Financial Services (Investment and Fiduciary Services)
Repealed Subsidiary 2007/002
FINANCIAL SERVICES (CAPITAL ADEQUACY OF INVESTMENT FIRMS) REGULATIONS 2007
1. An internal hedge is a position that materially or completely offsets the component risk element of a non-trading book position or a set of positions. Positions arising from internal hedges are eligible for trading book capital treatment, provided that they are held with trading intent and that the general criteria on trading intent and prudent valuation specified in Parts A and B are met. In particular–
internal hedges shall not be primarily intended to avoid or reduce capital requirements;
internal hedges shall be properly documented and subject to particular internal approval and audit procedures;
the internal transaction shall be dealt with at market conditions;
the bulk of the market risk that is generated by the internal hedge shall be dynamically managed in the trading book within the authorised limits; and
internal transactions shall be carefully monitored.
Monitoring shall be ensured by adequate procedures.
2. The treatment referred to in paragraph 1 applies without prejudice to the capital requirements applicable to the ‘non-trading book leg’ of the internal hedge.
3. Notwithstanding paragraphs 1 and 2, when an investment firm hedges a non-trading book credit risk exposure using a credit derivative booked in its trading book (using an internal hedge), the non-trading book exposure is not deemed to be hedged for the purposes of calculating capital requirements unless the investment firm purchases from an eligible third party protection provider a credit derivative meeting the requirements set out in paragraph 19 of Part 2 of Schedule 8 to of the FSCACI Regulations with regard to the non-trading book exposure. Without prejudice to the second sentence of paragraph 11 of Schedule 2, where such third party protection is purchased and is recognised as a hedge of a non-trading book exposure for the purposes of calculating capital requirements, neither the internal nor external credit derivative hedge shall be included in the trading book for the purposes of calculating capital requirements.