1998L0031 — EN — 21.07.1998 — 000.001 — 1
This document is meant purely as a documentation tool and the institutions do not assume any liability for its contents
►B DIRECTIVE98/31/ECOFTHEEUROPEANPARLIAMENTANDOFTHECOUNCIL
of22June1998
amending Council Directive 93/6/EEC on the capital adequacy of investment firms and credit
institutions
(OJ L 204, 21.7.1998, p. 13)
Corrected by:
►C1Corrigendum, OJ L 248, 8.9.1998, p. 20 (98/31/EC)
▼B
DIRECTIVE98/31/ECOFTHEEUROPEANPARLIAMENTAND
OFTHECOUNCIL
of22June1998
amending Council Directive 93/6/EEC on the capital adequacy of
investmentfirmsandcreditinstitutions
THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN
UNION,
Having regard to the Treaty establishing the European Community, and
in particular the first and third sentences of Article 57(2) thereof,
Having regard to the proposal from the Commission(1),
Having regard to the opinion of the Economic and Social Committee(2),
Having regard to the opinion of the European Monetary Institute(3),
Acting in accordance with the procedure laid down in Article 189b of
the Treaty(4),
(1)Whereas the risks associated with commodities trading andcommodity derivatives are currently subject to Council Directive89/647/EEC of 18 December 1989 ona solven cy ratio for creditinstitutions(
5); whereas, however, the market risksassociated with
those positions are not captured accurately by Directive 89/647/
EEC; whereas it is necessary to extend the concept of the ‘tradingbook’ to positions in commodities or commodity derivativeswhich are held for trading purposes and are subject mainly tomarket risks; whereas institutions must comply with this Directive
as regards the coverage of commodity risks ontheir overall
business; whereas the perpetration of serious fraud by certaincommodity futures traders is of growing concern to theCommunity and a threat to the image and integrity of the futurestrading business; whereas it is desirable that the Commissionshould consider defining an appropriate prudential framework in
order to prevent these fraudulent practices in the future;
(2)Whereas Council Directive 93/6/EEC of 15 March 1993 on the
capital adequacy of investment firms and credit institutions(6)
lays downa stan dardised method for the calculationof capital
requirements for market risks incurred by investment firms andcredit institutions; whereas institutions have developed their ownrisk-management systems (internal models), designed to measuremore accurately thanthe stan dardised method the market risksincurred by investment firms and credit institutions; whereas the
use of more accurate methods of measuring risks should be
encouraged;
(3)Whereas the use of such internal models for the purpose of
calculating capital requirements requires strict internal control
mechanisms and should be subject to recognition and supervisionby the competent authorities; whereas the continued reliability ofthe results of the internal model calculation should be verified bya back-testing procedure;
(4)Whereas it is appropriate that competent authorities may allowmargin requirements for exchange-traded futures and options, and1998L0031 — EN — 21.07.1998 — 000.001 — 2
(1) OJ C 240, 6.8.1997, p. 24, and OJ C 118, 17.4.1998, p. 16.
(2) OJ C 19, 21.1.1998, p. 9.
(3) Opinion delivered on 7 October 1997.
(4) Opinion of the European Parliament of 18 December 1997 (OJ C 14,
19.1.1998), Council common position of 9 March 1998 (OJ C 135, 30.4.1998,
p. 7) and Decision of the European Parliament of 30 April 1998 (OJ C 152,
18.5.1998). Council Decision of 19 May 1998.
(5) OJL 386,30.12.1989,p. 14. Directive as last amended byDirective 98/32/EC
of the European Parliament and of the Council (see page 26 of this Official
Journal).
(6) OJL 141, 11.6.1993, p. 1. Directive as amended by Directive 98/33/EC of the
European Parliament and of the Council (see page 29 of this Official Journal).
