Question ID: 676
Regulation Reference: Risk-Free Interest Rate - Matching adjustment
Article: 181
Status: Final
Date of submission: 20 Jul 2016
Question
The de-risked cashflows for default (by applying (1-PD) + PD x (1-0.7)) are lower than the Fundamental Spread adjusted cashflows (by applying (1+risk-free)/(1+risk-free+FS) for EIOPA CQS 6 years 3-6 inclusive (GBP at end-2015).
This makes the FS impact smaller than the default impact. Should FS (when converted to a yield) be set to a minimum of the default impact?
EIOPA answer
The PD part of the fundamental spread is applied via the de-risked cash flows. The remainder of the fundamental spread is to be applied as the maximum of the cost of downgrade and the fundamental spread less the PD, as noted in EIOPA’s published Excel template on the fundamental spread, PDs and cost of downgrades (cells AN6, AN46 of the currency tabs). In the cases you mention, this effectively requires the total fundamental spread to be set to the de-risking default impact, since the cost-of-downgrade is zero in these cases.