateral are marked-to-market daily and are subject to daily remargining;
        (d) following a Counterparty's failure to remargin, the time that is required between the last mark-to-market before the failure to remargin and the liquidation of the Collateral is considered to be no more than four business days;
        (e) the transaction is settled across a recognised settlement system for that type of transaction;
        (f) the documentation covering the agreement is standard market documentation for repos, reverse repos, Securities, lending transactions or Securities 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 may be terminated immediately; and
        (h) upon any event of default, regardless of whether the Counterparty is insolvent or bankrupt, the Authorised Person has the unfettered, legally enforceable right to immediately seize and liquidate the Collateral for the benefit of the Authorised Person.

    • PRU A4.5 PRU A4.5 Requirements for use of VaR models

      • PRU A4.5.1 PRU A4.5.1

        An Authorised Person using VaR models must:

        (a) use a minimum holding period of ten business days except in the case of an SFT, for which it must use a minimum holding period of five business days;
        (b) backtest its output by:
        (i) identifying a sample of 20 Counterparties, on an annual basis, which must include the ten largest Counterparties as determined by the Authorised Person according to its own Exposure measurement approach and ten others selected at random;
        (ii) comparing, for each day and for the sample of 20 Counterparties, the VaR estimate of the previous day for the Counterparty portfolio to the difference between the net value of the previous day's portfolio using today's market prices and the net value of that portfolio using the previous day's market prices; and
        (iii) counting it as an exception, where this difference exceeds the previous day's VaR estimate.

        • Guidance

          An Authorised Person should adjust the minimum holding period upwards for any Financial Instrument where the specified holding period would be inappropriate given the liquidity of the instrument concerned. When the outcome of the model consistently results in a large number of exceptions, either overall or for one significant Counterparty, the Authorised Person is expected to review the model assumptions and make modifications as appropriate.

    • PRU A4.6 PRU A4.6 Credit RWA — Unsettled Transactions, free deliveries and OTC Derivatives

      • Guidance

        1. Where settlement does not occur on the due date and neither party has released the relevant cash or Securities, an Authorised Person faces Market Risk, namely the differential between the contract price of the Securities and their current value in the market. In this case an Authorised Person also faces a Credit Risk Exposure for the Unsettled Transaction, for which the Authorised Person is required to hold regulatory capital. The relevant Credit Risk Exposure should be included in the calculation of Credit RWA for the Authorised Person.
        2. An Authorised Person is at risk for the whole amount of the contract (as well as any further movement in price) if it has delivered its leg of a contract before receipt of the other leg. In this case an Authorised Person must calculate the Credit Risk RWA for the free delivery transaction.
        3. For Derivatives (OTC and exchange-traded) and long settlement transactions, an Authorised Person is exposed to settlement risk. For Derivatives Contracts, the risk is that the price moves in an Authorised Person's favour so that it makes a book profit but at maturity the Authorised Person cannot realise that profit because the other party defaults.
        4. In cases of a system-wide failure of a settlement or clearing system, an Authorised Person need not calculate CRCOM on transactions remaining unsettled till the settlement or clearing system is brought back to normal operations.

      • PRU A4.6.1

        The Section applies in respect of items in both the Trading Book and Non-Trading Book.

      • PRU A4.6.2

        CRWs must be calculated on the Counterparty to the transaction, not on the Issuer of the Security.

      • PRU A4.6.3

        When calculating its Credit RWA, an Authorised Person must not include RWA arising from a transaction if it is a negative amount.

      • PRU A4.6.4

        CRW is applied in accordance with Section A4.3 except that the maximum CPW for an OTC Derivative is 50%.

      • Unsettled Transactions

        • PRU A4.6.5

          An Authorised Person must calculate the Credit RWA for transactions in which debt instruments, equities, foreign currencies and commodities (excluding repos, reverse repos and Securities or commodities lending/borrowing) remain unsettled after their due delivery dates, using the following formula:

          Credit RWA on Unsettled Transactions = E × the appropriate percentage from the second column in the table below:

          Number of business days after due settlement date Percentages used for calculation of Credit RWA on Unsettled Transactions
          0–4 0%
          5–15 100%
          16–30 500%
          31–45 750%
          46 or more 1000%

        • PRU A4.6.6

          If assets involved in the transaction are to be received by the Authorised Person and the transaction remains unsettled:

          E = max(MV-CV, 0)

          where MV is the market value of the assets and CV represents the contracted value for delivery of the assets.

        • PRU A4.6.7 PRU A4.6.7

          If assets involved in the transaction are to be delivered by the Authorised Person and the transaction remains unsettled:

          E = max(CV-MV, 0)

          • Guidance

            E is the price difference to which the Authorised Person is exposed, being the difference between the agreed settlement price for the debt instrument, equity, foreign currency or commodity in question and its current market value, where the difference could involve a loss for the firm.

      • Free delivery transactions

        • PRU A4.6.8

          An Authorised Person must calculate the Credit RWA in accordance with the table in Rule A4.6.11 for free delivery transactions in both the Trading and Non-Trading Book where it has:

          (a) delivered Securities or commodities before receiving payment;
          (b) paid for Securities or commodities before receiving the items purchased; or
          (c) entered into a foreign exchange contract undertaken in the spot market or contracted for forward settlement and has released funds to its Counterparty but has not yet received the funds in the other currency.

        • PRU A4.6.9 PRU A4.6.9

          If the settlement of the transaction is to be effected across a national border, Credit RWA needs to be calculated only when more than one business day has elapsed since the firm has made the relevant payment or delivery.

          • Guidance

            In respect of free delivery transactions referred to in Rule A4.6.9, if the dates when two payment legs are made are the same according to the time zones where each payment is made, they are deemed to have been settled on the same day.

        • PRU A4.6.10

          For a free delivery transaction an Authorised Person must determine its exposure E after the end of the first contractual payment or delivery date as follows:

          (a) if an Authorised Person has delivered Securities or Commodities or foreign exchange funds to a Counterparty and has not received payment:

          E = CV due to the Authorised Person

          (b) if an Authorised Person has made payment of CV to a Counterparty for commodities or Securities and has not received them:

          E = CV – MV of the Securities, commodities or foreign exchange funds due to it

        • PRU A4.6.11

          The Credit RWA in respect of free delivery transactions are to be calculated in accordance with the following table:

           

          Transaction stage Treatment
          Up to first contractual payment or delivery leg No calculation required
          From first contractual payment or delivery leg up to four business days after second contractual payment or delivery leg Treat as an exposure
          From five business days post contractual payment or delivery leg until extinction of the transaction Treat as an exposure with a risk-weight of 1000%

           

        • PRU A4.6.12

          An Authorised Person must treat an Exposure in accordance with the relevant provisions of Chapter 4.

        • PRU A4.6.13

          If the Authorised Person considers the total amount of the exposures resulting from free delivery transactions to be immaterial it may apply a risk weight of 100% to these exposures, except where a risk weight of 1000% is applied in accordance with Rule A4.6.11.

      • Derivatives and long settlement transactions – Standardised Approach to Counterparty Credit Risk (SA-CCR)

        • PRU A4.6.14

          The exposure at default (EAD) of Derivative transactions (OTC and exchangetraded) and long settlement transactions must be calculated in accordance with this Section unless the Authorised Person has been granted permission by the Regulator to use an internal model.

        • PRU A4.6.15 PRU A4.6.15

          EAD is to be calculated separately for each netting set. It is determined as follows:

          EAD = alpha* (RC + PFE)

          where:

          alpha = 1.4

          RC = the replacement cost calculated according to Rules A4.6.19 to A4.6.24

          PFE = the amount for potential future exposure calculated according to Rule A4.6.26

           

          • Guidance

            Details of how to net the PFCE are given in Rule A4.6.22.

        • PRU A4.6.16

          The replacement cost (RC) and the potential future exposure (PFE) components must be calculated differently for margined and unmargined netting sets. The EAD for a margined netting set is to be capped at the EAD of the same netting set calculated on an unmargined basis.

      • Netting Sets

        • PRU A4.6.17

          An Authorised Person may net transactions subject to any legally valid form of bilateral netting which results in legal substitution of one single payable/receivable amount for previous gross obligations.

