Scope of market risk inclusion

Should underlying securities in repo transactions be included in the calculation of own funds requirements for position risk when the firm does not have these securities on the balance sheet (i.e. the firm does not own these securities outright)?

Article 333 CRR states that “the transferor of securities or guaranteed rights relating to title to securities in a repurchase agreement and the lender of securities in a securities lending shall include these securities in the calculation of its own funds requirement under this Chapter provided that such securities are trading book positions”. A very strict reading of this could mean that any securities in repurchase agreement transactions are included in the calculation of own fund requirements for position risk, regardless of whether the firm owns these securities outright. However this does not represent the true economic risk of these transactions.  For example, if a firm reversed in a security via a reverse repo transaction and funded the security via a repo transaction with the same tenor, there is only residual funding risk but no market risk on the underlying securities (which are collateral) in this back-to-back transaction. If using the very conservative interpretation, specific market risk capital requirement would need to be taken on the underlying securities in the repo transaction. This would considerably overstate market risk requirements as it gives the same market risk capital requirement as if the firm owns the bond outright, when in reality the firm has no market risk exposure on the underlying bonds in this back to back transaction. This would also be inconsistent with the treatment under an IRB model which would have reflected minimum market risk capital requirement for the same transaction.  Therefore our interpretation of Article 333 is that its intention is not to include underlying securities in repo transactions if the firm does not own these securities outright. Rather, the rule disallows exclusion of securities owned by the firm which have been reversed out in repo transactions, i.e. securities owned outright still needs to be included in the market risk capital calculation even if it is funded via repo, as the firm is still subject to the same market risk on the securities. This interpretation is more aligned with true economic risks of these transactions and is also consistent with the requirements under IRB rules which do not include securities in repo transactions if they are not owned outright.