Global Trade Finance Review – GTR – has released an article on how ITFA has reviewed the guidelines for banks using capital requirements regulation (CRR)-compliant non-payment insurance policies. The move follows significant market debate in the past year over the eligibility of insurance as a credit risk mitigant for CRR purposes.

The drafting of the EU CRR in 2013 left significant room for interpretation. To address this challenge, various financial authorities, including the UK’s Prudential Regulation Authority (PRA) and the German Federal Financial Supervisory Authority, engaged in consultations with the market to provide clarification.

Both regulatory bodies considered the issue of when insurance cover complies with the eligibility criteria relevant for “guarantees” as defined in the CRR, thereby enabling banks to reduce risk-weighted assets.

The 2018 consultation process provided an opportunity to better inform the regulator about the processes and practical use of the non-payment insurance product for trade and transaction banking.

Following the consultation process, the PRA modified its original view on several points in a revised policy statement, which was published in March 2019, and also clarified how the CRR should be understood and applied in order to achieve regulatory capital reduction through the use of non-payment insurance.

In light of these clarifications, ITFA’s insurance committee, together with its legal adviser Sullivan, reviewed their 2016 guidelines for banks on the structure and content for CRR-compliant non-payment insurance policies.

GTR speaks to Sullivan partner Marian Boyle, head of the firm’s UK insurance and disputes practices, and Hannah Fearn, managing associate in the trade and export finance team, about what the new guidelines mean for the market.

GTR: What’s new in terms of these guidelines?

Boyle: The guidelines for CRR-complaint non-payment insurance policies are intended to provide an overview of the structure and content of policies used by banks in the calculation of capital requirements. The guidelines have been updated to take account of recent regulatory developments relating to the eligibility requirements applicable to the use of credit insurance for capital relief purposes, and to reflect market developments in the implementation of the Insurance Act 2015.

The guidelines include new and updated guidance on:

– the PRA’s expectations regarding the standard 180-day waiting period for payment of claims under non-payment policies;

– the PRA’s approach to the eligibility of exclusions, particularly standard exclusions that are outside the control of the insured (such as the nuclear exclusion);

– the interpretation of the CRR requirement that a credit protection contract must be “clearly defined and incontrovertible”; and

– market standard wording for certain clauses in post-Insurance Act 2015 policies, including the nuclear exclusion and sanctions provisions.

GTR: Why were the guidelines released?

Fearn: The guidelines were first published in August 2016, shortly after the Insurance Act 2015 came into force. They were drafted by ITFA’s insurance committee in response to a survey of the association’s members which called for guidance on the use of non-payment insurance as eligible unfunded credit protection, under the CRR.

The insurance committee intended that the guidelines should act as a useful tool for banks in navigating the complex rules surrounding the use of non-payment insurance as credit risk mitigation. However, the regulatory landscape has continued to change at a fast pace over the last three years, and it is important that the guidelines remain relevant and up to date.

The publication by the PRA of a consultation paper on this topic last year provoked a great deal of debate about the future eligibility of insurance as a credit risk mitigant for CRR purposes. The recent supervisory guidance from the PRA, which confirms that the product is capable of being an eligible credit risk mitigation technique, was very welcome. The ITFA insurance committee has taken this opportunity to update the guidelines to help the market understand the impact of the PRA’s guidance.

GTR: How will the guidelines impact the market?

Boyle: In recent years, non-payment insurance has become a widely used credit protection tool in the trade finance market. For the uninitiated, policy wordings (which are informed by market practice and legal principles applicable to insurance) may be daunting. In addition, banks increasingly seek to use credit protection instruments to achieve capital relief, so it is important that banks, brokers and insurers understand the eligibility criteria and how they apply to policy wordings.

The expectation is that the updated guidelines will assist members by providing a summary of what they can expect in a non-payment insurance product, as well as guidance on where policy drafting needs to take into account CRR requirements and the provisions of the Insurance Act 2015. As such, they will benefit both new entrants to the market, and experienced users who want to better understand the legal and regulatory landscape within which the product operates.

Fearn: Understanding the key drivers behind the drafting of certain policy clauses will hopefully facilitate a better informed negotiation between the users and providers of credit insurance and ultimately increase the confidence in, and use of, credit insurance in supporting trade finance transactions. The guidelines may also assist banks in educating their local regulators as to how the product performs as an effective credit risk mitigant.