FIMMDA WORKSHOP RUPEE DERIVATIVES

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FIMMDA WORKSHOPRUPEE DERIVATIVES

• MID-OFFICE AND BACK-OFFICE ISSUES

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SESSION OUTLINE

• Market Developments RBI Guidelines
• Proposed FIMMDA Conventions
• Capital Adequacy
• Credit Risk
• Market Risk
• Deal Processing Settlement
• Monitoring Control

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SESSION OUTLINE (contd)

• Documentation
• Accounting
• Tax Issues

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MARKET DEVELOPMENTSAND RBI REGULATIONS

• Permitted Products
• Plain Vanilla IRS FRA
• Participants
• Scheduled Banks, PDs and FIs
• Corporates
• Tenor Size
• No Restrictions
• Benchmarks
• Market Determined

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MARKET DEVELOPMENTS AND RBI REGULATIONS

• Capital Adequacy, Credit Market Risk Limits
• Accounting
• Market Making MTM basis
• Hedging Accrual basis
• Documentation
• Internal Control
• Differentiation between trading hedging
  transactions
• Segregation between functions - front mid/back
  office
• Concurrent Audit

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OVERNIGHT INDEX SWAPSPROPOSED FIMMDA CONVENTIONS

• Day Count
• Actual/365
• Value/Start Date
• Next Business Day (i.e. val tom)
• Exchange of Rate Fixing Notices
• Maturity period less than 3 months
• No Daily Exchange of Notices
• Maturity period greater than 3 months
• Quarterly Exchange of daily data for preceding
  quarter

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OVERNIGHT INDEX SWAPSPROPOSED FIMMDA CONVENTIONS

• Interest Exchanges
• One-time at maturity for short dated deals
• Periodic interest payments for longer dated deals
• Benchmarks
• NSE MIBOR
• Reuters MIBOR
• FIMMDA Overnight Rate
• Interest Calculation
• Floating Leg - Daily Compounding

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OVERNIGHT INDEX SWAPSPROPOSED FIMMDA CONVENTIONS

• Holiday Calendar
• Mumbai
• Minimum Notional Principal Amount
• INR 50 Mio

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CAPITAL ADEQUACY

• Credit Conversion Factor (as per BIS norms)
• Less than 1 year 0.5
• 1 to less than 2 years 1.0
• For each additional year 1.0
• Risk Weightings
• 20 for Banks/FI counterparties
• 100 for all others including corporate
  counterparties

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CAPITAL ADEQUACY

• Capital Charge Notional Principal
• X
• Conversion Factor
• X
• Risk Weightings
• X
• 8 for Banks/12 for PDs

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CAPITAL ADEQUACY

• Thus for a INR 50 Mio IRS, maturity 1 year,
  counterparty being a Bank, the capital charge
  for
• Bank - 50 Mio x 0.005 x 0.2 x 0.08 INR 4,000
• PD - 50 Mio x 0.005 x 0.2 x 0.12 INR 6,000

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CREDIT RISK

• Two components to calculate current exposure
• The way in which market rates and prices have
  moved since the transaction was executed, i.e.
  Mark to Market value (MTM),
• and
• the way in which market rates and prices might
  move over the remaining life of the transaction,
  i.e. Future Fluctuation Risk (FFR).

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CREDIT RISK

• Recorded credit risk should reflect both current
  exposure as well as an estimate of the potential
  exposure that would prevail at the time of
  counterparty default.
• Credit exposure calculation methodologies should
  be the same for all counterparties. Differences
  in credit quality should reflect in size of
  limit, and not in measurement of exposure.

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CREDIT RISK

• Current Credit Exposure MTM FFR
• FFR Notional Principal X Weighting X Term (in
  yrs)
• MTM value of the deal (i.e. its replacement
  cost) may be ve, -ve or zero. FFR is always ve.
• Where the calculation results in a -ve figure
  (if -ve MTM exceeds FFR), the credit exposure is
  zero, it cannot be negative.

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CREDIT RISK

• EXAMPLE - CURRENT EXPOSURE
• Notional Principal INR 50 Mio OIS
• Original Term 13 months
• Residual Term 12 months
• Current MTM INR 0.3 Mio
• Weighting 4 pa (say)
• Current Exposure 0.3 (50 x 4 x 1) INR 2.3
  Mio

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CREDIT RISK

• ALTERNATIVE METHODOLOGY
• Original Exposure Calculation
• Records a credit exposure which remains constant
  throughout the life of the transaction. However,
  it is advisable to calculate MTM at periodic
  intervals to ensure that actual exposure does not
  exceed original estimated exposure.

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MARKET RISK

• There are various methodologies available for
  use in identifying, measuring and managing
  interest rate risk
• Duration
• Present Value of a Basis Point (PVBP)
• Value at Risk (VAR)
• A brief look at VAR......

