STS Criterion 30. Credit protection payments

Description

Credit protection payments

Content

The credit protection payment following the occurrence of a credit event should be calculated based on the actual realised loss suffered by the originator, as worked out in accordance with its standard recovery policies and procedures for the relevant exposure types14 and as recorded by the originator in its Financial Statements at the time the payment is made. The final credit protection payment should be payable within a specified period following the end of the workout process for the relevant underlying exposure.

Transactions should provide that an interim credit protection payment is to be made, at the latest, 6 months after the credit event has occurred in cases, where the workout of the losses for the relevant underlying exposure has not been finalised by that time.

The interim credit protection payment should be, at least, the maximum of the impairment considered by the originator in its financial statements, in accordance with the applicable accounting framework, at the time the interim payment is made and, if applicable, the LGD determined in accordance with Part Three Title II Chapter 3 CRR that has to be applied to the corresponding underlying exposures in order to determine the IRB capital requirements on the originator for such underlying exposure according to the CRR. Where an interim credit protection payment is made, a final credit protection payment should be made in order to adjust the interim settlement of losses to the actual realised loss, in accordance with the first paragraph of this criterion.

Where the protected amount is less than the outstanding notional amount of the corresponding underlying exposure, the credit protection payment should be in the same proportion to the protected amount as the protection buyer’s realised loss bears the outstanding notional amount of the underling exposure, subject only to the rule on interim payments.

The method by which interim and final credit protection payments are calculated should be clearly specified in the credit protection agreement.

The rights of the protection buyer to receive protection payments under the synthetic securitisation should be enforceable.

The amounts payable by investors under the securitisation are clearly defined, capable of calculation in all circumstances and limited in amount.

The circumstances in which investors are required to make payments under the credit protection agreement should be clearly defined objective or subject to a determination by the verification agent, and limited in number.

The credit protection amount should be broken down to the level of individual underlying exposures.

Rationale

From the originator’s perspective, in order to ensure that the credit protection eventually covers the losses incurred by the originator, it is important that loss settlements do not fall short of the loss amounts as worked out by the originator. In addition, aligning credit protection payments to the loss amounts worked out by the originator ensures that the protection buyer’s and the protection seller’s interests in the transaction are more aligned, leading to better incentives on both sides of the transaction.

As the full work out of losses can be a lengthy process, depending on the type of asset class/collateral under consideration as well as the characteristics of national judicial and insolvency regimes, it is important from the originator’s perspective to ensure a minimum degree of timeliness in credit protection payments in all circumstances. For this reason, and also to ensure that the originator does not keep paying for credit protection on the protected notional amount of a given underlying exposure when a credit event has occurred in relation to that exposure, an interim payment should be make at the latest 6 months after such credit event has occurred. By means of a final adjustment payment, the payment to cover losses under the credit protection agreement in relation to a particular underlying exposures should then be adjusted to the fully worked-out loss amounts in order to ensure the coverage of actual losses through the credit protection.

Where an originator uses the IRB Approach for the purposes of determining its capital requirements for an underlying exposures, the interim payment should reflect, at least, the originator’s LGD assigned to the underlying exposure (regulatory LGD or own estimate). Where the institution decides to recognise in its financial statements a higher figure than the LGD used for capital requirements purposes, it is important that the interim payment reflects such a decision.

In order to facilitate the loss allocation in case of the occurrence of credit events, the credit protection coverage should be broken down to the level of individual underlying exposures, irrespective of whether the credit protection amount is specified with reference to the individual underlying exposures or to the obligors in respect of those exposures.