• PRU 4.15 PRU 4.15 Concentration Risk

    • Applicability and limits

      • PRU 4.15.1

        This Section applies with respect to Trading Book transactions as calculated in App2 and Non-Trading Book transactions as calculated in Section 4.8.

      • PRU 4.15.2

        For the purposes of this Section an Exposure that arises in the Trading Book is calculated by summing the following:

        (a) the net positive position (long positions net of short positions) for each Financial Instrument as set out in Rules A4.11.10 to A4.11.28;
        (b) the firm's net Underwriting Exposures for any Counterparty; and
        (c) any other Exposures arising from transactions, agreements and contracts that would give rise to Counterparty Credit Risk.

      • PRU 4.15.3

        For the purposes of this Section an Authorised Person must:

        (a) identify its Exposures;
        (b) identify its Counterparties, including whether any are Closely Related to each other or Connected to the Authorised Person;
        (c) measure the size of its Exposures;
        (d) establish the value of its Exposures;
        (e) determine the size of its Exposures as a proportion of its Capital Resources;
        (f) identify whether it has Exposures which are subject to the requirements of Section 4.13 (CRM);
        (g) identify which, if any, of its Exposures are exempt in accordance with Section A4.11 from the limits set out in Rules 4.15.4 to 4.15.7;
        (h) aggregate its Exposures to the same Counterparty or group of Closely Related Counterparties or group of Connected Counterparties;
        (i) monitor and control its Exposures on a daily basis within the Concentration Risk limits; and
        (j) notify the Regulator immediately of any breach of the limits set out in this Section and confirm it in writing.

    • Large Exposure limits

      • PRU 4.15.4

        A Large Exposure of an Authorised Person means a total Exposure which is greater than 10% of the firm's Capital Resources, to any Counterparty, Connected Counterparty, group of Connected Counterparties, or group of Closely Related Counterparties, whether in the Authorised Person's Trading Book or Non-Trading Book, or both.

      • PRU 4.15.5

        Subject to IFR Rule 5.4.15, an Authorised Person must ensure that Exposures in its Non-Trading Book and, subject to Rule 4.15.6, Trading Book to a Counterparty or to a group of Closely Related Counterparties or to a group of Connected Counterparties, after taking into account the effect of any eligible CRM, do not exceed 25% of its Capital Resources.

      • PRU 4.15.6 PRU 4.15.6

        Where an Authorised Person's Trading Book Exposure to a Counterparty or to a group of Closely Related Counterparties or to a group of Connected Counterparties, on its own or when added to any Non-Trading Book Exposure, is likely to exceed 25% of its Capital Resources, the Authorised Person must immediately give the Regulator written notice, explaining the nature of its Trading Book Exposure and seeking specific guidance from the Regulator regarding the prudential treatment of any such Exposure.

        • Guidance

          1. The effect of Rules 4.15.5 and 4.15.6, when taken together, impose a binding upper limit of 25% of Tier 1 on the portion of a Large Exposure in the Non-Trading Book.
          2. Where, under exceptional circumstances, the portion of the Large Exposure arising in the Trading Book causes the aggregate limit of 25% to be exceeded the Authorised Person is obliged to notify the Regulator in order to agree remedial actions to resolve the breach at the earliest opportunity.

      • PRU 4.15.7 PRU 4.15.7

        Subject to IFR Rule 5.4.16 an Authorised Person must ensure that the sum of its Large Exposures does not exceed 800% of its Capital Resources.

        • Guidance

          1. Exposures can arise in the Non-Trading Book and in the Trading Book from Credit Risk (for example on loans and advances) Counterparty Risk (for example, on unsettled trades and on Derivative contracts) and from Issuer risk (for example, on holdings of equities and bonds).
          2. Some Derivatives contracts may result in an Authorised Person being exposed to an Issuer as well as the Derivatives Counterparty. For example, a Derivative referenced on a Security may result in an Exposure to the Counterparty, to the transaction and to the Issuer of the underlying Security.
          3. Examples of an Exposure are actual or potential claims on a Counterparty including contingent liabilities arising in the normal course of an Authorised Person's business.
          4. App4 includes further Rules and Guidance on:
          a. fully and partially exempt Exposures, Exposures to undisclosed Counterparties, parental guarantees and capital maintenance agreements;
          b. identification of Exposures;
          c. identification of Closely Related and Connected Counterparties, and exemptions for Connected Counterparties;
          d. measuring Exposures to Counterparties and Issuers in relation to Derivatives, equity indices, and other items; and
          e. country risk Exposure.

