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Federal Reserve Bank
OF DALLAS
ROBERT

D. M c T E E R , J R .

P R E S ID E N T
A N D C H IE F E X E C U T IV E O F F IC E R

June 14 1995

DALLAS, TEXAS
75265-5906

N o tice 95-55

TO:

The Chief Executive Officer of each member
bank, bank holding company, and foreign agency
in the Eleventh Federal Reserve District

S U B JE C T
Supervisory In form ation —D erivatives
A ctivities o f B an k s an d S ecu rities Firm s
D ETA ILS

The Basle Committee on Banking Supervision and the Technical Committee
of the International Organisation of Securities Commissions (IOSCO) has issued a joint
framework for supervisory information about the derivatives activities of banks and
securities firms.
This joint framework, which is being issued to supervisors of banks and
securities firms, is part of a continuing effort to improve supervisors’ access to, and
evaluation of, timely and comprehensive information about institutions’ activities
involving over-the-counter and exchange-traded derivatives.
The joint framework has two main parts. The first part summarizes the risks
associated with derivatives (e.g., credit risk, liquidity risk, m arket risk) and discusses
qualitative and quantitative information that supervisors could obtain to assess these
risks. The paper also discusses earnings information that may be useful for supervisory
analysis purposes. The second part of the paper sets forth a common minimum supervi­
sory inform ation framework that focuses on a baseline of information that is useful for
supervisors to begin assessing the impact of derivatives on an institution’s risk pro­
file—primarily, information about the extent of an institution’s derivatives activities and
their credit risk.
The two committees plan to periodically update the joint supervisory
inform ation framework and to incorporate information about m arket risk into its
common minimum framework at a later stage.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333 -4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston
Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

ATTACHM ENT

A copy of the joint Basle Com m ittee/IOSCO supervisory information
framework, including an Executive Summary on pages i - iv, is attached.
M O R E IN F O R M A T IO N

For m ore information, please contact Gail Teague at (214) 922-6151 or Julie
Mills at (214) 922-6229. For additional copies of this Bank’s notice, please contact the
Public Affairs D epartm ent at (214) 922-5254.
Sincerely yours,

Framework for supervisory information

about the

derivatives activities of banks and securities firms

Joint report by the
B asle C om m ittee on B an k in g Su p ervision
and the
T echnical C om m ittee o f the In tern ation al O rgan isation of
Securities C om m ission s (" IO S C O " )

M ay 1995

Contents

Page
EXECUTIVE SUMMARY

i-iv

I.

Introduction

1

II.

Catalogue of information for supervisory purposes

6

1.

Credit risk

2.

Liquidity risk

10

3.

Market risk

12

4.

Earnings

III. Common minimum information framework
Annex 1: Framework for supervisory information on derivatives activities
Annex 2: Derivatives data elements and their uses
Annex 3: Common minimum information framework
Annex 4: Definitions for elements o f the common minimum information framework

7

14
16

EXECUTIVE SUMMARY

This paper presents a framework for supervisors to assess information about the
derivatives activities o f banks and securities firms. It has been developed jointly by the Basle
Committee on Banking Supervision and the International Organisation o f Securities
Commissions (IOSCO) and is being distributed to banking and securities supervisors world­
wide.
The framework is intended to enhance the information available to supervisors on
the exchange-traded and over-the-counter (OTC) derivatives activities o f banks and securities
firms. Given the rapid growth o f derivatives in recent years, it is important that supervisors
continuously improve their understanding of how these instruments affect the overall risk
profile and profitability o f banks and securities firms. The framework therefore presents the
type o f information that the two Committees believe should be available within regulated
firms and their material affiliates active in the derivatives markets and that should be
accessible to supervisors. In this sense, it represents an elaboration on the papers released
jointly by the Basle Committee and the IOSCO Technical Committee in July 1994 on the
subject o f management controls.
Mindful o f the need to limit regulatory burden, the framework provides for the
assessment of supervisory information through a series o f channels, including on-site
examinations and external audits, discussions with institutions, special surveys, as well as
regular reporting procedures.
The overall supervisory information framework presented in this paper consists o f
two main parts. The first is a "catalogue" of information that the Committees have identified
as important for an evaluation o f derivatives risks and that supervisors may draw from as they
expand their reporting systems. The second is a common minimum framework o f data
elements (a subset o f the catalogue) that the two Committees recommend that member
supervisors have available to them. The paper is organised into three sections, each o f which
is summarised below.
I.

Introduction
In addition to providing a general overview o f the paper, the introduction

discusses a series o f basic principles that underlie the overall supervisory information
framework. These include the following:
•

Supervisory data should be comprehensive, i.e. it should cover all types o f derivative
instruments and their major related risks and shed light on how derivatives contribute to
an institution's overall business and risk profile. Where appropriate, derivatives positions
should be evaluated together with related on-balance-sheet positions (e.g. for the purpose

(ii)

o f assessing market risks and earnings). Quantitative information on derivatives needs to
be evaluated in the context o f qualitative information on an institution's overall risk
profile and its ability to manage this risk.
•

Supervisors should attempt to obtain a comprehensive picture o f an institution's
derivatives activities across different legal entities and jurisdictions.

•

The derivatives activities o f an institution can change rapidly, affecting an institution's
risk profile and profitability. Data on derivatives should therefore be assessed with
sufficient frequency to give a meaningful and timely picture o f the risks faced by an
institution.

•

To limit the regulatory burden, supervisors are encouraged to draw on information that
banks and securities firms generate for internal purposes. There should be as much
consistency as possible between information obtained for reporting purposes and data that
institutions must already compile for the purpose o f complying with other supervisory
requirements. In light o f the different institutional, accounting and public policy
approaches to supervision across the member countries o f the two Committees, each
supervisory authority has flexibility to implement the common minimum framework in a
manner best suited to its regulatory environment.

•

Each supervisor would apply the common minimum framework to internationally active
institutions with significant derivatives operations, with flexibility also to extend the
framework to other institutions with significant involvement in derivatives.

II.

Catalogue o f information for supervisory purposes
The catalogue o f data items represents information that supervisors have

identified as important for assessing the risks arising from firms' derivatives activities. It is
intended to facilitate the development among supervisors o f consistent conceptual methods
for assessing the risk exposures related to derivatives. It is also intended to provide a basis for
discussion between firms and their supervisors about the type o f information that a firm
should be aiming to maintain as part o f its overall risk management control mechanism. In
this context, supervisors should seek to ensure that the firm has both quantitative and
qualitative information on its derivatives activities.
The information identified in the catalogue covers the following broad areas:

Credit risk: Credit risk is the risk that a counterparty may fail to fully perform on its financial
obligations. The framework focuses on the credit risk o f OTC derivatives rather than
exchange-traded derivatives, for which a reduction in risk is achieved through an organised
exchange or clearing house where there is payment and receipt o f margin. The primary
measures of credit risk are current credit exposure and potential credit exposure, taking into
account the risk reducing effects of legally enforceable netting agreements. In addition, the
framework covers information on credit enhancements for both current and potential credit

(iii)

exposure. Finally, the framework discusses ways to assess the concentration o f credit risk and
counterparty credit quality.

Liquidity risk: Two types o f liquidity risk that can be associated with derivative instruments
are covered in the framework: market liquidity risk and funding risk. Market liquidity risk is
the risk that a position cannot be eliminated quickly by either liquidating the instrument or by
establishing offsetting positions. Funding risk is the risk that derivatives positions place
adverse funding and cash flow pressures on an institution.
Market risk: Market risk is the risk that the value o f on- or off-balance-sheet positions will
decline before the positions can be liquidated or offset with other positions. The framework
covers two approaches for assessing market risks. One is to focus on position data that would
allow independent supervisory assessment o f an institution's market risks through some
supervisory model. The other is to evaluate information on an institution's internal estimates
o f market risks. These estimates could be based on value-at-risk methodologies, as well as cn
other approaches such as duration analysis, gap analysis, or scenario methods.
Earnings: The framework discusses various types o f information important for assessing the
impact o f derivatives on an institution's earnings profile. This includes information on trading
income, broken down by broad risk classes (interest rate risk, foreign exchange risk and
commodities and equities exposures), witho .t regard to the type o f instrument. The paper also
suggests that a finer disaggregation o f earnings could be useful for supervisory purposes. In
addition, the framework discusses the importance of assessing information on both unrealised
and realised derivatives losses.
Each o f these areas o f supervisory interest is presented in tabular form in Annexes
1 and 2 o f the paper.
III.

Common minimum reporting framework
The two Committees recommend that member supervisors have available to them

a minimum subset of the elements identified in the catalogue for large, internationally active
banks and securities firms with significant involvement in the derivatives markets. The
information contained in the common minimum framework represents a baseline of
information that the Committees have identified as important for supervisors to begin
assessing the nature and scope o f an institution's derivatives activities and how derivatives
contribute to a firm's overall risk profile. It is intended that supervisors supplement the
information in the common minimum framework with other information drawn from the
catalogue of data items discussed above.

(iv)

The common minimum framework is illustrated in tables 1-5 o f Annex 3. Its
focus is on information relating to credit risk, market liquidity risk and overall market
activity. It is expected that supervisors will revisit the common minimum framework
periodically to ensure that it is in line with the activities o f banks and securities firms, market
innovations and the state o f supervisory reporting in member countries. For example, the
minimum framework does not currently focus on market risks, an area that the Committees
plan to address in the future. The Committees also intend to review the framework in light o f
the planned efforts o f the Euro-currency Standing Committee o f G-l 0 central banks to
collect, on a regular basis, aggregate market data on the derivatives activities o f financial
institutions. Such co-ordination between banking and securities supervisors and central banks
should minimise increases in reporting burden by avoiding inconsistencies and duplication in
data collection,

Framework for supervisory information about the
derivatives activities o f banks and securities Firms

I.

Introduction
(a)

1.

Background
The Basle Committee on Banking Supervision and the Technical Committee of

the International Organisation o f Securities Commissions (IOSCO) have been working to
enhance the prudential supervision o f the derivatives operations o f banks and securities
firms.1 For example, in July 1994 the Basle Committee and the IOSCO Technical Committee
jointly released documents providing guidance on the sound risk management of derivatives
activities.
2.

