MIFIDPRU 4.14 K-TCD requirement

1. (1)

   1The K-TCD requirement of a MIFIDPRU investment firm is an amount equal to the sum of the TCD own funds requirement for all transactions specified in (2).

2. (2)

   This rule applies to the transactions in MIFIDPRU 4.14.3R where the transactions:

   1. (a)

      are recorded in the trading book of a firm dealing on own account (whether for itself or on behalf of a client); or

   2. (b)

      in the case of the transactions specified in MIFIDPRU 4.14.3R(2)-(7), are carried out by a firm that has the necessary permissions to deal on own account.

1Subject to MIFIDPRU 4.14.5R, the transactions to which MIFIDPRU 4.14.1R applies are as follows:

1. (1)

   derivative contracts listed in Annex II to the UK CRR, with the exception of the following:

   1. (a)

      derivative contracts directly or indirectly cleared through a CCP, where all of the following conditions are met:

      1. (i)

         the positions and assets of the firm related to the contracts are distinguished and segregated, at the level of both the clearing member and the CCP, from the position and assets of the clearing member and the other clients of that clearing member and, as a result of that distinction and segregation, those positions and assets are bankruptcy remote under applicable law in the event of default or insolvency of the clearing member or one or more of its other clients;

      2. (ii)

         the legal requirements applicable to or binding the clearing member facilitate the transfer of the client’s positions relating to the contracts and of the corresponding collateral to another clearing member within the applicable margin period of risk in the event of default or insolvency of the original clearing member; and

      3. (iii)

         the firm has obtained an independent, written and reasoned legal opinion that concludes that, in the event of a legal challenge, the firm would bear no losses on account of the insolvency of its clearing member or of any of its clearing member’s clients;

   2. (b)

      exchange-traded derivative contracts; and

   3. (c)

      derivative contracts held for hedging a position of the firm resulting from an activity outside the trading book;

2. (2)

   long settlement transactions;

3. (3)

   repurchase transactions;

4. (4)

   securities or commodities lending or borrowing transactions;

5. (5)

   margin lending transactions;

6. (6)

   any other types of securities financing transactions; and

7. (7)

   credits and loans referred to in the activity in point 2 of paragraph 1 of Part 3A of Schedule 2 to the Regulated Activities Order, if the firm is:

   1. (a)

      executing the trade in the name of the client; or

   2. (b)

      receiving and transmitting the order without executing it.

1A derivative contract that is directly or indirectly cleared through an authorised central counterparty is deemed to meet the conditions in MIFIDPRU 4.14.3R(1)(a).

1The K-TCD requirement does not apply to transactions with the following counterparties:

1. (1)

   central governments and central banks, where the underlying exposures would receive a 0% risk weight under article 114 of the UK CRR;

2. (2)

   multilateral development banks listed in article 117(2) of the UK CRR; or

3. (3)

   international organisations listed in article 118 of the UK CRR.

1. (1)

   1With the prior consent of the FCA, a firm may exclude transactions with the following counterparties from the calculation of its K-TCD requirement under MIFIDPRU 4.14.1R:

   1. (a)

      its parent undertaking;

   2. (b)

      its subsidiary;

   3. (c)

      a subsidiary of its parent undertaking; or

   4. (d)

      an undertaking with which the firm is linked by majority common management.

2. (2)

   To obtain the FCA consent in (1), the firm must demonstrate all of the following to the satisfaction of the FCA:

   1. (a)

      the counterparty is subject to appropriate prudential requirements and is one of the following:

      1. (i)

         a credit institution;

      2. (ii)

         an investment firm; or

      3. (iii)

         a financial institution;

   2. (b)

      the counterparty is:

      1. (i)

         included in the same prudential consolidation group as the firm on a full basis in accordance with the UK CRR or the consolidation provisions in MIFIDPRU 2.5; or

      2. (ii)

         supervised along with the firm for compliance with the group capital test in MIFIDPRU 2.6;

   3. (c)

      the counterparty is subject to the same risk evaluation, measurement and control procedures as the firm;

   4. (d)

      the counterparty is established in the UK; and

   5. (e)

      there is no current or foreseen material practical or legal impediment to the prompt transfer of own funds or repayment of liabilities from the counterparty to the firm.

