PIB A2.1 PIB A2.1 Detail in the Trading Book
PIB A2.1.1(1) This Appendix applies to an
Authorised Firmwhich meets the criteria in PIB Rule 2.2.1 and is thereby required to have a Trading Book.(2) An Authorised Firmwhich is required to have a Trading Bookmust:(a) have a Trading Bookpolicy in accordance with PIB section A2.2; and(b) include positions in its Trading Bookon a consistent basis in accordance with the policy and procedures set out in the Trading Bookpolicy.(3) An Authorised Firmmust include every position that is not included in its Trading Bookin its Non-Trading Book.(4) An Authorised Firmmust value every position included in its Trading Bookand the Non-Trading Bookin accordance with the relevant accounting standards and practices.
Value of Trading Book Positions
PIB A2.1.2(1) In calculating the value of positions for the purposes of PIB Rule 2.2.1(c) an
Authorised Firmmust value:(a) equities and debt instruments at their market prices;(b) derivatives according to the values of the underlying; and(c) underwriting positions according to the market value of the underlying Securities.(2) An Authorised Firmmust sum all long and short positions (ignoring the sign) to calculate its total Trading Booksize.
Positions Included in the Trading Book
PIB A2.1.3 PIB A2.1.3
Authorised Firmmust include in its Trading Book, subject to the Ruleson trading intent and hedging Non-Trading Book Exposures:(a) each proprietary position in a Financial Instrument, commodity or commodity derivative which is held with trading intent as detailed in PIB Rule A2.1.5(3);(b) each position arising from Matched Principalbroking and market making;(c) each position taken in order to hedge another element of the Trading Book;(d) each Exposuredue to a repurchase agreement (repo), or Securitiesand commodities lending, which is based on a Securityor commodity included in the Trading Book;(e) each Exposuredue to a reverse repurchase agreement (reverse repo), or Securitiesand commodities borrowing transaction included in the Trading Book;(f) each Exposurearising from an Unsettled Transaction, free delivery or OTC derivative; and(g) each Exposurein the form of a fee, commission, interest, dividend or margin on an exchange-traded derivative directly related to the items included in the Trading Book.
PIB A2.1.3 Guidance
Authorised Firmacts as principal (even in the context of activity normally described as 'broking' or 'customer business'), positions should be assigned to the Trading Book. This applies even if the nature of the business means that the only risks being incurred by the Authorised Firmare Counterparty Risks(that is, no Market Risk Capital Requirementsapply).
PIB A2.1.4(a) An
Authorised Firmmust not include loans or traded loans in its Trading Bookunless they have been used to hedge a Trading Booktransaction.(b) An Authorised Firmmust not include in its Trading Bookan Exposurerelating to a direct holding of immovable property.
PIB A2.1.5(1) An
Authorised Firmmust, subject to PIB Rule A2.1.3, only include in its Trading Book:(a) a position in a Financial Instrument, commodity or commodity derivative held with trading intent; or(b) a position hedging other positions in the Trading Book.(2) For the purpose of (1), such positions included in the Trading Bookmust be free of any restrictive covenants which limit their tradability or ability to be hedged.(3) For the purpose of (1), a position in a Financial Instrument, commodity or commodity derivative is held with trading intent if:(a) it is held with the intention of:(i) benefiting in the short term from actual or expected differences between buying and selling prices or from other price or interest-rate variations;(ii) selling it over the short term;(iii) locking in arbitrage profits; or(iv) market making;(b) it is marked to market or marked to model regularly on a prudent and consistent basis, as part of the Authorised Firm'sinternal risk management processes;(c) position-takers at the Authorised Firmhave autonomy in entering into or changing transactions within pre-determined limits, or the position satisfies other criteria which the Authorised Firmapplies to the composition of its Trading Book;(d) there is an appropriate documented trading strategy for the position, approved by senior management which includes the expected holding horizon; and(e) active monitoring of the position is undertaken using market information sources.
