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Dubai Financial Services Authority (DFSA): Contents

Dubai Financial Services Authority (DFSA)
Laws
Rulebook Modules
Prudential — Investment, Insurance Intermediation and Banking Module (PIB) [VER33/02-19]
PIB App4 Credit Risk
Sourcebook Modules
Consultation Papers
Policy Statements
DFSA Codes of Practice
Amendments to Legislation
Media Releases
Notices
Financial Markets Tribunal
Archive

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  • PIB A4.6 Credit RWA — Unsettled Transactions, free deliveries and OTC Derivatives

    • PIB A4.6 Guidance

      1. Where settlement does not occur on the due date and neither party has released the relevant cash or SecuritiesG , an Authorised FirmG faces Market RiskG , namely the differential between the contract price of the SecuritiesG and their current value in the market. In this case an Authorised FirmG also faces a Credit RiskG ExposureG for the Unsettled TransactionG , for which the Authorised FirmG is required to hold regulatory capital. The relevant Credit RiskG ExposureG should be included in the calculation of Credit RWAG for the Authorised FirmG .
      2. An Authorised FirmG is at risk for the whole amount of the contract (as well as any further movement in price) if it has delivered its leg of a contract before receipt of the other leg. In this case an Authorised FirmG must calculate the Credit RiskG RWAG for the free delivery transaction.
      3. For OTC DerivativesG and other contracts, an Authorised FirmG is exposed to settlement risk. For an OTC DerivativeG contract, the risk is that the price moves in an Authorised Firm'sG favour so that it makes a book profit but at maturity the Authorised FirmG cannot realise that profit because the other party defaults. The amount at risk is therefore less than the Authorised FirmG 's nominal ExposureG and is measured by calculating the proportion of the nominal ExposureG considered to be at risk -the Credit Equivalent AmountG .
      Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • PIB A4.6.1

      The section applies in respect of items in both the Trading BookG and Non-Trading BookG .

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

    • PIB A4.6.2

      CRWs must be calculated on the CounterpartyG to the transaction, not on the IssuerG of the SecurityG .

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

    • PIB A4.6.3

      When calculating its Credit RWAG , an Authorised FirmG must not include RWAG arising from a transaction if it is a negative amount.

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

    • PIB A4.6.4

      CRW is applied in accordance with PIB section A4.3 except that the maximum CPW for an OTC DerivativeG is 50%.

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

    • Unsettled Transactions

      • PIB A4.6.5

        An Authorised FirmG must calculate the Credit RWAG for transactions in which debt instruments, equities, foreign currencies and commodities (excluding repos, reverse repos and SecuritiesG or commodities lending/borrowing) remain unsettled after their due delivery dates, using the following formula:

        Credit RWAG on Unsettled TransactionsG = E x the appropriate percentage from the second column in the table below:

        Number of business days after due settlement date Percentages used for calculation of Credit RWAG on Unsettled TransactionsG
        0–4 0%
        5–15 100%
        16–30 500%
        31–45 750%
        46 or more 1000%
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.6.6

        If assets involved in the transaction are to be received by the Authorised FirmG and the transaction remains unsettled: E = MV-CV.

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

      • PIB A4.6.7

        If assets involved in the transaction are to be delivered by the Authorised FirmG and the transaction remains unsettled: E = CV-MV. If the values for E calculated above are negative, E = 0.

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

      • PIB A4.6.8

        An Authorised FirmG must determine E for an unsettled non-DvP transaction as equal to the outstanding receivables after the end of the first contractual payment or delivery date.

