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  • CA-10.5 CA-10.5 Equity Derivatives

    • CA-10.5.1

      For the purpose of calculating the specific and general market risk by the standardised approach, equity derivative positions should be converted into notional underlying equity positions, whether long or short. All equity derivatives and off-balance-sheet positions which are affected by changes in equity prices should be included in the measurement framework. This includes futures and swaps on both individual equities and on stock indices.

      Apr 08

    • CA-10.5.2

      The following guidelines will apply to the calculation of positions in different categories of equity derivatives. Banks which need further assistance in the calculation, particularly in relation to complex instruments, should contact the CBB:

      (a) Futures and forward contracts relating to individual equities should, in principle, be included in the calculation at current market prices;
      (b) Futures relating to stock indices should be included in the calculation, at the marked-to-market value of the notional underlying equity portfolio, i.e. as a single position based on the sum of the current market values of the underlying instruments;
      (c) Equity swaps are treated as two notional positions. For example, an equity swap in which a bank is receiving an amount based on the change in value of one particular equity or stock index, and paying a different index is treated as a long position in the former and a short position in the latter. Where one of the swap legs involves receiving/paying a fixed or floating interest rate, that exposure should be slotted into the appropriate time-band for interest rate related instruments as set out in chapter CA-9. The stock index leg should be covered by the equity treatment as set out in this chapter; and
      (d) Equity options and stock index options are either "carved out" together with the associated underlying instruments, or are incorporated in the general market risk measurement framework, described in this chapter, based on the delta-plus method. The treatment of options, being a complex issue, is dealt with in detail in chapter CA-13.
      Amended: April 2011
      Apr 08

    • CA-10.5.3

      A summary of the treatment of equity derivatives is set out in Paragraph CA-10.5.8.

      Amended: January 2012
      Apr 08

    • Specific Risk on Positions in Equity Indices

      • CA-10.5.4

        Positions in highly liquid equity indices whether they arise directly or through derivatives, attract a 2% capital charge in addition to the general market risk, to cover factors such as execution risk.

        Apr 08

      • CA-10.5.5

        For positions in equity indices not regarded as highly liquid, the specific risk capital charge is the highest specific risk charge that would apply to any of its components, as set out in Section CA-10.3.

        Amended: January 2012
        Apr 08

      • CA-10.5.6

        In the case of the futures-related arbitrage strategies set out below, the specific risk capital charge described above may be applied to only one index with the opposite position exempt from a specific risk capital charge. The strategies are as follows:

        (a) Where a bank takes an opposite position in exactly the same index, at different dates or in different market centres; and
        (b) Where a bank takes opposite positions in contracts at the same date in different but similar indices, provided the two indices contain at least 90% common components.
        Amended: April 2011
        Apr 08

      • CA-10.5.7

        Where a bank engages in a deliberate arbitrage strategy, in which a futures contract on a broad-based index matches a basket of stocks, it will be allowed to carve out both positions from the standardised methodology on the following conditions:

        (a) The trade has been deliberately entered into, and separately controlled; and
        (b) The composition of the basket of stocks represents at least 90% of the index when broken down into its notional components.

        In such a case, the minimum capital requirement is limited to 4% (i.e. 2% of the gross value of the positions on each side) to reflect divergence and execution risks. This applies even if all of the stocks comprising the index are held in identical proportions. Any excess value of the stocks comprising the basket over the value of the futures contract or vice versa is treated as an open long or short position.

        Amended: April 2011
        Apr 08

    • Counterparty Risk

      • CA-10.5.8

        Derivative positions may also generate counterparty risk exposure related to the counterparty in the trade, in addition to position risk requirements (specific and general) related to the underlying instrument, e.g. counterparty risk related to OTC trades through margin payments, fees payable or settlement exposures. The credit risk capital requirements will apply to such counterparty risk exposure.

        Summary of Treatment of Equity Derivatives

        Instrument Specific risk charge* General market risk charge
        Exchange-traded or OTC futures    
        -Individual equity Yes Yes, as underlying
        -Index Yes
        (see Section CA-10.5)                 		Yes, as underlying
        Options    
        -Individual equity Yes Either (a) or (b) as below (chapter CA-13 for a detailed description):
        (a) Carve out together with the associated hedging positions, and use:
        -simplified approach; or
        -scenario analysis; or
        -internal models (chapter CA-15).
        (b) General market risk charge according to the delta-plus method (gamma and vega should receive separate capital charges).
        -Index Yes
        * 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.
        Amended: January 2012
        Amended: April 2011
        Apr 08