2020 Universal registration document and annual financial report - BNP PARIBAS 415

5risks and CaPital adequaCy Pillar 3

5

Counterparty credit risk

Since 1 January 2014, date of entry into force of Regulation (EU) No. 575/2013, the system for measuring exposures to counterparty risk takes into account:

■ extension of the margin periods of risk in accordance with article 285 of the CRR;

■ inclusion of the specific correlation risk;

■ determination of a stressed EEPE calculated based on a calibration reflecting a particular period of stress.

Non-modelled exposure Mark-to-market method

For non-modelled counterparty credit risk exposures, the exposure at default is based on market price evaluation (Net Present Value + Add-On). The add-on is calculated in accordance with article 274 of Regulation (EU) No. 575/2013 as a fixed percentage according to the type of transaction and its remaining life.

LIMIT/MONITORING FRAMEWORK Limits reflecting the principles of the Group s Risk Appetite Statement are defined for the counterparty credit risk. These limits are set in accordance with the type of counterparty (banks, institutional investors, asset managers, hedge funds, corporates). For each counterparty, the maximum Potential Future Exposure value (MaxPFE) calculated by the internal model is compared on a daily basis with the limits assigned to each counterparty to check compliance with credit decisions.

These limits are defined and calibrated as part of the risk approval process. They are approved in the following committees (listed in ascending order of discretionary authority): Local Credit Committee, Regional Credit Committee, Global Credit Committee, General Management Credit Committee.

These measures are complemented by sets of directives (covering contingent market risk sensitivities per counterparty which are extracted from the market risk system) which provide further tools in the monitoring of counterparty credit risk and the prevention of systemic risk concentrations.

MITIGATION OF COUNTERPARTY CREDIT RISK As part of its risk management, the BNP Paribas Group implemented three counterparty risk mitigation mechanisms:

■ the signature of netting agreements for OTC transactions;

■ clearing through central counterparties, in the case of OTC or listed derivative transactions;

■ Bilateral initial margin exchange.

Netting agreements

Netting is used by the Bank in order to mitigate counterparty credit risk associated with derivatives trading. The main instance where netting occurs is in case of trades termination: if the counterparty defaults, all the trades are terminated at their current market value, and all the positive

and negative market values are summed to obtain a single amount (net) to be paid to or received from the counterparty. The balance ( close-out netting ) may be collateralised with cash, securities or deposits.

The Bank also applies settlement netting in order to mitigate counterparty credit risk in cases of currency settlement. This corresponds to the netting of all payments and receipts between the Bank and one counterparty in the same currency to be settled in the same day. The netting results in a single amount (for each currency) to be paid either by the Bank or by the counterparty.

Transactions affected by this are processed in accordance with bilateral or multilateral agreements respecting the general principles of the national or international framework. The main forms of bilateral agreements are those issued by Fédération Bancaire Française (FBF) and on an international basis by the International Swaps and Derivatives Association (ISDA).

Trade clearing through central counterparties

Trade clearing through central counterparties (CCPs) is part of BNP Paribas usual capital market activities. As a global clearing member, BNP Paribas contributes to the risk management framework of the CCPs through payment to a default fund as well as daily margin calls. The rules which define the relationships between BNP Paribas and the CCPs of which it is a member are described in each CCP s rulebook.

For Europe and the United States in particular, this scheme enables the reduction of notional amounts through the netting of the portfolio, on one hand, and, on the other, a transfer of the risk from several counterparties to a single central counterparty with a robust risk management framework.

In its clearing for third parties activity, BNP Paribas requests as well, and on a daily basis, the payment of margin calls from its clients.

Since default by one or more clearing houses would affect BNP Paribas, it has introduced dedicated monitoring of these central counterparties and closely tracks concentrations with them.

Bilateral initial margin exchange

Regulation (EU) No. 648/2012 (EMIR) stipulates the establishment of additional constraints for players in the derivatives markets, including the obligation to exchange collateral for contracts that are not centrally cleared. An initial guarantee deposit must be made by the Bank s most significant financial and non-financial counterparties. The purpose of this exchange is to mitigate the counterparty credit risk associated with over- the-counter derivatives trading that is not centrally cleared. The Bank s transactions with sovereign borrowers, central banks, and supranational entities are excluded from this system.

If the counterparty defaults, all the trades are terminated at their current market value by the Bank. The initial guarantee deposit hedges the variation in transactions during this liquidation period. The initial deposit reflects an extreme but plausible estimate of potential losses corresponding to an unilateral interval of confidence of 99% over a ten- day period, based on historic data including an episode of significant financial tensions.