Annex 16 Methods and conditions for reflecting the effects of credit risk mitigation techniques I. Definition of terms For the purposes of this Annex, the core market participant shall mean a) a central government or a central bank externally rated by an eligible rating agency or export credit agency, if these entities are assigned a rating corresponding to the fourth (or better) credit quality step for exposures to central governments and central banks under the Standardised Approach. For these purposes, a similar approach is applied to 1. regional governments and local authorities, exposures to which are treated as exposures to the central government in the same jurisdiction, 2. public sector entities which are treated as exposures to central governments under the Standardised Approach, 3. multilateral development banks eligible for a 0% risk weight under the Standardised Approach, or 4. international organizations eligible for a 0% risk weight under the Standardised Approach, or b) an institution, c) an insurance company or other financial institution eligible for a 20% risk weight under the Standardised Approach or, in the case of credit institutions applying the IRB Approach, a financial institution which does not have an external rating by an eligible rating agency, but it is internally rated as having a PD value equivalent to that associated with the external rating by an eligible rating agency determined by the competent authority to be associated with the second credit quality step or better under the rules of risk weighting of corporate exposures under the IRB Approach. d) a regulated collective investment undertaking that is subject to supervision and to capital or leverage requirements; e) a regulated pension fund that is subject to supervision, or f) a recognised clearing organization. II. Methods and conditions for reflecting the effects of funded credit protection The choice of the method of reflecting the effects of funded credit protection and related conditions depend on whether the funded credit protection is in the form of 1. netting, 2. financial collateral, 3. real estate, 4. receivables, 5. movables assets, or 6. leased property.
1. On-balance sheet netting In the case of an on-balance sheet netting agreement, the creditor treats the loans and the deposits that are subject to netting as cash collateral and uses the methods set out for financial collateral. 2. Master netting agreement a) In the case of a master netting agreement, under both the Standardised Approach and the IRB Approach the following methods may be used: 1. Financial Collateral Comprehensive Method or 2. Internal Models Approach, subject to the fulfilment of all conditions associated with each of the methods. b) If the Financial Collateral Comprehensive Method is used, the fully adjusted exposure value (E*) is calculated using the supervisory volatility adjustments pursuant to Tables 1 to 4 in this Annex or own estimates of volatility adjustments; provisions on the determination of volatility adjustments applied to financial collateral shall apply accordingly. The method of calculating the fully adjusted exposure value (E*) is as follows: 1. the net position in each type of security or commodity is calculated; the total value of securities or commodities of the relevant type borrowed, purchased or received under the master netting agreement is subtracted from the total value of securities or commodities of the relevant type lent, sold or provided pursuant under the master netting agreement. For these purposes, a type of securities shall mean securities issued by the same person, with the same issue date, the same maturity and the same period, to which the same rights and obligations are attached; 2. the net position in each currency is calculated, except for the settlement currency of the master netting agreement; the total value of securities denominated in each currency borrowed, purchased or received under the master netting agreement, increased by the amount of cash in the relevant currency borrowed or received under the agreement, is subtracted from the total value of securities in each currency lent, sold or provided under the master netting agreement, increased by the amount of cash in the relevant currency lent or transferred under this agreement, 3. the absolute value of a positive or negative net position in each type of securities or commodities is calculated and adjusted to reflect the appropriate volatility adjustment. The absolute value of the net position in each currency is calculated, except where the currency is the settlement currency pursuant to the master netting agreement, and adjusted to reflect the appropriate volatility adjustment for currency mismatch; 4. the fully adjusted exposure value (E*) with the use of the Financial Collateral Comprehensive Method is calculated using the formula
where: E* denotes the fully adjusted exposure value, E C E s H s E fx H fx denotes the exposure value as it would be determined under the Standardised Approach or the IRB Approach regardless of the existing exposure protection, denotes the value of the collateral received, denotes the absolute value of the net position in a given security or commodity, denotes the volatility adjustment appropriate to Es, denotes the absolute value of the net position in a currency different from the settlement currency pursuant to the master netting agreement, denotes the volatility adjustment appropriate to the currency mismatch between the exposure and the collateral. c) The Internal Models Approach (VaR models) may be used for the calculation of the fully adjusted exposure value (E*) resulting from the application of the master netting agreement covering transactions other than derivative transactions. This method takes into account the effects of correlation between security positions covered by the master netting agreement as well as the liquidity of the instruments concerned. The internal models used in this method provide estimates of the potential change in the value of the unsecured exposure amount (SumE - SumC). d) The use of the Internal Models Approach is subject to the following conditions: 1. The Internal Models Approach may be used for