The standard method for measuring the risk of holding or taking positions in debt securities and other interest-rate-related instruments in the trading book covers all fixed-rate and floating-rate debt securities and instruments that behave like them, including non-convertible preference shares.[3] An ADI must also include interest rate exposures arising from forward foreign exchange transactions and forward sales and purchases of equities and commodities. An ADI may include the interest rate exposure (exposure to a change in the value of an option due to a change in the interest rate) on foreign exchange, equity and commodity options. Convertible bonds must be treated as debt securities if they trade like debt securities, and as equities if they trade like equities.
In determining the capital charge for interest rate risk, an ADI must separately calculate the charges applying to the specific risk of each instrument, irrespective of whether it is a short or a long position, and to the interest rate risk in the portfolio (general market risk) where long and short positions in different securities or instruments can be offset.
Specific risk
The capital charges for specific risk are outlined in Tables 1 to 5 and paragraphs 6 to 19 of this Attachment. An ADI must not offset between different issues even if the issuer is the same, but may offset matched long and short positions in an identical issue (including positions in derivatives).
In Table 1, the ‘government’ category includes all forms of government paper including bonds, Treasury notes and other short‑term instruments. These debt instruments may be given a zero specific risk charge if:
they are issued, fully guaranteed or fully collateralised[5] by securities issued by the Australian Commonwealth, State or Territory governments or the Reserve Bank of Australia; or
they are issued, fully guaranteed or fully collateralised by securities issued by central governments or central banks within the Organisation for Economic Co-operation and Development (OECD); or
they are issued or fully guaranteed by non-OECD country central governments and central banks and have a residual maturity of one year or less and are denominated in local currency and the ADI’s holdings of such paper are funded by liabilities in the same currency.
The ‘qualifying’ category includes securities that are:
rated investment grade by at least two external credit assessment institutions (ECAIs) within the meaning of APS 112 for the purpose of risk-weighting claims on rated counterparties and exposures; or
rated investment grade by one ECAI or unrated, but deemed, subject to APRA’s written approval, to be of comparable investment quality by the ADI and the issuer has its equity included in a recognised market index (refer to Table 8). An ADI must apply to APRA for approval of a policy statement outlining securities the ADI considers to be of comparable investment quality.
In addition, debt securities may be treated as qualifying if they are:
issued or guaranteed by Australian local governments or Australian public sector entities (except those that have corporate status and operate on a commercial basis);[6]
issued or fully guaranteed by non-OECD country central governments or central banks and have a residual maturity of over one year and are denominated in local currency and the ADI’s holdings of such paper are funded by liabilities in the same currency;
issued or fully collateralised by claims on an international agency or regional development bank, including the International Monetary Fund, the International Bank for Reconstruction and Development, the Bank for International Settlements and the Asian Development Bank;
issued, guaranteed, endorsed[7] or accepted by an Australian ADI or a bank incorporated in another OECD[8] country, provided such instruments do not qualify as capital of the issuing institution;[9]
issued, guaranteed, endorsed or accepted by a non-OECD bank and have a residual maturity of one year or less, provided such instruments do not qualify as capital of the issuing institution;
issued or guaranteed by OECD state and regional governments or OECD public sector entities;
issued or guaranteed by an entity that is subject to an equivalent capital adequacy regime (covering both credit and market risk), as determined by APRA;[10] or
issued by institutions that are deemed, in writing, by APRA to be equivalent to investment grade quality and subject to comparable supervisory and regulatory arrangements.
An ADI using the internal ratings-based (IRB) approach for credit risk (refer to APS 113) for a portfolio may treat debt securities in that portfolio as qualifying if:
the securities are rated equivalent[11] to investment grade under the reporting ADI’s internal rating system, and APRA has confirmed the rating system complies with the requirements for an IRB approach; and
the issuer has securities listed on a recognised stock exchange within the meaning of APS 112.
Fund-raising instruments issued, guaranteed or accepted by an ADI and included in the trading book only attract capital charges for general market risk, not specific risk.[12]
Specific risk for securitisation exposures[13] and resecuritisation exposures
An ADI must apply a risk-weight of 1250 per cent (i.e. a 100 per cent risk capital charge) to a securitisation or resecuritisation exposure, unless it performs the due diligence specified below. This due diligence requires an ADI to:
on an ongoing basis, have a comprehensive understanding of the risk characteristics of its individual securitisation exposures, whether on-balance sheet or off-balance sheet, as well as the pools underlying its securitisation exposures;
have access to and periodically review performance information on the underlying pools in a timely manner;
for resecuritisations, have access to, and periodically review, information not only on the underlying securitisation tranches but also on the risk characteristics and performance of the pools underlying the securitisation tranches; and
have a comprehensive understanding of all structural features of a securitisation transaction that may have a material impact on the ADI’s exposures to the transaction.
