[Federal Register Volume 59, Number 163 (Wednesday, August 24, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20506]
[[Page Unknown]]
[Federal Register: August 24, 1994]
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FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0845]
Capital; Capital Adequacy Guidelines
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of Proposed Rulemaking.
SUMMARY: The Board of Governors of the Federal Reserve System is
proposing to amend its risk-based capital guidelines for state member
banks and bank holding companies. The proposal would revise and expand
the set of conversion factors used to calculate the potential future
exposure of derivative contracts and recognize effects of netting
arrangements in the calculation of potential future exposure for
derivative contracts subject to qualifying bilateral netting
arrangements.
The Board is proposing these amendments on the basis of proposed
revisions to the Basle Accord announced on July 15, 1994. The effect of
the proposed amendments would be twofold. First, long-dated interest
rate and exchange rate contracts would be subject to new higher
conversion factors and new conversion factors would be set forth that
specifically apply to derivative contracts related to equities,
precious metals, and other commodities. Second, institutions would be
permitted to recognize a reduction in potential future exposure for
transactions subject to qualifying bilateral netting arrangements.
DATES: Comments must be received on or before October 21, 1994.
ADDRESSES: Comments should refer to docket No. R-0845 and may be mailed
to William W. Wiles, Secretary, Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue, N.W., Washington,
D.C. 20551. Comments may also be delivered to Room B-2222 of the Eccles
Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the guard
station in the Eccles Building courtyard on 20th Street, N.W. (between
Constitution Avenue and C Street) at any time. Comments may be
inspected in Room MP-500 of the Martin Building between 9:00 a.m. and
5:00 p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's
Rules regarding availability of information.
FOR FURTHER INFORMATION CONTACT: Roger Cole, Deputy Associate Director
(202/452-2618), Norah Barger, Manager (202/452-2402), Robert Motyka,
Supervisory Financial Analyst (202/452-3621), Barbara Bouchard, Senior
Financial Analyst (202/452-3072), Division of Banking Supervision and
Regulation; or Stephanie Martin, Senior Attorney (202/452-3198), Legal
Division. For the hearing impaired only, Telecommunication Device for
the Deaf, Dorothea Thompson (202/452-3544).
SUPPLEMENTARY INFORMATION:
I. Background
The international risk-based capital standards (the Basle
Accord)1 set forth a framework for measuring capital adequacy
under which risk-weighted assets are calculated by assigning assets and
off-balance-sheet items to broad categories based primarily on their
credit risk, that is, the risk that a loss will be incurred due to an
obligor or counterparty default on a transaction.2 Off-balance-
sheet transactions are incorporated into risk-weighted assets by
converting each item into a credit equivalent amount which is then
assigned to the appropriate credit risk category according to the
identity of the obligor or counterparty, or if relevant, the guarantor
or the nature of the collateral.
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\1\The Basle Accord was proposed by the Basle Committee on
Banking Supervision (Basle Supervisors' Committee, BSC) and endorsed
by the central bank governors of the Group of Ten (G-10) countries
in July 1988. The Basle Supervisors' Committee is comprised of
representatives of the central banks and supervisory authorities
from the G-10 countries (Belgium, Canada, France, Germany, Italy,
Japan, Netherlands, Sweden, Switzerland, the United Kingdom, and the
United States) and Luxembourg. In January 1989 the Federal Reserve
Board adopted a similar framework to be used by state member banks
and bank holding companies.
\2\Other types of risks, such as market risks, generally are not
addressed by the risk-based framework.
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The credit equivalent amount of an interest rate or exchange rate
contract (rate contract) is determined by adding together the current
replacement cost (current exposure) and an estimate of the possible
increases in future replacement cost, in view of the volatility of the
current exposure over the remaining life of the contract (potential
future exposure, also referred to as the add-on). Each credit
equivalent amount is then assigned to the appropriate risk category
generally based on the identity of the counterparty. The maximum risk
weight applied to interest rate or exchange rate contracts is 50
percent.3
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\3\Exchange rate contracts with an original maturity of 14
calendar days or less and instruments traded on exchanges that
require daily payment of variation margin are excluded from the
risk-based capital ratio calculations.
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A. Current Exposure
A banking organization that has a rate contract with a positive
mark-to-market value has a current exposure to a possible loss equal to
the mark-to-market value.4 For risk-based capital purposes, if the
mark-to-market value is zero or negative, then there is no replacement
cost associated with the contract and the current exposure is zero. The
sum of current exposures for a defined set of contracts is sometimes
referred to as the gross current exposure for that set of contracts.
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\4\The loss to a banking organization from a counterparty's
default on a rate contract is the cost of replacing the cash flows
specified by the contract. The mark-to-market value is the present
value of the net cash flows specified by the contract, calculated on
the basis of current market interest and exchange rates.
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The Basle Accord, as endorsed in 1988, provided that current
exposure would be determined individually for every rate contract
entered into by a banking organization. Generally, institutions were
not permitted to offset, that is, net, positive and negative mark-to-
market values of multiple rate contracts with a single counterparty to
determine one current exposure relative to that counterparty.5 In
April 1993 the Basle Supervisors' Committee (BSC) proposed a revision
to the Basle Accord, endorsed by the G-10 Governors in July 1994, that
permits institutions to net positive and negative mark-to-market values
of rate contracts subject to a qualifying, legally enforceable,
bilateral netting arrangement. Under the revision to the Accord,
institutions with qualifying netting arrangements could replace the
gross current exposure of a set of contracts included in such an
arrangement with a single net current exposure for purposes of
calculating the credit equivalent amount for the included contracts. If
the net market value is positive, then that market value equals the
current exposure for the netting contract. If the net market value is
zero or negative, then the current exposure is zero.
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\5\Netting by novation, however, was recognized. Netting by
novation is accomplished under a written bilateral contract
providing that any obligation to deliver a given currency on a given
date is automatically amalgamated with all other obligations for the
same currency and value date. The previously existing contracts are
extinguished and a new contract, for the single net amount, is
legally substituted for the amalgamated gross obligations.
