Interpretation of the capital accord for the multilateral netting of forward value foreign exchange transactions

April 1996

This document provides an interpretation of the Basle Committee's Capital Accord for banks which participate in a multilateral netting arrangement for foreign exchange contracts such as the London-based Exchange Clearing House, Ltd. (ECHO) or the New York-based Multinet. The interpretation focuses on forward replacement risk, the cost of replacing cash flows on outstanding foreign exchange derivatives contracts in the case of counterparty default, and not on settlement risk.

The document presents a methodology for determining a clearing house participant's capital charge for current and potential future credit exposure. It also invites comment on two technical aspects of the interpretation: (1) the volatility of current exposure under multilateral netting as compared with bilateral netting and (2) the appropriate treatment of a participant's exposure to so-called "second round effects", which can arise when two or more of the other clearing house participants default simultaneously. The comment period ended in July 1996.