Credit Valuation Adjustment Risk

1.1

Unless otherwise stated, this Part applies to:

1. (1) a firm that is a CRR firm but not an SDDT; and;
2. (2) a CRR consolidation entity that is not an SDDT consolidation entity.

1.2

In this Part, the following definitions shall apply:

aggregate CVA

means the sum of regulatory CVA for all covered transactions.

clearing member

has the definition in Counterparty Credit Risk (CRR) Part 1.3.

client

has the definition in Counterparty Credit Risk (CRR) Part 1.3.

commodity delta risk factor

means the risk factor set in accordance with 5.30(3).

commodity vega risk factor

means the risk factor set in accordance with 5.30(4).

counterparty credit spread risk delta risk factor

means the risk factor set in accordance with 5.27(3).

covered transaction

means:

1. (1) a derivative transaction, but excluding:
   1. (a) derivatives transacted directly with a qualifying central counterparty;
   2. (b) derivatives transacted with a clearing member, where either:
      1. (i) the clearing member acts as financial intermediary between the firm and the qualifying central counterparty; or
      2. (ii) the clearing member guarantees the performance of the firm’s exposure to the qualifying central counterparty;
   3. (c) derivatives transacted with a qualifying central counterparty where the firm is a clearing member acting as a financial intermediary between a client and the qualifying central counterparty;
   4. (d) derivatives transacted with a client, where the firm is a clearing member acting as financial intermediary between the client and the qualifying central counterparty; and
   5. (e) transactions giving rise to exposures with counterparties meeting the conditions in 3.2.
2. (2) a securities financing transaction, if:
   1. (a) it is fair-valued by the firm under the firm’s applicable accounting framework; and
   2. (b) the firm's CVA risk arising from the transaction is material.

CVA portfolio

means a firm’s portfolio of covered transactions and eligible CVA hedges.

eligible BA-CVA hedge

means a transaction used for the purpose of mitigating the counterparty credit spread component of CVA risk and managed as such, and that is either:

1. (1) a single-name credit default swap or a single-name contingent credit default swap which must reference:
   1. (a) the counterparty directly;
   2. (b) an entity legally related to the counterparty; or
   3. (c) an entity that belongs to the same sector and region as the counterparty; or
2. (2) an index credit default swap.

eligible CVA hedge

has the same meaning as:

1. (1) eligible BA-CVA hedge if a firm uses BA-CVA; or
2. (2) eligible SA-CVA hedge if a firm uses SA-CVA.

eligible SA-CVA hedge

means a transaction used for the purposes of mitigating CVA risk that:

1. (1) is not split into several effective transactions;
2. (2) either:
   1. (a) hedges variability of the counterparty credit spread; or
   2. (b) hedges variability of the exposure component of CVA risk; and
3. (3) is eligible for the internal models approach for market risk in accordance with the Market Risk: Internal Model Approach (CRR) Part 1.1.

equity delta risk factor

means the risk factor set in accordance with 5.29(3).

equity vega risk factor

means the risk factor set in accordance with 5.29(7).

external CVA hedge

means a transaction used for the purpose of mitigating CVA risk entered into with a third party.

foreign exchange delta risk factor

means the risk factor set in accordance with 5.26(3).

foreign exchange vega risk factor

means the risk factor set in accordance with 5.26(6).

interest rate delta risk factor

means the risk factor set for the following currencies: USD, EUR, GBP, AUD, CAD, SEK or JPY in accordance with 5.25(3).

interest rate vega risk factor

means the risk factor set in accordance with 5.25(10).

internal CVA hedge

means a transaction used for the purpose of mitigating CVA risk entered into with the firm’s own trading desk.

legally related

means cases where the reference name and the counterparty are either a parent undertaking and its subsidiary or two subsidiaries of a common parent undertaking.

loss given default

means the ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default.

margin threshold

has the meaning in Counterparty Credit Risk (CRR) Part 1.3.

market risk Parts

means the:

1. (1) Market Risk: General Provisions (CRR) Part;
2. (2) Market Risk: Simplified Standardised Approach (CRR) Part;
3. (3) Market Risk: Advanced Standardised Approach (CRR) Part; and
4. (4) Market Risk: Internal Model Approach (CRR) Part.

other currencies interest rate delta risk factor

means the risk factor set for currencies other than USD, EUR, GBP, AUD, CAD, SEK and JPY in accordance with 5.25(3).

probability of default

means the probability of default of a counterparty.

qualified index

means:

1. (1) for delta risk, a credit or equity index that satisfies liquidity and diversification conditions specified in paragraph 3 of Market Risk: Advanced Standardised Approach (CRR) Part Article 325i; and
2. (2) for vega risk, any credit or equity index.

reference credit spread delta risk factor

means the risk factor set in accordance with 5.28(3).

reference credit spread vega risk factor

means the risk factor set in accordance with 5.28(6).

regulatory CVA

means a CVA calculated in line with the requirements in 5.5 to 5.12.

reporting currency

means the currency in which the firm’s annual reports are prepared.

risk class

means:

1. (1) for delta risk, the categories of risk listed in 5.15; and
2. (2) for vega risk, the categories of risk listed in 5.17.

risk factor

means any of the risk drivers of CVA risk, being the commodity delta risk factor, the commodity vega risk factor, the counterparty credit spread risk delta risk factor, the equity delta risk factor, the equity vega risk factor, the foreign exchange delta risk factor, the foreign exchange vega risk factor, the interest rate delta risk factor, the interest rate vega risk factor, the other currencies interest rate delta risk factor, the reference credit spread delta risk factor, and the reference credit spread vega risk factor, and risk factors relating to qualified index instruments in accordance with 5.21.

sensitivity

means the ratio of the change of aggregate CVA or the market value of all eligible SA-CVA hedges caused by a small change of the risk factor's current value to the size of the change, calculated for each risk factor in accordance with 5.25 to 5.30 and the prudent valuation standards set out in the Trading Book (CRR) Part Article 105.

2.1

A firm must comply with this Part on an individual basis.

2.2

A CRR consolidation entity must comply with this Part on a consolidated basis.

2.3

A firm or CRR consolidation entity to which this Part is applied in a sub-consolidation requirement must comply with this Part on a sub-consolidated basis, as set out in that requirement.

2.4

[Deleted]

2.5

[Deleted]

2.6

[Deleted]

2.7

[Deleted]

2.8

[Deleted]

3.1

A firm must calculate its own funds requirements for CVA risk using the following approaches:

1. (1) if it has permission to use SA-CVA, in accordance with Chapter 5;
2. (2) if it does not have permission to use SA-CVA:
   1. (a) if 4.1 applies, BA-CVA under Chapter 4; or
   2. (b) if 6.1 applies, the alternative approach under Chapter 6.

