4362 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

DEPARTMENT OF THE TREASURY amendments, generally with respect to D. Potential Future Exposure cleared transactions. IV. Revisions to the Cleared Transactions Framework Office of the Comptroller of DATES: Effective date: April 1, 2020. the Currency A. Trade Exposure Amount Mandatory compliance date: January 1, B. Treatment of Default Fund

2022, for advanced approaches banking Contributions 12 CFR Parts 3 and 32 organizations. V. Revisions to the Supplementary Leverage [Docket ID OCC–2018–0030] FOR FURTHER INFORMATION CONTACT: Ratio OCC: Margot Schwadron, Director or VI. Technical Amendments RIN 1557–AE44 Guowei Zhang, Expert, Capital A. Receivables Due From a QCCP Policy, (202) 649–7106; Kevin B. Treatment of Client Financial Collateral FEDERAL RESERVE SYSTEM Korzeniewski, Counsel, or Ron Held by a CCP Shimabukuro, Senior Counsel, Chief C. Clearing Member Exposure When CCP 12 CFR Part 217 Performance Is Not Guaranteed Counsel’s Office, (202) 649–5490; or, for D. Bankruptcy Remoteness of Collateral [Docket No. R–1629] persons who are deaf or hearing E. Adjusted Collateral Haircuts for impaired, TTY, (202) 649–5597. RIN 7100–AF22 Contracts Board: Constance M. Horsley, Deputy F. OCC Revisions to Lending Limits FEDERAL DEPOSIT INSURANCE Associate Director, (202) 452–5239; G. Other Clarifications and Technical David Lynch, Deputy Associate Amendments From the Proposal to the CORPORATION Final Rule Director, (202) 452–2081; Elizabeth VII. Impact of the Final Rule 12 CFR Parts 324 and 327 MacDonald, Manager, (202) 475–6316; Michael Pykhtin, Manager, (202) 912– VIII. Regulatory Analyses A. Paperwork Reduction Act RIN 3064–AE80 4312; Mark Handzlik, Lead Financial B. Regulatory Flexibility Act Institutions Policy Analyst, (202) 475– C. Plain Language Standardized Approach for Calculating 6636; Sara Saab, Senior Financial the Exposure Amount of Derivative D. Riegle Community Development and Institutions Policy Analyst II, (202) 872– Regulatory Improvement Act of 1994 Contracts 4936; or Cecily Boggs, Senior Financial E. OCC Unfunded Mandates Reform Act of AGENCY: The Office of the Comptroller Institutions Policy Analyst II, (202) 530– 1995 Determination of the Currency, Treasury; the Board of 6209; Division of Supervision and F. The Congressional Review Act Governors of the Federal Reserve Regulation; or Mark Buresh, Senior I. Introduction and Overview of the System; and the Federal Deposit Counsel, (202) 452–5270; Gillian Proposal Insurance Corporation. Burgess, Senior Counsel (202) 736– ACTION: Final rule. 5564; or Andrew Hartlage, Counsel, A. Overview of Derivative Contracts (202) 452–6483; Legal Division, Board of In general, derivative contracts

SUMMARY: The Office of the Comptroller Governors of the Federal Reserve represent agreements between parties of the Currency, the Board of Governors System, 20th and C Streets NW, either to make or receive payments or to of the Federal Reserve System, and the Washington, DC 20551. For the hearing buy or sell an underlying asset on a Federal Deposit Insurance Corporation impaired only, Telecommunication certain date (or dates) in the future. are issuing a final rule to implement a Device for the Deaf, (202) 263–4869. Parties generally use derivative new approach—the standardized FDIC: Bobby R. Bean, Associate contracts to mitigate risk, although such approach for counterparty Director, [email protected]; Irina Leonova, transactions may serve other purposes. (SA–CCR)—for calculating the exposure Senior Policy Analyst, ileonova@ For example, an amount of derivative contracts under fdic.gov; Peter Yen, Senior Policy contract allows a party to manage the these agencies’ regulatory capital rule. Analyst, [email protected], Capital Markets risk associated with a change in interest Under the final rule, an advanced Branch, Division of Risk Management rates, while a commodity derivative approaches banking organization may Supervision, (202) 898–6888; or Michael contract allows a party to fix commodity use SA–CCR or the internal models Phillips, Counsel, [email protected]; prices in the future and thereby methodology to calculate its advanced Catherine Wood, Counsel, cawood@ minimize any exposure attributable to approaches total risk-weighted assets, fdic.gov; Supervision Branch, Legal unfavorable movements in those prices. and must use SA–CCR, instead of the Division, Federal Deposit Insurance The value of a derivative contract, and current exposure methodology, to Corporation, 550 17th Street NW, thus a party’s exposure to its calculate its standardized total risk- Washington, DC 20429. counterparty, changes over the life of weighted assets. A non-advanced SUPPLEMENTARY INFORMATION: the contract based on movements in the value of the reference rates, assets, approaches banking organization may Table of Contents use the current exposure methodology indicators or indices underlying the or SA–CCR to calculate its standardized I. Introduction and Overview of the Proposal contract (reference exposures). A party total risk-weighted assets. The final rule A. Overview of Derivative Contracts with a positive current exposure expects B. The Basel Committee Standard on SA– also implements SA–CCR in other CCR to receive a payment or other beneficial aspects of the capital rule. Notably, the C. Overview of the Proposal transfer from the counterparty and is final rule requires an advanced II. Overview of the Final Rule considered to be ‘‘in the money.’’ A approaches banking organization to use A. Scope and Application of the Final Rule party that is in the money is subject to SA–CCR to determine the exposure B. Effective Date and Compliance Deadline the risk that the counterparty will amount of derivative contracts included C. Final Rule’s Interaction With Agency default on its obligations and fail to pay in the banking organization’s total Requirements and Other Proposals the amount owed under the transaction, III. Mechanics of the Standardized Approach leverage exposure, the denominator of for Counterparty Credit Risk which is referred to as counterparty the supplementary leverage ratio. In A. Exposure Amount credit risk. In contrast, a party with a addition, the final rule incorporates SA– B. Definition of Netting Sets and Treatment zero or negative current exposure does CCR into the cleared transactions of Financial Collateral not expect to receive a payment or framework and makes other C. Replacement Cost beneficial transfer from the counterparty

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4363 Two parties often will enter into a rule prescribes different approaches for and is considered to be ‘‘at the money’’ large number of derivative contracts measuring the exposure amount of or ‘‘out of the money.’’ A party that has together. In such cases, the parties may derivative contracts based on the size no current exposure to counterparty enter into a netting agreement to allow and risk profile of a banking credit risk may have exposure to for the offsetting of the derivative organization. All banking organizations counterparty credit risk in the future if contracts under the agreement in the the derivative contract becomes ‘‘in the are currently required to use the current event that one of the parties default and exposure method (CEM) to determine money.’’ to streamline certain aspects of the Parties to a derivative contract often the exposure amount of a derivative transactions, including the exchange of exchange collateral to mitigate contract for purposes of calculating collateral. Netting multiple contracts counterparty credit risk. If a standardized total risk-weighted assets.4 against each other can substantially counterparty defaults, the non- Certain large banking organizations may reduce the exposure if one of the parties defaulting party can sell the collateral to use CEM or the internal models were to default. A netting set reflects offset its exposure. In the derivatives methodology (IMM) to determine the those derivative contracts that are context, collateral may include variation exposure amount of a derivative and initial margin (also known subject to the same master netting 2 contract for advanced approaches risk- as independent collateral). Parties agreement. Parties to a derivative contract may weighted assets. In contrast to CEM, exchange variation margin on a periodic also clear their derivative contract IMM is an internal-models-based basis during the term of a derivative through a central counterparty (CCP). approach that requires supervisory contract, as typically specified in a The use of central clearing is designed approval. The capital rule also requires variation margin agreement or by to reduce the risk of engaging in certain large banking organizations to regulation.1 Variation margin offsets derivative transactions through the meet a supplementary leverage ratio, changes in the market value of a multilateral netting of exposures, derivative contract and thereby covers measured as the banking organization’s the potential loss arising from the establishment and enforcement of tier 1 capital relative to its total leverage 5 default of a counterparty. Variation collateral requirements, and the exposure. The total leverage exposure margin may not always be sufficient to promotion of market transparency. A measure captures both on- and off- party engages with a CCP either as a cover a party’s positive exposure (e.g., balance sheet assets, including the due to delays in receiving collateral), clearing member or as a clearing exposure amount of a banking and thus parties may exchange initial member client. A clearing member is a organization’s derivative contracts as member of, or a direct participant in, a 6 margin. Parties typically exchange determined under CEM. initial margin at the outset of the CCP that has authority to enter into derivative contract and in amounts that transactions with the CCP. A clearing include national banks, state member banks, are expected to reduce the likelihood of member may act as a financial insured state nonmember banks, savings intermediary with respect to the associations, and top-tier bank holding companies a positive exposure amount for the and savings and loan holding companies domiciled derivative contract in the event of the clearing member client and either take one position with the client and an in the United States, but exclude banking counterparty’s default, resulting in organizations subject to the Board’s Small Bank overcollateralization. offsetting position with the CCP (the Holding Company and Savings and Loan Holding To facilitate the exchange of principal model of clearing) or Company Policy Statement (12 CFR part 225, collateral, parties may enter into guarantee the performance of the appendix C), and certain savings and loan holding variation margin agreements that clearing member client to the CCP (the companies that are substantially engaged in agency model of clearing). With respect insurance underwriting or commercial activities or typically provide for a threshold amount that are estate trusts, and bank holding companies and a minimum transfer amount. The to the latter type of clearing, the clearing and savings and loan holding companies that are threshold amount is the maximum member generally is responsible for employee stock ownership plans. The agencies amount by which the market value of fulfilling initial and variation margin recently adopted a final rule to implement a the derivative contract can change calls from the CCP on behalf of its community bank leverage ratio framework that is client, irrespective of the client’s ability applicable, on an optional basis to depository before a party must collect or post institutions and depository institution holding variation margin (in other words, the to post such collateral. companies with less than $10 billion in total threshold amount specifies an The capital rule of the Office of the consolidated assets and that meet certain other acceptable amount of under- Comptroller of the Currency (OCC), the criteria. Such banking organizations that opt into collateralization). The minimum Board of Governors of the Federal the community bank leverage ratio framework will transfer amount is the smallest amount Reserve System (Board), and the Federal be deemed compliant with the capital rule’s generally applicable requirements and are not of collateral that a party must transfer Deposit Insurance Corporation (FDIC) (together, the agencies) requires a required to calculate risk-based capital ratios. See when it is required to exchange 84 FR 61776 (November 13, 2019). banking organization to hold regulatory collateral under the variation margin 4 CEM and IMM are also applied in other parts agreement. Parties generally apply a capital based on the exposure amount of of the capital rule. For example, advanced 3 discount (also known as a haircut) to its derivative contracts. The capital approaches banking organizations must use CEM to non-cash collateral to account for a determine the exposure amount of derivative 2 ‘‘Qualifying master netting agreement’’ is potential reduction in the value of the contracts included in total leverage exposure, the defined in §§ l.2 and l.3(d) of the capital rule. denominator of the supplementary leverage ratio. In collateral during the period between the See 12 CFR 3.2 and 3.3(d) (OCC); 12 CFR 217.2 and addition, the capital rule incorporates CEM into the last exchange of collateral before the 217.3(d) (Board); and 12 CFR 324.2 and 324.3(d) cleared transactions framework and makes other (FDIC). amendments, generally with respect to cleared close out of the derivative contract (as 3 in the case of default of the 12 CFR part 3 (OCC); 12 CFR part 217 (Board); transactions. See section II.C. of this 12 CFR part 324 (FDIC). The agencies have codified for further discussion. counterparty) and replacement of the the capital rule in different parts of title 12 of the SUPPLEMENTARY INFORMATION 5 contract on the market. This period is CFR, but the internal structure of the sections See infra note 23. Banking organizations subject within each agency’s rule are identical. All to Category I, Category II, or Category III standards known as the margin period of risk are subject to the supplementary leverage ratio. (MPOR). references to sections in the capital rule or the proposal are intended to refer to the corresponding 6 See 12 CFR 3.10(c)(4) (OCC); 12 CFR

sections in the capital rule of each agency. Banking 217.10(c)(4) (Board); and 12 CFR 324.10(c)(4) 1 See, e.g., 12 CFR part 45 (OCC); 12 CFR part 237 organizations subject to the agencies’ capital rule (FDIC). (Board); and 12 CFR part 349 (FDIC).

4364 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations factor, and therefore, are within the standard uses supervisory factors that B. The Basel Committee Standard on same asset class—interest rate, exchange reflect the volatilities observed in the SA–CCR rate, credit, equity, or commodities. As derivatives markets during the financial In 2014, the Basel Committee on derivatives within the same asset class crisis. The supervisory factors reflect the Banking Supervision released a new are highly correlated and thus have an potential variability of the primary risk approach for calculating the exposure economic relationship,9 under the Basel factor of the derivative contract over a amount of a derivative contract called Committee standard, derivative one-year horizon. The maturity factor the standardized approach for contracts within the same hedging set scales down the default one-year risk counterparty credit risk (SA–CCR) (the may be able to fully or partially offset horizon of the supervisory factor to the Basel Committee standard).7 Under the each other. risk horizon appropriate for the Basel Committee standard, a banking To obtain the PFE for each netting set, derivative contract. For the supervisory organization calculates the exposure a banking organization sums the delta adjustment, a banking organization amount of its derivative contracts at the adjusted derivative contract amount of applies a positive sign to the derivative netting set level, meaning, those all hedging sets within the netting set contract amount if the derivative contracts that the standard permits to be using an asset-class specific aggregation contract is long the and a netted against each other because they formula and multiples that amount by negative sign if the derivative contract is are subject to the same qualifying master the PFE multiplier. The PFE multiplier short the risk factor. A derivative netting agreement (QMNA), which must decreases exponentially from a value of contract is long the primary risk factor 8 meet certain operational requirements. one as the value of the financial if the fair value of the instrument The exposure amount of a derivative collateral held by the banking increases when the value of the primary contract not subject to a QMNA is organization exceeds the net fair value risk factor increases. A derivative calculated individually, and thus the of the derivative contracts within the contract is short the primary risk factor derivative contract constitutes a netting netting set, subject to a floor of five if the fair value of the instrument set of one. percent. Thus, the PFE multiplier decreases when the value of the primary The exposure amount of each netting accounts for both over-collateralization risk factor increases. The assumptions of set is equal to an alpha factor of 1.4 and the negative fair value amount of zero fair value and zero collateral allow multiplied by the sum of the the derivative contracts within the for recognition of offsetting and replacement cost of the netting set and netting set. diversification benefits between the potential future exposure (PFE) of For purposes of calculating the derivative contracts that share similar the netting set: hedging set amount, a banking risk factors (i.e., long and short exposure amount = 1.4 * (replacement organization calculates the adjusted derivative contracts within the same cost + PFE) notional amount of a derivative contract hedging set could fully or partially For netting sets that are not subject to and multiplies that amount by a offset one another). a variation margin agreement, corresponding supervisory factor, replacement cost reflects a banking maturity factor, and supervisory delta to C. Overview of the Proposal organization’s current on-balance-sheet determine a conservative estimate of On October 30, 2018, the agencies credit exposure to its counterparty effective expected positive exposure measured as the maximum of the fair published a notice of proposed (EEPE), assuming zero fair value and rulemaking (proposal) to implement SA– value of the derivative contracts within 10 zero collateral. The Basel Committee CCR 11 in order to provide important the netting set less the applicable 9 Derivative contracts within the same asset class improvements to risk sensitivity and collateral or zero. For netting sets that 12 are subject to a variation margin share the same primary risk factor, which implies calibration relative to CEM. In agreement, the replacement cost of a a closer alignment between all of the underlying particular, the implementation of SA– risk factors and a higher correlation factor. For a CCR is responsive to concerns that CEM netting set reflects the maximum directional portfolio, greater alignment between the possible unsecured exposure amount of risk factors would result in a more concentrated has not kept pace with certain market the netting set that would not trigger a risk, leading to a higher exposure amount. For a practices that have been adopted, balanced portfolio, greater alignment between the variation margin call. For the particularly by large banking risk factors would result in more offsetting of risk, organizations that are replacement cost calculation, a banking leading to a lower exposure amount. organization recognizes the collateral 10 Under IMM, an advanced approaches banking amount on a dollar-for-dollar basis, organization uses its own internal models to profile for each netting set into an effective EE determine the exposure amount of its derivative profile by applying a nondecreasing constraint to subject to any applicable haircuts. contracts. The exposure amount under IMM is the corresponding EE profile over the first year. The PFE reflects a measure of potential calculated as the product of the EEPE for a netting nondecreasing constraint prevents the effective EE changes in a banking organization’s set, which is the time-weighted average of the profile from declining with time by replacing the counterparty exposure for a netting set effective expected exposures (EE) profile over a one- EE amount at a given future date with the maximum of the EE amounts across this and all prior over a specified period. The PFE year horizon, and an alpha factor. For the purposes of regulatory capital calculations, the resulting simulation dates. The EEPE for a netting set is the calculation allows a banking exposure amount is treated as a loan equivalent time-weighted average of the effective EE profile organization to fully or partially offset exposure, which is the amount effectively loaned by over a one-year horizon. EEPE would be the the banking organization to the counterparty under appropriate loan equivalent exposure in a contracts within the same risk capital calculation if the following assumptions netting set that share similar risk factors, the derivative contract. A banking organization arrives at the exposure amount by first determining were true: There is no , based on the concept of hedging sets. the EE profile for each netting set. In general, EE systematic , and wrong-way risk (i.e., the Under the Basel Committee standard, profile is determined by computing exposure size of an exposure is positively correlated with the derivative contracts form a hedging set distributions over a set of future dates using Monte counterparty’s probability of default). However, Carlo simulations, and the expectation of exposure these conditions nearly never exist with respect to if they share the same primary risk at each date is the simple average of all positive a derivative contract. Thus, to account for these

Monte Carlo simulated exposures for each date. The , IMM requires a banking organization to 7 See ‘‘The standardized approach for measuring of short-term trades can cause the EE multiply EEPE by 1.4. counterparty credit risk exposures,’’ Basel profile to decrease, even though a banking 11 See 83 FR 64660 (December 17, 2018). Committee on Banking Supervision (March 2014, organization is likely to replace short-term trades 12 The SUPPLEMENTARY INFORMATION set forth in rev. April 2014), https://www.bis.org/publ/ with new trades (i.e., rollover). To account for the proposal includes a description of CEM. See id. bcbs279.pdf. rollover, a banking organization converts the EE at 64664. 8 See e.g. supra note 2.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4365 these commenters expressed concern allows a banking organization to elect, 13 active in the . The that the proposal could indirectly at the netting set level, to treat all such agencies also proposed SA–CCR to increase the fees they pay to enter into contracts within the same netting set as provide a method that is less complex derivative transactions to manage collateralized-to-market, thus allowing and involves less discretion than IMM, commercial risks in order to help offset netting of settled-to-market derivative which allows banking organizations to the regulatory capital costs of such contracts with collateralized-to-market use their own internal models to derivative contracts for banking derivative contracts within the same determine the exposure amount of their organizations. The commenters asserted 14 netting set. In order to make the derivative contracts. Although IMM is that any such effect would be in election, a banking organization must more risk-sensitive than CEM, IMM is contravention of separate public policy treat the settled-to-market derivative significantly more complex and requires objectives designed to support the contracts as collateralized-to-market prior supervisory approval.15 The ability of commercial end-users to derivative contracts for all purposes agencies based the core elements of the engage in derivative transactions for under the SA–CCR calculation, proposal on the Basel Committee SA– risk-management purposes.17 By 16 including by applying the MPOR CCR standard. contrast, other commenters that The agencies received approximately treatment applicable to collateralized-to- opposed the proposal expressed market derivative transactions.19 58 comments on the proposal from concerns that it could reduce capital interested parties, including banking held against derivative contracts. Commenters also criticized the organizations, trade groups, members of As discussed in detail below, the proposal’s approach to the recognition Congress, and advocacy organizations. agencies are finalizing the proposal with of collateral provided to support a Banking organizations and trade groups some modifications to address certain derivative contract for purposes of the offered widespread support for the concerns raised by commenters. In supplementary leverage ratio. In implementation of SA–CCR although particular, the final rule removes the response to commenters’ concerns, and they also suggested modifications to alpha factor of 1.4 from the exposure consistent with changes to the Basel various components of the proposal amount calculation for derivative Committee leverage ratio standard that largely to address concerns regarding its contracts with commercial end-user occurred during the comment period, calibration. Commenters who supported counterparties. This change will reduce the final rule allows for greater the proposal also expressed concerns the exposure amount of such derivative recognition of collateral in the with its proposed implementation contracts by roughly 29 percent, in calculation of total leverage exposure schedule and potential interaction with comparison to similar derivative relating to client-cleared derivative certain other U.S. laws and regulations. 20 contracts with a counterparty that is not contracts. Other commenters, including some a commercial end-user. II. Overview of the Final Rule commercial entities that use derivative Commenters also raised concerns contracts to manage risks arising from regarding the proposed netting Figure 1 below provides a high-level their business operations (commercial treatment for settled-to-market overview of SA–CCR under the Final end-users), opposed the proposal or derivative contracts.18 The final rule Rule. elements of the proposal. Specifically,

FIGURE 1—OVERVIEW OF SA–CCR UNDER THE FINAL RULE

Purpose ...... • The final rule implements the standardized approach for counterparty-credit risk, in a manner consistent with the core elements of the Basel Committee standard. • A banking organization uses SA–CCR (either on a mandatory or an optional basis) to determine the capital requirements for its derivative contracts. SA–CCR Mechanics...... Under the final rule, a banking organization using SA–CCR determines the exposure amount for a netting set of derivative contracts as follows: Exposure amount = alpha factor × (replacement cost + potential future exposure)

Key Elements of the SA–CCR Formula

Replacement Cost ...... The replacement cost of a derivative contract reflects the amount that it would cost a banking organization to replace the derivative contract if the counterparty were to immediately default. Under SA–CCR, re- placement cost is based on the fair value of a derivative contract under U.S. GAAP, with adjustments to reflect the exchange of collateral for margined transactions.

13 The agencies initially adopted CEM in 1989. certain types of counterparties (e.g., counterparties 19 Banking organizations that make such an See 54 FR 4168 (January 27, 1989) (Board and OCC); that are not financial entities and are using swaps election would apply the maturity factor applicable 54 FR 11500 (March 21, 1989) (FDIC). The last to or mitigate commercial risks) from the to margined transactions under the final rule. See significant update to CEM was in 1995. See 60 FR mandatory clearing requirement. 7 U.S.C. See also section III.D.4. of this SUPPLEMENTARY 46170 (September 5, 1995). 6s(e)(3)(C); 15 U.S.C. 78o–10(e)(3)(C); 12 see also . 14 The set forth in CFR part 45 (OCC); 12 CFR part 237 (Board); and INFORMATION SUPPLEMENTARY INFORMATION 20 the proposal includes a description of IMM. See 83 12 CFR part 349 (FDIC) ( margin rule). See ‘‘Leverage ratio treatment of client cleared FR at 64665. 18 Settled-to-market derivatives contracts are derivatives,’’ Basel Committee on Banking 15 See 12 CFR 3.122 (OCC); 12 CFR 217.122 those entered into between a central counterparty Supervision, June 2019, https://www.bis.org/bcbs/ (Board); and 12 CFR 324.122 (FDIC). and a banking organization, under which the publ/d467.pdf. See also section V of this 16 See supra note 7. central counterparty’s rulebook considers daily SUPPLEMENTARY INFORMATION. 17 See, e.g., The Commodity Exchange Act and the payments of variation margin as a settlement 21 A counterparty’s maximum exposure to a Securities Exchange Act of 1934, as amended by payment for the exposure that arises from marking netting set subject to a varation margin agreement the derivative contract to fair value. These sections 731 and 764, respectively, of the Dodd- equals the threshold amount plus minimum transfer payments are similar to traditional exchanges of Frank Wall Street Reform and Consumer Protection amount. Act, Public Law 111–203, 124 Stat. 1376, 1703–12, variation margin, except that the receiving party 22 1784–96 (2010), require the agencies to, in takes title to the payment from the transferring Net independent collateral amount (NICA), as establishing capital and margin requirements for party rather than holding the assets as collateral, described in section III. B of this SUPPLEMENTARY non-cleared swaps, provide an exemption for and thus effectively settles the contract. INFORMATION.

4366 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

FIGURE 1—OVERVIEW OF SA–CCR UNDER THE FINAL RULE—Continued For un-margined transactions: RC = max{V C; 0}, where replacement cost (RC) equals the maximum of the fair value of the derivative contract (after excluding any valuation adjustments) (V) less the net amount of any collateral (C) received from the counterparty and zero. For margined transactions: RC = max{V C; TH + MTA NICA; 0}, where replacement cost equals the maximum of (1) the sum of the fair values (after excluding any valuation adjustments) of the derivative contracts within the netting set less the net amount of collateral applicable to such derivative contracts; (2) the counterparty’s maximum exposure to the netting set under the variation margin agreement (TH + MTA),21 less the net collateral amount applicable to such derivative contracts (NICA 22); or (3) zero. Potential Future Exposure ...... The potential future exposure of a derivative contract reflects the possibility of changes in the value of the derivative contract over a specified period. Under SA–CCR, the potential future exposure amount is based on the notional amount and maturity of the derivative contract, volatilities observed during the fi- nancial crisis for different classes of derivative contracts (i.e., interest rate, exchange rate, credit, equity, and commodity), the exchange of collateral, and full or partial offsetting among derivative contracts that share an economic relationship. PFE = multiplier × aggregated amount, where the PFE multiplier decreases exponentially from a value of 1 to recognize the amount of any excess collateral and the negative fair values of derivative contracts within the netting set. The aggregated amount accounts for full or partial offsetting among derivative con- tracts within a hedging set that share an economic relationship, as well as observed volatilities in the ref- erence asset, the maturity of the derivative contract, and the correlation between the derivative contract and the reference exposure (i.e., long or short). Alpha Factor ...... The alpha factor is a measure of conservatism that is designed to address risks that are not directly cap- tured under SA–CCR, and to ensure that the capital requirement for a derivative contract under SA– CCR is generally not lower than the one produced under IMM. For most derivative contracts, the alpha factor equals 1.4; however, no alpha factor applies to derivative contracts with commercial end-user counterparties.

A. Scope and Application of the Final under the capital rule.24 Both the agreements with central counterparties Rule standardized approach and the (i.e., default fund contributions).26 advanced approaches require a banking The proposal would have replaced 1. Scoping Criteria organization to determine the exposure CEM with SA–CCR in the capital rule The capital rule provides two amount for derivative contracts for advanced approaches banking methodologies for determining total transacted through a central organizations. Thus, for purposes of the risk-weighted assets: The standardized counterparty (i.e., cleared transactions) advanced approaches, an advanced approach, which applies to all banking and derivative contracts that are not approaches banking organization would organizations, and the advanced have been required to use either SA– cleared transactions (i.e., noncleared approaches, which apply only to CCR or IMM to calculate the exposure derivative contracts, otherwise known ‘‘advanced approaches banking amount of its noncleared and cleared as over-the-counter derivative organizations,’’ (or banking derivative contracts and to use SA–CCR contracts).25 As part of the cleared organizations subject to Category I or to determine the risk-weighted asset Category II standards) 23 as defined transactions framework, a banking amount of its default fund organization also must determine the contributions. For purposes of the 23 The agencies recently adopted a final rule to risk-weighted asset amounts of any standardized approach, an advanced revise the criteria for determining the applicability contributions or commitments it may approaches banking organization would of regulatory capital and liquidity requirements for have to mutualized loss sharing have been required to use SA–CCR large U.S. and foreign banking organizations (tailoring final rule). Under the tailoring final rule, (instead of CEM) to calculate the

24 an advanced approaches banking organization Standardized total risk-weighted assets serve as exposure amount of its noncleared and means a banking organization subject to Category I a floor for advanced approaches total risk-weighted cleared derivative contracts and to or Category II standards. Category I standards apply assets. Advanced approaches banking organizations determine the risk-weighted asset to U.S. global systemically important bank holding must therefore calculate total risk-weighted assets amount of its default fund companies (U.S. GSIBs) and their depository under both approaches and use the result that institution subsidiaries, as identified based on the produces a more binding capital requirement. Total contributions. The proposal also would methodology in the Board’s U.S. GSIB surcharge risk-weighted assets are the denominator of the risk- have revised the total leverage exposure rule. Category II standards apply to banking based capital ratios; regulatory capital is the measure of the supplementary leverage organizations that are not subject to Category I numerator. ratio by replacing CEM with a modified standards and that have $700 billion or more in 25 total consolidated assets or $75 billion or more in Under the standardized approach, the risk- version of SA–CCR. cross-jurisdictional activity and to their depository weighted asset amount for a derivative contract Banking organizations that are not institution subsidiaries. Category III standards currently is the product of the exposure amount of advanced approaches banking apply to banking organizations that are not subject the derivative contract calculated under CEM and organizations 27 would have had to to Category I or II standards and that have $250 the risk weight for the type of counterparty as set choose either CEM or SA–CCR to billion or more in total consolidated assets or $75 forth in the capital rule. See generally 12 CFR 3.35 billion or more in any of nonbank assets, weighted (OCC); 12 CFR 217.35 (Board); and 12 CFR 324.35 calculate the exposure amount of short-term wholesale funding, or off-balance-sheet (FDIC). Under the advanced approaches, the risk- exposure. Category III standards also apply to 26 weighted asset amount for a derivative contract See 12 CFR 3.35(d) and 3.133(d) (OCC); 12 CFR depository institution subsidiaries of any holding 217.35(d) and 217.133(d) (Board); and 12 CFR currently is derived using either CEM or the company subject to Category III standards. Category 324.35(d) and 324.133(d) (FDIC). internal models methodology, which multiplies the IV standards apply to banking organizations with 27 Under this final rule, banking organizations total consolidated assets of $100 billion or more, exposure amount (or exposure at default amount) of that are not advanced approaches banking and their depositiory institution subsidiaries, that the derivative contract by a models-based formula organizations (i.e., banking organizations subject to do not meet any of the criteria for a higher category that uses risk parameters determined by a banking Category III or Category IV standards) are permitted of standards. See ‘‘Changes to Applicabiltiy organization’s internal methodologies. See generally to choose either CEM or SA–CCR for purposes of Thresholds for Regulatory Capital and Liquidity 12 CFR 3.132 (OCC); 12 CFR 217.132 (Board); and determining standardized risk-weighted assets. See Requirements,’’ 84 FR 59230 (November 1, 2019). 12 CFR 324.132 (FDIC). supra note 23.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4367 IMM to calculate the exposure amount based solely on the composition of a noncleared and cleared derivative of derivative contracts under the banking organization’s derivatives contracts and to determine the risk- standardized approach. Some of these portfolio, as suggested by commenters, weighted asset amount of default fund commenters also asked the agencies to would be inconsistent with these contributions under the standardized tailor the application of SA–CCR based objectives. approach. on the composition of a banking Consistent with the proposal, the final Some commenters raised concerns organization’s derivatives portfolio, rule includes CEM, SA–CCR, and IMM with the proposal’s use of multiple rather than solely based on whether the as methodologies for banking methods—CEM, SA–CCR, and IMM—to banking organization meets the organizations to use to determine the determine the exposure amount of definition of an advanced approaches exposure amount of derivative contracts derivative contracts. Specifically, banking organization. and prescribes which approach a commenters stated that including Limiting all banking organizations to banking organization must use based on multiple approaches for calculating the a single methodology would be the category of standards applicable to exposure amount of derivative contracts inconsistent with the agencies’ efforts to the banking organization.29 As under in the capital rule creates regulatory tailor the application of the capital rule the capital rule currently, the final rule burden and increases the potential for to the risk profiles of banking does not permit advanced approaches competitive inequalities. The organizations.28 In particular, while SA– banking organizations to use IMM to commenters asked the agencies to adopt CCR offers several improvements to the calculate the exposure amount of one methodology that all banking regulatory capital treatment for derivative contracts under the organizations would be required to use derivative contracts relative to CEM, it standardized approach. to determine the exposure amount of also requires internal systems Under the final rule and as reflected derivative contracts or, short of that, to enhancements and other operational further in Table 1, an advanced allow all banking organizations (i.e., modifications that could be particularly approaches banking organization both advanced approaches and non- burdensome for smaller, less complex generally may use SA–CCR or IMM for advanced approaches banking banking organizations. Moreover, purposes of determining advanced organizations) to elect to use any allowing banking organizations to use approaches total risk-weighted assets,30 approach—CEM, SA–CCR, or IMM—to IMM for purposes of determining and must use SA–CCR for purposes of determine the exposure amount for all standardized total risk-weighted assets determining standardized total risk- derivative contracts, as long as the would be inconsistent with an intended weighted assets as well as the approach is permitted or required under purpose of the standardized approach, supplementary leverage ratio. A non- any of the agencies’ rules to calculate which is to serve as a floor to model- advanced approaches banking the exposure amount of derivative derived outcomes under the advanced organization may continue to use CEM contracts. Other commenters, however, approaches. or elect to use SA–CCR for purposes of supported allowing advanced The proposal to require advanced the standardized approach and approaches banking organizations the approaches banking organizations to use supplementary leverage ratio (as to use IMM for noncleared and either SA–CCR or IMM to determine the applicable).31 Where a banking cleared derivative contracts to facilitate exposure amount of their noncleared organization has the option to choose closer alignment with internal risk- and cleared derivative contracts under among the approaches applicable to management practices of banking the advanced approaches provides such banking organization under the organizations because, according to the meaningful flexibility, promotes capital rule, it must use the same commenters, SA–CCR may not adapt consistency for banking organizations approach for all purposes. As discussed dynamically to changes in market that have substantial operations in in section II.C of this SUPPLEMENTARY conditions. multiple jurisdictions, and facilitates INFORMATION, the agencies will continue Some commenters also requested regulatory reporting and the supervisory to consider the extent to which SA–CCR changes to the applicability criteria for assessment of an advanced approaches should be incorporated into areas of the a particular methodology under the banking organization’s capital regulatory framework that are not capital rule. Specifically, commenters management program. An approach that addressed under this final rule in the asked the agencies to allow advanced tailors the applicability of SA–CCR context of separate rulemakings. approaches banking organizations to use

TABLE 1—SCOPE AND APPLICABILITY OF THE FINAL RULE

Noncleared derivative contracts Cleared transactions framework Default fund contribution

Advanced approaches banking or- Option to use SA–CCR or IMM .... Must use the same approach se- Must use SA–CCR. ganizations, advanced ap- lected for purposes of non- proaches total risk-weighted as- cleared derivative contracts. sets. Advanced approaches banking or- Must use SA–CCR ...... Must use SA–CCR ...... Must use SA–CCR. ganizations, total risk-weighted assets under the standardized approach.

28 See id. to determine its exposure to default fund Category III standards. See supra notes 5 and 23. 29 Id. contributions under the advanced approaches. The use of SA–CCR for purposes of the 31 30 As reflected in Table 1, an advanced The tailoring final rule revised the scope of supplementary leverage ratio is discussed in greater applicability of the supplementary leverage ratio, approaches banking organization must use SA–CCR detail in section V of this SUPPLEMENTARY such that it applies to U.S. and foreign banking INFORMATION. organizations subject to Category I, Category II, or

4368 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

TABLE 1—SCOPE AND APPLICABILITY OF THE FINAL RULE—Continued

Noncleared derivative contracts Cleared transactions framework Default fund contribution

Non-advanced approaches bank- Option to use CEM or SA–CCR ... Must use the same approach se- Must use the same approach se- ing organizations, total risk- lected for purposes of non- lected for purposes of non- weighted assets under the cleared derivative contracts. cleared derivative contracts. standardized approach.

Advanced approaches banking or- Must use SA–CCR to determine the exposure amount of derivative contracts for total leverage exposure. ganizations, supplementary le- verage ratio.

Banking organizations subject to Option to use CEM or SA–CCR to determine the exposure amount of derivative contracts for total leverage Category III capital standards, exposure. A banking organization must use the same approach, CEM or SA–CCR, for purposes of both supplementary leverage ratio. standardized total risk-weighted assets and the supplementary leverage ratio.

2. Applicability to Certain Derivative 3. Application to New Derivative B. Effective Date and Compliance Contracts Contracts and Immaterial Exposures Deadline The proposal would have required a Under the current capital rule, an The proposal included a transition banking organization to calculate the advanced approaches banking period, until July 1, 2020, by which time exposure amount for all derivative organization can use CEM for a period all advanced approaches banking contracts to which the banking of 180 days for material portfolios of organizations would have been required organization has an exposure. new derivative contracts and without to implement SA–CCR; however, both Commenters raised concerns regarding time limitations for immaterial advanced approaches and non-advanced the treatment of certain derivative portfolios of new derivative contracts to approaches banking organizations contracts under the proposal. satisfy the requirement that the total would have been able to adopt SA–CCR Specifically, several commenters asked exposure amount calculated under IMM as of the effective date of the final rule. the agencies to exclude from banking must be at least equal to the greater of Several commenters asked the organizations’ regulatory capital the expected positive exposure amount agencies to delay adoption of the final calculations derivative contracts with under either the modelled stress rule. Specifically, some of these commercial end-user counterparties, scenario or the modelled un-stressed commenters asked that the agencies while other commenters suggested that scenario multiplied by 1.4.33 Some delay adoption until completion of a the final rule should exclude physically commenters noted that the proposal did comprehensive study on the effect of the settled forward contracts. Other not replace CEM with SA–CCR for these proposal, including the effect of SA– commenters requested that the agencies purposes and suggested providing CCR on commercial end-user allow advanced approaches banking advanced approaches banking counterparties. Other commenters also organizations to continue to use CEM to organizations the option to consider SA– asked the agencies to delay adoption of calculate the exposure amount of their CCR, in place of CEM, to satisfy the same SA–CCR, or alternatively, the derivative contracts with commercial conservatism requirements. The mandatory compliance date, in order to end-user counterparties. agencies recognize that an advanced align its implementation with potential Excluding certain derivative contracts approaches banking organization may forthcoming changes to the U.S. from the application of the capital rule, need time to develop systems and regulatory capital framework that might as suggested by commenters, would collect sufficient data to appropriately be implemented through separate exclude a material source of credit risk model the exposure amount for material rulemakings.35 These commenters from a banking organization’s regulatory portfolios of new derivatives under expressed concern that the interaction capital requirements. Moreover, IMM. Therefore, under the final rule, an between SA–CCR and related aspects of requiring a banking organization to use advanced approaches banking the U.S. regulatory capital framework the same approach for its entire organization that elects to use IMM to could result in increased capital derivative portfolio when calculating calculate the exposure amount of its requirements for banking organizations either its standardized or advanced derivative contracts under the advanced that are not reflective of underlying risk. approaches total risk-weighted assets approaches may use SA–CCR for a In addition, some of these commenters promotes consistency in the regulatory period of 180 days for material specifically urged the agencies to pair capital treatment of derivative contracts, portfolios of new derivative contracts the adoption of SA–CCR with the and facilitates the supervisory and for immaterial portfolios of such implementation of the Basel assessment of a banking organization’s contracts without time limitations.34 Committee’s revised comprehensive capital management program.32 This treatment is consistent with the approach for securities financing Therefore, consistent with the proposal, current capital rule. transactions.36 These commenters the final rule does not provide an argued that banking organizations could 33 See 12 CFR 3.132(d)(10) (OCC); 12 CFR use derivative transactions as a exclusion for specific types of derivative 217.132(d)(10) (Board); and 12 CFR 324.132(d)(10) contracts nor does it permit the use of (FDIC). substitute for securities financing different methodologies based on the 34 Similar to CEM, as a standardized framework, type of derivative contract or SA–CCR is designed to produce sufficiently 35 For example, the commenters noted potential conservative exposure amounts, compared to those changes to the regulatory framework as a result of counterparty. calculated under IMM, that satisfy the conservatism the Basel Committee’s December 2017 release. See requirement under § .132(d)(10)(i). The final rule ‘‘Basel III: Finalising post-crisis reforms,’’ Basel 32 The final rule does not revise the FR Y–15 also makes similar conforming changes elsewhere Committee on Banking Supervision, December report to reflect SA–CCR, as discussed further in in § .132(d) and (e) to incorporate SA–CCR in the 2017, https://www.bis.org/bcbs/publ/d424.pdf. section II.C of this SUPPLEMENTARY INFORMATION. place of CEM. 36 Id.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4369 improvements to risk sensitivity and effective as of the effective date of the transactions and, therefore, adopting calibration relative to CEM and is final rule. SA–CCR without implementing the responsive to concerns that CEM has not revised comprehensive approach for kept pace with market practices used by C. Final Rule’s Interaction With Agency securities financing transactions could large banking organizations that are Requirements and Other Proposals lead to further concentration in the active in the derivatives market. The implementation of SA–CCR derivatives market and decreases in the Therefore, the agencies are not delaying affects other parts of the regulatory liquidity of the securities financing adoption of the final rule. The agencies framework. Commenters asked that the transactions market. Alternatively, other intend to monitor the implementation of agencies clarify the interaction between commenters urged the agencies to set SA–CCR as part of their ongoing SA–CCR and other existing aspects of the mandatory compliance date as of assessment of the effectiveness of the the framework that would be affected by January 2022 to align with other overall U.S. regulatory capital the adoption of SA–CCR, including the anticipated changes to the U.S. framework to determine whether there FDIC’s deposit insurance assessment regulatory capital framework, and are opportunities to reduce burden and methodology, the Banking Organization supported allowing banking improve its efficiency in a manner that Report (FR Y–15), the organizations to adopt SA–CCR or continues to support the safety and stress test projections in the Board’s portions of SA–CCR as early as the soundness of banking organizations and Comprehensive Capital Analysis and issuance of the final rule. U.S. financial stability. Review (CCAR) process, and the OCC’s Additionally, several commenters However, the agencies recognize that lending limits. Commenters also asked asked the agencies to align U.S. the implementation of SA–CCR requires that the agencies clarify the interaction implementation of SA–CCR with its advanced approaches banking between SA–CCR and potential future implementation schedule in other organizations to augment existing revisions to the U.S. regulatory capital jurisdictions, so as not to disadvantage systems or develop new ones, as all framework, including potential U.S. banking organizations and their such banking organizations must adopt implementation of the December 2017 U.S. clients relative to foreign firms. SA–CCR for the standardized approach Basel Committee release, Basel III: These commenters argued that a even if they plan to continue using IMM Finalising post-crisis reforms (Basel III 39 mandatory compliance date of January under the advanced approaches. finalization standard), and the Board’s 2022 would ensure internationally Accordingly, the final rule includes a stress capital buffer proposal. consistent implementation of SA–CCR mandatory compliance date for across jurisdictions and allow banking 1. FDIC Deposit Insurance Assessment advanced approaches banking Methodology organizations ample time to implement organizations of January 1, 2022, to Some commenters noted that the SA–CCR for purposes of both existing permit these banking organizations adoption of SA–CCR could affect the regulatory capital requirements and any additional time to adjust their systems, FDIC assessment methodology. In anticipated forthcoming changes to the as needed, to implement SA–CCR. The response to this comment, the FDIC U.S. regulatory capital framework. Other final rule also includes an effective date commenters suggested extending the shortly after publication that permits notes that a lack of historical data on derivative exposure using SA–CCR mandatory compliance date to January any banking organization to elect to makes the FDIC unable to incorporate 2022 for banking organizations that use adopt SA–CCR prior to the mandatory the SA–CCR methodology into the CEM currently and do not have compliance date. For this reason, the deposit insurance assessment pricing extensive derivatives portfolios. agencies do not believe that it is methodology for highly complex Conversely, several commenters asked necessary to provide any interim institutions 40 upon the effective date of the agencies to adopt the proposal as a adjustments to the current framework. final rule without delay and to retain Advanced approaches and non- this rule. The FDIC plans to review the proposed July 2020 mandatory advanced approaches banking derivative exposure data reported using compliance date. Of these, some organizations that adopt SA–CCR prior SA–CCR, and then consider options for commenters suggested that the effective to the mandatory compliance date must addressing the use of SA–CCR in the date for implementation of SA–CCR notify their appropriate Federal deposit insurance assessment system. In should be earlier than July 2020 for the supervisor. Non-advanced approaches the meantime, for purposes of reporting entirety or portions of the SA–CCR rule. banking organizations that adopt SA– counterparty exposures on Schedule These commenters also asked the CCR after the mandatory compliance RC–O, memorandum items 14 and 15, agencies to provide interim relief date also must notify their appropriate 39 through a reduction in risk weights for Federal supervisor. As the final rule See supra note 35. certain financial products, such as 40 A ‘‘highly complex institution’’ is defined as: does not allow banking organizations to (1) An insured depository institution (IDI) options, if the implementation of SA– use SA–CCR for a material subset of (excluding a credit card bank) that has had $50 CCR is delayed. derivative exposures under either the billion or more in total assets for at least four The agencies anticipate that the final consecutive quarters that either is controlled by a standardized or advanced approaches, a U.S. parent holding company that has had $500 rule will not materially change the banking organization cannot early adopt amount of capital in the banking system, billion or more in total assets for four consecutive SA–CCR on a partial basis.38 In quarters, or is controlled by one or more and that any change in a particular addition, the technical revisions in the intermediate U.S. parent holding companies that banking organization’s capital final rule, as described in section VI of are controlled by a U.S. holding company that has requirements, through either an increase this SUPPLEMENTARY INFORMATION, are had $500 billion or more in assets for four or a decrease in regulatory capital, consecutive quarters; or (2) a processing bank or would reflect the enhanced risk trust company. A processing bank or trust company sensitivity of SA–CCR relative to CEM, 38 The final rule allows banking organizations that is an IDI whose last three years’ non-lending as well as market conditions.37 In elect to use SA–CCR to continue to use method 1 interest income, fiduciary revenues, and investment or method 2 under CEM to calculate the risk- banking fees, combined, exceed 50 percent of total addition, SA–CCR provides important weighted asset amount for default fund revenues (and its last three years fiduciary revenues

contributions until January 1, 2022. See section are non-zero), whose total fiduciary assets total 37 The estimated impact of the final rule is IV.B. of this SUPPLEMENTARY INFORMATION for a more $500 billion or more and whose total assets for at described in greater detail in section VII of this detailed discussion on the treatment of default fund least four consecutive quarters have been $10 SUPPLEMENTARY INFORMATION. contributions under the final rule. billion or more. See 12 CFR 327.8(g) and (s).

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4371 some commenters asked the Board to losses associated with adverse economic highly complex institutions must clarify when a banking organization conditions, in an environment of continue to calculate derivative must incorporate SA–CCR into any economic uncertainty. The Board exposures using CEM (as set forth in 12 stress test projections made for purposes regularly reviews its stress testing CFR 324.34(b) under the final rule), but of the Comprehensive Capital Analysis models, and will continue to evaluate without any reduction for collateral and Review (CCAR) relative to the appropriateness of assumptions other than cash collateral that is all or the timing of its implementation for related to the largest counterparty part of variation margin and that regulatory capital purposes. Consistent default component. satisfies the requirements of 12 CFR with past capital planning practice, the 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and Board expects to make revisions so as to 4. Swap Margin Rule 324.10(c)(4)(ii)(C)(3)–(7) (as amended not require a banking organization to Commenters noted that the agencies’ under the final rule). Similarly, highly use SA–CCR for purposes of the CCAR margin and capital requirements for complex institutions must continue to exercise prior to adopting SA–CCR to covered swap entities rule (swap margin report the exposure amount associated calculate its risk-based and rule) uses a methodology similar to CEM with securities financing transactions, supplementary leverage capital to quantify initial margin requirements including cleared transactions that are requirements (as applicable) under the for non-cleared swaps and non-cleared securities financing transactions, using capital rule. To promote comparability security-based swaps.44 This final rule the standardized approach set forth in of stress test results across banking does not affect the swap margin rule or 12 CFR 324.37(b) or (c) (as amended organizations, for the 2020 stress test the calculation of appropriate margin under the final rule). The FDIC is cycle all banking organizations would and, therefore, the implementation of making technical amendments to its continue to use CEM for the CCAR SA–CCR will not require a banking assessment regulations to update cross- exercise. However, a banking organization to change the way it references to CEM and cash collateral organization that has elected to adopt complies with those requirements. requirements in 12 CFR part 324. SA–CCR in 2020 would be required to 5. OCC Lending Limits 2. The Banking Organization Systemic use SA–CCR for the CCAR exercise Risk Report (FR Y–15) beginning with the 2021 stress test In the proposal, the OCC proposed to cycle, and those who adopt in 2021 revise its lending limit rule at 12 CFR Some commenters noted that the must use SA–CCR for the CCAR exercise part 32, to update cross-references to adoption of SA–CCR could affect beginning with 2022 stress test cycle.42 CEM in the standardized approach and reporting on the Banking Organization Finally, a banking organization that to permit SA–CCR as an option for Systemic Risk Report (FR Y–15), which does not adopt SA–CCR until the calculation of exposures under lending must be filed by U.S. bank holding mandatory compliance date in 2022 limits. Commenters generally supported companies and certain savings and loan would not be required to use SA–CCR the OCC’s proposal to align holding companies with $100 billion or for the CCAR exercise until the 2023 measurement of counterparty credit risk more in total consolidated assets and and all subsequent stress test cycles. across regulatory requirements. The foreign banking organizations with $100 Prior to the time of adoption in stress OCC agrees with the commenters and billion or more in combined U.S. testing, the Board expects to update the therefore the final rule adopts revisions assets.41 In particular, these commenters Form FR Y–14 to implement these to the lending limits rule as proposed. requested that the agencies exclude the changes and to provide any necessary alpha factor from the exposure amount information on how to incorporate SA– 6. Single Counterparty Credit Limit calculation under SA–CCR for purposes CCR into a banking organization’s stress (SCCL) of the interconnectedness indicator test results.43 As noted in the proposal, the Board’s under the FR Y–15. The Board expects Commenters also suggested aligning single counterparty credit limit (SCCL) to address the use of SA–CCR for certain aspects of the CCAR exercise rule authorizes a banking organization purposes of the FR Y–15 in a separate with SA–CCR. Specifically, commenters subject to the SCCL to use any process. Until such time, banking asked the Board to revise the CCAR methodology that such a banking organizations that must report the FR Y– methodology for estimating losses under organization is authorized to use under 15 should continue to use CEM to the largest single counterparty default the capital rule to determine the credit determine the potential future exposure scenario to distinguish between exposure associated with a derivative of their derivative contracts for purposes margined and unmargined counterparty contract for purposes of the SCCL rule.45 of completing line 11(b) of Schedule B, relationships in a manner consistent Thus, as under the proposal, as of the consistent with the current instructions with SA–CCR. The methodologies for mandatory compliance date for SA– to the form. measuring counterparty exposure under CCR, to determine the credit exposure 3. Stress Test Projections in CCAR SA–CCR and supervisory stress testing associated with a derivative contract Commenters asked the Board to are designed to capture different types under the SCCL rule, an advanced clarify how the implementation of SA– of risks. In particular, the largest single approaches banking organization must CCR will interact with the supervisory counterparty default exercise seeks to use SA–CCR or IMM and a banking stress-testing program. In particular, ensure that a banking organization can organization subject to Category III absorb losses associated with the default standards, which include the SCCL rule, 41 See Reporting Form FR Y–15, Instructions for of any counterparty, in addition to must use whichever of CEM or SA–CCR Preparation of Banking Organization Systemic Risk Report (reissued December 2016). The Board 42 For banking organizations subject to Category 44 See supra note 17. recently finalized modifications the reporting panel IV supervisory stress test requirements, 2022 is an 45 See 83 FR 38460 (August 6, 2018). The Board- and certain substantive requirements of Form FR Y– on-cycle year. only tailoring final rule revised the scope of 15 in connection with the tailoring final rule 43 Banking organizations that report information applicability of the SCCL rule, such that it applies adopted by the agencies. See 84 FR 59032 on the FR Y–14 under SA–CCR must do so for all to U.S. and foreign banking organizations subject to (November 1, 2019) (Board-only final rule to schedules, including DFAST and CCAR. The Category I, II, or III standards, as applicable, and establish risk-based categories for determining anticipated standards described in this section foreign banking organizations with global prudential standards to large U.S. and foreign would apply equally for purposes of DFAST and consolidated assets of $250 billion or more. See banking organizations (Board-only tailoring final CCAR. supra note 41. rule)); see also supra note 23.

