PIB 5 PIB 5 Market Risk
PIB 5 Guidance1. This chapter addresses the regulatory requirements in respect of managing the
Market Riskexposures of an Authorised Firm. Market Riskrefers to the risk of incurring losses on positions held by an Authorised Firmwith trading intent, due to adverse changes in market prices or in underlying value drivers. This chapter aims to ensure that an Authorised Firmengaging in activities exposing the firm to risks associated with potential adverse movements in market prices adopts appropriate and effective risk management practices and holds regulatory capital of the right quality that is also commensurate with the risks involved.2. This chapter includes requirements that an Authorised Firm:a. implement a comprehensive Market Riskmanagement framework to manage, measure and monitor Market Riskcommensurate with the nature, scale and complexity of the firm's operations; andb. calculate the Market Risk Capital Requirementand hold the same.3. The chapter allows the use of standard pre-defined methodologies for estimating the capital requirement and also allows the use of DFSA-approved internal models to calculate a firm's Market Risk Capital Requirement. The chapter covers Rulesfor determining Market Risk Capital Requirementon exposures involving interest rate risk, equity risk, foreign exchange risk, commodities risk, options risk, collective investment fund risk and securities underwriting risk.4. PIB Appendix 5 provides the detailed requirements, parameters, calculation methodologies and formulae in respect of the primary requirements outlined in PIB chapter 5. PIB Appendix 5 also provides detailed guidance on criteria for approval of internal models for calculation of Market Risk Capital Requirement, incorporation of incremental risk charges in internal models, if allowed and guidance on the required level of stress testing.
PIB 5.1 PIB 5.1 Application
PIB 5.1.1 PIB 5.1.1
This chapter applies to an
Authorised Firmin Category1, 2, 3A or 5 as follows:
PIB 5.1.1 Guidance1. PIB Rule 5.3.1 provides that the
Market Risk Capital Requirementof an Authorised Firmis calculated as the sum of a number of subsidiary Capital Requirements. Sections PIB 5.4 to PIB 5.10 set out the manner in which each of those subsidiary Capital Requirementsmust be calculated, monitored and controlled by an Authorised Firm.2. In addition to complying with the applicable Rulesin PIB chapter 5, an Authorised Firminvesting in or holding Islamic Contractswhether or not for the purpose of a PSIAwill need to take account of the provisions under IFR RulesIFR 5.4.8 to IFR 5.4.14 to calculate the Market Riskfor those Islamic Contracts.
PIB 5.2 PIB 5.2 Market Risk Systems and Controls
PIB 5.2.1 PIB 5.2.1(1) An
Authorised Firmin Category1, 2, 3A or 5 must implement and maintain a Market Riskpolicy which enables it to identify, assess, control and monitor Market Risk.(2) The policy must be documented and include the Authorised Firm'srisk appetite and how it identifies, assesses, mitigates, controls and monitors that risk.(3) An Authorised Firmmust:(a) ensure that its risk management systems enable it to implement the Market Riskpolicy;(b) identify, assess, mitigate, control and monitor its Market Risk; and(c) review and update the policy at intervals that are appropriate to the nature, scale and complexity of its activities.
PIB 5.2.1 Guidance
Guidancein respect of what an Authorised Firm's Market Riskpolicy should include is provided in PIB section A5.1.
PIB 5.3 PIB 5.3 Calculation of the Market Risk Capital Requirement
PIB 5.3.1 PIB 5.3.1
Authorised Firmmust calculate its Market Risk Capital Requirementas the sum of the following components:(a) Interest Rate Risk Capital Requirement;(b) Equity Risk Capital Requirement;(c) Foreign Exchange Risk Capital Requirement;(d) Commodities Risk Capital Requirement;(e) Option Risk Capital Requirement;(f) Collective Investment FundRisk Capital Requirement; and(g) Securities Underwriting Capital Requirement.
PIB 5.3.1 Guidance1. Detailed
Rulesand Guidancein respect of the Market Risk Capital Requirementand each of its components in (a) to (g) are contained in this chapter.2. Rulesand Guidancein respect of calculating Market Riskfor Islamic Contractsare contained in IFR chapter 5.
PIB 5.4 PIB 5.4 Interest Rate Risk Capital Requirement
Authorised Firmin Category1 or 2 must calculate its Interest Rate Risk Capital Requirementin respect of Trading Booktransactions:(a) by applying its internal Market Riskmodel which has been approved by the DFSAfor this purpose; or(b) by applying the Rulesset out in PIB section A5.2.
