CA-12.1.1

This Chapter sets out the minimum capital requirements to cover the risk of holding or taking positions in commodities, including precious metals, but excluding gold (which is treated as a foreign currency according to the methodology explained in Chapter CA-11).

CA-12.1.2

The commodities position risk and the capital charges are calculated with reference to the entire business of a conventional bank licensee, i.e., the banking and trading books combined.

CA-12.1.3

The price risk in commodities is often more complex and volatile than that associated with currencies and interest rates. Commodity markets may also be less liquid than those for interest rates and currencies and, as a result, changes in supply and demand can have a more dramatic effect on price and volatility. Conventional bank licensees need also to guard against the risk that arises when a short position falls due before the long position. Owing to a shortage of liquidity in some markets, it might be difficult to close the short position and the conventional bank licensee might be "squeezed by the market". All these market characteristics, of commodities, can make price transparency and the effective hedging of risks more difficult.

CA-12.1.4

For spot or physical trading, the directional risk arising from a change in the spot price is the most important risk. However, conventional bank licensees applying portfolio strategies involving forward and derivative contracts are exposed to a variety of additional risks, which may well be larger than the risk of a change in spot prices (directional risk). These include:

CA-12.1.5

The capital charges for commodities risk envisaged by the rules within this Chapter are intended to cover the risks identified in Paragraph CA-12.1.4. In addition, however, conventional bank licensees face credit counterparty risk on over-the-counter derivatives, which must be incorporated into their credit risk capital requirements. Furthermore, the funding of commodities positions may well open a conventional bank licensee to interest rate or foreign exchange risk which is captured within the measurement framework set out in Chapters CA-9 and CA-11, respectively.⁴⁹

⁴⁹ Where a commodity is part of a forward contract (i.e.. a quantity of commodity to be received or to be delivered), any interest rate or foreign exchange risk from the other leg of the contract must be captured, within the measurement framework set out in Chapters CA-9 and CA-11, respectively. However, positions which are purely of a stock financing nature (i.e., a physical stock has been sold forward and the cost of funding has been locked in until the date of the forward sale) may be omitted from the commodities risk-calculation although they will be subject to the interest rate and counterparty risk capital requirements.

CA-12.1.6

Conventional bank licensees which have the intention and capability to use internal models for the measurement of their commodities risks and, hence, for the calculation of the capital requirement, must seek the prior written approval of the CBB for those models. The CBB's detailed rules for the recognition and use of internal models are included in Chapter CA-14. It is essential that the internal models methodology captures the directional risk, forward gap and interest rate risks, and the basis risk which are defined in Paragraph CA-12.1.4. It is also particularly important that models take proper account of market characteristics, notably the delivery dates and the scope provided to traders to close out positions.

CA-12.1.7

Conventional bank licensees which do not propose to use internal models must adopt either the maturity ladder approach or the simplified approach to calculate their commodities risk and the resultant capital charges. Both these approaches are described in Sections CA-12.3 and CA-12.4, respectively.