Entire Section

  • PIB A4.3 PIB A4.3 Collateral Calculations and Haircuts

    • "Core Market Participants"

      • PIB A4.3.1

        For the purposes of this section, "core market participant" means:

        (a) any central government or Central Bank;
        (b) any PSE;
        (c) any qualifying MDB;
        (d) any banking institution or securities firm;
        (e) any financial institution eligible for a 20% risk weight under PIB section 4.12;
        (f) any central Counterparty;
        (g) any regulated mutual fund that is subject to capital or leverage requirements; or
        (h) any regulated pension fund.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Calculation of E* for Collateralised Transactions Other than OTC Derivative Transactions and Long Settlement Transactions

      • PIB A4.3.2

        An Authorised Firm using the FCCA to calculate E* must adjust both the amount of the Exposure to the Counterparty and the value of any Collateral received in support of that Counterparty to take into account possible future fluctuations in the value of either due to market movements, by using the methods and haircuts set out in Rules PIB A4.3.6 to PIB A4.3.29.

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

      • PIB A4.3.3

        An Authorised Firm must calculate the appropriate haircuts to be applied using one of the following methods:

        (a) standard supervisory haircuts; or
        (b) own-estimate haircuts.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.4

        [Not currently in use]

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

      • PIB A4.3.5 PIB A4.3.5

        (1) As an alternative to the use of standard supervisory haircuts or own-estimate haircuts, an Authorised Firm may, subject to DFSA approval, use VaR models to reflect the price volatility of the Exposure and Collateral for SFTs which are covered by a qualifying bilateral Netting agreement. The requirements relating to the use of this approach are set out in PIB section A4.5.
        (2) An Authorised Firm may seek the DFSA's approval referred to in (1) only if it has al received the DFSA's approval to use the internal models approach for calculating the Market Risk Capital Requirement.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB A4.3.5 Guidance

          Approval for the use of the internal model approach is governed by PIB section 5.11 of PIB chapter 5 (Market Risk).

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

      • PIB A4.3.6 PIB A4.3.6

        An Authorised Firm using standard supervisory haircuts or own-estimate haircuts under the FCCA must calculate E* for any collateralised transaction not covered by a qualifying bilateral Netting agreement or a qualifying cross-product Netting agreement other than OTC Derivative transactions or long settlement transactions, using the following formula:

        E* = max {0, [E (or EAD)(1 + HE) – C(1 – HC – HFX)]}

        where;

        E* = Exposure value after risk mitigation;

        E = fair value of the Exposure calculated in accordance with PIB section 4.9;

        HE = haircut appropriate to the Exposure;

        C = fair value of the eligible financial Collateral received;

        HC = haircut appropriate to the Collateral, or if the Collateral is a basket of assets, the weighted sum of the haircuts appropriate to the assets in the basket where each weight is the proportion of the asset in the basket in units of currency; and

        HFX = haircut appropriate for currency mismatch between the Collateral and Exposure.

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

        • PIB A4.3.6 Guidance

          Where the residual maturity of the Collateral is shorter than the residual maturity of the Exposure, the Authorised Firm must substitute PA calculated in accordance with Rules PIB 4.13.14 to PIB 4.13.16 for C(1 − HC − HFX).

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

      • PIB A4.3.7

        An Authorised Firm using standard supervisory haircuts or own-estimate haircuts under the FCCA must calculate E* for any collateralised transaction covered by a qualifying bilateral Netting agreement or qualifying cross-product Netting agreement other than OTC Derivative transactions or long settlement transactions, using the following formula:

        E* = Max {0, [ Σ (E ) − Σ (C) + add-on]}

        where:

        E* = Exposure value after risk mitigation;

        E = fair value of the Exposure calculated in accordance with PIB section 4.9;

        C = fair value of eligible financial Collateral received; and

        Add-on = the add-on amount to reflect the market price volatility and foreign exchange volatility, calculated in accordance with PIB Rule A4.3.8 below.

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

      • PIB A4.3.8 PIB A4.3.8

        An Authorised Firm must calculate the add-on using one of the following approaches:

        (a) the approach according to the following formula:
        add on = Σ ((ES )(HS )) + Σ ((EFX )(HFX ))
        where:

        ES = absolute value of the net position in a given Security;

        HS = haircut appropriate to ES

        EFX = absolute value of the net position in a currency different from the settlement currency; and

        HFX = haircut appropriate for currency mismatch between the Collateral and Exposure;

        or
        (b) the approach using VaR models, provided the Authorised Firm has received approval from the DFSA as referred to in PIB Rule A4.3.5.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB A4.3.8 Guidance

          Approval for the use of the internal model approach is governed by PIB section 5.11 of PIB chapter 5 .

