(1)

The determination of the indirect exposure values to a client arising from derivative and credit derivative contracts for large exposures purposes should differ from the calculation method of the exposure value used for risk-based capital requirements set out in Regulation (EU) No 575/2013 because a default of the underlying instrument could lead to a profit instead of a loss. The indirect exposure value should therefore be dependent on the loss (i.e. positive exposure value) or gain (i.e. negative exposure value) that would result from a potential default of its underlying instrument. Under the large exposures regime set out in Part Four of Regulation (EU) No 575/2013, in the case of exposures in the trading book, institutions may offset positive and negative positions in the same financial instruments, or, under certain conditions, in different financial instruments, issued by a given client. The overall net exposure to an individual client is only considered if positive. Similarly, the overall net exposure to a given client, after the inclusion of the indirect exposures to that client arising from derivative or credit derivative contracts allocated to the trading book, should only be considered if positive. In order to avoid any offset of any indirect exposure arising from derivative or credit derivative contracts allocated to the non-trading book, any negative indirect exposure value arising from those positions should be set to zero.

(2)

In order to ensure that the default risk is appropriately captured, the indirect exposure value of options, regardless of whether allocated to the trading book or the non-trading book, should therefore depend on the changes in option prices that would result from a default of the respective underlying instrument, e.g. the option’s market value for ‘call’ options and the market value of the option minus its strike price for ‘put’ options.

(3)

The purpose of credit derivatives is to transfer credit risk in relation to borrowers without transferring the assets themselves. The role that institutions play as protection seller or protection buyer and the type of credit derivative they enter into should be taken into account for the determination of the indirect exposure value of the underlying instrument. The indirect exposure should therefore be equal to the market value of the credit derivative contract, which should be adjusted by the amount due to or expected to be received from the counterparty in the case of default of the issuer of the underlying debt instrument.

(4)

For other types of derivative contracts that constitute a combination of long and short positions, to ensure that the accurate default risk is captured, institutions should decompose those derivative contracts into individual transaction legs. Only the legs with default risk, where institutions have a risk of a loss in the case of default, should be relevant for the calculation of the indirect exposure value arising from those derivative contracts. However, where institutions are not able to apply that methodology, and to ensure a conservative treatment, they should be allowed to determine the indirect exposure value of the underlying instruments as the maximum loss that they could incur following the default of the issuer of the underlying to which the derivative refers.

(5)

Derivatives can be written on instruments having multiple underlying reference names. For those multi-underlying derivatives, where an institution can look through to the underlying reference names, and to ensure that the most accurate method is used, the indirect exposure value should be calculated by looking at the variation in the price of the derivative in case of default of each of the underlying reference names in the multi-underlying instrument. To ensure consistency with the large exposures framework applicable to transactions where there is an exposure to underlying assets, Article 6(1) and (2) of Commission Delegated Regulation (EU) No 1187/2014 (2) should apply to assign the exposures to the identified client, a separate client or the unknown client. In cases where institutions are not able to apply a look-through approach or where a look-through approach to a derivative with multiple reference names is unduly burdensome for them, and to ensure a conservative treatment, institutions should calculate the indirect exposure value by looking at the variation of the price of the derivative in the case of default of all those underlying reference names. Similarly, to ensure consistency with the large exposures framework applicable to transactions where there is an exposure to underlying assets, Article 6(3) of the Delegated Regulation (EU) No 1187/2014 should apply to assign the exposure to a separate client or the unknown client. In all cases where the underlying instruments are assigned to the unknown client, to avoid the risk that negative indirect exposure values are offset with positive indirect exposure values, institutions should set to zero any negative indirect exposure values.

(6)

This Regulation is based on the draft regulatory technical standards submitted to the Commission by the European Banking Authority.

(7)

The European Banking Authority has conducted open public consultations on the draft regulatory technical standards on which this Regulation is based, analysed the potential related costs and benefits and requested the advice of the Banking Stakeholder Group established in accordance with Article 37 of Regulation (EU) No 1093/2010 of the European Parliament and of the Council (3),