(a) Scope.
(1) This section applies to wholesale exposures
for which:
(i) Credit risk is fully covered by
an eligible guarantee or eligible credit derivative; or
(ii) Credit risk is covered
on a pro rata basis (that is, on a basis in which the Board-regulated
institution and the protection provider share losses proportionately)
by an eligible guarantee or eligible credit derivative.
(2) Wholesale exposures
on which there is a tranching of credit risk (reflecting at least
two different levels of seniority) are securitization exposures subject
to section 217.141 through section 217.145.
(3) A Board-regulated institution may elect
to recognize the credit risk mitigation benefits of an eligible guarantee
or eligible credit derivative covering an exposure described in paragraph
(a)(1) of this section by using the PD substitution approach or the
LGD adjustment approach in paragraph (c) of this section or, if the
transaction qualifies, using the double default treatment in section
217.135. A Board-regulated institution’s PD and LGD for the hedged
exposure may not be lower than the PD and LGD floors described in
section 217.131(d)(2) and (d)(3).
(4) If multiple eligible guarantees or
eligible credit derivatives cover a single exposure described in paragraph
(a)(1) of this section, a Board-regulated institution may treat the
hedged exposure as multiple separate exposures each covered by a single
eligible guarantee or eligible credit derivative and may calculate
a separate risk-based capital requirement for each separate exposure
as described in paragraph (a)(3) of this section.
(5) If a single eligible guarantee or eligible
credit derivative covers multiple hedged wholesale exposures described
in paragraph (a)(1) of this section, a Board-regulated institution
must treat each hedged exposure as covered by a separate eligible
guarantee or eligible credit derivative and must calculate a separate
risk-based capital requirement for each exposure as described in paragraph
(a)(3) of this section.
(6) A Board-regulated institution must use the same risk parameters
for calculating ECL as it uses for calculating the risk-based capital
requirement for the exposure.
(b) Rules of recognition.
(1) A Board-regulated institution may only
recognize the credit risk mitigation benefits of eligible guarantees
and eligible credit derivatives.
(2) A Board-regulated institution may only
recognize the credit risk mitigation benefits of an eligible credit
derivative to hedge an exposure that is different from the credit
derivative’s reference exposure used for determining the derivative’s
cash settlement value, deliverable obligation, or occurrence of a
credit event if:
(i) The reference exposure ranks pari passu (that is, equally) with or is junior to the hedged
exposure; and
(ii) The
reference exposure and the hedged exposure are exposures to the same
legal entity, and legally enforceable cross-default or cross-acceleration
clauses are in place to assure payments under the credit derivative
are triggered when the obligor fails to pay under the terms of the
hedged exposure.
(c) Risk parameters for hedged exposures.
(1) PD substitution approach.
(i) Full coverage. If an eligible guarantee or eligible credit derivative
meets the conditions in paragraphs (a) and (b) of this section and
the protection amount (P) of the guarantee or credit derivative is
greater than or equal to the EAD of the hedged exposure, a Board-regulated
institution may recognize the guarantee or credit derivative in determining
the Board-regulated institution’s risk-based capital requirement for
the hedged exposure by substituting the PD associated with the rating
grade of the protection provider for the PD associated with the rating
grade of the obligor in the risk-based capital formula applicable
to the guarantee or credit derivative in Table 1 of section 217.131
and using the appropriate LGD as described in paragraph (c)(1)(iii)
of this section. If the Board-regulated institution determines that
full substitution of the protection provider’s PD leads to an inappropriate
degree of risk mitigation, the Board-regulated institution may substitute
a higher PD than that of the protection provider.
(ii) Partial
coverage. If an eligible guarantee or eligible credit derivative
meets the conditions in paragraphs (a) and (b) of this section and
P of the guarantee or credit derivative is less than the EAD of the
hedged exposure, the Board-regulated institution must treat the hedged
exposure as two separate exposures (protected and unprotected) in
order to recognize the credit risk mitigation benefit of the guarantee
or credit derivative.
