Regulatory Capital Rules: Advanced Approaches Risk-Based Capital Rule; Market Risk Capital Rule

Federal RegisterAug 30, 2012

Ask Donna

What actually matters in this document.

Text

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. ID OCC-2012-0010]

RIN 1557-AD46

FEDERAL RESERVE SYSTEM

12 CFR Part 217

[Regulation Q; Docket No. R-1442]

RIN 7100 AD-87

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Parts 324 and 325

RIN 3064-AD97

Regulatory Capital Rules: Advanced Approaches Risk-Based Capital Rule; Market Risk Capital Rule

AGENCY:

Office of the Comptroller of the Currency, Treasury; the Board of Governors of the Federal Reserve System; and the Federal Deposit Insurance Corporation.

ACTION:

Joint notice of proposed rulemaking.

SUMMARY:

The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the agencies) are seeking comment on three notices of proposed rulemaking (NPRs) that would revise and replace the agencies' current capital rules.

In this NPR (Advanced Approaches and Market Risk NPR) the agencies are proposing to revise the advanced approaches risk-based capital rule to incorporate certain aspects of “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III) that the agencies would apply only to advanced approach banking organizations. This NPR also proposes other changes to the advanced approaches rule that the agencies believe are consistent with changes by the Basel Committee on Banking Supervision (BCBS) to its “International Convergence of Capital Measurement and Capital Standards: A Revised Framework” (Basel II), as revised by the BCBS between 2006 and 2009, and recent consultative papers published by the BCBS. The agencies also propose to revise the advanced approaches risk-based capital rule to be consistent with Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). These revisions include replacing references to credit ratings with alternative standards of creditworthiness consistent with section 939A of the Dodd-Frank Act.

Additionally, the OCC and FDIC are proposing that the market risk capital rule be applicable to federal and state savings associations, and the Board is proposing that the advanced approaches and market risk capital rules apply to top-tier savings and loan holding companies domiciled in the United States that meet the applicable thresholds. In addition, this NPR would codify the market risk rule consistent with the proposed codification of the other regulatory capital rules across the three proposals.

DATES:

Comments must be submitted on or before October 22, 2012.

ADDRESSES:

Comments should be directed to:

OCC:

Because paper mail in the Washington, DC area and at the OCC is subject to delay, commenters are encouraged to submit comments by the Federal eRulemaking Portal or email, if possible. Please use the title “Regulatory Capital Rules: Advanced Approaches Risk-based Capital Rule; Market Risk Capital Rule” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods:

•

Federal eRulemaking Portal—“Regulations.gov”:

Go to

http://www.regulations.gov,

under the “More Search Options” tab click next to the “Advanced Docket Search” option where indicated, select “Comptroller of the Currency” from the agency drop-down menu, and then click “Submit.” In the “Docket ID” column, select “OCC-2012-0010” to submit or view public comments and to view supporting and related materials for this proposed rule. The “How to Use This Site” link on the Regulations.gov home page provides information on using Regulations.gov, including instructions for submitting or viewing public comments, viewing other supporting and related materials, and viewing the docket after the close of the comment period.

•

Email: regs.comments@occ.treas.gov.

•

Mail:

Office of the Comptroller of the Currency, 250 E Street SW., Mail Stop 2-3, Washington, DC 20219.

•

Fax:

(202) 874-5274.

•

Hand Delivery/Courier:

250 E Street SW., Mail Stop 2-3, Washington, DC 20219.

Instructions:

You must include “OCC” as the agency name and “Docket Number OCC-2012-0010” in your comment. In general, OCC will enter all comments received into the docket and publish them on the Regulations.gov Web site without change, including any business or personal information that you provide such as name and address information, email addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure. Do not enclose any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure. You may review comments and other related materials that pertain to this notice by any of the following methods:

•

Viewing Comments Electronically:

Go to

http://www.regulations.gov

. Select “Document Type” of “Public Submissions,” in “Enter Keyword or ID Box,” enter Docket ID “OCC-2012-0010,” and click “Search.” Comments will be listed under “View By Relevance” tab at bottom of screen. If comments from more than one agency are listed, the “Agency” column will indicate which comments were received by the OCC.

•

Viewing Comments Personally:

You may personally inspect and photocopy comments at the OCC, 250 E Street SW., Washington, DC. For security reasons, the OCC requires that visitors make an appointment to inspect comments. You may do so by calling (202) 874-4700. Upon arrival, visitors will be required to present valid government-issued photo identification and to submit to security screening in order to inspect and photocopy comments.

•

Docket:

You may also view or request available background documents and project summaries using the methods described above.

Board:

When submitting comments, please consider submitting your comments by email or fax because paper mail in the Washington, DC area and at the Board may be subject to delay. You may submit comments, identified by Docket No. [XX][XX], by any of the following methods:

•

Agency Web Site: http://www.federalreserve.gov

. Follow the instructions for submitting comments at

http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm

•

Federal eRulemaking Portal: http://www.regulations.gov

. Follow the instructions for submitting comments.

•

Email: regs.comments@federalreserve.gov

. Include docket number in the subject line of the message.

•

Fax:

(202) 452-3819 or (202) 452-3102.

•

Mail:

Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue NW., Washington, DC 20551.

All public comments are available from the Board's Web site at

http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm

as submitted, unless modified for technical reasons. Accordingly, your comments will not be edited to remove any identifying or contact information. Public comments may also be viewed electronically or in paper form in Room MP-500 of the Board's Martin Building (20th and C Street NW., Washington, DC 20551) between 9 a.m. and 5 p.m. on weekdays.

FDIC:

You may submit comments by any of the following methods:

•

Federal eRulemaking Portal: http://www.regulations.gov

. Follow the instructions for submitting comments.

•

Agency Web site: http://www.FDIC.gov/regulations/laws/federal/propose.html

•

Mail:

Robert E. Feldman, Executive Secretary, Attention: Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.

•

Hand Delivered/Courier:

The guard station at the rear of the 550 17th Street Building (located on F Street), on business days between 7 a.m. and 5 p.m.

•

E-mail: comments@FDIC.gov

Instructions:

Comments submitted must include “FDIC” and “RIN 3064-D97.” Comments received will be posted without change to

http://www.FDIC.gov/regulations/laws/federal/propose.html,

including any personal information provided.

FOR FURTHER INFORMATION CONTACT:

OCC:

Margot Schwadron, Senior Risk Expert, (202) 874-6022, David Elkes, Risk Expert, (202) 874-3846, or Mark Ginsberg, Risk Expert, (202) 927-4580, or Ron Shimabukuro, Senior Counsel, Patrick Tierney, Counsel, Carl Kaminski, Senior Attorney, or Kevin Korzeniewski, Attorney, Legislative and Regulatory Activities Division, (202) 874-5090, Office of the Comptroller of the Currency, 250 E Street SW., Washington, DC 20219.

Board:

Anna Lee Hewko, Assistant Director, Capital and Regulatory Policy, (202) 530-6260, Thomas Boemio, Manager, Capital and Regulatory Policy, (202) 452-2982, or Constance M. Horsley, Manager, Capital and Regulatory Policy, (202) 452-5239, Division of Banking Supervision and Regulation; or Benjamin W. McDonough, Senior Counsel, (202) 452-2036, or April C. Snyder, Senior Counsel, (202) 452-3099, Legal Division, Board of Governors of the Federal Reserve System, 20th and C Streets NW., Washington, DC 20551. For the hearing impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-4869.

FDIC:

Bobby R. Bean, Associate Director,

bbean@fdic.gov;

Ryan Billingsley, Senior Policy Analyst,

rbillingsley@fdic.gov;

or Karl Reitz, Senior Policy Analyst,

kreitz@fdic.gov,

Capital Markets Branch, Division of Risk Management Supervision, (202) 898-6888; or Mark Handzlik, Counsel,

mhandzlik@fdic.gov,

Michael Phillips, Counsel,

mphillips@fdic.gov;

or Greg Feder, Counsel,

gfeder@fdic.gov,

Ryan Clougherty, Senior Attorney,

rclougherty@fdic.gov;

Supervision Branch, Legal Division, Federal Deposit Insurance Corporation, 550 17th Street NW., Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

In connection with the proposed changes to the agencies' capital rules in this NPR, the agencies are also seeking comment on the two related NPRs published elsewhere in today's

Federal Register

. In the notice titled “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action” (Basel III NPR) the agencies are proposing to revise their minimum risk-based capital requirements and criteria for regulatory capital, as well as establish a capital conservation buffer framework, consistent with Basel III. The Basel III NPR also includes transition provisions for banking organizations to come into compliance with its requirements.

In the notice titled “Regulatory Capital Rules: Standardized Approach for Risk-weighted Assets; Market Discipline and Disclosure Requirements” (Standardized Approach NPR), the agencies are proposing to revise and harmonize their rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses identified over recent years, including by incorporating aspects of the standardized framework in Basel II, and providing alternatives to credit ratings, consistent with section 939A of the Dodd-Frank Act. The revisions include methodologies for determining risk-weighted assets for residential mortgages, securitization exposures, and counterparty credit risk. The Standardized Approach NPR also would introduce disclosure requirements that would apply to top-tier banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital instruments.

The proposed requirements in the Basel III NPR and Standardized Approach NPR would apply to all banking organizations that are currently subject to minimum capital requirements (including national banks, state member banks, state nonmember banks, state and federal savings associations, and top-tier bank holding companies domiciled in the United States not subject to the Board's Small Bank Holding Company Policy Statement (12 CFR part 225, appendix C)), as well as top-tier savings and loan holding companies domiciled in the United States (collectively, banking organizations).

The proposals are being published in three separate NPRs to reflect the distinct objectives of each proposal, to allow interested parties to better understand the various aspects of the overall capital framework, including which aspects of the rules would apply to which banking organizations, and to help interested parties better focus their comments on areas of particular interest.

Table of Contents

I. Introduction

II. Risk-Weighted Assets—Proposed Modifications to the Advanced Approaches Rules

A. Counterparty Credit Risk

1. Revisions to the Recognition of Financial Collateral

2. Changes to Holding Periods and the Margin Period of Risk

3. Changes to the Internal Models Methodology (IMM)

4. Credit Valuation Adjustments

5. Cleared Transactions (Central Counterparties)

6. Stress period for Own Internal Estimates

B. Removal of Credit Ratings

C. Proposed Revisions to the Treatment of Securitization Exposures

1. Definitions

2. Operational Criteria for Recognizing Risk Transference in Traditional Securitizations

3. Proposed Revisions to the Hierarchy of Approaches

4. Guarantees and Credit Derivatives Referencing a Securitization Exposure

5. Due Diligence Requirements for Securitization Exposures

6. Nth-to-Default Credit Derivatives

D. Treatment of Exposures Subject to Deduction

E. Technical Amendments to the Advanced Approaches Rule

1. Eligible Guarantees and Contingent U.S. Government Guarantees

2. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Insurance Underwriting Subsidiaries

3. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Changes to FFIEC 009

4. Applicability of the Rule

5. Change to the Definition of Probability of Default Related to Seasoning

6. Cash Items in Process of Collection

7. Change to the Definition of Qualified Revolving Exposure

8. Trade-Related Letters of Credit

F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures

2. Enhanced Securitization Disclosure Requirements

3. Equity Holding That Are Not Covered Positions

III. Market Risk Capital Rule

IV. List of Acronyms

V. Regulatory Flexibility Act Analysis

VI. Paperwork Reduction Act

VII. Plain Language

VIII. OCC Unfunded Mandates Reform Act of 1995 Determination

I. Introduction

The Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) (collectively, the agencies) are issuing this notice of proposed rulemaking (NPR, proposal, or proposed rule) to revise the advanced approaches risk-based capital rule (advanced approaches rule) to incorporate certain aspects of “Basel III: A global regulatory framework for more resilient banks and banking systems” (Basel III). This NPR also proposes to revise the advanced approaches rule to incorporate other revisions to the Basel capital framework published by the Basel Committee on Banking Supervision (BCBS) in a series of documents between 2009 and 2011

and subsequent consultative papers. The proposal would also address relevant provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), and incorporate certain technical amendments to the existing requirements.

