Interest Rate Risk
| No: 44047144 | Date(g): 27/12/2022 | Date(h): 4/6/1444 | Status: In-Force |
| 14.3 | This section sets out the simplified standard approach for measuring the risk of holding or taking positions in debt securities and other interest rate related instruments in the trading book. The instruments covered include all fixed-rate and floating-rate debt securities and instruments that behave like them, including non-convertible preference shares.53 Convertible bonds, ie debt issues or preference shares that are convertible, at a stated price, into common shares of the issuer, will be treated as debt securities if they trade like debt securities and as equities if they trade like equities. The basis for dealing with derivative products is considered in [14.31] to [14.40]. | ||
| 14.4 | The minimum capital requirement is expressed in terms of two separately calculated amounts, one applying to the “specific risk” of each security, whether it is a short or a long position, and the other to the interest rate risk in the portfolio (termed “general market risk”) where long and short positions in different securities or instruments can be offset. | ||
| Specific risk | ||||||||||||||||||||||||||||||||||||||||||||||
| 14.5 | The capital requirement for specific risk is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer. In measuring the risk, offsetting will be restricted to matched positions in the identical issue (including positions in derivatives). Even if the issuer is the same, no offsetting will be permitted between different issues since differences in coupon rates, liquidity, call features, etc mean that prices may diverge in the short run. | |||||||||||||||||||||||||||||||||||||||||||||
| Netting is only allowed under limited circumstances for interest rate specific risk as explained in [14.5]: “offsetting will be restricted to matched positions in the identical issue (including positions in derivatives). Even if the issuer is the same, no offsetting will be permitted between different issues since differences in coupon rates, liquidity, call features, etc means that prices may diverge in the short run.” In addition, partial offsetting is allowed in two other sets of circumstances. One set of circumstances is described in [14.21] and concerns nth-to-default basked products. The other set of circumstances described in [14.16] to [14.18] pertains to offsetting between a credit derivative (whether total return swap or credit default swap) and the underlying exposure (ie cash position). Although this treatment applies generally in a one-for-one fashion, it is possible that multiple instruments could combine to create a hedge that would be eligible for consideration for partial offsetting. SAMA recognise that, in the case of multiple instruments comprising one side of the position, necessary conditions (ie the value of two legs moving in opposite directions, key contractual features of the credit derivative, identical reference obligations and currency/maturity mismatches) will be extremely difficult to meet, in practice. | ||||||||||||||||||||||||||||||||||||||||||||||
| 14.6 | The Specific risk capital requirements for “government” and “other” categories will be as follows: | |||||||||||||||||||||||||||||||||||||||||||||
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14.7 | The government category will include all forms of government54 paper including bonds, treasury bills and other short-term instruments, but SAMA will reserve the right to apply a specific risk capital requirement to securities issued by certain foreign governments, especially to securities denominated in a currency other than that of the issuing government. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.8 | When the government paper is denominated in the domestic currency and funded by the bank in the same currency, at SAMA later stage discretion a lower specific risk capital requirement may be applied. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.9 | The qualifying category includes securities issued by public sector entities and multilateral development banks, plus other securities that are: | |||||||||||||||||||||||||||||||||||||||||||||
| (1) | rated investment grade (IG)55 by at least two credit rating agencies specified by SAMA; or | |||||||||||||||||||||||||||||||||||||||||||||
| (2) | rated IG by one rating agency and not less than IG by any other rating agency specified by SAMA (subject to SAMA and Capital Market Authority “CMA”); or | |||||||||||||||||||||||||||||||||||||||||||||
| (3) | subject to SAMA approval, unrated, but deemed to be of comparable investment quality by the reporting bank, and the issuer has securities listed on a recognised stock exchange. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.10 | SAMA will be responsible for monitoring the application of these qualifying criteria, particularly in relation to the last criterion where the initial classification is essentially left to the reporting banks. SAMA will also have discretion to include within the qualifying category debt securities issued by banks in countries which have implemented this framework, subject to the express understanding that SAMA undertake prompt remedial action if a bank fails to meet the capital standards set forth in this framework. Similarly, SAMA will have discretion to include within the qualifying category debt securities issued by securities firms that are subject to equivalent rules. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.11 | Furthermore, the qualifying category shall include securities issued by institutions that are deemed to be equivalent to IG quality and subject to SAMA regulatory arrangements comparable to those under this framework. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.12 | Unrated securities may be included in the qualifying category when they are subject to SAMA approval, unrated, but deemed to be of comparable investment quality by the reporting bank, and the issuer has securities listed on a recognised stock exchange. This will remain unchanged for banks using the simplified standardised approach. For banks using the internal ratings-based (IRB) approach for a portfolio, unrated securities can be included in the qualifying category if both of the following conditions are met: | |||||||||||||||||||||||||||||||||||||||||||||
