Following is a summary of the Basel Committee’s final framework for measuring, reporting and limiting a bank’s exposures to single counterparties and groups of connected counterparties. The large exposures framework, which relies on a number of concepts in the Basel Committee’s risk-based capital framework, is intended to ensure greater international consistency in regulatory and supervisory approaches to large exposures and to act as a backstop to risk-based capital requirements.
Blackline Showing Changes: Davis Polk’s blackline of the Basel Committee’s April 2014 final vs. March 2013 proposed large exposures framework is available here.
Interaction with Dodd-Frank Single Counterparty Credit Limits
- The Federal Reserve stated that it will take into account the Basel Committee’s large exposures framework before finalizing single counterparty credit limits (SCCLs) under the Dodd-Frank Act for large U.S. bank holding companies, large foreign banking organizations and nonbank financial companies designated as systemically important by the Financial Stability Oversight Council (Nonbank SIFIs).
- There are significant differences among the Basel Committee’s large exposures framework, the Federal Reserve’s proposed SCCLs and the EU large exposures regime in CRD IV.
Basel Committee Next Steps
- The Basel Committee will, by 2016, review the appropriateness of setting a large exposure limit for exposures to qualifying central counterparties (QCCPs) related to clearing activities, which are currently exempted.
- The Basel Committee will also review the impact of the large exposures framework on monetary policy implementation.
Overview of the Basel Committee’s Large Exposures Framework
General Limit and G-SIB Limit
- General limit: The large exposures framework includes a general limit applied to all of a bank’s exposures to a single counterparty or group of connected counterparties (i.e., counterparties that are interdependent and likely to fail simultaneously), which is set at 25% of a bank’s Tier 1 capital.
- G-SIB limit: A stricter limit of 15% of Tier 1 capital will apply to exposures between global systemically important banks (G-SIBs).
- When a bank becomes a G-SIB, it and other G-SIBs must apply the 15% limit within 12 months of this event, which is the same time frame within which a bank that has become a G-SIB would need to satisfy its higher loss absorbency requirement.
- D-SIBs and Nonbank SIFIs: The Basel Committee stated that it “encourages jurisdictions to consider applying stricter limits to exposures between D-SIBs [domestic systemically important banks] and to exposures of smaller banks to G-SIBs. The same logic would also be valid for the application of tighter limits to exposures to non-bank G-SIFIs, and such a limit might be considered by the Committee in the future.”
- Breaches of the large exposure limit must be communicated immediately to the bank’s supervisor and must be rapidly rectified.
- The Basel Committee expects national supervisors to implement the large exposures framework by January 1, 2019.
- Supervisors may require banks to begin reporting large exposures before 2019.
Scope and Level of Application
- Scope of application: The large exposures framework applies to all internationally active banks. Basel Committee member jurisdictions have the option to set more stringent standards and to extend the application to a wider range of banks.
- Level of application: The large exposures framework is intended to serve as a backstop and complement to the Basel risk-based capital standards. Accordingly, it applies at the same level as the risk-based capital requirements are required to be applied following paragraphs 21 and 22 of the Basel capital framework, i.e., at every tier within a banking group.
- The application of the large exposures framework at the consolidated level implies that a bank must consider all exposures to third parties across the relevant regulatory consolidation group and compare the aggregate of those exposures with the group’s Tier 1 capital.
Large Exposures Reporting: In addition to the large exposures limit, a bank must report to its supervisor:
- All exposures with values ≥ 10% of the bank’s Tier 1 capital (“Large Exposures”);
- All other exposures (before the application of credit risk mitigation) with values ≥ 10% of the bank’s Tier 1 capital;
- All exempted exposures with values ≥ 10% of the bank’s Tier 1 capital; and
- The bank’s largest 20 exposures to counterparties, irrespective of the values of these exposures relative to the bank’s Tier 1 capital.
Group of Connected Counterparties
- The sum of the bank’s exposures to all the individual entities included within a group of connected counterparties is subject to the large exposure limit and to the regulatory reporting requirements as specified above.
