Credit Risk — Securitization Framework

A. Scope and definitions of transactions covered under the securitization framework

538. Banks must apply the securitization framework for determining regulatory capital requirements on exposures arising from traditional and synthetic securitizations or similar structures that contain features common to both.

Since securitizations may be structured in many different ways, the capital treatment of a securitization exposure must be determined on the basis of its economic substance rather than its legal form.

Similarly, supervisors will look to the economic substance of a transaction to determine whether it should be subject to the securitization framework for purposes of determining regulatory capital.

Banks are encouraged to consult with their national supervisors when there is uncertainty about whether a given transaction should be considered a securitization.

For example, transactions involving cash flows from real estate (e.g. rents) may be considered specialised lending exposures, if warranted.

539. A traditional securitization is a structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk positions or tranches reflecting different degrees of credit risk.

Payments to the investors depend upon the performance of the specified underlying exposures, as opposed to being derived from an obligation of the entity originating those exposures.

The stratified/tranched structures that characterise securitizations differ from ordinary senior/subordinated debt instruments in that junior securitization tranches can absorb losses without interrupting contractual payments to more senior tranches, whereas subordination in a senior/subordinated debt structure is a
matter of priority of rights to the proceeds of liquidation.

540. A synthetic securitization is a structure with at least two different stratified risk positions or tranches that reflect different degrees of credit risk where credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of funded (e.g. credit-linked notes) or unfunded (e.g. credit default swaps) credit derivatives or guarantees that serve to hedge the credit risk of the portfolio.

Accordingly, the investors’ potential risk is dependent upon the performance of the underlying pool.

541. Banks’ exposures to a securitization are hereafter referred to as “securitization exposures”.

Securitization exposures can include but are not restricted to the following:

• asset-backed securities

• mortgage-backed securities

• credit enhancements

• liquidity facilities

• interest rate or currency swaps

• credit derivatives

• tranched cover as described in paragraph 199.

• Reserve accounts, such as cash collateral accounts, recorded as an asset by the originating bank must also be treated as securitization exposures.

542. Underlying instruments in the pool being securitized may include but are not restricted to the following:

• loans

• commitments

• asset-backed and mortgage-backed securities

• corporate bonds

• equity securities

• private equity investments

The underlying pool may include one or more exposures.

B. Definitions and general terminology

1. Originating bank

543. For risk-based capital purposes, a bank is considered to be an originator with regard to a certain securitization if it meets either of the following conditions:

(a) The bank originates directly or indirectly underlying exposures included in the securitization;

(b) The bank serves as a sponsor of an asset-backed commercial paper (ABCP) conduit or similar programme that acquires exposures from third-party entities.

In the context of such programmes, a bank would generally be considered a sponsor and, in turn, an originator if it, in fact or in substance, manages or advises the programme, places securities into the market, or provides liquidity and/or credit enhancements.

2. Asset-backed commercial paper (ABCP) programme

544. An asset-backed commercial paper (ABCP) programme predominately issues commercial paper with an original maturity of one year or less that is backed by assets or other exposures held in a bankruptcy-remote, special purpose entity.

3. Clean-up call

545. A clean-up call is an option that permits the securitization exposures (e.g. asset backed securities) to be called before all of the underlying exposures or securitization exposures have been repaid.

In the case of traditional securitizations, this is generally accomplished by repurchasing the remaining securitization exposures once the pool balance or outstanding securities have fallen below some specified level.

In the case of a synthetic transaction, the clean-up call may take the form of a clause that extinguishes the credit protection.

4. Credit enhancement

546. A credit enhancement is a contractual arrangement in which the bank retains or assumes a securitization exposure and, in substance, provides some degree of added protection to other parties to the transaction.

5. Credit-enhancing interest-only strip

547. A credit-enhancing interest-only strip (I/O) is an on-balance sheet asset that

(i) represents a valuation of cash flows related to future margin income, and

(ii) is subordinated.

6. Early amortisation

548. Early amortisation provisions are mechanisms that, once triggered, allow investors to be paid out prior to the originally stated maturity of the securities issued.

For risk-based capital purposes, an early amortisation provision will be considered either controlled or non controlled.

A controlled early amortisation provision must meet all of the following conditions.

(a) The bank must have an appropriate capital/liquidity plan in place to ensure that it has sufficient capital and liquidity available in the event of an early amortisation.

(b) Throughout the duration of the transaction, including the amortisation period, there is the same pro rata sharing of interest, principal, expenses, losses and recoveries based on the bank’s and investors’ relative shares of the receivables outstanding at the beginning of each month.

(c) The bank must set a period for amortisation that would be sufficient for at least 90% of the total debt outstanding at the beginning of the early amortisation period to have been repaid or recognised as in default; and

(d) The pace of repayment should not be any more rapid than would be allowed by straight-line amortisation over the period set out in criterion (c).

549. An early amortisation provision that does not satisfy the conditions for a controlled early amortisation provision will be treated as a non-controlled early amortisation provision.

7. Excess spread

550. Excess spread is generally defined as gross finance charge collections and other income received by the trust or special purpose entity (SPE, specified in paragraph 552) minus certificate interest, servicing fees, charge-offs, and other senior trust or SPE expenses.

8. Implicit support

551. Implicit support arises when a bank provides support to a securitization in excess of its predetermined contractual obligation.

9. Special purpose entity (SPE)

552. An SPE is a corporation, trust, or other entity organised for a specific purpose, the activities of which are limited to those appropriate to accomplish the purpose of the SPE, and the structure of which is intended to isolate the SPE from the credit risk of an originator or seller of exposures.

SPEs are commonly used as financing vehicles in which exposures are sold to a trust or similar entity in exchange for cash or other assets funded by debt issued by the trust.

C. Operational requirements for the recognition of risk transference

553. The following operational requirements are applicable to both the standardised and IRB approaches of the securitization framework.

1. Operational requirements for traditional securitizations

554. An originating bank may exclude securitized exposures from the calculation of risk weighted assets only if all of the following conditions have been met.

Banks meeting these conditions must still hold regulatory capital against any securitization exposures they retain.

(a) Significant credit risk associated with the securitized exposures has been transferred to third parties.

