Content Options

View Options

Status: You are viewing the version of the handbook as on 2009-03-31.

BIPRU 7.11 Credit derivatives in the trading book

Scope

BIPRU 7.11.1RRP

This section applies to the treatment of credit derivatives in the trading book.

Establishment of positions created by credit derivatives: Treatment of the protection seller

BIPRU 7.11.2RRP

BIPRU 7.11.3R - BIPRU 7.11.11R relate to the treatment of the protection seller for the purpose of calculating the securities PRR. Positions are determined in accordance with BIPRU 7.11.4R - BIPRU 7.11.11R.

BIPRU 7.11.3RRP

When calculating the PRR of the protection seller, unless specified differently by other rules, the notional amount of the credit derivative contract must be used. For the purpose of calculating the specific risk PRR charge, other than for total return swaps, the maturity of the credit derivative contract is applicable instead of the maturity of the obligation.

BIPRU 7.11.4RRP

A total return swap creates a long position in the general market risk of the reference obligation and a short position in the general market risk of a zero-specific-risk security with a maturity equivalent to the period until the next interest fixing and which is assigned a 0% risk weight under the standardised approach to credit risk. It also creates a long position in the specific risk of the reference obligation.

BIPRU 7.11.5RRP

A credit default swap does not create a position for general market risk. For the purposes of specific risk, a firm must record a synthetic long position in an obligation of the reference entity, unless the derivative is rated externally and meets the conditions for a qualifying debt security, in which case a long position in the derivative is recorded. If premium or interest payments are due under the product, these cash flows must be represented as notional positions in zero-specific-risk securities.

BIPRU 7.11.6RRP

A single name credit linked note creates a long position in the general market risk of the note itself, as an interest rate product. For the purpose of specific risk, a synthetic long position is created in an obligation of the reference entity. An additional long position is created in the issuer of the note. Where the credit linked note has an external rating and meets the conditions for a qualifying debt security, a single long position with the specific risk of the note need only be recorded.

BIPRU 7.11.7RRP

In addition to a long position in the specific risk of the issuer of the note, a multiple name credit linked note providing proportional protection creates a position in each reference entity, with the total notional amount of the contract assigned across the positions according to the proportion of the total notional amount that each exposure to a reference entity represents. Where more than one obligation of a reference entity can be selected, the obligation with the highest risk weighting determines the specific risk.

BIPRU 7.11.8RRP

Where a multiple name credit linked note has an external rating and meets the conditions for a qualifying debt security, a single long position with the specific risk of the note need only be recorded.

BIPRU 7.11.9RRP

A first-asset-to-default credit derivative creates a position for the notional amount in an obligation of each reference entity. If the size of the maximum credit event payment is lower than the PRR requirement under the method in the first sentence of this rule, the maximum payment amount may be taken as the PRR requirement for specific risk.

BIPRU 7.11.10RRP

A second-asset-to-default credit derivative creates a position for the notional amount in an obligation of each reference entity less one (that with the lowest specific risk PRR requirement). If the size of the maximum credit event payment is lower than the PRR requirement under the method in the first sentence of this rule, this amount may be taken as the PRR requirement for specific risk.

BIPRU 7.11.11RRP

If a first or second-asset to default derivative is externally rated and meets the conditions for a qualifying debt security, then the protection seller need only calculate one specific risk charge reflecting the rating of the derivative.

Establishment of positions created by credit derivatives: Treatment of the protection buyer

BIPRU 7.11.12RRP

For the protection buyer, the positions are determined as the mirror imageof the protection seller, with the exception of a credit linked note (which entails no short position in the issuer). If at a given moment there is a call option in combination with a step-up, such moment is treated as the maturity of the protection. In the case of nth to default credit derivatives, a firm that is a protection buyer may off-set specific risk for n-1 of the underlyings (i.e., the n-1 assets with the lowest specific risk PRR).

Recognition of hedging provided by credit derivatives against cash positions

BIPRU 7.11.13RRP

  1. (1)

    BIPRU 7.11.14R - BIPRU 7.11.17R relate to specific risk PRR for trading book positions hedged by credit derivatives for the purposes of the calculation of the securities PRR.

  2. (2)

    A firm may take an allowance for protection provided by credit derivatives for the purposes in (1) in accordance with the principles set out in the rules referred to in (1).

  3. (3)

    BIPRU 7.11.13 R - BIPRU 7.11.17 R are subject to the requirements of the credit default swap PRR methods.

