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28. Equity Investments in Funds: Illustrative Example of the Calculation of Risk-Weighted Assets (RWA) Under the Look-Through Approach (LTA)
No: 44047144
Date(g): 27/12/2022 | Date(h): 4/6/1444
Status: In-Force
28.1
Consider a fund that replicates an equity index. Moreover, assume the following:
(1)
The bank uses the standardised approach (SA) for credit risk when calculating its capital requirements for credit risk and for determining counterparty credit risk exposures it uses the SA-CCR.
(2)
The bank owns 20% of the shares of the fund.
(3)
The fund holds forward contracts on listed equities that are cleared through a qualifying central counterparty (with a notional amount of USD 100); and
(4)
The fund presents the following balance sheet:
Assets
Cash
USD 20
Government bonds (AAA-rated)
USD 30
Variation margin receivable (ie collateral posted by the bank to the CCP in respect of the forward contracts)
USD 50
Liabilities
Notes payable
USD 5
Equity
Shares, retained earnings and other reserves
USD 95
28.2
The funds exposures will be risk weighted as follows:
(1)
The RWA for the cash (RWAcash) are calculated as the exposure of USD 20 multiplied by the applicable SA risk weight of 0%. Thus, RWAcash = USD 0.
(2)
The RWA for the government bonds (RWAbonds) are calculated as the exposure of USD 30 multiplied by the applicable SA risk weight of 0%. Thus, RWAbonds = USD 0.
(3)
The RWA for the exposures to the listed equities underlying the forward contracts (RWAunderlying) are calculated by multiplying the following three amounts: (1) the SA credit conversion factor of 100% that is applicable to forward purchases; (2) the exposure to the notional of USD 100; and (3) the applicable risk weight for listed equities under the SA which is 250%. Thus, RWAunderlying = 100% * USD100 * 250% = USD 250.
(4)
The forward purchase equities expose the bank to counterparty credit risk in respect of the market value of the forwards and the collateral posted that is not held by the CCP on a bankruptcy remote basis. For the sake of simplicity, this example assumes the application of SA-CCR results in an exposure value of USD 56. The RWA for counterparty credit risk (RWACCR) are determined by multiplying the exposure amount by the relevant risk weight for trade exposures to CCPs, which 2% in this case (see chapter 8 of Minimum Capital Requirements for Credit Risk for the capital requirements for bank exposures to CCPs). Thus, RWACCR = USD 56 * 2% = USD 1.12. (Note: There is no credit valuation adjustment, or CVA, charge assessed since the forward contracts are cleared through a CCP.)
28.3
The total RWA of the fund are therefore USD 251.12 = (0 + 0 +250 + 1.12).
28.4
The leverage of a fund under the LTA is calculated as the ratio of the fund’s total assets to its total equity, which in this examples is 100/95.
28.5
Therefore, the RWA for the bank’s equity investment in the fund is calculated as the product of the average risk weight of the fund, the fund’s leverage and the size of the banks equity investment. That is:
