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  • 1. Risk-weighted Assets for Equity Exposures

    • CA-5.5.2

      Risk-weighted assets for equity exposures in the trading book are subject to the market risk capital rules detailed in chapter CA-10.

      Apr 08

    • CA-5.5.3

      There are two approaches to calculate risk-weighted assets for equity exposures not held in the trading book: a market-based approach and a PD/LGD approach. Banks are permitted to select the approach subject to approval of CBB. Certain equity holdings are excluded as defined in paragraphs CA-5.5.18 to CA-5.5.20 and are subject to the capital charges required under the standardised approach.

      Apr 08

    • CA-5.5.4

      Banks' choices must be made consistently, and in particular not determined by regulatory arbitrage considerations.

      Apr 08

    • (i) Market-based Approach

      • CA-5.5.5

        Under the market-based approach, institutions are permitted to calculate the minimum capital requirements for their banking book equity holdings using one or both of two separate and distinct methods: a simple risk weight method or an internal models method. The method used should be consistent with the amount and complexity of the institution's equity holdings and commensurate with the overall size and sophistication of the institution. CBB may require the use of either method based on the individual circumstances of a bank.

        Apr 08

      • — Simple Risk Weight Method

        • CA-5.5.6

          Under the simple risk weight method, a 300% risk weight is to be applied to equity holdings that are publicly traded and a 400% risk weight is to be applied to all other equity holdings. A publicly traded holding is defined as any equity security traded on a recognised security exchange.

          Apr 08

        • CA-5.5.7

          Short cash positions and derivative instruments held in the banking book are permitted to offset long positions in the same individual stocks provided that these instruments have been explicitly designated as hedges of specific equity holdings and that they have remaining maturities of at least one year. Other short positions are to be treated as if they are long positions with the relevant risk weight applied to the absolute value of each position. In the context of maturity mismatched positions, the methodology is that for corporate exposures.

          Apr 08

      • Internal Models Method

        • CA-5.5.8

          IRB banks may use, or may be required by CBB to use, internal risk measurement models to calculate the risk-based capital requirement. Under this alternative, banks must hold capital equal to the potential loss on the institution's equity holdings as derived using internal value-at-risk models subject to the 99th percentile, one-tailed confidence interval of the difference between quarterly returns and an appropriate risk-free rate computed over a long-term sample period. The capital charge would be incorporated into an institution's risk-based CAR through the calculation of risk-weighted equivalent assets.

          Apr 08

        • CA-5.5.9

          The risk weight used to convert holdings into risk-weighted equivalent assets would be calculated by multiplying the derived capital charge by 12.5 (i.e. the inverse of the minimum 8% risk-based capital requirement). Capital charges calculated under the internal models method may be no less than the capital charges that would be calculated under the simple risk weight method using a 200% risk weight for publicly traded equity holdings and a 300% risk weight for all other equity holdings. These minimum capital charges would be calculated separately using the methodology of the simple risk weight approach. Further, these minimum risk weights are to apply at the individual exposure level rather than at the portfolio level.

          Apr 08

        • CA-5.5.10

          A bank may be permitted by CBB to employ different market-based approaches to different portfolios based on appropriate considerations and where the bank itself uses different approaches internally.

          Apr 08

        • CA-5.5.11

          Banks are permitted to recognise guarantees but not collateral obtained on an equity position wherein the capital requirement is determined through use of the market-based approach.

          Apr 08

    • (ii) PD/LGD Approach

      • CA-5.5.12

        The minimum requirements and methodology for the PD/LGD approach for equity exposures (including equity of companies that are included in the retail asset class) are the same as those for the IRB foundation approach for corporate exposures subject to the following specifications:

        (a) The bank's estimate of the PD of a corporate entity in which it holds an equity position must satisfy the same requirements as the bank's estimate of the PD of a corporate entity where the bank holds debt.46 If a bank does not hold debt of the company in whose equity it has invested, and does not have sufficient information on the position of that company to be able to use the applicable definition of default in practice but meets the other standards, a 1.5 scaling factor will be applied to the risk weights derived from the corporate risk-weight function, given the PD set by the bank. If, however, the bank's equity holdings are material and it is permitted to use a PD/LGD approach for regulatory purposes but the bank has not yet met the relevant standards, the simple risk-weight method under the market-based approach will apply;
        (b) An LGD of 90% would be assumed in deriving the risk weight for equity exposures; and
        (c) For these purposes, the risk weight is subject to a five-year maturity adjustment whether or not the bank is using the explicit approach to maturity elsewhere in its IRB portfolio.

        46 In practice, if there is both an equity exposure and an IRB credit exposure to the same counterparty, a default on the credit exposure would thus trigger a simultaneous default for regulatory purposes on the equity exposure.

        Amended: April 2011
        Apr 08

      • CA-5.5.13

        Under the PD/LGD approach, minimum risk weights as set out in section CA-5.5.14 and CA-5.5.15 apply. When the sum of UL and EL associated with the equity exposure results in less capital than would be required from application of one of the minimum risk weights, the minimum risk weights must be used. In other words, the minimum risk weights must be applied, if the risk weights calculated according to the preceding paragraph plus the EL associated with the equity exposure multiplied by 12.5 are smaller than the applicable minimum risk weights.

        Apr 08

      • CA-5.5.14

        A minimum risk weight of 100% applies for the following types of equities for as long as the portfolio is managed in the manner outlined below:

        (a) Public equities where the investment is part of a long-term customer relationship, any capital gains are not expected to be realised in the short term and there is no anticipation of (above trend) capital gains in the long term. It is expected that in almost all cases, the institution will have lending and/or general banking relationships with the portfolio company so that the estimated probability of default is readily available. Given their long-term nature, specification of an appropriate holding period for such investments merits careful consideration. In general, it is expected that the bank will hold the equity over the long term (at least five years); and
        (b) Private equities where the returns on the investment are based on regular and periodic cash flows not derived from capital gains and there is no expectation of future (above trend) capital gain or of realising any existing gain.
        Amended: April 2011
        Apr 08

      • CA-5.5.15

        For all other equity positions, including net short positions (as defined in section CA-5.5.7), capital charges calculated under the PD/LGD approach may be no less than the capital charges that would be calculated under a simple risk weight method using a 200% risk weight for publicly traded equity holdings and a 300% risk weight for all other equity holdings.

        Apr 08

      • CA-5.5.16

        The maximum risk weight for the PD/LGD approach for equity exposures is 1250%. This maximum risk weight can be applied, if risk weights calculated according to section CA-5.5.12 plus the EL associated with the equity exposure multiplied by 12.5 exceed the 1250% risk weight. Alternatively, banks may deduct the entire equity exposure amount, assuming it represents the EL amount, 50% from Tier 1 capital and 50% from Tier 2 capital.

        Apr 08

      • CA-5.5.17

        Hedging for PD/LGD equity exposures is, as for corporate exposures, subject to an LGD of 90% on the exposure to the provider of the hedge. For these purposes equity positions will be treated as having a five-year maturity.

        Apr 08

    • (iii) Exclusions to the Market-based and PD/LGD Approaches

      • CA-5.5.18

        Banks are allowed to exclude equity holdings in entities whose debt obligations qualify for a zero risk weight under the standardised approach to credit risk from the IRB approaches to equity (including those publicly sponsored entities where a zero risk weight can be applied).

        Apr 08

      • CA-5.5.19

        Equity exposures of a bank can be excluded from the IRB treatment based on materiality as defined in the following paragraph.

        Apr 08

      • CA-5.5.20

        The equity exposures of a bank are considered material if their aggregate value exceeds, on average over the prior year, 10% of bank's Tier 1 plus Tier 2 capital. This materiality threshold is lowered to 5% of a bank's Tier 1 plus Tier 2 capital if the equity portfolio consists of less than 10 individual holdings. CBB may use lower materiality thresholds in future.

        Apr 08