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23 November 2010 Supervision Supervision label Q&A

Question:

May exposures to subsidiaries of multinational corporations be accepted as ‘other risk-mitigating measures’ as referred to in section 3(e) of the Policy Rule on the Treatment of Concentration Risk in Emerging Countries (Beleidsregel behandeling concentratierisico opkomende landen) (hereinafter referred to as the Policy Rule)?

Answer:

Exposures to qualifying holdings of more than 50% of parent companies having their head office outside the country where the holding is established, are included, in fair proportion, in the calculation of the net material country concentration as referred to in section 4(1)(a) of the Policy Rule. In DNB’s view, fair proportion means that at least 50% of these exposures is included in the calculation. The institution must adequately demonstrate that the parent company is capable of supporting its qualifying holding in case a country risk event, as defined in the Policy Rule, arises. This may be evident from the following circumstances:

  • the holding has the same name as the parent company;
  • the parent company is globally active, has a sound financial reputation and is preferably listed on an international stock exchange;
  • the parent company is large enough to support the holding should the need arise;
  • there are no indications to the effect that the parent company would not be prepared, if required, to support the holding.

The above does not mean that, for the purposes of the Policy Rule, a ‘risk transfer’ is effected from the country of establishment of the holding to the country of establishment of the parent company. This will only be the case if the parent company has issued legally enforceable, complete and irrevocable guarantees regarding the exposures concerned.

Explanatory note – General

In consultations with supervised institutions prior to the adoption of the Policy Rule, the discussion focused on the scope of the category ‘other risk-mitigating measures’. Exposures to subsidiaries of multinational corporations (such as Coca Cola in country x or Unilever in country y) were mentioned explicitly on that occasion. In the context of the Policy Rule, the underlying reasoning was that a parent company established in another country than a holding to which it has an exposure will be able and prepared to take over (part of) the liabilities of the holding. Now that the Policy Rule is applied in ongoing supervision, there is a need for a further specification of the treatment of this type of exposures, because this subject affects a substantial number of institutions which are considered to comply with the Policy Rule.

DNB considers it reasonable to permit a mitigation of 50% of the value of such exposures in the calculation of the net material country concentration as referred to in section 4(1)(a) of the Policy Rule. This weighting is in line with the weightings assigned to the risk-mitigating measures defined in the Policy Rule (that is, collateral, trade financing and maturities), the risk weights in Chapter 2 of the Supervisory Regulation on Solvency Requirements for Credit Risk (Regeling solvabiliteitseisen voor het kredietrisico) and the weights commonly assigned in the market to such positions.

The readiness of the parent company to assume the liabilities of its holding is apparent first of all from the relationship of control existing between the two companies. If the parent company has no more than a minority participating interest, it will be more inclined to allow the holding to default or to allow a default to continue.

Explanatory note to the first bullet

The probability of a parent company being prepared to assume the liabilities of a holding will be higher as the reputation risk attending default on the part of the holding is larger. In DNB’s view, this is the case if the holding has the same name as the parent company. Possibly, this could also be the case if the holding sells products or renders services whose brands or product names are immediately identified with the parent company. However, if this is only the case within the country where the holding is established and active, this constitutes no reason for assuming that the parent company will be prepared to step in.

Explanatory note to the second and third bullets

Apart from the parent company’s preparedness to support its holding, it is also important that the parent company should be able to do so. In order to ascertain this ability, the supervised institution should demonstrate convincingly that this is the case. Possible indicators in this respect could be the size of the parent company relative to its holding (for instance, measured in terms of balance sheet total, own funds or net profit), the reputation of the group as a whole in general, the presence of sufficient hard-currency cash flows and a listing on a prominent stock exchange somewhere in the world. It should be noted that this is definitely not a exhaustive enumeration.

Explanatory note to the fourth bullet

This criterion has been included in order to prevent the parent company from segregating certain risks within the holding (such as the risk of a country event as defined in the Policy Rule). It is evidently not the intention that in such cases the exposures to the holding should be assigned a lower weighting. If there are indications that, for strategic reasons, the parent company wishes to dispose of the holding or if, in the past, the parent company failed to step in to resolve financial problems at (one of) its holdings, the lower weighting is not applied.

Sector(s)

  • Banks