Banks Act, 1990 (Act No. 94 of 1990)RegulationsRegulations relating to BanksChapter II : Financial, Risk-based and other related Returns and Instructions, Directives and Interpretations relating to the completion thereof23. Credit risk: monthly returnDirectives and interpretations for completion of monthly return concerning credit risk (Form BA 200)Subregulation (19) Calculation of counterparty credit exposure in terms of the internal model methodSubregulation (19)(a) Matters relating to the exposure amount or EAD, and matters related thereto |
| (a) | Matters relating to the exposure amount or EAD, and matters related thereto |
A bank that obtained the approval of the Registrar to adopt the internal model method for the measurement of the bank's exposure to counterparty credit risk—
| (i) | shall calculate its counterparty credit exposure or EAD amount at the level of each relevant netting set and through the application of the formulae specified below, provided that— |
| (A) | the bank shall in no case capture the effect of a reduction of EAD due to a clause in a collateral agreement that requires receipt of collateral when counterparty credit quality deteriorates; |
| (B) | when the bank's internal model includes the effect of collateral on changes in the market value of the netting set, the bank shall jointly model collateral other than cash of the same currency as the exposure itself with the exposure in its EAD calculations for securities financing transactions; |
| (C) | when the bank is unable to jointly model any relevant eligible collateral with the exposure to recognise in its EAD calculations for OTC derivatives the effect of collateral, other than cash of the same currency as the exposure itself, the bank shall apply either haircuts that meet the standards of the financial collateral comprehensive approach specified in subregulation (9) of these Regulations with own haircut estimates or the standard haircuts specified in subregulation (9)(b)(xi); |
| (D) | when the bank identified specific wrong way risk in respect of a counterparty, the bank shall calculate its relevant counterparty credit exposure or EAD amount and any related amount of required capital and reserve funds in accordance with the relevant requirements specified in subparagraph (ii) below. |
Exposure amount or EAD = α x EEPE
where:
| EAD | is the relevant exposure amount or exposure at default |
| α | is an alpha factor, which alpha factor shall be equal to 1.4 if the bank complies with all the relevant qualitative requirements specified in regulations 39(8) to 39(12) of these Regulations, provided that— |
| (i) | based on the reporting bank's exposure to counterparty credit risk, the bank's backtesting results of its model, the bank's level of compliance with the qualitative requirements specified in regulations 39(8) to 39(12) of these Regulations, and the related risk factors, the Registrar may specify a higher alpha factor, which related risk factors may include low granularity of counterparties, high exposures to general wrong-way risk or high correlation of market values across counterparties; |
| ii) | subject to the prior written approval of the Registrar and in accordance with the relevant requirements specified in paragraph (b) below, the bank may estimate its own alpha factor |
| EEPE | is the effective expected positive exposure, which effective expected positive exposure is the weighted average effective expected exposure during the first year of future exposure calculated across possible future values of relevant market risk factors such as interest rates or foreign exchange rates and in accordance with the formula specified below, provided that when all contracts in the relevant netting set mature before one year, effective expected positive exposure shall be the weighted average of effective expected exposure until all contracts in the netting set mature |
| Effective EPE= |  |
| where: |
| EE | is the expected exposure amount estimated by the bank's internal model at the relevant series of future dates |
and
the weights 
make provision for the cases when future exposure is calculated at dates that are not equally spaced over time
effective expected exposure shall be calculated recursively through the application of the formula specified below
Effective EEtk = max (effective EEtk-1, EEtk)
where:
| current date | shall be denoted by to |
and
| Effective EEto | shall be equal to the current exposure |
| (ii) | shall in the case of an instrument where a connection exists between the counterparty and the underlying issuer, and for which specific wrong way risk has been identified, calculate its relevant counterparty credit exposure or EAD amount and any related required amount of capital and reserve funds in accordance with the relevant requirements specified in this subparagraph (II), provided that— |
| (A) | when calculating its relevant required amount of capital and reserve funds for counterparty credit risk, the relevant aforesaid instrument in respect of which a connection exists between the counterparty and the underlying issuer shall be regarded as not being part of the same netting set as other transactions with that counterparty; |
| (B) | in the case of a single-name credit default swap, the exposure or EAD amount in respect of that swap counterparty shall be equal to the full expected loss in the remaining fair value of the underlying instruments assuming the underlying issuer is in liquidation; |
The use of the full amount of expected loss in remaining fair value of the underlying instrument allows the bank to recognise, in respect of such swap, the market value that has already been lost and any expected recoveries.
