PRU A2.1 PRU A2.1 Detail in the Trading Book
PRU A2.1.1(1) This Appendix applies to an Authorised Person which meets the criteria in Rule 2.2.1 and is thereby required to have a Trading Book.(2) An Authorised Person which is required to have a Trading Book must:(a) have a Trading Book policy in accordance with Section A2.2; and(b) include positions in its Trading Book on a consistent basis in accordance with the policy and procedures set out in the Trading Book policy.(3) An Authorised Person must include every position that is not included in its Trading Book in its Non-Trading Book.(4) An Authorised Person must value every position included in its Trading Book and the Non-Trading Book in accordance with the relevant accounting standards and practices.
Value of Trading Book positions
PRU A2.1.2(1) In calculating the value of positions for the purposes of Rule 2.2.1(c) an Authorised Person must value:(a) equities and debt instruments at their market prices;(b) Derivatives according to the values of the underlying; and(c) Underwriting positions according to the market value of the underlying Securities.(2) An Authorised Person must sum all long and short positions (ignoring the sign) to calculate its total Trading Book size.
Positions included in the Trading Book
PRU A2.1.3 PRU A2.1.3
An Authorised Person must include in its Trading Book, subject to the Rules on trading intent and hedging Non-Trading Book Exposures:(a) each proprietary position in a Financial Instrument, commodity or commodity Derivative which is held with trading intent as detailed in Rule A2.1.5(3);(b) each position arising from Matched Principal broking and market making;(c) each position taken in order to hedge another element of the Trading Book;(d) each Exposure due to a repurchase agreement (repo), or Securities and commodities lending, which is based on a Security or commodity included in the Trading Book;(e) each Exposure due to a reverse repurchase agreement (reverse repo), or Securities and commodities borrowing transaction included in the Trading Book;(f) each Exposure arising from an Unsettled Transaction, free delivery or OTC Derivative; and(g) each Exposure in the form of a fee, commission, interest, dividend or margin on an exchange-traded Derivative directly related to the items included in the Trading Book.
Whenever an Authorised Person acts as principal (even in the context of activity normally described as 'broking' or 'customer business'), positions should be assigned to the Trading Book. This applies even if the nature of the business means that the only risks being incurred by the Authorised Person are Counterparty Risks (that is, no Market Risk Capital Requirements apply).
PRU A2.1.4(a) An Authorised Person must not include loans or traded loans in its Trading Book unless they have been used to hedge a Trading Book transaction.(b) An Authorised Person must not include in its Trading Book an Exposure relating to a direct holding of immovable property.
PRU A2.1.5(1) An Authorised Person must, subject to Rule A2.1.3, only include in its Trading Book:(a) a position in a Financial Instrument, commodity or commodity Derivative held with trading intent; or(b) a position hedging other positions in the Trading Book.(2) For the purpose of (1), such positions included in the Trading Book must be free of any restrictive covenants which limit their tradability or ability to be hedged.(3) For the purpose of (1), a position in a Financial Instrument, commodity or commodity Derivative is held with trading intent if:(a) it is held with the intention of:(i) benefiting in the short term from actual or expected differences between buying and selling prices or from other price or interest-rate variations;(ii) selling it over the short term;(iii) locking in arbitrage profits; or(iv) market making;(b) it is marked to market or marked to model regularly on a prudent and consistent basis, as part of the Authorised Person's internal risk management processes;(c) position-takers at the Authorised Person have autonomy in entering into or changing transactions within pre-determined limits, or the position satisfies other criteria which the Authorised Person applies to the composition of its Trading Book;(d) there is an appropriate documented trading strategy for the position, approved by senior management which includes the expected holding horizon; and(e) active monitoring of the position is undertaken using market information sources.
