Back Custom print Link Text Only Rich Text Print

  • CA-3.4 CA-3.4 Treatment of derivatives contracts in the banking book

    • CA-3.4.1

      The treatment of forwards, swaps, purchased options and similar derivative contracts needs special attention because banks are not exposed to credit risk for the full face value of their contracts, but only to the potential cost of replacing the cash flow (on contracts showing positive value) if the counterparty defaults. The credit equivalent amounts (as referred to under Paragraph CA-3.4.13) will depend inter alia on the maturity of the contract and on the volatility of the rates and prices underlying that type of instrument.

      October 07

    • CA-3.4.2

      Instruments traded on exchanges may be excluded where they are subject to daily receipt and payment of cash variation margins.

      October 07

    • CA-3.4.3

      Options purchased over-the-counter are included with the same conversion factors as other instruments.

      October 07

    • Interest rate contracts

      • CA-3.4.4

        Interest rate contracts are defined to include single-currency interest rate swaps, basis swaps, forward rate agreements, interest rate futures, interest rate options purchased and similar instruments.

        October 07

    • Exchange rate contracts

      • CA-3.4.5

        Exchange rate contracts include cross-currency interest rate swaps, forward foreign exchange contracts, currency futures, currency options purchased and similar instruments.

        October 07

      • CA-3.4.6

        Exchange rate contracts with an original maturity of 14 calendar days or less may be excluded.

        October 07

    • Equity contracts

      • CA-3.4.7

        Equity contracts include forwards, swaps, purchased options and similar derivative contracts based on individual equities or on equity indices.

        October 07

    • Gold contracts

      • CA-3.4.8

        Gold contracts are treated the same as foreign exchange contracts for the purpose of calculating credit risk except that contracts with original maturity of 14 calendar days or less are included.

        October 07

      • CA-3.4.9

        Precious metals other than gold receive a separate treatment (see Section BR-4.1) and include forwards, swaps, purchased options and similar derivative contracts that are based on precious metals (e.g. silver, platinum, and palladium).

        October 07

    • Other commodities

      • CA-3.4.10

        Other commodities are also treated separately (see Section BR-4.1) and include forwards, swaps, purchased options and similar derivative contracts based on energy contracts, agricultural contracts, base metals (e.g. aluminium, copper, and zinc), and any other non-precious metal commodity contracts.

        October 07

    • General guidance on treatment of derivatives contracts

      • CA-3.4.11

        The following points should be noted for the treatment of certain derivatives contracts:

        (a) For contracts with multiple exchange of principal, the add-on factors are to be multiplied by the number of remaining payments in the contracts.
        (i) For contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset such that the market value of the contract is zero on these specified dates, the residual maturity would be set equal to the time until the next reset date.
        (ii) Forwards, swaps, purchased options and similar derivative contracts not covered in any of the above mentioned categories should be treated as 'other commodities'.
        (iii) No potential future credit exposure (as referred to under Paragraph CA-3.4.12) would be calculated for single currency floating/floating interest rate swaps.
        October 07

    • Calculation of weighted derivative exposures

      • CA-3.4.12

        Banks should calculate their weighted exposure under the above mentioned contracts according to the Current Exposure Method, which involves calculating the current replacement cost by marking contracts to market, thus capturing the current exposure without any need for estimation, and then adding a factor (the 'add-on') to reflect the potential future exposure over the remaining life of the contract.

        The 'add-on' factor table:

          Residual maturity of contracts
        1 year or less Over 1 year to 5 years Over 5 years
        Interest rate related contracts 0.000 0.005 0.015
        Foreign exchange & gold contracts 0.010 0.050 0.075
        Equity contracts 0.060 0.080 0.100
        Precious metals (except gold) 0.070 0.070 0.070
        Other commodities 0.120 0.120 0.150
        October 07

      • CA-3.4.13

        In order to reflect counterparty risk, the total credit equivalent amount, which results from the calculation in Paragraph CA-3.4.12 has to be broken down again according to type of counterparty, using the same classification into types (a), (b) and (c) given in Section CA-3.3. Finally, the exposure to each type of counterparty has to be weighted as 0%, 20% or 50% respectively, and the total weighted exposure calculated.

        October 07