| 6.5. | For unmargined transactions, the RC intends to capture the loss that would occur if a counterparty were to default and were closed out of its transactions immediately. The PFE add-on represents a potential conservative increase in exposure over a one-year time horizon from the present date (i.e. the calculation date).
|
| 6.6. | For margined trades, the RC intends to capture the loss that would occur if a counterparty were to default at the present or at a future time, assuming that the closeout and replacement of transactions occur instantaneously. However, there may be a period (the margin period of risk) between the last exchange of collateral before default and replacement of the trades in the market. The PFE add-on represents the potential change in value of the trades during this time period.
|
| 6.7. | In both cases, the haircut applicable to noncash collateral in the replacement cost formulation represents the potential change in value of the collateral during the appropriate time period (one year for unmargined trades and the margin period of risk for margined trades).
|
| 6.8. | Replacement cost is calculated at the netting set level, whereas PFE add-ons are calculated for each asset class within a given netting set and then aggregated (see 6.26 to 6.79 below).
|
| 6.9. | For capital adequacy purposes, banks may net transactions (e.g. when determining the RC component of a netting set) subject to novation under which any obligation between a bank and its counterparty to deliver a given currency on a given value date is automatically amalgamated with all other obligations for the same currency and value date, legally substituting one single amount for the previous gross obligations. Banks may also net transactions subject to any legally valid form of bilateral netting not covered in the preceding sentence, including other forms of novation. In every such case where netting is applied, a bank must satisfy SAMA that it has:
|
| | (1) | A netting contract with the counterparty or other agreement which creates a single legal obligation, covering all included transactions, such that the bank would have either a claim to receive or obligation to pay only the net sum of the positive and negative mark-to-market values of included individual transactions in the event a counterparty fails to perform due to any of the following: default, bankruptcy, liquidation or similar circumstances.7
|
| | (2) | Written and reasoned legal reviews that, in the event of a legal challenge, the relevant courts and administrative authorities would find the bank’s exposure to be such a net amount under:
|
| | (3) | The law of the jurisdiction in which the counterparty is chartered and, if the foreign branch of a counterparty is involved, then also under the law of the jurisdiction in which the branch is located;
|
| | | (a) | The law that governs the individual transactions; and
|
| | | (b) | The law that governs any contract or agreement necessary to effect the netting.
|
| | (4) | Procedures in place to ensure that the legal characteristics of netting arrangements are kept under review in light of the possible changes in relevant law.
|
| 6.10. | SAMA, after consultation when necessary with other relevant supervisors, must be satisfied that the netting is enforceable under the laws of each of the relevant jurisdictions. Thus, if any of these supervisors is dissatisfied about enforceability under its laws, the netting contract or agreement will not meet this condition and neither counterparty could obtain supervisory benefit.
|
| 6.11. | There are two formulations of replacement cost depending on whether the trades with a counterparty are margined or unmargined. The margined formulation could apply both to bilateral transactions and to central clearing relationships. The formulation also addresses the various arrangements that a bank may have to post and/or receive collateral that may be referred to as initial margin.
|
| | Formulation for unmargined transactions
|
| 6.12. | For unmargined transactions, RC is defined as the greater of:
|
| | | (i) | the current market value of the derivative contracts less net haircut collateral held by the bank (if any), and
|
| | | (ii) | zero. This is consistent with the use of replacement cost as the measure of current exposure, meaning that when the bank owes the counterparty money it has no exposure to the counterparty if it can instantly replace its trades and sell collateral at current market prices.8
|
| | The formula for RC is as follows, where:
|
| | (1) | V is the value of the derivative transactions in the netting set
|
| | (2) | C is the haircut value of net collateral held, which is calculated in accordance with the net independent collateral amount (NICA) methodology defined in 6.19.9
|
RC = max{V - C; 0}
|
| 6.13. | For the purpose of 6.12 above, the value of non-cash collateral posted by the bank to its counterparty is increased and the value of the non-cash collateral received by the bank from its counterparty is decreased using haircuts (which are the same as those that apply to repo-style transactions) for the time periods described in 6.7above.
|
| 6.14. | The formulation set out in 6.12 above, does not permit the replacement cost, which represents today’s exposure to the counterparty, to be less than zero. However, banks sometimes hold excess collateral (even in the absence of a margin agreement) or have out-of-the-money trades which can further protect the bank from the increase of the exposure. As discussed in 6.23 to 6.25 below, the SA-CCR allows such over-collateralization and negative mark-to market value to reduce PFE, but they are not permitted to reduce replacement cost.
|
| | Formulation for margined transactions
|
| 6.15. | The RC formula for margined transactions builds on the RC formula for unmargined transactions. It also employs concepts used in standard margining agreements, as discussed more fully below.
|
| 6.16. | The RC for margined transactions in the SA-CCR is defined as the greatest exposure that would not trigger a call for VM, taking into account the mechanics of collateral exchanges in margining agreements.10 Such mechanics include, for example, “Threshold”, “Minimum Transfer Amount” and “Independent Amount” in the standard industry documentation,11 which are factored into a call for VM.12 A defined, generic formulation has been created to reflect the variety of margining approaches used and those being considered by supervisors internationally.