In their joint release o f the July 1994 documents, the Basle Committee and the

IOSCO Technical Committee stated that they intended further consultations in the area of
derivatives and other topics o f common interest. These consultations have led to an
assessment o f the information necessary for effective supervision o f the derivatives activities
of banks and securities firms. As a result o f this work, the Basle Committee and the IOSCO
Technical Committee have designed and are distributing the information framework
elaborated in this paper to supervisors o f banks and securities firms. T is framework
describes information which the two Committees believe should be available within regulated
firms and material affiliates active in the derivatives markets and that should be accessible to
supervisors to assess the risks o f derivatives and their impact on institutions' financial
condition, capital adequacy and performance.
3.

Broadly defined, a derivative instrument is a financial contract whose value

depends on the values of one or more underlying assets or indexes.2 While derivatives

1

The Basle Committee on Banking Supervision is a Committee o f banking supervisory authorities which
was established by the central-bank Governors o f the Group o f Ten countries in 1975. It consists o f
senior representatives o f bank supervisory authorities and central banks from Belgium, Canada, France,
Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the
United States. It usually meets at the Bank for International Settlements in Basle, where its permanent
Secretariat is located.
The Technical Committee o f IOSCO is a committee o f the supervisory authorities for securities firms in
major industrialised countries. It consists o f senior representatives o f the securities regulators from
Australia. Canada. France. Germany, Hong Kong. Italy, Japan, M exico, Netherlands. Spain, Sweden,
Switzerland. United Kingdom, and the United States.

:

Examples o f derivative instruments include forward contracts and their variations, such as swaps.
forward rate agreements and futures contracts, and option contracts and their variations, such as caps,
floors and swaptions.

-2generally involve risks to which banks and securities firms have long been exposed, the rapid
growth and complexity o f these activities pose new challenges for firms and their supervisors.
These challenges, together with the continuing growth o f derivatives activities, underscore the
importance o f ensuring that firms maintain and supervisors have access to meaningful, timely
information concerning financial institutions' derivatives activities, both exchange-traded and
over-the-counter (OTC).
4.

The overall supervisory information framework advanced in this paper consists o f

two main components: 1) a catalogue discussing data that the Committees have identified as
important for an evaluation o f derivatives risks and that supervisors may choose from as they
expand their reporting systems and 2) a common minimum framework o f data elements (a
subset o f the catalogue) to which relevant supervisory authorities should have access. The
catalogue component o f the framework, discussed in section II, identifies the major types o f
risks arising from derivatives activities and the information needed to evaluate those risks.
The areas identified as o f particular interest to supervisors are credit risk, market risk,
liquidity risk and earnings.
5.

This catalogue o f data elements is intended to facilitate the development among

supervisors o f consistent conceptual methods for assessing the risk exposures related to
derivatives. The catalogue is also intended to serve as a basis for discussion between firms
and their supervisors about the type o f information which the firm should be aiming to
maintain as part o f its overall risk management control mechanism. In this context, the paper
should be seen as an elaboration on aspects of the July 1994 papers on the sound management
o f derivatives activities. While the catalogue has been developed for both banks and securities
firms, some o f the items o f the catalogue may be more relevant for banking supervisors than
for securities firm supervisors and vice versa.
6.

The common minimum framework, which is discussed in section III, represents a

baseline o f information that supervisors can use in assessing the impact o f derivatives on an
institution's overall risk profile. The minimum framework focuses to varying degrees on
information relating to credit risk, market liquidity risk and market activity.3 Individual
supervisors can then supplement this information with other data elements drawn from the
catalogue.
7.

The minimum framework is also intended to provide a basis for co-ordinating

supervisory reporting with other data collection initiatives on derivatives. In general, less
information is available to supervisors on OTC derivatives than on exchange-traded
derivatives, where statistics are available on the volume and value o f transactions and on open
interest. In the case o f OTC derivatives, in most jurisdictions bank and securities supervisors

3

While the common minimum framework does not currently cover market risk, the two Committees plan
to address this issue at a later stage.

-3-

do not collect information which gives an overall profile o f activity in such products. N or is
such information currently available on a global basis.
8.

Aggregated statistics on derivatives markets would be o f significant value to

supervisors. The growing use o f OTC derivatives in conjunction with exchange-traded
instruments reflects the financial market interrelationships between organised exchange
markets, OTC derivatives activities and related underlying cash markets. This
interrelationship between the markets underscores the need for supervisors to have access to
timely and accurate information on OTC risk exposures o f major market participants as well
as the overall activity in the OTC markets.
9.

In this context, a minimum level o f harmonisation across G-10 countries o f

supervisory information about derivatives could serve as an important input to the initiative
o f the Euro-currency Standing Committee o f G-l 0 central banks to collect globally on a
regular basis aggregate statistics on OTC and exchange-traded derivatives markets, both for
macroeconomic and for macroprudential purposes. Under the Euro-currency Standing
Committee initiative, data on the OTC and exchange-traded derivatives activities o f larger
banks and securities firms, and other major derivatives dealers would be collected and
aggregated. Co-ordination between supervisors and central banks on the data to be evaluated
would help to reduce duplication o f efforts and thus limit the reporting burden for the
banking and securities industry.
10.

For the purpose o f this overall information framework, the mechanism for

supervisory data analysis is not specified, allowing for the assessment o f information obtained
through various channels. Specifically, information may be obtained and assessed through
on-site examinations, discussions with institutions, special surveys or standard reports
routinely submitted to supervisors and audited financial statements and other reports
submitted by external auditors. The appropriate method for gathering information depends
upon the nature o f the data, the institutions under review and the relevant supervisory
authority. Certain information may be appropriate for all institutions whereas other types o f
data may be meaningful only for larger dealers.
(b)
11.

Basic principles
In developing an overall supervisory information framework for banks' and

securities firms' derivatives activities, the two Committees have been guided by a number o f
basic principles. In particular, the data should be comprehensive. It should cover all types o f
derivative instruments and their major related risks and facilitate the supervisor's analysis o f
how derivatives contribute to an institution's overall business and risk profile. The two
Committees recognise that derivatives activities constitute only a part of the overall activities
o f banks and securities firms. Consequently, derivatives should not be evaluated in isolation
from the overall risks o f an institution. This implies, for example, that for purposes of
assessing an institution's market risk and earnings profile, a portfolio approach incorporating

-4related cash and derivatives positions - and, thereby, also the impact o f hedging and other risk
management transactions - is required for meaningful interpretation. Moreover, quantitative
information on derivatives activities needs to be seen in the context o f qualitative information
on an institution's overall risk profile and its ability to manage this risk.
12.

Comprehensive evaluation o f the risks o f derivatives generally implies the

aggregation, consolidation and assessment o f information across a number o f activities and
legal entities. Where institutions undertake business activities which fall under the jurisdiction
o f different supervisors or where certain affiliates are not supervised, supervisors should
discuss with regulated firms how best to assess information that provides a comprehensive,
timely picture o f the risks associated with their overall derivatives and related activities. Bank
supervisors should attempt to obtain information about these activities on a consolidated
basis, while recognising the legal distinctions among subsidiaries.
13.

Data on derivatives should be assessed with sufficient frequency and timeliness to

give a meaningful picture o f an institution's risk profile. Derivatives activities may change
dramatically due to changes in the types o f derivatives products involved and whether
institutions are end-users o f such products to manage their risks or are acting as dealers.
Changes in derivatives products and the role o f an institution as an end-user or dealer can
affect the impact o f derivatives on an institution's risk profile and profitability. Therefore, it is
important for supervisors to be aware o f new derivative instruments in a timely manner
(particularly about higher risk and more complex instruments), how they are being used by
institutions and how institutions' risk management systems are being enhanced to address
these new developments. Moreover, it is important for supervisors to be aware in a timely
manner o f significant increases in the derivatives exposures o f banks and securities firms.
14.

The two Committees are aware o f the potential costs associated with requests for

additional information on institutions' derivatives activities and recognise that additional
information requirements should only arise where there is a clear supervisory need. To limit
the regulatory burden, supervisors are encouraged to draw on information that banks and
securities firms generate for internal purposes, where appropriate, for assessing the impact o f
derivatives on financial condition and performance. Moreover, there should be as much
consistency as is possible between information obtained for reporting purposes and data that
institutions must already compile to comply with other supervisory requirements. The overall
information framework should be sufficiently flexible to permit the incorporation o f new
market innovations without requiring frequent updating o f the framework itself. The two
Committees recognise that different institutional, accounting and public policy approaches to
supervision require that each supervisory' authority have flexibility to implement the common
minimum framework in a manner best suited to its regulatory environment. Each supervisor
would apply the common minimum framework to internationally active institutions with
significant derivatives operations, with flexibility also to extend the framework to other
institutions with significant involvement in derivatives.

-5 15.

The common minimum information framework has been constructed with the aim

o f achieving the assessment o f understandable and meaningful information about the
derivatives activities o f banks and securities firms that could facilitate comparisons across
institutions and, where possible, across countries. In this regard, it is intended that the overall
information framework contribute to simplifying the regulatory reporting environment for
banks and securities firms operating internationally. To the extent that the information is used
for aggregation purposes, the Committees recognise the importance o f ensuring that the
process o f aggregation not prejudice the confidentiality o f information obtained on individual
institutions by their supervisory authorities.

-6II.

Catalogue of information for supervisory purposes

16.

In monitoring the activities o f a financial institution involved in derivatives,

supervisors need to be satisfied that the firm has the ability to measure, analyse and manage
these risks. In order to achieve these objectives, supervisors should seek to ensure that the
firm has both quantitative and qualitative information on its derivatives activities.
17.

Quantitative information. Quantitative information about derivatives activities

should address the following broad areas:
- credit risk
- liquidity risk
- market risk
- earnings
Recognising that exchange-traded and OTC derivatives generally differ in their credit risk,
liquidity risk and the potential for complexity, the overall reporting framework distinguishes
between exchange-traded and OTC derivatives in identifying information needed for
supervisory assessment. Each o f the four broad areas is discussed in greater detail in sections
1 to 4 below.
18.

