• PRU A4.3 PRU A4.3 Collateral calculations and haircuts

    • Core market participants

      • PRU A4.3.1

        For the purposes of this Section, "core market participant" means:

        (a) any central government or Central Bank;
        (b) any PSE;
        (c) any qualifying MDB;
        (d) any banking institution or Securities firm;
        (e) any Financial Institution eligible for a 20% risk weight under Section 4.12;
        (f) any central counterparty;
        (g) any regulated mutual fund that is subject to capital or leverage requirements; or
        (h) any regulated pension fund.

    • Calculation of E* for collateralised transactions other than OTC Derivative transactions and long settlement transactions

      • PRU A4.3.2

        An Authorised Person using the FCCA to calculate E* must adjust both the amount of the Exposure to the Counterparty and the value of any Collateral received in support of that Counterparty to take into account possible future fluctuations in the value of either due to market movements, by using the methods and haircuts set out in Rules A4.3.6 to A4.3.29.

      • PRU A4.3.3

        An Authorised Person must calculate the appropriate haircuts to be applied using one of the following methods:

        (a) standard supervisory haircuts; or
        (b) own-estimate haircuts.

      • PRU A4.3.4

        [Reserved]

      • PRU A4.3.5 PRU A4.3.5

        (1) As an alternative to the use of standard supervisory haircuts or own-estimate haircuts, an Authorised Person may, subject to the Regulator's approval, use VaR models to reflect the price volatility of the Exposure and Collateral for SFTs which are covered by a qualifying bilateral Netting agreement. The requirements relating to the use of this approach are set out in Section A4.5.
        (2) An Authorised Person may seek the Regulator's approval referred to in (1) only if it has already received the Regulator's approval to use the internal models approach for calculating the Market Risk Capital Requirement.

        • Guidance

          Approval for the use of the internal model approach is governed by Section 5.11 of Chapter 5 (Market Risk).

      • PRU A4.3.6 PRU A4.3.6

        An Authorised Person using standard supervisory haircuts or own-estimate haircuts under the FCCA must calculate E* for any collateralised transaction not covered by a qualifying bilateral Netting agreement or a qualifying cross-product Netting agreement other than OTC Derivative transactions or long settlement transactions, using the following formula:

        E* = max {0, [E (or EAD)(1 + HE) - C(1 - HC - HFX)]}

        where;

        E* = Exposure value after risk mitigation;

        E = fair value of the Exposure calculated in accordance with Section 4.9;

        HE = haircut appropriate to the Exposure;

        C = fair value of the eligible financial Collateral received;

        HC = haircut appropriate to the Collateral, or if the Collateral is a basket of assets, the weighted sum of the haircuts appropriate to the assets in the basket where each weight is the proportion of the asset in the basket in units of currency; and

        HFX = haircut appropriate for currency mismatch between the Collateral and Exposure.

        • Guidance

          Where the residual maturity of the Collateral is shorter than the residual maturity of the Exposure, the Authorised Person must substitute PA calculated in accordance with Rules 4.13.14 to 4.13.16 for C(1 - HC - HFX).

      • PRU A4.3.7

        An Authorised Person using standard supervisory haircuts or own-estimate haircuts under the FCCA must calculate E* for any collateralised transaction covered by a qualifying bilateral Netting agreement or qualifying cross-product Netting agreement other than OTC Derivative transactions or long settlement transactions, using the following formula:

        𝐸 = Max {0, [∑(𝐸) − ∑(𝐶) + add-on]}

        where:

        E* = Exposure value after risk mitigation;

        E = fair value of the Exposure calculated in accordance with Section 4.9 of these Rules;

        C = fair value of eligible financial Collateral received; and

        add-on = the add-on amount to reflect the market price volatility and foreign exchange volatility, calculated in accordance with Rule A4.3.8 below.

      • PRU A4.3.8 PRU A4.3.8

        An Authorised Person must calculate the add-on using one of the following approaches:

        (a) the approach according to the following formula:

        add-on = ∑(𝐸𝑆 . 𝐻𝑆 ) + ∑(𝐸𝐹𝑋. 𝐻𝐹𝑋)

        where:

        ES = absolute value of the net position in a given Security;

        HS = haircut appropriate to ES

        EFX = absolute value of the net position in a currency different from the settlement currency; and

        HFX = haircut appropriate for currency mismatch between the Collateral and Exposure;

        or
        (b) the approach using VaR models, provided the Authorised Person has received approval from the Regulator as referred to in Rule A4.3.5.

        • Guidance

          Approval for the use of the internal model approach is governed by Section 5.11 of Chapter 5.