3. (3)

   To apply for FCA consent under (1), a firm must complete the form in MIFIDPRU 4 Annex 10R and submit it using the online notification and application system.

1The TCD own funds requirement for each transaction or netting set must be calculated using the following formula:

TCD own funds requirement = α * EV * RF * CVA

where:

1. (1)

   α = 1.2

2. (2)

   EV = the exposure value calculated in accordance with MIFIDPRU 4.14.8R

3. (3)

   RF = the risk factor applicable to the counterparty type as set out in the table in MIFIDPRU 4.14.29R

4. (4)

   CVA = the credit valuation adjustment calculated in accordance with MIFIDPRU 4.14.30R

1The exposure value must be calculated using the following formula:

Exposure value = Max (0; RC + PFE – C)

where:

1. (1)

   RC = the replacement cost calculated in accordance with MIFIDPRU 4.14.9R (which may be a positive value, thereby increasing the exposure value, or a negative value, thereby decreasing the exposure value)

2. (2)

   PFE = potential future exposure calculated in accordance with MIFIDPRU 4.14.10R

3. (3)

   C = collateral as determined in accordance with MIFIDPRU 4.14.24R and MIFIDPRU 4.14.25R (which may be a positive value, thereby decreasing the exposure value, or a negative value, thereby increasing the exposure value)

1. (1)

   1A firm must calculate the replacement cost for all transactions referred to in MIFIDPRU 4.14.3R.

2. (2)

   The replacement cost must be determined as follows:

   1. (a)

      for derivative contracts, the replacement cost is the CMV;

   2. (b)

      for long settlement transactions, the replacement cost is the settlement amount of cash to be paid or to be received by the firm upon settlement, with a receivable being treated as a positive amount and a payment being treated as a negative amount;

   3. (c)

      unless (d) applies, for repurchase transactions and securities or commodities lending or borrowing transactions, the replacement cost is the amount of cash lent or borrowed, with cash lent by the firm being treated as a positive amount and cash borrowed by the firm being treated as a negative amount;

   4. (d)

      for securities financing transactions, where both legs of the transaction are securities, the replacement cost is the CMV of the security lent by the firm, increased by the corresponding volatility adjustment in MIFIDPRU 4.14.25R; and

   5. (e)

      for margin lending transactions and the credits and loans referred to in MIFIDPRU 4.14.3R(7), the replacement cost is the book value of the asset in accordance with the applicable accounting framework.

1. (1)

   1A firm is required to calculate potential future exposure (PFE) only for derivative contracts.

2. (2)

   A firm must calculate the potential future exposure for derivative contracts in a netting set using one of the following approaches:

   1. (a)

      the hedging approach in MIFIDPRU 4.14.14R; or

   2. (b)

      the derivative netting ratio approach in MIFIDPRU 4.14.18R.

1Where a single derivative contract cannot be allocated to a netting set with other derivative contracts, it must be treated as a separate netting set for the purposes of MIFIDPRU 4.14.10R.

1A firm must apply its chosen approach under MIFIDPRU 4.14.10R:

1. (1)

   continuously for at least 24 months; and

2. (2)

   consistently across all its netting sets.

1. (1)

   1For the purposes of calculating the PFE of derivative contracts included within a netting set under MIFIDPRU 4.14.16R, a firm must:

   1. (a)

      calculate the effective notional amount of each contract (EN) in accordance with MIFIDPRU 4.14.20R;

   2. (b)

      allocate each derivative contract to an asset class in accordance with (2) and (3); and

   3. (c)

      calculate a separate net notional amount for each asset class in (b) by netting the EN of all derivative contracts allocated to that asset class, with long positions to be treated as positive amounts and short positions to be treated as negative amounts.

2. (2)

   Subject to (3), a firm must assign derivative contracts to separate asset classes as follows:

   1. (a)

      except as specified in (b) to (d), a derivative contract must be allocated to the relevant asset class specified in the table in MIFIDPRU 4.14.22R;

   2. (b)

      interest rate derivatives must be allocated to separate asset classes according to their currency;

   3. (c)

      foreign exchange derivatives must be allocated to separate asset classes according to each currency pair; and

   4. (d)

      derivative contracts falling within the “other” class in MIFIDPRU 4.14.22R may be allocated to the same class if their primary risk driver is identical, but otherwise must each be treated as a separate class.

