Please refer to the Thai text for the official version

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1 Unofficial Translation by the courtesy of The Foreign Banks' Association This translation is for the convenience of those unfamiliar with the Thai language. To Manager Please refer to the Thai text for the official version All Commercial Banks * The Bank of Thailand 19 October 2548 No. BOT. ForNorSor. (21) Wor. 4/2548 Re: Bank of Thailand Notification regarding Permission for Commercial Banks to Undertake Structured Derivative Transactions To continuously support the development of the new financial instruments and to provide clients with additional tools to hedge risks, the Bank of Thailand (BOT) hereby circulate the BOT notification Re: Permission for Commercial Banks to Undertake Structured Derivative Transactions dated 6 October 2005 issued by virtue of Section 9 bis of the Commercial Banking Act B.E 2505 (1962) and its subsequent amendments. The notification permits commercial banks to undertake structured derivative transactions within the scope of transactions and supervisory policy summarized as follows. 1. Commercial banks are permitted to undertake structured derivative transactions within the framework set out by the aforementioned BOT notification published in the Royal Gazette, General Issue, Volume 122, Special Section 114 Ngor dated 14 October The notification shall become in effect from 15 October 2005 onwards. 2. With reference to the Notification which states that commercial banks wishing to undertake leveraged transactions are required to obtain the permission from the Bank of Thailand prior to undertaking such transaction. For clarification, the BOT hereby sets out that derivative transaction involving leverage of over two times shall require the approval from the BOT on a case-by-case basis. As such, leveraged financial derivative transactions are not permitted for derivatives stipulated by the BOT to be carried out with counterparties who have underlying position. (Examples for suitability and adequacy test of underlying position are provided in the Attachments) 3. The application to be submitted to the BOT for the approval to undertake structured derivatives transaction on a case-by-case basis shall be directed to the Director of the Financial Institution Applications and Special Examination Department, Supervision Group of the Bank of Thailand. 4. Commercial banks are required to report data on outstanding positions of structured derivatives as at the end of each month by the end of the subsequent month. The first of such report shall be submitted by the end of November 2005, where the data shall be provided in an Excel file according to the standard format set out by the BOT and * Excluding international banking facilities and retail banks BOT Notification No (draft).rtf Page 1 of 40

2 the file shall be named using the following format, DDMSbbbyyyymmddSDV.xls, where- : DDMS is a fixed value (if no data in file, use ZDMS) bbb shall mean reporting bank code, e.g. Bangkok Bank code: 002 yyyy shall mean year of the reporting data, use the 4-digit Christian year, e.g mm shall mean month of the reporting data, values from dd last business day of the reporting month SDV.xls is a fixed value Commercial banks shall submit reports through the same channels used to submit Excel data files to the DMS system (Submit Data file), to the Data Management Department, the Bank of Thailand. 5. Commercial banks undertaking the aforementioned transactions must comply with the regulations set out in the Bank of Thailand Notification Re: Prescription of Ratio of Credits Granted, Investments and Contingent Liabilities by a Commercial Bank to Any Person to its Capital Funds dated 29 April 2003 and its subsequent amendments, according to the subcomponents of the transactions (Examples of credit equivalent amount calculations of the transactions are provided in the Attachments). This shall apply until the amendments to the said Notification are completed for the Large exposure supervision that take into account the structured derivative transactions. 6. Commercial banks undertaking the aforementioned transactions must comply with the regulations Re: Market Risk Supervision Policy of Financial Institutions and Related Reports dated 30 December 2003 and its subsequent amendments, and the BOT Notification Re: Stipulation on Maintenance of Capital Funds by Commercial Banks Registered in Thailand or the BOT Notification Re: Stipulation on Maintenance of Capital Funds by Branches of Foreign Banks dated 21 July 2004 and their subsequent amendments according to the subcomponents of the transactions (Examples of the calculations for the required capital maintenance for the transactions are provided in the Attachments). This shall apply until the amendments to the said Notifications are completed for the Capital adequacy supervision that take into account the structured derivative transactions. 7. Commercial banks undertaking the aforementioned transactions must comply with the policy guidelines Re: Policy Guideline for Maintenance of Foreign Exchange Positions dated 21 January 2003 and its subsequent amendments. Kindly be advised of these contents for your information and compliance. Regards, (Tongurai Limpiti) Senior Director, Financial Institutions Policy Group for Governor BOT Notification No (draft).rtf Page 2 of 40

3 Attachments 1. Attachment 2. BOT notification Re: Permission for Commercial Banks to Undertake Structured Derivative Transactions dated 6 October 2005 Risk Supervision Policy Department Tel , Remark: [ X ] The BOT will organize a clarification meeting on 1 November 2005 at 9.30 am at the conference room on the 7 th floor of Building 3, the Bank of Thailand. [ ] No clarification meeting has been organized BOT Notification No (draft).rtf Page 3 of 40

4 Attachment Guidelines for the Underlying test and Supervision of Structured Derivatives Topics Covered I. Suitability and Adequacy of the Underlying II. Supervision regarding Single Lending Limits III. Capital Funds for Counterparty Risk IV. CapitalFunds for Market Risk Assumption: In the examples herewith -: - For buying or selling FX forward, assume the client is an exporter, who would receive USD in six months time; - For Swap transactions, assume the client has USD debt with the obligations to make interest payments calculated from USD LIBOR, where the aforementioned transactions are viewed from the client s viewpoint; - THB/USD Spot rate as at the reporting date is THB 40 /USD. Example 1: Seagull Contract Components No. Client Commercial Bank 1 Buy USD Put/THB 41 Notional Amount 1 M$ Sell USD Put/THB 41 Notional Amount 1 M$ 2 3 Sell USD Call/THB 43 Notional Amount 1 M$ Sell USD Put/THB 39 Notional Amount 1 M$ Buy USD Call/THB 43 Notional Amount 1 M$ Buy USD Put/THB 39 Notional Amount 1 M$ BOT Notification No (draft).rtf Page 4 of 40

