TOPIC 6:
CAPITAL ADEQUACY REQUIREMENT (CAR) DETAILED CALCULATION
BASEL REQUIREMENT –
CAR FOR
FINANCIAL INSTITUTIONS
6.1. General Overview of CAR
6.2. Overall Framework
6.3 Major Proposals
6.4 Proposed Methodology - Illustrative Examples
Topic 6
6
CAPITAL ADEQUACY REQUIREMENT (CAR) DETAILED CALCULATION BASEL REQUIREMENT
– CAR FOR FINANCIAL INSTITUTIONS.......... 457-502
6.1 GENERAL OVERVIEW OF CAR.......................... 461
6.2 OVERALL FRAMEWORK.................................. 462 - 467 6.2.1 Summary of Key Changes.................................................... 463 - 467 A. Liquid Capital..................................................................... 463 B. Total Risk Requirement.................................................. 463 6.3 MAJOR PROPOSALS..................................... 468 - 478
6.4 PROPOSED METHODOLOGY – ILLUSTRATIVE EXAMPLES............................ 479 - 488 Table A1 ........................................................................................................... 489-490 Table A2 ........................................................................................................... 491 Table B Minimum Operation Risk Requirement.................................. 492 Table C Position Risk Factor for Standard Approach...................... 493 Table D Position Risk Factor for Building Block Approach............. 494 Table E Position Risk Requirement using Hedging Method or Basic Method.......................................... 495 Table F Counterparty Risk........................................................................ 496 Table G Counterparty Risk Requirement for Unsettled Agency Trades......................................................... 497 Table G Counterparty Risk Requirement for Unsettled Principal Trades....................................................... 498 Table H Counterparty Risk Requirement for Debt, Contra Losses and Other Amounts Due.................... 499
458
Table I Table J Table K Figure 6.1 Figure 6.2 Methodology for Calculating Counterparty Exposures (Credit Equivalent Amounts) For OTC Derivatives Transactions......................................... 500 Discounting for Collateral......................................................... 501 Large Exposure Risk Requirement for Single Equity........ 502 Summary of Proposed Liquid Capital...................................... 477 Summary of Proposed Total Risk Requirement.................. 478 Reference: 1. 2. ASX Guidelines on CAR Computation BIS Basel II Website: www.bis.org 459
TOPIC 6.1:
GENERAL OVERVIEW OF
CAR
460
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
TOPIC 6: CAPITAL ADEQUACY REQUIREMENT (CAR) DETAILED CALCULATION BASEL REQUIREMENT – CAR FOR FINANCIAL INSTITUTIONS 6.1 GENERAL OVERVIEW OF CAR APPROACH ADOPTED The overall approach adopted clearly identify the capital and risk calculation procedures into two separate streams: ☛ Liquid Capital ☛ Total Risk Requirement This may be illustrated as follows: Overall Framework Member Organization Operational Risk Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid CapitalCapital which qualifies to cover Total Risk Requirement Total Risk Requirement A separate sector for Liquid Capital and each component of the Total Risk Requirement has been prepared. 461 Professor Malick Sy
TOPIC 6.2:
OVERALL FRAMEWORK
6.2.1. Summary of Key Changes
462
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
6.2 OVERALL FRAMEWORK
6.2.1 Summary Of Key Changes
The overall framework proposed that:
☛
Member Organizations be required to attest annually that their risk management systems are operating effectively and adequately; and
☛
The prior quarter loss test be removed.
A. Liquid Capital
Liquid Capital represents the capital a Member Organization has available to meet its Total Risk Requirement. Accordingly, where an illiquid asset is held, this will be a deduction from Liquid Capital.
B. Total Risk Requirement
Total Risk Requirement represents the capital required to cover the sum of the individual risk areas identified. The individual risk areas consist of Operational Risk, Position Risk, Counterparty Risk, Large Exposure Risk and Underwriting Risk.
The capital requirement for each of these areas of risk will depend on the nature and extent of activities undertaken by the Member Organization. Specific rules are developed for each area.
