• PRU APP6 PRU APP6 MARKET RISK

    • PRU A6.1 PRU A6.1 Market Risk systems and controls

      • Guidance

        1. In accordance with Section 5.2, an Authorised Person is required to have a Market Risk policy. The Market Risk policy should address all aspects of Market Risk whether arising from assets, liabilities or the mismatch between assets and liabilities and whether off or on-balance sheet. Such a policy would be expected to include the following information:
        a. how, with particular reference to its activities, the Authorised Person defines and measures Market Risk;
        b. the Authorised Person's investment or trading strategy distinguishing, as applicable, between its Trading and Non-Trading Books;
        c. the detailed limit structure for Market Risk which should:
        i. address all key risk factors;
        ii. be commensurate with the volume and complexity of activity; and
        iii. be consistent with the Authorised Person's strategy, historical performance, and the overall level of earnings or capital the Authorised Person is willing to risk;
        d. procedures for:
        i. approving new products and activities that give rise to Market Risk;
        ii. regular risk position and performance reporting;
        iii. limit exception reporting and approval; and
        iv. reporting and controlling of off-market trades, if these are permitted;
        e. where internal models are used to set Capital Requirements (as provided for in Section 5.3), the methods and assumptions used in these models and how the models are tested; and
        f. the allocation of responsibilities for implementing the Market Risk policy and for monitoring adherence to, and the effectiveness of, the policy.
        2. An Authorised Person should measure its Market Risk using a robust and consistent methodology. The appropriate method of measurement will depend upon the nature of the products traded. The Authorised Person should consider whether the measurement methodologies should be tested, for example, through back-testing, and the frequency of such testing.
        3. An Authorised Person should be able to measure its Market Risk Exposure both across risk types, such as interest rate, foreign exchange and commodities, and across the entire portfolio.
        4. Where an Authorised Person is a member of a Group, which is subject to consolidated supervision, the Group should be able to monitor Market Risk Exposures on a consolidated basis (Chapter 8).
        5. An Authorised Person should have the capability to assess the impact of any new transaction on its Market Risk position on an on-going basis, and should be capable of carrying out a full measurement of its positions at least daily.
        6. An Authorised Person should implement an effective system for monitoring its Market Risk. This system should be independent of those within the Authorised Person which are responsible for taking Market Risk.
        7. An Authorised Person should implement a system of management reporting which provides relevant, accurate, comprehensive, timely and reliable Market Risk reports to relevant functions within the Authorised Person. These reports should:
        a. alert senior management's attention to the size of Exposures and the relationship between these Exposures and limits;
        b. cover exceptions to the Authorised Person's Market Risk policy;
        c. present the results from stress tests undertaken; and
        d. analyse and explain any changes to the level and nature of Market Risk and any remedial action proposed or taken.
        8. An Authorised Person should have procedures, including stop-loss procedures, for taking appropriate action according to the information within the management reports.
        9. An Authorised Person should ensure that there are controls and procedures for reporting any trades booked at off-market rates.
        10. An Authorised Person should ensure that risk monitoring is subject to a periodic independent check. Models used to determine or interpolate specific Market Risk factors should be independently reviewed or otherwise validated.
        11. Particular attention should be given to the monitoring of Market Risk that does not conform to the usual Market Risk policy, or which exceeds predetermined Market Risk limits and criteria, but is sanctioned because of particular circumstances in accordance with the Authorised Person's procedures. Unauthorised exceptions to policies, procedures and limits should be reported in a timely manner to the appropriate level of management along with any remedial action proposed or taken.
        12. Market Risk limits should be periodically reviewed in order to check their suitability for current market conditions and the Authorised Person's overall risk appetite.
        13. An Authorised Person should use a model or some form of analytical tool to assess risk in complex instruments or across portfolios. An Authorised Person which wishes to use such a model to determine part of its financial resources requirement, should refer to Section 5.3.
        14. An Authorised Person should also use stress testing to determine the potential effects of economic downturns, market events, changes in interest rates, foreign exchange or liquidity conditions.
        15. An Authorised Person should set an appropriate limit structure to control its Market Risk Exposure. The degree of granularity within the limit structure, or how hierarchical it is, will depend on the nature of the products traded (for example, whether the underlying risks are linear or non-linear) and the scale of the Authorised Person's overall business (for example, whether the Authorised Person is an active market maker). An Authorised Person should set limits on risks such as simple price or rate risk as well as on the factors, Delta, Gamma, Vega, Rho, and Theta, arising from Options positions.
        16. Limits should also be imposed against net or gross positions, and in relation to maximum allowable loss ('stop-loss'), value at risk, maturity gap, and illiquid or volatile markets.
        17. An Authorised Person should provide a process for the identification, timely reporting and subsequent action in respect of exceptions to limits. An Authorised Person should also ensure that limit breaches and action arising from exceptions are monitored. An Authorised Person may also consider whether it is appropriate to set intermediate thresholds that alert management when limits are approached, triggering review or other appropriate action, or both.
        18. Various methods can be used to hedge Market Risk. An Authorised Person should document the appropriate products to be used to hedge Exposure and identify individuals within the Authorised Person or Group responsible for monitoring hedge performance.
        19. An Authorised Person should ensure that it makes and maintains appropriate prudential records which show and explain the Authorised Person's transactions, disclose its financial position and Exposure to Market Risk and enable it to demonstrate compliance with these rules. In particular, an Authorised Person should have data history to enable it to perform back-testing of methods and assumptions used for stress and scenario testing and for value-at-risk models. Market Risk records should be retained for at least six years.

    • PRU A6.2 PRU A6.2 Interest Rate Risk Capital Requirement

      • Guidance

        Section A6.2 presents the method for the calculation of Specific Risk and General Market Risk in respect of the Interest Rate Risk Capital Requirement as referred to in Rule 5.4.1(b).

      • PRU A6.2.1

        An Authorised Person which calculates its Interest Rate Risk Capital Requirement in accordance with Rule 5.4.1(b) must apply the Rules in this Section.

      • PRU A6.2.2

        An Authorised Person must calculate its Interest Rate Risk Capital Requirement as the sum of the two following separate charges:

        (a) Specific Risk of each net position as calculated in accordance with Rule A6.2.13; and
        (b) General Market Risk calculated in accordance with Rule A6.2.15.

      • PRU A6.2.3 PRU A6.2.3

        An Authorised Person must calculate its Interest Rate Risk Capital Requirement in Trading Book positions in all fixed-rate and floating-rate debt Securities and instruments which behave like them, including:

        (a) non-convertible preference Shares;
        (b) Futures or forwards on a debt security or on interest rates;
        (c) swaps (or contracts for differences) whose value is based on interest rates;
        (d) the cash leg of a repurchase or a reverse repurchase agreement;
        (e) forward foreign exchange contracts or currency Futures;
        (f) interest rate legs of equity swaps;
        (g) interest rate legs of equity Futures or forwards; and
        (h) interest rate legs of equity based Options treated under internal models in Section 5.3.

        • Guidance

          Where these positions will require the derivation of notional positions before they can be included in the calculation of Specific Risk and General Market Risk requirements, an Authorised Person must derive the notional positions in accordance with Rules A6.2.5 to A6.2.12.

      • PRU A6.2.4

        (1) An Authorised Person may net, by value, long and short positions in the same debt instrument in its Trading Book to generate the individual net position in that instrument.
        (2) Instruments are considered to be the same for the purposes of (1) where:
        (a) the Issuer is the same;
        (b) the instruments have equivalent standing in liquidation; and
        (c) the currency, coupon and maturity are the same.

      • Derivation of notional positions for certain instruments (including interest rate Derivatives)

        • PRU A6.2.5

          (1) The interest rate risk measurement must include all interest rate Derivatives and off-balance sheet instruments in the Trading Book that react to changes in interest rates, including forward rate agreements other forward contracts, Futures, interest rate and cross-currency swaps and forward foreign exchange positions.
          (2) Derivatives must be converted into positions in the relevant underlying instruments and are subject to Specific and General Market Risk requirements set out in Rules A6.2.13 and A6.2.15. The amounts used in the calculation must be the market values of the principal amount of the underlying instrument or of the notional underlying instrument.
          (3) The manner in which an Authorised Person must derive a notional position (in the currency concerned) for certain instruments (including interest rate Derivatives) is set out in Rules A6.2.6 to A6.2.12.

      • Futures on interest rates and forward rate agreements

        • PRU A6.2.6

          A Future on an interest rate and a forward rate agreement must be treated as two notional zero coupon government Securities as follows:

          (a) where an Authorised Person sells an interest rate Future or buys a forward rate agreement:
          (i) the notional short position has a maturity equal to the time to expiry of the Future (or the settlement date of the forward rate agreements) plus the maturity of the borrowing period; and
          (ii) the notional long position has a maturity equal to the time to expiry of the Future (or the settlement date of the forward rate agreement); and
          (b) where an Authorised Person buys an interest rate Future or sells a forward rate agreement:
          (i) the notional short position has a maturity equal to the time to expiry of the Future (or the settlement date of the forward rate agreement); and
          (ii) the notional long position has a maturity equal to the time to expiry of the Future (or the settlement date of the forward rate agreement) plus the maturity of the Deposit period.

      • Futures and forwards on a single debt security

        • PRU A6.2.7

          A Future and a forward on a single debt Security must be treated as a notional debt a notional zero coupon government Security as follows:

          (a) where an Authorised Person has bought the Future or forward:
          (i) a notional long position in the underlying Security with a maturity:
          (A) in the case of a fixed rate bond, equal to the underlying Security; and
          (B) in the case of a floating rate bond, at the time to the next reset; and
          (ii) a notional short position in a zero coupon government Security with a maturity equal to the time to expiry of the Futures contract; and
          (b) where an Authorised Person has sold the Future or forward:
          (i) a notional short position in the underlying Security with a maturity:
          (A) in the case of a fixed rate bond, equal to the underlying Security; and
          (B) in the case of a floating rate bond, at the time to the next reset; and
          (ii) a notional long position in a zero coupon government Security with a maturity equal to the time to expiry of the Futures contract.

      • Future or forward on a basket of debt Securities

        • PRU A6.2.8

          A Future and a forward on a basket of debt Securities must be treated as a set of notional positions in the constituent debt Securities.

      • Interest rate and currency swaps

        • PRU A6.2.9 PRU A6.2.9

          An interest rate and a currency swap must be treated as two notional government Securities as follows:

          (a) where the Authorised Person is receiving fixed rate interest and paying floating rate interest:
          (i) a notional long position with a maturity equal to the length of the swap; and
          (ii) a notional short position with a maturity equal to the period remaining to the next interest rate reset date;
          (b) where the Authorised Person is paying fixed rate interest and receiving floating rate interest:
          (i) a notional short position with a maturity equal to the length of the swap; and
          (ii) a notional long position with a maturity equal to the period remaining to the next interest rate reset date;
          (c) where the Authorised Person is receiving fixed rate interest and paying fixed rate interest:
          (i) a notional long position with a maturity equal to the length of the swap; and
          (ii) a notional short position with a maturity equal to the length of the swap.
          (d) where the Authorised Person is receiving floating rate interest and paying floating rate interest:
          (i) a notional long position with a maturity equal to the period remaining to the next interest date reset date; and
          (ii) a notional short position with a maturity equal to the period remaining to the next interest rate reset date; and
          (e) the two notional government Securities must have a coupon equal to the rate of interest payable or receivable on the leg.

          • Guidance

            A currency swap is also subject to a Foreign Exchange Risk Capital Requirement (see Section 5.6).

      • Dual currency bonds

        • PRU A6.2.10

          A dual currency bond must be treated as two positions as follows:

          (a) a debt Security denominated in the currency in which the dual currency bond is issued; and
          (b) a foreign exchange forward for the purchase of the redemption currency (see Section 5.6).

      • Cash legs of repos

        • PRU A6.2.11 PRU A6.2.11

          The forward cash leg of a repo must be treated as a notional short position in a government Security with a maturity equal to that of the repo and coupon equal to the repo rate.

          • Guidance

            If a Security is subject to a repurchase agreement (but not a reverse repurchase agreement), the Authorised Person continues to calculate an Interest Rate Risk Capital Requirement on the Security because, although legal ownership transfers to the Counterparty, the economic benefit or loss remains with the Authorised Person.

