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BIPRU 7.2 Interest rate PRR

General rule

BIPRU 7.2.1RRP

  1. (1)

    A firm must calculate its interest rate PRR under BIPRU 7.2 by:

    1. (a)

      identifying which positions must be included within the interest rate PRR calculation;

    2. (b)

      deriving the net position in each debt security in accordance with BIPRU 7.2.36R-BIPRU 7.2.41R;

    3. (c)

      including these net positions in the interest rate PRR calculation for general market risk and the interest rate PRR calculation for specific risk; and

    4. (d)

      summing all PRRs calculated for general market risk and specific risk.

  2. (2)

    A firm must calculate its interest rate PRR by adding the amount calculated under (1) to the amount calculated under the basic interest rate PRR calculation under BIPRU 7.3.45R.

  3. (3)

    All net positions, irrespective of their signs, must be converted on a daily basis into the firm's base currency at the prevailing spot exchange rate before their aggregation.

  4. (4)

    Net positions must be classified according to the currency in which they are denominated. A firm must calculate the capital requirement for general market risk and specific risk in each individual currency separately.

BIPRU 7.2.2GRP

The interest rate PRR calculation divides the interest rate risk into the risk of loss from a general move in market interest rates, and the risk of loss from an individual debt security's price changing for reasons other than a general move in market interest rates. These are called general market risk and specific risk respectively.

Scope of the interest rate PRR calculation

BIPRU 7.2.3RRP

A firm's interest rate PRR calculation must:

  1. (1)

    include all trading book positions in debt securities, preference shares and convertibles, except:

    1. (a)

      positions in convertibles which have been included in the firm's equity PRR calculation;

    2. (b)

      positions fully deducted as a material holding under the calculations under the capital resources table, in which case the firm may exclude them; or

    3. (c)

      positions hedging an option which is being treated under BIPRU 7.6.26R (Table: Appropriate treatment for equities, debt securities or currencies hedging options);

  2. (2)

    include notional positions arising from trading book positions in the instruments listed in the table in BIPRU 7.2.4R; and

  3. (3)

    (if the firm is the transferor of debt securities or guaranteed rights relating to title to debt securities in a repurchase agreement or the lender of debt securities in a debt securities lending agreement) include such debt securities if those debt securities meet the criteria for inclusion in the trading book.

BIPRU 7.2.4RRP

Table: Instruments which result in notional positions

This table belongs to BIPRU 7.2.3R(2)

Instrument

See

Futures, forwards or synthetic futures on debt securities

BIPRU 7.2.13 R

Futures, forwards or synthetic futures on debt indices or baskets

BIPRU 7.2.14R

Interest rate futures or forward rate agreements (FRAs)

BIPRU 7.2.18 R

Interest rate swaps or foreign currency swaps

BIPRU 7.2.21R

Deferred start interest rate swaps or foreign currency swaps

BIPRU 7.2.24R

The interest rate leg of an equity swap (unless the firm calculates the interest rate PRR on the instrument using the basic interest rate PRR calculation in BIPRU 7.3 (Equity PRR and basic interest rate PRR for equity derivatives))

BIPRU 7.2.27R

The cash leg of a repurchase agreement or a reverse repurchase agreement

BIPRU 7.2.30R

Cash borrowings or deposits

BIPRU 7.2.31 R

Options on a debt security, a basket of debt securities, a debt security index, an interest rate or an interest rate future or swap (including an option on a future on a debt security) (unless the firm calculates a PRR on the option under BIPRU 7.6 (Option PRR))

BIPRU 7.2.32R

Dual currency bonds

BIPRU 7.2.33R

Foreign currency futures or forwards

BIPRU 7.2.34R

Gold futures or forwards

BIPRU 7.2.34R

Forwards, futures or options (except cliquets) on an equity, basket of equities or equity index (unless the firm calculates the interest rate PRR on the instrument using the basic interest rate PRR calculation in BIPRU 7.3)

BIPRU 7.2.34R

Credit derivatives

BIPRU 7.11

A warrant must be treated in the same way as an option

BIPRU 7.2.5GRP

BIPRU 7.2.3R(1) includes a trading book position in debt security, preference share or convertible that is subsequently repo'd under a repurchase agreement or lent under a stock lending agreement. Clearly, if the security had initially been obtained via a reverse repurchase agreement or stock borrowing agreement, the security would not have been included in the PRR calculation in the first place.

