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Dubai Financial Services Authority (DFSA): Contents

Dubai Financial Services Authority (DFSA)
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Prudential — Investment, Insurance Intermediation and Banking Module (PIB) [VER33/02-19]
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  • PIB 4.13 Credit Risk Mitigation

    • PIB 4.13 Guidance

      This section sets out the principles and methodologies for the recognition of Credit RiskG mitigation in the calculation of Credit RWAG .

      Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • General Requirements

      • PIB 4.13.1

        (1) An Authorised FirmG must not recognise the effects of Credit RiskG mitigation unless:
        (a) all documentation relating to that mitigation is binding on all relevant parties and legally enforceable in all relevant jurisdictions; and
        (b) the Authorised FirmG complies with the RulesG set out in this section, as applicable.
        (2) Where the calculation of Credit RWAG already takes into account the Credit RiskG mitigant, the provisions of this section do not apply.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.1 Guidance

          An Authorised FirmG should conduct 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. The review should cover relevant jurisdictions such as the jurisdiction whose law governs the credit protection or CollateralG agreement and the jurisdiction whose law governs the transaction subject to the credit protection or CollateralG agreement. There should be sufficient written documentary evidence to adequately support the conclusion drawn and rebut any legal challenge. While an Authorised FirmG may use either in-house or external legal counsel, it should consider whether or not in-house counsel opinion is appropriate. The senior management of the Authorised FirmG should ensure that an officer of the Authorised FirmG who is legally qualified and independent of the parties originating the transaction reviews the legal opinion and confirms that he is satisfied that an adequate review has been completed and that he agrees with the conclusions drawn. A record of these reviews should be kept and made available at the request of the DFSAG .

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.2

        Where an Authorised FirmG uses multiple Credit RiskG mitigation for a single ExposureG , the Authorised FirmG must divide the ExposureG into portions covered by each mitigation and must calculate the Credit RiskG -weighted ExposureG amount of each portion separately. An Authorised FirmG must apply the same approach when recognising eligible credit protection by a single protection provider where the eligible credit protection has differing maturities.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.3

        (1) An Authorised FirmG must take all appropriate steps to ensure the effectiveness of the Credit RiskG mitigation arrangements it employs and to address related risks.
        (2) Where an Authorised FirmG reduces or transfers Credit RiskG by the use of Credit RiskG mitigation, an Authorised FirmG must employ appropriate and effective policies and procedures to identify and control other risks which arise as a consequence of the transfer.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.3 Guidance

