BIPRU 7.3 Equity PRR and basic interest rate PRR for equity derivatives

1. (1)

   A firm must calculate its equity PRR by:

   1. (a)

      identifying which positions must be included within the PRR calculation (see BIPRU 7.3.2R);

   2. (b)

      deriving the net position in each equity in accordance with BIPRU 7.3.23R;

   3. (c)

      including each of those net positions in either the simplified equity method (see BIPRU 7.3.29R) or, subject to BIPRU 7.3.27R, the standard equity method (see BIPRU 7.3.32R); and

   4. (d)

      summing the PRR on each net position as calculated under the simplified equity method and standard equity method.

2. (2)

   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.

A firm's equity PRR calculation must:

1. (1)

   include all trading book positions in equities, unless:

   1. (a)

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

   2. (b)

      the position is hedging an option or warrant 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 7.3.3R; and

3. (3)

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

Unless specified otherwise, the value of each notional equity position equals the quantity of that equity underlying the instrument multiplied by the current market value of the equity.

A depository receipt must be treated as a notional position in the underlying equity.

Where a convertible is included in BIPRU 7.3's PRR calculation (see the table in BIPRU 7.3.3R):

1. (1)

   it must be treated as a position in the equity into which it converts; and

2. (2)

   the firm's equity PRR must be adjusted by making:

   1. (a)

      an addition equal to the current value of any loss which the firm would make if it did convert to equity; or

   2. (b)

      a deduction equal to the current value of any profit which the firm would make if it did convert to equity (subject to a maximum deduction equal to the PRR on the notional position underlying the convertible).

A future (including a synthetic future), forward or CFD on a single equity must be treated as a notional position in that equity.

A future (including a synthetic future), forward or CFD on an equity index or basket must be treated as either:

1. (1)

   a position in each of the underlying equities; or

2. (2)

   the positions shown in the table in BIPRU 7.3.16R.

The notional positions created under BIPRU 7.3.15R have the following values:

1. (1)

   where only one notional position is created, it has a value equal to the total market value of the equities underlying the contract; or

2. (2)

   where more than one notional position is created, each one has a value which reflects the relevant equity's or country's contribution to the total market value of the equities underlying the contract.

The equity leg of an equity swap must be treated as a position in the underlying equity, equity basket or equity index, which is:

1. (1)

   long, if the firm has contracted to receive any increase and pay any decrease in the value of the underlying equities or equity index; and

2. (2)

   short, if the firm has contracted to receive any decrease and pay any increase in the value of the underlying equities or equity index.

If included in BIPRU 7.3's PRR calculation (see the table in BIPRU 7.3.3R), options must be treated as follows:

1. (1)

   an option on a single equity must be treated as a notional position in that equity;

2. (2)

   an option on a basket of equities or equity index must be treated as a future on that basket or index; and

3. (3)

   an option on an equity future 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.

The net position in each equity 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 equity.

1. (1)

   When deriving the net position in each equity, a firm must not net long and short positions except in accordance with this rule.

2. (2)

   Subject to (3), a firm may net long and short positions in the same equity. Two equities are the same if and only if they:

   1. (a)

      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 equity may be treated as being in the same equity for the purpose of (1), where:

   1. (a)

      the tranches enjoy the same rights in all respects; and

   2. (b)

      the tranches become fungible with each other within 180 days, and thereafter the equity of one tranche can be delivered in settlement of the other tranche.

A firm must not net a reduced net underwriting position with any other equity position.

A firm must use the simplified equity method for reduced net underwriting positions.

Under the simplified equity method, the PRR for each equity, equity index, or equity basket equals the market value of the net position (ignoring the sign) multiplied by the appropriate PRA from the table in BIPRU 7.3.30R. The result must be converted into the firm's base currency at current spot foreign currency rates.

Under the standard equity method, a firm must:

1. (1)

   group equity positions into country portfolios as follows:

   1. (a)

      a position in an individual equity belongs to:

      1. (i)

         the country it is listed in;

      2. (ii)

         any of the countries it is listed in, if more than one; or

      3. (iii)

         the country it was issued from, if unlisted;

   2. (b)

      a position in an equity basket or index that is treated under BIPRU 7.3.15R(2), is allocated to one or more country portfolios based on the countries to which the underlying equities belong to under (a) or a notional country provided for in the table in BIPRU 7.3.16R; and

2. (2)

   sum:

   1. (a)

      the PRRs for specific risk calculated under BIPRU 7.3.33R; and

   2. (b)

      the PRRs for general market risk for each country portfolio as calculated under BIPRU 7.3.41R and BIPRU 7.3.42R.

Under the standard equity method, a firm must calculate a PRR for specific risk based on the net position in each equity, equity index or equity basket by multiplying its market value (ignoring the sign) by the appropriate PRA from the table in BIPRU 7.3.34R.

A qualifying equity index is one which is traded on a recognised investment exchange or a designated investment exchange and:

1. (1)

   is listed in the table in BIPRU 7.3.39R; or

2. (2)

   is not listed in the table in BIPRU 7.3.39R, but is constructed in such a way that:

   1. (a)

      it contains at least 20 equities;

   2. (b)

      no single equity represents more than 20% of the total index; and

   3. (c)

      no five equities combined represent more than 60% of the total index.

Under the standard equity method, a firm must apply approach one, as set out in BIPRU 7.3.41R, to each country portfolio (or part portfolio) unless the conditions in BIPRU 7.3.42R(3) are met, in which case the firm may instead apply approach two, as set out in BIPRU 7.3.42R, to the relevant country portfolios (or part portfolios).

Under approach one as referred to in BIPRU 7.3.40R, the PRR for general market risk equals the net value (ignoring the sign) of the country portfolio multiplied by 8%.

1. (1)

   Under approach two as referred to in BIPRU 7.3.40R, the PRR for general market risk is calculated using the following formula:


2. (2)

   In the formula in (1) CP_i denotes the net value of _ith country portfolio (converted to the firm's base currency using current spot foreign currency rates).

3. (3)

   The conditions referred to in BIPRU 7.3.40R that must be met for a firm to be able to use approach two as referred to in BIPRU 7.3.40R are as follows:

   1. (a)

      at least four country portfolios are included (that is: n 4);

   2. (b)

      only country portfolios for countries which are full members of the OECD, Hong Kong or Singapore are included;

   3. (c)

      no individual country portfolio comprises more than 30% of the total gross value of country portfolios included; and

   4. (d)

      the total net value of country portfolios included equals zero, that is:

   

This rule applies to a firm that does not include a forward, future, option or swap on an equity, basket of equities or equity index in the calculation of its interest rate PRR calculation under BIPRU 7.2 (Interest rate PRR). However it does not apply to cliquet as defined in BIPRU 7.6.18R (Table: Option PRR: methods for different types of option). A firm must calculate the interest rate PRR for a position being treated under this rule as follows:

1. (1)

   multiply the market value of the notional equity position underlying the instrument by the appropriate percentage from the table in BIPRU 7.3.47R; and

2. (2)

   sum the results from (1), ignoring the sign.

If a firm nets off positions in one or more of the equities constituting an equity index future, forward or CFD against one or more positions in the equity index future, forward or CFD itself, the firm must apply an additional equity PRR to the netted position to cover the risk of loss caused by the value of the future, forward or CFD not moving fully in line with that of its constituent equities. The same applies if a firm holds opposite positions in a future, forward or CFD on an equity index that are not identical in respect of either their maturity or their composition or both.