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Commonwealth legislation
This Act has been repealed and is no longer in force. It is retained for historical reference.
This Prudential Standard (APS 116) sets how authorised deposit-taking institutions (ADIs) and authorised non‑operating holding companies must measure, manage and hold capital for market risk from trading, foreign‑exchange and commodity positions. It requires either APRA’s standard method or an APRA‑approved internal model (VaR, stressed VaR, IRC), and imposes governance, valuation, back‑testing, reporting and approval processes. ADIs hold the capital; APRA approves models, may impose conditions, and can require a return to the standard method.
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Direct links to the current provisions in Banking (prudential standard) determination No. 9 of 2022.
Sourced from the Federal Register of Legislation (legislation.gov.au), CC BY 4.0.
Banking (prudential standard) determination No. 9 of 2022
Prudential Standard APS 116 Capital Adequacy: Market Risk
Banking Act 1959
I, Renée Roberts, a delegate of APRA:
(a) under subsection 11AF(3) of the Banking Act 1959 (the Act) REVOKE Banking (prudential standard) determination No. 4 of 2014 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 schedule, which applies to all ADIs and authorised NOHCs to the extent provided in paragraphs 2 to 4 of the prudential standard.
This instrument takes effect on 1 January 2023.
Dated: 1 December 2022
[Signed]
Renée Roberts
Executive Director
Policy and Advice Division
Interpretation
In this instrument:
APRA means the Australian Prudential Regulation Authority.
ADI and authorised NOHC have their respective meanings given in section 5 of the Act.
Schedule
Prudential Standard APS 116 Capital Adequacy: Market Risk comprises the document 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
2. This Prudential Standard applies to all authorised deposit-taking institutions (ADIs), with the exception of:
(a) foreign ADIs;
(b) purchased payment facility providers; and
(c) ADIs that:
(i) do not conduct trading book activity and do not have any foreign exchange or commodity positions; and
(ii) have included a statement to this effect in the risk management strategy required by Prudential Standard CPS 220 Risk Management (CPS 220); and that statement also outlines the arrangements in place to ensure that trading book activity does not take place.
3. A reference to an ADI in this Prudential Standard shall be taken as a reference to:
(a) an ADI on a Level 1 basis; and
(b) a group of which an ADI is a member on a Level 2 basis.
4. If an ADI to which the Prudential Standard applies is:
(a) 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
(b) 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.
5. Terms that are defined in Prudential Standard APS 001 Definitions appear in bold the first time they are used in this Prudential Standard.
6. In this Prudential Standard, unless the contrary intention appears, a reference to an Act, Regulations, Prudential Standard or Reporting Standard is a reference to the Act, Regulations, Prudential Standard or Reporting Standard as in force from time to time.
7. This Prudential Standard applies to all:
(a) trading book positions; and
(b) banking and trading book positions that give rise to foreign exchange or commodity risks.
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.
8. The treatment of counterparty credit risk capital requirements is excluded from this Prudential Standard and must be determined in accordance with Prudential Standards APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112) or APS 113 Capital Adequacy: Internal Ratings-based Approach to Credit Risk (APS 113), as appropriate.
9. The following definitions are used in this Prudential Standard:
(a) 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);
(b) credit events - events affecting the reference entity that trigger a credit‑event payment under the terms of the credit derivative contract;
(c) 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;
(d) 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;
(e) market risk - comprises general market risk and specific risk;
(f) marking-to-model - any valuation that has to be benchmarked, extrapolated or otherwise calculated from a market input;
(g) 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;
(h) 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;
(i) 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]
(j) 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;
(k) 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
(l) underlying exposure - the exposure that is being protected by the credit derivative.
10. An ADI that wishes to operate a trading book must, in accordance with Attachment A, submit for APRA’s approval a trading book policy statement that specifies those activities that belong in the trading book.
11. An ADI must allocate positions in financial instruments to its trading book if they are held with trading intent or in order to hedge other elements of the trading book. In allocating positions, an ADI must be guided by its trading book policy statement.
12. An ADI must maintain a framework for prudent valuation practices for trading book positions.
13. An ADI operating in the foreign exchange, commodities, interest rate or equities markets must ensure that appropriately robust risk measurement and management systems are in place.
14. An ADI must hold capital against:
(a) market risks arising from positions allocated to the trading book; and
(b) all foreign exchange and commodity risks.
15. An ADI must calculate the TFC capital requirement using one of the following methods:
(a) the standard method described in Attachment B, under which the TFC capital requirement is the sum of the market risk charges calculated in accordance with that method;
(b) the internal model approach described in Attachment C, under which the TFC capital requirement is the measure of market risk derived from applying that approach; or
(c) a combination of the standard method and the internal model approach, in which case the TFC capital requirement is the sum of the market risk capital requirements determined under the two methodologies.
16. Unless required to do otherwise by APRA (and subject to the conditions in paragraph 2 of Attachment B and paragraph 6 of Attachment C being satisfied):
(a) an ADI that has market-related activities in Australia and offshore branches (offshore Level 1 sites) and manages those market-related activities centrally may calculate its Level 1 TFC capital requirement allowing for netting and offsetting of short and long positions in exactly the same instrument that have been taken within the ADI, whether in Australia or an offshore Level 1 site; and
(b) an ADI that has market-related activities in Australia and either offshore branches or offshore subsidiaries (offshore Level 2 sites), and manages those market-related activities centrally may calculate its Level 2 TFC capital requirement allowing for netting and offsetting of short and long positions in exactly the same instrument that have been taken within the group, comprising the entities in Australia and the offshore Level 2 sites.
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).
17. An ADI that does not have model approval must calculate its TFC capital requirement using the standard method as set out in Attachment B and, in relation to credit derivative instruments held in the trading book, Attachment D[2].
18. An ADI may apply for model approval from APRA in relation to market risk.
19. 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.
20. 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.
21. 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:
(a) the ADI does not comply with this Prudential Standard; or
(b) it is appropriate, having regard to the particular circumstances of the ADI, to impose the additional conditions or make the variation or revocation.
22. 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.
23. 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.
24. 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.
25. An ADI may, subject to APRA’s written approval, use a combination of the internal model approach and the standard method. In doing so, the ADI must comply with the requirements detailed in Attachment C.
26. An ADI must not use a combination of the two methodologies within a particular risk category (e.g. interest rates, foreign exchange, equities and commodities) and within the same regional centre without prior written approval from APRA.
27. APRA may require an ADI that has model approval that does not cover all risk categories to extend the internal model to cover other market risk categories.
This is an opening excerpt, not the complete document.