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Article (12) Market Risk

CBUAE/BSD N 1198/2021 Effective from 25/2/2021
  1. 12.1Requirements on market risk must be read in conjunction with the Market Risk Regulation and accompanying Standards (Circular 164/2018).
    IBs must have in place an appropriate framework for market risk management in each stage of the contract, including reporting in respect of all assets held, particularly those that do not have a ready market and/or are exposed to high price volatility.
  2. 12.2IBs must establish a sound and comprehensive market risk management process and information system, which (among others) comprises:
    • -a conceptual framework to assist in identifying underlying market risks;
    • -guidelines governing risk taking activities in different portfolios of restricted IAH and their market risk limits;
    • -appropriate frameworks for pricing, valuation and income recognition; and
    • -a strong management information system for controlling, monitoring and reporting market risk exposure and performance to appropriate levels of senior management.

    Given that all the required measures are in place (e.g. pricing, valuation and income recognition frameworks, strong MIS for managing exposures, etc.), the applicability of any market risk management framework that has been developed should be assessed taking into account consequential business and reputation risks.

  3. 12.3IBs must adhere to the fiduciary duty to apply the same risk management policies and procedures to assets held on behalf of restricted Investment Account Holders as they do for assets held on behalf of shareholders and unrestricted Investment Account Holders.
  4. 12.4IBs must be able to quantify market risk exposures and assess exposure to the probability of future losses in their net open asset positions.
  5. 12.5IBs must take into consideration the specifics of each Shari’ah compliant instrument in the following manner:
    1. a.In operating Ijarah contracts, a lessor is exposed to market risk on the residual value of the leased asset at the term of the lease or if the lessee terminates the lease earlier (by defaulting), during the contract
    2. b.In Salam, an IB as a buyer is exposed to commodity price fluctuations on a long position after entering into a contract and while holding the subject matter until it is disposed of. In the case of parallel Salam, there is also the risk that a failure of delivery of the subject matter by the counterparty which exposes the IBs to commodity price risk as a result of the need to purchase a similar asset in the market in order to honor the parallel Salam contract.
    3. c.Before acquisition of financial assets not actively traded with the intention of selling them, an IB must analyze and assess the factors attributable to changes in liquidity of the markets in which the assets are traded and which give rise to greater market risk.

    IBs may hedge foreign exchange fluctuations arising from general FX spot rate changes in both cross-border transactions and the resultant foreign currency receivables and payables using Shari’ah compliant methods.

  6. 12.6In the valuation of assets where no direct market prices are available, IBs must incorporate in their own product program a detailed approach to valuing their market risk positions. IBs may employ appropriate forecasting techniques to assess the potential value of these assets.
    Where available valuation methodologies are deficient, IBs must assess the need (a) to allocate funds to cover risks resulting from illiquidity and uncertainty in assumptions underlying valuation and realization; and (b) to establish a contractual agreement with the counterparty specifying the methods to be used in valuing the assets