The BCBS is a committee of banking supervisory authorities, which was established by the central bank governors of the G-10 countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Sweden, Switzerland, Turkey, the United Kingdom, and the United States. Documents issued by the BCBS are available through the Bank for International Settlements Web site at

http://www.bis.org

. Basel III was published in December 2010 and revised in June 2011. The text is available at

http://www.bis.org/publ/bcbs189.htm

Public Law 111-203, 124 Stat. 1376 (July 21, 2010) (Dodd-Frank Act).

In this NPR, the Board also proposes applying the advanced approaches rule and the market risk rule to savings and loan holding companies, and the Board, FDIC, and OCC propose applying the market risk capital rule to savings and loan holding companies and to state and federal savings associations, respectively. In addition, this NPR would codify the market risk rule in a manner similar to the other regulatory capital rules in the three proposals. In a separate

Federal Register

notice, also published today, the agencies are finalizing changes to the market risk rule. As described in more detail below, the agencies are proposing changes to the advanced approaches rule in a manner consistent with the BCBS requirements, including the requirements introduced by the BCBS in “Enhancements to the Basel II framework” (2009 Enhancements) in July 2009 and in Basel III.

The main proposed revisions to the advanced approaches rule are related to treatment of counterparty credit risk, the securitization framework, and disclosure requirements.

See

“Enhancements to the Basel II framework” (July 2009), available at

http://www.bis.org/publ/bcbs157.htm

Consistent with Basel III, the proposal seeks to ensure that counterparty credit risk, credit valuation adjustments (CVA), and wrong-way risk are incorporated adequately into the agencies' regulatory capital requirements. More specifically, the NPR would establish a capital requirement for the market value of counterparty credit risk; propose a more risk-sensitive approach for certain transactions with central counterparties, including the treatment of default fund contributions to central counterparties; and make certain adjustments to the methodologies used to calculate counterparty credit risk requirements. In addition, consistent with the “2009 Enhancements,” the agencies propose strengthening the risk-based capital requirements for certain securitization exposures by requiring banking organizations that are subject to the advanced approaches rule to conduct more rigorous credit analysis of securitization exposures and enhancing the disclosure requirements related to these exposures.

In addition to the incorporation of the BCBS standards, the agencies are proposing changes to the advanced approaches rule in a manner consistent with the Dodd-Frank Act, by removing references to, or requirements of reliance on, credit ratings from their regulations.

Accordingly, the agencies are proposing to remove the ratings-based approach and the internal assessment approach for securitization exposures from the advanced approaches rule and require advanced approaches banking organizations to use either the supervisory formula approach (SFA) or a simplified version of the SFA when calculating capital requirements for securitization exposures. The agencies also are proposing to remove references to ratings from certain defined terms under the advanced approaches rule and replace them with alternative standards of creditworthiness. Finally, the proposed rule contains a number of proposed technical amendments that would clarify or adjust existing requirements under the advanced approaches rule.

See

section 939A of Dodd-Frank Act (15 U.S.C. 78o-7 note).

In addition, in today's

Federal Register

, the agencies are publishing two separate notices of proposed rulemaking that are both relevant to the calculation of capital requirements for institutions using the advanced approaches rule. The notice titled “Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action” (Basel III NPR), which is applicable to all banking organizations, would revise the definition of capital (the numerator of the risk-based capital ratios), establish the new minimum ratio requirements, and make other changes to the agencies' general risk-based capital rules related to regulatory capital. In addition, the Basel III NPR proposes that certain elements of Basel III apply only to institutions using the advanced approaches rule, including a supplementary Basel III leverage ratio and a countercyclical capital buffer. The Basel III NPR also includes transition provisions for banking organizations to come into compliance with the requirements of that proposed rule.

The notice titled “Regulatory Capital Rules: Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements” (Standardized Approach NPR) would also apply to all banking organizations. In the Standardized Approach NPR, the agencies are proposing to revise and harmonize their rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses identified over recent years, including by incorporating aspects of the BCBS' Basel II standardized framework, changes proposed in recent consultative papers published by the BCBS and alternatives to credit ratings, consistent with section 939A of the Dodd-Frank Act. The revisions include methodologies for determining risk-weighted assets for residential mortgages, securitization exposures, and

counterparty credit risk. The Standardized Approach NPR also would introduce disclosure requirements that would apply to top-tier banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital instruments.

The requirements proposed in the Basel III NPR and Standardized Approach NPR, as well as the market risk capital rule in this proposal, are proposed to become the “generally applicable” capital requirements for purposes of section 171 of the Dodd-Frank Act because they would be the capital requirements applied to insured depository institutions under section 38 of the Federal Deposit Insurance Act, without regard to asset size or foreign financial exposure. Banking organizations that are or would be subject to the advanced approaches rule (advanced approaches banking organizations) or the market risk rule should also review the Basel III NPR and Standardized Approach NPR.

II. Risk-Weighted Assets—Proposed Modifications to the Advanced Approaches

A. Counterparty Credit Risk

The recent financial crisis highlighted certain aspects of the treatment of counterparty credit risk under the Basel II framework that were inadequate and of banking organizations' risk management of counterparty credit risk that were insufficient. The Basel III revisions would address both areas of weakness by ensuring that all material on- and off-balance sheet counterparty risks, including those associated with derivative-related exposures, are appropriately incorporated into banking organizations' risk-based capital ratios. In addition, new risk management requirements in Basel III strengthen the oversight of counterparty credit risk exposures. The agencies are proposing the counterparty credit risk revisions in a manner generally consistent with Basel III, modified to incorporate alternative standards to the use of credit ratings. The discussion below highlights these revisions.

1. Revisions to the Recognition of Financial Collateral

Eligible Financial Collateral

The exposure-at-default (EAD) adjustment approach under section 132 of the proposed rules permits a banking organization to recognize the credit risk mitigation benefits of eligible financial collateral by adjusting the EAD to the counterparty. Such approaches include the collateral haircut approach, simple Value-at-Risk (VaR) approach and the internal models methodology (IMM).

Consistent with Basel III, the agencies are proposing to modify the definition of financial collateral so that resecuritizations would no longer qualify as eligible financial collateral under the advanced approaches rule. Thus, resecuritization collateral could not be used to adjust the EAD of an exposure. The agencies believe that this treatment is appropriate because resecuritizations have been shown to have more market value volatility than other collateral types. During the recent financial crisis, the market volatility of resecuritization exposures made it difficult for resecuritizations to serve as a source of liquidity because banking organizations were unable to sell those positions without incurring substantial loss or to use them as collateral for secured lending transactions.

Under the proposal, a securitization in which one or more of the underlying exposures is a securitization position would be considered a resecuritization. A resecuritization position under the proposal means an on- or off-balance sheet exposure to a resecuritization, or an exposure that directly or indirectly references a resecuritization exposure.

Consistent with these changes excluding less liquid collateral from the definition of financial collateral, the agencies also propose that conforming residential mortgages no longer qualify as financial collateral under the advanced approaches rule. As a result, under this proposal, a banking organization would no longer be able to recognize the credit risk mitigation benefit of such instruments through an adjustment to EAD. In addition, also consistent with the Basel framework, the agencies propose to exclude all debt securities that are not investment grade from the definition of financial collateral. As discussed in section II (B) of this preamble, the agencies are proposing to revise the definition of “investment grade” for both the advanced approaches rule and market risk capital rule.

Revised Supervisory Haircuts

As reflected in Basel III, securitization exposures have increased levels of volatility relative to other collateral types. To address this issue, Basel III incorporates new standardized supervisory haircuts for securitization exposures in the EAD adjustment approach based on the credit rating of the exposure. Consistent with section 939A of the Dodd Frank Act, the agencies are proposing an alternative approach to assigning standard supervisory haircuts for securitization exposures, and are also proposing to amend the standard supervisory haircuts for other types of financial collateral to remove the references to credit ratings.

Under the proposal, as outlined in table 1 below, the standard supervisory market price volatility haircuts would be revised based on the applicable risk weight of the exposure calculated under the standardized approach. Supervisory haircuts for exposures to sovereigns, government-sponsored entities, public sector entities, depository institutions, foreign banks, credit unions, and corporate issuers would be calculated based upon the risk weights for such exposures described under section 32 of the Standardized Approach NPR. The proposed table for the standard supervisory market price volatility haircuts would be revised as follows:

Table 1—Standard Supervisory Market Price Volatility Haircuts

Residual maturity

Haircut (in percents) assigned based on:

Sovereign issuers risk weight under § ___.32

Zero%

20% or 50%

100%

Non-sovereign issuers risk weight under § ___.32

20%

50%

100%

Investment grade securitization exposures

(in percent)

Less than or equal to 1 year

0.5

1.0

15.0

1.0

2.0

25.0

4.0

Greater than 1 year and less than or equal to 5 years

2.0

3.0

15.0

4.0

6.0

25.0

12.0

Greater than 5 years

4.0

6.0

15.0

8.0

12.0

25.0

24.0

Main index equities (including convertible bonds) and gold

15.0

Other publicly-traded equities (including convertible bonds)

25.0

Mutual funds

Highest haircut applicable to any security in which the fund can invest.

Cash collateral held

Zero

The market price volatility haircuts in Table 2 are based on a 10 business-day holding period.

Includes a foreign PSE that receives a zero percent risk weight.

The agencies are also proposing to clarify that if a banking organization lends instruments that do not meet the definition of financial collateral used in the Standardized Approach NPR and the advanced approaches rule (as modified by the proposal), such as non-investment grade corporate debt securities or resecuritization exposures, the haircut applied to the exposure would be the same as the haircut for equity that is publicly traded but which is not part of a main index.

Question 1:

The agencies solicit comments on the proposed changes to the recognition of financial collateral under the advanced approaches rule.

2. Changes to Holding Periods and the Margin Period of Risk

During the financial crisis, many financial institutions experienced significant delays in settling or closing-out collateralized transactions, such as repo-style transactions and collateralized over-the-counter (OTC) derivatives. The assumed holding period for collateral in the collateral haircut and simple VaR approaches and the margin period of risk in the IMM under Basel II proved to be inadequate for certain transactions and netting sets.

It also did not reflect the difficulties and delays experienced by institutions when settling or liquidating collateral during a period of financial stress.

Under the advanced approaches rule, the margin period of risk means, with respect to a netting set subject to a collateral agreement, the time period from the most recent exchange of collateral with a counterparty until the next required exchange of collateral plus the period of time required to sell and realize the proceeds of the least liquid collateral that can be delivered under the terms of the collateral agreement and, where applicable, the period of time required to re-hedge the resulting market risk, upon the default of the counterparty.

See

12 CFR part 3, appendix C, and part 167, appendix C (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 325, appendix D, and 12 CFR part 390, subpart Z, appendix A (FDIC).

Under Basel II, the minimum assumed holding period for collateral and margin period of risk are five days for repo-style transactions, and ten days for other collateralized transactions where liquid financial collateral is posted under a daily margin maintenance requirement. Under Basel III, a banking organization must assume a holding period of 20 business days under the collateral haircut or simple VaR approaches, or must assume a margin period of risk under the IMM of 20 business days for netting sets where: (1) The number of trades exceeds 5,000 at any time during the quarter (except if the counterparty is a central counterparty (CCP) or the netting set consists of cleared transactions with a clearing member); (2) one or more trades involves illiquid collateral posted by the counterparty; or (3) the netting set includes any OTC derivatives that cannot be easily replaced.

For purposes of determining whether collateral is illiquid or an OTC derivative cannot be easily replaced for these purposes, a banking organization could, for example, assess whether, during a period of stressed market conditions, it could obtain multiple price quotes within two days or less for the collateral or OTC derivative that would not move the market or represent a market discount (in the case of collateral) or a premium (in the case of an OTC derivative).

