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  • CA-4 CA-4 Interest rate risk - Standardised approach

    • CA-4.1 CA-4.1 Introduction

      • CA-4.1.1

        This Chapter describes the standardised approach for the measurement of the interest rate risk in the bank's trading book, in order to determine the capital requirement for this risk. The interest rate exposure captured includes exposure arising from interest-bearing and discounted financial instruments, derivatives which are based on the movement of interest rates, foreign exchange forwards, and interest rate exposure embedded in derivatives which are based on non-interest rate related instruments.

        October 07

      • CA-4.1.2

        For the guidance of the banks, and without being exhaustive, the following list includes financial instruments in the trading book to which interest rate risk capital requirements will apply, irrespective of whether or not the instruments carry coupons:

        (a) Bonds/loan stocks, debentures etc.;
        (b) Non-convertible preference shares;
        (c) Convertible securities such as preference shares and bonds, which are treated as debt instruments5;
        (d) Mortgage backed securities and other securitised assets6;
        (e) Certificates of Deposit;
        (f) Treasury bills, local authority bills, banker's acceptances;
        (g) Commercial paper;
        (h) Euronotes, medium term notes, etc.;
        (i) Floating rate notes, FRCDs etc.;
        (j) Foreign exchange forward positions;
        (k) Derivatives based on the above instruments and interest rates; and
        (l) Interest rate exposure embedded in other financial instruments.

        5See Section CA-5.1 for an explanation of the circumstances in which convertible securities, should be treated as equity instruments. In other circumstances, they should be treated as debt instruments.

        6 Traded mortgage securities and mortgage derivative products possess unique characteristics because of the risk of pre-payment. It is possible that including such products within the standardised methodology as if they were similar to other securitised assets may not capture all the risks of holding positions in them. Banks which have traded mortgage securities and mortgage derivative products should discuss their proposed treatment with the Central Bank and obtain the Central Bank's prior written approval for it.

        October 07

      • CA-4.1.3

        For instruments that deviate from the above structures, or could be considered complex, each bank should agree a written policy statement with the Central Bank about the intended treatment, on a case-by-case basis. In some circumstances, the treatment of an instrument may be uncertain, for example bonds whose coupon payments are linked to equity indices. The position risk of such instruments should be broken down into its components and allocated appropriately between the equity, interest rate and foreign exchange risk categories. Advice must be sought from the Central Bank in cases of doubt, particularly when a bank is trading an instrument for the first time.

        October 07

      • CA-4.1.4

        A security which is the subject of a repurchase or securities lending agreement will be treated as if it were still owned by the lender of the security, i.e., it will be treated in the same manner as other securities positions.

        October 07

      • CA-4.1.5

        The minimum capital requirement is expressed in terms of two separately calculated charges, one applying to the 'specific risk' of each position, and the other to the interest rate risk in the portfolio, termed 'general market risk'. The aggregate capital requirement for interest rate risk is the sum of the general market interest rate risk capital requirements across currencies, and the specific risk capital requirements.

        October 07

      • CA-4.1.6

        The specific risk capital requirement recognises that individual instruments may change in value for reasons other than shifts in the yield curve of a given currency. The general risk capital requirement reflects the price change of these products caused by parallel and non-parallel shifts in the yield curve, as well as the difficulty of constructing perfect hedges.

        October 07

      • CA-4.1.7

        There is general market risk inherent in all interest rate risk positions. This may be accompanied by one or more out of specific interest rate risk, counterparty risk, equity risk and foreign exchange risk, depending on the nature of the position. Banks should consider carefully which risks are generated by each individual position. It should be recognised that the identification of the risks will require the application of the appropriate level of technical skills and professional judgement.

        October 07

      • CA-4.1.8

        Banks which have the intention and capability to use internal models for the measurement of general and specific interest rate risks and, hence, for the calculation of the capital requirement, should seek the prior written approval of the Central Bank for those models. The Central Bank's detailed rules for the recognition and use of internal models are included in Chapter CA-9. Banks which do not use internal models should adopt the standardised approach to calculate the interest rate risk capital requirement, as set out in detail in this Chapter.

        October 07

    • CA-4.2 CA-4.2 Specific risk calculation

      • CA-4.2.1

        The capital charge for specific risk is designed to protect against a movement in the price of an individual instrument, owing to factors related to the individual issuer.