An ADI using either the standardised approach for credit risk or the standardised approach for market risk must calculate specific risk for securitisation exposures and resecuritisation exposures according to Tables 2 and 3 below. An ADI must apply a risk-weight of 1250 per cent i.e. a 100 per cent risk capital charge to the value of positions with long-term ratings of B+ and below and short-term ratings other than A-1/P-1, A-2/P-2, A-3/P-3. An ADI must also apply a risk-weight of 1250 per cent i.e. a 100 per cent risk capital charge, to the value of unrated positions, other than in the circumstances described in paragraph 6 of Attachment C to APS 120. The operational requirements for the recognition of external credit assessments outlined in Attachment B to APS 120 apply.
Table 2: Specific risk capital charges for securitisation exposures and resecuritisation exposures (long term ratings)
External credit assessment
AAA to AA-
A+ to A-
BBB+ to BBB-
BB+ to BB-
Below BB- or unrated
Securitisation exposures
1.6%
4%
8%
28%
100%
Resecuritisation exposures
3.2%
8%
18%
52%
100%
Table 3: Specific risk capital charges for securitisation exposures and resecuritisation exposures (short term ratings)
External credit assessment
A-1/P-1
A-2/P-2
A-3/P-3
Below A-3/P-3 or unrated
Securitisation exposures
1.6%
4%
8%
100%
Resecuritisation exposures
3.2%
8%
18%
100%
An ADI which has approval to use both the IRB approach for credit risk and the internal models approach for market risk must calculate the specific risk capital charges for rated securitisation and resecuritisation exposures positions according to Tables 4 and 5, depending on whether or not the positions are granular and/or senior[14]. The operational requirements for the recognition of external credit assessments outlined in Attachment B to APS 120 apply.
Table 4: Specific risk capital charges based on external credit assessments (long term ratings)
An ADI may, if APRA approves, calculate the specific risk capital charges for unrated securitisation and resecuritisation positions as follows.
An ADI with approval for the IRB approach for the asset classes which include the underlying exposures may apply the supervisory formula approach (refer to paragraphs 18 to 38 of Attachment D to APS 120). When estimating PDs and LGDs for calculating KIRB, the ADI must meet the minimum requirements for the IRB approach.
An ADI which has approval for using a value-at-risk measure for specific market risk (refer to paragraph 43 of Attachment C) for products or asset classes which include the underlying exposures may apply the supervisory formula approach (refer to paragraphs 18 to 38 of Attachment D to APS 120). When estimating PDs and LGDs for calculating KIRB, the ADI must meet the same standards as for calculating the incremental risk capital charge according to paragraphs 55 and 56 of Attachment C.
In all other cases an ADI must calculate the capital charge as eight per cent of the weighted-average risk weight that would be applied to the securitised exposures under the standardised approach, multiplied by a concentration ratio. This concentration ratio is equal to the sum of the nominal amounts of all the tranches divided by the sum of the nominal amounts of the tranches junior to or pari passu with the tranche in which the position is held, including that tranche itself.
The resulting specific risk capital charge must not be lower than any specific risk capital charge applicable to a rated more senior tranche. If an ADI is unable to determine the specific risk capital charge as described above or prefers not to apply the treatment described above to a position, it must apply a risk-weight of 1250 per cent i.e. a 100 per cent risk capital charge to that position.
Specific risk offsetting for the correlation portfolio
An ADI’s correlation trading portfolio includes securitisation exposures and nth-to-default credit derivatives that meet all of the following criteria:
the positions are neither resecuritisation positions, nor derivatives of securitisation exposures that do not provide a pro-rata share in the proceeds of a securitisation tranche (this criterion therefore excludes options on a securitisation tranche, or a synthetically leveraged super-senior tranche);
all reference entities are single-name products, including single-name credit derivatives, for which a liquid two-way market exists[15];
the positions do not reference underlying exposures that would be treated as a retail exposure or a property exposure under the standardised approach to credit risk (refer to APS 112); and
the positions do not reference a claim on a special purpose entity.
An ADI may also include in the correlation trading portfolio positions that hedge the positions described above and which are neither securitisation exposures nor nth-to-default credit derivatives and where a liquid two-way market (as described in footnote 15) exists for the instrument or its underlying exposures.
APRA may allow an ADI to determine the capital charge for specific interest rate risk for the correlation trading portfolio as the larger of:
the total specific risk capital charges that would apply just to the net long positions from the net long correlation trading exposures combined; and
the total specific risk capital charges that would apply just to the net short positions from the net short correlation trading exposures combined.
Transitional provisions for securitisation positions
Until 31 December 2013, APRA may allow an ADI to determine the capital charge for specific interest rate risk for the securitisation instruments that are not included in the correlation trading portfolio as the larger of:
the total specific risk capital charges that would apply just to the net long positions in securitisation instruments in the trading book; and
the total specific risk capital charges that would apply just to the net short positions in securitisation instruments in the trading book.