463 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
In all instances, Liquid Capital must exceed the Total Risk Requirement. This may be represented as follows. Liquid Capital less Total Risk Requirement Operational Risk Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid Margin $ $ The proposals for Liquid Capital and the components of the Total Risk Requirement are explained below. 464 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
LIQUID CAPITAL Liquid Capital is calculated as follows: Core Liquid Capital (Defined Below) Cumulative Preference Shares Approved Subordinated Debt Revaluation Reserve less the following specific Excluded Assets Fixed Assets Intangible Assets Futures Income Tax Benefits less the following Excluded Assets Types (to the extent that they are not secured by realizable assets, and recoverable within 30 days, where relevant) Other Non-Current Assets Charged Assets Deposits With Non Approved Persons Related/Associated Persons Balances Other Debtors Prepayments Other Illiquid Assets less the following Contingent Liabilities Guarantees, other than those arising in the ordinary course of the Member Organization’s securities business. Liquid Capital $ $ 465 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
CORE LIQUID CAPITAL For the purposes of these proposals and in keeping with practices in a number of other jurisdictions, a top tier of capital has been established and termed Core Liquid Capital. Core Liquid Capital does not include Approved Subordinated Debt. Core Liquid Capital is defined to consist of: Ordinary Issued and Paid-Up Shares Non Cumulative Preference Shares Share Premium Account All Reserves Excluding Revaluation Reserves Opening Retained Profits/Losses Adjusted for all Current Year Movements Partners Current and Capital Accounts Core Liquid Capital $ $ ASX recognizes that as a practical matter, situations may arise where, although a Member Organization fails to meet the Core Liquid Capital requirement, it would nevertheless be considered commercially impractical to require an immediate injection of ordinary paid up shares, for example, to remedy the situation. 466 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Accordingly it is proposed that Member Organizations would be permitted a six month period to permanently correct the situation. During the period that the Core Liquid Capital requirement was not satisfied Approved Subordinated Debt would be required to make up the shortfall.
OPERATIONAL RISK
DEFINITION
For capital adequacy purposes the Operational Risk amount is the requirement to maintain a specified level of capital, to both commence and remain in business and may vary according to the level of business activity and the risks incurred. It does not include the capital required to cover Position Risk, Counterparty Risk, Large Exposure Risk and Underwriting Risk.
467 Professor Malick Sy
TOPIC 6.3:
MAJOR PROPOSALS
468
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
6.3 MAJOR PROPOSALS ☛ The Base Requirement must be covered by holdings of Core Liquid Capital; ☛ The Base Requirement is the same, irrespective of legal structure; ☛ The Variable Requirement varies according to the risks undertaken; ☛ The Secondary Requirement may be required where the set of “prescriptive rules” do not adequately cover the risks a Member Organization is exposed to. The proposed Operational Risk methodology for corporations and partnerships is detailed below. (ASX Special Case) Base Requirement of $100,000 Plus Variable Requirement calculated at 8% of the capital required to cover Position Risk, Counterparty Risk and Underwriting Risk. Note: In exceptional circumstances ASX may impose an additional Secondary Requirement. 469 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
POSITION RISK
DEFINITION
For capital adequacy purposes, Position Risk arises where a Member Organization holds a financial instrument as principal, and there is a risk that the market value of the instrument may change.
This change may arise from either a change in the specific circumstances of the issuer of the instrument (e.g., a credit re-rating of the issuer), a change in the general economic environment which causes specific instrument valuation factors to change (e.g., a change in interest rates, currency or share prices) or for some other reason. Such Specific and General Risk factors are reflected in the proposals below.
Position Risk will cover the following exchange traded and non exchange traded instruments:
☛
Equity and equity derivatives; Debt and debt derivatives;
☛
☛ Foreign Exchange.
Position Risk in these instruments will be measured on a country by country basis.
470 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
EQUITY AND EQUITY DERIVATIVES
☛ Two overall approaches permitted: - -
Standard Approach
Building Block Approach (for liquid and diversified portfolios)
☛ For the Standard Approach, three Position Risk Factors (i.e.,
haircuts) to be introduced: - - - -
Single Stocks in Recognized Market Indices Recognized Market Indices
(not broken down into constituent stocks) Non Recognized Market Indices (not broken down into constituent stocks)
12%
Other Single Stocks 16%
8% 16%
☛ For the Building Block Approach:
- -
8% on “net position” (i.e., value of long positions less value of short positions) for market risk (General Risk);
Plus 8%, 4% or 2% on “gross position” depending on the stock or index classification (Specific Risk);
☛ Alternate approach for derivatives permitted;
☛
Offsets between physical and derivative principal positions permitted; Deliberate index arbitrate positions may be treated separately;
☛
☛ Limited use of internal options risk assessment models; ☛
Cost of verification of internal options risk assessment models to be paid for by Member Organizations.
471 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
DEBT AND DEBT DERIVATIVES
☛
Position Risk Factors based on RBA levels;
Position Risk Factors to vary according to residual maturity of instrument;
☛
☛ Two overall approaches permitted: - -
Standard Approach Building Block Approach
☛ Alternate approach for derivatives permitted;
☛
Offsets between physical and derivative principal positions permitted; Limited use of internal options risk assessment models;
Cost of verification of internal options risk assessment models to be paid for by Member Organizations.
