учебный год 2023 / de la Mata Munoz, Personal Security

mitigating effect in terms of capital relief. This is in line with the Basel II global approach of adapting capital requirements to real economic risk. In this respect, the principle of using CRMs relies on the fact that no exposure in respect of which credit risk mitigation is obtained shall produce a higher risk-weighted exposure amount or expected loss amount than an otherwise identical exposure in respect of which there is not credit risk mitigation. This principle is also reflected in the CRD13•

II. The concept ofCRM, unfunded credit protection and guarantee

1. The concept ofCRM: broad and comprehensive

The number and types of CRMs available to lending institutions has become extensive. In first place, the definition of Credit Risk Mitigation under Basel II and the CRD is unambiguous but broad. According to the new standards, CRM "means a technique used by a credit institution to reduce the credit risk associated with an exposure or exposures which the credit institution continues to hold" 14• This definition is broad and purely based on risk elements15•

2. The concept ofunfunded credit protection

A basic distinction is made between "funded"16 and "unfunded" credit protection.

13Art. 93. 2 CRD, Directive 2006/48/EC: "No exposure in respect of which credit risk mitigation is obtained shall 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."

14See art. 4 (30) CRD, Directive 2006/48/EC.

15This has facilitated innovation in this field. Several types of CRMs have been developed. The Bank of International Settlements has studied such developments and their impact on financial stability (which appear particularly important considering the 2008 financial crisis). See BIS, Credit Risk Trasfer Developments 2005 to 2007, 2008 and BIS, Credit Risk Transfer, 2003.

16According to art. 4 (31) CRD, Directive 2006/48/EC, funded credit protection is a "technique of credit risk mitigation where the reduction of the credit risk on the exposure of a credit institution derives from the right of the credit institution - in the event of the

default of the counterparty or on the occurrence of other specified credit events relating to the counterparty - to liquidate, or to obtain transfer or appropriation of, or to replace it with, the amount of the difference between the amount of the exposure and the amount of a claim on the credit institution". Proprietory security rights are funded credit protection in this context. Recognised types of unfunded credit protection are: financial collateral (e.g. collateral in the form of cash or debt securities); additional collateral eligible under the Foundation IRB approach (e.g. collateral in the form of real estate or short-term claims); other funded credit protection (e.g. collateral in the form of deposits held with third-party financial undertakings or life insurance policies); on-balance sheet netting

According to art. 4 (32) CRD, Directive 2006/48/EC, unfunded credit protection means a "technique of credit risk mitigation where the reduction of the credit risk on the exposure of a credit institution derives from the undertaking of a third party to pay an amount in the event of the default of the borrower or on the occurrence of other specified events".

Consequently, any kind of risk mitigation technique can be recognised as unfunded credit protection provided: a) it effectively mitigates the credit risk of a credit institution; b) it is provided by a third party and c) it covers either the case of default of the borrower or any occurrence of other specified events17.

Certainly, all typical personal security rights meet the definition of unfunded credit protection and may, hence, provide capital relief to the protected borrowers. Third-party guarantees and credit derivatives are explicitly recognised and regulated but any other type of credit protection meeting both the generic definitions and the minimum requirements are eligible for capital relief.

It can be concluded that the personal security rights are subject to be recognised for capital relief purposes are not numerus clausus.

3. The concept ofguarantee under the CRD

The term "guarantee" is not specifically defined neither in the Basel II Accord nor is it in the CRD. Rather than making reference to a specific type of regulated contract, it intends to cover any type of personal security right with a risk mitigating effect. In this sense, it is indeed true that "there is significant variance from country to country in the legal, contractual and operational characteristics of the guarantees and therefore recognition should be based on the real nature of the guarantee, irrespective of the terminology used. It is essential that any guarantee fulfilling the minimum requirements be recognised as an eligible credit risk mitigant. 18

vis-a-vis the same counterparty, the same customer or group or affiliated entities and master netting agreements covering repurchase transactions and capital market-driven transactions.

17 This definition opens the possibility for banks to use CRM for risks others than the borrower's default. That is for instance the case of Mortgage Insurance, by which the risk covered by the insurance company is the loss arising from a mortgage loan. This means, the insurance company secures the lender in case a borrower of a mortgage loan defaults and the lender still suffers a loss after foreclosing the collateral, which secures the loan. Under the previous regulation there are no general standards, which follow to the recognition of these kinds of CRMs. Basel II offers hence a wide range of possibilities for the use of existing mechanisms to manage and reduce the credit risk as well as the development of new products.

