Institutions may use the following types of credit derivatives, and instruments composed of such derivatives or that are economically effectively similar, as eligible credit protection: credit default swaps; total return swaps; and credit‑linked notes to the extent of their cash funding. Where an institution buys protection through a total return swap and records the net payments received on the swap as net income, but does not record the offsetting deterioration in the value of the protected asset through fair value reductions or by an addition to reserves, that credit protection does not qualify as eligible credit protection.

Where an institution conducts an internal hedge using a credit derivative, for the credit protection to qualify as eligible credit protection for the purposes of this Chapter the credit risk transferred to the trading book must be transferred out to a third party or parties. If that requirement and the Chapter’s requirements are met, institutions shall apply the rules in Sections 4 to 6 to calculate risk‑weighted exposure amounts and expected loss amounts for unfunded credit protection. First‑to‑default and all other nth‑to‑default credit derivatives are not eligible types of unfunded credit protection under this Chapter.