EBA · 2015_2198 Final Q&A

Classification of a performance bonds according to annex 1.

Regulation
Regulation (EU) No 575/2013 (CRR)
Article
Annex 1, para. 3
Topic
Credit risk
Submitted by
Competent authority
Submitted
2015-08-05
Answered
2016-06-03
Answer provided by
ESAs (EBA, ESMA, EIOPA)
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Question

Does a performance bonds which guarantee satisfactory completion of a project by a contractor with an original maturity of more than one year qualify as Medium/low risk according to CRR, annex I, item 3(a)(ii) ?

Background

According to CRR, annex I, item 3(a)(ii) performance bonds are mentioned as an example of warranties that under the heading of 'trade finance off-balance sheet items' classify as medium/low risk. A Danish performance bond which guarantees satisfactory completion of a project by a contractor normally has an original maturity of 5 years (arbejdsgaranti). Trade finance is defined in CRR art. 4(1)(80): 'trade finance' means financing, including guarantees, connected to the exchange of goods and services through financial products of fixed short-term maturity, generally of less than one year, without automatic rollover. Consequently, one could argue that a Danish performance bond does not fulfil the requirement to be treated as a 'trade finance' item. On the other hand, one could argue that a performance bond has to be assigned to the medium/low risk category, because CRR, annex I, item 3(a)(ii) covers all performance bonds - regardless of their maturity. This holds true for all performance bonds as long as they do not have the character of a credit substitute. Trade finance items should 'generally', but not exclusively have a maturity of less than one year.

Answer

A performance bond is usually issued by a bank or insurance company to guarantee satisfactory completion of a project by a contractor. It is not unusual for them to have a maturity exceeding one year. As the performance bonds in the example are described to have an original maturity of five years, they cannot be considered to meet the definition for trade finance, in Article 4(1)(80) CRR, which foresees fixed short-term maturities, generally of less than one year, and thus cannot be treated under CRR Annex 1, item 3(a)(ii). Since the performance bonds described do not correspond directly to any of the other items described in Annex 1, they should be treated under ' Other items carrying [full, medium, medium/low, low risk, as appropriate] and', where applicable, 'as communicated to EBA' .

Original source: European Banking Authority, Q&A ID 2015_2198

This Q&A is published by European Banking Authority and is non-binding. It does not constitute legal advice. Updated weekly from official ESA sources.

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