      • PRU A4.3.9

        Subject to Rules A4.3.10 to A4.3.12, an Authorised Person must determine HE, HC, HS and HFX referred to in Rules A4.3.6 to A4.3.8, in accordance with the standard supervisory haircuts in the table forming part of Rule A4.3.13.

      • PRU A4.3.10

        An Authorised Person may calculate HE, HC, HS and HFX using own-estimate haircuts in accordance with Rules A4.3.17 to A4.3.23 if it has received approval from the Regulator to use the internal models approach for calculating the Market Risk Capital Requirement. If the Authorised Person chooses to use own-estimate haircuts, it must do so consistently for determining haircuts for all eligible financial Collateral and all portfolios, except that it may, with the approval of the Regulator, use the standard supervisory haircuts in Rules A4.3.13 to A4.3.16 for any portfolio which is immaterial in size and risk profile.

      • PRU A4.3.11

        An Authorised Person may apply a value of zero to HE, HC and HS in the case of a qualifying SFT with a core market participant. This approach is not available to an Authorised Person using VaR models in accordance with Section A4.5 to calculate E*.

      • PRU A4.3.12

        An Authorised Person may apply a value of zero to HE, HC and HS in the case of an SFT where both the Exposure and Collateral are Securities issued by central governments where a value of zero has been prescribed by the banking regulator of that jurisdiction and Exposures to the central government of that jurisdiction have a Credit Quality Grade of 1 as set out in the table Rule 4.12.4.

    • Standard supervisory haircuts

      • PRU A4.3.13 PRU A4.3.13

        The standard supervisory haircuts, HE, HC and HS referred in Rules A4.3.6 to A4.3.8 (assuming daily remargining, daily revaluation and a ten-business day holding period), are subject to Rule A4.3.14, as follows:

        Debt security:
        Credit Quality Grade
        of issue – long-term
        Residual Maturity Standard Supervisory Haircut
        (%)
        Issuer
        Central
        government
        or central bank
        Other
        1 ≤ 1 year 0.5      1     
        > 1 year and ≤ 5 years 2      4     
        > 5 years 4      8     
        2 or 3,
        and unrated bank
        securities as defined
        in Rule 4.13.5(d)
        ≤ 1 year 1      2     
        > 1 year and ≤ 5 years 3      6     
        > 5 years 6      12     
        4 All 15      n/a     

         

        Debt security:
        Credit Quality Grade of issue
        – short-term
        Standard Supervisory Haircut
        (%)
        Issuer
        Central
        government
        or central bank
        Other
        I 0.5      1     
        II or III,
        and unrated bank securities as
        defined in Rule 4.13.5(d)
        1      2     

         

        Other collateral or exposure type

        Standard Supervisory Haircut
        (%)
        Gold 15     
        Any equity (including a convertible bond) included in a main index 15     
        Any equity (including a convertible bond) traded on a regulated exchange 25     
        Any unit in a Collective Investment Fund Highest haircut
        applicable to any
        Security in which
        the Fund can invest
        Cash in the same currency as the underlying exposure 0     
        Instruments in the Trading Book other than those listed (for pre-settlement Counterparty Exposures arising from SFTs included in the Trading Book). 25     

        • Guidance

          1. The Credit Quality Grade for a debt security is that associated specifically with that debt security issue.
          2. PSEs and MDBs should be treated as equivalent to central governments for the purpose of this table.

      • PRU A4.3.14

        The standard supervisory haircut, HE, for transactions in which an Authorised Person lends instruments that do not qualify as eligible financial Collateral (e.g. corporate debt Securities with a Credit Quality Grade of 4 or worse) is 25%.

      • PRU A4.3.15

        The standard supervisory haircut, HFX, for currency mismatch where Exposure and Collateral are denominated in different currencies based on a ten-business day holding period and daily revaluation is 8%.

      • PRU A4.3.16

        Where the minimum holding period, frequency of remargining or revaluation assumptions set out for eligible financial Collateral in Rule A4.3.13 differ from those of the Authorised Person, the Authorised Person must adjust HE, HC and HS using the formulae in Rules A4.3.25 to A4.3.26.

    • Own-estimate haircuts

      • PRU A4.3.17

        (1) An Authorised Person must apply for approval from the Regulator if it intends to use own-estimate haircuts.
        (2) An Authorised Person must not use own-estimate haircuts unless it has received approval to adopt the internal models approach to calculate the Market Risk Capital Requirement.
        (3) The Regulator may grant approval for an Authorised Person to use own-estimate haircuts subject to such conditions or restrictions as the Regulator may impose.

