Credit Risk Mitigation Specification¶

Collateral haircuts, overcollateralisation, FX mismatch, maturity mismatch, and guarantee substitution.

Regulatory Reference: CRR Articles 192-241

Test Group: CRR-D

Requirements Status¶

Exposure value for CRM purposes (Art. 223(4))¶

CRR Art. 223(4) and PRA PS1/26 Art. 223(4) both require that, when computing the exposure value E used for credit risk mitigation, off-balance-sheet items shall be valued at 100% of nominal, overriding the regulatory CCF. The actual CCF only re-couples afterwards.

"(b) for institutions calculating risk-weighted exposure amounts under the IRB Approach, they shall calculate the exposure value of the items listed in Article 166(8) to (10) by using a conversion factor of 100% rather than the conversion factors or percentages indicated in those paragraphs."

The pipeline implements this with two parallel EAD bases on the exposures frame:

For pure on-balance-sheet rows the two EAD bases are equal by construction.

On-balance-sheet netting (Art. 219) note. The Art. 223(4) override applies to collateral valuation. OBS netting under Art. 219 is its own drawn-only mechanism: the synthetic cash collateral generated from a negative-drawn loan is allocated pro-rata across positive-drawn loan siblings by on_bs_for_ead (the drawn portion), not by ead_for_crm. Off-balance-sheet rows (contingents, synthetic facility_undrawn rows) are excluded from the OBS-netting beneficiary set.

Worked example (FIRB cash collateral)¶

100m off-BS FIRB exposure, 75% CCF (Art. 166(8)(d) medium-risk commitment), 50m cash collateral; senior unsecured (LGDU=45%), cash LGDS=0%:

ead_for_crm    = 100m         (CCF=100% override)
ead_gross      =  75m         (post-CCF, used for RWA)
collateral     =  50m         (cash, 0% haircut)
LGD*           = (0% × 50 + 45% × (100−50)) / 100 = 22.5%
RWA            = ead_gross × K(PD, LGD*=22.5%, M) × 1.06

Pre-fix code netted collateral against the post-CCF ead_gross and produced LGD* = 15%, under-stating FIRB LGD by 7.5pp on this exposure.

Worked example (SA off-BS cash collateral)¶

100m off-BS, 50% CCF (medium-risk), 30m cash:

ead_for_crm           = 100m
E*                    = max(0, 100 − 30) = 70m       (Art. 223(5))
ead_after_collateral  = E* × CCF = 70 × 0.5 = 35m    (Art. 228(1))

Pre-fix code returned ead_after_collateral = max(0, 50 − 30) = 20m, under-stating EAD by 15m and therefore SA RWA.

Collateral Haircuts (CRR Art. 224 / PRA PS1/26 Art. 224)¶

CRR uses 3 maturity bands for bond haircuts; Basel 3.1 expands to 5 bands with increased haircuts at longer tenors. All values below are at the 10-day liquidation period.

Financial Collateral¶

Government Bonds (by CQS and Residual Maturity — Art. 224 Table 1)¶

CRR (3 maturity bands):

Basel 3.1 (5 maturity bands — PRA PS1/26 Art. 224 Table 1, 10-day liquidation period):

Key B31 change: the 5-band split re-groups the CRR 1–5yr and 5yr+ bands but does not raise sovereign haircuts for well-rated issuers. CQS 2–3 sovereigns remain at 6% even at the longest tenor; the CRR-era "5yr+ = 6%" simply splits into 5–10yr = 6% and >10yr = 6%. The cross-reference to the authoritative B31 spec is Government Bond Haircuts (5-Band).

CQS eligibility (Art. 197):

• CQS 1-4 government/central bank bonds are eligible as financial collateral (Art. 197(1)(b))
• CQS 5-6 government bonds are ineligible (Art. 197)
• CQS 1-3 institution/corporate bonds are eligible (Art. 197(1)(c)/(d)); CQS 4-6 are ineligible

Corporate/Institution Bonds (by CQS and Residual Maturity — Art. 224 Table 1)¶

CRR (3 maturity bands):

Basel 3.1 (5 maturity bands — PRA PS1/26 Art. 224 Table 1, 10-day liquidation period):

Key B31 changes: the 5-band split raises the longest-tenor haircuts materially while easing short-to-mid tenors. CQS 1 >10yr moves from the CRR 5yr+ flat 8% to 12%; CQS 2–3 >10yr moves from 12% to 20% (a +8pp uplift). By contrast, CQS 1 / 1–3yr eases from 4% to 3% and CQS 2–3 / 1–3yr eases from 6% to 4%. The cross-reference to the authoritative B31 spec is Corporate and Institution Bond Haircuts (5-Band).

Equity (Art. 224 Table 3)¶

Non-Financial Collateral¶

Non-financial collateral does not use the supervisory volatility haircut framework (Art. 224). Instead, it is recognised through the Foundation Collateral Method (Art. 230-231) using LGDS values within the LGD* formula. See F-IRB LGDS Values below for the per-framework values.

FX Mismatch Haircut (CRR Art. 224 Table 4 / Art. 233(3))¶

When financial collateral or unfunded credit protection is denominated in a currency different from the exposure: 8% base haircut (10-day liquidation), scaled by Art. 226(2) for other liquidation periods and by Art. 226(1) for non-daily revaluation.