- Two or more natural or legal persons shall be deemed a group of connected counterparties if at least one of the following criteria is satisfied:
- Control relationship: one of the counterparties, directly or indirectly, has control over the other(s).
- Economic interdependence: if one of the counterparties were to experience financial problems, in particular funding or repayment difficulties, the other(s), as a result, would also be likely to encounter funding or repayment difficulties.
- Control relationship: A control relationship automatically exists if one entity owns >50% of the voting rights of the other entity. In addition, banks must assess connectedness between counterparties based on control using the following criteria:
- Voting agreements (e.g., control of a majority of voting rights pursuant to an agreement with other shareholders);
- Significant influence on the appointment or dismissal of an entity’s administrative, management or supervisory body, such as the right to appoint or remove a majority of members in those bodies, or the fact that a majority of members have been appointed solely as a result of the exercise of an individual entity’s voting rights; and
- Significant influence on senior management, e.g., an entity has the power, pursuant to a contract or otherwise, to exercise a controlling influence over the management or policies of another entity (e.g., through consent rights over key decisions).
- Banks are also expected to refer to criteria specified in appropriate internationally recognized accounting standards for further qualitative guidance when determining control.
- Where control has been established based on any of these criteria, a bank may still demonstrate to its supervisor in exceptional cases, e.g., due to the existence of specific circumstances and corporate governance safeguards, that such control does not necessarily result in the entities concerned constituting a group of connected counterparties.
- Economic interdependence: In establishing connectedness based on economic interdependence, banks must consider, at a minimum, the following qualitative criteria:
- Where ≥ 50% of one counterparty’s gross receipts or gross expenditures (on an annual basis) is derived from transactions with the other counterparty (e.g., the owner of a residential/commercial property and the tenant who pays a significant part of the rent);
- Where one counterparty has fully or partly guaranteed the exposure of the other counterparty, or is liable by other means, and the exposure is so significant that the guarantor is likely to default if a claim occurs;
- Where a significant part of one counterparty’s production/output is sold to another counterparty, which cannot easily be replaced by other customers;
- When the expected source of funds to repay each loan one counterparty makes to another is the same and the counterparty does not have another source of income from which the loan may be fully repaid;
- Where it is likely that the financial problems of one counterparty would cause difficulties for the other counterparties in terms of full and timely repayment of liabilities;
- Where the insolvency or default of one counterparty is likely to be associated with the insolvency or default of the other(s);
- When two or more counterparties rely on the same source for the majority of their funding and, in the event of the common provider’s default, an alternative provider cannot be found -in this case, the funding problems of one counterparty are likely to spread to another due to a one-way or two-way dependence on the same main funding source.
- There may be circumstances where some of these criteria do not automatically imply an economic dependence that results in two or more counterparties being connected.
- Provided that a bank can demonstrate to its supervisor that a counterparty which is economically closely related to another counterparty may overcome financial difficulties, or even the second counterparty’s default, by finding alternative business partners or funding sources within an appropriate time period, the bank does not need to combine these counterparties to form a group of connected counterparties.
- There are cases where a thorough investigation of economic interdependencies will not be proportionate to the size of the exposures. Therefore, banks are expected to identify possible connected counterparties on the basis of economic interdependence in all cases where the sum of all exposures to one individual counterparty is >5% of the bank’s Tier 1 capital.
General Methods for Measuring Exposures
- The exposure values a bank must consider in order to identify large exposures to a counterparty are all those exposures defined under the Basel risk-based capital framework.
- A bank must consider both on- and off-balance sheet exposures included in either the banking or trading book and instruments with counterparty credit risk under the risk-based capital framework.
- An exposure to a counterparty that is deducted from capital must not be added to other exposures to that counterparty for the purpose of the large exposure limit.
- Banking book on-balance sheet non-derivative assets: The exposure value must be defined as the accounting value of the exposure (net of specific provisions and value adjustments). As an alternative, a bank may consider the exposure value gross of specific provisions and value adjustments.