      • PRU A4.3.18

        If An Authorised Person becomes aware after it has received approval to use own-estimate haircuts that it no longer complies with any of the requirements in Rules A4.3.17 to A4.3.23 or any of the conditions or restrictions imposed by the Regulator pursuant to Rule A4.3.17 or no longer meets the Rules, it must

        (a) inform the Regulator as soon as practicable;
        (b) assess the effect of the situation in terms of the risk posed to the Authorised Person;
        (c) prepare a plan to rectify the situation and inform the Regulator of its plan as soon as practicable; and
        (d) undertake prompt corrective action within a reasonable time in accordance with the plan prepared pursuant to (c).

      • PRU A4.3.19

        If An Authorised Person fails to comply with Rule A4.3.18, the Regulator may revoke its approval for the Authorised Person to use own-estimate haircuts. The Authorised Person may also be required to revise its estimates for the purpose of calculating regulatory Capital Requirements if its estimates of E*, does not adequately reflect its Exposure to Counterparty Credit Risk.

    • Requirements for use of own-estimate haircuts

      • PRU A4.3.20

        An Authorised Person using own-estimate haircuts must estimate the volatility for each individual instrument that is taken as eligible financial Collateral. In estimating such volatility, the Authorised Person must not take into account the correlations between unsecured Exposures, Collateral and exchange rates. Where there are Maturity Mismatches, the Authorised Person must apply Rules 4.13.14 to 4.13.16.

      • PRU A4.3.21

        An Authorised Person must ensure that the model used to estimate volatilities captures all the material risks run by it.

      • PRU A4.3.22 PRU A4.3.22

        In calculating the haircuts using internal estimates of volatilities, an Authorised Person must:

        (a) use a 99th percentile, one-tailed confidence interval;
        (b) use the minimum holding period and remargining or revaluation conditions according to the type of transaction as set out in Rules A4.3.24 to A4.3.26. Where the minimum holding period, remargining or revaluation conditions used by an Authorised Person differ from those set out above, it must adjust the haircuts using the formulae in Rules A4.3.25 to A4.3.26;
        (c) use a historical observation period (i.e. sample period) of at least one year.

        Where the Authorised Person uses a weighting scheme or other methods for the historical observation period, the "effective" observation period must be at least one year (i.e. the weighted average time lag of the individual observations must not be less than six months);
        (d) update its data sets at least once every three months and recalculate haircuts at least once every three months. The Regulator may require more frequent updates whenever there is an increase in volatility in market prices of the Collateral; and
        (e) use the estimated volatility data in the day-to-day risk management process of the Authorised Person and if the Authorised Person is using a longer holding period for risk management compared to the ones prescribed in Rules A4.3.24 to A4.3.26., then the longer holding period must also be applied for the calculation of haircuts.

        • Guidance

          1. An Authorised Person should:
          a. take into account the illiquidity of lower quality Collateral and should adjust the holding period upwards in cases where such a holding period would be inappropriate given the liquidity of the Collateral; and
          b. identify where historical data may understate potential volatility (e.g. a pegged currency);
          and deal with such cases by subjecting the data to stress testing.
          2. An Authorised Person, when considering the market liquidity of a Collateral, should consider four dimensions:
          a. immediacy, which refers to the speed with which a trade of a given size at a given cost is completed;
          b. depth, which refers to the maximum size of a trade for any given bid-ask spread;
          c. tightness, which refers to the difference between buy and sell prices; and
          d. resiliency, which refers to how quickly prices revert to original or fundamental levels after a large transaction.
          3. The Authorised Person should have experienced Persons familiar with the relevant market for the Collateral to judge the market liquidity of the Collateral and determine if the minimum holding period is sufficient for any given Collateral. The holding period should be deemed to be insufficient if the value of the Collateral would move by more than 1% should the Collateral be liquidated within the minimum holding period in these Rules, taking into account the immediacy, depth, tightness and resiliency of the market. In such a situation, the holding period should be adjusted upwards, such that the Collateral can be safely liquidated within the period, without causing a price movement of more than 1% relative to the value after the haircut.
          4. An Authorised Person should aim to update its data sets daily in line with industry practice. If the Authorised Person updates its data sets less than once every three months, it should be able to demonstrate to the Regulator that the volatilities of the market prices are stable. In addition, where the updating of data sets is less frequent, the Regulator will normally expect compensating controls in the form of stress testing.

      • PRU A4.3.23 PRU A4.3.23

        An Authorised Person must have robust and effective processes in place for ensuring compliance with documented internal policies, controls and procedures concerning the operation of the risk measurement system to support the use of own-estimate haircuts.