The H_fx scope is asymmetric and follows the regulatory text exactly:

• Financial collateral (Art. 224 comprehensive method) — H_fx applies via Art. 224 Table 4 to cash, gold, bonds, equity, and other instruments listed in Tables 1–4. Implemented in engine/crm/haircuts.py:apply_haircuts.
• Unfunded credit protection (Art. 233(3)) — H_fx applies to guarantees and credit derivatives where G* = G(1 − H_fx). Implemented separately in engine/crm/guarantees.py. Article 232 explicitly cross-references Art. 233(3) for life insurance / credit-linked notes.
• Funded non-financial collateral (Arts. 229–230) — H_fx does not apply. Article 233 is unambiguously located in Sub-Section 2 Unfunded credit protection, and Art. 229 ("Valuation") plus Art. 230 ("Calculating risk-weighted exposure amounts…") for immovable property, receivables, and other physical collateral make no reference to H_fx. The LGD* formula compares the raw collateral value C (rebased to the reporting currency upstream by FXConverter) against the C* / C** thresholds in Table 5. The engine implements this exclusion by gating the H_fx Polars expression on ~collateral_type.is_in(NON_FINANCIAL_COLLATERAL_TYPES) — see data/schemas.py:NON_FINANCIAL_COLLATERAL_TYPES.

PS1/26 inherits CRR's position on all three scopes; the engine behaviour is framework-agnostic.

Zero-Haircut Conditions (CRR Art. 227)¶

Under certain conditions, supervisory haircuts may be set to 0% for repo-style transactions:

• Both the exposure and collateral are cash or CQS 1 government bonds
• The transaction is subject to daily margin maintenance with a one-day margin period of risk
• The close-out period from the last MTM to the liquidation of the collateral following a re-margining failure is no more than 4 business days (Art. 227(2)(d) — see the verbatim text and FCSM cross-application)
• In the event of a counterparty failure to deliver margin, the transaction can be terminated and collateral liquidated promptly
• Settlement is via a delivery-versus-payment or equivalent mechanism
• The documentation is standard market documentation for the repo/SFT transaction type

Where these conditions are met, H_c = 0%, H_e = 0%, and H_fx = 0% (if applicable).

Volatility Scaling (CRR Art. 226)¶

Art. 226 defines two separate scaling formulas:

Art. 226(2) — Scaling between liquidation periods:

H_m = H_n × sqrt(T_m / T_n)

Art. 226(1) — Non-daily revaluation adjustment:

H = H_m × sqrt((NR + T_m - 1) / T_m)

Liquidation Period Dependency (CRR Art. 224, Tables 1-4)¶

Art. 224 Tables 1-4 provide haircuts at all three liquidation periods. When scaling is needed (e.g., applying a 10-day table haircut to a repo), use Art. 226(2). When revaluation is not daily, additionally apply Art. 226(1).

F-IRB LGDS Values (Art. 230 / Art. 161)¶

Under the Foundation Collateral Method, the collateral-adjusted LGD (LGD*) uses supervisory LGDS values that differ by framework:

Unsecured LGD (LGDU) for the unsecured portion of the LGD* formula:

LGD* Formula — Foundation Collateral Method (Art. 230)¶

The formula blends LGDU (unsecured) and LGDS (secured) across the secured and unsecured portions:

LGD* = LGDU × (EU / E(1+HE)) + LGDS × (ES / E(1+HE))

Where: - E(1+HE) = exposure value grossed up by the exposure volatility haircut - ES = haircut-adjusted collateral value, capped at E(1+HE): ES = min(C(1-HC-HFX), E(1+HE)) - EU = unsecured portion: EU = E(1+HE) - ES - LGDU = unsecured LGD (CRR: 45% uniform; B31: 40% non-FSE / 45% FSE per Art. 161(1)) - LGDS = secured LGD per framework (see F-IRB LGDS table above) - HC = collateral haircut, HE = exposure haircut, HFX = FX mismatch haircut

Scope of the H_FX term in the formula above:

• Financial collateral — HFX = 8% × √(T_m/10) × Art. 226(1) multiplier when collateral currency ≠ exposure currency, per Art. 224 Table 4.
• Funded non-financial collateral (receivables, real estate, other physical) — HFX = 0 regardless of currency mismatch. CRR Arts. 229–230 contain no FX volatility adjustment for Art. 230 collateral, and Art. 233 (the source of the 8%) sits in the unfunded-protection sub-section. The collateral value C is the market / mortgage-lending value per Art. 229, rebased to the reporting currency upstream by FXConverter at the spot rate. PS1/26 inherits this scope.

Note: The simplified formula LGD* = LGD × (E*/E) where E* = max(0, E(1+HE) - C(1-HC-HFX)) only works when LGDS = LGDU. For non-financial collateral (LGDS ≠ LGDU), the blended formula above is required.