          1. The use of techniques to reduce or transfer Credit RiskG may simultaneously increase other risks (residual risks) which include legal, operational, liquidity and Market RisksG . The DFSAG expects an Authorised FirmG to employ methods to identify and control these risks, including:
          a. strategy;
          b. consideration of the underlying credit;
          c. valuation;
          d. policies and procedures;
          e. systems;
          f. control of roll-off risks; and
          g. management of Concentration RiskG arising from the use of Credit RiskG mitigation and the interaction of such risk with the overall Credit RiskG profile of the Authorised FirmG .
          2. In order to fulfil the above, an Authorised FirmG should ensure a clearly articulated strategy for the use of Credit RiskG mitigation as an intrinsic part of the general credit strategy of an Authorised FirmG .
          3. Where an ExposureG is subject to Credit RiskG mitigation, credit managers should continue to assess the ExposureG on the basis of the obligor's creditworthiness. Credit managers should obtain and analyse sufficient financial information to determine the obligor's risk profile and its management and operational capabilities.
          4. CollateralG should be revalued frequently, and the unsecured ExposureG should also be monitored frequently. Frequent revaluation is prudent, and the revaluation of marketable securities should occur on at least a daily basis. Furthermore, measures of the potential unsecured ExposureG under collateralised transactions should be calculated under stressed and normal conditions. One such measure would take account of the time and cost involved if the obligor or CounterpartyG were to default and the CollateralG had to be liquidated. Furthermore, the setting of limits for collateralised CounterpartiesG should take account of the potential unsecured ExposureG . Stress tests and scenario analysis should be conducted to enable the Authorised FirmG to understand the behaviour of its portfolio of Credit RiskG mitigation arrangements under unusual market conditions. Any unusual or disproportionate risk identified should be managed and controlled.
          5. Clear policies and procedures should be established in respect of CollateralG management, including:
          a. the terms of CollateralG agreements;
          b. the types of CollateralG and enforcement of CollateralG terms (e.g. waivers of posting deadlines);
          c. the management of legal risks;
          d. the administration of agreement (e.g. detailed plans for determining default and liquidating CollateralG ); and
          e. the prompt resolution of disputes, such as valuation of CollateralG or positions, acceptability of CollateralG , fulfilment of legal obligations and the interpretation of contract terms.
          6. The policies and procedures referred to under GuidanceG note 1(d) should be supported by CollateralG management systems capable of tracking the location and status of posted CollateralG (including re-hypothecated CollateralG ), outstanding CollateralG calls and settlement problems.
          7. Where an Authorised FirmG obtains credit protection that differs in maturity from the underlying credit ExposureG , the Authorised FirmG should monitor and control its roll-off risks, i.e. the fact that the Authorised FirmG will be fully exposed when the protection expires, and the risk that it will be unable to purchase credit protection or ensure its capital adequacy when the credit protection expires.
          8. Taking as CollateralG large quantities of instruments issued by one obligor creates Concentration RiskG . An Authorised FirmG should have a clearly defined policy with respect to the amount of Concentration RiskG it is prepared to run. Such a policy might, for example, include a cap on the amount of CollateralG it would be prepared to take from a particular IssuerG or market. The Authorised FirmG should also take CollateralG and purchased credit protection into account when assessing the potential concentrations in its overall credit profile.
          9. Notwithstanding the presence of Credit RiskG mitigation considered for the purposes of calculating Credit RWAG amounts, an Authorised FirmG should continue to undertake a full Credit RiskG assessment of the underlying ExposureG .
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.4

        (1) An Authorised FirmG must be able to satisfy the DFSAG that it has systems in place to manage potential concentration of risk arising from its use of guarantees and Credit DerivativesG .
        (2) An Authorised FirmG must be able to demonstrate how its strategy in respect of its use of Credit RiskG mitigation techniques, and in particular use of Credit DerivativesG and guarantees interacts with its management of its overall risk profile.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Collateral

      • PIB 4.13.4 Guidance

        In order to recognise the effects of Credit RiskG mitigation of the types of CollateralG set out in Rules PIB 4.13.5 to PIB 4.13.7, an Authorised FirmG must ensure that the relevant requirements in PIB Rule 4.13.8 are complied with.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.5

