BIPRU 4.8 The IRB approach: Purchased receivables

BIPRU 4.8 applies with respect to purchased receivables.

For retail exposure that are purchased receivables, the grouping referred to in BIPRU 4.6.9 R must reflect the seller's underwriting practices and the heterogeneity of its customers.

The estimates for determining the risk parameters PD, LGD, conversion factor and EL must reflect all relevant information available to the purchasing firm regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing firm, or by external sources. The purchasing firm must evaluate any data relied upon which is provided by the seller.

[Note: BCD Annex VII Part 4 point 53]

With respect to BIPRU 4.6.26 R (Internal and external data for PD estimation: retail exposures) a firm may use external and internal reference data for PD estimation. A firm must use all relevant data sources as points of comparison.

[Note: BCD Annex VII Part 4 point 69 (part)]

For corporate exposure purchased receivables a firm may estimate ELs by obligor grade from long run averages of one-year realised default rates.

[Note: BCD Annex VII Part 4 point 60]

If a firm derives long run average estimates of PDs and LGDs for corporate exposure purchased receivables from an estimate of EL, and an appropriate estimate of PD or LGD, the process for estimating total losses must meet the overall standards for estimation of PD and LGD set out in the minimum IRB standards,2 and the outcome must be consistent with the concept of LGD as set out in BIPRU 4.3.99 R.

[Note: BCD Annex VII Part 4 point 61]

A firm may use external and internal reference data for its LGD estimates in the case of retail exposures that are purchased receivables.

[Note: BCD Annex VII Part 4 point 85]

BIPRU 4.8.11 R - BIPRU 4.8.15 R set out minimum requirements specific to the treatment of purchased receivables under the IRB approach.

The structure of the facility must ensure that under all foreseeable circumstances a firm has effective ownership and control of all cash remittances from the receivables. When the obligor makes payments directly to a seller or servicer a firm must verify regularly that payments are forwarded completely and within the contractually agreed terms. Servicer means an entity that manages a pool of purchased receivables or the underlying credit exposures on a day-to-day basis. A firm must have procedures to ensure that ownership over the receivables and cash receipts is protected against bankruptcy stays or legal challenges that could materially delay the lender's ability to liquidate or assign the receivables or retain control over cash receipts.

[Note: BCD Annex VII Part 4 point 105]

1. (1)

   A firm must monitor both the quality of the purchased receivables and the financial condition of the seller and servicer. In particular a firm must comply with the remaining provisions of this rule.

2. (2)

   A firm must assess the correlation among the quality of the purchased receivables and the financial condition of both the seller and servicer, and have in place internal policies and procedures that provide adequate safeguards to protect against such contingencies, including the assignment of an internal risk rating for each seller and servicer.

3. (3)

   A firm must have clear and effective policies and procedures for determining seller and servicer eligibility. A firm or its agent must conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller or servicer, detect fraud or operational weaknesses, and verify the quality of the seller's credit policies and servicer's collection policies and procedures. The findings of these reviews must be documented.

4. (4)

   A firm must assess the characteristics of the purchased receivables pools including:

   1. (a)

      over-advances;

   2. (b)

      history of the seller's arrears, bad debts, and bad debt allowances;

   3. (c)

      payment terms; and

   4. (d)

      potential contra accounts.

5. (4)

   A firm must have effective policies and procedures for monitoring on an aggregate basis single-obligor concentrations both within and across purchased receivables pools.

6. (5)

   A firm must ensure that it receives from the servicer timely and sufficiently detailed reports of receivables ageings and dilutions to ensure compliance with the firm's eligibility criteria and advancing policies governing purchased receivables, and provide an effective means with which to monitor and confirm the seller's terms of sale and dilution.

[Note: BCD Annex VII Part 4 point 106]

A firm must have systems and procedures for detecting deteriorations in the seller's financial condition and purchased receivables quality at an early stage, and for addressing emerging problems proactively. In particular a firm must have clear and effective policies, procedures, and information systems to monitor covenant violations, and clear and effective policies and procedures for initiating legal actions and dealing with problem purchased receivables.

[Note: BCD Annex VII Part 4 point 107]

A firm must have clear and effective policies and procedures governing the control of purchased receivables, credit, and cash. In particular, written internal policies must specify all material elements of the receivables purchase programme, including the advancing rates, eligible collateral, necessary documentation, concentration limits, and the way cash receipts are to be handled. These elements must take appropriate account of all relevant and material factors, including the seller's and servicer's financial condition, risk concentrations, and trends in the quality of the purchased receivables and the seller's customer base, and internal systems must ensure that funds are advanced only against specified supporting collateral and documentation.

[Note: BCD Annex VII Part 4 point 108]

A firm must have an effective internal process for assessing compliance with all internal policies and procedures. The process must include regular audits of all critical phases of the firm's receivables purchase programme, verification of the separation of duties between, firstly, the assessment of the seller and servicer and the assessment of the obligor and, secondly, between the assessment of the seller and servicer and the field audit of the seller and servicer and evaluations of back office operations, with particular focus on qualifications, experience, staffing levels, and supporting automation systems.

[Note: BCD Annex VII Part 4 point 109]

For its corporate exposure purchased receivables a firm must comply with the minimum requirements set out in BIPRU 4.8.11 R - BIPRU 4.8.15 R. For corporate exposure purchased receivables that comply in addition with the conditions set out in BIPRU 4.8.18 R, and where it would be unduly burdensome for a firm to use the risk quantification standards for corporate exposures as set out in the minimum IRB standards for these receivables, the risk quantification standards for retail exposures as set out in the minimum IRB standards may be used.

