Société Générale / Risk report 2021 - Pillar 3 2020

7 COUNTERPARTY CREDIT RISK MITIGATION OF COUNTERPARTY CREDIT RISK ON MARKET OPERATIONS | SOCIETE GENERALE GROUP | PILLAR 3 - 2021 141 MITIGATION OF COUNTERPARTY CREDIT RISK 7.2 ONMARKET OPERATIONS The Group uses various techniques to reduce this risk: the signing, in the most extensive way possible, of close-out netting p agreements for over-the-counter (OTC) transactions; the collateralisation of market operations, either through clearing p houses for eligible products (listed products and certain OTC products), or through a bilateral margin call exchange mechanism which covers both current exposure (variation margins) but also future exposure (initial margins). 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 termination (close-out) of all transactions governed by these agreements when one of the parties defaults, and on the other hand the settlement of a net amount corresponding to the total value of the portfolio, after netting of mutual debts and claims. This balance may be the subject of a guarantee or collateralisation. In order to reduce any legal risk associated with documentation and to comply with key international standards, the Group prefers to document these agreements under the main international standards as published by national or international professional associations such as International Swaps and Derivatives Association (ISDA), International Capital Market Association (ICMA), International Securities Lending Association (ISLA), French Banking Federation (FBF), etc. These contracts establish a set of contractual terms generally recognised as standard and give way to the modification or addition of more specific provisions between the parties in the final contract. This standardisation reduces implementation times and secures operations. Provisions detailing counterparty credit risk mitigation techniques are reviewed and analysed by the Bank’s legal services to ensure their applicability. Collateralisation Most of over-the-counter transactions are collateralised. There are two types of collateral exchanges: Mark-to-Market of positions in the time period between the last collection of margins and the liquidation of positions following the counterparty default. This initial deposit is kept by a third party (1) to ensure its immediate availability, even in the event of a default of the counterparty; initial margin (IM): an initial amount of collateral aiming at covering p potential future exposure, i.e. the unfavourable change in the variation margin (VM): collateral collected to cover current exposure p arising from Mark-to-Market changes, used as an approximation of the actual loss resulting from the default of one of the counterparties. The Group ensures a monitoring of collateral received and given both for the part covering the market value of the contracts (VM) and the risk of an unfavourable change in the Mark-to-Market of positions in the event of default of the counterparty (IM). The collaterals given and received, are subject to a ‘haircut’, which are negotiated at the time of signing of the collateral agreement. A haircut is the valuation percentage applicable to each type of collateral and is largely based on liquidity and price volatility of the underlying during both normal and stressed market conditions. Main types of collateral are cash or high-quality and liquid assets such as for example prime or high-grade sovereign bonds. BILATERAL COLLATERAL EXCHANGE The initial margin, historically very rare except with hedge funds, was generalised by EMIR and DFA Regulations. It is now mandatory for the Group to exchange IM and VM for non-cleared OTC derivatives transactions with a large number of its counterparties (its financial counterparties and some non-financial counterparties above certain thresholds). CLEARING HOUSES EMIR and DFA Regulations have also required that the most standard over-the-counter derivatives transactions be compensated through clearing houses. The Group thus compensates its own operations (principal activity), but also operates a client clearing activity (agency-type activity), which is subject to systematic margin calls to mitigate counterparty credit risk (customers posting daily variation margins and initial margins to Societe Generale, in order to cover current exposure and future exposure. See table “Breakdown of collateral for counterparty credit risk exposures” section 7.4 “Quantitative Information” for more information. Except for repos and clearing activites. (1)