Positions held with trading intent must comply with the following requirements:(a) trading intent must be evidenced in the strategies, policies and procedures established by the
Authorised Firmto manage the position or its portfolio;(b) there must be clearly defined policies and procedures for active management of the position to ensure the following:(i) the position is entered and/or managed on a trading desk;(ii) position limits are set and monitored for appropriateness;(iii) position-takers at the Authorised Firmhave autonomy in entering into or changing transactions within pre-determined limits, or the position satisfies other criteria which the Authorised Firmapplies to the composition of its Trading Book;(iv) the position is marked-to-market or marked-to-model at least daily on a prudent and consistent basis as part of the Authorised Firm'sinternal risk management processes;(v) where the position is marked-to-model, the parameters for the model are assessed on a daily basis;(vi) the position is monitored against the documented trading strategy including the monitoring of turnover and stale positions in the Authorised Firm's Trading Book;(vii) active monitoring of the position is undertaken using market information sources and an assessment made of the marketability or hedge-ability of the position or its component risks, including the assessment of the quality and availability of market inputs to the valuation process, level of markets turnover and sizes of positions traded in the market; and(viii) positions and exceptions are reported to senior management as an integral part of the risk management process of the Authorised Firm.
Treatment of Structural Foreign Exchange Positions
Authorised Firmin Category1 or 5 which has assumed a position in order to hedge partially or totally against the adverse effect of the exchange rate on its Capital Resources, in respect of an asset or any other item, may exclude such a position from the calculation of its net open foreign exchange positions subject to the following:(a) the position is of a non-dealing nature;(b) the position does no more than protect the Capital Resourcesof the Authorised Firm; and(c) any exclusion of the position is applied consistently, with the treatment of the hedge remaining the same for the life of the asset or other item.
In calculating its net open foreign exchange positions, an
Authorised Firmmay exclude any foreign exchange position related to:(a) items which are included as deductions from T1 Capital or deductions from T2 Capital, such as investments in unconsolidated subsidiaries; and(b) associated companies and joint ventures, denominated in foreign currencies, which are reported in the published accounts of an Authorised Firmat historic cost.
Repurchase and Reverse Repurchase Agreements
PIB A2.1.9 PIB A2.1.9
Authorised Firmmust include in its Trading Bookan Exposuredue to a repurchase agreement, reverse repurchase agreement, Securitiesand commodities borrowing, or Securitiesand commodities lending transactions if:(a) the Exposureis marked to market daily (cash borrowed or lent under a repurchase agreement or a reverse repurchase agreement may be included in the Trading Bookeven if not marked to market provided that the residual maturity of the borrowing or lending is one month or less);(b) the Collateralis adjusted to take account of changes in the value of the Securitiesor commodities involved;(c) the agreement or transaction provides for the Authorised Firm'sclaims to be automatically and immediately offset against its Counterparty'sclaims if the latter defaults; and(d) such agreements and transactions are confined to their accepted and appropriate use and artificial transactions, especially those not of a short-term nature, are excluded.
PIB A2.1.9 Guidance
Cash items include loans and deposits and the cash legs of repurchase, stock borrowing, reverse repurchase and stock lending transactions.
PIB A2.1.10 PIB A2.1.10
Where the conditions under PIB Rule A2.1.9 are not met, an
Authorised Firmmust, subject to PIB Rule A2.1.3, include an Exposurearising under a repurchase agreement, reverse repurchase agreement, securities and commodities borrowing or securities and commodities lending in its Non-Trading Book.
Hedging of a Trading Book Exposure by a Non-Financial Instrument
PIB A2.1.11 PIB A2.1.11(1) An
Authorised Firmmay hedge a Trading Book Exposure, completely or partially, by a non-financial instrument that is not listed in A2.1.3. The General Market Risk Exposureassociated with the non-financial instrument may be incorporated into the calculation of General Market Riskin the Trading Bookif:(a) the specific instrument is used to hedge an Exposurein an Authorised Firm's Trading Book;(b) the hedge position satisfies the Nettingrules contained in the relevant sections of the Market Riskchapter; and(c) the hedge position is marked to market or marked to model and is valued regularly on a prudent and consistent basis.(2) For the purposes of (1), the non-financial instrument must be treated as attracting capital charges as if it were a Financial Instrument.
PIB A2.1.11 Guidance1. If the conditions for incorporating non-financial instruments in the calculation of
General Market Riskin the Trading Bookunder PIB Rule A2.1.11 are not met, they will be treated as Non-Trading Bookitems.2. For the purposes of PIB section A2.1, a loan will attract General Market Risk(see PIB chapter 5) and Counterparty Risk(see PIB chapter 4) on the marked-to-market valuation.
PIB A2.1.12 PIB A2.1.12(1) If an internal hedge meets the criteria specified in (2), an
Authorised Firmmay include it in the Trading Bookwithout prejudice to the Capital Requirementapplication to the Non-Trading Book"leg" of the internal hedge.(2) Positions arising from internal hedges are eligible for Trading Bookcapital treatment, provided that they meet the criteria for trading intent specified in PIB Rule A2.1.5 and the following criteria on prudent valuation:(a) the internal hedge is not primarily intended to avoid or reduce Capital Requirementswhich the Authorised Firmwould be otherwise required to maintain;(b) the internal hedge is properly documented and subject to specific internal approval and audit procedures;(c) the internal hedge is dealt with at market conditions;(d) the bulk of the Market Riskwhich is generated by the internal hedge is dynamically managed in the Trading Bookwithin the limits approved by senior management; and(e) the internal hedge is carefully monitored with adequate procedures.(3) Where an Authorised Firmhedges a Non-Trading Book Exposureusing a Credit Derivativebooked in the Trading Book, the Non-Trading Book Exposureis not deemed to be hedged for the purpose of calculating its regulatory Capital Requirement, unless the Authorised Firmpurchases from an eligible protection provider a Credit Derivativewhich complies with the requirements and meets the guidelines set out in the relevant section of PIB chapter 4. Where eligible credit protection is purchased and is recognised as a hedge of the Non-Trading Book Exposurefor the purpose of calculating its regulatory Capital Requirement, the Authorised Firmmay exclude both the internal and external Credit Derivativehedge from the Trading Bookfor the purpose of calculating its regulatory Capital Requirementfor the period of the hedge.
PIB A2.1.12 Guidance
An internal hedge is a position that materially or completely offsets the component risk element of a
Non-Trading Bookposition or a set of positions.
Transfer of General Market Risk between the Trading Book and the Non-Trading Book
Transfer of General Market Risk between the Trading Book and the Non-Trading Book Guidance1.
General Market Riskarising from the Trading Bookmay hedge Non-Trading Bookpositions without reference to specific Financial Instruments.2. An Authorised Firmmay achieve the transfer of General Market Riskbetween the Trading Bookand Non-Trading Bookby entering into a notional legal agreement between the Trading Bookand Non-Trading Bookas if they were third parties.
PIB A2.1.13 PIB A2.1.13
Authorised Firmmust ensure that:(a) a transfer of General Market Riskbetween its Trading Bookand Non-Trading Bookis subject to appropriate documentation and evidenced by a clear audit trail;(b) positions held in its Non-Trading Bookthat are being hedged by General Market Riskarising from positions in the Trading Bookremain in the Non-Trading Book; and(c) the General Market Risk Exposureassociated with the positions in the Non-Trading Bookis incorporated into the calculation of General Market Riskin the Trading Book.
PIB A2.1.13 Guidance
An example of the application of PIB Rule A2.1.13(c) is as follows:a. An
Authorised Firmmay have a fixed-rate loan portfolio in the Non-Trading Book. Although the Non-Trading Bookdoes not attract a regulatory capital charge for interest rate risk, the portfolio is subject to interest rate risk. Firms may prefer to transfer this risk to the Trading Bookwhere it may be actively managed.b. The Authorised Firmmay transfer this interest rate risk by entering into, for example, a fixed versus floating rate swap between the Trading Bookand the Non-Trading Book. The notional long and short positions created as result of the swap are recorded in the Trading Book, and the swap positions may be treated as financial instruments provided that appropriate documentation is in place (see PIB Rule A2.1.14). The General Market Riskrequirements associated with the swap legs are allocated to the appropriate Trading Book General Market Riskbucket and thus may reduce the overall General Market Riskrequirement in the Trading Book.c. For an Authorised Firmto undertake such a transaction there should be existing positions in the Trading Book, which result in a sufficient General Market Riskrequirement to offset the General Market Riskcreated as a result of the swap.
PIB A2.1.14 PIB A2.1.14
Appropriate documentation under PIB A2.1.13 must cover:(a) details of the instruments or
Exposuresbeing transferred and the method used to transfer; and(b) the pricing of the transfer.
PIB A2.1.14 Guidance1. Separate documentation need not be produced for every transfer. If the same method is used for a number of transfers, a single document detailing the procedures will suffice. However, an
Authorised Firmmust still be able to distinguish transactions that have been undertaken for risk transfer purposes from other transactions.2. Arm's-length prices must be used in any transfer. 'Arm's-length' means the prevailing market price for the particular transaction.