5.Majority-owned or controlled banking entities, securities entities (where subject to broadly similar regulation or where securities activities are deemed banking activities) and other financial entities should generally be fully consolidated. Notwithstanding the banks decision on exercising control over an entity and the subsequent consolidation of that entity, the Central Bank reserves the right to determine whether the bank exercises control over an entity and hence may require banks to consolidate/deconsolidate entities.

6.In instances where it is not feasible to consolidate certain majority-owned banking, securities or other regulated financial entities¹, banks may, subject to prior Central Bank approval, opt for non-consolidation of such entities for regulatory capital purposes.

7.For group level reporting, if any majority-owned financial subsidiaries are not consolidated for capital purposes, all assets, liabilities and third-party capital investments in the subsidiaries will be removed from the bank’s balance sheet. All equity and other investments in regulatory capital instruments in those entities attributable to the bank / banking group will be deducted.

8.Banks are required to deduct from CET1 the full amount of any capital shortfalls of subsidiaries excluded from regulatory consolidation, that are regulated entities and are subject to capital requirements. The amount of the capital requirement and capital shortfall for this deduction is to be based on the regulations issued by the subsidiary’s regulator (i.e. based on the host regulator’s local capital adequacy requirements).

¹ Examples of the types of activities that financial entities might be involved in include financial leasing, issuing credit cards, portfolio management, investment advisory, custodial and safekeeping services and other similar activities that are ancillary to the business of banking.

Banking, securities, financial and insurance entities – (ownership in entity does not exceed 10%)

9.A bank’s equity interests in banking, securities, insurance and other financial entities are defined as investments in the capital of banking, securities, insurance and other financial entities if the bank owns up to 10% of the investee’s common share capital.

For detailed treatment of investments in such entities, refer to Section 3.9 - Regulatory Adjustments.

Banking, securities, financial and insurance entities – Significant investments (ownership in entity exceeds 10%)

10.Significant investments in banking, securities and other financial entities are defined as investments in the capital of banking, securities and other financial entities (that are outside the scope of regulatory consolidation) wherein the bank owns more than 10% of the investee’s common share capital. Such investments will be subject to the treatment outlined in Section 3.10 - Regulatory Adjustments.

11.Significant investments in commercial entities are subject to the treatment outlined in section 5. Subsidiaries that are commercial entities are not to be consolidated for regulatory capital purposes. In cases where a subsidiary that is a commercial entity has been consolidated for accounting purposes, the entity is to be deconsolidated for regulatory purposes (i.e. all assets, liabilities and equity will be removed from the bank’s balance sheet) and the book value of the investment will be subject to the treatment.

For detailed treatment of investments in such entities, refer to Section 5.

12.Total regulatory capital will consist of the sum of the following items:

1. i.Tier 1 capital, composed of
   1. a.Common Equity Tier 1 (“CET1”)
   2. b.Additional Tier 1 (“AT1”)
2. ii.Tier 2 capital.

These regulatory capital components are net of regulatory adjustments.

13.Article (2.2) of Capital Adequacy Regulation requires banks to apply the following minimum requirement, at all times:

1. i.CET1 capital must be at least 7.0% of risk-weighted assets (RWA).
2. ii.Tier 1 capital must be at least 8.5% of RWA.
3. iii.Total capital, calculated as sum of Tier 1 capital and Tier 2 capital, must be at least 10.5% of RWA.

14.Article (5.1) of Capital Adequacy Regulation requires banks to maintain a capital conservation buffer (CCB) of 2.5% of total risk weighted assets, in the form of CET1 capital.

15.Article (6) of Capital Adequacy Regulation requires banks to implement a countercyclical buffer (CCyB). Banks must meet the CCyB requirements by using CET1 capital exclusively. Banks will be subject to a countercyclical buffer that varies between zero and 2.5% of total risk weighted assets. The buffer that will apply to each bank will reflect the geographic composition of its portfolio of credit exposures. The CCyB buffer extends the capital conservation buffer (CCB).

16.Domestic Systemically Important Banks (D-SIBs) are required to comply with article (7) of the Capital Adequacy Regulation. The additional requirements for identified D-SIBs will be communicated individually by the Central Bank to each relevant bank. Banks must meet the D-SIB buffer requirements by using CET1 capital. The D-SIB buffer extends the capital conservation buffer (CCB).

17.Based on the outcome of the Supervisory Review and Evaluation Process (SREP) conducted by the Central Bank, a bank may be subject to an additional capital add-on, also referred to as individual Supervisory Capital Guidance requirement (SCG). Banks notified must apply the individual SCG requirement, as set by the Central Bank. The Individual SCG increases the minimum capital requirement.

18.The aggregation of all the capital buffers (CCB, CCyB and D-SIB) form an effective capital conservation buffer. Any breach of the capital conservation buffers will lead to the following additional supervisory requirements and constraints on distributions:

1. i.The relevant bank must immediately inform the Central Bank of the breach.
2. ii.The relevant bank shall submit an approved plan to restore its regulatory capital to meet the buffer level requirement.
3. iii.The relevant bank will be subjected to more intense supervision.
4. iv.Capital conservation restrictions will immediately become effective in the form of restriction of dividends as prescribed by the Central Bank.

19.As per Article 3.1 of the Capital Adequacy Regulation, CET1 capital consists of the sum of the following elements:

1. i.Common shares issued by a bank which are eligible for inclusion in CET1 (or the equivalent for non-joint stock companies);
2. ii.Share premium resulting from the issue of instruments included in CET1;
3. iii.Retained earnings;
4. iv.Legal reserves;
5. v.Statutory reserves;
6. vi.Accumulated other comprehensive income and other disclosed reserves;
7. vii.Common shares issued by consolidated subsidiaries of a bank and held by third parties, also referred to as minority interest, which are eligible for inclusion in CET1;
8. viii.Regulatory adjustments applied in the calculation of CET1.

20.Retained earnings and other comprehensive income include audited/reviewed interim profit or loss. Expected dividend payments are excluded from CET1.

Common shares issued by the bank

21.For an instrument to be included in CET1 capital, it must meet all of the following criteria stated below. In cases where banks issue non-voting common shares, they must be identical to voting common shares of the issuing bank in all respects except the absence of voting rights for inclusion in CET1.

1. i.Represents the most subordinated claim in liquidation of the bank.
2. ii.The investor is entitled to a claim on the residual assets that is proportional to its share of issued capital, after all senior claims have been paid in liquidation (i.e. has an unlimited and variable claim, not a fixed or capped claim).
3. iii.The principal is perpetual and never repaid outside of liquidation (setting aside discretionary repurchases or other means of effectively reducing capital in a discretionary manner that is allowable under relevant law and subject to the prior approval of the Central Bank).
4. iv.The bank does nothing to create an expectation at issuance that the instrument will be bought back, redeemed or cancelled, nor do the statutory or contractual terms provide any feature that might give rise to such an expectation.
5. v.Distributions are paid out of distributable items, including retained earnings. The level of distributions is not in any way tied or linked to the amount paid in at issuance and is not subject to a contractual cap (except to the extent that a bank is unable to pay distributions that exceed the level of distributable items).
6. vi.There are no circumstances under which the distributions are obligatory. Non-payment is, therefore, not an event of default.
7. vii.Distributions are paid only after all legal and contractual obligations have been met and payments on more senior capital instruments have been made. This means that there are no preferential distributions, including in respect of other elements classified as the highest quality issued capital.
8. viii.The issued capital takes the first and proportionately greatest share of any losses as they occur. Within the highest quality capital, each instrument absorbs losses on a going concern basis proportionately and pari passu with all the others.
9. ix.The paid-in amount is recognized as equity capital (i.e. not recognized as a liability) for determining balance sheet insolvency.
10. x.The paid-in amount is classified as equity under the relevant accounting standards.
11. xi.It is directly issued and paid-in and the bank cannot directly or indirectly have funded the purchase of the instrument.
12. xii.The paid-in amount is neither secured nor covered by a guarantee of the issuer or related entity or subject to any other arrangement that legally or economically enhances the seniority of the claim.
13. xiii.It is either only issued with the approval of the owners of the issuing bank, given directly by the owners or, if permitted by applicable law, given by the Board of Directors or by other persons duly authorized by the owners.
14. xiv.It is clearly and separately disclosed on the bank’s balance sheet.

22.Articles 3.2 of the Capital Adequacy Regulation, AT1 capital consists of the sum of the following elements:

1. i.Instruments issued by a bank which are eligible for inclusion in AT1 and are not included in CET1 (e.g. perpetual equity instruments, not included in CET1);
2. ii.Stock surplus, or share premium, resulting from the issue of instruments included in AT1;
3. iii.Instruments issued by consolidated subsidiaries of the bank and held by third parties which are eligible for inclusion in AT1 and are not included in CET1;
4. iv.Regulatory adjustments applied in the calculation of AT1.

23.The treatment of instruments issued out of consolidated subsidiaries of the bank and the regulatory deductions applied in the calculation of AT1 capital are addressed in the Tier Capital Instruments Standard.

Instruments issued by the bank that meet the Additional Tier 1 criteria

24.The following is the minimum set of criteria for an instrument issued by the bank to meet or exceed in order for it to be included in Additional Tier 1 capital:

1. i.Issued and paid-in
2. ii.Subordinated to depositors, general creditors and subordinated debt of the bank
3. iii.Is neither secured nor covered by a guarantee of the issuer or related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis bank creditors
4. iv.Is perpetual, i.e. there is no maturity date and there are no step-ups or other incentives to redeem
5. v.May be callable at the initiative of the issuer only after a minimum of five years:
   1. a.To exercise a call option a bank must receive prior Central Bank approval; and
   2. b.A bank must not do anything which creates an expectation that the call will be exercised; and
   3. c.Banks must not exercise a call unless:
      1. 1)They replace the called instrument with capital of the same or better quality and the replacement of this capital is done at conditions which are sustainable for the income capacity of the bank; or
      2. 2)The bank demonstrates that its capital position is well above the minimum capital requirements after the call option is exercised.
6. vi.Any repayment of principal (e.g. through repurchase or redemption) must be with prior Central Bank’s approval and banks should not assume or create market expectations that Central Bank’s approval will be given.
7. vii.Dividend/coupon discretion:
   1. a.the Central Bank and the bank must have full discretion at all times to cancel distributions/payments
   2. b.cancellation of discretionary payments must not be an event of default
   3. c.banks must have full access to cancelled payments to meet obligations as they fall due
   4. d.Cancellation of distributions/payments must not impose restrictions on the bank except in relation to distributions to common stockholders.
8. viii.Dividends/coupons must be paid out of distributable items
9. ix.The instrument cannot have a credit-sensitive dividend feature, that is a dividend/coupon that is reset periodically based in whole or in part on the banking organization’s credit standing.
10. x.The instrument cannot contribute to liabilities exceeding assets in the required balance sheet test to determine insolvency.
11. xi.Instruments classified as liabilities for accounting purposes must have principal loss absorption through a write-down mechanism which allocates losses to the instrument at a pre-specified trigger point. The loss absorption trigger must be set at a level of 7.625% of CET1. The write-down will have the following effects:
    1. 1.Reduce the claim of the instrument in liquidation;
    2. 2.Reduce the amount re-paid when a call is exercised; and
    3. 3.Partially or fully reduce coupon/dividend payments on the instrument.
12. xii.Neither the bank nor a related party over which the bank exercises control or significant influence can have purchased the instrument or otherwise come into possession of the instrument, such as through receipt of collateral or a reverse repurchase agreement, nor can the bank directly or indirectly have funded the purchase of the instrument.
13. xiii.The instrument cannot have any features that hinder recapitalization, such as provisions that require the issuer to compensate investors if a new instrument is issued at a lower price during a specified time frame.
14. xiv.[Applicable for Islamic banks only] If the instrument is not issued out of an operating entity or the holding company in the consolidated group (e.g. a special purpose vehicle – “SPV”), proceeds must be immediately available without limitation to an operating entity or the holding company in the consolidated group in a form which meets or exceeds all of the other criteria for inclusion in AT1 capital (Refer to the Capital Instruments Standards).
15. xv.In addition to the criteria outlined above, the instrument must meet criteria for minimum requirements to ensure loss absorbency at the point of non-viability. Please refer to the Capital Instruments Standards.

Share premium resulting from the issue of instruments included in Additional Tier 1 capital;

25.Share premium that is not eligible for inclusion in CET1, will only be permitted to be included in AT1 capital if the shares giving rise to the stock surplus are permitted to be included in AT1 capital.

26.Articles 3.3 of the Capital Adequacy Regulation, Tier 2 capital consists of the sum of the following elements:

1. i.Banks using the standardized approach for credit risk: general provisions or general loan loss reserves, up to maximum of 1.25% of credit RWA;
2. ii.Instruments issued by the bank that meet the criteria for inclusion in Tier 2 capital, and are not included in Tier 1 capital;
3. iii.Share premium resulting from the issue of instruments included in Tier 2 capital;
4. iv.Instruments which are eligible for inclusion of Tier 2 (refer to paragraph 27)
5. v.Instruments issued by consolidated subsidiaries of the bank and held by third parties that meet the criteria for inclusion in Tier 2 capital, and are not included in Tier 1 capital;
6. vi.Regulatory adjustments applied in the calculation of Tier 2.

27.The treatment of instruments issued out of consolidated subsidiaries of the bank and the regulatory deductions applied in the calculation of Tier 2 capital are addressed in the Tier Capital Instrument Standard.

Instruments issued by the bank that meet the Tier 2 criteria

28.The objective of Tier 2 capital is to provide loss absorption on a gone-concern basis. Based on this objective, the minimum set of criteria for an instrument to meet or exceed in order for it to be included in Tier 2 capital are set out below.

Criteria for inclusion in Tier 2 Capital

1. i.Issued and paid-in.
2. ii.Subordinated to depositors and general creditors of the bank.
3. iii.Is neither secured nor covered by a guarantee of the issuer or related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis depositors and general bank creditors
4. iv.Maturity:
   1. a.minimum original maturity of at least five years
   2. b.recognition in regulatory capital in the remaining five years before maturity will be amortized on an annualized straight line basis (i.e. 20% incremental reduction in recognition every successive year in the last five years)
   3. c.there are no step-ups or other incentives to redeem
5. v.May be callable at the initiative of the issuer only after a minimum of five years:
   1. a.To exercise a call option a bank must receive prior Central Bank’s approval;
   2. b.A bank must not do anything that creates an expectation that the call will be exercised; and
   3. c.Banks must not exercise a call unless:
      1. 1.They replace the called instrument with capital of the same or better quality and the replacement of this capital is done at conditions which are sustainable for the income capacity of the bank; or
      2. 2.The bank demonstrates that its capital position is well above the minimum capital requirements after the call option is exercised.
6. vi.The investor must have no rights to accelerate the repayment of future scheduled payments (coupon or principal), except in bankruptcy and liquidation.
7. vii.The instrument cannot have a credit-sensitive dividend feature, that is a dividend/coupon that is reset periodically based in whole or in part on the banking organization’s credit standing.
8. viii.Neither the bank nor a related party over which the bank exercises control or significant influence can have purchased the instrument or otherwise come into possession of the instrument, such as through receipt of collateral or a reverse repurchase agreement, nor can the bank directly or indirectly have funded the purchase of the instrument.
9. ix.[Applicable for Islamic banks only] If the instrument is not issued out of an operating entity or the holding company in the consolidated group (e.g. a special purpose vehicle – “SPV”), proceeds must be immediately available without limitation to an operating entity or the holding company in the consolidated group in a form which meets or exceeds all of the other criteria for inclusion in Tier 2 Capital (Refer to the Capital Instruments Standards).

29.In addition to the criteria outlined above, the instrument must meet the minimum requirements to ensure loss absorbency at the point of non-viability. Please refer to the Capital Instruments Standards.

Share premium resulting from the issue of instruments included in Tier 2 capital

30.Share premium that is not eligible for inclusion in Tier 1, will only be permitted to be included in Tier 2 capital if the shares giving rise to the stock surplus are permitted to be included in Tier 2 capital.
 

