Capital Requirements Regulation – PRA Consultation Paper CP6/18
by Grant Eldred
Those clients using non-payment credit insurance (“NPI”) (or other unfunded credit risk protection) as a credit risk mitigant (“CRM”) for capital relief should note the Consultation Paper issued by the PRA on 16th February 2018 (CP6/18) which attempts to clarify expectations regarding the eligibility of unfunded CRMs.
The CP6/18 refers only to “guarantees” (not insurance) because this is still the approach adopted under the Capital Requirements Regulation 575/2013 (“CRR”). However, it is now generally accepted that non-payment credit insurance, if suitably drafted to satisfy the eligibility requirements of the CRR (Art 194, 213 and 215), can fall within “guarantees” under the CRR. Although ostensibly an invitation to consult on proposals with any responses to be submitted to the PRA by May 2018, the Consultation Paper gives some indications as to the Bank of England/PRA’s views, particularly, with regard to the use of non-payment credit insurance as a “guarantee” and a risk mitigation technique under the CRR:
• Legal Opinions/Eligibility Criteria – Many have taken the view in the past that the independent legal opinion required by the CRR needs only confirm the guarantee/NPI is “legally effective and enforceable” (i.e. a more standard enforceability opinion). CP 6/18 indicates that the PRA expects the independent legal opinion also to cover the eligibility criteria set out in Art 194 of CRR.
• Legal Opinions/Jurisdiction – To cover the CRR requirement that the lender obtain an independent legal opinion to confirm the “guarantee” is “legally effective and enforceable in relevant jurisdictions” most have accepted a legal opinion from the jurisdiction of the provider will be needed, as well as an opinion on the law and wording of the contract itself. However, the PRA now indicates further jurisdiction(s) may need to be covered (i.e. the “jurisdiction where enforcement action may be taken”).
• Payment in a timely manner – The CRR requires any eligible unfunded CRM not to contain a clause which prevents the guarantor from being obliged to pay out in a “timely manner”. Little or no guidance has been provided in the past but the market has generally considered this does not impose a time limit but means that the process for payment must be clear and not allow for undue delay. As a result, particularly in relation to trade finance/receivables, NPI policies often include claims’ waiting periods of 90-180 days. The PRA states in CP6/18 that it considers that the CRR “timely manner” requirement means that the pay out should be made “without delay and within days, but not weeks or months”. Some exceptions are listed in CP 6/18 but, since this position appears to be at odds with the current practice, it is likely to be a central part of the consultation process.
• Exclusions and Limits to Coverage – The PRA considers what types of payments can fall within Art 215 (1) (c) of the CRR such that the value of the guarantee can be adjusted but the remaining limited coverage can qualify for capital relief. The PRA expresses the view that “limited coverage” refers only to a quantifiable portions of the exposure (i.e. certain types of payment such as principal, interest, fees etc.). Where a policy is limited in a manner other than quantum, firms may have sought to rely upon Art 215 (1) (c) to claim some limited capital relief under the CRR. However, this approach by the PRA may exclude them from claiming that limited relief.
The consultation closes on the 16th May 2018. As well as responding to the issues raised by the consultation, clients should be considering the terms of unfunded CRM they are currently using for capital relief and/or are about to adopt. While the consultation continues and, thereafter until guidance is issued, the industry will have no alternative but to take heed of the views expressed by the PRA/Bank of England in CP6/18.
If you have any queries about this article, please get in touch with Grant Eldred, whose details appear below.