BIPRU 7.2.7GRP

Firms are reminded that the table in BIPRU 7.6.5R (Table: Appropriate PRR calculation for an option or warrant) divides options and warrants on interest rates, debt securities and interest rate futures and swaps into:

  1. (1)

    those which must be treated under BIPRU 7.6 (Option PRR); and

  2. (2)

    those which must be treated under either BIPRU 7.2 or BIPRU 7.6, the firm being able to choose whether BIPRU 7.2 or BIPRU 7.6 is used.

BIPRU 7.2.8GRP

Cliquets on equities, baskets of equities or equity indices do not attract an interest rate PRR. The table in BIPRU 7.2.4R excludes them from the scope of the interest rate PRR calculation in BIPRU 7.2 and BIPRU 7.3.45R excludes them from the basic interest rate PRR calculation in BIPRU 7.3 (Equity PRR and basic interest rate PRR for equity derivatives).

BIPRU 7.2.9GRP

The table in BIPRU 7.2.4R shows that equity derivatives are excluded from BIPRU 7.2's PRR calculation if they have been included in the basic interest rate PRR calculation in BIPRU 7.3 (see BIPRU 7.3.45R).

Derivation of notional positions: General approach

BIPRU 7.2.10GRP

BIPRU 7.2.11 R - BIPRU 7.2.35R convert the instruments listed in the table in BIPRU 7.2.4R into notional positions in:

  1. (1)

    the underlying debt security, where the instrument depends on the price (or yield) of a specific debt security; or

  2. (2)

    notional debt securities to capture the pure interest rate risk arising from future payments and receipts of cash (including notional payments and receipts) which, because they are designed to represent pure general market risk (and not specific risk), are called zero-specific-risk securities; or

  3. (3)

    both (1) and (2).

BIPRU 7.2.11RRP

  1. (1)

    For the purposes of calculating interest rate PRR, unless specified otherwise, a firm must derive the value of notional positions as follows:

    1. (a)

      notional positions in actual debt securities must be valued as the nominal amount underlying the contract at the current market price of the debt security; and

    2. (b)

      positions in zero-specific-risk securities must be valued using one of the two methods in (2).

  2. (2)

    A firm must use one of the following two methods for all positions arising under (1)(b) and must use the same method for all positions denominated in the same currency:

    1. (a)

      the present value approach, under which the zero-specific-risk security is assigned a value equal to the present value of all the future cash flows that it represents; or

    2. (b)

      the alternative approach, under which the zero-specific-risk security is assigned a value equal to:

      1. (i)

        the market value of the underlying notional equity position in the case of an equity derivative;

      2. (ii)

        the notional principal amount in the case of an interest rate or foreign currency swap; or

      3. (iii)

        the notional amount of the future cash flow that it represents in the case of any other CRD financial instrument.

BIPRU 7.2.12RRP

A firm must use BIPRU 7.2.11R(2)(a) in respect of any positions that it includes in the interest rate duration method.

Derivation of notional positions: Futures, forwards or synthetic futures on a debt security

BIPRU 7.2.13RRP

Futures, forwards or synthetic futures on a single debt security must be treated as follows:

  1. (1)

    a purchased future, synthetic future or forward is treated as:

    1. (a)

      a notional long position in the underlying debt security (or the cheapest to deliver (taking into account the conversion factor) where the contract can be satisfied by delivery of one from a range of securities); and

    2. (b)

      a notional short position in a zero coupon zero-specific-risk security with a maturity equal to the expiry date of the future or forward; and

  2. (2)

    a sold future, synthetic future or forward is treated as:

    1. (a)

      a notional short position in the underlying security (or the cheapest to deliver (taking into account the conversion factor) where the contract can be satisfied by delivery of one from a range of securities); and

    2. (b)

      a notional long position in a zero coupon zero-specific-risk security with a maturity equal to the expiry date of the future, synthetic future or forward.

Derivation of notional positions: Futures, forwards or synthetic futures on a basket or index of debt securities

BIPRU 7.2.14RRP

Futures, forwards or synthetic futures on a basket or index of debt securities must be converted into forwards on single debt securities as follows (and then the resulting positions must be treated under BIPRU 7.2.13R):

  1. (1)

    futures, synthetic futures or forwards on a single currency basket or index of debt securities must be treated as either:

    1. (a)

      a series of forwards, one for each of the constituent debt securities in the basket or index, of an amount which is a proportionate part of the total underlying the contract according to the weighting of the relevant debt security in the basket; or

    2. (b)

      a single forward on a notional debt security; and

  2. (2)

    futures, synthetic futures or forwards on multiple currency baskets or indices of debt securities must be treated as either:

    1. (a)

      a series of forwards (using the method described in (1)(a)); or

    2. (b)

      a series of forwards, each one on a notional debt security to represent one of the currencies in the basket or index, of an amount which is a proportionate part of the total underlying the contract according to the weighting of the relevant currency in the basket.