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On May 20, 1994, the Board and the Office of the Comptroller of the
Currency (OCC) issued a joint proposal to amend their respective risk-
based capital guidelines in accordance with the BSC April 1993
proposal.6 Generally, under the proposal, a bilateral netting
arrangement would be recognized for risk-based capital purposes only if
the netting arrangement is legally enforceable. The institution would
have to have a legal opinion(s) to this effect. The joint Federal
Reserve/OCC proposal is consistent with the final July 1994 change to
the Basle Accord. (A detailed discussion of the BSC proposal and the
Board/OCC proposed amendment to their risk-based capital guidelines can
be found at 59 FR 26456, May 20, 1994.)
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\6\The Office of Thrift Supervision issued a similar netting
proposal on June 14, 1994 and the Federal Deposit Insurance
Corporation issued its netting proposal on July 25, 1994.
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B. Potential Future Exposure
The second part of the credit equivalent amount, potential future
exposure, is an estimate of the additional exposure that may arise over
the remaining life of the contract as a result of fluctuations in
prices or rates. Such changes may increase the market value of the
contract in the future and, therefore, increase the cost of replacing
it if the counterparty subsequently defaults.
The add-on for potential future exposure is estimated by
multiplying the notional principal amount7 of the underlying
contract by a credit conversion factor that is determined by the
remaining maturity of the contract and the type of contract. The
existing set of conversion factors used to calculate potential future
exposure, referred to as the add-on matrix, is as follows:
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\7\The notional principal amount, or value, is a reference
amount of money used to calculate payment streams between the
counterparties. Principal amounts generally are not exchanged in
single-currency interest rate swaps, but generally are exchanged in
foreign exchange contacts (including cross-currency interest rate
swaps).
------------------------------------------------------------------------
Interest Exchange
rate rate
Remaining maturity contracts contracts
(in (in
percent) percent)
------------------------------------------------------------------------
One year or less.................................. 0 1.0
Over one year..................................... 0.5 5.0
------------------------------------------------------------------------
The conversion factors were determined through simulation studies
that estimated the potential volatility of interest and exchange rates
and analyzed the implications of movements in those rates for the
replacement costs of various types of interest rate and exchange rate
contracts. The simulation studies were conducted only on interest rate
and foreign exchange rate contracts, because at the time the Accord was
being developed activity in the derivatives market was for the most
part limited to these types of transactions. The analysis produced
probability distributions of potential replacement costs over the
remaining life of matched pairs of rate contracts.8 Potential
future exposure was then defined in terms of confidence limits for
these distributions. The conversion factors were intended to be a
compromise between precision, on the one hand, and complexity and
burden, on the other.9
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\8\A matched pair is a pair of contracts with identical terms,
with the banking organization the buyer of one of the contracts and
the seller of the other.
\9\The methodology upon which the statistical analyses were
based is described in detail in a technical working paper entitled
``Potential Credit Exposure on Interest Rate and Foreign Exchange
Rate Related Instruments.'' This paper is available upon request
from the Board's Freedom of Information Office.
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The add-on for potential future exposure is calculated for all
contracts, regardless of whether the market value is zero, positive, or
negative, or whether the current exposure is calculated on a gross or
net basis. The add-on will always be either a positive number or zero.
The recent revision to the Basle Accord to recognize netting for the
calculation of current exposure does not affect the calculation of
potential future exposure, which generally continues to be calculated
on a gross basis. This means that an add-on for potential future
exposure is calculated separately for each individual contract subject
to the netting arrangement and then these individual future exposures
are added together to arrive at a gross add-on for potential future
exposure. For contracts subject to a qualifying bilateral netting
arrangement in accordance with the newly adopted Accord changes, the
gross add-on for potential future exposure would be added to the net
current exposure to arrive at one credit equivalent amount for the
contracts subject to the netting arrangement.
The original Basle Accord noted that the credit conversion factors
in the add-on matrix were provisional and would be subject to revision
if volatility levels or market conditions changed.
II. Basle Proposals for the Treatment of Potential Future Exposure
Since the original Accord was adopted, the derivatives market has
grown and broadened. The use of certain types of derivative instruments
not specifically addressed in the Accord--notably commodity, precious
metals, and equity-linked transactions10--has become much more
widespread. As a result of continued review of the method for
calculating the add-on for potential future exposure, in July 1994 the
BSC issued two proposals for public consultation.11 The first
proposal would expand the matrix of add-on factors used to calculate
potential future exposure to take into account innovations in the
derivatives market. The second proposal would recognize reductions in
the potential future exposure of derivative contracts that result from
entering into bilateral netting arrangements. The second proposal is an
extension of the recent revision to the Accord recognizing bilateral
netting arrangements for purposes of calculating current exposure and
would formally extend the recognition of netting arrangements to
equity, precious metals and other commodity derivative contracts. The
consultation period for these BSC proposals is scheduled to end on
October 10, 1994.
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\1\0In general terms, these are off-balance-sheet transactions
that have a return, or a portion of their return, linked to the
price of a particular commodity, precious metal, or equity or to an
index of commodity, precious metal, or equity prices.
\1\1The proposals are contained in a paper from the BSC entitled
``The Capital Adequacy Treatment of the Credit Risk Associated with
Certain Off-Balance Sheet Items'' that is available upon request
from the Board's Freedom of Information Office.
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A. Expansion of Add-on Matrix
A recently concluded BSC review of the add-on for potential future
exposure indicated that the current add-on factors used to calculate
the add-on amount may produce insufficient capital for certain types of
derivative instruments, in particular, long-dated interest rate
contracts, commodity contracts, and equity-index contracts. The BSC
review indicated that the current add-on factors do not adequately
address the full range of contract structures and the timing of cash
flows. The review also showed that the conversion factors many
institutions are using to calculate potential future exposure for
commodity, precious metals, and equity contracts could result in
insufficient capital coverage in view of the volatility of the indices
or prices on the underlying assets from which these contracts derive
their value.12
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\1\2While commodity, precious metals, and equity contracts were
not explicitly covered by the original Accord, as the use of such
contracts became more prevalent, many G-10 banking supervisors,
including U.S. banking supervisors, have informally permitted
institutions to apply the conversion factors for exchange rate
contracts to these types of transactions pending development of a
more appropriate treatment.
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The BSC concluded that it was not appropriate to address these
problems with a significant departure from the existing methodology
used in the Accord. The BSC decided that it would be appropriate to
preserve the conversion factors existing in the Accord and add new
conversion factors. Consequently, the revision proposed by the BSC
retains the existing conversion factors for interest and exchange rate
contracts but applies new higher conversion factors to such contracts
with remaining maturities of five years and over.13 The proposal
also introduces conversion factors specifically applicable to
commodity, precious metals, and equity contracts. The new conversion
factors were determined on the basis of simulation studies that used
the same general approach that generated the original add-on conversion
factors.14
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\1\3The conversion factors for rate contracts with remaining
maturities of one to five years are currently applied to contracts
with a remaining maturity of over one year.
