Finalized Guidance Document Concerning the Implementation of Basel III

Revise the Shortcut Method for Estimating Effective EPE The following is a summary of the components. • Applicable to IMM banks • Amended ‘’short-cut‘’ method to take more realistic simplifying assumptions to estimate Effective EPE when a bank is unable to model margin requirements along with exposures 104. In order to elaborate on the aforementioned, Paragraph 41 of Annex 4 1 in Basel II will be revised as follows: 41. Shortcut method: a bank that can model EPE without margin agreements but cannot achieve the higher level of modeling sophistication to model EPE with margin agreements can use the following method for margined counterparties subject to re-margining and daily mark-to-market as described in paragraph 41 (i) 2 . The method is a simple approximation to Effective EPE and sets Effective EPE for a margined counterparty equal to the lesser of: a) Effective EPE without any held or posted margining collateral, plus any collateral that has been posted to the counterparty independent of the daily valuation and margining process or current exposure (ie initial margin or independent amount); or b) An add-on that reflects the potential increase in exposure over the margin period of risk plus the larger of i. the current exposure net of and including all collateral currently held or posted, excluding any collateral called or in dispute; or ii. the largest net exposure including all collateral held or posted under the margin agreement that would not trigger a collateral call. This amount should reflect all applicable thresholds, minimum transfer amounts, independent amounts and initial margins under the margin agreement. The add-on is calculated as E[max(ΔMtM, 0)], where E[…] is the expectation (ie the average over scenarios) and ΔMtM is the possible change of the mark-to-market value of the transactions during the margin period of risk. Changes in the value of collateral need to be reflected using the supervisory haircut method or the internal estimates method, but no collateral payments are assumed during the margin period of risk. The margin period of risk is subject to the supervisory floor specified in paragraphs 41(i) to 41(iii). Backtesting should test whether realized (current) exposures are consistent with the shortcut method prediction over all margin periods within one year. If some of the trades in the netting set have a maturity of less than one year, and the netting set has higher risk factor sensitivities without these trades, this fact should be taken into account. If backtesting indicates that effective EPE is underestimated, the bank should take actions to make the method more conservative, eg by scaling up risk factor moves. 1 Annex 5 of this document . 2 Where a bank generally uses this shortcut method to measure Effective EPE, this shortcut method may be used by a bank that is a clearing member in a CCP for its transactions with the CCP and with clients, including those client transactions that result in back-to-back trades with a CCP. 6.4.2 Preclude Downgrade Triggers from Being Reflected in EAD As a summary: • Applicable to IMM banks • Downgrade triggers in margin agreements resulted in liquidity strains for market participants during the crisis • Prevent the reflection in EAD of any clause in a collateral agreement that requires receipt of collateral when a counterparty’s credit quality deteriorates (downgrade triggers) 105. In order to explicitly disallow downgrade triggers in EAD, a new paragraph 41(iv) will be inserted into Annex 4 1 to read as follows: 41(iv). Banks using the internal models method must not capture the effect of a reduction of EAD due to any clause in a collateral agreement that requires receipt of collateral when counterparty credit quality deteriorates. 1 Annex 5 of this document .