        October 07

      • CA-4.2.2

        In measuring the specific risk for interest rate related instruments, a bank may net, by value, long and short positions (including positions in derivatives) in the same debt instrument to generate the individual net position in that instrument. Instruments will be considered to be the same where the issuer is the same, they have an equivalent ranking in a liquidation, and the currency, the coupon and the maturity are the same.

        October 07

      • CA-4.2.3

        The specific risk capital requirement is determined by weighting the current market value of each individual net position, whether long or short, according to its allocation among the following five broad categories:

        (a) Eligible central government debt instrument 0.00%
        (b) Qualifying items with residual maturity up to 6 months 0.25%
        (c) Qualifying items with residual maturity between 6 and 24 months 1.00%
        (d) Qualifying items with residual maturity exceeding 24 months 1.60%
        (e) Non-qualifying items 8.00%
        October 07

      • CA-4.2.4

        Eligible central 'government' debt instruments will include all forms of government paper, including bonds, treasury bills and other short-term instruments, but the Central Bank reserves the right to apply a specific risk weight to securities issued by certain foreign governments, especially to securities denominated in a currency other than that of the issuing government.

        October 07

      • CA-4.2.5

        Governments eligible are those which are members of either the Gulf Co-operation Council (GCC) or the Organisation for Economic Co-operation and Development (OECD).

        October 07

      • CA-4.2.6

        The 'qualifying' Category includes securities issued by or fully guaranteed by public sector entities and multilateral development banks (refer to Appendix CA-2), plus other securities that are:

        (a) Rated investment grade by at least two internationally recognised credit rating agencies (to be agreed with the Central Bank); or
        (b) Deemed to be of comparable investment quality by the reporting bank, provided that the issuer is rated investment grade by at least two internationally recognised credit rating agencies (to be agreed with the Central Bank); or
        (c) Rated investment grade by one credit rating agency and not less than investment grade by any internationally recognised credit rating agencies (to be agreed with the Central Bank); or
        (d) Unrated (subject to the approval of the Central Bank), but deemed to be of comparable investment quality by the reporting bank and where the issuer has securities listed on a recognised stock exchange, may also be included.
        October 07

    • CA-4.3 CA-4.3 General market risk calculation

      • CA-4.3.1

        The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates, i.e. the risk of parallel and non-parallel shifts in the yield curve. A choice between two principal methods of measuring the general market risk is permitted, a 'maturity' method and a 'duration' method. In each method, the capital charge is the sum of the following four components:

        (a) The net short or long position in the whole trading book;
        (b) A small proportion of the matched positions in each time-band (the 'vertical disallowance');
        (c) A larger proportion of the matched positions across different time-bands (the 'horizontal disallowance'); and
        (d) A net charge for positions in options, where appropriate (see Chapter CA-8).
        October 07

      • CA-4.3.2

        Separate maturity ladders should be used for each currency and capital charges should be calculated for each currency separately and then summed, by applying the prevailing foreign exchange spot rates, with no off-setting between positions of opposite sign.

        October 07

      • CA-4.3.3

        In the case of those currencies in which the value and volume of business is insignificant, separate maturity ladders for each currency are not required. Instead, the bank may construct a single maturity ladder and slot, within each appropriate time-band, the net long or short position for each currency. However, these individual net positions are to be summed within each time-band, irrespective of whether they are long or short positions, to arrive at the gross position figure for the time-band.

        October 07

      • CA-4.3.4

        A combination of the two methods (referred to under Paragraph CA-4.3.1) is not permitted. Any exceptions to this rule will require the prior written approval of the Central Bank. It is expected that such approval will only be given in cases where a bank clearly demonstrates to the Central Bank, the difficulty in applying, to a definite Category of trading instruments, the method otherwise chosen by the bank as the normal method. It is further expected that the Central Bank may, in future years, consider recognising the duration method as the approved method, and the use of the maturity method may be discontinued.

        October 07

    • CA-4.4 CA-4.4 Maturity method

      • CA-4.4.1

        A worked example of the maturity method is included in Appendix CA-3. The various time-bands and their risk weights, relevant to the maturity method, are illustrated in Paragraph CA-4.4.2(a) below.

