Capital charge—interest rate risk

81. The capital charge for general risk is for the risk of loss arising from changes in market interest rates. The capital charge for interest rate risk is calculated as the sum of 2 separate charges:

(a) a charge for the specific risk of holding a long or short position in an individual instrument; and

(b) a charge for the general risk of holding a long or short position in the market as a whole.

Specific risk capital charge—interest rate risk

82. The capital charge for specific risk arising from an on-balance-sheet or off-balance-sheet interest- rate position held in a banking business Bank’s Trading Book is calculated by multiplying the market value of the debt security by the applicable charge set out in column 5 of table F1 for the category and residual maturity of the instrument.

83. The Bank may offset matched long and short positions (including positions in derivatives) in identical instruments with exactly the same issuer, coupon, currency and maturity.

Table F1 specific risk capital charges

84. In column 2 of table F1:

government, as a category, includes all forms of government paper such as bonds, treasury bills and other short-term instruments.

qualifying, as a category, includes:

(a) securities issued by public sector enterprises and multilateral development banks;

(b) instruments rated investment grade by at least 2 ECRAs;

(c) instruments rated investment grade by 1 ECRA and 1 other credit rating agency that is not an ECRA; and

(d) unrated instruments, but only if:

(i) the banking business Bank has no reason to suspect that the particular instrument would have a rating less than investment grade if it were rated; and

(ii) the issuer of the instrument is rated investment grade and is regulated in its home jurisdiction in a way comparable to banks in the AIFC.

85. In deciding whether an issuer is regulated in a comparable way, the bank must look, in particular, at the home jurisdiction’s risk-based capital requirements and consolidated supervision.

other, as a category, includes:

(a) instruments issued or fully guaranteed by the central government or central bank of a state that is a member of the OECD;

(b) instruments fully collateralised by instruments described in paragraph (a); and

(c) instruments issued or fully guaranteed by the central government or central bank of a state that is not a member of the OECD, but only if:

(i) the instruments have a residual maturity of 1 year or less;

(ii) the instruments are denominated in the local currency of the issuer; and

(iii) the banking business Bank’s holdings in such instruments are funded by

liabilities in the same currency.

(d) In column 3 of table F 1, external credit rating means a long-term rating issued by an ECRA for the purpose of risk-weighting claims on rated counterparties and exposures.

86. Interest rate swaps, cross-currency swaps, forward rate agreements, forward foreign exchange transactions, interest rate futures and futures on an interest rate index are exempt from charges for specific risk. However, a specific risk capital charge must be calculated if the underlying is a debt security or an index representing a basket of debt securities. Futures and forward contracts, other than those mentioned in this paragraph are exempt from specific risk capital charge if:

(a) the Bank has a right to substitute cash settlement for physical delivery under the contract; and

(b) the price on settlement is calculated with reference to a general market price indicator.

Such contracts exempt from specific risk capital charge must not be offset against specific securities (including those securities that make up a market index).

General Risk Capital charge—interest rate risk

87. General risk is measured using the maturity method. In that method, positions are allocated to a maturity ladder before the capital charge is calculated. The Bank must add the absolute values of the individual net positions within each time band, whether long or short. The sum of the absolute values is the Bank’s gross position.

Maturity method

88. In the maturity method, long or short positions in debt securities (and in other sources of interest rate exposures such as derivative instruments) are allocated to the time bands in table F 2 (and then to the zones in table F 3) based on the residual maturity of the instrument and the interest rate of coupon payments. A Bank must allocate:

(a) positions in fixed-rate instruments according to their residual term to maturity; and

(b) positions in floating-rate instruments according to the residual term to the next re-pricing date.

89. The Bank may offset:

(a) long and short positions (whether actual or notional) in identical instruments with exactly the same issuer, coupon, currency and maturity; and

(b) matched swaps, forward contracts, futures and forward rate agreements that satisfy the criteria for matching derivative positions detailed later in this section F.

90. The steps to calculate the general risk capital charge are:

Step 1: Weight the positions in each time band by the risk factor corresponding to those positions in table F2.

Table F2 Time Bands and risk factors

Step2:              Offset the weighted long and short positions within each time band.

Example:          If the sum of the weighted long positions in a time band is USD 100 million and the sum of the weighted short positions in the band is USD 90 million, you offset the positions to come up with a matched position of USD 90 million and unmatched position of USD 10 million.

Step 3:              For each time band, apply a 10% capital charge (vertical disallowance) on the matched position calculated in step 2.

Example:          Continuing on from the example in step 2, apply the 10% on the QR90 million matched position to come up with a QR9 million vertical disallowance for the time band.

Step 4:              For the unmatched positions calculated in step 2, carry out 2 further rounds of offsetting using the zones (made up of time bands) in table F3 and apply the appropriate capital charge, as follows:

(a)first between the remaining unmatched positions within each of 3 zones and subject to a charge (expressed as a percentage) as follows:

(i)matched weighted positions within zone 1 x 40%;

(ii)matched weighted positions within zone 2 x 30%;

(iii)matched weighted positions within zone 3 x 30%;

(b)subsequently between the remaining unmatched positions across the three different zones (in the order set out below) and subject to a capital charge as follows:

(i)matched weighted positions between zones 1 and 2 x 40%;

(ii)matched weighted positions between zones 2 and 3 x 40%;

(iii)matched weighted positions between zones 1 and 3 x 100%.