      • Cash legs of reverse repos

        • PRU A6.2.12 PRU A6.2.12

          (1) The forward cash leg of a reverse repo must be treated as a notional long position in a government security with a maturity equal to that of the reverse repo and coupon equal to the repo rate.
          (2) An Authorised Person may exclude from the interest rate maturity framework (for both Specific and General Market Risk) long and short positions (both actual and notional) in identical Derivative instruments with exactly the same Issuer, coupon, currency and maturity. A fully-matched position in a Future or forward and its corresponding underlying instrument may also be fully offset, and thus excluded from the calculation.

          • Guidance

            If a Security is subject to a reverse repurchase agreement (but not a repurchase agreement), the Authorised Person does not calculate an Interest Rate Risk Capital Requirement on the Security because, although the firm obtains the legal title, the economic benefit or loss remains with the original holder.

      • Specific Risk

        • Guidance

          In respect of interest rate risk, a capital charge for Specific Risk is designed to protect against an adverse movement in the price of an individual Security owing to factors related to the individual Issuer.

        • PRU A6.2.13 PRU A6.2.13

          (1) An Authorised Person must calculate its Specific Risk as the sum of the market values of the individual net positions (whether they are long or short) multiplied by the appropriate risk percentage in (3).
          (2) An Authorised Person must not offset between different issues.
          (3) An Authorised Person must determine the appropriate risk percentage by reference to the following table:
           
          Issuer Credit Quality Grades Residual Term to Maturity Risk Percentage
          Sovereign Debt

          This category includes —
          (a) all forms of government debt, including bonds, treasury bills and other short-term instruments; and
          (b) Securities issued by PSEs which qualify for a 0% risk weight for Credit Risk.

          An Exposure to any debt Security issued by—

          (i) the central government or monetary authority; or
          (ii) other central governments with a Credit Quality Grade of 3 or better as set out in Chapter 4,
          which is denominated in the domestic currency and funded in the same currency must be assigned a 0% Specific Risk charge.
          The Regulator may, at its discretion, assign a higher risk charge other than the above to Securities issued by certain governments, especially in cases where the Securities are denominated in a currency other than that of the issuing government.
          1 Any 0.00%
          2 or 3 6 months or less 0.25%
          More than 6 and up to 24 months 1.00%
          More than 24 months 1.60%
          4 or 5 Any 8.00%
          6 Any 12.00%
          Unrated Any 8.00%
          Qualifying Debt

          This category includes —
          (a) any Security that is issued by an MDB;
          (b) any Security (including one issued by a PSE) which has a Credit Quality Grade of 3 or better as set out in Chapter 4; and
          (c) any unrated Security issued by a PSE which belongs to a country with a Credit Quality Grade of 1 as set out in Chapter 4.
            6 months or less 0.25%
            More than 6 and up to 24 months 1.00%
            More than 24 months 1.60%
          Other

          For Securities which have a high yield to redemption relative to government debt Securities issued in the same country, the Regulator will require the Authorised Person:
          (a) to apply a higher Specific Risk charge to such instruments; or
          (b) to disallow offsetting for the purpose of defining the extent of General Market Risk between such instruments and any other debt instruments.
          4 Any 8% or such other percentage as the Regulator may direct.
          5 or 6 Any 12% or such other percentage as the Regulator may direct.
          Unrated Any 8% or such other percentage as the Regulator may direct.

          • Guidance

            1. Offsetting is not permitted since differences in coupon rates, liquidity, and call features, for example, signify that prices may diverge in the short run.
            2. The "Other" category will receive the same Specific Risk requirement as a private-sector borrower under the CRCOM, 8%. However, since this may, in certain cases, considerably underestimate the Specific Risk for debt Securities which have a high yield to redemption relative to government debt Securities, the Regulator has the right to apply to such Securities a Specific Risk percentage higher than 8%.

        • PRU A6.2.14

          [Reserved]

      • General Market Risk

        • PRU A6.2.15

          (1) Subject to (3), an Authorised Person must calculate its General Market Risk on a currency by currency basis, irrespective of where the individual instruments are physically traded or listed. The calculations for each currency must then be added together to determine the amount of the Authorised Person's General Market Risk requirement.
          (2) An Authorised Person must calculate its General Market Risk requirement for each currency by applying one of the following approaches to all currencies, including to the single maturity ladder derived from the currencies identified under (3):
          (a) the simplified framework set out in Rule A6.2.16;
          (b) the Maturity Method set out in Rule A6.2.17; or
          (c) with the consent of the Regulator, the Duration Method set out in Rule A6.2.19.

      • Simplified Framework

        • PRU A6.2.16 PRU A6.2.16

          In applying the simplified framework, an Authorised Person must calculate its General Market Risk requirement for each currency by taking the following steps:

          (a) allocating the individual net positions to one of the time bands in the table below, as follows:
          (i) fixed-rate instruments are allocated to their time bands based upon the residual time to maturity; and
          (ii) floating-rate instruments are allocated to time bands based upon the time remaining to the re-determination of the coupon;
          (b) adding the market values of the individual net positions within each band irrespective of whether they are long or short positions to produce a gross position figure;
          (c) multiplying the amount in (b) by the risk percentage for the relevant maturity band in the table below; and
          (d) adding the calculations in (c) to arrive at the General Market Risk requirement.
           
          Zone Time band Risk percentage
          Coupon of 3% or more Coupon of less than 3%
          A 0≤1month 0≤1month 0.00%
          > 1≤3months > 1≤3months 0.20%
          > 3 ≤ 6 months > 3 ≤ 6 months 0.40%
          > 6 ≤ 12 months > 6 ≤ 12 months 0.70%
          B > 1 ≤ 2 years > 1.0 ≤ 1.9 years 1.25%
          > 2 ≤ 3 years > 1.9 ≤ 2.8 years 1.75%
          > 3 ≤ 4 years > 2.8 ≤ 3.6 years 2.25%
          C > 4 ≤ 5 years > 3.6 ≤ 4.3 years 2.75%
          > 5 ≤ 7 years > 4.3 ≤ 5.7 years 3.25%
          > 7 ≤ 10 years > 5.7 7.3 years 3.75%
          > 10 ≤ 15 years > 7.3 9.3 years 4.50%
          > 15 ≤ 20 years > 9.3 10.6 years 5.25%
          > 20 years > 10.6 ≤ 12.0 years 6.00%
            > 12.0 ≤ 20.0 years 8.00%
            > 20 years 12.50%

          • Guidance

            The risk percentages in the table above are designed to reflect the price sensitivity of the positions to changes in the interest rate.

      • Maturity Method

        • PRU A6.2.17

          Under the Maturity Method, the following steps must be carried out:

          (a) the maturity weighted position for each instrument must be calculated by multiplying the market value of each individual long or short net position by the appropriate risk percentage per the table in Rule A5.2.16;
          (b) the sum of the weighted long and the sum of the weighted short positions in each maturity band must be calculated;
          (c) these weighted long and short positions must be matched within a maturity band to give the total matched weighted position in the maturity band and the total unmatched weighted position which will be long or short in the maturity band;
          (d) the matched weighted positions in all maturity bands must be summed;
          (e) the unmatched weighted positions in all the maturity bands must then be matched within a zone leaving an unmatched position for the zone (which will either be short or long); and
          (f) the unmatched positions in each zone must be matched with the unmatched positions in other zones leaving the residual unmatched weighted position.

        • PRU A6.2.18 PRU A6.2.18

          The General Market Risk requirement for each currency must be calculated as the sum of the following:

          (a) 10% of the matched weighted positions in each maturity band;
          (b) 40% of the matched weighted position in zone A;
          (c) 30% of the matched weighted position in zones B and C;
          (d) 40% of the matched weighted position between zones A and B, and between zones B and C;
          (e) 100% of the matched weighted position between zones A and C; and
          (f) 100% of the residual unmatched weighted positions.

          • Guidance

            A worked example under the Maturity Method of the General Market Risk requirement calculation is as follows:

            Zone

            Time band
            (m = months, y = years)

            Aggregate positions
            per time band ($)
            Risk
            percentages
            Aggregate positions per time band – weighted ($)
            (M = matched, U = unmatched)
              By time band By zone Between zones
            Coupon ≥3% Coupon <3% Long Short   Long Short M U M U M U
            A ≤ 1m 0 ≤ 1m 100 -50 0.00% 0.00 0.00 0.00 0.00        
            > 1 and ≤ 3m > 1 and ≤ 3m 200 -100 0.20% -0.20 0.20 0.20 0.20 0.00 1.30    
            > 3 and ≤ 6 m > 3 and ≤ 6 m 300 -200 0.40% 1.20 -0.80 0.80 0.40        
            > 6 and ≤ 12 m > 6 and ≤ 12 m 400 -300 0.70% 2.80 -2.10 2.10 0.70        
                                     
            B > 1 and ≤ 2 y > 1.0 and ≤ 1.9 y 100 -200 1.25% 1.25 -2.50 1.25 -1.25     Zones A&B

            1.30

             
            > 2 and ≤ 3 y > 1.9 and ≤ 2.8 y 200 -300 1.75% 3.50 -5.25 3.50 -1.75 0.00 -5.25  
            > 3 and ≤ 4 y > 2.8 and ≤ 3.6 y 300 -400 2.25% 6.75 -9.00 6.75 -2.25       Zones A&C

            0.00

                                   
            C > 4 and ≤ 5 y > 3.6 and ≤ 4.3 y 100 -100 2.75% 2.75 -2.75 2.75 0.00     Zones B&C

            1.30

             
            > 5 and ≤ 7 y > 4.3 and ≤ 5.7 y 200 -200 3.25% 6.50 -6.50 6.50 0.00      
            > 7 and ≤ 10 y > 5.7 and ≤ 7.3 y 300 -100 3.75% 11.25 -3.75 3.75 7.50        
            > 10 and ≤ 15 y > 7.3 and ≤ 9.3 y 100 -200 4.50% 4.50 -9.00 4.50 -4.50 4.50 8.25    
            > 15 and ≤ 20 y > 9.3 and ≤ 10.6 y 200 -100 5.25% 10.50 5.25 5.25 5.25        
            > 20 y > 10.6 and ≤ 12.0 y 300 -300 6.00% 18.00 -18.00 18.00 0.00        
              > 12 and ≤ 20 y 0 0 8.00%                
              > 20 y 0 0 12.50%                
                                     
            Total               55.35     4.30    

            Total General Market Risk requirement = 10% ($55.35) + 40% ($0.00) + 30% ($0.00 + $4.50) + 40% ($1.30 + $3.95) + 100% ($4.30) + 100% ($0.00) = $13.29

      • Duration Method

        • PRU A6.2.19

          An Authorised Person with the necessary capability may, with the written consent of the Regulator, use the Duration Method, which produces a more accurate measure for General Market Risk than the Maturity Method. An Authorised Person must elect and use the Duration Method on a continuous basis and will be subject to supervisory monitoring of the systems used.

        • PRU A6.2.20

          Under the Duration Method, the following steps must be carried out:

          (a) the duration weighted position for each instrument must be calculated by multiplying the market value of each individual long or short net position by the Modified Duration in years and the assumed interest rate change in the table below;
          (b) the sum of the weighted long and the sum of the weighted short positions in each time band must be calculated;
          (c) these weighted long and short positions must be matched within a maturity band to give the total matched weighted position in the maturity band and the total unmatched weighted position which will be long or short in the maturity band;
          (d) the matched weighted positions in all maturity bands must be summed;
          (e) the unmatched weighted positions in all the maturity bands must then be matched within a zone leaving an unmatched position for the zone (which will either be short or long); and
          (f) the unmatched positions in each zone must be matched with the unmatched positions in other zones leaving the residual unmatched weighted position.
          Zone Modified Duration Assumed move in interest rates
          A 0 ≤ 1 month 1.00%
          > 1 ≤ 3 months 1.00%
          > 3 ≤ 6 months 1.00%
          > 6 ≤ 12 months 1.00%
          B > 1.0 ≤ 1.9 years 0.90%
          > 1.9 ≤ 2.8 years 0.80%
          > 2.8 ≤ 3.6 years 0.75%
          C > 3.6 ≤ 4.3 years 0.75%
          > 4.3 ≤ 5.7 years 0.70%
          > 5.7 ≤ 7.3 years 0.65%
          > 7.3 ≤ 9.3 years 0.60%
          > 9.3 ≤ 10.6 years 0.60%
          > 10.6 ≤ 12.0 years 0.60%
          > 12.0 ≤ 20.0 years 0.60%
          > 20 years 0.60%

           

        • PRU A6.2.21

          For the purposes of this Section Modified Duration is calculated as follows:

          Modified Duration = duration(D) / (1 + r)

          where:

          r = yield to maturity

          Ct = cash payment in time t

          m = total maturity

        • PRU A6.2.22 PRU A6.2.22

          The General Market Risk requirement for each currency must be calculated as the sum of the following:

          (a) 5% of the matched weighted positions in each time band;
          (b) 40% of the matched weighted position in zone A;
          (c) 30% of the matched weighted position in zones B and C;
          (d) 40% of the matched weighted position between zones A and B, and between zones B and C;
          (e) 100% of the matched weighted position between zones A and C; and
          (f) 100% of the residual unmatched weighted positions.