        October 07

      • CA-4.4.2

        The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

        (a) Individual long or short positions in interest-rate related instruments, including derivatives, are slotted into a maturity ladder comprising thirteen time-bands (or fifteen time-bands in the case of zero-coupon and deep-discount instruments, defined as those with a coupon of less than 3%), on the following basis:
        (i) Fixed rate instruments are allocated according to their residual term to maturity (irrespective of embedded puts and calls), and whether their coupon is below 3%;
        (ii) Floating rate instruments are allocated according to the residual term to the next repricing date;
        (iii) Positions in derivatives, and all positions in repos, reverse repos and similar products are decomposed into their components within each time band. Derivative instruments are covered in greater detail in Sections CA-4.6 to CA-4.9;
        (iv) Opposite positions of the same amount in the same issues (but not different issues by the same issuer), whether actual or notional, can be omitted from the interest rate maturity framework, as well as closely matched swaps, forwards, futures and FRAs which meet the conditions set out in Section CA-4.8. In other words, these positions are netted within their relevant time-bands; and
        (v) The Central Bank's advice must be sought on the treatment of instruments that deviate from the above structures, or which may be considered sufficiently complex to warrant the Central Bank's attention.
        Maturity method: time-bands and risk weights
            Coupon > 3% Coupon < 3% Risk weight
          Zone 1 1 month or less 1 month or less 0.00%
          1 to 3 months 1 to 3 months 0.20%
            3 to 6 months 3 to 6 months 0.40%
            6 to 12 months 6 to 12 months 0.70%
          Zone 2 1 to 2 years 1 to 1.9 years 1.25%
            2 to 3 years 1.9 to 2.8 years 1.75%
            3 to 4 years 2.8 to 3.6 years 2.25%
          Zone 3 4 to 5 years 3.6 to 4.3 years 2.75%
            5 to 7 years 4.3 to 5.7 years 3.25%
            7 to 10 years 5.7 to 7.3 years 3.75%
            10 to 15 years 7.3 to 9.3 years 4.50%
            15 to 20 years 9.3 to 10.6 years 5.25%
            > 20 years 10.6 to 12 years 6.00%
              12 to 20 years 8.00%
              >> 20 years 12.50%
        (b) The market values of the individual long and short net positions in each maturity band are multiplied by the respective risk weighting factors given in Paragraph CA-4.4.2(a) above.
        (c) Matching of positions within each maturity band (i.e. vertical matching) is done as follows:
        •   Where a maturity band has both weighted long and short positions, the extent to which the one offsets the other is called the matched weighted position. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a band) is called the unmatched weighted position for that band.
        (d) Matching of positions, across maturity bands, within each zone (i.e. horizontal matching - level 1), is done as follows:
        (e) Where a zone has both unmatched weighted long and short positions for various bands, the extent to which the one offsets the other is called the matched weighted position for that zone. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a zone) is called the unmatched weighted position for that zone.
        (f) Matching of positions, across zones (i.e. horizontal matching - level 2), is done as follows:
        (i) The unmatched weighted long or short position in zone 1 may be offset against the unmatched weighted short or long position in zone 2. The extent to which the unmatched weighted positions in zones 1 and 2 are offsetting is described as the matched weighted position between zones 1 and 2.
        (ii) After step (i) above, any residual unmatched weighted long or short position in zone 2 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 2 and 3 are offsetting is described as the matched weighted position between zones 2 and 3.
        The calculations in steps (i) and (ii) above may be carried out in reverse order (i.e. zones 2 and 3, followed by zones 1 and 2).
        (iii) After steps (i) and (ii) above, any residual unmatched weighted long or short position in zone 1 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 1 and 3 are offsetting is described as the matched weighted position between zones 1 and 3.
        (g) Any residual unmatched weighted positions, following the matching within and between maturity bands and zones as described above, will be summed.
        (h) The general interest rate risk capital requirement is the sum of:
        (i) Matched weighted positions in all maturity bands × 10%
        (ii) Matched weighted positions in zone 1 × 40%
        (iii) Matched weighted positions in zone 2 × 30%
        (iv) Matched weighted positions in zone 3 × 50%
        (v) Matched weighted positions between zones 1&2 × 40%
        (vi) Matched weighted positions between zones 2&3 × 40%
        (vii) Matched weighted positions between zones 1&3 × 100%
        (viii) Residual unmatched weighted positions × 100%

        Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.
        October 07

    • CA-4.5 CA-4.5 Duration method

      • CA-4.5.1

        The duration method is an alternative approach to measuring the exposure to parallel and non-parallel shifts in the yield curve, and recognises the use of duration as an indicator of the sensitivity of individual positions to changes in market yields. Under this method, banks may use a duration-based system for determining their general interest rate risk capital requirements for traded debt instruments and other sources of interest rate exposures including derivatives. A worked example of the duration method is included in Appendix CA-4. The various time-bands and assumed changes in yield, relevant to the duration method, are illustrated below.

