Market risk

Regulatory capital treatment of market risk

Our VaR model is consistent with the regulatory measure of market risk capital and has been approved by the Swiss Federal Banking Commission (SFBC), our main regulator. Our base metals and soft commodities derivatives trading business is currently subject to the standardized approach for market risk capital, which is a very conservative treatment, but we are seeking SFBC approval to incorporate it in the approved VaR model. The majority of our trading activities fall under the definition of trading book for regulatory capital treatment. This means that both general and residual market risks in these books are subject to a market risk capital requirement. It also means that the securities and other assets in tradable form are not generally subject to banking book capital requirements, which are typically higher. If a trading position in an asset ceases to be eligible for trading book treatment (for example if it becomes illiquid) it must be underpinned by capital on a banking book basis, but it remains subject to a market risk control framework for internal control purposes. Market risk regulatory capital is based on 10 day VaR while regulatory backtesting is based on 1 day VaR. As required by regulation, backtesting exceptions are notified to our internal and external auditors and relevant regulators. Non trading foreign exchange exposures other than structural positions are subject to a market risk regulatory capital charge and are included in VaR for this purpose. Other non-trading market risks are not subject to such a charge but interest rate risk in the banking book is reported to Swiss regulators.

For further explanation of regulatory capital treatment please see note 28 of our Financial Report 2005.