Positions held with trading intent must comply with the following requirements:(a) trading intent must be evidenced in the strategies, policies and procedures established by the Authorised Person to manage the position or its portfolio;(b) there must be clearly defined policies and procedures for active management of the position to ensure the following:(i) the position is entered and/or managed on a trading desk;(ii) position limits are set and monitored for appropriateness;(iii) position-takers at the Authorised Person have autonomy in entering into or changing transactions within pre-determined limits, or the position satisfies other criteria which the Authorised Person applies to the composition of its Trading Book;(iv) the position is marked-to-market or marked-to-model at least daily on a prudent and consistent basis as part of the Authorised Person's internal risk management processes;(v) where the position is marked-to-model, the parameters for the model are assessed on a daily basis;(vi) the position is monitored against the documented trading strategy including the monitoring of turnover and stale positions in the Authorised Person's Trading Book;(vii) active monitoring of the position is undertaken using market information sources and an assessment made of the marketability or hedge-ability of the position or its component risks, including the assessment of the quality and availability of market inputs to the valuation process, level of markets turnover and sizes of positions traded in the market; and(viii) positions and exceptions are reported to senior management as an integral part of the risk management process of the Authorised Person.
Treatment of structural foreign exchange positions
An Authorised Person in Category 1 or 5 which has assumed a position in order to hedge partially or totally against the adverse effect of the exchange rate on its Capital Resources, in respect of an asset or any other item, may exclude such a position from the calculation of its net open foreign exchange positions subject to the following:(a) the position is of a non-dealing nature;(b) the position does no more than protect the Capital Resources of the Authorised Person; and(c) any exclusion of the position is applied consistently, with the treatment of the hedge remaining the same for the life of the asset or other item.
In calculating its net open foreign exchange positions, an Authorised Person may exclude any foreign exchange position related to:(a) items which are included as deductions from T1 Capital or deductions from T2 Capital, such as investments in unconsolidated subsidiaries; and(b) associated companies and joint ventures, denominated in foreign currencies, which are reported in the published accounts of an Authorised Person at historic cost.
Repurchase and reverse repurchase agreements
PRU A2.1.9 PRU A2.1.9
An Authorised Person must include in its Trading Book an Exposure due to a repurchase agreement, reverse repurchase agreement, Securities and commodities borrowing, or Securities and commodities lending transactions if:(a) the Exposure is marked to market daily (cash borrowed or lent under a repurchase agreement or a reverse repurchase agreement may be included in the Trading Book even if not marked to market provided that the residual maturity of the borrowing or lending is one month or less);(b) the Collateral is adjusted to take account of changes in the value of the Securities or commodities involved;(c) the agreement or transaction provides for the Authorised Person's claims to be automatically and immediately offset against its Counterparty's claims if the latter defaults; and(d) such agreements and transactions are confined to their accepted and appropriate use and artificial transactions, especially those not of a short-term nature, are excluded.
Cash items include loans and Deposits and the cash legs of repurchase, stock borrowing, reverse repurchase and stock lending transactions. The Trading Book treatment for such Exposures is set out in Rule A4.7.
PRU A2.1.10 PRU A2.1.10
Where the conditions under Rule A2.1.9 are not met, an Authorised Person must, subject to Rule A2.1.3, include an Exposure arising under a repurchase agreement, reverse repurchase agreement, Securities and commodities borrowing or Securities and commodities lending in its Non-Trading Book.
Hedging of a Trading Book Exposure by a non-Financial Instrument
PRU A2.1.11 PRU A2.1.11(1) An Authorised Person may hedge a Trading Book Exposure, completely or partially, by a non-Financial Instrument that is not listed in A2.1.3. The General Market Risk Exposure associated with the non-Financial Instrument may be incorporated into the calculation of General Market Risk in the Trading Book if:(a) the specific instrument is used to hedge an Exposure in an Authorised Person's Trading Book;(b) the hedge position satisfies the Netting rules contained in the relevant Sections of the Market Risk Chapter; and(c) the hedge position is marked to market or marked to model and is valued regularly on a prudent and consistent basis.(2) For the purposes of (1), the non-Financial Instrument must be treated as attracting capital charges as if it were a Financial Instrument.
Guidance1. If the conditions for incorporating non-Financial Instruments in the calculation of General Market Risk in the Trading Book under Rule A2.1.11 are not met, they will be treated as Non-Trading Book items.
