[Federal Register Volume 60, Number 171 (Tuesday, September 5, 1995)]
[Rules and Regulations]
[Pages 46170-46185]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-21608]
[[Page 46169]]
_______________________________________________________________________
Part IV
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 3
Federal Reserve System
12 CFR Parts 208 and 225
Federal Deposit Insurance Corporation
12 CFR Part 325
_______________________________________________________________________
Risk-Based Capital Standards: Derivative Transactions; Final Rule
Federal Register / Vol. 60, No. 171 / Tuesday, September 5, 1995 /
Rules and Regulations
[[Page 46170]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 95-20]
RIN 1557-AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0845]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB43
Risk-Based Capital Standards: Derivative Transactions
AGENCIES: Office of the Comptroller of the Currency (OCC), Department
of the Treasury; Board of Governors of the Federal Reserve System
(Board); and Federal Deposit Insurance Corporation (FDIC).
ACTION: Final rule.
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SUMMARY: The OCC, the Board, and the FDIC (the banking agencies) are
amending their respective risk-based capital standards for banks and
bank holding companies (banking organizations, institutions). This
final rule implements a recent revision to the Basle Accord revising
and expanding the set of conversion factors used to calculate the
potential future exposure of derivative contracts and recognizing the
effects of netting arrangements in the calculation of potential future
exposure for derivative contracts subject to qualifying bilateral
netting arrangements. The effect of this final rule is threefold.
First, long-dated interest rate and exchange rate contracts are subject
to higher conversion factors and new conversion factors are set forth
that specifically apply to derivative contracts related to equities,
precious metals, and other commodities. Second, institutions are
permitted to recognize a reduction in potential future credit exposure
for transactions subject to qualifying bilateral netting arrangements.
Third, derivative contracts related to equities, precious metals and
other commodities may be recognized in bilateral netting arrangements
for risk-based capital purposes.
EFFECTIVE DATE: October 1, 1995.
FOR FURTHER INFORMATION CONTACT: OCC: For issues relating to netting
and the calculation of risk-based capital ratios, Roger Tufts, Senior
Economic Advisor (202/874-5070), Office of the Chief National Bank
Examiner. For legal issues, Eugene H. Cantor, Senior Attorney,
Securities and Corporate Practices (202/874-5210), or Ronald
Shimabukuro, Senior Attorney, Legislative and Regulatory Activities
Division (202/874-5090), Office of the Comptroller of the Currency, 250
E Street, S.W., Washington, D.C. 20219.
Board: Roger Cole, Deputy Associate Director (202/452-2618), Norah
Barger, Manager (202/452-2402), Robert Motyka, Supervisory Financial
Analyst (202)/452-3621), Barbara Bouchard, Supervisory 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, Telecommunications Device for the Deaf,
Dorothea Thompson (202/452-3544), 20th and C Streets, N.W., Washington,
D.C. 20551.
FDIC: William A. Stark, Assistant Director, (202/898-6972), Curtis
Wong, Capital Markets Specialist, (202/898-7327), Division of
Supervision, or Jeffrey M. Kopchik, Counsel, (202/898-3872), Legal
Division, FDIC, 550 17th St., N.W., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
I. Background
The Basle Accord1 established a risk-based capital framework
for assessing capital adequacy that was implemented in the United
States by the banking agencies in 1989. Under this framework, off-
balance-sheet transactions are incorporated into the risk-based
structure by converting each item into a credit equivalent amount that
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 collateral.
\1\The Basle Accord is a risk-based framework that was proposed
by the Basle Committee on Banking Supervision (Basle Supervisors
Committee) 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.
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The credit equivalent amount of an off-balance-sheet interest rate
or exchange rate contract (rate contract) is determined by adding
together the current replacement cost (current exposure) of the
contract and an estimate of the possible increase in future replacement
cost (potential future exposure, also referred to as the add-on) in
view of the volatility of the current exposure of the contract. The
maximum risk category for rate contracts is 50 percent.2
\2\Exchange rate contracts with an original maturity of 14
calendar days or less and instruments traded on exchanges that
require daily receipt and payment of cash variation margin are
excluded from the risk-based capital ratio calculations.
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Current Exposure
For risk-based capital purposes, a rate contract with a positive
mark-to-market value has a current exposure equal to that market value.
If the mark-to-market value is zero or negative, then 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. When they were initially issued, the Basle
Accord and the banking agencies' risk-based capital standards provided,
generally, that current exposure would be determined individually for
each rate contract entered into by a banking organization.
In July 1994 the Basle Accord was revised to permit institutions to
net, that is, offset, positive and negative mark-to-market values of
rate contracts entered into with a single counterparty subject to a
qualifying, legally enforceable, bilateral netting arrangement.
Effective at year-end 1994, the banking agencies each amended, in a
uniform manner, their risk-based capital standards to implement the
revision to the Accord.3 Accordingly, U.S. banking organizations
with qualifying, legally enforceable, bilateral netting arrangements
may replace the gross current exposure of a set of contracts included
in such an arrangement with a single net current exposure for purposes
of determining the credit equivalent amount for the included contracts.
\3\The Board issued its amendment on December 7, 1994 (59 FR
62987), the OCC and FDIC issued their amendments on December 28,
1994 (59 FR 66645 for the OCC final rule and 59 FR 66656 for the
FDIC final rule).
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Potential Future Exposure
The potential future exposure portion of the credit equivalent
amount for rate contracts is an estimate of the additional credit
exposure that may arise as a result of fluctuations in prices or rates.
The add-on for potential future exposure is estimated by multiplying
the notional principal amount4 of the contract by a credit
conversion factor that is determined by the remaining maturity of the
contract and the type of
[[Page 46171]]
contract. The original conversion factors in the Basle Accord and the
banking agencies' risk-based capital standards are set forth in the
following matrix:
\4\The notional principal amount is a reference amount of money
used to calculate payment streams between counterparties.
------------------------------------------------------------------------
Interest Exchange
Remaining maturity rate (in rate (in
percent) percent)
------------------------------------------------------------------------
One year or less.................................. 0 1.0
Over one year..................................... 0.5 5.0
------------------------------------------------------------------------
An individual add-on for potential future exposure is calculated
for all rate 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 banking agencies' recent amendments to expand
the recognition of bilateral netting arrangements did not revise the
calculation of the add-on for potential future exposure. Accordingly,
an add-on is calculated separately for each individual contract subject
to a qualifying bilateral netting arrangement. These individual
potential future exposures are added together to arrive at a gross add-
on amount. The gross add-on amount is added to the net current exposure
to determine one credit equivalent amount for the contracts subject to
the qualifying bilateral netting arrangement.
Commenters to the Basle proposal to expand the recognition of
bilateral netting arrangements urged regulators to also recognize
reductions in potential future credit exposure arising from such
arrangements. They also commented that commodity and equity derivative
transactions should be eligible for netting for risk-based capital
purposes. Accordingly, in July 1994 the Basle Supervisors Committee
proposed revisions to the Basle Accord regarding the risk-based capital
treatment of derivative transactions.5 Under the proposed
revision, the matrix of conversion factors used to calculate potential
future exposure would be expanded to take into account innovations in
the derivatives markets. Specifically, the Basle Committee proposed
that higher conversion factors be added to address long-dated
transactions (that is, contracts with remaining maturities over five
years) and new conversion factors be added to explicitly cover certain
types of derivatives transactions not directly mentioned by the Accord
when it was endorsed in 1988. These include commodity-, precious metal-
, and equity-linked derivative transactions.6 The proposed
revision also would have formally extended the recognition of
qualifying bilateral netting arrangements to commodity, precious metal,
and equity derivative contracts so that these types of transactions
could be netted when determining current exposure for the netting
contract. In addition, the proposed revision set forth a formula for
institutions to employ in recognizing reductions in the potential
future exposure of derivatives contracts that can result from entering
into qualifying bilateral netting arrangements.
\5\The proposed revisions are contained in a document 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 or OCC's Freedom of Information Offices or the
FDIC's Office of the Executive Secretary.
\6\In general terms, these are off-balance-sheet derivative
contracts that have a return, or a portion of their return, linked
to the price or an index of prices for a particular commodity,
precious metal, or equity. These types of transactions were not
specifically addressed in the 1988 Accord (or in the banking
agencies' original risk-based capital standards) because they were
not prevalent in the derivatives markets at that time.
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II. The Agencies' Proposals
After the Basle Supervisors Committee issued its proposed revisions
to the Basle Accord, the banking agencies each issued for public
comment proposals to amend their respective risk-based capital
standards based on the international proposal.7 The agencies'
proposed conversion factor matrix is set forth below:
\7\The Board issued its proposal on August 24, 1994 (59 FR
43508), the OCC issued its proposal on September 1, 1994 (59 FR
45243), and the FDIC issued its proposal on October 19, 1994 (59 FR
52714).
Conversion Factor Matrix\1\
[Amounts in percent]
----------------------------------------------------------------------------------------------------------------
Foreign Precious
Residual maturity Interest exchange Equity\2\ metals, Other
rate and gold except gold commodities
----------------------------------------------------------------------------------------------------------------
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
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\1\For contracts with multiple exchanges of principal, the factors are to be multiplied by the number of
remaining payments in the contract.
