In case of an institution’s guaranteeing the amount of a customer’s original investment into a CIU and a minimum yield:
1. To which risk category for off-balance sheet items in Annex I CRR shall these guarantees be assigned, in particular shall this assignment depend on any risk mitigation techniques used by the CIU?
2. Shall these guarantees be treated as an exposure in the form of units or shares in a CIU, which would in particular allow the institution to look-through to the underlying exposures of the CIU, provided the conditions for looking-through are met?
An institution has the following contractual obligations with respect to a customer’s investment into a structured fund that meets the definition of a CIU [Article 4(1)(7) CRR]:
(a) to replace a certain percentage of the customer's loss relative to the amount of his original investment into the CIU; and
(b) to make payments to this customer up to a guaranteed yield relative to the amount of his original investment into the CIU to the extent this guaranteed yield is not generated by the CIU.
The question is related to the following structure: The institution is providing guarantees for "formula" funds, “formula-based funds” or “structured funds”. These funds allow the investors to benefit from the rise of the market but limit the risk of the investors because the invested amount (capital) is to a certain extent guaranteed by the institution if the value of the underlying plummets (e.g. if the value falls below 95%) relative to the amount of his original investment into the CIU. The institution also guarantees the investors a certain minimum yield relative to the amount of his original investment into the CIU.
The fund covers its risks by derivatives with third parties that are intended to secure both a minimum yield and the capital. The fund also holds some liquid assets (it is a legal requirement for the funds to hold a minimal stock of securities) which stem from swapping (with a banking counterparty) a part of the cash collected from investors against some securities. When the fund expires, the cash is returned to the fund; the securities serve as collateral for the cash transfer.
The guarantee of the institution is only triggered if the fund’s derivatives with third parties fail to ensure a minimum yield or the capital, or if the cash is not returned by the counterparty for the securities. The institution is obliged to limit the losses of the investors to ensure they recover a certain percentage [e.g. 95%] of the reference value at liquidation calculated according to the formula of the funds, and receive a minimum yield.
To the extent that these “guarantees” are treated under the banking book rules, as it would be for instance if the derogation for small trading book business established in Article 94 CRR is applied, the following treatment should be followed:
1. In case of an institution guaranteeing the amount of a customer’s original investment into a CIU and a minimum yield, as in the case at hand, the institution’s guarantees, to the extent that they have the character of credit substitutes, need to be assigned to the “full risk” category for off-balance sheet items, according to Annex I, (1)(a) CRR, and this applies irrespective of whether the CIU is using techniques to mitigate the loss risk for the investor.
2. As credit substitutes for investments into a CIU, the guarantees given in the case at hand constitute for the institution exposures in the form of units or shares in the CIU according to Article 132 and 152 CRR. This applies also to the guarantee of the minimum yield because this is equivalent to an obligation to replace the loss that would have happened had the customer additionally invested the amount equal to the minimum yield into units or shares in the CIU.
The exposure value is determined (a) by the guaranteed percentage of the amount invested by the customer; and (b) by the guaranteed minimum yield.
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.