        October 07

      • Duration method: time-bands and assumed changes in yield

          Time-band Assumed change in yield
        Zone 1 1 month or less 1.00
          1 to 3 months 1.00
          3 to 6 months 1.00
          6 to 12 months 1.00
        Zone 2 1 to 1.9 years 0.90
          1.9 to 2.8 years 0.80
          2.8 to 3.6 years 0.75
        Zone 3 3.6 to 4.3 years 0.75
          4.3 to 5.7 years 0.70
          5.7 to 7.3 years 0.65
          7.3 to 9.3 years 0.60
          9.3 to 10.6 years 0.60
          10.6 to 12 years 0.60
          12 to 20 years 0.60
          > 20 years 0.60
        October 07

        • CA-4.5.2

          Banks should notify the Central Bank of the circumstances in which they elect to use this method. Once chosen, the duration method must be consistently applied, in accordance with the requirements of Section CA-4.3.

          October 07

        • CA-4.5.3

          Where a bank has chosen to use the duration method, it is possible that it will not be suitable for certain instruments. In such cases, the bank should seek the advice of the Central Bank or obtain approval for application of the maturity method to the specific Category(ies) of instruments, in accordance with the provisions of Section CA-4.3.

          October 07

        • CA-4.5.4

          The steps in the calculation of the general market risk for interest rate positions, under this method, are set out below:

          (a) The bank will determine the Yield-to-Maturity (YTM) for each individual net position in fixed rate and floating rate instruments, based on the current market value. The basis of arriving at individual net positions is explained in Section CA-4.4 above. The YTM for fixed rate instruments is determined without any regard to whether the instrument is coupon bearing, or whether the instrument has any embedded options. In all cases, YTM for fixed rate instruments is calculated with reference to the final maturity date and, for floating rate instruments, with reference to the next repricing date.
          (b) The bank will calculate, for each debt instrument, the modified duration (M) on the basis of the following formula:

          M = D/(1+r)
          where, Sigma m t = 1 t × C/(1+r) t
          D (duration) = Sigma m t = 1 C/(1+r) t


          r = YTM % per annum expressed as a decimal

          C = Cash flow at time t

          t = time at which cash flows occur, in years

          m = time to maturity, in years
          (c) Individual net positions, at current market value, are allocated to the time-bands illustrated in Paragraph CA-4.5.1, based on their modified duration.
          (d) The bank will then calculate the modified duration-weighted position for each individual net position by multiplying its current market value by the modified duration and the assumed change in yield.
          (e) Matching of positions within each time band (i.e. vertical matching) is done as follows:
          •   Where a time band has both weighted long and short positions, the extent to which the one offsets the other is called the matched weighted position. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a band) is called the unmatched weighted position for that band.
          (f) Matching of positions, across time bands, within each zone (i.e. horizontal matching - level 1), is done as follows:
          •   Where a zone has both unmatched weighted long and short positions for various bands, the extent to which the one offsets the other is called the matched weighted position for that zone. The remainder (i.e. the excess of the weighted long positions over the weighted short positions, or vice versa, within a zone) is called the unmatched weighted position for that zone.
          (g) Matching of positions, across zones (i.e. horizontal matching - level 2), is done as follows:
          (i) The unmatched weighted long or short position in zone 1 may be offset against the unmatched weighted short or long position in zone 2. The extent to which the unmatched weighted positions in zones 1 and 2 are offsetting is described as the matched weighted position between zones 1 and 2.
          (ii) After step (i) above, any residual unmatched weighted long or short position in zone 2 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 2 and 3 are offsetting is described as the matched weighted position between zones 2 and 3.
          The calculations in steps (i) and (ii) above may be carried out in reverse order (i.e. zones 2 and 3, followed by zones 1 and 2).
          (iii) After steps (a) and (b) above, any residual unmatched weighted long or short position in zone 1 may be matched by offsetting the unmatched weighted short or long position in zone 3. The extent to which the unmatched positions in zones 1 and 3 are offsetting is described as the matched weighted position between zones 1 and 3.
          (h) Any residual unmatched weighted positions, following the matching within and between maturity bands and zones as described above, will be summed.
          (i) The general interest rate risk capital requirement is the sum of:
          (i) Matched weighted positions in all maturity bands × 5%
          (ii) Matched weighted positions in zone 1 × 40%
          (iii) Matched weighted positions in zone 2 × 30%
          (iv) Matched weighted positions in zone 3 × 30%
          (v) Matched weighted positions between zones 1 & 2 × 40%
          (vi) Matched weighted positions between zones 2 & 3 × 40%
          (vii) Matched weighted positions between zones 1 & 3 × 100%
          (viii) Residual unmatched weighted positions × 100%