If, over the two previous quarters, more than two margin disputes on a netting set have occurred that lasted longer than the holding period or margin period of risk used in the EAD calculation, then a banking organization would use a holding period or a margin period of risk for that netting set that is at least two times the minimum holding period that would otherwise be used for that netting set. Margin disputes occur when the banking organization and its counterparty do not agree on the value of collateral or on the eligibility of the collateral provided. In addition, such disputes also can occur when a banking organization and its counterparty disagree on the amount of margin that is required, which could result from differences in the valuation of a transaction, or from errors in the calculation of the net exposure of a portfolio (for instance, if a transaction is incorrectly included or excluded from the portfolio).

Consistent with Basel III, the agencies propose to amend the advanced approaches rule to incorporate these adjustments to the holding period in the collateral haircut and simple VaR approaches, and to the margin period of risk in the IMM that a banking organization may use to determine its capital requirement for repo-style transactions, OTC derivative transactions, or eligible margin loans. For cleared transactions, which are discussed below, the agencies propose that a banking organization not be required to adjust the holding period or margin period of risk upward when determining the capital requirement for its counterparty credit risk exposures to the central counterparty, which is also consistent with Basel III.

Question 2:

The agencies solicit comments on the proposed changes to holding periods and margin periods of risk.

3. Changes to the Internal Models Methodology

During the recent financial crisis, increased volatility in the value of derivative positions and collateral led to higher counterparty exposures than amounts estimated by banking organizations' internal models. To address this issue, under Basel III, when

using the IMM, banking organizations are required to determine their capital requirements for counterparty credit risk using stressed inputs. Consistent with Basel III, the agencies propose to amend the advanced approaches rule so that the capital requirement for IMM exposures would be equal to the larger of the capital requirement for those exposures calculated using data from the most recent three-year period and data from a three-year period that contains a period of stress reflected in the credit default spreads of the banking organization's counterparties.

Under the proposal, an IMM exposure would be defined as a repo-style transaction, eligible margin loan, or OTC derivative for which a banking organization calculates its EAD using the IMM. A banking organization would be required to demonstrate to the satisfaction of the banking organization's primary federal supervisor at least quarterly that the stress period coincides with increased credit default swap (CDS) spreads, or other credit spreads of its counterparties and have procedures to evaluate the effectiveness of its stress calibration. These procedures would be required to include a process for using benchmark portfolios that are vulnerable to the same risk factors as the banking organization's portfolio. In addition, the primary federal supervisor could require a banking organization to modify its stress calibration if the primary federal supervisor believes that another calibration would better reflect the actual historic losses of the portfolio.

Consistent with Basel III, the agencies are proposing to require a banking organization to subject its internal models to an initial validation and annual model review process. As part of the model review process, the agencies propose that a banking organization would need to have a backtesting program for its model that includes a process by which unacceptable model performance would be identified and remedied. In addition, the agencies propose that when a banking organization multiplies expected positive exposure (EPE) by the default scaling factor alpha of 1.4 when calculating EAD, the primary federal supervisor may require the banking organization to set that alpha higher based on the performance of the banking organization's internal model.

The agencies also are proposing to require a banking organization to have policies for the measurement, management, and control of collateral, including the reuse of collateral and margin amounts, as a condition of using the IMM. Under the proposal, a banking organization would be required to have a comprehensive stress testing program that captures all credit exposures to counterparties and incorporates stress testing of principal market risk factors and the creditworthiness of its counterparties.

Under Basel II, a banking organization was permitted to capture within its internal model the effect on EAD of a collateral agreement that requires receipt of collateral when the exposure to the counterparty increases. Basel II also contained a “shortcut” method to provide a banking organization whose internal model did not capture the effects of collateral agreements with a method to recognize some benefit from the collateral agreement. Basel III modifies that “shortcut” method by setting effective EPE to a counterparty as the lesser of the following two exposure calculations: (1) The exposure without any held or posted margining collateral, plus any collateral posted to the counterparty independent of the daily valuation and margining process or current exposure, or (2) an add-on that reflects the potential increase of exposure over the margin period of risk plus the larger of (i) the current exposure of the netting set reflecting all collateral received or posted by the banking organization excluding any collateral called or in dispute; or (ii) the largest net exposure (including all collateral held or posted under the margin agreement) that would not trigger a collateral call. The add-on would be computed as the largest expected increase in the netting set's exposure over any margin period of risk in the next year. The agencies propose to include the Basel III modification of the “shortcut” method in this NPR.

Recognition of Wrong-way Risk

The financial crisis also highlighted the interconnectedness of large financial institutions through an array of complex transactions. To recognize this interconnectedness and to mitigate the risk of contagion from the banking sector to the broader financial system and the general economy, Basel III includes enhanced requirements for the recognition and treatment of wrong-way risk in the IMM. The proposed rule would define wrong-way risk as the risk that arises when an exposure to a particular counterparty is positively correlated with the probability of default of such counterparty itself.

The agencies are proposing enhancements to the advanced approaches rule that would require banking organizations' risk management procedures to identify, monitor, and control wrong-way risk throughout the life of an exposure. These risk management procedures should include the use of stress testing and scenario analysis. In addition, where a banking organization has identified an IMM exposure with specific wrong-way risk, the banking organization would be required to treat that transaction as its own netting set. Specific wrong-way risk is a type of wrong way risk that arises when either the counterparty and issuer of the collateral supporting the transaction, or the counterparty and the reference asset of the transaction, are affiliates or are the same entity.

In addition, where a banking organization has identified an OTC derivative transaction, repo-style transaction, or eligible margin loan with specific wrong-way risk for which the banking organization would otherwise apply the IMM, the banking organization would insert the probability of default (PD) of the counterparty and a loss given default (LGD) equal to 100 percent into the appropriate risk-based capital formula specified in table 1 of section 131 of the proposed rule, then multiply the output of the formula (K) by an alternative EAD based on the transaction type, as follows:

(1) For a purchased credit derivative, EAD would be the fair value of the underlying reference asset of the credit derivative contract;

(2) For an OTC equity derivative,

EAD would be the maximum amount that the banking organization could lose if the fair value of the underlying reference asset decreased to zero;

Equity derivatives that are call options are not subject to a counterparty credit risk capital requirement for specific wrong-way risk.

(3) For an OTC bond derivative (that is, a bond option, bond future, or any other instrument linked to a bond that gives rise to similar counterparty credit risks), EAD would be the smaller of the notional amount of the underlying reference asset and the maximum amount that the banking organization could lose if the fair value of the underlying reference asset decreased to zero; and

(4) For repo-style transactions and eligible margin loans, EAD would be calculated using the formula in the collateral haircut approach of section 132 and with the estimated value of the collateral substituted for the parameter C in the equation.

Question 3:

The agencies solicit comment on the appropriateness of the proposed calculation of capital requirements for OTC equity or bond derivatives with specific wrong-way risk. What alternatives should be made

available to banking organizations in order to calculate the EAD in such cases? What challenges would a banking organization face in estimating the EAD for OTC derivative transactions with specific wrong-way risk if the agencies were to permit a banking organization to use its incremental risk model that meets the requirements of section 8 of the market risk rule instead of the proposed alternatives?

Increased Asset Value Correlation Factor

To recognize the correlation of financial institutions' creditworthiness attributable to similar sensitivities to common risk factors, the agencies are proposing to incorporate the Basel III increase in the correlation factor used in the formula provided in table 1 of section 131 of the proposed rule for certain wholesale exposures. Under the proposed rule, banking organizations would apply a multiplier of 1.25 to the correlation factor for wholesale exposures to unregulated financial institutions that generate a majority of their revenue from financial activities, regardless of asset size. This category would include highly leveraged entities such as hedge funds and financial guarantors. In addition, banking organizations would apply a multiplier of 1.25 to the correlation factor for wholesale exposures to regulated financial institutions with consolidated assets of greater than or equal to $100 billion.

The proposed definitions of “financial institution” and “regulated financial institution” are set forth and discussed in the Basel III NPR.

4. Credit Valuation Adjustments

CVA is the fair value adjustment to reflect counterparty credit risk in the valuation of an OTC derivative contract. The BCBS reviewed the treatment of counterparty credit risk and found that roughly two-thirds of counterparty credit risk losses during the crisis were due to marked-to-market losses from CVA, while one-third of counterparty credit risk losses resulted from actual defaults. Basel II addressed counterparty credit risk as a combination of default risk and credit migration risk. Credit migration risk accounts for market value losses resulting from deterioration of counterparties' credit quality short of default and is addressed in Basel II via the maturity adjustment multiplier. However, the maturity adjustment multiplier in Basel II was calibrated for loan portfolios and may not be suitable for addressing CVA risk. Accordingly, Basel III requires banking organizations to directly reflect CVA risk through an additional capital requirement.

The Basel III CVA capital requirement would reflect the CVA due to changes of counterparties' credit spreads, assuming fixed expected exposure (EE) profiles. Basel III provides two approaches for calculating the CVA capital requirement: the simple approach and the advanced CVA approach. The agencies are proposing both approaches for calculating the CVA capital requirement (subject to certain requirements discussed below), but without references to credit ratings.

Only a banking organization that is subject to the market risk capital rule and has obtained prior approval from its primary federal supervisor to calculate both the EAD for OTC derivative contracts using the IMM described in section 132 of the proposed rule, and the specific risk add-on for debt positions using a specific risk model described in section 207(b) of subpart F would be eligible to use the advanced CVA approach. A banking organization that receives such approval would continue to use the advanced CVA approach until it notifies its primary federal supervisor in writing that it expects to begin calculating its CVA capital requirement using the simple CVA approach. The notice would include an explanation from the banking organization as to why it is choosing to use the simple CVA approach and the date when the banking organization would begin to calculate its CVA capital requirement using the simple CVA approach.

Under the proposal, when calculating a CVA capital requirement, a banking organization would be permitted to recognize the hedging benefits of single name CDS, single name contingent CDS, index CDS (CDS

ind

), and any other equivalent hedging instrument that references the counterparty directly, provided that the equivalent hedging instrument is managed as a CVA hedge in accordance with the banking organization's hedging policies. Consistent with Basel III, under this NPR, a tranched or nth-to-default CDS would not qualify as a CVA hedge. In addition, the agencies propose that any position that is recognized as a CVA hedge would not be a covered position under the market risk capital rule, except in the case where the banking organization is using the advanced CVA approach, the hedge is a CDS

ind

, and the VaR model does not capture the basis between the spreads of the index that is used as the hedging instrument and the hedged counterparty exposure over various time periods, as discussed in further detail below.

To convert the CVA capital requirement to a risk-weighted asset amount, a banking organization would multiply its CVA capital requirement by 12.5. Under the proposal, because the CVA capital requirement reflects market risk, the CVA risk-weighted asset amount would not be a component of credit risk-weighted assets and therefore would not be subject to the 1.06 multiplier for credit risk-weighted assets.

Simple CVA Approach

The agencies are proposing the Basel III formula for the simple CVA approach to calculate the CVA capital requirement (K

CVA

), with a modification in a manner consistent with section 939A of the Dodd-Frank Act. A banking organization would use the formula below to calculate its CVA capital requirement for OTC derivative transactions. The banking organization would calculate K

CVA

as the square root of the sum of the capital requirement for each of its OTC derivative counterparties multiplied by 2.33. The simple CVA approach is based on an analytical approximation derived from a general CVA VaR formulation under a set of simplifying assumptions:

• All credit spreads have a flat term structure;

• All credit spreads at the time horizon have a lognormal distribution;

• Each single name credit spread is driven by the combination of a single systematic factor and an idiosyncratic factor;

• The correlation between any single name credit spread and the systematic factor is equal to 0.5;

• All credit indices are driven by the single systematic factor; and

• The time horizon is short (the square root of time scaling to 1 year is applied in the end).

