Would it be consistent with the intent of the CRR, if the adjustment to the residual maturity is made in circumstances where the terms of the trade are reset such that the mark to market of the contract is materially close but not perfectly zero? If this were not the case, it would be highly unlikely that under valuation principles imposed by current accounting standards and regulatory requirements that the clause could ever be applied in practice.
The regulation states that 'for contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset so that the market value of the contract is zero on those specified dates, the residual maturity shall be equal to the time until the next reset date.' The purpose of this provision is to better align the regulatory exposure measure to the risks in the transaction. The effect of setting the maturity equal to the next reset date is often to reduce the add-on for potential future exposure. This is justified by the fact that the future mark-to-market movement is significantly reduced by the regular reset. As an example, the industry trades a standard product that is defined by ISDA (Article 10 of the 2006 Definitions) under the name 'Mark-to-market Currency Swap'. Our understanding is that this paragraph is intended to apply to these Mark-to-market Currency Swaps (inter alia), notwithstanding that due to any 'Spread' associated with the Floating Amount, the MTM following the reset is reduced substantially to zero but not exactly to zero and the resultant MTM could be either an immaterial positive or negative amount. For these trades, the effect of the reset is to remove the MTM attributable to the primary risk. We believe that the requirement (dating from Basel 1) predates much of the additional complexity of current derivative valuation and that the intent of the requirement is met by normal market standard reset terms regardless of accounting complication arising from issues such as CVA, DVA, FFVA and other second order effects. We believe that the effect of the reset is to remove the primary risk of the trade and the risk, FX, that is used in table 1 of chapter 6 to calculate the appropriate potential future credit exposure.
In accordance with Article 274(2)(c) of Regulation (EU) No 575/2013 (CRR) the setting of the residual maturity equal to the time until the next reset date shall be applied only for such contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset so that the market value of the contract is zero on those specified dates.
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.