3. (3)

   Derivative contracts that would fall within a specific asset class under (2) must be allocated to a separate asset class if:

   1. (a)

      they reference the basis between two risk factors and are denominated in a single currency (i.e. they are basis transactions), in which case all basis transactions referencing that same pair of risk factors must be allocated to a separate asset class; or

   2. (b)

      they reference the volatility of a risk factor (i.e. they are volatility transactions), in which case all volatility transactions referencing that same risk factor must be allocated to a separate asset class.

1For the purposes of MIFIDPRU 4.14.10R(2)(a), a firm must calculate the potential future exposure of derivative contracts included within a netting set by:

1. (1)

   multiplying the absolute value of the net notional amount under MIFIDPRU 4.14.14R(1)(c) for each asset class within the netting set by the supervisory factor for that asset class specified in MIFIDPRU 4.14.22R;

2. (2)

   adding together the product of the calculation in (1) for all asset classes within the netting set; and

3. (3)

   multiplying the sum under (2) by:

   1. (a)

      0.42, for netting sets of transactions with financial or non-financial counterparties for which, if required, collateral is exchanged bilaterally with the counterparty in accordance with the conditions laid down in article 11 of EMIR; or

   2. (b)

      1, for other netting sets.

1A firm must calculate a net potential future exposure for each netting set using the following formula:

where:

1. (1)

   PFEnet = the net potential future exposure for the netting set;

2. (2)

   PFEgross = the sum of the potential future exposure of all derivative contracts included in the netting set, calculated by multiplying the absolute value of the effective notional amount of each derivative contract (as calculated in accordance with MIFIDPRU 4.14.20R) by the relevant supervisory factor for the corresponding asset class specified in MIFIDPRU 4.14.22R;

3. (3)

   RCnet = the sum of the replacement cost (as determined in accordance with MIFIDPRU 4.14.9R) of all transactions included in the netting set, unless that sum is a negative amount, in which case RCnet is zero; 2

4. (4)

   RCgross = the sum of the replacement cost (as determined in accordance with MIFIDPRU 4.14.9R) of all transactions included in the netting set that have a positive CMV, and2

5. (5)

   where the value of RCgross is zero, then the result of RCnet divided by RCgross is deemed to be:2

   1. (a)

      a value of ‘1’ when a netting set consists of a single derivative contract; or2

   2. (b)

      a value of zero when a netting set consists of more than one derivative contract.2

1For the purposes of MIFIDPRU 4.14.10R(2)(b), the potential future exposure for the derivative contracts included within a netting set is the product of multiplying PFEnet (as determined in accordance with MIFIDPRU 4.14.18R) by:

1. (1)

   0.42, for netting sets of transactions with financial or non-financial counterparties for which, if required, collateral is exchanged bilaterally with the counterparty in accordance with the conditions laid down in article 11 of EMIR; or

2. (2)

   1, for other netting sets.

1. (1)

   1The effective notional amount is calculated as follows:

   Effective notional amount = N * D * SD

   1. (a)

      N = the notional amount, determined in accordance with (2);

   2. (b)

      D = the duration, calculated in accordance with (3); and

   3. (c)

      SD = the supervisory delta, calculated in accordance with (5).

2. (2)

   The notional amount, unless clearly stated and fixed until maturity, is determined as follows:

   1. (a)

      for foreign exchange derivative contracts:

      1. (i)

         if one leg of the contract is in the domestic currency, the notional amount is the notional amount of the foreign currency leg of the contract, converted into the domestic currency;

      2. (ii)

         if both legs of the contract are denominated in currencies other than the domestic currency, the notional amount of each leg must be converted into the domestic currency and the leg with the larger value in the domestic currency is the notional amount; and

      3. (iii)

         the term “domestic currency”, when used in this rule, refers to the currency in which the firm reports to the FCA;

   2. (b)

      for equity and commodity derivatives contracts and emissions allowances and derivatives thereof, the notional amount is the product of the market price of one unit of the instrument and the number of units referenced by the trade;

