Could the subsidiary / branch of an EU credit institution established outside the EU use local criteria (i.e. criteria widely used by credit entities and public bodies in the relevant foreign jurisdiction) to classify an undertaker as a small or medium-sized enterprise in order assign to its exposures a risk weight of 75% according to Article 123?Could the subsidiary / branch of an EU credit institution established outside the EU use local criteria (i.e. criteria widely used by credit entities and public bodies in the relevant foreign jurisdiction) to classify an undertaker as a small or medium-sized enterprise in order assign to its exposures a risk weight of 75% according to Article 123?
According to Article 123, exposures shall be eligible for the retail exposure class (and a risk weight of 75%) if certain requisites are met, among them that the exposure shall be either to a natural person or to a small or medium-sized enterprise (SME).
While there is no SME definition in Regulation 575/2013 Article 501(2)(b), includes a reference to the European Commission Recommendation, concerning the definition of micro, small and medium-sized enterprises to the end of applying the capital requirements deduction for credit risk on exposures to SME. But the same Article 501 clarified that the reference to the Commission Recommendation is “for the purpose of this article” and also that among the criteria listed in its Annex (number of employees, annual turnover or size of balance sheet) only the annual turnover should be taken into account.
As for the retail exposures referred in Article 123, the entity should define the scope of this segment of its activity (SME), taking into account the peculiarities of the markets, countries and currencies in which it operates. In this sense, and, when relevant, the entity should use the said Recommendation as a guidance, as it is stated in Q&A 2013_27. In this sense, it is worth mentioning the Recommendation was to be applied for Community policies “within the Community and the European Economic Area.”
Credit entities established outside the EU, subsidiaries of an EU-parent company, should develop their business in a different monetary, economic and regulatory environment, and their policies and business organisation (among it the client segmentation) must take into account the peculiarities of the markets in which they operate.
In turn, management information must be adapted to the organisation of the business so that its results allow to accurately measure the cost and income of the different activities and adopt the possible actions of optimisation of the business of the entity.
As regard the segmentation of credit exposures in order to calculate own funds requirements, Article 147(5) CRR letters (b) and (c), applicable to IRB approach, establishes that those with SME which- additionally to the fulfillment of other requirements - are not managed individually as corporate and represent one of a significant number of similarly managed exposures, are eligible as retail exposures. In the same sense, Article 123(b), applicable to standardised approach establishes that an SME exposure shall be one of a significant number with similar characteristics to be eligible as retail.
The approach under which the own funds requirements for the credit risk exposures are calculated should not be taken into account in order to classify a business as an SME. Counterparties must be identified based in a risk management criteria to obtain a segmentation consistent with the mentioned articles regardless the corresponding own funds requirements are calculated under the standardized or the IRB approach.
The classification of a counterpart as an SME- with the exceptions explicitly included in the CRR, such as the criteria for the application of the SME “factor”- should follow the segmentation used in credit risk management which, in turn, will be adjusted to the entity´s business organisation and the market environment in which the business is developed.
As clarified in Q&A 27, Commission Recommendation 2003/361/CE provides guidance to institutions in order to identify qualifying exposures to SMEs for Articles different than Article 501 Regulation (EU) No 575/2013 as amended by Regulation (EU) 2019/876 (CRR2), where the use of the mentioned Recommendation is required (Article 501(2)(b) CRR2).
The subsidiaries established in a non-EU country are not subject to CRR2 on their individual basis, but to the local supervisory regulations in that third country. On the other hand, branches (as defined in Article 4(1)(17) CRR2) established in a third country form a legally dependent part of the institution, which has to comply with the CRR2, including for exposures arising from transactions carried out by these branches.
Nevertheless, for the case of subsidiaries established in a third country, where they use - for the purposes of complying with the local supervisory regulations in that third country - a definition of SME different from that used by the EU parent undertaking for the basis of the consolidated situation, the EU parent undertaking has, under Article 11(1) CRR2, to apply the CRR2 definition for the purpose of prudential consolidation in order to account for exposures in third countries held by its third country subsidiaries.