\2\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.
The proposed matrix was designed to accommodate a variety of
contracts and was intended to provide a reasonable balance between
precision, on the one hand, and complexity and burden, on the other.
The agencies also proposed the same methodology as the Basle
Supervisors Committee to calculate a reduction in the add-on amount for
contacts subject to qualifying bilateral netting arrangements. Under
the agencies' proposals, institutions would apply the following
formula8 to adjust the amount of the add-on for potential future
exposure:
\8\This formula may also be expressed as: Anet = (1-
P)Agross + P(NGR x Agross) [P or policy factor = 0.5].
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Anet = 0.5(Agross +(NGR x Agross))
Where Anet is the adjusted add-on for all contracts subject to
the netting arrangement, Agross is the amount of the add-on as
calculated under the current agency standards, and NGR is the ratio of
the net current exposure of the set of contracts included in the
netting arrangement to the gross current exposure of those contracts.
The proposals would have given partial credit to the effect of the NGR
by applying a weighted averaging factor of 0.5.
Under the proposals, institutions would calculate a separate NGR
for each counterparty with which it has a qualifying bilateral netting
contract. The proposals requested general comments as well as specific
comment as to whether the NGR should be calculated on a counterparty-
by-counterparty basis or on an aggregate basis for all contracts
subject to qualifying bilateral netting arrangements.
[[Page 46172]]
III. Comments Received
The banking agencies together received nineteen public comments on
their proposed amendments. Fifteen of the commenters were banks and
bank holding companies and four were industry trade associations and
other organizations. Commenters generally supported the proposed
amendments, in particular the recognition of the effects of bilateral
netting arrangements in the calculation of potential future exposure,
and several urged adoption of the amendments as soon as possible.
Commenters offered suggestions and opinions on several aspects of the
proposals including the conversion factors, the formula for recognizing
potential future exposure, ways of calculating the NGR, and recognizing
additional risk-reducing techniques.
Expanded Matrix
Over one half of the commenters addressed the proposed expanded
conversion factor matrix. Of these commenters, most indicated the
proposed factors were generally reasonable and acceptable. Several
commenters discussed the underlying assumptions used in the simulation
models for arriving at the proposed factors for commodity transactions
and expressed concern that the conversion factors for certain commodity
derivative transactions were too high. One commenter suggested the
conversion factor for commodity contracts across all time bands should
be twelve percent. Another commenter expressed the view that the
proposed conversion factor for interest rate contracts with remaining
maturities greater than five years (1.5 percent) was an excessive
increment over the current 0.5 percent conversion factor for interest
rate contracts with remaining maturities greater than one year. This
commenter suggested an additional time band for interest rate contracts
with five to eight years remaining maturity and a corresponding
conversion factor of 1.0 percent. Another commenter suggested there
should be no capital charge for potential future exposure for commodity
contracts based on two floating indices.
One commenter supported continuing the existing time band of ``one
year or less'' as opposed to the proposed time band of ``less than one
year.'' Two commenters expressed the view that the proposed time band
for contracts with remaining maturities greater than five years was
unnecessary. One commenter suggested adding a time band and appropriate
conversion factors for contracts with remaining maturities between one
and two years.
Several commenters discussed the matrix footnotes. One suggested
extending the footnote applicable to equity contracts with automatic
reset features following a payment to any derivative contract with
effective early termination or periodic reset features. With regard to
the footnote pertaining to contracts with multiple exchanges of
principal, one commenter requested further clarification on the types
of contracts included, while another expressed the view that
multiplying the conversion factor by the number of remaining payments
in a contract was too conservative. A few commenters recommended
clarification as to the appropriate capital treatment when transactions
are leveraged or enhanced by a stated multiple.
Netting and Potential Future Exposure
A number of commenters discussed the proposed formula for
recognizing the effects of bilateral netting arrangements in the
calculation of potential future exposure. Most of these commenters
supported the use of the NGR as a reasonable proxy to estimate the
risk-reducing benefits of netting arrangements. Several commenters
supported giving full weight to the NGR or, alternatively, weighting
the NGR with a higher averaging factor than the proposed 0.5 factor.
Another commenter offered a revised formula that would weight the
netting portion of the formula by two and divide the entire formula by
three. This commenter stated the revised formula would effectively
reduce the credit equivalent amount and place greater emphasis on the
portion of the formula affected by a netting arrangement. One commenter
suggested that net credit risk should be the basis for the add-on
amount.
Several commenters addressed the proposal's specific request for
comment on whether the NGR should be calculated on a counterparty-by-
counterparty basis or on an aggregate basis across all portfolios
eligible for capital netting treatment. A few commenters supported a
counterparty-by-counterparty NGR as providing a more accurate
indication of credit risks. Other commenters preferred an aggregate
NGR, characterizing an aggregate NGR as less burdensome to calculate.
Two commenters suggested applying a single NGR to all counterparties
within each risk weight classification.
Other Comments
Several commenters encouraged recognizing other risk reducing
techniques such as margin and collateral agreements, frequent
settlement of mark-to-market values, and periodic resetting of terms
and early termination agreements. One commenter suggested there should
be no capital charge for potential future exposure when current
exposure is less than a certain level (e.g., negative $1 million). One
commenter suggested using negative net mark-to-market values to offset
potential future exposure. A few commenters supported the use of
internal systems to calculate capital requirements and recommended
continued monitoring of developments in the banking industry.
IV. Final Rule
After consideration of the comments received and further
deliberation on the issues involved, the banking agencies have
determined to adopt a final rule that is substantially the same as
proposed. The final rule amends the matrix of conversion factors used
to calculate potential future exposure and permits institutions to
recognize the effects of qualifying bilateral netting arrangements in
the calculation of potential future exposure. The final rule is
consistent with a revision to the Basle Accord announced by the Basle
Supervisors Committee in April 1995.9
\9\The revision to the Basle Accord is in an annex with the
heading ``Forwards, swaps, purchased options and similar derivative
contracts'' that was issued along with the Basle Supervisors
Committee's consultative proposal on Market Risk on April 12, 1995.
This document is available upon request from the Board's and OCC's
Freedom of Information Offices and the FDIC's Office of the
Executive Secretary.
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Expanded Matrix
The banking agencies believe that the proposed conversion factors
generally provide a reasonable measure of potential future exposure for
long-dated interest rate and exchange rate contracts and for other
derivative instruments not addressed in the original Accord. In
addition, the banking agencies believe that the proposed matrix
adequately accommodates a variety of contracts and appropriately
provides a reasonable balance between precision, and complexity and
burden. The agencies, however, have taken into consideration issues
raised by commenters regarding the simulation methods used to arrive at
the conversion factors for other commodities. After additional
simulation analysis, the agencies have concluded that the conversion
factor for other commodity transactions with maturities of one year or
less should be lowered from 12 percent to 10 percent. Any off-balance-
sheet derivative contract not explicitly covered by the expanded matrix
is subject to the add-on conversion factors for other
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commodities. Furthermore, in response to commenters' concerns, the
banking agencies have revised the proposed time band of ``less than one
year'' to ``one year or less'' to maintain consistency with the
existing time bands for remaining maturity.
The proposed matrix included a footnote applicable to equity
contracts that automatically reset market value to zero following a
payment. Under the proposal, the remaining maturity of such contracts
would be the time until the next payment. Several commenters asserted
this treatment should extend to a wider range of contacts. The agencies
have determined that for contracts structured to settle outstanding
exposure to zero following specified payment dates and where the terms
of the contract are reset so that the market value of the contract is
zero on these dates, the remaining maturity may be set equal to the
time until the next reset date. However, the agencies believe that a
long-dated interest rate swap, with, for example, a six-month zero
reset provision, represents a greater risk than an interest rate swap
that terminates after six months. The final rule provides that the
minimum add-on conversion factor for interest rate contacts with
remaining maturities of greater than one year is 0.5 percent.
Under the final rule, which is identical to the proposal in this
regard, gold derivative contracts are accorded the same conversion
factors as exchange rate contracts. However, while exchange rate
contracts with original maturities of fourteen calendar days or less
may be excluded from the risk-based ratio calculation,10 gold
contracts with such original maturities are to be included.
\10\Exchange rate contracts with original maturities of 14
calendar days or less are normally excluded from the risk-based
capital ratio. When such contracts are included in a bilateral
netting arrangement, however, the institution may elect consistently
either to include or exclude all mark-to-market values of those
contracts when determining net current exposure. These contracts
should continue to be excluded when determining potential future
exposure.
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Finally, the agencies note that the conversion factors are to be
regarded as provisional and may be subject to amendment as a result of
changes in the volatility of rates and prices.
