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  • CA-10 CA-10 Market Risk — Equity Position Risk — (STA)

    • CA-10.1 CA-10.1 Introduction

      • CA-10.1.1

        This Chapter sets out the minimum capital requirements to cover the risk of holding or taking positions in equities in the conventional bank licensee's trading book.

        January 2015

      • CA-10.1.2

        For the guidance of the conventional bank licensees, and without being exhaustive, the following list includes financial instruments in the trading book, including forward positions, to which equity position risk capital requirements apply:

        (a) Common stocks, whether voting or non-voting;
        (b) Depository receipts (which should be included in the measurement framework in terms of the underlying shares);
        (c) Convertible preference securities (non-convertible preference securities are treated as bonds);
        (d) Convertible debt securities which convert into equity instruments and are, therefore, treated as equities (see Paragraph CA-10.1.3 below);
        (e) Commitments to buy or sell equity securities; and
        (f) Derivatives based on the above instruments.
        January 2015

      • CA-10.1.3

        Convertible debt securities must be treated as equities where:

        (a) The first date at which the conversion may take place is less than three months ahead, or the next such date (where the first date has passed) is less than a year ahead; and
        (b) The convertible is trading at a premium of less than 10%, where the premium is defined as the current marked-to-market value of the convertible less the marked-to-market value of the underlying equity, expressed as a percentage of the latter.

        In other instances, convertibles must be treated as either equity or debt securities, based reasonably on their market behaviour.

        January 2015

      • CA-10.1.4

        For instruments that deviate from the structures described in Paragraphs CA-10.1.2 and CA-10.1.3, or which could be considered complex, each conventional bank licensees must agree on a written policy statement with the CBB 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 must 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 CBB in cases of doubt, particularly when a conventional bank licensee is trading an instrument for the first time.

        January 2015

      • CA-10.1.5

        Where equities are part of a forward contract, a future or an option (i.e. a quantity of equities to be received or delivered), any interest rate or foreign currency exposure from the other leg of the contract must be included in the measurement framework as described in Chapters CA-9 and CA-11, respectively.

        January 2015

      • CA-10.1.6

        As with interest rate related instruments, the minimum capital requirement for equities is expressed in terms of two separately calculated charges, one applying to the "specific risk" of holding a long or short position in an individual equity, and the other to the "general market risk" of holding a long or short position in the market as a whole.

        January 2015

      • CA-10.1.7

        Conventional bank licensees must follow the standardised approach to calculate the equity position risk capital requirement, as set out in detail in this Chapter.

        January 2015

    • CA-10.2 CA-10.2 Calculation of Equity Positions

      • CA-10.2.1

        A conventional bank licensee may net long and short positions in the same equity instrument, arising either directly or through derivatives, to generate the individual net position in that instrument. For example, a future in a given equity may be offset against an opposite cash position in the same equity, albeit the interest rate risk arising out of the future must be calculated separately in accordance with the rules set out in Chapter CA-9.

        January 2015

      • CA-10.2.2

        A conventional bank licensee may net long and short positions in one tranche of an equity instrument against another tranche only where the relevant tranches:

        (a) Rank pari passu in all respects; and
        (b) Become fungible within 180 days, and thereafter the equity instruments of one tranche can be delivered in settlement of the other tranche.
        January 2015

      • CA-10.2.3

        Positions in depository receipts may only be netted against positions in the underlying stock if the stock is freely deliverable against the depository receipt. If a conventional bank licensee takes a position in depository receipts against an opposite position in the underlying equity in different markets (i.e. arbitrage), it may offset the position provided that any costs on conversion are fully taken into account. Furthermore, the foreign exchange risk arising out of these positions must be included in the measurement framework as set out in Chapter CA-11.

        January 2015

      • CA-10.2.4

        More detailed guidance on the treatment of equity derivatives is set out in Section CA-10.5.

        January 2015

      • CA-10.2.5

        Equity positions, arising either directly or through derivatives, must be allocated to the country in which each equity is listed. Where an equity is listed in more than one country, the conventional bank licensee must discuss the appropriate country allocation with the CBB.

        January 2015

    • CA-10.3 CA-10.3 Specific Risk Calculation

      • CA-10.3.1

        Specific risk is defined as the conventional bank licensee's gross equity positions (i.e. the sum of all long equity positions and of all short equity positions), and is calculated for each country or equity market. For each national market in which the conventional bank licensee holds equities, it must sum the market values of its individual net positions as determined in accordance with Section CA-10.2, irrespective of whether they are long or short positions, to produce the overall gross equity position for that market.

        January 2015

      • CA-10.3.2

        The capital charge for specific risk is 8%.

        January 2015

    • CA-10.4 CA-10.4 General Risk Calculation

      • CA-10.4.1

        The general market risk is the difference between the sum of the long positions and the sum of the short positions (i.e. the overall net position) in each national equity market. In other words, to calculate the general market risk, the conventional bank licensee must sum the market value of its individual net positions for each national market, as determined in accordance with Section CA-10.2, taking into account whether the positions are long or short.

        January 2015

      • CA-10.4.2

        The general market equity risk measure is 8% of the overall net position in each national market.

        January 2015

    • 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 must 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 must be included in the measurement framework. This includes futures and swaps on both individual equities and on stock indices.

        January 2015

      • CA-10.5.2

        The following guidelines apply to the calculation of positions in different categories of equity derivatives. Conventional bank licensees which need further assistance in the calculation, particularly in relation to complex instruments, must contact the CBB:

        (a) Futures and forward contracts relating to individual equities must be included in the calculation at current market prices;
        (b) Futures relating to stock indices must 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 conventional bank licensee 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 must be slotted into the appropriate time-band for interest rate related instruments as set out in Chapter CA-9. The stock index leg must 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.
        January 2015

      • CA-10.5.3

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

        January 2015

      • 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.

          January 2015

        • 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.

          January 2015

        • 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 conventional bank licensee takes an opposite position in exactly the same index, at different dates or in different market centres; and
          (b) Where a conventional bank licensee takes opposite positions in contracts at the same date in different but similar indices, provided the two indices contain at least 90% common components.
          January 2015

        • CA-10.5.7

          Where a conventional bank licensee engages in a deliberate arbitrage strategy, in which a futures contract on a broad-based index matches a basket of stocks, it is 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.

          January 2015

      • 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 apply to such counterparty risk exposure.

          January 2015

      • 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 CA-10.5)        		 Yes, as underlying
        Options    
        - Individual equity

        - Index        		 Yes

        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).
        * 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.
        January 2015