\1\4The methodology and results of the statistical analyses are
summarized in a paper entitled ``The Calculation of Add-Ons for
Derivative Contracts: the ``Expanded Matrix'' Approach'' that is
available upon request from the Board's Freedom of Information
Office.
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The proposed matrix is set forth below:
Conversion Factor Matrix*
[Amounts in percent]
----------------------------------------------------------------------------------------------------------------
Precious
Interest Foreign metals, Other
Residual maturity rate exchange Equity** except gold commodities
and gold
----------------------------------------------------------------------------------------------------------------
Less than one year............................. 0.0% 1.0% 6.0% 7.0% 12.0%
One to five years.............................. 0.5% 5.0% 8.0% 7.0% 12.0%
Five years or more............................. 1.5% 7.5% 10.0% 8.0% 15.0%
----------------------------------------------------------------------------------------------------------------
*For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining
payments in the contract.
**For contracts that automatically reset to zero value following a payment, the remaining maturity is set equal
to the time remaining until the next payment.
Gold is included within the foreign exchange column because the
price volatility of gold has been found to be comparable to the
exchange rate volatility of major currencies. In addition, the BSC
determined that gold's role as a financial asset distinguishes it from
other precious metals. The proposed matrix is designed to accommodate
the different structures of contracts, as well as the observed
disparities in the volatilities of the associated indices or prices of
the underlying assets.
Two footnotes are attached to the matrix to address two particular
contract structures. The first relates to contracts with multiple
exchanges of principal. Since the level of potential future exposure
rises generally in proportion to the number of remaining exchanges, the
conversion factors are to be multiplied by the number of remaining
payments (that is, exchanges of principal) in the contract. This
treatment is intended to ensure that the full level of potential future
exposure is adequately covered. The second footnote applies to equity
contracts that automatically reset to zero each time a payment is made.
The credit risk associated with these contracts is similar to that of a
series of shorter contracts beginning and ending at each reset date.
For this type of equity contract the remaining maturity is set equal to
the time remaining until the next payment.
While the capital charges resulting from the application of the new
proposed conversion factors may not provide complete coverage for risks
associated with any single contract, the BSC believes the factors will
provide a reasonable level of prudential coverage for derivative
contracts on a portfolio basis. Like the original matrix, the proposed
expanded matrix is designed to provide a reasonable balance between
precision, and complexity and burden.
B. Recognition of the Effects of Netting
The simulation studies used to generate the conversion factors for
potential future exposure analyzed the implications of underlying rate
and price movements on the current exposure of contracts without taking
into account reductions in exposure that could result from legally
enforceable netting arrangements. Thus, the conversion factors are most
appropriately applied to non-netted contracts, and when applied to
legally enforceable netted contracts, they could in some cases,
overstate the potential future exposure.
Comments provided during the consultative process of revising the
Basle Accord to recognize qualifying bilateral netting arrangements and
further research conducted by the BSC, have suggested that netting
arrangements can reduce not only a banking organization's current
exposure for the transactions subject to the netting arrangement, but
also its potential future exposure for those transactions.15
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\1\5While current exposure is intended to cover an
organization's credit exposure at one point in time, potential
future exposure provides an estimate of possible increases in future
replacement cost, in view of the volatility of current exposure over
the remaining life of the contract. The greater the tendency of the
current exposure to fluctuate over time, the greater the add-on for
potential future exposure should be to cover possible fluctuations.
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As a result, in July 1994 the BSC issued a proposal to incorporate
into the calculation of the add-on for potential future exposure a
method for recognizing the risk-reducing effects of qualifying netting
arrangements. Under the proposal, institutions could recognize these
effects only for transactions subject to legally enforceable bilateral
netting arrangements that meet the requirements of netting for current
exposure as set forth in the recent revision to the Accord.
Depending on market conditions and the characteristics of a banking
organization's derivative portfolio, netting arrangements can have
substantial effects on the organization's potential future exposure to
multiple derivative contracts it has entered into with a single
counterparty. Should the counterparty default at some future date, the
institution's exposure would be limited to the net amount the
counterparty owes on the date of default rather than the gross current
exposure of the included contracts. By entering into a netting
arrangement a bank may reduce not only its current exposure, but
possibly its future exposure as well. Nevertheless, while in many
circumstances a netting arrangement can reduce the potential future
exposure of a counterparty portfolio, this is not always the
case.16
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\1\6For purposes of this discussion, a portfolio refers to a set
of contracts with a single counterparty. A banking organization's
global portfolio refers to all of the contracts in the institution's
total derivatives portfolio that are subject to qualifying netting
arrangements.
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The most important factors influencing whether a netting
arrangement will have an effect on potential future exposure are the
volatilities of the current exposure to the counterparty on both a
gross and net basis.17 The volatilities of net current exposure
and gross current exposure of the portfolio may not necessarily be the
same. Volatility of gross current exposure is influenced primarily by
the fluctuations of the market values of positively valued contracts.
Volatility of net current exposure on the other hand, is influenced by
the fluctuations of the market values of all contracts within the
portfolio. In those cases where net current exposure has a tendency to
fluctuate more over time than gross current exposure, a netting
arrangement will not reduce the potential future exposure. However, in
those situations where net current exposure has a tendency to fluctuate
less over time than gross current exposure, a netting arrangement can
reduce the potential future exposure.
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\1\7Volatility in this discussion is the tendency of the market
value of a contract to vary or fluctuate over time. A highly
volatile portfolio would have a tendency to fluctuate significantly
over short periods of time. One of the most important factors
influencing a portfolio's volatility is the correlation of the
contracts within the portfolio, that is, the degree to which the
contracts in the portfolio respond similarly to changing market
conditions.
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Net current exposure is likely to be less volatile relative to the
volatility of gross current exposure when the portfolio of contracts as
a whole is more diverse than the subset of positively valued contracts.
When a netting arrangement is applied to a diversified portfolio and
the positively valued contracts within the portfolio as a group are
less diversified than the overall portfolio, then the effect of the
netting arrangement will likely be to reduce the potential future
exposure of the portfolio.