5 Pay-off Diagram for the Client Pay-off Diagram for the Commercial Bank I. Suitability and Adequacy of the Underlying Scenario Spot 39 Exercise - Bank exercises 39 - Client exercises 41 Suitability of the Underlying Required Underlying Offsetting Netting = 0 39 < Spot < 41 Client exercises 41 Exporter sells USD 1 M$ 41 Spot 43 Option is not exercised N/A N/A Spot > 43 Bank exercises 43 Exporter sells USD 1 M$ - In this case, the client must have a minimum Underlying amount of 1 M$ BOT Notification No (draft).rtf Page 5 of 40

6 II. Supervision regarding Single Lending Limits (Original Approach) For calculations of Single Lending Limits for the aforementioned transaction, the credit equivalent amount of such transaction shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF Credit Equibalent Amount 1 Buy USD 43 1,000,000 x 40 = 40,000, ,000 2 Buy USD 39 1,000,000 x 40 = 40,000, ,000 Total Credit Equivalent Amount of the Transaction 1,600,000 III. Capital Maintenance for Counterparty Risk For calculations of capital maintenance for counterparty risk of the aforementioned transaction, the capital required shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF RWA Required Ratio Capital Funds 1 Buy 43 1,000,000 x 40 = 40,000, % 8.5% 34,000 2 Buy 39 1,000,000 x 40 = 40,000, % 8.5% 34,000 Total Capital Maintenance for Counterparty Risk 68,000 IV. Capital Maintenance for Market Risk The commercial bank must maintain capital fund against market risks based on the subcomponents of the transaction, which in this example are as follows. i. USD Put/THB 41 ii. USD Call/THB 43 iii. USD Put/THB 39 BOT Notification No (draft).rtf Page 6 of 40

7 Example 2: Forward Plus Contract Components No. Client Commercial Bank Buy USD Put/THB 41 Notional Amount 1 M$ Sell USD Call/THB 41 Notional Amount 1 M$ Sell USD Call/THB 45 Notional Amount 1 M$ Sell USD Put/THB 41 Notional Amount 1 M$ Buy USD Call/THB 41 Notional Amount 1 M$ Buy USD Call/THB 45 Notional Amount 1 M$ Pay-off Diagram for the Client Pay-off Diagram for the Commercial Bank BOT Notification No (draft).rtf Page 7 of 40

8 I. Suitability and Adequacy of the Underlying Scenario Exercise Suitability of the Underlying Spot 41 Client exercises 41 Exporter sells USD 1 M$ 41 < Spot < 45 Bank exercises 41 Exporter sells USD 1 M$ Required Underlying Spot 45 - Bank exercises 41 - Bank exercises 45 - Exporter sells USD - Exporter sells USD 1 M$ + 1 M$ - In this case, the client must have a minimum Underlying amount of 2 M$ II. Supervision regarding Single Lending Limits (Original Approach) For calculations of Single Lending Limits for the aforementioned transaction, the credit equivalent amount shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF Credit Equivalent Amount 1 Buy 41 1,000,000 x 40 = 40,000, ,000 2 Buy 45 1,000,000 x 40 = 40,000, ,000 Total Credit Equivalent Amount of the Transaction 1,600,000 III. Capital Maintenance for Counterparty Risk For calculations of capital maintenance for counterparty risk of the aforementioned transaction, the capital required shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF RWA Required Ratio Capital Funds 1 Buy 41 1,000,000 x 40 = 40,000, % 8.5% 34,000 2 Buy 45 1,000,000 x 40 = 40,000, % 8.5% 34,000 Total Capital Maintenance for Counterparty Risk 68,000 BOT Notification No (draft).rtf Page 8 of 40

9 IV. Capital Maintenance for Market Risk The commercial bank must maintain capital funds against market risks based on the subcomponents of the transaction, which in this example are as follows. i. USD Put/THB 41 ii. USD Call/THB 41 iii. USD Call/THB 45 Example 3: Coupon Swap and Call Spread (on Principal) Assume: Components Notional Amount THB 100,000,000 USD 2,500,000 Amortized principal over 10 installments of USD 250,000 per installment Contract maturity is 5 years No. Client Commercial Bank 1 Coupon Swap - Receive USD LIBOR interest on USD Notional and - Pay THBFIX interest (Semi- Annually) on THB Notional (Fixed inception) 2 Buy Series of USD Call/THB Put at Strike 40 /$ (according to the repayment schedule : assume 0.25 M$ per instalment) 3 Sell Series of USD Call/THB Put at Strike 42 /$ (according to the repayment schedule : assume 0.25 M$ per instalment) Coupon Swap - Pay USD LIBOR interest on USD Notional and - Receive THBFIX interest (Semi- Annually) on THB Notional (Fixed inception) Sell Series of USD Call/THB Put at Strike 40 /$ (according to the repayment schedule : assume 0.25 M$ per instalment) Buy Series of USD Call/THB Put at Strike 42 /$ (according to the repayment schedule : assume 0.25 M$ per instalment) BOT Notification No (draft).rtf Page 9 of 40

