Instruction No. 27-2016 of November 16 on Market Risk Governance

INSTRUCTION NO. 27/16 of November 16
SUBJECT: MARKET RISK GOVERNANCE

Considering the provisions established in Notice No. 07/2016 of June 22 on Risk Governance, Financial Institutions must adopt functions, policies, and risk management processes for the identification, assessment, monitoring, control, and reporting of market risk;

In these terms, and under the combined provisions of letters d) and f) of Article 21 and letter d) of paragraph 1 of Article 51, both of Law No. 16/10 of July 15 – Law of the Bank National of Angola, and Article 90 of Law No. 12/15 of June 17 – Law of the Bases of Financial Institutions.

I DETERMINE:

1. Definitions

Without prejudice to the definitions established in the Law of the Bases of Financial Institutions, for the purposes of this Instruction, the following are understood:

1.1 Banking book: set of financial instruments of an Institution not held in the trading book.

1.2 Trading book: all positions in financial instruments and commodities held by an Institution, for trading purposes or for hedging positions held for trading purposes. In these terms, the following are considered positions held for trading purposes:

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a) proprietary positions and positions resulting from services provided to clients and market making;

b) positions intended for short-term resale;

c) positions intended to take advantage of short-term, actual or expected, differences between purchase and sale prices or other price or interest rate variations.

1.3 Risk factor: aspect or characteristic that influences risk. In the assessment of risks, the characteristics of products and financial markets, borrowers, and processes in place at Institutions are relevant, namely.

1.4 Settlement function: structural unit responsible for settling and accounting for operations in which the Institution is involved.

1.5 Risk position: exposure relative to an asset, an off-balance sheet item, or a financial derivative instrument, plus profits of any nature not received that are reflected in accounting as amounts receivable, regardless of whether they are due or overdue, in accordance with the criteria of the Chart of Accounts Manual for Financial Institutions.

1.6 Basis risk: arising from the use of imperfect hedging instruments.

1.7 Market liquidity risk: arising from a position that cannot be liquidated at market price due to lack of liquidity in the same.

2. Organizational and Operational Structure Requirements

2.1 According to the provisions of paragraph 9 of Article 9 of the Notice on risk governance, Institutions must ensure the existence of a body of staff with experience, knowledge, and training to act prudently in the assessment, approval, and management of market risk.

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2.2 Institutions must define an unequivocal and consistent decision-making hierarchy for decisions regarding trading activity.

2.3 The governing body must delegate competencies and adequately invest in the necessary resources to ensure that the initiation and monitoring process of trading activity coordinates the efforts of the various staff involved and that their decisions are made in a solid and consistent manner.

2.4 Institutions may refrain from the segregation of functions required in paragraph 1 of Article 9 of the Notice on risk governance, provided that the risk of their trading activity is considered immaterial, that is, has little relevance in the overall activity of the Institutions, and alternative control mechanisms are created.

2.5 Transactions that result in new positions must be analyzed promptly by the risk management function, in order to ensure timely reduction of the risk inherent in the trading book or the application of control measures.

2.6 Before concluding agreements linked to trading and investment activities, particularly in clearing agreements and guarantee agreements, assessments must be carried out by areas independent of trading, with the objective of verifying that they are legally applicable.

2.7 Whenever transactions are processed by intermediaries, these must be duly identified.

2.8 Institutions must ensure that, at the time of the transaction, the terms and conditions, including additional clauses, are fully agreed upon by the intervening parties and that they are confirmed, registered, and documented immediately.

2.9 Institutions must ensure that the transaction confirmation contains all relevant information, as well as verify that the counterparty's confirmation is received immediately, in order to direct them directly to the settlement function.

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2.10 Institutions may refrain from transaction confirmation whenever:

a) these are processed through an automatic settlement system, which executes transactions only when the reconciled data correspond to each other; or,

b) both parties are allowed access to the transaction information and that it is analyzed in a way to ensure that:

i. transaction documents are complete and were submitted on time;

ii. the data provided by operators are correct, complete, and in accordance with the confirmation data of the brokers, with the prints of the trading systems, and with any other relevant sources, whenever available;

iii. transactions are within limits, regarding their type and scope;

iv. the terms of the transaction are in accordance with market conditions; and,

v. any deviations from predefined standards are identified.

2.11 For the purposes of sub-letter v. of the previous point, Institutions must establish adequate procedures, discriminated by type of transaction, that allow the assessment of the alignment of transactions with market conditions.