Step 5: The absolute value of the net amount remaining is the net position.

Table F 3 Zones for coupons

Step 6:     Calculate the horizontal allowance by adding the charges from paragraphs (a) and (b) of step 4.

Step 7:     Calculate the general risk capital charge as the sum of:

(a) the net position calculated from steps 1 to 4;

(b) the vertical disallowance from step 3;

(c) the horizontal disallowance from steps 4 and 5; and

(d) the net charge for positions in options, where appropriate, calculated in accordance with the guidelines on options risk in this BPG.

Positions in currencies

91. A Bank must use separate maturity ladders for positions in each currency, with capital charges calculated separately for each currency and then summed. Positions in different currencies are not to be offset. If the Bank’s position in a currency is less than 5% of the value of the Bank’s banking book assets, that currency is taken to be a residual currency and the Bank may use a single maturity ladder for all residual currencies (instead of having to use separate maturity ladders for each currency). The Bank must enter, into each appropriate time band, the net long or short position for residual currencies. The Bank must apply, with no further offsets, the risk factor in column 3 of table 6.6.8A to the position in each time band for residual currencies.

Futures and forward contracts

92. A Bank must treat futures and forward contracts on bank or corporate debt (including forward rate agreements) as a combination of a long and a short position in the underlying debt security. Futures and forward contracts not on bank or corporate debt must be treated as a combination of a long and a short position in a notional government security.

93. The maturity of a futures contract or a forward rate agreement is the period until delivery or exercise of the contract, plus the life of the underlying (or notional underlying) instrument. The Bank must report the long and short positions at the market value of the underlying (or notional underlying) security or portfolio of securities. If a range of instruments may be delivered to fulfil a contract, the Bank may choose the deliverable security to be allocated to the maturity ladder. The Bank must, however, take account of any conversion factor specified by the exchange where the instrument must be delivered.

Swaps

94. A Bank must treat a swap as two notional positions in government securities with maturities. Both legs of the swap must be reported at their market values. For swaps that pay or receive a fixed or floating interest rate against some other reference price (for example, a stock index), the Bank must:

(a) enter the interest rate component into the appropriate maturity category; and

(b) include any equity component in the measurement of equity risk.

95. Each leg of a cross-currency swap must be reported in the maturity ladder for the currency concerned. The capital charge for any foreign exchange risk arising from the swaps must be calculated in accordance with the provisions of Section E of this Chapter.

Derivatives

96. In the measurement of interest rate risk, a Bank must include interest rate derivatives and off- balance-sheet instruments in the Trading Book if those instruments react to changes in interest rates. The Bank must convert derivatives into positions in the relevant underlying to enable the Bank to calculate specific and general risk capital charges. To determine the capital charges, the value of the positions must be the market value of the underlying or notional underlying.

97. Positions in derivatives are subject to charges for general risk in the same way as cash positions. However, matched positions are exempt from the charges if the positions satisfy the criteria specified in the rest of this section. Positions in derivatives must be allocated to a maturity ladder and treated in accordance with this Rule and the maturity method.

Criteria for matching derivative positions

98. A Bank may offset a matched position in derivatives if the positions relate to the same underlying instruments, have the same nominal value and are denominated in the same currency. For futures, the positions in the underlying (or notional underlying) instruments must be for identical products and must mature within 7 days of each other.

99. For swaps, forward rate agreements and forward contracts:

(a) the reference rate (for floating-rate positions) must be identical and the coupons must differ by no more than 15 basis points; and

(b) the next interest-fixing date (or, for fixed-coupon positions or forward contracts, the residual maturity) must comply with the following requirements:

(i) if either instrument has an interest-fixing date or residual maturity up to and including 1 month in the future, the dates or residual maturities must be the same for both instruments;

(ii) if either instrument has an interest-fixing date or residual maturity more than 1 month, but no more than 1 year, in the future, the dates or residual maturities must be within 7 days of each other;

(iii) if either instrument has an interest-fixing date or residual maturity more than 1 year in the future, the dates or residual maturities must be within 30 days of each other.

100. A Bank that writes options may offset the delta- equivalent values of options (including the delta- equivalent value of legs arising out of the treatment of caps and floors in accordance with the provisions on options risk in this Chapter. However, for offsetting between a matched position in a futures or forward contract and its underlying, the provisions of the following paragraphs apply.

101. A Bank may offset long and short positions (whether actual or notional) in identical instruments with exactly the same issuer, coupon, currency and maturity and may offset a matched position in a futures or forward contract and its corresponding underlying. The net position must be reported. The Bank may offset positions in a futures or forward contract with a range of deliverable instruments and the corresponding underlying only if:

(a) there is a readily identifiable underlying security; and

(b) the price of that security and the price of the futures or forward contract move in close alignment.

102. The Bank must treat each leg of a cross-currency swap or forward foreign exchange transaction as a notional position in the relevant instrument, and must include the position in the calculation for each currency.