- Banking book and trading book OTC derivatives (and any other instrument with counterparty credit risk): The exposure value for instruments that give rise to counterparty credit risk and are not securities financing transactions (SFTs) must be the exposure at default (EAD) calculated according to the Basel Committee’s recently finalized standardized approach for counterparty credit risk (SA-CCR) – Davis Polk’s summary of SA-CCR is available here.
- SFTs: The Basel Committee is undertaking a review of the Standardised Approach for credit risk in the Basel risk-based capital framework, which includes a review of the comprehensive approach used to measure SFT exposures (referred to in U.S. Basel III as the “Collateral Haircut Approach”).
- The Basel Committee expects that the forthcoming revised comprehensive approach and supervisory haircuts – or equivalent non-internal model method – will be appropriate for large exposures purposes.
- The Basel Committee expects its review of the Standardised Approach to be completed in advance of the implementation deadline for the large exposures framework. But in the event of a delay, banks would be allowed to use the method they currently use for calculating their risk-based capital requirements for SFTs.
- Banking book off-balance sheet items: For the purpose of the large exposures framework, off-balance sheet items will be converted into credit exposure equivalents through the use of credit conversion factors (CCFs) by applying the CCFs in the Standardised Approach, subject to a floor of 10%.
Recognition of Eligible Credit Risk Mitigation (CRM) Techniques
- Eligible CRM techniques for large exposures purposes are those that meet the minimum requirements and eligibility criteria for the recognition of unfunded credit protection and financial collateral that qualify as eligible financial collateral under the Standardised Approach.
- Other forms of collateral that are only eligible under the internal-ratings based (IRB) approach in accordance with paragraph 289 of Basel II (e.g., receivables, commercial and residential real estate and other collateral) are not eligible to reduce exposure values for large exposures purposes.
- A bank must recognize an eligible CRM technique in the calculation of an exposure whenever it has used this technique to calculate its risk-based capital requirements, and provided it meets the conditions for recognition under the large exposures framework.
- Treatment of maturity mismatches in CRM: In accordance with provisions in the Basel risk-based capital framework, hedges with maturity mismatches (i.e., where the residual maturity of the CRM is < the residual maturity of the position being hedged) are recognized only when their original maturities are ≥ 1 year and residual maturities are ≥ 3 months.
- If there is a maturity mismatch with respect to CRM (collateral, on-balance sheet netting, guarantees and credit derivatives) recognized in the risk-based capital framework, the adjustment of the CRM for the purpose of large exposures is determined using the same approach as in the risk-based capital framework.
- On-balance sheet netting: Where a bank has in place legally enforceable netting arrangements for loans and deposits, it may calculate the exposure values for large exposures purposes according to the calculation it uses for risk-based capital purposes – i.e., on the basis of net credit exposures subject to the conditions set out in the approach to on-balance sheet netting in the Basel risk-based capital framework.
- Recognition of CRM techniques in reduction of original exposure: A bank must reduce the value of the exposure to the original counterparty by the amount of the eligible CRM technique recognized in the risk-based capital framework. This recognized amount is:
- In the case of unfunded credit protection, the value of the protected portion.
- When the bank uses the simple approach for risk-based capital purposes – the value of the portion of the claim collateralized by the market value of the recognized financial collateral.
- In the case of financial collateral when the bank applies the comprehensive approach, the value of the collateral adjusted after applying the required haircuts. The haircuts used to reduce the collateral amount are the prescribed supervisory haircuts under the comprehensive approach. Internally-modeled haircuts may not be used.
- Recognition of exposures to CRM providers: Whenever a bank is required to recognize a reduction of the exposure to the original counterparty due to an eligible CRM technique, it must also recognize an exposure to the CRM provider. Generally, the amount assigned to the CRM provider is the amount by which the exposure to the original counterparty is reduced.
