Examples of instruments with equity-like behaviour

(a) common shares (whether voting or non-voting)

(b) convertible securities and commitments to buy or sell equity securities

(c) convertible bonds that trade like equities.

106. A Bank may report short and long positions in instruments relating to the same issuer on a net basis. The Bank must calculate the long or short position in the equity market on a market-by- market basis. That is, the Bank must make a separate capital calculation for each exchange in which it holds equities, irrespective of whether it is a recognised exchange or not.

107. In calculating the capital charge for equity position risk, a Bank must include equity derivatives and off-balance-sheet positions that are affected by changes in equity prices (such as futures and swaps on individual equities and stock indices). To calculate the charges for equity position risk for equity derivatives and other off-balance-sheet positions, the Bank must convert positions into notional equity positions, such that:

(a) equity derivatives and off-balance-sheet positions relating to individual equities are reported at current market prices;

(b) equity derivatives and off-balance-sheet positions relating to stock indices are reported as the mark-to-market value of the notional underlying equity portfolio; and

(c) equity swaps are treated as two notional positions.

Capital Charge for equity risk

108. The capital charge for equity position risk consists of 2 separately calculated charges:

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

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

109. The capital charge for specific risk is 8% of the gross position of a Bank in equities listed on a recognised exchange and 12% of the gross position of the Bank in other equities. Gross position, of a Bank in an equity market, is the sum of the absolute values of all short equity positions and all long equity positions of the Bank.

110. The capital charge for general risk is 8% of the net position of a Bank. Net position, of a Bank in an equity market, is the difference between long equity positions and short equity positions of the Bank.

111. Equity position is the net of short and long exposures to an individual company or stock or unit. It is measured on the gross position across the company rather than individual transactions. If a Bank takes a position in depository receipts against an opposite position in the underlying equity, irrespective of whether it is listed in the same country where the receipts were issued or not, it may offset the positions only if any costs on conversion are taken into account in full.

112. The Bank may offset matched positions in an identical equity or stock index in each market, resulting in a single net long or short position to which the specific and general risk capital charges are to be applied. For this purpose, a future in an equity may be offset against an opposite physical position in the same equity.

Charges for index contracts

113. In the case of an index contract on an index considered by the Bank as a diversified index, the Bank must apply a general risk capital charge of 8%, and a specific risk capital charge of 2%, to the net long or short position in the contract. For any other index contract, the Bank must apply a general risk capital charge of 8%, and a specific risk capital charge of 4%, to the net long or short position in the contract.

114. If required to do so by the AFSA, the Bank must demonstrate how the Bank arrived at the assessment that the index is a diversified one and be able to explain the rationale behind that assessment. The index must have a minimum number of equities. There must be an absolute threshold below which the index cannot be considered sufficiently diversified to ignore the specific risk completely. None of the equities must significantly influence the volatility of the index. Equities must not represent more than a certain percentage of the total index value. The index must have equities diversified from a geographical perspective. The index must represent equities that are diversified from an economic perspective. Different ‘industries’ must be represented in the index.

115. If a Bank uses a futures-related arbitrage strategy under which the Bank takes an opposite position in exactly the same index at different dates or in different markets, the Bank:

(a) may apply the 2% specific risk capital charge in paragraph 12 above of this section to only 1 position; and

(b) may exempt the opposite position from any capital charge for specific and general risks.

116. The Bank may also apply the 2% specific risk capital charge if:

(a) the Bank has opposite positions in contracts at the same date in 2 similar indices; and

(b) the AFSA has notified the Bank in writing that the 2 indices have sufficient common components to allow offsetting.

117. If the Bank engages in an arbitrage strategy under which a futures contract on a broadly-based index matches a basket of shares, the Bank:

(a) may decompose the index position into notional positions in each of the constituent stocks; and

(b) may include the notional positions and the disaggregated physical basket in the country portfolio, netting the physical positions against the index equivalent positions in each stock.

118. If the values of the physical and futures positions are matched, the capital charge is 4% (that is, 2% of the gross value of the positions on each side). The Bank may use this provision to apply the 4% capital charge to a position that is part of the arbitrage strategy only if:

(a) a minimum correlation of 0.9 between the basket of shares and the index can be clearly established over at least the preceding year, and the Bank has satisfied the AFSA that the method the Bank has chosen is accurate; or

(b) the composition of the basket of shares represents at least 90% of the index.

119. The Bank must treat 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, as an open long or short position, and must use the approach for index contracts specified above, as appropriate. If an arbitrage does not satisfy the conditions in paragraph 114 above of this Section, the Bank must treat the index position using the approach for index contracts.

When basket of shares is 90% of index

120. To determine whether a basket of shares represents at least 90% of an index, the relative weight of each stock in the basket must be compared to the weight of that stock in the index to calculate a percentage slippage from its weight in the index. Stocks that are included in the index but are not held in the basket have a slippage equal to their percentage weight in the index. The sum of the slippages across all stocks in the index represents the total slippage from the index. The absolute values of the percentage slippages must be summed. Deducting the total slippage from 100 gives the percentage coverage of the index to be compared to the required minimum of 90%.