Prudential Regulation Authority Rulebook

1.

A firm must calculate the loss-given-default on a single name exposure as equal to the sum of the loss-given-default on each of the exposures to counterparties belonging to the single name exposure on the following basis:

1. (1) the loss-given-default must be net of the liabilities towards counterparties belonging to the single name exposure provided that:
   1. (a) those liabilities and exposures are set off in the case of default of the counterparties; and
   2. (b) 3G2 and 3G3 are complied with in relation to that right of set-off; and
2. (2) no offsetting shall be allowed for if the liabilities are expected to be met before the credit exposure is cleared.

2.

Where a firm has concluded contractual netting agreements covering several derivatives that represent credit exposure to the same counterparty, it may calculate the loss-given-default on those derivatives, as set out in 3E4.5 to 3E4.8, on the basis of the combined economic effect of  all of those derivatives that are covered by the same contractual netting agreement, provided that 3G2 and 3G3 are complied with in relation to the netting.

3.

A firm must calculate the loss-given-default on a reinsurance arrangement or insurance securitisation in accordance with the following formula:

$$LGD=max[50\mathrm{\%}\cdot (Recoverables+50\mathrm{\%}\cdot {RM}_{re})-F\cdot Collateral;0]$$

where:

1. (a) Recoverables denotes the best estimate of amounts recoverable from the reinsurance arrangement or insurance securitisation and the corresponding debtors;
2. (b) RM_re denotes the risk mitigating effect on underwriting risk of the reinsurance arrangement or securitisation;
3. (c) Collateral denotes the risk-adjusted value of collateral provided by way of a collateral arrangement in relation to the reinsurance arrangement or securitisation; and
4. (d) F denotes a factor to take into account the economic effect of the collateral arrangement in relation to the reinsurance arrangement or securitisation in case of any credit event related to the counterparty, determined in accordance with 3E10.7.

4.

Where the reinsurance arrangement is with a UK Solvency II undertaking, a third country insurance undertaking or a third country reinsurance undertaking and 60% or more of that counterparty’s assets are subject to collateral arrangements, a firm must calculate the loss-given-default in accordance with the following formula:

$$LGD=max(90\mathrm{\%}\cdot (Recoverables+50\mathrm{\%}\cdot {RM}_{re})-F^{\mathrm{\prime }}\cdot Collateral;0)$$

where:

F’ denotes a factor to take into account the economic effect of the collateral arrangement in relation to the reinsurance arrangement or securitisation in the case of a credit event related to the counterparty, determined in accordance with 3E10.7.

5.

A firm must calculate the loss-given-default on a derivative falling within 3E5.1 in accordance with the following formula:

$$LGD=max(18\mathrm{\%}\cdot (Derivative+50\mathrm{\%}\cdot {RM}_{fin})-50\mathrm{\%}\cdot F^{\mathrm{\prime }}\cdot Value;0)$$

where:

1. (a) Derivative denotes the value of the derivative determined in accordance with Valuation 2.1 to 2.2;
2. (b) RM _fin denotes the risk-mitigating effect on market risk of the derivative;
3. (c) Value denotes the value of the assets held as collateral, provided by way of a collateral arrangement, determined in accordance with Valuation 2.1 to 2.2; and
4. (d) F′ denotes a factor to take into account the economic effect of the collateral arrangement in relation to the derivative in case of a credit event related to the counterparty, determined in accordance with 3E10.7.

6.

Notwithstanding 3E4.5, a firm must calculate the loss-given-default on a derivative falling within 3E5.2 in accordance with the following formula:

$$LGD=max(16\mathrm{\%}\cdot (Derivative+50\mathrm{\%}\cdot {RM}_{fin})-50\mathrm{\%}\cdot F"\cdot Value;0)$$

where:

1. (a) Derivative denotes the value of the derivative in accordance with Valuation 2.1 to 2.2;
2. (b) RM _fin denotes the risk-mitigating effect on market risk of the derivative;
3. (c) Value denotes the value of the assets held as collateral, provided by way of a collateral arrangement, in accordance with Valuation 2.1 to 2.2; and
4. (d) F′′ denotes a factor to take into account the economic effect of the collateral arrangement in relation to the derivative in case of a credit event related to the counterparty, determined in accordance with 3E10.7.