Qualitative information. In order to effectively evaluate banks' and securities

firms' derivatives activities and related risks, supervisors should assess qualitative
information about institutions' systems, policies and practices for measuring and managing
the risks o f derivatives. This includes, for example, information on the risk limits that banks
and securities firms use to manage their exposures and any changes in these limits. The risk
management guidelines for derivatives, which were issued by the two Committees in July
1994 and which highlight key attributes o f the risk management systems o f banks and
securities firms, may be used as a guide in requesting information on institutions' systems,
policies and practices.4
19.

The following sections describe in greater detail the different elements o f the

framework for supervisory information about derivatives activities. The narrative discussion
is summarised in tabular form in Annex 1. In Annex 1, two columns are provided for each o f
the major risk categories. The first column identifies a supervisory concern or use, and the
second column describes the information that could be applicable to that use. Explanations
follow that summarise how each data item might be used or why it is important from a
supervisory perspective. In general, the data and related explanations reflect widely accepted
concepts and techniques for measurement of risk exposure that are based on new
developments in practice. Some information elements address multiple supervisory uses listed

4

Risk M anagem ent Guidelines fo r D erivatives. Basle Committee on Banking Supervision, July 1994 and
O perational and Financial Risk M anagem ent C ontrol M echanism s fo r O ver-the-C ounter D erivatives
A ctivities o f R egulated Securities Firms. Technical Committee o f IOSCO, July 1994.

-7in the first column o f Annex 1. To summarise such overlaps, Annex 2 cross-references the
information elements with the supervisory uses that have been identified.
1.

Credit Risk

20.

Credit risk is the risk that a counterparty may fail to fully perform on its financial

obligations. With respect to derivatives, it is appropriate to differentiate between the credit
risk o f exchange-traded and OTC instruments. Owing to the reduction in credit risk achieved
by organised exchanges and clearing houses, supervisors may need to evaluate less
information on exchange-traded derivatives for credit risk purposes than on OTC instruments.
Accordingly, the following discussion on credit risk pertains primarily to OTC contracts.5
21.

The Committees recognise that the notional amount of OTC derivative contracts

does not reflect the actual counterparty risk. Credit risk for an OTC contract is best broken
into two components, current credit exposure to the counterparty and the potential credit
exposure that may result from changes in the market value underlying the derivative contract.
To the extent possible, credit risk from derivatives should be considered as part o f an
institution's overall credit risk exposure. This should include exposure from other offbalance-sheet credit instruments such as standby letters o f credit as well as the credit risk
from on-balance-sheet positions.
(a)
22.

Current credit exposure
Current credit exposure is measured as the cost o f replacing the cash flow o f

contracts with positive mark-to-market value (replacement cost) if the counterparty defaults.
Legally enforceable bilateral netting agreements can significantly reduce the amount o f an
institution's credit risk to each o f its counterparties. These netting agreements can extend
across different product types such as foreign exchange, interest rate, equity-linked and
commodity contracts. Therefore, an institution's current credit exposure from derivative
contracts is best measured as the positive mark-to-market replacement cost of all derivative
products on a counterparty by counterparty basis, taking account of any legally enforceable
bilateral netting agreements.
23.

For individual institutions, breaking out the gross positive and negative market

values o f contracts may have supervisory value by providing an indication o f the extent to
which legally enforceable bilateral netting agreements reduce an institution's credit exposure.

5

Credit risk is o f most concern in the case o f OTC derivative contracts since exchange clearing houses
for derivatives employ risk management systems that substantially mitigate credit risks to their
members. Both futures and options exchanges typically mark exposures to market each day. In the case
o f futures exchanges, members' exposures to the clearing house are eliminated each day, and often
intra-day, through variation margin payments. In the case o f options exchanges, clearing house
exposures to written options are fully collateralised.

- 8 -

(b) Potential credit exposure
24.

In light o f the potential volatility o f replacement costs over time, prudential

analysis should not only focus on replacement cost at a given point in time but also on its
potential to change. Potential credit exposure can be defined as the exposure o f the contract
that may be realised over its remaining life due to movements in the rates or prices
underlying the contract. For banks, under the requirements o f the 1988 Basle Capital Accord,
potential exposure is captured through a so-called "add-on", which is calculated by
multiplying the contract's gross or effective6 notional principal by a conversion factor that is
based on the price volatility o f the underlying contract. Bank supervisors should therefore
evaluate information on the add-ons that banks must already compile for their risk-based
capital calculations. Such information could include notional amounts by product category
(i.e. interest rate, foreign exchange, equities, precious metals and other commodities) and by
remaining maturity (i.e. one year or less, over one year to five years and more than five
years). The Basle Accord defines remaining maturity as the maturity o f the derivative
contract. However, supervisors could also take into account information on the instrument
underlying the derivative contract.
25.

Some banks and securities firms have developed sophisticated simulation models

that may produce more precise estimates o f their potential credit exposures than under the
add-ons approach, and supervisors may wish to take account o f the results o f these models.
These models are generally based on probability analysis and techniques modelling the
volatility o f the underlying variables (exchange rates, interest rates, equity prices, etc.) and
the expected effect o f movements o f these variables on the contract value over time.
Estimates o f potential credit exposure by simulations are heavily influenced by the
parameters used (a discussion o f the major parameters that can influence simulation results is
included in the market risk section below). Supervisors and firms should discuss the
parameters and other aspects o f the models to ensure an appropriate level o f understanding
and confidence in the use of such models.
(c)
26.

Credit enhancements
Information on credit enhancements used in connection with OTC derivative

transactions is important to an effective supervisory assessment o f the credit risk inherent in
an institution's derivatives positions. Collateral can be required by an institution to reduce
both its current and potential credit risk exposure. Collateral held against the current exposure
o f derivative contracts with a counterparty effectively reduces credit risk and, therefore,
merits supervisory attention. However, supervisors need to consider the legal enforceability

6

Effective notional principal is obtained by adjusting the notional amount to reflect the true exposure o f
contracts that are leveraged or otherwise enhanced by the structure o f the transaction.

-9o f netting agreements and the quality and marketability o f collateral.7 For supervisory
analysis purposes, collateral held by an institution in excess o f its netted credit exposure to a
counterparty would not reduce current credit exposure below zero but could reduce potential
credit exposure. Supervisors could obtain a better understanding o f how collateral reduces
credit risk by collecting information separately on collateral with a market value less than or
equal to the netted current exposure to the counterparty and collateral with market values in
excess o f the netted current exposure and o f the nature o f that collateral.
27.

OTC contract provisions that require a counterparty to post initial collateral (or

additional collateral as netted current exposure increases) may be used to reduce potential
credit exposure. An OTC contract that is subject to a collateral or margin agreement may
have lower potential exposure, since collateral would be required in the future to offset any
increase in credit exposure. Accordingly, information about the notional amount and market
value o f OTC contracts subject to collateral agreements could enhance supervisory
understanding o f an institution's potential credit risk.
(d)
28.

Concentration of credit risk
As with loans, an identification o f significant counterparty OTC credit exposures

relative to an institution's capital is important for an evaluation of credit risk. This
information should be evaluated together with qualitative information on an institution's
credit risk controls. To identify significant exposures and limit reporting burden, supervisors
could focus on those counterparties presenting netted current and potential credit exposure
above a certain threshold. As a minimum, supervisors could identify the 10 largest
counterparties to which an institution is exposed, subject to the minimum threshold used.
29.

Since counterparty exposure may stem from different instruments, overall risk

concentrations with single counterparties or groups o f counterparties cannot be measured
accurately if the analysis is limited to single instruments (e.g. swaps) or classes o f instruments
(e.g. OTC derivatives). For this reason, institutions should aim to monitor counterparty
exposures on an integrated basis, taking into consideration both cash instruments and offbalance-sheet relationships. Supervisors could also consider information on exposure to
counterparties in specific business sectors or to counterparties within a certain country or
region.
30.

Supervisors could also analyse information on aggregate exposures to various

exchanges, both on- and off-balance-sheet, and on exposures to certain types o f collateral
supporting derivative instruments. Overexposure to specific issues or markets can lead to
additional credit concerns, particularly in the case o f banks and securities firms with

7

For example, supervisors could obtain additional insights through information on OTC contracts with
collateral recognised under the Basle Capital Accord (for banks) and OTC contracts with other readily
marketable, high quality securities as collateral.

- 10significant activity in securities markets. Some securities supervisors address this
concentration risk by deducting from capital all positions above a certain level o f market
turnover or by applying some other suitable benchmarks. Supervisors without such provisions
should ensure that they are at least informed about these concentrations, whether in the form
o f holdings o f the underlying security itself or in the form o f OTC derivatives positions
which require the firm to deliver or receive such concentrated positions.
(e)
31.

Counterparty credit quality
Credit risk is jointly dependent upon credit exposure to the counterparty and the

probability o f the counterparty's default. Information on the current and potential credit
exposure to counterparties o f various credit quality would increase supervisory insights into
the probability o f credit loss. Information indicative o f counterparty credit quality includes
total current and potential credit exposure - taking into account legally enforceable bilateral
netting agreements - to counterparties with various characteristics, e.g. Basle Capital Accord
risk weights (for banks), credit ratings assigned by rating agencies, or the institution's internal
credit rating system. Information on guarantees, standby letters o f credit, or other credit
enhancements may also enhance supervisory understanding o f credit quality. Aggregate
information on past-due status and past-due information by major counterparties, together
with information on actual credit losses, may be o f particular interest for identifying pending
counterparty credit quality problems in the OTC derivatives markets.
2.

Liqui ’ity risk

32.

As with cash instruments, there are two basic types o f liquidity risk that can be

associated with derivative instruments: market liquidity risk and funding risk.
(a)
33.