10 Pay-off Diagram for the Client Pay-off Diagram for the Commercial Bank. I. Suitability and Adequacy of the Underlying Scenario Coupon Swap Client receives USD LIBOR interest on USD Notional Client pays THBFIX interest on THB Notional (Semi-Annually) - The client has an obligation to pay USD LIBOR interest; therefore, it s suitable for client to enter into such transaction. Call Spread on Principal Amount Exercise Suitability of the Underlying Spot < 40 Option is not exercised N/A N/A Required Underlying 40 Spot < 42 Client exercises 40 Debtor buys USD 0.25 M$ Spot 42 - Client exercises 40 - Bank exercises 42 Offsetting Netting = 0 - In this case, the client must have a minimum Underlying amount of 0.25 M$ x Number of Instalments for Principal Repayments (2.5 M$) BOT Notification No (draft).rtf Page 10 of 40

11 II. Supervision regarding Single Lending Limits (Original Approach) For calculations of Single Lending Limits for the aforementioned transaction, the credit equivalent amount shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF Credit Equivalent Amount 1 Coupon Swap THB 100,000, ,000,000 2 Buy 42, maturity 6 mths 250,000 x 40 = 10,000, ,000 3 Buy 42, maturity 1 yr 250,000 x 40 = 10,000, ,000 4 Buy 42, maturity 1.5 yrs 250,000 x 40 = 10,000, ,000 5 Buy 42, maturity 2 yrs 250,000 x 40 = 10,000, ,000 6 Buy 42, maturity 2.5 yrs 250,000 x 40 = 10,000, ,000 7 Buy 42, maturity 3 yrs 250,000 x 40 = 10,000, ,000 8 Buy 42, maturity 3.5 yrs 250,000 x 40 = 10,000, ,000 9 Buy 42, maturity 4 yrs 250,000 x 40 = 10,000, , Buy 42, maturity 4.5 yrs 250,000 x 40 = 10,000, , Buy 42, maturity 5 yrs 250,000 x 40 = 10,000, ,000 Total Credit Equivalent Amount of the Transaction 9,400,000 III. Capital Miantenance for Counterparty Risk For calculations of capital maintenance for counterparty risk of the aforementioned transaction, the capital required shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF RWA Required Ratio Capital Funds 1 Coupon Swap THB 100,000, % 8.5% 212, Buy 42, maturity 6 mths Buy 42, maturity 1 yr Buy 42, maturity 1.5 yrs Buy 42, maturity 2 yrs Buy 42, maturity 2.5 yrs 250,000 x 40 = 10,000, % 8.5% 8, ,000 x 40 = 10,000, % 8.5% 8, ,000 x 40 = 10,000, % 8.5% 21, ,000 x 40 = 10,000, % 8.5% 21, ,000 x 40 = 10,000, % 8.5% 21,250 BOT Notification No (draft).rtf Page 11 of 40

12 No. Derivatives Notional Amt. CCF RWA 7 Buy 42, maturity 3 yrs Required Ratio Capital Funds 250,000 x 40 = 10,000, % 8.5% 21, Buy 42, maturity 3.5 yrs Buy 42, maturity 4 yrs Buy 42, maturity 4.5 yrs 250,000 x 40 = 10,000, % 8.5% 21, ,000 x 40 = 10,000, % 8.5% 21, ,000 x 40 = 10,000, % 8.5% 21, Buy 42, maturity 5 yrs 250,000 x 40 = 10,000, % 8.5% 21,250 Total Capital Maintenance for Counterparty Risk 399,500 IV. Capital Maintenance for Market Risk The commercial bank must maintain capital funds against market risks based on the subcomponents of the transaction, which in this example are as follows. i. Coupon Swap ii. USD Call/THB 40, 10 contracts (6 mths, 1 yr, 1.5 yrs, 2 yrs, 2.5 yrs, 3 yrs, 3.5 yrs, 4 yrs, 4.5 yrs and 5 yrs maturity) iii. USD Call/THB 42, 10 contracts (6 mths 1 yr, 1.5 yrs, 2 yrs, 2.5 yrs, 3 yrs, 3.5 yrs, 4 yrs, 4.5 yrs and 5 yrs maturity) BOT Notification No (draft).rtf Page 12 of 40

13 Example 4: Components No. Client Commercial Bank 1 Buy USD Put/THB 41 Notional Amount 1 M$ Sell USD Put/THB 41 Notional Amount 1 M$ 2 3 Sell USD Call/THB 41 Notional Amount 1 M$ Buy Digital 43 Payoff 3 /$ (Premium 1 /$) Buy USD Call/THB 41 Notional Amount 1 M$ Sell Digital 43 Payoff 3 /$ (Premium 1 /$) Pay-off Diagram for the Client Pay-off Diagram for the Commercial Bank BOT Notification No (draft).rtf Page 13 of 40