Mixed Collateral Pools (Art. 231)¶

When an exposure is secured by multiple collateral types, allocation is sequential (waterfall), not pro-rata:

For each collateral type i (in chosen order):
  ES_i = min(C_i, E(1+HE) - sum(ES_k for k < i))
  EU = E(1+HE) - sum(ES_i)

Blended LGD* = sum(LGDS_i × ES_i / E(1+HE)) + LGDU × EU / E(1+HE)

The institution may choose the ordering (most favourable = lowest LGDS first). Typical waterfall: financial collateral first (LGDS=0%), then receivables (20%), then real estate (20%), then other physical (25%), with the remainder at LGDU.

Note: Pro-rata allocation gives different LGD* than sequential fill when total collateral < total exposure. Art. 231 requires sequential fill.

Non-Financial Collateral Recognition (CRR Art. 230)¶

Non-financial collateral is recognised through the Foundation Collateral Method using the LGD* formula with LGDS values.

Eligibility for Other Physical Collateral (CRR Art. 199(6))¶

Before any Art. 230 LGD* mechanics can be applied, other physical collateral (i.e., physical collateral that is not immovable property under Art. 199(2)–(4) or receivables under Art. 199(5)) must clear the Art. 199(6) eligibility gate. CRR Art. 199(6) requires the competent authority to permit the institution to use the collateral, and is conditional on all four of the following:

The (d) test is a collateral-type-level historical realisation track record — it is assessed across the institution's full population of past liquidations of that collateral type, not loan-by-loan. Failing the test (or any of (a)–(c)) renders the collateral type ineligible: it cannot enter the Art. 230 LGD* waterfall at all, and there is no fallback to a haircut-based recognition.

Art. 199(6) eligibility is the gate; Art. 230 governs the mechanics (the C*/C** minimum coverage thresholds and the LGDS values applied to the secured portion via the LGD* formula). The two articles operate in sequence: 199(6) decides whether the collateral type may be used at all, and 230 then converts the eligible collateral into an LGD effect subject to the 30% C* minimum and 140% C** full-recognition thresholds for "other collateral" in Art. 230 Table 5.

Art. 199(6) also feeds the documentation duty: institutions shall document fulfilment of (a)–(d) and the operational requirements under Art. 210. Art. 199(8) further requires the PRA to publish a list of types of physical collateral for which institutions can assume that conditions (a) and (b) of paragraph 6 are met (condition (d) is institution-specific and cannot be satisfied by such a list).

Overcollateralisation Ratios¶

The code implements overcollateralisation ratios (1.25x receivables, 1.4x RE/physical) and 30% minimum thresholds for RE and other physical collateral. These ratios divide the haircut-adjusted collateral value before it enters the LGD* waterfall, effectively reducing the recognised secured portion.

Regulatory basis: These ratios appear in CRR Art. 230(2) (conditions for non-financial collateral recognition) and are preserved under PRA PS1/26. They are not the same as the supervisory volatility haircuts in Art. 224.

Minimum Coverage Requirements¶

Art. 230 specifies conditions for collateral eligibility: - The collateral must be properly valued and regularly revalued - The collateral value must be sufficient to justify the LGDS applied - Specific conditions apply per collateral type (e.g., real estate valuation requirements per Art. 229)

Maturity Mismatch (CRR Art. 237-239)¶

CRR Section 5 of Chapter 4 covers maturity mismatches across both funded and unfunded credit protection. Art. 238(1A) (carried into PRA Rulebook unchanged) enumerates the in-scope CRM methods; Art. 237 sets the eligibility gates; Art. 239 sets the per-method valuation formula.

Methods in Scope (CRR Art. 238(1A))¶

The CRR maturity-mismatch framework applies to credit protection recognised under any of the following methods:

The same eligibility gates and adjustment formulas therefore apply to collateral and to guarantees/CDS — there is no separate maturity-mismatch treatment for unfunded protection in CRR. FCSM (Art. 222) and the A-IRB own-LGD treatment (Art. 183) are the only CRM methods that sit outside this perimeter (FCSM is excluded by Art. 239(1); own-LGD captures maturity mismatches inside the LGD model).

Maturity Mismatch Eligibility (CRR Art. 237)¶

When a maturity mismatch exists (protection residual maturity < exposure residual maturity), credit protection is only eligible if all of the following conditions are met:

1. Art. 237(1) — combined test: if the protection has residual maturity < 3 months and protection maturity < underlying exposure maturity, "that protection does not qualify as eligible credit protection" (CRR Art. 237(1) verbatim, docs/assets/crr.pdf p. 232).
2. Art. 237(2)(a) — original maturity ≥ 1 year: "Where there is a maturity mismatch the credit protection shall not qualify as eligible" (CRR Art. 237(2) chapeau verbatim) where the original maturity of the protection is less than one year.
3. Art. 237(2)(b) — not a 1-day M-floor exposure: the same chapeau applies where the exposure is a short-term exposure specified as subject to a one-day floor rather than a one-year floor in respect of the maturity value M under Art. 162(3) (repos, SFTs with daily margining, short-term trade-finance IRB exposures).

If any condition fails, the protection value is zeroed (collateral value = 0 for the mismatched portion). These gates apply uniformly to funded and unfunded protection — a guarantee or CDS with original maturity < 1 year is ineligible for an exposure with residual maturity > 1 year, just as a financial-collateral instrument with the same characteristics is.

