AIFC BANKING BUSINESS PRUDENTIAL RULES AIFC RULES NO. FR0023 OF 2018 (with amendments as of 12 December 2021, which commence on 12 December 2021) Approval Date: 30 July 2018 Commencement Date: 30 July 2018

5.1 Credit Risk Management – Systems and Controls

(1) A Bank must implement and maintain comprehensive Credit Risk management systems and controls which:

(a) are appropriate to the Bank’s type, scope, complexity and scale of operations;

(b) enable the Bank to effectively identify, assess, monitor, mitigate and control Credit Risk and to ensure that adequate Capital is available to support the Credit Risk exposures assumed; and

(c) ensure effective implementation of the Credit Risk strategy and policy.

(2) A Bank must:

(a) identify, assess, monitor, mitigate and, control its Credit Risk; and

(b) implement and maintain a prudent Credit Risk management policy which enables it to identify, assess, monitor, control and mitigate its Credit Risk.

(3) The Credit Risk management policy must:

(a) be documented and approved by its governing body;

(b) include the Bank’s risk appetite for Credit Risk;

(c) be appropriate to the nature, scale and complexity of its activities and for its risk profile;

(d) must establish procedures, systems, processes, controls and approaches to identify, measure, evaluate, manage and control or mitigate its Credit Risk and to ensure the integrity of its Credit Risk management;

(e) must set out the organizational structure, and must define the responsibilities and roles, for managing Credit Risk;

(f) ensure that its risk management framework including but not limited to tools, methodologies and, systems enable it to implement its Credit Risk management policy; and

(g) be reviewed and updated at a reasonable frequency, but at least on an annual basis.

(4) A Bank’s Credit Risk management policy must establish:

(a) a well-documented and effectively-implemented process for assuming Credit Risk that does not rely unduly on external credit assessments;

(b) well-defined criteria for approving credit (including prudent underwriting standards), and renewing, refinancing and restructuring existing credit;

(c) a process for identifying the approving authority for credit, given its size and complexity;

(d) effective Credit Risk administration, including:

(і) regular analysis of counterparties’ ability and willingness to repay; and

(ii) monitoring of documents, legal covenants, contractual requirements, and collateral and other Credit Risk Mitigation techniques;

(e) effective systems for the accurate and timely identification, measurement, evaluation, management and control or mitigation of Credit Risk, and reporting to the Bank’s Governing Body and senior management;

(f) prudent and appropriate credit limits that are consistent with the Bank’s risk tolerance, risk profile and capital;

(g) provide for process and criteria for identification and recognition of problem assets as well as systems for measurement and reporting of problem assets;

(h) the criteria and responsibility for Credit Risk reporting, and the scope, manner and frequency of reporting, to the Governing Body or a committee of the governing body;

(і) establish, and must provide for the regular review of, the Bank’s Credit Risk tolerance and credit exposure limits to control credit exposures of the Bank;

(j) procedures for tracking and reporting exceptions to credit limits and deviations from Credit Risk management policies; and

(k) effective controls for the quality, reliability and relevance of data and validation procedures.

Note Guidance in respect of the contents of a Bank’s Credit Risk management policy which is required to satisfy the regulatory requirement in the Rule 5.1 is provided in Chapter 5 of the BPG issued by the AFSA.

(5) A Bank’s Credit Risk management policy must ensure that credit decisions are free of conflicts of interest and are made on an arm’s-length basis. In particular, the credit approval and credit review functions must be independent of the credit initiation function.

(6) A Bank’s Credit Risk management policy must provide for monitoring the total indebtedness of each counterparty and any risk factors that might result in default (including any significant unhedged foreign exchange risk).

(7) A Bank must give the AFSA full access to information about its credit portfolio. The Bank must also give the AFSA access to staff involved in assuming, managing, controlling and reporting on Credit Risk.

(8) The Credit Risk management policy must enable the Bank to carry out stress-tests on its credit portfolio at intervals appropriate for the nature, scale and complexity of the Bank’s business and using various scenarios based on appropriate assumptions. The policy must take into account the Bank’s Credit Risk profile (including on-balance-sheet and off-balance-sheet exposures) and tolerance in the context of the markets and macroeconomic conditions in which the Bank operates. The Bank’s Credit Risk stress testing must include procedures to make any changes to its Credit Risk management framework based on the results from the stress testing.