BIPRU 7.11.14RRP

  1. (1)

    A firm may take full allowance when the value of two legs always move in the opposite direction and broadly to the same extent.

  2. (2)

    This will be the case in the following situations:

    1. (a)

      the two legs consist of completely identical instruments; or

    2. (b)

      a long cash position is hedged by a total rate of return swap (or vice versa) and there is an exact match between the reference obligation and the underlying exposure (i.e., the cash position).

  3. (3)

    The maturity of the swap itself may be different from that of the underlying exposure for the purposes of (2)(b).

  4. (4)

    In these situations, a firm must not apply a specific risk PRR to either side of the position.

BIPRU 7.11.15RRP

An 80% offset may be applied when the value of two legs always move in the opposite direction and where there is an exact match in terms of the reference obligation, the maturity of both the reference obligation and the credit derivative, and the currency of the underlying exposure. In addition, key features of the credit derivative contract must not cause the price movement of the credit derivative materially to deviate from the price movements of the cash position. To the extent that the transaction transfers risk, an 80% specific risk offset may be applied to the side of the transaction with the higher PRR, while the specific risk requirements on the other side are zero.

BIPRU 7.11.16RRP

  1. (1)

    A firm may take partial allowance when the value of two legs usually move in the opposite direction. This would be the case in the situations set out in (2) - (4).

  2. (2)

    The first situation referred to in (1) is that the position falls under BIPRU 7.11.16 R (2)(b) but there is an asset mismatch between the reference obligation and the underlying exposure. However, the positions meet the following requirements:

    1. (a)

      the reference obligation ranks pari passu with or is junior to the underlying obligation; and

    2. (b)

      the underlying obligation and reference obligation share the same obligor and have legally enforceable cross-default or cross-acceleration clauses.

  3. (3)

    The second situation referred to in (1) is that the position falls under BIPRU 7.11.14 R (2)(a) or BIPRU 7.11.15 R but there is a currency or maturity mismatch between the credit protection and the underlying asset (currency mismatches must be included in the normal reporting with respect to the foreign currency PRR1).

  4. (4)

    The third situation referred to in (1) is that the position falls under BIPRU 7.11.15 R but there is an asset mismatch between the cash position and the credit derivative. However, the underlying asset is included in the (deliverable) obligations in the credit derivative documentation.

  5. (5)

    In each of those situations, rather than adding the specific risk PRR requirements for each side of the transaction, only the higher of the two PRR requirements applies.

BIPRU 7.11.17RRP

In all situations not falling under BIPRU 7.11.14 R - BIPRU 7.11.16 R, a firm must assess a specific risk PRR charge against both sides of the positions.

Special treatment of credit default swaps: Provisions applicable to all methods

BIPRU 7.11.18R

BIPRU 7.11.18 R - BIPRU 7.11.58 R set out the calculation of the specific risk portion of the interest rate PRR for credit default swaps.

BIPRU 7.11.19R

The specific risk portion of the interest rate PRR is calculated separately for:

  1. (1)

    credit default swaps (other than those in (2));

  2. (2)

    credit default swaps that are also securitisation positions; and

  3. (3)

    other positions;

that are subject to the interest rate PRR.

BIPRU 7.11.20RRP

The specific risk portion of the interest rate PRR for positions falling into BIPRU 7.11.19 R (1) and BIPRU 7.11.19 R (2) must be calculated in accordance with the credit default swap PRR methods rather than in accordance with BIPRU 7.2 (Interest rate PRR) and the other provisions of BIPRU 7.11. However a firm may apply BIPRU 7.11.13 R- BIPRU 7.11.17 R before applying the credit default swap PRR methods. If it does so the firm must apply the credit default swap PRR methods to the remaining position in credit default swaps.

BIPRU 7.11.21R

In accordance with the principle in BIPRU 7.11.19 R, there is no netting for the purpose of calculating specific risk PRR charges (BIPRU 7.2.37 R - BIPRU 7.2.40 R (Deriving the net position in each debt security: Netting positions in the same debt security) or otherwise) between:

  1. (1)

    a position falling into BIPRU 7.11.19 R (1) or BIPRU 7.11.19 R (2) and one falling into BIPRU 7.11.19 R (3); or

  2. (2)

    a position falling into BIPRU 7.11.19 R (1) and one falling into BIPRU 7.11.19 R (2).

BIPRU 7.11.22R

  1. (1)

    A firm must calculate the interest rate PRR for specific risk for credit default swaps falling into BIPRU 7.11.19 R (1) under the ordinary credit default swap PRR method.

