Journal of Risk

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A review of the foreign exchange base currency approach under the standardized approach of the Fundamental Review of the Trading Book and issues related to the pegged reporting currency

Ted Yu

  • Demonstrates the invariance of delta FX risk charge of any reporting currency under the standardized approach of FRTB.
  • Explains the variance of delta FX risk charges of different report currencies using the triangular relationship of currency pairs.
  • Illustrates an example on how the variance amplifies for a pegged reporting currency.
  • Proposes a method for the delta FX risk calculation of the pegged reporting currency.

The foreign exchange (FX) base currency approach under the standardized approach of the Fundamental Review of the Trading Book (FRTB) has been newly introduced to the Basel Committee on Banking Supervision (BCBS) standards to calculate the FX risk capital charge. This new approach acknowledges the triangular relationship of currency pairs and allows banks to calculate the FX risk relative to a base currency instead of to the reporting currency. When we adopt the parameters in the BCBS standards to calculate the delta risk charge, anomalies in the risk charges for the same risk exposure are found under different approaches and under different reporting currencies. The anomalies increase when the approach applies to a pegged reporting currency. We provide numerical examples to explain the reason for the variance and to prove that the delta risk charge for spot FX portfolios should be invariant for any reporting currency given that an appropriate correlation is set. We also propose a workable solution with a minimal change to the BCBS standards to solve the anomalies for the pegged reporting currency.

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