BIPRU Prudential sourcebook for Banks, Building Societies and Investment Firms

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BIPRU 1

Application

BIPRU 1.1

Application

  • 01/01/2007

BIPRU 1.1.1

handbook-guidance

There is no overall application statement for BIPRU. Each chapter or section has its own application statement. Broadly speaking however, BIPRU applies to:

  1. (1) a bank;
  2. (2) a building society;
  3. (3) a BIPRU investment firm; and
  4. (4) groups containing such firms.

BIPRU 1.1.2

handbook-rule
BIPRU applies to a firm in relation to the whole of its business, except where a particular provision provides for a narrower scope.

BIPRU 1.1.3

handbook-guidance
In the main BIPRU only applies to a UCITS investment firm in respect of designated investment business (excluding scheme management activity). However BIPRU 2.2 (Internal capital adequacy standards), BIPRU 2.3 (Interest rate risk in the non-trading book), BIPRU 8 (Group risk - consolidation) and BIPRU 11 (Disclosure) apply to the whole of its business.

Purpose

BIPRU 1.1.4

handbook-guidance
BIPRU 1.1 implements in part Articles 3(1)(b), 5, 9, 10 and 20 of the Capital Adequacy Directive.

Guidance on the categorisation of BIPRU investment firms

BIPRU 1.1.5

handbook-guidance
Guidance on the categorisation of investment firms for the purposes of BIPRU and GENPRU is included in PERG 13 (Guidance on the scope of the Markets in Financial Instruments Directive and the recast Capital Adequacy Directive).

The definition of a BIPRU firm

BIPRU 1.1.6

handbook-rule

Subject to BIPRU 1.1.7 R, a BIPRU firm means a firm that is:[deleted]

  1. (1) a building society; or
  2. (2) a bank; or
  3. (3) a full scope BIPRU investment firm; or
  4. (4) a BIPRU limited licence firm; or
  5. (5) a BIPRU limited activity firm.

BIPRU 1.1.7

handbook-rule

None of the following is a BIPRU firm and each of the following is excluded from each of the categories of BIPRU investment firm listed in BIPRU 1.1.6 R (3) to BIPRU 1.1.6R (5) and BIPRU 1.1.18 R (2) to (4):

  1. (1) an incoming EEA firm;
  2. (2) an incoming Treaty firm;
  3. (3) any other overseas firm;
  4. (4) an ELMI;
  5. (5) an insurer; and
  6. (6) an ICVC.

BIPRU 1.1.8

handbook-rule

BIPRU 1.1.9

handbook-guidance
EEA firms are subject to the prudential standards of their home state regulator. But the Banking Consolidation Directive permits a host state competent authority to require a BCD credit institution to meet certain standards relating to its liquidity. The FSA's approach to liquidity for such firms is set out in BIPRU 12.

BIPRU 1.1.10

handbook-guidance
  1. (1) This paragraph applies to an undertaking that would be a third country BIPRU firm if it were authorised under the Act.
  2. (2) Except in exceptional circumstances, it is the FSA's policy that it will not give an overseas applicant a Part IV permission unless the FSA is satisfied that the applicant will be subject to prudential regulation by its home state regulatory body that is broadly equivalent to that provided for in the Handbook and the applicable EEA prudential sectoral legislation. The FSA will take into account not only the requirements to which the firm is subject but how they are enforced. The FSA will also take into account the laws, regulations and administrative provisions to which it is subject in its home state. The reasons for that policy include:
    1. (a) it is unlikely that a firm that is not subject to equivalent supervision will be able to satisfy the threshold conditions (and in particular threshold condition 5 (Suitability)) and it is unlikely that it will be possible to establish that the firm does satisfy them;
    2. (b) such a firm is likely to pose a threat to the interests of consumers and potential consumers, particularly as effective supervision of an overseas firm depends on cooperation between the FSA and the regulatory body that authorises the firm in its home country and on the FSA being able to place appropriate reliance on the supervision carried out by such regulatory body; and
    3. (c) under Article 38(1) of the Banking Consolidation Directive the FSA should not apply to branches of credit institutions having their head office outside the EEA, when commencing or carrying on their business, provisions which result in more favourable treatment than that accorded to branches of credit institutions having their head office in the EEA.
  3. (3) If an undertaking is not subject to equivalent supervision in its home state and it wishes to carry on in the United Kingdom regulated activities coming within the scope of the activities that define a BIPRU firm it should establish a subsidiary undertaking in the United Kingdom. Such a subsidiary undertaking should be able to show, amongst other things, how it would comply with the threshold conditions (and in particular threshold conditions 3 (Close links) and 5 (Suitability)).
  4. (4) If in exceptional circumstances the FSA does grant a Part IV permission to an undertaking that is not subject to equivalent prudential regulation the FSA is likely to take measures under the regulatory system to compensate for the lack of equivalent supervision. These may include applying the prudential requirements for BIPRU firms to the firm.
  5. (5) An overseas firm that is subject to equivalent supervision is subject to the threshold conditions and the Principles. BIPRU and GENPRU do not generally apply. However BIPRU 12 applies to a credit institution with respect to liquidity risk in relation to its United Kingdom branch.

Types of investment firm: Limited activity firms

BIPRU 1.1.11

handbook-rule

A limited activity firm means (as specified by Article 20(3) of the Capital Adequacy Directive (Exemptions from operational risk)) a CAD investment firm that satisfies the following conditions:

  1. (1) it meets the criteria in (a) or the criteria in (b):
    1. (a) it deals on own account only:
      1. (i) for the purpose of fulfilling or executing a client order; or
      2. (ii) for the purpose of gaining entrance to a clearing and settlement system or a recognised investment exchange or designated investment exchange when acting in an agency capacity or executing a client order; or
    2. (b) it satisfies the following conditions:
      1. (i) it does not hold client money or securities in relation to investment services that it provides and is not authorised to do so;
      2. (ii) the only investment service it undertakes is dealing on own account;
      3. (iii) it has no external customers in relation to investment services it provides; and
      4. (iv) the execution and settlement of its transactions in relation to investment services it provides takes place under the responsibility of a clearing institution and are guaranteed by that clearing institution;
  2. (2) (in the case of a CAD investment firm that is a BIPRU investment firm) its base capital resources requirement is €730,000;
  3. (3) (in the case of a CAD investment firm that is an EEA firm) it is subject to the CRD implementation measures of its Home State for Article 9 of the Capital Adequacy Directive (Initial capital requirement of €730,000); and
  4. (4) (in the case of any other CAD investment firm) its base capital resources requirement would be €730,000 if it had been a BIPRU investment firm on the basis of the assumptions in BIPRU 1.1.14 R (3)(a) and BIPRU 1.1.14 R (3)(b).

Types of investment firm: Limited licence firms

BIPRU 1.1.12

handbook-rule

A limited licence firm means (as specified by Article 20(2) of the Capital Adequacy Directive (Exemptions from operational risk)) a CAD investment firm that is not authorised to:

  1. (1) deal on own account; or
  2. (2) provide the investment services of underwriting or placing financial instruments (as referred to in point 6 of Section A of Annex I of MiFID) on a firm commitment basis.

Types of investment firm: CAD full scope firm

BIPRU 1.1.13

handbook-rule

Types of investment firm: CAD investment firm

BIPRU 1.1.14

handbook-rule
  1. (1) In accordance with Article 3(1)(b) of the Capital Adequacy Directive, a person is a CAD investment firm if it falls into (2) or (3).
  2. (2) A person whose head office is in an EEA State is a CAD investment firm if it is an investment firm that is subject to the requirements imposed by MiFID but excludes the following:
    1. (a) a bank, a building society or an ELMI;
    2. (b) a credit institution;
    3. (c) a local; and
    4. (d) an exempt CAD firm.
  3. (3) An investment firm whose head office is not in an EEA State is a CAD investment firm if it would have fallen into (2) if:
    1. (a) its head office had been in an EEA State; and
    2. (b) it had carried on all its business in the EEA and had obtained whatever authorisations for doing so are required under MiFID.

BIPRU 1.1.15

handbook-guidance

The following are excluded from the definition of a CAD investment firm and hence from the definition of BIPRU investment firm:

  1. (1) an investment firm to which MiFID does not apply under Article 2(1); and
  2. (2) an investment firm with the benefit of an exemption pursuant to Article 3 of MiFID.

Types of investment firm: Exempt CAD firm

BIPRU 1.1.16

handbook-rule

In accordance with Article 3(1)(b)(iii) of the Capital Adequacy Directive (Definitions), an exempt CAD firm means an investment firm that satisfies the following conditions:

  1. (1) it would have been a CAD investment firm if exempt CAD firms were not excluded from the definition; and
  2. (2) it is only authorised to provide the service of investment advice and/or receive and transmit orders from investors (as referred to in Section A of Annex I of MiFID) without in both cases holding money or securities belonging to its clients and which for that reason may not at any time place itself in debit with its clients.

Types of BIPRU investment firm

BIPRU 1.1.17

handbook-rule
  1. (1) A BIPRU limited licence firm means a limited licence firm that falls into (4).
  2. (2) A BIPRU limited activity firm means a limited activity firm that falls into (4).
  3. (3) A full scope BIPRU investment firm means a CAD full scope firm that falls into (4).
  4. (4) A limited licence firm, limited activity firm or CAD full scope firm falls into (4) if:
    1. (a) it is a firm; and
    2. (b) its head office is in the United Kingdom and it is not otherwise excluded from the definition of BIPRU firm under BIPRU 1.1.7 R.

Alternative classification of BIPRU investment firms

BIPRU 1.1.18

handbook-rule

BIPRU investment firm are divided into the following classes for the purposes of the calculation of the base capital resources requirement and for the purpose of any other provision of the Handbook that applies this classification:

  1. (1) a UCITS investment firm;
  2. (2) a BIPRU 50K firm;
  3. (3) a BIPRU 125K firm; and
  4. (4) a BIPRU 730K firm.

Types of investment firm: BIPRU 125K firm

BIPRU 1.1.19

handbook-rule

A BIPRU 125K firm means a BIPRU investment firm that satisfies the following conditions:

  1. (1) it does not:
    1. (a) deal on own account; or
    2. (b) underwrite issues of financial instruments (as referred in Section A of Annex I of MiFID) on a firm commitment basis;
  2. (2) it holds clients' money or securities in relation to investment services it provides or is authorised to do so;
  3. (3) it offers one or more of the following services (all as referred to in Section A of Annex I of MiFID):
    1. (a) reception and transmission of investors' orders for financial instruments; or
    2. (b) the execution of investors' orders for financial instruments; or
    3. (c) the management of individual portfolios of investments in financial instruments;
  4. (4) it is not a UCITS investment firm and;
  5. (5) it does not operate a multilateral trading facility.

Types of investment firm: BIPRU 50K firm

BIPRU 1.1.20

handbook-rule

A BIPRU 50K firm means a BIPRU investment firm that satisfies the following conditions:

  1. (1) it satisfies the conditions in BIPRU 1.1.19 R (1) and (3);
  2. (2) it does not hold clients' money or securities in relation to investment services it provides and it is not authorised to do so;
  3. (3) it is not a UCITS investment firm; and
  4. (4) it does not operate a multilateral trading facility.

Types of investment firm: 730K firm

BIPRU 1.1.21

handbook-rule

Types of investment firm: Part IV permission

BIPRU 1.1.22

handbook-rule
A firm also falls into one of the categories of BIPRU investment firm listed in BIPRU 1.1.6 R (3)to (5) or BIPRU 1.1.18 R if its Part IV permission contains a requirement that it comply with the rules in GENPRU and BIPRU applicable to that category of firm. If a firm is subject to such a requirement and it would otherwise also fall into another category of BIPRU investment firm it does not fall into that other category.

Meaning of dealing on own account

BIPRU 1.1.23

handbook-rule
  1. (1) Dealing on own account means (for the purpose of GENPRU and BIPRU) the service of dealing in any financial instruments for own account as referred to in point 3 of Section A of Annex I to MiFID, subject to (2) and (3).
  2. (2) In accordance with article5(2) of the Capital Adequacy Directive (Definition of dealing on own account), a CAD investment firm that executes investors' orders for financial instruments and holds such financial instruments for its own account does not for that reason deal on own account if the following conditions are met:
    1. (a) such position only arise as a result of the CAD investment firm's failure to match investors' orders precisely;
    2. (b) the total market value of all such positions is no higher than 15% of the CAD investment firm's initial capital;
    3. (c) (in the case of a BIPRU investment firm) it complies with the main BIPRU firm Pillar 1 rules and BIPRU 10 (Large exposures requirements);
    4. (d) (in the case of a CAD investment firm that is an EEA firm) it complies with the CRD implementation measures of its Home State for Articles 18 and 20 (Minimum capital requirements) and 28 (Large exposures) of the Capital Adequacy Directive;
    5. (e) (in the case of any other CAD investment firm) it would comply with the rules in (2)(c) if it had been a BIPRU investment firm on the basis of the assumptions in BIPRU 1.1.14 R (3)(a) and BIPRU 1.1.14R (3)(b); and
    6. (f) such positions are incidental and provisional in nature and strictly limited to the time required to carry out the transaction in question.
  3. (3) In accordance with Article 5(2) of the Capital Adequacy Directive, the holding of non-trading book positions in financial instruments in order to invest capital resources is not dealing on own account for the purposes referred to in BIPRU 1.1.18 R.

Interpretation of the definition of types of firm and undertaking

BIPRU 1.1.24

handbook-rule

For the purposes of the definitions in BIPRU 1.1, a person does any of the activities referred to in BIPRU 1.1 if:

  1. (1) it does that activity anywhere in the world; or
  2. (2) if its permission includes that activity; or
  3. (3) (in the case of an EEA firm) it is authorised by its Home State regulator to do that activity; or
  4. (4) (if the carrying on of that activity is prohibited in a state or territory without an authorisation in that state or territory) that firm has such an authorisation.

BIPRU 1.1.25

handbook-rule

For the purposes of the definitions in BIPRU 1.1, a person offers any of the services referred to in BIPRU 1.1.19 R (3) if:

  1. (1) it offers that service anywhere in the world; or
  2. (2) any of BIPRU 1.1.24 R (1) to BIPRU 1.1.24R (4) apply.

BIPRU 1.1.26

handbook-rule
For the purposes of the definitions in BIPRU 1.1, a person has an authorisation to do any of the activities referred to in BIPRU 1.1 if any of BIPRU 1.1.24 R (2) to (4) apply.

BIPRU 1.2

Definition of the trading book

  • 01/01/2007

Application

BIPRU 1.2.1

handbook-rule
This section applies to a BIPRU firm.

Purpose

BIPRU 1.2.2

handbook-guidance
This section implements certain provisions of the Capital Adequacy Directive and the Banking Consolidation Directive relating to the trading book. The precise provisions being implemented are listed as a note after each rule.

Definition of the trading book: General

BIPRU 1.2.3

handbook-rule

The trading book of a firm consists of all position in CRD financial instrument and commodities held either with trading intent or in order to hedge other elements of the trading book and which are either free of any restrictive covenants on their tradability or able to be hedged.

[Note: CAD Article 11(1)]

Definition of the trading book: Positions

BIPRU 1.2.4

handbook-rule

The term position includes proprietary positions and positions arising from client servicing and market making.

BIPRU 1.2.5

handbook-guidance
Positions arising from client servicing include those arising out of contracts where a firm acts as principal (even in the context of activity described as 'broking' or 'customer business'). Such positions should be allocated to a firm's trading book if the intent is trading (see BIPRU 1.2.10 R). This applies even if the nature of the business means that generally the only risks incurred by the firm are counterparty risks (i.e. no market risk charges apply). If the nature of the business means that generally the only risks incurred by the firm are counterparty risks, the position will generally still meet the trading intent requirement in BIPRU 1.2.10 R if the position would meet the trading intent requirement if position risk did arise. The FSA understands that business carried out under International Uniform Brokerage Execution ("Give-Up") Agreements involve back to back trades as principal. Thus positions arising out of business carried out under such agreements should be allocated to a firm's trading book.

Definition of the trading book: Repos

BIPRU 1.2.6

handbook-rule
Term trading-related repo-style transactions that a firm accounts for in its non-trading book may be included in the trading book for capital requirement purposes so long as all such repo-style transactions are included. For this purpose, trading-related repo-style transactions are defined as those that meet the requirements of BIPRU 1.2.4 R, BIPRU 1.2.10 R and BIPRU 1.2.12 R, and both legs are in the form of either cash or securities includable in the trading book. Regardless of where they are booked, all repo-style transactions are subject to a non-trading book counterparty credit risk charge.
[Note: CAD Annex VII Part D point 4]

BIPRU 1.2.6A

handbook-guidance
Capital requirements for term trading-related repo-style transactions are the same whether the risks arise in the trading book as counterparty credit risk or in the non-trading book as credit risk.

CRD financial instruments

BIPRU 1.2.7

handbook-rule

A CRD financial instrument means any contract that gives rise to both a financial asset of one party and a financial liability or equity instrument of another party.

BIPRU 1.2.8

handbook-rule

CRD financial instruments include both primary CRD financial instrument or cash instruments, and derivative CRD financial instruments the value of which is derived from the price of an underlying CRD financial instrument, a rate, an index or the price of another underlying item and include as a minimum the instruments specified in Section C of Annex I to the MIFID.

[Note: CAD Article 3(1) last paragraph]

BIPRU 1.2.9

handbook-guidance

Generally, for the purpose of the definition of CRD financial instrument:

  1. (1) a financial asset means cash, the right to receive cash or another financial asset, the contractual right to exchange financial assets on potentially favourable terms or an equity instrument; and
  2. (2) a financial liability means the contractual obligation to deliver cash or another financial asset or to exchange financial liabilities under conditions that are potentially unfavourable.

Trading intent

BIPRU 1.2.10

handbook-rule

Positions held with trading intent for the purpose of the definition of the trading book are those held intentionally for short-term resale and/or with the intention of benefiting from actual or expected short-term price differences between buying and selling prices, or from other price or interest rate variations.

BIPRU 1.2.11

handbook-rule

Trading intent must be evidenced on the basis of the strategies, policies and procedures set up by the firm to manage the position or portfolio in accordance with BIPRU 1.2.12 R.

BIPRU 1.2.12

handbook-rule

Positions/portfolios held with trading intent must comply with the following requirements:

  1. (1) there must be a clearly documented trading strategy for the position/instrument or portfolios, approved by senior management, which must include the expected holding horizon;
  2. (2) there must be clearly defined policies and procedures to monitor the position against the firm's trading strategy including the monitoring of turnover and stale position in the firm's trading book; and
  3. (3) there must be clearly defined policies and procedures for the active management of the position, which must include the following:
    1. (a) position entered into on a trading desk;
    2. (b) position limits are set and monitored for appropriateness;
    3. (c) dealers have the autonomy to enter into/manage the position within agreed limits and according to the approved strategy;
    4. (d) positions are reported to senior management as an integral part of the firm's risk management process; and
    5. (e) positions are actively monitored with reference to market information sources and an assessment made of the marketability or hedge-ability of the position or its component risks, including the assessment of, the quality and availability of market inputs to the valuation process, level of market turnover, sizes of positions traded in the market.

[Note: CAD Annex VII Part A]

Internal hedges

BIPRU 1.2.13

handbook-rule

Internal hedges may be included in the trading book, in which case BIPRU 1.2.14 R to BIPRU 1.2.16 R apply.

[Note: CAD Article 11(5)]

BIPRU 1.2.14

handbook-rule
  1. (1) An internal hedge is a position that materially or completely offsets the component risk element of a non-trading book position or a set of position. Positions arising from internal hedges are eligible for trading book capital treatment, provided that they are held with trading intent and that the general criteria on trading intent and prudent valuation specified in BIPRU 1.2.12 R and the trading book systems and controls rules. In particular:
    1. (a) internal hedges must not be primarily intended to avoid or reduce capital requirements;
    2. (b) internal hedges must be properly documented and subject to particular internal approval and audit procedures;
    3. (c) the internal transaction must be dealt with at market conditions;
    4. (d) the bulk of the market risk that is generated by the internal hedge must be dynamically managed in the trading book within the authorised limits; and
    5. (e) internal transactions must be carefully monitored.
  2. (2) Monitoring must be ensured by adequate procedures.

[Note: CAD Annex VII Part C point 1]

BIPRU 1.2.15

handbook-rule

The treatment referred to in BIPRU 1.2.14 R applies without prejudice to the capital requirements applicable to the "non-trading book leg" of the internal hedge.

BIPRU 1.2.16

handbook-rule

By way of derogation from BIPRU 1.2.14 R to BIPRU 1.2.15 R, when a firm hedges a non-trading book credit risk exposure using a credit derivative booked in its trading book (using an internal hedge), the non-trading book exposure is not deemed to be hedged for the purposes of calculating capital requirements unless the firm purchases from an eligible third party protection provider a credit derivative meeting the requirements set out in BIPRU 5.7.13 R (Additional requirements for credit derivatives) with regard to the non-trading book exposure. Without prejudice to the second sentence of BIPRU 14.2.10 R, where such third party protection is purchased and is recognised as a hedge of a non-trading book exposure for the purposes of calculating capital requirements, neither the internal nor external credit derivative hedge must be included in the trading book for the purposes of calculating capital requirements.

Size thresholds

BIPRU 1.2.17

handbook-rule
  1. (1) Subject to (3), a firm may calculate its capital requirements for its trading book business in accordance with the standardised approach to credit risk (or, if it has an IRB permission, the IRB approach) as it applies to the non-trading book where the size of the trading book business meets the following requirements:
    1. (a) the trading book business of the firm does not normally exceed 5% of its total business;
    2. (b) its total trading book position do not normally exceed €15 million; and
    3. (c) the trading book business of the firm never exceeds 6% of its total business and its total trading book positions never exceed €20 million.
  2. (2) Subject to (3), if (1) applies, the following are disapplied:
    1. (a) the rules relating to the interest rate PRR, the equity PRR, the CIU PRR and the PRR calculated under BIPRU 7.11 (Credit derivatives in the trading book);
    2. (b) the rules relating to the option PRR (but only in relation to positions which under BIPRU 7.6.5 R (Table: Appropriate calculation for an option or warrant) may be subject to one of the other PRR charges listed in (2)(a) or which would be subject to such a PRR charge if BIPRU 7.6.5 R did not require an option PRR to be calculated);
    3. (c) BIPRU 7.10 (Use of a Value at Risk Model) so far as BIPRU 7.10 relates to the risks covered by the requirements in (a) and (b); and
    4. (d) BIPRU 14 (Capital requirements for settlement and counterparty risk).
  3. (3) If (1) applies, the following continue to apply:
    1. (a) the rules relating to the commodity PRR and the foreign currency PRR;
    2. (b) the rules relating to the option PRR (so far as not disapplied under (2)(b);
    3. (c) BIPRU 7.10 (so far as not disapplied under (2)(c));
    4. (d) BIPRU 14.2.3 R to BIPRU 14.2.8 R (Credit derivatives); and
    5. (e) BIPRU 14.2.15 R to BIPRU 14.2.16 R (Collateral for repurchase transactions and other products).

[Note: CAD Article 18(2)]

BIPRU 1.2.18

handbook-rule

In order to calculate the proportion that trading book business bears to total business for the purpose of BIPRU 1.2.17 R (1)(a) to BIPRU 1.2.17R (1)(c) the firm must refer to the size of the combined on- and off-balance-sheet business. For this purpose, debt instruments must be valued at their market prices or their principal values, equities at their market prices and derivatives according to the nominal or market values of the instruments underlying them. Long positions and short positions must be summed regardless of their signs.

[Note: CAD Article 18(3)]

BIPRU 1.2.19

handbook-rule

If a firm should happen for more than a short period to exceed either or both of the limits imposed in BIPRU 1.2.17 R (1)(a) and BIPRU 1.2.17R (1)(b) or either or both of the limits imposed in BIPRU 1.2.17 R (1)(c):

  1. (1) BIPRU 1.2.17 R ceases to apply; and
  2. (2) the firm must notify the FSA.

[Note: CAD Article 18(4)]

BIPRU 1.2.20

handbook-guidance
As required by BIPRU 8.7.21 R (Special rules for the consolidated market risk requirement), a firm should consider whether it meets the threshold conditions in BIPRU 1.2.17 R on both an unconsolidated (or solo) basis and a consolidated basis. If a firm's trading activities on both an unconsolidated (or solo) basis and a consolidated basis are below the threshold size, it may be appropriate for the firm not to adopt the trading book treatment. However, even if the firm does not apply the trading book treatment it should still adopt a trading book policy statement. That statement may be restricted to identifying the activities the firm normally considers to be trading and that would constitute part of its trading book. The firm should use this policy statement to help it to decide whether or not adopting the trading book treatment is appropriate.

Systems and controls for the trading book

BIPRU 1.2.21

handbook-rule

A firm must implement policies and processes for the measurement and management of all material sources and effects of market risks.

BIPRU 1.2.22

handbook-rule

A firm must establish and maintain systems and controls to manage its trading book, in accordance with the trading book systems and controls rules, BIPRU 1.2.6 R (Definition of the trading book: Repos) and the overall financial adequacy rule to BIPRU 1.2.27 R (Trading book policy statements).

BIPRU 1.2.23

handbook-rule

A firm must establish and maintain systems and controls sufficient to provide prudent and reliable valuation estimates.

BIPRU 1.2.24

handbook-rule

Systems and controls must include at least the following elements:

  1. (1) documented policies and procedures for the process of valuation (including clearly defined responsibilities of the various areas involved in the determination of the valuation, sources of market information and review of their appropriateness, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, month end and ad-hoc verification procedures); and
  2. (2) reporting lines for the department accountable for the valuation process that are clear and independent of the front office.

[Note: CAD Annex VII Part B point 2]

BIPRU 1.2.25

handbook-rule

The reporting line in relation to the matters covered by BIPRU 1.2.21 R to BIPRU 1.2.24 R must ultimately be to an executive director on the firm's governing body.

Trading book policy statements

BIPRU 1.2.26

handbook-rule

A firm must have clearly defined policies and procedures for determining which positions to include in the trading book for the purposes of calculating its capital requirements, consistent with the criteria set out in BIPRU 1.2.3 R to BIPRU 1.2.4 R, BIPRU 1.2.10 R to BIPRU 1.2.11 R, BIPRU 1.1.13 R and BIPRU 1.2.22 R and taking into account the firm's risk management capabilities and practices. Compliance with these policies and procedures must be fully documented and subject to periodic internal audit.

[Note: CAD Annex VII Part D point 1]

BIPRU 1.2.27

handbook-rule

A firm must have clearly defined policies and procedures for overall management of the trading book. At a minimum these policies and procedures must address:

  1. (1) the activities the firm considers to be trading and as constituting part of the trading book for capital requirement purposes;
  2. (2) the extent to which a position can be marked-to-market daily by reference to an active, liquid two-way market;
  3. (3) for positions that are marked-to-model, the extent to which the firm can:
    1. (a) identify all material risks of the position;
    2. (b) hedge all material risks of the position with instruments for which an active, liquid two-way market exists; and
    3. (c) derive reliable estimates for the key assumptions and parameters used in the model;
  4. (4) the extent to which the firm can, and is required to, generate valuations for the position that can be validated externally in a consistent manner;
  5. (5) the extent to which legal restrictions or other operational requirements would impede the firm's ability to effect a liquidation or hedge of the position in the short term;
  6. (6) the extent to which the firm can, and is required to, actively risk manage the position within its trading operation; and
  7. (7) the extent to which the firm may transfer risk or positions between the non-trading book and trading book and the criteria for such transfers.

[Note: CAD Annex VII Part D point 2]

BIPRU 1.2.28

handbook-guidance

The policies and procedures referred to in BIPRU 1.2.27 R (1) should cover:

  1. (1) the CRD financial instrument and commodities that the firm proposes to trade in, including the currencies, maturities, issuers and quality of issues; and
  2. (2) any instruments to be excluded from its trading book.

BIPRU 1.2.29

handbook-rule
  1. (1) The policies and procedures referred to in the overall financial adequacy rule and BIPRU 1.2.27 R must be recorded in a single written document. A firm may record those policies and procedures in more than one written document if the firm has a single written document that identifies:
    1. (a) all those other documents; and
    2. (b) the parts of those documents that record those policies and procedures.
  2. (2) A trading book policy statement means the single document referred to in this rule.

BIPRU 1.2.30

handbook-rule
  1. (1) A firm must notify the FSA as soon as is reasonably practicable when it adopts a trading book policy statement.
  2. (2) A firm must notify the FSA as soon as is reasonably practicable if the trading book policy statement is subject to significant changes.

BIPRU 1.2.31

handbook-guidance
A significant change for the purpose of the overall Pillar 2 rule includes new types of customers or business requiring different funding or provisioning.

BIPRU 1.2.32

handbook-guidance
There is likely to be an overlap between what the trading book policy statement should contain and other documents such as dealing or treasury manuals. A cross reference to the latter in the trading book policy statement is adequate and material in other documents need not be set out again in the trading book policy statement. However where this is the case the matters required to be included in the trading book policy statement should be readily identifiable.

BIPRU 1.2.33

handbook-guidance
The trading book policy statement may be prepared on either a consolidated or a solo (or solo-consolidated) basis. It should be prepared on a consolidated basis when a group either manages its trading risk centrally or employs the same risk management techniques in each group member. A trading book policy statement prepared on a consolidated basis should set out how it applies to each firm in the group and should be approved by each such firm's governing body.

Treatments common to the trading book and the non-trading book

BIPRU 1.2.34

handbook-guidance
Capital requirements for foreign currency risk and commodity position risk are the same whether the risk arises in the trading book or the non-trading book. The calculation of capital requirements for foreign currency risk is set out in BIPRU 7.5. The calculation of capital requirements for commodity position risk is set out in BIPRU 7.4.

Trading book treatments

BIPRU 1.2.35

handbook-guidance
All positions that are in a firm's trading book require capital to cover position risk and may require capital to cover counterparty credit risk and to cover large exposures. Counterparty credit risk in the trading book is dealt with by BIPRU 14 and capital for large exposures is covered by BIPRU 10.

Non-trading book treatments

BIPRU 1.2.36

handbook-guidance
All positions that are not in a firm's trading book are included in its non-trading book and subject capital requirements for the non-trading book unless they are deducted from capital resources under GENPRU 2.2 (Capital resources).

BIPRU 1.3

Applications for advanced approaches and waivers

Application

BIPRU 1.3.1

handbook-rule
This section of the Handbook applies to every BIPRU firm that wishes to apply for a permission to use any of the approaches set out in BIPRU 1.3.2 G.

Purpose

BIPRU 1.3.2

handbook-guidance
  1. (1) A firm may apply for an Article 129 permission or a waiver in respect of:
    1. (a) the IRB approach;
    2. (b) the advanced measurement approach;
    3. (c) the CCR internal model method; and
    4. (d) the VaR model approach.
  2. (2) A firm should apply for a waiver if it wants to:
    1. (a) apply the CAD 1 model approach; or
    2. (b) apply the master netting agreement internal models approach; or
    3. (c) disapply consolidated supervision under BIPRU 8 for its UK consolidation group or non-EEA sub-group; or
    4. (d) apply the treatment in BIPRU 2.1 (Solo-consolidation waiver); or
    5. (da) apply the treatment for a core UK group in BIPRU 3.2.25 R (Zero risk-weighting for intra-group exposures) or in BIPRU 10.8A (Intra-group exposures: core UK group); or
    6. (e) apply the treatment for a non-core large exposures group in BIPRU 10.9A (Intra-group exposures: non-core large exposures group); or
    7. (f) apply the treatment in BIPRU 10.6.35 R (Sovereign large exposure waiver).

Article 129

BIPRU 1.3.3

handbook-guidance
An EEA parent institution and its subsidiary undertakings or the subsidiary undertakings of its EEA parent financial holding company that wish to use any of the approaches listed in BIPRU 1.3.2 G (1) in respect of its group, including members of its group that are BIPRU firms, may apply for an Article 129 permission.

BIPRU 1.3.4

handbook-guidance
The Article 129 procedure allows an EEA parent institution and its subsidiary undertakings or the subsidiary undertakings of its EEA parent financial holding company to apply for permission to use the approaches in BIPRU 1.3.2 G (1) without making separate applications to the competent authority of each EEA State where members of a firm's group are authorised.

BIPRU 1.3.5

handbook-guidance

BIPRU 1.3.6

handbook-guidance
Where a firm or its group has been granted an Article 129 permission, each competent authority, including the lead competent authority, will need to take action to apply that Article 129 permission to the institutions that they authorise. Part 3 of the Capital Requirements Regulations 2006 governs how the FSA will take that action, whether or not the FSA is the lead competent authority.

Article 129 permissions and waivers - specific conditions

BIPRU 1.3.7

handbook-directions
When an advanced measurement approach is intended to be used by an EEA parent institution and its subsidiary undertakings or the subsidiary undertakings of an EEA parent financial holding company, the application of a firm in accordance with BIPRU 1.3.14 D must include the elements listed in BIPRU 6.5.5 R (Minimum standards for the advanced measurement approach).

[Note: BCD Article 105(2)]

BIPRU 1.3.8

handbook-directions
When an advanced measurement approach is intended to be used by an EEA parent institution and its subsidiary undertakings or the subsidiary undertakings of an EEA parent financial holding company, the application of a firm must include a description of the methodology used for allocating operational risk capital between the different entities of the group.

[Note: BCD annex X Part 3 point 30]

BIPRU 1.3.9

handbook-directions
For the purposes of BIPRU 1.3.8 D, the application of a firm must indicate whether and how diversification effects are intended to be factored in the risk measurement system.

[Note: BCD annex X Part 3 point 31]

Waiver - general

BIPRU 1.3.10

handbook-guidance

As explained in SUP 8, under of the Act, the FSA may not grant a waiver to a firm unless it is satisfied that:

  1. (1) compliance by the firm with the rules, or with the rules as modified, would be unduly burdensome or would not achieve the purpose for which the rules were made; and
  2. (2) the waiver would not result in undue risk to persons whose interests the rules are intended to protect objects.

BIPRU 1.3.11

handbook-guidance
The conditions relating to the use of an approach listed in BIPRU 1.3.2 G referred to in the relevant chapter of BIPRU are minimum standards. Satisfaction of those conditions does not automatically mean the FSA will grant a waiver referred to in those paragraphs. The FSA will in addition also apply the tests in section 148 of the Act.

BIPRU 1.3.12

handbook-guidance
In the FSA's view, if the minimum standards referred to in BIPRU 1.3.11 G are satisfied, the conditions referred to in BIPRU 1.3.10 G (1) will generally be met.

Forms and method of application

BIPRU 1.3.13

handbook-directions
Subject to BIPRU 1.3.14 D to BIPRU 1.3.20 D, if a firm wishes to apply for a waiver to apply an approach set out in BIPRU 1.3.2 G, it must comply with SUP 8.3.3 D.

BIPRU 1.3.14

handbook-directions
If a firm wishes to apply for a waiver or an Article 129 permission to use the advanced measurement approach, it must complete and submit the form in BIPRU 1 Annex 1D D.

BIPRU 1.3.15

handbook-directions
If a firm wishes to apply for a waiver or an Article 129 permission to use the IRB approach, it must complete and submit the form in BIPRU 1 Annex 2D D.

BIPRU 1.3.16

handbook-directions
If a firm wishes to apply for a waiver or an Article 129 permission to use the CCR internal model method, it must complete and submit the form in BIPRU 1 Annex 3D D.

BIPRU 1.3.17

handbook-directions
Where a firm makes an application in accordance with BIPRU 1.3.14 D, BIPRU 1.3.15 D or BIPRU 1.3.16 D, the firm must state on the application whether it is making an application for a waiver or an Article 129 permission.

BIPRU 1.3.18

handbook-directions
Where a firm applies for a VaR model permission, the firm must state whether it is making an application for a waiver or an Article 129 permission.

BIPRU 1.3.19

handbook-guidance
In respect of the application for waivers to apply the approaches set out in BIPRU 1.3.2 G (1), the FSA will aim to give decisions on applications as soon as practicable. However, the FSA expects that it will take a significant period to determine and give a decision due to the complexity of the issues raised by the applications. Details of timelines for applications for waivers to use advanced approaches and under the Article 129 procedure are set out on the FSA website.

BIPRU 1.3.20

handbook-directions
Where a firm applies for a solo consolidation waiver, it must demonstrate how each of the conditions set out in BIPRU 2.1.20 R to BIPRU 2.1.24 R are met and address the criteria set out in the guidance in BIPRU 2.1.25 G as part of its application in accordance with BIPRU 1.3.13 D.

BIPRU 1.3.21

handbook-guidance
Before sending in an application for a waiver or Article 129 permission, a firm may find it helpful to discuss the application with its usual supervisory contact at the FSA. However, the firm should still ensure that all relevant information is included in the application.

BIPRU 1.4

Actions for damages

  • 01/01/2007

BIPRU 1.4.1

handbook-rule
A contravention of the rules in BIPRU does not give rise to a right of action by a private person under section 150 of the Act (and each of those rules is specified under section 150(2) of the Act as a provision giving rise to no such right of action).

BIPRU 1 Annex 1D

Application form to apply the advanced measurement approach

  • 01/01/2007

handbook-directions

BIPRU 1 Annex 2D

Application form to apply the IRB approach

  • 01/01/2007

handbook-directions

BIPRU 1 Annex 3D

Application form to apply the CCR internal model method approach

  • 01/01/2007

handbook-directions

Export chapter as

BIPRU 2

Capital

BIPRU 2.1

Solo consolidation

  • 01/01/2007

Application

BIPRU 2.1.1

handbook-rule
This section applies to a BIPRU firm that has a solo consolidation waiver.

Purpose

BIPRU 2.1.2

handbook-guidance
The purpose of this section is to implement Articles 70 and 118 of the Banking Consolidation Directive. It also implements Articles 2 and 28 of the Capital Adequacy Directive so far as they apply those provisions of the Banking Consolidation Directive to CAD investment firms.

BIPRU 2.1.3

handbook-guidance
The rules in GENPRU and BIPRU do not allow a firm that is a parent undertaking to incorporate the capital and requirements of a subsidiary undertaking in the calculation of that firm's capital resources and capital resources requirement. A firm that wishes to incorporate a subsidiary undertaking for this purpose should therefore apply for a solo consolidation waiver.

Applying for a solo consolidation waiver

BIPRU 2.1.4

handbook-guidance
BIPRU 1.3 (Applications for advanced approaches) explains how to apply for a solo consolidation waiver.

General

BIPRU 2.1.5

handbook-guidance
The FSA will not grant a firm a solo consolidation waiver with respect to a subsidiary undertaking unless the firm and the subsidiary undertaking meet the standards in BIPRU 2.1.19 R to BIPRU 2.1.24 R.

BIPRU 2.1.6

handbook-guidance
A solo consolidation waiver will modify the relevant parts of GENPRU, BIPRU and SYSC referred to in BIPRU 2.1.7 R to BIPRU 2.1.8 R to apply BIPRU 2.1 to a firm.

The basic rules for solo consolidation

BIPRU 2.1.7

handbook-rule
A firm that has a solo consolidation waiver must incorporate in the calculation of its requirements under the main BIPRU firm Pillar 1 rules and BIPRU 10 (Large exposure requirements) each subsidiary undertaking to which the solo consolidation waiver applies. This does not apply to the base capital resources requirement.

BIPRU 2.1.8

handbook-rule
  1. (1) A firm that has a solo consolidation waiver must meet the obligations in SYSC 12.1.13 R (Application of certain systems and controls rules on a consolidated basis) on a consolidated basis with respect to the firm and each subsidiary undertaking to which the firm's solo consolidation waiver applies.
  2. (2) If (1) applies, SYSC 12.1.13 R applies to the group made up of the firm and its subsidiary undertakings referred to in (1) in the same way as it applies to a UK consolidation group or non-EEA sub-group.
  3. (3) If (1) applies, the provisions of SYSC and BIPRU listed in SYSC 12.1.13 R do not apply to the firm on a solo basis.

Solo consolidation and capital and concentration risk requirements

BIPRU 2.1.9

handbook-rule
BIPRU 2.1.10 R to BIPRU 2.1.18 R apply for the purposes of BIPRU 2.1.7 R.

BIPRU 2.1.10

handbook-rule
A firm must treat itself and each subsidiary undertaking referred to in BIPRU 2.1.7 R as a single undertaking and must apply, on that basis, BIPRU 8 (Group risk - consolidation) to the group made up of the firm and such subsidiary undertakings in the same way as BIPRU 8 applies to a UK consolidation group or non-EEA sub-group.

BIPRU 2.1.11

handbook-rule
Subject to BIPRU 2.1.13 R, a firm must calculate its capital resources in accordance with BIPRU 8.6 (Consolidated capital resources).

BIPRU 2.1.12

handbook-rule
A firm must calculate its capital resources requirement in accordance with BIPRU 8.7.13 R (3) (Treating group members as a single undertaking for consolidation purposes).

BIPRU 2.1.13

handbook-rule
Where GENPRU applies a different method of calculating capital resources or capital resources requirements depending on the category into which the firm in question falls, the method that applies is the one that would apply to the firm on a solo basis.

BIPRU 2.1.14

handbook-guidance
For example, the effect of BIPRU 2.1.13 R is that if a firm that is applying BIPRU 2.1 is a limited licence firm it should continue to apply the capital resources and capital resources requirement applicable to a limited licence firm.

BIPRU 2.1.15

handbook-rule
A firm must continue to calculate its base capital resources requirement and the requirement in GENPRU 2.1.42 R (Calculation of capital resources requirement on authorisation) on a solo basis.

BIPRU 2.1.16

handbook-rule
A firm must apply BIPRU 10 (Large exposure requirements) in accordance with BIPRU 8.9A (Consolidated large exposures requirements). Accordingly the firm must apply BIPRU 8.9A to the group made up of the firm and the subsidiary undertakings referred to in BIPRU 2.1.7 R in the same way as BIPRU 8.9A applies to a UK consolidation group or non-EEA sub-group.

BIPRU 2.1.17

handbook-guidance
One effect of BIPRU 2.1.16 R is that BIPRU 10.8A (Core UK groups) and BIPRU 10.9A (Non-core large exposures groups) do not apply. The corresponding provisions of BIPRU 8.9A (Consolidated large exposures requirements) apply instead.

BIPRU 2.1.18

handbook-rule
A firm must include in full any subsidiary undertaking in respect of which the firm applies BIPRU 2.1 in the calculations under BIPRU 2.1.7 R.

Minimum standards

BIPRU 2.1.19

handbook-rule
A firm must not apply BIPRU 2.1 to a subsidiary undertaking to which the firm's solo consolidation waiver applies BIPRU 2.1 unless in addition it meets the conditions in BIPRU 2.1.20 R to BIPRU 2.1.24 R.

BIPRU 2.1.20

handbook-rule
The risk evaluation, measurement and control procedures of the firm must cover the subsidiary undertaking referred to in BIPRU 2.1.19 R.

BIPRU 2.1.21

handbook-rule
The firm must hold more than 75% of the voting rights attaching to the shares in the capital of the subsidiary undertaking referred to in BIPRU 2.1.19 R and must have the right to appoint or remove a majority of the members of the governing body of the subsidiary undertaking.

BIPRU 2.1.22

handbook-rule
The material exposures or material liabilities of the subsidiary undertaking referred to in BIPRU 2.1.19 R must be to the firm.

BIPRU 2.1.23

handbook-rule
Where the firm is a parent institution in a Member State, it must have measures in place that ensure the satisfactory allocation of risks within the group consisting of the firm and each subsidiary undertaking to which BIPRU 2.1 is applied.

BIPRU 2.1.24

handbook-rule
A firm must be able to demonstrate fully to the FSA the circumstances and arrangements, including legal arrangements, by virtue of which there are no material practical or legal impediments, and none are foreseen, to the prompt transfer of the capital resources of the subsidiary undertaking referred to in BIPRU 2.1.19 R or repayment of liabilities when due by the subsidiary undertaking to the firm.

BIPRU 2.1.25

handbook-guidance

The following are the criteria that the FSA will take into account when considering whether the condition in BIPRU 2.1.24 R is going to be met:

  1. (1) the speed with which funds can be transferred or liabilities repaid to the firm and the simplicity of the method for the transfer or repayment;
  2. (2) whether there are any interests other than those of the firm in the subsidiary undertaking and what impact those other interests may have on the firm's control over the subsidiary undertaking and on the ability of the firm to require a transfer of funds or repayment of liabilities;
  3. (3) whether the prompt transfer of funds or repayment of liabilities to the firm might harm the reputation of the firm or its subsidiary undertakings;
  4. (4) whether there are any tax disadvantages for the firm or the subsidiary undertaking as a result of the transfer of funds or repayment of liabilities;
  5. (5) whether there are any exchange controls that may have an impact on the transfer of funds or repayment of liabilities;
  6. (6) whether there are assets in the subsidiary undertaking available either to be transferred or liquidated for the purposes of the transfer of funds or repayment of liabilities;
  7. (7) whether any regulatory requirements impact on the ability of the subsidiary undertaking to transfer funds or repay liabilities promptly;
  8. (8) whether the purpose of the subsidiary undertaking prejudices the prompt transfer of funds or repayment of liabilities;
  9. (9) whether the legal structure of the subsidiary undertaking prejudices the prompt transfer of funds or repayment of liabilities;
  10. (10) whether the contractual relationships of the subsidiary undertaking with the firm and other third parties prejudices the prompt transfer of funds or repayment of liabilities;
  11. (11) whether past and proposed flows of funds between the subsidiary undertaking and the firm demonstrate the ability to make prompt transfer of funds or repayment of liabilities; and
  12. (12) whether the degree of solo consolidation by the firm undermines the FSA's ability to assess the soundness of the firm as a legal entity (taking into account any other subsidiary undertakings to which BIPRU 2.1 is being applied).

BIPRU 2.1.26

handbook-guidance
The effect of BIPRU 2.1.19 R is that even though a firm's solo consolidation waiver applies BIPRU 2.1 with respect to a subsidiary undertaking, the firm should not apply BIPRU 2.1 with respect to that subsidiary undertaking unless in addition it meets the conditions in BIPRU 2.1.20 R to BIPRU 2.1.24 R.

BIPRU 2.1.27

handbook-guidance
A firm should not apply BIPRU 2.1 to a subsidiary undertaking to which the firm's solo consolidation waiver applies if it ceases to be a subsidiary undertaking of the firm even if the solo consolidation waiver is not varied by removing the subsidiary undertaking.

BIPRU 2.1.28

handbook-guidance
If a subsidiary undertaking referred to in BIPRU 2.1.27 G later becomes a subsidiary undertaking again the firm should not apply BIPRU 2.1 to it unless the solo consolidation waiver is varied to re-apply it with respect to the subsidiary undertaking.

BIPRU 2.2

Internal capital adequacy standards

  • 01/01/2007

Application

BIPRU 2.2.1

handbook-guidance
BIPRU 2.2 applies to a BIPRU firm.

Purpose

BIPRU 2.2.2

handbook-guidance
  1. (1) BIPRU 2.2 sets out guidance on GENPRU 1.2 (Adequacy of financial resources) so far as it applies to a BIPRU firm. In particular it sets out guidance on how a firm should carry out its ICAAP, as well as some factors the FSA will take into consideration when undertaking a SREP. The terms ICAAP and SREP are explained in BIPRU 2.2.4 G. BIPRU 2.2.41 R-BIPRU 2.2.43 R are rules that apply to a firm with an IRB permission.
  2. (2) BIPRU 2.2 is for the most part written on the basis that GENPRU 1.2 (Adequacy of financial resources) applies to a firm on a solo basis. However it is still relevant when GENPRU 1.2 applies on a consolidated basis. When GENPRU 1.2 applies on a consolidated basis, BIPRU 2.2 should be read with appropriate adjustments.

Meaning of capital

BIPRU 2.2.3

handbook-guidance
For the purpose of BIPRU 2.2, "capital" refers to a firm's financial resources, capital resources and internal capital, all as referred to in the overall Pillar 2 rule.

The ICAAP and the SREP: Introduction

BIPRU 2.2.4

handbook-guidance

The adequacy of a firm's capital needs to be assessed both by a firm and the FSA. This process involves:

  1. (1) an internal capital adequacy assessment process (ICAAP), which a firm is obliged to carry out in accordance with the ICAAP rules; and
  2. (2) a supervisory review and evaluation process (SREP), which is conducted by the FSA.

The ICAAP and the SREP: The ICAAP

BIPRU 2.2.5

handbook-guidance

The obligation to conduct an ICAAP, includes requirements on a firm to:

  1. (1) carry out regularly assessments of the amounts, types and distribution of financial resources, capital resources and internal capital that it considers adequate to cover the nature and level of the risks to which it is or might be exposed (GENPRU 1.2.30 R to GENPRU 1.2.41 G (the overall Pillar 2 rule and related rules);
  2. (2) identify the major sources of risk to its ability to meet its liabilities as they fall due (the overall Pillar 2 rule);
  3. (3) conduct stress and scenario tests (the general stress and scenario testing rule), taking into account, in the case of a firm with an IRB permission, the stress test required by BIPRU 4.3.39 R to BIPRU 4.3.40 R (Stress tests used in assessment of capital adequacy for a firm with an IRB permission);
  4. (4) ensure that the processes, strategies and systems required by the overall Pillar 2 rule and used in its ICAAP, are both comprehensive and proportionate to the nature, scale and complexity of that firm's activities (GENPRU 1.2.35 R); and
  5. (5) document its ICAAP (GENPRU 1.2.60 R).

BIPRU 2.2.6

handbook-guidance
Where a firm is a member of a group, it should base its ICAAP on the consolidated financial position of the group. The group assessment should include information on diversification benefits and transferability of resources between members of the group and an apportionment of the capital required by the group as a whole to the firm (GENPRU 1.2.44 G to GENPRU 1.2.56 G (Application of GENPRU 1.2 on a solo and consolidated basis: Processes and tests)). A firm may, instead of preparing the ICAAP itself, adopt as its ICAAP an assessment prepared by other group members.

BIPRU 2.2.7

handbook-guidance

A firm should ensure that its ICAAP is:

  1. (1) the responsibility of the firm's governing body;
  2. (2) reported to the firm's governing body; and
  3. (3) forms an integral part of the firm's management process and decision-making culture.

The ICAAP and the SREP: The SREP

BIPRU 2.2.8

handbook-guidance
The FSA will review a firm's ICAAP, including the results of the firm's stress tests carried out under GENPRU and BIPRU, as part of its SREP. Provided that the FSA is satisfied with the appropriateness of a firm's capital assessment, the FSA will take into account that firm's ICAAP and stress tests in its SREP. More material on stress tests for a firm with an IRB permission can be found in BIPRU 2.2.41 R to BIPRU 2.2.45 G.

BIPRU 2.2.9

handbook-guidance

The SREP is a process under which the FSA:

  1. (1) reviews the arrangements, strategies, processes and mechanisms implemented by a firm to comply with GENPRU, BIPRU and SYSC and with requirements imposed by or under the regulatory system and evaluates the risks to which the firm is or might be exposed;
  2. (2) determines whether the arrangements, strategies, processes and mechanisms implemented by the firm and the capital held by the firm ensures a sound management and coverage of the risks in (1); and
  3. (3) (if necessary) requires the firm to take the necessary actions or steps at an early stage to address any failure to meet the requirements referred to in (1).

BIPRU 2.2.10

handbook-guidance
As part of its SREP, the FSA may ask a firm to provide it with the results of that firm's ICAAP, together with an explanation of the process used. Where appropriate, the FSA will ask for additional information on the ICAAP.

BIPRU 2.2.11

handbook-guidance
As part of its SREP, the FSA will consider whether the amount and quality of capital which a firm should hold to meet its CRR in GENPRU 2.1 (Calculation of capital resources requirements) is sufficient for that firm to comply with the overall financial adequacy rule.

BIPRU 2.2.12

handbook-guidance
After completing a review as part of the SREP, the FSA will normally give that firm individual guidance (individual capital guidance), advising it of the amount and quality of capital which it should hold to meet the overall financial adequacy rule.

BIPRU 2.2.12A

handbook-guidance
As part of its SREP, the FSA will also consider whether a firm should hold a capital planning buffer and, in that case, the amount and quality of such capital planning buffer. In making these assessments, the FSA will have regard to the nature, scale and complexity of a firm's business and of the major sources of risks relevant to such business as referred to in the general stress and scenario testing rule. Accordingly, a firm's capital planning buffer should be of sufficient amount and adequate quality to allow the firm to continue to meet the overall financial adequacy rule in the face of adverse circumstances, after allowing for realistic management actions.

BIPRU 2.2.12B

handbook-guidance
After completing a review as part of the SREP, the FSA may notify the firm of the amount and quality of capital which it should hold as a capital planning buffer over and above the level of capital recommended as its ICG. The FSA may set a firm's capital planning buffer either as an amount and quality of capital which it should hold now (that is, at the time of the FSA's notification following the firm's SREP) or, in exceptional cases, as a forward looking target that the firm should build up over time.

BIPRU 2.2.12C

handbook-guidance
Where the amount or quality of capital which the FSA considers a firm should hold to meet the overall financial adequacy rule or as a capital planning buffer is not the same as that which results from a firm's ICAAP, the FSA usually expects to discuss any such difference with the firm. Where necessary, the FSA may consider the use of its powers under section 166 of the Act (Reports by skilled persons) to assist in such circumstances.

BIPRU 2.2.13

handbook-guidance
If a firm considers that the individual capital guidance given to it is inappropriate to its circumstances it should, consistent with Principle 11 (Relations with regulators), inform the FSA that it disagrees with that guidance. The FSA may reissue individual capital guidance if, after discussion with the firm, the FSA concludes that the amount or quality of capital that the firm should hold to meet the overall financial adequacy rule is different from the amount or quality initially suggested by the FSA.

BIPRU 2.2.13A

handbook-guidance
If a firm disagrees with the FSA's assessment as to the amount or quality of capital planning buffer that it should hold, it should, consistent with Principle 11 (Relations with regulators), notify the FSA of its disagreement. The FSA may reconsider its initial assessment if, after discussion with the firm, the FSA concludes that the amount or quality of capital that the firm should hold as capital planning buffer is different from the amount or quality initially suggested.

BIPRU 2.2.14

handbook-guidance
The FSA will not give individual capital guidance to the effect that the amount of capital advised in that guidance is lower than the amount of capital which a firm should hold to meet its CRR.

BIPRU 2.2.15

handbook-guidance
If, after discussion, the FSA and a firm still do not agree on an adequate level of capital, the FSA may consider using its powers under section 45 of the Act to vary on its own initiative a firm's Part IV permission so as to require it to hold capital in accordance with the FSA's view of the capital necessary to comply with the overall financial adequacy rule. In deciding whether it should use its powers under section 45, the FSA will take into account the amount and quality of the capital planning buffer which the firm should hold as referred to in BIPRU 2.2.12A G and BIPRU 2.2.12B G. SUP 7 provides further information about the FSA's powers under section 45.

The drafting of individual capital guidance and capital planning buffer

BIPRU 2.2.16

handbook-guidance
If the FSA gives individual capital guidance to a firm, the FSA will state what amount and quality of capital the FSA considers the firm needs to hold in order to comply with the overall financial adequacy rule. It will generally do so by saying that the firm should hold capital resources of an amount which is at least equal to a specified percentage of that firm's capital resources requirement plus one or more static add-ons in relation to specific risks in accordance with the overall Pillar 2 rule.

BIPRU 2.2.17

handbook-guidance
  1. (1) Individual capital guidance may refer to two types of capital resources.
  2. (2) The first type is referred to as general capital. It refers to total tier one capital resources and tier two capital resources after deductions.
  3. (3) The second type is referred to as total capital. It refers to total tier one capital resources, tier two capital resources and tier three capital resources after deductions.

BIPRU 2.2.18

handbook-guidance
  1. (1) In both of the cases in BIPRU 2.2.17 G capital resources should be calculated in the same way as they are in GENPRU 2.2 (Capital resources). This includes the rules limiting the amount of capital that can be included in the various tiers of capital when capital resources are being calculated.
  2. (2) GENPRU 2.2.42 R does not allow innovative tier one capital to count as tier one capital resources for certain purposes. This restriction does not apply for the purposes in BIPRU 2.2.17 G.

BIPRU 2.2.19

handbook-guidance
  1. (1) Individual capital guidance may also be given with respect to group capital resources. This paragraph explains how such guidance should be interpreted unless the individual capital guidance specifies another interpretation.
  2. (2) If BIPRU 8.2.1 R (General consolidation rule for a UK consolidation group) applies to the firm the guidance relates to its UK consolidation group. If BIPRU 8.3.1 R (General consolidation rule for a non-EEA sub-group) applies to the firm the guidance relates to its non-EEA sub-group. If both apply to the firm the guidance relates to its UK consolidation group and to its non-EEA sub-group.
  3. (3) The guidance will be on the overall financial adequacy rule as it applies on a consolidated basis under GENPRU 1.2.59 R (Application of GENPRU 1.2 on a solo and consolidated basis: Adequacy of resources) and insofar as it refers to capital resources.
  4. (4) BIPRU 2.2.16 G to BIPRU 2.2.18 G apply for the purpose of this paragraph as they apply to guidance given on a solo basis. References to capital resources should be read as being to consolidated capital resources.

BIPRU 2.2.19A

handbook-guidance
Where the FSA notifies a firm that it should hold a capital planning buffer, the notification will state what amount and quality of capital the FSA considers that is adequate for the firm to hold as such. This will normally be notified to the firm together with its individual capital guidance and expressed as a separate amount of capital resources that the firm should hold in excess of the amount of capital resources indicated as its individual capital guidance.

BIPRU 2.2.19B

handbook-guidance
For the purposes of BIPRU 2.2.19A G, BIPRU 2.2.17 G to BIPRU 2.2.19 G apply as they apply to individual capital guidance. References in those provisions to individual capital guidance or guidance should be read as if they were references to capital planning buffer. In relation to BIPRU 2.2.19G (3) and GENPRU 1.2.59 R, where the general stress and scenario testing rule, as part of the ICAAP rules, applies to a firm on a consolidated basis, the FSA may notify the firm that it should hold a group capital planning buffer. In these cases, the firm should ensure that the group holds a capital planning buffer of sufficient amount and adequate quality to allow it to continue to meet the overall financial adequacy rule in the face of adverse circumstances, after allowing for realistic management actions.

Failure to meet individual capital guidance and monitoring and reporting on the capital planning buffer

BIPRU 2.2.20

handbook-guidance

A firm's continuing to hold capital in accordance with its individual capital guidance and its ability to carry on doing so is a fundamental part of the FSA's supervision of that firm. Therefore if a firm's capital resources have fallen, or are expected to fall, below the level advised in individual capital guidance, then, consistent with Principle 11 (Relations with regulators), a firm should inform the FSA of this fact as soon as practicable, explaining why this has happened or is expected to happen and:

  1. (1) what action the firm intends to take to increase its capital resources or to reduce its risks and hence its capital requirements; or
  2. (2) what modification the firm considers should be made to the individual capital guidance which it has been given.

BIPRU 2.2.21

handbook-guidance
In the circumstance set out in BIPRU 2.2.20 G, the FSA may ask a firm for alternative or more detailed proposals and plans or further assessments and analyses of capital adequacy and risks faced by the firm. The FSA will seek to agree with the firm appropriate timescales and scope for any such additional work, in light of the circumstances which have arisen.

BIPRU 2.2.22

handbook-guidance
If a firm has not accepted individual capital guidance given by the FSA it should, nevertheless, inform the FSA as soon as practicable if its capital resources have fallen, or are expected to fall, below the level suggested by that individual capital guidance.

BIPRU 2.2.23

handbook-guidance
Monitoring the use of a firm's capital planning buffer is also a fundamental part of the FSA's supervision of that firm. A firm should only use its capital planning buffer to absorb losses or meet increased capital requirements if certain adverse circumstances materialise. These should be circumstances beyond the firm's normal and direct control, whether relating to a deteriorating external environment or periods of stress such as macroeconomic downturns or financial/market shocks, or firm-specific circumstances.

BIPRU 2.2.23A

handbook-guidance

Consistent with Principle 11 (Relations with regulators), a firm should notify the FSA as early as possible in advance where it has identified that it would need to use its capital planning buffer. The firm's notification should at least state:

  1. (1) what adverse circumstances are likely to force the firm to draw down its capital planning buffer;
  2. (2) how the capital planning buffer will be used up in line with the firm's capital planning projections; and
  3. (3) what plan is in place for the eventual restoration of the capital planning buffer.

BIPRU 2.2.23B

handbook-guidance
Following discussions with the firm on the items listed in BIPRU 2.2.23AG (1) to BIPRU 2.2.23AG (3), the FSA may put in place additional reporting arrangements to monitor the firm's use of its capital planning buffer in accordance with the plan referred to in BIPRU 2.2.23AG (3). The FSA may also identify specific trigger points as the capital planning buffer is being used up by the firm, which could lead to additional supervisory actions.

BIPRU 2.2.23C

handbook-guidance
Where a firm's capital planning buffer is being drawn down due to circumstances other than those referred to in BIPRU 2.2.23 G, such as poor planning or mismanagement, the FSA may ask the firm for more detailed plans for it to restore its capital planning buffer. In the light of the relevant circumstances, the FSA may consider taking other remedial actions, which may include using its powers under section 45 of the Act to vary on its own initiative a firm's Part IV permission.

BIPRU 2.2.23D

handbook-guidance
A firm should inform the FSA where its capital planning buffer is likely to start being drawn down even if it has not accepted the FSA's assessment as to the amount or quality of its capital planning buffer.

BIPRU 2.2.23E

handbook-guidance
Where a firm has started to use its capital planning buffer in circumstances where it was not possible to notify in advance, it should notify the FSA and provide the information referred to in BIPRU 2.2.23A G as soon as practicable afterwards.

BIPRU 2.2.23F

handbook-guidance
BIPRU 2.2.20 G to BIPRU 2.2.23E G also apply to individual capital guidance and to capital planning buffer on a consolidated basis as referred to in BIPRU 2.2.19 G.

Proportionality of an ICAAP

BIPRU 2.2.24

handbook-guidance
BIPRU 2.2.25 G to BIPRU 2.2.27 G set out what the FSA considers to be a proportional approach to preparing an ICAAP as referred to in GENPRU 1.2.35 R (The processes, strategies and systems required by the overall Pillar 2 rule should be comprehensive and proportionate), according to the relative degree of complexity of a firm's activities. If a firm adopts the appropriate approach, it may enable the FSA more easily to review a firm's ICAAP when the FSA undertakes its SREP. The FSA is also likely to place more reliance on an ICAAP which takes the appropriate form described in BIPRU 2.2.25 G to BIPRU 2.2.27 G than would otherwise be the case although there may also be circumstances in which the FSA will be able to rely on an ICAAP that is not drawn up in that form.

BIPRU 2.2.25

handbook-guidance
  1. (1) This paragraph applies to a small firm whose activities are simple and primarily not credit-related.
  2. (2) In carrying out its ICAAP it could:
    1. (a) identify and consider that firm's largest losses over the last 3 to 5 years and whether those losses are likely to recur;
    2. (b) prepare a short list of the most significant risks to which that firm is exposed;
    3. (c) consider how that firm would act, and the amount of capital that would be absorbed, in the event that each of the risks identified were to materialise;
    4. (d) consider how that firm's CRR might alter under the scenarios in (c) and how its CRR might alter in line with its business plans for the next 3 to 5 years;
    5. (e) consider whether any of the risks in the overall Pillar 2 rule is applicable to the firm (it is unlikely that any of those risks not already identified in (a) or (b) will apply to a firm whose activities are simple);
    6. (f) document the ranges of capital required in the scenarios identified and form an overall view on the amount and quality of capital which that firm should hold, ensuring that its senior management is involved in arriving at that view; and
    7. (g) (in order to determine the amount of capital that would be absorbed in the circumstances detailed in (c)) carry out simple sensitivity tests where the firm analyses the impact of a shift in the key risk parameters identified in (b) on the earnings of the firm.
  3. (3) A firm is also expected to form a view on the consolidated amount of capital it should hold as well as the capital required to be held in respect of each of the individual risks identified under the overall Pillar 2 rule. For that purpose, it may conservatively sum the results of the individual tests performed in (2)(c). If the firm chooses however to reduce that sum on the understanding that not all risks will materialise at the same time, then the firm should perform scenario tests that demonstrate that a reduction in capital is legitimate.
  4. (4) A firm should conduct stress tests and scenario analyses in accordance with GENPRU 1.2.42 R to assess how that firm's capital and CRR would alter and what that firm's reaction might be to a range of adverse scenarios, including operational and market events. Where relevant, a firm should also consider the impact of a severe economic or industry downturn on its future earnings, capital resources and capital resources requirement, taking into account its business plans. The downturn scenario should be based on forward looking hypothetical events calibrated against the most adverse movements in individual risk drivers experienced over a long historical period.

BIPRU 2.2.26

handbook-guidance

In relation to a firm whose activities are moderately complex, in carrying out its ICAAP, BIPRU 2.2.25 G (3) to (4) apply. In addition, it could:

  1. (1) having consulted the management in each major business line, prepare a comprehensive list of the major risks to which the business is exposed;
  2. (2) estimate, with the aid of historical data, where available, the range and distribution of possible losses which might arise from each of those risks and consider using shock stress tests to provide risk estimates;
  3. (3) consider the extent to which that firm's CRR adequately captures the risks identified in (1) and (2);
  4. (4) for areas in which the CRR is either inadequate or does not address a risk, estimate the additional capital (if any) needed to protect that firm and its customers, in addition to any other risk mitigation action that firm plans to take;
  5. (5) consider the risk that that firm's own analyses of capital adequacy may be inaccurate and that it may suffer from management weaknesses, which affect the effectiveness of its risk management and mitigation;
  6. (6) project that firm's business activities forward in detail for one year and in less detail for the next 3 to 5 years and estimate how that firm's capital and CRR would alter, assuming that business develops as expected;
  7. (7) assume that business does not develop as expected and consider how that firm's capital and CRR would alter and what that firm's reaction to a range of adverse economic scenarios might be (see GENPRU 1.2.30 R to GENPRU 1.2.43 G (the overall Pillar 2 rule and related rules and guidance)). Where appropriate, the adverse scenarios should consider the impact of market events that are instantaneous or occur over an extended period of time but which are nevertheless still co-dependent on movements in economic conditions;
  8. (8) document the results obtained from the analyses in (2), (4), (6), and (7) in a detailed report for that firm's senior management, and, where relevant, its governing body; and
  9. (9) ensure that systems and processes are in place to review against performance the accuracy of the estimates made in (2), (4), (6) and (7).

BIPRU 2.2.27

handbook-guidance
  1. (1) This paragraph applies to a proportional ICAAP in the case of a firm whose activities are complex.
  2. (2) A proportional approach to that firm's ICAAP should cover the matters identified in BIPRU 2.2.26 G, but is likely also to involve the use of models, most of which will be integrated into its day-to-day management and operation.
  3. (3) Models of the sort referred to in (2) may be linked so as to generate an overall estimate of the amount of capital that a firm considers appropriate to hold for its business needs. For example, a firm is likely to use value at risk models for market risk (see BIPRU 7.10), advanced modelling approaches for credit risk (see BIPRU 4) and, possibly, advanced measurement approaches for operational risk (see BIPRU 6.5). A firm might also use economic scenario generators to model stochastically its business forecasts and risks. A firm may also link such models to generate information on the economic capital desirable for that firm. A model which a firm uses to generate its target amount of economic capital is known as an economic capital model (ECM). Economic capital is the target amount of capital which maximises the return for a firm's stakeholders for a desired level of risk.
  4. (4) A firm is also likely to be part of a group and to be operating internationally. There is likely to be centralised control over the models used throughout the group, the assumptions made and their overall calibration.
  5. (5) The more a firm integrates into its business such economic capital modelling, the more it is likely to focus on managing risks for the benefit of its stakeholders. Consequently, ECMs may produce capital estimates that differ from the amount of capital needed for regulatory purposes. For the FSA to rely on the results of a firm's models, including ECMs, a firm should be able to explain the basis and results of its models and how the amount of capital produced by its models reflects the amount of capital needed for regulatory purposes. It may be that those amounts are not equal. Where they are not equal, the FSA will expect a firm to discuss any differences with the FSA. However, it may prove difficult to reconcile the outcome of a firm's modelling with the FSA's own assessment of the adequacy of that firm's capital. This may be the case when, for instance, matters of judgment are involved in arriving at a firm's capital assessment, or the FSA relies on information which cannot be fully disclosed to the firm (for example comparisons with the firm's peers). Nevertheless, a firm whose ECM produces a different amount of capital to that required for regulatory purposes is still obliged to comply with the overall Pillar 2 rule. A firm should therefore be able to explain to the FSA how the outcome of its ECM is adjusted so that it complies with the overall financial adequacy rule and the overall Pillar 2 rule.
  6. (6) Stress testing should provide senior management with a consolidated view of the amount of risk the firm is or might be exposed to under the chosen stress events. Senior management should therefore be presented with information that considers the possibility of the risks materialising simultaneously in various proportions. For instance, it would be misrepresentative to simulate market risk stressed events without considering that, in those circumstances, market counterparties may be more likely to default. Accordingly, a firm could:
    1. (a) carry out combined stress tests where assets and liabilities are individually subjected to simultaneous changes in two or more risk drivers; for instance, the change in value of each loan made by a firm may be estimated using simultaneous changes to both interest rates and stock market or property values;
    2. (b) integrate the results of market and credit risk models rather than aggregating the results of each model separately; and
    3. (c) consider scenarios which include systemic effects on the firm of wider failures in the firm's market or systems upon which the firm depends and also any possible systemic effects caused by the firm itself suffering losses which affect other market participants which in turn exacerbate the firm's position.
  7. (7) Furthermore, if a complex firm uses an ECM it should validate the assumptions of the model through a comprehensive stress testing programme. In particular this validation should:
    1. (a) test correlation assumptions (where risks are aggregated in this way) using combined stresses and scenario analyses;
    2. (b) use stress tests to identify the extent to which the firm's risk models omit non-linear effects, for instance the behaviour of derivatives in market risk models; and
    3. (c) consider not just the effect of parallel shifts in interest rate curves, but also the effect of curves becoming steeper or flatter.

Guidance on risks to be covered in an ICAAP

BIPRU 2.2.28

handbook-guidance
BIPRU 2.2.30 G to BIPRU 2.2.40 G set out guidance on some of the sources of risk identified in the overall Pillar 2 rule. BIPRU 2.2.41 R to BIPRU 2.2.45 G have material relating to a firm with an IRB permission.

BIPRU 2.2.29

handbook-guidance
  1. (1) A firm may take into account factors other than those identified in the overall Pillar 2 rule when it assesses the level of capital it wishes to hold. These factors might include external rating goals, market reputation and its strategic goals. However, a firm should be able to distinguish, for the purpose of its dialogue with the FSA, between capital it holds in order to comply with the overall financial adequacy rule, capital that it holds as a capital planning buffer and capital held for other purposes.
  2. (2) The calibration of the CRR assumes that a firm's business is well-diversified, well-managed with assets matching its liabilities and good controls, and stable with no large, unusual or high risk transactions. A firm may find it helpful to assess the extent to which its business in fact differs from these assumptions and therefore what adjustments it might be reasonable for it to make to the CRR to arrive at an adequate level of capital resources.

Interest rate risk arising from non-trading book activities

BIPRU 2.2.30

handbook-guidance
A firm should assess its exposure to changes in interest rates, in particular risks arising from the effect of interest rate changes on non-trading book activities that are not captured by the CRR. In doing so, a firm may wish to use stress tests to determine the impact on its balance sheet of a change in market conditions.

Securitisation risk

BIPRU 2.2.31

handbook-guidance
A firm should assess its exposure to risks transferred through the securitisation of assets should those transfers fail for whatever reason. A firm should consider the effect on its financial position of a securitisation arrangement failing to operate as anticipated or of the values and risks transferred not emerging as expected.

Residual risk

BIPRU 2.2.32

handbook-guidance
A firm should assess its exposure to residual risks that may result from the partial performance or failure of credit risk mitigation techniques for reasons that are unconnected with their intrinsic value. This could result from, for instance, ineffective documentation, a delay in payment or the inability to realise payment from a guarantor in a timely manner. Given that residual risks can always be present, a firm should assess the appropriateness of its CRR against its assumptions which underlie any risk mitigation measures it may have in place.

Concentration risk

BIPRU 2.2.33

handbook-guidance
A firm should assess, and monitor, in detail its exposure to sectoral, geographic, liability and asset concentrations. The FSA considers that concentrations in these areas increase a firm's exposure to credit risk. Where a firm identifies such concentrations it should consider the adequacy of its CRR.

Liquidity risk

BIPRU 2.2.34

handbook-guidance
In accordance with the overall Pillar 2 rule a firm should consider its exposure to liquidity risk and assess its response should that risk materialise.

BIPRU 2.2.35

handbook-guidance
When assessing liquidity risk, a firm should consider the extent to which there is a mismatch between assets and liabilities.

BIPRU 2.2.36

handbook-guidance
A firm should also, when assessing liquidity risk, consider the amount of assets it holds in highly liquid, marketable forms that are available should unexpected cash flows lead to a liquidity problem. The price concession of liquidating assets is of prime concern when assessing such liquidity risk and should therefore be built into a firm's ICAAP.

BIPRU 2.2.37

handbook-guidance

Some further areas to consider in developing the liquidity risk scenario might include:

  1. (1) any mismatching between expected asset and liability cash flows;
  2. (2) the inability to sell assets quickly;
  3. (3) the extent to which a firm's assets have been pledged; and
  4. (4) the possible need to reduce large asset positions at different levels of market liquidity and the related potential costs and timing constraints.

Business risk: General

BIPRU 2.2.38

handbook-guidance
A firm's CRR, being risk-sensitive, may vary as business cycles and economic conditions fluctuate over time. A deterioration in business or economic conditions could require a firm to raise capital or, alternatively, to contract its businesses, at a time when market conditions are most unfavourable to raising capital. Such an effect is known as procyclicality.

BIPRU 2.2.39

handbook-guidance
To reduce the impact of cyclical effects, a firm should aim to maintain an adequate capital planning buffer during an upturn in business and economic cycles such that it has sufficient capital available to protect itself in unfavourable market conditions.

BIPRU 2.2.40

handbook-guidance
To assess its expected capital requirements over the economic and business cycles, a firm may wish to project forward its financial position taking account of its business strategy and expected growth according to a range of assumptions as to the state of the economic or business environment which it faces. For example, an ICAAP should include an analysis of the impact that the actions of a firm's competitors might have on its performance, in order to see what changes in its environment the firm could sustain. Projections over a three to five year period would be appropriate in most circumstances. A firm may then calculate its projected CRR and assess whether it could be met from expected financial resources. Additional guidance on capital planning over an economic and business cycle can be found in GENPRU 1.2.73A G (Capital planning).

Business risk: Stress tests for firms using the IRB approach

BIPRU 2.2.41

handbook-rule
A firm with an IRB permission must ensure that there is no significant risk that it will not be able to meet its capital resource requirements for credit risk under GENPRU 2.1 (Calculation of capital resources requirements) at all times throughout an economic cycle, including the capital resources requirements for credit risk indicated by any stress test carried out under BIPRU 4.3.39 R to BIPRU 4.3.40 R (Stress tests used in assessment of capital adequacy for a firm with an IRB permission) as being likely to apply in the scenario tested. For the purpose of deciding what capital resources are or will be available to meet those credit risk requirements from time to time a firm must exclude capital resources that are likely to be required to meet its other capital requirements under GENPRU 2.1 at the relevant time. A firm must also be able to demonstrate to the FSA at any time that it is complying with this rule.

BIPRU 2.2.42

handbook-rule
BIPRU 2.2.41 R applies to a firm on a solo basis if BIPRU 4 (IRB approach) applies to it on a solo basis and applies on a consolidated basis if BIPRU 4 does.

BIPRU 2.2.43

handbook-rule

If BIPRU 2.2.41 R applies to a firm on a consolidated basis the following adjustments are made to BIPRU 2.2.41 R in accordance with the general principles of BIPRU 8 (Group risk - consolidation):

  1. (1) references to capital resources are to the consolidated capital resources of the firm's UK consolidation group or, as the case may be, its non-EEA sub-group; and
  2. (2) references to the capital requirements in GENPRU 2.1 (Calculation of capital resources requirements) are to the consolidated capital requirements with respect to the firm's UK consolidation group or, as the case may be, its non-EEA sub-group under BIPRU 8 (Group risk - consolidation).

BIPRU 2.2.44

handbook-guidance
If a firm's current available capital resources are less than the capital resources requirement indicated by the stress test that need not be a breach of BIPRU 2.2.41 R. The firm may wish to set out any countervailing effects and off-setting actions that can be demonstrated to the satisfaction of the FSA as being likely to reduce the difference referred to in the first sentence. The FSA is only likely to consider a demonstration of such actions as credible if those actions are set out in a capital management plan based on the procedures in GENPRU 1.2.73A G (Capital planning) and including a plan of the type referred to in GENPRU 1.2.73A G (5) that has been approved by the firm's senior management or governing body.

BIPRU 2.2.45

handbook-guidance
The countervailing factors and off-setting actions that a firm may rely on as referred to in BIPRU 2.2.44 G include, but are not limited to, projected balance sheet shrinkage, growth in capital resources resulting from retained profits between the date of the stress test and the projected start of the economic downturn, the possibility of raising new capital in a downturn, the ability to reduce dividend payments or other distributions, and the ability to allocate capital from other risks which can be shown to be negatively correlated with the firm's credit risk profile.

Systems and controls

BIPRU 2.2.46

handbook-guidance

A firm may decide to hold additional capital to mitigate any weaknesses in its overall control environment. These weaknesses might be indicated by the following:

  1. (1) a failure by a firm to complete an assessment of its systems and controls to establish whether they comply with SYSC; or
  2. (2) a failure by a firm's senior management to approve its financial results; or
  3. (3) a failure by a firm to consider an analysis of relevant internal and external information on its business and control environment.

BIPRU 2.2.47

handbook-guidance
In considering if there are any systems and control weaknesses and their effect on the adequacy of the CRR, a firm should be able to demonstrate to the FSA that all the issues identified in SYSC have been considered and that appropriate plans and procedures exist to deal adequately with adverse scenarios.

Risks which may be considered according to the nature of the activities of a firm

BIPRU 2.2.48

handbook-guidance
  1. (1) BIPRU 2.2.49 G to BIPRU 2.2.70 G set out guidance for:
    1. (a) a bank or building society;
    2. (b) an asset management firm; and
    3. (c) a securities firm;
  2. whose activities are either simple or moderately complex.
  3. (2) BIPRU 2.2.49 G to BIPRU 2.2.70 G provide examples of the sorts of risks which such a firm might typically face and of stress tests or scenario analyses which it might carry out as part of its ICAAP.
  4. (3) The material on securities firms is also relevant to a commodities firm.

Banks and building societies

BIPRU 2.2.49

handbook-guidance
The FSA considers that the concentration risk resulting from concentrated portfolios is significant for most banks and building societies.

BIPRU 2.2.50

handbook-guidance
If a bank or building society chooses to use the CRR as a starting point for its capital assessment, it should remember that, when assessing its exposure to concentration risk, the calculation of the CRR is based on the assumption that a firm is well-diversified.

BIPRU 2.2.51

handbook-guidance
In assessing the degree of credit concentration, a bank or building society should consider its degree of credit concentration in a particular economic or geographic area. Where the business of a firm is, by its nature, concentrated (for example, a specialised firm lending to one sector only), a firm should consider the impact of adverse economic factors, such as a rise in unemployment in the area in which it has a concentration of exposures, and its impact on asset quality. A gradual change of cultural environment could also affect a bank or building society and a firm should consider whether this issue should be the subject of scenario analysis.

BIPRU 2.2.52

handbook-guidance
Typically, a building society's portfolio is concentrated. The extent to which a building society can diversify its business is limited. A building society should, nevertheless, consider the impact of geographic concentrations on its capital by, for instance, analysing the effect of local economic factors such as unemployment and its impact on arrears, house prices and loan-to-value ratios.

BIPRU 2.2.53

handbook-guidance
Similarly, a building society should consider the concentration in its portfolio of certain product types that have, inherently, a more than average risk (for example, lifetime mortgages). It should, through scenario analyses in relation to its portfolio, assess the potential impact on its profitability and capital of those scenarios.

BIPRU 2.2.54

handbook-guidance
In relation to BIPRU 10 (Large exposures requirements), a bank or building society should take into account factors such as future business growth and cyclicality when it assesses the amount of capital which it will need to remain in compliance with those rules. A firm may also consider in its assessment whether any large exposures that it has identified are positively correlated.

BIPRU 2.2.55

handbook-guidance
Where a bank or building society lends to a counterparty which it assesses as representing a high credit risk, it should assess whether compliance with the rules in BIPRU in relation to credit risk is sufficient for it to manage that risk prudently.

BIPRU 2.2.56

handbook-guidance
The performance of specialised portfolios may, in some instances, depend on key individuals. This factor exacerbates concentration risk because the skill of those individuals in part limits the risk arising from a concentrated portfolio. The impact of those individuals is likely to be correspondingly greater in small firms. In developing its stress tests and scenario analyses, a bank or building society should therefore consider the impact of losing key individuals on its ability to operate normally, as well as the direct impact on its revenues.

BIPRU 2.2.57

handbook-guidance
A bank or building society should assess the sensitivity of its financial position to adverse movements in interest rates. For instance, a bank or building society should assess its sensitivity to interest rate risk arising from interest rate mismatches between assets and liabilities. A building society is exposed to interest rate risk to the extent that it borrows on a short term basis but lends over a longer period.

BIPRU 2.2.58

handbook-guidance
When assessing the adequacy of its capital, a bank or building society should not only consider the vulnerability of its revenue, but also the sensitivity of its funding and, in particular, its ability to raise additional funding in time of economic stress. A bank or building society should therefore consider whether its funding pool is sufficiently diversified. For example, where a bank is reliant solely on its parent to provide funding, its access to funds may be suddenly restricted should the parent's creditworthiness be downgraded. Similarly, a bank or building society may consider the impact of an increase in bond rates or a rating downgrade, if relevant, on its capital cost and its subsequent ability to raise capital.

BIPRU 2.2.59

handbook-guidance
A bank or building society should assess the impact of its business plans on its capital over the time horizon which it uses in its business plans. A bank or building society should assess the impact on its capital of diversifying its activities and the risk it runs of failing to manage that new business successfully. For that purpose, it may consider the cost of a price war to enter a new competitive market or the risk of mis-pricing some products as a result of not having sufficient expertise in its new area of business.

BIPRU 2.2.60

handbook-guidance
A bank or building society is also exposed to reputational risk, as its ability to underwrite new business is heavily reliant on the standing of the reputation of the firm. A bank or building society may consider the impact on its financial position of legal disputes which damage its reputation.

