X47. Application of Division 2B
This Division applies to an authorized institution that chooses under section 10A(2)(b) to use the current exposure method to calculate the default risk exposure in respect of derivative contracts.
X48. Calculation of default risk exposure
(1) Subject to subsections (2) and (3) and section X48A, an authorized institution must use Formula FB1 to calculate the default risk exposure in respect of a derivative contract.
Formula FB1
Default risk exposure = α × (RC + PFE) where—
(a) α = 1.4;
(b) RC is the current exposure of the contract (if any collateral posted to the counterparty concerned for the contract is unsegregated collateral, the current exposure of the contract must include the current market value of the collateral); and
(c) PFE is the potential future exposure of the contract calculated in accordance with section X49.
(2) If the premium for a sold option has been fully paid upfront, the amount of default risk exposure of the option may be set to zero.
(3) If a credit-related derivative contract with periodic premium payments is not a sold option, the amount of default risk exposure incurred by the protection seller in the contract calculated under this section is capped at the amount of the unpaid premium under the contract.
X48A. Treatments for certain credit derivative contracts
An authorized institution may treat the default risk exposure in respect of a credit derivative contract as zero if—
(a) both of the following conditions are met—
(i) the contract is a credit default swap in which the institution is the protection seller;
(ii) a regulatory capital is held in respect of the risk-weighted amount calculated in accordance with Part 5 or 7 for the institution’s exposure to the credit risk of the reference obligation underlying the swap; or
(b) both of the following conditions are met—
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(i) the institution is the protection buyer in the contract;
(ii) the credit risk mitigation effect of the contract has been recognized and taken into account under Divisions 7 and 8 of Part 5 or Division 5 of Part 7, for the purposes of calculating the risk-weighted amount of the exposure to which credit protection is provided by the contract.
X49. Calculation of potential future exposure of derivative contract
(1) The potential future exposure of a derivative contract is calculated by multiplying the notional amount of the derivative contract by the credit conversion factor applicable to the contract determined in accordance with Table TB1 based on the type of derivative contract within which the contract falls.
Table TB1
Item Type of derivative contract
Credit conversion
factor 1. Interest rate contract—
(a) with a residual maturity of not more than 1 year; 0.5%
(b) with a residual maturity of more than 1 year but not more than 5 years;
2%
(c) with a residual maturity of more than 5 years. 4%
2. Credit-related derivative contract that references a single entity, or a single-name credit instrument, having category 1 credit quality grade—
(a) with a residual maturity of not more than 1 year; 0.5%
(b) with a residual maturity of more than 1 year but not more than 5 years;
2.5%
(c) with a residual maturity of more than 5 years 4.5%
3. Credit-related derivative contract that references an investment grade index—
(a) with a residual maturity of not more than 1 year; 0.5%
(b) with a residual maturity of more than 1 year but not more than 5 years;
2.5%
(c) with a residual maturity of more than 5 years 4.5%
4. Credit-related derivative contract that references a single entity, or a single-name credit instrument, having category 2 credit quality grade—
(a) with a residual maturity of not more than 1 year; 1.5%
(b) with a residual maturity of more than 1 year but not more than 5 years;
7.0%
(c) with a residual maturity of more than 5 years. 12.5%
5. Credit-related derivative contract that references a single entity that does not have any ECAI issuer rating or a single-name credit instrument that does not have any long-term ECAI issue specific rating—
(a) with a residual maturity of not more than 1 year; 1.5%
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Table TB1
Item Type of derivative contract
Credit conversion
factor (b) with a residual maturity of more than 1 year but not more
than 5 years;
7.0%
(c) with a residual maturity of more than 5 years. 12.5%
6. Credit-related derivative contract that references a non-investment grade index—
(a) with a residual maturity of not more than 1 year; 1.5%
(b) with a residual maturity of more than 1 year but not more than 5 years;
7.0%
(c) with a residual maturity of more than 5 years. 12.5%
7. Credit-related derivative contract that references a single entity, or a single-name credit instrument, having category 3 credit quality grade—
(a) with a residual maturity of not more than 1 year; 6.0%
(b) with a residual maturity of more than 1 year but not more than 5 years;
26.5%
(c) with a residual maturity of more than 5 years. 47.0%
8. Exchange rate contract 4%
9. Equity-related derivative contract that references a single name 32%
10. Equity-related derivative contract that references an index 20%
11. Commodity-related derivative contract the underlying commodity of which is precious metal (including gold)
18%
12. Commodity-related derivative contract the underlying commodity of which is electricity
40%
13. Commodity-related derivative contract (other than those referred to in items 11 and 12)
18%
14. Any other derivative contract not specified in items 1 to 13 the applicable
(2) For the purpose of subsection (1)—
(a) if the derivative contract is a contract to which section X50 is applicable, the notional amount must be determined in accordance with that section; and
(b) the type of derivative contract within which a contract falls must be determined based on the contract’s primary risk factor.