▼B
on a transitional basis for cleared over-the-counter derivatives of
the same nature, to be used as substitutes for the capitalrequirement calculated for such instruments in accordance with
this Directive, provided that this does not lead to a capital
requirement which is lower than the capital requirementcalculated according to the other methods prescribed in thisDirective; whereas the application of this principle does notrequire that the equivalence between such margin requirements
and the capital requirements calculated according to the other
methods prescribed in this Directive must be continually verifiedby the institutions applying this principle;
(5)Whereas the rules adopted at the wider international level may, inorder to encourage more sophisticated risk-management methodsbased on internal models, lower capital requirements for creditinstitutions from third countries; whereas those credit institutionscompete with investment firms and credit institutions incorpo-
rated in the Member States; whereas for investment firms and
credit institutions incorporated in the Member States, only anamendment of Directive 93/6/EEC can provide similar incentivesfor the development and use of internal models;
(6)Whereas for the purpose of calculating market-risk-capitalrequirements, positions in gold and gold derivatives should betreated in a similar fashion to foreign-exchange positions;
(7)Whereas the issue of subordinated debt should not automaticallyexclude an issuer's equity from being included in a portfolio
qualifying for a 2 % specific-risk weighting according to point 33
of Annex I to Directive 93/6/EEC;
(8)Whereas this Directive is inaccordan ce with the work of aninternational forum of banking supervisors on the supervisorytreatment of market risk and of positions in commodities andcommodity derivatives;
(9)Whereas it is necessary to have a transitional capital regime on anoptional basis for investment firms and credit institutionsundertaking significant commodities business, having a diversi-
fied commodity portfolio and being not yet able to use models for
the purpose of calculating the commodities risk capital require-ment, in order to ensure a harmonious application of thisDirective;
(10)Whereas this Directive is the most appropriate means of attainingthe objectives sought and does not go beyond what is necessary toachieve those objectives,
HAVE ADOPTED THIS DIRECTIVE:
Article 1
93/6/EEC is hereby amended as follows:1. Article 2 is amended as follows:
(a) point 6(a) and the introductory phrase and subpoints (i) and (ii) of
point 6(b) shall be replaced by the following:
‘(a) its proprietary positions in financial instruments, commod-
ities and commodity derivatives which are held for resaleand/or which are taken on by the institution with theintention of benefiting in the short term from actual and/orexpected differences between their buying and selling prices,
or from other price or interest-rate variations, and positions
in financial instruments, commodities and commodityderivatives, arising from matched principal broking, orpositions taken in order to hedge other elements of thetrading book;
(b) the exposures due to the unsettled transactions, free
deliveries and over-the-counter (OTC) derivative instru-ments referred to in paragraphs 1, 2, 3 and 5 of Annex II, the1998L0031 — EN — 21.07.1998 — 000.001 — 3
▼B
exposures due to repurchase agreements and securities and
commodities lending which are based on securities orcommodities included in the trading book as defined in (a)
referred to in paragraph 4 of Annex II, those exposures due
to reverse repurchase agreements and securities-borrowingand commodities-borrowing transactions described in thesame paragraph, provided the competent authorities soapprove, which meet either conditions (i), (ii), (iii) and (v)
or conditions (iv) and (v) as follows:
(i) the exposures are marked to market daily following the
procedures laid down in Annex II;
(ii) the collateral is adjusted inorder to take accoun t of
material changes in the value of the securities orcommodities involved in the agreement or transactionin question, according to a rule acceptable to thecompetent authorities’;
(b) points 15 and 16 shall be replaced by the following:
‘15. “warrant” shall mean a security which gives the holder the
right to purchase an underlying at a stipulated price until orat the warrant's expiry date. It may be settled by the deliveryof the underlying itself or by cash settlement.
16. “stock financing” shall means positions where physical
stock has been sold forward and the cost of funding has beenlocked inun til the date of the forward sale’;
(c) point 17, first paragraph, shall be replaced by the following:
‘17. “repurchase agreement” and “reverse repurchase agreement”
shall mean any agreement in which an institution or its
counter-party transfers securities or commodities or guaran-teed rights relating to title to securities or commoditieswhere that guarantee is issued by a recognised exchangewhich holds the rights to the securities or commodities andthe agreement does not allow an institution to transfer or
pledge a particular security or commodity to more thanon e
counter-party at one time, subject to a commitment torepurchase them (or substituted securities or commodities ofthe same description) at a specified price on a future datespecified, or to be specified, by the transferor, being a
repurchase agreement for the institution selling the securities
or commodities and a reverse repurchase agreement for theinstitution buying them’;
(d) point 18 shall be replaced by the following:
‘18. “securities or commodities lending” and “securities or
commodities borrowing” shall mean any transaction in
which an institution or its counter-party transfers securitiesor commodities against appropriate collateral subject to acommitment that the borrower will return equivalentsecurities or commodities at some future date or whenrequested to do so by the transferor, that transaction being
securities or commodities lending for the institution
transferring the securities or commodities and beingsecurities or commodities borrowing for the institution towhich they are transferred.
Securities or commodities borrowing shall be considered an
interprofessional transaction when the counter-party is
subject to prudential coordination at Community level oris a Zone A credit institution as defined in Directive 89/647/EEC or is a recognised third-country investment firm orwhen the transaction is concluded with a recognised clearinghouse or exchange’;
2. in Article 4(1), first subparagraph, points (i) and (ii) shall be replaced
by the following:
‘(i) the capital requirements, calculated in accordance with Annexes
I, II and VI and, as appropriate, Annex VIII, for their trading-book business;1998L0031 — EN — 21.07.1998 — 000.001 — 4
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(ii) the capital requirements, calculated in accordance with Annexes
III and VII and, as appropriate, Annex VIII, for all of theirbusiness activities’.
3. Article 5(2) shall be replaced by the following:
‘2. Notwithstanding paragraph 1, those institutions which calculate
the capital requirements for their trading-book business in accordance
with Annexes I and II, and as appropriate Annex VIII, shall monitorand control their large exposures in accordance with Directive 92/121/EEC subject to the modifications laid down in Annex VI to thisDirective’;
4. Article 7(10) and the introductory part of Article 7(11), shall be
replaced by the following:
‘10. Where the rights of waiver provided for inparagraphs 7 an d 9
are not exercised, the competent authorities may, for the purpose of
calculating the capital requirements set out in Annexes I and VIII andthe exposures to clients set out in Annex VI on a consolidated basis,permit positions in the trading book of one institution to offsetpositions in the trading book of another institution according to therules set out in Annexes I, VI and VIII.