An asset management firm

BIPRU 2.2.61

handbook-guidance
An asset manager is primarily exposed to operational risk and reputational risk.
  • 01/01/2007

BIPRU 2.2.62

handbook-guidance

When assessing reputational risk an asset manager should consider issues such as:

  1. (1) how poor performance can affect its ability to generate profits;
  2. (2) the effect on its financial position should one or more of its key fund managers leave that firm;
  3. (3) the effect on its financial position should it lose some of its largest customers; and
  4. (4) how poor customer services can affect its financial position; for example, a firm which has outsourced the management of customer accounts may want to consider the impact on its own reputation of the service provider failing to deliver the service.
  • 01/01/2007

BIPRU 2.2.63

handbook-guidance
As an asset manager's mandates become more complex, the risk of it failing to comply fully with the terms of its contracts increases. In the event of such failure, a firm can be exposed to substantial losses resulting from customers' claims and legal actions. Although the FSA would expect an asset manager to have in place adequate controls to mitigate that risk, it may also like to consider the potential cost to it should customers claim that it has not adhered to mandates. Past claims and compensation may provide a useful benchmark for an asset manager to assess its sensitivity to future legal action. In assessing the adequacy of its capital, an asset manager may therefore consider whether it could absorb the highest operational loss it has suffered over the last 3 to 5 years.
  • 01/01/2007

BIPRU 2.2.64

handbook-guidance

In relation to the issues identified in BIPRU 2.2.63 G, an asset manager should consider, for example:

  1. (1) the direct cost to it resulting from fraud or theft;
  2. (2) the direct cost arising from customers' claims and legal action in the future; an asset manager could consider the impact on its financial position if a legal precedent were to encourage its customers to take legal action against that firm for failing to advise correctly on a certain type of product; the relevance of such scenarios is likely to depend on whether the asset manager is acting on a discretionary basis or solely as advisor; and
  3. (3) where it has obtained professional indemnity insurance, the deductibles and individual or aggregate limits on the sums insured.
  • 01/01/2007

BIPRU 2.2.65

handbook-guidance

The FSA expects an asset manager to consider the impact of economic factors on its ability to meet its liabilities as they fall due. An asset manager should therefore develop scenarios which relate to its strategic and business plan. An asset manager might therefore consider:

  1. (1) the effect of a market downturn affecting both transaction volumes and the market values of assets in its funds; in assessing the impact of such a scenario, an asset manager may consider the extent to which it can remain profitable (for example, by rapidly scaling down its activities and reducing its costs);
  2. (2) the impact on current levels of capital if it plans to undertake a significant restructuring; and
  3. (3) the impact on current levels of capital if it plans to enter a new market or launch a new product; it should assess the amount of capital it needs to hold, when operating for the first time in a market in which it lacks expertise.
  • 01/01/2007

A securities firm

BIPRU 2.2.66

handbook-guidance
  1. (1) A securities firm may consider the impact of the situations listed in (a) to (c) on its capital levels when assessing its exposure to concentration risk:
    1. (a) the potential loss that could arise from large exposures to a single counterparty;
    2. (b) the potential loss that could arise from exposures to large transactions or to a product type; and
    3. (c) the potential loss resulting from a combination of events such as a sudden increase in volatility leaving a hitherto fully-margined client unable to meet the margin calls due to the large size of the underlying position and the subsequent difficulties involved in liquidating its position.
  2. (2) An example of the analysis in (1)(b) relates to a securities firm which relies on the income generated by a large, one-off corporate finance transaction. It may want to consider the possibility of legal action arising from that transaction which prevents the payment of its fees. Additionally, an underwriting firm may, as a matter of routine, commit to place a large amount of securities. It may therefore like to assess the impact of losses arising from a failure to place the securities successfully.
  • 01/01/2007

BIPRU 2.2.67

handbook-guidance

Where a securities firm deals in illiquid securities (for example, unlisted securities or securities listed on illiquid markets), or holds illiquid assets, potentially large losses can arise from trades that have failed to settle or because of large unrealised market losses. A securities firm may therefore consider the impact of liquidity risk on its exposure to:

  1. (1) credit risk; and
  2. (2) market risk.
  • 01/01/2007

BIPRU 2.2.68

handbook-guidance

Counterparty risk rules only partially capture the risk of settlement failure as the quantification of risk is only based on mark-to-market values and does not take account of the volatility of the securities over the settlement period. A securities firm's assessment of its exposure to counterparty risk should take into account:

  1. (1) whether it acts as arranger only or whether it also executes trades;
  2. (2) the types of execution venues which it uses; for example, the London Stock Exchange or a retail service provider (RSP) have more depth than multilateral trading facilities; and
  3. (3) whether it offers extended settlements and free delivery compared to delivery versus payment business.

BIPRU 2.2.69

handbook-guidance
  1. (1) A securities firm should also consider the impact of external factors on the levels of capital it needs to hold. Scenarios covering such external factors should relate to its strategy and business plan. A securities firm might wish to consider the questions in (2) to (7).
  2. (2) Whether it plans to participate in a one-off transaction that might strain temporarily or permanently its capital.
  3. (3) Whether the unevenness of its revenue suggests that it should hold a capital buffer. Such an assessment could be based, for instance, on an analysis of past revenue and the volatility of its capital.
  4. (4) How its income might alter as interest rates fluctuate where it is obliged to pay interest to its clients in excess of interest it earns on client money deposits.
  5. (5) How its capital would be affected by a market downturn. For instance, how sensitive that firm is to a sharp reduction of trading volumes.
  6. (6) How political and economic factors will affect that firm's business. For instance, a commodity firm may wish to consider the impact of a sharp increase in prices on initial margins and, consequently, on its liquidity.
  7. (7) Whether it anticipates expanding its activities (for example, by offering clearing services), and if so, the impact on its capital.
  • 01/01/2007

BIPRU 2.2.70

handbook-guidance
A securities firm may also want to assess the impact of its internal credit limits on its levels of capital. For instance, a firm whose internal procedures authorise dealing without cash in the account or without pre-set dealing limits might consider more capital is required than if it operated stricter internal credit limits.
  • 01/01/2007

Capital models

BIPRU 2.2.71

handbook-guidance
A firm may approach its assessment of adequate capital by developing a model, including an ECM (see BIPRU 2.2.27 G), for some or all of its business risks. The assumptions required to aggregate risks modelled and the confidence levels adopted should be considered by a firm's senior management. A firm should also consider whether any relevant risks, including systems and control risks, are not captured by the model.

BIPRU 2.2.72

handbook-guidance
A firm should not expect the FSA to accept as adequate any particular model that it develops or automatically to reflect the results from the model in any individual capital guidance or capital planning buffer. However, the FSA will take into account the results of a sound and prudent model when giving individual capital guidance or when dealing with the firm in relation to its capital planning buffer (see GENPRU 1.2.19 G (Outline of provisions related to GENPRU 2.1 (Adequacy of financial resources))).

BIPRU 2.2.73

handbook-guidance

There is no prescribed approach as to how a firm should develop its internal capital model. However, a firm should be able to demonstrate:

  1. (1) the confidence levels set and whether these are linked to its corporate strategy;
  2. (2) the time horizons set for the different types of business that it undertakes;
  3. (3) the extent of historic data used and back-testing carried out;
  4. (4) that it has in place a process to verify the correctness of the model's outputs; and
  5. (5) that it has the skills and resources to operate, maintain and develop the model.

BIPRU 2.2.74

handbook-guidance

In relation to the use of an ECM (see BIPRU 2.2.27 G), the FSA is likely to place more reliance on a firm's ICAAP if the firm provides the following information:

  1. (1) a comparison of the amount of capital that the ECM generates in respect of each of the risks captured in the CRR before aggregation with the corresponding components of the CRR calculation; and
  2. (2) evidence that the guidance in BIPRU 2.2.71 G to BIPRU 2.2.78 G has been followed.

BIPRU 2.2.75

handbook-guidance
If a firm adopts a top-down approach to developing its internal model, it should be able to allocate the outcome of the internal model to risks it has previously identified in relation to each separate legal entity, business unit or business activity, as appropriate. In relation to a firm which is a member of a group, GENPRU 1.2.53 R (Application of GENPRU 1.2 on a solo and consolidated basis: Processes and tests) sets out how internal capital identified as necessary by that firm's ICAAP should be allocated.

BIPRU 2.2.76

handbook-guidance
If a firm's internal model makes explicit or implicit assumptions in relation to correlations within or between risk types, or in relation to diversification benefits between business types, the firm should be able to explain to the FSA, with the support of empirical evidence, the basis of those assumptions.

BIPRU 2.2.77

handbook-guidance
A firm's model should also reflect the past experience of both the firm and the sectors in which it operates.

BIPRU 2.2.78

handbook-guidance
The values assigned to inputs into a firm's model should be derived either stochastically, by assuming the value of an item can follow an appropriate probability distribution and by selecting appropriate values at the tail of the distribution, or deterministically, using appropriate prudent assumptions. For options or guarantees which change in value significantly in certain economic or demographic circumstances, a stochastic approach would normally be appropriate.

BIPRU 2.3

Interest rate risk in the non-trading book

  • 01/01/2007

Application

BIPRU 2.3.1

handbook-rule
This section of the Handbook applies to a BIPRU firm.

BIPRU 2.3.2

handbook-guidance
  1. (1) Interest rate risk in the non-trading book will normally be a major source of risk for:
    1. (a) a bank;
    2. (b) a building society; and
    3. (c) a BIPRU investment firm that deals on own account (including underwriting on a firm commitment basis) and whose non-trading book business equals or exceeds 15% of its total business.
  2. (2) However it will not normally be a significant risk for any other BIPRU investment firm.
  3. (3) The test in (1)(c) should be carried out in the same way as it is for the purpose of the 5% test in BIPRU 1.2.17 R (Definition of the trading book).
  4. (4) Where BIPRU 2.3 is applied on a consolidated basis (see BIPRU 2.3.13 R) the test in (1)(c) should be carried out in the same way as it is under BIPRU 8.7.24 R (Trading book size for the purposes of consolidation).

BIPRU 2.3.3

handbook-guidance

Interest rate risk in the non-trading book may arise from a number of sources for example:

  1. (1) risks related to the mismatch of repricing of assets and liabilities and off balance sheet short and long-term positions;
  2. (2) risks arising from hedging exposure to one interest rate with exposure to a rate which reprices under slightly different conditions;
  3. (3) risk related to the uncertainties of occurrence of transactions e.g. when expected future transactions do not equal the actual transactions; and
  4. (4) risks arising from consumers redeeming fixed rate products when market rates change.

Purpose

BIPRU 2.3.4

handbook-guidance
BIPRU 2.3 sets out more detail on how the systems and controls requirements in SYSC and GENPRU 1.2.30 R (Processes, strategies and systems for risks) and the requirements about stress and scenario testing in GENPRU 1.2.36 R apply to interest rate risk in the non-trading book.

BIPRU 2.3.5

handbook-guidance
BIPRU 2.3 implements Article 124(5) of the Banking Consolidation Directive.

Proportionality

BIPRU 2.3.6

handbook-guidance
The guidance on proportionality in BIPRU 2.2 applies to BIPRU 2.3.

Stress testing for interest rate risk: General requirement

BIPRU 2.3.7

handbook-rule
  1. (1) As part of its obligations under GENPRU 1.2.30 R (Processes, strategies and systems for risks) and GENPRU 1.2.36 R (Stress and scenario tests) a firm must carry out an evaluation of its exposure to the interest rate risk arising from its non-trading activities.
  2. (2) The evaluation under (1) must cover the effect of a sudden and unexpected parallel change in interest rates of 200 basis points in both directions.
  3. (3) A firm must immediately notify the FSA if any evaluation under this rule suggests that, as a result of the change in interest rates described in (2), the economic value of the firm would decline by more than 20% of its capital resources.

BIPRU 2.3.8

handbook-guidance
A firm should, under BIPRU 2.3.7 R (2), apply a 200 basis point shock to each major currency exposure.

BIPRU 2.3.9

handbook-guidance

For a larger and/or more complex firm, appropriate systems to evaluate and manage interest rate risk in the non-trading book should include:

  1. (1) the ability to measure the exposure and sensitivity of the firm's activities, if material, to repricing risk, yield curve risk, basis risk and risks arising from embedded optionality (for example, pipeline risk, prepayment risk) as well as changes in assumptions (for example those about customer behaviour);
  2. (2) consideration as to whether a purely static analysis of the impact on their current portfolio of a given shock or shocks should be supplemented by a more dynamic simulation approach; and
  3. (3) scenarios in which different interest rate paths are computed and in which some of the assumptions (e.g. about behaviour, contribution to risk and balance sheet size and composition) are themselves functions of interest rate level.

BIPRU 2.3.10

handbook-guidance

Under GENPRU 1.2.60 R, a firm is required to make a written record of its assessments made under GENPRU 1.2. A firm's record of its approach to evaluating and managing interest rate risk as it affects the firm's non-trading activities should cover the following issues:

  1. (1) the internal definition of and boundary between "banking book" and "trading activities" (see BIPRU 1.2);
  2. (2) the definition of economic value and its consistency with the method used to value assets and liabilities (e.g. discounted cashflows);
  3. (3) the size and the form of the different shocks to be used for internal calculations;
  4. (4) the use of a dynamic and / or static approach in the application of interest rate shocks;
  5. (5) the treatment of commonly called "pipeline transactions" (including any related hedging);
  6. (6) the aggregation of multicurrency interest rate exposures;
  7. (7) the inclusion (or not) of non-interest bearing assets and liabilities (including capital and reserves);
  8. (8) the treatment of current and savings accounts (i.e. the maturity attached to exposures without a contractual maturity);
  9. (9) the treatment of fixed rate assets (liabilities) where customers still have a right to repay (withdraw) early;
  10. (10) the extent to which sensitivities to small shocks can be scaled up on a linear basis without material loss of accuracy (i.e. covering both convexity generally and the non-linearity of pay-off associated with explicit option products);
  11. (11) the degree of granularity employed (for example offsets within a time bucket); and
  12. (12) whether all future cash flows or only principal balances are included.

BIPRU 2.3.11

handbook-guidance
The FSA will periodically review whether the level of the shock referred to in BIPRU 2.3.7 R (2) is appropriate in the light of changing circumstances, in particular the general level of interest rates (for instance periods of very low interest rates) and their volatility. A firm's internal systems should therefore be flexible enough to compute its sensitivity to any standardised shock that is prescribed. If a 200 basis point shock would imply negative interest rates or if such a shock would otherwise be considered inappropriate, the FSA will consider adjusting the requirements accordingly.

Stress testing for interest rate risk: Frequency

BIPRU 2.3.12

handbook-rule
  1. (1) A firm must carry out the evaluations required by BIPRU 2.3.7 R as frequently as necessary for it to be reasonably satisfied that it has at all times a sufficient understanding of the degree to which it is exposed to the risks referred to in that rule and the nature of that exposure. In any case it must carry out those evaluations no less frequently than required by (2) or (3).
  2. (2) The minimum frequency of the evaluation in BIPRU 2.3.7 R (1) is once each year.
  3. (3) The minimum frequency of the evaluation in BIPRU 2.3.7 R (2) is once each quarter.

Consolidation

BIPRU 2.3.13

handbook-rule
GENPRU 1.2.45 R to GENPRU 1.2.59 R (Application of GENPRU 1.2 on a solo and consolidated basis) apply to BIPRU 2.3 as they apply to GENPRU 1.2.30 R and GENPRU 1.2.36 R.

Export chapter as

BIPRU 3

Standardised credit risk

BIPRU 3.1

Application and purpose

  • 01/01/2007

Application

BIPRU 3.1.1

handbook-rule
BIPRU 3 applies to a BIPRU firm.

Purpose

BIPRU 3.1.2

handbook-guidance

BIPRU 3 implements:

  1. (1) Articles 78 to 80, paragraph (1) of Article 81, Article 83, Annex II and Parts 1 and 3 of Annex VI of the Banking Consolidation Directive;
  2. (2) Article 18 of the Capital Adequacy Directive so far as it applies Articles 78 to 80, paragraph (1) of Article 81, Article 83 and Parts 1 and 3 of Annex VI of the Banking Consolidation Directive to investment firms; and
  3. (3) Article 40 of the Capital Adequacy Directive for the purposes of the calculation of credit risk under the Banking Consolidation Directive.

BIPRU 3.1.3

handbook-guidance
BIPRU 3.1 sets out how a firm should calculate the credit risk capital component, which is one of the elements that make up the credit risk capital requirement under GENPRU 2.1.51 R. Part of that calculation involves calculating risk weighted exposure amounts for exposures in the firm's non-trading book. The rest of BIPRU 3 sets out how the firm should carry out that calculation.

BIPRU 3.1.4

handbook-guidance
BIPRU 5 deals with the effect of credit risk mitigation on the calculation of risk weighted exposure amounts. BIPRU 13 deals with the calculation of exposure values for certain kinds of products. BIPRU 14.3 deals with the calculation of the counterparty risk capital component for unsettled transactions in the trading book and non-trading book. BIPRU 14.4 deals with capital resources with respect to free deliveries.

Calculation of the credit risk capital component

BIPRU 3.1.5

handbook-rule
The credit risk capital component of a firm is 8% of the total of its risk weighted exposure amounts for exposures falling into BIPRU 3.1.6 R, calculated in accordance with BIPRU 3.

BIPRU 3.1.6

handbook-rule

An exposure falls into this rule if:

  1. (1) it is in a firm's non-trading book; and
  2. (2) it has not been deducted from the firm's capital resources under GENPRU 2.2.

BIPRU 3.2

The central principles of the standardised approach to credit risk

  • 01/01/2007

BIPRU 3.2.1

handbook-rule

Subject to BIPRU 13:

  1. (1) the exposure value of an asset item must be its balance-sheet value, subject to any value adjustments required by GENPRU 1.3; and
  2. (2) the exposure value of an off-balance sheet item listed in the table in BIPRU 3.7.2 R must be the percentage of its value set out in that table.

[Note: BCD Article 78(1) part]

BIPRU 3.2.2

handbook-rule

The off-balance sheet items listed in the table in BIPRU 3.7.2 R must be assigned to the risk categories as indicated in that table.

BIPRU 3.2.3

handbook-rule

Where an exposure is subject to funded credit protection, a firm may modify the exposure value applicable to that item in accordance with BIPRU 5.

BIPRU 3.2.4

handbook-guidance

BIPRU 13 sets out the method for determination of the exposure value of a financial derivative instrument, with the effects of contracts of novation and other netting agreements taken into account for the purposes of that method in accordance with BIPRU 13.7.

BIPRU 3.2.5

handbook-guidance

BIPRU 13.3 and BIPRU 13.8 set out the provisions applying to the treatment and determination of the exposure value of repurchase transactions, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions (SFTs).

[Note: reference to BCD Article 78(2) second sentence. Implementation in BIPRU 13]

BIPRU 3.2.6

handbook-guidance
BIPRU 13 also sets out the methods for the determination of exposure values for long settlement transactions.

BIPRU 3.2.7

handbook-guidance

BIPRU 13.8 provides that, in the case of a firm using the financial collateral comprehensive method under BIPRU 5, where an exposure takes the form of an SFT, the exposure value should be increased by the volatility adjustment appropriate to such securities or commodities set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R (Supervisory volatility adjustments approach and the own estimates of volatility adjustments approach).

BIPRU 3.2.8

handbook-guidance

BIPRU 13.3.13 R and BIPRU 13.8.8 R set out the provisions relating to determination of the exposure value of certain credit risk exposures outstanding with a central counterparty, where the central counterparty credit risk exposures with all participants in its arrangements are fully collateralised on a daily basis.

Exposure Classes

BIPRU 3.2.9

handbook-rule

A firm must assign each exposure to one of the following exposure classes:

  1. (1) claims or contingent claims on central governments or central banks;
  2. (2) claims or contingent claims on regional governments or local authorities;
  3. (3) claims or contingent claims on administrative bodies and non-commercial undertakings;
  4. (4) claims or contingent claims on multilateral development banks;
  5. (5) claims or contingent claims on international organisation;
  6. (6) claims or contingent claims on institutions;
  7. (7) claims or contingent claims on corporates;
  8. (8) retail claims or contingent retail claims;
  9. (9) claims or contingent claims secured on real estate property;
  10. (10) past due items;
  11. (11) items belonging to regulatory high-risk categories;
  12. (12) claims in the form of covered bonds;
  13. (13) securitisation positions;
  14. (14) short-term claims on institutions and corporates;
  15. (15) claims in the form of CIUs; or
  16. (16) other items.

[Note: BCD Article 79(1)]

BIPRU 3.2.10

handbook-rule

To be eligible for the retail exposure class, an exposure must meet the following conditions:

  1. (1) the exposure must be either to an individual person or persons, or to a small or medium sized entity;
  2. (2) the exposure must be one of a significant number of exposures with similar characteristics such that the risks associated with such lending are substantially reduced; and
  3. (3) the total amount owed to the firm, its parent undertakings and its subsidiary undertakings, including any past due exposure, by the obligor client or group of connected clients, but excluding claims or contingent claims secured on residential real estate collateral, must not, to the knowledge of the firm, exceed €1 million.

[Note: BCD Article 79(2)]

BIPRU 3.2.11

handbook-rule

A firm must take reasonable steps to acquire the knowledge referred to in BIPRU 3.2.10 R (3).

BIPRU 3.2.12

handbook-rule

Securities are not eligible for the retail exposure class.

BIPRU 3.2.13

handbook-rule

The present value of retail minimum lease payments is eligible for the retail exposure class.

Retail exposures: Significance

BIPRU 3.2.14

handbook-guidance
A key driver of the preferential risk weight afforded retail exposures is the lower correlation and systematic risk associated with such exposures. This aspect is unrelated to the absolute number of retail exposures. Accordingly in defining what constitutes a significant number of retail exposures for the purpose of BIPRU 3.2.10 R (2), a firm need only satisfy itself that the number of retail exposures is sufficiently large to diversify away idiosyncratic risk. This assessment will be subject to supervisory review and part of a firm's SREP. It will be looked at as one of the issues relating to overall diversification.

Retail exposures: Aggregation: Reasonable steps

BIPRU 3.2.15

handbook-guidance
In deciding what steps are reasonable for the purposes of BIPRU 3.2.11 R, a firm may take into account complexity and cost, as well as the materiality of the impact upon its capital calculation. A firm should be able to demonstrate to the FSA that it has complied with the obligation to take reasonable steps under BIPRU 3.2.11 R in the way it takes these factors into account.

Retail exposures: Aggregation: Single risk

BIPRU 3.2.16

handbook-guidance
  1. (1) The definition of group of connected clients is set out in the Glossary. Paragraph (2) of that definition is "two or more persons ... who are to be regarded as constituting a single risk because they are so interconnected that, if one of them were to experience financial problems, the other or all of the others would be likely to encounter repayment difficulties".
  2. (2) Say that a firm has exposures to A and B. When deciding whether A and B come within paragraph (2) of the definition two conditions should be satisfied. Firstly the connections between A and B should mean that if A experiences financial problems, B should be likely to encounter repayment difficulties. Secondly, the connections between A and B should mean that if B experiences financial problems, A should be likely to encounter repayment difficulties.
  3. (3) The guidance in BIPRU 3.2.16 G is provided for the purpose of BIPRU 3.2.10 R only and not for the purposes of any other provision in the Handbook that uses the defined term group of connected clients.

Retail exposures: Aggregation: Personal and business exposures

BIPRU 3.2.17

handbook-guidance
If a firm has exposures to an owner of a retail SME in his personal capacity and exposures to the retail SME the firm should aggregate the two types of exposure for the purpose of BIPRU 3.2.10 R (3), although it should not include claims secured on residential real estate collateral. In deciding what steps are reasonable for the purposes of BIPRU 3.2.11 R in aggregating these two types of exposure, a firm may take into account the materiality of those personal exposures. A firm should be able to demonstrate to the FSA that it has complied with the obligation to take reasonable steps under BIPRU 3.2.11 R when taking into account materiality in this way.

Retail exposures: Exchange rate

BIPRU 3.2.18

handbook-guidance
Where an exposure is denominated in a currency other than the euro, a firm may calculate the euro equivalent for purposes of BIPRU 3.2.10 R using any appropriate set of exchange rates provided its choice has no obvious bias and that the firm is consistent in its approach to choosing rates.

Retail exposures: Frequency of monitoring

BIPRU 3.2.19

handbook-guidance
A firm may monitor compliance with the €1m threshold in BIPRU 3.2.10 R on the basis of approved limits provided it has internal control procedures that are sufficient to ensure that amounts owed cannot diverge from approved limits to such an extent as to give rise to a material breach of the €1m threshold.

BIPRU 3.2.20

handbook-rule
  1. (1) To calculate risk weighted exposure amounts, risk weights must be applied to all exposures, unless deducted from capital resources, in accordance with the provisions of BIPRU 3.4.
  2. (2) The application of risk weights must be based on the standardised credit risk exposure class to which the exposure is assigned and, to the extent specified in BIPRU 3.4, its credit quality.
  3. (3) Credit quality may be determined by reference to:
    1. (a) the credit assessments of eligible ECAIs in accordance with the provisions of BIPRU 3; or
    2. (b) the credit assessments of export credit agencies as described in BIPRU 3.4.

[Note: BCD Article 80(1)]

BIPRU 3.2.21

handbook-rule

For the purposes of applying a risk weight, as referred to in BIPRU 3.2.20 R, the exposure value must be multiplied by the risk weight specified or determined in accordance with the standardised approach.

BIPRU 3.2.22

handbook-rule

Notwithstanding BIPRU 3.2.20 R, where an exposure is subject to credit protection the risk weight applicable to that item may be modified in accordance with BIPRU 5.

BIPRU 3.2.23

handbook-rule

Risk weighted exposure amounts for securitised exposures must be calculated in accordance with BIPRU 9.

BIPRU 3.2.24

handbook-rule

Exposures the calculation of risk weighted exposure amounts for which is not otherwise provided for under the standardised approach must be assigned a risk weight of 100%.

Zero risk-weighting for intra-group exposures: core UK group

BIPRU 3.2.25

handbook-rule
  1. (1) Subject to BIPRU 3.2.35 R, and with the exception of exposures giving rise to liabilities in the form of the items referred to in BIPRU 3.2.26 R, a firm is not required to comply with BIPRU 3.2.20 R (Calculation of risk weighted exposures amounts under the standardised approach) in the case of the exposures of the firm to a counterparty which is its parent undertaking, its subsidiary undertaking or a subsidiary undertaking of its parent undertaking provided that the following conditions are met:
    1. (a) the counterparty is
      1. (i) a core concentration risk group counterparty; and
      2. (ii) an institution, financial holding company, financial institution, asset management company or ancillary services undertaking subject to appropriate prudential requirements;
    2. (b) [deleted]
    3. (ba) (in relation to a subsidiary undertaking) 100% of the voting rights attaching to the shares in the counterparty's capital is held by the firm or a financial holding company (or a subsidiary undertaking of the financial holding company), whether individually or jointly, and that the firm or financial holding company (or its subsidiary undertaking) must have the right to appoint or remove a majority of the members of the board of directors, committee of management or other governing body of the counterparty;
    4. (c) the counterparty is subject to the same risk evaluation, measurement and control procedures as the firm;
    5. (d) the counterparty is incorporated in the United Kingdom; and
    6. (e) there is no current or foreseen material practical or legal impediment to the prompt transfer of capital resources or repayment of liabilities from the counterparty to the firm.
  2. (2) Where a firm chooses under (1) not to apply BIPRU 3.2.20 R, it must assign a risk weight of 0% to the exposure.
  3. (3) A firm need not apply the treatment in (1) and (2) to every exposure that is eligible for that treatment.

[Note: BCD Article 80(7)]

BIPRU 3.2.25A

handbook-guidance
  1. (1) Firms are referred to BIPRU 10.8A (Intra-group exposures: core UK group) under which exposures within the core UK group are exempt from the limits described in BIPRU 10.5 (Limits on exposures) if they would be assigned a risk weight of 0% under BIPRU 3.2.25 R.
  2. (2) Therefore, a firm that is applying for a core UK group waiver should demonstrate that it meets the conditions in BIPRU 3.2.25 R and BIPRU 10.8A for establishing a core UK group. A firm that is granted a core UK group waiver may rely on it for the purpose of assigning a risk weight of 0% to exposures within its core UK group and for the purpose of exempting the exposures within the core UK group from the 25% large exposure limit.

BIPRU 3.2.26

handbook-rule

A firm must not apply the treatment in BIPRU 3.2.25 R to exposures giving rise to liabilities in the form of any of the following items:

  1. (1) in the case of a BIPRU firm, any tier one capital or tier two capital; and
  2. (2) in the case of any other undertaking, any item that would be tier one capital or tier two capital if the undertaking were a BIPRU firm.

[Note: BCD Article 80(7), part]

BIPRU 3.2.27

handbook-rule
  1. (1) [deleted]
    1. (a) [deleted]
    2. (b) [deleted]
    3. (c) [deleted]
  2. (2) [deleted]

BIPRU 3.2.27A

handbook-rule
  1. (1) For the purpose of BIPRU 3.2.25R (1)(e), a firm must be able on an ongoing basis to demonstrate fully to the FSA the circumstances and arrangements, including legal arrangements, by virtue of which there are no material practical or legal impediments, and none are foreseen, to the prompt transfer of capital resources or repayment of liabilities from the counterparty to the firm.
  2. (2) In relation to a counterparty that is not a firm, the arrangements referred to in (1) must include a legally binding agreement with each firm that is a member of the core UK group that it will promptly on demand by the firm increase the firm's capital resources by an amount required to ensure that the firm complies with GENPRU 2.1 (Calculation of capital resources requirements), BIPRU 10 (Large exposures) and any other requirements relating to capital resources or concentration risk imposed on a firm by or under the regulatory system.

BIPRU 3.2.28

handbook-guidance
For the purpose of BIPRU 3.2.25 R (1)(c) it is the risk management functions of the group that should be integrated, rather than the group's operational management. A firm should ensure that if risk management functions are integrated in this way it should be possible for the FSA to undertake qualitative supervision of the management of the integrated risk management function.

BIPRU 3.2.29

handbook-guidance
In relation to a core concentration risk group counterparty, an undertaking is included within the scope of consolidation of a group on a full basis if it is at the head of the group or if its assets and liabilities are taken into account in full as referred to in BIPRU 8.5.2 G (Basis of inclusion of undertakings in consolidation).

BIPRU 3.2.29A

handbook-guidance
  1. (1) In relation to BIPRU 3.2.25 R (1)(ba), a subsidiary undertaking should generally be 100% owned and controlled by a single shareholder. However, if a subsidiary undertaking has more than one shareholder, that undertaking may be a member of the core UK group if all its shareholders are also members of the same core UK group.
  2. (2) For the purpose of BIPRU 3.2.25R (1)(d) (Incorporation in the UK), if a counterparty is of a type that falls within the scope of the Council Regulation of 29 May 2000 on insolvency proceedings (Regulation 1346/2000/EC) and it is established in the United Kingdom other than by incorporation, a firm wishing to include that counterparty in its core UK group may apply to the FSA for a waiver of this condition if it can demonstrate fully to the FSA that the counterparty's centre of main interests is situated in the United Kingdom within the meaning of that Regulation.

BIPRU 3.2.30

handbook-guidance

For the purpose of BIPRU 3.2.25R (1)(e) (Prompt transfer of capital resources):

  1. (1) in the case of an undertaking that is a firm the requirement in BIPRU 3.2.25R (1)(e) for the prompt transfer of capital resources refers to capital resources in excess of the capital and financial resources requirements to which it is subject under the regulatory system; and
  2. (2) the following guidance relating to the condition in BIPRU 10.8A.2 R (6) requiring the prompt transfer of capital resources within a core UK group as applicable for the exemption from large exposure limits is also relevant:
    1. (a) BIPRU 10.8A.6 G in respect of the criteria that the FSA will consider when assessing whether the condition requiring the prompt transfer of capital resources is going to be met; and
    2. (b) BIPRU 10.8A.7 G (2) in respect of the counterparty's obligation to increase the firm's capital resources and the limitations that may be permitted.

BIPRU 3.2.31

handbook-guidance
The requirement in BIPRU 3.2.25 R (1)(e) for the prompt repayment of liabilities refers to the prompt repayment of liabilities when due.

BIPRU 3.2.32

handbook-guidance
The guidance in BIPRU 3.2.30 G - BIPRU 3.2.31 G does not apply to BIPRU 2.1 (Solo consolidation) even though the provisions have similar wording. This is because the purpose of the provisions in BIPRU 2.1 is to define the conditions under which two undertakings should be treated as a single undertaking. The purpose of BIPRU 3.2.25 R (1) is to define the circumstances in which it is appropriate to apply a zero risk weight.

BIPRU 3.2.33

handbook-guidance
A firm that has chosen to apply the treatment in BIPRU 3.2.25 R should monitor the exposures to which a 0% risk weight is applied under that treatment and report these to the FSA as required.

BIPRU 3.2.34

handbook-guidance
If a firm has an IRB permission and exposures are exempted from the IRB approach under BIPRU 4.2.26 R (6) the firm may apply a 0% risk weight to them under BIPRU 3.2.25 R (2) (Zero risk weighting for intra-group exposures) if the conditions in BIPRU 3.2.25 R (1) are satisfied.

BIPRU 3.2.35

handbook-rule
  1. (1) A firm may not apply BIPRU 3.2.25 R unless it has a core UK group waiver.
  2. (2) [deleted]
  3. (3) A firm may stop applying BIPRU 3.2.25 R or may stop applying it to some exposures.
  4. (4) [deleted]
  5. (5) A firm must notify the FSA if it becomes aware that any exposure that it has treated as exempt under BIPRU 3.2.25 R has ceased to meet the conditions for exemption or if the firm ceases to treat an exposure under that rule.

BIPRU 3.2.37

handbook-guidance
BIPRU 3 Annex 1 G is a flow chart guide to assessing whether an intra-group exposure can be zero risk weighted using the standardised approach subject to the conditions set out in BIPRU 3.2.25 R - BIPRU 3.2.35 R.

Exposures to recognized third-country investment firms, clearing houses and investment exchanges

BIPRU 3.2.38

handbook-rule

For the purposes of the standardised approach (including as it applies for the purposes of BIPRU 14) and without prejudice to BIPRU 13.3.13 R and BIPRU 13.8.8 R (Exposure to a central counterparty), exposures to recognised third country investment firms and exposures to recognised clearing houses, designated clearing houses, recognised investment exchanges and designated investment exchanges must be treated as exposures to institutions.

[Note: CAD Article 40]

BIPRU 3.3

The use of the credit assessments of ratings agencies

  • 01/01/2007

BIPRU 3.3.1

handbook-rule

An external credit assessment may be used to determine the risk weight of an exposure in accordance with BIPRU 3.2.20 R to BIPRU 3.2.26 R only if the ECAI which provides it is recognised by the FSA as an eligible ECAI for the purposes of the standardised approach to credit risk.

Recognition of ratings agencies

BIPRU 3.3.2

handbook-guidance
The FSA will recognise an ECAI as an eligible ECAI for the purposes of BIPRU 3, or will refuse to recognise an ECAI or will revoke its recognition of an ECAI as an eligible ECAI in accordance with the Capital Requirements Regulations 2006.

BIPRU 3.3.3

handbook-guidance
Regulation 22 of the Capital Requirements Regulations 2006 deals with recognition by the FSA of eligible ECAIs for exposure risk weight purposes. Regulation 25 deals with revoking recognition.

BIPRU 3.3.4

handbook-guidance
The criteria which the FSA must apply when assessing ECAIs for recognition for exposure risk weighting purposes are set out in Regulation 22 and Schedule 1 to the Capital Requirements Regulations 2006. In making an assessment against those criteria and in carrying out the mapping process described in BIPRU 3.3.7 G to BIPRU 3.3.9 G the FSA will have regard to the approach set out in the Committee of European Banking Supervisors' "Guidelines on the recognition of External Credit Assessment Institutions" dated 20 January 2006. The FSA does not expect to recognise an ECAI unless the information set out in those guidelines has been submitted to it.

BIPRU 3.3.5

handbook-guidance
The list of eligible ECAIs is published on the FSA website. When the FSA recognises an ECAI as an eligible ECAI, it publishes that decision by amending the list of eligible ECAIs on the FSA website to include the name of the eligible ECAI. When the FSA determines that the recognition of an ECAI should be revoked, it publishes that decision by deleting the name of the ECAI from the list on the FSA website

BIPRU 3.3.6

handbook-guidance
The list of eligible ECAIs includes those who have been recognised as eligible for exposure risk weighting purposes by a competent authority of another EEA State and are subsequently recognised as eligible ECAIs by the FSA without carrying out its own evaluation process under Regulation 22(2) of the Capital Requirements Regulations 2006.

Mapping of credit assessments

BIPRU 3.3.7

handbook-guidance
Under Regulation 22(3) of the Capital Requirements Regulations 2006 the FSA is obliged to determine, taking into account the requirements set out in Schedule 2 to the Capital Requirements Regulations 2006, with which of the credit quality steps set out in Part 1 of Annex VI of the Banking Consolidation Directive the relevant credit assessments of an eligible ECAI are to be associated. Those determinations should be objective and consistent.

BIPRU 3.3.8

handbook-rule
The credit quality step with which a relevant credit assessment of an eligible ECAI is to be associated is that in the table mapping the credit assessments of eligible ECAIs to credit quality steps published by the FSA under Regulation 22(3) of the Capital Requirements Regulations 2006.

BIPRU 3.3.9

handbook-guidance

The table mapping the credit assessments of eligible ECAIs to credit quality steps is published on the FSA website and amended from time to time in line with additions to and deletions from the list of eligible ECAIs. The table includes mappings made by a competent authority of another EEA State which are subsequently recognised by the FSA without carrying out its own determination process under Regulation 22(5) of the Capital Requirements Regulations 2006.

BIPRU 3.4

Risk weights under the standardised approach to credit risk

  • 01/01/2007

Risk weights: Exposures to central governments or central banks: Treatment

BIPRU 3.4.1

handbook-rule

Without prejudice to BIPRU 3.4.2 R to BIPRU 3.4.9 R, exposures to central governments and central banks must be assigned a 100% risk weight.

BIPRU 3.4.2

handbook-rule

Subject to BIPRU 3.4.4 R, exposures to central governments and central banks for which a credit assessment by a nominated ECAI is available must be assigned a risk weight according to the table in BIPRU 3.4.3 R in accordance with the assignment by the FSA in accordance with the Capital Requirements Regulations 2006 of the credit assessments of eligible ECAIs to six steps in a credit quality assessment scale.

Table: Exposures to central governments and central banks for which a credit assessment by a nominated ECAI is available

BIPRU 3.4.3

handbook-rule
This table belongs to BIPRU 3.4.2 R.

BIPRU 3.4.4

handbook-rule

Exposures to the European Central Bank must be assigned a 0% risk weight.

Exposures in the national currency of the borrower

BIPRU 3.4.5

handbook-rule

Exposures to EEA States' central governments and central banks denominated and funded in the domestic currency of that central government and central bank must be assigned a risk weight of 0%.

BIPRU 3.4.6

handbook-rule

When the competent authorities of a third country which apply supervisory and regulatory arrangements at least equivalent to those applied in the EEA assign a risk weight which is lower than that indicated in BIPRU 3.4.1 R to BIPRU 3.4.3 R to exposures to their central government and central bank denominated and funded in the domestic currency, a firm may risk weight such exposures in the same manner.

Use of credit assessments by export credit agencies

BIPRU 3.4.7

handbook-rule

An export credit agency credit assessment may be recognised by a firm for the purpose of determining the risk weight to be applied to an exposure under the standardised approach if either of the following conditions is met:

  1. (1) the credit assessment is a consensus risk score from export credit agencies participating in the OECD "Arrangement on Guidelines for Officially Supported Export Credits"; or
  2. (2) the export credit agency publishes its credit assessments, and the export credit agency subscribes to the OECD agreed methodology, and the credit assessment is associated with one of the eight minimum export insurance premiums (MEIP) that the OECD agreed methodology establishes.

[Note: BCD Annex VI Part 1 point 6]

BIPRU 3.4.8

handbook-rule

Exposures for which a credit assessment by an export credit agency is recognised for risk weighting purposes must be assigned a risk weight according to the table in BIPRU 3.4.9 R.

Table: Exposure for which a credit assessment by an export credit agency is recognised

BIPRU 3.4.9

handbook-rule
This table belongs to BIPRU 3.4.8 R.

Exposures to regional governments or local authorities: General

BIPRU 3.4.10

handbook-rule

Without prejudice to BIPRU 3.4.15 R to BIPRU 3.4.19 R:

  1. (1) a firm must risk weight exposures to regional governments and local authorities in accordance with BIPRU 3.4.11 R to BIPRU 3.4.14 R and BIPRU 3.4.19A R; and
  2. (2) the preferential treatment for short-term exposures specified in BIPRU 3.4.37 R, BIPRU 3.4.39 R and BIPRU 3.4.44 R must not be applied.

[Note: BCD Annex VI Part 1 point 8]

Exposures to regional governments or local authorities: Central government risk weight based method

BIPRU 3.4.11

handbook-rule
  1. (1) Exposures to regional governments and local authorities must be assigned a risk weight according to the credit quality step to which exposures to the central government of the jurisdiction in which the regional government or local authority is established are assigned in accordance with the table in BIPRU 3.4.12 R.
  2. (2) Exposures to an unrated regional government or local authority must not be assigned a risk weight lower than that applied to exposures to its central government.

[Note: BCD Annex VI Part 1 points 25 and 26]

Table: Central government risk weight based method

BIPRU 3.4.12

handbook-rule
This table belongs to BIPRU 3.4.11 R.

BIPRU 3.4.13

handbook-rule

For exposures to regional governments and local authorities established in countries where the central government is unrated, the risk weight must be not more than 100%.

BIPRU 3.4.14

handbook-rule

For exposures to regional governments and local authorities with an original effective maturity of three months or less, the risk weight must be 20%.

[Note: BCD Annex VI Part 1 point 28]

BIPRU 3.4.15

handbook-rule

A firm must treat an exposure to a regional government or local authority of the United Kingdom listed in BIPRU 3 Annex 2 R as an exposure to the central government of the United Kingdom.

BIPRU 3.4.16

handbook-guidance

The FSA will include a regional government or local authority in the list in BIPRU 3 Annex 2 R where there is no difference in risk between exposures to that body and exposures to the central government of the United Kingdom because of the specific revenue-raising powers of the regional government or local authority, and the existence of specific institutional arrangements the effect of which is to reduce the risk of default.

[Note: BCD Annex VI Part 1 point 9]

BIPRU 3.4.17

handbook-rule

A firm must treat an exposure to a regional government or local authority of an EEA State other than the United Kingdom as an exposure to the central government in whose jurisdiction that regional government or local authority is established if that regional government or local authority is included on the list of regional governments and local authorities drawn up by the competent authority in that EEA State under a CRD implementation measure with respect to point 9 of Part 1 of Annex VI of the Banking Consolidation Directive.

[Note: BCD Annex VI Part 1 point 9]

BIPRU 3.4.18

handbook-rule

Exposures to churches or religious communities constituted in the form of a legal person under public law must, in so far as they raise taxes in accordance with legislation conferring on them the right to do so, be treated as exposures to regional governments and local authorities, except that BIPRU 3.4.15 R and BIPRU 3.4.17 R do not apply.

[Note: BCD Annex VI Part 1 point 10]

BIPRU 3.4.19

handbook-rule

When competent authorities of a third country jurisdiction which apply supervisory and regulatory arrangements at least equivalent to those applied in the EEA treat exposures to regional governments and local authorities as exposures to their central government, a firm may risk weight exposures to such regional governments and local authorities in the same manner.

BIPRU 3.4.19A

handbook-rule

Without prejudice to BIPRU 3.4.17 R to BIPRU 3.4.19 R, an exposure to a regional government or local authority of an EEA State denominated and funded in the domestic currency of that regional government or local authority must be assigned a risk weight of 20%.

[Note: BCD Annex VI Part 2(b)]

Exposures to administrative bodies and non-commercial undertakings

BIPRU 3.4.20

handbook-rule
BIPRU 3.4.21 R to BIPRU 3.4.26 R set out the provisions applying to exposures to administrative bodies and non-commercial undertakings.

Treatment

BIPRU 3.4.21

handbook-rule

Without prejudice to BIPRU 3.4.22 R to BIPRU 3.4.26 R, exposures to administrative bodies and non-commercial undertakings must be assigned a 100% risk weight.

[Note: BCD Annex VI Part 1 point 12]

Public sector entities

BIPRU 3.4.22

handbook-rule

Without prejudice to BIPRU 3.4.23 R to BIPRU 3.4.26 R, exposures to public sector entities must be assigned a 100% risk weight.

[Note: BCD Annex VI Part 1 point 13]

BIPRU 3.4.23

handbook-rule

A firm may treat an exposure to a public sector entity as an exposure to a regional government or local authority in accordance with BIPRU 3.4.11 R to BIPRU 3.4.14 R.

BIPRU 3.4.24

handbook-rule

In exceptional circumstances a firm may treat an exposure to a public sector entity established in the United Kingdom as an exposure to the central government of the United Kingdom if there is no difference in risk between exposures to that body and exposures to the central government of the United Kingdom because of the existence of an appropriate guarantee by the central government.

[Note: BCD Annex VI Part 1 point 15]

BIPRU 3.4.25

handbook-rule

Where a competent authority of another EEA State implements points 14 or 15 of Part 1 of Annex VI of the Banking Consolidation Directive by exercising the discretion to treat exposures to public sector entities as exposures to institutions or as exposures to the central government of the EEA State concerned, a firm may risk weight exposures to the relevant public sector entities in the same manner.

[Note: BCD Annex VI Part 1 point 16]

BIPRU 3.4.26

handbook-rule

When competent authorities of a third country jurisdiction, which apply supervisory and regulatory arrangements at least equivalent to those applied in the EEA, treat exposures to public sector entities as exposures to institutions, a firm may risk weight exposures to the relevant public sector entities in the same manner.

[Note: BCD Annex VI Part 1 point 17]

Exposures to multilateral development banks: Treatment

BIPRU 3.4.27

handbook-rule

Without prejudice to BIPRU 3.4.28 R to BIPRU 3.4.29 R:

  1. (1) a firm must treat exposures to multilateral development banks in the same manner as exposures to institutions in accordance with BIPRU 3.4.34 R to BIPRU 3.4.39 R (Exposures to institutions: credit assessment based method); and
  2. (2) the preferential treatment for short-term exposures specified in BIPRU 3.4.37 R, BIPRU 3.4.39 R and BIPRU 3.4.44 R must not be applied.

[Note: BCD Annex VI Part 1 point 19]

BIPRU 3.4.28

handbook-rule

An exposure to a multilateral development bank listed in point (1) of the definition in the Glossary must be assigned a 0% risk weight.

[Note: BCD Annex VI Part 1 point 20]

BIPRU 3.4.29

handbook-rule

A risk weight of 20% must be assigned to the portion of unpaid capital subscribed to the European Investment Fund.

Exposures to international organisations

BIPRU 3.4.30

handbook-rule

Exposures to the following international organisations must be assigned a 0% risk weight:

  1. (1) the EU;
  2. (2) the International Monetary Fund; and
  3. (3) the Bank for International Settlements.

[Note: BCD Annex VI Part 1 point 22]

Exposures to institutions: General

BIPRU 3.4.31

handbook-rule
BIPRU 3.4.32 R to BIPRU 3.4.48 R set out the treatment to be accorded to exposures to institutions.

Exposures to institutions: Treatment

BIPRU 3.4.32

handbook-rule

Without prejudice to BIPRU 3.4.33 R to BIPRU 3.4.47 R, exposures to financial institutions authorised and supervised by the competent authorities responsible for the authorisation and supervision of credit institutions and subject to prudential requirements equivalent to those applied to credit institutions must be risk weighted as exposures to institutions.

Exposures to institutions: Risk weight floor on exposures to unrated institutions

BIPRU 3.4.33

handbook-rule

Exposures to an unrated institution must not be assigned a risk weight lower than that applied to exposures to its central government.

Exposures to institutions: Credit assessment based method

BIPRU 3.4.34

handbook-rule

Exposures to institutions with a residual maturity of more than three months for which a credit assessment by a nominated ECAI is available must be assigned a risk weight according to the table in BIPRU 3.4.35 R in accordance with the assignment by the FSA in accordance with the Capital Requirements Regulations 2006 of the credit assessments of eligible ECAIs to six steps in a credit quality assessment scale.

Table: Exposures to institutions with a residual maturity of more than three months for which a credit assessment by a nominated ECAI is available

BIPRU 3.4.35

handbook-rule
This table belongs to BIPRU 3.4.34 R.

BIPRU 3.4.36

handbook-rule

Without prejudice to BIPRU 3.4.33 R, exposures to unrated institutions must be assigned a risk weight of 50%.

[Note: BCD Annex VI Part 1 point 30]

BIPRU 3.4.37

handbook-rule

Exposures to an institution with a residual maturity of three months or less for which a credit assessment by a nominated ECAI is available must be assigned a risk weight according to the table in BIPRU 3.4.38 R in accordance with the assignment by the FSA in accordance with the Capital Requirements Regulations 2006 of the credit assessments of eligible ECAIs to six steps in a credit quality assessment scale.

Table: Exposures to an institution with a residual maturity of three months or less for which a credit assessment by a nominated ECAI is available

BIPRU 3.4.38

handbook-rule
This table belongs to BIPRU 3.4.37 R.

BIPRU 3.4.39

handbook-rule

Without prejudice to BIPRU 3.4.33 R, exposures to unrated institutions having an original effective maturity of three months or less must be assigned a 20% risk weight

Exposures to institutions: Interaction with short-term credit assessments

BIPRU 3.4.40

handbook-rule

If there is no short-term credit assessment as set out in BIPRU 3.4.112 R, the general preferential treatment for short-term exposures as specified in BIPRU 3.4.37 R applies to all exposures to institutions of up to three months residual maturity.

BIPRU 3.4.41

handbook-rule

If there is a short-term credit assessment as set out in BIPRU 3.4.112 R and such an assessment determines the application of a more favourable or identical risk weight than the use of the general preferential treatment for short-term exposures, as specified in BIPRU 3.4.37 R, then the short-term assessment and risk weighting specified in BIPRU 3.4.112 R must be used for that specific exposure only. Other short-term exposures must follow the general preferential treatment for short-term exposures, as specified in BIPRU 3.4.37 R.

[Note: BCD Annex VI Part 1 point 35]

BIPRU 3.4.42

handbook-rule

If there is a short-term credit assessment as set out in BIPRU 3.4.112 R and such an assessment determines a less favourable risk weight than the use of the general preferential treatment for short-term exposures, as specified in BIPRU 3.4.37 R, then the general preferential treatment for short-term exposures must not be used and all unrated short-term claims must be assigned the same risk weight as that applied by the specific short-term assessment.

BIPRU 3.4.43

handbook-guidance
BIPRU 3 Annex 4 G contains a flow diagram guide to determining the risk weight to be applied to short-term exposures to institutions according to whether a short-term credit assessment is available.

Exposures to institutions: Short-term exposures in the national currency of the borrower

BIPRU 3.4.44

handbook-rule

A firm may assign to an exposure to an institution formed under the law of the United Kingdom of a residual maturity of 3 months or less denominated and funded in pounds sterling a risk weight that is one category less favourable than the preferential risk weight, as described in BIPRU 3.4.5 R (Exposures in the national currency of the borrower), assigned to exposures to the central government of the United Kingdom.

[Note: BCD Annex VI Part 1 point 37]

BIPRU 3.4.45

handbook-rule
  1. (1) Where a competent authority of another EEA State implements point 37 of Part 1 of Annex VI of the Banking Consolidation Directive by exercising the discretion to allow the treatment in that point, a firm may assign to the relevant national currency exposures the risk weight permitted by that CRD implementation measure.
  2. (2) When the competent authority of a third country which applies supervisory and regulatory arrangements at least equivalent to those applied in the EEA assigns to an exposure to an institution formed under the law of that third country of a residual maturity of 3 months or less denominated and funded in the national currency a risk weight that is one category less favourable than the preferential risk weight, as described in BIPRU 3.4.6 R (Exposures in the national currency of the borrower), assigned to exposures to the central government of that third country, a firm may risk weight such exposures in the same manner.

[Note: BCD Annex VI Part 1 point 37]

BIPRU 3.4.46

handbook-rule

No exposures of a residual maturity of 3 months or less denominated and funded in the national currency of the borrower may be assigned a risk weight less than 20%.

Exposures to institutions: Investments in regulatory capital instruments

BIPRU 3.4.47

handbook-rule

Investments in equity or regulatory capital instruments issued by institutions must be risk weighted at 100%, unless deducted from capital resources.

[Note: BCD Annex VI Part 1 point 39]

Exposures to institutions: Minimum reserves required by the ECB

BIPRU 3.4.48

handbook-rule

Where an exposure to an institution is in the form of minimum reserves required by the European Central Bank or by the central bank of an EEA State to be held by the firm, a firm may assign the risk weight that would be assigned to exposures to the central bank of the EEA State in question provided:

  1. (1) the reserves are held in accordance with Regulation (EC) No. 1745/2003 of the European Central Bank of 12 September 2003 or a subsequent replacement regulation or in accordance with national requirements in all material respects equivalent to that Regulation; and
  2. (2) in the event of the bankruptcy or insolvency of the institution where the reserves are held, the reserves will be fully repaid to the firm in a timely manner and will not be available to meet other liabilities of the institution.

[Note: BCD Annex VI Part 1 point 40]

Exposures to corporates: General

BIPRU 3.4.49

handbook-guidance
BIPRU 3.4.50 R to BIPRU 3.4.52 R set out the treatment to be accorded to exposures to corporates.

Exposures to corporates: Treatment

BIPRU 3.4.50

handbook-rule

Exposures for which a credit assessment by a nominated ECAI is available must be assigned a risk weight according to the table in BIPRU 3.4.51 R in accordance with the assignment by the FSA in accordance with the Capital Requirements Regulations 2006 of the credit assessments of eligible ECAIs to six steps in a credit quality assessment scale.

Table: Exposures for which a credit assessment by a nominated ECAI is available

BIPRU 3.4.51

handbook-rule
This table belongs to BIPRU 3.4.50 R.

BIPRU 3.4.52

handbook-rule

Unrated exposures must be assigned a 100% risk weight or the risk weight of its central government, whichever is the higher.

Retail exposures

BIPRU 3.4.53

handbook-rule

Exposures that comply with the criteria listed in BIPRU 3.2.10 R must be assigned a risk weight of 75%. However a firm may treat such an exposure under BIPRU 3.2.24 R (100% risk weight).

[Note: BCD Annex VI Part 1 point 43]

Exposures secured by real estate property

BIPRU 3.4.54

handbook-rule
BIPRU 3.4.55 R to BIPRU 3.4.94 R set out the treatment to be accorded to exposures secured by real estate property.

BIPRU 3.4.55

handbook-rule

Without prejudice to BIPRU 3.4.56 R to BIPRU 3.4.94 R, exposures fully secured by real estate property must be assigned a risk weight of 100%.

[Note: BCD Annex VI Part 1 point 44]

Exposures secured by mortgages on residential property

BIPRU 3.4.56

handbook-rule

Without prejudice to BIPRU 3.4.85 R, an exposure or any part of an exposure fully and completely secured, to the satisfaction of the firm, by mortgages on residential property which is or shall be occupied or let by the owner or the beneficial owner in the case of personal investment companies must be assigned a risk weight of 35%.

BIPRU 3.4.56A

handbook-rule
  1. (1) A firm must not treat a lifetime mortgage as an exposure fully and completely secured on residential property for the purposes of BIPRU 3.4.56 R unless the amount of the exposure is calculated according to the following formula:
exposure amount =


where:
    1. (a) P is the current outstanding balance on the lifetime mortgage;
    2. (b) i is the interest rate charged on the lifetime mortgage, which for the purposes of this calculation must not be lower than the discount rate referred to in (c);
    3. (c) d is the discount rate which is the risk-free rate as represented by the yield on 10-year UK government bonds; and
    4. (d) T is the projected number of years to maturity of the exposure.
  1. (2) Notwithstanding (1)(c), a firm may calculate an annual average discount rate provided there is no obvious bias in its calculation and it is consistent in its approach.

BIPRU 3.4.56B

handbook-guidance
  1. (1) This paragraph provides guidance on BIPRU 3.4.56A R.
  2. (2) For the purposes of BIPRU 3.4.56A R (2), a firm may use the FTSE UK gilt 10-year yield index which the Council of Mortgage Lenders makes available to its members.
  3. (3) If a firm offers a variable interest rate on a lifetime mortgage, it should calculate an average interest rate in a way which is consistent with the calculation of the discount rate.
  4. (4) To determine the projected number of years to maturity of the exposure, a firm may use the standard mortality tables published by the Institute of Actuaries or the Faculty of Actuaries. For internal risk management purposes, the firm should use factual data or seek actuarial advice to determine how the information in these tables may be adjusted to take account of regional and other relevant variations.

BIPRU 3.4.57

handbook-rule

Exposures fully and completely secured, to the satisfaction of the firm, by shares in Finnish residential housing companies, operating in accordance with the Finnish Housing Company Act of 1991 or subsequent equivalent legislation, in respect of residential property which is or shall be occupied or let by the owner must be assigned a risk weight of 35%.

[Note: BCD Annex VI Part 1 point 46]

BIPRU 3.4.58

handbook-rule

Without prejudice to BIPRU 3.4.85 R, an exposure or any part of an exposure to a tenant under a property leasing transaction concerning residential property under which the firm is the lessor and the tenant has an option to purchase, must be assigned a risk weight of 35% provided that the firm is satisfied that the exposure of the firm is fully and completely secured by its ownership of the property.

[Note: BCD Annex VI Part 1 point 47]

BIPRU 3.4.59

handbook-guidance
An Ijara mortgage is an example of an exposure described in BIPRU 3.4.58 R.

BIPRU 3.4.60

handbook-rule
  1. (1) In the exercise of its judgement for the purposes of BIPRU 3.4.56 R to BIPRU 3.4.58 R, a firm may be satisfied only if the conditions in (2) to (6) are met.
  2. (2) The value of the property does not materially depend upon the credit quality of the obligor. This requirement does not preclude situations where purely macroeconomic factors affect both the value of the property and the performance of the borrower.
  3. (3) The risk of the borrower does not materially depend upon the performance of the underlying property or project, but rather on the underlying capacity of the borrower to repay the debt from other sources. As such, repayment of the facility does not materially depend on any cash flow generated by the underlying property serving as collateral.
  4. (4) The minimum requirements about:
    1. (a) legal certainty in BIPRU 3.4.64 R;
    2. (b) monitoring of property values in BIPRU 3.4.66 R;
    3. (c) documentation in BIPRU 3.4.72 R; and
    4. (d) insurance in BIPRU 3.4.73 R;
  5. are met.
  6. (5) The valuation rules set out in BIPRU 3.4.77 R to BIPRU 3.4.80 R are met.
  7. (6) The value of the property exceeds the exposures by a substantial margin as set out in BIPRU 3.4.81 R, BIPRU 3.4.83 R, BIPRU 3.4.84 R or BIPRU 3.4.85 R (as applicable).

[Note: BCD Annex VI Part 1 point 48]

BIPRU 3.4.61

handbook-rule

BIPRU 3.4.60 R (3) does not apply to exposures fully and completely secured by mortgages on residential property which is situated within the United Kingdom.

BIPRU 3.4.62

handbook-guidance
The Banking Consolidation Directive permits a competent authority to disapply the condition in BIPRU 3.4.60 R (3), if it has evidence that a well-developed and long-established residential real estate market is present in its territory with loss rates which are sufficiently low to justify such treatment. BIPRU 3.4.61 R implements that option. However, if the evidence changes so that these conditions are no longer satisfied, the FSA may be obliged to revoke BIPRU 3.4.61 R.

BIPRU 3.4.63

handbook-rule

If a CRD implementation measure of another EEA State exercises the discretion in point 49 of Part 1 of Annex VI of the Banking Consolidation Directive to dispense with the condition corresponding to BIPRU 3.4.60 R (3) (The risk of the borrower should not materially depend upon the performance of the underlying property or project), a firm may apply a risk weight of 35% to such exposures fully and completely secured by mortgages on residential property situated in that EEA State.

BIPRU 3.4.64

handbook-rule

The requirements about legal certainty referred to in BIPRU 3.4.60 R (4)(a) are as follows:

  1. (1) the mortgage or charge must be enforceable in all relevant jurisdictions which are relevant at the time of conclusion of the credit agreement, and the mortgage or charge must be properly filed on a timely basis;
  2. (2) the arrangements must reflect a perfected lien (i.e. all legal requirements for establishing the pledge shall have been fulfilled); and
  3. (3) the protection agreement and the legal process underpinning it must enable the firm to realise the value of the protection within a reasonable timeframe.

[Note: BCD Annex VIII Part 2 point 8(a)]

BIPRU 3.4.65

handbook-guidance
The term protection agreement in BIPRU 3.4.64 R (3) refers to the contract or deed by which the mortgage or charge is established.

BIPRU 3.4.66

handbook-rule
  1. (1) The requirements about monitoring of property values referred to in BIPRU 3.4.60 R (4)(b) are as follows:
    1. (a) the value of the property must be monitored on a frequent basis and at a minimum once every three years for residential real estate;
    2. (b) more frequent monitoring must be carried out where the market is subject to significant changes in conditions;
    3. (c) statistical methods may be used to monitor the value of the property and to identify property that needs revaluation;
    4. (d) the property valuation must be reviewed by an independent valuer when information indicates that the value of the property may have declined materially relative to general market prices; and
    5. (e) for loans exceeding €3 million or 5% of the capital resources of the firm, the property valuation must be reviewed by an independent valuer at least every three years.
  2. (2) For the purposes of (1), 'independent valuer' means a person who possesses the necessary qualifications, ability and experience to execute a valuation and who is independent from the credit decision process.

[Note: BCD Annex VIII Part 2 point 8(b)]

BIPRU 3.4.67

handbook-guidance
A property will need to be revalued over time to ensure that the original purchase price does not overstate the degree of security provided by the property. Ijara providers should undertake revaluations in the same way as providers of conventional mortgages.

BIPRU 3.4.68

handbook-guidance
For the purposes of BIPRU 3.4.66 R (1)(a), the monitoring of property values should be an inherent part of risk managing and tracking the portfolio. The requirement to monitor property values does not include the physical assessment of each property in the portfolio.

BIPRU 3.4.69

handbook-guidance
For the purposes of BIPRU 3.4.66 R (1)(d) and (e), the review of a property valuation is more in-depth than the normal monitoring process required by BIPRU 3.4.66 R (1)(a). This requirement is likely to include a review of the property value on an individual exposure basis. Where an exposure is secured by multiple properties, the review can be undertaken at the level of the exposure, rather than at the level of each individual property.

BIPRU 3.4.70

handbook-guidance
The review of property values required by BIPRU 3.4.66 R (1)(e) may lead to an amendment of the value assigned to the property under by BIPRU 3.4.80 R.

BIPRU 3.4.71

handbook-guidance
For the purposes of BIPRU 3.4.66 R (2), necessary qualifications need not be professional qualifications but the firm should be able to demonstrate that he or she has the necessary ability and experience to undertake the review.

BIPRU 3.4.72

handbook-rule

The requirements about documentation referred to in BIPRU 3.4.60 R (4)(c) are that the types of residential real estate accepted by the firm and its lending policies in this regard must be clearly documented.

BIPRU 3.4.73

handbook-rule

The requirements about insurance referred to in BIPRU 3.4.60 R (4)(d) are that the firm must have procedures to monitor that the property taken as protection is adequately insured against damage.

BIPRU 3.4.74

handbook-guidance
For the purposes of BIPRU 3.4.73 R a firm should, as a minimum, ensure that it is a requirement of each loan that the property taken as collateral must have adequate buildings insurance at all times, which should be reviewed when any new loan is extended against the property.

BIPRU 3.4.75

handbook-guidance
A firm may deal with the risk that insurance on properties taken as protection may be inadequate by taking out insurance at the level of the portfolio.

BIPRU 3.4.76

handbook-rule
The valuation rules referred to in BIPRU 3.4.60 R (5) are set out in BIPRU 3.4.77 R to BIPRU 3.4.80 R.

BIPRU 3.4.77

handbook-rule

The property must be valued by an independent valuer at or less than the market value. In those EEA States that have laid down rigorous criteria for the assessment of the mortgage lending value in statutory or regulatory provisions the property may instead be valued by an independent valuer at or less than the mortgage lending value.

[Note: BCD Annex VIII Part 3 point 62]

BIPRU 3.4.78

handbook-rule

Market value means the estimated amount for which the property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion. The market value must be documented in a transparent and clear manner.

BIPRU 3.4.79

handbook-rule

Mortgage lending value means the value of the property as determined by a prudent assessment of the future marketability of the property taking into account long-term sustainable aspects of the property, the normal and local market conditions, the current use and alternative appropriate uses of the property. Speculative elements must not be taken into account in the assessment of the mortgage lending value. The mortgage lending value must be documented in a transparent and clear manner.

BIPRU 3.4.80

handbook-rule

The value of the collateral must be the market value or mortgage lending value reduced as appropriate to reflect the results of the monitoring required under BIPRU 3.4.60 R (4)(b) and BIPRU 3.4.66 R and to take account of any prior claims on the property.

BIPRU 3.4.81

handbook-rule
A firm may not treat an exposure as fully and completely secured by residential property located in the United Kingdom for the purpose of BIPRU 3.4.56 R or BIPRU 3.4.58 R unless the amount of the exposure or of the secured part of the exposure referred to in BIPRU 3.4.56 R or BIPRU 3.4.58 R, as the case may be, is 80% or less of the value of the residential property on which it is secured.

BIPRU 3.4.82

handbook-guidance
  1. (1) The application of BIPRU 3.4.81 R may be illustrated by an example. If a firm has a mortgage exposure of £100,000 secured on residential property in the United Kingdom that satisfies the criteria listed in BIPRU 3.4.56 R to BIPRU 3.4.80 R and the value of that property is £100,000, then £80,000 of that exposure may be treated as fully and completely secured and risk weighted at 35%. The remaining £20,000 may be risk weighted at 75% provided the exposure meets the criteria in BIPRU 3.2.10 R. The portion risk weighted at 75% should be treated as a retail exposure for the purposes of the aggregation calculations specified in BIPRU 3.2.10 R (3). A diagrammatic illustration of this example is in (2).
  2. (2)
  1. (3) The same approach applies to exposures described in BIPRU 3.4.58 R. On initiation a 35% risk weight should be applied to the first 80% of the principal/"purchase price" outstanding, with a 75% risk weight being applied to the remainder of the principal (assuming that the exposure meets the requirements in BIPRU 3.2 to be treated as a retail exposure).

BIPRU 3.4.83

handbook-rule
A firm may only treat an exposure as fully and completely secured by residential property situated in another EEA State for the purposes of BIPRU 3.4.56 R or BIPRU 3.4.58 R if it would be treated as fully and completely secured by the relevant CRD implementation measures in that EEA State implementing points 45 and 47 of Part 1 of Annex VI of the Banking Consolidation Directive.

BIPRU 3.4.84

handbook-rule
For the purposes of BIPRU 3.4.56 R or BIPRU 3.4.58 R, a firm may only treat an exposure as fully and completely secured by residential property situated in the territory of a third-country competent authority that is listed as equivalent for credit risk in BIPRU 8 Annex 6 R if it would be treated as fully and completely secured under the applicable requirements of that third-country competent authority (including any applicable loan-to-value ceiling).

BIPRU 3.4.85

handbook-rule

For the purposes of BIPRU 3.4.56 R or BIPRU 3.4.58 R, where the residential property in question is situated in the territory of a third-country competent authority that is not listed as equivalent for credit risk in BIPRU 8 Annex 3 R:

  1. (1) a firm must not treat an exposure as fully and completely secured by the residential property in question unless the value of the property exceeds the exposures by a substantial margin, which must be at least 20%;
  2. (2) the firm must apply a risk weight of 50% to the exposure.

BIPRU 3.4.86

handbook-guidance
For the purposes of BIPRU 3.4.85 R (1) and in order to satisfy itself that an exposure is fully and completely secured by the relevant property, a firm should make its own assessment of the appropriate margin in each case, using its knowledge of the market in the relevant country and of its own portfolio.

BIPRU 3.4.87

handbook-guidance
If a firm has more than one exposure secured on the same property they should be aggregated and treated as if they were a single exposure secured on the property for the purposes of BIPRU 3.4.56 R and BIPRU 3.4.58 R and BIPRU 3.4.81 R, BIPRU 3.4.83 R and BIPRU 3.4.84 R.

BIPRU 3.4.88

handbook-guidance
If an exposure is secured on property that is used in part for residential purposes in accordance with BIPRU 3.4.56 R and partly for commercial purposes (such as a farm, public house, guest house or shop) it may be treated as secured by residential real estate if the firm can demonstrate that the property's main use is, or will be, residential and that the value of the property is not significantly affected by its commercial use.

Exposures secured by mortgages on commercial real estate

BIPRU 3.4.89

handbook-rule

Exposures or any part of an exposure secured by mortgages on offices or other commercial premises which cannot properly be considered to fall within any other standardised credit risk exposure class or to qualify for a lower risk weight under BIPRU 3 must be assigned a risk weight of 100%.

[Note: BCD Annex VI Part 1 point 51]

BIPRU 3.4.90

handbook-rule

Exposures fully and completely secured by shares in Finnish housing companies, operating in accordance with the Finnish Housing Company Act of 1991 or subsequent equivalent legislation, in respect of offices or other commercial premises may be assigned a risk weight of 50%.

BIPRU 3.4.91

handbook-rule

If a CRD implementation measure in another EEA State implements the discretion in point 51 of Part 1 of Annex VI of the Banking Consolidation Directive, a firm may apply the same treatment as that CRD implementation measure to exposures falling within the scope of that CRD implementation measure which are fully and completely secured by mortgages on offices or other commercial premises situated in that EEA State.

BIPRU 3.4.92

handbook-rule

If a CRD implementation measure in another EEA State implements the discretion in point 53 of Part 1 of Annex VI of the Banking Consolidation Directive, a firm may apply the same treatment as that CRD implementation measure to exposures related to property leasing transactions concerning offices or other commercial premises situated in that EEA State and governed by statutory provisions whereby the lessor retains full ownership of the rented assets until the tenant exercises his option to purchase, as long as that exposure falls within the scope of that CRD implementation measure.

BIPRU 3.4.93

handbook-rule

In particular, if a firm applies BIPRU 3.4.91 R or BIPRU 3.4.92 R, it must comply with the corresponding CRD implementation measures in relation to points 54-56 of Part 1 of Annex VI of the Banking Consolidation Directive.

BIPRU 3.4.94

handbook-rule
  1. (1) If a CRD implementation measure in another EEA State implements the discretion in point 58 of Part 1 of Annex VI of the Banking Consolidation Directive to dispense with the condition in point 54(b) for exposures fully and completely secured by mortgages on commercial property situated in that EEA State, a firm may apply the same treatment as that CRD implementation measure to exposures fully and completely secured by mortgages on commercial property situated in that EEA State falling within the scope of that CRD implementation measure.
  2. (2) However a firm may not apply the treatment in (1) if the eligibility to use that treatment under the CRD implementation measure referred to in (1) ceases as contemplated under point 59 of Annex VI of the Banking Consolidation Directive (condition in point 54(b) must apply where conditions in point 58 are not satisfied).

[Note: BCD Annex VI Part 1 points 58, 59 and 60]

Past due items

BIPRU 3.4.95

handbook-guidance
BIPRU 3.4.96 R to BIPRU 3.4.101 R set out the treatment to be accorded to past due items.

BIPRU 3.4.96

handbook-rule

Without prejudice to the provisions contained in BIPRU 3.4.97 R to BIPRU 3.4.101 R, the unsecured part of any item that is past due for more than 90 days (irrespective of the amount of that item or of the unsecured portion of that item) must be assigned a risk weight of:

  1. (1) 150% if value adjustments are less than 20% of the unsecured part of the exposure gross of value adjustments; and
  2. (2) 100% if value adjustments are no less than 20% of the unsecured part of the exposure gross of value adjustments.

[Note: BCD Annex VI Part 1 point 61]

BIPRU 3.4.97

handbook-rule

For the purpose of defining the secured portion of the past due item, eligible collateral and guarantees must be those eligible for credit risk mitigation purposes under BIPRU 5.

BIPRU 3.4.98

handbook-guidance
For the purposes of BIPRU 3.4.97 R, the secured portion of a past due item is dealt with under BIPRU 5 (Credit risk mitigation). A firm may treat the secured portion of an exposure covered by a mortgage indemnity product that meets the relevant CRM eligibility criteria as secured for the purposes of BIPRU 3.4.97 R. The risk weight to be applied to the secured portion is determined under BIPRU 5.7.21 R to BIPRU 5.7.24 R. The risk weight of the unsecured portion is determined in accordance with BIPRU 3.4.96 R.

BIPRU 3.4.99

handbook-rule

Exposures indicated in BIPRU 3.4.56 R to BIPRU 3.4.63 R (Exposures secured by mortgages on residential property) must be assigned a risk weight of 100% net of value adjustments if they are past due for more than 90 days. If value adjustments are no less than 20% of the exposure gross of value adjustments, the risk weight to be assigned to the remainder of the exposure is 50%.

BIPRU 3.4.100

handbook-guidance

The application of BIPRU 3.4.96 R and BIPRU 3.4.99 R may be illustrated on the basis of a £110,000 loan on a property valued at £100,000, where £80,000 of the loan is secured and £30,000 of the exposure is unsecured and provisions of £20,000 are taken:

  1. (1) Option 1 (application of BIPRU 3.4.96 R):
    1. (a) provision of £20,000 taken on £80,000 secured exposure;
    2. (b) provision exceeds 20%, so the firm should risk weight the remaining £60,000 secured exposure at 50%;
    3. (c) the risk weight to be applied to the unsecured exposure of £30,000 is 150%;
    4. (d) the average risk weight to be assigned to the net exposure of £90,000 is 83%.
  2. (2) Option 2 (application of BIPRU 3.4.99 R):
    1. (a) provision of £20,000 taken on £30,000 unsecured exposure;
    2. (b) provision exceeds 20%, so the firm should risk weight the remaining £10,000 unsecured exposure at 100%;
    3. (c) the risk weight to be applied to the secured exposure of £80,000 is 100%;
    4. (d) the average risk weight to be assigned to the net exposure of £90,000 is 100%.

BIPRU 3.4.101

handbook-rule

Exposures indicated in BIPRU 3.4.89 R to BIPRU 3.4.94 R (Exposures secured by mortgages on commercial real estate) must be assigned a risk weight of 100% if they are past due for more than 90 days.

BIPRU 3.4.102

handbook-rule

Non past due items to be assigned a 150% risk weight under BIPRU 3.4 and for which value adjustments have been established may be assigned a risk weight of:

  1. (1) 100% if value adjustments are no less than 20% of the exposure value gross of value adjustments; and
  2. (2) 50%, if value adjustments are no less than 50% of the exposure value gross of value adjustments.



Items belonging to regulatory high-risk categories

BIPRU 3.4.103

handbook-rule
BIPRU 3.4.104 R sets out the treatment to be accorded to items belonging to regulatory high-risk categories.

BIPRU 3.4.104

handbook-rule

Exposures listed in BIPRU 3 Annex 3 R must be assigned a risk weight of 150%.

[Note: BCD Annex VI Part 1 point 66]

BIPRU 3.4.105

handbook-guidance
For the purposes of point 66 of Part 1 of Annex VI of the Banking Consolidation Directive, the exposures listed in BIPRU 3 Annex 3 R are in the view of the FSA associated with particularly high risk.

Exposures in the form of covered bonds

BIPRU 3.4.106

handbook-rule
BIPRU 3.4.107 R to BIPRU 3.4.110 R set out the treatment to be accorded to exposures in the form of covered bonds.

BIPRU 3.4.107

handbook-rule
  1. (1) Covered bonds means covered bonds as defined in paragraph (1) of the definition in the glossary (Definition based on Article 22(4) of the UCITS Directive) and collateralised by any of the following eligible assets:
    1. (a) exposures to or guaranteed by central governments, central bank, public sector entities, regional governments and local authorities in the EEA;
    2. (b)
      1. (i) exposures to or guaranteed by non-EEA central governments, non-EEA central banks, multilateral development banks, international organisations that qualify for the credit quality step 1;
      2. (ii) exposures to or guaranteed by non-EEA public sector entities, non-EEA regional governments and non-EEA local authorities that are risk weighted as exposures to institutions or central governments and central banks according to BIPRU 3.4.23 R, BIPRU 3.4.24 R, BIPRU 3.4.10 R or BIPRU 3.4.16 G to BIPRU 3.4.17 R respectively and that qualify for the credit quality step 1; and
      3. (iii) exposures in the sense of this point (b) that qualify as a minimum for the credit quality step 2, provided that they do not exceed 20% of the nominal amount of outstanding covered bonds of issuing institutions;
    3. (c) exposures to institutions that qualify for the credit quality step 1 but so that:
      1. (i) the total exposure of this kind must not exceed 15% of the nominal amount of the outstanding covered bonds of the issuing credit institution;
      2. (ii) exposures caused by transmission and management of payments of the obligors of, or liquidation proceeds in respect of, loans secured by real estate to the holders of covered bonds must not be comprised by the 15% limit; and
      3. (iii) exposures to institutions in the EEA with a maturity not exceeding 100 days are not comprised by the step 1 requirement but those institutions must as a minimum qualify for credit quality step 2;
    4. (d) loans secured:
      1. (i) by residential real estate or shares in Finnish residential housing companies as referred to in BIPRU 3.4.57 R up to the lesser of the principal amount of the liens that are combined with any prior liens and 80% of the value of the pledged properties; or
      2. (ii) by senior units issued by French Fonds Communs de Créances or by equivalent securitisation entities governed by the laws of an EEA State securitising residential real estate exposures provided that the special public supervision to protect bond holders as provided for in Article 52(4) of Directive 2009/65/EC of the European Parliament and of the Council ensures that the assets underlying such units must, at any time while they are included in the cover pool, be at least 90% composed of residential mortgages that are combined with any prior liens up to the lesser of the principal amounts due under the units, the principal amounts of the liens, and 80% of the value of the pledged properties, that the units qualify for credit quality step 1 and that such units do not exceed 10% of the nominal amount of the outstanding issue; or
    5. (e)
      1. (i) loans secured by commercial real estate or shares in Finnish housing companies as referred to in BIPRU 3.4.57 R up to the lesser of the principal amount of the liens that are combined with any prior liens and 60% of the value of the pledged properties; or
      2. (ii) loans secured by senior units issued by French Fonds Communs de Créances or by equivalent securitisation entities governed by the laws of an EEA State securitising commercial real estate exposures provided that the special public supervision to protect bond holders as provided for in Article 52(4) of Directive 2009/65/EC of the European Parliament and of the Council ensures that the assets underlying such units must, at any time while they are included in the cover pool, be at least 90% composed of commercial mortgages that are combined with any prior liens up to the lesser of the principal amounts due under the units, the principal amounts of the liens, and 60% of the value of the pledged properties, that the units qualify for credit quality step 1 and that such units do not exceed 10% of the nominal amount of the outstanding issue; or
      3. (iii) a firm may recognise loans secured by commercial real estate as eligible where the loan to value ratio of 60% is exceeded up to a maximum level of 70% if the value of the total assets pledged as collateral for the covered bonds exceed the nominal amount outstanding on the covered bond by at least 10%, and the bondholders' claim meets the legal certainty requirements set out in BIPRU 3 and BIPRU 5; the bondholders' claim must take priority over all other claims on the collateral; or
    6. (f) loans secured by ships where only liens that are combined with any prior liens within 60% of the value of the pledged ship.
  2. (2) For the purposes of BIPRU 3.4.107 R (1)(d)(ii) and BIPRU 3.4.107 R (1)(e)(ii)exposures caused by transmission and management of payments of the obligors of, or liquidation proceeds in respect of, loans secured by pledged properties of the senior units or debt securities must not be comprised in calculating the 90% limit.
  3. (3) For the purposes of BIPRU 3.4.107 R to BIPRU 3.4.110 R "collateralised" includes situations where the assets described in subpoints (1)(a) to (1)(f) are exclusively dedicated in law to the protection of the bond-holders against losses.
  4. (4) [deleted]
  5. (4A) Until 31 December 2013, the 10% limit for senior units issued by French Fonds Communs de Créances or by equivalent securitisation entities as specified in (1)(d)(ii) and (1)(e)(ii) does not apply, provided that:
    1. (a) the securitised residential or commercial real estate exposures were originated by a member of the same consolidated group of which the issuer of the covered bonds is also a member or by an entity affiliated to the same central body to which the issuer of the covered bonds is also affiliated (that common group membership or affiliation to be determined at the time the senior units are made collateral for covered bonds); and
    2. (b) a member of the same consolidated group of which the issuer of the covered bonds is also a member or an entity affiliated to the same central body to which the issuer of the covered bonds is also affiliated retains the whole first loss tranche supporting those senior units.
  6. (5) Until 31 December 2010 the figure of 60% in (1)(f) can be replaced with a figure of 70%.

[Note: BCD Annex VI Part 1 point 68]

BIPRU 3.4.108

handbook-rule

A firm must for real estate collateralising covered bonds meet the minimum requirements set out in BIPRU 3.4.64 R to BIPRU 3.4.73 R and the valuation rules set out in BIPRU 3.4.77 R to BIPRU 3.4.80 R.

BIPRU 3.4.109

handbook-rule

Notwithstanding BIPRU 3.4.107 R to BIPRU 3.4.108 R, covered bonds meeting the definition of Article 22(4) of the UCITS Directive and issued before 31 December 2007 are also eligible for the preferential treatment until their maturity.

BIPRU 3.4.110

handbook-rule

Covered bonds must be assigned a risk weight on the basis of the risk weight assigned to senior unsecured exposures to the credit institution which issues them. The following correspondence between risk weights applies:

  1. (1) if the exposures to the institution are assigned a risk weight of 20%, the covered bond must be assigned a risk weight of 10%;
  2. (2) if the exposures to the institution are assigned a risk weight of 50%, the covered bond must be assigned a risk weight of 20%;
  3. (3) if the exposures to the institution are assigned a risk weight of 100%, the covered bond must be assigned a risk weight of 50%; and
  4. (4) if the exposures to the institution are assigned a risk weight of 150%, the covered bond must be assigned a risk weight of 100%.

[Note: BCD Annex VI Part 1 point 71]

Items representing securitisation positions

BIPRU 3.4.111

handbook-rule

Risk weighted exposure amounts for securitisation positions must be determined in accordance with BIPRU 9.

Exposures to institutions and corporates with a short-term credit assessment

BIPRU 3.4.112

handbook-rule

Exposures to institutions where BIPRU 3.4.34 R to BIPRU 3.4.39 R apply, and exposures to corporates for which a short-term credit assessment by a nominated ECAI is available must be assigned a risk weight according to the table in BIPRU 3.4.113 R in accordance with the mapping by the FSA in accordance with the Capital Requirements Regulations 2006 of the credit assessments of eligible ECAIs to six steps in a credit quality assessment scale.

