172. Where a supervisor applies a specific carve-out to repo-style transactions in securities issued by its domestic government, then other supervisors may choose to allow banks incorporated in their jurisdiction to adopt the same approach to the same transactions.

Treatment of repo-style transactions covered under master netting agreements

173. The effects of bilateral netting agreements covering repo-style transactions will be recognised on a counterparty-by-counterparty basis if the agreements are legally enforceable in each relevant jurisdiction upon the occurrence of an event of default and regardless of whether the counterparty is insolvent or bankrupt.

In addition, netting agreements must:

(a) provide the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon an event of default, including in the event of insolvency or bankruptcy of the counterparty;

(b) provide for the netting of gains and losses on transactions (including the value of any collateral) terminated and closed out under it so that a single net amount is owed by one party to the other;

(c) allow for the prompt liquidation or setoff of collateral upon the event of default; and

(d) be, together with the rights arising from the provisions required in (a) to (c) above, legally enforceable in each relevant jurisdiction upon the occurrence of an event of default and regardless of the counterparty's insolvency or bankruptcy.

174. Netting across positions in the banking and trading book will only be recognised when the netted transactions fulfil the following conditions:

(a) All transactions are marked to market daily; * and

(b) The collateral instruments used in the transactions are recognised as eligible financial collateral in the banking book.

* The holding period for the haircuts will depend as in other repo-style transactions on the frequency of margining.

175. The formula in paragraph 147 will be adapted to calculate the capital requirements for transactions with netting agreements.

176. For banks using the standard supervisory haircuts or own-estimate haircuts, the framework below will apply to take into account the impact of master netting agreements.

53. The starting point for this formula is the formula in paragraph 147 which can also be presented as the following:

E* = max {0, [(E – C) + (E x He) + (C x Hc) + (C x Hfx)]}.

177. The intention here is to obtain a net exposure amount after netting of the exposures and collateral and have an add-on amount reflecting possible price changes for the securities involved in the transactions and for foreign exchange risk if any.

The net long or short position of each security included in the netting agreement will be multiplied by the appropriate haircut. All other rules regarding the calculation of haircuts stated in paragraphs 147 to 172 equivalently apply for banks using bilateral netting agreements for repo-style transactions.

Use of models

178. As an alternative to the use of standard or own-estimate haircuts, banks may be permitted to use a VaR models approach to reflect the price volatility of the exposure and collateral for repo-style transactions, taking into account correlation effects between security positions.

This approach would apply to repo-style transactions covered by bilateral netting agreements on a counterparty-by-counterparty basis. At the discretion of the national supervisor, firms are also eligible to use the VaR model approach for margin lending transactions, if the transactions are covered under a bilateral master netting agreement that meets the requirements of paragraphs 173 and 174.

The VaR models approach is available to banks that have received supervisory recognition for an internal market risk model
according to paragraph 718 (LXX).

Banks which have not received supervisory recognition for use of models according to paragraph 718 (LXX) can separately apply for supervisory recognition to use their internal VaR models for calculation of potential price volatility for repo-style transactions.

Internal models will only be accepted when a bank can prove the quality of its model to the supervisor through the backtesting of its output using one year of historical data.

Banks must meet the model validation requirement of paragraph 43 of Annex 4 to use VaR for repo-style and other SFTs.

In addition, other transactions similar to repostyle transactions (like prime brokerage) and that meet the requirements for repo-style transactions, are also eligible to use the VaR models approach provided the model used meets the operational requirements set forth in Section I.F of Annex 4.

179. The quantitative and qualitative criteria for recognition of internal market risk models for repo-style transactions and other similar transactions are in principle the same as in paragraphs 718 (LXXIV) to 718 (LXXVI).

With regard to the holding period, the minimum will be 5-business days for repo-style transactions, rather than the 10-business days in paragraph 718 (LXXVI) (c). For other transactions eligible for the VaR models approach, the 10-business day holding period will be retained. The minimum holding period should be adjusted upwards for market instruments where such a holding period would be inappropriate given the liquidity of the instrument concerned.

180. (Deleted)

181. The calculation of the exposure E* for banks using their internal model will be the following:

E* = max {0, [(ΣE – ΣC) + VaR output from internal model]}

In calculating capital requirements banks will use the previous business day’s VaR number.

181 (i). Subject to supervisory approval, instead of using the VaR approach, banks may also calculate an expected positive exposure for repo-style and other similar SFTs, in accordance with the Internal Model Method set out in Annex 4 of this Framework.

(iii) The simple approach

Minimum conditions

182. For collateral to be recognised in the simple approach, the collateral must be pledged for at least the life of the exposure and it must be marked to market and revalued with a minimum frequency of six months.

Those portions of claims collateralised by the market value of recognised collateral receive the risk weight applicable to the collateral instrument.

The risk weight on the collateralised portion will be subject to a floor of 20% except under the conditions specified in paragraphs 183 to 185.

The remainder of the claim should be assigned to the risk weight appropriate to the counterparty.

A capital requirement will be applied to banks on either side of the collateralised transaction: for example, both repos and reverse repos will be subject to capital requirements.

Exceptions to the risk weight floor

183. Transactions which fulfil the criteria outlined in paragraph 170 and are with a core market participant, as defined in 171, receive a risk weight of 0%.

If the counterparty to the transactions is not a core market participant the transaction should receive a risk weight of
10%.

184. OTC derivative transactions subject to daily mark-to-market, collateralised by cash and where there is no currency mismatch should receive a 0% risk weight.

Such transactions collateralised by sovereign or PSE securities qualifying for a 0% risk weight in the standardised approach can receive a 10% risk weight.

185. The 20% floor for the risk weight on a collateralised transaction will not be applied and a 0% risk weight can be applied where the exposure and the collateral are denominated in the same currency, and either:

• the collateral is cash on deposit as defined in paragraph 145 (a); or

• the collateral is in the form of sovereign/PSE securities eligible for a 0% risk weight, and its market value has been discounted by 20%.

(iv) Collateralised OTC derivatives transactions

186. Under the Current Exposure Method, the calculation of the counterparty credit risk charge for an individual contract will be as follows:

counterparty charge = [(RC + add-on) – CA] x r x 8%

where:

RC = the replacement cost,

add-on = the amount for potential future exposure calculated according to paragraph 92(i) and 92(ii) of Annex 4,

CA = the volatility adjusted collateral amount under the comprehensive approach prescribed in paragraphs 147 to 172, or zero if no eligible collateral is applied to the transaction, and

r = the risk weight of the counterparty.

187. When effective bilateral netting contracts are in place, RC will be the net replacement cost and the add-on will be ANet as calculated according to paragraphs 96(i) to 96(vi) of Annex 4.

The haircut for currency risk (Hfx) should be applied when there is a mismatch between the collateral currency and the settlement currency.

Even in the case where there are more than two currencies involved in the exposure, collateral and settlement currency, a single haircut assuming a 10-business day holding period scaled up as necessary depending on the frequency of mark-to-market will be applied.

187(i). As an alternative to the Current Exposure Method for the calculation of the counterparty credit risk charge, banks may also use the Standardised Method and, subject to supervisory approval, the Internal Model Method as set out in Annex 4 of this Framework.

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