In addition, they may allow foreign-exchange positions in one
institution to offset foreign-exchange positions in another institutionin accordance with the rules set out in Annex III and/or Annex VIII.They may also allow commodities positions in one institution tooffset commodities positions in another institution in accordance withthe rules set out in Annex VII and/or Annex VIII.
11. The competent authorities may also permit offsetting of the
trading book and of the foreign-exchange and commodities positions,respectively, of undertakings located in third countries, subject to thesimultaneous fulfilment of the following conditions:’.
5. Article 8(5) shall be replaced by the following:
‘5. The competent authorities shall oblige institutions to report to
them immediately any case in which their counter-parties in
repurchase and reverse repurchase agreements or securities andcommodities-lending and securities and commodities-borrowingtransactions default on their obligations. The Commission shallreport to the Council on such cases and their implications for thetreatment of such agreements and transactions in this Directive not
more thanthree years after the date referred to inArticle 12. Such
report shall also describe the way that institutions meet those ofconditions (i) to (v) in Article 2(6)(b) that apply to them, in particularcondition (v). Furthermore it shall give details of any changes in therelative volume of institutions' traditional lending and their lending
through reverse repurchase agreements and securities-borrowing or
commodities-borrowing transactions. If the Commission concludeson the basis of this report and other information that furthersafeguards are needed to prevent abuse, it shall make appropriateproposals’.
6. The following Article shall be inserted:
‘Article 11a
Until 31 December 2006, Member States may authorise their
institutions to use the minimum spread, carry and outright rates set
out in the following table instead of those indicated in paragraphs 13,
14, 17 and 18 of Annex VII provided that the institutions, in theopinion of their competent authorities:
(i) undertake significant commodities business,
(ii) have a diversified commodities portfolio, and
(iii) are not yet in a position to use internal models for the purpose of
calculating the capital requirement on commodities risk inaccordance with Annex VIII.1998L0031 — EN — 21.07.1998 — 000.001 — 5
▼B
Table
Precious
metals
(except
gold)Base
metalsAgricul-
tural
products
(softs)Other,
including
energy
products
Spread rate (%) 1,0 1,2 1,5 1,5
Carry rate (%) 0,3 0,5 0,6 0,6
Outright rate (%) 8 10 12 15
Member States shall inform the Commission of the use they make of
this Article’.
7. Annexes I, II, III and V shall be amended, and Annexes VII and VIII
added in accordance with the Annex to this Directive.
Article 2
1. Member States shall bring into force the laws, regulations and
administrative provisions necessary to comply with this Directive notlater than 24 months after the date of its entry into force. They shallforthwith inform the Commission thereof.
WhenMember States adopt these measures, they shall con taina
reference to this Directive or shall be accompanied by such reference on
the occasion of their official publication. The methods of making suchreference shall be laid down by Member States.
2. Member States shall communicate to the Commission the text of
the mainprovision s of domestic law which they adopt inthe fieldgoverned by this Directive.
Article 3
This Directive shall enter into force on the day of its publication in the
OfficialJournaloftheEuropeanCommunities .
Article 4
This Directive is addressed to the Member States.1998L0031 — EN — 21.07.1998 — 000.001 — 6
▼B
ANNEX
1. Annex I is amended as follows:
(a) In Paragraph 4, the last sentence is deleted and the following subparagraph
is added:
‘The competent authorities may allow the capital requirement for an
exchange-traded future to be equal to the margin required by the exchange
if they are fully satisfied that it provides anaccurate measure of the risk
associated with the future and that it is at least equal to the capital
requirement for a future that would result from a calculation made using
the method set out in the remainder of this Annex or applying the internal
models method described in Annex VIII. Until 31 December 2006 the
competent authorities may also allow the capital requirement for an OTC
derivatives contract of the type referred to in this paragraph cleared by a
clearing house recognised by them to be equal to the margin required by
the clearing house if they are fully satisfied that it provides an accurate
measure of the risk associated with the derivatives contract and that it is at
least equal to the capital requirement for the contract in question that
would result from a calculationmade usin g the method set out inthe
remainder of this Annex or applying the internal models method described
in Annex VIII’.
(b) Inparagraph 5, the third subparagraph is replaced by the followin g:
‘The competent authorities shall require that the other risks, apart from the
delta risk, associated with options are safeguarded against. The competent
authorities may allow the requirement against a written exchange-traded
optionto be equal to the marginrequired by the exchan ge if they are fully
satisfied that it provides anaccurate measure of the risk associated with
the option and that it is at least equal to the capital requirement against an
optionthat would result from a calculationmade usin g the method set out
in the remainder of this Annex or applying the internal models method
described in Annex VIII. Until 31 December 2006 the competent
authorities may also allow the capital requirement for an OTC option
cleared by a clearing house recognised by them to be equal to the margin
required by the clearing house if they are fully satisfied that it provides an
accurate measure of the risk associated with the optionan d that it is at
least equal to the capital requirement for an OTC option that would result
from a calculation made using the method set out in the remainder of this
Annex or applying the internal models method described in Annex VIII.In
addition they may allow the requirement on a bought exchange-traded or
OTC option to be the same as that for the instrument underlying it, subject
to the constraint that the resulting requirement does not exceed the market
value of the option. The requirement against a written OTC option shall be
set in relation to the instrument underlying it’.
