Prudential Regulation Authority Rulebook

4.1

This chapter is relevant to PRA-authorised CRR firms. It sets out the PRA’s expectations of firms in respect of the CRR securitisation capital framework in the following sections:
(i) ‘Hierarchy of methods’ –with respect to the exercise of discretions which determine the methods applied for calculating securitisation Risk Weighted Exposure Amounts (RWEAs).
(ii) ‘Interim mapping of External Credit Assessment Institutions (ECAIs) structured finance credit assessments to Credit Quality Steps (CQS)’ — with respect to the interim mapping of rating agency grades to CQS for the purposes of securitisation positions risk weighted under the External Ratings Based Approach (SEC-ERBA).

4.2

CRR Article 254 introduces the hierarchy of methods for calculating securitisation RWEAs, summarised below:
(i) where the conditions set out in Article 258 are met, the Securitisation Internal Ratings Based Approach (the ‘SEC-IRBA’) in accordance with Articles 259-260;
(ii) where the SEC-IRBA may not be used, the Securitisation Standardised Approach (the SEC-SA) in accordance with Article 261-262; and
(iii) where the SEC-SA may not be used, the Securitisation External Ratings Based Approach (the ‘SEC-ERBA’) in accordance with Articles 263-264 for rated positions or positions in respect of which an inferred rating may be used.

4.3

Under CRR Articles 254(4) and 258(2), the PRA may use the following discretions, on a case-by-case basis to:
(i) prohibit firms from applying SEC-SA, when the risk-weighted exposure amount resulting from the application of the SEC-SA is not commensurate with the risks posed to the institution or to financial stability; and
(ii) prohibit the use of SEC-IRBA where securitisations have highly complex or risky features.

4.4

The PRA intends to use these discretions in order to support its primary objective of maintaining the safety and soundness of firms. Although the PRA does not favour any single method, in some cases Pillar 1 capital requirements arrived at under the SEC-ERBA may be a more appropriate reflection of risk to the firm than those arrived at under the SEC-SA or SEC-IRBA. When considering an exercise of its discretions, the PRA will take into account, among other things, the aggregate impact on a firm’s overall capital requirements. The PRA does not expect firms to solicit ECAI ratings for all of their securitisation positions.

4.5

When determining whether to exercise its discretion under Articles 254(4) and 258(2), the PRA will consider whether securitisations a firm is exposed to exhibit features which are not explicitly captured in the SEC-SA or SEC-IRBA methods. The PRA may also consider the appropriateness of underlying credit risk weights for the portfolio as reflected in the K_SA or K_IRB determined under Article 255.

4.6

The SEC-IRBA is sensitive to a wider range of inputs than the SEC-SA. Therefore where the presence of a highly complex or risky feature leads the PRA to exercise its discretion to preclude the use of the SEC-IRBA, the PRA is also likely to prohibit the use of the SEC-SA on the grounds that the risk weights under the SEC-SA are not commensurate with the risks posed to the institution.

4.7

The SEC-SA and SEC-IRBA methods can only recognise a defined number of items in their calculation of capital requirements, primarily focused on credit risk. These methods may fail to recognise the presence of non-credit risks. To an extent some additional non-credit risks which can arise from securitisation are reflected in the ‘non-neutrality’ of the securitisation capital framework.² However the level of non-neutrality is driven by pre-defined inputs (eg STS status).

4.8

When the SEC-SA or SEC-IRBA method is applied to a securitisation position, there is also a risk that the K_SA or K_IRB derived using the credit risk capital framework is inappropriate. This may be because the underlying exposures are affected by risk drivers which are not adequately captured by the credit risk framework.

4.9

In the presence of risk characteristics and structural features which are not explicitly captured in the formulas of the SEC-SA or SEC-IRBA, including features not adequately captured in the underlying credit risk framework, it is possible that an appropriate assessment by an ECAI takes into account those features. In such cases the SEC-ERBA may more appropriately reflect the risk posed to the institution.

4.10

Examples of features or characteristics which expose firms to risks not captured in the SEC-SA or SEC-IRBA include, but are not limited to, those listed in Article 258(2)(a) to (d), and:
(a) interest rate risks or foreign exchange risks which arise due to mismatches between the underlying pool and the issued notes, and which are not adequately hedged;
(b) features or characteristics which expose holders of securitisation notes to the risk that market conditions at the date of the sale or refinance of underlying exposures result in losses, such as exposure to residual value risk;
(c) portfolios which exhibit a high degree of single name, sectoral or geographical credit concentration risk;
(d) portfolios where the underlying exposures may be highly correlated in the event of a stress;
(e) complex mechanisms which impact the priority of payments, for example the existence of turbo features; and
(f) for transactions to which the SEC-SA applies, where the characteristics of the underlying portfolio exhibit material dilution risk.