(b) The transferor does not maintain effective or indirect control over the transferred exposures.

The assets are legally isolated from the transferor in such a way (e.g. through the sale of assets or through subparticipation) that the exposures are put beyond the reach of the transferor and its creditors, even in bankruptcy or receivership.

These conditions must be supported by an opinion provided by a qualified legal counsel.

The transferor is deemed to have maintained effective control over the transferred credit risk exposures if it:

(i) is able to repurchase from the transferee the previously transferred exposures in order to realise their benefits; or

(ii) is obligated to retain the risk of the transferred exposures.

The transferor’s retention of servicing rights to the exposures will not necessarily constitute indirect control of the exposures.

(c) The securities issued are not obligations of the transferor.

Thus, investors who purchase the securities only have claim to the underlying pool of exposures.

(d) The transferee is an SPE and the holders of the beneficial interests in that entity have the right to pledge or exchange them without restriction.

(e) Clean-up calls must satisfy the conditions set out in paragraph 557.

(f) The securitization does not contain clauses that

(i) require the originating bank to alter systematically the underlying exposures such that the pool’s weighted average credit quality is improved unless this is achieved by selling assets to independent and unaffiliated third parties at market prices;

(ii) allow for increases in a retained first loss position or credit enhancement provided by the originating bank after the transaction’s inception; or

(iii) increase the yield payable to parties other than the originating bank, such as investors and third-party providers of credit enhancements, in response to a deterioration in the credit quality of the underlying
pool.

2. Operational requirements for synthetic securitizations

555. For synthetic securitizations, the use of CRM techniques (i.e. collateral, guarantees and credit derivatives) for hedging the underlying exposure may be recognised for risk-based capital purposes only if the conditions outlined below are satisfied:

(a) Credit risk mitigants must comply with the requirements as set out in Section II.D of this Framework.

(b) Eligible collateral is limited to that specified in paragraphs 145 and 146. Eligible collateral pledged by SPEs may be recognised.

(c) Eligible guarantors are defined in paragraph 195. Banks may not recognise SPEs as eligible guarantors in the securitization framework.

(d) Banks must transfer significant credit risk associated with the underlying exposure to third parties.

(e) The instruments used to transfer credit risk may not contain terms or conditions that limit the amount of credit risk transferred, such as those provided below:

• Clauses that materially limit the credit protection or credit risk transference (e.g. significant materiality thresholds below which credit protection is deemed not to be triggered even if a credit event occurs or those that allow for the termination of the protection due to deterioration in the credit quality of the underlying exposures);

• Clauses that require the originating bank to alter the underlying exposures to improve the pool’s weighted average credit quality;

• Clauses that increase the banks’ cost of credit protection in response to deterioration in the pool’s quality;

• Clauses that increase the yield payable to parties other than the originating bank, such as investors and third-party providers of credit enhancements, in response to a deterioration in the credit quality of the reference pool; and

• Clauses that provide for increases in a retained first loss position or credit enhancement provided by the originating bank after the transaction’s inception.

(f) An opinion must be obtained from a qualified legal counsel that confirms the enforceability of the contracts in all relevant jurisdictions.

(g) Clean-up calls must satisfy the conditions set out in paragraph 557.

556. For synthetic securitizations, the effect of applying CRM techniques for hedging the underlying exposure are treated according to paragraphs 109 to 210.

In case there is a maturity mismatch, the capital requirement will be determined in accordance with paragraphs 202 to 205.

When the exposures in the underlying pool have different maturities, the longest maturity must be taken as the maturity of the pool.

Maturity mismatches may arise in the context of synthetic securitizations when, for example, a bank uses credit derivatives to transfer part or all of the credit risk of a specific pool of assets to third parties.

When the credit derivatives unwind, the transaction will terminate.

This implies that the effective maturity of the tranches of the synthetic securitization may differ from that of the underlying exposures.

Originating banks of synthetic securitizations must treat such maturity mismatches in the following manner.

A bank using the standardised approach for securitization must deduct all retained positions that are unrated or rated below investment grade.

A bank using the IRB approach must deduct unrated, retained positions if the treatment of the position is deduction specified in paragraphs 609 to 643.

Accordingly, when deduction is required, maturity mismatches are not taken into account.

For all other securitization exposures, the bank must apply the maturity mismatch treatment set forth in
paragraphs 202 to 205.

3. Operational requirements and treatment of clean-up calls

557. For securitization transactions that include a clean-up call, no capital will be required due to the presence of a clean-up call if the following conditions are met:

(i) the exercise of the clean-up call must not be mandatory, in form or in substance, but rather must be at the
discretion of the originating bank;

(ii) the clean-up call must not be structured to avoid allocating losses to credit enhancements or positions held by investors or otherwise structured to provide credit enhancement; and

(iii) the clean-up call must only be exercisable when 10% or less of the original underlying portfolio, or securities issued remain, or, for synthetic securitizations, when 10% or less of the original reference portfolio value remains.

558. Securitization transactions that include a clean-up call that does not meet all of the criteria stated in paragraph 557 result in a capital requirement for the originating bank.

For a traditional securitization, the underlying exposures must be treated as if they were not securitized.

Additionally, banks must not recognise in regulatory capital any gain-on-sale, as defined in paragraph 562.

For synthetic securitizations, the bank purchasing protection must hold capital against the entire amount of the securitized exposures as if they did not benefit from any credit protection.

If a synthetic securitization incorporates a call (other than a cleanup call) that effectively terminates the transaction and the purchased credit protection on a specific date, the bank must treat the transaction in accordance with paragraph 556 and paragraphs 202 to 205.

559. If a clean-up call, when exercised, is found to serve as a credit enhancement, the exercise of the clean-up call must be considered a form of implicit support provided by the bank and must be treated in accordance with the supervisory guidance pertaining to securitization transactions.

D. Treatment of securitization exposures
1. Calculation of capital requirements

560. Banks are required to hold regulatory capital against all of their securitization exposures, including those arising from the provision of credit risk mitigants to a securitization transaction, investments in asset-backed securities, retention of a subordinated tranche, and extension of a liquidity facility or credit enhancement, as set forth in the following sections.

Repurchased securitization exposures must be treated as retained securitization exposures.

