Download Guidance Note

Sept 2000
Guidance Note
AGN 113.3 - The Standard Method
1.
The standard method is comprised of five sections: traded debt securities
and other interest rate related securities, traded equities and other equity
instruments, foreign exchange, commodities and options on each of these
asset classes. For each asset class, the method provides some alternative
methodologies that allow ADIs to use a range of techniques to calculate
the market risks arising from their trading activities.
2.
ADIs which run global consolidated books should report short and long
positions in exactly the same instrument on a net basis, no matter where
they are booked. Positions taken in an offshore branch or subsidiary may
be netted provided that the position taking of that site is monitored by the
Australian office on a daily basis. Nonetheless, there will be
circumstances in which individual positions should be taken into the
measurement system without any offsetting or netting against positions in
the remainder of the group. For example, positions should not be netted
where there are obstacles to the quick repatriation of profits from a
foreign subsidiary or branch or from offshore transactions taken by the
ADI itself or where there are legal and procedural difficulties in carrying
out the timely management of risks on a consolidated basis.
Interest Rate Risk
3.
1
This section describes the standard method 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.1 Interest rate
exposures arising from forward foreign exchange transactions and
forward sales and purchases of equities and commodities must also be
included. The rho interest rate exposure on foreign exchange, equity and
commodity options may be included. Convertible bonds, ie debt issues or
preference shares that are convertible into common shares of the issuer,
will be treated as debt securities if they trade like debt securities and as
A security which 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
security’s positions.
AGN 113.3 – 1
Sept 2000
equities if they trade like equities. The basis for dealing with derivative
products is considered in Paragraphs 22 to 25 below.
4.
The minimum capital requirement is expressed in terms of two separately
calculated charges, one applying to the “specific risk” of each instrument,
irrespective of 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. An example of how general market risk is to be calculated is set
out in AGN 113.5.
Specific risk
5.
The capital charge 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, an ADI may offset
matched long and short positions in an 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.
6.
The specific risk charge is graduated in five broad categories as follows:
government
0.00%
qualifying
0.25%
residual term to final maturity 6 months or
less
1.00%
residual term to final maturity greater than
6 months and up to and including 24
months
1.60%
residual term to final maturity exceeding
24 months
other
7.
8.00%.
The category “government” includes all forms of government paper
including bonds, Treasury notes and other short-term instruments. Such
debt instruments are given a zero specific risk charge if:
AGN 113.3 – 2
Sept 2000
8.
(a)
they are issued by, fully guaranteed by, or fully collateralised2 by
securities issued by, the Australian Commonwealth Government,
State (including Territories) governments or the Reserve Bank of
Australia; or
(b)
they are issued by, fully guaranteed by, or fully collateralised by
securities issued by, central governments or central banks within the
OECD; or
(c)
they are issued by, or fully guaranteed by non-OECD country
central governments and central banks, and have a residual maturity
of one year or less and are denominated in local currency and the
ADI’s holdings of such paper are funded by liabilities in the same
currency.
The “qualifying” category includes securities that are:
(a)
(b)
9.
rated investment-grade by at least two of the credit rating agencies
listed in Table 1 at the end of this section (this list may be amended
periodically); or
rated investment-grade by one rating agency or unrated, but deemed
to be of comparable investment quality by the reporting ADI
(subject to approval by APRA), and the issuer has its equity
included in a recognised market index (listed in Table 5 in the
Section “Equity Position Risk”). Each ADI must agree a policy
statement with APRA concerning those securities that it considers to
be of comparable investment quality.
In addition, debt securities will be treated as qualifying if any of the
following conditions apply:
(a)
they are issued by, or guaranteed by, Australian local governments
or Australian public sector entities (except those which have
corporate status and operate on a commercial basis)3;
(b)
they are issued by, or fully guaranteed by, non-OECD country
central governments and central banks and have a residual maturity
of over one year and are denominated in local currency and the
2
Refer to APS 112 – Capital Adequacy: Credit Risk (Collateral and Guarantees) for acceptable
collateral and guarantee arrangements. In the case that the guarantee or collateral value is at least as
large as the debt instrument's market value the arrangement will be regarded as fully guaranteed or
collateralised.
3
Refer to APS 112 – Capital Adequacy: Credit Risk.
AGN 113.3 – 3
Sept 2000
ADI’s holdings of such paper are funded by liabilities in the same
currency;
(c)
they are issued by, or fully collateralised by claims on, an
international agency or regional development bank, including the
International Monetary Fund, the International Bank for
Reconstruction and Development, the Bank for International
Settlements and the Asian Development Bank;
(d)
they are issued, guaranteed, endorsed4 or accepted by an Australian
ADI5 or a bank incorporated in other OECD6 countries, provided
that such instruments do not qualify as capital of the issuing
institution7;
(e)
they are issued, guaranteed, endorsed or accepted by a non-OECD
bank and have a residual maturity of one year or less, provided that
such instruments do not qualify as capital of the issuing institution8;
(f)
they are issued by, or guaranteed by, OECD state and regional
governments or OECD public-sector entities;
(g)
they are issued by, or guaranteed by, an entity that is subject to a
capital adequacy regime (covering both credit and market risk)
which is equivalent to APRA’s requirements. The Australian Stock
Exchange and the European Economic Community’s Capital
Adequacy Directive are deemed to have equivalent regimes as are
the regulators of investment firms from the following countries:
Canada, Hong Kong, Japan, Switzerland and the USA. ADIs may
apply to APRA to have other countries or other regulators added to
this list.
10. Appropriately rated asset-backed securities (for example, mortgagebacked securities) are eligible for the qualifying specific risk charge.
4
Only where the ADI is the first endorser.
5
As defined in APS 112 – Capital Adequacy: Credit Risk.
6
This includes banks in non-OECD countries of the Asia-Pacific areas that are accorded the same
credit risk weight as OECD banks under APS 112 – Capital Adequacy: Credit Risk.
7
Instruments that are regarded as capital of the issuing institution should be assessed on the basis of
the rating of the issue rather than the issuer; only those issues satisfying the requirements of
Paragraph 8 may be regarded as qualifying.
8
Refer Footnote 7.
AGN 113.3 – 4
Sept 2000
11. Fund raising instruments issued, guaranteed or accepted by the ADI and
included in the trading book only attract capital requirements for general
market risk, not specific risk.9
General market risk
12. The capital requirements for general market risk are designed to capture
the risk of loss arising from changes in market interest rates. Within the
standard approach, a choice between two principal methods of measuring
the risk is permitted, a “maturity” method and a “duration” method. In
each method, positions are allocated across a maturity ladder, and the
capital charge is then calculated as the sum of four components:
(a)
the net short or long weighted position across the whole trading
book;
(b)
a small proportion of the matched positions in each time band (the
“vertical disallowance”);
(c)
a larger proportion of the matched positions across different time
bands (the “horizontal disallowance”); and
(d)
a net charge for positions in options, where appropriate (refer
Section “Treatment of Options”).
13. Separate maturity ladders must be used for positions in each currency.
Capital charges should be calculated for each currency separately and
then summed with no offsetting between positions of different currencies.
In the case of those currencies in which business is insignificant (residual
currencies), separate maturity ladders for each currency are not required.
Rather, the ADI may construct a single maturity ladder and record, within
each appropriate time band, the net long or short position in each
currency. However, the absolute value of these individual net positions
must be summed within each time band, irrespective of whether they are
long or short positions, to produce a gross position figure.