    • Exclusions from the Large Exposure limits

      • PRU 4.15.8

        (1) For the purposes of this Section, Exposure excludes:
        (a) claims and other assets required to be deducted for the purposes of calculating an Authorised Person's Capital Resources;
        (b) a transaction entered into by an Authorised Person as depository or as agent that does not create any legal liability on the part of the Authorised Person;
        (c) claims resulting from foreign exchange transactions where an Authorised Person has paid its side of the transaction and the countervalue remains unsettled during the two business days following the due payment or due delivery date. After two business days the claim becomes an Exposure;
        (d) claims arising as a result of Money transmission, payment services, clearing and settlement, correspondent banking or Financial Instruments clearing, settlement and custody services to clients, delayed receipts in funding and other Exposures arising from Client activity which do not last longer than the following business day;
        (e) in the case of the services outlined in (d) intra-day Exposures to Financial Institutions who provide these services are excluded;
        (f) claims resulting from the purchase and sale of Securities during settlement where both the Authorised Person and the Counterparty are up to five business days overdue in settling. The five business days include the due payment or due delivery date. After five business days, the claim becomes an Exposure; and
        (g) Exposures that are guaranteed by the Authorised Persons Parent in accordance with Rule 4.15.18.
        (2) For the purposes of this Section, Exposure to a central counterparty which carry a 0% CCR in accordance with Section 4.8 are excluded.

      • PRU 4.15.9

        An Authorised Person need not include fully exempt Exposures, as referred to in Rule A4.11.1 when monitoring compliance with the limits in Rules 4.15.5, 4.15.6 and 4.15.7.

    • Institutional exemption

      • PRU 4.15.10 PRU 4.15.10

        For Exposures to a Financial Institution, or a group of Connected Counterparties one of which is a Financial Institution, the total amount of an Authorised Person's Exposures may exceed 25% of its Capital Resources, provided those institutions are Investment Grade (Credit Quality Grades 1 to 3) and subject to the following:

        (a) Exposures to any entities within the group of Connected Counterparties that are not Financial Institutions are limited to 25% of Capital Resources after taking account of CRM;
        (b) the Exposures must not form part of the Capital Resources of the Counterparty;
        (c) the Counterparty Risk profile must be subject to review on at least an annual basis; and
        (d) Exposures of this nature must not in any case exceed a maximum of $100 million or 100% of Capital Resources, whichever is the lower.

        • Guidance

          The Regulator will, in exceptional circumstances, consider an application to waive or modify the limits set out above. In such circumstances the Authorised Person will have to make a submission to the Regulator as to why its specific circumstances would warrant a relaxation of the limits specified in (d) above.

    • Systems and Controls

      • PRU 4.15.11 PRU 4.15.11

        (1) An Authorised Person must implement and maintain systems and controls to identify its Exposures and effectively manage Concentration Risks as a result of its activities.
        (2) Such systems and controls in place must be proportionate to the nature, scale and complexity of the Authorised Person and must include written policies and procedures to address Concentration Risks, both on and off balance sheet, which:
        (a) are approved by the Governing Body on at least an annual basis; and
        (b) include internal approval limits for Exposures as well as limits for the risks associated with specific sectors, geographic location and single economic risk factors.

        • Guidance

          The Regulator expects the systems and controls to include:

          a. processes for the tiered approval of Exposures based on size, risk profile and complexity;
          b. mechanisms for identifying, recording and monitoring all Exposures with particular focus on Large Exposures;
          c. mechanisms in place for the monitoring and control of Exposures to Counterparties and Groups of Connected Counterparties;
          d. mechanisms for monitoring and recording Exposures within its Group;
          e. mechanisms to monitor Counterparties in the same economic sector and exposed to single economic risks;
          f. mechanisms to identify and control risks arising from single geographic jurisdictions; and
          g. mechanisms to identify risks arising from related activities or commodities.