the calculation of risk-weighted exposure amounts in both the Standardised Approach and the IRB Approach. If the liable entity decides to use this method, it must do so for all counterparties and all securities, excluding immaterial portfolios where the liable entity may use the Financial Collateral Comprehensive Method with the supervisory volatility adjustments or with own estimates of volatility adjustments, 2. the Internal Models Approach is available to the liable entity that has received recognition for the use of internal models for the calculation of capital requirements for credit or market risks in the trading portfolio; 3. the liable entity that has not received supervisory recognition for use of such internal models for the calculation of capital requirements for credit or market risks in the trading portfolio may apply to the relevant competent authority for recognition of the model for the purpose of calculating the fully adjusted exposure value (E*) resulting from the application of the master netting agreement using the Internal Models Approach. At the same time, the liable entity is able to demonstrate that its risk management system for managing the risks arising from the transactions covered by the master netting agreement is conceptually sound and implemented with integrity. The liable entity is also able to demonstrate that the requirements on VaR models for the calculation of capital requirements for the market risk in the trading portfolio are satisfied; 4. a 5-day period is assigned to securities repurchase transactions or to securities lending and borrowing transactions, a 10-day period is assigned to other transactions; if this period is not adequate due to the
liquidity of the relevant instrument, the minimum time will be extended, 5. internal models may be used for margin lending transactions as well, if these are covered by a bilateral master netting agreement meeting the conditions for the calculation of the exposure amount with counterparty credit risk, and the relevant competent authority has approved their use, 6. when the Internal Models Approach is used, the fully adjusted exposure value (E*) is calculated using the formula where: E* denotes the fully adjusted exposure value, E - C E C VaR denotes the unsecured exposure value, denotes the exposure value as would be determined under the Standardised Approach or the IRB Approach in the absence of credit risk protection, denotes the value of the securities borrowed, purchased or received securities or the cash borrowed or received in respect of each such exposure, denotes the previous business day s model output. e) In the case of exposures from repurchase transactions, securities or commodities lending or borrowing transactions and/or margin lending transactions covered by the master netting agreements, the fully adjusted exposure amount (E*) replaces the exposure value (E). 3. Financial collateral a) In the case of financial collateral, within 1. the Standardised Approach either the Financial Collateral Simple Method or the Financial Collateral Comprehensive Method may be used. It is not possible to use the Financial Collateral Simple Method and the Financial Collateral Comprehensive Method simultaneously, unless the liable entity does so for the purpose of Article 92, 1 and 2. The liable entity shall demonstrate to the Czech National Bank that this extraordinary use of both methods is not used selectively with the aim of reducing minimum capital requirements, and does not cause a circumvention of prudential rules; 2. the IRB Approach the Financial Collateral Comprehensive Method may be used. b) Cash, securities or commodities purchased, borrowed or received within repurchase transactions or securities or commodities lending or borrowing transactions and/or margin lending transactions are treated as financial collateral. c) Under the Financial Collateral Simple Method, the value of eligible financial collateral equals its market value as determined according to the eligibility requirements for financial collateral. If the Financial Collateral Simple Method is used in the determination of the risk weight of an exposure or a part of this exposure
corresponding to the market value of the eligible financial collateral (hereinafter the collateralised part of the exposure ), the following procedure is applied: 1. The collateralised part of the value of the exposure may be assigned a 0% risk weight, if it is 1.1 a collateralised part of the exposure arising from repurchase transactions or loans or securities lending or borrowing transactions meeting the conditions for the use of a 0% volatility adjustment. If the counterparty in such a transaction is not a core market participant, the risk weight of the collateralised part of the exposure is at least 10%; 1.2 a collateralised part of the exposure arising from OTC derivative transactions that are subject to daily marking-to-market, collateralised by a cash collateral and where there is no currency mismatch. If they are collateralised by debt securities issued by central governments or central banks which are assigned a 0% risk weight under the Standardised Approach, the risk weight of at least 10% is assigned to the extent of the collateralisation of the exposure value. For these purposes, debt securities issued by the following entities may be treated accordingly: 1.2.1. regional governments or local authorities exposures to which are treated as exposures to the central government in the same jurisdiction under the Standardised Approach, 1.2.2 multilateral development banks to which a 0% risk weight is assigned under the Standardised Approach, or 1.2.3 international organizations to which a 0% risk weight is assigned under the Standardised Approach, 1.3 transactions where the exposure and the financial collateral are denominated in the same currency and, at the same time, the financial collateral is in the form of either cash collateral or debt securities issued by central governments or central banks eligible for a 0% risk weight under the Standardised Approach. For the purpose of determining the secured part of the exposure, the market value of such securities is discounted by 20%. For these purposes, debt securities issued by the following entities may be treated accordingly: 1.3.1 regional governments or local authorities exposures to which are treated as exposures to the central government in the same jurisdiction under the Standardised Approach, 1.3.2 multilateral development banks to which a 0% risk weight is assigned under the Standardised Approach, or 1.3.3 international organizations to which a 0% risk weight is assigned under the Standardised Approach. 