BPCE - 2019 RISK REPORT Pillar III

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COUNTERPARTY RISK

Counterparty risk management 6.1

Counterparty risk is the credit risk generated on market, investment and/or settlement transactions. It is the risk of the counterparty not being able to meet its obligations to Group institutions. It is also related to the cost of replacing a derivative instrument if the counterparty defaults, and is similar to market risk given default.

Counterparty risk also arises on cash management and market activities conducted with customers, and on clearing activities via a clearing house or external clearing agent. Exposure to counterparty risk is measured using the internal ratings-based approach and standardized approach. BPCE manages counterparty risk daily using a standardized approach, given the nature of vanilla transactions.

Measuring counterparty risk

In economic terms, Groupe BPCE and its subsidiaries measure counterparty risk for derivative instruments (swaps or structured products, for instance) using the IRB method for Natixis, or the mark-to-market method for other institutions. In order to perfect the economic measurement of the current and potential risk inherent in derivatives, a tracking mechanism based on a standardized economic measurement is currently being instituted throughout Groupe BPCE. Natixis uses an internal model to measure and manage its own counterparty risk. Using Monte Carlo simulations for the main risk factors, this model measures the positions on each

counterparty and for the entire lifespan of the exposure, taking netting and collateralization criteria into account. The model thus determines the EPE (Expected Positive Exposure) profile and the PFE (Potential Future Exposure) profile, the latter being the main indicator used by Natixis for assessing counterparty risk exposure. This indicator is calculated as the 97.7% percentile of the distribution of exposures for each counterparty. With respect to the Group’s other entities, the counterparty risk base for market transactions is calculated using a mark-to-market approach.

Counterparty risk mitigation techniques

Counterparty risk is subject to groupwide caps and limits, which are validated by the Group Credit and Counterparty Committee. Use of clearing houses and futures contracts (daily margin calls under ISDA agreements, for example) govern relations with the main customers (mainly Natixis). Accordingly, the Group has implemented EMIR requirements. The principles of counterparty risk management are based on: a risk measurement determined according to the type of • instrument in question, the term of the transactions, and whether or not any netting and collateralization agreements are in place; counterparty risk limits and allocation procedures; • a value adjustment in respect of counterparty risk: the CVA • (Credit Value Adjustment) represents the market value of a counterparty’s default risk (see CVA section below); incorporation of wrong-way risk: wrong-way risk refers to the • risk that a given counterparty exposure is heavily correlated with the counterparty’s probability of default. From a regulatory standpoint, counterparty risk is represented by: specific wrong-way risk, i.e. the risk generated when, due to • the nature of the transactions entered into with a counterparty, there is a direct link between its credit quality and the amount of the exposure;

general wrong-way risk, i.e. the risk generated when there is a • correlation between the counterparty’s credit quality and general market factors. Natixis complies with Article 291.6 of the European regulation of June 26, 2013, including the obligation to report wrong-way risk (WWR). The article states that “institutions shall provide senior management and the appropriate committee of the management body with regular reports on both Specific and General Wrong-Way risks and the steps being taken to manage those risks.” Specific wrong-way risk is subject to a specific capital requirement (Article 291.5 of the European regulation of June 26, 2013 on prudential requirements for credit institutions and investment firms), while general wrong-way risk is assessed using the WWR stress scenarios defined for each asset class. In the event the Bank’s external credit rating is downgraded, it may be required to provide additional cash or collateral to investors under agreements that include rating triggers. In particular, in calculating the liquidity coverage ratio (LCR), the amounts of these additional cash outflows and additional collateral requirements are measured. These amounts comprise the payment the bank would have to make within 30 calendar days in the event its credit rating were downgraded by as much as three notches.

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RISK REPORT PILLAR III 2019 | GROUPE BPCE

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