Société Générale / Risk Report - Pillar III

6 CREDIT AND COUNTERPARTY CREDIT RISK COUNTERPARTY CREDIT RISK

Counterparty credit risk measurement Replacement risk The replacement risk measurement is based on an internal model which determines the Group's exposure profiles. PRINCIPLES OF THE MODEL The future fair value of market transactions with each counterparty is forecast from Monte Carlo models based on historical analysis of market risk factors. The principle of the model is to design the possible future financial market conditions by simulating the changes in the main risk factors to which the Group’s portfolio is sensitive. For these simulations, the model uses different diffusion models to account for the inherent characteristics of the risk factors considered and uses a 10-year history window for their calibration. The portfolios of derivatives contracts and securities and lending transactions with the different counterparties are then revalued according to these different scenarios at the different future dates until the maturity of the transactions, taking into account the contracts' terms and conditions, notably in terms of netting and collateralisation. The exposure distribution obtained makes it possible to calculate regulatory capital requirements for counterparty credit risk and to ensure the risk monitoring of positions. REGULATORY INDICATOR The ACPR (Prudential Supervisory and Resolution Authority) approved the use of the internal model described above in order to determine the EEPE indicator (Effective Expected Positive Exposure) used in the calculation of the CCR regulatory capital requirements. For products not managed in the internal model as well as for the Group’s entities that have not been authorised by the supervisor to use the internal model, the Group uses the marked-to-market valuation method for derivatives (3) and the financial collateral comprehensive method for securities financing transactions (SFT). The effects of netting agreements and collateralisation are taken into account either by their simulation in the internal model, or by applying the netting rules as defined in the marked-to-market valuation method or the financial collateral method, and by subtracting the collateral value. These exposures are then weighted by rates depending on the counterparty’s credit quality to calculate the Risk-Weighted Assets (RWA). These rates can be determined via the Standardised Approach or the Advanced Approach (AIRB). The RWA breakdown for each approach is available in the table "Analysis of counterparty credit risk exposure by approach” in section 6.9 "Counterparty rik detail"). ECONOMIC INDICATOR To monitor the risk of positions, the Group relies mainly on a maximum exposure metric determined from the Monte Carlo simulations, called internally Credit Value at Risk (CVaR) or PFE (Potential Future Exposure). This is the largest loss that could occur after eliminating 1% of the most adverse occurrences. This metric is calculated at different future dates, which are then aggregated into buckets, each of them being framed by limits. The Group has also developed a set of stress test scenarios that are used to calculate the exposure that would result from changes in the fair value of transactions concluded with all its counterparties in the event of an extreme shock affecting the market parameters.

CLOSE-OUT NETTING AGREEMENTS Societe Generale’s standard policy is to conclude master agreements including provisions for close-out netting. These provisions allow on the one hand the immediate close-out of all transactions governed by these agreements when the default of one of the parties occurs, and on the other hand the settlement of a net amount corresponding to the total value of the portfolio, after netting mutual debts and claims. Societe Generale’s preference – for the purpose of reducing any legal risk related to documentation – is to document these agreements under the main international standards as published by industry associations or national professional associations, such as International Swaps and Derivatives Association (ISDA), International Capital Market Association (ICMA), International Securities Lending Association (ISLA) and the French Banking Federation ( Fédération Bancaire Française - FBF). These agreements establish a set of contractual terms that are generally recognised as standard and allow for the modification or addition of more specific provisions between the parties in the final contract. This standardisation reduces implementation delays and makes operations safer. The enforceability of the provisions detailing these credit risk mitigation techniques is analysed and the conclusions are maintained by the legal department of the Group. COLLATERALISATION Most of OTC transactions are collateralised. There are two different types of collateral exchanges: the initial margin (IM), which is the initial amount of collateral, p aiming at covering potential future exposure, i.e. the adverse variation of the mark-to-market in the interval between the last collection of margins and the liquidation of positions following the default of a counterparty. This initial deposit is retained by a third party (1) to ensure its immediate availability, even in the event of the counterparty’s default; the variation margin (VM), which is the collateral collected to p mitigate the current exposure arising from mark-to-market variations, used as a proxy for the actual loss arising from the default of one of the parties. Bilateral variation and initial margin requirements Historically, initial margins were very rare, except with hedge funds. They are now generalised by the EMIR and DFA regulations. It is now mandatory for the Group to exchange initial margins and variation margins for non-cleared OTC derivatives transactions with a large number of its counterparties (its financial counterparties and some non-financial counterparties above certain thresholds (2) ). Central Counterparties (CCP) The EMIR and DFA regulations also require that the most standardised OTC derivatives transactions be cleared via CCP. The Group clears its house trades, but also operates a client clearing activity (agency business) which is subject to systematic margin calls to mitigate counterparty credit risk (customers sending daily variation margins and initial margins to Societe Generale to cover current and future exposure). For further information, see table "Breakdown of collateral for counterparty credit risk exposures” in section 6.9 "Counterparty risk detail").

Except for repos and clearing activities. (1) Progressive implementation for the IM which will pursue until 2020 depending on the type of counterparties and the size of the positions held. (2) In this method, the EAD (Exposure At Default) relative to the Bank’s counterparty credit risk is determined by aggregating the positive market values of all the transactions (3) (replacement cost), and increasing the sum with an add-on.

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PILLAR 3 - 2020 | SOCIETE GENERALE GROUP |