- Credit derivatives: For positions hedged by credit derivatives, any reduction in exposure to the original counterparty will correspond to a new exposure to the credit protection provider, as described above, except in the following situation:
- When the credit protection takes the form of a credit default swap (CDS) and either the CDS provider or the referenced entity is not a financial entity, the amount to be assigned to the credit protection provider is not the amount by which the exposure to the original counterparty is reduced but, instead, the counterparty credit risk exposure value calculated according to SA-CCR – Davis Polk’s summary of SA-CCR is available here.
- For these purposes, financial entities include:
- Regulated financial institutions, defined as a parent and its subsidiaries where any substantial legal entity in the consolidated group is supervised by a regulator that imposes prudential requirements consistent with international standards. These include, but are not limited to, prudentially regulated insurance companies, broker-dealers, banks, thrifts and futures commission merchants; and
- Unregulated financial institutions, defined as legal entities whose main business includes: the management of financial assets, lending, factoring, leasing, provision of credit enhancements, securitization, investments, financial custody, central counterparty services, proprietary trading and other financial services activities identified by supervisors.
Measuring Exposures for Trading Book Positions
- General rule: A bank must add any exposures to a single counterparty arising in the trading book to any other exposures to that counterparty in the banking book to calculate its total exposure to that counterparty. Trading book positions in financial instruments such as bonds and equities must be constrained by the large exposure limit, but concentrations in a particular commodity or currency need not be.
- Exposure value of plain vanilla debt and equity instruments: The exposure value of straight debt instruments and equities is defined as the accounting value of the exposure (i.e., the market value of the respective instruments).
- Exposure value of derivatives: Instruments such as swaps, futures, forwards and credit derivatives must be converted into positions following the risk-based capital framework. These instruments are decomposed into their individual legs. Only transaction legs representing exposures in the scope of the large exposures framework need be considered. For example:
- A future on stock X is decomposed into a long position in stock X and a short position in a risk-free interest rate exposure in the respective funding currency.
- A typical interest rate swap is represented by a long position in a fixed and a short position in a floating interest rate exposure or vice versa.
- Exposure value of credit derivatives: In the case of credit derivatives that represent sold credit protection, the exposure to the referenced name must be the amount due in the case that the respective referenced name triggers the instrument, minus the absolute value of the credit protection.
- In the case that the market value of the credit derivative is positive from the perspective of the protection seller, such a positive market value would also have to be added to the exposure of the protection seller to the protection buyer.
- For credit-linked notes, the protection seller needs to consider positions both in the bond of the note issuer and in the underlying referenced by the note.
- Exposure value of options: The exposure value of options is measured differently under the large exposures framework and the risk-based capital framework. The exposure value must be based on the change(s) in option prices that would result from a default of the respective underlying instrument.
- The exposure value for a simple long call option would therefore be its market value and for a short put option would be equal to the strike price of the option minus its market value.
- In the case of short call or long put options, a default of the underlying would lead to a profit (i.e., a negative exposure) instead of a loss, resulting in an exposure of the option’s market value in the former case and equal the strike price of the option minus its market value in the latter case. The resulting positions will in all cases be aggregated with those from other exposures. After aggregation, negative net exposures must be set to zero.
- Exposure values of banks’ investments in index positions, securitizations, hedge funds or investment funds must be calculated applying the same rules as for similar instruments in the banking book.
- Offsetting between long and short trading book positions in the same issue: Banks may offset long and short positions in the same issue (two issues are defined as the same if the issuer, coupon, currency and maturity are identical). Consequently, banks may consider a net position in a specific issue for the purpose of calculating a bank’s exposure to a particular counterparty.
- Offsetting between long and short positions in different issues: Positions in different issues from the same counterparty may be offset only when the short position is junior to the long position, or if the positions are of the same seniority. Similarly, for positions hedged by credit derivatives, the hedge may be recognized provided the short position is junior or of equivalent security to the long position.