14. In the maturity method, long or short positions in debt securities and other
sources of interest rate exposures, including derivative instruments, are
entered into a maturity ladder comprising thirteen time bands (or fifteen
time bands in the case of low-coupon instruments). These time bands are
specified in Table 2 at the end of this section. Fixed-rate instruments
should be allocated according to the residual term to maturity and
9
Where the ADI has guaranteed or accepted the instrument, capital must also be held against the
credit risk of the issuer (refer APS 112 – Capital Adequacy: Credit Risk).
AGN 113.3 – 5
Sept 2000
floating-rate instruments according to the residual term to the next
repricing date. Opposite positions of the same amount in the same issue
(but not different issues by the same issuer) can be omitted from the
interest rate maturity framework (refer Paragraph 32) as can closely
matched swaps, forwards, futures and FRAs which meet the conditions
set out in Paragraphs 32 to 35.
15. The first step in the calculation of the capital charge 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 risk
weights for each time band are set out in Table 2. Zero-coupon bonds and
low-coupon bonds (defined as bonds with a coupon of less than
3 per cent) should be entered according to the time bands set out in the
second column of Table 2.
16. The next step in the calculation is to offset the weighted longs and shorts
within each time band. Weighted positions arising from low-coupon
instruments should be combined with other weighted positions, across
corresponding time bands, at this stage.
17. Since each band would include different instruments and different
maturities, a 10 per cent capital charge to reflect basis risk and gap risk
should be levied on the smaller of the offsetting positions (ie the matched
position), be it long or short, in each time band. Thus, if the sum of the
weighted longs in a time band is $100 million and the sum of the
weighted shorts is $90 million, the so-called “vertical disallowance” for
that time band would be 10 per cent of $90 million (ie $9.0 million).
18. The result of the above calculations is to produce a net weighted position,
long or short, in each time band and a set of vertical disallowances. The
maturity ladder is then divided into three zones defined as zero and up to
one year, over one year and up to 4 years and over 4 years.10 ADIs must
then conduct two rounds of offsetting, first between the net time band
positions within each zone and subsequently between the net positions
across the three different zones (that is, between adjacent zones and
non-adjacent zones). The offsetting will be subject to a scale of
disallowances expressed as a fraction of the matched positions, as set out
in Table 3 at the end of this section. The residual net position in each zone
may be carried over and offset against opposite positions in other zones.
10
The zones for coupons less than 3 per cent are 0 and up to one year, over one and up to 3.6 years,
and over 3.6 years.
AGN 113.3 – 6
Sept 2000
19. The general market risk capital requirement will be the sum of:
Net position
100%
Vertical
11
disallowances

Net short or long weighted positions
Matched weighted positions
in all maturity bands
 10%
 40%
Matched weighted positions within zone 1

Matched weighted positions within zone 2
Horizontal
30%
Matched weighted positions within zone 3

30% disallowances
Matched weighted positions between zones 1 & 2

40% Matched weighted positions between zones 2 & 3 
40% Matched weighted positions between zones 1 & 3 
100%
20. Under the alternative duration method, ADIs with the necessary
capability may, with APRA’s consent, use a more accurate method of
measuring all of their general market risk by calculating the price
sensitivity of each position separately. ADIs that elect to use the method
must do so on a continuing basis (unless a change in method is approved
by APRA) and will be subject to monitoring by APRA of the systems
used. The mechanics of this method are as follows:
(a)
11
calculate the price sensitivity of each instrument in terms of a
change in interest rates of between 0.6 and 1.0 percentage points
(refer Table 2) depending on the modified duration of the instrument
(based on the time bands in the second column of Table 2);
(b)
enter the resulting sensitivity measures into a duration-based ladder
in the fifteen time bands set out in the second column of Table 2;
(c)
subject long and short positions in each time band to a 5 per cent
vertical disallowance to capture basis risk; and
(d)
carry forward the net positions in each time band for horizontal
offsetting subject to the disallowances set out in Table 3.
The smaller of the absolute value of the short and long positions within each time band.
AGN 113.3 – 7
Sept 2000
21. In the case of residual currencies (refer Paragraph 13 above) the gross
positions in each time band will be subject to either the risk weightings
set out in Table 2, if positions are reported using the maturity method, or
the assumed changes in yield set out in Table 2, if positions are reported
using the duration method, with no further offsets.
Interest rate derivatives
22. 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 forward rate agreements (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 the Section “Treatment of Options”. A summary
of the rules for dealing with interest rate derivatives is set out in Table 4
at the end of this section.
Calculation of positions
23. Derivatives must be converted into positions in the relevant underlying
and become subject to specific and general market risk charges. In order
to determine the capital charge under the standard method, the amounts
reported should be the market value of the principal amount of the
underlying or of the notional underlying.
Futures and forward contracts, including forward rate agreements
24. These instruments are treated as a combination of a long and a short
position in a notional government security or, in the case of futures or
forwards on bank or corporate debt, as a combination of a long and a
short position in the underlying debt security. The maturity of a future or
a FRA will be the period until delivery or exercise of the contract, plus
the life of the underlying or notional underlying instrument. For example,
a long position in a June three-year government bond future (taken in
April) is to be reported as a long position in a government security with a
maturity of three years and two months and a short position in a
government security with a maturity of two months. The long and short
positions should be reported at the market value of the underlying or
notional underlying security or portfolio of securities. Where a range of
deliverable instruments may be delivered to fulfil the contract, the ADI
has flexibility to elect which deliverable security goes into the maturity or
AGN 113.3 – 8
Sept 2000
duration ladder but should take account of any conversion factor defined
by the exchange.12
Swaps
25. Swaps should be treated as two notional positions in government
securities with relevant maturities. For example, an interest rate swap
under which an ADI 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 maturity equivalent to the residual life of the
swap. Both legs of the swap are to be reported at their market values. For
swaps that pay or receive a fixed or floating interest rate against some
other reference price, eg a stock index, the interest rate component should
be entered into the appropriate repricing maturity category, with the
equity component being included in the equity framework. The separate
legs of cross-currency swaps are to be reported in the relevant maturity
ladders for the currencies concerned and any foreign exchange risk
included in the Section “Foreign Exchange Risk”.
Pre-processing techniques
26. ADIs will be permitted to use alternative methods to calculate the
positions to be included in the maturity or duration ladder. Such formulae
may be applied to all interest rate sensitive positions, arising from both
physical and derivative instruments, including swaps, FRAs, option deltaequivalents and forward foreign exchange. One method would be to first
convert the cash flows required under each transaction into their present
values. For that purpose, each cash flow should be discounted using zerocoupon yields. A single net present value (NPV) for each time band
would be calculated using procedures that apply to zero-coupon bonds
(the cash flows should be entered into the general market risk framework
as set out earlier using the time bands specified in the second column of
Table 2). To determine price sensitivity, the NPV in each time band
would be weighted by the risk weights given in Table 2. An alternative
method would be to calculate the sensitivity of the NPV in each time band
using the changes in yield given in Table 2 (again, the cash flows would
be allocated using the time bands set out in the second column of
Table 2).
27. Other methods which produce similar results could also be used. Use of
any such alternative treatments will, however, only be allowed if:
12
In some cases in permitting delivery of a security against a futures contract the full value of the
contract is not recognised, but rather some pre-specified fraction of the value is recognised  that
fraction is termed the “conversion factor”.