Maturity Mismatch Adjustment (CRR Art. 239)¶

Two parallel formulas — Art. 239(2) for funded methods (a)–(d) and Art. 239(3) for unfunded methods (e)–(f). The multiplier (t − 0.25) / (T − 0.25) is identical between the two; only the protection input differs.

Art. 239(2) — funded protection (methods (a)–(d)):

CVAM = CVA × (t - 0.25) / (T - 0.25)

CVAM substitutes for CVA in the FCCM E* formula at Art. 223(5), or flows through Art. 219(3) for on-balance sheet netting.

Art. 239(3) — unfunded protection (methods (e)–(f)):

GA = G* × (t - 0.25) / (T - 0.25)

GA is used as the credit-protection amount input to the RWSM (Art. 235, SA / slotting) or the PSM (Art. 236, IRB) — the same formula governs guarantee and credit-derivative maturity mismatches under both SA and IRB.

In both formulas: t = residual protection maturity (years, capped at T); T = min(residual exposure maturity, 5) years. No adjustment when t ≥ T (the multiplier collapses to 1).

Multi-Level Collateral Allocation¶

Collateral is allocated at three levels, distributed pro-rata:

1. Exposure level - Collateral pledged directly against an exposure
2. Facility level - Collateral pledged against a facility, shared across its exposures
3. Counterparty level - Collateral pledged against a counterparty, shared across all exposures

Financial and non-financial collateral are tracked separately to apply the correct overcollateralisation ratios and minimum thresholds.

Nested facilities — ancestor cascade¶

The facility level is hierarchy-aware: facilities may nest (a facility whose parent is another facility, expressed via FACILITY_MAPPING_SCHEMA with child_type = "facility"). Collateral pledged at any ancestor facility (immediate parent, grandparent, … root) cascades pro-rata (by ead_for_crm) to every descendant exposure of that facility, not just the exposures whose immediate parent_facility_reference matches the pledged facility.

The HierarchyResolver emits an ancestor_facilities list column on each exposure (its parent plus every ancestor up to the root, including the facility itself). The CRM stage (_build_facility_lookup for pledge_percentage resolution, and _cascade_facility_collateral for the allocation) consumes it:

• A pledge_percentage at an ancestor facility F resolves against the whole subtree EAD of F (Σ ead_for_crm over all descendants), not F's direct exposures only.
• Each descendant's share of F's collateral is ead_for_crm / subtree_ead(F, pool).
• Pledges made at several ancestor levels stack on a descendant.
• A pledge at a specific facility reaches only that facility's subtree — sibling subtrees sharing a common root are unaffected.

The cascade is pool-aware (see below) and reduces exactly to single-level allocation when no facility hierarchy is present (ancestor_facilities = [parent]).

The same ancestor cascade applies to facility-level provisions and guarantees (engine/crm/provisions.py, engine/crm/guarantees.py): a provision (CRR Art. 111(2)) or guarantee (CRR Art. 213-217) pledged at any ancestor facility is allocated pro-rata across the whole descendant subtree (by EAD-equivalent weight / ead_after_collateral respectively), so all three credit-protection types behave consistently across nested facilities.

Pool-Aware Pro-Rata for AIRB Mixes (CRR Art. 181)¶

Under A-IRB, the firm's own modelled LGD already reflects the credit-risk-mitigating effect of any collateral incorporated in the model. To prevent double-counting when a counterparty has both A-IRB and non-A-IRB exposures, the pipeline splits the pro-rata base by pool:

• AIRB-eligible pool = exposures where the modelled LGD is preserved by CRM (approach == AIRB and the row is not falling back to the supervisory formula).
• Non-AIRB pool = FIRB / SA / Slotting (and AIRB rows that fall back to the supervisory formula under Art. 169B insufficient-data fallback or Foundation election under Basel 3.1).

Behaviour:

Setting is_airb_model_collateral = True is the firm's assertion that the collateral has been used to construct the internal LGD model. The flag has no numerical effect on AIRB rows (their modelled LGD is preserved either way) but it ensures the collateral is excluded from CRM allocation to non-AIRB exposures of the same counterparty / facility.

Guarantee Substitution (CRR Art. 213-217)¶

Approach¶

The guarantor's risk weight replaces the borrower's risk weight for the guaranteed portion of the exposure, but only when this is beneficial.

Application Logic¶

1. Look up the guarantor's risk weight based on entity type and CQS
2. Compare to the borrower's risk weight
3. If guarantor RW < borrower RW, apply substitution on the guaranteed portion
4. If guarantor RW ≥ borrower RW, no substitution (guarantee is non-beneficial)

Blended Risk Weight¶

For partially guaranteed exposures:

RW_blended = (unguaranteed_portion x borrower_RW + guaranteed_portion x guarantor_RW) / EAD

Tracking Fields¶

The calculator tracks pre- and post-CRM values for audit:

• pre_crm_counterparty_reference / post_crm_counterparty_guaranteed
• pre_crm_exposure_class / post_crm_exposure_class_guaranteed
• guaranteed_portion / unguaranteed_portion
• is_guarantee_beneficial

Unfunded Credit Protection Adjustments (Art. 233)¶

FX Mismatch for Guarantees/CDS (Art. 233(3-4))¶

When a guarantee or credit derivative is denominated in a different currency from the exposure:

G* = G × (1 - H_fx)

Where H_fx is from Art. 224 Table 4 at the applicable liquidation period (8% at 10-day, scaled by Art. 226(1) if not daily revalued). The guaranteed amount must be reduced before applying substitution.