          • Guidance

            A worked example of the General Market Risk requirement calculation under the Duration Method is as follows:

            Zone

            Time band
            (m = months, y = years)

            Aggregate positions
            per time band ($)
            Assumed move
            in interest rates
            (% pa)
            Modified
            duration
            (years)
            Aggregate positions per time band – weighted ($)
            (M = matched, U = unmatched)
              By time band By zone Between zones
            Long Short Long Short M U M U M U
            A ≤ 1m 100 -50 1.00% 0.00 0.00 0.00 0.00 0.00 0.00 1.30    
            > 1 and ≤ 3m 200 -100 1.00% 0.20 0.40 -0.20 0.20 0.20        
            > 3 and ≤ 6 m 300 -200 0.40% 1.00 0.40 1.20 -0.80 0.40        
            > 6 and ≤ 12 m 400 -300 1.00% 0.70 2.80 -2.10 2.10 0.70        
                                     
            B > 1.0 and ≤ 1.9 y 100 -200 0.90% 1.40 1.26 -2.52 1.26 -1.26 0.00 -5.27 Zones A&B
            1.30
             
            > 1 and ≤ 3m 200 -100 1.00% 0.20 0.40 -0.20 0.20 0.20      
            > 2.8 and ≤ 3.6 y 300 -400 0.75% 3.00 6.75 -9.00 6.75 -2.25       Zones A&C 0.00
                                   
            C > 3.6 and ≤ 4.3 y 100 -100 0.75% 3.65 2.74 -2.74 2.74 0.00 4.50 8.89 Zones B&C
            3.97
             
            > 4.3 and ≤ 5.7 y 200 -200 0.70% 4.65 6.51 -6.51 6.51 0.00      
            > 5.7 and ≤ 7.3 y 300 -100 0.65% 5.80 11.31 -3.77 3.77 7.54        
            > 7.3 and ≤ 9.3 y 100 -200 0.60% 7.50 4.50 -9.00 4.50 -4.50        
            > 9.3 and ≤ 10.6 y 200 -100 0.60% 9.75 11.70 -5.85 5.85 5.85        
            > 10.6 and ≤ 12.0 y 0 0 0.60% 11.00 0.00 0.00 0.00 0.00        
            > 12 and ≤ 20 y 300 -300 0.60% 14.50 26.10 -26.10 26.10 0.00        
            > 20 y 0 0 0.60% 22.00 0.00 0.00 0.00 0.00        
                                     
            Total                 64     4.92  

            Total General Market Risk requirement = 5% ($64.10) + 40% ($0) + 30% ($4.50) + 40% ($5.27) + 100% ($0) + 100% ($4.92) = $11.58

    • PRU A6.3 PRU A6.3 Equity Risk Capital Requirement

      • Guidance

        Section A6.3 presents the method for the calculation of Equity Risk Capital Requirement for the purpose of Rule 5.5.1(b).

      • PRU A6.3.1

        An Authorised Person which calculates its Equity Risk Capital Requirement in accordance with Rule 5.5.1(b) must apply the Rules in this Section.

      • PRU A6.3.2 PRU A6.3.2

        An Authorised Person must calculate its Equity Risk Capital Requirement by:

        (a) identifying all applicable positions within the scope of the requirement, including notional positions derived from certain instruments;
        (b) Netting positions where they meet the conditions for Netting set in Rule A6.3.19;
        (c) calculating an Equity Risk Capital Requirement for each individual position using the standard method in accordance with Rule A6.3.23 or the simplified method in accordance with Rule A6.3.31;
        (d) in the case of a forward, Future, Option or company issued Warrant on an equity, basket of equities or equity index, adding an Interest Rate Risk Capital Requirement; and
        (e) summing the Capital Requirements calculated in accordance with (c) and (d).

        • Guidance

          For the purposes of Rule A6.3.2(d), an Authorised Person is required to calculate the applicable Interest Rate Risk Capital Requirement in accordance with Rule A6.2.13 and the other applicable Rules in Section A6.2.

      • PRU A6.3.3 PRU A6.3.3

        (1) For the purposes of Rule A6.3.2(a) an Authorised Person must calculate an Equity Risk Capital Requirement for long and short Trading Book positions in equities and instruments which exhibit behaviour similar to equities including but not limited to:
        (a) depository receipts;
        (b) Futures or forwards on an equity, baskets of equities or equity indices;
        (c) net Underwriting commitments; and
        (d) investments in unleveraged Collective Investment Funds.
        (2) An Authorised Person should calculate either an Equity Risk Capital Requirement or an Option Risk Capital Requirement for a Trading Book position in:
        (a) an equity hedging an Option;
        (b) an equity hedging a company-issued Warrant;
        (c) an Option on an equity, basket of equities, equity index or equity Future provided it is in the money by at least the risk percentage stipulated in A6.3.31; and
        (d) a company issued Warrant which relates to an equity, basket of equities or equity index provided it is in the money by at least the risk percentage stipulated in A6.3.31.

        • Guidance

          1. If an Authorised Person has an investment in a leveraged Collective Investment Fund, it should seek guidance from the Regulator in respect of the appropriate prudential treatment.
          2. In respect of Options that are out of the money, an Authorised Person must apply the requirements of Section 5.8.

      • PRU A6.3.4

        An Authorised Person must calculate either an Equity Risk Capital Requirement or an Option Risk Capital Requirement for a Trading Book position in the equity leg of an equity swap in accordance with Rule A6.3.12.

      • PRU A6.3.5

        An Authorised Person must calculate either an Equity Risk Capital Requirement or Interest Rate Risk Capital Requirement for a Trading Book position in a Convertible in accordance with Rules A6.3.6 and A6.3.7.

      • PRU A6.3.6

        An Authorised Person must treat a Convertible as the underlying equity into which it converts, where:

        (a) the first date at which conversion can take place is less than three months ahead, or the next such date (where the first has passed) is less than a year ahead; and
        (b) the Convertible is trading at a premium of less than 10% to the underlying equity.

      • PRU A6.3.7

        An Authorised Person which treats a Convertible as an equity must make an adjustment to the capital component as follows:

        (a) an addition equal to any loss on conversion; or
        (b) a deduction equal to any profit on conversion (subject to a maximum reduction to zero).

      • PRU A6.3.8

        An Authorised Person must not calculate an Equity Risk Capital Requirement for a Trading Book position in:

        (a) material holdings deducted under Chapter 3 for the purposes of calculating an Authorised Person's Capital Resources;
        (b) the interest rate leg of an equity swap, equity Future or forward, or equity based Option; or
        (c) a non-Convertible preference security.

      • Derivation of notional positions

        • PRU A6.3.9

          An Authorised Person must, before Netting, derive a notional position for a depository receipt, a swap, a Future, a forward, an Option and a company issued Warrant in the calculation of its Equity Risk Capital Requirement.

      • Depository receipts

        • PRU A6.3.10

          An Authorised Person must treat a depository receipt as a notional position in the underlying equity.

        • PRU A6.3.11

          A position in a depository receipt must only be netted against a position in the underlying equity if the equity is deliverable against the depository receipt.

      • Equity swaps

        • PRU A6.3.12

          An Authorised Person must treat an equity swap as two notional positions: an interest rate leg and an equity leg, as follows:

          (a) the interest rate leg must be included in the Interest Rate Risk Calculation and treated as a notional government Security in accordance with the provisions for interest rate swaps in Section 5.4; and.
          (b) the equity leg must be treated as a long or short position in:
          (i) where the payout or receipt of funds is based on, respectively, the appreciation or depreciation in price of the underlying equities, a Future; or
          (ii) where the payout is the appreciation in price of the underlying equities, an Option, in which case the Authorised Person must calculate an Option Risk Capital Requirement in accordance with Section 5.8.

      • Equity Futures and forwards

        • PRU A6.3.13

          An Authorised Person must treat a Future or forward on a single equity as a notional position in the underlying equity. In addition, an interest rate leg must be included in the interest rate risk calculation in Section 5.4 as a notional government security.

        • PRU A6.3.14

          An Authorised Person must treat a Future or forward on a single country equity index as either:

          (a) notional positions in the constituent equities; or
          (b) a single notional position.

        • PRU A6.3.15

          Where Rule A6.3.14(b) applies, an Authorised Person must apply the highest risk percentage to the single notional position that would apply to any one of its constituents.

        • PRU A6.3.16

          An Authorised Person must treat a Future or forward on a multiple country equity index as either:

          (a) notional positions in the constituent equities; or
          (b) a number of notional positions being one for each of the countries which is represented in the index, in the proportion of that country's representation in the index.

        • PRU A6.3.17

          Where Rule A6.3.16(b) applies, an Authorised Person must apply the highest risk percentage to each notional position that would apply to any one of its constituents.

      • Equity Options and company issued Warrants

        • PRU A6.3.18

          An Authorised Person must treat an Option or company issued Warrant on an equity, basket of equities or equity index that is eligible to be included in the equity method as a notional position in the underlying equity or equities as follows:

          (a) a purchased call Option and a written put Option must be treated as a long position; and
          (b) a purchased put Option and a written call Option must be treated as a short position.

      • Netting

        • Guidance

          1. Before calculating the Equity Risk Capital Requirement, positions may be netted in order to produce the individual net position.
          2. Since the Netting of positions for Equity Risk Capital Requirement purposes does not involve legal or contractual issues, this material appears here rather than in the Netting Section of the Credit Risk Chapter.

        • PRU A6.3.19

          (1) An Authorised Person may only net equity positions when:
          (a) long and short (including notional) positions are in the same tranche of the same equity; and
          (b) long and short (including notional) positions are in different tranches of the same equity where the tranches enjoy the same rights in all respects and become fungible within 180 days, and thereafter the equity of one tranche can be delivered in settlement of the equity of the other tranche.
          (2) For the purposes of (1)(a), an equity is the same as another, only if they enjoy the same rights in all respects and are fungible with each other.

      • Calculation of the Equity Risk Capital Requirement

        • Guidance

          There are two methods for calculating the Equity Risk Capital Requirement: the standard method and the simplified method. The standard method requires two separate calculations. The first is Specific Risk and the second is General Market Risk. The simplified method is easier to calculate but usually results in a higher Capital Requirement than the standard method. In addition, Authorised Persons must calculate an Interest Rate Risk Capital Requirement for a forward, a Future, an Option or a company issued Warrant.

        • PRU A6.3.20

          (1) An Authorised Person must allocate an equity position or notional position to the country in which the equity is listed.
          (2) An equity listed in more than one country must be allocated to one of the countries in which it is listed.

        • PRU A6.3.21

          An Authorised Person must allocate an unlisted equity to the country in which it is issued.

      • The concentration test

        • PRU A6.3.22 PRU A6.3.22

          An Authorised Person must apply either the standard method or simplified method to an equity position, except that where an individual net position exceeds 20% of the sum of the long and short positions (ignoring the sign) of its country portfolio, the simplified method must be applied to the excess.

          • Guidance

            The part of the individual net position that does not exceed 20% may be treated under the simplified or standard method.

      • Standard method

        • PRU A6.3.23

          Under the standard method, the total Equity Risk Capital Requirement is the sum of the Specific Risk requirements for all individual net equity positions and the General Market Risk requirements calculated separately for each country.

      • Specific Risk

        • PRU A6.3.24

          Specific Risk must be calculated for each net position in an individual equity.

