BIPRU 7.2 Interest rate PRR

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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 7.2.52R(3) is subject to BIPRU 7.2.54R.

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.

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.

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).

1. (1)

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

   
2. (2)
   
3. (3)

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

   1. (a)

      C_t=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

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.

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