BIPRU 7.2.15GRP

Under BIPRU 7.2.14R(2)(b), a forward on basket of three Euro denominated debt securities and two Dollar denominated debt securities would be treated as a forward on a single notional Euro denominated debt security and a forward on a single notional Dollar denominated debt security.

BIPRU 7.2.16RRP

The notional debt securities in BIPRU 7.2.14R are assigned a specific risk PRA and a general market risk PRA equal to the highest that would apply to the debt securities in the basket or index.

BIPRU 7.2.17GRP

The debt security with the highest specific risk PRA within the basket might not be the same as the one with the highest general market risk PRA. BIPRU 7.2.16R requires a firm to select the highest percentages even where they relate to different debt securities in the basket or index, and regardless of the proportion of those debt securities in the basket or index.

Derivation of notional positions: Interest rate futures and forward rate agreements (FRAs)

BIPRU 7.2.18RRP

Interest rate futures or FRAs must be treated as the two notional positions (one long, one short) shown in the table in BIPRU 7.2.19R.

BIPRU 7.2.19RRP

Table: Interest rate futures and FRAs

This table belongs to BIPRU 7.2.18R

A short position in a zero coupon zero-specific-risk security

A long position in a zero coupon zero-specific-risk security

Where the firm buys an interest rate future or sells an FRA

Maturity equals the expiry date of the future (or settlement date of the FRA)

Maturity equals the expiry date of the future (or settlement date of the FRA) plus the maturity of the notional borrowing/deposit

Where the firm sells an interest rate future or buys an FRA

Maturity equals the expiry date of the future (or settlement date of the FRA) plus the maturity of the notional borrowing/deposit

Maturity equals the expiry date of the future (or settlement date of the FRA)

BIPRU 7.2.20GRP

  1. (1)

    The following example illustrates BIPRU 7.2.18R and BIPRU 7.2.19R in conjunction with BIPRU 7.2.11R (the last rule determines the value of notional positions). A firm sells £1mn notional of a 3v6 FRA at 6%. This results in:

    1. (a)

      a short position in a zero-specific-risk security with a zero coupon, three month maturity, and a nominal amount of £1million; and

    2. (b)

      a long position in a zero-specific-risk security with a zero coupon, six month maturity, and nominal amount of £1,015,000 (i.e. notional plus interest at 6% over 90 days).

  2. (2)

    If a firm were to apply the approach in BIPRU 7.2.11R(2)(a) the two nominal amounts would have to be present valued.

Derivation of notional positions: Interest rate swaps or foreign currency swaps

BIPRU 7.2.21RRP

Interest rate swaps or foreign currency swaps without deferred starts must be treated as the two notional positions (one long, one short) shown in the table in BIPRU 7.2.22R.

BIPRU 7.2.22RRP

Table: Interest rate and foreign currency swaps

This table belongs to BIPRU 7.2.21R

Paying leg (which must be treated as a short position in a zero-specific-risk security)

Receiving leg (which must be treated as a long position in a zero-specific-risk security)

Receiving fixed and paying floating

Coupon equals the floating rate and maturity equals the reset date

Coupon equals the fixed rate of the swap and maturity equals the maturity of the swap

Paying fixed and receiving floating

Coupon equals the fixed rate of the swap and maturity equals the maturity of the swap

Coupon equals the floating rate and maturity equals the reset date

Paying floating and receiving floating

Coupon equals the floating rate and maturity equals the reset date

Coupon equals the floating rate and maturity equals the reset date

BIPRU 7.2.23GRP

For a foreign currency swap, the two notional zero-specific-risk securities would be denominated in different currencies. A foreign currency swap is also included in the foreign currency PRR1 calculation.

Derivation of notional positions: Deferred start interest rate swaps or foreign currency swaps

BIPRU 7.2.24RRP

Interest rate swaps or foreign currency swaps with a deferred start must be treated as the two notional positions (one long, one short) shown in the table in BIPRU 7.2.25R.

