Review of Connected Exposures Policy: Response to Submissions

Ref #20048421 v1.6

Review of
Connected
Exposures Policy.
Response to Submissions
24 January 2023

1 Review of Connected Exposures Policy Ref #20048421 v1.6 Contents

1. Background _______________________________________________________________________________ 2
2. Consultation process _____________________________________________________________________ 3
3. Summary of submissions and the Reserve Bank’s policy position ______________________ 4
   Q2. Interbank exposures 4
   Q3. The definition of a connected person 4
   Q4. Conduct Requirements 6
   Q5. Gross Exposure Limit 7
   Q6. Net Exposure Limits 8
   Q7. Surveys and Information Collection 8
   Q8. Implementation Arrangements and Q18. Capital Measure 9 Q9. Impacts of the Proposed Policy Changes 9 Q10. General Principles for Exposure Measure 10 Q11. Market-Related Contracts 10 Q12. On-Balance Sheet Items (except “market related contracts”) 10 Q13. Off-Balance Sheet Contingent Credit Exposures 11 Q14. Calculation of Exposure Value for Financial Instruments Held for Trading 11 Q15. Recognition of Eligible Credit Risk Mitigations 12 Q16. On-Balance Sheet Netting 12 Q17. Treatment of Maturity Mismatches in CRM 13
4. Summary of other matters covered in the submissions ________________________________ 13

2 Review of Connected Exposures Policy Ref #20048421 v1.6

1. Background
   Banks incorporated and registered in New Zealand (a ‘New Zealand bank’) must comply with a range of rules put in place by the Reserve Bank of New Zealand - Te Pūtea Matua to support financial stability. Together, the rules reduce the risk of a bank failing and protect New Zealanders from the associated economic and social costs if a bank failure were to occur. The rules that are covered in the Reserve Bank’s Connected Exposures Policy limit the risks to a bank from transactions with and exposures to connected persons (e.g., conflicts of interest and failure). Connected exposures are a bank’s exposures to its connected persons – connected persons are natural or legal persons who are closely related to the bank. For example, a bank’s owners or other entities which the bank’s owners may have influence over. Exposures to connected persons can take a variety of forms – for example, loans, leases, deposits, investments (which include investments in equities and bonds issued by connected persons), undrawn lines of credit, bank guarantees of a connected person’s obligations to third parties and financial contracts (such as derivatives) with connected persons. In principle, any forms of transactions and arrangements that banks entered into with connected persons are considered as exposures to connected persons. The Connected Exposures Policy defines a connected person, sets out requirements on a bank’s systems and controls to manage the relevant risks such as conflicts of interest, and sets a way to measure a banking group’s exposures to connected persons. The policy then requires banks to limit the size of the total connected exposures in relation to their capital. These rules help prevent bank failure in New Zealand, and ultimately helps support financial stability in New Zealand. The current version of the connected exposure policy has been in place without major policy updates for over ten years. We have become aware of some issues that banks have encountered when measuring an exposure amount under the Connected Exposures Policy. These issues are mainly due to some ambiguity and inconsistency in the current wording of the policy. These issues appear to lead to a conservative calculation of connected exposures and might prevent banks from using what is common practice in financial markets (e.g., margin payments for derivatives contracts). According to feedback from industry, this constrains banks’ ability to manage credit and market risks appropriately and efficiently. We acknowledge that these ambiguities and inconsistencies exist and that they warrant a review of the policy. In November 2021 we proposed to clarify the methods used to calculate connected exposures. We also suggested changes to bring the Connected Exposures Policy more in line with the existing standardised capital adequacy framework, while maintaining the effectiveness of the policy.1 ____________ 1 The Reserve Bank’s consultation paper for a review of the Connected Exposures Policy
   (BS8) is available here. https://www.rbnz.govt.nz/- /media/ReserveBank/Files/Publications/Policy-development/Banks/Review-of-Connected-Exposures-Policy-BS8/Review-of-Connected-Exposures-Policy-BS8-Consultation￾Document.pdf?revision=d8fc8262-cd67-4d88-bb12-698d5a161067