        • Guidance

          In order to demonstrate compliance with Rule A4.3.23, an Authorised Person should give due regard to the following expectations of the Regulator:

          (a) the risk measurement system should be used in conjunction with internal Exposure limits;
          (b) the risk management processes of an Authorised Person relating to the use of own-estimate haircuts should be subject to internal audit at least once a year, covering the following areas:
          (i) the integration of risk measures into daily risk management;
          (ii) the validation of any significant change in the risk management process;
          (iii) the accuracy and completeness of position data;
          (iv) the verification of the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources; and
          (v) the accuracy and appropriateness of volatility assumptions.
          (c) such internal audits referred to in (b) are not to be confused with an internal validation of the risk management systems surrounding the use of own-estimate haircuts. All significant risk models employed to support the use of own-estimate haircuts should be validated at least once a year. The internal audits serve as an independent process check to help ensure that the validation is sufficiently robust and effective.

    • Minimum holding periods, remargining or revaluation conditions

      • PRU A4.3.24

        The following table sets out the minimum holding periods and remargining or revaluation conditions for different types of transactions where an Authorised Person uses own-estimate haircuts:

        Transaction type Minimum holding period Remargining/ Revaluation Condition
        Repos, reverse repos, Securities or commodities lending or Securities or commodities borrowing transactions Five business days daily remargining
        OTC Derivative transactions and margin lending transactions Ten business days daily remargining
        Exposures secured by eligible financial Collateral 20 business days daily revaluation

      • PRU A4.3.25

        Where the assumed minimum holding period is not met or remargining or revaluation conditions are not fulfilled, an Authorised Person must calculate the applicable haircut using the following formula:

        H = HM √{[NR + (TM - 1)]/ TM}


        where -

        "H" refers to the haircut;

        "HM" refers to the haircut under the minimum holding period;

        "TM" refers to the minimum holding period for the type of transaction or eligible financial Collateral; and

        "NR" refers to the actual number of business days between remargining or revaluation, as the case may be.

      • PRU A4.3.26

        When an Authorised Person uses a holding period, TN, which is different from the specified minimum holding period, TM, the Authorised Person must calculate HM using the following formula:

        HM = HN√(TM/TN)

        where -

        "TN" refers to the holding period used by the Authorised Person for deriving HN; and

        "HN" refers to the haircut based on the holding period TN.

    • Recognition of eligible financial Collateral under FCSA

      • PRU A4.3.27

        Subject to A4.3.28, an Authorised Person which has taken eligible financial Collateral for a CR Exposure and is using the FCSA may recognise the effects of CRM of the eligible financial Collateral as follows:

        (a) break down the Exposure into -
        (i) a collateralised portion with E equal to the latest fair value of the eligible financial Collateral; and
        (ii) an uncollateralised portion with E equal to the E of the CR Exposure less the latest fair value of the eligible financial Collateral;
        and
        (b) for the purposes of calculating the Credit RWA amount pursuant to Rule 4.8.3, use:
        (i) for the collateralised portion, the CRW that is applicable to the eligible financial Collateral as though the Authorised Person had a direct Exposure to that Collateral; and
        (ii) for the uncollateralised portion, the CRW that is applicable to the obligor.

      • PRU A4.3.28

        If the CRW determined in accordance with A4.3.27(b)(i) is less than 20%, an Authorised Person must apply a CRW of 20% to the collateralised portion of the CR Exposure, except in the following cases:

        (a) a qualifying SFT where the Counterparty in the transaction is a core market participant, in which case the Authorised Person may apply a risk weight of 0%;
        (b) a qualifying SFT where the Counterparty in the transaction is not a core market participant, in which case the Authorised Person may apply a risk weight of 10%;
        (c) an OTC Derivative transaction subject to daily mark-to-market that is collateralised by cash, and where there is no currency mismatch, in which case the Authorised Person may apply a risk weight of 0%;
        (d) an OTC Derivative transaction subject to daily mark-to-market that is collateralised by Exposures to central governments, Central Banks or PSE or a combination thereof qualifying for a 0% risk weight in accordance with the Rules in Chapter 4, and where there is no currency mismatch, in which case the Authorised Person may apply a risk weight of 10%; and
        (e) a transaction where there is no currency mismatch and the Collateral comprises -
        (i) cash on Deposit as set out in Rule 4.13.5(a); or
        (ii) Exposures in the central government and Central Bank asset class or in the PSE asset class or a combination thereof qualifying for a 0% risk weight under the Rules in Section 4.12, and the latest fair value of such Collateral has been discounted by 20% for the purposes of determining the value of the collateralised portion of the CR Exposure in accordance with Rule A4.3.27(a)(i), in which case the Authorised Person may apply a CRW of 0%.

      • PRU A4.3.29

        An Authorised Person which is using FCSA must not recognise the effects of CRM of any Collateral with a Maturity Mismatch.