Art. 114(4)/(7) Domestic Sovereign Treatment Under Substitution¶

Under the substitution approach (Art. 215-217), the guaranteed portion is treated as an exposure to the guarantor. For an EU/UK central government or central bank guarantor, Art. 114(4) (and Art. 114(7) for Basel 3.1) grants a 0% risk weight when that substituted exposure is denominated in the sovereign's domestic currency.

The domestic-currency test is therefore evaluated against the guarantee currency, not the currency of the underlying exposure. A GBP loan guaranteed by an EU sovereign in EUR still qualifies for 0% RW on the guaranteed portion, because the substituted claim against the sovereign is in EUR. The cross-currency mismatch between the guarantee and the underlying loan is handled separately by the Art. 233(3) 8% FX haircut above.

This short-circuit takes precedence over the internal-rating routing: a sovereign guarantor with an internal PD and IRB permission still receives the 0% SA treatment when the guarantee is in the sovereign's domestic currency.

CDS Restructuring Exclusion Haircut (Art. 233(2) / Art. 216(1))¶

If a credit derivative does not include restructuring as a credit event: - Protection value is reduced by 40% (if protection amount ≤ exposure value) - Protection value is capped at 60% of exposure value (if protection amount > exposure value) - Exception: Art. 216(3) exemption applies where restructuring requires 100% vote amendment and the reference entity is subject to a well-established bankruptcy code

Partial Protection and Tranching (CRR Art. 233A / Art. 234)¶

Proportional Coverage (Art. 233A)¶

When unfunded credit protection covers only a proportion of the exposure:

• The covered portion receives the protection provider's risk weight (substitution)
• The uncovered portion retains the obligor's risk weight
• The split is simple pro-rata: covered = guarantee_amount / exposure_value

Tranched Coverage (Art. 234)¶

When credit protection covers a specific tranche (first loss or mezzanine) rather than proportional coverage:

• First loss tranche: The protection covers losses up to a specified threshold. The firm bears losses above the threshold. The protected portion uses the protection provider's risk weight; the retained senior tranche uses the obligor's risk weight.
• Second loss / mezzanine tranche: More complex — the firm bears first losses up to the attachment point, protection covers the mezzanine band. The first loss portion may attract higher risk weights (up to 1250% for securitisation-like treatment).
• Maturity mismatch: Standard maturity mismatch adjustment (Art. 239(2)/(3); Art. 238 governs maturity measurement) applies to the protected tranche.

Cross-Approach CCF Substitution (CRR Art. 153(3))¶

When an IRB exposure is guaranteed by a counterparty under the Standardised Approach, the guaranteed portion uses SA CCFs instead of IRB supervisory CCFs.

Guarantor Approach Determination¶

The guarantor's approach is "sa" when: - The firm lacks IRB permission for the guarantor's exposure class, OR - The guarantor has only an external rating (no internal PD)

The guarantor's approach is "irb" only when both conditions are met: - The firm has IRB permission for the guarantor's exposure class, AND - The guarantor has an internal rating with PD

EAD Split¶

ead_guaranteed = guarantee_ratio × (drawn + undrawn × ccf_sa)
ead_unguaranteed = (1 - guarantee_ratio) × (drawn + undrawn × ccf_irb)

Output Fields¶

• ccf_original, ccf_guaranteed, ccf_unguaranteed
• guarantee_ratio, guarantor_approach, guarantor_rating_type

Provision Resolution (Before CRM)¶

Provisions are resolved before the CRM waterfall (and before CCF application). See Provisions Specification for the drawn-first deduction approach and multi-level beneficiary resolution. The CRM waterfall (collateral → guarantees) operates on the provision-adjusted EAD.

CRM Method Selection (PRA PS1/26 Art. 191A)¶

Basel 3.1 replaces the old Art. 108 with Art. 191A, introducing a formal decision tree for CRM method selection. Key structural rules:

• Para 2(d): No double-counting — funded and unfunded CRM must not be recognised simultaneously on the same portion of an exposure.
• Para 3: Consistency — an institution must use the same CRM method for the same type of unfunded credit protection across its portfolio.
• Para 5 (Art. 193): Multiple CRM forms on a single exposure require the exposure to be subdivided into separately-covered parts.
• Para 6 (Art. 193): Multiple items of the same CRM form with different maturities require the exposure to be subdivided by maturity.
• Para 7 (Art. 193): Single collateral item covering multiple exposures must be allocated without double-counting.