The BSC has studied and analyzed several alternatives for taking
into account the effects of netting when calculating the capital charge
for potential future exposure. In particular, the BSC reviewed one
general method proposed by commenters to the April 1993 netting
proposal. This method would reduce the amount of the add-on for
potential future exposure by multiplying the calculated gross add-on by
the ratio of the portfolio's net current exposure to gross current
exposure (the net-to-gross ratio or NGR). The NGR is used as a proxy
for the risk-reducing effects of the netting arrangement on the
potential future exposure. The more diversified the portfolio, the
lower the net current exposure tends to be relative to gross current
exposure.
The BSC incorporated this method into its proposal. However, given
that there are portfolio-specific situations in which the NGR does not
provide a good indication of these effects, the BSC proposal gives only
partial weight to the effects of the NGR on the add-on for potential
future exposure. The proposed method would average the amount of the
add-on as currently calculated (Agross) and the same amount
multiplied by the NGR to arrive at a reduced add-on (Anet) for
contracts subject to qualifying netting arrangements in accordance with
the requirements set forth in the recently revised Accord. This formula
is expressed as:
Anet=.5(Agross+(NGR x Agross)).
For example, a bank with a gross current exposure of 500,000, a net
current exposure of 300,000, and a gross add-on for potential future
exposure of 1,200,000, would have an NGR of .6 (300,000/500,000) and
would calculate Anet as follows:
.5(1,200,000+(.6 x 1,200,000))
Anet=960,000
For banking organizations with an NGR of 50 percent, the effect of this
treatment would be to permit a reduction in the amount of the add-on by
25 percent. The BSC believes that most dealer banks are likely to have
an NGR in the vicinity of 50 percent.
The BSC proposal does not specify whether the NGR should be
calculated on a counterparty-by-counterparty basis or on an aggregate
basis for all transactions subject to qualifying, legally enforceable
netting arrangements. The proposal requests comment on whether the
choice of method could bias the results and whether there is a
significant difference in calculation burden between the two methods.
The BSC proposal also acknowledges that simulations using
institutions' internal models for measuring credit risk exposure would
most likely produce the most accurate determination of the effect of
netting arrangements on potential future exposures. The proposal states
that the use of such models would be considered at some future date.
III. The Board Proposal
In light of the BSC proposal, the Board believes that it is
appropriate to seek comment on proposed revisions to the calculation of
the add-on for potential future exposure for derivative contracts.
Therefore, the Board is proposing to amend its risk-based capital
guidelines for state member banks and bank holding companies to expand
the matrix of conversion factors, and to permit institutions that make
use of qualifying netting arrangements to recognize the effects of
those netting arrangements in the calculation of the add-on for
potential future exposure. The second part of the proposed amendment is
contingent on the adoption of a final amendment to the Board's risk-
based capital guidelines to recognize bilateral close-out netting
arrangements and would formally extend this recognition to commodity,
precious metals, and equity derivative contracts.
With regard to the portion of the proposal to expand the conversion
factor matrix, the Board is proposing the same conversion factors set
forth in the BSC proposal. The Board agrees with the BSC that the
existing conversion factors applicable to long-dated transactions do
not provide sufficient capital for the risks associated with those
types of contracts. The Board also agrees with the BSC that the
conversion factors for foreign exchange transactions are significantly
too low for commodity, precious metals, and equity derivative contracts
due to the volatility of the associated indices and the prices on the
underlying assets.18
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\1\8Similar to the BSC proposal, the Board's proposed amendment
specifies that for equity contracts that automatically reset to zero
value following a payment, the remaining maturity is set equal to
the time remaining until the next payment. Also, for contracts with
multiple exchanges of principal, the conversion factors are to be
multiplied by the number of remaining payments in the contract.
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The Board is proposing the same formula as the BSC proposal to
calculate a reduction in the add-on for potential future exposure for
contracts subject to qualifying netting contracts. The Board recognizes
several advantages with this formula. First, the formula uses bank-
specific information to calculate the NGR. The NGR is simple to
calculate and uses readily available information. The Board believes
the use of the averaging factor of 0.5 is an important aspect of the
proposed formula because it means the add-on for potential future
exposure can never be reduced to zero and banking organizations will
always hold some capital against derivative contracts, even in those
instances where the net current exposure is zero.
The Board is seeking comment on all aspects of this proposal. As
mentioned earlier, the BSC proposal seeks comment on whether the NGR
should be calculated on a counterparty-by-counterparty basis, or on a
global basis for all contracts subject to qualifying bilateral netting
arrangements. The Board's proposed regulatory language would require
the calculation of a separate NGR for each counterparty with which it
has a qualifying netting contract. However, the Board is also seeking
comment as to which method of calculating the NGR would be most
efficient and appropriate for institutions with numerous qualifying
bilateral netting arrangements. With either calculation method the NGR
would be applied separately to adjust the add-on for potential future
exposure for each netting arrangement. The Board notes that some
preliminary findings indicate that a global NGR may be less burdensome
to apply since the same NGR would be used for each counterparty with a
netting arrangement, but counterparty specific NGRs may provide a more
accurate indication of the credit risk associated with each
counterparty.
Regulatory Flexibility Act Analysis
The Board does not believe that adoption of this proposal would
have a significant economic impact on a substantial number of small
business entities (in this case, small banking organizations), in
accord with the spirit and purposes of the Regulatory Flexibility Act
(5 U.S.C 601 et seq.). In this regard, while some small institutions
with limited derivative portfolios may experience an increase in
capital charges, for most of these institutions the proposal will have
no effect. For institutions with more developed derivative portfolios
the overall affect of the proposal will likely be to reduce regulatory
burden and the capital charge for certain transactions. In addition,
because the risk-based capital standards generally do not apply to bank
holding companies with consolidated assets of less than $150 million,
this proposal will not affect such companies.
Paperwork Reduction Act
The Federal Reserve has determined that its proposed amendments, if
adopted, would not increase the regulatory paperwork burden of banking
organizations pursuant to the provisions of the Paperwork Reduction Act
(44 U.S.C. 3501 et. seq.).
List of Subjects
12 CFR Part 208
Accounting, Agriculture, Banks, banking, Capital adequacy,
Confidential business information, Currency, Federal Reserve System,
Reporting and recordkeeping requirements, Securities, State member
banks.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Capital
adequacy, Federal Reserve System, Holding companies, Reporting and
recordkeeping requirements, Securities.
