| 14.63 | This section sets out the simplified standardised approach for measuring the risk of holding or taking positions in commodities, including precious metals, but excluding gold (which is treated as a foreign currency according to the methodology set out in [14.53] to [14.62] above). A commodity is defined as a physical product which is or can be traded on a secondary market, eg agricultural products, minerals (including oil) and precious metals.
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| 14.64 | The price risk in commodities is often more complex and volatile than that associated with currencies and interest rates. Commodity markets may also be less liquid than those for interest rates and currencies and, as a result, changes in supply and demand can have a more dramatic effect on price and volatility.75 These market characteristics can make price transparency and the effective hedging of commodities risk more difficult.
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| 14.65 | The risks associated with commodities include the following risks:
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| | (1) | For spot or physical trading, the directional risk arising from a change in the spot price is the most important risk.
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| | (2) | However, banks using portfolio strategies involving forward and derivative contracts are exposed to a variety of additional risks, which may well be larger than the risk of a change in spot prices. These include:
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| | | (a) | basis risk (the risk that the relationship between the prices of similar commodities alters through time);
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| | | (b) | interest rate risk (the risk of a change in the cost of carry for forward positions and options); and
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| | | (c) | forward gap risk (the risk that the forward price may change for reasons other than a change in interest rates).
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| | (3) | In addition, banks may face counterparty credit risk on over-the-counter derivatives, but this is captured by one of the methods set out in 5 to 9 and 11 of SAMA Minimum Capital Requirements for Counterparty Credit Risk (CCR) and Credit Valuation Adjustment (CVA)
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| | (4) | The funding of commodities positions may well open a bank to interest rate or FX exposure and if that is so the relevant positions should be included in the measures of interest rate and FX risk described in [14.3] to [14.40] and [14.53] to [14.62], respectively.76
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| 14.66 | There are two alternatives for measuring commodities position risk under the simplified standardised approach that are described in [14.68] to [14.73] below. Commodities risk can also be measured, using either (i) the maturity ladder approach, which is a measurement system that captures forward gap and interest rate risk separately by basing the methodology on seven time bands as set out in [14.68] to [14.71] below or (ii) the simplified approach, which is a very simple framework as set out in [14.72] and [14.73] below. Both the maturity ladder approach and the simplified approach are appropriate only for banks that, in relative terms, conduct only a limited amount of commodities business.
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| 14.67 | For the maturity ladder approach and the simplified approach, long and short positions in each commodity may be reported on a net basis for the purposes of calculating open positions. However, positions in different commodities will, as a general rule, not be offsettable in this fashion. Nevertheless, SAMA will have discretion to permit netting between different subcategories77 of the same commodity in cases where the subcategories are deliverable against each other. They can also be considered as offsettable if they are close substitutes against each other and a minimum correlation of 0.9 between the price movements can be clearly established over a minimum period of one year. However, a bank wishing to base its calculation of capital requirements for commodities on correlations would have to satisfy SAMA of the accuracy of the method that has been chosen and obtain its prior approval.
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Maturity ladder approach
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| 14.68 | In calculating the capital requirements under the maturity ladder approach, banks will first have to express each commodity position (spot plus forward) in terms of the standard unit of measurement (barrels, kilos, grams etc). The net position in each commodity will then be converted at current spot rates into the national currency.
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| 14.69 | Secondly, in order to capture forward gap and interest rate risk within a time band (which, together, are sometimes referred to as curvature/spread risk), matched long and short positions in each time band will carry a capital requirement. The methodology is similar to that used for interest rate related instruments as set out in [14.3] to [14.40]. Positions in the separate commodities (expressed in terms of the standard unit of measurement) will first be entered into a maturity ladder while physical stocks should be allocated to the first time band. A separate maturity ladder will be used for each commodity as defined in [14.67] above.78 For each time band as set out in Table 10, the sum of short and long positions that are matched will be multiplied first by the spot price for the commodity, and then by the spread rate of 1.5%.
