The Federal Banking Agencies’ Regulatory Capital Proposals: Treatment of Derivatives and Collateral and Guarantees Mitigating Credit Risk Associated With Derivatives

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On June 12, 2012, the federal banking agencies (the Office of the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation) formally proposed for comment, in a series of three separate but related proposals, substantial revisions to the U.S. regulatory capital regimen for banking organizations that, if adopted, will have a significant impact on the U.S. banking industry. One of these proposals, “Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements” (the “Proposal”), details the extent to which banking organizations would, upon the Proposal’s adoption, be required to hold risk-based capital for counterparty risk for derivatives transactions. The Proposal is based in significant part on the “standardized approach” for the weighting and calculation of risk-based capital requirements under the 2004-2006 Basel II Accord (“Basel II”). The method for determining risk-weighted assets for derivatives transactions, as for onbalance sheet exposures generally, is to multiply (i) the relevant risk weight by (ii) the relevant exposure amount.

The regime for risk-weighted assets contained in the Proposal is complex. However, the regulators’ policy preference for cleared derivatives over non-cleared transactions is clear. In requiring significantly higher risk weights for non-cleared OTC transactions than for cleared transaction — indeed, the risk weight for a non-cleared transaction may be 50 times the risk weight for a cleared transaction — the Proposal implements the regulators’ stated preference for cleared transactions.

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