BIPRU 7.2.25RRP

Table: Deferred start interest rate and foreign currency swaps

This table belongs to BIPRU 7.2.24R

Paying leg (which must be treated as a short position in a zero-specific-risk security with a coupon equal to the fixed rate of the swap)

Receiving leg (which must be treated as a long position in a zero-specific-risk security with a coupon equal to the fixed rate of the swap)

Receiving fixed and paying floating

maturity equals the start date of the swap

maturity equals the maturity of the swap

Paying fixed and receiving floating

maturity equals the maturity of the swap

maturity equals the start date of the swap

BIPRU 7.2.26GRP

An example of BIPRU 7.2.24R is as follows. A firm enters into a five year swap which starts in two year's time. The firm has contracted to receive 6% and pay six month Libor on a principal amount of £1 million. This results in a long position in a 7 year debt security and a short position in a 2 year debt security. Both have a coupon of 6%. BIPRU 7.2.24R deals with the capital treatment of the delayed start date; once the swap has started, BIPRU 7.2.21R applies.

Derivation of notional positions: Swaps where only one leg is an interest rate leg (e.g. equity swaps)

BIPRU 7.2.27RRP

A firm must treat a swap with only one interest rate leg as a notional position in a zero-specific-risk security:

  1. (1)

    with a coupon equal to that on the interest rate leg;

  2. (2)

    with a maturity equal to the date that the interest rate will be reset; and

  3. (3)

    which is a long position if the firm is receiving interest payments and short if making interest payments.

BIPRU 7.2.28GRP

BIPRU 7.2.27R includes equity swaps, commodity swaps and any other swap where only one leg is an interest rate leg.

Derivation of notional positions: Cash legs of repurchase agreements and reverse repurchase agreements

BIPRU 7.2.29GRP

Firms are reminded that for the purposes of BIPRU 7.2.30R, a repurchase agreement includes a sell/buy back or stock lending; and a reverse repurchase agreement includes a buy/sell back or a stock borrowing.

BIPRU 7.2.30RRP

The forward cash leg of a repurchase agreement or reverse repurchase agreement must be treated as a notional position in a zero-specific-risk security which:

  1. (1)

    is a short notional position in the case of a repurchase agreement; and a long notional position in the case of a reverse repurchase agreement;

  2. (2)

    has a value equal to the market value of the cash leg;

  3. (3)

    has a maturity equal to that of the repurchase agreement or reverse repurchase agreement; and

  4. (4)

    has a coupon equal to:

    1. (a)

      zero, if the next interest payment date coincides with the maturity date; or

    2. (b)

      the interest rate on the contract, if any interest is due to be paid before the maturity date.

Derivation of notional positions: Cash borrowings and deposits

BIPRU 7.2.31RRP

A cash borrowing or deposit must be treated as a notional position in a zero coupon zero-specific-risk security which:

  1. (1)

    is a short position in the case of a borrowing and a long position in the case of a deposit;

  2. (2)

    has a value equal to the market value of the borrowing or deposit;

  3. (3)

    has a maturity equal to that of the borrowing or deposit, or the next date the interest rate is reset (if earlier); and

  4. (4)

    has a coupon equal to:

    1. (a)

      zero, if the next interest payment date coincides with the maturity date; or

    2. (b)

      the interest rate on the borrowing or deposit, if any interest is due to be paid before the maturity date.

Derivation of notional positions: Options and warrants

BIPRU 7.2.32RRP

  1. (1)

    Where included in the PRR calculation in BIPRU 7.2 (see the table in BIPRU 7.2.4R), options and warrants must be treated in accordance with this rule.

  2. (2)

    An option or warrant on a debt security, a basket of debt securities or a debt security index must be treated as a position in that debt security, basket or index.

  3. (3)

    An option on an interest rate must be treated as a position in a zero coupon zero-specific-risk security with a maturity equal to the sum of the time to expiry of the option and the length of the period for which the interest rate is fixed.

  4. (4)

    An option on a future - where the future is based on an interest rate or debt security - must be treated as:

    1. (a)

      a long position in that future for purchased call options and written put options; and

    2. (b)

      a short position in that future for purchased put options and written call options.

  5. (5)

    An option on a swap must be treated as a deferred starting swap.