14 Consideration of the Digital Call Option: Use a Call Spread with a Strike difference = 25 Basis Points (Buy USD 43 and Sell USD 43.25) for replication of a Digital Call To obtain a Payoff of 3 /$ on a Notional Amount of 1 M$, the aforementioned USD Call Spread is required on a Notional Amount of 12 M$ (3,000,000 / 0.25) Therefore, commercial bank s selling a Digital Call 43 with a Payoff of 3 /$ is comparable to commercial bank s Selling a USD Notional amount 12 M$ Buying a USD 43 Notional amount 12 M$ I. Suitability and Adequacy of the Underlying Scenarios Option Exercise Suitability of the Underlying Spot < 41 Client exercises Put Option Exporter sells USD 1 M$ 41 Spot < 43 Bank exercises Call Option Exporter sells USD 1 M$ Required Underlying Spot 43 Bank exercises Call Option Client exercises Digital Call Offsetting 1 M$ 1 - In this case, the client must have a minimum Underlying amount of 1 M$ II. Supervision regarding Single Lending Limits (Original Approach) For calculations of Single Lending Limits for the aforementioned transaction, the credit equivalent amount shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF 1 2 Buy USD 41 Buy USD 43 Credit Equivalent Amount 1,000,000 x 40 = 40,000, ,000 12,000,000 x 40 = 480,000, ,600,000 Total Credit Equivalent Amount of the Transaction 10,400,000 1 Offsetting between the Digital Option and other Derivatives may be carried out only in terms of the suitability of the Underlying, but the Netting shall not be permitted between the Notional Amount of the Digital Option and that of other Derivatives with regards to the Underlying amount required for the client to undertake the transaction. BOT Notification No (draft).rtf Page 14 of 40

15 III. Capital Maintenance for Counterparty Risk For calculations of capital maintenance for counterparty risk of the aforementioned transaction, capital required shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF RWA 1 2 Buy USD 41 Buy USD 43 1,000,000 x 40 = 40,000,000 12,000,000 x 40 = 480,000,000 Required Ratio Capital Funds % 8.5% 34, % 8.5% 408,000 Total Capital Maintenance for Counterparty Risk 442,000 IV. Capital Maintenance for Market Risk The commercial bank must maintain capital fund against market risks based on the subcomponents of the transaction, which in this example are as follows. Example 5: Components i. USD Put/THB 41 ii. USD Call/THB 41 iii. Digital 43 No. Clients Commercial Bank 1 Buy USD Put/THB 41 Notional Amount 1 M$ Sell USD Put/THB 41 Notional Amount 1 M$ 2 3 Sell USD Call/THB 41 Notional Amount 1 M$ Sell Digital 43 Payoff 3 /$ (Premium 1 /$) Buy USD Call/THB 41 Notional Amount 1 M$ Buy Digital 43 Payoff 3 /$ (Premium 1 /$) BOT Notification No (draft).rtf Page 15 of 40

16 Pay-off Diagram for the Client Pay-off Diagram for the Commercial Bank Consideration of the Digital Call Option: Use a Call Spread with a Strike difference = 25 Basis Points (Buy USD 43 and Sell USD 43.25) for replication of a Digital Call To obtain a Payoff of 3 /$ on a Notional Amount of 1 M$, the aforementioned USD Call Spread is required on a Notional Amount of 12 M$ (3,000,000 / 0.25) Therefore, commercial bank s buying a Digital Call 43 with a Payoff of 3 /$ is comparable to the commercial bank s Buying USD 43 Notional amount 12 M$ Selling USD Notional amount 12 M$ BOT Notification No (draft).rtf Page 16 of 40

17 I. Suitability and Adequacy of the Underlying Scenarios Option Exercise Suitability of the Underlying Spot < 41 Client exercises Put Option Exporter sell USD 1 M$ 41 Spot < 43 Bank exercises Call Option Exporter sell USD 1 M$ Underlying Amount Spot 43 Bank exercises Call Option Bank exercises Digital Call Exporter sell USD Exporter sell USD 1 M$ + 1 M$ II. - In this case, the client must have a minimum Underlying amount of 2 M$ Supervision regarding Single Lending Limits (Original Approach) For calculations of Single Lending Limits for the aforementioned transaction, the credit equivalent amount shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF Credit Equivalent Amount 1 Buy USD 41 1,000,000 x 40 = 40,000, ,000 2 Buy USD 43 12,000,000 x 40 = 480,000, ,600,000 III. Total Credit Equivalent Amount of the Transaction 10,400,000 Capital Maintenance for Counterparty Risk For calculations of capital maintenance for counterparty risk of the aforementioned transaction, capital required shall be calculated based on the subcomponents of the transaction, which in this example are as follows. No. Derivatives Notional Amt. CCF RWA 1 Buy USD 41 2 Buy USD 43 1,000,000 x 40 = 40,000,000 12,000,000 x 40 = 480,000,000 Required Ratio Capital Funds % 8.5% 34, % 8.5% 408,000 Total Capital Maintenance for Counterparty Risk 442,000 BOT Notification No (draft).rtf Page 17 of 40

18 IV. Capital Maintenance for Market Risk The commercial bank must maintain capital fund against market risks based on the subcomponents of the transaction, which in this example are the following three derivatives. i. USD Put/THB 41 ii. USD Call/THB 41 iii. Digital 43 BOT Notification No (draft).rtf Page 18 of 40

