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

(the exercise date T i and the current value of the underlying P i of the digital option must be used). The absolute value of the digital-option effective notional must be capped by the ratio of the digital payoff to the relevant supervisory factor. (4) If a trade’s payoff can be represented as a combination of European option payoffs (e.g. collar, butterfly/calendar spread, straddle, strangle), each European option component must be treated as a separate trade. 6.45. For the purposes of effective notional calculations, multiple-payment options may be represented as a combination of single-payment options. In particular, interest rate caps/floors may be represented as the portfolio of individual caplets /floorlets, each of which is a European option on the floating interest rate over a specific coupon period. For each caplet/floorlet, S i and T i are the time periods starting from the current date to the start of the coupon period, while E i is the time period starting from the current date to the end of the coupon period. 6.46. In the case of options (e.g. interest rate caps/floors that may be represented as the portfolio of individual caplets/floorlets), banks may decompose those products in a manner consistent with 6.45. Banks may not decompose linear products (e.g. ordinary interest rate swaps). Supervisory factors: SF i 6.47. Supervisory factors ( SF i ) are used, together with aggregation formulas, to convert effective notional amounts into the add-on for each hedging set. 18 The way in which supervisory factors are used within the aggregation formulas varies between asset classes. The supervisory factors are listed in Table 2 under 6.75. Hedging sets 6.48. The hedging sets in the different asset classes are defined as follows, except for those described in 6.49 and 6.50: (1) Interest rate derivatives consist of a separate hedging set for each currency. (2) FX derivatives consist of a separate hedging set for each currency pair. (3) Credit derivatives consist of a single hedging set. (4) Equity derivatives consist of a single hedging set. (5) Commodity derivatives consist of four hedging sets defined for broad categories of commodity derivatives: energy, metals, agricultural and other commodities. 6.49. Derivatives that reference the basis between two risk factors and are denominated in a single currency 19 (basis transactions) must be treated within separate hedging sets within the corresponding asset class. There is a separate hedging set 20 for each pair of risk factors (i.e. for each specific basis). Examples of specific bases include three-month Libor versus six-month Libor, three-month Libor versus three-month T-Bill, one-month Libor versus overnight indexed swap rate, Brent Crude oil versus Henry Hub gas. For hedging sets consisting of basis transactions, the supervisory factor applicable to a given asset class must be multiplied by one-half. 6.50. Derivatives that reference the volatility of a risk factor (volatility transactions) must be treated within separate hedging sets within the corresponding asset class. Volatility hedging sets must follow the same hedging set construction outlined in