4370 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations could be less willing to engage in more closely align with the treatment of that it uses to calculate its standardized derivative contracts with commercial investment-grade corporate exposures total risk-weighted assets. end-users who may lack the capability under the revised Basel III finalization 7. Potential Future Revisions to the and scale to provide financial collateral standard.51 Agencies’ Rules recognized under the capital rule. The agencies recognize that derivative Commenters also expressed concern contracts between banking organizations Commenters requested additional that any increase in hedging costs for and commercial end-users may include information on the interaction of SA– commercial end-users could have an credit risk mitigants that do not qualify CCR with other potential revisions that adverse impact on the broader economy. as financial collateral under the capital the agencies may make to their Commenters generally suggested that rule.52 In addition, and in contrast to respective regulatory capital rules. the agencies address these issues derivative contracts with financial end- Potential revisions identified by through changes to the alpha factor, users, derivative contracts with commenters included the either by removing it for all derivative commercial end-users have heightened implementation of the Basel III contracts with commercial end-user potential to present right-way risk.53 finalization standard and the Board’s counterparties, or only for such The final rule removes the alpha factor proposal to integrate the capital rule and contracts that are unmargined. from the exposure amount formula for CCAR and stress test rules published in 46 Commenters asserted that providing derivative contracts with commercial April 2018. In addition, the proposed relief for derivative contracts with end-user counterparties. The agencies net stable funding ratio rule would commercial end-user counterparties intend for this treatment to better align cross-reference netting provisions of the would not undermine the goals of the with the counterparty credit risk agencies’ supplementary leverage ratio 47 proposal because these transactions presented by such exposures due to the that are amended under the final rule. comprise a small percentage of presence of credit risk mitigants and the The agencies will consider the outstanding derivatives and may present potential for such transactions to calibration and operation of SA–CCR for less risk than other directional, present right-way risk. In particular, the purposes of any such potential revisions unmargined derivatives. In support of agencies recognize that derivative through the rulemaking process. this assertion, commenters argued that exposures to commercial end-user III. Mechanics of the Standardized commercial end-users typically provide counterparties may be less likely to Approach for Counterparty Credit Risk collateral that is not recognized as present the types of risks that the alpha financial collateral under the capital factor was designed to address, as A. Exposure Amount rule but nonetheless reduces the discussed previously, and therefore Under the proposal, the exposure counterparty credit risk of the believe that removing the alpha factor amount of a netting set would have been underlying transaction.48 Commenters for such exposures improves the equal to an alpha factor of 1.4 also argued that removing or reducing calibration of SA–CCR. The agencies multiplied by the sum of the the alpha factor for such derivative note that this approach also may replacement cost of the netting set and contracts would be consistent with mitigate the concerns of commenters the PFE of the netting set. The purposes congressional and regulatory efforts regarding the potential effects of the of the alpha factor were to address designed to facilitate the ability of such proposal relative to congressional and certain risks that are not captured under counterparties to enter into derivative other regulatory actions designed to SA–CCR and to ensure that exposure contracts to manage commercial risks.49 mitigate the effect that post-crisis amounts produced under SA–CCR Some commenters argued that derivatives market reforms have on the generally would not be lower than those applying the alpha factor to derivative ability of these parties to enter into under IMM, in support of its use as a contracts with commercial end-user derivative contracts to manage broadly applicable and standardized counterparties is misaligned with the commercial risks. The agencies intend methodology. In addition, the proposal risks that the alpha factor was intended to monitor the implementation of SA– would have set the exposure amount at to address under IMM, such as wrong- CCR as part of their ongoing assessment zero for a netting set that consists of way risk.50 Some commenters of the effectiveness of the overall U.S. only sold options in which the recommended reducing the alpha factor regulatory capital framework to counterparty to the options paid the to 0.65 for derivative contracts with determine whether there are premiums up front and that the options investment grade commercial end-user opportunities to improve the ability of within the netting set are not subject to counterparties, or with non-investment commercial end-users to enter into a variation margin agreement. grade commercial end-user derivative contracts with banking Commenters stated that the proposal counterparties that are supported by a organizations in a manner that would increase the exposure amount of letter of credit or provide a first-priority continues to support the safety and derivative contracts with commercial lien on assets that do not present wrong- soundness of banking organizations and end-users, relative to CEM, because way risk with respect to the underlying U.S. financial stability. commercial end-users often have derivative contract. These commenters Beyond the concerns related to directional, unmargined derivative argued that reducing the alpha factor to commercial end-users, commenters portfolios, which would not receive the benefits of collateral recognition and 0.65 would improve risk sensitivity and netting under SA–CCR in the form of a 51 See supra note 3555. reduction to the replacement cost and 48 The types of collateral that commercial end- 52 Under § l.2 of the capital rule, financial PFE amounts. As a result, commenters users provide that do not qualify as financial collateral means cash or liquid and readily collateral under the capital rule are discussed in marketable securities, in which a banking expressed concern that banking further detail in section III.B. of this SUPPLEMENTARY organization has a perfected first-priority security organizations would pass the costs of INFORMATION. interest in the collateral. See 12 CFR 3.2 (OCC); 12 higher capital to commercial end-users 49 See supra note 17. CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). in the form of higher fees or, 50 Wrong way risk means that the size of an 53 Right way risk means that the size of an exposure is positively correlated with the exposure is negatively correlated with the alternatively, that banking organizations counterparty’s probability of default—that is, the counterparty’s probability of default—that is, the

exposure amount of the derivative contract exposure amount of the derivative contract 46 See 83 FR 18160 (April 25, 2018). increases as the counterparty’s probability of decreases as the counterparty’s probability of 47 See 81 FR 35124 (June 1, 2016). default increases. default increases.

4372 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations commenters asserted that custody exposure amount = 1.4 * (replacement recommended other changes to the banking organizations do not maintain cost + PFE). alpha factor. Several commenters large portfolios of derivative contracts However, for a derivative contract suggested removing the alpha factor across a broad range of tenors (i.e., the with a commercial end-user from the SA–CCR methodology amount of time remaining before the counterparty, the exposure amount is altogether, whereas other commenters end date of the derivative contract) and suggested that the alpha factor should represented as follows: asset classes and that the foreign apply only to the PFE component. Some exposure amount = (replacement cost + exchange derivative portfolio of a commenters supported reducing or PFE). custody banking organization is eliminating the alpha factor as it applies To operationalize the exposure intended to serve the investment needs to all or a subset of derivative contracts. amount formula for derivative contracts of the custody banking organization’s Commenters that recommended with commercial end-user clients rather than to take on economic removing the alpha factor argued that counterparties, the final rule provides a risk. the rationale for adopting the alpha definition of commercial end-user. factor for purposes of IMM does not In contrast, some commenters who Under the final rule, a commercial end- apply in the context of SA–CCR supported the alpha factor suggested user means a company that is using because, in contrast to IMM, SA–CCR is that concerns regarding its impact on derivatives to hedge or mitigate a non-modelled approach and does not the exposure amount calculated under commercial risk, and is not a financial require an adjustment to account for SA–CCR are overstated. Specifically, entity listed in section 2(h)(7)(C)(i)(I) model risk. Similarly, other commenters these commenters argued that banking through (VIII) of the Commodity noted that the alpha factor is less organizations have incentives to Exchange Act 56 or is not a financial meaningful in the United States minimize estimates of risk for regulatory entity listed in section 3C(g)(3)(A)(i) because, under the capital rule, the capital purposes and that internal through (viii) of the Securities Exchange standardized approach serves as a floor models failed to account properly for Act.57 The definition also includes an to the advanced approaches for total risk during the crisis and have been entity that qualifies for the exemption risk-weighted assets. Some of these criticized in analyses conducted since from clearing under section 2(h)(7)(A) of commenters also stated that the then. In addition, these commenters the Commodity Exchange Act by virtue potential elimination of the advanced stated that although SA–CCR uses of section 2(h)(7)(D) of the Commodity approaches in connection with the U.S. estimates of for individual Exchange Act, including entities that are implementation of the Basel III positions that are based on observed, exempted from the definition of finalization standard would eliminate crisis period volatilities, greater financial entity under section use of IMM and undermine the need for recognition of netting and margin under 2(h)(7)(C)(iii) of the Commodity the alpha factor. Other commenters SA–CCR may fully offset any Exchange Act; 58 or qualifies for the argued that because IMM incorporates conservatism resulting from the use of exemption from clearing under section relatively higher stressed-volatility updated volatility estimates. 3C(g)(1) of the Securities Exchange Act inputs while the supervisory factors As noted in the proposal, the alpha by virtue of section 3C(g)(4) of the under SA–CCR are static, attempts to Securities Exchange Act.59 Including have SA–CCR yield a more conservative factor helps to instill an appropriate level of conservatism and further these entities within the commercial end- exposure amount than IMM in all cases user definition permits affiliates that could result in SA–CCR producing support the use of SA–CCR as a broadly hedge commercial risks on behalf of a excessive capital requirements that are applicable and standardized parent entity that is not a financial entity disconnected from the actual risk of the methodology. Additionally, the alpha to qualify as a commercial end- user, underlying exposures. Alternatively, factor serves to capture certain risks which would accommodate business other commenters recommended only (e.g., wrong-way risk, non-granular risk organizations that hedge commercial applying the alpha factor to PFE. These exposures, etc.) that are not fully risks through transactions conducted by commenters argued that applying the reflected under either IMM or SA–CCR. alpha factor to replacement cost would Adopting commenters’ affiliates rather than directly by the be inappropriate as the fair value of on- recommendations could reduce the parent company. Overall, the definition balance sheet derivatives are not subject efficacy of SA–CCR as a standardized covers commercial end- users and to model uncertainty. approach that serves a floor to internal generally excludes financial entities. Commenters that supported reducing models-based approaches. For large, This definition has the advantage of the alpha factor recommended revising internationally active banking being generally consistent with other the calibration to reflect the derivatives organizations, consistency with the regulations promulgated by the Basel Committee standard also helps to agencies, including the swap margin market reforms that followed the 60 financial crisis, such as mandatory reduce operational burden and rule. Referencing provisions of the clearing requirements promulgated by minimize any incentives such banking Commodities Exchange Act or the Commodity Futures Trading organizations may have to book Securities Exchange Act promotes Commission (CFTC) 54 and the swap activities in legal entities located in consistency with other regulations and margin rule.55 Of these, some jurisdictions that provide relatively offers a significant compliance benefit to commenters supported applying a lower more favorable regulatory capital 56 7 U.S.C. 2(h)(7)(C)(i)(I) through (VIII). The alpha factor to heavily over- treatment. commercial end-user definition also applies to collateralized portfolios in order to Accordingly, the final rule transactions with affiliates of entities that enter into provide greater collateral recognition. incorporates an alpha factor of 1.4 in the derivative contracts on behalf of those entities that meet the criteria under section 2(h)(7)(D) of the Additionally, some commenters exposure amount formula, except as it expressed concern that the alpha factor Commodity Exchange Act. applies to derivative contracts with 57 15 U.S.C. 78c–3(g)(3)(A)(i) through (viii). could adversely affect custody banking commercial end-user counterparties for 58 7 U.S.C. 2(h)(7)(A), (C)(iii), and (D). organizations. In particular, the which the alpha factor is removed under 59 15 U.S.C. 78c–3(g)(1) and (4).

the final rule. The exposure amount 60 See supra note 17. 54 See 17 CFR part 50. formulas are represented as follows: 55 See supra note 17.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4373 qualifying cross-product master netting To qualify as a QMNA, the netting 61 institutions subject to the final rule. In agreement. The proposal would have agreement must satisfy certain addition, in the swap margin rule allowed a banking organization to operational requirements under § l.3 of context, the agencies observed that calculate the exposure amount of the capital rule.67 differences in risk profiles justified multiple derivative contracts under the Some commenters expressed concern distinguishing between financial end- same netting set so long as each that the proposed definition of netting users and non-financial end-users, on derivative contract is subject to the same set could inadvertently affect the the grounds that financial firms present QMNA. treatment for repo-style transactions a higher level of risk than other types of Some commenters raised concerns under other provisions of the capital counterparties and are more likely to with the proposal’s reliance on netting rule. The proposed definition was default during a period of financial to reduce exposure amounts on a point- intended to reflect that under SA–CCR stress, thus posing greater risk to the in-time basis instead of on a dynamic a banking organization would determine safety and soundness of the basis and suggested revising the 62 the exposure amount for a derivative counterparty and systemic risk. While proposal to account for situations that contract at the netting set level, which some commenters requested an may arise during stress periods that would have included a single derivative exemption for entities that was slightly could disrupt the availability of netting. contract. However, to address the narrower or broader than the definition As an example, the commenters noted commenters’ concern, the agencies have the agencies are adopting in the final that during the financial crisis some revised the definition of netting set rule, as noted above, the distinction banking organizations requested to under the final rule to mean a group of drawn by this definition is appropriate novate their ‘‘in-the-money’’ derivative transactions with a single counterparty to differentiate derivative transactions contracts with another counterparty, that are subject to a QMNA and, with that have the potential to present right- while leaving the banking organization’s respect to derivative contracts only, also way risk from those that do not.63 ‘‘out-of-the-money’’ positions with the includes a single derivative contract Other commenters asked the agencies initial counterparty. The agencies to clarify that the proposal would apply between a banking organization and a believe it is appropriate to allow for the 68 an exposure amount of zero to sold counterparty. With respect to repo- netting of derivative contracts under SA– style transactions, this definition is options in which the counterparty to the CCR on a point-in-time basis, as allowing options has paid the premiums up front consistent with the current capital rule. for netting on a point-in-time basis The proposal set forth definitions for and that are not subject to a variation under SA–CCR is consistent with margin agreement. Consistent with the variation margin, variation margin U.S. generally accepted accounting amount, independent collateral, and net proposal, under the final rule, an principles (U.S. GAAP) and facilitates exposure amount of zero applies to sold independent collateral amount. The implementation of the final rule. The proposal would have defined variation options that are not subject to a capital rule relies significantly on variation margin agreement and for margin as financial collateral that is banking organizations’ U.S. GAAP subject to a collateral agreement and which the counterparty has paid the balance sheets and thus requires 64 provided by one party to its premiums up front. This treatment is banking organizations to determine appropriate because the counterparty to counterparty to meet the performance of capital ratios on a point-in-time basis. the first party’s obligations under one or the option has no future payment The risks related to stress events obligation under the derivative contract more derivative contracts between the identified by the commenters may be parties as a result of a change in value and the banking organization, as the further addressed in the context of stress option seller, has no exposure to of such obligations since the last testing and resolution planning. Thus, exchange of such collateral. The counterparty credit risk. the agencies are adopting as final the variation margin amount would have netting treatment under the proposal, B. Definition of Netting Sets and been equal to the fair value amount of with the exception of the availability of Treatment of Financial Collateral the variation margin that a counterparty netting among collateralized-to-market Under the capital rule, a netting set is to a netting set has posted to a banking and settled-to-market derivative currently defined as a group of organization less the fair value amount contracts, which is discussed below in transactions with a single counterparty of the variation margin posted by the section III.D.4. of this that are subject to a qualifying master SUPPLEMENTARY banking organization to the netting agreement (QMNA) or a INFORMATION. Under the final rule, a group of counterparty. qualifying cross-product master netting derivative contracts subject to the same The proposal would have required the agreement. The proposal would have variation margin amount to be adjusted QMNA are part of the same netting revised the definition of netting set to by the existing standard supervisory set.65 In general, a QMNA means a mean either one derivative contract haircuts under § .132(b)(2)(ii)(A)( ) of netting agreement that permits a l 1 between a banking organization and a the capital rule. The standard banking organization to terminate, single counterparty, or a group of supervisory haircuts reflect potential close-out on a net basis, and promptly derivative contracts between a banking liquidate or set off collateral upon an term funding transactions such as repurchase organization and a single counterparty 66 that are subject to the same qualifying event of default of the counterparty. agreements. Under the 2017 final rule, the agencies master netting agreement or the same revised the definition of QMNA under the capital 65 The definition of netting set also clarifies that rule such that qualified financial contracts could be

61 The definition of a commercial end-user in the a netting set can be composed of a single derivative subject to a QMNA (notwithstanding other final rule does not extend to an organization contract and retains certain components of the operational requirements). See 82 FR 42882 exempted by the CFTC pursuant to section definition that are specific to IMM. (September 12, 2017). 2(h)(7)(C)(ii) of the Commodity Exchange Act (7 66 See supra note 2. In 2017, the agencies adopted 67 See supra note 2. U.S.C. 2(h)(7)(C)(ii)) or exempted by the Securities a final rule that requires GSIBs and the U.S. 68 Consistent with the current definition of and Exchange Commission pursuant to section operations of foreign GSIBs to amend their qualified netting set, for purposes of the internal models 3C(g)(3)(B) of the Securities Exchange Act of 1934 financial contracts to prevent their immediate methodology in § l.132(d) of the capital rule, (15 U.S.C. 78c–3(g)(3)(B)). cancellation or termination if such a banking netting set also includes a qualifying cross-product 62 See 80 FR 74839, 74853 (April 1, 2016). organization enters bankruptcy or a resolution master netting agreement. See 12 CFR 3.132(d) 63 Id. process. Qualified financial contracts include (OCC); 12 CFR 217.132(d) (Board); and 12 CFR 64 See § l.132(c)(5)(iii) of the final rule. derivative contracts, securities lending, and short- 324.132(d) (FDIC).

4374 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations standard supervisory haircuts under purposes. Consistent with the capital future changes in the value of the § l.132(b)(2)(ii)(A)(1) of the capital rule, the final rule does not recognize financial collateral by adjusting for any rule. the alternative collateral arrangements potential decrease in the value of the The agencies did not receive comment suggested by commenters. Liens and financial collateral received by a on the proposed definitions of variation asset pledges, by contrast, may not be banking organization and any potential margin, variation margin amount, rapidly available to support losses in an increase in the value of the financial independent collateral, and event of default because the assets they collateral posted by the banking independent collateral amount. Several attach to can be illiquid and thus organization over supervisory-provided commenters, however, advocated for difficult to value and sell for cash after holding periods. The standard recognition of alternative collateral enforcement of a security interest in the supervisory haircuts are based on a ten- arrangements under SA–CCR to address collateral or foreclosure, which is business-day holding period, and the the potential impact of the proposal on inconsistent with the principle that capital rule requires a banking derivative contracts with certain derivatives should be able to be closed organization to adjust, as applicable, the counterparties, including commercial out easily and quickly in an event of standard supervisory haircuts to align end-users. As noted above, the default.73 In addition, recognizing with the associated derivative contract commenters argued that SA–CCR could letters of credit would add significant (or repo-style transaction) according to unduly increase capital requirements for complexity to the capital rule. In 69 the formula in § l.132(b)(2)(ii)(A)(4). derivative exposures to commercial end- particular, recognition of letters of credit The proposal would have defined user counterparties because they often as financial collateral would require the independent collateral as financial do not provide collateral in the form of introduction of appropriate qualification collateral, other than variation margin, cash or liquid and readily marketable criteria, as well as a framework for that is subject to a collateral agreement, securities. Commenters stated that considering the counterparty credit risk or in which a banking organization has companies, including commercial end- of institutions providing the letters of a perfected, first-priority security users, regularly use alternative security credit. The agencies also believe that the interest or, outside of the United States, arrangements, such as liens on assets, a removal of the alpha factor for the legal equivalent thereof (with the letter of credit, or a parent company derivative contract exposures to exception of cash on deposit and guarantee, to offset the counterparty commercial end-users helps to address notwithstanding the prior security credit risk of their derivative contracts, commenters’ concerns that the proposal interest of any custodial agent or any and that banking organizations should would have resulted in unduly high prior security interest granted to a CCP be able to recognize the credit risk- risk-weighted asset amounts for in connection with collateral posted to mitigating benefits of such arrangements derivative contracts with commercial that CCP), and the amount of which under SA–CCR. end-user counterparties. does not change directly in response to In support of their recommendation, Accordingly, the agencies are the change in value of the derivative commenters noted that a line of credit adopting without change the proposed contract or contracts that the financial functions similarly to the exchange of definitions for variation margin, collateral secures. margin because the line of credit is independent collateral, variation margin Net independent collateral amount available to be drawn upon by the amount, and independent collateral would have been defined as the fair banking organization in advance of amount, as well as the proposed value amount of the independent default as the counterparty’s application of the standard supervisory collateral that a counterparty to a creditworthiness deteriorates. Moreover, haircuts under the capital rule. netting set has posted to a banking the line of credit can be structured so organization less the fair value amount that its amount may increase over the C. Replacement Cost of the independent collateral posted by life of the derivative contract based on The proposal would have provided the banking organization to the certain credit quality metrics. separate formulas to determine counterparty, excluding such amounts Commenters added that common replacement cost that apply depending held in a bankruptcy-remote manner,70 industry practice allows banking on whether the counterparty to a or posted to a qualifying central organizations to accept these forms of banking organization is required to post counterparty (QCCP) 71 and held in collateral from counterparties and to variation margin. Specifically, the conformance with the operational reflect their credit risk-mitigating replacement cost for a netting set that is requirements in § l.3 of the capital benefits when they calculate the not subject to a variation margin rule. As with the variation margin exposure amount under IMM. agreement would have equaled the amount, the independent collateral Commenters also argued that derivative greater of (1) the sum of the fair values amount would have been subject to the contracts with commercial end-users (after excluding any valuation may present right-way risk for banking adjustments) of the derivative contracts 69 As described in section III.D. of this organizations, in contrast to derivative within the netting set, less the net SUPPLEMENTARY INFORMATION, the final rule applies contracts with financial institution a five-day holding period for the purpose of the independent collateral amount margin period of risk to all derivative contracts counterparties, and that this feature of applicable to such derivative contracts, subject to a variation margin agreement that are these transactions supports recognition or (2) zero.74 client-facing derivative transactions, as defined in the final rule, regardless of the method the banking of alternative forms of collateral. organization uses to calculate the exposure amount The capital rule only recognizes 73 The Board and OCC issued the capital rule as of the derivative contract. As described in section certain forms of collateral that qualify as a joint final rule on October 11, 2013 (78 FR 62018) VI.E. of this SUPPLEMENTARY INFORMATION, the ‘‘financial collateral,’’ as defined under and the FDIC issued the capital rule as a collateral haircuts for such transactions similarly substantially identical interim final rule on 72 reflect a five-business-day holding period under the the rule. In general, the items that September 10, 2013 (78 FR 53340). In April 14, final rule. qualify as financial collateral under the 2014, the FDIC issued the interim final rule as a 70 ‘‘Bankruptcy remote’’ is defined in § l.2 of the capital rule exhibit sufficient liquidity final rule with no substantive changes (79 FR capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 and asset quality to serve as credit risk 20754). (Board); and 12 CFR 324.2 (FDIC). 74 Replacement cost is calculated based on the 71 ‘‘Qualifying central counterparty’’ is defined in mitigants for risk-based capital assumption that the counterparty has defaulted.

§ l.2 of the capital rule. See 12 CFR 3.2 (OCC); 12 Therefore, this calculation cannot include valuation CFR 217.2 (Board); and 12 CFR 324.2 (FDIC). 72 See supra note 52. adjustments based on counterparty’s credit quality,

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4375 the netting set were not subject to a The final rule adopts the proposed For a netting set that is subject to a variation margin agreement.75 replacement cost formulas and related variation margin agreement where the In addition, the proposal would have definitions, with one modification. The counterparty is required to post provided adjustments for determining agencies recognize that in determining variation margin, replacement cost the replacement cost of a netting set that the fair value of a derivative on a would have equaled the greater of (1) is subject to multiple variation margin banking organization’s balance sheet, the sum of the fair values (after agreements or a hybrid netting set, the recognized CVA on the netting set excluding any valuation adjustments) of which is a netting set composed of at of OTC derivative contracts is intended the derivative contracts within the least one derivative contract subject to to reflect the credit quality of the netting set, less the sum of the net a variation margin agreement under counterparty. The final rule permits independent collateral amount and the which the counterparty must post advanced approaches banking variation margin amount applicable to variation margin and at least one organizations to reduce EAD, calculated such derivative contracts; (2) the sum of derivative contract that is not subject to according to SA–CCR, by the recognized the variation margin threshold and the such a variation margin agreement, and CVA on the balance sheet, for the minimum transfer amount applicable to for multiple netting sets subject to a purposes of calculating advanced the derivative contracts within the single variation margin agreement. approaches total risk-weighted assets. netting set, less the net independent Some commenters supported the This treatment is consistent with the collateral amount applicable to such proposed replacement cost calculation recognition of CVA under CEM as it derivative contracts; or (3) zero. As and, in particular, the cap based on the applies to advanced approaches banking noted in the proposal, the formula to margin exposure threshold and organizations that use CEM for purposes determine the replacement cost of a minimum transfer amount. The of determining advanced approaches netting set subject to a variation margin commenters argued that the unmargined total risk-weighted assets.76 agreement would have accounted for the exposure amount more accurately The final rule otherwise adopts maximum possible unsecured exposure reflects the exposure amount for short- without change the proposed amount of the netting set that would not dated trades subject to a higher MPOR, replacement cost formulas and related trigger a variation margin call. For as the close-out period reflected in definitions, as well as the proposed example, a netting set with a high MPOR cannot be increased beyond the treatment to cap the exposure amount variation margin threshold has a higher maturity of the transactions. Other for a margined netting set at the replacement cost compared to an commenters advocated subtracting maximum exposure amount for an equivalent netting set with a lower incurred CVA from the exposure unmargined, but otherwise identical, variation margin threshold. Therefore, amount of a netting set. In support of netting set. the proposal would have provided their recommendation, the commenters Under § l.132(c)(6)(ii) of the final definitions for variation margin noted that IMM allows incurred CVA to rule, the replacement cost of a netting threshold and the minimum transfer be subtracted from EAD, and that the set that is not subject to a variation amount. agencies previously extended such margin agreement is represented as Under the proposal, the variation treatment to advanced approaches follows: margin threshold would have meant the banking organizations that use CEM to calculate advanced approaches risk- replacement cost = max{V¥C; 0}, maximum amount of a banking weighted assets. Where: organization’s credit exposure to its counterparty that, if exceeded, would V is the fair values (after excluding any require the counterparty to post 75 There could be a situation unrelated to the valuation adjustments) of the derivative variation margin to the banking value of the variation margin threshold in which contracts within the netting set; and the exposure amount of a margined netting set is organization. The minimum transfer C is the net independent collateral amount greater than the exposure amount of an equivalent applicable to such derivative contracts. amount would have meant the smallest unmargined netting set. For example, in the case of amount of variation margin that may be a margined netting set composed of short-term The same requirement applies to a transferred between counterparties to a transactions with a residual maturity of ten business days or less, the risk horizon equals the netting set that is subject to a variation netting set. The proposal included this MPOR, which under the final rule is set to a margin agreement under which the treatment to address transactions for minimum floor of ten business days. The risk counterparty is not required to post which the variation margin agreement horizon for an equivalent unmargined netting set also is set to ten business days because this is the variation margin. For such a netting set, includes a variation margin threshold floor for the remaining maturity of such a netting C also includes the negative amount of that is set at a level high enough to make set. However, the maturity factor for the margined the variation margin that the banking the netting set effectively unmargined. netting set is greater than the one for the equivalent organization posted to the counterparty In such a case, the variation margin unmargined netting set because of the application of a factor of 1.5 to margined derivative contracts. (thus increasing replacement cost). threshold would result in an In such an instance, the exposure amount of a For netting sets subject to a variation inappropriately high replacement cost, margined netting set is more than the exposure margin agreement under which the because it is not reflective of the risk amount of an equivalent unmargined netting set by counterparty must post variation associated with the derivative contract a factor of 1.5, thus triggering the cap. In addition, in the case of margin disputes, the MPOR of a margin, the replacement cost formula is but rather the terms of the variation margined netting set is doubled, which could provided under § l.132(c)(6)(i) of the margin agreement. To address this issue, further increase the exposure amount of a margined final rule and is represented as follows: the proposal would have provided that netting set comprised of short-term transactions the exposure amount of a netting set with a residual maturity of ten business days or less replacement cost = max{V¥C; VMT + above an equivalent unmargined netting set. The MTA¥NICA; 0}, subject to a variation margin agreement agencies believe, however, that such instances could not exceed the exposure amount rarely occur and thus would have minimal effect on Where: of the same netting set calculated as if banking organizations’ regulatory capital. Therefore, V is the fair values (after excluding any the final rule limits the exposure amount of a valuation adjustments) of the derivative margined netting set to no more than the exposure contracts within the netting set; such as CVA, which reflect the discounted present amount of an equivalent unmargined netting set. value of losses if the counterparty were to default However, the agencies expect to monitor the in the future. application of this treatment under the final rule. 76 See 80 FR 41409 (July 15, 2015).

4376 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

min{VNS; 0}¥min{CMA; 0}; 0} reflects 1. Hedging Set Amounts C is the sum of the net independent collateral the exposure amount produced when amount and the variation margin amount Under the proposal, a banking the banking organization posts variation organization would have determined the applicable to such derivative contracts; margin and independent collateral to its VMT is the variation margin threshold hedging set amount by asset class. To applicable to the derivative contracts counterparty (i.e., this component specify each asset class, the proposal within the netting set; and contributes to replacement cost only in would have maintained the existing MTA is the minimum transfer amount instances when CMA is negative). definitions in the capital rule for applicable to the derivative contracts D. Potential Future Exposure interest rate, exchange rate, credit, within the netting set. equity, and commodity derivative NICA is the net independent collateral Under the proposal, the PFE for a contracts. The proposal would have amount applicable to such derivative netting set would have equaled the contracts. provided hedging set definitions for product of the PFE multiplier and the each asset class and sought comment on For a netting set that is subject to aggregated amount. To determine the an alternative approach for the multiple variation margin agreements, aggregated amount, a banking definition and treatment of exchange or a hybrid netting set, a banking organization would have been required rate derivative contracts to recognize the organization must determine to determine the hedging set amounts economic relationships of exchange rate replacement cost using the methodology for the derivative contracts within a chains (i.e., when more than one described in § l.132(c)(11)(i) of the netting set, where a hedging set is currency pair can offset the risk of final rule. Under this paragraph, a comprised of derivative contracts that another). For example, a Yen/Dollar banking organization must use the share similar risk factors based on asset and a Dollar/Euro standard replacement cost formula class (i.e., interest rate, exchange rate, forward contract, taken together, may be (described in § l.132(c)(6)(i) for a credit, equity, and commodity). The economically equivalent, with properly netting set subject to a variation margin aggregated amount would have equaled set notional amounts, to a Yen/Euro agreement), except that the variation the sum of all hedging set amounts forward contract when they are subject margin threshold equals the sum of the within a netting set. to the same QMNA. The proposal also variation margin thresholds of all the Under the proposal, a banking would have included separate variation margin agreements within the organization would have used a two- treatments for volatility derivative netting set and the minimum transfer step process to determine the hedging contracts and basis derivative contracts. amount equals the sum of the minimum set amount for an asset class. First, a Some commenters recommended that transfer amounts of all the variation banking organization would have the agencies revise the definitions for margin agreements within the netting determined the composition of a interest rate, exchange rate, equity, and set. hedging set using the asset class commodity derivative contracts for SA– For multiple netting sets subject to a definitions set forth in the proposal. CCR. In particular, the commenters single variation margin agreement, a Second, the banking organization would noted that there could be instances in banking organization must assign a have determined hedging set amount which the existing definitions in the single replacement cost to the multiple using asset class specific formulas. The capital rule are not aligned with the netting sets according to the following hedging set amount formulas require a primary risk factor for a derivative formula, as provided under banking organization to determine an contract, and therefore would differ § l.132(c)(10)(i) of the final rule: adjusted derivative contract amount for from the classifications used under SA– Replacement Cost = max{SNS max{VNS; each derivative contract, and to CCR. To address this concern, 0}¥max{CMA; 0}; 0} + max{SNS aggregate those amounts to arrive at the commenters requested allowing banking min{VNS; 0}¥min{CMA; 0}; 0}, hedging set amount for an asset class.77 organizations to use the primary risk Where: The final rule adopts the formula for factor for the derivative contract instead NS is each netting set subject to the variation determining PFE as proposed. Under of one based on the asset class margin agreement MA; § l.132(c)(7) of the final rule, the PFE definitions set forth in the proposal. VNS is the sum of the fair values (after of a netting set equals the product of the The final rule maintains the excluding any valuation adjustments) of PFE multiplier and the aggregated definitions of interest rate, exchange the derivative contracts within the amount. The final rule defines the netting set NS; and rate, equity, and commodity derivative aggregated amount as the sum of all contracts, as the definitions are largely CMA is the sum of the net independent collateral amount and the variation hedging set amounts within the netting aligned with existing derivative margin amount applicable to the set. This formula is represented in the products and market practices. In derivative contracts within the netting final rule as follows: addition to being sufficiently broad to sets subject to the single variation margin PFE = PFE multiplier * aggregated capture the various types of derivative agreement. amount, contracts, the existing asset class The component max{SNS max{VNS; Where aggregated amount is the sum definitions are well-established, well- 0}¥max{CMA; 0}; 0} reflects the of each hedging set amount within the understood, and generally have exposure amount produced by netting netting set. functioned as intended in the capital sets that have current positive market value. Variation margin and rule. The final rule preserves the ability

77 of the primary Federal regulator to independent collateral collected from Section III.D.1. of this SUPPLEMENTARY the counterparty to the transaction can INFORMATION discusses the methodology for address derivative contracts with offset the current positive market value determining the composition of a hedging set using multiple risk factors by requiring them of these netting sets (i.e., this the asset class distinctions set forth in the final rule. to be included in multiple hedging sets Section III.D.2. of this SUPPLEMENTARY INFORMATION component contributes to replacement discusses the methodology for determining the under § l.132(c)(2)(iii)(H).78 cost only in instances when CMA is adjusted derivative contract amount for each positive). However, netting sets that derivative contract. Section III.D.3. of this 78 The Board is the primary Federal regulator for have current negative market value are SUPPLEMENTARY INFORMATION discusses the PFE bank holding companies, savings and loan holding multiplier. Section III.D.4. of this SUPPLEMENTARY companies, intermediate holding companies of not allowed to offset the exposure INFORMATION discusses the PFE calculation for foreign banks, and state member banks; the OCC is amount. The component max{SNS nonstandard margin agreements. the primary Federal regulator for all national banks

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4377 exchange rate derivative contracts. An end date of the derivative contract) are Some commenters supported the interest rate hedging set means all generally highly correlated, and thus alternative treatment for recognizing the interest rate derivative contracts within would have provided a greater offset economic relationships of exchange rate a netting set that reference the same relative to interest rate derivative chains described in the proposal, but reference currency. Thus, there could be contracts that do not have close tenors. only if modified to address any as many interest rate hedging sets in a In particular, the proposed formula for potential overstatement in the exposure netting set as distinct currencies determining the hedging set amount for amounts produced when creating referenced by the interest rate derivative interest rate derivative contracts would separate hedging sets for each foreign contracts in the netting set. A credit have permitted full offsetting within a currency. The agencies believe that the hedging set would mean all credit tenor category and partial offsetting alternative treatment described in the derivative contracts within a netting set. across tenor categories, with tenor proposal, if modified to incorporate Similarly, an equity hedging set means categories of less than one year, between correlation parameters as suggested by all contracts within a one and five years, and more than five commenters, would add a level of netting set. Consequently, there could years. The proposal would have applied complexity to the alternative treatment be at most one equity hedging set and a correlation factor of 70 percent across that would make it inappropriate for use one credit hedging set within a netting adjacent tenor categories and a in a standardized framework that is set. A commodity hedging set means all correlation factor of 30 percent across intended for potential implementation commodity derivative contracts within a by all banking organizations. The nonadjacent tenor categories. The tenor netting set that reference one of the of a derivative contract would have been agencies further believe that the following commodity categories: alternative treatment described in the based on the period between the present Energy, metal, agricultural, or other date and the end date of the derivative proposal, if modified to require the commodities. Therefore, there could be maximum of long or short risk contract, where end date would have no more than four commodity derivative meant the last date of the period positions, would not add meaningful contract hedging sets within a netting risk sensitivity by not taking into referenced by the derivative contract, or set. if the derivative contract references account the correlations between Consistent with the proposal, the final another instrument, the period currency risk factors. Therefore, the rule sets forth separate treatments for referenced by the underlying agencies are adopting as final the asset volatility derivative contracts and basis instrument. class and hedging set definitions as derivative contracts. A basis derivative proposed. contract is a non-foreign exchange Some commenters asked the agencies To determine each hedging set derivative contract (i.e., the contract is to allow banking organizations to amount, a banking organization first denominated in a single currency) in recognize interest rate derivative must group into separate hedging sets which the cash flows of the derivative contracts within the same QMNA as derivative contracts that share similar contract depend on the difference belonging to the same factors based on the following asset between two risk factors that are hedging set, even if such derivative classes: Interest rate, exchange rate, attributable solely to one of the contracts reference different currencies. credit, equity, and commodity. Basis following derivative asset classes: According to the commenters, such an derivative contracts and volatility Interest rate, credit, equity, or approach would allow banking derivative contracts require separate commodity. A basis derivative contract organizations to recognize the hedging sets. A banking organization hedging set means all basis derivative diversification benefits of multi- then must determine each hedging set contracts within a netting set that currency interest rate derivative amount using asset-class specific reference the same pair of risk factors portfolios. Some of these commenters formulas that allow for full or partial and are denominated in the same also suggested potential ways to offsetting. If the risk of a derivative currency. In contrast, a volatility implement this approach. Under one contract materially depends on more derivative contract means a derivative approach, a banking organization would than one risk factor, whether interest contract in which the payoff of the calculate the maximum exposure for the rate, exchange rate, credit, equity, or derivative contract explicitly depends interest rate derivative contracts within factor, a banking on a measure of volatility for the the QMNA under two scenarios using a organization’s primary Federal regulator underlying risk factor of the derivative single-factor model. The first scenario may require the banking organization to contract. Examples of volatility would receive a correlation factor of include the derivative contract in each derivative contracts include variance zero percent across interest rate appropriate hedging set. Under the final and volatility swaps and options on exposures in different currencies, while rule, the hedging set amount of a realized or . A the second scenario would receive a hedging set composed of a single volatility derivative contract hedging set correlation factor of 70 percent. The derivative contract equals the absolute means all volatility derivative contracts former scenario would produce the value of the adjusted derivative contract within a netting set that reference one largest amount for portfolios balanced amount of the derivative contract. of interest rate, exchange rate, credit, across net short and net long currency Section l.132(c)(2)(iii) of the final equity, or commodity risk factors, exposures, while the latter scenario rule provides the respective hedging set separated according to the requirements would produce the largest amount for definitions. As noted, an exchange rate under § l.132(c)(2)(iii)(A)–(E) of the portfolios that primarily consist of net hedging set means all exchange rate final rule. long or net short currency positions. derivative contracts within a netting set The second approach would use a a. Interest Rate Derivative Contracts that reference the same currency pair. single-factor model to aggregate interest Thus, there could be as many exchange Under the proposal, the hedging set rate derivative contracts per currency rate hedging sets within a netting set as amount for a hedging set of interest rate type to recognize correlations across distinct currency pairs referenced by the derivative contracts would have currencies. Alternatively, other recognized that interest rate derivative commenters stated that yield curve and Federal savings associations; and the FDIC is contracts with close tenors (i.e., the correlations across major currencies the primary Federal regulatory for all state amount of time remaining before the could be used to establish correlation nonmember banks and savings associations.

4378 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations interest rate derivatives under SA–CCR currencies can move in different factors for interest rate derivative is overly conservative. Other directions, rendering correlations contracts that reference different commenters criticized the proposal as unstable. In addition, adopting the currencies. These commenters noted not providing a sufficient justification commenters’ recommendations could that the Basel Committee’s standard on for the requirement that interest rate add significant complexity to the final minimum capital requirements for hedging sets must be settled in the same rule. The agencies therefore are market risk incorporates a correlation currency to be included within the same adopting as final the proposed treatment parameter to reflect diversification hedging set, in contrast to the proposed for determining the hedging set amount benefits across multi-currency interest treatment for credit, commodity, and of interest rate derivative contracts. rate portfolios.79 These commenters also equity derivative contracts. Under § l.132(c)(8)(i) of the final rule, stated that studies regarding the Basel The fact that a set of derivative a banking organization must calculate Committee standard suggest that, by not contracts are subject to the same QMNA recognizing any hedging or is not determinative of whether hedging the hedging set amount for interest rate diversification benefits across benefits across derivative contracts derivative contracts according to the currencies, the proposed method to actually exist. Interest rates in different following formula: calculate the hedging set amount for

Where: highly correlated. Therefore, under the percent, while an index derivative IR AddOnTB1 equals the sum of the adjusted proposal, the formula for determining contract would have received a derivative contract amounts within the the hedging set amount for exchange correlation factor of 80 percent to reflect hedging set with an end date of less than rate derivative contracts would have partial diversification of idiosyncratic one year from the present date; allowed for full offsetting within the risk within an index. As noted in the IR AddOnTB2 equals the sum of the adjusted exchange rate derivative contract proposal, the pairwise correlation derivative contract amounts within the hedging set with an end date of one to hedging set. The agencies did not between two entities is the product of five years from the present date; and receive comment regarding the formula the corresponding correlation factors, so IR AddOnTB3 equals the sum of the adjusted for determining the hedging set amount that the pairwise correlation between derivative contract amounts within the for exchange rate derivative contracts, two single-name derivatives is 25 hedging set with an end date of more and are adopting it as proposed. Under percent, between one single-name and than five years from the present date. § l.132(c)(8)(ii) of the final rule, the one index derivative is 40 percent, and Consistent with the proposal, the final hedging set amount for exchange rate between two index derivatives is 64 rule also includes a simpler formula that derivative contracts equals the absolute percent. The application of a higher does not provide an offset across tenor value of the sum of the adjusted correlation factor does not necessarily categories. Under this approach, the derivative contract amounts within the result in a higher exposure amount hedging set amount for interest rate hedging set. because the proposal generally would have yielded a lower exposure amount derivative contracts equals the sum of c. Credit Derivative Contracts and for balanced portfolios relative to the absolute amounts of each tenor Equity Derivative Contracts category, which is the sum of the directional portfolios. adjusted derivative contract amounts Under the proposal, a banking Several commenters asked the within each respective tenor category. organization would have used the same agencies to allow banking organizations The simpler formula always results in a formula to determine the hedging set to decompose indices within credit and more conservative measure of the amount for both its credit derivative equity asset classes to reflect the hedging set amount for interest rate contracts and equity derivative exposure of highly correlated net long derivative contracts of different tenor contracts. The formula would allow full and short positions within an index. categories, but may be less burdensome offsetting for credit or equity contracts Under § l.132(c)(5)(vi) of the final rule, for banking organizations with smaller that reference the same entity, and a banking organization may elect to interest rate derivative contract partial offsetting when aggregating decompose indices within credit and portfolios. A banking organization may across distinct reference entities. In equity asset classes, such that a banking use this simpler formula for some or all addition, the proposal would have organization would treat each of its interest rate derivative contracts. provided supervisory correlation component of the index as a separate parameters for credit derivative single-name derivative contract. Thus, b. Exchange Rate Derivative Contracts contracts and equity derivative contracts under this election, a banking Exchange rate derivative contracts based on whether the derivative organization would apply the SA–CCR that reference the same currency pair contract referenced a single-name entity methodology to each component of the generally are driven by the same market or an index. index as if it were a separate single- factor (i.e., the exchange spot rate A single-name derivative would have name derivative contract instead of between these currencies) and thus are received a correlation factor of 50 applying the SA–CCR methodology to

79 See ‘‘Minimum capital requirements for market (January 2019, rev. February 2019), https:// risk,’’ Basel Committee on Banking Supervision www.bis.org/bcbs/publ/d457.pdf.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4379 rule.80 The agencies will monitor the Under the final rule, a banking the index derivative contract. This application of the decomposition organization must determine the approach provides enhanced risk approach, including the correlation hedging set amount for its credit and sensitivity to the SA–CCR framework by assumptions between an index and its equity derivative contracts set forth in allowing for recognition of the hedging components, to ensure that the § .132(c)(8)(iii) of the final rule, as benefits provided by the components of l an index. In addition, this approach is approach is functioning as intended. follows: similar to other aspects of the capital

Where: contracts that are included in different Texas Intermediate and Saudi Light k is each reference entity within the hedging commodity categories (i.e., a forward crude oil. set; contract on crude oil cannot hedge a In response to comments, K is the number of reference entities within forward contract on corn). § l.132(c)(5)(vi) of the final rule allows the hedging set; a banking organization to elect to ( ) equals the sum of the adjusted Several commenters asked the AddOn Refk decompose commodity indices, such derivative contract amounts for all agencies to clarify the offsetting derivative contracts within the hedging treatment among the different types of that a banking organization would treat set that reference reference entity k; and contracts within the energy category each component of the index as a rk equals the applicable supervisory (e.g., electricity and oil/gas derivative separate, single-name derivative correlation factor, as provided in Table 2. contracts). Some commenters asked the contract. Thus, under this election, a banking organization would apply the d. Commodity Derivative Contracts The agencies to allow banking organizations to decompose derivative contracts that SA–CCR methodology to each proposal would have required a reference commodity indices, such that component of the index as if it were a banking organization to determine the a banking organization would treat each separate, single-name derivative hedging set amount for commodity component of the index as a separate contract, instead of applying the SA– derivative contracts based on the single-name derivative contract. CCR methodology to the index following four commodity categories: derivative contract. This approach Consistent with the proposal, the final Energy, metal, agricultural and other. provides enhanced risk sensitivity to the rule permits full offsetting for all The proposal would have permitted full SA–CCR framework by allowing for offsetting for all derivative contracts derivative contracts within a hedging set better recognition of hedging benefits within the same commodity category that reference the same commodity type, provided by the components of an (i.e., within a hedging set) that reference and partial offsetting for all derivative index. In addition, this approach is the same commodity type, and partial contracts within a hedging set that similar to other aspects of the capital reference different commodity types offsetting for all derivative contracts rule.83 82 within the same commodity category within the same commodity category. The agencies recognize that specifying that reference different commodity This treatment applies consistently to separate commodity types is types. each of the four commodity categories, operationally difficult; indeed, it is Under the proposal, a commodity including energy. For example, likely infeasible to sufficiently specify type would have referred to a specific electricity derivative contracts within all relevant distinctions between commodity within one of the four the same hedging set may fully offset commodity types in order to capture all commodity categories. Additionally, the each other, whereas electricity basis risk. Therefore, the agencies will proposal would not have provided derivative contracts and non-electricity monitor the commodity-type separate supervisory factors for different derivate contracts (e.g., oil derivative distinctions made within the industry commodity types within the energy contracts) within the same hedging set for purposes of both the full offset commodity category.81 For example, may only partially offset each other treatment for commodity derivative under the proposal, a hedging set could because they are different commodity contracts of the same type and the have been composed of crude oil types within the same commodity decomposition approach for commodity derivative contracts and electricity category. indices, to ensure that they are being derivative contracts, with each subject In an attempt to appropriately balance applied and functioning as intended. to the same supervisory factor. A risk sensitivity with operational burden, Consistent with the proposal, a banking organization would have been consistent with the proposal, the final banking organization must assign a able to fully offset all crude oil rule allows banking organizations to derivative contract to the ‘‘other’’ derivative contracts against each other recognize commodity types without commodity category if the derivative and all electricity derivative contracts regard to characteristics such as location contract does not meet the criteria for against each other (as they reference the or quality. For example, a banking the energy, metal or agricultural same commodity type). In addition, a organization may recognize crude oil as commodity categories. banking organization would not have a commodity type, and would not need The hedging set amount for been able to offset commodity derivative to distinguish further between West commodity derivative contracts would

80 See e.g., 12 CFR 3.53 (OCC); 12 CFR 217.53 82 The final rule provides separate supervisory 83 See supra note 80. (Board); and 12 CFR 324.53 (FDIC). factors for electricity derivative contracts and other 81 See section III.D.2.b. of this SUPPLEMENTARY types of commodity derivative contracts within the INFORMATION for a more detailed discussion on energy category as discussed further in section supervisory factors under the final rule. III.D.2.b.iii. of this SUPPLEMENTARY INFORMATION.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4381

be determined under § l.132(c)(8)(iv) of the final rule, as follows:

Where: contract and reflects the attributes of the duration would have incorporated k is each commodity type within the hedging most common derivative contracts in measures of the number of business set; each asset class. The supervisory factor days from the present day until the start K is the number of commodity types within converts the adjusted notional amount date for the derivative contract (S), and the hedging set; of the derivative contract into an EEPE the number of business days from the AddOn(Typek) equals the sum of the adjusted based on the measured volatility present day until the end date for the derivative contract amounts for all derivative contracts within the hedging specific to each asset class over a one- derivative contract (E). 85 set that reference commodity type k; and year horizon. The supervisory delta Some commenters argued that the r equals the applicable supervisory adjustment accounts for the sensitivity standard notional definition would not correlation factor, as provided in Table 2 of a derivative contract (scaled to unit produce reasonably accurate exposure of the preamble. size) to the underlying primary risk estimates of a banking organization’s factor, including the correct sign closeout risk for all types of derivative 2. Adjusted Derivative Contract Amount (positive or negative) to account for the contracts. These commenters Under the proposal, the adjusted direction of the derivative contract recommended allowing banking derivative contract amount would have amount relative to the primary risk organizations to use internal represented a conservative estimate of factor.86 Finally, the maturity factor methodologies to determine the effective expected positive exposure scales down, if necessary, the derivative adjusted notional amount for derivative 84 (EEPE) for a netting set consisting of contract amount from the standard one- contracts that are not specifically a single derivative contract, assuming year horizon used for supervisory factor covered under the formulas and zero market value and zero collateral, calibration to the risk horizon relevant methodologies set forth in the proposal. that is either positive (if a long position) for a given contract. The final rule maintains the formulas or negative (if a short position). A and methodologies for determining the banking organization would have a. Adjusted Notional Amount adjusted notional amount for interest calculated the adjusted derivative i. Interest Rate and Credit Derivative rate and credit derivative contracts, as contract amount as a product of four Contracts generally one of these will be applicable components: The adjusted notional Under the proposal, a banking for most derivative contracts. However, amount, the applicable supervisory organization would have applied the the agencies recognize that such factor, the applicable supervisory delta same formula to interest rate derivative approaches may not be applicable to all adjustment, and the applicable maturity contracts and credit derivative contracts types of derivative contracts, and that a factor. The adjusted derivative contact to arrive at the adjusted notional different approach may be necessary to amount for each asset class would have amount. For such contracts, the adjusted determine the adjusted notional amount been aggregated under the hedging set of a derivative contract. In such a case, amount formulas for each asset class, as notional amount would have equaled the product of the notional amount of a banking organization must consult described above. The agencies received with its primary Federal regulator prior the derivative contract, as measured in no comments on this aspect of the to using an alternative approach to the U.S. dollars, using the exchange rate on proposal, and are finalizing the formula formulas or methodologies set forth in the date of the calculation, and the for determining the adjusted derivative the final rule. supervisory duration. The supervisory contract amount as proposed under Some commenters suggested revising § .132(c)(9) of the final rule. l 85 Specifically, the supervisory factors are the proposal to provide a separate The formula to determine the adjusted intended to reflect the EEPE of a single at-the- measure of S for fixed-to-floating derivative contract amount is money linear trade of unit size, zero market value interest rate derivative contracts where represented as follows: and one-year maturity referencing a given risk the floating rate is determined at the factor in the absence of collateral. See supra note adjusted derivative contract amount = di 10. beginning of the reset period and paid * di * MFi * SFi. 86 Sensitivity of a derivative contract to a risk at the end, defined as the time period Where: factor is the ratio of the change in the market value until the earliest reset date, measured in of the derivative contract caused by a small change di is the adjusted notional amount; years. in the risk factor to the value of the change in the According to the commenters, the di is the applicable supervisory delta risk factor. In a linear derivative contract, the payoff adjustment; of the derivative contract moves at a constant rate proposal could overestimate the MFi is the applicable maturity factor; and with the change in the value of the underlying risk duration for such derivative contracts, SFi is the applicable supervisory factor. factor. In a nonlinear contract, the payoff of the as it would include the time period for derivative contract does not move at a constant rate which the floating rate (and, therefore, The adjusted notional amount with the change in the value of the underlying risk accounts for the size of the derivative factor. The sensitivity is positive if the derivative the floating leg payment) is captured in contract is long the risk factor and negative if the the supervisory duration. The 84 See supra note 10. derivative contract is short the risk factor. commenters also noted that such

4380 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations banking organizations. The agencies factors (positive or negative) and the treatment could significantly affect the therefore are adopting as final the number of units. According to these adjusted notional amount for a short- proposed treatment for determining the commenters, such an approach would dated interest rate derivative portfolio. adjusted notional amount of interest rate better reflect the risk of such Other commenters recommended and credit derivative contracts. transactions because SA–CCR requires changes to the measure of S for basis Some commenters requested changes the use of floating notional values, and derivative contracts, for which the to address forward-settling mortgage- the notional value may change after floating rates on the reference exposure backed securities traded in the to-be- execution based on increases or are set at the beginning of the payment announced (TBA) market. Specifically, decreases in the spread. The period. Some of these commenters these commenters asked the agencies to commenters also argued that such an recommended measuring S as the recalibrate the adjusted notional amount approach would be consistent with period (in years) as the earliest reset for TBA derivative contracts to account guidance released by the CFTC date of the two floating-rate components for the term of the mortgage loans regarding the notional amount for of the contract, if the reset dates are underlying the securities. Other locational basis derivative contracts.87 different. commenters recommended measuring S The final rule does not incorporate the The treatment recommended by the for TBA derivative contracts as the time- commenters’ suggestion, as the purpose commenters cannot be made applicable weighted average term of the mortgages of the proposed treatment is to obtain to all interest rate derivatives; for underlying the securities. In response to the absolute volatility of the contract example, it would not be appropriate for commenter concerns, the agencies are price, which is related to each risk in arrears swaps, in which the rate is set clarifying that for an interest rate factor rather than the spread. at the end of the reset period instead of derivative contract or credit derivative The final rule adopts without change the beginning, and for forward rate contract that is a variable notional swap, the proposed treatment for determining agreements. In addition, adopting the including mortgage-backed securities the adjusted notional amount for credit commenters’ recommendations could traded in the TBA market, the notional and interest rate derivative contracts. add significant complexity to the final amount is equal to the time-weighted Under § l.132(c)(9)(ii)(A) of the final rule because it would require additional average of the contractual notional rule, the adjusted notional amount for parameters in the adjusted notional amounts of such a swap over the such contracts equals the product of the amount formula that would be used remaining life of the swap. notional amount of the derivative only in certain circumstances. Such an Other commenters recommended contract, as measured in U.S. dollars approach would create additional measuring the adjusted notional amount using the exchange rate on the date of burden for banking organizations that for basis derivative contracts as the the calculation, and the supervisory adopt SA–CCR and could adversely product of the absolute value of the duration. The formula to determine the affect the agencies’ ability to use SA– spread between the two underlying risk supervisory duration is as follows: CCR to assess comparability across

