Instruction No. 12/2019
Official Gazette No. 6/2019 2nd Supplement • 2019/06/28

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Topics
Supervision :: Prudential Rules

Index

Text of the Instruction

Text of the Instruction

Subject: Specification of the types of exposures that should be associated with higher risks under Article 128 of Regulation (EU) No. 575/2013 of the European Parliament and of the Council of 26 June 2013

Article 128 of Regulation (EU) No. 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No. 648/2012 (“Regulation (EU) No. 575/2013”) establishes, for the purposes of calculating own funds requirements for credit risk under the Standardised Approach, the assignment of a 150% risk weight to exposures that are associated with particularly high risks.

Under paragraph 3 of Article 128 of Regulation (EU) No. 575/2013, when assessing whether an exposure is associated with particularly high risks, institutions shall take into account, in particular, the existence of a high risk of loss as a result of debtor default.

With the aim of promoting convergence in the practices followed by institutions and supervisors and avoiding unjustified variability in the calculation of the amount of risk-weighted exposures under the Standardised Approach and in fulfilment of the mandate conferred on it in paragraph 3 of Article 128 of Regulation (EU) No. 575/2013, the European Banking Authority (“EBA”) issued, on 17 January 2019, guidelines specifying the types of exposures that should be associated with high risks and under what circumstances - EBA/GL/2019/01 (“Guidelines”). The draft Guidelines were, prior to their approval, submitted to public consultation promoted by the EBA in April 2018.

Banco de Portugal notified the EBA of its intention to adopt the Guidelines, which are fully incorporated into national law through this Instruction, the text of which corresponds to the final text of the Guidelines issued by the EBA.

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Bearing in mind, in the context of the Single Supervisory Mechanism, the division of the exercise of supervisory tasks between Banco de Portugal, as the national competent authority, and the European Central Bank, under Regulation (EU) No. 1024/2013 of the Council of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions, this Instruction applies to less significant credit institutions, within the meaning of paragraph 4 of Article 6 of the said Regulation. Considering the scope of application of Regulation (EU) No. 575/2013, the instruction also applies to investment firms qualified as financial companies.

The exercise of identifying elements associated with particularly high risks required by this Instruction must cover all risk classes, with particular emphasis on the risk classes referred to in points (g), (p) and (q) of Article 112 of Regulation (EU) No. 575/2013 (i.e., exposures to corporates, exposures to equities and other items, respectively).

In this exercise, institutions should consider exposures that present levels and ranges of risk factors that are not common to other debtors or transactions of the same risk class.

For the exposures referred to in paragraph 2 of Article 3 of this Instruction, this criterion is considered automatically met, and institutions must assign them to the risk class elements associated with particularly high risks and assign them a 150% risk weight.

In order to enable the monitoring of the characteristics of exposures to which a 150% risk weight is assigned resulting from the application of paragraph 3 of Article 128 of Regulation (EU) No. 575/2013, a duty is introduced for institutions to report to Banco de Portugal whenever they identify other types of exposure, other than those referred to in point (b) of paragraph 1 and paragraph 2, both of Article 3 of this Instruction, that entail a particularly high risk of loss. The notification should be accompanied by a description of the main characteristics of the exposure and will subsequently be forwarded by Banco de Portugal to the EBA.

Additionally, on the EBA's own initiative, the Guidelines further specify characteristics of exposures that should be classified as venture capital investments and private equity investments for the purposes of the provisions in the corresponding points of paragraph 2 of Article 128 of Regulation (EU) No. 575/2013. For this purpose, institutions should consider that

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venture capital investments and private equity investments include, at a minimum, exposures that meet the requirements set out in Articles 7 and 8 of this Instruction. Accordingly, Banco de Portugal, in the exercise of the competence conferred on it by Article 17 of its Organic Law and by point (f) of paragraph 1 of Article 116 of the General Regime for Credit Institutions and Financial Companies, approved by Decree-Law No. 298/92 of 31 December, determines the following:

Article 1 Subject matter

This Instruction implements in the national legal order the Guidelines of the European Banking Authority on the specification of the types of exposures that should be associated with high risk (EBA/GL/2019/01), hereinafter referred to as the "Guidelines", specifying:

a) The types of exposures that are not listed in paragraph 2 of Article 128 of Regulation (EU) No. 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms ("Regulation (EU) No. 575/2013") and that should be associated with particularly high risk, and in what circumstances, in accordance with the provisions of paragraph 3 of Article 128 of Regulation (EU) No. 575/2013;

b) The minimum requirements whose verification leads to the classification of exposures as investments in venture capital firms and investments in private equity for the purposes of the provisions of points (a) and (c) of paragraph 2 of Article 128 of Regulation (EU) No. 575/2013.

Article 2. Subjective scope

This Instruction applies to the following entities:

a) Less significant credit institutions, within the meaning of paragraph 4 of Article 6 of Regulation (EU) No. 1024/2013 of the Council of 15 October, which confers specific tasks on the European Central Bank with regard to policies relating to the prudential supervision of credit institutions;

b) Investment firms qualified as financial companies within the meaning of point (a) of paragraph 1 of Article 6 of the General Regime for Credit Institutions and Financial Companies, approved by Decree-Law No. 298/92 of 31 December.

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Article 3.

Identification of elements associated with particularly high risk

1. For the purposes of paragraph 3 of Article 128 of Regulation (EU) No. 575/2013, the entities referred to in the previous article identify as elements associated with particularly high risk:

a) Exposures that present levels and ranges of risk factors that are not common to other debtors or transactions of the same risk class;

b) Equity exposures, under the terms of Article 4 of this Instruction.