        (1) For an Authorised FirmG using the FCSA, eligible financial CollateralG comprises:
        (a) cash (as well as certificates of deposit or other similar instruments issued by the Authorised FirmG ) on deposit with the Authorised FirmG ;
        (b) gold;
        (c) any debt security:
        (i) with an Original MaturityG of one year or less that has a short-term Credit Quality GradeG of 3 or better as set out in PIB section 4.12; or
        (ii) with an Original MaturityG of more than one year that has a Credit Quality GradeG of 4 or better as set out in PIB section 4.12 if it is issued by a central government or Central BankG , or a Credit Quality GradeG of 3 or better as set out in PIB section 4.12 if it is issued by any other entity;
        (d) any debt security issued by a bank that does not have an external credit assessment by a recognised ECAIG if it fulfils the following criteria:
        (i) any debt security which is listed on a regulated exchange;
        (ii) the debt security is classified as senior debt, not subordinated to any other debt obligations of its IssuerG ;
        (iii) all other rated debt securities issued by the same IssuerG which rank equally with the mentioned debt security have a long term or short term (as applicable) Credit Quality GradeG by a recognised ECAIG of "3" or better;
        (iv) the Authorised FirmG is not aware of information to suggest that the issue would justify a Credit Quality GradeG of below "3" as indicated in (iii) above; and
        (v) the Authorised FirmG can demonstrate to the DFSAG that the market liquidity of the debt security is sufficient to enable the Authorised FirmG to dispose the debt security at market price.
        (e) any equity security (including convertible bonds) that is included in a main index; or
        (f) any UnitG in a Collective Investment FundG where:
        (i) a price for the units is publicly quoted daily; and
        (ii) at least 90% of the deposited property of the FundG is invested in instruments listed in this RuleG .
        (2) Cash-funded credit-linked notesG issued by an Authorised FirmG against ExposuresG in the Non-Trading BookG which fulfil the criteria for eligible Credit DerivativesG must be treated as cash collateralised transactions.
        (3) Cash, mentioned in (1)(a), includes cash on deposit, certificates of deposit or other similar instruments issued by the Authorised FirmG that are held as CollateralG at a third-party bank in a non-custodial arrangement and that are pledged or assigned to the Authorised FirmG . This is subject to the pledge or assignment being unconditional and irrevocable. Under the FCSA, the risk weight to be applied to the ExposureG covered by such CollateralG must be the risk weight of the third-party bank.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.5 Guidance

          1. For the purposes of Rule PIB 4.13.5 and PIB 4.13.6, eligible financial CollateralG excludes any T1 Capital instrument or T2 Capital instrument issued by any entity in the Financial GroupG of the Authorised FirmG , which is held by the Authorised FirmG or any of its Financial GroupG entities as CollateralG .
          2. For an Authorised FirmG using UnitsG of a FundG under the FCSA approach, the use or potential use by that FundG of DerivativeG instruments solely to hedge investments listed in PIB Rule 4.13.5 should not preclude the UnitsG in that FundG from being recognised as eligible financial CollateralG .
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.6

        For an Authorised FirmG using the FCCA, eligible financial CollateralG comprises:

        (a) any instrument listed in PIB Rule 4.13.5;
        (b) any equity SecurityG (including a convertible bond) that is traded on a regulated exchange;
        (c) any UnitG in a Collective Investment FundG which invests in equity securities referred to in (b), where:
        (i) a price for the UnitsG is publicly quoted daily; and
        (ii) at least 90% of the deposited property of the FundG is invested in instruments listed in this RuleG and PIB Rule 4.13.5.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.7

        In the case of any Counterparty RiskG ExposuresG in Rules PIB 4.13.5. and PIB 4.13.6 arising from an SFT which are included in the Trading BookG , eligible financial CollateralG includes all instruments which an Authorised FirmG may include in its Trading BookG .

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.7 Guidance

          For an Authorised FirmG using UnitsG of a FundG under the FCSA approach, the use or potential use by that FundG of DerivativeG instruments solely to hedge investments listed in PIB Rule 4.13.5 should not preclude the UnitsG in that FundG from being recognised as eligible financial CollateralG .

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Requirements for Recognition of Collateral

      • PIB 4.13.8

        An Authorised FirmG must ensure that the following requirements are complied with before it recognises the effects of Credit RiskG mitigation of any CollateralG :

        (a) the legal mechanism by which CollateralG is pledged, assigned or transferred must confer on the Authorised FirmG the right to liquidate or take legal possession of the CollateralG , 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 CounterpartyG (and, where applicable, of the custodian holding the CollateralG );
        (b) the Authorised FirmG has taken all steps necessary to fulfil those requirements under the law applicable to the Authorised Firm'sG interest in the CollateralG for obtaining and maintaining an enforceable security interest by registering it with a registrar or for exercising a right to net or set off in relation to title transfer CollateralG ;
        (c) the credit quality of the CounterpartyG and the value of the CollateralG do not have a material positive correlation;
        (d) securities issued by the CounterpartyG or any Closely RelatedG CounterpartyG are not eligible;
        (e) the Authorised FirmG has implemented procedures for the timely liquidation of CollateralG to ensure that any legal conditions required for declaring default of CounterpartyG and liquidating the CollateralG are observed, and that the CollateralG can be liquidated promptly; and
        (f) where the CollateralG is held by a custodian, the Authorised FirmG has taken reasonable steps to ensure that the custodian segregates the CollateralG from its own assets.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Guarantees