   3. (c)

      for transactions with multiple pay-offs that are state contingent including digital options or target redemption forwards, a firm must calculate the notional amount for each state and use the largest resulting calculation;

   4. (d)

      where the notional is a formula of market values, the firm must use the CMVs to determine the trade notional amount;

   5. (e)

      for variable notional swaps such as amortising and accreting swaps, a firm must use the average notional over the remaining life of the swap as the trade notional amount;

   6. (f)

      leveraged swaps must be converted to the notional amount of the equivalent unleveraged swap so that where all of the rates in a swap are multiplied by a factor, the stated notional amount is multiplied by the factor on the interest rates to determine the notional amount; and

   7. (g)

      for a derivative contract with multiple exchanges of principal, the stated notional amount must be multiplied by the number of exchanges of principal in the derivative contract to determine the notional amount.

3. (3)

   The duration must be determined in accordance with the following:

   1. (a)

      for all derivative contracts other than interest rate contracts and credit derivative contracts, the duration is 1;

   2. (b)

      for interest rate contracts and credit derivative contracts, the duration is determined in accordance with the following formula in which the time to maturity is specified in years:

      Duration = (1 – exp (-0.05 * time to maturity)) / 0.05

4. (4)

   The maturity of a contract must be determined as follows:

   1. (a)

      for an option, the maturity is the latest contractual exercise date as specified by the contract;

   2. (b)

      for a derivative contact that is structured such that on specified dates, any outstanding exposure is settled and the terms are reset so that the fair value of the contract is zero, the remaining maturity is the time until the next reset date;

   3. (c)

      for any other derivative contract, the maturity is the latest date on which the contract may still be executed; and

   4. (d)

      in each case, if the derivative contract references the value of another interest rate or credit instrument, the time period must be determined on the basis of that underlying instrument.

5. (5)

   The supervisory delta must be determined as follows:

   1. (a)

      for options and swaptions, the firm may calculate the supervisory delta itself by using an appropriate model if:

      1. (i)

         the model the firm uses meets the minimum standards set out in MIFIDPRU 4.12.12G to MIFIDPRU 4.12.18G (Minimum standards for own estimates of delta), as modified by MIFIDPRU 4.14.21R, for each type of option or swaption for which it calculates delta;

      2. (ii)

         the firm has notified the FCA that the minimum standards in (i) are met before the firm begins to use its own estimates for the relevant supervisory delta; and

      3. (iii)

         the notification in (ii) is made using the form in MIFIDPRU 4 Annex 5R and submitted using the online notification and application system;

   2. (b)

      for transactions other than options and swaptions, or transactions in respect of which a firm is unable to use an appropriate model in accordance with (a), the supervisory delta is 1 or -1; and

   3. (c)

      in each case, the supervisory delta must reflect the relationship between the contract and the underlying, whereby a contract that increases exposure (by increasing RC) as the underlying increases shall have a positive supervisory delta, and a contract that decreases exposure (by decreasing RC) as the underlying increases shall have a negative supervisory delta.

1. (1)

   1When applying the minimum standards in MIFIDPRU 4.12.12G to MIFIDPRU 4.12.18G for the purposes of MIFIDPRU 4.14.20R(5)(a), the standards apply with the following modifications:

   1. (a)

      a reference to the “standardised approach” is a reference to the rules in this section relating to the calculation of the K-TCD requirement; and

   2. (b)

      a reference to the K-NPR requirement is a reference to the K-TCD requirement.

2. (2)

   In addition to the minimum standards in MIFIDPRU 4.12.12G to MIFIDPRU 4.12.18G a firm must also confirm to the FCA that the relevant model estimates the rate of change of the value of the option for small changes in the market value of the underlying.

1Transactions relating to gold or gold derivatives must be allocated to the foreign exchange asset class in MIFIDPRU 4.14.22R.

1. (1)

   1This rule applies for the purposes of determining the value of C under MIFIDPRU 4.14.8R.

2. (2)

   For the transactions specified in MIFIDPRU 4.14.3R(1), (5) and (7), the value of the C is the notional amount of collateral received by the firm, decreased in accordance with the relevant volatility adjustment specified in MIFIDPRU 4.14.25R.

3. (3)

   Unless (4) applies, for the transactions specified in MIFIDPRU 4.14.3R(2), (3), (4) and (6), the value of the C is the sum of:

   1. (a)

      the CMV of the security leg; and

   2. (b)

      the net amount of collateral posted or received by the firm.

4. (4)

   For securities financing transactions where both legs of the transaction are securities, the value of the C is the CMV of the security borrowed by the firm.

5. (5)

   Where the firm is purchasing or has lent the security, the CMV of the security shall be treated as a negative amount and shall be decreased to a larger negative amount, using the volatility adjustment specified in MIFIDPRU 4.14.25R.

6. (6)

   Where the firm is selling or has borrowed the security, the CMV of the security shall be treated as a positive amount and be decreased by the volatility adjustment specified in MIFIDPRU 4.14.25R.

7. (7)

   Where different types of transactions are covered by a contractual netting agreement that meets the requirements in MIFIDPRU 4.14.28R(3), the applicable volatility adjustments in column C (volatility adjustment other transactions) of the table in MIFIDPRU 4.14.25R must be applied to the respective amounts calculated under (3)(a) and (b) on an issuer basis within each asset class.

8. (8)

   Where there is a currency mismatch between the transaction and the collateral received or posted, an additional currency mismatch volatility adjustment of 8% shall apply.

1For the purposes of calculating its K-TCD requirement, a firm may, in the following order:

1. (1)

   first, treat perfectly matching contracts included in a netting agreement as if they were a single contract with a notional principal equivalent to the net receipts;

2. (2)

   second, net other transactions subject to novation under which all obligations between the firm and its counterparty are automatically amalgamated in such a way that the novation legally substitutes one set single net amount for the previous gross obligations; and

3. (3)

   third, net other transactions where the firm ensures that the following conditions have been met:

   1. (a)

      the transactions are covered by a netting contract with the counterparty, or by another agreement that creates a single legal obligation, such that the firm would have either a claim to receive, or obligation to pay, only the net sum of the positive and negative mark-to-market values of the individual transactions if a counterparty fails to perform due to any of the following:

      1. (i)

         default;

      2. (ii)

         bankruptcy;

      3. (iii)

         liquidation; or

      4. (iv)

         similar circumstances;

   2. (b)

      in the event of default of a counterparty, the netting contract does not contain any clause that permits a non-defaulting counterparty to make limited payments only, or no payments at all, to the estate of the defaulting party even if the defaulting party is a net creditor;

   3. (c)

      the firm has obtained an independent, written and reasoned legal opinion that, in the event of a legal challenge to the netting agreement, the firm’s claims and obligations would be equivalent to those referred to in (a) under each of the following legal regimes:

      1. (i)

         the law of the jurisdiction in which the counterparty is incorporated;

      2. (ii)

         if a foreign branch of a counterparty is involved, the law of the jurisdiction in which the branch is located;

      3. (iii)

         the law that governs the individual transactions included in the netting agreement; or

      4. (iv)

         the law that governs any contract or agreement necessary to effect the netting.

1. (1)

   1For the purposes of this rule, the “credit valuation adjustment” (CVA) means an adjustment to the mid-market valuation of the portfolio of transactions with a counterparty that reflects the CMV of the credit risk of the counterparty to the firm, but does not reflect the CMV of the credit risk of the firm to the counterparty.

2. (2)

   The CVA for all transactions is 1.5, except for the transactions in (3).

3. (3)

   The CVA for the following transactions is 1:

   1. (a)

      the following transactions, if they do not exceed the clearing threshold specified in article 10(3) and (4) of EMIR:

      1. (i)

         transactions with non-financial counterparties (as defined in point (9) of article 2 of EMIR); or

      2. (ii)

         transactions with non-financial counterparties established in a third country;

   2. (b)

      intra-group transactions as provided for in article 3 of EMIR;

   3. (c)

      long settlement transactions;

   4. (d)

      securities financing transactions unless the FCA has notified the firm that the firm’s CVA risk exposures arising from those transactions are material; and

   5. (e)

      credits and loans referred to in MIFIDPRU 4.14.3R(7).