Derivation of notional positions: Bonds where the coupons and principal are paid in different currencies

BIPRU 7.2.33RRP

Where a debt security pays coupons in one currency, but will be redeemed in a different currency, it must be treated as:

  1. (1)

    a debt security denominated in the coupon's currency; and

  2. (2)

    a foreign currency forward to capture the fact that the debt security's principal will be repaid in a different currency from that in which it pays coupons, specifically:

    1. (a)

      a notional forward sale of the coupon currency and purchase of the redemption currency, in the case of a long position in the debt security; or

    2. (b)

      a notional forward purchase of the coupon currency and sale of the redemption currency, in the case of a short position in the debt security.

Derivation of notional positions: Interest rate risk on other futures, forwards and options

BIPRU 7.2.34RRP

Other futures, forwards, options and swaps treated under BIPRU 7.2 must be treated as positions in zero-specific-risk securities, each of which:

  1. (1)

    has a zero coupon;

  2. (2)

    has a maturity equal to that of the relevant contract; and

  3. (3)

    is long or short according to the table in BIPRU 7.2.35R.

BIPRU 7.2.35RRP

Table: Interest rate risk on other futures, forwards, options and swaps

This table belongs to BIPRU 7.2.34R.

Instrument

Notional positions

foreign currency forward or future

a long position denominated in the currency purchased

and

a short position denominated in the currency sold

Gold forward or future

a long position if the forward or future involves an actual (or notional) sale of gold

or

a short position if the forward or future involves an actual (or notional) purchase of gold

Equity forward or future, or option (unless the interest rate PRR is calculated under the basic interest rate PRR calculation in BIPRU 7.3)

A long position if the contract involves an actual (or notional) sale of the underlying equity

or

A short position if the contract involves an actual (or notional) purchase of the underlying equity

Deriving the net position in each debt security: General

BIPRU 7.2.36RRP

The net position in a debt security is the difference between the value of the firm's long positions (including notional positions) and the value of its short positions (including notional positions) in the same debt security.

Deriving the net position in each debt security: Netting positions in the same debt security

BIPRU 7.2.37RRP
  1. (1)

    A firm must not net positions (including notional positions) unless those positions are in the same debt security. This rule sets out the circumstances in which debt securities may be treated as the same for these purposes.

  2. (2)

    Subject to (3) long and short positions are in the same debt security, and a debt security is the same as another if and only if:

    1. (a)

      they enjoy the same rights in all respects; and

    2. (b)

      are fungible with each other.

  3. (3)

    Long and short positions in different tranches of the same debt security may be treated as being in the same debt security for the purpose of (1) where:

    1. (a)

      the tranches enjoy the same rights in all respects; and

    2. (b)

      the tranches become fungible within 180 days and thereafter the debt security of one tranche can be delivered in settlement of the other tranche.

Deriving the net position in each debt security: Netting the cheapest to deliver security with other deliverable securities

BIPRU 7.2.38RRP

A firm may net a short notional position in the cheapest to deliver security arising from a short future or forward (see BIPRU 7.2.13R(2)(a)) under which the seller has a choice of which debt security it may use to settle its obligations against a long position in any deliverable security up to a maximum of 90% of the common nominal amounts. The residual long and short nominal amounts must be treated as separate long and short positions.

BIPRU 7.2.39RRP

The netting permitted by BIPRU 7.2.38R only relates to where the firm has sold the future or forward. It does not relate to where the firm has bought a future or forward.

Deriving the net position in each debt security: Netting zero-specific-risk securities with different maturities

BIPRU 7.2.40RRP

A firm may net a notional long position in a zero-specific-risk security against a notional short position in a zero-specific-risk security if:

  1. (1)

    they are denominated in the same currency;

  2. (2)

    their coupons do not differ by more than 15 basis points; and

  3. (3)

    they mature:

    1. (a)

      on the same day, if they have residual maturities of less than one month;

    2. (b)

      within 7 days of each other, if they have residual maturities of between one month and one year; and

    3. (c)

      within 30 days of each other, if they have residual maturities in excess of one year.

Deriving the net position in each debt security: Reduced net underwriting positions in debt securities

BIPRU 7.2.41RRP

A firm must not net a reduced net underwriting position in a debt security with any other debt security position.

BIPRU 7.2.42G

Specific risk calculation

BIPRU 7.2.43RRP

  1. (1)

    A firm must calculate the specific risk portion of the interest rate PRR for each debt security by multiplying the market value of the individual net position (ignoring the sign) by the appropriate PRA from the table in BIPRU 7.2.44R or as specified by BIPRU 7.2.45R - BIPRU 7.2.47R.

  2. (2)

    Notional positions in zero-specific-risk securities do not attract specific risk.