| (1) | the securities are rated equivalent56 to IG under the reporting bank’s internal rating system, which SAMA has confirmed complies with the requirements for an IRB approach; and | |||||||||||||||||||||||||||||||||||||||||||||
| (2) | the issuer has securities listed on a recognised stock exchange. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.13 | However, since this may in certain cases considerably underestimate the specific risk for debt instruments which have a high yield to redemption relative to government debt securities, SAMA will have the discretion: | |||||||||||||||||||||||||||||||||||||||||||||
| (1) | to apply a higher specific risk charge to such instruments; and/or | |||||||||||||||||||||||||||||||||||||||||||||
| (2) | to disallow offsetting for the purposes of defining the extent of general market risk between such instruments and any other debt instruments. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.14 | The specific risk capital requirement of securitisation positions as defined in a 18.1 to 18.6 of SAMA Minimum Capital Requirements for Credit Risk that are held in the trading book is to be calculated according to the revised method for such positions in the banking book as set out in revisions to the securitisation framework. A bank shall calculate the specific risk capital requirement applicable to each net securitisation position by dividing the risk weight calculated as if it were held in the banking book by [12.5]. | |||||||||||||||||||||||||||||||||||||||||||||
| 14.15 | Banks may limit the capital requirement for an individual position in a credit derivative or securitisation instrument to the maximum possible loss. For a short risk position this limit could be calculated as a change in value due to the underlying names immediately becoming default risk-free. For a long risk position, the maximum possible loss could be calculated as the change in value in the event that all the underlying names were to default with zero recoveries. The maximum possible loss must be calculated for each individual position. | |||||||||||||||||||||||||||||||||||||||||||||
| When a bank buys credit protection for an asset-backed security (ABS) tranche and (due to netting rules) the bank is treated as having a net short position, the simplified standardised capital requirement for the net short position is often determined by the max potential loss. This is particularly true when the underlying ABS tranche has been severely downgraded and written down. In particular, banks note that if the underlying ABS continues to deteriorate, the overall capital requirement progressively increases and is dominated by the charge against the short side of the hedged position. | ||||||||||||||||||||||||||||||||||||||||||||||
| Some examples (without and with off-set) illustrate how the Max Loss principle should apply. | ||||||||||||||||||||||||||||||||||||||||||||||
| Max loss without offset: | ||||
| Suppose the bank has net long and net short positions that reference similar, but not the same, underlying assets. In other words the bank hedges an A-rated mezzanine residential mortgage-backed security (RMBS) tranche (notional = USD 100) with a credit default swap (CDS) on a similar but different A-rated mezzanine RMBS (also having notional = USD 100). | ||||
| Suppose the RMBS tranche owned by the bank is now rated C, and has value of USD 15. Also assume that the value of the CDS on the different RMBS has a current value of USD 80. Further, suppose that the current value of the RMBS underlying this CDS is USD 20 and is also rated C. Finally, suppose that the CDS would be valued at USD –2 if the underlying RMBS tranche were to recover unexpectedly and become risk-free. | ||||
| The correct treatment is as follows: min (USD 15, USD 15) (long leg) + min (USD 20, USD 82) (short leg) = USD 35. | ||||
| No off-set would be permissible in this example, because the same underlying asset has not been hedged. The capital requirement should, therefore, be calculated by summing the charges against the long and short legs. The maximum loss principle would apply to each individual position. | ||||
| Please note that the market value of the underlying has been applied in determining the exposure value of the CDS. | ||||
| Max loss with offset: | ||||
| Suppose the bank hedges an A-rated mezzanine RMBS tranche with a CDS referencing the same RMBS having notional of USD 100. Suppose the RMBS tranche is now rated C, and has value USD 15, while the current value of the CDS is USD 85. Suppose that the value of the CDS would equal USD –2 if the RMBS tranche were to recover unexpectedly and become risk-free. | ||||
| In this example, if the CDS exactly matched the RMBS in tenor, then offsetting could potentially apply. In that instance, the capital requirement should equal 20% of max{min(USD 15, USD 15), min(USD 15, USD 87)} = USD 3. | ||||
| If the tenors were not matched (ie maturity mismatch), then the capital requirement should equal max{min(USD 15, USD 15), min(USD 15, USD 87)} = USD 15. | ||||
| Please note that the maximum loss principle cannot be applied on a portfolio basis. | ||||
| 14.16 | Full allowance will be recognised for positions hedged by credit derivatives when the values of two legs (ie long and short) always move in the opposite direction and broadly to the same extent. This would be the case in the following situations, in which cases no specific risk capital requirement applies to both sides of the position: | |||
| (1) | the two legs consist of completely identical instruments; or | |||
| (2) | a long cash position (or credit derivative) is hedged by a total rate of return swap (or vice versa) and there is an exact match between the reference obligation and the underlying exposure (ie the cash position).57 | |||
| According to [14.16] to [14.18], the offsetting treatment is applied to a cash position that is hedged by a credit derivative or a credit derivative that is hedged by another credit derivative, assuming there is an exact match in terms of the reference obligations. The illustration of the treatment would be as following: | ||||