Netting and Potential Future Exposure
The final rule adopts, in substantially the same form, the proposed
methodology for reducing potential future exposure for contracts
subject to qualifying bilateral netting arrangements. The agencies have
considered the argument presented by several commenters that the
proposed formula did not give sufficient recognition to reductions in
credit risk resulting from participating in qualifying netting
arrangements. These commenters suggested giving full weight to the NGR
or, alternatively, that it be weighted at 90 percent. The agencies
believe that only partial weight should be given to the NGR as it is
neither a precise, nor a stable indicator of future changes in net
exposure relative to changes in gross exposure. The agencies agree, to
a limited extent, with commenters that a 0.5 averaging factor (referred
to as the policy or P factor) may not sufficiently recognize reductions
in potential future exposure resulting from qualifying bilateral
netting arrangements and have determined that the P factor should be
raised to 0.6. This weight represents an appropriate compromise between
recognizing effects of bilateral netting arrangements in calculating
the add-on and providing a cushion against additional exposure that may
arise as a result of fluctuations in prices or rates. The formula
adopted by the agencies is expressed as:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
The agencies have also considered comments discussing whether the
NGR should be calculated on a counterparty-by-counterparty basis (that
is, an individual NGR for each bilateral netting contract) or on an
aggregate basis for all contracts subject to legally enforceable
netting arrangements. The agencies have determined that an institution
may elect to calculate separate NGRs for each of its bilateral netting
arrangements or an aggregate NGR so long as the method chosen is used
consistently and is subject to examiner review.
Regardless of the method employed by an institution to calculate
its NGR(s), the NGR should be applied separately and individually to
each of the institution's bilateral netting arrangements. If an
institution calculates an NGR for each bilateral netting arrangement,
then it should use a different NGR when determining the potential
future exposure for each bilateral netting arrangement. If an
institution aggregates its net and gross replacement costs across all
bilateral netting contracts to determine a single NGR, then it should
use the same NGR when determining the potential future exposure for
each bilateral netting arrangement.
Institutions with equity, precious metal, and other commodity
contracts included in bilateral netting contracts should now include
those types of transactions when determining the net current exposure
for the bilateral netting contract and when determining potential
future exposure in accordance with this final rule.
The final rule permits, subject to certain conditions, institutions
to take into account qualifying collateral when assigning the credit
equivalent amount of a netting arrangement to the appropriate risk
category in accordance with the procedures and requirements currently
set forth in each agency's risk-based capital standards.
Finally, the agencies note that the methodology for recognizing the
effects of qualifying bilateral netting arrangements is subject to
review and revision as determined to be appropriate.
V. Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, the
agencies do not believe that this final rule will have a significant
impact on a substantial number of small business entities in accord
with the spirit and purposes of the Regulatory Flexibility Act (5
U.S.C. 601 et seq.). In this regard, while some institutions with
limited derivative portfolios may experience an increase in capital
charges, for most of these institutions the final rule will have no
effect. For institutions with more developed derivative portfolios, the
overall effect of the rule will likely be to reduce regulatory burden
and decrease the capital charge for certain derivative 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 final rule will not affect such companies.
VI. Paperwork Reduction Act and Regulatory Burden
The agencies have determined that this final rule will 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.).
Section 302 of the Riegle Community Development and Regulatory
Improvement Act of 1994 (Pub. L. 103-325, 108 Stat. 2160) provides that
the federal banking agencies must consider the administrative burdens
and benefits of any new regulation that imposes additional requirements
on insured depository institutions. As noted above, the rule may result
in higher capital charges for some institutions and lower charges for
others, but any additional paperwork or recordkeeping burden should be
minimal. The rule provides a more accurate measure of risks related to
derivative contracts and the capital required to cover those risks.
[[Page 46174]]
Section 302 also requires such a rule to become effective on the
first day of the calendar quarter following publication of the rule,
unless the agency, for good cause, determines an earlier effective date
is appropriate. Accordingly, the agencies have determined that an
effective date of October 1, 1995 is appropriate.
VII. OCC Executive Order 12866
It has been determined that this final rule is not a significant
regulatory action as defined in Executive Order 12866.
VIII. OCC Unfunded Mandates Act of 1995
Section 202 of the Unfunded Mandates Act of 1995 (Unfunded Mandates
Act) (signed into law on March 22, 1995) requires that certain agencies
prepare a budgetary impact statement before promulgating a rule that
includes a federal mandate that may result in the expenditure by state,
local, and tribal governments, in the aggregate, or by the private
sector, of $100 million or more in any one year. If a budgetary impact
statement is required, section 205 of the Unfunded Mandates Act also
requires the agency to identify and consider a reasonable number of
regulatory alternatives before promulgating a rule. The OCC has
determined that this joint agency final rule will not result in
expenditures by state, local and tribal governments, or by the private
sector, of more than $100 million in any one year. Accordingly, the OCC
has not prepared a budgetary impact statement or specifically addressed
the regulatory alternatives considered.
As discussed in the preamble, this joint agency final rule amends
the risk-based capital guidelines to (1) revise and expand the credit
conversion factors used to calculate the potential future credit
exposure for derivative contracts and long-dated interest rate and
foreign exchange rate contracts and (2) permit banks to net multiple
derivative contracts subject to a qualifying bilateral netting contract
when calculating the potential future credit exposure. While the impact
of this final rule on any particular national bank will depend on the
composition of its derivatives portfolio, the OCC believes that this
final rule generally will have little or no impact on most banks since
most banks have limited derivative portfolios. For those banks with
more developed derivatives portfolios, the OCC believes that the effect
of this final rule will likely be a decrease in the capital
requirements for certain derivative contracts.
List of Subjects
12 CFR Part 3
Administrative practice and procedure, Capital, National banks,
Reporting and recordkeeping requirements, Risk.
12 CFR Part 208
Accounting, Agriculture, Banks, banking, Confidential business
information, Crime, Currency, Federal Reserve System, Flood insurance,
Mortgages, Reporting and recordkeeping requirements, Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Bank deposit insurance, Banks, banking, Capital adequacy, Reporting
and recordkeeping requirements, Savings associations, State nonmember
banks.
Authority and Issuance
OFFICE OF THE COMPTROLLER OF THE CURRENCY
12 CFR CHAPTER I
For the reasons set out in the joint preamble, appendix A to part 3
of title 12, chapter 1 of the Code of Federal Regulations is amended as
set forth below.
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 1835, 3907, and 3909.
2. In appendix A, to part 3, section 1 is revised by redesignating
paragraphs (c)(10) through (c)(30) as paragraphs (c)(11) through
(c)(31) and adding new paragraph (c)(10) to read as follows:
Appendix A to Part 3--Risk-Based Capital Guidelines
Section 1. Purpose, Applicability of Guidelines, and Definitions.
* * * * *
(c) * * *
(10) Derivative contract means generally a financial contract
whose value is derived from the values of one or more underlying
assets, reference rates or indexes of asset values. Derivative
contracts include interest rate, foreign exchange rate, equity,
precious metals and commodity contracts, or any other instrument
that poses similar credit risks.
* * * * *
3. In appendix A, to part 3, section 3 is amended:
a. By revising paragraph (a)(1)(viii);
b. In paragraph (a)(3)(ii) by removing the words ``interest rate
and exchange rate contracts,'' and adding in their place the words
``derivative contracts,''; and
c. In paragraph (b) by revising the introductory text and
paragraph (b)(5).
The revisions read as follows:
* * * * *
Section 3. Risk Categories/Weights for On-Balance Sheet Assets and
Off-Balance Sheet Items.
* * * * *
(a) * * *
(1) * * *
(viii) That portion of assets and off-balance sheet
transactions9a collateralized by cash or securities issued or
directly and unconditionally guaranteed by the United States
Government or its agencies, or the central government of an OECD
country, provided that:9b
\9a\See footnote 22 in section 3(b)(5)(iii) of this appendix A
(collateral held against derivative contracts).
\9b\Assets and off-balance sheet transactions collateralized by
securities issued or guaranteed by the United States Government or
its agencies, or the central government of an OECD country include,
but are not limited to, securities lending transactions, repurchase
agreements, collateralized letters of credit, such as reinsurance
letters of credit, and other similar financial guarantees. Swaps,
forwards, futures, and options transactions are also eligible, if
they meet the collateral requirements. However, the OCC may at its
discretion require that certain collateralized transactions be risk
weighted at 20 percent if they involve more than a minimal risk.
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* * * * *
(b) Off-Balance Sheet Activities. The risk weight assigned to an
off-balance sheet item is determined by a two-step process. First,
the face amount of the off-balance sheet item is multiplied by the
appropriate credit conversion factor specified in this section. This
calculation translates the face amount of an off-balance sheet item
into an on-balance sheet credit equivalent amount. Second, the
resulting credit equivalent amount is then assigned to the proper
risk category using the criteria regarding obligors, guarantors, and
collateral listed in section 3(a) of this appendix A. Collateral and
guarantees are applied to the face amount of an off-balance sheet
item; however, with respect to derivative contracts under section
3(b)(5) of this appendix A, collateral and guarantees are applied to
the credit equivalent amounts of such derivative contracts. The
following are the credit conversion factors and the off-balance
sheet items to which they apply.
* * * * *
(5) Derivative contracts. (i) Calculation of credit equivalent
amounts. The credit equivalent amount of a derivative contract
equals the sum of the current credit exposure and the potential
future credit exposure of the derivative contract. The calculation
of credit equivalent amounts must be measured in U.S. dollars,
regardless of the currency or currencies specified in the derivative
contract.
