STS Criterion 36. Eligible credit protection agreement counterparties and collateral

Description

Eligible credit protection agreement, counterparties and collateral

Content

Only the following credit protection arrangements establishing the synthetic securitisation should be allowed:

• A. a guarantee meeting the requirements set out in Chapter 4 of Part Three Title II of the CRR, by which the credit risk is transferred to any of the entities listed under Article 214 (2) (a) to (d) of the CRR, provided that the exposures to the protection provider qualify for a 0% risk weight under Chapter Two of Part Three Title II of the CRR, or;
• B. a guarantee meeting the requirements set out in Chapter 4 of Part Three Title II of the CRR which benefits from a counter-guarantee of any of the entities referred to in point (i); or
• C.other credit protection in the form of guarantees or credit derivatives not referred to under the previous two points that is meeting the requirements set out in Sub-Section 2 of Section 3, Chapter 4 of Part Three Title II of the CRR as amended by Article 249 of the CRR, provided that the obligations of the protection seller are subject to the following collateral requirements.

When the collateral is provided in accordance with the point C, both the originator and the protection seller need to have recourse to high quality collateral, in either of the following forms:

• collateral is in the form of 0% risk weighted debt securities, held in a trust or entity set up for the sole purpose of holding securities whose notional value takes into account clearly determined and conservative haircuts to appropriately mitigate market and other risks, and which have a short remaining maturity of maximum 3 months, and under robust custody arrangements, or
• collateral in the form of cash held with a third party credit institution with a sufficient credit quality standing.

In addition, the following requirements should apply to the collateral:

• The rights of the originator to use the collateral to meet protection payment obligations of the investors should be enforceable. Security arrangements should be provided to ensure such right of the protection buyer.
• The rights of the investors when the synthetic securitisation is no longer outstanding to the return of any collateral that has not been used to meet protection payments should be enforceable.
• Where collateral is invested in securities, the securitisation documentation should set out the eligibility criteria and custody arrangement for such securities.

Where the investors remain exposed to the credit risk of the originator, this must be clearly disclosed in the securitisation documentation.

The originator should obtain an opinion from a qualified legal counsel confirming the enforceability of the credit protection in all relevant jurisdictions.

Rationale

Unlike in the case of traditional (true sale) securitisation, in synthetic securitisation transactions the actual extent of credit risk transfer also depends on:

• The risk of default of the protection provider, in case of unfunded credit risk mitigation arrangements, or;
• The risk that the protection buyer may not have access to the collateral in a timely fashion and/or without incurring losses on the value of that collateral, in case of funded protection.

It is important that synthetic transactions eliminate or adequately minimise the counterparty credit risk incurred by the originator, to adequately mimic comparable traditional securitisation positions where such risk does not arise.

In the case of unfunded credit risk protection arrangements, this is ensured by restricting the scope of eligible protection providers to those entities that are eligible providers in accordance with the CRR and that the CRR recognises as counterparties to be risk-weighted at 0% in accordance with the Standardised Approach for credit risk.

Where the counterparty is not recognised by the CRR to be eligible for a 0% risk weight, the resulting counterparty credit risk can be mitigated by requiring the counterparty to fund the credit protection by providing high quality collateral (which in case of synthetic securitisation making use of an SSPE may include the issuance of credit linked notes). In order to mitigate the counterparty credit risk for both the originator and the protection seller, such high quality collateral should be held with a third party (such as in form of EU government securities or supranational entities held in a trust or a similar entity, or in form of cash held with a third party credit institutions).

In addition, a legal opinion should be provided to the originator to confirm that the credit protection is enforceable in all relevant jurisdictions. This requirement already exist under the CRR (Art. 245(4)(g)), and to ensure level playing field it should be applicable to all eligible originators under the STS synthetic framework.