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QUESTION

CFG/RBS Comments

Q 37: The agencies recognize that this is a conservative approach and seek comment on other approaches to consider in determining a given security for purposes of the collateral haircut approach.

The haircuts are currently calculated using credit spreads (for debt securities). Securities are assigned to credit spread bands for which one single haircut is calculated. The approach differs for those debt securities falling below investment grade for which haircut is calculated individually.

Q 38: The agencies seek comment on methods banks would use to ensure enforceability of single product OTC derivative netting agreements in the absence of an explicit written legal opinion requirement.

No comment.

Q 39: The agencies request comment on all aspect of the effective EPE approach to counterparty credit risk, and in particular on the appropriateness of the monotonically increasing effective EE function, the alpha constant of 1.4, and the floor on internal estimates of alpha of 1.2.

The proposed approach would present issues if applied to more advanced methods used for measuring EPE for collateralised counterparties, which capture the effects of margining. Such approaches would typically involve looking at the exposure by marking-to-market of the underlying transactions, removing the modelled collateral balance and margin period of risk. This would be undertaken at several time points in the first year. Where changes in mark-to-market are the result of market rate movements, this would present a measure which is likely to be relatively constant. However, where changes in mark to market are the result of contractual cash-flows, the measure is subject to extreme spikes. The results from such an approach are not suited to a monotonically increasing function.

The concept of a floor is not helpful – this stifles research and innovation and, in extreme cases, may discourage banks from adopting the approach altogether. The need for conservatism is well understood and accepted, but it is not best reflected in a floor. Having a floor set at a level will not encourage diversification in the overall risk of a portfolio when the model indicates an alpha which is lower than the floor level.

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