(A) The Board-regulated institution must calculate
its risk-based capital requirement for the protected exposure under
section 217.131, where PD is the protection provider’s PD, LGD is
determined under paragraph (c)(1)(iii) of this section, and EAD is
P. If the Board-regulated institution determines that full substitution
leads to an inappropriate degree of risk mitigation, the Board-regulated
institution may use a higher PD than that of the protection provider.
(B) The Board-regulated
institution must calculate its risk-based capital requirement for
the unprotected exposure under section 217.131, where PD is the obligor’s
PD, LGD is the hedged exposure’s LGD (not adjusted to reflect the
guarantee or credit derivative), and EAD is the EAD of the original
hedged exposure minus P.
(C) The treatment in paragraph (c)(1)(ii) of this section is applicable
when the credit risk of a wholesale exposure is covered on a partial
pro rata basis or when an adjustment is made to the effective notional
amount of the guarantee or credit derivative under paragraphs (d),
(e), or (f) of this section.
(iii) LGD
of hedged exposures. The LGD of a hedged exposure under the PD
substitution approach is equal to:
(A) The lower of the LGD of the
hedged exposure (not adjusted to reflect the guarantee or credit derivative)
and the LGD of the guarantee or credit derivative, if the guarantee
or credit derivative provides the Board-regulated institution with
the option to receive immediate payout upon triggering the protection;
or
(B) The LGD of the guarantee
or credit derivative, if the guarantee or credit derivative does not
provide the Board-regulated institution with the option to receive
immediate payout upon triggering the protection.
(2) LGD adjustment approach.
(i) Full coverage. If an eligible guarantee
or eligible credit derivative meets the conditions in paragraphs (a)
and (b) of this section and the protection amount (P) of the guarantee
or credit derivative is greater than or equal to the EAD of the hedged
exposure, the Board-regulated institution’s risk-based capital requirement
for the hedged exposure is the greater of:
(A) The risk-based
capital requirement for the exposure as calculated under section 217.131,
with the LGD of the exposure adjusted to reflect the guarantee or
credit derivative; or
(B)
The risk-based capital requirement for a direct exposure to the protection
provider as calculated under section 217.131, using the PD for the
protection provider, the LGD for the guarantee or credit derivative,
and an EAD equal to the EAD of the hedged exposure.
(ii) Partial coverage. If an eligible guarantee
or eligible credit derivative meets the conditions in paragraphs (a)
and (b) of this section and the protection amount (P) of the guarantee
or credit derivative is less than the EAD of the hedged exposure,
the Board-regulated institution must treat the hedged exposure as
two separate exposures (protected and unprotected) in order to recognize
the credit risk mitigation benefit of the guarantee or credit derivative.
(A) The Board-regulated institution’s risk-based capital requirement
for the protected exposure would be the greater of:
(1) The risk-based capital requirement
for the protected exposure as calculated under section 217.131, with
the LGD of the exposure adjusted to reflect the guarantee or credit
derivative and EAD set equal to P; or
(2) The risk-based capital requirement
for a direct exposure to the guarantor as calculated under section
217.131, using the PD for the protection provider, the LGD for the
guarantee or credit derivative, and an EAD set equal to P.
(B) The Board-regulated institution
must calculate its risk-based capital requirement for the unprotected
exposure under section 217.131, where PD is the obligor’s PD, LGD
is the hedged exposure’s LGD (not adjusted to reflect the guarantee
or credit derivative), and EAD is the EAD of the original hedged exposure
minus P.
(3) M of hedged
exposures. For purposes of this paragraph (c), the M of the hedged
exposure is the same as the M of the exposure if it were unhedged.
(d) Maturity
mismatch.
(1) A Board-regulated institution that
recognizes an eligible guarantee or eligible credit derivative in
determining its risk-based capital requirement for a hedged exposure
must adjust the effective notional amount of the credit risk mitigant
to reflect any maturity mismatch between the hedged exposure and the
credit risk mitigant.