- In order to determine the relative seniority of positions, securities may be allocated into broad buckets of seniority (e.g., equity, subordinated debt and senior debt). For those banks that find it excessively burdensome to allocate securities to different buckets based on relative seniority, they may recognize no offsetting of long and short positions in different issues relating to the same counterparty in calculating exposures.
- Net short positions after offsetting: When the result of the offsetting is a net short position with a single counterparty, this net exposure need not be considered as an exposure for large exposure purposes.
- Netting across the banking and trading books is not permitted.
Exemption for Sovereign Exposures and Entities Connected with Sovereigns
- A bank’s exposures to sovereigns and their central banks are exempt.
- This exemption also applies to public sector entities treated as sovereigns under the risk-based capital framework.
- Any portion of an exposure guaranteed by, or secured by financial instruments issued by, sovereigns would be similarly excluded from the large exposures framework to the extent that the eligibility criteria for CRM recognition are met.
- Where two or more entities that are outside the scope of the sovereign exemption are controlled by or economically dependent on an entity that falls within the scope of the sovereign exemption, and are otherwise not connected, those entities need not be deemed to constitute a group of connected counterparties
- If a bank has an exposure to an exempted entity that is hedged by a credit derivative, the bank will have to recognize an exposure to the counterparty providing the credit protection as prescribed above, notwithstanding the fact that the original exposure is exempted.
- Reporting: A bank must report exposures subject to the sovereign exemption if these exposures meet the definition of a large exposure (defined above).
- Intraday interbank exposures: To avoid disturbing the payment and settlement processes, intraday interbank exposures are not subject to the large exposures framework – either for reporting purposes or for application of the large exposure limit.
- For other interbank exposures, the Basel Committee will undertake further observation and consider whether, for the purposes of ensuring there are no unavoidable adverse consequences for the implementation of monetary policy, a specific treatment for a limited range of interbank exposures may be necessary. This observation period, and any subsequent adjustments to this framework, will be concluded by 2016.
- In stressed circumstances, supervisors may have to accept a breach of an interbank limit ex post, in order to help ensure stability in the interbank market.
Collective Investment Undertakings (CIUs), Securitization Vehicles and Other Structures
- Banks must consider exposures even when a legal entity sits between the bank and the underlying exposures, i.e., when the bank invests in a legal entity that, in turn, has exposures to assets (“underlying assets”).
- Banks must assign the exposure amount, i.e., the amount invested in a particular fund, securitization or other structure with underlying assets, to specific counterparties following the approach described below.
- No look through approach: A bank may assign the exposure amount to the structure itself, defined as a distinct counterparty, if it can demonstrate that the bank’s exposure amount to each underlying asset of the structure is <0.25% of its Tier 1 capital, considering only those exposures to underlying assets that result from the investment in the structure itself and using the exposure value calculated below. In this case, a bank is not required to look through the structure to identify the underlying assets.
- By definition, this test will be passed if the bank’s entire investment in a structure is < 0.25% of its Tier 1 capital.
- If the look-through approach is not required, a bank’s exposure to the structure is the nominal amount it invests in the structure.
- Look through approach (LTA): A bank must look through the structure to identify those underlying assets for which the underlying exposure value is ≥ 0.25% of its Tier 1 capital. In this case, the counterparty corresponding to each of the underlying assets must be identified so that these underlying exposures can be added to any other direct or indirect exposure to the same counterparty. The bank’s exposure amount to the underlying assets that are < 0.25% of the bank’s Tier 1 capital may be assigned to the structure itself (i.e., partial look-through is permitted).
- If a bank is unable to identify the underlying assets of a structure:
- The bank must assign the total exposure amount of its investment to the structure where the total amount of its exposure is ≤ 0.25% of its Tier 1 capital;
- Otherwise, the bank must assign the total exposure amount to the unknown client. The bank must aggregate all unknown exposures as if they related to a single counterparty (the unknown client), which is subject to the large exposure limit.
- Even when the LTA is not required, a bank must nevertheless be able to demonstrate that regulatory arbitrage considerations have not influenced the decision whether to look through or not – e.g., that the bank has not circumvented the large exposure limit by investing in several individually immaterial transactions with identical underlying assets.