Table: Exposures to institutions where BIPRU 3.4.34 R to BIPRU 3.4.39 R apply, and exposures to corporates for which a short-term credit assessment by a nominated ECAI is available

BIPRU 3.4.113

handbook-rule
This table belongs to BIPRU 3.4.112 R.

Exposures in the form of collective investment undertakings (CIUs)

BIPRU 3.4.114

handbook-rule
BIPRU 3.4.115 R to BIPRU 3.4.125 R set out the treatment to be accorded to exposures in the form of CIUs.

BIPRU 3.4.115

handbook-rule

Without prejudice to BIPRU 3.4.116 R to BIPRU 3.4.125 R, exposures in CIUs must be assigned a risk weight of 100%.

BIPRU 3.4.116

handbook-rule

Exposures in the form of CIUs for which a credit assessment by a nominated ECAI is available must be assigned a risk weight according to the table in BIPRU 3.4.117 R in accordance with the assignment by the FSA in accordance with the Capital Requirements Regulations 2006 of the credit assessments of eligible ECAIs to six steps in a credit quality assessment scale.

BIPRU 3.4.117

handbook-rule
Table: Exposures in the form of CIUs for which a credit assessment by a nominated ECAI is available
This table belongs to BIPRU 3.4.116 R.

BIPRU 3.4.118

handbook-rule

Where a firm considers that a position in a CIU is associated with particularly high risks it must assign that position a risk weight of 150%.

BIPRU 3.4.119

handbook-guidance
A firm should consider a CIU as being high risk where there is no external credit assessment from an eligible ECAI and where the CIU has specific features (such as high levels of leverage or lack of transparency) that prevent it from meeting the eligibility criteria laid out in BIPRU 3.4.121 R.

BIPRU 3.4.120

handbook-guidance
Other examples of high risk CIUs are: one in which a substantial element of the CIU's property is made up of items that would attract a risk weight of over 100%; or one whose mandate (as referred to in BIPRU 3.4.124 R) would permit it to invest in a substantial amount of such items.

BIPRU 3.4.121

handbook-rule

Where BIPRU 3.4.116 R does not apply, a firm may determine the risk weight for a CIU as set out in BIPRU 3.4.123 R to BIPRU 3.4.125 R, if the following eligibility criteria are met:

  1. (1) one of the following conditions is satisfied:
    1. (a) the CIU is managed by a company which is subject to supervision in an EEA State; or
    2. (b) the following conditions are satisfied:
      1. (i) the CIU is managed by a company which is subject to supervision that is equivalent to that laid down in EU law; and
      2. (ii) cooperation between competent authorities is sufficiently ensured; and
  2. (2) the CIU's prospectus or equivalent document includes:
    1. (a) the categories of assets in which the CIU is authorised to invest; and
    2. (b) if investment limits apply, the relative limits and the methodologies to calculate them; and
  3. (3) the business of the CIU is reported on at least an annual basis to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period.

[Note: BCD Annex VI Part 1 point 77]

BIPRU 3.4.122

handbook-rule

If another EEA competent authority approves a third country CIU as eligible under a CRD implementation measure with respect to point 77(a) of Part 1 of Annex VI of the Banking Consolidation Directive then a firm may make use of this recognition.

[Note: BCD Annex VI Part 1 point 78]

BIPRU 3.4.123

handbook-rule

Where a firm is aware of the underlying exposures of a CIU, it may look through to those underlying exposures in order to calculate an average risk weight for the CIU in accordance with the standardised approach.

BIPRU 3.4.124

handbook-rule

Where a firm is not aware of the underlying exposures of a CIU, it may calculate an average risk weight for the CIU in accordance with the standardised approach subject to the following rules: it will be assumed that the CIU first invests, to the maximum extent allowed under its mandate, in the standardised credit risk exposure classes attracting the highest capital requirement, and then continues making investments in descending order until the maximum total investment limit is reached.

BIPRU 3.4.125

handbook-rule

A firm may rely on a third party to calculate and report, in accordance with the methods set out in BIPRU 3.4.123 R to BIPRU 3.4.124 R, a risk weight for the CIU provided that the correctness of the calculation and report is adequately ensured.

Other items

BIPRU 3.4.126

handbook-rule
BIPRU 3.4.127 R to BIPRU 3.4.133 R set out the treatment to be accorded to other items as referred to in BIPRU 3.2.9 R (16).

Treatment

BIPRU 3.4.127

handbook-rule

Tangible assets within the meaning of Article 4(10) of the Bank Accounts Directive must be assigned a risk weight of 100%.

[Note: BCD Annex VI Part 1 point 82]

BIPRU 3.4.128

handbook-rule

Prepayments and accrued income for which a firm is unable to determine the counterparty in accordance with the Bank Accounts Directive, must be assigned a risk weight of 100%.

[Note: BCD Annex VI Part 1 point 83]

BIPRU 3.4.129

handbook-rule

Cash items in the process of collection must be assigned a 20% risk weight. Cash in hand and equivalent cash items must be assigned a 0% risk weight.

BIPRU 3.4.130

handbook-rule

Holdings of equity and other participations except where deducted from capital resources must be assigned a risk weight of at least 100%.

BIPRU 3.4.131

handbook-rule

Gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities must be assigned a 0% risk weight.

[Note: BCD Annex VI Part 1 point 87]

BIPRU 3.4.132

handbook-rule

In the case of asset sale and repurchase agreements and outright forward purchases, the risk weight must be that assigned to the assets in question and not to the counterparties to the transactions.

BIPRU 3.4.133

handbook-rule

Where a firm provides credit protection for a number of exposures under terms that the nth default among the exposures triggers payment and that this credit event terminates the contract, and where the product has an external credit assessment from an eligible ECAI the risk weights prescribed in BIPRU 9 must be assigned. If the product is not rated by an eligible ECAI, the risk weights of the exposures included in the basket must be aggregated, excluding n-1 exposures, up to a maximum of 1250% and multiplied by the nominal amount of the protection provided by the credit derivative to obtain the risk weighted asset amount. The n-1 exposures to be excluded from the aggregation must be determined on the basis that they include those exposures each of which produces a lower risk weighted exposure amount than the risk weighted exposure amount of any of the exposures included in the aggregation.

[Note: BCD Annex VI Part 1 point 89]

BIPRU 3.4.134

handbook-rule

The exposure value for leases must be the discounted minimum lease payments. Minimum lease payments are the payments over the lease term that the lessee is or can be required to make and any bargain option (i.e. an option the exercise of which is reasonably certain). Any guaranteed residual value fulfilling the set of conditions in BIPRU 5.7.1 R (Eligibility), regarding the eligibility of protection providers as well as the minimum requirements for recognising other types of guarantees provided in BIPRU 5.7.6 R (Minimum requirements: General) to BIPRU 5.7.12 R(Additional requirements for guarantees) must also be included in the minimum lease payments. These exposures must be assigned to the relevant exposure class in accordance with BIPRU 3.2.9 R, BIPRU 3.2.10 R, BIPRU 3.2.11 R, BIPRU 3.2.12 R, BIPRU 3.2.13 R and BIPRU 3.2.14 G. When the exposure is a residual value of leased properties, the risk weighted exposure amounts must be calculated as follows:

1/t * 100% * exposure value;


where t is the greater of 1 and the nearest number of whole years of the lease term remaining.

[Note: BCD Annex VI Part 1, point 90]

BIPRU 3.5

Simplified method of calculating risk weights

  • 01/01/2007

BIPRU 3.5.1

handbook-guidance
This section (BIPRU 3.5) sets out a simplified approach to calculating risk weights. This approach is only relevant to an exposure class for which risk weights are determined by the ratings of a nominated ECAI or an export credit agency. For other exposure classes a firm should use the normal approach under the standardised approach.

BIPRU 3.5.2

handbook-guidance
The approach in this section is only likely to be relevant for a limited licence firm or a limited activity firm that has only incidental credit exposures and for whom it would be prohibitively costly to establish the systems needed to include the credit assessments of ECAIs and export credit agencies in its regulatory capital calculations. However the approach may be used by other firms if appropriate. A firm should notify the FSA if it adopts the approach in this section.

BIPRU 3.5.3

handbook-guidance
Rather than risk weighting exposures individually, a firm eligible to apply the simplified approach should apply a single risk weight to all exposures in each exposure class. The simplified risk weight for exposures in a particular class will be the risk weighting for unrated entities for each exposure class in which the external credit assessments influence risk weights.

BIPRU 3.5.4

handbook-guidance
The table in BIPRU 3.5.5 G has a summary of the risk weights that a firm should use if it uses the simplified method of calculating risk weights referred to in BIPRU 3.5.1 G.

BIPRU 3.5.5

handbook-guidance
Table : Simplified method of calculating risk weights
This table belongs to BIPRU 3.5.4 G.

BIPRU 3.5.6

handbook-guidance
If an exposure is guaranteed and if under BIPRU 5 the firm may treat the exposure as being to the guarantor, the simplified approach may be used for the guarantor. The key provisions are BIPRU 5.7.23 R to BIPRU 5.7.25 R.

BIPRU 3.5.7

handbook-guidance
If an exposure is collateralised and if under BIPRU 5 the firm may recognise the collateral, the simplified approach may be used to determine the risk weight to be applied to the collateralised exposure. The key provisions are BIPRU 5.4.18 R to BIPRU 5.4.21 R.

BIPRU 3.5.8

handbook-rule
If a firm does not nominate one or more eligible ECAIs as referred to in BIPRU 3.6.4 R the firm must not use the financial collateral comprehensive method.

BIPRU 3.6

Use of rating agencies' credit assessments for the determination of risk weights under the standardised approach to credit risk

  • 01/01/2007

BIPRU 3.6.1

handbook-rule

The use of ECAI credit assessments for the calculation of a firm's risk weighted exposure amounts must be consistent and in accordance with BIPRU 3.6. Credit assessments must not be used selectively.

[Note: BCD Article 83(1)]

BIPRU 3.6.2

handbook-rule

Where the FSA's recognition of an ECAI is not limited to its solicited credit assessments, a firm may use an unsolicited credit assessment of an eligible ECAI for the calculation of a firm's risk weighted exposure amounts.

[Note: BCD Article 83(2)]

BIPRU 3.6.3

handbook-guidance
The FSA's recognition of an ECAI may be limited to its solicited credit assessments. Where this is the case a firm should not use unsolicited assessments. The FSA may indicate that the unsolicited ratings of an eligible ECAI are not to be used for the purposes of BIPRU 3 if those assessments are considered to be inferior in quality to the general quality of solicited assessments or if it considers that the ECAI's strategy in relation to the issuing of unsolicited assessments is founded in the placing of undue pressure on the rated entity to pay for a rating.

Treatment

BIPRU 3.6.4

handbook-rule

A firm may nominate one or more eligible ECAIs to be used for the determination of risk weights to be assigned to asset and off-balance sheet items.

[Note: BCD Annex VI Part 3 point 1]

BIPRU 3.6.5

handbook-rule

A firm which decides to use the credit assessments produced by an eligible ECAI for a certain class of items must use those credit assessments consistently for all exposures belonging to that class.

[Note: BCD Annex VI Part 3 point 2]

BIPRU 3.6.6

handbook-rule

A firm which decides to use the credit assessments produced by an eligible ECAI must use them in a continuous and consistent way over time.

[Note: BCD Annex VI Part 3 point 3]

BIPRU 3.6.7

handbook-rule

A firm can only use ECAIs' credit assessments that take into account all amounts both in principal and in interest owed to it.

[Note: BCD Annex VI Part 3 point 4]

BIPRU 3.6.8

handbook-rule

If only one credit assessment is available from a nominated ECAI for a rated item, that credit assessment must be used to determine the risk weight for that item.

[Note: BCD Annex VI Part 3 point 5]

BIPRU 3.6.9

handbook-rule

If two credit assessments are available from nominated ECAIs and the two correspond to different risk weights for a rated item, the higher risk weight must be applied.

[Note: BCD Annex VI Part 3 point 6]

BIPRU 3.6.10

handbook-rule

If more than two credit assessments are available from nominated ECAIs for a rated item, the two assessments generating the two lowest risk weights must be referred to. If the two lowest risk weights are different, the higher risk weight must be assigned. If the two lowest risk weights are the same, that risk weight must be assigned.

[Note: BCD Annex VI Part 3 point 7]

BIPRU 3.6.11

handbook-rule
  1. (1) If a firm has decided to make use of the credit assessments of export credit agencies, when risk weighting exposures to central governments or central banks, if two or more credit assessments are available to a firm from export credit agencies or if credit assessments are available to a firm from both nominated ECAIs and export credit agencies, the firm must adopt the approach in this rule.
  2. (2) If two credit assessments are available and correspond to different risk weights for a rated item, the higher risk weight must be applied.
  3. (3) If more than two credit assessments are available for a rated item, the assessments generating the two lowest risk weights must be referred to:
    1. (a) if the two lowest risk weights are the same, that risk weight must be applied; or
    2. (b) if the two lowest risk weights are different, the higher of the two must be applied.
  4. (4) If a firm does not for the purposes of BIPRU 3 make any use of the consensus risk scores referred to in BIPRU 3.4.7 R (1) it may treat those scores as not being available to it for the purpose of this rule. Likewise, if a firm does not for the purposes of BIPRU 3 make any use of the credit assessments of a particular export credit agency as referred to in BIPRU 3.4.7 R (2) it may treat those assessments as not being available to it for the purpose of this rule.

Issuer and issue credit assessment

BIPRU 3.6.12

handbook-rule

Where a credit assessment exists for a specific issuing program or facility to which the item constituting the exposure belongs, this credit assessment must be used to determine the risk weight to be assigned to that item.

[Note: BCD Annex VI Part 3 point 8]

BIPRU 3.6.13

handbook-rule

Where no directly applicable credit assessment exists for a certain item, but a credit assessment exists for a specific issuing program or facility to which the item constituting the exposure does not belong or a general credit assessment exists for the issuer, then that credit assessment must be used if it produces a higher risk weight than would otherwise be the case or if it produces a lower risk weight and the exposure in question ranks pari passu or senior in all respects to the specific issuing program or facility or to senior unsecured exposures of that issuer as relevant.

[Note: BCD Annex VI Part 3 point 9]

BIPRU 3.6.14

handbook-rule

BIPRU 3.6.12 R and BIPRU 3.6.13 R are not to prevent the application of BIPRU 3.4.107 R to BIPRU 3.4.110 R (Exposures in the form of covered bonds).

[Note: BCD Annex VI Part 3 point 10]

BIPRU 3.6.15

handbook-rule
Credit assessments for issuers within a corporate group cannot be used as credit assessment of another issuer within the same corporate group.

[Note: BCD Annex VI Part 3 point 11]

Long-term and short-term credit assessments

BIPRU 3.6.16

handbook-rule

Short-term credit assessments may only be used for short-term asset and off-balance sheet items constituting exposures to institutions and corporates.

BIPRU 3.6.17

handbook-rule

Any short-term credit assessment may only apply to the item the short-term credit assessment refers to, and it must not be used to derive risk weights for any other item.

BIPRU 3.6.18

handbook-rule

Notwithstanding BIPRU 3.6.17 R, if a short-term rated facility is assigned a 150% risk weight, then all unrated unsecured exposures on that obligor whether short-term or long-term must also be assigned a 150% risk weight.

[Note: BCD Annex VI Part 3 point 14]

BIPRU 3.6.19

handbook-rule

Notwithstanding BIPRU 3.6.17 R, if a short-term rated facility is assigned a 50% risk weight, no unrated short-term exposure may be assigned a risk weight lower than 100%.

Domestic and foreign currency items

BIPRU 3.6.20

handbook-rule

A credit assessment that refers to an item denominated in the obligor's domestic currency cannot be used to derive a risk weight for another exposure on that same obligor that is denominated in a foreign currency.

BIPRU 3.6.21

handbook-rule

Notwithstanding BIPRU 3.6.20 R, when an exposure arises through a firm's participation in a loan that has been extended by a multilateral development bank whose preferred creditor status is recognised in the market, the credit assessment on the obligors' domestic currency item may be used for risk weighting purposes.

[Note: BCD Annex VI Part 3 point 17]

BIPRU 3.7

Classification of off-balance-sheet items

  • 01/01/2007

BIPRU 3.7.1

handbook-rule

In accordance with BIPRU 3.2.1 R (2) and BIPRU 3.2.2 R, a firm must:

  1. (1) assign an off-balance sheet item listed in the table in BIPRU 3.7.2 R to the risk category indicated in column 1 of that table; and
  2. (2) determine the exposure value of that item as the percentage of its value for the appropriate risk category as set out in column 3 of the table in BIPRU 3.7.2 R.

Table: Classification of off-balance-sheet items

BIPRU 3.7.2

handbook-rule
This table belongs to BIPRU 3.7.1 R
[Note: BCD Annex II]

BIPRU 3 Annex 1

Guidance on the standardised approach zero risk weighting for intra-group exposures

  • 01/01/2007

handbook-guidance
This flow chart belongs to BIPRU 3.2.25 R - BIPRU 3.2.35 R.

Flowchart - zero risk weighting for intra-group exposures

BIPRU 3 Annex 2

Regional governments and local authorities eligible for the treatment in BIPRU 3.4.15R

  • 01/01/2007

handbook-rule

BIPRU 3 Annex 3

High risk exposures

  • 01/01/2007

handbook-rule

BIPRU 3 Annex 4

Exposures to institutions: Interaction with short-term credit assessments in BIPRU 3.4.40R

  • 01/01/2007

handbook-guidance

Export chapter as

BIPRU 4

The IRB approach

BIPRU 4.1

The IRB approach: Application, purpose and overview

  • 01/01/2007

Application

BIPRU 4.1.1

handbook-rule
BIPRU 4 applies to a firm with an IRB permission.

Purpose

BIPRU 4.1.2

handbook-guidance

BIPRU 4 implements the following provisions of the Banking Consolidation Directive:

  1. (1) Articles 84 - 89; and
  2. (2) Annex VII.

BIPRU 4.1.3

handbook-guidance

BIPRU 4 also implements Annex VIII of the Banking Consolidation Directive so far as it applies to the IRB approach. In particular, it implements (in part):

  1. (1) from Part 1 of that Annex, points 12-16, 19-22, 26(g)(ii) and 27;
  2. (2) from Part 2 of that Annex, points 8-11; and
  3. (3) from Part 3 of that Annex, points 1, 11, 20, 23-24, 58(h), 61, 64-79 and 90-93.

BIPRU 4.1.4

handbook-guidance
BIPRU 4 also implements article 40 of the Capital Adequacy Directive as it applies to the IRB approach.

BIPRU 4.1.5

handbook-guidance
Other material on the IRB approach can be found in BIPRU 8 (Group risk), BIPRU 9 (Securitisation), BIPRU 13 (The calculation of exposure values for financial derivatives, securities financing transactions and long settlement transactions) and BIPRU 14 (Capital requirements for settlement and counterparty risk). BIPRU 5 (Credit risk mitigation) also contains material applicable to the IRB approach.

Overview

BIPRU 4.1.6

handbook-guidance
The IRB approach is an alternative to the standardised approach for calculating a firm's credit risk capital requirements. It may be applied to all a firm's exposures or to some of them, subject to various limitations on partial use as set out in BIPRU 4.2. Under the IRB approach capital requirements are based on a firm's own estimates of certain parameters together with other parameters set out in the Banking Consolidation Directive.

BIPRU 4.1.7

handbook-guidance
Exposures are divided into a number of distinct exposure classes. These are listed in BIPRU 4.3.2 R. There is a special treatment for purchased receivables, although they do not form an exposure class on their own.

BIPRU 4.1.8

handbook-guidance
For exposures in the sovereign, institution and corporate IRB exposure class, there is a foundation IRB approach under which a firm provides its own estimates of PD and an advanced IRB approach under which a firm additionally provides its own estimates of LGD and conversion factors. The distinction between the foundation IRB approach and the advanced IRB approach only applies to this IRB exposure class.

BIPRU 4.1.9

handbook-guidance
For retail exposures, a firm provides its own estimates of PD, LGD and conversion factors.

BIPRU 4.1.10

handbook-guidance
For the corporate exposure class there is a separate sub-class of specialised lending exposure. A firm may calculate risk weights for these exposures, where it is able to do so, in the same way as it does for the rest of its corporate exposure class, i.e. using the foundation IRB approach or the advanced IRB approach. Where a firm is not able to use this approach it may calculate risk weights for specialised lending exposures by slotting them into predetermined risk weights.

BIPRU 4.1.11

handbook-guidance
For equity exposures there are two approaches based on market based measures and a third under which a firm uses its own estimates of PD only.

IRB permissions: general

BIPRU 4.1.12

handbook-guidance
The rules in GENPRU and BIPRU do not allow a firm to use the IRB approach. A firm that wishes to use the IRB approach should therefore apply for permission to use the IRB approach using the application procedure explained in BIPRU 1.3. If a firm's application is granted, its terms will be set out in an IRB permission.

BIPRU 4.1.13

handbook-guidance
The FSA recognises that the nature of IRB approaches will vary between firms. The scope of and the requirements and conditions set out in an IRB permission may therefore differ in substance or detail from BIPRU 4 in order to address individual circumstances adequately. However any differences will only be allowed if they are compliant with the Banking Consolidation Directive. An IRB permission will implement any such variation by modifying the relevant provisions of GENPRU and BIPRU. An IRB permission may also include additional conditions to meet the particular circumstances of the firm.

BIPRU 4.1.14

handbook-guidance
  1. (1) The FSA will only grant an IRB permission if it is satisfied that the firm's systems for the management and rating of credit risk exposures are sound and implemented with integrity and, in particular, that they meet the standards in BIPRU 4.2.2 R in accordance with the minimum IRB standards.
  2. (2) Under BIPRU 4.2.11 R, a firm applying for an IRB permission is required to demonstrate that it has been using for the IRB exposure classes in question rating systems that were broadly in line with the minimum IRB standards for internal risk measurement and management purposes for at least three years prior to the date of its IRB permission.
  3. (3) Under BIPRU 4.2.13 R, a firm applying for the use of own estimates of LGDs and/or conversion factors should demonstrate that it has been estimating and employing own estimates of LGDs and/or conversion factors in a manner that was broadly consistent with the minimum IRB standards for use of own estimates for at least three years prior to the date of its IRB permission or of a variation of its IRB permission that, in either case, entitles the firm to use own estimates of LGDs and/or conversion factors.

Link to standard rules: Incorporation of the IRB output into the capital calculation

BIPRU 4.1.15

handbook-guidance
An IRB permission will modify GENPRU 2.1.51 R (Calculation of the credit risk capital requirement) by amending, to the extent set out in the IRB permission, the calculation of the credit risk capital requirement in accordance with BIPRU 4 and the other provisions of the Handbook relating to the IRB approach.

BIPRU 4.1.16

handbook-rule

A firm must calculate its credit risk capital component as the sum of:

  1. (1) (for exposures to which the standardised approach is applied) the credit risk capital component as calculated under BIPRU 3.1.5 R; and
  2. (2) (for exposures to which the IRB approach is applied to which the standardised approach would otherwise apply in accordance with BIPRU 3.1.5 R (Credit risk capital component)), 8% of the total of the firm's risk weighted exposure amounts calculated in accordance with the IRB approach.

BIPRU 4.1.17

handbook-guidance
For exposures covered by an IRB permission, BIPRU 5 (Credit risk mitigation) is modified by BIPRU 4.10.

BIPRU 4.1.18

handbook-guidance
Under BIPRU 4.9, a firm is required to deal with securitisation positions under those provisions of BIPRU 9 applicable to a firm using the IRB approach.

BIPRU 4.1.19

handbook-guidance
Exposures treated under BIPRU 13 are required to be dealt with in accordance with the IRB approach to the extent set out in BIPRU 13.

BIPRU 4.1.20

handbook-guidance
By modifying GENPRU 2.1.51 R to allow the firm to use the IRB approach to calculate all or part of its risk weighted exposure amounts, the FSA is treating it like an application rule. The modification means that the provisions of BIPRU relating to the IRB approach supersede the rules relating to the standardised approach for exposures coming within the scope of the IRB permission.

BIPRU 4.1.21

handbook-rule

A reference in the Handbook to a provision of the IRB approach, in the case of a firm:

  1. (1) excludes any provision of the IRB approach set out in the Handbook that is not applied to that firm by its IRB permission;
  2. (2) includes any additional provision contained in the firm's IRB permission; and
  3. (3) takes into account any other amendments made to the provisions in the Handbook relating to the IRB approach made by the firm's IRB permission.

BIPRU 4.1.22

handbook-rule
To the extent that a firm's IRB permission does not allow it to use a particular approach in the Handbook relating to the IRB approach the Handbook provision in question does not apply to the firm.

BIPRU 4.1.23

handbook-rule

If a provision of the Handbook relating to the IRB approach says that a firm may do something if its IRB permission allows it, a firm may do that thing unless its IRB permission expressly says that it may not do so except that:

  1. (1) BIPRU 4.2.18 R - BIPRU 4.2.19 R (Sequential implementation of IRB approach) and BIPRU 4.2.26 R (1)-BIPRU 4.2.26R (5) (Combined use of standardised approach with IRB approach) only apply if expressly permitted by a firm's IRB permission;
  2. (2) a firm may not use the advanced IRB approach for the sovereign, institution and corporate IRB exposure class except to the extent expressly permitted by the firm's IRB permission;
  3. (3) if a firm uses its own estimates of LGD and conversion factors it may only take into account unfunded credit protection to reduce LGD in the manner set out in its IRB permission;
  4. (4) if a firm uses its own estimates of LGD and conversion factors it may only recognise the effects of financial collateral under BIPRU 10.2.19 R (Firms using own estimates of LGD and conversion factors under the IRB approach) in the manner set out in its IRB permission;
  5. (5) a firm must deal with equity exposures in the manner set out in its IRB permission; and
  6. (6) (in the case of collateral that is only eligible for recognition under paragraph 21 of Part 1 of Annex VIII of the Banking Consolidation Directive (Other physical collateral)) a firm may not recognise as eligible collateral an item of a type referred to in BIPRU 4.10.16 R (Other physical collateral) unless that item is of a type specified as permitted in its IRB permission.

BIPRU 4.1.24

handbook-guidance

An IRB permission will set out firm-specific material. This will generally include:

  1. (1) details about the firm's methodology for carrying out the IRB approach, including the models and rating systems that a firm should use;
  2. (2) reporting requirements; and
  3. (3) requirements about internal control structure.

Compliance

BIPRU 4.1.25

handbook-rule

If a firm ceases to comply with the requirements of the IRB approach, it must either present to the FSA a plan for a timely return to compliance or demonstrate that the effect of non-compliance is immaterial.

[Note: BCD Article 84(5)]

BIPRU 4.1.26

handbook-guidance
If a firm ceases to comply with the requirements of the IRB approach, the FSA may revoke the IRB permission or take other appropriate supervisory action.

BIPRU 4.1.27

handbook-guidance
For the purposes of BIPRU 4.1.25 R, the FSA will expect a firm to demonstrate that, taking into account all instances where the firm has not complied with the requirements of the IRB approach, the effect of non-compliance is immaterial.

BIPRU 4.2

The IRB approach: High level material

  • 01/01/2007

Application

BIPRU 4.2.1

handbook-rule
This section applies to all exposures treated under the IRB approach.

General approach to granting an IRB permission

BIPRU 4.2.2

handbook-rule

A firm's systems for the management and rating of credit risk exposures must be sound and implemented with integrity and, in particular, they must meet the following standards in accordance with the minimum IRB standards:

  1. (1) the firm's rating systems provide for a meaningful assessment of obligor and transaction characteristics, a meaningful differentiation of risk and accurate and consistent quantitative estimates of risk;
  2. (2) internal ratings and default and loss estimates used in the calculation of capital requirements and associated systems and processes play an essential role in the risk management and decision-making process, and in the credit approval, internal capital allocation and corporate governance functions of the firm;
  3. (3) the firm has a credit risk control unit responsible for its rating systems that is appropriately independent and free from undue influence;
  4. (4) the firm collects and stores all relevant data to provide effective support to its credit risk measurement and management process; and
  5. (5) the firm documents its rating systems, the rationale for their design and validates its rating systems.

[Note: BCD Article 84(2) (part)]

BIPRU 4.2.3

handbook-rule

Where an EEA parent institution and its subsidiary undertakings or an EEA parent financial holding company and its subsidiary undertakings use the IRB approach on a unified basis, the question whether the minimum IRB standards are met is answered by considering the parent undertaking and its subsidiary undertakings together unless the firm's IRB permission specifies otherwise.

[Note: BCD Article 84(2) (part)]

Outsourcing

BIPRU 4.2.4

handbook-guidance
  1. (1) This guidance sets out the basis on which a firm may rely upon a rating system or data provided by another member of its group.
  2. (2) A firm may rely upon a rating system or data provided by another member of its group if the following conditions are satisfied:
    1. (a) the firm only does so to the extent that it is appropriate, given the nature and scale of the firm's business and portfolios and the firm's position within the group;
    2. (b) the group is an EEA banking and investment group;
    3. (c) the integrity of the firm's systems and controls is not adversely affected;
    4. (d) the outsourcing of these functions meets the requirements of SYSC; and
    5. (e) (if the provision of the rating system or data is not carried out in the United Kingdom or in the jurisdiction of the competent authority that is the lead regulator of the group) the firm can demonstrate to the FSA that the ability of the FSA and that lead regulator to carry out their responsibilities under the Handbook, the Banking Consolidation Directive and the Capital Adequacy Directive are not adversely affected.
  3. (3) If a firm does use a rating system or data provided by another member of its group, the requirements in BIPRU 4 continue to apply to that firm in respect of that rating system and data. A firm cannot absolve itself of the responsibility for complying with those requirements by claiming that any breach is caused by the actions of a third party to which the firm has delegated tasks. The rating system and data provision are still those of the firm, even though personnel elsewhere in the firm's group are carrying out these functions on its behalf. So any references in BIPRU to what a firm, its personnel and its management should and should not do still apply.
  4. (4) If a firm does use a rating system or data provided by another group member, the firm's governing body should formally delegate those functions to the persons or bodies that are to carry them out.
  5. (5) Before delegating the provision of a rating system or data to another group member, the firm's governing body should have explicitly considered the arrangement and decided that it is appropriate and that it enables the firm to meet the conditions in (2).

Assessment and estimation

BIPRU 4.2.5

handbook-guidance
  1. (1) This paragraph provides guidance on BIPRU 4.2.2 R and in particular BIPRU 4.2.2 R (1).
  2. (2) The information that a firm produces or uses for the purpose of the IRB approach should be reliable and take proper account of the different users of the information produced (customers, shareholders, regulators and other market participants).
  3. (3) A firm should establish quantified and documented targets and standards, against which it should test the accuracy of data used in its rating systems.
  4. (4) Tests under (3) might include:
    1. (a) report and accounts reconciliation, including completeness in relation to (b);
    2. (b) whether every exposure has a PD, LGD and, if applicable, conversion factor for reporting purposes;
    3. (c) whether the firm's risk control environment has key risk indicators for the purpose of monitoring and ensuring data accuracy;
    4. (d) whether the firm has an adequate business and information technology infrastructure with fully documented processes;
    5. (e) whether the firm has clear and documented standards on ownership of data (including inputs and manipulation) and timeliness of current data (daily, monthly, real time); and
    6. (f) whether the firm has a comprehensive quantitative audit programme.
  5. (5) The reconciliation referred to in 4(a) should be reasonably fit for purpose. In particular it should meet the standards in (6) and (7).
  6. (6) For data inputs, testing for accuracy of data, including the reconciliation referred to in 4(a), should be sufficiently detailed so that, together with other available evidence, it gives reasonable assurance that data input into the rating system is accurate, complete and appropriate. Input data fails the required standard if it gives rise to a serious risk of material misstatement in the capital requirement either immediately or subsequently.
  7. (7) For data outputs, the firm, as part of the reconciliation referred to in 4(a), should be able to identify and explain material differences between the outputs produced under accounting standards and those produced under the requirements of the IRB approach, including in relation to areas that address similar concepts in different ways (for example expected loss on the one hand and accounting provisions on the other).
  8. (8) A firm should have clear and documented standards and policies about the use of data in practice (including information technology standards) which should in particular cover the firm's approach to the following:
    1. (a) data access and security;
    2. (b) data integrity, including the accuracy, completeness, appropriateness and testing of data; and
    3. (c) data availability.

Further requirements concerning the use test

BIPRU 4.2.6

handbook-rule
If a firm uses separate models for the purpose of the IRB approach and for its internal purposes as referred to in BIPRU 4.2.2 R (2) it must be able to demonstrate the reasonableness of any differences between those models.

BIPRU 4.2.7

handbook-guidance
  1. (1) This paragraph provides guidance on BIPRU 4.2.2 R and in particular BIPRU 4.2.2 R (2).
  2. (2) The IRB approach as applicable to a firm should be an integral part of its business and risk management processes and procedures to the extent that credit risk is relevant to them. It should also have a substantial influence on its decision-making and actions.
    1. (a) particular regard should be had to the use of the IRB approach in:
      1. (i) credit approval;
      2. (ii) individual and portfolio limit setting;
      3. (iii) reporting of credit risk information; and
      4. (iv) provisioning;
    2. (b) other relevant aspects include:
      1. (i) assessment of economic capital;
      2. (ii) internal capital allocation so far as related to credit risk;
      3. (iii) risk appetite;
      4. (iv) strategy and acquisitions;
      5. (v) profitability and performance; and
      6. (vi) performance-related remuneration;
    3. (c) the carrying out of the firm's obligations under the overall Pillar 2 rule; and
    4. (d) matters relating to the firm's infrastructure, including information technology, skills and resources and organisational culture.

BIPRU 4.2.8

handbook-guidance
This paragraph provides further guidance on BIPRU 4.2.2 R and in particular BIPRU 4.2.2 R (2). In the FSA's view risk management has an essential role in informing risk decisions. However, an essential role does not necessarily mean an exclusive role or even always a primary role. There may be justifiable differences between the IRB approach and the firm's use of rating systems for its internal purposes as referred to in BIPRU 4.2.2 R (2). For example, internal standards and policies may refer to estimates of PD and LGD for the length of the asset rather than to estimates based on a one-year period (in the case of PD estimates) or on an economic downturn (in the case of LGD estimates) required by the IRB approach.

BIPRU 4.2.9

handbook-guidance
If a firm uses scorecards for its internal credit approval process and the models it uses for the purpose of the IRB approach are fundamentally different from those scorecards, a firm's demonstration of how this is compatible with BIPRU 4.2.2 R (2) might include demonstrating that estimates calculated under the IRB approach are used to change sanctioning decisions at an individual or portfolio level. Examples of this might include amending cut-offs, the application of policy rules, the revision of an existing scorecard or the introduction of a new one or taking strategic decisions on which segments of the market to target.

BIPRU 4.2.10

handbook-guidance
To the extent that a firm uses LGD estimates in its internal risk management processes that differ from the downturn LGDs used in the calculation of risk weighted assets (see BIPRU 4.3.103 R), the reasons for the difference should be documented in accordance with BIPRU 4.3.109 R.

Requirements concerning the experience requirement

BIPRU 4.2.11

handbook-rule

A firm must be able to demonstrate that it has been using for the IRB exposure classes in question rating systems that were broadly in line with the minimum IRB standards for internal risk measurement and management purposes for at least three years prior to the date of its IRB permission.

[Note: BCD Article 84(3)]

BIPRU 4.2.12

handbook-guidance

In meeting the experience requirement under BIPRU 4.2.11 R, the FSA would expect a firm to be able to demonstrate that it has been:

  1. (1) operating an internal rating system with estimates of PD;
  2. (2) meeting the standards in BIPRU 4 for senior management knowledge and reporting; and
  3. (3) meeting the standards in BIPRU 4 relating to the use of rating systems in its business;

for the required minimum 3 year period.

BIPRU 4.2.13

handbook-rule

A firm that has applied for the use of own estimates of LGDs and/or conversion factors must be able to demonstrate to the FSA that it has been estimating and employing own estimates of LGDs and/or conversion factors in a manner that was broadly consistent with the minimum IRB standards for use of own estimates of those parameters for at least three years prior to the date of its IRB permission or of a variation of its IRB permission that, in either case, entitled the firm to use own estimates of LGDs and/or conversion factors.

[Note: BCD Article 84(4)]

BIPRU 4.2.14

handbook-guidance

In meeting the experience requirement under BIPRU 4.2.13 R, the FSA would expect a firm to be able to demonstrate that it has been:

  1. (1) operating an internal rating system with estimates of LGD and with conversion factors; and
  2. (2) compliant with BIPRU 4.2.11 R as applied to the advanced IRB approach.

for the required minimum 3 year period.

BIPRU 4.2.15

handbook-guidance
In the FSA's view the standard required by BIPRU 4.2.11 R and BIPRU 4.2.13 R is for a rating system to be improved in the light of experience during the three year period so that it meets the minimum requirements more fully for the last year than for the two prior years, provided that the rating system has not changed so profoundly that experience from the first or second years becomes of marginal relevance in assessing the reliability of the changed rating system.

Implementation of the internal ratings based approach

BIPRU 4.2.16

handbook-rule
A firm must comply with any requirements in its IRB permission relating to the matters described in BIPRU 4.2.17 R - BIPRU 4.2.35 G.

BIPRU 4.2.17

handbook-rule

Without prejudice to BIPRU 4.2.26 R, a firm and any parent undertaking and its subsidiary undertakings must implement the IRB approach for all exposures.

[Note: BCD Article 85(1) (part)]

BIPRU 4.2.18

handbook-rule

To the extent that a firm's IRB permission permits this, implementation may be carried out sequentially across the different IRB exposure classes within the same business unit, across different business units in the same group or for the use of own estimates of LGDs or conversion factors for the calculation of risk weights for the sovereign, institution and corporate IRB exposure class.

BIPRU 4.2.19

handbook-rule

In the case of the retail exposures, implementation may (but only to the extent provided for in the firm's IRB permission) be carried out sequentially across the categories of exposures to which the different correlations in BIPRU 4.6.41 R-BIPRU 4.6.44 R correspond.

[Note: BCD Article 85(1) (part)]

BIPRU 4.2.20

handbook-rule
  1. (1) Implementation of the IRB approach as referred to in BIPRU 4.2.18 R must be carried out within a reasonable period of time as set out in the IRB permission.
  2. (2) The implementation must be carried out subject to strict conditions determined by the FSA and set out in the IRB permission.
  3. (3) A firm must not use the flexibility under BIPRU 4.2.18 R selectively with the purpose of achieving reduced minimum capital requirements in respect of those IRB exposure classes or business units that are yet to be included in the IRB approach or in the use of own estimates of LGDs and conversion factors.


[Note: BCD Article 85(2)]

BIPRU 4.2.21

handbook-guidance
  1. (1) A firm should achieve full roll-out of the IRB approach to all its exposures, subject to the exemptions outlined in BIPRU 4.2.26 R, within the period specified in its IRB permission. A firm should not retain a permanent mix of portfolios on the standardised approach and the IRB approach, on the foundation IRB approach and the advanced IRB approach or on a mixture of all approaches with the exception of portfolios covered by those exemptions.
  2. (2) This applies to a move:
    1. (a) from the standardised approach to the IRB approach;
    2. (b) from the foundation IRB approach to the advanced IRB approach; and
    3. (c) from the transitional rules and guidance for BIPRU to the IRB approach.
  3. (3) The period referred to in BIPRU 4.2.20 R (1) will generally be not more than three years of starting use of the IRB approach or the advanced IRB approach as applicable.

BIPRU 4.2.22

handbook-rule

A firm using the IRB approach for any IRB exposure class must at the same time use the IRB approach for the equity exposure class.

[Note: BCD Article 85(3)]

BIPRU 4.2.23

handbook-rule

Subject to BIPRU 4.2.17 R - BIPRU 4.2.20 R, BIPRU 4.2.22 R and BIPRU 4.2.26 R, a firm that has an IRB permission must not use the standardised approach for the calculation of risk weighted exposure amounts for the exposures to which the IRB approach applies under the IRB permission.

[Note: BCD Article 85(4)]

BIPRU 4.2.24

handbook-rule

Subject to BIPRU 4.2.17 R - BIPRU 4.2.22 R and BIPRU 4.2.26 R, a firm whose IRB permission provides for the use of the advanced IRB approach for the calculation of LGDs and conversion factors for the sovereign, institution and corporate IRB exposure class must not use the LGD values and conversion factors applicable to the foundation IRB approach for the exposures to which the advanced IRB approach applies under the IRB permission.

[Note: BCD Article 85(5)]

BIPRU 4.2.25

handbook-guidance
The FSA will not agree to a firm's request to revoke or vary its IRB permission so as to permit the firm to revert to the standardised approach except for demonstrated good cause. Likewise, the FSA will not agree to a firm's request to revoke or vary its IRB permission so as to permit the firm to revert to the foundation IRB approach if the IRB permission provides for it to use the advanced IRB approach, except for demonstrated good cause.

Combined use of methodologies: Basic provisions

BIPRU 4.2.26

handbook-rule
  1. (1) To the extent that its IRB permission permits this, a firm permitted to use the IRB approach in the calculation of risk weighted exposure amounts and expected loss amounts for one or more IRB exposure classes may apply the standardised approach in accordance with this rule.
  2. (2) A firm may apply the standardised approach to the IRB exposure class referred to in BIPRU 4.3.2 R (1) (Sovereigns) where the number of material counterparties is limited and it would be unduly burdensome for the firm to implement a rating system for these counterparties. A firm may include in this treatment an exposure of the type described in BIPRU 3.4.18 R (Exposures to churches or religious communities) that would fall within BIPRU 3.4.15 R or BIPRU 3.4.17 R (Exposure to a regional government or local authority) if those provisions had not been excluded by BIPRU 3.4.18 R.
  3. (3) A firm may apply the standardised approach to the IRB exposure class referred to in BIPRU 4.3.2 R (2) (Institutions), where the number of material counterparties is limited and it would be unduly burdensome for the firm to implement a rating system for these counterparties.
  4. (4) A firm may apply the standardised approach to exposures in non-significant business units as well as IRB exposure classes that are immaterial in terms of size and perceived risk profile.
  5. (5) A firm may apply the standardised approach to exposures to the central governments of EEA States and their regional governments, local authorities and administrative bodies, provided that:
    1. (a) there is no difference in risk between the exposures to the central government and those other exposures because of specific public arrangements; and
    2. (b) exposures to the central government are assigned a 0% risk weight under the standardised approach.
  6. (6) A firm may apply the standardised approach to exposures of a firm to a counterparty which is its parent undertaking, its subsidiary undertaking or a subsidiary undertaking of its parent undertaking provided that the counterparty is an institution, a financial holding company, a financial institution, an asset management company or an ancillary services undertaking subject to appropriate prudential requirements.
  7. (7) A firm may apply the standardised approach to equity exposures to entities whose credit obligations qualify for a 0% risk weight under the standardised approach (including those publicly sponsored entities where a zero risk weight can be applied).
  8. (8) A firm may apply the standardised approach to equity exposures incurred under legislative programmes to promote specified sectors of the economy that provide significant subsidies for the investment to the firm and involve some form of government oversight and restrictions on the equity investments. This exclusion is limited to an aggregate of 10% of capital resources.
  9. (9) A firm may apply the standardised approach to the exposures identified in BIPRU 3.4.48 R (Exposures in the form of minimum reserves required by the European Central Bank or by the central bank of an EEA State) meeting the conditions specified therein.
  10. (10) A firm may apply the standardised approach to state and state-reinsured guarantees pursuant to BIPRU 5.7.12 R (Conditions for state and state-reinsured guarantees).

[Note: BCD Article 89(1)]

Combined use of methodologies: Documentation

BIPRU 4.2.27

handbook-guidance
As part of the application for an IRB permission, a firm should have a well documented policy explaining the basis on which exposures are to be selected for permanent exemption from the IRB approach and for treatment under the standardised approach. The firm's roll out plan should also contain provisions for the continuing application of that policy on a consistent basis over time.

Combined use of methodologies: Sovereign and institutional, exposures

BIPRU 4.2.28

handbook-guidance
A firm intending to make use of BIPRU 4.2.26 R (2) or BIPRU 4.2.26 R (3) should demonstrate to the FSA when applying for an IRB permission that it meets the requirements of those provisions with respect to its sovereign or, as the case may be, institutional, exposures.

Combined use of methodologies: Meaning of non-significance and immateriality

BIPRU 4.2.29

handbook-rule

For the purposes of BIPRU 4.2.26 R (4), the equity exposure IRB exposure class of a firm must be considered material if its aggregate value, excluding equity exposures incurred under legislative programmes as referred to in BIPRU 4.2.26 R (8) but including exposures in a CIU treated as equity exposures in accordance with BIPRU 4.9.11 R to BIPRU 4.9.15 R, exceeds, on average over the preceding year, 10% of the firm's capital resources. If the number of those equity exposures is less than 10 individual holdings, that threshold is 5% of the firm's capital resources.

[Note: BCD Article 89(2)]

BIPRU 4.2.30

handbook-rule
  1. (1) This rule sets out what must be treated as being non-significant business or immaterial for the purposes of BIPRU 4.2.26 R (4), for exposures that do not fall within the equity exposure IRB exposure class.
  2. (2) A firm may elect permanently to exclude exposures from the IRB approach and apply the standardised approach. However a firm may only make use of this exemption to the extent that:
    1. (a) the consolidated credit risk requirement (adjusted under (6)) so far as it is attributable to the excluded exposures;
  3. would be no more than 15% of:
    1. (b) the consolidated credit risk requirement (adjusted under (6)) with respect to all exposures (including the ones dealt with under (a)).
  4. (3) Exposures excluded under BIPRU 4.2.29 R or BIPRU 4.2.26 R (2), BIPRU 4.2.26 R (3) and BIPRU 4.2.26 R (5)-BIPRU 4.2.26 R (7) must not be included in (a) or (b).
  5. (4) The calculation in (2)(a) is based on the standardised approach.
  6. (5) The calculation in (2)(b) is based on whichever of the standardised approach and the IRB approach would apply to the exposures referred to in (2)(b) at the time when the calculation is being made.
  7. (6) The consolidated credit risk requirement is adjusted for the purposes of this rule as follows:
    1. (a) the element based on the concentration risk capital component is excluded, with only the elements based on the credit risk capital component and the counterparty risk capital component being taken into account; and
    2. (b) the calculation is carried out with respect to the group of undertakings referred to in BIPRU 4.2.17 R.
  8. (7) If a group with respect to which the calculation in this rule is being carried out is not required to calculate the consolidated credit risk requirement, the calculations in this rule must be carried out as if it were.

BIPRU 4.2.31

handbook-rule

If a firm applies to use the advanced IRB approach for the sovereign, institution and corporate IRB exposure class, BIPRU 4.2.26 R (4) also applies with respect to exposures in that class. For these purposes, to the extent permitted in the firm's IRB permission, a firm may:

  1. (1) exclude some exposures from the IRB approach and apply the standardised approach to those exposures; and
  2. (2) exclude other exposures from the advanced IRB approach and apply the foundation IRB approach to those exposures.

BIPRU 4.2.32

handbook-guidance

Where BIPRU 4.2.31 R applies:

  1. (1) the 15% limit in BIPRU 4.2.30 R (2) is a combined limit for excluded exposures remaining on the standardised approach and excluded exposures remaining on the foundation IRB approach; and
  2. (2) the calculation in BIPRU 4.2.30 R (2)(a) is carried out under whichever method of calculation would be applicable to the exposure in question.

Combined use of methodologies: Territorial aspects

BIPRU 4.2.33

handbook-guidance
  1. (1) This guidance sets out at what level the tests in BIPRU 4.2.30 R- BIPRU 4.2.32 G will be applied in the case of a firm that is a member of a group that is part of a bigger group.
  2. (2) If an EEA banking and investment group for which the FSA is the lead regulator is part of a wider EEA banking and investment group for which the FSA is also lead regulator then BIPRU 4.2.30 R- BIPRU 4.2.32 G apply with respect to that wider group.
  3. (3) If an EEA banking and investment group for which the FSA is the lead regulator is part of a wider EEA banking and investment group for which another competent authority is lead regulator then BIPRU 4.2.26 R (4) applies with respect to that wider group but the requirements of that lead regulator will generally apply in place of BIPRU 4.2.30 R- BIPRU 4.2.32 G.
  4. (4) If an EEA banking and investment group for which the FSA is the lead regulator is part of a wider third-country banking and investment group that is subject to equivalent supervision by a regulatory authority outside the EEA, then BIPRU 4.2.26 R (4) applies with respect to both that wider group and the sub-group of which the FSA is lead regulator. However the requirements of that third country regulator apply in place of BIPRU 4.2.30 R- BIPRU 4.2.32 G. The question of whether supervision is equivalent is decided in accordance with GENPRU 3.2 (Third country groups).
  5. (5) If an EEA banking and investment group for which the FSA is the lead regulator is part of a wider third-country banking and investment group that is not subject to equivalent supervision by a regulatory authority outside the EEA, then BIPRU 4.2.30 R- BIPRU 4.2.32 G will apply. BIPRU 4.2.30 R- BIPRU 4.2.32 G will apply to the whole group if GENPRU 3.2.9 R (Supervision by analogy) applies. If GENPRU 3.2.4 G (Alternative measures) applies, BIPRU 4.2.30 R- BIPRU 4.2.32 G will apply to the EEA banking and investment group.
  6. (6) In the case of a group described in (2) or (3) in respect of which the Article 129 procedure applies then BIPRU 4.2.26 R (4) applies with respect to that wider group. The detailed requirements that apply will be decided in accordance with that procedure.

Combined use of methodologies: Intra-group exposures

BIPRU 4.2.34

handbook-guidance
  1. (1) Generally, the FSA will consider excluding, through a firm's IRB permission, exposures falling into BIPRU 4.2.26 R (6) from the IRB approach. The degree to which this exclusion applies will be set out in the firm's IRB permission.
  2. (2) Exposures excluded under (1) will be eligible for a 0% risk weight under the standardised approach if they satisfy the conditions in BIPRU 3.2.25 R to BIPRU 3.2.27A R (Zero risk weight for certain intra-group exposures).
  3. (3) Exposures to or holdings in any non-financial undertakings in a firm's group are not eligible for permanent exemption from the IRB approach under BIPRU 4.2.26 R (6), as they are not subject to consolidated supervision. It is also the FSA's policy that exposures to or holdings in any insurance undertaking are ineligible. Such exposures should remain on the IRB approach unless excluded under another part of BIPRU 4.2.26 R.
  4. (4) If a firm uses the exemption in (1) it should have a policy that:
    1. (a) provides for the identification of connected counterparties excluded under (1);
    2. (b) identifies exposures that would be permanently exempted from the IRB approach under (1); and
    3. (c) identifies the connected counterparty exposures that are not permitted to be permanently exempted from the IRB approach under (1).
  5. (5) The policy in (4) should be applied consistently to all exposures excluded under (1).

Combined use of methodologies: Purchase of a new businesses

BIPRU 4.2.35

handbook-guidance
  1. (1) This guidance deals with some possible effects of acquiring a major new business after the grant of an IRB permission.
  2. (2) A firm should if possible ensure that the exposures arising through the acquisition are dealt with in accordance with the firm's IRB permission.
  3. (3) If the acquisition is made during the currency of a roll out plan under BIPRU 4.2.18 R, a firm should ensure that the exposures arising through the acquisition are dealt with in accordance with that plan. For these purposes the existing and the acquired business should be considered together. The whole of the firm's business, including the newly acquired business, should be included in both the denominator and numerator of the fraction in BIPRU 4.2.30 R.
  4. (4) If a firm cannot comply with (2) the FSA will consider an application to vary the firm's IRB permission in order to deal with the acquisition. For example the FSA may agree to extend the time by which the roll out should be completed (see BIPRU 4.2.20 R). However any such variation should be consistent with the provisions of BIPRU 4.2 that would have applied if the acquisition had been included in the firm's original application for an IRB permission.
  5. (5) If the acquisition is made after a firm has completed its roll out under BIPRU 4.2.18 R the FSA will not in general agree to an application to treat an exposure:
    1. (a) under the standardised approach if it would otherwise be treated under the IRB approach under the firm's IRB permission; or
    2. (b) under the foundation IRB approach if it would otherwise be treated under the advanced IRB approach under the firm's IRB permission.
  6. (6) Any application to disapply the policy in (5) will be treated in accordance with the approach set out in BIPRU 4.2.25 G.
  7. (7) The FSA will also adopt the approach in (5) while a roll out plan is in progress if, in relation to an exposure of a particular type, the period for completion of the roll out for those exposures under that plan has ended.

BIPRU 4.3

The IRB approach: Provisions common to different exposure classes

  • 01/01/2007

Application

BIPRU 4.3.1

handbook-rule
This section applies to all exposures treated under the IRB approach.

Exposure classes

BIPRU 4.3.2

handbook-rule

Each exposure must be assigned to one of the following exposure classes:

  1. (1) claims or contingent claims on central governments and central banks;
  2. (2) claims or contingent claims on institutions;
  3. (3) claims or contingent claims on corporates;
  4. (4) retail claims or contingent retail claims;
  5. (5) equity claims;
  6. (6) securitisation positions; and
  7. (7) non credit-obligation assets.

[Note: BCD Article 86(1)]

BIPRU 4.3.3

handbook-rule

The methodology used by a firm for assigning exposures to different IRB exposure classes must be appropriate and consistent over time.

[Note: BCD Article 86(9)]

Calculation of risk weighted exposure amounts

BIPRU 4.3.4

handbook-rule

The risk weighted exposure amounts for credit risk for exposures belonging to one of the exposure classes referred to in (1) to (4) must, unless deducted from capital resources, be calculated in accordance with the following provisions:

  1. (1) for exposures in the sovereign, institution and corporate IRB exposure class, BIPRU 4.4.57 R to BIPRU 4.4.60 R, BIPRU 4.4.79 R, BIPRU 4.5.8 R to BIPRU 4.5.10 R (for specialised lending exposures), BIPRU 4.9.3 R and BIPRU 4.8.16 R to BIPRU 4.8.17 R (for purchased corporate exposure receivables);
  2. (2) for exposures in the retail exposure class, BIPRU 4.6.41 R to BIPRU 4.6.44 R, BIPRU 4.6.57 R and BIPRU 4.8.18 R to BIPRU 4.8.20 R (for purchased retail exposure receivables);
  3. (3) for exposures in the equity exposure class, BIPRU 4.7.5 R to BIPRU 4.7.6 R, BIPRU 4.7.9 R to BIPRU 4.7.11 R, BIPRU 4.7.14 R to BIPRU 4.7.16 R and BIPRU 4.7.24 R to BIPRU 4.7.25 R; and
  4. (4) for exposures in the non credit-obligation assets exposure class, BIPRU 4.9.6 R.

[Note: BCD Article 87(1)]

BIPRU 4.3.5

handbook-rule

The calculation of risk weighted exposure amounts for credit risk and dilution risk must be based on the relevant parameters associated with the exposure in question. These include probability of default (PD), loss given default (LGD), maturity (M) and the exposure value of the exposure. PD and LGD may be considered separately or jointly, in accordance with the provisions relating to PD and LGD in BIPRU 4.4, BIPRU 4.6, BIPRU 4.7 and BIPRU 4.8 at:

  1. (1) for exposures in the sovereign, institution and corporate IRB exposure class, BIPRU 4.4.34 R - BIPRU 4.4.35 R, BIPRU 4.4.42 R to BIPRU 4.4.43 R, BIPRU 4.4.63 R - BIPRU 4.4.66 R, BIPRU 4.4.80 R and, for PD and LGD for dilution risk of purchased corporate exposure receivables, BIPRU 4.8.23 Rand BIPRU 4.8.26 R;
  2. (2) for exposures in the retail exposure class, BIPRU 4.6.50 R - BIPRU 4.6.54 R, BIPRU 4.6.58 R, and, for PD and LGD for dilution risk of purchased retail exposure receivables, BIPRU 4.8.24 R and BIPRU 4.8.27 R; and
  3. (3) for exposures in the equity exposure class, BIPRU 4.7.18 R and BIPRU 4.7.20 R - BIPRU 4.7.21 R.

[Note: BCD Article 87(3)]

Calculation of expected loss amounts

BIPRU 4.3.6

handbook-rule

The expected loss amounts for exposures belonging to one of the IRB exposure classes referred to in (1) to (3) must be calculated in accordance with the methods set out in the following provisions:

  1. (1) for exposures in the sovereign, institution and corporate IRB exposure class, BIPRU 4.4.61 R to BIPRU 4.4.62 R and (for specialised lending exposures) BIPRU 4.5.13 R to BIPRU 4.5.15R;
  2. (2) for exposures in the retail exposure class, BIPRU 4.6.47 R to BIPRU 4.6.48 R;
  3. (3) for exposures in the equity exposure class, BIPRU 4.7.12 R, BIPRU 4.7.17 R and BIPRU 4.7.26 R; and
  4. (4) (for purchased receivables falling into one of the IRB exposure classes in (1) to (3)) BIPRU 4.8.30 R.

[Note: BCD Article 88(1)]

BIPRU 4.3.7

handbook-rule

The calculation of expected loss amounts in accordance with BIPRU 4.3.6 R must be based on the same input figures of PD, LGD and the exposure value for each exposure as being used for the calculation of risk weighted exposure amounts in accordance with BIPRU 4. For defaulted exposures, where a firm uses its own estimate of LGDs, EL must be the firm's best estimate of expected loss (ELBE), for the defaulted exposure in accordance with BIPRU 4.3.122 R.

[Note: BCD Article 88(2)]

Treatment of expected loss amounts

BIPRU 4.3.8

handbook-rule

The expected loss amounts calculated in accordance with BIPRU 4.3.6 R (1), BIPRU 4.3.6 R (2) and BIPRU 4.3.6 R (4) must be subtracted from the sum of value adjustments and provisions related to these exposures. Discounts on balance sheet exposures purchased when in default according to BIPRU 4.4.71 R must be treated in the same manner as value adjustments. Expected loss amounts for securitised exposures and value adjustments and provisions related to these exposures must not be included in this calculation.

[Note: BCD Annex VII Part 1 point 36]

Corporate governance

BIPRU 4.3.9

handbook-rule

All material aspects of the rating and estimation processes must be approved by the firm's governing body or a designated committee thereof and senior management. These parties must possess a general understanding of the firm's rating systems and detailed comprehension of its associated management reports.

[Note: BCD Annex VII Part 4 point 124]

BIPRU 4.3.10

handbook-guidance
  1. (1) A firm's governing body or designated committee may choose to approve only material aspects of the firm's rating systems and material changes to the firm's rating systems.
  2. (2) Where a firm's governing body or designated committee chooses to approve only material aspects of the firm's rating systems and material changes to the firm's rating systems:
    1. (a) the firm's governing body or designated committee should define the firm's overall approach to material aspects of rating and estimation processes for all rating systems, including non-material rating systems and approve a policy statement defining that approach; and
    2. (b) the firm should define and document the process for approval of non-material aspects of the firm's rating systems.

BIPRU 4.3.11

handbook-rule

Senior management must provide notice to the governing body or a designated committee thereof of material changes or exceptions from established policies that will materially impact the operations of the firm's rating systems.

[Note: BCD Annex VII Part 4 point 125]

BIPRU 4.3.12

handbook-guidance

Where the firm's rating systems are used on a unified basis for the parent undertaking and its subsidiary undertakings under BIPRU 4.2.3 R, and approval and reporting of the ratings systems are carried out at the group level, the governance requirements in BIPRU 4.3.9 R and BIPRU 4.3.11 R may be met if:

  1. (1) the subsidiary undertakings have delegated to the governing body or designated committee of the EEA parent institution or EEA parent financial holding company responsibility for approval of the firm's rating systems;
  2. (2) the governing body or designated committee of the EEA parent institution or EEA parent financial holding company approves either:
    1. (a) all aspects of the firm's rating systems, and material changes; or
    2. (b) all aspects of the firm's rating systems that are material in the context of the group, and material changes to those, and a policy statement defining the overall approach to material aspects of rating and estimation processes for all rating systems, including non-material rating systems.

BIPRU 4.3.13

handbook-rule

Senior management must have a good understanding of the rating system's designs and operations. Senior management must ensure on an ongoing basis that the rating systems are operating properly. Senior management must be regularly informed by the credit risk control units about the performance of the rating process, areas needing improvement, and the status of efforts to improve previously identified deficiencies.

[Note: BCD Annex VII Part 4 point 126]

BIPRU 4.3.14

handbook-rule

Internal ratings-based analysis of the firm's credit risk profile must be an essential part of the management reporting required under BIPRU 4.3.9 R, BIPRU 4.3.11 R and BIPRU 4.3.13 R. Reporting must include at least risk profile by grade, migration across grades, estimation of the relevant parameters per grade, and comparison of realised default rates and, to the extent that own estimates are used, of realised LGDs and realised conversion factors against expectations and stress-test results. Reporting frequencies must depend on the significance and type of information and the level of the recipient.

[Note: BCD Annex VII Part 4 point 127]

Credit risk control

BIPRU 4.3.15

handbook-rule

The credit risk control unit must be independent from the personnel and management functions responsible for originating or renewing exposures and report directly to senior management. The unit must be responsible for the design or selection, implementation, oversight and performance of the rating systems. It must regularly produce and analyse reports on the output of the rating systems.

BIPRU 4.3.16

handbook-rule

The areas of responsibility for the credit risk control unit(s) must include the following:

  1. (1) testing and monitoring grades and pools;
  2. (2) production and analysis of summary reports from the firm's rating systems;
  3. (3) implementing procedures to verify that grade and pool definitions are consistently applied across departments and geographic areas;
  4. (4) reviewing and documenting any changes to the rating process, including the reasons for the changes;
  5. (5) reviewing the rating criteria to evaluate if they remain predictive of risk (and changes to the rating process, criteria or individual rating parameters must be documented and retained);
  6. (6) active participation in the design or selection, implementation and validation of models used in the rating process;
  7. (7) oversight and supervision of models used in the rating process; and
  8. (8) ongoing review and alterations to models used in the rating process.

[Note: BCD Annex VII Part 4 point 129]

BIPRU 4.3.17

handbook-rule

Notwithstanding BIPRU 4.3.16 R, a firm using pooled data according to BIPRU 4.3.92 R - BIPRU 4.3.94 R (Overall requirements for estimation) may outsource the following tasks:

  1. (1) production of information relevant to testing and monitoring grades and pools;
  2. (2) production of summary reports from the firm's rating systems;
  3. (3) production of information relevant to review of the rating criteria to evaluate if they remain predictive of risk;
  4. (4) documentation of changes to the rating process, criteria or individual rating parameters; and
  5. (5) production of information relevant to ongoing review and alterations to models used in the rating process.

[Note: BCD Annex VII Part 4 point 130 (part)]

BIPRU 4.3.18

handbook-rule

A firm making use of BIPRU 4.3.17 R must ensure that the FSA has access to all relevant information from the third party that is necessary for examining compliance with the minimum IRB standards and the firm's IRB permission and that the FSA may perform on-site examinations to the same extent as within the firm.

[Note: BCD Annex VII Part 4 point 130 (part)]

Documentation of rating systems

BIPRU 4.3.19

handbook-rule

A firm must document the design and operational details of its rating systems. The documentation must evidence compliance with the minimum IRB standards and the firm's IRB permission, and address topics including portfolio differentiation, rating criteria, responsibilities of parties that rate obligors and exposures, frequency of assignment reviews, and management oversight of the rating process.

[Note: BCD Annex VII Part 4 point 31]

BIPRU 4.3.20

handbook-rule
A firm must ensure that all documentation relating to its rating systems or otherwise required by the rules governing the IRB approach are stored, arranged and indexed in such a way that the firm would be able to make them all available to the FSA, or to make any class or description of them specified by the FSA available to the FSA, immediately on demand or within a short time thereafter.

BIPRU 4.3.21

handbook-rule

A firm must document the rationale for and analysis supporting its choice of rating criteria. A firm must document all major changes in the risk rating process, and such documentation must support identification of changes made to the risk rating process subsequent to the last review by the FSA. The organisation of rating assignment including the rating assignment process and the internal control structure must also be documented.

[Note: BCD Annex VII Part 4 point 32]

BIPRU 4.3.22

handbook-rule

A firm must document the specific definitions of default and loss used internally and demonstrate consistency with the definitions of default and loss set out in the glossary and BIPRU 4.

BIPRU 4.3.23

handbook-guidance
A firm's documentation relating to data should include clear identification of responsibility for data quality. A firm should set standards for data quality and aim to improve them over time. A firm should measure its performance against those standards. A firm should ensure that its data is of high enough quality to support its risk management processes and the calculation of its capital requirements.

BIPRU 4.3.24

handbook-rule

Where a firm employs statistical models in the rating process, the firm must document its methodologies. This material must:

  1. (1) provide a detailed outline of the theory, assumptions and/or mathematical and empirical basis of the assignment of estimates to grades, individual obligors, exposures, or pools, and the data source(s) used to estimate the model;
  2. (2) establish a rigorous statistical process (including out-of-time and out-of-sample performance tests) for validating the model; and
  3. (3) indicate any circumstances under which the model does not work effectively.

[Note: BCD Annex VII Part 4 point 34]

Rating systems

BIPRU 4.3.25

handbook-rule
A rating system comprises all of the methods, processes, controls, data collection and IT systems that support the assessment of credit risk, the assignment of exposures to grades or pools (rating), and the quantification of default and loss estimates for a certain type of exposure.

[Note: BCD Annex VII Part 4 point 1]

BIPRU 4.3.26

handbook-rule

If a firm uses multiple rating systems, the rationale for assigning an obligor or a transaction to a rating system must be documented and applied in a manner that appropriately reflects the level of risk.

[Note: BCD Annex VII Part 4 point 2]

BIPRU 4.3.27

handbook-rule

Assignment criteria and processes must be periodically reviewed to determine whether they remain appropriate for the current portfolio and external conditions.

[Note: BCD Annex VII Part 4 point 3]

BIPRU 4.3.28

handbook-rule

Where a firm uses direct estimates of risk parameters these may be seen as the outputs of grades on a continuous rating scale.

[Note: BCD Annex VII Part 4 point 4]

Validation of internal estimates

BIPRU 4.3.29

handbook-rule

A firm must have robust systems in place to validate the accuracy and consistency of rating systems, processes, and the estimation of all relevant risk parameters (PD, LGD, conversion factors and EL). A firm must be able to demonstrate to the FSA that the internal validation process enables it to assess the performance of internal rating and risk estimation systems consistently and meaningfully.

[Note: BCD Annex VII Part 4 point 110]

BIPRU 4.3.30

handbook-rule
  1. (1) A firm must validate its rating systems. Its validation process must include, as a minimum, the elements set out in (2) - (8).
  2. (2) A firm must establish and define standards of objectivity, accuracy, stability and conservatism that it designs its ratings systems to meet. It must have processes that establish whether its rating systems meet those standards.
  3. (3) A firm must establish and define standards of accuracy of calibration (i.e. whether outcomes are consistent with estimate) and discriminative power (i.e. the ability to rank-order risk) that it designs its rating systems to meet. It must have processes that establish whether its rating systems meet those standards.
  4. (4) A firm must have polices and standards that specify the actions to be taken when a rating system fails to meet the standards of accuracy and discriminative power referred to in (2) and (3).
  5. (5) A firm's validation process must include a mix of developmental evidence, benchmarking and process verification. A firm's validation process must include policies on how this mixture varies between different rating systems.
  6. (6) A firm's validation process must include the use of both quantitative and qualitative techniques.
  7. (7) A firm's validation process must include policies on how validation procedures are expected to vary over time.
  8. (8) A firm's validation process must include independent input into and review of its rating systems.
  9. (9) The standards set under (2) and (3) must meet the minimum IRB standards.
  10. (10) For the purpose of (5):
    1. (a) developmental evidence means evidence that substantiates whether the logic and quality of a rating system (including the quantification process) adequately discriminates between different levels of, and delivers accurate estimates of PD, EL, LGD and conversion factors (as applicable); and
    2. (b) process verification means the process of establishing whether the methods used in a rating system to discriminate between different levels of risk and to quantify PD, EL, LGD and conversion factors are being used, monitored and updated in the way intended in the design of the rating system.

BIPRU 4.3.31

handbook-guidance
A firm should have regard to the involvement of management at an appropriately senior level in the validation process.

BIPRU 4.3.32

handbook-guidance
The approach to validation may vary with the significance of the exposures covered by a rating system.

BIPRU 4.3.33

handbook-rule

A firm must regularly compare realised default rates with estimated PDs for each grade and where realised default rates are outside the expected range for that grade a firm must specifically analyse the reasons for the deviation. A firm using its own estimates of LGDs and/or conversion factors must also perform analogous analysis for own estimates of LGDs and conversion factors. Such comparisons must make use of historical data that cover as long a period as possible. A firm must document the methods and data used in such comparisons. This analysis and documentation must be updated at least annually.

[Note: BCD Annex VII Part 4 point 111]

BIPRU 4.3.34

handbook-guidance
  1. (1) This paragraph sets out guidance on assessing the adequacy of a rating system's discriminative power (see BIPRU 4.3.30 R (3) on the meaning of discriminative power).
  2. (2) A firm should be able to explain the performance of its rating systems against its chosen measure (or measures) of discriminative power. In making this comparison a firm should rely primarily on actual historic default experience where this is available. In particular, a firm should be able to explain:
    1. (a) the extent of any potential inaccuracy in these measures, caused in particular by small sample size; and
    2. (b) the potential for divergence in the future, whether caused by changing economic conditions or other factors.
  3. (3) The assessment of discriminative power should include appropriate use of external benchmarks where available.
  4. (4) The FSA will, in assessing the firm's performance, take into consideration the sophistication of the measure of discrimination chosen.
  5. (5) In the case of a portfolio for which there is insufficient default experience to provide any confidence in statistical measures of discriminative power a firm need not carry out the procedure in (2) and may instead use other methods. For example, it may make use of comparison with an external measurement approach by analysing whether the firm's rating systems and the external approach rank common obligors in broadly similar ways. A firm should be able to explain the methodology it uses and the rationale for its use.

BIPRU 4.3.35

handbook-rule

A firm must also use other appropriate quantitative validation tools and comparisons with relevant external data sources. The analysis must be based on data that is appropriate to the portfolio, is updated regularly, and covers a relevant observation period. A firm's internal assessments of the performance of its rating systems must be based on as long a period as possible.

[Note: BCD Annex VII Part 4 point 112]

BIPRU 4.3.36

handbook-rule

The methods and data used for quantitative validation must be consistent through time. Changes in estimation and validation methods and data (both data sources and periods covered) must be documented.

[Note: BCD Annex VII Part 4 point 113

BIPRU 4.3.37

handbook-rule

A firm must have sound internal standards for situations where deviations in realised PDs, LGDs, conversion factors and, where EL is used, total losses, from expectations become significant enough to call the validity of the estimates into question. These standards must take account of business cycles and similar systematic variability in default and loss experience. Where realised values continue to be higher than expected values, a firm must revise estimates upward to reflect its default and loss experience.

[Note: BCD Annex VII Part 4 point 114]

Internal audit

BIPRU 4.3.38

handbook-rule

Internal audit or another comparable independent auditing unit must review at least annually the firm's rating systems and its operations, including the operations of the firm and the estimation of PDs, LGDs, ELs and conversion factors. Areas of review must include adherence to all applicable minimum requirements.

[Note: BCD Annex VII Part 4 point 131]

Stress tests used in assessment of capital adequacy

BIPRU 4.3.39

handbook-rule

A firm must have in place sound stress testing processes for use in the assessment of its capital adequacy. Stress testing must involve identifying possible events or future changes in economic conditions that could have unfavourable effects on the firm's credit exposures and assessment of the firm's ability to withstand such changes.

[Note: BCD Annex VII Part 4 point 40]

BIPRU 4.3.39A

handbook-guidance
The FSA expects that firms will routinely make use of stress testing and scenario analysis as a tool in the calibration and/or validation of their IRB approach parameters in order to increase the accuracy or, at least, the conservatism of the estimates. Stress testing should include a thorough exploration of various outturns different to the firm's normal expectations in order to give the firm a clear view of the potential for the forward-looking estimate to be different from that indicated by the primary data source(s). Firms should consider this as an integral part of their quantification process, and should have clear standards for how the results of the stress tests affect the final estimates used for the IRB approach parameters.

BIPRU 4.3.40

handbook-rule
  1. (1) A firm must regularly perform a credit risk stress test to assess the effect of certain specific conditions on its total capital requirements for credit risk. The test to be employed must be one chosen by the firm. The test to be employed must be meaningful and reasonably conservative. Stressed portfolios must contain the vast majority of a firm's total exposures covered by the IRB approach.
  2. (2) The stress test must be designed to assess the firm's ability to meet its capital requirements for credit risk under GENPRU 2.1 during all stages of the economic cycle and during an economic downturn scenario based on forward looking hypothetical events calibrated against the most adverse movements in individual risk drivers experienced over a long historical period.
  3. (3) In particular the stress test must address the impact (including by ratings migration) of changes in the credit quality of its credit risk counterparties including its protection providers. A firm using the treatment set out in BIPRU 4.4.79 R must in particular consider the impact of protection providers falling outside the eligibility criteria.
  4. (4) The stress test must be conducted on the basis of the firm's exposures (on- and off-balance sheet) as they stand at the time of the stress test.
  5. (5) The stress test must be carried out at least annually and also in the event of a significant change in the state of the economy.
  6. (6) A firm need not assume that the recession referred to in (2) will occur in the 12 months immediately following the stress test. Instead, the stress test must incorporate a plausible time horizon for the occurrence of the cyclical deterioration of the severity tested for. A firm need not assume that the downturn will occur for all portfolios in all jurisdictions simultaneously.

[Note: BCD Annex VII Part 4 points 41 and 42]

BIPRU 4.3.41

handbook-guidance
To the extent that the economic conditions assumed in the stress tests required under BIPRU 4.3.39 R or BIPRU 4.3.40 R coincide with the conditions assumed in the production of economic downturn LGDs (see BIPRU 4.3.103 R), the LGDs to be used might be expected to be similar.

BIPRU 4.3.42

handbook-guidance
The requirement in BIPRU 4.3.40 R (2) is to identify, in a forward-looking manner, severe but plausible downturn conditions relevant to business lines and jurisdictions and to determine the likely impact of those conditions on a firm's credit risk regulatory capital requirements. The description of the economic recession contained in BIPRU 4.3.40 R (2) should not be taken as stipulating one approach (e.g. statistical) over other approaches (e.g. scenario analysis) in the identification of the relevant recessionary circumstances.

Rating systems: Assignment to grades or pools

BIPRU 4.3.43

handbook-rule

A firm must have specific definitions, processes and criteria for assigning exposures to grades or pools within a rating system.

[Note: BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.44

handbook-rule

The grade or pool definitions and criteria must be sufficiently detailed to allow those charged with assigning ratings consistently to assign obligors or facilities posing similar risk to the same grade or pool. This consistency must exist across lines of business, departments and geographic locations within each rating system.

[Note: BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.45

handbook-guidance
In meeting BIPRU 4.3.44 R a firm should have regard to its application to each rating system.

BIPRU 4.3.46

handbook-rule

The documentation of the rating process must allow third parties to understand the assignments of exposures to grades or pools, to replicate grade and pool assignments and to evaluate the appropriateness of the assignments to a grade or a pool.

[Note: BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.47

handbook-rule

The criteria referred to in BIPRU 4.3.43 R must also be consistent with the firm's internal lending standards and its policies for handling troubled obligors and facilities.

[Note: BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.48

handbook-rule

A firm must take all relevant information into account in assigning obligors and facilities to grades or pools. Information must be current and must enable the firm to forecast the future performance of the exposure. The less information a firm has, the more conservative must be its assignments of exposures to obligor and facility grades or pools. If a firm uses an external rating as a primary factor determining an internal rating assignment, the firm must ensure that it considers other relevant information.

[Note: BCD Annex VII Part 4 point 18]

Rating systems: General governance

BIPRU 4.3.49

handbook-guidance
  1. (1) This paragraph contains guidance on BIPRU 4.3.43 R and more general guidance about the governance of rating systems.
  2. (2) In determining the assignment referred to in BIPRU 4.3.43 R, a firm should have regard to the sensitivity of the rating to movements in fundamental risk drivers.
  3. (3) A firm should, for any rating system, be able to demonstrate that it acts appropriately or has an appropriate policy, as applicable, with respect to:
    1. (a) any deficiencies caused by its not being sensitive to movements in fundamental risk drivers or for any other reason;
    2. (b) periodic review and action in the light of such review;
    3. (c) provision of appropriate internal guidance to staff to ensure consistency in the use of the rating system, including the assignment of exposures or facilities to pools or grades;
    4. (d) dealing with potential weaknesses of the rating system;
    5. (e) identifying appropriate and inappropriate uses of the rating system and acting on that identification;
    6. (f) novel or narrow rating approaches; and
    7. (g) ensuring the appropriate level of stability over time of the rating system.

Rating systems: Overrides

BIPRU 4.3.50

handbook-rule

For grade and pool assignments a firm must document the situations in which human judgement may override the inputs or outputs of the assignment process and the personnel responsible for approving these overrides. A firm must document these overrides and the personnel responsible. A firm must analyse the performance of the exposures whose assignments have been overridden. This analysis must include assessment of the performance of exposures whose rating has been overridden by a particular person, accounting for all the responsible personnel.

[Note: BCD Annex VII Part 4 point 25]

Rating systems: Use of models

BIPRU 4.3.51

handbook-rule
  1. (1) This paragraph applies to the use of statistical models and/or other mechanical methods to assign exposures to obligor grades, obligor pools, facility grades or facility pools.
  2. (2) A firm must be able to demonstrate to the FSA that the model has good predictive power and that capital requirements are not distorted as a result of its use.
  3. (3) The input variables to the model must form a reasonable and effective basis for the resulting predictions. The model must not have material biases.
  4. (4) A firm must have in place a process for vetting data inputs into the model, which includes an assessment of the accuracy, completeness and appropriateness of the data.
  5. (5) A firm must be able to demonstrate to the FSA that the data used to build the model is representative of the population of the firm's actual obligors or exposures.
  6. (6) A firm must have a regular cycle of model validation that includes monitoring of model performance and stability, review of model specification and testing of model outputs against outcomes.
  7. (7) A firm must complement the statistical model by human judgement and human oversight to review model-based assignments and to ensure that the models are used appropriately. Review procedures must aim at finding and limiting errors associated with model weaknesses. Human judgements must take into account all relevant information not considered by the model. A firm must document how human judgement and model results are to be combined.
  8. (8) Use of a model obtained from a third-party vendor that claims proprietary technology is not a justification for exemption from documentation or any other of the requirements in BIPRU 4 or a firm's IRB permission for rating systems. A firm must be able to satisfy the FSA that all those requirements are satisfied if it uses such a model.

[Note: BCD Annex VII Part 4 points 30 and 35 (part)]

BIPRU 4.3.52

handbook-guidance
  1. (1) This paragraph contains guidance on BIPRU 4.3.51 R (7).
  2. (2) BIPRU 4.3.51 R (7) does not require that each individual assignment of an exposure to a pool or grade should be the subject of an open-ended review by reference to factors not covered by the model if:
    1. (a) that is not necessary in order to meet the requirements of BIPRU 4 about the ability of the rating system to predict and to discriminate (as referred to in BIPRU 4.3.29 R to BIPRU 4.3.30 R (Validation of internal estimates)); and
    2. (b) the outputs of the model are not designed to be supplemented by such a review.

BIPRU 4.3.53

handbook-guidance
  1. (1) This paragraph contains guidance on BIPRU 4.3.51 R for the use of external models.
  2. (2) BIPRU 4.3.51 R (2) - BIPRU 4.3.51 R (8) also apply to mechanical methods to assign exposures or obligors to facility grades or pools and to a combination of models and mechanical methods.
  3. (3) The standards which a firm applies to an external model should not be lower than those for internal models.
  4. (4) The FSA will not accredit any individual model or vendor. The burden is on a firm to satisfy itself that external models are fit for purpose and meet the relevant requirements of the IRB approach.
  5. (5) Notwithstanding that commercial confidentiality may limit the willingness of vendors of external models to disclose all details, a firm should ensure that it is able to obtain sufficiently detailed information to be able to satisfy the requirements of the IRB approach.
  6. (6) A firm should have a clear understanding of responsibilities for support and maintenance of external models. This should include how new developments will be brought in and what entitlement the firm has to receive and/or request specific enhancements. A firm should ensure that the requirements of BIPRU 4.3.51 R and other provisions of the IRB approach are complied with on an ongoing basis.
  7. (7) If a firm uses an external model it should have regard to the following:
    1. (a) the adequacy of the information it has about the population on which the model is built;
    2. (b) the comparability of the population referred to in (a) to the exposures with respect to which it is using that model;
    3. (c) what the drivers of the model are and their relevance to the exposures with respect to which it is using the model; and
    4. (d) how the firm satisfies itself that the standards required by the IRB approach for an internal model are met by the external model.

Rating systems: Data maintenance

BIPRU 4.3.54

handbook-rule

A firm must collect and store data on aspects of its internal ratings as required under BIPRU 11 (Disclosure).

[Note: BCD Annex VII Part 4 point 36]

Rating systems: IT systems

BIPRU 4.3.55

handbook-guidance
A firm should ensure that IT systems relevant to the operation of its rating systems are sound and robust. A firm's IT systems should provide rapid availability of databases and appropriate archiving. Adequate controls should be in place to prevent unauthorised changes to data being made. Contingency processes and plans should be in place to deal with events of system failure. A firm should document work-flows and procedures related to data collection and storage.

Definition of default: Main provisions

BIPRU 4.3.56

handbook-rule

A default must be considered to have occurred with regard to a particular obligor when either or both of the two following events has taken place:

  1. (1) the firm considers that the obligor is unlikely to pay its credit obligations to the firm, the parent undertaking or any of its subsidiary undertakings in full, without recourse by the firm to actions such as realising security (if held); and
  2. (2) the obligor is past due more than 90 days on any material credit obligation to the firm, the parent undertaking or any of its subsidiary undertakings.

[Note: BCD Annex VII Part 4 point 44 (part)]

BIPRU 4.3.57

handbook-rule

The following provisions also apply with respect to the definition of default:

  1. (1) for overdrafts, days past due commence once an obligor has breached an advised limit, has been advised a limit smaller than current outstandings, or has drawn credit without authorisation and the underlying amount is material;
  2. (2) an advised limit means a limit which has been brought to the knowledge of the obligor;
  3. (3) days past due for credit cards commence on the minimum payment due date;
  4. (4) in the case of retail exposures and exposures to public sector entities the number of days past due is as set out in BIPRU 4.4.22 R and BIPRU 4.6.20 R; and
  5. (5) in all cases for the purposes of the definition of default, a credit obligation or, for overdrafts, the underlying amount, is material if, when added to the other exposures of the obligor, the total exceeds the amount which the firm treats as a material default for its internal risk measurement and management purposes.