(c) Paragraph 6 is replaced by the following:
‘6. Warrants relating to debt instruments and equities shall be treated in
the same way as options under paragraph 5’.
(d) Paragraph 33(i) is replaced by the following:
‘(i) the equities shall not be those of issuerswhich have issued only traded
debt instruments that currently attract an 8 % requirement in Table 1
appearing in paragraph 14 or that attract a lower requirement only
because they are guaranteed or secured’.
2. Annex II is amended as follows:
(a) Paragraph 1 is replaced by the following:
‘1. In the case of transactions in which debt instruments, equities and
commodities (excluding repurchase and reverse repurchase agree-
ments and securities or commodities lending and securities or
commodities borrowing) are unsettled after their due delivery dates,
an institution must calculate the price difference to which it is
exposed. This is the difference between the agreed settlement price for
the debt instrument, equity or commodity in question and its current
market value, where the difference could involve a loss for the
institution. It must multiply this difference by the appropriate factor in
columnAof the table appearin g inparagraph 2 inorder to calculate its
capital requirement’.1998L0031 — EN — 21.07.1998 — 000.001 — 7
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(b) Paragraphs 3.1 and. 3.2 are replaced by the following:
‘3.1. An institution shall be required to hold capital against counterparty
risk if:
(i) it has paid for securities or commodities before receiving them
or it has delivered securities or commodities before receiving
payment for them;
and
(ii) in the case of cross-border transactions, one day or more has
elapsed since it made that payment or delivery.
3.2. The capital requirement shall be 8 % of the value of the securities or
commodities or cash owed to the institution multiplied by the risk
weighting applicable to the relevant counterparty’.
(c) The heading before paragraph 4.1 and the first subparagraph of paragraph
4.1 are replaced by the following:
‘Repurchase and reverse repurchase agreements, securities or
commoditieslendingandborrowing
4.1. In the case of repurchase agreements and securities or commodities
lending based on securities or commodities included in the trading
book the institution shall calculate the difference between the market
value of the securities or commodities and the amount borrowed by
the institution or the market value of the collateral, where that
difference is positive. In the case of reverse repurchase agreements
and securities or commodities borrowing, the institution shall
calculate the difference between the amount the institution has lent
or the market value of the collateral and the market value of the
securities or commodities it has received, where that difference is
positive’.
3. Annex III is amended as follows:
(a) Paragraph 1 is replaced by the following:
‘1. If the sum of an institution's overall net foreign-exchange position and
its net gold position, calculated in accordance with the procedure set
out below, exceeds 2 % of its total ownfunds,it shall multiply the sum
of its net foreign-exchange position and its net gold position by 8 % in
order to calculate its own-funds requirement against foreign-exchange
risk.
Until 31 December 2004, the competent authorities may allow
institutions to calculate their own-fundsrequirement by multiplying by
8 % the amount by which the sum of the overall net foreign-exchange
position and the net gold position exceeds 2 % of the total own
funds.’.
(b) Paragraphs 3.1 and 3.2 are replaced by the following:
‘3.1. Firstly, the institution's net open position in each currency (including
the reporting currency) and in gold shall be calculated. This position
shall consist of the sum of the following elements (positive or
negative):
— the net spot position (i. e. all asset items less all liability items,
including accrued interest, in the currency in question or, for
gold, the net spot position in gold),
— the net forward position (i. e. all amounts to be received less all
amounts to be paid under forward exchange and gold transac-
tions, including currency and gold futures and the principal on
currency swaps not included in the spot position),
— irrevocable guarantees (and similar instruments) that are certain
to be called and likely to be irrecoverable,
— net future income/expenses not yet accrued but already fully
hedged (at the discretion of the reporting institution and with the
prior consent of the competent authorities, net future income/
expenses not yet entered in accounting records but already fully
hedged by forward foreign-exchange transactions may be
included here). Such discretion must be exercised on a consistent
basis,
— the net delta (or delta-based) equivalent of the total book of
foreign-currency and gold options,
— the market value of other (i. e. non-foreign-currency and non-
gold) options,
— any positions which an institution has deliberately taken in order
to hedge against the adverse effect of the exchange rate on its1998L0031 — EN — 21.07.1998 — 000.001 — 8
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capital ratio may be excluded from the calculationof n et open
currency positions. Such positions should be of a non-trading or
structural nature and their exclusion, and any variation of the
terms of their exclusion, shall require the consent of the
competent authorities. The same treatment subject to the same
conditions as above may be applied to positions which an
institution has which relate to items that are already deducted in
the calculationof ownfun ds.