  2. (2)

    A firm must calculate the interest rate PRR for specific risk for credit default swaps falling into BIPRU 7.11.19 R (2) under the securitisation credit default swap PRR method.

Ordinary credit default swap PRR method: Introduction

Ordinary credit default swap PRR method: Grouping of credit derivatives

BIPRU 7.11.24R

A firm must group together all credit default swaps being treated under the ordinary credit default swap PRR method that give rise to notional positions in the same security for specific risk purposes under the procedure in BIPRU 7.11.2 R - BIPRU 7.11.12 R and that may be netted under BIPRU 7.11.56 R.

BIPRU 7.11.25R

The provisions in BIPRU 7.11.2 R - BIPRU 7.11.12 R about the creation of a specific risk charge for credit default swaps reflecting the rating of the derivative (see BIPRU 7.11.11 R and part of BIPRU 7.11.5 R) do not apply for the purposes of calculating the ordinary credit default swap PRR method.

Ordinary credit default swap PRR method: Main rule for calculating the specific risk PRR

BIPRU 7.11.26R

The specific risk portion of the interest rate PRR or credit default swaps treated under the ordinary credit default swap PRR method is the higher of:

  1. (1)

    an amount equal to what would have been the specific risk portion of the interest rate PRR for such credit default swaps if it had been calculated under of BIPRU 7.2.43 R to BIPRU 7.2.50 R (Specific risk calculation for interest rate risk), taking into account BIPRU 7.11.19 R and BIPRU 7.11.21 R; and

  2. (2)

    the sum of the valuation change capital charge (see BIPRU 7.11.28 R) and the default capital charge (see BIPRU 7.11.36 R) for all such credit derivatives.

Ordinary credit default swap PRR method: The valuation change capital charge

BIPRU 7.11.27R

A firm must allocate each credit default swap grouped together under BIPRU 7.11.24 R to the time bands set out in BIPRU 7.11.33 R for the purposes of calculating the valuation change capital charge.

BIPRU 7.11.28R

The valuation change capital charge for a group of credit default swaps created under BIPRU 7.11.24 R is equal to three2 multiplied by the larger of the potential loss produced under BIPRU 7.11.29 R and the potential loss produced under BIPRU 7.11.30 R. The total valuation change capital charge for credit default swaps treated under the ordinary credit default swap PRR method is equal to the sum of such amounts for all such groups.

2
BIPRU 7.11.29R

  1. (1)

    The amount of the potential loss calculated under this rule is calculated as follows.

  2. (2)

    Within each time band the firm must calculate the net valuation change in the credit default swaps that would occur if spreads (as defined in BIPRU 7.11.55 R) were to increase by the amount shown in BIPRU 7.11.34 R. The amount of the change in spread is the same for each time band.

  3. (3)

    The potential loss calculated under this rule is the sum of all bands that create a net loss. Bands which produce a profit must be ignored.

  4. (4)

    The time bands referred to in this rule are those established under BIPRU 7.11.27 R.

BIPRU 7.11.30R

The amount of the potential loss calculated under this rule is calculated in the same way as it is under BIPRU 7.11.29 R except that the net valuation change is the one that would occur if spreads were to decrease by the amount shown in BIPRU 7.11.34 R.

BIPRU 7.11.31R

The valuation change in BIPRU 7.11.29 R - BIPRU 7.11.30 R is applied to the current value of the credit default swap.

BIPRU 7.11.32R

The credit quality step applicable under the table in BIPRU 7.11.34 R is that which would be attributable to the security in question under the standardised approach to credit risk. If a rating from an eligible ECAI is not available to the firm it must treat that position as having credit quality step 6. The security in question is the one by reference to which the grouping under BIPRU 7.11.24 R is carried out (the reference entity).

BIPRU 7.11.33R

Time bands

This table belongs to BIPRU 7.11.27 R

Time band

Residual contract maturity

1

Less than three months

2

Three months to one year

3

Over one year to two and half years

4

Over two and a half years to five years

5

Greater than five years

BIPRU 7.11.34R

Stress factors based on rating of reference entity

This table belongs to BIPRU 7.11.29 R and BIPRU 7.11.30 R

Credit quality step 1

Credit quality step 2

Credit quality step 3

Credit quality step 4

Credit quality step 5

Credit quality step 6

0.4 x spread

0.35 x spread

0.3 x spread

0.4 x spread

0.45 x spread

0.45 x spread

Spread is defined in BIPRU 7.11.55 R.

