International banking regulators are proposing potentially less stringent capital requirements for swaps trading.
An amendment to the 1988 Basel Capital Accord that would change the formula for measuring the risk of derivatives and other off-balance-sheet activity will be unveiled today at an annual conference of the International Swaps and Derivatives Association in New York.
Bankers who have seen it are applauding the proposal, saying it more accurately reflects the risks of trading in the $16 trillion market. The proposal comes when many bankers are worried about disruptive regulation in the wake of some widely publicized trading losses.
'Netting' for the Future Under the proposal, banks that currently calculate replacement costs by marking each transaction to market, would instead use a "netting" formula to calculate future exposure.
The committee feared that the old calculation captured the current exposure, but did not take into account potential future exposure - or "add on" - over the life of a transaction.
"Under the original Basel proposal you had to calculate capital requirements on a gross basis, or a swap-by-swap basis," said Ernest C. Goodrich, a managing director at Merrill Lynch and a vice chairman of the dealers association. "Netting allows you to sum the positive and negative positions with a third party to come up with the capital requirement. It can result in less capital put toward a particular position."
The proposal "recognizes the material reduction in credit risk that ISDA has achieved by establishing its master netting agreements as the industry benchmark and by working to ensure that their provisions are enforceable," said Gay H. Evans, chairman of the association and a managing director of Bankers Trust International.
"The Basel Committee also has recognized that cross-product master netting agreements may cover the full range of forwards, swaps, options, and similar derivatives," said Dan Cunningham, the association's general counsel and a partner in the New York law firm of Cravath, Swaine & Moore.
The Basel Committee on Banking Supervision will accept comments until Oct. 10. The measure is expected to take effect by mid-1995.