3 Review of Connected Exposures Policy Ref #20048421 v1.6 The main proposals covered in the consultation material include:
 Allowing banks to recognise eligible credit risk mitigations (e.g., collateral received for derivative and securities financing transactions) for the purpose of the connected exposure policy in the same manner and eligible conditions as that are set out in the existing standardised approach for calculating credit risk capital requirements.;  Clearly setting out the eligibility conditions for recognising credit risk mitigations, and removing the gross exposure limit (note that the net exposure limits will be maintained);  Applying a flat 100% Credit Conversion Factor (CCF) to banks’ off-balance sheet contingent credit exposures to connected persons only for the purpose of connected exposure policy;  Exempting some specified interbank exposures to avoid potential constraints that banks may face given banks’ intraday operational practice; and  Expanding the definition of a connected person by adding: “an entity in which a director of the registered bank has a substantial interest (other than the registered bank and entities in which the registered bank itself has a substantial interest)”, to respond to a recommendation made in the International Monetary Fund (IMF)’s 2017 Financial Sector Assessment Programme (FSAP) review and to be consistent with Principle 20 of the Basel Core Principles for Effective Banking Supervision. We intend to progress with the proposals from our November 2021 Consultation Paper, with some amendments following stakeholder feedback. The rationale for these changes is set out in this paper along with a summary of stakeholder feedback. The specific wording for the proposed requirements is set out in the Exposure Draft published together with this paper. The requirements will be finalised after we receive comments on any technical or workability issues. We invite interested parties to submit comments on any technical or workability issues to: shoko.seta@rbnz.govt.nz by 8 March 2023. The Connected Exposures Policy will be integrated into the Banking Prudential Requirements (BPR) after this review. Its title will be ‘BPR210: Connected Exposures Policy’.
2. Consultation process
The consultation for a review of the Connected Exposures Policy (BS8) lasted from 29 November 2021 to 31 March 2022. The Reserve Bank received nine submissions, which we are publishing on our website along with this document. The submissions came from seven individual banks and one each from New Zealand Bankers’ Association (NZBA) and the New Zealand Financial Markets Association (NZFMA). This paper summarises the themes and views raised in submissions and clarifies the policy positions included in the exposure draft. Readers are encouraged to refer to the actual submissions for further details. In addition to receiving written submissions, the Reserve Bank engaged with industry through roundtable and bilateral meetings. In some cases these meetings saw additional issues raised, beyond those included in the formal submissions. Where possible, we have also responded to the additional issues that industry raised with us outside of their formal submissions. Beyond our proposals regarding the policy, submitters asked for clarity about how the proposals would fit into a Standards environment in the Deposit Takers Act if and when it is enacted in the