(i) Deduction

561. When a bank is required to deduct a securitization exposure from regulatory capital, the deduction must be taken 50% from Tier 1 and 50% from Tier 2 with the one exception noted in paragraph 562.

Credit enhancing I/Os (net of the amount that must be deducted from Tier 1 as in paragraph 562) are deducted 50% from Tier 1 and 50% from Tier 2.

Deductions from capital may be calculated net of any specific provisions taken against the relevant securitization exposures.

562. Banks must deduct from Tier 1 any increase in equity capital resulting from a securitization transaction, such as that associated with expected future margin income (FMI) resulting in a gain-on-sale that is recognised in regulatory capital.

Such an increase in capital is referred to as a “gain-on-sale” for the purposes of the securitization framework.

563. For the purposes of the EL-provision calculation as set out in Section III.G, securitization exposures do not contribute to the EL amount.

Similarly, any specific provisions against securitization exposures are not to be included in the measurement of eligible provisions.

(ii) Implicit support

564. When a bank provides implicit support to a securitization, it must, at a minimum, hold capital against all of the exposures associated with the securitization transaction as if they had not been securitized.

Additionally, banks would not be permitted to recognise in regulatory capital any gain-on-sale, as defined in paragraph 562.

Furthermore, the bank is required to disclose publicly that

(a) it has provided non-contractual support and

(b) the capital impact of doing so.

2. Operational requirements for use of external credit assessments

565. The following operational criteria concerning the use of external credit assessments apply in the standardised and IRB approaches of the securitization framework:

(a) To be eligible for risk-weighting purposes, the external credit assessment must take into account and reflect the entire amount of credit risk exposure the bank has with regard to all payments owed to it.

For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with timely repayment of both principal and interest.

(b) The external credit assessments must be from an eligible ECAI as recognised by the bank’s national supervisor in accordance with paragraphs 90 to 108 with the following exception.

In contrast with bullet three of paragraph 91, an eligible credit assessment must be publicly available.

In other words, a rating must be published in an accessible form and included in the ECAI’s transition matrix.

Consequently, ratings that are made available only to the parties to a transaction do not satisfy this
requirement.

(c) Eligible ECAIs must have a demonstrated expertise in assessing securitizations, which may be evidenced by strong market acceptance.

(d) A bank must apply external credit assessments from eligible ECAIs consistently across a given type of securitization exposure.

Furthermore, a bank cannot use the credit assessments issued by one ECAI for one or more tranches and those of another ECAI for other positions (whether retained or purchased) within the same securitization structure that may or may not be rated by the first ECAI.

Where two or more eligible ECAIs can be used and these assess the credit risk of the same securitization exposure differently, paragraphs 96 to 98 will apply.

(e) Where CRM is provided directly to an SPE by an eligible guarantor defined in paragraph 195 and is reflected in the external credit assessment assigned to a securitization exposure(s), the risk weight associated with that external credit assessment should be used.

In order to avoid any double counting, no additional capital recognition is permitted. If the CRM provider is not recognised as an eligible guarantor in paragraph 195, the covered securitization exposures should be treated as unrated.

(f) In the situation where a credit risk mitigant is not obtained by the SPE but rather applied to a specific securitization exposure within a given structure (e.g. ABS tranche), the bank must treat the exposure as if it is unrated and then use the CRM treatment outlined in Section II.D or in the foundation IRB approach of Section III, to recognise the hedge.

3. Standardised approach for securitization exposures
(i) Scope

566. Banks that apply the standardised approach to credit risk for the type of underlying exposure(s) securitized must use the standardised approach under the securitization framework.

(ii) Risk weights

567. The risk-weighted asset amount of a securitization exposure is computed by multiplying the amount of the position by the appropriate risk weight determined in accordance with the following tables.

For off-balance sheet exposures, banks must apply a CCF and then risk weight the resultant credit equivalent amount.

If such an exposure is rated, a CCF of 100% must be applied.

For positions with long-term ratings of B+ and below and short-term ratings other than A-1/P-1, A-2/P-2, A-3/P-3, deduction from capital as defined in paragraph 561 is required.

Deduction is also required for unrated positions with the exception of the circumstances described in paragraphs 571 to 575.

(95) The rating designations used in the following charts are for illustrative purposes only and do not indicate any preference for, or endorsement of, any particular external assessment system.

568. The capital treatment of positions retained by originators, liquidity facilities, credit risk mitigants, and securitizations of revolving exposures are identified separately.

The treatment of clean-up calls is provided in paragraphs 557 to 559.

Investors may recognise ratings on below-investment grade exposures

569. Only third-party investors, as opposed to banks that serve as originators, may recognise external credit assessments that are equivalent to BB+ to BB- for risk weighting purposes of securitization exposures.

Originators to deduct below-investment grade exposures

570. Originating banks as defined in paragraph 543 must deduct all retained securitization exposures rated below investment grade (i.e. BBB-).

(iii) Exceptions to general treatment of unrated securitization exposures

571. As noted in the tables above, unrated securitization exposures must be deducted with the following exceptions:

(i) the most senior exposure in a securitization,

(ii) exposures that are in a second loss position or better in ABCP programmes and meet the requirements
outlined in paragraph 574, and

(iii) eligible liquidity facilities.

Treatment of unrated most senior securitization exposures

572. If the most senior exposure in a securitization of a traditional or synthetic securitization is unrated, a bank that holds or guarantees such an exposure may determine the risk weight by applying the “look-through” treatment, provided the composition of the underlying pool is known at all times.

Banks are not required to consider interest rate or currency swaps when determining whether an exposure is the most senior in a securitization for the purpose of applying the “look-through” approach.

573. In the look-through treatment, the unrated most senior position receives the average risk weight of the underlying exposures subject to supervisory review.

Where the bank is unable to determine the risk weights assigned to the underlying credit risk exposures, the
unrated position must be deducted.

Treatment of exposures in a second loss position or better in ABCP programmes

574. Deduction is not required for those unrated securitization exposures provided by sponsoring banks to ABCP programmes that satisfy the following requirements:

(a) The exposure is economically in a second loss position or better and the first loss position provides significant credit protection to the second loss position;

(b) The associated credit risk is the equivalent of investment grade or better; and

(c) The bank holding the unrated securitization exposure does not retain or provide the first loss position.