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

      • PIB A4.3.9

        Subject to Rules PIB A4.3.10 to PIB A4.3.12, an Authorised Firm must determine HE, HC, HS and HFX referred to in Rules PIB A4.3.6 to PIB A4.3.8, in accordance with the standard supervisory haircuts in the table forming part of PIB Rule A4.3.13.

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

      • PIB A4.3.10

        An Authorised Firm may calculate HE, HC, HS and HFX using own-estimate haircuts in accordance with Rules PIB A4.3.17 to PIB A4.3.23 if it has received approval from the DFSA to use the internal models approach for calculating the Market Risk Capital Requirement. If the Authorised Firm chooses to use own-estimate haircuts, it must do so consistently for determining haircuts for all eligible financial Collateral and all portfolios, except that it may, with the approval of the DFSA, use the standard supervisory haircuts in Rules PIB A4.3.13 to PIB A4.3.16 for any portfolio which is immaterial in size and risk profile.

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

      • PIB A4.3.11

        An Authorised Firm may apply a value of zero to HE, HC and HS in the case of a qualifying SFT with a core market participant. This approach is not available to an Authorised Firm using VaR models in accordance with PIB section A4.5 to calculate E*.

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

      • PIB A4.3.12

        An Authorised Firm may apply a value of zero to HE, HC and HS in the case of an SFT where both the Exposure and Collateral are Securities issued by central governments where a value of zero has been prescribed by the banking regulator of that jurisdiction and Exposures to the central government of that jurisdiction have a Credit Quality Grade of 1 as set out in the table in PIB Rule 4.12.4.

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

    • Standard Supervisory Haircuts

      • PIB A4.3.13 PIB A4.3.13

        The standard supervisory haircuts, HE, HC and HS referred in Rules PIB A4.3.6 to PIB A4.3.8 (assuming daily remargining or revaluation and a ten-business day holding period), are subject to PIB Rule A4.3.14, as follows:

        Eligible Financial Collateral Standard Supervisory Haircuts
        Issue Rating for Debt Securities Residual Maturity Central Governments or Central Banks Other Issuers
        Any debt security with a Credit Quality Grade of 1 or short-term Credit Quality Grade of "I". ≤ 1 year 0.005 0.01
        > 1 year, ≤ 5 years 0.02 0.04
        > 5 years 0.04 0.08
        Any debt security with a Credit Quality Grade of 2 or 3 or short-term Credit Quality Grade of "II" and "III" and unrated bank securities as defined in PIB Rule 4.13.5(d). ≤ 1 year 0.01 0.02
        > 1 year, ≤ 5 years 0.03 0.06
        > 5 years 0.06 0.12
        Any debt security with a Credit Quality Grade of 4. All 0.15 NA
        Gold 0.15
        Any equity (including a convertible bond) included in a main index. 0.15
        Any other equity (including a convertible bond) traded on a regulated exchange. 0.25
        Any Unit in a Collective Investment Fund. highest haircut applicable to any Security in which the fund can invest
        Cash in the same currency as the underlying Exposure. 0
        Instruments in the Trading Book other than those listed (for pre-settlement Counterparty Exposures arising from SFTs included in the Trading Book). 0.25
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB A4.3.13 Guidance

          PSEs and MDBs should be treated as equivalent to central governments for the purpose of this table.

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

      • PIB A4.3.14

        The standard supervisory haircut, HE, for transactions in which an Authorised Firm lends instruments that do not qualify as eligible financial Collateral (e.g. corporate debt Securities with a Credit Quality Grade of 4 or worse) is 0.25.

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

      • PIB A4.3.15

        The standard supervisory haircut, HFX, for currency mismatch where Exposure and Collateral are denominated in different currencies based on a ten-business day holding period and daily revaluation is 0.08.

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

      • PIB A4.3.16

        Where the minimum holding period, frequency of remargining or revaluation assumptions set out for eligible financial Collateral in PIB Rule A4.3.13 differ from those of the Authorised Firm, the Authorised Firm must adjust HE, HC and HS using the formulae in Rules PIB A4.3.25 to PIB A4.3.26.

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

    • Own-Estimate Haircuts

      • PIB A4.3.17

        (1) An Authorised Firm must apply for approval from the DFSA if it intends to use own-estimate haircuts.
        (2) An Authorised Firm must not use own-estimate haircuts unless it has received approval to adopt the internal models approach to calculate the Market Risk Capital Requirement.
        (3) The DFSA may grant approval for an Authorised Firm to use own-estimate haircuts subject to such conditions or restrictions as the DFSA may impose.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.18

        If An Authorised Firm becomes aware after it has received approval to use own-estimate haircuts that it no longer complies with any of the requirements in Rules PIB A4.3.17 to PIB A4.3.23 or any of the conditions or restrictions imposed by the DFSA pursuant to PIB Rule A4.3.17 or no longer meets the Rules, it must

