Capital Adequacy Guideline-Credit Unions not members of a federation, trust companies and ...

263 Pages·2014·2.56 MB·English

CAPITAL ADEQUACY GUIDELINE

CREDIT UNIONS NOT MEMBERS OF A FEDERATION,
TRUST COMPANIES AND SAVINGS COMPANIES

January 2015
Table of Contents

Abbreviations iii
Introduction 1
Chapter 1. Overview ............................................................................................... 4
1.1 Scope of Application ............................................................................................ 4
1.2 The leverage ratio ................................................................................................ 5
1.3 Calculation of minimum capital requirements ...................................................... 6
1.4 Regulatory capital ................................................................................................ 6
1.5 Total risk weighted assets .................................................................................... 9
Chapter 2. Definition of Capital ........................................................................... 12
2.1 Regulatory capital and criteria for inclusion ....................................................... 12
2.2 Redemption or purchase .................................................................................... 23
2.3 Collectives allowances (Tier 2) .......................................................................... 24
2.4 Amortization ....................................................................................................... 25
2.5 Non-viability contingent capital requirements (« NVCC ») ................................ 26
2.6 Required Adjustments to Capital and Deduction Thresholds ............................ 29
2.7 Changes to the treatment of certain assets ....................................................... 38
2.8 Capital instrument quality assessment .............................................................. 39
2.9 Transitional arrangements ................................................................................. 39
Chapter 3. Credit Risk– Standardized Approach ................................................ 46
3.1 Risk Weight Categories ..................................................................................... 46
3.2 Categories of off-balance sheet instruments ..................................................... 59
3.3 Credit conversion factors ................................................................................... 64
3.4 Forwards, swaps, purchased options and other similar derivative contracts .... 65
3.5 Netting of forwards, swaps, purchased options and other similar derivatives ... 67
3.6 Commitments ..................................................................................................... 71
3.7 External credit assessments and the mapping process .................................... 74
Chapter 4. Credit Risk Mitigation ........................................................................ 81
4.1 Standardized approach ...................................................................................... 81
Chapter 5. Credit Risk – Securitization Framework ......................................... 106
5.1 Securitization Framework ................................................................................ 106
5.2 Definitions and general terminology ................................................................ 108
5.3 Operational requirements for the recognition of risk transference................... 112
5.4 Treatment of securitization exposures ............................................................. 116
Chapter 6. Operational Risk ............................................................................... 131
6.1. Definition of operational risk............................................................................. 131
6.2 The measurement methodologies ................................................................... 131
6.3 Qualifying criteria ............................................................................................. 137
6.4 Partial use ........................................................................................................ 140
Chapter 7. Market Risk ....................................................................................... 141
Chapter 8. Supervisory Review Process .......................................................... 142
8.1 Board and senior oversight .............................................................................. 144
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8.2 Sound capital assessment ............................................................................... 147
8.3 Comprehensive assessment of risks ............................................................... 149
8.4 Monitoring and reporting .................................................................................. 152
8.5 Internal control review ...................................................................................... 153
8.6 Specific issues to be addressed under the supervisory review process ......... 153
8.7 Operational risk ................................................................................................ 160
8.8 Supervisory review process for securitization .................................................. 161
8.9 Fair value valuation practices .......................................................................... 168
Chapter 9. Market discipline .............................................................................. 171
9.1 Disclosure framework ...................................................................................... 171
9.2 Disclosure requirements .................................................................................. 174
9.3 Remuneration disclosure requirements ........................................................... 188

ANNEXES

Annex 1-I Minimum capital requirements ......................................................................... 193
Annex 1-II Minimum capital conservation ratios at various levels of Tier 1A capital ........ 194
Annex 1-III (a) Capital targets .................................................................................................. 195
Annex 1-III (b) Transitional arrangements ............................................................................... 196
Annex 1-IV Financial leverage ratio – calculation and definition of components ............... 198
Annex 2-I (a) Self-Assessment Grid for Inclusion in Tier 1A ................................................. 215
Annex 2-I (b) Self-Assessment Grid for Inclusion in Tier 1B ................................................. 217
Annex 2-I (c) Self-Assessment Grid for Inclusion in Tier 2 .................................................... 221
Annex 2-II Example of the 15 % of Tier 1A limit on specified items .................................. 224
Annex 3-I Capital Treatment for Failed Trades and Non-DvP Transactions .................... 225
Annex 3-II Treatment of Counterparty Credit Risk and Cross-Product Netting ................ 227
Annex 4-I Overview of Methodologies for the Capital Treatment of Transactions Secured by
Financial Collateral under the Standardized approach .................................... 250
Annex 4-II Credit Derivatives - Product Types .................................................................. 252
Annex 6 Mapping of Business Lines .............................................................................. 256