[Note: BCD Annex VII Part 4 point 44 (part)]

Definition of default: Materiality

BIPRU 4.3.58

handbook-rule
Where a firm applies the definition of default at facility level in accordance with BIPRU 4.6.21 R, it should define materiality for the purposes of BIPRU 4.3.57 R (5) by reference to the facility amount only, disregarding other exposures of the obligor.

BIPRU 4.3.59

handbook-rule
A firm must have a policy which sets out how it will determine whether a credit obligation or, for overdrafts, the underlying amount, is material for the purposes of the definition of default in BIPRU 4.3.56 R (2) and BIPRU 4.3.57 R (5).

Definition of default: Identification of obligor

BIPRU 4.3.60

handbook-guidance
  1. (1) This paragraph contains guidance on the definition of default.
  2. (2) If:
    1. (a) a firm ordinarily assigns exposures in the sovereign, institution and corporate IRB exposure class to a member of a group substantially on the basis of membership of that group and a common group rating; and
    2. (b) the firm does so in the case of a particular group;
  3. (3) the firm should consider whether members of that group should be treated as a single obligor for the purpose of the definition of default.
  4. (4) The FSA would not expect a firm to treat an obligor as part of a single obligor under (2) if the firm rates its exposures on a stand alone basis or if its rating is notched. A rating is notched if it takes into account individual risk factors or otherwise reflects risk factors that are not applied on a common group basis.
  5. (5) Accordingly if a group has two members who are separately rated the default of one does not necessarily imply the default of the other.

Definition of default: Days past due

BIPRU 4.3.61

handbook-guidance
  1. (1) This paragraph contains guidance on the meaning of days past due for the purposes of the definition of default.
  2. (2) If an amount is overdue by the relevant number of days past due because of administrative oversight on the part of the obligor or the firm, a firm with sufficient information may, retrospectively if necessary, treat that as not involving a default if:
    1. (a) that failure is not associated with any increase in the risk referred to in BIPRU 4.3.56 R (1); and
    2. (b) treating it as not being in default is consistent with the way that the firm treated the failure in its relationship with the obligor.
  3. (3) If a firm takes advantage of this provision it should have a policy about the circumstances in which it can apply the treatment in (2). That policy should be documented and consistently applied.

BIPRU 4.3.62

handbook-guidance
Days past due is only one part of the definition of default and should be treated as a back-stop. A firm should not rely solely on the number of days past due set by BIPRU 4 but should also consider all other indicators of unlikeliness to pay when assessing whether a default has occurred.

Definition of default: Unlikeliness to pay

BIPRU 4.3.63

handbook-rule
  1. (1) Elements to be taken as indications of unlikeliness to pay must include the items set out in this rule.
  2. (2) The firm putting the credit obligation on non-accrued status must be taken as an indication of unlikeliness to pay.
  3. (3) The firm making a value adjustment resulting from a significant perceived decline in credit quality subsequent to the firm taking on the exposure must be taken as an indication of unlikeliness to pay.
  4. (4) The firm selling the credit obligation at a material credit-related economic loss must be taken as an indication of unlikeliness to pay.
  5. (5) The firm consenting to a distressed restructuring of the credit obligation must be taken as an indication of unlikeliness to pay where this is likely to result in a diminished financial obligation caused by the material forgiveness, or postponement, of principal, interest or (where relevant) fees. This includes in the case of equity exposures assessed under a PD/LGD approach, distressed restructuring of the equity itself.
  6. (6) The firm having filed for the obligor's bankruptcy or a similar order in respect of an obligor's credit obligation to the firm, the parent undertaking or any of its subsidiary undertakings must be taken as an indication of unlikeliness to pay.
  7. (7) The obligor seeking or having been placed in bankruptcy or similar protection where this would avoid or delay repayment of a credit obligation to the firm, the parent undertaking or any of its subsidiary undertakings must be taken as an indication of unlikeliness to pay.


[Note: BCD Annex VII Part 4 point 45]

BIPRU 4.3.64

handbook-guidance

A firm may use the amount overdue as an additional indication of unlikeliness to pay. If a firm uses this approach, the days past due element of the definition of default continues to apply, including the provisions relating to the fixed number of days past due referred to in BIPRU 4.3.57 R (4). A firm might make the use of a definition of default that takes into account the amount overdue consistent with the days past due element of the definition by setting the amount overdue at such a level that, taking into account:

  1. (1) the order in which payments are applied against overdue payments; and
  2. (2) the number of payment dates, the time between them, the amount of the overdue payments that results in a default under the definition used by the firm and other relevant factors;

it is not possible for any payment to be past due by a number of days exceeding the maximum amount specified in BIPRU for the purposes of the definition of default without there being a default under the part of the definition of default based on the amount overdue.

BIPRU 4.3.65

handbook-guidance
In the case of a retail exposure, a value adjustment resulting from significant perceived decline in credit quality falling within BIPRU 4.3.63 R (3) need not necessarily be taken as an indication of unlikeliness to pay if a firm employs formulaic portfolio provisioning based on a number of days overdue for its retail exposures. However, if such an exposure reaches the compulsory days past due indicator for the purposes of the definition of default it should automatically be deemed to be in default, regardless of the provisioning situation.

BIPRU 4.3.66

handbook-guidance
An obligation should be considered a distressed restructuring under BIPRU 4.3.63 R (5) if an independent third party, with expertise in the relevant area, would not be prepared to provide financing on substantially the same terms and conditions.

BIPRU 4.3.67

handbook-guidance
  1. (1) The realisation or forfeiture of collateral may be taken as an indication of unlikeliness to pay for the purposes of the definition of default.
  2. (2) However, the realisation or forfeiture of collateral may not indicate unlikeliness to pay:
    1. (a) in the case of an exposure in a market (such as one that involves retail exposures involving margin lending) in which it is established practice for collateral to be sold if its value falls below a certain percentage of the exposure and the obligor does not restore the margin (but this exception does not apply if the value of the collateral has fallen below the amount outstanding); or
    2. (b) if the firm is able to demonstrate that for some other reason the realisation or forfeiture of collateral is not a meaningful indication of unlikeliness to pay.

BIPRU 4.3.68

handbook-guidance
  1. (1) If an obligor approach is being taken with respect to retail exposures (that is, the application of the definition of default at an obligor level rather than at a facility level as set out in BIPRU 4.6.21 R,) a firm should ensure that the PD associated with unsecured exposures is not understated as a result of the presence of any collateralised exposures. A firm should be able to explain to the FSA, if asked, how it has ensured that its estimate of PD is appropriate for both secured and unsecured exposures covered by an obligor rating approach.
  2. (2) In the view of the FSA, firms typically find that the PD of a residential mortgage is lower than the PD of an unsecured loan to the same borrower.

BIPRU 4.3.69

handbook-guidance
A firm may, but without prejudice to BIPRU 4.4.22 R and BIPRU 4.6.20 R (Fixed numbers of days past due), use additional, or stricter, indicators of unlikeliness to pay if it uses these indicators for internal purposes in accordance with BIPRU 4.2.2 R (2) (Use tests) and if the disclosures under BIPRU 11 (Disclosure) are on this basis.

Risk quantification: Definition of default: Other provisions

BIPRU 4.3.70

handbook-rule

A firm must (if it uses external data that is not itself consistent with the definition of default) be able to demonstrate to the FSA that appropriate adjustments have been made that achieve broad equivalence with the definition of default.

[Note: BCD Annex VII Part 4 point 46]

BIPRU 4.3.71

handbook-rule

If a firm considers that a previously defaulted exposure is such that no trigger of default continues to apply, the firm must rate the obligor or facility as it would for a non-defaulted exposure. Should the definition of default subsequently be triggered, another default must be deemed to have occurred.

[Note: BCD Annex VII Part 4 point 47]

BIPRU 4.3.72

handbook-guidance
A firm should have a clear and documented policy for determining whether an exposure that has been in default should subsequently be returned to performing status.

Risk quantification: Overall requirements for estimation: General

BIPRU 4.3.73

handbook-rule

BIPRU 4.3.74 R to BIPRU 4.3.131 R apply to a firm's own estimates of risk parameters used in the IRB approach.

[Note: BCD Annex VII Part 4 point 43]

BIPRU 4.3.74

handbook-rule

A firm's own estimates of the risk parameters PD, LGD, conversion factor and EL must incorporate all relevant data, information and methods. The estimates must be derived using both historical experience and empirical evidence, and must not be based purely on judgemental considerations. The estimates must be plausible and intuitive and must be based on the material drivers of the respective risk parameters. The less data a firm has, the more conservative it must be in its estimation.

[Note: BCD Annex VII Part 4 point 49]

BIPRU 4.3.75

handbook-guidance
  1. (1) This paragraph provides guidance on BIPRU 4.3.73 R.
  2. (2) Relevant data and information under BIPRU 4.3.73 R includes external data.
  3. (3) Where internal default and loss experience is scarce, a firm should consider using material relevant external information. When using external information such as industry averages when determining LGD or conversion factors, a firm should consider whether this data is appropriate to its own experience and whether adjustments are necessary.

BIPRU 4.3.76

handbook-rule
  1. (1) In calculating estimates of PD, LGD and conversion factors a firm must adjust the averages of historical experience referred to in the historical averages rules in order to ensure that those estimates are accurate estimates of the default rate, loss rate or conversion factor over the long-run.
  2. (2) The historical average rules means the requirements in BIPRU 4 relating to the calculation of PD, LGD and conversion factors using historical averages (and in particular BIPRU 4.4.24 R, BIPRU 4.4.30 R, BIPRU 4.8.7 R, BIPRU 4.8.8 R, BIPRU 4.6.24 R, BIPRU 4.6.27 R, BIPRU 4.3.99 R and BIPRU 4.3.125 R).

BIPRU 4.3.77

handbook-guidance
Where a firm is able to demonstrate that the effect is immaterial in accordance with BIPRU 4.1.25 R (Compliance), it may estimate average LGDs and conversion factors under the historical average rules in a way that does not strictly comply with BIPRU 4.3.94 R (Default weighted average), provided the final estimates of LGD and conversion factors following the adjustments to averages of historical experience are made on the basis of default weighted averages for the facility grade or pool in question.

BIPRU 4.3.78

handbook-guidance
A firm may carry out the adjustments under BIPRU 4.3.76 R (Adjustments to averages of historical experience) by adjusting the data from which estimates are made rather than by adjusting the estimates themselves if it can demonstrate that capital requirements are not underestimated as a result.

BIPRU 4.3.79

handbook-guidance
While the qualitative requirements in BIPRU 4 are important for all portfolios, they are of even greater importance in those cases where a firm lacks sufficient historical data to calibrate or validate its estimates of PD, LGD or conversion factors on the basis of proven statistical significance, sometimes referred to as low default portfolios.

BIPRU 4.3.80

handbook-rule
  1. (1) A firm must collect data on what it considers to be the main drivers of the risk parameters PD, LGD, conversion factor and EL for each group of obligors or facilities.
  2. (2) A firm must document its identification of the main drivers of risk parameters.
  3. (3) A firm must be able to demonstrate that its process of identification is reasonable and appropriate.

BIPRU 4.3.81

handbook-rule
In its processes for identifying the main drivers of risk parameters, a firm must set out its reasons for concluding that the data sources chosen provide in themselves sufficient discriminative power and accuracy and why additional potential data sources do not provide relevant and reliable information that would be expected materially to improve the discriminative power and accuracy of its estimates of the risk parameter in question. This does not require an intensive analysis of all factors.

BIPRU 4.3.82

handbook-guidance
If a firm uses a rating model to assign exposures to the borrower or facility grades, it may reflect the data on main drivers of risk parameters by its inclusion in the model as a risk driver or as part of a subsequent process that adjusts the output of that model to calculate the risk parameters PD, LGD, conversion factor and EL.

BIPRU 4.3.83

handbook-rule

A firm must be able to provide a breakdown of its loss experience in terms of default frequency, LGD, conversion factor, or loss where EL estimates are used, by the factors it sees as the drivers of the respective risk parameters. A firm must be able to demonstrate to the FSA that its estimates are representative of long-run experience.

[Note: BCD Annex VII Part 4 point 50]

BIPRU 4.3.84

handbook-rule

Any changes in lending practice or the process for pursuing recoveries over the observation periods referred to in BIPRU 4.4.31 R (Observation period for sovereigns, institutions and corporates for PDs), BIPRU 4.6.28 R (Observation period for retail exposures for PDs), BIPRU 4.4.54 R (Observation period for sovereigns, institutions and corporates for LGDs), BIPRU 4.6.33 R (Observation period for retail exposures for LGDs), BIPRU 4.4.55 R (Observation period for sovereigns, institutions and corporates for conversion factors) and BIPRU 4.6.38 R (Observation period for retail exposures for conversion factors) must be taken into account. A firm's estimates must reflect the implications of technical advances and new data and other information, as it becomes available. A firm must review its estimates when new information comes to light but at least on an annual basis.

[Note: BCD Annex VII Part 4 point 51]

BIPRU 4.3.85

handbook-rule

The population of exposures represented in the data used for estimation, the lending standards used when the data was generated and other relevant characteristics must be comparable with those of a firm's exposures and standards. A firm must also be able to demonstrate to the FSA that the economic or market conditions that underlie the data are relevant to current and foreseeable conditions. The number of exposures in the sample and the data period used for quantification must be sufficient to provide a firm with confidence in the accuracy and robustness of its estimates.

[Note: BCD Annex VII Part 4 point 52]

BIPRU 4.3.86

handbook-guidance
It may be reasonable for a firm to treat foreseeable in BIPRU 4.3.85 R as referring to the most distant date to which it carries out detailed capital planning.

BIPRU 4.3.87

handbook-guidance

A firm should be able to demonstrate to the FSA:

  1. (1) how, with respect to each rating system, both assignment of ratings and estimates of PD, LGD and conversion factors are affected by:
    1. (a) movements in the economic cycle; and
    2. (b) other cyclical effects which are material to levels of default, loss or the amount of exposures at default for the exposures covered by the rating system; and
  2. (2) the level of conservatism inherent in its ratings, as provided for by BIPRU.

BIPRU 4.3.88

handbook-rule

A firm must add to its estimates a margin of conservatism that is related to the expected range of estimation errors. Where methods and data are less satisfactory and the expected range of errors is larger, the margin of conservatism must be larger.

[Note: BCD Annex VII Part 4 point 54]

BIPRU 4.3.89

handbook-guidance
Estimation of PD through the use of a technique set out in BIPRU does not remove the need to make conservative adjustments, where necessary, related to the expected range of estimation errors so that capital requirements produced by the relevant model or other rating system are not understated.

BIPRU 4.3.90

handbook-rule

If a firm uses different estimates for the calculation of risk weights and internal purposes it must be documented. The firm must be able to demonstrate to the FSA the reasonableness of such estimates.

[Note: BCD Annex VII Part 4 point 55]

BIPRU 4.3.91

handbook-guidance

If a firm can demonstrate to the FSA that for data that has been collected prior to 31 December 2006, appropriate adjustments have been made to achieve broad equivalence with the definitions of default or loss, the FSA may in the IRB permission allow the firm some flexibility in the application of the required standards for data.

[Note: BCD Annex VII Part 4 point 56]

Risk quantification: Overall requirements for estimation: Pooled data

BIPRU 4.3.92

handbook-rule

If a firm uses data that is pooled across institutions it must be able to demonstrate to the FSA that:

  1. (1) the rating systems and criteria of other firms in the pool are similar to its own;
  2. (2) the pool is representative of the portfolio for which the pooled data is used; and
  3. (3) the pooled data is used consistently over time by the firm for its permanent estimates.

[Note: BCD Annex VII Part 4 point 57]

BIPRU 4.3.93

handbook-guidance
BIPRU 4.3.92 R (1) is intended to ensure that data entering a pool is consistent and does not contain distortions as a result of different contributors' practices. It is not intended to constrain the use of pooled data by one firm that is contributed by a second firm where the differences do not affect the data being contributed.

BIPRU 4.3.94

handbook-rule

If a firm uses data that is pooled across institutions it remains responsible for the integrity of its rating systems. If a firm uses such data it must be able to demonstrate to the FSA that it has sufficient in-house understanding of its rating systems, including effective ability to monitor and audit the rating process.

[Note: BCD Annex VII Part 4 point 58]

Risk quantification: Overall requirements for estimation: Requirements specific to PD estimates

BIPRU 4.3.95

handbook-rule
  1. (1) If:
    1. (a) a firm's internal experience of exposures of a type covered by a model or other rating system is 20 defaults or fewer; and
    2. (b) in the firm's view, reliable estimates of PD cannot be derived from external sources of default data, including the use of market price related data, for all the exposures covered by the rating system;
  2. the firm must estimate PD for exposures covered by that rating system in accordance with this rule.
  3. (2) A firm must use a statistical technique to derive the distribution of defaults implied by the firm's experience, estimating PDs (the "statistical PD") from the upper bound of a confidence interval set by the firm in order to produce conservative estimates of PDs in accordance with BIPRU 4.3.88 R.
  4. (3) The techniques chosen for the purposes of (2) must take account, as a minimum, of the following modelling issues:
    1. (a) the number of defaults and number of obligor years in the sample;
    2. (b) the number of years from which the sample was drawn;
    3. (c) the interdependence between default events for individual obligors;
    4. (d) the interdependence between default rates for different years; and
    5. (e) the choice of the statistical estimators and the associated distributions and confidence intervals.
  5. (4) The firm must further adjust the statistical PD to the extent necessary to take account of the following:
    1. (a) any likely differences between the observed default rates over the period covered by the firm's default experience and the long-run PD for each grade in accordance with BIPRU 4.4.24 R and BIPRU 4.6.24 R; and
    2. (b) any other information that indicates (taking into account the robustness and cogency of that information) that the statistical PD is likely to be an inaccurate estimate of PD.
  6. (5) This rule is in addition to the other requirements in BIPRU about the calculation of PD.
  7. (6) When a firm calculates whether it has 20 defaults or fewer under the calculation in (1)(a), it must only take into account defaults that occurred during periods that are relevant to the validation under BIPRU 4 of the model or other rating system in question.

BIPRU 4.3.96

handbook-guidance
A firm may if appropriate also choose to use the approach in BIPRU 4.3.91 G if the internal experience on exposures covered by a rating system is greater than 20 defaults.

BIPRU 4.3.97

handbook-guidance
If a firm excludes defaulted exposures that have been cured (as referred to in BIPRU 4.3.71 R) or restructured (as referred to in BIPRU 4.3.63 R (5)) from estimates of LGD in accordance with BIPRU 4.3.110 G, it may also exclude cures from estimates of PD for these exposures.

Risk quantification: Overall requirements for estimation: Requirements specific to own-LGD estimates

BIPRU 4.3.98

handbook-rule
BIPRU 4.3.98 R to BIPRU 4.3.123 R set out requirements specific to own-LGD estimates.

BIPRU 4.3.99

handbook-rule

A firm must estimate LGDs by facility grade or pool on the basis of the average realised LGDs by facility grade or pool using all observed defaults within the data sources (default weighted average).

[Note: BCD Annex VII Part 4 point 73]

BIPRU 4.3.100

handbook-rule
A firm must calculate the default weighted average on the basis of the number of defaults included in the calculations made under the historical average rules so far as they relate to the calculation of PDs and must not be weighted by the size of exposures.

BIPRU 4.3.101

handbook-rule
  1. (1) A firm's estimates of LGDs must take into account:
    1. (a) data in respect of relevant incomplete workouts; and
    2. (b) the possibility that the proportion of defaulted exposures which are cured (as referred to in BIPRU 4.3.71 R) or restructured (as referred to in BIPRU 4.3.63 R (5)) or the length of the period over which a firm makes recoveries under a defaulted exposure may be different from the firm's observed historic experience.
  2. (2) An incomplete workout as referred to in (1)(a) means a defaulted exposure included in the data set on which the firm's LGD estimates are based, but for which the recovery process is still in progress, with the result that the final realised losses in respect of that exposure are not yet certain.

BIPRU 4.3.102

handbook-guidance
The changes referred to in BIPRU 4.3.101 R (1)(b) may be caused by external factors, such as the economic environment, as well as factors specific to the obligor, the transaction or the policies of the firm.

BIPRU 4.3.103

handbook-rule

A firm must use LGD estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver constant realised LGDs by grade or pool over time, a firm must make adjustments to its estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn.

[Note: BCD Annex VII Part 4 point 74]

BIPRU 4.3.104

handbook-rule
  1. (1) A firm must have a rigorous and well documented process for:
    1. (a) assessing the effects, if any, of economic downturn conditions on recovery rates; and
    2. (b) producing LGD estimates consistent with downturn conditions as referred to in BIPRU 4.3.103 R.
  2. (2) That process must include the following, which may be included in an integrated manner:
    1. (a) identification of appropriate downturn conditions for each IRB exposure class within each jurisdiction;
    2. (b) identification of adverse dependencies, if any, between default rates and recovery rates; and
    3. (c) incorporation of adverse dependencies, if identified, between default rates and recovery rates in the firm's estimates of LGD in a manner that meets the requirements in BIPRU 4.3.103 R relating to an economic downturn.

BIPRU 4.3.105

handbook-guidance
A firm may derive the LGD in accordance with BIPRU 4.3.104 R (2)(c) either by directly assigning to the facility grade or pool an estimate of LGD appropriate for downturn conditions, or alternatively by estimating a default weighted average LGD in accordance with BIPRU 4.3.99 R and BIPRU 4.3.76 R and converting it into an LGD appropriate for downturn conditions by the use of a formula. It should be able to demonstrate that that formula produces well-founded estimates of LGDs consistent with downturn conditions for the exposures in question.

BIPRU 4.3.106

handbook-guidance
A firm may combine IRB exposure classes, jurisdictions or both for the purpose of BIPRU 4.3.104 R (2)(a) if it can demonstrate that the downturn conditions to which the portfolios are subject will be similar.

BIPRU 4.3.107

handbook-guidance
The adverse dependencies referred to in BIPRU 4.3.104 R (2)(b) will not always exist. However, if a firm uses LGDs that do not allow for such adverse dependencies, it should be able to justify its decision.

BIPRU 4.3.108

handbook-guidance
Data relating to economic downturn conditions is likely to be scarce. Accordingly, a firm should use internal data, external data or a combination of data sources in order to produce appropriate downturn LGD estimates in accordance with BIPRU 4.3.103 R.

BIPRU 4.3.109

handbook-rule
A firm must retain sufficient data on both LGDs calculated on a economic downturn basis and calculated on a long-run average basis (as referred to in BIPRU 4.3.103 R) to be able to demonstrate to the FSA (if asked) that its estimates based on an economic downturn are no less conservative than the long-run average as referred to in that rule.

BIPRU 4.3.110

handbook-guidance
Where a firm is able to demonstrate that the effect is immaterial in accordance with BIPRU 4.1.25 R (Compliance), it may exclude defaulted exposures that have been cured (as referred to in BIPRU 4.3.67 G (1)) or restructured (as referred to in BIPRU 4.3.63 R (5)) from the data about default and loss experience on which LGDs are calculated provided it can demonstrate that its calculation of capital requirements (including capital requirements resulting from the application of capital floors under the transitional rules and guidance in BIPRU) are not reduced as a result of this approximation.

BIPRU 4.3.111

handbook-rule
Irrespective of whether calculated on an economic downturn or long-run average basis, each LGD estimate must be at least zero.

BIPRU 4.3.112

handbook-guidance
In order to support an LGD estimate which is very low or zero, a firm should be able to demonstrate that the estimate adequately reflects the expected experience on a default weighted average basis or in a downturn as appropriate, taking into account the costs and discount rate associated with realisations and the operation of BIPRU 4.3.118 R.

BIPRU 4.3.113

handbook-rule
The methods that a firm uses for discounting cash flows for the purposes of estimating LGDs must take account of the uncertainties associated with the receipt of recoveries with respect to a defaulted exposure. If a firm intends to use a discount rate that does not take full account of the uncertainty in recoveries, it must be able to explain by what other process it has taken into account that uncertainty for the purposes of calculating LGDs.

BIPRU 4.3.114

handbook-guidance
The uncertainty referred to in BIPRU 4.3.113 R can be addressed by adjusting cash flows to certainty-equivalents or by using a discount rate that embodies an appropriate risk premium; or by a combination of the two.

BIPRU 4.3.115

handbook-guidance
A firm may exclude from its calculation of loss indirect costs that it incurs for the purpose of making recoveries with respect to a defaulted exposure if it would also have incurred those costs if there had not been a default.

BIPRU 4.3.116

handbook-rule

A firm must consider the extent of any dependence between the risk of the obligor with that of the collateral or collateral provider. Cases where there is a significant degree of dependence must be addressed in a conservative manner.

[Note: BCD Annex VII Part 4 point 75]

BIPRU 4.3.117

handbook-rule

Currency mismatches between the underlying obligation and the collateral must be treated conservatively in the firm's assessment of LGD.

[Note: BCD Annex VII Part 4 point 76]

BIPRU 4.3.118

handbook-rule

To the extent that LGD estimates take into account the existence of collateral, these estimates must not solely be based on the collateral's estimated market value. LGD estimates must take into account the effect of the potential inability of the firm expeditiously to gain control of its collateral and liquidate it.

[Note: BCD Annex VII Part 4 point 77]

BIPRU 4.3.119

handbook-guidance
  1. (1) A firm may comply with BIPRU 4.3.118 R by reducing the amount of the collateral taken into account for the purposes of calculating LGD (applying a haircut to the collateral), basing that reduction on validated realisation experience and using conservatism to reflect the uncertainties.
  2. (2) If collateral is used to reduce the LGD, a firm should be able to demonstrate how the risk in BIPRU 4.3.118 R has been accounted for. To the extent that it is adequately accounted for in that way it need not be reflected again as part of the residual risk in relation to collateral under the overall Pillar 2 rule.

BIPRU 4.3.120

handbook-rule

To the extent that LGD estimates take into account the existence of collateral, a firm must establish internal requirements for collateral management, legal certainty and risk management that are generally consistent with those set out in BIPRU 5 (Credit risk mitigation) as modified by BIPRU 4.10.

[Note: BCD Annex VII Part 4 point 78]

BIPRU 4.3.121

handbook-rule

To the extent that a firm recognises collateral for determining the exposure value for counterparty credit risk according to the CCR standardised method or the CCR internal model method, any amount expected to be recovered from the collateral must not be taken into account in the LGD estimates.

[Note: BCD Annex VII Part 4 point 79]

BIPRU 4.3.122

handbook-rule

For the specific case of exposures already in default, a firm must use the sum of its best estimate of expected loss for each exposure given current economic circumstances and exposure status and the possibility of additional unexpected losses during the recovery period.

[Note: BCD Annex VII Part 4 point 80]

BIPRU 4.3.123

handbook-rule

To the extent that unpaid late fees have been capitalised in a firm's income statement, they must be added to the firm's measure of exposure and loss.

[Note: BCD Annex VII Part 4 point 81]

Risk quantification: Overall requirements for estimation: Requirements specific to own-conversion factor estimates

BIPRU 4.3.124

handbook-rule
BIPRU 4.3.125 R - BIPRU 4.3.131 R set out requirements specific to own-conversion factor estimates.

BIPRU 4.3.125

handbook-rule

A firm must estimate conversion factors by facility grade or pool on the basis of the average expected conversion factors by facility grade or pool using all observed defaults within the data sources (default weighted average).

[Note: BCD Annex VII Part 4 point 87]

BIPRU 4.3.126

handbook-guidance
  1. (1) A firm using own estimates of conversion factors should take into account all facility types that may result in an exposure when an obligor defaults, including uncommitted facilities.
  2. (2) A firm should treat a facility as an exposure from the earliest date at which a customer is able to make drawings under it.
  3. (3) To the extent that a firm makes available multiple facilities, it should be able to demonstrate:
    1. (a) how it deals with the fact that exposures on one may become exposures under another on which the losses are ultimately incurred; and
    2. (b) the impact of its approach on its capital requirements.

BIPRU 4.3.127

handbook-rule

A firm must use conversion factor estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver realised conversion factors at a constant level by grade or pool over time, a firm must make adjustments to its estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn.

[Note: BCD Annex VII Part 4 point 88]

BIPRU 4.3.128

handbook-rule

A firm's estimates of conversion factors must reflect the possibility of additional drawings by the obligor up to and after the time a default event is triggered. The conversion factor estimate must incorporate a larger margin of conservatism where a stronger positive correlation can reasonably be expected between the default frequency and the magnitude of conversion factor.

[Note: BCD Annex VII Part 4 point 89]

BIPRU 4.3.129

handbook-rule

In arriving at estimates of conversion factors a firm must consider its specific policies and strategies adopted in respect of account monitoring and payment processing. A firm must also consider its ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events.

[Note: BCD Annex VII Part 4 point 90]

BIPRU 4.3.130

handbook-rule

A firm must have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per obligor and per grade. A firm must be able to monitor outstanding balances on a daily basis.

[Note: BCD Annex VII Part 4 point 91]

BIPRU 4.3.131

handbook-rule

If a firm uses different estimates of conversion factors for the calculation of risk weighted exposure amounts and internal purposes it must be documented. The firm must be able to demonstrate their reasonableness to the FSA.

[Note: BCD Annex VII Part 4 point 92]

Risk quantification: Overall requirements for estimation: Comparability

BIPRU 4.3.132

handbook-guidance
  1. (1) This paragraph contains guidance about the interpretation of the requirements relating to comparability in BIPRU 4.3.85 R. It is also relevant to the requirement for representative data in BIPRU 4.3.51 R (5), to the references to comparability in the additional guidance in BIPRU 4.3.53 G (7)(b) and to the requirements for similarity in BIPRU 4.3.92 R.
  2. (2) In general, comparability should be based on analyses of the population of exposures represented in the data, the lending standards used when the data was generated (where relevant) and other relevant characteristics in relation to the corresponding properties of the firm's own portfolio. Other relevant characteristics could include the distribution of the obligors across industries, the size distribution of the exposures and similarity with respect to the geographic or demographic distribution of the exposures.

BIPRU 4.4

The IRB approach: Exposures to corporates, institutions and sovereigns

  • 01/01/2007

Application

BIPRU 4.4.1

handbook-rule
  1. (1) This section applies with respect to the sovereign, institution and corporate IRB exposure class.
  2. (2) The sovereign, institution and corporate IRB exposure class includes specialised lending exposures.
  3. (3) Both BIPRU 4.4 and BIPRU 4.5 (Specialised lending exposures) apply to specialised lending exposures. A firm may calculate risk weighted exposure amounts for a specialised lending exposure either:
    1. (a) (if it is able to do so) in accordance with BIPRU 4.4; or
    2. (b) in accordance with BIPRU 4.4 as modified by BIPRU 4.5.

Definition

BIPRU 4.4.2

handbook-rule

The following exposures must be treated as exposures to central governments and central banks:

  1. (1) exposures to regional governments, local authorities or public sector entities which are treated as exposures to central governments under the standardised approach; and
  2. (2) exposures to multilateral development banks and international organisations which attract a risk weight of 0% under the standardised approach.

[Note: BCD Article 86(2)]

BIPRU 4.4.3

handbook-rule

The following exposures must be treated as exposures to institutions:

  1. (1) exposures to regional governments and local authorities which are not treated as exposures to central governments under the standardised approach;
  2. (2) exposures to public sector entities which are treated as exposures to institutions under the standardised approach;
  3. (3) exposures to multilateral development banks which do not attract a 0% risk weight under the standardised approach; and
  4. (4) without prejudice to BIPRU 13.3.13 R and BIPRU 13.8.7 R (Exposures to a central counterparty) exposures to recognised third country investment firms and exposures to recognised clearing houses and designated investment exchanges.

[Note: BCD Article 86(3) and CAD Article 40]

BIPRU 4.4.4

handbook-rule

Any credit obligation not assigned to the IRB exposure classes referred to in BIPRU 4.3.2 R (1) (Sovereigns), BIPRU 4.3.2 R (2) (Institutions) and BIPRU 4.3.2 R (4) - BIPRU 4.3.2 R (6) (Retail, equity and securitisations) must be assigned to the corporate exposure class.

[Note: BCD Article 86(7)]

Rating system: Structure of rating system

BIPRU 4.4.5

handbook-rule
BIPRU 4.4.6 R - BIPRU 4.4.21 R apply in addition to BIPRU 4.3.25 R - BIPRU 4.3.28 R (Rating systems).

BIPRU 4.4.6

handbook-rule

A rating system must take into account obligor and transaction risk characteristics.

[Note: BCD Annex VII Part 4 point 5]

BIPRU 4.4.7

handbook-rule

A rating system must have an obligor rating scale which reflects exclusively quantification of the risk of obligor default. The obligor rating scale must have a minimum of seven grades for non-defaulted obligors and one for defaulted obligors.

[Note: BCD Annex VII Part 4 point 6]

BIPRU 4.4.8

handbook-rule

An obligor grade means for the purpose of BIPRU 4 as it applies to the sovereign, institution and corporate IRB exposure class a risk category within a rating system's obligor rating scale, to which obligors are assigned on the basis of a specified and distinct set of rating criteria, from which estimates of PD are derived. A firm must document both the relationship between obligor grades in terms of the level of default risk each grade implies and the criteria used to distinguish that level of default risk.

[Note: BCD Annex VII Part 4 point 7]

BIPRU 4.4.9

handbook-rule

A firm with portfolios concentrated in a particular market segment and range of default risk must have enough obligor grades within that range to avoid undue concentrations of obligors in a particular grade. Significant concentrations within a single grade must be supported by convincing empirical evidence that the obligor grade covers a reasonably narrow PD band and that the default risk posed by all obligors in the grade falls within that band.

[Note: BCD Annex VII Part 4 point 8]

Rating system: Assignment to grades or pools

BIPRU 4.4.10

handbook-guidance
Material on assignment to grades or pools can be found in BIPRU 4.3.43 R - BIPRU 4.3.48 R.

Rating system: Assignment of exposures

BIPRU 4.4.11

handbook-rule

Each obligor must be assigned to an obligor grade as part of the credit approval process.

[Note: BCD Annex VII Part 4 point 19]

BIPRU 4.4.12

handbook-rule

Each separate legal entity to which a firm is exposed must be separately rated. A firm must be able to demonstrate to the FSA that it has acceptable policies regarding the treatment of individual obligor clients and groups of connected clients.

[Note: BCD Annex VII Part 4 point 22]

BIPRU 4.4.13

handbook-rule

Separate exposures to the same obligor must be assigned to the same obligor grade, irrespective of any differences in the nature of each specific transaction. Exceptions, where separate exposures are allowed to result in multiple grades for the same obligor are:

  1. (1) country transfer risk, this being dependent on whether the exposures are denominated in local or foreign currency;
  2. (2) where the treatment of associated guarantees to an exposure may be reflected in an adjusted assignment to an obligor grade; and
  3. (3) where consumer protection, bank secrecy or other legislation prohibit the exchange of client data.

[Note: BCD Annex VII Part 4 point 23]

Rating system: Overrides

BIPRU 4.4.14

handbook-guidance
Material on overrides can be found in BIPRU 4.3.50 R.

Rating system: Integrity of assignment process

BIPRU 4.4.15

handbook-rule

Assignments and periodic reviews of assignments must be completed or approved by an independent party that does not directly benefit from decisions to extend the credit.

[Note: BCD Annex VII Part 4 point 26]

BIPRU 4.4.16

handbook-rule

A firm must update assignments at least annually. High risk obligors and problem exposures must be subject to more frequent review. A firm must undertake a new assignment if material information on the obligor or exposure becomes available.

[Note: BCD Annex VII Part 4 point 27]

BIPRU 4.4.17

handbook-guidance
Although it will not usually be the case that facility ratings and conversion factors will have to be updated more frequently than annually, LGDs and exposure values are subject to more frequent recalculation due to their connection to drawn balances, which can vary on a daily basis.

BIPRU 4.4.18

handbook-rule

A firm must have an effective process to obtain and update relevant information on obligor characteristics that affect PDs, and on transaction characteristics that affect LGDs and conversion factors.

[Note: BCD Annex VII Part 4 point 28]

Rating system: Use of models

BIPRU 4.4.19

handbook-guidance
Material on the use of models can be found in BIPRU 4.3.51 R - BIPRU 4.3.53 G.

Rating system: Documentation of rating systems

BIPRU 4.4.20

handbook-guidance
Material on the documentation of rating systems can be found in BIPRU 4.3.19 R - BIPRU 4.3.24 R.

Rating system: Data maintenance

BIPRU 4.4.21

handbook-rule

In addition to complying with the material in BIPRU 4.3.54 R (Data maintenance) a firm must collect and store:

  1. (1) complete rating histories on obligors and recognised guarantors;
  2. (2) the dates the ratings were assigned;
  3. (3) the key data and methodology used to derive the rating;
  4. (4) the person responsible for the rating assignment;
  5. (5) the identity of obligors and exposures that defaulted;
  6. (6) the date and circumstances of such defaults;
  7. (7) data on the PDs and realised default rates associated with rating grades and ratings migration; and
  8. (8) (in the case of a firm not using the advanced IRB approach in the calculation of LGDs and/or conversion factors) data on comparisons of realised LGDs to the values as set out in BIPRU 4.4.34 R and BIPRU 4.8.25 R and realised conversion factors to the values as set out in BIPRU 4.4.37 R, BIPRU 4.4.45 R and BIPRU 4.6.44 R.

[Note: BCD Annex VII Part 4 point 37]

Risk quantification: Definition of default

BIPRU 4.4.22

handbook-rule
  1. (1) This rule, in accordance with BIPRU 4.3.57 R (4) (Definition of default), sets the exact number of days past due that a firm should abide by in the case of exposures to PSEs.
  2. (2) For counterparts that are PSEs situated within the United Kingdom the number of days past due is 180.
  3. (3) For counterparts that are PSEs situated in another EEA State the number of days past due is the lower of:
    1. (a) 180; and
    2. (b) the number of days past due fixed under the CRD implementation measure with respect to point 48 of Part 4 of Annex VII of the Banking Consolidation Directive for that EEA State for such exposures.
  4. (4) For counterparts that are PSEs in a state outside the EEA the number of days past due is the lower of:
    1. (a) 180; and
    2. (b) (if a number of days past due for such exposures has been fixed under any law of that state applicable to undertakings in the banking sector or the investment services sector that implements the IRB approach) that number.

[Note: BCD Annex VII Part 4 point 44 (part) and point 48 (part)]

Risk quantification: Overall requirements for estimation: Requirements specific to PD estimation

BIPRU 4.4.23

handbook-rule

BIPRU 4.4.24

handbook-rule

A firm must estimate PDs by obligor grade from long run averages of one-year default rates.

[Note: BCD Annex VII Part 4 point 59]

BIPRU 4.4.25

handbook-rule

A firm must use PD estimation techniques only with supporting analysis. A firm must recognise the importance of judgmental considerations in combining results of techniques and in making adjustments for limitations of techniques and information.

[Note: BCD Annex VII Part 4 point 62]

BIPRU 4.4.26

handbook-guidance
Where rating agency experience or the output of a statistical default model are the primary component of PD estimation, a firm should consider whether it needs to make adjustments for other relevant information, such as internal experience, conservatism and cyclical effects. In making these adjustments, a firm should consider the extent to which it needs to take account of the potential for both under-recording of actual defaults experienced and divergence of actual experience from the true underlying average PD.

BIPRU 4.4.27

handbook-rule

To the extent that a firm uses data on internal default experience for the estimation of PDs it must be able to demonstrate in its analysis that the estimates are reflective of underwriting standards and of any differences in the rating system that generated the data and the current rating system. Where underwriting standards or rating systems have changed, a firm must add a greater margin of conservatism in its estimate of PD.

[Note: BCD Annex VII Part 4 point 63]

BIPRU 4.4.28

handbook-rule

To the extent that a firm associates or maps its internal grades to the scale used by an ECAI or similar organisations and then attributes the default rate observed for the external organisation's grades to the firm's grades, mappings must be based on a comparison of internal rating criteria to the criteria used by the external organisation and on a comparison of the internal and external ratings of any common obligors. Biases or inconsistencies in the mapping approach or underlying data must be avoided. The external organisation's criteria underlying the data used for quantification must be oriented to default risk only and not reflect transaction characteristics. The firm's analysis must include a comparison of the default definitions used, subject to the requirements in BIPRU 4.3.56 R to BIPRU 4.3.71 R and BIPRU 4.4.22 R (Definition of default). The firm must document the basis for the mapping.

[Note: BCD Annex VII Part 4 point 64]

BIPRU 4.4.29

handbook-guidance
It is unlikely that a firm will be able to convince the FSA that it had considered all relevant and available information, as required by BIPRU 4.3.74 R, if it used only data from one ECAI or similar organisation, where other relevant information is available.

BIPRU 4.4.30

handbook-rule

To the extent that a firm uses statistical default prediction models it may estimate PDs as the simple average of default-probability estimates for individual obligors in a given grade. The firm's use of default probability models for this purpose must meet the standards specified in BIPRU 4.3.51 R.

[Note: BCD Annex VII Part 4 point 65]

BIPRU 4.4.31

handbook-rule

Irrespective of whether a firm is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation period spans a longer period for any source, and this data is relevant, this longer period must be used. A firm not permitted to use own estimates of LGDs or conversion factors may have, when it implements the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data cover a period of five years.

[Note: BCD Annex VII Part 4 point 66 (part)]

IRB foundation approach: General

BIPRU 4.4.32

handbook-rule
BIPRU 4.4.33 R - BIPRU 4.4.39 R set out requirements specific to the foundation IRB approach.

BIPRU 4.4.33

handbook-rule

Under the foundation IRB approach a firm must apply the LGD values set out in BIPRU 4.4.34 R and BIPRU 4.8.25 R and the conversion factors set out in BIPRU 4.4.37 R.

[Note: BCD Article 87(8)]

IRB foundation approach: LGDs

BIPRU 4.4.34

handbook-rule

A firm must use the following LGD values:

  1. (1) senior exposures without eligible collateral, 45%;
  2. (2) subordinated exposures without eligible collateral, 75%;
  3. (3) a firm may recognise funded and unfunded credit protection in the LGD in accordance with BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10;
  4. (4) covered bonds may be assigned an LGD value of 11.25%; and
  5. (5) for certain senior corporate exposure purchased receivables, for certain subordinated corporate exposure purchased receivables and for dilution risk of corporate purchased receivables the provisions of BIPRU 4.8.25 R (LGDs for corporate receivables) apply.

[Note: BCD Annex VII Part 2 point 8 (part)]

BIPRU 4.4.35

handbook-rule

[deleted]

  1. (1) [deleted]
  2. (2) [deleted]
  3. (3) [deleted]
  4. (4) [deleted]

Foundation IRB approach: Exposure value and conversion factors

BIPRU 4.4.36

handbook-rule

BIPRU 4.4.37

handbook-rule
  1. (1) The exposure value for the items set out in this rule must be calculated as the committed but undrawn amount multiplied by the applicable conversion factor set out in this rule.
  2. (2) For credit lines which are uncommitted, that are unconditionally cancellable at any time by the firm without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower's credit worthiness, a conversion factor of 0 % applies. To apply a conversion factor of 0% a firm must actively monitor the financial condition of the obligor, and its internal control systems must enable it immediately to detect a deterioration in the credit quality of the obligor.
  3. (3) For short-term letters of credit arising from the movement of goods, a conversion factor of 20% applies for both the issuing and confirming firms.
  4. (4) For other credit lines, note issuance facilities (NIFs), and revolving underwriting facilities (RUFs), a conversion factor of 75% applies.
  5. (5) For undrawn purchase commitments for revolving purchased receivables falling under BIPRU 4.8.29 R, the conversion factor set out in that rule applies.

[Note: BCD Annex VII Part 3 point 9 (part)]

BIPRU 4.4.38

handbook-rule

Where a commitment refers to the extension of another commitment, the lower of the two conversion factors associated with the individual commitment must be used.

[Note: BCD Annex VII Part 3 point 10]

BIPRU 4.4.39

handbook-rule

For all off-balance sheet items other than mentioned in BIPRU 4.4.37 R, BIPRU 4.4.45 R, BIPRU 4.4.71 R - BIPRU 4.4.78 R, BIPRU 4.6.44 R, BIPRU 4.8.28 R and BIPRU 4.8.29 R, the exposure value must be the following percentage of its value:

  1. (1) 100% if it is a full risk item;
  2. (2) 50% if it is a medium risk item;
  3. (3) 20% if it is a medium/low risk item; and
  4. (4) 0% if it is a low risk item.

For the purposes of this rule the off-balance sheet items must be assigned to risk categories as indicated in BIPRU 3.7 (Classification of off-balance sheet items).

[Note: BCD Annex VII Part 3 point 11]

Advanced IRB approach: General

BIPRU 4.4.40

handbook-rule
BIPRU 4.4.41 R - BIPRU 4.4.55 R set out requirements specific to the advanced IRB approach.

BIPRU 4.4.41

handbook-rule

Under the advanced IRB approach a firm must use its own estimates of LGDs and conversion factors in accordance with BIPRU 4.

[Note: BCD Article 87(9)]

Advanced IRB approach: LGDs and PDs

BIPRU 4.4.42

handbook-rule

A firm using own LGD estimates under the advanced IRB approach may recognise unfunded credit protection by adjusting PDs subject to BIPRU 4.4.43 R.

[Note: BCD Annex VII Part 2 point 6]

BIPRU 4.4.43

handbook-rule

Notwithstanding BIPRU 4.4.34 R and BIPRU 4.8.25 R, if a firm's IRB permission permits it to use own LGD estimates under the advanced IRB approach for exposures to which BIPRU 4 applies and permits it to use the approach in this rule, unfunded credit protection may be recognised by adjusting PD and/or LGD estimates subject to the minimum IRB standards. A firm must not assign guaranteed exposures an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor.

[Note: BCD Annex VII Part 2 point 10]

BIPRU 4.4.44

handbook-guidance
A firm using the advanced IRB approach may only recognise unfunded credit protection in accordance with BIPRU 4.4.43 R. The other methods for recognising unfunded credit risk mitigation under the standardised approach and foundation IRB approach are not available to a firm on the advanced IRB approach.

Advanced IRB approach: Conversion factors

BIPRU 4.4.45

handbook-rule

If a firm uses its own estimates of conversion factors under the advanced IRB approach it must calculate the exposure value of off-balance sheet exposures calculated with the use of conversion factors by using its own estimates of conversion factors across different product types as mentioned in BIPRU 4.4.37 R and BIPRU 4.4.39 R (2) to BIPRU 4.4.39 R (4).

[Note: BCD Annex VII Part 3 point 9 (part)]

BIPRU 4.4.46

handbook-guidance
Under BIPRU 4.4.45 R, a firm may calculate exposure values by calculating the amount expected to be claimed, instead of the maximum possible amount of the potential claim. The figure for the amount expected to be claimed should not be less than the current outstandings from time to time.

Advanced IRB approach: Structure of the rating system

BIPRU 4.4.47

handbook-rule

BIPRU 4.4.48

handbook-rule

If a firm's IRB permission provides for it to use the advanced IRB approach for the calculation of LGDs, its rating system must incorporate a distinct facility rating scale which exclusively reflects LGD related transaction characteristics.

[Note: BCD Annex VII Part 4 point 9]

BIPRU 4.4.49

handbook-rule

A facility grade means for the purpose of the advanced IRB approach a risk category within a rating system's facility scale to which exposures are assigned on the basis of a specified and distinct set of rating criteria from which own estimates of LGDs are derived. The grade definition must include both a description of how exposures are assigned to the grade and of the criteria used to distinguish the level of risk across grades.

[Note: BCD Annex VII Part 4 point 10]

BIPRU 4.4.50

handbook-rule

Significant concentrations within a single facility grade must be supported by convincing empirical evidence that the facility grade covers a reasonably narrow LGD band, respectively, and that the risk posed by all exposures in the grade falls within that band.

[Note: BCD Annex VII Part 4 point 11]

Advanced IRB approach: Assignment of exposures

BIPRU 4.4.51

handbook-rule

For a firm permitted to use own estimates of LGDs or conversion factors under the advanced IRB approach, each exposure must be assigned to a facility grade as part of the credit approval process. This is in addition to the requirements in BIPRU 4.4.11 R - BIPRU 4.4.13 R.

[Note: BCD Annex VII Part 4 point 20]

BIPRU 4.4.52

handbook-guidance
BIPRU 4.4.50 R and BIPRU 4.4.51 R should be read in the light of BIPRU 4.3.28 R.

Advanced IRB approach: Data maintenance

BIPRU 4.4.53

handbook-rule

As well as complying with BIPRU 4.3.54 R and BIPRU 4.4.21 R (Data maintenance), a firm using own estimates of LGDs and/or conversion factors under the advanced IRB approach must collect and store:

  1. (1) complete histories of data on the facility ratings and LGD and conversion factor estimates associated with each rating scale;
  2. (2) the dates the ratings were assigned and the estimates were done;
  3. (3) the key data and methodology used to derive the facility ratings and LGD and conversion factor estimates;
  4. (4) the person who assigned the facility rating and the person who provided LGD and conversion factor estimates;
  5. (5) data on the estimated and realised LGDs and conversion factors associated with each defaulted exposure;
  6. (6) data on the LGD of the exposure before and after evaluation of the effects of a guarantee or credit derivative, for a firm that reflects the credit risk mitigating effects of guarantees or credit derivatives through LGD; and
  7. (7) data on the components of loss for each defaulted exposure.

[Note: BCD Annex VII Part 4 Point 38]

Advanced IRB approach: Requirements specific to own-LGD estimates

BIPRU 4.4.54

handbook-rule

In addition to the requirements in BIPRU 4.3.74 R - BIPRU 4.3.94 R (General requirements about risk quantification) and BIPRU 4.3.98 R - BIPRU 4.3.123 R (Requirements for risk quantification specific to own-LGD estimates), estimates of LGD must be based on data over a minimum of five years, increasing by one year each year after implementation until a minimum of seven years is reached, for at least one data source. If the available observation period spans a longer period for any source, and the data is relevant, this longer period must be used.

[Note: BCD Annex VII Part 4 point 82]

Advanced IRB approach: Requirements specific to own-conversion factor estimates

BIPRU 4.4.55

handbook-rule

In addition to the requirements in BIPRU 4.3.124 R - BIPRU 4.3.131 R (Requirements specific to own-conversion factor estimates), estimates of conversion factors must be based on data over a minimum of five years, increasing by one year each year after implementation until a minimum of seven years is reached, for at least one data source. If the available observation period spans a longer period for any source, and the data is relevant, this longer period must be used.

[Note: BCD Annex VII Part 4 point 93]

Calculations: General

BIPRU 4.4.56

handbook-rule
The remainder of this section applies to both the foundation IRB approach and the advanced IRB approach.

Calculations: Risk-weighted exposure amounts

BIPRU 4.4.57

handbook-rule

Subject to BIPRU 4.4.59 R to BIPRU 4.4.60 R, BIPRU 4.5.6 R, BIPRU 4.5.8 R - BIPRU 4.5.10 R (Risk weights for specialised lending), BIPRU 4.8.16 R, BIPRU 4.8.17 R (Risk weights for corporate exposure purchased receivables) and BIPRU 4.9.3 R (Securitisation: provision of credit protection), risk weighted exposure amounts must be calculated according to the formulae in the table in BIPRU 4.4.58 R and the adjustment formula in BIPRU 4.4.79 R (Double default).

[Note: BCD Annex VII Part 1 point 3]

BIPRU 4.4.58

handbook-rule

Table: Formulae for the calculation of risk weighted exposure amounts
This table belongs to BIPRU 4.4.57 R

[Note: BCD Annex VII Part 1 point 3]

BIPRU 4.4.59

handbook-rule

For exposures to companies where the total annual sales for the consolidated group of which the firm is a part is less than EUR 50 million a firm may use the following correlation formula for the calculation of risk weights for corporate exposures. In this formula S is expressed as total annual sales in millions of Euros with EUR 5 million < = S < = EUR 50 million. Reported sales of less than EUR 5 million must be treated as if they were equivalent to EUR 5 million. In accordance with BIPRU 4.8.21 R, for purchased receivables the total annual sales are the weighted average by individual exposures of the pool. The formula for the calculation of correlation (R) is:
0.12×(1-EXP(-50*PD))/(1-EXP(-50))+ 0.24*
[1-(1-EXP(-50*PD))/(1-EXP(-50))]
-0.04*(1-(S-5)/45)

[Note: BCD Annex VII Part 1 point 5 (part)]

BIPRU 4.4.60

handbook-rule

A firm must for the purpose of BIPRU 4.4.59 R substitute total assets of the consolidated group for total annual sales when total annual sales are not a meaningful indicator of firm size and total assets are a more meaningful indicator than total annual sales.

[Note: BCD Annex VII Part 1 point 5 (part)]

Calculations: Expected loss amounts

BIPRU 4.4.61

handbook-rule

Expected loss amounts must be calculated according to the formulae in the table in BIPRU 4.4.62 R.

[Note: BCD Annex VII Part 1 point 30 (part)]

BIPRU 4.4.62

handbook-rule

Table: Formulae for the calculation of expected loss amounts
This table belongs to BIPRU 4.4.61 R

[Note: BCD Annex VII Part 1 point 30 (part)]

Calculations: PD

BIPRU 4.4.63

handbook-rule

A firm must provide its own estimates of PDs in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(6) (part)]

BIPRU 4.4.64

handbook-rule

The PD of a corporate exposure or an exposure in the IRB exposure class referred to in BIPRU 4.3.2 R (2) (Institutions) must be at least 0.03%.

[Note: BCD Annex VII Part 2 point 2]

BIPRU 4.4.65

handbook-rule

The PD of obligors in default must be 100%.

[Note: BCD Annex VII Part 2 point 4]

BIPRU 4.4.66

handbook-rule

Subject to BIPRU 4.4.42 R (Advanced IRB approach: LGDs and PDs) a firm may recognise unfunded credit protection in the PD in accordance with the provisions of BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10. For dilution risk, however, a firm may also recognise unfunded credit protection providers which are specified in its IRB permission in addition to those indicated in the CRM eligibility conditions.

[Note: BCD Annex VII Part 2 point 5]

Calculations: Maturity

BIPRU 4.4.67

handbook-rule
  1. (1) A firm must calculate maturity (M) for each of the exposures referred to in this rule in accordance with this rule and subject to BIPRU 4.4.68 R to BIPRU 4.4.70 R. In all cases, M must be no greater than 5 years.
  2. (2) For an instrument subject to a cash flow schedule M must be calculated according to the following formula:
where CFt denotes the cash flows (principal, interest payments and fees) contractually payable by the obligor in period t.
  1. (3) For derivatives subject to a master netting agreement M must be the weighted average remaining maturity of the exposure, where M must be at least 1 year. The notional amount of each exposure must be used for weighting the maturity.
  2. (4) For exposures arising from fully or nearly-fully collateralised financial derivative instruments transactions and fully or nearly-fully collateralised margin lending transactions which are subject to a master netting agreement M must be the weighted average remaining maturity of the transactions where M must be at least 10 days. For repurchase transactions or securities or commodities lending or borrowing transactions which are subject to a master netting agreement, M must be the weighted average remaining maturity of transactions, where M must be at least 5 days.The notional amount of each transaction must be used for weighting the maturity.
  3. (5) Where a firm uses the CCR internal model method to calculate the exposure values, M must be calculated for exposures to which a firm applies this method and for which the maturity of the longest-dated contract contained in the netting set is greater than one year according to the following formula:
where:
dfk = the risk-free discount factor for future time period tk and the remaining symbols are defined in BIPRU 13.6.
  1. (6) Notwithstanding (7), a firm that uses a CCR internal model method model to calculate a one-sided credit valuation adjustment (CVA) may use the effective credit duration estimated by the model as M if permitted to do so by its CCR internal model method permission.
  2. (7) Subject to BIPRU 4.4.68 R, for netting sets in which all contracts have an original maturity of less than one year the formula in (2) must be applied.
  3. (8) If a firm is permitted under its IRB permission to use own PD estimates for corporate exposure purchased receivables, for drawn amounts M must equal the purchased receivables exposure weighted average maturity, where M must be at least 90 days. This same value of M must also be used for undrawn amounts under a committed purchase facility provided the facility contains effective covenants, early amortisation triggers, or other features that protect the purchasing firm against a significant deterioration in the quality of the future receivables it is required to purchase over the facility's term. Absent such effective protections, M for undrawn amounts must be calculated as the sum of the longest-dated potential receivable under the purchase agreement and the remaining maturity of the purchase facility, where M must be at least 90 days.
  4. (9) For any other instrument than mentioned in this rule or when a firm is not in a position to calculate M as set out in (2), M must be the maximum remaining time (in years) that the obligor is permitted to take fully to discharge its contractual obligations, where M must be at least 1 year.
  5. (10) Notwithstanding (2) and (9), M must be at least one-day for:
    1. (a) import letters of credit (including standby letters of credit issued for similar purposes) and acceptances under them;
    2. (b) export letters of credit confirmation and negotiation;
    3. (c) pre-shipment and post-shipment acceptances and financing;
    4. (d) export and import loans collateralised by underlying goods, up to a maximum maturity of 180 days; and
    5. (e) performance guarantees, bid bonds and other guarantees (including standby letters of credit issued for similar purposes) relating to the export and import of goods and services;
provided these exposures are not part of the firm's ongoing financing of the obligor.

[Note: BCD Annex VII Part 2 point 13 (part)]

BIPRU 4.4.68

handbook-rule

Notwithstanding BIPRU 4.4.67 R (2) - (4) and (8)-(9), M must be at least one-day for:

  1. (1) fully or nearly-fully collateralised financial derivative instruments;
  2. (2) fully or nearly-fully collateralised margin lending transactions; and
  3. (3) repurchase transactions, securities or commodities lending or borrowing transactions,

provided the documentation requires daily remargining and daily revaluation and includes provisions that allow for the prompt liquidation or setoff of collateral in the event of default or failure to re-margin.

[Note: BCD Annex VII Part 2 point 14 (part)]

BIPRU 4.4.69

handbook-guidance

The last paragraph of paragraph 14 of Part 2 of Annex VII of the Banking Consolidation Directive says: "In addition, for other short-term exposures specified by the competent authorities which are not part of the credit institution's ongoing financing of the obligor, M shall be at least one-day. A careful review of the particular circumstances shall be made in each case." BIPRU 4.4.67R (10) is currently the only instance where the FSA has specified any such short-term exposures.

[Note: BCD Annex VII Part 2 point 14 (part)]

BIPRU 4.4.70

handbook-rule

Maturity mismatches must be treated as specified in BIPRU 4.10 and BIPRU 5 (Credit risk mitigation).

[Note: BCD Annex VII Part 2 point 16]

Calculations: Exposure value

BIPRU 4.4.71

handbook-rule

Unless provided otherwise in BIPRU 4 the exposure value of on-balance sheet exposures must be measured gross of value adjustments. This also applies to assets purchased at a price different than the amount owed. For purchased assets, the difference between the amount owed and the net value recorded on the balance-sheet of the firm is denoted discount if the amount owed is larger, and premium if it is smaller.

[Note: BCD Annex VII Part 3 point 1]

BIPRU 4.4.72

handbook-rule
A firm must not treat the exposure value of a facility as being less than current drawings under it. Interest accrued to date on an exposure under a facility must be included in current drawings or an allowance for it must be built into the conversion factor.

BIPRU 4.4.73

handbook-rule

Where a firm uses master netting agreements in relation to repurchase transactions or securities or commodities lending or borrowing transactions the exposure value must be calculated in accordance with BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10, and BIPRU 13.8.

[Note: BCD Annex VII Part 3 point 2]

BIPRU 4.4.74

handbook-rule

For on-balance sheet netting of loans and deposits a firm must apply for the calculation of the exposure value the methods set out in BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10.

[Note: BCD Annex VII Part 3 point 3]

BIPRU 4.4.75

handbook-rule

The exposure value for leases must be the discounted minimum lease payments. Minimum lease payments are the payments over the lease term that the lessee is or can be required to make and any bargain option (i.e. option the exercise of which is reasonably certain). Any guaranteed residual value fulfilling the set of conditions in BIPRU 5.7.1 R (Eligibility), as modified by BIPRU 4.10.38 R and BIPRU 4.10.39 R (Unfunded credit protection: Eligibility of providers) regarding the eligibility of protection providers as well as the minimum requirements for recognising other types of guarantees provided in BIPRU 5.7.6 R (Minimum requirements: General) to BIPRU 5.7.12 R (Additional requirements for guarantees) should also be included in the minimum lease payments.

[Note: BCD Annex VII Part 3 point 4]

BIPRU 4.4.76

handbook-rule

Where an exposure takes the form of securities or commodities sold, posted or lent under repurchase transactions or securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions, the exposure value must be the value of the securities or commodities determined in accordance with GENPRU 1.3 (Valuation). Where the financial collateral comprehensive method is used, the exposure value must be increased by the volatility adjustment appropriate to such securities or commodities as set out in BIPRU 4.10 and BIPRU 5 (Credit risk mitigation). The exposure value of repurchase transactions, securities or commodities lending or borrowing transactions, long settlements transactions and margin lending transactions must be determined in accordance with BIPRU 13.

[Note: BCD Annex VII Part 3 point 7]

BIPRU 4.4.77

handbook-rule

Notwithstanding BIPRU 4.4.76 R, the exposure value of credit risk exposures outstanding, as determined by the firm, with a central counterparty must be determined in accordance with BIPRU 13.3.3 R and BIPRU 13.8.8 R (Exposure to central counterparty), provided that the central counterparty's CCR exposures with all participants in its arrangements are fully collateralised on a daily basis.

[Note: BCD Annex VII Part 3 point 8]

BIPRU 4.4.78

handbook-rule

In the case of any financial derivative instrument, the exposure value must be determined by the methods set out in BIPRU 13.

[Note: BCD Annex VII Part 3 point 5]

Double default

BIPRU 4.4.79

handbook-rule

The risk weighted exposure amount for each exposure which meets the requirements set out in BIPRU 5.7.2 R and BIPRU 4.4.83 R (Double default) may be adjusted according to the following formula:

  1. (1) Risk weighted exposure amount = RW *exposure value * (0.15 + 160*PDpp)]
  2. (2) PDpp = PD of the protection provider
  3. (3) RW must be calculated using the relevant risk weight formula set out in BIPRU 4.4.57 R for the exposure, the PD of the obligor and the LGD of a comparable direct exposure to the protection provider. The maturity factor (b) must be calculated using the lower of the PD of the protection provider and the PD of the obligor.

[Note: BCD Annex VII Part 1 point 4]

BIPRU 4.4.80

handbook-rule

Notwithstanding BIPRU 4.4.34 R and BIPRU 4.4.43 R, for the purposes of BIPRU 4.4.79 R, the LGD of a comparable direct exposure to the protection provider shall either be the LGD associated with an unhedged facility to the guarantor or the unhedged facility of the obligor, depending upon whether in the event both the guarantor and the obligor default during the life of the hedged transaction available evidence and the structure of the guarantee indicate that the amount recovered would depend on the financial condition of the guarantor or obligor, respectively

[Note: BCD Annex VII Part 2 point 11]

BIPRU 4.4.81

handbook-rule

For the purposes of BIPRU 4.4.79 R, M must be the effective maturity of the credit protection but at least 1 year.

[Note: BCD Annex VII Part 2 point 13 (part)]

BIPRU 4.4.82

handbook-rule
BIPRU 4.4.83 R applies to the eligibility of protection providers under the IRB approach which qualify for the treatment set out in BIPRU 4.4.79 R.

BIPRU 4.4.83

handbook-rule

An institution, an insurance undertaking (including an insurance undertaking that carries out reinsurance) or an export credit agency which fulfils the following conditions may be recognised as an eligible provider of unfunded credit protection which qualifies for the treatment set out in BIPRU 4.4.79 R:

  1. (1) the protection provider has sufficient expertise in providing unfunded credit protection;
  2. (2) the protection provider is regulated in a manner equivalent to the rules laid down in the Banking Consolidation Directive or had, at the time the credit protection was provided, a credit assessment by an eligible ECAI which is associated with credit quality step 3 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;
  3. (3) the protection provider had, at the time the credit protection was provided, or for any period of time thereafter, an internal rating with a PD equivalent to or lower than that associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;
  4. (4) the protection provider has an internal rating with a PD equivalent to or lower than that associated with credit quality step 3 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;

For the purpose of this rule, credit protection provided by an export credit agency must not benefit from any explicit central government counter-guarantee.

[Note: BCD Annex VIII Part 1 point 29]

BIPRU 4.4.84

handbook-rule
BIPRU 4.4.85 R applies to the requirements to qualify for the treatment set out in BIPRU 4.4.79 R.

BIPRU 4.4.85

handbook-rule

To be eligible for the treatment set out in BIPRU 4.4.79 R, credit protection deriving from a guarantee or credit derivative must meet the following conditions:

  1. (1) the underlying obligation must be to:
    1. (a) a corporate exposure, excluding an exposure to an insurance undertaking (including an insurance undertaking that carries out reinsurance); or
    2. (b) an exposure to a regional government, local authority or public sector entity which is not treated as an exposure to a central government or a central bank according to BIPRU 4.4.2 R; or
    3. (c) an exposure to retail SME, classified as a retail exposure according to BIPRU 4.6.2 R;
  2. (2) the underlying obligors must not be members of the same group as the protection provider;
  3. (3) the exposure must be hedged by one of the following instruments:
    1. (a) single name unfunded credit derivatives or single name guarantees;
    2. (b) first to default basket products, with these the treatment must be applied to the asset within the basket with the lowest risk weighted exposure amount;
    3. (c) nth to default basket products, with these the protection obtained is only eligible for consideration under this framework if eligible (n-1)th default protection has also been obtained or where (n-1) of the assets within the basket has/have already defaulted and where this is the case the treatment must be applied to the asset within the basket with the lowest risk weighted exposure amount;
  4. (4) the credit protection must meet the requirements set out in BIPRU 5.7.6 R - BIPRU 5.7.8 R (Minimum requirements: Operational requirements), BIPRU 5.7.11 R (Additional requirements for guarantees) and BIPRU 5.7.13 R - BIPRU 5.7.14 R (Additional requirements for credit derivatives);
  5. (5) the risk weight that is associated with the exposure prior to the application of the treatment in BIPRU 4.4.79 R does not already factor in any aspect of the credit protection;
  6. (6) a firm must have the right and expectation to receive payment from the protection provider without having to take legal action in order to pursue the counterparty for payment;
  7. (7) the purchased credit protection must absorb all credit losses incurred on the hedged portion of an exposure that arise due to the occurrence of credit events outlined in the contract;
  8. (8) if the payout structure provides for physical settlement, then there must be legal certainty with respect to the deliverability of a loan, bond or contingent liability and if a firm intends to deliver an obligation other than the underlying exposure, it must ensure that the deliverable obligation is sufficiently liquid so that the firm would have the ability to purchase it for delivery in accordance with the contract;
  9. (9) the terms and conditions of credit protection arrangements must be legally confirmed in writing by both the protection provider and the firm;
  10. (10) a firm must have a process in place to detect excessive correlation between the creditworthiness of a protection provider and the obligor of the underlying exposure due to their performance being dependent on common factors beyond the systematic risk factor;
  11. (11) in the case of protection against dilution risk, the seller of purchased receivables must not be a member of the same group as the protection provider; and
  12. (12) with reference to (6), to the extent possible, a firm must take steps to satisfy itself that the protection provider is willing to pay promptly should a credit event occur.

[Note: BCD Annex VIII Part 2 point 22]

BIPRU 4.5

The IRB approach: Specialised lending exposures

  • 01/01/2007

Application

BIPRU 4.5.1

handbook-rule
BIPRU 4.5 applies with respect to the exposures referred to in BIPRU 4.5.3 R.

BIPRU 4.5.2

handbook-rule
Except for BIPRU 4.5.1 R and BIPRU 4.5.3 R, BIPRU 4.5 only applies to the extent that a firm applies the method in BIPRU 4.5 (slotting).

Definition of specialised lending

BIPRU 4.5.3

handbook-rule

Within the corporate exposure IRB exposure class, a firm must separately identify as specialised lending exposures, exposures which possess the following characteristics:

  1. (1) the exposure is to an entity which was created specifically to finance and/or operate physical assets;
  2. (2) the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate; and
  3. (3) the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise.

[Note: BCD Article 86(6)]

Treatment of specialised lending

BIPRU 4.5.4

handbook-rule
If a firm is using or is applying to use the advanced IRB approach for some or all of its exposures in the sovereign, institution and corporate IRB exposure class, then specialised lending exposures treated under BIPRU 4.5.8 R (Slotting) must be treated as being dealt with under the advanced IRB approach for the purposes of the calculations in BIPRU 4.2.30 R and BIPRU 4.2.31 R. If a firm is not using or applying to use the advanced IRB approach for any of its exposures in the sovereign, institutionl and corporate IRB exposure class, in the cases in which it is necessary to distinguish between the advanced IRB approach and the foundation IRB approach, then specialised lending exposures treated under BIPRU 4.5.8 R must be treated as being dealt with under the foundation IRB approach for the purposes of the calculations in BIPRU 4.2.30 R and BIPRU 4.2.31 R.

Structure of rating system

BIPRU 4.5.5

handbook-rule

A firm using the methods set out in BIPRU 4.5.8 R (Slotting) for assigning risk weights for specialised lending exposures is exempt from the requirement to have an obligor rating scale which reflects exclusively quantification of the risk of obligor default for these exposures. Notwithstanding BIPRU 4.4.7 R (Seven grades for exposures to sovereigns, institutions and corporates), a firm must have for these exposures four grades for non-defaulted obligors and one grade for defaulted obligors.

[Note: BCD Annex VII Part 4 point 12 and point 21]

Assignment of exposures

BIPRU 4.5.6

handbook-rule
  1. (1) A firm using the methods set out in BIPRU 4.5.8 R (Slotting) for assigning risk weights for specialised lending exposures must assign each of these exposures to a grade in accordance with BIPRU 4 Annex 1 R, taking into account the following factors:
    1. (a) financial strength;
    2. (b) political and legal environment;
    3. (c) transaction and/or asset characteristics;
    4. (d) strength of the sponsor and developer including any public private partnership income stream; and
    5. (e) security package.
  2. (2) A firm must slot exposures into the five columns in the tables in BIPRU 4.5.9 R and BIPRU 4.5.13 R as follows:
    1. (a) a firm must slot an exposure categorised as strong under Annex X into column 1;
    2. (b) a firm must slot an exposure categorised as good under the Annex X into column 2;
    3. (c) a firm must slot an exposure categorised as satisfactory under Annex X into column 3;
    4. (d) a firm must slot an exposure categorised as weak under Annex X into column 4;
    5. (e) in accordance with BIPRU 4.5.5 R a firm must slot an exposure in default into column 5.

[Note: BCD Annex VII Part 1 point 6 (part)]

Calculation of risk-weighted exposure amounts

BIPRU 4.5.7

handbook-rule

Notwithstanding BIPRU 4.3.5 R (Use of relevant parameters for calculating risk weighted exposure amounts), the calculation of risk weighted exposure amounts for credit risk for specialised lending exposures may be calculated in accordance with BIPRU 4.5.8 R.

[Note: BCD Article 87(5)]

BIPRU 4.5.8

handbook-rule

For specialised lending exposures in respect of which a firm cannot demonstrate that its PD estimates meet the minimum IRB standards it must assign risk weights to these exposures according to the table in BIPRU 4.5.9 R.

[Note: BCD Annex VII Part 1 point 6 (part)]

BIPRU 4.5.9

handbook-rule

Table: Risk weights for specialised lending
This table belongs to BIPRU 4.5.8 R

[Note: BCD Annex VII Part 1 point 6 (part)]

BIPRU 4.5.10

handbook-rule

A firm may generally assign preferential risk weights of 50% to exposures in category 1, and a 70% risk weight to exposures in category 2 if:

  1. (1) its IRB permission allows this; and
  2. (2) the firm's underwriting characteristics and other risk characteristics are substantially strong for the relevant category.

[Note: BCD Annex VII Part 1 point 6 (part)]

BIPRU 4.5.11

handbook-guidance
  1. (1) If a firm applies for an IRB permission or for a variation of an IRB permission that permits the treatment in BIPRU 4.5.10 R it should demonstrate that its standards exceed those of the slotting criteria provided for in BIPRU 4.5 and result in ratings that are stronger than the benchmarks referred to in (3).
  2. (2) If a firm has an IRB permission that permits the treatment in BIPRU 4.5.10 R it should continue to be able to demonstrate the matters in (1) to the FSA if asked.
  3. (3) Although a firm should map its internal ratings to the supervisory categories set out in the table in BIPRU 4.5.9 R using the slotting criteria provided in BIPRU 4.5.6 R, each supervisory category broadly corresponds to a range of external credit assessments of BBB- or better, BB+ or BB, BB- or B+ and B to C- (or their equivalents). The fifth category covers default.

Calculation of expected loss amounts

BIPRU 4.5.12

handbook-rule

The EL values for specialised lending exposures where a firm uses the methods set out in BIPRU 4.5.8 R for assigning risk weights must be assigned according to the table in BIPRU 4.5.13 R.

[Note: BCD Annex VII Part 1 point 31 (part)]

BIPRU 4.5.13

handbook-rule

Table: Expected loss values for specialised lending
This table belongs to BIPRU 4.5.12 R

[Note: BCD Annex VII Part 1 point 31 (part)]

BIPRU 4.5.14

handbook-rule

Where a firm's IRB permission authorises it generally to assign preferential risk weights as outlined in BIPRU 4.5.10 R of 50% to exposures in category 1, and 70% to exposures in category 2, the EL value for exposures in category 1 must be 0%, and for exposures in category 2 must be 0.4%.

[Note: BCD Annex VII Part 1 point 31 (part)]

BIPRU 4.6

The IRB approach: Retail exposures

  • 01/01/2007

Application

BIPRU 4.6.1

handbook-rule
BIPRU 4.6 applies with respect to the exposures referred to in BIPRU 4.6.2 R.

Definition of retail exposures

BIPRU 4.6.2

handbook-rule

To be eligible to be treated as a retail exposure, exposures must meet the following criteria:

  1. (1) they must be either to an individual person or persons, or to a small or medium sized entity, provided in the latter case that the total amount owed to the firm and parent undertaking and its subsidiary undertakings, including any past due exposure, by the obligor client or group of connected clients, but excluding claims or contingent claims secured on residential real estate collateral, must not, to the knowledge of the firm, which must have taken reasonable steps to confirm the situation, exceed EUR 1 million;
  2. (2) they are treated by the firm in its risk management consistently over time and in a similar manner;
  3. (3) they are not managed just as individually as exposures in the corporate exposure IRB exposure class; and
  4. (4) they each represent one of a significant number of similarly managed exposures.

[Note: BCD Article 86(4) (part)]

BIPRU 4.6.3

handbook-rule

The present value of retail minimum lease payments is eligible to be treated as a retail exposure.

[Note: BCD Article 86(4) (part)]

BIPRU 4.6.4

handbook-guidance
  1. (1) This paragraph sets out guidance on BIPRU 4.6.2 R so far as it relates to the boundary between retail exposures and corporate exposures.
  2. (2) In deciding what steps are reasonable for the purposes of BIPRU 4.6.2 R (1), a firm may take into account complexity and cost, as well as the materiality of the impact upon its capital calculation. A firm should be able to demonstrate to the FSA that it has complied with the obligation to take reasonable steps under BIPRU 4.6.2 R (1) in the way it takes these factors into account.
  3. (3) If a firm has exposures to an owner of a retail SME in his personal capacity and exposures to the retail SME the firm should aggregate the two types of exposure for the purpose of BIPRU 4.6.2 R (1), although it should not include claims secured on residential real estate collateral. In deciding what steps are reasonable for the purposes of BIPRU 4.6.2 R (1) in aggregating these two types of exposure, a firm may take into account the materiality of those personal exposures. A firm should be able to demonstrate to the FSA that it has complied with the obligation to take reasonable steps under BIPRU 4.6.2 R (1) when taking into account materiality in this way.
  4. (4) The definition of group of connected clients is set out in the glossary. Paragraph (2) of that definition is "two or more persons ... who are to be regarded as constituting a single risk because they are so interconnected that, if one of them were to experience financial problems, the other or all of the others would be likely to encounter repayment difficulties". Say that a firm has exposures to A and B. When deciding whether A and B come within paragraph (2) of the definition two conditions should be satisfied. Firstly the connections between A and B should mean that if A experiences financial problems, B should be likely to encounter repayment difficulties. Secondly, the connections between A and B should mean that if B experiences financial problems, A should be likely to encounter repayment difficulties
  5. (5) A firm should have its own documented policy on the types of exposures that, in accordance with BIPRU 4.6, qualify as retail SME exposures. The FSA would not expect that a definition based on the EUR 1m exposure limit would be adequate on its own.
  6. (6) The purpose of the definition of retail exposure is to separate a non-granular retail and small and medium sized business portfolio from other business so that a separate capital calculation may be applied to that portfolio that takes into account its non-granularity. Where retail exposures are assigned to pools it is the statistical characteristics of these pools which are used to derive the IRB approach estimates. Therefore pools should be reasonably homogenous and subject to consistent risk management practices.
  7. (7) A firm should have sufficient controls to ensure that any inadvertent assignment of non-eligible exposures to the retail exposure IRB exposure class is sufficiently immaterial that it does not result in any significant distortion of the overall statistical characteristics of the sub-sets of that IRB exposure class which arise when the exposures are assigned to grades or pools. Cost considerations do not justify inclusion of non-eligible exposures if the effect would be material. Sample testing could be one method of demonstrating that the impact would be immaterial. BIPRU 4.1.25 R applies to exposures treated in accordance with this sub-paragraph (7).
  8. (8) If an exposure to a small or medium sized business crosses the retail exposure size boundary it should be treated as a corporate, unless, in accordance with BIPRU 4.1.25 R, the excess is immaterial because of its size or because it is temporary.
  9. (9) BIPRU 4.6.2 R does not require that exposures to retail SMEs should never be individually managed. In deciding whether the frequency and extent of individual management does or does not make exposures ineligible for the retail exposure IRB exposure class, a firm should consider whether that individual management is:
    1. (a) sufficiently insignificant not to disrupt the homogeneity of the pool;
    2. (b) consistent with the management of other exposures in the same retail exposure pool; and
    3. (c) significantly different in extent from the individual management that occurs for corporate exposures, looked at as a whole.
  10. (10) Where an exposure is denominated in other currencies, a firm may calculate the Euro equivalent for the purposes of BIPRU 4.6.2 R (1) using any appropriate set of exchange rates provided its choice has no obvious bias and that the firm is consistent in its approach to choosing rates.
  11. (11) A firm may monitor compliance with the €1m threshold in BIPRU 4.6.2 R (1) on the basis of approved limits provided that it has internal control procedures that are sufficient to ensure that amounts owed cannot diverge from those approved limits to such an extent as to give rise to a breach of the €1m threshold or, if the firm is relying on provisions relating to reasonable steps in BIPRU 4.6.2 R (1), any material breach of that threshold.

Rating system: Structure of rating system

BIPRU 4.6.5

handbook-guidance
Further material on the structure of rating systems can be found in BIPRU 4.3.25 R - BIPRU 4.3.28 R.

Rating system: Assignment to grades or pools

BIPRU 4.6.6

handbook-rule

Rating systems must reflect both obligor and transaction risk, and must capture all relevant obligor and transaction characteristics.

[Note: BCD Annex VII Part 4 point 13]

BIPRU 4.6.7

handbook-rule

The level of risk differentiation must ensure that the number of exposures in a given grade or pool is sufficient to allow for meaningful quantification and validation of the loss characteristics at the grade or pool level. The distribution of exposures and obligors across grades or pools must be such as to avoid excessive concentrations.

[Note: BCD Annex VII Part 4 point 14]

BIPRU 4.6.8

handbook-guidance
  1. (1) This paragraph contains guidance on the level of differentiation referred to in BIPRU 4.6.7 R.
  2. (2) It is important that a firm achieves adequate segmentation to deliver robust estimates of LGD and conversion factors, as well as PD. Whether the focus should be more on exposure size or collateral type is a question of fact for the particular circumstances in which the assignment of exposures to grades or pools occurs. Typically the FSA would expect both to be important.
  3. (3) A firm may allocate retail exposures to pools based on direct estimates of PD, LGD and conversion factors as well as using an approach under which the firm segments first and attributes PD, LGD and conversion factors afterwards. However the result should in either case be that the pools are sufficiently homogenous.
  4. (4) The number and size of pools should be determined in relation to the objective of establishing homogeneous risk. Pools should be of sufficient size to permit the production of robust risk estimates but should not be so large as to obscure variations in quality.

BIPRU 4.6.9

handbook-rule

A firm must be able to demonstrate to the FSA that the process of assigning exposures to grades or pools provides for a meaningful differentiation of risk, provides for a grouping of sufficiently homogenous exposures, and allows for accurate and consistent estimation of loss characteristics at grade or pool level.

[Note: BCD Annex VII Part 4 point 15 (part)]

BIPRU 4.6.10

handbook-guidance
For purchased receivables, BIPRU 4.8 contains material about assignment to grades or pools.

BIPRU 4.6.11

handbook-rule
  1. (1) A firm must consider the following risk drivers when assigning exposures to grades or pools:
    1. (a) obligor risk characteristics;
    2. (b) transaction risk characteristics, including product or collateral types or both; and
    3. (c) delinquency.
  2. (2) In the case of (1)(b) a firm must explicitly address cases where several exposures benefit from the same collateral.
  3. (3) However:
    1. (a) a firm need not consider delinquency if this is compatible with its IRB permission; and
    2. (b) (in the case of a firm with an IRB permission that permits the firm not to consider delinquency) it should be able to demonstrate to the FSA that delinquency is not a material risk driver for the exposures treated in this way.

[Note: BCD Annex VII Part 4 Point 16]

Rating system: Assignment of exposures

BIPRU 4.6.12

handbook-rule

Each exposure must be assigned to a grade or a pool as part of the credit approval process.

[Note: BCD Annex VII Part 4 point 24]

Rating system: Overrides

BIPRU 4.6.13

handbook-guidance
Material on overrides can be found in BIPRU 4.3.50 R.

Rating system: Integrity of assignment process

BIPRU 4.6.14

handbook-rule

A firm must at least annually update obligor and facility assignments or review the loss characteristics and delinquency status of each identified risk pool whichever is applicable. A firm must also at least annually review in a representative sample the status of individual exposures within each pool as a means of ensuring that exposures continue to be assigned to the correct pool.

[Note: BCD Annex VII Part 4 point 29]

BIPRU 4.6.15

handbook-guidance
Annual rescoring is one method of meeting the requirement in BIPRU 4.6.14 R. However a firm need not carry out this update by means of a full re-run of a credit scoring model if it is able to demonstrate that its method is appropriate to the portfolio given its materiality and its impact on its capital requirements and that the firm still meets the minimum IRB standards.

