Introduction

Guidance

(1) This Chapter addresses the regulatory requirements in respect of managing the Market Risk exposures of a Bank. Market Risk refers to the risk of incurring losses on positions held by a Bank with trading intent (usually in its Trading Book), caused by adverse movements in market prices or in underlying value drivers. This chapter aims to ensure that a Bank engaging in activities exposing it to such Market risks adopts appropriate and effective risk management practices and holds adequate regulatory capital of the right quality required to support the level of such risks assumed.

(2) This Chapter includes requirements that a Bank:

• (a) implement a comprehensive Market Risk management framework to manage, measure and monitor Market Risk commensurate with the nature, scale and complexity of its operations; and
• (b) calculate and hold the Market Risk Capital Requirement, according to the methodologies provided in the BPG issued by the AFSA.

(3) This Chapter includes rules requiring Banks to determine Market Risk Capital Requirement on exposures involving interest rate risk, equity risk, foreign exchange risk, commodities risk, options risk, collective investment fund risk and securities underwriting risk. The rules in this Chapter allow the use of standard pre-defined methodologies for estimating the Market Risk Capital Requirement as well as the use of AFSA-approved internal models to calculate a Bank’s Market Risk Capital Requirement.

(4) The detailed requirements specifying the calculation methodologies, parameters, metrics and formulae in respect of the primary requirements outlined in this chapter are provided in the Banking Prudential Guideline (BPG) issued by the AFSA. The BPG also provides detailed guidance on criteria on Trading Book and inclusion of exposures in a Trading Book, criteria for approval of internal models for calculation of Market Risk Capital Requirement, incorporation of incremental risk charges in internal models, if allowed and guidance on the required level of stress testing.

6.1 Market Risk Management – Systems and Controls

(1) A Bank must implement and maintain a Market Risk management policy which enables it to identify, assess, monitor, control and mitigate Market Risk.

(2) The Market Risk management policy must be documented and include the Bank’s risk appetite for Market Risk exposures. The policy must also set out as to how the Bank identifies, assesses, mitigates, controls and monitors that risk.

(3) A Bank must:

1. (a) identify, assess, monitor, mitigate and, control its Market Risk exposures;
2. (b) hold adequate Capital, at all times, to support Market Risk exposures assumed as part of its Trading Book and Banking Book activities;
3. (c) ensure that its risk management framework including but not limited to tools, methodologies and, systems enable it to implement its Market Risk management policy;
4. (d) review and update its Market Risk management policy at a frequency appropriate to the nature, scale and complexity of its Trading Book activities.

(4) A Bank’s Governing Body must ensure that its Market Risk management policy enables it to obtain a comprehensive bank-wide view of its Market Risk exposures and takes into account the risk of a significant deterioration in market liquidity of its exposures. Guidance Guidance in respect of the contents of a Bank’s Market Risk management policy which is required to satisfy the regulatory requirement in the Rule 6.1 is provided in the BPG issued by the AFSA.

6.2. Trading Book

(1) A Bank’s Trading Book consists of the positions held by the Bank (whether on-balance-sheet or off-balance-sheet) that must be included in the Trading Book in accordance with these rules. Other positions held by the Bank must be included in its Banking Book. Note A Bank is required to have policies to distinguish consistently between trading activities and banking activities

(2) A Bank must have a Trading Book if:

• (a) it has positions that must be included in the Trading Book; and
• (b) the total value of the positions described in paragraph (a) has exceeded 5% of the total of the Bank’s on-balance-sheet and off- balance-sheet positions at any time in the previous 12 months.

(3) The Bank must include, in the Trading Book, positions and exposures of the following kinds:

• (a) a position in a financial instrument, commodity or commodity derivative;
• (b) a principal broking position in a financial instrument, commodity or commodity derivative;
• (c) a position taken to hedge an exposure in the Trading Book;
• (d) an exposure from a repurchase agreement, or securities or commodities lending, that is based on a position in a security or commodity included in the Trading Book;
• (e) an exposure from a reverse repurchase agreement, or securities and commodities borrowing, that is based on a position in a security or commodity included in the Trading Book;
• (f) an exposure from an unsettled transaction, a free delivery or an over the counter derivative;
• (g) an exposure in the form of a fee, commission, interest, dividend or margin on an exchangetraded derivative directly related to a position included in the Trading Book.

(4) The Bank must also include in its Trading Book:

• (a) total-rate-of-return swaps (except those that have been transacted to hedge a Banking Book credit exposure); and
• (b) open short positions in credit derivatives.

(5) The Bank must not include in its Trading Book:

• (a) positions held for liquidity management; and
• (b) loans (unless they are used to hedge a position in the Trading Book).

(6) The Bank’s positions must be valued in accordance with the relevant accounting standards and prudent valuation guidance provided in the BPG issued by the AFSA.

(7) The Bank must have a well-documented Trading Book policy for keeping the Trading Book up-todate and to ensure the inclusion of appropriate positions accurately.

(8) The Trading Book policy must be approved by the Bank’s governing body, and the Bank must be able to demonstrate compliance with it if directed by the AFSA to do so.

Guidance

Guidance relating to the contents of a Bank’s Trading Book policy, the detailed requirements in relation to switching of positions between its Trading Book and Banking Book which are required to satisfy the regulatory requirement in the Rule 6.2 and the related supervisory expectations of the AFSA are provided in the BPG issued by the AFSA.

