For the calculation of potential future credit exposure, when should the notional amount be used and when the underlying value? Which notional amount should be used: Notional of the derivative contract or notional of the underlying?

Example: Stock Option Stock Market Price: 100 Strike Price of the Option: 40 Number of Shares per Option contract: 10 Maturity of the contract: 6 months A credit institution buys 1 contract in the above option. Assuming there is no time value of the contract, the market price (option premium) would be 60. This gives the following values: Contract notional amount: 1 contract x 10 shares x 40 (notional) = 400 Contract market value: 1 contract x 10 shares x 60 = 600 Underlying nominal (= underlying market value): 1 contract x 10 shares x 100 (current market price) = 1000 Since the CRR should harmonize the calculation, we would expect no differences anymore, but the CRR is not clear what to use in that point.

According to Article 274(2) of Regulation (EU) No. 575/2013 (CRR), the potential future credit exposure is the product of the notional amount or underlying value and a percentage according to the table.

The notional amount or underlying value for derivatives of different asset classes should be determined as follows:

• For interest rates and credit derivatives, the notional amount is given in the underlying trade.
• For foreign exchange derivatives, in the event that just one leg of a derivative is denominated in a foreign currency, the notional amount of the foreign leg should be converted to the domestic currency and the leg with the larger domestic currency value is the adjusted notional amount. If both legs of a foreign exchange derivative (e.g. Cross Currency Interest Rate Swap) are denominated in currencies other than the domestic currency, the notional amount of each leg is converted to the domestic currency and the leg with the larger domestic currency value is the adjusted notional amount.
• For equity and commodity derivatives, where a trade notional amount is stated clearly in the contract, this notional amount should be used. Otherwise, the market value of the underlying should be used.

The example from the background section refers to a call option on a stock and provides a notional amount. Thus, the potential future credit exposure should be based on the notional amount , given by:

Notional amount x  number of shares  x  Percentage: 40 x 10 x 6% = 24 .

Update 16.09.2021: This Q&A has been archived in light of the change(s) in Article 274 to Regulation (EU) No 575/2013 (CRR), applicable from 28.06.2021.