☛
☛
FOREIGN EXCHANGE
MAJOR PROPOSALS
☛ A Member Organization will not be required to calculate a foreign exchange risk requirement provided that: -
The greater of the sum of the gross long positions or the sum of the gross short positions in all foreign currencies does not exceed 100% of Liquid Capital; and -
The greater of the sum of the net open long positions or the net open short positions in each currency does not exceed 2% of Liquid Capital.
472 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
COUNTERPARTY RISK
DEFINITION
For capital adequacy purposes, Counterparty Risk exists where there is a risk that a counterparty will default, in whole or part, on its financial obligations.
MAJOR PROPOSALS
☛
A 4% charge required on net client debit and credit balances from transaction date;
☛
Free deliveries and stock borrowing transactions require specific capital identification;
☛
Non exchange traded derivative transactions to require capital; Exchange traded warrants to require capital;
☛
☛ Exposure to sub underwriters to require capital.
LARGE EXPOSURE RISK
DEFINITION
For capital adequacy purposes a Large Exposure Risk exists where a Member Organization has a large proportional exposure to a counterparty or to a principal position.
473 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
MAJOR PROPOSALS
COUNTERPARTY LARGE EXPOSURE
☛
Counterparty requirements commence after normal settlement date has passed;
☛
Groups of connected persons to be treated as a single exposure;
☛ An additional capital requirement is only necessary where an
exposure to a single counterparty is greater than 10% of Liquid Capital. In such cases, an additional capital charge equal to the capital requirement determined in the counterparty rules will be required;
☛ For the purposes of calculating counterparty large exposure, an
exposure to a sub-underwriter may be excluded unless the sub-underwriter has failed to comply with the terms of the sub-underwriting agreement.
474 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
ISSUER LARGE EXPOSURE
☛
Issuer requirements commence from transaction date; Some securities are excluded from these requirements; Relative to Member Organizations’ Capital
An additional capital requirement is only necessary where a Net Position (either long or short) in an individual issue or to an individual issuer is greater than 25% of Liquid Capital.
☛
☛
☛ Relative to Instrument on Issue
An additional capital requirement is only necessary where a Net Position (either long or short) in an individual issue is greater than 5% or 10% (equity/debt securities respectively) of the instrument on issue.
For equities, the additional capital charge will be 12% for Stocks in Recognized Market Indices and 16% for Other Single Stocks on the excess over the threshold limit.
475 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
UNDERWRITING RISK
DEFINITION
For capital adequacy purposes, Underwriting Risk exists where there is a binding commitment to acquire securities, whether equity or debt, at a price, at a point in time.
Capital raisings entered into on a “best efforts” type basis may be ignored for the purposes of these proposed rules. Underwriting agreements with “disaster/walk away” clauses should not be considered best efforts underwritings.
Sub-underwritings, firm allocations and firm commitments represent the extent to which underwriting commitments have been transferred to another party (i.e., they have been sub-underwritten).
For the purposes of calculating a capital requirement to cover Underwriting Risk, a Member Organization who enters into an underwriting, sub-underwriting or similar type of agreement should assess the risk in the same manner where the liability for any shortfall remains continuously with that Member Organization. However, where an amount is placed by an underwriter to a sub-underwriter, the amount should be treated by the underwriter as a Counterparty Risk rather than an Underwriting Risk (refer Counterparty Risk section) as this more correctly reflects the nature of the risk. Should a sub-underwriter fail to complete its obligations under the sub-underwriting agreement, the amount would accordingly revert to an Underwriting or Position Risk, depending on the circumstances.
The principle of Underwriting Risk ‘changing’ to a Counterparty Risk should be continued for all subsequent underwriting and sub-underwriting arrangements.
