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Erscheinung:14.08.2020 | Topic Own funds, Risk management New form for netting notifications
BaFin publishes form for less significant institutions
From 1 October 2020, banks must use a form in order to notify BaFin if they wish to reduce their credit risks using netting (see info box “Netting as a credit risk mitigation technique").
Up until now, no particular form was required for the notifications. From the beginning of January until early March 2020, the form was open for consultation, and it is intended for use by, amongst others, the less significant institutions (LSIs) under German supervision. But non-CRR credit institutions which are governed by the European Capital Requirements Regulation (CRR) in accordance with section 1a of the German Banking Act (Kreditwesengesetz – KWG), and institutions as defined under point (3) of Article 4 (1) in conjunction with point (2) of the CRR, must also switch to the new form for their netting notifications by no later than the implementation deadline of 1 October 2020. However, the new notification form is already available online so that the institutions can use it now.
At a glance:Netting as a credit risk mitigation technique
To reduce their capital requirements, institutions can apply a number of credit risk mitigation techniques in accordance with the CRR. In particular, this involves collateralisation agreements which the institutions use to mitigate their credit risk exposures. Whether and to what extent institutions are allowed to recognise such collateral is defined in Part Three, Title II, Chapter 4 of the CRR.
Netting is one such credit risk mitigation technique. In the event of certain predefined events occurring, e.g. one of the parties defaulting, a set of outstanding mutual financial contracts that have been consolidated by the respective counterparties under a master agreement are offset against each other (close-out netting). As a rule, master agreements contain clauses which define how the parties terminate their agreement and how a single net payment is calculated, the result being a single receivable instead of several receivables from individual transactions. A netting agreement therefore reduces the credit risk from the transactions with one counterparty to the difference between the obligations still outstanding.
Most master agreements are designed to allow a counterparty to terminate the agreement, or they make provisions for the agreement to end automatically if, for example, one of the counterparties defaults or their credit rating deteriorates.
In accordance with the CRR, the legal validity and enforceability of the netting agreements in the various jurisdictions is supported by legal opinions provided by the institutions. In order for netting agreements to be recognised, an institution must also fulfil the monitoring and controlling tasks stated in the CRR. Of particular relevance in this context is Article 297(1) to (3) of the CRR which stipulates that institutions must establish and maintain procedures to ensure that the legal validity and enforceability of their contractual nettings are reviewed in the light of changes in the law of relevant jurisdictions referred to in Article 296(2)(b) of the CRR.
Recognition as risk-reducing
If institutions want to treat their netting agreements as risk reducing in accordance with Article 295 et seq. of the CRR and take them into account when calculating own funds requirements, these need to be recognised by the competent supervisory authority. In Germany, the competent authority is BaFin. The CRR does not clearly specify the precise procedure for supervisory recognition of netting agreements and leaves this up to the supervisory authority in question. The ECB has been applying a standard recognition procedure for the Significant Institutions (SIs) since 31 January 2020, including a form for netting notifications published for this purpose. BaFin has based its recognition procedure on that of the ECB.
Agreements subject to a notification obligation are bilateral contracts for novation and other bilateral agreements (points (a) and (b) of Article 295 of the CRR) as well as contractual cross-product netting agreements (point (c) of Article 295 of the CRR). The bulk of the netting agreements concern other bilateral agreements under point (b) of Article 295 of the CRR in which the counterparties offset their mutual claims from derivatives transactions. A residual net obligation of the business partner is converted into a non-derivative claim and settled in the usual settlement process.
Form for netting notifications from 1 October 2020
In its consultation of the form, BaFin took account of the comments of the German Banking Industry Committee (Deutsche Kreditwirtschaft – DK) of 6 March 2020. BaFin has already published the final version of the new notification form that is to be used from 1 October 2020 in order to facilitate the implementation process for institutions.
The notification form consists of two parts. The first part deals with confirmations for the requirements set out in Article 296 of the CRR regarding the recognition of contractual netting agreements and for the obligations set out in Article 297 of the CRR. These confirmations concern the conditions for recognising each individual netting agreement – for example, with regard to a walk-away clause – or conditions pertaining to an institution’s internal procedures.
In the second part of the notification form, the institutions enter information on the type of netting agreement, the governing law and the counterparty’s jurisdiction, including any supporting legal opinions. Information on the type of counterparty, which was originally requested in the consultation draft, is not required in the new notification form.
Similar to the confirmation procedure applied by the ECB for the SIs, BaFin also requires its institutions to make their necessary confirmations via the notification form. This has the benefit of reducing the amount of work involved in the recognition process for both BaFin and the institutions.
If there are changes to certain netting conditions in a netting agreement that has already been notified and these changes do not entail disadvantages for one of the involved parties, a separate notification is not required. The pre-requisite is that the institution must document that an individual review was carried out internally or that a corresponding supplementary opinion was obtained externally.
Institutions can address any general questions regarding implementation directly to the central netting notification unit at BaFin. Any institution-specific questions and the netting notifications should be addressed to the supervisor responsible for the institution, as before.
Author
Jeannine Zimmermann
BaFin Division for Policy Issues relating to Restructuring
Please note
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