575. Where these conditions are satisfied, the risk weight is the greater of

(i) 100% or

(ii) the highest risk weight assigned to any of the underlying individual exposures covered by the facility.

Risk weights for eligible liquidity facilities

576. For eligible liquidity facilities as defined in paragraph 578 and where the conditions for use of external credit assessments in paragraph 565 are not met, the risk weight applied to the exposure’s credit equivalent amount is equal to the highest risk weight assigned to any of the underlying individual exposures covered by the facility.

(iv) Credit conversion factors for off-balance sheet exposures

577. For risk-based capital purposes, banks must determine whether, according to the criteria outlined below, an off-balance sheet securitization exposure qualifies as an ‘eligible liquidity facility’ or an ‘eligible servicer cash advance facility’.

All other off-balance sheet securitization exposures will receive a 100% CCF.

Eligible liquidity facilities

578. Banks are permitted to treat off-balance sheet securitization exposures as eligible liquidity facilities if the following minimum requirements are satisfied:

(a) The facility documentation must clearly identify and limit the circumstances under which it may be drawn. Draws under the facility must be limited to the amount that is likely to be repaid fully from the liquidation of the underlying exposures and any seller-provided credit enhancements.

In addition, the facility must not cover any losses incurred in the underlying pool of exposures prior to a draw, or be structured such that draw-down is certain (as indicated by regular or continuous draws);

(b) The facility must be subject to an asset quality test that precludes it from being drawn to cover credit risk exposures that are in default as defined in paragraphs 452 to 459.

In addition, if the exposures that a liquidity facility is required to fund are externally rated securities, the facility can only be used to fund securities that are externally rated investment grade at the time of funding;

(c) The facility cannot be drawn after all applicable (e.g. transaction-specific and programme-wide) credit enhancements from which the liquidity would benefit have been exhausted; and

(d) Repayment of draws on the facility (i.e. assets acquired under a purchase agreement or loans made under a lending agreement) must not be subordinated to any interests of any note holder in the programme (e.g. ABCP programme) or subject to deferral or waiver.

579. Where these conditions are met, the bank may apply a 20% CCF to the amount of eligible liquidity facilities with an original maturity of one year or less, or a 50% CCF if the facility has an original maturity of more than one year.

However, if an external rating of the facility itself is used for risk-weighting the facility, a 100% CCF must be applied.

Eligible liquidity facilities available only in the event of market disruption

580. Banks may apply a 0% CCF to eligible liquidity facilities that are only available in the event of a general market disruption (i.e. whereupon more than one SPE across different transactions are unable to roll over maturing commercial paper, and that inability is not the result of an impairment in the SPEs’ credit quality or in the credit quality of the underlying exposures).

To qualify for this treatment, the conditions provided in paragraph 578 must be satisfied.

Additionally, the funds advanced by the bank to pay holders of the capital market instruments (e.g. commercial paper) when there is a general market disruption must be secured by the underlying assets, and must rank at least pari passu with the claims of holders of the capital market instruments.

Treatment of overlapping exposures

581. A bank may provide several types of facilities that can be drawn under various conditions.

The same bank may be providing two or more of these facilities.

Given the different triggers found in these facilities, it may be the case that a bank provides duplicative
coverage to the underlying exposures.

In other words, the facilities provided by a bank may overlap since a draw on one facility may preclude (in part) a draw under the other facility.

In the case of overlapping facilities provided by the same bank, the bank does not need to hold additional capital for the overlap.

Rather, it is only required to hold capital once for the position covered by the overlapping facilities (whether they are liquidity facilities or credit enhancements).

Where the overlapping facilities are subject to different conversion factors, the bank must attribute the overlapping part to the facility with the highest conversion factor.

However, if overlapping facilities are provided by different banks, each bank must hold capital for the maximum amount of the facility.

Eligible servicer cash advance facilities

582. Subject to national discretion, if contractually provided for, servicers may advance cash to ensure an uninterrupted flow of payments to investors so long as the servicer is entitled to full reimbursement and this right is senior to other claims on cash flows from the underlying pool of exposures.

At national discretion, such undrawn servicer cash advances or facilities that are unconditionally cancellable without prior notice may be eligible for a 0% CCF.

(v) Treatment of credit risk mitigation for securitization exposures

583. The treatment below applies to a bank that has obtained a credit risk mitigant on a securitization exposure. Credit risk mitigants include guarantees, credit derivatives, collateral and on-balance sheet netting. Collateral in this context refers to that used to hedge the credit risk of a securitization exposure rather than the underlying exposures of the securitization transaction.

584. When a bank other than the originator provides credit protection to a securitization exposure, it must calculate a capital requirement on the covered exposure as if it were an investor in that securitization.

If a bank provides protection to an unrated credit enhancement, it must treat the credit protection provided as if it were directly holding the unrated credit enhancement.

Collateral

585. Eligible collateral is limited to that recognised under the standardised approach for CRM (paragraphs 145 and 146). Collateral pledged by SPEs may be recognised.

Guarantees and credit derivatives

586. Credit protection provided by the entities listed in paragraph 195 may be recognised.

SPEs cannot be recognised as eligible guarantors.

587. Where guarantees or credit derivatives fulfil the minimum operational conditions as specified in paragraphs 189 to 194, banks can take account of such credit protection in calculating capital requirements for securitization exposures.

588. Capital requirements for the guaranteed/protected portion will be calculated according to CRM for the standardised approach as specified in paragraphs 196 to 201.

Maturity mismatches

589. For the purpose of setting regulatory capital against a maturity mismatch, the capital requirement will be determined in accordance with paragraphs 202 to 205.

When the exposures being hedged have different maturities, the longest maturity must be used.

(vi) Capital requirement for early amortisation provisions
Scope

590. As described below, an originating bank is required to hold capital against all or a portion of the investors’ interest (i.e. against both the drawn and undrawn balances related to the securitized exposures) when:

(a) It sells exposures into a structure that contains an early amortisation feature; and

(b) The exposures sold are of a revolving nature. These involve exposures where the borrower is permitted to vary the drawn amount and repayments within an agreed limit under a line of credit (e.g. credit card receivables and corporate loan commitments).

