TD Bank 2011 Annual Report Download - page 119

TD BANK GROUP ANNUAL REPORT 2011 FINANCIAL RESULTS 117
DERIVATIVE-RELATED RISKS
Market Risk
Derivatives, in the absence of any compensating upfront cash payments,
generally have no market value at inception. They obtain value, positive
or negative, as relevant interest rates, foreign exchange rates, equity,
commodity or credit prices or indices change, such that the previously
contracted terms of the derivative transactions have become more or
less favourable than what can be negotiated under current market
conditions for contracts with the same terms and the same remaining
period to expiry.
The potential for derivatives to increase or decrease in value as a
result of the foregoing factors is generally referred to as market risk.
This market risk is managed by senior officers responsible for the
Bank’s trading business and is monitored independently by the Bank’s
Risk Management Group.
Credit Risk
Credit risk on derivatives, also known as counterparty credit risk, is the
risk of a financial loss occurring as a result of the failure of a counter-
party to meet its obligation to the Bank. The Treasury Credit area
within the Wholesale Bank is responsible for implementing and ensuring
compliance with credit policies established by the Bank for the
management of derivative credit exposures.
Derivative-related credit risks are subject to the same credit approval,
limit and monitoring standards that are used for managing other trans-
actions that create credit exposure. This includes evaluating the credit-
worthiness of counterparties, and managing the size, diversification
and maturity structure of the portfolios. The Bank actively engages in
risk mitigation strategies through the use of multi-product derivative
master netting agreements, collateral and other risk mitigation tech-
niques. Master netting agreements reduce risk to the Bank by allowing
the Bank to close out and net transactions with counterparties subject
to such agreements upon the occurrence of certain events. The effect
of these master netting agreements is shown in the table below entitled
“Credit Exposure of Derivatives”.
Also shown in the table entitled “Credit Exposure of Derivatives”,
is the current replacement cost, which is the positive fair value of
all outstanding derivatives, and represents the Bank’s maximum deriv-
ative credit exposure. The credit equivalent amount is the sum of the
current replacement cost and the potential future exposure, which is
calculated by applying factors supplied by OSFI to the notional princi-
pal amount of the derivatives. The risk-weighted amount is determined
by applying standard measures of counterparty credit risk to the credit
equivalent amount.
Credit Exposure of Derivatives
(millions of Canadian dollars) 2011 2010
Current Credit Risk- Current Credit Risk-
replacement equivalent weighted replacement equivalent weighted
cost1 amount amount cost1 amount amount
Interest rate contracts
Forward rate agreements $ 23 $ 34 $ 5 $ 22 $ 40 $ 8
Swaps 35,048 46,581 18,322 26,817 33,600 13,978
Options purchased 767 860 337 669 770 293
Total interest rate contracts 35,838 47,475 18,664 27,508 34,410 14,279
Foreign exchange contracts
Forward contracts 6,364 11,878 2,170 6,148 11,683 2,209
Swaps 237 405 59 2,267 3,315 865
Cross-currency interest rate swaps 10,823 30,312 9,322 10,587 27,276 9,107
Options purchased 623 1,064 236 800 1,431 284
Total foreign exchange contracts 18,047 43,659 11,787 19,802 43,705 12,465
Other contracts
Credit derivatives 48 447 158 96 588 203
Equity contracts 4,691 7,954 1,033 3,039 6,053 1,456
Commodity contracts 1,021 1,167 238 626 1,239 304
Total other contracts 5,760 9,568 1,429 3,761 7,880 1,963
Total derivatives 59,645 100,702 31,880 51,071 85,995 28,707
Less: impact of master netting agreements 45,611 65,949 22,531 37,566 54,233 19,494
Total derivatives after netting 14,034 34,753 9,349 13,505 31,762 9,213
Less: impact of collateral 5,875 6,062 1,959 5,343 5,644 2,107
Net derivatives $ 8,159 $ 28,691 $ 7,390 $ 8,162 $ 26,118 $ 7,106
1 Exchange-traded instruments and non-trading credit derivatives, which are given
financial guarantee treatment for credit risk capital purposes, are excluded in
accordance with the guidelines of OSFI. The total positive fair value of the excluded
contracts as at October 31, 2011 was $775 million (2010 – $604 million).