Where: ), and is based on the factor, the notional amount equals the S is the number of business days from the assumption of a continuous stream of notional amount of an equivalent present day until the start date for the equal payments and a constant unleveraged swap. derivative contract, or zero if the start continuously compounded interest rate ii. Exchange Rate Derivative Contracts date has already passed; and of 5 percent. The exponential function E is the number of business days from the provides discounting for S and E at 5 Under the proposal, the adjusted present day until the end date for the notional amount for an exchange rate derivative contract. percent continuously compounded. In all cases, the supervisory duration is derivative contract would have equaled A banking organization must calculate the notional amount of the non-U.S. the supervisory duration for the period floored at ten business days (or 0.04, based on an average of 250 business denominated currency leg of the that starts at S and ends at E, where S derivative contract, as measured in U.S. days per year). equals the number of business days dollars using the exchange rate on the between the present date and the start For an interest rate derivative contract date of the calculation. In general, the date for the derivative contract, or zero or a credit derivative contract that is a non-U.S. dollar denominated currency if the start date has passed, and E equals variable notional swap, the notional leg is the source of exchange rate the number of business days from the amount equals the time-weighted volatility. If both legs of the exchange present date until the end date for the average of the contract notional amounts rate derivative contract are denominated derivative contract. The supervisory of such a swap over the remaining life in currencies other than U.S. dollars, the duration recognizes that interest rate of the swap. For an interest rate adjusted notional amount of the derivative contracts and credit derivative contract or a credit derivative derivative contract would have been the derivative contracts with a longer tenor contract that is a leveraged swap, in largest leg of the derivative contract, have a greater degree of variability than which the notional amounts of all legs measured in U.S. dollars. For an an identical derivative contract with a of the derivative contract are divided by exchange rate derivative contract with shorter tenor for the same change in the a factor and all rates of the derivative multiple exchanges of principal, the underlying risk factor (interest rate or contract are multiplied by the same notional amount would have equaled

87 See CFTC, Division of Swap Dealer and Intermediary Oversight, FAQs About Swap Entities (Oct. 12, 2012), at 1.

4382 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Act (Dodd-Frank Act), which prohibits Alternatively, if the agencies declined to the notional amount of the derivative the use of credit ratings in Federal adopt the PD band-based approach for contract multiplied by the number of regulations.88 As an alternative, the purposes of the final rule, the exchanges of principal under the proposal would have introduced an commenters suggested lowering the derivative contract. The agencies approach that satisfies section 939A of proposed supervisory factor for received no comments on the proposed the Dodd-Frank Act while allowing for investment grade single-name credit adjusted notional amount for exchange a level of granularity among the derivatives from 0.5 percent to 0.46 rate derivative contracts, and are supervisory factors applicable to single- percent, to eliminate the impact of adopting it as final under name credit derivatives that would have rounding (to the nearest tenth) that was § l.132(c)(9)(ii)(B) of the final rule. been generally consistent with the Basel conducted for purposes of the proposal. 89 iii. Equity and Commodity Derivative Committee standard. Under the Other commenters suggested aligning Contracts proposal for single-name credit the supervisory factor for investment derivative contracts, investment grade grade single-name credit derivatives to Under the proposal, a banking derivative contracts would have the lowest supervisory factor under the organization would have applied the received a supervisory factor of 0.5 Basel Committee standard, 0.38 percent, same single-factor formula to equity percent, speculative grade derivative based on the view that the most derivative contracts and commodity contracts would have received a creditworthy issuers in the United derivative contracts. For such contracts, supervisory factor of 1.3 percent, and States are no more prone to default than the adjusted notional amount would sub-speculative grade derivative the most creditworthy issuers in other have equaled the product of the fair contracts would have received a jurisdictions. value of one unit of the reference supervisory factor of 6.0 percent. For SA–CCR is a standardized approach, instrument underlying the derivative credit derivative contracts that reference and the use of PD bands to assign contract and the number of such units an index, investment grade derivative supervisory factors to single-name credit referenced by the derivative contract. By contracts would have received 0.38 derivatives would require the use of design, the proposed treatment would percent and speculative grade derivative internal models, which generally are not have reflected the current price of the contracts would have received 1.06 appropriate for a standardized approach underlying reference instrument. For percent. The proposal would have that is intended to be implementable by example, if a banking organization has revised the capital rule to include banking organizations of all sizes. In a derivative contract that references definitions for speculative grade and sub- addition, providing such treatment as an 15,000 pounds of frozen concentrated speculative grade (the capital rule option in SA–CCR could introduce more orange juice currently priced at $0.0005 already includes a definition for risk sensitivity solely for more a pound then the adjusted notional investment grade). The agencies sophisticated banking organizations that amount would be $7.50. For an equity received several comments on the currently determine PD for purposes of derivative contract or a commodity supervisory factors for credit derivative the advanced approaches, and derivative contract that is a volatility contracts, but no comments on the potentially provide a competitive derivative contract, a banking proposed definitions of speculative advantage to such firms and adversely organization would have been required grade and sub-speculative grade. affect the use of SA–CCR to assess to replace the unit price with the Several commenters encouraged the comparability across banking underlying volatility referenced by the agencies to reconsider the proposed organizations. In addition, lowering the volatility derivative contract and replace methodology for determining the supervisory factor for single-name the number of units with the notional supervisory factors for single-name investment grade credit derivatives to amount of the volatility derivative credit derivative contracts. As an 0.38 percent would fail to recognize the contract. By design, the proposed alternative, the commenters meaningful differences in the risks treatment would have reflected that the recommended an approach that maps captured by the investment grade payoff of a volatility derivative contract probability of default (PD) bands to the category under the proposal and the generally is determined based on a credit rating categories and the final rule, relative to the category and notional amount and the realized or corresponding supervisory factors set supervisory factor that correspond implied volatility (or variance) forth in the Basel Committee standard solely to an AAA credit rating under the referenced by the derivative contract for single-name credit derivatives, Basel Committee standard. In response and not necessarily the unit price of the consistent with the approach used to to comments, however, the final rule underlying reference instrument. The assign a counterparty risk weight under applies a 0.46 percent supervisory factor agencies received no comments on the the simple CVA approach in the to investment grade single-name credit 90 proposed adjusted notional amount for advanced approaches. According to derivative contracts. This change will equity and commodity derivative the commenters, this approach would enhance the precision and risk contracts, including instances in which more closely align with the granularity sensitivity of the final rule, without such a contract is a volatility derivative and the supervisory factors provided introducing undue complexity or contract, and are adopting it without under the Basel Committee standard, materially affecting the amount of while meeting the requirements of change under § l.132(c)(9)(ii)(C) of the regulatory capital a banking final rule. section 939A of the Dodd-Frank Act. organization must hold for such b. Supervisory Factor derivative contracts relative to the 88 See Public Law 111–203, 124 Stat. 1376 (2010), proposal. i. Credit Derivative Contracts section 939A. This provision is codified as part of Therefore, the final rule adopts the the Securities Exchange Act of 1934 at 15 U.S.C. In contrast to the Basel Committee 78o–7. supervisory factors for credit derivative standard, the proposal would not have 89 Specifically, the supervisory factors in the contracts, as proposed, with one provided for the use of credit ratings to Basel Committee’s SA–CCR standard are as follows modification to the supervisory factor determine the supervisory factor for (in percent): AAA and AA–0.38, A–0.42; BBB–0.54; for investment grade single-name credit credit derivative contracts due to BB–1.06; B–1.6; CCC–6.0. derivative contracts as described above. 90 See 12 CFR 3.132(e)(5) (OCC); 12 CFR section 939A of the Dodd-Frank Wall 217.132(e)(5) (Board); and 12 CFR 324.132(e)(5) In addition, the final rule maintains the Street Reform and Consumer Protection (FDIC). current definition of investment grade

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4383 due diligence to determine the types or allocating exposures across the in the capital rule, and adopts the appropriate category for a single-name various alternate categories posed by proposed definitions for ‘‘speculative credit derivative, in view of the commenters, and then calibrating grade’’ and ‘‘sub-speculative grade.’’ performance criteria in the definitions supervisory factors associated with each The supervisory factors are reflected in for each category under the final rule. A of those sub-categories, would increase Table 2 of this SUPPLEMENTARY banking organization may consider the the complexity of applying SA–CCR and INFORMATION. credit rating for a single-name credit reduce comparability among banking The investment grade category derivative in making that determination organizations. Further adjustments to generally captures single-name credit as part of a multi-factor analysis. In the supervisory factor for equity derivative contracts consistent with the addition, the agencies expect a banking derivative contracts to align with the three highest supervisory factor organization to have and retain support revised Basel III market risk standard, as categories under the Basel Committee for its analysis and assignment of the recommended by commenters, standard. The capital rule defines respective credit categories. potentially could be considered if that investment grade to mean that the entity standard is implemented in the United ii.Equity Derivative Contracts to which the banking organization is States in a future rulemaking. Therefore, exposed through a loan or security, or Under the proposal, single-name the final rule adopts as proposed the the reference entity with respect to a equity derivative contracts would have supervisory factors for equity derivative credit derivative contract, has adequate received a supervisory factor of 32 contracts, as reflected in Table 2 of the capacity to meet financial commitments percent and equity derivative contracts final rule. for the projected life of the asset or that reference an index would have exposure. Such an entity or reference received a supervisory factor of 20 iii. Commodity Derivative Contracts entity has adequate capacity to meet percent. The agencies received several The proposal would have established financial commitments, as the risk of its comments regarding the proposed four commodity categories: Energy, default is low and the full and timely supervisory factors for equity derivative metals, agriculture, and other. Energy repayment of principal is expected.91 contracts. In general, the commenters derivative contracts would have The speculative grade category recommended various approaches to received a supervisory factor of 40 generally captures single-name credit distinguish among the risks of single- percent, whereas derivative contracts in derivative contracts consistent with the name equity derivative contracts and the non-energy commodity categories next two lower supervisory factor thereby provide additional granularity (i.e., metal, agricultural, and other) each categories under the Basel Committee in the supervisory factors that would have received a supervisory standard. The final rule defines the term correspond to such exposures. The factor of 18 percent. speculative grade to mean that the approaches offered by the commenters The agencies received a number of reference entity has adequate capacity to would distinguish among (1) investment comments on the proposed supervisory meet financial commitments in the near grade and non-investment grade issuers; factors for commodity derivative term, but is vulnerable to adverse (2) issuers in advanced and emerging contracts. Several commenters economic conditions, such that should markets; (3) issuers with large market encouraged the agencies to recalibrate economic conditions deteriorate, the capitalizations and those with small the supervisory factors for commodity reference entity would present elevated market capitalizations; and (4) issuers in derivative contracts to reflect the market default risk. The sub-speculative grade different industry sectors. Some of the price of forward contracts, stating that category corresponds to the lowest approaches suggested by commenters this would better reflect the actual supervisory factor category under the align with the Basel Committee market volatility of the commodity derivatives Basel Committee standard, with the risk standard.93 Commenters also market compared to the market price of term sub-speculative grade defined suggested various permutations of these spot contracts. According to these under the final rule to mean that the approaches (e.g., use of sector commenters, such an approach would reference entity depends on favorable differentiation in combination with a reflect the widespread use of economic conditions to meet its distinction for advanced and emerging commodity derivative contracts in the financial commitments, such that markets). Some commenters provided market, as a way to hedge commodity should economic conditions deteriorate, analysis suggesting that each of these price risk for months or years into the the reference entity likely would default approaches could offer additional future. As an alternative to this on its financial commitments. Each of granularity and allow for lower recommendation, commenters suggested these categories includes exposures that supervisory factors for investment full alignment with the supervisory perform largely in accordance with the grade, advanced markets, and large cap factors for commodity derivative performance criteria that define each issuers, relative to the supervisory contracts in the Basel Committee category under the final rule, and factors under the proposal and the Basel standard, which applies a 40 percent therefore result in capital requirements Committee standard. Commenters also supervisory factor to electricity that are broadly equivalent to those suggested incorporating one of the derivative contracts and an 18 percent resulting from application of the above distinctions into the supervisory supervisory factor to oil/gas derivative supervisory factors under the Basel factors for equity indices. contracts, each within the energy The agencies acknowledge that category. Committee standard.92 The agencies expect that banking certain aspects of the proposal could be Other commenters expressed concern organizations would conduct their own revised to enhance its risk sensitivity; that the proposed supervisory factors for however, any such revisions must be commodity derivative contracts were 91 ‘‘Investment grade’’ is defined in § l.2 of the balanced against the objectives of not sufficiently granular. These capital rule. See 12 CFR 3.2 (OCC); 12 CFR 217.2 simplicity and ensuring comparability commenters argued that each of the (Board); and 12 CFR 324.2 (FDIC). among banking organizations that commodity categories set forth in the 92 An empirical analysis for the supervisory implement SA–CCR. Attempting to proposal would include a wide range of factors applied to the investment grade and commodity types that present different speculative grade categories is set forth in the define different categories of market

SUPPLEMENTARY INFORMATION section of the proposal. See 83 FR 64660, 64675 (December 17, levels of risk. As a result, the 2018). 93 See supra note 79. commenters expressed concern that the

4384 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations contracts under multiple regulatory the primary risk factor, and are not proposal would overstate the amount of regimes, and could provide incentives based on the purpose for which such a capital that must be held for certain for such banking organizations to book derivative contract may be entered into. lower-risk commodities, particularly commodity derivatives in an entity Therefore, consistent with the proposal, natural gas and certain types of located in the jurisdiction that provides under the final rule a banking 94 agricultural commodities. Several for the most favorable treatment from a organization must treat a gold derivative commenters expressed concern that the regulatory capital perspective. contract as a commodity derivative proposed supervisory factors for Other commenters recommended contract, with a supervisory factor of 18 commodity derivative contracts would revising the proposal to provide percent. indirectly increase the cost of such separate recognition for derivative The final rule adopts the supervisory contracts for commercial end-user contracts that reference commodity factors for commodity derivative counterparties, who may use indices. According to these commenters, contracts, as proposed, with one commodity derivative contracts to diversification across different modification to the supervisory factor manage commercial risk. commodities significantly lowers the for contracts that are In response to comments, the final volatility of a diversified index when not electricity derivative contracts as rule adopts a separate supervisory factor compared to the undiversified discussed above. The supervisory of 18 percent for all energy derivative volatilities of the index constituents. factors are reflected in Table 2 of this contracts except for electricity The final rule does not include a and Table derivative contracts, which receive a SUPPLEMENTARY INFORMATION specific treatment for commodity 2 to § l.132 of the final rule. supervisory factor of 40 percent. This indices because they are typically treatment enhances the risk sensitivity highly heterogeneous depending on iv. Interest Rate Derivative Contracts of the supervisory factors for derivative their compositions and maturities and, Under the proposal, interest rate contract types within the energy as a result, a single calibration for such derivative contracts would have commodity category in a manner that a broad asset class will not provide for received a supervisory factor of 0.5 aligns with the Basel Committee the risk sensitivity intended by SA– percent. The agencies did not receive 95 standard. The final rule does not CCR. comments on this aspect of the revise the other supervisory factors Under the proposal, a banking proposal, and are adopting it as proposed for commodity derivatives, or organization would have been required proposed, as reflected in Table 2 of this provide for more granularity in the to treat a gold derivative contract as a SUPPLEMENTARY INFORMATION. supervisory factors. In addition to commodity derivative contract rather presenting significant challenges and than an exchange rate derivative v. Exchange Rate Derivative Contracts materially increasing the complexity of contract, and apply a supervisory factor Under the proposal, exchange rate the framework (as noted in section of 18 percent. Several commenters derivative contracts would have III.D.1.d. of this SUPPLEMENTARY argued for revising the proposal to received a supervisory factor of 4 INFORMATION), revising the proposal to recognize gold derivative contracts as a percent. As noted in the discussion on include additional commodity type of exchange rate derivative supervisory factors for commodity categories for specific commodity types contract. According to the commenters, derivative contracts, several could limit the full offset treatment such treatment would be consistent commenters supported treating gold available to commodity types within the with CEM, IMM, the Basel Committee’s derivative contracts as a type of same category. Recalibrating the Basel II accord issued in 2004 (Basel exchange rate derivative contract. supervisory factors for commodity II),96 and industry practice. The However, as noted previously, treating a derivative contracts to reflect the commenters also asserted that, similar gold derivative as an exchange rate volatility driven by forward prices also to currencies, gold serves as a derivative contract would significantly would not be appropriate for all macroeconomic hedge to dynamic understate the risk associated with such commodity derivative contracts because market conditions including declining exposures. The agencies are therefore the value of short-term derivative equity prices, inflationary pressures, adopting as final the proposal to treat a contracts—which also are prevalent and political crises. gold derivative contract as a commodity within the market—is driven by spot Based on an analysis of price data for derivative contract. The agencies did prices rather than forward prices. gold, silver, nickel and platinum from not receive comments on other aspects Moreover, such an approach would January 2001 to January 2019, gold of the proposed supervisory factors for materially deviate from the Basel exhibits historical volatility levels that exchange rate derivative contracts, and Committee standard and could create are generally consistent with those are adopting them as final, as reflected material inconsistencies in the observed for other metals, and are in Table 2 of this SUPPLEMENTARY international treatment of derivative nearly identical to the historical INFORMATION. contracts across jurisdictions. Any such volatility levels observed for platinum inconsistencies could create regulatory over the same period. Accordingly, vi. Volatility Derivative Contracts and compliance burdens for large, treating a gold derivative contract as an Basis Derivative Contracts internationally active banking exchange rate derivative contract would For volatility derivative contracts, the organizations required to determine significantly understate the risk proposal would have required a banking capital requirements for derivative associated with such exposures, organization to multiply the applicable

notwithstanding their treatment under supervisory factor based on the asset 94 See section III.D.1.d. of this SUPPLEMENTARY either Basel II, IMM or CEM. Moreover, INFORMATION. class related to the volatility measure by 95 As described in section III.D.1.d. of this the supervisory factors under SA–CCR a factor of five. This treatment would SUPPLEMENTARY INFORMATION, for purposes of are calibrated to volatilities observed in have recognized that volatility calculating the hedging set amount, the final rule permits full offsetting for all derivative contracts derivative contracts are inherently within a hedging set that reference the same 96 See ‘‘International Convergence of Capital subject to more price volatility than the commodity type, and partial offsetting for all Measurement and Capital Standards: A Revised derivative contracts within a hedging set that Framework,’’ Basel Committee on Banking underlying asset classes they reference. reference different commodity types within the Supervision (June 2004), https://www.bis.org/publ/ For basis derivative contracts, the same commodity category. bcbs107.pdf. proposal would have required a banking

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4385 difference in volatilities of highly supervisory factors for volatility organization to multiply the applicable correlated risk factors, which would derivative contracts and basis derivative supervisory factor based on the asset have resulted in a lower volatility than contracts, and the final rule adopts this class related to the basis measure by a a derivative contract that is not a basis aspect of the proposal without change. factor of one half. This treatment would derivative contract. The agencies did have reflected that the volatility of a not receive comments on the proposed basis derivative contract is based on the

TABLE 2—SUPERVISORY OPTION VOLATILITY AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS

Supervisory Supervisory Supervisory option correlation factor 1 Asset class Category Type volatility factor (percent) (percent) (percent)

Interest rate ...... N/A ...... N/A ...... 50 N/A 0.50 Exchange rate ...... N/A ...... N/A ...... 15 N/A 4.0 Credit, single name ...... Investment grade ...... N/A ...... 100 50 0.46 Speculative grade ...... N/A ...... 100 50 1.3 Sub-speculative grade ...... N/A ...... 100 50 6.0 Credit, index ...... Investment Grade ...... N/A ...... 80 80 0.38 Speculative Grade ...... N/A ...... 80 80 1.06 N/A ...... N/A ...... 120 50 32 Equity, index ...... N/A ...... N/A ...... 75 80 20 Commodity ...... Energy ...... Electricity ...... 150 40 40 Other ...... 70 40 18 Metals ...... N/A ...... 70 40 18 Agricultural ...... N/A ...... 70 40 18 Other ...... N/A ...... 70 40 18 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in Table 2, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in Table 2. c. Supervisory Delta Adjustment proposal. Conversely, other commenters (positive or negative) with respect to the Under the proposal, a banking supported the agencies’ proposal with underlying risk factor, as such contracts organization would have applied the respect to the calibration of supervisory are considered to be linear in the supervisory delta adjustment to account deltas. primary risk factor. Accordingly, the for the sensitivity of a derivative As generally noted above, SA–CCR is supervisory delta adjustment equals one contract to the underlying primary risk a standardized framework, and the use if such a derivative contract is long the factor, including the correct sign of internal models to determine option primary risk factor and negative one if (positive for long and negative for short) volatility would generally not be it is short the primary risk factor. to account for the direction of the appropriate for a standardized approach As noted above, because options derivative contract amount relative to that is intended to be implementable by contracts are nonlinear, a banking the primary risk factor. Because option all banking organizations and used to organization must use the Black-Scholes contracts are nonlinear, the proposal facilitate supervisory assessments of Model to determine the supervisory would have required a banking comparability across banking delta adjustment for options contracts. organization to use the Black-Scholes organizations. Allowing banking However, because the Black-Scholes Model to determine the supervisory organizations to use internal models for Model assumes that the underlying risk delta adjustment. purposes of the final rule would not factor is greater than zero, consistent Some commenters argued that use of support these objectives. The agencies with the proposal, the final rule the Black-Scholes Model is not note that advanced approaches banking incorporates a parameter, lambda (l), so appropriate for certain path-dependent organizations may continue to use IMM, that the Black-Scholes Model may be options, because their price is not which is a model-based approach, to used where the underlying risk factor determined by a single price but instead determine the exposure amount of has a negative value. In particular, the is determined by the path of the price derivative contracts for purposes of Black Scholes formula provides a ratio, for the underlying asset during the calculating advanced approaches total P/K, as an input to the natural logarithm option’s tenor. For such path-dependent risk-weighted assets.97 function. P is the fair value of the options, the commenters asked that The final rule adopts the supervisory underlying instrument and K is the banking organizations instead be delta adjustment as proposed. Under . The natural logarithm allowed to use existing internal models. § l.132(c)(9)(iii) of the final rule, the function can be defined only for Similarly, other commenters requested supervisory delta adjustment for amounts greater than zero, and allowing banking organizations to use derivative contracts that are not options therefore, a reference risk factor with a modeled volatilities for purposes of the or collateralized debt obligation negative value (e.g., negative interest supervisory delta adjustment, rather tranches must account only for the rates) would make the supervisory delta than the volatilities prescribed by the direction of the derivative contract adjustment inoperable.

97 See supra note 25. one sold European option of the same type as the exactly outside the region between the two strikes. 98 Under the final rule, a banking organization original option (put or call) with the strike prices The absolute value of the sum of the adjusted must represent binary options with strike K as the set equal to 0.95 * K and 1.05 * K. The size of the derivative contract amounts of the bought and sold combination of one bought European option and position in the European options must be such that options is capped at the payoff amount of the binary the payoff of the is reproduced option.

4386 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

Where: s equals the supervisory option volatility, (such as interest rate caps and floors),101 F is the standard normal cumulative determined in accordance with Table 2 a banking organization must represent distribution function; of the preamble. each payment option as a combination P equals the current fair value of the Consistent with the proposal, under of effective single-payment options instrument or risk factor, as applicable, the final rule, for a derivative contract (such as interest rate caplets and underlying the option; that can be represented as a floorlets). A banking organization K equals the strike price of the option; combination of standard option payoffs cannot decompose linear derivative T equals the number of business days until (such as , spread, contracts (such as swaps) into the latest contractual exercise date of the components. option; and , , and 100 l equals zero for all derivative contracts, ), a banking organization For a derivative contract that is a except that for interest rate options that must treat each standard option collateralized debt obligation tranche, a reference currencies currently associated component as a separate derivative banking organization must determine with negative interest rates l must be contract. For a derivative contract that the supervisory delta adjustment equal to max {¥L + 0.1%; 0}; 99 and includes multiple-payment options according to the following formula:

Where: all underlying exposures, expressed as a whether a derivative contract is subject A is the attachment point, which equals the decimal value between zero and one. to a variation margin agreement. For ratio of the notional amounts of all The final rule applies a positive sign derivative contracts subject to a underlying exposures that are to the resulting amount if the banking variation margin agreement, the subordinated to the banking organization purchased the maturity factor would have been based organization’s exposure to the total on the ratio of the supervisory-provided notional amount of all underlying collateralized debt obligation tranche and applies a negative sign if the MPOR applicable to the type of exposures, expressed as a decimal value derivative contract and 250 business between zero and one; 102 and banking organization sold the days. The proposal would have defined D is the detachment point, which equals one collateralized debt obligation tranche. MPOR as the period from the most minus the ratio of the notional amounts d. Maturity Factor of all underlying exposures that are recent exchange of collateral under a senior to the banking organization’s The proposal would have provided variation margin agreement with a exposure to the total notional amount of separate maturity factors based on defaulting counterparty until the

99 The same value of li must be used for all A calendar spread consists of a short call (put) is similar to the straddle, but the investor is interest rate options that are denominated in the option and a long call (put) option on the same purchasing (selling) out-of-the-money options in a same currency. The value of li for a given currency underlying stock and with the same exercise price, strangle, while in a straddle, the investor is would be equal to the lowest value L of Pi and Ki but with different maturities. If the investor expects purchasing (selling) at-the-money options. of all interest rate options in a given currency that limited price movement on the stock in the near- 101 the banking organization has with all term but a significant longer-term price increase, An interest rate cap is a series of interest rate counterparties. the investor will sell the short-dated and call options (‘‘caplets’’) in which the option seller 100 A collar is a combination of a long position purchase the long-dated call option. pays the option buyer when the reference rate in the stock, a long and a short call A straddle consists of a long (short) call option exceeds the predetermined level in the contract. An option, in which the investor gives up the upside and long (short) put option on the same underlying interest rate floor is a series of interest rate put on the stock (by selling the call option) to obtain stock, with the same exercise price and with the options (‘‘floorlets’’) in which the option seller pays downside protection (through the purchase of the same maturity, in which the investor pays (receives) the options buyer when the reference rate falls put option). two option premiums upfront. In a long straddle, below the contractual floor. A butterfly spread consists of a long put (call) the investor pays two premiums upfront for the 102 In the case of a first-to-default credit with a low exercise price, a long put (call) with a options in order to hedge against expected large derivative, there are no underlying exposures that high exercise price, and two short puts (calls) with future stock price moves regardless of direction. In are subordinated to the banking organization’s an intermediate exercise price, in which the a short straddle, the investor receives two option investor earns a profit if the underlying asset equals premiums upfront based on their expectation of low exposure and A = 0. In the case of a second-or- the intermediate exercise price of two short puts future price volatility. subsequent-to-default credit derivative, the smallest (calls) but has limited their potential loss to no A strangle consists of a call and put option on the (n¥1) notional amounts of the underlying more than the low exercise price of the long put same underlying stock and with the same exercise exposures are subordinated to the banking (call). date, but with different exercise prices. The strategy organization’s exposure.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4387 the proposal is different from the type of counterparty to the derivative derivative contracts are closed out and existing criteria under the IMM. Under contract because the agencies intend for the resulting market risk is re-hedged. the proposal, a banking organization the maturity factor to capture the time For derivative contracts subject to a would have been required to double the period to close out a defaulted variation margin agreement that are not applicable MPOR floor if the derivative counterparty and the degree of legal cleared transactions, MPOR would have contract is subject to an outstanding certainty with respect to such close-out been floored at ten business days. For dispute over margin. Under the IMM, a period. With respect to comments derivative contracts subject to a banking organization must double the regarding the MPOR for exposures to variation margin agreement and that are applicable MPOR only if over the two commercial end-user counterparties, cleared transactions, MPOR would have previous quarters more than two margin removing the alpha factor for derivative been floored at five business days. For contracts with such counterparties derivative contracts not subject to a disputes in a netting set have occurred should help to address the commenters’ variation margin agreement, the and lasted longer than the MPOR. The concerns. maturity factor would have been based agencies are aligning the treatment in on the ratio of the remaining maturity of the final rule with this approach. Some commenters asked the agencies the derivative contract, capped at 250 Therefore, a banking organization must to replace the term ‘‘exotic derivative business days, with the numerator double the applicable MPOR only if contracts’’ 105 under the proposal with floored at ten business days. over the two previous quarters more ‘‘derivative contracts that are not easily Several commenters asked the than two margin disputes in a netting replaceable’’ in order to allow banking agencies to clarify whether a five- set have occurred, and each margin organizations to rely on existing business-day MPOR floor would apply dispute lasted longer than the MPOR.104 operational processes rather than to the exposure of a clearing member This approach is consistent with the requiring the establishment of new ones banking organization to its client that treatment under IMM, which has to identify ‘‘exotic derivative contracts.’’ arises when the clearing member generally functioned as intended. In These commenters noted that banking banking organization is acting as a addition, alignment with IMM will organizations have already established financial intermediary and enters into reduce operational burden for firms that the operational processes necessary for an offsetting derivative contract with a are required to use SA–CCR for identifying derivative contracts as ‘‘not CCP or when the clearing member calculating standardized risk-weighted easily replaceable’’ to comply with other banking organization provides a assets, but have received prior aspects of the capital rule. In response guarantee to the CCP on the supervisory approval to use IMM to to commenters’ concerns, the agencies performance of the client on a derivative calculate risk-weighted assets under the are replacing the term ‘‘exotic derivative contract with the CCP. In response to advanced approaches. contract’’ with ‘‘derivative contract that comments, the final rule applies a five- Other commenters requested revising cannot be easily replaced.’’ business-day MPOR floor to the the proposal to allow banking For the reasons described above, the exposure of a clearing member banking organizations to treat all derivative agencies are adopting as final the organization to its client that arises contracts with a commercial end-user proposed maturity factor adjustment when the clearing member banking counterparty as subject to a variation under § l.132(c)(9)(iv) of the final rule, organization is acting as a financial margin agreement and apply a holding subject to the clarifications and intermediary and enters into an period of no more than ten business revisions discussed above. Under the offsetting derivative contract with a days, regardless of whether the final rule, for derivative contracts not QCCP or when the clearing member derivative contract is subject to a subject to a variation margin agreement, banking organization provides a variation margin agreement. The reasons or derivative contracts subject to a guarantee to the QCCP on the provided by commenters for this request variation margin agreement under performance of the client on a derivative were to help address the types of which the counterparty to the variation contract with the QCCP (defined under concerns raised by commenters margin agreement is not required to post this final rule as a ‘‘client-facing regarding exposures to commercial end- variation margin to the banking derivative transaction,’’ as described user counterparties, as discussed organization, a banking organization 103 below). previously. The final rule does not must determine the maturity factor Some commenters noted that the provide maturity factors based on the using the following formula: criteria for doubling the MPOR under

For derivative contracts subject to a must determine the maturity factor Where M equals the greater of ten variation margin agreement under using the following formula: business days and the remaining which the counterparty must post maturity of the contract, as measured in variation margin, a banking organization business days.

103 Section 132(c)(9)(iv)(A)(2)(ii) of the proposed The final rule is consistent with the Basel 105 Under the proposal, a banking organization rule text would have applied a five-business-day Committee standard regarding capital requirements would have been required to use a MPOR of 20 MPOR floor to cleared transactions subject to a for bank exposures to central counterparties and business days for a derivative contract that is within variation margin agreement. In order to capture the with the treatment of these transactions under the a netting set that is composed of more than 5,000 longer close-out period required in the event of a agencies’ implementation of CEM. See infra note derivative contracts that are not cleared central counterparty failure, the final rule text at section 132(c)(9)(iv)(A)(1) provides that MPOR 116. transactions, or if a netting set contains one or more cannot be less than ten business days for 104 The adopted treatment is also consistent with trades involving illiquid collateral or exotic transactions subject to a variation margin agreement the application of the standard supervisory haircuts derivative contracts. that are not client-facing derivative transactions. under § l.132(b)(2)(ii)(A)(4) of the final rule.

4388 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations contract is the period until the next the floor to 1 percent because initial reset date.107 In addition, derivative margin requirements for uncleared contracts with daily settlement would swaps under the swap margin rule be treated as unmargined derivative generally are calibrated to a 99 percent Where MPOR refers to the period contracts. However, as discussed in confidence level. Additionally, these from the most recent exchange of section III.D.4. of this SUPPLEMENTARY commenters argued that the floor should collateral under a variation margin INFORMATION, a banking organization not be a component of the PFE agreement with a defaulting may elect to treat settled-to-market multiplier function but instead should counterparty until the derivative derivative contracts as collateralized-to- act as an independent floor to the contracts are closed out and the market derivative contracts subject to a recognition of collateral under the PFE resulting market risk is re-hedged. variation margin agreement and apply function. According to these comments, The final rule introduces the term the maturity factor for derivative while these changes would result in ‘‘client-facing derivative transactions’’ contracts subject to a variation margin more risk-sensitive initial margin to describe the exposure of a clearing agreement. recognition for heavily member banking organization to its overcollateralized netting sets, the 3. PFE Multiplier client that arises when the clearing overall impact would remain member banking organization is either Under the proposal, the PFE conservative due to the overcalibration acting as a financial intermediary and multiplier would have recognized, if of the add-on. Other commenters asked enters into an offsetting derivative present, the amount of excess collateral the agencies to recognize the effect of contract with a QCCP or when the available and the negative fair value of collateral on a dollar-for-dollar basis, clearing member banking organization the derivative contracts within the subject to haircuts, similar to the provides a guarantee to the QCCP on the netting set. Specifically, the PFE recognition of collateral under the performance of the client for a multiplier would have decreased replacement cost component of SA– derivative contract with the QCCP. exponentially from a value of one as the CCR. Under the final rule, the agencies are value of the financial collateral held Relative to CEM, SA–CCR is more clarifying that the MPOR is floored at exceeds the net fair value of the sensitive to the risk-reducing benefits of five business days for derivative derivative contracts within the netting collateral. However, the agencies contracts subject to a variation margin set, subject to a floor of 5 percent. This recognize that as a standardized agreement that are client-facing function accounted for the fact that the framework, SA–CCR may not derivative transactions. For all other proposed aggregated amount formula appropriately capture risks in all cases derivative contracts subject to a would not have recognized financial (e.g., collateral haircuts may be less than variation margin agreement, the MPOR collateral and would have assumed a those realized in stress periods) and is floored at ten business days. If over zero market value for all derivative therefore believe it is appropriate to the previous two quarters a netting set contracts. instill conservatism. The combination of is subject to two or more outstanding Several commenters argued that the the exponential function and the floor margin disputes that lasted longer than PFE multiplier is too conservative and provides adequate recognition of the MPOR, the applicable MPOR is does not appropriately account for the collateral while maintaining a sufficient twice the MPOR provided for those risk-reducing effects of collateral. Some level of conservatism by limiting transactions in the absence of such commenters argued that the calibration decreases in PFE due to large amounts 106 disputes. For a derivative contract of the aggregated amount for a netting of collateral and preventing PFE from that is within a netting set that is set would result in an overly reaching zero for any amount of margin. composed of more than 5,000 derivative conservative PFE multiplier amount, This ensures that some amount of contracts that are not cleared and that the aggregated amount in the capital will be maintained even in transactions, or if a netting set contains PFE multiplier should be divided by at situations where the transaction is one or more transactions involving least two to mitigate such conservatism. overcollateralized. The commenters’ illiquid collateral or a derivative Other commenters argued that because recommendations could, in certain contract that cannot be easily replaced, other factors under SA–CCR already circumstances, undermine these the MPOR is floored at 20 business contribute to the conservative objectives. Therefore, the final rule days. recognition of initial margin (e.g., the adopts the PFE multiplier as proposed. For a cleared derivative contract in calibration of the add-on, use of an Under the final rule, a banking which on specified dates any exponential function, and reflection of organization must calculate the PFE outstanding exposure of the derivative collateral volatility through haircuts that multiplier using the formula set forth in contract is settled and the fair value of do not allow any diversification across §l.132(c)(7)(i) of the final rule, as the derivative contract is reset to zero, collateral), the agencies should decrease follows: the remaining maturity of the derivative

Where: V is the sum of the fair values (after the derivative contracts within the excluding any valuation adjustments) of netting set;

106 In general, a party will not have violated its required variation margin, including the timely with the counterparty promptly following the obligation to collect or post variation margin from initiation and continued pursuit of formal dispute applicable cure period and notification or to a counterparty if: The counterparty has refused resolution mechanisms; or has otherwise requirements. or otherwise failed to provide or accept the required demonstrated that it has made appropriate efforts to 107 See 12 CFR 3.2 (OCC); 12 CFR 217.2 (Board); variation margin to or from the party; and the party collect or post the required variation margin; or has made the necessary efforts to collect or post the commenced termination of the derivative contract and 12 CFR 324.2 (FDIC).

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4389 a banking organization would have such contracts are within the same C is the sum of the net independent collateral divided the netting set into sub-netting netting set. amount and the variation margin amount The proposal’s distinction between applicable to the derivative contracts sets and calculated the aggregated within the netting set; and amount for each sub-netting set. In margined and unmargined derivative A is the aggregated amount of the netting set. particular, all derivative contracts contracts would not have fully captured within the netting set that are not the relationship between settled-to- The PFE multiplier decreases as the market derivative contracts and net fair value of the derivative contracts subject to a variation margin agreement or that are subject to a variation margin collateralized-to-market derivative within the netting set less the amount of contracts that are cleared transactions as collateral decreases below zero. agreement under which the defined under § l.2 of the capital rule. Specifically, when the component V¥ C counterparty is not required to post variation margin would have formed a In particular, under both cleared settled- is greater than zero, the multiplier is to-market and cleared collateralized-to- equal to one. When the component V¥ single sub-netting set. A banking organization would have been required market derivative transactions a banking C is less than zero, the multiplier is organization must either make a equal to an amount less than one and to calculate the aggregated amount for this sub-netting set as if the netting set settlement payment or exchange decreases exponentially in value as the collateral to support its outstanding absolute value of V¥ C increases. The were not subject to a variation margin agreement. All derivative contracts credit obligation to the counterparty on PFE multiplier approaches a floor of 5 a periodic basis. Such contracts are percent as the absolute value of V¥ C within the netting set that are subject to variation margin agreements under functionally and economically similar becomes very large as compared with from a credit risk perspective, and the aggregated amount of the netting set. which the counterparty must post variation margin and that share the therefore, the final rule allows a banking 4. PFE Calculation for Nonstandard same MPOR value would have formed organization to elect, at the netting set Margin Agreements another sub-netting set. A banking level, to treat all the settled-to-market When a single variation margin organization would have been required derivative contracts within the netting agreement covers multiple netting sets, to calculate the aggregated amount for set that are cleared transactions as subject to a variation margin agreement the parties exchange variation margin this sub-netting set as if the netting set and receive the benefits of netting with based on the aggregated market value of were subject to a variation margin cleared collateralized-to-market the netting sets—i.e., netting sets with agreement, using the MPOR value derivative contracts. That is, a banking positive and negative market values can shared by the derivative contracts organization that makes such election offset one another to reduce the amount within the netting set. of variation margin that the parties are Several commenters asked the will treat such cleared settled-to-market required to exchange. This can result, agencies to allow banking organizations derivative contracts as cleared however, in a situation in which margin to net based solely on whether a QMNA collateralized-to-market derivative exchanged between the parties will be that provides for closeout netting per contracts, using the higher maturity factor applicable to collateralized-to- insufficient relative to the banking applicable law in the event of default is 112 organization’s exposure amount for the in place. These commenters asserted market derivative contracts. Similarly, for listed options, the netting sets.108 To address such a that netting should not be limited to agencies are clarifying that a banking situation, the proposal would have derivative contracts with the same organization may elect to treat listed required a banking organization to MPOR because the purpose of the options on securities or listed options assign a single PFE to each netting set MPOR is to capture the risks associated on futures with equity-style margining covered by a single variation margin with an extended closeout period upon that are cleared transactions as agreement, calculated as if none of the a counterparty’s default and that margined derivatives. Under the final derivative contracts within the netting differences in MPOR are unrelated to rule, a banking organization may elect to set are subject to a variation margin the legal ability to net upon closeout, treat all such transactions within the agreement. The agencies did not receive which should be based only on legal same netting set as being subject to a comments on this aspect of the certainty which is established under variation margin agreement with a zero proposal, and are adopting it as U.S. law if the netting agreement is a threshold amount and a zero minimum proposed under § l.132(c)(10)(ii) of the QMNA. In particular, commenters were transfer amount, given that the daily net final rule. concerned that the proposal would option value credits and debits are The proposal also would have prohibit banking organizations from economically equivalent to an exchange provided a separate calculation to being able to net settled-to-market 109 of variation margin under a zero determine PFE for a situation in which derivative contracts with collateralized- threshold and a zero minimum transfer a netting set is subject to more than one to-market derivative contracts,110 as amount. Consistent with the treatment variation margin agreement, or for a well as futures-style options and options described above for settled-to-market hybrid netting set. Under the proposal, with equity-style margining,111 even if derivative contracts that are treated as 108 For example, consider a variation margin 109 See supra note 18. collateralized-to-market, a banking agreement with a zero threshold amount that covers two separate netting sets, one with a positive 110 In general, in a collateralized-to-market market value of 100 and the other with a market derivative contract, title of transferred collateral addition, under U.S. GAAP, the option is an asset value of negative 100. The aggregate market value stays with the posting party. and the banking organization could use it in the of the netting sets would be zero and thus no 111 In general, for margining for options, the buyer event of a client’s default to offset any other losses variation margin would be exchanged. However, the of the option pays a premium upfront to the seller the buyer may have. banking organization’s aggregate exposure amount and there is no exchange of variation margin. The 112 § l.132(c)(9)(iv)(A) of the final rule. Similar to for these netting sets would be equal to 100 because buyer, however, may credit the net value of the the treatment under CEM, SA–CCR provides a the negative market value of the second netting set option against its initial margin requirements. The lower maturity factor for cleared settled-to-market would not be available to offset the positive market seller, in turn, receives a debit against its initial derivative contracts that meet certain criteria. See value of the first netting set. In the event of default margin requirement in the amount of the net option ‘‘Regulatory Capital Treatment of Certain Centrally- of the counterparty, the banking organization would value. The option is subject to daily revaluation cleared Derivative Contracts Under Regulatory pay the counterparty 100 for the second netting set with increases and decreases to the net option value Capital Rules’’ (August 14, 2017), OCC Bulletin: and would be exposed to a loss of 100 on the first resulting in adjustments to the buyer’s and the 2017–27; Board SR letter 07–17; and FDIC Letter netting set. seller’s net option value credits and debits. In FIL–33–2017.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4391 must use to determine the risk-weighted organization and must be reflected in organization that elects to apply this asset amount for its default fund risk-weighted assets under the capital treatment must apply the maturity factor contributions. The proposed revisions rule. Collateral held in a manner that is applicable to margined derivative were consistent with standards not bankruptcy remote exposes a contracts. developed by the Basel Committee.116 banking organization to risk of loss Except for the changes described should the CCP fail and the banking above, the agencies are adopting the A. Trade Exposure Amount organization is unable to recover its proposed approach for netting sets Under the proposal, an advanced collateral. This counterparty credit risk subject to more than one variation approaches banking organization that is separate from, and in addition to, the margin agreement, or for a hybrid risk inherent to the collateral itself. 113 elected to use SA–CCR for purposes of netting set. determining the exposure amount of a Thus, the final rule does not remove IV. Revisions to the Cleared noncleared derivative contract under from the calculation of trade exposure Transactions Framework the advanced approaches would have amount the requirement to include non- Under the capital rule, a banking been required to also use SA–CCR cash initial margin posted to a CCP that organization must maintain regulatory (instead of IMM) to determine the trade is not held in a bankruptcy remote capital for its exposure to, and certain exposure amount for a cleared manner. collateral posted in connection with, a derivative contract under the advanced Other commenters asked for derivative contract that is a cleared approaches. In addition, an advanced clarification regarding the scope of approaches banking organization would transactions that would be subject to the transaction (as defined under § l.2 of cleared transactions framework. In the capital rule). A clearing member have been required to use SA–CCR to determine the exposure amount for both particular, the commenters asked the banking organization also must hold agencies to clarify the treatment of an risk-based capital for its default fund its cleared and noncleared derivative exposure between a banking contributions.114 The proposal would contracts under the standardized organization and a clearing member have revised the cleared transactions approach. A non-advanced approaches where the banking organization acts as framework under the capital rule by banking organization that elected to use agent for its client for a cleared replacing CEM with SA–CCR for SA–CCR for purposes of determining transaction by providing a guarantee to advanced approaches banking the exposure amount of a non-cleared the clearing member of the QCCP for the organizations in both the advanced derivative contract would have been performance of the client. The final rule approaches and standardized approach. required to use SA–CCR (instead of clarifies that, in such a situation, the Non-advanced approaches banking CEM) to determine the trade exposure banking organization may treat its organizations would have been amount for a cleared derivative contract. exposure to the transaction as if the permitted to elect to use SA–CCR or Several commenters recommended banking organization were the clearing CEM for noncleared and cleared providing advanced approaches banking member and directly facing the QCCP derivative contracts, but would have organizations the option to use SA–CCR ( the banking organization would been required to use the same approach or IMM for purposes of the cleared i.e., for both.115 In addition, the proposal transactions framework, regardless of have no exposure to the clearing would have simplified the formula that the banking organization’s election to member or the QCCP as long as it does a clearing member banking organization use SA–CCR or IMM to determine the not provide a guarantee to the client on exposure amount of noncleared the performance of the clearing member or QCCP).117 Furthermore, in such a 113 § l.132(c)(11)(ii) of the final rule. derivative contracts under the advanced 114 A default fund contribution means the funds approaches. As discussed in section situation, the banking organization may contributed or commitments made by a clearing II.A. of this treat the exposure resulting from the member banking organization to a CCP’s SUPPLEMENTARY , the agencies believe that guarantee of the client’s performance mutualized loss-sharing arrangement. See 12 CFR INFORMATION obligations with respect to the 3.2 (OCC); 12 CFR 217.2 (Board); and 12 CFR 324.2, requiring an advanced approaches underlying derivative contract as a (FDIC). banking organization to use one of 115 client-facing derivative transaction.118 At the time of the proposal, an advanced either SA–CCR or IMM for both cleared approaches banking organization meant a banking Similarly, under CEM, the banking and noncleared derivative contracts organization that has at least $250 billion in total organization may adjust the exposure consolidated assets or if it has consolidated on- under the advanced approaches amount for the client-facing derivative balance sheet foreign exposures of at least $10 promotes consistency in the regulatory transaction by applying a scaling factor billion, or if it is a subsidiary of a depository capital treatment of derivative contracts institution, bank holding company, savings and of the square root of 1 2 (which equals loan holding company or intermediate holding and facilitates the supervisory 0.707107) to such exposure or higher if company that is an advanced approaches banking assessment of a banking organization’s organization. Under the tailoring proposals adopted the banking organization⁄ determines a capital management program. 119 by the agencies, the supplementary leverage ratio longer holding period is appropriate. also would have applied to banking organizations Some commenters asked the agencies Some commenters asked the agencies subject to Category III. Banking organizations to remove from the calculation of trade to clarify how a clearing member subject to Category III standards would have been exposure amount the requirement to banking organization that acts as agent permitted to use CEM or a modified version of SA– include non-cash initial margin posted CCR for purposes of the supplementary leverage on behalf of a client should reflect its ratio, but consistent with the proposal to implement to a CCP that is not held in a bankruptcy- temporary exposure to the client for the SA–CCR, they would have been required to use the remote manner. According to same approach (CEM or SA–CCR) for all purposes commenters, this requirement would 117 See 12 CFR 3.3(a) (OCC); 12 CFR 217.3(a) under the capital rule. See ‘‘Proposed Changes to overstate the banking organization’s (Board); and 12 CFR 324.3(a) (FDIC). the Applicability Thresholds for Regulatory Capital exposure to such collateral, because 118 As described in section III.D.2.d. of this and Liquidity Requirements,’’ 83 FR 66024 SUPPLEMENTARY INFORMATION, for the client-facing (December 21, 2018) and ‘‘Changes to Applicability collateral posted to a CCP remains on derivative transaction (i.e., the banking Thresholds for Regulatory Capital Requirements for the balance sheet of the banking organization’s exposure to the client due to the Certain U.S. Subsidiaries of Foreign Banking

Organizations and Application of Liquidity guarantee), the banking organization would treat the Requirements to Foreign Banking Organizations, 116 See ‘‘Capital requirements for bank exposures exposure as a non-cleared derivative contract using Certain U.S. Depository Instititution Holding to central counterparties,’’ Basel Committee on the five-business-day minimum MPOR. Companies, and Certain Depository Institution Banking Supervision (April 2014), https:// 119 See 12 CFR 3.34(e) (OCC); 12 CFR 217.34(e) Subsidiaries,’’ 84 FR 24296 (May 24, 2019). www.bis.org/publ/bcbs282.pdf. (Board); and 12 CFR 324.34(e) (FDIC).