Note Guidance in respect of a Bank’s policies for Credit Risk assessment which is required to satisfy the regulatory requirement in the Rule 5.1 is provided in paragraphs 10 and 11 of Chapter 5 of the BPG issued by the AFSA.

5.2 Role of Governing Body—Credit Risk

(1) A Bank’s Governing Body must ensure that its Credit Risk management policy enables it to obtain a comprehensive bank-wide view of its Credit Risk exposures and covers the full credit lifecycle including credit underwriting, credit evaluation, and the Credit Risk management of the Bank’s trading activities.

(2) A Bank must ensure that its Governing Body is responsible for monitoring the nature and level of Credit Risk assumed by it and for monitoring the Credit Risk management process.

(3) The Governing Body of the Bank must also ensure that:

(a) an appropriate senior management structure with clearly defined responsibilities and roles for Credit Risk management and for compliance with the Bank’s Risk strategy, is established and maintained;

(b) the Credit Risk management framework is consistent with the Bank’s risk profile and its systemic importance.

(c) the Bank’s senior management and other relevant staff have the necessary experience to manage Credit Risk and to effectively implement the Credit Risk management policy;

(d) appropriate Credit limits covering Credit Risk management in both day-to-day and stressed conditions are set;

(e) stress-tests, funding strategies, contingency funding plans and holdings of high-quality liquid assets are effective and appropriate for the Bank;

(f) the Bank’s senior management:

(і) develops a Credit Risk management policy in accordance with the Bank’s Credit Risk tolerance;

(ii) monitors the Bank’s Credit Risk profile and reports to the Governing Body regularly;

(iii) determines, and sets out in the Bank’s Credit Risk management policy, the structure, responsibilities and controls for managing Credit Risk and for overseeing the Credit Risk of all legal entities, branches and subsidiaries in the jurisdictions in which the Bank is active; and

(iv) monitors trends and market developments that could present significant, unprecedented or complex challenges for managing Credit Risk so that appropriate and timely changes to the Credit Risk management policy can be made.

(4) The Governing Body must regularly review reports on the Bank’s Credit Risk profile and portfolio returns and, where necessary, information on new or emerging problem assets. The Governing Body of the Bank must also review the Credit Risk tolerance and strategy at least on an annual basis.

(5) The Governing Body must approve:

(a) the Bank’s Credit Risk management policy; and

(b) its Credit Risk tolerance and risk strategy.

5.3 Classification of Credit exposures

(1) Unless a Bank has established something more detailed, the Bank must classify credits into 1 of the 5 categories in table 5A. Nothing in the table prevents a Bank from classifying a credit under a higher risk category than the table requires.

(2) Unless there is good reason not to do so, the same category must be given to all credit exposures to the same counterparty.

Table 5A Categories of credit

5.4 Problem Assets and Impaired Assets

(1) A Bank’s Credit Risk management policy must facilitate the Bank’s collection of past-due obligations, and its management of problem assets through:

(a) monitoring of their credit quality;

(b) early identification and ongoing oversight; and

(c) review of their classification, provisioning and write-offs.

(2) The refinancing of a special mention or impaired credit must not be used to reclassify the credit to a more favourable category.

(3) The AFSA may require a special mention credit to be managed individually, and may set a higher level of provision for the credit, if the AFSA is of the view that market circumstances or any other industry-related concerns require such action.

5.5 Using ratings from External Credit Rating Agencies (ECRAs)

(1) A Bank must use only a solicited Credit Risk rating determined by an ECRA in determining the risk-weights for the Bank’s exposures. The Bank must use the ratings determined by an ECRA consistently and in accordance with these rules and its Credit Risk management policy.

(2) If there is only one assessment by an ECRA for a particular claim or asset, that assessment must be used to determine the risk-weight of the claim or asset. If there are two assessments by ECRAs and the assessments map into different risk weights, the higher risk-weight must be applied. If there are three or more assessments with different risk weights, the assessments corresponding to the two lowest risk-weights should be referred to, and the higher of those two risk-weights must be applied.