[[Page 46175]]
(A) Current credit exposure. The current credit exposure for a
single derivative contract is determined by the mark-to-market value
of the derivative contract. If the mark-to-market value is positive,
then the current credit exposure equals that mark-to-market value.
If the mark-to-market is zero or negative, then the current credit
exposure is zero. The current credit exposure for multiple
derivative contracts executed with a single counterparty and subject
to a qualifying bilateral netting contract is determined as provided
by section 3(b)(5)(ii)(A) of this appendix A.
(B) Potential future credit exposure. The potential future
credit exposure for a single derivative contract, including a
derivative contract with negative mark-to-market value, is
calculated by multiplying the notional principal19 of the
derivative contract by one of the credit conversion factors in Table
A--Conversion Factor Matrix of this appendix A, for the appropriate
category.20 The potential future credit exposure for gold
contracts shall be calculated using the foreign exchange rate
conversion factors. For any derivative contract that does not fall
within one of the specified categories in Table A--Conversion Factor
Matrix of this appendix A, the potential future credit exposure
shall be calculated using the other commodity conversion factors.
Subject to examiner review, banks should use the effective rather
than the apparent or stated notional amount in calculating the
potential future credit exposure. The potential future credit
exposure for multiple derivatives contracts executed with a single
counterparty and subject to a qualifying bilateral netting contract
is determined as provided by section 3(b)(5)(ii)(A) of this appendix
A.
\19\For purposes of calculating either the potential future
credit exposure under section 3(b)(5)(i)(B) of this appendix A or
the gross potential future credit exposure under section
3(b)(5)(ii)(A)(2) of this appendix A for foreign exchange contracts
and other similar contracts in which the notional principal is
equivalent to the cash flows, total notional principal is the net
receipts to each party falling due on each value date in each
currency.
\20\No potential future credit exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating indices, so-called floating/floating or basis swaps;
the credit equivalent amount is measured solely on the basis of the
current credit exposure.
Table A--Conversion Factor Matrix\1\
----------------------------------------------------------------------------------------------------------------
Foreign
Interest exchange Precious Other
Remaining maturity\2\ rate rate and Equity\2\ metals commodity
gold
----------------------------------------------------------------------------------------------------------------
One year or less.............................. 0.0 1.0 6.0 7.0 10.0
Over one to five years......................... 0.5 5.0 8.0 7.0 12.0
Over five years................................ 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
\1\For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
number of remaining payments in the derivative contract.
\2\For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
than one year shall be subject to a minimum conversion factor of 0.5 percent.
(ii) Derivative contracts subject to a qualifying bilateral
netting contract. (A) Netting calculation. The credit equivalent
amount for multiple derivative contracts executed with a single
counterparty and subject to a qualifying bilateral netting contract
as provided by section (3)(b)(5)(ii)(B) of this appendix A is
calculated by adding the net current credit exposure and the
adjusted sum of the potential future credit exposure for all
derivative contracts subject to the qualifying bilateral netting
contract.
(1) Net current credit exposure. The net current credit exposure
is the net sum of all positive and negative mark-to-market values of
the individual derivative contracts subject to a qualifying
bilateral netting contract. If the net sum of the mark-to-market
value is positive, then the net current credit exposure equals that
net sum of the mark-to-market value. If the net sum of the mark-to-
market value is zero or negative, then the net current credit
exposure is zero.
(2) Adjusted sum of the potential future credit exposure. The
adjusted sum of the potential future credit exposure is calculated as:
Anet=0.4 x Agross+(0.6 x NGR x Agross)
Anet is the adjusted sum of the potential future credit
exposure, Agross is the gross potential future credit exposure,
and NGR is the net to gross ratio. Agross is the sum of the
potential future credit exposure (as determined under section
3(b)(5)(i)(B) of this appendix A) for each individual derivative
contract subject to the qualifying bilateral netting contract. The
NGR is the ratio of the net current credit exposure to the gross
current credit exposure. In calculating the NGR, the gross current
credit exposure equals the sum of the positive current credit
exposures (as determined under section 3(b)(5)(i)(A) of this
appendix A) of all individual derivative contracts subject to the
qualifying bilateral netting contract.
(B) Qualifying bilateral netting contract. In determining the
current credit exposure for multiple derivative contracts executed
with a single counterparty, a bank may net derivative contracts
subject to a qualifying bilateral netting contract by offsetting
positive and negative mark-to-market values, provided that:
(1) The qualifying bilateral netting contract is in writing.
(2) The qualifying bilateral netting contract is not subject to
a walkaway clause.
(3) The qualifying bilateral netting contract creates a single
legal obligation for all individual derivative contracts covered by
the qualifying bilateral netting contract. In effect, the qualifying
bilateral netting contract must provide that the bank would have a
single claim or obligation either to receive or to pay only the net
amount of the sum of the positive and negative mark-to-market values
on the individual derivative contracts covered by the qualifying
bilateral netting contract. The single legal obligation for the net
amount is operative in the event that a counterparty, or a
counterparty to whom the qualifying bilateral netting contract has
been assigned, fails to perform due to any of the following events:
default, insolvency, bankruptcy, or other similar circumstances.
(4) The bank obtains a written and reasoned legal opinion(s)
that represents, with a high degree of certainty, that in the event
of a legal challenge, including one resulting from default,
insolvency, bankruptcy, or similar circumstances, the relevant court
and administrative authorities would find the bank's exposure to be
the 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 of the jurisdiction that governs the individual
derivative contracts covered by the bilateral netting contract; and
(iii) The law of the jurisdiction that governs the qualifying
bilateral netting contract.
(5) The bank establishes and maintains procedures to monitor
possible changes in relevant law and to ensure that the qualifying
bilateral netting contract continues to satisfy the requirement of
this section.
(6) The bank maintains in its files documentation adequate to
support the netting of a derivative contract.\21\
\21\By netting individual derivative contracts for the purpose
of calculating its credit equivalent amount, a bank represents that
documentation adequate to support the netting of a set of derivative
contract is in the bank's files and available for inspection by the
OCC. Upon determination by the OCC that a bank's files are
inadequate or that a qualifying bilateral netting contract may not
be legally enforceable in any one of the bodies of law described in
section 3(b)(5)(ii)(B)(3)(i) through (iii) of this appendix A, the
underlying derivative contracts may not be netted for the purposes
of this section.
[[Page 46176]]
---------------------------------------------------------------------------
(iii) Risk weighting. Once the bank determines the credit
equivalent amount for a derivative contract or a set of derivative
contracts subject to a qualifying bilateral netting contract, the
bank assigns that amount to the risk weight category appropriate to
the counterparty, or, if relevant, the nature of any collateral or
guarantee.\22\ However, the maximum weight that will be applied to
the credit equivalent amount of such derivative contract(s) is 50
percent.
\22\Derivative contracts are an exception to the general rule of
applying collateral and guarantees to the face value of off-balance
sheet items. The sufficiency of collateral and guarantees is
determined on the basis of the credit equivalent amount of
derivative contracts. However, collateral and guarantees held
against a qualifying bilateral netting contract is not recognized
for capital purposes unless it is legally available for all
contracts included in the qualifying bilateral netting contract.
---------------------------------------------------------------------------
(iv) Exceptions. The following derivative contracts are not
subject to the above calculation, and therefore, are not part of the
denominator of a national bank's risk-based capital ratio:
(A) An exchange rate contract with an original maturity of 14
calendar days or less;\23\ and
\23\Notwithstanding section 3(b)(5)(B) of this appendix A, gold
contracts do not qualify for this exception.
---------------------------------------------------------------------------
(B) A derivative contract that is traded on an exchange
requiring the daily payment of any variations in the market value of
the contract.
* * * * *
4. Table 3, at the end of appendix A, is revised to read as
follows:
* * * * *
Table 3--Treatment of Derivative Contracts
1. The current exposure method is used to calculate the credit
equivalent amounts of derivative contracts. These amounts are
assigned a risk weight appropriate to the obligor or any collateral
or guarantee. However, the maximum risk weight is limited to 50
percent. Multiple derivative contracts with a single counterparty
may be netted if those contracts are subject to a qualifying
bilateral netting contract.
Conversion Factor Matrix\1\
[Percent]
----------------------------------------------------------------------------------------------------------------
Foreign
Interest exchange Precious Other
Remaining maturity\2\ rate rate and Equity\2\ metals commodity
gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 7.0 10.0
Over one to five years......................... 0.5 5.0 8.0 7.0 12.0
Over five years................................ 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
\1\For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
number of remaining payments in the derivative contract.
\2\For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
than one year shall be subject to a minimum conversion factor of 0.5 percent.
2. The following derivative contracts will be excluded:
a. Exchange rate contract with an original maturity of 14
calendar days or less; and
b. Derivative contract traded on exchanges and subject to daily
margin requirements.
Dated: August 24, 1995.
Eugene A. Ludwig,
Comptroller of the Currency.
FEDERAL RESERVE SYSTEM
12 CFR CHAPTER II
For the reasons set out in the joint preamble, the Board of
Governors of the Federal Reserve System amends 12 CFR parts 208 and 225
as set forth below.