        • PRU A4.6.18

          In every case in which netting is applied, the Authorised Person must demonstrate to the Regulator that it has the following in place:

          (a) A netting contract with the counterparty or other agreement which creates a single legal obligation, covering all included transactions, such that the Authorised Person would have either a claim to receive or obligation to pay only the net sum of the positive and negative mark-to-market values of included individual transactions in the event a counterparty fails to perform due to any of the following:
          (i) default,
          (ii) bankruptcy,
          (iii) liquidation, or
          (iv) similar circumstances.
          (b) Written and reasoned legal reviews that, in the event of a legal challenge, the relevant courts and administrative authorities would find the exposure of the Authorised Person to be such a net amount under:
          (i) The law of the jurisdiction in which the counterparty is chartered and, if the foreign branch of a counterparty is involved, then also under the law of the jurisdiction in which the branch is located;
          (ii) The law that governs the individual transactions; and
          (iii) The law that governs any contract or agreement necessary to effect the netting.
          (c) Proceduresto ensure that the legal characteristics of netting arrangements are kept under review in light of the possible changes in relevant law.

      • Calculation of RC for unmargined transactions

        • PRU A4.6.19

          An unmargined transaction is a transaction in which variation margin is not exchanged. Collateral other than variation margin may be present.

        • PRU A4.6.20

          RC for unmargined transactions is calculated in accordance with the following formula:

          RC = max{V – C; 0}

          where:

          V = the value of the derivative transactions in the netting set (constituted in accordance with Rule A4.6.18); and

          C = the haircut value of the net collateral held, calculated in accordance with Section A4.3.

           

        • PRU A4.6.21

          Derivative contracts with a one-way margining agreement in favour of the Authorised Person's counterparty must be treated as unmargined transactions.

      • Net Independent Collateral Amount

        • Guidance

          An Authorised Person may calculate the PFCE arising under OTC Derivative contracts on a net basis.

        • PRU A4.6.22

          The independent collateral amount (ICA) is (i) collateral (other than variation margin) posted by the counterparty that is available to the Authorised Person on default of the counterparty; and/or (ii) the Independent Amount parameter as defined in standard industry documentation.

        • PRU A4.6.23

          The net independent collateral amount (NICA) is any ICA posted by the counterparty less unsegregated collateral posted by the Authorised Person.

      • Calculation Of RC For Margined Transactions

        • PRU A4.6.24 PRU A4.6.24

          RC for margined transactions is calculated in accordance with the following formula:

          RC = max{V – C; TH + MTA – NICA; 0}

          where:

          V = the value of the derivative transactions in the netting set (constituted in accordance with Rule A4.6.18);

          C = the haircut value of the net collateral held, calculated in accordance with Section A4.3;

          TH = the positive threshold before the counterparty is required to send the Authorised Person collateral;

          MTA = the minimum transfer amount applicable to the counterparty;

          NICA = the net independent collateral amount.

          • Guidance

            (TH + MTA – NICA) represents the largest exposure that would not trigger a variation margin call. For example, without initial margin, the greatest exposure that would not trigger a variation call is the threshold plus any minimum transfer amount.

      • Potential Future Exposure

        • PRU A4.6.25

          The PFE consists of (i) an aggregate add-on component, which consists of add-ons calculated for each asset class and (ii) a multiplier that allows for the recognition of excess collateral or negative mark-to-market value for the transactions.

        • PRU A4.6.26

          PFE is calculated as follows:

          PFE = multiplier * AddOnaggregate

          where:

          AddOnaggregate = the aggregate add-on component; and 

          multiplier = a function of three inputs (V, C and AddOnaggregate), calculated in accordance with Rule A4.6.27.

        • PRU A4.6.27

          The multiplier input is calculated in accordance with the following formula:

          PRU_Ver06_A4_6_27.PNG

          where:

          exp(…) = the exponential function;

          Floor = 5%;

          V = the value of the derivative transactions in the netting set; and

          C = the haircut value of the net collateral held, calculated in accordance with Section A4.3.

      • General Steps For Calculating The Add-On

        • PRU A4.6.28

          For each transaction, the Authorised Person must identify the primary risk factor or factors and attribute the transaction to one or more of the five asset classes: interest rate, foreign exchange, credit, equity or commodity.

        • PRU A4.6.29 PRU A4.6.29

          The Authorised Person must determine the add-on for each asset class in accordance with the asset-class-specific formulae set out in A4.6.35A4.6.58.

          • Guidance

            Most derivative transactions have one primary risk driver, defined by the reference underlying instrument (e.g. an interest rate curve for an interest rate swap, a reference entity for a credit default swap, a foreign exchange rate for an FX call option etc.).

      • Formulae And Parameters Common To All Asset Classes

        • PRU A4.6.30

          The following formulae and adjustments are used in the determination of the add-ons for all asset classes.

      • Supervisory Delta Adjustment: δi

        • PRU A4.6.31 PRU A4.6.31

          The Authorised Person must include the following supervisory delta adjustments in the calculation of the relevant add-on where relevant.

          δi Long in the primary risk
          factor
          Short in the primary risk
          factor
          Instruments that are
          not options or CDO
          tranches
          +1 -1
          δi Bought Sold
          Call options
          Put options
          With the following parameters:

          Pi = underlying price (spot, forward, average etc.)

          Ki = strike price

          Ti = latest contractual exercise date of the option

          The supervisory volatility σi of an option is specified on the basis of the supervisory factor applicable to the trade in accordance with the table set out in A4.6.34.

          δi Purchased (long protection) Sold (short protection)
          CDO tranches
          With the following parameters:

          Ai = attachment point of the CDO tranche

          Di = detachment point of the CDO tranche

          • Guidance

            "Long in the primary risk factor" means that the market value of the instrument increases, whereas "short in the primary risk factor" means that the market value of the instrument decreases when the value of the primary risk factor increases. The symbol Φ in these equations represents the standard normal cumulative distribution function.

      • Time Risk Horizons – Unmargined Transactions

        • PRU A4.6.32 PRU A4.6.32

          The Authorised Person must calculate the maturity factor (MFi) of unmargined transactions in accordance with the following formula:

          where Mi is the remaining maturity of the transaction, floored at ten business days.

          • Guidance

            The formula requires that the minimum time risk horizon for unmargined transactions is the lesser of one year and the remaining maturity of the derivative contract, floored at ten business days.

      • Time Risk Horizons – Margined Transactions

        • PRU A4.6.33

          The Authorised Person must calculate the MFi of margined transactions in accordance with the following formula:

          The appropriate margin period of risk (MPORi) is determined in accordance with the following table:

          Transaction Type Minimum Margin Period of Risk (MPORi)
          Non-centrally-cleared derivative transactions subject to daily margin agreements Ten business days
          Centrally cleared derivative transactions subject to daily margin agreements Five business days
          Netting sets consisting of 5,000 or more transactions that are not with a central counterparty Twenty business days
          Netting sets with outstanding disputes Double the MPORi for the relevant category of transaction

      • Supervisory factors, correlation and supervisory option volatilities

        • PRU A4.6.34

          Supervisory factors are specific to each asset class. The Authorised Person must refer to the table below to determine the supervisory factor relevant to their determination of the add-on for their particular asset class in accordance with the asset-class-specific formulae set out in Rules A4.6.35 to A4.6.58.

          Asset Class Subclass Supervisory factor SF (%) Correlation ρ (%) Supervisory option volatility σ (%)
          Interest rate   0.50 n/a 50
          Foreign exchange   4.0 n/a 15
          Credit, single name (where CQG represents Credit Quality Grade) CQG 1 0.38 50 100
          CQG 2 0.42 50 100
          CQG 3 0.54 50 100
          CQG 4 1.06 50 100
          CQG 5 1.6 50 100
          CQG 6 6.0 50 100
          Credit, index Investment Grade 0.38 80 80
          Non-Investment Grade 1.06 80 80
          Equity, single name   32 50 120
          Equity, index   20 80 75
          Commodity Electricity 40 40 150
          Oil/Gas 18 40 70
          Metals 18 40 70
          Agricultural 18 40 70
          Other 18 40 70

      • Trade Level Adjusted Notional – Interest Rate (di (IR)) And Credit Derivatives (di (Credit))

        • PRU A4.6.35

          For interest rate and credit derivatives, the trade-level adjusted notional is the product of the trade notional amount, converted to the domestic currency, and the supervisory duration (SDi):

          Trade-level adjusted notional = Trade notional amount * SDi

        • PRU A4.6.36

          SDi is determined in accordance with the following formula:

          𝑆𝐷𝑖=exp(‐0.05𝑆𝑖)−exp(‐0.05𝐸𝑖)/0.05

          where 𝑆𝑖 and 𝐸𝑖 are the start and end dates, respectively, of the time period referenced by the interest rate or credit derivative, floored by ten business days.

      • Add - On For Interest Rate Derivatives

        • PRU A4.6.37

          The add-on for interest rate derivatives is the sum of the add-ons for each hedging set of interest rate derivatives transacted with a counterparty in a netting set.

