[Federal Register Volume 59, Number 234 (Wednesday, December 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-30040]


[[Page Unknown]]

[Federal Register: December 7, 1994]


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FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-0837]

 

Capital; Capital Adequacy Guidelines

AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.

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SUMMARY: The Board of Governors of the Federal Reserve System (Board) 
is amending its risk-based capital guidelines to recognize the risk-
reducing benefits of qualifying bilateral netting contracts. This final 
rule implements a recent revision to the Basle Accord permitting the 
recognition of such netting arrangements. The effect of the final rule 
is that state member banks and bank holding companies (banking 
organizations, institutions) may net positive and negative mark-to-
market values of interest and exchange rate contracts in determining 
the current exposure portion of the credit equivalent amount of such 
contracts to be included in risk-weighted assets.

EFFECTIVE DATE: December 31, 1994.

FOR FURTHER INFORMATION CONTACT: Roger Cole, Deputy Associate Director 
(202/452-2618), Norah Barger, Manager (202/452-2402), Robert Motyka, 
Supervisory Financial Analyst (202)/452-3621), Barbara Bouchard, 
Supervisory Financial Analyst (202/452-3072), Division of Banking 
Supervision and Regulation; or Stephanie Martin, Senior Attorney (202/
452-3198), Legal Division. For the hearing impaired only, 
Telecommunications Device for the Deaf, Dorothea Thompson (202/452-
3544), 20th and C Streets, N.W., Washington, D.C. 20551.

SUPPLEMENTARY INFORMATION:

Background

    The Basle Accord1 established a risk-based capital framework 
which was implemented for state member banks and bank holding companies 
by the Board in 1989. Under this framework, off-balance-sheet interest 
rate and exchange rate contracts (rate contracts) are incorporated into 
risk weighted assets by converting each contract into a credit 
equivalent amount. This amount is then assigned to the appropriate 
credit risk category according to the identity of the obligor or 
counterparty or, if relevant, the guarantor or the nature of the 
collateral. The credit equivalent amount of an interest or exchange 
rate contract can be assigned to a maximum credit risk category of 50 
percent.
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    \1\The Basle Accord is a risk-based framework that was proposed 
by the Basle Committee on Banking Supervision (Basle Supervisors' 
Committee) and endorsed by the central bank governors of the Group 
of Ten (G-10) countries in July 1988. The Basle Supervisors' 
Committee is comprised of representatives of the central banks and 
supervisory authorities from the G-10 countries (Belgium, Canada, 
France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the 
United Kingdom, and the United States) and Luxembourg.
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    The credit equivalent amount of a rate contract is determined by 
adding together the current replacement cost (current exposure) and an 
estimate of the possible increase in future replacement cost in view of 
the volatility of the current exposure over the remaining life of the 
contract (potential future exposure, also referred to as the add-
on).2
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    \2\This method of determining credit equivalent amounts for rate 
contracts is identified in the Basle Accord as the current exposure 
method, which is used by most international banks.
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    For risk-based capital purposes, a rate contract with a positive 
mark-to-market value has a current exposure equal to that market value. 
If the mark-to-market value of a rate contract is zero or negative, 
then there is no replacement cost associated with the contract and the 
current exposure is zero. The original Basle Accord and the Board's 
guidelines provided that current exposure would be determined 
individually for each rate contract entered into by a banking 
organization; institutions generally were not permitted to offset, that 
is, net, positive and negative market values of multiple rate contracts 
with a single counterparty to determine one current credit exposure 
relative to that counterparty.3
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    \3\It was noted in the Accord that the legal enforceability of 
certain netting arrangements was unclear in some jurisdictions. The 
legal status of netting by novation, however, was determined to be 
settled and this limited type of netting was recognized. Netting by 
novation is accomplished under a written bilateral contract 
providing that any obligation to deliver a given currency on a given 
date is automatically amalgamated with all other obligations for the 
same currency and value date. The previously existing contracts are 
extinguished and a new contract for the single net amount, in 
effect, legally replaces the amalgamated gross obligations.
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    In April 1993 the Basle Supervisors' Committee proposed a revision 
to the Basle Accord, endorsed by the G-10 Governors in July 1994, that 
permits institutions to net positive and negative market values of rate 
contracts subject to a qualifying, legally enforceable, bilateral 
netting arrangement. Under the revision, institutions with a qualifying 
netting arrangement may calculate a single net current exposure for 
purposes of determining the credit equivalent amount for the included 
contracts.4 If the net market value of the contracts included in 
such a netting arrangement is positive, then that market value equals 
the current exposure for the netting contract. If the net market value 
is zero or negative, then the current exposure is zero.
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    \4\The revision to the Accord notes that national supervisors 
must be satisfied about the legal enforceability of a netting 
arrangement under the laws of each jurisdiction relevant to the 
arrangement. The Accord also states that, if any supervisor is 
dissatisfied about enforceability under its own laws, the netting 
arrangement does not satisfy this condition and neither counterparty 
may obtain supervisory benefit.
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The Board's Proposal