7.

A firm must calculate the loss-given-default on derivatives other than those referred to in 3E4.5 and 3E4.6 in accordance with the following formula, provided that the derivative contract meets the requirements of Article 11 of Regulation (EU) 648/2012:

$$LGD=max(90\mathrm{\%}\cdot (Derivative+{50\mathrm{\%}\cdot RM}_{fin})-50\mathrm{\%}\cdot F^{\mathrm{\prime }\mathrm{\prime }\mathrm{\prime }}\cdot Value;0)$$

where:

1. (a) Derivative denotes the value of the derivative determined in accordance with Valuation 2.1 to 2.2;
2. (b) RM _fin denotes the risk-mitigating effect on market risk of the derivative;
3. (c) Value denotes the value of the assets held as collateral, provided by way of a collateral arrangement, determined in accordance with Valuation 2.1 to 2.2; and
4. (d) F′′′ denotes a factor to take into account the economic effect of the collateral arrangement in relation to the derivative in case of a credit event related to the counterparty, determined in accordance with 3E10.7.

8.

A firm must calculate the loss-given-default on derivatives not covered by 3E4.5, 3E4.6 and 3E4.7 in accordance with the following formula:

$$LGD=max(90\mathrm{\%}\cdot (Derivative+{RM}_{fin})-F^{\mathrm{\prime }\mathrm{\prime }\mathrm{\prime }}\cdot Collateral;0)$$

where:

1. (a) Derivative denotes the value of the derivative determined in accordance with Valuation 2.1 to 2.2;
2. (b) RM _fin denotes risk-mitigating effect on market risk of the derivative;
3. (c) Collateral denotes the risk-adjusted value of collateral provided by way of a collateral arrangement in relation to the derivative; and
4. (d) F′′′ denotes a factor to take into account the economic effect of the collateral arrangement in relation to the derivative in case of a credit event related to the counterparty, determined in accordance with 3E10.7.

9.

Where the loss-given-default on derivatives is to be calculated on the basis referred to in 3E4.2, the following rules apply for the purposes of 3E4.5 to 3E4.8:

1. (1) the value of the derivative must be the sum of the values of the derivatives covered by the contractual netting arrangement;
2. (2) the risk-mitigating effect must be determined at the level of the combination of derivatives covered by the contractual netting arrangement; and
3. (3) the risk-adjusted value of collateral provided by way of a collateral arrangement must be determined at the level of the combination of derivatives covered by the contractual netting arrangement.

10.

A firm must calculate the loss-given-default on a mortgage loan in accordance with the following formula:

$$LGD=max(Loan-(80\mathrm{\%}\cdot Mortgage+Guarantee);0)$$

where:

1. (a) Loan denotes the value of the mortgage loan determined in accordance with Valuation 2.1 to 2.2;
2. (b) Mortgage denotes the risk-adjusted value of the mortgage; and
3. (c) Guarantee denotes the amount that the guarantor would be required to pay to the firm if the obligor of the mortgage loan were to default at a time when the value of the property held as mortgage were equal to 80% of the risk-adjusted value of the mortgage.

11.

For the purposes of 3E4.10(c), a guarantee must only be recognised if it is provided by a counterparty mentioned in 3D24.2(1) to (3) and it complies with the requirements set out in 3G2, 3G3 and 3G9.1(1) to (5).

12.

A firm must calculate the loss-given-default on a legally binding commitment as referred to in 3.14(5) as the difference between its nominal value and its value in accordance with Valuation 2.1 to 2.2.

13.

The loss-given-default on cash at bank as referred to in Schedule 3 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008/410 as amended from time to time, of a deposit with a ceding undertaking, of an item listed in 3.14(4) or 3.15(5), or of a receivable from an intermediary or policyholder debtor, as well as any other exposure not listed elsewhere in this Chapter must be equal to its value in accordance with Valuation 2.1 to 2.2.