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

        • PIB A4.6.8 Guidance

          1. E is the price difference to which the Authorised FirmG is exposed, being the difference between the agreed settlement price for the debt instrument, equity, foreign currency or commodity in question and its current market value, where the difference could involve a loss for the firm.
          2. In cases of a system-wide failure of a settlement or clearing system, an Authorised FirmG need not calculate CRCOMG on transactions remaining unsettled till the settlement or clearing system is brought back to normal operations.
          3. In respect of unsettled non-DvP transactions referred to in PIB Rule A4.6.8, if the dates when two payment legs are made are the same according to the time zones where each payment is made, they are deemed to have been settled on the same day.
          Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

    • Free Delivery Transactions

      • PIB A4.6.9

        The CRW for transactions in which an Authorised FirmG has:

        (a) delivered SecuritiesG or commodities before receiving payment;
        (b) paid for SecuritiesG or commodities before receiving the items purchased; or
        (c) entered into a foreign exchange contract undertaken in the spot market or contracted for forward settlement and has released funds to its CounterpartyG but has not yet received the funds in the other currency;

        is calculated by the formula:

        Credit RWAG on free deliveries = E x CRW x the multiplier from the table below:

        Number of business days since delivery multiplier used for calculation of Credit RWAG on free deliveries
        0–15 1
        16–30 5
        31–45 7.5
        46 or more 10
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A.4.6.10

        If an Authorised FirmG has delivered commodities or SecuritiesG to a CounterpartyG and has not received payment: E = CV due to the Authorised FirmG .

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

      • PIB A4.6.11

        If an Authorised FirmG has made payment to a CounterpartyG for commodities or SecuritiesG and has not received them: E = MV of the commodities or SecuritiesG .

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

      • PIB A4.6.12

        If the settlement of the transaction is to be effected across a national border, Credit RWAG needs to be calculated only when more than one business day has elapsed since the firm has made the relevant payment or delivery.

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

      • PIB A4.6.13

        In the case of a Non-Trading BookG item, an Authorised FirmG must treat an ExposureG in accordance with the relevant provisions of PIB chapter 4.

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

    • Financial Derivatives

      • PIB A4.6.14

        For the purposes of calculating Credit RWAG , a financial DerivativeG includes, but is not limited to OTC DerivativesG and Credit DerivativesG . ExposuresG dealt with under this section do not include ExposuresG to CCPs which qualify for a zero ExposureG value.

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

      • PIB A4.6.15

        For OTC DerivativeG transactions: Credit RWAG = CEAG x CRW.

        where:

        (a) contracts traded on exchanges, where they are subject to daily margining requirements, are excluded; and
        (b) CEAG is calculated using the formula:
        CEAG = the replacement cost of the OTC DerivativeG contract (obtained by marking to market) (in the case of a transaction with negative replacement cost, a value of zero) + PFCE.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

        • PIB A4.6.15 Guidance

          Details of how to net the PFCE are given in PIB Rule A4.6.22.

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

      • PIB A4.6.16

        (1) In case of Credit DerivativesG including but not limited to total return swaps and credit default swaps, an Authorised FirmG must determine its PFCE by multiplying the nominal amount of the instrument by the following percentages:
        (a) 5% where the reference obligation of the Credit DerivativeG is one that if it gave rise to a direct ExposureG of the Authorised FirmG would be a qualifying reference obligation; or
        (b) 10% where the reference obligation is one that if it gave rise to a direct ExposureG of the Authorised FirmG would not be a qualifying reference obligation.
        (2) For the purposes of this RuleG , a "qualifying reference obligation" means any SecurityG that is issued by any MDB, any SecurityG (including one issued by a PSE) that has a Credit Quality GradeG of 3 or better as set out in PIB section 4.12 based on the external credit assessment of at least one recognised external credit rating agency, and any unrated SecurityG issued by a PSE which belongs to a country with a Credit Quality GradeG of 1 as set out in PIB section 4.12.
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.6.17

        In the case of credit default swaps, an Authorised FirmG which is a seller of credit protection may assign a PFCE of 0%, unless the protection is subject to close-out on the insolvency of the buyer.