18 Cools, Letter of the Ministry of Finance, Financial Supervisory Authority, Bank of Finland, to the European Commission, Letter 1 (26), 23rd October 2003, 13. (http://rahoi-

256 Chapter 5: Basel II and the Capital Requirements Directive

The term "guarantee" is, hence, to be understood in broad terms and not as a regulated type of contract.

For instance, the Finnish Authorities argued that the types of guarantees found in Finland, where a protection provider guarantees the loss after the lending institution has realised other credit risk mitigation, thus ensuring the exposure, fulfil the requirements imposed on guarantees in the CRD. This approach has been generally accepted within the EU. Contracts such as mortgage insurance have been, as a result, recognised as a "guarantee" in this context and for the purpose of credit risk mitigation.19

III. The regulation ofCRMs in Basel II and the CRD

1. In general

CRMs are regulated in the Basel II Accord as well as in the CRD (arts.

20

90-93 as further developed in the annexes ). The CRM framework sets requirements on CRM techniques which an institution must meet in order to qualify for a reduction of its capital requirements. The framework also determines how application of CRM techniques affects capital requirements under the Standardised Approach (RSA) and the Internal Ratings Based approaches. If application of credit risk mitigation does not result in reduction of the risk-weighted items, a financial undertaking need not take account of the credit mitigating effect in its calculations.

2. Application ofCRMs for capital relief distinction between !RB and RSA banks

The distinction between those banks following the IRB Approach and those "standard" banks (RSA) also reflects on the regulation applicable to CRMs.

For those banks using the Standard Approach, the reduction of capital by the use of CRMs is based on the substitution principle: the risk weighting for the operation is substituted by that of the guarantor, which will depend on the latter's quality as a guarantor. For instance, lending activities

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19See Answers from the Capital Requirements Directive Transposition Group; Area: 2006/48/EC, Annex VIII, Part I; Issue: Credit risk mitigation - eligibility; Question number: 184; Date of question: 8/12/1006; Publication of answer: 15 January 2007. (http://ec.europa.eu/intemal_market/bank/regcapital/transposition_en.htm).

20The application of the Lamfalussy (comitology) approach to these annexes will allow more flexible possibilities to amend the text through a system of committees and avoiding hence going through the standard co-decision procedure for EU legislation, which is long-lasting and burdensome.

are risk weighted 100%. This means that banks need to align 8% of each credit granted independently of the quality of the borrower. If the credit is guaranteed, the risk weighting applied to the operation will be that of the guarantor. Supposed the guarantor is a AAA rated company, then the risk weighting is 20%. Accordingly, the capital that the bank needs to keep aside as capital requirement is 20% of 8%, which amounts 1,6o/o instead of 8%. The benefit for the bank is 6.4%.

IRB banks use more sophisticated risk measuring and management systems. They can calculate the precise impact of the reduction of risk caused by the use of a CRM within their risk management formulas. The use of a CRM normally reduces the Probability of Default (PD) and the Loss Given Default (LGD) and IRB banks are able to calculate this reduction and diminish, as a consequence, also the allocation of capital. The final result depends on the precise combination of elements present and included into the mathematical calculations.

3. Minimum requirements for CRMs to be recognisedfor capital relief

a) Requirements related to the CRMprovider

The new regulation sets the type of guarantors that are recognised as valid to provide any type of credit risk mitigants for the purpose of capital relief21. These security providers do have an allocated risk weighting which

21 See Annex VIII, Part 2, 2, CRD, Directive 2006/48/EC under 2. "unfunded credit protection:

2.1. Eligibility of protection providers under all approaches:

26.(a) central governments and central banks;

(b)regional governments or local authorities;

(c)multilateral development banks;

(d)international organisations exposures to which a 0 % risk weight under Articles 78 to

83is assigned;

(e)public sector entities, claims on which are treated by the competent authorities as claims on institutions or central governments under Articles 78 to 83;

(f)institutions; and

(g)(i) have a credit assessment by a recognised ECAI which has been determined by the competent authorities to be associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporates under Articles 78 to 83; and

(ii)in the case of credit institutions calculating risk-weighted exposure amounts and expected loss amounts under Articles 84 to 89, do not have a credit assessment by a recognised ECAI and are internally rated as having a PD equivalent to that associated with the credit assessments of ECAis determined by the competent authorities to be associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporate under Articles 78 to 83.

27. Where risk-weighted exposure amounts and expected loss amounts are calculated under Articles 84 to 89, to be eligible a guarantor must be internally rated by the credit institution in accordance with the provisions of Annex VII, Part 4.

is used to calculate the risk mitigating effect of the guarantee and as a consequence also of the credit. Individual guarantors do not have a risk weighting allocated in the Basel Accord or CRD, so that personal security rights (unfunded credit protection) granted by a private individual (retail) do not provide any capital relief for the bank.

b) Specific minimum requirements for "Guarantees" to qualify as a CRM under RSA approach

Basel II and the CRD foresee a number of specific requirements applicable to "guarantees" in order to be recognised CRMs.

