BPR210: Connected Exposures Policy Exposure Draft

Ref #20048420 v1.3

BPR210 Connected Exposures Policy

1 1 Document Title Ref #20048420 v1.3 Contents Part A: Introduction and definitions __________________________________________________________ 2 A.1 Purpose of this document 2 A.2 Scope and level of application 2 A.3 Definition of connected person 2 Part B: Requirements __________________________________________________________________________ 5 B.1 Exposures limits 5 B.2 Conduct 6 B.3 Directors’ attestation, systems and controls 6 Part C: Exposure measurement _______________________________________________________________ 7 C.1 General measurement principles 7 C.2 Definition of exposure value 7 C.3 Recognition of CRMs in reduction of exposures to its connected person 8 C.4 Eligible credit risk mitigation 8 C.5 Calculation of exposure value for trading book positions 9

2 2 Document Title Ref #20048420 v1.3 Part A: Introduction and definitions A.1 Purpose of this document

1. The purpose of the connected exposures policy is to support the stability of the financial system by: (a) addressing the risk of conflict of interest with connected persons; (b) preventing abuses arising in transactions with connected persons; and (c) providing a back-stop measure to a locally incorporated registered bank in the event its prevention measures have failed.
2. This requires a locally incorporated registered bank to monitor transactions with connected persons and have appropriate and effective systems and controls in place to ensure that the risks are managed and that credit exposures to connected persons are not contrary to the interests of its banking group.
3. The policy also requires a locally incorporated registered bank to measure its banking group’s exposures to connected persons and limit the size of aggregate connected exposures in relation to the banking group’s capital.
4. This document sets out the following: (a) definition of a connected person; (b) requirements on conduct, systems and controls; and (c) requirements on measuring a banking group’s exposures to connected persons and limit the size of the total connected exposures in relation to the banking group’s capital. A.2 Scope and level of application
5. Exposure limits are set out in Part B. The limits are applicable to a locally incorporated registered bank and limit the banking group’s exposures to the bank’s connected persons. The banking group of a locally incorporated registered bank is defined in clause 4(1) of the Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order 2014 (as amended)).
6. A locally incorporated registered bank (a ‘registered bank’ unless otherwise specified) is generally subject to standard conditions of registration relating to exposure to connected persons.
7. The Reserve Bank reserves the right to impose non-standard conditions of registration or to vary the standard conditions of registration of a registered bank where special circumstances arise and/or it considers it appropriate to do so. A.3 Definition of connected person
8. A person (A) is a connected person of a registered bank if— (a) A is a director or senior manager of the registered bank or of any of its associated persons; or (b) A is a relative of a director or senior manager of the registered bank or of any of its associated persons; or (c) A is a subsidiary of the registered bank; or

3 3 Document Title Ref #20048420 v1.3 (d) A has control of the registered bank; or (e) A has significant influence over the registered bank; or (f) the registered bank has control of A; or (g) the registered bank has significant influence over A; or (h) a director of the registered bank has either control of or significant influence over A; or (i) any other person who has either control of or significant influence over the registered bank has either control of or significant influence over A; or (j) 40% or more of A’s governing body are the same persons as 40% or more of the governing body of — (i) the registered bank; or (ii) another person that has either control of or significant influence over the registered bank. 2. Director means,— (a) in relation to a company, any person occupying the position of a director of the company by whatever name called; or (b) in relation to a partnership (other than a limited partnership), any partner; or (c) in relation to a limited partnership, any general partner; or (d) in relation to a body corporate or unincorporate, other than a company, partnership, or limited partnership, any person occupying a position in the body that is comparable with that of a director of a company. 3. Senior manager means a person who occupies any of the following positions (by whatever name called): (a) chief executive; or (b) chief financial officer; or (c) a manager who reports directly to the chief executive. 4. A person (A) is an associated person with another person (B) if— (a) B is A’s holding entity or subsidiary; or (b) 50% or more of the voting securities of A, other than voting securities that carry no right to participate beyond a specified amount in a distribution of either profits or capital, are held by B and persons that are an associated person with B (whether directly or indirectly, but other than in a fiduciary capacity); or (c) 50% or more of the voting securities of each of A and B, other than voting securities that carry no right to participate beyond a specified amount in a distribution of either profits or capital, are held by members of the other (whether directly or indirectly, but other than in a fiduciary capacity); or (d) the businesses of A and B have been carried on in such a manner that the separate business of each person, or a substantial part of it, is not readily identifiable; or (e) there is another person with which both persons are associated persons. 5. A person is another person’s holding entity if, and only if, that other person is its subsidiary.