4390 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations the standardized approach. However, a definition. Whether or not a particular collateral posted by the clearing member non-advanced approaches banking arrangement meets the definition in the banking organization to the CCP, which organization that elects to use SA–CCR regulation depends on the facts and the client subsequently will post to the to calculate the exposure amount for its circumstances of the particular clearing member banking organization. noncleared derivative contracts must arrangement. The agencies may consider The commenters stated that the use SA–CCR to calculate the trade whether revisions to the definition are collateral advanced by the clearing exposure amount for its cleared necessary in connection with future member banking organization on behalf derivative contracts. rulemakings if the definition is not of the client creates a receivable under functioning as intended. U.S. GAAP until the clearing member B. Treatment of Default Fund Other commenters asked the Board to banking organization receives the Contributions revise Regulation HH 123 to require collateral from the client. Accordingly, The proposal would have revised QCCPs regulated by the Board to make the commenters sought clarification on certain of the approaches that a banking available to clearing member banking whether the amount of such receivables organization could use to determine the organizations the information required should be reflected in exposure amount risk-weighted asset amount for its to calculate the QCCP’s hypothetical of the client-facing derivative default fund contributions. Specifically, capital requirement. The commenters transaction or treated as a separate the proposal would have eliminated raised concerns that while domestic exposure to the client. Such receivables method one and method two under QCCPs will likely be prepared to expose the clearing member banking section 133(d)(3) of the capital rule, provide the requisite data to calculate organization to risk of loss should the either of which may be used by a the hypothetical capital requirement, no client fail to subsequently post the clearing member banking organization regulation requires them to do so, and collateral to the clearing member to determine the risk-weighted asset that foreign QCCPs are not subject to banking organization. This credit risk is amount for its default fund U.S. regulation and may not be prepared separate from, and in addition to, the contributions to a QCCP.121 In its place, to provide the requisite data. The counterparty credit risk of the exposure the proposal would have implemented a commenters also encouraged the arising from the client-facing derivative single approach for a clearing member agencies to work with the SEC and the transaction, which represents the banking organization to determine the guarantee the clearing member banking CFTC to make similar revisions to their risk-weighted asset amount for its organization provides for the client’s regulations applicable to domestic default fund contributions to a QCCP, performance on the underlying QCCPs and with international standard which would have been less complex derivative transaction. Thus, consistent setters and foreign regulators to ensure than method one but also more granular with U.S. GAAP, a clearing member that foreign QCCPs will be capable of than method two. The proposal would banking organization must treat such a providing U.S. banking organizations have maintained the approach by which receivable as a credit exposure to the with the data required for the client for purposes of the capital rule, a clearing member banking organization hypothetical capital calculations under separate from the treatment applicable determines its risk-weighted asset the proposal. Lastly, the commenters to the client-facing derivative amount for its default fund asked that the agencies clarify that transaction under this final rule. contributions to a CCP that is not a banking organizations may rely on the For the reasons discussed above, the QCCP.122 amount of a foreign QCCP’s agencies are adopting as final under Some commenters asked the agencies hypothetical capital requirement to clarify that a banking organization’s § l.133(b) of the final rule the proposal produced under a Basel-compliant SA– commitment to enter into reverse to replace CEM with SA–CCR for CCR regime. repurchase agreements with a CCP are advanced approaches banking The proposal did not contemplate not default fund contributions. Certain organizations in the capital rule, with changes to Regulation HH and thus the one modification to introduce the CCPs may require clearing members to agencies view these comments as out of defined term ‘‘client-facing derivative provide funding in the form of reverse scope for this rulemaking. In addition, transactions’’ and clarify that such repurchase agreements in the event of a the Board’s Regulation HH serves a exposures receive a five-business-day clearing member’s default in order to different purpose than the capital rule minimum MPOR under SA–CCR, as support the liquidity needs of the CCP. and covers a different set of entities. discussed above. An advanced The capital rule defines default fund However, the agencies recognize the approaches banking organization that contributions as the funds contributed concerns raised by the commenters with elects to use SA–CCR for purposes of to or commitments made by a clearing respect to potential difficulties for determining the exposure amount of its member to a CCP’s mutualized loss banking organizations in calculating the noncleared derivative contracts under sharing arrangements. The proposal did hypothetical capital requirement of a the advanced approaches must also use not contemplate changes to the QCCP and intend to monitor whether SA–CCR (instead of IMM) to determine definition of default fund contributions banking organizations experience difficulties obtaining the hypothetical the trade exposure amount for its and the final rule does not revise this cleared derivative contracts under the capital requirement (or the requisite

120 advanced approaches. 121 Method one is a complex three-step approach information required to calculated it) A non-advanced approaches banking that compares the default fund of the QCCP to the from the QCCP to perform this organization may continue to use CEM capital the QCCP would be required to hold if it 124 to determine the trade exposure amount were a banking organization and provides a method calculation. In recognition of these for its cleared derivative contracts under to allocate the default fund deficit or excess back to the clearing member. Method two is a simplified 123 See 12 CFR part 234. Regulation HH relates to approach in which the risk-weighted asset amount the regulation of designated financial market 120 As discussed in section II.A. of this for a default fund contribution to a QCCP equals utilities by the Board. SUPPLEMENTARY INFORMATION, an advanced 1,250 percent multiplied by the default fund 124 Under the capital rule, if a CCP does not approaches banking organization must use SA–CCR contribution, subject to a cap. provide the hypothetical capital requirement (or, to determine the trade exposure amount for its 122 In that case, the risk-weighted asset amount is alternatively, the required data) the CCP is not a cleared derivative contracts and the exposure the sum of the clearing member banking QCCP and a banking organization must apply a risk amount for its noncleared derivative contracts organization’s default fund contributions multiplied weight of 1250 percent to its default fund under the standardized approach. by 1,250 percent. Continued

4392 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

contribution to a QCCP, a clearing calculating KCCP, the PFE multiplier concerns, the final rule allows banking member banking organization first includes collateral held by a QCCP in organizations that elect to use SA–CCR calculates the hypothetical capital which the QCCP has a legal claim in the to continue to use method 1 or method requirement of the QCCP (KCCP), unless event of the default of the member or 2 under CEM to calculate the risk- the QCCP has already disclosed it, in client, including default fund weighted asset amount for default fund which case the banking organization contributions of that member. In 125 contributions until January 1, 2022. must rely on that disclosed figure. In addition, the QCCP must use a MPOR of This is intended to provide sufficient either case, a banking organization may ten business days in the maturity factor time for clearing member banking choose to use a higher amount of KCCP adjustment. A banking organization that organizations to coordinate with CCPs than the minimum calculated under the elects to use CEM to determine the to obtain the hypothetical capital formula or disclosed by the QCCP if the exposure amount of its derivative requirement produced under SA–CCR banking organization has concerns contracts under the standardized (or the requisite information to calculate about the nature, structure, or approach must use a KCCP calculated it) from the CCPs, in order for such characteristics of the QCCP. In effect, using CEM. entities to qualify as QCCPs after the EAD must be calculated separately for KCCP serves as a consistent measure of mandatory compliance date. The a QCCP’s default fund amount. each clearing member banking agencies are also clarifying that after Under the final rule, a clearing organization’s sub-client accounts and January 1, 2022, the mandatory member banking organization must sub-house account (i.e., for the clearing compliance date, a banking organization calculate KCCP according to the member’s proprietary activities). If the that is using SA–CCR may only consider following formula: clearing member banking organization’s a foreign CCP to be a QCCP for purposes collateral and its client’s collateral are KCCP = SCMi EADi * 1.6 percent, of the capital rule if the foreign CCP held in the same account, then the EAD produces its hypothetical capital Where: of that account would be the sum of the requirement under SA–CCR (as CMi is each clearing member of the QCCP; EAD for the client-related transactions implemented by the CCP’s home and within the account and the EAD of the EADi is the exposure amount of the QCCP to country in a manner consistent with the each clearing member of the QCCP, as house-related transactions within the Basel Committee standard). The determined under § l.133(d)(6).127 account. In such a case, for purposes of agencies intend to monitor whether determining such EADs, the The component includes both banking organizations experience EADi independent collateral of the clearing the clearing member banking difficulties obtaining the hypothetical member banking organization and its organization’s own transactions, the capital requirement (or alternatively, the client must be allocated in proportion to client transactions guaranteed by the required data) after the January 1, 2022, the respective total amount of clearing member, and all values of mandatory compliance date. If, after independent collateral posted by the collateral held by the QCCP (including clearing member banking organization January 2022, significant obstacles the clearing member banking remain after a banking organization has to the QCCP. This treatment protects organization’s pre-funded default fund against a clearing member banking made best efforts to obtain the necessary contribution) against these transactions. information from CCPs (e.g., due to organization recognizing client The 1.6 percent amount represents the collateral to offset the QCCP’s exposures delays in the implementation of the product of a capital ratio of 8 percent Basel Committee standard in other to the clearing member banking and a 20 percent risk weight of a organization’s proprietary activity in the jurisdictions), its primary Federal clearing member banking organization. regulator may permit the banking calculation of KCCP. Subject to the transitional provisions In addition, if any account or sub- organization to use method 2 of CEM to described above, as of January 1, 2022, account contains both derivative calculate risk-weighted asset amounts a banking organization that is required contracts and repo-style transactions, for default fund contributions for a or elects to use SA–CCR to determine the EAD of that account is the sum of specified period. The agencies otherwise are generally the exposure amount for its derivative the EAD for the derivative contracts adopting without change the proposed contracts under the standardized within the account and the EAD of the revisions to the risk-weighted asset approach must use a KCCP calculated repo-style transactions within the calculation for default fund using SA–CCR for both the standardized account. If independent collateral is contributions under § .133(d) of the approach and the advanced held for an account containing both l 128 final rule.126 Thus, to determine the approaches. For purposes of derivative contracts and repo-style capital requirement for a default fund transactions, then such collateral must 127 Section 133(d)(6) of the proposed rule text be allocated to the derivative contracts contributions to the CCP. See definition of would have required a banking organization to sum ‘‘qualifying central counterparty’’ under § l.2 of the exposure amount of all underlying transactions, and repo-style transactions in the capital rule, 12 CFR 3.2 (OCC); 12 CFR 217.2 the collateral held by the CCP, and any prefunded proportion to the respective product- (Board); and 12 CFR 324.2 (FDIC). default contributions. In a technical correction to specific exposure amounts. The 125 In cases where a banking organization uses the proposal, and to recognize that collateral held respective product specific exposure method 1 to calculate the risk-weighted asset by the QCCP and any prefunded default fund amount for a default fund contribution, a QCCP that contributions serve to mitigate this exposure, the amounts must be calculated, excluding provides the banking organization its hypothetical final rule text at section 133(d)(6) clarifies that the effects of collateral, according to capital requirement produced using CEM would banking organizations under the final rule must § l.132(b) of the capital rule for repo- still qualify as a QCCP until January 1, 2022. subtract from the exposure amount the value of style transactions and to § l.132(c)(5) 126 In a nonsubstantive change, the agencies moved collateral held by the QCCP and any prefunded for derivative contracts. paragraphs (i) and (ii) of § l.133(d)(3) of the default contributions. The final rule is consistent proposed rule text to paragraphs (iv) and (v) under with the Basel Committee standard regarding A clearing member banking § l.133(d)(6) of the final rule text. The agencies capital requirements for bank exposures to central organization also must calculate its counterparties. See supra note 116. made this change because these sections provide capital requirement (KCMi), which is the instruction on calculating EAD for default fund 128 The final rule does not revise the calculations capital requirement for its default fund contribution accounts, which are covered under for determining the exposure amount of repo-style contribution, subject to a floor equal to § l.133(d)(6). In addition, the agencies changed the transactions for purposes of determining the risk- reference to (e)(4) in § l.133(d)(3) of the proposed weighted asset amount of a banking organization’s a 2 percent risk weight multiplied by rule text to (d)(4). default fund contributions. the clearing member banking

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4393 requirement increases as its default fund contribution to a QCCP organization’s prefunded default fund contribution to the default fund may not exceed the capital requirement contribution to the QCCP and an 8 increases relative to the QCCP’s own that would apply if the same exposure percent capital ratio. This calculation prefunded amounts and the total were calculated as if it were to a CCP allocates KCCP on a pro rata basis to each prefunded default fund contributions that is not a QCCP. clearing member based on the clearing from all clearing members to the QCCP. A clearing member banking member’s share of the overall default In all cases, a clearing member banking organization calculates according to the fund contributions. Thus, a clearing organization’s capital requirement for its following formula: 129 member banking organization’s capital

Where: version of SA–CCR would have limited agencies to assess the effectiveness of

KCCP is the hypothetical capital requirement the recognition of collateral to certain collateral in offsetting the operational of the QCCP; cash variation margin 132 in the risks arising from the provision of client DFpref is the prefunded default fund replacement cost calculation, but would clearing services. contribution of the clearing member not have allowed for recognition of any banking organization to the QCCP; Commenters that supported greater financial collateral in the PFE recognition of client collateral argued DFCCP is the QCCP’s own prefunded amounts 133 (e.g., contributed capital, retained component. that such an approach would be earnings) that are contributed to the The proposal sought comment on consistent with the G20 mandate to default fund waterfall and are junior or whether the agencies should broaden establish policies that support the use of pari passu to the default fund the recognition of collateral in the central clearing for derivative contribution of the members; and supplementary leverage ratio to also transactions,135 as it could decrease the DF pref is the total prefunded default fund CM include collateral provided by a client regulatory capital cost of providing contributions from clearing members of clearing services and thereby improve the QCCP. to a clearing member banking organization in connection with a access to clearing services for clients, V. Revisions to the Supplementary cleared transaction (client collateral), in reduce concentration among clearing Leverage Ratio recognition of recent policy efforts to member banking organizations, and Under the capital rule, advanced support migration of derivative improve the portability of client approaches banking organizations and transactions to CCPs, including an positions to other clearing members, banking organizations subject to October 2018 consultative release by the particularly in times of stress. Other Category III standards must satisfy a Basel Committee on the treatment of commenters argued that allowing an minimum supplementary leverage ratio client collateral in the international advanced approaches banking requirement of 3 percent.130 The leverage ratio standard.134 Several organization to use the same SA–CCR supplementary leverage ratio is the ratio commenters urged the agencies to methodology as proposed for the risk- of tier 1 capital to total leverage recognize greater amounts of client based framework would simplify the exposure, where total leverage exposure collateral, including margin, in either capital rule for advanced approaches includes both on-balance sheet assets PFE or in both replacement cost and banking organizations. and certain off-balance sheet PFE. Other commenters, however, Some commenters urged the agencies exposures.131 argued that the agencies should not to consider the risk to financial stability The proposal would have revised the recognize greater amounts of client if implementation of SA–CCR further capital rule to require advanced collateral, including cash or non-cash exacerbates the trend towards approaches banking organizations to use initial and variation margin, in concentration among clearing service a modified version of SA–CCR, instead connection with cleared transactions providers or leads to a reduction in of CEM, to determine the on- and off- entered into on behalf of clients or any access to clearing for non-clearing- balance sheet amounts of derivative amount of margin collateral within the member entities. Of these, some contracts for purposes of calculating supplementary leverage ratio. In commenters also argued that the total leverage exposure. The modified addition, some commenters urged the proposed SA–CCR methodology could

129 The agencies are clarifying that KCMi must be organization with the option to reduce any positive § l.10(c)(4)(ii)(C)(1)(ii) through (iii) and multiplied by 12.5 to arrive at the risk-weighted fair value of a derivative contract by the amount of § l.10(c)(4)(ii)(C)(3) through (7) of the capital rule. asset amount for a default fund contribution. any cash collateral received from the counterparty, 134 See ‘‘Consultative Document: Leverage ratio 130 See 12 CFR 3.10(a)(5) (OCC); 12 CFR provided the relevant GAAP criteria for offsetting treatment of client cleared derivatives,’’ Basel 217.10(a)(5) (Board); and 12 CFR 324.10(a)(5) are met (the GAAP offset option). Similarly, under Committee on Banking Supervision (October 2018), (FDIC). the GAAP offset option, a banking organization has https://www.bis.org/bcbs/publ/d451.pdf. 131 See supra note 6. the option to offset the negative mark-to-fair value 135 The Group of Twenty (G20) was established in 132 Consistent with CEM, the proposal would of a derivative contract with a counterparty. See 1999 to bring together industrialized and have permitted an advanced approaches banking Accounting Standards Codification paragraphs 815– developing economies to discuss key issues in the organization to recognize cash variation margin in 10–45–1 through 7 and 210–20–45–1. Under the global economy. Members include finance ministers the on-balance component calculation only if (1) capital rule, a banking organization that applies the and central bank governors from Argentina, the cash variation margin met the conditions under Australia, Brazil, Canada, China, France, Germany, GAAP offset option to determine the carrying value § l.10(c)(4)(ii)(C)(3) through (7) of the proposed India, Indonesia, Italy, Japan, Mexico, Russia, Saudi rule; and (2) it had not been recognized in the form of its derivative contracts would be required to Arabia, South Africa, Republic of Korea, Turkey, of a reduction in the fair value of the derivative reverse the effect of the GAAP offset option for the United Kingdom, and the United States and the contracts within the netting set under the advanced purposes of determining total leverage exposure, European Union. See ‘‘Leaders’ Statement: The approaches banking organization’s operative unless the collateral is cash variation margin Pittsburgh Summit,’’ G–20 (September 24–25, accounting standard. recognized as settled with the derivative contract as 2009), https://www.treasury.gov/resource-center/ 133 To determine the carrying value of derivative a single unit of account for balance sheet international/g7-g20/Documents/pittsburgh_ contracts, U.S. GAAP provides a banking presentation and satisfies the conditions under summit_leaders_statement_250909.pdf.

4394 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations that solvency of clearing member enforcement of collateral requirements, indirectly adversely affect clearing banking organizations is critical to the and promotion of market transparency. member clients with directional and stability of CCPs and that broadening Also, this treatment is consistent with long-dated portfolios, such as pension the recognition of client collateral under the G20 mandate to establish policies funds, mutual funds, life insurance the supplementary leverage ratio could that support the use of central clearing, companies and other end-users that use undermine the advances made by and recent developments by the Basel derivatives largely for risk management central clearing mandates in stabilizing Committee. Specifically, on June 26, purposes. Specifically, these global financial markets. These 2019, the Basel Committee released a commenters argued that such entities commenters added that higher levels of standard that revises the leverage ratio have already experienced difficulty in regulatory capital at clearing member treatment of client-cleared derivatives obtaining and maintaining access to banking organizations could improve contracts to generally align with the central clearing from banking their ability to assume client positions measurement of such exposures under organizations due to the treatment of from a defaulted clearing member in SA–CCR as used for risk-based capital client margin, which substantially stress, and that the agencies have purposes.137 The standard was designed increases the capital requirements under authority to provide temporary relief to to balance the robustness of the the supplementary leverage ratio for leverage capital requirements if doing so supplementary leverage ratio as a non- banking organizations that provide would be necessary to allow a banking risk-based safeguard against clearing services. organization to absorb the client unsustainable sources of leverage with Other commenters argued that positions of an insolvent clearing the policy objective set by G20 leaders limiting the recognition of client member. With respect to concentration to promote central clearing of collateral in the supplementary leverage concerns, these commenters argued that standardized derivative contracts as part ratio could have pro-cyclical effects that lowering capital requirements for of mitigating systemic risk and making undermine the core objectives of the clearing member banking organizations derivative markets safer. The final rule clearing framework. These commenters would not reduce concentration in the similarly maintains the complementary asserted that CCPs typically increase provision of clearing services; rather, purpose of risk-based and leverage collateral requirements during stress any further reduction in capital capital requirements, in a manner that is periods, and therefore can cause requirements for clearing member expected to have minimal impact on clearing member banking organizations banking organizations would only overall capital levels, will reduce to be bound, or further bound, by the benefit banking organizations that burden by reducing the number of supplementary leverage ratio during already provide these services. In separate calculations required, and will that time. According to the commenters, addition, these commenters expressed not impede important policy objectives procyclicality in the capital concern regarding the introduction of regarding central clearing. requirements for a clearing member risk mitigants into the leverage capital Banking organizations subject to the could undermine the client-account requirements, and stated that such a supplementary leverage ratio under portability objective of the central revision could blur the distinction Category III that continue to use CEM to clearing framework if the clearing between leverage and risk-based capital determine the total leverage exposure member is unable to acquire a book of requirements. measure are not permitted to recognize cleared derivatives from another failing The final rule allows a clearing the risk-reducing effects of client clearing member due to the regulatory member banking organization to collateral other than with respect to capital costs of such acquisition. recognize the risk-reducing effect of certain transfers of cash variation Furthermore, some commenters client collateral in replacement cost and margin in replacement cost. Relative to posited that greater recognition of the PFE for purposes of calculating total CEM, SA–CCR is more sensitive to the risk-reducing effects of client collateral recognition of collateral, and therefore for purposes of the supplementary leverage exposure under certain 136 the commenters’ concerns are more leverage ratio would be appropriate due circumstances. This treatment applies to a banking organization’s pronounced in that context. Moreover, to the manner in which clearing most clearing member banking member banking organizations collect exposure to its client-facing derivative transactions. For such exposures, the organizations are advanced approaches such collateral and the protections such banking organizations that are required collateral receives under existing banking organization would use SA– CCR, as applied for risk-based capital to use SA–CCR or IMM for the cleared regulations. Specifically, these transactions framework, and extending commenters noted that CFTC purposes, which permits recognition of both cash and non-cash margin received such treatment to CEM would have regulations prohibit rehypothecation of limited impact, if any, in the aggregate. client collateral, and explicitly limit a from a client in replacement cost and PFE. The agencies believe that this Some commenters noted that section clearing member banking organization’s 34 of the capital rule allows a banking use of collateral received from a client treatment appropriately recognizes recent developments in the use of organization subject to the to purposes that fulfil the clearing supplementary leverage ratio to exclude member’s obligations to the CCP or to central clearing and maintains levels of capital consistent with safe and sound the PFE of all credit derivatives or other cover losses in the event of that client’s similar instruments through which it operations of banking organizations default. provides credit protection, but without engaged in these activities. Although By contrast, commenters who regard to credit risk mitigation, there are some risks associated with opposed greater recognition of the risk- provided that it does not adjust the net- CCPs, the agencies believe that central reducing effects of client collateral to-gross ratio. Under the capital rule, a clearing through CCPs generally reduces under the supplementary leverage ratio banking organization subject to the the effective exposure of derivative expressed concern that such an supplementary leverage ratio that contracts through the multilateral approach would decrease capital levels chooses to exclude the PFE of credit among clearing member banking netting of exposures, establishment and derivatives or other similar instruments organizations and therefore could 136 The recognition of client collateral provided through which it provides credit increase risks to both safety and soundness and U.S. financial stability. under the final rule only applies in the context of In particular, some commenters noted SA–CCR, not CEM. 137 See supra note 20.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4395 by banking organizations and further clearing member banking organization protection must do so consistently over review by the agencies. The agencies would be required to cover only the time for the calculation of the PFE for did not receive comment on these amount of any deficiency between the all such instruments. The agencies are technical amendments, and are liquidation value of the collateral and clarifying that the same treatment would finalizing them as proposed. The the CCP’s exposure to the client. apply under SA–CCR for purposes of agencies did receive several suggestions However, were the clearing member 138 the supplementary leverage ratio. In for other clarifications and technical banking organization to enter into the particular, a banking organization changes to the proposal. The agencies derivative contract directly with the subject to the supplementary leverage are adopting many of these suggestions client, the clearing member would ratio may choose to exclude from the in the final rule. These changes are establish and maintain a perfected first- PFE component of the exposure amount described below. priority security interest in the calculation the portion of a written A. Receivables Due From a QCCP collateral, and the exposure of the credit derivative that is not offset clearing member to the client would according to § l.10(c)(4)(ii)(D)(1)–(2) The final rule revises § l.32 of the similarly be mitigated only to the extent and for which the effective notional capital rule to clarify that cash collateral the collateral is sufficient to cover the amount of the written credit derivative posted by a clearing member banking exposure amount of the transaction at is included in total leverage exposure. organization to a QCCP, and which the time of default. Therefore, the final The agencies generally are adopting as could be considered a receivable due rule revises the definition of financial final the proposed requirement that a from the QCCP under U.S. GAAP, collateral to allow clearing member banking organization that is required to should not be risk-weighted as a banking organizations to recognize as corporate exposure. Instead, for a client- use SA–CCR or elects to use SA–CCR to financial collateral noncash client cleared trade the cash collateral posted calculate the exposure amount of its collateral posted to a CCP. In this to a QCCP receives a risk weight of 2 derivative contracts for purposes of the situation, the clearing member banking percent, if the cash associated with the supplementary leverage ratio must use organization is not required to establish trade meets the requirements under the modified version of SA–CCR and retain a first-priority security § .35(b)(3)(i)(A) or § .133(b)(3)(i)(A) described in § l.10(c)(4)(ii) of the final l l interest in the collateral for it to qualify 139 of the capital rule, or 4 percent, if the rule, with a few revisions. For a as financial collateral under § .2 of the collateral does not meet the l client-facing derivative transaction, capital rule. however, the banking organization requirements necessary to receive the 2 calculates the exposure amount under percent risk weight. For a trade made on C. Clearing Member Exposure When § l.132(c)(5). behalf of the clearing member’s own CCP Performance Is Not Guaranteed account, the cash collateral posted to a Consistent with the proposal, written The final rule revises § l.35(c)(3) of options must be included in total QCCP receives a 2 percent risk weight. the capital rule to align the capital leverage exposure even though the final The agencies intend for this amendment requirements under the standardized rule allows certain written options to to maintain incentives for banking approach for client-cleared transactions organizations to post cash collateral and receive an exposure amount of zero for with the treatment under § l.133(c)(3) 140 recognize that a receivable from a QCCP risk-based capital purposes. of the advanced approaches. that arises in the context of a trade Specifically, the final rule allows a VI. Technical Amendments exposure should not be treated as clearing member banking organization equivalent to a receivable that would The proposal would have made that does not guarantee the performance arise if, for example, a banking several technical corrections and of the CCP to the clearing member’s organization made a loan to a CCP. clarifications to the capital rule to client to apply a zero percent risk address certain provisions that B. Treatment of Client Financial weight to the CCP-facing portion of the revision based on questions presented transaction. The agencies previously Collateral Held by a CCP implemented this treatment for 138 See 79 FR 57725, 57731–57732 (Sept. 26, Under § l.2 of the capital rule, 2014). financial collateral means, in part, purposes of the advanced 141 139 Some commenters requested clarification collateral in which a banking approaches. regarding the items to be summed under organization has a perfected first- § l.10(c)(4)(ii)(C)(1) of the proposed rule. The D. Bankruptcy Remoteness of Collateral priority security interest in the agencies are clarifying that the items to be summed The final rule removes the under this paragraph (now located at collateral. However, when a banking § l.10(c)(4)(ii)(C)(2)(i) of the final rule) are the organization is acting on behalf of a requirement in § l.35(b)(4)(i) of the replacement cost of each derivative contract or client, it generally is required to post standardized approach and single product netting set of derivative contracts to any client collateral to the CCP, in § l.133(b)(4)(i) of the advanced which the advanced approaches banking approaches that collateral posted by a organization is a counterparty, as described under which case the CCP establishes and 10(c)(4)(ii)(C)(2)(i) of the final rule. Section maintains a perfected first-priority clearing member client banking l.10(c)(4)(ii)(C)(2)(ii) of the final rule serves to security interest in the collateral instead organization to a clearing member adjust, under certain situations, the items to be of the clearing member. As a result, the banking organization must be summed under § l.10(c)(4)(ii)(C)(2)(i). In addition, bankruptcy remote from a custodian in these commenters requested clarification of the capital rule does not permit a clearing application of § l.10(c)(4)(ii)(C)(2) in the proposal. member banking organization to order for the client banking organization The agencies are removing § l.10(c)(4)(ii)(C)(2) recognize client collateral posted to a to avoid the application of risk-based from the final rule, as this provision is captured CCP as financial collateral. capital requirements related to the under the definition of the cash variation margin collateral, and clarifies that a custodian terms in the formula described under Client collateral posted to a CCP § l.10(c)(4)(ii)(C)(2)(i). remains available to mitigate the risk of must be acting in its capacity as a 140 Under the final rule, the exposure amount of a credit loss on a derivative contract in custodian for this treatment to apply.142 a netting set that consists of only sold options in the event of a client default. which the premiums have been fully paid by the 141 Specifically, when a client defaults the See 80 FR 41411 (July 15, 2015). counterparty to the options and where the options 142 See 12 CFR 3.35(b)(4) and 3.133(b)(4) (OCC); are not subject to a variation margin agreement is CCP will use the client collateral to 12 CFR 217.35(b)(4) and 217.133(b)(4) (Board); and zero. See section III.A. of this SUPPLEMENTARY offset its exposure to the client, and the 12 CFR 324.35(b)(4) and 324.133(b)(4) (FDIC). INFORMATION for further discussion.

4396 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations period. The final rule also requires a standardized approach.143 The data The agencies believe this revision is banking organization to use a larger cover diverse portfolios of derivative appropriate because the collateral scaling factor for collateral haircuts for contracts, both in terms of asset type would generally be considered to be client-facing derivatives when it and counterparty. In addition, the data bankruptcy remote if the custodian is determines a holding period longer than include firms that serve as clearing acting in its capacity as a custodian with five days is appropriate. members, allowing the agencies to respect to the collateral. Therefore, this consider the effect of the proposal under revision applies only in cases where the F. OCC Revisions to Lending Limits the cleared transactions framework for collateral is deposited with a third-party The OCC proposed to revise its both a direct exposure to a CCP and a custodian, not in cases where a clearing lending limit rule at 12 CFR part 32. The clearing member’s exposure to its client member banking organization offers current lending limits rule references with respect to client-facing derivative ‘‘self-custody’’ arrangements with its sections of CEM in the OCC’s advanced transactions. As a result, the analysis clients. In addition, this revision makes approaches capital rule as one available provides a reasonable proxy for the the collateral requirement for a clearing methodology for calculating exposures potential changes for all advanced member client banking organization to derivatives transactions. However, approaches banking organizations. consistent with the treatment of these sections were proposed to be The agencies estimated that, under collateral posted by a clearing member amended or replaced with SA–CCR in the proposal, the exposure amount for banking organization, which does not the advanced approaches. Therefore, the derivative contracts held by advanced require that the posted collateral be OCC proposed to replace the references approaches banking organizations bankruptcy remote from the custodian, would have decreased by approximately but requires in each case that the to CEM in the advanced approaches with references to CEM in the 7 percent. The agencies also estimated custodian be acting in its capacity as a that the proposal would have resulted in custodian. standardized approach. The OCC also proposed to adopt SA–CCR as an option an approximately 5 percent increase in E. Adjusted Collateral Haircuts for for calculation of exposures under advanced approaches banking Derivative Contracts lending limits. organizations’ standardized risk- The agencies received two comments weighted assets associated with For a cleared transaction, the clearing derivative contract exposures.144 In supporting the OCC’s proposal to use member banking organization must addition, the proposal would have determine the exposure amount for the SA–CCR to measure counterparty credit resulted in an increase (approximately client-facing derivative transaction of risk under both the capital rules and 30 basis points) in advanced approaches the derivative contract using the other agency rules, including lending banking organizations’ supplementary collateralized transactions framework limits, as creating less burden on leverage ratios, on average. under § l.37(c)(3) of the capital rule or institutions. The OCC agrees that it The agencies made several changes to the counterparty credit risk framework would be less burdensome for the SA–CCR methodology for the final under § l.132(b)(2)(ii) of the capital institutions to use similar rule that could have a material effect on rule. The clearing member banking methodologies to measure counterparty the impact of the final rule. First, the organization may recognize the credit credit risk across OCC regulations, and final rule changes certain of the risk-mitigation benefits of the collateral therefore are finalizing these revisions supervisory factors for commodity posted by the client; however, under to the lending limits rule as proposed. derivative contracts to coincide with the §§ l.37(c) and l.132(b) of the capital G. Other Clarifications and Technical supervisory factors in the Basel rule, the value of the collateral must be 145 Amendments From the Proposal to the Committee standard. Second, the discounted by the application of a Final Rule standard supervisory haircut to reflect 143 The agencies estimated that, on aggregate, any market price volatility in the value Some commenters suggested that the exposure amounts under SA–CCR would equal of the collateral over a ten-business-day agencies make a revision to the approximately 170 percent of the exposure amounts for identical derivative contracts under IMM. Thus, holding period. For a repo-style approaches for calculating capital firms that use IMM currently would likely continue transaction, the capital rule applies a requirements regarding CVAs under to use IMM to determine the exposure amount of scaling factor of the square root of 1 2 § l.132(e). Under the final rule, the their derivative contracts to determine advanced (which equals 0.707107) to the standard agencies are clarifying that for purposes approaches total risk-weighted assets. However, the standardized approach serves as a floor on supervisory haircuts to reflect the ⁄ of calculating the CVA capital advanced approaches banking organizations’ total limited risk to collateral in those requirements under § l.132(e)(5)(i)(C), risk-weighted assets. Thus, a firm would only transactions and effectively reduce the (e)(6)(i)(B) and (e)(6)(viii), an advanced receive the benefit of IMM if the firm is not bound holding period to five business days. approaches banking organization must by standardized total risk-weighted assets. 144 The proposal would have provided a use SA–CCR instead of CEM where CEM Total risk-weighted assets are a function of the exposure amount of the netting set and the similar reduction in the haircuts for was provided as an option. In addition, applicable risk-weight of the counterparty. Total client-facing derivative transactions, as the final rule revises the definition of risk-weighted assets increase under the analysis they typically have a holding period of CEM in § l.2 to refer to § l.34(b) while exposure amounts decrease because higher less than ten business days. Some applicable risk weights amplify increases in the instead of § l.34(a). exposure amount of certain derivative contracts, commenters requested clarification which outweighs decreases in the exposure amount whether a five-business-day holding VII. Impact of the Final Rule of other derivative contracts. period would apply for the purpose of For the proposal, the agencies 145 The change in the supervisory factors for calculating collateral haircuts for client- reviewed data provided by advanced commodity derivative contracts will not result in a facing derivatives under change in the agencies initial estimate of the impact approaches banking organizations that of the final rule. This is because the data received § l.132(b)(2)(ii)(A)(3) of the proposal. represent a significant majority of the from the advanced approach banking organizations The final rule revises §§ l.37(c)(3)(iii) derivatives market. In particular, the already reflected the supervisory factors for and l.132(b)(2)(ii)(A)(3) of the capital agencies analyzed the change in commodity derivative contracts included in the Basel Standard, and the agencies did not adjust the rule to adjust the holding period for exposure amount between CEM and SA– data to account for the proposed 40 percent client-facing derivative transactions by CCR, as well as the change in risk- supervisory factor for all energy derivative applying a scaling factor of 0.71, which weighted assets as determined under the contracts. represents a five-business-day holding

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4397 affected by any changes to the Income (Call Reports) (FFIEC 031, final rule removes the alpha factor for calculation of total leverage exposure. FFIEC 041, and FFIEC 051) and exposures to commercial end-users. These banking organizations retain the Regulatory Capital Reporting for Third, the final rule allows a banking option of using CEM, including for the Institutions Subject to the Advanced organization to treat settled-to-market supplementary leverage ratio, if Capital Adequacy Framework (FFIEC derivative contracts as subject to a applicable, and the agencies anticipate 101).148 The OCC and FDIC expect to variation margin agreement, allowing that only those banking organizations clarify the reporting instructions for such contracts to net with collateralized- that receive a material net benefit from DFAST 14A, and the Board expects to to-market derivative contracts of the using SA–CCR would elect to use it. clarify the reporting instructions for the same netting set. Lastly, the final rule Therefore, the agencies continue to find Consolidated Financial Statements for allows clearing member banking that the impact on non-advanced Holding Companies (FR Y–9C), Capital organizations to recognize client approaches banking organizations under Assessments and Stress Testing (FR Y– collateral under the supplementary the final rule would be limited. 14A and FR Y–14Q), and Banking leverage ratio, to the Organization Systemic Risk Report (FR same extent a banking organization may VIII. Regulatory Analyses Y–15) as appropriate to reflect the recognize collateral for risk-based A. Paperwork Reduction Act changes to the regulatory capital rule capital purposes. The agencies’ regulatory capital rule related to this final rule. Using the same data set as used for contains ‘‘collections of information’’ the proposal, the agencies found that the B. Regulatory Flexibility Act within the meaning of the Paperwork exposure amount for derivative The Regulatory Flexibility Act, Reduction Act (PRA) of 1995 (44 U.S.C. OCC: contracts held by advanced approaches 5 U.S.C. 601 (RFA), requires an 3501–3521). In accordance with the et seq. banking organizations will decrease by requirements of the PRA, the agencies agency, in connection with a final rule, approximately 9 percent under the final may not conduct or sponsor, and the to prepare a Final Regulatory Flexibility rule. Generally speaking, exposure respondent is not required to respond Analysis describing the impact of the amounts for interest rate, credit and to, an information collection unless it rule on small entities (defined by the foreign exchange derivatives would be displays a currently-valid Office of Small Business Administration (SBA) for purposes of the RFA to include expected to decrease, and exposure Management and Budget (OMB) control commercial banks and savings amounts for equities and commodities number. The OMB control number for institutions with total assets of $600 would be expected to increase. The the OCC is 1557–0318, Board is 7100– million or less and trust companies with agencies estimate that the final rule will 0313, and FDIC is 3064–0153. The total revenue of $41.5 million or less) or result in an approximately 4 percent information collections that are part of to certify that the final rule would not decrease in advanced approaches the agencies’ regulatory capital rule will have a significant economic impact on banking organizations’ standardized not be affected by this final rule and a substantial number of small entities. risk-weighted assets associated with therefore no final submissions will be As of December 31, 2018, the OCC derivative contract exposures and that made by the FDIC or OCC to OMB under supervised 782 small entities. The rule the final rule will result in an increase section 3507(d) of the PRA (44 U.S.C. would impose requirements on all OCC (approximately 37 basis points) in 3507(d)) or section 1320.11 of the supervised entities that are subject to advanced approaches banking OMB’s implementing regulations (5 CFR the advanced approaches risk-based organizations’ reported supplementary 1320) in connection with this capital rules, which typically have leverage ratios, on average. While too rulemaking.147 much precision should not be attached As a result of this final rule, the assets in excess of $250 billion, and to estimates regarding individual agencies have proposed to clarify the therefore would not be small entities. banking organizations owing to reporting instructions for the While small entities would have the option to adopt SA–CCR, the OCC does variations in data quality, estimated Consolidated Reports of Condition and not expect any small entities to elect changes in individual banking organizations’ supplementary leverage that option. Therefore, the OCC ratios range from 5 basis points to 85 147 The OCC and FDIC submitted their ¥ estimates the final rule would not basis points. information collections to OMB at the proposed In the proposal, the agencies found rule stage. However, these submissions were done generate any costs for small entities. solely in an effort to apply a conforming Therefore, the OCC certifies that the that the effects of the proposed rule methodology for calculating the burden estimates likely would be limited for non- and not due to the proposed rule. OMB filed final rule would not have a significant advanced approaches banking comments requesting that the agencies examine economic impact on a substantial public comment in response to the proposed rule number of OCC-supervised small organizations. First, these banking and describe in the supporting statement of its next organizations hold relatively small entities. collection any public comments received regarding The RFA generally requires derivative portfolios. Non-advanced the collection as well as why (or why it did not) FDIC: that, in connection with a final approaches banking organizations incorporate the commenters’ recommendation. In addition, OMB requested that the OCC and the rulemaking, an agency prepare and account for less than 9 percent of FDIC note the convergence of the agencies on the make available for public comment a derivative contracts of all banking single methodology. The agencies received no final regulatory flexibility analysis organizations, even though they account comments on the information collection describing the impact of the rule on for roughly 36 percent of total assets of requirements. Since the proposed rule stage, the agencies have conformed their respective small entities.149 However, a regulatory all banking organizations.146 Second, methodologies in a separate final rulemaking titled, flexibility analysis is not required if the nearly all non-advanced approaches ‘‘Regulatory Capital Rule: Implementation and agency certifies that the final rule will banking organizations are not subject to Transition of the Current Expected Credit Losses not have a significant economic impact supplementary leverage ratio Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and on a substantial number of small requirements, and thus would not be Conforming Amendments to Other Regulations,’’ 84 entities. The SBA has defined ‘‘small FR 4222 (February 14, 2019), and have had their 146 According to data from the Consolidated submissions approved through OMB. As a result, entities’’ to include banking Reports of Condition and Income for a Bank with the agencies information collections related to the Domestic and Foreign Offices (FFIEC report forms regulatory capital rules are currently aligned and 148 See 84 FR 53227 (October 4, 2019). 031, 041, and 051), as of March 31, 2018. therefore no submission will be made to OMB. 149 5 U.S.C. 601 et seq.

4398 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4. A Description of and an Estimate of and other compliance requirements onto organizations with total assets of less the Number of Small Entities to Which small entities. than or equal to $600 million that are the Rule Will Apply or an Explanation The FDIC does not expect any small independently owned and operated or of Why no Such Estimate Is Available entity to adopt SA–CCR, given the owned by a holding company with less internal systems enhancements and than or equal to $600 million in total As of June 30, 2019, the FDIC operational modifications needed for assets.150 Generally, the FDIC considers supervised 3,424 institutions, of which SA–CCR adoption. A small institution 2,665 are considered small entities for a significant effect to be a quantified will elect to use SA–CCR only if the net the purposes of RFA. These small IDIs effect in excess of 5 percent of total benefits of doing so are positive. Thus, hold $514 billion in assets, accounting annual salaries and benefits per the FDIC expects the proposed rule will for 16.6 percent of total assets held by not impose any net economic costs on institution, or 2.5 percent of total non- 151 FDIC-supervised institutions. these entities. interest expenses. The FDIC believes The final rule will require advanced that effects in excess of these thresholds approaches institutions to use either 6. A Description of the Steps the Agency typically represent significant effects for SA–CCR or IMM to calculate the Has Taken To Minimize the Significant FDIC-supervised institutions. exposure amount of its noncleared and Economic Impact on Small Entities For the reasons described below, the cleared derivative contracts under the As described above, the FDIC does not FDIC believes that the final rule will not advanced approaches. For purposes of believe this rule will have a significant have a significant economic impact on determining the exposure amount of its economic impact on a substantial a substantial number of small entities. noncleared and cleared derivative number of small entities. Further, since Nevertheless, the FDIC has conducted contracts under the standardized adopting SA–CCR is voluntary, only and is providing a final regulatory approach, an advanced approaches entities that expect to benefit from SA– flexibility analysis. institution must use SA–CCR. An CCR will adopt it. advanced approaches institution must Board: An initial regulatory flexibility 1. The Need for, and Objectives of, the use SA–CCR to determine the risk- analysis (IRFA) was included in the Rule weighted asset amount of its default proposal in accordance with section fund contributions under both the 603(a) of the Regulatory Flexibility Act The policy objective of the final rule approaches. There are no FDIC- (RFA), 5 U.S.C. 601 et seq. In the IRFA, is to provide a new and more risk- supervised advanced approaches the Board requested comment on the sensitive methodology for calculating institutions that are considered small effect of the proposed rule on small the exposure amount for derivative entities for the purposes of RFA.152 entities and on any significant contracts. SA–CCR will replace the The final rule will allow, but not alternatives that would reduce the existing CEM methodology for advanced require, non-advanced approaches regulatory burden on small entities. The approaches institutions. Non-advanced institutions to replace CEM with SA– Board did not receive any comments on approaches banking organizations will CCR as the approach for calculating the IRFA. The RFA requires an agency have the option of using SA–CCR in EAD. While this allowance applies to all to prepare a final regulatory flexibility place of CEM. 2,665 small entities, only 401 (15 analysis unless the agency certifies that percent) report holding any volume of the rule will not, if promulgated, have 2. The Significant Issues Raised by the a significant economic impact on a Public Comments in Response to the derivatives and would therefore be affected by differences between CEM substantial number of small entities. Initial Regulatory Flexibility Analysis and SA–CCR. These 401 banks’ holdings Based on its analysis, and for the No significant issues were raised by of derivatives account for only 7.6 reasons stated below, the Board certifies that the rule will not have a significant the public comments in response to the percent of their assets, so the effects of economic impact on a substantial initial regulatory flexibility analysis. calculating the exposure amount of derivatives using SA–CCR on their number of small entities.154 3. Response of the Agency to Any capital requirements would likely be Under regulations issued by the Small Comments Filed by the Chief Counsel insignificant.153 Since adoption of SA– Business Administration, a small entity for Advocacy of the Small Business CCR is optional, these banks would includes a bank, bank holding company, Administration in Response to the weigh the benefits of SA–CCR adoption or savings and loan holding company Proposed Rule against its costs. Given that SA–CCR with assets of $600 million or less and adoption necessitates internal systems trust companies with total assets of No comments were filed by the Chief enhancements and other operational $41.5 million or less (small banking 155 Counsel for Advocacy of the Small modifications that could be particularly organization). As of June 30, 2019, Business Administration in response to burdensome for smaller, less complex there were approximately 2,976 small the proposed rule. banking organizations, the FDIC expects bank holding companies, 133 small that no small institutions will likely savings and loan holding companies, 150 The SBA defines a small banking organization adopt SA–CCR. and 537 small SMBs. as having $600 million or less in assets, where an As discussed in the SUPPLEMENTARY organization’s ‘‘assets are determined by averaging 5. A Description of the Projected INFORMATION section, the final rule the assets reported on its four quarterly financial Reporting, Recordkeeping and Other revises the capital rule to provide a new statements for the preceding year.’’ See 13 CFR Compliance Requirements of the Rule and more risk-sensitive methodology for 121.201 (as amended by 84 FR 34261, effective No small entity will be compelled to calculating the exposure amount for August 19, 2019). In its determination, the ‘‘SBA derivative contracts. For purposes of counts the receipts, employees, or other measure of use SA–CCR, so the rule does not size of the concern whose size is at issue and all impose any reporting, recordkeeping 154 5 U.S.C. 605(b). of its domestic and foreign affiliates.’’ See 13 CFR

121.103. Following these regulations, the FDIC uses 155 See 13 CFR 121.201. Effective August 19, a covered entity’s affiliated and acquired assets, 151 Consolidated Reports of Condition and Income 2019, the SBA revised the size standards for averaged over the preceding four quarters, to for the quarter ending June 30, 2019. banking organizations to $600 million in assets determine whether the covered entity is ‘‘small’’ for 152 Id. from $550 million in assets. 84 FR 34261 (July 18, the purposes of RFA. 153 Id. 2019).

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4399 C. Plain Language in any one year (adjusted for inflation). calculating advanced approaches total The OCC has determined that this final risk-weighted assets, an advanced Section 722 of the Gramm-Leach- Bliley Act 158 requires the Federal rule would not result in expenditures by approaches Board-regulated institution State, local, and Tribal governments, or may use either SA–CCR or the internal banking agencies to use plain language in all proposed and final rules the private sector, of $100 million or models methodology. For purposes of more in any one year. Accordingly, the calculating standardized total risk- published after January 1, 2000. The agencies have sought to present the final OCC has not prepared a written weighted assets, an advanced rule in a simple and straightforward statement to accompany this proposal. approaches Board-regulated institution manner, and did not receive comment must use SA–CCR and a non-advanced F. The Congressional Review Act on the use of plain language. approaches Board-regulated institution For purposes of Congressional Review may elect either SA–CCR or CEM.156 In D. Riegle Community Development and Act, the OMB makes a determination as addition, for purposes of the Regulatory Improvement Act of 1994 to whether a final rule constitutes a denominator of the supplementary Pursuant to section 302(a) of the ‘‘major’’ rule.161 If a rule is deemed a leverage ratio, the final rule integrates Riegle Community Development and ‘‘major rule’’ by the OMB, the SA–CCR into the calculation of the Regulatory Improvement Act Congressional Review Act generally denominator, replacing CEM.157 (RCDRIA),159 in determining the provides that the rule may not take The Board does not expect that the effective date and administrative effect until at least 60 days following its final rule will result in a material compliance requirements for new publication.162 change in the level of capital regulations that impose additional The Congressional Review Act defines maintained by small banking reporting, disclosure, or other a ‘‘major rule’’ as any rule that the organizations or in the compliance requirements on IDIs, each Federal Administrator of the Office of burden on small banking organizations banking agency must consider, Information and Regulatory Affairs of because the framework is optional for consistent with principles of safety and the OMB finds has resulted in or is non-advanced approaches banking soundness and the public interest, any likely to result in—(A) an annual effect organizations. To the extent that small administrative burdens that such on the economy of $100,000,000 or banking organizations elect to adopt SA– regulations would place on depository more; (B) a major increase in costs or CCR because it provides advantageous institutions, including small depository prices for consumers, individual institutions, and customers of regulatory capital treatment of industries, Federal, State, or local depository institutions, as well as the derivatives, any implementation costs or government agencies or geographic benefits of such regulations. In addition, increased compliance costs associated regions, or (C) significant adverse effects section 302(b) of RCDRIA requires new with SA– CCR should be outweighed by on competition, employment, regulations and amendments to the capital impact of SA–CCR. In any investment, productivity, innovation, or regulations that impose additional event, small banking organizations on the ability of United States-based reporting, disclosures, or other new enterprises to compete with foreign- generally do not have substantial requirements on IDIs generally to take portfolios of derivative contracts and based enterprises in domestic and effect on the first day of a calendar export markets.163 As required by the therefore any impact of SA–CCR on quarter that begins on or after the date capital requirements is expected to be Congressional Review Act, the agencies on which the regulations are published will submit the final rule and other minimal. For these reasons, the Board 160 in final form. appropriate reports to Congress and the does not expect the rule to have a In accordance with these provisions significant economic impact on a Government Accountability Office for of RCDRIA, the agencies considered any review. substantial number of small entities. administrative burdens, as well as benefits, that the final rule would place List of Subjects 156 Advanced approaches banking organizations include depository institutions, bank holding on depository institutions and their 12 CFR Part 3 companies, savings and loan holding companies, or customers in determining the effective intermediate holding companies subject to Category date and administrative compliance Administrative practice and I or Category II standards. See supra note 23. requirements of the final rule. In procedure, Capital, National banks, 157 In general, the Board’s capital rule only conjunction with the requirements of Risk. applies to bank holding companies and savings and loan holding companies that are not subject to the RCDRIA, the final rule is effective on 12 CFR Part 32 Board’s Small Bank Holding Company and Savings April 1, 2020. and Loan Holding Company Policy Statement, National banks, Reporting and which applies to bank holding companies and E. OCC Unfunded Mandates Reform Act recordkeeping requirements. savings and loan holding companies with less than of 1995 Determination $3 billion in total assets that also meet certain 12 CFR Part 217 additional criteria. In addition, the agencies The OCC analyzed the proposed rule recently adopted a final rule to implement a under the factors set forth in the Administrative practice and community bank leverage ratio framework that is Unfunded Mandates Reform Act of 1995 procedure, Banks, Banking, Capital, applicable, on an optional basis to depository (UMRA) (2 U.S.C. 1532). Under this Federal Reserve System, Holding institutions and depository institution holding companies. companies with less than $10 billion in total analysis, the OCC considered whether consolidated assets and that meet certain other the final rule includes a Federal 12 CFR Part 324 criteria. Such banking organizations that opt into mandate that may result in the the community bank leverage ratio framework will expenditure by State, local, and Tribal Administrative practice and be deemed compliant with the capital rule’s procedure, Banks, Banking, Capital generally applicable requirements and are not governments, in the aggregate, or by the required to calculate risk-based capital ratios. See private sector, of $100 million or more adequacy, Savings associations, State supra note 3. Very few bank holding companies and non-member banks.

savings and loan holding companies that are small 158 See Public Law 106–102, section 722, 113 Stat. entities would be impacted by the final rule because 1338, 1471 (1999). 161 5 U.S.C. 801 et seq. very few such entities are subject to the Board’s 159 12 U.S.C. 4802(a). 162 5 U.S.C. 801(a)(3). capital rule. 160 12 U.S.C. 4802. 163 5 U.S.C. 804(2).