Part 1 — Funded CRM with CCR Exposure¶

CCR exposures → IMM / SFT VaR Method / Financial Collateral Comprehensive Method (FCCM) / Financial Collateral Simple Method (FCSM, SA only)

Part 2 — Funded CRM without CCR¶

1. On-balance sheet netting → Art. 219
2. Financial collateral → FCSM (Art. 222, SA only) / FCCM (Art. 223)
3. Immovable property / receivables / other physical → Foundation Collateral Method (Art. 229-231, F-IRB) / LGD Modelling (A-IRB)
4. Life insurance / instruments from institutions → Other Funded Protection Method (Art. 232)

Part 3 — Unfunded CRM¶

• SA / Slotting → Risk-Weight Substitution Method (Art. 235)
• F-IRB / A-IRB → Parameter Substitution Method (Art. 236)
• A-IRB (own estimates) → LGD Adjustment Method (Art. 183)

Part 4 — Unfunded Covered by Funded¶

Where an unfunded credit protection contract is itself covered by funded credit protection, the funded CRM is applied to the unfunded protection first (Parts 1-2), then the adjusted unfunded protection is applied to the original exposure (Part 3).

CRM Eligibility Principles (Art. 193-194)¶

Art. 193 — General Principles¶

• Para 5: Where multiple forms of CRM cover a single exposure (e.g., collateral + guarantee), the institution must subdivide the exposure into the portion covered by each form and calculate the risk-weighted exposure amount for each portion separately.
• Para 6: Where multiple items of the same CRM form have different maturities (e.g., two guarantees with different expiry dates), the institution must subdivide the exposure according to the maturity of each protection item.
• Para 7: Where a single collateral item covers multiple exposures, the institution must allocate the collateral value across the exposures without double-counting. The total recognised collateral value across all covered exposures must not exceed the collateral's market value.

Art. 194 — Eligibility Conditions¶

Funded credit protection (Art. 194(1)-(4)):

• Must be from the eligible lists in Art. 197-200
• Must be sufficiently liquid and stable in value over time
• No material positive correlation between the collateral value and the obligor's credit quality (own-issued debt is excluded)

Unfunded credit protection (Art. 194(5)-(6)):

• Must be an eligible agreement type per Art. 203 (guarantees) or Art. 204(1) (credit derivatives)
• Must be legally effective and enforceable in all relevant jurisdictions
• Protection provider must be from the eligible list in Art. 201

Eligible Collateral (Art. 197)¶

Art. 197 lists eligible financial collateral for the FCSM, FCCM, and Foundation Collateral Method:

Eligible Unfunded Protection Providers (Art. 201)¶

Financial Collateral Simple Method — FCSM (Art. 222)¶

Paragraph references below verified verbatim against docs/assets/crr.pdf pp. 216–217 (UK-onshored CRR Art. 222, as amended to 1 Jan 2022).

Scope (Art. 222(1)). SA-only method. "Institutions shall not use both the Financial Collateral Simple Method and the Financial Collateral Comprehensive Method, except for the purposes of Articles 148(1) and 150(1)" (CRR Art. 222(1) verbatim — permanent partial use / phased IRB roll-out), and "Institutions shall not use this exception selectively with the purpose of achieving reduced own funds requirements or with the purpose of conducting regulatory arbitrage".

Under the FCSM the risk weight of the collateral substitutes for the obligor risk weight on the secured portion of the exposure. The unsecured remainder keeps the counterparty's unsecured risk weight.

Art. 222(3) — 20% RW Floor¶

The collateralised portion takes the risk weight that would apply to a direct exposure to the collateral instrument (Art. 222(3), first sub-paragraph), subject to a minimum 20% floor (Art. 222(3), second sub-paragraph), except as specified in paragraphs 4 to 6.

Art. 222(4) — 0% / 10% Floor for SFTs (Art. 227 Criteria)¶

CRR Art. 222(4) verbatim (docs/assets/crr.pdf p. 217):

For repurchase transactions and securities lending or borrowing transactions that meet the criteria in Art. 227, the collateralised portion receives:

• 0% RW where the counterparty is a core market participant (as enumerated in Art. 227(3) — sovereigns / central banks eligible for 0% RW under Art. 114, supervised institutions and investment firms, certain insurance undertakings, regulated CIUs subject to capital requirements, regulated pension funds, and recognised clearing organisations);
• 10% RW where the counterparty is not a core market participant — that is, the counterparty fails the Art. 227(3) enumeration even though all other Art. 227(2) preconditions are met. The 10% reflects the higher counterparty-credit-risk tail under a re-margining failure when the obligor sits outside the closed circle of regulated market participants who underpin the 0% treatment.

Art. 222(4) is a risk-weight floor, not a haircut. It substitutes for the obligor risk weight on the collateralised portion of the SFT — it does not modify the collateral's market value. Volatility haircuts are an FCCM mechanic (Art. 223–227) that does not exist under FCSM; FCSM uses the unadjusted market value of the collateral (Art. 222(2)) and expresses risk mitigation purely through the substituted RW.

Art. 222(4) governs SFTs only — it does not extend to non-SFT transactions or to OTC derivative collateralisation (those fall under paragraphs 5 and 6 respectively).

