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Large exposures - frequently asked questions

These frequently asked questions (FAQs) provide information to assist regulated entities to interpret Prudential Standard APS 221 Large Exposures and Reporting Standard ARS 221.0 Large Exposures.

They do not provide an exhaustive list of examples and regulated entities are encouraged to contact APRA where they have questions regarding the interpretation of the relevant prudential standards.

1. Structured vehicle requirements

1.1 How are exposures to a structured vehicle and its underlying assets measured?

References:

Exposures to a structured vehicle must be measured on a basis that is consistent with exposures to any other counterparty, unless otherwise required by APS 221. Under paragraph 32 of APS 221, in measuring large exposures an ADI must include all on-balance sheet exposures and off-balance sheet exposures in both the banking book and trading book and instruments that would give rise to counterparty credit risk, in this case in relation to a structured vehicle.

A large exposure is calculated net of those exposures excluded under paragraph 18 of APS 221. Where an exposure to a structured vehicle satisfies the criteria of paragraph 18 of APS 221 and is therefore excluded, it is then also excluded from the requirements relating to look-through in paragraphs 22 to 26 of Attachment A of APS 221.

For the purposes of applying the look-through requirements, it is intended that ADIs look through to the underlying assets that the structured vehicle holds as part of its pool of investments. An ADI’s potential future claims on investor commitments (e.g. through subscription credit facilities) are not considered to be assets of the structured vehicle and hence these are not included as exposures that an ADI has for the purposes of looking through structured vehicles.

Exposures to underlying assets of the structured vehicle are to be measured according to paragraphs 25 and 26 of Attachment A of APS 221. Worked examples A and B, which can be found below, can be followed to determine the exposure to the underlying assets of a structured vehicle.

1.2 Does the threshold of 0.25 per cent of an ADI’s Tier 1 Capital, in paragraphs 23 and 24 of Attachment A of APS 221, apply after completing the calculations in paragraphs 25 or 26 of Attachment A of APS 221?

References:

Paragraph 23 of Attachment A of APS 221, outlines that an ADI is not required to assign an exposure to an underlying asset of a structured vehicle if the exposure to an underlying asset is less than 0.25 per cent of the ADI’s Tier 1 Capital. Paragraphs 25 and 26 outline how exposure values to underlying assets of a structured vehicle are calculated.

To apply the test included in paragraph 23, the exposure values first need to be calculated in accordance with paragraphs 25 and 26. Hence the calculations in paragraphs 25 and 26 need to be completed first.

1.3 When an ADI has an exposure to a structured vehicle that is subject to the look-through requirements for the purposes of measuring and reporting exposures, how often is the ADI expected to receive updated information on the structured vehicle’s asset composition?

References:

An ADI will use information provided by a structured vehicle to measure exposures to underlying assets of a structured vehicle, in accordance with paragraphs 24 to 26 of Attachment A of APS 221.

APRA expects that an ADI will receive information about the composition of a structured vehicle’s underlying assets on a frequency that reflects the volatility of the structured vehicle’s composition. For structured vehicles with very stable asset compositions, less frequent (for example annual) reporting may be acceptable. Where the underlying composition is volatile, the ADI should receive reporting on a frequency which will limit the risk that reported values become unreliable. This may also mean that an ADI will need to request additional reporting when markets or market indicators that impact the value of a structured vehicle’s assets are also experiencing volatility.

1.4 Paragraph 24(b) of Attachment A of APS 221 outlines the treatment of assets of a structured vehicle that cannot be identified. What does it mean for an ADI to have an exposure to an underlying asset that ‘cannot be identified’?

Reference:

Paragraph 24 of Attachment A of APS 221 requires that where an ADI has an exposure to an underlying asset that cannot be identified and the exposure value is greater than or equal to 0.25 per cent of the ADI’s Tier 1 Capital, the ADI must assign the exposure value to an unknown counterparty which is treated as a distinct counterparty to the ADI.

An underlying asset that ‘cannot be identified’ is one where the ADI has an exposure to an underlying asset but the legal name of the counterparty of the asset cannot be identified (e.g. due to the reporting limitations of the structured vehicle).

Additionally, APRA considers that it would be reasonable for an ADI to treat an underlying asset as one that ‘cannot be identified’ where the ADI does not have a direct exposure to the counterparty of the asset, and the ADI’s only exposure to the counterparty arises from the application of the look-through requirements in paragraphs 22 to 26 of Attachment A of APS 221. In this case, it is not expected that an ADI establish a counterparty in its systems for the purposes of recording a look-through exposure. In this circumstance, the ADI would treat its exposure to the counterparty as an unknown counterparty exposure in accordance with paragraph 24(b) of Attachment A of APS 221.

1.5 How do the look-through requirements apply to a structured vehicle which holds assets such as investments in other structured vehicles?

Reference:

The look-through requirements should generally be applied using a single level look-through (i.e. an ADI will look through its exposure to a structured vehicle and recognise its exposure to the underlying assets held directly by the structured vehicle).

In some circumstances, however, to align with the intent of the look-through requirements it may be appropriate to look through a second level of the structure in order to appropriately identify the underlying risk. This could occur for example if the asset that had been identified when looking-through a structured vehicle was an investment in another structured vehicle. In that case, if the size of the exposure were material, it would be appropriate for the ADI to apply look-through at the next level down as well. 

Worked Example A

This worked example outlines the calculation methodology for an ADI’s exposure to a structured vehicle with a single tranche structure, per paragraph 25 of Attachment A of APS 221.

The amounts listed under (1) are the nominal value of each underlying asset in the structure.
The ADI has a $15 exposure to the vehicle, meaning the ADI holds a 15 per cent share of the securities in the vehicle.