General provisions/General loan-loss reserves:

31.Provisions or loan-loss reserves held against future, presently unidentified losses are freely available to meet losses which subsequently materialize and therefore qualify for inclusion within Tier 2. Provisions ascribed to identified deterioration of particular assets or known liabilities, whether individual or grouped, should be excluded. Furthermore, general provisions or general reserves for loan losses will be limited to a maximum of 1.25% of credit risk weighted risk assets calculated under the standardised approach.
 

Capital component of Capital Adequacy Regulation

32.If a bank has complied with the minimum CET1 and Tier 1 capital ratios, the excess AT1 capital can be counted to meet the total capital ratio, also referred to as Capital Adequacy Ratio (CAR).
 

33.Profit-sharing investment accounts must not be classified as part of an Islamic bank’s regulatory capital as referred to in Article 2 of Capital Adequacy Regulation.

34.Investment risk reserves and a portion of the Profit Equalization Reserve (PER), if any, belong to the equity of investment account holders, and thus must not be used in the calculation of an Islamic bank’s regulatory capital. As the purpose of a PER is to smooth the profit pay-outs and not to cover losses, any portion of a PER that is part of the Islamic bank’s reserves must not be treated as regulatory capital as referred to in Article 2 of Capital Adequacy Regulations.

35. In order for an instrument issued by a bank to be included in AT1 or Tier 2 capital, it must also meet or exceed the minimum requirements defined in Capital Instruments Standards. These requirements are in addition to the criteria for AT1 and Tier 2 instruments stated above.

Common shares issued by consolidated subsidiaries (that is within the scope of regulatory consolidation)

36.Minority interest arising from the issue of common shares by a fully consolidated subsidiary of the bank may receive recognition in CET1 only if:

1. i.The instrument giving rise to the minority interest would, if issued by the bank, meet all of the criteria for classification as common shares for regulatory capital purposes; and
2. ii.The subsidiary that issued the instrument is itself a bank. (It is noted that minority interest in a subsidiary that is a bank is strictly excluded from the parent bank’s common equity if the parent bank or affiliate has entered into any arrangements to fund directly or indirectly minority investment in the subsidiary whether through an SPV or through another vehicle or arrangement. The treatment outlined here, thus, is strictly available where all minority investments in the bank subsidiary solely represent genuine third party common equity contributions to the subsidiary.)

37.The amount of capital meeting the above criteria that will be recognized in consolidated CET1 is calculated as follows

Total minority interest meeting the two criteria above minus the amount of the surplus CET1 of the subsidiary attributable to the minority shareholders.

1. i.Surplus CET1 of the subsidiary is calculated as the CET1 (after the application of regulatory deductions) of the subsidiary minus the lower of:
   1. a.the minimum CET1 requirement of the subsidiary plus the capital conservation buffer (i.e. 9.5% of risk weighted assets) and
   2. b.the portion of the parent’s consolidated minimum CET1 requirement plus the capital conservation buffer (i.e. 9.5% of consolidated risk weighted assets) that relates to the subsidiary.
2. ii.The amount of the surplus CET1 that is attributable to the minority shareholders is calculated by multiplying the surplus CET1 by the percentage of CET1 that is held by minority shareholders.

Tier 1 qualifying capital issued by consolidated subsidiaries (that is within the scope of regulatory consolidation)

38.Tier 1 capital instruments issued by a fully consolidated subsidiary of the bank to third party investors (including amounts under paragraph 37) may receive recognition in Tier 1 capital only if the instruments would, if issued by the bank meet all of the criteria for classification as Tier 1 capital.
 

39.The amount of this capital that will be recognized in Tier 1 will be calculated as follows:

Total Tier 1 of the subsidiary issued to third parties minus the amount of the surplus Tier 1 of the subsidiary attributable to the third party investors.

1. i.Surplus Tier 1 of the subsidiary is calculated as the Tier 1 of the subsidiary (after the application of regulatory deductions) minus the lower of:
   1. a.the minimum Tier 1 requirement of the subsidiary plus the capital conservation buffer (i.e. 11% of risk weighted assets) and
   2. b.the portion of the parent’s consolidated minimum Tier 1 requirement plus the capital conservation buffer (i.e. 11% of consolidated risk weighted assets) that relates to the subsidiary.
2. ii.The amount of the surplus Tier 1 that is attributable to the third party investors is calculated by multiplying the surplus Tier 1 by the percentage of Tier 1 that is held by third party investors.

The amount of this Tier 1 capital that will be recognized in Additional Tier 1 will exclude amounts recognized in CET1 under paragraph 37.

Tier 1 and Tier 2 qualifying capital issued by consolidated subsidiaries (that is within the scope of regulatory consolidation)

40.Total capital instruments (i.e. Tier 1 and Tier 2 capital instruments) issued by a fully consolidated subsidiary of the bank to third party investors (including amounts under paragraph 37 and 39) may receive recognition in Total Capital only if the instruments would, if issued by the bank, meet all of the criteria for classification as Tier 1 or Tier 2 capital
 

41.The amount of this capital that will be recognized in consolidated Total Capital will be calculated as follows:

Total capital instruments of the subsidiary issued to third parties minus the amount of the surplus Total Capital of the subsidiary attributable to the third party investors.

1. i.Surplus Total Capital of the subsidiary is calculated as the Total Capital of the subsidiary (after the application of regulatory deductions) minus the lower of:
   1. a.the minimum Total Capital requirement of the subsidiary plus the capital conservation buffer (i.e. 13% of risk weighted assets) and
   2. b.the portion of the parent’s consolidated minimum Total Capital requirement plus the capital conservation buffer (i.e.13% of consolidated risk weighted assets) that relates to the subsidiary.
2. ii.The amount of the surplus Total Capital that is attributable to the third party investors is calculated by multiplying the surplus Total Capital by the percentage of Total Capital that is held by third party investors.

The amount of this Total Capital that will be recognized in Tier 2 will exclude amounts recognized in CET1 under paragraph 37 and amounts recognized in AT1 under paragraph 39 above.

42.An illustrative example for calculation of minority interest and other capital issued out of consolidated subsidiaries that is held by the third parties is furnished as Appendix 4 in Guidance for Capital Adequacy of Banks in the UAE.

Other Instructions relating to the calculation of the amount of minority interest

43.All calculations must be undertaken in respect of the subsidiary on a sub-consolidated basis (i.e. the subsidiary must consolidate all of its subsidiaries that are also included in the wider consolidated group). However, the bank may elect to give no recognition (in consolidated capital of the group) to the capital issued by the subsidiary to third parties.

44.Where capital has been issued to third parties out of an SPV, none of this capital can be included in CET1. However, such capital can be included in consolidated AT1 or Tier 2 capital and treated as if the bank itself had issued the capital directly to the third-parties only if:

1. i.it meets all the relevant entry criteria; and
2. ii.the only asset of the SPV is its investment in the capital of the bank in a form that meets or exceeds all the relevant entry criteria (as required by criterion xiv for Additional Tier 1 and criterion ix for Tier 2 capital)

In cases where the capital has been issued to third parties through an SPV via a fully consolidated subsidiary of the bank, such capital may, subject to the requirements of this paragraph, be treated as if the subsidiary itself had issued it directly to the third parties and may be included in the bank’s consolidated AT1 or Tier 2 in accordance with the treatment outlined in paragraphs 39 and 41.

46.Goodwill and all other intangibles must be deducted in the calculation of CET1 (this deduction includes mortgage servicing rights), including any goodwill included in the valuation of significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation. The full amount is to be deducted net of any associated deferred tax liability, which would be extinguished if the intangible assets become impaired or derecognized under the relevant accounting standards.

47.Banks are required to use the IFRS definition of intangible assets to determine which assets are classified as intangible and required to be deducted.

48.Deferred tax assets (DTAs) that rely on future profitability of the bank to be realized are to be deducted in the calculation of CET1. Deferred tax assets may be netted with associated deferred tax liabilities (DTLs) only if the DTAs and DTLs relate to taxes levied by the same taxation authority and the relevant taxation authority permits offsetting.

49.The treatment for DTA are classified as:

1. i.Where these DTAs relate to temporary differences (e.g. allowance for credit losses) the amount to be deducted is set out in the “threshold deductions”.
2. ii.All other DTAs, e.g. those relating to operating losses, such as the carry forward of unused tax losses, or unused tax credits, are to be deducted in full net of DTL as described above.

50.The DTLs permitted to be netted against DTAs must exclude amounts that have been netted against the deduction of goodwill, intangibles and defined benefit pension assets, and must be allocated on a pro rata basis between DTAs subject to the threshold deduction treatment and DTAs that are to be deducted in full.

51.An over-instalment of tax or, in some jurisdictions, current year tax losses carried back to prior years may give rise to a claim or receivable from the government or local tax authority. Such amounts are typically classified as current tax assets for accounting purposes. The recovery of such a claim or receivable would not rely on the future profitability of the bank and would be assigned the relevant sovereign risk weighting.

52.The amount of the cash flow hedge reserve that relates to the hedging of items that are not fair valued on the balance sheet (including projected cash flows) should be derecognized in the calculation of CET1. This means that positive amounts should be deducted and negative amounts should be added back.

53.This treatment specifically identifies the element of the cash flow hedge reserve that is to be derecognized for prudential purposes. It removes the element that gives rise to artificial volatility in common equity, as in this case the reserve only reflects one half of the picture (the fair value of the derivative, but not the changes in fair value of the hedged future cash flow).

54.Derecognize in the calculation of CET1 any increase in equity capital resulting from a securitization transaction, such as that associated with expected Future Margin Income (FMI) resulting in a gain-on-sale.

55.Derecognize in the calculation of CET1, all unrealized gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank’s own credit risk.

56.Defined benefit pension fund liabilities, as included on the balance sheet, must be fully recognized in the calculation of CET1 (i.e. CET1 cannot be increased through derecognizing these liabilities).

57.For each defined benefit pension fund that is an asset on the balance sheet, the asset should be deducted in the calculation of CET1 net of any associated deferred tax liability, which would be extinguished if the asset should become impaired or derecognized under the relevant accounting standards.

58.Assets in the fund to which the bank has unrestricted and unfettered access can, with Central Bank’s approval, offset the deduction. Such offsetting assets should be given the risk weight they would receive if they were owned directly by the bank.

59.This treatment addresses the concern that assets arising from pension funds may not be capable of being withdrawn and used for the protection of depositors and other creditors of a bank. The concern is that their only value stems from a reduction in future payments into the fund. The treatment allows banks to reduce the deduction of the asset if they can address these concerns and show that the assets can be easily and promptly withdrawn from the fund.

60.All of a bank’s investments in its own common shares, whether held directly or indirectly, will be deducted in the calculation of CET1 (unless already derecognized under the relevant accounting standards).

61.In addition, any own stock, which the bank could be contractually obliged to purchase, should be deducted in the calculation of CET1. The treatment described will apply irrespective of the location of the exposure in the banking book or the trading book. In addition:

1. i.Gross long positions may be deducted net of short positions in the same underlying exposure only if the short positions involve no counterparty risk.
2. ii.Banks should look through holdings of index securities to deduct exposures to own shares. However, gross long positions in own shares resulting from holdings of index securities may be netted against short position in own shares resulting from short positions in the same underlying index. In such cases, the short positions may involve counterparty risk (which will be subject to the relevant counterparty credit risk charge).

62.Following the same approach outlined above, banks must deduct investments in their own AT1 in the calculation of their AT1 capital and must deduct investments in their own Tier 2 in the calculation of their Tier 2 capital.

63.Reciprocal cross holdings of capital that are designed to artificially inflate the capital position of banks will be deducted in full from CET1.
 

64.The regulatory adjustment described in this Standard applies to investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation and where the bank does not own more than 10% of the issued common share capital of the entity. In addition,

1. i.Investments include direct, indirect and synthetic holdings of capital instruments. For example, banks should look through holdings of index securities to determine their underlying holdings of capital.
   
   If banks find it operationally burdensome to look through and monitor their exact exposure to the capital of other financial institutions as a result of their holdings of index securities, Central Bank may permit banks, subject to prior supervisory approval, to use a conservative estimate. The methodology for the estimate should demonstrate that in no case will the actual exposure be higher than the estimated exposure. If a look-through or an acceptable estimate are not possible, the full amount of the investment should be accounted for.
    
2. ii.Holdings in both the banking book and trading book are to be included. Capital includes common stock and all other types of cash and synthetic capital instruments (e.g. subordinated debt). It is the net long position that is to be included (i.e. the gross long position net of short positions in the same underlying exposure where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year).
3. iii.Underwriting positions held for five working days or less can be excluded. Underwriting positions held for longer than five working days must be included.
4. iv.If the capital instrument of the entity in which the bank has invested does not meet the criteria for CET1, AT1, or Tier 2 capital of the bank, the capital is to be considered common shares for the purposes of this regulatory adjustment.
5. v.Banks may, with prior Central Bank’s approval, exclude temporarily certain investments where these have been made in the context of resolving or providing financial assistance to reorganize a distressed institution.

65.If the total of all holdings listed above in aggregate exceed 10% of the bank’s common equity (after applying all other regulatory deductions in full, apart from the deductions outlined in this Standard (paragraph 63 to 71)) then the amount above 10% is required to be deducted from CET1.

66.Amounts below the threshold that are not deducted are to be risk weighted as follows:

1. i.Amounts below the threshold that are in the banking book are to be risk weighted as per the credit risk (i.e. investments that are not listed and not marked to market will be risk weighted at 150% and investments that are listed will be risk weighted at 100%).
2. ii.Amounts below the threshold that are in the trading book are to be risk weighted as per the market risk rules.

67.The regulatory adjustment described in this Standard applies to investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation where the bank owns more than 10% of the issued common share capital of the issuing entity or where the entity is an affiliate of the bank. An affiliate of a bank is defined as a company that controls, or is controlled by, or is under common control with, the bank. Control of a company is defined as (1) ownership, control, or holding with power to vote 20% or more of a class of voting securities of the company; or (2) consolidation of the company for financial reporting purposes. In addition,

1. i.Investments include direct, indirect and synthetic holdings of capital instruments. For example, banks should look through holdings of index securities to determine their underlying holdings of capital.
2. ii. Holdings in both the banking book and trading book are to be included. Capital includes common stock and all other types of cash and synthetic capital instruments (e.g. subordinated debt). It is the net long position that is to be included (i.e. the gross long position net of short positions in the same underlying exposure where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year)
3. iii.Underwriting positions held for five working days or less can be excluded. Underwriting positions held for longer than five working days must be included.
4. iv.If the capital instrument of the entity in which the bank has invested does not meet the criteria for CET1, AT1, or Tier 2 capital of the bank, the capital is to be considered common shares for the purposes of this regulatory adjustment. If the investment is issued out of a regulated financial entity and not included in regulatory capital in the relevant sector of the financial entity, it is not required to be deducted.
5. v.Banks may, with prior Central Bank’s approval, exclude temporarily certain investments where these have been made in the context of resolving or providing financial assistance to reorganize a distressed institution.

68.All investments included above that are not common shares must be fully deducted from CET1.

69.Investments included above that are common shares will be subject to the “Threshold deductions” treatment described in the section 4 below.

6.Exposure to the Federal Government and Emirates Government receives 0% risk weight, if such exposures are denominated and funded in AED or USD for a transition period of 7 years from the date of implementation of this Standard. After the transition period, 0% risk weights are only applied to exposures that are denominated and funded in AED.

7.A 0% risk weight may also be applied to exposures to other GCC sovereigns and their central banks only if these exposures are denominated and funded in the domestic currency of that sovereign and the Supervisory authority of that sovereign has adopted such preferential treatment for exposures to its own sovereign and central bank.

8.Exposure to the Federal Government and Emirates Government in currencies other than AED or USD and claims on other sovereigns and central banks that do not meet the criteria set out in paragraph 6, are risk weighted as follows:

9.Exposure to the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Union, the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF) receive a 0% risk weight.

