Directive 2000/12/EC of the European Parliament and of the CouncilShow full title

ANNEX III

THE TREATMENT OF OFF-BALANCE-SHEET ITEMS

1. CHOICE OF THE METHOD U.K.

To measure the credit risks associated with the contracts listed in points 1 and 2 of Annex IV, credit institutions may choose, subject to the consent of the competent authorities, one of the methods set out below. Credit institutions which have to comply with Article 6(1) of Directive 93/6/EEC(1) must use method 1 set out below. To measure the credit risks associated with the contracts listed in point 3 of Annex IV all credit institutions must use method 1 set out below.

2. METHODS U.K.

Method 1: the ‘mark to market’ approach U.K.

• by attaching current market values to contracts (mark to market), the current replacement cost of all contracts with positive values is obtained.

• to obtain a figure for potential future credit exposure(2), the notional principal amounts or underlying values are multiplied by the following percentages:

  TABLE 1^{a b}

  a Contracts which do not fall within one of the five categories indicated in this table shall be treated as contracts concerning commodities other than precious metals.
  b For contracts with multiple exchanges of principal, the percentages have to be multiplied by the number of remaining payments still to be made according to the contract.
  c For contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset such that the market value of the contract is zero on these specified dates, the residual maturity would be equal to the time until the next reset date. In the case of interest-rate contracts that meet these criteria and have a remaining maturity of over one year, the percentage shall be no lower than 0,5 %.
  Residual maturityc	Interest-rate contracts	Contracts concerning foreign-exchange rates and gold	Contracts concerning equities	Contracts concerning precious metals except gold	Contracts concerning commodities other than precious metals
  One year or less	0 %	1 %	6 %	7 %	10 %
  Over one year, less than five years	0,5 %	5 %	8 %	7 %	12 %
  Over five years	1,5 %	7,5 %	10 %	8 %	15 %

  For the purpose of calculating the potential future exposure in accordance with step (b) the competent authorities may allow credit institutions until 31 December 2006 to apply the following percentages instead of those prescribed in Table 1 provided that the institutions make use of the option set out in Article 11a of Directive 93/6/EEC for contracts within the meaning of paragraph 3(b) and (c) of Annex IV:

  TABLE 1a

  Residual maturity	Precious metals (except gold)	Base metals	Agricultural products (softs)	Other, including energy products
  One year or less	2 %	2,5 %	3 %	4 %
  Over one year, less than five years	5 %	4 %	5 %	6 %
  Over five years	7,5 %	8 %	9 %	10 %

• the sum of current replacement cost and potential future credit exposure is multiplied by the risk weightings allocated to the relevant counterparties in Article 43.

Method 2: the ‘original exposure’ approach U.K.

• the notional principal amount of each instrument is multipliedby the percentages given below:

  TABLE 2

  a In the case of interest-rate contracts, credit institutions may, subject to the consent of their competent authorities, choose either original or residual maturity.
  Original maturitya	Interest-rate contracts	Contracts concerning foreign-exchange rates and gold
  One year or less	0,5 %	2 %
  More than one year but not exceeding two years	1 %	5 %
  Additional allowance for each additional year	1 %	3 %

• the original exposure thus obtained is multiplied by the risk weightings allocated to the relevant counterparties in Article 43.

For methods 1 and 2 the competent authorities must ensure that the notional amount to be taken into account is an appropriate yardstick for the risk inherent in the contract. Where, for instance, the contract provides for a multiplication of cash flows, the notional amount must be adjusted in order to take into account the effects of the multiplication on the risk structure of that contract.

3. CONTRACTUAL NETTING (CONTRACTS FOR NOVATION AND OTHER NETTING AGREEMENTS) U.K.

(a) Types of netting that competent authorities may recognise U.K.

For the purpose of this point 3 ‘counterparty’ means any entity (including natural persons) that has the power to conclude a contractual netting agreement.

The competent authorities may recognise as risk-reducing the following types of contractual netting:

(i)

bilateral contracts for novation between a credit institution and its counterparty under which mutual claims and obligations are automatically amalgamated in such a way that this novation fixes one single net amount each time novation applies and thus creates a legally binding, single new contract extinguishing former contracts;

(ii)

other bilateral agreements between a credit institution and its counterparty.

(b) Conditions for recognition U.K.

The competent authorities may recognise contractual netting as risk-reducing only under the following conditions:

(i)

a credit institution must have a contractual netting agreement with its counterparty which creates a single legal obligation, covering all included transactions, such that, in the event of a counterparty's failure to perform owing to default, bankruptcy, liquidation or any other similar circumstance, the credit institution would have a claim to receive or an obligation to pay only the net sum of the positive and negative mark-to-market values of included individual transactions;

(ii)

a credit institution must have made available to the competent authorities written and reasoned legal opinions to the effect that, in the event of a legal challenge, the relevant courts and administrative authorities would, in the cases described under (i), find that the credit institution's claims and obligations would be limited to the net sum, as described in (i), under:

• the law of the jurisdiction in which the counterparty is incorporated and, if a foreign branch of an undertaking is involved, also under the law of the jurisdiction in which the branch is located,

• the law that governs the individual transactions included, and

• the law that governs any contract or agreement necessary to effect the contractual netting;

(iii)

a credit institution must have procedures in place to ensure that the legal validity of its contractual netting is kept under review in the light of possible changes in the relevant laws.

