| 11.1 | An important part of a bank’s trading desk internal risk management model is the specification of an appropriate set of market risk factors. Risk factors are the market rates and prices that affect the value of the bank’s trading positions. The risk factors contained in a trading desk risk management model must be sufficient to represent the risks inherent in the bank’s portfolio of on- and off-balance sheet trading positions. Although banks will have some discretion in specifying the risk factors for their internal models, the following requirements must be fulfilled.
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| 11.2 | A bank’s market risk capital requirement models should include all risk factors that are used for pricing. In the event a risk factor is incorporated in a pricing model but not in the trading desk risk management model, the bank must support this omission to the satisfaction of SAMA.
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| 11.3 | A bank’s market risk capital requirement model must include all risk factors that are specified in the standardised approach for the corresponding risk class, as set out in [6] to [8]. In the event a standardised approach risk factor is not included in the market risk capital requirement model, the bank must support this omission to the satisfaction of SAMA.
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| | (1) | For securitised products, banks are prohibited from using internal models to determine market risk capital requirements. Banks must use the standardised approach to determine the market risk capital requirements for securitised products as set out in [3.11]. Accordingly, a bank’s market risk capital requirement model should not specify risk factors for securitisations as defined in [7.10] to [7.11].
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| 11.4 | A bank’s market risk capital requirement model and any stress scenarios calculated for non- modellable risk factors must address non-linearities for options and other relevant products (eg mortgage-backed securities), as well as correlation risk and relevant basis risks (eg basis risks between credit default swaps and bonds).
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| 11.5 | A bank may use proxies for which there is an appropriate track record for their representation of a position (eg an equity index used as a proxy for a position in an individual stock). In the event a bank uses proxies, the bank must support their use to the satisfaction of SAMA.
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| 11.6 | For general interest rate risk, a bank must use a set of risk factors that corresponds to the interest rates associated with each currency in which the bank has interest rate sensitive on- or off- balance sheet trading positions.
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| | (1) | The trading desk risk management model must model the yield curve using one of a number of generally accepted approaches (eg estimating forward rates of zero coupon yields).
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| | (2) | The yield curve must be divided into maturity segments in order to capture variation in the volatility of rates along the yield curve.
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| | (3) | For material exposures to interest rate movements in the major currencies and markets, banks must model the yield curve using a minimum of six risk factors.
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| | (4) | The number of risk factors used ultimately should be driven by the nature of the bank’s trading strategies. A bank with a portfolio of various types of securities across many points of the yield curve and that engages in complex arbitrage strategies would require the use of a greater number of risk factors than a bank with less complex portfolios.
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| 11.7 | The trading desk risk management model must incorporate separate risk factors to capture credit spread risk (eg between bonds and swaps). A variety of approaches may be used to reflect the credit spread risk arising from less-than-perfectly correlated movements between government and other fixed income instruments, such as specifying a completely separate yield curve for non- government fixed income instruments (eg swaps or municipal securities) or estimating the spread over government rates at various points along the yield curve.
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| 11.8 | For exchange rate risk, the trading desk risk management model must incorporate risk factors that correspond to the individual foreign currencies in which the bank’s positions are denominated. Because the output of a bank’s risk measurement system will be expressed in the bank’s reporting currency, any net position denominated in a foreign currency will introduce foreign exchange risk. A bank must utilise risk factors that correspond to the exchange rate between the bank’s reporting currency and each foreign currency in which the bank has a significant exposure.
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| 11.9 | For equity risk, a bank must utilise risk factors that correspond to each of the equity markets in which the bank holds significant positions.
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| | (1) | At a minimum, a bank must utilise risk factors that reflect market-wide movements in equity prices (eg a market index). Positions in individual securities or in sector indices may be expressed in beta-equivalents relative to a market-wide index.
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| | (2) | A bank may utilise risk factors that correspond to various sectors of the overall equity market (eg industry sectors or cyclical and non-cyclical sectors). Positions in individual securities within each sector may be expressed in beta-equivalents relative to a sector index.
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| | (3) | A bank may also utilise risk factors that correspond to the volatility of individual equities.
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| | (4) | The sophistication and nature of the modelling technique for a given market should correspond to the bank’s exposure to the overall market as well as the bank’s concentration in individual equities in that market.
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| 11.10 | For commodity risk, bank must utilise risk factors that correspond to each of the commodity markets in which the bank holds significant positions.
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| | (1) | For banks with relatively limited positions in commodity-based instruments, the bank may utilise a straightforward specification of risk factors. Such a specification could entail utilising one risk factor for each commodity price to which the bank is exposed (including different risk factors for different geographies where relevant).
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| | (2) | For a bank with active trading in commodities, the bank’s model must account for variation in the convenience yield40 between derivatives positions such as forwards and swaps and cash positions in the commodity.
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| 11.11 | For the risks associated with equity investments in funds:
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| | (1) | For funds that meet the criterion set out in [5.8](5)(a) (ie funds with look- through possibility), banks must consider the risks of the fund, and of any associated hedges, as if the fund’s positions were held directly by the bank (taking into account the bank’s share of the equity of the fund, and any leverage in the fund structure). The bank must assign these positions to the trading desk to which the fund is assigned.
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| | (2) | For funds that do not meet the criterion set out in [5.8](5)(a), but meet both the criteria set out in [5.8](5)(b) (ie daily prices and knowledge of the mandate of the fund), banks must use the standardised approach to calculate capital requirements for the fund.
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