35.In addition to the CCR exposure arising from the fair value of the contracts, written credit derivatives create a notional credit exposure arising from the creditworthiness of the reference entity. Therefore, written credit derivatives must be treated consistently with cash instruments (e.g. loans, bonds) for the purposes of the leverage ratio exposure measure.

36.The effective notional amount referenced by a written credit derivative is to be included in the leverage ratio exposure measure unless the written credit derivative is included in a transaction cleared on behalf of a client of the bank acting as a CM (or acting as a clearing services provider in a multi-level client structure) and the transaction meets the requirements for the exclusion of trade exposures to the QCCP (or, in the case of a multi- level client structure, the requirements for the exclusion of trade exposures to the CM or the QCCP). The “effective notional amount” is obtained by adjusting the notional amount to reflect the true exposure of contracts that are leveraged or otherwise enhanced by the structure of the transaction. Further, the effective notional amount of a written credit derivative may be reduced by any negative change in fair value amount that has been incorporated into the calculation of Tier 1 capital with respect to the written credit derivative.

The resulting amount may be further reduced by the effective notional amount of a purchased credit derivative on the same reference name, provided that:

• •the credit protection purchased through credit derivatives is otherwise subject to the same or more conservative material terms as those in the corresponding written credit derivative. Material terms include the level of subordination, optionality, credit events, reference and any other characteristics relevant to the valuation of the derivative;
• •the remaining maturity of the credit protection purchased through credit derivatives is equal to or greater than the remaining maturity of the written credit derivative;
• •the credit protection purchased through credit derivatives is not purchased from a counterparty whose credit quality is highly correlated with the value of the reference obligation;
• •in the event that the effective notional amount of a written credit derivative is reduced by any negative change in fair value reflected in the bank’s Tier 1 capital, the effective notional amount of the offsetting credit protection purchased through credit derivatives must also be reduced by any resulting positive change in fair value reflected in Tier 1 capital; and
• •the credit protection purchased through credit derivatives is not included in a transaction that has been cleared on behalf of a client (or that has been cleared by the bank in its role as a clearing services provider in a multi-level client services structure) and for which the effective notional amount referenced by the corresponding written credit derivative is excluded from the leverage ratio exposure measure according to this paragraph.

37.For the purposes of the leverage ratio, the term “written credit derivative” refers to a broad range of credit derivatives through which a bank effectively provides credit protection and is not limited solely to credit default swaps and total return swaps. When written options create a similar potential credit exposure to an underlying entity, that credit exposure also must be included in the leverage ratio exposure.

38.For the purposes of the leverage ratio, two reference names are considered to be the same only if they refer to the same legal entity.

39.Credit protection on a pool of reference names purchased through credit derivatives may offset credit protection sold on individual reference names if the credit protection purchased is economically equivalent to purchasing credit protection separately on each of the individual names in the pool. If a bank purchases credit protection on a pool of reference names through credit derivatives, but the credit protection purchased does not cover the entire pool (i.e. the protection covers only a subset of the pool, as in the case of an nth-to- default credit derivative or a securitization tranche), then the written credit derivatives on the individual reference names may not be offset. However, such purchased credit protection may offset written credit derivatives on a pool provided that the credit protection purchased through credit derivatives covers the entirety of the subset of the pool on which the credit protection has been sold.

40.Where a bank purchases credit protection through a total return swap and records the net payments received as net income, but does not record offsetting deterioration in the value of the written credit derivative (either through reductions in fair value or by an addition to reserves) in Tier 1 capital, the credit protection will not be recognized for the purpose of offsetting the effective notional amounts related to written credit derivatives.

41.Banks may choose to exclude from the netting set for the PFE calculation the portion of a written credit derivative which is not offset and for which the effective notional amount is included in the leverage ratio exposure measure.