BIPRU 7.7 Position risk requirements for collective investment undertakings

Collective investment undertaking PRR calculation

BIPRU 7.7.1R

A firm must calculate its CIU PRR by:

  1. (1)

    identifying which CIU positions must be included within the scope of the PRR calculation (see BIPRU 7.7.2R);

  2. (2)

    identifying which CIU positions are to be subject to the CIU PRR and which positions are to be subject to one of the other PRR charges;

  3. (3)

    converting on a daily basis net positions into the firm's base currency at the prevailing spot exchange rate before their aggregation;

  4. (4)

    calculating an individual PRR for each position in a CIU (see BIPRU 7.7.5R);

  5. (5)

    summing the resulting individual PRRs.

Scope of the PRR calculation for collective investment undertakings

BIPRU 7.7.2R

  1. (1)

    A firm's PRR calculation must include all trading book positions in CIUs.

  2. (2)

    A firm's CIU PRR calculation must include all trading book positions in CIUs unless they are treated under one of the CIU look through methods and included in the PRR calculations for the relevant underlying investments or subject to an option PRR.

  3. (3)

    A firm's PRR calculation for CIUs must include notional positions arising from trading book positions in options or warrants on collective investment undertakings.

General rules

BIPRU 7.7.3R

Unless noted otherwise, no netting is permitted between the underlying investments of a CIU and other positions held by a firm for the purposes of calculating the PRR charge for a position in a CIU.

BIPRU 7.7.4R

A firm may rely on a third party to calculate and report PRR capital requirements for position risk (general market risk and specific risk) for positions in CIUs falling within BIPRU 7.7.9R and BIPRU 7.7.11R, in accordance with the methods set out in BIPRU 7.7, provided that the correctness of the calculation and the report is adequately ensured.

Calculation of the collective investment undertaking PRR

BIPRU 7.7.5R

Without prejudice to other provisions in BIPRU 7.7, a position in a CIU is subject to a collective investment undertaking PRR (general market risk and specific risk) of 32%. Without prejudice to provisions in BIPRU 7.5.18R (Foreign currency PRR for CIUs) or, if the firm has a VaR model permission, BIPRU 7.10.44R (Commodity risks and VaR models) taken together with BIPRU 7.5.18R, where the modified gold treatment set out in those rules is used, a position in a CIU is subject to a securities PRR requirement for position risk (general market risk and specific risk ) and a foreign currency PRR1 of no more than 40%.

Look through methods: General criteria

BIPRU 7.7.6R

A firm may determine the securities PRR requirement for positions in CIUs which meet the criteria set out in BIPRU 7.7.7R, by one of the following methods:

  1. (1)

    the standard CIU look through method (BIPRU 7.7.4R and BIPRU 7.7.7R - BIPRU 7.7.10R); or

  2. (2)

    the modified CIU look through method (BIPRU 7.7.4R, BIPRU 7.7.7R - BIPRU 7.7.8R and BIPRU 7.7.11R - BIPRU 7.7.12R).

BIPRU 7.7.7R

The general eligibility criteria for using the methods in BIPRU 7.7.4R and BIPRU 7.7.9R - BIPRU 7.7.11R, for CIUs issued by companies supervised or incorporated within the EEA are that:

  1. (1)

    the CIU's prospectus or equivalent document must include:

    1. (a)

      the categories of assets the CIU is authorised to invest in;

    2. (b)

      if investment limits apply, the relative limits and the methodologies to calculate them;

    3. (c)

      if leverage is allowed, the maximum level of leverage; and

    4. (d)

      if investment in OTC financial derivatives or repo-style transactions are allowed, a policy to limit counterparty risk arising from these transactions;

  2. (2)

    the business of the CIU must be reported in half-yearly and annual reports to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period;

  3. (3)

    the units/shares of the CIU are redeemable in cash, out of the undertaking's assets, on a daily basis at the request of the Unitholder;

  4. (4)

    investments in the CIU must be segregated from the assets of the CIU manager; and

  5. (5)

    there must be adequate risk assessment, by the investing firm, of the CIU.

BIPRU 7.7.8R

Third country CIUs are eligible if the requirements in BIPRU 7.7.7R (1) - BIPRU 7.7.7R (5) are met.

Standard CIU look through method: General

BIPRU 7.7.9R

  1. (1)

    Where a firm is aware of the underlying investments of the CIU on a daily basis the firm may look through to those underlying investments in order to calculate the securities PRR for position risk (general market risk and specific risk) for those positions in accordance with the methods set out in the securities PRR requirements or, if the firm has a VaR model permission, in accordance with the methods set out in BIPRU 7.10 (Use of a Value at Risk Model).

  2. (2)

    Under this approach, positions in CIUs must be treated as positions in the underlying investments of the CIU. Netting is permitted between positions in the underlying investments of the CIU and other positions held by the firm, as long as the firm holds a sufficient quantity of units to allow for redemption/creation in exchange for the underlying investments.

Standard CIU look through method: Index or basket funds

BIPRU 7.7.10R

  1. (1)

    A firm may calculate the securities PRR for position risk (general market risk and specific risk) for positions in CIUs in accordance with the methods set out in the securities PRR requirements or, if the firm has a VaR model permission, in accordance with the methods set out in BIPRU 7.10 (Use of a Value at Risk Model), to assumed positions representing those necessary to replicate the composition and performance of the externally generated index or fixed basket of equities or debt securities referred to in (a), subject to the following conditions:

    1. (a)

      the purpose of the CIU's mandate is to replicate the composition and performance of an externally generated index or fixed basket of equities or debt securities; and

    2. (b)

      a minimum correlation of 0.9 between daily price movements of the CIU and the index or basket of equities or debt securities it tracks can be clearly established over a minimum period of six months.

  2. (2)

    Correlation as referred to in (1)(b) means the correlation coefficient between daily returns on the CIU and the index or basket of equities or debt securities it tracks.

CIU modified look through method

BIPRU 7.7.11R

Where a firm is not aware of the underlying investments of the CIU on a daily basis, the firm may calculate the securities PRR for position risk (general market risk and specific risk) in accordance with the methods set out in the securities PRR requirements, subject to the following conditions:

  1. (1)

    it must be assumed that the CIU first invests to the maximum extent allowed under its mandate in the asset classes attracting the highest securities PRR for position risk (general market risk and specific risk), and then continues making investments in descending order until the maximum total investment limit is reached;

  2. (2)

    the firm must take account of the maximum indirect exposure that it could achieve by taking leveraged positions through the CIU when calculating its securities PRR for position risk, by proportionally increasing the position in the CIU up to the maximum exposure to the underlying investment items resulting from the investment mandate; and

  3. (3)

    should the securities PRR for position risk (general market risk and specific risk) under this approach exceed that set out in BIPRU 7.7.5R, the PRR charge must be capped at that level.

BIPRU 7.7.12R

For the purpose of BIPRU 7.7.11R (1) the position in the CIU must be treated as a direct holding in the assumed position.

CAD 1 models and VaR models

BIPRU 7.7.13G

Where BIPRU 7.7 permits a firm to calculate the PRR charge for a position in a CIU using the rules in BIPRU 7 relating to the underlying investment, a firm that has:

  1. (1)

    a CAD 1 model waiver that covers positions in CIUs may use the rules as modified by that waiver; and

  2. (2)

    a VaR model permission that covers positions in CIUs may use its VaR model.

Options on a CIU

BIPRU 7.7.14G

An option on a CIU should be treated in accordance with BIPRU 7.6.35R to BIPRU 7.6.37G (Options on a CIU).