As defined in Article 4(1)(39) of Regulation (EU) No 575/2013 (CRR), clients can be included into ‘groups of connected clients’ through criteria of control (Article 4(1)(39)(a)) or economic interconnection (Article 4(1)(39)(b)).
What is the correct treatment of exposure to a client in case when the client is connected with other natural or legal persons through criteria of control and / or economic interconnection?
Should the institution include and report all those clients connected with particular client as one ‘group of connected clients’ regardless of criteria of connection (control vs. economic interconnection) or should the institution include and report particular client in two (or more) groups where one group includes clients that are connected with particular client through criteria of control and the other separate group (or more groups) is formed of clients that are connected with particular client through criteria of economic interconnection?
According to Article 4(1)(39) “…‘group of connected clients’ means any of the following:
(a) two or more natural or legal persons who, unless it is shown otherwise, constitute a single risk because one of them, directly or indirectly, has control over the other or others;
(b) two or more natural or legal persons between whom there is no relationship of control as described in point (a) but 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, in particular funding or repayment difficulties, the other or all of the others would also be likely to encounter funding or repayment difficulties. …”
Institution has exposure to four companies (A, B, C and D). Company A owns more than 50% of voting power and directly controls company B. Institution considers those two companies interconnected through criteria of control.
Company B is connected with companies C and D through economic interconnection (there is no control between companies B, C and D).
Should an institution include and report all companies as one single group of connected clients? Or should an institution include one group of connected clients formed by companies A and B and the other group of connected clients formed by companies B, C and D and report and treat those two groups as separate groups of connected clients?
As described in the EBA Guidelines on connected clients under Article 4(1)(39) of Regulation (EU) No 575/2013 (EBA/GL/2017/15), the concepts of control and economic dependency are two types of interconnection to be assessed separately on the basis of the individual circumstances. However, there are situations where both types of dependencies are interlinked and could therefore exist within one group of connected clients in such a way that all relevant clients constitute a single risk. Where clients that are part of different control groups are interconnected via economic dependency, all entities for which a chain of contagion exists need to be grouped into one group of connected clients Therefore the chain of contagion leading to possible default of all entities concerned is the relevant factor for the grouping and needs to be assessed in each individual case.
Using the example presented in the background, the institution needs to consider the possible chain of contagion leading to possible financial difficulties and further assess the nature of the economic dependency between B, C and D. The institution should clarify whether C and D are economically dependent on B and whether B can be easily replaced by another client or vice versa. Depending on the chain of contagion leading to financial difficulties or possible default, the institution should then form a comprehensive group or several smaller groups of connected clients and submit large exposures reports accordingly. For example, where C and D are so strongly economically dependent on B that B cannot be easily replaced, the group of connected clients will include A, B, C and D (because financial difficulties of A will lead to financial difficulties of B; and financial difficulties of B will likely lead to financial difficulties of C and D). This would also be the case where a mutual dependency exists between B and C and B and D. However, if B is economically dependent on C and D, but C and D are not dependent on B, 3 separate groups of connected clients may be identified: A+B, B+C and B+D (because financial difficulties of A, or C, or D will lead to financial difficulties of B; but financial difficulties of B will not lead to financial difficulties of C or D).
*The Q&A was amended on the 24/11/2017 only to update the reference to the then finalised EBA Guidelines on connected clients.
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.