CA-5.1.1

"Market risk" is defined as the risk of losses in on- and off-balance sheet positions arising from movements in market prices. The risks that are subject to the market risk capital requirement are:

³⁵ An equity position treated under "equity exposures in the banking book" is dealt with under the credit risk, as set out in Paragraphs CA-4.8.7 to CA-4.8.15.

CA-5.1.2

A trading book consists of positions in financial instruments, foreign exchange and commodities and inventories held either with trading intent or in order to hedge other elements of the trading book. To be eligible for trading book capital treatment, financial instruments must be free of any restrictions on their tradability. In addition, positions must be frequently and accurately valued, and the portfolio must be actively managed. Open equity stakes in Shari'a compliant hedge funds, private equity investments and real estate holdings do not meet the definition of the trading book, owing to significant constraints on the ability of banks to liquidate these positions and value them reliably on a daily basis. Such holdings must therefore be held in the Islamic bank licensee's banking book and treated as equity holding in corporates, except real estate which must be treated as per Paragraph CA-4.2.27 and Chapter CA-9 of this Module.

CA-5.1.3

A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. Financial instruments include both primary financial instruments (or cash instruments) and forward financial instruments.

CA-5.1.4

A financial asset is any asset that is cash, the right to receive cash or another financial asset; or the contractual right to exchange financial assets on potentially favourable terms, or an equity instrument. A financial liability is the contractual obligation to deliver cash or another financial asset or to exchange financial liabilities under conditions that are potentially unfavourable.

CA-5.1.5

Trading positions are defined as those positions of a bank that are held for short -term resale and/or with the intent of benefiting from actual or expected short-term price movements or to lock in arbitrage profits, and may include for example proprietary positions, positions arising from client servicing (e.g. matched principal broking) and market making. Islamic bank licensees must have clearly outlined policies and procedures for including or not including any position in the trading book for purposes of calculating their regulatory capital requirement, to ensure compliance with the criteria for trading book set forth in this section and taking into account the Islamic bank licensee's risk management capabilities and practices. Such policies must be commensurate with the Islamic bank licensee's capabilities and capacities for risk management. The Islamic bank licensee must have well-documented procedures to comply with stated policies, which must be fully documented and subject to periodic internal audit.

CA-5.1.6

Policies and procedures must, at a minimum, address the following:

The list above is not intended to provide a series of tests that a product or group of related products must pass to be eligible for inclusion in the trading book. Rather, the list provides a minimum set of key points that must be addressed by the policies and procedures for overall management of an Islamic bank licensee's trading book.

CA-5.1.7

The basic requirements for positions eligible to receive trading book capital treatment are:

CA-5.1.8

This Section provides Islamic bank licensees with guidance on prudent valuation for positions that are accounted for at fair value, whether they are in the trading book or in the banking book. This guidance is especially important for positions without actual market prices or observable inputs to valuation, as well as less liquid positions which, although they will not be excluded from the trading book solely on grounds of lesser liquidity, raise CBB's concerns about prudent valuation.

CA-5.1.8.A

Positions in the Islamic bank licensee's own eligible regulatory capital instruments are deducted from capital. Positions in other banks', securities firms', and other financial entities' eligible regulatory capital instruments, as well as intangible assets, are subject to the same treatment as that set down by the CBB for such assets held in the banking book (see Chapter CA-2 of this Module).

CA-5.1.9

The valuation guidance set forth below is not intended to require Islamic bank licensees to change valuation procedures for financial reporting purposes. The CBB will assess an Islamic bank licensee's valuation procedures for consistency with this guidance. One factor in the CBB's assessment of whether an Islamic bank licensee must take a valuation adjustment for regulatory purposes under Paragraphs CA-5.1.18.A to CA-5.1.20 is the degree of consistency between the Islamic bank licensee's valuation procedures and these guidelines.

CA-5.1.9A

A framework for prudent valuation practices must at a minimum include the requirements outlined in this Section.

CA-5.1.10

Islamic bank licensees must have robust systems and controls, with documented policies and procedures for the valuation process. These systems must be integrated with the Islamic bank licensees' enterprise risk management processes and must have the ability to give confidence to the CBB and management regarding the reliability of the valuations. These policies and procedures must include: (a) clearly defined responsibilities of the personnel and departments involved in the valuation; (b) sources of market information, and review of their reliability; (c) frequency of independent valuations; (d) timing of closing prices; (e) procedures for adjusting valuations between periods; (f) ad-hoc verification procedures; and (g) reporting lines for the valuation department that must be independent of the front office. Such policies and procedures must also take into consideration compliance with IFRS or AAOIFI accounting standards as applicable and CBB requirements.

Marking to Market

Marking to Model

CA-5.1.15

Independent price verification is distinct from daily mark-to-market. It is the process by which market prices or model inputs are regularly verified for accuracy. While daily marking-to-market may be performed by dealers, verification of market prices or model inputs must be performed by a unit independent of the dealing room, at least monthly (or, depending on the nature of the market/trading activity, more frequently). It need not be performed as frequently as daily mark-to-market, since the objective, i.e. independent, marking of positions, should reveal any error or bias in pricing, which should result in the elimination of inaccurate daily marks.

CA-5.1.16

Independent price verification entails a higher standard of accuracy in that the market prices or model inputs are used to determine profit and loss figures, whereas daily marks are used primarily for management reporting in between reporting dates. For independent price verification, where pricing sources are more subjective, e.g. only one available broker quote, prudent measures such as valuation adjustments may be appropriate.

CA-5.1.17

As part of their procedures for marking to market, Islamic bank licensees must establish and maintain procedures for considering valuation adjustments. Islamic bank licensees using third-party valuations must consider whether valuation adjustments are necessary. Such considerations are also necessary when marking to model.

CA-5.1.18

Islamic bank licensees must consider the following valuation adjustments/reserves at a minimum: unearned profit, close-out costs, operational risks, early termination, investing and funding costs, and future administrative costs and, where appropriate, model risk.

CA-5.1.18.A

Islamic bank licensees must establish and maintain procedures for judging the necessity of and calculating an adjustment to the current valuation of less liquid positions for regulatory capital purposes. This adjustment may be in addition to any changes to the value of the position required for financial reporting purposes and must be designed to reflect the illiquidity of the position. Islamic bank licensees must consider the need for an adjustment to a position's valuation to reflect current illiquidity whether the position is marked to market using market prices or observable inputs, third-party valuations or marked to model.

CA-5.1.19

Bearing in mind that the underlying 10-day assumptions made about liquidity in the market risk capital charge may not be consistent with the Islamic bank licensee's ability to sell or hedge out less liquid positions, where appropriate, Islamic bank licensees must take an adjustment to the current valuation of these positions, and review their continued appropriateness on an on-going basis. Reduced liquidity may have arisen from market events. Additionally, close-out prices for concentrated positions and/or stale positions must be considered in establishing the adjustments. Islamic bank licensees must consider all relevant factors when determining the appropriateness of the adjustments for less liquid positions. These factors may include, but are not limited to, the amount of time it would take to hedge out the position/risks within the position, the average volatility of bid/offer spreads, the availability of independent market quotes (number and identity of market makers), the average and volatility of trading volumes (including trading volumes during periods of market stress), market concentrations, the aging of positions, the extent to which valuation relies on marking-to-model, and the impact of other model risks not included in Paragraph CA-5.1.18.A.

CA-5.1.20

The adjustment to the current valuation of less liquid positions made under Paragraph CA-5.1.19 must impact Tier 1 regulatory capital and may exceed those valuation adjustments made under financial reporting standards and Paragraphs CA-5.1.17 and CA-5.1.18.