    On May 20, 1994, the Board and the Office of the Comptroller of the 
Currency (OCC) issued a joint proposal to amend their respective risk-
based capital standards (59 FR 26456) in accordance with the Basle 
Supervisors' Committee's April 1993 proposal.5 The joint proposal 
provided that for capital purposes institutions regulated by the Board 
and the OCC could net the positive and negative market values of 
interest and exchange rate contracts subject to a qualifying, legally 
enforceable, bilateral netting contract to calculate one current 
exposure for that netting contract (sometimes referred to as the master 
netting contract).
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    \5\The Office of Thrift Supervision (OTS) issued a similar 
netting proposal on June 14, 1994 and the Federal Deposit Insurance 
Corporation (FDIC) issued its netting proposal on July 25, 1994.
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    The proposal provided that the net current exposure would be 
determined by adding together all positive and negative market values 
of individual contracts subject to the netting contract. The net 
current exposure would equal the sum of the market values if that sum 
is a positive value, or zero if the sum of the market values is zero or 
a negative value. The proposals did not alter the calculation method 
for potential future exposure.\6\
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    \6\Potential future exposure is estimated by multiplying the 
effective notional amount of a contract by a credit conversion 
factor which is based on the type of contract and the remaining 
maturity of the contract. Under the Board/OCC proposal, a potential 
future exposure amount would be calculated for each individual 
contract subject to the netting contract. The individual potential 
future exposures would then be added together to arrive at one total 
add-on amount.
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    Under the proposal, institutions would be able to net for risk-
based capital purposes only with a written bilateral netting contract 
that creates a single legal obligation covering all included individual 
rate contracts and does not contain a walkaway clause.\7\ The proposal 
required an institution to obtain a written and reasoned legal 
opinion(s) stating that under the master netting contract the 
institution would have a claim to receive, or an obligation to pay, 
only the net amount of the sum of the positive and negative market 
values of included individual contracts if a counterparty failed to 
perform due to default, insolvency, bankruptcy, liquidation, or similar 
circumstances.
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    \7\A walkaway clause is a provision in a netting contract that 
permits a non-defaulting counterparty to make lower payments than it 
would make otherwise under the contract, or no payment at all, to a 
defaulter or to the estate of a defaulter, even if the defaulter or 
the estate of the defaulter is a net creditor under the contract.
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    The proposal indicated that the legal opinion must normally cover: 
(i) The law of the jurisdiction in which the counterparty is chartered, 
or the equivalent location in the case of noncorporate entities, and if 
a branch of the counterparty is involved, the law of the jurisdiction 
in which the branch is located; (ii) the law that governs the 
individual contracts covered by the netting contract; and (iii) the law 
that governs the netting contract.
    The proposal provided that an institution must maintain in its 
files documentation adequate to support the bilateral netting contract. 
Documentation would typically include a copy of the bilateral netting 
contract, legal opinions and any related translations. In addition, the 
proposal required an institution to establish and maintain procedures 
to ensure that the legal characteristics of netting contracts would be 
kept under review.
    Under the proposal, the Federal Reserve could disqualify any or all 
contracts from netting treatment for risk-based capital purposes if the 
requirements of the proposal were not satisfied. In the event of 
disqualification, the affected contracts would be treated as though 
they were not subject to the master netting contract. The proposal 
indicated that outstanding netting by novation arrangements would not 
be grandfathered, that is, such arrangements would have to meet all of 
the proposed requirements for qualifying bilateral netting contracts.
    The proposal requested general comments as well as specific 
comments on the nature of collateral arrangements and the extent to 
which collateral might be recognized in conjunction with bilateral 
netting contracts.

Comments Received

    The Board received nineteen public comments on the proposed 
amendment. Eleven comments were from banking organizations and five 
were from industry trade associations and organizations. In addition, 
there were three comments from law firms. All commenters supported the 
expanded recognition of bilateral netting contracts for risk-based 
capital purposes. Several commenters encouraged recognition of such 
contracts as quickly as possible. Many of the commenters concurred with 
one of the principal underlying tenets of the proposal, that is, that 
legally enforceable bilateral netting contracts can provide an 
efficient and desirable means for institutions to reduce or control 
credit exposure. A few commenters noted that, in their view, the 
recognition of bilateral netting contracts would create an incentive 
for market participants to use such arrangements and would encourage 
lawmakers to clarify the legal status of netting arrangements in their 
jurisdictions. One commenter noted that the expanded recognition of 
bilateral netting contracts would help keep U.S. banking organizations 
competitive in global derivatives markets.
    While generally expressing their endorsement for the expanded 
recognition of bilateral netting contracts, nearly all commenters 
offered suggestions or requested clarification regarding details of the 
proposals. In particular, the commenters raised issues concerning 
specifics of the required legal opinions, the treatment of collateral, 
and the grandfathering of walkaway clauses and novation agreements.

Legal Opinions

    Almost all commenters addressed the proposed requirement that 
institutions obtain legal opinions concluding that their bilateral 
netting contracts would be enforceable in all relevant jurisdictions. 
Commenters did not object to the general requirement that they secure 
legal opinions, rather they raised a number of questions about the form 
and substance of an acceptable opinion.
    Form. Several commenters requested clarification as to the specific 
form of the legal opinion. Commenters wanted to know if a memorandum of 
law would satisfy the requirement or if a legal opinion would be 
required. They questioned whether a memorandum or opinion could be 
addressed to, or obtained by, an industry group, and whether a generic 
opinion or memorandum relating to a standardized netting contract would 
satisfy the legal opinion requirement.
    Several commenters suggested that an opinion secured on behalf of 
the banking industry by an organization should be sufficient so long as 
the individual institution's counsel concurs with the opinion and 
concludes that the opinion applies directly to the institution's 
specific netting contract and to the individual contracts subject to 
it. A few commenters requested confirmation that legal opinions would 
not have to follow a predetermined format.
    Scope. Several commenters identified two possible interpretations 
of the proposed language with regard to the scope of the legal 
opinions. They asked for clarification as to whether the opinions would 
be required to discuss only whether all relevant jurisdictions would 
recognize the contractual choice of law, or whether they must also 
discuss the enforceability of netting in bankruptcy or other instances 
of default. One commenter suggested deleting the requirement for a 
choice of law analysis.
    A number of commenters objected to the proposed requirement that 
the legal opinion for a multibranch netting contract (that is, a 
netting contract between multinational banks that includes contracts 
with branches of the parties located in various jurisdictions) address 
the enforceability of netting under the law of the jurisdiction where 
each branch is located. These commenters stated that it should be 
sufficient for the legal opinion to conclude that netting would be 
enforced in the jurisdiction of the counterparty's home office if the 
master netting contract provides that all transactions are considered 
obligations of the home office and the branch jurisdictions recognize 
that provision.
    Severability. Several commenters expressed concern about the 
proposed treatment for netting contracts that include contracts with 
branches in jurisdictions where the enforceability of netting is 
unclear. In such circumstances, commenters asserted, unenforceability 
or uncertainty in one jurisdiction should not invalidate the entire 
netting contract for risk-based capital netting treatment. These 
commenters contended that contracts with branches of a counterparty in 
jurisdictions that recognize netting arrangements should be netted and 
contracts with branches in jurisdictions where the enforceability of 
netting is not supported by legal opinions should, for risk-based 
capital purposes, be severed, or removed from the master netting 
contract and treated as though they were not subject to that contract. 
These commenters noted that this treatment should only be available to 
the extent it is supported by legal opinion.
    Conclusions. The proposal required a legal opinion to conclude that 
``relevant court and administrative authorities would find'' the 
netting to be effective. Many commenters that discussed this aspect of 
the proposal expressed concern that this standard was too high. They 
suggested, instead, that the opinions be required to conclude that 
netting ``should'' be effective.
    A few commenters requested clarification regarding the proposed 
requirement that the netting contract must create a single legal 
obligation.

