The Prudential Regulation Authority (PRA) has published a consultation paper (CP6/18) (Consultation Paper) in which it consults on proposals to clarify its expectations regarding the eligibility of guarantees as unfunded credit protection under the Capital Requirements Regulation (575/2013) (CRR). Attached to the Consultation Paper are draft updates to the PRA’s Supervisory Statement 17/13 on Credit Risk Mitigation (Supervisory Statement), which the PRA intends will be used to implement these proposals following consultation.


Unfunded credit protection which meets the requirements specified in Article 194 of the CRR can be used as a form of eligible credit risk mitigation, allowing firms subject to the CRR to reduce the amount of capital that they are required to hold against particular exposures. As a result, certain guarantees may be considered eligible credit risk mitigation provided they meet the relevant requirements under the CRR.

The CRR requirements in relation to credit risk mitigation are prescriptive and often require extensive interpretation. To be considered eligible credit risk mitigation the relevant technique must be supported by an independent, written and reasoned legal opinion to establish the arrangements are legally valid and enforceable in all relevant jurisdictions. A firm must be able to provide this to its relevant competent authority on request.

Consultation paper

The PRA states in the Consultation Paper that the proposals are designed to provide "additional clarity" in respect of how the PRA considers the criteria for unfunded credit protection to be met in order to be considered eligible credit risk mitigation. It is fair to say, however, that the clarifications demonstrate that the PRA will be looking to firms (and their legal counsel) to ensure they have given extensive legal and practical consideration to the effects of the relevant instrument in order for the PRA to be sufficiently comfortable that the technique meets the relevant requirements of the CRR. In this article, we consider some of the key clarifications made by the PRA in respect of the requirements for guarantees to qualify as eligible credit risk mitigation under the CRR.

The Consultation Paper closes on 18 May 2018.

Legally effective and enforceable in all relevant jurisdictions

The PRA clarifies that it expects the guarantee to be legally effective and enforceable in:

  • The country of the guarantee’s governing law
  • The jurisdiction in which the guarantor is incorporated, and
  • "Could well include other jurisdictions where enforcement action may be taken"

The PRA’s expectations are not entirely clear in this respect. For example, it is unclear whether, in the PRA’s view, the phrase “could well include other jurisdictions” leaves the relevant jurisdiction issue to the discretion of the firm seeking to rely on credit risk mitigation; or what factors should be taken into account when considering whether to obtain legal opinions from other jurisdictions.

The PRA also clarifies that it expects the practical ease of enforcement should also be considered. However, there is no further guidance as to what extent the practical ease of enforcement could/would be considered an impediment. This expectation clarifies that the scope of enforceability extends, perhaps unsurprisingly, beyond the mere legal ability to enforce the guarantee to the practical elements of enforceability, although the question of how far remains unanswered.

Clearly defined and incontrovertible

The CRR permits credit risk mitigation where liability under the credit protection is "clearly defined and incontrovertible".

The PRA states that it interprets "incontrovertible" to mean that the "wording of the guarantee should be clear and unambiguous, and leave no practical scope for the guarantor to dispute, contest, and challenge or otherwise seek to be released from, or reduce, their liability". This definition is of particular assistance, since "incontrovertible" is otherwise not defined in the CRR, although in itself it does not appear to change (in any material way) the way that legal opinions have generally been drafted through market practice.

The PRA states that it expects firms to consider the terms of the guarantee itself, the remedies available under applicable law and whether there are scenarios in which the guarantor could, in practice, successfully seek to reduce or be released from liability under the guarantee. Again, this goes beyond mere "legal scope" to reduce liability or be released from liability (ie through terms in the guarantee itself or by the operation of law) and looks at the practical factors. The PRA, however, does not provide examples of what such "practical scope" might extend to.

Guarantor obliged to pay out in a timely manner

The PRA clarifies its interpretation of this provision as including the further condition that "the firm must have the right to pursue, in a timely manner, the guarantor for any monies due under the guarantee, and that payment shall not be subject to the firm first having to pursue the defaulting obligor for recovery".

In respect of this, our view is that one of the key aspects of this Consultation Paper is the sentence that follows: “the PRA would expect firms to review existing agreements to ensure that they do not contain such clauses, or clauses that could be construed this way”. Such an expectation could incur a cost to firms in reviewing relevant guarantees and legal opinions previously given.

The PRA also clarifies that it interprets "in a timely manner" to mean that the guarantor is obliged, contractually, to pay out without delay and within days, but not weeks or months, of the date on which the obligor fails to make payment due under the claim in respect of which the protection is provided.

The PRA considers the "only' exceptions to these timescales are:

  • For guarantees covering residential mortgage loans, where the CRR specifically provides that the protection may pay out within 24 months (CRR Article 215(1)(a))
  • Where provisional payments are made under guarantees provided by mutual guarantee schemes or by public sector bodies (CRR Article 215(2)), and
  • Where CRR Part Three, Title II, Chapter 4 is applied in respect of a securitisation position in the different context of CRR Part Three, Title II, Chapter 5 (Securitisation)

Where certain types of payment are excluded, the value of the guarantee is adjusted

Article 215(1)(c) CRR allows for "certain types of payment" to be excluded from the guarantee, but if this is done, the value of the guarantee must be adjusted by the firm to reflect the "limited coverage". The PRA gives more guidance about the "certain types of payment" that can be excluded from the guarantee and "limited coverage" that the guarantee offers.

The PRA considers that, in the context of Article 215(1)(c) CRR, "limited coverage" refers to a quantifiable portion of the exposure. The ‘certain types of payment’ refer to different sums the obligor may be required to pay to the firm under the contract (such as the principal, interest, margin payments, fees and charges). For example, it contemplates a guarantor guaranteeing non-payment of principal, but not interest payments due by the obligor, or both principal and interest payments, but not fees or other charges.