Use of credit insurance as credit risk mitigation under the standardised approach for credit risk and application of the CRM eligibility requirements to certain clauses which are typical for credit insurance contracts

Does the inclusion of a general exclusions clause (including for example, an exclusion for losses caused by a so-called nuclear event, war or a loss as a result of a fraud or dispute) in a credit insurance contract render the contract non-compliant with the credit risk mitigation (CRM) eligibility requirements for guarantees in CRR, in particular Article 213(1)(c)(iii) CRR, assuming all other conditions have been fulfilled?

Institutions use credit insurance for - amongst others - CRM purposes. There are a number of typical elements in a credit insurance contract, which need to be considered. One of these is the general exclusions clause (excluding cover for losses as a result of nuclear events or fraud). Below we provide further background on business practices, the concept of conditionality, considerations in favour of a positive answer to the question and that such credit insurance contracts are ineligible and arguments supporting the view that such credit insurance contracts should be considered eligible.   Business practices It should be noted that a (nuclear) exclusion clause is a rather common clause in many (insurance) contracts. Such a clause can be summarised as an exclusion clause under which the insurer (guarantor) is not obliged to pay out under the insurance to the beneficiary thereof, even if the debtor (guarantee party) has breached the contract clauses or covenants.   Conditionality For this question the notion of “conditionality” is relevant. It may be noted that at least three notions of conditionality must be distinguished with regard to guarantees (and insurance contracts): Order of actions. In business practice, unconditional and conditional guarantees are distinguished, to refer to the order of actions to be pursued by the beneficiary of the guarantee. Broadly speaking a conditional guarantee implies that the beneficiary has to seek payments from the obligor / guaranteed party first, usually to the point  of forcing the obligor into bankruptcy. An unconditional guarantee on the other hand, would allow the beneficiary to claim the benefits from the guarantor, without substantial legal action against the obligor. Revocability. In the CRR, in most instances, the notions of revocability of the guarantee and conditionality of the guarantee, refer to the notion that a guarantee could be revoked by the issuer, depending on the contract features, and certain specified trigger events. Conditional pay out. The scope of events covered by the guarantee are – as a starting point – presumably all scenarios under which the obligor (guaranteed party) defaults. However, as with all contracts, some events may be out of scope of the coverage. Such excluded events would not terminate the guarantee contract, but would be a ground (or reason) for the guarantor not to pay-out on the guarantee in the event of default of the obligor (guaranteed party). The CRR is silent on the possibility of out-of-scope events.   Considerations supporting ineligibility of a guarantee including a nuclear exclusions & arguments for eligibility The main line of interpretation of the CRR is that institutions need to demonstrate the eligibility of a guarantee contract. Under the standardised approach (SA) and Foundation IRB (F-IRB) approach, guarantees must meet the CRM eligibility requirements listed in Part 3, Title II, Chapter 4 CRR. Especially, the condition in Article 213(1)(c)(iii) CRR could be read to disqualify credit insurance contracts with an exclusions clause for CRM purposes. However, it can be argued that this condition should not be understood as disqualifying a credit insurance contract for CRM purposes because it contains an exclusions clause. In addition, it is questionable whether Article 213(1)(c)(iii) CRR should apply in that way. This provision seems to cover the situation that the insured party has a claim, but the contract includes clauses that are not within the insured party’s control but could hinder or prevent pay-out by the insurer. However, an exclusion clause in an insurance contract works in such a way that no claim under the contract arises in the situations covered by the exclusion clause. It limits the extent of the cover. The latter should not lead to non-compliance with the eligibility requirements as Article 213(1)(b) CRR explicitly requires the extent of the credit protection (insurance cover) to be clearly defined and incontrovertible.