AGN 113.3 – 9
Sept 2000
(a)
APRA is satisfied with the accuracy of the systems being used;
(b)
the positions calculated fully reflect the sensitivity of the cash flows
to interest rate changes and are entered into the appropriate time
bands; and
(c)
the positions allocated to a single maturity ladder are denominated in
the same currency.
28. Positions calculated using the pre-processing method may not be offset
against weighted positions calculated using the maturity method. That is,
pre-processing positions must be allocated to separate maturity ladders
and separate general market risk charges must be calculated. Preprocessing positions may, however, be combined with any weighted
positions obtained using the duration method.
Calculation of capital charges for derivatives
methodology
under the standard
Specific risk
29. Interest rate and cross-currency swaps, FRAs, forward foreign exchange
contracts and interest rate futures will not be subject to a specific risk
charge (they are, however, subject to the credit risk provisions set out in
APS 112 – Capital Adequacy: Credit Risk). This exemption also applies
to futures on an interest rate index (eg BBSW). In the case of contracts
where the underlying is a specific debt security, or an index representing a
basket of debt securities, a specific risk charge will apply as set out in
Paragraphs 5 to 11.13
30. When a future or forward comprises a range of deliverable instruments
with different issuers then a specific risk charge will only apply to long
positions in the future or forward, not short positions. The reason for this
is that the holder of a short futures position will be able to select the most
favourable security to deliver against the futures contract, and thereby
avoid issuer specific price risk. An ADI holding a long position is not able
to dictate which security it will receive and therefore remains exposed to
the issuer specific risk. The one exception to this requirement is a long
position in a bank bill futures contract traded on the Sydney Futures
Exchange, which is exempt from a specific risk capital charge.
13
Consistent with APS 112 – Capital Adequacy: Credit Risk, forward and futures contracts where the
ADI has a right to substitute cash settlement for physical delivery and the price on settlement is
calculated with reference to a general market price indicator will be exempt from specific risk
charges.
AGN 113.3 – 10
Sept 2000
General market risk
31. 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
Paragraph 35 below. The various categories of instruments should be
entered into the maturity ladder and treated according to the rules
identified earlier.
Allowable offsetting of matched positions (specific and general market risk)
32. ADIs 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 offset14 and thus
excluded from the calculation.15
33. When the future or the forward comprises a range of deliverable
instruments, offsetting of positions in the future or forward contract and
the corresponding underlying is only permissible in cases where there is a
readily identifiable underlying security which is most profitable for the
ADI 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.
34. No offsetting will be allowed between positions in different currencies;
the separate legs of cross-currency swaps or forward foreign exchange
deals are to be treated as notional positions in the relevant instruments and
included in the appropriate calculation for each currency.
14
The leg representing the time to expiry of the future (that is, the net exposure from the combination
of the future and the underlying) should, however, be reported. For example, consider an ADI
holding a long position in a government bond maturing in ten years and three months time and a
short position in a 10-year bond futures contract expiring in three months time. The long 10-year
bond holding and the short 10-year position arising from the futures contract offset each other,
leaving a long position in the 1 to 3 months time band which must be included.
15
Consistent with APS 112 – Capital Adequacy: Credit Risk, forward and futures contracts where the
ADI has a right to substitute cash settlement for physical delivery and the price on settlement is
calculated with reference to a general market price indicator (such as the average bank bill rate)
cannot be offset against specific securities (including those securities making up the market index).
AGN 113.3 – 11
Sept 2000
35. Opposite positions within and across product groups16 can in certain
circumstances also 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.17 In addition:
(a)
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;
(b)
For swaps, FRAs and forwards18 the reference rate (for floating-rate
positions) must be identical and the coupon closely matched (ie
within 15 basis points). Also, the next interest fixing date or, for
fixed coupon positions or forwards, the residual maturity, must
correspond within the following limits:
(i)
if either of the instruments which are candidates for offsetting
have an interest fixing date or residual maturity up to and
including one month then those dates or residual maturities
must be the same for both instruments;
(ii) if either of the instruments which are candidates for offsetting
have an interest fixing date or residual maturity greater than
one month and up to and including one year then those dates or
residual maturities must be within seven days of each other; or
(iii) if either of the instruments which are candidates for offsetting
have an interest fixing date or residual maturity over one year
then those dates or residual maturities must be within thirty
days of each other.
Index
16
This excludes offsetting between a matched position in a future or forward and its underlying,
which is governed by Paragraphs 32 and 33. It does include 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
Paragraph 94 of the Section “Treatment of Options” can also be offset against each other under the
rules laid down in this paragraph.
17
The separate legs of different swaps may also be “matched” subject to the same conditions.
18
Spot, or cash, positions in the same currency may be offset subject to these same conditions.
AGN 113.3 – 12
Sept 2000
Table 1 Credit rating agencies and investment grade ratings
Minimum Ratings
Securities
Money
Market
Obligations
For all issuers
Moody’s Investor Services
Standard & Poors Corporation
Baa3
BBB-
P3
A3
Fitch IBCA (Aust.) Ltd
BBB-
F-3
For all ADIs and subsidiaries of ADIs
(not otherwise eligible as qualifying securities)
Thomson Financial BankWatch
BBB-
TBW-3
For Canadian Issuers
Canadian Bond Rating Service
Dominion Bond Rating Service
B++low
BBB low
A-3
R-2
For Japanese Issuers
Japan Credit Rating Agency Ltd
BBB-
J-2
Nippon Investor Services Inc
The Japan Bond Research Institute
Mikuni & Co
Fitch Investors Services Inc
BBBBBBBBB
BBB-
a-3
A-2
M-3
F-3
For United States Issuers
Duff & Phelps Inc
Fitch Investors Services Inc
BBBBBB-
3
F-3
AGN 113.3 – 13
Sept 2000
Table 2 Time bands and risk weights
Coupon 3% or more
Coupon less than 3%
or
the duration method
Risk
weight
(%)
Assumed
changes in
yield (%)
1 month or less
1 month or less
0.00
1.00
over 1 and up to 3 months
Over 1 and up to 3 months
0.20
1.00
over 3 and up to 6 months
Over 3 and up to 6 months
0.40
1.00
over 6 and up to 12 months
Over 6 and up to 12 months
0.70
1.00
over 1 and up to 2 years
Over 1.0 and up to 1.9 years
1.25
0.90
over 2 and up to 3 years
Over 1.9 and up to 2.8 years
1.75
0.80
over 3 and up to 4 years
Over 2.8 and up to 3.6 years
2.25
0.75
over 4 and up to 5 years
Over 3.6 and up to 4.3 years
2.75
0.75
over 5 and up to 7 years
Over 4.3 and up to 5.7 years
3.25
0.70
over 7 and up to 10 years
Over 5.7 and up to 7.3 years
3.75
0.65
over 10 and up to 15 years
Over 7.3 and up to 9.3 years
4.50
0.60
over 15 and up to 20 years
Over 9.3 and up to 10.6 years
5.25
0.60
over 20 years
Over 10.6 and up to 12 years
6.00
0.60
Over 12 and up to 20 years
8.00
0.60
Over 20 years
12.50
0.60
AGN 113.3 – 14
Sept 2000
Table 3 Horizontal disallowances
Zones19
Time band
Within the
zone
Between
adjacent zones
Between zones
1 and 3
0 – 1 month
1 – 3 months
Zone 1
3 – 6 months
40%
40%
6 – 12 months
1 – 2 years
Zone 2
2 – 3 years
100%
30%
3 – 4 years
40%
4 – 5 years
5 – 7 years
7 – 10 years
Zone 3
10 – 15 years
30%
15 – 20 years
over 20 years
19
The zones for coupons less than 3% are 0 to 1 year, over 1 to 3.6 years, and over 3.6 years.