          Item (i) is referred to as the vertical disallowance, items (ii) through (iv) as the first set of horizontal disallowances, and items (v) through (vii) as the second set of horizontal disallowances.
          October 07

    • CA-4.6 CA-4.6 Derivatives

      • CA-4.6.1

        Banks which propose to use internal models to measure the interest rate risk inherent in derivatives will seek the prior written approval of the Central Bank for using those models. The use of internal models to measure market risk, and the Central Bank's rules applicable to them, are discussed in detail in Chapter CA-9.

        October 07

      • CA-4.6.2

        Where a bank, with the prior written approval of the Central Bank, uses an interest rate sensitivity model, the output of that model is used, by the duration method, to calculate the general market risk as described in Section CA-4.5.

        October 07

      • CA-4.6.3

        Where a bank does not propose to use models, it must use the techniques described in the following Paragraphs, for measuring the market risk on interest rate derivatives. The measurement system should include all interest rate derivatives and off-balance-sheet instruments in the trading book which react to changes in interest rates (e.g. forward rate agreements, other forward contracts, bond futures, interest rate and cross-currency swaps, options and forward foreign exchange contracts). Where a bank has obtained the approval of the Central Bank for the use of non-interest rate derivatives models, the embedded interest rate exposures should be incorporated in the standardised measurement framework described in Sections CA-4.7 to CA-4.9.

        October 07

      • CA-4.6.4

        Derivative positions will attract specific risk only when they are based on an underlying instrument or security. For instance, where the underlying exposure is an interest rate exposure, as in a swap based upon interbank rates, there will be no specific risk, but only counterparty risk. A similar treatment applies to FRAs, forward foreign exchange contracts and interest rate futures. However, for a swap based on a bond yield, or a futures contract based on a debt security or an index representing a basket of debt securities, the credit risk of the issuer of the underlying bond will generate a specific risk capital requirement. Future cash flows derived from positions in derivatives will generate counterparty risk requirements related to the counterparty in the trade, in addition to position risk requirements (specific and general market risk) related to the underlying security.

        October 07

      • CA-4.6.5

        A summary of the rules for dealing with interest rate derivatives (other than options) is set out in Section CA-4.9. The treatment of options, being a complex issue, is dealt with in detail in Chapter CA-8.

        October 07

    • CA-4.7 CA-4.7 Calculation of derivative positions

      • CA-4.7.1

        The derivatives should be converted to positions in the relevant underlying and become subject to specific and general market risk charges as described in Sections CA-4.2 and CA-4.3, respectively. For the purpose of calculation by the standard formulae, the amounts reported are the market values of the principal amounts of the underlying or of the notional underlying. For instruments where the apparent notional amount differs from the effective notional amount, banks should use the latter.

        October 07

      • CA-4.7.2

        The remaining Paragraphs in this Section include the guidelines for the calculation of positions in different categories of interest rate derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the Central Bank in writing.

        October 07

      • Forward foreign exchange contracts

        • CA-4.7.3

          A forward foreign exchange position is decomposed into legs representing the paying and receiving currencies. Each of the legs is treated as if it were a zero coupon bond, with zero specific risk, in the relevant currency and included in the measurement framework as follows:

          (a) If the maturity method is used, each leg is included at the notional amount.
          (b) If the duration method is used, each leg is included at the present value of the notional zero coupon bond.
          October 07

      • Deposit futures and FRAs

        • CA-4.7.4

          Deposit futures, forward rate agreements and other instruments where the underlying is a money market exposure will be split into two legs as follows:

          (a) The first leg will represent the time to expiry of the futures contract, or settlement date of the FRA as the case may be.
          (b) The second leg will represent the time to expiry of the underlying instrument.
          (c) Each leg will be treated as a zero coupon bond with zero specific risk.
          (d) For deposit futures, the size of each leg is the notional amount of the underlying money market exposure. For FRAs, the size of each leg is the notional amount of the underlying money market exposure discounted to present value, although in the maturity method, the notional amount may be used without discounting.
          For example, under the maturity method, a single 3-month Euro$ 1,000,000 deposit futures contract expiring in 3 months' time will have one leg of $ 1,000,000 representing the 8 months to contract expiry, and another leg of $ 1,000,000 in the 11 months' time-band representing the time to expiry of the deposit underlying the futures contract.
          October 07

      • Bonds futures and forwards bond transactions

        • CA-4.7.5

          Bond futures, forward bond transactions and the forward leg of repos, reverse repos and other similar transactions will use the two-legged approach. A forward bond transaction is one where the settlement is for a period other than the prevailing norm for the market.

          (a) The first leg is a zero coupon bond with zero specific risk. Its maturity is the time to expiry of the futures or forward contract. Its size is the cash flow on maturity discounted to present value, although in the maturity method, the cash flow on maturity may be used without discounting.
          (b) The second leg is the underlying bond. Its maturity is that of the underlying bond for fixed rate bonds, or the time to the next reset for floating rate bonds. Its size is as set out in (c) and (d) below.
          (c) For forward bond transactions, the underlying bond and amount is used at the present spot price.
          (d) For bond futures, the principal amounts for each of the two legs is reckoned as the futures price times the notional underlying bond amount.
          (e) Where a range of deliverable instruments may be delivered to fulfil a futures contract (at the option of the 'short'), then the following rules are used to determine the principal amount, taking account of any conversion factors defined by the exchange:
          (i) The 'long' may use one of the deliverable bonds, or the notional bond on which the contract is based, as the underlying instrument, but this notional long leg may not be offset against a short cash position in the same bond.
          (ii) The 'short' may treat the notional underlying bond as if it were one of the deliverable bonds, and it may be offset against a short cash position in the same bond.
          (f) For futures contracts based on a corporate bond index, the positions will be included at the market value of the notional underlying portfolio of securities.
          (g) A repo (or sell-buy or stock lending) involving exchange of a security for cash should be represented as a cash borrowing - i.e. a short position in a government bond with maturity equal to the repo and coupon equal to the repo rate. A reverse repo (or buy-sell or stock borrowing) should be represented as a cash loan - i.e. a long position in a government bond with maturity equal to the reverse repo and coupon equal to the repo rate. These positions are referred to as 'cash legs'.
          (h) It should be noted that, where a security owned by the bank (and included in its calculation of market risk) is repo'd, it continues to contribute to the bank's interest rate or equity position risk calculation.
          October 07

      • Swaps

        • CA-4.7.6

          Swaps are treated as two notional positions in government securities with the relevant maturities.

          (a) Interest rate swaps will be decomposed into two legs, and each leg will be allocated to the maturity band equating to the time remaining to repricing or maturity. For example, an interest rate swap in which a bank is receiving floating rate interest and paying fixed is treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed rate instrument of maturity equivalent to the residual life of the swap.
          (b) For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the interest rate component should be slotted into the appropriate repricing or maturity Category, with the equity component being included in the equity risk measurement framework as described in Chapter CA-5.
          (c) For cross currency swaps, the separate legs are included in the interest rate risk measurement for the currencies concerned, as having a fixed/floating leg in each currency. Alternatively, the two parts of a currency swap transaction are split into forward foreign exchange contracts and treated accordingly.
          (d) Where a swap has a deferred start, and one or both legs have been fixed, then the fixed leg(s) will be sub-divided into the time to the commencement of the leg and the actual swap leg with fixed or floating rate. A swap is deemed to have a deferred start when the commencement of the interest rate calculation periods is more than two business days from the transaction date, and one or both legs have been fixed at the time of the commitment. However, when a swap has a deferred start and neither leg has been fixed, there is no interest rate exposure, albeit there will be counterparty exposure.
          (e) Where a swap has a different structure from those discussed above, it may be necessary to adjust the underlying notional principal amount, or the notional maturity of one or both legs of the transaction.
          October 07

        • CA-4.7.7

          Banks with large swap books may use alternative formulae for these swaps to calculate the positions to be included in the maturity or duration ladder. One method would be to first convert the cash flows required by the swap into their present values. For this purpose, each cash flow should be discounted using the zero coupon yields, and a single net figure for the present value of the cash flows entered into the appropriate time-band using procedures that apply to zero or low coupon (less than 3%) instruments. An alternative method would be to calculate the sensitivity of the net present value implied by the change in yield used in the duration method (as set out in Section CA-4.5), and allocate these sensitivities into the appropriate time-bands.