(3) For the purposes of items 3 and 6 in Table TB1—
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(a) an index is an investment grade index where the minimum credit rating for inclusion in the index specified by the index service provider concerned, if mapped to a scale of credit quality grades in accordance with Table A, B or C of Schedule 6, as the case requires, would be mapped to a credit quality grade of 1, 2 or 3; and
(b) a non-investment grade index is an index that is not an investment grade index.
(4) For the purposes of items 2, 4 and 7 in Table TB1, an authorized institution must determine whether a single entity or a single-name credit instrument has a category 1, 2 or 3 credit quality grade by mapping the ECAI issuer rating of the entity, or the long-term ECAI issue specific rating of the credit instrument, to a scale of credit quality grades in accordance with—
(a) if the entity is a corporate incorporated in India or the credit instrument is issued by such a corporate—Part 2 of Table C in Schedule 6; or
(b) in any other case—Table A in Schedule 6 (regardless of whether the entity or issuer of the credit instrument is a sovereign or not).
(5) For the purposes of items 2, 4 and 7 in Table TB1—
(a) a single entity, or a single-name credit instrument, has a category 1 credit quality grade if the ECAI rating concerned is mapped to a credit quality grade of 1, 2 or 3;
(b) a single entity, or a single-name credit instrument, has a category 2 credit quality grade if the ECAI rating concerned is mapped to—
(i) a credit quality grade of 4;
(ii) subject to paragraph (iii), a credit quality grade of 5; or
(iii) in the case of an ECAI rating mapped in accordance with Part 2 of Table C in Schedule 6—a credit quality grade of 5 where the ECAI rating is CARE BB-, CARE BB- (Is), CRISIL BB-, [ICRA] BB-, Ir BB- or above; or
(c) a single entity, or a single-name credit instrument, has a category 3 credit quality grade if the ECAI rating concerned is mapped to—
(i) subject to paragraph (ii), a credit quality grade of 6; or
(ii) in the case of an ECAI rating mapped in accordance with Part 2 of Table C in Schedule 6—a credit quality grade of 5 where the ECAI rating is below CARE BB-, CARE BB- (Is), CRISIL BB-, [ICRA] BB- or Ir BB-.
(6) Subject to subsection (7)(a), for the purposes of Table TB1—
(a) the residual maturity of an interest rate contract that references the value of another interest rate contract (underlying contract) or interest rate instrument is the length of the time period from the current date to the maturity date of the underlying contract or instrument; and
(b) the residual maturity of a credit-related derivative contract that references the value of another credit-related derivative contract (underlying contract) or credit instrument is the length of the time period from the current date to the maturity date of the underlying contract or instrument.
(7) If a derivative contract is structured to settle the outstanding exposures under the contract on specified dates and the terms of the contract are reset so that the fair value of the contract is zero on the specified dates, an authorized institution—
(a) must treat the residual maturity of the contract as the period from the current date until the next reset date; and
(b) if the contract is an interest rate contract and its remaining time to final maturity is more than one year, must not apply a CCF of less than 2% to the contract.
X50. Notional amount of certain types of derivative contracts (1) Subject to subsections (2) and (3)—
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(a) the notional amount of an exchange rate contract is—
(i) the notional amount of the foreign currency leg of the contract, converted to Hong Kong dollars at the current market spot exchange rate; or
(ii) if both legs of the contract are denominated in currencies other than Hong Kong dollars—the notional amount of the leg that, after having been converted to Hong Kong dollars at the current market spot exchange rate, has the larger value; and (b) the notional amount of an equity-related derivative contract or a commodity-related
derivative contract is—
(i) if the underlying exposure of the contract is an equity or a commodity—the product of the current market price of one unit of the equity or commodity and the number of units referenced by the contract;
(ii) if the underlying exposure of the contract is an index (including an index on volatility)— the product of the current level of the index and the value of each index point designated in the contract; or
(iii) if the contract is a volatility transaction—the product of the volatility measure specified in the contract and the contractual notional amount of the contract.
(2) For a derivative contract that has multiple exchanges of principal, the notional amount of the contract is the product of the remaining number of exchanges of principal to be made under the contract and the stated notional amount of the contract.
(3) If the stated notional amount of a derivative contract is leveraged or enhanced by the structure of the contract, the notional amount of the contract is the effective notional amount of the contract calculated by taking into account the effect of the leverage or enhancement, as the case may be.
X51. Authorized institution to hold regulatory capital for credit risk or market risk of posted collateral
To avoid doubt, an authorized institution must, for collateral posted by it for derivative contracts (whether the collateral is included in the calculation under section X48 or not), hold regulatory capital for the credit risk or market risk, whichever is applicable, of the collateral itself calculated under Part 5, 7 or 8, as the case requires—
(a) as if it had not been posted as collateral; and
(b) if the collateral is held by another person, as if the collateral were held by the institution.