• CA-8 CA-8 Market Risk — Trading Book

    • CA-8.1 CA-8.1 Definition of the Trading Book

      • CA-8.1.1

        "Market risk" is defined as the risk of losses in on- and off-balance sheet positions arising from movements in market prices. The risks that are subject to the market risk capital requirement are:

        (a) Equity position risk in the trading book (see Chapter CA-10);42
        (b) Interest rate risk in trading positions in financial instruments in the trading book (see Chapter CA-9);
        (c) Foreign exchange risk (see Chapter CA-11); and
        (d) Commodities risk (see Chapter CA-12).

        42 Equity positions in the banking book are dealt with under Paragraph CA-3.2.26.

        January 2015

      • CA-8.1.2

        A trading book consists of positions in financial instruments and commodities held either with trading intent or in order to hedge other elements of the trading book, along with open foreign exchange positions in both the banking and the trading book. To be eligible for trading book capital treatment, financial instruments must either be free of any restrictive covenants on their tradability or able to be hedged completely. In addition, positions must be frequently and accurately valued, and the portfolio must be actively managed (open equity stakes in hedge funds, private equity investments, positions in a securitisation warehouse and real estate holdings do not meet the definition of the trading book, owing to significant constraints on the ability of banks to liquidate these positions and value them reliably on a daily basis. Such holdings must therefore be held in the conventional bank licensee's banking book and treated as equity holding in corporates, except real estate which must be treated as per Paragraph CA-3.2.29).

        January 2015

      • CA-8.1.3

        A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Financial instruments include both primary financial instruments (or cash instruments) and derivative financial instruments. A financial asset is any asset that is cash, the right to receive cash or another financial asset; or the contractual right to exchange financial assets on potentially favourable terms, or an equity instrument. A financial liability is the contractual obligation to deliver cash or another financial asset or to exchange financial liabilities under conditions that are potentially unfavourable.

        January 2015

      • CA-8.1.4

        Positions held with trading intent are those held intentionally for short-term resale and/or with the intent of benefiting from actual or expected short-term price movements or to lock in arbitrage profits, and may include for example proprietary positions, positions arising from client servicing (e.g. matched principal broking) and market making. It is therefore possible that conventional bank licensees may sometimes not have a trading book as defined above. Nonetheless the conventional bank licensee's strategy and business plan must take account of the requirements of this Chapter in case a conventional bank licensee does take on positions with trading intent.

        January 2015

      • CA-8.1.5

        Conventional bank licensees must have clearly defined policies and procedures for determining which exposures to include in, and to exclude from, the trading book for purposes of calculating their regulatory capital, to ensure compliance with the criteria for trading book set forth in this Section and taking into account the conventional bank licensee's risk management capabilities and practices. The conventional bank licensee must have well-documented procedures to comply with stated policies, which must be fully documented and subject to periodic internal audit.

        January 2015

      • CA-8.1.6

        The policies and procedures referred to in Paragraph CA-8.1.5 must, at a minimum, address the following general considerations:

        (a) The activities the conventional bank licensee considers to be trading and as constituting part of the trading book for regulatory capital purposes;
        (b) The extent to which an exposure can be marked-to-market daily by reference to an active, liquid two-way market;
        (c) For exposures that are marked-to-model, the extent to which the conventional bank licensee can:
        (i) Identify the material risks of the exposure;
        (ii) Hedge the material risks of the exposure and the extent to which hedging instruments would have an active, liquid two-way market; and
        (iii) Derive reliable estimates for the key assumptions and parameters used in the model;
        (d) The extent to which the conventional bank licensee can and is required to generate valuations for the exposure that can be validated externally in a consistent manner;
        (e) The extent to which legal restrictions or other operational requirements would impede the conventional bank licensee's ability to effect an immediate liquidation of the exposure;
        (f) The extent to which the conventional bank licensee is required to, and can, actively risk manage the exposure within its trading operations; and
        (g) The extent to which the conventional bank licensee may transfer risk or exposures between the banking and the trading books and criteria for such transfers.

        The list above is not intended to provide a series of tests that a product or group of related products must pass to be eligible for inclusion in the trading book. Rather, the list provides a minimum set of key points that must be addressed by the policies and procedures for overall management of a conventional bank licensee's trading book.

        January 2015

      • CA-8.1.7

        The basic requirements for positions eligible to receive trading book capital treatment are as follows:

        (a) Clearly documented trading strategy for the position/instrument or portfolios, approved by senior management (which would include expected holding horizon);
        (b) Clearly defined policies and procedures for the active management of the position, which must include:
        (i) Positions are managed on a trading desk;
        (ii) Position limits are set and monitored for appropriateness;
        (iii) Dealers have the autonomy to enter into/manage the position within agreed limits and according to the agreed strategy;
        (iv) Positions are marked to market at least daily and when marking to model the parameters must be assessed on a daily basis;
        (v) Positions are reported to senior management as an integral part of the institution's risk management process; and
        (vi) Positions are actively monitored with reference to market information sources (assessment must be made of the market liquidity or the ability to hedge positions or the portfolio risk profiles). This would include assessing the quality and availability of market inputs to the valuation process, level of market turnover, sizes of positions traded in the market, etc.; and
        (c) Clearly defined policy and procedures to monitor the positions against the conventional bank licensee's trading strategy including the monitoring of turnover and stale positions in the conventional bank licensee's trading book.
        January 2015

      • CA-8.1.8

        When a conventional bank licensee hedges a banking book credit risk exposure using a credit derivative booked in its trading book (i.e. using an internal hedge), the banking book exposure is not deemed to be hedged for capital purposes unless the conventional bank licensee purchases from an eligible third party protection provider a credit derivative meeting the requirements of Paragraph CA-4.5.3 vis-à-vis the banking book exposure. Where such third party protection is purchased and is recognised as a hedge of a banking book exposure for regulatory capital purposes, neither the internal nor external credit derivative hedge would be included in the trading book for regulatory capital purposes.