        • PRU A4.6.38

          Interest rate derivatives consist of a separate hedging set for each currency. Interest rate derivatives are divided into three time 'buckets' as follows: less than or equal to one year, greater than one year and lessthanor equal to five years, and more than five years.

        • PRU A4.6.39

          The add-on for a hedging set of interest rate derivatives is calculated in two steps:

        • Step 1

          • PRU A4.6.40 PRU A4.6.40

            The effective notional is calculated in accordance with the following formula:

            where:
            i ε (Ccyj, MBk) refers to trades of currency j that belong to maturity bucket k.

            • Guidance

              The effect of this formula is that the effective notional for each time bucket and currency is the sum of the trade-level adjusted notional amounts multiplied by the supervisory delta adjustments and the maturity factor.

        • Step 2

          • PRU A4.6.41

            The Authorised Person must aggregate across maturity buckets for each hedging set in accordance with the following formula:

          • PRU A4.6.42

            The Authorised Person must then determine the hedging set level add-on in accordance with the following formula:

          • PRU A4.6.43

            The Authorised Person must then aggregate the interest rate derivative add-on across hedging sets by simple summation, as follows:

      • Add - On For Credit Derivatives

        • A4.6.44 PRU A4.6.44

          All credit derivatives referencing the same entity may be offset fully to form an entity-level effective notional amount:

          where i ε Entityk refers to trades of Entityk.

          • Guidance

            The effect of this formula is that the effective notional for each entity is the sum of the trade-level adjusted notional amounts multiplied by the supervisory delta adjustments and the maturity factor.

        • PRU A4.6.45

          The add-on for all positions referencing the entity is determined in accordance with the following formula:

          𝐴𝑑𝑑𝑂𝑛(𝐸𝑛𝑡𝑖𝑡𝑦𝑘) = 𝑆𝐹𝑘(𝐶𝑟𝑒𝑑𝑖𝑡)∗ 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒𝑁𝑜𝑡𝑖𝑜𝑛𝑎𝑙𝑘(𝐶𝑟𝑒𝑑𝑖𝑡)

          where SFk is the supervisory factor for the credit asset class, determined in accordance with the table set out in A4.6.36.

        • PRU A4.6.46

          The cumulative add-on for the credit derivatives hedging set is determined in accordance with the following formula:

          where ρ (credit)k is the appropriate correlation factor corresponding to the entity k, determined in accordance with the table set out in A4.6.36.

      • Trade Level Adjusted Notional – Foreign Exchange Derivatives

        • A4.6.47 PRU A4.6.47

          The adjusted notional of foreign exchange derivatives is defined as the notional of the foreign currency leg of the contract, converted to the domestic currency.

          • Guidance

            If both legs of the foreign exchange derivative are denominated in currencies other than the domestic currency, the notional amount of each leg is converted to the domestic currency and the leg with the larger domestic currency value is the adjusted notional amount.

      • Add - On For Foreign Exchange Derivatives

        • A4.6.48 PRU A4.6.48

          The effective notional for foreign exchange derivatives is calculated in accordance with the following formula:

          where i ε HSj refers to trades of hedging set HSj

          • Guidance

            The effective notional for each currency pair, given by the above formula, is the sum of the trade-level adjusted notional amounts multiplied by the supervisory delta adjustments and the maturity factor.

        • PRU A4.6.49

          The Authorised Person must calculate the hedging set level add-on in accordance with the following formula:

        • PRU A4.6.50

          The Authorised Person must then aggregate the foreign exchange derivative addon across hedging sets by simple summation, as follows:

      • Trade Level Adjusted Notional – Equity And Commodity Derivatives

        • PRU A4.6.51

          For equity and commodity derivatives, the adjusted notional is defined as the product of the current price of one unit of the stock or commodity and the number of units referenced by the trade.

      • Add - On For Equity Derivatives

        • A4.6.52 PRU A4.6.52

          The Authorised Person must determine the effective notional value of an equity derivative transaction referenced to an entity in accordance with the following formula:

          • Guidance

            The effective notional for each entity, calculated in accordance with the above formula, is the sum of the trade-level adjusted notional amounts multiplied by the supervisory delta adjustments and the maturity factor.

        • PRU A4.6.53

          The Authorised Person must calculate the add-on for all positions referencing entity k and its effective notional in accordance with the following formula:

        • PRU A4.6.54

          The Authorised Person must calculate the add-on for the hedging set in accordance with the following formula:

          where ρk (equity) is the appropriate correlation factor corresponding to the entity k, determined in accordance with the table set out in A4.6.34.

      • Add - On For Commodity Derivatives

        • A4.6.55 PRU A4.6.55

          The Authorised Person must determine the effective notional value of a commodity derivative transaction in a commodity of a particular type listed in A4.6.34 in accordance with the following formula:

          where i εTypek j refers to trades of commodity type k in hedging set j.

          • Guidance

            The effective notional for each commodity derivative, calculated in accordance with the above formula, is the sum of the trade-level adjusted notional amounts multiplied by the supervisory delta adjustments and the maturity factor.

        • PRU A4.6.56

          The Authorised Person must determine the add-on for all commodity derivatives of commodity type k in accordance with the following formula:

        • PRU A4.6.57

          The Authorised Person must determine the add-on for its commodity hedging set in accordance with the following formula:

           

          where ρj (com) is the appropriate correlation factor, determined in accordance with the table in A4.6.34, for the hedging set j.

        • PRU A4.6.58

          The Authorised Person must determine the add-on for its commodity asset class in accordance with the following formula:

    • PRU A4.7 PRU A4.7 Credit RWA — repurchase agreements, reverse repurchase agreements, similar transactions and other deferred settlements

      • PRU A4.7.1

        This Section applies to transactions in the Trading Book in relation to repurchase agreements, reverse repurchase agreements, similar transactions and deferred settlements.

      • PRU A4.7.2

        For repurchase agreements and reverse repurchase agreements the formula for Credit RWA, which must be calculated from T, is as follows:

        Credit RWA = E × CRW.

      • PRU A4.7.3

        For repurchase agreements:

        E = MV of the Securities sold - value of the Collateral or cash received.

      • PRU A4.7.4

        For reverse repurchase agreements:

         E = Amount paid or Collateral given — MV of the Securities received.

      • PRU A4.7.5

        If the E calculated is negative:

        Credit RWA = 0.

      • PRU A4.7.6

        The MV of Securities and the value of cash lodged must include accrued interest.

      • PRU A4.7.7

        The MV of Securities and the value of Collateral under A4.7.3 to A4.7.6 should be calculated in accordance with the CRM provisions set out in Section 4.13.

      • PRU A4.7.8

        For deferred settlement purchases and sales transactions over the spot period: Credit RWA = 0.

      • PRU A4.7.9

        The 'spot period' means the shortest time between T and:

        (a) the contractual settlement date;
        (b) the normal local market settlement date; and
        (c) T + five business days.

      • PRU A4.7.10

        For deferred settlement purchases and sales transactions with a contractual settlement date after the spot period as set out above but less than (T + five business days):

        Credit RWA = E x CRW.

      • PRU A4.7.11

        Not currently in use.

      • PRU A4.7.12 PRU A4.7.12

        For deferred settlement purchases and sales transactions with a contractual settlement date exceeding (T + five business days):

        Credit RWA = E x CRW x the appropriate percentage from the table below:

         

        Number of business days calculated from
        T
        Percentages used for calculation of Credit RWA on deferred settlement transactions
        6–30 500%
        31–45 750%
        46 or more 1000%

        • Guidance

          Credit RWA for deferred settlement transactions applies even if the deferred settlement contract is not overdue.

    • PRU A4.8 PRU A4.8 Credit RWA — other Trading Book transactions

      • PRU A4.8.1 PRU A4.8.1

        For Counterparty Exposures in the Trading Book not covered by Sections A4.6 and A4.7, the following formula applies: Credit RWA = E × CRW.

        • Guidance

          Examples include Counterparty Exposures in relation to exchange-traded Derivatives, unpaid margin requirements, Trading Book qualifying Deposits, and fees and interest.

      • PRU A4.8.2

        Where a Counterparty has not fully paid a margin requirement on a Derivative transaction listed on an exchange or cleared through a clearing house: E = the shortfall.

      • PRU A4.8.3

        Where an Authorised Person sells or writes an Option to a Counterparty or buys an Option on behalf of a Counterparty and the Counterparty has not paid the full Option premium: E = the uncovered premium on the transaction.

