Regulators Trim Capital Requirements For Offsetting Derivatives

U.S. banking regulators adopted rules Tuesday that reduce the amount of capital banks must hold against some derivatives positions.

The rules, jointly adopted by the Office of the Comptroller of the Currency, the Federal Reserve Board, and the Federal Deposit Insurance Corp., let institutions calculate a net exposure for their derivatives positions with individual counterparties. Ultimately, the change will reflect the lower risk of offsetting positions by lowering the capital required to be held against them.

"It's moving the regulatory view of our business more in line with not only the legal framework, but also the way we manage the business," said Joseph Bauman, director of Bank of America's derivatives group and a director of the International Swaps and Derivatives Association.

He said the change is something the association and the industry have pushed since the original Basel Accord on derivatives capital requirements was announced in 1988. Modifications to that accord, which are similar to those adopted by U.S. regulators, were proposed by the Basel Committee on Banking Supervision earlier this year.

Prior to the modifications, an institution had to consider each contract individually, regardless of whether it was offset by another transaction with the same client. In effect, this meant that the institution calculated its exposure by assuming interest rates, foreign exchange rates, or other benchmarks were both higher and lower at the same future time.

Mr. Bauman said the association had requested a capital formula that compared the netted value of the derivatives portfolio with each customer against the gross value of the contracts, a change that would give a more accurate picture of the institution's overall risk position.

"If the portfolio had a very low value because netting was effective, then it would lower the amount of capital the institution would be required to hold against those transactions," he said.

U.S. regulators adopted many of the association's suggestions for netting but require that some capital be maintained, even if the positions offset completely.

The minimum is 40% of the base capital add-ons required for each type of contract.

For interest rate contracts with maturities longer than five years, the rules increase the traditional capital requirement by 1.5%. For similar contracts maturing in one to five years, the capital add-on is 0.5%.

Likewise, foreign exchange contracts maturing in five or more years will now have a 7.5% capital add-on, compared with 5% for deals maturing one to five years in the future.

Equity, precious metals, and commodities transactions will have capital add-ons for the first time. The additional requirements will range from 6% for certain equity deals to 15% for some commodities contracts.

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