How does SA-CCR compute exposure at default for derivative portfolios?

SA-CCR is the Basel Committee's standardized method for computing Exposure at Default (EAD) for derivative positions. It replaced the older Current Exposure Method (CEM) and Standardized Method (SM), which were criticized for being too simplistic and not risk-sensitive enough.

The Master Formula

EAD = alpha x (RC + PFE)

Where:

• alpha = 1.4 (regulatory multiplier to account for model uncertainty)
• RC = Replacement Cost (current exposure)
• PFE = Potential Future Exposure (how much exposure could grow)

Component 1: Replacement Cost (RC)

For unmargined trades:

RC = max(V - C, 0)

For margined trades:

RC = max(V - C, TH + MTA - NICA, 0)

Where:

• V = mark-to-market value of the netting set
• C = collateral held (net of haircuts)
• TH = threshold amount in the CSA
• MTA = minimum transfer amount
• NICA = net independent collateral amount

Component 2: Potential Future Exposure (PFE)

PFE = multiplier x AddOn_aggregate

The multiplier accounts for excess collateral (if C > V, it reduces PFE below the add-on):

multiplier = min[1, floor + (1 - floor) x exp(V - C) / (2 x (1 - floor) x AddOn)]

where floor = 0.05 (PFE can never be less than 5% of the gross add-on).

The AddOn is computed by asset class:

• Interest Rate
• Foreign Exchange
• Credit
• Equity
• Commodity

Each asset class has its own formula based on notional, delta adjustment, maturity factor, and supervisory factor.

Simplified Example

Elmridge Bank has an unmargined netting set with Oakmont Securities:

• Portfolio MtM (V) = +$8M (in Elmridge's favor)
• Collateral held (C) = $3M
• AddOn (computed from asset-class formulas) = $12M

RC = max(8 - 3, 0) = $5M

Multiplier: Since V > C (net positive), multiplier = 1.0

PFE = 1.0 x $12M = $12M

EAD = 1.4 x (5 + 12) = 1.4 x $17M = $23.8M

Now suppose collateral increases to $15M (over-collateralized):

RC = max(8 - 15, 0) = $0

Multiplier: V - C = 8 - 15 = -7. The multiplier formula kicks in:

multiplier = min[1, 0.05 + 0.95 x exp(-7 / (2 x 0.95 x 12))] = min[1, 0.05 + 0.95 x exp(-0.307)] = min[1, 0.05 + 0.95 x 0.736] = min[1, 0.749] = 0.749

PFE = 0.749 x $12M = $8.99M

EAD = 1.4 x (0 + 8.99) = $12.59M

Excess collateral reduces EAD significantly but cannot eliminate PFE entirely (5% floor).

For more SA-CCR practice, explore our FRM Part II question bank.