4 Review of Connected Exposures Policy Ref #20048421 v1.6 future. We have endeavoured to respond to these points subject to the future changes and developments. The structure of this response document matches that of the consultation paper published in November 2021. The Section 3 of this document covers questions 1 to 18 in the consultation paper, and the Section 4 covers other matters raised in the feedback.
3. Summary of submissions and the Reserve Bank’s policy
position
All the submitters expressed their broad support by responding to the Reserve Bank's proposed overall approach for reviewing the Connected Exposure Policy (Question 1). Specific points that the stakeholders agreed on were:
(i) making the policy consistent with both the capital adequacy framework (the simplest approach) and international best practice; (ii) reducing ambiguity in the Connected Exposure Policy; and (iii) clearly setting the eligibility conditions for recognising credit risk mitigations and removing the gross exposure limit. This section summarises submissions for Questions 2 to 18 in the consultation paper, and provides further explanation of the Reserve Bank’s policy positions, after having regard to the submissions. The Reserve Bank intends to seek feedback to the exposure draft wording to identify any technical or workability issues prior to making a final policy decision in H1 2023. Q2. Interbank exposures Under the current BS8 it is not clear whether interbank exposures are included in the exposures that are subject to the connected exposures limit, while the capital adequacy framework includes interbank exposures regardless of whether it is intra-day or inter-day. To provide consistency with the capital adequacy framework, and to reduce ambiguity in the policy, we sought stakeholders’ views on a simple alignment with the capital adequacy framework, including whether there is any need for an exemption for intraday interbank exposures. Stakeholders’ feedback Stakeholders expressed general support for alignment with the standardised capital adequacy framework. Separately, stakeholders sought clarity about the scope of interbank exposures which will be captured under the Connected Exposures Policy. The Reserve Bank’s policy position in the Exposure Draft policy The policy clarifies that a bank must not exceed the exposure limits at the end of each working day at all times. This means that the exposure limits apply to the end-of-day exposures. Intra-day exposures are not subject to the exposure limits, regardless of whether it is an interbank exposure or not. Q3. The definition of a connected person We proposed expanding the definition of a connected person by adding: “an entity in which a director of the registered bank has a substantial interest (other than the registered bank and entities in which the registered bank itself has a substantial interest)”. This proposal was to respond

5 Review of Connected Exposures Policy Ref #20048421 v1.6 to one of the recommendations made in the International Monetary Fund (IMF)’s 2017 Financial Sector Assessment Programme (FSAP) review, and to make the scope of a connected person in line with Principle 20 of the Basel Core Principles for Effective Banking Supervision. Stakeholders’ feedback Most submitters asked us to make the definition of connected person in the Connected Exposures Policy as closely aligned as possible with the definition of related party in either the NZ International Accounting Standard 24 (NZ IAS 24) Related Party Disclosures or the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML Act). If implemented, this alignment would mean that the definition would be expanded further than what we had originally proposed. One submitter enclosed its estimated credit exposure amount to connected persons using the definition of related party in the accounting standards. Its estimate indicated that the counter￾proposed alignment would slightly increase the number of the submitter’s connected persons, and consequently increase its aggregated credit exposures to connected persons by 1 percent of its estimate without factoring in the counter proposal. Submitters who advocated for the expansion of the definition explained that their proposed expansion would help reduce the operational complexity and confusion that has been caused with different definitions among seemingly the same concepts. A few submitters additionally requested clarification of underlying definitions which constitute the definition of connected person. The Reserve Bank’s policy position in the Exposure Draft policy We do not intend to incorporate the definition in NZ IAS 24 or the AML Act by referencing it in the policy. This is because, if we incorporate them, every time the accounting standards or the AML Act is amended, the definition and size of connected exposures will consequently be changed, even though our prudential policy objectives have not changed. We also do not intend to directly insert these definitions in the Connected Exposure Policy, because the requirements need a clear perimeter of a connected person for the purpose of the prudential regulation – this will not be the case if the definition is subject to possible changes in the NZ IAS or AML Act definitions. However, we understand the submitters' argument regarding the operational complexities. Therefore, we have taken the substance of the feedback on board, and we have defined a connected person based on the definition of related party proposed in the Exposure Draft of the Deposit Takers Bill2 . The perimeter in this definition is much closer to that of the related party defined in the NZ IAS 24 than what we had originally proposed in the consultation on the connected exposure policy. We have also included some of underlying concepts in the accounting standard by using the same terminologies where appropriate in the
exposure draft. For example, the terminology - “substantial interest” - has been replaced using terminologies - “control” and “significant influence” - to respond to feedback received during the post-consultation engagements with banks. ____________ In December 2021 the Reserve Bank released an exposure draft of the Deposit Takers Bill for public consultation. The exposure draft was a preview of the Bill, enabling anyone with a view to submit feedback before we provided final advice to the Minister and develop the Bill to be introduced to Parliament. https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/consultations/banks/deposit-takers-act/exposure-draft-of-the-deposit-takers-bill.pdf