| [14.16] to [14.18], are applicable not only when the underlying position being hedged is a cash position, but also when the position being hedged is a credit default swap (CDS) or other credit derivative. They also apply regardless of whether the cash positions or reference obligations of the credit derivative are single-name or securitisation exposures. | ||||
| For example, when a long cash position is hedged using a CDS, the 80% offset treatment of [14.17] (the partial allowance treatment of [14.18]) generally applies when the reference obligation of the CDS is the cash instrument being hedged and the currencies and remaining maturities of the two positions are (are not) identical. Similarly, when a purchased CDS is hedged with a sold CDS, the 80% offset treatment (the partial allowance treatment) generally applies when both the long and short CDSs have the same reference obligations and the currencies and remaining maturities of the long and short CDSs are (are not) identical. The full allowance (100% offset) treatment generally applies only when there is zero basis risk between the instrument being hedged and the hedging instrument, such as when a cash position is hedged with a total rate of return swap referencing the same cash instrument and there is no currency mismatch, or when a purchased CDS position is hedged by selling a CDS with identical terms in all respects, including reference obligation, currency, maturity, documentation clauses (eg credit payout events, methods for determining payouts for credit events, etc), and structure of fixed and variable payments over time. | ||||
| It is worth noting that the conditions under which partial or full offsetting of risk positions that are subject to interest rate specific risk are narrowly defined. In practice, offsets between securitisation positions and credit derivatives are unlikely to be recognised in most cases due to the explicit requirements in [14.16] to [14.18] on reference names etc. | ||||
| 14.17 | An 80% offset will be recognised when the value of two legs (ie long and short) always moves in the opposite direction but not broadly to the same extent. This would be the case when a long cash position (or credit derivative) is hedged by a credit default swap (CDS) or a credit-linked note (or vice versa) and there is an exact match in terms of the reference obligation, the maturity of both the reference obligation and the credit derivative, and the currency of the underlying exposure. In addition, key features of the credit derivative contract (eg credit event definitions, settlement mechanisms) should not cause the price movement of the credit derivative to materially deviate from the price movements of the cash position. To the extent that the transaction transfers risk (ie taking account of restrictive payout provisions such as fixed payouts and materiality thresholds), an 80% specific risk offset will be applied to the side of the transaction with the higher capital requirement, while the specific risk requirement on the other side will be zero. | |||
| 14.18 | Partial allowance will be recognised when the value of the two legs (ie long and short) usually moves in the opposite direction. This would be the case in the following situations: | |||
| (1) | The position is captured in [14.16](2), but there is an asset mismatch between the reference obligation and the underlying exposure. Nonetheless, the position meets the requirements in [CRE22.86]. | |||
| (2) | The position is captured in [14.16](1) or [14.17] but there is a currency or maturity mismatch58 between the credit protection and the underlying asset. | |||
| (3) | The position is captured in [14.17] but there is an asset mismatch between the cash position (or credit derivative) and the credit derivative hedge. However, the underlying asset is included in the (deliverable) obligations in the credit derivative documentation. | |||
| 14.19 | In each of these cases in [14.16] to [14.18], the following rule applies. Rather than adding the specific risk capital requirements for each side of the transaction (ie the credit protection and the underlying asset) only the higher of the two capital requirements will apply. | |||
| 14.20 | In cases not captured in [14.16] to [14.18], a specific risk capital requirement will be assessed against both sides of the position. | |||
| 14.21 | An nth-to-default credit derivative is a contract where the payoff is based on the nth asset to default in a basket of underlying reference instruments. Once the nth default occurs the transaction terminates and is settled. | |||
| (1) | The capital requirement for specific risk for a first-to-default credit derivative is the lesser of: | |||
| (a) | the sum of the specific risk capital requirements for the individual reference credit instruments in the basket; and | |||
| (b) | the maximum possible credit event payment under the contract. | |||
| (2) | Where a bank has a risk position in one of the reference credit instruments underlying a first-to-default credit derivative and this credit derivative hedges the bank’s risk position, the bank is allowed to reduce, with respect to the hedged amount, both the capital requirement for specific risk for the reference credit instrument and that part of the capital requirement for specific risk for the credit derivative that relates to this particular reference credit instrument. Where a bank has multiple risk positions in reference credit instruments underlying a first-to-default credit derivative, this offset is allowed only for that underlying reference credit instrument having the lowest specific risk capital requirement. | |||
| (3) | The capital requirement for specific risk for an nth-to-default credit derivative with n greater than one is the lesser of: | |||
| (a) | the sum of the specific risk capital requirements for the individual reference credit instruments in the basket but disregarding the (n-1) obligations with the lowest specific risk capital requirements; and | |||
