Market updates and sector developments

The US Fed has updated its FAQs on Regulation Q to provide guidance in connection with the recognition of CLNs under the capital rule, a step that the US CRT market has been awaiting for over a year. Under the capital rule, a Fed-regulated institution can recognise the credit risk mitigation of the collateral on a reference portfolio under the rules for synthetic securitisations, provided that the requirements in section 41 or 141 are met and that the transaction satisfies the definition of ‘synthetic securitisation’.

The FAQs state that a synthetic securitisation must first include a guarantee or credit derivative and, in the case of a credit derivative, the derivative must be executed under standard industry credit derivative documentation. Second, the operational criteria for the SSFA require use of a recognised credit risk mitigant, such as collateral.

In contrast, the direct CLNs the Fed has reviewed generally do not satisfy either the definition of synthetic securitisation or the operational requirements of the SSFA. It notes that direct CLNs frequently reference, but are not executed under, standard industry credit derivative documentation and the cash purchase consideration is property owned by the note issuer, not property in which the note issuer has a collateral interest. As such, institutions that issue direct CLNs - or have consolidated subsidiaries that issue them - would not automatically be able to recognise such transactions as synthetic securitisations under the capital rule.

However, the FAQs do recognise that firms can, in principle, transfer a portion of the credit risk on the referenced assets to investors via a direct CLN at least as effectively as the synthetic securitisations that qualify under the capital rule. Therefore, the guidance notes that, on appropriate facts, a reservation of authority can be requested where the primary issues presented by the transaction are limited to these two common issues.

In other news…

PRA delays output floor policies
The UK PRA has updated its timetable for implementing the Basel 3.1 standards in the UK, to support firms in their planning processes. The consultation period ended on 31 March and the authority says it has been considering the feedback it received since then.

First, the implementation date of the final Basel 3.1 policies has been extended by six months to 1 July 2025 and the transitional period has been reduced to 4.5 years, to ensure full implementation by 1 January 2030. Second, to allow appropriate time to fully consider the responses to the credit risk and output floor proposals without delaying publication of rules on the other parts of the package, the authority intends to split publication of its near-final Basel 3.1 policy statements into two.

In 4Q23, the PRA intends to publish the near-final policies on market risk, credit valuation adjustment risk, counterparty credit risk and operational risk. In 2Q24, it intends to publish the near-final policies on credit risk, the output floor and reporting and disclosure requirements.