Collateral

    Twelve commenters addressed the proposal's specific request for 
comment on the nature of collateral and the extent to which collateral 
might be recognized in conjunction with bilateral netting contracts. 
All of these commenters believed collateral should be recognized as a 
means of reducing credit exposure. A few commenters noted that 
collateral arrangements are increasingly being used with derivative 
transactions.
    Several commenters stated that for netting contracts that call for 
the use of collateral, the amount of required collateral is determined 
from the net mark-to-market value of the master netting contract. A few 
commenters added that mark-to-market collateral often is used in 
conjunction with a collateral ``add-on'' based on such things as the 
notional amount of the underlying contracts, the maturities of the 
contracts, the credit quality of the counterparty, and volatility 
levels.
    A number of commenters offered their opinions as to how collateral 
should be recognized for risk-based capital purposes. Some suggested 
that the existing method of recognizing collateral for purposes of 
assigning credit equivalent amounts to risk categories is applicable to 
derivative transactions as well. Other commenters expressed the view 
that collateral should be recognized when assigning risk weights to the 
extent it is legally available to cover the total credit exposure for 
the bilateral netting contract in the event of default and that this 
availability should be addressed in the legal opinions.
    Several other commenters suggested separating the net current 
exposure and potential future exposure of bilateral netting contracts 
for determining collateral coverage and appropriate risk weights. One 
commenter favored recognizing collateral for capital purposes by 
allowing an institution to offset net current exposure by the amount of 
the collateral to further reduce the credit equivalent amount.
    Two commenters requested clarification that contracts subject to 
qualifying netting contracts could be eligible for a zero percent risk 
weight if the transaction is properly collateralized in accordance with 
the Board's collateralized transactions rule.8
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    \8\In December 1992 the Board issued an amendment to its risk-
based capital guidelines permitting certain collateralized 
transactions to qualify for a zero percent risk weight (57 FR 62180, 
December 30, 1992). In order to qualify for a zero percent risk 
weight, an institution must maintain a positive margin of qualifying 
collateral at all times. Thus, the collateral arrangement should 
provide for immediate liquidation of the claim in the event that a 
positive margin of collateral is not maintained. The OCC has issued 
a similar proposal (58 FR 43822, August 18, 1993).
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Walkaway Clauses

    Several commenters addressed the proposed prohibition against 
walkaway clauses in contracts qualifying for netting for risk-based 
capital purposes. While most of these commenters agreed that, 
ultimately, walkaway clauses should be eliminated from master netting 
contracts, they favored a phase-out period, during which outstanding 
bilateral netting contracts containing walkaway clauses could qualify 
for capital netting treatment. Several commenters contended that if a 
defaulter is a net debtor under the contract, the existence of a 
walkaway clause would not affect the amount owed to the non-defaulting 
creditor.

Novation

    A few commenters expressed concern that the proposal did not 
grandfather outstanding novation agreements. These commenters suggested 
a phase-in period during which novation agreements would not be 
required to be supported by legal opinions.

Other Issues

    One commenter requested greater detail on the nature and extent of 
examination review procedures. Two commenters stated that in some 
situations obtaining translations might be burdensome. Another 
commenter suggested assurance that the Federal Reserve would not 
disqualify netting contracts in an unreasonable manner.
    Approximately one-half of the commenters expressed concern that the 
proposal specifically was limited to interest rate and exchange rate 
contracts. All of these opposed limiting the range of products that 
could be included under qualifying netting contracts. In this regard, 
one commenter noted that where there is sufficient legal support 
confirming the enforceability of cross-product netting, such netting 
should be recognized for capital purposes.
    A number of commenters used the proposal as an opportunity to 
discuss the manner in which the add-on for potential future exposure is 
calculated. They suggested netting contracts should be recognized not 
only as a way to reduce the current exposure to a counterparty, but 
also the effects of such netting contracts should be taken into account 
to reduce the amount of capital organizations must hold against the 
potential future exposure to the counterparty.

Final Rule

    After considering the public comments received and further 
deliberating the issues involved, the Board is adopting a final rule 
recognizing, for capital purposes, qualifying bilateral netting 
contracts. This final rule is substantially the same as proposed.

Legal Opinions

    Form. The final rule requires that institutions obtain a written 
and reasoned legal opinion(s) concluding that the netting contract is 
enforceable in all relevant jurisdictions. This requirement is aimed at 
ensuring there is a substantial legal basis supporting the legal 
enforceability of a netting contract before reducing a banking 
organization's capital requirement based on that netting contract. A 
legal opinion, as generally recognized by the legal community in the 
United States, can provide such a legal basis. A memorandum of law may 
be an acceptable alternative as long as it addresses all of the 
relevant issues in a credible manner.
    As discussed in the proposal, the legal opinions may be prepared by 
either an outside law firm or an institution's in-house counsel. The 
salient requirements for an acceptable legal opinion are that it: (i) 
Addresses all relevant jurisdictions; and (ii) concludes with a high 
degree of certainty that in the event of a legal challenge the banking 
organization's claim or obligation would be determined by the relevant 
court or administrative authority to be the net sum of the positive and 
negative mark-to-market values of all individual contracts subject to 
the bilateral netting contract. The subject matter and complexity of 
required legal opinions will vary.
    To some extent, institutions may use general, standardized opinions 
to help support the legal enforceability of their bilateral netting 
contracts. For example, a banking organization may have obtained a 
memorandum of law addressing the enforceability of netting provisions 
in a particular foreign jurisdiction. This opinion may be used as the 
basis for recognizing netting generally in that jurisdiction. However, 
with regard to an individual master netting contract, the general 
opinion would need to be supplemented by an opinion that addresses 
issues such as the enforceability of the underlying contracts, choice 
of law, and severability.
    For example, the Board does not believe that a generic opinion 
prepared for a trade association with respect to the effectiveness of 
netting under the standard form agreement issued by the trade 
association, by itself, is adequate to support a netting contract. 
Banking organizations using such general opinions would need to 
supplement them with a review of the terms of the specific netting 
contract that the institution is executing.
    Scope. With regard to the scope of the legal opinions, that is, 
what areas of analysis must be covered, the Board is of the opinion 
that legal opinions must address the validity and enforceability of the 
entire netting contract. The opinion must conclude that under the 
applicable state or other jurisdictional law the netting contract is a 
legal, valid, and binding contract, enforceable in accordance with its 
terms, even in the event of insolvency, bankruptcy, or similar 
proceedings. Opinions provided on the law of jurisdictions outside of 
the U.S. should include a discussion and conclusion that netting 
provisions do not violate the public policy or the law of that 
jurisdiction.
    The Board has further determined that one of the most critical 
aspects of a qualifying netting contract is the contract's 
enforceability in any jurisdiction whose law would likely be applied in 
an enforcement action, as well as the jurisdiction where the 
counterparty's assets reside. In this regard, and in light of the 
policy in some countries to liquidate branches of foreign banking 
organizations independent of the head office, the Board is retaining 
its proposed requirement that legal opinions address the netting 
contract's enforceability under: (i) The law of the jurisdiction in 
which the counterparty is chartered, or the equivalent location in the 
case of noncorporate entities, and if a branch of the counterparty is 
involved, the law of the jurisdiction in which the branch is located; 
(ii) the law that governs the individual contracts subject to the 
bilateral netting contract; and (iii) the law that governs the netting 
contract.
    Severability. The Board recognizes that for some multibranch 
netting contracts an organization may not be able to obtain a legal 
opinion(s) concluding that netting would be enforceable in every 
jurisdiction where branches covered under the master netting contract 
are located. The Board concurs with commenters that in such situations 
it may be inefficient to require institutions to renegotiate netting 
contracts to ensure they cover only those jurisdictions where netting 
is clearly enforceable. The Board has determined that, in certain 
circumstances for capital purposes, banking institutions may use master 
bilateral netting contracts that include contracts with branches across 
all jurisdictions. Banking institutions should calculate their net 
current exposure for the contracts in those jurisdictions where netting 
clearly is enforceable as supported by legal opinion(s). The remaining 
contracts subject to the netting contract should be severed from the 
netting contract and treated as though they were not subject to the 
netting contract for capital and credit purposes. This approach of 
essentially dividing contracts subject to the netting contact into two 
categories--those that clearly may be netted and those that may not--is 
acceptable provided that the banking organization's legal opinions 
conclude that the contracts that do not qualify for netting treatment 
are legally severable from the master netting contract and that such 
severance will not undermine the enforceability of the netting contract 
for the remaining qualifying contracts.
    Conclusions. The Board has retained the proposed language that 
legal opinions must represent that netting would be enforceable in all 
relevant jurisdictions. In response to commenters' assertions that the 
standard for this type of legal opinion is too high, the Board notes 
that use of the word ``would'' in the capital rules does not 
necessarily mean that the legal opinions must also use the word 
``would'' or that enforceability must be determined to be an absolute 
certainty. The intent, rather, is for banking organizations to secure a 
legal opinion concluding that there is a high degree of certainty that 
the netting contract will survive a legal challenge in any applicable 
jurisdiction. The degree of certainty should be apparent from the 
reasoning set out in the opinion.
    The Board notes that the requirement for legal opinions to conclude 
that netting contracts must create a single legal obligation applies 
only to those individual contracts that are covered by, and included 
under, the netting contract for capital purposes. As discussed above, a 
netting contract may include individual contracts that do not qualify 
for netting treatment, provided that these individual contracts are 
legally severable from the contracts to be netted for capital purposes.
    Institutions generally must include all contracts covered by a 
qualifying netting contract in calculating the current exposure of that 
netting contract. In the event a netting contract covers transactions 
that are normally excluded from the risk-based ratio calculation--for 
example, exchange rate contracts with an original maturity of fourteen 
calendar days or less or instruments traded on exchanges that require 
daily payment of variation margin--an institution may choose to either 
include or exclude all mark-to-market values of such contracts when 
determining net current exposure, but this choice must be followed 
consistently.