476 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
DIAGRAMMATIC SUMMARY The proposals are summarized diagrammatically in the following: Figure 6.1 Summary of Proposed Liquid Capital LIQUID CAPITALAdjustment Core Liquid Capital ☛ Ordinary issued and Paid-Up Shares ☛ Non-Cumulative Preference Shares ☛ Shares Premium Account ☛ All Reserves Excluding Revaluation Reserves☛ Opening Retained Profits/Losses Adjusted For All Current Year Movements ☛ Partners Current and Capital Accounts ☛ Plus Cumulative Preference Shares ☛ Plus Approved Subordinated Debt ☛ Plus Revaluation Reserve ☛ Less Excluded Assets Types ☛ Less Contingent Liabilities 477 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Figure 6.2 Summary of Proposed Total Risk Requirement OPERATIONAL Standard Approach Offsets allowed ☛ Base Requirement ☛ Plus an amount that varies with the level of activities undertaken ☛Capital required from trade date on agency trades ☛ New measures introduced for other counterparty exposuresCapital requiredto cover:☛ Significant counterparty exposure☛ Significant issuer exposure - Relative to Member Organizations’ Capital - Relative to Instrument on IssueRISK POSITIONRISK COUNTERPARTYRISK LARGE EXPOSURERISK UNDERWRITINGRISK Country Equities Foreign ExchangeBuilding BlockApproach Offsets allowed DebtPortfolio Approach Offsets allowed FutureDirection Limited internal options risk models Limited internal options risk models Full use of internal models Correlation recognition No correlation recognition Correlation recognition Capital required from:☛ Time underwriting commitment is entered into ☛ Sub underwritten amounts reduce capital requirements 478 Professor Malick Sy
TOPIC 6.4:
PROPOSED METHODOLOGY
- ILLUSTRATIVE EXAMPLES
479
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
6.4 PROPOSED METHODOLOGY - ILLUSTRATIVE EXAMPLES The proposed methodologies are illustrated via the use of examples. These are detailed as follows: Example 1 - Counterparty and Large Exposure Risk Agency Trade Assume a client sells $40,000 of stock through a Member Organization that has $500,000 of Liquid Capital. Capital Requirement Elapsed Time Counterparty Risk Large Exposure Risk T (1) $1,600 (2) -- TOTAL $1,600 - (1) $40,000 x 4% = $1,600 (Counterparty Risk) (2) N/A; as ten days after normal settlement has not passed (Large Exposure Risk) Liquid Capital Calculation $ $ Liquid Capital less Total Risk Requirement Operational Risk (3) Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid Margin (3) $100,000 + ($1,600 x 8%) = $100,128 100,128 - 1,600 - - 500,000 (101,728) 398,272 (Operational Risk) 480 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Example 2 – Position and Large Exposure Risk Principal Securities Trade Only Assume, two AOI stocks, stock A and stock B are held by a Member Organization that has $1,000,000 of Liquid Capital. Assume the Member Organization has $20,000 of stock A and the amount on issue for stock A is $2,000,000. Assume the Member Organization has $260,000 of stock B and the amount on issue for stock B is $2,000,000. As only two stocks are held the Standard Approach must be used. Capital Requirement Position Risk Large Exposure Risk Stock A B Market Value $20,000 $260,000 (1) $2,400 (2) $31,200 Relative to Member Organization (3) - (3) $1,200 Relative to Instrument (4) - (4) $19,200 (5) $1,200 (6) $19,200 TOTAL $33,600 $20,400 (1) (2) (3) Position Risk of Stock A $20,000 x 12% = $2,400 Position Risk of Stock B $260,000 x 12% = $31,200 Large Exposure Risk – Relative to Member Organization 25% of Liquid Capital is: $1,000,000 x 25% = $250,000 Stock A, not applicable Stock B: $260,000 > $250,000, hence capital requirement is ($260,000 - $250,000) x 12% = $1,200 481 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
(4) Large Exposure Risk – Relative to Instrument on Issue 5% of individual issue is $2,000,000 x 5% = $100,000 Stock A, not applicable Stock B: $260,000 > $100,000, hence capital requirement is ($260,000 - $100,000) x 12% = $19,200 (5) ASX may consider reducing the “large” requirements in certain circumstances. Liquid Capital Calculation $ $ Liquid Capital less Total Risk Requirement Operational Risk (6) Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid Margin (6) $100,000 + ($33,600 x 8%) = $102,688 102,688 33,600 - 20,400 - 1,000,000 (156,688) 843,312 (Operational Risk) 482 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Hedging Method Table Equity Position Long in security Short in security Option Position Long Put Short Call Long Call Short Put In the money by more than the PRF% Zero D Zero D In the money by less than the PRF% A D B D Out of the money C E C E Key PRF% The Standard