1. For the purposes of the application of this Article, Annex II shall include a reference to derivative instruments for the transfer of credit risk as mentioned in point (8) of Section C of Annex I to Directive 2004/39/EC.
2. When calculating risk-weighted exposure amounts for counterparty risk of items in the trading book, institutions shall comply with the following principles:
(a) in the case of total return swap credit derivatives and credit default swap credit derivatives, to obtain a figure for potential future credit exposure under the method set out in Section 3, the nominal amount of the instrument shall be multiplied by the following percentages:
(i) 5 %, where the reference obligation is one that, if it gave rise to a direct exposure of the institution, would be a qualifying item for the purposes of Part Three, Title IV, Chapter 2;
(ii) 10 %, where the reference obligation is one that, if it gave rise to a direct exposure of the institution, would not be a qualifying item for the purposes of Part Three, Title IV, Chapter 2.
In the case of an institution whose exposure arising from a credit default swap represents a long position in the underlying, the percentage for potential future credit exposure may be 0 %, unless the credit default swap is subject to close-out upon the insolvency of the entity whose exposure arising from the swap represents a short position in the underlying, even though the underlying has not defaulted.
Where the credit derivative provides protection in relation to ‘nth to default’ amongst a number of underlying obligations, an institution shall determine which of the percentage figures set out in the first subparagraph applies by reference to the obligation with the nth lowest credit quality which, if incurred by the institution, would be a qualifying item for the purposes of Part Three, Title IV, Chapter 2;
(b) institutions shall not use the Financial Collateral Simple Method set out in Article 222 for the recognition of the effects of financial collateral;
(c) in the case of repurchase transactions and securities or commodities lending or borrowing transactions booked in the trading book, institutions may recognise as eligible collateral all financial instruments and commodities that are eligible to be included in the trading book;
(d) for exposures arising from OTC derivative instruments booked in the trading book, institutions may recognise commodities that are eligible to be included in the trading book as eligible collateral;
(e) for the purposes of calculating volatility adjustments where such financial instruments or commodities which are not eligible under Chapter 4 are lent, sold or provided, or borrowed, purchased or received by way of collateral or otherwise under such a transaction, and an institution is using the Supervisory Volatility Adjustments Approach under Section 3 of Chapter 4, institutions shall treat such instruments and commodities in the same way as non-main index equities listed on a recognised exchange;
(f) where an institution is using the Own Estimates of Volatility adjustments Approach under Section 3 of Chapter 4 in respect of financial instruments or commodities which are not eligible under Chapter 4, it shall calculate volatility adjustments for each individual item. Where an institution has obtained the approval to use the internal models approach defined in Chapter 4, it may also apply that approach in the trading book;
(g) in relation to the recognition of master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions, or other capital market-driven transactions, institutions shall only recognise netting across positions in the trading book and the non-trading book when the netted transactions fulfil the following conditions:
(i) all transactions are marked to market daily;
(ii) any items borrowed, purchased or received under the transactions may be recognised as eligible financial collateral under Chapter 4 without the application of points (c) to (f) of this paragraph;
(h) where a credit derivative included in the trading book forms part of an internal hedge and the credit protection is recognised under this Regulation in accordance with Article 204, institutions shall apply one of the following approaches:
(i) treat it as if there were no counterparty risk arising from the position in that credit derivative;
(ii) consistently include for the purpose of calculating the own funds requirements for counterparty credit risk all credit derivatives in the trading book forming part of internal hedges or purchased as protection against a CCR exposure where the credit protection is recognised as eligible under Chapter 4.