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 continues 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; 42 U.S.C.
4012a, 4104a, 4104b.
2. In part 208, appendix A is amended by revising the last
paragraph of 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 * * *
\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.
---------------------------------------------------------------------------
* * * * *
3. In part 208, appendix A is amended by revising the section
III.E. heading and section III.E. to read as follows:
* * * * *
III. * * *
E. Derivative Contracts (Interest Rate, Exchange Rate,
Commodity-- (including precious metals) and Equity-Linked Contracts)
1. Scope. Credit equivalent amounts are computed for each of the
following off-balance-sheet derivative contracts:
a. Interest Rate Contracts. These include single currency
interest rate swaps, basis swaps, forward rate agreements, interest
rate options purchased (including caps, collars, and floors
purchased), and any other instrument linked to interest rates that
gives rise to similar credit risks (including when-issued securities
and forward forward deposits accepted).
b. Exchange Rate Contracts. These include cross-currency
interest rate swaps, forward foreign exchange contracts, currency
options purchased, and any other instrument linked to exchange rates
that gives rise to similar credit risks.
c. Equity Derivative Contracts. These include equity-linked
swaps, equity-linked options purchased, forward equity-linked
contracts, and any other instrument linked to equities that gives
rise to similar credit risks.
d. Commodity (including precious metal) Derivative Contracts.
These include commodity-linked swaps, commodity-linked options
purchased, forward commodity-linked contracts, and any other
instrument
[[Page 46177]]
linked to commodities that gives rise to similar credit risks.
e. Exceptions. Exchange rate contracts with an original maturity
of fourteen or fewer calendar days and derivative contracts traded
on exchanges that require daily receipt and payment of cash
variation margin may be excluded from the risk-based ratio
calculation. Gold contracts are accorded the same treatment as
exchange rate contracts except that gold contracts with an original
maturity of fourteen or fewer calendar days are included in the
risk-based ratio calculation. Over-the-counter options purchased are
included and treated in the same way as other derivative contracts.
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 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 underlying rates, prices, and indices, as well as
counterparty credit quality.
c. The potential future credit exposure of a contract, including
a contract with a negative mark-to-market value, is estimated by
multiplying the notional principal amount of the contract by a
credit conversion factor. Banks should use, subject to examiner
review, the effective rather than the apparent or stated notional
amount in this calculation. The credit conversion factors are:
Conversion Factors
[In percent]
----------------------------------------------------------------------------------------------------------------
Commodity,
Interest Exchange excluding Precious
Remaining maturity rate rate and Equity precious metals,
gold metals except gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 10.0 7.0
Over one to five years......................... 0.5 5.0 8.0 12.0 7.0
Over five years................................ 1.5 7.5 10.0 15.0 8.0
----------------------------------------------------------------------------------------------------------------
d. For a contract that is structured such that on specified
dates any outstanding exposure is settled and the terms are reset so
that the market value of the contract is zero, the remaining
maturity is equal to the time until the next reset date. For an
interest rate contract with a remaining maturity of more than one
year that meets these criteria, the minimum conversion factor is 0.5
percent.
e. For a contract with multiple exchanges of principal, the
conversion factor is multiplied by the number of remaining payments
in the contract. A derivative contract not included in the
definitions of interest rate, exchange rate, equity, or commodity
contracts as set forth in section III.E.1. of this appendix A, is
subject to the same conversion factors as a commodity, excluding
precious metals.
f. No potential future exposure is calculated for a single
currency interest rate swap in which payments are made based upon
two floating rate indices (a so called floating/floating or basis
swap); the credit exposure on such a contract is evaluated solely on
the basis of the mark-to-market value.
g. 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:
i. 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 to receive, or obligation to pay, 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,
liquidation, or similar circumstances.
ii. 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 the net amount under:
1. 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;
2. The law that governs the individual contracts covered by the
netting contract; and
3. The law that governs the netting contract.
iii. 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.
iv. The bank maintains in its files documentation adequate to
support the netting of derivative 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
\49\A walkaway clause is 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 the defaulter or
the estate of the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------
c. A bank netting individual contracts for the purpose of
calculating credit equivalent amounts of derivative contracts,
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. The Federal Reserve may
determine that a bank's files are inadequate or that a netting
contract, or any of its underlying individual contracts, may not be
legally enforceable under any one of the bodies of law described in
section III.E.3.a.ii. of this appendix A. If such a determination is
made, the netting contract may be disqualified from recognition for
risk-based capital purposes or underlying individual contracts may
be treated as though they are not subject to the netting contract.
d. The credit equivalent amount of contracts that are subject to
a qualifying bilateral netting contract is calculated by adding (i)
the current exposure of the netting contract (net current exposure)
and (ii) the sum of the estimates of potential future credit
exposures on all individual contracts subject to the netting
contract (gross potential future exposure) adjusted to reflect the
effects of the netting contract.50
\50\For purposes of calculating potential future credit exposure
to a netting counterparty 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
falling due on each value date in each currency.
e. The net current exposure is the sum of all positive and
negative mark-to-market values of the individual contracts included
in 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
[[Page 46178]]
exposure is zero. The Federal Reserve may determine that a netting
contract qualifies for risk-based capital netting treatment even
though certain individual contracts included under the netting
contract may not qualify. In such instances, the nonqualifying
contracts should be treated as individual contracts that are not
subject to the netting contract.
f. 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.
g. The effects of the bilateral netting contract on the gross
potential future exposure are recognized through the application of
a formula that results in an adjusted add-on amount (Anet). The
formula, which employs the ratio of net current exposure to gross
current exposure (NGR) is expressed as:
Anet = (0.4 x Agross) + 0.6(NGR x Agross)
h. The NGR may be calculated in accordance with either the
counterparty-by-counterparty approach or the aggregate approach.
i. Under the counterparty-by-counterparty approach, the NGR is
the ratio of the net current exposure for a 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. Net negative mark-to-
market values for individual netting contracts with the same
counterparty may not be used to offset net positive mark-to-market
values for other netting contracts with that counterparty.
ii. Under the aggregate approach, the NGR is the ratio of the
sum of all of the net current exposures for qualifying bilateral
netting contracts to the sum of all of the gross current exposures
for those netting contracts (each gross current exposure is
calculated in the same manner as in section III.E.3.h.i. of this
appendix A). Net negative mark-to-market values for individual
counterparties may not be used to offset net positive mark-to-market
values for other counterparties.
iii. A bank must consistently use either the counterparty-by-
counterparty approach or the aggregate approach to calculate the
NGR. Regardless of the approach used, the NGR should be applied
individually to each qualifying bilateral netting contract to
determine the adjusted add-on for that netting contract.
i. In the event a netting contract covers contracts that are
normally excluded from the risk-based ratio calculation--for
example, exchange rate contracts with an original maturity of
fourteen or fewer calendar days or instruments traded on exchanges
that require daily payment and receipt of cash variation margin--a
bank may elect to either include or exclude all mark-to-market
values of such contracts when determining net current exposure,
provided the method chosen is applied consistently.
4. Risk Weights. Once the credit equivalent amount for a
derivative contract, or a group of derivative contracts subject to a
qualifying bilateral netting contract, has been determined, that
amount is assigned to the risk category appropriate to the
counterparty, or, if relevant, the guarantor or the nature of any
collateral.51 However, the maximum risk weight applicable to
the credit equivalent amount of such contracts is 50 percent.
\51\For 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.
---------------------------------------------------------------------------
5. Avoidance of double counting. a. In certain cases, credit
exposures arising from the derivative contracts covered by section
III.E. of this appendix A 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
derivative instruments covered by these guidelines may need to be
excluded from balance sheet assets in calculating a bank's risk-
based capital ratios.
b. Examples of the calculation of credit equivalent amounts for
contracts covered under this section III.E. are contained in
Attachment V of this appendix A.
* * * * *
4. In appendix A to part 208, Attachments IV and V are revised to
read as follows:
* * * * *
Attachment IV--Credit Conversion Factors for Off-Balance-Sheet Items
for State Member Banks
100 Percent Conversion Factor
1. Direct credit substitutes. (These include general guarantees
of indebtedness and all guarantee-type instruments, including
standby letters of credit backing the financial obligations of other
parties.)
2. Risk participations in bankers acceptances and direct credit
substitutes, such as standby letters of credit.
3. Sale and repurchase agreements and assets sold with recourse
that are not included on the balance sheet.
4. Forward agreements to purchase assets, including financing
facilities, on which drawdown is certain.
5. Securities lent for which the bank is at risk.
50 Percent Conversion Factor
1. Transaction-related contingencies. (These include bid-bonds,
performance bonds, warranties, and standby letters of credit backing
the nonfinancial performance of other parties.)
2. Unused portions of commitments with an original maturity
exceeding one year, including underwriting commitments and
commercial credit lines.
3. Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs), and similar arrangements.
20 Percent Conversion Factor
Short-term, self-liquidating trade-related contingencies,
including commercial letters of credit.
Zero Percent Conversion Factor
Unused portions of commitments with an original maturity of one
year or less, or which are unconditionally cancellable at any time,
provided a separate credit decision is made before each drawing.
