Can a Bank with a netting set to a QCCP counterparty combining cash instruments (already settled) with derivatives apply the cross-product netting?
Article 429a (Calculation of the exposure value of derivatives) of Commission Delegated Regulation (EU) 2015/62 of 10 October 2014, states that “In determining the exposure value, institutions may take into account the effects of contracts for novation and other netting agreements in accordance with Article 295. Cross product netting shall not apply. However, institutions may net within the product category referred to in point (25) (c) of Article 272 ...."
It is our understanding that cross-product netting derivative to derivative is the one contemplated in such article. However a much common way to reduce the derivative exposure is to have the cash equity or bond as part of a portfolio that combines cash instruments (already settled) with derivatives with the condition that both cash instruments and derivatives are part of a portfolio within a QCCP. This means that an account holder in a CCP with a long equity or bond position fully pledged to the QCCP can be offset with a short position of equivalent derivative instrument.
The example would be a bank member or with an individual segregated client in the QCCP with a long 100 shares fully pledged to the CCP and short a futures contract in the same underlying, HAS NO LEVERAGE AT ALL AS BOTH LEGS OF THE POSITION ARE UNCONDITIONALLY TIED UP TO THE CCP. For this reason preventing cash instruments fully pledged to the QCCP to be diminishing derivatives exposures has no reason behind the final goal of limiting derivatives exposure with the leverage ratio. It would be quite illogical that for the purpose of calculating leverage ratio it is allowed a exposure reduction on a combined position of long futures and short synthetic (short call and long put) and not allowing the reduction with a position of long cash instrument and short synthetic.
The netting rules, applicable in order to determine the exposure value of derivatives, are laid down in the second
last subparagraph of Article 429c(1) 429a(1) of Regulation (EU) No 575/2013 (CRR) as amended by Regulation (EU) 2015/62. According to this subparagraph the third subparagraph, cross-product netting shall not apply. Under certain conditions, however, institutions may net within the same product category as referred to in point 25(c) of Article 272 CRR and credit derivatives being where they are subject to a contractual cross-product netting agreement as referred to in point (c) of (Article 295 (c) of the CRR ). The legal text thus does not provide the possibility to net cash instruments with derivatives.
Update 26.03.2021: This Q&A has been updated in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR).