[Editor’s Note: The following post is authored by Davis Polk & Wardwell LLP]
The OCC has issued a final rule specifying the methods for calculating credit exposure arising from derivatives and securities financing transactions for purposes of the federal lending limits that apply to national banks, federal and state branches and agencies of foreign banks and federal and state savings associations. The final rule, like the June 2012 OCC interim final rule that it revises, implements Section 610 of the Dodd-Frank Act, which requires federal lending limits to take into account credit exposure arising from derivatives and securities financing transactions.
The OCC’s final rule reflects a further convergence in methods for measuring credit exposure from derivatives and securities financing transactions between bank capital rules and legal lending limits. Among other changes, the OCC’s final rule (1) further extends the compliance date of the Section 610- related provisions to October 1, 2013; (2) replaces the Remaining Maturity Method for calculating credit exposure arising from derivatives with the Current Exposure Method in the bank capital rules, which takes into account, to a certain extent, the effects of netting and collateral; (3) revises the treatment of credit derivatives; and (4) permits banks to calculate credit exposure arising from securities financing transactions using the Collateral Haircut Approach, which also takes into account the effects of netting and collateral.
Section 610 is one of several provisions in the Dodd-Frank Act that requires banks to take into account credit exposure arising from derivatives and securities financing transactions in calculating prudential limits. It remains to be seen whether the Federal Reserve Board will propose similar methods for purposes of implementing the Dodd-Frank Act’s amendments to Section 23A of the Federal Reserve Act, which became effective on July 21, 2012. Among other things, the Dodd-Frank Act expanded the definition of “covered transaction” in Section 23A to include derivative and securities lending or borrowing transactions with an affiliate, to the extent they give rise to credit exposure to the affiliate. Similarly, it is unclear to what extent the methods used in the OCC’s lending limits final rule may also be reflected in the Federal Reserve’s final Dodd-Frank single counterparty credit limits for large U.S. bank holding companies, large foreign banking organizations and systemically important nonbank financial companies.
Using visuals, tables and examples, this memorandum describes the key changes to the OCC’s interim final rule and the methods for calculating credit exposure arising from derivatives and securities financing transactions.
Click here to read the entire update.