6 Review of Connected Exposures Policy Ref #20048421 v1.6 We have also set some underlying definitions (e.g., ‘director’, ‘senior manager’ and ‘control’) based on the definitions in the Deposit Takers Bill (DTB)3 in a view to help reducing banks’ implementation costs. Some definitions in the exposure draft may therefore be different from the definitions in other existing Banking Prudential Regulation documents. These definitions in the exposure draft of the Connected Exposure Policy will be replaced to be in line with those to be defined in the DTB if and when it is enacted in the future. Q4. Conduct Requirements The IMF’s 2017 assessment recommended that the Reserve Bank additionally require banks to obtain their Board’s approval prior to providing loans to connected persons and the writing-off of such loans. Given that there is already an attestation framework in place under the Disclosure Order in Council (OiC), we considered two options:
 Option 1 – Continue to rely on the current attestation framework, so long as we remain confident that it supports the effectiveness of the management of the conflicts of interest. This includes those relating to loan provisions to connected persons and the writing-off of such loans.  Option 2 - If the Reserve Bank for whatever reason ceases to be satisfied with banks’ policies, procedures and practices to manage conflicts of interest when providing loans to connected persons and writing-off such loans, we will add this specific board approval requirement in the Connected Exposures Policy. Stakeholders’ feedback The majority of the submitters argued that explicit board approval is not needed, because the risk associated with loans to connected persons has been managed under the attestation regime along with each bank's existing risk management framework. One submitter stated that Option 2 would increase banks' compliance costs and operational process time significantly. A submitter sought clarity on how the Reserve Bank's proposed conduct requirements would align with Directors’ Due Diligence Duty in relation to ‘prudential obligations’, once the DTB is enacted in the future. The Reserve Bank’s policy position in the Exposure Draft policy Instead of imposing a specific requirement for Board approval, we intend to impose an overarching requirement by clarifying a bank’s responsibility for having effective systems and controls in place to manage conflicts of interest, and to ensure that credit exposures to connected persons are not contrary to the interests of the bank’s banking group. The ‘systems’ include:
(i) adequate policies and procedures approved by the registered bank’s board to ensure that credit exposures to connected persons (e.g., loan provisions to connected persons and the writing-off of such loans) are not contrary to the interests of the registered bank’s banking group; and ____________ 3 The Deposit Takers Bill was introduced to Parliament on 22 September 2022. It is expected to come into force as law after receiving Royal Assent in mid-to-late 2023. https://legislation.govt.nz/bill/government/2022/0162/latest/LMS469449.html

7 Review of Connected Exposures Policy Ref #20048421 v1.6 (ii) adequate arrangements to monitor and control the banking group’s exposures to connected persons to ensure the registered bank’s compliance with the exposure limits at all times. These overarching requirements on a bank’s systems and controls 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) (OiC). The OiC and the Connected Exposure Policy work together in a complementary way to manage the risk of conflicts of interest and prevent abuses arising in transactions with connected persons. This complementarity will be maintained regardless of whether it is the OiC or the directors’ due diligence duty under the DTB once it is enacted in the future. We 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 the connected exposure policy. We will monitor the effectiveness of a bank’s systems and controls through supervisory engagement and information collection. This may include information about the terms and conditions of individual exposures. (Please see the Question 7). Q5. Gross Exposure Limit In view of the requirements, conditions and eligibility criteria for credit risk mitigations (CRMs) being clearly set out in the revised Connected Exposures Policy, the Reserve Bank considered two options:
 Option 1: Removing the gross exposure limit; and  Option 2: Maintaining it in some form. Stakeholders’ feedback All the submitters who responded on this question supported the removal of the gross exposure limit subject to the requirements, conditions and eligibility criteria for CRMs being clearly set out in the Connected Exposures Policy. The Reserve Bank’s policy position in the Exposure Draft The Reserve Bank applies in the connected exposure policy the same requirements, conditions and eligibility criteria for CRMs as those in the standard approach in the Reserve Bank document ‘BPR131: Standardised credit risk RWAs’ (BPR131) and ‘BPR132: Credit Risk Mitigation’ (BPR132). We have clarified these requirements, conditions and eligibility criteria for CRMs in the Connected Exposures Policy and its guidance. We consider these to be sufficiently clear to eliminate any confusion or ambiguity that may be associated with the current Connected Exposures Policy. These changes and clarifications raise the question as to whether a gross exposure limit is still required. Maintaining the limit would mean that the gross limit could be binding in some circumstances, even if the netted exposures, after allowing for all eligible forms of credit risk mitigation, were substantially lower and within the limit. This would limit the effective role of the CRMs, which is contrary to the objectives associated with the review. We therefore intend to remove the gross exposure limit. Any bank-specific compliance issue will be dealt through supervisory engagements.