The approximation is based on the linearization of the dependence of both CVA and CDS hedges on credit spreads. Given the assumptions listed above (most notably, the single-factor assumption), CVA VaR can be expressed using an analytical formula. The formula of the simple CVA approach is obtained by applying certain standardizations, conservative adjustments, and scaling to the analytical CVA VaR result.

A banking organization would calculate K

CVA

, where:

EP30AU12.023

In Formula 1, w

refers to the weight applicable to counterparty i assigned according to Table 2 below.

In Basel III, the BCBS assigned w

based on the external rating of the counterparty. However, to comply with the Dodd-Frank requirement to remove references to ratings, the agencies propose to assign w

based on the relevant PD of the counterparty, as assigned by the banking organization. W

ind

in Formula 1 refers to the weight applicable to the CDS

ind

based on the average weight under Table 2 of the underlying reference names that comprise the index.

These weights represent the assumed values of the product of a counterparties' current credit spread and the volatility of that credit spread.

Table 2—Assignment of Counterparty Weight Under the Simple CVA

Internal PD

(in percent)

Weight W

ind

(in percent)

0.00-0.07

0.70

>0.07-0.15

0.80

>0.15-0.40

1.00

>0.4-2.00

2.00

>2.0—6.00

3.00

>6.0

10.00

EAD

total

in Formula 1 refers to the sum of the EAD for all netting sets of OTC derivative contracts with counterparty i calculated using the current exposure methodology described in section 132(c) of the proposed rule as adjusted by Formula 2 or the IMM described in section 132(d) of the proposed rule. When the banking organization calculates EAD using the IMM, EAD

total

equals EAD

unstressed

EP30AU12.024

in Formulas

1 and 2 refers to the EAD-weighted average of the effective maturity of each netting set with counterparty i (where each netting set's M cannot be smaller than one). M

hedge

in Formula 1 refers to the notional weighted average maturity of the hedge instrument. M

ind

in Formula 1 equals the maturity of the CDS

ind

or the notional weighted average maturity of any CDS

ind

purchased to hedge CVA risk of counterparty i.

The term “exp” is the exponential function.

in Formula 1 refers to the sum of the notional amounts of any purchased single name CDS referencing counterparty

that is used to hedge CVA risk to counterparty

multiplied by (1-exp(−0.05 × M

hedge

))/(0.05 × M

hedge

). B

ind

in Formula 1 refers to the notional amount of one or more CDS

ind

purchased as protection to hedge CVA risk for counterparty

multiplied by (1-exp(−0.05 × M

ind

))/(0.05 × M

ind

). A banking organization would be allowed to treat the notional amount in the index attributable to that counterparty as a single name hedge of counterparty

) when calculating K

CVA

and subtract the notional amount of B

from the notional amount of the CDS

ind.

The banking organization would be required to then calculate its capital requirement for the remaining notional amount of the CDS

ind

as a stand-alone position.

Advanced CVA Approach

Under the advanced CVA approach, a banking organization would use the VaR model it uses to calculate specific risk under section 205(b) of subpart F or another model that meets the quantitative requirements of sections 205(b) and 207(b) of subpart F to calculate its CVA capital requirement for a counterparty by modeling the impact of changes in the counterparty's credit spreads, together with any recognized CVA hedges on the CVA for the counterparty. A banking organization's total capital requirement for CVA equals the sum of the CVA capital requirements for each counterparty.

The agencies are proposing that the VaR model incorporate only changes in the counterparty's credit spreads, not changes in other risk factors. The banking organization would not be required to capture jump-to-default risk in its VaR model. A banking organization would be required to include any immaterial OTC derivative portfolios for which it uses the current exposure methodology by using the EAD calculated under the current exposure methodology as a constant EE in the formula for the calculation of CVA and setting the maturity equal to the greater of half of the longest maturity occurring in the netting set and the notional weighted average maturity of all transactions in the netting set.

In order for a banking organization to receive approval to use the advanced CVA approach, under the NPR, the

banking organization would need to have the systems capability to calculate the CVA capital requirement on a daily basis, but would not be expected or required to calculate the CVA capital requirement on a daily basis.

The CVA capital requirement under the advanced CVA approach would be equal to the general market risk capital requirement of the CVA exposure using the ten-business-day time horizon of the revised market risk framework. The capital requirement would not include the incremental risk requirement of subpart F. The agencies propose to require a banking organization to use the Basel III formula for the advanced CVA approach to calculate K

CVA

as follows:

EP30AU12.025

In Formula 3:

(A) t

= the time of the i-th revaluation time bucket starting from t

= 0.

(B) t

= the longest contractual maturity across the OTC derivative contracts with the counterparty.

= the CDS spread for the counterparty at tenor t

used to calculate the CVA for the counterparty. If a CDS spread is not available, the banking organization would use a proxy spread based on the credit quality, industry and region of the counterparty.

(D) LGD

MKT

= the loss given default of the counterparty based on the spread of a publicly traded debt instrument of the counterparty, or, where a publicly traded debt instrument spread is not available, a proxy spread based on the credit quality, industry and region of the counterparty.

(E) EE

= the sum of the expected exposures for all netting sets with the counterparty at revaluation time t

calculated using the IMM.

(F) D

= the risk-free discount factor at time t

where D

= 1.

(G) Exp is the exponential function.

Under the proposal, if a banking organization's VaR model is not based on full repricing, the banking organization would use either Formula 4 or Formula 5 to calculate credit spread sensitivities. If the VaR model is based on credit spread sensitivities for specific tenors, the banking organization would calculate each credit spread sensitivity according to Formula 4:

EP30AU12.026

If the VaR

model uses credit spread sensitivities to parallel shifts in credit spreads, the banking organization would calculate each credit spread sensitivity according to Formula 5:

EP30AU12.027

For the final time bucket, i = T.

To calculate the CVA

UnstressedVAR

measure in Formula 3, a banking organization would use the EE for a counterparty calculated using current market data to compute current exposures and would estimate model parameters using the historical observation period required under section 205(b)(2) of subpart F. However, if a banking organization uses the shortcut method described in section 132(d)(5) of the proposed rule to capture the effect of a collateral agreement when estimating EAD using the IMM, the banking organization would calculate the EE for the counterparty using that method and keep that EE constant with the maturity equal to the maximum of half of the longest maturity occurring in the netting set, and the notional weighted average maturity of all transactions in the netting set.

To calculate the CVA

StressedVAR

measure in Formula 3, the banking organization would use the EE

for a counterparty calculated using the stress calibration of the IMM. However, if a banking organization uses the shortcut method described in section 132(d)(5) of the proposed rule to capture the effect of a collateral agreement when estimating EAD using the IMM, the banking organization would calculate the EE

for the counterparty using that method and keep that EE

constant with the maturity equal to the greater of half of the longest maturity occurring in the netting set with the notional amount equal to the weighted average maturity of all transactions in the netting set. Consistent with Basel III, the agencies propose to require a banking organization to calibrate the VaR model inputs to historical data from the most severe twelve-month stress period contained within the three-year stress period used to calculate EE

. However, the agencies propose to retain the flexibility to require a banking organization to use a different period of significant financial stress in the calculation of the CVA

StressedVAR

measure that would better reflect actual historic losses of the portfolio.

Under the NPR, a banking organization's VaR model would be required to capture the basis between the spreads of the index that is used as the hedging instrument and the hedged counterparty exposure over various time periods, including benign and stressed environments. If the VaR model does not capture that basis, the banking organization would be permitted to reflect only 50 percent of the notional amount of the CDS

ind

hedge in the VaR model. The remaining 50 percent of the notional amount of the CDS

ind

hedge would be a covered position under the market risk capital rule.

Question 4:

The agencies solicit comments on the proposed CVA capital requirements, including the simple CVA approach and the advanced CVA approach.

5. Cleared Transactions (Central Counterparties)

CCPs help improve the safety and soundness of the derivatives and repo-style transaction markets through the multilateral netting of exposures, establishment and enforcement of collateral requirements, and market transparency. Under the current advanced approaches rule, exposures to qualifying central counterparties (QCCPs) received a zero percent risk weight. However, when developing Basel III, the BCBS recognized that as more derivatives and repo-style transactions move to CCPs, the potential for systemic risk increases. To address these concerns, the BCBS has sought comment on a specific capital requirement for such transactions with CCPs and a more risk-sensitive approach for determining a capital requirement for a banking organization's contributions to the default funds of these CCPs. The BCBS also has sought comment on a preferential capital treatment for exposures arising from derivative and repo-style transactions with, and related default fund contributions to, CCPs that meet the standards established by the Committee on Payment and Settlement Systems (CPSS) and International Organization of Securities Commissions (IOSCO).

The treatment for exposures that arise from the settlement of cash transactions (such as equities, fixed income, spot (FX), and spot commodities) with a QCCP where there is no assumption of ongoing counterparty credit risk by the QCCP after settlement of the trade and associated default fund contributions remains unchanged.

See

CPSS, “Recommendations for Central Counterparties,” (November 2004),

available at http://www.bis.org/publ/cpss64.pdf?

A banking organization that is a clearing member, a term that is defined in the Basel III NPR as a member of, or direct participant in, a CCP that is entitled to enter into transactions with the CCP, or a clearing member client, proposed to be defined as a party to a cleared transaction associated with a CCP in which a clearing member acts either as a financial intermediary with respect to the party or guarantees the performance of the party to the CCP, would first calculate its trade exposure for a cleared transaction. The trade exposure amount for a cleared transaction would be determined as follows:

(1) For a cleared transaction that is a derivative contract or netting set of derivative contracts, the trade exposure amount equals:

(i) The exposure amount for the derivative contract or netting set of derivative contracts, calculated using the methodology used to calculate exposure amount for OTC derivative contracts under section 132(c) or 132(d) of this NPR, plus

(ii) The fair value of the collateral posted by the banking organization and held by the CCP or a clearing member in a manner that is not bankruptcy remote.

(2) For a cleared transaction that is a repo-style transaction, the trade exposure amount equals:

(i) The exposure amount for the repo-style transaction calculated using the methodologies under sections 132(b)(2), 132(b)(3) or 132(d) of this NPR, plus

(ii) The fair value of the collateral posted by the banking organization and held by the CCP or a clearing member in a manner that is not bankruptcy remote.

When the banking organization calculates EAD under the IMM, EAD would be calculated using the most recent three years of historical data, that is, EAD

unstressed

. Trade exposure would not include any collateral held by a custodian in a manner that is bankruptcy remote from the CCP.

Under the proposal, a clearing member banking organization would apply a risk weight of 2 percent to its trade exposure amount with a QCCP. The proposed definition of QCCP is discussed in the Standardized Approach NPR preamble. A banking organization that is a clearing member client would apply a 2 percent risk weight to the trade exposure amount if:

(1) The collateral posted by the banking organization to the QCCP or clearing member is subject to an arrangement that prevents any losses to the clearing member due to the joint default or a concurrent insolvency, liquidation, or receivership proceeding of the clearing member and any other clearing member clients of the clearing member; and

(2) The clearing member client has conducted sufficient legal review to conclude with a well-founded basis (and maintains sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from default or a receivership, insolvency, or liquidation proceeding) the relevant court and administrative authorities

would find the arrangements to be legal, valid, binding, and enforceable under the law of the relevant jurisdiction, provided certain additional criteria are met.

The agencies believe that omnibus accounts (that is, accounts that are generally established by clearing entities for non-clearing members) in the United States would satisfy these requirements because of the protections afforded client accounts under certain regulations of the Securities and Exchange Commission (SEC) and Commodities Futures Trading Commission (CFTC).

If the criteria above are not met, a banking organization that is a clearing member client would apply a risk weight of 4 percent to the trade exposure amount.

See

Securities Investor Protection Act of 1970, 15 U.S.C Section 78aaa—78lll; 17 CFR part 300; 17 CFR part 190.

For a cleared transaction with a CCP that is not a QCCP, a clearing member and a banking organization that is a clearing member client would risk weight the trade exposure according to the risk weight applicable to the CCP under the Standardized Approach NPR.