This calculation must be undertaken separately from the calculation for the correlation trading portfolio as described in paragraph 17 of this Attachment.
Limitation of specific risk capital charge to maximum possible loss
An ADI may limit the capital charge for an individual position in a credit derivative or securitisation instrument to the maximum possible loss. For a short risk position, an ADI may calculate this limit as a change in value due to the underlying names immediately becoming default risk-free. For a long position, the maximum possible loss may be calculated as the change in value in the event that all the underlying names were to default with zero recoveries.
General market risk
The capital charges for general market risk capture the risk of loss arising from changes in market interest rates. An ADI using the standard method may either use the maturity method or may apply to APRA for written approval to use the duration method of measuring general market risk. An ADI that has approval to use the duration method must do so on a continuing basis, unless a change in method is approved, in writing, by APRA. In each method, positions are allocated across a maturity ladder and the capital charge is calculated as the sum of four components:
the net short or long weighted position across the whole trading book;
a small proportion of the matched positions in each time band (the ‘vertical disallowance’);
a larger proportion of the matched positions across different time bands (the ‘horizontal disallowance’); and
a net charge for positions in options, where appropriate.
An ADI must use separate maturity ladders for positions in each currency, with capital charges calculated separately for each currency and then summed, with no offsetting between positions of different currencies. Where business in one or more currencies is insignificant (residual currencies), the ADI may construct a single maturity ladder for those currencies and record, within each appropriate time band, the net long or short position in each currency, rather than having to use separate maturity ladders for each currency. The ADI must sum the absolute value of the individual net positions within each time band, irrespective of whether they are long or short positions, to produce a gross position figure.
In the maturity method, long or short positions in debt securities and other sources of interest rate exposures, including derivative instruments, are entered into a maturity ladder comprising thirteen time bands (or 15 time bands in the case of low-coupon instruments) (refer to Table 6). An ADI must allocate fixed-rate instruments according to the residual term to maturity and floating-rate instruments according to the residual term to the next repricing date. Zero-coupon bonds and bonds with a coupon of less than three per cent must be entered according to the time bands set out in the second column of Table 6. An ADI may omit from the interest rate maturity framework opposite positions of the same amount in the same issue (but not different issues by the same issuer) and closely matched swaps, forwards, futures and forward rate agreements (FRAs) that comply with paragraphs 38 to 40 of this Attachment.
To calculate the general market risk capital charge using the maturity method, an ADI must:
weight the positions in each time band by the risk-weight corresponding to the position’s time band (refer to Table 6); then
offset the weighted longs and shorts within each time band, where weighted positions arising from low-coupon instruments are combined with other weighted positions across corresponding time bands; then
offset the weighted longs and shorts within each zone (refer to Table 7), using only positions that have not been already been offset under (b); then
offset the weighted longs and shorts between zones using positions that have not already been offset under (b) and (c).
The net amount remaining is the net position.
An ADI must then calculate the vertical disallowances for each time band as 10 per cent of the smaller of the offsetting positions determined according to paragraph 23(b) of this Attachment, whether long or short.
An ADI must then calculate the horizontal disallowances as the sum of:
40 per cent of the smaller of the offsetting weighted positions within zone 1 determined according to paragraph 23(c) of this Attachment;
30 per cent of the smaller of the offsetting weighted positions within zones 2 and 3 determined according to paragraph 23(d) of this Attachment; and
40 per cent of the smaller of the offsetting weighted positions between zones 1 and 2, and between zones 2 and 3 determined according to paragraph 23(d) of this Attachment.
An ADI must calculate the general market risk capital charge under the maturity method as the sum of the net position and the vertical and horizontal disallowances.
Under the duration method, an ADI must:
calculate the price sensitivity of each instrument in terms of a change in interest rates of between 0.6 and 1.0 percentage points depending on the modified duration of the instrument (refer to Table 6);
enter the resulting sensitivity measures into a duration-based ladder in the fifteen time bands set out in the second column of Table 6;
subject long and short positions in each time band to a five per cent vertical disallowance to capture basis risk; and
carry forward the net positions in each time band for horizontal offsetting subject to the disallowances (refer to Table 7).
An ADI must subject the gross positions in each time band for residual currencies to either the risk weightings in Table 6 if positions are reported using the maturity method, or the assumed changes in yield in Table 6, if positions are reported using the duration method, with no further offsets.
Interest rate derivatives
An ADI’s measurement system must include all interest rate derivatives and off-balance sheet instruments in the trading book that react to changes in interest rates. Options must be treated in accordance with the methods outlined in paragraphs 77 to 95 of this Attachment.
An ADI must convert derivatives into positions in the relevant underlying to become subject to specific and general market risk charges. To determine the capital charge, the amounts reported must be the market value of the principal amount of the underlying or of the notional underlying.