        • PRU A6.3.25

          The Specific Risk of each individual net equity position is its market value (ignoring the sign) multiplied by 8%.

        • PRU A6.3.26

          [Reserved]

        • PRU A6.3.27

          [Reserved]

        • PRU A6.3.28

          [Reserved]

        • PRU A6.3.29

          An Authorised Person must calculate General Market Risk on a country-by-country basis.

        • PRU A6.3.30

          An Authorised Person must calculate the General Market Risk for each country in the following way:

          (a) all individual net positions are multiplied by 8%;
          (b) long and short positions in each country portfolio are netted; and
          (c) if the net equity position is negative, the sign must be reversed.

      • Simplified method

        • PRU A6.3.31

          The Equity Risk Capital Requirement for each country is the sum of the market value of all individual net positions (ignoring the sign) multiplied by the appropriate risk percentage in the table below:

          Position Percentage risk
          Single equities 16%
          Broad-based indices (not broken down into constituent equities) 8%
          All other indices (not broken down into constituent equities) 16%

        • PRU A6.3.32

          For the purposes of Rule A6.3.31, a broad-based index means an index specified in the table under (c) or an index that satisfies the following criteria:

          (a) the index contains at least twenty Shares;
          (b) the weighting of the largest company is not greater than 20% of the total index; and
          (c) the weighting of the largest five companies is not greater than 60% of the total index.
           
          Country Index
          Australia All Ordinaries
          Austria Austrian Traded Index
          Belgium BEL 20
          Canada TSE 35, TSE 100, TSE 300
          France CAC 40, SBF 250
          Germany DAX
          European Dow Jones Stoxx 50 Index, FTSE Eurotop 300, MSCI Euro Index
          Hong Kong Hang Seng
          Italy MIB 30
          Japan Nikkei 225, Nikkei 300, TOPIX
          Korea Kospi
          Netherlands AEX
          Singapore Straits Times Index
          Spain IBEX 35
          Sweden OMX
          Switzerland SMI
          UK FTSE 100, FTSE Mid 250, FTSE All Share
          US S&P 500, Dow Jones Industrial Average, NASDAQ Composite, Russell 2000

    • PRU A6.4 PRU A6.4 Foreign Exchange Risk Capital Requirement

      • Guidance

        Section A6.4 presents the method for the calculation of Foreign Exchange Risk Capital Requirement for the purpose of Rule 5.6.1(b).

      • PRU A6.4.1

        An Authorised Person which calculates its Foreign Exchange Risk Capital Requirement in accordance with Rule 5.6.1(b) must apply the Rules in this Section.

      • PRU A6.4.2

        An Authorised Person must calculate its Foreign Exchange Risk Capital Requirement by using the standard method as follows:

        (a) calculating its net open position in each currency and in gold;
        (b) calculating its overall net open position in accordance with Rule A6.4.4; and
        (c) multiplying the overall net open position by the percentage provided in Rule A6.4.5.

      • Measuring the net open position in a single currency

        • PRU A6.4.3

          An Authorised Person must calculate its net open position in each currency, and in gold, by summing:

          (a) the net spot position, being all asset items less all liability items, including accrued interest, denominated in the currency in question;
          (b) the net forward position, being all amounts to be received less all amounts to be paid under forward foreign exchange transactions, including currency Futures and the principal on currency swaps not included in the spot position;
          (c) guarantees and similar instruments that are certain to be called and are likely to be irrecoverable;
          (d) net future income/expenses not yet accrued but already fully hedged, at the discretion of the Authorised Person; and
          (e) any other item representing a profit or loss in Foreign Currencies.

      • Measuring the overall net open position

        • PRU A6.4.4

          (1) An Authorised Person must convert the net position in each Foreign Currency and in gold at spot rates into the reporting currency.
          (2) The overall net open position is measured by aggregating:
          (a) the sum of the net short positions or the sum of the net long positions, whichever is the greater; plus
          (b) the net position (short or long) in gold, regardless of sign.

        • PRU A6.4.5 PRU A6.4.5

          The Foreign Exchange Risk Capital Charge is 8% of the overall net open position.

          • Guidance

            1. An example of how to calculate the overall net open position is as follows:
             
            YEN EURO GB   Saudi Riyal $   Gold
            +50 +100 +150 -20 -180 -35
            TOTAL +300 TOTAL-200 TOTAL 35
            2. The Foreign Exchange Risk Capital Charge would be 8% of the absolute value of the greater of either the net long currency positions or the net short currency positions (i.e. 300 in this example) plus the net position in gold (35) = 335 x 8%=26.8.
            3. Forward currency and gold positions will normally be valued at current spot market exchange rates. Using forward exchange rates would be inappropriate since it would result in the measured positions reflecting to some extent current interest rate differentials. However, an Authorised Person which bases its normal management accounting on net present values is expected to use the net present values of each position, discounted using current interest rates and valued at current spot rates, for measuring its forward currency and gold positions.

      • Treatment of accrued interest and expenses, forwards, and structural positions

        • PRU A6.4.6

          (1) An Authorised Person must include interest accrued and accrued expenses as a position.
          (2) If an Authorised Person includes future income/expenses it must do so on a consistent basis and not include only those expected future flows that reduce its position.
          (3) An Authorised Person may exclude any positions which it has deliberately taken in order to hedge partially or totally against the adverse effect of the exchange rate on its Capital Resources, from the calculation of net open currency positions, if each of the following conditions is met:
          (a) the positions are of a structure that is of a non-dealing nature;
          (b) the Authorised Person has notified the Regulator in writing of its intention to rely upon this Rule; and
          (c) any exclusion of the position must be applied consistently, with the treatment of the hedge remaining the same for the life of the assets or other items.
          (4) An Authorised Person need not include positions related to:
          (a) items which are deducted from its capital when calculating its Capital Resources, including investments in non-consolidated subsidiaries; or
          (b) other long-term participations denominated in Foreign Currencies which are reported in the published accounts at historic cost.

    • PRU A6.5 PRU A6.5 Commodities Risk Capital Requirement

      • Guidance

        Section A6.5 presents the method for the calculation of Commodities Risk Capital Requirement for the purpose of Rule 5.7.1(b).

      • PRU A6.5.1

        An Authorised Person which calculates its Commodities Risk Capital Requirements in accordance with Rule 5.7.1(b) must apply the Rules in this Section.

      • Calculation of Commodities Risk Capital Requirement

        • PRU A6.5.2

          (1) An Authorised Person must calculate its Commodities Risk Capital Requirement by applying the Maturity Ladder approach in Rule A6.5.5 or the Simplified Approach in Rule A6.5.6 to all Non-Trading and Trading Book:
          (a) commodity positions;
          (b) commodity Derivatives and off-balance sheet positions that are affected by changes in commodity prices, having derived notional commodity positions; and
          (c) other positions against which no other Market or Credit Risk Capital Requirement has been applied.
          (2) An Authorised Person must determine notional commodity positions by converting the commodity Derivatives into notional underlying commodity positions and assigning appropriate maturities in accordance with Rule A6.5.3.

      • Treatment of commodity Derivatives

        • PRU A6.5.3

          An Authorised Person must:

          (a) incorporate all Futures and forward contracts relating to individual commodities in the measurement system as notional amounts and assigned a maturity with reference to the expiry date;
          (b) incorporate commodity swaps where one leg is a fixed price and the other the current market price as a series of positions equal to the notional amount of the contract, with one position corresponding to each payment on the swap and slotted into the Maturity Ladder accordingly. The positions will be long positions if the Authorised Person is paying fixed and receiving floating, and short positions if the Authorised Person is receiving fixed and paying floating; and
          (c) incorporate commodity swaps where the legs are in different commodities in the relevant Maturity Ladder. No offsetting will be allowed in this regard except where the commodities belong to the same sub-category.

        • PRU A6.5.4 PRU A6.5.4

          (1) Subject to (2), an Authorised Person must not net positions in different commodities for the purpose of calculating open positions.
          (2) An Authorised Person may net positions in different commodities where those commodities:
          (a) are deliverable against each other; and
          (b) are in one or more sub-categories of the same category;

          • Guidance

            1. For the purposes of Rule A6.5.4, an example of a category is oil. An example of a sub-category is Brent.
            2. For the Simplified Approach and the Maturity Ladder approach, long and short positions in each commodity may be reported on a net basis for the purposes of calculating open positions.

      • Maturity Ladder approach

        • PRU A6.5.5 PRU A6.5.5

          (1) An Authorised Person which uses the Maturity Ladder approach to calculate the Commodities Risk Capital Requirement must:
          (a) express each commodity position (spot and forward) in terms of the standard unit of measurement and net long and short positions maturing on the same day or maturing within ten business days of each other in the case of contracts traded in markets with daily delivery dates;
          (b) allocate the positions remaining after taking the steps in (a) to the appropriate maturity band in the following table:
           
          Band Maturity of Position
          1 0 to 1 month
          2 1 to 3 months
          3 3 to 6 months
          4 6 to 12 months
          5 1 to 2 years
          6 2 to 3 years
          7 Over 3 years
          (c) calculate the spread charge each time long and short positions are matched within each band. In each instance, the spread charge equals the matched amount multiplied first by the unit spot price for the commodity and then by a spread rate of 1.5%;
          (d) calculate a carry charge for each position that is carried across to another maturity band. In each instance, the carry charge equals the carried position multiplied first by the unit spot price for the commodity, then by the carry rate of 0.6% and finally by the number of bands by which the position is carried;
          (e) repeat (c) if necessary;
          (f) calculate the outright charge by multiplying all remaining unmatched positions (long plus short, ignoring the sign) by the unit spot price for the commodity, then by 15%; and
          (g) sum the totals for Bands 2 to 7 referred to in (b), to reach the total requirement.
          (2) For the purposes of (1)(b), an Authorised Person must:
          (a) allocate physical stocks to the first maturity band; and
          (b) set a separate Maturity Ladder for each commodity.

          • Guidance

            The table below illustrates the calculation of the Commodity Risk Capital Requirement on an individual commodity using the Maturity Ladder approach.

             

      • Simplified Approach

        • PRU A6.5.6

          An Authorised Person using the Simplified Approach to calculate the Commodities Risk Capital Requirement must sum:

          (a) 15% of the net position multiplied by the spot price for the commodity; and
          (b) 3% of the gross position (long plus short, ignoring the sign) multiplied by the spot price of the commodity.

    • PRU A6.6 PRU A6.6 Option Risk Capital Requirement

      • Guidance

        Section A6.6 presents the method for the calculation of Option Risk Capital Requirement for the purpose of Rule 5.8.1(b).

      • PRU A6.6.1

        An Authorised Person which calculates its Option Risk Capital Requirement in accordance with Rule 5.8.1(b) must apply the Rules in this Section.

      • Calculation of Option Risk Capital Requirement

        • PRU A6.6.2

          (1) An Authorised Person may use the Simplified Approach set out in Rule A6.6.3 to calculate its Option Risk Capital Requirement only if:
          (a) it does not write Options; or
          (b) where it writes Options, all written Options are hedged by perfectly matched long positions in exactly the same Options.
          (2) An Authorised Person which writes Options must, unless (1) applies, use the advanced approach known as the Delta-plus method set out in Rule A6.6.5 to calculate its Option Risk Capital Requirement.

      • Simplified Approach

        • PRU A6.6.3 PRU A6.6.3

          An Authorised Person using the Simplified Approach must treat the positions for the Options and the associated underlying instrument, cash or forward, and calculate the capital charge for each position, by reference to the following table:

          Position Treatment
          Long cash and long put or short cash and long call. The capital charge is the market value of the underlying instrument multiplied by the sum of Specific and General Market Risk percentages for the underlying Instrument less the amount the Option is in the money, if any, bounded at zero.
          Long call or long put. The capital charge will be the lesser of:
          •   the market value of the underlying instrument multiplied by the sum of Specific and General Market Risk percentages for the underlying instrument; or
          •   the market value of the Options.

          • Guidance

            As an example of how the calculation would work, if a holder of 100 Shares currently valued at $10 each holds an equivalent put Option with a strike price of $11, the capital charge would be: $1,000 × 16% (i.e., 8% specific plus 8% General Market Risk) = $160, less the amount the Option is in the money ($11 - $10) × 100 = $100, i.e., the capital charge would be $60. A similar methodology applies for Options whose underlying instrument is a Foreign Currency, an interest rate related instrument or a commodity.