19 Bank of Thailand Notification Re: Permitting Commercial Banks to Undertake Structured Derivative Transactions 1. Rationale of Notification The Bank of Thailand previously issued a circular No. Thor por tor For.Sor.Wor. (21) Wor 1300/2548 dated 20 July 2005 permitting commercial banks to undertake plain vanilla derivatives. However, other derivative transactions, deemed by the Bank of Thailand as structured derivatives, required approval on a case by case basis. At the present, it is time to issue the general guideline permitting commercial banks to undertake some structured derivative transactions in order to continuously support the development of the financial derivatives, providing additional tools for efficient risk management. This guideline shall also provide clarity and understanding of the policies regarding structured derivatives and promote fairness in carrying out financial institution business. The Bank of Thailand, therefore, issued this Notification to set out the types and scope of the structured derivative business commercial banks shall be permitted to undertake. 2. Statutory Power By virtue of Section 9 bis of the Commercial Banking Act B.E (1962) and its amendments, the Bank of Thailand permits commercial banks to undertake structured derivative transactions based on the type and scope set out in this Notification. 3. Scope of Application This Notification shall be applied to all commercial banks under the law governing commercial banking, except international banking facilities and retail banks. 4. Contents 4.1 Principles Commercial banks may carry out structured derivative transactions set out in Section 4.2, where transactions must comply with the following five principles. (1) Commercial banks must be able to efficiently manage the risks associated with the transactions. (2) Commercial banks shall not propose such transactions to clients in such a way that encourage speculation in foreign exchange, foreign interest rates or foreign financial indices, which are not beneficial to the economy and may have a detrimental impact on the stability of the domestic financial systems as well as financial institutions system. BOT Notification No (draft).rtf Page 19 of 40

20 (3) Commercial banks must prepare sufficient documentation as evidence of transactions for examination purposes, and summit report regarding the transactions in the formats set out by the Bank of Thailand. (4) Commercial banks must clearly explain the characteristics and risks associated with the transactions to ensure client understanding, and provide the evidence that the bank has performed the client s suitability analysis (5) In cases where transactions are carried out by overseas branches of the Thai commercial banks, the commercial banks must comply with the business framework and supervisory guidelines of the country where the branches are located, and must also comply with BOT regulations set out in sections 4.3, 4.5, 4.6, and Permitted Financial Derivatives The Bank of Thailand permit commercial banks to undertake structured derivatives inwhich the referenced variables are interest rate, exchange rate, or financial indices 1 calculated from interest rates or exchange rates, as follows. (1) The structured derivatives as listed in the Attachment 1, which the BOT considered appropriate for commercial banks to undertake and may be classified as follows. (a) Packaged Vanilla Derivatives, which are combinations of plain vanilla derivatives 2, for example, Collars. (b) Barrier Derivatives, which are derivatives that set up the barrier levels in order to consider the validity of the contract, for example, Knock-In Forwards or Knock-Out Forwards. (c) Derivatives which are a combination of plain vanilla derivatives, Barrier Derivatives, and/ or digital options 3, for example, Range Bonus Forwards. (d) Average Rate Options, contracts to buy or sell an underlying asset in future, where the profit or loss of the contract would be equal to the difference between the average underlying asset price over the specified time period and the strike price set in 1 The financial indices, calculated from exchange rate and/ or interest rate parameters, must comply with the following conditions. (a) Financial indices were developed by trustworthy institutions; (b) Financial indices are widely used in Thailand or international markets; (c) Financial indices have continuous daily quotation through real time information provider; and (d) Financial indices whose calculation methods are clearly set out, detailing data sources of the variables and the factors applied in the calculations. As such, the variables and factors used must move freely according to the market forces with no single individual being able to influence the movements of the variables, factors, or financial indices. 2 Plain vanilla derivatives include Foreign Exchange Forward Contracts, Currency Futures, Foreign Exchange Swaps, Cross Currency Swaps, Currency Options (Put and Call), Interest Rate Swaps (including Interests Rate Swaps in Arrears), Basis Swaps, Interest Rate Futures, Forward Rate Agreements, and Interest Rate Options (Cap and Floor). 3 Derivative contracts which specify fixed payoffs would be paid if the asset price behave following the conditions set out in the contract. BOT Notification No (draft).rtf Page 20 of 40

21 advance, for example, Average Put Options. Average Strike Options, contracts which their strike prices were set at the average asset prices over the specified period; for example, Average Strike Calls. (2) Structured derivative transactions in section 4.1 (1) which give the right to the customer or to the commercial bank to cancel the contract prior to maturity or give them the right to extend the contract beyond its maturity (Cancellable or Extendable Options). (3) Plain Vanilla Derivatives which give the right to the customer or to the commercial bank to cancel the contract prior to maturity or give them the right to extend the contract beyond its maturity (Cancellable or Extendable Options). (4) Loans proposed in conjunction with the aforementioned derivatives in sections 4.2 (1) (3). Commercial banks who wish to undertake derivative transactions other than those set out, or derivative transactions of the type specified in section 4.2 (1)-(4) with maturities over 10 years, or derivative transactions involving several times leveraging specified by the BOT, must submit application for the BOT approval on a case by case basis. Where the BOT does not make any objection to the application within 15 business days upon receiving the application together with the complete and accurate documents from the commercial bank, it shall be deemed that the commercial bank is permitted to undertake the requested transactions. However, the Bank of Thailand may order the commercial bank to cease undertaking the said derivative transactions should it become apparent that the said transactions are inconsistent with principles and transactions framework set by the BOT. Any commercial bank with queries or doubts regarding whether derivative transactions it wishes to undertake are within the BOT s permitted framework should confer with the BOT prior to undertaking such transactions. 4.3 Requirements regarding Risk Management Commercial banks must have risk management systems, which are efficient, appropriate, and consistent with the characteristics, quantity, and complexity of transactions as follows. (1) Commercial banks board of directors or management committee with relevant authority and responsibility, in case of foreign banks branches, must understand the transactions and associated risks. Sub-committees and high level management designated to supervise such transaction must be knowledgeable and have in-depth understanding in the transactions and the associated risks. They must also closely monitor to ensure that the transactions are carried out in accordance with an approved policy and place a priority to risk management of these transactions. BOT Notification No (draft).rtf Page 21 of 40