- Applying LTA to a structure where all investors rank pari passu (e.g., CIU): When the LTA is required, the exposure value assigned to a counterparty is the pro rata share that the bank holds in the structure multiplied by the value of the underlying asset in the structure.
- E.g., a bank holding a 1% share of a structure that invests in 20 assets each with a value of 5 must assign an exposure of 0.05 to each of the counterparties. An exposure to a counterparty must be added to any other direct or indirect exposures the bank has to that counterparty.
- Applying LTA to a structure with different seniority levels among investors (e.g., securitization vehicles): When the LTA is required, the exposure value to a counterparty is measured for each tranche within the structure, assuming a pro rata distribution of losses amongst investors in a single tranche. To calculate the exposure value to the underlying asset, a bank must:
- First, consider the lower of the value of the tranche in which the bank invests and the nominal value of each underlying asset included in the underlying portfolio of assets;
- Second, apply the pro rata share of the bank’s investment in the tranche to the value determined in the first step above.
- Identification of additional risks: Banks must identify third parties (e.g., originator, fund manager, liquidity provider and credit protection provider) that may constitute an additional risk factor inherent in a structure itself rather than in the underlying assets. Such a third party could be a risk factor for more than one structure in which a bank invests. The identification of an additional risk factor has two implications.
- 1) The first implication is that banks must connect their investments in those structures with a common risk factor to form a group of connected counterparties.
- In some cases, the manager would be regarded as a distinct counterparty so that the sum of a bank’s investments in all of the funds managed by this manager would be subject to the large exposure limit, with the exposure value being the total value of the different investments. But in other cases, the identity of the manager may not comprise an additional risk factor – e.g., if the legal framework governing the regulation of particular funds requires separation between the legal entity that manages the fund and the legal entity that has custody of the fund’s assets.
- In the case of structured finance products, the liquidity provider or sponsor of short-term programs – asset-backed commercial paper (ABCP) conduits and structured investment vehicles (SIVs) – may warrant consideration as an additional risk factor (with the exposure value being the amount invested).
- Similarly, in synthetic deals, the protection providers (sellers of protection by means of CDS/guarantees) may be an additional source of risk and a common factor for interconnecting different structures (the exposure value would correspond to the percentage value of the underlying portfolio).
- 2) The second implication is that banks may add their investments in a set of structures associated with a third party that constitutes a common risk factor to other exposures (e.g., a loan) it has to that third party. Whether the exposures to such structures must be added to any other exposures to the third party would again depend on a case-by-case consideration of the specific features of the structure and on the role of the third party.
- In the example of the fund manager, adding together the exposures may not be necessary because potentially fraudulent behavior may not necessarily affect the repayment of a loan.
- The assessment may be different where the risk to the value of investments underlying the structures arises in the event of a third-party default. For example, in the case of a credit protection provider, the source of the additional risk for the bank investing in a structure is the default of the credit protection provider. The bank must add the investment in the structure to the direct exposures to the credit protection provider since both exposures might crystallize into losses in the event that the protection provider defaults.
- 1) The first implication is that banks must connect their investments in those structures with a common risk factor to form a group of connected counterparties.
- It is conceivable that a bank may consider multiple third parties to be potential drivers of additional risk. In this case, the bank must assign the exposure resulting from the investment in the relevant structures to each of the third parties.
Exposures to Central Counterparties (CCPs)
- QCCPs: The Basel Committee will consider the appropriateness of a large exposure limit for banks’ exposures to qualifying central counterparties (QCCPs) after an observation period that will be concluded in 2016.
- In the meantime, banks’ exposures to QCCPs related to clearing activities are exempt from the large exposures framework.
