Bank of Montreal 2015 Annual Report Download - page 148

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 legally enforceable master
netting agreements to the extent that unfavourable contracts with the same counterparty must be settled concurrently with 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, determined 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 on the basis of the creditworthiness of the counterparty, as prescribed by OSFI.
(Canadian $ in millions) 2015 2014
Replacement
cost
Credit risk
equivalent
Risk-
weighted
assets
Replacement
cost
Credit risk
equivalent
Risk-
weighted
assets
Interest Rate Contracts
Swaps 18,590 22,037 – 17,546 21,371 –
Forward rate agreements 25 24 – 445 –
Purchased options 633 651 – 691 705 –
Total interest rate contracts 19,248 22,712 1,461 18,241 22,121 1,393
Foreign Exchange Contracts
Cross-currency swaps 5,128 8,602 – 2,153 5,039 –
Cross-currency interest rate swaps 6,847 13,696 – 5,705 11,219 –
Forward foreign exchange contracts 4,191 7,838 – 4,376 6,477 –
Purchased options 115 768 – 415 837 –
Total foreign exchange contracts 16,281 30,904 2,034 12,649 23,572 1,656
Commodity Contracts
Swaps 993 2,472 – 376 1,902 –
Purchased options 69 1,043 – 30 1,109 –
Total commodity contracts 1,062 3,515 496 406 3,011 472
Equity Contracts 892 3,366 214 896 3,547 208
Credit Default Swaps 36 245 34 80 271 42
Total derivatives 37,519 60,742 4,239 32,272 52,522 3,771
Less: impact of master netting agreements (27,415) (40,140) – (28,885) (35,585) –
Total 10,104 20,602 4,239 3,387 16,937 3,771
The total derivatives and the impact of master netting agreements for replacement cost do not include exchange-traded derivatives with a fair value of $719 million as at October 31, 2015 ($383 million
in 2014).
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
2015 2014 2015 2014
Canada 19,492 52 14,395 45 5,832 58 1,769 52
United States 7,702 21 7,579 23 2,609 26 875 26
United Kingdom 3,220 9 3,623 11 398 4 232 7
Other countries (1) 7,105 18 6,675 21 1,265 12 511 15
Total 37,519 100% 32,272 100% 10,104 100% 3,387 100%
(1) No other country represented 15% or more of our replacement cost in 2015 or 2014.
BMO Financial Group 198th Annual Report 2015 161