      • PRU A4.8.4

        Where a Counterparty has not fully met amounts owed to an Authorised Person arising out of losses on closed-out Derivative transactions or has not fully settled amounts owed in respect of periodic or final settlement of transactions: E = the unpaid loss.

    • PRU A4.9 PRU A4.9 Exposures to central counterparties

      • PRU A4.9.1

        This Section applies to exposures arising from Derivatives, SFTs and/or long settlement transactions that are cleared by a central counterparty (CCP). Exposures arising from the settlement of cash transactions (equities, fixed income, spot FX and spot commodities) are not subject to this Section.

      • PRU A4.9.2 PRU A4.9.2

        Authorised Persons must:

        (a) monitor all their exposures to CCPs; and must have adequate procedures for the regular reporting of information on those exposures to senior management and appropriate committee or committees of the management body; and
        (b) assess, through appropriate scenario analysis and stress testing, whether the level of capital held by the Authorised Person against exposures to a CCP is adequate.

        • Guidance

          The assessment under Rule A4.9.2(b) must cover the inherent risks of exposures to the CCP, including potential future credit exposures, exposures from default fund contributions and, where the Authorised Person is acting as a clearing member of the CCP, exposures resulting from contractual arrangements providing for commitments to take over or replace offsetting transactions from clients of another clearing member, in case such other clearing member defaults or becomes insolvent.

      • Trade Exposure Of A Clearing Member To A Qualifying Central Counterparty

        • PRU A4.9.3

          Where an Authorised Person acts as a clearing member, either for its own purposes or as an intermediary between a client and a qualifying central counterparty (QCCP), it must calculate Credit RWA in respect of its Trade Exposure to the QCCP in accordance with Rule A4.6.14, except that it must apply a CRW of 2%, unless Rule A4.9.4 applies.

        • PRU A4.9.4

          Where an Authorised Person is acting as an intermediary between a client and a QCCP and the terms of the QCCP-related transaction stipulate that the Authorised Person is not obligated to reimburse the client for any losses suffered due to changes in the value of that transaction in the event that the QCCP defaults, it may apply a CRW of 0% when calculating Credit RWA in respect of its Trade Exposure to the QCCP.

      • Trade Exposure Of A Clearing Member To A Non - QCCP

        • PRU A4.9.5

          (1) The Protection Buyer relies on the Protection Seller to pay the Credit Event Payment if a Credit Event occurs, and therefore must compute Credit RWAs for the Counterparty Risk involved.
          (2) The Protection Seller is exposed to the Protection Buyer only if there are premium or interest rate-related payments outstanding.

      • Credit default products

        • Trade Exposure Of A Clearing Member To A Client

          • PRU A4.9.6

            Where an Authorised Person acts as a clearing member, and in that capacity, acts as an intermediary between a client and a CCP, it must calculate Credit RWA in respect of its Trade Exposure to the client in accordance with Rule A4.6.14, together with App5 and relevant provisions of Section 4.13 in respect of any Collateral posted by the client, if applicable.

        • Trade Exposure Of A Client To A Clearing Member

          • PRU A4.9.8

            For the purposes of Rule A4.9.7 above, the following conditions must be met:

            (a) the clearing member's offsetting transaction with a QCCP is identified by the QCCP as a client transaction and collateral to support it is held by the QCCP and/or the clearing member, as applicable, under arrangements that would prevent any losses to the Authorised Person due to: (i) the default or insolvency of the clearing member, (ii) the default or insolvency of the clearing member's other clients; and (iii) the joint default or insolvency of the clearing member and any of its other clients;

             

            (b) the Authorised Person has conducted sufficient legal review (and undertaken such further review as necessary to ensure continuing enforceability) that concludes that, in the event of legal challenge, the relevant courts and administrative authorities would find that the Authorised Person would bear no losses on account of the insolvency of its clearing member or of any of its clearing member's clients under the relevant laws of the relevant jurisdiction(s); and

             

            (c) laws, regulations, rules, contractual or administrative arrangements applicable to or binding the Authorised Person or the QCCP facilitate the transfer of the Authorised Person's position relating to that contract and transaction and of the corresponding collateral to another clearing member within the applicable margin period of risk in the event of default or insolvency of the original clearing member. In such a circumstance, the Authorised Person's position and the collateral must be transferred at market value unless the client requests to close out the position at market value.

             

          • PRU A4.9.7 PRU A4.9.7

            Where an Authorised Person is a client of a clearing member, and enters into a transaction with the clearing member acting as an intermediary between the Authorised Person and a CCP, it must calculate Credit RWA in respect of its Trade Exposure to the clearing member as if it were a Trade Exposure to a QCCP provided all the conditions in Rule A4.9.8 are satisfied.

            • PRU A4.9.9

              Where an Authorised Person is a client of the clearing member and the conditions set out in Rule A4.9.8 are not satisfied, the Authorised Person must capitalise its exposure to the clearing member as a bilateral OTC transaction in accordance with A4.6.14.

            • PRU A4.9.10

              Without prejudice to Rule A4.9.9, where an Authorised Person that is a client is not protected from losses where the clearing member and another client of the clearing member jointly default, but all the other conditions set out in Rule A4.9.8 are met, it must calculate Credit RWA in respect of its exposure to the clearing member in accordance with Rule A4.6.14, except that it must apply a CRW of 4%.

        • Trade Exposures In An Indirect Clearing Arrangement

          • PRU A4.9.11

            Where an Authorised Person that is a client accesses the services of a CCP through indirect clearing arrangements (where, for example it is a client of a clearing member's client), it may calculate Credit RWA in respect of its exposure to its intermediary in accordance with Rules A4.9.7 and A4.9.8, provided that the conditions set out in Rule A4.9.8 are satisfied at every level of the chain of intermediaries.

        • Treatment Of Posted Collateral

          • PRU A4.9.12

            Any collateral posted pursuant to transactions covered by Rules A4.9.3 to A4.9.11 must, from the perspective of the Authorised Person posting such collateral, receive the CRWs that otherwise apply to such assets or collateral, regardless of the fact that such collateral has been posted as collateral as part of a clearing arrangement.

          • A4.9.13 PRU A4.9.13

            Where collateral of a clearing member or client is posted with a QCCP or a clearing member, the Authorised Person posting such collateral must also recognise credit risk arising as a result of the collateral being exposed to risk of loss based on the creditworthiness of the entity holding such collateral according to the following Rules:

            (a) Where the entity holding such collateral is the QCCP, a CRW of 2% applies to collateral posted in relation to Trade Exposures. The relevant CRW of the QCCP will apply to collateral posted for other purposes. Where the Authorised Person uses the SA-CCR to calculate exposures, collateral posted which is not held in a bankruptcy remote manner must be accounted for in the NICA term in accordance with Rule A4.6.14. Where the Authorised Person uses an IMM Model in accordance with Rule A4.6.14, the alpha multiplier must be applied to the exposure on posted collateral.
            (b) All collateral posted by the clearing member (including cash, securities, other pledged assets and excess initial or variation margin) that is held by a custodian and is bankruptcy remote from the QCCP, is not subject to a capital requirement for Counterparty Credit Risk exposure to such bankruptcy remote custodian (i.e. the related CRW is 0%).
            (c) Collateral posted by a client, that is held by a custodian, and is bankruptcy remote from the QCCP, the clearing member and other clients, is not subject to a capital requirement for Counterparty Credit Risk. If the collateral is held at the QCCP on a client's behalf and is not held on a bankruptcy remote basis, a 2% risk-weight must apply to the collateral if the conditions in Rule A4.9.9 are met; or 4% if the conditions in Rule A4.9.10 are met.

            • Guidance

              The treatments set out in Rule A4.9.13 are summarised in the table below.

              Collateral Bankruptcy
              remote
              Conditions Risk weight
              posted by held by
              Clearing member QCCP No   2%
              Client Clearing member No   CRW of QCCP
              Clearing member Custodian Yes   0%
              Client Custodian Yes   0%
              QCCP Yes Rule A4.9.8 2%
              QCCP No Rule A4.9.10 4%

               

        • Calculation Of Credit RWA In Relation To Prefunded Contributions To The Default Fund Of A QCCP

          • PRU A4.9.14

            An Authorised Person acting as a clearing member must apply the following treatment to its exposures arising from its contributions to a default fund maintained by a QCCP:

            (a) it must calculate the Credit RWA for its prefunded contributions to the default fund of a QCCP in accordance with the approach set out in Rules A4.9.15 to A4.9.17; or
            (b) it must calculate the Credit RWA for its contributions to the default fund of a Non-QCCP in accordance with the approach set out in Rule A4.9.18.