Market liquidity risk
Market liquidity risk is the risk that a position cannot be eliminated quickly by

either liquidating the instrument or by establishing an offsetting position. Information that
breaks out exchange-traded and OTC derivatives could further supervisory understanding o f
an institution's market liquidity risk. Although exchange-traded and OTC markets both
contain liquid and illiquid contracts, the basic differences between the two markets give an
indication o f the comparative difficulty o f offsetting exposures using other instruments.8
Among both OTC and exchange-traded products, information on broad risk categories (i.e.,
interest rate, foreign exchange, equities and commodities) and types o f instrument would be
useful in judging the market liquidity o f an institution's positions. Accordingly, notional
amounts and market values o f exchange-traded and OTC instruments by type (and perhaps by

8

Market illiquidity may stem from the customised nature o f some OTC contracts which can include
fundamental elements o f market risk in combinations that may not be easily replicated using
standardised exchange-traded contracts or other OTC instruments.

- 11 maturity and by product) could enhance a supervisor's understanding o f an institution's
market liquidity risk. In addition, supervisors could gain important insights into an
institution's market liquidity by taking into account the availability o f alternative hedging
strategies and closely substitutable instruments.
34.

To understand the market liquidity risk arising from an institution's derivatives

activities, supervisors would benefit greatly from a picture o f the aggregate size o f the market
in which the institution is active. This is particularly important for OTC derivatives, which
are generally tailored to the specific needs o f customers and for which marking to market is
more difficult than for standardised products with liquid markets. As a result, it may be
difficult to unwind a position in an appropriate time frame because o f its size, the availability
o f suitable counterparties, or the narrowness o f the market. Currently available information
on notional values o f derivative instruments provides, at best, an incomplete indication o f the
aggregate size o f the market for a particular derivative instrument or o f an institution's
participation in that market. An alternative, yet still imperfect, measure o f market size would
be the gross positive and gross negative market values o f contracts by risk category or
product. Such data would provide an indication o f the economic or market value of the
derivative instruments held by banks and securities firms in a particular market at a point in
time and an institution's concentration in that market.
(b)
35.

Funding risk
Funding risk is the risk o f derivatives activities placing adverse funding and cash

flow pressures on an institution. Funding risk stemming from derivatives alone provides only
a partial picture o f an institution's liquidity position. In general, funding risk is best analysed
on an institution-wide basis across all financial instruments. However, it is also important for
supervisors to understand the impact o f derivatives on an institution's overall liquidity
position.
36.

Separate analysis o f notiona-l contract amounts o f exchange-traded and OTC

instruments (as described earlier) should augment supervisory awareness o f funding risks,
particularly given the requirements for margin and daily cash settlement o f exchange-traded
instruments and the resulting demands for liquidity that large positions in these instruments
may entail. For example, significant positions in OTC contracts hedged with exchange-traded
instruments could result in liquidity pressures arising from the daily margin and cash
requirements o f the exchange-traded products. Data on OTC contracts with collateral or other
"margin-like" requirements may also be necessary for assessing liquidity risk. In addition,
information about the notional amounts and expected cash flows of derivatives according to
specified time intervals would be helpful in assessing funding risk.
37.

Information on OTC contracts subject to “triggering agreements” provides further

information about funding risk. Triggering agreements generally entail contractual provisions
requiring the liquidation o f the contract or the posting of collateral if certain events, such as a

- 12downgrade in credit rating, occur. Substantial positions in contracts with triggering
agreements could increase funding risk by requiring the liquidation o f contracts or the
pledging o f collateral when the institution is experiencing financial stress. Accordingly,
information on the total notional amount and replacement cost o f OTC contracts (aggregated
across products) with triggering provisions provides supervisors with important information
about liquidity risk.
38.

Supervisors should also consider evaluating information based on institutions'

sensitivity analyses o f the effect o f adverse market developments on their funding
requirements. This information would shed light on the potential for additional margin or
collateral calls associated with exchange-traded and OTC derivatives positions due to changes
in market variables such as interest rates and exchange rates.
3.
39.

Market risk
Market risk is the risk that the value o f on- or off-balance-sheet positions will

decline before the positions can be liquidated or offset with other positions. Supervisors
should assess information on market risk by major categories o f risk, such as interest rates,
foreign exchange rates, equity prices and commodities. The market risk o f derivatives is best
assessed for the entire institution and should combine cash and derivatives positions. The
assessment should cover all types of activities generating market risks. Supervisors may also
consider breakdowns o f positions at the level o f individual portfolios, including, in the case
o f banks, trading and non-trading acti’ 'ties.
40.

Supervisors will be interested in some or all o f the following: position data that

would allow independent supervisory assessment o f market risk through the use o f some
supervisory model or monitoring criteria and data derived from an institution's own internal
estimates o f market risk.
41.

For certain institutions, particularly those that are not major dealers, it may be

appropriate to obtain position data (e.g. equities, debt securities, foreign exchange and
commodities), which could be drawn from the framework o f the Basle Committee's
standardised approach for market risk, once adopted, or from other approaches adopted by
national banking and securities supervisors. The collection o f position data could be carried
out at various levels o f detail, depending on the nature and scope o f the institution's trading
and derivatives activities. The detail can range from a broad measure o f exposure at the
portfolio level to a finer disaggregation by instrument and maturity.
42.

As an alternative or supplement to assessing position data, supervisors could

evaluate available information on an institution's internal estimates o f market risk. For some
institutions, this information could be derived from their internal value-at-risk methodology,
which involves the assessment o f potential losses due to adverse movements in market prices
o f a specified probability over a defined period of time. As an alternative to value-at-risk,
supervisors may find it useful on a case-by-case basis to assess internally-generated

- 13 -

information on eamings-at-risk,9 duration or gap analysis, scenario analyses, or any other
approach that sheds light on an institution's market risk. W hatever the approach taken,
supervisors should consider the measure o f market risk exposure in the context o f the
institution's limit policies.
43.If a firm uses value-at-risk models for measuring market risks, the supervisor
should evaluate in detail the methodology used, including its main parameters. Key
parameters for evaluating value-at-risk estimates include: (1) the volatility and correlation
assumptions o f the model (either implied or historical volatilities), (2) the holding period over
which the change in portfolio value is measured (e.g., two weeks), (3) the confidence interval
used to estimate exposure (e.g., 99% o f all outcomes) and (4) the historical sample period
(e.g., one year or two years) over which risk factor prices are observed.
44.

Value-at-risk measured solely at a point in time may not provide appropriate

insights about market risk due to the speed with which positions in derivatives and other
instruments can be altered. Such difficulties may be addressed by the use o f summary
statistics for the period over which the institution is reporting. For example, supervisors could
require institutions to communicate information on the highest value-at-risk number
measured during the reporting period, together with monthly or quarterly averages o f valueat-risk exposures. By comparing end-of-period value-at-risk with these other measures,
supervisors can better understand the volatility which has occurred in these measures during
the period. Supervisors could also encourage or require institutions to convey comparisons of
daily value-at-risk estimates with daily changes in actual portfolio value over a given
period.10 Internal models should be validated by comparing past estimates o f risk with actual
results and by assessing the models' major assumptions.
45.

Institutions with significant trading books should subject their portfolios on a

regular basis to stress tests using various assumptions and scenarios. These analyses o f the
portfolio under "worst case" scenarios should preferably be performed on an institution-wide
basis and should include an identification o f the major assumptions used. Quantitative
information on the results o f stress scenarios, which could be specified by supervisors or
institutions themselves, coupled with qualitative analyses o f the actions that management
might take under particular scenarios, would be very useful for supervisory purposes.
Examples of scenarios for interest rate risk include a parallel yield curve shift o f a determined
amount, a steepening or flattening o f the yield curve, or a change o f correlation assumptions.

9

Under mark-to-market accounting, value-at-risk w ill equal eamings-at-risk because changes in value
are reflected in earnings. If accrual accounting is applied to certain positions, value-at-risk and
eamings-at-risk will differ because all changes in value are not reflected in earnings.

10

The report o f the Euro-currency Standing Committee, a discussion paper entitled. Public D isclosure o f
M arket a n d C redit Risks by Financial Interm ediaries, issued in September 1994 (Fisher Report),
discusses factors to consider in interpreting value-at-risk measures, among other topics.

- 1446.

To minimise burden, supervisory assessment o f market risks should draw as much

as possible on the information that institutions must collect for supervisory capital purposes.
In the case o f the banking sector, the Basle Committee's market risk capital requirements,
once finalised and implemented, should serve as a basis for supervisory information on banks'
market risks. In addition, bank supervisors should consider adopting some o f the definitions
o f the market risk capital standards for reporting purposes, such as the definition o f the
trading book.
4.

Earnings

47.

As with cash market instruments, the profitability o f derivatives activities and

related on-balance-sheet positions are o f interest to supervisors. The separate effects on
income o f trading activities and activities other than trading would also be o f interest.
48.

Accounting standards and valuation techniques differ from country to country and

many member supervisors have little or no legal authority in this area. The Committees
therefore recognise that earnings information identified under this framework may not be
fully comparable across member countries.
(a)
49.

Trading purposes
Many sophisticated market participants view cash and derivative instruments as

ready substitutes; their use o f derivatives is complementary to cash instruments and positions
in financial instruments are often managed as a whole. For supervisors to consider
information that concentrates solely on derivatives and to omit similar data on cash
instruments could be misleading. In this context, the decomposition o f trading revenues (from
cash and derivative instruments) according to broad risk classes - interest rate risk, foreign
exchange risk, commodities and equities exposures, or other risks to the firm - without regard
to the type o f instrument that produced the trading income, may better describe the outcome
o f overall risk taking by the organisation.
50.

The systems o f some banks or securities firms may not decompose trading

revenues by broad categories o f risk. Under these circumstances, simplifying assumptions can
be used to approximate this categorisation o f income. For example, if a particular department
o f an institution typically handles domestic bonds and related derivatives, it may be
appropriate to consider trading gains and losses on these instruments as interest related
income. Further, the income from complex instruments that are exposed to both foreign
exchange and interest rate risk could be classified according to the primary attribute o f the
instrument (e.g., either as a foreign currency or an interest rate instrument).
51.

