How shall the covered part of the exposure be reported where the collateral is a Covered Bond?
We have a scenario where a EUR 10 million loan to an unrated corporate (PD = 1%) is secured by a covered bond of an AA-rated bank with remaining maturity of 3 years and a market value of EUR 9.9 million.
The instructions on C 07.00, c090-c100 (substitution of the exposure due to CRM) refer to Articles 222 (3), Article 235 (1) to (2) and Article 236 of CRR and state: ‘Outflows correspond to the covered part of the Original Exposure pre conversion factors, that is deducted from the obligor's exposure class and subsequently assigned to the protection provider's exposure class. This amount shall be considered as an Inflow into the protection provider's exposure class.’
In the example above, the obligor is an unrated Corporate. The covered part will be reported as ‘outflow’ on the ‘corporates’ sheet.
However, under the substitution approach, where will the covered part be reported as ‘Inflow’ ? On ‘corporates’ sheet (same sheet) or ‘covered bonds’ exposure class sheet?
With reference to a similar question 2016_2693, where Cash (Financial Col. Simple method) is reported on ‘Other Assets’ rather than protection providers class.
The reporting of CRM techniques with substitution effect is explained in section 3.1.1. of Annex II to Regulation (EU) No 680/2014 (ITS on Supervisory Reporting). According to paragraph 44, in the case of an exposure being secured by unfunded credit protection, the secured part is assigned as an outflow e.g. in the exposure class of the obligor (in the example in the question: ‘exposure to corporates’) and as an inflow in the exposure class of the protection provider. Paragraph 45 continues that the substitution effect shall reflect the risk weighting treatment effectively applicable to the covered part of the exposure and that the covered part of the exposure is therefore risk weighted according the SA approach and reported in template C 07.00 of Annex I to the ITS on Supervisory Reporting.
The provisions of paragraphs 44 and 45 apply analogously to cases of funded credit protection, where the financial collateral is recognised according to the financial collateral simple method in accordance with Articles 222 (1) and (2) of Regulation (EU) No 575/2013, as in the example provided (exposure secured by a covered bond).
Consequently the allocation of the secured part to an exposure class has to follow the decision tree of section 3.2.3 paragraph 64 et seq. of Annex II.
In the example provided by the submitter, the secured part is secured by a covered bond issued by a rated institution. According to the decision tree, this secured part would be reported as an inflow in the exposure class ‘Exposures in the form of covered bonds (Article 129 of Regulation (EU) 575/2013)’.