Valuation changes for credit default swaps resulting in positions in multiple securities

BIPRU 7.11.35R
  1. (1)

    This rule applies if BIPRU 7.11.24 R results in a credit default swap being split into positions in more than one security.

  2. (2)

    The firm must, for each notional security produced as described in (1), apply to the whole of the credit default swap in question the stresses in the table in BIPRU 7.11.34 R using the credit quality step in the table in BIPRU 7.11.34 R for that security.

  3. (3)

    The firm must then allocate the different changes in the value of the credit default swap under (2) between the calculations for each security produced as described in (1) on a proportional basis in accordance with the principles in BIPRU 7.11.2 R - BIPRU 7.11.12 R. The firm must do this by multiplying the amount of the change in (2) calculated with respect to the security in question by a fraction based on the proportion of the credit default swap attributable to the security under those principles.

Ordinary credit default swap PRR method: The default capital charge

BIPRU 7.11.36R

The default capital charge for each group of credit default swaps created under BIPRU 7.11.24 R is equal to two2 multiplied by the amount in BIPRU 7.11.37 R. The total default capital charge for credit default swaps treated under the ordinary credit default swap PRR method is equal to the sum of such amounts for each such group.

2
BIPRU 7.11.37R
  1. (1)

    The amount calculated under this rule is the amount resulting from the calculation in (5).

  2. (2)

    A firm must fully net all notional positions along a timeline by calculating, for all credit default swaps in the group in question created under BIPRU 7.11.24 R, the net positions in the security in question for all times in the future until those positions expire or otherwise cease to exist.

  3. (3)

    The firm must calculate the net positions under (2) in accordance with BIPRU 7.2.37 R - BIPRU 7.2.40 R (Deriving the net position in each debt security: Netting positions in the same debt security).

  4. (4)

    The firm must identify the largest long position to which it is exposed over the next year.

  5. (5)

    The firm must then multiply the amount established under (4) by the appropriate PRA that would have applied for the purpose of calculating the specific risk portion of the interest rate PRR under BIPRU 7.2 (Interest rate PRR).

  6. (6)

    The security in question is the one by reference to which the grouping under BIPRU 7.11.24 R is carried out (the reference entity).

Securitisation credit default swap PRR method: Introduction

Securitisation credit default swap PRR method: Main rule for calculating the specific risk PRR

BIPRU 7.11.39R

The specific risk portion of the interest rate PRR for credit default swaps treated under the securitisation credit default swap PRR method is the higher of:

  1. (1)

    an amount equal to what would have been the specific risk portion of the interest rate PRR for such credit default swaps if it had been calculated under of BIPRU 7.2.43 R to BIPRU 7.2.50 R (Specific risk calculation for interest rate risk), taking into account BIPRU 7.11.19 R and BIPRU 7.11.21 R; and

  2. (2)

    the sum of the valuation change capital charge (see BIPRU 7.11.40 R) and the default capital charge (see BIPRU 7.11.48 R) for all such credit derivatives.

Securitisation credit default swap PRR method: Valuation change capital charge: General

BIPRU 7.11.40R

In order to calculate the valuation change capital charge a firm must group together each credit default swap that relates to the same securitisation. The valuation change capital charge for each such group is equal to three2 multiplied by the potential loss amount in BIPRU 7.11.41 R. The total valuation change capital charge for credit default swaps treated under the securitisation credit default swap PRR method is equal to the sum of such amounts for each such group.

2
BIPRU 7.11.41R
  1. (1)

    The potential loss amount as referred to in BIPRU 7.11.40 R for a group of credit default swaps relating to the same securitisation is equal to the greatest loss the firm would suffer in the scenarios set out in the matrix in BIPRU 7.11.43 R. Each scenario consists of the combination of one of the nine scenarios on the vertical axis with one of the three scenarios on the horizontal axis.

  2. (2)

    T as referred to in that matrix is the amount set out in the table in BIPRU 7.11.44 R.

  3. (3)

    Stresses (1) - (4) as referred to in that matrix are further defined in BIPRU 7.11.45 R - BIPRU 7.11.46 R.

  4. (4)

    The underlying reference entities referred to in that matrix refer to the obligor under the securities that are the subject of the securitisation in question. In the case of a resecuritisation the reference entities are the ultimate underling obligors (the obligors under the securitised securitisation).