Rating system: Use of models

BIPRU 4.6.16

handbook-guidance
Material on the use of models can be found in BIPRU 4.3.51 R - BIPRU 4.3.53 G.

Rating system: Documentation

BIPRU 4.6.17

handbook-guidance
Material on documentation can be found in BIPRU 4.3.19 R - BIPRU 4.3.24 R.

Rating system: Data maintenance

BIPRU 4.6.18

handbook-rule

In addition to complying with BIPRU 4.3.54 R (Data maintenance) a firm must collect and store:

  1. (1) data used in the process of allocating exposures to grades or pools;
  2. (2) data on the estimated PDs, LGDs and conversion factors associated with grades or pools of exposures;
  3. (3) the identity of obligors and exposures that defaulted;
  4. (4) for defaulted exposures, data on the grades or pools to which the exposure was assigned over the year prior to default and the realised outcomes on LGD and conversion factor; and
  5. (5) data on loss rates for qualifying revolving retail exposures.

[Note: BCD Annex VII Part 4 point 39]

Risk quantification: Definition of default

BIPRU 4.6.19

handbook-guidance
Material on the definition of default can be found in BIPRU 4.3.56 R - BIPRU 4.3.72 G.

BIPRU 4.6.20

handbook-rule
  1. (1) This rule, in accordance with BIPRU 4.3.57 R (4) (Definition of default), sets the exact number of days past due that a firm must abide by in the case of retail exposures.
  2. (2) For retail exposures to counterparts situated within the United Kingdom the number of days past due is 180 days with the exception of retail SME exposures. For these exposures the number is 90 days.
  3. (3) For retail exposures to counterparts situated in another EEA State the number of days past due is the lower of:
    1. (a) 180; and
    2. (b) the number of days past due fixed under the CRD implementation measure in that EEA State with respect to paragraph 48 of Part 4 of Annex VII of the Banking Consolidation Directive for such exposures.
  4. (4) For retail exposures to counterparts in a state outside the EEA the number of days past due is the lower of:
    1. (a) 180; and
    2. (b) (if a number of days past due for such exposures has been fixed under any national law of that state applicable to undertakings in the banking sector or the investment services sector that implements the IRB approach) that number.

[Note: BCD Annex VII Part 4 point 44 (part) and point 48 (part)]

BIPRU 4.6.21

handbook-rule

A firm may apply the definition of default at a facility level.

[Note: BCD Annex VII Part 4 point 44 (part)]

BIPRU 4.6.22

handbook-guidance
Where a firm chooses to apply the definition of default at facility level and a customer has defaulted on a facility, then default on that facility is likely to influence the PD assigned to that customer on other facilities and so should be taken into account.

Risk quantification: Overall requirements for estimation

BIPRU 4.6.23

handbook-guidance
Material on the overall requirements for estimation can be found in BIPRU 4.3.73 R - BIPRU 4.3.94 R.

Risk quantification: Requirements specific to PD estimation

BIPRU 4.6.24

handbook-rule

A firm must estimate PDs by obligor grade or pool from long run averages of one-year default rates.

[Note: BCD Annex VII Part 4 point 67]

BIPRU 4.6.25

handbook-rule

Notwithstanding BIPRU 4.6.24 R, PD estimates may also be derived from realised losses and appropriate estimates of LGDs.

[Note: BCD Annex VII Part 4 point 68]

BIPRU 4.6.26

handbook-rule

A firm must regard internal data for assigning exposures to grades or pools as the primary source of information for estimating loss characteristics. A firm may use external data (including pooled data) or statistical models for quantification provided a strong link can be demonstrated between:

  1. (1) the firm's process of assigning exposures to grades or pools and the process used by the external data source; and
  2. (2) the firm's internal risk profile and the composition of the external data.

[Note: BCD Annex VII Part 4 point 69]

BIPRU 4.6.27

handbook-rule

If a firm derives long run average estimates of PD and LGD for retail exposures from an estimate of total losses, and an appropriate estimate of PD or LGD, the process for estimating total losses must meet the minimum IRB standards for estimation of PD and LGD, and the outcome must be consistent with the concept of LGD as set out in BIPRU 4.3.99 R (Default weighted average).

[Note: BCD Annex VII Part 4 point 70]

BIPRU 4.6.28

handbook-rule

Irrespective of whether a firm is using external, internal, pooled data sources or a combination of the three, for its estimation of loss characteristics, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation spans a longer period for any source, and these data are relevant, this longer period must be used. However:

  1. (1) a firm need not give equal importance to historic data if this is compatible with its IRB permission; and
  2. (2) (in the case of a firm with an IRB permission that permits this treatment of historic data) the firm must be able to convince the FSA that more recent data is a better predictor of loss rates.

[Note: BCD Annex VII Part 4 point 71 (part)]

BIPRU 4.6.29

handbook-rule

A firm may have, when implementing the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data covers a period of five years.

[Note: BCD Annex VII Part 4 point 71 (part)]

BIPRU 4.6.30

handbook-rule

A firm must identify and analyse expected changes of risk parameters over the life of credit exposures (seasoning effects).

[Note: BCD Annex VII Part 4 point 72]

Risk quantification: Requirements specific to own-LGD estimation

BIPRU 4.6.31

handbook-rule

Notwithstanding BIPRU 4.3.99 R (Default weighted average), LGD estimates may be derived from realised losses and appropriate estimates of PDs.

BIPRU 4.6.32

handbook-rule

Notwithstanding BIPRU 4.3.128 R (Additional drawings), a firm may reflect future drawings either in its conversion factor or in its LGD estimates.

[Note: BCD Annex VII Part 4 point 84]

BIPRU 4.6.33

handbook-rule

Estimates of LGD must be based on data over a minimum of five years. Notwithstanding BIPRU 4.3.99 R (Default weighted average):

  1. (1) a firm need not give equal importance to historic data if this is permitted by its IRB permission; and
  2. (2) (in the case of a firm with an IRB permission that permits this treatment of historic data) the firm must be able to convince the FSA that more recent data is a better predictor of loss rates.

[Note: BCD Annex VII Part 4 point 86 (part)]

BIPRU 4.6.34

handbook-rule

A firm may have, when it implements the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data covers a period of five years.

[Note: BCD Annex VII Part 4 point 86 (part)]

BIPRU 4.6.35

handbook-guidance
The FSA does not assume that all portfolios are sensitive to downturns. The FSA also accepts that for some portfolios, particularly in unsecured lending, the impact of the material drivers on LGD may be weak. However the burden is on the firm to demonstrate that its models are appropriate for the circumstances in which they are applied.

BIPRU 4.6.36

handbook-guidance
Additional material on requirements specific to own-LGD estimation can be found in BIPRU 4.3.98 R - BIPRU 4.3.123 R.

Risk quantification: Requirements specific to own-conversion factor estimates

BIPRU 4.6.37

handbook-rule

Notwithstanding BIPRU 4.3.128 R (Additional drawings), a firm may reflect future drawings either in its conversion factors or in its LGD estimates.

[Note: BCD Annex VII Part 4 point 94]

BIPRU 4.6.38

handbook-rule

Estimates of conversion factors must be based on data over a minimum of five years. Notwithstanding BIPRU 4.3.125 R:

  1. (1) a firm need not give equal importance to historic data if this is permitted by its IRB permission; and
  2. (2) (in the case of a firm with an IRB permission that permits this treatment of historic data) the firm must be able to convince the FSA if asked that more recent data is a better predictor of loss rates.

[Note: BCD Annex VII Part 4 point 95 (part)]

BIPRU 4.6.39

handbook-rule

A firm may have, when it implements the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data cover a period of five years.

[Note: BCD Annex VII Part 4 point 95 (part)]

BIPRU 4.6.40

handbook-guidance
Additional material on requirements specific to own-conversion factor estimation can be found in BIPRU 4.3.124 R - BIPRU 4.3.131 R.

Calculation of risk weighted exposure amounts for retail exposures: General

BIPRU 4.6.41

handbook-rule

Subject to BIPRU 4.6.43 R and BIPRU 4.6.44 R, the risk weighted exposure amounts for retail exposures must be calculated according to the formulae in the table in BIPRU 4.6.42 R.

[Note: BCD Annex VII Part 1 point 10 1st sentence]

BIPRU 4.6.42

handbook-rule

Table: Risk weighted exposure amounts for retail exposures
This table belongs to BIPRU 4.6.41 R

[Note: BCD Annex VII Part 1 point 10 (part)]

Calculation of risk weighted exposure amounts for retail exposures: Retail mortgages

BIPRU 4.6.43

handbook-rule

For retail exposures secured by real estate collateral a correlation (R) of 0.15 must replace the correlation formula in the table in BIPRU 4.6.42 R.

[Note: BCD Annex VII Part 1 point 12]

Calculation of risk weighted exposure amounts for retail exposures: Qualifying revolving retail exposures

BIPRU 4.6.44

handbook-rule
  1. (1) For qualifying revolving retail exposures a correlation (R) of 0.04 must replace the correlation formula in the table in BIPRU 4.6.42 R.
  2. (2) Retail exposures qualify as qualifying revolving retail exposures if they meet the following conditions:
    1. (a) the IRB permission of the firm in question does not disapply this paragraph;
    2. (b) the exposures are to individuals;
    3. (c) the exposures are revolving, unsecured, and, to the extent they are not drawn, immediately and unconditionally cancellable by the firm;
    4. (d) the maximum exposure to a single individual in the sub-portfolio is EUR 100,000 or less;
    5. (e) the firm is able to demonstrate to the FSA that the use of the correlation formula in this paragraph is limited to portfolios that have exhibited low volatility of loss rates, relative to their average level of loss rates, especially within the low PD bands; and
    6. (f) the firm is able to demonstrate to the FSA that treatment as a qualifying revolving retail exposure is consistent with the underlying risk characteristics of the sub-portfolio.
  3. (3) In the context of this rule revolving exposures are defined as those where customers' outstanding balances are permitted to fluctuate based on their decisions to borrow and repay, up to a limit established by the firm in question. Undrawn commitments may be considered as unconditionally cancellable if the terms permit the firm to cancel them to the full extent allowable under consumer protection and related legislation.

[Note: BCD Annex VII Part 1 point 13 (part) and Part 3 point 9(a) (part)]

BIPRU 4.6.45

handbook-guidance
A firm should be able to demonstrate the low volatility of loss rates mentioned in BIPRU 4.6.44 R (2)(e) at the time of the initial application for an IRB permission and thereafter at any time on request. The benchmark level should be the volatility of loss rates for the qualifying revolving retail exposure portfolio relative to the volatilities of loss rates of other relevant types of retail exposures. A firm should demonstrate low volatility by reference to data on the mean and standard deviation of loss rates over a time period that can be regarded as representative of the long-run performance of the portfolios concerned.

BIPRU 4.6.46

handbook-guidance
In the FSA's view a sub-portfolio consisting of credit card or overdraft obligations will usually meet the condition in BIPRU 4.6.44 R (2)(f). In the FSA's view it is unlikely that any other type of retail exposure will do so. If a firm wishes to apply the treatment in BIPRU 4.6.44 R (1) to product types other than credit card or overdraft obligations it should first discuss this with the FSA.

Calculation of expected loss amounts

BIPRU 4.6.47

handbook-rule

Expected loss amounts must be calculated according to the formulae in the table in BIPRU 4.6.48 R.

[Note: BCD Annex VII Part 1 point 30 (part)]

BIPRU 4.6.48

handbook-rule

Table: Formulae for the calculation of expected loss amounts
This table belongs to BIPRU 4.6.47 R

[Note: BCD Annex VII Part 1 point 30 (part)]

Calculation of PDs

BIPRU 4.6.49

handbook-rule

A firm must provide its own estimates of PDs in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(6) (part)]

BIPRU 4.6.50

handbook-rule

The PD of an exposure must be at least 0.03%.

[Note: BCD Annex VII Part 2 point 17]

BIPRU 4.6.51

handbook-rule

The PD of obligors in default must be 100%. If a firm is using the facility level approach described in BIPRU 4.6.21 R, the PD of an exposure in default must be 100%.

[Note: BCD Annex VII Part 2 point 18]

BIPRU 4.6.52

handbook-rule

Unfunded credit protection may be recognised by adjusting PDs subject to BIPRU 4.6.54 R. For dilution risk, where a firm does not use its own estimates of LGDs, this must be subject to compliance with BIPRU 5 (Credit risk mitigation) modified by BIPRU 4.10 and, for this purpose, a firm may recognise unfunded credit protection providers other than those indicated in the CRM eligibility conditions provided the firm is able to demonstrate that the unfunded protection provider giving the undertaking is sufficiently reliable and that the protection agreement is legally effective in accordance with BIPRU 5.2.7 R (Unfunded credit protection).

[Note: BCD Annex VII Part 2 point 20]

Calculation of LGDs

BIPRU 4.6.53

handbook-rule

A firm must provide its own estimates of LGDs in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(7) (part)]

BIPRU 4.6.54

handbook-rule

Unfunded credit protection may be recognised as eligible by adjusting PD or LGD estimates subject to the minimum IRB standards as specified in BIPRU 4.10.43 R - BIPRU 4.10.48 R and in accordance with the IRB permission either in support of an individual exposure or a pool of exposures. A firm must not assign guaranteed exposures an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor.

[Note: BCD Annex VII Part 2 point 22]

Calculation of exposure values and own conversion factors

BIPRU 4.6.55

handbook-rule
Except where otherwise specified, BIPRU 4.4.37 R - BIPRU 4.4.39 R (Exposure value and conversion factors), BIPRU 4.4.45 R (AIRB conversion factors) and BIPRU 4.4.71 R - BIPRU 4.4.78 R (Calculation of exposure values for sovereigns, institutions and corporates) also apply to retail exposures.

BIPRU 4.6.56

handbook-rule

A firm must provide its own estimates of conversion factors in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(7) (part)]

Double default

BIPRU 4.6.57

handbook-rule

The risk weighted exposure amount for each exposure to retail SME as defined in BIPRU 4.6.2 R which meets the requirements set out in BIPRU 4.4.83 R and BIPRU 4.4.85 R may be calculated according to BIPRU 4.4.79 R (Double default).

[Note: BCD Annex VII Part 1 point 11]

BIPRU 4.6.58

handbook-rule

Notwithstanding BIPRU 4.6.54 R for the purposes of BIPRU 4.4.80 R the LGD of a comparable direct exposure to the protection provider must either be the LGD associated with an unhedged facility to the guarantor or the unhedged facility of the obligor, depending upon whether in the event both the guarantor and obligor default during the life of the hedged transaction available evidence and the structure of the guarantee indicate that the amount recovered would depend on the financial condition of the guarantor or obligor, respectively.

[Note: BCD Annex VII Part 2 point 23]

BIPRU 4.7

The IRB approach: Equity exposures

  • 01/01/2007

Application

BIPRU 4.7.1

handbook-rule
BIPRU 4.7 applies with respect to the exposures referred to in BIPRU 4.7.2 R.

Definition of equity exposures

BIPRU 4.7.2

handbook-rule

The following exposures must be classed as equity exposures:

  1. (1) non-debt exposures conveying a subordinated, residual claim on the assets or income of the issuer; and
  2. (2) debt exposures the economic substance of which is similar to the exposures specified in (1).

[Note: BCD Article 86(2)]

Calculation of risk-weighted exposure amounts

BIPRU 4.7.3

handbook-rule

Notwithstanding BIPRU 4.3.5 R (Relevant parameters), the calculation of risk weighted exposure amounts for credit risk for all exposures belonging to the equity exposure IRB exposure class must be calculated in accordance with one of the following ways:

  1. (1) the simple risk weight approach (see BIPRU 4.7.8 R;
  2. (2) the PD/LGD approach (see BIPRU 4.7.13 R); and
  3. (3) the internal models approach (see BIPRU 4.7.23 R);

in accordance with BIPRU 4.7 and subject to the firm's IRB permission.

[Note: BCD Article 87(4) (part)]

BIPRU 4.7.4

handbook-rule

Even if a firm's IRB permission would otherwise permit the use of the internal models approach as referred to in BIPRU 4.7.3 R (3), it may only use that approach if it meets the minimum requirements in BIPRU 4.7.27 R - BIPRU 4.7.35 R.

[Note: BCD Article 87(4) (part)]

BIPRU 4.7.5

handbook-rule

A firm may employ different approaches to different portfolios where the firm itself uses different approaches internally. A firm must, if it uses different approaches in accordance with the previous sentence, be able to demonstrate to the FSA that the choice is made consistently and is not determined by regulatory arbitrage considerations.

[Note: BCD Annex VII Part 1 point 17]

BIPRU 4.7.6

handbook-rule

Notwithstanding BIPRU 4.7.5 R a firm may, if its IRB permission permits it to do so, attribute the risk weighted exposure amounts for equity exposures to ancillary services undertakings according to the treatment of non credit-obligation assets.

[Note: BCD Annex VII Part 1 point 18]

Exposure value

BIPRU 4.7.7

handbook-rule

The exposure value must be the value presented in the financial statements. Admissible equity exposure measures are the following:

  1. (1) for investments held at fair value with changes in value flowing directly through income and into capital resources, the exposure value is the fair value presented in the balance sheet;
  2. (2) for investments held at fair value with changes in value not flowing through income but into a tax-adjusted separate component of equity, the exposure value is the fair value presented in the balance sheet; and
  3. (3) for investments held at cost or at the lower of cost or market value, the exposure value is the cost or market value presented in the balance sheet.

[Note: BCD Annex VII Part 3 point 12]

The calculation of risk-weighted exposure amounts for equity exposures: The simple risk weight approach: Introduction

BIPRU 4.7.8

handbook-rule
BIPRU 4.7.9 R to BIPRU 4.7.12 R set out the simple risk weight approach for calculating the risk weighted exposure amounts for equity exposures as referred to in BIPRU 4.7.3 R (1).

The calculation of risk-weighted exposure amounts for equity exposures: The simple risk weight approach: Risk weighted exposure amounts

BIPRU 4.7.9

handbook-rule

The risk weighted exposure amounts must be calculated according to the following formula:
risk-weighted exposure amounts = RW * exposure value;
where:

  1. (1) risk weight (RW) = 190% for private equity exposures in sufficiently diversified portfolios;
  2. (2) risk weight (RW) = 290% for exchange traded equity exposures; and
  3. (3) risk weight (RW) = 370% for all other equity exposures.

[Note: BCD Annex VII Part 1 point 19]

BIPRU 4.7.10

handbook-rule

Short cash positions and derivative instruments held in the non-trading book are permitted to offset long positions in the same individual stocks provided that these instruments have been explicitly designated as hedges of specific equity exposures and that they provide a hedge for at least another year. Other short positions must be treated as if they are long positions with the relevant risk weight assigned to the absolute value of each position. In the context of maturity mismatched positions, the method is that for corporate exposures as set out in BIPRU 4.4.70 R.

[Note: BCD Annex VII Part 1 point 20]

BIPRU 4.7.11

handbook-rule

A firm may recognise unfunded credit protection obtained on an equity exposure in accordance with the methods set out in BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10.

[Note: BCD Annex VII Part 1 point 21]

The calculation of risk-weighted exposure amounts for equity exposures: The simple risk weight approach: Expected loss

BIPRU 4.7.12

handbook-rule

The expected loss amounts for equity exposures must be calculated according to the following formula:

  1. (1) expected loss amount = EL × exposure value; and
  2. (2) the EL values must be the following:
    1. (a) expected loss (EL) = 0.8% for private equity exposures in sufficiently diversified portfolios;
    2. (b) expected loss (EL) = 0.8% for exchange traded equity exposures; and
    3. (c) expected loss (EL) = 2.4% for all other equity exposures.

[Note: BCD Annex VII Part 1 point 32]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Introduction

BIPRU 4.7.13

handbook-rule

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Risk weighted exposure amounts

BIPRU 4.7.14

handbook-rule

The risk weighted exposure amounts must be calculated according to the formulas in BIPRU 4.4.58 R (Risk weighted exposure amounts for sovereigns, institutions and corporates). If a firm does not have sufficient information to use the definition of default a scaling factor of 1.5 must be assigned to the risk weights.

[Note: BCD Annex VII Part 1 point 22]

BIPRU 4.7.15

handbook-rule

At the individual exposure level the sum of the expected loss amount multiplied by 12.5 and the risk weighted exposure amount must not exceed the exposure value multiplied by 12.5.

[Note: BCD Annex VII Part 1 point 23]

BIPRU 4.7.16

handbook-rule

A firm may recognise unfunded credit protection obtained on an equity exposure in accordance with the methods set out in BIPRU 5 (Credit risk mitigation) as modified by BIPRU 4.10. This must be subject to an LGD of 90% on the exposure to the provider of the hedge. For private equity exposures in sufficiently diversified portfolios an LGD of 65% may be used.

[Note: BCD Annex VII Part 1 point 24]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Calculation of expected loss amounts

BIPRU 4.7.17

handbook-rule

The expected loss amounts for equity exposures must be calculated according to the following formulae:

  1. (1) expected loss (EL) = PD × LGD; and
  2. (2) expected loss amount = EL × exposure value.

[Note: BCD Annex VII Part 1 point 33]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: PDs

BIPRU 4.7.18

handbook-rule

PDs must be determined according to the methods for corporate exposures. The following minimum PDs must be applied:

  1. (1) 0.09% for exchange traded equity exposures where the investment is part of a long-term customer relationship;
  2. (2) 0.09% for non-exchange traded equity exposures where the returns on the investment are based on regular and periodic cash flows not derived from capital gains;
  3. (3) 0.40% for exchange traded equity exposures including other short positions as set out in BIPRU 4.7.10 R; and
  4. (4) 1.25% for all other equity exposures including other short positions as set out in BIPRU 4.7.10 R.

[Note: BCD Annex VII Part 2 point 24]

BIPRU 4.7.19

handbook-rule

BIPRU 4.4.29 G (five year observation period) applies to the PD/LGD approach.

[Note: BCD Annex VII Part 4 point 66 (part)]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: LGDs

BIPRU 4.7.20

handbook-rule

Private equity exposures in sufficiently diversified portfolios may be assigned an LGD of 65%.

[Note: BCD Annex VII Part 2 point 25]

BIPRU 4.7.21

handbook-rule

All other exposures must be assigned an LGD of 90%.

[Note: BCD Annex VII Part 2 point 26]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Maturity

BIPRU 4.7.22

handbook-rule

M (maturity) assigned to all exposures must be 5 years.

[Note: BCD Annex VII Part 2 point 27]

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Introduction

BIPRU 4.7.23

handbook-rule
BIPRU 4.7.24 R to BIPRU 4.7.35 R set out the internal models approach for calculating the risk weighted exposure amounts for equity exposures as referred to in BIPRU 4.7.3 R (3).

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Risk weighted exposure amounts

BIPRU 4.7.24

handbook-rule

The risk weighted exposure amount is the potential loss on the firm's equity exposures as derived using internal value-at-risk models subject to the 99th percentile, one-tailed confidence interval of the difference between quarterly returns and an appropriate risk-free rate computed over a long-term sample period, multiplied by 12.5. The risk weighted exposure amounts at the equity exposure portfolio level must not be less than the total of the sums of the minimum risk weighted exposure amounts required under the PD/LGD approach and the corresponding expected loss amounts multiplied by 12.5 and calculated on the basis of the PD values set out in BIPRU 4.7.18 R (1) and the corresponding LGD values set out in BIPRU 4.7.20 R and BIPRU 4.7.21 R.

[Note: BCD Annex VII Part 1 point 25]

BIPRU 4.7.25

handbook-rule

A firm may recognise unfunded credit protection obtained on an equity position.

[Note: BCD Annex VII Part 1 point 26]

The calculation of risk weighted exposure amounts for equity exposures: The internal models approach: Expected loss amounts

BIPRU 4.7.26

handbook-rule

The expected loss amounts for equity exposures under the internal models approach must be 0%.

[Note: BCD Annex VII Part 1 point 34]

The calculation of risk weighted exposure amounts for equity exposures: The internal models approach: Capital requirements and risk quantification

BIPRU 4.7.27

handbook-rule
  1. (1) A firm must meet the standards set out in (2) to (9) for the purpose of calculating capital requirements.
  2. (2) The estimate of potential loss must be robust to adverse market movements relevant to the long-term risk profile of the firm's specific holdings. The data used to represent return distributions must reflect the longest sample period for which data is available and be meaningful in representing the risk profile of the firm's specific equity exposures. The data used must be sufficient to provide conservative, statistically reliable and robust loss estimates that are not based purely on subjective or judgmental considerations. A firm must be able to demonstrate to the FSA that the shock employed provides a conservative estimate of potential losses over a relevant long-term market or business cycle.
  3. (3) A firm must combine empirical analysis of available data with adjustments based on a variety of factors in order to attain model outputs that achieve appropriate realism and conservatism. In constructing Value at Risk (VaR) models estimating potential quarterly losses, a firm may use quarterly data or convert shorter horizon period data to a quarterly equivalent using an analytically appropriate method supported by empirical evidence and through a well-developed and documented thought process and analysis. Such an approach must be applied conservatively and consistently over time. Where only limited relevant data is available a firm must add appropriate margins of conservatism.
  4. (4) The models used must be able to capture adequately all of the material risks embodied in equity returns including both the general market risk and specific risk exposure of the firm's equity exposure portfolio. The internal models must adequately explain historical price variation, capture both the magnitude and changes in the composition of potential concentrations, and be robust to adverse market environments. The population of risk exposures represented in the data used for estimation must be closely matched to or at least comparable with those of the firm's equity exposures.
  5. (5) The internal model must be appropriate for the risk profile and complexity of a firm's equity exposure portfolio. Where a firm has material holdings with values that are highly non-linear in nature the internal models must be designed to capture appropriately the risks associated with such instruments.
  6. (6) Mapping of individual positions to proxies, market indices, and risk factors must be plausible, intuitive, and conceptually sound.
  7. (7) A firm must be able to demonstrate to the FSA through empirical analyses the appropriateness of risk factors, including their ability to cover both general market risk and specific risk.
  8. (8) The estimates of the return volatility of equity exposures must incorporate relevant and available data, information, and methods. Independently reviewed internal data or data from external sources (including pooled data) must be used.
  9. (9) A rigorous and comprehensive stress-testing programme must be in place.


[Note: BCD Annex VII Part 4 point 115]

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Risk management and controls

BIPRU 4.7.28

handbook-rule
  1. (1) With regard to the development and use of internal models for capital requirement purposes, a firm must establish policies, procedures, and controls to ensure the integrity of the model and modelling process. These policies, procedures, and controls must include the ones set out in the rest of this paragraph.
  2. (2) There must be full integration of the internal model into the overall management information systems of the firm and in the management of the non-trading book equity exposure portfolio. In particular they must be used in:
    1. (a) measuring and assessing equity exposure portfolio performance (including the risk adjusted performance);
    2. (b) allocating economic capital to equity exposures; and
    3. (c) evaluating overall capital adequacy and the investment management process.
  3. (3) A firm must have established management systems, procedures, and control functions for ensuring the periodic and independent review of all elements of the internal modelling process, including approval of model revisions, vetting of model inputs, and review of model results, such as direct verification of risk computations. These reviews must assess the accuracy, completeness, and appropriateness of model inputs and results and focus on both finding and limiting potential errors associated with known weaknesses and identifying unknown model weaknesses. Such reviews may be conducted by an internal independent unit, or by an independent external third party.
  4. (4) There must be adequate systems and procedures for monitoring investment limits and the risk exposures of equity exposures.
  5. (5) The units responsible for the design and application of the model must be functionally independent from the units responsible for managing individual investments.
  6. (6) Parties responsible for any aspect of the modelling process must be adequately qualified. Management must allocate sufficient skilled and competent resources to the modelling function.

[Note: BCD Annex VII Part 4 point 116]

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Validation and documentation

BIPRU 4.7.29

handbook-rule

A firm must have a robust system in place to validate the accuracy and consistency of its internal models and modelling processes. All material elements of the internal models and the modelling process and validation must be documented.

[Note: BCD Annex VII Part 4 point 117]

BIPRU 4.7.30

handbook-rule

A firm must use the internal validation process to assess the performance of its internal models and processes in a consistent and meaningful way.

[Note: BCD Annex VII Part 4 point 118]

BIPRU 4.7.31

handbook-rule

The methods and data used for quantitative validation must be consistent through time. Changes in estimation and validation methods and data (both data sources and periods covered) must be documented.

[Note: BCD Annex VII Part 4 point 119]

BIPRU 4.7.32

handbook-rule

A firm must regularly compare actual equity exposure returns (computed using realised and unrealised gains and losses) with modelled estimates. Such comparisons must make use of historical data that cover as long a period as possible. A firm must document the methods and data used in such comparisons. This analysis and documentation must be updated at least annually.

[Note: BCD Annex VII Part 4 point 120]

BIPRU 4.7.33

handbook-rule

A firm must make use of other quantitative validation tools and comparisons with external data sources. The analysis must be based on data that are appropriate to the portfolio, are updated regularly, and cover a relevant observation period. A firm's internal assessments of the performance of its models must be based on as long a period as possible.

[Note: BCD Annex VII Part 4 point 121]

BIPRU 4.7.34

handbook-rule

A firm must have sound internal standards for situations where comparison of actual equity exposure returns with the models' estimates calls the validity of the estimates or of the models as such into question. These standards must take account of business cycles and similar systematic variability in equity exposure returns. All adjustments made to internal models in response to model reviews must be documented and consistent with the firm's model review standards.

[Note: BCD Annex VII Part 4 point 122]

BIPRU 4.7.35

handbook-rule

The internal model and the modelling process must be documented, including the responsibilities of parties involved in the modelling, and the model approval and model review processes.

[Note: BCD Annex VII Part 4 point 123]

BIPRU 4.8

The IRB approach: Purchased receivables

  • 01/01/2007

Application

BIPRU 4.8.1

handbook-rule
BIPRU 4.8 applies with respect to purchased receivables.

BIPRU 4.8.2

handbook-guidance

Purchased receivables do not form an IRB exposure class on their own. For any purchased receivable, the provisions of the sections of BIPRU 4 that deal with the IRB exposure class to which it belongs also apply, as modified by this section.

[Note: BCD Annex VII Part 4 point 15 (part)]

Structure of rating systems

BIPRU 4.8.3

handbook-rule
For retail exposure that are purchased receivables, the grouping referred to in BIPRU 4.6.9 R must reflect the seller's underwriting practices and the heterogeneity of its customers.

Risk quantification: Overall requirements for estimation: General

BIPRU 4.8.4

handbook-guidance
Further general material about the requirements for estimation can be found in BIPRU 4.3.73 R - BIPRU 4.3.94 R.

BIPRU 4.8.5

handbook-rule

The estimates for determining the risk parameters PD, LGD, conversion factor and EL must reflect all relevant information available to the purchasing firm regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing firm, or by external sources. The purchasing firm must evaluate any data relied upon which is provided by the seller.

[Note: BCD Annex VII Part 4 point 53]

Risk quantification: Overall requirements for estimation: Requirements specific to PD estimation

BIPRU 4.8.6

handbook-rule

With respect to BIPRU 4.6.26 R (Internal and external data for PD estimation: retail exposures) a firm may use external and internal reference data for PD estimation. A firm must use all relevant data sources as points of comparison.

[Note: BCD Annex VII Part 4 point 69 (part)]

BIPRU 4.8.7

handbook-rule

For corporate exposure purchased receivables a firm may estimate ELs by obligor grade from long run averages of one-year realised default rates.

[Note: BCD Annex VII Part 4 point 60]

BIPRU 4.8.8

handbook-rule

If a firm derives long run average estimates of PDs and LGDs for corporate exposure purchased receivables from an estimate of EL, and an appropriate estimate of PD or LGD, the process for estimating total losses must meet the overall standards for estimation of PD and LGD set out in the minimum IRB standards, and the outcome must be consistent with the concept of LGD as set out in BIPRU 4.3.99 R.

[Note: BCD Annex VII Part 4 point 61]

Risk quantification: Overall requirements for estimation: Requirements specific to own-LGD estimates

BIPRU 4.8.9

handbook-rule

A firm may use external and internal reference data for its LGD estimates in the case of retail exposures that are purchased receivables.

[Note: BCD Annex VII Part 4 point 85]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: General

BIPRU 4.8.10

handbook-rule
BIPRU 4.8.11 R - BIPRU 4.8.15 R set out minimum requirements specific to the treatment of purchased receivables under the IRB approach.

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Legal certainty

BIPRU 4.8.11

handbook-rule

The structure of the facility must ensure that under all foreseeable circumstances a firm has effective ownership and control of all cash remittances from the receivables. When the obligor makes payments directly to a seller or servicer a firm must verify regularly that payments are forwarded completely and within the contractually agreed terms. Servicer means an entity that manages a pool of purchased receivables or the underlying credit exposures on a day-to-day basis. A firm must have procedures to ensure that ownership over the receivables and cash receipts is protected against bankruptcy stays or legal challenges that could materially delay the lender's ability to liquidate or assign the receivables or retain control over cash receipts.

[Note: BCD Annex VII Part 4 point 105]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Effectiveness of monitoring systems

BIPRU 4.8.12

handbook-rule
  1. (1) A firm must monitor both the quality of the purchased receivables and the financial condition of the seller and servicer. In particular a firm must comply with the remaining provisions of this rule.
  2. (2) A firm must assess the correlation among the quality of the purchased receivables and the financial condition of both the seller and servicer, and have in place internal policies and procedures that provide adequate safeguards to protect against such contingencies, including the assignment of an internal risk rating for each seller and servicer.
  3. (3) A firm must have clear and effective policies and procedures for determining seller and servicer eligibility. A firm or its agent must conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller or servicer, detect fraud or operational weaknesses, and verify the quality of the seller's credit policies and servicer's collection policies and procedures. The findings of these reviews must be documented.
  4. (4) A firm must assess the characteristics of the purchased receivables pools including:
    1. (a) over-advances;
    2. (b) history of the seller's arrears, bad debts, and bad debt allowances;
    3. (c) payment terms; and
    4. (d) potential contra accounts.
  5. (4) A firm must have effective policies and procedures for monitoring on an aggregate basis single-obligor concentrations both within and across purchased receivables pools.
  6. (5) A firm must ensure that it receives from the servicer timely and sufficiently detailed reports of receivables ageings and dilutions to ensure compliance with the firm's eligibility criteria and advancing policies governing purchased receivables, and provide an effective means with which to monitor and confirm the seller's terms of sale and dilution.

[Note: BCD Annex VII Part 4 point 106]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Effectiveness of work-out systems

BIPRU 4.8.13

handbook-rule

A firm must have systems and procedures for detecting deteriorations in the seller's financial condition and purchased receivables quality at an early stage, and for addressing emerging problems proactively. In particular a firm must have clear and effective policies, procedures, and information systems to monitor covenant violations, and clear and effective policies and procedures for initiating legal actions and dealing with problem purchased receivables.

[Note: BCD Annex VII Part 4 point 107]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Effectiveness of systems for controlling collateral, credit availability and cash

BIPRU 4.8.14

handbook-rule

A firm must have clear and effective policies and procedures governing the control of purchased receivables, credit, and cash. In particular, written internal policies must specify all material elements of the receivables purchase programme, including the advancing rates, eligible collateral, necessary documentation, concentration limits, and the way cash receipts are to be handled. These elements must take appropriate account of all relevant and material factors, including the seller's and servicer's financial condition, risk concentrations, and trends in the quality of the purchased receivables and the seller's customer base, and internal systems must ensure that funds are advanced only against specified supporting collateral and documentation.

[Note: BCD Annex VII Part 4 point 108]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Compliance with the firm's internal policies and procedures

BIPRU 4.8.15

handbook-rule

A firm must have an effective internal process for assessing compliance with all internal policies and procedures. The process must include regular audits of all critical phases of the firm's receivables purchase programme, verification of the separation of duties between, firstly, the assessment of the seller and servicer and the assessment of the obligor and, secondly, between the assessment of the seller and servicer and the field audit of the seller and servicer and evaluations of back office operations, with particular focus on qualifications, experience, staffing levels, and supporting automation systems.

[Note: BCD Annex VII Part 4 point 109]

Calculation of risk-weighted asset amounts: Eligibility for different treatments: Corporate exposures

BIPRU 4.8.16

handbook-rule

For its corporate exposure purchased receivables a firm must comply with the minimum requirements set out in BIPRU 4.8.11 R - BIPRU 4.8.15 R. For corporate exposure purchased receivables that comply in addition with the conditions set out in BIPRU 4.8.18 R, and where it would be unduly burdensome for a firm to use the risk quantification standards for corporate exposures as set out in the minimum IRB standards for these receivables, the risk quantification standards for retail exposures as set out in the minimum IRB standards may be used.

[Note: BCD Annex VII Part 1 point 7]

BIPRU 4.8.17

handbook-rule

For corporate exposure purchased receivables, refundable purchase discounts, collateral or partial guarantees that provide first-loss protection for default losses, dilution losses, or both, may be treated as first-loss positions under the provisions in BIPRU 9 (Securitisation) about the IRB approach.

[Note: BCD Annex VII Part 1 point 8]

Calculation of risk weighted asset amounts: Eligibility for different treatments: Retail exposures

BIPRU 4.8.18

handbook-rule

To be eligible for the retail exposure treatment purchased receivables must comply with the minimum requirements set out in BIPRU 4.8.11 R - BIPRU 4.8.15 R and the following conditions:

  1. (1) the firm has purchased the receivables from unrelated, third party sellers, and its exposure to the obligor of the receivable does not include any exposures that are directly or indirectly originated by the firm itself;
  2. (2) the purchased receivables must be generated on an arm's-length basis between the seller and the obligor (and as such, intercompany accounts receivables and receivables subject to contra-accounts between firms that buy and sell to each other are ineligible);
  3. (3) the purchasing firm has a claim on all proceeds from the purchased receivables or a pro-rata interest in the proceeds; and
  4. (4) the portfolio of purchased receivables is sufficiently diversified.

[Note: BCD Annex VII Part 1 point 14]

BIPRU 4.8.19

handbook-rule

With respect to retail exposures, for purchased receivables, refundable purchase discounts, collateral or partial guarantees that provide first-loss protection for default losses, dilution losses, or both, may be treated as first-loss positions under the provisions in BIPRU 9 (Securitisation) about the IRB approach.

[Note: BCD Annex VII Part 1 point 15]

BIPRU 4.8.20

handbook-rule

For hybrid pools of purchased retail exposure receivables where the purchasing firm cannot separate exposures secured by real estate collateral and qualifying revolving retail exposures from other retail exposures, the retail risk weight function producing the highest capital requirements for those exposures must apply.

[Note: BCD Annex VII Part 1 point 16]

Calculation of risk weighted asset amounts for dilution risk

BIPRU 4.8.21

handbook-rule

The risk weights for dilution risk for purchased receivables (both corporate exposures and retail exposures) must be calculated according to this rule. The risk weights must be calculated according to the formula in BIPRU 4.4.58 R. However, for the purposes of that formula, the total annual sales referred to in BIPRU 4.4.59 R are the weighted average by individual exposures of the pool. The input parameters PD and LGD and the exposure value must be determined under the applicable provisions of BIPRU 4 as modified by this section. M (maturity) must be 1 year. However:

  1. (1) a firm need not recognise dilution risk if its IRB permission permits this; and
  2. (2) (in the case of a firm with an IRB permission that permits the treatment of dilution risk in (1)) the firm must be able to convince the FSA that dilution risk is immaterial.

[Note: BCD Article 87(2) (part) and Annex VII Part 1 point 28]

Calculation of risk weighted exposure amounts: PDs

BIPRU 4.8.22

handbook-rule

For purchased corporate exposure receivables in respect of which a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the PDs for these exposures must be determined according to the following methods:

  1. (1) for senior claims on purchased corporate exposure receivables PD must be the firm's estimate of EL divided by LGD for these receivables;
  2. (2) for subordinated claims on purchased corporate exposure receivables PD must be the firm's estimate of EL; and
  3. (3) if a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the LGD estimate may be used.

[Note: BCD Annex VII Part 2 point 3]

BIPRU 4.8.23

handbook-rule

In the case of corporate exposures, for dilution risk of purchased receivables PD must be set equal to EL estimate for dilution risk. If a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for dilution risk of purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the PD estimate may be used. A firm may recognise unfunded credit protection in the PD in accordance with the provisions of BIPRU 9 and BIPRU 5 as modified by BIPRU 4.10. A firm may recognise those unfunded credit protection providers set out in its IRB permission in addition to those indicated in the CRM eligibility conditions. Where a firm's IRB permission allows it to use its own LGD estimates for dilution risk of purchased corporate receivables, the firm may recognise unfunded credit protection by adjusting PDs subject to the provisions of BIPRU 4.4.43 R.

[Note: BCD Annex VII Part 2 point 7]

BIPRU 4.8.24

handbook-rule

In the case of retail exposures, for dilution risk of purchased receivables PD must be set equal to EL estimates for dilution risk. If a firm can decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the PD estimate may be used.

[Note: BCD Annex VII Part 2 point 19]

Calculation of risk weighted asset amounts: LGDs: Corporate exposures

BIPRU 4.8.25

handbook-rule

The following LGD values apply for purchased corporate exposure receivables:

  1. (1) for senior purchased corporate exposure receivables exposures where a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the value is 45%;
  2. (2) for subordinated purchased corporate exposure receivables exposures where a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the value is 100%; and
  3. (3) for dilution risk of purchased corporate exposure receivables, the value is 75%.

[Note: BCD Annex VII Part 2 point 8(e) to (g)]

BIPRU 4.8.26

handbook-rule

Notwithstanding BIPRU 4.4.34 R and BIPRU 4.8.25 R, for dilution risk and default risk if a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the LGD estimate for purchased corporate exposure receivables may be used.

[Note: BCD Annex VII Part 2 point 9]

Calculation of risk weighted asset amounts: LGDs: Retail exposures

BIPRU 4.8.27

handbook-rule

For dilution risk of purchased retail exposure receivables an LGD value of 75% must be used. If a firm can decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the LGD estimate may be used.

[Note: BCD Annex VII Part 2 point 21]

Calculation of risk weighted asset amounts: Exposure value

BIPRU 4.8.28

handbook-rule

The exposure value for the calculation of risk weighted exposure amounts of purchased receivables must be the outstanding amount minus the capital requirements for dilution risk prior to credit risk mitigation.

[Note: BCD Annex VII Part 3 point 6]

BIPRU 4.8.29

handbook-rule
  1. (1) The exposure value for the items in (2) must be calculated as the committed but undrawn amount multiplied by a conversion factor.
  2. (2) For undrawn purchase commitments for revolving purchased receivables that are unconditionally cancellable or that effectively provide for automatic cancellation at any time by the firm without prior notice, a conversion factor of 0% applies. To apply a conversion factor of 0%, a firm must actively monitor the financial condition of the obligor, and its internal control systems must enable it immediately to detect a deterioration in the credit quality of the obligor.

[Note: BCD Annex VII Part 3 point 9 (c)]

Calculation of expected loss amounts

BIPRU 4.8.30

handbook-rule

The expected loss amounts for dilution risk of purchased receivables must be calculated according to the following formula:

expected loss (EL) = PD × LGD; and expected loss amount = EL × exposure value.

[Note: BCD Article 88(5) and Annex VII Part 1 point 35]

BIPRU 4.9

The IRB approach: Securitisation, non-credit obligations assets and CIUs

  • 01/01/2007

Application

BIPRU 4.9.1

handbook-rule
BIPRU 4.9 applies with respect to securitisation exposures, non credit-obligation assets and exposures to CIUs.

Securitisation exposures

BIPRU 4.9.2

handbook-rule

The following must be calculated in accordance with BIPRU 9 (Securitisation):

  1. (1) risk-weighted exposure amounts for securitised exposures and for exposures belonging to the IRB exposure class referred to in BIPRU 4.3.2 R (6) (securitisation positions); and
  2. (2) the expected loss amounts for securitised exposures.

[Note: BCD Article 87(10) and Article 88(3)]

Provision of credit protection

BIPRU 4.9.3

handbook-rule

Where a firm provides credit protection for a number of exposures under terms that the nth default among the exposures shall trigger payment and that this credit event shall terminate the contract, if the product has an external credit assessment from an eligible ECAI the risk weights set out in BIPRU 9 must be applied. If the product is not rated by an eligible ECAI, the risk weights of the exposures included in the basket must be aggregated, excluding n-1 exposures where the sum of the expected loss amount multiplied by 12.5 and the risk weighted exposure amount must not exceed the nominal amount of the protection provided by the credit derivative multiplied by 12.5. The n-1 exposures to be excluded from the aggregation must be determined on the basis that they must include those exposures each of which produces a lower risk weighted exposure amount than the risk weighted exposure amount of any of the exposures included in the aggregation.

[Note: BCD Annex VII Part 1 point 9]

Non credit obligation assets: Introduction

BIPRU 4.9.4

handbook-rule

Non credit obligation assets: Inclusion of residual value of leases

BIPRU 4.9.5

handbook-rule

The non credit obligation asset IRB exposure class includes the residual value of leased properties, if not included in the lease exposure as defined in BIPRU 4.4.75 R.

[Note: BCD Article 86(8)]

Non credit obligation assets: Risk weighted exposure amount

BIPRU 4.9.6

handbook-rule

The risk weighted exposure amounts must be calculated according to the formula:
Risk-weighted exposure amount = 100% * exposure value except for when the exposure is a residual value of leased properties in which case it must be calculated as follows:
1/t * 100% * exposure value; where t is the greater of 1 and the nearest number of whole years of the lease remaining.

[Note: BCD Annex VII Part 1 point 27]

BIPRU 4.9.7

handbook-guidance
t should be an integer number reflecting the nearest number of whole years of the lease remaining and should decrease as the lease matures so that the discounted value steps up gradually from a small value to 100% as the end of the lease approaches.

BIPRU 4.9.8

handbook-rule

Where a firm has full recourse in respect of purchased receivables for default risk and for dilution risk, to the seller of the purchased receivables, BIPRU 4.8.21 R and BIPRU 4.8.30 R need not be applied. The exposure may instead be treated as a collateralised exposure.

[Note: BCD Article 87(2) (part)]

Non credit obligation assets: Exposure value

BIPRU 4.9.9

handbook-rule

The exposure value of non credit-obligation assets must be the value presented in the financial statements.

[Note: BCD Annex VII Part 3 point 13]

Non credit obligation assets: Expected loss amounts

BIPRU 4.9.10

handbook-rule

For non credit-obligation assets the expected loss amount must be zero.

[Note: BCD Article 88(4)]

Collective investment undertakings

BIPRU 4.9.11

handbook-rule
  1. (1) Where exposures in the form of a CIU meet the criteria set out in BIPRU 3.4.121 R to BIPRU 3.4.122 R (Conditions for look through treatment under the standardised approach) and the firm is aware of all of the underlying exposures of the CIU, the firm must look through to those underlying exposures in order to calculate risk weighted exposure amounts and expected loss amounts in accordance with the methods set out in BIPRU 4. BIPRU 4.9.12 R applies to the part of the underlying exposures of the CIU of which the firm is not aware or could not reasonably be aware. In particular, BIPRU 4.9.12 R must apply where it would be unduly burdensome for the firm to look through the underlying exposures in order to calculate risk weighted exposure amounts and expected loss amounts in accordance with methods set out in this rule.
  2. (2) Where (1) applies but a firm does not meet the conditions for using the methods set out in BIPRU 4 for all or part of the underlying exposures of the CIU, risk weighted exposure amounts and expected loss amounts must be calculated in accordance with the following approaches.
  3. (3) For equity exposures the approach set out in BIPRU 4.7.9 R - BIPRU 4.7.12 R (Simple risk weights) must be used. If, for those purposes, the firm is unable to differentiate between private equity, exchange-traded and other equity exposures, it must treat the exposures concerned as other equity exposures.
  4. (4) For all other underlying exposures, the standardised approach must be used, subject to the following modifications:
    1. (a) [deleted]
    2. (b) [deleted]
    3. (c) for exposures subject to a specific risk weight for unrated exposures or subject to the credit quality step yielding the highest risk weight for a given exposure class, the risk weight must be multiplied by a factor of two, but cannot be higher than 1250%; and
    4. (d) for all other exposures, the risk weight must be multiplied by a factor of 1.1 and subject to a minimum of 5%.

[Note: BCD Article 87(11)]

BIPRU 4.9.12

handbook-rule
  1. (1) Where exposures in the form of a CIU do not meet the criteria set out in BIPRU 3.4.121 R to BIPRU 3.4.122 R (Conditions for look through treatment under the standardised approach) or the firm is not aware of all of the underlying exposures of the CIU, a firm must look through to the underlying exposures and calculate risk weighted exposure amounts and expected loss amounts in accordance with the approach set out in BIPRU 4.7.9 R - BIPRU 4.7.12 R (Simple risk weights). If, for those purposes, the firm is unable to differentiate between private equity, exchange-traded and other equity exposures, it must treat the exposures concerned as other equity exposures. For these purposes, non-equity exposures must be assigned to one of the classes (private equity, exchange traded equity or other equity) set out in BIPRU 4.7.9 R (Simple risk weight approach) and unknown exposures must be assigned to the other equity class.
  2. (2) Alternatively to the method described in (1), a firm may calculate itself or rely on a third party to calculate and report the average risk weighted exposure amounts based on the CIU's underlying exposures and calculated in accordance with the approaches in BIPRU 4.9.11R (3) to BIPRU 4.9.11R (4), provided that the correctness of the calculation and the report is adequately ensured.
  3. (3) [deleted]
  4. (4) [deleted]
    1. (a) [deleted]
    2. (b) [deleted]

[Note: BCD Article 87(12)]

BIPRU 4.9.13

handbook-guidance
For the purposes of BIPRU 4.9.12 R (1), in the case of non-equity exposures a firm should look at the risk profile of the underlying exposures and map these to an equivalent equity risk weight. For example, if the underlying exposures are exchange-traded, the risk weight of exchange-traded equity exposures will apply. If the underlying exposures are unknown, the risk weight of the other equity class will apply. Only under exceptional circumstances would supervisors expect to see non-equity exposures mapped to the diversified private equity risk weight.

BIPRU 4.9.14

handbook-guidance
For the purposes of BIPRU 4.9.12 R (2), a firm should ensure that any third party relied on for the calculations and report possesses the necessary competence and experience to ensure that the calculations and report are correct.

BIPRU 4.9.15

handbook-rule

The expected loss amounts for exposures referred to in BIPRU 4.9.11 R - BIPRU 4.9.12 R must be calculated in accordance with the methods set out in BIPRU 4.4.61 R (Calculation of expected loss for sovereigns, institutions and corporates), BIPRU 4.5.12 R - BIPRU 4.5.14 R (Calculation of expected loss for specialised lending), BIPRU 4.6.47 R - BIPRU 4.6.48 R (Calculation of expected loss for retail exposures), BIPRU 4.7.12 R, BIPRU 4.7.17 R and BIPRU 4.7.26 R (Calculation of expected loss for equity exposures) and BIPRU 4.8.30 R (Dilution risk of purchased receivables).

[Note: BCD Article 88(6)]

BIPRU 4.10

The IRB approach: Credit risk mitigation

  • 01/01/2007

Application

BIPRU 4.10.1

handbook-guidance
BIPRU 4.10 applies to all exposures treated under the IRB approach.

Purpose

BIPRU 4.10.2

handbook-guidance
BIPRU 4.10 sets out modifications to BIPRU 5 (Credit risk mitigation) for those exposures for which the IRB approach is being used.

General

BIPRU 4.10.3

handbook-rule

A firm using the IRB approach, but not using its own estimates of LGD and conversion factors, may recognise credit risk mitigation in accordance with BIPRU 5 as modified by BIPRU 4.10 in the calculation of risk weighted exposure amounts for the purposes of the calculation of the credit risk capital component or as relevant expected loss amounts for the purposes of the calculation in GENPRU 2.2.191 R to GENPRU 2.2.193 R or GENPRU 2.2.236 R.

[Note: BCD Article 91 (as it applies to the IRB approach)]

BIPRU 4.10.4

handbook-rule
  1. (1) Where the requirements of BIPRU 5.2.2 R - BIPRU 5.2.8 R are met the calculation of risk weighted exposure amounts, and, as relevant, expected loss amounts, may be modified in accordance with BIPRU 5 as modified by BIPRU 4.10.
  2. (2) No exposure in respect of which credit risk mitigation is obtained must produce a higher risk weighted exposure amount or expected loss amount than an otherwise identical exposure in respect of which there is no credit risk mitigation.
  3. (3) Where the risk weighted exposure amount already takes account of credit protection under the IRB approach the calculation of the credit protection must not be further recognised under BIPRU 5 or BIPRU 4.10.
  4. (4) Subject to BIPRU 5.2.8 R (Maturity mismatches), BIPRU 5.2.9 R (Combinations of credit risk mitigation in the standardised approach) and BIPRU 5.7.27 R to BIPRU 5.7.28 R (Basket credit risk mitigation techniques), where the CRM eligibility conditions and the CRM minimum requirements are satisfied, the calculation of risk weighted exposure amounts and expected loss amounts under the IRB approach may be modified in accordance with the provisions of BIPRU 5 and BIPRU 4.10 that deal with calculating the effects of credit risk mitigation.

[Note: BCD Article 93 and Annex VIII Part 3 point 1(as they apply to the IRB approach)]

Eligibility of funded credit protection: General

BIPRU 4.10.5

handbook-rule

In addition to the collateral set out in BIPRU 5.3.1 R to BIPRU 5.3.2 R, BIPRU 5.4.1 R to BIPRU 5.4.8 R and BIPRU 5.6.1 R (Eligibility of funded credit protection) the provisions of BIPRU 4.10.6 R - BIPRU 4.10.12 R (Eligibility of real estate collateral), BIPRU 4.10.14 R (Eligibility: receivables), BIPRU 4.10.16 R (Eligibility: other physical collateral), and BIPRU 4.10.19 R (Eligibility: leasing), apply where a firm calculates risk weighted exposure amounts and expected loss amounts under the IRB approach.

[Note: BCD Annex VIII Part 1 point 12]

Real estate collateral: Types of eligible collateral: General

BIPRU 4.10.6

handbook-rule
  1. (1) Residential real estate property which is or will be occupied or let by the owner or the beneficial owner in the case of personal investment companies and commercial real estate property, that is offices and other commercial premises, may be recognised as eligible collateral where the conditions set out in the remaining provisions of this paragraph are met.
  2. (2) The value of the property must not materially depend upon the credit quality of the obligor. This requirement does not preclude situations where purely macro-economic factors affect both the value of the property and the performance of the borrower.
  3. (3) The risk of the borrower must not materially depend upon the performance of the underlying property or project, but rather on the underlying capacity of the borrower to repay the debt from other sources. As such, repayment of the facility must not materially depend on any cash flow generated by the underlying property serving as collateral.

[Note: BCD Annex VIII Part 1 point 13]

BIPRU 4.10.7

handbook-rule

The condition in BIPRU 4.10.6 R (3) does not apply to exposures secured by residential real estate property situated within the United Kingdom.

[Note: BCD Annex VIII Part 1 point 16 (part)]

BIPRU 4.10.8

handbook-guidance
  1. (1) Under paragraph 16 of Part 1 of Annex VIII of the Banking Consolidation Directive, a competent authority may only disapply the condition in BIPRU 4.10.6 R (3) if the competent authority has evidence that the relevant market is well-developed and long-established with loss-rates which are sufficiently low to justify such action.
  2. (2) If the evidence were to change so that the action was no longer justified the FSA would expect to revoke BIPRU 4.10.7 R.

BIPRU 4.10.9

handbook-rule
  1. (1) The condition in BIPRU 4.10.6 R (3) does not apply for exposures secured by residential real estate property situated within the territory of another EEA State.
  2. (2) However (1) only applies if and to the extent that the CRD implementation measures for that EEA State in relation to the IRB approach implement the option set out in paragraph 16 of Part 1 of Annex VIII of the Banking Consolidation Directive (waiver for residential real estate property) with respect to residential real estate property situated within that EEA State. Therefore (1) does not apply if the eligibility to use this treatment under those measures ceases as contemplated under paragraph 18 of Part 1 of Annex VIII of the Banking Consolidation Directive (suspension of alternative treatment).

[Note: BCD Annex VIII Part 1 point 16 (part)]

BIPRU 4.10.10

handbook-rule
  1. (1) The condition in BIPRU 4.10.6 R (3) does not apply for commercial real estate property situated within the territory of another EEA State.
  2. (2) However (1) only applies if and to the extent that the CRD implementation measures for that EEA State in relation to the IRB approach implement the option set out in paragraph 17 of Part 1 of Annex VIII of the Banking Consolidation Directive (waiver for commercial real estate property) with respect to commercial real estate property situated within that EEA State. Therefore (1) does not apply if the eligibility to use this treatment under those measures ceases as contemplated under paragraph 18 of Part 1 of Annex VIII of the Banking Consolidation Directive (suspension of alternative treatment).

[Note: BCD Annex VIII Part 1 point 19]

Real estate collateral: Types of eligible collateral: Finnish housing legislation

BIPRU 4.10.11

handbook-rule

A firm may also recognise as eligible collateral shares in Finnish residential housing companies operating in accordance with the Finnish Housing Company Act of 1991 or subsequent equivalent legislation in respect of residential property which is or will be occupied or let by the owner, as residential real estate collateral, provided that the conditions in BIPRU 4.10.6 R are met.

[Note: BCD Annex VIII Part 1 point 14]

BIPRU 4.10.12

handbook-rule

A firm may also recognise as eligible collateral shares in Finnish housing companies operating in accordance with the Finnish Housing Company Act of 1991 or subsequent equivalent legislation as commercial real estate collateral, provided that the conditions in BIPRU 4.10.6 R are met.

[Note: BCD Annex VIII Part 1 point 15]

Real estate collateral: Minimum requirements for recognition

BIPRU 4.10.13

handbook-rule

For the recognition of real estate collateral: the minimum requirements in BIPRU 3.4.64 R - BIPRU 3.4.73 R must be met with the following adjustments:

  1. (1) those provisions apply to all real estate collateral eligible under BIPRU 4.10; and
  2. (2) the minimum frequency of valuation as referred to in BIPRU 3.4.66 R is once every year for commercial real estate.

[Note: BCD Annex VIII Part 2 point 8 (as it applies to the IRB approach)]

Receivables: Types of eligible collateral

BIPRU 4.10.14

handbook-rule

Amounts receivable linked to a commercial transaction or transactions with an original maturity of less than or equal to one year may be recognised as eligible collateral. Eligible receivables do not include those associated with securitisations, sub-participations or credit derivatives or amounts owed by affiliated parties.

[Note: BCD Annex VIII Part 1 point 20]

Receivables: Minimum requirements for recognition

BIPRU 4.10.15

handbook-rule
  1. (1) For the recognition of receivables as collateral the requirements in this paragraph must be met.
  2. (2) The legal mechanism by which the collateral is provided must be robust and effective and ensure that the lender has clear rights over the proceeds.
  3. (3) A firm must take all steps necessary to fulfil local requirements in respect of the enforceability of security interests. There must be a framework which allows the lender to have a first priority claim over the collateral subject to any claims of preferential creditors provided for in applicable insolvency law.
  4. (4) A firm must have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions.
  5. (5) The collateral arrangements must be properly documented, with a clear and robust procedure for the timely collection of collateral. A firm's procedures must ensure that any legal conditions required for declaring the default of the borrower and timely collection of collateral are observed. In the event of the obligor's financial distress or default, a firm must have legal authority to sell or assign the receivables to other parties without consent of the receivables obligors.
  6. (6) A firm must have a sound process for determining the credit risk associated with the receivables. Such a process must include, among other things, analyses of the obligor's business and industry and the types of customers with whom the obligor does business. Where a firm relies on the obligor to ascertain the credit risk of the customers, the firm must review the obligor's credit practices to ascertain their soundness and credibility.
  7. (7) The margin between the amount of the exposure and the value of the receivables must reflect all appropriate factors, including the cost of collection, concentration within the receivables pool pledged by an individual obligor, and potential concentration risk within the firm's total exposures beyond that controlled by the firm's general methodology. A firm must maintain a continuous monitoring process appropriate to the receivables. Additionally, compliance with loan covenants, Environmental restrictions, and other legal requirements must be reviewed on a regular basis.
  8. (8) The receivables pledged by an obligor must be diversified and not be unduly correlated with the obligor. Where there is material positive correlation, the attendant risks must be taken into account in the setting of margins for the collateral pool as a whole.
  9. (9) Receivables from affiliates of the obligor (including subsidiary undertakings and employees) must not be recognised as risk mitigants.
  10. (10) A firm must have a documented process for collecting receivable payments in distressed situations. The requisite facilities for collection must be in place, even when the firm normally looks to the obligor for collections.

[Note: BCD Annex VIII Part 2 point 9]

Other physical collateral: Types of eligible collateral

BIPRU 4.10.16

handbook-rule

A firm may recognise as eligible collateral a physical item of a type other than those types indicated in BIPRU 4.10.6 R - BIPRU 4.10.12 R (Eligibility of real estate collateral) if its IRB permission provides that the firm may treat collateral of that type as eligible and if the firm is able to demonstrate the following:

  1. (1) the existence of liquid markets for disposal of the collateral in an expeditious and economically efficient manner;
  2. (2) the existence of well-established, publicly available market prices for the collateral; and
  3. (3) there is no evidence that the net prices it receives when collateral is realised deviates significantly from the market prices referred to in (b).

[Note: BCD Annex VIII Part 1 point 21]

BIPRU 4.10.17

handbook-guidance
If a firm wishes to recognise other types of collateral in accordance with BIPRU 4.10.16 R (whether as part of its application for an IRB permission or under a variation of its IRB permission) it should demonstrate to the FSA how the criteria in BIPRU 4.10.16 R (1) - BIPRU 4.10.16 R (3) have been met with respect to that type of collateral.

Other physical collateral: Minimum requirements for recognition

BIPRU 4.10.18

handbook-rule
  1. (1) If a type of other physical collateral referred to in BIPRU 4.10.16 R is potentially eligible under a firm's IRB permission a firm must only recognise it as eligible if the minimum requirements in (2) to (10) are met.
  2. (2) The collateral arrangement must be legally effective and enforceable in all relevant jurisdictions and must enable the firm to realise the value of the property within a reasonable timeframe.
  3. (3) With the sole exception of permissible prior claims referred to in BIPRU 4.10.15 R (3), only first liens on, or charges over, collateral must be permissible. As such, the firm must have priority over all other lenders to the realised proceeds of the collateral.
  4. (4) The value of the property must be monitored on a frequent basis and at a minimum once every year. More frequent monitoring must be carried out where the market is subject to significant changes in conditions.
  5. (5) The loan agreement (or other agreement documenting the exposure) must include detailed descriptions of the collateral plus detailed specifications of the manner and frequency of revaluation.
  6. (6) The types of physical collateral accepted by the firm and policies and practices in respect of the appropriate amount of each type of collateral relative to the exposure amount must be clearly documented in internal credit policies and procedures available for examination.
  7. (7) The firm's credit policies with regard to the transaction structure must address appropriate collateral requirements relative to the exposure amount, the ability to liquidate the collateral readily, the ability to establish objectively a price or market value, the frequency with which the value can readily be obtained (including a professional appraisal or valuation), and the volatility or a proxy of the volatility of the value of the collateral.
  8. (8) Both initial valuation and revaluation must take fully into account any deterioration or obsolescence of the collateral. Particular attention must be paid in valuation and revaluation to the effects of the passage of time on fashion- or date-sensitive collateral.
  9. (9) The firm must have the right to inspect the property physically. It must have policies and procedures addressing its exercise of the right to physical inspection.
  10. (10) The firm must have procedures to monitor that the property taken as protection is adequately insured against damage.

[Note: BCD Annex VIII Part 2 point 10]

Leasing: Types of eligible transactions and conditions of eligibility

BIPRU 4.10.19

handbook-rule
  1. (1) Where the requirements set out in this paragraph are met, exposures arising from transactions whereby a firm leases property to a third party must be treated the same as loans collateralised by the type of property leased.
  2. (2) For the exposures arising from leasing transactions to be treated as collateralised by the type of property leased, the following conditions must be met:
    1. (a) the conditions set out or referred to in BIPRU 4.10.13 R or BIPRU 4.10.18 R as appropriate for the recognition as collateral of the type of property leased are met;
    2. (b) there is robust risk management on the part of the lessor with respect to the use to which the leased asset is put, its age, and planned duration of its use, including appropriate monitoring of the value of the security;
    3. (c) there is in place a robust legal framework establishing the lessor's legal ownership of the asset and its ability to exercise its rights as owner in a timely fashion; and
    4. (d) where this has not already been ascertained in calculating the LGD level, the difference between value of the unamortised amount and the market value of the security must not be so large as to overstate the credit risk mitigation attributed to the leased assets.

[Note: BCD Annex VIII Part 1 point 22 and Part 2 point 11]

Calculating risk-weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Introduction

BIPRU 4.10.20

handbook-rule
BIPRU 4.10.21 R - BIPRU 4.10.37 R and BIPRU 4.10.49 R set out how the calculation of risk weighted exposure amounts and expected loss amounts under BIPRU 4.1 - BIPRU 4.9 may be modified to take into account credit risk mitigation that meets the CRM eligibility conditions and the CRM minimum requirements.

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Valuation: Receivables

BIPRU 4.10.21

handbook-rule

The value of receivables for the purpose of calculating the effect of credit risk mitigation must be the amount receivable.

[Note: BCD Annex VIII Part 3 point 66]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Valuation: Other physical collateral

BIPRU 4.10.22

handbook-rule

Physical collateral recognised as eligible as described in BIPRU 4.10.16 R must be valued for the purpose of calculating the effect of credit risk mitigation at its market value. Market value is the estimated amount for which the property would exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction.

[Note: BCD Annex VIII Part 3 point 67]

Calculating risk weighted exposure amounts and expected loss amounts: General treatment

BIPRU 4.10.23

handbook-rule
BIPRU 4.10.24 R - BIPRU 4.10.29 R apply to collateral in the form of real estate collateral, receivables, other physical collateral and leasing permitted by BIPRU 4.10 and exposures secured by such collateral.

BIPRU 4.10.24

handbook-rule

LGD* (the effective loss given default) calculated as set out in BIPRU 4.10.25 R - BIPRU 4.10.28 R must be taken as the LGD.

[Note: BCD Annex VIII Part 3 point 68]

BIPRU 4.10.25

handbook-rule

Where the ratio of the value of the collateral (C) to the exposure value (E) is below a threshold level of C* (the required minimum collateralisation level for the exposure) as laid down in BIPRU 4.10.28 R, LGD* must be the LGD laid down in the other sections of BIPRU 4 for uncollateralised exposures to the counterparty. For this purpose, the exposure value of items listed in BIPRU 4.4.37 R to BIPRU 4.4.39 R and BIPRU 4.8.29 R must be calculated using a conversion factor or percentage of 100% rather than the conversion factors or percentages indicated in those rules.

[Note: BCD Annex VIII Part 3 point 69]

BIPRU 4.10.26

handbook-rule

Where the ratio of the value of the collateral to the exposure value exceeds a second, higher threshold level of C** (i.e. the required level of collateralisation to receive full LGD recognition) as laid down in BIPRU 4.10.28 R, LGD* must be that prescribed in that table.

[Note: BCD Annex VIII Part 3 point 70]

BIPRU 4.10.27

handbook-rule

Where the required level of collateralisation C** is not achieved in respect of the exposure as a whole, the exposure must be considered to be two exposures - that part in respect of which the required level of collateralisation C** is achieved and the remainder.

[Note: BCD Annex VIII Part 3 point 71]

BIPRU 4.10.28

handbook-rule

Table: Minimum LGD for secured portion of exposures
This table belongs to BIPRU 4.10.24 R - BIPRU 4.10.27 R

[Note: BCD Annex VIII Part 3 point 72 (part)]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Alternative treatment for real estate collateral

BIPRU 4.10.29

handbook-rule
  1. (1) A firm may apply the treatment in paragraph 74 of Part 3 of Annex VIII of the Banking Consolidation Directive (50% risk weight for exposures secured by real estate) in respect of exposures collateralised by:
    1. (a) residential real estate property; or
    2. (b) commercial real estate property;
  2. located in the territory of another EEA State.
  3. (2) However (1)(a) or (1)(b) only applies if the CRD implementing measures for that EEA State with respect to the IRB approach have implemented the option set out in the provision of the Banking Consolidation Directive referred to in (1) with respect to the relevant category of real estate property situated within that EEA State.
  4. (3) The use of the treatment in (1) with respect to property in another EEA State must be subject to the same conditions as apply under the relevant CRD implementation measures for that EEA State.

[Note: BCD Annex VIII Part 3 point 75]

Calculating risk weighted exposure amounts and expected loss amounts: Mixed pools of collateral

BIPRU 4.10.30

handbook-rule
  1. (1) Where:
    1. (a) risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach; and
    2. (b) an exposure is collateralised by both financial collateral and other eligible collateral;
  2. LGD* to be taken as the LGD for the purposes of the IRB approach must be calculated in accordance with this rule.
  3. (2) A firm must subdivide the volatility-adjusted value of the exposure (i.e. the value after the application of the volatility adjustment as set out in BIPRU 5.4.28 R (Volatility adjustments under the financial collateral comprehensive method) into parts each covered by only one type of collateral. That is, the firm must divide the exposure into the part covered by eligible financial collateral, the part covered by receivables, the parts covered by commercial real estate property collateral and/or residential real estate property collateral, the part covered by other eligible collateral, and the unsecured part, as relevant.
  4. (3) LGD* for each part of exposure must be calculated separately in accordance with the relevant provisions of BIPRU 5 (Credit risk mitigation) and BIPRU 4.10.

[Note: BCD Annex VIII Part 3 points 76 to 78]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Other modifications of the rules on credit risk mitigation: Financial collateral simple method

BIPRU 4.10.31

handbook-rule

The financial collateral simple method must not be used under the IRB approach.

[Note: BCD Annex VIII Part 3 point 24 (part)]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Other modifications of the rules on credit risk mitigation: Master netting agreements

BIPRU 4.10.32

handbook-rule
  1. (1) This rule sets out how the calculations under BIPRU 5.6.11 R (Using the supervisory volatility adjustments or the own estimates volatility adjustments approaches to master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions) must be modified under the IRB approach.
  2. (2) Where risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach, E is the exposure value for each separate exposure under the agreement referred to in the provisions listed in (1) that would apply in the absence of the credit protection.

[Note: BCD Annex VIII Part 3 point 11 (as it applies to the IRB approach)]

BIPRU 4.10.33

handbook-rule
  1. (1) This rule sets out how the calculations under BIPRU 5.6.24 R (Using the internal models approach to master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions) must be modified under the IRB approach.
  2. (2) Where risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach E is the exposure value for each separate exposure under the agreement referred to in the provisions listed in (1) that would apply in the absence of the credit protection.

[Note: BCD Annex VIII Part 3 point 20 (as it applies to the IRB approach)]

BIPRU 4.10.34

handbook-rule
  1. (1) This rule sets out how the calculations under BIPRU 5.6.29 R (Calculating risk-weighted exposure amounts and expected loss amounts for master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions) must be modified under the IRB approach.
  2. (2) E* must be taken as the exposure value of the exposure to the counterparty arising from the transactions subject to the master netting agreement referred to in the provisions listed in (1) for the purposes of BIPRU 4.

[Note: BCD Annex VIII Part 3 point 23 (as it applies to the IRB approach)]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Other modifications of the rules on credit risk mitigation: Financial collateral comprehensive method

BIPRU 4.10.35

handbook-rule
  1. (1) This rule sets out how the calculations under BIPRU 5.4.28 R (Calculating adjusted values under the financial collateral comprehensive method) must be modified under the IRB approach.
  2. (2) E as referred to in the provisions listed in (1) is the exposure value as would be determined under the IRB approach if the exposure was not collateralised. For this purpose, where a firm calculates risk weighted exposure amounts under the IRB approach, the exposure value of the items listed in BIPRU 4.4.37 R to BIPRU 4.4.39 R, BIPRU 4.4.45 R, BIPRU 4.6.44 R (3) and BIPRU 4.8.29 R must be calculated using a conversion factor of 100% rather than the conversion factors or percentages indicated in those provisions.

BIPRU 4.10.36

handbook-rule
  1. (1) This rule sets out the calculation of risk weighted exposure amounts and expected loss amounts under the financial collateral comprehensive method for a firm using the IRB approach.
  2. (2) LGD* (the effective loss given default) calculated as set out in this paragraph must be taken as the LGD for the purposes of BIPRU 4.
  3. (3) LGD* = LGD x (E*/E) where:
    1. (a) LGD is the loss given default that would apply to the exposure under the IRB approach if the exposure was not collateralised;
    2. (b) E is the exposure value as calculated under BIPRU 4; and
    3. (c) E* is as calculated under BIPRU 5.4.28 R (3) (Calculation of adjusted values under the financial collateral comprehensive method).

[Note: BCD Annex VIII Part 3 point 61]

BIPRU 4.10.37

handbook-rule
  1. (1) In the case of a firm using the IRB approach to calculate risk weighted exposure amounts and expected loss amounts, the persons in (2) are added to the list in BIPRU 5.4.64 R (Definition of core market participant).
  2. (2) The persons referred to in (1) are other financial companies (including insurance companies) exposures to which do not have a credit assessment by an eligible ECAI and are internally rated as having a probability of default equivalent to that associated with the credit assessments of ECAIs that are associated with credit quality step 2 or above under the rules for the risk weighting of exposures under the standardised approach to credit risk.

[Note: BCD Annex VIII Part 3 point 58(h) (as it applies to the IRB approach)]

Unfunded credit protection: Eligibility of providers

BIPRU 4.10.38

handbook-rule
  1. (1) In the case of a firm using the IRB approach in calculating risk weighted exposure amounts and expected loss amounts, the persons in (2) are added to the list in BIPRU 5.7.1 R (List of eligible providers of unfunded credit protection).
  2. (2) The persons referred to in (1) are other corporate entities, including parent undertakings, subsidiary undertakings and affiliate corporate entities of the firm, that do not have a credit assessment by an eligible ECAI and are internally rated as having a probability of default equivalent to that associated with the credit assessments of ECAIs that are associated with credit quality step 2 or above under the rules for the risk weighting of exposures under the standardised approach to credit risk.

[Note: BCD Annex VIII Part 1 point 26(g)(ii)]

BIPRU 4.10.39

handbook-rule

Where risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach, to be eligible a guarantor must be internally rated by a firm in accordance with the provisions of the minimum IRB standards.

[Note: BCD Annex VIII Part 1 point 27]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Introduction

BIPRU 4.10.40

handbook-rule

BIPRU 4.10.41 R to BIPRU 4.10.48 R set out the minimum requirements:

  1. (1) assessing the effect of guarantees and credit derivatives for:
    1. (a) exposures in the sovereign, institution and corporate IRB exposure class where the advanced IRB approach is being used to calculate LGDs; and
    2. (b) retail exposures; and
  2. (2) additionally, in the case of retail exposure guarantees, to the assignment of exposures to grades or pools, and the estimation of PD.

[Note: BCD Annex VII Part 4 point 97]

BIPRU 4.10.41

handbook-rule

The requirements in BIPRU 4.10.40 R (2) and BIPRU 4.10.42 R - BIPRU 4.10.48 R do not apply to guarantees provided by institutions, central governments, central banks and other corporate entities which meet the requirements in BIPRU 5.7.1 R (7) if the firm has received approval under BIPRU 4.2 to apply the standardised approach for exposures to such entities. In this case the requirements of BIPRU 5 (credit risk mitigation) apply.

[Note: BCD Annex VII Part 4 point 96]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Eligible guarantors and guarantees

BIPRU 4.10.42

handbook-rule

A firm must have clearly specified criteria for the types of guarantors it recognises for the calculation of risk weighted exposure amounts.

[Note: Annex VII Part 4 point 98]

BIPRU 4.10.43

handbook-rule

For recognised guarantors the same requirements as for obligors as set out in BIPRU 4.3.43 R - BIPRU 4.3.48 R (Assignment to grades and pools), BIPRU 4.4.11 R - BIPRU 4.4.18 R and BIPRU 4.4.51 R (Assignment of exposures and rating systems), BIPRU 4.5.6 R (Assignment of exposures) and BIPRU 4.6.11 R and BIPRU 4.6.14 R (Assignment of exposures and rating systems) apply.

[Note: BCD Annex VII Part 4 point 99]

BIPRU 4.10.44

handbook-rule

The guarantee must be evidenced in writing, non-cancellable on the part of the guarantor, in force until the obligation is satisfied in full (to the extent of the amount and tenor of the guarantee) and legally enforceable against the guarantor in a jurisdiction where the guarantor has assets to attach and enforce a judgement. Guarantees prescribing conditions under which the guarantor may not be obliged to perform (conditional guarantees) may be recognised if the IRB permission permits this. A firm must (in the case of a firm with an IRB permission that permits conditional guarantees) be able to demonstrate to the FSA that the assignment criteria adequately address any potential reduction in the risk mitigation effect.

[Note: BCD Annex VII Part 4 point 100]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Adjustment criteria

BIPRU 4.10.45

handbook-rule

A firm must have clearly specified criteria for adjusting grades, pools or LGD estimates, and in the case of retail exposures and eligible purchased receivables, the process of allocating exposures to grades or pools, to reflect the impact of guarantees for the calculation of risk weighted exposure amounts. These criteria must comply with the minimum requirements referred to in BIPRU 4.10.43 R.

[Note: BCD Annex VII Part 4 point 101]

BIPRU 4.10.46

handbook-rule

The criteria in BIPRU 4.10.45 R must be plausible and intuitive. They must address the guarantor's ability and willingness to perform under the guarantee, the likely timing of any payments from the guarantor, the degree to which the guarantor's ability to perform under the guarantee is correlated with the obligor's ability to repay, and the extent to which residual risk to the obligor remains.

[Note: BCD Annex VII Part 4 point 102]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Credit derivatives

BIPRU 4.10.47

handbook-rule

The minimum requirements for guarantees set out in BIPRU 4.10 also apply for single name credit derivatives. In relation to a mismatch between the underlying obligation and the reference obligation of the credit derivative or the obligation used for determining whether a credit event has occurred the requirements set out under BIPRU 5.7.14 R (Mismatches and credit derivatives) apply. For retail exposures and eligible purchased receivables, this paragraph applies to the process of allocating exposures to grades or pools.

[Note: BCD Annex VII Part 4 point 103]

BIPRU 4.10.48

handbook-rule

The criteria applied by BIPRU 4.10.47 R must address the payout structure of the credit derivative and conservatively assess the impact this has on the level and timing of recoveries. A firm must consider the extent to which other forms of residual risk remain.

[Note: BCD Annex VII Part 4 point 104]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Calculating risk weighted exposure amounts and expected loss amounts

BIPRU 4.10.49

handbook-rule
  1. (1) This rule relates to the calculation of risk-weighted exposure amounts and expected loss amounts in the case of unfunded credit protection.
  2. (2) BIPRU 5.7.21 R (Tranching) applies for the purpose in (1).
  3. (3) The provisions in (4) replace those in BIPRU 5.7.22 R to BIPRU 5.7.25 R (Calculating risk weighted exposure amounts under the standardised approach in the case of unfunded credit protection).
  4. (4) For the covered portion of the exposure value E (based on the adjusted value of the credit protection GA), the PD for the purposes of BIPRU 4 may be the PD of the protection provider, or a PD between that of the borrower and that of the guarantor if a full substitution is deemed not to be warranted. In the case of subordinated exposures and non-subordinated unfunded protection, the LGD to be applied for the purposes of BIPRU 4 may be that associated with senior claims.
  5. (5) For any uncovered portion of the exposure value E the PD must be that of the borrower and the LGD must be that of the underlying exposure.
  6. (6) GA is the value of G* as calculated under BIPRU 5.7.17 R (Valuation of unfunded credit protection) further adjusted for any maturity mismatch as laid down in BIPRU 4.10.51 R (Maturity mismatches).
  7. (7) E is the exposure value as related to the following rules: BIPRU 4.4.38 R, BIPRU 4.4.39 R, BIPRU 4.4.71 R to BIPRU 4.4.78 R, BIPRU 4.7.7 R, BIPRU 4.8.28 R, BIPRU 4.8.29 R and BIPRU 4.9.9 R. For this purpose, the exposure value of the items referred to in BIPRU 4.4.37 R to BIPRU 4.4.39 R and BIPRU 4.8.29 R must be calculated using a conversion factor or percentage of 100% rather than the conversion factors or percentages indicated in those rules.

[Note: BCD Annex VIII Part 3 points 90 to 92]

Maturity mismatches

BIPRU 4.10.50

handbook-rule

In addition to BIPRU 5.8.2 R, where there is a maturity mismatch the credit protection must not be recognised where the exposure is a short term exposure specified in the firm's IRB permission as being subject to a one-day floor rather than a one-year floor in respect of the maturity value (M) under BIPRU 4.4.68 R.

[Note: BCD Annex VIII Part 4 point 2(b)]

BIPRU 4.10.51

handbook-rule

GA as calculated under BIPRU 5.8.11 R is then taken as the value of the protection for the purposes of calculating the effects of unfunded credit protection under the IRB approach.

[Note: BCD Annex VIII Part 4 point 8 (part)]

BIPRU 4 Annex 1

Supervisory Slotting Criteria for Specialised Lending

  • 01/01/2007

handbook-rule
This Annex outlines the criteria that must be used to slot a specialised lending exposure into the categories in BIPRU 4.5.6 R.

This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for project finance exposures.This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for income-producing real estate exposures This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for object finance exposures This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for commodities finance exposures.

Export chapter as

BIPRU 5

Credit risk mitigation

BIPRU 5.1

Application and purpose

  • 01/01/2007

Application

BIPRU 5.1.1

handbook-rule
BIPRU 5 applies to a BIPRU firm.

Purpose

BIPRU 5.1.2

handbook-guidance
BIPRU 5 implements, in part, Articles 78(1) and 91 to 93 and Annex VIII of the Banking Consolidation Directive.

BIPRU 5.1.3

handbook-guidance
BIPRU 5 sets out the principles for the recognition of credit risk mitigation in the calculation of risk weighted exposure amounts for the purposes of the calculation of the credit risk capital component.

BIPRU 5.1.4

handbook-guidance
BIPRU 4.10 implements those parts of Articles 91 to 93 and Annex VIII of the Banking Consolidation Directive which are specific to the recognition of credit risk mitigation by firms using the IRB approach, and modifies the application of the provisions in BIPRU 5 to those firms.

BIPRU 5.1.5

handbook-guidance
In certain cases provisions specific to the IRB approach have been kept in BIPRU 5 in order to reduce duplication. The main examples are certain references to expected loss and references in the IRB approach in the provisions in BIPRU 5.7 about basket CRM techniques.

BIPRU 5.2

The central principles of credit risk mitigation

  • 01/01/2007

BIPRU 5.2.1

handbook-rule

A firm using the standardised approach may recognise credit risk mitigation in accordance with BIPRU 5 in the calculation of risk weighted exposure amounts for the purposes of the calculation of the credit risk capital component.

