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  • — Operational Requirements for Recognition of Double Default

    • CA-5.3.35

      The double default framework is only applicable where the following conditions are met:

      (a) The risk weight that is associated with the exposure prior to the application of the framework does not already factor in any aspect of the credit protection;
      (b) The entity selling credit protection is a bank42, investment firm or insurance company (but only those that are in the business of providing credit protection, including mono-lines, re-insurers, and non-sovereign credit export agencies43), referred to as a financial firm, that:
      •   It is regulated in a manner broadly equivalent to that in this Module (where there is appropriate supervisory oversight and transparency/market discipline), or externally rated as at least investment grade by a credit rating agency deemed suitable for this purpose by CBB;
      •   Had an internal rating with a PD equivalent to or lower than that associated with an external A- rating at the time the credit protection for an exposure was first provided or for any period of time thereafter; and
      •   Has an internal rating with a PD equivalent to or lower than that associated with an external investment-grade rating.
      (c) The underlying obligation is:
      •   A corporate exposure as defined in paragraphs CA-5.2.5 to CA-5.2.15 (excluding specialised lending exposures for which the supervisory slotting criteria approach described in paragraphs CA-5.3.6 to CA-5.3.11 is being used); or
      •   A claim on a PSE that is not a sovereign exposure as defined in paragraph CA-5.2.16; or
      •   A loan extended to a small business and classified as a retail exposure as defined in paragraph CA-5.2.18.
      (d) The underlying obligor is not:
      •   A financial firm as defined in (b); or
      •   A member of the same group as the protection provider.
      (e) The credit protection meets the minimum operational requirements for such instruments as outlined in paragraphs CA-4.5.1 to CA-4.5.5;
      (f) In keeping with paragraph CA-4.5.2 for guarantees, for any recognition of double default effects for both guarantees and credit derivatives a bank must have the right and expectation to receive payment from the credit protection provider without having to take legal action in order to pursue the counterparty for payment. To the extent possible, a bank must take steps to satisfy itself that the protection provider is willing to pay promptly if a credit event should occur;
      (g) The purchased credit protection absorbs all credit losses incurred on the hedged portion of an exposure that arise due to the credit events outlined in the contract;
      (h) If the payout structure provides for physical settlement, then there must be legal certainty with respect to the deliverability of a loan, bond, or contingent liability. If a bank intends to deliver an obligation other than the underlying exposure, it must ensure that the deliverable obligation is sufficiently liquid so that the bank would have the ability to purchase it for delivery in accordance with the contract;
      (i) The terms and conditions of credit protection arrangements must be legally confirmed in writing by both the credit protection provider and the bank;
      (j) In the case of protection against dilution risk, the seller of purchased receivables must not be a member of the same group as the protection provider; and
      (k) There is no excessive correlation between the creditworthiness of a protection provider and the obligor of the underlying exposure due to their performance being dependent on common factors beyond the systematic risk factor. The bank has a process to detect such excessive correlation. An example of a situation in which such excessive correlation would arise is when a protection provider guarantees the debt of a supplier of goods or services and the supplier derives a high proportion of its income or revenue from the protection provider.

      42 This does not include PSEs and MDBs, even though claims on these may be treated as claims on banks according to paragraph CA-5.2.17.

      43By non-sovereign it is meant that credit protection in question does not benefit from any explicit sovereign counter-guarantee.

      Amended: April 2011
      Apr 08