Minimum Capital Requirements for Market Risk

The risks associated with commodities include the following risks: (1) For spot or physical trading, the directional risk arising from a change in the spot price is the most important risk. (2) However, banks using portfolio strategies involving forward and derivative contracts are exposed to a variety of additional risks, which may well be larger than the risk of a change in spot prices. These include: (a) basis risk (the risk that the relationship between the prices of similar commodities alters through time); (b) interest rate risk (the risk of a change in the cost of carry for forward positions and options); and (c) forward gap risk (the risk that the forward price may change for reasons other than a change in interest rates). (3) In addition, banks may face counterparty credit risk on over-the-counter derivatives, but this is captured by one of the methods set out in 5 to 9 and 11 of SAMA Minimum Capital Requirements for Counterparty Credit Risk (CCR) and Credit Valuation Adjustment (CVA) (4) The funding of commodities positions may well open a bank to interest rate or FX exposure and if that is so the relevant positions should be included in the measures of interest rate and FX risk described in [14.3] to [14.40] and [14.53] to [14.62] , respectively. 76 14.66 There are two alternatives for measuring commodities position risk under the simplified standardised approach that are described in [14.68] to [14.73] below. Commodities risk can also be measured, using either (i) the maturity ladder approach, which is a measurement system that captures forward gap and interest rate risk separately by basing the methodology on seven time bands as set out in [14.68] to [14.71] below or (ii) the simplified approach, which is a very simple framework as set out in [14.72] and [14.73] below. Both the maturity ladder approach and the simplified approach are appropriate only for banks that, in relative terms, conduct only a limited amount of commodities business. 14.67 For the maturity ladder approach and the simplified approach, long and short positions in each commodity may be reported on a net basis for the purposes of calculating open positions. However, positions in different commodities will, as a general rule, not be offsettable in this fashion. Nevertheless, SAMA will have discretion to permit netting between different subcategories 77 of the same commodity in cases where the subcategories are deliverable against each other. They can also be considered as offsettable if they are close substitutes against each other and a minimum correlation of 0.9 between the price movements can be clearly established over a minimum period of one year. However, a bank wishing to base its calculation of capital requirements for commodities on correlations would have to satisfy SAMA of the accuracy of the method that has been chosen and obtain its prior approval. Maturity ladder approach 14.68 In calculating the capital requirements under the maturity ladder approach, banks will first have to express each commodity position (spot plus forward) in terms of the standard unit of measurement (barrels, kilos, grams etc). The net position in each commodity will then be converted at current spot rates into the national currency.