3.2. The competent authorities shall have the discretion to allow
institutions to use the net present value when calculating the net
open position in each currency and in gold.’.
(c) Paragraph 4, first sentence, is replaced by the following:
‘4. Secondly, net short and long positions in each currency other than the
reporting currency and the net long or short position in gold shall be
converted at spot rates into the reporting currency’.
(d) Paragraph 7 is replaced by the following:
‘7. Secondly, until 31 December 2004, the competent authorities may
allow institutions to apply an alternative method to those outlined in
paragraphs 1 to 6 for the purposes of this Annex. The capital
requirement produced by this method must be sufficient to exceed 2 %
of the net open position as measured in paragraph 4 and, on the basisof an analysis of exchange-rate movements during all the rolling 10-
working-day periods over the preceding three years, to exceed the
likely loss 99 % or more of the time.
The alternative method described in the first subparagraph may only
be used under the following conditions:
(i) the calculation formula and the correlation coefficients are set by
the competent authorities, based on their analysis of exchange-rate
movements;
(ii) the competent authorities review the correlation coefficients
regularly in the light of developments in foreign-exchange
markets.’.
4. Annex V is amended as follows:
(a) Paragraph 2, first sentence, is replaced by the following: ‘Notwithstanding
paragraph 1, the competent authorities may permit those institutions which
are obliged to meet the own-funds requirements laid down in Annexes I,
II, III, IV, VI, VII and VIII to use an alternative definition when meeting
those requirements only’.
(b) Paragraph 4 is replaced by the following:
‘4. The subordinated loan capital referred to in paragraph 2(c) may not
exceed a maximum of 150 % of the original own funds left to meet the
requirements laid down in Annexes I, II, III, IV, VI, VII, and VIII and
may approach that maximum only in particular circumstances
acceptable to the relevant authorities’.
(c) Paragraphs 6 and 7 are replaced by the following:
‘6. The competent authorities may permit investment firms to exceed the
ceiling for subordinated loan capital prescribed in paragraph 4 if they
judge it prudentially adequate and provided that the total of such
subordinated loan capital and the items referred to in paragraph 5 does
not exceed 200 % of the original own funds left to meet the
requirements imposed in Annexes I, II, III, IV, VI, VII and VIII or
250 % of the same amount where investment firms deduct item 2(d)
referred to in paragraph 2 when calculating own funds.
7. The competent authorities may permit the ceiling for subordinated
loancapital prescribed inparagraph 4 to be exceeded by a credit
institution if they judge it prudentially adequate and provided that the
total of such subordinated loan capital and the items referred to in
paragraph 5 does not exceed 250 % of the original own funds left to
meet the requirements imposed in Annexes I, II, III, VI, VII and VIII’.1998L0031 — EN — 21.07.1998 — 000.001 — 9
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5. The following Annexes are added:
‘ANNEXVII
COMMODITIESRISK
1. Each positionincommodities or commodity derivatives shall be
expressed in terms of the standard unit of measurement. The spot price
ineach commodity shall be expressed inthe reportin g curren cy.
2. Positions in gold or gold derivatives shall be considered as being subject
to foreign-exchange risk and treated according to Annex III or Annex
VIII, as appropriate, for the purpose of calculating market risk.
3. For the purposes of this Annex, positions which are purely stock financing
may be excluded from the commodities risk calculationon ly.
4. The interest-rate and foreign-exchange risks not covered by other
provisions of this Annex shall be included in the calculation of general
risk for traded debt instruments and in the calculation of foreign-exchange
risk.
5. When the short position falls due before the long position, institutions
shall also guard against the risk of a shortage of liquidity which may exist
insome markets.
6. For the purpose of paragraph 19, the excess of an institution's long (short)
positions over its short (long) positions in the same commodity and
identical commodity futures, options and warrants shall be its net position
in each commodity. The competent authorities shall allow positions in
derivative instruments to be treated, as laid down in paragraphs 8, 9 and
10, as positions in the underlying commodity.
7. The competent authorities may regard the following positions as positions
inthe same commodity:
— positions in different sub-categories of commodities in cases where the
sub-categories are deliverable against each other,
and
— positions in similar commodities if they are close substitutes and if a
minimum correlation of 0,9 between price movements can be clearly
established over a minimum period of one year.
Particularinstruments
8. Commodity futures and forward commitments to buy or sell individual
commodities shall be incorporated in the measurement system as notional
amounts in terms of the standard unit of measurement and assigned a
maturity with reference to expiry date. The competent authorities may
allow the capital requirement for an exchange-traded future to be equal to
the marginrequired by the exchan ge if they are fully satisfied that it
provides anaccurate measure of the risk associated with the future an d
that it is at least equal to the capital requirement for a future that would
result from a calculation made using the method set out in the remainder
of this Annex or applying the internal models method described in Annex
VIII. Until 31 December 2006 the competent authorities may also allow
the capital requirement for an OTC commodity derivatives contract of the
type referred to in this paragraph cleared by a clearing house recognised
by them to be equal to the marginrequired by the clearin g house if they
are fully satisfied that it provides anaccurate measure of the risk
associated with the derivatives contract and that it is at least equal to the
capital requirement for the contract in question that would result from a
calculation made using the method set out in the remainder of this Annex
or applying the internal models method described in Annex VIII.