10.PSEs include the following categories:

1. (i)Non-Commercial PSEs; and
2. (ii)Other PSEs including commercial PSEs (Government Related Entity (GRE) i.e. commercial PSEs that are fully owned or more than 50% in ownership by the UAE government).

11.Non-Commercial PSEs that are acknowledged by the Central Bank may be treated in the same as Claims on Bank. However, the preferential treatment for short-term claims under Claims on Bank must not be applied to non-commercial PSE. The Central Bank issues a GRE list to banks on a regular basis that the Central Bank considers Non-Commercial PSEs that qualify for this treatment. The Central Bank may allow certain domestic Non-Commercial PSEs to be treated same manner as claims on UAE sovereign if these entities have specific revenue raising powers and have specific institutional arrangements the effect of which is to reduce their risks of default.

12.Exposure to all other PSEs that are not included on the Central Bank’s list must be treated like exposures to corporates as per section III.F below.

13.With the exception of the MDBs that meet the criteria specified at paragraph 14 below, the risk weights applied to exposures to MDBs must be based on external credit assessments as set out in the table below.

14.A 0% risk weight will be applied to exposures to highly rated MDBs that meet the Basel Committee on Banking Supervision (BCBS) eligibility criteria for MDBs risk weighted at 0%.

1. (i)The BCBS will continue to evaluate eligibility on a case-by-case basis so it is not possible to provide a definitive list of the MDBs that satisfy the BCBS's eligibility criteria. The up-to-date list of MDBs that meet the BCBS's eligibility criteria can be found on the BCBS's website www.bis.org.
2. (ii)As a national discretion, exposures to the Arab Monetary Fund (AMF) receive 0% risk weight.

15.Claims on banks must be risk weighted based on the external credit assessment of the bank itself as set out in the table below. For the purposes of calculating capital requirements, a bank exposure is defined as a claim on any financial institution that is licensed to take deposits from the public and is subject to appropriate prudential standards and level of supervision.

16.Claims on unrated banks shall be risk-weighted at 50%. No claim on an unrated bank may receive a risk weight lower than that applied to claims on its sovereign of incorporation.

17.A preferential risk weight that is one category more favourable shall be applied to claims with an original maturity of three months or less, subject to a floor of 20%. This treatment shall be available to both rated and unrated banks, but not to banks risk weighted at 150%. Short-term claims in the table below are defined as having an original maturity of three months or less. However, claims with (contractual) original maturity under three months which are rolled over (i.e., where the effective maturity is longer than three months) shall not qualify as short-term claims and shall not enjoy the preferential risk weighting treatment.

18.Claims on securities firms shall be treated as claims on banks provided the securities firms are authorized by a competent authority and subject to supervisory and regulatory arrangements that are the same or equivalent to those under this standards, including, in particular, risk-based capital requirements. Otherwise, such claims must follow the rules for claims on corporates as per section III F below.

19.The table provided below in the next paragraph illustrates the risk weighting of rated corporate claims, including claims on insurance companies.

20.The standard risk weight for unrated claims on corporates shall be 100%. No claim on an unrated corporate may be given a risk weight that is lower than that assigned to its sovereign of incorporation. For unrated exposures to Small- and Medium-sized Entities (SME) that do not meet the criteria in paragraph 21, an 85% risk weight will be applied. The Central Bank may, at its sole discretion, require a higher risk weighting for some unrated corporates as advised to banks directly where appropriate.

21.A 75% risk weighting may apply for exposures classified as “Retail” except as provided below for past due loans as per section III J below. For an exposure to be classified as “Retail” the Central Bank will need to be satisfied that the four criteria listed below are met:

1. (i)Orientation criterion – Exposure to a natural person or persons, or Small- and Medium-sized Entities (SME);
2. (ii)Product criterion – Eligible products included are credit cards, revolving credit, personal lending and small business credit facilities. Residential mortgage products are excluded as these are treated separately as “Claims Secured by Residential Property” as per section H below;
3. (iii)Granularity criterion – No exposure to any one counterparty can exceed 0.20% of the total regulatory retail portfolio being evaluated (exposure is gross before any credit risk mitigation; and one counterparty includes connected persons);
4. (iv)Value criterion –
   1. (i)Maximum aggregated exposure to one counterparty must not exceed the value of AED 4,000,000 for exposures to SME,
   2. (ii)For all other exposures, the maximum aggregated exposure to one counterparty must not exceed the value of AED 2,000,000.

22.The Central Bank reserves the right to increase the 75% risk weight if this risk weight value is deemed to be too low based on the default experience for these types of exposures in the UAE. Exposures to SMEs that do not meet all of the above criteria set out in paragraph 21 are treated as under the corporate asset class and must follow the rules for claims on corporates as per Section III F above.

23.A 35% risk weighting shall apply to exposures fully secured by eligible immovable residential property that is occupied by the owner or that is rented, and where the purpose of the facility is to fund the purchase of the property. This risk weight value shall be applied only where there exists a substantial margin of additional security over the amount of the loan.

24.Residential property shall be considered eligible immovable property if the following criteria are met:

1. (i)A mortgage is enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement and shall be appropriately filed within a reasonable time;
2. (ii)All legal requirements for establishing the mortgage have been fulfilled;
3. (iii)The protection agreement and the legal process underpinning it enable the bank to realise the value of the property within a reasonable timeframe;
4. (iv)Location of the property must be in the UAE; and
5. (v)Banks shall have in place procedures to monitor that the property taken as credit protection is adequately insured against the risk of damage.

25.Banks shall be responsible to monitor on an ongoing basis that the criteria listed in paragraph 24 above are met. In case of failure to conduct such internal monitoring or if the results of such internal monitoring indicate that the criteria are not met, the residential property cannot be considered eligible immovable property for the application of the 35% risk weight.

26.Banks shall clearly document the types of residential immovable property they accept and their lending policies in this regard.

27.Exposures secured by eligible residential real estate, as specified by the eligibility criteria set out in paragraph 24 above, and for which the 35% risk weight applies must not exceed any of the two items below:

1. (i)85% of the market value of the property (i.e., the LTV ratio must be less than or equal to 85%); and
2. (ii)AED 10 million;

28.If the two criteria listed above in paragraph 27 cannot be definitively established or met, then the 35% risk weight cannot be applied. If the exposure meets the criteria for regulatory retail claims as set out at paragraph 21 then a 75% risk weight applies, otherwise a 100% risk weighting must be used.

29.The Central Bank may increase the 35% risk weight if this risk weight is deemed to be too low based on the default experience for these types of exposures in the UAE.

30.A 100% risk weighting shall apply to exposures secured by commercial real estate. For the purposes of this paragraph, a commercial real estate exposure is an exposure secured by immovable property that is not residential real estate as per section III H above.

31.The unsecured portion of any loan (other than a residential mortgage loan as per section H above) that is past due for more than 90 days, net of specific provisions (including partial write-offs), must be risk-weighted as follows:

1. (i)150% risk weight when specific provisions are less than 20% of the outstanding amount of the loan;
2. (ii)100% risk weight when specific provisions are 20% and above of the outstanding amount of the loan.

32.In the case of residential mortgage loans as per section H above, when such loans are past due for more than 90 days they shall be risk weighted at 100%, net of any specific provisions.

33.For the purpose of defining the secured portion of the past due loan, eligible collateral and guarantees shall be the same as for Credit Risk Mitigation set out below at section IV.

34.Past due retail loans are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion specified in Paragraph 21, for risk-weighting purposes.

35.The following claims shall be risk weighted at 150% or higher:

1. (i)Claims on sovereigns, PSEs, banks, and securities firms rated below B-;
2. (ii)Claims on corporates rated below BB-;
3. (iii)Past due loans as set out in section J above; and
4. (iv)Real estate acquired in settlement of debt and not liquidated within the statutory period (Article 93 of Federal Law).

36.The Central Bank may apply a 150% or higher risk weight reflecting the higher risks associated with the assets.

37.The risk weights applicable to securitisation and re-securitisation exposures are set out in the Standards on Capital for Securitisation Exposures.

38.Gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities shall be treated as cash and therefore risk-weighted at 0%.

39.Cash items in the process of collection are risk-weighted at 20%.

40.Investments in commercial entities shall be treated as per the Capital Supply standard.

41.Exposure to investments in the capital of banking, securities, financial and insurance entities, must be treated as per the Capital Supply standard.

42.The treatment of securitisation exposures is presented separately in line with Securitisation Standard below in these standards.

43.The standard risk weight for exposure to all other assets not specifically mentioned shall be 100%.

44.Off-balance sheet items must be converted into credit exposure equivalents through the use of CCF.

Credit Conversion Factor of 100%

45.The following items must be converted into credit exposure equivalents through the use of CCF of 100%:

1. (i)All direct credit substitutes, including general guarantees of indebtedness (such as standby letters of credit serving as financial guarantees for loans and securities) and acceptances (such as endorsements with the character of acceptances);
2. (ii)Sale and repurchase agreements and asset sales with recourse, where the credit risk remains with the bank;
3. (iii)Forward asset purchases, forward deposits and commitments for the unpaid portion of partly-paid shares and securities which represent commitments with certain draw-downs, and which shall be risk-weighted according to the type of asset and not according to the type of counterparty with whom the transaction has been entered into;
4. (iv)The lending of banks’ securities or the posting of securities as collateral by banks, including instances where these arise out of repo-style transactions (i.e., repurchase/reverse repurchase and securities lending/securities borrowing transactions). Section IV on credit risk mitigation sets out the requirements for the calculation of risk-weighted assets where the credit converted exposure is secured by eligible collateral;
5. (v)Off-balance sheet items that are credit substitutes not explicitly included in any other category (including credit derivatives such as credit default swaps).

Credit Conversion Factor of 50%

46.The following items must be converted into credit exposure equivalents through the use of CCF of 50%:

1. (i)Transaction-related contingent items (e.g., performance bonds, bid bonds warranties, and standby letters of credit related to particular transactions);
2. (ii)Underwriting commitments under note issuance and revolving underwriting facilities regardless of maturity of the underlying facility;
3. (iii)Other commitments that are not unconditionally cancellable with an original maturity exceeding one year.

Credit Conversion Factor of 20%

47.The following items must be converted into credit exposure equivalents through the use of CCF of 20%:

1. (i)Other commitments not unconditionally cancellable with an original maturity of one year or less; and
2. (ii)Short-term self-liquidating trade letters of credit arising from the movement of goods (e.g., documentary credits collateralised by the underlying shipment), for both issuing and confirming banks.

Credit Conversion Factor of 0%

48.Any commitments that are unconditionally cancellable at any time by the bank without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower’s creditworthiness must be converted into credit exposure equivalents using CCF of 0%.

Other Principles

49.Where there is an undertaking to provide a commitment on an off-balance sheet item (i.e., commitment for a commitment), banks shall apply the lower of the two applicable CCFs.

50.The credit equivalent amount of OTC derivatives that expose a bank to counterparty credit risk shall be calculated under the rules set forth below in the Counterparty Credit Risk Standard below.

Failed Trades and Non-DvP Transactions

51.Banks shall closely monitor securities, commodities, and foreign exchange transactions that have failed or not been timely settled.

Principles for Failed Trades and Non-DvP Transactions

52.DvP also refers to PvP transactions for the purpose of this Standard. Transactions settled through a DvP system, providing simultaneous exchanges of securities for cash, expose firms to a risk of loss on the difference between the transaction valued at the agreed settlement price and the transaction valued at current market price (i.e., positive current exposure). Transactions where cash is paid without receipt of the corresponding receivable (securities, foreign currencies, gold, or commodities) or, conversely, deliverables were delivered without receipt of the corresponding cash payment (i.e., non-DvP, or free-delivery transactions) expose firms to a risk of loss on the full amount of cash paid or deliverables delivered. Specific capital charges address these two kinds of exposures.

53.The following capital treatment is applicable to all transactions on securities, foreign exchange instruments, and commodities that give rise to a risk of delayed settlement or delivery. This includes transactions through recognised clearing houses that are subject to daily mark-to-market and payment of daily variation margins and that involve a mismatched trade. Repurchase and reverse-repurchase agreements as well as securities lending and borrowing that have failed to settle are excluded from this capital treatment. (All repurchase and reverse-repurchase agreements as well as securities lending and borrowing, including those that have failed to settle, shall be treated in accordance with the sections on CRM below).

54.In cases of a system wide failure of a settlement or clearing system, the Central Bank may use its discretion to waive capital charges until the situation is rectified.

55.Failure of a counterparty to settle a trade in itself shall not be deemed a default for purposes of credit risk.

Capital Requirements for Failed Trades and Non-DvP Transactions

56.The capital requirement for failed trades and Non-DvP transactions shall be calculated as follows:

1. (i)For DvP transactions, if the payments have not yet taken place five business days after the settlement date, firms must calculate a capital charge by multiplying the positive current exposure of the transaction by the appropriate factor, according to the table below.
    

   Number of working days after the agreed settlement date	Corresponding risk multiplier
   From 5 to 15	8%
   From 16 to 30	50%
   From 31 to 45	75%
   46 or more	100%

2.  
3. (ii)For Non-DvP transactions (i.e., free deliveries), after the first contractual payment/delivery leg, the bank that has made the payment shall treat its exposure as a loan if the second leg has not been received by the end of the business day. This means that a bank shall use the risk weights set forth in the exposure classes set out in this Standard. However, when exposures are not material, banks may choose to apply a uniform 100% risk-weight to these exposures, in order to avoid the burden of a full credit assessment.
4. (iii)If five business days after the second contractual payment/delivery date the second leg has not yet effectively taken place, the bank that has made the first payment leg shall deduct from capital the full amount of the value transferred plus replacement cost, if any. This treatment shall apply until the second payment/delivery leg is effectively made.

Introduction

57.Banks may use a number of techniques to mitigate the credit risks to which they are exposed. For example, exposures may be collateralised by first priority claims, in whole or in part with cash or securities, a loan exposure may be guaranteed by a third party, or a bank may buy a credit derivative to offset various forms of credit risk. Additionally, banks may agree to net loans owed to them against deposits from the same counterparty.

58.In this Standard, “counterparty” is used to denote a party to whom a bank has an on or off-balance sheet credit exposure. That exposure may, for example, take the form of a loan of cash or securities (where the counterparty would traditionally be called the borrower), of securities posted as collateral, of a commitment or of exposure under an OTC derivatives contract

General Requirements for legal certainty

59.The Central Bank recognizes certain credit risk mitigation techniques for regulatory capital purposes, provided that all documentation used in collateralised transactions and for documenting on-balance sheet netting, guarantees and credit derivatives are binding on all parties and legally enforceable in all relevant jurisdictions, and that banks have conducted sufficient legal review to verify this and have a well-founded legal basis to reach this conclusion, and undertake such further review as necessary to ensure continuing enforceability.

60.Where a bank has a single exposure covered either by more than one type of credit risk mitigation, or by differing maturities of protection provided by the same credit protection provider, the bank shall:

1. (i)Subdivide the exposure into parts covered by each type or maturity of credit risk mitigation tool; and
2. (ii)Calculate the risk-weighted assets for each part obtained in point (i) above separately in accordance with the risk weights applicable to each exposure category as described in the relevant section.

61.The comprehensive approach for the treatment of collateral (described further below from paragraph 85) shall also be applied to calculate the counterparty risk charges for OTC derivatives and repo-style transactions booked in the trading book.

62.No transaction in which CRM techniques are used shall receive a higher capital requirement than an otherwise identical transaction where such techniques are not used.

63.The effects of CRM shall not be double counted. Therefore, no additional supervisory recognition of CRM for regulatory capital purposes shall be granted on claims for which an issue-specific rating is used that already reflects that CRM. Principal-only ratings shall also not be allowed within the framework of CRM to claims for which an external credit assessment can be conducted.