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| Time bands and spread rates | Table 10 | | Time band | Spread rate | | 0-1 month | 1.5% | | 1-3 months | 1.5% | | 3-6 months | 1.5% | | 6-12 months | 1.5% | | 1-2 years | 1.5% | | 2-3 years | 1.5% | | over 3 years | 1.5% |
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14.70 |
The residual net positions from nearer time bands may then be carried forward to offset exposures in time bands that are further out. However, recognising that such hedging of positions among different time bands is imprecise, a surcharge equal to 0.6% of the net position carried forward will be added in respect of each time band that the net position is carried forward. The capital requirement for each matched amount created by carrying net positions forward will be calculated as in [14.69] above. At the end of this process, a bank will have either only long or only short positions, to which a capital requirement of 15% will apply.
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| 14.71 | All commodity derivatives and off-balance sheet positions that are affected by changes in commodity prices should be included in this measurement framework. This includes commodity futures, commodity swaps, and options where the “delta-plus” method79 is used (see [14.77] to [14.80] below). In order to calculate the risk, commodity derivatives should be converted into notional commodities positions and assigned to maturities as follows:
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| | (1) | Futures and forward contracts relating to individual commodities should be incorporated as notional amounts of the standard unit of measurement (barrels, kilos, grams etc) and should be assigned a maturity with reference to expiry date.
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| | (2) | Commodity swaps where one leg is a fixed price and the other the current market price should be incorporated as a series of positions equal to the notional amount of the contract, with one position corresponding with each payment on the swap and slotted into the maturity ladder accordingly. The positions would be long positions if the bank is paying fixed and receiving floating, and short positions if the bank is receiving fixed and paying floating.80
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| | (3) | Commodity swaps where the legs are in different commodities are to be incorporated in the relevant maturity ladder. No offsetting will be allowed in this regard except where the commodities belong to the same subcategory as defined in [14.67] above.
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Simplified approach
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| 14.72 | In calculating the capital requirement for directional risk under the simplified approach, the same procedure will be adopted as in the maturity ladder approach described above (see [14.68] and [14.71]. Once again, all commodity derivatives and off-balance sheet positions that are affected by changes in commodity prices should be included. The capital requirement will equal 15% of the net position, long or short, in each commodity.
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| 14.73 | In order to protect the bank against basis risk, interest rate risk and forward gap risk under the simplified approach, the capital requirement for each commodity as described in [14.68] and [14.71] above will be subject to an additional capital requirement equivalent to 3% of the bank’s gross positions, long plus short, in that particular commodity. In valuing the gross positions in commodity derivatives for this purpose, banks should use the current spot price.
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75 Banks need also to guard against the risk that arises when the short position falls due before the long position. Owing to a shortage of liquidity in some markets, it might be difficult to close the short position and the bank might be squeezed by the market.
76 Where a commodity is part of a forward contract (quantity of commodities to be received or to be delivered), any interest rate or foreign currency exposure from the other leg of the contract should be reported as set out in [14.3] to 14.40] and [14.53] to [14.62]. Positions which are purely stock financing (ie a physical stock has been sold forward and the cost of funding has been locked in until the date of the forward sale) may be omitted from the commodities risk calculation although they will be subject to interest rate and counterparty risk requirements.
77 Commodities can be grouped into clans, families, subgroups and individual commodities. For example, a clan might be Energy Commodities, within which Hydro-Carbons are a family with Crude Oil being a subgroup and West Texas Intermediate, Arabian Light and Brent being individual commodities.
78 For markets that have daily delivery dates, any contracts maturing within 10 days of one another may be offset.
79 For banks using other approaches to measure options risk, all options and the associated underlyings should be excluded from both the maturity ladder approach and the simplified approach.
80 If one of the legs involves receiving/paying a fixed or floating interest rate, that exposure should be slotted into the appropriate repricing maturity band in the maturity ladder covering interest rate related instruments.
