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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 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