EBA · 2016_2590 Final Q&A

Netting set treatment for trades with Specific Wrong Way Risk

Regulation
Regulation (EU) No 575/2013 (CRR)
Article
291, para. 5
Topic
Market risk
Submitted by
Consultancy firm
Submitted
2016-01-22
Answered
2016-11-18
Answer provided by
ESAs (EBA, ESMA, EIOPA)
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Question

For a netting set with three OTC derivative trades (trades A, B and C), Trade A is identified existing Specific Wrong-Way Risk. The underlying collateral was assigned in trade level, namely collateral 1, 2 and 3 allocated to trade A, B and C respectively. When removing trade A from the netting set and treated as a separate netting set, shall the underlying collateral be considered?

Background

Article 291(5)(a) of Regulation (EU) No 575/2013 (CRR) suggested that "the instruments where Specific Wrong-Way risk exists shall not be included in the same netting set as other transactions with the counterparty, and shall each be treated as a separate netting set", where this Article does not explicitly describe the treatment if there is Credit Support Annex (CSA) under ISDA master netting agreement. Therefore it is not clear whether Article 291(5)(a) of Regulation (EU) No 575/2013 (CRR) requires the Bank to consider the collateral effect of the netting. If required, we need clarity the correct treatment for considering the collateral effect for compliance.

Answer

Article 291(5)(a) of Regulation (EU) No 575/2013 (CRR) requires that trade A is separated from the remaining netting set of trade B and C, if Specific Wrong-Way risk has been identified and where there exists a legal connection between the counterparty and the issuer of the underlying of the OTC derivative. Note that Article 291 CRR only applies to the internal model method (IMM) for CCR. It has to be noted that for these kind of trades, special exposure treatment is required according to Article 291(5)(b)-(f) CRR. Article 291(5) CRR does not contain requirements regarding the assignment of collateral values to netting sets. Thus, the institution is free to assign collateral values 1, 2, and 3 to either the separated netting set containing trade A, the remaining netting set containing trades B and C or both netting sets.

Original source: European Banking Authority, Q&A ID 2016_2590

This Q&A is published by European Banking Authority and is non-binding. It does not constitute legal advice. Updated weekly from official ESA sources.

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