• 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