|
| | Incorporating NICA into replacement cost
|
| 6.17. | One objective of the SA-CCR is to reflect the effect of margining agreements and the associated exchange of collateral in the calculation of CCR exposures. The following paragraphs address how the exchange of collateral is incorporated into the SA-CCR.
|
| 6.18. | To avoid confusion surrounding the use of terms initial margin and independent amount which are used in various contexts and sometimes interchangeably, the term independent collateral amount (ICA) is introduced. ICA represents:
|
| | | (i) | collateral (other than VM) posted by the counterparty that the bank may seize upon default of the counterparty, the amount of which does not change in response to the value of the transactions it secures and/or
|
| | | (ii) | the Independent Amount (IA) parameter as defined in standard industry documentation. ICA can change in response to factors such as the value of the collateral or a change in the number of transactions in the netting set.
|
| 6.19. | Because both a bank and its counterparty may be required to post ICA, it is necessary to introduce a companion term, net independent collateral amount (NICA), to describe the amount of collateral that a bank may use to offset its exposure on the default of the counterparty. NICA does not include collateral that a bank has posted to a segregated, bankruptcy remote account, which presumably would be returned upon the bankruptcy of the counterparty. That is, NICA represents any collateral (segregated or unsegregated) posted by the counterparty less the unsegregated collateral posted by the bank. With respect to IA, NICA takes into account the differential of IA required for the bank minus IA required for the counterparty.
|
| 6.20. | For margined trades, the replacement cost is calculated using the following formula, where:
|
| | (1) | V and C are defined as in the unmargined formulation, except that C now includes the net variation margin amount, where the amount received by the bank is accounted with a positive sign and the amount posted by the bank is accounted with a negative sign
|
| | (2) | TH is the positive threshold before the counterparty must send the bank collateral
|
| | (3) | MTA is the minimum transfer amount applicable to the counterparty
|
RC = max{V - C; TH + MTA - NICA; 0}
|
| 6.21. | TH + MTA – NICA represents the largest exposure that would not trigger a VM call and it contains levels of collateral that need always to be maintained. For example, without initial margin or IA, the greatest exposure that would not trigger a variation margin call is the threshold plus any minimum transfer amount. In the adapted formulation, NICA is subtracted from TH + MTA. This makes the calculation more accurate by fully reflecting both the actual level of exposure that would not trigger a margin call and the effect of collateral held and /or posted by a bank. The calculation is floored at zero, recognizing that the bank may hold NICA in excess of TH + MTA, which could otherwise result in a negative replacement cost.
|
| | PFE add-on for each netting set
|
| 6.22. | The PFE add-on consists of:
|
| | | (i) | an aggregate add-on component; and
|
| | | (ii) | a multiplier that allows for the recognition of excess collateral or negative mark-to-market value for the transactions within the netting set. The formula for PFE is as follows, where:
|
| | (1) | AddOnaggregate is the aggregate add-on component (see 6.27 below)
|
| | (2) | multiplier is defined as a function of three inputs: V, C and AddOnaggregate
|
PFE = multiplier * AddOnaggregate
|
7 The netting contract must not contain any clause which, in the event of default of a counterparty, permits a non-defaulting counterparty to make limited payments only, or no payments at all, to the estate of the defaulting party, even if the defaulting party is a net creditor.
8 The haircut applicable in the replacement cost calculation for unmargined trades should follow the formula in paragraphs 62 of chapter 9 of the Minimum Capital Requirements for Credit Risk. In applying the formula, banks must use the maturity of the longest transaction in the netting set as the value for N , capped at 250 days, in order to R scale haircuts for unmargined trades, which is capped at 100%.
9 As set out in 6.4, netting sets that include a one-way margin agreement in favor of the bank’s counterparty (i.e. the bank posts, but does not receive variation margin) are treated as unmargined for the purposes of SA-CCR. For such netting sets, C also includes, with a negative sign, the variation margin amount posted by the bank to the counterparty.
10 See chapter 12 and Chapter 13 of this framework for illustrative examples of the effect of standard margin agreements on the SA-CCR formulation.
11 For example, the 1992 (Multicurrency-Cross Border) Master Agreement and the 2002 Master Agreement published by the International Swaps & Derivatives Association, Inc. (ISDA Master Agreement). The ISDA Master Agreement includes the ISDA Credit Support Annexes: the 1994 Credit Support Annex (Security Interest – New York Law), or, as applicable, the 1995 Credit Support Annex (Transfer – English Law) and the 1995 Credit Support Deed (Security Interest – English Law).
12 For example, in the ISDA Master Agreement, the term “Credit Support Amount”, or the overall amount of collateral that must be delivered between the parties, is defined as the greater of the Secured Party’s Exposure plus the aggregate of all Independent Amounts applicable to the Pledgor minus all Independent Amounts applicable to the Secured Party, minus the Pledgor’s Threshold and zero.