        • PRU A6.6.4

          (1) For the purposes of Rule A6.6.3, the Specific Risk percentage for:
          (a) a currency Option is 8%; and
          (b) an Option on commodities is 15%.
          (2) For the purposes of Rule A6.6.3, in the case of an Option with a residual maturity of more than six months, the strike price must be compared with the forward, not current price, or if the Authorised Person is unable to do this, then the Money amount must be taken to be zero.

      • Delta-plus method

        • Guidance

          The Delta-plus method uses the sensitivity parameters or "Greek letters" associated with Options to measure their Option Risk Capital Requirement. Under this method, the Delta-equivalent position of each Option becomes part of the standardised methodology set out in Sections 5.4 to 5.7 with the Delta-equivalent amount subject to the applicable General Market Risk requirements. Separate capital charges are then applied to the Gamma and Vega risks of the Option positions.

        • PRU A6.6.5

          (1) An Authorised Person that writes or purchases Options may include Delta-weighted Options positions within the standardised methodology set out in Sections A6.2 to A6.5. Such Options must be reported as a position equal to the market value of the underlying instrument multiplied by the Delta.
          (2) An Authorised Person is also required to measure and Vega risks in order to calculate the total capital charge. These sensitivities will be calculated according to an approved proprietary Options pricing model.
          (3) Delta-weighted positions with debt Securities or interest rates as the underlying instrument must be inserted into the interest rate timebands, as set out in Section A6.2. A two-legged approach must be used as for other Derivatives, requiring one entry at the time the underlying instrument takes effect and a second at the time the underlying instrument matures. Floating rate instruments with caps or floors must be treated as a combination of floating rate Securities and a series of European-style Options.
          (4) The capital charge for Options with equities as the underlying instrument must also be based on the Delta-weighted positions which must be incorporated in the measure of Equity Risk Capital Requirement described in Section A6.3. For purposes of this calculation, each national market must be treated as a separate underlying instrument.
          (5) The capital charge for Options on commodities, foreign currency (including gold) positions must be based on the method set out in Section 5.8. For Delta risk, the net Delta-based equivalent of the commodities, foreign currency including gold) Options must be incorporated into the measurement of the Exposure for the respective currency (or gold) position.
          (6) Individual net Delta positions as described above must be treated as the underlying instrument in accordance with Sections A6.4 to A6.5.

        • PRU A6.6.6

          An Authorised Person using the Delta-plus method must calculate its Market Risk Capital Requirement for Options by:

          (a) calculating the Delta-weighted position of each Option in accordance with Rule A6.6.7 and adding these Delta-weighted positions to the net positions in the relevant risk category referred in Sections A6.2 to A6.6 for the purpose of calculating the Specific Risk and General Market Risk Capital Requirements;
          (b) calculating the Capital Requirement for Gamma risk of its Option positions (including hedge positions) based on the Options pricing model of the an Authorised Person, in accordance with Rules A6.6.8 to A6.6.9;
          (c) calculating the Capital Requirement for Vega risk of its Option positions (including hedge positions) based on the Options pricing model of an Authorised Person, in accordance with Rule A6.6.10; and
          (d) summing the Capital Requirements determined in (b) and (c).

        • PRU A6.6.7

          An Authorised Person must calculate its Delta-weighted position for each Option as follows:

          Delta-weighted position = Market value of the underlying instrument or commodities × Delta

        • PRU A6.6.8

          In addition to the capital charges referred to in Rule A6.6.5, arising from Delta risk, an Authorised Person must calculate the Gamma for each Option position, including hedge positions in the following way:

          (a) for each individual Option a "Gamma impact" must be calculated as:
          Gamma impact = ½ × Gamma × VU2
          where VU = Variation of the underlying instrument of the Option;
          (b) VU must be calculated as follows:
          (i) for interest rate Options if the underlying instrument is a bond, the market value of the underlying instrument should be multiplied by the risk weights set out in Section 5.4 for the underlying instrument. An equivalent calculation should be carried out where the underlying instrument is an interest rate, again based on the assumed changes in the corresponding yield in Rule A6.2.16;
          (ii) for Options on equities and equity indices, the market value of the underlying instrument should be multiplied by 8%;
          (iii) for foreign exchange and gold Options, the market value of the underlying instrument should be multiplied by 8%; and
          (iv) for Options on commodities, the market value of the underlying instrument should be multiplied by 15%; and
          (c) for the purpose of this calculation the following positions must be treated as the same underlying instrument:
          (i) for interest rates, each timeband as set out in Rule A6.2.16;
          (ii) for equities and stock indices, each national market;
          (iii) for foreign currencies and gold, each currency pair and gold; and
          (iv) for commodities, positions in the same individual commodity as defined in Section A6.5 for Commodities Risk Capital Requirement.

        • PRU A6.6.9 PRU A6.6.9

          An Authorised Person must calculate its Capital Requirement for Gamma risk by:

          (a) calculating the net Gamma impact in respect of each underlying Financial Instrument or commodity by aggregating the individual Gamma impacts for each Option position in respect of that underlying Financial Instrument or commodity (which may be either positive or negative); and
          (b) aggregating the absolute value of the net Gamma impacts that are negative.

          • Guidance

            1. The underlying Financial Instrument or commodity should be taken to be the asset which would be received if the Option were exercised. In addition, the notional value should be used for items where the market value of the underlying Financial Instrument or commodity could be zero (e.g. caps and floors, swaptions). Certain notional positions in zero-specific-risk Securities do not attract Specific Risk, e.g. interest rate and currency swaps, Forward Rate Agreement (FRA), forward foreign exchange contracts, interest rate Futures and Futures on an interest rate index. Similarly, Options on such zero-specific-risk Securities also bear no Specific Risk. For the purposes of this sub-paragraph:
            a. the specific and general risk weights in respect of Options on interest rate-related instruments are determined in accordance with Section A6.2;
            b. the specific and general risk weights in respect of Options on equities and equity indices are determined in accordance with Section A6.3;
            c. the risk weight in respect of foreign currency and gold Options is 8%; and
            d. the risk weight in respect of Options on commodities is 15%.
            For Options with a residual maturity of more than six months, the strike price should be compared with the forward, and not current, price. Where an Authorised Person is unable to do this, the in-the-money amount would be zero.
            2. An Authorised Person which trades in exotic Options (e.g. barriers, digitals) would use either the scenario approach or the Internal Models Approach (IMA) to calculate its Market Risk Capital Requirement for such Options, unless it is able to demonstrate to the Regulator that the Delta-plus method is appropriate. In the case of Options on Futures or forwards, the relevant underlying is that on which the Future or forward is based (e.g. for a bought call Option on a June 3-month bill Future, the relevant underlying is the 3-month bill).

        • PRU A6.6.10

          An Authorised Person must calculate its Capital Requirement for Vega risk by:

          (a) multiplying the sum of the Vegas for all Option positions in respect of the same underlying Financial Instrument or commodity, as defined in the Rule 5.6.8(c), by a proportional shift in volatility of ±25%; and
          (b) aggregating the absolute value of the individual Capital Requirements which have been calculated for Vega risk.

    • PRU A6.7 PRU A6.7 Collective Investment Fund Risk Capital Requirement

      • Guidance

        This Section presents the method for the calculation of Collective Investment Fund Risk Capital Requirement for the purpose of Rule 5.9.1(b).

      • PRU A6.7.1

        An Authorised Person which calculates its Collective Investment Fund Risk Capital Requirement in accordance with Rule 5.9.1(b) must apply the Rules in this Section.

      • PRU A6.7.2

        An Authorised Person must calculate its Collective Investment Fund Risk Capital Requirement by:

        (a) identifying all applicable positions in Funds within the scope of the requirement, including notional positions derived from certain instruments;
        (b) identifying the positions in Funds which will be subject to the risk Capital Requirements specified under this Section;
        (c) converting on a daily basis net positions in every Fund to the Authorised Person's base currency at the prevailing spot foreign exchange rate;
        (d) calculating a Collective Investment Fund Risk Capital Requirement for each individual position in a Fund; and
        (e) summing the resultant Capital Requirements calculated in (d).

      • PRU A6.7.3

        (1) For the purposes of Rule A6.7.2, an Authorised Person must calculate its Collective Investment Fund Risk Capital Requirement for all Trading Book positions in Funds, unless they are covered under one of the Fund look through methods and included in the risk Capital Requirement calculations for the relevant underlying Investments or subject to an Option Risk Capital Requirement.
        (2) An Authorised Person must also calculate its Collective Investment Fund Risk Capital Requirement for notional positions arising from Trading Book positions in Options or Warrants on Funds.

      • Calculation of the Collective Investment Fund Risk Capital Requirement

        • Guidance

          There are two main approaches for calculating the Collective Investment Fund Risk Capital Requirement. The first approach involves directly calculating a risk Capital Requirement for any position in any Fund. The second approach involves using a look-though method which involves calculating the risk Capital Requirements for the positions or Exposures in underlying assets or Investments of the Fund, using the relevant or applicable risk Capital Requirement calculation methods. As the name suggests, a look-through method involves looking through the Fund to identify the underlying positions and trying to calculate the capital required to address the risk of loss arising from volatility in market prices of such underlying positions.

        • PRU A6.7.4

          Without prejudice to other provisions in this Section, a position in a Fund is subject to a Collective Investment Fund risk capital charge (General Market Risk and Specific Risk) of 32%, subject to Rules A6.7.5 and A6.7.6.

      • Look through methods

        • PRU A6.7.5

          An Authorised Person may determine the Collective Investment Fund Risk Capital Requirement for positions in Funds, using the standard Collective Investment Fund look-through method, provided the relevant positions meet the criteria set out in Rule A6.7.6.

        • PRU A6.7.6

          An Authorised Person may use the standard Fund look-through method, only if the positions are in Funds which meet the following eligibility criteria:

          (a) the Fund's prospectus or equivalent document must include:
          (i) the categories of assets the Fund is authorised to invest in;
          (ii) if investment limits apply, the relative limits and the methodologies to calculate them;
          (iii) if leverage is allowed, the maximum level of leverage; and
          (iv) if investment in OTC financial Derivatives or repo-style transactions are allowed, a policy to limit Counterparty Risk arising from these transactions;
          (b) the Fund must publish half-yearly accounts and annual reports to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period;
          (c) the Units of the Fund are redeemable in cash, out of the Fund's assets, on a daily basis at the request of the Unitholder;
          (d) Investments in the Fund must be segregated from the assets of the Fund Manager; and
          (e) there must be adequate risk assessment, by the investing firm, of the Fund.

        • PRU A6.7.7

          [Reserved]

      • Standard Collective Investment Fund look through method: General

        • PRU A6.7.8

          In the case of an Authorised Person being aware of the underlying assets or Investments of the Fund on a daily basis, the Authorised Person may look through to those underlying Investments in order to calculate the Market Risk Capital Requirement (General Market Risk and Specific Risk) for those positions in accordance with the methods set out in the relevant Section of Chapter 5 for calculating the relevant Market Risk Capital Requirement.

        • PRU A6.7.9

          In this method, positions in Funds must be treated as positions in the underlying Investments of the Fund. Netting is permitted between positions in the underlying Investments of the Fund and other positions held by the Authorised Person, as long as the Authorised Person holds a sufficient quantity of Units to allow for redemption/creation in exchange for the underlying Investments.

      • Standard Collective Investment Fund look through method: Index or Basket Funds

        • PRU A6.7.10

          (1) An Authorised Person may calculate the risk Capital Requirements for positions in Funds in accordance with the methods set out in various Sections of Chapter 5 applicable to various underlying assets or Investments, on assumed positions representing those necessary to replicate the composition and performance of the externally generated index or fixed basket of equities or debt Securities, subject to the following conditions:
          (a) the Fund's mandate is to replicate the composition and performance of an externally generated index or fixed basket of equities or debt Securities; and
          (b) a minimum correlation of 0.9 between daily price movements of the Fund and the index or basket of equities or debt Securities it tracks, exists over the previous six month period.
          (2) Correlation as referred to in (1)(b) means the correlation coefficient between daily returns on the Fund and that on the index or basket of equities or debt Securities it tracks.

