Minimum Capital Requirements for Market Risk

In cases where a transaction exactly matches with a third-party transaction (ie a back-to-back transaction), the instruments used in both transactions must be excluded from the RRAO capital requirement. Any instrument that is listed and/or eligible for central clearing must be excluded from the RRAO. Hedges (for example, dividend swaps hedging dividend risks) may be excluded from the RRAO only if the hedge exactly matches the trade (ie via a back-to-back transaction) as per [9.7]. For the example cited, dividend swaps should remain within the RRAO. As per [9.7], The total return swap (TRS) on an underlying product may be excluded from the RRAO capital requirement if there is an equal and opposite exposure in the same TRS. If no exactly matching transaction exists, the entire notional of the TRS would be allocated to the RRAO. 38 Examples of exotic underlying exposures include: longevity risk, weather, natural disasters, future realised volatility (as an underlying exposure for a swap). Calculation of the Residual Risk Add-on 9.8 The residual risk add-on must be calculated in addition to any other capital requirements within the standardised approach. The residual risk add-on is to be calculated as follows. (1) The scope of instruments that are subject to the RRAO must not have an impact in terms of increasing or decreasing the scope of risk factors subject to the delta, vega, curvature or DRC treatments in the standardised approach. (2) The RRAO is the simple sum of gross notional amounts of the instruments bearing residual risks, multiplied by a risk weight. (a) The risk weight for instruments with an exotic underlying specified in [9.3] is 1.0%. (b) The risk weight for instruments bearing other residual risks specified in [9.4] is 0.1%. 39 39 Where the bank cannot satisfy the RRAO provides a sufficiently prudent capital charge, then the bank will address any potentially under-capitalised risks by imposing a conservative additional capital charge under Pillar 2. 10- Internal Models Approach: General Provisions General Criteria 10.1 The use of internal models for the purposes of determining market risk capital requirements is conditional upon the explicit approval from SAMA 10.2 SAMA will only approve a bank’s use of internal models to determine market risk capital requirements if, at a minimum: (1) SAMA is satisfied that the bank’s risk management system is conceptually sound and is implemented with integrity; (2) the bank has, in SAMA view, a sufficient number of staff skilled in the use of sophisticated models not only in the trading area but also in the risk control, audit and, if necessary, back office areas; (3) the bank’s trading desk risk management model has, in SAMA judgement, a proven track record of reasonable accuracy in measuring risk; (4) the bank regularly conducts stress tests along the lines set out in [10.19] to [10.23] ; and (5) the positions included in the bank’s internal trading desk risk management models for determining minimum market risk capital requirements are held in trading desks that have been approved for the use of those models and that have passed the required tests described in [10.17] . (6) A bank must also be able to participate in testing exercises to provide any additional information required to satisfy SAMA of the adequacy of the internal model (both prior to model approval and subsequently, if SAMA wishes to review the internal model). 10.3 SAMA may insist on a period of initial monitoring and live testing of a bank’s internal trading desk risk management model before it is used for the purposes of determining the bank’s market risk capital requirements.