CA-5.6.1

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 and silver (which is treated as a foreign currency according to the methodology explained in section CA-5.5) as well as the inventory risk which results from a bank holding assets with a view to reselling or leasing them. A commodity is defined as a physical product which is and can be traded on a secondary market — for example, agricultural products, minerals (including oil) and precious metals. Inventory risk is defined as arising from holding items in inventory either for resale under a Murabahah contract, or with a view to leasing under an Ijara contract. In the case of inventory risk, the simplified approach described in Paragraph CA-5.6.13 is applied.

CA-5.6.2

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). Furthermore, the funding of commodities positions may well open an Islamic bank licensee to foreign exchange risk which should be captured within the measurement framework set out in Section CA-5.5.

CA-5.6.3

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.

CA-5.6.4

All contracts (Salam, Musharakah, Mudarabah or Commodity Murabahah) involving commodities as defined in Sections CA-3.3, CA-3.6, CA-3.7 and CA-3.11 are subject to commodities risk and a capital charge as per the relevant provisions must be computed.

CA-5.6.5

Commodities risk can be measured using either the maturity ladder approach or the simplified approach for the purpose of calculating the capital charge for commodities risk. Islamic bank licensees must notify the CBB of which approach they propose to follow. This is for reporting purposes on the form PIR. An Islamic bank licensee which proposes to use the maturity ladder approach will not be allowed to revert to the simplified approach without the prior approval of the CBB.

CA-5.6.6

Under both approaches, Islamic bank licensees must first express each commodity position (e.g. Salam and Parallel Salam) in terms of the standard unit of measurement (i.e. barrels, kilograms, grams, etc.). Assets and liabilities 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 Islamic bank licensee's reporting currency.

CA-5.6.7

Positions in different commodities³⁶ cannot be offset for the purpose of calculating the open-positions as described in Paragraph CA-5.6.6 except in the following instances:

³⁶ Commodities can be grouped into clans, 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 subgroup, and West Texas Intermediate, Arabian Light and Brent being individual commodities.

CA-5.6.8

Islamic bank licensees, which wish to net positions based on correlation (in the manner discussed in Subparagraph CA-5.6.7(c)), must satisfy the CBB of the accuracy of the method which they propose to adopt.

CA-5.6.9

A worked example of the maturity ladder approach is set out in Appendix CA-13 and the table in Paragraph CA-5.6.10 illustrates the maturity time-bands of the maturity ladder for each commodity.

CA-5.6.10

The steps in the calculation of the commodities risk by the maturity ladder approach are:

³⁷ 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.

CA-5.6.11

After the two steps in Paragraph CA-5.6.10 are completed, the residual (or 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. This surcharge is in addition to the capital charge calculated in Paragraph CA-5.6.10 for each matched amount created by carrying net positions forward.

CA-5.6.12

Any net position at the end of the carrying forward and offsetting processes described in Paragraphs CA-5.6.10 and CA-5.6.11 attract a capital charge of 15%.

CA-5.6.12A

Although there are differences in volatility between different commodities, only one uniform capital charge for open positions in all commodities applies in the interest of simplicity.

CA-5.6.13

Under the simplified approach as applied to commodities, the net position, long or short, in each commodity requires a capital charge of 15% to cater for directional risk plus an additional capital charge of 3% of the gross positions — that is, long plus short positions — to cater for basis risk. The capital charge of 15% applies to assets held by Islamic bank licensees in inventory with a view to resale or lease.

CA-5.6.14

For Istisna work-in-process (WIP), WIP inventory belonging to the Islamic bank licensee must attract a capital charge of 8% (equivalent to a 100% RW). In the case of the balance of unbilled WIP inventory under Istisna` without parallel Istisna`, in addition to the RW for credit risk a capital charge of 1.6% is applied (equivalent to a 20% RW) to cater for market risk exposure.

CA-5.6.15

The funding of a commodities position that exposes the Islamic bank licensee to foreign exchange exposure is also subject to a capital charge as measured under foreign exchange risk (refer to Section CA-5.5).