Determination of the exposure at defaul in case of unfunded credit protection

Unfunded credit protection is not recognised by amending the exposure value but (a) either by adjusting PD or LGD estimates, according to Articles 108(2), 164(2) and 183(1) to (3) CRR, in case an institution uses own estimates of LGDs and conversion factors; (b) or by replacing the PD and/or the LGD (as applicable) for the portion of the exposure value covered by the adjusted value of the unfunded credit protection, according to Articles 108(2) and 236(1) CRR. Therefore, applying a conversion factor or a certain percentage in the calculation of the exposure value does not prevent from recognising unfunded credit protection. When an institution does not use own estimates of LDGs and conversion factors, the CRR prescribes an order for the determination of the covered portion of the exposure value. Per Article 236(3) CRR the exposure value considered for this purpose is to be calculated by applying a conversion factor or percentage of 100% instead of the conversion factors or percentages applicable in the calculation of the exposure value. The covered portion of the exposure value is therefore to be determined in relation to the total value of off-balance sheet items listed in Article 166(8) to (10) CRR. In contrast, when an institution uses own estimates of LGDs and conversion factors, recognition of unfunded credit protection does not require the separate identification of a covered portion of the exposure value, because risk mitigation by unfunded credit protection may be recognised by directly adjusting PD or LGD estimates in accordance to Article 164(2) CRR. Instead, as prescribed by Article 183(2) CRR, an institution shall have clearly specified criteria to reflect the impact of guarantees.   This would not prevent the institution from considering exclusively the exposure value resulting from the application of the conversion factors or percentages according to Article 166(8) to (10) CRR. On the contrary, it is explicitly required when recognising unfunded credit protection by adjusting the LGD, that is defined in Article 4(1)(55) CRR as the ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default.