Guidance Note
AGN 113.1 - The Trading Book and
Trading Book Policy Statement
Sept 2000
1. For the purpose of determining capital charges on market risks arising from interest rate and equities positions, a distinction is made between positions in an ADI’s trading book and banking book. An ADI should allocate to the trading book positions in financial instruments, including derivative products and other off-balance sheet instruments, which:
(a) are held for short-term resale; or
(b) are taken on by the ADI with the intention of benefiting in the short-term from actual and/or expected differences between their buying and selling prices, or from other price or interest rate variations; or
(c) arise from broking and market making; or
(d) are taken in order to hedge other elements of the trading book.
2. Whether a transaction should be included in an ADI’s trading book depends on the intent with which the transaction was undertaken. Positions may be considered to be held with a trading intent if:
(a) they are marked-to-market on a daily basis as part of the internal risk management processes. APRA recognises that good risk management practices may dictate that some non-traded positions are marked-to-market on a regular basis – such positions need not necessarily be included in the trading book; or
(b) the position-takers have autonomy in entering into transactions (in marketable instruments) within predetermined limits; or
(c) the positions satisfy any other criteria which the ADI applies to the composition of its trading book on a consistent basis.
3. In order to obtain an accurate and fair measure of market risk, it may be necessary for ADIs (subject to supervisory approval) to include within the
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Sept 2000
market risk measure certain non-trading instruments which hedge trading activities (such as certain types of deposits). These instruments, as well as any other financial instruments which are not part of the trading book, will not be subject to the specific risk capital charges as set out in this Prudential Standard but will remain subject to the credit risk capital requirements set out in APS 112 – Capital Adequacy: Credit Risk.
4. ADIs may raise funds by the issue of instruments such as certificates of deposit. Such positions may be included in the trading book if the instrument meets the trading book definition.
5. Transactions dealt internally within an ADI or ADI group should be treated as follows:
(a) with regard to internal transactions between portfolios within the trading book, ADIs will be free to either eliminate all internal deals before measuring positions exposed to market risk or include any or all internal deals in their position reporting (provided that they do so on a consistent basis);
(b) internal transactions dealt between the trading book and the banking book are to be included in the measurement of trading book positions.
6. APRA will monitor how ADIs allocate financial instruments between the trading book and the banking book through the on-site review process. ADIs must ensure that a clear audit trail is created at the time transactions are entered into, to facilitate monitoring of compliance with the criteria by which items are allocated to the trading or banking book.
The Trading Book Policy Statement
7. An ADI’s trading book policy statement should detail the criteria used by the ADI in classifying trading positions. The statement should stipulate:
(a) whether the ADI intends to operate a trading book, and whether it has relevant positions in interest rates, equities, foreign exchange or commodities;
(b) who can approve or modify the trading book policy statement;
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(c) the operational definition of the trading book to be adopted by the ADI, including a clear description of what treasury transactions are to be classified as trading activities, the treatment of inter-desk deals, and the criteria used to identify hedges;
(d) the procedures to ensure that the criteria by which items are allocated to the trading or banking books are adhered to on a consistent basis. These would include, for example, who is responsible for monitoring adherence to the trading book policy statement, how often this is checked, how this is done, and how the continuing appropriateness of allocations is confirmed (for example, if there are swaps hedging a loan portfolio and the loans are repaid early, how these swaps would be identified and dealt with);
(e) any expected circumstances under which risk and/or instruments may be transferred between the trading and banking books, and the controls in place to ensure that no inappropriate switching of positions between these books occurs (such as who can approve the transfers and the accounting treatment of such transfers);
(f) a list of the financial instruments to be included within the trading book and the proposed risk measurement methodology to be adopted for each instrument;
(g) the valuation methodology to be adopted for each of these instruments (including, for example, whether mark-to-market accounting is adopted, the sources of rates, whether the most conservative side of the bid-offer spread is used, the treatment of illiquid instruments, and policies concerning any reserves or provisions held against mark-to-market profit and loss). Valuation methods should normally be the same for capital calculations as for the ADI’s financial accounts and a statement to this effect, or an explanation if this does not occur, should be included;
(h) whether there are any subsidiaries and/or offshore branches undertaking transactions to be included in the trading book. If so, a list of any such subsidiaries and/or offshore branches should be included, along with a description of the trading activities residing within such entities;
(i) the ADI’s policy regarding dealings in unrated securities, and how these will be dealt with in terms of the Prudential Standard. If the ADI considers some unrated securities to be of investment quality, a statement on how this judgement is made should be included;
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(j) whether there are any structural foreign exchange positions. Where appropriate, the operational definition of positions to be excluded from the calculation of an ADI’s foreign exchange exposure, in accordance with AGN 113.3, should be set out. A description of the policies covering the identification and management of structural foreign exchange positions, to ensure that trading activities are not classified as structural, should also be included;
(k) that the statement will be subject to regular review; and
(l) that APRA will be immediately notified of any changes made to the trading book policy statement.
8. The trading book policy statement should be incorporated into an ADI’s risk management systems description and be covered by the annual management attestation.
9. If an ADI wishes to make a case that it does not have a trading book, it should make a statement to this effect in its risk management systems description. The statement should outline the policies concerning holdings of government securities, bank bills, derivative instruments and any other readily marketable instruments, the arrangements in place to ensure that these instruments are not held for trading purposes, the criteria for determining whether a position constitutes a hedge, and policies regarding structural foreign exchange positions.
Index
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