Capital Adequacy Guideline

304 Pages·2016·3.07 MB·English

CAPITAL ADEQUACY GUIDELINE

Credit unions not member of a federation, trust
companies and savings companies

January 2017
TABLE OF CONTENTS

Introduction ............................................................................................................... 1
Chapter 1. Overview ............................................................................................... 4
1.1 Scope of application ........................................................................................ 4
1.2 Leverage ratio.................................................................................................. 5
1.3 Calculation of minimum capital requirements ................................................... 6
1.4 Regulatory capital ............................................................................................ 7
1.5 Total risk weighted assets (RWA) .................................................................. 10
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 .................................................................................................. 24
2.5 Non-viability contingent capital requirements (NVCC) .................................... 25
2.6 Required adjustments to capital and deduction thresholds ............................ 28
2.7 Changes to the treatment of certain assets .................................................... 38
2.8 Capital instrument quality assessment ........................................................... 38
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 .................................................. 63
3.3 Credit conversion factors ............................................................................... 67
3.4 Forwards, swaps, purchased options and other similar derivative contracts .. 69
3.5 Netting of forwards, swaps, purchased options and other similar derivatives . 70
3.6 Commitments ................................................................................................ 72
3.7 External credit assessments and the mapping process ................................. 75
Chapter 4. Credit risk mitigation .......................................................................... 82
4.1 Standardized approach .................................................................................. 82
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 ................................................................................................... 141

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Chapter 7. Market risk ........................................................................................ 142
Chapter 8. Supervisory review process ............................................................ 143
8.1 Board and senior oversight .......................................................................... 145
8.2 Sound capital assessment ........................................................................... 147
8.3 Comprehensive assessment of risks ........................................................... 149
8.4 Monitoring and reporting .............................................................................. 153
8.5 Internal control review .................................................................................. 153
8.6 Specific issues to be addressed under the supervisory review process ....... 154
8.7 Operational risk ........................................................................................... 161
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........................................................ 192

Annex 1-I Minimum capital requirements ....................................................... 197
Annex 1-II Minimum capital conservation ratios at various levels of Tier
1A capital ....................................................................................... 198
Annex 1-III (a) Capital targets ................................................................................ 199
Annex 1-III (b) Transitional arrangements ............................................................. 200
Annex 1-IV Leverage ratio – calculation and definition of components ............. 202
Annex 2-I (a) Self-assessment grid for inclusion in Tier 1A .................................. 220
Annex 2-I (b) Self-assessment grid for inclusion in Tier 1B .................................. 222
Annex 2-I (c) Self-assessment grid for inclusion in Tier 2 .................................... 226
Annex 2-II Example of the 15% of Tier 1A limit on specified items .................. 229
Annex 3-I Capital treatment for failed trades and non-DvP transactions ......... 230
Annex 3-II Treatment of counterparty credit risk and cross-product netting ..... 232
Annex 3-III Application of the SA-CCR to sample portfolios ............................. 273
Annex 3-IV Effect of standard margin agreements on the SA-CCR
formulation ..................................................................................... 284
Annex 3-V Effect of standard margin agreements on the SA-CCR
formulation ..................................................................................... 287
Annex 3-VI Calculation of Equity investments in funds risk-weighted assets .... 288
Annex 4-I Overview of methodologies for the capital treatment of
transactions secured by financial collateral under the
standardized approach ................................................................... 290
Annex 4-II Credit derivatives - Product types................................................... 292
Annex 6 Mapping of business lines .............................................................. 296

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Abbreviations

ABS Asset-backed securities
ABCP Asset-backed commercial paper
AMA Advanced measurement approach
BCBS Basel Committee on Banking Supervision
BIS Bank for international settlements
CC Central counterparty
CCF Credit conversion factor
CCR Counterparty credit risk
CICA Canadian Institute of Chartered Accountants
CMHC Canada Mortgage and Housing 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

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Abbreviations
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FSAP Financial Sector Assessment Program
FSCA Act respecting financial services cooperatives
GAAP Generally accepted accounting principles
IAA Internal assessment approach
IFRS International Financial Reporting Standards
IMF International Monetary Fund
IOSCO International Organization of Securities Commissions
IRB approach Internal ratings-based approach
MDB Multilateral development bank
Moody’s Moody’s Investors Service
MPOR Margin Period of Risk
MTA Minimum Transfer Amount
NHA National Housing Act
NICA Net Independent Collateral Amount
OECD Organisation for Economic Co-operation and Development
PSE Public sector entity
QCC Qualifying Central Counterpartie
RC Replacement cost
RRE Residential real estate
S&P Standard & Poor’s
SA-CCR Standardised Approach for counterparty credit risk

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Abbreviations
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SFTs Securities financing transactions
SM Standard method
SPE Special purpose entity
SPV Special purpose vehicle
UCITS Undertakings for collective investments in 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 capital.2 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
sets 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 8) 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 9) is designed to increase market discipline by ensuring that financial
institutions foster and focus on transparency and communication with respect to their
risk exposures.

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.

1 CQLR, 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 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.

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) has undertaken work
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.

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. This Guideline sets 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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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.

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)

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 is effective January 1, 2017.

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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, CQLR., c. C-67.3;
 An Act respecting trust companies and savings companies, CQLR, c. S-29.01.

1.1 Scope of application

This Capital Adequacy 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 fiduciary.7 A savings
company borrows funds in the form of deposits for the purposes of loans and
investments.8

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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Chapter 1
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