AGN 113.3 – 15
Sept 2000
Table 4 Summary of treatment of interest rate derivatives
Instrument
Specific
General market risk
risk20
Exchange-traded futures
- Government debt security
No
Yes, as two positions
- Corporate debt security
Yes
Yes, as two positions
- Index on interest rates
No
Yes, as two positions
- Government debt security
No
Yes, as two positions
- Corporate debt security
Yes
Yes, as two positions
- Index on interest rates
No
Yes, as two positions
FRAs, swaps
No
Yes, as two positions
Forward foreign exchange
No
Yes, as one position in each currency
OTC forwards
Options
(refer Section “Treatment of Options”)
Either
(a)
- Government debt security
No
- Corporate debt security
Yes
- Index on interest rates
No
- FRAs, swaps
No
- simplified approach
- contingent loss analysis
or
(b)
20
Carve out together with the
associated hedging
positions:
Apply the delta-plus
method (gamma and vega
should each receive a
separate capital charge)
This is the specific risk charge relating to the issuer of the instrument. Under APS 112 – Capital
Adequacy: Credit Risk there remains a separate capital charge for counterparty risk.
AGN 113.3 – 16
Sept 2000
Equity Position Risk
36. This section sets out a minimum capital standard to cover the risk of
positions in equities in the trading book. It applies to long and short
positions in all instruments that exhibit market behaviour similar to
equities. The instruments covered include ordinary shares, whether voting
or non-voting, convertible securities that behave like equities, and
commitments to buy or sell equity securities. Non-convertible preference
shares are to be excluded from these calculations. They are covered by the
interest rate risk requirements described in the Section “Interest Rate
Risk”. Long and short positions in instruments relating to the same issuer
may be reported on a net basis. The treatment of derivative products,
share indices and index arbitrage is described in the section below on
equity derivatives.
Specific and general market risk
37. As with debt securities, the minimum capital standard for equities is
expressed in terms of two separately calculated charges for the “specific
risk” of holding a long or short individual equity position and for the
“general market risk” of holding a long or short position in the market as
a whole. The long or short position in the market must be calculated on a
market-by-market basis. A separate calculation has to be carried out for
each national market in which the ADI holds equities.
38. Specific risk is defined as a proportion of the ADI’s gross equity positions
(ie the sum of the absolute value of all long equity positions and of all
short equity positions).21 The capital charge for specific risk will be
8 per cent, unless the portfolio is both liquid and well diversified, in
which case the charge will be 4 per cent.
39. Individual equities included in the indices listed in Table 5 at the end of
this section are considered to be liquid (this list may be amended
periodically).
40. A portfolio of liquid equities will be regarded as well diversified provided
that the following requirements are met:
(a)
21
no individual liquid equity position comprises more than 10 per cent
of the gross value of the ADI’s portfolio of equities traded on the
markets in each particular country (the “country portfolio”); and
An “equity position” is the net of short and long exposures to an individual company. Hence,
specific risk is assessed on the gross position across companies rather than individual transactions.
AGN 113.3 – 17
Sept 2000
(b)
the sum of the gross value of liquid equity positions which
individually comprise more than 5 and up to 10 per cent of the gross
value of the country portfolio does not exceed 50 per cent of the
gross value of the ADI's portfolio in that country.
41. If a liquid country portfolio can be split into two sub-portfolios such that
one of the sub-portfolios would meet the diversification requirements, the
lower specific risk charge may be applied to the diversified sub-portfolio.
Individual positions may be divided between sub-portfolios. Portfolios or
sub-portfolios that do not meet the diversification requirements will
continue to attract the 8 per cent specific risk weight.
42. General market risk will be assessed on the difference between the sum of
the longs and the sum of the shorts (ie the overall net position in an equity
market). The general market risk charge will be 8 per cent of the net
position. Again, a separate capital charge calculation must be carried out
for each national market in which the ADI holds equities.
Equity derivatives
43. Except for options, which are dealt with in the Section “Treatment of
Options”, equity derivatives and off-balance sheet positions which are
affected by changes in equity prices, should be included in the
measurement system.22 This includes futures and swaps on both
individual equities and on stock indices. The derivatives are to be
converted into positions in the relevant underlying. The treatment of
equity derivatives is summarised in Table 6 at the end of this section.
Calculation of positions
44. In order to calculate the specific and general market risk capital charges
using the standard method, positions in derivatives should be converted
into notional equity positions:
22
(a)
futures and forward contracts relating to individual equities should
be reported at current market prices;
(b)
futures relating to stock indices should be reported as the
mark-to-market value of the notional underlying equity portfolio;
Where equities form one leg of a forward or futures contract (the quantity of equities 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 the Sections “Interest Rate Risk” and “Foreign Exchange Risk”
respectively.
AGN 113.3 – 18
Sept 2000
(c)
equity swaps are to be treated as two notional positions; 23 and
(d)
equity options and stock index options must either be “carved out”
together with the associated underlying assets (that is, the options
and their associated hedges are excluded from the calculations
performed for all other equity positions and a separate risk charge is
obtained using the simplified approach or contingent loss method set
out in the Section “Treatment of Options”) or be incorporated in the
measurement of specific and general market risk described in this
section using the delta-plus method (refer Section “Treatment of
Options”).
45. If an ADI takes a position in depository receipts against an opposite
position in the underlying equity or the same equity listed in a different
country, it may offset the position (ie bear no capital charge) but only on
condition that any costs on conversion are fully taken into account.
Calculation of capital charges
Measurement of specific and general market risk
46. Matched positions in each identical equity or stock index in each market
may be fully offset, resulting in a single net short or long position to
which the specific and general market risk charges will apply. For
example, a future in a given equity may be offset against an opposite
physical position in the same equity.24
Risk in relation to an index
47. Besides general market risk, a specific risk capital charge of 2 per cent
will apply to the net long or short position in an index contract listed in
Table 5 at the end of this section.
48. Positions in indices not listed in Table 5 must either be decomposed into
their component shares, or be treated as a single position based on the
sum of current market values of the underlying instruments; if treated as a
23
For example, an equity swap in which an ADI is receiving an amount based on the change in value
of one particular equity or stock index and paying a different index will be treated as a long position
in the former and a short position in the latter. Where one of the legs involves receiving/paying a
fixed or floating interest rate, that exposure should be entered into the appropriate repricing time
band for interest rate related instruments as set out in the Section “Interest Rate Risk”. The stock
index should be covered by the equity treatment detailed in Paragraphs 47 and 48.
24
The interest rate risk arising out of the futures contract, however, should be reported as set out in
the Section “Interest Rate Risk”.
AGN 113.3 – 19
Sept 2000
single position, the specific risk requirement is the highest specific risk
charge which would apply to any of the index’s constituent shares.