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MARKET RISK

• VALUE AT RISK (VAR)
• VAR is a statistical measure of potential losses
  on open interest rate risk positions given
• underlying interest rate volatilities
• a level of confidence
• a time horizon
• assumed correlation between interest rates
• open risk positions

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MARKET RISK

• VAR EXAMPLE
• Assumptions
• 95 confidence level
• 1 day time horizon
• Interest Rate Volatilities (2?)
• 1 month 160 bps
• 3 month 110 bps
• 6 month 80 bps
• 1 correlation between interest rates

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MARKET RISK

• VAR EXAMPLE
• Interest Rate Risk Ladder
• Current
• Period Cash Flows Rates PVBP
• 1 month (100,000,000) 8.50 763
• 3 month 200,000,000 9.50 (4,464)
• 6 month (300,000,000) 11.00 12,826

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MARKET RISK

• VAR EXAMPLE
• VAR PVBP1Vol1 PVBP3Vol3 PVBP6Vol6
• (763160) (- 4464110) (1282680)
• 122080 - 491040 1051732
• 682,772

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DEAL PROCESSINGAND SETTLEMENT

• Verify and approve system deal input - deal
  amendments if required
• Generate and despatch outward confirmations
• Confirmation of settlement amounts at maturity or
  periodic dates
• Settlement of net interest amounts at maturity or
  periodic dates
• Safe-keeping of all deal related documentation
  for audit purposes

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MONITORINGAND CONTROL

• Setting up of credit and market risk limits, and
  daily monitoring reporting of limit excesses if
  any
• Daily/periodic rate fixings
• Monitoring of inward confirmations not received
• Financial and management accounting
• PL reporting
• Regulatory reporting

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DOCUMENTATION

• INTERBANK
• ISDA Master Agreement
• Individual confirmations for each transaction
• CORPORATE
• ISDA Master Agreement
• Company Board Resolution
• Delegation of transaction authority along with
  specimen signatures
• Certificate that the transaction is a balance
  sheet hedge

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ACCOUNTING FOR OIS

• GENERAL ACCOUNTING PRINCIPLES
• Trading Swaps
• Daily MTM with PL taken to book
• No coupon/yield accruals
• Gains/losses realised on interest payment date/s
• Hedging Swaps
• Daily coupon/yield accruals
• MTM valuation for management information only

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ACCOUNTING FOR OIS

• ACCOUNTING ENTRIES GENERATION
• Event Related
• Trade Date
• Start/Value Date
• Interest Payment Dates
• Maturity Date
• Daily Entries
• PL (trading) and Accrual (hedging)

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ACCOUNTING FOR OISAN EXAMPLE

• Trade Date Day 0 Todays Date Day 2
• Value Date Day 2 Next Proc Dt Day 3
• Maturity Date Day 93
• Pay Leg 10 A/365
• Recv Leg NSE MIBOR A/365 (First Fix 8.00)
• Daily Compounding
• Notional Prin INR 50 Mio
• Payment At maturity on net basis
• Reval Rate 10.5 (Fixed Leg)

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ACCOUNTING FOR OISAN EXAMPLE

• EVENT RELATED ENTRIES
• Trade Date (Reverse on Value Date)
• Commitment Accounts (off B/S)
• Swap Receivable Unsettled INR 50 Mio
• Swap Payable Unsettled INR 50 Mio
• Value Date (Reverse on Maturity Date)
• Contract Accounts (off B/S)
• Swap Receivable INR 50 Mio
• Swap Payable INR 50 Mio

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ACCOUNTING FOR OISAN EXAMPLE

• Calculation of Present Values (disc to NPD)
• Fixed Leg
• PV - 51,246,575
• 1(0.105/36590)
• - 49,953,264
• Floating Leg
• PV 50,000,000

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ACCOUNTING FOR OISAN EXAMPLE

• Trading Swap
• MTM Fixed Leg 50,000,000 - 49,953,264
• 46,736
• MTM Floating Leg Nil
• MTM on Swap 46,736
• In case of daily re-setting and discounting to
  next processing date, no MTM generated

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ACCOUNTING FOR OISAN EXAMPLE

• Trading Swap Accounting Entries
• Daily MTM (On B/S)
• Swap Unrealised PL INR 46,736 CR
• Swap Reval Provision INR 46,736 DR
• Updated daily from trade date to maturity date,
  reversed to realised PL on maturity date.
• Interest Payment Date/s (On B/S)
• Swap Realised PL DR/CR
• INR Nostro DR/CR

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ACCOUNTING FOR OISAN EXAMPLE

• Hedging Swap
• Yield Accrual Fixed Leg - 50 Mio x 10 / 365 x
  1
• - 13,699
• Yield Accrual Fltg Leg 50 Mio x 8 / 365 x 1
• 10,959
• Yield Accrual on Swap - 2,740

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ACCOUNTING FOR OISAN EXAMPLE

• Hedging Swap
• MTM Fixed Leg 50 Mio - 49,953,264 13,699
• 60,435
• MTM Floating Leg 50 Mio - 50 Mio - 10,959
• - 10,959
• MTM on Swap 49,476

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ACCOUNTING FOR OISAN EXAMPLE

• Hedging Swap Accounting Entries
• Daily Coupon Accrual (On B/S)
• Hedging Coupon PL INR 2,740 DR
• Hedging Coupon Accrual INR 2,740 CR
• On interest payment date accrual balance reversed
  against INR Nostro

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ACCOUNTING FOR OISAN EXAMPLE

• Hedging Swap Accounting Entries
• MTM - for MIS purposes only (Off B/S)
• Swap Hedging Revaluation INR 49,476 CR
• Swap Hedging Revaluation Contra INR 49,476 DR

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ACCOUNTING FOR OISAN EXAMPLE

• MTM Hedge Yield Accrual MTM Trading
• Thus in our example,
• 49,476 - 2,740 46,736

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TAX STAMP DUTY ISSUES

• Receipt and payment streams to be treated as
  revenue income and expenses
• No TDS deductions on interest flows
• Stamp duty payable on ISDA Master Agreement
• Stamp Duty on Deal Confirmations ??