64.Considering that, while the use of CRM techniques reduces or transfers credit risk, it simultaneously may increase other risks (residual risks), and that residual risks include legal, operational, liquidity and market risks, banks shall employ robust procedures and processes to control these risks, including strategy, consideration of the underlying credit, valuation, policies and procedures, systems, control of roll-off risks, and management of concentration risk arising from the bank’s use of CRM techniques and its interaction with the bank’s overall credit risk profile. Where these risks are not adequately controlled, the Central Bank may impose additional capital charges or take other supervisory actions under Pillar 2.

65.The banks shall also observe the Central Bank’s Pillar 3 requirements to obtain capital relief in respect of any CRM techniques.

66.A collateralised transaction is one in which:

1. (i)Banks have a credit exposure or potential credit exposure; and
2. (ii)Credit exposure or potential credit exposure is hedged in whole or in part by collateral posted by a counterparty or by a third party on behalf of the counterparty.

67.Where banks take eligible financial collateral (e.g., cash or securities, more specifically as per section IV C (a)), they are allowed to reduce their credit exposure to a counterparty when calculating their capital requirements to take account of the risk mitigating effect of the collateral.

Overall framework

68.Banks may opt for either the simple approach (described further in Section IV C(c)), which substitutes the risk weighting of the collateral for the risk weighting of the counterparty for the collateralised portion of the exposure (generally subject to a 20% floor), or for the Comprehensive Approach (described further in Section IV C(b)), which allows fuller offset of collateral against exposures, by effectively reducing the exposure amount by the value ascribed to the collateral.

69.Partial collateralisation is recognised in both approaches.

70.Mismatches in the maturity of the underlying exposure and the collateral shall only be allowed under the comprehensive approach.

71.Banks shall operate under either the simple approach or comprehensive approach, but not both approaches, in the banking book, but only under the comprehensive approach in the trading book.

72.Banks that intend to apply the comprehensive approach require prior approval from the Central Bank.

Minimum Conditions

73.The minimum conditions set out below must be met before capital relief will be granted in respect of any form of collateral under either the simple approach or comprehensive approach.

74.In addition to the general requirements for legal certainty set out above at paragraph 59 to 65, the legal mechanism by which collateral is pledged or transferred shall ensure that the bank has the right to liquidate or take legal possession of it, in a timely manner, in the event of the default, insolvency or bankruptcy (or one or more otherwise-defined credit events set out in the transaction documentation) of the counterparty (and, where applicable, of the custodian holding the collateral). Furthermore, banks shall take all steps necessary to fulfil those requirements under the law applicable to the bank’s interest in the collateral for obtaining and maintaining an enforceable security interest, e.g., by registering it with a registrar, or for exercising a right to net or set off in relation to title transfer collateral.

75.In order for collateral to provide protection, the credit quality of the counterparty and the value of the collateral must not have a material positive correlation (for example, securities issued by the counterparty - or by any related group entity - would provide little protection and so would be ineligible).

76.Banks shall have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the collateral are observed, and that collateral can be liquidated promptly.

77.Where the collateral is held by a custodian, banks shall take reasonable steps to ensure that the custodian segregates the collateral from its own assets.

78.A capital requirement shall be applied to a bank on either side of the collateralised transaction (for example, both repos and reverse repos shall be subject to capital requirements). Likewise, both sides of a securities lending and borrowing transaction shall be subject to explicit capital charges, as shall the posting of securities in connection with a derivative exposure or other borrowing.

79.Where a bank, acting as an agent, arranges a repo-style transaction (i.e., repurchase/reverse repurchase and securities lending/borrowing transactions) between a customer and a third party and provides a guarantee to the customer that the third party will perform on its obligations, then the risk to the bank shall be the same as if the bank had entered into the transaction as a principal. In such circumstances, a bank shall be required to calculate capital requirements as if it were itself the principal.

The simple approach

80.In the simple approach the risk weighting of the collateral instrument collateralising or partially collateralising the exposure shall be substituted for the risk weighting of the counterparty. Details of this framework are provided further below at section IV C (c).

The comprehensive approach

81.In the comprehensive approach, when taking collateral, banks shall calculate their adjusted exposure amount to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral. Using haircuts, banks shall adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either, occasioned by market movements (exposure amounts may vary, for example where securities are being lent.) This will produce volatility-adjusted amounts for both exposure and collateral. Unless either side of the transaction is cash, the volatility-adjusted amount for the exposure shall be higher than the exposure and for the collateral, it shall be lower.

82.Where the exposure and collateral are held in different currencies an additional downwards adjustment shall be made to the volatility adjusted collateral amount to take account of possible future fluctuations in exchange rates.

83.Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty. The framework for performing these calculations is set out further below in paragraph 97 to 100.

84.Banks shall use the standard supervisory haircuts and the parameters therein as set by the Central Bank. The use of own-estimate haircuts that rely on banks own internal estimates of market price volatility is prohibited.

85.The size of the individual haircuts shall depend on the type of instrument, type of transaction and the frequency of marking-to-market and re-margining (for example, repo style transactions subject to daily marking-to-market and to daily re-margining will receive a haircut based on a 5-business day holding period and secured lending transactions with daily mark-to-market and no re-margining clauses will receive a haircut based on a 20-business day holding period. These haircut numbers will be scaled up using the square root of time formula depending on the frequency of re-margining or marking-to-market).

86.For certain types of repo-style transactions (broadly speaking government bond repos) banks are permitted in certain cases not to apply the standard supervisory haircuts in calculating the exposure amount after risk mitigation. Paragraph 108 lists cases where such treatment is allowed.

87.The effect of master netting agreements covering repo-style transactions can be recognised for the calculation of capital requirements subject to the conditions specified in Paragraph 110.

On-balance sheet netting

88.Where banks have legally enforceable netting arrangements for loans and deposits they may calculate capital requirements on the basis of net credit exposures subject to the conditions in paragraphs 120.

Guarantees and credit derivatives

89.Where guarantees or credit derivatives are direct, explicit, irrevocable and unconditional, and the Central Bank is satisfied that banks fulfil certain minimum operational conditions relating to risk management processes, banks are allowed to take account of such credit protection in calculating capital requirements.

90.A range of guarantors and protection providers are recognized by the Central Bank. A substitution approach shall be applied. Thus only guarantees issued by or protection provided by entities with a lower risk weight than the counterparty will lead to reduced capital charges since the protected portion of the counterparty exposure is assigned the risk weight of the guarantor or protection provider, whereas the uncovered portion retains the risk weight of the underlying counterparty. Detailed operational requirements for the recognition of guarantees and credit derivatives are given below in paragraphs 122 to 128.

Maturity mismatch

91.Where the residual maturity of the CRM is less than that of the underlying credit exposure a maturity mismatch occurs.

92.Where there is a maturity mismatch and the CRM has an original maturity of less than one year, the CRM shall not be recognised for capital purposes. In other cases where there is a maturity mismatch, partial recognition shall be given to the CRM for regulatory capital purposes as detailed below in paragraphs 137 to 140.

93.Under the simple approach, such partial recognition is not allowed for collateral maturity mismatches.

Miscellaneous

94.The treatments for pools of credit risk mitigants and first- and second-to-default credit derivatives are given in paragraphs 141 to 145.

a) Eligible financial collateral

95.The following collateral instruments are eligible for recognition in the simple approach:

1. (i)Cash (as well as certificates of deposit or comparable instruments issued by the lending bank) on deposit with the bank which is incurring the counterparty exposure.
   
   Note 1: Cash funded credit linked notes issued by the bank against exposures in the banking book which fulfil the criteria for credit derivatives will be treated as cash collateralised transactions.
   
   Note 2: When cash on deposit, certificates of deposit or comparable instruments issued by the lending bank are held as collateral at a third-party bank in a noncustodial arrangement, if they are openly pledged/assigned to the lending bank and if the pledge/assignment is unconditional and irrevocable, the exposure amount covered by the collateral (after any necessary haircuts for currency risk) will receive the risk weight of the third-party bank);
    
2. (ii)Gold;
3. (iii)Debt securities rated by a recognised external credit assessment institution where these are either:
   • ○Rated at least BB- when issued by sovereigns or PSEs that are treated as sovereigns by the Central Bank; or
   • ○At least BBB- when issued by other entities (including banks and securities firms); or
   • ○At least A-3/P-3 for short-term debt instruments.
4. (iv)Debt securities not rated by a recognised external credit assessment institution where these are:
   • ○Issued by a bank; and
   • ○Listed on a recognised exchange; and
   • ○Classified as senior debt; and
   • ○All rated issues of the same seniority by the issuing bank must be rated at least BBB- or A-3/P-3 by a recognised external credit assessment institution; and
   • ○The bank holding the securities as collateral has no information to suggest that the issue justifies a rating below BBB- or A-3/P-3 (as applicable); and
   • ○The Central Bank is sufficiently confident about the market liquidity of the security.
5. (v)Equities (including convertible bonds) that are included in a main index (a widely accepted index that ensures adequate liquidity, depth of market, and size of bid-ask spread).
6. (vi)UCITS and mutual funds where:
   • ○A price for the units is publicly quoted daily; and
   • ○The UCITS/mutual fund is limited to investing in the instruments listed in this paragraph. However, the use or potential use by a UCITS/mutual fund of derivative instruments solely to hedge investments listed in this paragraph and the next paragraph shall not prevent units in that UCITS/mutual fund from being eligible financial collateral.

96.The following collateral instruments are eligible for recognition in the comprehensive approach:

1. (i)All of the collateral instruments that are eligible for recognition in the Simple Approach, as outlined in the above at paragraph 95;
2. (ii)Equities (including convertible bonds) which are not included in a main index but which are listed on a recognised exchange;
3. (iii)UCITS/mutual funds which include such equities.

b) The Comprehensive Approach

Calculation of Adjusted exposure

97.For a collateralised transaction, the exposure amount after risk mitigation is calculated as follows:

98.The exposure amount after risk mitigation shall be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction.

99.The treatment for transactions where there is a mismatch between the maturity of the counterparty exposure and the collateral is given in paragraphs 137 to 140.

100.Where the collateral is a basket of assets, the haircut on the basket will be

Standard supervisory haircuts

101.The following table sets the standard supervisory haircuts (assuming daily mark-to-market, daily re-margining and a 10-business day holding period), expressed as percentages:

102.The standard supervisory haircut for currency risk where exposure and collateral are denominated in different currencies is 8% (also based on a 10-business day holding period and daily mark-to-market).

103.For transactions in which the bank lends non-eligible instruments (e.g., noninvestment grade corporate debt securities), the haircut to be applied on the exposure must be the same as the one for equity traded on a recognised exchange.

Adjustment for different holding periods and non-daily mark-to-market or re-margining

104.For some transactions, depending on the nature and frequency of the revaluation and re-margining provisions, different holding periods are appropriate. The framework for collateral haircuts distinguishes between repo-style transactions (i.e., repo/reverse repos and securities lending/borrowing), “other capital-market-driven transactions” (i.e., OTC derivatives transactions and margin lending) and secured lending. In capital-market-driven transactions and repo-style transactions, the documentation contains re-margining clauses; in secured lending transactions, it generally does not.

105.The minimum holding period for various products or transactions is summarised in the table below:

106.When the frequency of re-margining or revaluation is longer than the minimum, the minimum haircut numbers shall be scaled up depending on the actual number of business days between re-margining or revaluation using the square root of time formula below:

107.When a bank calculates the volatility on a T_N day holding period which is different from the specified minimum holding period T_M, the H_M will be calculated using the square root of time formula:

Conditions for zero Haircut on repo-style transactions with a core market participant

108.For repo-style transactions where the following conditions are satisfied, and the counterparty is a Core Market Participant (see definition in the next paragraph), banks may choose not to apply the haircuts specified in the Comprehensive Approach and may instead apply a haircut of zero. However, counterparties specified in 109 (iii), (iv), (v) and (vi) require prior approval from the Central Bank.

1. (i)Both the exposure and the collateral are cash or a sovereign security or PSE security qualifying for a 0% risk weight in the standardised approach;
2. (ii)Both the exposure and the collateral are denominated in the same currency;
3. (iii)Either the transaction is overnight or both the exposure and the collateral are marked-to-market daily and are subject to daily re-margining;
4. (iv)Following a counterparty’s failure to re-margin, the time that is required between the last mark-to-market before the failure to re-margin and the liquidation of the collateral is considered to be no more than four (4) business days. It is noted this does not require the bank to always liquidate the collateral but rather to have the capability to do so within the given time frame;
5. (v)The transaction is settled across a settlement system proven for that type of transaction;
6. (vi)The documentation covering the agreement is standard market documentation for repo-style transactions in the securities concerned;
7. (vii)The transaction is governed by documentation specifying that if the counterparty fails to satisfy an obligation to deliver cash or securities or to deliver margin or otherwise defaults, then the transaction is immediately terminable; and
8. (viii)Upon any default event, regardless of whether the counterparty is insolvent or bankrupt, the bank has the unfettered, legally enforceable right to immediately seize and liquidate the collateral for its benefit.

109.Core Market Participants are the following entities:

1. (i)Sovereigns, central banks and Non-commercial PSEs;
2. (ii)Banks and securities firms;
3. (iii)Other financial companies (including insurance companies) eligible for a 20% risk weight in the standardised approach;
4. (iv)Regulated mutual funds that are subject to capital or leverage requirements;
5. (v)Regulated pension funds; and
6. (vi)Recognised clearing organisations.

Treatment of repo-style transactions covered under master netting agreements

110.The effects of bilateral netting agreements covering repo-style transactions will be recognised on a counterparty-by-counterparty basis if the agreements are legally enforceable in each relevant jurisdiction upon the occurrence of an event of default and regardless of whether the counterparty is insolvent or bankrupt. In addition, netting agreements must:

1. (i)Provide the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon an event of default, including in the event of insolvency or bankruptcy of the counterparty; and
2. (ii)Provide for the netting of gains and losses on transactions (including the value of any collateral) terminated and closed out under it so that a single net amount is owed by one party to the other; and
3. (iii)Allow for the prompt liquidation or setoff of collateral upon the event of default; and
4. (iv)Be, together with the rights arising from the provisions required in (i) to (iii) above, legally enforceable in each relevant jurisdiction upon the occurrence of an event of default and regardless of the counterparty's insolvency or bankruptcy.

111.Netting across positions in the banking and trading book will only be recognized when the netted transactions fulfil both of the following two conditions:

1. (i)All transactions are marked to market daily. It is noted that the holding period for the haircuts will depend as in other repo-style transactions on the frequency of margining; and
2. (ii)The collateral instruments used in the transactions are recognised as eligible financial collateral in the banking book.

112.The formula in paragraphs 97 will be adapted to calculate the capital requirements for transactions with netting agreements.

113.For banks using the standard supervisory haircuts, the framework below will apply to take into account the impact of master netting agreements.

114.The intention here is to obtain a net exposure amount after netting of the exposures and collateral and have an add-on amount reflecting possible price changes for the securities involved in the transactions and for foreign exchange risk if any. The net long or short position of each security included in the netting agreement will be multiplied by the appropriate haircut. All other rules regarding the calculation of haircuts stated in paragraphs under the comprehensive approach equivalently apply for banks using bilateral netting agreements for repo-style transactions.

c) The Simple Approach

Minimum conditions

115.For collateral to be recognised in the simple approach the collateral must be pledged for at least the life of the exposure and it must be marked to market and revalued with a minimum frequency of six months. Those portions of claims collateralised by the market value of recognised collateral receive the risk weight applicable to the collateral instrument. The risk weight on the collateralised portion will be subject to a floor of 20% except under the conditions specified in paragraphs 116 to 118. The remainder of the claim must be assigned to the risk weight appropriate to the counterparty. A capital requirement will be applied to banks on either side of the collateralised transaction: for example, both repos and reverse repos will be subject to capital requirements.

Exceptions to the risk weight floor

116.Transactions that fulfil the criteria outlined in paragraph 108 and are with a core market participant, as defined in paragraph 109; receive a risk weight of 0%. If the counterparty to the transactions is not a core market participant, the transaction must receive a risk weight of 10%.

