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Dubai Financial Services Authority (DFSA): Contents

Dubai Financial Services Authority (DFSA)
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Prudential — Investment, Insurance Intermediation and Banking Module (PIB) [VER33/02-19]
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  • PIB 7 Interest Rate Risk in the Non-Trading Book

    • Introduction

      • PIB 7 Guidance

        1. This chapter relates to interest rate risk in the Non-Trading BookG . In relation to the Trading BookG , an Interest Rate Risk Capital RequirementG is imposed as a component of the Market Risk Capital RequirementG under PIB chapter 5.
        2. Non-Trading BookG interest rate risk is normally a major source of risk for a bank or a firm that deals on its own account (including underwriting on a firm commitment basis) and whose Non-Trading BookG assets equal or exceed 15% of its total assets. Interest rate risk in the Non-Trading BookG may arise from a number of sources, for example:
        a. risks related to the mismatch of repricing of assets and liabilities and off balance sheet short and long-term positions;
        b. risks arising from hedging exposure to one interest rate with exposure to a rate which reprices under slightly different conditions;
        c. risks related to the uncertainties of occurrence of transactions, for example, when expected future transactions do not equal the actual transactions; and
        d. risks arising from consumers redeeming fixed rate products when market rates change.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 7.1 Application

      • PIB 7.1.1

        This chapter applies to an Authorised FirmG in CategoryG 1 or 2 on a solo basis.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 7.1.2

        Where an Authorised FirmG to which this chapter applies is part of a Financial GroupG , this chapter also applies on a consolidated basis in relation to all the entities within the Financial GroupG .

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 7.2 Stress Testing for Non-Trading Book Interest Rate Risk

      • PIB 7.2.1

        An Authorised FirmG must carry out an evaluation of its ExposureG to the interest rate risk arising from its Non-Trading BookG activities. An Authorised FirmG with balance sheet positions in different currencies must measure its risk ExposuresG in each of the material currencies.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 7.2.2

        (1) The evaluation under PIB Rule 7.2.1 must cover the effect of a sudden and unexpected parallel change in interest rates of 200 basis points in both directions.
        (2) An Authorised FirmG must apply a 200 basis point shock to each material currency ExposureG it faces as part of its Non-Trading BookG .
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 7.2.3

        An Authorised FirmG must immediately notify the DFSAG if any evaluation under this section suggests that, as a result of the change in interest rates described in PIB Rule 7.2.2, the economic value of the firm would decline by more than 20% of its Capital ResourcesG .

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 7.2.3 Guidance

          For the purposes of PIB Rule 7.2.1, an Authorised FirmG should consider each currency accounting for 5% or more of its Non-Trading BookG assets or Non-Trading bookG liabilities as a material currency ExposureG .

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 7.2.4 Frequency of Stress Testing

        An Authorised FirmG must carry out the evaluations required by PIB Rule 7.2.1 as frequently as necessary for it to be reasonably satisfied that it has at all times a sufficient understanding of the degree to which it is exposed to the risks referred to in that PIBG RuleG and the nature of that ExposureG . In any case it must carry out those evaluations no less frequently than required by PIB Rule 7.2.6.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 7.2.5

        In order to carry out effectively the stress testing requirements specified in PIB Rule 7.2.2, an Authorised FirmG must include appropriate scenarios into its stress testing programmes for measuring its vulnerability to loss arising from the impact of adverse interest rate movements on its Non-Trading BookG structure.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB 7.2.6

        (1) Subject to (2), the minimum frequency of the evaluation referred to in PIB Rule 7.2.1 is once each year.
        (2) The minimum frequency of an evaluation of the effect of a sudden and unexpected parallel change in interest rates as referred to in PIB Rule 7.2.2 is once each quarter.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 7.2.6 Guidance

          For the purposes of PIB Rule 7.2.6, an Authorised FirmG should consider the standards for stress testing recommended in the paper published by the Basel Committee for BankingG Supervision — PrinciplesG for management and supervision of interest rate risk — in July 2004. In particular, an Authorised FirmG should include the technical specifications of a standardised interest rate shock detailed in Annex 3 of that paper as part of its systems for measurement of interest rate risk in the Non-Trading BookG .

          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 7.3 Non-Trading Book Interest Rate Risk Under Chapter 10

      • PIB 7.3.1

        In order to meet effectively the obligations specified under PIB chapter 10, which includes the need to address Non-Trading BookG interest rate risk, an Authorised FirmG is required to make a written record of its assessments made under Rules specified in PIB chapter 10.