        • Prefunded Contributions To The Default Fund Of A QCCP

          • PRU A4.9.15

            An Authorised Person acting as a clearing member must calculate its Credit RWA for its prefunded contributions to the default fund of a QCCP in accordance with the steps set out in Rules A4.9.16 and A4.9.17 below.

          • A4.9.16 PRU A4.9.16

            An Authorised Person must first calculate the hypothetical capital requirement of the QCCP (KCCP) due to its counterparty credit risk exposures to all of its clearing members and their clients in accordance with the following formula:

            where:

            RW = a risk weight of 20%;

            Capital ratio= 10%;

            EADi = the exposure amount of the QCCP to clearing member i, including both the clearing member's own transactions and client transactions guaranteed by the clearing member, and all values of collateral held by the QCCP held over all clearing member accounts (including the clearing member's prefunded default fund contribution) against these transactions, relating to the valuation at the end of the regulatory reporting date before the margin called on the final margin call of that day is exchanged.

            • Guidance

              1. Where clearing members provide client clearing services, and client transactions and collateral are held in separate sub-accounts to the clearing member's proprietary business, each such client sub-account should enter the sum separately, i.e. the member EAD in the formula above is then the sum of the client sub-account EADs and any house sub-account EAD. This will ensure that client collateral cannot be used to offset the exposures of the QCCP to clearing members' proprietary activity in the calculation of KCCP. If any of these sub-accounts contains both derivatives and SFTs, the EAD of that sub-account is the sum of the derivative EAD and the SFT EAD. If the default fund contributions of the member (DFi) are not split with regard to client and house sub-accounts, they must be allocated per subaccount according to the respective fraction the initial margin of that subaccount has in relation to the total initial margin posted by or for the account of the clearing member.
              (2) For derivatives, EADi is calculated as the bilateral trade exposure the QCCP has against clearing member i using the approach in Rule A4.6.14. All collateral held by a QCCP to which that QCCP has a legal claim in the event of default of a member or client, including default fund contributions of that member (DFi), is used to offset the exposure of the QCCP to that member or client, through inclusion in the potential future exposure multiplier in accordance with Rule A4.6.14.
              (3) For SFTs, EAD is equal to max(EBRMi – IMi – DFi; 0), where: a. EBRMi denotes the exposure value to clearing member i before risk mitigation. For the purposes of this calculation, variation margin that has been exchanged (before the margin called on the final margin call of that day) enters into the mark-to-market value of the transactions;
              b. IMi is the initial margin collateral posted by clearing member i with the QCCP;
              c. DFi is the prefunded default fund contribution by clearing member i that will be applied upon such clearing member's default, either along with or immediately following such member's initial margin, to reduce the QCCP loss.

          • A4.9.17 PRU A4.9.17

            An Authorised Person must next calculate the capital requirement for each clearing member in accordance with the following formula:

            where:

            KCMi = the capital requirement on the default fund contribution of clearing member i;

            DFprefCM = the total prefunded default fund contributions from clearing members;

            DFCCP = the prefunded own resources of the CCP (e.g. contributed capital, retained earnings, etc.), which are contributed to the default waterfall, where these are junior or pari passu to prefunded member contributions; and

            DFprefi = the prefunded default fund contributions provided by clearing member i.

            • Guidance

              1. If the Regulator is not provided with a calculation of KCCP, DFprefCM and DFCCP or if the Regulator is not able to confirm those calculations, the treatment set out in Rule A4.9.18 shall apply to the calculation made by the relevant Authorised Person to the default fund of a QCCP.
              2. KCCP should be calculated on a quarterly basis at a minimum, although the Regulator may require more frequent calculations in case of material changes (such as the QCCP clearing a new product). If the Authorised Person or Regulator performed the calculations, it should make available to any other Authorised Person which acts as a clearing member sufficient aggregate information about the composition of the exposures of the QCCP to clearing members and information provided to the Authorised Person for the purposes of the calculation of KCCP, DFprefCM and DFCCP.
              3. Such information should be provided a least on a quarterly basis. KCCP and KCMi should be recalculated at least quarterly, and should also be recalculated when there are material changes to the number or exposure of cleared transactions or material changes to the financial resources of the QCCP.

        • Prefunded And Unfunded Contributions To The Default Fund Of A Non - QCCP

          • PRU A4.9.18

            An Authorised Person must calculate Credit RWA for the exposures arising from its contributions to the default fund of a Non-QCCP in accordance with the following formula:

            Credit RWA = (DF + UC) × 10

            where:

            DF = the total prefunded default fund contributions provided by the Authorised Person; and

            UC = the total unfunded default fund contributions which the Non-QCCP may require the Authorised Person to provide.

            The Regulator may determine whether an Authorised Person's unfunded contribution to the default fund should be factored into the imposition of an Individual Capital Requirement under Rule 10.6.

        • Cap On Total Credit RWA With Regard To QCCPs

          • PRU A4.9.19

            An Authorised Person's total Credit RWA for Trade Exposures to a QCCP and default fund exposures to a QCCP must be limited to the total Credit RWA that would apply if the exposures were to a Non-QCCP.

    • PRU A4.10 PRU A4.10 Securitisation

      • PRU A4.10.1 PRU A4.10.1

        An Authorised Person which is an Originator or a Sponsor of a Traditional Securitisation may exclude securitised Exposures from the calculation of Credit RWA amounts only if all of the following conditions have been complied with:

        (a) except as provided in (g), (i) and (k), significant Credit Risk associated with the securitised Exposures has been transferred from the Originator to third parties;
        (b) the Authorised Person does not maintain effective or indirect control over the underlying Exposures;
        (c) the assets are legally isolated from the Authorised Person in order to ensure the assets are beyond the reach of the Authorised Person in the event of bankruptcy or receivership;
        (d) the Securities issued are not the obligations of the Authorised Person;
        (e) the Securities are issued pursuant to the securitisation by an SPE and the holders of the beneficial interests in that entity have the right to pledge or exchange them without restriction;
        (f) where a securitisation includes a Clean-Up Call, Clean-Up Calls must satisfy the conditions set out in Rule A4.10.3.
        (g) the documentation of the securitisation does not contain any clauses that:
        (i) require the Authorised Person systematically to alter the underlying Exposures such that the pool's weighted average credit quality is improved unless this is achieved by selling Exposures to independent and unaffiliated third parties which are not Connected to the Authorised Person or Related Persons of the Authorised Person in accordance with Rule 4.4.6 at market prices;
        (ii) allow for increases in a retained First Loss Position or Credit Enhancement provided by the Authorised Person after the securitisation's inception;
        (iii) other than step-up features incorporated in relation to the underlying Exposures of the securitisation, increase the yield payable to parties other than the Authorised Person, such as investors and third-party providers of Credit Enhancements, in response to deterioration in the credit quality of the underlying Exposures in the pool; or
        (iv) other than Clean-Up Calls, oblige the Authorised Person to repurchase any of the underlying Exposures, at any time, except where that obligation arises from the exercise of a representation or warranty given by the Authorised Person. The Authorised Person may give a representation or warranty solely in respect of the nature or existing state of facts of any underlying Exposure, that is capable of being verified, at the time of its transfer.
        (h) the transfer of the underlying Exposures or the transfer of risk through sub-participation does not contravene the terms and conditions of any underlying agreement in respect of the underlying Exposures and where applicable, all the necessary consents for the transfer or sub-participation have been obtained;
        (i) the documentation of the securitisation specifies that, if cash flows relating to the underlying Exposures are rescheduled or renegotiated, the SPE to which the Exposures have been transferred and not the Authorised Person, would be subject to the rescheduled or renegotiated terms;
        (j) the Authorised Person receives a fixed amount of consideration for the underlying Exposures;
        (k) the Authorised Person holds not more than 20% of the aggregate original amount of all Securities issued by the SPE, except where such holdings comprise entirely of Securities that have a Credit Quality Grade of 1 as set out in Rules in Sections 4.11 and 4.12, and all transactions with the SPE are conducted at arm's length and on market terms and conditions;
        (l) where the assets relate to the Islamic Financial Business of an Authorised Person, a written confirmation from the appointed Shari'a Supervisory Board that the securitisation complies with Shari'a; and
        (m) each of the points (a) to (l) must be evidenced and confirmed by a legal opinion from a qualified legal counsel.