BIPRU 7.2.44RRP

Table: specific risk PRAs

This table belongs to BIPRU 7.2.43R.

Issuer

Residual maturity

PRA

Debt securities issued or guaranteed by central governments, issued by central banks, international organisations, multilateral development banks or EEA States' regional governments or local authorities which would qualify for credit quality step 1 or which would receive a 0% risk weight under the standardised approach to credit risk.

Any

0%

(A) Debt securities issued or guaranteed by central governments, issued by central banks, international organisations, multilateral development banks or EEA States' regional governments or local authorities which would qualify for credit quality step 2 or 3 under the standardised approach to credit risk.

(B) Debt securities issued or guaranteed by institutions which would qualify for credit quality step 1 or 2 under the standardised approach to credit risk.

(C) Debt securities issued or guaranteed by institution which would qualify for credit quality step 3 under BIPRU 3.4.34 R (Exposures to institutions: Credit assessment based method) or which would do so if it had an original effective maturity of three months or less.

(D) Debt securities issued or guaranteed by corporates which would qualify for credit quality step 1 or 2 under the standardised approach to credit risk.

(E) Other qualifying debt securities (see BIPRU 7.2.49R)

Zero to six months

0.25%

over 6 and up to and including 24 months

1%

Over 24 months

1.6%

(A) Debt securities issued or guaranteed by central governments, issued by central banks, international organisations, multilateral development banks or EEA States' regional governments or local authorities or institutions which would qualify for credit quality step 4 or 5 under the standardised approach to credit risk.

(B) Debt securities issued or guaranteed by corporates which would qualify for credit quality step 3 or 4 under the standardised approach to credit risk.

(C) Exposures for which a credit assessment by a nominated ECAI is not available.

Any

8%

(A) Debt securities issued or guaranteed by central governments, issued by central banks, international organisations, multilateral development banks or EEA States' regional governments or local authorities or institution which would qualify for credit quality step 6 under the standardised approach to credit risk.

(B) Debt securities issued or guaranteed by corporate which would qualify for credit quality step 5 or 6 under the standardised approach to credit risk.

(C) An instrument that shows a particular risk because of the insufficient solvency of the issuer of liquidity. This paragraph applies even if the instrument would otherwise qualify for a lower PRA under this table.

Any

12%

Note: The question of what a corporate is and of what category a debt security falls into must be decided under the rules relating to the standardised approach to credit risk.

BIPRU 7.2.45RRP

To the extent that a firm applies the IRB approach, to qualify for a credit quality step for the purpose of the table in BIPRU 7.2.44R the obligor of the exposure must have an internal rating with a PD equivalent to or lower than that associated with the appropriate credit quality step under the standardised approach to credit risk.

BIPRU 7.2.46RRP

A debt security issued by a non-qualifying issuer must receive a specific risk PRA of 8% or 12% according to the table in BIPRU 7.2.44R. However a firm must apply a higher specific risk PRA to such a debt security and/or not recognise offsetting for the purposes of defining the extent of general market risk between such a security and any other debt securities to the extent that doing otherwise would not be a prudent treatment of specific risk or general market risk.

BIPRU 7.2.47R

A securitisation exposures that would be subject to a deduction treatment under the treatment set out in GENPRU 2.2 (Capital resources) or risk weighted at 1250% as set out in BIPRU 9 (Securitisation) is subject to a capital charge that is no less than that set out under those treatments. Unrated1 liquidity facilities are subject to a capital charge that is no less than that set out in BIPRU 9.

BIPRU 7.2.48G

BIPRU 7.2.43R includes both actual and notional positions. However, notional positions in zero-specific-risk security do not attract specific risk. For example:

  1. (1)

    interest rate swaps, foreign currency swaps, FRAs, interest rate futures, foreign currency forwards, foreign currency futures, and the cash leg of repurchase agreements and reverse repurchase agreements create notional positions which will not attract specific risk; whilst

  2. (2)

    futures, forwards and swaps which are based on the price (or yield) of one or more debt securities will create at least one notional positions that attracts specific risk.

