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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Published In: Administrative Agency Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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