    • Recognition of Credit Risk mitigations

      • PRU 4.15.12

        For the purposes of this Section, an Authorised Person may reduce the value of its Exposures, at its discretion, by any one or more of the following:

        (a) the amount of any specific provision made, where the provision relates to the risk of a credit loss occurring on that Exposure and is not held as part of a general provision or reserve against its Credit Risks;
        (b) Netting its claims on and liabilities to a Counterparty, provided that the conditions in Section 4.13 of CRM are met;
        (c) the amount of Collateral held against its Exposures, where that Collateral is of a type listed based on the FCSA and FCCA approaches and meeting the requirements under Section 4.13;
        (d) the amount of any eligible guarantees as permitted under Section 4.13.9;
        (e) the value of a Credit Derivative, where the Credit Derivative is an instrument included in Rule 4.13.11 and the transaction meets the conditions set out in that Section; and
        (f) the effects of transactions transferring Credit Risks from the Authorised Person to another party through securitisation, provided that the conditions in Section 4.14 are met.

      • PRU 4.15.13

        An Authorised Person intending to utilise any of the provisions contained in Section 4.13 (CRM) for the purposes of reducing Exposure values should have in place policies and procedures addressing the following:

        (a) risks arising from Maturity Mismatches between Exposures and any credit protection on those Exposures;
        (b) the Concentration Risk arising from the application of CRM techniques, including indirect Large Exposures — for example to a single Issuer of Securities taken as Collateral; and
        (c) the conduct of stress testing on CRM taken as Collateral.

      • PRU 4.15.14

        Where an Authorised Person has availed itself of the reductions to Exposure values as set out in A4.11 the Authorised Person must calculate the Exposure as a percentage of its Capital Resources on both a gross and net basis.

      • PRU 4.15.15

        An Authorised Person that avails itself of the reduction in its Exposure value through the application of Rule A4.11 must conduct periodic stress tests on its Exposures against the realisable value of any Collateral considered under with the FCSA or FCCA.

      • PRU 4.15.16 PRU 4.15.16

        Where the value of the Collateral under the stress scenario is lower than the value applied under Rule 4.15.12 the lower value should be used when determining the Exposure value for the purposes of this Section.

        • Guidance

          Such stress tests should include market value changes of underlying Collateral, risks relating to liquidity and realisation of such Collateral in stress scenarios. An assessment of the impact of any such changes on the Exposure value and the capital position of the Authorised Person should be conducted. Stress testing of these positions should be conducted at least once a year.

      • PRU 4.15.17 PRU 4.15.17

        An Authorised Person must document its policy for the use of any of the exclusions in Rule 4.15.12.

        • Guidance

          Such policy should include risks such as Maturity Mismatches, stress testing of Collateral values, indirect Exposures arising from CRM, such as mitigation provided on Exposures by the same Counterparty.

    • Treatment of Parental Guarantees

      • PRU 4.15.18

        An Authorised Person may exclude an Exposure from the Concentration Risk limits set out in Rules 4.15.5 to 4.15.7 if the Authorised Person's Parent;

        (a) is set to increase, on the basis of a legally binding agreement, the Authorised Person's Capital Resources, promptly and on demand, by:
        (i) an amount that is sufficient to reverse completely the effect of any loss the Authorised Person may sustain in connection with that Exposure; or
        (ii) the amount required to ensure that the Authorised Person complies with its Capital Requirement set out in Chapter 3; or
        (b) guarantees the Exposure to a Counterparty or to a group of Closely Related Counterparties which are not Connected to the Authorised Person only if the following conditions are met:
        (i) the guarantee is to be provided by the Authorised Person's Parent, or regulated member of its Group;
        (ii) the criteria for guarantees must be in line with the CRM requirements as set out in Section 4.13;
        (iii) the entity providing the guarantee must be a bank regulated to standards acceptable to the Regulator;
        (iv) the total amount of guarantees provided to the Authorised Person must be less than 10% of the Capital Resources of the entity providing the guarantee;
        (v) the Parent must be rated as a Credit Quality Grade of 1 or 2 by a recognised credit rating agency;
        (vi) the Authorised Person must provide confirmation from the Home State Regulator of the entity providing the guarantee that it is satisfied that the entity providing the guarantee has sufficient resources to provide such guarantees and has no objection to the provision of such guarantees;
        (vii) the Authorised Person should provide an annual confirmation that there are no changes to the enforceability of such guarantees; and
        (viii) the Authorised Person must notify the Regulator when such guarantees represent 200%, 400% and 600% of Capital Resources. The overall Large Exposure limit of 800% will apply.