The Prudential Regulation Authority publishes Policy Statement updating its Supervisory Statement on Credit Risk Mitigation
London, UK – March 13, 2019 - Today the Prudential Regulation Authority ('PRA') has published a Policy Statement and updated Supervisory Statement on credit risk mitigation ('CRM'), which will come into force on 13 September 2019.
It relates to the use of different types of guarantees as unfunded CRM for the purposes of calculating capital requirements under the EU Capital Requirements Regulation ('CRR').
Last year, the PRA published a consultation paper on this subject, setting out certain draft proposals which caused serious concern in the market.
Geoffrey Wynne, Head of the Trade & Export Finance Group and Sullivan’s London office, commented: "At a first reading this looks like good news for those who use guarantees as a credit risk mitigant as it clarifies a number of concerns particularly in respect of the use of credit insurance. It shows the power of industry-led reaction to concerns. As a warning it is still best to proceed with caution as the paper indicates, and we remain ready to assist through the jungle of words."
Key issues arising out of the consultation paper included:
- The PRA's expectations that the provider of the credit protection must be obliged to pay the beneficiary bank "without delay and within days, but not weeks or months" of the counterparty's default, conflicted with the typical waiting periods agreed in credit insurance policies and export credit agency guarantees.
- There was a lack of clarity as to whether credit insurance policies containing market standard exclusions, such as an exclusion for nuclear-related events, would be considered eligible where the operation of such exclusions is outside the strict control of the insured.
The PRA received numerous responses to the consultation paper, and has made a number of significant changes to its proposals in direct response to that feedback, including:
- In respect of the timeliness requirement, the PRA decided not to implement its proposal and acknowledges that there may be difficulties in applying a single measure of timeliness to all the different products that may be used as guarantees. This is positive news for banks using credit insurance and ECA guarantees, as the standard waiting periods for these instruments will not automatically render them ineligible as CRM.
- In the case of the nuclear exclusion often found in credit insurance policies, the PRA advises that this may be contrary to the CRR requirements unless "in all circumstances the clause is immaterial to the guaranteed exposure and the risk of an obligor default under that exposure". This means that a policy containing this exclusion can be eligible as CRM, where the bank can demonstrate that it meets this condition.
- Notwithstanding the positive changes noted above, the PRA considers that in some cases the use of guarantees as CRM has actually proved to be less effective than expected, resulting in residual risks. In some circumstances the PRA will expect a bank to hold additional capital to account for these "residual risks", even where an instrument meets the CRR criteria for CRM.
The publications can be viewed on the Bank of England's site.
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