8 Review of Connected Exposures Policy Ref #20048421 v1.6 Q6. Net Exposure Limits The Reserve Bank requested that banks estimate aggregate net credit exposures reflecting all the changes proposed in the consultation paper and to submit the estimated data so that we could assess if the current net exposure limits are appropriate based off estimate data provided from banks. Stakeholders’ feedback Five submitters provided us with comparable estimates. Their estimated impact of our proposed changes to the aggregated net exposure amount (NZD value) ranged from -14 to +0.25 percent (average -4 percent). Responding to our request, some banks endeavoured to estimate aggregate net credit exposures reflecting all the changes proposed in the consultation paper (including the recognition of credit risk mitigations, the 100 percent CCF and the definition of connected person), while other banks focused on an estimate of the impact of our proposed changes in the credit risk mitigations. The 100 percent CCF and the expansion of the definition of connected persons increased the aggregated net exposure amount, while the recognition of credit risk mitigations decreased the net exposure amount. Overall, the banks’ estimates suggested that the net exposure amounts as a percentage of capital would decrease by 2.7 percentage points on average. The Reserve Bank’s policy position in the Exposure Draft policy We assessed the appropriateness of the current net exposure limits (ranging from 15 to 75 percent) based on banks’ estimates provided during the consultation process and compared the estimates against banks’ survey returns data. Banks’ estimates indicate that our proposed changes are unlikely to make significant changes to the banks’ net exposure amounts. Hence, we intend to maintain the current limits at this stage, and will assess the appropriateness on an ongoing basis using the survey data. If we find sound reason, we will carry out a review of the net exposure limits. . Q7. Surveys and Information Collection The Reserve Bank sought views on (i) making corresponding changes to the connected exposures survey and the large exposures survey for consistency and (ii) adding terms, names, and repayment status of a bank’s transaction with its connected persons in the connected exposure survey for responding to the IMF’s recommendation. Stakeholders’ feedback All the submitters supported consistency among the connected exposure policy, the connected exposure survey and the large exposure survey. (ii) Some submitters indicated concerns about providing the Reserve Bank with terms, names, and repayment status of each individual loans. Several submitters suggested alternative approaches where the Reserve Bank: collects the information at an aggregated level (e.g., party or types of exposures); sets de minimus value thresholds for the reporting; or obtains the information through a prudential reporting (instead of statistic survey) or during on-site inspections. Separately,
one submitter asked whether the Reserve Bank has legislative powers to collect terms, names, and repayment status of each individual loans, given it would include confidential personal data.