117.OTC derivative transactions subject to daily mark-to-market, collateralised by cash and where there is no currency mismatch must receive a 0% risk weight. Such transactions collateralised by sovereign can receive a 10% risk weight.

118.The 20% floor for the risk weight on a collateralised transaction will not be applied and a 0% risk weight can be applied where the exposure and the collateral are denominated in the same currency, and either:

1. (i)The collateral is cash on deposit as defined in item (i), namely Cash, in paragraph 95; or
2. (ii)The collateral is in the form of sovereign and its market value has been discounted by 20%.

d) Collateralised OTC derivatives transactions

119.Under the SA-CCR Standard, the calculation of risk weighted assets for counterparty credit risk depends on replacement cost and an add-on for potential future exposure, and takes into account collateral in the manner specified in that Standard. The haircut for currency risk (H_fx) must be applied when there is a mismatch between the collateral currency and the settlement currency. Even in the case where there are more than two currencies involved in the exposure, collateral and settlement currency, a single haircut assuming a 10- business day holding period scaled up as necessary depending on the frequency of mark- to-market will be applied.

120.A bank may use the net exposure of loans and deposits as the basis for its capital adequacy calculation in accordance with the formula in Paragraph 97, where the bank:

1. (i)Has a well-founded legal basis for concluding that the netting or offsetting agreement is enforceable in each relevant jurisdiction regardless of whether the counterparty is insolvent or bankrupt;
2. (ii)Is able at any time to determine those assets and liabilities with the same counterparty that are subject to the netting agreement;
3. (iii)Monitors and controls its roll-off risks; and
4. (iv)Monitors and controls the relevant exposures on a net basis.

121.Assets (loans) are treated as exposure and liabilities (deposits) as collateral. The haircuts will be zero except when a currency mismatch exists. A 10-business day holding period will apply when daily mark-to-market is conducted and all the requirements stipulated under paragraphs 101, 107, and 137 to 140 will apply.

a) Operational requirements

Operational requirements common to guarantees and credit derivatives

122.A guarantee (counter-guarantee) or credit derivative must represent a direct claim on the protection provider and must be explicitly referenced to specific exposures or a pool of exposures, so that the extent of the cover is clearly defined and incontrovertible. Other than non-payment by a protection purchaser of money due in respect of the credit protection contract it must be irrevocable; there must be no clause in the contract that would allow the protection provider unilaterally to cancel the credit cover or that would increase the effective cost of cover as a result of deteriorating credit quality in the hedged exposure (Note that the irrevocability condition does not require that the credit protection and the exposure be maturity matched; rather that the maturity agreed ex ante may not be reduced ex post by the protection provider. Paragraph 138 sets forth the treatment of call options in determining remaining maturity for credit protection). It must also be unconditional; there must be no clause in the protection contract outside the direct control of the bank that could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original counterparty fails to make the payment(s) due.

Additional operational requirements for guarantees

123.In addition to the legal certainty requirements described in paragraph 59, in order for a guarantee to be recognised, the following conditions must be satisfied:

1. (i)On the qualifying default/non-payment of the counterparty, the bank may pursue the guarantor for any monies outstanding under the documentation governing the transaction within a reasonable time period. The guarantor may make one lump sum payment of all monies under such documentation to the bank, or the guarantor may assume the future payment obligations of the counterparty covered by the guarantee. The bank must have the right to receive any such payments from the guarantor without first having to take legal actions in order to pursue the counterparty for payment;
2. (ii)The guarantee is an explicitly documented obligation assumed by the guarantor; and
3. (iii)Except as noted in the following sentence, the guarantee covers all types of payments the underlying obligor is expected to make under the documentation governing the transaction, for example notional amount, margin payments etc. Where a guarantee covers payment of principal only, interests and other uncovered payments must be treated as an unsecured amount in accordance with paragraph 136.

Additional operational requirements for credit derivatives

124.In order for a credit derivative contract to be recognised, the following conditions must be satisfied:

1. (i)The credit events specified by the contracting parties must at a minimum cover:
   • ○Failure to pay the amounts due under terms of the underlying obligation that are in effect at the time of such failure (with a grace period that is closely in line with the grace period in the underlying obligation);
   • ○Bankruptcy, insolvency or inability of the obligor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; and
   • ○Restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that results in a credit loss event (i.e., charge-off, specific provision or other similar debit to the profit and loss account). When restructuring is not specified as a credit event, refer to the next paragraph;
2. (ii)If the credit derivative covers obligations that do not include the underlying obligation, item (vii) below governs whether the asset mismatch is permissible;
3. (iii)The credit derivative shall not terminate prior to expiration of any grace period required for a default on the underlying obligation to occur as a result of a failure to pay, subject to the provisions of paragraph 137;
4. (iv)Credit derivatives allowing for cash settlement are recognised for capital purposes insofar as a robust valuation process is in place in order to estimate loss reliably. There must be a clearly specified period for obtaining post-credit event valuations of the underlying obligation. If the reference obligation specified in the credit derivative for purposes of cash settlement is different than the underlying obligation, item (vii) below governs whether the asset mismatch is permissible;
5. (v)If the protection purchaser’s right/ability to transfer the underlying obligation to the protection provider is required for settlement, the terms of the underlying obligation must provide that any required consent to such transfer may not be unreasonably withheld;
6. (vi)The identity of the parties responsible for determining whether a credit event has occurred must be clearly defined. This determination must not be the sole responsibility of the protection seller. The protection buyer must have the right/ability to inform the protection provider of the occurrence of a credit event;
7. (vii)A mismatch between the underlying obligation and the reference obligation under the credit derivative (i.e. the obligation used for purposes of determining cash settlement value or the deliverable obligation) is permissible if (i) the reference obligation ranks pari passu with or is junior to the underlying obligation, and (ii) the underlying obligation and reference obligation share the same obligor (i.e., the same legal entity) and legally enforceable cross-default or cross-acceleration clauses are in place; and
8. (viii)A mismatch between the underlying obligation and the obligation used for purposes of determining whether a credit event has occurred is permissible if (i) the latter obligation ranks pari passu with or is junior to the underlying obligation, and (ii) the underlying obligation and reference obligation share the same obligor (i.e., the same legal entity) and legally enforceable cross-default or cross-acceleration clauses are in place.

125.When the restructuring of the underlying obligation is not covered by the credit derivative, but the other requirements in the previous paragraph are met, partial recognition of the credit derivative will be allowed. If the amount of the credit derivative is less than or equal to the amount of the underlying obligation, 60% of the amount of the hedge can be recognized as covered. If the amount of the credit derivative is larger than that of the underlying obligation, then the amount of eligible hedge is capped at 60% of the amount of the underlying obligation.

126.Only credit default swaps and total return swaps that provide credit protection equivalent to guarantees will be eligible for recognition. The exception stated in paragraph 127 below applies.

127.Where a bank buys credit protection through a total return swap and records the net payments received on the swap as net income, but does not record offsetting deterioration in the value of the asset that is protected (either through reductions in fair value or by an addition to reserves), the credit protection will not be recognised. The treatment of first-to-default and second-to-default products is covered separately in paragraphs 142 to 145.

128.Other types of credit derivatives will not be eligible for recognition at this time. Note that cash funded credit linked notes issued by the bank against exposures in the banking book which fulfil the criteria for credit derivatives will be treated as cash collateralised transactions.

b) Range of eligible guarantors (counter-guarantors)/protection providers

129.Credit protection given by the following entities will be recognised:

1. (i)Sovereign entities (including the Bank for International Settlements, the International Monetary Fund, the European Central Bank and the European Community, as well as those MDBs eligible for 0% risk weight listed in paragraph 14), PSEs, banks (including other MDBs) and Securities Firms with a lower risk weight than the counterparty;
2. (ii)Other entities rated A- or better by an eligible credit assessment institution. This would include credit protection provided by parent, subsidiary and affiliate companies when they have a lower risk weight than the obligor.

c) Risk weights

130.The protected portion is assigned the risk weight of the protection provider. The uncovered portion of the exposure is assigned the risk weight of the underlying counterparty.

131.Materiality thresholds on payments below which no payment is made in the event of loss are equivalent to retained first loss positions and must be deducted in full from the capital of the bank purchasing the credit protection.

Proportional cover

132.Where the amount guaranteed, or against which credit protection is held, is less than the amount of the exposure, and the secured and unsecured portions are of equal seniority, i.e., the bank and the guarantor share losses on a pro-rata basis capital relief will be afforded on a proportional basis: i.e., the protected portion of the exposure will receive the treatment applicable to eligible guarantees/credit derivatives, with the remainder treated as unsecured.

Tranched cover

133.Where the bank transfers a portion of the risk of an exposure in one or more tranches to a protection seller or sellers and retains some level of risk of the loan and the risk transferred and the risk retained are of different seniority, banks may obtain credit protection for either the senior tranches (e.g., second loss portion) or the junior tranche (e.g., first loss portion). In this case, the rules as set out in the Securitisation chapter below will apply.

d) Currency mismatches

134.Where the credit protection is denominated in a currency different from that in which the exposure is denominated — i.e., there is a currency mismatch — the amount of the exposure deemed to be protected will be reduced by the application of a haircut H_FX, i.e.

135.The appropriate haircut based on a 10-business day holding period (assuming daily marking-to-market) will be applied. Banks using the supervisory haircuts shall apply 8%. The haircut value of 8% must be scaled up using the square root of time formula, depending on the frequency of revaluation of the credit protection as described in paragraphs 106.

e) Sovereign guarantees and counter-guarantees

136.Portions of claims guaranteed by the UAE sovereign, where the guarantee is denominated in AED and the exposure is funded in AED are risk weighted at 0%. A claim may be covered by a guarantee that is indirectly counter-guaranteed by a sovereign. Such a claim may be treated as covered by a sovereign guarantee provided that:

1. (i)The sovereign counter-guarantee covers all credit risk elements of the claim;
2. (ii)Both the original guarantee and the counter-guarantee meet all operational requirements for guarantees, except that the counter-guarantee need not be direct and explicit to the original claim; and
3. (iii)The Central Bank is satisfied that the cover is robust and that no historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct sovereign guarantee.

137.For the purposes of calculating risk-weighted assets, a maturity mismatch occurs when the residual maturity of a hedge is less than that of the underlying exposure.

a) Definition of maturity

138.The maturity of the underlying exposure and the maturity of the hedge must both be defined conservatively. The effective maturity of the underlying must be gauged as the longest possible remaining time before the counterparty is scheduled to fulfil its obligation, taking into account any applicable grace period. For the hedge, embedded options which may reduce the term of the hedge must be taken into account so that the shortest possible effective maturity is used. Where a call is at the discretion of the protection seller, the maturity will always be at the first call date. If the call is at the discretion of the protection buying bank but the terms of the arrangement at origination of the hedge contain a positive incentive for the bank to call the transaction before contractual maturity, the remaining time to the first call date will be deemed to be the effective maturity (For example, where there is a step-up in cost in conjunction with a call feature or where the effective cost of cover increases over time even if credit quality remains the same or increases, the effective maturity will be the remaining time to the first call).

b) Risk weights for maturity mismatches

139.As outlined in paragraph 95, hedges with maturity mismatches are only recognized when their original maturities are greater than or equal to one year. As a result, the maturity of hedges for exposures with original maturities of less than one year must be matched to be recognised. In all cases, hedges with maturity mismatches will no longer be recognised when they have a residual maturity of three months or less.

140.When there is a maturity mismatch with recognised credit risk mitigants (collateral, on-balance sheet netting, guarantees and credit derivatives) the following adjustment will be applied.

a) Treatment of pools of CRM techniques

141.In the case where a bank has multiple CRM techniques covering a single exposure (e.g. a bank has both collateral and guarantee partially covering an exposure), the bank will be required to subdivide the exposure into portions covered by each type of CRM technique (e.g. portion covered by collateral, portion covered by guarantee) and the risk-weighted assets of each portion must be calculated separately. When credit protection provided by a single protection provider has differing maturities, they must be subdivided into separate protection as well.

b) First-to-default credit derivatives

142.There are cases where a bank obtains credit protection for a basket of reference names and where the first default among the reference names triggers the credit protection and the credit event also terminates the contract. In this case, the bank may recognize regulatory capital relief for the asset within the basket with the lowest risk-weighted amount, but only if the notional amount is less than or equal to the notional amount of the credit derivative.

143.With regard to the bank providing credit protection through such an instrument, if the product has an external credit assessment from an eligible credit assessment institution, the risk weight applied to securitisation tranches will be specified in the Securitisation Standard. If the product is not rated by an eligible external credit assessment institution, the risk weights of the assets included in the basket will be aggregated up to a maximum of 1250% and multiplied by the nominal amount of the protection provided by the credit derivative to obtain the risk-weighted asset amount.

c) Second-to-default credit derivatives

144.In the case where the second default among the assets within the basket triggers the credit protection, the bank obtaining credit protection through such a product will only be able to recognise any capital relief if first-default-protection has also been obtained or when one of the assets within the basket has already defaulted.

145.For banks providing credit protection through such a product, the capital treatment is the same as in paragraph 143, with one exception. The exception is that, in aggregating the risk weights, the asset with the lowest risk weighted amount can be excluded from the calculation.

5.Banks must calculate RWA for CCR at the level of nettings sets for derivatives. Accordingly, a bank must group all exposures for each counterparty into one or more netting sets. In every such case where netting is applied, a bank must satisfy the Central Bank that it has:

• •A contract with the counterparty or other agreement that creates a single legal obligation, covering all included transactions, such that the bank would have either a claim to receive or obligation to pay only the net sum of the positive and negative mark-to-market values of included individual transactions in the event a counterparty fails to perform due to default, bankruptcy, liquidation, or similar circumstances.
• •Written and reasoned legal reviews that in the event of a legal challenge, the relevant courts and administrative authorities would find the bank’s exposure to be such a net amount under:
  • •The law of the jurisdiction in which the counterparty is chartered and, if the foreign branch of a counterparty is involved, then also under the law of the jurisdiction in which the branch is located;
  • •The law that governs the individual transactions; and
  • •The law that governs any contract or agreement necessary to affect the netting.
• •Procedures in place to ensure that the legal characteristics of netting arrangements are kept under review in light of the possible changes in relevant law.

6.The Central Bank, after consultation when necessary with other relevant supervisors, must be satisfied that the netting is enforceable under the laws of each of the relevant jurisdictions.

7.A bank must calculate RWA for CCR by (i) calculating the Exposure At Default (EAD) for each netting set associated with a counterparty, (ii) summing EAD across netting sets for that counterparty, (iii) calculating risk-weighted EAD by multiplying the total EAD for a counterparty by the risk-weight corresponding to the exposure class to which that counterparty belongs under general risk-based capital requirements, (iv) summing the resulting risk-weighted EAD across all counterparties within a given exposure class and (v) summing across exposure classes.

8.Banks must calculate EAD separately for each netting set, as the sum of the Replacement Cost (RC) of the netting set plus the calculated Potential Future Exposure (PFE) for the netting set, with the sum of the two multiplied by a factor of 1.4:

$$\mathrm{E}\mathrm{A}\mathrm{D}=(\mathrm{R}\mathrm{C}+\mathrm{P}\mathrm{F}\mathrm{E})\times 1.4$$
 

9.Margined and un-margined netting sets require different calculation methods for RC and PFE. The EAD for a margined netting set is capped at the EAD of the same netting set calculated on an un-margined basis. That is, for a netting set covered by a margin agreement, the bank may calculate EAD as if the netting set is un-margined, and may use that value as the EAD if it is lower than the EAD calculation considering margin.

10.The time-period for the haircut applicable to non-cash collateral for the RC calculation should be one year for un-margined trades, and the relevant margin period of risk for margined trades.

11.Banks must calculate replacement cost at the netting set level. Calculations for margined and un-margined transactions differ.

12.Banks first must calculate the total current market value of the derivative contracts in the netting set. Banks may net transactions within a netting set that are subject to any legally valid form of bilateral netting, including netting by novation. Banks must then subtract from that total current market value the net value of collateral (after application of collateral haircuts) held by the bank for the netting set. The result is the Net Current Value (NCV) of the transactions in the netting set.

