Key Takeaways
- • The UK Prudential Regulation Authority (PRA) found that many banks lacked a comprehensive risk framework to monitor and control their combined exposure to particular private equity (PE) firms, according to its thematic review of counterparty credit risk management.
- • Banks were unable to systematically identify and measure combined PE sector credit and counterparty exposures because risk processes were aligned to product lines or industry sectors rather than providing an overarching view.
- • Stress tests were run only within individual business unit portfolios or product silos and were not aggregated, leaving banks without a holistic view of PE-linked scenario losses.
- • Boards were not specifically informed of aggregate PE sector or single-sponsor exposures and had not conducted a holistic risk assessment.
- • The PRA expects banks to flag PE-related transaction, exposure and collateral data in trade capture and risk systems, and to calculate exposures by sector, financial sponsor and individual fund, citing BCBS 239 and expectations following the Archegos Capital Management default.
Summary
The PRA's thematic review of counterparty credit risk management found that many banks did not have a comprehensive risk framework to monitor and control their specific combined exposure to particular private equity firms. According to the review, this gap led to further deficiencies: banks could not stress test their PE exposures comprehensively, and boards lacked effective oversight of PE-related exposures and risks. The PRA said the findings were not surprising given the growth of the PE market, but it expressed disappointment because similar issues had been highlighted in letters following the default of Archegos Capital Management and in its thematic review of fixed income financing.
On data aggregation, some banks could not systematically identify and measure combined PE sector credit and counterparty exposures within their overall risk data. Counterparty credit risk processes were aligned to product lines or industry sectors without a mechanism to provide an overarching view. Several banks also could not calculate consolidated exposure data linked directly or indirectly to individual financial sponsors, and often had no risk appetite framework to limit aggregate PE exposures to a given sponsor. The PRA expects banks to flag all PE-related transaction and exposure data, together with collateral pledges, in their trade capture and risk management systems, and to calculate and monitor exposures at sector level, by financial sponsor and by individual PE fund. The PRA noted this requirement is not new, referencing BCBS 239 (2013) and expectations published by it and the FCA after the Archegos default.
On interlinkages, banks lacked independent credit and CCRM procedures to identify, measure, combine and record risks arising from overlapping financial claims, liens and security interests linked directly or indirectly to the same PE fund or portfolio company. The PRA expects credit due diligence and management information to recognise overlapping exposures, collateral and claims where performance and recovery values are interlinked.
On stress testing, banks ran scenarios only within individual business units or product silos and did not consider results in aggregate, a problem the PRA links to weak data aggregation. As PE fund exposures grow, the PRA expects banks to assess the potential for higher default and loss correlations under stress, applying analysis to all direct and indirect exposures to individual sponsors and to the sector overall. Stress tests should be modular and tailored to product risk profiles, should include theoretical scenarios not limited to historic default rates or past correlations, and should allocate results to individual sponsors and funds. Independent credit and CCRM functions should use this information to assess the size and composition of PE-linked financing and derivatives exposures.
On governance, the PRA said bank boards were not specifically informed of aggregate exposures to the PE sector or to individual sponsors and so had not made a holistic risk assessment. Boards should be informed of these aggregate exposures, consider them within group strategy, and satisfy themselves that exposures to material sponsor clients and the PE sector are appropriate relative to the bank's overall risk profile.
On data aggregation, some banks could not systematically identify and measure combined PE sector credit and counterparty exposures within their overall risk data. Counterparty credit risk processes were aligned to product lines or industry sectors without a mechanism to provide an overarching view. Several banks also could not calculate consolidated exposure data linked directly or indirectly to individual financial sponsors, and often had no risk appetite framework to limit aggregate PE exposures to a given sponsor. The PRA expects banks to flag all PE-related transaction and exposure data, together with collateral pledges, in their trade capture and risk management systems, and to calculate and monitor exposures at sector level, by financial sponsor and by individual PE fund. The PRA noted this requirement is not new, referencing BCBS 239 (2013) and expectations published by it and the FCA after the Archegos default.
On interlinkages, banks lacked independent credit and CCRM procedures to identify, measure, combine and record risks arising from overlapping financial claims, liens and security interests linked directly or indirectly to the same PE fund or portfolio company. The PRA expects credit due diligence and management information to recognise overlapping exposures, collateral and claims where performance and recovery values are interlinked.
On stress testing, banks ran scenarios only within individual business units or product silos and did not consider results in aggregate, a problem the PRA links to weak data aggregation. As PE fund exposures grow, the PRA expects banks to assess the potential for higher default and loss correlations under stress, applying analysis to all direct and indirect exposures to individual sponsors and to the sector overall. Stress tests should be modular and tailored to product risk profiles, should include theoretical scenarios not limited to historic default rates or past correlations, and should allocate results to individual sponsors and funds. Independent credit and CCRM functions should use this information to assess the size and composition of PE-linked financing and derivatives exposures.
On governance, the PRA said bank boards were not specifically informed of aggregate exposures to the PE sector or to individual sponsors and so had not made a holistic risk assessment. Boards should be informed of these aggregate exposures, consider them within group strategy, and satisfy themselves that exposures to material sponsor clients and the PE sector are appropriate relative to the bank's overall risk profile.
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