Arbitrage
49. In the case of the futures-related arbitrage strategies described below, the
additional 2 per cent capital charge described in Paragraph 47 may be
applied to only one index with the opposite position exempt from a capital
charge for both specific risk and general market risk. The strategies are:
(a)
when the ADI takes an opposite position in exactly the same index
at different dates or in different market centres; or
(b)
when the ADI has an opposite position in contracts at the same date
in different but similar indices, subject to APRA’s agreement that
the two indices contain sufficient common components to justify
offsetting.
50. Where an ADI engages in a deliberate arbitrage strategy, in which a
futures contract on a broadly-based index matches a basket of shares, it
may decompose the index position into notional positions in each of the
constituent stocks and include these notional positions and the
disaggregated physical basket in the country portfolio, netting the
physical positions against the index-equivalent positions in each stock.
Alternatively, an ADI may choose to apply the capital charge set out in
Paragraph 52 provided that:
(a)
the trade has been deliberately entered into and separately
controlled; and
(b)
the composition of the basket of shares represents at least
90 per cent of the index when broken down into its notional
components, or a minimum correlation between the basket of shares
and the index of 0.9 can be clearly established over a minimum
period of one year;25
Where these conditions are not met, the arbitrage must be dealt with using
the approach set out in Paragraph 53.
51. To determine whether a basket of shares represents at least 90 per cent of
the index, the relative weight of each stock in the physical basket should
be compared to the weight of each stock in the index to calculate a
25
An ADI wishing to rely on the correlation based criteria will need to satisfy APRA of the accuracy
of the method chosen.
AGN 113.3 – 20
Sept 2000
percentage slippage from the index weights. For example, where a stock
represents 5 per cent of the index, but the holding of that stock in the
basket only represents 4.5 per cent of the total basket value, the
percentage slippage of that stock is 0.5 per cent. Stocks which comprise
the index but which are not held in the physical basket have a slippage
equal to their percentage weight in the index. The sum of these
differences across each stock in the index represents the total level of
slippage from the index. In summing the percentage differences, no
netting should be applied between under market-weight and over marketweight holdings (ie the absolute values of the percentage slippages should
be summed). Deducting the total slippage from 100 gives the percentage
coverage of the index which should be compared to the required
minimum of 90 per cent. An example of this calculation is presented in
AGN 113.5.
52. In such cases as described in Paragraph 50, where the values of the
physical and futures positions are matched, the capital charge must be
assessed as 2 per cent of the gross value of the positions on each side (ie a
total of 4 per cent). Any excess value of the shares comprising the basket
over the value of the futures contract, or excess value of the futures
contract over the value of the basket, is to be treated as an open long or
short position and dealt with using the approach described in
Paragraph 53.
53. In the case of an arbitrage that does not satisfy the requirements of
Paragraph 50, the index position should be treated according to either
Paragraph 47 or Paragraph 48 as appropriate. The physical basket of
shares should then be disaggregated into individual positions and included
in the country portfolio for calculation of the capital charge.
Index
AGN 113.3 – 21
Sept 2000
Table 5 Market indices
Australia
S&P/ASX 200
Japan
Nikkei 225
Australia
XPI
Netherlands
AEX
Austria
ATX
Spain
IBEX 35
Belgium
BEL20
Sweden
OMX
Canada
TSE 35
Switzerland
SMI
France
CAC 40
UK
FTSE 100
Germany
DAX
UK
FTSE mid-250
Hong Kong
Hang Seng
USA
S&P 500
Italy
MIB 30
Table 6 Summary of treatment of equity derivatives
Instrument
Specific risk26
General market risk
Exchange-traded or OTC
futures
Individual equity
Yes
Yes, as underlying
Index
2%
Yes, as underlying
Options (refer Section
“Treatment of Options”)
Individual equity
Index
Either
Yes
2%
(a) Carve out together with the associated
hedging positions
- simplified approach
- contingent loss analysis
or
(b) General market risk charge according
to the delta-plus method (gamma and
vega should each receive a separate
capital charge)
Rho risk may be included with other
interest rate exposures as described in the
Section “Interest Rate Risk”.
26
This is the specific risk charge relating to the issuer of the instrument. Under APS 112 – Capital
Adequacy: Credit Risk, there remains a separate capital charge for counterparty credit risk.
AGN 113.3 – 22
Sept 2000
Foreign Exchange Risk
54. This section sets out a minimum capital standard to cover the risk of
holding or taking positions in foreign currencies and gold. 27
55. Taking on foreign exchange positions may expose an ADI to interest rate
exposure (for example, in forward foreign exchange contracts). In such a
case the relevant interest rate positions should be included in the
calculation of interest rate risk described in the Section “Interest Rate
Risk”.
56. Two processes are needed to calculate the capital requirement for foreign
exchange risk. The first is to measure the exposure in a single currency
position. The second is to measure the risks inherent in an ADI’s mix of
long and short positions in different currencies. The capital charge will be
8 per cent of the foreign exchange net open position plus 8 per cent of the
net position in gold.
Measuring the exposure in a single currency
57. The ADI’s net open position in each currency must be calculated by
summing:
(a)
27
the net spot position (ie all asset items less all liability items,
including accrued interest, denominated in the currency in question);
(b)
the net forward position (ie all amounts to be received less all
amounts to be paid under forward foreign exchange transactions,
including currency futures, the principal on currency swaps not
included in the spot position, and interest rate transactions such as
futures, swaps, etc denominated in a foreign currency);
(c)
guarantees (and similar instruments) that are certain to be called and
likely to be irrecoverable;
(d)
net future income/expenses not yet accrued but already fully hedged
(at the discretion of the reporting ADI);
(e)
any other item representing a profit or loss in foreign currencies; and
Gold must be dealt with as a foreign exchange position rather than as a commodity position because
its volatility is more in line with foreign currencies and it is typically managed in a similar manner
to foreign currencies.
AGN 113.3 – 23
Sept 2000
(f)
the net delta-equivalent of the total book of foreign currency
options.28
58. Positions in composite currencies need to be separately reported but, for
measuring ADIs’ open positions, may be either treated as a currency in
their own right or split into their component parts on a consistent basis.
59. Currency pairs subject to a binding inter-governmental agreement linking
the two currencies may be treated as the one currency.
60. Several aspects call for more specific comment: the treatment of interest
and other income and expenses; the treatment of gold; the measurement
of forward currency and gold positions; and the treatment of “structural”
positions.
The treatment of interest, other income and expenses
61. Interest and other income accrued (ie earned but not yet received) should
be included as a position. Accrued expenses should also be included.
Unearned but expected future interest and anticipated expenses may be
excluded unless the amounts are certain and ADIs have taken the
opportunity to hedge them. If ADIs include future income/expenses, they
should do so on a consistent basis and will not be permitted to select only
those expected future flows which reduce their position.
The treatment of gold positions
62. Positions in gold should be measured in the same manner as described in
Paragraph 76 of the Section “Commodities Risk”.29 Since the interbank
market price for gold is effectively denominated in US dollars, any ADI
with an open gold position takes on exposure to movements in both the
gold price and the US dollar/Australian dollar exchange rate. In
recognition of this, ADIs may double count gold in Australian dollar
equivalent amounts, firstly as a gold exposure and secondly as a US dollar
exposure. That is, a long position in gold may be recorded both as a long
gold exposure and a long US dollar exposure. The US dollar exposure can
then be netted against US dollar exposures arising from other activities.