Collateral posted by a clearing member or clearing member client banking organization that is held in a manner that is bankruptcy remote from the CCP would not be subject to a capital requirement for counterparty credit risk. As with all posted collateral, the banking organization would continue to have a capital requirement for any collateral provided to a CCP or a custodian in connection with a cleared transaction.

Under the proposal, a cleared transaction would not include an exposure of a banking organization that is a clearing member to its clearing member client where the banking organization is either acting as a financial intermediary and enters into an offsetting transaction with a CCP or where the banking organization provides a guarantee to the CCP on the performance of the client. Such a transaction would be treated as an OTC derivative transaction. However, the agencies recognize that this treatment may create a disincentive for banking organizations to act as intermediaries and provide access to CCPs for clients. As a result, the agencies are considering approaches that could address this disincentive while at the same time appropriately reflect the risks of these transactions. For example, one approach would allow banking organizations that are clearing members to adjust the EAD calculated under section 132 downward by a certain percentage or, for banking organizations using the IMM, to adjust the margin period of risk. International discussions are ongoing on this issue, and the agencies would expect to revisit the treatment of these transactions in the event that the BCBS revises its treatment of these transactions.

Default Fund Contribution

The agencies are proposing that, under the advanced approaches rule, a banking organization that is a clearing member of a CCP calculate its capital requirement for its default fund contributions at least quarterly or more frequently upon material changes to the CCP. Banking organizations seeking more information on the proposed risk-based capital treatment of default fund contributions should refer to the preamble of the Standardized Approach NPR.

Question 5:

The agencies request comment on the proposed treatment of cleared transactions. The agencies solicit comment on whether the proposal provides an appropriately risk-sensitive treatment of a transaction between a banking organization that is a clearing member and its client and a clearing member's guarantee of its client's transaction with a CCP by treating these exposures as OTC derivative contracts. The agencies also request comment on whether the adjustment of the exposure amount would address possible disincentives for banking organizations that are clearing members to facilitate the clearing of their clients' transactions. What other approaches should the agencies consider and why?

Question 6:

The agencies are seeking comment on the proposed calculation of the risk-based capital for cleared transactions, including the proposed risk-based capital requirements for exposures to a QCCP. Are there specific types of exposures to certain QCCPs that would warrant an alternative risk-based capital approach? Please provide a detailed description of such transactions or exposures, the mechanics of the alternative risk-based approach, and the supporting rationale.

6. Stress Period for Own Internal Estimates

Under the collateral haircut approach in the advanced approaches rule, banking organizations that receive prior approval from their primary federal supervisory may calculate market price and foreign exchange volatility using own internal estimates. To receive approval to use such an approach, banking organizations are required to base own internal estimates on a historical observation period of at least one year, among other criteria. During the financial crisis, increased volatility in the value of collateral led to higher counterparty exposures than estimated by banking organizations. In response, the agencies are proposing in this NPR to modify the quantitative standards for approval by requiring banking organizations to base own internal estimates of haircuts on a historical observation period that reflects a continuous 12-month period of significant financial stress appropriate to the security or category of securities. As described in the Standardized Approach NPR preamble, a banking organization would also be required to have policies and procedures that describe how it determines the period of significant financial stress used to calculate the banking organization's own internal estimates, and to be able to provide empirical support for the period used. To ensure an appropriate level of conservativeness, in certain circumstances a primary federal supervisor may require a banking organization to use a different period of significant financial stress in the calculation of own internal estimates for haircuts.

B. Removal of Credit Ratings

Consistent with section 939A of the Dodd-Frank Act, the agencies are proposing a number of changes to the definitions in the advanced approaches rule that currently reference credit ratings.

These changes are similar to alternative standards proposed in the Standardized Approach NPR and alternative standards that already have been implemented in the agencies' market risk capital rule. In addition, the agencies are proposing necessary changes to the hierarchy for risk weighting securitization exposures necessitated by the removal of the ratings-based approach, as described further below.

See

76 FR 79380 (Dec. 21, 2011).

The agencies propose to use an “investment grade” standard that does not rely on credit ratings as an alternative standard in a number of requirements under the advanced approaches rule, as explained below. Under this NPR and the Standardized Approach NPR, investment grade would mean that the entity to which the banking organization is exposed through a loan or security, or the reference entity with respect to a credit derivative, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has adequate capacity to meet financial commitments if the risk

of its default is low and the full and timely repayment of principal and interest is expected.

Eligible Guarantor

Under the current advanced approaches rule, guarantors are required to meet a number of criteria in order to be considered as eligible guarantors under the securitization framework. For example, the entity must have issued and outstanding an unsecured long-term debt security without credit enhancement that has a long-term applicable external rating in one of the three highest investment-grade rating categories. The agencies are proposing to replace the term “eligible securitization guarantor” with the term “eligible guarantor,” which includes certain entities that have issued and outstanding an unsecured debt security without credit enhancement that is investment grade. Other modifications to the definition of eligible guarantor are discussed in subpart C of this preamble.

Eligible Double Default Guarantor

Under this proposal, the term “eligible double default guarantor,” with respect to a guarantee or credit derivative obtained by a banking organization, means:

(1)

U.S.-based-entities.

A depository institution, bank holding company, savings and loan holding company, or securities broker or dealer registered with the SEC under the Securities Exchange Act of 1934 (15 U.S.C. 78o

et seq.

), if at the time the guarantee is issued or any time thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade.

(2)

Non-U.S.-based entities.

A foreign bank, or a non-U.S.-based securities firm if the banking organization demonstrates that the guarantor is subject to consolidated supervision and regulation comparable to that imposed on U.S. depository institutions, or securities broker-dealers) if at the time the guarantee is issued or anytime thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade. Under the proposal, insurance companies in the business of providing credit protection would no longer be eligible double default guarantors.

Conversion Factor Matrix for OTC Derivative Contracts

Under this proposal and Standardized Approach NPR, the agencies propose to retain the metrics used to calculate the potential future exposure (PFE) for derivative contracts (as set forth in table 3 of the proposed rule), and apply the proposed definition of “investment grade.”

Money Market Fund Approach

Previously, under the advanced approaches money market fund approach, banking organizations were permitted to assign a 7 percent risk weight to exposures to money market funds that were subject to SEC rule 2a-7 and that had an applicable external rating in the highest investment grade rating category. In this NPR, the agencies propose to eliminate the money market fund approach. The agencies believe it is appropriate to eliminate the preferential risk weight for money market fund investments due to the agencies' and banking organizations' experience with them during the recent financial crisis, in which they demonstrated, at times, elevated credit risk. As a result of the proposed changes, a banking organization would use one of the three alternative approaches under section 154 of this proposal to determine the risk weight for its exposures to a money market fund, subject to a 20 percent floor.

Modified Look-Through Approaches for Equity Exposures to Investment Funds

Under the proposal, risk weights for equity exposures under the simple modified look-through approach would be based on the highest risk weight assigned according to subpart D of the Standardized Approach NPR based on the investment limits in the fund's prospectus, partnership agreement, or similar contract that defines the fund's permissible investments.

Qualifying Operational Risk Mitigants

Under section 161 of the proposal, a banking organization may adjust its estimate of operational risk exposure to reflect qualifying operational risk mitigants. Previously, for insurance to be considered as a qualifying operational risk mitigant, it was required to be provided by an unaffiliated company rated in the three highest rating categories by a nationally recognized statistical ratings organization (NRSRO). Under the proposal, qualifying operational risk mitigants, among other criteria, would be required to be provided by an unaffiliated company that the banking organization deems to have strong capacity to meet its claims payment obligations and the obligor rating category to which the banking organization assigns the company is assigned a PD equal to or less than 10 basis points.

Question 7:

The agencies request comment on the proposed use of alternative standards as they would relate to the definitions of investment grade, eligible guarantor, eligible double default guarantor under the advanced approaches rule, as well as the treatment of certain OTC derivative contracts, operational risk mitigants, money market mutual funds, and investment funds under the advanced approaches rule.

C. Proposed Revisions to the Treatment of Securitization Exposures

1. Definitions

Consistent with the

2009 Enhancements

and as proposed in the Standardized Approach NPR, the agencies are proposing to introduce a new definition for resecuritization exposures and broaden the definition of securitization. In addition, the agencies are proposing to amend the existing definition of traditional securitization in order to exclude certain types of investment firms from treatment under the securitization framework.

The definition of a securitization exposure would be broadened to include an exposure that directly or indirectly references a securitization exposure. Specifically, a securitization exposure would be defined as an on-balance sheet or off-balance sheet credit exposure (including credit-enhancing representations and warranties) that arises from a traditional securitization or synthetic securitization exposure (including a resecuritization), or an exposure that directly or indirectly references a securitization exposure. The agencies are proposing to define a resecuritization exposure as (1) an on- or off-balance sheet exposure to a resecuritization; or (2) an exposure that directly or indirectly references a resecuritization exposure. An exposure to an asset-backed commercial paper (ABCP) program would not be a resecuritization exposure if either: the program-wide credit enhancement does not meet the definition of a resecuritization exposure; or the entity sponsoring the program fully supports the commercial paper through the provision of liquidity so that the commercial paper holders effectively are exposed to the default risk of the sponsor instead of the underlying exposures. Resecuritization would mean a securitization in which one or more of the underlying exposures is a securitization exposure.

The recent financial crisis demonstrated that resecuritization exposures, such as collateralized debt obligations (CDOs) comprised of asset-backed securities (ABS), generally present greater levels of risk relative to

other securitization exposures due to their increased complexity and lack of transparency and potential to concentrate systematic risk. Accordingly, the

2009 Enhancements

amended the Basel II internal ratings-based approach in the securitization framework to require a banking organization to assign higher risk weights to resecuritization exposures than other, similarly-rated securitization exposures. In this proposal, the agencies are proposing to assign risk weights under the simplified supervisory formula approach (SSFA) in a manner that would result in higher risk weights for resecuritization exposures. In addition, the agencies are proposing to modify the definition of financial collateral such that resecuritizations would no longer qualify as eligible financial collateral under the advanced approaches rule.

Asset-Backed Commercial Paper

The following is an example of how to evaluate whether a transaction involving a traditional multi-seller ABCP conduit would be considered a resecuritization exposure under the proposed rule. In this example, an ABCP conduit acquires securitization exposures where the underlying assets consist of wholesale loans and no securitization exposures. As is typically the case in multi-seller ABCP conduits, each seller provides first-loss protection by over-collateralizing the conduit to which it sells its loans. To ensure that the commercial paper issued by each conduit is highly-rated, a banking organization sponsor provides either a pool-specific liquidity facility or a program-wide credit enhancement such as a guarantee to cover a portion of the losses above the seller-provided protection.

The pool-specific liquidity facility generally would not be treated as a resecuritization exposure under this proposal because the pool-specific liquidity facility represents a tranche of a single asset pool (that is, the applicable pool of wholesale exposures), which contains no securitization exposures. However, a sponsor's program-wide credit enhancement that does not cover all losses above the seller-provided credit enhancement across the various pools generally would constitute tranching of risk of a pool of multiple assets containing at least one securitization exposure, and therefore would be treated as a resecuritization exposure.

In addition, if the conduit from the example funds itself entirely with a single class of commercial paper, then the commercial paper generally would not be considered a resecuritization exposure if either the program-wide credit enhancement did not meet the proposed definition of a resecuritization exposure, or the commercial paper was fully guaranteed by the sponsoring banking organization. When the sponsoring banking organization fully guarantees the commercial paper, the commercial paper holders effectively would be exposed to the default risk of the sponsor instead of the underlying exposures, thus ensuring that the commercial paper does not represent a tranched risk position.