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

      • PIB A4.6.18

        In cases where a Credit DerivativeG provides protection in relation to "nth to default" amongst a number of underlying obligations, an Authorised FirmG must apply a percentage in accordance with PIB Rule A4.6.16G applicable to the obligation with the nth lowest credit quality determined by whether it is one that if incurred by the Authorised FirmG would be a qualifying reference obligation for the purposes of PIB Rule A4.6.16(1)(a).

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

        • PIB A4.6.18 Guidance

          Where the Credit DerivativeG is a first to default transaction, the appropriate percentage for the PFCE will be determined by the lowest credit quality of the underlying obligations in the basket. If there are nonqualifying items in the basket, the percentage applicable to the non-qualifying reference obligations should be used. For second and any subsequent default transactions, underlying assets should continue to be allocated according to credit quality: i.e. for a second to default transaction, the applicable percentage figure is the percentage applicable to the second lowest credit quality.

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

      • PIB A4.6.19

        For OTC DerivativeG transactions other than Credit DerivativesG , PFCE is calculated by multiplying the NP of the contract by the appropriate percentage from the table below.

        Type of contract Residual maturity of contract
        <1 Year 1–5 Years >5 Years
        Single currency interest rate basis swaps 0.0% 0.0% 0.0%
        Interest rate Single currency interest rate swaps other than basis swaps
        Multiple currency basis swaps
        Forward-rate agreements
        Interest rate futures
        Interest rate OptionsG purchased
        DerivativesG referenced on an Investment GradeG debt Item
        Other contracts of a similar nature to those in this box.
        0.0% 0.5% 1.5%
        Foreign exchange (including gold) except as referred to in A4.6.20 Cross-currency interest-rate swaps.

        Forward foreign exchange contracts.

        Currency futures.

        Currency OptionsG purchased.

        Other contracts of a similar nature to those in this box, including gold.
        1.0% 5.0% 7.5%
        Equities Cash settled forward contracts

        Contracts of a nature similar to those in the interest rate and foreign exchange boxes.

        DerivativesG referenced on a bond which is not an Investment GradeG debt Item.
        6.0% 8.0% 10.0%
        Precious metals (except gold) Contracts of a nature similar to those in the interest rate and foreign exchange boxes concerning precious metals, except gold. 7.0% 7.0% 8.0%
        Commodities (except precious metals) and any other contracts Contracts of a nature similar to those in the interest rate or foreign exchange boxes concerning commodities other than precious metals. 10.0% 12.0% 15.0%
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.6.20

        If the contract is an OTC foreign exchange contract (not including gold) with an Original MaturityG of 14 days or less: CEAG = 0.

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

      • PIB A4.6.21

        Where a contract price is based upon more than one underlying instrument, the higher of the relevant PFCE multipliers must be used.

        NettingG of PFCE

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

        • PIB A4.6.21 Guidance

          An Authorised FirmG may calculate the PFCE arising under OTC derivative contracts on a net basis.

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

      • PIB A4.6.22

        Where the conditions in in PIB section 4.13 are met, an Authorised FirmG may calculate its net PFCE on OTC derivative contracts using the following formula:

        PFCE reduced = 0.4 x PFCE gross + 0.6 x NGR x PFCE gross

        where:

        (a) "PFCE reduced" is the reduced figure for PFCE for all contracts with a given CounterpartyG included in the NettingG agreement;
        (b) "PFCE gross" is the sum of the figures for PFCE for all contracts with a given CounterpartyG which are included in the NettingG agreement; and
        (c) "NGR" is the net-to-gross ratio, being the quotient of the net replacement cost for all contracts included in the NettingG agreement with a given CounterpartyG (numerator) and the gross replacement cost for all contracts included in the NettingG agreement with that CounterpartyG (denominator).
        Derived from RM111/2012 (Made 15th October 2012). [VER20/12-12]

      • PIB A4.6.23

        For the purposes of PIB Rule A4.6.19, the applicable maturity date must be the maturity of the longest date.

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