Collateral

    The final rule permits, subject to certain conditions, institutions 
to take into account qualifying collateral when assigning the credit 
equivalent amount of a netting contract to the appropriate risk weight 
category in accordance with the procedures and requirements currently 
set forth in the Board's risk-based capital guidelines. The Board has 
added language to the final rule clarifying that collateral must be 
legally available to cover the credit exposure of the netting contract 
in the event of default. For example, the collateral may not be pledged 
solely against one individual contract subject to the master netting 
contract. The legal availability of the collateral must be addressed in 
the legal opinions.

Walkaway Clauses

    The Board has considered the suggestion made by some commenters of 
a phase-out period for outstanding contracts with walkaway clauses. The 
Board continues to believe that walkaway clauses do not reduce credit 
risk. Accordingly, the final rule retains the provision that bilateral 
netting contracts with walkaway clauses are not eligible for netting 
treatment for risk-based capital purposes and does not provide for a 
phase-out period.

Novation

    The proposal required all netting contracts, including netting by 
novation agreements, to be supported by written legal opinions. The 
Board does not agree with commenters that a grandfathering period for 
outstanding novation agreements is needed. Rather, the Board continues 
to believe that all netting contracts must be held to the same 
standards in order to promote certainty as to the legal enforceability 
of the contracts and to decrease the risks faced by counterparties in 
the event of default. Under the final rule, a netting by novation 
agreement must meet the requirements for a qualifying bilateral netting 
contract.

Other Issues

    The Board has considered all of the other issues raised by 
commenters. With regard to documentation, the Board reiterates that, as 
with all provisions of risk-based capital, a banking organization must 
maintain in its files appropriate documentation to support any 
particular capital treatment including netting of rate contracts. 
Appropriate documentation typically would include a copy of the 
bilateral netting contract, supporting legal opinions, and any related 
translations. The documentation should be available to examiners for 
their review.
    The Board recognizes commenters' concerns that the proposed rule 
was limited specifically to interest and exchange rate contracts. The 
Board notes that both the Basle Accord and the Board's risk-based 
capital guidelines currently do not address derivatives contracts other 
than rate contracts. This final rule does not attempt to go beyond the 
scope of the existing risk-based capital framework and applies only to 
netting contracts encompassing interest rate and foreign exchange rate 
contracts. The Board, however, notes that the Basle Supervisors' 
Committee issued a proposal for public comment in July 1994 to amend 
the Basle Accord that explicitly would set forth the risk-based capital 
treatment for other types of derivative transactions, such as 
commodity, precious metal, and equity contracts. In this regard, the 
Board issued a similar proposal, based on the Basle Supervisors' 
Committee proposal, to amend its risk-based capital guidelines (59 FR 
43508, August 24, 1994).
    Until the Basle Accord has been revised and the Board's risk-based 
capital rules have been amended to encompass commodity, precious metal, 
and equity derivative contracts, the Board, rather than automatically 
disqualifying from capital netting treatment an entire netting contract 
that includes non-rate-related transactions, will permit institutions 
to apply the following treatment. In determining the current exposure 
of otherwise qualifying netting contracts that include non-rate-related 
contracts, institutions will be permitted to net the positive and 
negative mark-to-market values of the included interest and exchange 
rate contracts, while severing the non-rate-related contracts and 
treating them for risk-based capital purposes as individual contracts 
that are not subject to the master netting contract. (This treatment is 
similar to the treatment applied to a netting contract that includes 
contracts in jurisdictions where the enforceability of netting is not 
supported by legal opinion. With non-rate-related contracts, however, 
legal opinions on severability are not required.)
    The Board notes that the regulatory language with regard to the 
calculation of potential future exposure remains essentially the same 
as that proposed. The Board has clarified an underlying premise of the 
current exposure method for calculating credit exposure as set forth in 
the Basle Accord, that is, the add-on for potential future exposure 
must be calculated based on the effective, rather than the apparent, 
notional principal amount and the notional amount an institution uses 
will be subject to examiner review.9
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    \9\The notional amount is, generally, a stated reference amount 
of money used to calculate payment streams between the 
counterparties. In the event that the effect of the notional amount 
is leveraged or enhanced by the structure of the transaction, 
institutions must use the actual, or effective, notional amount when 
determining potential future exposure.
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Regulatory Flexibility Act Analysis

    Pursuant to section 605(b) of the Regulatory Flexibility Act, the 
Board hereby certifies that this final rule will not have a significant 
impact on a substantial number of small business entities. Accordingly, 
a regulatory flexibility analysis is not required.