The requirements set in the CRD for guarantees to be eligible are only applicable for banks undergoing the RSA approach, i.e. those with less sophisticated risk management tools22•

According to the CRD23 for the credit protection deriving from a guarantee or credit derivative to be recognised the following conditions shall be met:

(a)the credit protection shall be direct;

(b)the extent of the credit protection shall be clearly defined and incontrovertible;

28.By way of derogation from point 26, the Member States may also recognise as eligible providers of unfunded credit protection, other 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.

2.2 Eligibility of protection providers under the IRB Approach which qualify for the treatment set out in Annex VII, Part 1, point 4.

29.- the protection provider has sufficient expertise in providing unfunded credit protection;

-the protection provider is regulated in a manner equivalent to the rules laid down in this

Directive, or had, at the time the credit protection was provided, a credit assessment by a recognised ECAI which had been determined by the competent authorities to be associated with credit quality step 3, or above, under the rules for the risk weighting of exposures to corporate under Articles 78 to 83;

-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 Articles 78 to 83; and

-the 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 Articles 78 to 83.

For the purpose of this point, credit protection provided by export credit agencies shall not benefit from any explicit central government counter-guarantee."

22See Annex VIII, Part 3, 2.1 CRD, Directive 2006/48/EC.

23Annex VIII, Part 3, 2.1, 14, CRD, Directive 2006/48/EC, under "Requirements common to guarantees and credit derivatives".

gage insurance and similar types of unfunded credit protection for residential mortgage loans29•

c) Specific minimum requirements for "Guarantees" to qualify as a CRM under /RB approach

Banks following the IRB approach are not subject to the requirements. However, each countries' supervisor will have to approve the risk models developed by each financial institution, including the risk mitigating effect of their CRM. Normally, similar conditions should be deemed necessary in order to approve the use of security rights as CRM for the purpose of capital relief.

which are treated as claims on the central government in whose jurisdiction they are established under Articles 78 to 83, a multi-lateral development bank to which a 0 % risk weight is assigned under or by virtue of Articles 78 to 83, or a public sector entity, claims on which are treated as claims on credit institutions under Articles 78 to 83, the exposure may be treated as protected by a guarantee provided by the entity in question, provided the following conditions are satisfied:

(a)the counter guarantee covers all credit risk elements of the claim;

(b)both the original guarantee and the counterguarantee meet the requirements for guarantees set out in points 14, 15 and 18, except that the counterguarantee need not be direct; and

(c)the competent authority is satisfied that the cover is robust and that nothing in the historical evidence suggests that the coverage of the counterguarantee is less than effectively equivalent to that of a direct guarantee by the entity in question.

17.The treatment set out in point 16 also applies to an exposure which is not counter guaranteed by an entity listed in that point if that exposure's counter guarantee is in turn directly guaranteed by one of the listed entities and the conditions listed in that point are satisfied."

28 Annex VIII, Part 3, 2.2, 19 CRD, Directive 2006/48/EC: "19. In the case of guaran-

tees provided in the context of mutual guarantee schemes recognised for these purposes by the competent authorities or provided by or counter guaranteed by entities referred to in point 16, the requirements in point 18(a) shall be considered to be satisfied where either of the following conditions are met: (a) the lending credit institution 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 credit institution proportional to the coverage of the guarantee; or (b) the lending credit institution can demonstrate 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."

29 Annex VIII, Part 3, 2.3, 18 a) in fine CRD, Directive 2006/48/EC under "Additional requirements for guarantees": ( ...) In the case of unfunded credit protection covering residential mortgage loans, the requirements in point 14(c)(iii) and in the first subparagraph of this point have only to be satisfied within 24 months ( ... )".

In any case, regarding the current text of the minimum requirements for a guarantee to be eligible, there is a great need for clarification still. National regulators and supervisors should, hence, focus on the final intention of the regulation, diluting any major perceived ambiguity before releasing any capital in the system. Regulators and supervisors need to check every particular CRM and test its ability to provide effective risk mitigation.

4. Possibilities to develop new CRMs under Basel II: scope for innovation?

The new international capital standard - Basel II - needs to remain flexible and able to adapt to emerging practices and risks. Basel II has been conceived as a new framework, which should contribute to a prudent capital requirements regulation but leaving scope to market evolution and innovation. It intends to enhance the development of new instruments and methodologies of risk measurement and management or at least to be able to recognise them when they are effectively used in the practice provided they meet the criteria set from a regulatory perspective for a stable financial system.