3.2

In addition to transactions that must be excluded under point (b) of Article 382(4) of CRR, a firm may exclude from its calculation of own funds requirements for CVA risk transactions that meet the following conditions:

1. (1) the counterparty is:
   1. (a) included in the firm's prudential consolidation group on a full basis; or
   2. (b) an entity in the firm's group and the transaction between the counterparty and the firm is eliminated on accounting consolidation under the applicable accounting framework or the accounting standards applicable to the firm's ultimate parent undertaking;
2. (2) both the counterparty and the firm are subject to appropriate centralised risk evaluation, measurement and control procedures; and
3. (3) there are no current or foreseen material practical or legal impediment to the prompt transfer of own funds or repayment of liabilities from the counterparty to the firm.

3.3

A firm must:

1. (1) notify the PRA in writing three months prior to the date at which it starts excluding transactions with a counterparty in accordance with 3.2 and confirm the notification every three years thereafter; and
2. (2) include in each notification to the PRA:
1. (a) the name of the counterparty excluded in accordance with 3.2; and
2. (b) an explanation of how the conditions in 3.2 are met.

3.4

A firm must:

1. (1) if it hedges CVA risk, use only eligible CVA hedges;
2. (2) not include external CVA hedges that are eligible CVA hedges in its calculation of its own funds requirements for market risk under the market risk Parts; and
3. (3) include external CVA hedges that are not eligible CVA hedges in its trading book calculation of market risk own funds requirements under the market risk Parts.

3.5

A firm may include an internal CVA hedge that is subject to curvature risk in accordance with Market Risk: Advanced Standardised Approach (CRR) Part Articles 325e and 325g, default risk charge in accordance with Market Risk: Advanced Standardised Approach (CRR) Part Article 325v to 325ad, or residual risk add-on in accordance with Market Risk: Advanced Standardised Approach (CRR) Part Article 325u, as an eligible CVA hedge only if the trading desk that is the internal counterparty to the CVA desk enters into a transaction or a set of transactions with one or more external counterparties that exactly offsets the trading desk’s position with the CVA desk.

3.6

For the purposes of 4.4, 5.27 and 5.28, where a counterparty is not externally rated, a firm that has been granted permission from the PRA under the Credit Risk: Internal Ratings Based Approach (CRR) Part Article 143 to use the internal rating based approach in accordance with the Credit Risk: Internal Ratings Based Approach (CRR) Part to calculate credit risk own funds requirements in respect of exposures to the counterparty must map the internal rating to an external rating and assign a risk weight corresponding to either investment grade or high yield.

4.1

A firm that:

1. (1) does not have permission from the PRA to use SA-CVA; and
2. (2) if relevant to the firm, has not chosen to use the alternative approach in Chapter 6;

must calculate its own funds requirements for CVA risk for covered transactions in accordance with this Chapter.

4.2

If a firm does not use any eligible BA-CVA hedges to hedge CVA risk it must calculate its own funds requirement for CVA risk in accordance with the following formula:

\[{\rm DS}_{\rm BA-CVA}\times \rm K_{\rm reduced}\]

where:

1. DS_BA-CVA = 0.65; and
2. K_reduced is calculated in accordance with the following formula:

\[\rm K_{\rm reduced}=\sqrt{\left(\rho\cdot\sum_{\rm C}{{\rm SCVA}_\rm C\ }\right)^2+(1-\rm\rho^2)\cdot\sum_{\rm C}{\rm SCVA}_\rm C^2}\]

4.3

For the purposes of 4.2, a firm must calculate SCVA_C in accordance with the following formula:

\[{\rm SCVA}_\rm C=\frac{1}{\alpha}\cdot{\rm RW}_\rm C\cdot\ \sum_{\rm NS}{\rm M_{\rm NS}\cdot{\rm EAD}_{\rm NS}\cdot{\rm DF}_{\rm NS}}\]

where:

1. RW_C is the risk weight for a counterparty that reflects the volatility of its credit spread as prescribed in the table at 4.4;
2. NS = netting set;
3. M_NS is the effective maturity for the netting set, calculated:
4. (1) for a firm using the methods set out in Section 6 of Chapter 3 of the Counterparty Credit Risk (CRR) Part:
   1. (a) in accordance with point (g) of paragraph 2A of Credit Risk: Internal Ratings Based Approach (CRR) Part Article 162 for netting sets with a maturity of greater than one year, except that M_NS is not capped at five years but instead at the longest contractual remaining maturity in the netting set; or
   2. (b) paragraph 2 of Credit Risk: Internal Ratings Based Approach (CRR) Part Article 162 for netting sets with a maturity of less than one year;
5. (2) for a firm not using the methods set out in Section 6 of Chapter 3 of the Counterparty Credit Risk (CRR) Part using the average notional weighted maturity in accordance with paragraph 2 of Credit Risk: Internal Ratings Based Approach (CRR) Part Article 162, except M_NS is not capped at five years but instead at the longest contractual remaining maturity in the netting set;
6. EAD_NS is the exposure at default of the netting set, calculated in the same manner in which the firm calculates exposure at default for determining own funds requirements for counterparty credit risk, in accordance with either Sections 3 to 5 of Counterparty Credit Risk (CRR) Part or Section 6 of Chapter 3 of the Counterparty Credit Risk (CRR) Part;
7. DF_NS, the supervisory discount factor for the netting set, is:
8. (1) 1 if a firm has been granted permission from the PRA under Counterparty Credit Risk (CRR) Part Article 283 to use the Internal Model Method to calculate the exposure at default as part of its own funds requirements calculation for counterparty credit risk; or

(2) \[\frac{1- \rm e^{-0.05\cdot \rm M_{\rm NS}}}{0.05\cdot \rm M_{\rm NS}}\] if a firm does not have permission to use the Internal Model Method to calculate exposure at default;

1. α= the value of a as specified in the Counterparty Credit Risk (CRR) Part;
2. c= all counterparties for which the firm uses BA-CVA to calculate its own funds requirements for CVA risk and with which the firm has at least one covered transaction.

4.4

For the purposes of 4.3, a firm must set the value of RW_C in accordance with the table below:

4.5

If a firm uses one or more eligible BA-CVA hedges to hedge CVA risk it must calculate its own funds requirement for CVA risk in accordance with the following formula:

\[{\rm DS}_{\rm BA-CVA}\times\rm K_{\rm full}\]

where:

1. DS_BA-CVA = 0.65;
2. K_full = β · K_reduced + (1 - β) · K_hedged;

where:

1. β = 0.25;
2. K_reduced is calculated in accordance with 4.2.

