учебный год 2023 / de la Mata Munoz, Personal Security

244 Chapter 4: Plurality ofsecurity rights

debt(§ 426 par. 1 sent. 2 BGB, art. 1299 Italian CC and art. 1145 Spanish CC all with parallel wording).

The compensation may also be based on the claim for subrogation. The question of the legal basis for the demand for compensation can be relevant in commercial practice. For instance, in those cases in which any other co-debtor has granted another security for his own debt, subrogation serves to assign this security right to the performing debtor. However, it is only the German Civil Code that expressly grants a right of subrogation to the performing co-debtor in§ 426 par. 2 BGB.

In contrast, neither in Italy nor in Spain has such a right been expressly included among the rules of co-debt. However, the general rules of subrogation (art. 1210 no. 3° Spanish CC and art. 1203 no 3° Italian CC) have been declared75 to be applicable to the situation in which one co-debtor performs. Consequently, the final result is the same in all of these three legal systems. The performing surety shall thus receive compensation from all the other sureties for their respective parts of the total amount.

cc) Solution for a special case. Concurrency ofguarantee and other security rights

A special arrangement of a plurality of securities is the concurrency of a guarantee and other security rights. A possible solution that is suggested in order to reduce the unfair consequences of the absence of regulation with regard to the internal relationship among "independent" sureties is to grant the guarantor an advantageous or privileged position. This solution has been extensively discussed in Germany, where this issue has been described as being a "time-honoured matter of dispute" (altehrwlirdige Streitfrage 76) by writers and by the courts77 . By contrast, in Spain and Italy this alternative has never had such a corresponding resonance78 •

The starting point of this discussion is to consider whether the guarantee itself contains a special factor of risk. In all countries, the surety compels himself with his whole present and future patrimony to secure the debt of another person. The grant of a real security right may imply a greater risk for the surety. Depending on the circumstances of the case, this might be a much higher risk than the one that is assumed by a surety79• However, the

75Case law and explanation in: De Maria/Franzoni, 902; Diez-Picazo, Fundamentos,

214.

76Reinicke and Tiedtke, 186.

77In favour: Horn/Staudinger on § 774 no. 65-74. Contra: Lambsdorffand Skora, no.

313.

78Guilarte keeps breve notice of these theories in Guilarte, 318 ff.

79Opinion of the German Supreme Court: BGH 29 June 1986, BGHZ 108, 179; BGH 24 September 1992, NJW 1992, 3228.

latter is liable with regard to his whole future patrimony. Such a form of liability is never present in the case of a real security. This therefore makes a surety worthy of special protection80• Hence, the Law grants the surety special legal privileges or protective rules (favor fideiussoris).

For instance, the surety enjoys a right of subrogation that is expressly granted ex lege in art. 1949 Italian CC and 1839 Spanish CC. The proprietary surety is also subrogated into the rights of the creditor upon performance. However, this right is only a presumption that is established in art. 1203 par. 3 Italian CC and 1210 par. 3° Spanish CC. Moreover, according to art. 1852 Spanish CC, the surety is discharged whenever an act of the creditor prevents him from being subrogated into his rights, mortgages and privileges81 • The German Supreme Court has also considered that other provisions on guarantee such as the benefit of discussion act as evidence that the legislator has taken into account the special risk of the surety and has thus decided to compensate the surety with such provisions82•

It may be wondered whether these rules are sufficient compensation for the special risk of the guarantor. The guarantor may also deserve a privileged position within the internal relationship. The German Supreme Court holds that the guarantor should not be given a privileged position within the internal relationship. Therefore the guarantor should be treated like every other surety within the internal relationship83. However, this is still considered to be a controversial issue by legal scholars, some of whom are not convinced by the reasoning of the Supreme Court84.

Current banking practice tends to give preference to proprietary security rights. This is due to the fact that they are easily enforceable. In many instances it is the case that proprietary sureties are persons that have a small patrimony. However they may become the owner of a valuable good that is acquired over time or is inherited. Therefore, a person whose solvency would otherwise be insufficient to enable them to grant a guarantee is required to grant a proprietary security over the one unique valuable good. It would therefore be unfair to grant a legal privilege to one of the sureties upon a criterion that is based on the assumed risk, if this criterion does not take into account the risk that is really assumed by each party in relation to their economic situation. The reasons that are cited to support the prefe-

80Reinicke and Tiedtke, 186.

81This theory has been considered in Germany regarding§ 776774 BGB; see KnU!el, 559, 588 .

82BGH 28 February 1989, BGHZ 107, 92.

83BGH 29 June 1989, BGHZ 108, 179; BGH 24 September 1992, NJW 1992, 3228;

Reinicke and Tiedtke, 186.