Finer disaggregation o f trading revenue within risk categories, for example, by

origination revenue, credit spread revenue and other trading revenue could be useful in

- 15evaluating an organisation's performance relative to its risk profile.1 However, even those
1
dealers with sophisticated information systems may not now be able to differentiate income
beyond broad risk categories. As the analytical abilities and systems o f market participants
evolve, it m ay be desirable to consider supervisory information that differentiates between
revenue earned from meeting customer needs and that earned from other sources.
Furthermore, as market participants' systems evolve, it may be desirable for supervisors to
evaluate information that differentiates between trading revenue earned from cash and
derivatives positions in each broad risk category. As with cash instruments, a rapid build-up
o f material trading losses on derivative instruments may indicate deficiency in an institution's
risk management systems and other internal controls that it should promptly evaluate and
correct.
(b)
52.

Purposes other than trading
Information about derivatives held for purposes other than trading (end-user

derivatives holdings) can also be useful to supervisors. For example, quantitative information
that includes the effect on reported earnings o f off-balance-sheet positions held by the
organisation to manage interest rate and other risks would be useful. When combined with
information on other factors affecting net interest margins and interest rate sensitivity, this
could provide insight into whether derivatives were being used to reduce interest rate risk or
to take positions inconsistent with this objective.
(c)
53.

Identifying unrealised or deferred losses
As with cash instruments, any material build-up o f unrealised losses or losses that

have been realised but deferred by the institution may be an area o f supervisory interest,
particularly for banking supervisors. At a minimum, the detection of such losses, and
particularly, an accumulation of such losses, should prompt supervisory inquiry. Derivative
contracts with unrealised losses or deferred losses may reduce future earnings and capital
positions when these losses are reflected in profits and losses for accounting purposes.
Therefore, when unrealised losses or deferred amounts are material, it is important for
supervisors to consider an institution's plans for reflecting these losses in their reported profits
and losses for accounting purposes. Moreover, a rapid build-up of material unrealised or
deferred losses may indicate a deficiency in an institution's internal controls and accounting
systems that it should promptly evaluate or correct.

11

As industry participants have recognised, trading revenue components may include: (1) origination
revenue that results from the initial calculation o f the market value o f new transactions; (2) credit
spread revenue that results from changes during the period in the unearned credit spread; and (3) other
trading revenues resulting from changes in the value o f the portfolio due to market movements and the
passage o f time.

- 16-

(d)
54.

Derivatives valuation reserves and actual credit losses
Supervisors should assess information on the valuation reserves that an institution

has established for its derivatives activities and on any credit losses on derivative instruments
that the institution has experienced during the period. In assessing these valuation reserves
and any credit losses, it is important to understand the institution's risk management policies
and valuation practices regarding derivatives. In addition, supervisors should determine how
the institution reflected valuation reserves and credit losses in its balance sheet and income
statement. Information on valuation reserves and the treatment o f credit losses is useful in
understanding how adverse changes in derivatives risks can affect an institution's financial
condition and earnings.
III.

Common minimum information framework
(a)

55.

Overview
The two Committees recommend that member supervisors have available to them

a minimum subset o f the catalogue o f data items listed in the above section for large
internationally active banks and securities firms with significant derivatives activities. This
common minimum framework is presented in Annex 3 and focuses primarily on information
relating to credit risk, market liquidity risk and overall market activity. Annex 4 provides
common definitions for the concepts used in the common minimum reporting framework.
56.

The common minimum framework represents a baseline o f information that the

Committees have identified as important for supervisors to begin assessing the nature anc.
scope o f an institution's derivatives activities and how derivatives contribute to an institution's
overall risk profile. Based on considerations such as an institution's size and business
activities, supervisors may wish to supplement the information o f the common minimum
framew'ork with other information drawn from the catalogue presented in the previous
section. It is expected that supervisors would revisit the common minimum framework
periodically to ensure that it is in line with activities o f banks and securities firms, market
innovations and the state of supervisory reporting at the level o f individual member countries.
For example, the common minimum framework presented in this paper currently does not
focus on market risk. However, in the case o f banks, supervisory capital standards for market
risks, once finalised, could serve as a basis for assessing comparable information on these
risks.
57.

The development o f a common minimum framework o f information could also

support the efforts of the Euro-currency Standing Committee o f G-10 central banks to collect,
on a regular basis, aggregate market data on the derivatives activities of financial institutions.
Compilation and disclosure o f aggregate market data on derivatives activities could serve a
useful supervisor)' function. For example, disclosure o f aggregate market data could give
supervisors a better picture o f how concentrated an institution's activities are in a particular

- 17 product. Such co-ordination o f data collection initiatives between banking and securities
supervisors and central banks also could contribute to limiting the reporting burden for the
banking and securities industries.
(b)
58.

Description o f minimum framework tables
The elements of the common minimum framework are summarised in Tables 1

through 5 o f Annex 3. The tables are intended to illustrate the information under the
minimum framework and do not reflect required reporting forms.
59.

Table 1 provides information for understanding the scope and nature o f an

institution's involvement in the derivatives markets. The table provides notional amounts by
broad category o f risk (interest rate, exchange rate, precious metals, other commodities and
equities) and by instrument type (forwards, swaps and options). The table also gives
supervisors a picture o f whether the institution is primarily involved in OTC derivatives or
exchange-traded contracts. Finally, the information helps supervisors understand whether
derivatives are being used for trading purposes or for purposes other than trading such as
hedging, which is particularly relevant for banking institutions. As indicated in footnote
number 1, supervisors are also encouraged to obtain separate information on certain
instruments, particularly on leveraged and other high-risk derivative instruments.
60.

Table 2 summarises the minimum information for assessing the market values

(gross positive and gross negative) by broad risk categories, including a distinction between
contracts that are held for trading purposes and those held for purposes other than trading
(generally, this distinction is of more relevance to banking supervisors). The information on
market values provides supervisors with an alternative to notional amounts for gauging an
institution's involvement in the derivatives markets. In addition, information on positive and
negative market values enables supervisors to determine if an institution is a net creditor or
borrower. Identifying market values for contracts other than trading can, in the case o f banks,
shed light on an institution's risk management strategy and the extent to which it may be
exposed to a significant build-up o f unrealised losses. Finally, in addition to market values,
Table 2 illustrates that information on potential credit exposure by major category o f risk
should be considered an element of the minimum framework.
61.

Table 3 identifies information on the notional amounts of derivatives by broad

category o f risk and by maturity (one year or less, over one year through five years, over five
years.) Given the importance o f maturity information for assessing the risks of options, these
are broken out in a separate line item for each o f the broad risk categories.
62.

Table 4 focuses on counterparty credit risk taking into account the credit quality

o f the counterparty'. The counterparty credit quality categories are sufficiently flexible to
allow for the application o f the Basle Capital Accord risk-weighting framework for banks, as
well as an approach based on either rating agency grades or on the equivalent internally
generated ratings of an institution. The measurement o f counterparty credit exposure

- 18incorporates the impact o f legally enforceable netting agreements as well as the use o f
collateral and guarantees. Furthermore, the table provides extra information on the quality
and value o f collateral and guarantees associated with derivative instruments.
63.

Table 5 supplements the information on credit quality contained in Table 4 by

focusing on instruments that are past-due by 30-89 days and by 90 days or more, and on
actual credit losses. The information in the over 90 day category could also include
information on derivatives that in the institution's assessment will not be fully collectible
though they are currently performing. The table indicates the flexibility for supervisors to
apply different maturity breakdowns if their national reporting systems do not use the time
intervals presented in the minimum framework. In addition, information on the credit losses
arising from derivatives activities is included as part o f the minimum framework.

Framework for Supervisory Information on Derivatives Activities
Use
1. C r e d it R is k ( O T C C o n t r a c t s )

(A ) C u r r e n t C r e d i t E x p o s u r e

Description
R isk o f lo s s (a ggregated acro ss all a c tiv itie s) due to counterparty default. T o th e ex ten t p o ssib le , credit
risk from on - and o ff-b a la n ce -sh e et instrum ents sh o u ld be co n sid ered together.
P o sitiv e R ep la cem en t C ost:
1.
2.

(B )

N etted to reflect le g a lly en fo rcea b le bilateral n ettin g a g reem en ts (a lso c o n sid er a v era g e and
range o f v a lu es o v er reporting period).
G ross by typ e - interest rate, foreign e x c h a n g e , eq u ity , p recio u s m eta ls and other
c o m m o d itie s.

P o t e n t ia l C r e d i t E x p o s u r e

D ata a llo w in g in d ep en d en t su p erv iso ry a sse ssm en t
o f exp osu re.

Data reflectin g in stitu tio n ’s a sse ssm e n t u sin g
internal m o d els.

G ross N o tio n a ls
1.
2.

B y ty p e - interest rate, foreign ex c h a n g e , eq u ity , p recio u s m eta ls and oth er co m m o d itie s.
M aturity - o n e year or le ss, o v er o n e year through fiv e years, o v e r fiv e years.

Internally generated estim a tes o f potential credit risk ca lcu la ted b y counterparty and su m m ed . U tilise
m o d el sp e cific a tio n s and param eters that are eith er d esign ated b y the su p erv iso r or currently e m p lo y e d by
the individual in stitu tion s in the risk m an agem en t p ro cess.

(C ) C r e d it E n h a n c e m e n t s

C ollateral - H ow m u ch o f cred it e x p o su re is

M arket v a lu e o f collateral h eld again st netted current and poten tial exp osu re.

collateralised ?
C ollateral A g reem en ts - H o w m u ch o f p oten tial
exp osu re is su b ject to colla tera l agreem en ts?
(D ) C o n c e n t r a t io n s o f C r e d i t

N o tio n a l am ount and m arket valu e o f contracts w ith agreem en ts to p ro v id e a d d itio n a l collateral sh o u ld
credit ex p o su re increase.
N u m b er o f counterparties w ith current and p oten tial cred it e x p o su res greater than a sp e c ifie d m in im u m
le v e l o f the reporter's capital. T otal ex p o su re to th ese counterparties (p o sitiv e n et rep lacem en t c o st and
potential credit ex p o su re). C ounterparty credit e x p o su re is better ev alu ated b y tak in g in to con sid eration
both ca sh -in stru m en t and o ff-b a la n ce -sh e e t relation sh ip s. S u p ervisors m a y a ls o w ish to obtain
inform ation on an institution's a g gregate e x p o su res to v ariou s e x c h a n g e s and on their ex p o su r e s to certain
ty p es o f collateral.