4.6

For the purposes of 4.5, a firm must calculate K_hedged in accordance with the following formula:

\[\rm K_{\rm hedged}=\sqrt{\left(\rho\cdot\sum_{\rm C}{\left({\rm SCVA}_\rm C-{\rm SNH}_C\right)- \rm IH\ }\right)^2+(1-\rho^2)\cdot\sum_{\rm C}{\left({\rm SCVA}_\rm C-{\rm SNH}_\rm C\right)^2+\sum_{\rm C}{\rm HMA}_\rm C}}\]

where:

1. SCVA_C is calculated in accordance with 4.3;
2. ρ= 50%;
3. SNH_C is calculated in accordance with 4.7;
4. IH is calculated in accordance with 4.8;
5. HMA_C is calculated in accordance with 4.9;
6. c= all counterparties for which the firm uses BA-CVA to calculate its own funds requirements for CVA risk and with which the firm has at least one covered transaction.

4.7

For the purposes of 4.6, a firm must calculate SNH_C in accordance with the following formula:

\[\rm SNH_{\rm C} = \sum_{\rm h∊C}\rm r_{\rm hc}\cdot\rm RW_{\rm h}\cdot\rm M_{\rm h}^{\rm SN}\cdot\rm B_{\rm h}^{\rm SN}\cdot \rm DF_{\rm h}^{\rm SN}\]

4.8

For the purposes of 4.6, a firm must calculate IH in accordance with the following formula:

\[\rm IH=\sum_{\rm i}{{{\rm RW}_\rm i^{\rm ind}}_\rm i\cdot \rm M_i^{\rm ind}\cdot \rm B_i^{\rm ind}\cdot{\rm DF}_\rm i^{\rm ind}}\]

\[{\rm RW}_i^{\rm ind}\] is the supervisory risk weight of the index eligible BA-CVA hedge, as specified in the table at 4.4 but adjusted as follows:

1. (1) for an index where all index constituents belong to the same sector and are of the same credit quality, the firm must multiply the relevant value in the table at 4.4 by 0.7;
2. (2) for an index spanning multiple sectors or with a mixture of investment grade constituents and other grade constituents, the firm must calculate the name-weighted average of the risk weights from the table at 4.4 and then multiply by 0.7;
3. i= the index that denotes all index hedges that the firm has taken out to hedge CVA risk.

4.9

For the purposes of 4.6, a firm must calculate HMA_C in accordance with the following formula:

\[\rm HMA_C= \sum\nolimits_{h∊C} \left(1-\rm r_{\rm hc}^{2}\right)\cdot \left(\rm RW_{\rm h}\cdot \rm M_{\rm h}^{\rm SN}\cdot\rm B_{\rm h}^{\rm SN}\cdot \rm DF_{\rm h}^{\rm SN}\right)^2\]

where:

\[\rm r_{\rm hc}, \ \rm M_{\rm h}^{\rm SN}, \ \rm B_{\rm h}^{\rm SN}, \ \rm DF_{\rm h}^{\rm SN}, \ and \ \rm RW_{\rm h}\] are as set out in 4.7.

4.10

For the purposes of 4.7, a firm must set the value of r_hc in accordance with the table below:

5.1

This Chapter applies to a firm which has permission from the PRA to use SA-CVA to calculate its own funds requirement for CVA risk, applying the requirements of this Chapter to the extent and subject to any modifications set out in the permission.

[Note: This is a permission under sections 144G and 192XC of FSMA to which Part 8 of the Capital Requirements Regulations applies]

5.2

A firm may with the prior permission of the PRA use SA-CVA to calculate its own funds requirement for CVA risk if, on applying for such permission, the firm can demonstrate to the satisfaction of the PRA that:

1. (1) it is able to calculate, and report to the PRA, its own funds requirement for CVA risk in accordance with this Chapter;
2. (2) it complies with the qualitative requirements in 5.13; and
3. (3) it has a CVA desk or similar dedicated function responsible for risk management and hedging of CVA risk.

[Note: This is a permission under sections 144G and 192XC of FSMA to which Part 8 of the Capital Requirements Regulations applies]

5.3

A firm that has permission from the PRA to use SA-CVA:

1. (1) must use SA-CVA to calculate its own funds requirement for CVA risk in accordance with this Chapter to the extent and subject to any modifications set out in the permission;
2. (2) may choose to use BA-CVA to calculate its own funds requirement for CVA risk for one or more netting sets in respect of which it has permission from the PRA to use SA-CVA; and
3. (3) may split a netting set into two netting sets, one containing transactions in respect of which the firm uses BA-CVA in accordance with 5.3(2) and the other containing transactions in respect of which the firm uses SA-CVA if:
   1. (a) the split is consistent with the treatment of the netting set used by the firm for calculating CVA under the firm’s applicable accounting framework; or
   2. (b) the firm’s permission from the PRA to use SA-CVA does not cover all the transactions within a netting set.
4. (4) shall comply with the requirements of 5.2(1) to (3).

5.4

A firm’s application for permission under 5.2 must contain:

1. (1) an explanation that the firm meets the conditions in 5.2;
2. (2) the firm’s policies for ensuring compliance with Chapters 2, 3, 5 and 7; and
3. (3) an explanation of the firm’s intended split of covered transactions between SA-CVA and BA-CVA, including netting sets, in accordance with 5.3(2).

5.5

A firm must:

1. (1) calculate its own funds requirement for CVA risk on a monthly basis;
2. (2) have the ability to calculate its own funds requirement for CVA risk on a daily basis;
3. (3) calculate regulatory CVA for each counterparty with which it has at least one covered transaction; and
4. (4) express the regulatory CVA by specifying that non-zero losses must have a positive value.

5.6

A firm must calculate regulatory CVA:

1. (1) as the expectation of future losses resulting from default of the counterparty under the assumption that the firm is free from the default risk;
2. (2) based on at least the following three sets of inputs:
   1. (a) term structure of market-implied probability of default;
   2. (b) market-consensus expected loss given default; and
   3. (c) simulated paths of discounted future exposure; and
3. (3) by ensuring that for transactions with a significant level of dependence between the exposure and the counterparty’s credit quality, the dependence is taken into account across at least one of the inputs in (2).