22 . (2) Commercial banks must clearly specified policies, strategies, and procedures in conducting the transaction, managing the associated risks, and carrying out internal control, in a written form. (3) The aforementioned Policies and risk management must be approved by the bank s board of directors or management committee with the relevant authority and responsibility, in the case of foreign bank branches. Additionally, every policy change must be approved by the board of directors or the said management committee while the strategies and procedures for undertaking transactions, managing the associated risks, and internal controls must be approved by the subcommittee responsible for overseeing such business transaction. (4) Commercial banks must have an independent risk management unit to assess, monitor, control, and supervise their overall risk management. The risk management reports must be made directly to the board of directors via the risk management committee on a regular basis. In case of foreign banks branches, the risk management unit may be established at the regional office, but the reports must be made regularly to a unit designated by the head office. (5) Commercial banks must allocate sufficient resources to efficiently and comprehensively accommodate the transaction. The resources must be adequately knowledgeable, insightful, with appropriate expertise and experience.. (6) Commercial banks must be confident that internal control and risk management systems are efficient. As such, internal control and risk management measures must -: (a) reflect and accommodate all the risks from the transactions. The focus should be put on the efficiency of management system of interest rate risk, foreign exchange risk, risks resulting from options transactions (e.g. delta, vega, gamma, theta, and rho), liquidity risk and credit risk, including also pre-settlement risk and settlement risk. Commercial banks must have risk measurement system that can clearly, accurately, and precisely reflect the associated risks and each type of risks. (b) be implemented to control the risks in practice, and the proper risk management approaches, for example, Delta/ Gamma/ Vega-hedging, and Dynamic/ Static Replication Portfolios, shall be selected to cope with the risks of the commercial banks. Additionally, Limits must be established in congruent with their relevant risk management system, operation procedures, and capital positions. (c) Commercial banks must set the appropriate and clear guidelines and procedures for assessment of the fair value (mark to market) which can reflect the actual market value. The assessment of fair value (marking to market) of the outstanding balance must be made at the end of every business day. BOT Notification No (draft).rtf Page 22 of 40

23 (d) A test to ensure the efficiency, accuracy, and preciseness of the risk management system must be carried out within an appropriate timeframe, for example, back testing and stress testing of the value at risk model (VaR) must be conducted regularly. The Bank of Thailand shall grant the exemption regarding risk management systems requirement under Section 6 (a), (b), and (d) in cases where commercial banks employ back to back risk management method. The exemption shall end on 31 December Additionally, the alleviation regarding the mark-to-market of structured derivatives under Section 6 (c) are also granted to those employ back-to-back risk management method but the commercial banks shall perform mark-to-market at least for every publicly disclosed financial statements. This shall end on 31 December During these periods, however, commercial banks should prepare to implement the risk management systems in accordance with the aforementioned risk management requirement. (7) In undertaking Barrier Derivative transactions or the transactions that comprise barrier derivatives and/or digital options, commercial banks must carry out back to back risk management method for the barrier derivatives and/or digital options unless otherwise stipulated by the Bank of Thailand. (8) Commercial banks must ensure that the internal control system can support such transactions in an efficient, adequate, and appropriate manner. Clear and written rules and procedures on internal control as well as proper controlling structure and segregation of duties must be in place. The internal control system and the practice of internal control measures shall be monitored regularly. In addition, the bank shall have in place the information system for risk reporting and the risk reports shall be submitted to an audit committee or a unit designated from the head office (in case of foreign banks branches), whereby such unit may be at the regional office. 4.4 Requirements regarding Prevention of Speculation (1) Commercial banks are permitted to undertake structured derivative transactions within the following scope: BOT Notification No (draft).rtf Page 23 of 40

24 FX licensed 4 Counterparty Institutional Investor 5 Individual Nonresident 6 Domestic reference interest rates (A) (A) (A) (E) Foreign reference interest rates Indices calculated from foreign reference interest rates (A) (B) or (C) or (D) (B) or (D) (E) (A) (B) or (C) (B) (E) Foreign exchange rates (A) (B) (B) (E) Indices calculated from foreign exchange rates (A) (x) (x) (E) Where -: (A) Commercial banks may undertake structured derivative transactions referenced to the specified variable with the specified counterparty without required underlying, except in the cases where the counterparty is a natural person where transactions may be undertaken only to hedge the client s risks from existing underlying positions. (B) Commercial banks may undertake structured derivative transactions referenced to the specified variable with the specified counterparty only if the said counterparty has an underlying position which is an obligation to obtain or to deliver foreign currency of the same currency of which its term is consistent with the conditions in the derivative contract or obtain permission from the Competent Officer on a case by case basis. Derivative transactions referenced to foreign exchange rates must be settled by physical delivery of the foreign currency stated in the contract. (C) Commercial banks may undertake structured derivative transactions referenced to the specified underlying variable with the specified counterparty only for swap transactions which do not involve an exchange of the principals and are settled in Thai Baht. However, the commercial bank must ensure that the counterparty has the investment in debt instrument and the investment will be held throughout the life of the swap transaction. 4 Refers to permitted legal entities as specified under the Exchange Control Act 5 Refers to institutional investors following Attachment 2. 6 Refers to non-residents as specified under the Exchange Control Act. BOT Notification No (draft).rtf Page 24 of 40