4400 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations guarantee on the performance of a client prior security interest of any custodial 12 CFR Part 327 on a transaction between the client and agent or any prior security interest Bank deposit insurance, Banks, a QCCP. granted to a CCP in connection with Banking, Savings associations. * * * * * collateral posted to that CCP), and the means an entity amount of which does not change Office of the Comptroller of the Commercial end-user that: directly in response to the value of the Currency (1)(i) Is using derivative contracts to derivative contract or contracts that the For the reasons set out in the joint hedge or mitigate commercial risk; and financial collateral secures. preamble, the OCC amends 12 CFR parts (ii)(A) Is not an entity described in * * * * * 3 and 32 as follows: section 2(h)(7)(C)(i)(I) through (VIII) of Minimum transfer amount means the the Commodity Exchange Act (7 U.S.C. smallest amount of variation margin that PART 3—CAPITAL ADEQUACY 2(h)(7)(C)(i)(I) through (VIII)); or may be transferred between STANDARDS (B) Is not a ‘‘financial entity’’ for counterparties to a netting set pursuant purposes of section 2(h)(7) of the to the variation margin agreement. ■ 1. The authority citation for part 3 continues to read as follows: Commodity Exchange Act (7 U.S.C. * * * * * 2(h)) by virtue of section 2(h)(7)(C)(iii) Net independent collateral amount Authority: 12 U.S.C. 93a, 161, 1462, 1462a, of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or means the fair value amount of the 1463, 1464, 1818, 1828(n), 1828 note, 1831n (2)(i) Is using derivative contracts to note, 1835, 3907, 3909, and 5412(b)(2)(B). independent collateral, as adjusted by hedge or mitigate commercial risk; and the standard supervisory haircuts under ■ 2. Section 3.2 is amended by: (ii) Is not an entity described in § 3.132(b)(2)(ii), as applicable, that a ■ a. Adding the definitions of ‘‘Basis section 3C(g)(3)(A)(i) through (viii) of counterparty to a netting set has posted derivative contract,’’ ‘‘Client-facing the Securities Exchange Act of 1934 (15 to a national bank or Federal savings derivative transaction,’’ and U.S.C. 78c–3(g)(3)(A)(i) through (viii)); association less the fair value amount of ‘‘Commercial end-user’’ in alphabetical or the independent collateral, as adjusted order; (3) Qualifies for the exemption in by the standard supervisory haircuts ■ b. Revising the definitions of ‘‘Current section 2(h)(7)(A) of the Commodity under § 3.132(b)(2)(ii), as applicable, exposure’’ and ‘‘Current exposure Exchange Act (7 U.S.C. 2(h)(7)(A)) by posted by the national bank or Federal methodology;’’ virtue of section 2(h)(7)(D) of the Act (7 savings association to the counterparty, ■ c. Revising paragraph (2) of the U.S.C. 2(h)(7)(D)); or excluding such amounts held in a definition of ‘‘Financial collateral;’’ (4) Qualifies for an exemption in bankruptcy remote manner or posted to ■ d. Adding the definitions of section 3C(g)(1) of the Securities a QCCP and held in conformance with ‘‘Independent collateral,’’ ‘‘Minimum Exchange Act of 1934 (15 U.S.C. 78c– the operational requirements in § 3.3. transfer amount,’’ and ‘‘Net independent 3(g)(1)) by virtue of section 3C(g)(4) of Netting set means a group of collateral amount’’ in alphabetical the Act (15 U.S.C. 78c–3(g)(4)). transactions with a single counterparty order; * * * * * that are subject to a qualifying master ■ e. Revising the definition of ‘‘Netting Current exposure means, with respect netting agreement. For derivative set;’’ and to a netting set, the larger of zero or the contracts, netting set also includes a ■ f. Adding the definitions of fair value of a transaction or portfolio of single derivative contract between a ‘‘Speculative grade,’’ ‘‘Sub-speculative transactions within the netting set that national bank or Federal savings grade,’’ ‘‘Variation margin,’’ ‘‘Variation would be lost upon default of the association and a single counterparty. margin agreement,’’ ‘‘Variation margin counterparty, assuming no recovery on For purposes of the internal model amount,’’ ‘‘Variation margin threshold,’’ the value of the transactions. methodology under § 3.132(d), netting and ‘‘Volatility derivative contract’’ in Current exposure methodology means set also includes a group of transactions alphabetical order. the method of calculating the exposure with a single counterparty that are The additions and revisions read as amount for over-the-counter derivative subject to a qualifying cross-product follows: contracts in § 3.34(b). master netting agreement and does not * * * * * § 3.2 Definitions. include a transaction: Financial collateral * * * (1) That is not subject to such a master * * * * * (2) In which the national bank and netting agreement; or Basis derivative contract means a non- Federal savings association has a (2) Where the national bank or foreign-exchange derivative contract perfected, first-priority security interest Federal savings association has (i.e., the contract is denominated in a or, outside of the United States, the legal identified specific wrong-way risk. single currency) in which the cash flows equivalent thereof (with the exception * * * * * of the derivative contract depend on the of cash on deposit; and notwithstanding Speculative grade means the reference difference between two risk factors that the prior security interest of any entity has adequate capacity to meet are attributable solely to one of the custodial agent or any priority security financial commitments in the near term, following derivative asset classes: interest granted to a CCP in connection but is vulnerable to adverse economic Interest rate, credit, equity, or with collateral posted to that CCP). conditions, such that should economic commodity. * * * * * conditions deteriorate, the reference * * * * * Independent collateral means entity would present an elevated default Client-facing derivative transaction financial collateral, other than variation risk. means a derivative contract that is not margin, that is subject to a collateral * * * * * a cleared transaction where the national agreement, or in which a national bank Sub-speculative grade means the bank or Federal savings association is and Federal savings association has a reference entity depends on favorable either acting as a financial intermediary perfected, first-priority security interest economic conditions to meet its and enters into an offsetting transaction or, outside of the United States, the legal financial commitments, such that with a qualifying central counterparty equivalent thereof (with the exception should such economic conditions (QCCP) or where the national bank or of cash on deposit; notwithstanding the deteriorate the reference entity likely Federal savings association provides a

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4401 hypothecated the securities received, paragraph (c)(4)(ii)(B)(2)(ii) of this would default on its financial and, for a national bank or Federal section, and, for any counterparty that is commitments. savings association that uses the not a commercial end-user, multiplied * * * * * standardized approach for counterparty by 1.4; and Variation margin means financial credit risk under § 3.132(c) for its (ii) For purposes of paragraph collateral that is subject to a collateral standardized risk-weighted assets, less (c)(4)(ii)(B)(2)(i) of this section, a agreement provided by one party to its the fair value of any derivative national bank or Federal savings counterparty to meet the performance of contracts; association may set the value of the term the first party’s obligations under one or (B)(1) For a national bank or Federal C in § 3.132(c)(7)(i) equal to the amount more transactions between the parties as savings association that uses the current of collateral posted by a clearing a result of a change in value of such exposure methodology under § 3.34(b) member client of the national bank or obligations since the last time such for its standardized risk-weighted assets, Federal savings association, in financial collateral was provided. the potential future credit exposure connection with the client-facing Variation margin agreement means an (PFE) for each derivative contract or derivative transactions within the agreement to collect or post variation each single-product netting set of netting set; margin. derivative contracts (including a cleared (C)(1)(i) For a national bank or Federal Variation margin amount means the transaction except as provided in savings association that uses the current fair value amount of the variation paragraph (c)(4)(ii)(I) of this section and, exposure methodology under § 3.34(b) margin, as adjusted by the standard at the discretion of the national bank or for its standardized risk-weighted assets, supervisory haircuts under Federal savings association, excluding a the amount of cash collateral that is § 3.132(b)(2)(ii), as applicable, that a forward agreement treated as a received from a counterparty to a counterparty to a netting set has posted derivative contract that is part of a derivative contract and that has offset to a national bank or Federal savings repurchase or reverse repurchase or a the mark-to-fair value of the derivative association less the fair value amount of securities borrowing or lending asset, or cash collateral that is posted to the variation margin, as adjusted by the transaction that qualifies for sales a counterparty to a derivative contract standard supervisory haircuts under treatment under U.S. GAAP), to which and that has reduced the national bank § 3.132(b)(2)(ii), as applicable, posted by the national bank or Federal savings or Federal savings association’s on- the national bank or Federal savings association is a counterparty as balance sheet assets, unless such cash association to the counterparty. determined under § 3.34, but without collateral is all or part of variation Variation margin threshold means the regard to § 3.34(b), provided that: margin that satisfies the conditions in amount of credit exposure of a national (i) A national bank or Federal savings paragraphs (c)(4)(ii)(C)(3) through (7) of bank or Federal savings association to association may choose to exclude the this section; and its counterparty that, if exceeded, would PFE of all credit derivatives or other (ii) The variation margin is used to require the counterparty to post similar instruments through which it reduce the current credit exposure of variation margin to the national bank or provides credit protection when the derivative contract, calculated as Federal savings association pursuant to calculating the PFE under § 3.34, but described in § 3.34(b), and not the PFE; the variation margin agreement. without regard to § 3.34(b), provided and Volatility derivative contract means a that it does not adjust the net-to-gross (iii) For the purpose of the calculation derivative contract in which the payoff ratio (NGR); and of the NGR described in of the derivative contract explicitly (ii) A national bank or Federal savings § 3.34(b)(2)(ii)(B), variation margin association that chooses to exclude the depends on a measure of the volatility described in paragraph (c)(4)(ii)(C)(1)(ii) PFE of credit derivatives or other similar of an underlying risk factor to the of this section may not reduce the net instruments through which it provides derivative contract. current credit exposure or the gross credit protection pursuant to paragraph * * * * * current credit exposure; or (c)(4)(ii)(B)(1) of this section must do so (2)(i) For a national bank or Federal ■ 3. Section 3.10 is amended by revising consistently over time for the savings association that uses the paragraphs (c)(4)(ii)(A) through (C) to calculation of the PFE for all such standardized approach for counterparty read as follows: instruments; or credit risk under § 3.132(c) for its (2)(i) For a national bank or Federal standardized risk-weighted assets, the § 3.10 Minimum capital requirements. savings association that uses the * * * * * replacement cost of each derivative standardized approach for counterparty contract or single product netting set of (c) * * * credit risk under section § 3.132(c) for (4) * * * derivative contracts to which the its standardized risk-weighted assets, national bank or Federal savings (ii) * * * the PFE for each netting set to which the (A) The balance sheet carrying value association is a counterparty, calculated national bank or Federal savings according to the following formula, and, of all of the national bank or Federal association is a counterparty (including savings association’s on-balance sheet for any counterparty that is not a cleared transactions except as provided commercial end-user, multiplied by 1.4: assets, plus the value of securities sold in paragraph (c)(4)(ii)(I) of this section = max{ + under a repurchase transaction or a and, at the discretion of the national Replacement Cost V¥CVMr securities lending transaction that bank or Federal savings association, CVMp;0} qualifies for sales treatment under U.S. excluding a forward agreement treated Where: GAAP, less amounts deducted from tier as a derivative contract that is part of a V equals the fair value for each derivative 1 capital under § 3.22(a), (c), and (d), repurchase or reverse repurchase or a contract or each single-product netting and less the value of securities received securities borrowing or lending set of derivative contracts (including a in security-for-security repo-style cleared transaction except as provided in transaction that qualifies for sales paragraph (c)(4)(ii)(I) of this section and, transactions, where the national bank or treatment under U.S. GAAP), as Federal savings association acts as a at the discretion of the national bank or determined under § 3.132(c)(7)(i), in Federal savings association, excluding a securities lender and includes the which the term C in § 3.132(c)(7)(i) forward agreement treated as a derivative securities received in its on-balance equals zero except as provided in contract that is part of a repurchase or sheet assets but has not sold or re-

4402 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations derivative contract, provided that for the Federal savings association. (i) A reverse repurchase or a securities purposes of this paragraph national bank or Federal savings borrowing or lending transaction that qualifies for sales treatment under U.S. (c)(4)(ii)(C)(6), currency of settlement association that is not an advanced GAAP); means any currency for settlement approaches national bank or Federal savings association must use the current CVMr equals the amount of cash collateral specified in the governing qualifying received from a counterparty to a master netting agreement and the credit exposure methodology (CEM) described derivative contract and that satisfies the support annex to the qualifying master in paragraph (b) of this section to conditions in paragraphs (c)(4)(ii)(C)(3) netting agreement, or in the governing calculate the exposure amount for all its through (7) of this section, or, in the case rules for a cleared transaction; and OTC derivative contracts, unless the of a client-facing derivative transaction, (7) The derivative contract and the national bank or Federal savings the amount of collateral received from variation margin are governed by a association makes the election provided the clearing member client; and qualifying master netting agreement in paragraph (a)(1)(ii) of this section. CVMp equals the amount of cash collateral (ii) A national bank or Federal savings that is posted to a counterparty to a between the legal entities that are the derivative contract and that has not counterparties to the derivative contract association that is not an advanced offset the fair value of the derivative or by the governing rules for a cleared approaches national bank or Federal contract and that satisfies the conditions transaction, and the qualifying master savings association may elect to in paragraphs (c)(4)(ii)(C)(3) through (7) netting agreement or the governing rules calculate the exposure amount for all its of this section, or, in the case of a client- for a cleared transaction must explicitly OTC derivative contracts under the facing derivative transaction, the amount stipulate that the counterparties agree to standardized approach for counterparty of collateral posted to the clearing settle any payment obligations on a net credit risk (SA–CCR) in § 3.132(c) by member client; basis, taking into account any variation notifying the OCC, rather than (ii) Notwithstanding paragraph margin received or provided under the calculating the exposure amount for all (c)(4)(ii)(C)(2)(i) of this section, where contract if a credit event involving its derivative contracts using CEM. A multiple netting sets are subject to a either counterparty occurs; national bank or Federal savings single variation margin agreement, a * * * * * association that elects under this national bank or Federal savings paragraph (a)(1)(ii) to calculate the ■ 4. Section 3.32 is amended by revising exposure amount for its OTC derivative association must apply the formula for paragraph (f) to read as follows: replacement cost provided in contracts under SA–CCR must apply the § 3.132(c)(10)(i), in which the term CMA § 3.32 General risk weights. treatment of cleared transactions under may only include cash collateral that * * * * * § 3.133 to its derivative contracts that are cleared transactions and to all satisfies the conditions in paragraphs (f) Corporate exposures. (1) A national (c)(4)(ii)(C)(3) through (7) of this section; bank or Federal savings association default fund contributions associated and must assign a 100 percent risk weight to with such derivative contracts, rather (iii) For purposes of paragraph all its corporate exposures, except as than applying § 3.35. A national bank or (c)(4)(ii)(C)(2)(i), a national bank or provided in paragraph (f)(2) of this Federal savings association that is not Federal savings association must treat a section. an advanced approaches national bank or Federal savings association must use derivative contract that references an (2) A national bank or Federal savings the same methodology to calculate the index as if it were multiple derivative association must assign a 2 percent risk exposure amount for all its derivative contracts each referencing one weight to an exposure to a QCCP arising contracts and, if a national bank or component of the index if the national from the national bank or Federal Federal savings association has elected bank or Federal savings association savings association posting cash to use SA–CCR under this paragraph elected to treat the derivative contract as collateral to the QCCP in connection (a)(1)(ii), the national bank or Federal multiple derivative contracts under with a cleared transaction that meets the savings association may change its § 3.132(c)(5)(vi); requirements of § 3.35(b)(3)(i)(A) and a election only with prior approval of the (3) For derivative contracts that are 4 percent risk weight to an exposure to not cleared through a QCCP, the cash OCC. a QCCP arising from the national bank (2) Advanced approaches national collateral received by the recipient or Federal savings association posting counterparty is not segregated (by law, bank or Federal savings association. An cash collateral to the QCCP in advanced approaches national bank or regulation, or an agreement with the connection with a cleared transaction counterparty); Federal savings association must that meets the requirements of calculate the exposure amount for all its (4) Variation margin is calculated and § 3.35(b)(3)(i)(B). transferred on a daily basis based on the derivative contracts using SA–CCR in (3) A national bank or Federal savings § 3.132(c) for purposes of standardized mark-to-fair value of the derivative association must assign a 2 percent risk contract; total risk-weighted assets. An advanced weight to an exposure to a QCCP arising approaches national bank or Federal (5) The variation margin transferred from the national bank or Federal under the derivative contract or the savings association must apply the savings association posting cash treatment of cleared transactions under governing rules of the CCP or QCCP for collateral to the QCCP in connection a cleared transaction is the full amount § 3.133 to its derivative contracts that with a cleared transaction that meets the that is necessary to fully extinguish the are cleared transactions and to all requirements of § 3.35(c)(3)(i). net current credit exposure to the default fund contributions associated counterparty of the derivative contracts, * * * * * with such derivative contracts for subject to the threshold and minimum ■ 5. Section 3.34 is revised to read as purposes of standardized total risk- transfer amounts applicable to the follows: weighted assets. counterparty under the terms of the (b) Current exposure methodology derivative contract or the governing § 3.34 Derivative contracts. exposure amount—(1) Single OTC rules for a cleared transaction; (a) Exposure amount for derivative derivative contract. Except as modified —(1) (6) The variation margin is in the form contracts National bank or Federal by paragraph (c) of this section, the of cash in the same currency as the savings association that is not an exposure amount for a single OTC currency of settlement set forth in the advanced approaches national bank or derivative contract that is not subject to

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4403 derivative contract by the appropriate section, the PFE must be calculated a qualifying master netting agreement is conversion factor in Table 1 to this using the appropriate ‘‘other’’ equal to the sum of the national bank’s section. conversion factor. or Federal savings association’s current (B) For purposes of calculating either (D) A national bank or Federal savings credit exposure and potential future the PFE under this paragraph (b)(1)(ii) association must use an OTC derivative credit exposure (PFE) on the OTC or the gross PFE under paragraph contract’s effective notional principal derivative contract. (b)(2)(ii)(A) of this section for exchange amount (that is, the apparent or stated (i) Current credit exposure. The rate contracts and other similar notional principal amount multiplied by current credit exposure for a single OTC contracts in which the notional any multiplier in the OTC derivative derivative contract is the greater of the principal amount is equivalent to the contract) rather than the apparent or fair value of the OTC derivative contract cash flows, notional principal amount is stated notional principal amount in or zero. the net receipts to each party falling due calculating PFE. (ii) (A) The PFE for a single OTC PFE. on each value date in each currency. (E) The PFE of the protection provider derivative contract, including an OTC (C) For an OTC derivative contract of a credit derivative is capped at the derivative contract with a negative fair that does not fall within one of the net present value of the amount of value, is calculated by multiplying the specified categories in Table 1 to this unpaid premiums. notional principal amount of the OTC

TABLE 1 TO § 3.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS 1

Credit Credit (non- Foreign (investment investment- Precious Remaining maturity 2 Interest rate exchange grade Equity metals Other rate and gold reference grade (except gold) 3 reference asset) asset)

One year or less ...... 0.00 0.01 0.05 0.10 0.06 0.07 0.10 Greater than one year and less than or equal to five years ...... 0.005 0.05 0.05 0.10 0.08 0.07 0.12 Greater than five years ...... 0.015 0.075 0.05 0.10 0.10 0.08 0.15 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 2 For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A national bank or Federal savings association must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an outstanding unsecured long-term debt security without credit enhancement that is investment grade. A national bank or Federal savings association must use the column labeled ‘‘Credit (non-investment-grade reference asset)’’ for all other credit derivatives.

(2) Multiple OTC derivative contracts positive current credit exposures (as association must substitute the exposure subject to a qualifying master netting determined under paragraph (b)(1)(i) of amount calculated under paragraph agreement. Except as modified by this section) of all individual derivative (b)(1) or (2) of this section for SE in the paragraph (c) of this section, the contracts subject to the qualifying equation in § 3.37(c)(2). exposure amount for multiple OTC master netting agreement. (d) Counterparty credit risk for credit derivative contracts subject to a (c) Recognition of credit risk derivatives—(1) Protection purchasers. qualifying master netting agreement is mitigation of collateralized OTC A national bank or Federal savings equal to the sum of the net current derivative contracts. (1) A national bank association that purchases a credit credit exposure and the adjusted sum of or Federal savings association using derivative that is recognized under the PFE amounts for all OTC derivative CEM under paragraph (b) of this section § 3.36 as a credit risk mitigant for an contracts subject to the qualifying may recognize the credit risk mitigation exposure that is not a covered position master netting agreement. benefits of financial collateral that under subpart F of this part is not (i) Net current credit exposure. The secures an OTC derivative contract or required to compute a separate net current credit exposure is the greater multiple OTC derivative contracts counterparty credit risk capital of the net sum of all positive and subject to a qualifying master netting requirement under this subpart negative fair values of the individual agreement (netting set) by using the provided that the national bank or OTC derivative contracts subject to the simple approach in § 3.37(b). Federal savings association does so qualifying master netting agreement or (2) As an alternative to the simple consistently for all such credit zero. approach, a national bank or Federal derivatives. The national bank or (ii) Adjusted sum of the PFE amounts. savings association using CEM under Federal savings association must either The adjusted sum of the PFE amounts, paragraph (b) of this section may include all or exclude all such credit Anet, is calculated as Anet = (0.4 × recognize the credit risk mitigation derivatives that are subject to a Agross) + (0.6 × NGR × Agross), where: benefits of financial collateral that qualifying master netting agreement (A) Agross = the gross PFE (that is, the secures such a contract or netting set if from any measure used to determine sum of the PFE amounts as determined the financial collateral is marked-to-fair counterparty credit risk exposure to all under paragraph (b)(1)(ii) of this section value on a daily basis and subject to a relevant counterparties for risk-based for each individual derivative contract daily margin maintenance requirement capital purposes. subject to the qualifying master netting by applying a risk weight to the (2) Protection providers. (i) A national agreement); and uncollateralized portion of the bank or Federal savings association that (B) Net-to-gross Ratio (NGR) = the exposure, after adjusting the exposure is the protection provider under a credit ratio of the net current credit exposure amount calculated under paragraph derivative must treat the credit to the gross current credit exposure. In (b)(1) or (2) of this section using the derivative as an exposure to the calculating the NGR, the gross current collateral haircut approach in § 3.37(c). underlying reference asset. The national credit exposure equals the sum of the The national bank or Federal savings bank or Federal savings association is

4404 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations transactions equals the exposure clearing member national bank or not required to compute a counterparty amount calculated according to Federal savings association is acting as credit risk capital requirement for the paragraph (b)(1) or (2) of this section a financial intermediary on behalf of a credit derivative under this subpart, multiplied by the scaling factor of the clearing member client, the transaction provided that this treatment is applied square root of 1 2 (which equals offsets another transaction that satisfies consistently for all such credit 0.707107). If the national bank or the requirements set forth in § 3.3(a), derivatives. The national bank or Federal savings⁄ association determines and the clearing member national bank Federal savings association must either that a longer period is appropriate, the or Federal savings association is not include all or exclude all such credit national bank or Federal savings obligated to reimburse the clearing derivatives that are subject to a association must use a larger scaling member client in the event of the CCP qualifying master netting agreement factor to adjust for a longer holding default. from any measure used to determine period as follows: * * * * * counterparty credit risk exposure. (ii) The provisions of this paragraph ■ 7. Section 3.37 is amended by revising (d)(2) apply to all relevant paragraphs (c)(3)(iii), (c)(3)(iv)(A) and counterparties for risk-based capital (C), (c)(4)(i)(B) introductory text, and purposes unless the national bank or (c)(4)(i)(B)(1) to read as follows: Federal savings association is treating Where H = the holding period greater than the credit derivative as a covered or equal to five days. § 3.37 Collateralized transactions. position under subpart F of this part, in Additionally, the OCC may require * * * * * which case the national bank or Federal the national bank or Federal savings (c) * * * savings association must compute a association to set a longer holding (3) * * * supplemental counterparty credit risk period if the OCC determines that a (iii) For repo-style transactions and capital requirement under this section. longer period is appropriate due to the client-facing derivative transactions, a (e) Counterparty credit risk for equity nature, structure, or characteristics of national bank or Federal savings derivatives. (1) A national bank or the transaction or is commensurate with association may multiply the standard Federal savings association must treat the risks associated with the transaction. an equity derivative contract as an supervisory haircuts provided in ■ 6. Section 3.35 is amended by adding equity exposure and compute a risk- paragraphs (c)(3)(i) and (ii) of this paragraph (a)(3), revising paragraph 1 weighted asset amount for the equity section by the square root of 2 (which (b)(4)(i), and adding paragraph (c)(3)(iii) equals 0.707107). For client-facing derivative contract under §§ 3.51 to read as follows: through 3.53 (unless the national bank derivative transactions, if a larger⁄ scaling factor is applied under § 3.34(f), or Federal savings association is treating § 3.35 Cleared transactions. the contract as a covered position under (a) * * * the same factor must be used to adjust the supervisory haircuts. subpart F of this part). (3) Alternate requirements. (2) In addition, the national bank or Notwithstanding any other provision of (iv) * * * Federal savings association must also this section, an advanced approaches (A) TM equals a holding period of calculate a risk-based capital national bank or Federal savings longer than 10 business days for eligible requirement for the counterparty credit association or a national bank or Federal margin loans and derivative contracts risk of an equity derivative contract savings association that is not an other than client-facing derivative under this section if the national bank advanced approaches national bank or transactions or longer than 5 business or Federal savings association is treating Federal savings association and that has days for repo-style transactions and the contract as a covered position under elected to use SA–CCR under client-facing derivative transactions; subpart F of this part. § 3.34(a)(1) must apply § 3.133 to its * * * * * (3) If the national bank or Federal derivative contracts that are cleared savings association risk weights the (C) TS equals 10 business days for transactions rather than this section. eligible margin loans and derivative contract under the Simple Risk-Weight (b) * * * Approach (SRWA) in § 3.52, the contracts other than client-facing (4) * * * derivative transactions or 5 business national bank or Federal savings (i) Notwithstanding any other days for repo-style transactions and association may choose not to hold risk- requirements in this section, collateral client-facing derivative transactions. based capital against the counterparty posted by a clearing member client credit risk of the equity derivative national bank or Federal savings * * * * * contract, as long as it does so for all association that is held by a custodian (4) * * * such contracts. Where the equity (in its capacity as custodian) in a (i) * * * derivative contracts are subject to a manner that is bankruptcy remote from (B) The minimum holding period for qualified master netting agreement, a the CCP, clearing member, and other a repo-style transaction and client- national bank or Federal savings clearing member clients of the clearing facing derivative transaction is five association using the SRWA must either member, is not subject to a capital business days and for an eligible margin include all or exclude all of the requirement under this section. loan and a derivative contract other than contracts from any measure used to * * * * * a client-facing derivative transaction is determine counterparty credit risk (c) * * * ten business days except for exposure. (3) * * * transactions or netting sets for which (f) Clearing member national bank’s (iii) Notwithstanding paragraphs paragraph (c)(4)(i)(C) of this section or Federal savings association’s (c)(3)(i) and (ii) of this section, a applies. When a national bank or exposure amount. The exposure amount clearing member national bank or Federal savings association calculates of a clearing member national bank or Federal savings association may apply a an own-estimates haircut on a T -day Federal savings association using CEM N risk weight of zero percent to the trade holding period, which is different from under paragraph (b) of this section for exposure amount for a cleared the minimum holding period for the a client-facing derivative transaction or transaction with a CCP where the transaction type, the applicable haircut netting set of client-facing derivative

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4405 than client-facing derivative listed in the ‘‘Old footnote number’’ (HM) is calculated using the following transactions; column is redesignated as the footnote square root of time formula: * * * * * number listed in the ‘‘New footnote * * * * * number’’ column as follows: (1) TM equals 5 for repo-style § § 3.134, 3.202, and 3.210 [Amended] transactions and client-facing derivative ■ 8. For each section listed in the transactions and 10 for eligible margin following table, the footnote number loans and derivative contracts other

Old footnote New footnote Section number number

3.134(d)(3) ...... 30 31 3.202, paragraph (1) introductory text of the definition of ‘‘Covered position’’ ...... 31 32 3.202, paragraph (1)(i) of the definition of ‘‘Covered position’’ ...... 32 33 3.210(e)(1) ...... 33 34

■ 9. Section 3.132 is amended by: holding period longer than ten business business days. If a netting set contains ■ a. Revising paragraphs (b)(2)(ii)(A)(3) days (for eligible margin loans) or five one or more trades involving illiquid through (5); business days (for repo-style collateral or a derivative contract that ■ b. Adding paragraphs (b)(2)(ii)(A)(6) transactions), using the formula cannot be easily replaced, a national and (7); provided in paragraph (b)(2)(ii)(A)(6) of bank or Federal savings association ■ c. Revising paragraphs (c) heading and this section where the conditions in this must use a minimum holding period of (c)(1) and (2) and (5) through (8); paragraph (b)(2)(ii)(A)(4) apply. If the twenty business days. ■ d. Adding paragraphs (c)(9) through number of trades in a netting set (ii) Notwithstanding paragraph (11); exceeds 5,000 at any time during a (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) ■ e. Revising paragraph (d)(10)(i); quarter, a national bank or Federal of this section, for collateral associated ■ f. In paragraphs (e)(5)(i)(A) and (H), savings association must adjust the with a derivative contract in a netting removing ‘‘Table 3 to § 3.132’’ and supervisory haircuts upward on the set under which more than two margin adding in its place ‘‘Table 4 to this basis of a minimum holding period of disputes that lasted longer than the section’’; twenty business days for the following holding period occurred during the ■ g. In paragraphs (e)(5)(i)(C) and quarter (except when a national bank or previous two quarters, the minimum (e)(6)(i)(B), removing ‘‘current exposure Federal savings association is holding period is twice the amount methodology’’ and adding in its place calculating EAD for a cleared provided under paragraph ‘‘standardized approach for transaction under § 3.133). If a netting (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) counterparty credit risk methodology’’ set contains one or more trades of this section. wherever it appears; involving illiquid collateral, a national (6) A national bank or Federal savings ■ h. Redesignating Table 3 to § 3.132 bank or Federal savings association association must adjust the standard following paragraph (e)(5)(ii) as Table 4 must adjust the supervisory haircuts supervisory haircuts upward, pursuant to § 3.132; and upward on the basis of a minimum to the adjustments provided in ■ i. Revising paragraph (e)(6)(viii). holding period of twenty business days. paragraphs (b)(2)(ii)(A)(3) through (5) of The revisions and additions read as If over the two previous quarters more this section, using the following follows: than two margin disputes on a netting formula:

§ 3.132 Counterparty credit risk of repo- set have occurred that lasted longer than style transactions, eligible margin loans, the holding period, then the national and OTC derivative contracts. bank or Federal savings association * * * * * must adjust the supervisory haircuts (b) * * * upward for that netting set on the basis (2) * * * of a minimum holding period that is at (ii) * * * least two times the minimum holding (A) * * * period for that netting set. Where:

(3) For repo-style transactions and (5)(i) A national bank or Federal TM equals a holding period of longer than 10 client-facing derivative transactions, a savings association must adjust the business days for eligible margin loans national bank or Federal savings supervisory haircuts upward on the and derivative contracts other than association may multiply the basis of a holding period longer than ten client-facing derivative transactions or supervisory haircuts provided in business days for collateral associated longer than 5 business days for repo- with derivative contracts (five business style transactions and client-facing paragraphs (b)(2)(ii)(A)(1) and (2) of this derivative transactions; section by the square root of 1 2 (which days for client-facing derivative HS equals the standard supervisory haircut; equals 0.707107). If the national bank or contracts) using the formula provided in and Federal savings association determines⁄ paragraph (b)(2)(ii)(A)(6) of this section TS equals 10 business days for eligible that a longer holding period is where the conditions in this paragraph margin loans and derivative contracts appropriate for client-facing derivative (b)(2)(ii)(A)(5)(i) apply. For collateral other than client-facing derivative transactions, then it must use a larger associated with a derivative contract transactions or 5 business days for repo- scaling factor to adjust for the longer that is within a netting set that is style transactions and client-facing derivative transactions. holding period pursuant to paragraph composed of more than 5,000 derivative (b)(2)(ii)(A)(6) of this section. contracts that are not cleared (7) If the instrument a national bank (4) A national bank or Federal savings transactions, a national bank or Federal or Federal savings association has lent, association must adjust the supervisory savings association must use a sold subject to repurchase, or posted as haircuts upward on the basis of a minimum holding period of twenty collateral does not meet the definition of

4406 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations (B) With respect to exchange rate options in which the premiums have financial collateral, the national bank or derivative contracts, all such contracts been fully paid by the counterparty to Federal savings association must use a within a netting set that reference the the options and where the options are 25.0 percent haircut for market price same currency pair; not subject to a variation margin volatility (HS). (C) With respect to credit derivative agreement is zero. * * * * * contract, all such contracts within a (iv) Notwithstanding the requirements (c) EAD for derivative contracts—(1) netting set; of paragraph (c)(5)(i) of this section, the Options for determining EAD. A (D) With respect to equity derivative exposure amount of a netting set in national bank or Federal savings contracts, all such contracts within a which the counterparty is a commercial association must determine the EAD for netting set; end-user is equal to the sum of a derivative contract using the (E) With respect to a commodity replacement cost, as calculated under standardized approach for counterparty derivative contract, all such contracts paragraph (c)(6) of this section, and the credit risk (SA–CCR) under paragraph within a netting set that reference one potential future exposure of the netting (c)(5) of this section or using the of the following commodity categories: set, as calculated under paragraph (c)(7) internal models methodology described Energy, metal, agricultural, or other of this section. in paragraph (d) of this section. If a commodities; (v) For purposes of the exposure amount calculated under paragraph national bank or Federal savings (F) With respect to basis derivative association elects to use SA–CCR for contracts, all such contracts within a (c)(5)(i) of this section and all one or more derivative contracts, the netting set that reference the same pair calculations that are part of that exposure amount determined under SA– of risk factors and are denominated in exposure amount, a national bank or CCR is the EAD for the derivative the same currency; or Federal savings association may elect, at the netting set level, to treat a derivative contract or derivative contracts. A (G) With respect to volatility contract that is a cleared transaction that national bank or Federal savings derivative contracts, all such contracts is not subject to a variation margin association must use the same within a netting set that reference one agreement as one that is subject to a methodology to calculate the exposure of interest rate, exchange rate, credit, variation margin agreement, if the amount for all its derivative contracts equity, or commodity risk factors, derivative contract is subject to a and may change its election only with separated according to the requirements requirement that the counterparties prior approval of the OCC. A national under paragraphs (c)(2)(iii)(A) through make daily cash payments to each other bank or Federal savings association may (E) of this section. to account for changes in the fair value reduce the EAD calculated according to (H) If the risk of a derivative contract of the derivative contract and to reduce paragraph (c)(5) of this section by the materially depends on more than one of the net position of the contract to zero. credit valuation adjustment that the interest rate, exchange rate, credit, If a national bank or Federal savings national bank or Federal savings equity, or commodity risk factors, the association makes an election under this association has recognized in its balance OCC may require a national bank or paragraph (c)(5)(v) for one derivative sheet valuation of any derivative Federal savings association to include contract, it must treat all other contracts in the netting set. For the derivative contract in each derivative contracts within the same purposes of this paragraph (c)(1), the appropriate hedging set under netting set that are eligible for an credit valuation adjustment does not paragraphs (c)(2)(iii)(A) through (E) of election under this paragraph (c)(5)(v) as include any adjustments to common this section. derivative contracts that are subject to a equity tier 1 capital attributable to * * * * * variation margin agreement. changes in the fair value of the national (5) Exposure amount. (i) The exposure (vi) For purposes of the exposure bank’s or Federal savings association’s amount of a netting set, as calculated amount calculated under paragraph liabilities that are due to changes in its under paragraph (c) of this section, is (c)(5)(i) of this section and all own credit risk since the inception of equal to 1.4 multiplied by the sum of calculations that are part of that the transaction with the counterparty. the replacement cost of the netting set, exposure amount, a national bank or (2) Definitions. For purposes of this as calculated under paragraph (c)(6) of Federal savings association may elect to paragraph (c) of this section, the this section, and the potential future treat a credit derivative contract, equity following definitions apply: exposure of the netting set, as calculated derivative contract, or commodity (i) End date means the last date of the under paragraph (c)(7) of this section. derivative contract that references an period referenced by an interest rate or (ii) Notwithstanding the requirements index as if it were multiple derivative credit derivative contract or, if the of paragraph (c)(5)(i) of this section, the contracts each referencing one derivative contract references another exposure amount of a netting set subject component of the index. instrument, by the underlying to a variation margin agreement, (6) Replacement cost of a netting set— instrument, except as otherwise excluding a netting set that is subject to (i) Netting set subject to a variation provided in paragraph (c) of this a variation margin agreement under margin agreement under which the section. which the counterparty to the variation counterparty must post variation (ii) Start date means the first date of margin agreement is not required to post margin. The replacement cost of a the period referenced by an interest rate variation margin, is equal to the lesser netting set subject to a variation margin or credit derivative contract or, if the of the exposure amount of the netting agreement, excluding a netting set that derivative contract references the value set calculated under paragraph (c)(5)(i) is subject to a variation margin of another instrument, by underlying of this section and the exposure amount agreement under which the instrument, except as otherwise of the netting set calculated as if the counterparty is not required to post provided in paragraph (c) of this netting set were not subject to a variation margin, is the greater of: section. variation margin agreement. (A) The sum of the fair values (after (iii) means: Hedging set (iii) Notwithstanding the excluding any valuation adjustments) of (A) With respect to interest rate requirements of paragraph (c)(5)(i) of the derivative contracts within the derivative contracts, all such contracts this section, the exposure amount of a netting set less the sum of the net within a netting set that reference the netting set that consists of only sold independent collateral amount and the same reference currency;

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4407 Federal savings association is the greater (iv) Netting set subject to multiple variation margin amount applicable to of: variation margin agreements or a hybrid such derivative contracts; (A) The sum of the fair values (after Notwithstanding paragraphs (B) The sum of the variation margin netting set. excluding any valuation adjustments) of (c)(6)(i) and (ii) of this section, the threshold and the minimum transfer the derivative contracts within the replacement cost for a netting set subject amount applicable to the derivative netting set less the sum of the net to multiple variation margin agreements contracts within the netting set less the independent collateral amount and or a hybrid netting set must be net independent collateral amount variation margin amount applicable to calculated according to paragraph applicable to such derivative contracts; such derivative contracts; or (c)(11)(i) of this section. or (B) Zero. (7) (C) Zero. (iii) Multiple netting sets subject to a Potential future exposure of a (ii) Netting sets not subject to a single variation margin agreement. netting set. The potential future variation margin agreement under Notwithstanding paragraphs (c)(6)(i) exposure of a netting set is the product which the counterparty must post and (ii) of this section, the replacement of the PFE multiplier and the aggregated variation margin. The replacement cost cost for multiple netting sets subject to amount. of a netting set that is not subject to a a single variation margin agreement (i) PFE multiplier. The PFE multiplier variation margin agreement under must be calculated according to is calculated according to the following which the counterparty must post paragraph (c)(10)(i) of this section. formula: variation margin to the national bank or

Where: (iii) Multiple netting sets subject to a for purposes of total leverage exposure V is the sum of the fair values (after single variation margin agreement. under § 3.10(c)(4)(ii)(B), the potential excluding any valuation adjustments) of Notwithstanding paragraphs (c)(7)(i) future exposure for a netting set subject the derivative contracts within the and (ii) of this section and when to multiple variation margin agreements netting set; calculating the potential future exposure or a hybrid netting set must be C is the sum of the net independent collateral for purposes of total leverage exposure calculated according to paragraph amount and the variation margin amount under § 3.10(c)(4)(ii)(B), the potential (c)(11)(ii) of this section. applicable to the derivative contracts future exposure for multiple netting sets (8) Hedging set amount—(i) Interest within the netting set; and subject to a single variation margin rate derivative contracts. To calculate A is the aggregated amount of the netting set. agreement must be calculated according the hedging set amount of an interest to paragraph (c)(10)(ii) of this section. rate derivative contract hedging set, a (ii) Aggregated amount. The (iv) Netting set subject to multiple national bank or Federal savings aggregated amount is the sum of all variation margin agreements or a hybrid association may use either of the hedging set amounts, as calculated netting set. Notwithstanding paragraphs formulas provided in paragraphs under paragraph (c)(8) of this section, (c)(7)(i) and (ii) of this section and when (c)(8)(i)(A) and (B) of this section: within a netting set. calculating the potential future exposure (A) Formula 1 is as follows:

(B) Formula 2 is as follows: calculated under paragraph (c)(9) of this hedging set amount equals the absolute section, within the hedging set with an Hedging set amount = |AddOnTB1IR| + value of the sum of the adjusted end date of one to five years from the | IR| + | IR|. derivative contract amounts, as AddOnTB2 AddOnTB3 present date; and IR calculated under paragraph (c)(9) of this Where in paragraphs (c)(8)(i)(A) and (B) of AddOnTB3 is the sum of the adjusted this section: derivative contract amounts, as section, within the hedging set. IR AddOnTB1 is the sum of the adjusted calculated under paragraph (c)(9) of this (iii) Credit derivative contracts and derivative contract amounts, as section, within the hedging set with an equity derivative contracts. The hedging calculated under paragraph (c)(9) of this end date of more than five years from the set amount of a credit derivative section, within the hedging set with an present date. end date of less than one year from the contract hedging set or equity derivative present date; (ii) Exchange rate derivative contract hedging set within a netting set IR AddOnTB2 is the sum of the adjusted contracts. For an exchange rate is calculated according to the following derivative contract amounts, as derivative contract hedging set, the formula:

4408 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

Where: determined under paragraph (c)(9) of this (iv) Commodity derivative contracts. k is each reference entity within the hedging section, for all derivative contracts The hedging set amount of a commodity set. within the hedging set that reference derivative contract hedging set within a K is the number of reference entities within reference entity k. netting set is calculated according to the the hedging set. equals the applicable supervisory rk following formula: AddOn(Refk) equals the sum of the adjusted correlation factor, as provided in Table 2 derivative contract amounts, as to this section.

Where: amount for each basis derivative by each of the supervisory delta k is each commodity type within the hedging contract hedging set and each volatility adjustment, pursuant to paragraph set. derivative contract hedging set. A (c)(9)(iii) of this section, the maturity K is the number of commodity types within national bank or Federal savings factor, pursuant to paragraph (c)(9)(iv) the hedging set. association must calculate such hedging of this section, and the applicable AddOn(Typek) equals the sum of the adjusted set amounts using one of the formulas derivative contract amounts, as supervisory factor, as provided in Table determined under paragraph (c)(9) of this under paragraphs (c)(8)(i) through (iv) of 2 to this section. this section that corresponds to the section, for all derivative contracts (ii) (A)( ) within the hedging set that reference primary risk factor of the hedging set Adjusted notional amount. 1 reference commodity type k. being calculated. For an interest rate derivative contract r equals the applicable supervisory (9) Adjusted derivative contract or a credit derivative contract, the correlation factor, as provided in Table 2 amount—(i) Summary. To calculate the adjusted notional amount equals the to this section. adjusted derivative contract amount of a product of the notional amount of the (v) Basis derivative contracts and derivative contract, a national bank or derivative contract, as measured in U.S. volatility derivative contracts. Federal savings association must dollars using the exchange rate on the Notwithstanding paragraphs (c)(8)(i) determine the adjusted notional amount date of the calculation, and the through (iv) of this section, a national of derivative contract, pursuant to supervisory duration, as calculated by bank or Federal savings association paragraph (c)(9)(ii) of this section, and the following formula: must calculate a separate hedging set multiply the adjusted notional amount

Where: notional amounts of such a swap over derivative contract, as measured in U.S. S is the number of business days from the the remaining life of the swap; and dollars using the exchange rate on the present day until the start date of the (ii) For an interest rate derivative date of the calculation. If both legs of derivative contract, or zero if the start contract or a credit derivative contract the exchange rate derivative contract are date has already passed; and that is a leveraged swap, in which the denominated in currencies other than E is the number of business days from the notional amount of all legs of the U.S. dollars, the adjusted notional present day until the end date of the derivative contract are divided by a amount of the derivative contract is the derivative contract. factor and all rates of the derivative largest leg of the derivative contract, as contract are multiplied by the same measured in U.S. dollars using the (2) For purposes of paragraph factor, the notional amount is equal to exchange rate on the date of the (c)(9)(ii)(A)(1) of this section: the notional amount of an equivalent calculation. (i) For an interest rate derivative unleveraged swap. (2) Notwithstanding paragraph contract or credit derivative contract (B)(1) For an exchange rate derivative (c)(9)(ii)(B)(1) of this section, for an that is a variable notional swap, the contract, the adjusted notional amount exchange rate derivative contract with notional amount is equal to the time- is the notional amount of the non-U.S. multiple exchanges of principal, the weighted average of the contractual denominated currency leg of the national bank or Federal savings

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4409 (2) Notwithstanding paragraph an option contract or collateralized debt association must set the adjusted (c)(9)(ii)(C)(1) of this section, when obligation tranche, the supervisory delta notional amount of the derivative calculating the adjusted notional adjustment is 1 if the fair value of the contract equal to the notional amount of amount for an equity derivative contract derivative contract increases when the the derivative contract multiplied by the or a commodity derivative contract that value of the primary risk factor number of exchanges of principal under is a volatility derivative contract, the increases and ¥1 if the fair value of the the derivative contract. national bank or Federal savings derivative contract decreases when the (C)(1) For an equity derivative association must replace the unit price value of the primary risk factor contract or a commodity derivative with the underlying volatility increases. referenced by the volatility derivative contract, the adjusted notional amount (B)(1) For a derivative contract that is is the product of the fair value of one contract and replace the number of units with the notional amount of the an option contract, the supervisory delta unit of the reference instrument adjustment is determined by the underlying the derivative contract and volatility derivative contract. (iii) Supervisory delta adjustments. following formulas, as applicable: the number of such units referenced by (A) For a derivative contract that is not the derivative contract.

(2) As used in the formulas in Table (v) l equals zero for all derivative that the national bank or Federal savings 2 to this section: contracts except interest rate options for association has with all counterparties. (i) F is the standard normal the currencies where interest rates have Then, l is set according to this formula: cumulative distribution function; negative values. The same value of l l = max{¥L + 0.1%, 0}; and (ii) P equals the current fair value of must be used for all interest rate options (vi) s equals the supervisory option the instrument or risk factor, as that are denominated in the same applicable, underlying the option; volatility, as provided in Table 3 to of currency. To determine the value of l this section. (iii) K equals the strike price of the option; for a given currency, a national bank or (C)(1) For a derivative contract that is (iv) T equals the number of business Federal savings association must find a collateralized debt obligation tranche, days until the latest contractual exercise the lowest value L of P and K of all the supervisory delta adjustment is date of the option; interest rate options in a given currency determined by the following formula:

(2) As used in the formula in (ii) D is the detachment point, which decimal value between zero and one; paragraph (c)(9)(iii)(C)(1) of this section: equals one minus the ratio of the and (i) A is the attachment point, which notional amounts of all underlying (iii) The resulting amount is equals the ratio of the notional amounts exposures that are senior to the national designated with a positive sign if the of all underlying exposures that are bank’s or Federal savings association’s collateralized debt obligation tranche subordinated to the national bank’s or exposure to the total notional amount of was purchased by the national bank or Federal savings association’s exposure all underlying exposures, expressed as a Federal savings association and is to the total notional amount of all designated with a negative sign if the underlying exposures, expressed as a savings association’s exposure. In the case of a collateralized debt obligation tranche 30 decimal value between zero and one; second-or-subsequent-to-default credit derivative, was sold by the national bank or Federal

the smallest (n¥1) notional amounts of the savings association. 30 In the case of a first-to-default credit derivative, underlying exposures are subordinated to the there are no underlying exposures that are national bank’s or Federal savings association’s (iv) Maturity factor. (A)(1) The subordinated to the national bank’s or Federal exposure. maturity factor of a derivative contract

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4411 is not subject to a variation margin margin, calculated according to the that is subject to a variation margin agreement as one that is subject to a following formula: agreement, excluding derivative variation margin agreement, the national Replacement Cost = max{SNS max{VNS; contracts that are subject to a variation bank or Federal savings association 0} ¥ max{CMA; 0}; 0} + max{SNS margin agreement under which the must treat the derivative contract as min{VNS; 0} ¥ min{CMA; 0}; 0} counterparty is not required to post subject to a variation margin agreement Where: variation margin, is determined by the with maturity factor as determined NS is each netting set subject to the variation following formula: according to (c)(9)(iv)(A) of this section, margin agreement MA. and daily settlement does not change VNS is the sum of the fair values (after the end date of the period referenced by excluding any valuation adjustments) of the derivative contract. the derivative contracts within the Where MPOR refers to the period (v) Derivative contract as multiple netting set NS. from the most recent exchange of effective derivative contracts. A national CMA is the sum of the net independent bank or Federal savings association collateral amount and the variation collateral covering a netting set of margin amount applicable to the derivative contracts with a defaulting must separate a derivative contract into derivative contracts within the netting counterparty until the derivative separate derivative contracts, according sets subject to the single variation margin contracts are closed out and the to the following rules: agreement. resulting market risk is re-hedged. (A) For an option where the (ii) Calculating potential future (2) Notwithstanding paragraph counterparty pays a predetermined exposure. Notwithstanding paragraph (c)(9)(iv)(A)(1) of this section: amount if the value of the underlying (c)(5) of this section, a national bank or (i) For a derivative contract that is not asset is above or below the strike price Federal savings association shall assign a client-facing derivative transaction, and nothing otherwise (binary option), a single potential future exposure to MPOR cannot be less than ten business the option must be treated as two multiple netting sets that are subject to days plus the periodicity of re- separate options. For purposes of a single variation margin agreement margining expressed in business days paragraph (c)(9)(iii)(B) of this section, a under which the counterparty must post minus one business day; binary option with strike K must be variation margin equal to the sum of the (ii) For a derivative contract that is a represented as the combination of one potential future exposure of each such client-facing derivative transaction, bought European option and one sold netting set, each calculated according to MPOR cannot be less than five business European option of the same type as the paragraph (c)(7) of this section as if such days plus the periodicity of re- original option (put or call) with the nettings sets were not subject to a margining expressed in business days strikes set equal to 0.95 * K and 1.05 * variation margin agreement. minus one business day; and K so that the payoff of the binary option (11) Netting set subject to multiple (iii) For a derivative contract that is is reproduced exactly outside the region variation margin agreements or a hybrid within a netting set that is composed of between the two strikes. The absolute netting set—(i) Calculating replacement more than 5,000 derivative contracts value of the sum of the adjusted cost. To calculate replacement cost for that are not cleared transactions, or a derivative contract amounts of the either a netting set subject to multiple netting set that contains one or more bought and sold options is capped at the variation margin agreements under trades involving illiquid collateral or a payoff amount of the binary option. which the counterparty to each derivative contract that cannot be easily (B) For a derivative contract that can variation margin agreement must post replaced, MPOR cannot be less than be represented as a combination of variation margin, or a netting set twenty business days. standard option payoffs (such as collar, composed of at least one derivative (3) Notwithstanding paragraphs butterfly spread, calendar spread, contract subject to variation margin (c)(9)(iv)(A)(1) and (2) of this section, for straddle, and strangle), a national bank agreement under which the a netting set subject to two or more or Federal savings association must treat counterparty must post variation margin outstanding disputes over margin that each standard option component as a and at least one derivative contract that lasted longer than the MPOR over the separate derivative contract. is not subject to such a variation margin previous two quarters, the applicable (C) For a derivative contract that agreement, the calculation for floor is twice the amount provided in includes multiple-payment options, replacement cost is provided under (c)(9)(iv)(A)(1) and (2) of this section. (such as interest rate caps and floors), a paragraph (c)(6)(i) of this section, except (B) The maturity factor of a derivative national bank or Federal savings that the variation margin threshold contract that is not subject to a variation association may represent each payment equals the sum of the variation margin margin agreement, or derivative option as a combination of effective thresholds of all variation margin contracts under which the counterparty single-payment options (such as interest agreements within the netting set and is not required to post variation margin, rate caplets and floorlets). the minimum transfer amount equals is determined by the following formula: (D) A national bank or Federal savings the sum of the minimum transfer

association may not decompose linear amounts of all the variation margin derivative contracts (such as swaps) into agreements within the netting set. components. (ii) Calculating potential future Where M equals the greater of 10 (10) Multiple netting sets subject to a exposure. (A) To calculate potential business days and the remaining single variation margin agreement—(i) future exposure for a netting set subject maturity of the contract, as measured in Calculating replacement cost. to multiple variation margin agreements business days. Notwithstanding paragraph (c)(6) of this under which the counterparty to each variation margin agreement must post (C) For purposes of paragraph section, a national bank or Federal (c)(9)(iv) of this section, if a national savings association shall assign a single variation margin, or a netting set bank or Federal savings association has replacement cost to multiple netting sets composed of at least one derivative elected pursuant to paragraph (c)(5)(v) that are subject to a single variation contract subject to variation margin of this section to treat a derivative margin agreement under which the agreement under which the contract that is a cleared transaction that counterparty must post variation counterparty to the derivative contract

4410 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations (B) For purposes of paragraph (2) All derivative contracts within the must post variation margin and at least (c)(11)(ii)(A) of this section, the netting netting set that are subject to variation one derivative contract that is not set must be divided into sub-netting sets margin agreements in which the subject to such a variation margin as follows: counterparty must post variation margin agreement, a national bank or Federal (1) All derivative contracts within the and that share the same value of the savings association must divide the netting set that are not subject to a netting set into sub-netting sets (as MPOR form a single sub-netting set. The variation margin agreement or that are aggregated amount for this sub-netting described in paragraph (c)(11)(ii)(B) of subject to a variation margin agreement this section) and calculate the set is calculated as if the netting set is under which the counterparty is not subject to a variation margin agreement, aggregated amount for each sub-netting required to post variation margin form using the MPOR value shared by the set. The aggregated amount for the a single sub-netting set. The aggregated derivative contracts within the netting netting set is calculated as the sum of amount for this sub-netting set is set. the aggregated amounts for the sub- calculated as if the netting set is not netting sets. The multiplier is calculated subject to a variation margin agreement. for the entire netting set.

TABLE 3 TO § 3.132—SUPERVISORY OPTION VOLATILITY, SUPERVISORY CORRELATION PARAMETERS, AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS

Supervisory Supervisory Supervisory option correlation 1 Asset class Category Type volatility factor factor (percent) (percent) (percent)

Interest rate ...... N/A ...... N/A ...... 50 N/A 0.50 Exchange rate ...... N/A ...... N/A ...... 15 N/A 4.0 Credit, single name ...... Investment grade ...... N/A ...... 100 50 0.46 Speculative grade ...... N/A ...... 100 50 1.3 Sub-speculative grade ...... N/A ...... 100 50 6.0 Credit, index ...... Investment Grade ...... N/A ...... 80 80 0.38 Speculative Grade ...... N/A ...... 80 80 1.06 Equity, single name ...... N/A ...... N/A ...... 120 50 32 Equity, index ...... N/A ...... N/A ...... 75 80 20 Commodity ...... Energy ...... Electricity ...... 150 40 40 Other ...... 70 40 18 Metals ...... N/A ...... 70 40 18 Agricultural ...... N/A ...... 70 40 18 Other ...... N/A ...... 70 40 18 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3.