PRU A2.1.12 PRU A2.1.12(1) If an internal hedge meets the criteria specified in (2), an Authorised Person may include it in the Trading Book without prejudice to the Capital Requirement application to the Non-Trading Book "leg" of the internal hedge.(2) Positions arising from internal hedges are eligible for Trading Book capital treatment, provided that they meet the criteria for trading intent specified in Rule A2.1.5 and the following criteria on prudent valuation:(a) the internal hedge is not primarily intended to avoid or reduce Capital Requirements which the Authorised Person would be otherwise required to maintain;(b) the internal hedge is properly documented and subject to specific internal approval and audit procedures;(c) the internal hedge is dealt with at market conditions;(d) the bulk of the Market Risk which is generated by the internal hedge is dynamically managed in the Trading Book within the limits approved by senior management; and(e) the internal hedge is carefully monitored with adequate procedures.(3) Where an Authorised Person hedges a Non-Trading Book Exposure using a Credit Derivative booked in the Trading Book, the Non-Trading Book Exposure is not deemed to be hedged for the purpose of calculating its regulatory Capital Requirement, unless the Authorised Person purchases from an eligible protection provider a Credit Derivative which complies with the requirements and meets the guidelines set out in the relevant Section of Chapter 4. Where eligible credit protection is purchased and is recognised as a hedge of the Non-Trading Book Exposure for the purpose of calculating its regulatory Capital Requirement, the Authorised Person may exclude both the internal and external Credit Derivative hedge from the Trading Book for the purpose of calculating its regulatory Capital Requirement for the period of the hedge.
An internal hedge is a position that materially or completely offsets the component risk element of a Non-Trading Book position or a set of positions.
Transfer of General Market Risk between the Trading Book and the Non-Trading Book
Guidance1. General Market Risk arising from the Trading Book may hedge Non-Trading Book positions without reference to specific Financial Instruments.2. An Authorised Person may achieve the transfer of General Market Risk between the Trading Book and Non-Trading Book by entering into a notional legal agreement between the Trading Book and Non-Trading Book as if they were third parties.
PRU A2.1.13 PRU A2.1.13
An Authorised Person must ensure that:(a) a transfer of General Market Risk between its Trading Book and Non-Trading Book is subject to appropriate documentation and evidenced by a clear audit trail;(b) positions held in its Non-Trading Book that are being hedged by General Market Risk arising from positions in the Trading Book remain in the Non-Trading Book; and(c) the General Market Risk Exposure associated with the positions in the Non-Trading Book is incorporated into the calculation of General Market Risk in the Trading Book.
An example of the application of Rule A2.1.13(c) is as follows:a. An Authorised Person may have a fixed-rate loan portfolio in the Non-Trading Book. Although the Non-Trading Book does not attract a regulatory capital charge for interest rate risk, the portfolio is subject to interest rate risk. Firms may prefer to transfer this risk to the Trading Book where it may be actively managed.b. The Authorised Person may transfer this interest rate risk by entering into, for example, a fixed versus floating rate swap between the Trading Book and the Non-Trading Book. The notional long and short positions created as result of the swap are recorded in the Trading Book, and the swap positions may be treated as Financial Instruments provided that appropriate documentation is in place (see Rule A2.1.14). The General Market Risk requirements associated with the swap legs are allocated to the appropriate Trading Book General Market Risk bucket and thus may reduce the overall General Market Risk requirement in the Trading Book.c. For an Authorised Person to undertake such a transaction there should be existing positions in the Trading Book, which result in a sufficient General Market Risk requirement to offset the General Market Risk created as a result of the swap.
PRU A2.1.14 PRU A2.1.14
Appropriate documentation under A2.1.13 must cover:(a) details of the instruments or Exposures being transferred and the method used to transfer; and(b) the pricing of the transfer.
Guidance1. Separate documentation need not be produced for every transfer. If the same method is used for a number of transfers, a single document detailing the procedures will suffice. However, an Authorised Person must still be able to distinguish transactions that have been undertaken for risk transfer purposes from other transactions.2. Arm's-length prices must be used in any transfer. 'Arm's-length' means the prevailing market price for the particular transaction.