Biennial review of the risk control measures in Eurosystem credit operations

4 September 2008

Every two years the ECB conducts a review of the risk control measures for Eurosystem credit operations. These risk control measures are applied to the assets deposited by the Eurosystem’s counterparties as collateral for the credit the Eurosystem gives through its open market operations and the marginal lending facility, as well as in the form of intra-day credit for payment systems purposes (see Section 6.4 of “The implementation of monetary policy in the euro area – General Documentation on Eurosystem monetary policy instruments and procedures”, commonly referred to as the “General Documentation” [1]).

The Eurosystem’s collateral framework has proven robust and efficient over the years, and during the recent episode of financial market turbulence. In particular, the acceptance of a wide range of collateral contributes to the resilience of euro area financial markets.

While fully preserving this feature, following its biennial review the ECB has incorporated some technical refinements in its risk control framework for Eurosystem credit operations. These technical refinements, which are set out below, reflect, inter alia, improvements in the methodological framework, the assessment of market and liquidity risk characteristics of eligible assets, the actual use of eligible assets by counterparties and new developments in financial instruments.

(1) With regard to the risk control measures applied to marketable assets, a new liquidity category for marketable assets will be introduced (see Table 6 of the “General Documentation”). This new category IV will be composed of credit institution debt instruments (other than Jumbo and traditional covered bank bonds) that were previously part of category III. Old category IV will be renamed category V. The valuation haircuts applied to eligible marketable assets in the different liquidity categories will be as follows:

Levels of valuation haircuts applied to eligible marketable assets in relation to fixed coupon and zero coupon instruments (percentages)
Liquidity categories
Category I Category II Category III Category IV Category V
Fixed coupon Zero coupon Fixed coupon Zero coupon Fixed coupon Zero coupon Fixed coupon Zero coupon Fixed or zero coupon
0-1 0.5 0.5 1 1 1.5 1.5 6.5 6.5 12*
1-3 1.5 1.5 2.5 2.5 3 3 8 8
3-5 2.5 3 3.5 4 4.5 5 9.5 10
5-7 3 3.5 4.5 5 5.5 6 10.5 11
7-10 4 4.5 5.5 6.5 6.5 8 11.5 13
>10 5.5 8.5 7.5 12 9 15 14 20

* Assets in this liquidity category that are given a theoretical value (in accordance with Section 6.5 of the “General Documentation”) will be subject to an additional valuation markdown of 5%.

As can be seen from the table above, assets in new liquidity category V (former liquidity category IV) will be subject to a haircut of 12% regardless of their residual maturity and coupon structure. This corresponds to the level of haircuts that was previously assigned to assets in this liquidity category with a fixed coupon and a residual maturity of over ten years. Furthermore, assets in this liquidity category that are given a theoretical value (in accordance with Section 6.5 of the “General Documentation”) will be subject to an additional valuation haircut. This haircut will be applied directly to the theoretical value of the asset in the form of a valuation markdown of 5%, which corresponds to an additional haircut of 4.4%.

(2) The definition of “close links”, as given in Section 6.2.3 of the “General Documentation”, will be extended to include situations in which a counterparty submits an asset-backed security as collateral when it (or any third party that has close links to it) provides support to that asset-backed security by entering into a currency hedge with the issuer or guarantor of the asset-backed security or by providing liquidity support of more than 20% of the nominal value of the asset-backed security.

(3) With regard to the Eurosystem Credit Assessment Framework (see Section 6.3 of the “General Documentation”), for an asset to be eligible as collateral, the related credit assessment issued by an eligible external credit assessment institution (ECAI) must be based on a public rating. In the case of asset-backed securities, ratings must be explained in a publicly available credit-rating report (either a detailed pre-sale report or a new issue report). This report must include a comprehensive analysis of the structural and legal aspects, a detailed collateral pool analysis, an analysis of the transaction participants and any other relevant particularities of the transaction. Moreover, ECAIs must publish rating reviews for asset-backed securities at least on a quarterly basis. These reviews should necessarily contain an update of the key transaction data (e.g. composition of the collateral pool, transaction participants and capital structure) and performance data.

Finally, it is recalled that the Eurosystem has the possibility to limit or exclude the use of certain assets as collateral for its credit operations, also at the level of individual counterparties, if required, to ensure adequate risk protection of the Eurosystem in line with Article 18.1 of the Protocol on the Statute of the European System of Central Banks and of the European Central Bank.

All the above-mentioned changes to the risk control framework for Eurosystem credit operations will enter into force on 1 February 2009 and will be reflected in the forthcoming update of the “General Documentation”.


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