Question ID
2025_7470
Legal act
Regulation (EU) No 575/2013 (CRR)
Topic
Credit risk
Article
207
Paragraph
2
Subparagraph
2
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations
Not applicable
Article/Paragraph
Not applicable
Type of submitter
Credit institution
Subject matter
Eligibility as collateral under article 207(2) of secured notes designed specifically to remove any material positive correlation between the value of the note and the credit quality of its issuer.
Question

Entity A issues a secured note designed specifically to remove any material positive correlation between the value of the note and the credit quality of its issuer (entity A). The note is secured by assets uncorrelated to entity A. In legal structure I, entity A deposits the assets with a third-party custodian trust account, pledged to the note holders.  In a variant legal structure II, entity A sells the assets to a SPV, which has been setup by entity A for that sole purpose; the SPV then issues a guarantee to the noteholders, backed by the assets it holds.

Bank B enters into a reverse repo with entity A, where it lends cash to entity A and receives the secured note as collateral.

From bank B’s perspective, does such secured note qualify as eligible collateral under CRR article 207(2) when:

  • the secured note is secured by the assets held in a third party custodian trust account, pledged to the noteholders (legal structure I)?
  • the secured note is guaranteed by a SPV holding the assets (variant legal structure II)?
Background on the question

For a security received as collateral to effectively reduce (Counterparty) Credit Risk RWAs, the CRR requires in particular that its value is not materially positively correlated with the credit quality of the obligor/counterparty (‘Wrong Way Risk’).

These requirements are laid out under:

  • Chapter 4, Title II, Part THREE (Credit Risk Mitigation for Credit Risk RWAs), article 207
  • Chapter 6, Title II, Part THREE (Counterparty Credit Risk RWAs), article 291

CRR article 207(2) 1st sub-paragraph provides that in order to be eligible as collateral, a financial asset must not be materially positively correlated with the credit quality of the obligor.

CRR article 207(2) 2nd sub-paragraph adds that no securities issued by the obligor or any related group entity can qualify as eligible collateral, with the exception of covered bonds falling within the terms of Article 129 when they are posted as collateral for a repurchase transaction.

CRR article 291(5) requires institution to apply a specific treatment when both 1) Specific Wrong Way Risk (S-WWR) has been identified and 2) the counterparty and the issuer of the underlying of the transaction are legally linked.

Financial institutions have recently developed and issued so-called secured notes (e.g. EMTN-S), designed specifically to retain value in the event of the issuer defaulting by removing the material positive correlation feature of standard unsecured notes. Article 207(2) remains unchanged since CRR was first published in the EU OJ in 2013 while these products where only developed in the last few years.

Usually, a financial institution will setup a bankruptcy remote third-party custodian trust account or SPV for that sole purpose and then transfer to it a pool of assets uncorrelated to the credit quality of the financial institution, for a value in excess of the repayment obligations under the note. In the case of a third-party custodian trust account, the assets are pledged to the benefit of the noteholders. In the case of the SPV, it provides a guarantee to the noteholders ensuring payment of the note backed by the pool of assets.

Submission date
Status
Question under review
Answer prepared by
Answer prepared by the EBA.