• RM-4 RM-4 Market Risk

    • RM-4.1 RM-4.1 Market Risk

      • RM-4.1.1

        This Chapter sets out principles in respect of market risk, which refer to the potential impact of adverse price movements such as benchmark rates, foreign exchange (FX) rates, equity prices and commodity prices, on the economic value of an asset. Market risk exposures may occur at certain times or throughout the contract.

        January 2013

    • RM-4.2 RM-4.2 Definition and Profiles of Market Risk

      • RM-4.2.1

        For the purpose of this Module, market risk is defined as the risk of losses in on-and off-balance sheet positions arising from movements in market prices i.e. fluctuations in values in tradable, marketable or leaseable assets (including sukuk) and in off-balance sheet individual portfolios (for example Collective Investment Undertakings). The risks relate to the current and future volatility of market values of specific assets (for example, the commodity price of a Salam asset, the market value of a sukuk, the market value of Murabaha assets purchased to be delivered over a specific period) and of foreign exchange rates. Market risk capital requirements are outlined in paragraph CA-1.1.4.

        January 2013

      • RM-4.2.2

        In operating Ijarah, a lessor is exposed to market risk on the residual value of the leased asset at the maturity of the lease or if the lessee defaults or exercises early termination rights during the contract. In IMB, a lessor is exposed to market risk on the carrying value of the leased asset (as collateral) in the event that the lessee defaults on the lease obligations.

        January 2013

      • RM-4.2.3

        In Salam, Islamic bank licensees are exposed to commodity price fluctuations on a long position after entering into a contract and while holding the subject matter until it is disposed of. In the case of parallel Salam, there is also the risk that a failure of delivery of the subject matter would leave the Islamic bank licensee exposed to commodity price risk as a result of the need to purchase a similar asset in the spot market in order to honour the parallel Salam contract.

        January 2013

      • RM-4.2.4

        When Islamic bank licensees are involved in buying assets that are not actively traded with the intention of selling them, it is important to analyse and assess the factors attributable to changes in liquidity of the markets in which the assets are traded and which give rise to greater market risk. Assets traded in illiquid markets may not be realisable at prices quoted in other more active markets.

        January 2013

      • RM-4.2.5

        Islamic bank licensees are also exposed to foreign exchange fluctuations arising from general FX spot rate changes in both cross-border transactions and the resultant foreign currency receivables and payables. These exposures may be hedged using Shari a compliant methods.

        January 2013

    • RM-4.3 RM-4.3 Operational Considerations

      • RM-4.3.1

        Islamic bank licensees must implement an appropriate framework for market risk management (including reporting) in respect of all related assets held, including those that do not have a ready market and/or are exposed to high price volatility.

        January 2013

      • RM-4.3.2

        The Board must develop a market risk strategy including the level of acceptable market risk appetite taking into account contractual agreements with fund providers, types of risk-taking activities and target markets in order to maximise returns while keeping exposures at or below the pre-determined levels. The strategy must be reviewed periodically by the Board, communicated to relevant staff and disclosed to fund providers.

        January 2013

      • RM-4.3.3

        Islamic bank licensees must establish an appropriate sound and comprehensive market risk management process and information system, which (among others) comprise:

        (a) A conceptual framework to assist in identifying underlying market risks;
        (b) Guidelines governing risk taking activities in different portfolios of assets financed by investments accounts and portfolios of Collective Investment Undertakings and their market risk limits;
        (c) Appropriate frameworks for pricing, valuation and income recognition; and
        (d) A strong MIS for controlling, monitoring and reporting market risk exposure and performance to appropriate levels of senior management.

        Given that all the required measures are in place (e.g. pricing, valuation and income recognition frameworks, strong MIS for managing exposures, etc.), the applicability of any market risk management framework that has been developed must be assessed taking into account consequential business and reputation risks.

        January 2013

      • RM-4.3.4

        Islamic bank licensees must be able to quantify market risk exposures and assess exposure to the probability of future losses in their net open asset positions.

        January 2013

      • RM-4.3.5

        The risk exposures in investment securities are similar to the risks faced by conventional financial intermediaries, namely market price, liquidity, foreign exchange rates and credit risk. In this regard, Islamic bank licensees must ensure that their strategy includes the definition of their risk appetite for these tradable assets and that this risk appetite is adequately supported by capital held for that purpose.

        January 2013

      • RM-4.3.6

        In the valuation of assets where no direct market prices are available, Islamic bank licensees must incorporate in their own product programme a detailed approach to valuing their market risk positions.

        January 2013

      • RM-4.3.7

        Islamic bank licensees may employ appropriate forecasting techniques agreed with their external auditor to assess the potential value of these assets.

        January 2013

      • RM-4.3.8

        Where available valuation methodologies are deficient, Islamic bank licensees must assess the need to:

        (a) Allocate funds to cover risks resulting from illiquidity, new assets and uncertainty in assumptions underlying valuation and realisation; and
        (b) Establish a contractual agreement with the counterparty specifying the methods to be used in valuing the assets.9

        9 It should be noted that similar arrangements are suggested to mitigate contract cancellation, which is explained under RM-2 Credit Risk.

        January 2013

      • Collective Investment Undertakings (CIUs)

        • RM-4.3.9

          Islamic bank licensees have a fiduciary duty to apply the same risk management policies and procedures to assets held on behalf of investors in CIUs as they do for assets held on behalf of shareholders and unrestricted IAH.

          January 2013

        • RM-4.3.10

          Where Islamic bank licensees play the role of market maker to CIUs, this gives rise to liquidity risk, which should be managed according to appropriate procedures as set out in Chapter RM-5

          January 2013