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  • RM-4.1 RM-4.1 Market Risk

    • RM-4.1.1

      Investment firm licensees must document their framework for the proactive management of market risk. This policy must be approved and regularly reviewed by the Board of Directors of the licensee.

      Adopted: July 2007

    • RM-4.1.2

      Market risk relates to the exposure of the licensee to fluctuations in the market value, currency or yield in respect of positions in financial instruments (either long or short).

      Adopted: July 2007

    • RM-4.1.3

      A licensee's market risk policy document should identify its appetite for market risk, systems for identifying, reporting and documenting market risk and mitigation factors in place. In particular, the market risk policy should cover for market risk:

      (a) How, with particular reference to its activities, the licensee defines and measures market risk;
      (b) The licensee's business aims in incurring market risk including:
      (i) Identifying the types and sources of market risk to which the licensee wishes to be exposed (and the limits on that exposure) and those to which the licensee wishes not to be exposed (and how that is to be achieved);
      (ii) Specifying the level of diversification required by the licensee and the licensee's tolerance for risk concentrations (and the limits on those exposures and concentrations);
      (c) The licensee's investment strategy;
      (d) The financial instruments, commodities, assets and liabilities (and mismatches between assets and liabilities) that a licensee is exposed to and the limits on those exposures;
      (e) Activities that are intended to hedge or mitigate market risk including mismatches caused by, for example, differences in the assets and liabilities and maturity mismatches; and
      (f) The methods and assumptions used for measuring linear, non-linear and geared market risk including the rationale for selection, ongoing validation and testing. Methods might include stress testing and scenario analysis, option Greeks, asset/liability analysis, correlation analysis and Value-at-Risk (VaR). Exposure to non-linear or geared market risk is typically through the use of derivatives.
      Adopted: July 2007

    • Risk Identification

      • RM-4.1.4

        Investment firm licensees must have in place appropriate risk reporting systems that enable them to identify the types and amount of market risk to which they are (or potentially could be) exposed to. The information that systems should capture may include but is not limited to position data which may consist of raw time series of position rates, index levels and prices and derived time series of benchmark yield curves, spreads, implied volatilities, historical volatilities and correlations.

        Adopted: July 2007

    • Risk Measurement

      • RM-4.1.5

        Investment firm licensees must carry out stress testing to access the resilience of their financial resources to any identified areas of material market risk under reasonably foreseeable circumstances. This stress testing may take into account the rating and geographical spread of its assets, the duration of their maturity relative to the licensee's liabilities and the fluctuation of interest and currency rates.

        Adopted: July 2007

      • RM-4.1.6

        The licensee should consider potential market risk events that may affect its solvency. These include the following:

        (a) Reduced value of equities due to stock market falls etc;
        (b) Variation in interest rates and the effect on the market value of investments;
        (c) A lower level of investment income than planned;
        (d) Inadequate valuation of assets;
        (e) The direct impact on the portfolio of currency devaluation, as well as the effect on related markets and currencies; and
        (f) The extent of any mismatch of assets and liabilities of any type (eg. maturity, currency, market, repricing etc.).
        Adopted: July 2007

      • RM-4.1.7

        Where the licensee considers that the nature of its assets and the matching of its liabilities result in no significant market risk exposure (eg. its investments consist entirely of cash and bank deposits), it will not be expected to carry out stress testing. The CBB will expect it to document the reasons for its decision and be prepared to discuss these during an onsite visit.

        Adopted: July 2007

    • Valuation

      • RM-4.1.8

        Wherever possible, a licensee must mark to market the value of its financial instruments, based on readily available close out prices from independent sources.

        Amended: July 2012
        Adopted: July 2007

      • RM-4.1.9

        Where marking to market is not possible, a firm must use mark to model in order to measure the value of its financial instruments. Marking to model is any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input.

        Amended: July 2012
        Adopted: July 2007

      • RM-4.1.10

        A licensee must ensure that its Board of Directors and senior management are aware of the positions which are subject to mark to model and understand the materiality of the uncertainty this creates in the reporting of the performance of the business of the firm and the risks to which it is subject.

        Adopted: July 2007

      • RM-4.1.11

        In addition to marking to market or marking to model, a licensee must perform independent price verification, such that market prices or model inputs are regularly verified for accuracy and independence.