Approach PRF% A [(PRF% - 1) x equity position value at] + mark to market value [ the exercise price ] of equity position B [(1 - PRF%) x equity position value at] - mark to market value [ the exercise price ] of equity position C The mark to market value of the equity position multiplied by the PRF%. D The mark to market value of the equity position multiplied by the PRF%. The result may be reduced by the mark to market value of the option subject to a maximum reduction to zero. E The hedging method is no longer permitted. The margin method must be used for the option position and the equity position should be treated under either the Standard or Building Block Approach. Note: For purchase options, the mark to market value must be the in the money amount multiplied by the quantity underlying the option. For written options, the mark to market value must be the sum of: The in the money amount multiplied by the quantity underlying options; and the initial premium received for the option. 483 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Example 3 – Position Risk Principal Securities Trade Assume 5 long AOI stocks, each with a market value of $20,000 are held (total value $100,000) and 1 AOI stock with a market value of $20,000 is short sold by a Member Organization that has $1,000,000 Liquid Capital. As there are 5 long stocks from a Recognized Market Index and no Net Position exceeds 20% of the gross value of the portfolio $120,000 (i.e., $100,000 + $20,000), the Building Block Approach may be used. The Standard Approach may also be used if so desired. A comparison of the capital requirements under each method is provided. As no stock exceeds 25% of the Member Organizations’ Liquid Capital and if it is assumed that there are no large exposures to an issuer a Large Exposure Risk does not need to be calculated. Building Block Approach Capital Requirement Position Risk AOI Stock Market Value Specific Risk General Risk Long 1 $20,000 2 $20,000 3 $20,000 4 $20,000 5 $20,000 $100,000 Short 6 Net Gross TOTAL ($20,000) (1) $4,000 (1) $800 $80,000 - (2) $6,400 $4,800 - $11,200 (1) (2) Market value for each stock x 4% Net Market value x 8% 484 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Liquid Capital Calculation $ $ Liquid Capital less Total Risk Requirement Operational Risk (3) Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid Margin 100,896 11,200 - - - 1,000,000 (112,096) 887,904 (Operational Risk) (3) $100,000 + ($11,200 x 8%) = $100,896 Standard Approach AOI Stock Market Value Long 1 $20,000 2 $20,000 3 $20,000 4 $20,000 5 $20,000 $100,000 Short 6 ($20,000) Capital Requirement Position Risk (1) $12,000 (1) $2,400 TOTAL $14,400 (1) Market value x 12% 485 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Liquid Capital Calculation $ $ Liquid Capital less Total Risk Requirement Operational Risk (2) Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid Margin 101,152 14,400 - - - 1,000,000 (115,552) 884,448 (2) $100,000 + ($14,400 x 8%) = $101,152 (Operational Risk) As illustrated above the “benefit” of the Building Block Approach relative to the Standard Approach is that a capital saving of $3,200 (i.e., $14,400 - $11,200) was achieved for Position Risk and an overall saving of $3,456 (i.e., $115,552 - $112,096) for Total Risk. 486 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Example 4 – Underwriting and Counterparty Risk Underwriting and Sub-underwriting Assume Member Organization A agrees to underwrite on AOI stocks for $3,000,000. Member Organization A then enters into a written sub-underwriting agreement with Member Organization B for $1,000,000. Member Organization A has Liquid Capital of $250,000. The following would apply from the day of commitment. Member Organization A Capital Requirement Stock Underwriting Risk Counterparty Risk AOI Stock TOTAL (1) $72,000 $72,000 (2) $4,800 $4,800 (1) (2) The 20% in this calculation represents a counterparty weighting, for the sub-underwriter who is a Member Organization. Liquid Capital Calculation – Member Organization A only $ $ Liquid Capital less Total Risk Requirement Operational Risk (3) Position Risk Counterparty Risk Large Exposure Risk Underwriting Risk Liquid Margin (3) 106,144 0 4,800 - 72,000 250,000 (182,944) 67,056 (Operational Risk) Underwriting Risk $2,000,000 x 12% x 30% = $72,000 Counterparty Risk $1,000,000 x 8% x 20% x 30% = $4,800 $100,000 + (($4,800+$72,000) x 8%) = $106,144 487 Professor Malick Sy
Topic 6: Capital Adequacy Requirement (CAR) Detailed Calculation
BASEL Requirement – CAR For Financial Institutions
