Basel Committee Consults on Derivatives

Terry Flanagan

The Basel Committee on Friday released consultative papers on the treatment of derivatives-related transactions under the capital adequacy framework.

The first consultation, “A non-internal model method for capitalizing counterparty credit risk exposures,” outlines a proposal to improve the methodology for assessing the counterparty credit risk associated with derivative transactions.

The proposal would, when finalized, replace the capital framework’s existing methods – the Current Exposure Method (CEM) and the Standardized Method.

The proposal improves on the risk sensitivity of the CEM by differentiating between margined and unmargined trades. The proposed non-internal model method updates supervisory factors to reflect the level of volatilities observed over the recent stress period and provides a more meaningful recognition of netting benefits.

The second consultation, “Capital treatment of bank exposures to central counterparties,” sets out proposals for calculating regulatory capital for a bank’s exposures to central counterparties (CCPs).

This proposal has been developed in close cooperation with the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO). It is designed to replace an interim treatment for bank exposures to CCPs issued by the Basel Committee in July 2012.

“These two proposals continue the Committee’s work to finalize the post-crisis overhaul of the capital framework, as well as contributing to broader G20 efforts to encourage central clearing and so improve the resilience of derivatives markets,” said Stefan Ingves, chairman of the Basel Committee and Governor of Sveriges Riksbank.

The Basel Committee on Banking Supervision, in cooperation with the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO), is seeking views on potential changes to the capital treatment of banks’ exposure to central counterparties (CCPs).

The Basel Committee published an interim standard in July 2012 and noted at that time that additional work was needed to improve the capital framework. Introduction of the interim standard represented an important step towards ensuring appropriate measurement, monitoring and management of banks’ exposures to CCPs, exposures which had previously attracted no regulatory capital charge.

The proposed changes to the interim standard seek to establish a capital treatment that ensures banks’ exposures to central counterparties are adequately capitalized, while also preserving incentives for central clearing.

They promote robust risk management by banks and CCPs, including by encouraging CCPs to satisfy the CPSS-IOSCO Principles for financial market infrastructures (PFMIs). The proposed changes respond to evidence that application of the interim rules could lead both to instances of very little capital being held against exposures to some CCPs, and potentially in certain cases, to capital charges that are higher than for bilateral (non-centrally-cleared) transactions.

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