Definition of Traditional Securitization

Since issuing the advanced approaches rules in 2007, the agencies have received feedback from banking organizations that the existing definition of traditional securitization is inconsistent with their risk experience and market practice. The agencies have reviewed this definition in light of this feedback and agree with commenters that changes to it may be appropriate. The agencies are proposing to exclude from the definition of traditional securitization exposures to investment funds, collective investment funds, pension funds regulated under the Employee Retirement Income Security Act (ERISA) and their foreign equivalents, and transactions regulated under the Investment Company Act of 1940 and their foreign equivalents, because these entities are generally prudentially regulated and subject to strict leverage requirements. Moreover, the agencies believe that the capital requirements for an extension of credit to, or an equity holding in these transactions would be more appropriately calculated under the rules for corporate and equity exposures, and that the securitization framework was not designed to apply to such transactions.

Accordingly, the agencies propose to amend the definition of a traditional securitization by excluding any fund that is (1) An investment fund, as defined under the rule, (2) a pension fund regulated under ERISA or a foreign equivalent, or (3) a company regulated under the Investment Company Act of 1940 or a foreign equivalent. Under the current rule, the definition of investment fund, which the agencies are not proposing to amend, means a company all or substantially all of the assets of which are financial assets; and that has no material liabilities.

Question 8:

The agencies request comment on the proposed revisions to the definition of traditional securitization.

Under the current advanced approaches rule, the definition of eligible securitization guarantor includes, among other entities, any entity (other than a securitization special purpose entity (SPE)) that has issued and has outstanding an unsecured long-term debt security without credit enhancement that has a long-term applicable external rating in one of the three highest investment-grade rating categories, or has a PD assigned by the banking organization that is lower than or equal to the PD associated with a long-term external rating in the third highest investment grade category. The agencies are proposing to remove the existing references to ratings from the definition of an eligible guarantor (the proposed new term for an eligible securitization guarantor). As revised, the definition for an eligible guarantor would include:

(1) A sovereign, the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage Corporation (Farmer Mac), a multilateral development bank, a depository institution, a bank holding company, a savings and loan holding company (as defined in 12 U.S.C. 1467a), a credit union, or a foreign bank; or

(2) An entity (other than an SPE):

(i) That at the time the guarantee is issued or anytime thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade;

(ii) Whose creditworthiness is not positively correlated with the credit risk of the exposures for which it has provided guarantees; and

(iii) That is not an insurance company engaged predominately in the business of providing credit protection (such as a monoline bond insurer or re-insurer).

During the financial crisis, certain guarantors of securitization exposures had difficulty honoring those guarantees as the financial condition of the guarantors deteriorated at the same time as the guaranteed exposures experienced losses. Therefore, the agencies are proposing to add the requirement related to the correlation between the guarantor's creditworthiness and the credit risk of the exposures it has guaranteed to address this concern.

Question 9:

The agencies request comment on the proposed revisions to the definition of eligible securitization guarantor.

2. Operational Criteria for Recognizing Risk Transference in Traditional Securitizations

Section 41 of the current advanced approaches rule includes operational criteria for recognizing the transfer of risk. Under the criteria, a banking organization that transfers exposures that it has originated or purchased to a securitization SPE or other third party in connection with a traditional securitization may exclude the exposures from the calculation of risk-weighted assets only if certain conditions are met. Among the criteria listed is that the transfer is considered a sale under the Generally Accepted Accounting Principles (GAAP).

The purpose of the criterion that the transfer be considered a sale under GAAP was to ensure that the banking organization that transferred the exposures was not required under GAAP to consolidate the exposures on its balance sheet. Given changes in GAAP since the rule was published in 2007, the agencies propose to amend paragraph (a)(1) of section 41 of the advanced approaches rule to require that the transferred exposures are not reported on the banking organization's balance sheet under GAAP.

For more information on the changes in GAAP related to the transfer of exposures,

see

Financial Accounting Standards Board, Topics 810 and 860.

Question 10:

The agencies request comment on the proposed revisions to operational criteria under section 41 of the advanced approaches rule.

3. Proposed Revisions to the Hierarchy of Approaches

Consistent with section 939A of the Dodd-Frank Act, the agencies are proposing to remove the advanced approaches rule's ratings-based approach (RBA) and internal assessment approach (IAA) for securitization exposures. Under the proposal, the hierarchy for securitization exposures would be modified as follows:

(1) A banking organization would be required to deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from a securitization and apply a 1,250 percent risk weight to the portion of a credit-enhancing interest-only strip (CEIO) that does not constitute after-tax gain-on-sale.

(2) If a securitization exposure does not require deduction, a banking organization would be required to assign a risk weight to the securitization exposure using the supervisory formula approach (SFA). The agencies expect banking organizations to use the SFA rather than the SSFA in all instances where data to calculate the SFA is available.

(3) If the banking organization cannot apply the SFA because not all the relevant qualification criteria are met, it would be allowed to apply the SSFA. A banking organization should be able to explain and justify (e.g., based on data availability) to its primary federal regulator any instances in which the banking organization uses the SSFA rather than the SFA for its securitization exposures.

If the banking organization does not apply the SSFA to the exposure, the banking organization would be required to assign a 1,250 percent risk weight, unless the exposure qualifies for a treatment available to certain ABCP exposures under section 44 of Standardized Approach NPR.

The SSFA, described in detail in the Standardized Approach NPR, is similar in construct and function to the SFA. A banking organization would need several inputs to calculate the SSFA. The first input is the weighted-average capital requirement under the requirements described in Standardized Approach NPR that would be applied to the underlying exposures if they were held directly by the banking organization. The second and third inputs indicate the position's level of subordination and relative size within the securitization. The fourth input is the level of delinquencies experienced on the underlying exposures. A bank would apply the hierarchy of approaches in section 142 of this proposed rule to determine which approach it would apply to a securitization exposure.

Banking organizations using the advanced approaches rule should note that the Standardized Approach NPR would require the use of the SSFA for certain securitizations subject to the advanced approaches rule.

Question 11:

The agencies request comment on the proposed revisions to the hierarchy for securitization exposures under the advanced approaches rule.

4. Guarantees and Credit Derivatives Referencing a Securitization Exposure

The advanced approaches rule includes methods for calculating risk-weighted assets for nth-to-default credit derivatives, including first-to-default credit derivatives and second-or-subsequent-to-default credit derivatives.

The advanced approaches rule, however, does not specify how to treat guarantees or non-nth-to-default credit derivatives purchased or sold that reference a securitization exposure. Accordingly, the agencies are proposing clarifying revisions to the risk-based capital requirements for credit protection purchased or provided in the form of a guarantee or derivative other than nth-to-default credit derivatives that reference a securitization exposure.

Nth-to-default credit derivative means a credit derivative that provides credit protection only for the nth-defaulting reference exposure in a group of reference exposures.

See

12 CFR part 3, appendix C, section 42(l) (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 325, appendix D, section 4(l), and 12 CFR part 390, subpart Z, appendix A, section 4(l) (FDIC).

For a guarantee or credit derivative (other than an nth-to-default credit derivative), the proposal would require a banking organization to determine the risk-based capital requirement for the guarantee or credit derivative as if it directly holds the portion of the reference exposure covered by the guarantee or credit derivative. The banking organization would calculate its risk-based capital requirement for the guarantee or credit derivative by applying either (1) the SFA as provided in section 143 of the proposal to the reference exposure if the bank and the reference exposure qualify for the SFA; or (2) the SSFA as provided in section 144 of the proposal. If the guarantee or credit derivative and the reference securitization exposure would not qualify for the SFA, or the SSFA, the bank would be required to assign a 1,250 percent risk weight to the notional amount of protection provided under the guarantee or credit derivative.

The proposal also would modify the advanced approaches rule to clarify how a banking organization may recognize a guarantee or credit derivative (other than an nth-to-default credit derivative) purchased as a credit risk mitigant for a securitization exposure held by the banking organization. In addition, the proposal adds a provision that would require a banking organization to use section 131 of the proposal instead of the approach required under the hierarchy of approaches in section 142 to calculate the risk-based capital requirements for a credit protection purchased by a banking organization in the form of a guarantee or credit derivative (other than an nth-to-default credit derivative) that references a securitization exposure that a banking organization does not hold. Credit protection purchased that references a securitization exposure not held by a banking organization subjects the banking organization to counterparty credit risk with respect to the credit protection but not credit risk to the securitization exposure.

Question 12:

The agencies request comment on the proposed revisions to the treatment of guarantees and credit derivatives that reference a securitization exposure.

5. Due Diligence Requirements for Securitization Exposures

As the recent financial crisis unfolded, weaknesses in exposures underlying securitizations became apparent and resulted in NRSROs downgrading many securitization exposures held by banks. The agencies found that many banking organizations relied on NRSRO ratings as a proxy for the credit quality of securitization exposures they purchased and held without conducting their own sufficient independent credit analysis. As a result, some banking organizations did not have sufficient capital to absorb the losses attributable to these exposures. Accordingly, consistent with the

2009 Enhancements,

the agencies are proposing to implement due diligence requirements that banking organizations would be required to use the SFA or SSFA to determine the risk-weighted asset amount for securitization exposures under the advanced approaches proposal. These disclosure requirements are consistent with those required in the standardized approach, as discussed in the Standardized Approach NPR.

Question 13:

The agencies solicit comments on what, if any, are specific challenges that are involved with meeting the proposed due diligence requirements and for what types of securitization exposures? How might the agencies address these challenges while ensuring that a banking organization conducts an appropriate level of due diligence commensurate with the risks of its exposures?

6. Nth-to-Default Credit Derivatives

The agencies propose that a banking organization that provides credit protection through an nth-to-default derivative assign a risk weight to the derivative using the SFA or the SSFA. In the case of credit protection sold, a banking organization would determine its exposure in the nth-to-default credit derivative as the largest notional dollar amount of all the underlying exposures.

When applying the SSFA to protection provided in the form of an nth-to-default credit derivative, the attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the banking organization's exposure to the total notional amount of all underlying exposures. For purposes of applying the SFA, parameter A would be set equal to the credit enhancement level (L) used in the SFA formula. In the case of a first-to-default credit derivative, there are no underlying exposures that are subordinated to the banking organization's exposure. In the case of a second-or-subsequent-to default credit derivative, the smallest (n-1) underlying exposure(s) are subordinated to the banking organization's exposure.

Under the SSFA, the detachment point (parameter D) would be the sum of the attachment point and the ratio of the notional amount of the banking organization's exposure to the total notional amount of the underlying exposures. Under the SFA, Parameter D would be set to equal L plus the thickness of the tranche (T) under the SFA formula. A banking organization that does not use the SFA or SSFA to calculate a risk weight for an nth-to-default credit derivative would assign a risk weight of 1,250 percent to the exposure.

For the treatment of protection purchased through an nth-to-default, a banking organization would determine its risk-based capital requirement for the underlying exposures as if the banking organization had synthetically securitized the underlying exposure with the lowest risk-based capital requirement and had obtained no credit risk mitigant on the underlying exposures. A banking organization would calculate a risk-based capital requirement for counterparty credit risk according to section 132 of the proposal for a first-to-default credit derivative that does not meet the rules of recognition for guarantees and credit derivatives under section 134(b).

A banking organization that obtains credit protection on a group of underlying exposures through a nth-to-default credit derivative that meets the rules of recognition of section 134(b) of the proposal (other than a first-to-default credit derivative) would be permitted to recognize the credit risk mitigation benefits of the derivative only if the banking organization also has obtained credit protection on the same underlying exposures in the form of first-through-(n-1)-to-default credit derivatives; or if n-1 of the underlying exposures have already defaulted. If a banking organization satisfies these requirements, the banking organization would determine its risk-based capital requirement for the underlying exposures as if the banking organization had only synthetically securitized the underlying exposure with the nth lowest risk-based capital requirement and had obtained no credit risk mitigant on the other underlying exposures. A banking organization that does not fulfill these requirements would calculate a risk-based capital requirement for counterparty credit risk according to section 132 of the proposal for a nth-to-default credit derivative that does not meet the rules of recognition of section 134(b) of the proposal.