Credit Conversion for Derivative Contracts
1. The credit equivalent amount of a derivative contract is the
sum of the current credit exposure of the contract and an estimate
of potential future increases in credit exposure. The current
exposure is the positive mark-to-market value of the contract (or
zero if the mark-to-market value is zero or negative). For
derivative contracts that are subject to a qualifying bilateral
netting contract, the current exposure is, generally, the net sum of
the positive and negative mark-to-market values of the contracts
included in the netting contract (or zero if the net sum of the
mark-to-market values is zero or negative). The potential future
exposure is calculated by multiplying the effective notional amount
of a contract by one of the following credit conversion factors, as
appropriate:
Conversion Factors
[In percent]
----------------------------------------------------------------------------------------------------------------
Commodity,
Interest Exchange excluding Precious
Remaining maturity rate rate and Equity precious metals,
gold metals except gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 10.0 7.0
Over one to five years......................... 0.5 5.0 8.0 12.0 7.0
Over five years................................ 1.5 7.5 10.0 15.0 8.0
----------------------------------------------------------------------------------------------------------------
[[Page 46179]]
For contracts subject to a qualifying bilateral netting
contract, the potential future exposure is, generally, the sum of
the individual potential future exposures for each contract included
under the netting contract adjusted by the application of the
following formula:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
NGR is the ratio of net current exposure to gross current
exposure.
2. No potential future exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating indices, that is, so called floating/floating or basis
swaps. The credit exposure on these contracts is evaluated solely on
the basis of their mark-to-market value. Exchange rate contracts
with an original maturity of fourteen days or fewer are excluded.
Instruments traded on exchanges that require daily receipt and
payment of cash variation margin are also excluded.
Attachment V--Calculating Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Notional Potential Current Credit
Type of contract principal Conversion exposure Mark-to- exposure equivalent
amount factor (dollars) market (dollars) amount
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward foreign
exchange......................... 5,000,000 0.01 50,000 100,000 100,000 150,000
(2) 4-year forward foreign
exchange......................... 6,000,000 0.05 300,000 -120,000 0 300,000
(3) 3-year single-currency fixed &
floating interest rate swap...... 10,000,000 0.005 50,000 200,000 200,000 250,000
(4) 6-month oil swap.............. 10,000,000 0.10 1,000,000 -250,000 0 1,000,000
(5) 7-year cross-currency floating
& floating interest rate swap.... 20,000,000 0.075 1,500,000 -1,500,000 0 1,500,000
Total....................... ........... ........... 2,900,000 + 300,000 3,200,000
----------------------------------------------------------------------------------------------------------------
a. If contracts (1) through (5) above are subject to a
qualifying bilateral netting contract, then the following applies:
------------------------------------------------------------------------
Potential Credit
Contract future Net current equivalent
exposure exposure amount
------------------------------------------------------------------------
(1).............................. 50,000 ........... ...........
(2).............................. 300,000 ........... ...........
(3).............................. 50,000 ........... ...........
(4).............................. 1,000,000 ........... ...........
(5).............................. 1,500,000 ........... ...........
Total...................... 2,900,000 +0 2,900,000
------------------------------------------------------------------------
Note: The total of the mark-to-market values from the first table is -
$1,370,000. Since this is a negative amount, the net current exposure
is zero.
b. To recognize the effects of bilateral netting on potential
future exposure the following formula applies:
Anet=(.4 x Agross)+.6(NGR x Agross)
c. In the above example where the net current exposure is zero,
the credit equivalent amount would be calculated as follows:
NGR=0=(0/300,000)
Anet=(0.4 x $2,900,000)+0.6 (0 x $2,900,000)
Anet=$1,160,000
The credit equivalent amount is $1,160,000+0=$1,160,000.
d. If the net current exposure was a positive number, for
example $200,000, the credit equivalent amount would be calculated
as follows:
NGR=.67=($200,000/$300,000)
Anet=(0.4 x $2,900,000)+0.6(.67 x $2,900,000)
Anet=$2,325,800.
The credit equivalent amount would be
$2,325,800+$200,000=$2,525,800.
* * * * *
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, 1828(o), 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
2. In part 225, appendix A is amended by revising the last
paragraph of 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. In part 225, appendix A is amended by revising the section
III.E. heading and section III.E. to read as follows:
* * * * *
III. * * *
E. Derivative Contracts (Interest Rate, Exchange Rate,
Commodity- (including
[[Page 46180]]
precious metals) and Equity-Linked Contracts)
1. Scope. Credit equivalent amounts are computed for each of the
following off-balance-sheet derivative contracts:
a. Interest Rate Contracts. These include single currency
interest rate swaps, basis swaps, forward rate agreements, interest
rate options purchased (including caps, collars, and floors
purchased), and any other instrument linked to interest rates that
gives rise to similar credit risks (including when-issued securities
and forward forward deposits accepted).
b. Exchange Rate Contracts. These include cross-currency
interest rate swaps, forward foreign exchange contracts, currency
options purchased, and any other instrument linked to exchange rates
that gives rise to similar credit risks.
c. Equity Derivative Contracts. These include equity-linked
swaps, equity-linked options purchased, forward equity-linked
contracts, and any other instrument linked to equities that gives
rise to similar credit risks.
d. Commodity (including precious metal) Derivative Contracts.
These include commodity-linked swaps, commodity-linked options
purchased, forward commodity-linked contracts, and any other
instrument linked to commodities that gives rise to similar credit
risks.
e. Exceptions. Exchange rate contracts with an original maturity
of fourteen or fewer calendar days and derivative contracts traded
on exchanges that require daily receipt and payment of cash
variation margin may be excluded from the risk-based ratio
calculation. Gold contracts are accorded the same treatment as
exchange rate contracts except that gold contracts with an original
maturity of fourteen or fewer calendar days are included in the
risk-based ratio calculation. Over-the-counter options purchased are
included and treated in the same way as other derivative contracts.
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 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 underlying rates, prices, and indices, as well as
counterparty credit quality.
c. The potential future credit exposure of a contract, including
a contract with a negative mark-to-market value, is estimated by
multiplying the notional principal amount of the contract by a
credit conversion factor. Banking organizations should use, subject
to examiner review, the effective rather than the apparent or stated
notional amount in this calculation. The credit conversion factors
are:
Conversion Factors
[In percent]
----------------------------------------------------------------------------------------------------------------
Commodity,
Interest Exchange excluding Precious
Remaining maturity rate rate and Equity precious metals,
gold metals except gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 10.0 7.0
Over one to five years......................... 0.5 5.0 8.0 12.0 7.0
Over five years................................ 1.5 7.5 10.0 15.0 8.0
----------------------------------------------------------------------------------------------------------------
d. For a contract that is structured such that on specified
dates any outstanding exposure is settled and the terms are reset so
that the market value of the contract is zero, the remaining
maturity is equal to the time until the next reset date. For an
interest rate contract with a remaining maturity of more than one
year that meets these criteria, the minimum conversion factor is 0.5
percent.
e. For a contract with multiple exchanges of principal, the
conversion factor is multiplied by the number of remaining payments
in the contract. A derivative contract not included in the
definitions of interest rate, exchange rate, equity, or commodity
contracts as set forth in section III.E.1. of this appendix A is
subject to the same conversion factors as a commodity, excluding
precious metals.
f. No potential future exposure is calculated for a single
currency interest rate swap in which payments are made based upon
two floating rate indices (a so called floating/floating or basis
swap); the credit exposure on such a contract is evaluated solely on
the basis of the mark-to-market value.
g. 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:
i. 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 banking organization
would have a claim to receive, or obligation to pay, 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, liquidation, or similar circumstances.
ii. 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 banking organization's
exposure to be the net amount under:
1. 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;
2. The law that governs the individual contracts covered by the
netting contract; and
3. The law that governs the netting contract.
iii. 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.
iv. The banking organization maintains in its files
documentation adequate to support the netting of derivative
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
\53\A walkaway clause is 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 the defaulter or
the estate of the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------
c. A banking organization netting individual contracts for the
purpose of calculating credit equivalent amounts of derivative
contracts represents that it has met the requirements of this
appendix A and all the appropriate documents are in the banking
organization's files and available for inspection by the Federal
Reserve. The Federal Reserve may determine that a
[[Page 46181]]
banking organization's files are inadequate or that a netting contract,
or any of its underlying individual contracts, may not be legally
enforceable under any one of the bodies of law described in section
III.E.3.a.ii. of this appendix A. If such a determination is made,
the netting contract may be disqualified from recognition for risk-
based capital purposes or underlying individual contracts may be
treated as though they are not subject to the netting contract.
d. The credit equivalent amount of contracts that are subject to
a qualifying bilateral netting contract is calculated by adding (i)
the current exposure of the netting contract (net current exposure)
and (ii) the sum of the estimates of potential future credit
exposures on all individual contracts subject to the netting
contract (gross potential future exposure) adjusted to reflect the
effects of the netting contract.54
\54\For purposes of calculating potential future credit exposure
to a netting counterparty 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
falling due on each value date in each currency.