Paperwork Reduction Act and Regulatory Burden

    The Board has determined that this final rule will not increase the 
regulatory paperwork burden of banking organizations pursuant to the 
provisions of the Paperwork Reduction Act (44 U.S.C. 3501 et seq.).
    Section 302 of the Riegle Community Development and Regulatory 
Improvement Act of 1994 (Pub. L. 103-325, 108 Stat. 2160) provides that 
the federal banking agencies must consider the administrative burdens 
and benefits of any new regulation that imposes additional requirements 
on insured depository institutions. Section 302 also requires such a 
rule to take effect on the first day of the calendar quarter following 
final publication of the rule, unless the agency, for good cause, 
determines an earlier effective date is appropriate.
    The new capital rule imposes certain requirements on depository 
institutions that wish to net the current exposures of their rate 
contracts for purposes of calculating their risk-based capital 
requirements. For these institutions, any burden of complying with the 
requirements of netting under a legally enforceable netting contract 
and obtaining the necessary legal opinions should be outweighed by the 
benefits associated with a lower capital requirement. The new rule will 
not affect institutions that do not wish to net for capital purposes. 
For these reasons, the Board has determined that an effective date of 
December 31, 1994 is appropriate, in order to allow banking 
organizations to take advantage of netting in their year-end 
statements, if they so desire. For these same reasons, in accordance 
with 5 U.S.C. 553(d)(3) the Board finds there is good cause not to 
follow the 30-day notice requirements of 5 U.S.C. 553(d) and to make 
the rule effective on December 31, 1994.

List of Subjects

12 CFR Part 208

    Accounting, Agriculture, Banks, banking, Branches, Capital 
adequacy, Confidential business information, Crime, Currency, Federal 
Reserve System, Mortgages, Reporting and recordkeeping requirements, 
Securities, State member banks.

12 CFR Part 225

    Administrative practice and procedure, Banks, banking, Capital 
adequacy, Federal Reserve System, Holding companies, Reporting and 
recordkeeping requirements, Securities.

Authority and Issuance

    For the reasons set out in the preamble, parts 208 and 225 of 
chapter II of title 12 of the Code of Federal Regulations are amended 
as set forth below.

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

    1. The authority citation for part 208 is revised to read as 
follows:

    Authority: 12 U.S.C. 36, 248(a) and 248(c), 321-338a, 371d, 461, 
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105, 
3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g), 
78l(i), 78o-4(c)(5), 78q, 78q-1 and 78w; 31 U.S.C. 5318.

    2. Appendix A to part 208 is amended by revising:
    a. Section III.E.2.;
    b. Section III.E.3;
    c. Section III.E.5.;
    d. The last heading and two subsequent paragraphs of Attachment IV; 
and
    e. Attachment V.
    The revisions read as follows:

Appendix A to Part 208--Capital Adequacy Guidelines for State Member 
Banks: Risk-Based Measure

* * * * *

III. * * *

E. * * *

    12. Calculation of credit equivalent amounts. a. The credit 
equivalent amount of an off-balance-sheet rate contract that is not 
subject to a qualifying bilateral netting contract in accordance 
with section III.E.5. of this appendix A is equal to the sum of (i) 
the current exposure (sometimes referred to as the replacement cost) 
of the contract; and (ii) an estimate of the potential future credit 
exposure over the remaining life of the contract.
    b. The current exposure is determined by the mark-to-market 
value of the contract. If the mark-to-market value is positive, then 
the current exposure is that mark-to-market value. If the mark-to-
market value is zero or negative, then the current exposure is zero. 
Mark-to-market values are measured in dollars, regardless of the 
currency or currencies specified in the contract, and should reflect 
changes in the relevant rates, as well as counterparty credit 
quality.
    c. The potential future credit exposure of a contract, including 
a contract with a negative mark-to-market value, is estimated by 
multiplying the notional principal amount of the contract by a 
credit conversion factor. Banks should, subject to examiner review, 
use the effective rather than the apparent or stated notional amount 
in this calculation. The conversion factors are:

------------------------------------------------------------------------
                                                     Interest   Exchange
                                                       rate       rate  
                Remaining maturity                  contracts  contracts
                                                    (percent)  (percent)
------------------------------------------------------------------------
One year or less..................................       0          1.0 
Over one year.....................................       0.5        5.0 
------------------------------------------------------------------------

    d. Examples of the calculation of credit equivalent amounts for 
these instruments are contained in Attachment V of this appendix A.
    e. Because exchange rate contracts involve an exchange of 
principal upon maturity, and exchange rates are generally more 
volatile than interest rates, higher conversion factors have been 
established for foreign exchange rate contracts than for interest 
rate contracts.
    f. No potential future credit exposure is calculated for single 
currency interest rate swaps in which payments are made based upon 
two floating rate indices, so-called floating/floating or basis 
swaps; the credit exposure on these contracts is evaluated solely on 
the basis of their mark-to-market values.
    3. Risk weights. Once the credit equivalent amount for an 
interest rate or exchange rate contract has been determined, that 
amount is assigned to the risk weight category appropriate to the 
counterparty, or, if relevant, to the guarantor or the nature of any 
collateral.49 However, the maximum weight that will be applied 
to the credit equivalent amount of such instruments is 50 percent.
---------------------------------------------------------------------------

    \4\9For interest and exchange rate contracts, sufficiency of 
collateral or guarantees is determined by the market value of the 
collateral or the amount of the guarantee in relation to the credit 
equivalent amount. Collateral and guarantees are subject to the same 
provisions noted under section III.B. of this appendix A. Collateral 
held against a netting contract is not recognized for capital 
purposes unless it is legally available to support the single legal 
obligation created by the netting contract.
---------------------------------------------------------------------------

