How Mandatory Break Clauses Affect Swap Counterparty Credit Exposure

Summary

The document asks how a mandatory break clause changes counterparty credit risk (CCR) exposure for a five-year interest rate swap that can be terminated after one year. It compares the expected exposure profile during the first year with that of an otherwise similar swap without a break clause, and asks whether the clause makes the trade resemble a one-year swap until the termination date.

It also raises the treatment of exposure after the break: if the swap is terminated, the remaining exposure would depend on its market value at that time, while potential future exposure capital might no longer apply to the closed trade. The document provides no answer, calculation, or supporting evidence, so it does not establish whether exposure before the break is reduced or how the closeout value should be handled. Resolving those points requires the applicable CCR exposure methodology and the contractual details of the break and settlement.

Key ideas

• A mandatory break clause may affect a swap’s counterparty exposure profile.
• The question focuses on whether exposure changes before the scheduled break date.
• At termination, the swap’s market value may determine the amount due between the parties.
• The document poses these issues but does not provide a solution or evidence.

Tags

# What happens to a Swap CCR if there is a mandatory breaking clause?


# What happens to a Swap CCR if there is a mandatory breaking clause?












I doubt with regards to this. If for instance, we have the same two 5-year swaps one of them with a Mandatory Break clause in year one, what would be the differences in the CCR profile during the first year?

Would it be the same profile for both of them, since the break clause still hasn't been executed?

If this is the case, is this exposure the same as one of a 1-year swap with the difference that the CCR at the moment t=1 year would be the expected market value for the swap with the break clause?

If the CCR exposures weren't the same for the first year, would be any kind of reduction in the exposure for the swap with the break clause? From the first year onwards, the contract is liquidated and you would get the market value of the swap, being unnecessary to keep the capital levels of the potential future exposure.

Many thanks!

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