Minimum Capital Requirements for Market Risk

This section sets out a minimum capital standard to cover the risk of holding or taking positions in equities in the trading book. It applies to long and short positions in all instruments that exhibit market behaviour similar to equities, but not to non-convertible preference shares (which are covered by the interest rate risk requirements described in [14.3] to [14.40] ). Long and short positions in the same issue may be reported on a net basis. The instruments covered include common stocks (whether voting or non-voting), convertible securities that behave like equities, and commitments to buy or sell equity securities. The treatment of derivative products, stock indices and index arbitrage is described in [14.44] to [14.52] below. Specific and general market risks 14.42 As with debt securities, the minimum capital standard for equities is expressed in terms of two separately calculated capital requirements for the specific risk of holding a long or short position in an individual equity and for the general market risk of holding a long or short position in the market as a whole. Specific risk is defined as the bank’s gross equity positions (ie the sum of all long equity positions and of all short equity positions) and general market risk as the difference between the sum of the longs and the sum of the shorts (ie the overall net position in an equity market).The long or short position in the market must be calculated on a market-by-market basis, ie a separate calculation has to be carried out for each national market in which the bank holds equities. 14.43 The capital requirement for specific risk and for general market risk will each be 8%. Equity derivatives 14.44 Except for options, which are dealt with in [14.74] to [14.86] , equity derivatives and off- balance sheet positions that are affected by changes in equity prices should be included in the measurement system. 65 This includes futures and swaps on both individual equities and on stock indices. The derivatives are to be converted into positions in the relevant underlying. The treatment of equity derivatives is summarised in [14.52] below. 14.45 In order to calculate the standard formula for specific and general market risk, positions in derivatives should be converted into notional equity positions: (1) Futures and forward contracts relating to individual equities should in principle be reported at current market prices. (2) Futures relating to stock indices should be reported as the marked-to-market value of the notional underlying equity portfolio. (3) Equity swaps are to be treated as two notional positions. 66 (4) Equity options and stock index options should be either carved out together with the associated underlyings or be incorporated in the measure of general market risk described in this section according to the delta-plus method. 14.46 Matched positions in each identical equity or stock index in each market may be fully offset, resulting in a single net short or long position to which the specific and general market risk charges will apply. For example, a future in a given equity may be offset against an opposite cash position in the same equity. 67 14.47 Besides general market risk, a further capital requirement of 2% will apply to the net long or short position in an index contract comprising a diversified portfolio of equities. This capital requirement is intended to cover factors such as execution risk. SAMA will take care to ensure that this 2% risk weight applies only to well- diversified indices and not, for example, to sectoral indices.