Minimum Capital Requirements for Market Risk

For exchange rate risk, the trading desk risk management model must incorporate risk factors that correspond to the individual foreign currencies in which the bank’s positions are denominated. Because the output of a bank’s risk measurement system will be expressed in the bank’s reporting currency, any net position denominated in a foreign currency will introduce foreign exchange risk. A bank must utilise risk factors that correspond to the exchange rate between the bank’s reporting currency and each foreign currency in which the bank has a significant exposure. 11.9 For equity risk, a bank must utilise risk factors that correspond to each of the equity markets in which the bank holds significant positions. (1) At a minimum, a bank must utilise risk factors that reflect market-wide movements in equity prices (eg a market index). Positions in individual securities or in sector indices may be expressed in beta-equivalents relative to a market-wide index. (2) A bank may utilise risk factors that correspond to various sectors of the overall equity market (eg industry sectors or cyclical and non-cyclical sectors). Positions in individual securities within each sector may be expressed in beta-equivalents relative to a sector index. (3) A bank may also utilise risk factors that correspond to the volatility of individual equities. (4) The sophistication and nature of the modelling technique for a given market should correspond to the bank’s exposure to the overall market as well as the bank’s concentration in individual equities in that market. 11.10 For commodity risk, bank must utilise risk factors that correspond to each of the commodity markets in which the bank holds significant positions. (1) For banks with relatively limited positions in commodity-based instruments, the bank may utilise a straightforward specification of risk factors. Such a specification could entail utilising one risk factor for each commodity price to which the bank is exposed (including different risk factors for different geographies where relevant). (2) For a bank with active trading in commodities, the bank’s model must account for variation in the convenience yield 40 between derivatives positions such as forwards and swaps and cash positions in the commodity. 11.11 For the risks associated with equity investments in funds: (1) For funds that meet the criterion set out in [5.8] (5)(a) (ie funds with look- through possibility), banks must consider the risks of the fund, and of any associated hedges, as if the fund’s positions were held directly by the bank (taking into account the bank’s share of the equity of the fund, and any leverage in the fund structure). The bank must assign these positions to the trading desk to which the fund is assigned. (2) For funds that do not meet the criterion set out in [5.8] (5)(a), but meet both the criteria set out in [5.8] (5)(b) (ie daily prices and knowledge of the mandate of the fund), banks must use the standardised approach to calculate capital requirements for the fund. 40 The convenience yield reflects the benefits from direct ownership of the physical commodity (eg the ability to profit from temporary market shortages). The convenience yield is affected both by market conditions and by factors such as physical storage costs. Model Eligibility of Risk Factors