[Note: BCD Article 91]

BIPRU 5.2.2

handbook-rule

The technique used to provide the credit protection together with the actions and steps taken and procedures and policies implemented by a lending firm must be such as to result in credit protection arrangements which are legally effective and enforceable in all relevant jurisdictions.

[Note: BCD Article 92(1)]

BIPRU 5.2.3

handbook-rule
  1. (1) A firm must not recognise credit protection as eligible until it has conducted sufficient legal review confirming that the credit protection arrangements are legally effective and enforceable in all relevant jurisdictions in accordance with BIPRU 5.2.2 R.
  2. (2) A firm must re-conduct legal reviews as necessary to ensure continuing enforceability and effectiveness.

BIPRU 5.2.4

handbook-rule

A lending firm must take all appropriate steps to ensure the effectiveness of the credit protection arrangement and to address related risks.

[Note: BCD Article 92(2)]

Funded credit protection

BIPRU 5.2.5

handbook-rule

In the case of funded credit protection:

  1. (1) to be eligible for recognition the assets relied upon must be sufficiently liquid and their value over time sufficiently stable to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk weighted exposure amounts and to the degree of recognition allowed; eligibility is limited to the assets set out in the CRM eligibility conditions; and
  2. (2) the lending firm must have the right to liquidate or retain, in a timely manner, the assets from which the protection derives in the event of the default, insolvency or bankruptcy of the obligor - or other credit event set out in the transaction documentation - and, where applicable, of the custodian holding the collateral; the degree of correlation between the value of the assets relied upon for protection and the credit quality of the obligor must not be undue.

[Note: BCD Article 92(3) and (4)]

Treatment of credit linked notes

BIPRU 5.2.6

handbook-guidance
A credit linked note should be treated, to the extent of its cash funding, as funded credit protection. Therefore the conditions in BIPRU 5 regulating the eligibility of protection providers for unfunded credit protection do not apply. However the other provisions about the requirements for the recognition of unfunded credit protection do apply.

Unfunded credit protection

BIPRU 5.2.7

handbook-rule

In the case of unfunded credit protection:

  1. (1) to be eligible for recognition the party giving the undertaking must be sufficiently reliable, and the protection agreement legally effective and enforceable in the relevant jurisdictions, to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk weighted exposure amounts and to the degree of recognition allowed; and
  2. (2) eligibility is limited to the protection providers and types of protection agreement set out in the CRM eligibility conditions.

[Note: BCD Article 92(5)]

Minimum requirements

BIPRU 5.2.8

handbook-rule

The minimum requirements set out in BIPRU 5 must be complied with.

[Note: BCD Article 92(6)]

BIPRU 5.2.9

handbook-rule

A firm must be able to satisfy the FSA that it has adequate risk management processes to control the risks to which the firm may be exposed as a result of carrying out credit risk mitigation. Those processes must include appropriate stress tests and scenario analyses relating to those risks, including residual risk and the risks relating to the intrinsic value of the credit risk mitigation.

[Note: BCD Annex VIII Part 2 point 1]

BIPRU 5.2.10

handbook-rule

Notwithstanding the presence of credit risk mitigation taken into account for the purposes of calculating risk weighted exposure amounts and as relevant expected loss amounts, a firm must continue to undertake full credit risk assessment of the underlying exposure and must be in a position to demonstrate to the FSA the fulfilment of this requirement. In the case of repurchase transactions and/or securities or commodities lending or borrowing transactions the underlying exposure must, for the purposes of this rule only, be deemed to be the net amount of the exposure.

[Note: BCD Annex VIII Part 2 point 2]

Calculating the effects of the credit risk mitigation

BIPRU 5.2.11

handbook-rule

Where the requirements of BIPRU 5.2.2 R to BIPRU 5.2.8 R are met the calculation of risk weighted exposure amounts, may be modified in accordance with BIPRU 5.

[Note: BCD Article 93(1)]

BIPRU 5.2.12

handbook-rule

No exposure in respect of which credit risk mitigation is obtained may produce a higher risk weighted exposure amount than an otherwise identical exposure in respect of which there is no credit risk mitigation.

[Note: BCD Article 93(2)]

BIPRU 5.2.13

handbook-rule

Where the risk weighted exposure amount already takes account of credit protection under the standardised approach the calculation of the credit protection must not be further recognised under BIPRU 5.

[Note: BCD Article 93(3)]

BIPRU 5.2.14

handbook-rule

Subject to BIPRU 5.8, BIPRU 5.9 and BIPRU 5.7.27 R to BIPRU 5.7.28 R, where the CRM eligibility conditions and the CRM minimum requirements are satisfied, the calculation of risk weighted exposure amounts under the standardised approach may be modified in accordance with the provisions of BIPRU 5.

[Note: BCD Annex VIII Part 3 point 1]

BIPRU 5.2.15

handbook-rule

Cash, securities or commodities purchased, borrowed or received under a repurchase transaction or securities or commodities lending or borrowing transaction must be treated as collateral.

[Note: BCD Annex VIII Part 3 point 2]

BIPRU 5.3

On balance sheet netting

  • 01/01/2007

Eligibility

BIPRU 5.3.1

handbook-rule

A firm may recognise as eligible the on-balance sheet netting of mutual claims between the firm and its counterparty.

[Note: BCD Annex VIII Part 1 point 3]

BIPRU 5.3.2

handbook-rule

Without prejudice to BIPRU 5.6.1 R, eligibility is limited to reciprocal cash balances between a firm and a counterparty. Only loans and deposits of the lending firm may be subject to a modification of risk weighted exposure amounts and, as relevant, expected loss amounts as a result of an on-balance sheet netting agreement.

[Note: BCD Annex VIII Part 1 point 4]

Minimum requirements

BIPRU 5.3.3

handbook-rule

For on-balance sheet netting agreements - other than master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions and/or other capital market-driven transactions - to be recognised for the purposes of BIPRU 5 the following conditions must be satisfied:

  1. (1) they must be legally effective and enforceable in all relevant jurisdictions, including in the event of the insolvency or bankruptcy of a counterparty;
  2. (2) the firm must be able to determine at any time those assets and liabilities that are subject to the on-balance sheet netting agreement;
  3. (3) the firm must monitor and control the risks associated with the termination of the credit protection; and
  4. (4) the firm must monitor and control the relevant exposures on a net basis.

[Note: BCD Annex VIII Part 2 point 3]

Calculating the effects of credit risk mitigation

BIPRU 5.3.4

handbook-rule

Loans and deposits with a lending firm subject to on-balance sheet netting are to be treated as cash collateral.

[Note: BCD Annex VIII Part 3 point 4]

BIPRU 5.4

Financial collateral

  • 01/01/2007

Eligibility

BIPRU 5.4.1

handbook-rule
  1. (1) Where the credit risk mitigation used relies on the right of a firm to liquidate or retain assets, eligibility depends upon whether risk weighted exposure amounts, and, as relevant, expected loss amounts, are calculated under the standardised approach or the IRB approach.
  2. (2) Eligibility further depends upon whether the financial collateral simple method is used or the financial collateral comprehensive method.
  3. (3) In relation to repurchase transactions and securities or commodities lending or borrowing transactions, eligibility also depends upon whether the transaction is booked in the non-trading book or the trading book.

[Note: BCD Annex VIII Part 1 point 6]

BIPRU 5.4.2

handbook-rule

The following financial items may be recognised as eligible collateral under all approaches and methods:

  1. (1) cash on deposit with, or cash assimilated instruments held by, the lending firm;
  2. (2) debt securities issued by central governments or central banks which securities have a credit assessment by an eligible ECAI or export credit agency recognised as eligible for the purposes of the standardised approach, which is associated with credit quality step 4 or above under the rules for the risk weighting of exposures to central governments and central banks under the standardised approach;
  3. (3) debt securities issued by institutions which securities have a credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of exposures to a credit institution under the standardised approach;
  4. (4) debt securities issued by other entities which securities have a credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;
  5. (5) debt securities with a short-term credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of short term exposures under the standardised approach;
  6. (6) equities or convertible bonds that are included in a main index; and
  7. (7) gold.

[Note: BCD Annex VIII Part 1 point 7 (part)]

BIPRU 5.4.3

handbook-rule

For the purposes of BIPRU 5.4.2 R (2), 'debt securities issued by central governments or central banks' include -

  1. (1) debt securities issued by regional governments or local authorities exposures to which are treated as exposures to the central government in whose jurisdiction they are established under the standardised approach;
  2. (2) debt securities issued by public sector entities which are treated as exposures to central governments in accordance with BIPRU 3.4.24 R;
  3. (3) debt securities issued by multilateral development banks to which a 0% risk weight is assigned under the standardised approach; and
  4. (4) debt securities issued by international organisations which are assigned a 0% risk weight under the standardised approach.

[Note: BCD Annex VIII Part 1 point 7 (part)]

BIPRU 5.4.4

handbook-rule

For the purposes of BIPRU 5.4.2 R (3), 'debt securities issued by institutions' include:

  1. (1) debt securities issued by regional governments or local authorities other than those exposures to which are treated as exposures to the central government in whose jurisdiction they are established under the standardised approach;
  2. (2) debt securities issued by public sector entities, exposures to which are treated as exposures to a credit institution under the standardised approach;
  3. (3) debt securities issued by multilateral development banks other than those to which a 0% risk weight is assigned under the standardised approach.

[Note: BCD Annex VIII Part 1 point 7 (part)]

BIPRU 5.4.5

handbook-rule

Debt securities issued by institutions which securities do not have a credit assessment by an eligible ECAI may be recognised as eligible collateral if they fulfil the following criteria:

  1. (1) they are listed on a recognised investment exchange or a designated investment exchange;
  2. (2) they qualify as senior debt;
  3. (3) all other rated issues by the issuing institution of the same seniority have a credit assessment by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weight of exposures to institutions or short term exposures under the standardised approach;
  4. (4) the lending firm has no information to suggest that the issue would justify a credit assessment below that indicated in (3); and
  5. (5) the firm can demonstrate to the FSA that the market liquidity of the instrument is sufficient for these purposes.

[Note: BCD Annex VIII Part 1 point 8]

BIPRU 5.4.6

handbook-rule
  1. (1) Units in CIUs may be recognised as eligible collateral if the following conditions are satisfied:
    1. (a) they have a daily public price quote;
    2. (b) the CIU is limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R; and
    3. (c) if the CIU is not limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R, units may be recognised with the value of the eligible assets as collateral under the assumption that the CIU has invested to the maximum extent allowed under its mandate in non-eligible assets. In cases where non-eligible assets can have a negative value due to liabilities or contingent liabilities resulting from ownership, the firm must calculate the total value of the non-eligible assets and must reduce the value of the eligible assets by that of the non-eligible assets in case the latter is negative in total.
  2. (2) The use (or potential use) by a CIU of derivative instruments to hedge permitted investments shall not prevent units in that CIU from being eligible.

[Note: BCD Annex VIII Part 1 point 9]

BIPRU 5.4.7

handbook-rule

In relation to BIPRU 5.4.2 R (2) to (5):

  1. (1) where a security has two credit assessments by eligible ECAIs, the less favourable assessment must be deemed to apply;
  2. (2) in cases where a security has more than two credit assessments by eligible ECAIs:
    1. (a) the two most favourable assessments must be deemed to apply; or
    2. (b) if the two most favourable credit assessments are different, the less favourable of the two must be deemed to apply.

[Note: BCD Annex VIII Part 1 point 10]

BIPRU 5.4.8

handbook-rule
  1. (1) In addition to the collateral set out in BIPRU 5.4.2 R to BIPRU 5.4.7 R, where a firm uses the financial collateral comprehensive method, the following financial items may be recognised as eligible collateral:
    1. (a) equities or convertible bonds not included in a main index but traded on a recognised investment exchange or a designated investment exchange;
    2. (b) units in CIUs if the following conditions are met:
      1. (i) they have a daily public price quote; and
      2. (ii) the CIU is limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R and the items mentioned in (a); and
    3. (c) if the CIU is not limited to investing in instruments that are eligible for recognition under BIPRU 5.4.2 R to BIPRU 5.4.5 R and the items mentioned in (a) of this rule, units may be recognised with the value of the eligible assets as collateral under the assumption that the CIU has invested to the maximum extent allowed under its mandate in non-eligible assets. In cases where non-eligible assets can have a negative value due to liabilities or contingent liabilities resulting from ownership, the firm must calculate the total value of the non-eligible assets and must reduce the value of the eligible assets by that of the non-eligible assets, in case the latter is negative in total.
  2. (2) The use (or potential use) by a CIU of derivative instruments to hedge permitted investments shall not prevent units in that CIU from being eligible.

[Note: BCD Annex VIII Part 1 point 11]

Minimum requirements

BIPRU 5.4.9

handbook-rule

For the recognition of financial collateral and gold, the following conditions must be met:

  1. (1) the low correlation conditions in BIPRU 5.4.10 R;
  2. (2) the legal certainty conditions in BIPRU 5.4.11 R; and
  3. (3) the operational requirements in BIPRU 5.4.12 R.

[Note: BCD Annex VIII Part 2 point 6]

BIPRU 5.4.10

handbook-rule

The low correlation conditions referred to in BIPRU 5.4.9 R (1) are as follows:

  1. (1)
    1. (a) the credit quality of the obligor and the value of the collateral must not have a material positive correlation; and
    2. (b) securities issued by the obligor, or any related group entity are not eligible.
  2. (2) notwithstanding (1)(b), the obligor's own issues of covered bonds falling within the terms of BIPRU 3.4.107 R to BIPRU 3.4.109 R may be recognised as collateral for repurchase transactions, provided that (1)(a) is complied with.

[Note: BCD Annex VIII Part 2 point 6(a)]

BIPRU 5.4.11

handbook-rule

The legal certainty conditions referred to in BIPRU 5.4.9 R (2) are as follows:

  1. (1) a firm must fulfil any contractual and statutory requirements in respect of, and take all steps necessary to ensure, the enforceability of the collateral arrangements under the law applicable to its interest in the collateral;
  2. (2) in accordance with the general principle in BIPRU 5.2.2 R, a firm must have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions; and
  3. (3) a firm must re-conduct such review as necessary to ensure continuing enforceability.

[Note: BCD Annex VIII Part 2 point 6(b)]

BIPRU 5.4.12

handbook-rule

The operational requirements referred to in BIPRU 5.4.9 R (3) are as follows:

  1. (1) the collateral arrangements must be properly documented, with a clear and robust procedure for the timely liquidation of collateral;
  2. (2) a firm must employ robust procedures and processes to control risks arising from the use of collateral - including risks of failed or reduced credit protection, valuation risks, risks associated with the termination of the credit protection, concentration risk arising from the use of collateral and the interaction with the firm's overall risk profile;
  3. (3) a firm must have documented policies and practices concerning the types and amounts of collateral accepted;
  4. (4) a firm must calculate the market value of the collateral, and revalue it accordingly, with a minimum frequency of once every six months and whenever the firm has reason to believe that there has occurred a significant decrease in its market value; and
  5. (5) where the collateral is held by a third party, a firm must take reasonable steps to ensure that the third party segregates the collateral from its own assets.

[Note: BCD Annex VIII Part 2 point 6(c)]

BIPRU 5.4.13

handbook-rule

In addition to the requirements set out in BIPRU 5.4.9 R, for the recognition of financial collateral under the financial collateral simple method the residual maturity of the protection must be at least as long as the residual maturity of the exposure.

[Note: BCD Annex VIII Part 2 point 7]

The financial collateral simple method: General

BIPRU 5.4.14

handbook-rule
BIPRU 5.4.17 R - BIPRU 5.4.22 R set out the calculation of the effects of credit risk mitigation under the financial collateral simple method.

BIPRU 5.4.15

handbook-rule

The financial collateral simple method is available only where risk weighted exposure amounts are calculated under the standardised approach to credit risk.

[Note: BCD Annex VIII Part 3 point 24 (part)]

BIPRU 5.4.16

handbook-rule

A firm must not use both the financial collateral simple method and the financial collateral comprehensive method, unless such use is for the purposes of BIPRU 4.2.17 R to BIPRU 4.2.19 R and BIPRU 4.2.26 R, and such use is provided for by the firm's IRB permission. A firm must demonstrate to the FSA that this exceptional application of both methods is not used selectively with the purpose of achieving reduced minimum capital requirements and does not lead to regulatory arbitrage.

[Note: BCD Annex VIII Part 3 point 24 (part)]

The financial collateral simple method: Valuation

BIPRU 5.4.17

handbook-rule

Under the financial collateral simple method, recognised financial collateral is assigned a value equal to its market value as determined in accordance with BIPRU 5.4.12 R.

[Note: BCD Annex VIII Part 3 point 25]

The financial collateral simple method: Calculating risk-weighted exposure amounts

BIPRU 5.4.18

handbook-rule

The risk weight that would be assigned under the standardised approach to credit risk if the lending firm had a direct exposure to the collateral instrument must be assigned to those portions of exposure values collateralised by the market value of recognised collateral. For this purpose, the exposure value of an off-balance sheet item listed in BIPRU 3.7.2 R must be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R. The risk weight of the collateralised portion must be a minimum of 20% except as specified in BIPRU 5.4.19 R to BIPRU 5.4.21 R. The remainder of the exposure value receives the risk weight that would be applied to an unsecured exposure to the counterparty under the standardised approach.

[Note: BCD Annex VIII Part 3 point 26]

The financial collateral simple method: Repurchase transactions and securities lending or borrowing transactions

BIPRU 5.4.19

handbook-rule

A risk weight of 0% must be assigned to the collateralised portion of the exposure arising from transactions which fulfil the criteria enumerated in BIPRU 5.4.62 R or BIPRU 5.4.65 R. If the counterparty to the transaction is not a core market participant a risk weight of 10% must be assigned.

[Note: BCD Annex VIII Part 3 point 27]

The financial collateral simple method: financial derivative instruments subject to daily mark-to-market

BIPRU 5.4.20

handbook-rule

A risk weight of 0% must, to the extent of the collateralisation, be assigned to the exposure values determined under BIPRU 13 for financial derivative instruments and subject to daily marking-to-market, collateralised by cash or cash assimilated instruments where there is no currency mismatch. A risk weight of 10% must be assigned to the extent of the collateralisation to the exposure values of such transactions collateralised by debt securities issued by central governments or central banks which are assigned a 0% risk weight under the standardised approach.

[Note: BCD Annex VIII Part 3 point 28 (part)]

BIPRU 5.4.21

handbook-rule

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

  1. (1) the collateral is cash on deposit or a cash assimilated instrument; or
  2. (2) the collateral is in the form of debt securities issued by central governments or central banks eligible for a 0% risk weight under the standardised approach, and its market value has been discounted by 20%.

[Note: BCD Annex VIII Part 3 point 29]

BIPRU 5.4.22

handbook-rule

For the purposes of BIPRU 5.4.20 R and BIPRU 5.4.21 R 'debt securities issued by central governments or central banks' must include:

  1. (1) debt securities issued by regional governments or local authorities exposures to which are treated as exposures to the central government in whose jurisdiction they are established under the standardised approach;
  2. (2) debt securities issued by multilateral development banks to which a 0% risk weight is assigned under or by virtue of the standardised approach; and
  3. (3) debt securities issued by international organisations which are assigned a 0% risk weight under the standardised approach.

[Note: BCD Annex VIII Part 3 point 28 (part)]

The financial collateral comprehensive method: General

BIPRU 5.4.23

handbook-rule

BIPRU 5.4.24

handbook-rule

In valuing financial collateral for the purposes of the financial collateral comprehensive method, volatility adjustments must be applied to the market value of collateral, as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R, in order to take account of price volatility.

[Note: BCD Annex VIII Part 3 point 30]

BIPRU 5.4.25

handbook-rule

Subject to the treatment for currency mismatches in the case of financial derivative instrument set out in BIPRU 5.4.26 R, where collateral is denominated in a currency that differs from that in which the underlying exposure is denominated, an adjustment reflecting currency volatility must be added to the volatility adjustment appropriate to the collateral as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 31]

BIPRU 5.4.26

handbook-rule

In the case of financial derivative instrument covered by netting agreements recognised under BIPRU 13, a volatility adjustment reflecting currency volatility must be applied when there is a mismatch between the collateral currency and the settlement currency. Even in the case where multiple currencies are involved in the transactions covered by the netting agreement, only a single volatility adjustment may be applied.

[Note: BCD Annex VIII Part 3 point 32]

BIPRU 5.4.27

handbook-rule

In the case of a firm using the financial collateral comprehensive method, where an exposure takes the form of securities or commodities sold, posted or lent under a repurchase transaction or under a securities or commodities lending or borrowing transaction, and margin lending transactions the exposure value must be increased by the volatility adjustment appropriate to such securities or commodities as prescribed in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Article 78(1), third sentence]

The financial collateral comprehensive method: Calculating adjusted values

BIPRU 5.4.28

handbook-rule
  1. (1) The volatility-adjusted value of the collateral to be taken into account is calculated as follows in the case of all transactions except those transactions subject to recognised master netting agreements to which the provisions set out in BIPRU 5.6.5 R to BIPRU 5.6.29 R are to be applied:
  2. CVA = C x (1-HC-HFX)
  3. (2) The volatility-adjusted value of the exposure to be taken into account is calculated as follows:
  4. EVA = E x (1+HE), and in the case of financial derivative instruments EVA = E.
  5. (3) The fully adjusted value of the exposure, taking into account both volatility and the risk-mitigating effects of collateral is calculated as follows:
  6. E * = max {0, [EVA - CVAM]}
  7. Where:
    1. (a) E is the exposure value as would be determined under the standardised approach if the exposure was not collateralised.
    2. (b) EVA is the volatility-adjusted exposure amount.
    3. (c) CVA is the volatility-adjusted value of the collateral.
    4. (d) CVAM is CVA further adjusted for any maturity mismatch in accordance with the provisions of BIPRU 5.8.
    5. (e) HE is the volatility adjustment appropriate to the exposure (E), as calculated under BIPRU 5.4.30 R to BIPRU 5.4.65 R.
    6. (f) HC is the volatility adjustment appropriate for the collateral, as calculated under BIPRU 5.4.30 R to BIPRU 5.4.65 R.
    7. (g) HFX is the volatility adjustment appropriate for currency mismatch, as calculated under BIPRU 5.4.30 R to BIPRU 5.4.65 R.
    8. (h) E * is the fully adjusted exposure value taking into account volatility and the risk-mitigating effects of the collateral.
  8. (4) For the purpose of (3)(a), for a firm calculating risk weighted exposure amounts under the standardised approach the exposure value of an off-balance sheet items listed in BIPRU 3.7 must be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R and BIPRU 3.7.2 R.

[Note: BCD Annex VIII Part 3 point 33]

The financial collateral comprehensive method: Calculation of volatility adjustments to be applied: General

BIPRU 5.4.29

handbook-rule
BIPRU 5.4.30 R - BIPRU 5.4.65 R set out the calculation of volatility adjustments under the financial collateral comprehensive method.

BIPRU 5.4.30

handbook-rule

Volatility adjustments may be calculated in two ways: the supervisory volatility adjustments approach and the own estimates of volatility adjustments approach.

[Note: BCD Annex VIII Part 3 point 34]

BIPRU 5.4.31

handbook-rule

A firm may choose to use the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach independently of the choice it has made between the standardised approach and the IRB approach for the calculation of risk weighted exposure amounts. However, if a firm seeks to use the own estimates of volatility adjustments approach, it must do so for the full range of instrument types, excluding immaterial portfolios where it may use the supervisory volatility adjustments approach.

[Note: BCD Annex VIII Part 3 point 35 (part)]

BIPRU 5.4.32

handbook-rule

Where the collateral consists of a number of recognised items, the volatility adjustment must be
(H = Σi αi Hi)
where:

  1. (1) ai is the proportion of an item to the collateral as a whole; and
  2. (2) Hi is the volatility adjustment applicable to that item.

[Note: BCD Annex VIII Part 3 point 35 (part)]

The financial collateral comprehensive method: Supervisory volatility adjustments approach

BIPRU 5.4.33

handbook-rule
BIPRU 5.4.34 R - BIPRU 5.4.43 R set out the calculation of volatility adjustments under the supervisory volatility adjustments approach.

BIPRU 5.4.34

handbook-rule

The volatility adjustments to be applied under the supervisory volatility adjustments approach (assuming daily revaluation) are those set out in the tables in BIPRU 5.4.35 R - BIPRU 5.4.38 R.

[Note: BCD Annex VIII Part 3 point 36]

Table: Volatility adjustments for debt securities described in BIPRU 5.4.2R(2) and (3) - (4)

BIPRU 5.4.35

handbook-rule
This table belongs to BIPRU 5.4.34 R.

Table: Volatility adjustments for debt securities described in BIPRU 5.4.2R(5)

BIPRU 5.4.36

handbook-rule
This table belongs to BIPRU 5.4.34 R.

Table: Volatility adjustments for other collateral or exposure types

BIPRU 5.4.37

handbook-rule
This table belongs to BIPRU 5.4.34 R.

Table: Volatility adjustments for currency mismatch

BIPRU 5.4.38

handbook-rule
This table belongs to BIPRU 5.4.34 R.

BIPRU 5.4.39

handbook-rule
  1. (1) For secured lending transactions the liquidation period is 20 business days.
  2. (2) For repurchase transactions (except insofar as such transactions involve the transfer of commodities or guaranteed rights relating to title to commodities) and securities lending or borrowing transactions the liquidation period is 5 business days.
  3. (3) For other capital market-driven transactions, the liquidation period is 10 business days.

[Note: BCD Annex VIII Part 3 point 37]

BIPRU 5.4.40

handbook-rule

In the tables in BIPRU 5.4.35 R - BIPRU 5.4.38 R and in BIPRU 5.4.41 R to BIPRU 5.4.43 R, the credit quality step with which a credit assessment of the debt security is associated is the credit quality step with which the external credit assessment is associated under the standardised approach. For the purposes of this rule, BIPRU 5.4.7 R also applies.

[Note: BCD Annex VIII Part 3 point 38]

BIPRU 5.4.41

handbook-rule

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

[Note: BCD Annex VIII Part 3 point 39]

BIPRU 5.4.42

handbook-rule

For eligible units in CIUs the volatility adjustment is the weighted average volatility adjustments that would apply, having regard to the liquidation period of the transaction as specified in BIPRU 5.4.39 R, to the assets in which the fund has invested. If the assets in which the fund has invested are not known to the firm, the volatility adjustment is the highest volatility adjustment that would apply to any of the assets in which the fund has the right to invest.

[Note: BCD Annex VIII Part 3 point 40]

BIPRU 5.4.43

handbook-rule

For unrated debt securities issued by institutions and satisfying the eligibility criteria in BIPRU 5.4.5 R the volatility adjustments are the same as for securities issued by institutions or corporates with an external credit assessment associated with credit quality steps 2 or 3.

[Note: BCD Annex VIII Part 3 point 41]

The financial collateral comprehensive method: Own estimates of volatility adjustments approach: General

BIPRU 5.4.44

handbook-rule
BIPRU 5.4.45 R - BIPRU 5.4.60 R deal with the calculation of volatility adjustments under the own estimates of volatility adjustments approach.

BIPRU 5.4.45

handbook-rule

A firm complying with the requirements set out in BIPRU 5.4.50 R to BIPRU 5.4.60 R may use the own estimates of volatility adjustments approach for calculating the volatility adjustments to be applied to collateral and exposures.

[Note: BCD Annex VIII Part 3 point 42]

BIPRU 5.4.46

handbook-rule

When debt securities have a credit assessment from an eligible ECAI equivalent to investment grade or better, a firm may calculate a volatility estimate for each category of security.

[Note: BCD Annex VIII Part 3 point 43]

BIPRU 5.4.47

handbook-rule

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

[Note: BCD Annex VIII Part 3 point 44]

BIPRU 5.4.48

handbook-rule

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

[Note: BCD Annex VIII Part 3 point 45]

BIPRU 5.4.49

handbook-rule

A firm using the own estimates of volatility adjustments approach must estimate volatility of the collateral or foreign exchange mismatch without taking into account any correlations between the unsecured exposure, collateral and/or exchange rates.

[Note: BCD Annex VIII Part 3 point 46]

The financial collateral comprehensive method: Own estimates of volatility adjustments approach: Quantitative Criteria

BIPRU 5.4.50

handbook-rule

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

[Note: BCD Annex VIII Part 3 point 47]

BIPRU 5.4.51

handbook-rule

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

[Note: BCD Annex VIII Part 3 point 48]

BIPRU 5.4.52

handbook-rule

A firm may use volatility adjustment numbers calculated according to shorter or longer liquidation periods, scaled up or down to the liquidation period set out in BIPRU 5.4.51 R for the type of transaction in question, using the square root of time formula:
(HM = HN )√TM/TN)
where:

  1. (1) TM is the relevant liquidation period;
  2. (2) HM is the volatility adjustment under TM ; and
  3. (3) HN is the volatility adjustment based on the liquidation period TN.

[Note: BCD Annex VIII Part 3 point 49]

BIPRU 5.4.53

handbook-rule

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

[Note: BCD Annex VIII Part 3 point 50]

BIPRU 5.4.54

handbook-rule

The historical observation period (sample period) for calculating volatility adjustments must be a minimum length of one year. For a firm that uses a weighting scheme or other methods for the historical observation period, the effective observation period must be at least one year (that is, the weighted average time lag of the individual observations must not be less than 6 months).

[Note: BCD Annex VIII Part 3 point 51]

BIPRU 5.4.55

handbook-guidance
The FSA may also require a firm to calculate its volatility adjustments using a shorter observation period if, in the FSA's judgement, this is justified by a significant upsurge in price volatility.

BIPRU 5.4.56

handbook-rule

A firm must update its data sets at least once every three months and must also reassess them whenever market prices are subject to material changes. This implies that volatility adjustments must be computed at least every three months.

[Note: BCD Annex VIII Part 3 point 52]

The financial collateral comprehensive method: Own estimates of volatility adjustments approach: Qualitative Criteria

BIPRU 5.4.57

handbook-rule

The volatility estimates must be used in the day-to-day risk management process of a firm including in relation to its internal exposure limits.

[Note: BCD Annex VIII Part 3 point 53]

BIPRU 5.4.58

handbook-rule

If the liquidation period used by a firm in its day-to-day risk management process is longer than that set out in BIPRU 5.4 for the type of transaction in question, the firm's volatility adjustments must be scaled up in accordance with the square root of time formula set out in BIPRU 5.4.52 R.

[Note: BCD Annex VIII Part 3 point 54]

BIPRU 5.4.59

handbook-rule

A firm must have established procedures for monitoring and ensuring compliance with a documented set of policies and controls for the operation of its system for the estimation of volatility adjustments and for the integration of such estimations into its risk management process.

[Note: BCD Annex VIII Part 3 point 55]

BIPRU 5.4.60

handbook-rule

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

  1. (1) the integration of estimated volatility adjustments into daily risk management;
  2. (2) the validation of any significant change in the process for the estimation of volatility adjustments;
  3. (3) the verification of the consistency, timeliness and reliability of data sources used to run the system for the estimation of volatility adjustments, including the independence of such data sources; and
  4. (4) the accuracy and appropriateness of the volatility assumptions.

[Note: BCD Annex VIII Part 3 point 56]

The financial collateral comprehensive method: Scaling up of volatility adjustments

BIPRU 5.4.61

handbook-rule

The volatility adjustments set out in BIPRU 5.4.34 R to BIPRU 5.4.43 R are the volatility adjustments to be applied where there is daily revaluation. Similarly, where a firm uses its own estimates of the volatility adjustments in accordance with BIPRU 5.4.45 R to BIPRU 5.4.60 R, these must be calculated in the first instance on the basis of daily revaluation. If the frequency of revaluation is less than daily, larger volatility adjustments must be applied. These must be calculated by scaling up the daily revaluation volatility adjustments, using the following 'square root of time' formula:
(H = HM√(NR + (TM - 1))/(TM)))
where:

  1. (1) H is the volatility adjustment to be applied;
  2. (2) HM is the volatility adjustment where there is daily revaluation;
  3. (3) NR is the actual number of business days between revaluations; and
  4. (4) TM is the liquidation period for the type of transaction in question.

[Note: BCD Annex VIII Part 3 point 57]

The financial collateral comprehensive method: Conditions for applying a 0% volatility adjustment

BIPRU 5.4.62

handbook-rule

In relation to repurchase transaction and securities lending or borrowing transactions, where a firm uses the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach and where the conditions set out in (1) - (8) are satisfied, a firm may, instead of applying the volatility adjustments calculated under BIPRU 5.4.30 R to BIPRU 5.4.61 R, apply a 0% volatility adjustment:

  1. (1) both the exposure and the collateral are cash or debt securities issued by central governments or central banks within the meaning of BIPRU 5.4.2 R (2) and eligible for a 0% risk weight under the standardised approach;
  2. (2) both the exposure and the collateral are denominated in the same currency;
  3. (3) either the maturity of the transaction is no more than one day or both the exposure and the collateral are subject to daily marking-to-market or daily remargining;
  4. (4) it is considered that the time between the last marking-to-market before a failure to remargin by the counterparty and the liquidation of the collateral is no more than four business days;
  5. (5) the transaction is settled across a settlement system proven for that type of transaction;
  6. (6) the documentation covering the agreement is standard market documentation for repurchase transactions or securities lending or borrowing transactions in the securities concerned;
  7. (7) the transaction is governed by documentation specifying that if the counterparty fails to satisfy an obligation to deliver cash or securities or to deliver margin or otherwise defaults, then the transaction is immediately terminable; and
  8. (8) the counterparty is a core market participant.

[Note: BCD Annex VIII Part 3 point 58 (part)]

BIPRU 5.4.63

handbook-rule

The option in BIPRU 5.4.62 R is not available in respect of a firm using the master netting agreement internal models approach.

[Note: BCD Annex VIII Part 3 point 58 (part)]

BIPRU 5.4.64

handbook-rule

Core market participant means the following entities:

  1. (1) the entities mentioned in BIPRU 5.4.2 R (2) exposures to which are assigned a 0% risk weight under the standardised approach to credit risk;
  2. (2) institutions;
  3. (3) other financial companies (including insurance companies) exposures which are assigned a 20% risk weight under the standardised approach;
  4. (4) regulated CIUs that are subject to capital or leverage requirements;
  5. (5) regulated pension funds; and
  6. (6) a recognised clearing house or designated clearing house.

[Note: BCD Annex VIII Part 3 point 58 (part)]

BIPRU 5.4.65

handbook-rule

If under the CRD implementation measure for a particular EEA State with respect to point 58 of Part 3 of Annex VIII of the Banking Consolidation Directive (Conditions for applying the 0% volatility adjustment) the treatment set out in that point is permitted to be applied in the case of repurchase transactions or securities lending or borrowing transactions in securities issued by the domestic government of that EEA State, then a firm may adopt the same approach to the same transactions.

[Note: BCD Annex VIII Part 3 point 59]

Financial collateral comprehensive method: Calculating risk-weighted exposure amounts

BIPRU 5.4.66

handbook-rule

Under the standardised approach E* as calculated under BIPRU 5.4.28 R must be taken as the exposure value for the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R. In the case of off-balance sheet items listed in BIPRU 3.7, E* must be taken as the value to which the percentages indicated in BIPRU 3.2.1 R and BIPRU 3.7.2 R must be applied to arrive at the exposure value.

[Note: BCD Annex VIII Part 3 point 60]

BIPRU 5.5

Other funded credit risk mitigation

  • 01/01/2007

Deposits with third parties: Eligibility

BIPRU 5.5.1

handbook-rule

Cash on deposit with, or cash assimilated instruments held by, a third party institution in a non-custodial arrangement and pledged to a lending firm may be recognised as eligible credit protection.

[Note: BCD Annex VIII Part 1 point 23]

Deposits with third parties: Minimum requirements

BIPRU 5.5.2

handbook-rule

To be eligible for the treatment set out at BIPRU 5.5.3 R, the protection referred to in BIPRU 5.5.1 R must satisfy the following conditions:

  1. (1) the borrower's claim against the third party institution is openly pledged or assigned to the lending firm and such pledge or assignment is legally effective and enforceable in all relevant jurisdictions;
  2. (2) the third party institution is notified of the pledge or assignment;
  3. (3) as a result of the notification, the third party institution is able to make payments solely to the lending firm or to other parties with the lending firm's consent; and
  4. (4) the pledge or assignment is unconditional and irrevocable.

[Note: BCD Annex VIII Part 2 point 12]

Deposits with third parties: Calculating the effects of the credit risk mitigation

BIPRU 5.5.3

handbook-rule

Where the conditions set out in BIPRU 5.5.2 R are satisfied, credit protection falling within the terms of BIPRU 5.5.1 R may be treated as a guarantee by the third party institution.

[Note: BCD Annex VIII Part 3 point 79]

Life insurance policies: Eligibility

BIPRU 5.5.4

handbook-rule

Life insurance policies pledged to a lending firm may be recognised as eligible credit protection.

[Note: BCD Annex VIII Part 1 point 24]

Life insurance policies: Minimum requirements

BIPRU 5.5.5

handbook-rule

For life insurance policies pledged to a lending firm to be recognised the following conditions must be met:

  1. (1) the party providing the life insurance must be subject to Directive 2002/83/EC and Directive 2001/17/EC of the European Parliament and of the Council, or is subject to supervision by a competent authority of a third country which applies supervisory and regulatory arrangements at least equivalent to those applied in the Community;
  2. (2) the life insurance policy is openly pledged or assigned to the lending firm;
  3. (3) the party providing the life insurance is notified of the pledge or assignment and as a result may not pay amounts payable under the contract without the consent of the lending firm;
  4. (4) the surrender value is declared by the company providing the life insurance and is non-reducible;
  5. (4A) the surrender value must be paid in a timely manner upon request;
  6. (4B) the surrender value must not be requested without the consent of the lending firm;
  7. (5) the lending firm must have the right to cancel the policy and receive the surrender value in a timely way in the event of the default of the borrower;
  8. (6) the lending firm is informed of any non-payments under the policy by the policyholder;
  9. (7) the credit protection must be provided for the maturity of the loan. Where this is not possible because the insurance relationship ends before the loan relationship expires, the lending firm must ensure that the amount deriving from the insurance contract serves the lending firm as security until the end of the duration of the credit agreement; and
  10. (8) the pledge or assignment must be legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

[Note: BCD Annex VIII Part 2 point 13 (part)]

BIPRU 5.5.6

handbook-rule

Where it is not possible for a firm to meet the condition set out in BIPRU 5.5.5 R (7), because the insurance relationship ends before the loan relationship expires, the firm must ensure that the amount deriving from the insurance contract serves the firm as security until the end of the duration of the credit agreement.

[Note: BCD Annex VIII Part 2 point 13 (part)]

Life insurance policies: Calculating the effects of the credit risk mitigation

BIPRU 5.5.7

handbook-rule
  1. (1) Where the conditions set out in BIPRU 5.5.5 R are satisfied, the portion of the exposure collateralised by the current surrender value of credit protection falling within the terms of BIPRU 5.5.4 R must be either:
    1. (a) subject to the risk weights specified in (3) where the exposure is subject to the standardised approach to credit risk; or
    2. (b) assigned an LGD of 40% where the exposure is subject to the IRB approach but not subject to the firm's own estimates of LGD.
  2. (2) In case of a currency mismatch, the current surrender value must be reduced according to BIPRU 5.7.17 R and BIPRU 5.7.18R, the value of the credit protection being the current surrender value of the life insurance policy.
  3. (3) For the purpose of (1)(a), the following risk weights must be assigned on the basis of the risk weight assigned to a senior unsecured exposure to the company providing the life insurance:
    1. (a) a risk weight of 20%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 20%;
    2. (b) a risk weight of 35%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 50%;
    3. (c) a risk weight of 70%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 100%; and
    4. (d) a risk weight of 150%, where the senior unsecured exposure to the company providing the life insurance is assigned a risk weight of 150%.

[Note: BCD Annex VIII Part 3 point 80]

Instruments purchased on request: Eligibility

BIPRU 5.5.8

handbook-rule

Instruments issued by third party institutions which will be repurchased by that institution on request may be recognised as eligible credit protection.

[Note: BCD Annex VIII Part 1 point 25]

Instruments purchased on request: Calculating the effects of the credit risk mitigation

BIPRU 5.5.9

handbook-rule

Instruments eligible under BIPRU 5.5.8 R may be treated as a guarantee by the issuing institution.

[Note: BCD Annex VIII Part 3 point 81]

BIPRU 5.5.10

handbook-rule

For the purposes of BIPRU 5.5.9 R, the value of the credit protection recognised is the following:

  1. (1) where the instrument will be repurchased at its face value, the value of the protection is that amount; or
  2. (2) where the instrument will be repurchased at market price, the value of the protection is the value of the instrument valued in the same way as the debt securities specified in BIPRU 5.4.5 R.

[Note: BCD Annex VIII Part 3 point 82]

Credit linked notes

BIPRU 5.5.11

handbook-rule

Investments in credit linked notes issued by a lending firm may be treated as cash collateral.

[Note: BCD Annex VIII Part 3 point 3]

BIPRU 5.6

Master netting agreements

  • 01/01/2007

Eligibility

BIPRU 5.6.1

handbook-rule
  1. (1) For a firm adopting the financial collateral comprehensive method, the effects of bilateral netting contracts covering repurchase transactions, securities or commodities lending or borrowing transactions, and/or other capital market-driven transactions with a counterparty may be recognised.
  2. (2) Without prejudice to BIPRU 14 to be recognised the collateral taken and securities or commodities borrowed within such agreements must comply with the eligibility requirements for collateral set out at BIPRU 5.4.2 R to BIPRU 5.4.8 R.

[Note: BCD Annex VIII Part 1 point 5]

Minimum requirements

BIPRU 5.6.2

handbook-rule

For master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market-driven transactions to be recognised for the purposes of BIPRU 5, they must:

  1. (1) be legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or insolvency of the counterparty;
  2. (2) give the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon the event of default, including in the event of the bankruptcy or insolvency of the counterparty; and
  3. (3) provide for the netting of gains and losses on transactions closed out under a master agreement so that a single net amount is owed by one party to the other.

[Note: BCD Annex VIII Part 2 point 4]

BIPRU 5.6.3

handbook-rule

In addition the minimum requirements for the recognition of financial collateral under the financial collateral comprehensive method set out in BIPRU 5.4.9 R must be fulfilled.

[Note: BCD Annex VIII Part 2 point 5]

Calculation of the fully adjusted exposure value: the supervisory volatility adjustments approach and the own estimates of volatility adjustments approach

BIPRU 5.6.4

handbook-rule

BIPRU 5.6.5

handbook-rule

In calculating the 'fully adjusted exposure value' (E*) for the exposures subject to an eligible master netting agreement covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market-driven transactions, a firm must calculate the volatility adjustments to be applied in the manner set out in BIPRU 5.6.6 R to BIPRU 5.6.11 R either using the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R for the financial collateral comprehensive method. For the use of the own estimates of volatility adjustments approach the same conditions and requirements apply as under the financial collateral comprehensive method.

BIPRU 5.6.6

handbook-rule

A firm must calculate the net position in each type of security or commodity by subtracting from the total value of the securities or commodities of that type lent, sold or provided under the master netting agreement, the total value of securities or commodities of that type borrowed, purchased or received under the agreement.

[Note: BCD Annex VIII Part 3 point 6]

BIPRU 5.6.7

handbook-rule

For the purposes of BIPRU 5.6.6 R, type of security means securities which are issued by the same entity, have the same issue date, the same maturity and are subject to the same terms and conditions and are subject to the same liquidation periods as indicated in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 7]

BIPRU 5.6.8

handbook-rule

A firm must calculate the net position in each currency other than the settlement currency of the master netting agreement by subtracting from the total value of securities denominated in that currency lent, sold or provided under the master netting agreement added to the amount of cash in that currency lent or transferred under the agreement, the total value of securities denominated in that currency borrowed, purchased or received under the agreement added to the amount of cash in that currency borrowed or received under the agreement.

[Note: BCD Annex VIII Part 3 point 8]

BIPRU 5.6.9

handbook-rule

A firm must apply the volatility adjustment appropriate to a given type of security or cash position to the absolute value of the positive or negative net position in the securities of that type.

[Note: BCD Annex VIII Part 3 point 9]

BIPRU 5.6.10

handbook-rule

A firm must apply the foreign exchange risk (fx) volatility adjustment to the net positive or negative position in each currency other than the settlement currency of the master netting agreement.

[Note: BCD Annex VIII Part 3 point 10]

BIPRU 5.6.11

handbook-rule


E * must be calculated according to the following formula:
E * = max {0, [(Σ(E) -Σ (C)) + Σ (|net position in each security| x Hsec) + (Σ|Efx| x Hfx)]}
where:

  1. (1) (where risk weighted exposure amounts are calculated under the standardised approach) E is the exposure value for each separate exposure under the agreement that would apply in the absence of the credit protection;
  2. (2) C is the value of the securities or commodities borrowed, purchased or received or the cash borrowed or received in respect of each such exposure;
  3. (3) Σ(E) is the sum of all Es under the agreement;
  4. (4) Σ(C) is the sum of all Cs under the agreement;
  5. (5) Efx is the net position (positive or negative) in a given currency other than the settlement currency of the agreement as calculated under BIPRU 5.6.8 R;
  6. (6) Hsec is the volatility adjustment appropriate to a particular type of security;
  7. (7) Hfx is the foreign exchange volatility adjustment; and
  8. (8) E * is the fully adjusted exposure value.

[Note: BCD Annex VIII Part 3 point 11]

Calculation of the fully adjusted exposure value: the master netting agreement internal models approach

BIPRU 5.6.12

handbook-rule

BIPRU 5.6.13

handbook-guidance
A firm that wishes to use the master netting agreement internal models approach will need to apply to the FSA for a master netting agreement internal models approach permission. BIPRU 1.3 sets out the requirements and procedures relating to those applications.

BIPRU 5.6.14

handbook-guidance
A master netting agreement internal models approach permission will amend, to the extent set out in the master netting agreement internal models approach permission, BIPRU 5.6.1 R so as to provide that, with the exceptions provided in BIPRU 5.6, a firm must use the master netting agreement internal models approach for the purposes of the calculations specified in BIPRU 5.6.

BIPRU 5.6.15

handbook-guidance

A firm which has been granted a VaR model waiver will still need to make an application to the FSA for a master netting agreement internal models approach permission. However, the application should generally be straightforward as a firm which is able to satisfy the requirements for a VaR model waiver should usually also be able to satisfy the requirements for a master netting agreement internal models approach permission.

[Note: BCD Annex VIII Part 3 point 14]

BIPRU 5.6.16

handbook-rule

The master netting agreement internal models approach is an alternative to using the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach in calculating volatility adjustments for the purpose of calculating the 'fully adjusted exposure value' (E*) resulting from the application of an eligible master netting agreement covering repurchase transactions, securities or commodities lending or borrowing transactions and/or other capital market-driven transactions other than derivative transactions. The master netting agreement internal models approach takes into account correlation effects between security positions subject to a master netting agreement as well as the liquidity of the instruments concerned. The internal model used for the master netting agreement internal models approach must provide estimates of the potential change in value of the unsecured exposure amount (ΣE -ΣC).

[Note: BCD Annex VIII Part 3 point 12 (part)]

BIPRU 5.6.17

handbook-rule

A firm may also use the internal model used for the master netting agreement internal models approach for margin lending transactions if the transactions are covered under the firm's master netting agreement internal models approach permission and the transactions are covered by a bilateral master netting agreement that meets the requirements set out in BIPRU 13.7.

[Note: BCD Annex VIII Part 3 point 12 (part)]

BIPRU 5.6.18

handbook-rule

A firm may use the master netting agreement internal models approach independently of the choice it has made between the standardised approach and the IRB approach for the calculation of risk weighted exposure amounts. However, if a firm uses the master netting agreement internal models approach, it must do so for all counterparties and securities, excluding immaterial portfolios where it may use the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 13]

BIPRU 5.6.19

handbook-rule
  1. (1) A firm must be able to satisfy the FSA that the firm's risk management system for managing the risks arising on the transactions covered by the master netting agreement is conceptually sound and implemented with integrity and that, in particular, the minimum qualitative standards in (2) - (11) are met.
  2. (2) The internal risk-measurement model used for calculation of potential price volatility for the transactions is closely integrated into the daily risk-management process of the firm and serves as the basis for reporting risk exposures to senior management of the firm.
  3. (3) The firm has a risk control unit that is independent from business trading units and reports directly to senior management. The unit must be responsible for designing and implementing the firm's risk-management system. It must produce and analyse daily reports on the output of the risk-measurement model and on the appropriate measures to be taken in terms of position limits.
  4. (4) The daily reports produced by the risk-control unit are reviewed by a level of management with sufficient authority to enforce reductions of positions taken and of overall risk exposure.
  5. (5) The firm has sufficient staff skilled in the use of sophisticated models in the risk control unit.
  6. (6) The firm has established procedures for monitoring and ensuring compliance with a documented set of internal policies and controls concerning the overall operation of the risk-measurement system.
  7. (7) The firm's models have a proven track record of reasonable accuracy in measuring risks demonstrated through the back-testing of its output using at least one year of data.
  8. (8) The firm frequently conducts a rigorous programme of stress testing and the results of these tests are reviewed by senior management and reflected in the policies and limits it sets.
  9. (9) The firm must conduct, as part of its regular internal auditing process, an independent review of its risk-measurement system. This review must include both the activities of the business trading units and of the independent risk-control unit.
  10. (10) At least once a year, the firm must conduct a review of its risk management system.
  11. (11) The internal model used for the master netting agreement internal models approach must meet the requirements set out in BIPRU 13.6.65 R to BIPRU 13.6.67 R.

[Note: BCD Annex VIII Part 3 point 16]

BIPRU 5.6.19A

handbook-guidance
This paragraph provides guidance in relation to BIPRU 5.6.19R (8). In carrying out the stress testing programme, a firm should evaluate the simultaneous impact of individual stress scenarios on its counterparty exposures, its positions and the aggregate amount of margin calls that it would receive. A firm's stress scenarios should take into account the possibility that the liquidation period may be substantially longer than 5 days for repurchase transactions and securities lending or borrowing transactions, and 10 days for other types of securities financing transactions.

BIPRU 5.6.20

handbook-rule

The calculation of the potential change in value must be subject to the following minimum standards:

  1. (1) at least daily calculation of the potential change in value;
  2. (2) a 99th percentile, one-tailed confidence interval;
  3. (3) a 5-day equivalent liquidation period, except in the case of transactions other than securities repurchase transaction or securities lending or borrowing transactions where a 10-day equivalent liquidation period should be used;
  4. (4) an effective historical observation period of at least one year except where a shorter observation period is justified by a significant upsurge in price volatility; and
  5. (5) three-monthly data set updates.

[Note: BCD Annex VIII Part 3 point 17]

BIPRU 5.6.21

handbook-rule

The internal risk-measurement model must capture a sufficient number of risk factors in order to capture all material price risks.

[Note: BCD Annex VIII Part 3 point 18]

BIPRU 5.6.22

handbook-rule

A firm may use empirical correlations within risk categories and across risk categories provided that it is able to satisfy the FSA that the firm's system for measuring correlations is sound and implemented with integrity.

[Note: BCD Annex VIII Part 3 point 19]

BIPRU 5.6.23

handbook-guidance
The FSA will not grant a master netting agreement internal models approach permission if it is not satisfied that the standards in BIPRU 5.6.19 R to BIPRU 5.6.22 R are met.

BIPRU 5.6.24

handbook-rule

The fully adjusted exposure value (E*) for a firm using the master netting agreement internal models approach must be calculated according to the following formula:
E * = max {0, [(ΣE -ΣC) + (VaR output of the internal models)]}
where

  1. (1) (where risk weighted exposure amounts are calculated under the standardised approach) E is the exposure value for each separate exposure under the agreement that would apply in the absence of the credit protection;
  2. (2) C is the value of the securities borrowed, purchased or received or the cash borrowed or received in respect of each such exposure;
  3. (3) Σ (E) is the sum of all Es under the agreement; and
  4. (4) Σ (C) is the sum of all Cs under the agreement.

[Note: BCD Annex VIII Part 3 point 20]

BIPRU 5.6.25

handbook-rule

In calculating risk weighted exposure amounts using the master netting agreement internal models approach, a firm must use the previous business day's model output.

[Note: BCD Annex VIII Part 3 point 21]

BIPRU 5.6.26

handbook-guidance
No changes should be made to the internal model used for the master netting agreement internal models approach unless the change is not material. Material changes to such a model will require a variation of the master netting agreement internal models approach permission. Materiality is measured against the model as it was at the time that the master netting agreement internal models approach permission was originally granted or, any later date set out in the master netting agreement internal models approach permission for this purpose. If a firm is considering making material changes to such a model then it should notify the FSA at once.

BIPRU 5.6.27

handbook-guidance
If a firm ceases to meet the requirements of BIPRU 5 in relation to the master netting agreement internal models approach, the firm should notify the FSA at once.

BIPRU 5.6.28

handbook-guidance
The FSA is likely to revoke a master netting agreement internal models approach permission if a firm ceases to meet the requirements of BIPRU 5 in relation to the master netting agreement internal models approach.

Calculation of risk weighted exposure amounts under the standardised approach

BIPRU 5.6.29

handbook-rule
  1. (1) A firm must under the standardised approach calculate risk weighted exposure amounts for repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market-driven transactions covered by master netting agreements under this rule.
  2. (2) E * as calculated under BIPRU 5.6.5 R to BIPRU 5.6.25 R must be taken as the exposure value of the exposure to the counterparty arising from the transactions subject to the master netting agreement for the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R.

[Note: BCD Annex VIII Part 3 point 22]

BIPRU 5.7

Unfunded credit protection

  • 01/01/2007

Eligibility

BIPRU 5.7.1

handbook-rule

The following parties may be recognised as eligible providers of unfunded credit protection:

  1. (1) central governments and central banks;
  2. (2) regional governments or local authorities;
  3. (3) multilateral development banks;
  4. (4) international organisations exposures which are assigned a 0% risk weight under the standardised approach;
  5. (5) public sector entities, claims on which are treated as claims on institutions or central governments under the standardised approach;
  6. (6) institutions;
  7. (7) other corporate entities, including parent undertakings, subsidiary undertakings and affiliate corporate entities of the firm, that have a credit assessment by an eligible ECAI associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporates under the standardised approach.

[Note: BCD Annex VIII Part 1 point 26]

Types of credit derivatives

BIPRU 5.7.2

handbook-rule

The following types of credit derivatives, and instruments that may be composed of such credit derivatives or that are economically effectively similar, may be recognised as eligible;

  1. (1) credit default swaps;
  2. (2) total return swaps; and
  3. (3) credit linked notes to the extent of their cash funding.

[Note: BCD Annex VIII Part 1 point 30]

BIPRU 5.7.3

handbook-rule

Where a firm buys credit protection through a total return swap and records the net payments received on the swap as net income, but does not record offsetting deterioration in the value of the asset that is protected (either through reductions in fair value or by an addition to reserves), the credit protection must not be recognised as eligible.

[Note: BCD Annex VIII Part 1 point 31]

Internal hedges

BIPRU 5.7.4

handbook-rule

When a firm conducts an internal hedge using a credit derivative - i.e. hedges the credit risk of an exposure in the non-trading book with a credit derivative booked in the trading book - in order for the protection to be recognised as eligible for the purposes of BIPRU 4.10 or BIPRU 5 the credit risk transferred to the trading book must be transferred out to a third party or parties. In such circumstances, subject to the compliance of such transfer with the requirements for the recognition of credit risk mitigation set out in BIPRU 4.10 or BIPRU 5, the rules for the calculation of risk weighted exposure amounts and expected loss amounts where unfunded credit protection is acquired set out in BIPRU 4.10 or BIPRU 5 must be applied.

[Note: BCD Annex VIII Part 1 point 32]

Minimum requirements: General

BIPRU 5.7.5

handbook-rule
BIPRU 5.7.6 R to BIPRU 5.7.10 R deal with requirements common to guarantees and credit derivatives.

BIPRU 5.7.6

handbook-rule

Subject to BIPRU 5.7.9 R, for the credit protection deriving from a guarantee or credit derivative to be recognised the following conditions must be met:

  1. (1) the credit protection must be direct;
  2. (2) the extent of the credit protection must be clearly defined and incontrovertible;
  3. (3) the credit protection contract must not contain any clause, the fulfilment of which is outside the direct control of the lender, that:
    1. (a) would allow the protection provider unilaterally to cancel the protection;
    2. (b) would increase the effective cost of protection as a result of deteriorating credit quality of the protected exposure;
    3. (c) could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original obligor fails to make any payments due; or
    4. (d) could allow the maturity of the credit protection to be reduced by the protection provider; and
  4. (4) it must be legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

[Note: BCD Annex VIII Part 2 point 14]

BIPRU 5.7.7

handbook-guidance
For the purposes of BIPRU 5.7.6 R (3)(a), payment of premiums and other monies due under the contract is within the control of the lending firm. So a clause that allows the protection provider unilaterally to cancel the contract after a reasonable period due to non payment of such monies will not mean that the condition in that rule is not met.

Minimum requirements: Operational requirements

BIPRU 5.7.8

handbook-rule

A firm must be able to satisfy the FSA that it has systems in place to manage potential concentration of risk arising from the firm's use of guarantees and credit derivatives. The firm must be able to demonstrate how its strategy in respect of its use of credit derivatives and guarantees interacts with its management of its overall risk profile.

[Note: BCD Annex VIII Part 2 point 15]

Minimum requirements: Sovereign and other public sector counter-guarantees

BIPRU 5.7.9

handbook-rule

Where an exposure is protected by a guarantee which is counter-guaranteed by a central government or central bank, a regional government or local authority or a public sector entity claims on which are treated as claims on the central government in whose jurisdiction they are established under the standardised approach, a multilateral development bank or an international organisation, to which a 0% risk weight is assigned under or by virtue of the standardised approach, or a public sector entity, claims on which are treated as claims on credit institutions under the standardised approach, the exposure may be treated as protected by a guarantee provided by the entity in question provided the following conditions are satisfied:

  1. (1) the counter-guarantee covers all credit risk elements of the claim;
  2. (2) both the original guarantee and the counter-guarantee meet the requirements for guarantees set out in BIPRU 5.7.6 R, BIPRU 5.7.8 R and BIPRU 5.7.11 R, except that the counter-guarantee need not be direct; and
  3. (3) the firm is able to satisfy the FSA that the cover is robust and that nothing in the historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct guarantee by the entity in question.

[Note: BCD Annex VIII Part 2 point 16]

BIPRU 5.7.10

handbook-rule

The treatment of BIPRU 5.7.9 R applies, also, to an exposure which is not counter-guaranteed by an entity listed in that rule if the exposure's counter-guarantee is in its turn directly guaranteed by one of the listed entities and the conditions listed in BIPRU 5.7.9 R are satisfied.

[Note: BCD Annex VIII Part 2 point 17]

Additional requirements for guarantees

BIPRU 5.7.11

handbook-rule

For a guarantee to be recognised the following conditions must also be met:

  1. (1) on the qualifying default of and/or non-payment by the counterparty, the lending firm must have the right to pursue, in a timely manner, the guarantor for any monies due under the claim in respect of which the protection is provided;
  2. (2) payment by the guarantor must not be subject to the lending firm first having to pursue the obligor;
  3. (3) in the case of unfunded credit protection covering residential mortgage loans, the requirements in BIPRU 5.7.6 R (3)(c) and in this rule have only to be satisfied within 24 months;
  4. (4) the guarantee must be an explicitly documented obligation assumed by the guarantor;
  5. (5) subject to (6), the guarantee must cover all types of payments the obligor is expected to make in respect of the claim; and
  6. (6) where certain types of payment are excluded from the guarantee, the recognised value of the guarantee must be adjusted to reflect the limited coverage.

[Note: BCD Annex VIII Part 2 point 18]

BIPRU 5.7.12

handbook-rule

In the case of guarantees provided in the context of mutual guarantee schemes recognised for these purposes by another EEA competent authority under a CRD implementation measure with respect to point 19 of Part 2 of Annex VIII of the Banking Consolidation Directive or provided by or counter-guaranteed by entities referred to in BIPRU 5.7.9 R, the requirements in BIPRU 5.7.11 R (1) - (3) will be satisfied where either of the following conditions are met:

  1. (1) the lending firm has the right to obtain in a timely manner a provisional payment by the guarantor calculated to represent a robust estimate of the amount of the economic loss, including losses resulting from the non-payment of interest and other types of payment which the borrower is obliged to make, likely to be incurred by the lending firm proportional to the coverage of the guarantee; or
  2. (2) the lending firm is able to demonstrate to the FSA that the loss-protecting effects of the guarantee, including losses resulting from the non-payment of interest and other types of payments which the borrower is obliged to make, justify such treatment.

[Note: BCD Annex VIII Part 2 point 19]

Additional requirements for credit derivatives

BIPRU 5.7.13

handbook-rule

For a credit derivative to be met the following conditions must also be met.

  1. (1) Subject to (2), the credit events specified under the credit derivative must at a minimum include:
    1. (a) the failure to pay the amounts due under the terms of the underlying obligation that are in effect at the time of such failure (with a grace period that is closely in line with or shorter than the grace period in the underlying obligation);
    2. (b) the bankruptcy, insolvency or inability of the obligor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; and
    3. (c) the restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that results in a credit loss event (i.e. value adjustment or other similar debit to the profit and loss account).
  2. (2) Where the credit events specified under the credit derivative do not include restructuring of the underlying obligation as described in (1)(c), the credit protection may nonetheless be recognised subject to a reduction in the recognised value as specified in BIPRU 5.7.16 R.
  3. (3) In the case of credit derivatives allowing for cash settlement a robust valuation process must be in place in order to estimate loss reliably. There must be a clearly specified period for obtaining post-credit-event valuations of the underlying obligation.
  4. (4) If the protection purchaser's right and ability to transfer the underlying obligation to the protection provider is required for settlement, the terms of the underlying obligation must provide that any required consent to such transfer may not be unreasonably withheld.
  5. (5) The identity of the parties responsible for determining whether a credit event has occurred must be clearly defined. This determination must not be the sole responsibility of the protection provider. The protection buyer must have the right/ability to inform the protection provider of the occurrence of a credit event.

[Note: BCD Annex VIII Part 2 point 20]

BIPRU 5.7.14

handbook-rule

A mismatch between the underlying obligation and the reference obligation under the credit derivative (i.e. the obligation used for the purposes of determining cash settlement value or the deliverable obligation) or between the underlying obligation and the obligation used for purposes of determining whether a credit event has occurred is permissible only if the following conditions are met:

  1. (1) the reference obligation or the obligation used for purposes of determining whether a credit event has occurred, as the case may be, ranks pari passu with or is junior to the underlying obligation; and
  2. (2) the underlying obligation and the reference obligation or the obligation used for purposes of determining whether a credit event has occurred, as the case may be, share the same obligor (i.e., the same legal entity) and there are in place legally enforceable cross-default or cross-acceleration clauses.

[Note: BCD Annex VIII Part 2 point 21]

Unfunded credit protection: Valuation

BIPRU 5.7.15

handbook-rule
BIPRU 5.7.16 R to BIPRU 5.7.19 R set out the provisions applying to the valuation of unfunded credit protection.

BIPRU 5.7.16

handbook-rule
  1. (1) The value of unfunded credit protection (G) is the amount that the protection provider has undertaken to pay in the event of the default or non-payment of the borrower or on the occurrence of other specified credit events.
  2. (2) In the case of credit derivatives which do not include as a credit event restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that result in a credit loss event (e.g. value adjustment, the making of a value adjustment or other similar debit to the profit and loss account):
    1. (a) where the amount that the protection provider has undertaken to pay is not higher than the exposure value, the value of the credit protection calculated under (1) must be reduced by 40%; or
    2. (b) where the amount that the protection provider has undertaken to pay is higher than the exposure value, the value of the credit protection must be no higher than 60% of the exposure value.

[Note: BCD Annex VIII Part 3 point 83]

BIPRU 5.7.17

handbook-rule

Where unfunded credit protection is denominated in a currency different from that in which the exposure is denominated (a currency mismatch) the value of the credit protection must be reduced by the application of a volatility adjustment HFX as follows:
G* = G x (1-HFX)
where:

  1. (1) G is the nominal amount of the credit protection;
  2. (2) G* is G adjusted for any foreign currency risk; and
  3. (3) Hfx is the volatility adjustment for any currency mismatch between the credit protection and the underlying obligation.

[Note: BCD Annex VIII Part 3 point 84 (part)]

BIPRU 5.7.18

handbook-rule

Where there is no currency mismatch:
G* = G

[Note: BCD Annex VIII Part 3 point 84 (part)]

BIPRU 5.7.19

handbook-rule

The volatility adjustments to be applied for any currency mismatch may be calculated based on the supervisory volatility adjustments approach or the own estimates of volatility adjustments approach as set out in BIPRU 5.4.30 R to BIPRU 5.4.65 R.

[Note: BCD Annex VIII Part 3 point 85]

Calculating risk weighted exposure amounts and expected loss amounts

BIPRU 5.7.20

handbook-rule
BIPRU 5.7.21 R to BIPRU 5.7.28 R set out the provisions applying to the calculation of risk weighted exposure amounts.

Calculating risk weighted exposure amounts: Partial protection - tranching

BIPRU 5.7.21

handbook-rule

Where a firm transfers a part of the risk of a loan in one or more tranches, BIPRU 9 applies. Materiality thresholds on payments below which no payment shall be made in the event of loss are considered to be equivalent to retained first loss positions and to give rise to a tranched transfer of risk.

[Note: BCD Annex VIII Part 3 point 86]

Calculating risk-weighted exposure amounts : The standardised approach

BIPRU 5.7.22

handbook-rule
BIPRU 5.7.23 R to BIPRU 5.7.25 R set out the provisions applying to the calculation of risk weighted exposure amounts under the standardised approach in the case of unfunded credit protection.

Calculating risk weighted exposure amounts: standardised approach: Full protection

BIPRU 5.7.23

handbook-rule

For the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R, g shall be the risk weight to be assigned to an exposure, the exposure value (E) of which is fully protected by unfunded credit protection (GA), where:

  1. (1) g is the risk weight of exposures to the protection provider as specified under the standardised approach;
  2. (2) GA is the value of G* as calculated under BIPRU 5.7.17 R further adjusted for any maturity mismatch as laid down in BIPRU 5.8; and
  3. (3) E is the exposure value according to BIPRU 3.2.1 R to BIPRU 3.2.3 R and BIPRU 13; for this purpose the exposure value of an off-balance sheet item listed in BIPRU 3.7.2 R shall be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R.

[Note: BCD Annex VIII Part 3 point 87]

Calculating risk weighted exposure amounts: Standardised approach: Partial protection - equal seniority

BIPRU 5.7.24

handbook-rule

Where the protected amount is less than the exposure value and the protected and unprotected portions are of equal seniority - i.e. the firm and the protection provider share losses on a pro-rata basis, proportional regulatory capital relief is afforded. For the purposes of BIPRU 3.2.20 R to BIPRU 3.2.26 R risk weighted exposure amounts must be calculated in accordance with the following formula:
(E-GA) x r + GA x g
where:

  1. (1) E is the exposure value; according to BIPRU 3.2.1 R to BIPRU 3.2.3 R and BIPRU 13; for this purpose, the exposure value of an off-balance sheet item listed in BIPRU 3.7.2 R shall be 100% of its value rather than the exposure value indicated in BIPRU 3.2.1 R;
  2. (2) GA is the value of G* as calculated under BIPRU 5.7.17 R further adjusted for any maturity mismatch as laid down in BIPRU 5.8;
  3. (3) r is the risk weight of exposures to the obligor as specified under the standardised approach; and
  4. (4) g is the risk weight of exposures to the protection provider as specified under the standardised approach.

[Note: BCD Annex VIII Part 3 point 88]

Calculating risk weighted exposure amounts: standardised approach: Sovereign guarantees

BIPRU 5.7.25

handbook-rule

A firm may apply the treatment provided for in BIPRU 3.4.5 R to BIPRU 3.4.7 R to exposures or parts of exposures guaranteed by the central government or central bank, where the guarantee is denominated in the domestic currency of the borrower and the exposure is funded in that currency.

[Note: BCD Annex VIII Part 3 point 89]

Calculating risk-weighted exposure amounts and expected loss amounts: Basket CRM techniques

BIPRU 5.7.26

handbook-rule
BIPRU 5.7.27 R to BIPRU 5.7.28 R set out the provisions applying to the calculation of risk weighted exposure amount and expected loss amounts where basket credit risk mitigation techniques are used.

First-to-default credit derivatives

BIPRU 5.7.27

handbook-rule

Where a firm obtains credit protection for a number of exposures under terms that the first default among the exposures will trigger payment and that this credit event will terminate the contract, the firm may modify the calculation of the risk weighted exposure amount and, as relevant, the expected loss amount of the exposure which would in the absence of the credit protection produce the lowest risk weighted exposure amount under the standardised approach or the IRB approach as appropriate in accordance with BIPRU 4.10 or BIPRU 5, but only if the exposure value is less than or equal to the value of the credit protection.

[Note: BCD Annex VIII Part 6 point 1]

Nth-to-default credit derivatives

BIPRU 5.7.28

handbook-rule

Where the nth default among the exposures triggers payment under the credit protection provided by a credit derivative, a firm purchasing the protection may only recognise the protection for the calculation of risk weighted exposure amounts and, as relevant, expected loss amounts if protection has also been obtained for defaults 1 to n-1 or when n-1 defaults have already occurred. In such cases the methodology must follow that set out in BIPRU 5.7.27 R for first-to-default derivatives appropriately modified for nth-to-default products.

[Note: BCD Annex VIII Part 6 point 2]

BIPRU 5.8

Maturity mismatches

  • 01/01/2007

BIPRU 5.8.1

handbook-rule

For the purposes of calculating risk weighted exposure amounts, a maturity mismatch occurs when the residual maturity of the credit protection is less than that of the protected exposure. Protection of less than three months residual maturity, the maturity of which is less than the maturity of the underlying exposure, must not be recognised.

[Note: BCD Annex VIII Part 4 point 1]

BIPRU 5.8.2

handbook-rule

Where there is a maturity mismatch the credit protection must not be recognised where the original maturity of the protection is less than 1 year.

[Note: BCD Annex VIII Part 4 point 2 (part)]

Definition of maturity

BIPRU 5.8.3

handbook-rule

Subject to a maximum of 5 years, the effective maturity of the underlying is the longest possible remaining time before the obligor is scheduled to fulfil its obligations. Subject to BIPRU 5.8.4 R, the maturity of the credit protection is the time to the earliest date at which the protection may terminate or be terminated.

[Note: BCD Annex VIII Part 4 point 3]

BIPRU 5.8.4

handbook-rule

Where there is an option to terminate the protection which is at the discretion of the protection seller, the maturity of the protection must be taken to be the time to the earliest date at which that option may be exercised. Where there is an option to terminate the protection which is at the discretion of the protection buyer and the terms of the arrangement at origination of the protection contain a positive incentive for the firm to call the transaction before contractual maturity, the maturity of the protection must be taken to be the time to the earliest date at which that option may be exercised; otherwise such an option may be considered not to affect the maturity of the protection.

[Note: BCD Annex VIII Part 4 point 4]

BIPRU 5.8.5

handbook-rule

Where a credit derivative is not prevented from terminating prior to expiration of any grace period required for a default on the underlying obligation to occur as a result of a failure to pay the maturity of the protection must be reduced by the amount of the grace period.

[Note: BCD Annex VIII Part 4 point 5]

Valuation of protection: Transactions subject to funded credit protection - financial collateral simple method

BIPRU 5.8.6

handbook-rule
BIPRU 5.8.7 R sets out the calculation for the valuation of transactions subject to funded credit protection under the financial collateral simple method.

BIPRU 5.8.7

handbook-rule

Where there is a mismatch between the maturity of the exposure and the maturity of the protection, the collateral must not be recognised.

[Note: BCD Annex VIII Part 4 point 6]

Valuation of protection: Transactions subject to funded credit protection - financial collateral comprehensive method

BIPRU 5.8.8

handbook-rule
BIPRU 5.8.9 R sets out the calculation for the valuation of transactions subject to funded credit protection under the financial collateral comprehensive method.

BIPRU 5.8.9

handbook-rule
  1. (1) The maturity of the credit protection and that of the exposure must be reflected in the adjusted value of the collateral according to the following formula:
  2. CVAM = CVA x (t-t*)/(T-t*)
  3. where:
    1. (a) CVA is the volatility adjusted value of the collateral as specified in BIPRU 5.4.28 R or the amount of the exposure, whichever is the lowest;
    2. (b) t is the number of years remaining to the maturity date of the credit protection calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or the value of T, whichever is the lower;
    3. (c) T is the number of years remaining to the maturity date of the exposure calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or 5 years, whichever is the lower; and
    4. (d) t* is 0.25.
  4. (2) CVAM must be taken as CVA further adjusted for maturity mismatch to be included in the formula for the calculation of the fully adjusted value of the exposure (E*) set out at BIPRU 5.4.28 R.

[Note: BCD Annex VIII Part 4 point 7]

Valuation of protection: Transactions subject to unfunded credit protection

BIPRU 5.8.10

handbook-rule
BIPRU 5.8.11 R sets out the calculation for the valuation of transactions subject to unfunded credit protection.

BIPRU 5.8.11

handbook-rule
  1. (1) The maturity of the credit protection and that of the exposure must be reflected in the adjusted value of the credit protection according to the following formula:
  2. GA = G* x (t-t*)/(T-t*)
  3. where:
    1. (a) G* is the amount of the protection adjusted for any currency mismatch;
    2. (b) GA is G* adjusted for any maturity mismatch;
    3. (c) t is the number of years remaining to the maturity date of the credit protection calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or the value of T, whichever is the lower;
    4. (d) T is the number of years remaining to the maturity date of the exposure calculated in accordance with BIPRU 5.8.3 R to BIPRU 5.8.5 R, or 5 years, whichever is the lower; and
    5. (e) t* is 0.25.
  4. (2) GA is then taken as the value of the protection for the purposes of BIPRU 5.7.16 R to BIPRU 5.7.25 R.

[Note: BCD Annex VIII Part 4 point 8]

BIPRU 5.9

Combinations of credit risk mitigation in the standardised approach

  • 01/01/2007

BIPRU 5.9.1

handbook-rule

In the case where a firm calculating risk weighted exposure amounts under the standardised approach has more than one form of credit risk mitigation covering a single exposure (e.g. a firm has both collateral and a guarantee partially covering an exposure), the firm must subdivide the exposure into parts covered by each type of credit risk mitigation tool (e.g. a part covered by collateral and a portion covered by guarantee) and the risk weighted exposure amount for each portion must be calculated separately in accordance with the provisions of the standardised approach and BIPRU 5.

[Note: BCD Annex VIII Part 5 point 1]

BIPRU 5.9.2

handbook-rule

When credit protection provided by a single protection provider has differing maturities, a similar approach to that described in BIPRU 5.9.1 R must be applied.

[Note: BCD Annex VIII Part 5 point 2]

Export chapter as

BIPRU 6

Operational risk

BIPRU 6.1

Operational risk: Application and purpose

  • 01/01/2007

Application

BIPRU 6.1.1

handbook-rule

BIPRU 6 applies to a BIPRU firm except for:

  1. (1) a BIPRU limited licence firm; and
  2. (2) a BIPRU limited activity firm.

BIPRU 6.1.2

handbook-guidance
A BIPRU limited licence firm or BIPRU limited activity firm that wishes to calculate an operational risk capital requirement in accordance with this chapter for the purposes of its capital resources requirement should apply for a waiver to modify GENPRU 1.1 or seek a variation to its permission so that it is treated as a full scope BIPRU investment firm.

Purpose

BIPRU 6.1.3

handbook-guidance

The purpose of BIPRU 6 is:

  1. (1) to detail the requirement to hold capital to cover operational risk losses and have appropriate systems and controls in place to manage operational risk; and
  2. (2) to explain how to calculate the operational risk capital requirement, or ORCR.

BIPRU 6.1.4

handbook-guidance

BIPRU 6 implements:

  1. (1) Articles 102 to 104;
  2. (2) Article 105, in part; and
  3. (3) Annex X;

of the Banking Consolidation Directive.

BIPRU 6.2

Operational risk: Methodologies and systems

  • 01/01/2007

The definition of ORCR

BIPRU 6.2.1

handbook-rule

The operational risk capital requirement (ORCR) for a firm is an amount calculated in accordance with:

  1. (1) the basic indicator approach (see BIPRU 6.3); or
  2. (2) the standardised approach (see BIPRU 6.4).

[Note: BCD Article 102(1)]

BIPRU 6.2.2

handbook-guidance
The simplest method of calculating the ORCR is the basic indicator approach and a firm should use this approach if it does not, or is not permitted to, use another approach.

BIPRU 6.2.3

handbook-guidance
A firm does not need a waiver to use the standardised approach. However there are eligibility conditions that a firm should satisfy if it is to use this approach. If it does not satisfy them, it should not use this approach.

BIPRU 6.2.4

handbook-guidance

A firm may apply to the FSA for a waiver from BIPRU 6.2.1 R in order to use its own advanced measurement approach for the calculation of its ORCR (see BIPRU 6.5). If the waiver is granted, the ORCR will be an amount determined in accordance with such waiver.

[Note: BCD Article 105(1)]

Restrictions on changing the approach used for calculating ORCR

BIPRU 6.2.5

handbook-rule

A firm that calculates its ORCR using the standardised approach must not change to calculating its ORCR using the basic indicator approach.

[Note: BCD Article 102(2) (part)]

BIPRU 6.2.6

handbook-guidance

A firm may apply to the FSA for a waiver from BIPRU 6.2.5 R where it can demonstrate good cause for changing to the basic indicator approach.

[Note: BCD Article 102(2) (part)]

BIPRU 6.2.7

handbook-rule

A firm that calculates its ORCR using an advanced measurement approach must not change to calculating its ORCR using the standardised approach or the basic indicator approach.

[Note: BCD Article 102(3) (part)]

BIPRU 6.2.8

handbook-guidance

A firm may apply to the FSA for a waiver from BIPRU 6.2.7 R where it can demonstrate good cause for changing to the standardised approach or the basic indicator approach as the case may be.

[Note: BCD Article 102(3) (part)]

Combination of different methodologies

BIPRU 6.2.9

handbook-rule

Without prejudice to any other conditions that may be imposed by a firm's AMA permission, where a firm's AMA permission allows it to use an advanced measurement approach in combination with either the basic indicator approach or the standardised approach, the firm must comply with the following conditions:

  1. (1) all operational risks of the firm are captured;
  2. (2) the firm must be able to satisfy the FSA with respect to the methodology used to cover different activities, geographical locations or other relevant divisions determined on an internal basis; and
  3. (3) BIPRU 6.4.1 R and BIPRU 6.5.6 R must be complied with for the part of activities covered by the standardised approach and advanced measurement approaches respectively.

[Note: BCD Article 102(4) and Annex X, Part 4 point 1]

BIPRU 6.2.10

handbook-guidance

Where a firm's AMA permission allows it to use an advanced measurement approach in combination with either the basic indicator approach or the standardised approach, the FSA may impose additional conditions on a case by case basis as follows:

  1. (1) on the date of implementation of an advanced measurement approach, a significant part of the firm's operational risks are captured by the advanced measurement approach; and
  2. (2) the firm is obliged to roll out the advanced measurement approach to a material part of its operations within a time schedule set out in its AMA permission.

[Note: BCD Annex X, Part 4 point 2]

BIPRU 6.2.11

handbook-rule

A firm applying for an AMA permission to use a combination of different approaches must be able to show that:

  1. (1) at the date of implementation of the advanced measurement approach, approximately 50% (or more) of the firm's operational risk is captured under the AMA; and
  2. (2) the firm has committed to roll out the advanced measurement approach for around 85% (or more) of its operational risk, subject to the remaining percentage not being concentrated in a single operation, within a timescale set out in the AMA permission.

BIPRU 6.2.12

handbook-rule

For the determination of its ORCR, a firm must not use any of the following combinations of methodologies:

  1. (1) the basic indicator approach with the standardised approach;
  2. (2) the basic indicator approach with the alternative standardised approach; or
  3. (3) the standardised approach with the alternative standardised approach for the same business line.

BIPRU 6.2.13

handbook-guidance

A firm may apply to the FSA for a waiver from BIPRU 6.2.12 R (1) and BIPRU 6.2.12 R (2) in exceptional circumstances, such as the recent acquisition of new business, which require a transition period for the roll out of the standardised approach (or the alternative standardised approach). In this event, a firm will need to make a commitment to roll out the standardised approach (or the alternative standardised approach) within a time schedule agreed with the FSA.

[Note: BCD Annex X, Part 4 points 3 and 4]

BIPRU 6.3

Operational risk: Basic indicator approach

  • 01/01/2007

ORCR

BIPRU 6.3.1

handbook-rule

The ORCR under the basic indicator approach is equal to 15% of the relevant indicator defined in this section.

[Note: BCD Article 103 and Annex X, Part 1 point 1]

Relevant indicator: General

BIPRU 6.3.2

handbook-rule
  1. (1) The relevant indicator is the three-year average of the sum of:
    1. (a) a firm's net interest income; and
    2. (b) a firm's net non-interest income.
  2. (2) The three-year average must be calculated on the basis of the last three yearly observations at the end of the financial year. When audited figures are not available, business estimates may be used.
  3. (3) If for any given observation, the sum of a firm's net interest income and net non-interest income is negative or equal to zero, this figure must be excluded from both the numerator and denominator when calculating the three year average. The relevant indicator must be calculated as the sum of the positive figures divided by the number of positive figures.

[Note: BCD Annex X, Part 1 points 2 to 4]

Relevant indicator: An example calculation

BIPRU 6.3.3

handbook-guidance

If a firm has:

  1. (1) two positive yearly relevant indicators of £20 each; and
  2. (2) the final yearly observation shows a negative figure of £5; then

the relevant indicator is calculated as £20, being £40 (sum of positive figures) divided by 2 (number of positive figures).

Relevant indicator: Insufficient income data

BIPRU 6.3.4

handbook-guidance
A firm that does not have sufficient income data to meet the three-year requirement (e.g. a start-up) may use its forecasted gross income projections for all or part of the three year time period when calculating its relevant indicator.

Relevant indicator: Application of accounting categories

BIPRU 6.3.5

handbook-rule
  1. (1) This rule applies to a firm that is subject to the Bank Accounts Directive.
  2. (2) Based on accounting categories for the profit and loss account of credit institutions under Article 27 of the Bank Accounts Directive, the relevant indicator in BIPRU 6.3.2 R must be expressed as the sum of the elements listed in the table in BIPRU 6.3.6 R.
  3. (3) Each element in the table in BIPRU 6.3.6 R must be included in the sum with its positive or negative sign.