(d) * * * may assume that the standardized § 3.133 Cleared transactions. (10) * * * approach for counterparty credit risk (a) General requirements—(1) (i) With prior written approval of the pursuant to paragraph (c) of this section Clearing member clients. A national OCC, a national bank or Federal savings meets the conservatism requirement of bank or Federal savings association that association may set EAD equal to a this section. is a clearing member client must use the measure of counterparty credit risk * * * * * methodologies described in paragraph exposure, such as peak EAD, that is (e) * * * (b) of this section to calculate risk- more conservative than an alpha of 1.4 (6) * * * weighted assets for a cleared times the larger of EPEunstressed and transaction. (viii) If a national bank or Federal EPEstressed for every counterparty whose (2) A national bank savings association uses the Clearing members. EAD will be measured under the or Federal savings association that is a standardized approach for counterparty alternative measure of counterparty clearing member must use the credit risk pursuant to paragraph (c) of exposure. The national bank or Federal methodologies described in paragraph this section to calculate the EAD for any savings association must demonstrate (c) of this section to calculate its risk- immaterial portfolios of OTC derivative the conservatism of the measure of weighted assets for a cleared transaction contracts, the national bank or Federal counterparty credit risk exposure used and paragraph (d) of this section to savings association must use that EAD for EAD. With respect to paragraph calculate its risk-weighted assets for its as a constant EE in the formula for the (d)(10)(i) of this section: default fund contribution to a CCP. calculation of CVA with the maturity (A) For material portfolios of new (b) * * * OTC derivative products, the national equal to the maximum of: (1) Risk-weighted assets for cleared bank or Federal savings association may (A) Half of the longest maturity of a transactions. (i) To determine the risk- assume that the standardized approach transaction in the netting set; and weighted asset amount for a cleared for counterparty credit risk pursuant to (B) The notional weighted average transaction, a national bank or Federal paragraph (c) of this section meets the maturity of all transactions in the savings association that is a clearing conservatism requirement of this section netting set. member client must multiply the trade for a period not to exceed 180 days. 10. Section 3.133 is amended by exposure amount for the cleared (B) For immaterial portfolios of OTC revising paragraphs (a), (b)(1) through transaction, calculated in accordance derivative contracts, the national bank (3), (b)(4)(i), (c)(1) thorough (3), (c)(4)(i), with paragraph (b)(2) of this section, by or Federal savings association generally and (d) to read as follows: the risk weight appropriate for the

4412 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations insolvency, or receivership proceedings) (ii) For a cleared transaction that is a cleared transaction, determined in the relevant court and administrative repo-style transaction or netting set of accordance with paragraph (b)(3) of this authorities would find the arrangements repo-style transactions, trade exposure section. to be legal, valid, binding, and amount equals the EAD calculated (ii) A clearing member client national enforceable under the law of the under § 3.132(b)(2) or (3) or (d), plus the bank’s or Federal savings association’s relevant jurisdictions. fair value of the collateral posted by the total risk-weighted assets for cleared (B) 4 percent, if the requirements of clearing member national bank or transactions is the sum of the risk- paragraph (b)(3)(i)(A) of this section are Federal savings association and held by weighted asset amounts for all of its not met. the CCP in a manner that is not cleared transactions. (ii) For a cleared transaction with a bankruptcy remote. When the clearing (2) Trade exposure amount. (i) For a CCP that is not a QCCP, a clearing member national bank or Federal cleared transaction that is a derivative member client national bank or Federal contract or a netting set of derivative savings association calculates EAD for savings association must apply the risk the cleared transaction under § 3.132(d), contracts, trade exposure amount equals weight applicable to the CCP under the EAD for the derivative contract or EAD equals EADunstressed. subpart D of this part. (3) Cleared transaction risk weights. netting set of derivative contracts (4) * * * (i) A clearing member national bank or calculated using the methodology used (i) Notwithstanding any other Federal savings association must apply to calculate EAD for derivative contracts requirement of this section, collateral a risk weight of 2 percent to the trade set forth in § 3.132(c) or (d), plus the fair posted by a clearing member client exposure amount for a cleared value of the collateral posted by the national bank or Federal savings transaction with a QCCP. clearing member client national bank or association that is held by a custodian Federal savings association and held by (in its capacity as a custodian) in a (ii) For a cleared transaction with a the CCP or a clearing member in a manner that is bankruptcy remote from CCP that is not a QCCP, a clearing manner that is not bankruptcy remote. the CCP, clearing member, and other member national bank or Federal When the national bank or Federal clearing member clients of the clearing savings association must apply the risk savings association calculates EAD for member, is not subject to a capital weight applicable to the CCP according the cleared transaction using the requirement under this section. to subpart D of this part. (iii) Notwithstanding paragraphs methodology in § 3.132(d), EAD equals * * * * * (c)(3)(i) and (ii) of this section, a EADunstressed. (c) * * * clearing member national bank or (ii) For a cleared transaction that is a (1) Risk-weighted assets for cleared Federal savings association may apply a repo-style transaction or netting set of transactions. (i) To determine the risk- repo-style transactions, trade exposure weighted asset amount for a cleared risk weight of zero percent to the trade amount equals the EAD for the repo- transaction, a clearing member national exposure amount for a cleared style transaction calculated using the bank or Federal savings association transaction with a QCCP where the methodology set forth in § 3.132(b)(2) or must multiply the trade exposure clearing member national bank or (3) or (d), plus the fair value of the amount for the cleared transaction, Federal savings association is acting as collateral posted by the clearing member calculated in accordance with paragraph a financial intermediary on behalf of a client national bank or Federal savings (c)(2) of this section by the risk weight clearing member client, the transaction association and held by the CCP or a appropriate for the cleared transaction, offsets another transaction that satisfies clearing member in a manner that is not determined in accordance with the requirements set forth in § 3.3(a), bankruptcy remote. When the national paragraph (c)(3) of this section. and the clearing member national bank bank or Federal savings association (ii) A clearing member national bank’s or Federal savings association is not calculates EAD for the cleared or Federal savings association’s total obligated to reimburse the clearing transaction under § 3.132(d), EAD risk-weighted assets for cleared member client in the event of the QCCP equals EADunstressed. transactions is the sum of the risk- default. (3) Cleared transaction risk weights. weighted asset amounts for all of its (4) * * * (i) For a cleared transaction with a cleared transactions. (i) Notwithstanding any other QCCP, a clearing member client national (2) Trade exposure amount. A requirement of this section, collateral bank or Federal savings association clearing member national bank or posted by a clearing member national must apply a risk weight of: Federal savings association must bank or Federal savings association that (A) 2 percent if the collateral posted calculate its trade exposure amount for is held by a custodian (in its capacity as by the national bank or Federal savings a cleared transaction as follows: a custodian) in a manner that is association to the QCCP or clearing (i) For a cleared transaction that is a bankruptcy remote from the CCP, member is subject to an arrangement derivative contract or a netting set of clearing member, and other clearing that prevents any loss to the clearing derivative contracts, trade exposure member clients of the clearing member, member client national bank or Federal amount equals the EAD calculated using is not subject to a capital requirement savings association due to the joint the methodology used to calculate EAD under this section. default or a concurrent insolvency, for derivative contracts set forth in * * * * * liquidation, or receivership proceeding § 3.132(c) or (d), plus the fair value of (d) Default fund contributions—(1) of the clearing member and any other the collateral posted by the clearing General requirement. A clearing clearing member clients of the clearing member national bank or Federal member national bank or Federal member; and the clearing member client savings association and held by the CCP savings association must determine the national bank or Federal savings in a manner that is not bankruptcy risk-weighted asset amount for a default association has conducted sufficient remote. When the clearing member fund contribution to a CCP at least legal review to conclude with a well- national bank or Federal savings quarterly, or more frequently if, in the founded basis (and maintains sufficient association calculates EAD for the opinion of the national bank or Federal written documentation of that legal cleared transaction using the savings association or the OCC, there is review) that in the event of a legal methodology in § 3.132(d), EAD equals a material change in the financial challenge (including one resulting from EADunstressed. condition of the CCP. an event of default or from liquidation,

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4413 membership characteristics of the CCP QCCP, as calculated under the (2) Risk-weighted asset amount for and riskiness of its transactions, in cases methodology set forth in paragraph default fund contributions to where such default fund contributions (d)(4) of this section, multiplied by 12.5. nonqualifying CCPs. A clearing member may be unlimited. (4) Capital requirement for default national bank’s or Federal savings (3) Risk-weighted asset amount for fund contributions to a QCCP. A association’s risk-weighted asset amount default fund contributions to QCCPs. A for default fund contributions to CCPs clearing member national bank’s or clearing member national bank’s or that are not QCCPs equals the sum of Federal savings association’s risk- Federal savings association’s capital such default fund contributions weighted asset amount for default fund requirement for its default fund multiplied by 1,250 percent, or an contributions to QCCPs equals the sum contribution to a QCCP (KCM) is equal amount determined by the OCC, based to: of its capital requirement, KCM for each on factors such as size, structure, and

Where: Federal savings association and the CCP (iv) EAD must be calculated KCCP is the hypothetical capital requirement that are cleared transactions and any separately for each clearing member’s of the QCCP, as determined under guarantees that the national bank or sub-client accounts and sub-house paragraph (d)(5) of this section; Federal savings association has account (i.e., for the clearing member’s pref DF is the prefunded default fund provided to the CCP with respect to proprietary activities). If the clearing contribution of the clearing member national bank or Federal savings performance of a clearing member client member’s collateral and its client’s association to the QCCP; on a derivative contract, the EAD is collateral are held in the same default DFCCP is the QCCP’s own prefunded amounts equal to the exposure amount for all fund contribution account, then the that are contributed to the default such derivative contracts and guarantees EAD of that account is the sum of the waterfall and are junior or pari passu of derivative contracts calculated under EAD for the client-related transactions with prefunded default fund SA–CCR in § 3.132(c) (or, with respect within the account and the EAD of the contributions of clearing members of the to a CCP located outside the United house-related transactions within the CCP; and States, under a substantially identical pref account. For purposes of determining DFCM is the total prefunded default fund contributions from clearing members of methodology in effect in the such EADs, the independent collateral the QCCP to the QCCP. jurisdiction) using a value of 10 of the clearing member and its client business days for purposes of must be allocated in proportion to the (5) Hypothetical capital requirement § 3.132(c)(9)(iv); less the value of all respective total amount of independent of a QCCP. Where a QCCP has provided collateral held by the CCP posted by the collateral posted by the clearing member its K , a national bank or Federal CCP clearing member national bank or to the QCCP. savings association must rely on such Federal savings association or a clearing disclosed figure instead of calculating member client of the national bank or (v) If any account or sub-account KCCP under this paragraph (d)(5), unless Federal savings association in contains both derivative contracts and the national bank or Federal savings connection with a derivative contract repo-style transactions, the EAD of that association determines that a more for which the national bank or Federal account is the sum of the EAD for the conservative figure is appropriate based savings association has provided a derivative contracts within the account on the nature, structure, or guarantee to the CCP and the amount of and the EAD of the repo-style characteristics of the QCCP. The the prefunded default fund contribution transactions within the account. If hypothetical capital requirement of a of the national bank or Federal savings independent collateral is held for an QCCP ( ), as determined by the KCCP association to the CCP. account containing both derivative national bank or Federal savings (iii) With respect to any repo-style contracts and repo-style transactions, association, is equal to: transactions between the national bank then such collateral must be allocated to KCCP = SCMi EADi * 1.6 percent or Federal savings association and the the derivative contracts and repo-style Where: CCP that are cleared transactions, EAD transactions in proportion to the respective product specific exposure CMi is each clearing member of the QCCP; is equal to: and EAD = max{EBRM ¥ IM ¥ DF; 0} amounts, calculated, excluding the is the exposure amount of each clearing effects of collateral, according to EADi Where: member of the QCCP to the QCCP, as § 3.132(b) for repo-style transactions and determined under paragraph (d)(6) of EBRM is the sum of the exposure amounts of to § 3.132(c)(5) for derivative contracts. this section. each repo-style transaction between the national bank or Federal savings (vi) Notwithstanding any other (6) EAD of a clearing member national association and the CCP as determined provision of paragraph (d) of this bank or Federal savings association to a under § 3.132(b)(2) and without section, with the prior approval of the QCCP. (i) The EAD of a clearing member recognition of any collateral securing the OCC, a national bank or Federal savings national bank or Federal savings repo-style transactions; association may determine the risk- association to a QCCP is equal to the IM is the initial margin collateral posted by the national bank or Federal savings weighted asset amount for a default sum of the EAD for derivative contracts fund contribution to a QCCP according determined under paragraph (d)(6)(ii) of association to the CCP with respect to the repo-style transactions; and to § 3.35(d)(3)(ii). this section and the EAD for repo-style DF is the prefunded default fund ■ transactions determined under contribution of the national bank or 10. Section 3.173 is amended in Table paragraph (d)(6)(iii) of this section. Federal savings association to the CCP 13 to § 3.173 by revising line 4 under (ii) With respect to any derivative that is not already deducted in paragraph Part 2, Derivative exposures, to read as contracts between the national bank or (d)(6)(ii) of this section. follows:

4414 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

§ 3.173 Disclosures by certain advanced approaches national banks or Federal savings associations and Category III national banks or Federal savings associations. * * * * *

TABLE 13 TO § 3.173—SUPPLEMENTARY LEVERAGE RATIO

Dollar amounts in thousands

Tril Bil Mil Thou

* * * * * * *

Part 2: Supplementary leverage ratio

* * * * * * *

Derivative exposures

* * * * * * * 4 Current exposure for derivative exposures (that is, net of cash variation margin).

* * * * * * *

■ 11. Section 3.300 is amended by PART 32—LENDING LIMITS FEDERAL RESERVE SYSTEM adding paragraphs (g) and (h) to read as 12 CFR Chapter II follows: ■ 12. The authority citation for part 32 continues to read as follows: Authority and Issuance § 3.300 Transitions. For the reasons set forth in the * * * * * Authority: 12 U.S.C. 1 et seq., 12 U.S.C. 84, 93a, 1462a, 1463, 1464(u), 5412(b)(2)(B), and preamble, chapter II of title 12 of the (g) SA–CCR. An advanced approaches 15 U.S.C. 1639h. Code of Federal Regulations is amended national bank or Federal savings as set forth below: association may use CEM rather than ■ 13. Section 32.9 is amended by SA–CCR for purposes of §§ 3.34(a) and revising paragraph (b)(1)(iii) and adding PART 217—CAPITAL ADEQUACY OF 3.132(c) until January 1, 2022. An paragraph (b)(1)(iv) to read as follows: BANK HOLDING COMPANIES, advanced approaches national bank or SAVINGS AND LOAN HOLDING Federal savings association must § 32.9 Credit exposure arising from COMPANIES, AND STATE MEMBER provide prior notice to the OCC if it derivative and securities financing BANKS (REGULATION Q) transactions. decides to begin using SA–CCR before ■ 14. The authority citation for part 217 * * * * * January 1, 2022. On January 1, 2022, continues to read as follows: and thereafter, an advanced approaches (b) * * * Authority: 12 U.S.C. 248(a), 321–338a, national bank or Federal savings (1) * * * 481–486, 1462a, 1467a, 1818, 1828, 1831n, association must use SA–CCR for (iii) Current Exposure Method. The 1831o, 1831p–l, 1831w, 1835, 1844(b), 1851, purposes of §§ 3.34(a), 3.132(c), and 3904, 3906–3909, 4808, 5365, 5368, 5371, 3.133(d). Once an advanced approaches credit exposure arising from a derivative and 5371 note. national bank or Federal savings transaction (other than a credit ■ 15. Section 217.2 is amended by: association has begun to use SA–CCR, derivative transaction) under the ■ a. Adding the definitions of ‘‘Basis the advanced approaches national bank Current Exposure Method shall be calculated pursuant to 12 CFR 3.34(b)(1) derivative contract,’’ ‘‘Client-facing or Federal savings association may not derivative transaction,’’ and change to use CEM. and (2) and (c) or 324.34(b)(1) and (2) and (c), as appropriate. ‘‘Commercial end-user’’ in alphabetical (h) Default fund contributions. Prior order; (iv) Standardized Approach for to January 1, 2022, a national bank or ■ b. Revising the definitions of ‘‘Current The Federal savings association that Counterparty Credit Risk Method. exposure’’ and ‘‘Current exposure calculates the exposure amounts of its credit exposure arising from a derivative methodology;’’ transaction (other than a credit derivative contracts under the ■ c. Revising paragraph (2) of the standardized approach for counterparty derivative transaction) under the definition of ‘‘Financial collateral;’’ Standardized Approach for credit risk in § 3.132(c) may calculate ■ d. Adding the definitions of the risk-weighted asset amount for a Counterparty Credit Risk Method shall ‘‘Independent collateral,’’ ‘‘Minimum default fund contribution to a QCCP be calculated pursuant to 12 CFR transfer amount,’’ and ‘‘Net independent under either method 1 under 3.132(c)(5) or 324.132(c)(5), as collateral amount’’ in alphabetical § 3.35(d)(3)(i) or method 2 under appropriate. order; § 3.35(d)(3)(ii), rather than under * * * * * ■ e. Revising the definition of ‘‘Netting § 3.133(d). set;’’ and

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4415 fair value of a transaction or portfolio of single derivative contract between a ■ f. Adding the definitions of transactions within the netting set that Board-regulated institution and a single ‘‘Speculative grade,’’ ‘‘Sub-speculative would be lost upon default of the counterparty. For purposes of the grade,’’ ‘‘Variation margin,’’ ‘‘Variation counterparty, assuming no recovery on internal model methodology under margin agreement,’’ ‘‘Variation margin the value of the transactions. § 217.132(d), netting set also includes a amount,’’ ‘‘Variation margin threshold,’’ Current exposure methodology means group of transactions with a single and ‘‘Volatility derivative contract’’ in the method of calculating the exposure counterparty that are subject to a alphabetical order. amount for over-the-counter derivative qualifying cross-product master netting The additions and revisions read as contracts in § 217.34(b). agreement and does not include a follows: * * * * * transaction: § 217.2 Definitions. Financial collateral * * * (1) That is not subject to such a master netting agreement; or * * * * * (2) In which the Board-regulated institution has a perfected, first-priority (2) Where the Board-regulated Basis derivative contract means a non- security interest or, outside of the institution has identified specific foreign-exchange derivative contract United States, the legal equivalent wrong-way risk. (i.e., the contract is denominated in a thereof, (with the exception of cash on single currency) in which the cash flows * * * * * deposit; and notwithstanding the prior of the derivative contract depend on the Speculative grade means the reference security interest of any custodial agent difference between two risk factors that entity has adequate capacity to meet are attributable solely to one of the or any priority security interest granted financial commitments in the near term, following derivative asset classes: to a CCP in connection with collateral but is vulnerable to adverse economic Interest rate, credit, equity, or posted to that CCP). conditions, such that should economic commodity. * * * * * conditions deteriorate, the reference means entity would present an elevated default * * * * * Independent collateral financial collateral, other than variation risk. Client-facing derivative transaction margin, that is subject to a collateral means a derivative contract that is not * * * * * agreement, or in which a Board- a cleared transaction where the Board- Sub-speculative grade means the regulated institution has a perfected, regulated institution is either acting as reference entity depends on favorable first-priority security interest or, outside a financial intermediary and enters into economic conditions to meet its of the United States, the legal equivalent an offsetting transaction with a financial commitments, such that thereof (with the exception of cash on qualifying central counterparty (QCCP) should such economic conditions deposit; notwithstanding the prior or where the Board-regulated institution deteriorate the reference entity likely security interest of any custodial agent would default on its financial provides a guarantee on the or any prior security interest granted to performance of a client on a transaction commitments. a CCP in connection with collateral * * * * * between the client and a QCCP. posted to that CCP), and the amount of * * * * * Variation margin means financial which does not change directly in collateral that is subject to a collateral Commercial end-user means an entity response to the value of the derivative agreement provided by one party to its that: contract or contracts that the financial (1)(i) Is using derivative contracts to counterparty to meet the performance of collateral secures. the first party’s obligations under one or hedge or mitigate commercial risk; and * * * * * (ii)(A) Is not an entity described in more transactions between the parties as Minimum transfer amount means the section 2(h)(7)(C)(i)(I) through (VIII) of a result of a change in value of such smallest amount of variation margin that obligations since the last time such the Commodity Exchange Act (7 U.S.C. may be transferred between financial collateral was provided. 2(h)(7)(C)(i)(I) through (VIII)); or counterparties to a netting set pursuant means an (B) Is not a ‘‘financial entity’’ for Variation margin agreement to the variation margin agreement. agreement to collect or post variation purposes of section 2(h)(7) of the * * * * * margin. Commodity Exchange Act (7 U.S.C. Net independent collateral amount Variation margin amount means the 2(h)) by virtue of section 2(h)(7)(C)(iii) means the fair value amount of the fair value amount of the variation of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or independent collateral, as adjusted by margin, as adjusted by the standard (2)(i) Is using derivative contracts to the standard supervisory haircuts under supervisory haircuts under hedge or mitigate commercial risk; and § 217.132(b)(2)(ii), as applicable, that a § 217.132(b)(2)(ii), as applicable, that a (ii) Is not an entity described in counterparty to a netting set has posted counterparty to a netting set has posted section 3C(g)(3)(A)(i) through (viii) of to a Board-regulated institution less the to a Board-regulated institution less the the Securities Exchange Act of 1934 (15 fair value amount of the independent fair value amount of the variation U.S.C. 78c–3(g)(3)(A)(i) through (viii)); collateral, as adjusted by the standard margin, as adjusted by the standard or supervisory haircuts under supervisory haircuts under (3) Qualifies for the exemption in § 217.132(b)(2)(ii), as applicable, posted § 217.132(b)(2)(ii), as applicable, posted section 2(h)(7)(A) of the Commodity by the Board-regulated institution to the by the Board-regulated institution to the Exchange Act (7 U.S.C. 2(h)(7)(A)) by counterparty, excluding such amounts counterparty. virtue of section 2(h)(7)(D) of the Act (7 held in a bankruptcy remote manner or Variation margin threshold means the U.S.C. 2(h)(7)(D)); or posted to a QCCP and held in amount of credit exposure of a Board- (4) Qualifies for an exemption in conformance with the operational regulated institution to its counterparty section 3C(g)(1) of the Securities requirements in § 217.3. that, if exceeded, would require the Exchange Act of 1934 (15 U.S.C. 78c– Netting set means a group of counterparty to post variation margin to 3(g)(1)) by virtue of section 3C(g)(4) of transactions with a single counterparty the Board-regulated institution pursuant the Act (15 U.S.C. 78c–3(g)(4)). that are subject to a qualifying master to the variation margin agreement. * * * * * netting agreement. For derivative Volatility derivative contract means a Current exposure means, with respect contracts, netting set also includes a derivative contract in which the payoff to a netting set, the larger of zero or the

4416 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations derivatives or other similar instruments (2)(i) For a Board-regulated institution of the derivative contract explicitly through which it provides credit that uses the standardized approach for depends on a measure of the volatility protection pursuant to paragraph counterparty credit risk under of an underlying risk factor to the (c)(4)(ii)(B)(1) of this section must do so § 217.132(c) for its standardized risk- derivative contract. consistently over time for the weighted assets, the replacement cost of * * * * * calculation of the PFE for all such each derivative contract or single ■ 16. Section 217.10 is amended by instruments; or product netting set of derivative revising paragraphs (c)(4)(ii)(A) through (2)(i) For a Board-regulated institution contracts to which the Board-regulated (C) to read as follows: that uses the standardized approach for institution is a counterparty, calculated counterparty credit risk under section according to the following formula, and, § 217.10 Minimum capital requirements. § 217.132(c) for its standardized risk- for any counterparty that is not a * * * * * weighted assets, the PFE for each commercial end-user, multiplied by 1.4: (c) * * * netting set to which the Board-regulated Replacement Cost = max{V¥CVMr + (4) * * * institution is a counterparty (including CVMp; 0} (ii) * * * cleared transactions except as provided Where: (A) The balance sheet carrying value in paragraph (c)(4)(ii)(I) of this section of all of the Board-regulated institution’s and, at the discretion of the Board- V equals the fair value for each derivative regulated institution, excluding a contract or each single-product netting on-balance sheet assets, plus the value set of derivative contracts (including a of securities sold under a repurchase forward agreement treated as a cleared transaction except as provided in transaction or a securities lending derivative contract that is part of a paragraph (c)(4)(ii)(I) of this section and, transaction that qualifies for sales repurchase or reverse repurchase or a at the discretion of the Board-regulated treatment under U.S. GAAP, less securities borrowing or lending institution, excluding a forward amounts deducted from tier 1 capital transaction that qualifies for sales agreement treated as a derivative contract that is part of a repurchase or under § 217.22(a), (c), and (d), and less treatment under U.S. GAAP), as determined under § 217.132(c)(7), in reverse repurchase or a securities the value of securities received in borrowing or lending transaction that security-for-security repo-style which the term C in § 217.132(c)(7)(i) qualifies for sales treatment under U.S. transactions, where the Board-regulated equals zero except as provided in GAAP); institution acts as a securities lender paragraph (c)(4)(ii)(B)(2)(ii) of this CVMr equals the amount of cash collateral and includes the securities received in section, and, for any counterparty that is received from a counterparty to a its on-balance sheet assets but has not not a commercial end-user, multiplied derivative contract and that satisfies the sold or re-hypothecated the securities by 1.4; and conditions in paragraphs (c)(4)(ii)(C)(3) received, and, for a Board-regulated (ii) For purposes of paragraph through (7) of this section, or, in the case (c)(4)(ii)(B)(2)(i) of this section, a Board- of a client-facing derivative transaction, institution that uses the standardized the amount of collateral received from approach for counterparty credit risk regulated institution may set the value of the term C in § 217.132(c)(7)(i) equal the clearing member client; and under § 217.132(c) for its standardized CVMp equals the amount of cash collateral risk-weighted assets, less the fair value to the amount of collateral posted by a that is posted to a counterparty to a of any derivative contracts; clearing member client of the Board- derivative contract and that has not (B)(1) For a Board-regulated regulated institution in connection with offset the fair value of the derivative institution that uses the current the client-facing derivative transactions contract and that satisfies the conditions exposure methodology under within the netting set; in paragraphs (c)(4)(ii)(C)(3) through (7) § 217.34(b) for its standardized risk- (C)(1)(i) For a Board-regulated of this section, or, in the case of a client- institution that uses the current facing derivative transaction, the amount weighted assets, the potential future of collateral posted to the clearing credit exposure (PFE) for each exposure methodology under § 217.34(b) for its standardized risk- member client; derivative contract or each single- weighted assets, the amount of cash (ii) Notwithstanding paragraph product netting set of derivative collateral that is received from a (c)(4)(ii)(C)(2)(i) of this section, where contracts (including a cleared counterparty to a derivative contract multiple netting sets are subject to a transaction except as provided in and that has offset the mark-to-fair value single variation margin agreement, a paragraph (c)(4)(ii)(I) of this section and, of the derivative asset, or cash collateral Board-regulated institution must apply at the discretion of the Board-regulated that is posted to a counterparty to a the formula for replacement cost institution, excluding a forward derivative contract and that has reduced provided in § 217.132(c)(10)(i), in which agreement treated as a derivative the Board-regulated institution’s on- the term CMA may only include cash contract that is part of a repurchase or balance sheet assets, unless such cash collateral that satisfies the conditions in reverse repurchase or a securities collateral is all or part of variation paragraphs (c)(4)(ii)(C)(3) through (7) of borrowing or lending transaction that margin that satisfies the conditions in this section; and qualifies for sales treatment under U.S. paragraphs (c)(4)(ii)(C)(3) through (7) of (iii) For purposes of paragraph GAAP), to which the Board-regulated this section; and (c)(4)(ii)(C)(2)(i), a Board-regulated institution is a counterparty as (ii) The variation margin is used to institution must treat a derivative determined under § 217.34, but without reduce the current credit exposure of contract that references an index as if it regard to § 217.34(b), provided that: the derivative contract, calculated as were multiple derivative contracts each (i) A Board-regulated institution may described in § 217.34(b), and not the referencing one component of the index choose to exclude the PFE of all credit PFE; and if the Board-regulated institution elected derivatives or other similar instruments (iii) For the purpose of the calculation to treat the derivative contract as through which it provides credit of the NGR described in multiple derivative contracts under protection when calculating the PFE § 217.34(b)(2)(ii)(B), variation margin § 217.132(c)(5)(vi); under § 217.34, but without regard to described in paragraph (c)(4)(ii)(C)(1)(ii) (3) For derivative contracts that are § 217.34(b), provided that it does not of this section may not reduce the net not cleared through a QCCP, the cash adjust the net-to-gross ratio (NGR); and current credit exposure or the gross collateral received by the recipient (ii) A Board-regulated institution that current credit exposure; or counterparty is not segregated (by law, chooses to exclude the PFE of credit

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4417 regulated institution posting cash all its derivative contracts using SA– regulation, or an agreement with the collateral to the QCCP in connection CCR in § 217.132(c) for purposes of counterparty); with a cleared transaction that meets the standardized total risk-weighted assets. (4) Variation margin is calculated and requirements of § 217.35(b)(3)(i)(B). An advanced approaches Board- transferred on a daily basis based on the (3) A Board-regulated institution must regulated institution must apply the mark-to-fair value of the derivative assign a 2 percent risk weight to an treatment of cleared transactions under contract; exposure to a QCCP arising from the § 217.133 to its derivative contracts that (5) The variation margin transferred Board-regulated institution posting cash are cleared transactions and to all under the derivative contract or the collateral to the QCCP in connection default fund contributions associated governing rules of the CCP or QCCP for with a cleared transaction that meets the with such derivative contracts for a cleared transaction is the full amount requirements of § 217.35(c)(3)(i). purposes of standardized total risk- that is necessary to fully extinguish the weighted assets. net current credit exposure to the * * * * * (b) Current exposure methodology counterparty of the derivative contracts, ■ 18. Section 217.34 is revised to read —(1) subject to the threshold and minimum as follows: exposure amount Single OTC transfer amounts applicable to the derivative contract. Except as modified counterparty under the terms of the § 217.34 Derivative contracts. by paragraph (c) of this section, the derivative contract or the governing (a) Exposure amount for derivative exposure amount for a single OTC rules for a cleared transaction; contracts—(1) Board-regulated derivative contract that is not subject to a qualifying master netting agreement is (6) The variation margin is in the form institution that is not an advanced equal to the sum of the Board-regulated of cash in the same currency as the approaches Board-regulated institution. institution’s current credit exposure and currency of settlement set forth in the (i) A Board-regulated institution that is potential future credit exposure (PFE) derivative contract, provided that for the not an advanced approaches Board- on the OTC derivative contract. purposes of this paragraph regulated institution must use the (i) The (c)(4)(ii)(C)(6), currency of settlement current exposure methodology (CEM) Current credit exposure. means any currency for settlement described in paragraph (b) of this current credit exposure for a single OTC specified in the governing qualifying section to calculate the exposure derivative contract is the greater of the master netting agreement and the credit amount for all its OTC derivative fair value of the OTC derivative contract support annex to the qualifying master contracts, unless the Board-regulated or zero. netting agreement, or in the governing institution makes the election provided (ii) PFE. (A) The PFE for a single OTC rules for a cleared transaction; and in paragraph (a)(1)(ii) of this section. derivative contract, including an OTC derivative contract with a negative fair (7) The derivative contract and the (ii) A Board-regulated institution that variation margin are governed by a is not an advanced approaches Board- value, is calculated by multiplying the qualifying master netting agreement regulated institution may elect to notional principal amount of the OTC between the legal entities that are the calculate the exposure amount for all its derivative contract by the appropriate counterparties to the derivative contract OTC derivative contracts under the conversion factor in Table 1 to this or by the governing rules for a cleared standardized approach for counterparty section. transaction, and the qualifying master credit risk (SA–CCR) in § 217.132(c) by (B) For purposes of calculating either netting agreement or the governing rules notifying the Board, rather than the PFE under this paragraph (b)(1)(ii) for a cleared transaction must explicitly calculating the exposure amount for all or the gross PFE under paragraph stipulate that the counterparties agree to its derivative contracts using CEM. A (b)(2)(ii)(A) of this section for exchange settle any payment obligations on a net Board-regulated institution that elects rate contracts and other similar basis, taking into account any variation under this paragraph (a)(1)(ii) to contracts in which the notional margin received or provided under the calculate the exposure amount for its principal amount is equivalent to the contract if a credit event involving OTC derivative contracts under SA–CCR cash flows, notional principal amount is either counterparty occurs; must apply the treatment of cleared the net receipts to each party falling due on each value date in each currency. * * * * * transactions under § 217.133 to its derivative contracts that are cleared (C) For an OTC derivative contract ■ 17. Section 217.32 is amended by transactions and to all default fund that does not fall within one of the revising paragraph (f) to read as follows: contributions associated with such specified categories in Table 1 to this § 217.32 General risk weights. derivative contracts, rather than section, the PFE must be calculated * * * * * applying § 217.35. A Board-regulated using the appropriate ‘‘other’’ conversion factor. (f) Corporate exposures. (1) A Board- institution that is not an advanced (D) A Board-regulated institution regulated institution must assign a 100 approaches Board-regulated institution must use an OTC derivative contract’s percent risk weight to all its corporate must use the same methodology to exposures, except as provided in calculate the exposure amount for all its effective notional principal amount (that paragraph (f)(2) of this section. derivative contracts and, if a Board- is, the apparent or stated notional principal amount multiplied by any (2) A Board-regulated institution must regulated institution has elected to use assign a 2 percent risk weight to an SA–CCR under this paragraph (a)(1)(ii), multiplier in the OTC derivative exposure to a QCCP arising from the the Board-regulated institution may contract) rather than the apparent or Board-regulated institution posting cash change its election only with prior stated notional principal amount in collateral to the QCCP in connection approval of the Board. calculating PFE. with a cleared transaction that meets the (2) Advanced approaches Board- (E) The PFE of the protection provider requirements of § 217.35(b)(3)(i)(A) and regulated institution. An advanced of a credit derivative is capped at the a 4 percent risk weight to an exposure approaches Board-regulated institution net present value of the amount of to a QCCP arising from the Board- must calculate the exposure amount for unpaid premiums.

4418 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

TABLE 1 TO § 217.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS 1

Credit Credit Foreign (non- Precious (investment investment- Remaining maturity 2 Interest rate exchange grade Equity metals Other rate and gold reference grade (except gold) 3 reference asset) asset)

One year or less ...... 0.00 0.01 0.05 0.10 0.06 0.07 0.10 Greater than one year and less than or equal to five years ...... 0.005 0.05 0.05 0.10 0.08 0.07 0.12 Greater than five years ...... 0.015 0.075 0.05 0.10 0.10 0.08 0.15 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 2 For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A Board-regulated institution must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an out- standing unsecured long-term debt security without credit enhancement that is investment grade. A Board-regulated institution must use the column labeled ‘‘Credit (non-investment- grade reference asset)’’ for all other credit derivatives.

(2) Multiple OTC derivative contracts (2) As an alternative to the simple that this treatment is applied subject to a qualifying master netting approach, a Board-regulated institution consistently for all such credit agreement. Except as modified by using CEM under paragraph (b) of this derivatives. The Board-regulated paragraph (c) of this section, the section may recognize the credit risk institution must either include all or exposure amount for multiple OTC mitigation benefits of financial collateral exclude all such credit derivatives that derivative contracts subject to a that secures such a contract or netting are subject to a qualifying master netting qualifying master netting agreement is set if the financial collateral is marked- agreement from any measure used to equal to the sum of the net current to-fair value on a daily basis and subject determine counterparty credit risk credit exposure and the adjusted sum of to a daily margin maintenance exposure. the PFE amounts for all OTC derivative requirement by applying a risk weight to (ii) The provisions of this paragraph contracts subject to the qualifying the uncollateralized portion of the (d)(2) apply to all relevant master netting agreement. exposure, after adjusting the exposure counterparties for risk-based capital (i) Net current credit exposure. The amount calculated under paragraph purposes unless the Board-regulated net current credit exposure is the greater (b)(1) or (2) of this section using the institution is treating the credit of the net sum of all positive and collateral haircut approach in derivative as a covered position under negative fair values of the individual § 217.37(c). The Board-regulated subpart F of this part, in which case the OTC derivative contracts subject to the institution must substitute the exposure Board-regulated institution must qualifying master netting agreement or amount calculated under paragraph compute a supplemental counterparty zero. (b)(1) or (2) of this section for SE in the credit risk capital requirement under (ii) Adjusted sum of the PFE amounts. equation in § 217.37(c)(2). this section. The adjusted sum of the PFE amounts, (d) Counterparty credit risk for credit (e) Counterparty credit risk for equity Anet, is calculated as Anet = (0.4 × derivatives—(1) Protection purchasers. derivatives. (1) A Board-regulated Agross) + (0.6 × NGR × Agross), where: A Board-regulated institution that institution must treat an equity (A) Agross = the gross PFE (that is, the purchases a credit derivative that is derivative contract as an equity sum of the PFE amounts as determined recognized under § 217.36 as a credit exposure and compute a risk-weighted under paragraph (b)(1)(ii) of this section risk mitigant for an exposure that is not asset amount for the equity derivative for each individual derivative contract a covered position under subpart F of contract under §§ 217.51 through 217.53 subject to the qualifying master netting this part is not required to compute a (unless the Board-regulated institution agreement); and separate counterparty credit risk capital is treating the contract as a covered (B) Net-to-gross Ratio (NGR) = the requirement under this subpart position under subpart F of this part). ratio of the net current credit exposure provided that the Board-regulated (2) In addition, the Board-regulated to the gross current credit exposure. In institution does so consistently for all institution must also calculate a risk- calculating the NGR, the gross current such credit derivatives. The Board- based capital requirement for the credit exposure equals the sum of the regulated institution must either include counterparty credit risk of an equity positive current credit exposures (as all or exclude all such credit derivatives derivative contract under this section if determined under paragraph (b)(1)(i) of that are subject to a qualifying master the Board-regulated institution is this section) of all individual derivative netting agreement from any measure treating the contract as a covered contracts subject to the qualifying used to determine counterparty credit position under subpart F of this part. master netting agreement. risk exposure to all relevant (3) If the Board-regulated institution (c) Recognition of credit risk counterparties for risk-based capital risk weights the contract under the mitigation of collateralized OTC purposes. Simple Risk-Weight Approach (SRWA) derivative contracts. (1) A Board- (2) Protection providers. (i) A Board- in § 217.52, the Board-regulated regulated institution using CEM under regulated institution that is the institution may choose not to hold risk- paragraph (b) of this section may protection provider under a credit based capital against the counterparty recognize the credit risk mitigation derivative must treat the credit credit risk of the equity derivative benefits of financial collateral that derivative as an exposure to the contract, as long as it does so for all secures an OTC derivative contract or underlying reference asset. The Board- such contracts. Where the equity multiple OTC derivative contracts regulated institution is not required to derivative contracts are subject to a subject to a qualifying master netting compute a counterparty credit risk qualified master netting agreement, a agreement (netting set) by using the capital requirement for the credit Board-regulated institution using the simple approach in § 217.37(b). derivative under this subpart, provided SRWA must either include all or

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4419 (b) * * * (iv) * * * exclude all of the contracts from any (4) * * * (A) T equals a holding period of measure used to determine counterparty M (i) Notwithstanding any other longer than 10 business days for eligible credit risk exposure. requirements in this section, collateral margin loans and derivative contracts (f) Clearing member Board-regulated posted by a clearing member client other than client-facing derivative The institution’s exposure amount. Board-regulated institution that is held transactions or longer than 5 business exposure amount of a clearing member by a custodian (in its capacity as days for repo-style transactions and Board-regulated institution using CEM custodian) in a manner that is client-facing derivative transactions; under paragraph (b) of this section for bankruptcy remote from the CCP, a client-facing derivative transaction or clearing member, and other clearing * * * * * netting set of client-facing derivative member clients of the clearing member, (C) TS equals 10 business days for transactions equals the exposure is not subject to a capital requirement eligible margin loans and derivative amount calculated according to under this section. contracts other than client-facing paragraph (b)(1) or (2) of this section * * * * * derivative transactions or 5 business multiplied by the scaling factor the (c) * * * days for repo-style transactions and square root of 1 2 (which equals (3) * * * client-facing derivative transactions. 0.707107). If the Board-regulated (iii) Notwithstanding paragraphs * * * * * institution determines⁄ that a longer (c)(3)(i) and (ii) of this section, a (4) * * * period is appropriate, the Board- clearing member Board-regulated (i) * * * regulated institution must use a larger institution may apply a risk weight of (B) The minimum holding period for scaling factor to adjust for a longer zero percent to the trade exposure a repo-style transaction and client- holding period as follows: amount for a cleared transaction with a facing derivative transaction is five CCP where the clearing member Board- business days and for an eligible margin regulated institution is acting as a loan and a derivative contract other than financial intermediary on behalf of a a client-facing derivative transaction is clearing member client, the transaction ten business days except for Where H = the holding period greater than offsets another transaction that satisfies transactions or netting sets for which or equal to five days. the requirements set forth in § 217.3(a), paragraph (c)(4)(i)(C) of this section Additionally, the Board may require and the clearing member Board- applies. When a Board-regulated the Board-regulated institution to set a regulated institution is not obligated to institution calculates an own-estimates reimburse the clearing member client in longer holding period if the Board haircut on a TN-day holding period, determines that a longer period is the event of the CCP default. which is different from the minimum appropriate due to the nature, structure, * * * * * holding period for the transaction type, or characteristics of the transaction or is ■ 20. Section 217.37 is amended by the applicable haircut (HM) is calculated commensurate with the risks associated revising paragraphs (c)(3)(iii), using the following square root of time with the transaction. (c)(3)(iv)(A) and (C), (c)(4)(i)(B) formula: introductory text, and (c)(4)(i)(B)( ) to ■ 19. Section 217.35 is amended by 1 * * * * * read as follows: adding paragraph (a)(3), revising (1) TM equals 5 for repo-style paragraph (b)(4)(i), and adding § 217.37 Collateralized transactions. transactions and client-facing derivative paragraph (c)(3)(iii) to read as follows: * * * * * transactions and 10 for eligible margin loans and derivative contracts other § 217.35 Cleared transactions. (c) * * * (3) * * * than client-facing derivative (a) * * * (iii) For repo-style transactions and transactions; (3) Alternate requirements. client-facing derivative transactions, a * * * * * Notwithstanding any other provision of Board-regulated institution may this section, an advanced approaches multiply the standard supervisory § § 217.134, 217.202, and 217.210 Board-regulated institution or a Board- haircuts provided in paragraphs (c)(3)(i) [Amended] regulated institution that is not an and (ii) of this section by the square root ■ 21. For each section listed in the advanced approaches Board-regulated of 1 2 (which equals 0.707107). For following table, the footnote number institution and that has elected to use client-facing derivative transactions, if a listed in the ‘‘Old footnote number’’ SA–CCR under § 217.34(a)(1) must larger⁄ scaling factor is applied under column is redesignated as the footnote apply § 217.133 to its derivative § 217.34(f), the same factor must be used contracts that are cleared transactions number listed in the ‘‘New footnote to adjust the supervisory haircuts. rather than this section. number’’ column as follows:

Old footnote New footnote Section number number

217.134(d)(3) ...... 30 31 217.202, paragraph (1) introductory text of the definition of ‘‘Covered position’’ ...... 31 32 217.202, paragraph (1)(i) of the definition of ‘‘Covered position’’ ...... 32 33 217.210(e)(1) ...... 33 34

■ 22. Section 217.132 is amended by: ■ c. Revising paragraphs (c) heading and ■ f. In paragraphs (e)(5)(i)(A) and (H), ■ a. Revising paragraphs (b)(2)(ii)(A)(3) (c)(1) and (2) and (5) through (8); removing ‘‘Table 3 to § 217.132’’ and through (5); ■ d. Adding paragraphs (c)(9) through adding in its place ‘‘Table 4 to this ■ b. Adding paragraphs (b)(2)(ii)(A)(6) (11); section’’; and (7); ■ e. Revising paragraph (d)(10)(i);

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4421 upward on the basis of a holding period institution must use a 25.0 percent ■ g. In paragraphs (e)(5)(i)(C) and longer than ten business days for haircut for market price volatility (Hs). (e)(6)(i)(B), removing ‘‘current exposure collateral associated with derivative * * * * * methodology’’ and adding in its place contracts (five business days for client- (c) EAD for derivative contracts—(1) ‘‘standardized approach to counterparty facing derivative contracts) using the A Board- credit risk’’ wherever it appears; formula provided in paragraph Options for determining EAD. ■ h. Redesignating Table 3 to § 217.132 regulated institution must determine the (b)(2)(ii)(A)(6) of this section where the EAD for a derivative contract using the following paragraph (e)(5)(ii) as Table 4 conditions in this paragraph to § 217.132; and standardized approach for counterparty (b)(2)(ii)(A)(5)(i) apply. For collateral ■ i. Revising paragraph (e)(6)(viii). credit risk (SA–CCR) under paragraph associated with a derivative contract The revisions and additions read as (c)(5) of this section or using the that is within a netting set that is follows: internal models methodology described composed of more than 5,000 derivative in paragraph (d) of this section. If a contracts that are not cleared § 217.132 Counterparty credit risk of repo- Board-regulated institution elects to use style transactions, eligible margin loans, transactions, a Board-regulated SA–CCR for one or more derivative and OTC derivative contracts. institution must use a minimum holding * * * * * period of twenty business days. If a contracts, the exposure amount (b) * * * netting set contains one or more trades determined under SA–CCR is the EAD (2) * * * involving illiquid collateral or a for the derivative contract or derivatives (ii) * * * derivative contract that cannot be easily contracts. A Board-regulation institution (A) * * * replaced, a Board-regulated institution must use the same methodology to (3) For repo-style transactions and must use a minimum holding period of calculate the exposure amount for all its client-facing derivative transactions, a twenty business days. derivative contracts and may change its Board-regulated institution may election only with prior approval of the multiply the supervisory haircuts (ii) Notwithstanding paragraph Board. A Board-regulated institution provided in paragraphs (b)(2)(ii)(A)(1) (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) may reduce the EAD calculated and (2) of this section by the square root of this section, for collateral associated according to paragraph (c)(5) of this of 1 2 (which equals 0.707107). If the with a derivative contract in a netting section by the credit valuation Board-regulated institution determines set under which more than two margin adjustment that the Board-regulated that⁄ a longer holding period is disputes that lasted longer than the institution has recognized in its balance appropriate for client-facing derivative holding period occurred during the two sheet valuation of any derivative transactions, then it must use a larger previous quarters, the minimum holding contracts in the netting set. For scaling factor to adjust for the longer period is twice the amount provided purposes of this paragraph (c)(1), the holding period pursuant to paragraph under paragraph (b)(2)(ii)(A)(1) or (3) or credit valuation adjustment does not (b)(2)(ii)(A)(6) of this section. (b)(2)(ii)(A)(5)(i) of this section. include any adjustments to common (4) A Board-regulated institution must (6) A Board-regulated institution must equity tier 1 capital attributable to adjust the supervisory haircuts upward adjust the standard supervisory haircuts changes in the fair value of the Board- on the basis of a holding period longer upward, pursuant to the adjustments regulated institution’s liabilities that are than ten business days (for eligible provided in paragraphs (b)(2)(ii)(A)(3) due to changes in its own credit risk margin loans) or five business days (for through (5) of this section, using the since the inception of the transaction repo-style transactions), using the following formula: with the counterparty. formula provided in paragraph (2) Definitions. For purposes of this (b)(2)(ii)(A)(6) of this section where the paragraph (c) of this section, the conditions in this paragraph following definitions apply: (b)(2)(ii)(A)(4) apply. If the number of (i) End date means the last date of the trades in a netting set exceeds 5,000 at period referenced by an interest rate or any time during a quarter, a Board- credit derivative contract or, if the regulated institution must adjust the derivative contract references another supervisory haircuts upward on the instrument, by the underlying basis of a minimum holding period of Where: instrument, except as otherwise twenty business days for the following TM equals a holding period of longer than 10 provided in paragraph (c) of this quarter (except when a Board-regulated business days for eligible margin loans section. institution is calculating EAD for a and derivative contracts other than cleared transaction under § 217.133). If client-facing derivative transactions or (ii) Start date means the first date of a netting set contains one or more trades longer than 5 business days for repo- the period referenced by an interest rate involving illiquid collateral, a Board- style transactions and client-facing or credit derivative contract or, if the regulated institution must adjust the derivative transactions; derivative contract references the value supervisory haircuts upward on the Hs equals the standard supervisory haircut; of another instrument, by underlying basis of a minimum holding period of and instrument, except as otherwise twenty business days. If over the two Ts equals 10 business days for eligible provided in paragraph (c) of this margin loans and derivative contracts previous quarters more than two margin section. other than client-facing derivative (iii) Hedging set means: disputes on a netting set have occurred transactions or 5 business days for repo- that lasted longer than the holding style transactions and client-facing (A) With respect to interest rate period, then the Board-regulated derivative transactions. derivative contracts, all such contracts institution must adjust the supervisory within a netting set that reference the haircuts upward for that netting set on (7) If the instrument a Board-regulated same reference currency; the basis of a minimum holding period institution has lent, sold subject to (B) With respect to exchange rate that is at least two times the minimum repurchase, or posted as collateral does derivative contracts, all such contracts holding period for that netting set. not meet the definition of financial within a netting set that reference the (5)(i) A Board-regulated institution collateral, the Board-regulated same currency pair; must adjust the supervisory haircuts

4420 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations this section, the exposure amount of a agreement under which the (C) With respect to credit derivative netting set that consists of only sold counterparty is not required to post contract, all such contracts within a options in which the premiums have variation margin, is the greater of: netting set; been fully paid by the counterparty to (D) With respect to equity derivative (A) The sum of the fair values (after the options and where the options are contracts, all such contracts within a excluding any valuation adjustments) of not subject to a variation margin netting set; the derivative contracts within the agreement is zero. (E) With respect to a commodity netting set less the sum of the net derivative contract, all such contracts (iv) Notwithstanding the requirements independent collateral amount and the within a netting set that reference one of paragraph (c)(5)(i) of this section, the variation margin amount applicable to of the following commodity categories: exposure amount of a netting set in such derivative contracts; Energy, metal, agricultural, or other which the counterparty is a commercial (B) The sum of the variation margin commodities; end-user is equal to the sum of threshold and the minimum transfer (F) With respect to basis derivative replacement cost, as calculated under amount applicable to the derivative contracts, all such contracts within a paragraph (c)(6) of this section, and the contracts within the netting set less the netting set that reference the same pair potential future exposure of the netting net independent collateral amount of risk factors and are denominated in set, as calculated under paragraph (c)(7) applicable to such derivative contracts; the same currency; or of this section. or (G) With respect to volatility (v) For purposes of the exposure (C) Zero. amount calculated under paragraph derivative contracts, all such contracts (ii) Netting sets not subject to a (c)(5)(i) of this section and all within a netting set that reference one variation margin agreement under calculations that are part of that of interest rate, exchange rate, credit, which the counterparty must post exposure amount, a Board-regulated equity, or commodity risk factors, variation margin. The replacement cost separated according to the requirements institution may elect to treat a derivative of a netting set that is not subject to a under paragraphs (c)(2)(iii)(A) through contract that is a cleared transaction that variation margin agreement under (E) of this section. is not subject to a variation margin which the counterparty must post (H) If the risk of a derivative contract agreement as one that is subject to a variation margin to the Board-regulated materially depends on more than one of variation margin agreement, if the institution is the greater of: interest rate, exchange rate, credit, derivative contract is subject to a (A) The sum of the fair values (after equity, or commodity risk factors, the requirement that the counterparties excluding any valuation adjustments) of Board may require a Board-regulated make daily cash payments to each other the derivative contracts within the institution to include the derivative to account for changes in the fair value netting set less the sum of the net contract in each appropriate hedging set of the derivative contract and to reduce independent collateral amount and under paragraphs (c)(1)(iii)(A) through the net position of the contract to zero. variation margin amount applicable to (E) of this section. If a Board-regulated institution makes such derivative contracts; or * * * * * an election under this paragraph (B) Zero. (5) Exposure amount. (i) The exposure (c)(5)(v) for one derivative contract, it amount of a netting set, as calculated must treat all other derivative contracts (iii) Multiple netting sets subject to a under paragraph (c) of this section, is within the same netting set that are single variation margin agreement. equal to 1.4 multiplied by the sum of eligible for an election under this Notwithstanding paragraphs (c)(6)(i) the replacement cost of the netting set, paragraph (c)(5)(v) as derivative and (ii) of this section, the replacement as calculated under paragraph (c)(6) of contracts that are subject to a variation cost for multiple netting sets subject to this section, and the potential future margin agreement. a single variation margin agreement exposure of the netting set, as calculated (vi) For purposes of the exposure must be calculated according to under paragraph (c)(7) of this section. amount calculated under paragraph paragraph (c)(10)(i) of this section. (ii) Notwithstanding the requirements (c)(5)(i) of this section and all (iv) Netting set subject to multiple of paragraph (c)(5)(i) of this section, the calculations that are part of that variation margin agreements or a hybrid exposure amount of a netting set subject exposure amount, a Board-regulated netting set. Notwithstanding paragraphs to a variation margin agreement, institution may elect to treat a credit (c)(6)(i) and (ii) of this section, the excluding a netting set that is subject to derivative contract, equity derivative replacement cost for a netting set subject a variation margin agreement under contract, or commodity derivative to multiple variation margin agreements which the counterparty to the variation contract that references an index as if it or a hybrid netting set must be margin agreement is not required to post were multiple derivative contracts each calculated according to paragraph variation margin, is equal to the lesser referencing one component of the index. (c)(11)(i) of this section. of the exposure amount of the netting (6) Replacement cost of a netting set— (7) Potential future exposure of a set calculated under paragraph (c)(5)(i) (i) Netting set subject to a variation netting set. The potential future of this section and the exposure amount margin agreement under which the exposure of a netting set is the product of the netting set calculated under counterparty must post variation of the PFE multiplier and the aggregated paragraph (c)(5)(i) of this section as if margin. The replacement cost of a amount. the netting set were not subject to a netting set subject to a variation margin (i) PFE multiplier. The PFE multiplier variation margin agreement. agreement, excluding a netting set that is calculated according to the following (iii) Notwithstanding the is subject to a variation margin formula: requirements of paragraph (c)(5)(i) of

4422 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations Notwithstanding paragraphs (c)(7)(i) under § 217.10(c)(4)(ii)(B)(2), the Where: and (ii) of this section and when potential future exposure for a netting V is the sum of the fair values (after calculating the potential future exposure set subject to multiple variation margin excluding any valuation adjustments) of for purposes of total leverage exposure the derivative contracts within the agreements or a hybrid netting set must netting set; under § 217.10(c)(4)(ii)(B)(2), the be calculated according to paragraph C is the sum of the net independent collateral potential future exposure for multiple (c)(11)(ii) of this section. amount and the variation margin amount netting sets subject to a single variation applicable to the derivative contracts margin agreement must be calculated (8) Hedging set amount—(i) Interest within the netting set; and according to paragraph (c)(10)(ii) of this rate derivative contracts. To calculate A is the aggregated amount of the netting set. section. the hedging set amount of an interest rate derivative contract hedging set, a (ii) Aggregated amount. The (iv) Netting set subject to multiple Board-regulated institution may use aggregated amount is the sum of all variation margin agreements or a hybrid either of the formulas provided in hedging set amounts, as calculated netting set. Notwithstanding paragraphs under paragraph (c)(8) of this section, (c)(7)(i) and (ii) of this section and when paragraphs (c)(8)(i)(A) and (B) of this within a netting set. calculating the potential future exposure section: (iii) Multiple netting sets subject to a for purposes of total leverage exposure (A) Formula 1 is as follows: single variation margin agreement.