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Abbreviations

ABS Asset-backed securities
ABCP Asset-backed commercial paper
AMA Advanced measurement approach
BIS Bank for international settlements
CC Central counterparty
CCF Credit conversion factor
CCR Counterparty credit risk
Canadian Institute of Chartered
CICA
Accountants
Canada Mortgage and Housing
CMHC
Corporation
CRE Commercial real estate
CRM Credit risk mitigation
CMV Current market value
DTA Deferred tax assets
DTL Deferred tax liabilities
DvP system Delivery-versus-payment system
ECA Export credit agency
ECAI External credit assessment institution
Fitch Fitch Rating Services
FMI Future margin income
FSAP Financial Sector Assessment Program
Act respecting financial services
FSCA
cooperatives
GAAP Generally accepted accounting principles
IAA Internal assessment approach
International Financial Reporting
IFRS
Standards
IMF International Monetary Fund
International Organization of Securities
IOSCO
Commissions
IRB approach Internal ratings-based approach
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MDB Multilateral development bank
Moody’s Moody’s Investors Service
NHA National Housing Act
Organisation for Economic Co-operation
OECD
and Development
PSE Public sector entity
RRE Residential real estate
S&P Standard & Poor’s
SFTs Securities financing transactions
SM Standard method
SPE Special purpose entity
SPV Special purpose vehicle
Undertakings for collective investments in
UCITS
transferable securities
VaR Value at risk

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Introduction

The Act respecting trust companies and savings companies (“TCSCA”) and the Act
respecting financial services cooperatives (“FSCA”)1, empower the AMF to issue
Guidelines concerning the adequacy of their capital2. In addition, legislative provisions
impose capital requirements pursuant to which trust companies and savings companies
(“companies”), as well as credit unions not members of a federation3 (“credit unions”),
must maintain adequate capital4 for their operations. They are also required to adhere to
sound and prudent management practices, in particular by complying with this
Guideline5.

The Capital Adequacy Guideline was provided to credit unions not members of a
federation, trust companies and savings companies in January 2011. That Guideline set
out with certain adjustments the capital measurement requirements also known as
“Basel II”, initially published in June 2006.

This capital standard proposes a comprehensive risk-sensitive approach, encouraging
financial institutions to better manage and more accurately assess their risks. This
framework is based on three pillars.

Pillar 1 (Chapters 1 to 7) makes it possible to adapt the minimum capital requirements to
the risk profile of each establishment by offering establishments a broader range of
methods for assessing credit, operational and market risks.

Pillar 2 (Chapter 9) deals with the supervisory review process and is intended not only to
ensure that establishments have adequate capital to support all the risks in their
business, but also to encourage them to develop and use better risk management and
monitoring techniques.

Pillar 3 (Chapter 10) is designed to increase market discipline by ensuring that financial
institutions foster and focus on transparency and communication with respect to their risk
exposures.

Initial Approach Adopted for the Guideline

This Guideline was developed in light of the characteristics of the target financial
institutions and with due regard to optimum harmonization of requirements, given that
several of these financial institutions operate in other markets.

This Guideline sets out the capital standards on which the AMF relies to assess whether
a credit union or company maintains sufficient capital to ensure sound and prudent
management under applicable laws.

1 RSQ, c. C-67.3.
2 Section 565 (1) FSCA and section 314.1 (1) TCSCA.
3 For purposes of the FSCA, every credit union is, by definition, a financial services cooperative (s. 1 of the FSCA).
4 Section 451 FSCA and section 195 TCSCA.
5 Section 66 FSCA and section 177.2 TCSCA.
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Introduction
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This Guideline contains the requirements pertaining to the simpler approaches under the
Basel II framework, that is, the standardized approach to credit risk and the basic
indicator approach and standardized approach to operational risk. It does not include
specific requirements for market risk. However, if the AMF considers that trading has
become a more significant part of the activities of the target financial institutions, the
AMF may revisit the capital adequacy requirements to take into consideration the effect
of market risk on the risk profile of these establishments.

Any credit union or company that wishes to apply the internal ratings-based (IRB)
approach to credit risk and/or the advanced measurement approach (AMA) to
operational risk must notify the AMF, which will specify the applicable terms and
conditions. Once an institution has obtained the authorization from its regulator to apply
such approaches, the AMF may determine6 whether the framework implemented allows
the institution to satisfy the capitalization with regard to sound and prudent management
requirements under Québec law.

Since this Guideline applies to credit unions and companies, the text includes certain
specific considerations, particularly in the first two chapters, given that they deal with the
scope of application of the Guideline and the definition of capital, both of which are
tailored to the specific characteristics of such institutions. In addition, in those areas in
which “national discretion” may be exercised or when the AMF wishes to clarify the
expected treatment, the manner in which the requirements are to be applied are
described in text boxes clearly identified as “AMF Note”.

Provisions updated

The Basel Committee on Banking Supervision (“Basel Committee”) undertook to make
improvements to Basel II. This resulted in the publication of a number of documents in
June 2009 containing certain provisions (such as securitization, the supervisory review
process and market discipline) whose coming into effect was postponed until
January 1, 2012. In order to provide credit unions that are not members of a federation,
trust companies and savings companies with a prudential framework that is consistent
with and comparable to international capital standards, the AMF incorporated these
provisions to comply with this new date of coming into effect. In addition, some changes
introduced in July 2011 with respect to compensation disclosure requirements have
been incorporated into this Guideline.