    • PRU A6.8 PRU A6.8 Securities Underwriting Risk Capital Requirement

      • Guidance

        Section A6.8 presents the method for calculating a net Underwriting position or reduced net Underwriting position, which is then included in the calculation of Market Risk Capital Requirements as specified in this Chapter. Section A6.8 also deals with Concentration Risk.

      • PRU A6.8.1

        (1) An Authorised Person which calculates its Securities Underwriting Risk Capital Requirement in accordance with Rule 5.10.7(b) must apply the Rules in this Section.
        (2) An Authorised Person which underwrites or sub-underwrites an issue of Securities must, for the purposes of calculating its Market Risk Capital Requirement:
        (a) identify commitments to underwrite or sub-underwrite which give rise to an Underwriting position;
        (b) identify the time of initial commitment; and
        (c) calculate the net Underwriting position, reduced net Underwriting position or the net Underwriting Exposure.

      • PRU A6.8.2 PRU A6.8.2

        An Authorised Person must include the net Underwriting position or reduced net Underwriting position where:

        (a) debt Securities are being underwritten;
        (b) equities are being underwritten; or
        (c) Warrants are being underwritten.

        • Guidance

          1. Sub-Underwriting is a commitment given by one firm to someone other than the Issuer or seller of the Securities to sub-underwrite all or part of an issue of Securities. The net Underwriting position calculated in Rule A6.8.6 will also be used in calculating the net Underwriting Exposure under Rules A6.8.11 to A6.8.14.
          2. The net Underwriting position or reduced net Underwriting position arising from Underwriting or sub-Underwriting a rights or Warrants issue should be calculated using the current market price of the underlying Security for the purposes of the Equity Risk Capital Requirement or Option Risk Capital Requirement. However, the risk Capital Requirements will be limited to the value of the net Underwriting position calculated using the initial issue price of the rights or Warrants. Where there is no market price because the rights or Warrants are in relation to a new class of Securities and the initial price has not been set the net Underwriting position or reduced net Underwriting is the amount of the commitment.

      • Commitment to underwrite Securities

        • PRU A6.8.3 PRU A6.8.3

          (1) For the purpose of Rule A6.8.1, an Authorised Person underwrites or sub-underwrites an issue of Securities where:
          (a) it gives a commitment to an Issuer of Securities to underwrite an issue of Securities;
          (b) in the case of new Securities (as defined in Rule A6.8.4) it gives a commitment to a seller of Securities to underwrite a sale of those Securities;
          (c) it gives a commitment to a Person, other than the Issuer of Securities or, if (b) applies, the seller of the Securities, to sub-underwrite an issue of Securities; or
          (d) it is a member of a syndicate or Group that gives a commitment of the type described in (a) to (c).
          (2) Unless a Rule deals with an issue of Securities separately or the context otherwise requires, a provision of Section A6.8 that deals with Underwriting also applies to sub-Underwriting.

          • Guidance

            Block trades, including bought deals, and private placements are not within the scope of this Chapter because they involve an outright purchase by an Authorised Person of the relevant Securities.

        • PRU A6.8.4

          For the purposes of Rule A6.8.3(b), an Authorised Person must treat Securities as being new if they are:

          (a) Securities that, prior to the allotment following the Underwriting, were not in issue; or
          (b) Securities that have not previously been offered for sale or subscription to the public and have not been admitted to trading on a market operated by a Recognised Body or an overseas investment exchange.

      • Grey market transactions

        • PRU A6.8.5 PRU A6.8.5

          (1) An Authorised Person that buys and sells Securities before issue is dealing in the grey market for the purposes of this Section.
          (2) The other Rules in Section A6.8 do not apply to an Authorised Person with respect to its dealings in the grey market unless the Authorised Person:
          (a) has an Underwriting commitment to the Issuer in respect of those Securities; or
          (b) has a sub-Underwriting commitment in respect of those Securities and is using the grey market solely for the purpose of reducing that sub-Underwriting commitment.
          (3) The other Rules in Section A6.8 do not apply to an Authorised Person with respect to its dealings in the grey market if the transaction is undertaken by the proprietary trading part of the Authorised Person or is undertaken for proprietary trading purposes.

          • Guidance

            In Rule A6.8.5, the grey market is the market in which dealers "buy" and "sell" Securities ahead of issue. In reality the dealers are buying and selling promises to deliver the Securities when issued.

      • Calculating the net Underwriting position

        • PRU A6.8.6

          An Authorised Person must calculate a net Underwriting position from the date of initial commitment until the Underwriting process ends, as the initial gross commitment adjusted for:

          (a) Underwriting or sub-Underwriting commitments obtained from others since the time of initial commitment;
          (b) purchases or sales of the Securities since the time of initial commitment;
          (c) any allocation of Securities granted or received, arising from the commitment to underwrite the Securities, since the time of initial commitment; and
          (d) in the case of sales in the grey market, as defined in Rule A6.8.5, any sales of the Securities as at the time of initial commitment or since the time of initial commitment is subject, in both cases, to the following conditions:
          (i) any sales of the Securities as at the time of initial commitment must be confirmed in writing at the time of initial commitment;
          (ii) sales must be net of any purchases in the grey market; and
          (iii) any allocation of Securities granted or received, arising from the commitment to underwrite the Securities, since the time of initial commitment.

        • PRU A6.8.7 PRU A6.8.7

          If the allocation of Securities has not been fixed, an Authorised Person must calculate the gross amount of its commitment, for the purpose of Rule A6.8.6, by reference to the maximum amount it has committed to underwrite until the time the allocation is set. An Underwriting commitment may only be reduced under this Rule on the basis of a formal agreement.

          • Guidance

            Allocations may arise, after date of initial commitment, from the agreement to underwrite. For example, obligations or rights may be allocated to or from the Issuer, the Underwriting Group or syndicate.

      • Time of initial commitment

        • PRU A6.8.8

          (1) Subject to (2), the time of initial commitment is the earlier of:
          (a) in the case of Underwriting, the time the Authorised Person agrees with the Issuer of Securities to underwrite those Securities;
          (b) in the case of Underwriting falling under Rule A6.8.3(b), the time the Authorised Person agrees with the seller of Securities to underwrite those Securities;
          (c) in the case of sub-Underwriting, the time the Authorised Person agrees with the Person referred to Rule A6.8.3(c) to sub-underwrite those Securities;
          (d) in the case of Rule A6.8.3(d), the time the Group or syndicate in question (or a member of that Group or syndicate on behalf of the others) agrees with the Issuer or other Person to whom the commitment is given as referred to in Rule A6.8.3(d) to underwrite or sub-underwrite the Securities in question; or
          (e) if the firm at that time has a commitment (whether legally or binding or not), the time the price and allocation of the issue or offer are set.
          (2) If an Authorised Person has an irrevocable and unfettered right to withdraw from an Underwriting commitment, exercisable within a certain period, the commitment commences (and thus the time of initial commitment occurs) when that right expires.

      • Working day 0

        • PRU A6.8.9 PRU A6.8.9

          For the purposes of Section A6.8, working day 0 is the business day on which a firm that is Underwriting or sub-Underwriting becomes unconditionally committed to accepting a known quantity of Securities at a specified price.

          • Guidance

            For debt issues and Securities which are issued in a similar manner, working day 0 is the later of the date on which the Securities are allotted and the date on which payment for them is due. For equity issues and Securities which are issued in a similar manner, working day 0 is the later of the date on which the offer becomes closed for subscriptions and the date on which the allocations are made public. For rights issues, working day 0 is the first day after the date on which the offer becomes closed to acceptances for subscription.

      • Calculating the reduced net Underwriting position

        • PRU A6.8.10

          To calculate the reduced net Underwriting position an Authorised Person must apply the reduction factors in the table below to the net Underwriting position calculated under Rule A6.8.6 as follows:

          (a) in respect of debt Securities, an Authorised Person must calculate two reduced net Underwriting positions; one for inclusion in the Authorised Person's interest rate Specific Risk calculation, the other for inclusion in its interest rate General Market Risk calculation; and
          (b) in respect of equities, an Authorised Person must calculate only one reduced net Underwriting position, and then include it in the simplified equity method.

      • Reduction Factors

        Underwriting Timeline Debt Issue Equity Issue
        General Market risk Specific Risk General Market Risk Specific Risk
        Date of initial commitment until working day 0 0% 100% 90% 90%
        Working day 1 0% 90% 90% 90%
        Working day 2 0% 75% 75% 75%
        Working day 3 0% 75% 75% 75%
        Working day 4 0% 50% 50% 50%
        Working day 5 0% 25% 25% 25%
        Working day 6 and onwards 0% 0% 0% 0%

      • Large Exposure risk from Underwriting Securities: Calculating the net Underwriting Exposure

        • PRU A6.8.11

          For Large Exposures purposes, the total amount of an Authorised Person's Trading Book Exposures to any Person must include net Underwriting Exposure to that Person.

        • PRU A6.8.12

          An Authorised Person must include any other Exposures arising out of Underwriting (including any Counterparty Exposures to any sub-underwriters) for the purposes of calculating the total amount of its Trading Book Exposures to a Person for Large Exposures purposes.

        • PRU A6.8.13

          An Authorised Person, before entering into a new Underwriting commitment, must be able to recalculate the Counterparty Credit Risk capital component to the level of detail necessary to ensure that the firm's Capital Resources Requirement does not exceed the firm's Capital Resources.

        • PRU A6.8.14 PRU A6.8.14

          An Authorised Person must calculate the net Underwriting Exposure to an Issuer by applying the relevant reduction factors in the table below to its net Underwriting position calculated under Rule A6.8.6.

          Time Reduction factor to be applied to net Underwriting position
          Initial commitment to working day 0 100%
          Working day 0 100%
          Working day 1 90%
          Working day 2 75%
          Working day 3 75%
          Working day 4 50%
          Working day 5 25%
          Working day 6 onwards 0%

          • Guidance

            The effect of the Rule and the table above is that there is no concentration limit for net Underwriting

            Exposures between initial commitment and the end of working day 0.

      • Risk management

        • PRU A6.8.15 PRU A6.8.15

          (1) An Authorised Person must take reasonable steps to establish and maintain such systems and controls to monitor and manage its Underwriting and sub-Underwriting business as are appropriate to the nature, scale and complexity of its Underwriting and sub-Underwriting business.
          (2) In particular, an Authorised Person must have systems to monitor and control its Underwriting Exposures between the time of the initial commitment and working day one in the light of the nature of the risks incurred in the markets in question.

          • Guidance

            An Authorised Person should take reasonable steps to:

            a. allocate responsibility for the management of its Underwriting and sub-Underwriting business;
            b. allocate adequate resources to monitor and control its Underwriting and sub-Underwriting business;
            c. satisfy itself that its systems to monitor Exposure to Counterparties will calculate, revise and update its Exposure to each Counterparty arising from its Underwriting or sub-Underwriting business;
            d. satisfy itself of the suitability of each Person who performs functions for it in connection with the firm's Underwriting and sub-Underwriting business having regard to the Person's skill and experience; and
            e. satisfy itself that its procedures and controls to monitor and manage its Underwriting business address, on an on-going basis, the capacity of sub-underwriters to meet sub-Underwriting commitments.