* * * * *
    5. Netting. a. For purposes of this appendix A, netting refers 
to the offsetting of positive and negative mark-to-market values in 
the determination of a current exposure to be used in the 
calculation of a credit equivalent amount. Any legally enforceable 
form of bilateral netting (that is, netting with a single 
counterparty) of rate contracts is recognized for purposes of 
calculating the credit equivalent amount provided that:
    i. The netting is accomplished under a written netting contract 
that creates a single legal obligation, covering all included 
individual contracts, with the effect that the bank would have a 
claim to receive, or obligation to pay, only the net amount of the 
sum of the positive and negative mark-to-market values on included 
individual contracts in the event that a counterparty, or a 
counterparty to whom the contract has been validly assigned, fails 
to perform due to any of the following events: Default, insolvency, 
liquidation, or similar circumstances.
    ii. The bank obtains a written and reasoned legal opinion(s) 
representing that in the event of a legal challenge--including one 
resulting from default, insolvency, liquidation, or similar 
circumstances--the relevant court and administrative authorities 
would find the bank's exposure to be such a net amount under:
    1. The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities, and if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    2. The law that governs the individual contracts covered by the 
netting contract; and
    3. The law that governs the netting contract.
    iii. The bank establishes and maintains procedures to ensure 
that the legal characteristics of netting contracts are kept under 
review in the light of possible changes in relevant law.
    iv. The bank maintains in its files documentation adequate to 
support the netting of rate contracts, including a copy of the 
bilateral netting contract and necessary legal opinions.
    b. A contract containing a walkaway clause is not eligible for 
netting for purposes of calculating the credit equivalent 
amount.50
---------------------------------------------------------------------------

    \5\0A walkaway clause is a provision in a netting contract that 
permits a non-defaulting counterparty to make lower payments than it 
would make otherwise under the contract, or no payment at all, to a 
defaulter or to the estate of a defaulter, even if the defaulter or 
the estate of the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------

    c. By netting individual contracts for the purpose of 
calculating its credit equivalent amount, a bank represents that it 
has met the requirements of this appendix A and all the appropriate 
documents are in the bank's files and available for inspection by 
the Federal Reserve. The Federal Reserve may determine that a bank's 
files are inadequate or that a netting contract, or any of its 
underlying individual contracts, may not be legally enforceable 
under any one of the bodies of law described in paragraph 5.a.ii.1. 
through 5.a.ii.3. of section III of this appendix A. If such a 
determination is made, the netting contract may be disqualified from 
recognition for risk-based capital purposes or underlying individual 
contracts may be treated as though they are not subject to the 
netting contract.
    d. The credit equivalent amount of rate contracts that are 
subject to a qualifying bilateral netting contract is calculated by 
adding (i) the current exposure of the netting contract, and (ii) 
the sum of the estimates of the potential future credit exposures on 
all individual contracts subject to the netting contract, estimated 
in accordance with section III.E.2. of this appendix A.51
---------------------------------------------------------------------------

    \5\1For purposes of calculating potential future credit exposure 
to a netting counterparty for foreign exchange contracts and other 
similar contracts in which notional principal is equivalent to cash 
flows, total notional principal is defined as the net receipts 
falling due on each value date in each currency. The reason for this 
is that offsetting contracts in the same currency maturing on the 
same date will have lower potential future exposure as well as lower 
current exposure.
---------------------------------------------------------------------------

    e. The current exposure of the netting contract is determined by 
summing all positive and negative mark-to-market values of the 
individual contracts included in the netting contract. If the net 
sum of the mark-to-market values is positive, then the current 
exposure of the netting contract is equal to that sum. If the net 
sum of the mark-to-market values is zero or negative, then the 
current exposure of the netting contract is zero. The Federal 
Reserve may determine that a netting contract qualifies for risk-
based capital netting treatment even though certain individual 
contracts may not qualify. In such instances, the nonqualifying 
contracts should be treated as individual contracts that are not 
subject to the netting contract.
    f. In the event a netting contract covers contracts that are 
normally excluded from the risk-based ratio calculation--for 
example, exchange rate contracts with an original maturity of 
fourteen calendar days or less, or instruments traded on exchanges 
that require daily payment of variation margin--an institution may 
elect to consistently either include or exclude all mark-to-market 
values of such contracts when determining net current exposure.
    g. An example of the calculation of the credit equivalent amount 
for rate contracts subject to a qualifying netting contract is 
contained in Attachment V of this appendix A.
* * * * *

Attachment IV--Credit Conversion Factors for Off-Balance-Sheet Items 
for State Member Banks

* * * * *

Credit Conversion for Interest Rate and Exchange Rate Contracts

    1. The credit equivalent amount of a rate contract is the sum of 
the current credit exposure of the contract and an estimate of 
potential future increases in credit exposure. The current exposure 
is the positive mark-to-market value of the contract (or zero if the 
mark-to-market value is zero or negative). For rate contracts that 
are subject to a qualifying bilateral netting contract the current 
exposure is, generally, the net sum of the positive and negative 
mark-to-market values of the contracts included in the netting 
contract (or zero if the net sum of the mark-to-market values is 
zero or negative). The potential future exposure is calculated by 
multiplying the effective notional amount of a contract by one of 
the following credit conversion factors, as appropriate:

------------------------------------------------------------------------
                                                     Interest   Exchange
                                                       rate       rate  
                Remaining maturity                  contracts  contracts
                                                    (percent)  (percent)
------------------------------------------------------------------------
One year or less..................................        0         1.0 
Over one year.....................................        0.5       5.0 
------------------------------------------------------------------------

    2. No potential future exposure is calculated for single 
currency interest rate swaps in which payments are made based upon 
two floating indices, that is, so called floating/floating or basis 
swaps. The credit exposure on these contracts is evaluated solely on 
the basis of their mark-to-market value. Exchange rate contracts 
with an original maturity of fourteen days or less are excluded. 
Instruments traded on exchanges that require daily payment of 
variation margin are also excluded.

 Attachment V--Calculation of Credit Equivalent Amounts for Interest Rate and Exchange Rate-Related Transactions
                                             for State Member Banks                                             
----------------------------------------------------------------------------------------------------------------
                          Potential                  +                   Current          =           Credit    
                          exposure    ------------------------------    exposure    -------------   equivalent  
   Type of contract   ----------------                              ----------------                  amount    
 (remaining maturity)     Notional      Conversion      Potential                      Current   ---------------
                          principal       factor        exposure     Mark-to-market    exposure                 
                          (dollars)                     (dollars)         value       (dollars)                 
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward                                                                                             
 foreign exchange....       5,000,000          .01           50,000         100,000      100,000         150,000
(2) 120-day forward                                                                                             
 foreign exchange....       6,000,000          .01           60,000        -120,000            0          60,000
(3) 3-year single-                                                                                              
 currency interest-                                                                                             
 rate swap...........      10,000,000          .005          50,000         200,000      200,000         250,000
(4) 3-year single-                                                                                              
 currency fixed/                                                                                                
 floating interest-                                                                                             
 rate swap...........      10,000,000          .005          50,000        -250,000            0          50,000
(5) 7-year cross-                                                                                               
 currency floating/                                                                                             
 floating interest-                                                                                             
 rate swap...........      20,000,000          .05        1,000,000      -1,300,000            0       1,000,000
                      ------------------------------------------------------------------------------------------
      Total..........  ..............  ............       1,210,000  ..............      300,000       1,510,000
----------------------------------------------------------------------------------------------------------------