591. The capital requirement should reflect the type of mechanism through which an early amortisation is triggered.

592. For securitization structures wherein the underlying pool comprises revolving and term exposures, a bank must apply the relevant early amortisation treatment (outlined below in paragraphs 594 to 605) to that portion of the underlying pool containing revolving exposures.

593. Banks are not required to calculate a capital requirement for early amortisations in the following situations:

(a) Replenishment structures where the underlying exposures do not revolve and the early amortisation ends the ability of the bank to add new exposures;

(b) Transactions of revolving assets containing early amortisation features that mimic term structures (i.e. where the risk on the underlying facilities does not return to the originating bank);

(c) Structures where a bank securitizes one or more credit line(s) and where investors remain fully exposed to future draws by borrowers even after an early amortisation event has occurred;

(d) The early amortisation clause is solely triggered by events not related to the performance of the securitized assets or the selling bank, such as material changes in tax laws or regulations.

Maximum capital requirement

594. For a bank subject to the early amortisation treatment, the total capital charge for all of its positions will be subject to a maximum capital requirement (i.e. a ‘cap’) equal to the greater of

(i) that required for retained securitization exposures, or

(ii) the capital requirement that would apply had the exposures not been securitized.

In addition, banks must deduct the entire amount of any gain-on-sale and credit enhancing I/Os arising from the securitization transaction in accordance with paragraphs 561 to 563.

Mechanics

595. The originator’s capital charge for the investors’ interest is determined as the product of

(a) the investors’ interest

(b) the appropriate CCF (as discussed below), and

(c) the risk weight appropriate to the underlying exposure type, as if the exposures had not been securitized.

As described below, the CCFs depend upon whether the early amortisation repays investors through a controlled or non-controlled mechanism.

They also differ according to whether the securitized exposures are uncommitted retail credit lines (e.g. credit
card receivables) or other credit lines (e.g. revolving corporate facilities).

A line is considered uncommitted if it is unconditionally cancellable without prior notice.

(vii) Determination of CCFs for controlled early amortisation features

596. An early amortisation feature is considered controlled when the definition as specified in paragraph 548 is satisfied.

Uncommitted retail exposures

597. For uncommitted retail credit lines (e.g. credit card receivables) in securitizations containing controlled early amortisation features, banks must compare the three-month average excess spread defined in paragraph 550 to the point at which the bank is required to trap excess spread as economically required by the structure (i.e. excess spread trapping point).

598. In cases where such a transaction does not require excess spread to be trapped, the trapping point is deemed to be 4.5 percentage points.

599. The bank must divide the excess spread level by the transaction’s excess spread trapping point to determine the appropriate segments and apply the corresponding conversion factors, as outlined in the following table.

600. Banks are required to apply the conversion factors set out above for controlled mechanisms to the investors’ interest referred to in paragraph 595.

Other exposures

601. All other securitized revolving exposures (i.e. those that are committed and all nonretail exposures) with controlled early amortisation features will be subject to a CCF of 90% against the off-balance sheet exposures.

(viii) Determination of CCFs for non-controlled early amortisation features

602. Early amortisation features that do not satisfy the definition of a controlled early amortisation as specified in paragraph 548 will be considered non-controlled and treated as follows.

Uncommitted retail exposures

603. For uncommitted retail credit lines (e.g. credit card receivables) in securitizations containing non-controlled early amortisation features, banks must make the comparison described in paragraphs 597 and 598:

604. The bank must divide the excess spread level by the transaction’s excess spread trapping point to determine the appropriate segments and apply the corresponding conversion factors, as outlined in the following table.

Other exposures

605. All other securitized revolving exposures (i.e. those that are committed and all nonretail exposures) with non-controlled early amortisation features will be subject to a CCF of 100% against the off-balance sheet exposures.

4. Internal ratings-based approach for securitization exposures
(i) Scope

606. Banks that have received approval to use the IRB approach for the type of underlying exposures securitized (e.g. for their corporate or retail portfolio) must use the IRB approach for securitizations.

Conversely, banks may not use the IRB approach to securitization unless they receive approval to use the IRB approach for the underlying exposures from their national supervisors.

607. If the bank is using the IRB approach for some exposures and the standardised approach for other exposures in the underlying pool, it should generally use the approach corresponding to the predominant share of exposures within the pool.

The bank should consult with its national supervisors on which approach to apply to its securitization
exposures.

To ensure appropriate capital levels, there may be instances where the supervisor requires a treatment other than this general rule.

608. Where there is no specific IRB treatment for the underlying asset type, originating banks that have received approval to use the IRB approach must calculate capital charges on their securitization exposures using the standardised approach in the securitization framework, and investing banks with approval to use the IRB approach must apply the RBA.

(ii) Hierarchy of approaches

609. The Ratings-Based Approach (RBA) must be applied to securitization exposures that are rated, or where a rating can be inferred as described in paragraph 617.

Where an external or an inferred rating is not available, either the Supervisory Formula (SF) or the
Internal Assessment Approach (IAA) must be applied. 

The IAA is only available to exposures (e.g. liquidity facilities and credit enhancements) that banks (including third-party banks) extend to ABCP programmes.

Such exposures must satisfy the conditions of paragraphs 619 and 620.

For liquidity facilities to which none of these approaches can be applied, banks may apply the treatment specified in paragraph 639.

Exceptional treatment for eligible servicer cash advance facilities is specified in paragraph 641.

Securitization exposures to which none of these approaches can be applied must be deducted.

(iii) Maximum capital requirement

610. For a bank using the IRB approach to securitization, the maximum capital requirement for the securitization exposures it holds is equal to the IRB capital requirement that would have been assessed against the underlying exposures had they not been securitized and treated under the appropriate sections of the IRB framework including Section III.G. In addition, banks must deduct the entire amount of any gain-on-sale and credit enhancing I/Os arising from the securitization transaction in accordance with paragraphs 561 to 563.

(iv) Ratings-Based Approach (RBA)

611. Under the RBA, the risk-weighted assets are determined by multiplying the amount of the exposure by the appropriate risk weights, provided in the tables below.