    • PRU A6.9 PRU A6.9 Use of internal models for Market Risk

      • PRU A6.9.1 PRU A6.9.1 Criteria for use of internally developed Market Risk models

        • Guidance

          • Qualitative standards

            1. Any internal model used for purposes of Chapter 5 of these Rules should be conceptually sound and implemented with integrity and, in particular, all of the following qualitative requirements should be met:
            a. any internal model used to calculate Capital Requirements for equity risk, interest rate risk, foreign exchange risk or commodities risk should be closely integrated into the daily risk management process set out in (b) and serve as the basis for reporting risk Exposures to senior management;
            b. the Authorised Person should have a risk control unit that is independent from business trading units and reports directly to senior management. The unit should be responsible for designing and implementing any internal model used for purposes of Chapter 5. The unit should conduct the initial and on-going validation of any internal model used for purposes of Chapter 5. The unit should produce and analyse daily reports on the output of any internal model used for calculating Capital Requirements for position risk, foreign exchange risk and commodities risk, and on the appropriate measures to be taken in terms of trading limits;
            c. the Authorised Person's management body and senior management should be actively involved in the risk control process and the daily reports produced by the risk control unit are reviewed by a level of management with sufficient authority to enforce both reductions of positions taken by individual traders as well as in the Authorised Person's overall risk Exposure;
            d. the Authorised Person should have sufficient numbers of staff skilled in the use of sophisticated internal models, and including the ones used for purposes of Chapter 5, in the trading, risk-control, audit and back-office areas;
            e. the Authorised Person should have established procedures for monitoring and ensuring compliance with a documented set of internal policies and controls concerning the overall operation of its internal models, and including the ones used for purposes of Chapter 5;
            f. any internal model used for purposes of Chapter 5 should have a proven track record of reasonable accuracy in measuring risks;
            g. the Authorised Person should frequently conduct a rigorous programme of stress testing, including reverse stress tests, which encompasses any internal model used for purposes of Chapter 5 and the results of these stress tests should be reviewed by senior management and reflected in the policies and limits it sets. This process should particularly address illiquidity of markets in stressed market conditions, Large Exposures and concentration risks, one way markets, event and jump-to-default risks, non-linearity of products, deep out-of-the-money positions, positions subject to the gapping of prices and other risks that may not be captured appropriately in the internal models. The shocks applied should reflect the nature of the portfolios and the time it could take to hedge out or manage risks under severe market conditions; and
            h. the Authorised Person should conduct, as part of its regular internal auditing process, an independent review of its internal models, and including the ones used for purposes of Chapter 5.
            2. The review referred to in h. of Guidance note 1 above, should include the activities both of the business trading units and of the independent risk-control unit. At least once a year, the Authorised Person should conduct a review of its overall risk management process. The review should consider the following:
            a. the adequacy of the documentation of the risk-management system and process and the organisation of the risk-control unit;
            b. the integration of risk measures into daily risk management and the integrity of the management information system;
            c. the process the Authorised Person employs for approving risk-pricing models and valuation systems that are used by front and back-office personnel;
            d. the scope of risks captured by the risk-measurement model and the validation of any significant changes in the risk-measurement process;
            e. the accuracy and completeness of position data, the accuracy and appropriateness of volatility and correlation assumptions, and the accuracy of valuation and risk sensitivity calculations;
            f. the verification process the Authorised Person employs to evaluate the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources; and
            g. the verification process the Authorised Person uses to evaluate back-testing that is conducted to assess the models' accuracy.
            3. As techniques and best practices evolve, Authorised Persons should apply those new techniques and practices in any internal model used for purposes of Chapter 5.

          • Specification of Market Risk factors

            4. Any internal model used to calculate Capital Requirements for equity position risk, interest rate risk, foreign exchange risk, commodities risk and any internal model for correlation trading should meet all of the following requirements:
            a. the model must capture accurately reflect, on a continuous basis, all material price risks, including General Market Risks and, where approval has been granted in relation to Specific Risk, Specific Risks arising on the underlying portfolio, and should ensure that sufficient risk factors are properly specified; and
            b. the model should capture a sufficient number of risk factors, depending on the level of activity of the Authorised Person in the respective markets. The risk factors in the model should be sufficient to capture the risks inherent in the Authorised Person's portfolio of on and off-balance sheet trading positions. The Authorised Person should at least incorporate those risk factors in its model that are incorporated into its pricing model. The risk-measurement model should capture nonlinearities for Options and other products as well as correlation risk and basis risk. Where proxies for risk factors are used they should show a good track record for the actual position held. Although an Authorised Person will have some discretion in specifying the risk factors for its internal models, the Regulator expects that such models will meet the criteria specified in the following paragraphs.
            5. Any internal model used to calculate Capital Requirements for position risk, foreign exchange risk or commodities risk should meet all of the following requirements:
            a. the model should incorporate a set of risk factors corresponding to the interest rates in each currency in which the Authorised Person has interest rate sensitive on or off balance sheet positions. The Authorised Person should model the yield curves using one of a number of generally accepted approaches, for example, by estimating forward rates of zero-coupon yields. For material Exposures to interest-rate risk in the major currencies and markets, the yield curve should be divided into a minimum of six maturity segments, to capture the variations of volatility of rates along the yield curve. The model should also capture the risk of less than perfectly correlated movements between different yield curves. The risk measurement system should incorporate separate risk factors to capture spread risk, for example, between bonds and swaps;
            b. the model should incorporate risk factors corresponding to gold and to the individual foreign currencies in which the Authorised Person's positions are denominated. For Collective Investment Funds the actual foreign exchange positions of the Fund should be taken into account. Authorised Persons may rely on third party reporting of the foreign exchange position of the Fund, where the correctness of this report is adequately ensured. If an Authorised Person is not aware of the foreign exchange positions of a Fund, this position should be carved out of the model and treated separately;
            c. the model should use a separate risk factor at least for each of the equity markets in which the Authorised Person holds significant positions. At a minimum, this will include a risk factor that is designed to capture market-wide movements in equity prices, for example, a market index. Positions in individual Securities or in sector indices could be expressed in "beta-equivalents" relative to this market-wide index. A relatively more detailed approach would be to have risk factors corresponding to various sectors of the overall equity market, for instance, industry sectors or cyclical and non-cyclical sectors. The most extensive approach would be to have risk factors corresponding to the volatility of individual equity issues;
            d. the model should use a separate risk factor at least for each commodity in which the Authorised Person holds significant positions. The model must also capture the risk of less than perfectly correlated movements between similar, but not identical, commodities and the Exposure to changes in forward prices arising from Maturity Mismatches. It should also take account of market characteristics, notably delivery dates and the scope provided to traders to close out positions; For more actively traded portfolios, the model should also take account of variation in the "convenience yield" between Derivative positions such as forwards and swaps and cash positions in the commodity; and
            e. the Authorised Person's internal model should conservatively assess the risk arising from less liquid positions and positions with limited price transparency under realistic market scenarios. In addition, the internal model should meet minimum data standards. Proxies should be appropriately conservative and should be used only where available data is insufficient or is not reflective of the true volatility of a position or portfolio.
            6. Authorised Persons may, in any internal model used for purposes of Chapter 5, use empirical correlations within risk categories and across risk categories only if the Authorised Person's approach for measuring correlations is sound and implemented with integrity.

          • Quantitative standards

            7. The Regulator will usually only approve an internal Value-at-Risk (VaR) model or its use when the VaR model meets the following quantitative criteria:
            a. VaR should be computed at least on a daily basis;
            b. in calculating the value-at-risk, a 99th percentile, one-tailed confidence interval is to be used;
            c. in calculating VaR, an instantaneous price shock equivalent to a 10 day movement in prices is to be used, i.e., the minimum "holding period" will be ten trading days;
            d. an effective historical observation period of at least one year except where a shorter observation period is justified by a significant upsurge in price volatility; and
            e. its data set is updated by the Authorised Person no less frequently than once every month and is reassessed whenever market prices are subject to material changes.
            8. An Authorised Person may use VaR numbers calculated according to shorter holding periods than ten days scaled up to ten days by an appropriate methodology that is reviewed periodically.

          • Qualitative standards

            9. In addition to the standards outlined under 7 and 8:
            a. no particular type of model is prescribed. So long as each model used captures all the material risks run by the Authorised Person, the Authorised Person will be free to use models based, for example, on variance-covariance matrices, historical simulations, or Monte Carlo simulations;
            b. an Authorised Person will have discretion to recognise empirical correlations within broad risk categories, for example, interest rates, exchange rates, equity prices and commodity prices, including related Options volatilities in each risk factor category;
            c. an Authorised Person's models should accurately capture the unique risks associated with Options within each of the broad risk categories; and
            d. an Authorised Person should calculate, on a daily basis, its Market Risk Capital Requirement or any component for which an internal model is used, expressed as the higher of (a) its previous day's VaR number measured according to the parameters specified in this Section and (b) an average of the daily VaR measures on each of the preceding 60 business days, multiplied by a multiplication factor.
            10. The Regulator will usually set a multiplication factor of 3 that must be used by the Authorised Person where all the qualitative and quantitative criteria are satisfied. This will be imposed as a condition on the approval and may be varied by the Regulator should circumstances require.
            11. In addition to the calculation of VaR, an Authorised Person using internal VaR models, an Authorised Person should at least on a weekly basis, calculate a 'Stressed VaR' of the current portfolio, in accordance with the requirements set out in Guidance note 7, with VaR model inputs calibrated to historical data from a continuous 12-month period of significant financial stress relevant to the Authorised Person's portfolio. The choice of such historical data should be subject to at least annual review by the Authorised Person, which should notify the outcome to the Regulator.
            12. An Authorised Person using an internal model should calculate Capital Requirement for the relevant risk categories, as the sum of points (a) and (b):
            a. the higher of:
            i. its previous day's VaR number calculated in accordance with Guidance note 7 of this guidance under A6.9.1; or
            ii. an average of the daily value-at-risk numbers calculated in accordance with Guidance note 7 of A6.9.1, on each of the preceding 60 business days (VaRavg), multiplied by the multiplication factor referred in Guidance note 8 of A6.9.1; plus
            b. the higher of:
            i. its latest available stressed-value-at-risk number calculated in accordance with Guidance note 9 of A6.9.1 (sVaRt-1); or
            ii. an average of the stressed VaR numbers calculated in accordance with Guidance note 9 of A6.9.1 during the preceding 60 business days (sVaRavg), multiplied by the multiplication factor (ms) according to Guidance note 10.

          • Regulatory back-testing and multiplication factors

            13. The results of the Stressed VaR calculations referred to in Guidance note 11 of A6.9.1 should be scaled up by the multiplication factors given below.
            14. The multiplication factor referred to above is defined as the sum of 3 and an addend of between 0 and 1, where that addend should depend on the number of violations for the most recent 250 business days as evidenced by the Authorised Person's back-testing of the VaR as set out in Guidance note 7 above.
             
            Number of violations addend
            Fewer than 5 0.00
            5 0.40
            6 0.50
            7 0.65
            8 0.75
            9 0.85
            10 or more 1.00
            15. An Authorised Person should count daily violations on the basis of back-testing on hypothetical and actual changes in the portfolio's value. A violation for this purpose is defined as a one-day change in the portfolio's value that exceeds the related one-day VaR number generated by the Authorised Person's model. For the purpose of determining the addend the number of violations should be assessed at least on a quarterly basis and should be equal to the higher of the number of violations under hypothetical and actual changes in the value of the portfolio.
            16. Back-testing on hypothetical changes in the portfolio's value should be based on a comparison between the portfolio's end-of-day value and, assuming unchanged positions, its value at the end of the subsequent day. Back-testing on actual changes in the portfolio's value should be based on a comparison between the portfolio's end-of-day value and its actual value at the end of the subsequent day excluding fees, commissions, and net interest income.
            17. The Regulator may in individual cases limit the addend to that resulting from violations under hypothetical changes, where the number of violations under actual changes does not result from deficiencies in the internal model.
            18. In order to enable the Regulator to monitor the appropriateness of the multiplication factors on an ongoing basis, the Authorised Person should notify promptly, and in any case no later than within five working days, any violations that result from its back-testing programme.

          • Internal Validation

            19. Authorised Persons should have processes in place to ensure that all their internal models used for purposes of Chapter 5 have been adequately validated by suitably qualified parties independent of the development process to ensure that they are conceptually sound and adequately capture all material risks. The validation should be conducted when the internal model is initially developed and when any significant changes are made to the internal model.

            The validation should also be conducted on a periodic basis but especially where there have been any significant structural changes in the market or changes to the composition of the portfolio which might lead to the internal model no longer being adequate. As techniques and best practices for internal validation evolve, Authorised Persons should apply these advances. Internal model validation should not be limited to back-testing, but should, at a minimum, also include the following:
            a. tests to demonstrate that any assumptions made within the internal model are appropriate and do not underestimate or overestimate the risk;
            b. in addition to regulatory back-testing of programmes, Authorised Persons should carry out their own internal model validation tests, including back-testing, in relation to the risks and structures of their portfolios; and
            c. the use of hypothetical portfolios to ensure that the internal model is able to account for particular structural features that may arise, for example material basis risks and Concentration Risk.
            20. The Authorised Person should perform back-testing on both actual and hypothetical changes in the portfolio's value.

