Interest Rate Risk

Swaps will be treated as two notional positions in government securities with relevant maturities. For example, an interest rate swap under which a bank 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 14.35 Banks 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 offset 60 and thus excluded from the calculation. When the future or the forward comprises a range of deliverable instruments offsetting of positions in the future or forward contract and its underlying is only permissible in cases where there is a readily identifiable underlying security that is most profitable for the trader 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. No offsetting will be allowed between positions in different currencies; the separate legs of cross-currency swaps or forward FX deals are to be treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency. 14.36 In addition, opposite positions in the same category of instruments 61 can in certain circumstances 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. 62 In addition: (1) 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; (2) for swaps and FRAs: the reference rate (for floating rate positions) must be identical and the coupon closely matched (ie within 15 basis points); and (3) for swaps, FRAs and forwards: the next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits: (a) less than one month hence: same day; (b) between one month and one year hence: within seven days; and (c) over one year hence: within 30 days. 14.37 Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the payments required by the swap into their present values. For that purpose, each payment should be discounted using zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time band using procedures that apply to zero- (or low-) coupon bonds; these figures should be slotted into the general market risk framework as set out above. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the maturity or duration method and allocate these sensitivities into the time bands set out in [14.26] or [14.29]. Other methods which produce similar results could also be used. Such alternative treatments will, however, only be allowed if: (1) SAMA is fully satisfied with the accuracy of the systems being used; (2) the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time bands; and (3) the positions are denominated in the same currency.