For the reasons set forth in the preamble, the Board proposes to
amend 12 CFR parts 208 and 225 as follows.
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 is revised to read as
follows:
Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461,
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105,
3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),
78l(i), 78o-4(c)(5), 78q, 78q-1 and 78w; 31 U.S.C. 5318.
2. Appendix A to part 208 is amended by revising the last paragraph
in section III.C.3. and footnote 40 in the introductory text of section
III.D. to read as follows:
Appendix A to Part 208--Capital Adequacy Guidelines for State Member
Banks: Risk-Based Measure
* * * * *
III. * * *
C. * * *
3. * * *
Credit equivalent amounts of derivative contracts involving
standard risk obligors (that is, obligors whose loans or debt
securities would be assigned to the 100 percent risk category) are
included in the 50 percent category, unless they are backed by
collateral or guarantees that allow them to be placed in a lower
risk category.
* * * * *
D. * * * \40\ * * *
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\40\The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral or the amount of the guarantee in relation to the face
amount of the item, except for derivative contracts, for which this
determination is generally made in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section III.B of this appendix A.
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* * * * *
3. Appendix A to part 208 is amended by revising the section III.E.
heading and section III.E.1. to read as follows:
* * * * *
III. * * *
E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity
(including precious metals), and Equity Contracts)
1. Scope. (a) Credit equivalent amounts are computed for each of
the following off-balance-sheet derivative contracts:
I. Interest Rate Contracts
A. Single currency interest rate swaps.
B. Basis swaps.
C. Forward rate agreements.
D. Interest rate options purchased (including caps, collars, and
floors purchased).
E. Any other instrument that gives rise to similar credit risks
(including when-issued securities and forward deposits accepted).
II. Exchange Rate Contracts
A. Cross-currency interest rate swaps.
B. Forward foreign exchange contracts.
C. Currency options purchased.
D. Any other instrument that gives rise to similar credit risks.
III. Commodity (including precious metal) or Equity Derivative
Contracts
A. Commodity or equity linked swaps.
B. Commodity or equity linked options purchased.
C. Forward commodity or equity linked contracts.
D. Any other instrument that gives rise to similar credit risks.
(b) Exchange rate contracts with an original maturity of
fourteen calendar days or less and derivative contracts traded on
exchanges that require daily payment of variation margin may be
excluded from the risk-based ratio calculation. Over-the-counter
options purchased, however, are included and treated in the same way
as other derivative contracts.
* * * * *
4. In appendix A to part 208, section III.E.2. and section
III.E.3., as those sections were proposed to be revised at 59 FR 26461,
May 20, 1994, are revised to read as follows:
* * * * *
III. * * *
E. * * *
2. Calculation of credit equivalent amounts. (a) The credit
equivalent amount of a derivative contract that is not subject to a
qualifying bilateral netting contract in accordance with section
III.E.3. of this appendix A is equal to the sum of (i) the current
exposure (sometimes referred to as the replacement cost) of the
contract and (ii) an estimate of the potential future credit
exposure over the remaining life of the contract.
(b) The current exposure is determined by the mark-to-market
value of the contract. If the mark-to-market value is positive, then
the current exposure is equal to that mark-to market value. If the
mark-to-market value is zero or negative, then the current exposure
is zero. Mark-to-market values are measured in dollars, regardless
of the currency or currencies specified in the contract and should
reflect changes in both underlying rates, prices, and indices, and
counterparty credit quality.
(c) The potential future credit exposure of a contract,
including contracts with negative mark-to-market values, is
estimated by multiplying the notional principal amount of the
contract by one of the following credit conversion factors, as
appropriate:
Conversion Factor Matrix*
[Amounts in percent]
----------------------------------------------------------------------------------------------------------------
Precious
Interest Exchange metals Other
Residual maturity rate rate and Equity** except gold commodities
gold
----------------------------------------------------------------------------------------------------------------
Less than one year............................. 0.0 1.0 6.0 7.0 12.0
One to five years.............................. 0.5 5.0 8.0 7.0 12.0
Five years or more............................. 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
*For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining
payments in the contract.
**For contracts that reset to zero value following a payment, the remaining maturity is set equal to the time
until the next payment.
(d) No potential future exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating rate indices (so called floating/floating or basis
swaps); the credit exposure on these contracts is evaluated solely
on the basis of their mark-to-market values.
(e) The Board notes that the conversion factors set forth above,
which are based on observed volatilities of the particular types of
instruments, are subject to review and modification in light of
changing volatilities or market conditions.
3. Netting. (a) For purposes of this appendix A, netting refers
to the offsetting of positive and negative mark-to-market values
when determining a current exposure to be used in the calculation of
a credit equivalent amount. Any legally enforceable form of
bilateral netting (that is, netting with a single counterparty) of
derivative contracts is recognized for purposes of calculating the
credit equivalent amount provided that:
(1) The netting is accomplished under a written netting contract
that creates a single legal obligation, covering all included
individual contracts, with the effect that the bank would have a
claim or obligation to receive or pay, respectively, only the net
amount of the sum of the positive and negative mark-to-market values
on included individual contracts in the event that a counterparty,
or a counterparty to whom the contract has been validly assigned,
fails to perform due to any of the following events: default,
insolvency, bankruptcy, or similar circumstances.
(2) The bank obtains a written and reasoned legal opinion(s)
representing that in the event of a legal challenge, including one
resulting from default, insolvency, liquidation or similar
circumstances, the relevant court and administrative authorities
would find the bank's exposure to be such a net amount under:
(i) the law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities, and if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
(ii) the law that governs the individual contracts covered by
the netting contract; and
(iii) the law that governs the netting contract.
(3) The bank establishes and maintains procedures to ensure that
the legal characteristics of netting contracts are kept under review
in the light of possible changes in relevant law.
(4) The bank maintains in its files documentation adequate to
support the netting of rate contracts, including a copy of the
bilateral netting contract and necessary legal opinions.
(b) A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent
amount.49
---------------------------------------------------------------------------
\4\9For purposes of this section, a walkaway clause means a
provision in a netting contract that permits a non-defaulting
counterparty to make lower payments than it would make otherwise
under the contract, or no payment at all, to a defaulter or to the
estate of a defaulter, even if a defaulter or the estate of a
defaulter is a net creditor under the contract.