5.7

For the purposes of point (a) of 5.6(2):

1. (1) a firm must estimate the term structure of market-implied probability of default using credit spreads of the counterparty where these are observable in the market;
2. (2) where credit spreads of the counterparty are not observable in the market, a firm must estimate market-implied probability of default from proxy spreads:
   1. (a) by estimating the credit spread curve of the counterparty from observable credit spreads using a methodology that discriminates on at least the following three variables:
      1. (i) a measure of credit quality;
      2. (ii) industry; and
      3. (iii) region;
   2. (b) by estimating the credit spread curve of the counterparty from the credit spread observed in the market of a single reference name, and must be able to justify the appropriateness of each use of a single reference name to the PRA; or
   3. (c) using its own assessment of credit risk where no appropriate credit spreads are observable. Where historical probabilities of default are used as part of this assessment, the firm must not base the resulting spread on historical probability of default only.

5.8

For the purposes of point (b) of 5.6(2):

1. (1) unless 5.8(3) applies, the market-consensus expected loss given default value used by the firm must be the same as the one used to calculate the risk-neutral probability of default from credit spreads;
2. (2) the firm must ensure that collateral provided by the counterparty does not change the seniority of the derivative exposure;
3. (3) by way of derogation from (1), if the seniority of the transactions with the counterparty differs from the seniority of senior unsecured bonds that is implied by the value of expected loss given default, the firm must reflect this difference in seniority by adjusting the value of expected loss given default.

5.9

For the purposes of point (c) of 5.6(2):

1. (1) a firm must:
   1. (a) produce the simulated paths of discounted future exposure by pricing all derivative transactions with the counterparty along simulated paths of relevant market risk factors and discounting the prices to the date of calculation using risk-free interest rates along the path; and
   2. (b) simulate all market risk factors material for the transactions with a counterparty as stochastic processes for an appropriate number of paths defined on an appropriate set of future time points extending to the maturity of the longest transaction.
2. (2) a firm may recognise collateral as risk mitigation if:
   1. (a) the collateral management requirements specified in Counterparty Credit Risk (CRR) Part Article 287 are satisfied;
   2. (b) all documentation used in collateralised transactions is binding on all parties and legally enforceable in all relevant jurisdictions; and
   3. (c) the firm has conducted sufficient legal review to verify the condition in point (b) of 5.9(2) and undertakes such further review as necessary to ensure continuing enforceability.
3. (3) a firm must, for exposures to counterparties subject to a margin agreement, ensure that:
   1. (a) the simulated paths of discounted future exposure capture the effects of margining collateral that is recognised as risk mitigation along each exposure path;
   2. (b) its exposure model appropriately captures all the relevant contractual features including whether unilateral or bilateral, the frequency of margin calls, the type of collateral, margin thresholds, independent amounts, initial margins and minimum transfer amounts; and
   3. (c) its exposure model assumes a margin period of risk which cannot be less than:
      1. (i) 4+N business days for securities financing transactions unless the margin agreement has daily or intra-daily exchange of margin, where the margin period of risk is 5 business days; or
      2. (ii) 9+N business days for all other transactions;
      3. where:
      4. N = the re-margining period specified in the margin agreement.

5.10

A firm must:

1. (1) obtain the simulated paths of discounted future exposure from the exposure models used by the firm for calculating CVA under the firm’s applicable accounting framework, adjusted as necessary to meet the requirements of this Chapter; and
2. (2) use the same model calibration process (with the exception of the margin period of risk), market and transaction data as it uses for calculating CVA under the firm’s applicable accounting framework.

5.11

A firm must ensure the generation of market risk factor paths underlying its exposure models comply with the following requirements:

1. (1) drifts of risk factors are consistent with a risk-neutral probability measure and not historical calibration of drifts;
2. (2) the volatilities and correlations of risk factors are calibrated to:
   1. (a) market data, if sufficient data exist in a given market; or
   2. (b) historical market data, if sufficient data is not available; and
3. (3) the distribution of modelled risk factors account for the possible non-normality of the distribution of exposures.

5.12

A firm must ensure that its calculation of regulatory CVA recognises netting sets in the same manner in which the firm calculates CVA under the firm’s applicable accounting framework.

5.13

A firm must ensure that:

1. (1) its exposure models used for calculating regulatory CVA are part of a CVA risk management framework that includes the identification, measurement, management, approval and internal reporting of CVA risk;
2. (2) its senior management is actively involved in the risk control process and must regard CVA risk control as an essential aspect of the business to which sufficient resources are devoted;
3. (3) it has a process for ensuring compliance with a documented set of internal policies, controls and procedures concerning the operation of the exposure system it uses for calculating CVA under the firm’s applicable accounting framework;
4. (4) it maintains an independent control unit that is responsible for the effective initial and ongoing validation of its exposure models, which is:
   1. (a) independent from the business credit and trading units, including the CVA desk;
   2. (b) adequately staffed; and
   3. (c) reports directly to senior management of the firm;
5. (5) its documentation of the process for initial and ongoing validation of its exposure models:
   1. (a) is detailed enough to enable a third party to understand how the models operate, their limitations, and their key assumptions, and to recreate the analysis;
   2. (b) sets out the minimum frequency with which ongoing validation will be conducted as well as other circumstances under which additional validation will be conducted; and
   3. (c) describes how the validation is conducted with respect to data flows and portfolios, what analyses are used and how representative counterparty portfolios are constructed;
6. (6) the pricing models used to calculate exposure for a given path of risk factors must:
   1. (a) be tested against appropriate independent benchmarks for a wide range of market states as part of the initial and ongoing model validation process; and
   2. (b) for options, account for the non-linearity of option value with respect to risk factors;
7. (7) its internal audit function carries out an independent review of the overall CVA risk management process on a regular basis, covering both the activities of the CVA desk and the independent risk control unit;
8. (8) it defines criteria against which to assess the exposure models and their inputs, and has a written policy describing the process to assess performance of the exposure models and remedy unacceptable performance;
9. (9) its exposure models capture transaction-specific information in order to aggregate exposures at the level of the netting set;
10. (10) it assigns transactions to the appropriate netting set within the model;
11. (11) it reflects transaction terms and specifications in its exposure models in a timely, complete and conservative fashion;
12. (12) it stores transaction terms and specifications in a secure database that is subject to formal and periodic internal audit;
13. (13) it subjects the transmission of transaction terms and specifications data to the exposure model to internal audit and formal reconciliation processes are in place between the exposure model and source data systems to verify on an ongoing basis that transaction terms and specifications are reflected in the exposure model appropriately;
14. (14) it uses in its exposure models current and historical market data that is:
    1. (a) acquired independently of the lines of business and is compliant with the firm’s applicable accounting framework;
    2. (b) fed into the exposure models in a timely and complete fashion;
    3. (c) maintained in a secure database subject to periodic internal audit; and
    4. (d) subject to a well-developed data integrity process to handle erroneous or anomalous data observations; and
15. (15) it sets internal policies to identify suitable proxies where its exposure models rely on proxy market data and it can demonstrate empirically on an ongoing basis that the proxy provides a conservative representation of the underlying risk under adverse market conditions.

