Under the Financial Collateral Comprehensive Method of the CRM Framework, the volatility-adjusted value of the collateral is calculated by applying adjustments for fluctuations in market value and for maturity and currency differences, if any. The adjusted value of the exposure is determined, in principle, by subtracting the adjusted value of the collateral from the (price volatility-adjusted) value of the exposure (for formulas, see).
Two methods are available for the calculation of volatility adjustments: the Supervisory methodand the Own Estimates method. An institution applying the Own Estimates method must apply it to all types of instruments, with the exception of immaterial portfolios. There are conditions attached to the use of the Own Estimates method.
Conditions applying to risk management
Application of the Own Estimates method for volatility adjustments requires that an institution’s risk management satisfies the following conditions:
- The institution must adopt procedures aiming to ensure that the estimates are used in day-to-day risk management, including the determination of internal position limits; and
- The estimation system and its integration in the risk management procedures is evaluated at least once a year.
Conditions applying to the estimation method
The method used to estimate volatility adjustments must meet the following requirements:
- For collateral items of investment grade or better credit quality, institutions may estimate volatility per collateral category. Classification must take account of the issuer, external credit rating, residual maturity and modified duration of each collateral item. For collateral items of lower credit grades, volatility adjustments must be estimated for each individual item.
- Estimations must not take account of any correlations between unsecured exposure, collateral and/or exchange rate.
- A one-tailed confidence interval of 99% must be observed.
- Conditions apply to the manner in which the duration of liquidation periods and the marking-to-market frequency are taken into account.
- The liquidation period must be 20 business days for secured lending transactions; 5 business days for repurchase transactions not relating to commodities and for securities lending or borrowing transactions, and 10 business days for other capital market driven transactions and repurchase transactions relating to commodities.
- Estimations must take into account any illiquidity of assets.
- In principle, the effective observation period must comprise at least one year.
- Datasets must be updated at least once every three months.
- The historical observation period must be at least one year unless DNB decides otherwise.
Exceptions applying to repurchase agreements and securities lending
A 0% volatility adjustment applies to repurchase agreements not relating to commodities, provided all of the following requirements are met:
- Both the exposure and the collateral are in cash or debt securities issued by central governments or central banks and eligible for a 0 % risk weight under the Standardised Approach.
- The exposure and the collateral are denominated in the same currency.
- Either the maturity of the transaction is no more than one day or both the exposure and the collateral are subject to daily marking-to-market or daily remargining.
- On failure to remargin, liquidation will take place within four business days.
- The settlement system is adequate.
- The counterparty is a core market participant.
- The documentation is standard market documentation for repurchase transactions.
On default by the counterparty, the exposure becomes repayable without notice.