      • PIB 4.13.9

        (1) An Authorised FirmG may recognise the effects of Credit RiskG mitigation of a guarantee only if it is provided by any of the following entities:
        (a) central government or Central BankG ;
        (b) MDB referred to in PIB Rule 4.12.8
        (c) International Organisations referred to in PIB Rule 4.12.9;
        (d) PSE;
        (e) banks and securities firms which qualify for inclusion in bank asset class; or
        (f) any other entity that has a Credit Quality GradeG "3" or above.
        (2) An Authorised FirmG must not recognise the effects of Credit RiskG mitigation of a guarantee unless all of the following requirements are complied with:
        (a) the guarantee is an explicitly documented obligation assumed by the guarantor;
        (b) the guarantee represents a direct claim on the guarantor;
        (c) the extent of the credit protection cover is clearly defined and incontrovertible;
        (d) other than in the event of non-payment by the Authorised FirmG of money due in respect of the guarantee if applicable, there is an irrevocable obligation on the part of the guarantor to pay out a predetermined amount upon the occurrence of a credit event, as defined under the guarantee;
        (e) the guarantee does not contain any clause, the fulfilment of which is outside the direct control of the Authorised FirmG , that:
        (i) would allow the guarantor to cancel the guarantee unilaterally;
        (ii) would increase the effective cost of the guarantee as a result of deteriorating credit quality of the underlying ExposureG ;
        (iii) could prevent the guarantor from being obliged to pay out in a timely manner in the event that the underlying obligor fails to make any payment due; or
        (iv) could allow the maturity of the guarantee agreed ex-ante to be reduced ex-post by the guarantor;
        (f) the Authorised FirmG is able in a timely manner to pursue the guarantor for any monies outstanding under the documentation governing the transaction on the default of, or non-payment by, the underlying obligor without first having to take legal action to pursue the underlying obligor for payment; and
        (g) the guarantee covers all types of payments that the underlying obligor is expected to make under the documentation governing the transaction, except in the case of accrued interest, accrued expenses or fees outstanding, where these are deemed immaterial.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.9 Guidance

          1. PIB Rule 4.13.9(2)(e) does not include any guarantee with a cancellation clause where it is provided that any obligation incurred or transaction entered into prior to any cancellation, unilateral or otherwise, continues to be guaranteed by the guarantor.
          2. The guarantee payments may be in the form of the guarantor making a lump sum payment of all monies to the Authorised FirmG or the guarantor assuming the future payment obligations of the CounterpartyG covered by the guarantee, as specified in the relevant documentation governing the guarantee.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.10

        In addition to the requirements in PIB Rule 4.13.9, where an Authorised FirmG has an ExposureG that is protected by a guarantee or that is counter-guaranteed by a central government or Central BankG , a regional government or local authority or a PSE claims on which are treated as claims on the central government in whose jurisdiction they are established, a MDB or an international organisation to which a 0% risk weight is assigned under PIB section 4.12, an Authorised FirmG may treat the ExposureG as being protected by a direct guarantee from the central government or Central BankG in question, provided the following requirements are complied with:

        (a) the counter-guarantee covers all Credit RiskG elements of the ExposureG ;
        (b) both the original guarantee and the counter-guarantee comply with all the requirements for guarantees set out in this section, except that the counter-guarantee need not be direct and explicit with respect to the original ExposureG ; and
        (c) the Authorised FirmG is able to satisfy the DFSAG that the cover is robust and that nothing in the historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct guarantee by the entity in question.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Credit Derivatives

