Entire Section

  • PIB 5 PIB 5 Market Risk

    • Introduction

      • PIB 5 Guidance

        1. This chapter addresses the regulatory requirements in respect of managing the Market Risk exposures of an Authorised Firm. Market Risk refers to the risk of incurring losses on positions held by an Authorised Firm with trading intent, due to adverse changes in market prices or in underlying value drivers. This chapter aims to ensure that an Authorised Firm engaging 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 Risk management framework to manage, measure and monitor Market Risk commensurate with the nature, scale and complexity of the firm's operations; and
        b. calculate the Market Risk Capital Requirement and 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 Rules for determining Market Risk Capital Requirement on 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.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.1 PIB 5.1 Application

      • PIB 5.1.1 PIB 5.1.1

        This chapter applies to an Authorised Firm in Category 1, 2, 3A or 5 as follows:

        (a) sections PIB 5.2 to PIB 5.11 apply to an Authorised Firm in Category 1 or 2;
        (b) sections PIB 5.2 and PIB 5.6 apply to an Authorised Firm in Category 3A; and
        (c) sections PIB 5.2, PIB 5.3 and PIB 5.5 to PIB 5.11 apply to an Authorised Firm in Category 5.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.1.1 Guidance

          1. PIB Rule 5.3.1 provides that the Market Risk Capital Requirement of an Authorised Firm is 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 Requirements must be calculated, monitored and controlled by an Authorised Firm.
          2. In addition to complying with the applicable Rules in PIB chapter 5, an Authorised Firm investing in or holding Islamic Contracts whether or not for the purpose of a PSIA will need to take account of the provisions under IFR Rules IFR 5.4.8 to IFR 5.4.14 to calculate the Market Risk for those Islamic Contracts.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.2 PIB 5.2 Market Risk Systems and Controls

      • PIB 5.2.1 PIB 5.2.1

        (1) An Authorised Firm in Category 1, 2, 3A or 5 must implement and maintain a Market Risk policy which enables it to identify, assess, control and monitor Market Risk.
        (2) The policy must be documented and include the Authorised Firm's risk appetite and how it identifies, assesses, mitigates, controls and monitors that risk.
        (3) An Authorised Firm must:
        (a) ensure that its risk management systems enable it to implement the Market Risk policy;
        (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.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.2.1 Guidance

          Guidance in respect of what an Authorised Firm's Market Risk policy should include is provided in PIB section A5.1.

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.3 PIB 5.3 Calculation of the Market Risk Capital Requirement

      • PIB 5.3.1 PIB 5.3.1

        An Authorised Firm must calculate its Market Risk Capital Requirement as 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 Fund Risk Capital Requirement; and
        (g) Securities Underwriting Capital Requirement.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.3.1 Guidance

          1. Detailed Rules and Guidance in respect of the Market Risk Capital Requirement and each of its components in (a) to (g) are contained in this chapter.
          2. Rules and Guidance in respect of calculating Market Risk for Islamic Contracts are contained in IFR chapter 5.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.4 PIB 5.4 Interest Rate Risk Capital Requirement

      • PIB 5.4.1

        An Authorised Firm in Category 1 or 2 must calculate its Interest Rate Risk Capital Requirement in respect of Trading Book transactions:

        (a) by applying its internal Market Risk model which has been approved by the DFSA for this purpose; or
        (b) by applying the Rules set out in PIB section A5.2.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.5 PIB 5.5 Equity Risk Capital Requirement

      • PIB 5.5.1

        An Authorised Firm in Category 1, 2 or 5, must calculate its Equity Risk Capital Requirement in respect of Trading Book transactions:

        (a) by applying its internal Market Risk Model which has been approved by the DFSA for this purpose; or
        (b) by applying the Rules set out in PIB section A5.3.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.6 PIB 5.6 Foreign Exchange Risk Capital Requirement

      • PIB 5.6.1

        An Authorised Firm in Category 1, 2, 3A or 5 must, subject to PIB Rule 5.6.2, calculate its Foreign Exchange Risk Capital Requirement in respect of Trading Book and Non-Trading Book foreign exchange positions by:

        (a) applying its internal Market Risk model which has been approved by the DFSA for this purpose; or
        (b) applying the Rules in PIB section A5.4.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.6.2

        An Authorised Firm need not calculate a Foreign Exchange Risk Capital Requirement if:

        (a) its Foreign Currency business, 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 Resources as 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 Resources as defined in PIB chapter 3.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.7 PIB 5.7 Commodities Risk Capital Requirement

      • PIB 5.7.1

        An Authorised Firm in Category 1, 2 or 5 must calculate its Commodities Risk Capital Requirement in respect of Trading Book and Non-Trading Book commodity positions by:

        (a) applying its internal Market Risk model which has been approved by the DFSA for this purpose; or
        (b) applying the Rules set out in PIB section A5.5.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.8 PIB 5.8 Option Risk Capital Requirement

      • PIB 5.8.1

        An Authorised Firm in Category 1, 2 or 5 must calculate an Option Risk Capital Requirement if it has positions in Options in its Trading Book by:

        (a) applying its internally developed Market Risk model which has been approved by the DFSA for this purpose; or
        (b) by applying the Rules set out in PIB section A5.6.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.9 PIB 5.9 Collective Investment Fund Risk Capital Requirement