9. Commodity swaps where one side of the transaction is a fixed price and
the other the current market price shall be incorporated into the maturity
ladder approach as a series of positionsequal to the notional amount of the
contract, with one position corresponding with each payment on the swap
and slotted into the maturity ladder set out in the table appearing in
paragraph 13. The positions would be long positions if the institution is
paying a fixed price and receiving a floating price and short positions if
the institution is receiving a fixed price and paying a floating price.
Commodity swaps where the sides of the transaction are in different
commodities are to be reported in the relevant reporting ladder for the
maturity ladder approach.1998L0031 — EN — 21.07.1998 — 000.001 — 10
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10. Optionson commodities or oncommodity derivatives shall be treated as if
they were positions equal in value to the amount of the underlying to
which the optionrefers, multiplied by its delta for the purposes of this
Annex. The latter positions may be netted off against any offsetting
positions in the identical underlying commodity or commodity derivative.
The delta used shall be that of the exchange concerned, that calculated by
the competent authorities or, where none of those is available or for OTC
options, that calculated by the institution itself, subject to the competent
authorities being satisfied that the model used by the institution is
reasonable.
However, the competent authorities may also prescribe that institutions
calculate their deltas using a methodology specified by the competent
authorities.
The competent authorities shall require that the other risks, apart from the
delta risk, associated with commodity options are safeguarded against.
The competent authorities may allow the requirement for a written
exchange-traded commodity option to be equal to the margin required by
the exchange if they are fully satisfied that it provides an accurate measure
of the risk associated with the optionan d that it is at least equal to the
capital requirement against an option that would result from a calculation
made using the method set out in the remainder of this Annex or applying
the internal models method described in Annex VIII. Until 31 December
2006 the competent authorities may also allow the capital requirement for
an OTC commodity option cleared by a clearing house recognised by
them to be equal to the marginrequired by the clearin g house if they are
fully satisfied that it provides anaccurate measure of the risk associated
with the option and that it is at least equal to the capital requirement for an
OTC optionthat would result from a calculationmade usin g the method
set out in the remainder of this Annex or applying the internal models
method described in Annex VIII. In addition they may allow the
requirement on a bought exchange-traded or OTC commodity option to be
the same as that for the commodity underlying it, subject to the constraint
that the resulting requirement does not exceed the market value of the
option. The requirement for a written OTC option shall be set in relation
to the commodity underlying it.
11. Warrants relating to commodities shall be treated in the same way as
commodity options under paragraph 10.
12. The transferor of commodities or guaranteed rights relating to title to
commodities in a repurchase agreement and the lender of commodities in
a commodities lending agreement shall include such commodities in the
calculation of its capital requirement under this Annex.
(a)Maturityladderapproach
13. The institution shall use a separate maturity ladder in line with the
following table for each commodity. All positions in that commodity and
all positions which are regarded as positions in the same commodity
pursuant to paragraph 7 shall be assigned to the appropriate maturity
bands. Physical stocks shall be assigned to the first maturity band.
Maurity band
(1)Spread rate
(in%)
(2)
0≤1 month 1,50
>1≤3 months 1,50
>3≤6 months 1,50
>6≤12 months 1,50
>1≤2 years 1,50
>2≤3 years 1,50
> 3 years 1,50
14. Competent authorities may allow positions which are, or are regarded
pursuant to paragraph 7 as, positions in the same commodity to be offset
and assigned to the appropriate maturity bands on a net basis for:
— positions in contracts maturing on the same date,
and
— positions in contracts maturing within 10 days of each other if the
contracts are traded on markets which have daily delivery dates.1998L0031 — EN — 21.07.1998 — 000.001 — 11
▼B
15. The institution shall then work out the sum of the long positions and the
sum of the short positions in each maturity band. The amount of the
former (latter) which are matched by the latter (former) ina given
maturity band shall be the matched positions in that band, while the
residual long or short position shall be the unmatched position for the
same band.
16. That part of the unmatched long (short) position for a given maturity band
that is matched by the unmatched short (long) position for a maturity band
further out shall be the matched positionbetweentwo maturity ban ds.
That part of the unmatched long or unmatched short position that cannot
be thus matched shall be the unmatched position.
17. The institution's capital requirement for each commodity shall be
calculated onthe basis of the relevan t maturity ladder as the sum of the
following:
(i) the sum of the matched long and short positions, multiplied by the
appropriate spread rate as indicated in the second column of the table
appearing in paragraph 13 for each maturity band and by the spotprice for the commodity;
(ii) the matched positionbetweentwo maturity ban ds for each maturity
band into which an unmatched position is carried forward, multiplied
by 0,6 % (carry rate) and by the spot price for the commodity;
(iii) the residual unmatched positions, multiplied by 15 % (outright rate)
and by the spot price for the commodity.
