According to Article 42 (a) institutions may calculate the amount of holdings of own Common Equity Tier 1 instruments on the basis of the net long position provided that both the following conditions are met:

(i) the long and short positions are in the same underlying exposure and the short positions involve no counterparty risk;

(ii) either both the long and the short positions are held in the trading book or both are held in the non-trading book;

Consider the following two cases:

We have a long forward position with underlying Own Common Equity Tier I instruments =30 and short forward position with underlying Own Common Equity Tier I instruments=20. Both long and short positions are maintained with the same counterparty and are included in a master netting agreement.

We have a long forward position with underlying Own Common Equity Tier I instruments =30 and short forward position with underlying Own Common Equity Tier I instruments=40. Both long and short positions are maintained with the same counterparty and are included in a master netting agreement.

According to Article 42 a) i)  long and short positions can be netted if the short positions involve no counterparty risk.

Interpretative doubts arise regarding the identification of short position within a master netting agreement. In our view, the master netting agreement should be considered one single contract,  the single net amounts fixed by such contracts rather than the gross amounts involved should be considered. In this regard if the single net amount is long there’s no short position (point 1 in the example above). If the single net amount is  short, it should be analyzed if the short position does involve counterparty risk.  

Explanatory note: The master netting agreement we are considering complies with the conditions required under CRR (Article 206)

Explanatory Text

Consider as an assumption that BBVA has long and short positions in its own equity maintained using derivatives with the same counterparty (for example a non rated corporate) and all the positions are covered with a master netting agreement signed with that counterparty (CRR eligible master netting agreement).

Under this assumption we’ll analyze three different situations:

 Case A. The long position in BBVA's equity is higher than the short position (also a short position with BBVA's equity as underlying)

o   Gross Long position =+100

o   Short position =-80

o   Net Long Position=+20

o   Net short Position=0

 Equity deduction = 20

In this case, the gross long position that BBVA has in its balance sheet is higher than the short position. If the master netting agreement is settled the counterparty does not have to pay anything to BBVA because the settlement is done by the net amount. In this case is BBVA who owns money to the counterparty, so there is no counterparty credit risk. In this case our understanding is that the short position can be netted given that there’s no counterparty risk associated to the short position. 

In this regard, according to Article 42 CRR, the amount to be deducted would be calculated on the basis of the net long position (20)

 Case B. The long position in BBVA's equity is exactly equal to the short position

o   Gross Long position =80

o   Short position =-80

o   Net Long Position=0

o   Net short Position=0                               

In this case, the gross long position that BBVA has in its balance sheet is equal to the short position. If the master netting agreement is settled the counterparty does not have to pay anything to BBVA because the settlement is done by the net amount. Again, our understanding as the previous case is that there’s no counterparty risk associated to the short position. 

In this regard, according to Article 42 CRR, the amount to be deducted would be calculated on the basis of the net long position (0) 

Case C. The long position in equity is lower than the short position

o   Gross Long position =+80

o   Short position =-100

o   Net Long Position=0

o   Net Short Position=-20

In this case, the gross long position that BBVA has in its balance sheet is lower than the short position. If the master netting agreement is settled the counterparty does have to liquidate/pay the amount corresponding to the net short position. Our understanding in this case is that the short position can be split into two parts:

                      a) a short position of -80 with no counterparty risk

                      b) a "net" short position of -20 with counterparty risk

Our understanding is that, following  Article 42 a) i), -80 of the short positions can be used in order to net the gross long position of +80. Case B can be used in order to understand the logic behind case C. Imagine the case B where the equity deduction is zero, if the short position with the same counterparty increases the equity deduction should continue being zero.