        Adopted: July 2007

      • RM-4.1.12

        Systems and controls regarding valuations should include the following:

        (a) The department responsible for the validation of the value of assets and liabilities should be independent of the business trading area, and should be adequately resourced by suitably qualified staff;
        (b) All valuations should be checked and validated at appropriate intervals;
        (c) A licensee should establish a review procedure to check :
        (i) The quality and appropriateness of the price sources used;
        (ii) The level of any valuation reserves held; and
        (iii) The valuation methodology employed for each product and consistent adherence to that methodology;
        (d) A licensee should document its policies and procedures relating to the entire valuation process. In particular, the following should be documented:
        (i) The valuation methodologies employed for all product categories;
        (ii) Details of the price sources used for each product;
        (iii) The procedures to be followed where a valuation is disputed internally or with a service provider;
        (iv) The level at which a difference between a valuation assigned to an asset or liability and the valuation used for validation purposes will be reported on an exceptions basis and investigated;
        (v) Where a licensee is using its own internal estimate to produce a valuation, it should document in detail the process followed in order to produce the valuation; and
        (vi) The review procedures established by a licensee in relation to the requirements of this section should be adequately documented and include the rationale for the policy.
        Adopted: July 2007

    • Risk Monitoring

      • RM-4.1.13

        The investment firm licensee's risk reporting and monitoring system should be independent of the employees who are responsible for exposing the licensee to risk.

        Adopted: July 2007

      • RM-4.1.14

        The market risk policy of a licensee may require the production of market risk reports at various levels within the licensee. These reports should provide sufficiently accurate market risk data to relevant functions within the licensee, and should be timely enough to allow any appropriate remedial action to be proposed and taken, for example:

        (a) At firm wide level, a market risk report may include information:
        (i) Summarising and commenting on the total market risk that a firm is exposed to and market risk concentrations by business unit, asset class and country;
        (ii) On VaR calculations, compared to risk limits by business unit, asset class and country;
        (iii) Commenting on significant risk concentrations and market developments; and
        (iv) On market risk in particular legal entities and geographical regions;
        (b) At the business unit level, a market risk report may include information summarising market risk by currency, trading desk, maturity or duration band, or by instrument type;
        (c) At the trading desk level, a market risk report may include detailed information summarising market risk by individual trader, instrument, position, currency, or maturity or duration band; and
        (d) All risk data should be readily reconcilable back to the prime books of entry with a fully documented audit trail.
        Adopted: July 2007

      • RM-4.1.15

        Risk monitoring reports and systems must be subject to periodic independent review by suitably qualified staff.

        Adopted: July 2007

    • Risk Control

      • RM-4.1.16

        Risk control is the independent monitoring, assessment and supervision of business units within the defined policies and procedures of the market risk policy. This may be achieved by:

        (a) Setting an appropriate market risk limit structure to control the licensee's exposure to market risk; for example, by setting out a detailed market risk limit structure at the corporate level, the business unit level and the trading desk level which addresses all the key market risk factors and is commensurate with the volume and complexity of activity that the licensee undertakes;
        (b) Setting limits on risks such as price or rate risk, as well as those factors arising from options such as delta, gamma, vega, rho and theta;
        (c) Setting limits on net and gross positions, market risk concentrations, the maximum allowable loss (also called 'stop-loss'), VaR, potential risks arising from stress testing and scenario analysis, gap analysis, correlation, liquidity and volatility; and
        (d) Considering whether it is appropriate to set intermediate (early warning) thresholds that alert management when limits are being approached, triggering review and action where appropriate.
        Adopted: July 2007

    • Record Keeping

      • RM-4.1.17

        In relation to market risk, an investment firm licensee must retain appropriate prudential records of:

        (a) [This Subparagraph was deleted in January 2016 and requirements moved to (c)];
        (b) The nature and amounts of off and on balance sheet exposures, including aggregations of exposures;
        (c) Off and on market trades in financial instruments and other assets and liabilities; and
        (d) Methods and assumptions used in stress testing and scenario analysis and in VaR models.
        Amended: January 2016
        Adopted: July 2007

      • RM-4.1.18

        A licensee should keep a data history to enable it to perform back testing of methods and assumptions used for stress testing and scenario analysis and for VaR models.

        Adopted: July 2007