Definition of a qualifying debt security

BIPRU 7.2.49RRP

A debt security is a qualifying debt security if:

  1. (1)

    it qualifies for a credit quality step under the standardised approach to credit risk corresponding at least to investment grade; or

  2. (2)

    it has a PD which, because of the solvency of the issuer, is not higher than that of the debt securities referred to under (1) under the IRB approach; or

  3. (3)

    it is a debt security for which a credit assessment by a nominated ECAI is unavailable and which meets the following conditions:

    1. (a)

      it is considered by the firm to be sufficiently liquid;

    2. (b)

      it is of investment quality, according to the firm's own discretion, at least equivalent to that of the debt securities referred to under (1); and

    3. (c)

      it is listed on at least one regulated market or designated investment exchange; or

  4. (4)

    it is a debt security issued by an institution subject to the capital adequacy requirements set out in the Banking Consolidation Directive that satisfies the following conditions:

    1. (a)

      it is considered by the firm to be sufficiently liquid;

    2. (b)

      its investment quality is, according to the firm's own discretion, at least equivalent to that of the assets referred to under (1) above; or

  5. (5)

    it is a debt security issued by an institution that is deemed to be of equivalent or higher credit quality than that associated with credit quality step 2 under the standardised approach to credit risk and that is subject to supervision and regulatory arrangements comparable to those under the Capital Adequacy Directive.

BIPRU 7.2.50RRP

A firm must not treat a debt security as a qualifying debt security if it would be prudent to consider that the debt security concerned is subject to too high a degree of specific risk for it to be treated as a qualifying debt security.

BIPRU 7.2.51GRP

The manner in which a firm assesses a debt security for the purpose of treatment as a qualifying debt security will be subject to scrutiny by the FSA. The FSA may take action to overturn the firm's judgement if it considers that the debt security should not be treated as a qualifying debt security.

General market risk calculation: General

BIPRU 7.2.52RRP

A firm must calculate the general market risk portion of the interest rate PRR for each currency using either:

  1. (1)

    the interest rate simplified maturity method;

  2. (2)

    the interest rate maturity method; or

  3. (3)

    the interest rate duration method.

BIPRU 7.2.53R
BIPRU 7.2.54RRP

A firm must not use the interest rate duration method for index-linked securities. Instead, these securities must:

  1. (1)

    be attributed a coupon of 3%; and

  2. (2)

    be treated separately under either the interest rate simplified maturity method or the interest rate maturity method.

General market risk calculation: Simplified maturity method

BIPRU 7.2.55GRP

The interest rate simplified maturity method weights individual net positions to reflect their price sensitivity to changes in interest rates. The weights are related to the coupon and the residual maturity of the instrument (or the next interest rate re-fix date for floating rate items).

BIPRU 7.2.56RRP

Under the interest rate simplified maturity method, the portion of the interest rate PRR for general market risk equals the sum of each individual net position (long or short) multiplied by the appropriate PRA in the table in BIPRU 7.2.57R. A firm must assign its net positions to the appropriate maturity bands in the table in BIPRU 7.2.57R on the basis of residual maturity in the case of fixed-rate instruments and on the basis of the period until the interest rate is next set in the case of instruments on which the interest rate is variable before final maturity.

BIPRU 7.2.57RRP

Table: general market risk PRAs

This table belongs to BIPRU 7.2.56R.

Zone

Maturity band

PRA

Coupon of 3% or more

Coupon of less than 3%

One

0 ≤ 1 month

0 ≤ 1 month

0.00%

> 1 ≤ 3 months

> 1 ≤ 3 months

0.20%

> 3 ≤ 6 months

> 3 ≤ 6 months

0.4%

> 6 ≤ 12 months

> 6 ≤ 12 months

0.7%

Two

> 1 ≤ 2 years

> 1.0 ≤ 1.9 years

1.25%

> 2 ≤ 3 years

> 1.9 ≤ 2.8 years

1.75%

> 3 ≤ 4 years

> 2.8 ≤ 3.6 years

2.25%

Three

> 4 ≤ 5 years

> 3.6 ≤ 4.3 years

2.75%

> 5 ≤ 7 years

> 4.3 ≤ 5.7 years

3.25%

> 7 ≤ 10 years

> 5.7 ≤ 7.3 years

3.75%

> 10 ≤ 15 years

> 7.3 ≤ 9.3 years

4.5%

> 15 ≤ 20 years

> 9.3 ≤ 10.6 years

5.25%

> 20 years

> 10.6 ≤ 12.0 years

6.00%

> 12.0 ≤ 20.0 years

8.00%

> 20 years

12.50%

General market risk calculation: The maturity method

BIPRU 7.2.58GRP

The interest rate maturity method builds on the interest rate simplified maturity method by partially recognising offsetting positions. BIPRU 7.2.61G provides an illustration of the interest rate maturity method.