84Reinicke and Tiedtke, 187; Guilarte 1979, 318 ff.

forms the obligation. Therefore he should not just receive a "corresponding part" of the sum.

The solution to this problem is to consider this "part" as not being per capita in relation to the debtors but rather as being subject to the agreement of the parties. The right to be refunded would therefore be agreed to by them. For example, the new debtor that is assuming the debt for a security purpose would have a 100 % right of refund against the other co-debtor (secured party), while this other co-debtor would have a 0% against the new debtor. If one of them also has a guarantee (or any other kind of security) to ensure his debt, then the right of the other co-debtor to profit from this guarantee will be dependent upon the right of refund that this one has against his co-debtor.

If in our example, the debtor with no right of refund has constituted a joint and several guarantee ensuring his debt, the one that is enjoying a 100% right of refund may require the total payment of the debt from the guarantor. Otherwise, if the guarantor is the first party that is required to make payment by the creditor, the guarantor will not have any right of refund against the co-debtor of his principal if the principal does not refund him.

VI. Concurrency ofguarantee contracts and letters ofcomfort

Legal writers have not clarified the effects of the concurrency of letters of comfort with guarantee contracts. However, according to the variety of the formulations of the letters of comfort, the solutions are dependent on the facts and circumstances of each case and the actual wording of the relevant letter.

Chapter 5

Personal security rights as Credit Risk Mitigators in the Basle II Accord and in the Capital Requirements Directive

Introduction

In terms of risk management, personal security rights play a significant role reducing the credit risk assumed by the creditor, i.e. as credit risk mitigators. Such risk mitigating factor has been recently recognised by the regulators in view of calculating the regulatory capital1 requirements for financial institutions.

Credit risk, market risk, and operational risk have increased in complexity over the latest years becoming a key concern for banking regulators worldwide and even more after the 2007 financial turmoil. The tools and mechanisms to monitor and measure those risks have also become increasingly sophisticated and more comprehensive than ever before. Moreover, the ability to measure, manage and transfer this kind of risks has improved dramatically as well. The Capital Adequacy Accord2 published in June 2004 by the Basel Committee on Banking Supervision (commonly known as Basel II) has taken this increased capacity to manage and transfer risk into account for the new capital requirement standards.

The Basel II regulatory framework aims at improving the sensitivity to the risks that banks actually face and offer stronger incentives for im-

1 On regulatory capital, see: Elizalde and Repullo, Economic and Regulatory Capital in Banking: What is the Difference?, CEMFI and UPNA, July 2006 (ftp://ftp.cemfi.es/ pdf/papers/repullo/economic%20capital.pdf).

2 "International Convergence of Capital Measurement and Capital Standards: A revised Framework'', 2004 (http://www.bis.org/publ/bcbsl28.htm). This document has been incorporated in the comprehensive version of International Convergence of Capital Measurement and Capital Standards: A Revised Framework, June 2006, including the elements of the 1988 Accord that were not revised during the Basel II process, the 1996 Amendment to the Capital Accord to Incorporate Market Risks, and the 2005 paper on The Application of Basel II to Trading Activities and the Treatment of Double Default Effects.

proved risk management3. This goal is achieved by providing an extensive regulatory framework that reflects more accurately the effective underlying risks in the banking sector and takes into account the significant advances in risk management practices, and applied technologies as well as developments in the banking markets since the publication of Basel I in 1988. For this purpose, capital requirements have been more closely aligned to the risk of credit loss and a new capital charge for exposures has been introduced to the risk of loss caused by operational failures . Within this context, Credit Risk Mitigation Techniques (CRM)4 have been largely considered in the new regulation as a way to reduce the capital requirements for banks.

Within the EU, the new Basel II Accord has been implemented in the form of the so called Capital Requirements Directive (CRD), published in June 20065 and implemented then at national level in the EU Member States6 • The EU Commission published the proposal for the CRD in July 2004. The content of the Directive mainly reflects the letter and spirit of the Basel II Accord7• Both texts regulate extensively the use of Credit Risk Mitigation Techniques as methods to effectively reduce credit risk8. Under the new regulation, all kinds of lenders (those operating under the Standard

3 For a practical approach towards credit risk under the Basel II Accord see: Glantz, Mun, The banker's handbook on credit risk: implementing Basel II, Burlington, 2008.

Credit Risk Mitigation is also often referred to as Credit Risk Transfer (CRT).

5The Capital Requirements Directive, comprising Directive 2006/48/EC and Directive 2006/49/EC, was published in the Official Journal on Friday 30 June.