- The definition of QCCP for large exposures purposes is the same as that used for risk-based capital purposes. A QCCP is an entity that is licensed to operate as a CCP (including a license granted by way of confirming an exemption), and is permitted by the appropriate regulator/overseer to operate as such with respect to the products offered. This is subject to the provision that the CCP is based and prudentially supervised in a jurisdiction where the relevant regulator/overseer has established, and publicly indicated that it applies to the CCP on an ongoing basis, domestic rules and regulations that are consistent with the CPSS-IOSCO Principles for Financial Market Infrastructures.
- Non-QCCPs: In the case of non-QCCPs, banks must measure their exposure as a sum of both the clearing exposures described and the non-clearing exposures, and must comply with the general large exposure limit of 25% of Tier 1 capital.
- The concept of connected counterparties does not apply in the context of exposures to CCPs that are specifically related to clearing activities.
- Calculation of exposures related to clearing activities: Banks must identify exposures to a CCP related to clearing activities and add together these exposures. Exposures related to clearing activities are listed in the table below together with the exposure value to be used:
Type of Exposure
Calculated using the methods set forth in the large exposures framework for the relevant type of exposure (e.g., SA-CCR for derivative exposure)
Segregated initial margin
Non-segregated initial margin
Nominal amount of initial margin posted
Pre-funded default fund contributions
Nominal amount of the funded contribution
Unfunded default fund contributions
Nominal amount. If equity interest is deducted from Tier 1 capital, it is excluded from the large exposures framework.
- For exposures related to clearing services (e.g., bank acting as a clearing member or being a client of a clearing member), a bank must determine the counterparty to which exposures must be assigned by applying the provisions in the Basel Committee’s final risk-based capital standards for banks exposures to CCPs – Davis Polk summary here.
- Calculation of exposures not related to clearing activities: Exposures that are not directly related to clearing services provided by the CCP (e.g., funding facilities, credit facilities and guarantees) must be measured according to the general rules that apply to any other counterparty.
- General definition: Covered bonds are bonds issued by a bank or mortgage institution and are subject by law to special public supervision designed to protect bond holders. Proceeds deriving from the issue of these bonds must be invested in conformity with the law in assets which, during the whole period of the validity of the bonds, are capable of covering claims attached to the bonds and which, in the event of the failure of the issuer, would be used on a priority basis for the reimbursement of the principal and payment of the accrued interest.
- A covered bond satisfying the conditions below may be assigned an exposure value of ≥ 20% of the nominal value of the bank’s covered bond holding. Other covered bonds must be assigned an exposure value equal to 100% of the nominal value of the bank’s covered bond holding. The counterparty to which the exposure value is assigned is the issuing bank.
- Conditions: To be eligible to be assigned an exposure value of < 100%, a covered bond must satisfy all the following conditions at inception and throughout its remaining maturity:
- It must meet the general definition stated above;
- The pool of underlying assets must exclusively consist of:
- Claims on, or guaranteed by, sovereigns, their central banks, public sector entities or multilateral development banks;
- Claims secured by mortgages on residential real estate that would qualify for a ≤ 35% risk weight under the Standardised Approach and have a loan-to-value ratio of ≤ 80%; and/or
- Claims secured by commercial real estate that would qualify for the ≤ 100% risk-weight under the Standardised Approach and with a loan-to-value of ≤ 60%;
- The nominal value of the pool of assets assigned to the covered bond instrument(s) by its issuer should exceed its nominal outstanding value by ≥ 10%. The value of the pool of assets for this purpose does not need to be that required by the legislative framework. However, if the legislative framework does not stipulate a ≥ 10% requirement, the issuing bank needs to publicly disclose on a regular basis that their cover pool meets the ≥ 10% requirement in practice. In addition to the primary assets listed above, the additional collateral may include substitution assets (cash or short term liquid and secure assets held in substitution of the primary assets to top up the cover pool for management purposes) and derivatives entered into for the purposes of hedging the risks arising in the covered bond program.
- In order to calculate the required maximum loan-to-value for residential real estate and commercial real estate referred to above, the operational requirements in paragraph 509 of the Basel risk-based capital framework regarding the objective market value of collateral and the frequent revaluation must be used.