PIB 5.5 PIB 5.5 Equity Risk Capital Requirement
Authorised Firmin Category1, 2 or 5, must calculate its Equity Risk Capital Requirementin respect of Trading Booktransactions:(a) by applying its internal Market RiskModel which has been approved by the DFSAfor this purpose; or(b) by applying the Rulesset out in PIB section A5.3.
PIB 5.6 PIB 5.6 Foreign Exchange Risk Capital Requirement
Authorised Firmin Category1, 2, 3A or 5 must, subject to PIB Rule 5.6.2, calculate its Foreign Exchange Risk Capital Requirementin respect of Trading Bookand Non-Trading Bookforeign exchange positions by:(a) applying its internal Market Riskmodel which has been approved by the DFSAfor this purpose; or(b) applying the Rulesin PIB section A5.4.
Authorised Firmneed not calculate a Foreign Exchange Risk Capital Requirementif:(a) its Foreign Currencybusiness, defined as the greater of the sum of its gross long positions and the sum of its gross short positions in all Foreign Currencies, does not exceed 100% of Capital Resourcesas defined in PIB chapter 3; and(b) its overall net open position as defined in PIB Rule A5.4.4 does not exceed 2% of its Capital Resourcesas defined in PIB chapter 3.
PIB 5.7 PIB 5.7 Commodities Risk Capital Requirement
Authorised Firmin Category1, 2 or 5 must calculate its Commodities Risk Capital Requirementin respect of Trading Bookand Non-Trading Bookcommodity positions by:(a) applying its internal Market Riskmodel which has been approved by the DFSAfor this purpose; or(b) applying the Rulesset out in PIB section A5.5.
PIB 5.8 PIB 5.8 Option Risk Capital Requirement
Authorised Firmin Category1, 2 or 5 must calculate an Option Risk Capital Requirementif it has positions in Optionsin its Trading Bookby:(a) applying its internally developed Market Riskmodel which has been approved by the DFSAfor this purpose; or(b) by applying the Rulesset out in PIB section A5.6.
PIB 5.9 PIB 5.9 Collective Investment Fund Risk Capital Requirement
Authorised Firmin Category1, 2 or 5 must calculate its Collective Investment FundRisk Capital Requirementin respect of Trading Bookpositions in Unitsin a Collective Investment Fundby:(a) applying its internally developed Market Riskmodel which has been approved by the DFSAfor this purpose; or(b) applying the Rulesset out in PIB section A5.7.
PIB 5.10 PIB 5.10 Securities Underwriting Capital Requirement
PIB 5.10.1 PIB 5.10.1
This section applies to an
Authorised Firmin Category1, 2 or 5 in respect of Trading Book Securities Underwritingpositions.
PIB 5.10.1 Guidance1. This section sets out a framework for calculating the amount of
Capital Requirementwhen an Authorised Firmhas commitments to underwrite an issue of Securities, and the associated risk management standards which an Authorised Firm Underwriting Securitiesmust meet.2. Underwritingis defined in the Glossary as an arrangement under which a party agrees to buy, before issue, a specified quantity of Securitiesin an issue of Securitieson a given date and at a given price, if no other party has purchased or acquired them.
PIB 5.10.2 PIB 5.10.2
Authorised Firmmust establish and maintain such systems and controls to monitor and manage its Underwritingand sub-underwriting business as are appropriate to the nature, scale and complexity of its Underwritingand sub-underwriting business.
PIB 5.10.2 Guidance1. An
Authorised Firmshould take reasonable steps to:a. allocate responsibility for the management of its Underwritingand sub-underwriting business;b. allocate adequate resources of the Authorised Firmto monitor and control its Underwritingand sub-underwriting business;c. satisfy itself that its systems to monitor its Exposureto a Counterpartywill calculate, revise and update its Underwriting Exposureto each Counterpartyand its Capital Requirements;d. satisfy itself of the suitability of each person who performs functions for it in connection with the Authorised Firm's Underwritingbusiness, having regard to the person's skill and experience; ande. satisfy itself that its procedures and controls to monitor and manage its Underwritingbusiness address the capacity of sub-underwriters to meet sub-underwriting commitments.
PIB 5.10.3(1) An
Authorised Firmmust calculate a Securities Underwriting Capital Requirementif it has a commitment to underwrite or sub-underwrite an issue of Securities.(2) An Authorised Firmhas a commitment to underwrite or sub-underwrite an issue of Securitieswhere:(a) it gives a commitment to an Issuerof Securitiesto underwrite an issue of Securities;(b) it gives a commitment to sub-underwrite an issue of Securities; or(c) it is a member of a syndicate or Groupthat gives a commitment to an Issuerto underwrite an issue of Securitiesor a commitment to sub-underwrite an issue of Securities.
