(a) Netting of add-ons

In the July proposal, the Committee invited industry comment on whether the net to gross ratio (NGR) should be calculated on a counterparty by counterparty basis or on an aggregate basis. The Committee has concluded that neither approach is likely systematically to bias the results of the overall capital calculation and that supervisors should have discretion to permit both methods, on condition that the method chosen by an institution should be used on a consistent basis.

A number of respondents argued that the NGR weight of 0.5 in the formula of the July proposal significantly understates the reduction in potential exposure resulting from legally valid bilateral netting agreements. The Committee has reviewed these comments and concludes that an NGR weight of 0.6 should be applied. This weight represents an appropriate compromise between recognising the effects of netting in the add-ons and providing a cushion against potential fluctuations in the net current exposure.

(b) The expanded matrix

A number of respondents argued that the July proposal's treatment of equity contracts with automatic zero value reset provisions should be extended to all contracts in the matrix. The Committee has reviewed this issue and concluded that the residual maturity of contracts covered by the expanded matrix may be set equal to the time until the next reset date if the following conditions are met 1) the contract must be structured to settle outstanding exposure following specified payment dates and 2) at these specified dates, the terms of the contract must be reset such that the market value is zero. However, in the case of interest rate contracts with remaining maturity of more than one year that meet the above criteria, the add-on factor will be subject to a floor of 0.5%. The reason for this floor is that while the above contract features limit potential price movements of long-dated instruments to the period until the next reset date, the contract still represents a long-term obligation and consequently greater risk than a contract with a shorter maturity. A floor ensures that the capital charge for such a contract is never zero.

A number of commenters questioned the assumptions of contract structure and volatility used to arrive at the add-on factors for "other commodities" in the July 1994 proposal. Based on additional work, the Committee concluded that it would be reasonable to reduce the add-ons for the less than one year remaining maturity row from 12% to 10%.

The Committee has modified the residual maturity rows of the expanded matrix to include the last day of the year. The residual maturities are to be defined as follows: one year or less, over one year to five years, and over five years.

April 1995