(3) If a Bank invests in an instrument with an issue-specific rating, the risk-weight to be applied to the instrument must be based on that rating.

(4) If the Bank invests in an unrated instrument and the issuer of the instrument is assigned a rating that results in a lower risk-weight than the risk-weight normally applied to an unrated position, the Bank may apply the lower risk-weight to the instrument but only if the claim for the instrument has the same priority as, or is senior to, the claims to which the issuer rating relates. If the instrument is junior to the claims to which the issuer rating relates, the Bank must apply the risk-weight normally applied to an unrated position.

(5) If the Bank invests in an unrated instrument and the issuer of the instrument is assigned a rating that results in a higher risk-weight than the risk-weight normally applied to an unrated position, the Bank must apply the higher risk-weight to the instrument if the claim for that instrument has the same priority as, or is junior to, the claims to which the issuer rating relates.

(6) A Bank must not use a Credit Risk rating for one entity in a Financial Group to determine the risk-weight for an unrated entity in the same Financial Group. If the rated entity has guaranteed the unrated entity’s exposure to the Bank, the guarantee may be recognised for risk- weighting purposes if it satisfies the criteria set out in this Chapter on Guarantees.

(7) If an issuer rating is assigned to a counterparty and a Bank applies a risk-weight to an unrated position based on the rating of an equivalent exposure to the same counterparty:

(a) the Bank must use that counterparty’s domestic-currency rating for any exposure denominated in the currency of the counterparty’s place of residence or incorporation; and

(b) the Bank must use that counterparty’s foreign-currency rating for any exposure denominated in a foreign currency.

(8) A short-term Credit Risk rating must be used only for short-term claims relating to banks and corporations (such as those arising from the issuance of commercial paper). The rating is taken to be issue-specific and must be used only to assign risk-weights for claims arising from a rated facility.

(9) If a short-term rated exposure is assigned a risk-weight of 50%, an unrated short-term exposure to the same counterparty cannot be assigned a risk-weight lower than 100%. If a short-term facility of an issuer is assigned a risk-weight of 150% based on the facility’s Credit Risk rating, all unrated claims of the issuer (whether long-term or short-term) must be assigned a risk-weight of 150%.

5.6 Calculation of Risk-Weighted Assets (RWAs)

(1) A Bank must apply risk-weights to all of its on-balance-sheet and off-balance-sheet asset items using the Risk-Weighted Assets method, defined in this Rule.

(2) If a claim or asset to which a risk-weight must be applied by a Bank is secured by eligible financial collateral or a guarantee (or there is mortgage indemnity insurance, or a credit derivative instrument or netting agreement), the Credit Risk Mitigation techniques allowed in this Chapter may be used to reduce the Bank’s Credit Risk capital requirement.

(3) A Bank must not rely only on a rating determined by an ECRA to assess the risks associated with an exposure. The Bank must also carry out its own Credit Risk assessment of each exposure (rated or unrated) to determine whether the risk-weights applied to each of them are appropriate. The determination must be based on each exposure’s inherent risk.

(4) If there are reasonable grounds to believe that the inherent risk of an exposure is significantly higher than that implied by the risk-weight assigned to it, the Bank must consider the higher risk (and apply a higher risk-weight) in calculating the Credit Risk capital requirement.

(5) A Bank must take into account all commitments in calculating its Credit Risk capital requirement, whether or not those commitments contain material adverse change clauses or other provisions that are intended to relieve the Bank of its obligations under particular conditions.

(6) Notwithstanding the provisions of these rules, the AFSA may determine the risk-weighted amount of a particular on-balance-sheet or off-balance-sheet Exposure of a Bank, if the AFSA considers that the Bank has not risk-weighted the Exposure appropriately. Such a determination must be issued by the AFSA, in writing.

(7) The AFSA may also impose specific capital requirements or limits on significant risk exposures, including those that the AFSA considers have not been adequately transferred or mitigated.