5.14

A firm must calculate its own funds requirement for CVA risk as the sum of the own funds requirements for:

1. (1) delta risk calculated in accordance with 5.15; and
2. (2) vega risk calculated in accordance with 5.17;

for the firm’s entire CVA portfolio.

5.15

A firm must calculate the own funds requirement for delta risk as the sum of the delta risk own funds requirement calculated separately for each of the following risk classes using the formula in 5.24:

1. (1) interest rate risk;
2. (2) foreign exchange risk;
3. (3) counterparty credit spread risk;
4. (4) reference credit spread risk;
5. (5) equity risk;
6. (6) commodity risk.

5.16

A firm must assign an eligible SA-CVA hedge for credit spread delta risk in its entirety either to the counterparty credit spread or to the reference credit spread risk class.

5.17

A firm must calculate the own funds requirement for vega risk as the sum of the vega risk own funds requirement calculated for each of the following risk classes using the formula in rule 5.24:

1. (1) interest rate risk;
2. (2) foreign exchange risk;
3. (3) reference credit spread risk;
4. (4) equity risk;
5. (5) commodity risk.

5.18

A firm may use smaller values of risk factor shifts than the shifts specified in 5.25 to 5.30 for each risk class if doing so is consistent with its internal risk management calculations.

5.19

A firm must calculate sensitivities for vega risk:

1. (1) whether or not the CVA portfolio includes options; and
2. (2) by applying the relevant volatility shift to the risk class as required by 5.25 to 5.30 to the volatilities used for generating risk factor paths and pricing options.

5.20

If an eligible SA-CVA hedge is an index instrument, a firm must:

1. (1) calculate its sensitivities to all risk factors upon which the value of the index depends; and
2. (2) calculate the index sensitivity to the risk factor by applying the shift of the risk factor to all index constituents that depend on the risk factor and recalculating the changed value of the index.

5.21

For the purpose of calculating the delta and vega sensitivities for counterparty credit spread risk, reference credit spread risk and equity risk in accordance with 5.25 to 5.30, a firm may use additional risk factors that correspond to qualified index instruments, provided that the firm:

1. (1) calculates delta and vega sensitivities to a risk factor that corresponds to a qualified index as a single sensitivity to the underlying qualified index;
2. (2) where 75% or more of the constituents of a qualified index are mapped to the same sector, maps the qualified index to that same sector; and
3. (3) where less than 75% of the constituents of a qualified index are mapped to the same sector, maps the sensitivity to the applicable qualified index bucket.

5.22

A firm must calculate the weighted sensitivities of the aggregate CVA and of the market value of all eligible SA-CVA hedges to each risk factor applicable to each risk class in accordance with the following formulae:

\[{\rm WS}_\rm k^{\rm CVA}=\ {{\rm RW}_{\rm k\ }\rm s}_\rm k^{\rm CVA}\]

\[{\rm WS}_\rm k^{\rm Hdg}=\ {{\rm RW}_{\rm k\ }\rm s}_\rm k^{\rm Hdg}\]

where:

5.23

A firm must calculate the net weighted sensitivity of the CVA portfolio to each risk factor in accordance with the following formula:

\[{\rm WS}_{\rm k\ }={\rm WS}_\rm k^{\rm CVA}-{\rm WS}_\rm k^{\rm Hdg}\]

where:

5.24

For each risk class, a firm must:

1. (1) for each bucket (b), aggregate the weighted sensitivities into an own funds requirement (K_b) in accordance with the following formula:

\[\rm K_b=\sqrt{\left(\sum_{\rm k\in b}{\rm WS}_\rm k^2+\sum_{\rm k\in b}{\sum_{\rm l\in b,l \neq k}\rm\rho_{kl}{\rm WS}_k{\rm WS}_l}\right)+\rm \ R\cdot\sum_{\rm k\in b}{{(({\rm WS}_\rm k^{\rm Hdg})}^2)}}\]

where:

1. (2) aggregate the own funds requirement calculated for each bucket in accordance with (1) across buckets within each risk class to calculate the own funds requirement for each risk class (K), in accordance with the following formula:

\[\rm K=m_{\rm CVA}\sqrt{\sum_{\rm b}\rm K_\rm b^2+\sum_{\rm b}{\sum_{\rm b\neq c}\gamma_{\rm bc\ }\rm S_bS_c}}\]

where:

\[\rm S_b=\rm max{\left\{-\rm K_b;\rm min{\left(\sum_{\rm k\in b}{\rm WS}_\rm k;\rm K_b\right)}\right\}}\]

where:

\[\rm S_c=\rm max{\left\{-\rm K_c;\rm min{\left(\sum_{\rm k\in c}{\rm WS}_\rm k;\rm K_c\right)}\right\}}\]

where:

5.25

For the purposes of calculating the own funds requirement for interest rate risk in accordance with 5.14 to 5.24, a firm must:

1. (1) set buckets for individual currencies;
2. (2) set cross-bucket correlation (γ_bc) at 0.5 for all currency pairs (b, c);
3. (3) set the delta risk factor for interest rate risk to either:
   1. (a) for the following currencies: USD, EUR, GBP, AUD, CAD, SEK or JPY, the absolute change of the inflation rate and of the risk-free yields for the following five tenors: one year, two years, five years, 10 years and 30 years; or
   2. (b) for all other currencies, the absolute change of the inflation rate and the parallel shift of the entire risk-free yield curve for a given currency;
4. (4) for each interest rate delta risk factor measure the sensitivities to:
   1. (a) the risk-free yields by changing the risk-free yield for the relevant tenor for all curves in the relevant currency associated with the bucket by 0.0001 and dividing the resulting change in the aggregate CVA, and the value of eligible CVA hedges, by 0.0001; and
   2. (b) the inflation rate by changing the inflation rate by 0.0001 and dividing the resulting change in the aggregate CVA, and the value of eligible CVA hedges, by 0.0001;
5. (5) set the risk weight (RW_k) for each interest rate delta risk factor (k) as follows:

1. (6) set the correlations (ρ_kl) between pairs of each interest rate delta risk factor (k, l) as follows:

