How do you calculate the cap for netting sets subject to a contractual margin agreement mentioned in Article 274(3) CRR?
I would like to use the following example. There is a netting set that is subject to a contractual margin agreement containing only interest derivatives and cash collateral, applying the Articles literally.
For the calculation of the replacement cost in Article 275, CMV = -30, VM = -35, TH = MTA = NICA = 0.
If you plug this into the formulas, you get
RC_nomargin = 0 (as in Article 275 1.)
RC_margin = 5 (as in Article 275 2.)
For the potential future exposure (PFE) in Article 278, we use
Addon_nomargin = 10
Addon_margin = 3
To calculate the multiplier in Article 278 3. we have to use CMV and VM again, resulting in
Multiplier_nomargin = min(1, 0.05 + (1-0.05)*exp(-30/(2*(1-0.05)*10)))=0.246
Multiplier_margin = 1
PFE_nomargin = 2.46
PFE_margin = 3
Going back to Article 274, the resulting exposure value is
Exposure_nomargin = 1.4*(0+2.46)= 3.64
Exposure_margin = 1.4*(5+3) = 11.2
According to this calculation, we would have to use the non-margined exposure (3.64), which is smaller than the net exposure of the netting set (CMV - VM = 5). This is a result which is troubling from a credit risk perspective, since the exposure for a netting set should always be larger than the net exposure due to the volatile nature of derivatives.
This question has been rejected because the issue it deals with is already explained or addressed in Article 272(12a) and 274(3) of Regulation (EU) No 575/2013 as amended by Regulation (EU) 2019/876 (Capital Requirements Regulation or CRR). For further information on the purpose of this tool and on how to submit questions, please see 'Additional background and guidance for asking questions'.