Art. 227(2)(a)–(h) — Preconditions for the FCSM SFT Carve-Out¶

Art. 222(4) is gated by the eight conditions in Art. 227(2). All eight must be met for the 0% / 10% RW to apply; otherwise the SFT falls back to the Art. 222(3) 20% RW floor. The conditions cover (a) eligible cash / 0%-RW sovereign collateral, (b) single-currency exposure and collateral, (c) one-day maturity or daily MTM / re-margining, (d) the 4-business-day close-out window detailed below, (e) a proven settlement system, (f) standard market documentation, (g) immediate terminability on default, and (h) core-market-participant counterparty status (the Art. 227(3) list — sovereigns/CBs eligible for 0% RW, institutions, investment firms, certain insurers, regulated CIUs, regulated pension funds, recognised clearing organisations).

Art. 227(2)(d) — 4-business-day close-out window¶

The close-out window in (d) is the operational tail risk gate. CRR Art. 227(2)(d) (verbatim, docs/assets/crr.pdf p. 226):

This is an eligibility precondition for the Art. 222(4) 0% / 10% RW — not a haircut-style adjustment. The four business days are measured from the last successful MTM (i.e., the last point at which the institution and counterparty agreed the value of the collateral) to the actual liquidation of the collateral following the counterparty's re-margining failure. If contractual or operational arrangements cannot demonstrate close-out within four business days, condition (d) fails, all of Art. 227(2) fails, and the SFT cannot use the FCSM SFT carve-out — it falls back to the Art. 222(3) 20% RW floor.

The same Art. 227(2)(d) gate also governs the FCCM 0% volatility adjustment under Art. 227(1) (the title paragraph of Art. 227 is "Conditions for applying a 0% volatility adjustment under the Financial Collateral Comprehensive Method"). Both methods inherit the four-business-day test from the same paragraph; the difference is what the test gates — under FCSM it gates the RW substitution at Art. 222(4), under FCCM it gates the 0% volatility adjustment at Art. 227(1) replacing the Art. 224 haircuts.

Art. 222(6) — 0% Floor for Same-Currency Cash or 0%-RW Sovereign Debt (non-SFT, non-derivative)¶

For transactions other than those referred to in paragraphs 4 and 5, institutions may assign a 0% risk weight where the exposure and the collateral are denominated in the same currency and either:

• (a) the collateral is cash on deposit or a cash-assimilated instrument; or
• (b) the collateral is debt securities issued by central governments or central banks eligible for a 0% RW under Art. 114, with the collateral's market value discounted by 20%.

Art. 222(7) extends the "central government / central bank debt securities" definition used in paragraphs 5 and 6 to include:

• debt securities of regional governments or local authorities treated as central-government exposures under Art. 115;
• debt securities of multilateral development banks attracting a 0% RW under Art. 117(2);
• debt securities of international organisations attracting a 0% RW under Art. 118;
• debt securities of public sector entities treated as central-government exposures under Art. 116(4).

No Maturity Mismatch Adjustment for FCSM (Art. 239(1))¶

Where the credit protection's residual maturity is shorter than the exposure's residual maturity, under CRR Art. 239(1) "the collateral does not qualify as eligible funded credit protection" (CRR verbatim, docs/assets/crr.pdf p. 233). Under PS1/26 Art. 239(1) (effective 1 January 2027) the same rule is re-cast obligation-voiced: "an institution using the Financial Collateral Simple Method shall not use the collateral as eligible funded credit protection" — the near-final PS9/24 text "may not use" was replaced with "shall not use" in the final instrument (resolves D2.55). The maturity-mismatch adjustment formulas in Art. 239(2)/(3) do not apply to FCSM-collateralised exposures under either framework — the protection is simply not recognised.

FCSM Formula¶

RW_secured   = max(floor, RW_collateral)
RW_unsecured = RW_obligor

where floor ∈ {0%, 10%, 20%} selected per Art. 222(3)–(6):
    0%  → Art. 222(4) core-market SFT, or Art. 222(6) same-currency (a)/(b)
    10% → Art. 222(4) non-core-market SFT
    20% → Art. 222(3) default floor (no carve-out applies)

Eligibility: Collateral must be eligible financial collateral per Art. 197.

The calculator uses the Financial Collateral Comprehensive Method by default; the FCSM path is reserved for firms that elect it under Art. 148(1) / Art. 150(1).

Financial Collateral Comprehensive Method — FCCM (Art. 223)¶

The FCCM adjusts both the exposure value and the collateral value using volatility haircuts, producing a net adjusted exposure value (E*).

Art. 223(5) — E* Formula¶

E* = max(0, E(1 + HE) - CVA(1 - HC - HFX))

Where:

The resulting E is the exposure value after CRM. If E = 0, the exposure is fully collateralised (subject to the 0% floor on E). If E > 0, the residual is the unsecured portion.

For F-IRB exposures, the FCCM result feeds into the LGD* formula (Art. 230) rather than directly substituting the risk weight.

Credit-Linked Notes (Art. 218)¶

Credit-linked notes (CLNs) issued by the institution are treated as cash collateral (funded credit protection):

• The CLN is treated as cash equivalent — Art. 194(6)(c) condition is deemed satisfied
• The embedded CDS must qualify as eligible unfunded credit protection
• Funded protection value = nominal amount of the CLN minus any credit event reduction

Note: Art. 218 does not introduce a separate issuer risk weight check — the CLN is treated as cash collateral with 0% haircut.