18. The institution's overall capital requirement for commodities risk shall be
calculated as the sum of the capital requirements calculated for each
commodity according to paragraph 17.
(b)Simplifiedapproach
19. The institution's capital requirement for each commodity shall be
calculated as the sum of:
(i) 15 % of the net position, long or short, multiplied by the spot price for
the commodity;
(ii) 3 % of the gross position, long plus short, multiplied by the spot price
for the commodity.
20. The institution's overall capital requirement for commodities risk shall be
calculated as the sum of the capital requirements calculated for each
commodity according to paragraph 19.
ANNEXVIII
INTERNALMODELS
1. The competent authorities may, subject to the conditions laid down in this
Annex, allow institutions to calculate their capital requirements for
position risk, foreign-exchange risk and/or commodities risk using their
own internal risk-management models instead of or in combination with
the methods described in Annexes I, III and VII. Explicit recognition by
the competent authorities of the use of models for supervisory capital
purposes shall be required ineach case.
2. Recognition shall only be given if the competent authority is satisfied that
the institution's risk-management system is conceptually sound and
implemented with integrity and that, in particular, the following
qualitative standards are met:
(i) the internal risk-measurement model is closely integrated into the
daily risk-management process of the institution and serves as the
basis for reporting risk exposures to senior management of the
institution;
(ii) the institution has a risk control unit that is independent from
business trading units and reports directly to senior management.
The unit must be responsible for designing and implementing the
institution's risk-management system. It shall produce and analyse
daily reports on the output of the risk-measurement model and on
the appropriate measures to be takeninterms of tradin g limits;
(iii) the institution's board of directors and senior management are
actively involved in the risk-control process and the daily reports
produced by the risk-control unit are reviewed by a level of
management with sufficient authority to enforce both reductions of
positions taken by individual traders as well as in the institution's
overall risk exposure;1998L0031 — EN — 21.07.1998 — 000.001 — 12
▼B
(iv) the institution has sufficient numbers of staff skilled in the use of
sophisticated models in the trading, risk-control, audit and back-
office areas;
(v) the institution has established procedures for monitoring and
ensuring compliance with a documented set of internal policies
and controls concerning the overall operation of the risk-measure-
ment system;
(vi) the institution's models have a proven track record of reasonable
accuracy inmeasurin g risks;
(vii) the institution frequently conduct a rigorous programme of stress
testing and the results of these tests are reviewed by senior
management and reflected in the policies and limits it sets;
(viii) the institution must conduct, as part of its regular internal auditing
process, an independent review of its risk-measurement system.
This review must include both the activities of the business trading
units and of the independent risk-control unit. At least once a year,
the institution must conduct a review of its overall risk-management
process. The review must consider:
— the adequacy of the documentation of the risk-management
system and process and the organisation of the risk-control unit,
— the integration of market risk measures into daily risk manage-
ment and the integrity of the management information system,
— the process the institution employs for approving risk-pricing
models and valuation systems that are used by front and back-
office personnel,
— the scope of market risks captured by the risk-measurement
model and the validation of any significant changes in the risk-
measurement process,
— the accuracy and completeness of position data, the accuracy
and appropriateness of volatility and correlation assumptions,
and the accuracy of valuation and risk sensitivity calculations,
— the verificationprocess the in stitutionemploys to evaluate the
consistency, timeliness and reliability of data sources used to
run internal models, including the independence of such data
sources,
and
— the verificationprocess the in stitutionuses to evaluate back-
testing that is conducted to assess the model's accuracy.
3. The institution shall monitor the accuracy and performance of its model
by conducting a back-testing programme. The back-testing has to provide
for each business day a comparison of the one-day value-at-risk measure
generated ►C1by the institution's model for the portfolio's end-of-day
positions to the one-day change of the portfolio's value ◄by the end of
the subsequent business day. Competent authorities shall examine the
institution's capability to perform back-testing on both actual and
hypothetical changes in the portfolio's value. Back-testing on hypothetical
changes in the portfolio's value is based on a comparison between the
portfolio's end-of-day value and, assuming unchanged positions, its value
at the end of the subsequent day. Competent authorities shall require
institutions to take appropriate measures to improve their back-testing
programme if deemed deficient.
4. For the purpose of calculating capital requirements for specific risk
associated with traded debt and equity positions, the competent authorities
may recognise the use of an institution's internal model if in addition to
compliance with the conditions in the remainder of this Annex the model:
— explains the historical price variation in the portfolio,
— captures concentration in terms of magnitude and changes of
compositionof the portfolio,
— is robust to an adverse environment,— is validated through back-testing aimed at assessing whether specific
risk is being accurately captured. If competent authorities allow this
back-testing to be performed on the basis of relevant sub-portfolios,
these must be chosen in a consistent manner.
5. Institutions using internal models which are not recognised in accordance
with paragraph 4 shall be subject to a separate capital charge for specific
risk as calculated according to Annex I.
