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PRA Consultation Paper (CP)

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Bob Penn

Partner

London

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31 January 2019

Published on credit risk mitigation: the eligibility of financial collateral

Paper

Article 207(2) of the EU Capital Requirements Regulation (CRR1) prohibits the recognition of financial collateral (a form of funded credit risk mitigation (CRM)) where the credit quality of an obligor and the value of the collateral provided in respect of the exposure to that obligor are materially positively correlated. The PRA (on 10 January) issued a CP (linked here2 ) proposing new guidance in interpreting this provision.

The proposed guidance relates to the PRA’s expectations re: (i) matters to be considered, in general, when assessing whether a material positive correlation exists for purposes of Article 207(2) (the Proposed General Guidance re Material Positive Correlation); and (ii) specific requirements when assessing whether a material positive correlation exists for purposes of Article 207(2) in the context of limited recourse exposures, including exposures to special purpose entities (SPEs) (the Proposed Guidance re Collateral Diversity in Limited Recourse Lending). The proposed guidance is significant. 

The Proposed Guidance re Limited Recourse Lending in particular has immediate commercial implications for institutions engaged in margin lending, but will also require consideration by institutions that recognise financial collateral in respect of other forms of limited recourse exposures, including exposures to SPEs. 

The CP is relevant to UK banks, building societies and PRA-designated UK investment firms that are subject to the CRR and recognise financial collateral3 . It will also be relevant to providers of financial collateral to those entities, wherever located and whether or not subject to the CRR themselves. 

The proposals are relevant both to the recognition of financial collateral under the financial collateral CRM requirements themselves4 and to other parts of the CRR, and other legislation, that cross-refer to relevant aspects of the financial collateral CRM requirements, such as recognition of collateral under the Advanced Internal Ratings Based (AIRB) approach5 and counterparty credit risk and large exposures frameworks.