25 (D) Commercial banks may undertake Quanto Interest Rate Swap transactions referenced to the specified variable with the specified counterparty where the counterparty must have Thai Baht-denominated debt as the underlying. (E) Commercial banks may undertake transactions referenced to the specified variable with the specified counterparty, where the transactions must not violate the laws and regulations under the Exchange Control Act and BOT s Measures to prevent Thai Baht speculation. (X) Commercial banks may not undertake transactions referenced to the specified variable with the specified counterparty. The Bank of Thailand may order the commercial bank to cease its undertaking of a certain type of the structured derivative, or stipulate additional conditions, if the BOT consider that the undertaking of the said transaction is not in line with the Principles. (2) In undertaking structured derivative transactions, commercial banks shall comply with the rule on currency denomination of a transaction as follows: (A) In the case of transactions with residents, settlement must be carried out only in Thai baht, except for those dealt with authorized juristic person under the exchange control law, which can be settled either in Baht or foreign currency; (B) transactions with non-residents must be in foreign currency only, however, transactions may be carried out in Thai baht only if the transactions are not inconsistent with BOT s Measures to prevent Thai Baht speculation. (3) In carrying out transactions in Section 4.2 concerning exchange rates or transactions involving settlement in foreign currency which is restricted by the underlying requirement under Section 4.4 (1), where underlying is defined as obligation to obtain or to deliver foreign currency, commercial banks may undertake transactions only to provide hedging 7 to the clients. The underlying must be considered according to the following guidelines. (a) Carrying out the transactions must result in the client s hedging against their risks in every scenario. (b) Commercial banks must undertake transactions which are not in excess of clients current underlying, considering all possible scenarios which may occur. (c) In analysing (a) and (b), netting of derivative transactions within the same scenario is permitted. (d) The term of the structured derivative contract must be consistent with that of the client s underlying position. 7 Hedging against risks, refers to carrying out transactions whose risk profile is the reverse of the existing positions, or transactions which materially reduce or limit the risk of losses from existing positions when the underlying price moves in an adverse direction to the said positions. BOT Notification No (draft).rtf Page 25 of 40

26 To undertake the transactions with counterparties who have the obligation to obtain or deliver foreign currency, commercial banks must request for the documents from the clients indicating the underlying obligation to obtain or deliver foreign currency in the future. The amount of foreign currency and the maturity date of such structured derivatives transactions shall not exceed the amount and the payment dates specified in the documents. (4) Undertaking transactions according to Section 4.2, including the hedging of the risks arising from those transactions in Section 4.2, must be in compliance with the Exchange Control Law and the relevant regulations and the BOT s Measures to prevent Thai Baht speculation. 4.5 Data Management and Reporting (1) Commercial banks undertaking transactions under Section 4.2 must record and keep transactions data, including the reference number, trade date, maturity date, transaction type, counterparty, reference variables, components of the transaction and position of each derivative component 8, transaction currency, contractual amount, the Thai baht-equivalent amount, the delta equivalent or fair value of the transaction. Data shall be stored in computerize form using the report formats set by the Bank of Thailand (Attachment 3). Commercial banks have to summit such report to the Bank of Thailand on a monthly basis by the last day of the following month, through channels to be set by the Bank of Thailand. Additionally, documentary evidence of the transactions shall be kept at the commercial bank for the Bank of Thailand examinations or for submiting to the Bank of Thailand upon request. (2) When offering the transaction under Section 4.2 for the first time, or changes are made to the components of the transaction, commercial banks must submit details of such transaction to the Bank of Thailand within 15 business days from the trade date, reporting the characteristics of the transaction including components of the transaction, the term sheet, and risk management methodologies. The Bank of Thailand may order the commercial bank to cease undertaking such transactions if the Bank of Thailand determines the transaction is inconsistent with the principles and scope set out by the Bank of Thailand. 4.6 Providing Information to Clients (1) Prior to undertaking transactions set out in Section 4.2 with the counterparties that are not commercial banks, the commercial bank have to perform client suitability analysis according to the guidelines which shall be set out by the Bank of 8 The position of each derivative component refers to the commercial bank s position with regards to each derivative component as the buyer/ seller, receiver/ payer. BOT Notification No (draft).rtf Page 26 of 40

27 Thailand. Additionally, commercial bank shall keep evidence to prove that the bank has carried out such analysis. (2) Commercial banks undertaking transactions set out in Section 4.2 must clearly explain the nature of the transactions and the associated risks to the clients. The information to be disclosed to the clients must be in accordance with the requirement to be set out by the Bank of Thailand. 4.7 Undertaking Transactions by Thai Commercial Banks Abroad The transactions undertaken by overseas branches of Thai commercial banks shall be subject to the supervisory regulations of the country where the branches are located, and must comply with the guidelines specified in Sections 4.3, 4.5, 4.6, and 4.8 of the Notification. 4.8 Other Requirements (1) Commercial banks that undertake structured derivative transactions must ensure that the contracts are legally enforceable and must comply with the supervisory guidelines governing the transactions as prescribed by the Bank of Thailand (2) Commercial banks that undertake structured derivative transactions must record the transactions and disclose the information in accordance with the accounting standard and the international practice. 4.9 Procedures in the Cases where a Commercial Bank has Previously Gained Permission to Undertake Structured Derivative Transactions on a Case by Case Basis Commercial banks which have received permission to undertake structured derivative transactions on a case by case basis prior to the effective date of this Notification shall comply with this Notification. With regards to the transactions previously permitted on a case by case basis, if these transactions are not in-line with the scope set in this Notification, commercial banks could no longer undertake such transactions. For the transactions carried out previously, banks are permitted to hold these transactions until the maturity of the contract, where banks may not extend the maturity without permission from the Bank of Thailand on a case by case basis Changes of the Scope of Structured Derivative Transactions Permitted to Commercial Banks In the future, the Bank of Thailand may have a necessity to review and amend supervisory guidelines regarding the undertaking of structured derivative BOT Notification No (draft).rtf Page 27 of 40

