PIB 4.13.11(1) An
Authorised Firmmay recognise the effects of Credit Riskmitigation of a Credit Derivativeonly if it is provided by any of the following entities:(a) central government or Central Bank;(c) International Organisations referred to in PIB Rule 4.12.9;(d) PSE;(e) banks and securities firms which qualify for inclusion in bank asset class; or(f) any other entity that has a Credit Quality Grade"3" or better.(2) An Authorised Firmmay recognise the effects of Credit Riskmitigation of only the following types of Credit Derivatives:(a) credit default swaps;(b) total return swaps;(c) credit linked noteswhich are cash funded; and(d) instruments that are composed of, or are similar in economic substance, to one or more of the Credit Derivativesin (a) to (c).
PIB 4.13.12 PIB 4.13.12
Authorised Firmmust not recognise the effects of Credit Riskmitigation of any Credit Derivativeunless all of the following requirements are complied with:(a) the terms and conditions of any credit protection obtained via a Credit Derivativemust be set out in writing by both the Authorised Firmand the provider of credit protection;(b) the Credit Derivativemust represent a direct claim on the provider of credit protection;(c) the extent of the credit protection cover is clearly defined and incontrovertible;(d) other than in the event of non-payment by the Authorised Firmof money due in respect of the Credit Derivative, there is an irrevocable obligation on the part of the provider of the credit protection to pay out a pre-determined amount upon the occurrence of a credit event, as defined under the Credit Derivativecontract;(e) the Credit Derivativecontract must not contain any clause, the fulfilment of which is outside the direct control of the Authorised Firm, that:(i) would allow the provider of credit protection to cancel the credit protection cover unilaterally;(ii) would increase the effective cost of the credit protection cover as a result of deteriorating credit quality of the underlying Exposure;(iii) could prevent the provider of credit protection from being obliged to pay out in a timely manner in the event that the underlying obligor fails to make any payment due; or(iv) could allow the maturity of the credit protection agreed ex-ante to be reduced ex-post by the provider of credit protection;(f) the credit events specified by the contracting parties must at a minimum cover:(i) failure to pay the amounts due under terms of the underlying Exposurethat are in effect at the time of such failure (with a grace period, if any, that is closely in line with the grace period in the underlying Exposure);(ii) bankruptcy, insolvency or inability of the underlying obligor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; and(iii) restructuring of the underlying Exposureinvolving forgiveness or postponement of principal, interest or fees that results in a credit loss event (i.e. charge-off, specific provision or other similar debit to the profit and loss account);(g) the Credit Derivativemust not terminate prior to the maturity of the underlying Exposureor expiration of any grace period required for a default on the underlying Exposureto occur as a result of a failure to pay;(h) a robust valuation process to estimate loss reliably must be in place in order to estimate loss reliably for any Credit Derivativethat allows for cash settlement. There must be a clearly specified period for obtaining post-credit event valuations of the underlying obligation;(i) where the right or ability of the Authorised Firmto transfer the underlying Exposureto the credit protection provider is required for settlement, the terms of the underlying Exposuremust provide that any required consent to such transfer may not be unreasonably withheld;(j) the identity of the parties responsible for determining whether a credit event has occurred must be clearly defined. This determination must not be the sole responsibility of the credit protection provider. The Authorised Firmmust have the right or ability to inform the credit protection provider of the occurrence of a credit event; and(k) the underlying obligation and the reference obligation specified in the Credit Derivativecontract for the purpose of determining the cash settlement value or the deliverable obligation or for the purpose of determining whether a credit event has occurred may be different only if:(i) the reference obligation ranks pari passu with or is junior to the underlying obligation; and(ii) the underlying obligation and reference obligation share the same obligor (i.e. the same legal entity) and legally enforceable cross-default or cross-acceleration clauses are in place.
PIB 4.13.12 Guidance1. An
Authorised Firmshould not recognise the effects of Credit Riskmitigation of a total return swap if it purchases credit protection through a total return swap and records the net payments received on the swap as net income, but does not record offsetting deterioration in the value of the underlying asset that is protected (either through reductions in its marked-to-market value or by an addition to reserves).2. The DFSAwould generally consider the requirements in (f) to have been complied with even if the requirements are not specifically set out so long as the obligations of the credit protection provider under the Credit Derivativecontract would include those requirements.3. The DFSAwould generally consider the cash settlement methodology provided in the ISDA Credit DerivativesDefinitions as satisfying the requirement for obtaining post-credit event valuations of the underlying obligation.