Minimum Capital Requirements for Market Risk

A real price is representative for a risk factor of a bank where the bank is able to extract the value of the risk factor from the value of the real price. The bank must have policies and procedures that describe its mapping of real price observations to risk factors. The bank must provide sufficient information to SAMA in order to determine if the methodologies the bank uses are appropriate. Bucketing approach for the RFET 11.16 Where a risk factor is a point on a curve or a surface (and other higher dimensional objects such as cubes), in order to count real price observations for the RFET, banks may choose from the following bucketing approaches: (1) The own bucketing approach. Under this approach, the bank must define the buckets it will use and meet the following requirements: (a) Each bucket must include only one risk factor, and all risk factors must correspond to the risk factors that are part of the risk-theoretical profit and loss (RTPL) of the bank for the purpose of the profit and loss (P&L) attribution (PLA) test. 44 (b) The buckets must be non-overlapping. (2) The regulatory bucketing approach. Under this approach, the bank must use the following set of standard buckets as set out in Table 1. (a) For interest rate, foreign exchange and commodity risk factors with one maturity dimension (excluding implied volatilities) (t, where t is measured in years), the buckets in row (A) below must be used. (b) For interest rate, foreign exchange and commodity risk factors with several maturity dimensions (excluding implied volatilities) (t, where t is measured in years), the buckets in row (B) below must be used. (c) Credit spread and equity risk factors with one or several maturity dimensions (excluding implied volatilities) (t, where t is measured in years), the buckets in row (C) below must be used. (d) For any risk factors with one or several strike dimensions (delta, δ; ie the probability that an option is “in the money” at maturity), the buckets in row (D) below must be used. 45 (e) For expiry and strike dimensions of implied volatility risk factors (excluding those of interest rate swaptions), only the buckets in rows (C) and (D) below must be used. (f) For maturity, expiry and strike dimensions of implied volatility risk factors from interest rate swaptions, only the buckets in row (B), (C) and (D) below must be used. Standard buckets for the regulatory bucketing approach Table 1 Row Bucket 1 2 3 4 5 6 7 8 9 (A) 0≤t<0.75 0.75≤t<1.5 1.5≤t<4 4≤t<7 7≤t<12 12≤t<18 18≤t<25 25≤t<35 35≤t<∞ (B) 0≤t<0.75 0.75≤t<4 4≤t<10 10≤t<18 18≤t<30 30≤t<∞ (C) 0≤t<1.5 1.5≤t<3.5 3.5≤t<7.5 7.5≤t<15 15≤t<∞ (D) 0≤δ<0.05 0.05≤δ<0.3 0.3≤δ<0.7 0.7≤δ<0.95 0.95≤δ<1.00 11.17 Banks may count all real price observations allocated to a bucket to assess whether it passes the RFET for any risk factors that belong to the bucket. A real price Observation must be allocated to a bucket for which it is representative of any risk factors that belong to the bucket. 11.18 As debt instruments mature, real price observations for those products that have been identified within the prior 12 months are usually still counted in the maturity bucket to which they were initially allocated per [11.17]. When banks no longer need to model a credit spread risk factor belonging to a given maturity bucket, banks are allowed to re-allocate the real price observations of this bucket to the adjacent (shorter) maturity bucket. 46 A real price observation may only be counted in a single maturity bucket for the purposes of the RFET. 11.19 Where a bank uses a parametric function to represent a curve/surface and defines the function’s parameters as the risk factors in its risk measurement system, the RFET must be passed at the level of the market data used to calibrate the function’s parameters and not be passed directly at the level of these risk factor parameters (due to the fact that real price observations may not exist that are directly representative of these risk factors).