(2) A maturity mismatch occurs when the residual maturity of a credit
risk mitigant is less than that of the hedged exposure(s).
(3) The residual maturity of
a hedged exposure is the longest possible remaining time before the
obligor is scheduled to fulfil its obligation on the exposure. If
a credit risk mitigant has embedded options that may reduce its term,
the Board-regulated institution (protection purchaser) must use the
shortest possible residual maturity for the credit risk mitigant.
If a call is at the discretion of the protection provider, the residual
maturity of the credit risk mitigant is at the first call date. If
the call is at the discretion of the Board-regulated institution (protection
purchaser), but the terms of the arrangement at origination of the
credit risk mitigant contain a positive incentive for the Board-regulated
institution to call the transaction before contractual maturity, the
remaining time to the first call date is the residual maturity of
the credit risk mitigant.
31(4)
A credit risk mitigant with a maturity mismatch may be recognized
only if its original maturity is greater than or equal to one year
and its residual maturity is greater than three months.
(5) When a maturity mismatch
exists, the Board-regulated institution must apply the following adjustment
to the effective notional amount of the credit risk mitigant: Pm = E × (t − 0.25)/(T − 0.25), where:
(i) Pm = effective notional amount of the credit risk mitigant,
adjusted for maturity mismatch;
(ii) E = effective notional amount of
the credit risk mitigant;
(iii) t = the lesser of T or the residual
maturity of the credit risk mitigant, expressed in years; and
(iv) T = the lesser of
five or the residual maturity of the hedged exposure, expressed in
years.
(e) Credit derivatives without restructuring as
a credit event. If a Board-regulated institution recognizes an
eligible credit derivative that does not include as a credit event
a restructuring of the hedged exposure involving forgiveness or postponement
of principal, interest, or fees that results in a credit loss event
(that is, a charge-off, specific provision, or other similar debit
to the profit and loss account), the Board-regulated institution must
apply the following adjustment to the effective notional amount of
the credit derivative: Pr = Pm × 0.60, where:
(1) Pr = effective
notional amount of the credit risk mitigant, adjusted for lack of
restructuring event (and maturity mismatch, if applicable); and
(2) Pm =
effective notional amount of the credit risk mitigant adjusted for
maturity mismatch (if applicable).
(f) Currency mismatch.
(1) If a Board-regulated institution recognizes
an eligible guarantee or eligible credit derivative that is denominated
in a currency different from that in which the hedged exposure is
denominated, the Board-regulated institution must apply the following
formula to the effective notional amount of the guarantee or credit
derivative: Pc = Pr × (1 − HFX),
where:
(i) Pc = effective notional
amount of the credit risk mitigant, adjusted for currency mismatch
(and maturity mismatch and lack of restructuring event, if applicable);
(ii) Pr = effective notional amount of the credit risk mitigant (adjusted
for maturity mismatch and lack of restructuring event, if applicable);
and
(iii) HFX = haircut appropriate for the currency mismatch between the credit
risk mitigant and the hedged exposure.
(2) A Board-regulated institution must
set HFX equal to 8 percent unless it qualifies for the
use of and uses its own internal estimates of foreign exchange volatility
based on a ten-business-day holding period and daily marking-to-market
and remargining. A Board-regulated institution qualifies for the use
of its own internal estimates of foreign exchange volatility if it
qualifies for:
(i) The own-estimates haircuts in section
217.132(b)(2)(iii);
(ii) The simple VaR methodology in section 217.132(b)(3); or
(iii) The internal models
methodology in section 217.132(d).
(3) A Board-regulated institution must
adjust HFX calculated in paragraph (f)(2) of this section
upward if the Board-regulated institution revalues the guarantee or
credit derivative less frequently than once every ten business days
using the square root of time formula provided in section 217.132(b)(2)(iii)(A)(2).