Member Organization B Stock AOI Stock TOTAL Capital Requirement Underwriting Risk (4) $36,000 $36,000 (4) There is no Counterparty Risk to consider as Member Organization B has not sub-underwritten the amount to any other party. Underwriting Risk $1,000,000 x 12% x 30% = $36,000 488 Professor Malick Sy
TABLE A1
RETURN PRESCRIBED IN TERMS OF THE RULES Member company Balance Sheet as at Capital Employed Ordinary Share Capital
Preference Share Capital – Non Cumulative /Non-Redeemable Reserve Fund – Non distributable Share Premium Account
Capital Reserves Audited Retained Earnings CORE CAPITAL Preference Share Capital – Others Approved Subordinated Loan
Revaluation Reserves Unaudited Loss/
Unaudited Profits Loans secured against Fixed Assets Term Loan Unsecured Loans Deferred Taxation Provision for Taxation Hire Purchase Creditors
$ $ $ Total Ranking for Not Ranking for Liquid Capital Liquid Capital ( ) ( )
489 Professor Malick Sy
TABLE A1 – Cont’d
$ $ $
Ranking for Not Ranking for
Total
Liquid Capital Liquid Capital Employment of Capital
Intangible Assets Fixed Assets Long Term Investments - Listed Investments - UnListed Investments - Subsidiary/Related Companies Long Term Receivables Other Non-current Assets/Tax Assets
Current Assets
Cash and Banks Balances
Deposits – approved banks & financial institutions Deposits – others Marketable Securities
Less: Provision in diminution in value Trade Debtors – Dealers (gross)
Less: Provision for Bad & Doubtful Debts Less: Provision for Interest in Suspense Trade Debtors – Clients (Contra Losses – gross)
Less: Provision for Bad & Doubtful Debts
- Specific Provision - General Provision
Less: Provision for Interest in Suspense Outstanding contracts < T + 6 Clients Margin Accounts Directors Account Loans & Advances
Amount due from Holding Company
Amount due from Subsidiary/Related Companies Prepayment Other Debtors Other/Charged Assets
Current Liabilities
Bank Overdraft/Revolving Credits Short Term Loans/Borrowings Trust Accounts - client - others
Trade Creditors - Dealers - Clients
Outstanding Contracts < T + 6 Directors Account Other Creditors and Accruals Remisier’s Accounts Hire Purchase Creditors
Provision for Taxation Proposed Dividends Amount due to Holding Company
Amount due to Subsidiary/Related Companies
Less Contingent Liabilities
LIQUID CAPITAL Total Risk Requirement
LIQUID MARGIN CAPITAL ADEQUACY RATIO
( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) Liquid Capital
Total Risk
Requirement
490 Professor Malick Sy
TABLE A2
RETURN PRESCRIBED IN TERMS OF THE RULES
Ref
Position Risk
Total MC’s PRR Total Position Risk
Counterparty Risk Total clients contra loss CRR Total counterparties trade settlement CRR Total free deliveries CRR Total netting losses CRR Total Sub underwriting given CRR Total counterparty Risk Large Exposure Risk
Counterparty (relative to Effective Shareholder’s Funds)
Position risk equity (relative to issuer’s paid up capital Position risk equity (relative to Effective Shareholder’s Funds
Position risk debt (relative to Effective Shareholder’s Funds)
Total Large Exposure Underwriting Risk
U/W risk = exposure x PRF of equity x 30%
Operational Risk For category A, 25% of annual expenditure or $ 10 million, whichever is higher For category B, 25% of annual expenditure or $ 5 million, whichever is higher
Total Risk Requirement
491 Professor Malick Sy
TABLE B RULE (15)
MINIMUM OPERATION RISK REQUIREMENT CATEGORY A B MINIMUM OPERATIONAL RISK REQUIREMENT TYPE OF BUSINESS ALLOWABLE
• Any type of permitted • Agency business business • Principal securities trading
• Sub-underwriting
• Subsidiaries involved in exchange traded futures and options • Nil
• Lead underwriting
• Issuing of call warrants
• OTC derivatives and market making
• Subsidiaries to conduct collective investment schemes
TYPE OF NOT BUSINESS ALLOWABLE
492 Professor Malick Sy
TABLE C RULE (27)
POSITION RISK FACTOR FOR STANDARD APPROACH INSTRUMENT
POSITION RISK FACTOR
23% 28% 10%
30% 100%
12% 16% 8%
100%
KLSE Equities
• KLCI Stocks
• Other stocks, including MESDAQ
• KLCI Futures Suspended Securities • Voluntary suspension
• Compulsory suspension International Equities
• Single stocks in Recognized Market Indices
• Other single international stocks of Recognized stock exchanges
• Recognized Market Indices Other Securities
Not being those categorized above
RECOGNIZEDD MARKET INDICES
Country Index Country Index EOE 25 All Ordinaries Netherlands Australia
Spain IBEX 35 ATX Austria
Sweden OMX BEL 20 Belgium
Switzerland SMI TSE 35 Canada
UK FTSE 100 CAC 40 France
UK FTSE mid-250 DAX Germany
USA S&P 500 Nikkei 225 Japan
493 Professor Malick Sy
TABLE D RULE (28)
POSITION RISK FACTOR FOR BUILDING BLOCK APPRAOCH
INSTRUMENT
KLSE Equities
Specific Risk • KLCI Stocks
• Other stocks, including MESDAQ
• KLCI Futures
General Risk