---------------------------------------------------------------------------
e. The net current exposure is the sum of all positive and
negative mark-to-market values of the individual contracts included
in 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. The Federal Reserve may determine
that a netting contract qualifies for risk-based capital netting
treatment even though certain individual contracts included under
the netting contract may not qualify. In such instances, the
nonqualifying contracts should be treated as individual contracts
that are not subject to the netting contract.
f. 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.
g. The effects of the bilateral netting contract on the gross
potential future exposure are recognized through the application of
a formula that results in an adjusted add-on amount (Anet). The
formula, which employs the ratio of net current exposure to gross
current exposure (NGR), is expressed as:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
h. The NGR may be calculated in accordance with either the
counterparty-by-counterparty approach or the aggregate approach.
i. Under the counterparty-by-counterparty approach, the NGR is
the ratio of the net current exposure for a 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. Net negative mark-to-
market values for individual netting contracts with the same
counterparty may not be used to offset net positive mark-to-market
values for other netting contracts with the same counterparty.
ii. Under the aggregate approach, the NGR is the ratio of the
sum of all of the net current exposures for qualifying bilateral
netting contracts to the sum of all of the gross current exposures
for those netting contracts (each gross current exposure is
calculated in the same manner as in section III.E.3.h.i. of this
appendix A). Net negative mark-to-market values for individual
counterparties may not be used to offset net positive current
exposures for other counterparties.
iii. A banking organization must use consistently either the
counterparty-by-counterparty approach or the aggregate approach to
calculate the NGR. Regardless of the approach used, the NGR should
be applied individually to each qualifying bilateral netting
contract to determine the adjusted add-on for that netting contract.
i. In the event a netting contract covers contracts that are
normally excluded from the risk-based ratio calculation--for
example, exchange rate contracts with an original maturity of
fourteen or fewer calendar days or instruments traded on exchanges
that require daily payment and receipt of cash variation margin--an
institution may elect to either include or exclude all mark-to-
market values of such contracts when determining net current
exposure, provided the method chosen is applied consistently.
4. Risk Weights. Once the credit equivalent amount for a
derivative contract, or a group of derivative contracts subject to a
qualifying bilateral netting contract, has been determined, that
amount is assigned to the risk category appropriate to the
counterparty, or, if relevant, the guarantor or the nature of any
collateral.55 However, the maximum risk weight applicable to
the credit equivalent amount of such contracts is 50 percent.
\55\For 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.
---------------------------------------------------------------------------
5. Avoidance of double counting. a. In certain cases, credit
exposures arising from the derivative contracts covered by section
III.E. of this appendix A 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
derivative instruments covered by these guidelines may need to be
excluded from balance sheet assets in calculating a banking
organization's risk-based capital ratios.
b. Examples of the calculation of credit equivalent amounts for
contracts covered under this section III.E. are contained in
Attachment V of this appendix A.
* * * * *
4. In appendix A to part 225, Attachments IV and V are revised to
read as follows:
* * * * *
Attachment IV--Credit Conversion Factors for Off-Balance-Sheet Items
for Bank Holding Companies
100 Percent Conversion Factor
1. Direct credit substitutes. (These include general guarantees
of indebtedness and all guarantee-type instruments, including
standby letters of credit backing the financial obligations of other
parties.)
2. Risk participations in bankers acceptances and direct credit
substitutes, such as standby letters of credit.
3. Sale and repurchase agreements and assets sold with recourse
that are not included on the balance sheet.
4. Forward agreements to purchase assets, including financing
facilities, on which drawdown is certain.
5. Securities lent for which the banking organization is at
risk.
50 Percent Conversion Factor
1. Transaction-related contingencies. (These include bid-bonds,
performance bonds, warranties, and standby letters of credit backing
the nonfinancial performance of other parties.)
2. Unused portions of commitments with an original maturity
exceeding one year, including underwriting commitments and
commercial credit lines.
3. Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs), and similar arrangements.
20 Percent Conversion Factor
Short-term, self-liquidating trade-related contingencies,
including commercial letters of credit.
Zero Percent Conversion Factor
Unused portions of commitments with an original maturity of one
year or less, or which are unconditionally cancellable at any time,
provided a separate credit decision is made before each drawing.
Credit Conversion for Derivative Contracts
1. The credit equivalent amount of a derivative contract is the
sum of the current credit exposure of the contract and an estimate
of potential future increases in credit exposure. The current
exposure is the positive mark-to-market value of the contract (or
zero if the mark-to-market value is zero or negative). For
derivative contracts that are subject to a qualifying bilateral
netting contract, the current exposure is, generally, the net sum of
the positive and negative mark-to-market values of the contracts
included in the netting contract (or zero if the net sum of the
mark-to-market values is zero or negative). The potential future
exposure is calculated by multiplying the effective notional amount
of a contract by one of the following credit conversion factors, as
appropriate:
[[Page 46182]]
Conversion Factors
[In percent]
----------------------------------------------------------------------------------------------------------------
Commodity,
Interest Exchange excluding Precious
Remaining maturity rate rate and Equity precious metals,
gold metals except gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 10.0 7.0
Over one to five years......................... 0.5 5.0 8.0 12.0 7.0
Over five years................................ 1.5 7.5 10.0 15.0 8.0
----------------------------------------------------------------------------------------------------------------
For contracts subject to a qualifying bilateral netting
contract, the potential future exposure is, generally, the sum of
the individual potential future exposures for each contract included
under the netting contract adjusted by the application of the
following formula:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
NGR is the ratio of net current exposure to gross current
exposure.
2. No potential future exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating indices, that is, so called floating/floating or basis
swaps. The credit exposure on these contracts is evaluated solely on
the basis of their mark-to-market value. Exchange rate contracts
with an original maturity of fourteen or fewer days are excluded.
Instruments traded on exchanges that require daily receipt and
payment of cash variation margin are also excluded.
Attachment V--Calculating Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Notional Potential Current Credit
Type of Contract principal Conversion exposure Mark-to- exposure equivalent
amount factor (dollars) market (dollars) amount
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward foreign
exchange......................... 5,000,000 .01 50,000 100,000 100,000 150,000
(2) 4-year forward foreign
exchange......................... 6,000,000 .05 300,000 -120,000 0 300,000
(3) 3-year single-currency fixed &
floating interest rate swap...... 10,000,000 .005 50,000 200,000 200,000 250,000
(4) 6-month oil swap.............. 10,000,000 .10 1,000,000 -250,000 0 1,000,000
(5) 7-year cross-currency floating
& floating interest rate swap.... 20,000,000 .075 1,500,000 -1,500,000 0 1,500,000
Total....................... ........... ........... 2,900,000 + 300,000 3,200,000
----------------------------------------------------------------------------------------------------------------
a. If contracts (1) through (5) above are subject to a
qualifying bilateral netting contract, then the following applies:
------------------------------------------------------------------------
Potential Credit
Contract future Net current equivalent
exposure exposure amount
------------------------------------------------------------------------
(1).............................. 50,000 ........... ...........
(2).............................. 300,000 ........... ...........
(3).............................. 50,000 ........... ...........
(4).............................. 1,000,000 ........... ...........
(5).............................. 1,500,000 ........... ...........
Total...................... 2,900,000 +0 2,900,000
------------------------------------------------------------------------
Note: The total of the mark-to-market values from the first table is-
$1,370,000. Since this is a negative amount the net current exposure
is zero.
b. To recognize the effects of bilateral netting on potential
future exposure the following formula applies:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
c. In the above example, where the net current exposure is zero,
the credit equivalent amount would be calculated as follows:
NGR=0=(0/300,000)
Anet=(0.4 x $2,900,000)+.6(0 x $2,900,000)
Anet=$1,160,000
The credit equivalent amount is $1,160,000+0=$1,160,000.
d. If the net current exposure was a positive number, for
example $200,000, the credit equivalent would be calculated as
follows:
NGR=.67=($200,000/$300,000)
Anet=(0.4 x $2,900,000)+0.6(.67 x $2,900,000)
Anet=$2,325,800
The credit equivalent amount would be
$2,325,800+$200,000=$2,525,800.
* * * * *
By order of the Board of Governors of the Federal Reserve
System, August 25, 1995.
Jennifer J. Johnson,
Deputy Secretary of the Board.
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR CHAPTER III
For the reasons set forth in the joint preamble, the Board of
Directors of the FDIC amends 12 CFR part 325 as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 continues to read as
follows:
Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(I), 1828(n),
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat.
1761, 1789, 1790 (12 U.S.C. 1831n note) Pub. L. 102-242, 105 Stat.
2236, 2355, 2386 (12 U.S.C. 1828 note).
2. In appendix A to part 325, section II is amended by:
a. Revising the last sentence in section II.C. Category 3;
b. Redesignating footnotes 35 through 38 as footnotes 36 through
39;
c. Adding new footnote 35 at the end of the introductory text of
section II.D.; and
d. Revising section II.E. to read as follows:
[[Page 46183]]
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
* * * * *
II. * * *
C. * * *
Category 3 * * * In addition, the credit equivalent amount of
derivative contracts that do not qualify for a lower risk weight are
assigned to the 50 percent risk category.
* * * * *
D. * * *35 * * *
\35\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 II.B. of this appendix A.