5.7 Calculation of RWAs – for On-Balance Sheet Exposures

(1) A Bank’s total RWAs for its on-balance-sheet items must be calculated as the sum of the risk-weighted amounts of each of its on-balance-sheet items.

(2) The RWA of an on-balance-sheet item must be calculated by multiplying its exposure (after taking into account any applicable Credit Risk Mitigation) by the applicable risk-weight in table 5B.

(3) If column 3 of table 5B states that the risk weight is «based on ECRA rating» for a particular asset, the applicable risk-weight for that asset item must be derived from the table 5C. If a claim or asset’s risk-weight is to be based on the ECRA rating and there is no such rating from an ECRA, the Bank must apply the risk-weight in the last column of table 5C.

Table 5B Risk-weights for on-balance-sheet items

Table 5C Risk-weights based on ratings determined by ECRAs

Note In table 5C, the ratings are shown according to Standard & Poor’s conventions. If a claim or asset is not rated by Standard & Poor’s, its rating must be mapped to the equivalent Standard & Poor’s rating.

5.8 Specialised lending

A specialised lending exposure is risk-weighted one rating less favourable than the rating that would apply, under table 5C, to the counterparty to the transaction (or to the party to whom that counterparty has the right of recourse).

5.9 Risk-weights for unsecured part of claim that is past due for more than 90 days

(1) The risk-weight for the unsecured part of a claim (other than a claim secured by an eligible residential mortgage) that is past due for more than 90 days is:

(a) 150% if the specific provisions are less than 20% of the past due claim;

(b) 100% if the specific provisions are 20% or more, but less than 50%, of the past due claim; or

(c) 50% if the specific provisions are 50% or more of the past due claim.

(2) The risk-weight for the unsecured part of a claim secured by an eligible residential mortgage that is past due for more than 90 days is:

(a) 100% if the specific provisions are less than 20% of the past due claim; or

(b) 50% if the specific provisions are 20% or more of the past due claim.

5.10 Calculation of RWAs – for Off-Balance Sheet Exposures

(1) A Bank’s total risk-weighted off-balance-sheet items is the sum of the risk-weighted amounts of its market-related and non- market-related off-balance-sheet items. An off-balance-sheet item must be converted to a credit equivalent amount before it can be risk- weighted.

(2) The risk-weighted amount of an off-balance-sheet item is calculated using the following steps in the same sequence:

(a) convert the notional principal amount of the item to its on-balance-sheet equivalent (credit equivalent amount).

(b) multiply the resulting credit equivalent amount by the risk-weight in table 5B or 5C, as applicable to the claim or asset.

(3) A Bank must include derivatives and all market-related off-balance-sheet items (including on-balance-sheet unrealised gains on market-related off-balance-sheet items) in calculating its risk-weighted credit exposures. A market-related item must be valued at its current market price.

5.11 Credit equivalent amounts for market-related items

(1) A Bank must calculate the credit equivalent amount of each of its market-related items. Unless the item is covered by an eligible netting agreement, the credit equivalent amount of a market- related off-balance-sheet item is the sum of the current credit exposure and the potential future credit exposure from the item.

(2) The procedure, formula and the credit conversion factors for this rule are provided in Section E (14) of Chapter 5 of the BPG.

(3) Potential future credit exposure must be based on an effective, rather than an apparent, notional principal amount. If the stated notional principal amount of an item is leveraged or enhanced by the structure of the item, the Bank must use the effective notional principal amount in calculating the potential future credit exposure. No potential future credit exposure is calculated for a single-currency floating/floating interest rate swap. The credit exposure from such an interest rate swap must be based on mark-to-market values.

5.12 Calculation of credit equivalent amounts

(1) Credit conversion factors for items with terms subject to reset: In case of an item structured to settle outstanding exposures after specified payment dates on which the terms are reset (that is, the mark- to-market value of the item becomes zero on the specified dates), the period up to the next reset date must be taken as the item’s residual maturity. For an interest rate item of that kind that is taken to have a residual maturity of more than 1 year, the credit conversion factor to be applied must not be less than 0.5% even if there are reset dates of a shorter maturity. For an item with 2 or more exchanges of principal, the credit conversion factor must be multiplied by the number of remaining exchanges under the item.