• All single stocks and market indices International Equities
Specific Risk
• Single stocks in Recognized Market Indices
• Other single international stocks of Recognized stock exchanges
• Recognized Market Indices
General Risk
• All single stocks and market indices Other Securities
Not being those categorized above
POSITION RISK
FACTOR
13% 18% 0% 10%
4% 8% 0% 8%
100%
494 Professor Malick Sy
TABLE E RULES (30) and (31)
POSITION RISK REQUIREMENT USING HEDGING METHOD OR BASIC METHOD
Equity Position
Option Position Long call
Long put
Short call Short Put
Long put Short call
Long call Short put
In the Money In the Money Out of the % % Money >= PRF% < PRF%
NL
NL NSO NSO % SHI 0% SHI
NL NL NSO NSO LPI SHI LCI SHI
NL NL NSI NSI HO HO HO HO
Basic Method
Naked
Hedging Method
Long in security
Short in security
Key
PRF% The Standard Approach PRF%
NL The lesser of the underlying instrument multiplied by PRF% and the current value of the option on the Member company’s books
NSI The market value of the underlying instrument multiplied by PRF%
NSO The market value of the underlying position multiplied by PRF% minus 0.5 times the amount by which the option is in the money, subject to a maximum reduction to zero
LPI The market value of the underlying position minus (1-PRF%) times the underlying position at exercise price
HO The market value of the underlying position times PRF%
SHI The market value of the underlying position times PRF% minus mark to market value of option, subject to maximum reduction to zero
LCI (1+PRF%) times the underlying position at exercise price minus the market value of the underlying position, subject to maximum reduction to zero
495 Professor Malick Sy
TABLE F RULE (38)
COUNTERPARTY RISK
Counterparty Exposure
Government
• Central government
• Government related agencies State/Local Government
• State/Local government
Financial Institutions
• Banks and financial institutions licensed under the Banking and Financial Institutions Act, 1989
• Banks licensed under the Islamic Banking Act, 1983 Clearing Houses and Exchanges
• Clearing Houses
• Recognized stock exchanges
Malaysian authorized investment firms
• A holder of a fund manager’s licence under Section 15A of the Securities Industry Act, 1983
• A person who is declared to be an exempt fund manager under Section 15A(2) of the Securities Industry Act, 1983 in relation to the unit trust schemes Member Companies
• Member companies under Stage 4 trading restrictions
• Member companies not under trading restrictions agencies Other counterparties (not being those categorized above)
Weight
0%
0%
20%
20%
50%
100% 50 100%
496 Professor Malick Sy
TABLE G RULE (39)(a)
COUNTERPARTY RISK REQUIREMENT FOR UNSETTLED AGENCY TRADES Agency Transaction
Time period for application of Percentage
T to T+4 of clients
Counterparty Risk Requirement
0%
• 8% of the mark to market value of the contract multiplied by the weighting, if the current market value less the transaction value of the stock is positive
• 0%, if the current market value less the transaction value of the stock is zero or negative • The mark to market value multiplied by the weighting, if the current market value less the transaction value of the stock is positive
• 0%, if the current market value less the transaction value of the stock is zero or negative
0%
• 8% of the mark to market value of the contract multiplied by the weighting, if the transaction value less current market value of the stock is positive
• 0%, if the transaction value less current market value of the stock is zero or negative • The mark to market value multiplied by the weighting, if the transaction value less current market value of the stock is positive
• 0%, if the transaction value less current market value of the stock is zero or negative
1. Sales contract (scrip delivery) From T+5 to T+30 of clients
Beyond T+30 of clients
2. Purchase contracts (cash payments)
T to T+30 of clients
From T+6 to T+30 of clients
Beyond T+30 of clients
497 Professor Malick Sy
TABLE G RULE (39)(a)
COUNTERPARTY RISK REQUIREMENT FOR UNSETTLED PRINCIPAL TRADES Principal Transaction
Time period for application of Percentage
T to T+5 of counterparties i.e., KLSE or other Member
Companies
Counterparty Risk Requirement
0%
• 8% of the mark to market value of the contract multiplied by the weighting, if the transaction value less current market value of the stock is positive
• 0%, if the transaction value less current market value of the stock is zero or negative • The mark to market value multiplied by the weighting, if the transaction value less current market value of the stock is positive
• 0%, if the transaction value less current market value of the stock is zero or negative
