The purpose of this revision is to keep pace with financial innovation and progress in risk management practices for trading and derivatives activities, particularly with regard to market risk. This initiative is part of the continuing effort by the Basle Committee and by IOSCO to monitor the trading and derivatives activities of banks and securities firms. In this regard, this revision builds upon earlier work of the two Committees, including the 1994 joint release of guidelines for improving risk management of derivatives activities and subsequent risk management guidance, and the 1995 joint recommendations for enhancing public disclosure in this important area that were presented in annual joint disclosure survey reports since that year. Moreover, since the initial release of the joint supervisory information framework for derivatives the Basle Committee amended its Capital Accord in 1996 to address market risk and in 1997 issued risk management guidance on interest rate risk that applies to banks. In addition, IOSCO has been exploring options for capturing market risk in the capital adequacy and risk management standards that apply to securities firms.

Given the continuing expansion of trading and derivatives activities in a context of volatile market conditions, it is important that supervisors further improve their understanding of how such activities affect the overall risk profile and profitability of banks and securities firms. The framework therefore presents examples of the type of information that the two Committees believe should be available within regulated firms and their material affiliates active in the derivatives markets or with significant exposure to market risks, and that should be accessible to supervisors. While the 1995 supervisory information framework concentrated on derivatives, the 1998 update expands the framework to more comprehensively address the market risk exposure arising from trading in both cash and derivatives instruments.

Mindful of the need to limit regulatory burden, the framework provides for flexible ways to collect supervisory information, including on-site examinations and external audits, discussions with institutions, special surveys, as well as regular reporting procedures. The framework also encourages supervisors to draw from internal information systems that banks and securities firms are developing to monitor their exposure to the various risks embedded in trading and derivatives activities. Furthermore, this reporting framework is meant to be consistent with the risk management standards and capital adequacy requirements that may be applicable to global banks and securities firms.

The overall supervisory information framework presented in this paper consists of two main parts. The first is a catalogue of data that the Committees have identified as important for an evaluation of the risks present in trading and derivatives activities, and that supervisors may build upon as they expand their reporting system. The second is a common minimum framework of internationally harmonised baseline information about derivatives activities (a subset of the catalogue) that the two Committees recommend that supervisors have available to them. The common minimum framework, while focusing primarily on information useful for assessing institutions' overall involvement in derivatives activities and their credit risk, has been expanded in this revision to illustrate information which is useful for assessing the market risk of trading and derivatives activities. The overall paper is organised into three sections, each of which is summarised below.

I. Introduction

In addition to providing a general overview of the paper, the introduction discusses a series of basic principles that underlie the overall supervisory information framework. These include the following:

• Supervisory data should be comprehensive, i.e. it should cover all types of derivative instruments and their major related risks and shed light on how derivatives contribute to an institution's overall business and risk profile. Where appropriate, derivatives positions should be evaluated together with related on-balance-sheet positions (e.g., for the purpose of assessing market risks and earnings). Quantitative information on derivatives needs to be evaluated in the context of qualitative information on an institution's overall risk profile and its ability to manage this risk.

• Supervisors should attempt to obtain a comprehensive picture of an institution's derivatives activities across different legal entities and jurisdictions.

• The trading and derivatives activities of an institution can change rapidly, affecting an institution's risk profile and profitability. Data on these activities should therefore be assessed with sufficient frequency to give a meaningful and timely picture of the risks faced by an institution.

• To limit the regulatory burden, supervisors are encouraged to draw on information that banks and securities firms generate for internal purposes. There should be as much consistency as possible between information obtained for reporting purposes and data that institutions must already compile for the purpose of complying with other supervisory requirements. In light of the different institutional, accounting and public policy approaches to supervision across the member countries of the two Committees, each supervisory authority has flexibility to implement the common minimum framework in a manner best suited to its regulatory environment.

• Each supervisor would apply the common minimum framework to internationally active institutions with significant derivatives operations, with flexibility also to extend the framework to other institutions with significant involvement in derivatives.

II. Catalogue of information for supervisory purposes

The catalogue of data items represents information that supervisors have identified as important for assessing the risks arising from firms' derivatives activities. It is intended to facilitate the development among supervisors of consistent conceptual methods for assessing the risk exposures related to derivatives. It is also intended to provide a basis for discussion between firms and their supervisors about the type of information that a firm should be aiming to maintain as part of its overall risk management control mechanism. In this context, supervisors should seek to ensure that the firm has both quantitative and qualitative information on its derivatives activities.

The information identified in the catalogue covers the following broad areas:

• Credit risk: Credit risk is the risk that a counterparty may fail to fully perform on its financial obligations. The framework focuses on the credit risk of OTC derivatives rather than exchange-traded derivatives, for which a reduction in risk is achieved through an organised exchange or clearing house where there is payment and receipt of margin. The primary measures of credit risk are current credit exposure and potential credit exposure, taking into account the risk reducing effects of legally enforceable netting agreements. In addition, the framework covers information on credit enhancements for both current and potential credit exposure. Finally, the framework discusses ways to assess the concentration of credit risk and counterparty credit quality.

• Liquidity risk: Two types of liquidity risk that can be associated with derivative instruments are covered in the framework: market liquidity risk and funding risk. Market liquidity risk is the risk that a position cannot be eliminated quickly by either liquidating the instrument or by establishing offsetting positions. Funding risk is the risk that derivatives positions place adverse funding and cash flow pressures on an institution.

• Market risk: Market risk is the risk that the value of on- or off-balance-sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates, and commodity prices. The framework covers two approaches for assessing market risks. One is to focus on position data that would allow independent supervisory assessment of an institution's market risks through some supervisory model. The other is to evaluate information on an institution's internal estimates of market risks. These estimates could be based on value-at-risk methodologies, as well as on other approaches such as duration analysis, or scenario methods.

• Earnings: The framework discusses various types of information important for assessing the impact of derivatives on an institution's earnings profile. This includes information on trading income, broken down by broad risk classes (interest rate risk, foreign exchange risk and commodities and equities exposures), without regard to the type of instrument. The paper also suggests that a finer disaggregation of earnings could be useful for supervisory purposes. In addition, the framework discusses the importance of assessing information on both unrealised and realised derivatives losses.

III. Common minimum information framework

The two Committees recommend that supervisors have available to them a minimum subset of the elements identified in the catalogue for large, internationally active banks and securities firms with significant involvement in derivatives activities. The information contained in the common minimum framework represents a baseline of information that the Committees have identified as important for supervisors to begin assessing the nature and scope of an institution's derivatives activities and how derivatives contribute to a firm's overall risk profile. It is intended that supervisors supplement the information in the common minimum framework with other information drawn from the catalogue of data items discussed above.

The common minimum framework is illustrated in tables 1-5 of Annex 3. The common minimum framework, which initially focused on overall activity and credit risk of derivatives, has been enhanced to also address the market risk of trading and derivatives activities. In considering trading portfolios of both cash and derivatives instruments as well as non-traded derivatives, this approach is consistent with the information about market risk which global institutions typically would develop for risk management purposes and capital adequacy purposes. This extension of the common minimum framework is presented in Annexes 4 and 5 that present for banks and securities firms, respectively, two approaches to market risk information. The first approach is based on internal models that are increasingly used by global institutions for risk management purposes. The second approach is a standardised approach which may be alternatively used by institutions for capital purposes. The illustrations presented in Annexes 4 and 5 show examples of the types of information that global banks and securities firms would typically develop under these two approaches, which could then be useful for supervisory analysis.