      • PIB 5.9.1

        An Authorised Firm in Category 1, 2 or 5 must calculate its Collective Investment Fund Risk Capital Requirement in respect of Trading Book positions in Units in a Collective Investment Fund by:

        (a) applying its internally developed Market Risk model which has been approved by the DFSA for this purpose; or
        (b) applying the Rules set out in PIB section A5.7.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.10 PIB 5.10 Securities Underwriting Capital Requirement

      • PIB 5.10.1 PIB 5.10.1

        This section applies to an Authorised Firm in Category 1, 2 or 5 in respect of Trading Book Securities Underwriting positions.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.10.1 Guidance

          1. This section sets out a framework for calculating the amount of Capital Requirement when an Authorised Firm has commitments to underwrite an issue of Securities, and the associated risk management standards which an Authorised Firm Underwriting Securities must meet.
          2. Underwriting is defined in the Glossary as an arrangement under which a party agrees to buy, before issue, a specified quantity of Securities in an issue of Securities on a given date and at a given price, if no other party has purchased or acquired them.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.10.2 PIB 5.10.2

        An Authorised Firm must 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.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.10.2 Guidance

          1. An Authorised Firm should take reasonable steps to:
          a. allocate responsibility for the management of its Underwriting and sub-underwriting business;
          b. allocate adequate resources of the Authorised Firm to monitor and control its Underwriting and sub-underwriting business;
          c. satisfy itself that its systems to monitor its Exposure to a Counterparty will calculate, revise and update its Underwriting Exposure to each Counterparty and its Capital Requirements;
          d. satisfy itself of the suitability of each person who performs functions for it in connection with the Authorised Firm's 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 the capacity of sub-underwriters to meet sub-underwriting commitments.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.10.3

        (1) An Authorised Firm must calculate a Securities Underwriting Capital Requirement if it has a commitment to underwrite or sub-underwrite an issue of Securities.
        (2) An Authorised Firm has a commitment to underwrite or sub-underwrite an issue of Securities where:
        (a) it gives a commitment to an Issuer of Securities to 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 Group that gives a commitment to an Issuer to underwrite an issue of Securities or a commitment to sub-underwrite an issue of Securities.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.10.4

        An Authorised Firm must 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 Firm signs an agreement with the Issuer of Securities to underwrite those Securities; or
        (b) the time the price and allocation of the issue are set.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.10.5

        Where the issue price has not been fixed, an Authorised Firm must use the highest estimate of the price and its allocation for the purpose of calculating its initial gross commitment.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.10.6

        If an Authorised Firm has at its discretion an irrevocable right to withdraw from an Underwriting commitment, exercisable within a certain period, the commitment commences when that right expires.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.10.7

        An Authorised Firm must calculate its Securities Underwriting Risk Capital Requirement by:

        (a) applying its internally developed Market Risk model which has been approved by the DFSA for this purpose; or
        (b) applying the Rules in PIB section A5.8.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 5.11 PIB 5.11 Use of Internal Market Risk Models

      • PIB 5.11.1 PIB 5.11.1

        An Authorised Firm in Category 1, 2 or 5 may use an internal model to calculate its Market Risk Capital Requirement or any components of its Market Risk Capital Requirement if its internal model and its use have been approved in writing by the DFSA.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.11.1 Guidance

          Guidance in respect of criteria for use of internally developed Market Risk models is provided in PIB section A5.9.

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.11.2

        If the DFSA approves 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 Requirement or any component of it.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.11.3

        An Authorised Firm which 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.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 5.11.4 PIB 5.11.4

        An Authorised Firm that has received approval for the use of an internal model may only revert to calculating its Market Risk Capital Requirement or any component of it in accordance with PIB App5 with the prior written consent of the DFSA.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 5.11.4 Guidance

          1. This section sets out the conditions under which an Authorised Firm is permitted to use an internal model to calculate its Market Risk Capital Requirement or any component of its Market Risk Capital Requirement. An Authorised Firm that 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 Netting of long and short positions and have greater risk sensitivity.
          2. In assessing whether to give approval, the DFSA will consider an Authorised Firm's risk 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 DFSA will 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 Requirement has been approved by another appropriate regulator or the DFSA is satisfied having been provided by the Authorised Firm with such opinions from independent experts as it may require, that the model adequately addresses Market Risk requirements;
          b. use of the methodology is integrated into the governance and control framework of the Authorised Firm. Specifically, the Governing Body and senior management of the Authorised Firm receives and reviews appropriate reports in respect of the entity;
          c. it is satisfied that the Authorised Firm's risk management system is conceptually sound and is implemented with integrity;
          d. the Authorised Firm has 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's models have a proven track record of reasonable accuracy in measuring risk; and
          f. the Authorised Firm regularly conducts stress tests.
          4. In determining whether an internal value at risk (VaR) model meets the standard for approval, the DFSA will apply the criteria set out in PIB section A5.9, which are based on the Basel Market Risk Capital Amendment 1996 and Basel Revisions to the Basel II Market Risk framework 2009 and which can be grouped under the following headings:
          a. qualitative standards;
          b. specification of Market Risk factors;
          c. quantitative standards;
          d. adjustments to Market Risk Capital Requirements;
          e. stress testing; and
          f. combination of internally developed models and the Standardised Methodology.
          5. In addition to value-at-risk models, the DFSA recognises 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's interest rate Market Risk Capital Requirement calculation under the Duration Method.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]