(a) Scope.
(1) General. A Board-regulated institution may recognize the credit risk mitigation
benefits of an eligible guarantee or eligible credit derivative by
substituting the risk weight associated with the protection provider
for the risk weight assigned to an exposure, as provided under this
section.
(2) This section
applies to 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.
(3) Exposures on which
there is a tranching of credit risk (reflecting at least two different
levels of seniority) generally are securitization exposures subject
to sections 217.41 through 217.45.
(4) If multiple eligible guarantees or
eligible credit derivatives cover a single exposure described in 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-weighted
asset amount for each separate exposure as described in paragraph
(c) of this section.
(5) If a single eligible guarantee or eligible credit derivative
covers multiple hedged exposures described in paragraph (a)(2) 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-weighted asset amount
for each exposure as described in paragraph (c) of this section.
(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 with, or is subordinated to, the hedged exposure;
and
(ii) The reference
exposure and the hedged exposure are to the same legal entity, and
legally enforceable cross-default or cross-acceleration clauses are
in place to ensure payments under the credit derivative are triggered
when the obligated party of the hedged exposure fails to pay under
the terms of the hedged exposure.
(c) Substitution approach.
(1) 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 exposure amount of the hedged exposure, a Board-regulated
institution may recognize the guarantee or credit derivative in determining
the risk-weighted asset amount for the hedged exposure by substituting
the risk weight applicable to the guarantor or credit derivative protection
provider under this subpart D for the risk weight assigned to the
exposure.
(2) 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 exposure amount 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.
(i) The
Board-regulated institution may calculate the risk-weighted asset
amount for the protected exposure under this subpart D, where the
applicable risk weight is the risk weight applicable to the guarantor
or credit derivative protection provider.
(ii) The Board-regulated institution
must calculate the risk-weighted asset amount for the unprotected
exposure under this subpart D, where the applicable risk weight is
that of the unprotected portion of the hedged exposure.
(iii) The treatment provided in this
section is applicable when the credit risk of an exposure is covered
on a partial pro rata basis and may be applicable 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.
(d) Maturity
mismatch adjustment.
(1) A Board-regulated institution that
recognizes an eligible guarantee or eligible credit derivative in
determining the risk-weighted asset amount 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
obligated party of the hedged exposure is scheduled to fulfil its
obligation on the hedged 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.
(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
reduce 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) Adjustment for 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 reduce 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 adjustment.
(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 eight 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.
A Board-regulated institution qualifies for the use of its own internal
estimates of foreign exchange volatility if it qualifies for the use
of its own-estimates haircuts in section 217.37(c)(4).
(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 10 business days
using the following square root of time formula:
Figure 1. DISPLAY EQUATION
$$
\mathrm{H_{FX} = 8\% \sqrt{\frac{T_M}{10}}} \text{ ,}
$$
where TM equals the greater of 10 or the number of days between revaluation.
