We have an interesting question from one of our members.
"We usually perform OTC FX transactions with clients backed-to-back on the market (with Banks). Now we are going to perform a FX swap (i.e. Spot + forward) JPY/EUR for the Bank account for 1 week at the longest. The purpose is to get EUR place @ CB for LCR compliance purpose (no trading purposes).
Bank's Management think that this should be considered as a trading position and therefore be classified within the Bank's trading book. I'm not an expert of trading book but at first sight I'm not willing to classify this transaction within the TB."
Could you please share your thoughts on this subject? I really appreciate any kind of contribution.
Global Risk Community, Founder
To answer properly needs somewhat more details how will the swap be closed out. If the purpose relate to a reporting compliance on a temporary basis without automatic close from an already unrecoverable commitment the transaction may be classified as suggested by Laurence.
In other cases it must be classified as a trading book transaction
If a client wishes to sell debt securities to a bank instead of taking a loan, the asset will now be assigned to the trading book instead. The bank will then keep specific risk capital for the securities as well as market risk capital.
The main differences are:
1. Assets that are held for trading are put in the trading book, assets that are held to maturity are held in the banking book
2. Assets in the trading book are marked-to-market daily, assets in the banking book are held at historic cost
3. The value-at-risk for assets in the trading book is calculated at a 99% confidence level based on a 10-day time horizon. The value-at-risk for assets in the banking book are calculated at a 99.9% confidence level on a one-year horizon.
"Risk Management and Financial Institutions" (John Hull)
Is the risk material ? or a single one-off transaction in EUR/JPY? Trading Book means all positions in financial instruments and commodities held by an institution either with trading intent or in order to hedge positions held with trading intent;
Positions held with trading intent means the following in your case: Proprietary positions and positions arising from client servicing and market making.
You transaction seems to be used for balance sheet and liquidity management. Why not add it to the non-trading books of ALM..relavent sections of FRTB are section 2 Defining the trading book.