The CRR defines indirect holdings as 'any exposure to an intermediate entity that has an exposure to capital instruments issued by a financial sector entity (FSE) where, in the event the capital instruments issued by the FSE were permanently written off, the loss that the institution would incur as a result would not be materially different from the loss the institution would incur from a direct holding of those capital instruments issued by the FSE'. Accordingly, the institution is required to perform an internal assessment in order to determine if the loss would be materially different or not. As the CRR and the respective Commission Delegated Regulation 2015/923 provide no guidance on how this assessment should be made, confirmation is sought that stress scenarios that are already utilised by the institution for internal risk management purposes as part of the credit approval process, can be used for this purpose. To provide additional background, three illustrative examples and an illustrative stress scenario analysis are provided below.

I. Illustrative examples Example 1: The bank provides financing to an SPV which is owned by a third party. The financing takes the form of a non-recourse loan which is collateralised by FSE shares. The initial Loan-To-Value (LTV) is 50%, i.e. the initial value of the shares exceeds the loan amount by a factor of two (over-collateralisation). Except for the over-collateralisation (low LTV) there is no additional risk mitigation, i.e. the FSE shares represent the only assets of the SPV and no additional collateral is provided. Example 2: Identical to example 1, but the SPV now owns government bonds in addition to the FSE shares. The initial market values of the government bonds and the FSE shares are identical. The initial LTV (taking both the government bonds and the FSE shares into account) remains 50%. Example 3: The bank provides financing to an SPV which is owned by a third party. The financing takes the form of a non-recourse margin loan which is collateralised by FSE shares. The initial LTV remains 50% as per example 1. The value of the collateral shares is monitored on a daily basis and the SPV is subject to margin calls if the LTV reaches 65% (margin trigger) due to a share price decline. If the margin trigger is reached, the third party has the right but not the obligation to immediately inject cash into the SPV which is provided to the bank as additional margin collateral in order to restore the initial LTV of 50%. If the third party does not provide additional collateral, an 'event of default' will have occurred and the bank will have the right to immediately enforce its security pledge and liquidate the collateral shares in the market to recover the loan amount. II. Illustrative stress scenario A stress scenario is applied that involves an initial sudden price decline of the FSE collateral shares equal to the historically observed 99th loss percentile over 10 trading days. Thereafter, a further daily price decline is assumed equal to the historically observed 95th loss percentile on each day until the share price will have fallen to zero. In example 3, this stress scenario is applied to the share price immediately after the margin trigger has been reached assuming no margin collateral will be provided to restore the initial LTV. The bank then starts liquidating the shares during a period of further daily price decline assuming that 20% of the historical daily average trading volume can be sold each day. III. Analysis Example 1: If the stress scenario is applied, the market value of the FSE shares declines in line with the scenario parameters, but the bank has no right to liquidate the shares before their value will have fallen to zero. The bank will therefore incur a loss that equals the full loan amount. Accordingly, the loan to the SPV meets the definition of an indirect holding. Example 2: If the stress scenario is applied, the market value of the FSE shares declines in line with the scenario parameters. As in example 1, the bank has no right to liquidate the FSE shares before their value will have fallen to zero. Nonetheless the bank will not incur a loss in this example as the value of the government bonds is sufficient to recover the loan amount. Accordingly, the loss incurred from the loan is materially different to the loss incurred from holding the FSE shares directly. Consequently, the loan does not meet the definition of an indirect holding. Example 3: First, it is assumed that the share price has reached the margin trigger but the margin call is not met. Then, if the stress scenario is applied, the shares are subject to an immediate sudden price decline equal to the historically observed 99th loss percentile over 10 trading days. Following this initial price decline, the bank now starts liquidating the FSE shares assuming continued further daily price declines equal to the historically observed 95th loss percentile and that 20% of the historical daily average trading volume can be sold each day. If the total liquidation value of the FSE shares still exceeds the loan amount in this stress scenario, the bank will not incur a loss. Accordingly, the loss incurred from the loan is materially different to the loss incurred from holding the FSE shares directly. Consequently, the loan does not meet the definition of an indirect holding. Whilst examples 1 and 2 were included in this section to explain the principle, there is actual client demand for non-recourse margin loans as per example 3. The key rationale for borrowers to enter into non-recourse margin loans is to raise funding while protecting their broader asset portfolios from recourse in the event of default. This restriction in recourse is typically achieved by the borrower placing their shares into an SPV and the lending bank extending a loan to that SPV together with a pledge. The SPV creates legal isolation from the borrowers other assets which it wants to protect.