I would like to use the following example. There is a netting set that is subject to a contractual margin agreement containing only interest derivatives and cash collateral, applying the Articles literally.

 

For the calculation of the replacement cost in Article 275, CMV = -30, VM = -35, TH = MTA = NICA = 0.

If you plug this into the formulas, you get

RC_nomargin = 0 (as in Article 275 1.)

RC_margin = 5 (as in Article 275 2.)

 

For the potential future exposure (PFE) in Article 278, we use

Addon_nomargin = 10

Addon_margin = 3

 

To calculate the multiplier in Article 278 3. we have to use CMV and VM again, resulting in

Multiplier_nomargin = min(1, 0.05 + (1-0.05)*exp(-30/(2*(1-0.05)*10)))=0.246

Multiplier_margin = 1

 

Resulting in

PFE_nomargin = 2.46

PFE_margin = 3

 

Going back to Article  274, the resulting exposure value is

Exposure_nomargin = 1.4*(0+2.46)= 3.64

Exposure_margin = 1.4*(5+3) = 11.2

 

According to this calculation, we would have to use the non-margined exposure (3.64), which is smaller than the net exposure of the netting set (CMV - VM = 5). This is a result which is troubling from a credit risk perspective, since the exposure for a netting set should always be larger than the net exposure due to the volatile nature of derivatives.