612. The risk weights depend on

(i) the external rating grade or an available inferred rating,

(ii) whether the credit rating (external or inferred) represents a long-term or a shortterm credit rating,

(iii) the granularity of the underlying pool and

(iv) the seniority of the position.

613. For purposes of the RBA, a securitization exposure is treated as a senior tranche if it is effectively backed or secured by a first claim on the entire amount of the assets in the underlying securitized pool.

While this generally includes only the most senior position within a securitization transaction, in some instances there may be some other claim that, in a technical sense, may be more senior in the waterfall (e.g. a swap claim) but may be disregarded for the purpose of determining which positions are subject to the “senior
tranches” column.

Examples:

(a) In a typical synthetic securitization, the “super-senior” tranche would be treated as a senior tranche, provided that all of the conditions for inferring a rating from a lower tranche are fulfilled.

(b) In a traditional securitization where all tranches above the first-loss piece are rated, the most highly rated position would be treated as a senior tranche.

However, when there are several tranches that share the same rating, only the most senior one in
the waterfall would be treated as senior.

(c) Usually a liquidity facility supporting an ABCP programme would not be the most senior position within the programme; the commercial paper, which benefits from the liquidity support, typically would be the most senior position.

However, if the liquidity facility is sized to cover all of the outstanding commercial paper, it can be viewed as
covering all losses on the underlying receivables pool that exceed the amount of over-collateralisation/reserves provided by the seller and as being most senior.

As a result, the RBA risk weights in the left-most column can be used for such positions.

On the other hand, if a liquidity or credit enhancement facility constituted a mezzanine position in economic substance rather than a senior position in the underlying pool, then the “Base risk weights” column is applicable.

614. The risk weights provided in the first table below apply when the external assessment represents a long-term credit rating, as well as when an inferred rating based on a long-term rating is available.

615. Banks may apply the risk weights for senior positions if the effective number of underlying exposures (N, as defined in paragraph 633) is 6 or more and the position is senior as defined above.

When N is less than 6, the risk weights in column 4 of the first table below apply.

In all other cases, the risk weights in column 3 of the first table below apply.

RBA risk weights when the external assessment represents a long-term credit rating and/or an inferred rating derived from a long-term assessment

616. The risk weights in the table below apply when the external assessment represents a short-term credit rating, as well as when an inferred rating based on a short-term rating is available. The decision rules outlined in paragraph 615 also apply for short-term credit ratings.

RBA risk weights when the external assessment represents a short-term credit rating and/or an inferred rating derived from a short-term assessment

Use of inferred ratings

617. When the following minimum operational requirements are satisfied a bank must attribute an inferred rating to an unrated position.

These requirements are intended to ensure that the unrated position is senior in all respects to an externally rated securitization exposure termed the ‘reference securitization exposure’.

Operational requirements for inferred ratings

618. The following operational requirements must be satisfied to recognise inferred ratings.

(a) The reference securitization exposure (e.g. ABS) must be subordinate in all respects to the unrated securitization exposure.

Credit enhancements, if any, must be taken into account when assessing the relative subordination of the unrated exposure and the reference securitization exposure.

For example, if the reference securitization exposure benefits from any third-party guarantees or other credit enhancements that are not available to the unrated exposure, then the latter may not be assigned an
inferred rating based on the reference securitization exposure.

(b) The maturity of the reference securitization exposure must be equal to or longer than that of the unrated exposure.

(c) On an ongoing basis, any inferred rating must be updated continuously to reflect any changes in the external rating of the reference securitization exposure.

(d) The external rating of the reference securitization exposure must satisfy the general requirements for recognition of external ratings as delineated in paragraph 565.

(v) Internal Assessment Approach (IAA)

619. A bank may use its internal assessments of the credit quality of the securitization exposures the bank extends to ABCP programmes (e.g. liquidity facilities and credit enhancements) if the bank’s internal assessment process meets the operational requirements below.

Internal assessments of exposures provided to ABCP programmes must be mapped to equivalent external ratings of an ECAI.

Those rating equivalents are used to determine the appropriate risk weights under the RBA for purposes of assigning the notional amounts of the exposures.

620. A bank’s internal assessment process must meet the following operational requirements in order to use internal assessments in determining the IRB capital requirement arising from liquidity facilities, credit enhancements, or other exposures extended to an ABCP programme.

(a) For the unrated exposure to qualify for the IAA, the ABCP must be externally rated.

The ABCP itself is subject to the RBA.

(b) The internal assessment of the credit quality of a securitization exposure to the ABCP programme must be based on an ECAI criteria for the asset type purchased and must be the equivalent of at least investment grade when initially assigned to an exposure.

In addition, the internal assessment must be used in the bank’s internal risk management processes, including management information and economic capital systems, and generally must meet all the relevant requirements of the IRB framework.

(c) In order for banks to use the IAA, their supervisors must be satisfied

(i) that the ECAI meets the ECAI eligibility criteria outlined in paragraphs 90 to 108 and

(ii) with the ECAI rating methodologies used in the process.

In addition, banks have the responsibility to demonstrate to the satisfaction of their supervisors how these
internal assessments correspond with the relevant ECAI’s standards.

For instance, when calculating the credit enhancement level in the context of the IAA, supervisors may, if warranted, disallow on a full or partial basis any seller provided recourse guarantees or excess spread, or any other first loss credit enhancements that provide limited protection to the bank.

(d) The bank’s internal assessment process must identify gradations of risk.

Internal assessments must correspond to the external ratings of ECAIs so that supervisors can determine which internal assessment corresponds to each external rating category of the ECAIs.

(e) The bank’s internal assessment process, particularly the stress factors for determining credit enhancement requirements, must be at least as conservative as the publicly available rating criteria of the major ECAIs that are externally rating the ABCP programme’s commercial paper for the asset type being purchased by the
programme.

However, banks should consider, to some extent, all publicly available ECAI ratings methodologies in developing their internal assessments.

• In the case where (i) the commercial paper issued by an ABCP programme is externally rated by two or more ECAIs and (ii) the different ECAIs’ benchmark stress factors require different levels of credit enhancement to achieve the same external rating equivalent, the bank must apply the ECAI stress factor that requires the most conservative or highest level of credit protection.