Authorised Firmmust regard a commitment to underwrite an issue of Securities, subject to any right set out in PIB Rule 5.10.6, as the initial commitment to underwrite from the earlier of:(a) the time the Authorised Firmsigns an agreement with the Issuerof Securitiesto underwrite those Securities; or(b) the time the price and allocation of the issue are set.
Where the issue price has not been fixed, an
Authorised Firmmust use the highest estimate of the price and its allocation for the purpose of calculating its initial gross commitment.
Authorised Firmhas at its discretion an irrevocable right to withdraw from an Underwritingcommitment, exercisable within a certain period, the commitment commences when that right expires.
Authorised Firmmust calculate its Securities Underwriting Risk Capital Requirementby:(a) applying its internally developed Market Riskmodel which has been approved by the DFSAfor this purpose; or(b) applying the Rules in PIB section A5.8.
PIB 5.11 PIB 5.11 Use of Internal Market Risk Models
PIB 5.11.1 PIB 5.11.1
Authorised Firmin Category1, 2 or 5 may use an internal model to calculate its Market Risk Capital Requirementor any components of its Market Risk Capital Requirementif its internal model and its use have been approved in writing by the DFSA.
PIB 5.11.1 Guidance
Guidancein respect of criteria for use of internally developed Market Riskmodels is provided in PIB section A5.9.
DFSAapproves the use of an internal model, it may:(a) impose, withdraw or amend at any time conditions in respect of the use of the internal model; and(b) withdraw approval if it forms the view that the internal model or its use is no longer suitable for the calculation of the Authorised Firm's Market Risk Capital Requirementor any component of it.
Authorised Firmwhich uses an internal model in accordance with PIB Rule 5.11.1 must have in place a rigorous and comprehensive stress-testing programme which meets the criteria set out in PIB Rule A5.9.4.
PIB 5.11.4 PIB 5.11.4
Authorised Firmthat has received approval for the use of an internal model may only revert to calculating its Market Risk Capital Requirementor any component of it in accordance with PIB App5 with the prior written consent of the DFSA.
PIB 5.11.4 Guidance1. This section sets out the conditions under which an
Authorised Firmis permitted to use an internal model to calculate its Market Risk Capital Requirementor any component of its Market Risk Capital Requirement. An Authorised Firmthat wishes to use an internal model to calculate any part of this requirement is required to apply to the DFSA. Internal models will commonly permit more extensive Nettingof long and short positions and have greater risk sensitivity.2. In assessing whether to give approval, the DFSAwill consider an Authorised Firm'srisk management standards; the quantitative model standards; the stress-testing and back-testing standards and the process surrounding the calculation of the appropriate regulatory Capital Requirement.3. The DFSAwill usually only give its approval for the use of an internal risk model if:a. the use of the model to calculate the Market Risk Capital Requirementhas been approved by another appropriate regulator or the DFSAis satisfied having been provided by the Authorised Firmwith such opinions from independent experts as it may require, that the model adequately addresses Market Riskrequirements;b. use of the methodology is integrated into the governance and control framework of the Authorised Firm. Specifically, the Governing Bodyand senior management of the Authorised Firmreceives and reviews appropriate reports in respect of the entity;c. it is satisfied that the Authorised Firm'srisk management system is conceptually sound and is implemented with integrity;d. the Authorised Firmhas sufficient numbers of staff skilled in the use of sophisticated models not only in the trading area but also in the risk control, audit, and if necessary, back office areas;e. the Authorised Firm'smodels have a proven track record of reasonable accuracy in measuring risk; andf. the Authorised Firmregularly conducts stress tests.4. In determining whether an internal value at risk (VaR) model meets the standard for approval, the DFSAwill apply the criteria set out in PIB section A5.9, which are based on the Basel Market RiskCapital Amendment 1996 and Basel Revisions to the Basel II Market Riskframework 2009 and which can be grouped under the following headings:a. qualitative standards;b. specification of Market Riskfactors;c. quantitative standards;d. adjustments to Market Risk Capital Requirements;e. stress testing; andf. combination of internally developed models and the Standardised Methodology.5. In addition to value-at-risk models, the DFSArecognises option risk aggregation models and interest rate 'pre-processing' or sensitivity models, as set out under the EU's Capital Adequacy Directive (these are the so-called 'CAD1 models').6. Option risk aggregation models analyse and aggregate options risks for interest rate, equity, foreign exchange and commodity options.7. Interest rate pre-processing models are used to calculate weighted positions for inclusion in an Authorised Firm'sinterest rate Market Risk Capital Requirementcalculation under the Duration Method.