Examples of this are presented in AGN 113.5.
28
Subject to separately calculated capital charges for gamma risk and vega risk as described in the
Section “Treatment of Options”. Alternatively, options and their associated underlying assets may
be subject to one of the other methods described in the Section “Treatment of Options”.
29
Where gold is part of a forward contract (the quantity of gold to be received or to be delivered), the
interest rate and foreign exchange exposure from the other leg of the contract should be reported as
set out in the Section “Interest Rate Risk” and in Paragraph 57 above.
AGN 113.3 – 24
Sept 2000
The measurement of forward currency and gold positions
63. Forward currency and gold positions will normally be valued at current
spot market exchange rates. ADIs which base their normal management
accounting on net present values are expected to use the net present
values of each forward position, discounted using current interest rates
and translated at current spot rates, for measuring their forward currency
and gold positions. Using forward exchange rates would be inappropriate
since it would result in the measured positions reflecting current interest
rate differentials only and not the absolute level of interest rates in each
currency.
The treatment of structural positions
64. A matched currency position will protect an ADI against loss from
movements in exchange rates, but will not necessarily protect its capital
adequacy ratio. If an ADI has its capital denominated in Australian dollars
and has a portfolio of foreign currency assets and liabilities that is
completely matched, its capital/asset ratio will fall if the domestic
currency depreciates. By running a short position in the domestic
currency the ADI can protect its capital adequacy ratio, although the
position would lead to a loss if the domestic currency were to appreciate.
65. Any positions which an ADI has deliberately taken in order to hedge
partially or totally against the adverse effect of the exchange rate on its
capital ratio may be excluded from the calculation of net open currency
positions, subject to each of the following conditions being met:
(a)
such positions need to be of a “structural”, ie of a non-trading,
nature;
(b)
the “structural” position excluded does no more than protect the
ADI’s capital adequacy ratio (that is, these positions cannot be
manipulated for speculative or profit driven purposes); and
(c)
any exclusion of the position needs to be applied consistently, with
the treatment of the hedge remaining the same for the life of the
assets or other items.
66. Structural positions include:
(a)
any position arising from an instrument which qualifies as capital of
the ADI (refer APS 111 – Capital Adequacy: Measurement of
Capital);
AGN 113.3 – 25
Sept 2000
(b)
(c)
any position entered into in relation to the net investment in a
self-sustaining subsidiary, the accounting consequence of which is
to reduce or eliminate what would otherwise be a movement in the
foreign currency translation reserve; or
investments in overseas subsidiaries or associates which are fully
deducted from an institution’s capital for capital adequacy purposes
(refer APS 111 – Capital Adequacy: Measurement of Capital).
67. Individual ADIs will be required to submit their definition of structural
positions, and policies concerning identification and management of those
positions, to APRA for approval and inclusion in ADIs’ management
systems descriptions (refer AGN 113.1).
Measuring the foreign exchange risk in a portfolio of foreign currency
positions and gold
68. Under the standard method, the nominal amount (or net present value) of
the net position in each foreign currency and in gold is converted at spot
rates into the reporting currency.30 The overall net open position is
measured by aggregating:
(a)
the sum of the net short positions or the sum of the net long
positions, whichever is the greater; plus
(b)
the net position (short or long) in gold, regardless of sign.
69. The capital charge will be 8 per cent of the overall net open position (an
example of the calculation is provided in AGN 113.5)
Index
Commodities Risk
70. This section establishes a minimum capital requirement to cover the risk
of holding positions in commodities, including precious metals, but
excluding gold (which is treated as a foreign currency according to the
30
Where the ADI is assessing its foreign exchange risk on a consolidated basis, it may be technically
impractical in the case of some marginal operations to include the currency positions of a foreign
branch or subsidiary of the ADI. In such cases the internal limit in each currency applied to such
entities may be used as a proxy for the positions. Provided there is adequate ex post monitoring of
actual positions against such limits, the limits should be added, without regard to sign, to the net
open position in each currency.
AGN 113.3 – 26
Sept 2000
methodology set out in the Section “Foreign Exchange Risk”). A
commodity is defined as a tradeable physical product, eg agricultural
products, minerals (including oil) and precious and base metals.
71. For spot or physical trading, the risk arising from a change in the spot
price (directional risk) is the most important risk. However, ADIs 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:
(a)
basis risk (the risk that the relationship between the prices of similar
commodities alters through time);
(b)
interest rate risk (the risk of a change in the cost of carry for forward
positions and options); and
(c)
forward gap risk (the risk that the forward price may change for
reasons other than a change in interest rates).
72. The funding of commodities positions may well expose an ADI to interest
rate or foreign exchange risk and if this is so the relevant positions should
be included in the measures of interest rate and foreign exchange risk
described in the Sections “Interest Rate Risk” and “Foreign Exchange
Risk”.31
73. Commodities risk can be measured in a standardised manner, using either
a measurement system which captures forward gap and interest rate risk
separately by basing the methodology on a maturity ladder of seven time
bands, or a simplified approach.
74. 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. Positions in different commodities
may not, as a general rule, be offset. Netting between different
commodities of the same sub-group32 in cases where the commodities are
deliverable against each other will, however, be permitted. Commodities
may also be considered as offsettable if they are close substitutes for each
other and a minimum correlation between price movements of 0.9 can be
clearly established over a minimum period of one year. An ADI wishing
31
Where a commodity is part of a forward contract (a quantity of commodities is to be received or to
be delivered), any interest rate, equity or foreign currency exposure from the other leg of the
contract should be reported as set out in the Sections “Interest Rate Risk”, “Equity Position Risk”
and “Foreign Exchange Risk” respectively.
32
Commodities can be grouped into sub-groups. For example, West Texas Intermediate, Arabian
Light and Brent are individual commodities within the Crude Oil sub-group.
AGN 113.3 – 27
Sept 2000
to use correlation-based offsetting will need to satisfy APRA of the
accuracy of the method chosen.
75. As is the case with gold (refer Paragraph 62) the interbank market for
many commodities is effectively denominated in a foreign currency
(usually US dollars). Hence, subject to prior approval from APRA, ADIs
may double count foreign currency denominated commodities once as a
commodity exposure and secondly as a foreign currency exposure.
Examples of this treatment are given in AGN 113.5.
Maturity ladder approach
76. In calculating the capital charges under the maturity ladder approach,
ADIs 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 rates into Australian dollars.
77. 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 also carry a
capital charge. The methodology is similar to that used for interest rate
related instruments as set out in the Section “Interest Rate Risk”.
Positions in each separate commodity (expressed in Australian dollar
terms) should be entered into a maturity ladder (shown in Table 7 at the
end of this section). Physical stocks should be allocated to the first time
band. A separate maturity ladder must be used for each commodity as
defined in Paragraph 74 above.33
78. Within each time band, a capital charge for spread risk of 3 per cent of the
matched position (the smaller of the absolute value of the short and long
positions within a time band) is to be applied.
79. 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 capital charge equal to 0.6 per cent of the net position carried
forward will be applied each time a position is carried forward to the next
time band. The capital charge for each matched amount created by
carrying net positions forward will be calculated as in Paragraph 78.
33
For markets which have daily delivery dates, any contracts maturing within ten days of one another
may be offset.