2. In all other cases the secured part of the exposure value is assigned the risk weight that would be assigned under the Standardised Approach to a direct exposure to the collateral instrument, but always at least 20%. 3. The remainder of the exposure value is assigned the risk weight that would be assigned to an unsecured exposure to the given counterparty under the Standardised Approach. 4. For these purposes, the exposure value of an off-balance item under Annex 6 to this Decree means 100% of its value rather than the value of the exposure under Article 87, 3. d) If the Financial Collateral Comprehensive Method is used, the fully adjusted exposure value (E*) is determined using the supervisory volatility adjustments pursuant to
Tables 1 to 4 in this Annex or volatility adjustments based on own estimates. The following method of calculating the fully adjusted exposure value (E*) is used: 1. The market value of the financial collateral is adjusted using volatility adjustments to reflect price volatility and currency volatility. Where the financial collateral is not denominated in the same currency as the exposure, an adjustment reflecting the currency mismatch is applied. In the case of OTC derivative transactions covered by a recognised master netting agreement, a volatility adjustment reflecting the currency mismatch is used, if the financial collateral is denominated in a currency different from the settlement currency of the OTC derivative transactions. If the OTC derivative transactions covered by a recognised master netting agreement are denominated in different currencies, only a single volatility adjustment for the currency mismatch is applied. 2. In the case of transactions covered by a recognised master netting agreement, the fully adjusted exposure value (E*) is calculated using the formulae set out in the paragraphs regarding the master netting agreement. 3. In the case of all other transactions, the fully adjusted exposure value (E*) is calculated using the following formulae: where: C va denotes the market value of the financial collateral adjusted to reflect the price volatility and the currency volatility, C H c H fx denotes the market value of the financial collateral, denotes the volatility adjustments appropriate to the price volatility of the financial collateral, denotes the volatility adjustment appropriate to the currency mismatch between the exposure and the collateral. where: E va denotes the volatility-adjusted exposure value; in the case of OTC derivative transactions, E va = E; E H e denotes the exposure value as it would be determined under the Standardised Approach or the IRB Approach regardless of the existing protection of the exposure; in the case of off-balance sheet items pursuant to Annex 6 to this Decree or pursuant to Annex 13, IV.1, k to this Decree, the exposure value for these purposes corresponds to their book value minus any provisions multiplied by a conversion factor of 100%; denotes the volatility adjustment appropriate to the exposure,
where: E* denotes the fully adjusted exposure value, E va C vam denotes the volatility-adjusted exposure value; in the case o OTC derivative transactions, E va = E; denotes the market value of the financial collateral adjusted to reflect the price volatility and the currency volatility (C va ), further adjusted according to the maturity mismatch formula. e) When using the Standardised Approach, the fully adjusted exposure value (E*) replaces the exposure amount (E). In the case of off-balance sheet items pursuant to Annex 6 of the Decree, the fully adjusted exposure value (E*) is multiplied by a conversion factor. f) When using the IRB Approach without the internal estimates of the LGD value or the conversion factors, the effective loss given default (LGD*) is calculated to replace the LGD value for exposures with eligible financial collateral. The effective loss given default (LGD*) is calculated using the formula where: LGD* denotes the effective loss given default, LGD denotes the loss given default for an unsecured exposure pursuant to Annex 13 to this Decree, E* denotes the fully adjusted exposure value, E denotes the exposure value. g) Both in the case of the Standardised Approach and the IRB Approach, volatility adjustments may be calculated using the supervisory volatility adjustments or own estimates of volatility adjustments. If the liable entity decides to use own estimates of volatility adjustments, it must do so for the full range of instrument types, excluding immaterial portfolios where the supervisory volatility adjustments may be used. h) Supervisory volatility adjustments are set out in Tables 1 to 4 in this Annex. Daily revaluation of the financial collateral is a prerequisite for their use. The following principles apply when using the supervisory volatility adjustments: 1. the period is assigned as follows: 1.1 5-day for repurchase transactions and securities lending or borrowing transactions, except for repurchase transactions involving the transfer of commodities or rights to commodities, where a 20-day period is assigned, 1.2 20-day for collateralised lending transactions, 1.3 10-day for margin lending transactions; 2. the credit quality step with which the external rating of the relevant debt security is associated corresponds to the credit quality step under the Standardised Approach. Should the securities have more than one external rating, the relevant financial collateral provisions set out in Annex 15 to this Decree will be used;