4.11

The PRA, in conjunction with the Financial Policy Committee (FPC) or on its own initiative, may identify financial stability risks arising from firms’ securitisation activity. Where the RWEA calculated under the SEC-SA method is not commensurate with the risk posed to financial stability, the PRA may mitigate the risk by use of Article 254(4).

4.12

The PRA expects firms to have regard, during their ICAAP, to the provisions in SS31/15 paragraphs 2.39 and 2.40.³ The PRA will monitor possible risks to safety and soundness with reference to Common Reporting (COREP) and a firm’s ICAAP document. The information provided in a firm’s ICAAP document, supplemented by information received by other means such as regulatory reporting, will be used to assist the PRA in its assessment of whether firms’ securitisation exposures using the SEC-SA or SEC-IRBA are appropriately capitalised.

4.13

The PRA may request additional information in order to evaluate whether Pillar 1 capital requirements appropriately reflect the risk posed to an institution. The PRA expects firms to provide this information within 30 business days, unless agreed otherwise.

4.14

This additional information may vary on a case-by-case basis, but should include:
(i) A list of the securitisation positions to which the SEC-SA or the SEC-IRBA is applied.
(ii) For each securitisation position listed in (i):
o the asset class of the underlying securitised exposures;
o the risk characteristics and structural features exhibited by the securitisation that may materially impact the performance of the firm’s securitisation position, and which are not explicitly taken into account by the method applied;
o unless already provided in the most recent Common Reporting (COREP) submission:⁴
- for positions risk-weighted under the SEC-IRBA, the risk-weighted exposure amount for that securitisation position under the SEC-IRBA, SEC-ERBA (for rated positions only) and SEC-SA insofar as each method can be used; or
- for rated positions risk-weighted under the SEC-SA, the risk-weighted exposure amounts for that securitisation position under the SEC-ERBA.
o a hyperlink to the prospectus of the transaction, or where no prospectus is available a copy of the offering circular or equivalent; and
o for rated securitisation positions, the latest rating(s) attributed to the position and the ECAI(s) which provided that rating.

4.15

Where the PRA considers that the exercise of its discretion under Articles 254(4) or 258(2) is justified, it will inform the firm in writing.

4.16

The PRA may choose to exercise one or both of the discretions under Articles 254(4) and 258(2) in respect of a securitisation position or a defined group of securitisation positions.

4.17

The PRA may choose to exercise the discretion under Article 254(4) to an unrated securitisation position for which a rating may not be inferred, in which case it may require the firm to apply a 1,250% risk weight to the securitisation position.

4.18

Relevant senior management should ensure that firms are using appropriate methods to capitalise their securitisation exposures.

4.19

For these purposes, relevant senior management means the individual(s) performing the relevant SMF(s), and employees subject to the Certification Regime involved in investment decisions in securitisation exposures (eg relevant Material Risk Takers (MRTs) under the Remuneration rules).

4.20

Under Article 254(3), firms may decide to apply the SEC-ERBA instead of the SEC-SA to all of their rated securitisations or positions in respect of which an inferred rating may be used.

4.21

Firms should notify the PRA of a decision made under CRR Article 254(3). That notification should be sent simultaneously by email to securitisation.hierarchy@bankofengland.co.uk and to the firm’s usual supervisory contact. This notification should include information on the impact of such a decision on the firm’s securitisation RWEAs.

4.22

CRR Article 270e stipulates that the PRA may produce implementing Technical Standards (ITS) mapping the credit assessments of ECAIs to the CQS specified in the CRR for the purposes of calculating risk-weighted exposure amounts under the SEC-ERBA.⁵

4.23

Prior to adoption of this ITS, the PRA expects firms to use the illustrative Basel securitisation ERBA mapping for long-term ratings,⁶ as set out in Table 1 below for long-term ratings. For short-term ratings, PRA expects firms to use the existing short-term mapping in Commission Implementing Regulation (EU) 2016/1801⁷ on laying down technical standards with regard to the mapping of credit assessments for securitisation. These tables will be superseded once the relevant ITS has been adopted.

Table 1: Long-term ECAI assessment mapping