The ADI’s exposure to each underlying asset for the purposes of measuring large exposures is calculated as the nominal value of the underlying asset (1) divided by the total value of the vehicle multiplied by the value of the ADI’s exposure to the vehicle. In the case of Asset 1, that is:
$30 / $100 x $15 = $4.50, which is the answer provided in (3).

(1) Calculation of Structured vehicle and underlying assets
Asset 1 $30.00
Asset 2 $20.00
Asset 3 $20.00
Asset 4 $18.00
Asset 5 $10.00
Asset 6 $2.00
Total $100.00

(2) ADI holds: $ 15.00

(3) ADI's exposure to underlying assets
Asset 1 $4.50
Asset 2 $3.00
Asset 3 $3.00
Asset 4 $2.70
Asset 5 $1.50
Asset 6 $0.30
Total $15.00

Worked Example B

This worked example outlines the calculation methodology for an ADI’s exposure to a structured vehicle with a multiple tranche structure, per paragraph 26 of Attachment A of APS 221.

  1. The amounts listed under (1a) are the nominal value of each underlying asset in the structure. The amounts listed under (1b) are the nominal value of each tranche and the amount of that tranche that the ADI has an exposure to.
  2. As per paragraph 26(a) of Attachment A, identify the lower of the value of the tranche and the nominal value of each underlying asset. In this example:
    • For Tranche A and Asset 1, the lower of $80 and $30, which is $30.
    • For Tranche A and Asset 6, the lower of $80 and $2, which is $2.
  3. As per paragraph 26(b) of Attachment A, apply the pro rata share of the ADI’s exposure in the tranche to the value determined in paragraph 26(a) (step 2 in this example). In this example:
    • For Tranche A and Asset 1, $30 x $6 / $80 = $2.25.
    • For Tranche A and Asset 6, $2 x $6 / $80 = $0.15.
  4. As per paragraph 26 of Attachment A, the ADI’s exposure to each asset is then calculated as the sum of its exposures to the asset as calculated in step 3, capped at the total nominal value of the underlying asset. In the case of Asset 6:
    • The lower of $2 and $2.06 (where $2.06 is equal to the sum of $0.15, $0.77 and $1.14), which is $2.
(1a) Structured vehicle and underlying assets
Asset 1 $30.00
Asset 2 $20.00
Asset 3 $20.00
Asset 4 $18.00
Asset 5 $10.00
Asset 6 $2.00
Total $100.00
(1b) Multiple tranches of the structured vehicle
Tranche Value ADI holds
Tranche A $80.00 $6.00
Tranche B $13.00 $5.00
Tranche C $7.00 $4.00
Total $100.00 $15.00
(2) The lower of the value of the tranche and asset, per paragraph 26(a) of Attachment A
Tranche A B C
Asset 1 $30.00 $13.00 $7.00
Asset 2 $20.00 $13.00 $7.00
Asset 3 $20.00 $13.00 $7.00
Asset 4 $18.00 $13.00 $7.00
Asset 5 $10.00 $10.00 $7.00
Asset 6 $2.00 $2.00 $2.00
(3) The pro rata share of exposure, per paragraph 26(b) of Attachment A
Tranche A B C
Asset 1 $2.25 $5.00 $4.00
Asset 2 $1.50 $5.00 $4.00
Asset 3 $1.50 $5.00 $4.00
Asset 4 $1.35 $5.00 $4.00
Asset 5 $0.75 $3.85 $4.00
Asset 6 $0.15 $0.77 $1.14
(4) ADI's exposure to underlying assets
Tranch Exposure
Asset 1 $11.25
Asset 2 $10.50
Asset 3 $10.50
Asset 4 $10.35
Asset 5 $8.60
Asset 6 $2.00

2. Trading book and settlement exposures

2.1 When a bank has sold protection through a credit derivative to a counterparty and the derivative has a positive market value, is there a need, beyond recognising the exposure at default calculated under APS 180, to add a further exposure to the protection buyer?

References:

Consistent with paragraph 1(b) of Attachment A of APS 221, the exposure to the protection buyer is measured as the exposure at default (EAD). There is no further exposure to be added if the credit derivative has a positive mark to market (MTM) as this positive MTM is already accounted for in the EAD exposure measurement.

References:

Under paragraph 18(g) of APS 221, a large exposure excludes exposures arising in the course of settlement of market-related contracts unless the transaction remains unsettled after its delivery due date in which case the exposure value is the positive current exposure amount.

The settlement of a market-related contract becomes an exposure under APS 221 after the delivery due date, allowing for time zone differences.

2.3 What settlement exposures should be reported under section C of ARF 221.0? 

References:

Section C of ARF 221.0 requires an ADI to report settlement exposures exceeding or equal to 10 per cent of Tier 1 Capital. Settlement exposures are defined in paragraph 18(g) of APS 221 as those exposures arising from the settlement of market-related contracts which are excluded from large exposures. ARF 221.0 instructions require these settlement exposures to be reported as at the end of the reporting period.

Settlement exposures on non-delivery-versus-payment (non-DVP) transactions will be the positive current exposure amount (i.e. the notional amount on the derivative) on the reporting date. As both legs of a DVP transaction are settled simultaneously, there is no exposure to be reported under section C of ARF 221.0.

Note: These FAQs are published for information purposes only. The content of these FAQs is not legal advice. Users are encouraged to obtain professional advice about the application of any legislation or prudential standard to their particular circumstances.

Users should exercise their own skill and care when relying on any material contained in the FAQs. APRA disclaims any liability for any loss or damage arising out of any use of or reliance on these FAQs.