1. (7) for each other currency interest rate delta risk factor measure the sensitivity to:
   1. (a) the yield curve by applying a parallel shift to all risk-free yield curves in a given currency by 0.0001 and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.0001; and
   2. (b) the inflation rate by changing the inflation rate by 0.0001 and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.0001;
2. (8) set the other currencies interest rate delta risk factor risk weights (RW_k) for both the risk-free yield curve and the inflation rate at 1.58%;
3. (9) set the other currencies interest rate delta risk factor correlations (ρ_kl) between the risk-free yield curve and the inflation rate at 40%;
4. (10) set the interest rate vega risk factors for all currencies to the simultaneous relative change of all volatilities for the inflation rate and a simultaneous relative change of all interest rate volatilities for a given currency;
5. (11) for the interest rate vega risk factor measure the sensitivity:
   1. (a) to the interest rate volatilities by applying a simultaneous shift to all interest rate volatilities by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible CVA hedges, by 0.01;
   2. (b) to the inflation rate volatilities by applying a simultaneous shift to inflation rate volatilities for a given currency by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible CVA hedges, by 0.01;
6. (12) for both the interest rate volatilities and the inflation rate volatilities for the interest rate vega risk factor set the risk weights (RW_k) at 100% for all currencies; and
7. (13) for the interest rate vega risk factor set the correlations (ρ_kl) between the interest rate volatilities and the inflation rate volatilities at 40%.

5.26

For the purposes of calculating the own funds requirement for foreign exchange risk in accordance with 5.14 to 5.24, a firm must:

1. (1) set buckets per individual currencies except for the firm’s reporting currency;
2. (2) set the cross-bucket correlation (γ_bc) at 0.6 for all currency pairs;
3. (3) set the foreign exchange delta risk factor to the relative change of the FX spot rate between a given currency and the firm’s reporting currency, where the FX spot rate is the current market price of one unit of another currency expressed in the units of the firm’s reporting currency;
4. (4) for the foreign exchange delta risk factor for all currencies measure the sensitivities to:
   1. (a) foreign exchange spot rates by shifting the exchange rate between the firm’s reporting currency and another currency by 1% relative to its current value and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.01; and
   2. (b) for transactions that reference an exchange rate between a pair of currencies where neither currency is the firm’s reporting currency, the foreign exchange spot rates between the firm’s reporting currency and each of the referenced currencies that are not the firm’s reporting currency;
5. (5) for all exchange rates between the firm’s reporting currency and another currency set the foreign exchange delta risk factor risk weights (RW_k) at 11%;
6. (6) set the foreign exchange vega risk factor to a simultaneous relative change of all volatilities for an exchange rate between the firm’s reporting currency and another given currency;
7. (7) for the foreign exchange vega risk factor for all currencies measure:
   1. (a) the sensitivities to the foreign exchange volatilities by simultaneously shifting all volatilities for a given exchange rate between the firm’s reporting currency and another currency by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges by 0.01;
   2. (b) for transactions that reference an exchange rate between a pair of currencies where neither is the firm’s reporting currency, the volatilities of the foreign exchange spot rates between the firm’s reporting currency and each of the referenced currencies that are not the firm’s reporting currency; and
8. (8) for the foreign exchange vega risk factor set the risk weights (RW_k) at 100%.

5.27

For the purposes of calculating the own funds requirement for counterparty credit spread risk in accordance with 5.14 to 5.24, a firm must:

1. (1) assign exposures to buckets in accordance with the following table:

where:

1. (a) a firm must:
   1. (i) only assign instruments that reference a qualified index to bucket 8, while all single-name and all non-qualified index hedges must be assigned to buckets 1 to 7; and
   2. (ii) for any instrument referencing an index assigned to buckets 1 to 7, calculate the sensitivity of the hedge to each index constituent.

1. (2) set cross-bucket correlations (γ_bc) as follows:

1. (3) set the counterparty credit spread risk delta risk factors for a given bucket to absolute shifts of credit spreads of each counterparty, reference name (for counterparty credit spread hedges, if any) or qualified index for the following tenors: 0.5 years, one year, three years, five years and 10 years;
2. (4) for each bucket, measure the sensitivity to the counterparty credit spread risk delta risk factors by, for each counterparty, reference name or qualified index, and each tenor point, shifting the relevant credit spread by 0.0001 and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.0001;
3. (5) set the risk weights (RW_k) for each risk factor (k) according to the following table depending on the counterparty’s bucket:

1. (6) for buckets 1 to 7, calculate the correlation parameter (ρ_kl) between two weighted sensitivities (WS_k) and (WS_l) according to the following formula:

\[\rho_{\rm kl}=\rho_{\rm tenor}\cdot\ \rho_{\rm name}\ \cdot\rho_{\rm quality}\]

1. (7) for bucket 8, calculate the correlation parameter (ρ_kl) between two weighted sensitivities (WS_k) and (WS_l) in accordance with the following formula:

\[\rho_{\rm kl}=\rho_{\rm tenor}\cdot\ \rho_{\rm name}\ \cdot\rho_{\rm quality}\]

5.28

For the purposes of calculating the own funds requirement for reference credit spread risk in accordance with 5.14 to 5.24, a firm must:

1. (1) assign exposures to buckets in accordance with the following table:

2. Bucket number	Credit quality	Sector of reference name
   1	Investment grade	Sovereigns including central banks, multilateral development banks
   2		Local government, government-backed non-financials, education and public administration
   3		Financials including government-backed financials
   4		Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying
   5		Consumer goods and services, transportation and storage, administrative and support service activities
   6		Technology, telecommunications
   7		Health care, utilities, professional and technical activities
   8	High yield and not rated	Sovereigns including central banks, multilateral development banks
   9		Local government, government-backed non-financials, education and public administration
   10		Financials including government-backed financials
   11		Basic materials, energy, industrials, agriculture, manufacturing, mining and quarrying
   12		Consumer goods and services, transportation and storage, administrative and support service activities
   13		Technology, telecommunications
   14		Health care, utilities, professional and technical activities
   15	(Not applicable)	Other sector
   16	Investment grade	Qualified index
   17	High yield	Qualified index

3. (2) for reference credit spread delta risk and vega risk set the cross-bucket correlations (y_bc) for buckets (b, c):
   
   1. (a) between buckets of the same credit quality, by applying the cross-bucket correlations in the following table:

4. Bucket	1/8	2/9	3/10	4/11	5/12	6/13	7/14	15	16	17
   1/8	100%	75%	10%	20%	25%	20%	15%	0%	45%	45%
   2/9		100%	5%	15%	20%	15%	10%	0%	45%	45%
   3/10			100%	5%	15%	20%	5%	0%	45%	45%
   4/11				100%	20%	25%	5%	0%	45%	45%
   5/12					100%	25%	5%	0%	45%	45%
   6/13						100%	5%	0%	45%	45%
   7/14							100%	0%	45%	45%
   15								100%	0%	0%
   16									100%	75%
   17										100%