4 4 Document Title Ref #20048420 v1.3 6. Subsidiary means a subsidiary within the meaning of sections 5 to 8 of the Companies Act 1993. 7. Voting rights and voting securities have the same meaning as in section 2 of the Banking (Prudential Supervision) Act 1989. 8. A relative, in relation to any person, means: (a) the person’s spouse, civil union partner, or de facto partner; or (b) any parent, step-parent, brother, sister, child, or stepchild of the person; or (c) any parent, step-parent, brother, sister, child, or stepchild of the person’s spouse, civil union partner, or de facto partner. 9. A person (B) has control of another person (C) if — (a) B has the power (whether directly or indirectly) to — (i) exercise, or control the exercise of, 50% or more of the voting rights in C; or (ii) appoint 50% or more of the directors of C; or (b) B has, together with one or more specified persons, the power (whether directly or indirectly) to — (i) exercise, or control the exercise of, 50% or more of the voting rights in C; or (ii) appoint 50% or more of the directors of C. 10. A person (B) has significant influence over another person (C) if — (a) B has the ability (whether directly or indirectly) to — (i) exercise, or control the exercise of, 20% or more of voting rights in C; or (ii) appoint 25% or more of the board of directors of C; or (b) B has, together with one or more specified persons, the ability (whether directly or indirectly) to — (i) exercise, or control the exercise of, 20% or more of the voting rights in C; or (ii) appoint 25% or more of the board of directors of C. 11. Specified person, in relation to sections 9 and 10 of this document, means— (a) a person who is acting, or will act, jointly or in concert with B in respect of exercising, or controlling the exercise of, a power referred to in section 9(b)(i) or (ii) or section 10(b)(i) or (ii) of this document; or (b) a person who acts, or is accustomed to acting, in accordance with the wishes of B. 12. Governing body means,— (a) in relation to a body corporate, the board of directors (or other persons or body exercising powers of management, however described) of the body corporate: (b) in relation to a partnership or other unincorporated body of persons, either— (i) the board of directors (or other persons or body exercising powers of management, however described) of the partnership or other unincorporated body of persons; or (ii) if there is no board or other persons or body as described in subsection 12(b)(i) of this document, the partners of the partnership or members of the unincorporated body of persons

5 5 Document Title Ref #20048420 v1.3 13. The central government of any country with a long-term credit rating of A- or A3 or above, or its equivalent is not a connected person. 14. Any member of the registered bank’s banking group is not a connected person. 15. Non-bank connected person means any connected person other than a registered bank or an entity which a registered bank has either control of or significant influence over. Guidance: The meaning of ’director’, ’senior manager’, ’associated person’, ’holding entity’, ’subsidiary’, ’relative’, ’control’, ’specified person’ and ’governing body’ are based on the definitions in the Deposit Takers Bill. Some definitions in this document may be different from the definitions in other existing BPR documents. The definitions in this document will be replaced to be in line with those to be defined in the Deposit Takers Act if and when it has been enacted. Part B: Requirements B.1 Exposures limits

1. Aggregate credit exposures of the banking group to all connected persons must not exceed the rating-contingent limit outlined in the following matrix at the end of each working day at all times. Credit rating1 Connected exposure limit (% of the Banking Group’s Tier 1 capital) AA/Aa2 and above 75 AA-/Aa3 70 A+/A1 60 A/A2 40 A-/A3 30 BBB+/Baa1 and below 15
2. Within the rating-contingent limit, credit exposures to non-bank connected persons must not exceed 15 percent of the banking group’s tier 1 capital at the end of each working day at all times. Guidance: The exposure limits apply to the end-of-day exposures. Intra-day exposures are not subject to the exposure limits.
3. The exposures must be measured as specified in Part C of this document.
4. The aggregate credit exposures are the sum of exposures, across all connected persons, measured by each of connected persons.
5. ’Tier 1 capital’ has the same meaning as in the Reserve Bank document ‘BPR110: Capital Definitions’, in the version applying to the registered bank in its conditions of registration.

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1 The rating scales in this column are presented as “Standard & Poor’s scale/Moody’s Investor Services scale,” noting that Fitch Ratings’ scale is identical to Standard & Poor’s.