6The CRD has been transposed:

a)In Italy by amendments introduced to the Circolare n.155 18 dicembre 1991 as updated in June 2007) and Circolare n.216 5 agosto 1996 as updated in July 2007). Also see Circolare 263 sets out the compulsory regime for all banks starting from January 1st 2008. See also: Basilea 2 consultants; II Nuovo Accardo di Basilea e i sistemi di Internal Rating; 1.7 II ruolo delle garanzie; http://www.basilea2.it/garanzie.pdf;

b)In Spain through the Real Decreto 216/2008, de 15 de febrero, de recursos propios de las entidades financieras complemented by the Circular 3/2008, a las entidades de credito, sobre determinaci6n y control de los recursos propios minimos, as approved May 22, 2008;

c)In Germany by amendments introduced to the Banking Act, the Solvabilitatsverordnung and the Mindestanforderung an das Risikomanagement (MaRisk). See Deutsche Bundesbank, Transposing the new Basel capital rules into German Law, monthly report, December 2006. http://www.bundesbank.de/download/volkswirtschaft/mba/2006/200612

mba_en_transposing.pdf.

7 Within this Part, where the Basel II Accord is mentioned, the same is also valid for

the Capital Requirements Directive. Legal references are made to the Capital Requirements Directive.

8 The explanatory memorandum of the CRD mentions the lack of recognition of effective risk mitigation as one of the shortcomings of the previous regulation and one of the needs for improved European requirements.

Approach and those under IRB)9 will be allowed to reduce capital requirements through the use of a wide range of security rights (personal and proprietary) and other techniques to mitigate credit risk.

In this Chapter we revise the meaning and structure of the Basel II Accord and the CRD focusing on the regulation of credit risk mitigation techniques and specifically on the treatment of personal security rights as eligible to provide capital relief to the lending (secured) institutions.

A. The New Basel II Accord and the Capital

RequirementsDirective

I. A risk sensitive banking regulation for a changing environment

In the last years, risk management practices and technologies have experience a significant evolution and are more generally used within the banking sector.

Also the banking markets have clearly evolved since the adoption of the first Capital Requirement Framework (Basel I) in 1988, which approach towards risk measuring remained rather simple. As way of example, the 1988 Accord sets capital requirements based on broad classes of exposures and does not distinguish between the relative degrees of creditworthiness among individual borrowers. Moreover, there was no explicit recognition of effective risk mitigation, which followed to a generally less accurate consideration of risk.

During the last years, the 1988 Basel Capital Accord has grown more pervasive, being integrated into national regulations in most advanced countries. Meanwhile, the limitations and shortcomings of this rather simple regulation have become progressively more manifest. The existence of a gap between supervisory requirements and risk-based measures of economic capital has led to forms of regulatory arbitrage. Paradoxically, the inability of the 1988 Accord to differentiate between investment grade and junk borrowers might also have made some financial institutions more risk-seeking, instead of helping them control their risks.

The stagnant rules set out in the 1988 Accord have not kept pace with advances in sound risk management practices, the existing capital regulations not reflecting banks' actual business practices.

This drawback was acknowledged by supervisors and addressed by the

10

Basel Committee on Banking Supervision , which engaged for several

9 See below under: Chapter 5, A., II. The goal of the Basel II Accord and the tree pillars methodology, 251.

years in a revision process that finally lead to the "International Convergence of Capital Measurement and Capital Standards: a Revised Framework"11, also known as the New Basel Capital Accord - Basel II (Basel II).

This new framework presents a more sophisticated set of standards for establishing minimum capital requirements for banking organisations, intending to lessen the gap between regulatory capital requirements and real economic risk faced by these organisations.

The Basel II Framework as also reflected in the CRD, hence, sets out the details for adopting more risk-sensitive minimum capital requirements for banking organisations. The new framework reinforces these risksensitive requirements by laying out principles for banks to assess the adequacy of their capital and for supervisors to review such assessments to ensure banks have adequate capital to support their risks. It also seeks to strengthen market discipline by enhancing transparency in banks' financial reporting. The Basel Committee, however, intended to maintain broadly the aggregate level of minimum capital requirements set in the 1988 Accord, while providing incentives to adopt the more advanced risk-sensitive approaches of the revised Framework. Basel II combines these minimum capital requirements with supervisory review and market discipline to encourage improvements in risk management.

In this regard, the Committee recognises the need to distinguish between those banks that are able to better assess their risk and those that have less sophisticated tools to do so. In assessing their capital requirements, the first follow the "Internal Rating Based" (IRB) approach which allow them to better identify the actual need for capital requirement according to their real risks. The second type of banks will follow a simplified method to assess their capital requirements, in line with that set up in the Basel Accord of 1988 based on Risk Weightings. This distinction aims at providing incentives for banks to develop better risk assessment tools in order to adapt their capital needs to their real risk.

