Scope of asset value correlation adjustment for regulated entities

Should Undertakings for Collective Investment in Transferable Securities (UCITS) be treated as “subject to prudential regulation in the Union,” such that credit exposures to UCITS are only subject to the Asset Value Correlation (AVC) adjustment where the total assets of the counterparty on an individual or consolidated basis exceed EUR 70 billion? Should third country funds which are regulated on a comparable basis to UCITS (for example, US Investment Act 1940 funds, Employee Retirement and Income Security Act funds) receive the same treatment ?

We understand the asset value correlation adjustment reflects the increased systemic risk associated with certain financial institutions. Systemic risk is expected to be lower where a counterparty is both(i) subject to a high standard of prudential regulatory oversight; and(ii) relatively small. ‘Prudential regulation’ is not defined – on a very limited view, it could be read as meaning firms subject to risk-based capital requirements via CRR (banks and investment firms) and Solvency II (insurers). However, funds are also subject to extensive regulatory requirements, including restrictions on leverage, which should also limit their systemic risk. We are not seeking clarification on the treatment of exposures in the form of units or shares in CIUs according to Article 152 CRR. The type of activity that prompted our question is:(i) lending to the CIU, either on a secured or senior unsecured basis; and(ii) counterparty risk exposure on OTC derivatives with the CIU. These are credit and counterparty risk exposures that are distinct from holding units or shares in the CIU. The bank’s lending/derivative trading with the CIU does not convey any ownership interest, we are transacting with the CIU in the same way as any other customers. In the event of the CIU’s insolvency or default, our claim would rank senior to those holding units or shares in the CIU. CIUs may borrow from the credit institution in order to meet their day-to-day cashflow needs, or to leverage their returns (within the investment mandate agreed for each CIU). CIUs may enter into derivative transactions with us as outright trading positions; alternatively, they may do so in order to hedge risks associated with their asset holdings. Although it is the investment management company that will set up these arrangements they are doing so on the CIU’s behalf; the bank’s contractual counterparty as a bank is the CIU itself – the bank has no recourse to the management company. It is therefore the CIU’s credit risk that is relevant for calculating the bank’s risk-weighted exposure amounts. The bank does so using CRR Article 153, hence the need to consider whether the 1.25 multiplier applies under Article 153(2).