6 6 Document Title Ref #20048420 v1.3 6. In relation to A2.2(2) and B1.6 in BPR110, an advance will be considered to be of a capital nature and defined as ‘advances of a capital nature by a banking group to connected persons’, if, in a connected person’s financial statements, it is described as a capital or subordinated debt instrument and/or it is counted as capital under the capital adequacy requirements imposed by a parent supervisor. 7. For the purpose of compliance with the rating-contingent limit: (a) The credit rating will be the rating applicable to the registered bank’s long-term senior unsecured New Zealand dollar obligations payable in New Zealand, in New Zealand dollars. Where a registered bank has more than one credit rating, the lowest rating will be used in determining the connected exposure limit. (b) Only credit ratings produced by rating agencies approved by the Reserve Bank may be used. Those agencies are: Standard & Poor’s, Moody’s Investor Services and Fitch Ratings. (The Reserve Bank’s ’Statement of Principles’ (BS1), in particular Appendix Three of BS1, provides details on the approval of credit rating agencies.) (c) A three-month grace period starting from the date of a credit rating downgrade will be allowed for the limit which applies before the downgrade to reduce to the new limit based on the above matrix. The Reserve Bank will consider allowing an extension of the limit adjustment period if a registered bank has structural reasons for not being able to comply within the three-month period. The limit extension would be for a specific time period (but no longer than an additional three months). B.2 Conduct

1. Exposures of a registered bank’s banking group to connected persons must not be on more favourable terms (e.g. as relates to such matters as credit assessment, tenor, interest rates, amortisation schedules, requirement for collateral) than corresponding exposures to non￾connected persons.
2. A registered bank must adequately monitor its banking group’s transactions with connected persons to take appropriate steps to control the risks to prevent abuses arising in such transactions and to address the risk of conflict of interest, as set out in subsection B.3. B.3 Directors’ attestation, systems and controls
3. A registered bank must maintain a clear and appropriate allocation of responsibility, among the registered bank’s directors, for the registered bank’s compliance with the requirements set out in this Policy.
4. A registered bank must take reasonable care to establish and maintain effective systems to ensure the registered banks’ compliance with the requirements in this Policy at all times. Guidance: The purpose of this sub-section B.3 is to encourage registered banks’ directors to take appropriate practical responsibility for the bank’s arrangements to ensure the registered bank’s compliance with the requirements in this Policy. This sub-section B.3 should be read in conjunction with the required directors’ statement in the Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order 2014 (as amended). Guidance: Examples of the ’systems’ in the sub-section B.3(2) include (i) adequate policies and procedures approved by the registered bank’s board to ensure that credit exposures to connected persons (e.g., writing off of exposures to connected persons) are not contrary to the interests of the registered bank’s banking group; and (ii) adequate arrangements to monitor and

7 7 Document Title Ref #20048420 v1.3 control the banking group’s exposures to connected persons to ensure the registered bank’s compliance with the exposure limits at all times. Part C: Exposure measurement C.1 General measurement principles

1. The exposure values that a registered bank must consider in order to identify exposures to a connected person are all those exposures covered under the Capital Adequacy Framework defined in the Reserve Bank document ’BPR100: Capital adequacy’.
2. It must consider both on- and off-balance sheet exposures included in either the banking or trading book and instruments with counterparty credit risk under the Capital Adequacy Framework (e.g., derivatives and securities financing transactions (SFTs)).
3. A registered bank must not recognise any kinds of credit risk mitigations or potential recoveries other than the eligible credit risk mitigations specified in C.3 and C.4 in this document. Guidance: Some banks may take into account other relevant factors (e.g. credit quality) in their internal risk management framework to set internal exposure limits to their counterparties, including connected persons. However, such internal measures must not be recognised for the purpose of the connected exposures policy.
4. An asset deducted from capital must not be included in exposures to a connected person in accordance with A1.3(2) of the Reserve Bank document BPR131: Standardised Credit Risk RWAs (BPR131). Guidance: For example, assets which have been written off should not be included in the definition of exposure, as long as the registered bank has reduced their capital commensurately. This is because, if an exposure has Tier 1 capital held against the value of the exposure, there is no prudential benefit from an added limit to the size of the exposure relative to capital. C.2 Definition of exposure value
5. The exposure value for any on-balance sheet items must be defined as the value after deducting any impairment allowances attributable to the exposure in accordance with A1.3(2)(b) of BPR131. As a conservative alternative option, a registered bank may use the gross exposure value without deductions.
6. For the purpose of the connected exposures policy, off-balance sheet items will be converted into the credit equivalent amount (CEA) through the use of credit conversion factors (CCFs) by applying a flat 100% CCF. Guidance: This flat 100% CCF is applicable only when registered banks calculate an exposure value for the purpose of the connected exposure policy. This is because the connected exposures policy is focused on the maximum possible loss that could arise in the event of the sudden failure of a connected person, and therefore it is appropriate to assume that a

