UK Regulator Launches Consultation on Eligibility of Financial Collateral Under Capital Requirements Regulation

The U.K. Prudential Regulation Authority has launched a consultation on proposed amendments to its Supervisory Statement on credit risk mitigation to clarify its expectations around the eligibility of financial collateral. The consultation paper is relevant for banks, building societies and PRA-designated U.K. investment firms that are subject to the Capital Requirements Regulation. The consultation closes on April 10, 2019.
 
The Capital Requirements Regulation sets out, amongst other things, requirements for the types of collateral eligible to be used for credit risk mitigation purposes by financial institutions. The CRR specifies that, for financial collateral, the credit quality of the obligor and the collateral itself must not have a material positive correlation. The PRA has found that, in the context of non-recourse loans, a significant devaluation of the financial collateral may trigger a default of the obligor and therefore compromise the risk mitigation of the collateral, but firms were not always applying the CRR correctly in this scenario. The PRA therefore proposes, in its consultation paper, to insert additional guidance in its Supervisory Statement on the eligibility of financial collateral where there is a correlation between the collateral value and the credit quality of the obligor. The proposed guidance includes confirmation by the PRA that any financial collateral asset whose value has a material positive correlation with the total value of all the assets to which the lender has legal recourse would meet the definition of "material positive correlation" under the CRR. It also sets out the PRA's expectation that firms will not recognise such collateral when running internal credit risk mitigation modelling processes.
 
View the PRA's Consultation Paper.
 
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