---------------------------------------------------------------------------
* * * * *
E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity
(including precious metal) and Equity Derivative Contracts)
1. Credit equivalent amounts are computed for each of the
following off-balance-sheet derivative contracts:
(a) Interest Rate Contracts
(i) Single currency interest rate swaps.
(ii) Basis swaps.
(iii) Forward rate agreements.
(iv) Interest rate options purchased (including caps, collars,
and floors purchased).
(v) Any other instrument linked to interest rates that gives
rise to similar credit risks (including when-issued securities and
forward deposits accepted).
(b) Exchange Rate Contracts
(i) Cross-currency interest rate swaps.
(ii) Forward foreign exchange contracts.
(iii) Currency options purchased.
(iv) Any other instrument linked to exchange rates that gives
rise to similar credit risks.
(c) Commodity (including precious metal) or Equity Derivative
Contracts
(i) Commodity- or equity-linked swaps.
(ii) Commodity- or equity-linked options purchased.
(iii) Forward commodity- or equity-linked contracts.
(iv) Any other instrument linked to commodities or equities that
gives rise to similar credit risks.
2. Exchange rate contracts with an original maturity of 14
calendar days or less and derivative contracts traded on exchanges
that require daily receipt and payment of cash variation margin may
be excluded from the risk-based ratio calculation. Gold contracts
are accorded the same treatment as exchange rate contracts except
gold contracts with an original maturity of 14 calendar days or less
are included in the risk-based calculation. Over-the-counter options
purchased are included and treated in the same way as other
derivative contracts.
3. Credit Equivalent Amounts for Derivative Contracts. (a) The
credit equivalent amount of a derivative contract that is not
subject to a qualifying bilateral netting contract in accordance
with section II.E.5. of this appendix A is equal to the sum of:
(i) The current exposure (which is equal to the mark-to-market
value,40 if positive, and is sometimes referred to as the
replacement cost) of the contract; and
\40\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.
---------------------------------------------------------------------------
(ii) An estimate of the potential future credit exposure.
(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.
(c) The potential future credit exposure of a contract,
including a contract with a negative mark-to-market value, is
estimated by multiplying the notional principal amount of the
contract by a credit conversion factor. Banks should, subject to
examiner review, use the effective rather than the apparent or
stated notional amount in this calculation. The credit conversion
factors are:
Conversion Factor Matrix
----------------------------------------------------------------------------------------------------------------
Exchange Precious
Remaining maturity Interest rate and Equity metals, Other
rate gold except gold commodities
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0% 1.0% 6.0% 7.0% 10.0%
More than one year to five years............... 0.5% 5.0% 8.0% 7.0% 12.0%
More than five years........................... 1.5% 7.5% 10.0% 8.0% 15.0%
----------------------------------------------------------------------------------------------------------------
(d) For contracts that are structured to settle outstanding
exposure on specified dates and where the terms are reset such that
the market value of the contract is zero on these specified dates,
the remaining maturity is equal to the time until the next reset
date. For interest rate contracts with remaining maturities of more
than one year and that meet these criteria, the conversion factor is
subject to a minimum value of 0.5 percent.
(e) For contracts with multiple exchanges of principal, the
conversion factors are to be multiplied by the number of remaining
payments in the contract. Derivative contracts not explicitly
covered by any of the columns of the conversion factor matrix are to
be treated as ``other commodities.''
(f) 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.
4. Risk Weights and Avoidance of Double Counting. (a) Once the
credit equivalent amount for a derivative contract, or a group of
derivative contracts subject to a qualifying bilateral netting
agreement, has been determined, that amount is assigned to the risk
category appropriate to the counterparty, or, if relevant, the
guarantor or the nature of any collateral. However, the maximum
weight that will be applied to the credit equivalent amount of such
contracts is 50 percent.
(b) 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 a
bank's risk-based capital ratio.
(c) The FDIC notes that the conversion factors set forth in
section II.E.3. of appendix A, 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.
(d) Examples of the calculation of credit equivalent amounts for
these types of contracts are contained in Table IV of this appendix
A.
5. 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:
(i) 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
[[Page 46184]]
perform due to default, bankruptcy, liquidation, or similar
circumstances;
(ii) 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, bankruptcy or similar
circumstances, the relevant court and administrative authorities
would find the bank's exposure to be such a net amount under:
(1) 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;
(2) The law that governs the individual contracts covered by the
netting contract; and
(3) The law that governs the netting contract.
(iii) 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; and
(iv) The bank maintains in its file documentation adequate to
support the netting of derivative 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.41
\41\For 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.
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(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 FDIC. Upon determination by the FDIC 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 paragraphs (ii)(1)
through (3) of section II.E.5.(a) 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 of 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.42
\42\For purposes of calculating 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.
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(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 effects of the bilateral netting contract on the gross
potential future exposure are recognized through application of a
formula, resulting in an adjusted add-on amount (Anet). The
formula, which employs the ratio of net current exposure to gross
current exposure (NGR) is expressed as:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
The effect of this formula is that Anet is the weighted
average of Agross, and Agross adjusted by the NGR.
(g) The NGR may be calculated in either one of two ways--
referred to as the counterparty-by-counterparty approach and the
aggregate approach.
(i) Under the counterparty-by-counterparty approach, 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 II.E. of this appendix A.
(ii) Under the aggregate approach, the NGR is the ratio of the
sum of all of the net current exposures for qualifying bilateral
netting contracts to the sum of all of the gross current exposures
for those netting contracts (each gross current exposure is
calculated in the same manner as in section II.E.5.(g)(i) of this
appendix A). Net negative mark-to-market values to individual
counterparties cannot be used to offset net positive current
exposures to other counterparties.
(iii) A bank must use consistently either the counterparty-by-
counterparty approach or the aggregate approach to calculate the
NGR. Regardless of the approach used, the NGR should be applied
individually to each qualifying bilateral netting contract to
determine the adjusted add-on for that netting contract.
3. In appendix A to part 325, Table III is amended by:
a. In the last sentence, removing ``II.E.3.'' and adding in its
place ``II.E.5.''; and
b. Revising the chart and its heading to read as follows:
Table III. * * *
* * * * *
Credit Conversion for Derivative Contracts
* * * * *
Conversion Factor Matrix
----------------------------------------------------------------------------------------------------------------
Exchange Precious
Remaining maturity Interest rate and Equity metals, Other
rate gold except gold commodities
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0% 1.0% 6.0% 7.0% 10.0%
More than one year to five years............... 0.5% 5.0% 8.0% 7.0% 12.0%
More than five years........................... 1.5% 7.5% 10.0% 8.0% 15.0%
----------------------------------------------------------------------------------------------------------------
* * * * *
4. Appendix A to part 325, Table IV, is revised to read as follows:
Table IV.--Calculation of Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Potential exposure + Current = Credit equivalent amount
------------------------------------------------ exposure --------------------------------------- Credit
Notional ------------- Potential Mark-to Current equivalent
Type of contract (remaining principal Conversion exposure market exposure amount
maturity) (dollars) factor (dollars) value (dollars)
----------------------------------------------------------------------------------------------------------------
(1) 120-Day Forward Foreign
Exchange......................... 5,000,000 .01 50,000 100,000 100,000 150,000
(2) 4-Year Forward Foreign
Exchange......................... 6,000,000 .05 300,000 -120,000 0 300,000
(3) 3-Year Single-Currency Fixed/
Floating Interest Rate Swap...... 10,000,000 .005 50,000 200,000 200,000 250,000
[[Page 46185]]
(4) 6-Month Oil Swap.............. 10,000,000 .10 1,000,000 -250,000 0 1,000,000
(5) 7-Year Cross-Currency Floating/
Floating Interest Rate Swap...... 20,000,000 .075 1,500,000 -1,500,000 0 1,500,000
Total....................... ........... ........... 2,900,000 ........... 300,000 3,200,000
----------------------------------------------------------------------------------------------------------------
(1) 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 exposure* amount
above)
----------------------------------------------------------------------------------------------------------------
(1)....................................... 50,000
(2)....................................... 300,000
(3)....................................... 50,000
(4)....................................... 1,000,000
(5)....................................... 1,500,000
Total............................... 2,900,000 + 0 = 2,900,000
----------------------------------------------------------------------------------------------------------------
*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.
(2) To recognize the effects of netting on potential future
exposure, the following formula applies:
Anet=(0.4 x Agross)+0.6(NGR x Agross)
(3) In the above example:
NGR=0=(0/300,000)
Anet=(0.4 x 2,900,000)+0.6(0 x 2,900,000)
Anet=1,160,000
Credit Equivalent Amount: 1,160,000+0=1,160,000
(4) 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=(0.4 x 2,900,000)+0.6(.67 x 2,900,000)
Anet=2,325,800
Credit Equivalent Amount: 2,325,800+200,000=2,525,800
By order of the Board of Directors.
Dated at Washington, D.C. this 25th day of August, 1995.
Federal Deposit Insurance Corporation.
Jerry L. Langley,
Executive Secretary.
[FR Doc. 95-21608 Filed 9-1-95; 8:45 am]
BILLING CODE 4810-33-P, 6210-01-P, 6714-01-P