13.For un-margined transactions, RC for a netting set is equal to the NCV, provided the NCV is greater than zero. If that value is not greater than zero, RC equals zero.

14.For margined transactions, RC depends on the greatest exposure that would not trigger a call for variation margin, taking into account the mechanics of collateral exchanges in the margining agreements. That critical exposure level is equal to the threshold level of variation that would require a transfer of collateral, plus the minimum transfer amount of the collateral. The bank should subtract from that exposure amount the NICA, if any, to calculate the RC for margined transactions. However, the resulting RC may be no less than the RC if the netting set were un-margined. That is, for a margined netting set the RC is equal to the larger of the amount calculated according to this paragraph, or the RC for the same netting set if un-margined.

15.Bilateral transactions with a one-way margining agreement in favor of the bank’s counterparty (that is, where the bank posts margin but the counterparty does not) must be treated as un-margined transactions.

16.If multiple margin agreements apply to a single netting set, the bank must divide the netting set into sub-netting sets that align with each respective margin agreement, and calculate RC for each sub-netting set separately.

17.Calculation of PFE relies on computation of various “add-on” amounts, which are intermediate measures of exposure that are combined in various ways to compute PFE. The bank must calculate PFE for each netting set as a simple summation of the add-ons computed for each of the various asset classes within that netting set, multiplied by a multiplier that allows for recognition of excess collateral or negative mark-to-market value for the transactions. Requirements for calculation of the multiplier and the add-ons for each asset class are described below in this Standard.

18.The bank must allocate all derivatives transactions to one or more of the following asset classes based on the primary risk driver of the transaction:

• •Interest Rate Derivatives
• •Foreign Exchange Derivatives
• •Credit Derivatives
• •Equity Derivatives
• •Commodity Derivatives

19.As described in more detail below in this Standard, trades within each of these asset classes are further divided into hedging sets, and an aggregation method is applied to aggregate trade-level inputs at the hedging set level and finally at the asset class level. For derivative transactions within the credit, equity, and commodity asset classes, this aggregation involves a supervisory correlation parameter to capture important aspects of basis risk and diversification.
 

20.For trades that may have more than one risk driver (e.g. multi-asset or hybrid derivatives), banks must apply an analysis based on risk-driver sensitivities and volatility of the underlying reference price or rate to determine the existence of a dominant risk driver, and make the asset class allocation accordingly. When a derivative is materially exposed to risk drivers spanning more than one asset class, a bank must assign the position to each relevant asset class rather than to a single asset class, with appropriate delta adjustment. The Central Bank may direct banks to assign complex derivatives to multiple asset classes, regardless of analysis that the bank may or may not have conducted.

21.As is the case with Replacement Cost, if multiple margin agreements apply to a single netting set, the bank must divide the netting set into sub-netting sets that align with each respective margin agreement, and calculate the PFE for each sub-netting set separately.

22.Banks must calculate adjusted notional amounts from trade-level notional amounts for each transaction as described in this Standard.

23.For foreign exchange derivatives, the adjusted notional is defined as the notional of the foreign currency leg of the contract, converted to the domestic currency. If both legs of a foreign exchange derivative are denominated in currencies other than the domestic currency, the notional amount of each leg should be converted to the domestic currency, and the adjusted notional amount is equal to the value of the leg with the larger domestic currency value.

24.For equity and commodity derivatives, the adjusted notional is equal to the product of the current price of one unit of the stock or commodity and the number of units referenced by the trade. For equity and commodity volatility transactions, adjusted notional is equal to the product of the underlying volatility and the notional value of the transaction.

25.For interest rate derivatives and credit derivatives, the trade-level adjusted notional in units of domestic currency must be multiplied by a supervisory duration (SD) measure as follows:

1. a)First, the bank must determine the start date of the time period referenced by the interest rate or credit contract, and time that remains until that start date, measured in years; this is “S.” If the derivative references the value of another interest rate or credit instrument (as with a swaption or bond option), the time period is that of the underlying instrument. If the time-period referenced by the derivative has already started, the bank must set S to zero.
2. b)Next, the bank must determine the end date of the time period referenced by the interest rate or credit contract, and the time remaining until that end date, measured in years; this is “E.” If the derivative references the value of another interest rate or credit instrument (as with a swaption or bond option), the time period is that of the underlying instrument.
3. c)The bank then must compute SD for the transaction using the following formula, with the identified values of S and E based on the terms of the contract (where “exp” denotes the exponential function):

   $$\frac{\mathrm{<img\; alt="1"\; data-entity-type="file"\; data-entity-uuid="c6a4d0fd-a755-4522-8106-39045a41616c"\; height="36"\; src="/sites/default/files/inline-images/4\_5.png"\; width="221">}}{}$$
    

4. d)Finally, the bank calculates the adjusted notional amount for the transaction by multiplying the trade notional amount by the supervisory duration SD.

26.Banks also must apply the following rules when determining trade notional amounts, for transaction covered by the cases noted below:

1. a)For transactions with payoffs that are state contingent such as digital options or target redemption forwards, a bank must calculate the trade notional amount for each state, and use the largest resulting calculation.
2. b)If the notional is based on a formula that depends on market values, the bank must enter the current market values to determine the trade notional amount to be used in computing adjusted notional amount.
3. c)For variable notional swaps such as amortizing and accreting swaps, banks must use the average notional over the remaining life of the swap as the trade notional amount.
4. d)For leveraged swaps in which rates are multiplied by a factor, the bank must multiply the stated notional by the same factor to determine the trade notional amount.
5. e)For a derivative contract with multiple exchanges of principle, the bank must multiply the notional by the number of exchanges of principle in the derivative contract to determine the trade notional amount.

27.Banks must determine a supervisory delta adjustment for each transaction for use in calculations of effective notional amounts. Banks must apply supervisory delta adjustments at the trade level that reflect the direction of the transaction - that is, whether the position is long or short in the primary risk driver - and on whether the transaction is an option, CDO tranche, or neither. Supervisory delta adjustments are provided in Table 1.

Table 1: Supervisory Delta Adjustments

Definitions for Table 1

For options:
 

In this expression, P is the current forward value of the underlying price or rate, K is the exercise or strike price of the option, T is the time to the latest contractual exercise date of the option, a is the appropriate supervisory volatility from Table 2, and 0 is the standard normal cumulative density function. A supervisory volatility of 50% should be used on swaptions for all currencies.

For CDO tranches:

In this expression, A is the attachment point of the CDO tranche and D is the detachment point of the CDO tranche.

28.Banks must determine a maturity factor (MF) for each transaction for use in calculations of effective notional amounts, with the specific calculation method for MF depending on whether the derivative transaction is margined or un-margined.

29.For un-margined transactions, the maturity factor must be set equal to 1.0, unless the remaining maturity of the derivative transaction is less than one year. If the remaining maturity is less than one year, the maturity factor for an un-margined transaction is computed as the square root of the remaining maturity expressed in years, on a business-day-count basis, as follows:

30.If an un-margined transaction has a remaining maturity of 10 business days or less, the bank must set the maturity factor equal to the square root of (10/250).

31.For margined transactions, the maturity factor MF must be based on the margin period of risk (MPOR) appropriate for the margining agreement containing the transaction, measured in days, and computed as follows:

32.The bank must determine MPOR based on the terms of the margined transaction, subject to the following minimums:

1. a)At least ten business days for non-centrally-cleared derivative transactions subject to daily margin agreements.
2. b)At least five business days for centrally cleared derivative transactions subject to daily margin agreements that clearing members have with their clients.
3. c)At least twenty business days for netting sets consisting of 5000 or more transactions that are not centrally cleared.

33.The bank must double the MPOR for netting sets that have experienced more than two margin call disputes over the previous two calendar quarters if those disputes were not resolved within a period corresponding to the MPOR that would otherwise be applicable.

Allocation of Transactions to Hedging Sets

34.Banks must allocate every transaction within each netting set to a hedging set according to the following rules for each asset class:

1. a)Interest Rate Derivatives: A hedging set must be created for each set of interest rate derivatives that reference interest rates of the same currency. Interest rate derivative hedging sets are further subdivided into maturity categories, as described below. In interest rate hedging sets, full offset is recognized between long and short positions within one maturity category, and partial offset across maturity categories. Note that the number of interest rate hedging sets may differ between different netting sets, depending on the number of distinct currencies.
2. b)Foreign Exchange Derivatives: A hedging set consists of derivatives that reference the same currency pair. Full offset is recognized between long and short positions in any currency pair. Note that the number of foreign exchange hedging sets may vary between different netting sets.
3. c)Credit Derivatives: All credit derivatives should be allocated to a single hedging set. Full offset is recognized between long and short positions referencing the same entity (name or index) within the hedging set.
4. d)Equity Derivatives: All equity derivatives should be allocated to a single hedging set. Full offset is recognized between long and short positions referencing the same entity (name or index) within the hedging set.
5. e)Commodity Derivatives: In the commodity asset class, separate hedging sets are used for energy, metals, agriculture, and other commodities. Full offset of long and short positions is recognized between derivatives referencing the same commodity type, while PFE add-on calculations provide partial offset between different commodity types within the same commodity hedging set.

35.Basis transactions and volatility transactions must form separate hedging sets within their respective asset classes.

1. a)All basis transactions in a netting set that belong to the same asset class and reference the same pair of risk factors form a single hedging set, and follow the hedging set aggregation rules for the relevant asset class. The bank must treat each pair of risk factors as a separate hedging set.
2. b)The bank must place all volatility transactions in a netting set into a distinct hedging set within the corresponding asset class, according to the rules of that asset class. For example, all equity volatility transactions within a netting set form a single volatility hedging set within that netting set.

Add-on for Interest Rate Derivatives

36.For interest rate derivatives, banks must assign each contract to one of three maturity categories based on the remaining life of the contract:
 

37.The bank must then calculate the effective notional amount for each interest rate derivative hedging set (that is, for the set of interest rate derivatives in any single currency) by summing across transactions within a maturity category the product of the adjusted notional amount of the transaction, the maturity factor for the transaction, and the supervisory delta adjustment. That is, for each individual interest rate derivative within a maturity category in a single hedging set, the bank must calculate:

$$\text{Adjusted Notional Amount}\times \text{Supervisory Delta Adjustment}\times \text{MF}$$
 

and then sum that product across all interest rate derivatives in one maturity category in that hedging set to get the effective notional amount.

38.For each interest rate hedging set, the result will be three effective notional amounts, one for each maturity category: D1 for Category 1, D2 for Category 2, and D3 for Category 3. The bank may then combine these effective notional amounts from each maturity category using the following formula:

39.As an alternative, the bank may choose to combine the effective notional values as the simple sum of the absolute values for each of the three maturity categories within a hedging set, which has the effect of ignoring potential offsets. That is, as an alternative to the calculation above, the bank may calculate:

$$|D1|+|D2|+|D3|$$
 

40.Regardless of the approach used to combine the effective notional amounts, the bank must multiply the result of the calculation by the supervisory factor for the interest rate asset class from Table 2, and sum across all interest rate hedging sets to calculate the aggregate add-on for the interest rate asset class.

Add-on for Foreign Exchange Derivatives

41.For foreign exchange derivatives, banks must calculate the effective notional amount for each hedging set (that is, for the set of foreign exchange derivatives referencing a single currency pair) by summing across transactions within a hedging set the product of the adjusted notional amount of the transaction, the maturity factor for the transaction, and the supervisory delta adjustment. That is, for each individual foreign exchange derivative in a single hedging set (that is, referencing a single currency pair), the bank must calculate:

$$\text{Adjusted Notional Amount}\times \text{Supervisory Delta Adjustment}\times \mathrm{MF}$$
 

and then sum that product across all foreign exchange derivatives in that hedging set to get the effective notional amount for the hedging set.

42.The bank must multiply the absolute value of the resulting effective notional amount for each hedging set (each currency pair) by the supervisory factor for the foreign exchange asset class from Table 2, and sum across all foreign exchange hedging sets to calculate the aggregate add-on for the foreign exchange asset class.

Add-on for Credit Derivatives

43.For credit derivatives, banks must calculate the effective notional amount for each entity (that is, for each set of credit derivatives referencing a single name or credit index) by summing, across all credit derivative transactions that reference that entity, the product of the adjusted notional amount of the transaction, the maturity factor for the transaction, and the supervisory delta adjustment. That is, for each individual credit derivative referencing any single entity, the bank must calculate:

$$\text{Adjusted Notional Amount}\times \text{Supervisory Delta Adjustment}\times \mathrm{MF}$$
 

for each transaction and then sum that product across all credit derivatives that reference that entity to get the effective notional amount for the entity.

44.The bank must calculate the entity-level add-on by multiplying the result of this calculation by the appropriate supervisory factor from Table 2, depending on the rating of the entity (for single-name derivatives) or depending on whether the index is investment grade or speculative grade (for index derivatives).

45.For credit derivatives that reference unrated single-name entities, the bank should use the Supervisory Factor corresponding to BBB rated entities. However, where the entity has an elevated risk of default, banks should use the Supervisory Factor corresponding to BB rated entities. For credit index entities, the classification into investment grade or speculative grade should be determined based on the credit quality of the majority of the individual components of the index.

46.The bank must use the entity-level add-ons to calculate the add-on for the credit derivative hedging set. This is done through a calculation based on the use of supervisory correlation factors from Table 2. Specifically, the bank must calculate the add-on for the credit derivative hedging set by calculating:

47.Note that credit derivatives that are basis or volatility transactions must be treated in separate hedging sets within the credit derivatives asset class, with adjustments to supervisory factors as required under this Standard. In that case, the add-on for the credit derivatives asset class is the sum of the hedging set add-on calculated above, plus add-ons for any basis or volatility hedging sets.

Add-on for Equity Derivatives

48.For equity derivatives, banks must calculate the effective notional amount for each entity (that is, for each set of equity derivatives referencing a single name or equity index) by summing, across all equity derivatives transactions that reference that entity, the product of the adjusted notional amount of the transaction, the maturity factor for the transaction, and the supervisory delta adjustment. That is, for each individual equity derivative referencing any single entity, the bank must calculate:

$$\text{Adjusted Notional Amount}\times \text{Supervisory Delta Adjustment}\times \mathrm{MF}$$
 

for each transaction and then sum that product across all equity derivatives that reference that entity to get the effective notional amount for the entity.

49.The bank must calculate the entity-level add-on by multiplying the result of this calculation by the appropriate supervisory factor from Table 2.

50.The bank must use the entity-level add-ons to calculate the add-on for the equity derivative hedging set. This is done through a calculation based on the use of supervisory correlation factors from Table 2 for single-name equities and equity indexes. Specifically, the bank must calculate the add-on for the equity derivative hedging set by calculating:

51.Note that equity derivatives that are basis or volatility transactions must be treated in separate hedging sets within the equity derivatives asset class, with adjustments to supervisory factors as required under this Standard. In that case, the add-on for the equity derivatives asset class is the sum of the hedging set add-on calculated above, plus add-ons for any basis or volatility hedging sets.

Add-on for Commodity Derivatives

52.For the commodity asset class, a bank must assign each commodity derivative to one of the four hedging sets: energy, metals, agriculture, or other. The bank should also define one or more commodity types within each hedging set, and assign each derivative transaction to one of those commodity types. Long and short trades within a single commodity type can be fully offset.

53.The bank must establish appropriate governance processes for the creation and maintenance of the list of defined commodity types that are used for CCR calculations. These types should have clear definitions stated in written policies, and independent internal review or validation processes should ensure that the commodity types are applied properly. Internal review and validation processes also should determine that commodities grouped as a single type are in fact reasonably similar. Only commodity types established through adequately controlled internal processes may be used.