        (a) inform the DFSA as soon as practicable;
        (b) assess the effect of the situation in terms of the risk posed to the Authorised Firm;
        (c) prepare a plan to rectify the situation and inform the DFSA of its plan as soon as practicable; and
        (d) undertake prompt corrective action within a reasonable time in accordance with the plan prepared pursuant to (c).
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.19

        If An Authorised Firm fails to comply with PIB Rule A4.3.18, the DFSA may revoke its approval for the Authorised Firm to use own-estimate haircuts. The Authorised Firm may also be required to revise its estimates for the purpose of calculating regulatory Capital Requirements if its estimates of E*, does not adequately reflect its Exposure to Counterparty Credit Risk.

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

    • Requirements for Use of Own-Estimate Haircuts

      • PIB A4.3.20

        An Authorised Firm using own-estimate haircuts must estimate the volatility for each individual instrument that is taken as eligible financial Collateral. In estimating such volatility, the Authorised Firm must not take into account the correlations between unsecured Exposures, Collateral and exchange rates. Where there are maturity mismatches, the Authorised Firm must apply Rules PIB 4.13.14 to PIB 4.13.16.

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

      • PIB A4.3.21

        An Authorised Firm must ensure that the model used to estimate volatilities captures all the material risks run by it.

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

      • PIB A4.3.22 PIB A4.3.22

        In calculating the haircuts using internal estimates of volatilities, an Authorised Firm must:

        (a) use a 99th percentile, one-tailed confidence interval;
        (b) use the minimum holding period and remargining or revaluation conditions according to the type of transaction as set out in Rules PIB A4.3.24 to PIB A4.3.26. Where the minimum holding period, remargining or revaluation conditions used by an Authorised Firm differ from those set out above, it must adjust the haircuts using the formulae in Rules PIB A4.3.25 to PIB A4.3.26;
        (c) use a historical observation period (i.e. sample period) of at least one year. Where the Authorised Firm uses a weighting scheme or other methods for the historical observation period, the "effective" observation period must be at least one year (i.e. the weighted average time lag of the individual observations must not be less than six months);
        (d) update its data sets at least once every three months and recalculate haircuts at least once every three months. The DFSA may require more frequent updates whenever there is an increase in volatility in market prices of the Collateral; and
        (e) use the estimated volatility data in the day-to-day risk management process of the Authorised Firm and if the Authorised Firm is using a longer holding period for risk management compared to the ones prescribed in Rules PIB A4.3.24 to PIB A4.3.26., then the longer holding period must also be applied for the calculation of haircuts.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB A4.3.22 Guidance

          1. An Authorised Firm should:
          a. take into account the illiquidity of lower quality Collateral and should adjust the holding period upwards in cases where such a holding period would be inappropriate given the liquidity of the Collateral; and
          b. identify where historical data may understate potential volatility (e.g. a pegged currency); and deal with such cases by subjecting the data to stress testing.
          2. An Authorised Firm, when considering the market liquidity of a Collateral, should consider four dimensions:
          a. immediacy, which refers to the speed with which a trade of a given size at a given cost is completed;
          b. depth, which refers to the maximum size of a trade for any given bid-ask spread;
          c. tightness, which refers to the difference between buy and sell prices; and
          d. resiliency, which refers to how quickly prices revert to original or fundamental levels after a large transaction.
          3. The Authorised Firm should have experienced persons familiar with the relevant market for the Collateral to judge the market liquidity of the Collateral and determine if the minimum holding period is sufficient for any given Collateral. The holding period should be deemed to be insufficient if the value of the Collateral would move by more than 1% should the Collateral be liquidated within the minimum holding period in these Rules, taking into account the immediacy, depth, tightness and resiliency of the market. In such a situation, the holding period should be adjusted upwards, such that the Collateral can be safely liquidated within the period, without causing a price movement of more than 1% relative to the value after the haircut.
          4. An Authorised Firm should aim to update its data sets daily in line with industry practice. If the Authorised Firm updates its data sets less than once every three months, it should be able to demonstrate to the DFSA that the volatilities of the market prices are stable. In addition, where the updating of data sets is less frequent, the DFSA will normally expect compensating controls in the form of stress testing.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.23 PIB A4.3.23

        An Authorised Firm must have robust and effective processes in place for ensuring compliance with documented internal policies, controls and procedures concerning the operation of the risk measurement system to support the use of own-estimate haircuts.