   1. (b) between buckets 1 to 14 of different credit quality, by dividing the correlations in the table at point (a) of 5.28(2) by 2;
5. (3) set the reference credit spread delta risk factor for a given bucket to the simultaneous absolute shift of the credit spreads of all tenors for all reference names in the bucket;
6. (4) for each bucket measure the sensitivity to the reference credit spread delta risk factors by simultaneously shifting the credit spreads of all tenors for all reference names in the bucket by 0.0001 and dividing the resulting change in the aggregate CVA, and the market value of eligible SA-CVA hedges, by 0.0001;
7. (5) for the reference credit spread delta risk factors set the risk weights (RW_k) in accordance with the following tables depending on the reference name’s bucket:

8. Investment grade bucket	1	2	3	4	5	6	7	8	9
   Risk Weight	0.5%	1.0%	5.0%	3.0%	3.0%	2.0%	1.5%	2.0%	4.0%

9. High yield/Not rated bucket	10	11	12	13	14	15	16	17
   Risk Weight	12.0%	7.0%	8.5%	5.5%	5.0%	12.0%	1.5%	5.0%

10. (6) set the reference credit spread vega risk factor for a given bucket is the simultaneous relative shift of the volatilities of credit spreads of all tenors for all reference names in the bucket;
11. (7) for each bucket measure the sensitivity to the reference credit spread vega risk factor by simultaneously shifting the volatilities of credit spreads of all tenors for all reference names in the bucket by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.01;
12. (8) set the risk weights (RW_k) for the credit spread volatilities for the reference credit spread vega risk factor, at 100%.

5.29

For the purposes of calculating the own funds requirement for equity risk in accordance with 5.14 to 5.24, a firm must:

1. (1) assign exposures to buckets as follows:

2. Bucket number	Size	Region	Sector of issuer
   1	Large market capitalisation	Emerging market economies	Consumer goods and services, transportation and storage, administrative and support service activities, healthcare, utilities
   2			Telecommunications, industrials
   3			Basic materials, energy, agriculture, manufacturing, mining and quarrying
   4			Financials including government-backed financials, real estate activities, technology
   5		Advanced economies	Consumer goods and services, transportation and storage, administrative and support service activities, healthcare, utilities
   6			Telecommunications, industrials
   7			Basic materials, energy, agriculture, manufacturing, mining and quarrying
   8			Financials including government-backed financials, real estate activities, technology
   9	Small market capitalisation	Emerging market economies	All sectors described under bucket numbers 1, 2, 3, and 4
   10		Advanced economies	All sectors described under bucket numbers 5, 6, 7, and 8
   11	(Not applicable)		Other sector
   12	Large capitalisation, advanced economies		Qualified index
   13	Other		Qualified index

3. where:
   market capitalisation=	the sum of the market capitalisation across all stock markets globally of the same legal entity, unless its parent undertaking has listed securities, in which case the market capitalisation of the parent undertaking;
   large market capitalisation=	a market capitalisation equal to or greater than GBP 1.6 billion;
   small market capitalisation=	a market capitalisation of less than GBP 1.6 billion;
   advanced economies=	the UK, Canada, the United States, Mexico, the euro area, Norway, Sweden, Denmark, Switzerland, Japan, Australia, New Zealand, Singapore and Hong Kong SAR;
   emerging market economies=	all economies that are not advanced economies.

4. (2) for the purposes of (1):
   1. (a) when assigning a risk exposure to a sector bucket, rely on a classification that is commonly used in the market for grouping issuers by industry sector;
   2. (b) assign each issuer to one of the sector buckets in the table in 5.29(1) and assign all issuers from the same industry to the same sector;
   3. (c) assign to bucket 11 any risk positions from any issuer that the firm cannot assign to a sector in a manner that complies with points (a) and (b) of 5.29(2);
   4. (d) assign multinational multi-sector equity issuers to a bucket according to the most material region and sector in which the issuer operates;
5. (3) set the equity delta risk factor to the simultaneous relative shift of equity spot prices for all reference names in the bucket;
6. (4) set cross-bucket correlation (γ_bc) at:
   1. (a) 15% for cross-bucket pairs within buckets 1 to 10;
   2. (b) 75% for cross-bucket pairs within buckets 12 and 13;
   3. (c) 45% for cross-bucket pairs between buckets 12 or 13 and any of buckets 1 to 10; and
   4. (d) 0% for all cross-bucket pairs that include bucket 11.
7. (5) for each bucket measure the sensitivity to the equity delta risk factor by simultaneously shifting the equity spot prices for all reference names in the bucket by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.01;
8. (6) for the equity delta risk factor, set risk weights (RW_k) depending on the reference name’s bucket in accordance with the following table:

9. Bucket number	Risk weight
   1	55%
   2	60%
   3	45%
   4	55%
   5	30%
   6	35%
   7	40%
   8	50%
   9	70%
   10	50%
   11	70%
   12	15%
   13	25%

10. (7) set the equity vega risk factor to the simultaneous relative shift of the volatilities for all reference names in the bucket;
11. (8) for each bucket measure the sensitivity to the equity vega risk factor by simultaneously shifting the volatilities for all reference names in the bucket by 1% relative to their current values and dividing the resulting change in the aggregate CVA and the value of eligible SA-CVA hedges by 0.01;
12. (9) for the equity vega risk factor, set the risk weights (RW_k) at 78% for large market capitalisation buckets and at 100% for the other buckets.

5.30

For the purposes of calculating the own funds requirement for commodity risk in accordance with 5.14 to 5.24, a firm must:

1. (1) assign exposures to buckets as follows:

