Bank of Montreal 2014 Annual Report Download - page 138

Notes
Derivative-Related Credit Risk
Over-the-counter derivative instruments are subject to credit risk arising
from the possibility that counterparties may default on their obligations.
The credit risk associated with derivatives is normally a small fraction of
the notional amount of the derivative instrument. Derivative contracts
generally expose us to potential credit loss if changes in market rates
affect a counterparty’s position unfavourably and the counterparty
defaults on payment. The credit risk is represented by the positive fair
value of the derivative instrument. We strive to limit credit risk by
dealing with counterparties that we believe are creditworthy, and we
manage our credit risk for derivatives using the same credit risk process
that is applied to loans and other credit assets.
We also pursue opportunities to reduce our exposure to credit
losses on derivative instruments, including through collateral and by
entering into master netting agreements with counterparties. The credit
risk associated with favourable contracts is eliminated by master netting
agreements to the extent that unfavourable contracts with the same
counterparty cannot be settled before favourable contracts.
Exchange-traded derivatives have limited potential for credit
exposure as they are settled net daily with each exchange.
Terms used in the credit risk table below are as follows:
Replacement cost represents the cost of replacing all contracts that
have a positive fair value, using current market rates. It represents in
effect the unrealized gains on our derivative instruments. Replacement
costs disclosed below represent the net of the asset and liability to a
specific counterparty where we have a legally enforceable right to offset
the amount owed to us with the amount owed by us and we intend
either to settle on a net basis or to realize the asset and settle the
liability simultaneously.
Credit risk equivalent represents the total replacement cost plus an
amount representing the potential future credit exposure, as outlined in
OSFI’s Capital Adequacy Guideline.
Risk-weighted assets represent the credit risk equivalent, weighted
based on the creditworthiness of the counterparty, as prescribed by
OSFI.
(Canadian $ in millions) 2014 2013
Replacement
cost
Credit risk
equivalent
Risk-
weighted
assets
Replacement
cost
Credit risk
equivalent
Risk-
weighted
assets
Interest Rate Contracts
Swaps 17,546 21,371 – 21,621 26,813 –
Forward rate agreements 445 – 540 –
Purchased options 691 705 – 589 657 –
Total interest rate contracts 18,241 22,121 1,393 22,215 27,510 1,758
Foreign Exchange Contracts
Cross-currency swaps 2,153 5,039 – 1,156 4,091 –
Cross-currency interest rate swaps 5,705 11,219 – 3,459 15,671 –
Forward foreign exchange contracts 4,376 6,477 – 1,957 3,854 –
Purchased options 415 837 – 90 227 –
Total foreign exchange contracts 12,649 23,572 1,656 6,662 23,843 2,448
Commodity Contracts
Swaps 376 1,902 – 501 2,289 –
Purchased options 30 1,109 – 66 1,045 –
Total commodity contracts 406 3,011 472 567 3,334 621
Equity Contracts 896 3,547 208 520 3,054 113
Credit Default Swaps 80 271 42 90 448 310
Total derivatives 32,272 52,522 3,771 30,054 58,189 5,250
Less: impact of master netting agreements (28,885) (35,585) – (27,493) (38,607) –
Total 3,387 16,937 3,771 2,561 19,582 5,250
The total derivatives and the impact of master netting agreements for replacement cost do not include exchange-traded derivatives with a fair value of $383 million as at October 31, 2014 ($205 million
in 2013).
Transactions are conducted with counterparties in various geographic locations and industry sectors. Set out below is the replacement cost of
contracts before and after the impact of master netting agreements with customers located in the following countries, based on country of ultimate
risk.
(Canadian $ in millions, except as noted) Before master netting agreements After master netting agreements
2014 2013 2014 2013
Canada 14,395 45 12,425 41 1,769 52 1,389 54
United States 7,579 23 7,193 24 875 26 728 28
United Kingdom 3,623 11 4,761 16 232 7 148 6
Other countries (1) 6,675 21 5,675 19 511 15 296 12
Total 32,272 100% 30,054 100% 3,387 100% 2,561 100%
(1) No other country represented 15% or more of our replacement cost in 2014 or 2013.
BMO Financial Group 197th Annual Report 2014 151