In December 2010, the Basel Committee published two major documents setting out
provisions known as “Basel III”. The first document, entitled “Basel III: A global regulatory
framework for more resilient banks and banking systems” (revised June 2011), as well
as the second one, Basel III: International framework for liquidity risk measurement,
standards and monitoring, introduced provisions which included the tightening of the
criteria for inclusion of capital instruments in the best tier as well as liquidity ratios. Most
of the provisions found in these documents take effect on January 1, 2014. However,
they will be phased in over a ten-year period.

6 Based on the AMF guideline dealing with the adequacy of the capital base of financial services cooperatives which
provides a prudential framework that is consistent with and comparable to the international standards set out in the
document entitled International Convergence of Capital Measurement and Capital Standards, also known as
“Basel II” and in the documents comprising “Basel III”, namely Basel III: A global regulatory framework for more
resilient banks and banking systems and Basel III: International framework for liquidity risk measurement, standards
and monitoring.
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Introduction
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For ease of reference, the generic terms “financial institution” and “institution” refer to all
credit unions and companies covered by the scope of this Guideline.

International Financial Reporting Standards (IFRS)

International Financial Reporting Standards (“IFRS”) have replaced Canadian generally
accepted accounting principles (“GAAP”) for the preparation of financial statements of
Canadian publicly accountable enterprises for fiscal years beginning January 1, 2011.

The AMF will publish a Notice in its Bulletin regarding the new or amended standards
(published by the International Accounting Standards Board (“IASB”)) once they take
effect. These standards could change how capital adequacy requirements are
calculated.

Coming into effect

This updated capital adequacy Guideline will come into effect on January 1, 2015.

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Introduction
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Chapter 1. Overview

Outlined below is an overview of capital adequacy requirements for credit unions and
companies governed by the following statutes:

 An Act respecting financial services cooperatives, R.S.Q., c. C-67.3
 An Act respecting trust companies and savings companies, R.S.Q., c. S-29.01

1.1 Scope of Application

This adequacy of capital Guideline applies, on a consolidated basis, to each credit union
and each company, and covers primarily all the operations of the credit union or
company and all other financial activities carried out within their subsidiaries.

In the normal course, a credit union carries on financial activities such as receiving
deposits, providing credit and offering other financial products and services to its
members.

In the normal course, a trust company acts as tutor or curator to property, liquidator,
syndic, sequestrator, adviser to a person of full age, trustee or fiduciary7. A savings
company borrows funds in the form of deposits for the purposes of loans and
investments8.

For purposes of computing regulatory capital, the Guideline applies on a consolidated
basis, including all the subsidiaries controlled by the institution.

The following are excluded from a consolidated institution by way of deconsolidation:

 Investments in insurance subsidiaries;

 Investments in other regulated financial institutions whose
leverage is inappropriate for a deposit institution.

7 Section 170 TCSCA.
8 Section 171 TCSCA.
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1.2 The leverage ratio

AMF Note

The Basel Committee introduced a leverage ratio with implementation planned in the first
fiscal quarter of 2018. This ratio is described briefly below and in greater detail in Annex 1-IV.

However, unlike other countries, Canada already has a leverage ratio which is defined slightly
differently from that of the Basel Committee in terms of its composition. This former ratio will
be replaced by the Basel III leverage ratio ("leverage ratio").

The AMF expects institutions covered by this Guideline to maintain on continuous basis a
minimum leverage ratio greater or equal to 3% starting to January 1, 2015.

In order to minimize the number of definitions of capital, the category of capital (capital 1)
used to compute the leverage ratio is defined in chapter 2 of this Guideline.

Computing of the ratio and the definition of the components are presented in Annex 1-IV.

The paragraphs in this section are drafted from the document entitled Basel III: Leverage
Ratio Framework and Disclosure Requirements, published in January 2014. Since the
provisions of these paragraphs are subject to change based on changes in calibration
criteria, the AMF, if necessary, will revised the provisions contained in Annex 1-IV.

The Basel III leverage ratio is defined as the capital measure (the numerator)9 divided by
the exposure measure (the denominator).

This ratio expressed as a percentage is computed as follows:

Capital measure
Leverage ratio=
Exposure measure

Each credit union and each company, as defined in section 1.1, must maintain on
continuous basis a minimum leverage ratio greater or equal to 3%. This ratio provides an
overall measure of the adequacy of capital in light of the institution’s total assets and the
growth of such assets.

This ratio is calculated in a comparable manner across jurisdictions with adjustments for
different accounting standards in force. Its main objective is to limit the excessive
leverage taken on balance sheet and off-balance sheet.

The provisions concerning the items included in the calculation of this ratio are in
Annex 1-IV.

9 Capitals to consider are the capital category 1. This includes capital 1A and 1B categories.
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