    If contracts (1) through (5) above are subject to a qualifying 
bilateral netting contract, then the following applies:

----------------------------------------------------------------------------------------------------------------
                                              Potential                                                         
                                               future                   Net current                   Credit    
                                           exposure (from       +       exposure\1\       =         equivalent  
                                               above)                                                 amount    
----------------------------------------------------------------------------------------------------------------
(1)......................................          50,000                                                       
(2)......................................          60,000                                                       
(3)......................................          50,000                                                       
(4)......................................          50,000                                                       
(5)......................................      1,000,0000                                                       
                                          ----------------------------------------------------------------------
      Total..............................       1,210,000  ...........            0  ...........       1,210,000
----------------------------------------------------------------------------------------------------------------
\1\The total of the mark-to-market values from above is -1,370,000. Since this is a negative amount, the net    
  current exposure is zero.                                                                                     

* * * * *

 PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

    1. The authority citation for part 225 is revised to read as 
follows:
    Authority: 12 U.S.C. 1817(j)(13), 1818, 1831i, 1831p-1, 
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and 
3909.
    2. Appendix A to part 225 is amended by revising:
    a. Section III.E.2.;
    b. Section III.E.3.;
    c. Section III.E.5.;
    d. The last heading and subsequent two paragraphs of Attachment IV; 
and
    e. Attachment V.
    The revisions read as follows:

Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Risk-Based Measure

* * * * *

III. * * *

E. * * *

    2. Calculation of credit equivalent amounts. a. The credit 
equivalent amount of an off-balance sheet rate contract that is not 
subject to a qualifying bilateral netting contract in accordance 
with section III.E.5. of this appendix A is equal to the sum of (i) 
the current exposure (sometimes referred to as the replacement cost) 
of the contract; and an (ii) estimate of the potential future credit 
exposure over the remaining life of the contract.
    b. The current exposure is determined by the mark-to-market 
value of the contract. If the mark-to-market value is positive, then 
the current exposure is that mark-to-market value. If the mark-to-
market value is zero or negative, then the current exposure is zero. 
Mark-to-market values are measured in dollars, regardless of the 
currency or currencies specified in the contract, and should reflect 
changes in the relevant rates, as well as counterparty credit 
quality.
    c. The potential future credit exposure of a contract, including 
a contract with a negative mark-to-market value, is estimated by 
multiplying the notional principal amount of the contract by a 
credit conversion factors. Banking organizations should, subject to 
examiner review, use the effective rather than the apparent or 
stated notional amount in this calculation. The conversion factors 
are:

------------------------------------------------------------------------
                                                     Interest   Exchange
                                                       rate       rate  
                Remaining maturity                  contracts  contracts
                                                    (percent)  (percent)
------------------------------------------------------------------------
One year or less..................................        0         1.0 
Over one year.....................................        0.5       5.0 
------------------------------------------------------------------------

    d. Examples of the calculation of credit equivalent amounts for 
these instruments are contained in Attachment V of this appendix A.
    e. Because exchange rate contracts involve an exchange of 
principal upon maturity, and exchange rates are generally more 
volatile than interest rates, higher conversion factors have been 
established for exchange rate contracts than for interest rate 
contracts.
    f. No potential future credit exposure is calculated for single 
currency interest rate swaps in which payments are made based upon 
two floating rate indices, so-called floating/floating or basis 
swaps; the credit exposure on these contracts is evaluated solely on 
the basis of their mark-to-market values.
    3. Risk weights. Once the credit equivalent amount for an 
interest rate or exchange rate contract has been determined, that 
amount is assigned to the risk weight category appropriate to the 
counterparty or, if relevant, to the guarantor or the nature of any 
collateral.53 However, the maximum weight that will be applied 
to the credit equivalent amount of such instruments is 50 percent.
---------------------------------------------------------------------------

    \5\3 For interest and exchange rate contracts, sufficiency of 
collateral or guarantees is determined by the market value of the 
collateral or the amount of the guarantee in relation to the credit 
equivalent amount. Collateral and guarantees are subject to the same 
provisions noted under section III.B. of this appendix A. Collateral 
held against a netting contract is not recognized for capital 
purposes unless it is legally available to support the single legal 
obligation created by the netting contract.
---------------------------------------------------------------------------

* * * * *
    5. Netting. a. For purposes of this appendix A, netting refers 
to the offsetting of positive and negative mark to-market values in 
the determination of a current exposure to be used in the 
calculation of a credit equivalent amount. Any legally enforceable 
form of bilateral netting (that is, netting with a single 
counterparty) of rate contracts is recognized for purposes of 
calculating the credit equivalent amount provided that:
    i. The netting is accomplished under a written netting contract 
that creates a single legal obligation, covering all included 
individual contracts, with the effect that the organization would 
have a claim to receive, or obligation to receive or pay, only the 
net amount of the sum of the positive and negative mark-to-market 
values on included individual contracts in the event that a 
counterparty, or a counterparty to whom the contract has been 
validly assigned, fails to perform due to any of the following 
events: default, bankruptcy, liquidation, or similar circumstances.
    ii. The banking organization obtains a written and reasoned 
legal opinion(s) representing that in the event of a legal 
challenge--including one resulting from default, bankruptcy, 
liquidation, or similar circumstances--the relevant court and 
administrative authorities would find the banking organization's 
exposure to be such a net amount under:
    1. The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities, and if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    2. The law that governs the individual contracts covered by the 
netting contract; and
    3. The law that governs the netting contract.
    iii. The banking organization establishes and maintains 
procedures to ensure that the legal characteristics of netting 
contracts are kept under review in the light of possible changes in 
relevant law.
    iv. The banking organization maintains in its files 
documentation adequate to support the netting of rate contracts, 
including a copy of the bilateral netting contract and necessary 
legal opinions.
    b. A contract containing a walkaway clause is not eligible for 
netting for purposes of calculating the credit equivalent 
amount.54
---------------------------------------------------------------------------