3. for non-eligible securities or commodities lent or sold under repurchase transactions or securities or commodities lending or borrowing transactions, the volatility adjustment is the same as for non-main index equities listed on a recognised stock exchange, 4. for eligible units in collective investment undertakings the volatility adjustment is the weighted average volatility adjustment that would apply, having regard to the period as specified in Annex 16, II., 3., h), 1., to the assets in which the fund has invested. If the assets in which the collective investment undertaking has invested are not known to the liable entity, the volatility adjustment is the highest volatility adjustment that would apply to any of the assets in which the relevant collective investment undertaking has the right to invest; 5. for eligible debt securities unrated by an eligible rating agency issued by institutions, the volatility adjustment is the same as for debt securities issued by institutions or corporate debt securities with an external rating corresponding to the second or the third credit quality step, 6. volatility adjustments for debt securities issued by central governments or central banks specified in Tables 1 and 2 in this Annex are used for debt securities issued by central governments or central banks, if such securities have a rating by an eligible rating agency or export credit agency corresponding to the fourth (or better) credit quality step for exposures to central governments and central banks under the Standardised Approach. For these purposes, debt securities issued by the following entities may be treated accordingly: 6.1 regional governments or local authorities exposures to which are treated as exposures to central governments in the same jurisdiction under the Standardised Approach, 6.2 multilateral development banks to which a 0% risk weight is assigned under the Standardised Approach, or 6.3 international organizations to which a 0% risk weight is assigned under the Standardised Approach; 7. volatility adjustments for debt securities issued by institutions or other persons specified in Tables 1 and 2 in this Annex are used for debt securities issued by institutions, if such securities have a rating by an eligible rating agency or export credit agency corresponding to the third (or better) credit quality step for exposures to institutions under the Standardised Approach. For these purposes, debt securities issued by the following entities may be treated accordingly: 7.1 regional governments and local authorities other than those exposures to which are treated as exposures to the central government in the same jurisdiction under the Standardised Approach, 7.2 public sector entities exposures to which are treated as exposures to institutions under the Standardised Approach, 7.3 multilateral development banks other than those to which a 0%risk weight is assigned under the Standardised Approach, or 7.4 other persons, if such securities have a rating by an eligible rating agency corresponding to the third (or better) credit quality step for corporate exposures under the Standardised Approach; Table 1
Credit quality step with which the external rating of the relevant debt security is associated Residual Maturity Volatility adjustments for debt securities issued by central governments or central banks 20-day period 10-day period 5-day period Volatility adjustments for debt securities issued by institutions or other persons 20-day period 10-day period 5-day period 1 1 year 0,707 0,5 0,354 1,414 1 0,707 >1 5 2,828 2 1,414 5,657 4 2,828 years > 5 years 5,657 4 2,828 11,314 8 5,657 2-3 1 year 1,414 1 0,707 2,828 2 1,414 >1 5 4,243 3 2,121 8,485 6 4,243 years > 5 years 8,485 6 4,243 16,971 12 8,485 4 1 year 21,213 15 10,607 - - >1 5 21,213 15 10,607 - - years > 5 years 21,213 15 10,607 - - Credit quality step with which the external rating of the relevant short term debt security is associated Volatility adjustments for debt securities issued by central governments or central banks with short-term external ratings 20-day period 10-day period 5-day period Table 2 Volatility adjustments for debt securities issued by institutions or other persons with short-term external ratings 20-day period 10-day period 5-day period 1 0,707 0,5 0,354 1,414 1 0,707 2-3 1,414 1 0,707 2,828 2 1,414 Table 3 Volatility adjustments for other forms of financial collateral or exposure types Equities and convertible bonds included in the main index of a recognised stock exchange Other equities or convertible bonds listed on a recognised stock exchange but not included in the main index 20-day period 10-day period 5-day period 21,213 15 10,607 35,355 25 17,678 Cash collateral 0 0 0 Gold 21,213 15 10,607 Table 4
Volatility adjustments for currency mismatch 20-day period 11,314 10-day period 5-day period 8 5,657 i) The liable entity may use own volatility estimates for calculating the volatility adjustments to be applied to exposures and financial collateral, if it is able to demonstrate the fulfilment of the following conditions and the Czech National Bank has not refused their use: 1. any correlations between the unsecured exposure, financial collateral and/or foreign exchange rates are not taken into account in the estimates of volatility adjustments for financial collateral or currency mismatch, 2. volatility adjustments for financial collateral are determined for 2.1 debt securities which have an external rating by an eligible rating agency equivalent to investment grade for each category of security in a way to be representative for the securities included in the respective category. In determining relevant categories, the type of the issuer of the security, the external rating of the securities, their residual maturity and their modified duration are taken into account; 2.2 debt securities which have an external rating by an eligible rating agency equivalent to below investment grade separately for each security, or 2.3 other types of financial collateral separately for each type. 3. in calculating the volatility adjustments, a 99 th percentile one-tailed confidence interval is used, 4. the period is assigned as follows: 4.1 5-day for repurchase transactions and securities lending or borrowing transactions, except for repurchase transactions involving the transfer of commodities or rights to commodities, where a 20-day period is assigned, 4.2 20-day for collateralised lending transactions, 4.3 10-day for margin lending transactions; 5. if the period for a given transaction type used for determining an estimated volatility adjustment is other than 5, 10 or 20 days, the volatility adjustment is scaled up or down using the square root of time formula: where: H m denotes the volatility adjustment for the period T m for the relevant transaction type, H n denotes the own estimate of the volatility adjustment based on the period T n,