6. For the purpose of paragraph 10(ii) the results of the institution's own
calculationshall be scaled up by a multiplicationfactor of at least 3.
7. The multiplicationfactor shall be in creased by a plus-factor of between0
and 1 in accordance with the following table, depending on the number of1998L0031 — EN — 21.07.1998 — 000.001 — 13
▼B
overshootings for the most recent 250 business days as evidenced by the
institution's back-testing. Competent authorities shall require the institu-
tions to calculate overshootings consistently on the basis of back-testing
either onactual or onhypothetical chan ges inthe portfolio's value. An
overshooting is a one-day change in the portfolio's value that exceeds the
related one-day value-at-risk measure generated by the institution's model.
For the purpose of determining the plus-factor the number of over-
shootings shall be assessed at least quarterly.
Number of overshootings Plus-factor
Fewer than5 0,00
5 0,406 0,507 0,65
8 0,75
9 0,85
10 or more 1,00
The competent authorities can, in individual cases and owing to an
exceptional situation, waive the requirement to increase the multiplication
factor by the plus-factor according to the above table, if the institution has
demonstrated to the satisfaction of the competent authorities that such an
increase is unjustified and that the model is basically sound.
If numerous overshootings indicate that the model is not sufficiently
accurate, the competent authorities shall revoke the model's recognition or
impose appropriate measures to ensure that the model is improved
promptly.
In order to allow competent authorities to monitor the appropriateness of
the plus-factor on an ongoing basis, institutions shall notify promptly, and
in any case no later than within five working days, the competent
authorities of overshootings that result form their back-testing programme
and that would according to the above table imply an increase of a plus-
factor.
8. If the institution's model is recognised by the competent authorities in
accordance with paragraph 4 for the purpose of calculating capital
requirements for specific risk, the institution shall increase its capital
requirement calculated pursuant to paragraphs 6, 7 and 10 by a surcharge
inthe amoun t of either:
(i) the specific risk portionof the value-at-risk measure which should be
isolated according to supervisory guidelines; or, at the institution's
option,
(ii) the value-at-risk measures of sub-portfolios of debt and equity
positions that contain specific risk.
Institutions using option (ii) are required to identify their sub-portfolio
structure beforehand and should not change it without the consent of the
competent authorities.
9. The competent authorities may waive the requirement pursuant to
paragraph 8 for a surcharge if the institution demonstrates that in line
with agreed international standards its model accurately captures also the
event risk and default risk for its traded debt and equity positions.
10. Each institution must meet a capital requirement expressed as the higher
of:
(i) its previous day's value-at-risk number measured according to the
parameters specified in this Annex;
(ii) anaverage of the daily value-at-risk measures oneach of the
preceding 60 business days, multiplied by the factor mentioned in
paragraph 6, adjusted by the factor mentioned in paragraph 7.
11. The calculation of value-at-risk shall be subject to the following minimum
standards:
(i) at least daily calculationof value-at-risk;
(ii) a 99th percentile, one-tailed confidence interval;
(iii) a 10-day equivalent holding period;
(iv) aneffective historical observationperiod of at least on e year except
where a shorter observation period is justified by a significant
upsurge inprice volatility;1998L0031 — EN — 21.07.1998 — 000.001 — 14
▼B
(v) three-monthly data set updates.
12. The competent authorities shall require that the model captures accurately
all the material price risks of options or option-like positions and that any
other risks not captured by the model are covered adequately by own
funds.
13. The competent authorities shall require that the risk-measurement model
captures a sufficient number of risk factors, depending on the level of
activity of the institution in the respective markets. As a minimum, the
following provisions shall be respected:
(i) for interest rate risk, the risk-measurement system shall incorporate a
set of risk factors corresponding to the interest rates in each currency
in which the institution has interest rate sensitive on- or off-balance
sheet positions. The institution shall model the yield curves using one
of the generally accepted approaches. For material exposures to
interest-rate risk in the major currencies and markets, the yield curve
shall be divided into a minimum of six maturity segments, to capture
the variations of volatility of rates along the yield curve. The risk-
measurement system must also capture the risk of less than perfectly
correlated movements between different yield curves;
(ii) for foreign-exchange risk, the risk-measurement system shall
incorporate risk factors corresponding to gold and to the individual
foreign currencies in which the institution's positions are denomi-
nated;
(iii) for equity risk, the risk-measurement system shall use a separate risk
factor at least for each of the equity markets inwhich the in stitution
holds significant positions;
(iv) for commodity risk, the risk-measurement system shall use a separate
risk factor at least for each commodity inwhich the in stitutionholds
significant positions. The risk-measurement system must also capture
the risk of less thanperfectly correlated movemen ts betweensimilar,
but not identical, commodities and the exposure to changes in
forward prices arising from maturity mismatches. It shall also take
account of market characteristics, notably delivery dates and the
scope provided to traders to close out positions.
14. The competent authorities may allow institutions to use empirical
correlations within risk categories and across risk categories if they are
satisfied that the institution's system for measuring correlations is sound
and implemented with integrity’.1998L0031 — EN — 21.07.1998 — 000.001 — 15