    \5\4A walkaway clause is a provision in a netting contract that 
permits a non-defaulting counterparty to make lower payments than it 
would make otherwise under the contract, or no payment at all, to a 
defaulter or to the estate of a defaulter even if the defaulter or 
the estate of the defaulter is a net creditor under the contract.
---------------------------------------------------------------------------

    c. By netting individual contracts for the purpose of 
calculating its credit equivalent amount, a banking organization 
represents that it has met the requirements of this appendix A and 
all the appropriate documents are in the organization's files and 
available for inspection by the Federal Reserve. The Federal Reserve 
may determine that a banking organization's files are inadequate or 
that a netting contract, or any of its underlying individual 
contracts, may not be legally enforceable under any one of the 
bodies of law described in paragraph 5.a.ii.1. through 5.a.ii.3. of 
section III of this appendix A. If such a determination is made, the 
netting contract may be disqualified from recognition for risk-based 
capital purposes or underlying individual contracts may be treated 
as though they are not subject to the netting contract.
    d. The credit equivalent amount of rate contracts that are 
subject to a qualifying bilateral netting contract is calculated by 
adding (i) the current exposure of the netting contract, and (ii) 
the sum of the estimates of the potential future credit exposures on 
all individual contracts subject to the netting contract, estimated 
in accordance with section III.E.2. of this appendix A.55
---------------------------------------------------------------------------

    \5\5For purposes of calculating potential future credit exposure 
to a netting counterparty for foreign exchange contracts and other 
similar contracts in which notional principal is equivalent to cash 
flows, total notional principal is defined as the net receipts 
falling due on each value date in each currency. The reason for this 
is that offsetting contracts in the same currency maturing on the 
same date will have lower potential future exposure as well as lower 
current exposure.
---------------------------------------------------------------------------

    e. The current exposure of the netting contract is determined by 
summing all positive and negative mark-to-market values of the 
individual contracts included in the netting contract. If the net 
sum of the mark-to-market values is positive, then the current 
exposure of the netting contract is equal to that sum. If the net 
sum of the mark-to-market values is zero or negative, then the 
current exposure of the netting contract is zero. The Federal 
Reserve may determine that a netting contract qualifies for risk-
based capital netting treatment even though certain individual 
contracts may not qualify. In such instances, the nonqualifying 
contracts should be treated as individual contracts that are not 
subject to the netting contract.
    f. In the event a netting contract covers contracts that are 
normally excluded from the risk-based ratio calculation--for 
example, exchange rate contracts with an original maturity of 
fourteen calendar days or less, or instruments traded on exchanges 
that require daily payment of variation margin--an institution may 
elect to consistently either include or exclude all mark-to-market 
values of such contracts when determining net current exposure.
    g. An example of the calculation of the credit equivalent amount 
for rate contracts subject to a qualifying netting contract is 
contained in Attachment V of this appendix A.
* * * * *

Attachment IV--Credit Conversion Factors for Off-Balance-Sheet Items 
for Bank Holding Companies

* * * * *

Credit Conversion for Interest Rate and Exchange Rate Contracts

    1. The credit equivalent amount of a rate contract is the sum of 
the current credit exposure of the contract and an estimate of 
potential future increases in credit exposure. The current exposure 
is the positive mark-to-market value of the contract (or zero if the 
mark-to-market value is zero or negative). For rate contracts that 
are subject to a qualifying bilateral netting contract the current 
exposure is the net sum of the positive and negative mark-to-market 
values of the contracts included in the netting contract (or zero if 
the net sum of the mark-to-market values is zero or negative). The 
potential future exposure is calculated by multiplying the effective 
notional amount of a contract by one of the following credit 
conversion factors, as appropriate:

------------------------------------------------------------------------
                                                     Interest   Exchange
                                                       rate       rate  
                Remaining maturity                  contracts  contracts
                                                    (percent)  (percent)
------------------------------------------------------------------------
One year or less..................................        0         1.0 
Over one year.....................................        0.5       5.0 
------------------------------------------------------------------------

    2. No potential future exposure is calculated for single 
currency interest rate swaps in which payments are made based upon 
two floating indices, that is, so called floating/floating or basis 
swaps. The credit exposure on these contracts is evaluated solely on 
the basis of their mark-to-market value. Exchange rate contracts 
with an original maturity of fourteen days or less are excluded. 
Instruments traded on exchanges that require daily payment of 
variation margin are also excluded.

Attachment V.--Calculation of Credit Equivalent Amounts for Interest Rate and Exchange Rate-Related Transactions
                                           for Bank Holding Companies                                           
----------------------------------------------------------------------------------------------------------------
                            Potential exposure              +            Current          =           Credit    
                      ----------------------------------------------    exposure    -------------   equivalent  
   Type of contract       Notional                      Potential   ----------------   Current        amount    
 (remaining maturity)     principal     Conversion      exposure     Mark-to-market    exposure  ---------------
                          (dollars)       Factor        (dollars)         value       (dollars)                 
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward                                                                                             
 foreign exchange....       5,000,000          .01           50,000         100,000      100,000         150,000
(2) 120-day forward                                                                                             
 foreign exchange....       6,000,000          .01           60,000        -120,000            0          60,000
(3) 3-year single-                                                                                              
 currency fixed/                                                                                                
 floating interest                                                                                              
 rate swap...........      10,000,000          .005          50,000         200,000      200,000         250,000
(4) 3-year single-                                                                                              
 currency fixed/                                                                                                
 floating interest-                                                                                             
 rate swap...........      10,000,000          .005          50,000        -250,000            0          50,000
(5) 7-year cross-                                                                                               
 currency floating/                                                                                             
 floating interest-                                                                                             
 rate swap...........      20,000,000          .05        1,000,000      -1,300,000            0       1,000,000
                      ------------------------------------------------------------------------------------------
      Total..........                                     1,210,000  ..............      300,000       1,510,000
----------------------------------------------------------------------------------------------------------------

    If contracts (1) through (5) above are subject to a qualifying 
bilateral netting contract, then the following applies:

----------------------------------------------------------------------------------------------------------------
                                              Potential                                                         
                                               future                   Net current                   Credit    
                                           exposure (from       +       exposure\1\       =         equivalent  
                                               above)                                                 amount    
----------------------------------------------------------------------------------------------------------------
(1)......................................          50,000                                                       
(2)......................................          60,000                                                       
(3)......................................          50,000                                                       
(4)......................................          50,000                                                       
(5)......................................       1,000,000                                                       
----------------------------------------------------------------------------------------------------------------
      Total..............................       1,210,000  ...........            0  ...........      1,210,000 
----------------------------------------------------------------------------------------------------------------
\1\The total of the mark-to-market values from above is -1,370,000. Since this is a negative amount, the net    
  current exposure is zero.                                                                                     

* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, December 1, 1994.
William W. Wiles,
Secretary of the Board.
[FR Doc. 94-30040 Filed 12-6-94; 8:45 am]
BILLING CODE 6210-01-P