          October 07

        • CA-4.7.8

          Banks which propose to use the approaches described in Paragraph CA-4.7.7, or any other similar alternative formulae, should obtain the prior written approval of the Central Bank. The Central Bank will consider the following factors before approving any alternative methods for calculating the swap positions:

          (a) Whether the systems proposed to be used are accurate;
          (b) Whether the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time-bands; and
          (c) Whether the positions are denominated in the same currency.
          October 07

    • CA-4.8 CA-4.8 Netting of derivative positions

      • Permissible offsetting of fully matched positions for both specific and general market risk

        • CA-4.8.1

          Banks may exclude from the interest rate risk calculation, altogether, the long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity. A matched position in a future or a forward and its corresponding underlying may also be fully offset, albeit the leg representing the time to expiry of the future is included in the calculation.

          October 07

        • CA-4.8.2

          When the future or the forward comprises a range of deliverable instruments, offsetting of positions in the futures or forward contract and its underlying is only permitted in cases where there is a readily identifiable underlying security which is most profitable for the trader with a short position to deliver. The price of this security, sometimes called the 'cheapest-to-deliver', and the price of the future or forward contract should, in such cases, move in close alignment. No offsetting will be allowed between positions in different currencies. The separate legs of cross-currency swaps or forward foreign exchange contracts are treated as notional positions in the relevant instruments and included in the appropriate calculation for each currency.

          October 07

      • Permissible offsetting of closely matched positions for general market risk only

        • CA-4.8.3

          For the purpose of calculation of the general market risk, in addition to the permissible offsetting of fully matched positions as described in Paragraph CA-4.8.1 above, opposite positions giving rise to interest rate exposure can be offset if they relate to the same underlying instruments, are of the same nominal value and are denominated in the same currency and, in addition, fulfil the following conditions:

          (a) For futures:
          Offsetting positions in the notional or underlying instruments to which the futures contract relates should be for identical products and mature within seven days of each other.
          (b) For swaps and FRAs:
          The reference rate (for floating rate positions) must be identical and the coupons must be within 15 basis points of each other.
          (c) For swaps, FRAs and forwards:
          The next interest fixing date or, for fixed coupon positions or forwards, the residual maturity must correspond within the following limits:
          •   less than one month: same day;
          •   between one month and one year: within 7 days;
          •   over one year: within 30 days.
          October 07

    • CA-4.9 CA-4.9 Calculation of capital charge for derivatives

      • CA-4.9.1

        After calculating the derivatives positions, taking account of the permissible offsetting of matched positions, as explained in Section CA-4.8, the capital charges for specific and general market risk for interest rate derivatives are calculated in the same manner as for cash positions, as described earlier in this Chapter.

        Summary of treatment of interest rate derivative

        Instrument Specific risk charge* General market risk charge
        Exchange-traded futures    
             
        - Government** debt security No Yes, as two positions
             
        - Corporate debt security Yes Yes, as two positions
             
        - Index on interest rates (e.g. LIBOR) No Yes, as two positions
             
        - Index on basket of debt securities Yes Yes, as two positions
             
        OTC forwards    
             
        - Government** debt security No Yes, as two positions
             
        - Corporate debt security Yes Yes, as two positions
             
        - Index on interest rates No Yes, as two positions
             
        FRAs No Yes, as two positions
             
        Swaps    
        - Based on interbank rates No Yes, as two positions
             
        - Based on Government** bond yields No Yes, as two positions
             
        - Based on corporate bond yields Yes Yes, as two positions
             
        Forward foreign exchange No Yes, as one position in each currency
             
        Options    
        - Government** debt security No Either (a) or (b) as below (see Chapter CA-8 for a detailed description):
             
        •   Corporate debt security
        •   Index on interest rates
        •   FRAs, swaps
        		Yes

        No

        No
        (a) Carve out together with the associated hedging positions, and use:
        •   simplified approach; or
        •   scenario analysis; or
        •   internal models (see Chapter CA-9).
        (b) General market risk charge according to the delta-plus method (gamma and vega should receive separate capital charges).
        *This is the specific risk charge relating to the issuer of the instrument. Under the credit risk rules, there remains a separate capital charge for the counterparty risk.

        **As defined in Section CA-4.2.
        October 07