T m T n denotes the specific minimum period for the relevant transaction type (5, 10, or 20 days), denotes the period used for the estimate of volatility adjustment H n, 6. the liable entity takes into account the fact that lower-quality financial collateral tends to be less liquid. If there are doubts concerning the liquidity of the financial collateral, the period used for the calculation of the volatility adjustment is extended. The liable entity identifies situations where historical data may understate potential volatility, e.g. a pegged currency. Such cases are dealt with by means of a stress scenario; 7. the historical observation period (sample period) for calculating volatility adjustments is at least one year. If weighting schemes or other historical observation period methods are used, the effective observation period is at least one year, meaning that the weighted average time lag of the individual observations is at least 6 months. The liable entity may calculate the risk amount using a shorter effective observation period, if this is justifiable, e.g. by a significant upsurge in price volatility; 8. the liable entity updates its data sets and determines volatility adjustments at least once in every 3 months and whenever market prices are subject to material changes, 9. the liable entity uses the volatility estimates in the day-to-day risk management process, including in relation to the internal exposure limits, 10. the liable entity shall have established procedures for monitoring and ensuring compliance with a documented set of policies and controls for the operation of the system for the determination of volatility adjustments based on own estimates and for the integration of these estimates into the risk management process, 11. the internal audit process of the liable entity includes a regular independent review of the system for the determination of volatility adjustments based on own estimates. A review of the overall system for the determination of volatility adjustments based on own estimates and for the integration of these estimates into the risk management process takes place at least once a year and specifically addresses, at a minimum: 11.1 the integration of own estimates of volatility adjustments into the daily risk management, 11.2 the validation of any significant changes in the process of estimation of volatility adjustments, 11.3 the verification of the consistency, integrity, timeliness and reliability of the data sources used to run the system for the determination of volatility adjustments based on own estimates, including the independence of such data sources, 11.4 the accuracy and appropriateness of the volatility assumptions used when estimating the volatility adjustments. j) Supervisory volatility adjustments are used in the case of daily revaluation. Similarly, own estimates are calculated on the basis of daily revaluation. If, however, the frequency of revaluation is less than daily, the volatility adjustments based on daily revaluation are scaled up depending on the actual revaluation frequency using the square root of time formula:
where: H denotes the volatility adjustment to be applied for the given revaluation, H m denotes the volatility adjustment applicable in the case of daily revaluation, N r denotes the actual number of business days between the revaluations, T m denotes the specific minimum period for the relevant transaction type (5, 10, or 20 days). k) If the Financial Collateral Comprehensive Method using the supervisory volatility adjustments or volatility adjustments based on own estimates is used, a 0% volatility adjustment may be used for repurchase transactions or securities lending or borrowing transactions, provided that the following conditions are satisfied: 1. both the exposure and the collateral are cash collateral or debt securities issued by central governments or central banks, if such securities have a rating by an eligible rating agency or export credit agency corresponding to the fourth (or better) credit quality step for exposures to central governments and central banks under the Standardised Approach. For these purposes, debt securities issued by the following entities may be treated accordingly: 1.1 regional governments or local authorities exposures to which are treated as exposures to the central government in the same jurisdiction under the Standardised Approach, 1.2 multilateral development banks to which a 0% risk weight is assigned under the Standardised Approach, or 1.3 international organizations to which a 0% risk weight is assigned under the Standardised Approach, or 2. both the exposure and the collateral are denominated in the same currency, 3. either the original maturity of the transaction is no more than one day or both the exposure and the financial collateral are subject to daily marking-to-market or daily remargining, 4. if the obligor fails to remargin, the time between the last marking-to-market or remargining and the of the financial collateral can be expected to be no more than 4 business days, 5. the transaction is settled across a settlement system proven for that type of transactions, 6. the documentation covering the agreement is standard market documentation for repurchase transactions or securities lending or borrowing transactions, 7. the transaction is governed by documentation specifying that if the counterparty fails to meet an obligation to deliver cash or securities or to deliver the margin or otherwise defaults, then the transaction is immediately terminable, 8. the counterparty in the transaction is a core market participant. l) In the case of master netting agreements, similar conditions apply, except for the liable entity which uses the Internal Models Approach.
