5.Banks must treat in-scope equity positions in a manner consistent with one or more of the following three approaches: the “look-through approach”, the “mandate-based approach” and the “fall-back approach”.

1.Look-through approach (LTA)

6.The look-through approach (LTA) requires a bank to risk weight the underlying exposures of a fund as if the bank held the exposures directly. LTA must be used by a bank when:

1. (iii)there is sufficient and frequent information provided to the bank regarding the underlying exposures of the fund to determine the applicable risk weights and exposure amounts; and
2. (iv)such information is subject to verification by an independent third party.

7.To satisfy condition (i) above, the frequency of financial reporting of the fund must be the same as, or more frequent than, the financial reporting obligation of the bank, and the granularity of the financial information must be sufficient to calculate the corresponding risk weights and exposure amounts without requiring an external audit. To satisfy condition (ii) above, there must be verification of the underlying exposures by an independent third party, such as a depository or custodian bank or, where applicable, a fund management company.

8.Under the LTA, a bank must risk weight all underlying exposures of a fund as if the bank held those exposures directly. This includes, for example, any underlying exposure arising from the fund’s derivatives activities and the counterparty credit risk (CCR) exposure associated with those derivatives. However, instead of determining the applicable credit valuation adjustment (CVA) capital associated with the fund’s derivatives exposures, a bank should instead increase the CCR exposure by 50 percent (that is, multiply the CCR exposure by a factor of 1.5) before applying the risk weight associated with the counterparty. Banks are not required to apply the 1.5 factor to transactions for which the CVA capital charge would not otherwise be applicable, such as those conducted directly with central counterparties.

9.Banks may rely on third-party calculations to determine the risk weights associated with equity investments in funds (that is, the underlying risk weights of the exposures of the fund) if they cannot obtain adequate data or information themselves to perform the calculations. In such cases, however, the bank must increase the resulting risk weight by 20 percent (that is, multiplied by a factor of 1.2) relative to the risk weight that would be applicable if the bank held the exposure directly.

10.Banks should use the risk weights from the LTA to compute RWA for the fund. After calculating the RWA for a fund according to the LTA, banks must calculate the average risk weight for that fund (Avg RW_fund) by dividing the total RWA of the fund by the total (unweighted) assets of the fund.

2.Mandate-based approach (MBA)

11.Banks should use the second approach, the mandate-based approach (MBA), only when the conditions for applying the LTA are not met. Banks should use the information contained in a fund’s mandate or in the relevant regulations governing such investment funds to perform a conservative calculation of the applicable risk weights for the assets of the fund.

12.Under the MBA, on-balance-sheet exposures (that is, the fund’s assets) are risk weighted assuming that the underlying portfolios are invested to the maximum extent allowed under the fund’s mandate in assets that would attract the highest risk weights, and then progressively in other assets that attract lower risk weights. If more than one risk weight could be applied to a given exposure, the bank should use the highest applicable risk weight.

13.The notional amount of derivative exposures and off-balance-sheet items should be risk-weighted according to the requirements of the risk-based capital standards.

14.Banks should calculate the CCR exposure associated with a fund’s derivative positions in accordance with the Central Bank’s Standard for Counterparty Credit Risk Capital. If replacement cost cannot be determined, the bank should use the notional amount of the derivative as the replacement cost. If the Potential Future Exposure (PFE) cannot be determined, the bank should use an amount equal to 15 percent of the notional value as the PFE.

15.As with the LTA, banks should account for CVA Risk on derivatives by increasing the CCR exposure by 50 percent (that is, multiply the CCR exposure by a factor of 1.5) before applying the risk weight associated with the counterparty. Banks are not required to apply the 1.5 factor for transactions to which the CVA capital charge would not otherwise be applicable, such as those conducted directly with central counterparties.

16.As with the LTA, after calculating the RWA for a fund according to the MBA, banks must calculate the average risk weight for that fund (Avg RW_fund) by dividing the RWA of the fund by the total (unweighted) assets of the fund.

3.Fall-back approach (FBA)

17.When the conditions for applying either the LTA or the MBA are not met, banks are required to apply the FBA, under which Avg RW_fund for a bank’s investment in the fund is set equal to 1250 percent.