9 Review of Connected Exposures Policy Ref #20048421 v1.6 The Reserve Bank’s policy position in the Exposure Draft policy There is no reporting requirement in the policy. When making the corresponding update on the data survey instruction and templates, we will ensure that consistency is maintained among the connected exposure policy, the connected exposure survey and the large exposure survey. We appreciate the feedback provided regarding individual loan data. We have not yet decided how to address this point. Reflecting the feedback we received, we will decide the most appropriate way to collect these data for the purpose of the Reserve Bank monitoring effectiveness of each bank’s systems and controls in relation to transactions with connected persons. Q8. Implementation Arrangements and Q18. Capital Measure The Reserve Bank proposed that IRB banks use the ‘standardised equivalent Tier 1 capital’ to calculate the aggregate credit exposures under the Connected Exposures Policy (Question 18). In relation to the proposal, we sought views on our proposed implementation arrangement to implement the amended BS8 at the same time as or after the implementation of the Dual Reporting Requirements (Question 8). Stakeholders’ feedback (Question 8) The majority of the submitters supported implementation of the amended BS8 after the implementation of the Dual Reporting Requirements. Two submitters requested a longer transition period, for the case where bespoke measurements (e.g., 100 percent CCF) and/or the loan term reporting are introduced. (Question 18) One submitter opposed the Reserve Bank's proposal to use the "standardised ‘equivalent Tier 1 capital’. This submitter explained this was for consistency with the disclosure requirements in the Orders in Council and the regulatory capital base used for the capital ratio calculation. The Reserve Bank’s policy position in the Exposure Draft policy (Question 18) We have taken this feedback into account and intend to instead require that IRB banks use Tier 1 capital, instead of the ‘standardised equivalent Tier 1 capital’. (Question 8) The link with the dual reporting requirements no longer exists without using the ‘standardised equivalent Tier 1 capital’. Q9. Impacts of the Proposed Policy Changes The Reserve Bank sought views on our proposed changes and any impacts that banks and the financial system may encounter with the proposed changes. We also sought any feedback about possible risks that might result from allowing more bilateral netting agreements to be eligible under the Connected Exposures Policy. Stakeholders’ feedback All the submitters expressed their support for allowing banks to recognise credit risk mitigations eligible for standardised banks under BPR132, and apply the same requirements, conditions and eligibility criteria for the recognition of collateral, guarantees, and credit derivatives under BPR132 and Part E of BPR131.

10 Review of Connected Exposures Policy Ref #20048421 v1.6 All the submitters, except one, stated that the Reserve Bank's proposal will address the current adverse impact of the Connected Exposures Policy by reducing complexity and aligning it with the international best practice, which will not introduce additional risks. One submitter argued that the Reserve Bank's proposal would only benefit banks that are exposed to Australian connected persons, and could cause disadvantage to some other banks who use a netting agreement which does not meet the requirements set out in BPR131 or BPR132. The submitter also mentioned that it could cause disadvantage to those banks who choose not to recognise eligible credit risk mitigations for the purpose of the Connected Exposures Policy. The Reserve Bank’s policy position in the Exposure Draft policy Our concern is not whether or not exposures are to a specific jurisdiction. Our concern is that only netting agreements that meet the requirements of BPR131 and BPR132 should be recognised for the purpose of the prudential requirements, including the Connected Exposures Policy. Banks that use agreements that do not comply with the conditions of the Reserve Bank’s regulatory requirements should not recognise the non-compliant agreements as part of the regulatory calculations. Q10. General Principles for Exposure Measure The Reserve Bank sought views on these general principles on our proposed exposure measure. Stakeholders’ feedback One submitter recommended the general principles include an intention to keep the Connected Exposures Policy as simple as possible. The Reserve Bank’s policy position in the Exposure Draft policy We will keep the Connected Exposures Policy as simple as possible by aligning only with the Standardised approach to credit risk. Q11. Market-Related Contracts The Reserve Bank sought views on the replacement of the phrase ‘market related contracts’ with ‘derivatives and securities financing transactions’ (SFTs). Stakeholders’ feedback The Reserve Bank's proposed replacement was unanimously supported. The Reserve Bank’s policy position in the Exposure Draft policy We replaced the terminology as proposed. Q12. On-Balance Sheet Items (except ‘market related contracts’) The Reserve Bank sought views on the proposal to allow IRB banks to use gross exposure values, if netting of any impairment allowances is operationally burdensome. Stakeholders’ feedback The submitters unanimously supported the Reserve Bank's proposal to allow IRB banks to use gross exposure values, if netting of any impairment allowances is operationally burdensome.

