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Commonwealth legislation
This Act has been repealed and is no longer in force. It is retained for historical reference.
What it does: This Prudential Standard requires authorised deposit-taking institutions (ADIs) and authorised NOHCs that take market-price risks (trading-book, foreign‑exchange or commodity positions) to run governance, measurement and valuation systems and to hold regulatory capital for market risk. It prescribes two calculation routes — a prescribed standard method or an APRA‑approved internal model — and gives APRA powers to approve, vary or revoke model use and to require extra capital or reversion to the standard method (Application; Key principles; TFC capital requirement; Attachments B–C).
Who pays and who decides: ADIs must hold the capital; APRA approves models, sets multipliers/plus factors, and enforces reporting, back‑testing and stress‑testing controls, changing firms’ measurement, reporting and hedging behaviour.
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Direct links to the current provisions in Banking (prudential standard) determination No. 9 of 2012 - Prudential Standard APS 116 - Capital Adequacy: Market Risk.
Sourced from the Federal Register of Legislation (legislation.gov.au), CC BY 4.0.
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Banking (prudential standard) determination No. 9 of 2012
Prudential Standard APS 116 Capital Adequacy: Market Risk
Banking Act 1959
I, John Francis Laker, delegate of APRA:
(a) under subsection 11AF(3) of the Banking Act 1959 (the Act) REVOKE Banking (prudential standard) determination No. 6 of 2011 including Prudential Standard APS 116 Capital Adequacy: Market Risk made under that Determination; and
(b) under subsection 11AF(1) of the Act DETERMINE Prudential Standard APS 116 Capital Adequacy: Market Risk in the form set out in the attached Schedule, which applies to ADIs and authorised NOHCs to the extent provided in paragraphs 2 to 4 of the prudential standard.
This instrument takes effect on 1 January 2013.
Dated 29 November 2012
[Signed]
John Francis Laker
Chair
Interpretation
In this instrument:
ADI is short for authorised deposit-taking institution which has the meaning given in section 5 of the Act.
APRA means the Australian Prudential Regulation Authority.
authorised NOHC has the meaning given in section 5 of the Act.
Schedule
Prudential Standard APS 116 Capital Adequacy: Market Risk comprises the 60 pages commencing on the following page.
Prudential Standard APS 116
Capital Adequacy: Market Risk
Objective and key requirements of this Prudential Standard
This Prudential Standard requires an authorised deposit-taking institution engaging in activities that give rise to risks associated with potential movements in market prices to adopt risk management practices and hold regulatory capital that is commensurate with the risks involved.
The key requirements of this Prudential Standard are that an authorised deposit-taking institution must:
have a framework to manage, measure and monitor market risk commensurate with the nature, scale and complexity of the institution’s operations; and
use the standard method or an APRA-approved internal model approach to determine the institution’s capital requirement for market risk.
Table of contents
Attachments
Attachment B - The standard method
Attachment C - The internal model approach
Attachment D - Treatment of credit derivatives in the trading book
This Prudential Standard applies to all authorised deposit-taking institutions (ADIs), with the exception of:
foreign ADIs - a foreign ADI must, however, be subject to comparable capital adequacy standards in its home country;
purchased payment facility providers (PPF providers); and
ADIs that:
do not conduct trading book activity and do not have any foreign exchange or commodity positions; and
have included a statement to this effect in their description of their risk management systems; and that statement also outlines the arrangements in place to ensure that trading book activity does not take place.
A reference to an ADI in this Prudential Standard shall be taken as a reference to:
an ADI on a Level 1 basis; and
a group of which an ADI is a member on a Level 2 basis.
If an ADI to which the Prudential Standard applies is:
the holding company for a group of bodies corporate, the ADI must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable; or
a subsidiary of an authorised non-operating holding company (authorised NOHC), the authorised NOHC must ensure that the requirements in this Prudential Standard are met on a Level 2 basis, where applicable.
For the purposes of this Prudential Standard, no distinction is drawn, in principle, between risks arising from physical positions and from positions in derivative instruments.
The following definitions are used in this Prudential Standard:
credit-event payment - the amount that is payable by the credit protection provider to the credit protection buyer under the terms of the credit derivative contract following the occurrence of a credit event. The payment can be in the form of physical settlement (payment of par in exchange for physical delivery of a deliverable obligation of the reference entity) or cash settlement (either a payment determined on a par-less-recovery basis, i.e. determined using the par value of the reference obligation less that obligation’s recovery value, or a fixed amount, or a fixed percentage of the par amount);
credit events - events affecting the reference entity that trigger a credit‑event payment under the terms of the credit derivative contract;
deliverable obligation - any obligation of the reference entity that can be delivered, under the terms of the contract, if a credit event occurs. A deliverable obligation is relevant for credit derivatives that are to be physically settled;
general market risk - the risk of loss owing to changes in the general level of market prices or interest rates. It arises from positions in interest rate, equities, foreign exchange and commodities;
market risk - comprises general market risk and specific risk;
marking-to-model - any valuation that has to be benchmarked, extrapolated or otherwise calculated from a market input;
nth-to-default credit derivative - a contract where the payoff is based on the nth asset to default in a basket of underlying reference instruments. Once the nth default occurs the transaction terminates and is settled;
reference entity - the entity or entities whose obligations are used to determine whether a credit event has occurred under the terms of the credit derivative contract;
reference obligation - the obligation used to calculate the amount payable when a credit event occurs under the terms of a credit derivative contract. A reference obligation is relevant for obligations that are to be cash settled (on a par-less-recovery basis);[1]
specific risk - the risk that the value of a security will change due to issuer-specific factors. It applies to interest rate and equity positions related to a specific issuer;
traded market risk, foreign exchange and commodities capital requirement (TFC capital requirement) - the regulatory capital that an ADI is required to hold against its exposure to market risk in accordance with this Prudential Standard; and
underlying exposure - the exposure that is being protected by the credit derivative.
In each case the ADI may do so regardless of where the positions are booked (refer to paragraph 2 of Attachment B) and, if using the internal model approach, allowing for risk diversification between positions (refer to paragraph 6 of Attachment C).
An ADI may apply for model approval from APRA in relation to market risk.
An ADI’s model approval may specify how the internal model is to apply, including approvals under Attachment C. APRA’s prior written approval is required for any material changes to the market risk internal model. Prior notification to APRA is required for material changes to other components of the market risk management framework. APRA may impose conditions on the model approval.
Once an ADI has obtained model approval, it must continue to employ that internal model on an ongoing basis unless, or except to the extent that, the model approval is revoked or suspended in respect to some or all of the ADI’s market risk exposures. A return, at the ADI’s request, to the standard method to market risk will generally only be permitted in exceptional circumstances.
APRA may, at any time in writing to the ADI, vary or revoke a model approval, or impose additional conditions on the model approval if it determines that:
the ADI does not comply with this Prudential Standard; or
it is appropriate, having regard to the particular circumstances of the ADI, to impose the additional conditions or make the variation or revocation.
Where an ADI’s model approval has been varied or revoked, APRA may, in writing, require the ADI to revert to the standard method to measure market risk for some or all of its market risk exposures, until it meets the conditions specified by APRA for returning to the internal model approach.
An ADI that has received model approval from APRA may rely on its own internal estimate (based on the approved market risk measurement model) of market risk for determining its TFC capital requirement. That estimate must be fundamentally sound and consistent with the scope of market risk defined in paragraph 8(e) of this Prudential Standard.
APRA may, in writing, require an ADI to reduce its market risk or increase its capital if APRA considers that the ADI’s capital for market risk is not commensurate with the ADI’s market risk profile.
This is an opening excerpt, not the complete document.