CA-6 CA-6 Commodities risk
CA-6.1 CA-6.1 Introduction
CA-6.1.1
This Section 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-5).
October 07CA-6.1.2
The commodities position risk and the capital charges are calculated with reference to the entire business of a bank (i.e. the banking and trading books combined).
October 07CA-6.1.3
The price risk in commodities is often more complex and volatile than that associated with currencies. Banks need to guard against the risk that arises when a liability (i.e. in a Parallel Salam transaction) position falls due before the asset position (i.e. a failure associated with or delay in the Salam contract). Owing to a shortage of liquidity in some markets, it might be difficult to close the Parallel Salam position and the bank might be 'squeezed by the market'. All these commodity market characteristics can result in price transparency and the effective management of risk.
October 07CA-6.1.4
All contracts (salam, musharaka or mudaraba) involving commodities as defined in Section CA-1.3 are subject to commodities risk and a capital charge as per the provisions outlined in Sections CA-6.2 to CA-6.4 should be computed.
October 07CA-6.1.5
Banks should adopt either the simplified approach to calculate their commodities risk and the resultant capital charges or the maturity ladder approach. Where banks have Salam and Parallel Salam contracts, the maturity ladder approach must be used.
October 07CA-6.2 CA-6.2 Calculation of commodities positions
CA-6.2.1
Banks will first express each commodity position (i.e. Salam and Parallel Salam) in terms of the standard unit of measurement (i.e. barrels, kilograms, grams, etc). Asset and liability positions in a commodity are reported on a net basis for the purpose of calculating the net open position in that commodity. For markets which have daily delivery dates, any contracts maturing within ten days of one another may be offset. The net position in each commodity is then converted, at spot rates, into the bank's reporting currency.
October 07CA-6.2.2
Positions in different commodities cannot be offset for the purpose of calculating the open-positions as described in Paragraph CA-6.2.1 above. However, where one or more sub-categories2 of the same Category are in effect and are directly deliverable against each other, netting between those sub-categories is permitted. Furthermore, if two or more sub-categories of the same Category are considered as close substitutes for each other, and minimum correlation of 0.9 between their price movements is clearly established over a minimum period of one year, the bank may, with the prior written approval of the Central Bank, net positions in those sub-categories.
2 Commodities can be grouped into clan, families, sub-groups and individual commodities. For example, a clan might be Energy Commodities, within which Hydro-Carbons is a family with Crude Oil being a sub-group and West Texas Intermediate, Arabian Light and Brent being individual commodities.
October 07CA-6.2.3
Banks, which wish to net positions based on correlation (in the manner discussed in Paragraph CA-6.2.2 above), will need to satisfy the Central Bank of the accuracy of the method which it proposes to adopt.
October 07CA-6.3 CA-6.3 Maturity Ladder Approach
CA-6.3.1
A worked example of the maturity ladder approach is set out in Appendix CA-1 and the table below illustrates the maturity time-bands of the maturity ladder for each commodity. As stated in Section CA-6.1, banks having Salam and Parallel Salam transactions must use the maturity ladder approach.
October 07CA-6.3.2
The steps in the calculation of the commodities risk by the maturity ladder approach are:
(a) The net positions in individual commodities, expressed in terms of the standard unit of measurement, are first slotted into the maturity ladder. Physical stocks are allocated to the first-time band. A separate maturity ladder is used for each commodity as defined in Section CA-6.2. The net positions in commodities are calculated as explained in Section CA-6.2.(b) Asset and liability positions in the same time-band are matched. The sum of the matched asset and liability positions is multiplied first by the spot price of the commodity, and then by a spread of 1.5% for each time-band as set out in the table below. This represents the capital charge in order to capture all risks within a time-band (which, together, are sometimes referred to as curvature risk).Time band3 0-1 months 1-3 months 3-6 months 6-12 months 1-2 years 2-3 years over 3 years (c) The residual (unmatched) net positions from nearer time-bands are then carried forward to offset opposite positions (i.e. asset against liability and vice versa) in time bands that are further out. However, a surcharge of 0.6% of the net position carried forward is added in respect of each time-band that the net position is carried forward, to recognise that such management of positions between different time-bands is imprecise. The surcharge is in addition to the capital charge for each matched amount created by carrying net positions forward, and is calculated as explained in step (b) above.(d) At the end of step (c), there will be either asset or liability positions, to which a capital charge of 15% will apply. The Central Bank recognises that there are differences in volatility between different commodities, but has, nevertheless, decided that one uniform capital charge for open positions in all commodities shall apply in the interest of simplicity of the measurement, and given the fact that banks normally run rather small open positions in commodities. Banks will be required to submit in writing, details of their commodities business in order to capture the market risk on this business and to enable the Central Bank to evaluate whether the models approach should be adopted by the bank.
3 Instruments, where the maturity is on the boundary of two maturity time-bands, should be placed into the earlier maturity band. For example, instruments with a maturity of exactly one-year are placed into the 6 to 12 months time-band.
October 07CA-6.4 CA-6.4 Simplified Approach
CA-6.4.1
Banks who do not enter into Salam and Parallel Salam transactions and do not have any short positions in commodities may use the simplified approach to compute the capital charge. In the simplified approach, the capital charge is computed at 15% of the net position. Net positions in commodities are calculated as explained in Section CA-6.2. For the time being the Central Bank is not requiring additional 3% capital charge for basis risk.
October 07
