Can incurred CVA, which is recognised as an incurred write-down in the Balance sheet, be used in the calculation of the Leverage Ratio Exposure for derivatives contracts?
Incurred CVA is an accounting value adjustment that helps to ensure that the asset value and the capital of a firm are appropriately reduced to reflect the expected losses as a result of a counterparty’s credit quality.
The incurred CVA amount is posted to the Balance Sheet reducing the asset value and recognised through the statement of profit or loss (“P&L”). Article 273(6) of CRR prescribes to recognise incurred CVA as a reduction in the exposure at default calculation (EAD) for contract listed in Annex II of CRR, when calculated with one of the methods set out in Section 3 to 6 of Chapter 6 in Title II Part Three of CRR.
It therefore follows that Article 273(6) is applicable under the EAD calculation method prescribed in Article 274 (Mark-to-market Method).
Article 429a(1) of the DR refers to Articles 274 and 299(2) for the Leverage Ratio exposure measure of derivatives but it does not explicitly refer to Article 273(6). Consequently, although article 273(6) is directly applicable to the method set out in Article 274 in the EAD calculation for default risk capital, it is unclear if the same logic should be applied when calculating the Leverage Ratio Exposure.
In accordance with Article 429(9) of Regulation (EU) No 575/2013 (CRR), as amended by Regulation (EU) 2015/62, the leverage ratio exposure value of contracts listed in Annex II and of credit derivatives has to be calculated pursuant to Article 429a CRR. According to Article 429a(1) CRR, the exposure value of derivatives should be determined in accordance with the method set out in Article 274 CRR (Mark-to-Market Method for credit risk) or – if certain conditions are met – with the method set out in Article 275 CRR (Original Exposure Method). However, the leverage ratio framework does not take into account all provisions of the counterparty credit risk framework. It is also noted that in this regard the leverage ratio calculation typically does not include the reductions in the risk based framework.
Against this background and given that none of the paragraphs of Article 429a CRR makes reference to Article 273(6) CRR, it follows that the incurred CVA shall not be used to reduce the leverage ratio exposure value of derivatives.