Minimum Capital Requirements for Market Risk

Cash equity positions (ie stocks) are assigned to a maturity of either more than one year or three months, at banks’ discretion. [8.16] states that for the standardised approach DRC requirement, cash equity positions may be attributed a maturity of three months or a maturity of more than one year, at firms’ discretion. Such restrictions do not exist in [13] for the internal models approach, which allows banks discretion to apply a 60-day liquidity horizon for equity sub-portfolios. Furthermore, [8.15] states “... the JTD for all exposures of maturity less than one year and their hedges are scaled by a fraction of a year”. Given the above- mentioned paragraphs, for purposes of the standardised approach DRC requirement, the bank is not permitted to assign cash equities and equity derivatives such as index futures any maturity between three months and one year on a sub-portfolio basis in order to avoid broken hedges As required by [8.16], cash equity positions are assigned a maturity of either more than one year or three months. There is no discretion permitted to assign cash equity positions to any maturity between three months and one year. In determining the offsetting criterion, [8.17] specifies that the maturity of the derivatives contract be considered, not the maturity of the underlying instrument. [8.18] further states that the maturity weighting applied to the JTD for any product with maturity of less than three months is floored at three months. To illustrate how the standardised approach DRC requirement should be calculated with a simple hypothetical portfolio, consider equity index futures with one month to maturity and a negative market value of EUR 10 million (–EUR 10 million, maturity 1M), hedged with the underlying equity positions with a positive market value of EUR 10 million (+EUR 10 million). Both positions in the example should be considered having a three-month maturity. Based on [8.15], which requires maturity scaling, defined as a fraction of the year, of positions and their hedge, the JTD for the above trading portfolio would be calculated as follows: 1/4*10 – 1/4*10 = 0. 8.17 For derivative exposures, the maturity of the derivative contract is considered in determining the offsetting criterion, not the maturity of the underlying instrument. 8.18 The maturity weighting applied to the JTD for any sort of product with a maturity of less than three months (such as short term lending) is floored at a weighting factor of one-fourth or, equivalently, three months (that means that the positions having shorter-than-three months remaining maturity would be regarded as having a remaining maturity of three months for the purpose of the DRC requirement). In the case where a total return swap (TRS) with a maturity of one month is hedged by the underlying equity, and if there were sufficient legal terms on the TRS such that there is no settlement risk at swap maturity as the swap is terminated based on the executed price of the stock/bond hedge and any unwind of the TRS can be delayed (beyond the swap maturity date) in the event of hedge disruption until the stock/bond can be liquidated. The net JTD for such a position would be zero. If the contractual/legal terms of the derivative allow for the unwinding of both legs of the position at the time of expiry of the first to mature with no exposure to default risk of the underlying credit beyond that point, then the JTD for the maturity-mismatched position is equal to zero. Net jump-to-default risk positions (net JTD)