CRR2 - Risk weight for CIU exposures
The approach to evaluating risk weight for Collective Investment Undertaking (CIU) exposures has changed under the new CRR2 rules. There are three approaches outlined, and banks can select the specific approach based on the amount of information available about the underlying exposures of the CIUs. The three approaches are:-
1) Look through approach – where information about the underlying exposures of the CIU is available, bank can risk weight these underlying exposures as if it was a directly held by the bank [Article 132(a)(1)]
2) Mandate based approach – where the underlying exposures are not available, the exposures are risk weighted in accordance with the CIUs specific mandate. It is assumed that the CIU first incurs exposures to those that attract the highest risk weight and continues incurring exposures in descending order of risk weight. In calculating the risk weight, it is also assumed that the CIU incurs leverage to the maximum extent possible. [Article 132(a)(2)]
3) Fall-back approach – where the above two approaches cannot be applied, the exposures are risk weighted at 1250% [Article 132(2)]
Off-balance sheet and derivative exposures of the CIU should also be evaluated and risk weighted accordingly. For derivative exposures, if it is not possible to calculate the credit valuation adjustment, the bank can calculate the own funds requirement as 50% of own funds requirement calculated using one of the ‘Counterparty Credit Risk’ approaches. [Article 132(a)(3)]
For calculating the derivatives counterparty credit risk, if the bank does not have sufficient information, the bank can use the approach outlined below [Article 132(a)(5) - PRA]:-
where net replacement cost [Article 274(2) and 282(2)] is not known, banks can use the sum of the notional amounts
where potential future exposure [Article 274(2) and 282(2)] is not known, banks can set this as 15% of the sum of notional amounts
In order to use the look through or mandate based approaches, the following conditions have to be met [Article 132(3)]:-
CIU is a UK Undertakings Collective Investment in Transferable Securities (UCITS), eligible UK Alternative Investment Fund (AIF), or CIU managed by a company that is established and regulated in another country that is considered equivalent by HM Treasury
CIU prospectus includes the categories of assets it is authorised can invest
CIU prospectus includes, where limits apply, the relative limit and methodology to calculate it
CIU reports its exposures at least as frequently as those of the bank [for mandate-based approach this can be determined based on the investment mandate when the bank first incurs the exposure or when the CIUs investment mandate changes]
CIU reports the exposures at a granular level, allowing the bank to calculate the risk weight accordingly
CIU’s report of underlying exposures is independently verified by third-party (e.g. audited) [only for look-through approach]
Implementation timeline: As per HM Treasury, PRA and FCA join statement issued on 16 Nov 2020, CRR2 UK implementation date is targeted for 1 January 2022.