(2) The procedure, formula and the credit conversion factors for the calculation of risk-weighted assets for single-name swaps are detailed in Section E (15) of Chapter 5 of the BPG.

(3) A Bank must calculate the credit equivalent amount of each of its non-market-related items. The procedure, formula and the credit conversion factors for the calculation of risk-weighted assets for single-name swaps are detailed in Section E (16) of Chapter 5 of the BPG.

(4) In calculating the credit equivalent amount of a non-market-related off- balance-sheet item that is an undrawn (or partly drawn) commitment, a Bank must use the undrawn amount of the commitment.

(5) For an irrevocable commitment to provide an off-balance-sheet facility, the original maturity must be taken to be the period from the commencement of the commitment until the associated facility expires.

5.13 Policies—foreign exchange rollovers

(1) A Bank must have policies for entering into and monitoring rollovers on foreign exchange transactions and the policies must restrict the Bank’s capacity to enter into such rollovers. The Bank must notify the AFSA if it enters into a rollover in breach of its policy. Such rollovers must be approved by the Governing Body of the Bank. The AFSA may direct how the rollover is to be treated for capital adequacy purposes.

(2) A bank should have systems and controls to identify, monitor, control and report off-market transactions.

(3) The Bank must not enter into a transaction at an off-market price, unless the transaction is a historical rate rollover on a foreign exchange transaction. A historical rate rollover on a foreign exchange transaction may be entered into at an off-market price (instead of current market price).

Credit Risk Mitigation

5.14 Requirements—Credit Risk Mitigation techniques

(1) A Bank’s Credit Risk management policy must set out the conditions under which Credit Risk Mitigation techniques may be used. The policy must enable the Bank to manage Credit Risk Mitigation techniques and the risks associated with their use.

(2) The Bank must analyse the protection given by Credit Risk Mitigation techniques to ensure that any residual Credit Risk is identified, measured, evaluated, managed and controlled or mitigated. If the Bank accepts collateral, its policy must state the types of collateral that it will accept, and the basis and procedures for valuing collateral.

(3) If the Bank uses netting agreements, it must have a netting policy that sets out its approach. The netting policy must provide for monitoring netting agreements and must enable the Bank to monitor and report netted transactions on both gross and net bases.

(4) To obtain capital relief, the Credit Risk Mitigation technique and every document giving effect to it must be binding on all parties and enforceable in all the relevant jurisdictions. A Bank must review the enforceability of a Credit Risk Mitigation technique that it uses. The Bank must have a well-founded legal basis for any conclusion about enforceability and must carry out further reviews to ensure that the technique remains enforceable.

(5) The effects of a Credit Risk Mitigation technique must not be double-counted. The Bank is not allowed to obtain capital relief if:

(a) the risk-weight for the claim or asset is based on an issue-specific rating; and

(b) the ECRA that determined the rating had taken the technique into consideration in doing so.

5.15 Standard haircuts for Credit Risk Mitigation calculations

(1) A Bank must use the standard haircuts (expressed in percentages) set out in this rule in any calculation relating to Credit Risk mitigation. The haircuts are applied after risk mitigation to calculate adjusted exposures and are intended to take into account possible future price fluctuations.

(2) In table 5 D:

other issuers include banks, corporates, and public sector enterprises that are not treated as sovereigns.

sovereign includes a multilateral development bank, and a non- commercial public sector enterprise, that has a zero per cent risk-weight.

Table 5 D Haircuts for debt securities

Note Table 5 D item 3, column 5: securities rated BB+ or below are eligible financial collateral only if issued by a sovereign or non-commercial public sector enterprise—see Rule 5.17 (1) (c) (і).

Table 5 E Haircuts for other instruments

(3) The procedure, formulas and the methods for the calculation of haircuts for Credit Risk Mitigation techniques with various types of currency mismatches are detailed in Section F (8 to 10) of Chapter 5 of the BPG.