(B) Formula 2 is as follows: calculated under paragraph (c)(9) of this hedging set amount equals the absolute IR Hedging set amount = |AddOn | + section, within the hedging set with an value of the sum of the adjusted |AddOnIR | + |AddOnIR TB1 end date of one to five years from the derivative contract amounts, as TB2 TB3|. present date; and calculated under paragraph (c)(9) of this

Where in paragraphs (c)(8)(i)(A) and (B) of IR AddOn TB3 is the sum of the adjusted this section: derivative contract amounts, as section, within the hedging set. IR AddOn TB1 is the sum of the adjusted calculated under paragraph (c)(9) of this (iii) Credit derivative contracts and derivative contract amounts, as section, within the hedging set with an equity derivative contracts. The hedging calculated under paragraph (c)(9) of this end date of more than five years from the set amount of a credit derivative section, within the hedging set with an present date. end date of less than one year from the contract hedging set or equity derivative present date; (ii) Exchange rate derivative contract hedging set within a netting set IR AddOn TB2 is the sum of the adjusted contracts. For an exchange rate is calculated according to the following derivative contract amounts, as derivative contract hedging set, the formula:

Where: determined under paragraph (c)(9) of this (iv) Commodity derivative contracts. k is each reference entity within the hedging section, for all derivative contracts The hedging set amount of a commodity set. within the hedging set that reference derivative contract hedging set within a K is the number of reference entities within reference entity k. netting set is calculated according to the the hedging set. equals the applicable supervisory rk following formula: AddOn(Refk) equals the sum of the adjusted correlation factor, as provided in Table 2 derivative contract amounts, as to this section.

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4423

Where: separate hedging set amount for each notional amount by each of the k is each commodity type within the hedging basis derivative contract hedging set and supervisory delta adjustment, pursuant set. each volatility derivative contract to paragraph (c)(9)(iii) of this section, K is the number of commodity types within hedging set. A Board-regulated the maturity factor, pursuant to the hedging set. institution must calculate such hedging paragraph (c)(9)(iv) of this section, and AddOn(Typek) equals the sum of the adjusted derivative contract amounts, as set amounts using one of the formulas the applicable supervisory factor, as determined under paragraph (c)(9) of this under paragraphs (c)(8)(i) through (iv) provided in Table 2 to this section. that corresponds to the primary risk section, for all derivative contracts (ii) (A)( ) within the hedging set that reference factor of the hedging set being Adjusted notional amount. 1 reference commodity type. calculated. For an interest rate derivative contract r equals the applicable supervisory (9) Adjusted derivative contract or a credit derivative contract, the correlation factor, as provided in Table 2 amount—(i) Summary. To calculate the adjusted notional amount equals the to this section. adjusted derivative contract amount of a product of the notional amount of the (v) Basis derivative contracts and derivative contract, a Board-regulated derivative contract, as measured in U.S. volatility derivative contracts. institution must determine the adjusted dollars using the exchange rate on the Notwithstanding paragraphs (c)(8)(i) notional amount of derivative contract, date of the calculation, and the through (iv) of this section, a Board- pursuant to paragraph (c)(9)(ii) of this supervisory duration, as calculated by regulated institution must calculate a section, and multiply the adjusted the following formula:

Where: denominated currency leg of the the number of such units referenced by S is the number of business days from the derivative contract, as measured in U.S. the derivative contract. present day until the start date of the dollars using the exchange rate on the (2) Notwithstanding paragraph derivative contract, or zero if the start date of the calculation. If both legs of (c)(9)(ii)(C)(1) of this section, when date has already passed; and the exchange rate derivative contract are calculating the adjusted notional E is the number of business days from the denominated in currencies other than amount for an equity derivative contract present day until the end date of the or a commodity derivative contract that derivative contract. U.S. dollars, the adjusted notional amount of the derivative contract is the is a volatility derivative contract, the (2) For purposes of paragraph largest leg of the derivative contract, as Board-regulated institution must replace (c)(9)(ii)(A)(1) of this section: measured in U.S. dollars using the the unit price with the underlying (i) For an interest rate derivative exchange rate on the date of the volatility referenced by the volatility contract or credit derivative contract calculation. derivative contract and replace the that is a variable notional swap, the number of units with the notional (2) Notwithstanding paragraph notional amount is equal to the time- amount of the volatility derivative (c)(9)(ii)(B)(1) of this section, for an weighted average of the contractual contract. exchange rate derivative contract with notional amounts of such a swap over (iii) Supervisory delta adjustments. multiple exchanges of principal, the the remaining life of the swap; and (A) For a derivative contract that is not (ii) For an interest rate derivative Board-regulated institution must set the an option contract or collateralized debt contract or a credit derivative contract adjusted notional amount of the obligation tranche, the supervisory delta that is a leveraged swap, in which the derivative contract equal to the notional adjustment is 1 if the fair value of the notional amount of all legs of the amount of the derivative contract derivative contract increases when the derivative contract are divided by a multiplied by the number of exchanges value of the primary risk factor of principal under the derivative factor and all rates of the derivative increases and ¥1 if the fair value of the contract are multiplied by the same contract. derivative contract decreases when the factor, the notional amount is equal to (C)(1) For an equity derivative value of the primary risk factor the notional amount of an equivalent contract or a commodity derivative increases. unleveraged swap. contract, the adjusted notional amount (B)(1) For a derivative contract that is (B)(1) For an exchange rate derivative is the product of the fair value of one an option contract, the supervisory delta contract, the adjusted notional amount unit of the reference instrument adjustment is determined by the is the notional amount of the non-U.S. underlying the derivative contract and following formulas, as applicable:

4424 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

(2) As used in the formulas in Table (v) l equals zero for all derivative regulated institution has with all 2 to this section: contracts except interest rate options for counterparties. Then, l is set according (i) F is the standard normal the currencies where interest rates have to this formula: l = max{¥L + 0.1%, 0}; cumulative distribution function; negative values. The same value of l and (ii) P equals the current fair value of must be used for all interest rate options (vi) s equals the supervisory option the instrument or risk factor, as that are denominated in the same applicable, underlying the option; volatility, as provided in Table 3 to this currency. To determine the value of (iii) K equals the strike price of the l section. for a given currency, a Board-regulated option; (C)(1) For a derivative contract that is (iv) T equals the number of business institution must find the lowest value L a collateralized debt obligation tranche, days until the latest contractual exercise of P and K of all interest rate options in the supervisory delta adjustment is date of the option; a given currency that the Board- determined by the following formula:

(2) As used in the formula in negative sign if the collateralized debt margining expressed in business days paragraph (c)(9)(iii)(C)(1) of this section: obligation tranche was sold by the minus one business day; (i) A is the attachment point, which Board-regulated institution. (ii) For a derivative contract that is a equals the ratio of the notional amounts (iv) Maturity factor. (A)(1) The client-facing derivative transaction, of all underlying exposures that are maturity factor of a derivative contract cannot be less than five business days subordinated to the Board-regulated that is subject to a variation margin plus the periodicity of re-margining institution’s exposure to the total agreement, excluding derivative expressed in business days minus one notional amount of all underlying business day; and exposures, expressed as a decimal value contracts that are subject to a variation margin agreement under which the (iii) For a derivative contract that is between zero and one; 30 counterparty is not required to post (ii) D is the detachment point, which within a netting set that is composed of equals one minus the ratio of the variation margin, is determined by the more than 5,000 derivative contracts notional amounts of all underlying following formula: that are not cleared transactions, or a exposures that are senior to the Board- netting set that contains one or more regulated institution’s exposure to the trades involving illiquid collateral or a total notional amount of all underlying derivative contract that cannot be easily exposures, expressed as a decimal value replaced, MPOR cannot be less than between zero and one; and Where MPOR refers to the period twenty business days. from the most recent exchange of (iii) The resulting amount is (3) Notwithstanding paragraphs designated with a positive sign if the collateral covering a netting set of (c)(9)(iv)(A)(1) and (2) of this section, for collateralized debt obligation tranche derivative contracts with a defaulting a netting set subject to two or more was purchased by the Board-regulated counterparty until the derivative outstanding disputes over margin that institution and is designated with a contracts are closed out and the lasted longer than the MPOR over the resulting market risk is re-hedged. previous two quarters, the applicable 30 In the case of a first-to-default credit derivative, (2) Notwithstanding paragraph floor is twice the amount provided in there are no underlying exposures that are subordinated to the Board-regulated institution’s (c)(9)(iv)(A)(1) of this section: (c)(9)(iv)(A)(1) and (2) of this section. exposure. In the case of a second-or-subsequent-to- (i) For a derivative contract that is not (B) The maturity factor of a derivative default credit derivative, the smallest (n¥1) notional amounts of the underlying exposures are a client-facing derivative transaction, contract that is not subject to a variation subordinated to the Board-regulated institution’s MPOR cannot be less than ten business margin agreement, or derivative exposure. days plus the periodicity of re- contracts under which the counterparty

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4425 Board-regulated institution may and at least one derivative contract that is not required to post variation margin, represent each payment option as a is not subject to such a variation margin is determined by the following formula: combination of effective single-payment agreement, the calculation for

options (such as interest rate caplets and replacement cost is provided under floorlets). paragraph (c)(6)(i) of this section, except (D) A Board-regulated institution may that the variation margin threshold Where M equals the greater of 10 not decompose linear derivative equals the sum of the variation margin business days and the remaining contracts (such as swaps) into thresholds of all variation margin maturity of the contract, as measured in components. agreements within the netting set and (10) business days. Multiple netting sets subject to a the minimum transfer amount equals —(i) (C) For purposes of paragraph single variation margin agreement the sum of the minimum transfer (c)(9)(iv) of this section, if a Board- Calculating replacement cost. amounts of all the variation margin regulated institution has elected Notwithstanding paragraph (c)(6) of this agreements within the netting set. pursuant to paragraph (c)(5)(v) of this section, a Board-regulated institution (ii) Calculating potential future section to treat a derivative contract that shall assign a single replacement cost to exposure. (A) To calculate potential is a cleared transaction that is not multiple netting sets that are subject to future exposure for a netting set subject subject to a variation margin agreement a single variation margin agreement to multiple variation margin agreements as one that is subject to a variation under which the counterparty must post under which the counterparty to each variation margin, calculated according margin agreement, the Board-regulated variation margin agreement must post institution must treat the derivative to the following formula: variation margin, or a netting set contract as subject to a variation margin Replacement Cost = max{SNSmax{VNS; composed of at least one derivative agreement with maturity factor as 0} ¥ max{CMA; 0}; 0} + contract subject to variation margin determined according to (c)(9)(iv)(A) of max{SNSmin{VNS; 0} ¥ min{CMA; agreement under which the this section, and daily settlement does 0}; 0} counterparty to the derivative contract not change the end date of the period Where: must post variation margin and at least referenced by the derivative contract. NS is each netting set subject to the variation one derivative contract that is not (v) Derivative contract as multiple margin agreement MA; subject to such a variation margin effective derivative contracts. A Board- VNS is the sum of the fair values (after agreement, a Board-regulated institution regulated institution must separate a excluding any valuation adjustments) of must divide the netting set into sub- derivative contract into separate the derivative contracts within the netting sets (as described in paragraph derivative contracts, according to the netting set NS; and (c)(11)(ii)(B) of this section) and CMA is the sum of the net independent calculate the aggregated amount for each following rules: collateral amount and the variation (A) For an option where the sub-netting set. The aggregated amount margin amount applicable to the for the netting set is calculated as the counterparty pays a predetermined derivative contracts within the netting amount if the value of the underlying sets subject to the single variation margin sum of the aggregated amounts for the asset is above or below the strike price agreement. sub-netting sets. The multiplier is calculated for the entire netting set. and nothing otherwise (binary option), (ii) Calculating potential future (B) For purposes of paragraph the option must be treated as two exposure. Notwithstanding paragraph (c)(11)(ii)(A) of this section, the netting separate options. For purposes of (c)(5) of this section, a Board-regulated set must be divided into sub-netting sets paragraph (c)(9)(iii)(B) of this section, a institution shall assign a single potential binary option with strike K must be future exposure to multiple netting sets as follows: represented as the combination of one that are subject to a single variation (1) All derivative contracts within the bought European option and one sold margin agreement under which the netting set that are not subject to a European option of the same type as the counterparty must post variation margin variation margin agreement or that are original option (put or call) with the equal to the sum of the potential future subject to a variation margin agreement strikes set equal to 0.95 * K and 1.05 * exposure of each such netting set, each under which the counterparty is not K so that the payoff of the binary option calculated according to paragraph (c)(7) required to post variation margin form is reproduced exactly outside the region of this section as if such nettings sets a single sub-netting set. The aggregated between the two strikes. The absolute were not subject to a variation margin amount for this sub-netting set is value of the sum of the adjusted agreement. calculated as if the netting set is not derivative contract amounts of the (11) Netting set subject to multiple subject to a variation margin agreement. bought and sold options is capped at the variation margin agreements or a hybrid (2) All derivative contracts within the payoff amount of the binary option. netting set—(i) Calculating replacement netting set that are subject to variation (B) For a derivative contract that can cost. To calculate replacement cost for margin agreements in which the be represented as a combination of either a netting set subject to multiple counterparty must post variation margin standard option payoffs (such as collar, variation margin agreements under and that share the same value of the butterfly spread, calendar spread, which the counterparty to each MPOR form a single sub-netting set. The straddle, and strangle), a Board- variation margin agreement must post aggregated amount for this sub-netting regulated institution must treat each variation margin, or a netting set set is calculated as if the netting set is standard option component as a composed of at least one derivative subject to a variation margin agreement, separate derivative contract. contract subject to variation margin using the MPOR value shared by the (C) For a derivative contract that agreement under which the derivative contracts within the netting includes multiple-payment options, counterparty must post variation margin set. (such as interest rate caps and floors), a

4426 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

TABLE 3 TO § 217.132—SUPERVISORY OPTION VOLATILITY, SUPERVISORY CORRELATION PARAMETERS, AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS

Supervisory Supervisory Supervisory option correlation 1 Asset class Category Type volatility factor factor (percent) (percent) (percent)

Interest rate ...... N/A ...... N/A ...... 50 N/A 0.50 Exchange rate ...... N/A ...... N/A ...... 15 N/A 4.0 Credit, single name ...... Investment grade ...... N/A ...... 100 50 0.46 Speculative grade ...... N/A ...... 100 50 1.3 Sub-speculative grade ...... N/A ...... 100 50 6.0 Credit, index ...... Investment Grade ...... N/A ...... 80 80 0.38 Speculative Grade ...... N/A ...... 80 80 1.06 Equity, single name ...... N/A ...... N/A ...... 120 50 32 Equity, index ...... N/A ...... N/A ...... 75 80 20 Commodity ...... Energy ...... Electricity ...... 150 40 40 Other ...... 70 40 18 Metals ...... N/A ...... 70 40 18 Agricultural ...... N/A ...... 70 40 18 Other ...... N/A ...... 70 40 18 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3.

(d) * * * calculation of CVA with the maturity (ii) A clearing member client Board- (10) * * * equal to the maximum of: regulated institution’s total risk- (i) With prior written approval of the (A) Half of the longest maturity of a weighted assets for cleared transactions Board, a Board-regulated institution transaction in the netting set; and is the sum of the risk-weighted asset may set EAD equal to a measure of (B) The notional weighted average amounts for all of its cleared counterparty credit risk exposure, such maturity of all transactions in the transactions. as peak EAD, that is more conservative netting set. (2) Trade exposure amount. (i) For a than an alpha of 1.4 times the larger of cleared transaction that is a derivative ■ 23. Section 217.133 is amended by EPEunstressed and EPEstressed for every contract or a netting set of derivative counterparty whose EAD will be revising paragraphs (a), (b)(1) through contracts, trade exposure amount equals measured under the alternative measure (3), (b)(4)(i), (c)(1) through (3), (c)(4)(i), the EAD for the derivative contract or of counterparty exposure. The Board- and (d) to read as follows: netting set of derivative contracts regulated institution must demonstrate § 217.133 Cleared transactions. calculated using the methodology used the conservatism of the measure of to calculate EAD for derivative contracts (a) —(1) counterparty credit risk exposure used General requirements set forth in § 217.132(c) or (d), plus the A Board- for EAD. With respect to paragraph Clearing member clients. fair value of the collateral posted by the (d)(10)(i) of this section: regulated institution that is a clearing clearing member client Board-regulated member client must use the (A) For material portfolios of new institution and held by the CCP or a methodologies described in paragraph OTC derivative products, the Board- clearing member in a manner that is not regulated institution may assume that (b) of this section to calculate risk- bankruptcy remote. When the Board- the standardized approach for weighted assets for a cleared regulated institution calculates EAD for counterparty credit risk pursuant to transaction. the cleared transaction using the paragraph (c) of this section meets the (2) Clearing members. A Board- methodology in § 217.132(d), EAD regulated institution that is a clearing conservatism requirement of this section equals EADunstressed. for a period not to exceed 180 days. member must use the methodologies (ii) For a cleared transaction that is a (B) For immaterial portfolios of OTC described in paragraph (c) of this repo-style transaction or netting set of derivative contracts, the Board-regulated section to calculate its risk-weighted repo-style transactions, trade exposure institution generally may assume that assets for a cleared transaction and amount equals the EAD for the repo- the standardized approach for paragraph (d) of this section to calculate style transaction calculated using the counterparty credit risk pursuant to its risk-weighted assets for its default methodology set forth in § 217.132(b)(2) paragraph (c) of this section meets the fund contribution to a CCP. or (3) or (d), plus the fair value of the conservatism requirement of this (b) * * * collateral posted by the clearing member section. (1) Risk-weighted assets for cleared client Board-regulated institution and * * * * * transactions. (i) To determine the risk- held by the CCP or a clearing member (e) * * * weighted asset amount for a cleared in a manner that is not bankruptcy (6) * * * transaction, a Board-regulated remote. When the Board-regulated (viii) If a Board-regulated institution institution that is a clearing member institution calculates EAD for the uses the standardized approach for client must multiply the trade exposure cleared transaction under § 217.132(d), counterparty credit risk pursuant to amount for the cleared transaction, EAD equals EADunstressed. paragraph (c) of this section to calculate calculated in accordance with paragraph (3) Cleared transaction risk weights. the EAD for any immaterial portfolios of (b)(2) of this section, by the risk weight (i) For a cleared transaction with a OTC derivative contracts, the Board- appropriate for the cleared transaction, QCCP, a clearing member client Board- regulated institution must use that EAD determined in accordance with regulated institution must apply a risk as a constant EE in the formula for the paragraph (b)(3) of this section. weight of:

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4427 (ii) A clearing member Board- offsets another transaction that satisfies (A) 2 percent if the collateral posted regulated institution’s total risk- the requirements set forth in § 217.3(a), by the Board-regulated institution to the weighted assets for cleared transactions and the clearing member Board- QCCP or clearing member is subject to is the sum of the risk-weighted asset regulated institution is not obligated to an arrangement that prevents any loss to amounts for all of its cleared reimburse the clearing member client in the clearing member client Board- transactions. the event of the QCCP default. regulated institution due to the joint (2) Trade exposure amount. A (4) * * * default or a concurrent insolvency, clearing member Board-regulated (i) Notwithstanding any other liquidation, or receivership proceeding institution must calculate its trade requirement of this section, collateral of the clearing member and any other exposure amount for a cleared posted by a clearing member Board- clearing member clients of the clearing transaction as follows: regulated institution that is held by a member; and the clearing member client (i) For a cleared transaction that is a custodian (in its capacity as a custodian) Board-regulated institution has derivative contract or a netting set of in a manner that is bankruptcy remote conducted sufficient legal review to derivative contracts, trade exposure from the CCP, clearing member, and conclude with a well-founded basis amount equals the EAD calculated using other clearing member clients of the (and maintains sufficient written the methodology used to calculate EAD clearing member, is not subject to a documentation of that legal review) that for derivative contracts set forth in capital requirement under this section. in the event of a legal challenge § 217.132(c) or (d), plus the fair value of * * * * * (including one resulting from an event the collateral posted by the clearing (d) —(1) of default or from liquidation, member Board-regulated institution and Default fund contributions insolvency, or receivership proceedings) held by the CCP in a manner that is not General requirement. A clearing the relevant court and administrative bankruptcy remote. When the clearing member Board-regulated institution authorities would find the arrangements member Board-regulated institution must determine the risk-weighted asset amount for a default fund contribution to be legal, valid, binding, and calculates EAD for the cleared to a CCP at least quarterly, or more enforceable under the law of the transaction using the methodology in frequently if, in the opinion of the relevant jurisdictions. § 217.132(d), EAD equals EAD . unstressed Board-regulated institution or the Board, (B) 4 percent, if the requirements of (ii) For a cleared transaction that is a paragraph (b)(3)(i)(A) of this section are repo-style transaction or netting set of there is a material change in the not met. repo-style transactions, trade exposure financial condition of the CCP. (ii) For a cleared transaction with a amount equals the EAD calculated (2) Risk-weighted asset amount for CCP that is not a QCCP, a clearing under § 217.132(b)(2) or (3) or (d), plus default fund contributions to member client Board-regulated the fair value of the collateral posted by nonqualifying CCPs. A clearing member institution must apply the risk weight the clearing member Board-regulated Board-regulated institution’s risk- applicable to the CCP under subpart D institution and held by the CCP in a weighted asset amount for default fund of this part. manner that is not bankruptcy remote. contributions to CCPs that are not (4) * * * When the clearing member Board- QCCPs equals the sum of such default (i) Notwithstanding any other regulated institution calculates EAD for fund contributions multiplied by 1,250 requirement of this section, collateral percent, or an amount determined by posted by a clearing member client the cleared transaction under § 217.132(d), EAD equals EAD . the Board, based on factors such as size, Board-regulated institution that is held unstressed (3) structure, and membership by a custodian (in its capacity as a Cleared transaction risk weights. (i) A clearing member Board-regulated characteristics of the CCP and riskiness custodian) in a manner that is institution must apply a risk weight of of its transactions, in cases where such bankruptcy remote from the CCP, 2 percent to the trade exposure amount default fund contributions may be clearing member, and other clearing for a cleared transaction with a QCCP. unlimited. member clients of the clearing member, (ii) For a cleared transaction with a (3) Risk-weighted asset amount for is not subject to a capital requirement CCP that is not a QCCP, a clearing default fund contributions to QCCPs. A under this section. member Board-regulated institution clearing member Board-regulated * * * * * must apply the risk weight applicable to institution’s risk-weighted asset amount (c) * * * the CCP according to subpart D of this for default fund contributions to QCCPs (1) Risk-weighted assets for cleared part. equals the sum of its capital (i) To determine the risk- transactions. (iii) Notwithstanding paragraphs requirement, KCM for each QCCP, as weighted asset amount for a cleared (c)(3)(i) and (ii) of this section, a calculated under the methodology set transaction, a clearing member Board- clearing member Board-regulated forth in paragraph (d)(4) of this section, regulated institution must multiply the institution may apply a risk weight of multiplied by 12.5. trade exposure amount for the cleared zero percent to the trade exposure (4) Capital requirement for default transaction, calculated in accordance amount for a cleared transaction with a fund contributions to a QCCP. A with paragraph (c)(2) of this section by QCCP where the clearing member clearing member Board-regulated the risk weight appropriate for the Board-regulated institution is acting as a institution’s capital requirement for its cleared transaction, determined in financial intermediary on behalf of a default fund contribution to a QCCP accordance with paragraph (c)(3) of this clearing member client, the transaction (KCM) is equal to: section.

4428 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations provided to the CCP with respect to collateral are held in the same default Where: performance of a clearing member client fund contribution account, then the KCCP is the hypothetical capital requirement on a derivative contract, the EAD is EAD of that account is the sum of the of the QCCP, as determined under paragraph (d)(5) of this section; equal to the exposure amount for all EAD for the client-related transactions DFpref is the prefunded default fund such derivative contracts and guarantees within the account and the EAD of the contribution of the clearing member of derivative contracts calculated under house-related transactions within the Board-regulated institution to the QCCP; SA–CCR in § 217.132(c) (or, with account. For purposes of determining DFCCP is the QCCP’s own prefunded amounts respect to a CCP located outside the such EADs, the independent collateral that are contributed to the default United States, under a substantially of the clearing member and its client waterfall and are junior or pari passu identical methodology in effect in the must be allocated in proportion to the with prefunded default fund contributions of clearing members of the jurisdiction) using a value of 10 respective total amount of independent CCP; and business days for purposes of collateral posted by the clearing member pref DFCM is the total prefunded default fund § 217.132(c)(9)(iv); less the value of all to the QCCP. contributions from clearing members of collateral held by the CCP posted by the (v) If any account or sub-account the QCCP to the QCCP. clearing member Board-regulated contains both derivative contracts and (5) Hypothetical capital requirement institution or a clearing member client repo-style transactions, the EAD of that of a QCCP. Where a QCCP has provided of the Board-regulated institution in account is the sum of the EAD for the its KCCP, a Board-regulated institution connection with a derivative contract derivative contracts within the account must rely on such disclosed figure for which the Board-regulated and the EAD of the repo-style instead of calculating KCCP under this institution has provided a guarantee to transactions within the account. If paragraph (d)(5), unless the Board- the CCP and the amount of the independent collateral is held for an regulated institution determines that a prefunded default fund contribution of account containing both derivative more conservative figure is appropriate the Board-regulated institution to the contracts and repo-style transactions, based on the nature, structure, or CCP. then such collateral must be allocated to characteristics of the QCCP. The (iii) With respect to any repo-style the derivative contracts and repo-style hypothetical capital requirement of a transactions between the Board- transactions in proportion to the QCCP (KCCP), as determined by the regulated institution and the CCP that respective product specific exposure Board-regulated institution, is equal to: are cleared transactions, EAD is equal amounts, calculated, excluding the to: KCCP = SCMi EADi * 1.6 percent effects of collateral, according to Where: EAD = max{EBRM¥IM¥DF; 0} § 217.132(b) for repo-style transactions and to § 217.132(c)(5) for derivative CMi is each clearing member of the QCCP; Where: and EBRM is the sum of the exposure amounts of contracts. EADi is the exposure amount of each clearing each repo-style transaction between the (vi) Notwithstanding any other member of the QCCP to the QCCP, as Board-regulated institution and the CCP provision of paragraph (d) of this determined under paragraph (d)(6) of as determined under § 217.132(b)(2) and this section. section, with the prior approval of the without recognition of any collateral Board, a Board-regulated institution (6) EAD of a clearing member Board- securing the repo-style transactions; is the initial margin collateral posted by may determine the risk-weighted asset regulated institution to a QCCP. (i) The IM the Board-regulated institution to the amount for a default fund contribution EAD of a clearing member Board- CCP with respect to the repo-style to a QCCP according to regulated institution to a QCCP is equal transactions; and § 217.35(d)(3)(ii). to the sum of the EAD for derivative DF is the prefunded default fund contracts determined under paragraph contribution of the Board-regulated ■ 24. Section 217.173 is amended in (d)(6)(ii) of this section and the EAD for institution to the CCP that is not already Table 13 to § 217.173 by revising line 4 repo-style transactions determined deducted in § 217.133(d)(6)(ii). under Part 2, Derivative exposures, to read as follows: under paragraph (d)(6)(iii) of this (iv) EAD must be calculated section. separately for each clearing member’s § 217.173 Disclosures by certain advanced (ii) With respect to any derivative sub-client accounts and sub-house contracts between the Board-regulated approaches Board-regulated institutions account (i.e., for the clearing member’s and Category III Board-regulated institution and the CCP that are cleared proprietary activities). If the clearing institutions. transactions and any guarantees that the member’s collateral and its client’s * * * * * Board-regulated institution has

TABLE 13 TO § 217.173—SUPPLEMENTARY LEVERAGE RATIO

Dollar amounts in thousands

Tril Bil Mil Thou

* * * * * * *

Part 2: Supplementary leverage ratio

* * * * * * *

Derivative exposures

* * * * * * * 4 Current exposure for derivative exposures (that is, net of cash variation margin).

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4429

TABLE 13 TO § 217.173—SUPPLEMENTARY LEVERAGE RATIO—Continued

Dollar amounts in thousands

Tril Bil Mil Thou

* * * * * * *

■ 25. Section 217.300 is amended by ■ 27. Section 324.2 is amended by: (ii)(A) Is not an entity described in adding paragraph (h) and (i) to read as ■ a. Adding the definitions of ‘‘Basis section 2(h)(7)(C)(i)(I) through (VIII) of follows: derivative contract,’’ ‘‘Client-facing the Commodity Exchange Act (7 U.S.C. derivative transaction,’’ and 2(h)(7)(C)(i)(I) through (VIII)); or § 217.300 Transitions. ‘‘Commercial end-user’’ in alphabetical (B) Is not a ‘‘financial entity’’ for * * * * * order; purposes of section 2(h)(7) of the (h) SA–CCR. An advanced approaches ■ b. Revising the definition of ‘‘Current Commodity Exchange Act (7 U.S.C. Board-regulated institution may use exposure’’ and ‘‘Current exposure 2(h)) by virtue of section 2(h)(7)(C)(iii) CEM rather than SA–CCR for purposes methodology;’’ of the Act (7 U.S.C. 2(h)(7)(C)(iii)); or of §§ 217.34(a) and 217.132(c) until ■ c. Revising paragraph (2) of the (2)(i) Is using derivative contracts to hedge or mitigate commercial risk; and January 1, 2022. A Board-regulated definition of ‘‘Financial collateral;’’ (ii) Is not an entity described in institution must provide prior notice to ■ d. Adding the definitions of section 3C(g)(3)(A)(i) through (viii) of the Board if it decides to begin using SA– ‘‘Independent collateral,’’ ‘‘Minimum the Securities Exchange Act of 1934 (15 CCR before January 1, 2022. On January transfer amount,’’ and ‘‘Net independent U.S.C. 78c–3(g)(3)(A)(i) through (viii)); 1, 2022, and thereafter, an advanced collateral amount’’ in alphabetical or approaches Board-regulated institution order; must use SA–CCR for purposes of §§ (3) Qualifies for the exemption in ■ e. Revising the definition of ‘‘Netting 217.34(a), 217.132(c), and 217.135(d). section 2(h)(7)(A) of the Commodity set;’’ and Once an advanced approaches Board- Exchange Act (7 U.S.C. 2(h)(7)(A)) by ■ f. Adding the definitions of regulated institution has begun to use virtue of section 2(h)(7)(D) of the Act (7 ‘‘Speculative grade,’’ ‘‘Sub-speculative SA–CCR, the advanced approaches U.S.C. 2(h)(7)(D)); or grade,’’ ‘‘Variation margin,’’ ‘‘Variation Board-regulated institution may not (4) Qualifies for an exemption in change to use CEM. margin agreement,’’ ‘‘Variation margin section 3C(g)(1) of the Securities amount,’’ ‘‘Variation margin threshold,’’ (i) Default fund contributions. Prior to Exchange Act of 1934 (15 U.S.C. 78c– and ‘‘Volatility derivative contract’’ in 3(g)(1)) by virtue of section 3C(g)(4) of January 1, 2022, a Board-regulated alphabetical order. institution that calculates the exposure the Act (15 U.S.C. 78c–3(g)(4)). The additions and revisions read as * * * * * amounts of its derivative contracts follows: under the standardized approach for Current exposure means, with respect counterparty credit risk in § 217.132(c) § 324.2 Definitions. to a netting set, the larger of zero or the fair value of a transaction or portfolio of may calculate the risk-weighted asset * * * * * transactions within the netting set that amount for a default fund contribution means a non- Basis derivative contract would be lost upon default of the to a QCCP under either method 1 under foreign-exchange derivative contract § 217.35(d)(3)(i) or method 2 under counterparty, assuming no recovery on (i.e., the contract is denominated in a the value of the transactions. § 217.35(d)(3)(ii), rather than under single currency) in which the cash flows § 217.133(d). Current exposure methodology means of the derivative contract depend on the the method of calculating the exposure FEDERAL DEPOSIT INSURANCE difference between two risk factors that amount for over-the-counter derivative CORPORATION are attributable solely to one of the contracts in § 324.34(b). following derivative asset classes: * * * * * For the reasons forth out in the Interest rate, credit, equity, or Financial collateral * * * preamble, 12 CFR parts 324 and 327 are commodity. amended as set forth below. (2) In which the FDIC-supervised * * * * * institution has a perfected, first-priority PART 324—CAPITAL ADEQUACY OF Client-facing derivative transaction security interest or, outside of the FDIC-SUPERVISED INSTITUTIONS means a derivative contract that is not United States, the legal equivalent a cleared transaction where the FDIC- thereof (with the exception of cash on ■ 26. The authority citation for part 324 supervised institution is either acting as deposit; and notwithstanding the prior continues to read as follows: a financial intermediary and enters into security interest of any custodial agent an offsetting transaction with a Authority: 12 U.S.C. 1815(a), 1815(b), or any priority security interest granted 1816, 1818(a), 1818(b), 1818(c), 1818(t), qualifying central counterparty (QCCP) to a CCP in connection with collateral 1819(Tenth), 1828(c), 1828(d), 1828(i), or where the FDIC-supervised posted to that CCP). 1828(n), 1828(o), 1831o, 1835, 3907, 3909, institution provides a guarantee to the * * * * * 4808; 5371; 5412; Pub. L. 102–233, 105 Stat. QCCP on the performance of a client on Independent collateral means 1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. a transaction between the client and a financial collateral, other than variation L. 102–242, 105 Stat. 2236, 2355, as amended QCCP. by Pub. L. 103–325, 108 Stat. 2160, 2233 (12 margin, that is subject to a collateral * * * * * U.S.C. 1828 note); Pub. L. 102–242, 105 Stat. agreement, or in which a FDIC- 2236, 2386, as amended by Pub. L. 102–550, Commercial end-user means an entity supervised institution has a perfected, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note); that: first-priority security interest or, outside Pub. L. 111–203, 124 Stat. 1376, 1887 (15 (1)(i) Is using derivative contracts to of the United States, the legal equivalent U.S.C. 78o–7 note). hedge or mitigate commercial risk; and thereof (with the exception of cash on

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4431 deteriorate the reference entity likely sold or re-hypothecated the securities deposit; notwithstanding the prior would default on its financial received, and, for a FDIC-supervised security interest of any custodial agent commitments. institution that uses the standardized or any prior security interest granted to * * * * * approach for counterparty credit risk a CCP in connection with collateral means financial under § 324.132(c) for its standardized posted to that CCP), and the amount of Variation margin collateral that is subject to a collateral risk-weighted assets, less the fair value which does not change directly in agreement provided by one party to its of any derivative contracts; response to the value of the derivative counterparty to meet the performance of (B)(1) For a FDIC-supervised contract or contracts that the financial the first party’s obligations under one or institution that uses the current collateral secures. more transactions between the parties as exposure methodology under * * * * * a result of a change in value of such § 324.34(b) for its standardized risk- Minimum transfer amount means the obligations since the last time such weighted assets, the potential future smallest amount of variation margin that financial collateral was provided. credit exposure (PFE) for each may be transferred between Variation margin agreement means an derivative contract or each single- counterparties to a netting set pursuant agreement to collect or post variation product netting set of derivative to the variation margin agreement. margin. contracts (including a cleared * * * * * Variation margin amount means the transaction except as provided in Net independent collateral amount fair value amount of the variation paragraph (c)(4)(ii)(I) of this section and, means the fair value amount of the margin, as adjusted by the standard at the discretion of the FDIC-supervised independent collateral, as adjusted by supervisory haircuts under institution, excluding a forward the standard supervisory haircuts under § 324.132(b)(2)(ii), as applicable, that a agreement treated as a derivative § 324.132(b)(2)(ii), as applicable, that a counterparty to a netting set has posted contract that is part of a repurchase or counterparty to a netting set has posted to a FDIC-supervised institution less the reverse repurchase or a securities to a FDIC-supervised institution less the fair value amount of the variation borrowing or lending transaction that fair value amount of the independent margin, as adjusted by the standard qualifies for sales treatment under U.S. collateral, as adjusted by the standard supervisory haircuts under GAAP), to which the FDIC-supervised supervisory haircuts under § 324.132(b)(2)(ii), as applicable, posted institution is a counterparty as § 324.132(b)(2)(ii), as applicable, posted by the FDIC-supervised institution to determined under § 324.34, but without by the FDIC-supervised institution to the counterparty. regard to § 324.34(b), provided that: the counterparty, excluding such Variation margin threshold means the (i) A FDIC-supervised institution may amounts held in a bankruptcy remote amount of credit exposure of a FDIC- choose to exclude the PFE of all credit manner or posted to a QCCP and held supervised institution to its derivatives or other similar instruments in conformance with the operational counterparty that, if exceeded, would through which it provides credit requirements in § 324.3. require the counterparty to post protection when calculating the PFE Netting set means a group of variation margin to the FDIC-supervised under § 324.34, but without regard to transactions with a single counterparty institution pursuant to the variation § 324.34(b), provided that it does not that are subject to a qualifying master margin agreement. adjust the net-to-gross ratio (NGR); and netting agreement. For derivative Volatility derivative contract means a (ii) A FDIC-supervised institution that contracts, netting set also includes a derivative contract in which the payoff chooses to exclude the PFE of credit single derivative contract between a of the derivative contract explicitly derivatives or other similar instruments FDIC-supervised institution and a single depends on a measure of the volatility through which it provides credit counterparty. For purposes of the of an underlying risk factor to the protection pursuant to paragraph internal model methodology under derivative contract. (c)(4)(ii)(B)(1) of this section must do so § 324.132(d), netting set also includes a * * * * * consistently over time for the group of transactions with a single calculation of the PFE for all such counterparty that are subject to a ■ 28. Section 324.10 is amended by revising paragraphs (c)(4)(ii)(A) through instruments; or qualifying cross-product master netting ( )( ) For a FDIC-supervised (C) to read as follows: 2 i agreement and does not include a institution that uses the standardized transaction: § 324.10 Minimum capital requirements. approach for counterparty credit risk (1) That is not subject to such a master * * * * * under section § 324.132(c) for its netting agreement; or (c) * * * standardized risk-weighted assets, the (2) Where the FDIC-supervised (4) * * * PFE for each netting set to which the institution has identified specific (ii) * * * FDIC-supervised institution is a wrong-way risk. (A) The balance sheet carrying value counterparty (including cleared * * * * * of all of the FDIC-supervised transactions except as provided in Speculative grade means the reference institution’s on-balance sheet assets, paragraph (c)(4)(ii)(I) of this section and, entity has adequate capacity to meet plus the value of securities sold under at the discretion of the FDIC-supervised financial commitments in the near term, a repurchase transaction or a securities institution, excluding a forward but is vulnerable to adverse economic lending transaction that qualifies for agreement treated as a derivative conditions, such that should economic sales treatment under U.S. GAAP, less contract that is part of a repurchase or conditions deteriorate, the reference amounts deducted from tier 1 capital reverse repurchase or a securities entity would present an elevated default under § 324.22(a), (c), and (d), and less borrowing or lending transaction that risk. the value of securities received in qualifies for sales treatment under U.S. * * * * * security-for-security repo-style GAAP), as determined under Sub-speculative grade means the transactions, where the FDIC-supervised § 324.132(c)(7), in which the term C in reference entity depends on favorable institution acts as a securities lender § 324.132(c)(7)(i) equals zero except as economic conditions to meet its and includes the securities received in provided in paragraph (c)(4)(ii)(B)(2)(ii) financial commitments, such that its on-balance sheet assets but has not of this section, and, for any counterparty should such economic conditions

4430 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations derivative contract and that satisfies the support annex to the qualifying master that is not a commercial end-user, conditions in paragraphs (c)(4)(ii)(C)(3) netting agreement, or in the governing multiplied by 1.4; and through (7) of this section, or, in the case rules for a cleared transaction; and ( ) For purposes of paragraph of a client-facing derivative transaction ii (7) The derivative contract and the (c)(4)(ii)(B)(2)(i) of this section, a FDIC- on behalf of a clearing member client, variation margin are governed by a supervised institution may set the value the amount of collateral received from the clearing member client; and qualifying master netting agreement of the term C in § 324.132(c)(7)(i) equal between the legal entities that are the CVMp equals the amount of cash collateral to the amount of collateral posted by a counterparties to the derivative contract clearing member client of the FDIC- that is posted to a counterparty to a derivative contract and that has not or by the governing rules for a cleared supervised institution in connection offset the fair value of the derivative transaction, and the qualifying master with the client-facing derivative contract and that satisfies the conditions netting agreement or the governing rules transactions within the netting set; in paragraphs (c)(4)(ii)(C)(3) through (7) for a cleared transaction must explicitly (C)(1)(i) For a FDIC-supervised of this section, or, in the case of a client- stipulate that the counterparties agree to institution that uses the current facing derivative transaction on behalf of settle any payment obligations on a net a clearing member client, the amount of exposure methodology under basis, taking into account any variation § 324.34(b) for its standardized risk- collateral posted to the clearing member client; margin received or provided under the weighted assets, the amount of cash contract if a credit event involving collateral that is received from a (ii) Notwithstanding paragraph either counterparty occurs; counterparty to a derivative contract (c)(4)(ii)(C)(2)(i) of this section, where and that has offset the mark-to-fair value multiple netting sets are subject to a * * * * * of the derivative asset, or cash collateral single variation margin agreement, a ■ 29. Section 324.32 is amended by that is posted to a counterparty to a FDIC-supervised institution must apply revising paragraph (f) to read as follows: derivative contract and that has reduced the formula for replacement cost the FDIC-supervised institution’s on- provided in § 324.132(c)(10)(i), in which § 324.32 General risk weights. * * * * * balance sheet assets, unless such cash the term CMA may only include cash collateral is all or part of variation collateral that satisfies the conditions in (f) Corporate exposures. (1) A FDIC- margin that satisfies the conditions in paragraphs (c)(4)(ii)(C)(3) through (7) of supervised institution must assign a 100 paragraphs (c)(4)(ii)(C)(3) through (7) of this section; and percent risk weight to all its corporate exposures, except as provided in this section; and (iii) For purposes of paragraph (ii) The variation margin is used to (c)(4)(ii)(C)(2)(i), a FDIC-supervised paragraph (f)(2) of this section. reduce the current credit exposure of institution must treat a derivative (2) A FDIC-supervised institution the derivative contract, calculated as contract that references an index as if it must assign a 2 percent risk weight to described in § 324.34(b), and not the were multiple derivative contracts each an exposure to a QCCP arising from the PFE; and referencing one component of the index FDIC-supervised institution posting (iii) For the purpose of the calculation if the FDIC-supervised institution cash collateral to the QCCP in of the NGR described in elected to treat the derivative contract as connection with a cleared transaction § 324.34(b)(2)(ii)(B), variation margin multiple derivative contracts under that meets the requirements of described in paragraph (c)(4)(ii)(C)(1)(ii) § 324.132(c)(5)(vi); § 324.35(b)(3)(i)(A) and a 4 percent risk of this section may not reduce the net (3) For derivative contracts that are weight to an exposure to a QCCP arising current credit exposure or the gross not cleared through a QCCP, the cash from the FDIC-supervised institution current credit exposure; or collateral received by the recipient posting cash collateral to the QCCP in (2)(i) For a FDIC-supervised counterparty is not segregated (by law, connection with a cleared transaction institution that uses the standardized regulation, or an agreement with the that meets the requirements of approach for counterparty credit risk counterparty); § 324.35(b)(3)(i)(B). under § 324.132(c) for its standardized (4) Variation margin is calculated and (3) A FDIC-supervised institution risk-weighted assets, the replacement transferred on a daily basis based on the must assign a 2 percent risk weight to cost of each derivative contract or single mark-to-fair value of the derivative an exposure to a QCCP arising from the product netting set of derivative contract; FDIC-supervised institution posting contracts to which the FDIC-supervised (5) The variation margin transferred cash collateral to the QCCP in institution is a counterparty, calculated under the derivative contract or the connection with a cleared transaction according to the following formula, and, governing rules of the CCP or QCCP for that meets the requirements of for any counterparty that is not a a cleared transaction is the full amount § 324.35(c)(3)(i). commercial end-user, multiplied by 1.4: that is necessary to fully extinguish the * * * * * Replacement Cost = max{V¥CVMr + net current credit exposure to the ■ 30. Section 324.34 is revised to read CVMp; 0} counterparty of the derivative contracts, as follows: Where: subject to the threshold and minimum transfer amounts applicable to the § 324.34 Derivative contracts. V equals the fair value for each derivative contract or each single-product netting counterparty under the terms of the (a) Exposure amount for derivative set of derivative contracts (including a derivative contract or the governing contracts—(1) FDIC-supervised cleared transaction except as provided in rules for a cleared transaction; institution that is not an advanced paragraph (c)(4)(ii)(I) of this section and, (6) The variation margin is in the form approaches FDIC-supervised institution. at the discretion of the FDIC-supervised of cash in the same currency as the (i) A FDIC-supervised institution that is institution, excluding a forward currency of settlement set forth in the not an advanced approaches FDIC- agreement treated as a derivative derivative contract, provided that for the contract that is part of a repurchase or supervised institution must use the reverse repurchase or a securities purposes of this paragraph current exposure methodology (CEM) borrowing or lending transaction that (c)(4)(ii)(C)(6), currency of settlement described in paragraph (b) of this qualifies for sales treatment under U.S. means any currency for settlement section to calculate the exposure GAAP); specified in the governing qualifying amount for all its OTC derivative CVMr equals the amount of cash collateral master netting agreement and the credit contracts, unless the FDIC-supervised received from a counterparty to a

4432 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations approaches FDIC-supervised institution derivative contract by the appropriate institution makes the election provided must calculate the exposure amount for conversion factor in Table 1 to this in paragraph (a)(1)(ii) of this section. all its derivative contracts using SA– section. (ii) A FDIC-supervised institution that CCR in § 324.132(c) for purposes of (B) For purposes of calculating either is not an advanced approaches FDIC- standardized total risk-weighted assets. the PFE under this paragraph (b)(1)(ii) supervised institution may elect to An advanced approaches FDIC- calculate the exposure amount for all its supervised institution must apply the or the gross PFE under paragraph OTC derivative contracts under the treatment of cleared transactions under (b)(2)(ii)(A) of this section for exchange standardized approach for counterparty § 324.133 to its derivative contracts that rate contracts and other similar credit risk (SA–CCR) in § 324.132(c) by are cleared transactions and to all contracts in which the notional notifying the FDIC, rather than default fund contributions associated principal amount is equivalent to the calculating the exposure amount for all with such derivative contracts for cash flows, notional principal amount is its derivative contracts using CEM. A purposes of standardized total risk- the net receipts to each party falling due FDIC-supervised institution that elects weighted assets. on each value date in each currency. under this paragraph (a)(1)(ii) to (b) Current exposure methodology (C) For an OTC derivative contract calculate the exposure amount for its exposure amount—(1) Single OTC OTC derivative contracts under SA–CCR that does not fall within one of the derivative contract. Except as modified specified categories in Table 1 to this must apply the treatment of cleared by paragraph (c) of this section, the section, the PFE must be calculated transactions under § 324.133 to its exposure amount for a single OTC using the appropriate ‘‘other’’ derivative contracts that are cleared derivative contract that is not subject to transactions and to all default fund a qualifying master netting agreement is conversion factor. contributions associated with such equal to the sum of the FDIC-supervised (D) A FDIC-supervised institution derivative contracts, rather than institution’s current credit exposure and must use an OTC derivative contract’s applying § 324.35. A FDIC-supervised potential future credit exposure (PFE) effective notional principal amount (that institution that is not an advanced on the OTC derivative contract. is, the apparent or stated notional approaches FDIC-supervised institution (i) Current credit exposure. The principal amount multiplied by any must use the same methodology to current credit exposure for a single OTC multiplier in the OTC derivative calculate the exposure amount for all its derivative contract is the greater of the contract) rather than the apparent or derivative contracts and, if a FDIC- fair value of the OTC derivative contract supervised institution has elected to use stated notional principal amount in or zero. calculating PFE. SA–CCR under this paragraph (a)(1)(ii), (ii) PFE. (A) The PFE for a single OTC the FDIC-supervised institution may derivative contract, including an OTC (E) The PFE of the protection provider change its election only with prior derivative contract with a negative fair of a credit derivative is capped at the approval of the FDIC. value, is calculated by multiplying the net present value of the amount of (2) Advanced approaches FDIC- notional principal amount of the OTC unpaid premiums. supervised institution. An advanced

TABLE 1 TO § 324.34—CONVERSION FACTOR MATRIX FOR DERIVATIVE CONTRACTS 1

Credit Credit (non- Foreign (investment investment- Precious Remaining maturity 2 Interest rate exchange grade Equity metals Other rate and gold reference grade (except gold) 3 reference asset) asset)

One year or less ...... 0.00 0.01 0.05 0.10 0.06 0.07 0.10 Greater than one year and less than or equal to five years ...... 0.005 0.05 0.05 0.10 0.08 0.07 0.12 Greater than five years ...... 0.015 0.075 0.05 0.10 0.10 0.08 0.15 1 For a derivative contract with multiple exchanges of principal, the conversion factor is multiplied by the number of remaining payments in the derivative contract. 2 For an OTC derivative contract that is structured such that on specified dates any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity equals the time until the next reset date. For an interest rate derivative contract with a remaining maturity of greater than one year that meets these criteria, the minimum conversion factor is 0.005. 3 A FDIC-supervised institution must use the column labeled ‘‘Credit (investment-grade reference asset)’’ for a credit derivative whose reference asset is an out- standing unsecured long-term debt security without credit enhancement that is investment grade. A FDIC-supervised institution must use the column labeled ‘‘Credit (non- investment-grade reference asset)’’ for all other credit derivatives.