  5. (5)

    The valuation change under this rule is applied to the current value of the credit default swap.

BIPRU 7.11.42R

References in the table in BIPRU 7.11.43 R to credit quality steps are to the credit quality steps that would apply under the standardised approach to credit risk to the securities referred to in BIPRU 7.11.41 R (4). If a rating from an eligible ECAI is not available to the firm it must treat that security as having the lowest credit quality step.

BIPRU 7.11.43R

Calculation of the valuation change capital charge: Scenarios

This table belongs to BIPRU 7.11.41 R

Change in credit spread of the underlying reference entities

-T √spread

No change

+T √spread

(1)

Base correlation steepening (see row (1) of the table in BIPRU 7.11.46 R)

(2)

Base correlation flattening (see row (2) of the table in BIPRU 7.11.46 R)

(3)

Base correlation parallel up (see row (3) of the table in BIPRU 7.11.46 R)

(4)

Base correlation down (see row (4) of the table in BIPRU 7.11.46 R)

(5)

No correlation change

(6)

Combination of (1) and (3)

(7)

Combination of (1) and (4)

(8)

Combination of (2) and (3)

(9)

Combination of (2) and (4)

Spread is defined in BIPRU 7.11.55 R.

BIPRU 7.11.44R

Calculation of the valuation change capital charge: Definition of T

This table belongs to BIPRU 7.11.41 R

Credit quality step under the standardised approach to credit risk

T

1

0.4

2

0.35

3

0.3

4

0.4

5

0.45

6

0.45

Securitisation credit default swap PRR method: Valuation change capital charge: Base correlation

BIPRU 7.11.45R
  1. (1)

    This rule explains how the correlation calculations in the vertical axis of the matrix in BIPRU 7.11.43 R are to be carried out.

  2. (2)

    The firm must calculate the base correlation relating to each of the deemed tranches set out in the table in BIPRU 7.11.46 R. Base correlation refers, in relation to a securitisation position, to the correlation in credit risk between the securities that are the subject of that securitisation.

  3. (3)

    The firm must then multiply the base correlation for each deemed tranche under (2) by the relevant figure in the table in BIPRU 7.11.46 R. It must calculate each such base correlation in the way that a person would use to calculate the fair market value of a credit default swap on the following basis:

    1. (a)

      the tranche is the most junior tranche; and

    2. (b)

      the thickness of the tranche (as referred to in BIPRU 9 (Securitisation)) is equal to the percentage figure at the head of the relevant column in the table in BIPRU 7.11.46 R.

  4. (4)

    The firm must then produce a stressed base correlation curve through the use of interpolation based on the calculations under this rule.

  5. (5)

    Notwithstanding (3), the curve in (4) must not show a correlation above 100%.

  6. (6)

    The firm must then use the curve for the purpose of the revaluation of the credit default swap under BIPRU 7.11.41 R using an appropriate and prudent technique.

BIPRU 7.11.46R

Correlation moves

This table belongs to BIPRU 7.11.45 R

Thickness of tranche

3%

7%

10%

15%

30%

Scenario from BIPRU 7.11.43 R

(1) Base correlation steepening

0.7

0.9

1

1.1

1.3

(2) Base correlation flattening

1.3

1.1

1

0.9

0.7

(3) Base correlation parallel up

1.2

1.2

1.2

1.2

1.2

(4) Base correlation parallel down

0.8

0.8

0.8

0.8

0.8

BIPRU 7.11.47G

The fact that the FSA has used the base correlation methodology in this section does not mean that it endorses the use of that technique to value credit default swaps for other purposes. The FSA has used it in this section as it is well-known and publicly available. If a firm uses another technique to value its credit default swaps it should discuss this with the FSA.

Securitisation credit default swap PRR method: Default charge

BIPRU 7.11.48R

The default charge for a firm's position in a securitisation treated under the securitisation credit default swap PRR method is equal to the default charge for that position calculated under BIPRU 7.11.50 R and BIPRU 7.11.51 R. The total default charge for positions treated under the securitisation credit default swap PRR method is equal to the sum of those figures.

BIPRU 7.11.49R

To the extent that a firm has a matching long and short position in the same tranche of the same securitisation with the same maturity it may net the short and long positions.

BIPRU 7.11.50R

If a position is short, the default charge for that position is zero.