4. Real estates, receivables, movable assets and leased property a) The eligible real estates, including leased real estate property, are subject to the following conditions regarding the value to be taken into account: 1. the property is valued by an independent valuer, 2. the value of the real estate determined by an independent valuer does not exceed the market value; the market value is the estimated amount for which the real estate could be transferred on the date of the valuation between a willing buyer and a willing seller in an arm's length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion. The market value is documented in a transparent and clear manner; 3. if the independent valuer determines the real estate value, in particular for the purposes of mortgage bonds, the real estate value is not higher than the mortgage lending value 28). The mortgage lending value is documented in a transparent and clear manner; 4. the value of the collateral is the market value or the mortgage lending value of the pledged real estate reduced as appropriate to reflect the eligibility requirements for real estates and to take account of any prior claims on the property. b) The value of receivables is the amount that is not higher than the market value. c) The eligible movable assets may be recognised in the amount that is not higher than the market value. d) When using the IRB Approach without internal estimates of the LGD value or the conversion factors, the effective loss given default (LGD*) is applied for exposures with eligible collateral in the form of real estate, receivables or movable assets. The use of the effective loss given default (LGD*) is subject to the following conditions: 1. where the ratio of the value of the collateral (C) to the value of the exposure (E) is below the minimum required collateralisation level (the bottom threshold level, C*) pursuant to Table 5, the exposure is deemed to be unsecured; for this purpose, the value of an exposure (E) is determined by the use of a conversion factor of 100% instead of the conversion factors listed in Annex 13, IV.1, k to this Decree; 2. where the ratio of the value of the collateral (C) to the value of the exposure (E) is higher or equal to the upper threshold level (C**), the exposure is deemed to be secured. The effective loss given default (LGD*) pursuant to Table 5 in this Annex replaces the LGD value; 3. where the ratio of the value of the collateral (C) to the value of the exposure (E) is higher than or equal to the bottom threshold level (C*) and lower than the upper threshold level (C**), the exposure is divided in two parts, a secured part and an unsecured part. The value of the secured part of the exposure is calculated to keep the ratio of the value of the collateral (C) to the value of the secured part of the exposure higher than or equal to the upper threshold level (C**). The value of the unsecured part of the exposure corresponds to the difference between the value of the exposure (E) and the value of the secured part of the exposure. The effective loss given default (LGD*) pursuant to Table 5 in this Annex replaces the LGD value for the secured part of the exposure. For the unsecured part of the exposure, the effective loss given default (LGD*) does not replace the LGD value; 28) Article 29 of Act on Bonds and Debentures
for subordinated exposures LGD* for other than subordinated exposures Table 5 Threshold value bottom (C*) upper (C**) Receivables 65 % 35 % 0 % 125 % Real estate 65 % 35 % 30 % 140 % Movable assets 70 % 40 % 30 % 140 % 4. if a territory of another Member State is demonstrably well-developed and longestablished with sufficiently low loss-rates and the competent authority makes it possible to apply a 50% risk weight to the specified part of the exposure secured by a real estate located within its territory instead of the effective loss given default (LGD*), the liable entities in the Czech Republic may apply such a risk weight to exposures secured by real estates located within the territory of the relevant Member State under the same conditions as those applied in the respective Member State. III. Methods and conditions for reflecting the effects of unfunded credit protection a) The methods for reflecting the effects of unfunded credit protection and the related conditions depend on whether the unfunded credit protection is in the form of a guarantee, credit derivative or another form of unfunded credit protection. b) The value of the guarantee or the credit derivative (G) is the amount that the unfunded credit protection provider has undertaken to pay in the event of obligor default or if another stipulated credit event occurs. 1. Guarantees a) If the guarantee and the exposure are not denominated in the same currency (a currency mismatch), the value of the guarantee (G) is reduced by the application of volatility adjustments for currency mismatch, namely the supervisory volatility adjustments pursuant to Table 4 in this Annex or own estimates of volatility adjustments, identically as in the case of financial collateral. The value of the guarantee adjusted to reflect the currency mismatch (G*) is calculated using the following formula: where: G* G H fx denotes the value of the guarantee (G) adjusted for the currency mismatch, denotes the nominal amount of the unfunded credit protection, denotes the volatility adjustment for the currency mismatch determined for a 10-day period.