(2) Multiple OTC derivative contracts negative fair values of the individual to the gross current credit exposure. In subject to a qualifying master netting OTC derivative contracts subject to the calculating the NGR, the gross current agreement. Except as modified by qualifying master netting agreement or credit exposure equals the sum of the paragraph (c) of this section, the zero. positive current credit exposures (as exposure amount for multiple OTC (ii) Adjusted sum of the PFE amounts. determined under paragraph (b)(1)(i) of derivative contracts subject to a The adjusted sum of the PFE amounts, this section) of all individual derivative qualifying master netting agreement is Anet, is calculated as Anet = (0.4 × contracts subject to the qualifying equal to the sum of the net current Agross) + (0.6 × NGR × Agross), where: master netting agreement. credit exposure and the adjusted sum of (A) Agross = the gross PFE (that is, the sum of the PFE amounts as determined (c) Recognition of credit risk the PFE amounts for all OTC derivative under paragraph (b)(1)(ii) of this section mitigation of collateralized OTC contracts subject to the qualifying for each individual derivative contract derivative contracts. (1) A FDIC- master netting agreement. subject to the qualifying master netting supervised institution using CEM under (i) Net current credit exposure. The agreement); and paragraph (b) of this section may net current credit exposure is the greater (B) Net-to-gross Ratio (NGR) = the recognize the credit risk mitigation of the net sum of all positive and ratio of the net current credit exposure benefits of financial collateral that

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4433 institution is treating the credit that a longer period is appropriate due secures an OTC derivative contract or derivative as a covered position under to the nature, structure, or multiple OTC derivative contracts subpart F of this part, in which case the characteristics of the transaction or is subject to a qualifying master netting FDIC-supervised institution must commensurate with the risks associated agreement (netting set) by using the compute a supplemental counterparty with the transaction. simple approach in § 324.37(b). credit risk capital requirement under (2) As an alternative to the simple ■ 31. Section 324.35 is amended by this section. approach, a FDIC-supervised institution adding paragraph (a)(3), revising (e) using CEM under paragraph (b) of this Counterparty credit risk for equity paragraph (b)(4)(i), and adding (1) A FDIC-supervised section may recognize the credit risk derivatives. paragraph (c)(3)(iii) to read as follows: institution must treat an equity mitigation benefits of financial collateral derivative contract as an equity § 324.35 Cleared transactions. that secures such a contract or netting exposure and compute a risk-weighted (a) * * * set if the financial collateral is marked- asset amount for the equity derivative (3) to-fair value on a daily basis and subject Alternate requirements. contract under §§ 324.51 through 324.53 Notwithstanding any other provision of to a daily margin maintenance this section, an advanced approaches requirement by applying a risk weight to (unless the FDIC-supervised institution FDIC-supervised institution or a FDIC- the uncollateralized portion of the is treating the contract as a covered supervised institution that is not an exposure, after adjusting the exposure position under subpart F of this part). (2) In addition, the FDIC-supervised advanced approaches FDIC-supervised amount calculated under paragraph institution must also calculate a risk- institution and that has elected to use (b)(1) or (2) of this section using the based capital requirement for the SA–CCR under § 324.34(a)(1) must collateral haircut approach in counterparty credit risk of an equity apply § 324.133 to its derivative § 324.37(c). The FDIC-supervised contracts that are cleared transactions institution must substitute the exposure derivative contract under this section if rather than this section. amount calculated under paragraph the FDIC-supervised institution is treating the contract as a covered (b) * * * (b)(1) or (2) of this section for SE in the (4) * * * equation in § 324.37(c)(2). position under subpart F of this part. (3) If the FDIC-supervised institution (i) Notwithstanding any other (d) Counterparty credit risk for credit risk weights the contract under the requirements in this section, collateral derivatives—(1) Protection purchasers. A FDIC-supervised institution that Simple Risk-Weight Approach (SRWA) posted by a clearing member client purchases a credit derivative that is in § 324.52, the FDIC-supervised FDIC-supervised institution that is held recognized under § 324.36 as a credit institution may choose not to hold risk- by a custodian (in its capacity as risk mitigant for an exposure that is not based capital against the counterparty custodian) in a manner that is a covered position under subpart F of credit risk of the equity derivative bankruptcy remote from the CCP, this part is not required to compute a contract, as long as it does so for all clearing member, and other clearing separate counterparty credit risk capital such contracts. Where the equity member clients of the clearing member, requirement under this subpart derivative contracts are subject to a is not subject to a capital requirement provided that the FDIC-supervised qualified master netting agreement, a under this section. institution does so consistently for all FDIC-supervised institution using the * * * * * such credit derivatives. The FDIC- SRWA must either include all or (c) * * * supervised institution must either exclude all of the contracts from any (3) * * * include all or exclude all such credit measure used to determine counterparty (iii) Notwithstanding paragraphs derivatives that are subject to a credit risk exposure. (c)(3)(i) and (ii) of this section, a qualifying master netting agreement (f) Clearing member FDIC-supervised clearing member FDIC-supervised from any measure used to determine institution’s exposure amount. The institution may apply a risk weight of counterparty credit risk exposure to all exposure amount of a clearing member zero percent to the trade exposure relevant counterparties for risk-based FDIC-supervised institution using CEM amount for a cleared transaction with a capital purposes. under paragraph (b) of this section for CCP where the clearing member FDIC- (2) Protection providers. (i) A FDIC- a client-facing derivative transaction or supervised institution is acting as a supervised institution that is the netting set of client-facing derivative financial intermediary on behalf of a protection provider under a credit transactions equals the exposure clearing member client, the transaction derivative must treat the credit amount calculated according to offsets another transaction that satisfies derivative as an exposure to the paragraph (b)(1) or (2) of this section the requirements set forth in § 324.3(a), underlying reference asset. The FDIC- multiplied by the scaling factor the and the clearing member FDIC- 1 supervised institution is not required to square root of 2 (which equals supervised institution is not obligated to compute a counterparty credit risk 0.707107). If the FDIC-supervised reimburse the clearing member client in capital requirement for the credit institution determines⁄ that a longer the event of the CCP default. period is appropriate, the FDIC- derivative under this subpart, provided * * * * * that this treatment is applied supervised institution must use a larger scaling factor to adjust for a longer ■ 32. Section 324.37 is amended by consistently for all such credit revising paragraphs (c)(3)(iii), derivatives. The FDIC-supervised holding period as follows: (c)(3)(iv)(A) and (C), (c)(4)(i)(B) institution must either include all or introductory text, and (c)(4)(i)(B)(1) to exclude all such credit derivatives that read as follows: are subject to a qualifying master netting agreement from any measure used to § 324.37 Collateralized transactions. determine counterparty credit risk Where H = the holding period greater * * * * * exposure. than or equal to five days. Additionally, (c) * * * (ii) The provisions of this paragraph the FDIC may require the FDIC- (3) * * * (d)(2) apply to all relevant supervised institution to set a longer (iii) For repo-style transactions and counterparties for risk-based capital holding period if the FDIC determines client-facing derivative transactions, a purposes unless the FDIC-supervised

4434 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations derivative transactions or 5 business using the following square root of time FDIC-supervised institution may days for repo-style transactions and formula: multiply the standard supervisory client-facing derivative transactions. haircuts provided in paragraphs (c)(3)(i) * * * * * * * * * * and (ii) of this section by the square root (1) TM equals 5 for repo-style 1 (4) * * * of 2 (which equals 0.707107). For (i) * * * transactions and client-facing derivative client-facing derivative transactions, if a (B) The minimum holding period for transactions and 10 for eligible margin larger⁄ scaling factor is applied under a repo-style transaction and client- loans and derivative contracts other § 324.34(f), the same factor must be used facing derivative transaction is five than client-facing derivative to adjust the supervisory haircuts. business days and for an eligible margin transactions; (iv) * * * loan and a derivative contract other than * * * * * (A) TM equals a holding period of a client-facing derivative transaction is longer than 10 business days for eligible ten business days except for §§ 324.134, 324.202, and 324.210 margin loans and derivative contracts transactions or netting sets for which [Amended] other than client-facing derivative paragraph (c)(4)(i)(C) of this section transactions or longer than 5 business applies. When a FDIC-supervised ■ 33. For each section listed in the days for repo-style transactions and institution calculates an own-estimates following table, the footnote number client-facing derivative transactions; haircut on a TN-day holding period, listed in the ‘‘Old footnote number’’ * * * * * which is different from the minimum column is redesignated as the footnote (C) TS equals 10 business days for holding period for the transaction type, number listed in the ‘‘New footnote eligible margin loans and derivative the applicable haircut (HM) is calculated number’’ column as follows: contracts other than client-facing

Old footnote New footnote Section number number

324.134(d)(3) ...... 30 31 324.202, paragraph (1) introductory text of the definition of ‘‘Covered position’’ ...... 31 32 324.202, paragraph (1)(i) of the definition of ‘‘Covered position’’ ...... 32 33 324.210(e)(1) ...... 33 34

■ 34. Section 324.132 is amended by: provided in paragraphs (b)(2)(ii)(A)(1) period, then the FDIC-supervised ■ a. Revising paragraphs (b)(2)(ii)(A)(3) and (2) of this section by the square root institution must adjust the supervisory through (5); of 1 2 (which equals 0.707107). If the haircuts upward for that netting set on ■ b. Adding paragraphs (b)(2)(ii)(A)(6) FDIC-supervised institution determines the basis of a minimum holding period and (7); that⁄ a longer holding period is that is at least two times the minimum ■ c. Revising paragraphs (c) heading and appropriate for client-facing derivative holding period for that netting set. (c)(1) and (2) and (5) through (8); transactions, then it must use a larger (5)(i) A FDIC-supervised institution ■ d. Adding paragraphs (c)(9) through scaling factor to adjust for the longer must adjust the supervisory haircuts (11); holding period pursuant to paragraph upward on the basis of a holding period ■ e. Revising paragraph (d)(10)(i); (b)(2)(ii)(A)(6) of this section. longer than ten business days for ■ f. In paragraphs (e)(5)(i)(A) and (H), (4) A FDIC-supervised institution collateral associated with derivative removing ‘‘Table 3 to § 324.132’’ and must adjust the supervisory haircuts contracts (five business days for client- adding in its pace ‘‘Table 4 to this upward on the basis of a holding period facing derivative contracts) using the section’’; longer than ten business days (for formula provided in paragraph ■ g. In paragraphs (e)(5)(i)(C) and eligible margin loans) or five business (b)(2)(ii)(A)(6) of this section where the (e)(6)(i)(B), removing ‘‘current exposure days (for repo-style transactions), using conditions in this paragraph methodology’’ and adding in its place the formula provided in paragraph (b)(2)(ii)(A)(5)(i) apply. For collateral ‘‘standardized approach for (b)(2)(ii)(A)(6) of this section where the associated with a derivative contract counterparty credit risk’’ wherever it conditions in this paragraph that is within a netting set that is appears; (b)(2)(ii)(A)(4) apply. If the number of composed of more than 5,000 derivative ■ h. Redesignating Table 3 to § 324.132 trades in a netting set exceeds 5,000 at contracts that are not cleared following paragraph (e)(5)(ii) as Table 4 any time during a quarter, a FDIC- transactions, a FDIC-supervised to § 324.132; and supervised institution must adjust the institution must use a minimum holding ■ i. Revising paragraph (e)(6)(viii). supervisory haircuts upward on the period of twenty business days. If a The revisions and additions read as basis of a minimum holding period of netting set contains one or more trades follows: twenty business days for the following involving illiquid collateral or a § 324.132 Counterparty credit risk of repo- quarter (except when a FDIC-supervised derivative contract that cannot be easily style transactions, eligible margin loans, institution is calculating EAD for a replaced, a FDIC-supervised institution and OTC derivative contracts. cleared transaction under § 324.133). If must use a minimum holding period of * * * * * a netting set contains one or more trades twenty business days. (b) * * * involving illiquid collateral, a FDIC- (ii) Notwithstanding paragraph (2) * * * supervised institution must adjust the (b)(2)(ii)(A)(1) or (3) or (b)(2)(ii)(A)(5)(i) (ii) * * * supervisory haircuts upward on the of this section, for collateral associated (A) * * * basis of a minimum holding period of with a derivative contract in a netting (3) For repo-style transactions and twenty business days. If over the two set under which more than two margin client-facing derivative transactions, a previous quarters more than two margin disputes that lasted longer than the FDIC-supervised institution may disputes on a netting set have occurred holding period occurred during the two multiply the supervisory haircuts that lasted longer than the holding previous quarters, the minimum holding

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4435 does not include any adjustments to under paragraphs (c)(2)(iii)(A) through period is twice the amount provided common equity tier 1 capital (E) of this section. under paragraph (b)(2)(ii)(A)(1) or (3) or attributable to changes in the fair value * * * * * (b)(2)(ii)(A)(5)(i) of this section. of the FDIC-supervised institution’s (5) Exposure amount. (i) The exposure (6) A FDIC-supervised institution liabilities that are due to changes in its must adjust the standard supervisory amount of a netting set, as calculated own credit risk since the inception of under paragraph (c) of this section, is haircuts upward, pursuant to the the transaction with the counterparty. adjustments provided in paragraphs equal to 1.4 multiplied by the sum of (2) For purposes of this (b)(2)(ii)(A)(3) through (5) of this Definitions. the replacement cost of the netting set, paragraph (c) of this section, the section, using the following formula: as calculated under paragraph (c)(6) of following definitions apply: this section, and the potential future (i) End date means the last date of the exposure of the netting set, as calculated period referenced by an interest rate or under paragraph (c)(7) of this section. credit derivative contract or, if the (ii) Notwithstanding the requirements derivative contract references another of paragraph (c)(5)(i) of this section, the instrument, by the underlying exposure amount of a netting set subject instrument, except as otherwise to a variation margin agreement, provided in paragraph (c) of this excluding a netting set that is subject to Where: section. a variation margin agreement under T equals a holding period of longer than 10 M (ii) Start date means the first date of which the counterparty to the variation business days for eligible margin loans and derivative contracts other than the period referenced by an interest rate margin agreement is not required to post client-facing derivative transactions or or credit derivative contract or, if the variation margin, is equal to the lesser longer than 5 business days for repo- derivative contract references the value of the exposure amount of the netting style transactions and client-facing of another instrument, by underlying set calculated under paragraph (c)(5)(i) derivative transactions; instrument, except as otherwise of this section and the exposure amount Hs equals the standard supervisory haircut; provided in paragraph (c) of this of the netting set calculated as if the and section. netting set were not subject to a Ts equals 10 business days for eligible variation margin agreement. margin loans and derivative contracts (iii) Hedging set means: other than client-facing derivative (A) With respect to interest rate (iii) Notwithstanding the transactions or 5 business days for repo- derivative contracts, all such contracts requirements of paragraph (c)(5)(i) of style transactions and client-facing within a netting set that reference the this section, the exposure amount of a derivative transactions. same reference currency; netting set that consists of only sold (7) If the instrument a FDIC- (B) With respect to exchange rate options in which the premiums have supervised institution has lent, sold derivative contracts, all such contracts been fully paid by the counterparty to subject to repurchase, or posted as within a netting set that reference the the options and where the options are collateral does not meet the definition of same currency pair; not subject to a variation margin agreement is zero. financial collateral, the FDIC-supervised (C) With respect to credit derivative institution must use a 25.0 percent contract, all such contracts within a (iv) Notwithstanding the requirements haircut for market price volatility (Hs). netting set; of paragraph (c)(5)(i) of this section, the exposure amount of a netting set in * * * * * (D) With respect to equity derivative which the counterparty is a commercial (c) EAD for derivative contracts—(1) contracts, all such contracts within a end-user is equal to the sum of Options for determining EAD. A FDIC- netting set; replacement cost, as calculated under supervised institution must determine (E) With respect to a commodity the EAD for a derivative contract using paragraph (c)(6) of this section, and the derivative contract, all such contracts potential future exposure of the netting the standardized approach for within a netting set that reference one counterparty credit risk (SA–CCR) set, as calculated under paragraph (c)(7) of the following commodity categories: of this section. under paragraph (c)(5) of this section or Energy, metal, agricultural, or other using the internal models methodology (v) For purposes of the exposure commodities; amount calculated under paragraph described in paragraph (d) of this (F) With respect to basis derivative section. If a FDIC-supervised institution (c)(5)(i) of this section and all contracts, all such contracts within a calculations that are part of that elects to use SA–CCR for one or more netting set that reference the same pair derivative contracts, the exposure exposure amount, a FDIC-supervised of risk factors and are denominated in institution may elect, at the netting set amount determined under SA–CCR is the same currency; or the EAD for the derivative contract or level, to treat a derivative contract that (G) With respect to volatility derivatives contracts. A FDIC- is a cleared transaction that is not derivative contracts, all such contracts supervised institution must use the subject to a variation margin agreement within a netting set that reference one same methodology to calculate the as one that is subject to a variation of interest rate, exchange rate, credit, exposure amount for all its derivative margin agreement, if the derivative equity, or commodity risk factors, contracts and may change its election contract is subject to a requirement that separated according to the requirements only with prior approval of the FDIC. A the counterparties make daily cash under paragraphs (c)(2)(iii)(A) through FDIC-supervised institution may reduce payments to each other to account for the EAD calculated according to (E) of this section. changes in the fair value of the paragraph (c)(5) of this section by the (H) If the risk of a derivative contract derivative contract and to reduce the net credit valuation adjustment that the materially depends on more than one of position of the contract to zero. If a FDIC- FDIC-supervised institution has interest rate, exchange rate, credit, supervised institution makes an election recognized in its balance sheet valuation equity, or commodity risk factors, the under this paragraph (c)(5)(v) for one of any derivative contracts in the netting FDIC may require a FDIC-supervised derivative contract, it must treat all other set. For purposes of this paragraph institution to include the derivative derivative contracts within the same (c)(1), the credit valuation adjustment contract in each appropriate hedging set netting set that are eligible for an

4436 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations netting set less the sum of the net (B) Zero. election under this paragraph (c)(5)(v) as independent collateral amount and the (iii) Multiple netting sets subject to a derivative contracts that are subject to a variation margin amount applicable to single variation margin agreement. variation margin agreement. such derivative contracts; Notwithstanding paragraphs (c)(6)(i) (vi) For purposes of the exposure (B) The sum of the variation margin amount calculated under paragraph threshold and the minimum transfer and (ii) of this section, the replacement (c)(5)(i) of this section and all amount applicable to the derivative cost for multiple netting sets subject to calculations that are part of that contracts within the netting set less the a single variation margin agreement exposure amount, a FDIC-supervised net independent collateral amount must be calculated according to institution may elect to treat a credit applicable to such derivative contracts; paragraph (c)(10)(i) of this section. derivative contract, equity derivative or (iv) Netting set subject to multiple contract, or commodity derivative (C) Zero. variation margin agreements or a hybrid contract that references an index as if it (ii) Netting sets not subject to a netting set. Notwithstanding paragraphs were multiple derivative contracts each variation margin agreement under (c)(6)(i) and (ii) of this section, the referencing one component of the index. which the counterparty must post replacement cost for a netting set subject (6) — Replacement cost of a netting set variation margin. The replacement cost to multiple variation margin agreements (i) Netting set subject to a variation of a netting set that is not subject to a or a hybrid netting set must be margin agreement under which the variation margin agreement under calculated according to paragraph counterparty must post variation which the counterparty must post (c)(11)(i) of this section. margin. The replacement cost of a variation margin to the FDIC-supervised (7) netting set subject to a variation margin institution is the greater of: Potential future exposure of a agreement, excluding a netting set that (A) The sum of the fair values (after netting set. The potential future is subject to a variation margin excluding any valuation adjustments) of exposure of a netting set is the product agreement under which the the derivative contracts within the of the PFE multiplier and the aggregated counterparty is not required to post netting set less the sum of the net amount. variation margin, is the greater of: independent collateral amount and (i) PFE multiplier. The PFE multiplier (A) The sum of the fair values (after variation margin amount applicable to is calculated according to the following excluding any valuation adjustments) of such derivative contracts; or formula: the derivative contracts within the

Where: (iii) Multiple netting sets subject to a for purposes of total leverage exposure V is the sum of the fair values (after single variation margin agreement. under § 324.10(c)(4)(ii)(B), the potential excluding any valuation adjustments) of Notwithstanding paragraphs (c)(7)(i) future exposure for a netting set subject the derivative contracts within the and (ii) of this section and when to multiple variation margin agreements netting set; calculating the potential future exposure or a hybrid netting set must be C is the sum of the net independent collateral for purposes of total leverage exposure calculated according to paragraph amount and the variation margin amount under § 324.10(c)(4)(ii)(B), the potential (c)(11)(ii) of this section. applicable to the derivative contracts future exposure for multiple netting sets (8) Hedging set amount—(i) Interest within the netting set; and subject to a single variation margin rate derivative contracts. To calculate A is the aggregated amount of the netting set. agreement must be calculated according the hedging set amount of an interest to paragraph (c)(10)(ii) of this section. rate derivative contract hedging set, a (ii) The Aggregated amount. (iv) Netting set subject to multiple FDIC-supervised institution may use aggregated amount is the sum of all variation margin agreements or a hybrid either of the formulas provided in hedging set amounts, as calculated netting set. Notwithstanding paragraphs paragraphs (c)(8)(i)(A) and (B) of this under paragraph (c)(8) of this section, (c)(7)(i) and (ii) of this section and when section: within a netting set. calculating the potential future exposure (A) Formula 1 is as follows:

IR IR (B) Formula 2 is as follows: AddOnTB1 is the sum of the adjusted AddOnTB2 is the sum of the adjusted derivative contract amounts, as derivative contract amounts, as IR Hedging set amount = |AddOnTB1 | + calculated under paragraph (c)(9) of this calculated under paragraph (c)(9) of this |AddOnTB2IR + |AddOnTB3IR|. section, within the hedging set with an section, within the hedging set with an Where in paragraphs (c)(8)(i)(A) and (B) of end date of less than one year from the end date of one to five years from the this section: present date; present date; and

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4437 derivative contract hedging set, the (iii) Credit derivative contracts and IR is the sum of the adjusted AddOnTB3 hedging set amount equals the absolute derivative contract amounts, as equity derivative contracts. The hedging calculated under paragraph (c)(9) of this value of the sum of the adjusted set amount of a credit derivative section, within the hedging set with an derivative contract amounts, as contract hedging set or equity derivative end date of more than five years from the calculated under paragraph (c)(9) of this contract hedging set within a netting set present date. section, within the hedging set. is calculated according to the following (ii) Exchange rate derivative formula: contracts. For an exchange rate

Where: determined under paragraph (c)(9) of this (iv) Commodity derivative contracts. k is each reference entity within the hedging section, for all derivative contracts The hedging set amount of a commodity set. within the hedging set that reference derivative contract hedging set within a K is the number of reference entities within reference entity k. netting set is calculated according to the the hedging set. equals the applicable supervisory rk following formula: AddOn(Refk) equals the sum of the adjusted correlation factor, as provided in Table 2 derivative contract amounts, as to this section.

Where: separate hedging set amount for each notional amount by each of the k is each commodity type within the hedging basis derivative contract hedging set and supervisory delta adjustment, pursuant set. each volatility derivative contract to paragraph (c)(9)(iii) of this section, K is the number of commodity types within hedging set. A FDIC-supervised the maturity factor, pursuant to the hedging set. institution must calculate such hedging paragraph (c)(9)(iv) of this section, and AddOn(Typek) equals the sum of the adjusted set amounts using one of the formulas derivative contract amounts, as the applicable supervisory factor, as determined under paragraph (c)(9) of this under paragraphs (c)(8)(i) through (iv) provided in Table 2 to this section. that corresponds to the primary risk section, for all derivative contracts (ii) (A)( ) within the hedging set that reference factor of the hedging set being Adjusted notional amount. 1 commodity type k. calculated. For an interest rate derivative contract r equals the applicable supervisory (9) Adjusted derivative contract or a credit derivative contract, the correlation factor, as provided in Table 2 amount—(i) Summary. To calculate the adjusted notional amount equals the to this section. adjusted derivative contract amount of a product of the notional amount of the (v) Basis derivative contracts and derivative contract, a FDIC-supervised derivative contract, as measured in U.S. volatility derivative contracts. institution must determine the adjusted dollars using the exchange rate on the Notwithstanding paragraphs (c)(8)(i) notional amount of derivative contract, date of the calculation, and the through (iv) of this section, a FDIC- pursuant to paragraph (c)(9)(ii) of this supervisory duration, as calculated by supervised institution must calculate a section, and multiply the adjusted the following formula:

Where: that is a variable notional swap, the factor, the notional amount is equal to S is the number of business days from the notional amount is equal to the time- the notional amount of an equivalent present day until the start date of the weighted average of the contractual unleveraged swap. derivative contract, or zero if the start notional amounts of such a swap over (B)(1) For an exchange rate derivative date has already passed; and the remaining life of the swap; and contract, the adjusted notional amount E is the number of business days from the (ii) For an interest rate derivative is the notional amount of the non-U.S. present day until the end date of the contract or a credit derivative contract denominated currency leg of the derivative contract. that is a leveraged swap, in which the derivative contract, as measured in U.S. (2) For purposes of paragraph notional amount of all legs of the dollars using the exchange rate on the (c)(9)(ii)(A)(1) of this section: derivative contract are divided by a date of the calculation. If both legs of (i) For an interest rate derivative factor and all rates of the derivative the exchange rate derivative contract are contract or credit derivative contract contract are multiplied by the same denominated in currencies other than

4438 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations (C)(1) For an equity derivative the number of units with the notional U.S. dollars, the adjusted notional contract or a commodity derivative amount of the volatility derivative amount of the derivative contract is the contract, the adjusted notional amount contract. largest leg of the derivative contract, as is the product of the fair value of one (iii) Supervisory delta adjustments. measured in U.S. dollars using the unit of the reference instrument (A) For a derivative contract that is not exchange rate on the date of the underlying the derivative contract and an option contract or collateralized debt calculation. the number of such units referenced by obligation tranche, the supervisory delta (2) Notwithstanding paragraph the derivative contract. adjustment is 1 if the fair value of the (c)(9)(ii)(B)(1) of this section, for an (2) Notwithstanding paragraph derivative contract increases when the exchange rate derivative contract with (c)(9)(ii)(C)(1) of this section, when value of the primary risk factor multiple exchanges of principal, the calculating the adjusted notional increases and ¥1 if the fair value of the FDIC-supervised institution must set the amount for an equity derivative contract derivative contract decreases when the adjusted notional amount of the or a commodity derivative contract that value of the primary risk factor is a volatility derivative contract, the derivative contract equal to the notional increases. FDIC-supervised institution must (B)( ) For a derivative contract that is amount of the derivative contract 1 replace the unit price with the an option contract, the supervisory delta multiplied by the number of exchanges underlying volatility referenced by the adjustment is determined by the of principal under the derivative volatility derivative contract and replace following formulas, as applicable: contract.

(2) As used in the formulas in Table (v) l equals zero for all derivative supervised institution has with all 2 to this section: contracts except interest rate options for counterparties. Then, l is set according (i) F is the standard normal the currencies where interest rates have to this formula: l = max{¥L + 0.1%, 0}; cumulative distribution function; negative values. The same value of l and (ii) P equals the current fair value of must be used for all interest rate options (vi) s equals the supervisory option the instrument or risk factor, as that are denominated in the same applicable, underlying the option; volatility, as provided in Table 3 to this currency. To determine the value of l section. (iii) K equals the strike price of the option; for a given currency, a FDIC-supervised (C)(1) For a derivative contract that is (iv) T equals the number of business institution must find the lowest value L a collateralized debt obligation tranche, days until the latest contractual exercise of P and K of all interest rate options in the supervisory delta adjustment is date of the option; a given currency that the FDIC- determined by the following formula:

(2) As used in the formula in (ii) D is the detachment point, which (iii) The resulting amount is paragraph (c)(9)(iii)(C)(1) of this section: equals one minus the ratio of the designated with a positive sign if the (i) A is the attachment point, which notional amounts of all underlying collateralized debt obligation tranche equals the ratio of the notional amounts exposures that are senior to the FDIC- was purchased by the FDIC-supervised of all underlying exposures that are supervised institution’s exposure to the institution and is designated with a subordinated to the FDIC-supervised total notional amount of all underlying negative sign if the collateralized debt institution’s exposure to the total exposures, expressed as a decimal value obligation tranche was sold by the FDIC- notional amount of all underlying between zero and one; and supervised institution. exposures, expressed as a decimal value (iv) Maturity factor. (A)(1) The 30 between zero and one; exposure. In the case of a second-or-subsequent-to- maturity factor of a derivative contract default credit derivative, the smallest (n¥1) 30 In the case of a first-to-default credit derivative, notional amounts of the underlying exposures are that is subject to a variation margin there are no underlying exposures that are subordinated to the FDIC-supervised institution’s agreement, excluding derivative subordinated to the FDIC-supervised institution’s exposure. contracts that are subject to a variation

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4439 institution must treat the derivative Where: margin agreement under which the contract as subject to a variation margin NS is each netting set subject to the variation counterparty is not required to post agreement with maturity factor as margin agreement MA; variation margin, is determined by the determined according to (c)(9)(iv)(A) of VNS is the sum of the fair values (after following formula: this section, and daily settlement does excluding any valuation adjustments) of

not change the end date of the period the derivative contracts within the referenced by the derivative contract. netting set NS; and CMA is the sum of the net independent (v) Derivative contract as multiple collateral amount and the variation Where MPOR refers to the period effective derivative contracts. A FDIC- margin amount applicable to the from the most recent exchange of supervised institution must separate a derivative contracts within the netting collateral covering a netting set of derivative contract into separate sets subject to the single variation margin derivative contracts with a defaulting derivative contracts, according to the agreement. counterparty until the derivative following rules: (ii) Calculating potential future contracts are closed out and the (A) For an option where the exposure. Notwithstanding paragraph resulting market risk is re-hedged. counterparty pays a predetermined (c)(5) of this section, a FDIC-supervised (2) Notwithstanding paragraph amount if the value of the underlying institution shall assign a single potential (c)(9)(iv)(A)(1) of this section: asset is above or below the strike price future exposure to multiple netting sets (i) For a derivative contract that is not and nothing otherwise (binary option), that are subject to a single variation a client-facing derivative transaction, the option must be treated as two margin agreement under which the MPOR cannot be less than ten business separate options. For purposes of counterparty must post variation margin days plus the periodicity of re- paragraph (c)(9)(iii)(B) of this section, a equal to the sum of the potential future margining expressed in business days binary option with strike K must be exposure of each such netting set, each minus one business day; represented as the combination of one calculated according to paragraph (c)(7) (ii) For a derivative contract that is a bought European option and one sold of this section as if such nettings sets client-facing derivative transaction, European option of the same type as the were not subject to a variation margin MPOR cannot be less than five business original option (put or call) with the agreement. days plus the periodicity of re- strikes set equal to 0.95 * K and 1.05 * (11) Netting set subject to multiple margining expressed in business days K so that the payoff of the binary option variation margin agreements or a hybrid minus one business day; and is reproduced exactly outside the region netting set—(i) Calculating replacement (iii) For a derivative contract that is between the two strikes. The absolute cost. To calculate replacement cost for within a netting set that is composed of value of the sum of the adjusted either a netting set subject to multiple more than 5,000 derivative contracts derivative contract amounts of the variation margin agreements under that are not cleared transactions, or a bought and sold options is capped at the which the counterparty to each netting set that contains one or more payoff amount of the binary option. variation margin agreement must post trades involving illiquid collateral or a (B) For a derivative contract that can variation margin, or a netting set derivative contract that cannot be easily be represented as a combination of composed of at least one derivative replaced, MPOR cannot be less than standard option payoffs (such as collar, contract subject to variation margin twenty business days. butterfly spread, calendar spread, agreement under which the (3) Notwithstanding paragraphs straddle, and strangle), a FDIC- counterparty must post variation margin (c)(9)(iv)(A)(1) and (2) of this section, for supervised institution must treat each and at least one derivative contract that a netting set subject to two or more standard option component must be is not subject to such a variation margin outstanding disputes over margin that treated as a separate derivative contract. agreement, the calculation for lasted longer than the MPOR over the (C) For a derivative contract that replacement cost is provided under previous two quarters, the applicable includes multiple-payment options, paragraph (c)(6)(i) of this section, except floor is twice the amount provided in (such as interest rate caps and floors), a that the variation margin threshold (c)(9)(iv)(A)(1) and (2) of this section. FDIC-supervised institution may equals the sum of the variation margin (B) The maturity factor of a derivative represent each payment option as a thresholds of all variation margin contract that is not subject to a variation combination of effective single-payment agreements within the netting set and margin agreement, or derivative options (such as interest rate caplets and the minimum transfer amount equals contracts under which the counterparty floorlets). the sum of the minimum transfer is not required to post variation margin, (D) A FDIC-supervised institution amounts of all the variation margin is determined by the following formula: may not decompose linear derivative agreements within the netting set. contracts (such as swaps) into (ii) Calculating potential future components. exposure. (A) To calculate potential (10) Multiple netting sets subject to a future exposure for a netting set subject single variation margin agreement—(i) to multiple variation margin agreements Where M equals the greater of 10 Calculating replacement cost. under which the counterparty to each business days and the remaining Notwithstanding paragraph (c)(6) of this variation margin agreement must post maturity of the contract, as measured in section, a FDIC-supervised institution variation margin, or a netting set business days. shall assign a single replacement cost to composed of at least one derivative (C) For purposes of paragraph multiple netting sets that are subject to contract subject to variation margin (c)(9)(iv) of this section, if a FDIC- a single variation margin agreement agreement under which the supervised institution has elected under which the counterparty must post counterparty to the derivative contract pursuant to paragraph (c)(5)(v) of this variation margin, calculated according must post variation margin and at least section to treat a derivative contract that to the following formula: one derivative contract that is not is a cleared transaction that is not subject to such a variation margin subject to a variation margin agreement Replacement Cost = max{SNS max{VNS; agreement, a FDIC-supervised as one that is subject to a variation 0} ¥ max{CMA; 0}; 0} + max{SNS institution must divide the netting set margin agreement, the Board-regulated min{VNS; 0} ¥ min{CMA; 0}; 0}

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4441 (1) All derivative contracts within the margin agreements in which the into sub-netting sets (as described in netting set that are not subject to a counterparty must post variation margin paragraph (c)(11)(ii)(B) of this section) variation margin agreement or that are and that share the same value of the and calculate the aggregated amount for subject to a variation margin agreement MPOR form a single sub-netting set. The each sub-netting set. The aggregated under which the counterparty is not amount for the netting set is calculated aggregated amount for this sub-netting required to post variation margin form set is calculated as if the netting set is as the sum of the aggregated amounts for a single sub-netting set. The aggregated the sub-netting sets. The multiplier is subject to a variation margin agreement, amount for this sub-netting set is using the MPOR value shared by the calculated for the entire netting set. calculated as if the netting set is not derivative contracts within the netting (B) For purposes of paragraph subject to a variation margin agreement. set. (c)(11)(ii)(A) of this section, the netting (2) All derivative contracts within the set must be divided into sub-netting sets netting set that are subject to variation as follows:

TABLE 3 TO § 324.132—SUPERVISORY OPTION VOLATILITY, SUPERVISORY CORRELATION PARAMETERS, AND SUPERVISORY FACTORS FOR DERIVATIVE CONTRACTS

Supervisory Supervisory Supervisory option correlation 1 Asset class Subclass Type volatility factor factor (percent) (percent) (percent)

Interest rate ...... N/A ...... N/A ...... 50 N/A 0.50 Exchange rate ...... N/A ...... N/A ...... 15 N/A 4.0 Credit, single name ...... Investment grade ...... N/A ...... 100 50 0.46 Speculative grade ...... N/A ...... 100 50 1.3 Sub-speculative grade ...... N/A ...... 100 50 6.0 Credit, index ...... Investment Grade ...... N/A ...... 80 80 0.38 Speculative Grade ...... N/A ...... 80 80 1.06 Equity, single name ...... N/A ...... N/A ...... 120 50 32 Equity, index ...... N/A ...... N/A ...... 75 80 20 Commodity ...... Energy ...... Electricity ...... 150 40 40 Other ...... 70 40 18 Metals ...... N/A ...... 70 40 18 Agricultural ...... N/A ...... 70 40 18 Other ...... N/A ...... 70 40 18 1 The applicable supervisory factor for basis derivative contract hedging sets is equal to one-half of the supervisory factor provided in this Table 3, and the applicable supervisory factor for volatility derivative contract hedging sets is equal to 5 times the supervisory factor provided in this Table 3.

(d) * * * conservatism requirement of this (b) of this section to calculate risk- (10) * * * section. weighted assets for a cleared (i) With prior written approval of the * * * * * transaction. FDIC, a FDIC-supervised institution may (e) * * * (2) Clearing members. A FDIC- set EAD equal to a measure of (6) * * * supervised institution that is a clearing counterparty credit risk exposure, such (viii) If a FDIC-supervised institution member must use the methodologies as peak EAD, that is more conservative uses the standardized approach for described in paragraph (c) of this than an alpha of 1.4 times the larger of counterparty credit risk pursuant to section to calculate its risk-weighted EPEunstressed and EPEstressed for every paragraph (c) of this section to calculate assets for a cleared transaction and counterparty whose EAD will be the EAD for any immaterial portfolios of paragraph (d) of this section to calculate measured under the alternative measure OTC derivative contracts, the FDIC- its risk-weighted assets for its default of counterparty exposure. The FDIC- supervised institution must use that fund contribution to a CCP. supervised institution must demonstrate EAD as a constant EE in the formula for (b) * * * the conservatism of the measure of the calculation of CVA with the (1) Risk-weighted assets for cleared counterparty credit risk exposure used maturity equal to the maximum of: transactions. (i) To determine the risk- for EAD. With respect to paragraph (A) Half of the longest maturity of a weighted asset amount for a cleared (d)(10)(i) of this section: transaction in the netting set; and transaction, a FDIC-supervised (A) For material portfolios of new (B) The notional weighted average institution that is a clearing member OTC derivative products, the FDIC- maturity of all transactions in the client must multiply the trade exposure supervised institution may assume that netting set. amount for the cleared transaction, the standardized approach for ■ 35. Section 324.133 is amended by calculated in accordance with paragraph counterparty credit risk pursuant to revising paragraphs (a), (b)(1) through (b)(2) of this section, by the risk weight paragraph (c) of this section meets the (3), (b)(4)(i), (c)(1) through (3), (c)(4)(i), appropriate for the cleared transaction, conservatism requirement of this section and (d) to read as follows: determined in accordance with for a period not to exceed 180 days. paragraph (b)(3) of this section. (B) For immaterial portfolios of OTC § 324.133 Cleared transactions. (ii) A clearing member client FDIC- derivative contracts, the FDIC- (a) General requirements—(1) supervised institution’s total risk- supervised institution generally may Clearing member clients. A FDIC- weighted assets for cleared transactions assume that the standardized approach supervised institution that is a clearing is the sum of the risk-weighted asset for counterparty credit risk pursuant to member client must use the amounts for all of its cleared paragraph (c) of this section meets the methodologies described in paragraph transactions.

4440 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations institution must apply the risk weight (3) Cleared transaction risk weights. (2) (i) For a Trade exposure amount. applicable to the CCP under subpart D (i) A clearing member FDIC-supervised cleared transaction that is a derivative of this part. institution must apply a risk weight of contract or a netting set of derivative (4) * * * 2 percent to the trade exposure amount contracts, trade exposure amount equals (i) Notwithstanding any other for a cleared transaction with a QCCP. the EAD for the derivative contract or requirement of this section, collateral (ii) For a cleared transaction with a netting set of derivative contracts posted by a clearing member client CCP that is not a QCCP, a clearing calculated using the methodology used FDIC-supervised institution that is held member FDIC-supervised institution to calculate EAD for derivative contracts by a custodian (in its capacity as a must apply the risk weight applicable to set forth in § 324.132(c) or (d), plus the custodian) in a manner that is the CCP according to subpart D of this fair value of the collateral posted by the bankruptcy remote from the CCP, part. clearing member client FDIC-supervised clearing member, and other clearing (iii) Notwithstanding paragraphs institution and held by the CCP or a member clients of the clearing member, (c)(3)(i) and (ii) of this section, a clearing member in a manner that is not is not subject to a capital requirement clearing member FDIC-supervised bankruptcy remote. When the FDIC- under this section. institution may apply a risk weight of supervised institution calculates EAD * * * * * zero percent to the trade exposure for the cleared transaction using the (c) * * * methodology in § 324.132(d), EAD amount for a cleared transaction with a (1) Risk-weighted assets for cleared QCCP where the clearing member FDIC- equals EADunstressed. transactions. (i) To determine the risk- (ii) For a cleared transaction that is a supervised institution is acting as a weighted asset amount for a cleared financial intermediary on behalf of a repo-style transaction or netting set of transaction, a clearing member FDIC- repo-style transactions, trade exposure clearing member client, the transaction supervised institution must multiply the offsets another transaction that satisfies amount equals the EAD for the repo- trade exposure amount for the cleared style transaction calculated using the the requirements set forth in § 324.3(a), transaction, calculated in accordance and the clearing member FDIC- methodology set forth in § 324.132(b)(2) with paragraph (c)(2) of this section by supervised institution is not obligated to or (3) or (d), plus the fair value of the the risk weight appropriate for the reimburse the clearing member client in collateral posted by the clearing member cleared transaction, determined in the event of the QCCP default. client FDIC-supervised institution and accordance with paragraph (c)(3) of this (4) * * * held by the CCP or a clearing member section. (i) Notwithstanding any other in a manner that is not bankruptcy (ii) A clearing member FDIC- remote. When the FDIC-supervised supervised institution’s total risk- requirement of this section, collateral institution calculates EAD for the weighted assets for cleared transactions posted by a clearing member FDIC- cleared transaction under § 324.132(d), is the sum of the risk-weighted asset supervised institution that is held by a EAD equals EADunstressed. amounts for all of its cleared custodian (in its capacity as a custodian) (3) Cleared transaction risk weights. transactions. in a manner that is bankruptcy remote (i) For a cleared transaction with a (2) Trade exposure amount. A from the CCP, clearing member, and QCCP, a clearing member client FDIC- clearing member FDIC-supervised other clearing member clients of the supervised institution must apply a risk institution must calculate its trade clearing member, is not subject to a weight of: exposure amount for a cleared capital requirement under this section. (A) 2 percent if the collateral posted transaction as follows: * * * * * by the FDIC-supervised institution to (i) For a cleared transaction that is a (d) Default fund contributions—(1) the QCCP or clearing member is subject derivative contract or a netting set of General requirement. A clearing to an arrangement that prevents any loss derivative contracts, trade exposure member FDIC-supervised institution to the clearing member client FDIC- amount equals the EAD calculated using must determine the risk-weighted asset supervised institution due to the joint the methodology used to calculate EAD amount for a default fund contribution default or a concurrent insolvency, for derivative contracts set forth in to a CCP at least quarterly, or more liquidation, or receivership proceeding § 324.132(c) or (d), plus the fair value of frequently if, in the opinion of the FDIC- of the clearing member and any other the collateral posted by the clearing supervised institution or the FDIC, there clearing member clients of the clearing member FDIC-supervised institution is a material change in the financial member; and the clearing member client and held by the CCP in a manner that condition of the CCP. FDIC-supervised institution has is not bankruptcy remote. When the (2) Risk-weighted asset amount for conducted sufficient legal review to clearing member FDIC-supervised default fund contributions to conclude with a well-founded basis institution calculates EAD for the nonqualifying CCPs. A clearing member (and maintains sufficient written cleared transaction using the FDIC-supervised institution’s risk- documentation of that legal review) that methodology in § 324.132(d), EAD weighted asset amount for default fund in the event of a legal challenge equals EADunstressed. contributions to CCPs that are not (including one resulting from an event (ii) For a cleared transaction that is a QCCPs equals the sum of such default of default or from liquidation, repo-style transaction or netting set of fund contributions multiplied by 1,250 insolvency, or receivership proceedings) repo-style transactions, trade exposure percent, or an amount determined by the relevant court and administrative amount equals the EAD calculated the FDIC, based on factors such as size, authorities would find the arrangements under § 324.132(b)(2) or (3) or (d), plus structure, and membership to be legal, valid, binding, and the fair value of the collateral posted by characteristics of the CCP and riskiness enforceable under the law of the the clearing member FDIC-supervised of its transactions, in cases where such relevant jurisdictions. institution and held by the CCP in a default fund contributions may be (B) 4 percent, if the requirements of manner that is not bankruptcy remote. unlimited. paragraph (b)(3)(i)(A) of this section are When the clearing member FDIC- (3) Risk-weighted asset amount for not met. supervised institution calculates EAD default fund contributions to QCCPs. A (ii) For a cleared transaction with a for the cleared transaction under clearing member FDIC-supervised CCP that is not a QCCP, a clearing § 324.132(d), EAD equals EAD . institution’s risk-weighted asset amount member client FDIC-supervised unstressed

4442 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations forth in paragraph (d)(4) of this section, clearing member FDIC-supervised for default fund contributions to QCCPs multiplied by 12.5. institution’s capital requirement for its equals the sum of its capital (4) Capital requirement for default default fund contribution to a QCCP requirement, KCM for each QCCP, as fund contributions to a QCCP. A (KCM) is equal to: calculated under the methodology set

Where: provided to the CCP with respect to collateral are held in the same default

KCCP is the hypothetical capital requirement performance of a clearing member client fund contribution account, then the of the QCCP, as determined under on a derivative contract, the EAD is EAD of that account is the sum of the paragraph (d)(5) of this section; equal to the exposure amount for all EAD for the client-related transactions pref DF is the prefunded default fund such derivative contracts and guarantees within the account and the EAD of the contribution of the clearing member of derivative contracts calculated under FDIC-supervised institution to the QCCP; house-related transactions within the SA–CCR in § 324.132(c) (or, with account. For purposes of determining DFCCP is the QCCP’s own prefunded amounts that are contributed to the default respect to a CCP located outside the such EADs, the independent collateral waterfall and are junior or pari passu United States, under a substantially of the clearing member and its client with prefunded default fund identical methodology in effect in the must be allocated in proportion to the contributions of clearing members of the jurisdiction) using a value of 10 respective total amount of independent CCP; and business days for purposes of collateral posted by the clearing member pref is the total prefunded default fund DFCM § 324.132(c)(9)(iv); less the value of all to the QCCP. contributions from clearing members of collateral held by the CCP posted by the the QCCP to the QCCP. (v) If any account or sub-account clearing member FDIC-supervised contains both derivative contracts and (5) Hypothetical capital requirement institution or a clearing member client repo-style transactions, the EAD of that of a QCCP. Where a QCCP has provided of the FDIC-supervised institution in account is the sum of the EAD for the its KCCP, a FDIC-supervised institution connection with a derivative contract derivative contracts within the account must rely on such disclosed figure for which the FDIC-supervised and the EAD of the repo-style instead of calculating KCCP under this institution has provided a guarantee to transactions within the account. If paragraph (d)(5), unless the FDIC- the CCP and the amount of the independent collateral is held for an supervised institution determines that a prefunded default fund contribution of account containing both derivative more conservative figure is appropriate the FDIC-supervised institution to the contracts and repo-style transactions, based on the nature, structure, or CCP. then such collateral must be allocated to characteristics of the QCCP. The (iii) With respect to any repo-style hypothetical capital requirement of a transactions between the FDIC- the derivative contracts and repo-style transactions in proportion to the QCCP (KCCP), as determined by the supervised institution and the CCP that FDIC-supervised institution, is equal to: are cleared transactions, EAD is equal respective product specific exposure amounts, calculated, excluding the KCCP = SCMi EADi * 1.6 percent to: effects of collateral, according to EAD = max{EBRM ¥ IM ¥ DF; 0} Where: § 324.132(b) for repo-style transactions CMi is each clearing member of the QCCP; Where: and to § 324.132(c)(5) for derivative and EBRM is the sum of the exposure amounts of contracts. EADi is the exposure amount of each clearing each repo-style transaction between the member of the QCCP to the QCCP, as FDIC-supervised institution and the CCP (vi) Notwithstanding any other determined under paragraph (d)(6) of as determined under § 324.132(b)(2) and provision of paragraph (d) of this this section. without recognition of any collateral section, with the prior approval of the (6) EAD of a clearing member FDIC- securing the repo-style transactions; FDIC, a FDIC-supervised institution may is the initial margin collateral posted by supervised institution to a QCCP. (i) The IM determine the risk-weighted asset the FDIC-supervised institution to the amount for a default fund contribution EAD of a clearing member FDIC- CCP with respect to the repo-style supervised institution to a QCCP is transactions; and to a QCCP according to equal to the sum of the EAD for DF is the prefunded default fund § 324.35(d)(3)(ii). derivative contracts determined under contribution of the FDIC-supervised ■ 36. Section 324.173 is amended in paragraph (d)(6)(ii) of this section and institution to the CCP that is not already Table 13 to § 324.173 by revising line 4 the EAD for repo-style transactions deducted in paragraph (d)(6)(ii) of this section. under Part 2, Derivative exposures, to determined under paragraph (d)(6)(iii) read as follows: of this section. (iv) EAD must be calculated (ii) With respect to any derivative separately for each clearing member’s § 324.173 Disclosures by certain advanced contracts between the FDIC-supervised sub-client accounts and sub-house approaches FDIC-supervised institutions institution and the CCP that are cleared account (i.e., for the clearing member’s and Category III FDIC-supervised transactions and any guarantees that the proprietary activities). If the clearing institutions. FDIC-supervised institution has member’s collateral and its client’s * * * * *

Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations 4443

TABLE 13 TO § 324.173—SUPPLEMENTARY LEVERAGE RATIO

Dollar amounts in thousands

Tril Bil Mil Thou

* * * * * * *

Part 2: Supplementary leverage ratio

* * * * * * *

Derivative exposures

* * * * * * 4 Current exposure for derivative exposures (that is, net of cash variation margin).

* * * * * * *

■ 37. Section 324.300 is amended by SA–CCR, the advanced approaches Authority: 12 U.S.C. 1441, 1813, 1815, adding paragraphs (g) and (h) to read as FDIC-supervised institution may not 1817–19, 1821. follows: change to use CEM. ■ 39. Appendix A to subpart A of part (h) Default fund contributions. Prior § 324.300 Transitions. to January 1, 2022, a FDIC-supervised 327 is amended in section VI by revising * * * * * institution that calculates the exposure the entries ‘‘(2) Top 20 Counterparty (g) SA–CCR. An advanced approaches amounts of its derivative contracts Exposure/Tier 1 Capital and Reserves’’ FDIC-supervised institution may use under the standardized approach for and ‘‘(3) Largest Counterparty Exposure/ CEM rather than SA–CCR for purposes counterparty credit risk in § 324.132(c) Tier 1 Capital and Reserves’’ to read as of §§ 324.34(a) and 324.132(c) until may calculate the risk-weighted asset follows: January 1, 2022. A FDIC-supervised amount for a default fund contribution institution must provide prior notice to to a QCCP under either method 1 under Appendix A to Subpart A of Part 327— the FDIC if it decides to begin using SA– § 324.35(d)(3)(i) or method 2 under Method To Derive Pricing Multipliers CCR before January 1, 2022. On January § 324.35(d)(3)(ii), rather than under and Uniform Amount 1, 2022, and thereafter, an advanced § 324.133(d). * * * * * approaches FDIC-supervised institution must use SA–CCR for purposes of PART 327—ASSESSMENTS VI. Description of Scorecard Measures §§ 324.34(a), 324.132(c), and 324.133(d). Once an advanced approaches FDIC- ■ 38. The authority citation for part 327 supervised institution has begun to use continues to read as follows:

Scorecard measures 1 Description

* * * * * * * (2) Top 20 Counterparty Ex- Sum of the 20 largest total exposure amounts to counterparties divided by Tier 1 capital and reserves. The total posure/Tier 1 Capital and exposure amount is equal to the sum of the institution’s exposure amounts to one counterparty (or borrower) for Reserves. derivatives, securities financing transactions (SFTs), and cleared transactions, and its gross lending expo- sure (including all unfunded commitments) to that counterparty (or borrower). A counterparty includes an enti- ty’s own affiliates. Exposures to entities that are affiliates of each other are treated as exposures to one counterparty (or borrower). Counterparty exposure excludes all counterparty exposure to the U.S. Government and departments or agencies of the U.S. Government that is unconditionally guaranteed by the full faith and credit of the United States. The exposure amount for derivatives, including OTC derivatives, cleared trans- actions that are derivative contracts, and netting sets of derivative contracts, must be calculated using the methodology set forth in 12 CFR 324.34(b), but without any reduction for collateral other than cash collateral that is all or part of variation margin and that satisfies the requirements of 12 CFR 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and 324.10(c)(4)(ii)(C)(3) through (7). The exposure amount associated with SFTs, including cleared trans- actions that are SFTs, must be calculated using the standardized approach set forth in 12 CFR 324.37(b) or (c). For both derivatives and SFT exposures, the exposure amount to central counterparties must also include the default fund contribution.2

4444 Federal Register / Vol. 85, No. 16 / Friday, January 24, 2020 / Rules and Regulations

Scorecard measures 1 Description

(3) Largest Counterparty Ex- The largest total exposure amount to one counterparty divided by Tier 1 capital and reserves. The total exposure posure/Tier 1 Capital and amount is equal to the sum of the institution’s exposure amounts to one counterparty (or borrower) for deriva- tives, Reserves. SFTs, and cleared transactions, and its gross lending exposure (including all unfunded commitments) to that counterparty (or borrower). A counterparty includes an entity’s own affiliates. Exposures to entities that are affiliates of each other are treated as exposures to one counterparty (or borrower). Counterparty exposure ex- cludes all counterparty exposure to the U.S. Government and departments or agencies of the U.S. Government that is unconditionally guaranteed by the full faith and credit of the United States. The exposure amount for de- rivatives, including OTC derivatives, cleared transactions that are derivative contracts, and netting sets of deriv- ative contracts, must be calculated using the methodology set forth in 12 CFR 324.34(b), but without any re- duction for collateral other than cash collateral that is all or part of variation margin and that satisfies the re- quirements of 12 CFR 324.10(c)(4)(ii)(C)(1)(ii) and (iii) and 324.10(c)(4)(ii)(C)(3) through (7). The exposure amount associated with SFTs, including cleared transactions that are SFTs, must be calculated using the standardized approach set forth in 12 CFR 324.37(b) or (c). For both derivatives and SFT exposures, the expo- sure amount to central counterparties must also include the default fund contribution.2

* * * * * * * 1 The FDIC retains the flexibility, as part of the risk-based assessment system, without the necessity of additional notice-and-comment rule- making, to update the minimum and maximum cutoff values for all measures used in the scorecard. The FDIC may update the minimum and maximum cutoff values for the higher-risk assets to Tier 1 capital and reserves ratio in order to maintain an approximately similar distribution of higher-risk assets to Tier 1 capital and reserves ratio scores as reported prior to April 1, 2013, or to avoid changing the overall amount of as- sessment revenue collected. 76 FR 10672, 10700 (February 25, 2011). The FDIC will review changes in the distribution of the higher-risk assets to Tier 1 capital and reserves ratio scores and the resulting effect on total assessments and risk differentiation between banks when determining changes to the cutoffs. The FDIC may update the cutoff values for the higher-risk assets to Tier 1 capital and reserves ratio more frequently than annually. The FDIC will provide banks with a minimum one quarter advance notice of changes in the cutoff values for the higher-risk assets to Tier 1 capital and reserves ratio with their quarterly deposit insurance invoice. 2 EAD and SFTs are defined and described in the compilation issued by the Basel Committee on Banking Supervision in its June 2006 docu- ment, ‘‘International Convergence of Capital Measurement and Capital Standards.’’ The definitions are described in detail in Annex 4 of the docu- ment. Any updates to the Basel II capital treatment of counterparty credit risk would be implemented as they are adopted. http://www.bis.org/ publ/bcbs128.pdf.

* * * * * By order of the Board of Governors of the Dated at Washington, DC, on November 19, Federal Reserve System, November 19, 2019. 2019. Dated: November 18, 2019. Annmarie H. Boyd, Morris R. Morgan, Ann E. Misback, Assistant Executive Secretary. First Deputy Comptroller, Comptroller of the Secretary of the Board. Currency. Federal Deposit Insurance Corporation. [FR Doc. 2019–27249 Filed 1–23–20; 8:45 am] By order of the Board of Directors. BILLING CODE 4810–33–P