8 8 Document Title Ref #20048420 v1.3 connected person will take all possible actions to prevent its failure (e.g., drawing on any funds available to it in order to prolong its existence as a going concern). 3. A registered bank may enter into an unfunded contingent credit protection arrangement (e.g. guarantee, credit derivative and indemnity) with a connected person to reduce the value of its exposure to a counterparty that is not a connected person, to the extent of the portion protected under the unfunded contingent credit protection arrangement. Such arrangements give rise to a contingent credit exposure to connected persons. For the purpose of the connected exposures policy, the definition of exposure value excludes any such contingent exposures to connected persons. 4. The exposure value for derivatives and SFTs that give rise to counterparty credit risk must be measured in accordance with Part E of BPR131 in the version applying to the registered bank in its conditions of registration, which sets out the measurement methodology to calculate the CEA of the counterparty credit risk arising from these contracts. C.3 Recognition of CRMs in reduction of exposures to its connected person

1. When a registered bank has recognised eligible credit risk mitigation (CRM) for the purpose of risk-weighted asset (RWA) calculation for credit exposure, the registered bank may reduce the value of the exposure to its connected person, by the amount of the eligible CRM calculated in accordance with Part B, Part C and Sub-part D1 of the Reserve Bank document BPR132: Credit Risk Mitigation (BPR132) and recognised for the purpose of RWA calculation.
2. Types of CRMs that are allowed to be recognised for the purpose of the Connected Exposures Policy are only those available for adjusting standardised RWA calculations. Guidance:  As a conservative alternative option, a registered bank may choose to use gross exposure value without recognising eligible CRMs to measure exposures applicable to the connected exposure limits.  Registered banks are not allowed to recognise eligible CRMs that are not recognised for the purpose of RWA calculation for credit exposure.  Any other types of CRMs that are eligible only for internal-ratings based modelled exposures (e.g. real estate and collateral for lease financing) must not be used to reduce exposure values for the purpose of connected exposures policy. C.4 Eligible credit risk mitigation
3. Eligible CRMs are those that meet both the general requirements set out in A2 of the Reserve Bank document BPR132: Credit Risk Mitigation and all the relevant parts of requirements, conditions and eligibility criteria for the recognition of collaterals, guarantees, credit derivatives and on-balance sheet netting that are set out for adjusting standardised RWA calculation in BPR132 and Part E of BPR131. Guidance: To be an eligible CRM, all elements of the eligibility conditions including details of requirements and Guidance must be met. For example, section E3.1(2)(d)(i) of BPR131 clarifies the application of the phrase “laws of all relevant jurisdictions” by stating that “if a foreign branch of the counterparty is involved, the law of the jurisdiction in which the branch is located”. This means that a bilateral netting agreement

9 9 Document Title Ref #20048420 v1.3 involving a foreign branch of the counterparty can be eligible, but that involving a subsidiary of the counterparty cannot be eligible. Another example is that Guidance for section E3.1(2) clarifies that “a payment netting contract intended only to reduce the operational costs of daily settlements typically does not meet the conditions in subsection (2)”. All the Guidance should be taken into account as part of the eligibility conditions. 2. Registered banks must not recognise any form of unfunded contingent credit protection provided by its connected person. Guidance: This subsection C.4(2) is a recap of the subsections D1.2 and D2.2 of BPR132. Examples of unfunded contingent credit protection are a guarantee, credit derivative, indemnity. For clarity, unfunded contingent credit protection provided by Connected Person A against a failure of Connected Person B is not allowed to be recognised. Unfunded contingent credit protection provided by an entity other than a connected person against the failure of a connected person can be recognised. 3. A registered bank must use the standardised supervisory haircuts specified in subsection B2 of BPR132, and must not use its internally modelled haircuts. 4. In accordance with provisions set out in E1.3(1) of BPR132, a registered bank must not recognise a CRM that has (i) an effective original maturity of less than 12 months and (ii) a maturity mismatch with the underlying exposure. 5. If there is a maturity mismatch in respect of CRMs (collateral, on-balance sheet netting, guarantees and credit derivatives) recognised in accordance with Part E of BPR132, the adjustment of the credit protection for the purpose of calculating connected exposures is determined using the same approach as in Part E of BPR 132. C.5 Calculation of exposure value for trading book positions

1. Where a banking group holds positions in financial instruments (such as equities and bonds) issued by a connected person in its trading book, the registered bank must add those exposures to its exposures to the connected person that lie in the banking book. Guidance: This sub-section C.5 is relevant only for a registered bank whose banking group holds positions in financial instruments issued by a connected person for a trading purpose.
2. The exposure value must be measured in accordance with the Reserve Bank document BPR140: Market Risk.
3. A registered bank may offset long and short positions in financial instruments issued by its connected person within a trading book. Offsetting long and short positions across the banking and trading books is not permitted.