Accordingly, for such swap transactions, a bank that adopted—
| (i) | the standardised approach for the measurement of the bank's exposure to credit risk shall apply the relevant risk weight applicable to an unsecured transaction; |
| (ii) | the foundation or advanced IRB approach for the measurement of the bank's exposure to credit risk shall set LGD equal to 100 per cent. |
Recoveries may be possible on the underlying instrument beneath such a swap. The relevant capital requirement for such underlying exposure shall be calculated without reduction for the swap that introduces wrong way risk. Normally this will result in the underlying exposure being risk weighted equivalent to an unsecured transaction, that is, assuming the underlying exposure is an unsecured credit exposure.
| (C) | in the case of equity derivatives, bond options, securities financing transactions, etc., referencing a single company, EAD shall be equal to the value of the transaction under the assumption of a jump-to-default of the underlying security, provided that when this results in the re-use of possibly existing market risk calculations for IRC that already contain an LGD assumption, the LGD shall be set equal to 100 per cent; |
| (iii) | shall calculate an expected exposure amount or peak exposure amount based on a distribution of exposures that accounts for any non-normality in the said distribution of exposures, including any leptokurtosis, that is, fat tails; |
| (iv) | may, subject to the prior written approval of and such conditions as may be specified in writing by the Registrar, instead of calculating the exposure amount or EAD by multiplying effective expected positive exposure with the specified alpha factor specified in subparagraph (i) above, use a more conservative measure than effective expected positive exposure, such as a VaR model for counterparty exposure or another measure based on peak exposure instead of average exposure; |
| (v) | may in the calculation of its counterparty credit exposure or EAD apply any form of internal model, including a simulation model or analytical model, provided that— |
| (A) | the said internal model adopted by the reporting bank shall specify the forecasting distribution for changes in the market value of a netting set attributable to changes in market variables such as interest rates or foreign exchange rates, which forecasting distribution for changes in the market value of a netting set may include eligible financial collateral specified in subregulation (9)(b)(iv), provided that the bank shall in respect of the said collateral comply with the relevant quantitative, qualitative and data requirements relating to the internal model method, specified in this subregulation (19); |
| (B) | in respect of each relevant future date and based on the changes in the market variables, the model shall compute the bank's exposure to counterparty credit risk relating to a particular netting set; |
| (C) | in the case of a counterparty subject to a margining agreement, the model may capture future movements in the value of collateral; |
| (D) | to the extent that the reporting bank recognises collateral in the estimation of an exposure amount or EAD via current exposure, the bank shall not recognise the said benefit of collateral in its estimates of LGD, that is, the bank shall apply an LGD ratio of an otherwise similar uncollateralised facility when the bank recognises the value of collateral obtained in the estimation of an exposure amount or EAD; |
| (E) | the bank shall at all times comply with the relevant requirements specified in paragraph (f) below. |
| (vi) | shall determine the effective maturity relating to a particular netting set in accordance with the relevant requirements specified in paragraph (c) below; |
| (vii) | shall not in the calculation of its exposure amount or EAD apply any cross-product netting otherwise than in accordance with the relevant requirements specified in paragraph (d) below. |
| (viii) | shall in respect of any netting set subject to margining calculate the relevant exposure in accordance with the relevant requirements specified in paragraph (e) below; |
| (ix) | may in respect of any OTC derivative transaction or contract subject to novation or a legally enforceable bilateral netting agreement recognize the effect of the said novation or netting agreement in accordance with the relevant requirements specified in subregulation (17) above. |