| (b) | the maximum possible credit event payment under the contract. For nth-to- default credit derivatives with n greater than 1, no offset of the capital requirement for specific risk with any underlying reference credit instrument is allowed. | |||
| (4) | If a first or other nth-to-default credit derivative is externally rated, then the protection seller must calculate the specific risk capital requirement using the rating of the derivative and apply the respective securitisation risk weights as specified in [14.14], as applicable. | |||
| (5) | The capital requirement against each net nth-to-default credit derivative position applies irrespective of whether the bank has a long or short position, ie obtains or provides protection. | |||
| The framework mentions only tranches and nth-to-default products explicitly, but not nth to n+m-th-to-default products (eg the value depends on the default of the 5th, 6th, 7th and 8th default in a pool; only in specific cases such as the same nominal for all underlyings can this product be represented by, for example, a 5% to 8% tranche). The nth to n+m-th-to- default products are covered in the framework, such products are to be decomposed into individual nth-to-default products and the rules for nth-to-default products in [14.21] apply. | ||||
| In the example cited above, the capital requirement for a basket default swap covering defaults five to eight would be calculated as the sum of the capital requirements for a 5th- to-default swap, a 6th-to-default swap, a 7th-to-default swap and an 8th-to-default swap. | ||||
| 14.22 | A bank must determine the specific risk capital requirement for the correlation trading portfolio (CTP) as follows: | |||
| (1) | The bank computes: | |||
| (a) | the total specific risk capital requirements that would apply just to the net long positions from the net long correlation trading exposures combined; and | |||
| (b) | the total specific risk capital requirements that would apply just to the net short positions from the net short correlation trading exposures combined. | |||
| (2) | The larger of these total amounts is then the specific risk capital requirement for the CTP. | |||
| The approach of taking the larger of the specific risk capital requirements for net long positions and the specific risk capital requirement for net short positions are not applied to leveraged securitisation positions or option products on securitisation positions. Leveraged securitisation positions and option products on securitisation positions are securitisation positions. They are not admissible for the CTP. The capital requirements for specific risk will be determined as the sum of the capital requirements for specific risk against net long and net short positions. | ||||
| General market risk | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.23 | The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates. A choice between two principal methods of measuring the risk is permitted – a maturity method and a duration method. In each method, the capital requirement is the sum of four components: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | the net short or long position in the whole trading book; | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (2) | a small proportion of the matched positions in each time band (the “vertical disallowance”); | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (3) | a larger proportion of the matched positions across different time bands (the “horizontal disallowance”); and | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (4) | a net charge for positions in options, where appropriate (see [14.84] and [14.85]). | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.24 | Separate maturity ladders should be used for each currency and capital requirements should be calculated for each currency separately and then summed with no offsetting between positions of the opposite sign. In the case of those currencies in which business is insignificant, separate maturity ladders for each currency are not required. Rather, the bank may construct a single maturity ladder and slot, within each appropriate time band, the net long or short position for each currency. However, these individual net positions are to be summed within each time band, irrespective of whether they are long or short positions, to produce a gross position figure. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.25 | In the maturity method (see [14.29] for the duration method), long or short positions in debt securities and other sources of interest rate exposures including derivative instruments, are slotted into a maturity ladder comprising 13 time bands (or 15 time bands in the case of low coupon instruments). Fixed rate instruments should be allocated according to the residual term to maturity and floating-rate instruments according to the residual term to the next repricing date. Opposite positions of the same amount in the same issues (but not different issues by the same issuer), whether actual or notional, can be omitted from the interest rate maturity framework, as well as closely matched swaps, forwards, futures and forward rate agreements (FRAs) which meet the conditions set out in [14.35] and [14.36] below. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.26 | The first step in the calculation is to weight the positions in each time band by a factor designed to reflect the price sensitivity of those positions to assumed changes in interest rates. The weights for each time band are set out in Table 4. Zero-coupon bonds and deep-discount bonds (defined as bonds with a coupon of less than 3%) should be slotted according to the time bands set out in the second column of Table 4. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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14.27 | The next step in the calculation is to offset the weighted longs and shorts in each time band, resulting in a single short or long position for each band. Since, however, each band would include different instruments and different maturities, a 10% capital requirement to reflect basis risk and gap risk will be levied on the smaller of the offsetting positions, be it long or short. Thus, if the sum of the weighted longs in a time band is USD 100 million and the sum of the weighted shorts USD 90 million, the so-called vertical disallowance for that time band would be 10% of USD 90 million (ie USD 9 million). | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.28 | The result of the above calculations is to produce two sets of weighted positions, the net long or short positions in each time band (USD 10 million long in the example above) and the vertical disallowances, which have no sign. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | In addition, however, banks will be allowed to conduct two rounds of horizontal offsetting: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (a) | first between the net positions in each of three zones, where zone 1 is set as zero to one year, zone 2 is set as one year to four years, and zone 3 is set as four years and over (however, for coupons less than 3%, zone 2 is set as one year to 3.6 years and zone 3 is set as 3.6 years and over); and | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (b) | subsequently between the net positions in the three different zones. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (2) | The offsetting will be subject to a scale of disallowances expressed as a fraction of the matched positions, as set out in Table 5. The weighted long and short positions in each of three zones may be offset, subject to the matched portion attracting a disallowance factor that is part of the capital requirement. The residual net position in each zone may be carried over and offset against opposite positions in other zones, subject to a second set of disallowance factors. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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14.29 | Under the alternative duration method, banks with the necessary capability may, with SAMA’ consent, use a more accurate method of measuring all of their general market risk by calculating the price sensitivity of each position separately. Banks must elect and use the method on a continuous basis (unless a change in method is approved by SAMA) and will be subject to SAMA monitoring of the systems used. The mechanics of this method are as follows: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | First calculate the price sensitivity of each instrument in terms of a change in interest rates of between 0.6 and 1.0 percentage points depending on the maturity of the instrument (see Table 6); | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (2) | Slot the resulting sensitivity measures into a duration-based ladder with the 15 time bands set out in Table 6; | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (3) | Subject long and short positions in each time band to a 5% vertical disallowance designed to capture basis risk; and | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (4) | Carry forward the net positions in each time band for horizontal offsetting subject to the disallowances set out in Table 5 above. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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14.30 | In the case of residual currencies (see [14.24] above) the gross positions in each time band will be subject to either the risk weightings set out in [14.26], if positions are reported using the maturity method, or the assumed change in yield set out in [14.29], if positions are reported using the duration method, with no further offsets. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest rate derivatives | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.31 | The measurement system should include all interest-rate derivatives and off- balance sheet instruments in the trading book which react to changes in interest rates (eg FRAs, other forward contracts, bond futures, interest rate and cross-currency swaps and forward foreign exchange positions). Options can be treated in a variety of ways as described in [14.74] to [14.86]. A summary of the rules for dealing with interest rate derivatives is set out in [14.40]. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.32 | The derivatives should be converted into positions in the relevant underlying and become subject to specific and general market risk charges as described above. In order to calculate the standard formula described above, the amounts reported should be the market value of the principal amount of the underlying or of the notional underlying resulting from the Prudent Valuation Guidance. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.33 | Futures and forward contracts (including FRAs) are treated as a combination of a long and a short position in a notional government security. The maturity of a future or an FRA will be the period until delivery or exercise of the contract, plus – where applicable – the life of the underlying instrument. For example, a long position in a June three-month interest rate future (taken in April) is to be reported as a long position in a government security with a five-month maturity and a short position in a government security with a two-month maturity. Where a range of deliverable instruments may be delivered to fulfil the contract, the bank has flexibility to elect which deliverable security goes into the maturity or duration ladder but should take account of any conversion factor defined by the exchange. In the case of a future on a corporate bond index, positions will be included at the market value of the notional underlying portfolio of securities. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.34 | Swaps will be treated as two notional positions in government securities with relevant maturities. For example, an interest rate swap under which a bank is receiving floating rate interest and paying fixed will be treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed-rate instrument of | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.35 | Banks may exclude from the interest rate maturity framework altogether (for both specific and general market risk) long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity. A matched position in a future or forward and its corresponding underlying may also be fully offset60 and thus excluded from the calculation. When the future or the forward comprises a range of deliverable instruments offsetting of positions in the future or forward contract and its underlying is only permissible in cases where there is a readily identifiable underlying security that is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the “cheapest-to- deliver”, and the price of the future or forward contract should, in such cases, move in close alignment. No offsetting will be allowed between positions in different currencies; the separate legs of cross-currency swaps or forward FX deals are to be treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.36 | In addition, opposite positions in the same category of instruments61 can in certain circumstances be regarded as matched and allowed to offset fully. To qualify for this treatment, the positions must relate to the same underlying instruments, be of the same nominal value and be denominated in the same currency.62 In addition: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | for futures: offsetting positions in the notional or underlying instruments to which the futures contract relates must be for identical products and mature within seven days of each other; | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (2) | for swaps and FRAs: the reference rate (for floating rate positions) must be identical and the coupon closely matched (ie within 15 basis points); and | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (3) | for swaps, FRAs and forwards: the next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (a) | less than one month hence: same day; | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (b) | between one month and one year hence: within seven days; and | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (c) | over one year hence: within 30 days. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.37 | Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the payments required by the swap into their present values. For that purpose, each payment should be discounted using zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time band using procedures that apply to zero- (or low-) coupon bonds; these figures should be slotted into the general market risk framework as set out above. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the maturity or duration method and allocate these sensitivities into the time bands set out in [14.26] or [14.29]. Other methods which produce similar results could also be used. Such alternative treatments will, however, only be allowed if: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | SAMA is fully satisfied with the accuracy of the systems being used; | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (2) | the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time bands; and | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (3) | the positions are denominated in the same currency. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.38 | Interest rate and currency swaps, FRAs, forward FX contracts and interest rate futures will not be subject to a specific risk charge. This exemption also applies to futures on an interest rate index (eg London Interbank Offer Rate, or LIBOR). However, in the case of futures contracts where the underlying is a debt security, or an index representing a basket of debt securities, a specific risk charge will apply according to the credit risk of the issuer as set out in [14.5] to [14.21]. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.39 | General market risk applies to positions in all derivative products in the same manner as for cash positions, subject only to an exemption for fully or very closely matched positions in identical instruments as defined in [paragraphs 718(xiii) and 718(xiv) / [14.35] and [14.36]. The various categories of instruments should be slotted into the maturity ladder and treated according to the rules identified earlier. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 14.40 | Table 7 presents a summary of the regulatory treatment for interest rate derivatives, for market risk purposes. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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53 Traded mortgage securities and mortgage derivative products possess unique characteristics because of the risk of prepayment. Accordingly, for the time being, no common treatment will apply to these securities, which will be dealt with SAMA at aleates stage. A security that is the subject of a repurchase or securities lending agreement will be treated as if it were still owned by the lender of the security, ie it will be treated in the same manner as other securities positions.
54 Including, local and regional governments subject to a zero credit risk weight in the credit risk framework.
55 For example, IG include rated Baa or higher by Moody’s and BBB or higher by Standard and Poor’s.
56 Equivalent means the debt security has a one-year probability of default (PD) equal to or less than the one year PD implied by the long-run average one-year PD of a security rated IG or better by a qualifying rating agency.
57 The maturity of the swap itself may be different from that of the underlying exposure.
58 Currency mismatches should feed into the normal reporting of FX risk.
59 The zones for coupons less than 3% are 0 to 1 year, 1 to 3.6 years, and 3.6 years and over.
60 The leg representing the time to expiry of the future should, however, be reported.
61 This includes the delta-equivalent value of options. The delta equivalent of the legs arising out of the treatment of caps and floors as set out in [14.78] can also be offset against each other under the rules laid down in this paragraph.
62 The separate legs of different swaps may also be matched subject to the same conditions.
63 This is the specific risk charge relating to the issuer of the instrument. Under the credit risk rules, a separate capital requirement for the counterparty credit risk applies.
64 The specific risk capital requirement only applies to government debt securities that are rated below AA– (see [14.6] and [14.7]).