• PRU 7.4 PRU 7.4 Systems and controls for Non-Trading Book interest rate risk

    • Non-Trading Book interest rate risk policy

      • PRU 7.4.1 PRU 7.4.1

        (1) An Authorised Person must implement and maintain a policy which enables it to identify, assess, control and monitor its Non-Trading Book interest rate risk.
        (2) The policy must be documented and include an appropriate interest rate risk strategy as well as an enterprise-wide interest rate risk management framework appropriate to the nature, scale and complexity of its Non- Trading Book activities. The strategy and management framework must:
        (a) enable the Governing Body and senior management of the Authorised Person to have an enterprise-wide view of interest rate risk as it applies to non-trading activities;
        (b) include a system for identifying and assessing Non-Trading Book interest rate risk and its sources;
        (c) include a process for the measurement and monitoring of Non- Trading Book interest rate risk, using robust and consistent methods which enable the Authorised Person to implement the requirements set out in Rules 7.2.1 to 7.2.6; and
        (d) include a system for controlling and managing Non-Trading Book interest rate risk which enables it to comply with the overall risk management standards expected of an Authorised Person and ensure continued compliance with these Rules.
        (3) An Authorised Person must identify the Non-Trading Book interest rate risk impact of any new product, activity or service that it proposes to start and ensure that such impacts are duly addressed with adequate controls before the new product or activity is undertaken or introduced.
        (4) An Authorised Person must:
        (a) ensure that its risk management systems enable it to implement the Non-Trading Book interest rate risk policy;
        (b) identify, assess, mitigate, control and monitor the risk; and
        (c) review and update the policy at intervals that are appropriate to the nature, scale and complexity of its activities.

        • Guidance

          1. The Regulator expects that an Authorised Person's strategy towards Non-Trading Book interest rate risk will set out the approach that the Authorised Person will take towards management of the risk, including various quantitative and qualitative targets. It should be communicated to all relevant functions and staff within the organisation and be set out in the Authorised Person's Non-Trading Book interest rate risk policy.
          2. The Regulator expects that an Authorised Person's framework for managing Non-Trading Book interest rate risk will address the following:
          a. the Non-Trading Book interest rate risk management framework should be integrated into the Authorised Person's enterprise-wide risk management framework, including but not limited to. integration with its daily risk management practices;
          b. the output of the risk measurement system which forms part of the Non-Trading Book interest rate risk management framework should be used in reporting the level of that risk to the senior management and Governing Body of the Authorised Person;
          c. the measurement system should be capable of measuring the risk under the earnings approach. Depending on the scale and complexity of Non-Trading Book structure, the Authorised Person may also need to measure the risk based on economic value approach;
          d. an Authorised Person's Non-Trading Book interest rate risk measurement system should be clearly defined and consistent with the nature and complexity of its balance sheet structure;
          e. the processes, procedures and limits should be clearly documented and should reflect a consideration of the interest rate risk associated with the balance sheet structure of the Authorised Person, considering various asset and liability positions. These processes, procedures and limits should be reviewed and approved by appropriate levels of senior management;
          f. the framework should involve an accurate, informative and timely management system for interest rate risk, which is essential to keep the senior management and the Governing Body of the Authorised Person adequately informed to enable them to ensure compliance with the Non-Trading Book interest rate risk policy of the Authorised Person; and
          g. the Non-Trading Book interest rate risk framework should include measures to consider balancing cash flows and management of the risk's impact from new products or services through hedging using swaps or other Derivatives. Any such major hedging or risk management initiatives should be approved in advance by the Asset Liability Committee (ALCO) or the Governing Body of the Authorised Person.
          3. The Non-Trading Book interest rate risk measurement systems referred to in Rule 7.4.1(2)(c) should encompass all material drivers of the risk. Such systems should evaluate the effect of rate changes on earnings or economic value meaningfully and accurately within the context and complexity of their activities. They should be able to flag any excessive Exposures. An effective risk measurement system should address the following:
          a. evaluate all significant interest rate risk arising from the full range of an Authorised Person's assets, liabilities and off-balance sheet positions, both trading and non-trading;
          b. ensure that an integrated view of interest rate risk across products and business lines is available to management, particularly when different measurement systems and methods are used across different business lines;
          c. employ generally accepted financial models and ways of measuring risk; and
          d. ensure accurate and timely data on all aspects related to current positions.
          4. Authorised Persons should measure their vulnerability to loss in stressed market conditions, including the breakdown of key assumptions, and consider those results when establishing and reviewing their policies and limits for interest rate risk. Possible stress scenarios for this exercise should include:
          a. historical scenarios;
          b. changes in the general level of interest rates, e.g. changes in yields of 200 basis points or more in one year;
          c. changes in the relationships between key market rates (i.e. basis risk), e.g.
          i. a surge in term and savings Deposit rates and benchmark rates but no change in the prime rate, and
          ii. a drop in the prime rate but no change in term and savings Deposit rates and benchmark rates;
          d. changes in interest rates in individual time bands to different relative levels (i.e. yield curve risk);
          e. changes in the liquidity of key financial markets or changes in the volatility of market rates; and
          f. changes in key business assumptions and parameters such as the correlation between two currencies. In particular, changes in assumptions used for illiquid instruments and instruments with uncertain contractual maturities help understanding of an Authorised Person's risk profile.
          5. An Authorised Person should consider the standards for stress testing recommended in the paper published in July 2004 by the BCBS — Principles for management and supervision of interest rate risk — in developing the stress testing scenarios. In particular, an Authorised Person should include the technical specifications of a standardised interest rate shock detailed in Annex 3 of that paper.

    • Responsibilities of Governing Body

      • PRU 7.4.2 PRU 7.4.2

        (1) An Authorised Person must ensure that its Governing Body is responsible for monitoring the nature and level of Non-Trading Book interest rate risk assumed by the Authorised Person and the process used to manage that risk.
        (2) Without limiting the operation of (1), the responsibilities of an Authorised Person's Governing Body in respect of the risk include:
        (a) approving the Authorised Person's Non-Trading Book interest rate risk policy, including its strategy and management framework;
        (b) establishing and maintaining a senior management structure for the management of the risk and for ensuring compliance with the Authorised Person's risk strategy;
        (c) monitoring the Authorised Person's overall Non-Trading Book interest rate risk profile on a regular basis and being aware of any material changes in the Authorised Person's current or prospective profile; and
        (d) ensuring that Non-Trading Book interest rate risk is adequately identified, assessed, mitigated, controlled and monitored.

        • Guidance

          1. The Governing Body of the Authorised Person may delegate responsibility for establishing Non-Trading Book interest rate risk policies and strategies to the Asset and Liability Committee (ALCO) or an equivalent committee, which is the designated senior management committee for managing balance sheet structure and interest rate risk associated with it.
          2. An Authorised Person involved in banking activities or complex principal dealing activities should have a designated committee for design and implementation of Non-Trading Book interest rate risk management.
          3. An Authorised Person should establish and enforce operating limits and other practices that maintain Exposures within levels consistent with their internal policies and that accord with their approach to measuring the risk. In particular, Authorised Persons should set a limit on the extent to which floating rate Exposures are funded by fixed rate sources and vice versa to limit the risk. In floating rate lending, Authorised Persons should limit the extent to which they run any basis risk that may arise if lending and funding are not based on precisely the same market interest rate.