        January 2015

      • CA-8.1.8A

        Positions in the conventional bank licensee's own regulatory capital instruments are deducted from capital (as detailed in Chapter CA-2.4). Positions in other banks', securities firms', and other financial entities' eligible regulatory capital instruments, as well as intangible assets, are subject to the treatment set down in Chapter CA-2.4.

        January 2015

      • CA-8.1.9

        Term trading-related repo-style transactions that a conventional bank licensee accounts for in its banking book may be included in the conventional bank licensee's trading book for regulatory capital purposes so long as all such repo-style transactions are included. For this purpose, trading-related repo-style transactions are defined as only those that meet the requirements of Paragraphs CA-8.1.4 and CA-8.1.7 and both legs are in the form of either cash or securities includable in the trading book.

        January 2015

      • CA-8.1.10

        Regardless of where they are booked, all repo-style transactions are subject to a banking book counterparty credit risk charge.

        January 2015

      • CA-8.1.11

        For the purposes of this framework, the correlation trading portfolio incorporates securitisation exposures and n-th-to-default credit derivatives that meet the following criteria:

        (a) The positions are neither re-securitisation positions, nor derivatives of securitisation exposures that do not provide a pro-rata share in the proceeds of a securitisation tranche (this therefore excludes options on a securitisation tranche, or a synthetically leveraged super-senior tranche); and
        (b) All reference entities are single-name products, including single-name credit derivatives, for which a liquid two-way market exists. This will include commonly traded indices based on these reference entities. A two-way market is deemed to exist where there are independent bona fide offers to buy and sell so that a price reasonably related to the last sales price or current bona fide competitive bid and offer quotations can be determined within one day and settled at such price within a relatively short time conforming to trade custom.

        Positions which reference an underlying that would be treated as a retail exposure, a residential mortgage exposure or a commercial mortgage exposure under the standardised approach to credit risk are not included in the correlation trading portfolio. Positions which reference a claim on a special purpose entity are not included either. A conventional bank licensee may also include in the correlation trading portfolio positions that hedge the positions described above and which are neither securitisation exposures nor n-th-to-default credit derivatives and where a liquid two-way market as described above exists for the instrument or its underlyings.

        January 2015

    • CA-8.2

      [This Chapter has been moved to Chapter CA-16 in January 2012]

      January 2015

    • CA-8.3 CA-8.3 Treatment of Counterparty Credit Risk in the Trading Book

      • CA-8.3.1

        Conventional bank licensees must calculate the counterparty credit risk charge for OTC derivatives, repo-style and other transactions booked in the trading book, separate from the capital charge for general market risk and specific risk.43 The risk weights to be used in this calculation must be consistent with those used for calculating the capital requirements in the banking book. Thus, conventional bank licensees must use the standardised approach risk weights in the trading book.


        43 The treatment for unsettled foreign exchange and securities trades is set forth in Paragraph CA-3.3.13.

        January 2015

      • CA-8.3.2

        In the trading book, for repo-style transactions, all instruments, which are included in the trading book, may be used as eligible collateral. Those instruments which fall outside the banking book definition of eligible collateral are subject to a haircut at the level applicable to non-main index equities listed on recognised exchanges (as noted in Paragraph CA-4.3.7). Where conventional bank licensees are applying a VaR approach to measuring exposure for repo-style transactions, they also may apply this approach in the trading book in accordance with Paragraphs CA-4.3.22 to CA-4.3.25 and Appendix CA-2.

        January 2015

      • CA-8.3.3

        The calculation of the counterparty credit risk charge for collateralised OTC derivative transactions is the same as the rules prescribed for such transactions booked in the banking book.

        January 2015

      • CA-8.3.4

        The calculation of the counterparty charge for repo-style transactions must follow the rules in Paragraphs CA-4.3.3 to CA-4.3.25 and Appendix CA-2.

        January 2015

      • Credit Derivatives

        • CA-8.3.5

          The counterparty credit risk charge for single name credit derivative transactions in the trading book must be calculated applying the following potential future exposure add-on factors:

            Protection buyer Protection seller
          Total Return Swap    
          "Qualifying" reference obligation 5% 5%
          "Non-qualifying" reference obligation 10% 10%
          Credit Default Swap    
          "Qualifying" reference obligation 5% 5%**
          "Non-qualifying" reference obligation 10% 10%**

          There will be no difference depending on residual maturity.

          The definition of "qualifying" is the same as for the treatment of specific risk in chapter CA-9.

          ** The protection seller of a credit default swap is only subject to the add-on factor where it is subject to closeout upon the insolvency of the protection buyer while the underlying is still solvent. Add-on must then be capped to the amount of unpaid premiums.

          January 2015

        • CA-8.3.6

          Where the credit derivative is a first to default transaction, the add-on is determined by the lowest credit quality underlying in the basket, i.e. if there are any non-qualifying items in the basket, the non-qualifying reference obligation add-on is used. For second and subsequent to default transactions, underlying assets must continue to be allocated according to the credit quality, i.e. the second lowest credit quality determines the add-on for a second to default transaction etc.

          January 2015