For example, if one ECAI required enhancement of 2.5 to 3.5 times historical losses for an asset type to obtain a single A rating equivalent and another required 2 to 3 times historical losses, the bank must use the higher range of stress factors in determining the appropriate level of seller-provided credit enhancement.

• When selecting ECAIs to externally rate an ABCP, a bank must not choose only those ECAIs that generally have relatively less restrictive rating methodologies.

In addition, if there are changes in the methodology of one of the selected ECAIs, including the stress factors, that adversely affect the external rating of the programme’s commercial paper, then the revised rating methodology must be considered in evaluating whether the internal assessments assigned to ABCP
programme exposures are in need of revision.

• A bank cannot utilise an ECAI’s rating methodology to derive an internal assessment if the ECAI’s process or rating criteria is not publicly available.

However, banks should consider the non-publicly available methodology — to the extent that they have access to such information ─ in developing their internal assessments, particularly if it is more conservative than the publicly available criteria.

• In general, if the ECAI rating methodologies for an asset or exposure are not publicly available, then the IAA may not be used. However, in certain instances, for example, for new or uniquely structured transactions, which are not currently addressed by the rating criteria of an ECAI rating the programme’s commercial
paper, a bank may discuss the specific transaction with its supervisor to determine whether the IAA may be applied to the related exposures.

(f) Internal or external auditors, an ECAI, or the bank’s internal credit review or risk management function must perform regular reviews of the internal assessment process and assess the validity of those internal assessments.

If the bank’s internal audit, credit review, or risk management functions perform the reviews of the
internal assessment process, then these functions must be independent of the ABCP programme business line, as well as the underlying customer relationships.

(g) The bank must track the performance of its internal assessments over time to evaluate the performance of the assigned internal assessments and make adjustments, as necessary, to its assessment process when the performance of the exposures routinely diverges from the assigned internal assessments on those exposures.

(h) The ABCP programme must have credit and investment guidelines, i.e. underwriting standards, for the ABCP programme. In the consideration of an asset purchase, the ABCP programme (i.e. the programme administrator) should develop an outline of the structure of the purchase transaction.

Factors that should be discussed include

• the type of asset being purchased;

• type and monetary value of the exposures arising from the provision of liquidity facilities and credit enhancements;

• loss waterfall;

• and legal and economic isolation of the transferred assets from the entity selling the assets.

(i) A credit analysis of the asset seller’s risk profile must be performed and should consider, for example, past and expected future financial performance; current market position; expected future competitiveness; leverage, cash flow, and interest coverage; and debt rating.

In addition, a review of the seller’s underwriting standards, servicing capabilities, and collection processes should be performed.

(j) The ABCP programme’s underwriting policy must establish minimum asset eligibility criteria that, among other things,

• exclude the purchase of assets that are significantly past due or defaulted;

• limit excess concentration to individual obligor or geographic area; and

• limit the tenor of the assets to be purchased.

(k) The ABCP programme should have collections processes established that consider the operational capability and credit quality of the servicer.

The programme should mitigate to the extent possible seller/servicer risk through various methods, such as
triggers based on current credit quality that would preclude co-mingling of funds and impose lockbox arrangements that would help ensure the continuity of payments to the ABCP programme.

(l) The aggregate estimate of loss on an asset pool that the ABCP programme is considering purchasing must consider all sources of potential risk, such as credit and dilution risk.

If the seller-provided credit enhancement is sized based on only credit-related losses, then a separate reserve should be established for dilution risk, if dilution risk is material for the particular exposure pool.

In addition, in sizing the required enhancement level, the bank should review several years of historical
information, including losses, delinquencies, dilutions, and the turnover rate of the receivables.

Furthermore, the bank should evaluate the characteristics of the underlying asset pool, e.g. weighted average credit score, identify any concentrations to an individual obligor or geographic region, and the granularity of
the asset pool.

(m) The ABCP programme must incorporate structural features into the purchase of assets in order to mitigate potential credit deterioration of the underlying portfolio.

Such features may include wind down triggers specific to a pool of exposures.

621. The notional amount of the securitization exposure to the ABCP programme must be assigned to the risk weight in the RBA appropriate to the credit rating equivalent assigned to the bank’s exposure.

622. If a bank’s internal assessment process is no longer considered adequate, the bank’s supervisor may preclude the bank from applying the internal assessment approach to its ABCP exposures, both existing and newly originated, for determining the appropriate capital treatment until the bank has remedied the deficiencies. In this instance, the bank must revert to the SF or, if not available, to the method described in paragraph 639.

(vi) Supervisory Formula (SF)

623. As in the IRB approaches, risk-weighted assets generated through the use of the SF are calculated by multiplying the capital charge by 12.5. Under the SF, the capital charge for a securitization tranche depends on five bank-supplied inputs: the IRB capital charge had the underlying exposures not been securitized (KIRB); the tranche’s credit enhancement level (L) and thickness (T); the pool’s effective number of exposures (N); and the pool’s exposureweighted average loss-given-default (LGD). The inputs KIRB, L, T and N are defined below.

The capital charge is calculated as follows:

624. The Supervisory Formula is given by the following expression:

625. In these expressions, Beta[L; a, b] refers to the cumulative beta distribution with parameters a and b evaluated at L.96

626. The supervisory-determined parameters in the above expressions are as follows: τ = 1000, and ω = 20

Definition of K_IRB

627. KIRB is the ratio of (a) the IRB capital requirement including the EL portion for the underlying exposures in the pool to (b) the exposure amount of the pool (e.g. the sum of drawn amounts related to securitized exposures plus the EAD associated with undrawn commitments related to securitized exposures).

Quantity (a) above must be calculated in accordance with the applicable minimum IRB standards (as set out in Section III of this document) as if the exposures in the pool were held directly by the bank.

This calculation should reflect the effects of any credit risk mitigant that is applied on the underlying
exposures (either individually or to the entire pool), and hence benefits all of the securitization exposures.

KIRB is expressed in decimal form (e.g. a capital charge equal to 15% of the pool would be expressed as 0.15). For structures involving an SPE, all the assets of the SPE that are related to the securitizations are to be treated as exposures in the pool, including assets in which the SPE may have invested a reserve account, such as a cash collateral account.