For a guarantee or credit derivative (other than an nth-to-default credit derivative) provided by a banking organization that covers the full amount or a pro rata share of a securitization exposure's principal and interest, the banking organization would risk weight the guarantee or credit derivative as if it holds the portion of the reference exposure covered by the guarantee or credit derivative.

As a protection purchaser, if a banking organization chooses (and is able) to recognize a guarantee or credit derivative (other than an nth-to-default credit derivative) that references a securitization exposure as a credit risk mitigant, where applicable, the banking organization must apply section 145 of the proposal for the recognition of credit risk mitigants. If a banking organization cannot, or chooses not to, recognize a credit derivative that references a securitization exposure as a credit risk mitigant under section 145, the banking organization would determine its capital requirement only for counterparty credit risk in accordance with section 131 of the proposal.

Question 14:

The agencies request comment on the proposed treatment for nth-to-default credit derivatives.

D. Treatment of Exposures Subject to Deduction

Under the current advanced approaches rule, a banking organization must deduct certain exposures from total capital, including securitization exposures such as CEIOs, low-rated securitization exposures, and high-risk securitization exposures subject to the SFA; eligible credit reserves shortfall; and certain failed capital markets transactions.

Consistent with Basel III, the agencies are proposing that the exposures noted above that are currently deducted from total capital would instead be assigned a 1,250 percent risk weight, except as required under

subpart B of the Standardized Approach NPR, and except for deductions from total capital of insurance underwriting subsidiaries of bank holding companies. The proposed change would reduce the differences in the measure of tier 1 capital for risk-based capital purposes under the advanced approaches rule as compared to the leverage capital requirements.

Section 42(a)(1) of the advanced approaches rule states, in part, that a banking organization must deduct from total capital the portion of any CEIO that does not constitute gain-on-sale. The proposal would clarify that this provision relates to any CEIO that does not constitute

after-tax

gain-on-sale;

see

12 CFR part 3, appendix C, section 11, and 12 CFR part 167, section 11 (OCC); 12 CFR part 208, appendix F, section 11, and 12 CFR part 225, appendix G, section 11 (Board); 12 CFR part 325, appendix D, section 11, and 12 CFR part 390, subpart Z, appendix A, section 11 (FDIC).

The agencies note that such treatment is not equivalent to a deduction from tier 1 capital, as the effect of a 1,250 percent risk weight would depend on an individual banking organization's current risk-based capital ratios. Specifically, when a risk-based capital ratio (either tier 1 or total risk-based capital) exceeds 8.0 percent, the effect on that risk-based capital ratio of assigning an exposure a 1,250 percent risk weight would be more conservative than a deduction from total capital. The more a risk-based capital ratio exceeds 8.0 percent, the harsher is the effect of a 1,250 percent risk weight on risk-based capital ratios. Conversely, the effect of a 1,250 percent risk weight would be less harsh than a deduction from total capital for any risk-based capital ratio that is below 8.0 percent. Unlike a deduction from total capital, however, a bank's leverage ratio would not be affected by assigning an exposure a 1,250 percent risk weight.

The agencies are not proposing to apply a 1,250 percent risk weight to those exposures currently deducted from tier 1 capital under the advanced approaches rule. For example, the agencies are proposing that gain-on-sale that is deducted from tier 1 under the advanced approaches rule be deducted from common equity tier 1 under the proposed rule. In this regard, the agencies also clarify that any asset deducted from common equity tier 1, tier 1, or tier 2 capital under the advanced approaches rule would not be included in the measure of risk-weighted assets under the advanced approaches rule.

Question 15:

The agencies request comment on the proposed 1,250 percent risk weighting approach to CEIOs, low-rated securitization exposures, and high-risk securitization exposures subject to the SFA, any eligible credit reserves shortfall, and certain failed capital markets transactions.

E. Technical Amendments to the Advanced Approaches Rule

The agencies are proposing other amendments to the advanced approaches rule that are designed to refine and clarify certain aspects of the rule's implementation. Each of these revisions is described below.

1. Eligible Guarantees and Contingent U.S. Government Guarantees

In order to be recognized as an eligible guarantee under the advanced approaches rule, the guarantee, among other criteria, must be unconditional. The agencies note that this definition would exclude certain guarantees provided by the U.S. Government or its agencies that would require some action on the part of the bank or some other third party. However, based on their risk perspective, the agencies believe that these guarantees should be recognized as eligible guarantees. Therefore, the agencies are proposing to amend the definition of eligible guarantee so that it explicitly includes a contingent obligation of the U.S. Government or an agency of the U.S. Government, the validity of which is dependent on some affirmative action on the part of the beneficiary or a third party (for example, servicing requirements) irrespective of whether such contingent obligation would otherwise be considered a conditional guarantee. A corresponding provision is included in section 36 of the Standardized Approach NPR.

2. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Insurance Underwriting Subsidiaries

A banking organization is subject to the advanced approaches rule if it has consolidated assets greater than or equal to $250 billion, or if it has total consolidated on-balance sheet foreign exposures of at least $10 billion.

For bank holding companies, in particular, the advanced approaches rule provides that the $250 billion threshold criterion excludes assets held by an insurance underwriting subsidiary. However, a similar provision does not exist for the $10 billion foreign-exposure threshold criteria. Therefore, for bank holding companies and savings and loan holding companies, the Board is proposing to exclude assets held by insurance underwriting subsidiaries from the $10 billion in total foreign exposures threshold. The Board believes such a parallel provision would result in a more appropriate scope of application for the advanced approaches rule.

See

12 CFR part 3, appendix C, and 12 CFR part 167, appendix C (OCC); 12 CFR part 208, appendix F, and 12 CFR part 225, appendix G (Board); 12 CFR part 325, appendix D, and 12 CFR part 390, subpart Z (FDIC).

3. Calculation of Foreign Exposures for Applicability of the Advanced Approaches—Changes to FFIEC 009

The agencies are proposing to revise the advanced approaches rule to comport with changes to the Federal Financial Institutions Examination Council (FFIEC) Country Exposure Report (FFIEC 009) that occurred after the issuance of the advanced approaches rule in 2007. Specifically, the FFIEC 009 replaced the term “local country claims” with the term “foreign-office claims.” Accordingly, the agencies have made a similar change under section 100, the section of the advanced approaches rule that makes the rules applicable to a banking organization that has consolidated total on-balance sheet foreign exposures equal to $10 billion or more. As a result, to determine total on-balance sheet foreign exposure, a bank would sum its adjusted cross-border claims, local country claims, and cross-border revaluation gains calculated in accordance with FFIEC 009. Adjusted cross-border claims would equal total cross-border claims less claims with the head office or guarantor located in another country, plus redistributed guaranteed amounts to the country of the head office or guarantor.

4. Applicability of the Rule

The agencies believe it would not be appropriate for banking organizations to move in and out of the scope of the advanced approaches rule based on fluctuating asset sizes. As a result, the agencies are proposing to amend the advanced approaches rule to clarify that once a banking organization is subject to the advanced approaches rule, it would remain subject to the rule until its primary federal supervisor determines that application of the rule would not be appropriate in light of the banking organization's asset size, level of complexity, risk profile, or scope of operations. In connection with the consideration of a banking organization's level of complexity, risk profile, and scope of operations, the agencies also may consider a banking organization's interconnectedness and other relevant risk-related factors.

5. Change to the Definition of Probability of Default Related to Seasoning

The advanced approaches rule requires an upward adjustment to estimated PD for segments of retail exposures for which seasoning effects are material. The rationale underlying this requirement was the seasoning pattern displayed by some types of retail

exposures—that is, the exposures have very low default rates in their first year, rising default rates in the next few years, and declining default rates for the remainder of their terms. Because of the one-year internal ratings-based (IRB) default horizon, capital based on the very low PDs for newly originated, or “unseasoned,” loans would be insufficient to cover the elevated risk in subsequent years. The upward seasoning adjustment to PD was designed to ensure that banking organizations would have sufficient capital when default rates for such segments rose predictably beginning in year two.

Since the issuance of the advanced approaches rule, the agencies have found the seasoning provision to be problematic. First, it is difficult to ensure consistency across institutions, given that there is no guidance or criteria for determining when seasoning is “material” or what magnitude of upward adjustment to PD is “appropriate.” Second, the advanced approaches rule lacks flexibility by requiring an upward PD adjustment whenever there is a significant relationship between a segment's default rate and its age (since origination). For example, the upward PD adjustment may be inappropriate in cases where (1) The outstanding balance of a segment is falling faster over time (due to defaults and prepayments) than the default rate is rising; (2) the age (since origination) distribution of a portfolio is stable over time; or (3) where the loans in a segment are intended, with a high degree of certainty, to be sold or securitized within a short time period.

Therefore, the agencies are proposing to delete the regulatory (Pillar 1) seasoning provision and instead to treat seasoning under Pillar 2. In addition to the difficulties in applying the advanced approaches rule's seasoning requirements discussed above, the agencies believe that the consideration of seasoning belongs more appropriately in Pillar 2 First, seasoning involves the determination of minimum required capital for a period in excess of the 12-month time horizon of Pillar 1. It thus falls more appropriately under longer-term capital planning and capital adequacy, which are major focal points of the internal capital adequacy assessment process component of Pillar 2. Second, seasoning is a major issue only where a banking organization has a concentration of unseasoned loans. The capital treatment of loan concentrations of all kinds is omitted from Pillar 1; however, it is dealt with explicitly in Pillar 2.

6. Cash Items in Process of Collection

Previously under the advanced approaches rule issued in 2007, cash items in the process of collection were not assigned a risk-based capital treatment and, as a result, would have been subject to a 100 percent risk weight. Under the proposed rule, the agencies are revising the advanced approaches rule to risk weight cash items in the process of collection at 20 percent of the carrying value, as the agencies have concluded that this treatment would be more commensurate with the risk of these exposures. A corresponding provision is included in section 32 of the Standardized Approach NPR.

7. Change to the Definition of Qualified Revolving Exposure

The agencies are proposing to modify the definition of Qualified Revolving Exposure (QRE) such that certain unsecured and unconditionally cancellable exposures where a banking organization consistently imposes in practice an upper exposure limit of $100,000 and requires payment in full every cycle will now qualify as QRE. Under the current definition, only unsecured and unconditionally cancellable revolving exposures with a pre-established maximum exposure amount of $100,000 (such as credit cards) are classified as QRE. Unsecured, unconditionally cancellable exposures that require payment in full and have no communicated maximum exposure amount (often referred to as “charge cards”) are instead classified as “other retail.” For regulatory capital purposes, this classification is material and would generally result in substantially higher minimum required capital to the extent that the exposure's asset value correlation (AVC) will differ if classified as QRE (where it is assigned an AVC of 4 percent) or other retail (where AVC varies inversely with through-the-cycle PD estimated at the segment level and can go as high as almost 16 percent for very low PD segments).

The proposed definition would allow certain charge card products to qualify as QRE. Charge card exposures may be viewed as revolving in that there is an ability to borrow despite a requirement to pay in full. Where a banking organization consistently imposes in practice an upper exposure limit of $100,000 the agencies believe that charge cards are more closely aligned from a risk perspective with credit cards than with any type of “other retail” exposure and are therefore proposing to amend the definition of QRE in order to allow such products to qualify as QRE.

The agencies also have considered the appropriate treatment of hybrid cards. Hybrid cards have characteristics of both charge and credit cards. The agencies are uncertain whether it would be prudent to allow hybrid cards to qualify as QREs at this time. Hybrid cards are a relatively new product, and there is limited information available about them including data on their market and risk characteristics.

Question 16:

Do hybrid cards exhibit similar risk characteristics to credit and charge cards and should the agencies allow them to qualify as QREs? Commenters are requested to provide a detailed explanation, as appropriate, as well as the relevant data and impact analysis to support their positions. Such information should include data on the number or dollar-amounts of cards issued to date, anticipated growth rate, and performance data including default and delinquency rates, credit score distribution of cardholders, volatilities, or asset-value correlations.