5.16 Collateral

(1) A Bank is able to obtain capital relief by accepting collateral only if the collateral is eligible financial collateral. Collateral may be lodged by the counterparty of the Bank holding a credit exposure (or by a third party on behalf of the counterparty). If collateral is lodged by a third party, the third party must guarantee the counterparty’s obligation to the Bank and must indemnify the Bank if the counterparty fails to fulfil its obligation. The Bank must ensure that the guarantee does not fail for lack of consideration.

(2) The Bank must enter into a written agreement with the party lodging the collateral. The agreement must establish the Bank’s direct, explicit, irrevocable and unconditional recourse to the collateral. The mechanism by which collateral is lodged must allow the Bank to liquidate or take possession of the collateral in a timely way. The Bank must take all steps necessary to satisfy the legal requirements applicable to its interest in the collateral.

(3) There must not be a significant positive correlation between the value of the collateral and the credit quality of the borrower.

5.17 Eligible financial collateral

(1) The following are eligible financial collateral if they satisfy the criteria in sub-rule (2):

(a) gold bullion;

(b) cash;

(c) debt securities that are assigned, by an ECRA, a rating of:

(і) for sovereign or non-commercial public-sector enterprise securities that are eligible for zero per cent risk-weight—at least BB-;

(ii) for short-term debt securities—at least A-3/P-3; or

(iii) for any other securities—at least BBB-;

(d) subject to sub-rule (3), debt securities that have not been assigned a rating by an ECRA if:

(і) the securities are issued by a bank (in or outside the AIFC) as senior debt and are listed on a regulated exchange;

(ii) all rated issues of the same seniority issued by the bank have a credit rating of at least BBB-(for long-term debt instruments) or A-3/P-3 (for short-term debt instruments); and

(iii) the Bank and the holder of the collateral have no information suggesting that the securities should have a rating below BBB- or A-3/P-3;

(e) equities (including convertible bonds) that are included in a main index;

(f) tracker funds, mutual funds and undertakings for collective investments in transferable securities (UCITS) if:

(і) a price for the units is publicly quoted daily; and

(ii) the funds or UCITS are limited to investing in instruments listed in this sub-rule;

(g) equities (including convertible bonds) that are not included in a main index but are listed on a regulated exchange, and funds and UCITS described in paragraph (f) that include such equities.

(2) For collateral to be eligible financial collateral, it must be lodged for at least the life of the exposure and must be marked-to-market at least once a month. The release of collateral must be conditional on the repayment of the exposure, but collateral may be reduced in proportion to the amount of any reduction in the exposure.

(3) Collateral in the form of securities issued by the counterparty or a person connected to the counterparty is not eligible financial collateral. Insurance contracts, put options, and forward sales contracts or agreements are not eligible financial collateral.

(4) Cash collateral, in relation to a credit exposure, means collateral in the form of:

(a) notes and coins;

(b) certificates of deposit, bank bills and similar instruments issued by the Bank holding the exposure; or

(c) cash-funded credit-linked notes issued by a Bank against exposures in its Banking Book, if the notes satisfy the criterion for credit derivatives in Rule 5.19(2).

(5) Eligible financial collateral must be held by:

(a) the Bank;

(b) a branch (in or outside the AIFC) of the Bank;

(c) an entity that is a member of the financial group of which the Bank is a member;

(d) an independent custodian; or

(e) a central counterparty.

(6) The holder of cash collateral in the form of a certificate of deposit or bank bill issued by a Bank must keep possession of the instrument while the collateralised exposure exists. If the collateral is held by an independent custodian or central counterparty, the Bank must take reasonable steps to ensure that the holder segregates the collateral from the holder’s own assets.

(7) If collateral is held by a branch of a Bank and the branch is outside the AIFC, the agreement between the Bank and the party lodging the collateral must require the branch to act in accordance with the agreement.

Risk-weight for cash collateral

(8) A Bank may apply a zero per cent risk-weight to cash collateral if the collateral is held by the Bank itself. The Bank may apply a zero per cent risk-weight to cash collateral held by another member of the financial group of which the Bank is a member if the agreement between the Bank and the party lodging the collateral requires the holder of the collateral to act in accordance with the agreement.