C o u n t e r p a r t y C r e d i t Q u a l it y

T otal p o sitiv e net rep lacem en t c o st and p otential credit ex p o su re b y cou nterparty cred it q u ality (b y B a sle
C apital A ccord r isk -w eig h ts, by rating a g en cy grad es, or b y internal ratings).
Inform ation on p ast-d u e status and actual cred it lo s se s, b y m ajor cou n terp arties and in the aggregate.

Annex 1

(E )

Framework for Supervisory Information on Derivatives Activities
Use
II. L iq u id it y R is k

Description
------------------- :
----------------------------------------------------- ----------------------------- -rM arket liq u id ity risk - risk that p o sitio n can n ot be liquid ated or h ed ged .

----— —----------------------- ------ j

F unding risk - in su fficien t c a sh -flo w or liq u id a ssets to m eet c a sh -flo w req u irem en ts. (In addition to
inform ation b e lo w , inform ation about the notion al am ou n ts and ex p e c te d cash flo w s o f d eriv a tiv es
acco rd in g to sp e c ifie d tim e in tervals.)
(A )

I d e n t if y p o t e n t i a l m a r k e t l iq u i d i t y e x p o s u r e s .

N o tio n a l am ou n ts and m arket v a lu es for ex ch an ge-trad ed and O T C d e r iv a tiv es b y m arket and product
type:
-

OTC
• Interest Rate - forw ards, sw a p s, am o rtisin g sw a p s, o p tio n prod ucts
• F oreign E xch an ge - forw ards, sw a p s, op tion p rodu cts
•
•

-

E q u ities
C o m m o d itie s and other

E xch an ge-T rad ed Futures and O p tio n s
• Interest rate
• F oreign exch a n g e
• Equity
• C o m m o d ity and other

N o tio n a l am ou n ts and e x p ec te d cash in and o u tflo w s b y m aturities.
(B )

I d e n t if y O T C c o n t r a c t s w it h t r ig g e r i n g
p r o v is io n s .

N o tio n a ls and p o sitiv e and n eg a tiv e m arket v a lu e o f con tracts w ith triggerin g p r o v isio n s (th is in form ation
co m b in ed g iv e s a picture o f the n et flo w s, in and out, resu ltin g from con tracts w ith triggers):
that require the institution to liq u id ate or p ost collateral in the w a k e o f ad v erse e v e n ts a ffe c tin g it;
that the institution can require its counterparty to liquid ate or p o st co lla tera l in the w a k e o f ad verse
e v en ts a ffe ctin g that counterparty.

(C ) M a r k e t a c t iv it y

N o tio n a l am ounts and g r o ss p o sitiv e and g r o ss n e g a tiv e m arket v a lu e o f d e r iv a tiv es b y risk c a teg o ry and
contract typ e. T h is data co u ld b e agg reg a ted a cro ss in stitu tion s to p ro v id e in form ation on total m arket
size.

Framework for Supervisory Information on Derivatives Activities
Use
III.

M a r k e t R is k

Description
Risk o f loss from adverse changes in market prices - data w ill need to be collected separately for trading and non­
trading portfolios.
Data could be collected by broad risk category (i.e., interest rate, foreign exchange, equities, com m odities, etc.).
Market risk best assessed from a portfolio context.

Position data allow ing independent supervisory
assessm ent using sim plified approaches.

For example:
-

-

Net open positions (longs minus shorts) by risk category (interest rate, foreign exchange, equities,
com m odities).
For equity contracts, net open positions by individual issues.
For interest rate and com m odities contracts, net open positions by maturities. Duration information on interest
rate positions.
Options could be included on a delta-equivalent basis.

Other data for alternative supervisory m odels or screening criteria.
Data on institution's internal assessm ent o f market
risk.

Internally generated estimate o f market risk through a value-at-risk (V A R ) m ethodology, eam ings-at-risk, duration
or gap analysis, or som e other methodology. For information on V AR , can use m odel specifications and
parameters that are either designated by supervisors or currently em ployed by individual institutions in the risk
management process. These include:
1.
2.
3.
4.
5.

Position sensitivities
Market risk factor volatilities
Market risk factor correlations
Historical sample period and holding period
Confidence interval

Information on the average and range o f VAR estimates over the reporting period more informative than point in
time estimates.
Internal model validation information:
1.
2.
Results o f stress tests. The stress test could be specified by
supervisors, the institution itself, or by a combination o f both.

Comparisons o f estimated risk vs. actual results - back-testing
Major assumptions underlying m odels

A nalysis o f likelihood o f "worst case" scenarios preferably on an institution-wide basis.
Identification o f major assumptions.
Qualitative analysis o f actions management might take under particular scenarios.

Framework for Supervisory Information on Derivatives Activities
Use
IV .

Description

E a r n in g s
(A)

T rad in g purposes

Revenues from trading activities (derivatives and cash instruments) by risk type (interest rate, foreign exchange,
equities, com m odities and other) or by major trading desks (bonds, swaps, FX, equities, etc).

(B)

P urposes oth er than trading

Impact on net income: net increase (decrease) in interest incom e, net increase (decrease) in interest expense and
other (non-interest allocations).

((-)

Identify u n realised or d eferred losses

Notional amounts, market values and unrealised losses o f derivatives held on an accrual basis. Amount o f realised
losses on derivatives that have been deferred. Could be collected either by instrument or in total.

(0 )

D erivatives v a lu ation reserves and actual
credit losses

Amount o f valuation reserves or provisions and actual credit losses, and their earnings impact.

Derivatives data elements and their uses
E le m e n t
1.

U se

Gross or Effective Notionals:
OTC by Contract Type
Exchange-Traded by Contract Type
Position (Long and Short)

Credit and Liquidity Risks
Credit and Liquidity Risks
Market Risk

2.

Positive Net Replacem ent Cost

Credit Risk

3.

Gross Positive M arket Value by Broad Risk Category

Market Activity, Credit Risk and Liquidity Risk

4.

Gross Negative M arket Value by Broad Risk Category

Market Activity and Liquidity Risk

5.

Collateral

Credit Risk (Current and Potential Credit Exposure)

6.

Contracts with Collateral Agreements

Potential Credit Exposure and Liquidity Risk

7.

Counterparty Exposures Identified by Risk W eight or Investment
Rating (Positive Net Replacement Cost and Potential Credit
Exposure)

Credit Risk (Counterparty Credit Quality)

8.

Notional Am ounts for Broad Risk Categories o f Derivatives by
Maturities.

9.

Internal Estimate o f Potential Credit Exposure

10. Counterparties with Significant Netted Credit Exposure

Potential Credit Exposure, M arket Risk, Liquidity Risk

Credit Risk (Potential Exposure)
Concentration o f Credit Risk

Derivatives data elements and their uses
E le m e n t

U se

1 1.

Contracts with Trigging Provisions

Liquidity Risk

12.

Market Value o f Contracts Held for Other than Trading

Earnings

13.

Internal "Valuc-at-Risk" Estimates by Broad Risk Categories
(Including Interest Rates, Foreign Exchange Rates, Commodity and
Equity Prices)

Market Risk

14.

Position Data (Longs and Shorts) for Debt Securities, Equities,
Foreign Exchange and Commodities

Market Risk

15.

Trading Revenues (Cash and Derivative Instruments) by Risk Type
(Includes Interest Rate, Foreign Exchange, Equity, Commodity,
etc.)

Earnings

16.

Impact on Net Income (Net Interest Income, Net Interest Expense
and Other Non-interest Allocations) o f Derivatives Held for
Purposes Other Than Trading

Earnings

17.

Unrealised and Deferred Losses

Earnings

18.

Valuation Reserves and Credit Losses

Earnings, Credit Risk

Common minimum information framework
T ab le 1: N otional am ounts by un d erlyin g exposures

N o tio n a l a m o u n ts*

In te r e st rate
c o n tr a c ts

F o re ig n e x c h a n g e
a n d g o ld
c o n tr a c ts *

P r e c io u s m e ta ls
(o th e r th a n g o ld )
c o n tr a c ts

O th e r c o m m o d ity
c o n tr a c ts

E q u ity -lin k e d
c o n tr a c ts

O T C c o n tr a c ts

Forwards
Swaps
Purchased options
Written options
E x c h a n g e -tr a d e d c o n tr a c ts

Futures - long positions
Futures - short positions
Purchased options
Written options
T o ta l c o n tr a c ts h eld fo r tr a d in g ^
T o ta l c o n tr a c ts h eld fo r o th e r th a n tr a d in g

1.

While included in this table's aggregate information, supervisors may wish to obtain separate information on certain categories o f higher risk derivative instruments, as
appropriate.

2.

This does not include spot foreign exchange, which may be assessed as a separate item. W hile included in the aggregate information in this colum n, for securities firms,
information on the notional amounts o f gold contracts should be evaluated separately.

3.

For purposes o f these totals, all derivative instruments o f securities firms w ill be considered to be in the "contracts held for trading" category.

Common minimum information framework
T abic 2: O T C N otional am ounts, m arket values and potential cred it exposure

In te r e st rate
c o n tr a c ts

F o re ig n e x c h a n g e
a n d gold

P r e c io u s m e ta ls
(o th e r th a n g o ld )

c o n tr a c ts ^

T o ta l n o tio n a ls, m a r k e t v a lu e s and
p o te n tia l c r e d it e x p o su re *

O th e r c o m m o d ity
c o n tr a c ts

c o n tr a c ts

E q u ity -lin k e d
c o n tr a c ts

T o ta l n o tio n a l am ounts-*
C o n tr a c ts h eld for tr a d in g p u rp o se s^

(a)

Gross positive market value

(b)

Gross negative market value

C o n tr a c ts h eld for o th e r th a n tr a d in g

(a)

Gross positive market value

(b)

Gross negative market value

P o ten tia l c red it ex p o su re ^

1.