2. Bucket number	Commodity group	Examples
   1	Energy – Solid combustibles	coal, charcoal, wood pellets, nuclear fuel (including uranium)
   2	Energy – Liquid combustibles	crude oil (including Light-sweet, heavy, West Texas Intermediate and Brent); biofuels (including bioethanol and biodiesel); petrochemicals (including propane, ethane, gasoline, methanol and butane); refined fuels (including jet fuel, kerosene, gasoil, fuel oil, naphtha, heating oil and diesel)
   3	Energy – Electricity and carbon trading	electricity (including spot, day-ahead, peak and off-peak); carbon emissions trading (including certified emissions reductions, in-delivery month EU allowance, Regional Greenhouse Gas Initiative CO2 allowance and renewable energy certificates)
   4	Freight	dry-bulk route (including Capesize, Panamax, Handysize and Supramax); liquid-bulk/gas shipping route (such as Suezmax, Aframax and very large crude carriers)
   5	Metals – non-precious	base metal (including aluminium, copper, lead, nickel, tin and zinc); steel raw materials (including steel billet, steel wire, steel coil, steel scrap and steel rebar, iron ore, tungsten, vanadium, titanium and tantalum); minor metals (including cobalt, manganese, molybdenum)
   6	Gaseous combustibles	natural gas; liquefied natural gas
   7	Precious metals (including gold)	gold; silver; platinum; palladium
   8	Grains & oilseed	corn; wheat; soybean (including soybean seed, soybean oil and soybean meal); oats; palm oil; canola; barley; rapeseed (including rapeseed seed, rapeseed oil, and rapeseed meal); red bean, sorghum; coconut oil; olive oil; peanut oil; sunflower oil; rice
   9	Livestock & dairy	cattle (including live and feeder); hog; poultry; lamb; fish; shrimp; dairy (including milk, whey, eggs, butter and cheese)
   10	Softs and other agriculturals	cocoa; coffee (including arabica and robusta); tea; citrus and orange juice; potatoes; sugar; cotton; wool; lumber and pulp; rubber
   11	Other commodity	industrial minerals (including potash, fertiliser and phosphate rocks), rare earths; terephthalic acid; flat glass

3. (2) set the cross-bucket correlation (γ_bc) at:
   1. (a) 20% for all cross-bucket pairs that fall within bucket numbers 1 to 10; and
   2. (b) 0% for all cross-bucket pairs that include bucket 11;
4. (3) set the commodity delta risk factor to simultaneous relative shift of the commodity spot prices for all commodities in the bucket;
5. (4) set the commodity vega risk factor to simultaneous relative shift of the volatilities for all commodities in the bucket;
6. (5) for each bucket measure the sensitivity to the commodity delta risk factor by simultaneously shifting the spot prices of all commodities in the bucket by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.01;
7. (6) for the commodity delta risk factor, set the risk weights (RW_k) corresponding to the reference commodity’s bucket in accordance with the following table:

8. Bucket number	1	2	3	4	5	6	7	8	9	10	11
   RW	30%	35%	60%	80%	40%	45%	20%	35%	25%	35%	50%

9. (7) for each bucket measure the sensitivity to the commodity vega risk factor by simultaneously shifting the volatilities for all commodities in the bucket by 1% relative to their current values and dividing the resulting change in the aggregate CVA, and the value of eligible SA-CVA hedges, by 0.01; and
10. (8) for the commodity vega risk factor set the risk weights (RW_k) at 100%.

6.1

A firm that:

1. (1) has non-centrally cleared derivatives of a notional aggregate amount less than GBP 88 billion; and
2. (2) does not have permission from the PRA to use SA-CVA;

may choose to calculate its own funds requirement for CVA risk using the alternative approach in 6.2, instead of using BA-CVA.

6.2

A firm using the alternative approach must hold an own funds requirement for CVA risk equal to 100% of the firm’s own funds requirement for counterparty credit risk calculated in accordance with either:

1. (1) the Counterparty Credit Risk (CRR) Part and, if the firm has chosen to calculate its own funds requirement in respect of securities financing transactions in accordance with the Credit Risk Mitigation (CRR) Part, the Credit Risk Mitigation (CRR) Part; or
2. (2) if the firm has been granted permission by the PRA to do so, the Internal Model Method set out in Section 6 of Chapter 6 of Title II of Part Three of CRR, and, if the firm has chosen to calculate its own funds requirement in respect of securities financing transactions in accordance with the Credit Risk Mitigation (CRR) Part, the Credit Risk Mitigation (CRR) Part.

6.3

For the purposes of 6.2, a firm must:

1. (1) not recognise the effect of CVA hedges; and
2. (2) apply the alternative approach to the firm’s entire portfolio of covered transactions.

6.4

A firm that chooses to use the alternative approach in 6.2 must notify the PRA in writing that it meets the condition in 6.1(1) prior to using the alternative approach.

7.1

A firm may, until 1 January 2030:

1. (1) exclude from its calculation of own funds requirements for CVA risk transactions entered into prior to 1 January 2027 with the following counterparties:
1. (a) non-financial counterparties as defined in point (9) of Article 2 of Regulation (EU) No 648/2012 and non-financial counterparties established in a third country where those transactions do not exceed the clearing threshold as specified in Article 10(3) and (4) of Regulation (EU) No 648/2012;
2. (b) counterparties referred to in point (10) of Article 2 of Regulation (EU) No 648/2012 and point (1) of Article 89 of Regulation (EU) No 648/2012; and
3. (c) counterparties referred to in Article 1(4) and (5) of Regulation (EU) No 648/2012 and counterparties for which the firm had been assigning a risk weight of 0% for exposures to those counterparties in accordance with Articles 114(4) and 115(2) of CRR as those Articles applied immediately before revocation by the Treasury; or

(2) apply a final discount scalar (\[\hat{\omega}_{T}\]) to its own funds requirements for CVA risk in accordance with the following formula:

\[{\hat{\omega}}_{T}= {\rm max} \left({\bar{\omega}}_t, \frac{K_1^{b3.1\ scope}}{K_T^{b3.1\ scope}}\cdot {\bar{\omega}}_t + \frac{K_T^{b3.1\ scope}-K_1^{b3.1\ scope}}{K_T^{b3.1\ scope}}\cdot 100\% \right)\]

7.2

For the purposes of 7.1(2), the intermediate discount scalar (\[\bar{\omega}_{t}\]) must be calculated in accordance with the following formula:

\[{\bar{\omega}}_{t}={\rm max} \left( \omega_t, 100\% - \frac{K_1^{b3.1\ scope}-\ K_1^{CRR\ scope}}{K_1^{b3.1\ scope}}\cdot \frac{\left( 5-t \right)}{5}\cdot \frac{1-\omega_t}{1-\omega}\right)\]

7.3

For the purposes of 7.1(2), a firm must calculate:

(a) the final discount scalar (\[\hat{\omega}_T\]) at the same frequency as it calculates its own funds requirement for CVA risk;

(b) the transitional weighting cap (\[\omega_t\]) and the intermediate discount scalar (\[\bar{\omega}_t\]) as set out in 7.1(2) annually; and

(c) the legacy exempt ratio on 1 January 2027, and recalculate the legacy exempt ratio at any point there is a material change in quantum or risk of the firm’s transactions with counterparties referred to in 7.1(1).

7.4

If, as of 1 January 2027, a firm has not chosen to exclude a transaction in accordance with 7.1(1), the firm must include the transaction in its calculation of its own funds requirements for CVA risk until the maturity date of the transaction.

7.5

A firm that applies the treatment in 7.1(1) or (2) may apply either but not both during the period from and including 1 January 2027 to and including 31 December 2029.