      • PIB 4.13.11

        (1) An Authorised FirmG may recognise the effects of Credit RiskG mitigation of a Credit DerivativeG only if it is provided by any of the following entities:
        (a) central government or Central BankG ;
        (b) MDB referred to in Rules PIB 4.12.7 to PIB 4.12.9;
        (c) International Organisations referred to in PIB Rule 4.12.9;
        (d) PSE;
        (e) banks and securities firms which qualify for inclusion in bank asset class; or
        (f) any other entity that has a Credit Quality GradeG "3" or better.
        (2) An Authorised FirmG may recognise the effects of Credit RiskG mitigation of only the following types of Credit DerivativesG :
        (a) credit default swaps;
        (b) total return swaps;
        (c) credit linked notesG which are cash funded; and
        (d) instruments that are composed of, or are similar in economic substance, to one or more of the Credit DerivativesG in (a) to (c).
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.12

        An Authorised FirmG must not recognise the effects of Credit RiskG mitigation of any Credit DerivativeG unless all of the following requirements are complied with:

        (a) the terms and conditions of any credit protection obtained via a Credit DerivativeG must be set out in writing by both the Authorised FirmG and the provider of credit protection;
        (b) the Credit DerivativeG must represent a direct claim on the provider of credit protection;
        (c) the extent of the credit protection cover is clearly defined and incontrovertible;
        (d) other than in the event of non-payment by the Authorised FirmG of money due in respect of the Credit DerivativeG , there is an irrevocable obligation on the part of the provider of the credit protection to pay out a pre-determined amount upon the occurrence of a credit event, as defined under the Credit DerivativeG contract;
        (e) the Credit DerivativeG contract must not contain any clause, the fulfilment of which is outside the direct control of the Authorised FirmG , that:
        (i) would allow the provider of credit protection to cancel the credit protection cover unilaterally;
        (ii) would increase the effective cost of the credit protection cover as a result of deteriorating credit quality of the underlying ExposureG ;
        (iii) could prevent the provider of credit protection from being obliged to pay out in a timely manner in the event that the underlying obligor fails to make any payment due; or
        (iv) could allow the maturity of the credit protection agreed ex-ante to be reduced ex-post by the provider of credit protection;
        (f) the credit events specified by the contracting parties must at a minimum cover:
        (i) failure to pay the amounts due under terms of the underlying ExposureG that are in effect at the time of such failure (with a grace period, if any, that is closely in line with the grace period in the underlying ExposureG );
        (ii) bankruptcy, insolvency or inability of the underlying 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
        (iii) restructuring of the underlying ExposureG 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);
        (g) the Credit DerivativeG must not terminate prior to the maturity of the underlying ExposureG or expiration of any grace period required for a default on the underlying ExposureG to occur as a result of a failure to pay;
        (h) a robust valuation process to estimate loss reliably must be in place in order to estimate loss reliably for any Credit DerivativeG that allows for cash settlement. There must be a clearly specified period for obtaining post-credit event valuations of the underlying obligation;
        (i) where the right or ability of the Authorised FirmG to transfer the underlying ExposureG to the credit protection provider is required for settlement, the terms of the underlying ExposureG must provide that any required consent to such transfer may not be unreasonably withheld;
        (j) 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 credit protection provider. The Authorised FirmG must have the right or ability to inform the credit protection provider of the occurrence of a credit event; and
        (k) the underlying obligation and the reference obligation specified in the Credit DerivativeG contract for the purpose of determining the cash settlement value or the deliverable obligation or for the purpose of determining whether a credit event has occurred may be different only 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.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.12 Guidance