628. If the risk weight resulting from the SF is 1250%, banks must deduct the securitization exposure subject to that risk weight in accordance with paragraphs 561 to 563.

629. In cases where a bank has set aside a specific provision or has a non-refundable purchase price discount on an exposure in the pool, quantity

(a) defined above and quantity
(b) also defined above must be calculated using the gross amount of the exposure without the specific provision and/or non-refundable purchase price discount.

In this case, the amount of the non-refundable purchase price discount on a defaulted asset or the specific
provision can be used to reduce the amount of any deduction from capital associated with the securitization exposure.

Credit enhancement level (L)

630. L is measured (in decimal form) as the ratio of (a) the amount of all securitization exposures subordinate to the tranche in question to (b) the amount of exposures in the pool.

Banks will be required to determine L before considering the effects of any tranche-specific credit enhancements, such as third-party guarantees that benefit only a single tranche.

Any gain-on-sale and/or credit enhancing I/Os associated with the securitization are not to be included in the measurement of L. The size of interest rate or currency swaps that are more junior than the tranche in question may be measured at their current values (without the potential future exposures) in calculating the enhancement level.

If the current value of the instrument cannot be measured, the instrument should be ignored in the calculation of L.

631. If there is any reserve account funded by accumulated cash flows from the underlying exposures that is more junior than the tranche in question, this can be included in the calculation of L.

Unfunded reserve accounts may not be included if they are to be funded from future receipts from the underlying exposures.

Thickness of exposure (T)

632. T is measured as the ratio of (a) the nominal size of the tranche of interest to (b) the notional amount of exposures in the pool. In the case of an exposure arising from an interest rate or currency swap, the bank must incorporate potential future exposure.

If the current value of the instrument is non-negative, the exposure size should be measured by the
current value plus the add-on as in Section VII of Annex 4.

If the current value is negative, the exposure should be measured by using the potential future exposure only.
Effective number of exposures (N)

633. The effective number of exposures is calculated as:

where LGDi represents the average LGD associated with all exposures to the ith obligor.

In the case of re-securitization, an LGD of 100% must be assumed for the underlying securitized exposures.

 When default and dilution risks for purchased receivables are treated in an aggregate manner (e.g. a single reserve or over-collateralisation is available to cover losses from either source) within a securitization, the LGD input must be constructed as a weighted-average of the LGD for default risk and the 100% LGD for dilution risk.

The weights are the stand-alone IRB capital charges for default risk and dilution risk, respectively.

Simplified method for computing N and LGD

635. For securitizations involving retail exposures, subject to supervisory review, the SF may be implemented using the simplifications: h = 0 and v = 0.

636. Under the conditions provided below, banks may employ a simplified method for calculating the effective number of exposures and the exposure-weighted average LGD.

Let Cm in the simplified calculation denote the share of the pool corresponding to the sum of the largest ‘m’ exposures (e.g. a 15% share corresponds to a value of 0.15).

The level of m is set by each bank.

• If the portfolio share associated with the largest exposure, C1, is no more than 0.03 (or 3% of the underlying pool), then for purposes of the SF, the bank may set LGD=0.50 and N equal to the following amount

• Alternatively, if only C1 is available and this amount is no more than 0.03, then the bank may set LGD=0.50 and N=1/ C1.

(vii) Liquidity facilities

637. Liquidity facilities are treated as any other securitization exposure and receive a CCF of 100% unless specified differently in paragraphs 638 to 641.

If the facility is externally rated, the bank may rely on the external rating under the RBA.

If the facility is not rated and an inferred rating is not available, the bank must apply the SF, unless the IAA can be applied.

638. An eligible liquidity facility that can only be drawn in the event of a general market disruption as defined in paragraph 580 is assigned a 20% CCF under the SF.

That is, an IRB bank is to recognise 20% of the capital charge generated under the SF for the facility.

If the eligible facility is externally rated, the bank may rely on the external rating under the RBA provided it assigns a 100% CCF rather than a 20% CCF to the facility.

639. When it is not practical for the bank to use either the bottom-up approach or the top down approach for calculating KIRB, the bank may, on an exceptional basis and subject to supervisory consent, temporarily be allowed to apply the following method.

If the liquidity facility meets the definition in paragraph 578 or 580, the highest risk weight assigned under
the standardised approach to any of the underlying individual exposures covered by the liquidity facility can be applied to the liquidity facility. If the liquidity facility meets the definition in paragraph 578, the CCF must be 50% for a facility with an original maturity of one year or less, or 100% if the facility has an original maturity of more than one year.

If the liquidity facility meets the definition in paragraph 580, the CCF must be 20%.

In all other cases, the notional amount of the liquidity facility must deducted.

(viii) Treatment of overlapping exposures

640. Overlapping exposures are treated as described in paragraph 581.

(ix) Eligible servicer cash advance facilities

641. Eligible servicer cash advance facilities are treated as specified in paragraph 582.

(x) Treatment of credit risk mitigation for securitization exposures

642. As with the RBA, banks are required to apply the CRM techniques as specified in the foundation IRB approach of Section III when applying the SF.

The bank may reduce the capital charge proportionally when the credit risk mitigant covers first losses or losses on a proportional basis.

For all other cases, the bank must assume that the credit risk mitigant covers the most senior portion of the securitization exposure (i.e. that the most junior portion of the securitization exposure is uncovered).

 Examples for recognising collateral and guarantees under the SF are provided in Annex 7.

(xi) Capital requirement for early amortisation provisions

643. An originating bank must use the methodology and treatment described in paragraphs 590 to 605 for determining if any capital must be held against the investors’ interest.

For banks using the IRB approach to securitization, investors’ interest is defined as investors’ drawn balances related to securitization exposures and EAD associated with investors’ undrawn lines related to securitization exposures.

For determining the EAD, the undrawn balances of securitized exposures would be allocated between the seller’s and investors’ interests on a pro rata basis, based on the proportions of the seller’s and investors’
shares of the securitized drawn balances.

For IRB purposes, the capital charge attributed tothe investors’ interest is determined by the product of

(a) the investors’ interest

(b) the appropriate CCF

(c) K_IRB.

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