R331-23-6. Credit Exposure to Derivative Transactions

(1) Each bank or industrial loan corporation board of directors shall institute adequate policies and procedures to ensure that derivative positions are established for purposes of mitigating one or more risks inherent in an institution's normal business activities, and not for the purpose of increasing such exposure or for the purposes of speculation in price movement. The policies and procedures shall require the proper identification and prudent limitation of the risks associated with derivatives.

(2) Derivative transactions should be transacted subject to established market terms that provide for prudent counterparty risk mitigation techniques reflected in agreements developed by the International Swap Dealers Association ("ISDA").

(3) Valuation. Each bank or industrial loan corporation shall calculate the exposure to derivative transactions using a consistent method from one of the following:

(a) Internal Model Method.

(i) Credit exposure. The credit exposure of a derivative transaction under the Internal Model Method shall equal the sum of the current credit exposure of the derivative transaction and the potential future credit exposure of the derivative transaction.

(ii) Calculation of current credit exposure. A bank or industrial loan corporation shall determine its current credit exposure by the mark-to-market value of the derivative contract. If the mark-to-market value is positive, then the current credit exposure equals that mark-to-market value. If the mark-to-market value is zero or negative, then the current credit exposure is zero.

(iii) Calculation of potential future credit exposure. A bank or industrial loan corporation shall calculate its potential future credit exposure by using an internal model that has been, at least annually, validated by a qualified party independent from the valuation process.

(iv) Net credit exposure. A bank or industrial loan corporation that calculates its credit exposure by using the Internal Model Method pursuant to this paragraph may net credit exposures of derivative transactions arising under the same qualifying master netting agreement.

(b) Conversion Factor Matrix Method. The current credit exposure arising from a derivative transaction shall be equal to the product of the notional amount and conversion factor. The conversion factor is determined by asset class and by the maturity of assets: Interest rate, foreign exchange and gold derivatives are valued by multiplying the notional amount by the following multiples based on maturity of the contract: .015 for a maturity of 1 year or less, .03 for a maturity of 1-3 years, .06 for a maturity of 3-5 years, .12 for a maturity of 5-10 years, and .3 for a maturity of over 10 years. Equity derivatives, regardless of maturity will be multiplied by a factor of .2. Other derivatives, including commodities other than gold will be multiplied by: .06 for a maturity of a year or less, .18 for a maturity of 1-3 years, .3 for a maturity of 3-5 years, .6 for a maturity of 5-10 years and 1 for a maturity of over 10 years.

(c) Remaining Maturity Method. The current credit exposure arising from a derivative transaction under the Remaining Maturity Method shall be the greater of zero or the sum of the current mark-to-market value of the derivative transaction added to the product of the notional amount, the remaining maturity in years of the transaction and a fixed multiplicative factor. Like the conversion factor, the fixed multiplicative factor is determined by asset class, but instead of having a fixed value for purposes of the lending limit over the life of a contract, as the maturity diminishes so does the value for purposes of the lending limit. The fixed multiplicative factor for interest rate, foreign exchange and gold derivatives is 1.5%. For equity derivatives and any other derivatives including commodities the fixed multiplicative factor will be 6%.