28 transactions of commercial bank as deem appropriate, under the principle framework in Section Effective Date This notification shall come into force from the day following the announcement date in the Government Gazette. Notified on 6 October B.E (M.R. Pridiyathorn Devakula) Governor Bank of Thailand BOT Notification No (draft).rtf Page 28 of 40

29 Attachment 1 Permitted Structured Derivative Transactions Collar The transaction created from a combination of a long call option and a short put option, or a long put option and a short call option on the underlying asset such as on foreign exchanges, interest rates, and financial indices. The strike rate of the call option and out option may not be equal. In most cases, Collars are carried out with zero cost, which no fees will be charged as the fee required for buying the call or put option is offset by the fee received from selling the put or call option. Spread The transaction created from a combination of a long and a short call option, or a long and a short put option on the underlying asset such as on foreign exchange, interest rates, and financial indices. The long and the short position, on either call or put options, have different Strike Rates, and the notional amounts of the long and short position, on either call or put options, may not be equal. Seagull The transaction created from a combination of a Collar and a short call option in the case of the long call option under Collar, or a combination of a Collar and a short put option in the case of the long put option under Collar. Participating Forward/Options The transaction created from a combination of a long call option and a short put option, or a long put option and a short call option on the underlying asset, such as on foreign exchanges, interest rates, and financial indices. The call option and the put option may have the same Strike Rate ([Participating] Forward) or they may not ([Participating] Options), however, the notional amounts are unequal resulting in a partial hedge of risks for the client. Coupon Swap A type of Cross Currency Swap, where no principal exchange required; therefore, such transaction is an agreement between two counterparties to exchange two streams of interest cash flows calculated from the interest rate of the different currencies. BOT Notification No (draft).rtf Page 29 of 40

30 Average Rate Option / Average Strike Option The transaction that gives the buyer the right to buy (Call option) or sell (Put option) an underlying asset such as foreign exchange, interest rates, and financial indices in future. In case of Average Rate Option, the profit or loss from the contract would be equal to the difference between the average underlying asset price over a specified time period and the strike price set in advance. In case of Average Strike Options, its strike price was set at the average asset price over a specified period. Par Forward An agreement to buy or sell series of foreign currency at different point of time in the future, where the client agrees to buy or sell foreign currency under the agreement, at one particular forward rate applicable for all cashflow exchanges. Interest Rate Swaption The transaction that gives the buyer the right to enter into the interest rate swap transaction with the seller, according to the terms and conditions set out in the contract at origination. Arrears Fixing and Average rate Swap A Cross Currency Swap or Interest Rate Swap contract where the floating interest rate is fixed using the interest rate quoted at the end of the interest calculation period (generally, 2 days before the Interest Payment Date), differing from an ordinary Interest Rate Swap inwhich the interest rate is fixed using the rate quoted at the beginning of the interest calculation period. In case of Average Rate Swap, the floating interest rates may be set as follows. Average Advance, use the average daily interest rate over a set time interval specified at the beginning of the period. Average Arrears, use the average daily interest rate over a set time interval specified at the end of the period. Average Fixing, use the average interest rate over each interest calculation period. Quanto Interest Rate Swap An Interest Rate Swap for which the floating interest rate and the Notional principal are in different currencies. BOT Notification No (draft).rtf Page 30 of 40

31 Interest rate-linked FX Forward An agreement to buy or sell foreign currency in the future, where the client longs or shorts Interest Rate Options (such as cap and/or floor and/or digital option on Interest Rate) which will result in a more favourable exchange rate than normal rate should underlying interest rates move according to his expectations. Cross Currency Swap with Currency Options A type of Cross Currency Swap where the client also longs or shorts Currency Options in order to achieve the more favourable exchange rates than normal rate should underlying exchange rates move according to his expectations. Knock In Option The purchase or sale of an Option (Call/Cap/Put/Floor) where there are additional limitations on exercising option rights compare to the plain vanilla option. That is, at the origination, the derivative does not give the option buyer the rights to buy or sell the underlying asset such as foreign exchange, interest rate, or financial index at a future date at the pre-specified rate. However, if the underlying price moves higher, lower, within, or outside the Barrier(s) (depending on the agreed conditions) over the observation period, the option buyer shall have the rights to buy or sell the underlying asset at the prespecified strike rate in accordance with the terms of the contract. As such, the above conditions will lower the premiums of this option contract. Knock In Forward A synthetic forward/forward bought or sold on the underlying asset such as foreign exchange, interest rate, or financial index whereby some additional limitations apart from those of the plain vanilla option or forward agreement were included. That is, on the transaction date, the contract does not give the counterparties the rights or obligation to buy or sell the underlying asset in the future. However, if the underlying price moves higher, lower, within, or outside the Barrier(s) (depending on the agreed conditions) over the observation period, the counterparties must abide by the terms of the contract to buy or sell the underlying asset in the future at the pre-specified strike rate. Knock Out Option BOT Notification No (draft).rtf Page 31 of 40