Assessment of credit quality steps of bonds and loans based on an approved internal model

1.This Article shall apply in the following circumstances:

a) an insurance or reinsurance undertaking has concluded an agreement (“co-investment agreement”) to invest in bonds and loans jointly with another entity;

b) that other entity (“the co-investor”) is one or other of the following:

(i) an institution as defined in point (3) of Article 4(1) of Regulation (EU) No 575/2013 which uses the Internal Ratings Based Approach referred to in Article 143(1) of that Regulation;

(ii) an insurance or reinsurance undertaking which uses an internal model in accordance with Article 100 of Directive 2009/138/EC;

c) pursuant to the co-investment agreement, the insurance or reinsurance undertaking and the co-investor invest jointly in bonds and loans for which a credit assessment by a nominated ECAI is not available and for which debtors have not posted collateral that meets the criteria set out in Article 214;

d) the co-investment agreement provides that the co-investor shares with the insurance or reinsurance undertaking the probabilities of default produced by its Internal Ratings Based Approach or, as applicable, the credit quality steps produced by its internal model for the bonds or loans referred to in point (c) for the purpose of using that information for the calculation of the Solvency Capital Requirement of the insurance or reinsurance undertaking.

2. If all of the criteria set out in paragraphs 3 to 6 are met, the bonds and loans referred to in point (c) of paragraph 1 shall be assigned to credit quality steps determined as follows:

a) in a case where the co-investor falls within point (i) of paragraph 1(b), credit quality steps shall be determined on the basis of the most recent probabilities of default that the Internal Ratings Based Approach has produced;

b) in a case where the co-investor falls within point (ii) of paragraph 1(b), credit quality steps shall be the credit quality steps produced by the internal model.

3. The criteria in this paragraph are as follows:

a) the issuer of each bond or loan does not belong to the same corporate group as the insurance or reinsurance undertaking;

b) the issuer is not an insurance or reinsurance undertaking, an infrastructure entity, a credit institution, an investment firm, a financial institution, an AIFM, a UCITS investment management company, an institution for occupational retirement provision or a non-regulated undertaking carrying out financial activities;

c) the issuer has its head office in a country which is a member of the EEA;

d) more than 50 % of the issuer's annual revenue is denominated in currencies of countries which are members of the EEA or the OECD;

e) at least one of the following conditions is met for each of the last three financial years ending prior to the date on which the Solvency Capital Requirement is being calculated:

— the annual turnover of the issuer exceeds EUR 10 000 000;

— the balance sheet total of the issuer exceeds EUR 10 000 000;

— the number of staff employed by the issuer exceeds 50.

4.   The criteria in this paragraph are as follows:

a) the co-investment agreement defines the types of bonds and loans to be underwritten, and the applicable assessment criteria;

b) the co-investor provides the insurance or reinsurance undertaking with sufficient details of the underwriting process, including the criteria used, the organisational structure of the co-investor and the controls conducted by the co-investor;

c) the co-investor provides the insurance or reinsurance undertaking with data on all applications for bonds and loans to be underwritten;

d) the co-investor provides the insurance or reinsurance undertaking with details of all decisions to approve or reject applications for bonds and loans to be underwritten;

e) the co-investor retains an exposure of at least 20 % of the nominal value of each bond and loan;

f) the underwriting process is the same as the underwriting process followed by the co-investor for its other investments in comparable bonds and loans;

g) the insurance or reinsurance undertaking invests in all bonds and loans of the types referred to in point (a) for which the co-investor decides to approve the bond or loan application;

h) the co-investor provides the insurance or reinsurance undertaking with information that allows the undertaking to understand the Internal Ratings Based Approach or, as applicable, internal model and its limitations, as well as its adequacy and appropriateness, in particular:

(i) a description of the Internal Ratings Based Approach or, as applicable, internal model, including the inputs and risk factors, the quantification of risk parameters and the underlying methods, and the general methodology applied;

(ii) a description of the scope of the use of the Internal Ratings Based Approach or, as applicable, internal model;

(iii) a description of the model validation process and of other processes which allow the model's performance to be monitored, the appropriateness of its specification to be reviewed over time, and the results of the Internal Ratings Based Approach or, as applicable, internal model to be tested against experience.

5. In a case where the co-investor falls within point (i) of paragraph 1(b):

a) the insurance or reinsurance undertaking clearly documents to which credit quality step the probability of default produced by the institution's Internal Ratings Based Approach corresponds;

b) the mapping of probabilities of default to credit quality steps carried out by the insurance or reinsurance undertaking ensures that, for the bond or loan in question, the resulting level of capital requirement for the spread risk sub-module referred to in point (d) of the second subparagraph of Article 105(5) of Directive 2009/138/EC is appropriate;

c) the mapping is based on Table 1 in Annex I to Commission Implementing Regulation (EU) 2016/1799;

d) adjustments are made in a prudent manner to the probabilities of default before the mapping is carried out, taking into account the qualitative factors set out in Article 7 of Implementing Regulation (EU) 2016/1799;

e) an adjustment to the probabilities of default is made in either of the following situations:

(i) the time horizon covered by the Internal Ratings Based Approach deviates significantly from the 3-year time horizon set out in Article 4(2) of Implementing Regulation (EU) 2016/1799;

(ii) the definition of default used in the Internal Ratings Based Approach deviates significantly from the one set out in Article 4(4) of that Implementing Regulation.

6. In a case where the co-investor falls within point (ii) of paragraph 1(b), the internal model ensures that, for the bond or loan in question, the resulting level of capital requirement for the spread risk sub-module referred to in point (d) of the second subparagraph of Article 105(5) of Directive 2009/138/EC is appropriate