II. The goal ofthe Basel II Accord and the three pillars methodology

The global aim of the Basel II Accord is to promote the adequate capitalisation of banks as well as to encourage improvements in risk management, thereby strengthening the stability of the financial system. The Accord is structured in three pillars. The first one is focused on the strengthening of

10The Basel Committee on banking supervision is a group of central banks and bank supervisory authorities in the G 10 countries, which also developed the first standard in 1988.

11Find full text in the Bank of International Settlements website: http://www.bis.org/ publ/bcbs128.htm

252 Chapter 5: Basel II and the Capital Requirements Directive

the minimum requirements set out in the 1988 Accord, while the second and third pillars represent innovative additions to capital supervision.

i) In "Pillar 1" the Basel I's guidelines are revised by aligning the minimum capital requirements more closely to each bank's actual risk of economic loss.

Under Basel I, banks need to align 8% of each credit granted independently of the quality of the borrower. Basel II maintains this fixed percentage of 8% but improves the capital framework's sensitivity to the risk categories. Regarding credit risk, higher levels of capital are generally required for those borrowers that present higher levels of credit risk, and vice versa.

In order to calculate their capital requirements, banks may choose among three different approaches, depending on the level of sophistication of their risk management and internal control structures.

Under the "standardised approach" (RSA) to credit risk, banks that engage in less complex forms of lending and credit underwriting and that have simpler control structures may use external measures of credit risk (Risk Weightings) to assess the credit quality of their borrowers for regulatory capital purposes.

Banks that engage in more sophisticated risk-taking and that have developed advanced risk measurement systems may, with the approval of their supervisors, select from one of two "internal ratings-based" ("IRB") approaches to credit risk. Under an IRB approach, banks rely partly on their own measures of a borrowers' credit risk to determine their capital requirements, subject to strict data, validation, and operational requirements. The IRB Approach is based on the estimation by banks of two factors - the PD (Probability of Default) and the LGD (Loss Given Default) - for different kinds of activities using a complex formula established in the Accord to determine risk weightings. Under the IRB Advanced banks determine the risk weightings by adding to the Basel formula multiple internal factors.

Second, the new Framework establishes an explicit capital charge for a bank's exposures to the risk of losses caused by failures in systems, processes, or staff or that are caused by external events, such as natural disasters. Similar to the range of options provided for assessing exposures to credit risk, banks will choose one of three approaches for measuring their exposures to operational risk that they and their supervisors agree reflects the quality and sophistication of their internal controls over this particular risk area.

By aligning capital charges more closely to a bank's own measures of its exposures to credit and operational risk, the Basel II Framework encourages banks to refine those measures. It also provides explicit incentives in

the form of lower capital requirements for banks to adopt more comprehensive and accurate measures of risk as well as more effective processes for controlling their exposures to risk.

ii)"Pillar 2", foresees the need of exercising effective supervisory review of the banks' internal assessments of their overall risks in view of ensuring that bank management is exercising sound judgement and has set aside adequate capital for these risks.

Supervisors will evaluate the activities and risk profiles of individual banks to determine whether those organisations should hold higher levels of capital than the minimum requirements in Pillar 1 would specify and to see whether there is any need for remedial actions.

Engaging banks in a dialogue with the supervisor on their internal processes for measuring and managing their risk will likely motivate them to develop sound control structures and to improve those processes.

iii)"Pillar 3" leverages the ability of market discipline to motivate prudent management by enhancing the degree of transparency in banks' public reporting. It sets out the public disclosures which will likely lend greater insight into the adequacy of banks' capitalisation.

The Committee believes that, when marketplace participants have a sufficient understanding of a bank's activities and the controls it has in place to manage its exposures, they are better able to distinguish between banking organisations so that they can reward those that manage their risks prudently and penalise those that do not.

The CRD replicates this scheme for the EU banking context.

B. Recognition of Credit Risk Mitigation Techniques: an achievement of the Basel II Accord

I. Capital reliefthrough the use ofCredit Risk Mitigation Techniques (CRM)

CRM techniques are mechanisms aiming at effectively reducing the credit risk of a lender and are commonly used in today's banking practice12• One of the new features of the Basel II Accord is the recognition of such risk

12 However, this effective reduction of risk was not always recognised by regulators and supervisors in terms of minimum capital requirements. It is true that some risk mitigation techniques had partly been recognised in several jurisdictions by the national regulator. That is for instance the case for the use of Mortgage Insurance for high LTV loans in countries Like US, Canada or Australia. In these countries the use of MI for loans reduces the risk weighting of high LTV loans from 100 % to 50 %, diminishing so the capital requirements for the Lender. However these practices have developed differently in every country and only to a Limited extent.