02-029 C.M.R. ch. 128, § 8 - CREDIT EXPOSURE ARISING FROM DERIVATIVE TRANSACTIONS

1. Scope. This section sets forth the rules for calculating the credit exposure arising from a derivative transaction entered into by a financial institution for purposes of determining the financial institution's lending limit pursuant to this regulation.

2. Derivative transactions

A. Non-Credit Derivatives. Subject to paragraph 2(B) of this section, a financial institution shall calculate the credit exposure to a counterparty arising from a derivative transaction by one of the following methods. A financial institution shall use the same method for calculating counterparty credit exposure arising from all of its derivative transactions.

(1) Conversion Factor Matrix Method. The credit exposure arising from a derivative transaction under the Conversion Factor Matrix Method shall equal and remain fixed at the potential future credit exposure of the derivative transaction as determined at the execution of the transaction by reference to Table 1 below. Potential future exposure is equal to the notional value at origination multiplied by the conversion factor.

Table 1-Conversion Factor Matrix for Calculating Potential Future Credit Exposure.1
Original maturity 2	Interest Rate	Foreign exchange rate and gold	Equity	Other3 (includes commodities and precious metals except gold)
1 year or less...............	.015	.015	.20	.06
Over 1 to 3 years..........	.03	.03	.20	.18
Over 3 to 5 years...........	.06	.06	0.20	0.30
Over 5 to 10 years.........	.12	.12	0.20	.60
Over ten years..............	.30	.30	.20	1.0

(2) Remaining Maturity Method. The credit exposure arising from a derivative transaction under the Remaining Maturity Method shall equal the greater of zero or the sum of the current mark-to-market value of the derivative transaction added to the product of the notional amount of the transaction, the remaining maturity in years of the transaction, and a fixed multiplicative factor determined by reference to Table 2, below.

TABLE 2-REMAINING MATURITY FACTOR FOR CALCULATING CREDIT EXPOSURE
	Interest Rate	Foreign exchange rate and gold	Equity	Other 4 (includes commodities and precious metals except gold)
Multiplicative Factor	1.5%	1.5%	6%	6%

B. Credit Derivatives

(1) Notwithstanding paragraph 2(A) of this section, a financial institution that uses the Conversion Factor Matrix Method or Remaining Maturity Method shall calculate the counterparty credit exposure arising from credit derivatives entered by the financial institution by adding the net notional value of all protection purchased from the counterparty on each reference entity.

(2) A financial institution shall calculate the credit exposure to a reference entity arising from credit derivatives entered by the financial institution by adding the notional value of all protection sold on the reference entity. However, the financial institution may reduce its exposure to a reference entity by the amount of any eligible credit derivative purchased on that reference entity from an eligible protection provider.

¹ For an OTC 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 market 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 Transactions not explicitly covered by any other column in the Table are to be treated as "Other."

⁴ Transactions not explicitly covered by any other column in the Table are to be treated as "Other."

Notes

02-029 C.M.R. ch. 128, § 8