          1. An Authorised FirmG should not recognise the effects of Credit RiskG mitigation of a total return swap if it purchases 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 underlying asset that is protected (either through reductions in its marked-to-market value or by an addition to reserves).
          2. The DFSAG would generally consider the requirements in (f) to have been complied with even if the requirements are not specifically set out so long as the obligations of the credit protection provider under the Credit DerivativeG contract would include those requirements.
          3. The DFSAG would generally consider the cash settlement methodology provided in the ISDA Credit DerivativesG Definitions as satisfying the requirement for obtaining post-credit event valuations of the underlying obligation.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Currency Mismatches

      • PIB 4.13.13

        (1) In the case where there is a currency mismatch between the credit protection and the underlying ExposureG , an Authorised FirmG must reduce the amount of the ExposureG deemed to be protected by applying a haircut, as follows:
        Protected portion GA = G (1 - HFX)
        where:
        (a) G = notional amount of the credit protection; and
        (b) HFX = haircut appropriate for currency mismatch between the credit protection and underlying obligation ExposureG based on a ten-business day holding period, assuming daily mark-to-market.
        (2) An Authorised FirmG must determine HFX in the following manner:
        (a) if the Authorised FirmG uses standard supervisory haircuts, HFX is 8%; and
        (b) if the Authorised FirmG uses own-estimate haircuts, it must estimate HFX according to Rules PIB A4.3.6 to PIB A4.3.26 in PIB App4 based on a ten-business day holding period, assuming daily mark-to-market.
        (3) If the credit protection is not marked-to-market daily, HFX must be scaled in accordance with PIB Rule A4.3.25.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Maturity Mismatches

      • PIB 4.13.14

        An Authorised FirmG may recognise the effects of Credit RiskG mitigation for an ExposureG where there is a maturity mismatch only if the Credit RiskG mitigant has an Original MaturityG of at least one year and a residual maturity of more than three months. For the purposes of calculating Credit RWAG , a maturity mismatch occurs when the residual maturity of the Credit RiskG mitigant is less than that of the underlying ExposureG .

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.15

        (1) An Authorised FirmG must determine the maturity of the underlying ExposureG and the maturity of the Credit RiskG mitigant conservatively. The residual maturity of the underlying ExposureG must be gauged as the longest possible remaining time before the CounterpartyG is scheduled to fulfil its obligation, taking into account any applicable grace period.
        (2) In the case of Credit RiskG mitigant, embedded options which may reduce the term of the credit protection must be taken into account so that the shortest possible residual maturity is used. Where a call is at the discretion of the protection seller, the residual maturity will be at the first call date. If the call is at the discretion of the Authorised FirmG but the terms of the arrangement at origination of the Credit DerivativeG contain a positive incentive for the Authorised FirmG to call the transaction before contractual maturity, the remaining time to the first call date will be deemed to be the residual maturity.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.16

        (1) An Authorised FirmG must calculate the value of the Credit RiskG mitigation adjusted for any maturity mismatch (referred to as "PA"), using the following formula:
        PA = P(t-0.25)/(T-0.25)
        where —
        (a) P = value of the credit protection (e.g. CollateralG amount, guarantee amount) adjusted for any haircuts;
        (b) t = min (T, residual maturity of the Credit RiskG mitigant) expressed in years; and
        (c) T = min (5, residual maturity of the ExposureG ) expressed in years.
        (2) For residual maturity of the ExposureG in the case of a basket of ExposuresG with different maturities, an Authorised FirmG must use the longest maturity of any of the ExposuresG as the maturity of all the ExposuresG being hedged.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.16 Guidance

          The positive incentive for an Authorised FirmG to call the transaction before contractual maturity as referred in PIB Rule 4.13.15 would be, for example, a situation wherein there is a step-up in cost in conjunction with a call feature or where the effective cost of cover remains the same even if credit quality remains the same or increases.