0%
• 8% of the mark to market value of the contract multiplied by the weighting, if the current market value less transaction value of the stock is positive
• 0%, if the current market value less transaction value of the stock is zero or negative • The mark to market value multiplied by the weighting, if the current market value less transaction value of the stock is positive
• 0%, if the current market value less transaction value of the stock is zero or negative
1. Sales contract (cash receipt)
From T+6 to T+30 of counterparties
Beyond T+30 of counterparties
2. Purchase contracts (scrip delivery) T to T+5 of counterparties, i.e., KLSE or other Member
Companies
From T+6 to T+30 of counterparties
Beyond T+30 of counterparties
498 Professor Malick Sy
TABLE H RULE (39)(b)
COUNTERPARTY RISK REQUIREMENT FOR DEBT, CONTRA LOSSES AND OTHER AMOUNTS DUE Debt Aging Period Less than 16 days 16 to 30 days Over 30 days
Counterparty Risk Requirement (CRR)
Zero
50% of the amount due 100% of the amount due
499 Professor Malick Sy
TABLE I RULE (39)(e)
METHODOLOGY FOR CALCULATING COUNTERPARTY EXPOSURES (CREDIT EQUIVALENT AMOUNTS) FOR OTC DERIVATIVE TRANSACTIONS
Type of OTC
Derivative Transaction
Written Options
Credit Equivalent Amount
If A is positive 0 (no risk)
If A is negative 0 (no risk)
Individual share futures, OTC options, warrants and equity swaps Less than one year to maturity A + 1% of N 1% of N Over one year to maturity A + 5% of N 5% of N
Notes:
A = the mark to market value of the OTC derivative
N = the notional or actual principal amount or value underlying the contract
500 Professor Malick Sy
TABLE J RULE (40)(c)
DISCOUNTING FOR COLLATERAL
Type of Collateral Applicable Discount
Foreign Currency Cash Deposit
8% after conversion into Ringgit by applying • Foreign currency acceptance to the Exchange:-
prevailing Bank Negara Malaysia’s best available • US Dollar
exchange rate quoted commercial banks of Kuala • Currencies from European Economic Lumpur or by applying any other rate as may be Community (EEC) countries
determined by the Exchange
• Japanese Yen
• Hong Kong Dollar
• Australian Dollar • New Zealand Dollar • Singapore Dollar 100% after conversion into Ringgit by applying • Other foreign currency not acceptance to the prevailing Bank Negara Malaysia’s best available Exchange exchange rate quoted commercial banks of Kuala Lumpur or by applying any other rate as may be determined by the Exchange Quoted Securities
Position Risk Factor used in the Standard Approach, as
Securities listed on the Exchange or other recognized
prescribed in Table C.
stock exchanges (mark to market on a daily basis) Suspended Securities • Voluntary suspension Position Risk Factor used in the Standard Approach, as
prescribed in Table C. • Compulsory suspension
Malaysian Government securities, Khazanah bonds, Malaysian treasury bills, Malaysian Government investment certificates • Up to one (1) year maturity 2.5%
5.0% • More than one (1) year maturity
Cagamas bonds • Up to one (1) year maturity 12.5%
15.0% • More than one (1) year maturity
Letters of Credit
Letters of credit guaranteed by financial institutions
20%
licensed under the Banking and Financial Institutions Act, 1989 or the Islamic Banking Act, 1983 Negotiable Instruments of Deposit
Negotiable instruments of deposit guaranteed by
20% financial istitutions licensed under the Banking and
Financial Institutions Act, 1989 or the Islamic Banking Act, 1983
Other collateral or security
Any other collateral or security (not being those 100% categorized above) 501 Professor Malick Sy
TABLE K RULE (41)(d) and (e)
LARGE EXPOSURE RISK REQUIREMENT FOR SINGLE EQUITY LERR for Exposure to Equity Relative to Instrument on Issue Types of Equity
LERR
23% of the amount in excess of the net exposure or position
28% of the amount in excess of the net exposure or position
12% of the amount in excess of the net exposure or position
16% of the amount in excess of the net exposure or position
30% of the amount in excess of the net exposure or position
KLCI Stocks
Other Stocks, including MESDAQ
Single Stocks in Recognized Market Indices Other single stocks of Recognized Stock Exchanges
Voluntarily Suspended Securities
LERR for Exposure to Equity Relative to Effective Shareholders’ Funds
Types of Equity
KLCI Stocks
LERR
23% of the amount in excess
Other Stocks, including MESDAQ 28% of the amount in excess
Single Stocks in Recognized Market Indices 12% of the amount in excess
Other single stocks of Recognized Stock Exchanges 16% of the amount in excess
Voluntarily Suspended Securities
30% of the amount in excess
502 Professor Malick Sy
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