AGN 113.3 – 28
Sept 2000
80. Finally, a capital charge of 15 per cent of the net open position in the
commodity is to apply. An example of the maturity ladder approach is set
out in AGN 113.5.
81. All commodity derivatives and off-balance sheet positions which 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” method is used34 (refer
Section “Treatment of Options”). In order to calculate the risk,
commodity derivatives should be converted into notional commodities
positions and assigned to maturities as follows:
(a)
futures and forward contracts relating to individual commodities
should be incorporated in the measurement system as notional
amounts in terms of the standard units of measurement (eg barrels,
kilos) multiplied by the spot price of the commodity and should be
assigned a maturity based on the contract's expiry date;
(b)
commodity swaps where one leg is a fixed price and the other is 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 entered into the
maturity ladder accordingly. The positions would be long positions
if the ADI is paying fixed and receiving floating, and short positions
if the ADI is receiving fixed and paying floating;35
(c)
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 sub-group as defined in Paragraph 74.
Simplified approach
82. In calculating the capital charge for directional risk, the same procedure
should be adopted as in the maturity ladder approach above (refer
Paragraphs 76 and 81). The capital charge is equal to 15 per cent of the
overall net position, long or short, in each commodity.
34
For ADIs using other approaches to measure option price risk, all options and the associated
underlyings should be excluded from both the maturity ladder approach and the simplified
approach.
35
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.
AGN 113.3 – 29
Sept 2000
83. In order to protect the ADI against basis risk, interest rate risk and
forward gap risk, the capital charge for each commodity position as
described in Paragraphs 76 and 81 above is subject to an additional capital
charge equivalent to 3 per cent of the ADI’s gross positions (the absolute
value of all long positions plus the absolute value of all short positions
regardless of maturity), in that particular commodity. In valuing the gross
positions in commodity derivatives for this purpose, ADIs should use the
current spot price.
Table 7 Commodity time bands
Time band
1 month or less
over 1 month and up to 3 months
over 3 months and up to 6 months
over 6 months and up to 12 months
over 1 year and up to 2 years
over 2 years and up to 3 years
over 3 years
Index
Treatment of Options
84. In recognition of the diversity of ADIs’ activities in options several
alternative approaches will be permissible:
36
(a)
those ADIs which solely use purchased options36 will be free to use
the simplified approach described below;
(b)
those ADIs which also write options will be expected to use one of
the intermediate approaches (the delta-plus or contingent loss
methods) as set out below or the internal model approach detailed in
AGN 113.2. The more significant its trading, the more sophisticated
approach the ADI will be expected to use.
Where all the written option positions are hedged by perfectly matched long positions in exactly the
same options, no capital charge for market risk is required.
AGN 113.3 – 30
Sept 2000
85. Each individual ADI will be required to obtain prior approval from APRA
for the approach it wishes to take in the treatment of options.37
86. In the simplified approach, the positions for the options and the associated
underlying assets, cash or forward, are not subject to the standard
methodology but rather are “carved-out” and subject to separately
calculated capital charges that incorporate both general market risk and
specific risk. The risk numbers thus generated are then added to the
capital charges for the relevant category, ie interest rate related
instruments, equities, foreign exchange and commodities as described in
Sections above.
87. The delta-plus method uses the sensitivity parameters or “greeks”
associated with options to measure their market risk capital requirements.
Under this method, the delta-equivalent position of each option becomes
part of the standard methodology set out in Sections above with the
delta-equivalent amount subject to the applicable general market risk
charges. Separate capital charges are then applied to the gamma and vega
risks of the option positions.
88. The contingent loss approach uses simulation techniques to calculate
changes in the value of an options portfolio for changes in the level and
volatility of the prices of its associated underlyings. Under this approach,
the general market risk charge is determined by the largest loss produced
by a scenario “matrix” (ie a specified combination of underlying asset
price and volatility changes).
89. For the delta-plus method and the contingent loss approach the specific
risk capital charges are determined separately by multiplying the deltaequivalent amount of each option by the specific risk weights set out in
the Sections “Interest Rate Risk” and “Equity Position Risk”.
90. In addition to these market risk charges, purchased options remain subject
to the credit risk capital requirements specified in APS 112 – Capital
Adequacy: Credit Risk.
Simplified approach
91. ADIs which handle a limited range of purchased options only may use the
simplified approach set out in Table 8 below for particular trades.
37
ADIs doing business in certain classes of exotic options (e.g. barriers, digitals) may be required to
use the contingent loss approach (described below) or the internal models alternative (AGN 113.2),
which can accommodate more detailed revaluation approaches.
AGN 113.3 – 31
Sept 2000
Table 8 Simplified approach: capital charges
Position
Long cash and long put
or
Short cash and long call
Treatment
The capital charge will be the market value of
underlying security38 multiplied by the sum
specific and general market risk charges39 for
underlying less the amount the option is in
money (if any) bounded at zero.40
the
of
the
the
The capital charge will be the lesser of:
Long call
or
Long put
(i)
the market value of the underlying security
multiplied by the sum of specific and general
market risk charges for the underlying; and
(ii)
the market value of the option. 41
92. As an example of how the calculation would work, if a holder of 100
shares currently valued at $10 each holds an equivalent put option with a
strike price of $11, the capital charge would be: $1,000 x 16% (ie 8%
specific plus 8% general market risk) = $160, less the amount the option
is in the money ($11 - $10) x 100 = $100, ie the capital charge would be
$60. A similar methodology applies for options whose underlying is a
foreign currency, an interest rate related instrument or a commodity.
38
In some cases, such as foreign exchange, it may be unclear which side is the “underlying security”;
this should be taken to be the asset which would be received if the option were exercised. In
addition, the nominal value should be used for items where the market value of the underlying
instrument could be zero, eg caps and floors, swaptions, etc.
39
Some options (eg where the underlying is an interest rate, a currency or a commodity) bear no
specific risk but specific risk will be present in the case of options on certain interest rate related
instruments (eg options on a corporate debt security or corporate bond index; see Section “Interest
Rate Risk” for the relevant capital charges) and for options on equities and stock indices (see
Section “Equity Position Risk”). The charge under this measure for currency options will be 8%
and for options on commodities 15%.
40
For options with a residual maturity of more than six months the strike price should be compared
with the forward, not current, price. An ADI unable to do this must take the in-the-money amount
to be zero. For options with a residual maturity of less than six months ADIs, if able, should use the
forward price rather than the spot price.
41
Where the position does not fall within the trading book (ie options on certain foreign exchange or
commodities positions), it may be acceptable to use the book value instead.
AGN 113.3 – 32
Sept 2000
Delta-plus method
93. ADIs which write options may be allowed to include delta-weighted
options positions within the standard method set out in Sections above.42
Such options should be reported as a position equal to the sum of the
market values of the underlying multiplied by the sum of the absolute
values of the deltas. However, since delta does not cover all risks
associated with options positions, ADIs will also be required to measure
gamma (which measures the rate of change of delta) and vega (which
measures the sensitivity of the value of an option with respect to a change
in volatility) in order to calculate the total capital charge. These
sensitivities should be calculated using an approved Exchange model43 or
the ADI’s proprietary options pricing model subject to approval by
APRA.