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

        • PIB A4.3.23 Guidance

          In order to demonstrate compliance with PIB Rule A4.3.23, an Authorised Firm should give due regard to the following expectations of the DFSA:

          (a) the risk measurement system should be used in conjunction with internal Exposure limits;
          (b) the risk management processes of an Authorised Firm relating to the use of own-estimate haircuts should be subject to internal audit at least once a year, covering the following areas:
          (i) the integration of risk measures into daily risk management;
          (ii) the validation of any significant change in the risk management process;
          (iii) the accuracy and completeness of position data;
          (iv) the verification of the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources; and
          (v) the accuracy and appropriateness of volatility assumptions.
          (c) such internal audits referred to in (b) are not to be confused with an internal validation of the risk management systems surrounding the use of own-estimate haircuts. All significant risk models employed to support the use of own-estimate haircuts should be validated at least once a year. The internal audits serve as an independent process check to help ensure that the validation is sufficiently robust and effective.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Minimum Holding Periods, Remargining or Revaluation Conditions

      • PIB A4.3.24

        The following table sets out the minimum holding periods and remargining or revaluation conditions for different types of transactions where an Authorised Firm uses own-estimate haircuts:

        Minimum holding periods and remargining/revaluation conditions

        Transaction type Minimum holding period Remargining/ Revaluation Condition
        Repos, reverse repos, Securities or commodities lending or Securities or commodities borrowing transactions 5 business days daily remargining
        OTC Derivative transactions and margin lending transactions 10 business days daily remargining
        Exposures secured by eligible financial Collateral 20 business days daily revaluation
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.25

        Where the assumed minimum holding period is not met or remargining or revaluation conditions are not fulfilled, an Authorised Firm must calculate the applicable haircut using the following formula:

        H = HM √{[NR + (TM − 1)]/ TM}

        where —

        "H" refers to the haircut;

        "HM" refers to the haircut under the minimum holding period;

        "TM" refers to the minimum holding period for the type of transaction or eligible financial Collateral; and

        "NR" refers to the actual number of business days between remargining or revaluation, as the case may be.

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

      • PIB A4.3.26

        When an Authorised Firm uses a holding period, TN, which is different from the specified minimum holding period, TM, the Authorised Firm must calculate HM using the following formula:

        HM = HN√(TM/TN)

        where —

        "TN" refers to the holding period used by the Authorised Firm for deriving HN; and

        "HN" refers to the haircut based on the holding period TN.

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

    • Recognition of Eligible Financial Collateral under FCSA

      • PIB A4.3.27

        Subject to PIB A4.3.28, an Authorised Firm which has taken eligible financial Collateral for a CR Exposure and is using the FCSA may recognise the effects of Credit Risk mitigation of the eligible financial Collateral as follows:

        (a) break down the Exposure into —
        (i) a collateralised portion with E equal to the latest fair value of the eligible financial Collateral; and
        (ii) an uncollateralised portion with E equal to the E of the CR Exposure less the latest fair value of the eligible financial Collateral;
        and
        (b) for the purposes of calculating the Credit RWA amount pursuant to PIB Rule 4.8.3, use:
        (i) for the collateralised portion, the CRW that is applicable to the eligible financial Collateral as though the Authorised Firm had a direct Exposure to that Collateral; and
        (ii) for the uncollateralised portion, the CRW that is applicable to the obligor.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.28

        If the CRW determined in accordance with A4.3.27(b)(i) is less than 20%, an Authorised Firm must apply a CRW of 20% to the collateralised portion of the CR Exposure, except in the following cases:

        (a) a qualifying SFT where the Counterparty in the transaction is a core market participant, in which case the Authorised Firm may apply a risk weight of 0%;
        (b) a qualifying SFT where the Counterparty in the transaction is not a core market participant, in which case the Authorised Firm may apply a risk weight of 10%;
        (c) an OTC Derivative transaction subject to daily mark-to-market that is collateralised by cash, and where there is no currency mismatch, in which case the Authorised Firm may apply a risk weight of 0%;
        (d) an OTC Derivative transaction subject to daily mark-to-market that is collateralised by Exposures to central governments, Central Banks or PSE or a combination thereof qualifying for a 0% risk weight in accordance with the Rules in PIB chapter 4, and where there is no currency mismatch, in which case the Authorised Firm may apply a risk weight of 10%; and
        (e) a transaction where there is no currency mismatch and the Collateral comprises —
        (i) cash on deposit as set out in PIB Rule 4.13.5(a); or
        (ii) Exposures in the central government and Central Bank asset class or in the PSE asset class or a combination thereof qualifying for a 0% risk weight under the Rules in PIB section 4.12, and the latest fair value of such Collateral has been discounted by 20% for the purposes of determining the value of the collateralised portion of the CR Exposure in accordance with PIB Rule A4.3.27(a)(i),
        in which case the Authorised Firm may apply a CRW of 0%.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.3.29

        An Authorised Firm which is using FCSA must not recognise the effects of Credit Risk mitigation of any Collateral with a maturity mismatch.

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