        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB 7.3.1 Guidance

          1. This PIB chapter 7 does not impose an explicit Capital RequirementG relating to interest rate risk. Rather, the DFSAG may impose an Individual Capital RequirementG (ICR) under PIB chapter 10 where it is of the view that the Authorised Firm'sG Capital RequirementG is insufficient to address adequately all its risks, and in particular its ExposureG to interest rate risk in the Non-Trading BookG .
          2. Sections PIB 10.3 and PIB 10.4 of PIB chapter 10 require an Authorised FirmG to submit IRAPG and ICAAPG assessments to the DFSAG within 4 months of the end of the firm's financial year. The provisions also require the firm to ensure the assessments are documented in writing and to retain the records for at least 6 years.
          3. An Authorised Firm'sG record of its approach to evaluating and managing interest rate risk in its Non-Trading BookG , as part of its ICAAPG should cover the following issues:
          a. the internal definition of, and boundary between, "Non-Trading BookG " and "trading activities" in accordance with PIB chapter 2 and PIB App2;
          b. the definition of economic value and its consistency with the method used to value assets and liabilities (e.g. discounted cashflows);
          c. the size and the form of the different shocks to be used for internal calculations;
          d. the use of a dynamic and / or static approach in the application of interest rate shocks;
          e. the treatment of commonly called "pipeline transactions" (including any related hedging);
          f. the aggregation of multi-currency interest rate ExposuresG ;
          g. the inclusion (or not) of non-interest bearing assets and liabilities (including capital and reserves);
          h. the treatment of current and savings accounts (i.e. the maturity attached to ExposuresG without a contractual maturity);
          i. the treatment of fixed rate assets (liabilities) where customers still have a right to repay (withdraw) early;
          j. the extent to which sensitivities to small shocks can be scaled up on a linear basis without material loss of accuracy (i.e. covering both convexity generally and the non-linearity of pay-off associated with explicit option products);
          k. the degree of granularity employed (for example, offsets within a time bucket); and
          l. whether all future cash flows or only principal balances are included.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB 7.4 Systems and Controls for Non-Trading Book Interest Rate Risk

      • Non-Trading Book Interest Rate Risk Policy

        • PIB 7.4.1

          (1) An Authorised FirmG must implement and maintain a policy which enables it to identify, assess, control and monitor its Non-Trading BookG interest rate risk.
          (2) The policy must be documented and include an appropriate interest rate risk strategy as well as an enterprise-wide interest rate risk management framework appropriate to the nature, scale and complexity of its Non-Trading BookG activities. The strategy and management framework must:
          (a) enable the Governing BodyG and senior management of the Authorised FirmG to have an enterprise-wide view of interest rate risk as it applies to non-trading activities;
          (b) include a system for identifying and assessing Non-Trading BookG interest rate risk and its sources;
          (c) include a process for the measurement and monitoring of Non-Trading BookG interest rate risk, using robust and consistent methods which enable the Authorised FirmG to implement the requirements set out in Rules PIB 7.2.1 to PIB 7.2.6; and
          (d) include a system for controlling and managing Non-Trading BookG interest rate risk which enables it to comply with the overall risk management standards expected of an Authorised FirmG and ensure continued compliance with the RulesG in PIBG .
          (3) An Authorised FirmG must identify the Non-Trading BookG interest rate risk impact of any new product, activity or service that it proposes to start and ensure that such impacts are duly addressed with adequate controls before the new product or activity is undertaken or introduced.
          (4) An Authorised FirmG must:
          (a) ensure that its risk management systems enable it to implement the Non-Trading BookG interest rate risk policy;
          (b) identify, assess, mitigate, control and monitor the risk; and
          (c) review and update the policy at intervals that are appropriate to the nature, scale and complexity of its activities.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