b) If the period used for determining the own estimate of a volatility adjustment is other than 10 days, the volatility adjustment is scaled up or down for the period of 10 days using the square root of time formula, identically as in the case of financial collateral. c) If the frequency of revaluation due to foreign exchange rate fluctuations is less than daily, the volatility adjustments are scaled up depending on the actual revaluation frequency using the square root of time formula, identically as in the case of financial collateral. d) If the guarantee and the exposure are denominated in the same currency, the value of the guarantee adjusted for the currency mismatch (G*) equals the value of the guarantee (G). 2. Credit derivatives a) In the case of a credit derivative which does not include as a credit event restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that result in a credit loss event, particularly in the case of a value adjustment reflected in the income statement, the value of the credit derivative (G) is reduced 1. by 40%, if the value of the credit derivative (G) is not higher than the value of the exposure, 2. to the amount corresponding to 60% of the exposure value, if the value of the credit derivative (G) is higher than the value of the exposure. b) If the credit derivative and the exposure are not denominated in the same currency (a currency mismatch), the value of the credit derivative (G) is reduced by the application of a volatility adjustment for the currency mismatch, identically as in the case of guarantees. 3. Other unfunded credit protection a) Eligible cash collateral held by a third party institution and instruments issued by a third party institution which will be repurchased by that institution on request are treated as a guarantee by the third institution. b) In the case of cash collateral held by a third party institution, the calculation of effects and associated conditions pursuant to the provisions for guarantees apply. c) In the case of instruments issued by a third party institution which will be repurchased by that institution on request, the value of the protection is determined as follows: 1. where the instrument will be repurchased at its face value, the value of the protection is that amount, 2. where the instrument will be repurchased at the market price, the value of the protection is the value of the instrument valued in the same way as debt securities without external rating by an eligible rating agency issued by institutions, provided that 2.1 they are listed on a recognised stock exchange,
2.2 they qualify as senior debt, 2.3 all the other issues of debt securities of the same seniority (pari passu) issued by the issuing institution have a rating assigned by an eligible rating agency corresponding to the third (or better) credit quality step for institutions or for short-term exposures to institutions and short-term corporate exposures under the Standardised Approach; 2.4 the creditor has no information according to which the issue would justify a less favourable rating than that indicated above, and 2.5 the liable entity is able to demonstrate that the liquidity of such securities is sufficient for the purposes of credit risk mitigation; d) If the conditions stipulated in Annex 15 to this Decree are met, the value of an exposure collateralised by life insurance is determined as follows: 1. If the Standardised Approach provisions apply to the exposure, the risk weights set out in paragraph III.5 shall be used; 2. If provisions for the IRB Approach apply to the exposure, but own LGD estimates are not used, an LGD of 40% shall be assigned to the exposure. e) In the event of a currency mismatch, the value of life insurance equal to the surrender value shall be reduced according to the rules for the treatment of collateral currency mismatches. 4. Methods for reflecting the effects of unfunded credit protection a) When a part of the risk is transferred in one or more tranches, the provisions for securitisation apply. Materiality thresholds on payments below which no payment shall be made in the event of loss are considered to be equivalent to retained first loss positions and to give rise to a tranched transfer of risk. b) If the Standardised Approach is used, an exposure which is fully covered by unfunded credit protection is assigned the risk weight of the protection provider. The exposure amount (E), which, for this purpose, shall mean the exposure value under Article 87, is replaced by the value of the guarantee or the credit derivative (G) adjusted for any currency mismatch and maturity mismatch; in the event of off-balance items under Annex 6 to this Decree, the value of exposure (E) shall, for this purpose, correspond to 100% of its book value minus any provisions, rather than the value under Article 87, 3. The risk-weighted exposure amount fully covered by unfunded credit protection is calculated using the following formula: The risk-weighted exposure fully covered by unfunded credit protection = g G a, where: g denotes the risk weight of the protection provider, G a denotes the exposure amount fully covered by unfunded credit protection adjusted for currency mismatch (G*) and further adjusted according to the formula for maturity mismatch. c) If the Standardised Approach is used and the exposure is only partially covered by unfunded credit protection, the effects of the unfunded credit protection may be taken into account if the secured and unsecured parts of the exposure are of equal seniority (pari passu). The risk-weighted exposure amount partly covered by unfunded credit protection is calculated using the following formula:
The risk-weighted exposure partly covered by unfunded credit protection = r (E - G a ) + g G a, where: r denotes the risk weight of the exposure to the obligor, E denotes the exposure value under Article 87; in the event of off-balance items under Annex 6 to this Decree, the value of exposure (E) shall, for this purpose, correspond to 100% of its book value minus any provisions, rather than the value under Article 87, 3 G a g denotes the part of the exposure amount fully covered by unfunded credit protection adjusted for currency mismatch (G*) and further adjusted according to the formula for maturity mismatch, denotes the risk weight of the protection provider. d) If the Standardised Approach is used, the exposure or parts of the exposure guaranteed by a central government or a central bank and with a preferential risk weight pursuant to Annex 4, (e)(1) and (f) in the class of exposures to central governments and central banks applied may be assigned this risk weight, provided that the guarantee is denominated in the domestic currency of the obligor and the exposure is funded in that currency. e) If the IRB Approach is used, the PD value of the obligor may be replaced by the PD value of the protection provider or a PD value lower than the PD value of the obligor but higher than that of the protection provider for the secured exposure value or the secured part of the exposure value based on the adjusted protection value denoted as G a, if a full substitution is deemed not to be warranted. In the case of subordinated exposures and non-subordinated unfunded credit exposure, the LGD values for exposures that are not subordinated may be used. For the unsecured part of the exposure value the PD value of the obligor and the LGD value for the underlying exposure are used. The exposure amount fully covered by unfunded credit protection adjusted for any currency and maturity mismatch (G a ) is calculated using the formulae for the value of the guarantee or credit derivative adjusted for currency mismatch (G*) and further adjusted for maturity mismatch. In the case of off-balance items under Annex 13, IV.1, k to this Decree, the value of an exposure shall, for these purposes, correspond to its book value minus any provisions, multiplied by a conversion factor of 100%. 5. Taking Life Insurance Into Account The following risk weights shall be used for establishing the exposure value: a) 20%, if the unsecured priority exposure to the insurer is assigned a risk weight of 20%; b) 35%, if the unsecured priority exposure to the insurer is assigned a risk weight of 50%; c) 70%, if the unsecured priority exposure to the insurer is assigned a risk weight of 100%; d) 150%, if the unsecured priority exposure to the insurer is assigned a risk weight of 150%.