        • Guidance

          1. An Authorised Person is deemed to have effective control over the transferred Exposures if:
          a. it is able to repurchase from the transferee the previously transferred Exposures in order to realise their benefits; or
          b. it is obligated to retain the risk of the transferred Exposures.
          2. In this regard, an Authorised Person acting as a Servicer in respect of the transferred Exposures will not necessarily constitute effective control of the Exposures.
          3. In respect of Rule A4.10.1(j), the amount of consideration received in the form of a fixed amount of Securities in the SPE would generally be regarded as meeting this requirement if the transaction is conducted at arm's length and on market terms and conditions. Also, this requirement does not preclude excess cash from being channelled to the Authorised Person after all claims connected with the Securities issued by the SPE have been paid out.

      • PRU A4.10.2 PRU A4.10.2

        An Authorised Person which is an Originator or a Sponsor of a Synthetic Securitisation may recognise the credit protection obtained through the Synthetic Securitisation in its calculation of Credit RWA amounts only if all of the following conditions have been complied with:

        (a) significant Credit Risk associated with the underlying Exposures has been transferred from the Originator to third parties;
        (b) the instrument used to transfer the underlying Credit Risks must not contain terms or conditions that limit in any way the amount of Credit Risk transferred, including, but not limited to, clauses that:
        (i) materially limit the credit protection or Credit Risk transference (e.g. significant materiality thresholds below which credit protection is deemed not to be triggered even if a credit event occurs or those that allow for the termination of the protection due to deterioration in the credit quality of the underlying Exposures);
        (ii) require the Authorised Person to alter the underlying Exposures to improve the weighted average credit quality of the pool;
        (iii) increase the cost of credit protection to the Authorised Person in response to deterioration in the credit quality of the underlying Exposures;
        (iv) increase the yield payable to parties other than the Authorised Person, such as investors and third-party providers of Credit Enhancements, in response to a deterioration in the credit quality of the underlying Exposures; or
        (v) provide for increases in a retained First Loss Position or Credit Enhancement provided by the originating bank after the transaction's inception.
        (c) an Authorised Person must provide an external legal opinion from a qualified legal counsel that confirms each of the points (i-v) and the enforceability of the contracts in all relevant jurisdictions;
        (d) where the assets relate to the Islamic Financial Business of an Authorised Person, a written confirmation from the appointed Shari'a Supervisory Board that the securitisation complies with Shari'a;
        (e) where the securitisation includes a Clean-Up Call it must meet the requirements of Rule A4.10.3;
        (f) in the case where the risks associated with the underlying Exposures are transferred to an SPE:
        (i) the Securities issued by the SPE are not obligations of the Authorised Person;
        (ii) the holders of the beneficial interests in that SPE have the right to pledge or exchange their interests without restriction; and
        (iii) the Authorised Person holds not more than 20% of the aggregate original amount of all Securities issued by the SPE, except where such holdings consist entirely of Securities that have a Credit Quality Grade of 1 in accordance with Rules in Sections 4.11 and 4.12, and all transactions with the SPE are conducted at arm's length and on market terms and conditions;
        (g) the Authorised Person has, on an on-going basis, a comprehensive understanding of the risk characteristics of its individual securitisation Exposures, whether on or off-balance sheet, as well as the risk characteristics of the pools underlying its securitisation Exposures;
        (h) the Authorised Person is able to access performance information on the underlying Exposures on an on-going basis in a timely manner. Such information may include, as appropriate, Exposure type, percentage of loans 30, 60 and 90 days past due, default rates, prepayment rates, loans in foreclosure, property type, occupancy, average credit score or other measures of creditworthiness, average loan-to-value ratio, and industry and geographic diversification. For Re-securitisations, the Authorised Person should have information not only on the underlying securitisation tranches, such as the Issuers' names and credit quality, but also on the characteristics and performance of the pools underlying the securitisation tranches; and
        (i) the Authorised Person has a thorough understanding of all structural features of a securitisation transaction that would materially impact the performance of the transaction, such as the contractual waterfall and waterfall-related triggers, Credit Enhancements, liquidity enhancements, market value triggers, and deal-specific definitions of default.

        • Guidance

          In relation to Rules A4.10.1 and A4.10.2, significant Credit Risk will be considered to have been transferred by the Originator of a securitisation if:

          a. the RWA amounts of the mezzanine securitisation positions held by the Originator in the securitisation do not exceed 50% of the RWA amounts of all mezzanine securitisation positions existing in this securitisation; and
          b. where there are no mezzanine securitisation positions in a given securitisation and the Originator can demonstrate that the Exposure value of the securitisation positions that would be subject to deduction from Capital Resources or a 1250% risk weight exceeds a reasonable estimate of the expected loss on the securitised Exposures by a substantial margin, the Originator does not hold more than 20% of the Exposures values of the securitisation positions that would be subject to deduction from Capital Resources or a 1250% risk weight.

      • Operational requirements for the treatment of Clean-Up Calls

        • PRU A4.10.3

          Where a Clean-Up Call is included within a securitisation, the Authorised Person which has the ability to exercise the Clean-Up Call must ensure that:

          (a) the exercise of the Clean-Up Call must not be mandatory, in form or substance;
          (b) the Clean-Up Call must not be structured to avoid allocating losses to Credit Enhancements, or positions held by investors or in any way structured to provide Credit Enhancement; and
          (c) the Clean-Up Call must only be exercisable when 10% or less of the original underlying Exposures or Securities issued in that securitisation remains, or in the case of a Synthetic Securitisation, when 10% or less of the original reference portfolio value remains.

        • PRU A4.10.4

          Where the conditions listed in Rule A4.10.3 are not met the Authorised Person must hold capital against the Exposures as follows:

          (a) for a Traditional Securitisation the underlying Exposures must be treated as if they had not been securitised;
          (b) Authorised Persons must not include any gain-on-sale in any element or component of their Capital Resources;
          (c) for Synthetic Securitisations, the Authorised Person must hold capital against the entire amount of securitised Exposures; and
          (d) where a Synthetic Securitisation incorporates a call that is not a Clean-Up Call, the Authorised Person must treat the transaction in accordance with the relevant CRM techniques in Section 4.13.

        • PRU A4.10.5

          An Authorised Person must treat a currency mismatch or a Maturity Mismatch between the underlying Exposure being hedged and the CRM obtained through the Synthetic Securitisation in accordance with Rules in Sections 4.13 and A4.3.

    • PRU A4.11 PRU A4.11 Large Exposures

      • Exempt Exposures

        • PRU A4.11.1 PRU A4.11.1

          An Authorised Person may treat the following Exposures as exempt from the Concentration Risk limits in Chapter 4 if they are to Counterparties not Connected to the Authorised Person:

          (a) asset items or Exposures constituting claims on central governments and Central Banks which receive a Credit Quality Grade rating 1 or 2 in accordance with Rule 4.12.4;
          (b) asset items or Exposures constituting claims on international organisations and multi-lateral development banks (MDBs) which receive a 0% (Credit Quality Grade rating of 1) risk weight as set out at Rule 4.12.7;
          (c) asset items or Exposures carrying the explicit guarantees of either (a) or (b) where the claims on the entity providing the guarantee would receive a 0% weighting (Credit Quality Grade rating of 1);
          (d) Exposures for which the Authorised Person has Collateral in the form of cash Deposits or certificates of Deposit, including certificates of Deposit issued by the Authorised Person, held by the Authorised Person, or held by the Authorised Person's Parent Financial Institution or a Subsidiary of the Authorised Person, but only if:
          (i) the Authorised Person and its Parent Financial Institution or the Subsidiary of the Authorised Person concerned are subject to consolidated supervision; and
          (ii) the enforceability requirements in Section 4.13 (CRM) are met;
          (e) Exposures arising from undrawn credit facilities that are classified as low risk off balance sheet items and provided that an agreement has been concluded with the Client or group of Connected clients under which the facility can only be drawn only if it has been ascertained that it will not cause the limit as set out in Rule 4.15.5 to be exceeded;
          (f) Exposures secured by mortgages on residential property and leasing transactions under which the lessor retains full ownership of the residential property leased for as long as the lessee has not exercised his option to purchase, in all cases up to 50% of the value of the residential property concerned; and
          (g) material holdings in Financial Institutions and other Exposures which have been deducted from an Authorised Person's Capital Resources as required in Chapter 3.

          • Guidance

            1. In order to be applicable under (c) the guarantees must meet the requirements of Section 4.13.9 in relation to CRM.
            2. An Authorised Person can only treat Exposures as collateralised provided the conditions of Rules 4.13.5 to 4.13.8 (relating to CRM) are met. Item (d) also includes cash received under a CLN issued by the Authorised Person and loans and Deposits of a Counterparty to or with the Authorised Person which are subject to an on balance sheet Netting agreement recognised under Section 4.13 (CRM).
            3. The Regulator may consider a waiver for other sovereign Exposures where there is a local regulatory requirement to hold assets with a national regulatory authority. Authorised Persons will be required to apply for a waiver of the Large Exposure requirements in this regard and will be considered by the Regulator on a case by case basis.

