Question
(1) Where a bank holds an item which is treated as a financial institution capital instrument under CRR, can a guarantee or credit default swap over that instrument be considered a short position for the purposes of Articles 45(a), 59(a) or 69(a)? (2) Where a bank has an indirect holding of a financial institution capital instrument, can a guarantee or credit default swap over the host item be considered a short position in the underlying capital instrument for the purposes of Articles 45(a), 59(a) or 69(a)?
Background on the question
Articles 45(a), 59(a) and 69(a) refer to short positions in financial institution capital instruments. We are seeking clarity that a guarantee or credit default swap, which transfer the risk on an instrument to another party, may be considered a short position in the non trading book. The party providing the guarantee or credit default swap would then have a synthetic holding in the financial institution capital instrument. CRR also considers indirect holdings of financial institution capital instruments. The definition in Article 4(1)(114) is focused on long holdings because of its reference to the “loss” that would be incurred on a long holding, rather than the gain that would be experienced on any short holding. A firm may have a senior exposure which gives rise to an indirect holding in a capital instrument. If the senior exposure is treated in the same way as a long position in the capital instrument, it follows that a short position in the senior exposure should also be treated as a short position in the capital instrument.
Answer
A derivative (such as a credit default swap) or a guarantee provided for a capital instrument in which an institution directly holds a long position in respect of the underlying exposure may only be treated as an offsetting short position for the purposes of Articles 45(a), 59(a) or 69(a) of Regulation (EU) No 575/2013 if such a derivative is provided by an entity outside of the accounting and prudential scope of consolidation of the institution at all levels of consolidation, and if the derivative is such that it fully and promptly offsets any changes in value arising in the long position in the own funds instrument. A derivative which would cover only losses occurring after a default has occurred would not comply with the treatment set out above, and therefore may not be treated as an offsetting short position. The treatment outlined under point (1) above in respect of direct holdings of capital instruments also applies to indirect holdings.