W hile included in this table’s aggregate information, supervisors may wish to obtain separate information on certain categories o f higher risk derivative instruments, as
appropriate.

2.

This does not include spot foreign exchange, which may be assessed as a separate item. W hile included in the aggregate information in this colum n, for securities firms,
information on the notional amount, market value and potential future exposure o f gold contracts should be evaluated separately.

3.

The "total notional amounts” reflected on this line are the sum o f the notional amounts o f the OTC contracts summarised in Table 1.

4.

For purposes o f these totals, all derivative instruments o f securities firms w ill be considered to be in the "contracts held for trading" category.

5.

For banks, information on potential credit exposure should be in accordance with the Basle Capital Accord. Securities firms should use approaches acceptable to their
regulator in estimating these amounts.

Common minimum information framework
T ab le 3: O T C derivative con tracts’ notional am ounts by tim e intervals

O T C C o n tr a c ts 1

O n e y e a r o r less

O v e r o n e y e a r th r o u g h

O v e r Five y e a r s

fiv e y e a r s

(a)

Interest rate contracts
Purchased options

(b)

Foreign exchange and gold contracts^
Purchased options

(c)

Precious mclals (other than gold) contracts
Purchased options

(d)

Other com m odity contracts
Purchased options

(e)

Equity-linked contracts
Purchased options

1.

W hile included in this table's aggregate information, supervisors may wish to obtain separate information

on certain categories o f higher risk derivative instruments, as

appropriate.
2.

This does not include spot foreign exchange, which may be assessed as a separate item. W hile included in the aggregate information in this colum n, for securities firms,
information on the notional amounts (by time intervals) o f gold contracts should be evaluated separately.

Note: The information in this table is based on the remaining maturity o f the derivative instrument. Supervisors
broad risk categories noted above) based on the maturity o f the underlying.

may also want to evaluate information about options (by the

Common minimum information framework
T ab le 4: Inform ation on credit quality o f O T C derivative con tracts

E x p o su r e b e fo r e c o lla te r a l a n d g u a r a n te e s

C o u n te r p a r ty c r e d it q u a lity *

C r e d it e q u iv a le n t a m o u n t a fte r

C r o s s p o s itiv e m a r k e t v a lu e

C u r r e n t c r e d it e x p o su r e

P o te n tia l c r e d it e x p o su r e

C r e d it q u a lity *

C o lla te r a l

c o lla te r a l a n d g u a r a n te e s

G u a r a n te e s

1

2
3
Total

1

2
3

*

C r ed it q u a lity c a te g o r ie s w o u ld b e d e fin e d a s fo llo w s

1.

For banks, category 1 identifies counterparties given a 0% risk weight under the Basle Capital Accord.
For securities firms, category 1 identifies counterparties rated A A and above.

2.

For banks, category 2 identifies counterparties given a 20% risk weight under the Basle Capital
For securities firms, category 2 identifies counterparties rated BBB and above.

3.

For banks, category 3 identifies counterparties given a 50% risk weight under the Basle Capital Accord.
For securities firms, category 3 identifies counterparties rated below BBB.

Accord.

Note: When basing the above categories on ratings, an institution's equivalent internal credit grade ranking may be used when investment ratings are not available. M oreover, in
addition to using the credit quality categories based on Basle Accord risk w eights, bank supervisors may w ish to assess the above information by credit ratings assigned by
external rating agencies or by an institution's internal credit grade rankings.

Common minimum information framework
Table 5: Information about past-due OTC derivatives and credit losses^

B o o k v a lu e o f d e r iv a t iv e s p a s t -d u e 3 0 - 8 9 d a y s
B o o k v a lu e o f d e r iv a t iv e s p a s t -d u e 9 0 d a y s o r m o r e 2
G r o s s p o s i t iv e m a rk et v a lu e o f d e r iv a t iv e s p a st d u e 3 0 - 8 9 d a y s
G r o s s p o s i t iv e m a r k et v a lu e o f d e r iv a t iv e s p a s t -d u e 9 0 d a y s o r m o r e 2

C red it lo s s e s o n d e r iv a t iv e in s tr u m e n ts d u r in g th e p e r io d

1.

Certain countries may apply different maturity breakdowns when assessing past-due derivatives.
Also, supervisors may wish to consider information on derivatives that have been restructured due to deterioration in counterparty credit quality or past-due status, together
with information on collateral and guarantees supporting these exposures.
W hile included in this table's aggregate information, supervisors may wish to obtain separate information on certain categories o f higher risk derivative instruments, as
appropriate.

2.

Information about derivatives that are past due 90 or more should also include information about derivatives that, w hile not technically past-due, are with counterparties
that are not expected to pay the full amounts ow ed to the institution under the derivative contracts.

Annex 4

Definitions for elements o f the
common minim um inform ation fram ework

I.

Introduction
This set o f definitions refers to items identified in the common minimum

information framework for derivative instruments. These definitions are intended to assist
supervisors when analysing information about institutions' derivatives activities by improving
the consistency and comparability o f this information. The information presented below is
intended as supplemental guidance to the notes in Tables 1 - 5 o f the comm on minimum
information framework.
II.

General concepts
(a)

Broad risk categories (Tables 1 - 3 )
For supervisory analysis purposes, five broad risk categories for derivative

contracts are used in the common m inimum information framework. Derivative contracts
with multiple risk characteristics should be categorised based on the predominant risk
characteristics at the origination o f the contract. These five broad risk categories are
summarised below.
1.

Interest rate contracts. Interest rate contracts are contracts related to an interest-beai.ng
financial instrument or whose cash flows are determined by referencing interest rates or
another interest rate contract (e.g. an option on a futures contract to purchase a domestic
government bond). These contracts are generally used to adjust the institution's interest
rate exposure or, if the institution is an intermediary, the interest rate exposure o f
others. Interest rate contracts include single currency interest rate swaps, basis swaps,
forward rate agreements, futures contracts committing the institution to purchase or sell
financial instruments and whose predominant risk characteristic is interest rate risk and
interest rate options, including caps, floors, collars and corridors.
Excluded are contracts involving the exchange o f one or more foreign currencies (e.g.
cross currency swaps and currency options) and other contracts whose predominant risk
characteristic is foreign exchange risk, which should be evaluated as foreign exchange
contracts.
Excluded are commitments to purchase and sell when-issued securities from interest
rate contracts. Supervisors may wish to evaluate these separately.

2.

Foreign exchange contracts: Foreign exchange contracts are contracts to purchase
foreign currencies or contracts whose cash flows are determined by reference to foreign
currencies. Foreign currency contracts include forward foreign exchange, currency

-2futures, currency options, currency warrants and currency swaps. Such contracts are
usually used to adjust an institution's foreign currency exposure or, if the institution is
an intermediary, the foreign exchange exposure o f others. Spot foreign exchange
contracts can be excluded from this definition, as they are not derivative instruments.
All amounts reflected as foreign exchange contracts should be translated into the
institution's base (or functional) currency.
For the purpose o f supervisory analysis, only one side o f a foreign currency transaction
should be reported. In those transactions where foreign currencies are bought or sold
against an institution's base currency, include only that side o f the transaction which
involves the foreign currency. For example, if a US institution with a base currency of
US dollars enters into a futures contract in which it purchases US dollars against
Deutsche marks, then the amount o f Deutsche marks sold would be reflected as a
foreign exchange contract (in US dollar equivalent values). Consistent with this
approach, in cross-currency transactions, which involve the purchase and sale o f two
foreign currencies, only the purchase side should be reflected in the information about
foreign exchange contracts.
For purposes o f this analysis, bank supervisors should evaluate gold contracts together
with foreign exchange contracts. Supervisors o f banks and securities firms may also
wish to evaluate information about gold contracts separately.
3.

Precious metals (other than gold) contracts: All contracts that have a return, or portion
o f their return, linked to the price of silver, platinum and palladium contracts or to an
index of precious metals other than gold should be reflected in this broad risk category.

4.

Other commodity contracts: Other commodity contracts are contracts that have a
return, or a portion o f their return, linked to the price o f or to an index o f a commodity
such as petroleum, lumber, agricultural products, or to non-ferrous metals such as
copper or zinc. Other commodity contracts also include any other contracts that are not
appropriately categorised as interest rate, foreign exchange and gold, other precious
metals or equity derivative contracts.

5.

Equity-linked contracts'. Equity-linked derivative contracts are contracts that have a
return, or a portion o f their return, linked to the price o f a particular equity or to an
index o f equity prices, such as the Standard and Poor's 500 or the Nikkei.
B.

1.

Purposes for holding derivative instruments (Tables 1-2)

Contracts held fo r trading purposes: Contracts held for trading purposes include those
used in dealing and other trading activities accounted for at market value (or at lower of
cost or market value) with gains and losses recognised in earnings. Derivative

-3-

instruments used to hedge trading activities should also be reflected as derivatives held
for trading purposes.
Derivative trading activities include (a) regularly dealing in interest rate contracts,
foreign exchange contracts, equity derivative contracts and other off-balance-sheet
commodity contracts; (b) acquiring or taking positions in such items principally for the
purpose o f selling in the near term or otherwise with the intent to resell (or repurchase)
in order to profit from short-term price movements; or (c) acquiring or taking positions
in such items as an accommodation to customers.
2.

Contracts held f o r other than trading purposes: Derivative contracts that are held for
purposes other than trading include (a) off-balance-sheet contracts used to hedge debt
and equity securities not in the institution's trading accounts; (b) foreign exchange
contracts that are designated as, and are effective as, economic hedges o f items not in
trading accounts; and (c) other off-balance-sheet contracts used to hedge other assets or
liabilities not held for trading purposes. Included in this information are the notional
amount or par value o f contracts such as swap contracts intended to hedge interest rate
risk on commercial loans that are accounted for on a historical cost basis.
(c)

1.

