The risk scenario for calculating credit risk assumes a widening credit spread for credit-sensitive investments, according to the following breakdown into rating categories.
- Instruments with an AAA or equivalent rating: +60 basis points
- Instruments with an AA or equivalent rating: +80 basis points
- Instruments with an A or equivalent rating: +130 basis points
- Instruments with a BBB or equivalent rating: +180 basis points
- Instruments with a lower rating or non-rated instruments: +530 basis points
Widening credit spreads pose a risk to pension funds. Such widening may for instance be caused by deteriorating economic growth prospects. When credit spreads widen, the value of credit-related investments will decline. Besides corporate bonds, structured products, claims on counterparties and private derivatives contracts may also be exposed to credit risk. In calculating required own funds, the credit risk may be assumed to be zero for European government paper with an AAA or equivalent rating.
Credit risk is reflected in the interest margin on credit, the 'credit spread'. This is the difference between the effective return resulting from a set of cash flows whose payment depends on the creditworthiness of counterparties and the effective return resulting from the same set of cash flows if payment were 100% guaranteed.
The rating category is determined as much as possible on the basis of assessment by a qualified third party. De Nederlandsche Bank may set additional rules, for example with respect to the way a fund deals with ratings by third parties and how a fund determines rating categories itself, e.g. for a specific credit portfolio. In principle, a credit rating category based on an external rating is preferred. If no external rating is available, or if this is deemed to be of insufficient quality, a fund may also determine a rating itself on the basis of its own risk analysis. If this is also not an option, a shock of 530 basis points is applied.
Credit risk (S5) is determined on the basis of the scenarios related to the different rating categories. Pension funds are exposed to the risk of credit spread movements, which may cause a change in the value of their investments. Amid widening credit spreads, the value of credit-related investments will decline. The risk scenarios therefore assume an absolute widening of credit spreads. The sensitivity of a pension fund to credit spread movements depends among other things on the cash flow maturity characteristics of the instruments in its portfolio.
The aggregation of various risk factors assumes a correlation of 0.40 between interest rate risk and credit risk if the interest rate risk scenario is based on falling interest rates, and a correlation of nil if it is based on rising interest rates. A correlation of 0.5 is assumed between equity and real estate risk on the one hand and credit risk on the other.
Other credit risks
The credit risk scenarios are based on assumptions regarding certain characteristics of the investments made by pension funds. Funds are taken to be exposed to systemic credit risk only, and it is assumed that the investments are adequately spread across maturities, regions and sectors. If a pension fund's investments deviate materially from these assumptions, the fund may be exposed to more risk than assumed in the standard model. In such cases, the use of a partial internal model may be required.