Life Insurance Method (Art. 232)¶

Life insurance policies assigned to the lending institution as collateral:

• Eligible: Only life insurance policies with a current surrender value assigned/pledged to the institution (Art. 200(b) + Art. 212(2) operational requirements)
• Collateral value: The current surrender value, reduced for currency mismatch per Art. 233(3)
• SA risk weight (Art. 232(3)): The secured portion uses a mapped risk weight (not direct substitution) keyed off the senior-unsecured RW assigned to the insurer under the SA:

• F-IRB treatment (Art. 232(2)(b)): The secured portion uses LGD = 40% (not the standard LGDU)
• A-IRB treatment: Own LGD estimate for the secured portion

Note: Eligibility is per Art. 200(b) (eligible funded collateral) + Art. 212(2) (operational requirements), not Art. 201 (unfunded protection providers).

Parameter Substitution Method (Art. 236)¶

IRB-only method for unfunded credit protection (guarantees and credit derivatives):

• Covered portion: Uses protection provider's PD with exposure's LGD
• FIRB: covered LGD = supervisory LGD for senior unsecured claim on guarantor
• AIRB: covered LGD = own LGD estimate for senior unsecured claim on guarantor
• Uncovered portion: Uses obligor's own PD and LGD
• Expected loss: EL_covered = PD_guarantor × LGD_covered, EL_uncovered = PD_obligor × LGD
• Double recovery constraint: Combined coverage from funded + unfunded cannot exceed 100%

LGD Modelling Collateral Method (Basel 3.1 Art. 169A/169B)¶

New Basel 3.1 method for recognising collateral in A-IRB LGD estimates. This replaces the CRR approach of free-form LGD modelling with collateral:

Scope (Art. 169A)¶

• Available only for A-IRB exposures where the firm has approval to model LGD
• Firms must demonstrate that their LGD models appropriately capture collateral effects
• Model must be validated separately for secured and unsecured exposure segments

Key Requirements (Art. 169B)¶

• LGD estimates must reflect collateral-specific recovery characteristics
• Haircut approach: Firms may use own-estimate haircuts subject to PRA approval, or supervisory haircuts
• Collateral revaluation: Firms must revalue collateral at least annually, more frequently for volatile collateral
• Downturn LGD: Collateral values must be adjusted for economic downturn conditions
• The method must produce LGD estimates that are at least as conservative as the Foundation Collateral Method (Art. 230-231)
• LGD estimates remain subject to the A-IRB LGD floors per Art. 161(5)

Relationship to Other Methods¶

Parameter Substitution LGD Choice (Art. 236)¶

Under IRB parameter substitution for guaranteed exposures:

• F-IRB: The covered portion uses the supervisory LGD for a senior unsecured claim on the guarantor. For non-FSE guarantors this is 40%; for FSE guarantors this is 45%.
• A-IRB: The covered portion uses the firm's own LGD estimate for a senior unsecured claim on the guarantor, subject to A-IRB LGD floors.

The choice of LGD for the covered portion depends on the approach used for the guarantor's exposure class, not the obligor's approach.

Unfunded Credit Protection Transitional (Rule 4.11)¶

Rule 4.11 provides a narrow contractual carve-out for pre-existing unfunded credit protection during 1 January 2027 to 30 June 2028:

• Art. 213(1)(c)(i) normally requires that protection contracts do not allow the provider to unilaterally cancel or change the terms
• Rule 4.11 removes the words "or change" from Art. 213(1)(c)(i) for unfunded credit protection entered into prior to 1 January 2027
• Effect: legacy protection contracts that contain clauses allowing the provider to change (but not unilaterally cancel) the protection remain eligible during the transitional period under the new Basel 3.1 Art. 213 requirements

Rule 4.11 applies to unfunded credit protection only (guarantees and credit derivatives). Funded credit protection (collateral) transitions immediately to Basel 3.1 rules on 1 January 2027. The transitional is exposure-specific — each protection arrangement is assessed individually.

Key Scenarios¶

Basic CRM — CRR-D1 to CRR-D6¶

Advanced CRM — CRR-D7 to CRR-D14¶

These scenarios test the full CRM waterfall with guarantee substitution, credit derivatives, non-cash collateral types, overcollateralisation, and multi-mechanism chains. All use inline pipeline execution against unrated corporate borrowers (100% base RW) with £1,000,000 drawn unless otherwise stated.

CRR-D13 CRM Waterfall Detail¶

1. Provision deduction (Art. 110): drawn £1M − provision £100k = £900,000
2. Cash collateral (0% haircut): EAD = £900k − £300k = £600,000
3. Guarantee split: £200k at guarantor 20% RW + £400k at borrower 100% RW
4. Expected RWA ≈ £200k × 0.20 + £400k × 1.00 = £440,000

Provision-CRM Interaction — CRR-G4 to CRR-G6¶

These scenarios test provision deduction (Art. 110) as the first step in the CRM waterfall, before collateral recognition. They are tested in the advanced CRM pipeline to verify correct waterfall sequencing.

Structural Validation¶

Regulatory Haircut Reference (CRR Art. 224)¶

Acceptance Tests¶