The competent authorities must be satisfied, if necessary after consulting the other competent authorities concerned, that the contractual netting is legally valid under the law of each of the relevant jurisdictions. If any of the competent authorities are not satisfied in that respect, the contractual netting agreement will not be recognised as risk-reducing for either of the counterparties.

The competent authorities may accept reasoned legal opinions drawn up by types of contractual netting.

No contract containing a provision which permits a non-defaulting counterparty to make limited payments only, or no payments at all, to the estate of the defaulter, even if the defaulter is a net creditor (a ‘walkaway’ clause), may be recognised as risk-reducing.

The competent authorities may recognise as risk-reducing contractual-netting agreements covering foreign-exchange contracts with an original maturity of 14 calendar days or less written options or similar off-balance-sheet items to which this Annex does not apply because they bear only a negligible or no credit risk. If, depending on the positive or negative market value of these contracts, their inclusion in another netting agreement can result in an increase or decrease of the capital requirements, competent authorities must oblige their credit institution to use a consistent treatment.

(c) Effects of recognition U.K.

(i) Contracts for novation U.K.

The single net amounts fixed by contracts for novation, rather than the gross amounts involved, may be weighted. Thus, in the application of method 1, in

• step (a): the current replacement cost, and in

• step (b): the notional principal amounts or underlying values

may be obtained taking account of the contract for novation. In the application of method 2, in step (a) the notional principal amount may be calculated taking account of the contract for novation; the percentages of Table 2 must apply.

(ii) Other netting agreements U.K.

In application of method 1:

• in step (a) the current replacement cost for the contracts included in a netting agreement may be obtained by taking account of the actual hypothetical net replacement cost which results from the agreement; in the case where netting leads to a net obligation for the credit institution calculating the net replacement cost, the current replacement cost is calculated as ‘0’,

• in step (b) the figure for potential future credit exposure for all contracts included in a netting agreement may be reduced according to the following equation:

  

  where:

  — PCE_red

  =

  the reduced figure for potential future credit exposure for all contracts with a given counterparty included in a legally valid bilateral netting agreement,

  — PCE_gross

  =

  the sum of the figures for potential future credit exposure for all contracts with a given counterparty which are included in a legally valid bilateral netting agreement and are calculated by multiplying their notional principal amounts by the percentages set out in Table 1,

  — NGR

  =

  ‘net-to-gross ratio’: at the discretion of the competent authorities either:

  (i)

  separate calculation: the quotient of the net replacement cost for all contracts included in a legally valid bilateral netting agreement with a given counterparty (numerator) and the gross replacement cost for all contracts included in a legally valid bilateral netting agreement with that counterparty (denominator), or

  (ii)

  aggregate calculation: the quotient of the sum of the net replacement cost calculated on a bilateral basis for all counterparties taking into account the contracts included in legally valid netting agreements (numerator) and the gross replacement cost for all contracts included in legally valid netting agreements (denominator).

  If Member States permit credit institutions a choice of methods, the method chosen is to be used consistently.

For the calculation of the potential future credit exposure according to the above formula perfectly matching contracts included in the netting agreement may be taken into account as a single contract with a notional principal equivalent to the net receipts. Perfectly matching contracts are forward foreign-exchange contracts or similar contracts in which a notional principal is equivalent to cash flows if the cash flows fall due on the same value date and fully or partly in the same currency.

In the application of method 2, in step (a)

• perfectly matching contracts included in the netting agreement may be taken into account as a single contract with a notional principal equivalent to the net receipts, the notional principal amounts are multiplied by the percentages given in Table 2,

• for all other contracts included in a netting agreement, the percentages applicable may be reduced as indicated in Table 3:

TABLE 3

a In the case of interest-rate contracts, credit institutions may, subject to the consent of their competent authorities, choose either original or residual maturity.
Original maturitya	Interest-rate contracts	Foreign-exchange contracts
One year or less	0,35 %	1,5 %
More than one year but not more than two years	0,75 %	3,75 %
Additional allowance for each additional year	0,75 %	2,25 %

(1)

Council Directive 93/6/EEC of 15 March 1993 on the capital adequacy of investment firms and credit institutions (OJ L 141, 11.6.1993, p. 1). Directive amended by Directive 98/33/EC (OJ L 204, 21.7.1998, p. 29).

(2)

Except in the case of single-currency ‘floating/floating’ interest rate swaps in which only the current replacement cost will be calculated.