[Note: BCD Annex VII Part 1 point 7]

For corporate exposure purchased receivables, refundable purchase discounts, collateral or partial guarantees that provide first-loss protection for default losses, dilution losses, or both, may be treated as first-loss positions under the provisions in BIPRU 9 (Securitisation) about the IRB approach.

To be eligible for the retail exposure treatment purchased receivables must comply with the minimum requirements set out in BIPRU 4.8.11 R - BIPRU 4.8.15 R and the following conditions:

1. (1)

   the firm has purchased the receivables from unrelated, third party sellers, and its exposure to the obligor of the receivable does not include any exposures that are directly or indirectly originated by the firm itself;

2. (2)

   the purchased receivables must be generated on an arm's-length basis between the seller and the obligor (and as such, intercompany accounts receivables and receivables subject to contra-accounts between firms that buy and sell to each other are ineligible);

3. (3)

   the purchasing firm has a claim on all proceeds from the purchased receivables or a pro-rata interest in the proceeds; and

4. (4)

   the portfolio of purchased receivables is sufficiently diversified.

[Note: BCD Annex VII Part 1 point 14]

With respect to retail exposures, for purchased receivables, refundable purchase discounts, collateral or partial guarantees that provide first-loss protection for default losses, dilution losses, or both, may be treated as first-loss positions under the provisions in BIPRU 9 (Securitisation) about the IRB approach.

[Note: BCD Annex VII Part 1 point 15]

For hybrid pools of purchased retail exposure receivables where the purchasing firm cannot separate exposures secured by real estate collateral and qualifying revolving retail exposures from other retail exposures, the retail risk weight2 function producing the highest capital requirements for those exposures must apply.

[Note: BCD Annex VII Part 1 point 16]

The risk weights for dilution risk for purchased receivables (both corporate exposures and retail exposures) must be calculated according to this rule. The risk weights must be calculated according to the formula in BIPRU 4.4.58 R. However, for the purposes of that formula, the total annual sales referred to in BIPRU 4.4.59 R are the weighted average by individual exposures of the pool. The input parameters PD and LGD and the exposure value must be determined under the applicable provisions of BIPRU 4 as modified by this section. M (maturity) must be 1 year. However:

1. (1)

   a firm need not recognise dilution risk if its IRB permission permits this; and

2. (2)

   (in the case of a firm with an IRB permission that permits the treatment of dilution risk in (1)) the firm must be able to convince the FSA that dilution risk is immaterial.

[Note: BCD Article 87(2) (part) and Annex VII Part 1 point 28]

For purchased corporate exposure receivables in respect of which a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the PDs for these exposures must be determined according to the following methods:

1. (1)

   for senior claims on purchased corporate exposure receivables PD must be the firm's estimate of EL divided by LGD for these receivables;

2. (2)

   for subordinated claims on purchased corporate exposure receivables PD must be the firm's estimate of EL; and

3. (3)

   [to follow]

In the case of corporate exposures, for dilution risk of purchased receivables PD must be set equal to EL estimate for dilution risk. If a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for dilution risk of purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the PD estimate may be used. A firm may recognise unfunded credit protection in the PD in accordance with the provisions of BIPRU 9 and BIPRU 5 as modified by BIPRU 4.10. A firm may recognise those unfunded credit protection providers set out in its IRB permission in addition to those indicated in the CRM eligibility conditions. Where a firm's IRB permission allows it to use its own LGD estimates for dilution risk of purchased corporate receivables, the firm may recognise unfunded credit protection by adjusting PDs subject to the provisions of BIPRU 4.4.43 R.

[Note: BCD Annex VII Part 2 point 7]

In the case of retail exposures, for dilution risk of purchased receivables PD must be set equal to EL estimates for dilution risk. If a firm can decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the PD estimate may be used.

[Note: BCD Annex VII Part 2 point 19]

The following LGD values apply for purchased corporate exposure receivables:

1. (1)

   for senior purchased corporate exposure receivables exposures where a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the value is 45%;

2. (2)

   for subordinated purchased corporate exposure receivables exposures where a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the value is 100%; and

3. (3)

   for dilution risk of purchased corporate exposure receivables, the value is 75%.

[Note: BCD Annex VII Part 2 point 8(e) to (g)]

[to follow]

For dilution risk of purchased retail exposure receivables an LGD value of 75% must be used. If a firm can decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the LGD estimate may be used.

[Note: BCD Annex VII Part 2 point 21]

The exposure value for the calculation of risk weighted exposure amounts of purchased receivables must be the outstanding amount minus the capital requirements for dilution risk prior to credit risk mitigation.

[Note: BCD Annex VII Part 3 point 6]

1. (1)

   The exposure value for the items in (2) must be calculated as the committed but undrawn amount multiplied by a conversion factor.

2. (2)

   For undrawn purchase commitments for revolving purchased receivables that are unconditionally cancellable or that effectively provide for automatic cancellation at any time by the firm without prior notice, a conversion factor of 0% applies. To apply a conversion factor of 0%, a firm must actively monitor the financial condition of the obligor, and its internal control systems must enable it immediately to detect a deterioration in the credit quality of the obligor.

[Note: BCD Annex VII Part 3 point 9 (c)]

The expected loss amounts for dilution risk of purchased receivables must be calculated according to the following formula:

• expected loss (EL) = PD × LGD; and
• expected loss amount = EL × exposure value.