BIPRU 7.11.51R

If a position is long, the default charge for that position must be calculated in accordance with the following formula:

V x RW x AP2

where:

  1. (1)

    V means the notional amount of the position;

  2. (2)

    RW means the risk weight that the position would attract under BIPRU 9 (Securitisation); and

  3. (3)

    AP means the appropriate percentage from the table BIPRU 7.11.52 R.

BIPRU 7.11.52R

Calculation of the default requirement

This table belongs to BIPRU 7.11.51 R

Type of position

Resecuritisation position

Trades based on an index

Other

Risk weight

Less than 400%

4.8%

1.6%

3.2%

400% to less than 800%

6.4%

3.2%

4.8%

800% to less 1250%

8%

4.8%

6.4%

1250% and

over

8%

8%

8%

BIPRU 7.11.53R
  1. (1)

    The column of the table in BIPRU 7.11.52 R headed "Trades based on an index" applies if:

    1. (a)

      the position is not a resecuritisation position;

    2. (b)

      the underlying reference entities (as defined in BIPRU 7.11.41 R (4)) are identical to those that make up an index of entities widely used by those who deal in credit default swaps;

    3. (c)

      that index contains the price for entering into a credit default swap whose reference entities constitute all the entities in the index; and

    4. (d)

      the credit default swap is constructed in such a way that the firm is able to price the credit derivative using the index.

  2. (2)

    The column of the table in BIPRU 7.11.52 R headed "Other" applies to any case not covered by the other two categories in the table.

Special treatment of credit default swaps: Supplementary material

BIPRU 7.11.54R
BIPRU 7.11.55R

The spread referred to in the tables in BIPRU 7.11.34 R and BIPRU 7.11.43 R refers to the premia and other cash flows referred to in BIPRU 7.11.5 R (expressed as a percentage). The spread must be calculated every business day. It is the spread that would apply if the credit default swap in question were entered into on that day on arm's length commercial terms.

BIPRU 7.11.56R

Where a credit default swap PRR method requires netting between positions, a firm may only net positions arising out of credit default swaps that have comparable deliverable obligations, identical credit events and documentation that will act identically on the occurrence of a credit event.

BIPRU 7.11.57R

A notional position in a zero-specific-risk security created under BIPRU 7.11.5 R must not be treated under either credit default swap PRR method. The firm must instead treat it in accordance with the other rules for the calculation of the interest rate PRR.

BIPRU 7.11.58R
  1. (1)

    If the size of the maximum credit event payment under a credit default swap is lower than the PRR requirement that would otherwise apply, that credit default swap must be excluded from the credit default swap PRR methods. However BIPRU 7.11.19 R and BIPRU 7.11.21 R still apply.

  2. (2)

    A firm must work out whether (1) applies to a credit default swap by calculating the PRR for that credit default swap in accordance with this section (including the applicable credit default swap PRR method) on the assumption that it is the only item for which an interest rate PRR is being calculated.

Valuation

BIPRU 7.11.59G

GENPRU 1.3.29 R - GENPRU 1.3.35 G (General requirements: Valuation adjustments or reserves) are particularly relevant for a firm trading credit derivatives, especially for credit default swaps that are also securitisation positions.

Other risks relating to credit derivatives

BIPRU 7.11.60RRP

A firm must be able to describe, demonstrate and explain to the FSA its trading strategies in relation to credit derivatives both in theory and in practice.

BIPRU 7.11.61GRP

BIPRU 7.11.62 G - BIPRU 7.11.64 G G cover risks relating to credit derivatives that may not be captured in this section. This guidance is of particular relevance to the overall financial adequacy rule, the overall Pillar 2 rule and the general stress and scenario testing rule.

BIPRU 7.11.62GRP

BIPRU 7.11.5 R requires a firm to recognise any premiums payable or receivable under the contract as notional zero-specific-risk securities. These positions are then entered into the general market risk framework. As premium payments paid under such contracts are contingent on no credit event occurring, a credit event could significantly change the general market risk capital requirement. A firm should consider, under the overall Pillar 2 rule, whether this risk means that the capital requirements under this section materially understate the firm's general market risk position.

BIPRU 7.11.63GRP

If a firm recognises profits on a non-accrual basis it should consider whether the capital requirements for its credit derivatives business adequately cover the risk that any recognised profit may not be achieved due to a credit event occurring. This includes positions for which the firm may have a perfect hedge in place.

BIPRU 7.11.64G

If a firm uses models in its valuation process, it should consider whether the default capital requirements under the credit default swap PRR methods adequately cover the default losses that the firm's model estimates it will be exposed to.