6.3 Switching of positions or instruments between Books

(1) A Bank must not switch a position or an instrument between its Trading Book and Banking Book, unless it has received a written approval from the AFSA, allowing it to do so. The AFSA may approve such a switch subject to 1 or more conditions.

(2) The Bank must not benefit from any lower regulatory capital requirement resulting from such a switch even if that is approved by the AFSA.

6.4 Valuation of positions

(1) A Bank must use the mark-to-market method to value its positions and exposures in its Trading Book, if there is a market to mark the positions and exposures to. Mark-to-market means a valuation that is based on current market value.

(2) A position that is marked-to-market must be revalued daily, based on independently sourced current market prices.

(3) If it is not possible to value any of the positions in the Trading Book on a mark-to-market basis (for example, in the case of unlisted securities or where the market is illiquid), a Bank may use the mark-to-model method to value its positions and exposures. Mark-to-model means a valuation that has to be benchmarked, extrapolated or otherwise calculated from a market input, using a predefined model.

(4) A Bank must be able to demonstrate that its marking-to-model is prudent.

(5) A Bank must independently verify market prices and model inputs, to check that those prices and inputs are accurate. The verification must be done at least once a month.

(6) A Bank must consider making adjustments for positions that cannot be prudently valued (such as those that have become concentrated, less liquid or stale). For example, valuation adjustment would be appropriate if pricing sources are more subjective (such as when there is only one available broker quote).

(7) A Bank must establish and maintain procedures for considering valuation adjustments, irrespective of whether:

• (a) the Bank uses the mark-to-market or mark-to-model method; and
• (b) whether the valuation is done internally by the Bank or by a third party. Guidance Detailed guidance relating to the different valuation methods for the positions in a Bank’s Trading Book, the AFSA’s expectations regarding the use of those methods, the expectations of the AFSA regarding independent price verification as well as the issues to be considered as part of the valuation adjustments, are provided in the BPG issued by the AFSA.

6.5. Calculation of the Market Risk Capital Requirement

(1) A Bank must calculate its Market Risk Capital Requirement as the sum of the following components:

1. (a) Interest Rate Risk Capital Requirement;
2. (b) Equity Risk Capital Requirement;
3. (c) Foreign Exchange Risk Capital Requirement;
4. (d) Commodities Risk Capital Requirement; and
5. (e) Option Risk Capital Requirement.

(2) A Bank must calculate the Market Risk Capital Requirement for the following components, in respect of its Trading Book and Non-Trading Book positions for the relevant component, by applying the methodology, parameters, formulae and guidance set out in the BPG issued by the AFSA:

1. (a) Foreign Exchange Risk Capital Requirement;
2. (b) Commodities Risk Capital Requirement;

(3) A Bank must calculate the Market Risk Capital Requirement for the following components, in respect of its Trading Book positions for the relevant component, by applying the methodology, parameters, formulae and guidance set out in the BPG issued by the AFSA:

1. (a) Interest Rate Risk Capital Requirement;
2. (b) Equity Risk Capital Requirement; and
3. (c) Option Risk Capital Requirement. Guidance Detailed guidance specifying the tools, methodologies, parameters and formulae for calculating the various components of the Market Risk Capital Requirement outlined in Rule 6.2 above are included in the BPG issued by the AFSA.

6.6 Foreign Exchange Risk Capital Requirement

(1) A Bank must, subject to (2), calculate its Foreign Exchange Risk Capital Requirement in respect of Trading Book and Non-Trading Book foreign exchange positions.

(2) A Bank need not calculate a Foreign Exchange Risk Capital Requirement if:

1. (a) its foreign currency business, defined as the greater of the sum of its gross long positions and the sum of its gross short positions in all foreign currencies, does not exceed 100% of its Regulatory Capital as defined in Rule 4.13; and
2. (b) its overall net open position as defined in the BPG does not exceed 2% of its Regulatory Capital as defined in Rule 4.13.

6.7. Standard method and use of Internal Models

(1) A Bank is expected to use the standard methods for calculation of any component of the MarketRisk Capital Requirement, which are detailed in the BPG.

(2) A Bank may use an internal model to calculate any specific component of its Market Risk Capital Requirement, if that internal model and its use have been approved in writing by the AFSA. Guidance Detailed Guidance in respect of criteria for approval and use of internal models for calculation of Market Risk capital requirement is provided in the BPG issued by the AFSA.

(3) If the AFSA approves the use of an internal model, it may:

• (a) impose, withdraw or amend at any time conditions in respect of the use of the internal model; and
• (b) withdraw approval if it forms the view that the internal model or its use is no longer suitable for the calculation of the Bank’s Market Risk Capital Requirement or any component of it.

(4) A Bank which uses an internal model in accordance with Rule 6.7 (2) must have in place a rigorous and comprehensive stress-testing programme which meets the criteria set out in the BPG issued by the AFSA.

(5) A Bank that has received approval for the use of an internal model may only revert to the use of standard method for calculating its Market Risk Capital Requirement or any component of it, with the prior written consent of the AFSA.

(6) In the standard method, capital requirement is the sum of the capital charges, calculated in accordance with this Chapter, for the risks included in Market Risk.