---------------------------------------------------------------------------
(c) By netting individual contracts for the purpose of
calculating its credit equivalent amount, a bank represents that it
has met the requirements of this appendix A and all the appropriate
documents are in the bank's files and available for inspection by
the Federal Reserve. Upon determination by the Federal Reserve that
a bank's files are inadequate or that a netting contract may not be
legally enforceable under any one of the bodies of law described in
section III.E.3.(a)(2) (i) through (iii) of this appendix A,
underlying individual contracts may be treated as though they were
not subject to the netting contract.
(d) The credit equivalent amount of derivative contracts that
are subject to a qualifying bilateral netting contract is calculated
by adding (i) the net current exposure for the netting contract and
(ii) the sum of the estimates of potential future exposure for all
individual contracts subject to the netting contract, adjusted to
take into account the effects of the netting contract.
(e) The net current exposure is the sum of all positive and
negative mark-to-market values of the individual contracts subject
to the netting contract. If the net sum of the mark-to-market values
is positive, then the net current exposure is equal to that sum. If
the net sum of the mark-to-market values is zero or negative, then
the net current exposure is zero.
(f) The sum of the estimates of potential future exposure for
all individual contracts subject to the netting contract
(Agross), adjusted to reflect the effects of the netting
contract (Anet), is determined through application of a
formula. The formula, which employs the ratio of the net current
exposure to the gross current exposure (NGR), is expressed as:
Anet=.5(Agross+(NGR x Agross))
(g) Gross potential future exposure, or Agross, is
calculated by summing the estimates of potential future exposure
(determined in accordance with section III.E.2. of this appendix A)
for each individual contract subject to the qualifying bilateral
netting contract.50 The NGR is the ratio of the net current
exposure of the netting contract to the gross current exposure of
the netting contract. The gross current exposure is the sum of the
current exposures of all individual contracts subject to the netting
contract calculated in accordance with section III.E.2. of this
appendix A. The effect of this treatment is that Anet is the
average of Agross and Agross adjusted by the NGR.
---------------------------------------------------------------------------
\5\0For purposes of calculating gross potential future credit
exposure for foreign exchange contracts and other similar contracts
in which notional principal is equivalent to cash flows, total
notional principal is defined as the net receipts to each party
falling due on each value date in each currency.
---------------------------------------------------------------------------
* * * * *
5. Appendix A to part 208 is amended by revising section III.E.4.
to read as follows:
* * * * *
III. * * *
E. * * *
4. Risk weights. (a) Once the credit equivalent amount for a
derivative contract, or a group of derivative contracts subject to a
qualifying netting contract, has been determined, that amount is
assigned to the risk weight category appropriate to the
counterparty, or, if relevant, the guarantor or the nature of any
collateral.51 However, the maximum weight that will be applied
to the credit equivalent amount of such contracts is 50 percent.
---------------------------------------------------------------------------
\5\1For derivative contracts, sufficiency of collateral or
guarantees is generally determined by the market value of the
collateral or the amount of the guarantee in relation to the credit
equivalent amount. Collateral and guarantees are subject to the same
provisions noted under section III.B. of this appendix A.
---------------------------------------------------------------------------
* * * * *
6. In appendix A to part 208, section III.E.5., as that section was
proposed to be revised at 59 FR 26461, May 20, 1994, is revised to read
as follows:
* * * * *
III. * * *
E. * * *
5. Avoidance of double counting. (a) In certain cases, credit
exposures arising from the derivative contracts covered by these
guidelines may already be reflected, in part, on the balance sheet.
To avoid double counting such exposures in the assessment of capital
adequacy and, perhaps, assigning inappropriate risk weights,
counterparty credit exposures arising from the types of instruments
covered by these guidelines may need to be excluded from balance
sheet assets in calculating banks' risk-based capital ratios.
(b) Examples of the calculation of credit equivalent amounts for
these types of contracts are contained in Attachment V of this
appendix A.
* * * * *
7. In appendix A to part 208, Attachment V, as that attachment was
proposed to be revised at 59 FR 26462, May 20, 1994, is revised to read
as follows:
* * * * *
Attachment V--Calculation of Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Potential exposure + Current exposure = Credit equivalent amount
-----------------------------------------------------------------------------------
Type of contract (remaining Notional Potential Current
maturity) principal Conversion exposure Mark-to- exposure
(dollars) factor (dollars) market value (dollars)
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward foreign
exchange................... 5,000,000 01 50,000 100,000 100,000 150,000
(2) 6-year forward foreign
exchange................... 6,000,000 .075 450,000 -120,000 0 450,000
(3) 3-year interest rate
swap....................... 10,000,000 .005 50,000 200,000 200,000 250,000
(4) 1-year oil swap......... 10,000,000 .12 1,200,000 -250,000 0 1,200,000
(5) 7-year interest rate
swap....................... 20,000,000 .05 1,000,000 -1,300,000 0 1,000,000
-----------------------------------------------------------------------------------
Total................. 2,750,000 300,000 3,050,000
----------------------------------------------------------------------------------------------------------------
If contracts (1) through (5) above are subject to a qualifying
bilateral netting contract, then the following applies:
----------------------------------------------------------------------------------------------------------------
Potential
future Net Current Credit
exposure exposure\1\ equivalent
(from above) amount
----------------------------------------------------------------------------------------------------------------
(1)................................. 50,000
(2)................................. 450,000
(3)................................. 50,000
(4)................................. 1,200,000
(5)................................. 1,000,000
---------------------------------------------------------------------------
Total......................... 2,750,000 + 0 = 2,750,000
----------------------------------------------------------------------------------------------------------------
\1\The total of the mark-to-market values from above is -1,370,000. Since this is a negative amount, the net
current exposure is zero.
To recognize the effects of netting on potential future exposure the following formula applies:
Anet=.5(Agross+(NGR x Agross.)
In the above example: NGR=0 (0/300,000)Anet=.5(2,750,000+(0 x 2,750,000))Anet=1,375,000.
Credit equivalent amount: 1,375,000+0=1,375,000.
If the net current exposure was a positive amount, for example $200,000, the credit equivalent amount would be
calculated as follows: NGR=.67 (200,000/300,000)Anet=.5(2,750,000+(.67 x 2,750,000))Anet=2,296,250.
Credit Equivalent amount: 2,296,250+200,000=2,496,250.