94. For general market risk purposes, delta-weighted positions with debt
securities or interest rates as the underlying should be slotted into the
interest rate time bands, as set out in the Section “Interest Rate Risk”,
under the following procedure. A two-legged approach should be used, as
for other derivatives, requiring one entry at the time the underlying
contract takes effect and a second at the time the underlying contract
matures.44 For instance, in the case of a bought call option on a June
three-month bill future, the option will, in April, be considered on the
basis of its delta-equivalent value, to be a long position with a maturity of
five months and a short position with a maturity of two months.45 The
written option will be similarly entered as a long position with a maturity
of two months and a short position with a maturity of five months. Caps
and floors will be treated as a series of European-style options. For
example, the buyer of a two-year cap with semi-annual resets and a cap
rate of 15 per cent should treat the cap as a series of three bought call
options on a FRA with a reference rate of 15 per cent, each with a
negative sign at the maturity date of the underlying FRA and a positive
sign at the settlement date of the underlying FRA.
42
Delta measures the sensitivity of an option’s value to a change in the price of the underlying asset.
43
For example, the pricing models used by the Sydney Futures Exchange and the Australian Stock
Exchange Options Market.
44
In the case of options on futures or forwards the relevant underlying is that on which the future or
forward is based (eg for a bought call option on a June three-month bill future the relevant
underlying is the three-month bill).
45
A two-month call option on a 10 year bond future where delivery of the bond takes place in
September would be considered in April as a long bond position with a maturity of 10 years 5
months and a short five months deposit, both positions being delta-weighted.
AGN 113.3 – 33
Sept 2000
95. For options with debt securities as the underlying, a specific risk charge is
also applied to the delta-weighted position on the basis of the issuer of the
underlying security, as detailed in the Section “Interest Rate Risk”.
96. The capital charge for options with equities as the underlying will also be
based on the delta-weighted positions which will be incorporated in the
measure of market risk (both specific and general market risk) described
in the Section “Equity Position Risk”. The capital charge for options on
foreign exchange and gold positions will be based on the method set out
in the Section “Foreign Exchange Risk”. For delta risk, the net
delta-based equivalent of the foreign currency and gold options will be
incorporated into the measurement of the exposure for the respective
currency (or gold) position. The capital charge for options
on
commodities will be based on the incorporation of delta-weighted
positions into either the maturity ladder or simplified approach set out in
the Section “Commodities Risk”.
97. In addition to the above capital charge arising from delta risk, there will
be further capital charges for gamma risk and for vega risk. ADIs using
the delta-plus method will be required to calculate the gamma and vega
capital charges for each option position separately.
98. The capital charges for gamma risk should be calculated in the following
way:
Gamma impact = ½  gamma  (VU)2
where VU denotes the variation in the price of the underlying of the
option. VU must be calculated as follows:
(a)
for interest rate options, if the underlying is a bond, the market value
of the underlying should be multiplied by the risk weights set out in
Table 2 of the Section “Interest Rate Risk”. An equivalent
calculation should be carried out where the underlying is an interest
rate, based on the assumed changes in yield in Table 2;
(b)
for options on equities and equity indices, the market value of the
underlying should be multiplied by 8 per cent;
(c)
for options on foreign exchange and gold, the market value of the
underlying should be multiplied by 8 per cent; and
(d)
for options on commodities, the market value of the underlying
should be multiplied by 15 per cent.
AGN 113.3 – 34
Sept 2000
99. For the purpose of calculating the gamma impact, the following should be
treated as the same underlying:
(a)
for interest rates,46 each time band as set out in Table 2 of the
Section “Interest Rate Risk”, for ADIs using the maturity method.
ADIs using the duration method should use the time bands as set out
in the second column of Table 2;
(b)
for equities and stock indices, each national market;
(c)
for foreign currencies and gold, each currency pair and gold; and
(d)
for commodities, each individual commodity as defined in
Paragraph 74 of the Section “Commodities Risk”.
100. Each option on the same underlying will have a gamma impact that is
either positive or negative. These individual gamma impacts will be
summed, resulting in a net gamma impact for each underlying which is
either positive or negative. Only those gamma impacts that are negative
will be included in the capital calculation.
101. The total gamma capital charge will be the sum of the absolute value of
the net gamma impacts as calculated above.
102. To calculate vega risk ADIs must multiply the vega for each option by a
25 per cent proportional shift in the option's current volatility. The results
of this are then summed across each underlying.
103. The total capital charge for vega risk is calculated as the sum of the
absolute value of vega across each underlying.
Contingent loss approach
104. ADIs will also have the right to base the market risk capital charge for
options portfolios and associated hedging positions on contingent loss
matrix analysis. This will be accomplished by specifying a fixed range of
changes in the option portfolio’s risk factors (ie underlying price and
volatility) and calculating changes in the value of the option portfolio at
various points along this matrix. For the purpose of calculating the capital
charge, the ADI must revalue the option portfolio using matrices for
simultaneous changes in the option’s underlying rate or price and in the
volatility of that rate or price. A different matrix should be set up for each
46
Positions must be slotted into separate maturity ladders by currency.
AGN 113.3 – 35
Sept 2000
individual underlying as defined in Paragraph 99 above. As an alternative,
ADIs that are significant traders in options will, for interest rate options,
be permitted to base the calculation on a minimum of six sets of time
bands. When using this method, not more than three of the time bands (as
defined in column 1 of Table 2 of the Section “Interest Rate Risk”) should
be combined into any one set.
105. The options and related hedging positions will be evaluated over a
specified range above and below the current value of the underlying – this
defines the first dimension of the matrix. The range for interest rates is
consistent with the assumed changes in yield in Table 2 of the Section
“Interest Rate Risk”. Those ADIs using the alternative method for interest
rate options set out in the previous paragraph should use, for each set of
time bands, the highest of the assumed changes in yield applicable to the
group to which the time bands belong.47 The other ranges are ±8 per cent
for equities, ± 8 per cent for foreign exchange and gold, and ±15 per cent
for commodities. For all risk categories, at least seven price shifts
(including the current observation) must be used to divide the range into
equally spaced intervals.
106. The second dimension of the matrix entails a change in the volatility of
the underlying rate or price. A single change in the volatility of the
underlying rate or price equal to a proportional shift in volatility of
±25 per cent is expected to be sufficient in most cases. As circumstances
warrant, however, APRA may require that a different change in volatility
be used and/or that intermediate points on the matrix be calculated.
107. After calculating the matrix, each cell will contain the net profit or loss of
the option and the underlying hedge instrument. The capital charge for
each underlying should then be calculated as the largest loss contained in
the matrix.
108. The application of the contingent loss method by any specific ADI will be
subject to supervisory consent, particularly as regards the precise way that
the analysis is constructed. ADIs’ use of this method as part of the
standard method will also be subject to validation by APRA. ADIs will be
expected to comply with those qualitative standards listed in AGN 113.2
that are appropriate given the nature of the ADI’s business.
109. Besides the options risks mentioned above, APRA is conscious of the
other risks associated with options, eg rho (rate of change of the value of
the option with respect to the interest rate). While not proposing a
47
If, for example, the time-bands 3 to 4 years, 4 to 5 years and 5 to 7 years are combined the highest
assumed change in yield of these three bands would be 0.75.
AGN 113.3 – 36
Sept 2000
measurement system for those risks at present, it is expected that ADIs
undertaking significant options business at the very least monitor such
risks closely. Additionally, ADIs may incorporate rho into their capital
calculations for interest rate risk.
Index
AGN 113.3 – 37