8. Trade-Related Letters of Credit

In 2011, the BCBS revised the Basel II advanced internal ratings-based approach to remove the one-year maturity floor for trade finance instruments. Consistent with this revision, this proposed rule would specify that an exposure's effective maturity must be no greater than five years and no less than one year, except that an exposure's effective maturity must be no less than one day if the exposure is a trade-related letter of credit, or if the exposure has an original maturity of less than one year and is not part of a banking organization's ongoing financing of the obligor.

A corresponding provision is included in section 33 of the Standardized Approach NPR.

Question 17:

The agencies request comment on all the other proposed amendments to the advanced approaches rule described in section E (items 1 through 8), of this preamble.

F. Pillar 3 Disclosures

1. Frequency and Timeliness of Disclosures

Under the proposed rule, a banking organization is required to provide certain qualitative and quantitative disclosures on a quarterly, or in some cases, annual basis, and these disclosures must be “timely.” In the preamble to the advanced approaches rule issued in 2007, the agencies indicated that quarterly disclosures would be timely if they were provided within 45 days after calendar quarter-end. The preamble did not specify

expectations regarding annual disclosures. The agencies acknowledged that timing of disclosures required under the federal banking laws may not always coincide with the timing of disclosures under other federal laws, including federal securities laws and their implementing regulations by the SEC. The agencies also indicated that a banking organization may use disclosures made pursuant to SEC, regulatory reporting, and other disclosure requirements to help meet its public disclosure requirements under the advanced approaches rule.

The agencies understand that the deadline for certain SEC financial reports is more than 45 calendar days after calendar quarter-end. Therefore, the agencies are proposing to clarify in this NPR that, where a banking organization's fiscal year-end coincides with the end of a calendar quarter, the requirement for timely disclosure would be no later than the applicable reporting deadlines for regulatory reports (for example, FR Y-9C) and financial reports (for example, SEC Forms 10-Q and 10-K). When these deadlines differ, banking organizations would adhere to the later deadline. In cases where a banking organization's fiscal year-end does not coincide with the end of a calendar quarter, the agencies would consider those disclosures that are made within 45 days as timely.

2. Enhanced Securitization Disclosure Requirements

In view of the significant contribution of securitization exposures to the financial crisis, the agencies believe that enhanced disclosure requirements are appropriate. Consistent with the disclosures introduced by the 2009 Enhancements, the agencies are proposing to amend the qualitative section for Table 11.8 disclosures (Securitization) to include the following:

The nature of the risks inherent in a banking organization's securitized assets,

A description of the policies that monitor changes in the credit and market risk of a banking organization's securitization exposures,

A description of a banking organization's policy regarding the use of credit risk mitigation for securitization exposures,

A list of the special purpose entities a banking organization uses to securitize exposures and the affiliated entities that a bank manages or advises and that invest in securitization exposures or the referenced SPEs, and

A summary of the banking organization's accounting policies for securitization activities.

To the extent possible, the agencies are proposing the disclosure requirements included in the 2009 Enhancements. However, due to the prohibition on the use of credit ratings in the risk-based capital rules required by the Dodd-Frank Act, the proposed tables do not include those disclosure requirements related to the use of ratings.

3. Equity Holding That Are Not Covered Positions

Section 71 of the current advanced approaches rule requires banking organizations to include in their public disclosures a discussion of “important policies covering the valuation of and accounting for equity holdings in the banking book.” Since “banking book” is not a defined term under the advanced approaches rule, the agencies propose to refer to such exposures as equity holdings that are not covered positions.

III. Market Risk Capital Rule

In today's

Federal Register

, the federal banking agencies are finalizing revisions to the agencies' market risk capital rule (the market risk capital rule), which generally requires national banks, state banks, and bank holding companies with significant exposure to market risk to implement systems and procedures necessary to manage and measure that risk and to hold a commensurate amount of capital. As noted in the introduction of this preamble, in this NPR, the agencies are proposing to expand the scope of the market risk capital rule to include savings associations and savings and loan holding companies and codify the market risk rule in a manner similar to the other regulatory capital rules in the three proposals. In the process of incorporating the market risk rule into the regulatory capital framework, the agencies note that there will be some overlap among certain defined terms. In any final rule, the agencies intend to merge definitions and make any appropriate technical changes.

As a general matter, a banking organization subject to the market risk capital rule will not include assets held for trading purposes when calculating its risk-weighted assets for the purpose of the other risk-based capital rules. Instead, the banking organization must determine an appropriate capital requirement for such assets using the methodologies set forth in the final market risk capital rule. The banking organization then must multiply its market risk capital requirement by 12.5 to determine a risk-weighted asset amount for its market risk exposures and then add that amount to its credit risk-weighted assets to arrive at its total risk-weighted asset amount.

As described in the preamble to the market risk capital rule, the agencies revised their respective market risk rules to better capture positions subject to market risk, reduce pro-cyclicality in market risk capital requirements, enhance the rule's sensitivity to risks that were not adequately captured under the prior regulatory measurement methodologies, and increase transparency through enhanced disclosures.

The market risk capital rules is designed to determine capital requirements for trading assets based on general and specific market risk associated with these assets. General market risk is the risk of loss in the market value of positions resulting from broad market movements, such as changes in the general level of interest rates, equity prices, foreign exchange rates, or commodity prices. Specific market risk is the risk of loss from changes in the market value of a position due to factors other than broad market movements, including event risk (changes in market price due to unexpected events specific to a particular obligor or position) and default risk.

The agencies' current market risk capital rules do not apply to savings associations or savings and loan holding companies. The Board has previously expressed its intention to assess the condition, performance, and activities of savings and loan holding companies (SLHCs) on a consolidated risk-based basis in a manner that is consistent with the Board's established approach regarding bank holding company supervision while considering any unique characteristics of SLHCs and the requirements of the Home Owners' Loan Act.

Therefore, as noted above, the agencies are proposing in this NPR to expand the scope of the market risk rule to savings associations and savings and loan holding companies that meet the stated thresholds. As proposed, the market risk capital rule would apply to any savings association or savings and loan holding company whose trading activity (the gross sum of its trading assets and trading liabilities) is equal to 10 percent or more of its total assets or $1 billion or more. Under the proposed rule, each agency would retain the authority to apply its respective market risk rule to any entity under its jurisdiction, regardless of whether it

meets the aforementioned thresholds, if the agency deems it necessary or appropriate for safe and sound banking practices.

See

76 FR 22663 (April, 22, 2011).

As a general matter, savings associations and savings and loan holding companies do not engage in trading activity to a substantial degree. However, the agencies believe that any savings association or savings and loan holding company whose trading activity grows to the extent that it meets the thresholds should hold capital commensurate with the risk of the trading activity and should have in place the prudential risk management systems and processes required under the market risk capital rule. Therefore, the agencies believe it would be necessary and appropriate to expand the scope of the market risk rule to apply to savings associations and savings and loan holding companies.

Application of the market risk capital rule to all banking organizations with material exposure to market risk would be particularly important because of banking organizations' increased exposure to traded credit products, such as credit default swaps, asset-backed securities and other structured products, as well as other less liquid products. In fact, many of the revisions to the final market risk capital rule were made in response to concerns that arose during the financial crisis when certain trading assets suffered substantial losses, causing banking organizations holding those assets to suffer substantial losses. For example, in addition to a market risk capital requirement to account for general market risk, the revised rules apply more conservative standardized specific risk capital requirements to most securitization positions, implement an additional incremental risk capital requirement for a banking organization that models specific risk for one or more portfolios of debt or, if applicable, equity positions. Additionally, to address concerns about the appropriate treatment of traded positions that have limited price transparency, a banking organization subject to the market risk capital rule must have a well-defined valuation process for all covered positions.

Question 18:

The agencies request comment on the application of the market risk rule to savings associations and savings and loan holding companies.

IV. List of Acronyms

ABCP Asset-Backed Commercial Paper

ABS Asset-Backed Security

AVC Asset Value Correlation

BCBS Basel Committee on Banking Supervision

CCP Central Counterparty

CDO Collateralized Debt Obligation

CDS Credit Default Swap

CDS

ind

Index Credit Default Swap

CEIO Credit-Enhancing Interest-Only Strip

CPSS Committee on Payment and Settlement Systems

CVA Credit Valuation Adjustment

DFA Dodd-Frank Act

DvP Delivery-versus-Payment

E Measure of Effectiveness

EAD Exposure-at-Default

EE Expected Exposure

Expected Operational Loss (EOL)

EPE Expected Positive Exposure

FDIC Federal Deposit Insurance Corporation

FFIEC Federal Financial Institutions Examination Council

Federal Register

GAAP Generally Accepted Accounting Principles

HVCRE High-Volatility Commercial Real Estate

IAA Internal Assessment Approach

IMA Internal Models Approach

IMM Internal Models Methodology

I/O Interest-Only

IOSCO International Organization of Securities Commissions

IRB Internal Ratings-Based

Loss Given Default (LGD)

M Effective Maturity

NGR Net-to-Gross Ratio

NPR Notice of Proposed Rulemaking

NRSRO Nationally Recognized Statistical Rating Organization

OCC Office of the Comptroller of the Currency

OTC Over-the-Counter

PD Probability of Default

PFE Potential Future Exposure

PvP Payment-versus-Payment

QCCP Qualifying Central Counterparty

QRE Qualified Retail Exposure

RBA Ratings-Based Approach

RVC Ratio of Value Change

SFA Supervisory Formula Approach

SSFA Simplified Supervisory Formula Approach

U.S.C. United States Code

VaR Value-at-Risk

V. Regulatory Flexibility Act Analysis

The Regulatory Flexibility Act, 5 U.S.C. 601

et seq.

(RFA) requires an agency to provide an initial regulatory flexibility analysis with a proposed rule or to certify that the rule will not have a significant economic impact on a substantial number of small entities (defined for purposes of the RFA to include banks with assets less than or equal to $175 million) and publish its certification and a short, explanatory statement in the

Federal Register

along with the proposed rule.

The Board is providing an initial regulatory flexibility analysis with respect to this NPR. The OCC and FDIC are certifying that the proposals in this NPR will not have a significant economic impact on a substantial number of small entities.

Board

Under regulations issued by the Small Business Administration,

a small entity includes a depository institution or bank holding company with total assets of $175 million or less (a small banking organization). As of March 31, 2012 there were 373 small state member banks. As of December 31, 2011, there were approximately 128 small savings and loan holding companies and 2,385 small bank holding companies.

See

13 CFR 121.201.

The December 31, 2011, data are the most recent available data on small savings and loan holding companies and small bank holding companies.

As discussed previously in the Supplementary Information, the Board is proposing to revise its capital requirements to promote safe and sound banking practices, implement Basel III, and other aspects of the Basel capital framework, and codify its capital requirements.

The proposals also satisfy certain requirements under the Dodd-Frank Act by imposing new or revised minimum capital requirements on certain depository institution holding companies.

Additionally, under section 38(c)(1) of the Federal Deposit Insurance Act, the agencies may prescribe capital standards for depository institutions that they regulate.

In addition, among other authorities, the Board may establish capital requirements for state member banks under the Federal Reserve Act,

for state member banks and bank holding companies under the International Lending Supervision Act and Bank Holding Company Act,

and for savings and loan holding companies under the Home Owners' Loan Act.

See

12 U.S.C. 5371.

See

12 U.S.C. 1831o(c)(1).

See

12 CFR 208.43.

See

12 U.S.C. 3907; 12 U.S.C. 1844.

See

12 U.S.C. 1467a(g)(1).

The proposed requirements in this NPR generally would not apply to small bank holding companies that are not engaged in significant nonbanking activities, do not conduct significant off-balance sheet activities, and do not have a material amount of debt or equity securities outstanding that are registered with the SEC. These small bank holding companies remain subject to the Board's Small Bank Holding Company Policy Statement (Policy Statement).

See

12 CFR part 225, appendix C;