BIPRU 7.4 Commodity PRR

A firm must calculate its commodity PRR by:

1. (1)

   identifying which commodity position must be included within the scope of the PRR calculation (see BIPRU 7.4.2R);

2. (2)

   expressing each such position in terms of the standard unit of measurement of the commodity concerned;

3. (3)

   expressing the spot price in each commodity in the firm's base currency at current spot foreign exchange rates;

4. (4)

   calculating an individual PRR for each commodity (see BIPRU 7.4.20R); and

5. (5)

   summing the resulting individual PRRs.

A firm's commodity PRR calculation must, regardless of whether the positions concerned are trading book or non-trading book positions:

1. (1)

   include physical commodity positions;

2. (2)

   (if the firm is the transferor of commodities or guaranteed rights relating to title to commodities in a repurchase agreement or the lender of commodities in a commodities lending agreement) include such commodities;

3. (3)

   include notional positions arising from positions in the instruments listed in the table in BIPRU 7.4.4R; and

4. (4)

   exclude positions constituting a stock financing transaction.

Gold positions are excluded from the scope of the commodity PRR. Instead, they are included within the scope of the foreign exchange PRR (BIPRU 7.5).

Where a forward, future, CFD, synthetic future or option (unless already included in the firm's option PRR calculation) settles according to:

1. (1)

   the difference between the price set on trade date and that prevailing at contract expiry, the notional position:

   1. (a)

      equals the total quantity underlying the contract; and

   2. (b)

      has a maturity equal to the expiry date of the contract; and

2. (2)

   the difference between the price set on trade date and the average of prices prevailing over a certain period up to contract expiry, there is a notional position for each of the reference dates used in the averaging period to calculate the average price, which:

   1. (a)

      equals a fractional share of the total quantity underlying the contract; and

   2. (b)

      has a maturity equal to the relevant reference date.

Commitments to buy or sell at the average spot price of the commodity prevailing over some period between trade date and maturity must be treated as a combination of:

1. (1)

   a position equal to the full amount underlying the contract with a maturity equal to the maturity date of the contract which is:

   1. (a)

      long, where the firm will buy at the average price; or

   2. (b)

      short, where the firm will sell at the average price; and

2. (2)

   a series of notional positions, one for each of the reference dates where the contract price remains unfixed, each of which:

   1. (a)

      is long if the position under (1) is short, or short if the position under (1) is long;

   2. (b)

      equals a fractional share of the total quantity underlying the contract; and

   3. (c)

      has a maturity date of the relevant reference date.

Commodity index futures and commodity index options (unless the option is included in the firm's option PRR calculation), must be treated as follows:

1. (1)

   Step 1: the total quantity underlying the contract must be either:

   1. (a)

      treated as a single notional commodity position (separate from all other commodities); or

   2. (b)

      divided into notional positions, one for each of the constituent commodities in the index, of an amount which is a proportionate part of the total underlying the contract according to the weighting of the relevant commodity in the index;

2. (2)

   Step 2: each notional position determined in Step 1 must then be included:

   1. (a)

      when using the commodity simplified approach (BIPRU 7.4.24R), without adjustment; or

   2. (b)

      when using the commodity maturity ladder approach (BIPRU 7.4.25R) or the commodity extended maturity ladder approach (BIPRU 7.4.32R), with the adjustments in BIPRU 7.4.14R.

A firm must treat a commodity swap as a series of notional positions, one position for each payment under the swap, each of which:

1. (1)

   equals the total quantity underlying the contract;

2. (2)

   has a maturity corresponding to the payment date; and

3. (3)

   is long or short according to BIPRU 7.4.17R.

A firm must calculate a commodity PRR for each commodity separately using either the commodity simplified approach (BIPRU 7.4.24R), the commodity maturity ladder approach (BIPRU 7.4.25R) or the commodity extended maturity ladder approach (BIPRU 7.4.32R).

A firm must use the same approach for a particular commodity but need not use the same approach for all commodities.

1. (1)

   A firm must treat positions in different grades or brands of the same commodity-class as different commodities unless they:

   1. (a)

      can be delivered against each other; or

   2. (b)

      are close substitutes and have price movements which have exhibited a stable correlation coefficient of at least 0.9 over the last 12 months.