Notional amounts (Tables 1 - 3 )

General concepts: Notional amounts reflect the gross par value (e.g. for futures,
forwards and option contracts) or the notional amount (e.g. for forward rate agreements
and swaps), as appropriate, for all off-balance-sheet contracts. These contracts should
be evaluated under the broad risk categories summarised in II.(a). Furthermore, these
notional amounts should be stated in local currency.
For purposes o f the common minimum information framework, the notional amount or
par value for an off-balance-sheet derivative contract with a multiplier component is the
contract's effective notional amount or par value. For example, a swap contract with a
stated notional amount o f $1,000,000 whose terms called for quarterly settlement o f the
difference between 5% and LIBOR multiplied by 10 has an effective notional amount
o f $10,000,000.

2.

Special considerations fo r gold contracts, precious metals (other than gold) contracts
and other commodity contracts: The contract amount for commodity and other
contracts should be the quantity, e.g. number o f units, o f the commodity or product
contracted for purchase or sale multiplied by the contract price o f a unit.
The notional amount for a commodity contract with multiple exchanges o f principal is
the contractual amount multiplied by the number o f remaining payments (or exchanges
o f principal ) in the contract.

-4 3.

Special considerations f o r equity-linked contracts: The contract amount for equity
derivative contracts is the quantity, e.g. number o f units, o f the equity instrument or
equity index contracted for purchase or sale multiplied by the contract price o f a unit.

4.

Notional amounts o f OTC derivatives by tim e intervals (Table 3): Table 3 summarises
the notional amounts or par value o f OTC off-balance-sheet contracts included in
Tables 1 and 2 that are subject to credit risk. (For banks, these OTC contracts are
subject to risk-based capital requirements.) Such contracts include swaps, forwards and
OTC purchased options. The notional amounts and par values should be presented in
the column corresponding to the contract's remaining term to maturity from the
evaluation date. For supervisory analysis purposes, the remaining maturities are (1) one
year or less; (2) over one year through five years; and (3) over five years. Supervisors
may also want to evaluate information about purchased options based on the maturity o f
the underlying.
This information on notional amounts should not reflect the notional amount for single
currency interest rate swaps in which payments are made based upon two floating rate
indices, so-called floating/floating or basis swaps; foreign exchange contracts with an
original maturity o f fourteen days or less; and futures contracts.
The notional amount for an amortising off-balance-sheet derivative contract is the
contract's current (or, if appropriate, effective) notional amount. This notional amount
should be reflected in the column corresponding to the contract's remaining term to
final maturity.
(d)

Gross positive and negative market values (Tables 2 ,3 and 5 present
information on gross positive market values; Table 2 presents information on
gross negative market values)

1.

The market value o f an off-balance-sheet derivative contract is the amount at which a
contract could be exchange in a current transaction between willing parties, other than
in a forced or liquidation sale. If a quoted market price is available for a contract, the
market value for that contract is the product o f the number o f trading units o f the
contract multiplied by that market price. If a quoted market price is not available, the
institution's best estimate o f market value could be used, based on the quoted market
price o f a similar contract or on valuation techniques such as discounted cash flows.
Market values should be reflected in the local currency o f the institution.

2.

Gross positive market values represent the loss that an institution would incur in the
event of a counterparty default, as measured by the cost of replacing the contract at
current market rates or prices. (This measure does not reflect reductions in credit
exposure that would occur under legally enforceable netting arrangements.)

(e)

Current credit exposure (Table 4)

Current credit exposure (sometimes referred to as the replacement cost) is the market
value o f a contract when that value is positive. Current credit exposure amounts for
OTC off-balance-sheet derivative contracts reflect consideration o f the effects o f
applicable legally enforceable bilateral netting agreements.
For banks, current credit exposure amounts should be consistent with the risk-based
capital standards. The current credit exposure is zero when the market value is negative
or zero. Current credit exposure should be derived as follows: determine whether a
legally enforceable bilateral netting agreement is in place between the institution and a
counterparty. If such an agreement is in place, the market values o f all applicable
contracts with that counterparty that are included in the netting agreement are netted to
a single amount. Next, for all other contracts covered by the risk-based capital standards
that have positive market values, the total o f the positive market values is determined.
Then, current credit exposure is the sum o f (i) the net positive market values of
applicable contracts subject to legally enforceable bilateral netting agreements and (ii)
the total positive market values o f all other contracts covered by the risk-based capital
standards.
The definition o f a legally enforceable bilateral netting agreement for purposes o f this
item is the same as that set forth in the risk-based capital rules.
(f)

Information on credit quality o f OTC derivative contracts (Table 4)

Gross positive market value and current credit exposure have been defined in 11(d) and
11(e) above.
Potential credit exposure is the exposure o f the derivative contract that may be realised
over its remaining life due to movements in the rates or prices underlying the contract.
For banks, under the Basle Capital Accord, potential credit exposure is reflected
through a so-called "add-on", which is calculated by multiplying the contract's gross or
effective notional value by a conversion factor based on the price volatility of the
underlying contract. There are separate factors for interest rate contracts, foreign
exchange and gold contracts, precious metals (other than gold) contracts, other
commodities contracts and equity-linked contracts - distinguishing between the
remaining maturity o f the contract (i.e. one year or less, over one year to five years and
more than five years). The add-ons may also take account o f the effects of legally valid
netting agreements. For banks, information on potential credit exposure should be
consistent with bank supervisory guidelines, including risk-based capital standards.

-6Securities firms should use approaches acceptable to their regulators in estimating
potential credit exposure.
3.

For banks, information on the manner in which collateral and guarantees reduce current
and potential credit exposure should be consistent with the Basle Capital Accord. For
securities firms, information on the effects o f collateral and guarantees should reflect
approaches that are acceptable to their regulators.

(g)
1.

Information about past-due derivatives (Table 5)

The "book value" o f past-due derivatives is the amounts, if any, that are recorded as
assets by the institution in its balance sheet. These amounts may include amounts
accrued as receivable for interest rate swaps, the unamortised amount o f the premium
paid for an interest rate cap or floor, or the market value o f a derivative contract in a
gain position that has been recorded as an asset (e.g. in a trading account) on the
balance sheet.

2.

The "gross positive market value" o f past-due derivatives is consistent with the
definition o f "gross positive market value" presented above (11(d)). These gross positive
market values should be evaluated regardless o f whether they have been recorded as
assets on the balance sheet. This information should not include the market value of
derivative instruments with negative market values.

3.

Credit losses include declines in positive market values for derivatives that are
associated with deteriorating counterparty credit quality, when the mark to market
values o f these derivatives have been recorded on the balance sheet. Credit losses may
also include write-offs o f the book value o f derivatives - taking these write-offs against
provisions (allowances) for credit losses.

III. Definitions of specific types of derivatives
(a)
1.

Futures contracts

Futures contracts represent agreements for delayed delivery o f financial instruments or
commodities in which the buyer agrees to purchase and the seller agrees to deliver, at a
specified future date, a specified instrument at a specified price or yield. Futures
contracts are standardised and are traded on organised exchanges where the exchange or
a clearing house acts as the counterparty to each contract.
(b)

1.

Forward contracts

Forward contracts represent agreements for delayed delivery o f financial instruments or
commodities in which the buyer agrees to purchase and the seller agrees to deliver, at a
specified future date, a specified instrument or commodity at a specified price or yield.

-7Forward contracts are not traded on organised exchanges and their contractual terms are
not standardised.
(c)
1.

Option contracts

Option contracts convey either the right or the obligation, depending upon whether the
institution is the purchaser or the writer, respectively, to buy or sell a financial
instrument or commodity at a specified price on or before a specified future date. Some
options are traded on organised exchanges. Also, options can be written to meet the
specialised needs o f the counterparty to the transaction. These customised option
contracts are known as over-the-counter (OTC) options. Thus, over-the-counter option
contracts include all option contracts not traded on an organised exchange.

2.

The buyer o f an option contract has, for compensation (such as a fee or premium),
acquired the right (or option) to sell to, or purchase from, another party some financial
instrument or commodity at a stated price on or before a specified future date. The
seller o f the contract has, for such compensation, become obligated to purchase or sell
the financial instrument or commodity at the option o f the buyer o f the contract. A put
option contract obligates the seller o f the contract to purchase some financial instrument
or commodity at the option o f the buyer o f the contract. A call option contract obligates
the seller o f the contract to sell some financial instrument or commodity at the option of
the buyer o f the contract.

3.

In addition, swaptions, i.e. OTC options to enter into a swap contact, and OTC contracts
known as caps, floors, collars and corridors should be reflected as options for
supervisory analysis purposes.

4.

Generally, options such as a call feature that are embedded in loans, securities and other
on-balance-sheet assets and commitments to lend art. not included in the supervisory
analysis reflected in Tables 1 - 5 . Supervisors may wish to evaluate these embedded
options separately in certain situations.

5.

Purchased options: When assessing information on purchased options in Table 1, this
information should reflect the aggregate notional or par value of the financial
instruments or commodities that the institution has, for a fee or premium, purchased the
right to either purchase or sell under exchange-traded or OTC option contracts that are
outstanding as of the evaluation date. Also, include in OTC purchased options an
aggregate notional amount for purchased caps, floors and swaptions and for the
puf vnased portion of collars and corridors.

6.

Written options: When evaluating information on written options for Table 1, this
information should reflect the aggregate notional or par value of the financial

-8 instruments or commodities that the institution has, for compensation (such as a fee or
premium), obligated itself to either purchase or sell under exchange-traded or OTC
option contracts that are outstanding as o f the evaluation date. Also reflect as written
options the aggregate notional amount for written caps, floors and swaptions and for the
written portion o f collars and corridors.
(d)
1.

Swaps

Swaps are OTC transactions in which two parties agree to exchange payment streams
based on a specified notional amount for a specified period. Forward starting swap
contracts should be evaluated as swaps. The notional amount o f a swap is the
underlying principal amount upon which the exchange o f interest, foreign exchange or
other income or expense is based. The notional amount for a swap contract with a
multiplier component is the contract's effective notional amount. In those cases where
the institution is acting as an intermediary, both sides o f the transaction should be
reflected in the information in Table 1.