        • PRU A4.11.2

          Where Exposures to a Client are guaranteed by a third party, or secured by Collateral issued by a third party, an Authorised Person may:

          (a) provided the Collateral meets the requirements of Section 4.13 (CRM), and would be assigned a lower risk weight under Section 4.12, treat that portion of the Exposure which is secured by Collateral as an Exposure to the third party. An Authorised Person must treat the portion secured by Collateral as having being incurred to the third party providing the Collateral rather than to the Client for the purposes of considering the limits as set out at Rule 4.15.5; or
          (b) provided the guarantee meets the requirements of Section 4.13 (CRM), and would be assigned a lower risk weight under Section 4.12, treat that portion of the Exposure which is guaranteed as an Exposure to the third party. An Authorised Person must treat the portion guaranteed as having being incurred to the third party rather than to the Client for the purposes of considering the limits as set out at Rule 4.15.5. When considering the guarantee there must not be any Maturity Mismatch between the guarantee and the underlying Exposure.

        • PRU A4.11.3

          If an Exposure is partially guaranteed by an Authorised Person's Parent Financial Institution, and would be assigned a lower risk weight under Section 4.12, only that part of the Exposure subject to the guarantee is exempt from the Concentration Risk limits in Rule 4.15.5. When considering the treatment of this Rule an Authorised Person may also consider the exemptions permitted under Rule 4.15.18 relating to parental guarantees.

      • Identification of Counterparties

        • PRU A4.11.4 PRU A4.11.4

          When calculating the Exposures of an Authorised Person, the firm must include Trading Book Exposures and Non-Trading Book Exposures to:

          (a) a single Counterparty;
          (b) group of Closely Related Counterparties;
          (c) Connected Counterparties; and,
          (d) Transactions, schemes or Funds.

          • Guidance

            1. An individual Counterparty is a natural or legal Person, which include governments, local authorities, public sector enterprises (PSEs), trusts, corporations, unincorporated businesses and non-profit-making bodies.
            2. Examples of a Counterparty include:
            a. the customer or borrower;
            b. where the Authorised Person is providing a guarantee, the Person guaranteed;
            c. for a Derivatives contract, the Person with whom the contract was made;
            d. for most exchange-traded contracts involving a central clearing mechanism, that central clearing mechanism; and
            e. where a bill held by an Authorised Person has been accepted by another Financial Institution, the acceptor.

      • Group of Closely Related Counterparties

        • PRU A4.11.5

          (1) For Concentration Risk purposes, Persons are Closely Related if:
          (a) the insolvency or default of one of them is likely to be associated with the insolvency or default of the others;
          (b) it would be prudent when assessing the financial condition or creditworthiness of one to consider that of the others; or
          (c) there is, or is likely to be, a close relationship between the financial performance of those Persons.
          (2) Persons who are Closely Related to each other are also Connected with each other.

        • PRU A4.11.6 PRU A4.11.6

          (1) A single group of Closely Related Counterparties means, in relation to an Authorised Person, all the Persons to which the Authorised Person has an Exposure and which are Closely Related to each other.
          (2) An Authorised Person must treat two or more Persons as falling within a group of Closely Related Counterparties if the Authorised Person has Exposures to them all and any loss to the Authorised Person on any of the Exposures to one is likely to be associated with a loss to the Authorised Person with respect to at least one Exposure to each of the others.

          • Guidance

            Two or more Counterparties between whom there is no relationship of control as described in Rules A4.11.5 and A4.11.6 will be regarded as constituting a single risk if they are so interconnected that, if one of them were to experience financial problems, in particular funding or repayment difficulties, the other or all of the others would also be likely to encounter funding or repayment difficulties.

      • Connected Counterparties

        • PRU A4.11.7 PRU A4.11.7

          For Concentration Risk purposes, and in relation to a Person, a Connected Counterparty means another Person to whom the first Person has an Exposure and who fulfils one of the following conditions:

          (a) he is Connected to the first Person;
          (b) he is an Associate of the first Person;
          (c) the same Persons significantly influence the Governing Body of each of them; or
          (d) one of those Persons has an Exposure to the other that was not incurred for the clear commercial advantage of both of them and which is not on arm's length terms.

          • Guidance

            A group of Connected Counterparties would be considered to be such where the entities share the same ultimate owner even though they may not be formally structured as a Group.

      • Exposures to transactions, schemes or Funds

        • PRU A4.11.8 PRU A4.11.8

          Where an Authorised Person has an Exposure to a transaction, scheme, Fund, or other Exposure to a pool of underlying Exposures, the Authorised Person must assess the Exposure to determine whether the Exposure is a group of Closely Related Counterparties in its economic substance.

          • Guidance

            1. When considering this Rule the Authorised Person should consider the following factors:
            a. the structure, independence and control of the transaction, including governance arrangements;
            b. the inter relatedness of the underlying Exposures;
            c. beneficial owners of the underlying Exposures and whether they could be deemed Connected or Closely Related; and
            d. whether the transactions are conducted on an arm's length basis.
            2. An Authorised Person should look through the structure to determine whether there are any Counterparties or Exposures that should be considered a Concentration Risk.

      • Connected Counterparty exemptions

        • PRU A4.11.9

          An Authorised Person may treat as exempt from the Concentration Risk limits in Chapter 4 an Exposure to a Counterparty or Counterparties Connected to the Authorised Person if all of the following conditions are met:

          (a) the Authorised Person has given the Regulator written notice one month in advance of its intention to use the exemption and explained how it will ensure that it will still meet the Concentration Risk limits on a continuing basis when using the exemption;
          (b) the total amount of the Exposures that an Authorised Person is treating as exempt under this Rule does not exceed 50% of the Authorised Person's Capital Resources;
          (c) the Authorised Person makes and retains a record that identifies each Exposure it has treated in this way;
          (d) the Authorised Person is subject to consolidated supervision;
          (e) the Counterparty is:
          (i) an Authorised Person which is the subject of consolidated supervision; or
          (ii) a member of the Authorised Person's Group which is the subject of consolidated supervision to the satisfaction of the Regulator; and
          (f) the Exposure satisfies one or more of conditions (i) to (iii):
          (i) it is a loan made by the Authorised Person with a maturity of one year or less in the course of the Authorised Person carrying on a treasury role for other members of its Group;
          (ii) it is a loan to the Parent of the Authorised Person made in the course of a business carried on by the Authorised Person of lending to its Parent cash that is surplus to the needs of the Authorised Person, provided that the amount of that surplus fluctuates regularly; or
          (iii) it arises from the Authorised Person or a Counterparty Connected to the Authorised Person operating a central risk management function for Exposures arising from Derivatives contracts.

      • Measuring Exposure to Counterparties and Issuers

        • PRU A4.11.10

          Rules A4.11.12 to A4.11.28 apply to both Non-Trading Book and Trading Book Exposures.

        • PRU A4.11.11

          When calculating an Exposure, an Authorised Person must include accrued interest and dividends due.

        • PRU A4.11.12

          An Authorised Person must not offset Non-Trading Book and Trading Book Exposures.

        • PRU A4.11.13

          If an Exposure is partially guaranteed by an Authorised Person's Parent Financial Institution, and would be assigned a lower risk weight under Section 4.12, only that part of the Exposure subject to the guarantee is exempt from the Large Exposure limit in Rule 4.15.5. When considering the treatment of this Rule an Authorised Person may also consider the exemptions permitted under Rule 4.15.18 relating to parental guarantees.

        • PRU A4.11.14

          The value of an Authorised Person's Exposure to a Counterparty, whether in its Non-Trading Book or its Trading Book, is the amount at risk calculated in accordance with Chapter 4.

      • Exposures to Issuers

        • PRU A4.11.15

          An Authorised Person must calculate the value of an Exposure to the Issuer of a Security which is held in the Authorised Person's Non-Trading Book as the sum of the excess, where positive, of the book value of all long positions over all short positions (the net long position), for each identical instrument issued by that Issuer.

        • PRU A4.11.16

          For the purposes of Rule A4.11.15, short positions in one Security may be used to offset long positions in a non-identical Security issued by the same Issuer if:

          (a) both Securities are denominated in the same currency; and
          (b) where both Securities are:
          (i) fixed rate or index-linked, and are within the same residual maturity time band; or
          (ii) floating rate.