2. (2)

   If a firm relies on (1)(b) it must then monitor compliance with the conditions in that paragraph on a continuing basis.

If a firm intends to rely on the approach in BIPRU 7.4.22R(1)(b):

1. (1)

   it must notify the FSA in writing at least 20 business days prior to the date the firm starts relying on it; and

2. (2)

   the firm must, as part of the notification under (1), provide to the FSA the analysis of price movements on which it relies.

A firm which calculates a commodity PRR using the commodity simplified approach must do so by summing:

1. (1)

   15% of the net position multiplied by the spot price for the commodity; and

2. (2)

   3% of the gross position (long plus short, ignoring the sign) multiplied by the spot price for the commodity;

(and for these purposes the excess of a firm's long (short) positions over its short (long) positions in the same commodity (including notional positions under BIPRU 7.4.4R) is its net position in each commodity).

A firm using the commodity maturity ladder approach must calculate the commodity PRR following the steps in BIPRU 7.4.26R and then sum all spread charges, carry charges and outright charges that result. A firm must use a separate maturity ladder for each commodity.

1. (1)

   A firm must calculate the charges referred to in BIPRU 7.4.25R as follows.

2. (2)

   Step 1: offset long and short positions maturing:

   1. (a)

      on the same day; or

   2. (b)

      (in the case of positions arising under contracts traded in markets with daily delivery dates) within 10 business days of each other.

3. (3)

   Step 2: allocate the positions remaining after step 1 to the appropriate maturity band in the table in BIPRU 7.4.28R (physical commodity positions are allocated to band 1).

4. (4)

   Step 3: match long and short positions within each band. In each instance, calculate a spread charge equal to the matched amount multiplied first by the spot price for the commodity and then by the spread rate of 3%.

5. (5)

   Step 4: carry unmatched positions remaining after step 3 to another band where they can be matched, then match them. Do this until all matching possibilities are exhausted. In each instance, calculate:

   1. (a)

      a carry charge equal to the carried position multiplied by the spot price for the commodity, the carry rate of 0.6% and the number of bands by which the position is carried; and

   2. (b)

      a spread charge equal to the matched amount multiplied by the spot price for the commodity and the spread rate of 3%.

6. (6)

   Step 5: calculate the outright charge on the remaining positions (which will either be all long positions or all short positions). The outright charge equals the remaining position (ignoring the sign) multiplied by the spot price for the commodity and the outright rate of 15%.

A firm may use the commodity extended maturity ladder approach to calculate the commodity PRR for a particular commodity provided the firm:

1. (1)

   has a diversified commodities portfolio;

2. (2)

   undertakes significant commodities business;

3. (3)

   is not yet in a position to use the VaR model approach to calculate commodity PRR; and

4. (4)

   at least twenty business days before the date the firm uses that approach notifies the FSA in writing of:

   1. (a)

      its intention to use the commodity extended maturity ladder approach;1 and

   2. (b)

      the facts and matters relied on to demonstrate that the firm meets the criteria in (1) - (3).

A firm using the commodity extended maturity ladder approach must calculate its commodity PRR by:

1. (1)

   following the same steps as in BIPRU 7.4.26R but using the rates from the table in BIPRU 7.4.33R rather than those in BIPRU 7.4.26R; and

2. (2)

   summing all spread charges, carry charges and outright charge that result.

Where a firm is:

1. (1)

   treating a commodity index derivative as if it was based on a single separate commodity (see BIPRU 7.4.13R(1)(a)); and

2. (2)

   using the commodity extended maturity ladder approach to calculate the commodity PRR for that commodity;

it must determine which index constituent incurs the highest rate in the table in BIPRU 7.4.33R and apply that rate to the notional position for the purposes of BIPRU 7.4.32R.

If a short position to which BIPRU 7.4 applies falls due before a long position to which BIPRU 7.4 applies, a firm must also guard against the risk of a shortage of liquidity which may exist in some markets.

A firm must safeguard against other risks, apart from the delta risk, associated with commodity options.

The interest-rate and foreign-exchange risks not covered by other provisions of BIPRU 7.4 or by the provisions of BIPRU 7.2 (Interest rate PRR) or BIPRU 7.5 (Foreign currency PRR) must be included in the calculation of general market risk for traded debt securities and in the calculation of foreign currency PRR.