BIPRU 7.2.59RRP

Under the interest rate maturity method, the portion of the interest rate PRR for general market risk is calculated as follows:

  1. (1)

    Step 1: each net position is allocated to the appropriate maturity band in the table in BIPRU 7.2.57R and multiplied by the corresponding PRA;

  2. (2)

    Step 2: weighted long and short positions are matched within:

    1. (a)

      the same maturity band;

    2. (b)

      the same zone (using unmatched positions from (a)); and

    3. (c)

      different zones (using unmatched positions from (b) and matching between zones 1 and 2 and 2 and 3 before zone 1 and 3); and

  3. (3)

    Step 3: the portion of the interest rate PRR for general market risk is the sum of:

    1. (a)

      10% of the total amount matched within maturity bands;

    2. (b)

      40% of the amount matched within zone 1 under (2)(b);

    3. (c)

      30% of the amount matched within zones 2 & 3 under (2)(b);

    4. (d)

      40% of the amounts matched between zones 1 and 2, and between zones 2 and 3;

    5. (e)

      150% of the amount matched between zones 1 and 3; and

    6. (f)

      100% of the weighted positions remaining unmatched after (2)(c).

BIPRU 7.2.60GRP

The table in BIPRU 7.2.57R distinguishes between debt securities with a coupon of less than 3% and those with coupon in excess of 3%. However, this does not mean that the firm has to do a separate general market risk calculation for each; it merely ensures that when allocating debt securities to a particular band, their coupons are taken into account as well as their maturities. So for example, a 21 year 6% debt security falls into the same band as an 11 year 2% debt security. They are both weighted at 6%, and can be matched under BIPRU 7.2.59R(2)(a) (the first part of step two of the interest rate maturity method calculation) because they fall within the same band.

BIPRU 7.2.61GRP

This paragraph sets out an example of a calculation under the interest rate maturity method. In this example, a firm with a £ sterling base currency is processing its euro denominated positions.

BIPRU_Chapter_7_001rev

General market risk calculation: Duration method

BIPRU 7.2.62GRP

The interest rate duration method produces a more accurate measure of interest rate risk than the maturity methods but it is also more complex to calculate.

BIPRU 7.2.63RRP

  1. (1)

    A firm must use the following formula to calculate modified duration for the purpose of the interest rate duration method:

    BIPRU_Chapter_7_002rev1
  2. (2)
    BIPRU_Chapter_7_003rev
  3. (3)

    For the purpose of the formulae in (1) and (2):

    1. (a)

      Ct=cash payment at time t

    2. (b)

      m=total maturity

    3. (c)

      r=yield to maturity. In the case of a fixed-rate debt security a firm must take the current mark to market of the debt security and thence calculate its yield to maturity, which is the implied discount rate for that instrument. In the case of a floating rate instrument, a firm must take the current mark to market of the debt security and thence calculate its yield on the assumption that the principal is due on the date that the interest rate can next be changed.

    4. (d)

      t=time

BIPRU 7.2.64RRP

Under the interest rate duration method, the portion of the interest rate PRR for general market risk is calculated as follows:

  1. (1)

    Step 1: allocate each net position to the appropriate duration zone in the table in BIPRU 7.2.65R and multiply it by:

    1. (a)

      its modified duration (using the formula in BIPRU 7.2.63R); and

    2. (b)

      the appropriate assumed interest rate change in the table in BIPRU 7.2.65R;

  2. (2)

    Step 2: match weighted long and short positions:

    1. (a)

      within zones; and

    2. (b)

      across zones (using unmatched positions from (2)(a) and following the process in BIPRU 7.2.59R (2)(c)); and

  3. (3)

    Step 3: calculate the portion of the interest rate PRR for general market risk as the sum of:

    1. (a)

      100% of the weighted positions remaining unmatched after (2)(b);

    2. (b)

      2% of the matched weighted position in each zone;

    3. (c)

      40% of the matched weighted position between zones 1 and 2, and between zones 2 and 3; and

    4. (d)

      150% of the matched weighted position between zones 1 and 3.

BIPRU 7.2.65RRP

Table: Assumed interest rate change in the interest rate duration method

This table belongs to BIPRU 7.2.64R

Zone

Modified Duration

Assumed interest rate change

(percentage points)

1

0 ≤ 12 months

1.00

2

> 12 months ≤ 3.6 years

0.85

3

> 3.6 years

0.70

BIPRU 7.2.66RRP

If a firm uses the interest rate duration method it must do so on a consistent basis.