54.Banks must calculate the effective notional amount for each commodity type (that is, for each set of commodity derivatives that reference commodities of the same type) by summing, across all transactions that reference that commodity type, the product of the adjusted notional amount of the transaction, the maturity factor for the transaction, and the supervisory delta adjustment. That is, for each individual commodity derivative referencing any single commodity type, the bank must calculate:

$$\text{Adjusted Notional Amount}\times \text{Supervisory Delta Adjustment}\times \mathrm{MF}$$
 

for each transaction and then sum that product across all commodity derivatives that reference that commodity type to get the effective notional amount for the commodity type.

55.The bank must calculate the add-on for each commodity type by multiplying the result of this calculation by the appropriate supervisory factor from Table 2.

56.The bank must use the add-ons for each commodity type to calculate the add-on for each hedging set (energy, metals, agriculture, and other). This is done through a calculation using the supervisory correlation factor for commodity derivatives. Specifically, the bank must calculate the add-on for each of the four commodity derivative hedging sets by calculating:

57.Note that commodity derivatives that are basis or volatility transactions must be treated in separate hedging sets within the commodity derivatives asset class, with adjustments to supervisory factors as required under this Standard.

58.The add-on for the commodity derivatives asset class is the sum of the four hedging set add-ons as calculated above (some of which may be zero if the bank has no derivatives within one of the four hedging sets), plus corresponding add-ons for any basis or volatility hedging sets.

59.Commodity hedging sets have been defined in this Standard without regard to other potentially important characteristics of commodities, such as location and quality. For example, the energy hedging set contains commodity types such as crude oil, electricity, natural gas, and coal. The Central Bank may require a bank to use more refined definitions of commodity types if the Central Bank determines that the bank is significantly exposed to the basis risk of different products within any bank-defined commodity type.

60.Table 2 provides the values of Supervisory Factors, correlations, and supervisory option volatilities for use with each asset class and subclass.

61.For any basis transaction hedging set, the Supervisory Factor applicable to its relevant asset class or sub-class must be multiplied by 0.5.

62.For any volatility transaction hedging set, the Supervisory Factor applicable to its relevant asset class or sub-class must be multiplied by 5.0.

Table 2: Supervisory Factors, Correlations, and Volatilities

63.For each netting set, the bank must compute a PFE multiplier and multiply the sum of the asset class add-ons for the netting set by that multiplier. The bank must calculate the PFE multiplier using the NCV and the aggregate add-on for the netting set (AddOn_agg) according to the following formula (where “exp” denotes the exponential function):

64.Consistent with international regulatory standards, the Floor for this calculation is established at the level of 0.05 (5%) under this Standard.

65.If the PFE multiplier for a netting set is greater than 1.0 when calculated according to the formula above (which generally occurs when NCV>0), the bank should set the PFE multiplier equal to 1.0 when calculating PFE. Note that NCV is the same as the calculation of RC for un-margined transactions, but without the limitation of a lower bound of zero (that is, NCV can be negative).

66.If a single margin agreement applies to several netting sets, so that collateral is exchanged based on mark-to-market values that are netted across all transactions covered under the margin agreement irrespective of netting sets, calculations of both RC and PFE are affected as described in this Standard. Special treatment is necessary because it is problematic to allocate the common collateral to individual netting sets.

67.A bank must compute a single combined RC for all netting sets covered by the margin agreement. Combined RC is the sum of two elements, each of which must be no less than zero. The first element is equal to the un-margined current exposure the bank has to the counterparty, aggregated across all netting sets covered by the margin agreement, less the cash equivalent value of any collateral available to the bank at the time (including both VM and _NICA) if the bank is a net holder of collateral. The second term is added only when the bank is a net provider of collateral, and is equal to the current net value of the posted collateral, reduced by the un-margined current exposure of the counterparty to the bank aggregated across all netting sets covered by the margin agreement.

68.The bank must calculate PFE for transactions subject to a single margin agreement covering multiple netting sets as if those transactions were un-margined, with the resulting calculations of PFE for each netting set then aggregated through summation. Both the multiplier and the PFE add-on should be calculated as if the transactions were un-margined.

69.The Financial Stability Board has determined that central clearing of over-the-counter derivatives reduces global systemic risk. Accordingly, the Central Bank assigns lower risk weights to bank exposures to central counterparties (CCPs) that meet certain standards for qualification, as described below for Qualifying Central Counterparties (QCCPs).

70.Banks must treat exposures to non-qualifying CCPs as they would treat exposures to any other non-qualifying counterparty. If a CCP being treated as a QCCP ceases to qualify as a QCCP, exposures to that former QCCP may continue to be treated as though they were QCCP exposures for a period of three months, unless the Central Bank requires otherwise. After the three-month period, the bank’s exposures to such a CCP must be treated as bilateral counterparty credit exposures.

71.For a counterparty entity to be considered a QCCP for purposes of this Standard, the entity must meet the following conditions:

• •Be licensed to operate as a CCP and permitted to operate as such by the appropriate regulator or overseer with respect to the products that are centrally cleared.
• •Provide UAE banks with the information required to calculate RWA for any default fund exposures to the CCP according to the requirements stated in this Standard.
• •Be based and prudentially supervised in a jurisdiction where the relevant regulator or overseer has established and publicly indicated that domestic rules and regulations consistent with the CPMI-IOSCO Principles for Financial Market Infrastructures apply to the CCP on an ongoing basis. For CCPs in jurisdictions that do not have a CCP regulator applying the Principles to the CCP, the Central Bank may make a determination regarding whether the CCP meets the requirements for treatment as a QCCP.

72.A bank must have robust internal procedures to identify specific CCPs that qualify for treatment as QCCPs under this Standard. The internal identification process should reflect the conditions stated above in this Standard, and produce evidence the bank then provides to the Central Bank to demonstrate that a specific CCP meets the conditions for qualification. A bank may not treat any CCP as a QCCP for capital purposes unless and until the Central Bank reviews the bank’s determination and indicates no objection.

73.A bank must calculate RWA for exposures to QCCPs to reflect credit risk due to trade exposures (either as a clearing member of the QCCP or as a client of a clearing member), posted collateral, and default fund contributions. If a bank’s combined RWA for trade exposures to a QCCP and default fund contribution for that QCCP is higher than would apply for those same exposures if the QCCP were a non-qualifying CCP, the bank may treat the exposures as if the QCCP was non-qualifying.

Trade exposures to the QCCP

74.A risk weight of 2% applies to a bank’s trade exposure to the QCCP where the bank as a clearing member of the QCCP trades for its own account. The risk weight of 2% also applies to trade exposures to the QCCP arising from clearing services the bank provides to clients where the bank is obligated to reimburse those clients for losses in the event that the QCCP defaults.

75.In general, a bank must calculate exposure amounts for trade exposures to QCCPs as for other derivatives exposure under this Standard. Banks must use a minimum MPOR of 10 days for the calculation of trade exposures to QCCPs on over-the-counter derivatives. Where QCCPs retain variation margin against certain trades and the member collateral is not protected against the insolvency of the QCCP, the minimum horizon applied to the bank’s QCCP trade exposures must be the lesser of one year and the remaining maturity of the transaction, with a floor of 10 business days.

Treatment of posted collateral

76.Any assets or collateral posted to the QCCP by the bank must receive the banking book or trading book treatment it would receive under the capital adequacy framework, regardless of the fact that such assets have been posted as collateral. Where the entity holding such assets or collateral is the QCCP, a risk-weight of 2% applies to collateral included in the definition of trade exposures. The relevant risk-weight of the QCCP will apply to assets or collateral posted for other purposes.

77.A risk weight of zero applies to all collateral (including cash, securities, other pledged assets, and excess initial or variation margin) posted by the clearing member that is held by a custodian and is bankruptcy remote from the QCCP. Collateral posted by a client that is held by a custodian and is bankruptcy remote from the QCCP, the bank, and other clients of the bank is not subject to a CCR capital requirement.

78.Where a bank posts assets or collateral (either as a clearing member or on behalf of a client) with a QCCP or a clearing member, and the assets or collateral is not held in a bankruptcy remote manner, the bank must recognize credit risk based upon the creditworthiness of the entity holding such assets or collateral. Posted collateral not held in a bankruptcy remote manner must be accounted for in the NICA term for CCR calculations.

Default fund exposures

79.A bank’s default fund contributions as a clearing member of a QCCP must be included in the bank’s calculation of risk-weighted assets. Certain inputs required for the RWA calculation must be provided to the bank by the QCCP, its supervisor, or some other body with access to the required data, as described below. Provision of the necessary inputs is a condition for CCP qualification.

80.Risk-weighted assets for the bank’s default fund contributions should be calculated as:

where

• •RW is a risk weight of 20% unless the Central Bank determines that banks must apply a higher risk weight, for example to reflect a QCCP membership composed of relatively high-risk members;
• •DF_M is the bank’s total pre-funded contributions to the QCCP’s default fund;
• •DF is the total value of the QCCP’s default fund, including its own funds and the prefunded contributions from members; and
• •EAD is the sum of the QCCP’s exposure to all clearing members accounts, including clearing members’ own transactions, client transactions guaranteed by clearing members, and the value of all collateral held by the QCCP against those transactions (including clearing members’ prefunded default fund contributions) prior to exchange of margin in the final margin call on the date of the calculation. This exposure should include the exposure arising from client sub-accounts to the clearing member’s proprietary business where clearing members provide client-clearing services and the client transactions and collateral are held in separate (individual or omnibus) subaccounts.

81.However, if the RWA from the calculation above is less than 2% of the amount of the bank’s pre-funded contributions to the default fund, then the bank must set RWA equal to 2% of its pre-funded contributions to the default fund, which is 2%×DFM.

82.Exposure to each clearing member for the QCCP’s EAD calculation is the bilateral CCR trade exposure the QCCP has to the clearing member as calculated under this Standard, using MPOR of 10 days. All collateral held by a QCCP to which that QCCP has a legal claim in the event of the default of the member or client, including default fund contributions of that member, is used to offset the QCCP’s exposure to that member or client for the PFE multiplier. If the default fund contributions of the member are not split with regard to client and sub-accounts, they must be allocated to sub-accounts according to the initial margin of that sub-account as a fraction of the total initial margin posted by or for the account of the clearing member.

83.If clearing member default fund contributions are segregated by product types and only accessible for specific product types, the RWA calculation must be performed for each specific product giving rise to counterparty credit risk. Any contributions by the bank to prepaid default funds covering settlement-risk-only products should be risk-weighted at 0%. If the QCCP’s own prefunded resources cover multiple product types, the QCCP must allocate those funds to each of the calculations, in proportion to the respective product-specific EAD.

84.However, where a default fund is shared between products or types of business with settlement risk only (such as equities and bonds) and products or types of business which give rise to counterparty credit risk, all of the default fund contributions receive the risk weight determined above, without apportioning to different classes or types of business or products.

85.Banks must apply a risk weight of 1250% to default fund contributions to a non-qualifying CCP. For the purposes of this paragraph, the default fund contributions of such banks will include both the funded contributions and any unfunded contributions for which the bank could be liable upon demand by the CCP.

86.As a requirement for QCCP qualification, the CCP, its supervisor, or another body with access to the required data must calculate and provide values for EAD, D_FM, and DF in such a way to permit the supervisor of the CCP to oversee those calculations, and must share sufficient information about the calculation results to permit banks to calculate capital requirements for their exposures to the default fund, as well as to permit the Central Bank to review and confirm such calculations. The information must be provided at least quarterly, although the Central Bank may require more frequent calculations in the event of material changes, such as material changes to the number or size of cleared transactions, material changes to the financial resources of the QCCP, or initiation by the QCCP of clearing of a new product.

Clearing member exposures to clients

87.A bank as a clearing member of a QCCP must treat its exposure to clients as bilateral trades, irrespective of whether the bank as clearing member guarantees the trade or acts as an intermediary between the client and the QCCP.

88.If a bank as a clearing member of a QCCP collects collateral from a client and passes this collateral on to the QCCP, the bank may recognize this collateral for both the exposure to the QCCP and the exposure to the client.

89.If a bank as a clearing member conducts an exchange-traded derivatives transaction on a bilateral basis with a client, it is treated as a bilateral counterparty credit risk exposure rather than a QCCP exposure. In this case, the bank can compute the exposure to the client using a margin period of risk, subject to a minimum MPOR of at least five days.

90.These requirements also apply to transactions between lower-level clients and higher-level clients in a multi-level client structure. (A multi-level client structure is one in which banks can centrally clear as an indirect client of a clearing member; that is, when clearing services are provided to the bank by an institution that is not a direct clearing member, but is itself a client of a clearing member or another clearing client.)

Bank exposures as a client of clearing members

91.Where a bank is a client of a clearing member, and enters into a transaction with a clearing member who completes an offsetting transaction with the QCCP, of if a clearing member guarantees QCCP performance to the bank as a client, the bank’s exposures to the clearing member may be treated as trade exposures to the QCCP with a risk weight of 2% if the conditions below are met. (This also applies to exposures of lower-level clients to higher- level clients in a multi-level client structure, provided that for all intermediate client levels the two conditions below are met.)

• •Condition 1: Relevant laws, regulation, rules, contractual, or administrative arrangements make it highly likely that, in the event that the clearing member defaults or becomes insolvent, the offsetting transactions with the defaulted or insolvent clearing member would continue to be indirectly transacted through or by the QCCP, and that client positions and collateral with the QCCP would be transferred or closed out at market value.
• •Condition 2: Offsetting transactions are identified by the QCCP as client transactions, and collateral to support them is held by the QCCP and/or the clearing member under arrangements that prevent any losses to the client due to the default or insolvency of either the clearing member or other clients of the clearing member, or of a joint default or insolvency of the clearing member and any of its other clients.

92.Where a bank is a client of the clearing member and the two conditions above are not met, the bank must treat its exposures to the clearing member as an ordinary bilateral exposure under this Standard, not a QCCP exposure. If the two conditions above are met with the exception of the requirement regarding joint default or insolvency of the clearing member and any of its other clients, a 4% risk weight must be applied instead of 2%.

93.A bank must have conducted sufficient legal review (and undertake such further review as necessary to ensure continuing enforceability) and have a well-founded basis to conclude that, in the event of legal challenge, the relevant courts and administrative authorities would find that such arrangements mentioned above would be legal, valid, binding and enforceable under the relevant laws of the relevant jurisdictions. Upon the insolvency of the clearing member, there should be no legal impediment (other than the need to obtain an appropriate court order) to the transfer of the bank’s collateral to one or more surviving clearing members or to the bank or the bank’s nominee.

94.The treatment described here also applies to exposures resulting from posting of collateral by the bank as a client of a clearing member that is held by the QCCP on the bank’s behalf but not on a bankruptcy remote basis.

95.If a bank conducts an exchange-traded derivatives transaction on a bilateral basis with a clearing member as a client of that clearing member, the transaction is treated as a bilateral counterparty credit risk exposure, not a QCCP exposure. The same applies to transactions between lower-level clients and higher-level clients in a multi-level client structure.

96.The fact that a CCP qualifies as a QCCP does not relieve a bank of the responsibility to ensure that it maintains adequate capital to cover the risk of its exposures. Where the bank is acting as a clearing member, the bank should assess whether the level of capital held against exposures to a QCCP adequately addresses the inherent risks of those transactions through appropriate scenario analysis and stress testing.

97.A bank must monitor and report to its senior management and Board, or an appropriate committee of the Board, on a regular basis all of its exposures to QCCPs, including exposures arising from trading through a QCCP and exposures arising from QCCP membership obligations such as default fund contributions.

98.Bank calculations for Counterparty Credit Risk under this Standard and associated bank processes must be subject to appropriate levels of independent review and challenge. Reviews must cover material aspects of the calculations under this Standard, including but not limited to the determination of netting sets, the assignment of individual transactions to asset classes and hedging sets, the application of supervisory parameters, the definition of commodity types, the treatment of complex derivatives transactions, and the identification of QCCPs.

99.Banks offering Islamic financial services that use Shari’ah Compliant alternatives to derivatives approved by their internal Shari’ah control committees should calculate the risk weighted asset (RWA) to recognize the exposure amounts for counterparty credit risk (CCR) as a result of obligations arising from terms and conditions of contracts and documents of those Shari’ah compliant alternatives in accordance with provisions set out in this standard/guidance and in the manner acceptable by Shari’ah. This is applicable until relevant standards and/or guidance in respect of these transactions are issued specifically for banks offering Islamic financial services.