11 Review of Connected Exposures Policy Ref #20048421 v1.6 The Reserve Bank’s policy position in the Exposure Draft policy IRB banks may use the gross exposure value as a conservative alternative. Q13. Off-Balance Sheet Contingent Credit Exposures The Reserve Bank sought views on our proposed application of a flat 100 percent CCF for off￾balance sheet commitments to connected persons. Stakeholders’ feedback All the submitters sought clarity as to whether the proposed 100 percent flat CCF would apply only for the purpose of the Connected Exposures Policy or for the entire Capital Adequacy Framework. Separately, submitters sought clarity on the treatment of uncommitted facilities. A trade body, which is explicitly supported by the majority of the submitters, supported application of the proposed 100 percent flat CCF in the Connected Exposures Policy, while one submitter stated that it appeared somewhat inconsistent to have a bespoke CCF for off-balance sheet contingent liabilities. The Reserve Bank’s policy position in the Exposure Draft policy We have clarified in the Exposure draft that a 100 percent flat CCF must be applied for off-balance sheet commitments only for the purpose of the connected exposure policy. 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. Q14. Calculation of Exposure Value for Financial Instruments Held for Trading The Reserve Bank sought views on our proposed clarification of the measurement methodologies for financial instruments issued by a bank’s connected persons or derivatives with underlying financial instruments issued by a bank’s connected persons. Stakeholders’ feedback One submitter recommended the on-balance sheet accounting values be used to measure the value to financial instruments issued by a bank's connected persons so as to keep the Connected Exposures Policy simple and comparable to related party exposures in banks' financial statement. The Reserve Bank’s policy position in the Exposure Draft policy In banks’ disclosure statements, it appears that banks’ trading-purpose exposures to financial instruments issued by their connected persons is very limited. This means that the impact of the value of the financial instruments issued by connected persons to a bank’s financial position is also very limited. Considering the balance between cost and benefit, we think it is proportionate to use the valuation method in the BPR140 Market Risk for such trading-purpose financial instruments.

12 Review of Connected Exposures Policy Ref #20048421 v1.6 The BPR140 document sets out a methodology to calculate capital requirements for market risk. Compared to the three different approaches in the Basel Framework, our market risk calculation is the closest to the simplest one (i.e., the simplified standardised approach). Q15. Recognition of Eligible Credit Risk Mitigations The Reserve Bank sought views on (i) the proposal to apply the same conditions and same treatment of CRMs in the connected exposure policy as those in the standardised approach to credit risk in BPR131, and in BPR132, and (ii) the proposal that banks would not be able to recognise unfunded contingent credit protection provided by a connected person (e.g., a guarantee, credit derivative and indemnity) in the same way as the BPR132 sets out. The Reserve Bank also requested that banks send us a list of bilateral netting agreements that they are using (or intending to use) for derivatives and SFTs under BPR131 and BPR132, as well as, in the future if our proposed changes are implemented, under the connected exposure policy. Stakeholders’ feedback All the submitters expressed their support for allowing banks to consistently recognise credit risk mitigations eligible under BPR131 and BPR132, and consistently applying the same requirements, conditions and eligibility criteria for the recognition of collateral, guarantees, and credit derivatives under BPR132 and Part E of BPR131. The majority of the submitters explicitly stated their support to the Reserve Bank's proposed boundary of eligible credit risk mitigations for the purpose of the Connected Exposures Policy. Four submitters provided us with the ISDA Master Agreement that they are using for derivatives and SFTs under BPR131 and BPR132 or are intending to use in the future. One of the submitters additionally indicated that its agreement was a multilateral settlement netting agreement, combined with a bilateral netting agreement with a clause making multiple￾subsidiary and branch transactions available. The Reserve Bank’s policy position in the Exposure Draft policy Subject to the same requirements, conditions and eligibility criteria as in BPR 131 and BPR132, eligible CRMs can be recognised for the purpose of the connected exposure policy. These requirements include that banks must not recognise unfunded contingent credit protection provided by a connected person. We further delineated these requirements, conditions and eligibility criteria for eligible CRMs in the Connected Exposures Policy and guidance. Any bank-specific compliance issue on ineligible CRMs will be dealt through supervisory engagements and by enforcement response. For example, multilateral netting agreements will not be eligible in line with BPR 131 and BPR132. Q16. On-Balance Sheet Netting The Reserve Bank sought views on the proposal to allow on-balance sheet netting subject to meeting the requirements set out in C1.2 of BPR132. The Reserve Bank also
requested that banks send us a list of bilateral netting agreements that they are using (or intending to use) for on￾balance sheet netting under BPR132 as well as in the future if our proposed changes are implemented, under the Connected Exposures Policy.