IV. Consequences of maturity mismatch a) Where there is a maturity mismatch, the credit risk mitigation technique is not taken into account if 1. the original maturity of the protection is less than 1 year, 2. the secured exposure is a short-term one with the remaining maturity of up to 1 year and the maturity (M) of at least 1 day, 3. the remaining maturity of the protection is shorter than 3 months and, at the same time, shorter than the maturity of the secured exposure, or 4. the Financial Collateral Simple Method is used and a mismatch between the maturity of the secured exposure and the maturity of the protection occurs. b) Depending on whether the funded credit protection or unfunded credit protection is concerned, adjustments as a result of the maturity mismatch are calculated as follows: 1. in the case of funded credit protection, the maturity of the protection and that of the exposure are reflected in the adjusted value of the protection according to the following formula: where: C vam denotes the market value of the financial collateral adjusted for the price volatility and the currency volatility (C va ) and further adjusted according to the formula applicable to the maturity mismatch, C va t denotes the market value of the financial collateral adjusted for the price volatility and the currency volatility, or the exposure value, whichever is the lower, denotes the number of years remaining to the maturity of the collateral calculated according to the provisions for maturity, or the T value, whichever is the lower, T denotes the number of years remaining to the maturity of the exposure, or 5 years, if more than 5 years remain. 2. In the case of unfunded credit protection, the maturity of the protection and that of the exposure are reflected in the adjusted value of the protection according to the following formula: where: G a denotes the value of exposure secured by the unfunded credit protection adjusted for the currency mismatch and further adjusted according to the formula applicable to the maturity mismatch, G* denotes the value of the unfunded credit protection adjusted for the currency mismatch,
t denotes the number of years remaining to the maturity of the protection calculated according to the provisions for maturity, or the T value, whichever is the lower, T denotes the number of years remaining to the maturity of the exposure, or 5 years, if more than 5 years remain. V. Combination of credit risk mitigation techniques used a) If, when using the Standardised Approach, the liable entity has more than one form of funded credit protection or unfunded credit protection covering a single exposure, the exposure is divided into parts such that each part is covered by only one type of the protection. The risk-weighted exposure amount for each part is calculated separately. b) If, when using the IRB Approach, the liable entity has more than one form of funded credit protection or unfunded credit protection covering a single exposure, the exposure is divided into parts such that each part is covered by only one type of the protection. The LGD value for each part is calculated separately. Using the effective loss given default (LGD*) is subject to the following conditions: 1. the exposure value adjusted for volatility (E va ) calculated according to the provisions for financial collateral is divided into parts such that each part is covered by only one type of the eligible protection. For each part, the fully adjusted exposure value is calculated (E* covered by financial collateral, E* secured by real estate, E* secured by a receivable, E* secured by movable assets or E* without any eligible protection). If the liable entity makes internal assessments of the LGD value and reflects the unfunded credit protection in LGD, an identical procedure is used in the case of unfunded credit protection as well; 2. for the fully adjusted exposure values (E*), which are related to the individual parts of the exposure, the effective loss given defaults (LGD*) are calculated separately according to the provisions applicable to the appropriate types of protection. c) If the financial collateral consists of more eligible assets (basket of assets), the volatility adjustment is determined based on the following formula: where: H denotes the volatility adjustment for the financial collateral consisting of more eligible assets, a i denotes the share of the individual eligible asset in the basket, denotes the volatility adjustment for the individual eligible asset in the basket. H i