          • PIB 7.4.1 Guidance

            1. The DFSAG expects that an Authorised Firm'sG strategy towards Non-Trading BookG interest rate risk will set out the approach that the Authorised FirmG will take towards management of the risk, including various quantitative and qualitative targets. It should be communicated to all relevant functions and staff within the organisation and be set out in the Authorised Firm'sG Non-Trading BookG interest rate risk policy.
            2. The DFSAG expects that an Authorised Firm'sG framework for managing Non-Trading BookG interest rate risk will address the following:
            a. the Non-Trading BookG interest rate risk management framework should be integrated into the Authorised Firm'sG enterprise-wide risk management framework, including but not limited to integration with its daily risk management practices;
            b. the output of the risk measurement system which forms part of the Non-Trading BookG interest rate risk management framework should be used in reporting the level of that risk to the senior management and Governing BodyG of the Authorised FirmG ;
            c. the measurement system should be capable of measuring the risk under the earnings approach. Depending on the scale and complexity of Non-Trading BookG structure, the Authorised FirmG may also need to measure the risk based on economic value approach;
            d. an Authorised Firm'sG Non-Trading BookG interest rate risk measurement system should be clearly defined and consistent with the nature and complexity of its balance sheet structure;
            e. the processes, procedures and limits should be clearly documented and should reflect a consideration of the interest rate risk associated with the balance sheet structure of the Authorised FirmG , considering various asset and liability positions. These processes, procedures and limits should be reviewed and approved by appropriate levels of senior management;
            f. the framework should involve an accurate, informative and timely management system for interest rate risk, which is essential to keep the senior management and the Governing BodyG of the Authorised FirmG adequately informed to enable them to ensure compliance with the Non-Trading BookG interest rate risk policy of the Authorised FirmG ; and
            g. the Non-Trading BookG interest rate risk framework should include measures to consider balancing cash flows and management of the risk's impact from new products or services through hedging using swaps or other derivatives. Any such major hedging or risk management initiatives should be approved in advance by the Asset Liability Committee (ALCO) or the Governing BodyG of the Authorised FirmG .
            3. The Non-Trading BookG interest rate risk measurement systems referred to in PIB Rule 7.4.1(2)(c) should encompass all material drivers of the risk. Such systems should evaluate the effect of rate changes on earnings or economic value meaningfully and accurately within the context and complexity of their activities. They should be able to flag any excessive ExposuresG . An effective risk measurement system should address the following:
            a. evaluate all significant interest rate risk arising from the full range of an Authorised Firm'sG assets, liabilities and off-balance sheet positions, both trading and non-trading;
            b. ensure that an integrated view of interest rate risk across products and business lines is available to management, particularly when different measurement systems and methods are used across different business lines;
            c. employ generally accepted financial models and ways of measuring risk; and
            d. ensure accurate and timely data on all aspects related to current positions.
            4. Authorised FirmsG should measure their vulnerability to loss in stressed market conditions, including the breakdown of key assumptions, and consider those results when establishing and reviewing their policies and limits for interest rate risk. Possible stress scenarios for this exercise should include:
            a. historical scenarios such as the Asian Crisis in the late 1990s;
            b. changes in the general level of interest rates, e.g. changes in yields of 200 basis points or more in one year;
            c. changes in the relationships between key market rates (i.e. basis risk), e.g.
            i. a surge in term and savings deposit rates and benchmark rates like LIBOR but no change in the prime rate, and
            ii. a drop in the prime rate but no change in term and savings deposit rates and benchmark rates like LIBOR;
            d. changes in interest rates in individual time bands to different relative levels (i.e. yield curve risk);
            e. changes in the liquidity of key financial markets or changes in the volatility of market rates; and
            f. changes in key business assumptions and parameters such as the correlation between two currencies. In particular, changes in assumptions used for illiquid instruments and instruments with uncertain contractual maturities help understanding of an Authorised Firm'sG risk profile.
            5. An Authorised FirmG should consider the standards for stress testing recommended in the paper published in July 2004 by the Basel Committee for BankingG Supervision — PrinciplesG for management and supervision of interest rate risk — in developing the stress testing scenarios. In particular, an Authorised FirmG should include the technical specifications of a standardised interest rate shock detailed in Annex 3 of that paper.
            Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • Responsibilities of Governing Body

        • PIB 7.4.3

          (1) An Authorised FirmG must ensure that its Governing BodyG is responsible for monitoring the nature and level of Non-Trading BookG interest rate risk assumed by the Authorised FirmG and the process used to manage that risk.
          (2) Without limiting the operation of (1), the responsibilities of an Authorised Firm'sG Governing BodyG in respect of the risk include:
          (a) approving the Authorised Firm'sG Non-Trading BookG interest rate risk policy, including its strategy and management framework;
          (b) establishing and maintaining a senior management structure for the management of the risk and for ensuring compliance with the Authorised Firm'sG risk strategy;
          (c) monitoring the Authorised Firm'sG overall Non-Trading BookG interest rate risk profile on a regular basis and being aware of any material changes in the Authorised Firm'sG current or prospective profile; and
          (d) ensuring that Non-Trading BookG interest rate risk is adequately identified, assessed, mitigated, controlled and monitored.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

          • PIB 7.4.3 Guidance

            1. The Governing BodyG of the Authorised FirmG may delegate responsibility for establishing Non-Trading BookG interest rate risk policies and strategies to the Asset and Liability Committee (ALCO) or an equivalent committee, which is the designated senior management committee for managing balance sheet structure and interest rate risk associated with it.
            2. An Authorised FirmG involved in banking activities or complex principal dealing activities should have a designated committee for design and implementation of Non-Trading BookG interest rate risk management.
            3. An Authorised FirmG should establish and enforce operating limits and other practices that maintain ExposuresG within levels consistent with their internal policies and that accord with their approach to measuring the risk. In particular, Authorised FirmsG should set a limit on the extent to which floating rate ExposuresG are funded by fixed rate sources and vice versa to limit the risk. In floating rate lending, Authorised FirmsG should limit the extent to which they run any basis risk that may arise if lending and funding are not based on precisely the same market interest rate (e.g. LIBOR).
            Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]