        • PRU A4.11.17

          An Authorised Person must calculate the value of an Exposure to the Issuer of a Security that is held in the Authorised Person's Trading Book by calculating the excess of the current market value of all long positions over all short positions in all the Securities issued by that Issuer.

        • PRU A4.11.18

          An Authorised Person must not offset an Exposure to one Issuer against an Exposure to another even where the Issuers are in a group of Closely Related Counterparties.

        • PRU A4.11.19

          An Authorised Person must include as a long position a commitment by it to buy:

          (a) a debt Security or an equity at a future date; and
          (b) under a note issuance facility, at the request of the Issuer, a Security that is unsold on the issue date.

        • PRU A4.11.20

          An Authorised Person must include as a short position a commitment by it to sell a debt Security or equity at a future date.

        • PRU A4.11.21 PRU A4.11.21

          Where the equity leg of an equity swap is based on the change in value of an individual equity, it is treated as an Exposure to the Issuer of the equity.

          • Guidance

            An interest rate leg of an equity swap, or interest rate or currency swap does not generate an Exposure to an Issuer.

        • PRU A4.11.22

          When determining its Exposure to an Issuer arising from an Option, an Authorised Person must value the notional principal of an Option as the amount of principal underlying the Option.

        • PRU A4.11.23

          An Authorised Person must treat:

          (a) a written put Option as a long position in the underlying instrument valued at the strike price;
          (b) a written call Option as a short position in the underlying instrument valued at the strike price;
          (c) a purchased put Option as a short position in the underlying instrument valued at the strike price; and
          (d) a purchased call Option as a long position in the underlying instrument equal to the book value of the Option.

        • PRU A4.11.24 PRU A4.11.24

          An Authorised Person must, for the purposes of Concentration Risk, treat an Exposure to an Issuer arising from an index or basket of debt Securities or a non-broad-based equity index or basket, as a series of Exposures to the Issuers of the underlying instruments or equities in accordance with the procedures in Chapter 4.

          • Guidance

            Broadly based equity indices should not be broken down into their constituent stocks. A position related to a broadly based equity index does not generate an Exposure to any Issuer.

        • PRU A4.11.25

          An Authorised Person which receives cash on a repurchase agreement must treat the cash as if it is on its balance sheet and in accordance with Sections 4.9 and 4.13. Any Collateral received against repurchase agreements or Securities and commodities borrowing must also be treated as a balance sheet item under Sections 4.9 and 4.13.

        • PRU A4.11.26

          An Authorised Person must treat a reverse repurchase agreement or Securities and commodities lending in its Non-Trading Book as a collateralised loan and the Collateral it holds as an asset, provided that the Collateral is eligible financial Collateral as defined in Rule 4.13.5. If the Collateral is not such an eligible financial Collateral, the Authorised Person must treat the transaction as an unsecured loan to the Counterparty.

        • PRU A4.11.27

          An Authorised Person with repurchase agreements and reverse repurchase agreements in its Trading Book has an Exposure to:

          (a) the Issuer of the Security it has sold in a repurchase agreement; and
          (b) the Counterparty where the Securities or cash given by the Authorised Person exceed the Securities or cash it receives (i.e. there is a net margin given by the Authorised Person) in a repurchase agreement or reverse repurchase agreement.

        • PRU A4.11.28

          An Authorised Person must calculate in accordance with Section 5.10 an Exposure to the Issuer arising from the Underwriting or sub-Underwriting of a new Issue of Securities.

    • PRU A4.12 PRU A4.12 The Simplified Approach for Category 2 and 3A Firms

      • PRU A4.12.1

        This Section applies only to an Authorised Person in Category 2 or 3A for the purposes of Section 4.7.

      • PRU A4.12.2

        An Authorised Person that applies the Simplified Approach must comply with the requirements of Chapter 4 with the variations as prescribed below:

      • Risk Weights

        • Central government and Central Bank asset class

          • PRU A4.12.4 PRU A4.12.4

            Subject to Rules A4.12.5 and A4.12.6, an Authorised Person must risk-weight any CR Exposure in the central government and central bank asset class on the basis of the consensus country risk classifications of export credit agencies (referred to in this Section as "ECA") participating in the OECD's "Arrangement on Officially Supported Export Credits" and in accordance with the table below.


            Risk weights for the central government and central bank asset class

            Country risk
            classification
            0–1 2 3 4 to 6 7
            Risk Weights 0% 20% 50% 100% 150%

            • Guidance

              The consensus country risk classification for the purpose of the "Arrangement on Officially Supported Export Credits" is published by the OECD. At the time of the making of these Rules, the classification was available on the website of the OECD on the Export Credit Arrangement web-page of the Trade and Agriculture Directorate (http://www.oecd.org/trade/xcred/cre-crc-current-english.pdf).

          • PRU A4.12.5

            An Authorised Person must apply a 0% risk weight to any CR Exposure to any central government or any Central Bank of a GCC member country, which is denominated in the domestic currency, and funded in the domestic currency of that GCC member country.

          • PRU A4.12.6

            For any CR Exposure to any other central government or Central Bank which is denominated and funded in the local currency of that jurisdiction, an Authorised Person may apply such risk weights as may be specified by the banking regulator of that jurisdiction.

      • Bank asset class

        • PRU A4.12.8

          An Authorised Person must risk-weight any CR Exposure in the bank asset class on the basis of the consensus ECA country risk classifications as referred to in A4.12.4 for the jurisdictions in which they are incorporated, in accordance with the following table:

          Risk weights for the bank asset class

          Country risk
          classification
          0 or 1 2 3 4 to 6 7
          Risk Weights 20% 50% 100% 100% 150%

      • Corporate asset class

        • PRU A4.12.10

          An Authorised Person must apply a 100% risk weight to any CR Exposure in the corporate asset class.

        • Credit Risk mitigation — Collateral

          • PRU A4.12.12

            An Authorised Person may only use the financial Collateral Simplified Approach (FCSA) in its treatment of recognised Collateral for the purposes of calculating the Credit RWA for its Exposures booked in its Non-Trading Book.

          • PRU A4.12.13

            (1) For an Authorised Person using the FCSA, eligible financial Collateral comprises:
            (a) cash (as well as certificates of Deposit or other similar instruments issued by the Authorised Person) on Deposit with the Authorised Person;
            (b) gold;
            (c) any debt Securities issued by sovereigns (including a central government or Central Bank) of a jurisdiction that that has an ECA country risk score of 4 or better; and
            (d) any debt Securities issued by a PSE that is treated as a sovereign and is of a jurisdiction that has an ECA country risk score of 4 or better.
            (2) Cash-funded CLNs issued by an Authorised Person against Exposures in the Non-Trading Book which fulfil the criteria for eligible Credit Derivatives must be treated as cash collateralised transactions.
            (3) Cash, mentioned in (1)(a) includes cash on Deposit, certificates of Deposit or other similar instruments issued by the Authorised Person that are held as Collateral at a third-party bank in a non-custodial arrangement and that are pledged or assigned to the Authorised Person. This is subject to the pledge or assignment being unconditional and irrevocable. Under the FCSA, the risk weight to be applied to the Exposure covered by such Collateral must be the risk weight of the third-party bank.

          • PRU A4.12.14

            In the case of any Counterparty Risk Exposures in Rules A4.12.12 and A4.12.13, arising from an SFT which is included in the Trading Book, eligible financial Collateral includes all instruments which an Authorised Person may include in its Trading Book.

        • Credit Risk mitigation — Guarantees

          • PRU A4.12.16

            An Authorised Person may recognise guarantees provided by the following eligible guarantors:

            (a) the Bank for International Settlements, the International Monetary Fund, the European Central Bank, and the European Commission;
            (b) the MDBs referred to in Rule 4.12.8;
            (c) PSEs; and
            (d) other entities eligible for a CRW of 20% or better and with a lower risk weight than the Counterparty.

          • PRU A4.12.17

            For the purpose of calculating the risk weight of a guaranteed Exposure, an Authorised Person must assign the guaranteed portion the risk weight of the eligible guarantors. The uncovered portion of the Exposure must be assigned the risk weight of the underlying Counterparty.

          • PRU A4.12.18

            An Authorised Person can apply a 0% risk weight to any portions of Exposures guaranteed by central governments or Central Banks of a GCC member country where the guarantee is denominated in the domestic currency of that country, and the Exposure is funded in that same domestic currency.

          • PRU A4.12.19

            An Authorised Person must treat any materiality thresholds on payments below which no payment will be made in the event of loss as retained First Loss Positions and must deduct the full amount from its Capital Resources.