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • On-balance Sheet Netting

      • PIB 4.13.17

        (1) An Authorised FirmG may recognise as eligible the NettingG of an on-balance sheet ExposureG against an offsetting on-balance sheet item if the related NettingG agreement meets the condition in PIB Rule 4.13.19.
        (2) Eligibility for NettingG is limited to reciprocal cash balances between the Authorised FirmG and its CounterpartyG . Only loans and deposits of the Authorised FirmG may be subject to a modification of their Credit RWAsG as a result of an on-balance sheet NettingG agreement.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.18

        (1) Assets (loans) and liabilities (deposits) subject to recognised on-balance sheet NettingG are to be treated as cash CollateralG using the formula in PIB A4.3.6, under which an Authorised FirmG may use zero haircuts for ExposureG and CollateralG .
        (2) When a currency mismatch exists, an Authorised FirmG must apply the standard supervisory haircut of 8% for currency mismatch.
        (3) When a maturity mismatch exists between the off-setting items, an Authorised FirmG must apply the Rules PIB 4.13.14 to PIB 4.13.16 to address the maturity mismatch.
        (4) NetG credit ExposureG , after taking into account recognised NettingG , will be subject to the applicable CRW for the CounterpartyG .
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 4.13.19

        For an Authorised FirmG to recognise an on-balance sheet NettingG agreement for the purposes of PIB Rule 4.13.17, all of the following conditions must be satisfied:

        (1)
        (a) both the on-balance sheet ExposureG (asset) and the offsetting on-balance sheet item (liability) are owing between the Authorised FirmG and the same CounterpartyG ;
        (b) the Authorised FirmG nets the on-balance sheet ExposureG (asset) and the offsetting on-balance sheet item (liability) in a way that is consistent with its legal rights against the CounterpartyG ;
        (c) a legal right of set-off exists;
        (d) the agreement between the Authorised FirmG and the CounterpartyG does not contain a Walkaway ClauseG ;
        (e) the NettingG provided for in the agreement between the Authorised FirmG and the CounterpartyG is effective and enforceable in the event of default, bankruptcy, liquidation or other similar circumstances affecting either the CounterpartyG or the Authorised FirmG ;
        (f) the on-balance sheet ExposureG (asset) and the offsetting on-balance sheet item (liability) are monitored, controlled and managed on a net basis; and
        (g) the potential for roll-off ExposureG is monitored and controlled where there is a maturity mismatch; and
        (2) it has, in respect of each relevant jurisdiction, a written and reasoned legal opinion which:
        (a) has been provided by an external source of legal advice of appropriate professional standing;
        (b) confirms that the requirements of (1)(a)-(e) are met for all relevant jurisdictions; and
        (c) is kept under review to ensure that it remains correct and up to date in the event of changes to the relevant laws.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 4.13.19 Guidance

          1. An Authorised FirmG should assess whether any qualifications, assumptions or reservations contained in the legal opinion cast doubt upon the enforceability of the NettingG agreement. If, as a result of the qualifications, assumptions or reservations, there is material doubt about the enforceability of the agreement, the Authorised FirmG should assume that the requirements for NettingG have not been met.
          2. An Authorised FirmG using a standard form NettingG agreement and a supporting legal opinion should ensure that the relevant requirements in Rules PIB 4.13.17 to PIB 4.13.19 are met. A standard form NettingG agreement is a form of agreement which is prepared by a reputable, internationally recognised industry association and is supported by its own legal opinion. Where additional clauses are added to a standard form NettingG agreement, the Authorised FirmG should satisfy itself that the amended NettingG agreement continues to meet the legal and contractual requirements in Rules PIB 4.13.17 to PIB 4.13.19. For instance, in such cases, an Authorised FirmG may wish to obtain a second legal opinion to confirm that the relevant requirements in Rules PIB 4.13.17 to PIB 4.13.19 are still satisfied.
          3. PIB App4 sets out the calculation of the PFCE arising from OTC derivative contracts, on a net basis.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]