Under Article 429a(5) of the Regulation (EU) No 575/2013 (CRR), as modified by Commission Delegated Regulation (EU) 2015/62, for written credit derivatives, institutions shall include in the exposure value the effective notional amounts, in addition to the treatment laid down in paragraph 1. Is it allowable to exclude from the scope of written credit derivatives, OTC derivatives on high credit quality central government bonds?
High credit quality sovereign bonds are assigned a 0% risk weight under standard and internal methodologies. They do not bear any credit risk and as such may not be considered as credit derivatives.
According to Article 429a(5) of the Regulation (EU) No 575/2013 as amended by Commission Implementing Regulation (EU) 2015/62 (CRR) institutions shall in addition to the treatment laid down in Article 429a(1) CRR include in a written credit derivative’s exposure value the effective notional amounts referenced by this written credit derivative reduced by any negative fair value changes that have been incorporated in Tier 1 capital with respect to this written credit derivative. The resulting exposure may be reduced further by the effective notional amount of a purchased credit derivative on the same name, provided all of the conditions set out in points (a) to (e) of Article 429a(5) CRR are met.
There is no specific legal reference granting an institution the permission to exclude written credit derivatives from the leverage ratio’s exposure value of derivatives due to the underlying’s credit quality.
According to the legislator’s intention as laid down in Recital 10 of Commission Implementing Regulation (EU) 2015/62 calculating a written credit derivative’s exposure value by the Mark-To-Market Method as set out in Article 274 CRR is explicitly referred to as inappropriate to reflect the product’s leverage. Any deviation from the conditions set out in Article 429a(5) would be contrary to the legislator’s intention.
By taking into account the aforementioned considerations and the legislator’s objective to establish an accurate measure of an institution’s leverage via the leverage ratio - as set out in Recital 8 of Commission Implementing Regulation (EU) 2015/62 - amending the prescribed calculation of a written credit derivative’s exposure measure (based on the relevant underlying’s credit quality) is inappropriate. It is also not in line with the ultimate objective of the leverage ratio to serve as a supplementary non-risk based measure to the risk based capital requirement as stated in Recital 1 of the Regulation (EU) No 575/2013.