Banks are required to calculate RWA for CVA as a multiple of capital for CVA risk calculated as specified in these Standards. The calculation relies on regulatory measures of counterparty credit risk exposure, and recognizes the impact of differences in maturity, as well as adjustments to reflect certain common hedging activities that banks use to manage CVA risk. The relevant requirements are described in this Standard.

19.Bank calculations for CVA risk under these Standard and associated bank processes must be subject to appropriate levels of independent review and challenge. Reviews must cover material aspects of the calculations under these Standards, including but not limited to determination of eligible hedges, determination of maturities and amounts, mapping of counterparties to risk weights based on credit rating, and the CVA capital calculation.

20.Banks offering Islamic financial services that use Shari’ah Compliant alternatives to derivatives and Securities financing transactions (SFTs) approved by their internal Shari’ah control committees should calculate the risk weighted asset (RWA) for Credit Valuation Adjustment (CVA) of these Shari’ah compliant alternatives in accordance with provisions set out in this standard/guidance and in the manner acceptable by Shari’ah. This is applicable until relevant standards and/or guidance in respect of these transactions are issued specifically for banks offering Islamic financial services

5.Banks must treat in-scope equity positions in a manner consistent with one or more of the following three approaches: the “look-through approach”, the “mandate-based approach” and the “fall-back approach”.

1.Look-through approach (LTA)

6.The look-through approach (LTA) requires a bank to risk weight the underlying exposures of a fund as if the bank held the exposures directly. LTA must be used by a bank when:

1. (iii)there is sufficient and frequent information provided to the bank regarding the underlying exposures of the fund to determine the applicable risk weights and exposure amounts; and
2. (iv)such information is subject to verification by an independent third party.

7.To satisfy condition (i) above, the frequency of financial reporting of the fund must be the same as, or more frequent than, the financial reporting obligation of the bank, and the granularity of the financial information must be sufficient to calculate the corresponding risk weights and exposure amounts without requiring an external audit. To satisfy condition (ii) above, there must be verification of the underlying exposures by an independent third party, such as a depository or custodian bank or, where applicable, a fund management company.

8.Under the LTA, a bank must risk weight all underlying exposures of a fund as if the bank held those exposures directly. This includes, for example, any underlying exposure arising from the fund’s derivatives activities and the counterparty credit risk (CCR) exposure associated with those derivatives. However, instead of determining the applicable credit valuation adjustment (CVA) capital associated with the fund’s derivatives exposures, a bank should instead increase the CCR exposure by 50 percent (that is, multiply the CCR exposure by a factor of 1.5) before applying the risk weight associated with the counterparty. Banks are not required to apply the 1.5 factor to transactions for which the CVA capital charge would not otherwise be applicable, such as those conducted directly with central counterparties.

9.Banks may rely on third-party calculations to determine the risk weights associated with equity investments in funds (that is, the underlying risk weights of the exposures of the fund) if they cannot obtain adequate data or information themselves to perform the calculations. In such cases, however, the bank must increase the resulting risk weight by 20 percent (that is, multiplied by a factor of 1.2) relative to the risk weight that would be applicable if the bank held the exposure directly.

10.Banks should use the risk weights from the LTA to compute RWA for the fund. After calculating the RWA for a fund according to the LTA, banks must calculate the average risk weight for that fund (Avg RW_fund) by dividing the total RWA of the fund by the total (unweighted) assets of the fund.

2.Mandate-based approach (MBA)

11.Banks should use the second approach, the mandate-based approach (MBA), only when the conditions for applying the LTA are not met. Banks should use the information contained in a fund’s mandate or in the relevant regulations governing such investment funds to perform a conservative calculation of the applicable risk weights for the assets of the fund.

12.Under the MBA, on-balance-sheet exposures (that is, the fund’s assets) are risk weighted assuming that the underlying portfolios are invested to the maximum extent allowed under the fund’s mandate in assets that would attract the highest risk weights, and then progressively in other assets that attract lower risk weights. If more than one risk weight could be applied to a given exposure, the bank should use the highest applicable risk weight.

13.The notional amount of derivative exposures and off-balance-sheet items should be risk-weighted according to the requirements of the risk-based capital standards.

14.Banks should calculate the CCR exposure associated with a fund’s derivative positions in accordance with the Central Bank’s Standard for Counterparty Credit Risk Capital. If replacement cost cannot be determined, the bank should use the notional amount of the derivative as the replacement cost. If the Potential Future Exposure (PFE) cannot be determined, the bank should use an amount equal to 15 percent of the notional value as the PFE.

15.As with the LTA, banks should account for CVA Risk on derivatives by increasing the CCR exposure by 50 percent (that is, multiply the CCR exposure by a factor of 1.5) before applying the risk weight associated with the counterparty. Banks are not required to apply the 1.5 factor for transactions to which the CVA capital charge would not otherwise be applicable, such as those conducted directly with central counterparties.

16.As with the LTA, after calculating the RWA for a fund according to the MBA, banks must calculate the average risk weight for that fund (Avg RW_fund) by dividing the RWA of the fund by the total (unweighted) assets of the fund.

3.Fall-back approach (FBA)

17.When the conditions for applying either the LTA or the MBA are not met, banks are required to apply the FBA, under which Avg RW_fund for a bank’s investment in the fund is set equal to 1250 percent.

18.A bank may use a combination of the three approaches when determining the capital requirements for an equity investment in an individual fund, with one approach applied to a portion of the fund’s exposures and one or more other approaches applied to the fund’s other exposures. The requirements for each approach as articulated under this Standard must be met for any portions of the fund to which the LTA or MBA are applied. RWA calculations from each applied approach should be added together with the sum then divided by the total fund assets to compute Avg RW_fund.

19.When a bank has an investment in one fund (e.g., Fund A) that itself has an investment in another fund (e.g., Fund B), the risk weight applied to the investment holding of the first fund (that is, Fund A’s investment in Fund B) should be determined by using the same three approaches set out above (LTA, MBA, and FBA). If fund investments are further layered (for example, if Fund B has investments in a Fund C), the risk weights applied to the additional layers of investment (that is, Fund B’s investment in Fund C) can be determined using the LTA, but only if the LTA was also used for determining the risk weight for the investment in the fund at the previous layer (Fund A’s investment in Fund B). Otherwise, the bank must apply the FBA to the additional investment layers.

20.Equity holdings in entities whose debt obligations qualify for a zero risk weight can be excluded from the LTA, MBA and FBA approaches (including government sponsored entities where a zero risk weight can be applied), at the discretion of the UAE Central Bank. If the UAE Central Bank makes such exclusion, this will be available to all banks.

21.The UAE Central Bank may, in its absolute discretion, change the risk weighting of debt obligations from time to time as it finds necessary.

22.When determining the risk weight for a bank’s equity investment in a fund, a bank must apply a leverage adjustment to the average risk weight of the fund as calculated above.

23.Leverage for a fund is calculated as the ratio of total fund assets (not risk weighted) to total fund equity. Under the LTA, this ratio should be calculated from the information obtained on the fund’s asset holdings and financing. Under the MBA, banks should assume the maximum financial leverage permitted in the fund’s mandate, or the maximum permitted under the regulations governing the fund.

24.Banks must calculate the risk weight to be applied to their equity investments in any fund as the product of the fund’s average risk weight and the fund’s leverage:

25.The risk weight for a bank’s equity investment in any fund is subject to a cap of 1250 percent. If the calculation described in the paragraph above produces a result in excess of 1250 percent, the bank should use the maximum risk weight of 1250 percent instead.

26.Banks should compute the RWA for their investments in funds by multiplying the amount of the equity investment in a given fund by the risk weight calculated as described in this Standard, based on Avg RW_fund and the leverage of the fund determined according to this Standard.

6.An originating bank may exclude underlying exposures from the calculation of risk-weighted assets only if all of the following conditions for risk transference have been met.

1. a.Significant credit risk associated with the underlying exposures has been transferred to third parties.
2. b.Banks should obtain legal opinion that confirms true sale, that the transferor does not maintain effective or indirect control over the transferred exposures; that is, that the exposures are legally isolated from the transferor in such a way (e.g., through the sale of assets or through sub-participation) that the exposures are put beyond the reach of the transferor and its creditors, even in bankruptcy or receivership.
3. c.The transferor is not able to repurchase from the transferee the previously transferred exposures in order to realize their benefits and is not obligated to retain the risk of the transferred exposures.
4. d.The securities issued are not obligations of the transferor. Thus, investors who purchase the securities only have a claim on the underlying exposures.
5. e.The transferee is an SPE and the holders of the beneficial interests in that entity have the right to pledge or exchange them without restriction.
6. f.Clean-up calls satisfy the conditions set out in Section D below.
7. g.The securitisation does not contain clauses that (i) require the originating bank to alter the underlying exposures such that the pool’s credit quality is improved unless this is achieved by selling exposures to independent and unaffiliated third parties at market prices; (ii) allow for increases in a retained first-loss position or credit enhancement provided by the originating bank after the transaction’s inception; or (iii) increase the yield payable to parties other than the originating bank, such as investors and third-party providers of credit enhancements, in response to a deterioration in the credit quality of the underlying pool.
8. h.There are no termination options or triggers except eligible clean-up calls meeting the requirements of Section D below, termination for specific changes in tax and regulation, or early amortization provisions that result in the securitisation transaction failing the operational requirements set out in Section D below.
9. i.Such other conditions as the Central Bank shall provide after notification to banks pursuant to a circular or otherwise.

Banks meeting these above conditions must still hold regulatory capital against any exposure they retain under the securitisation.

7.The transferor’s retention of servicing rights to the exposures does not in itself constitute indirect control of the exposures.

8.For synthetic securitisations, the use of credit risk mitigation (CRM) techniques (i.e., collateral, guarantees and credit derivatives) for hedging the underlying exposure may be recognized for risk-based capital purposes only if the conditions outlined below are satisfied:

1. a.Credit risk mitigants comply with the requirements set out for CRM in the Central Bank’s Standard for Credit Risk.
2. b.Eligible collateral is limited to that specified as eligible under in the Central Bank’s Standards for Credit Risk (eligible collateral pledged by SPEs may be recognized).
3. c.Eligible guarantors are as defined in the Central Bank’s Standard for Credit Risk (SPEs are not considered to be eligible guarantors).
4. d.Significant credit risk associated with the underlying exposures is transferred by the bank to third parties.
5. e.Instruments used to transfer credit risk do not contain terms or conditions that limit the amount of credit risk transferred.
6. f.The bank obtains a legal opinion that confirms the enforceability of the contract.
7. g.Such other conditions as the Central Bank shall provide after notification to banks pursuant to a circular or otherwise.

9.Clean-up calls for synthetic securitisations also must satisfy the conditions set out in Section D below. If a synthetic securitisation incorporates a call (other than a clean-up call) that effectively terminates the transaction and the purchased credit protection on a specific date, the bank should treat this as required under the Central Bank’s Standard for Credit Risk for CRM maturity mismatch. This requirement does not apply to synthetic securitisations that are assigned a risk weight of 1250%.

10.A transaction is deemed to fail the operational requirements for traditional or synthetic securitisations stated above in this Standard if the bank originates or sponsors a securitisation transaction that includes one or more revolving credit facilities, and the securitisation transaction incorporates an early amortization or similar provision that, if triggered, would:

1. i.Subordinate the bank’s senior or pari passu interest in the underlying revolving credit facilities to the interest of other investors;
2. ii.Subordinate the bank’s subordinated interest to an even greater degree relative to the interests of other parties;
3. iii.In other ways increases the bank’s exposure to losses associated with the underlying revolving credit facilities; or
4. iv.Not satisfy any conditions as set by the Central Bank after notification to banks pursuant to a circular or otherwise.

11.If a transaction contains one of the following examples of an early amortization provision but otherwise meets the operational requirements for traditional or synthetic securitisations stated above in this Standard, the originating bank may exclude the underlying exposures associated with such a transaction from the calculation of risk-weighted assets, but must still hold regulatory capital against any securitisation exposures they retain in connection with the transaction:

1. a.Replenishment structures where the underlying exposures do not revolve and early amortization terminates the ability of the bank to add new exposures;
2. b.Transactions with revolving credit facilities containing early amortization features that mimic term structures (i.e., where the risk on the underlying revolving credit facilities does not return to the originating bank) and where the early amortization provision does not effectively result in subordination of the originator’s interest;
3. c.Structures where a bank securitizes one or more revolving credit facilities and where investors remain fully exposed to future drawdowns by borrowers even after an early amortization event has occurred; or
4. d.The early amortization provision is triggered solely by events not related to the performance of the underlying assets or the selling bank, such as material changes in tax laws or regulations.

12.For securitisation transactions that include a clean-up call, no capital shall be required due to the presence of a clean-up call if the following conditions are met:

1. a.The exercise of the clean-up call is not mandatory, in form or in substance, but rather is at the discretion of the originating bank;
2. b.The clean-up call is not structured to avoid allocating losses to credit enhancements or positions held by investors or otherwise structured to provide credit enhancement; and
3. c.The clean-up call is exercisable only when 10% or less of the original underlying portfolio or securities issued remains, or, for synthetic securitisations, when 10% or less of the original reference portfolio value remains.
4. d.Such other conditions as the Central Bank shall provide after notification to banks pursuant to a circular or otherwise.

13.Securitisation transactions that include a clean-up call that does not meet all of the criteria stated in the immediately preceding paragraph result in a capital requirement for the originating bank. For a traditional securitisation, the bank must treat the underlying exposures as if they were not securitized. Additionally, banks must not recognize in regulatory capital any gain on sale. For synthetic securitisations, the bank purchasing protection must hold capital against the entire amount of the securitized exposures as if they did not benefit from any credit protection.

14.If a clean-up call, when exercised, is found to serve as a credit enhancement, the exercise of the clean-up call must be considered a form of implicit support provided by the bank, and must be treated as such in accordance with the requirements related to implicit support stated below in this Standard.

15.The following types of securitisations, if the originating bank is UAE based, will only be permitted in specific instances and require the Central Bank’s approval:

1. a.securitisation of revolving credit facilities
2. b.synthetic securitisation
3. c.resecuritisation exposure

20.For regulatory capital purposes, the exposure amount of a securitisation exposure shall be calculated as the sum of the on-balance sheet amount of the exposure, or carrying value – taking into account purchase discounts and write-downs or specific provisions the bank took on this securitisation exposure – and any off-balance sheet exposure amount as applicable, in accordance with the requirements in the following paragraphs.

21.For credit risk mitigants sold or purchased by the bank, the exposure amount should be determined using the treatment of credit risk mitigation set out below in the section on treatment of credit risk mitigation in this Standard. For all off-balance-sheet facilities that are not credit risk mitigants, the bank should apply a credit conversion factor (CCF) of 100%.

22.For securitisation-related derivatives other than credit risk derivatives (such as interest rate or currency swaps sold or purchased as part of the securitisation), the Central Bank’s Standard on Counterparty Credit Risk should be used to calculate the exposure amount.

23.Banks shall compute the risk-weighted asset amount for a securitisation exposure by multiplying the exposure amount as defined in this section by the appropriate risk weight determined under one of the approaches discussed below in this Standard. Risk weight caps may apply, as described in the this Standard on risk-weight caps for securitisation.

24.Banks may adjust risk weights for overlapping exposures. An exposure A overlaps another exposure B if in all circumstances the bank can avoid any loss on exposure B by fulfilling its obligations with respect to exposure A. A bank may also recognize overlap between relevant capital charges for exposures in the trading book and securitisation exposures in the banking book, provided that the bank is able to calculate and compare the capital charges for the relevant exposures.

25.Banks must deduct from Common Equity Tier 1 any increase in equity capital resulting from a securitisation transaction, such as a gain on a sale associated with expected future margin income.