[Note: BCD Annex X, Part 1 point 5]

BIPRU 6.3.6

handbook-rule
Table: Relevant indicators This table belongs to BIPRU 6.3.5 R

BIPRU 6.3.7

handbook-guidance
Income from a participation held in an undertaking by the firm or a subsidiary undertaking of the firm should not be included in the relevant indicator calculations, to ensure that intra-group dividends and other intra-group income flows are not double counted.

BIPRU 6.3.8

handbook-guidance
Income received under an operating lease should be included as gross income less depreciation, not as gross rental income.

BIPRU 6.3.9

handbook-guidance
  1. (1) If a firm considers that, due to exceptional circumstances, using a three year average to calculate the relevant indicator would lead to a major overestimation of its ORCR, the firm may apply for a waiver from BIPRU 6.3.2 R.
  2. (2) Exceptional circumstances might include stopping or selling a major business line.

Qualifications

BIPRU 6.3.10

handbook-rule
  1. (1) The relevant indicator for the basic indicator approach must be calculated before the deduction of any provisions and operating expenses.
  2. (2) Operating expenses must include fees paid for outsourcing services rendered by third parties which are not a parent undertaking or subsidiary undertaking of the firm or a subsidiary undertaking of a parent undertaking which is also the parent undertaking of the firm. Expenditure on the outsourcing of services rendered by third parties may reduce the relevant indicator if the expenditure is incurred by an undertaking subject to supervision under, or equivalent to, the Banking Consolidation Directive.

[Note: BCD Annex X, Part 1 point 7]

BIPRU 6.3.11

handbook-guidance
The definition of 'outsourcing' for the purposes of BIPRU 6.3.10 R (2) is set out in detail in a Joint Forum paper of the Basel Committee on Banking Supervision entitled "Outsourcing in Financial Services" dated February 2005 and can be summarised as meaning a firm's use of a third party to perform activities on a continuing basis that would normally be undertaken by the firm, now or in the future and can be the initial transfer of an activity (or part of that activity) from the firm to a third party or a further transfer of an activity (or part thereof) from one third party service provider to another.

BIPRU 6.3.12

handbook-rule

The following elements must not be used in the calculation of the relevant indicator:

  1. (1) realised profits/losses from the sale of non-trading book items;
  2. (2) income from extraordinary or irregular items; and
  3. (3) income derived from insurance.

[Note: BCD Annex X, Part 1 point 8 (part)]

BIPRU 6.3.13

handbook-rule

When revaluation of trading items is part of the profit and loss statement, revaluation may be included in the calculation of the relevant indicator.

[Note: BCD Annex X, Part 1 point 8 (part)]

BIPRU 6.3.14

handbook-rule

When Article 36(2) of the Bank Accounts Directive is applied, revaluation booked in the profit and loss account must be included in the calculation of the relevant indicator.

[Note: BCD Annex X, Part 1 point 8 (part)]

BIPRU 6.3.15

handbook-rule

When a firm is subject to an accounting framework different from the one established by the Bank Accounts Directive, it must calculate the relevant income indicator on the basis of internal data that best reflect the definition in this section.

[Note: BCD Annex X, Part 1 points 6 and 9]

General risk management standards

BIPRU 6.3.16

handbook-guidance
  1. (1) In common with all BIPRU firms, a firm calculating its ORCR using the basic indicator approach is required to meet the general risk management standards set out in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R.
  2. (2) In meeting those general risk management standards, a firm that undertakes market-related activities should be able to demonstrate to the FSA that it has considered the Committee of European Banking Supervisors' Guidelines on the management of operational risk in market-related activities, published in October 2010. These can be found at http://www.eba.europa.eu/documents/Publications/Standards---Guidelines/2010/Management-of-op-risk/CEBS-2010-216-(Guidelines-on-the-management-of-op-.aspx

BIPRU 6.4

Operational risk: Standardised approach

  • 01/01/2007

Eligibility

BIPRU 6.4.1

handbook-rule
  1. (1) To be eligible for the standardised approach, a firm must meet the qualifying criteria set out in this rule, in addition to the general risk management standards set out in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R .
  2. (2) A firm must have a well-documented assessment and management system for operational risk with clear responsibilities for the system assigned within the firm. The system must identify the firm's exposures to operational risk and track relevant operational risk data, including material loss data.
  3. (3) A firm's operational risk assessment and management system must be subject to regular independent review.
  4. (4) A firm's operational risk assessment system must be closely integrated into the firm's risk management processes. Its output must be an integral part of the process of monitoring and controlling the firm's operational risk profile.
  5. (5) A firm must implement a system of management reporting that provides operational risk reports to relevant functions within the firm. A firm must have procedures in place for taking appropriate action in response to the information contained in such reports.

[Note: BCD Article 104(6) and Annex X, Part 2 point 12 (part)]

BIPRU 6.4.1A

handbook-guidance
In meeting the general risk management standards referred to in BIPRU 6.4.1 R (1), a firm that undertakes market-related activities should be able to demonstrate to the FSA that it has considered the Committee of European Banking Supervisors' Guidelines on the management of operational risk in market-related activities, published in October 2010. These can be found at http://www.eba.europa.eu/documents/Publications/Standards---Guidelines/2010/Management-of-op-risk/CEBS-2010-216-(Guidelines-on-the-management-of-op-.aspx

BIPRU 6.4.2

handbook-rule

A firm must comply with the criteria in BIPRU 6.4.1 R having regard to the size and scale of its activities and to the principle of proportionality.

[Note: BCD Annex X, Part 2 point 12 (part)]

Business lines

BIPRU 6.4.3

handbook-rule

Under the standardised approach, a firm must divide its activities into a number of business lines as set out in this section.

[Note: BCD Article 104(1)]

BIPRU 6.4.4

handbook-guidance
The list of activities in BIPRU 6.4.15 R is not a complete definition of the activities within a business line and it may be possible for an activity to be allocated to a business line other than the one to which it is attributed in BIPRU 6.4.15 R.

BIPRU 6.4.5

handbook-rule

For each business line, a firm must calculate a capital requirement for operational risk as a certain percentage of a relevant indicator, in accordance with the rules in this section.

[Note: BCD Article 104(2)]

ORCR calculated using the standardised approach

BIPRU 6.4.6

handbook-rule

The ORCR under the standardised approach is calculated as the three-year average of the yearly summations of the capital requirements across the business lines referred to in BIPRU 6.4.15 R.

[Note: BCD Annex X, Part 2 point 1 (part)]

BIPRU 6.4.7

handbook-rule

In any given year, negative capital requirements (resulting from negative gross income) in any business line may offset positive capital requirements in other business lines without limit. However, where the aggregate of the capital requirements across all business lines within a given year is negative, the input to the numerator for that year must be zero.

[Note: BCD Annex X, Part 2 point 1 (part)]

BIPRU 6.4.8

handbook-guidance
  1. (1) If a firm considers that, due to exceptional circumstances, using a three year average to calculate the relevant indicator would lead to a major overestimation of its ORCR, the firm may apply for a waiver from BIPRU 6.4.5 R.
  2. (2) Exceptional circumstances might include stopping or selling a major business line.

Relevant indicator

BIPRU 6.4.9

handbook-rule

The three year average in BIPRU 6.4.6 R must be calculated on the basis of the last three twelve monthly observations at the end of the financial year. When audited figures are not available, business estimates may be used.

[Note: BCD Annex X, Part 2 point 2]

Principles for business line mapping

BIPRU 6.4.10

handbook-rule

A firm must develop and document specific policies and criteria for mapping the relevant indicator for current business lines and activities into the framework for the standardised approach. The criteria must be reviewed and adjusted for new or changing business activities and risks as appropriate.

[Note: BCD Annex X, Part 2 point 4 (part)]

BIPRU 6.4.11

handbook-rule
  1. (1) The principles for business line mapping that a firm must meet are set out in this rule.
  2. (2) All activities must be mapped into the business lines in a mutually exclusive and jointly exhaustive manner.
  3. (3) Any activity which cannot be readily mapped into the business line framework, but which represents an ancillary function to an activity included in the framework, must be allocated to the business line it supports. If more than one business line is supported through the ancillary activity, an objective mapping criterion must be used (e.g., proportional allocation of the indicators).
  4. (4) If an activity cannot be mapped into a particular business line then the business line yielding the highest charge for the firm must be used. The same business line equally applies to any associated ancillary activity.
  5. (5) A firm may use internal pricing methods to allocate the relevant indicator between business lines.
  6. (6) The mapping of activities into business lines for operational risk capital purposes must be consistent with the definitions of business lines used by the firm for credit and market risks.
  7. (7) Senior management must be responsible for the mapping policy.
  8. (8) The mapping process to business lines must be subject to independent review.

[Note: BCD Annex X, Part 2 point 4 (part)]

BIPRU 6.4.12

handbook-guidance

A firm that is mapping activities to a business line should take into account:

  1. (1) the activities listed in respect of each business line in the table in BIPRU 6.4.15 R; and
  2. (2) the organisation of the firm's business in respect of that business line.

BIPRU 6.4.13

handbook-guidance
A firm should take into account its business and organisation when mapping activities to the business lines in the table in BIPRU 6.4.15 R.

BIPRU 6.4.14

handbook-rule

For the purposes of BIPRU 6.4.11 R (5), costs generated in one business line which are imputable to a different business line may be reallocated to the business line to which they pertain, for instance by using a treatment based on internal transfer costs between two business lines.

[Note: BCD Annex X, Part 2 point 4 (part)]

BIPRU 6.4.15

handbook-rule
Table: Percentages applying to the income indicator of individual business lines
This table belongs to BIPRU 6.4.3 R

The alternative standardised approach

BIPRU 6.4.16

handbook-guidance

Under the alternative standardised approach, a firm using the standardised approach may use alternative indicators for retail banking and commercial banking business lines if it complies with BIPRU 6.4.17 R to BIPRU 6.4.21 R.

[Note: BCD Annex X, Part 2 point 3]

Eligibility for the alternative standardised approach

BIPRU 6.4.17

handbook-rule

To be eligible to use the alternative standardised approach, a firm must meet the following conditions, in addition to the general risk management standards set out in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R :

  1. (1) the firm must meet the eligibility criteria for the standardised approach in BIPRU 6.4.1 R;
  2. (2) the firm must be overwhelmingly active in retail and/or commercial banking activities, which must account for at least 90% of its income; and
  3. (3) the firm must be able to demonstrate that a significant proportion of its retail and/or commercial banking activities comprise loans associated with a high probability of default, and that the alternative standardised approach provides an improved basis for assessing the operational risk.

[Note: BCD Article 104(3) and Annex X, Part 2 points 5 and 8 to 11]

BIPRU 6.4.18

handbook-guidance
In relation to BIPRU 6.4.17 R (3), the FSA's view is that a high probability of default is equal to or greater than 3.5%.

ORCR calculated using the alternative standardised approach

BIPRU 6.4.19

handbook-rule
  1. (1) The relevant indicators under the alternative standardised approach are the same as for the standardised approach except for the two following business lines:
    1. (a) retail banking; and
    2. (b) commercial banking.
  2. (2) For retail banking and commercial banking, the ORCR must be calculated as a normalised income indicator equal to the three-year average of the total nominal amount of loans and advances multiplied:
    1. (a) by 0.035, and then
    2. (b) by the appropriate business line percentage set out in BIPRU 6.4.15 R.

[Note: BCD Annex X, Part 2 point 6]

BIPRU 6.4.20

handbook-rule

For the retail and/or commercial banking business lines, the loans and advances must consist of the total drawn amounts in the corresponding credit portfolios.

[Note: BCD Annex X, Part 2 point 7 (part)]

BIPRU 6.4.21

handbook-rule

For the commercial banking business line, the securities held in the non-trading book must also be included.

[Note: BCD Annex X, Part 2 point 7 (part)]

BIPRU 6.5

Operational risk: Advanced measurement approaches

  • 01/01/2008

Application

BIPRU 6.5.1

handbook-rule
BIPRU 6.5 applies to a BIPRU firm with an AMA permission.

AMA permissions: general

BIPRU 6.5.2

handbook-guidance
The rules in GENPRU and BIPRU do not allow a firm to use the advanced measurement approach. A firm that wishes to use an advanced measurement approach, based on the firm's own operational risk measurement systems, for the calculation of its ORCR should therefore apply for AMA permission to use the advanced measurement approach as explained in BIPRU 1.3.

BIPRU 6.5.3

handbook-guidance
The FSA will not grant a firm an AMA permission to use the advanced measurement approach if the firm does not meet the standards in BIPRU 6.5.5 R.

BIPRU 6.5.4

handbook-guidance
An AMA permission will generally modify BIPRU 6.2.1 R (Calculation of ORCR) by amending, to the extent set out in the AMA permission, the calculation of the ORCR of the firm to be calculated in accordance with BIPRU 6.5.

Minimum standards

BIPRU 6.5.5

handbook-rule

A firm must be able to satisfy the FSA that it meets:

  1. (1) the general risk management standards in SYSC 4.1.1 R to SYSC 4.1.2 R and SYSC 7.1.16 R;
  2. (2) the qualitative standards set out in this section; and
  3. (3) the quantitative standards set out in this section.

[Note: BCD Article 105(2) and Annex X Part 3 point 1]

BIPRU 6.5.5A

handbook-guidance
In meeting the general risk management standards referred to in BIPRU 6.5.5 R (1), a firm that undertakes market-related activities should be able to demonstrate compliance with the Committee of European Banking Supervisors' Guidelines on the management of operational risk in market-related activities, published in October 2010. These can be found at http://www.eba.europa.eu/documents/Publications/Standards---Guidelines/2010/Management-of-op-risk/CEBS-2010-216-(Guidelines-on-the-management-of-op-.aspx

BIPRU 6.5.5B

handbook-guidance
In meeting the general risk management standards referred to in BIPRU 6.5.5R (1), a firm with AMA approval should be able to demonstrate to the FSA that it has considered and complies with Section III of the European Banking Authority's Guidelines on the Advanced Measurement Approach (AMA) - Extensions and Changes published in January 2012. These can be found at http://eba.europa.eu/cebs/media/Publications/Standards%20and%20Guidelines/2012/EBA-BS-2011-209-final-(EBA-GL-on-AMA-extensions-and-changes).pdf

Qualitative standards

BIPRU 6.5.6

handbook-rule
  1. (1) This rule sets out the qualitative standards that a firm's operational risk measurement system must meet.
  2. (2) A firm's internal operational risk measurement system must be closely integrated into its day-to-day risk management processes.
  3. (3) A firm must have an independent risk management function for operational risk.
  4. (4) There must be regular reporting of operational risk exposures and loss experience. The firm must have procedures for taking appropriate corrective action.
  5. (5) A firm's risk management system must be well documented. The firm must have a routine in place for ensuring compliance and policies for the treatment of non-compliance.
  6. (6) A firm's operational risk management processes and measurement systems must be subject to regular reviews performed by internal and/or external auditors.
  7. (7) A firm must ensure that in respect of its operational risk measurement system:
    1. (a) its internal validation processes are operating in a satisfactory manner; and
    2. (b) the data flows and processes associated with the risk measurement system are transparent and accessible.

[Note: BCD Annex X Part 3 points 2 to 7]

BIPRU 6.5.7

handbook-guidance

For the purposes of BIPRU 6.5.6 R (2), a firm should be able to show that:

  1. (1) its operational risk measurement systems and processes provide benefits to the firm and are not limited to determining regulatory capital;
  2. (2) the operational risk measurement system and framework forms part of the systems and controls it has in place; and
  3. (3) the operational risk measurement system and framework are capable of adapting to the changes in the business of the firm and evolving as the firm gains experience of risk management techniques.

BIPRU 6.5.8

handbook-guidance
For the purposes of BIPRU 6.5.6 R (3), a firm should be able to show that the independent risk management function is sufficiently separate from the business units of the firm to allow its professional judgement and recommendations to be effective and impartial.

BIPRU 6.5.9

handbook-guidance

For the purposes of BIPRU 6.5.6 R (4), a firm should ensure that:

  1. (1) its governing body or designated committee (where one is used) possesses a general understanding of the firm's AMA; and
  2. (2) its senior management possesses a good understanding of the firm's AMA and its operation.

BIPRU 6.5.10

handbook-guidance
  1. (1) A firm's governing body or designated committee may choose to approve only material aspects of the firm's AMA and material changes to the firm's AMA.
  2. (2) Where a firm's governing body or designated committee chooses to approve only material aspects of the firm's AMA and material changes to the firm's AMA:
    1. (a) the firm's governing body or designated committee should define the firm's overall approach to the AMA and approve a policy statement defining that approach; and
    2. (b) the firm should define and document the process for approval of non-material aspects of the firm's AMA.

BIPRU 6.5.11

handbook-guidance

For the purposes of BIPRU 6.5.6 R (7), a firm should develop and adopt an internal validation methodology of its operational risk measurement system and management processes that:

  1. (1) is proportionate and appropriate to the business of the firm;
  2. (2) takes into account changing market and operating conditions of the firm;
  3. (3) encompasses both quantitative and qualitative methods of the firm's operational risk measurement system;
  4. (4) is periodically assessed by the firm;
  5. (5) is subject to regular independent review to ensure effective implementation; and
  6. (6) is clearly documented.

Quantitative standards: process

BIPRU 6.5.12

handbook-rule
  1. (1) This rule sets out the quantitative standards that a firm's operational risk measurement system must meet with respect to process.
  2. (2) A firm must calculate its capital requirement as comprising both expected loss and unexpected loss, unless the firm can demonstrate that expected loss is adequately captured in its internal business practices.
  3. (3) The operational risk measure of a firm must capture potentially severe tail events, achieving a soundness standard comparable to a 99.9% confidence interval over a one year period.
  4. (4) The operational risk measurement system of a firm must have certain key elements to meet the soundness standard set out in (2) and (3). These elements must include the use of internal data, external data, scenario analysis and factors reflecting the business environment and internal control systems as set out in BIPRU 6.5.21 R to BIPRU 6.5.25 R.
  5. (5) A firm must have a well documented approach for weighting the use of the four elements in (4) in its overall risk measurement system.
  6. (6) A firm's risk measurement system must capture the major drivers of risk affecting the shape of the tail of the loss estimates.
  7. (7) A firm must only recognise correlations in operational risk losses across individual operational risk estimates to the extent they are set out in its AMA permission. The firm must validate its correlation assumptions using appropriate quantitative and qualitative techniques.
  8. (8) A firm's risk measurement system must be internally consistent and must avoid the multiple counting of qualitative assessments or risk mitigants recognised in other areas of the capital adequacy framework.

[Note: BCD Annex X Part 3 points 8 to 10, 11 (part) and 12]

BIPRU 6.5.13

handbook-rule

For the purposes of BIPRU 6.5.12 R (7), the firm must be able to show that its system for measuring correlations is sound, implemented with integrity, and takes into account the uncertainty surrounding any such correlation estimates, particularly in periods of stress.

[Note: BCD Annex X Part 3 point 11 (part)]

BIPRU 6.5.14

handbook-guidance

A firm should be able to satisfy the FSA that it has considered the following with respect to its operational risk measurement systems:

  1. (1) whether the choice of distributions used provides both a good fit with the data and an ability adequately to account for rare events;
  2. (2) whether the estimated parameters and capital numbers used for the simulated inclusion or exclusion of unusually large losses are sufficiently robust;
  3. (3) the co-dependency, or independency, of assumptions governing the relationships between risk types and between business lines;
  4. (4) the number of simulations or iterations required during model execution to provide reasonably stable capital results;
  5. (5) the emergence of different data types, such as the combination of internal and external loss data, based on different degrees of credibility; and
  6. (6) the methodologies used for the purposes of achieving a soundness standard comparable to a 99.9% confidence interval.

BIPRU 6.5.15

handbook-guidance

For the purposes of BIPRU 6.5.12 R (2), a firm should be able to show that its operational risk measurement systems that capture expected loss are:

  1. (1) clearly documented;
  2. (2) sound, implemented with integrity and consistently applied, and take into account uncertainty surrounding expected loss;
  3. (3) subject to regular reviews by the firm of the reasonableness of the expected loss estimates and comparisons with subsequent outcomes; and
  4. (4) based on justifiable assumptions for capturing and reviewing the reasonableness of the expected loss estimates.

BIPRU 6.5.16

handbook-guidance
For the purposes of BIPRU 6.5.15 G, the firm should use the business management definition it uses for the purposes of identifying an expected loss.

BIPRU 6.5.17

handbook-guidance

Where a firm is using a combination of budgeting and pricing for the purposes of the operational risk measurement system for capturing expected loss, a firm should be able to show that:

  1. (1) the process is transparent, can be repeated and provides support to the firm's management of its business;
  2. (2) to a reasonable degree of certainty, budgeted resources for the relevant year cover budgeted expected losses;
  3. (3) its forecasting takes into account both historic performance and drivers which may affect future trends; and
  4. (4) the forecasting in (3) is monitored on a periodic basis and adjusted as appropriate.

BIPRU 6.5.18

handbook-guidance

For the purposes of BIPRU 6.5.12 R (3), a firm should be able to show that in respect of its operational risk measurement system:

  1. (1) the methodology for obtaining a soundness standard comparable to a 99.9% confidence level is practical and appropriate;
  2. (2) it has assessed its overall model outputs as sufficiently robust; and
  3. (3) it reviews its methodology on an ongoing basis.

BIPRU 6.5.19

handbook-guidance

For the purpose of developing and reviewing its methodology for obtaining a soundness standard comparable to a 99.9% confidence level, a firm should consider whether any of the following are appropriate:

  1. (1) stress testing;
  2. (2) sensitivity analysis;
  3. (3) scenario analysis;
  4. (4) back testing; and
  5. (5) boot-strapping techniques.

BIPRU 6.5.20

handbook-guidance
Where a firm is using scaling for the purposes of the operational risk measurement system, it should be able to show that the methodology used is robust and based on assumptions that are meaningful and credible.

Quantitative standards: internal data

BIPRU 6.5.21

handbook-rule
  1. (1) This rule sets out the quantitative standards that a firm's operational risk measurement system must meet with respect to internal data.
  2. (2) A firm's internally generated operational risk measures must be based on a minimum historical observation period of five years. When a firm first moves to the advanced measurement approach, a three year historical observation period may be used.
  3. (3) A firm must be able to map its historical internal loss data into the business lines defined in BIPRU 6.4.15 R and into the event type categories defined in BIPRU 6.5.25 R, and must be able to provide this data to the FSA upon request. Loss events which affect the entire firm may be allocated to an additional business line 'corporate items' due to exceptional circumstances. The firm must have documented, objective criteria for allocating losses to the specified business lines and event types. A firm's operational risk losses that are related to credit risk and have historically been included in the internal credit risk databases must be recorded in the operational risk databases and be separately identified. Such losses will not be subject to the ORCR, as long as they continue to be treated as credit risk for the purposes of calculating the capital resources requirement. Operational risk losses that are related to market risks must be included in the scope of the capital requirement for operational risk.
  4. (4) A firm's internal loss data must be comprehensive in that it captures all material activities and exposures from all appropriate sub-systems and geographic locations. A firm must be able to demonstrate that any excluded activities or exposures, both individually and in combination, would not have a material impact on the overall risk estimates. A firm must define appropriate minimum loss thresholds for internal loss data collection.
  5. (5) Aside from information on gross loss amounts, a firm must collect information about the date of the event, any recoveries of gross loss amounts, as well as some descriptive information about the drivers or causes of the loss event.
  6. (6) A firm must have specific criteria for assigning loss data arising from an event in a centralised function or an activity that spans more than one business line, as well as from related events over time.
  7. (7) A firm must have documented procedures for assessing the ongoing relevance of historical loss data, including those situations in which judgement overrides, scaling or other adjustments may be used, to what extent they may be used and who is authorised to make such decisions.

[Note: BCD Annex X Part 3 points 13 to 18]

Quantitative standards: external data

BIPRU 6.5.22

handbook-rule
  1. (1) This rule sets out the quantitative standards that a firm's operational risk measurement system must meet with respect to external data.
  2. (2) A firm's operational risk measurement system must use relevant external data, especially when there is reason to believe that the firm is exposed to infrequent, yet potentially severe, losses. A firm must have a systematic process for determining the situations for which external data should be used and the methodologies used to incorporate the data in its measurement system. The conditions and practices for external data use should be regularly reviewed, documented and subject to periodic independent review.

[Note: BCD Annex X Part 3 point 19]

Quantitative standards: scenario analysis

BIPRU 6.5.23

handbook-rule
  1. (1) This rule sets out the quantitative standards that a firm's operational risk measurement system must meet with respect to scenario analysis.
  2. (2) A firm must use scenario analysis of expert opinion in conjunction with external data to evaluate its exposure to high severity events. Over time, such assessments must be validated and re-assessed through comparison to actual loss experience to ensure their reasonableness.

[Note: BCD Annex X Part 3 point 20]

Quantitative standards: business environment and internal control factors

BIPRU 6.5.24

handbook-rule
  1. (1) This rule sets out the quantitative standards that a firm's operational risk measurement system must meet with respect to business environment and internal control factors.
  2. (2) A firm's firm-wide risk assessment methodology must capture key business environment and internal control factors that can change its operational risk profile.
  3. (3) A firm must be able to justify the choice of each factor as a meaningful driver of risk, based on experience and involving the expert judgment of the affected business areas.
  4. (4) The sensitivity of risk estimates to changes in the factors and the relative weighting of the various factors must be well reasoned. In addition to capturing changes in risk due to improvements in risk controls, the framework must also capture potential increases in risk due to greater complexity of activities or increased business volume.
  5. (5) A firm must document this framework and make it subject to independent review within the firm and make it available for review by supervisors.
  6. (6) Over time, a firm must validate and re-assess the process and the outcomes through comparison to actual internal loss experience and relevant external data.

[Note: BCD Annex X Part 3 points 21 to 24]

Table: Loss event type classification

BIPRU 6.5.25

handbook-rule

This table belongs to BIPRU 6.5.21 R (3).

[Note: BCD Annex X Part 5 Table 3]

Impact of insurance and risk transfer mechanisms

BIPRU 6.5.26

handbook-rule
  1. (1) A firm may recognise the impact of insurance for the purposes of its operational risk measurement system subject to the conditions set out in this rule and BIPRU 6.5.27 R.
  2. (2) The provider must be authorised to provide insurance or re-insurance.
  3. (3) The provider must have a minimum claims paying ability rating by an eligible ECAI associated with credit quality step 3 or above under the rules for the risk weighting of exposures to firms under the standardised approach to credit risk.

[Note: BCD Annex X Part 3 points 25 to 26]

BIPRU 6.5.27

handbook-rule
  1. (1) A firm must ensure that its insurance and its insurance framework meet the conditions in this rule.
  2. (2) The insurance policy must have an initial term of no less than one year. For policies with a residual term of less than one year the firm must make appropriate haircuts to reflect the declining residual term of the policy, up to a full 100% haircut for policies with a residual term of 90 days or less.
  3. (3) The insurance policy must have a minimum notice period for cancellation of the contract of 90 days.
  4. (4) The insurance policy must contain no exclusions or limitations based upon supervisory actions or, in the case of a failed firm, that preclude the firm, its receiver or liquidator from recovering for damages suffered or expenses incurred by the firm, except in respect of events occurring after the initiation of receivership or liquidation proceedings in respect of the firm. The insurance policy may exclude coverage for any fine, penalty or punitive damages resulting from actions by a competent authority or third country competent authority.
  5. (5) The risk mitigation calculations must reflect the insurance coverage in a manner that is transparent in its relationship to, and consistent with, the actual likelihood and impact of loss used in the overall determination of the ORCR.
  6. (6) The insurance must be provided by a third party entity. In the case of insurance through captives and affiliates, the exposure must be laid off to an independent third party entity, for example through reinsurance that meets the eligibility criteria.
  7. (7) The framework for recognising insurance must be well reasoned and documented.
  8. (8) The methodology for recognising insurance must capture the following elements through discounts or haircuts in the amount of insurance recognition:
    1. (a) the residual term of a policy, where less than one year, as noted in (2);
    2. (b) a policy's cancellation terms, where less than one year;
    3. (c) mismatches in coverage of insurance policies; and
    4. (d) the uncertainty of payment.
  9. (9) The capital alleviation arising from the recognition of insurances and other risk transfer mechanisms must not exceed 20% of the capital requirement before the recognition of risk mitigation techniques.

[Note: BCD Annex X Part 3 points 27 to 29]

BIPRU 6.5.28

handbook-guidance
For the purposes of BIPRU 6.5.27 R (7), a firm should be able to demonstrate that the mitigating effect of the insurance is appropriate and relevant to the firm's business.

BIPRU 6.5.29

handbook-guidance
For the purposes of BIPRU 6.5.27 R (9), a firm should be able to set out clearly how it made its assessment of the appropriate level of capital alleviation, including any assumptions made by the firm and how the insurances and other risk transfer mechanisms have been factored into the firm's risk measurement system.

BIPRU 6.5.30

handbook-rule

A firm may recognise a risk transfer mechanism other than insurance to the extent that a noticeable risk mitigating effect is achieved and the risk transfer mechanism is included in the firm's AMA permission.

[Note: BCD Annex X Part 3 point 25]

BIPRU 6.5.30A

handbook-guidance
A firm that recognises the impact of insurance and operational risk mitigation techniques for the purposes of its operational risk measurement system should be able to show that it has considered the Commission of European Banking Supervisors' guidelines on operational risk mitigation techniques published in December 2009. This can be found at http://www.c-ebs.org/documents/Publications/Standards---Guidelines/2009/Operational-risk-mitigation-techniques/Guidelines.aspx.

Use of an advanced measurement approach on a groupwide basis

BIPRU 6.5.31

handbook-rule

Where an EEA parent institution and its subsidiary undertakings or an EEA parent financial holding company and its subsidiary undertakings use an advanced measurement approach on a unified basis for the parent undertaking and its subsidiary undertakings, the qualifying criteria set out in BIPRU 6.5 may be met by the parent undertaking and its subsidiary undertakings considered together where permitted by the AMA permission.

[Note: BCD Article 105(4)]

BIPRU 6.5.32

handbook-guidance

Where the AMA is used on a unified basis for the parent undertaking and its subsidiary undertakings, and approval and reporting of the AMA are carried out at the group level, the qualifying criteria in BIPRU 6.5 may be met if:

  1. (1) the subsidiary undertakings have delegated to the governing body or designated committee of the EEA parent institution or EEA parent financial holding company responsibility for approval of the AMA;
  2. (2) the governing body or designated committee of the EEA parent institution or EEA parent financial holding company approves either:
    1. (a) all aspects of the AMA, and material changes; or
    2. (b) all aspects of the AMA that are material in the context of the group, and material changes to those, and a policy statement defining the overall approach to the AMA.

Export chapter as

BIPRU 7

Market risk

BIPRU 7.1

Application, purpose, general provisions and non-standard transactions

  • 01/01/2007

Application

BIPRU 7.1.1

handbook-rule
This chapter applies to a BIPRU firm.

Purpose

BIPRU 7.1.2

handbook-guidance
The purpose of this chapter is to implement Annexes I, III, IV and V of the Capital Adequacy Directive.

General provisions: Obligation to calculate PRR

BIPRU 7.1.3

handbook-rule

A firm must calculate a PRR in respect of:

  1. (1) all its trading book positions;
  2. (2) all positions falling within BIPRU 7.5.3 R (Scope of the foreign exchange PRR calculation), whether or not in the trading book; and
  3. (3) all positions in commodities (including physical commodities) whether or not in the trading book;

even if no treatment is provided for that position in the other sections of this chapter.

BIPRU 7.1.4

handbook-rule

A firm must calculate a PRR for any position falling into BIPRU 7.1.3 R using:

  1. (1) the PRR calculations contained in BIPRU 7; or
  2. (2) another method provided the firm is able to demonstrate that in all circumstances the calculation being employed results in a higher PRR for the position than would be required under (1).

General provisions: Non-trading book items

BIPRU 7.1.5

handbook-guidance
Positions in instruments which are non-trading book items should be treated under BIPRU 3 (Standardised credit risk), BIPRU 4 (The IRB approach) or BIPRU 13 (Financial derivatives, SFTs and long settlement transactions) unless deducted as an illiquid asset. If they fall into BIPRU 7.1.3R(2) or (3) they also give rise to a PRR charge.

General provisions: Frequency of calculation

BIPRU 7.1.6

handbook-rule
A firm must be able to monitor its total PRR on an intra-day basis, and, before executing any trade, must be able to re-calculate PRR to the level of detail necessary to establish whether or not the firm's capital resources exceed its capital resources requirement.

BIPRU 7.1.7

handbook-guidance
A firm may rely on intra-day limits for the purposes of BIPRU 7.1.6R.

Purpose of rules for non-standard transactions and instruments for which no PRR treatment has been specified

BIPRU 7.1.8

handbook-guidance
The methodologies which have been developed for calculating PRR charges have been based on existing instruments and assume instruments with standard characteristics. However, as a result of innovation and because there are instruments which, although based on a standard contract, contain structural features which would make the rules in the rest of this chapter inappropriate, flexible rules are required. The rules in this section about transactions for which no PRR treatment has been specified and non-standard transactions are designed to address this.

Instruments for which no PRR treatment has been specified

BIPRU 7.1.9

handbook-rule
Where a firm has a position for which no PRR treatment has been specified, it must calculate the PRR for that position in accordance with BIPRU 7.1.12R-BIPRU 7.1.13R.

BIPRU 7.1.10

handbook-rule
If BIPRU 7.1.9 R applies, a firm must document its policies and procedures for calculating the PRR for that position of that type in its trading book policy statement.

BIPRU 7.1.11

handbook-guidance
Under BIPRU 1.2.30 R (2) a firm should notify the FSA as soon as is reasonably practicable if its trading book policy statement is subject to significant changes. Therefore if a firm makes a change in accordance with BIPRU 7.1.10R it should consider whether it is necessary to report it to the FSA.

BIPRU 7.1.12

handbook-rule
A firm may calculate the PRR for a position falling into BIPRU 7.1.9R by applying by analogy the rules relating to the calculation of the interest rate PRR, the equity PRR, the commodity PRR, the foreign currency PRR, the option PRR or the collective investment undertaking PRR if doing so is appropriate and if the position and PRR item are sufficiently similar to those that are covered by those rules.

BIPRU 7.1.13

handbook-rule
Where a firm has a position for which no PRR treatment has been specified and it is not applying BIPRU 7.1.12R, it must calculate a PRR of an appropriate percentage of the current value of the position calculated under GENPRU 1.3 (Valuation).

Instruments in non-standard form

BIPRU 7.1.14

handbook-rule
  1. (1) If a firm has a position:
    1. (a) in a PRR item in non-standard form; or
    2. (b) that is part of a non-standard arrangement; or
    3. (c) that, taken together with other positions (whether or not they are subject to PRR charges under BIPRU 7), gives rise to a non-standard market risk;
  2. the firm must notify the FSA of that fact and of details about the position, PRR item, arrangements and type of risk concerned.
  3. (2) Except as (1) provides to the contrary, (1) applies to a position that is subject to a PRR under BIPRU 7.1.3R.
  4. (3) The question of what is non-standard for the purposes of (1) must be judged by reference to the standards:
    1. (a) prevailing at the time the rule is being applied; and
    2. (b) of firms generally who carry on business which gives rise to PRRs under BIPRU 7 rather than merely by reference to the firm's own business.

BIPRU 7.1.15

handbook-rule
If a firm has a position or combination of positions falling into BIPRU 7.1.14R and the PRR relating to that position or positions materially underestimates the market risk incurred by the firm to which they give rise, the firm must calculate the PRR for that position or positions under BIPRU 7.1.13R.

Meaning of appropriate percentage for non-standard transactions

BIPRU 7.1.16

handbook-evidential-provisions
  1. (1) In BIPRU 7.1.13R and, to the extent that that rule applies BIPRU 7.1.13R, BIPRU 7.1.15R, an "appropriate percentage" is:
    1. (a) 100%; or
    2. (b) a percentage which takes account of the characteristics of the position concerned and of discussions with the FSA or a predecessor regulator under the Banking Act 1987 or the Financial Services Act 1986.
  2. (2) Compliance with (1) may be relied on as tending to establish compliance with BIPRU 7.1.13R or, insofar as it incorporates the requirements relating to an appropriate percentage, BIPRU 7.1.15R.
  3. (3) Contravention of (1) may be relied on as tending to establish contravention with BIPRU 7.1.13 R or, insofar as it incorporates the requirements relating to an appropriate percentage, BIPRU 7.1.15 R.

Stress testing and scenario analyses of trading book positions

BIPRU 7.1.17

handbook-rule
A firm must conduct a regular programme of stress testing and scenario analysis of its trading book positions, both at the trading desk level and on a firm-wide basis. The results of these tests must be reviewed by senior management and reflected in the policies and limits the firm sets.

BIPRU 7.1.17A

handbook-guidance
The firm's stress testing programme should be comprehensive in terms of both risk and firm coverage, and appropriate to the size and complexity of trading book positions held.

BIPRU 7.1.18

handbook-rule
In carrying out the stress tests and scenario analyses required by BIPRU 7.1.17 R, a firm must incorporate and take into account any other relevant stress tests and scenario analyses that it is required to carry out under any other provision of the Handbook, and in particular under BIPRU 7.10.72 R where the firm has a VaR model permission.

BIPRU 7.1.19

handbook-guidance

This paragraph gives guidance in relation to the stress testing programme that a firm must carry out in relation to its trading book positions.

  1. (1) The frequency of the stress testing of trading book positions should be determined by the nature of the positions.
  2. (2) The stress testing should include shocks which reflect the nature of the portfolio and the time it could take to hedge out or manage risks under severe market conditions.
  3. (3) The firm should have procedures in place to assess and respond to the results of the stress testing programme. In particular, stress testing should be used to evaluate the firm's capacity to absorb losses or to identify steps to be taken by the firm to reduce risk.
  4. (4) As part of its stress testing programme, the firm should consider how prudent valuation principles (see GENPRU 1.3) will be met in a stressed scenario.

BIPRU 7.1.20

handbook-guidance
The stress testing and scenario analysis under BIPRU 7.1.17 R should be taken into account under the overall Pillar 2 rule.

BIPRU 7.2

Interest rate PRR

  • 01/01/2007

General rule

BIPRU 7.2.1

handbook-rule
  1. (1) A firm must calculate its interest rate PRR under BIPRU 7.2 by:
    1. (a) identifying which positions must be included within the interest rate PRR calculation;
    2. (b) deriving the net position in each debt security in accordance with BIPRU 7.2.36R-BIPRU 7.2.41R;
    3. (c) including these net positions in the interest rate PRR calculation for general market risk and the interest rate PRR calculation for specific risk; and
    4. (d) summing all PRRs calculated for general market risk and specific risk.
  2. (2) A firm must calculate its interest rate PRR by adding the amount calculated under (1) to the amount calculated under the basic interest rate PRR calculation under BIPRU 7.3.45R.
  3. (3) All net positions, irrespective of their signs, must be converted on a daily basis into the firm's base currency at the prevailing spot exchange rate before their aggregation.
  4. (4) Net positions must be classified according to the currency in which they are denominated. A firm must calculate the capital requirement for general market risk and specific risk in each individual currency separately.

BIPRU 7.2.2

handbook-guidance
The interest rate PRR calculation divides the interest rate risk into the risk of loss from a general move in market interest rates, and the risk of loss from an individual debt security's price changing for reasons other than a general move in market interest rates. These are called general market risk and specific risk respectively.

Scope of the interest rate PRR calculation

BIPRU 7.2.3

handbook-rule

A firm's interest rate PRR calculation must:

  1. (1) include all trading book positions in debt securities, preference shares and convertibles, except:
    1. (a) positions in convertibles which have been included in the firm's equity PRR calculation;
    2. (b) positions fully deducted as a material holding under the calculations under the capital resources table, in which case the firm may exclude them; or
    3. (c) positions hedging an option which is being treated under BIPRU 7.6.26R (Table: Appropriate treatment for equities, debt securities or currencies hedging options);
  2. (2) include notional positions arising from trading book positions in the instruments listed in the table in BIPRU 7.2.4R; and
  3. (3) (if the firm is the transferor of debt securities or guaranteed rights relating to title to debt securities in a repurchase agreement or the lender of debt securities in a debt securities lending agreement) include such debt securities if those debt securities meet the criteria for inclusion in the trading book.

BIPRU 7.2.4

handbook-rule
Table: Instruments which result in notional positions
This table belongs to BIPRU 7.2.3R(2)

BIPRU 7.2.5

handbook-guidance
BIPRU 7.2.3R(1) includes a trading book position in debt security, preference share or convertible that is subsequently repo'd under a repurchase agreement or lent under a stock lending agreement. Clearly, if the security had initially been obtained via a reverse repurchase agreement or stock borrowing agreement, the security would not have been included in the PRR calculation in the first place.

BIPRU 7.2.6

handbook-guidance

BIPRU 7.2.7

handbook-guidance

Firms are reminded that the table in BIPRU 7.6.5R (Table: Appropriate PRR calculation for an option or warrant) divides options and warrants on interest rates, debt securities and interest rate futures and swaps into:

  1. (1) those which must be treated under BIPRU 7.6 (Option PRR); and
  2. (2) those which must be treated under either BIPRU 7.2 or BIPRU 7.6, the firm being able to choose whether BIPRU 7.2 or BIPRU 7.6 is used.

BIPRU 7.2.8

handbook-guidance
Cliquets on equities, baskets of equities or equity indices do not attract an interest rate PRR. The table in BIPRU 7.2.4R excludes them from the scope of the interest rate PRR calculation in BIPRU 7.2 and BIPRU 7.3.45R excludes them from the basic interest rate PRR calculation in BIPRU 7.3 (Equity PRR and basic interest rate PRR for equity derivatives).

BIPRU 7.2.9

handbook-guidance
The table in BIPRU 7.2.4R shows that equity derivatives are excluded from BIPRU 7.2's PRR calculation if they have been included in the basic interest rate PRR calculation in BIPRU 7.3 (see BIPRU 7.3.45R).

Derivation of notional positions: General approach

BIPRU 7.2.10

handbook-guidance

BIPRU 7.2.11 R - BIPRU 7.2.35R convert the instruments listed in the table in BIPRU 7.2.4R into notional positions in:

  1. (1) the underlying debt security, where the instrument depends on the price (or yield) of a specific debt security; or
  2. (2) notional debt securities to capture the pure interest rate risk arising from future payments and receipts of cash (including notional payments and receipts) which, because they are designed to represent pure general market risk (and not specific risk), are called zero-specific-risk securities; or
  3. (3) both (1) and (2).

BIPRU 7.2.11

handbook-rule
  1. (1) For the purposes of calculating interest rate PRR, unless specified otherwise, a firm must derive the value of notional positions as follows:
    1. (a) notional positions in actual debt securities must be valued as the nominal amount underlying the contract at the current market price of the debt security; and
    2. (b) positions in zero-specific-risk securities must be valued using one of the two methods in (2).
  2. (2) A firm must use one of the following two methods for all positions arising under (1)(b) and must use the same method for all positions denominated in the same currency:
    1. (a) the present value approach, under which the zero-specific-risk security is assigned a value equal to the present value of all the future cash flows that it represents; or
    2. (b) the alternative approach, under which the zero-specific-risk security is assigned a value equal to:
      1. (i) the market value of the underlying notional equity position in the case of an equity derivative;
      2. (ii) the notional principal amount in the case of an interest rate or foreign currency swap; or
      3. (iii) the notional amount of the future cash flow that it represents in the case of any other CRD financial instrument.

BIPRU 7.2.12

handbook-rule
A firm must use BIPRU 7.2.11R(2)(a) in respect of any positions that it includes in the interest rate duration method.

Derivation of notional positions: Futures, forwards or synthetic futures on a debt security

BIPRU 7.2.13

handbook-rule

Futures, forwards or synthetic futures on a single debt security must be treated as follows:

  1. (1) a purchased future, synthetic future or forward is treated as:
    1. (a) a notional long position in the underlying debt security (or the cheapest to deliver (taking into account the conversion factor) where the contract can be satisfied by delivery of one from a range of securities); and
    2. (b) a notional short position in a zero coupon zero-specific-risk security with a maturity equal to the expiry date of the future or forward; and
  2. (2) a sold future, synthetic future or forward is treated as:
    1. (a) a notional short position in the underlying security (or the cheapest to deliver (taking into account the conversion factor) where the contract can be satisfied by delivery of one from a range of securities); and
    2. (b) a notional long position in a zero coupon zero-specific-risk security with a maturity equal to the expiry date of the future, synthetic future or forward.

Derivation of notional positions: Futures, forwards or synthetic futures on a basket or index of debt securities

BIPRU 7.2.14

handbook-rule

Futures, forwards or synthetic futures on a basket or index of debt securities must be converted into forwards on single debt securities as follows (and then the resulting positions must be treated under BIPRU 7.2.13R):

  1. (1) futures, synthetic futures or forwards on a single currency basket or index of debt securities must be treated as either:
    1. (a) a series of forwards, one for each of the constituent debt securities in the basket or index, of an amount which is a proportionate part of the total underlying the contract according to the weighting of the relevant debt security in the basket; or
    2. (b) a single forward on a notional debt security; and
  2. (2) futures, synthetic futures or forwards on multiple currency baskets or indices of debt securities must be treated as either:
    1. (a) a series of forwards (using the method described in (1)(a)); or
    2. (b) a series of forwards, each one on a notional debt security to represent one of the currencies in the basket or index, of an amount which is a proportionate part of the total underlying the contract according to the weighting of the relevant currency in the basket.

BIPRU 7.2.15

handbook-guidance
Under BIPRU 7.2.14R(2)(b), a forward on basket of three Euro denominated debt securities and two Dollar denominated debt securities would be treated as a forward on a single notional Euro denominated debt security and a forward on a single notional Dollar denominated debt security.

BIPRU 7.2.16

handbook-rule
The notional debt securities in BIPRU 7.2.14R are assigned a specific risk PRA and a general market risk PRA equal to the highest that would apply to the debt securities in the basket or index.

BIPRU 7.2.17

handbook-guidance
The debt security with the highest specific risk PRA within the basket might not be the same as the one with the highest general market risk PRA . BIPRU 7.2.16R requires a firm to select the highest percentages even where they relate to different debt securities in the basket or index, and regardless of the proportion of those debt securities in the basket or index.

Derivation of notional positions: Interest rate futures and forward rate agreements (FRAs)

BIPRU 7.2.18

handbook-rule
Interest rate futures or FRAs must be treated as the two notional positions (one long, one short) shown in the table in BIPRU 7.2.19R.

BIPRU 7.2.19

handbook-rule
Table: Interest rate futures and FRAs
This table belongs to BIPRU 7.2.18R

BIPRU 7.2.20

handbook-guidance
  1. (1) The following example illustrates BIPRU 7.2.18R and BIPRU 7.2.19R in conjunction with BIPRU 7.2.11R (the last rule determines the value of notional positions). A firm sells £1mn notional of a 3v6 FRA at 6%. This results in:
    1. (a) a short position in a zero-specific-risk security with a zero coupon, three month maturity, and a nominal amount of £1million; and
    2. (b) a long position in a zero-specific-risk security with a zero coupon, six month maturity, and nominal amount of £1,015,000 (i.e. notional plus interest at 6% over 90 days).
  2. (2) If a firm were to apply the approach in BIPRU 7.2.11R(2)(a) the two nominal amounts would have to be present valued.

Derivation of notional positions: Interest rate swaps or foreign currency swaps

BIPRU 7.2.21

handbook-rule
Interest rate swaps or foreign currency swaps without deferred starts must be treated as the two notional positions (one long, one short) shown in the table in BIPRU 7.2.22R.

BIPRU 7.2.22

handbook-rule
Table: Interest rate and foreign currency swaps
This table belongs to BIPRU 7.2.21R

BIPRU 7.2.23

handbook-guidance
For a foreign currency swap, the two notional zero-specific-risk securities would be denominated in different currencies. A foreign currency swap is also included in the foreign currency PRR calculation.

Derivation of notional positions: Deferred start interest rate swaps or foreign currency swaps

BIPRU 7.2.24

handbook-rule
Interest rate swaps or foreign currency swaps with a deferred start must be treated as the two notional positions (one long, one short) shown in the table in BIPRU 7.2.25R.

BIPRU 7.2.25

handbook-rule
Table: Deferred start interest rate and foreign currency swaps
This table belongs to BIPRU 7.2.24R

BIPRU 7.2.26

handbook-guidance
An example of BIPRU 7.2.24R is as follows. A firm enters into a five year swap which starts in two year's time. The firm has contracted to receive 6% and pay six month Libor on a principal amount of £1 million. This results in a long position in a 7 year debt security and a short position in a 2 year debt security. Both have a coupon of 6%. BIPRU 7.2.24R deals with the capital treatment of the delayed start date; once the swap has started, BIPRU 7.2.21R applies.

Derivation of notional positions: Swaps where only one leg is an interest rate leg (e.g. equity swaps)

BIPRU 7.2.27

handbook-rule

A firm must treat a swap with only one interest rate leg as a notional position in a zero-specific-risk security:

  1. (1) with a coupon equal to that on the interest rate leg;
  2. (2) with a maturity equal to the date that the interest rate will be reset; and
  3. (3) which is a long position if the firm is receiving interest payments and short if making interest payments.

BIPRU 7.2.28

handbook-guidance
BIPRU 7.2.27R includes equity swaps, commodity swaps and any other swap where only one leg is an interest rate leg.

Derivation of notional positions: Cash legs of repurchase agreements and reverse repurchase agreements

BIPRU 7.2.29

handbook-guidance
Firms are reminded that for the purposes of BIPRU 7.2.30R, a repurchase agreement includes a sell/buy back or stock lending; and a reverse repurchase agreement includes a buy/sell back or a stock borrowing.

BIPRU 7.2.30

handbook-rule

The forward cash leg of a repurchase agreement or reverse repurchase agreement must be treated as a notional position in a zero-specific-risk security which:

  1. (1) is a short notional position in the case of a repurchase agreement; and a long notional position in the case of a reverse repurchase agreement;
  2. (2) has a value equal to the market value of the cash leg;
  3. (3) has a maturity equal to that of the repurchase agreement or reverse repurchase agreement; and
  4. (4) has a coupon equal to:
    1. (a) zero, if the next interest payment date coincides with the maturity date; or
    2. (b) the interest rate on the contract, if any interest is due to be paid before the maturity date.

Derivation of notional positions: Cash borrowings and deposits

BIPRU 7.2.31

handbook-rule

A cash borrowing or deposit must be treated as a notional position in a zero coupon zero-specific-risk security which:

  1. (1) is a short position in the case of a borrowing and a long position in the case of a deposit;
  2. (2) has a value equal to the market value of the borrowing or deposit;
  3. (3) has a maturity equal to that of the borrowing or deposit, or the next date the interest rate is reset (if earlier); and
  4. (4) has a coupon equal to:
    1. (a) zero, if the next interest payment date coincides with the maturity date; or
    2. (b) the interest rate on the borrowing or deposit, if any interest is due to be paid before the maturity date.

Derivation of notional positions: Options and warrants

BIPRU 7.2.32

handbook-rule
  1. (1) Where included in the PRR calculation in BIPRU 7.2 (see the table in BIPRU 7.2.4R), options and warrants must be treated in accordance with this rule.
  2. (2) An option or warrant on a debt security, a basket of debt securities or a debt security index must be treated as a position in that debt security, basket or index.
  3. (3) An option on an interest rate must be treated as a position in a zero coupon zero-specific-risk security with a maturity equal to the sum of the time to expiry of the option and the length of the period for which the interest rate is fixed.
  4. (4) An option on a future - where the future is based on an interest rate or debt security - must be treated as:
    1. (a) a long position in that future for purchased call options and written put options; and
    2. (b) a short position in that future for purchased put options and written call options.
  5. (5) An option on a swap must be treated as a deferred starting swap.

Derivation of notional positions: Bonds where the coupons and principal are paid in different currencies

BIPRU 7.2.33

handbook-rule

Where a debt security pays coupons in one currency, but will be redeemed in a different currency, it must be treated as:

  1. (1) a debt security denominated in the coupon's currency; and
  2. (2) a foreign currency forward to capture the fact that the debt security's principal will be repaid in a different currency from that in which it pays coupons, specifically:
    1. (a) a notional forward sale of the coupon currency and purchase of the redemption currency, in the case of a long position in the debt security; or
    2. (b) a notional forward purchase of the coupon currency and sale of the redemption currency, in the case of a short position in the debt security.

Derivation of notional positions: Interest rate risk on other futures, forwards and options

BIPRU 7.2.34

handbook-rule

Other futures, forwards, options and swaps treated under BIPRU 7.2 must be treated as positions in zero-specific-risk securities, each of which:

  1. (1) has a zero coupon;
  2. (2) has a maturity equal to that of the relevant contract; and
  3. (3) is long or short according to the table in BIPRU 7.2.35R.

BIPRU 7.2.35

handbook-rule
Table: Interest rate risk on other futures, forwards, options and swaps
This table belongs to BIPRU 7.2.34R.

Deriving the net position in each debt security: General

BIPRU 7.2.36

handbook-rule
The net position in a debt security is the difference between the value of the firm's long positions (including notional positions) and the value of its short positions (including notional positions) in the same debt security.

Deriving the net position in each debt security: Netting positions in the same debt security

BIPRU 7.2.37

handbook-rule
  1. (1) A firm must not net positions (including notional positions) unless those positions are in the same debt security. This rule sets out the circumstances in which debt securities may be treated as the same for these purposes.
  2. (2) Subject to (3) long and short positions are in the same debt security, and a debt security is the same as another if and only if:
    1. (a) they enjoy the same rights in all respects; and
    2. (b) are fungible with each other.
  3. (3) Long and short positions in different tranches of the same debt security may be treated as being in the same debt security for the purpose of (1) where:
    1. (a) the tranches enjoy the same rights in all respects; and
    2. (b) the tranches become fungible within 180 days and thereafter the debt security of one tranche can be delivered in settlement of the other tranche.

Deriving the net position in each debt security: Netting the cheapest to deliver security with other deliverable securities

BIPRU 7.2.38

handbook-rule
A firm may net a short notional position in the cheapest to deliver security arising from a short future or forward (see BIPRU 7.2.13R(2)(a)) under which the seller has a choice of which debt security it may use to settle its obligations against a long position in any deliverable security up to a maximum of 90% of the common nominal amounts. The residual long and short nominal amounts must be treated as separate long and short positions.

BIPRU 7.2.39

handbook-rule
The netting permitted by BIPRU 7.2.38R only relates to where the firm has sold the future or forward. It does not relate to where the firm has bought a future or forward.

Deriving the net position in each debt security: Netting zero-specific-risk securities with different maturities

BIPRU 7.2.40

handbook-rule

A firm may net a notional long position in a zero-specific-risk security against a notional short position in a zero-specific-risk security if:

  1. (1) they are denominated in the same currency;
  2. (2) their coupons do not differ by more than 15 basis points; and
  3. (3) they mature:
    1. (a) on the same day, if they have residual maturities of less than one month;
    2. (b) within 7 days of each other, if they have residual maturities of between one month and one year; and
    3. (c) within 30 days of each other, if they have residual maturities in excess of one year.

Deriving the net position in each debt security: Reduced net underwriting positions in debt securities

BIPRU 7.2.41

handbook-rule
A firm must not net a reduced net underwriting position in a debt security with any other debt security position.

BIPRU 7.2.42

handbook-guidance

Deriving the net position in the correlation trading portfolio

BIPRU 7.2.42A

handbook-rule

A correlation trading portfolio may only consist of securitisation positions and nth-to-default credit derivatives that meet the following criteria:

  1. (1) the positions are neither resecuritisation positions, nor options on a securitisation position, nor any other derivatives of securitisation exposures that do not provide a pro-rata share in the proceeds of a securitisation tranche;
  2. (2) all reference instruments are either single-name instruments, including single-name credit derivatives, for which a liquid two-way market exists, or commonly traded indices based on reference entities which meet this criterion;
  3. (3) the positions do not fall under the exposure classes outlined in BIPRU 3.2.9 R (8) (retail claims or contingent retail claims) and BIPRU 3.2.9 R (9) (claims or contingent claims secured on real estate property); and
  4. (4) the positions do not reference a claim on a special purpose vehicle.

BIPRU 7.2.42B

handbook-rule
Positions which are not securitisation positions or nth-to-default credit derivatives may be included in the correlation trading portfolio only if they hedge other such positions in this portfolio and a liquid two-way market exists for the relevant position or its reference entities.

BIPRU 7.2.42C

handbook-rule
For the purposes of BIPRU 7.2.42A R (2) and BIPRU 7.2.42B R, a two-way market may be deemed to exist only where there are independent, bona fide offers to buy and sell, so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one business day and settled at that price within a relatively short time conforming to trade custom.

BIPRU 7.2.42D

handbook-rule
A firm must calculate both the net long and the net short positions in the correlation trading portfolio by applying BIPRU 7.2.36 R and BIPRU 7.2.37 R or, where applicable, BIPRU 7.11.13 R to BIPRU 7.11.17 R.

Specific risk calculation

BIPRU 7.2.43

handbook-rule
  1. (1) A firm must calculate the specific risk portion of the interest rate PRR for each debt security by multiplying the market value of the individual net position (ignoring the sign) by the appropriate PRA from the table in BIPRU 7.2.44R or as specified by BIPRU 7.2.45R - BIPRU 7.2.48L R or by BIPRU 7.11.13 R - BIPRU 7.11.17 R.
  2. (2) Notional positions in zero-specific-risk securities do not attract specific risk.
  3. (3) For the purpose of (1), a firm may cap the product of multiplying the individual net position by the appropriate PRA at the maximum possible default-risk-related loss. For a short position in a credit derivative, a firm may calculate the maximum possible default-risk-related loss as a change in value due to the underlying names immediately becoming default-risk-free.

BIPRU 7.2.44

handbook-rule

Table: specific risk PRAs
This table belongs to BIPRU 7.2.43R.

[Note: CAD Annex I point 14 Table 1]

BIPRU 7.2.45

handbook-rule
To the extent that a firm applies the IRB approach, to qualify for a credit quality step for the purpose of the table in BIPRU 7.2.44R the obligor of the exposure must have an internal rating with a PD equivalent to or lower than that associated with the appropriate credit quality step under the standardised approach to credit risk.

BIPRU 7.2.46

handbook-rule
A debt security issued by a non-qualifying issuer must receive a specific risk PRA of 8% or 12% according to the table in BIPRU 7.2.44R. However a firm must apply a higher specific risk PRA to such a debt security and/or not recognise offsetting for the purposes of defining the extent of general market risk between such a security and any other debt securities to the extent that doing otherwise would not be a prudent treatment of specific risk or general market risk.

BIPRU 7.2.46A

handbook-guidance

BIPRU 7.2.43 R includes both actual and notional positions. However, notional positions in a zero-specific-risk security do not attract specific risk. For example:

  1. (1) interest-rate swaps, foreign-currency swaps, FRAs, interest-rate futures, foreign-currency forwards, foreign-currency futures, and the cash leg of repurchase agreements and reverse repurchase agreements create notional positions which will not attract specific risk; while
  2. (2) futures, forwards and swaps which are based on the price (or yield) of one or more debt securities will create at least one notional position that attracts specific risk.

Specific risk: securitisations and resecuritisations

BIPRU 7.2.48A

handbook-rule
  1. (1) Subject to (3), a firm must calculate the specific risk portion of the interest rate PRR for each securitisation and resecuritisation position by multiplying the market value of the individual net position (ignoring the sign) by the from the table in BIPRU 7.2.48D R or BIPRU 7.2.48E R, or in accordance with BIPRU 7.2.48F R, as applicable.
  2. (2) In calculating the specific risk capital charge of an individual net securitisation or resecuritisation position, a firm may cap the product of the weight and the individual net position at the maximum possible default-risk-related loss. For a short position, that limit may be calculated as a change in value due to the underlying names immediately becoming default-risk-free.
  3. (3) For a transitional period ending on 31 December 2013, where a firm holds securitisation and resecuritisation positions, other than positions included in the correlation trading portfolio, it must calculate:
    1. (a) the total specific risk capital charges that would apply just to the net long positions; and
    2. (b) the total specific risk capital charges that would apply just to the net short positions.
The total specific risk capital charge for securitisation and resecuritisation positions will be the higher of (3)(a) and (3)(b).

BIPRU 7.2.48B

handbook-rule
The firm must report to the FSA the total sum of its weighted net long and net short securitisation and resecuritisation positions, broken down by types of underlying assets.

BIPRU 7.2.48C

handbook-rule
When calculating the PRR of a protection seller in securitisation and resecuritisation credit derivatives, a firm must apply BIPRU 7.11.3 R.

BIPRU 7.2.48D

handbook-rule
Table: specific risk PRAs- standardised approach

BIPRU 7.2.48E

handbook-rule
Table: specific risk PRAs - IRB approach

BIPRU 7.2.48F

handbook-rule
  1. (1) A firm may use the supervisory formula method to calculate the appropriate PRA for specific risk where:
    1. (a) the firm is permitted to apply the supervisory formula method to the same position if it was held in its non-trading book in accordance with BIPRU 9.12; or
    2. (b) otherwise, the firm is expressly permitted by its VaR model permission to apply the supervisory formula method to calculate the appropriate PRA for specific risk.
  2. (2) The appropriate PRA under the supervisory formula method must be calculated by multiplying the risk weight calculated according to BIPRU 9.12.21 R by 8%.
  3. (3) Where relevant, estimates of PDs and LGDs as inputs to the supervisory formula method must be determined in accordance with BIPRU 4.
  4. (4) Where expressly permitted by its VaR model permission, a firm may use the approach outlined in BIPRU 7.10.55A R to BIPRU 7.10.55S G (Incremental Risk Charge) to determine PDs and LGDs as inputs to the supervisory formula method.

BIPRU 7.2.48G

handbook-rule
Where a securitisation position in the trading book is subject to an increased risk weight in accordance with BIPRU 9.15, the appropriate PRA must be calculated as 8% of the risk weight that would apply to the position in accordance with BIPRU 9.15.

BIPRU 7.2.48H

handbook-guidance
Originators, investors and sponsors of securitisations in the trading book will have to meet the requirements of BIPRU 9.3.1A R, BIPRU 9.3.15 R to BIPRU 9.3.20 R and BIPRU 9.15.

BIPRU 7.2.48I

handbook-guidance
  1. (1) Subject to BIPRU 7.2.48J G, BIPRU 9.15.9 R and BIPRU 9.15.10 R, where the investor, originator or sponsor of a securitisation fails to meet any of the requirements in BIPRU 9.3.18 R to BIPRU 9.3.20 R (Disclosure requirements) and BIPRU 9.15.11 R to BIPRU 9.15.16 R (investor due diligence requirements) in any material respect by reason of its negligence or omission, the FSA will use its powers under section 45 (Variation etc. on the Authority's own initiative) of the Act to impose an additional capital charge in accordance with BIPRU 7.2.48 GR. The additional capital charge imposed will be progressively increased with each relevant, subsequent infringement of the requirements in BIPRU 9.3.18 R to BIPRU 9.3.20 R and BIPRU 9.15.11 R to BIPRU 9.15.16A R, up to a maximum of 1250% risk weight.
  2. (2) Subject to BIPRU 9.3.22 G, BIPRU 9.15.9 R and BIPRU 9.15.10 R, where a credit institution fails to meet in any material respect the requirements in BIPRU 9.15.16A R (Group level requirements), the FSA may consider using its powers under section 45 (Variation etc on the Authority's own initiative) of the Act in the manner described in (1). In order to calculate the risk weights that would apply to the credit institution, the FSA may treat the securitisation investments of the subsidiary undertaking as if they were securitisation positions held directly by the credit institution.

BIPRU 7.2.48J

handbook-guidance
When calculating the additional capital charge it will impose under BIPRU 7.2.48G R, the FSA will take into account the exemption of certain securitisations from the scope of BIPRU 9.15.3 R under BIPRU 9.15.9 R and BIPRU 9.15.10 R and, if those exemptions are relevant, it will reduce the capital charge it would otherwise impose.

BIPRU 7.2.48K

handbook-rule
A securitisation exposure in the trading book that would be subject to deduction in accordance with GENPRU 2.2. (Capital resources) or to a 1250% risk weight in accordance with BIPRU 9 (Securitisation) is subject to a capital charge that is no less than that set out under those provisions, capped at the maximum possible default-risk-related loss. Unrated liquidity facilities are subject to a capital charge that is no less than that set out in BIPRU 9.

Specific risk: correlation trading portfolio

BIPRU 7.2.48L

handbook-rule
  1. (1) Where a firm holds a position in the correlation trading portfolio, it must calculate:
    1. (a) The total specific risk capital charges that would apply just to the net long positions of the correlation trading portfolio; and
    2. (b) The total specific risk capital charges that would apply just to the net short positions of the correlation trading portfolio.
  2. (2) The higher of (1)(a) and (1)(b) will be the specific risk capital charge for the correlation trading portfolio.
  3. (3) In calculating the specific risk capital charge of an individual net position in the correlation trading portfolio, a firm may cap the product of multiplying the individual net position by the appropriate PRA at the maximum possible default-risk-related loss. For a short position, a firm may calculate the maximum possible default-risk-related loss as a change in value due to the underlying names immediately becoming default-risk-free.

Definition of a qualifying debt security

BIPRU 7.2.49

handbook-rule

A debt security is a qualifying debt security if:

  1. (1) it qualifies for a credit quality step under the standardised approach to credit risk corresponding at least to investment grade; or
  2. (2) it has a PD which, because of the solvency of the issuer, is not higher than that of the debt securities referred to under (1) under the IRB approach; or
  3. (3) it is a debt security for which a credit assessment by a nominated ECAI is unavailable and which meets the following conditions:
    1. (a) it is considered by the firm to be sufficiently liquid;
    2. (b) it is of investment quality, according to the firm's own discretion, at least equivalent to that of the debt securities referred to under (1); and
    3. (c) it is listed on at least one regulated market or designated investment exchange; or
  4. (4) it is a debt security issued by an institution subject to the capital adequacy requirements set out in the Banking Consolidation Directive that satisfies the following conditions:
    1. (a) it is considered by the firm to be sufficiently liquid;
    2. (b) its investment quality is, according to the firm's own discretion, at least equivalent to that of the assets referred to under (1) above; or
  5. (5) it is a debt security issued by an institution that is deemed to be of equivalent or higher credit quality than that associated with credit quality step 2 under the standardised approach to credit risk and that is subject to supervision and regulatory arrangements comparable to those under the Capital Adequacy Directive.

BIPRU 7.2.50

handbook-rule
A firm must not treat a debt security as a qualifying debt security if it would be prudent to consider that the debt security concerned is subject to too high a degree of specific risk for it to be treated as a qualifying debt security.

BIPRU 7.2.51

handbook-guidance
The manner in which a firm assesses a debt security for the purpose of treatment as a qualifying debt security will be subject to scrutiny by the FSA. The FSA may take action to overturn the firm's judgement if it considers that the debt security should not be treated as a qualifying debt security.

General market risk calculation: General

BIPRU 7.2.52

handbook-rule

A firm must calculate the general market risk portion of the interest rate PRR for each currency using either:

  1. (1) the interest rate simplified maturity method;
  2. (2) the interest rate maturity method; or
  3. (3) the interest rate duration method.

BIPRU 7.2.53

handbook-rule

BIPRU 7.2.54

handbook-rule

A firm must not use the interest rate duration method for index-linked securities. Instead, these securities must:

  1. (1) be attributed a coupon of 3%; and
  2. (2) be treated separately under either the interest rate simplified maturity method or the interest rate maturity method.

General market risk calculation: Simplified maturity method

BIPRU 7.2.55

handbook-guidance
The interest rate simplified maturity method weights individual net positions to reflect their price sensitivity to changes in interest rates. The weights are related to the coupon and the residual maturity of the instrument (or the next interest rate re-fix date for floating rate items).

BIPRU 7.2.56

handbook-rule
Under the interest rate simplified maturity method, the portion of the interest rate PRR for general market risk equals the sum of each individual net position (long or short) multiplied by the appropriate PRA in the table in BIPRU 7.2.57R. A firm must assign its net positions to the appropriate maturity bands in the table in BIPRU 7.2.57R on the basis of residual maturity in the case of fixed-rate instruments and on the basis of the period until the interest rate is next set in the case of instruments on which the interest rate is variable before final maturity.

BIPRU 7.2.57

handbook-rule
Table: general market risk PRAs
This table belongs to BIPRU 7.2.56R.

General market risk calculation: The maturity method

BIPRU 7.2.58

handbook-guidance
The interest rate maturity method builds on the interest rate simplified maturity method by partially recognising offsetting positions. BIPRU 7.2.61G provides an illustration of the interest rate maturity method.

BIPRU 7.2.59

handbook-rule

Under the interest rate maturity method, the portion of the interest rate PRR for general market risk is calculated as follows:

  1. (1) Step 1: each net position is allocated to the appropriate maturity band in the table in BIPRU 7.2.57R and multiplied by the corresponding PRA;
  2. (2) Step 2: weighted long and short positions are matched within:
    1. (a) the same maturity band;
    2. (b) the same zone (using unmatched positions from (a)); and
    3. (c) different zones (using unmatched positions from (b) and matching between zones 1 and 2 and 2 and 3 before zone 1 and 3); and
  3. (3) Step 3: the portion of the interest rate PRR for general market risk is the sum of:
    1. (a) 10% of the total amount matched within maturity bands;
    2. (b) 40% of the amount matched within zone 1 under (2)(b);
    3. (c) 30% of the amount matched within zones 2 & 3 under (2)(b);
    4. (d) 40% of the amounts matched between zones 1 and 2, and between zones 2 and 3;
    5. (e) 150% of the amount matched between zones 1 and 3; and
    6. (f) 100% of the weighted positions remaining unmatched after (2)(c).

BIPRU 7.2.60

handbook-guidance
The table in BIPRU 7.2.57R distinguishes between debt securities with a coupon of less than 3% and those with coupon in excess of 3%. However, this does not mean that the firm has to do a separate general market risk calculation for each; it merely ensures that when allocating debt securities to a particular band, their coupons are taken into account as well as their maturities. So for example, a 21 year 6% debt security falls into the same band as an 11 year 2% debt security. They are both weighted at 6%, and can be matched under BIPRU 7.2.59R(2)(a) (the first part of step two of the interest rate maturity method calculation) because they fall within the same band.

BIPRU 7.2.61

handbook-guidance
This paragraph sets out an example of a calculation under the interest rate maturity method. In this example, a firm with a £ sterling base currency is processing its euro denominated positions.

General market risk calculation: Duration method

BIPRU 7.2.62

handbook-guidance
The interest rate duration method produces a more accurate measure of interest rate risk than the maturity methods but it is also more complex to calculate.

BIPRU 7.2.63

handbook-rule
  1. (1) A firm must use the following formula to calculate modified duration for the purpose of the interest rate duration method:
  3. (2)
  5. (3) For the purpose of the formulae in (1) and (2):
    1. (a) Ct=cash payment at time t
    2. (b) m=total maturity
    3. (c) r=yield to maturity. In the case of a fixed-rate debt security a firm must take the current mark to market of the debt security and thence calculate its yield to maturity, which is the implied discount rate for that instrument. In the case of a floating rate instrument, a firm must take the current mark to market of the debt security and thence calculate its yield on the assumption that the principal is due on the date that the interest rate can next be changed.
    4. (d) t=time

BIPRU 7.2.64

handbook-rule

Under the interest rate duration method, the portion of the interest rate PRR for general market risk is calculated as follows:

  1. (1) Step 1: allocate each net position to the appropriate duration zone in the table in BIPRU 7.2.65R and multiply it by:
    1. (a) its modified duration (using the formula in BIPRU 7.2.63R); and
    2. (b) the appropriate assumed interest rate change in the table in BIPRU 7.2.65R;
  2. (2) Step 2: match weighted long and short positions:
    1. (a) within zones; and
    2. (b) across zones (using unmatched positions from (2)(a) and following the process in BIPRU 7.2.59R (2)(c)); and
  3. (3) Step 3: calculate the portion of the interest rate PRR for general market risk as the sum of:
    1. (a) 100% of the weighted positions remaining unmatched after (2)(b);
    2. (b) 2% of the matched weighted position in each zone;
    3. (c) 40% of the matched weighted position between zones 1 and 2, and between zones 2 and 3; and
    4. (d) 150% of the matched weighted position between zones 1 and 3.

BIPRU 7.2.65

handbook-rule
Table: Assumed interest rate change in the interest rate duration method
This table belongs to BIPRU 7.2.64R

BIPRU 7.2.66

handbook-rule
If a firm uses the interest rate duration method it must do so on a consistent basis.

BIPRU 7.3

Equity PRR and basic interest rate PRR for equity derivatives

  • 01/01/2007

General rule

BIPRU 7.3.1

handbook-rule
  1. (1) A firm must calculate its equity PRR by:
    1. (a) identifying which positions must be included within the PRR calculation (see BIPRU 7.3.2R);
    2. (b) deriving the net position in each equity in accordance with BIPRU 7.3.23R;
    3. (c) including each of those net positions in either the simplified equity method (see BIPRU 7.3.29R) or, subject to BIPRU 7.3.27R, the standard equity method (see BIPRU 7.3.32R); and
    4. (d) summing the PRR on each net position as calculated under the simplified equity method and standard equity method.
  2. (2) All net positions, irrespective of their signs, must be converted on a daily basis into the firm's base currency at the prevailing spot exchange rate before their aggregation.

Scope of the equity PRR calculation

BIPRU 7.3.2

handbook-rule

A firm's equity PRR calculation must:

  1. (1) include all trading book positions in equities, unless:
    1. (a) the position is fully deducted as a material holding under the calculations under the capital resources table, in which case the firm may exclude it; or
    2. (b) the position is hedging an option or warrant which is being treated under BIPRU 7.6.26R (Table: Appropriate treatment for equities, debt securities or currencies hedging options);
  2. (2) include notional positions arising from trading book positions in the instruments listed in the table in BIPRU 7.3.3R; and
  3. (3) (if the firm is the transferor of equities or guaranteed rights relating to title to equities in a repurchase agreement or the lender of equities in an equities lending agreement) include such equities if those equities meet the criteria for inclusion in the trading book.

BIPRU 7.3.3

handbook-rule
Table: Instruments which result in notional positions
This table belongs to BIPRU 7.3.2R(2)

BIPRU 7.3.4

handbook-guidance
BIPRU 7.3.2R(1) includes a trading book position in an equity that is subsequently repo'd under a repurchase agreement or lent under a stock lending agreement. Clearly, if the equity had initially been obtained via a reverse repurchase agreement or stock borrowing agreement, the equity would not have been included in the trading book in the first place.

BIPRU 7.3.5

handbook-guidance
BIPRU 7.3.2R(1) includes net underwriting positions or reduced net underwriting positions in equities. BIPRU 7.3.27R requires a firm to use the simplified equity method in the case of reduced net underwriting positions. In the case of net underwriting positions that have not been reduced according to BIPRU 7.8.27R (Calculating the reduced net underwriting position), there is no such restriction; a firm can choose which of the two equity methods to use.

BIPRU 7.3.6

handbook-guidance

Firms are reminded that the table in BIPRU 7.6.5R (Table: Appropriate PRR calculation for an option or warrant) divides equity options and warrants into:

  1. (1) those which must be treated under BIPRU 7.6 (Option PRR); and
  2. (2) those which must be treated under either BIPRU 7.3 or BIPRU 7.6, the firm being able to choose whether BIPRU 7.3 or BIPRU 7.6 is used.

BIPRU 7.3.7

handbook-guidance
The table in BIPRU 7.3.3R does not require every convertible to be included in BIPRU 7.3 's PRR calculation. Where a convertible is not included in this PRR calculation, BIPRU 7.2.3R (1) (Scope of the interest rate PRR calculation) requires that it be included in the BIPRU 7.2PRR calculation.

BIPRU 7.3.8

handbook-guidance
Some of the instruments listed in the table in BIPRU 7.3.3R are also included in a firm's interest rate PRR calculation. For simplicity, a firm may use the interest rate PRR calculation in BIPRU 7.3 rather than the calculation in BIPRU 7.2 (Interest rate PRR). BIPRU 7.3.44G explains this in more detail.

Derivation of notional positions: General approach

BIPRU 7.3.9

handbook-guidance
BIPRU 7.3.10R - BIPRU 7.3.21R convert the instruments listed in the table in BIPRU 7.3.3R into notional positions in individual equities, equity baskets or equity indices.

BIPRU 7.3.10

handbook-rule
Unless specified otherwise, the value of each notional equity position equals the quantity of that equity underlying the instrument multiplied by the current market value of the equity.

BIPRU 7.3.11

handbook-guidance
  1. (1) An example of BIPRU 7.3.10R is as follows. The current market value of a particular equity is £2.50. If a firm contracts to sell this equity in five year's time for £3 it would treat the notional short equity position as having a value of £2.50 when calculating the equity PRR.
  2. (2) In effect, the forward position has been treated as being equivalent to a spot position for the purposes of calculating equity PRR. To capture the risk that the forward price changes relative to the spot price, forward equity positions are included in the firm's interest rate PRR calculation (see BIPRU 7.3.45R or the table in BIPRU 7.2.4R (Table: Instruments which result in notional positions)).

Derivation of notional positions: Depository receipts

BIPRU 7.3.12

handbook-rule
A depository receipt must be treated as a notional position in the underlying equity.

Derivation of notional positions: Convertibles

BIPRU 7.3.13

handbook-rule

Where a convertible is included in BIPRU 7.3's PRR calculation (see the table in BIPRU 7.3.3R):

  1. (1) it must be treated as a position in the equity into which it converts; and
  2. (2) the firm's equity PRR must be adjusted by making:
    1. (a) an addition equal to the current value of any loss which the firm would make if it did convert to equity; or
    2. (b) a deduction equal to the current value of any profit which the firm would make if it did convert to equity (subject to a maximum deduction equal to the PRR on the notional position underlying the convertible).

Derivation of notional positions: Futures, forwards and CFDs on a single equity

BIPRU 7.3.14

handbook-rule
A future (including a synthetic future), forward or CFD on a single equity must be treated as a notional position in that equity.

Derivation of notional positions: Futures, forwards and CFDs on equity indices or baskets

BIPRU 7.3.15

handbook-rule

A future (including a synthetic future), forward or CFD on an equity index or basket must be treated as either:

  1. (1) a position in each of the underlying equities; or
  2. (2) the positions shown in the table in BIPRU 7.3.16R.

BIPRU 7.3.16

handbook-rule
Table: Instruments which result in notional positions
This table belongs to BIPRU 7.3.15R(2)

BIPRU 7.3.17

handbook-guidance
An example of BIPRU 7.3.16R is as follows. A firm decides to treat a FTSE Eurotop 300 future under the standard equity method, and furthermore, chooses to treat it as one notional position. The table in BIPRU 7.3.16R requires that this notional position be treated as if it were from a separate notional country rather than any of the countries to which the underlying equities are from.

BIPRU 7.3.18

handbook-rule

The notional positions created under BIPRU 7.3.15R have the following values:

  1. (1) where only one notional position is created, it has a value equal to the total market value of the equities underlying the contract; or
  2. (2) where more than one notional position is created, each one has a value which reflects the relevant equity's or country's contribution to the total market value of the equities underlying the contract.

Derivation of notional positions: Equity legs of equity swaps

BIPRU 7.3.19

handbook-rule

The equity leg of an equity swap must be treated as a position in the underlying equity, equity basket or equity index, which is:

  1. (1) long, if the firm has contracted to receive any increase and pay any decrease in the value of the underlying equities or equity index; and
  2. (2) short, if the firm has contracted to receive any decrease and pay any increase in the value of the underlying equities or equity index.

BIPRU 7.3.20

handbook-guidance
The interest rate leg of an equity swap is included in a firm's interest rate PRR calculation (see the table in BIPRU 7.2.4R (Table: Instruments which result in notional positions)) unless it is treated under BIPRU 7.3.45R.

Derivation of notional positions: Options

BIPRU 7.3.21

handbook-rule

If included in BIPRU 7.3's PRR calculation (see the table in BIPRU 7.3.3R), options must be treated as follows:

  1. (1) an option on a single equity must be treated as a notional position in that equity;
  2. (2) an option on a basket of equities or equity index must be treated as a future on that basket or index; and
  3. (3) an option on an equity future must be treated as:
    1. (a) a long position in that future, for purchased call options and written put options; and
    2. (b) a short position in that future, for purchased put options and written call options.

Deriving the net position in each equity

BIPRU 7.3.22

handbook-rule
The net position in each equity is the difference between the value of the firm's long positions (including notional positions) and the value of its short positions (including notional positions) in the same equity.

BIPRU 7.3.23

handbook-rule
  1. (1) When deriving the net position in each equity, a firm must not net long and short positions except in accordance with this rule.
  2. (2) Subject to (3), a firm may net long and short positions in the same equity. Two equities are the same if and only if they:
    1. (a) enjoy the same rights in all respects; and
    2. (b) are fungible with each other.
  3. (3) Long and short positions in different tranches of the same equity may be treated as being in the same equity for the purpose of (1), where:
    1. (a) the tranches enjoy the same rights in all respects; and
    2. (b) the tranches become fungible with each other within 180 days, and thereafter the equity of one tranche can be delivered in settlement of the other tranche.

BIPRU 7.3.24

handbook-rule
A firm must not net a reduced net underwriting position with any other equity position.

BIPRU 7.3.25

handbook-guidance

Simplified and standard equity methods

BIPRU 7.3.26

handbook-guidance
BIPRU 7.3.1R (1) requires that the net position in each equity be included in either the simplified equity method or the standard equity method, subject to the restriction in BIPRU 7.3.27R. A firm does not have to use the same method for all equities.

BIPRU 7.3.27

handbook-rule

BIPRU 7.3.28

handbook-guidance
A firm may use either method for a net underwriting position; BIPRU 7.3.27R only relates to reduced net underwriting positions.

Simplified equity method

BIPRU 7.3.29

handbook-rule
Under the simplified equity method, the PRR for each equity, equity index, or equity basket equals the market value of the net position (ignoring the sign) multiplied by the appropriate PRA from the table in BIPRU 7.3.30R. The result must be converted into the firm's base currency at current spot foreign currency rates.

BIPRU 7.3.30

handbook-rule
Table: simplified equity method PRAs
This table belongs to BIPRU 7.3.29R

Standard equity method

BIPRU 7.3.31

handbook-guidance
The standard equity method divides the risk of loss from a firm's equity positions into the risk of loss from a general move in a country's equity market and the risk of loss from an individual equity's price changing relative to that country's equity market. These are called general market risk and specific risk respectively.

