Minimum Capital Requirements for Counterparty Credit Risk (CCR) and Credit Valuation Adjustment (CVA)

(expressed in USD thousands): EAD = alpha * (RC + multip; ier * AddOn aggregate ) = 1.4 * (60 + 1 * 347) = 569 Example 2: Credit derivatives (unmargined netting set) 12.22. Netting set 2 consists of three credit derivatives: one long single-name credit default swap (CDS) written on Firm A (rated AA), one short single-name CDS written on Firm B (rated BBB), and one long CDS index (investment grade). The table below summarizes the relevant contractual terms of the three derivatives. All notional amounts and market values in the table are in USD thousands. Trade # Nature Reference entity/index name Rating reference entity Residual maturity Base currency Notional (USD thousands) Position Market value (USD thousands) 1 Single name CDS Firm A AA 3 years USD 10,000 Protection buyer 20 2 Single-name CDS Firm B BBB 6 years EUR 10,000 Protection seller -40 3 CDS CDX.IG 5y Investment grade 5 years USD 10,000 Protection buyer 0 12.23. As in the previous example, the netting set is not subject to a margin agreement and there is no exchange of collateral (independent amount/IM) at inception. For unmargined netting sets, the replacement cost is calculated using the following formula, where: (1) V is a simple algebraic sum of the derivatives' market values at the reference date (2) C is the haircut value of the IM, which is zero in this example RC = max { V - C ; 0} 12.24. Thus, using the market values indicated in the table (expressed in USD thousands): RC = max {20 - 40 + 0 - 0; 0} = 0 12.25. Since in this example V-C is negative (equal to V, i.e. -20,000), the multiplier will be activated (i.e. it will be less than 1). Before calculating its value, the aggregate add-on ( AddOn aggregate ) needs to be determined. 12.26. All the transactions in the netting set belong to the credit derivatives asset class. The AddOn aggregate for the credit derivatives asset class can be calculated using the four steps set out in 6.64. 12.27. Step 1: Calculate the effective notional for each trade in the netting set. This is calculated as the product of the following three terms: (i) the adjusted notional of the trade (d); (ii) the supervisory delta adjustment of the trade (δ); and (iii) the maturity factor (MF). That is, for each trade i, the effective notional Di is calculated as D i = d i * MF i * δ i . 12.28. For credit derivatives, like interest rate derivatives, the trade-level adjusted notional ( d i ) is the product of the trade notional amount and the supervisory duration ( SD i ), i.e. d i = notional * SD i . The trade-level adjusted notional amounts for each of the trades in Example 2 are as follows: Trade # Notional (USD thousand) S i E i SD i Adjusted notional, d i (USD thousands) 1 10,000 0 3 2.79 27,858 2 10,000 0 6 5.18 51,836 3 5,000 0 5 4.42 44,240 12.29. 6.51 sets out the calculation of the maturity factor (MF i ) for unmargined trades. For trades that have a remaining maturity in excess of one year, which is the case for all trades in this example, the formula gives a maturity factor of 1. 12.30. As set out in 6.40 to 6.43, a supervisory delta is assigned to each trade. In particular: (1) Trade 1 and Trade 3 are long in the primary risk factors (CDS spread) and are not options so the supervisory delta is equal to 1 for each trade. (2) Trade 2 is short in the primary risk factor and is not an option; thus, the supervisory delta is equal to -1. 12.31. The effective notional for each trade in the netting set ( D i ) is calculated using the formula D i = d i * MF i * δ i and values for each term noted above. The results of applying the formula are as follows: Trade # Notional (USD thousands) Adjusted notional, d i (USD, thousands) Maturity Factor, MF i Delta, δ i Effective notional, D i (USD, thousands) 1 10,000 27,858 1 1 27,858 2 10,000 51,836 1 -1 -51,836 3 10,000 44,240 1 1 44,240 12.32. Step 2: Calculate the combined effective notional for all derivatives that reference the same entity. The combined effective notional of the entity ( EN e