* * * * *
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1831i, 1843(c)(8),
1844(b), 1972(l), 3106, 3108, 3310, 3331-3351, 3907, and 3909.
2. Appendix A to part 225 is amended by revising the last paragraph
in section III.C.3. and footnote 43 in the introductory text of section
III.D. to read as follows:
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
* * * * *
III. * * *
C. * * *
3. * * *
Credit equivalent amounts of derivative contracts involving
standard risk obligors (that is, obligors whose loans or debt
securities would be assigned to the 100 percent risk category) are
included in the 50 percent category, unless they are backed by
collateral or guarantees that allow them to be placed in a lower
risk category.
* * * * *
D. * * * \43\ * * *
---------------------------------------------------------------------------
\43\The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral or the amount of the guarantee in relation to the face
amount of the item, except for derivative contracts, for which this
determination is generally made in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section III.B of this Appendix A.
---------------------------------------------------------------------------
* * * * *
3. Appendix A to part 225 is amended by revising the section III.E.
heading and section III.E.1. to read as follows:
* * * * *
III. * * *
E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity
(including precious metals) and Equity Derivative Contracts).
1. Scope. (a) Credit equivalent amounts are computed for each of
the following off-balance-sheet derivative contracts:
I. Interest Rate Contracts
A. Single currency interest rate swaps.
B. Basis swaps.
C. Forward rate agreements.
D. Interest rate options purchased (including caps, collars, and
floors purchased).
E. Any other instrument that gives rise to similar credit risks
(including when-issued securities and forward deposits accepted).
II. Exchange Rate Contracts
A. Cross-currency interest rate swaps.
B. Forward foreign exchange contracts.
C. Currency options purchased.
D. Any other instrument that gives rise to similar credit risks.
III. Commodity (including precious metal) or Equity Derivative
Contracts
A. Commodity or equity linked swaps.
B. Commodity or equity linked options purchased.
C. Forward commodity or equity linked contracts.
D. Any other instrument that gives rise to similar credit risks.
(b) Exchange rate contracts with an original maturity of
fourteen calendar days or less and derivative contracts traded on
exchanges that require daily payment of variation margin may be
excluded from the risk-based ratio calculation. Over-the-counter
options purchased, however, are included and treated in the same way
as other derivative contracts.
* * * * *
4. In appendix A to part 225, section III.E.2. and section
III.E.3., as those sections were proposed to be revised at 59 FR 26463,
May 20, 1994, are revised to read as follows:
* * * * *
III. * * *
E. * * *
2. Calculation of credit equivalent amounts. (a) The credit
equivalent amount of a derivative contract that is not subject to a
qualifying bilateral netting contract in accordance with section
III.E.3. of this appendix A is equal to the sum of (i) the current
exposure (sometimes referred to as the replacement cost) of the
contract and (ii) an estimate of the potential future credit
exposure over the remaining life of the contract.
(b) The current exposure is determined by the mark-to-market
value of the contract. If the mark-to-market value is positive, then
the current exposure is equal to that mark-to market value. If the
mark-to-market value is zero or negative, then the current exposure
is zero. Mark-to-market values are measured in dollars, regardless
of the currency or currencies specified in the contract and should
reflect changes in both underlying rates and indices, and
counterparty credit quality.
(c) The potential future credit exposure of a contract,
including contracts with negative mark-to-market values, is
estimated by multiplying the notional principal amount of the
contract by one of the following credit conversion factors, as
appropriate:
Conversion Factor Matrix*
[Amounts in percent]
----------------------------------------------------------------------------------------------------------------
Precious
Interest Exchange metals Other
Residual maturity rate rate and Equity** except gold commodities
gold
----------------------------------------------------------------------------------------------------------------
Less than one year............................. 0.0 1.0 6.0 7.0 12.0
One to five years.............................. 0.5 5.0 8.0 7.0 12.0
Five years or more............................. 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
*For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of remaining
payments in the contract.
**For contracts that reset to zero value following a payment, the remaining maturity is set equal to the time
until the next payment.
(d) No potential future exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating rate indices (so called floating/floating or basis
swaps); the credit exposure on these contracts is evaluated solely
on the basis of their mark-to-market values.
(e) The Board notes that the conversion factors set forth above,
which are based on observed volatilities of the particular types of
instruments, are subject to review and modification in light of
changing volatilities or market conditions.
3. Netting. (a) For purposes of this appendix A, netting refers
to the offsetting of positive and negative mark-to-market values
when determining a current exposure to be used in the calculation of
a credit equivalent amount. Any legally enforceable form of
bilateral netting (that is, netting with a single counterparty) of
derivative contracts is recognized for purposes of calculating the
credit equivalent amount provided that:
(1) The netting is accomplished under a written netting contract
that creates a single legal obligation, covering all included
individual contracts, with the effect that the organization would
have a claim or obligation to receive or pay, respectively, only the
net amount of the sum of the positive and negative mark-to-market
values on included individual contracts in the event that a
counterparty, or a counterparty to whom the contract has been
validly assigned, fails to perform due to any of the following
events: default, insolvency, bankruptcy, or similar circumstances.
(2) The banking organization obtains a written and reasoned
legal opinion(s) representing that in the event of a legal
challenge, including one resulting from default, insolvency,
liquidation or similar circumstances, the relevant court and
administrative authorities would find the organization's exposure to
be such a net amount under:
(i) the law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities, and if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
(ii) the law that governs the individual contracts covered by
the netting contract; and
(iii) the law that governs the netting contract.
(3) The banking organization establishes and maintains
procedures to ensure that the legal characteristics of netting
contracts are kept under review in the light of possible changes in
relevant law.
(4) The banking organization maintains in its files
documentation adequate to support the netting of rate contracts,
including a copy of the bilateral netting contract and necessary
legal opinions.
(b) A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent
amount.53
---------------------------------------------------------------------------
\5\3For purposes of this section, a walkaway clause means a
provision in a netting contract that permits a non-defaulting
counterparty to make lower payments than it would make otherwise
under the contract, or no payment at all, to a defaulter or to the
estate of a defaulter, even if a defaulter or the estate of a
defaulter is a net creditor under the contract.