BIPRU 7.3.32

handbook-rule

Under the standard equity method, a firm must:

  1. (1) group equity positions into country portfolios as follows:
    1. (a) a position in an individual equity belongs to:
      1. (i) the country it is listed in;
      2. (ii) any of the countries it is listed in, if more than one; or
      3. (iii) the country it was issued from, if unlisted;
    2. (b) a position in an equity basket or index that is treated under BIPRU 7.3.15R(2), is allocated to one or more country portfolios based on the countries to which the underlying equities belong to under (a) or a notional country provided for in the table in BIPRU 7.3.16R; and
  2. (2) sum:
    1. (a) the PRRs for specific risk calculated under BIPRU 7.3.33R; and
    2. (b) the PRRs for general market risk for each country portfolio as calculated under BIPRU 7.3.41R and BIPRU 7.3.42R.

Standard equity method: Specific risk

BIPRU 7.3.33

handbook-rule
Under the standard equity method, a firm must calculate a PRR for specific risk based on the net position in each equity, equity index or equity basket by multiplying its market value (ignoring the sign) by the appropriate PRA from the table in BIPRU 7.3.34R.

BIPRU 7.3.34

handbook-rule
Table: PRAs for specific risk under the standard equity method
This table belongs to BIPRU 7.3.33R

Definition of a qualifying equity

Definition of a qualifying equity index

BIPRU 7.3.38

handbook-rule

A qualifying equity index is one which is traded on a recognised investment exchange or a designated investment exchange and:

  1. (1) is listed in the table in BIPRU 7.3.39R; or
  2. (2) is not listed in the table in BIPRU 7.3.39R, but is constructed in such a way that:
    1. (a) it contains at least 20 equities;
    2. (b) no single equity represents more than 20% of the total index; and
    3. (c) no five equities combined represent more than 60% of the total index.

BIPRU 7.3.39

handbook-rule
Table: Qualifying equity indices
This table belongs to BIPRU 7.3.38R

Standard equity method: General market risk: General

BIPRU 7.3.40

handbook-rule
Under the standard equity method, a firm must apply approach one, as set out in BIPRU 7.3.41R, to each country portfolio (or part portfolio) unless the conditions in BIPRU 7.3.42R(3) are met, in which case the firm may instead apply approach two, as set out in BIPRU 7.3.42R, to the relevant country portfolios (or part portfolios).

Standard equity method: General market risk: Approach One: No offset between different country portfolios

BIPRU 7.3.41

handbook-rule
Under approach one as referred to in BIPRU 7.3.40R, the PRR for general market risk equals the net value (ignoring the sign) of the country portfolio multiplied by 8%.

Standard equity method: General market risk: Approach Two: Limited offset between different country portfolios

BIPRU 7.3.42

handbook-rule
  1. (1) Under approach two as referred to in BIPRU 7.3.40R, the PRR for general market risk is calculated using the following formula:
  3. (2) In the formula in (1) CPi denotes the net value of ith country portfolio (converted to the firm's base currency using current spot foreign currency rates).
  4. (3) The conditions referred to in BIPRU 7.3.40R that must be met for a firm to be able to use approach two as referred to in BIPRU 7.3.40R are as follows:
    1. (a) at least four country portfolios are included (that is: n ≥ 4);
    2. (b) only country portfolios for countries which are full members of the OECD, Hong Kong or Singapore are included;
    3. (c) no individual country portfolio comprises more than 30% of the total gross value of country portfolios included; and
    4. (d) the total net value of country portfolios included equals zero, that is:

BIPRU 7.3.43

handbook-guidance
In order to meet BIPRU 7.3.42R(3)(d), it is likely that part of a country portfolio will have to be excluded from approach two under BIPRU 7.3.42R (and therefore included in approach one under BIPRU 7.3.41R), even if that country portfolio meets BIPRU 7.3.42R(3)(a) - (c).

Basic interest rate calculation for equity instruments

BIPRU 7.3.44

handbook-guidance
A basic interest rate PRR calculation is included in BIPRU 7.3 for a firm that does not wish to use the calculation in BIPRU 7.2 (Interest rate PRR). However, it tends to result in higher charges than the methods in BIPRU 7.2, largely because the interest rate PRR is calculated on each notional equity position separately and then summed without offsetting long and short positions.

BIPRU 7.3.45

handbook-rule

This rule applies to a firm that does not include a forward, future, option or swap on an equity, basket of equities or equity index in the calculation of its interest rate PRR calculation under BIPRU 7.2 (Interest rate PRR). However it does not apply to cliquet as defined in BIPRU 7.6.18R (Table: Option PRR: methods for different types of option). A firm must calculate the interest rate PRR for a position being treated under this rule as follows:

  1. (1) multiply the market value of the notional equity position underlying the instrument by the appropriate percentage from the table in BIPRU 7.3.47R; and
  2. (2) sum the results from (1), ignoring the sign.

BIPRU 7.3.46

handbook-guidance
Cliquets on equities, baskets of equities or equity indices do not attract an interest rate PRR. BIPRU 7.3.45R excludes them from the basic interest rate PRR calculation and the table in BIPRU 7.2.4R (Table: Instruments which result in notional positions) excludes them from the scope of the interest rate PRR calculation in BIPRU 7.2 (Interest rate PRR).

BIPRU 7.3.47

handbook-rule
Table: Percentages used in the basic interest rate PRR calculation for equity instruments
This table belongs to BIPRU 7.3.45R(1)

Additional capital charge in relation to equity indices

BIPRU 7.3.48

handbook-rule
If a firm nets off positions in one or more of the equities constituting an equity index future, forward or CFD against one or more positions in the equity index future, forward or CFD itself, the firm must apply an additional equity PRR to the netted position to cover the risk of loss caused by the value of the future, forward or CFD not moving fully in line with that of its constituent equities. The same applies if a firm holds opposite positions in a future, forward or CFD on an equity index that are not identical in respect of either their maturity or their composition or both.

BIPRU 7.4

Commodity PRR

  • 01/01/2007

General rule

BIPRU 7.4.1

handbook-rule

A firm must calculate its commodity PRR by:

  1. (1) identifying which commodity position must be included within the scope of the PRR calculation (see BIPRU 7.4.2R);
  2. (2) expressing each such position in terms of the standard unit of measurement of the commodity concerned;
  3. (3) expressing the spot price in each commodity in the firm's base currency at current spot foreign exchange rates;
  4. (4) calculating an individual PRR for each commodity (see BIPRU 7.4.20R); and
  5. (5) summing the resulting individual PRRs.

Scope of the commodity PRR calculation

BIPRU 7.4.2

handbook-rule

A firm's commodity PRR calculation must, regardless of whether the positions concerned are trading book or non-trading book positions:

  1. (1) include physical commodity positions;
  2. (2) (if the firm is the transferor of commodities or guaranteed rights relating to title to commodities in a repurchase agreement or the lender of commodities in a commodities lending agreement) include such commodities;
  3. (3) include notional positions arising from positions in the instruments listed in the table in BIPRU 7.4.4R; and
  4. (4) exclude positions constituting a stock financing transaction.

BIPRU 7.4.3

handbook-rule
Gold positions are excluded from the scope of the commodity PRR. Instead, they are included within the scope of the foreign exchange PRR (BIPRU 7.5).

BIPRU 7.4.4

handbook-rule
Table: Instruments which result in notional positions
This table belongs to BIPRU 7.4.2R(3)

BIPRU 7.4.5

handbook-guidance
BIPRU 7.4.2R includes a trading book position in a commodity that is subsequently repo'd under a repurchase agreement or lent under a stock lending agreement. Clearly, if the commodity had initially been obtained via a reverse repurchase agreement or stock borrowing agreement, the commodity would not have been included in the trading book in the first place.

BIPRU 7.4.6

handbook-guidance

Firms are reminded that the table in BIPRU 7.6.5R (Table: Appropriate PRR calculation for an option or warrant) divides commodity options into:

  1. (1) those which must be treated under BIPRU 7.6; and
  2. (2) those which must be treated under either BIPRU 7.4 or BIPRU 7.6 (Option PRR), the firm being able to choose whether BIPRU 7.4 or BIPRU 7.6 is used.

Derivation of notional positions: General

BIPRU 7.4.7

handbook-guidance
BIPRU 7.4.8R - BIPRU 7.4.19G convert the instruments listed in the table in BIPRU 7.4.4R into notional positions in the relevant commodities. These notional positions are expressed in terms of quantity (tonnes, barrels, etc), not value. The maturity of the position is only relevant where the firm is using the commodity maturity ladder approach or the commodity extended maturity ladder approach.

Derivation of notional positions: Futures, forwards, CFDs and options on a single commodity

BIPRU 7.4.8

handbook-rule

Where a forward, future, CFD, synthetic future or option (unless already included in the firm's option PRR calculation) settles according to:

  1. (1) the difference between the price set on trade date and that prevailing at contract expiry, the notional position:
    1. (a) equals the total quantity underlying the contract; and
    2. (b) has a maturity equal to the expiry date of the contract; and
  2. (2) the difference between the price set on trade date and the average of prices prevailing over a certain period up to contract expiry, there is a notional position for each of the reference dates used in the averaging period to calculate the average price, which:
    1. (a) equals a fractional share of the total quantity underlying the contract; and
    2. (b) has a maturity equal to the relevant reference date.

BIPRU 7.4.9

handbook-guidance
  1. (1) The following example illustrates BIPRU 7.4.8R (2).
  2. (2) A firm buys a Traded Average Price Option (TAPO - a type of Asian option) allowing it to deliver 100 tonnes of Grade A copper and receive $1,750 in June. If there were 20 business days in June the short notional positions will each:
    1. (a) equal 5 tonnes per day (1/20 of 100 tonnes); and
    2. (b) have a maturity equal to one of the business days in June (one for each day).
  3. (3) In this example as each business day in June goes by the quantity per day for the remaining days does not change (5 tonnes per day) only the days remaining changes. Therefore, halfway through June there are ten, 5 tonne short notional positions remaining each for the ten remaining business days in June.

Derivation of notional positions: Buying or selling a single commodity at an average of spot prices prevailing in the future

BIPRU 7.4.10

handbook-rule

Commitments to buy or sell at the average spot price of the commodity prevailing over some period between trade date and maturity must be treated as a combination of:

  1. (1) a position equal to the full amount underlying the contract with a maturity equal to the maturity date of the contract which is:
    1. (a) long, where the firm will buy at the average price; or
    2. (b) short, where the firm will sell at the average price; and
  2. (2) a series of notional positions, one for each of the reference dates where the contract price remains unfixed, each of which:
    1. (a) is long if the position under (1) is short, or short if the position under (1) is long;
    2. (b) equals a fractional share of the total quantity underlying the contract; and
    3. (c) has a maturity date of the relevant reference date.

BIPRU 7.4.11

handbook-guidance

The following guidance provides an example of BIPRU 7.4.10R. In January, a firm agrees to buy 100 tonnes of copper for the average spot price prevailing during the 20 business days in February, and will settle on 30 June. After entering into this agreement, the firm faces the risk that the average price for February increases relative to that for 30 June. Therefore, as highlighted in the table below:

  1. (1) the short positions reflect the fact that this could occur because any one of the remaining forward prices for February increase; and
  2. (2) the long position reflects the fact that this loss could occur because the forward price for 30 June falls.

BIPRU 7.4.12

handbook-guidance
Table: Example of buying at the average spot price prevailing in the future
This table belongs to BIPRU 7.4.11G

Derivation of notional positions: CFDs and options on a commodity index

BIPRU 7.4.13

handbook-rule

Commodity index futures and commodity index options (unless the option is included in the firm's option PRR calculation), must be treated as follows:

  1. (1) Step 1: the total quantity underlying the contract must be either:
    1. (a) treated as a single notional commodity position (separate from all other commodities); or
    2. (b) divided into notional positions, one for each of the constituent commodities in the index, of an amount which is a proportionate part of the total underlying the contract according to the weighting of the relevant commodity in the index;
  2. (2) Step 2: each notional position determined in Step 1 must then be included:
    1. (a) when using the commodity simplified approach (BIPRU 7.4.24R), without adjustment; or
    2. (b) when using the commodity maturity ladder approach (BIPRU 7.4.25R) or the commodity extended maturity ladder approach (BIPRU 7.4.32R), with the adjustments in BIPRU 7.4.14R.

BIPRU 7.4.14

handbook-rule
Table: Treatment of commodity index futures and commodity index options
This table belongs to BIPRU 7.4.13R(2)(b)

BIPRU 7.4.15

handbook-guidance
  1. (1) An example of using BIPRU 7.4.13R and the table in BIPRU 7.4.14R is as follows.
  2. (2) A firm is long a three-month commodity index future where the spot level of the index is based on the one, two and three month forward prices of aluminium, copper, tin, lead, zinc and nickel (18 prices in total).
  3. (3) Step 1: the firm should decide whether to treat the full quantity underlying the contract as a single notional commodity position or disaggregate it into notional positions in aluminium, copper, tin, lead, zinc and nickel. In this case the firm decides to disaggregate the contract into notional positions in aluminium, copper, tin, lead, zinc and nickel.
  4. (4) Step 2: if the firm uses the commodity simplified approach, nothing more need be done to arrive at the notional position. In this case the firm uses the commodity maturity ladder approach and so subdivides each position in each metal into three because the level of the index is based on the prevailing one, two and three month forward prices. Since the future will be settled in three months' time at the prevailing level of the index, the three positions for each metal will have maturities of four, five and six months respectively.

Derivation of notional positions: Commodity swaps

BIPRU 7.4.16

handbook-rule

A firm must treat a commodity swap as a series of notional positions, one position for each payment under the swap, each of which:

  1. (1) equals the total quantity underlying the contract;
  2. (2) has a maturity corresponding to the payment date; and
  3. (3) is long or short according to BIPRU 7.4.17R.

BIPRU 7.4.17

handbook-rule
Table: Treatment of commodity swaps
This table belongs to BIPRU 7.4.16R

BIPRU 7.4.18

handbook-guidance
The table in BIPRU 7.4.17R shows that where the legs of the swap are in different commodities, a series of forward positions are created for each commodity (that is, a series of short positions in commodity 'a' and a series of long positions in commodity 'b').

BIPRU 7.4.19

handbook-guidance
The table in BIPRU 7.4.17R also covers the case where one leg is unrelated to any commodity's price. This leg may be subject to a PRR under another part of BIPRU 7; for example, an interest rate based leg would have to be included in a firm's interest rate PRR calculation.

Calculating the PRR for each commodity: General

BIPRU 7.4.20

handbook-rule

BIPRU 7.4.21

handbook-rule
A firm must use the same approach for a particular commodity but need not use the same approach for all commodities.

BIPRU 7.4.22

handbook-rule
  1. (1) A firm must treat positions in different grades or brands of the same commodity-class as different commodities unless they:
    1. (a) can be delivered against each other; or
    2. (b) are close substitutes and have price movements which have exhibited a stable correlation coefficient of at least 0.9 over the last 12 months.
  2. (2) If a firm relies on (1)(b) it must then monitor compliance with the conditions in that paragraph on a continuing basis.

BIPRU 7.4.23

handbook-rule

If a firm intends to rely on the approach in BIPRU 7.4.22R(1)(b):

  1. (1) it must notify the FSA in writing at least 20 business days prior to the date the firm starts relying on it; and
  2. (2) the firm must, as part of the notification under (1), provide to the FSA the analysis of price movements on which it relies.

Calculating the PRR for each commodity: Simplified approach

BIPRU 7.4.24

handbook-rule

A firm which calculates a commodity PRR using the commodity simplified approach must do so by summing:

  1. (1) 15% of the net position multiplied by the spot price for the commodity; and
  2. (2) 3% of the gross position (long plus short, ignoring the sign) multiplied by the spot price for the commodity;

(and for these purposes the excess of a firm's long (short) positions over its short (long) positions in the same commodity (including notional positions under BIPRU 7.4.4R) is its net position in each commodity).

Calculating the PRR for each commodity: Maturity ladder approach

BIPRU 7.4.25

handbook-rule
A firm using the commodity maturity ladder approach must calculate the commodity PRR following the steps in BIPRU 7.4.26R and then sum all spread charges, carry charges and outright charges that result. A firm must use a separate maturity ladder for each commodity.

BIPRU 7.4.26

handbook-rule
  1. (1) A firm must calculate the charges referred to in BIPRU 7.4.25R as follows.
  2. (2) Step 1: offset long and short positions maturing:
    1. (a) on the same day; or
    2. (b) (in the case of positions arising under contracts traded in markets with daily delivery dates) within 10 business days of each other.
  3. (3) Step 2: allocate the positions remaining after step 1 to the appropriate maturity band in the table in BIPRU 7.4.28R (physical commodity positions are allocated to band 1).
  4. (4) Step 3: match long and short positions within each band. In each instance, calculate a spread charge equal to the matched amount multiplied first by the spot price for the commodity and then by the spread rate of 3%.
  5. (5) Step 4: carry unmatched positions remaining after step 3 to another band where they can be matched, then match them. Do this until all matching possibilities are exhausted. In each instance, calculate:
    1. (a) a carry charge equal to the carried position multiplied by the spot price for the commodity, the carry rate of 0.6% and the number of bands by which the position is carried; and
    2. (b) a spread charge equal to the matched amount multiplied by the spot price for the commodity and the spread rate of 3%.
  6. (6) Step 5: calculate the outright charge on the remaining positions (which will either be all long positions or all short positions). The outright charge equals the remaining position (ignoring the sign) multiplied by the spot price for the commodity and the outright rate of 15%.

BIPRU 7.4.27

handbook-guidance
The matched amount in BIPRU 7.4.26R is the lesser (ignoring the sign) of either the total long position or the total short position. For example, a band with 1000 long and 700 short results in a matched amount of 700. The unmatched amount would be 300.

BIPRU 7.4.28

handbook-rule
Table: Maturity bands for the maturity ladder approach
This table belongs to BIPRU 7.4.26R

BIPRU 7.4.29

handbook-guidance
BIPRU 7.4.30G is an example illustrating the calculation of the commodity PRR on an individual commodity using the commodity maturity ladder approach (BIPRU 7.4.26R). After the firm has carried out the pre-processing required by BIPRU 7.4.26R(2) (that is, step 1), it follows steps 2 to 5 as shown below. Because the firm is using the commodity maturity ladder approach the spread rate is 3%, the carry rate is 0.6% and the outright rate is 15%. The example assumes that the spot price for the commodity is £25.

BIPRU 7.4.30

handbook-guidance
Table: Example illustrating the commodity maturity ladder approach

This table belongs to BIPRU 7.4.29G

Calculating the PRR for each commodity: Extended maturity ladder approach

BIPRU 7.4.31

handbook-rule

A firm may use the commodity extended maturity ladder approach to calculate the commodity PRR for a particular commodity provided the firm:

  1. (1) has a diversified commodities portfolio;
  2. (2) undertakes significant commodities business;
  3. (3) is not yet in a position to use the VaR model approach to calculate commodity PRR; and
  4. (4) at least twenty business days before the date the firm uses that approach notifies the FSA in writing of:
    1. (a) its intention to use the commodity extended maturity ladder approach; and
    2. (b) the facts and matters relied on to demonstrate that the firm meets the criteria in (1) - (3).

BIPRU 7.4.32

handbook-rule

A firm using the commodity extended maturity ladder approach must calculate its commodity PRR by:

  1. (1) following the same steps as in BIPRU 7.4.26R but using the rates from the table in BIPRU 7.4.33R rather than those in BIPRU 7.4.26R; and
  2. (2) summing all spread charges, carry charges and outright charge that result.

BIPRU 7.4.33

handbook-rule
Table: Alternative spread, carry and outright rates
This table belongs to BIPRU 7.4.32R

BIPRU 7.4.34

handbook-guidance
For the purposes of BIPRU 7.4.31R(1) a firm has a diversified commodity portfolio where it holds positions in more than one commodity in each of the categories set out in the table in BIPRU 7.4.33R and holds positions across different maturities in those individual commodities. A firm would not have a diversified commodity portfolio if it held positions in only one commodity in each of the categories set out in the table in BIPRU 7.4.33R. This is because the rates in the table in BIPRU 7.4.33R assume firms have positions in more than one of that category's commodities. Different commodities within a given category are likely to exhibit different volatilities, so where a firm does not have a diversified commodity portfolio in that category, the rates applying to that category might underestimate the regulatory capital required for a certain commodity at certain times.

BIPRU 7.4.35

handbook-guidance
What constitutes significant business in BIPRU 7.4.31R(2) will vary from firm to firm. The more regularly the firm undertakes trades in commodities and the more consistently it has positions in the relevant commodity, the more likely it is to be undertaking significant business for the purposes of BIPRU 7.4.31R(2).

BIPRU 7.4.36

handbook-rule

Where a firm is:

  1. (1) treating a commodity index derivative as if it was based on a single separate commodity (see BIPRU 7.4.13R(1)(a)); and
  2. (2) using the commodity extended maturity ladder approach to calculate the commodity PRR for that commodity;

it must determine which index constituent incurs the highest rate in the table in BIPRU 7.4.33R and apply that rate to the notional position for the purposes of BIPRU 7.4.32R.

BIPRU 7.4.37

handbook-guidance
Where an index is only based on precious metals, BIPRU 7.4.13R and BIPRU 7.4.36R allow the firm to treat the single notional position as precious metal for the purposes of BIPRU 7.4.32R. However, if the index contained a mix of precious metals and base metals the firm would have to treat the notional position under BIPRU 7.4.36R as a base metal because base metals attract a higher rate than precious metals in the table in BIPRU 7.4.33R.

Liquidity and other risks

BIPRU 7.4.38

handbook-rule
If a short position to which BIPRU 7.4 applies falls due before a long position to which BIPRU 7.4 applies, a firm must also guard against the risk of a shortage of liquidity which may exist in some markets.

BIPRU 7.4.39

handbook-guidance
In particular, where BIPRU 7.4.38R applies and the short position constitutes a material position compared to a firm's total commodity positions, it should consider a further commodity PRR charge in respect of that position depending on the likelihood of a shortage of liquidity in that market.

BIPRU 7.4.40

handbook-rule
A firm must safeguard against other risks, apart from the delta risk, associated with commodity options.

BIPRU 7.4.41

handbook-rule
The interest-rate and foreign-exchange risks not covered by other provisions of BIPRU 7.4 or by the provisions of BIPRU 7.2 (Interest rate PRR) or BIPRU 7.5 (Foreign currency PRR) must be included in the calculation of general market risk for traded debt securities and in the calculation of foreign currency PRR.

BIPRU 7.5

Foreign currency PRR

  • 01/01/2007

General rule

BIPRU 7.5.1

handbook-rule

A firm must calculate its foreign currency PRR by:

  1. (1) identifying which foreign currency and gold positions to include in the PRR calculation;
  2. (2) calculating the net open position in each currency in accordance with this section (including where necessary the base currency calculated in the same way as it is for foreign currencies) and in gold;
  3. (3) calculating the open currency position for foreign currencies as calculated under BIPRU 7.5.19R and the net gold position (see BIPRU 7.5.20R); and
  4. (4) multiplying the sum of the absolutes of that open currency position and that net gold position by 8%.

BIPRU 7.5.2

handbook-guidance
An example of the operation of BIPRU 7.5.1R is as follows. A firm has an open currency position of £100 and a net gold position of £50. The sum (ignoring the sign) is £150, and so the foreign currency PRR is £12.

Scope of the foreign currency PRR calculation

BIPRU 7.5.3

handbook-rule

A firm's foreign currency PRR calculation must include the following items regardless of whether they are trading book or non-trading book positions:

  1. (1) all gold positions;
  2. (2) all spot positions in foreign currency (that is, all asset items less all liability items, including accrued interest, in the foreign currency in question);
  3. (3) all forward positions in foreign currency;
  4. (4) all CRD financial instruments and other items which are denominated in a foreign currency;
  5. (5) irrevocable guarantees (and similar instruments) that are certain to be called and likely to be irrecoverable to the extent they give rise to a position in gold or foreign currency; and
  6. (6) notional positions arising from the instruments listed in the table in BIPRU 7.5.5R.

BIPRU 7.5.4

handbook-rule
  1. (1) The following are excluded from a firm's foreign currency PRR calculation:
    1. (a) foreign currency assets which have been deducted in full from the firm's capital resources under the calculations under the capital resources table;
    2. (b) positions hedging (a);
    3. (c) positions that a firm has deliberately taken in order to hedge against the adverse effect of the exchange rate on the ratio of its capital resources to its capital resources requirement; and
    4. (d) transactions to the extent that they fully hedge net future foreign currency income or expenses which are known but not yet accrued.
  2. (2) If a firm uses an exclusion under (1) it must:
    1. (a) notify the FSA before it makes use of it;
    2. (b) include in the notification in (a) the terms on which the relevant item will be excluded;
    3. (c) not change the terms of the exclusion under (b); and
    4. (d) document its policy on the use of that exclusion in its trading book policy statement.
  3. (3) A position may only be excluded under (1)(b) or (c) if it is of a non-trading or structural nature.

BIPRU 7.5.5

handbook-rule
Table: instruments which result in notional foreign currency positions
This table belongs to BIPRU 7.5.3R(6).

BIPRU 7.5.6

handbook-guidance

Firms are reminded that the table in BIPRU 7.6.5R (Table: Appropriate PRR calculation for an option or warrant) divides foreign currency options and warrants into:

  1. (1) those which must be treated under BIPRU 7.6 (Option PRR); and
  2. (2) those which must be treated under either BIPRU 7.5 or BIPRU 7.6, the firm being able to choose whether BIPRU 7.5 or BIPRU 7.6 is used.

BIPRU 7.5.7

handbook-rule

When determining the currency of denomination firms must:

  1. (1) use the currency in which the firm accounts for the instrument where an instrument is quoted in more than one currency; and
  2. (2) treat depository receipts as positions in the underlying security.

BIPRU 7.5.8

handbook-guidance
Instruments denominated in a foreign currency include, amongst other things, assets and liabilities (including accrued interest); non-foreign currency derivative; net underwriting positions; reduced net underwriting positions; and irrevocable guarantees (or similar instruments) that are certain to be called.

BIPRU 7.5.9

handbook-rule
Where a contract is based on a basket of currencies, the firm can choose either to derive notional positions in each of the constituent currencies or treat it as a single notional position in a separate notional currency.

Derivation of notional positions: General

BIPRU 7.5.10

handbook-guidance
BIPRU 7.5.11R - BIPRU 7.5.18R derive notional currency positions for the instruments listed in the table in BIPRU 7.5.5R.

Derivation of notional positions: Foreign exchange forwards, futures, CFDs and synthetic futures

BIPRU 7.5.11

handbook-rule
  1. (1) A firm must treat a foreign currency forward, future, synthetic future or CFD as two notional currency positions as follows:
    1. (a) a long notional position in the currency which the firm has contracted to buy; and
    2. (b) a short notional position in the currency which the firm has contracted to sell.
  2. (2) In (1) the notional positions have a value equal to either:
    1. (a) the contracted amount of each currency to be exchanged in the case of a forward, future, synthetic future or CFD held in the non-trading book; or
    2. (b) the present value of the amount of each currency to be exchanged in the case of a forward, future, synthetic future or CFD held in the trading book.

BIPRU 7.5.12

handbook-guidance
  1. (1) The following example illustrates BIPRU 7.5.11R. In this example, a firm contracts to sell $106 for €108 in one year's time and the present values of each cash flow are $100 and €100 respectively.
  3. (2) In the non-trading book, this forward would be treated as a combination of a €108 long position and a $106 short position.
  4. (3) In the trading book, this forward would be treated as a combination of a €100 long position and a $100 short position.
  5. (4) Firms are reminded that foreign currency forwards held in the trading book should also be included in the firm's interest rate PRR calculation (see BIPRU 7.2.4R (Instruments which result in notional positions for the purpose of the interest rate PRR)).

Derivation of notional positions: Foreign currency swaps

BIPRU 7.5.13

handbook-rule
  1. (1) A firm must treat a foreign currency swap as:
    1. (a) a long notional position in the currency in which the firm has contracted to receive interest and principal; and
    2. (b) a short notional position in the currency in which the firm has contracted to pay interest and principal.
  2. (2) In (1) the notional positions have a value equal to either:
    1. (a) the nominal amount of each currency underlying the swap if it is held in the non-trading book; or
    2. (b) the present value amount of all cash flows in the relevant currency in the case of a swap held in the trading book.

BIPRU 7.5.14

handbook-guidance
  1. (1) The following example illustrates BIPRU 7.5.13R. In this example a firm enters into a five year foreign currency swap where it contracts to pay six month US$ Libor on $100 in return for receiving 6% fixed on €100. The present values of each leg are $100 and €98 respectively.
  2. (2) In the non-trading book, this swap would be treated as a combination of a €100 long position and a $100 short position.
  3. (3) In the trading book, this swap would be treated as a combination of a €98 long position and a $100 short position.
  4. (4) Firms are reminded that foreign currency swaps held in the trading book should also be included in the firm's interest rate PRR calculation (see BIPRU 7.2.4R (Instruments which result in notional positions for the purpose of the interest rate PRR)).

Derivation of notional positions: Foreign currency options and warrants

BIPRU 7.5.15

handbook-rule
Where included in BIPRU 7.5's PRR calculation (see the table in BIPRU 7.5.5R), a foreign currency option or warrant must be treated as a foreign currency forward.

Derivation of notional positions: Gold forwards, futures, synthetic futures and CFDs

BIPRU 7.5.16

handbook-rule
A forward, future, synthetic future or CFD on gold must be treated as a notional position in gold with a value equal to the amount of gold underlying multiplied by the current spot price for gold.

Derivation of notional positions: Gold options

BIPRU 7.5.17

handbook-rule
If included in the PRR calculation under BIPRU 7.5 (see the table in BIPRU 7.5.5R), a gold option must be treated as a gold forward.

Derivation of notional positions: CIUs

BIPRU 7.5.18

handbook-rule
  1. (1) This rule deals with positions in CIUs.
  2. (2) The actual foreign currency positions of a CIU must be included in a firm's foreign currency PRR calculation under BIPRU 7.5.1 R .
  3. (3) A firm may rely on third party reporting of the foreign currency positions in the CIU, where the correctness of this report is adequately ensured.
  4. (4) If a firm is not aware of the foreign currency positions in a CIU, the firm must assume that the CIU is invested up to the maximum extent allowed under the CIUs mandate in foreign currency and the firm must, for trading book positions, take account of the maximum indirect exposure that it could achieve by taking leveraged positions through the CIU when calculating its foreign currency PRR. This must be done by proportionally increasing the position in the CIU up to the maximum exposure to the underlying investment items resulting from the investment mandate.
  5. (5) The assumed position of the CIU in foreign currency calculated in accordance with BIPRU 7.5.18R(4) must be treated as a separate currency according to the treatment of investments in gold, subject to the modification that, if the direction of the CIUs investment is available, the total long position may be added to the total long open foreign currency position and the total short position may be added to the total short open foreign currency position. No netting is allowed between such positions prior to this calculation.

Open currency position

BIPRU 7.5.19

handbook-rule

A firm must calculate its open currency position by:

  1. (1) calculating the net position in each foreign currency;
  2. (2) converting each such net position into its base currency equivalent at current spot rates;
  3. (3) summing all short net positions and summing all long net positions calculated under (1) and (2); and
  4. (4) selecting the larger sum (ignoring the sign) from (3).

Net gold position

BIPRU 7.5.20

handbook-rule

A firm must calculate its net gold position by:

  1. (1) valuing all gold positions using the prevailing spot price for gold (regardless of the maturity of the positions);
  2. (2) offsetting long and short positions; and
  3. (3) converting the resulting net position into the base currency equivalent using the current spot foreign currency rate.

BIPRU 7.6

Option PRR

  • 01/01/2007

Option PRR calculation

BIPRU 7.6.1

handbook-rule

A firm must calculate its option PRR by:

  1. (1) identifying which option positions must be included within the scope of the option PRR calculation under BIPRU 7.6.3R - BIPRU 7.6.5R;
  2. (2) calculating the derived position in each option in accordance with BIPRU 7.6.9R - BIPRU 7.6.15R;
  3. (3) calculating the PRR for each derived position in accordance with BIPRU 7.6.16R - BIPRU 7.6.31R;
  4. (4) summing all of the PRRs calculated in accordance with (3).

BIPRU 7.6.2

handbook-guidance
Firms are reminded that the table in BIPRU 7.2.4R (Instruments which result in notional positions for the purposes of the interest rate PRR) and the table in BIPRU 7.3.3R (Instruments which result in notional positions for the purposes of the equity PRR) also require an interest rate PRR to be calculated for options on equities, baskets of equities or equities indices. The interaction between BIPRU 7.6 and the rest of Chapter 7 is illustrated in BIPRU 7.6.33G.

Scope of the option PRR calculation

BIPRU 7.6.3

handbook-rule

Except as permitted under BIPRU 7.6.5R, a firm's option PRR calculation must include:

  1. (1) each trading book position in an option on an equity, interest rate or debt security;
  2. (2) each trading book position in a warrant on an equity or debt security;
  3. (3) each trading book position in a CIU; and
  4. (4) each trading book and non-trading book position in an option on a commodity, currency or gold.

BIPRU 7.6.4

handbook-guidance

BIPRU 7.6.5

handbook-rule
Table: Appropriate PRR calculation for an option or warrant
This table belongs to BIPRU 7.6.3R

The in the money percentage

BIPRU 7.6.6

handbook-rule
  1. (1) The in the money percentage is calculated in accordance with this rule.
  2. (2) For a call option:
  3. Current market price of underlying - Strike price of the option * 100
  4. Strike price of the option
  5. (3) For a put option:
  6. Strike price of option - Current market price of underlying * 100
  7. Strike price of the option
  8. (4) In the case of an option on a basket of securities a firm may not treat the option as being in the money by the relevant percentage so as to enable the firm not to apply an option PRR under BIPRU 7.6.5R unless the conditions in BIPRU 7.6.5R are satisfied with respect to each kind of underlying investment.
  9. (5) (4) also applies to an option on a CIU if a firm is using one of the CIU look through methods.

The appropriate PRA

BIPRU 7.6.7

handbook-rule
  1. (1) The appropriate PRA for a position is that listed in the table in BIPRU 7.6.8R against the relevant underlying position.
  2. (2) If the firm uses the commodity extended maturity ladder approach or the commodity maturity ladder approach for a particular commodity under BIPRU 7.4 (Commodity PRR) the appropriate PRA for an option on that commodity is the outright rate applicable to the underlying position (see BIPRU 7.4.26R (Calculating the PRR for each commodity: Maturity ladder approach) and BIPRU 7.4.33R (Table: Alternative spread, carry and outright rates)).
  3. (3) If a firm does not have commodity positions treated under BIPRU 7.4 or does not have positions in the commodity in question treated under BIPRU 7.4 the restrictions in BIPRU 7.4 that regulate when a firm can and cannot use a particular method of calculating the commodity PRR apply for the purpose of establishing the appropriate PRA for the purposes of BIPRU 7.6.
  4. (4) If a firm is using one of the CIU look through methods for an option on a CIU the leveraging requirements in BIPRU 7.7 (Position risk requirements for collective investment undertakings) apply (see BIPRU 7.7.11R). For this purpose the amount of the appropriate PRAs under BIPRU 7.6.6R(5) is increased by the amount of that leveraging (expressed as a percentage) as calculated under BIPRU 7.7, subject to a maximum appropriate PRA of 32%.

BIPRU 7.6.8

handbook-rule
Table: Appropriate PRA
This table belongs to BIPRU 7.6.7R

Calculating derived positions

BIPRU 7.6.9

handbook-rule
A firm must calculate the derived position specified in the table in BIPRU 7.6.13R for each position included in its option PRR calculation.

Netting positions

BIPRU 7.6.10

handbook-rule
A firm may calculate a derived position for its net position in an option or a warrant, if the relevant options or warrants are identical or may be treated as identical under BIPRU 7.6.11R or BIPRU 7.6.12R.

BIPRU 7.6.11

handbook-rule
A firm may treat options or warrants as identical if they have the same strike price, maturity (except for an interest rate cap or floor - see BIPRU 7.6.12R) and underlying.

BIPRU 7.6.12

handbook-rule
A firm may treat as identical a purchased interest rate cap (or floor) and a written interest rate cap (or floor) only if they mature within 30 days of each other and all other terms are identical (a cap may not be netted against a floor).

Derived positions

BIPRU 7.6.13

handbook-rule
Table: Derived positions
This table belongs to BIPRU 7.6.9R

Combinations of options which can be treated as one option

BIPRU 7.6.14

handbook-rule

A firm may treat (for the purpose of calculating an option PRR under BIPRU 7.6) an option strategy listed in the table in BIPRU 7.6.15R as the single position in a notional option specified against that strategy in the table in BIPRU 7.6.15R, if:

  1. (1) each element of the strategy is transacted with the same counterparty;
  2. (2) the strategy is documented as a single structure;
  3. (3) the underlying for each part of the composite position (including any actual holding of the underlying) is the same under the PRR identical product netting rules;
  4. (4) the netting achieved does not result overall in a greater degree of netting in the calculation of the market risk capital requirement than would be permitted under the other standard market risk PRR rules;
  5. (5) each option in the structure has the same maturity and underlying; and
  6. (6) the constituent parts of the structure form an indivisible single contract, so that neither party can unwind or default on one part of the structure without doing so for the contract as a whole;

except that (1) and (6) only apply to the extent possible with respect to any part of the composite position held by the firm that consists of an actual holding of the underlying.

BIPRU 7.6.15

handbook-rule
Table: Option strategies
This table belongs to BIPRU 7.6.14R

The option PRR for an individual positions

BIPRU 7.6.16

handbook-rule
A firm must calculate the option PRR for each individual derived option position using the method specified in the table in BIPRU 7.6.18R, or, if more than one method is permitted, using one of those methods.

BIPRU 7.6.17

handbook-rule
A firm must convert its positions into its base currency in accordance with the procedures that apply for whichever of the other PRR charges is appropriate (see BIPRU 7.2.1R(3), BIPRU 7.3.1R(2), BIPRU 7.4.1R(3), BIPRU 7.5.19R(2), BIPRU 7.5.20R(3) and BIPRU 7.7.1R(3)).

BIPRU 7.6.18

handbook-rule
Table: Option PRR: methods for different types of option
This table belongs to BIPRU 7.6.16R

BIPRU 7.6.19

handbook-guidance
  1. (1) The option standard method is described in BIPRU 7.6.20R - BIPRU 7.6.22R.
  2. (2) The option hedging method is described in BIPRU 7.6.23G - BIPRU 7.6.28R.

The standard method: Purchased options and warrants

BIPRU 7.6.20

handbook-rule

Under the option standard method, the PRR for a purchased option or warrant is the lesser of:

  1. (1) the market value of the derived position (see BIPRU 7.6.9R) multiplied by the appropriate PRA (see BIPRU 7.6.8R); and
  2. (2) the market value of the option or warrant.

The standard method: Written options and warrants

BIPRU 7.6.21

handbook-rule
Under the option standard method, the PRR for a written option or warrant is the market value of the derived position (see BIPRU 7.6.9R) multiplied by the appropriate PRA (see BIPRU 7.6.8R). This result may be reduced by the amount the option or warrant is out of the money (subject to a maximum reduction to zero).

The standard method: Underwriting or sub-underwriting an issue of warrants

BIPRU 7.6.22

handbook-rule
Under the option standard method, the PRR for underwriting or sub-underwriting an issue of warrants is the net underwriting position (or reduced net underwriting position) multiplied by the current market price of the underlying securities multiplied by the appropriate PRA, but the result can be limited to the value of the net underwriting position (or reduced net underwriting position) calculated using the issue price of the warrant.

The hedging method

BIPRU 7.6.23

handbook-guidance
The option hedging method involves the option PRR being calculated on a combination of the option and its hedge.

BIPRU 7.6.24

handbook-rule

Under the option hedging method a firm must calculate the option PRR for individual positions as follows:

  1. (1) for an option or warrant on an equity, basket of equities or equity index and its equity hedge(s), the firm must, to the extent specified or permitted in the table in BIPRU 7.6.26R, use the calculation in the table in BIPRU 7.6.27R;
  2. (2) for an option or warrant on a debt security, basket of debt securities or debt security index and its debt security hedge(s), the firm must, to the extent specified or permitted in the table in BIPRU 7.6.26R, use the calculation in the table in BIPRU 7.6.27R;
  3. (3) for an option on gold and its gold hedge, the firm must, to the extent specified or permitted in the table in BIPRU 7.6.26R, use the calculation in the table in BIPRU 7.6.27R; and
  4. (4) for an option on a currency and its currency hedge, the firm must, to the extent specified or permitted in the table in BIPRU 7.6.26R, use the calculation in the table in BIPRU 7.6.28R.

BIPRU 7.6.25

handbook-rule
  1. (1) A firm may not use the option hedging method for:
    1. (a) an interest rate option and its hedge; or
    2. (b) a commodity option and its hedge; or
    3. (c) a CIU option and its hedge.
  2. (2) A firm may only use the option hedging method if the item underlying the option or warrant is the same as the hedge of the option or warrant under the PRR identical product netting rules.

BIPRU 7.6.26

handbook-rule
Table: Appropriate treatment for equities, debt securities or currencies hedging options
This table belongs to BIPRU 7.6.24R

BIPRU 7.6.27

handbook-rule
Table: The hedging method of calculating the PRR (equities, debt securities and gold)
This table belongs to BIPRU 7.6.24R(1) - (3)

BIPRU 7.6.28

handbook-rule
Table: The hedging method of calculating the PRR (currencies)
This table belongs to BIPRU 7.6.24R(4)

Specific methods and treatments: Digital options

BIPRU 7.6.29

handbook-rule
The option PRR for a digital option is the maximum loss of the option.

Specific methods and treatments: Written cliquet options

BIPRU 7.6.30

handbook-rule

The option PRR for a written cliquet option is the market value of the derived position (see BIPRU 7.6.9R) multiplied by the appropriate PRA (see BIPRU 7.6.8R) multiplied by F+1 (see the following provisions of this paragraph). This result may be reduced by the amount the option is out of the money (subject to a maximum reduction to zero). The option PRR for a written cliquet option is therefore defined by the following formula:
[ PRA * underlying * (F + 1)] - OTM
where:

  1. (1)
  3. (2) FR= Number of forward re-sets
  4. (3) Y= Years to maturity
  5. (4) OTM= the amount by which the option is out of the money

Specific methods and treatments: Quantos

BIPRU 7.6.31

handbook-rule
If the pay-out to the holder of a quanto option is fixed at the inception of the transaction a firm must add 8% to the PRA when applying the option standard method.

Interaction with other chapters

BIPRU 7.6.32

handbook-guidance
The application of an option PRR to a position does not prevent any of the other PRR charges from applying if they would otherwise do so. In particular if a firm applies an option PRR to an equity derivative an interest rate PRR will also generally apply.

BIPRU 7.6.33

handbook-guidance
The following diagram illustrates the relationship between BIPRU 7.6 and the rest of BIPRU 7.

Options on a commodity

BIPRU 7.6.34

handbook-rule
BIPRU 7.4.38R to BIPRU 7.4.41R (Liquidity and other risks) apply to commodity options treated under BIPRU 7.6 as well as to those treated under BIPRU 7.4 (Commodity PRR).

Options on a CIU

BIPRU 7.6.35

handbook-rule

For the purpose of identifying the appropriate treatment for the purpose of BIPRU 7.6.5R, the underlying position for the purpose of BIPRU 7.6.8R and the derived position under BIPRU 7.6.13R a firm may choose between treating an option on a CIU as being:

  1. (1) a position in the CIU itself; or
  2. (2) (if the conditions in BIPRU 7.7 (Position risk requirements for collective investment undertakings) for the use of the method in question are satisfied) positions in the underlying investments or assumed positions arising through the use of the standard CIU look through method or the modified CIU look through method.

BIPRU 7.6.36

handbook-guidance
  1. (1) This paragraph gives an example of how the appropriate PRA should be calculated for the purpose of deciding whether or not an option on a CIU is sufficiently in the money for the firm to have a choice whether or not to apply an option PRR. This example assumes that there is no leveraging (see BIPRU 7.7.11R (CIU modified look through method)).
  2. (2) Say that the CIU contains underlying equity position and the firm is using one of the CIU look through methods. The appropriate PRA for some is 8% and for the others is 12%. The firm should identify the highest appropriate PRA for the underlyings. In this case it is 12%. Therefore in this case the option would need to be in the money by more than 12% in order for the firm to have a choice between applying the option PRR or one of the other PRR charges.
  3. (3) However if the firm is not using one of the CIU look through methods the option would need to be in the money by more than 32% in order for the firm to have a choice between applying the option PRR or the CIU PRR.

BIPRU 7.6.37

handbook-guidance
BIPRU 7.6.10R - BIPRU 7.6.12R are subject to BIPRU 7.7.3R (netting). BIPRU 7.7.4R (use of third party) applies for the purpose of BIPRU 7.6.

BIPRU 7.7

Position risk requirements for collective investment undertakings

  • 01/01/2007

Collective investment undertaking PRR calculation

BIPRU 7.7.1

handbook-rule

A firm must calculate its CIU PRR by:

  1. (1) identifying which CIU positions must be included within the scope of the PRR calculation (see BIPRU 7.7.2R);
  2. (2) identifying which CIU positions are to be subject to the CIU PRR and which positions are to be subject to one of the other PRR charges;
  3. (3) converting on a daily basis net positions into the firm's base currency at the prevailing spot exchange rate before their aggregation;
  4. (4) calculating an individual PRR for each position in a CIU (see BIPRU 7.7.5R);
  5. (5) summing the resulting individual PRRs.

Scope of the PRR calculation for collective investment undertakings

BIPRU 7.7.2

handbook-rule
  1. (1) A firm's PRR calculation must include all trading book positions in CIUs.
  2. (2) A firm's CIU PRR calculation must include all trading book positions in CIUs unless they are treated under one of the CIU look through methods and included in the PRR calculations for the relevant underlying investments or subject to an option PRR.
  3. (3) A firm's PRR calculation for CIUs must include notional positions arising from trading book positions in options or warrants on collective investment undertakings.

General rules

BIPRU 7.7.3

handbook-rule
Unless noted otherwise, no netting is permitted between the underlying investments of a CIU and other positions held by a firm for the purposes of calculating the PRR charge for a position in a CIU.

BIPRU 7.7.4

handbook-rule
A firm may rely on a third party to calculate and report PRR capital requirements for position risk (general market risk and specific risk) for positions in CIUs falling within BIPRU 7.7.9R and BIPRU 7.7.11R, in accordance with the methods set out in BIPRU 7.7, provided that the correctness of the calculation and the report is adequately ensured.

Calculation of the collective investment undertaking PRR

BIPRU 7.7.5

handbook-rule
Without prejudice to other provisions in BIPRU 7.7, a position in a CIU is subject to a collective investment undertaking PRR (general market risk and specific risk) of 32%. Without prejudice to provisions in BIPRU 7.5.18R (Foreign currency PRR for CIUs) or, if the firm has a VaR model permission, BIPRU 7.10.44R (Commodity risks and VaR models) taken together with BIPRU 7.5.18R, where the modified gold treatment set out in those rules is used, a position in a CIU is subject to a securities PRR requirement for position risk (general market risk and specific risk ) and a foreign currency PRR of no more than 40%.

Look through methods: General criteria

BIPRU 7.7.6

handbook-rule

A firm may determine the securities PRR requirement for positions in CIUs which meet the criteria set out in BIPRU 7.7.7R, by one of the following methods:

  1. (1) the standard CIU look through method (BIPRU 7.7.4R and BIPRU 7.7.7R - BIPRU 7.7.10R); or
  2. (2) the modified CIU look through method (BIPRU 7.7.4R, BIPRU 7.7.7R - BIPRU 7.7.8R and BIPRU 7.7.11R - BIPRU 7.7.12R).

BIPRU 7.7.7

handbook-rule

The general eligibility criteria for using the methods in BIPRU 7.7.4R and BIPRU 7.7.9R - BIPRU 7.7.11R, for CIUs issued by companies supervised or incorporated within the EEA are that:

  1. (1) the CIU's prospectus or equivalent document must include:
    1. (a) the categories of assets the CIU is authorised to invest in;
    2. (b) if investment limits apply, the relative limits and the methodologies to calculate them;
    3. (c) if leverage is allowed, the maximum level of leverage; and
    4. (d) if investment in OTC financial derivatives or repo-style transactions are allowed, a policy to limit counterparty risk arising from these transactions;
  2. (2) the business of the CIU must be reported in half-yearly and annual reports to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period;
  3. (3) the units/shares of the CIU are redeemable in cash, out of the undertaking's assets, on a daily basis at the request of the unit holder;
  4. (4) investments in the CIU must be segregated from the assets of the CIU manager; and
  5. (5) there must be adequate risk assessment, by the investing firm, of the CIU.

BIPRU 7.7.8

handbook-rule
Third country CIUs are eligible if the requirements in BIPRU 7.7.7R (1) - BIPRU 7.7.7R (5) are met.

Standard CIU look through method: General

BIPRU 7.7.9

handbook-rule
  1. (1) Where a firm is aware of the underlying investments of the CIU on a daily basis the firm may look through to those underlying investments in order to calculate the securities PRR for position risk (general market risk and specific risk) for those positions in accordance with the methods set out in the securities PRR requirements or, if the firm has a VaR model permission, in accordance with the methods set out in BIPRU 7.10 (Use of a Value at Risk Model).
  2. (2) Under this approach, positions in CIUs must be treated as positions in the underlying investments of the CIU. Netting is permitted between positions in the underlying investments of the CIU and other positions held by the firm, as long as the firm holds a sufficient quantity of units to allow for redemption/creation in exchange for the underlying investments.

Standard CIU look through method: Index or basket funds

BIPRU 7.7.10

handbook-rule
  1. (1) A firm may calculate the securities PRR for position risk (general market risk and specific risk) for positions in CIUs in accordance with the methods set out in the securities PRR requirements or, if the firm has a VaR model permission, in accordance with the methods set out in BIPRU 7.10 (Use of a Value at Risk Model), to assumed positions representing those necessary to replicate the composition and performance of the externally generated index or fixed basket of equities or debt securities referred to in (a), subject to the following conditions:
    1. (a) the purpose of the CIU's mandate is to replicate the composition and performance of an externally generated index or fixed basket of equities or debt securities; and
    2. (b) a minimum correlation of 0.9 between daily price movements of the CIU and the index or basket of equities or debt securities it tracks can be clearly established over a minimum period of six months.
  2. (2) Correlation as referred to in (1)(b) means the correlation coefficient between daily returns on the CIU and the index or basket of equities or debt securities it tracks.

CIU modified look through method

BIPRU 7.7.11

handbook-rule

Where a firm is not aware of the underlying investments of the CIU on a daily basis, the firm may calculate the securities PRR for position risk (general market risk and specific risk) in accordance with the methods set out in the securities PRR requirements, subject to the following conditions:

  1. (1) it must be assumed that the CIU first invests to the maximum extent allowed under its mandate in the asset classes attracting the highest securities PRR for position risk (general market risk and specific risk), and then continues making investments in descending order until the maximum total investment limit is reached;
  2. (2) the firm must take account of the maximum indirect exposure that it could achieve by taking leveraged positions through the CIU when calculating its securities PRR for position risk, by proportionally increasing the position in the CIU up to the maximum exposure to the underlying investment items resulting from the investment mandate; and
  3. (3) should the securities PRR for position risk (general market risk and specific risk) under this approach exceed that set out in BIPRU 7.7.5R, the PRR charge must be capped at that level.

BIPRU 7.7.12

handbook-rule
For the purpose of BIPRU 7.7.11R (1) the position in the CIU must be treated as a direct holding in the assumed position.

CAD 1 models and VaR models

BIPRU 7.7.13

handbook-guidance

Where BIPRU 7.7 permits a firm to calculate the PRR charge for a position in a CIU using the rules in BIPRU 7 relating to the underlying investment, a firm that has:

  1. (1) a CAD 1 model waiver that covers positions in CIUs may use the rules as modified by that waiver; and
  2. (2) a VaR model permission that covers positions in CIUs may use its VaR model.

Options on a CIU

BIPRU 7.7.14

handbook-guidance
An option on a CIU should be treated in accordance with BIPRU 7.6.35R to BIPRU 7.6.37G (Options on a CIU).

BIPRU 7.8

Securities underwriting

  • 01/01/2007

General rules

BIPRU 7.8.1

handbook-guidance
BIPRU 7.8 sets out the method for calculating a net underwriting position or reduced net underwriting position, which is then included in the PRR calculation in other parts of BIPRU 7. It also deals with concentration risk. BIPRU 7.8 only relates to new securities, which is defined in BIPRU 7.8.12R.

BIPRU 7.8.2

handbook-rule

A firm which underwrites or sub-underwrites an issue of securities must, for the purposes of calculating its market risk capital component and its concentration risk capital component:

  1. (1) identify commitments to underwrite or sub-underwrite which give rise to an underwriting position (see BIPRU 7.8.8R);
  2. (2) identify the time of initial commitment (see BIPRU 7.8.13R); and
  3. (3) calculate the net underwriting position (set out in BIPRU 7.8.17R), reduced net underwriting position or the net underwriting exposure.

BIPRU 7.8.3

handbook-rule

A firm must include the net underwriting position or reduced net underwriting position in whichever one or more of the following is or are relevant:

  1. (1) BIPRU 7.2.3R (1) where debt securities are being underwritten;
  2. (2) BIPRU 7.3.2R (1) where equities are being underwritten;
  3. (3) BIPRU 7.6.22R where warrants are being underwritten; and
  4. (4) BIPRU 7.5.3R where the equities, debt securities or warrants being underwritten are denominated in a foreign currency.

BIPRU 7.8.4

handbook-rule
A firm must comply with BIPRU 7.8.3R from initial commitment (as determined under BIPRU 7.8.8R) until the end of the fifth business day after working day 0 (as determined under BIPRU 7.8.23R).

BIPRU 7.8.5

handbook-guidance
Sub-underwriting is a commitment given by one firm to someone other than the issuer or seller of the securities to sub-underwrite all or part of an issue of securities.

BIPRU 7.8.6

handbook-guidance
The net underwriting position calculated in BIPRU 7.8.17R will also be used in calculating the net underwriting exposure under BIPRU 7.8.34R.

BIPRU 7.8.7

handbook-guidance
The net underwriting position or reduced net underwriting position arising from underwriting or sub-underwriting a rights or warrants issue should be calculated using the current market price of the underlying security for the purposes of the equity PRR or option PRR. However, the PRR will be limited to the value of the net underwriting position calculated using the initial issue price of the rights or warrants. Where there is no market price because the rights or warrants are in relation to a new class of securities and the initial price has not been set the net underwriting position or reduced net underwriting is the amount of the commitment.

Commitment to underwriting securities

BIPRU 7.8.8

handbook-rule
  1. (1) For the purpose of BIPRU 7.8.2R (1), a firm has a commitment to underwrite or sub-underwrite an issue of securities where:
    1. (a) it gives a commitment to an issuer of securities to underwrite an issue of securities; or
    2. (b) (where BIPRU 7.8.12R (2) applies) it gives a commitment to a seller of securities to underwrite a sale of those securities;
    3. (c) it gives a commitment to a person, other than the issuer of securities or, if BIPRU 7.8.12R (2) applies, the seller of the securities, to sub-underwrite an issue of securities; or
    4. (d) it is a member of a syndicate or group that gives a commitment of the type described in (1)(a)-(c).
  2. (2) Unless a rule deals with them separately or the context otherwise requires, a provision of BIPRU 7.8 that deals with underwriting also applies to sub-underwriting.

Exclusions from BIPRU 7.8

BIPRU 7.8.9

handbook-guidance
  1. (1) Block trades, including bought deals, and private placements are not within the scope of BIPRU 7.8 because they involve an outright purchase by the firm of the relevant securities.
  2. (2) For the purpose of BIPRU 7.8 securities include debt and equity instruments and convertibles but excludes loans.

Grey market transactions

BIPRU 7.8.10

handbook-rule
  1. (1) A firm that buys and sells securities before issue is dealing in the grey market for the purposes of BIPRU 7.8.
  2. (2) BIPRU 7.8 does not apply to a firm with respect to its dealings in the grey market unless the firm:
    1. (a) has an underwriting commitment to the issuer in respect of those securities; or
    2. (b) has a sub-underwriting commitment in respect of those securities and is using the grey market solely for the purpose of reducing that sub-underwriting commitment.
  3. (3) BIPRU 7.8 does not apply to a firm with respect to its dealings in the grey market if the transaction is undertaken by the proprietary trading part of the firm or is undertaken for proprietary trading purposes.
  4. (4) BIPRU 7.8 does not apply to a firm with respect to its dealings in the grey market except as described in BIPRU 7.8.17R.

BIPRU 7.8.11

handbook-guidance
In BIPRU 7.8 the grey market is the market in which dealers "buy" and "sell" securities ahead of issue. In reality the dealers are buying and selling promises to deliver the securities when issued.

New securities

BIPRU 7.8.12

handbook-rule

For the purposes of BIPRU 7.8, a firm must treat securities as being new for the purposes of the definition of underwriting if they are:

  1. (1) securities that, prior to the allotment following the underwriting, were not in issue; or
  2. (2) securities that do not fall within (1) but that have not previously been offered for sale or subscription to the public and have not been admitted to trading on a market operated by a recognised investment exchange or an overseas investment exchange.

Time of initial commitment

BIPRU 7.8.13

handbook-rule

Subject to BIPRU 7.8.14R, the time of initial commitment is the earlier of:

  1. (1) (in the case of underwriting) the time the firm agrees with the issuer of securities to underwrite those securities; or
  2. (2) (in the case of underwriting falling under BIPRU 7.8.12R (2)) the time the firm agrees with the seller of securities to underwrite those securities; or
  3. (3) (in the case of sub-underwriting) the time the firm agrees with the person referred to BIPRU 7.8.8R (1)(c) to sub-underwrite those securities; or
  4. (4) (in the case of BIPRU 7.8.8R (1)(d)) the time the group or syndicate in question (or a member of that group or syndicate on behalf of the others) agrees with the issuer or other person to whom the commitment is given as referred to in BIPRU 7.8.8R (1)(d) to underwrite or sub-underwrite the securities in question; or
  5. (5) (if the firm at that time has a commitment, whether legally or binding or not) the time the price and allocation of the issue or offer are set.

BIPRU 7.8.14

handbook-rule
If a firm has an irrevocable and unfettered right to withdraw from an underwriting commitment, exercisable within a certain period, the commitment commences (and thus the time of initial commitment occurs) when that right expires.

BIPRU 7.8.15

handbook-guidance
Subject to the existence of a right described in BIPRU 7.8.14R an underwriting commitment commences even if it is subject to formal, legal or other conditions that would normally be expected to be satisfied.

BIPRU 7.8.16

handbook-guidance
A force majeure or material adverse change clause would not be a right of the sort referred to in BIPRU 7.8.14R.

Calculating the net underwriting position

BIPRU 7.8.17

handbook-rule

A firm must calculate a net underwriting position by adjusting the gross amount it has committed to underwrite for:

  1. (1) any sales or sub-underwriting commitments received that have been confirmed in writing at the time of initial commitment (but excluding any sales in the grey market as defined in BIPRU 7.8.10R (1));
  2. (2) any underwriting or sub-underwriting commitments obtained from others since the time of initial commitment;
  3. (3) any purchases or sales of the securities since the time of initial commitment (other than purchases or sales in the grey market as defined in BIPRU 7.8.10R (1));
  4. (4) (in the case of sales in the grey market as defined in BIPRU 7.8.10R (1)) any sales of the securities as at the time of initial commitment or since the time of initial commitment subject, in both cases, to the following conditions:
    1. (a) any sales of the securities as at the time of initial commitment must be confirmed in writing at the time of initial commitment; and
    2. (b) sales must be net of any purchases in the grey market as defined in BIPRU 7.8.10R (1); and
  5. (5) any allocation of securities granted or received, arising from the commitment to underwrite the securities, since the time of initial commitment.

BIPRU 7.8.18

handbook-rule
If the allocation of securities has not been fixed a firm must calculate the gross amount of its commitment, for the purposes of BIPRU 7.8.17R, by reference to the maximum amount it has committed to underwrite until the time the allocation is set.

BIPRU 7.8.19

handbook-rule
An underwriting commitment may only be reduced under BIPRU 7.8.17R on the basis of a formal agreement.

BIPRU 7.8.20

handbook-guidance
Allocations may arise, after date of initial commitment, from the agreement to underwrite. For example obligations or rights may be allocated to or from the issuer, the underwriting group or syndicate.

Over-allotment options

BIPRU 7.8.21

handbook-rule
  1. (1) This rule deals with the treatment of short positions that arise when a firm commits to distribute securities that it is underwriting in an amount that exceeds the allocation to the firm made by the issuer of the securities being underwritten.
  2. (2) When calculating its net underwriting position, a firm may use an over-allotment option granted to it by the issuer of the securities being underwritten to reduce the short positions in (1).
  3. (3) A firm may also use an over-allotment option granted to another member of the underwriting syndicate for the purpose in (2).
  4. (4) (2) and (3) only apply from working day 0.
  5. (5) (2) and (3) only apply to the extent that the treatment is consistent with the terms of the over-allotment option.

BIPRU 7.8.22

handbook-rule
Except as provided in BIPRU 7.8.21R, a firm must not take into account an over-allotment option granted to it or another member of the underwriting syndicate in calculating its net underwriting position.

Working day 0

BIPRU 7.8.23

handbook-rule
For the purposes of BIPRU 7.8 working day 0 is the business day on which a firm that is underwriting or sub-underwriting becomes unconditionally committed to accepting a known quantity of securities at a specified price.

BIPRU 7.8.24

handbook-guidance
For debt issues and securities which are issued in a similar manner, working day 0 is the later of the date on which the securities are allotted and the date on which payment for them is due.

BIPRU 7.8.25

handbook-guidance
For equity issues and securities which are issued in a similar manner, working day 0 is the later of the date on which the offer becomes closed for subscriptions and the date on which the allocations are made public.

BIPRU 7.8.26

handbook-guidance
For rights issues, working day 0 is the first day after the date on which the offer becomes closed to acceptances for subscription.

Calculating the reduced net underwriting position

BIPRU 7.8.27

handbook-rule

To calculate the reduced net underwriting position a firm must apply the reduction factors in the table in BIPRU 7.8.28R to the net underwriting position (calculated under BIPRU 7.8.17R) as follows:

  1. (1) in respect of debt securities, a firm must calculate two reduced net underwriting positions; one for inclusion in the firm's interest rate PRR specific risk calculation (BIPRU 7.2.43R), the other for inclusion in its interest rate PRR general market risk calculation (BIPRU 7.2.52R); and
  2. (2) in respect of equities, a firm must calculate only one reduced net underwriting position, and then include it in the simplified equity method (see BIPRU 7.3.29R).

BIPRU 7.8.28

handbook-rule
Table: Net underwriting position reduction factors
This table belongs to BIPRU 7.8.27R

BIPRU 7.8.29

handbook-guidance
The table in BIPRU 7.8.30G gives an example of the reduced net underwriting position calculation. The example is based on the firm starting with a commitment to underwrite £100 million of a new equity issue. Firms are reminded that in the case of an equity, the reduced net underwriting position should be treated under the simplified equity method (see BIPRU 7.8.27R (Simplified and standard equity methods) and BIPRU 7.8.27R).

BIPRU 7.8.30

handbook-guidance
Table: Example of the reduced net underwriting position calculation
This table belongs to BIPRU 7.8.29G

Large exposure risk from underwriting securities: Calculating the net underwriting exposure

BIPRU 7.8.31

handbook-rule
For the purposes of calculating the total amount of its trading book exposures to a person for concentration risk purposes, a firm must include net underwriting exposure to that person.

BIPRU 7.8.32

handbook-rule
A firm must include any other exposures arising out of underwriting (including any counterparty exposures to any sub-underwriters) for the purposes of calculating the total amount of its trading book exposures to a person for concentration risk purposes.

BIPRU 7.8.33

handbook-rule
A firm, before entering into a new underwriting commitment, must be able to recalculate the concentration risk capital component to the level of detail necessary to ensure that the firm's capital resources requirement does not exceed the firm's capital resources.

BIPRU 7.8.34

handbook-rule
Except where otherwise specified by a requirement on its Part IV permission, a firm must calculate the net underwriting exposure to an issuer by applying the relevant reduction factors in the table in BIPRU 7.8.35R to its net underwriting position calculated under BIPRU 7.8.17R.

BIPRU 7.8.35

handbook-rule
Table: Calculation of net underwriting exposure
This table belongs to BIPRU 7.8.34R

BIPRU 7.8.36

handbook-guidance
The effect of BIPRU 7.8.34R is that there is no concentration limit for net underwriting exposures between initial commitment and the end of working day 0, except where specified by a requirement on a firm's Part IV permission.

Large exposure risk from underwriting securities: Monitoring and reporting concentration risk

BIPRU 7.8.37

handbook-rule
For the purposes of concentration risk monitoring only, a firm must report its net underwriting exposure both before and after the application of the reduction factors in the table in BIPRU 7.8.35R.

Risk management

BIPRU 7.8.38

handbook-rule
A firm must take reasonable steps to establish and maintain such systems and controls to monitor and manage its underwriting and sub-underwriting business as are appropriate to the nature, scale and complexity of its underwriting and sub-underwriting business. In particular, a firm must have systems to monitor and control its underwriting exposures between the time of the initial commitment and working day one in the light of the nature of the risks incurred in the markets in question.

BIPRU 7.8.39

handbook-guidance

A firm should take reasonable steps to:

  1. (1) allocate responsibility for the management of its underwriting and sub-underwriting business;
  2. (2) allocate adequate resources to monitor and control its underwriting and sub-underwriting business;
  3. (3) satisfy itself that its systems to monitor exposure to counterparties will calculate, revise and update its exposure to each counterparty arising from its underwriting or sub-underwriting business;
  4. (4) satisfy itself of the suitability of each person who performs functions for it in connection with the firm's underwriting and sub-underwriting business having regard to the person's skill and experience; and
  5. (5) satisfy itself that its procedures and controls to monitor and manage its underwriting business address, on an on-going basis, the capacity of sub-underwriters to meet sub-underwriting commitments.

BIPRU 7.9

Use of a CAD 1 model

  • 01/01/2007

Introduction

BIPRU 7.9.1

handbook-guidance
A firm is required under GENPRU 2.1.52 R (Calculation of the market risk capital requirement) to calculate its market risk capital requirement using the rules in BIPRU 7. However, the FSA may at the firm's request modify GENPRU 2.1.52 R to allow the firm to calculate all or part of the PRR for the positions covered by that model by using a CAD 1 model (for options risk aggregation and/or interest rate pre-processing) or a VaR model (value at risk model) instead. BIPRU 7.10 (Use of a Value at Risk Model) deals with VaR model permissions.

BIPRU 7.9.2

handbook-guidance

The purpose of BIPRU 7.9 is to provide guidance on the FSA's policy for granting CAD 1 model waivers under section 148 of the Act (Modification or waiver of rules). The policy recognises that CAD 1 models may vary across firms but, as a minimum, the FSA will need to be satisfied:

  1. (1) about the quality of the internal controls and risk management relating to the model (see BIPRU 7.9.19G - BIPRU 7.9.23G for further details);
  2. (2) about the quality of the model standards; and
  3. (3) that the CAD 1 model captures and produces an accurate measure of the risks inherent in the portfolio covered by the CAD 1 model (see BIPRU 7.9.25G - BIPRU 7.9.53G for further details).

BIPRU 7.9.3

handbook-guidance
BIPRU 7.9 also explains how the output from the CAD 1 model is fed into the market risk capital requirement calculation.

BIPRU 7.9.4

handbook-guidance
If a CAD 1 model waiver is granted by the FSA, the waiver will contain certain requirements. In order adequately to address individual circumstances, these may differ from what is set out in BIPRU 7.9. The waiver will also identify the rules to which the waiver applies and the scope of model recognition granted to the firm.

BIPRU 7.9.5

handbook-guidance
Waivers permitting the use of models in the calculation of PRR will not be granted if that would be contrary to the CAD. Any waiver which is granted will only be granted on terms that are compatible with the CAD. Accordingly, the only waivers permitting the use of models in calculating PRR that the FSA is likely to grant are CAD 1 model waivers and VaR model permissions.

Scope of CAD 1 models

BIPRU 7.9.6

handbook-guidance
The FSA recognises two types of CAD 1 model. The table in BIPRU 7.9.7G describes them.

BIPRU 7.9.7

handbook-guidance
Table: Types of CAD 1 model
This table belongs to BIPRU 7.9.6G

BIPRU 7.9.8

handbook-guidance

Currently the FSA only envisages allowing recognition for options on CIUs if the CIU satisfies one of the following conditions:

  1. (1) it is a regulated collective investment scheme; or
  2. (2) the firm can demonstrate that it has characteristics that are similar to or better than an undertaking in (1) from the point of view of transparency and liquidity.

The CAD 1 model waiver application and review process

BIPRU 7.9.9

handbook-guidance
Details of the general waiver process are set out in SUP 8 (Waiver and modification of rules). Further details of the waiver process applicable to certain waivers relating to BIPRU (including CAD 1 model waivers) can be found in BIPRU 1.3 (Applications for advanced approaches). Because of the complexity of a CAD 1 model waiver, it is recommended that, as set out in SUP 8.3.4 G and BIPRU 1.3.21 G, a firm contact its usual contact at the FSA to discuss its proposed application. It should also be noted that the waiver recognition process in the case of a CAD 1 model may take longer than the timescales indicated in SUP 8.3.5 G.

BIPRU 7.9.10

handbook-guidance
In order to consider a CAD 1 model waiver request, the FSA may undertake a review to ensure that it is adequate and appropriate for the PRR calculation.

BIPRU 7.9.11

handbook-guidance
The model review process may be conducted through a series of visits covering various aspects of the firm's control and IT environment. Before these visits the FSA may ask the firm to provide some information relating to its waiver request accompanied by some specified background material. The model review visits are organised on a timetable that allows a firm being visited sufficient time to arrange the visit and provide the appropriate pre-visit information.

BIPRU 7.9.12

handbook-guidance
As part of the model review process, the following may be reviewed: organisational structure and personnel; details of the firm's market position in the relevant products; profit and risk information; valuation and reserving policies; operational controls; IT systems; model release and control procedures; risk management and control framework; risk appetite and limit structure and future developments relevant to model recognition.

BIPRU 7.9.13

handbook-guidance
The FSA will normally require meetings with senior management and staff from the front office, financial control, risk management, operations, systems development, information technology and audit areas.

BIPRU 7.9.14

handbook-guidance
A review by a skilled person may be used before a CAD 1 model waiver is granted to supplement the waiver process or after the waiver has been granted to review the CAD 1 model.

BIPRU 7.9.15

handbook-guidance

If the FSA grants a CAD 1 model waiver, the waiver direction will specify the particular rule which has been modified, and set out the requirements subject to which the waiver has been granted. These requirements may include:

  1. (1) the details of the calculation of PRR;
  2. (2) the CAD 1 model waiver methodology to be employed;
  3. (3) the products covered by the model (e.g. option type, maturity, currency); and
  4. (4) any notification requirements relating to the CAD 1 model waiver.

BIPRU 7.9.16

handbook-guidance
Where a firm operates any part of its CAD 1 model outside the United Kingdom, the FSA may take into account the results of any review of that model carried out by any overseas regulator concerned. The FSA may wish to receive information directly from that regulator.

Maintenance of model recognition

BIPRU 7.9.17

handbook-guidance
No changes should be made to a CAD 1 model unless the change is not material. Material changes to a CAD 1 model will require a renewed waiver to be issued. Materiality is measured from the time that the waiver is granted or, if the waiver has been varied in accordance with section 148 of the Act, any later time that may be specified in the waiver for these purposes. If a firm is considering making material changes to its CAD 1 model, then it should notify the FSA at once. If a firm wishes to change the products covered by the model it should apply for a variation of its CAD 1 model waiver.

BIPRU 7.9.18

handbook-guidance
If the CAD 1 model ceases to meet the requirements of the waiver, the firm should notify the FSA at once. The FSA may then revoke the waiver unless it is varied in accordance with section 148 of the Act. If the CAD 1 model waiver contains conditions it is a condition of using the CAD 1 model approach that the firm should continue to comply with those conditions.

Risk management standards

BIPRU 7.9.19

handbook-guidance
A firm with a complex portfolio is expected to demonstrate more sophistication in its modelling and risk management than a firm with a simple portfolio.

BIPRU 7.9.20

handbook-guidance
A firm should be able to demonstrate that the risk management standards set out in BIPRU 7.9 are satisfied by each legal entity with respect to which the CAD 1 model approach is being used (even though they are expressed to refer only to a firm). This is particularly important for subsidiary undertakings in groups subject to matrix management where the business lines cut across legal entity boundaries.

BIPRU 7.9.21

handbook-guidance
  1. (1) A firm should have a conceptually sound risk management system which is implemented with integrity and should meet the minimum standards set out in this paragraph.
  2. (2) A firm should have a risk control unit that is independent of business trading units and reports directly to senior management. The unit should be responsible for designing and implementing the firm's risk management system. It should produce and analyse daily reports on the risks run by the business and on the appropriate measures to be taken in terms of the trading limits.
  3. (3) A firm's senior management should be actively involved in the risk control process and the daily reports produced by the risk control unit should be reviewed by a level of management with sufficient authority to enforce reductions of positions taken by individual traders as well as in the firm's overall risk exposure.
  4. (4) The risk control group should have a sufficient number of staff with appropriate skills in the use of models.
  5. (5) A firm should have established procedures for monitoring and ensuring compliance with a documented set of appropriate internal policies and controls concerning the overall operation of the risk measurement and control framework. This should take into account the front, middle and back office functions.
  6. (6) A firm should conduct, as part of its regular internal audit process, a review of the systems and controls relating to its CAD 1 model. This review should include the valuation process, compliance with the CAD 1 model waiver's scope and the activities of the business trading units and the risk control units. This review should be undertaken by staff independent of the areas being reviewed.

BIPRU 7.9.22

handbook-guidance

In assessing whether the risk management and control framework is implemented with integrity, the FSA will consider the IT systems used to run the CAD 1 model and associated calculations. The assessment will include, where appropriate:

  1. (1) feeder systems; risk aggregation systems; the integrity of the data (i.e. whether it is complete, coherent and correct); reconciliations and checks on completeness of capture; and
  2. (2) system development, change control and documentation; security and audit trails; system availability and contingency procedures; network adequacy.

BIPRU 7.9.23

handbook-guidance

A firm should take appropriate steps to ensure that it has adequate controls relating to:

  1. (1) the derivation of the PRR from the CAD 1 model output;
  2. (2) CAD 1 model development, including independent validation;
  3. (3) reserving;
  4. (4) valuation (see GENPRU 1.3 (Valuation)), including independent validation; and
  5. (5) the adequacy of the IT infrastructure.

Model standards

BIPRU 7.9.24

handbook-guidance
A firm should take appropriate steps to ensure that its CAD 1 model captures and produces an accurate measure of the risks inherent in the portfolio covered by the CAD 1 model. These risks may include, but are not limited to, gamma, vega and rho.

Options risk aggregation models

BIPRU 7.9.25

handbook-guidance
For a firm to obtain a CAD 1 model waiver for its options risk aggregation model, it should have in place an appropriate options valuation model.

BIPRU 7.9.26

handbook-guidance
The FSA does not specify the methodology that a firm should employ in order to produce the appropriate outputs from its options risk aggregation CAD 1 model. However, BIPRU 7.9.27G - BIPRU 7.9.43G provide details of how a firm could meet the requirement to capture gamma, vega and rho risks using a scenario matrix approach. Where a firm adopts the scenario matrix approach then the standards set out in BIPRU 7.9.27G - BIPRU 7.9.43G should be followed. The firm should also take into account other risks not captured by the scenario matrix approach. If a firm does not use the scenario matrix approach it should use an equivalent methodology. If a firm uses an equivalent methodology it should be able to demonstrate that the approach used meets the requirements of BIPRU 7.9.

BIPRU 7.9.27

handbook-guidance
A scenario matrix is an approach by which an options portfolio is revalued given a number of simultaneous shifts in both the spot level of the underlying and the implied volatility.

BIPRU 7.9.28

handbook-guidance
The scenario matrix approach may be employed for all types of options on all types of underlying asset.

BIPRU 7.9.29

handbook-guidance
  1. (1) This paragraph provides an outline of the initial steps to be taken when using the scenario matrix approach.
  2. (2) A value for an option should be obtained using the firm's options valuation model.
  3. (3) The inputs into the options valuation model for implied volatility of the underlying asset and the price of the underlying asset should then be altered so that a new value for the option is obtained (details of the amount by which the implied volatility and the price of the underlying should be amended are set out in BIPRU 7.9.30G - BIPRU 7.9.36G).
  4. (4) The difference between the original value of the option and the new value obtained following the alterations should be input into the appropriate cell in the matrix. The value in the central cell where there is no change in implied volatility or price of the underlying should therefore be zero.
  5. (5) The process of obtaining a new price for the option should be repeated until the matrix is completed.

BIPRU 7.9.30

handbook-guidance
The alteration to the implied volatility (known as the implied volatility shift) referred to in BIPRU 7.9.29G (3) may be a proportional shift. The size of the shift depends on the remaining life of the option and the asset class of the underlying. The table in BIPRU 7.9.32G sets out the shifts that should be applied where a proportional shift is used. Alternatively, a firm may use a single shift across all maturities or use an absolute rather than a proportional implied volatility shift. Where a single shift or an absolute shift is used it should be at least as conservative as the proportional shifts. Any use of a single shift or an absolute shift should be reviewed and, if necessary updated, on a regular basis.

BIPRU 7.9.31

handbook-guidance
A firm may choose to use a less detailed term structure than that in the table in BIPRU 7.9.32G, but the shifts used should be no less conservative than those set out in that table. For example, a firm that uses one <3 month band, rather than the two bands (≤ 1 month and 1-3 months) set out in the table, should use the most conservative shift set out in the table for the bands covered. In this example that shift is 30%.

BIPRU 7.9.32

handbook-guidance
Table: proportional implied volatility shifts
This table belongs to BIPRU 7.9.30G

BIPRU 7.9.33

handbook-guidance
The size of the underlying price/rate shift depends on the asset class of the underlying as referred to in BIPRU 7.9.29G (3) and is set out in the table in BIPRU 7.9.34 G.

BIPRU 7.9.34

handbook-guidance
Table: underlying price/rate shifts
This table belongs to BIPRU 7.9.33G

BIPRU 7.9.35

handbook-guidance
The shifts outlined in the table in BIPRU 7.9.34G are the maximum shifts required; in addition there will be a number of intermediate shifts as a result of the minimum matrix size criteria set out in BIPRU 7.9.36G.

BIPRU 7.9.36

handbook-guidance
The minimum size of the scenario matrix should be 3x7, that is, three observations for implied volatility (including the actual implied volatility) and seven observations for the price of the underlying (including the actual price of the underlying). A firm should be able to justify its choice of granularity. Greater granularity may be required where the portfolio contains, for example, a large proportion of barrier options.

BIPRU 7.9.37

handbook-guidance
  1. (1) A different scenario matrix should be set up for each underlying asset type in accordance with this paragraph.
  2. (2) For equities (including single equities, baskets and indices) there should be a separate matrix for each national market or non-decomposed basket or non-decomposed multi-national index.
  3. (3) For foreign currency products there should be a separate matrix for each currency pair where appropriate.
  4. (4) For commodity products there should be a separate matrix for each commodity. The question whether two items are the same commodity should be decided in accordance with BIPRU 7.4 (Commodity PRR).
  5. (5) For interest rate products there should be a separate matrix for each currency. In addition, a firm should not offset the gamma and vega exposures (except in the circumstances set out in BIPRU 7.9.38G) arising from any one of the following types of product with the gamma and vega exposures arising from any of the other products in the list:
    1. (a) swaptions (options on interest rates);
    2. (b) interest rate options (including options on exchange-traded deposit or bill futures);
    3. (c) bond options (including options on exchange-traded bond futures); and
    4. (d) other types of options required by the CAD 1 model waiver to form their own separate class of underlying asset.
  6. (6) The other types of options referred to in (5)(d) will generally be exotic options that do not fall easily into (5)(a) - (c)).
  7. (7) For CIUs there should be a separate matrix for each CIU fund. If the firm applies one of the CIU look through methods under BIPRU 7.7 (Position risk requirements for collective investment undertakings), then (1) - (6) apply based on what the underlyings are.

BIPRU 7.9.38

handbook-guidance
A firm may offset gamma and vega exposures arising from the products listed in BIPRU 7.9.37G (5) where it can demonstrate that it trades different types of interest rate-related options as a portfolio and takes steps to control the basis risk between different types of implied volatility. To the extent that this is the case an individual matrix is not required for each of the products listed in BIPRU 7.9.37G (5) and a combined scenario matrix may be used.

BIPRU 7.9.39

handbook-guidance
Where it is imprudent fully to offset long-dated and short-dated vega exposure owing to the risk of non-parallel shifts in the yield curve, a firm should use an appropriate number of scenario matrices to take account of non-parallel shifts in the yield curve according to the maturity of the option or underlying.

BIPRU 7.9.40

handbook-guidance
Following the steps outlined in BIPRU 7.9.29G, a firm then removes the portion of the values in the matrix that can be attributed to the effect that delta has had on the change in the value of the option (a process known as delta-stripping).

BIPRU 7.9.41

handbook-guidance
Once the effect of delta has been removed from the matrix, the values left in the matrix relate to gamma and vega risk. A firm's PRR in relation to gamma and vega risk on the individual option is the absolute of the most negative cell in the scenario matrix produced. Where all cells are positive the PRR is zero. The total PRR for the gamma and vega risk on the portfolio of options is a simple sum of the individual requirements. This amount should then be fed into a firm's PRR calculation.

BIPRU 7.9.42

handbook-guidance
The values that have been obtained for the delta-equivalent positions of instruments included in the scenario matrix should then be treated in the same way as positions in the underlying. Where the delta obtained relates to interest rate position risk, the delta equivalent positions may be fed into the firm's interest rate pre-processing model to the extent that the positions fall within the scope of interest rate pre-processing models as set out in BIPRU 7.9.7G and provided that the firm's CAD 1 model waiver allows the firm's CAD 1 model to be used in this way. Alternatively, the delta obtained should be fed into the standard PRR calculations in BIPRU 7.2 (Interest rate PRR), BIPRU 7.3 (Equity PRR and basic interest rate PRR for equity derivatives), BIPRU 7.4 (Commodity PRR) or BIPRU 7.5 (Foreign currency PRR) as appropriate.

BIPRU 7.9.43

handbook-guidance
In using the scenario matrix approach, none of the steps followed will take specific account of a firm's exposure to rho risk. Where a firm can demonstrate that for interest rate-related options the rho sensitivity is effectively included in the delta sensitivities produced, there is no separate capital requirement relating to rho. For all other options except commodity options, a firm should calculate a rho sensitivity ladder by currency using its CAD 1 model and either feed this into the interest rate maturity method or interest rate duration method calculation or, where the firm's CAD 1 model waiver allows the firm's CAD 1 model to be used in this way, feed that ladder into an interest rate pre-processing model. Generally a CAD 1 model does not need to deal specifically with rho risk for commodity options.

Interest rate pre-processing models