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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

A bank's netting opinion for Country X covers banks incorporated there but has no coverage for branches of foreign firms. The bank trades with the Country X branch of a foreign dealer, with gross positive exposure of 120 and gross negative exposure of 80. Which treatment is most appropriate for the credit risk measurement?

The bank should measure exposure gross at 120, because without a supporting legal opinion for that branch netting cannot be relied upon in insolvency. Only positive values create exposure, so the negative 80 does not reduce it.

  1. ANet to 40 because the master agreement is signed
  2. BUse gross exposure of 120 for the branch's trades because netting is not supported by a legal opinionCorrect
  3. CUse 80 because negative values dominate
  4. DUse 200, the sum of absolute values, as exposure

Explanation

Netting recognition requires a well-founded legal opinion for the counterparty's type and jurisdiction. With none for the branch, the positive exposures are treated gross, giving 120. Absolute-sum is not the exposure measure.

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