United Kingdom (and EU regulation)

PRA statement on credit risk mitigation eligibility, risk-based capital treatment, and leverage ratio treatment of guarantees under the Energy Markets Financing Scheme

By Simon Lovegrove (UK) on October 19, 2022 Posted in Capital adequacy, United Kingdom

On 18 October 2022, the Prudential Regulation Authority (PRA) published a statement on credit risk mitigation (CRM) eligibility, risk-based capital treatment, and leverage ratio treatment of guarantees under the Energy Markets Financing Scheme (EMFS).

The statement sets out the PRA’s observations on the capital requirements relating to firms’ exposures under the scheme, particularly eligibility for recognition as unfunded CRM under the UK Capital Requirements Regulation (CRR). The statement also sets out observations of the treatment of exposures under the UK leverage ratio framework.

Key points include:

CRM eligibility of EMFS guarantees – The PRA considers that the terms of the guarantee provided under the scheme do not contain features that would render the guarantee ineligible for recognition as unfunded credit risk protection under the CRR, and the effects of the guarantee would appear to justify such treatment.
Observation on the EMFS scope of protection – The EMFS guarantee does not cover funds advanced after the lender learns of a use of funds previously advanced for a non-scheme purpose, or of a downgrade in the borrower’s credit rating to below the scheme minimum. Sums advanced in these circumstances are consequently not guaranteed and should be assigned the risk weight of the obligor. There is an exception for further advances made in these circumstances with the guarantor’s consent.
Firms applying the Standardised Approach (SA) for credit risk – The portion of an exposure benefiting from the protection of a guarantee provided by the Bank of England (the Bank) under the EMFS should be assigned the relevant central bank risk weight prescribed by the SA. Any residual part of the exposure that is not covered by the guarantee should be assigned the SA risk weight that would apply if the exposure were not guaranteed.
Firms applying an Internal Ratings based (IRB) approach for exposures to be obligor, with a permanent partial use (PPU) exemption for exposures to the guarantor – The portion of an exposure benefiting from the protection of a guarantee provided by the Bank under the scheme would be assigned the relevant central bank risk weight prescribed by the SA. Any residual part of the exposure that is not covered by the guarantee should be risk weighted according to the relevant approved IRB approach as if the exposure were not guaranteed.
Firms applying an IRB approach for exposures to the obligor and for exposures to the guarantor – Firms should adopt an approach to reflect the effect of the guarantee provided by the Bank that is consistent with their approved IRB models and their IRB permissions.
Leverage ratio treatment of exposures under the scheme – Firms should include exposures relating to the scheme in their leverage ratio total exposure measure, as calculated in accordance with the Leverage ratio (CRR) part of the PRA Rulebook.