          • Requirements for modelling Specific Risk

            21. An internal model used for calculating Capital Requirements for Specific Risk and an internal model for correlation trading should meet the following additional requirements:
            a. it explains the historical price variation in the portfolio;
            b. it captures concentration in terms of magnitude and changes of composition of the portfolio;
            c. it is robust to an adverse environment;
            d. it is validated through back-testing aimed at assessing whether Specific Risk is being accurately captured. If the Authorised Person performs such back-testing on the basis of relevant sub-portfolios, these must be chosen in a consistent manner;
            e. it captures name-related basis risk and should in particular be sensitive to material idiosyncratic differences between similar, but not identical, positions; and
            f. it captures event risk.

          • Exclusions from Specific Risk models

            22. An Authorised Person may choose to exclude from the calculation of its Specific Risk Capital Requirement using an internal model those positions for which it fulfils a Capital Requirement for Specific Risk in accordance with relevant Sections of Chapter 5.
            23. An Authorised Person may choose not to capture default and migration risks for debt instruments in its internal model where it is capturing those risks through internal models for incremental default and migration risk.

      • PRU A6.9.2 PRU A6.9.2 Incremental risk charge (IRC) model

        • Guidance

          1. An Authorised Person that uses an internal model for calculating Capital Requirements for Specific Risk of interest rate risk Exposures should also have an internal incremental default and migration risk (incremental risk charge, or IRC) model in place to capture the default and migration risks of its Trading Book positions that are incremental to the risks captured by the VaR measure as specified in Guidance note 7 of A6.9.1. An Authorised Person should demonstrate that its internal model meets soundness standards comparable to the Internal Ratings Based (IRB) approach for Credit Risk under the assumption of a constant level of risk, and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging and optionality.

        • Scope of the internal IRC model

          2. The internal IRC model should cover all positions subject to a Capital Requirement for specific interest rate risk, including those subject to a 0% Specific Risk capital charge under Rule A6.2.13, but should not cover securitisation positions and nth-to-default Credit Derivatives.
          3. The Authorised Person may, subject to approval by the Regulator, choose to include consistently all listed equity positions and Derivatives positions based on listed equities. The permission will be granted only if such inclusion is consistent with how the Authorised Person internally measures and manages risk.

        • Parameters of the internal IRC model

          4. Authorised Persons should use the internal model to calculate a number which measures losses due to default and internal or external ratings migration at the 99.9 % confidence interval over a time horizon of one year. Authorised Persons should calculate this number at least weekly.
          5. Correlation assumptions should be supported by analysis of objective data in a conceptually sound framework. The internal model should appropriately reflect Issuer concentrations. Concentrations that can arise within and across product classes under stressed conditions should also be reflected.
          6. The internal IRC model should reflect the impact of correlations between default and migration events. The impact of diversification between, on the one hand, default and migration events and, on the other hand, other risk factors should not be reflected.
          7. The internal model should be based on the assumption of a constant level of risk over the one-year time horizon, implying that given individual Trading Book positions or sets of positions that have experienced default or migration over their liquidity horizon are re-balanced at the end of their liquidity horizon to attain the initial level of risk. Alternatively, an Authorised Person may choose to consistently use a one-year constant position assumption.
          8. The liquidity horizons should be set according to the time required to sell the position or to hedge all material relevant price risks in a stressed market, having particular regard to the size of the position. Liquidity horizons should reflect actual practice and experience during periods of both systematic and idiosyncratic stresses. The liquidity horizon should be measured under conservative assumptions and should be sufficiently long that the act of selling or hedging, in itself, would not materially affect the price at which the selling or hedging would be executed.
          9. The determination of the appropriate liquidity horizon for a position or set of positions is subject to a floor of three months.
          10. The determination of the appropriate liquidity horizon for a position or set of positions should take into account an Authorised Person's internal policies relating to valuation adjustments and the management of stale positions. When an Authorised Person determines liquidity horizons for sets of positions rather than for individual positions, the criteria for defining sets of positions should be defined in a way that meaningfully reflects differences in liquidity. The liquidity horizons should be greater for positions that are concentrated, reflecting the longer period needed to liquidate such positions. The liquidity horizon for a securitisation warehouse should reflect the time to build, sell and securitise the assets, or to hedge the material risk factors, under stressed market conditions.

        • Recognition of hedges in the internal IRC model

          11. Hedges may be incorporated into an Authorised Person's internal model to capture the incremental default and migration risks. Positions may be netted when long and short positions refer to the same Financial Instrument. Hedging or diversification effects associated with long and short positions involving different instruments or different Financial Instruments of the same obligor, as well as long and short positions in different Issuers, may only be recognised by explicitly modelling gross long and short positions in the different instruments. Authorised Persons should reflect the impact of material risks that could occur during the interval between the hedge's maturity and the liquidity horizon as well as the potential for significant basis risks in hedging strategies by product, seniority in the capital structure, internal or external rating, maturity, vintage and other differences in the instruments. An Authorised Person should reflect a hedge only to the extent that it can be maintained even as the obligor approaches a credit or other event.
          12. For positions that are hedged via dynamic hedging strategies, a rebalancing of the hedge within the liquidity horizon of the hedged position may be recognised, provided that the Authorised Person:
          a. chooses to model rebalancing of the hedge consistently over the relevant set of Trading Book positions;
          b. demonstrates that the inclusion of rebalancing results in a better risk measurement; and
          c. demonstrates that the markets for the instruments serving as hedges are liquid enough to allow for such rebalancing even during periods of stress. Any residual risks resulting from dynamic hedging strategies must be reflected in the Capital Requirement.

        • Additional content of the internal IRC model

          13. The internal model to capture the incremental default and migration risks should reflect the nonlinear impact of Options, structured Credit Derivatives and other positions with material nonlinear behaviour with respect to price changes. The Authorised Person should also have due regard to the amount of model risk inherent in the valuation and estimation of price risks associated with such products.
          14. The internal model should be based on data that are objective and up-to-date.
          15. As part of the independent review and validation of their internal models used for purposes of this Chapter, an Authorised Person should in particular do all of the following:
          a. validate that its modelling approach for correlations and price changes is appropriate for its portfolio, including the choice and weights of its systematic risk factors;
          b. perform a variety of stress tests, including sensitivity analysis and scenario analysis, to assess the qualitative and quantitative reasonableness of the internal model, particularly with regard to the treatment of concentrations. Such tests should not be limited to the range of events experienced historically; and
          c. apply appropriate quantitative validation, including relevant internal modelling benchmarks.
          16. The internal model should be consistent with the Authorised Person's internal risk management methodologies for identifying, measuring, and managing trading risks.
          17. Authorised Persons should document their internal models so that their correlation and other modelling assumptions are transparent to the Regulator.
          18. The internal model should conservatively assess the risk arising from less liquid positions and positions with limited price transparency under realistic market scenarios. In addition, the internal model should meet minimum data standards. Proxies should be appropriately conservative and may be used only where available data is insufficient or is not reflective of the true volatility of a position or portfolio.

        • Not fully compliant IRC approaches

          19. If an Authorised Person uses an internal model to capture incremental default and migration risks that does not comply with all requirements specified in Guidance notes 4 to 18 of A6.9.2, but that is consistent with the Authorised Person's internal methodologies for identifying, measuring and managing incremental default and migration risks, it should be able to demonstrate that its internal model results in a Capital Requirement that is at least as high as if it were based on a model in full compliance with the requirements of the Guidance notes referred above. The Regulator will review compliance with the previous sentence at least annually.

      • PRU A6.9.3 PRU A6.9.3 Internal model for correlation trading

        • Guidance

          1. The Regulator will grant permission to use an internal model for calculating the Capital Requirement for a correlation trading portfolio only to Authorised Persons that have obtained the Regulator's approval to use an internal model for Specific Risk of interest rate risk Exposures and that meet the requirements for internal models specified earlier in this Section.
          2. Authorised Persons should use this internal model to calculate a number which adequately measures all price risks at the 99.9 % confidence interval over a time horizon of one year under the assumption of a constant level of risk, and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging and optionality. Authorised Persons should calculate this number at least weekly.
          3. The following risks should be adequately captured by the model referred to in Guidance note 1 of A6.9.3:
          a. the cumulative risk arising from multiple defaults, including different ordering of defaults, in tranched products;
          b. credit spread risk, including the Gamma and cross-Gamma effects;
          c. volatility of implied correlations, including the cross effect between spreads and correlations;
          d. basis risk, including both of the following:
          i. the basis between the spread of an index and those of its constituent single names; and
          ii. the basis between the implied correlation of an index and that of bespoke portfolios;
          e. recovery rate volatility, as it relates to the propensity for recovery rates to affect tranche prices;
          f. to the extent the comprehensive risk measure incorporated benefits from dynamic hedging, the risk of hedge slippage and the potential costs of rebalancing such hedges; and
          g. any other material price risks of positions in the correlation trading portfolio.
          4. An Authorised Person should use sufficient market data within the model referred to in Guidance note 1 in order to ensure that it fully captures the salient risks of those Exposures in its internal approach in accordance with the requirements set out in this guidance in A6.9.3. It should be able to demonstrate to the Regulator through back testing or other appropriate means that its model can appropriately explain the historical price variation of those products.
          5. The Authorised Person should have appropriate policies and procedures in place in order to separate the positions for which it holds permission to incorporate them in the Capital Requirement in accordance with this guidance in A6.9.3 from other positions for which it does not hold such permission.
          6. With regard to the portfolio of all the positions incorporated in the model referred to in Guidance note 1, the Authorised Person should regularly apply a set of specific, predetermined stress scenarios. Such stress scenarios should examine the effects of stress to default rates, recovery rates, credit spreads, basis risk, correlations and other relevant risk factors on the correlation trading portfolio. The Authorised Person should apply stress scenarios at least weekly and report at least quarterly to the Regulator the results, including comparisons with the Authorised Person's Capital Requirement in accordance with this point. Any instances where the stress test results materially exceed the Capital Requirement for the correlation trading portfolio should be reported to the Regulator in a timely manner.
          7. The internal model should conservatively assess the risk arising from less liquid positions and positions with limited price transparency under realistic market scenarios. In addition, the internal model should meet minimum data standards. Proxies should be appropriately conservative and may be used only where available data is insufficient or is not reflective of the true volatility of a position or portfolio.

      • Stress testing

        • PRU A6.9.4

          (1) For the purposes of Rule 5.11.3, an Authorised Person's internal model must meet the following criteria:
          (a) the Authorised Person's stress scenarios must cover a range of factors that can create extraordinary losses or gains in trading portfolios, or make the control of risk in those portfolios very difficult. These factors include low-probability events in all major types of risks, including the various components of market, credit, and Operational Risks;
          (b) the Authorised Person's stress tests must be both of a quantitative and qualitative nature, incorporating both Market Risk and liquidity aspects of market disturbances. Quantitative criteria must identify plausible stress scenarios to which the Authorised Person could be exposed. Qualitative criteria must emphasise that two major goals of stress testing are to evaluate the capacity of the Authorised Person's capital to absorb potential large losses and to identify steps the Authorised Person can take to reduce its risk and conserve capital; and
          (c) the Authorised Person must combine the use of supervisory stress scenarios with stress tests developed by the Authorised Person itself to reflect their Specific Risk characteristics. Information is required in three broad areas:
          (i) supervisory scenarios requiring no simulations by the Authorised Person — the Authorised Person must have information on the largest losses experienced during the reporting period available for supervisory review. This loss information must be compared to the level of capital that results from an Authorised Person's internal measurement system;
          (ii) supervisory scenarios requiring a simulation by the Authorised Person — the Authorised Person must subject its portfolio to a series of simulated stress scenarios and provide the Regulator with the results (e.g., the sensitivity of the Authorised Person's Market Risk Exposure to changes in the assumptions about volatilities and correlations); and
          (iii) scenarios developed by the Authorised Person itself to capture the specific characteristics of its portfolio.
          (2) In addition to the scenarios prescribed under (1)(c), an Authorised Person must also develop its own stress tests which it identifies as most adverse, based on the characteristics of its portfolio, for example, problems arising in a key region of the world combined with a sharp move in oil prices. The Authorised Person must also provide the Regulator with a description of the methodology used to identify and carry out the scenarios as well as with a description of the results derived from these scenarios.