In words of Jaime Caruana, former Governor of Bank of Spain and Chairman of the Basel Committee on Banking Supervision, "Basel II is just as much about aligning supervisory practices more closely with the industry's latest advances as it is about promoting improvements in the management of risk within the industry itself. Standard needs to evolve and keep pace with the times, whilst ensuring that new standards are not unduly burdensome and do not hinder firms' abilities to innovate"30.

At the same time, recent events in the financial markets31 have proved that an excessive hunger for innovation and the development of new, sophisticated products, of which the real systemic risks are not sufficiently under control, calls for a turn back to supervisory prudence based, among others, on the deep understanding of the instruments used. This is of course the case for those types of financial instruments which aim at managing risk and as a consequence are used to reduce the levels of capital

3°Caruana, Keynote address, 201h Annual General Meeting. ISDA (International Swaps and Derivatives Association), Barcelona, 16 March 2005.

31 The 2008 financial crisis which has followed to the bankruptcy of important investment Banks such as Lehman Brothers or the State intervention of financial and insurance institutions such as Fortis Bank, has changed the paradigmas of the banking business as well as that of the banking supervision. A worldwide important set of governmental measures had to be adopted to ensure the stability of the financial system. For an overview of the State measures taken to deal with the financial crisis see: Economic Stabilization Advisory Group, Governmental Assistance to the Financial Sector: an Overview of the Global Responses (v2), November 26, 2008 .

262 Chapter 5: Basel II and the Capital Requirements Directive

requirements, such as CRMs. The implementation of Basel II rules is hence a challenge for legislators and supervisors. Financial services providers often compete on their ability to create value by offering new products and services to customers. These instruments are initially tailored to unique sets of circumstances and may involve novel features of risk-taking or risk mitigation. According to the Basel II regulator, "the challenge therefore is to ensure that the rules support and encourage firms in their efforts to improve their ability to manage their businesses while pursuing new opportunities. It is the constant responsibility for legislators, for stan- dards-setters, and for supervisors, to follow the market evolution and adapt the spirit of the regulation to those innovative products and practices offered and used by the industry" 32•

Following this line of thoughts, the New Capital Accord should, in principle, not prevent other risk mitigation techniques to be applicable and reduce the capital requirements for banks. In this case, the current regulation should be interpreted as to be applicable and adapted to other existing and to the new risk mitigation techniques that might be used in the future. This viewpoint was probably the reasoning behind the Annex VIII, Part 1, paragraph 29 CRD, according to which transactions that are "economically effectively similar" to credit derivatives transactions can be recognised as CRMs. Although, there is no corresponding language for products which have a similar economic effect to a guarantee, the same principle could be considered to apply. While this remains true, the 2008 financial crisis has made it clear that the market innovation, when not sufficiently controlled and managed, may also bring a number of unknown or unpredicted risks with potential major impacts in the economy and the financial stability. The importance of ensuring high standards of solvency will likely imply a justified more cautious approach by legislators and supervisors worldwide.

32 Caruana, Keynote address, 201h Annual General Meeting. ISDA (International Swaps and Derivatives Association), Barcelona, 16 March 2005.

Chapter 6

Security rights in the EU context: market implication and harmonisation of EU Private Law

Introduction

In terms of economic impact, the EU market integration is a growing reality, which also reflects on the needs and use of security rights within Europe. Vice versa, availability of well functioning security rights also contributes to the economic development of the EU1• Policy measures aiming at achieving an integrated financial market do, hence, have an impact on the use of security in this marketplace. Particularly in a context of economic and financial crisis, action envisaged in order to promote the use of credit will also likely reflect on security.

In legal terms, EU legislation complements the national legal regimes applicable to security rights within the EU. Along the pages of this study, the core of EU legislation applicable to personal security2 has been referred to where and as appropriate in an integrated manner. Now, in view of the current trend towards harmonisation of European Private Law, a final reflection needs to be made on the impact that efforts made in this direction will have on the law and practice of security rights.

Finally, a critical reference is made to the specific work performed in view of harmonising the law applicable to personal security rights.

A. Security rights in the current EU context.

Law and Economics

I. EU policy action in view ofenhancing credit and its impact on security rights

The positive impact of credit in terms of economic development has also been recognised in the European context by the EU institutions3. It has

1 See under: Chapter 1, C., IV. Security contributes to economic development, 22.

2Mainly, EU consumer law as implemented in Italy and Spain.

3See among many other documents: Communication for the spring European Council

-Driving European recovery, 4.3.2009, COM (2009) 114 final, 2.