2. For the purposes of the provisions of point (a) of the previous paragraph, the following exposures present levels and ranges of risk factors that are not common to other debtors or transactions of the same risk class:

a) Financing of speculative investments in financial and non-financial assets that are not real estate, under the terms of Article 5 of this Instruction;

b) Exposure to an entity created specifically to finance or manage physical assets that are not real estate for which there is no external credit assessment, under the terms of Article 6 of this Instruction.

Article 4.

Equity exposures

For the purposes of point (b) of paragraph 1 of the previous article, equity exposures to a given issuer are considered, whenever one of the following conditions is met:

a) A risk weight of 150% is applied to an exposure of the entity referred to in Article 2 of this Instruction to debt securities of that issuer;

b) A risk weight of 150% would be applied to an exposure that the entity referred to in Article 2 of this Instruction held to debt securities of that issuer, as a result of the verification of one of the following conditions:

i) The associated credit assessment, carried out by an external rating agency appointed by the entity referred to in Article 2 of this Instruction, would result in the assignment of a risk weight of 150%;

ii) The issuer is in a situation of default, under the terms of Article 178 of Regulation (EU) No. 575/2013.

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Article 5.

Financing of speculative investments

For the purposes of point (a) of paragraph 2 of Article 3 of this Instruction, financing of speculative investments in financial and non-financial assets that are not real estate are considered to be those in which the debtor intends to resell the assets to generate profit, including speculative financing of movable goods, agricultural products or intangible assets, namely licenses or patents, when the following conditions are met:

a) There is a particularly high risk of loss in the event of default by the debtor, in particular, in the event of insufficient market liquidity or high volatility of the prices of the financed object, which has not yet been sufficiently mitigated by contractual provisions, including by irrevocable pre-sale agreements;

b) The debtor does not have other sufficient income and assets to mitigate the risk of loss for the entity referred to in Article 2 of this Instruction, in particular, in cases where this risk of loss is high given the debtor's financial resources.

Article 6.

Exposures to an entity created specifically to finance or manage physical assets

1. For the purposes of point (b) of paragraph 2 of Article 3 of this Instruction, exposures to an entity created specifically to finance or manage physical assets for which there is no external credit assessment, or exposures that are economically comparable, are considered when the following conditions are met:

a) The exposures contain contractual provisions that give the lender a significant level of control over the assets and the income generated by them;

b) The main source of repayment of the obligation is the income produced by the assets subject to financing, and not the independent capacity of a broader commercial company;

c) The entity referred to in Article 2 of this Instruction identifies a high risk of loss.

2. For the purposes of paragraph c) of the previous number, a high risk of loss is identified by reference to one of the following conditions:

a) The existence of significant deficiencies in the financial soundness of the corresponding instrumental entity;

b) The existence of significant uncertainty related to the political and legal framework of the project's location;

c) The characteristics of the operations or assets;

d) The weak soundness of the sponsor or promoter.

3. In the case of an exposure related to project financing in the form of a single project in its pre-operational phase, a high risk of loss is identified by reference, in addition to the criteria referred to in the previous number, to the existence of cash flows that, functioning simultaneously as collateral and source of repayment, are not of high quality.

4. For the purposes of the previous number, it is considered that:

a) A project is in its pre-operational phase when it does not yet have sufficient positive cash flows to cover any remaining contractual obligations and a decreasing long-term debt;

b) Cash flows are not of high quality when they do not allow for the timely satisfaction of financial commitments to the respective financing entity.

Article 7

Investments in venture capital companies

For the purposes of paragraph a) of no. 2 of Article 128 of Regulation (EU) No. 575/2013, investments in venture capital companies are considered to be those that satisfy the following conditions:

a) The investment is one of the following exposures:

i) An unlisted exposure that is not an exposure to debt securities and that implies a subordinated and residual credit on the assets or income of an unlisted company,

ii) An exposure to debt securities and other securities, partnerships, derivatives or other vehicles, whose economic substance is similar to that of the exposures specified in subparagraph i) and is not listed on a stock exchange;

b) The investment is made with the objective of financing start-up companies, namely the development of a new product and research

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related so that the company can place that product on the market, the creation of the company's production capacity or the expansion of the company's activity.

Article 8

Private equity investments

1. For the purposes of paragraph c) of no. 2 of Article 128 of Regulation (EU) No. 575/2013, private equity investments are considered to be those that satisfy the following conditions:

a) The investment is one of the following exposures:

i) An unlisted exposure that is not an exposure to debt securities and that implies a subordinated and residual credit on the assets or income of a company, or

ii) An exposure to debt securities and other securities, partnerships, derivatives or other vehicles, whose economic substance is similar to that of the exposures specified in subparagraph i) and is not listed on a stock exchange;

b) The investment is made with the intention of generating profit through a leveraged buyout, an initial public offering, the sale of the equity stake by other means or any operation whose economic substance is similar.

2. By way of derogation from the previous number, investments in which the entities referred to in Article 2 of this Instruction intend to develop a strategic commercial relationship with the company in which they invest are not considered private equity investments.

3. The entities referred to in Article 2 of this Instruction assess whether the investments referred to in the previous number constitute elements associated with high risks under the provisions of Articles 3 to 6 of this Instruction.

Article 9

Duty of notification

1. The entities referred to in Article 2 of this Instruction notify Banco de Portugal whenever they identify exposures that entail a particularly high risk of loss under no. 3 of Article 128 of Regulation (EU) No. 575/2013.

2. The notification referred to in the previous number is accompanied by a description of the main characteristics of the exposure.

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3. The duty of notification provided for in this article does not cover the exposures identified in Articles 4 to 6 of this Instruction.

Article 10 Entry into force

This Instruction enters into force on 1 July 2019.