---------------------------------------------------------------------------
(c) By netting individual contracts for the purpose of
calculating its credit equivalent amount, a banking organization
represents that it has met the requirements of this appendix A and
all the appropriate documents are in the organization's files and
available for inspection by the Federal Reserve. Upon determination
by the Federal Reserve that a banking organization's files are
inadequate or that a netting contract may not be legally enforceable
under any one of the bodies of law described in section
III.E.3.(a)(2) (i) through (iii) of this appendix A, underlying
individual contracts may be treated as though they were not subject
to the netting contract.
(d) The credit equivalent amount of derivative contracts that
are subject to a qualifying bilateral netting contract is calculated
by adding (i) the net current exposure for the netting contract and
(ii) the sum of the estimates of potential future exposure for all
individual contracts subject to the netting contract, adjusted to
take into account the effects of the netting contract.
(e) The net current exposure is the sum of all positive and
negative mark-to-market values of the individual contracts subject
to the netting contract. If the net sum of the mark-to-market values
is positive, then the net current exposure is equal to that sum. If
the net sum of the mark-to-market values is zero or negative, then
the net current exposure is zero.
(f) The sum of the estimates of potential future exposure for
all individual contracts subject to the netting contract
(Agross), adjusted to reflect the effects of the netting
contract (Anet), is determined through application of a
formula. The formula, which employs the ratio of the net current
exposure to the gross current exposure (NGR), is expressed as:
Anet=.5(Agross+(NGR x Agross))
(g) Gross potential future exposure, or Agross, is
calculated by summing the estimates of potential future exposure
(determined in accordance with section III.E.2. of this appendix A)
for each individual contract subject to the qualifying bilateral
netting contract.54 The NGR is the ratio of the net current
exposure of the netting contract to the gross current exposure of
the netting contract. The gross current exposure is the sum of the
current exposures of all individual contracts subject to the netting
contract calculated in accordance with section III.E.2. of this
appendix A. The effect of this treatment is that Anet is the
average of Agross and Agross adjusted by the NGR.
---------------------------------------------------------------------------
\5\4For purposes of calculating gross potential future credit
exposure for foreign exchange contracts and other similar contracts
in which notional principal is equivalent to cash flows, total
notional principal is defined as the net receipts to each party
falling due on each value date in each currency.
---------------------------------------------------------------------------
* * * * *
5. Appendix A to part 225 is amended by revising section III.E.4.
to read as follows:
* * * * *
III. * * *
E. * * *
4. Risk weights. (a) Once the credit equivalent amount for a
derivative contract, or a group of derivative contracts subject to a
qualifying netting contract, has been determined, that amount is
assigned to the risk weight category appropriate to the
counterparty, or, if relevant, the guarantor or the nature of any
collateral.55 However, the maximum weight that will be applied
to the credit equivalent amount of such contracts is 50 percent.
---------------------------------------------------------------------------
\5\5For derivative contracts, sufficiency of collateral or
guarantees is generally determined by the market value of the
collateral or the amount of the guarantee in relation to the credit
equivalent amount. Collateral and guarantees are subject to the same
provisions noted under section III.B. of this appendix A.
---------------------------------------------------------------------------
* * * * *
6. In appendix A to part 225, section III.E.5., as that section was
proposed to be revised at 59 FR 26463, May 20, 1994, is revised to read
as follows:
* * * * *
III. * * *
E. * * *
5. Avoidance of double counting. (a) In certain cases, credit
exposures arising from the derivative contracts covered by these
guidelines may already be reflected, in part, on the balance sheet.
To avoid double counting such exposures in the assessment of capital
adequacy and, perhaps, assigning inappropriate risk weights,
counterparty credit exposures arising from the types of instruments
covered by these guidelines may need to be excluded from balance
sheet assets in calculating banks' risk-based capital ratios.
(b) Examples of the calculation of credit equivalent amounts for
these types of contracts are contained in Attachment V of this
appendix A.
* * * * *
7. In appendix A to part 225, Attachment V, as that attachment
was proposed to be revised at 59 FR 26464, May 20, 1994, is revised
to read as follows:
* * * * *
Attachment V--Calculation of Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Potential Exposure + Current Exposure = Credit Equivalent Amount
-----------------------------------------------------------------------------------
Type of contract (remaining Notional Potential Current
maturity) principal Conversion exposure Mark-to- exposure
(dollars) factor (dollars) market value (dollars)
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward foreign
exchange................... 5,000,000 .01 50,000 100,000 100,000 150,000
(2) 6-year forward foreign
exchange................... 6,000,000 .075 450,000 -120,000 0 450,000
(3) 3-year interest rate
swap....................... 10,000,000 .005 50,000 200,000 200,000 250,000
(4) 1-year oil swap......... 10,000,000 .12 1,200,000 -250,000 0 1,200,000
(5) 7-year interest rate
swap....................... 20,000,000 .05 1,000,000 -1,300,000 0 1,000,000
-----------------------------------------------------------------------------------
Total................. 2,750,000 300,000 3,050,000
----------------------------------------------------------------------------------------------------------------
If contracts (1) through (5) above are subject to a qualifying
bilateral netting contract, then the following applies:
----------------------------------------------------------------------------------------------------------------
Potential
future Credit
exposure Net current Equivalent
(from above) exposure\1\ Amount
----------------------------------------------------------------------------------------------------------------
(1)................................. 50,000
(2)................................. 450,000
(3)................................. 50,000
(4)................................. 1,200,000
(5)................................. 1,000,000
---------------------------------------------------------------------------
Total......................... 2,750,000 + 0 = 2,750,000
----------------------------------------------------------------------------------------------------------------
\1\The total of the mark-to-market values from above is -1,370,000. Since this is a negative amount, the net
current exposure is zero.
To recognize the effects of netting on potential future exposure the following formula applies:
Anet=.5(Agross+(NGR x Agross).
In the above example: NGR=0 (0/300,000)Anet=.5(2,750,000+(0 x 2,750,000))Anet=1,375,000.
Credit equivalent amount: 1,375,000+0=1,375,000.
If the net current exposure was a positive amount, for example, $200,000, the credit equivalent amount would be
calculated as follows: NGR=.67 (200,000/300,000)Anet=.5(2,750,000+(.67 x 2,750,000))Anet=2,296,250.
Credit equivalent amount: 2,296,250+200,000=2,496,250.
* * * * *
By the order of the Board of Governors of the Federal Reserve
System, August 16, 1994.
William W. Wiles,
Secretary of the Board.
[FR Doc.94-20506 Filed 8-23-94 8:45am]
BILLING CODE 6210-01-P