13 Review of Connected Exposures Policy Ref #20048421 v1.6 Stakeholders’ feedback All the submitters expressed their support for allowing on-balance sheet netting in alignment with BPR131 and BPR132. However, none of the submitters indicated immediate needs for the credit risk mitigation. One submitter suggested to align alternatively with the on-balance sheet netting requirements of NZ IAS 32 or the offsetting requirements of NZ IFRS 7, instead of BPR132. Three submitters explicitly indicated that there was no bilateral on-balance sheet netting agreement currently in place or no immediate intention to recognise the credit risk mitigation. One submitter indicated its intention to use a multilateral settlement netting agreement with its owner and other subsidiaries to net loans and deposits on its balance sheet and recognise it as a credit risk mitigation. The Reserve Bank’s policy position in the Exposure Draft policy We have aligned with the on-balance sheet netting set out in BPR132 to provide consistency within the capital adequacy framework. Given that no submitters have recognised on-balance sheet netting, even under the capital adequacy framework, we have considered whether or not to allow on-balance sheet netting under the connected exposure policy, to prevent any illegitimate recognition of on-balance sheet netting. However, at this stage we have concluded that it is more appropriate to deal with a bank-specific compliance issue through supervisory engagements and by enforcement response. Q17. Treatment of Maturity Mismatches in CRM The Reserve Bank sought views on the proposed treatment of maturity mismatches under the Connected Exposures Policy. Stakeholders’ feedback Two submitters supported the Connected Exposures Policy to align with BPR132 including the treatment of maturity mismatches. One submitter indicated its inclination not to align with BPR132 only on the treatment of maturity mismatches to keep the Connected Exposures Policy as simple as possible. The Reserve Bank’s policy position in the Exposure Draft policy The revised connected exposure policy is aligned with the standardised approach in the capital adequacy framework including the treatment of maturity mismatches.
4. Summary of other matters covered in the submissions
Stakeholders sought clarity on how the proposed changes will dovetail into the Deposit Takers Bill if and when it is enacted (e.g., how any conduct requirements would align with the directors’ duties in the Deposit Takers’ Act) and how BS8 will be replaced with a new BPR document and then Standards under the Deposit Takers Act. The Reserve Bank’s policy position in the Exposure Draft policy To define a connected person, we set some key terminologies (e.g., ‘director’, ‘senior manager’ and ‘control’) based on the definitions in the Deposit Takers Bill (DTB) in a view to minimise the

14 Review of Connected Exposures Policy Ref #20048421 v1.6 industry’s implementation costs. Some definitions in the exposure draft may therefore be different from the definitions in other existing BPR documents. These definitions in the exposure draft of the Connected Exposure Policy will be replaced to be in line with those to be defined in the Deposit Takers Act if and when it has been enacted. A format of revised Connected Exposures Policy will be the same format as other Banking Prudential Regulations (BPR). This policy will be ‘BPR210 Connected Exposures Policy’. It will help facilitating transformation of the current BPR documents including the revised Connected Exposure Policy into the standards under the DTA once it is enacted in the future. Ultimately the content of the Standard will depend on the final specification of the Deposit Takers Act. For the directors’ duties, please see the Question 4.