2.12 The member of the governing body responsible for the analyses referred to in point 2.10 of this paragraph must be informed immediately of deviations regarding sub-letters iii) and iv) of the same point.

2.13 Transactions that do not comply with market conditions may be carried out, provided that the following situations occur cumulatively:

a) they are carried out at the request of the counterparty, provided there is a justification for their execution and the deviation from market conditions is unequivocally visible, information formalized at the level of supporting documentation;

b) they are carried out based on internal governance rules adjusted to the typology, scale, and structure of the transaction and to the group of clients;

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c) the deviation from market conditions is disclosed to the counterparty in the transaction confirmation; and,

d) in the case of material transactions, staff with management responsibilities are duly informed.

2.14 Transactions that do not comply with market conditions are permitted if they are carried out within the framework of internal rules and reported immediately to the responsible member of the governing body.

2.15 The internal rules mentioned in the previous point must specify authorized staff, the scope, and the registration procedures for transactions.

2.16 Whenever transactions that do not comply with market conditions are concluded, records of conversations related to them must be kept, archived, for at least three months.

2.17 Transactions concluded after the closing time for settlement must be flagged and included in the day's positions.

2.18 Information on late transactions and their respective documentation must be immediately forwarded to the middle and back office areas.

3. Identification

3.1 Institutions must define, formalize, and implement effective and rigorous policies and processes for the identification of market risk to ensure that it is duly identified, documented, and understood.

3.2 The market risk identification framework must be comprehensive in order to ensure that relevant risk concentrations for the Institution are considered, and considering that they may arise not only from risk positions in the trading book but also from risk positions outside the trading book.

4. Assessment

4.1 Institutions must assess market risk, considering relevant risk factors, particularly concentration and correlation, and proceed to analyze their impacts at the level of activity performance and the Institution's solidity.

4.2 Institutions must ensure that information and communication systems allow for the daily assessment of changes in market risk factors and market conditions in general.

4.3 Assessments for the trading book must occur on an intra-day basis, while for the banking book they must occur, at least, weekly, or whenever there are relevant changes.

4.4 Without prejudice to the provisions in the previous paragraph, depending on the nature of the activity, size, and complexity, and upon demonstration of adequacy, certain positions in the banking book may justify an assessment with another periodicity.

4.5 Institutions must define, formalize, and implement policies and processes, regarding the assessment process, including:

a) clear definition of the responsibilities of the different areas involved;

b) identification of market information sources and their adequacy;

c) identification of assumptions or criteria that may be used in the assessment of their portfolio positions;

d) formalization of potential adjustment procedures for assessments.

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5. Monitoring and Control - Stress Tests

5.1 Institutions must develop analyses for the follow-up and control of market risk, which include stress testing or crisis simulation methodologies and other monitoring techniques, adapted to their individual risk characteristics.

5.2 Institutions must have adequate information and communication systems to monitor the sensitivity of market risk assessments, when a factor or a combination of risk factors undergo changes.

5.3 Institutions must perform stress tests to:

a) identify extreme but possible market events that may affect their overall risk profile and financial situation;

b) consider potential or existing risk concentrations;

c) facilitate the development of risk management tools and risk mitigation techniques.

5.4 Stress tests must be developed in a way to provide information on the conditions under which the Institution's strategies, positions, concentration, and correlation between positions become more vulnerable.

5.5 Institutions must test the assumptions used in stress tests, notably for positions with lower market liquidity or for positions without agreed maturity.

6. Monitoring and Control - Interest Rate Risk

6.1 The monitoring of interest rate risk in the banking book must be carried out from two complementary perspectives, according to the Notice on interest rate risk in the banking book, analyzing the effect of changes in interest rates on:

a) the Institution's interest margin and analyzing the effect of these same changes;

b) the present value of balance sheet positions.

6.2 Without prejudice to the previous point, Institutions may develop complementary analyses to assess impacts inherent to other changes in interest rates.

6.3 The monitoring of interest rate risk in the banking book must be carried out by currency, whenever Institutions incur materially significant interest rate risks in different currencies.

6.4 The monitoring of interest rate risk must also consider the maturities inherent to the Institutions' balance sheet positions, and adequate assumptions must be established for positions with indefinite term or for positions where the maturity does not reflect the strategy and objectives inherent to their holding in the portfolio.

6.5 The policies and processes of interest rate risk monitoring may also include:

a) basis risk resulting from the use of different reference rates;

b) instruments that do not pay interest;

c) different types of deposits;

d) assets and liabilities subject to options.

