If the derivative exposure is guaranteed, can the weight be determined based on guarantor’s rating instead of counterparty’s rating, i.e. do we use the counterparty’s credit rating or the guarantor’s rating?

Illustrative example: Credit institution ‘A’ trades with the fully owned subsidiary of credit institution ‘B’. The subsidiary does not have an external credit rating and its internal credit rating is lower than that of ‘B’. Credit institution ‘B’ provides guarantee to its subsidiary. If ‘A’ wants to hedge its exposure to the subsidiary of ‘B’, it should buy CDS protection on ‘B’ (since subsidiary is guaranteed by credit institution ‘B’). When ‘A’ calculates CVA capital charge for its exposure to the subsidiary of ‘B’ under the standardised approach, it should use the credit rating of ‘B’. Is it correct to determine the weight based on credit rating of ‘B’ rather than ‘B’’s subsidiary?

In accordance with Article 384 of Regulation (EU) No.575/2013 (CRR), if a credit assessment by a nominated ECAI for credit institution 'B''s subsidiary is not available, and if credit institution 'A' uses the Standardised Approach for calculating capital requirements for credit risk, it shall assign a weight of w_i=1% to the credit institution 'B''s subsidiary, or, if credit institution 'A' uses Article 128 of the CRR to risk weight counterparty credit risk exposures to the credit institution 'B''s subsidiary, a weight of w_i =3% shall be assigned.

If a credit assessment by a nominated ECAI for credit institution 'B''s subsidiary is not available, and if credit institution 'A' uses the IRB Approach for calculating capital requirements for credit risk, it shall map the internal rating of credit institution 'B''s subsidiary to one of the external credit assessments, which shall be mapped to one of the six weights w_i as set out in Table 1 of Article 384 of the CRR.

Update 26.03.2021: This Q&A has been reviewed in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR) and continues to be relevant.