An ADI must treat futures and forward contracts (including FRAs) as a combination of a long and a short position in a notional government security or, in the case of futures or forwards on bank or corporate debt, as a combination of a long and a short position in the underlying debt security. The maturity of a future or an FRA is the period until delivery or exercise of the contract, plus the life of the underlying or notional underlying instrument. The long and short positions must be reported at the market value of the underlying or notional underlying security or portfolio of securities. Where a range of deliverable instruments may be delivered to fulfil the contract, the ADI may elect which deliverable security goes into the maturity or duration ladder but must take account of any conversion factor defined by the exchange.[16]
An ADI must treat swaps as two notional positions in government securities with relevant maturities. Both legs of the swap must be reported at their market values. For swaps that pay or receive a fixed or floating interest rate against some other reference price, e.g. a stock index, the ADI must enter the interest rate component into the appropriate repricing maturity category, with the equity component being included in the equity framework. The separate legs of cross-currency swaps must be reported in the relevant maturity ladders for the currencies concerned and the capital for any foreign exchange risk calculated in accordance with the methods outlined in paragraphs 56 to 64 of this Attachment.
Pre-processing techniques
An ADI may use alternative methods to calculate the positions to be included in the maturity or duration ladder, subject to APRA determining in writing that it is satisfied as to the accuracy of the systems being used. Such formulae may be applied to all interest-rate-sensitive positions, arising from both physical and derivative instruments, including swaps, FRAs, option delta-equivalents[17] and forward foreign exchange. An ADI may only use an alternative treatment if:
the positions calculated fully reflect the sensitivity of the cash flows to interest rate changes and are entered into the appropriate time bands; and
the positions allocated to a single maturity ladder are denominated in the same currency.
An ADI may combine positions calculated using a pre-processing method with any weighted positions calculated using the duration method but must not offset such positions against weighted positions calculated using the maturity method.
Calculation of capital charge for derivatives under the standard method
Interest rate and cross-currency swaps, FRAs, forward foreign exchange contracts, interest rate futures and futures on an interest rate index are not subject to a specific risk charge. Where the underlying is a specific debt security or an index representing a basket of debt securities, a specific risk charge must be calculated in accordance with paragraphs 5 to 19 of this Attachment.[18]
Bank bill futures contracts traded on the Australian Securities Exchange are exempt from a specific risk charge. For other futures or forwards comprising a range of deliverable instruments with different issuers, a specific risk charge applies to long positions in the future or forward, but not short positions.
Positions in all derivative products are subject to a general market risk capital charge in the same manner as for cash positions, except for fully or very closely matched positions in identical instruments in compliance with paragraph 41 of this Attachment. These positions must be entered into the maturity ladder and treated according to paragraphs 20 to 28 of this Attachment.
An ADI may exclude long and short positions (both actual and notional) in identical instruments with exactly the same issuer, coupon, currency and maturity from the interest rate maturity framework. An ADI may also fully offset, and exclude from the calculation, a matched position in a future or forward and its corresponding underlying may also be fully offset. The leg representing the time to expiry of the future (i.e. the net exposure from the combination of the future and the underlying) must, however, be reported.
An ADI may only offset positions in a future or forward comprising a range of deliverable instruments and the corresponding underlying where there is a readily identifiable underlying security that is most profitable for the ADI with a short position to deliver. The price of this security, sometimes called the ‘cheapest‑to‑deliver’, and the price of the future or forward contract must move in close alignment.
An ADI must not offset between positions in different currencies. It must treat separate legs of cross-currency swaps or forward foreign exchange deals as notional positions in the relevant instruments and include them in the appropriate calculation for each currency.
An ADI may fully offset opposite positions within and across product groups, including (if using the delta-plus method for options)[19] the delta-equivalent value of options (including the delta-equivalent value of legs arising out of the treatment of caps and floors as set out in paragraph 81 of this Attachment), subject to meeting the following conditions:
the positions must relate to the same underlying instruments, be of the same nominal value and be denominated in the same currency;[20]
for futures, offsetting positions in the notional or underlying instruments to which the futures contract relates must be for identical products and mature within seven days of each other; and
for swaps, FRAs and forwards,[21] the reference rate (for floating‑rate positions) must be identical and the coupons must differ by no more than 15 basis points. Also, the next interest fixing date or, for fixed coupon positions or forwards, the residual maturity, must correspond within the following limits:
if either instrument has an interest fixing date or residual maturity up to and including one month, the dates or residual maturities must be the same for both instruments; or
if either instrument has an interest fixing date or residual maturity greater than one month and up to and including one year, the dates or residual maturities must be within seven days of each other; or
if either instrument has an interest fixing date or residual maturity over one year, the dates or residual maturities must be within thirty days of each other.