6.6 Without prejudice to the provisions in points 6.1 to 6.5 of this paragraph, to measure the effects of interest rate changes, Institutions must use the following additional mechanisms:

a) repricing of payment and receipt terms, which consists of measuring the impact on the present value of repricing in the maturities of cash flows, considering variations in interest rates;

b) simulation techniques, which consist of measuring the impact on the present value and future cash flows, taking into account variations in relevant interest rates.

6.7 Whenever a relevant position subject to interest rate risk is taken, Institutions must monitor the sensitivity of the same in relation to the following changes:

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a) general level of interest rates;

b) slope, shape, and volatility of interest rate curves;

c) relationships between market interest rates;

d) assumptions related to the assessment of interest rate risk;

e) liquidity of the most systemically important financial markets.

7. Monitoring and Control - Limit System

7.1 The limit system established in accordance with number 7 of Article 7 of the Notice on Risk Governance must be compatible with the size, complexity, and sophistication of risk management systems, as well as the experience and competence of the Institution's staff.

7.2 Institutions must establish limits for market risk and its respective concentration, considering normal market conditions and extreme situations, and must use for this purpose the results obtained in stress tests.

7.3 Institutions must take appropriate limit reduction measures whenever relevant risks resulting from market risk concentration are identified.

7.4 Institutions must ensure that the limit system allows them to keep their risk positions at levels consistent with their internal policies.

7.5 Institutions may define sub-limits for each structural unit, portfolio, type of instrument, or for specific instruments.

7.6 The functions of taking positions in the trading book and their respective management must be defined and aligned with the limit system, to ensure the allocation of specific limits to relevant staff, based on their competence, experience, and hierarchical position.

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7.7 Institutions must establish a limit exception management mechanism, including prior authorization processes for the execution of transactions.

7.8 The exception management mechanism referred to in the previous point must be defined and formalized, including the attribution of responsibilities and the possible measures to be applied.

8. Reporting

8.1 Institutions must define, formalize, implement, and periodically review policies and procedures for reporting, which must be adequate to their nature, size, complexity, and risk profile.

8.2 In internal reporting, Institutions must provide the main results of the stages of identification, assessment, monitoring, and control of market risk and its respective concentration, to the governing body and to staff with management responsibilities, which must include, at least:

a) summaries of the Institution's aggregated risk positions;

b) trends in exposure to market risk factors, including interest rate, volatilities, among others;

c) compliance with market risk policies, processes, and limits, as well as situations in which limits were exceeded, identifying the reasons and the staff responsible for approval;

d) developments in new products or business initiatives;

e) stress test results;

f) qualitative and, when appropriate, quantitative information on inter and intra-risk concentrations.

8.3 Institutions must provide adequate and timely information, considering the variety of maturities and currencies in the Institutions' portfolios and other factors such as the distinction between trading book and banking book.

8.4 In external reporting, Institutions must define, formalize, and implement policies and processes to transmit comprehensive information to stakeholders, which must include, at least:

a) qualitative information, on:

i. investment strategies and their respective processes;

ii. structure and organization of the market risk management function;

iii. scope and nature of reporting and risk assessment systems;

iv. strategies and processes to monitor the continuous effectiveness of hedging or mitigation positions.

b) quantitative information, on:

i. overall gross exposure and average gross exposure during the period in question, discriminating the main types of risk positions;

ii. geographical distribution of risk positions, discriminating the most significant areas and the main types of risk positions in each area;

iii. distribution of risk positions by industry or counterparty, discriminating the main types of risk positions;

iv. capital requirement for market risk, in accordance with the Notice on regulatory capital requirements for market risk and counterparty credit risk in the trading book.

8.5 The periodicity of reporting must reflect the materiality and nature of the sources of market risk, especially regarding its volatility, and be duly arranged in the policies and processes provided for in point 8.1 of this paragraph.

8.6 Reports prepared on an extraordinary basis cannot be used as substitutes for regular reporting.

9. Sanctions

Non-compliance with the mandatory norms established in this Instruction constitutes an offense punishable under the terms of the Law of the Bases of Financial Institutions.

10. Transitional Provision

Institutions must be in compliance with the provisions of this Instruction in accordance with the transitional provisions of Notice No. 07/2016 of June 22, on Risk Governance.

11. Doubts and Omissions

Doubts and omissions resulting from the interpretation and application of this Instruction are resolved by the Bank National of Angola.

12. Entry into Force

This Instruction enters into force on the date of its publication.

PUBLISH-IT

Luanda, November 16, 2016