New York Adopts Credit Exposure Provisions
by: Margaret Wright
On April 9, 2014, the New York Department of Financial Services adopted an emergency rule regarding credit exposure arising from derivative transactions. The April 9, 2014 emergency rule is effective immediately, however is set to expire June 22, 2014.
Beginning in January 2013, similar emergency rules have been adopted concerning the same topic; however emergency adoptions are intended to only be valid for 90 days or less. Each emergency adoption on this subject has been substantially similar but has generally included small revisions and clarifications.
The emergency regulation concerning credit exposure arising from derivative transactions has been required as a result of the Dodd-Frank Act requirements which went into effect January 2013. Pursuant to the Dodd-Frank Act, “an insured state bank … may only engage in derivative transactions if [state law] takes into consideration credit exposure to derivative transactions.” To achieve Dodd-Frank compliance, a state’s lending limit rules must take into account credit exposure arising from derivative transactions. Compliance with the emergency regulation allows New York banks to continue to engage in derivative transactions, which are used regularly by many institutions to manage risk exposure.
Derivative Transactions
A derivative transaction is defined as follows:
“Any transaction that is a contract, agreement, swap, warrant, note, or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities, securities, currencies, interest or other rates, indices, or other assets”
A credit derivative is a financial contract that allows one party to transfer the credit risk of one or more exposures to another party.
In order to comply with the emergency regulation and continue to utilize derivative transactions, a bank must include its credit exposure arising from derivative transactions, including credit derivatives, in the calculation when computing the amount of outstanding loans to a person or entity for the purposes of lending limits.
The regulation outlines the calculation of credit exposure arising from credit derivatives by adding the net notional value as applicable to protection purchases and sales.
Alternative methods of calculation of credit exposure arising from derivative transactions are allowed as approved or as directed by the superintendent of the NY Department of Financial Services.
Exposure Mitigants
The regulation includes several credit exposure mitigants which may be utilized in determination of the calculation of risk. These mitigants include:
- The netting of credit exposures where the bank and counterparty have a qualifying master netting agreement;
- The reduction of credit exposure where credit is secured by readily marketable collateral; and
- The reduction of credit exposure to the extent hedged.
Exception
The regulation does allow for exemption from inclusion of credit exposure from derivative transactions in the calculation where the counterparty “has been designated by the Financial Stability Oversight Council as a financial market utility that is, or is likely to become, systemically important.”
About the Author
Margaret Wright, J.D., is Vice President and Regulatory Compliance Director at Bankers Advisory. She is a graduate of Stonehill College and earned her Juris Doctor at Suffolk University Law School. She is admitted to the Massachusetts Bar. She can be reached at Margaret@bankersadvisory.com
Margaret Wright, JD, is regulatory compliance director with CLA. She is a graduate of Stonehill College and earned her juris doctor at Suffolk University Law School. She is admitted to the Massachusetts Bar.
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