Journal of Risk 23(3), 57–73

DOI: 10.21314/JOR.2020.450

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Research Paper

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

PO Box TSW 273, Hong Kong; email: ted.ct.yu@gmail.com

(Received October 31, 2019; accepted December 9, 2020)

ABSTRACT
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 cur-
rency 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

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also propose a workable solution with a minimal change to the BCBS standards to
solve the anomalies for the pegged reporting currency.

Keywords: Fundamental Review of the Trading Book (FRTB); standardized approach; foreign
exchange (FX) base currency approach; market risk; Basel IV.

1 INTRODUCTION
On January 14, 2019, the Basel Committee on Banking Supervision (BCBS) pub-
lished the final version of the Fundamental Review of the Trading Book (FRTB),
named the “Minimum capital requirements for market risk” (BCBS 2019a). Now,
subject to supervisory approval, banks may choose to use the foreign exchange (FX)
base currency approach under the standardized approach of FRTB to calculate the
FX risk capital charge. Banks are allowed to consider a single currency as their base
currency instead of the reporting currency. The new approach is designed with the
good intention of acknowledging the triangular relationship of currency pairs. Under
the previous version of the FRTB (BCBS 2016), if a bank’s reporting currency is not
on the list of major currency pairs (say, THB), that bank will be required to decom-
pose a major currency pair (eg, USDJPY) into two currency pairs (eg, USDTHB
and THBJPY). A higher risk weight, and effectively a higher capital charge, will be
imposed on the bank with THB as the reporting currency. The new approach mit-
igates such disadvantages and allows banks to use USD as their base currency to
calculate the capital charge in USD and convert the charge to a reporting currency
using the spot FX rate (ie, USDTHB). Effectively, a non-USD bank can apply the
same preferential risk weight to its capital charge calculation as a USD bank. The
industry acknowledges that this enhancement levels the playing field for banks with
different reporting currencies.
In this paper, we investigate several questions. First, it is found that the capital
charges calculated using the FX base currency approach are different to those calcu-
lated using the reporting currency approach (ie, using the reporting currency) for the
same FX portfolio. What is the reason for this variance? Further, should the capital
charge of an FX portfolio be invariant for different reporting currencies?
Second, when we apply the BCBS FX risk charge to a pegged reporting currency,
what deficiencies and limitations should we be aware of? We seek to propose a
solution to mitigate such issues.
For ease of illustration, we will use simple FX spot portfolios in our examples.
This means that the portfolios are comprised of FX spot positions only. For the
FX risk charge, we focus on the FX delta risk only. We are aware that nonlin-
ear instruments (eg, options) may affect the generality of our work, but we do not
want to lose focus in this study. With reference to the inspirational papers of Farag

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 A review of the FX base currency approach 59

(2017, 2018a,b), we assume the portfolio has a mark-to-market (MtM) value of zero.
In fact, we should handle a nonzero MtM portfolio by treating it as a structural FX
position. Another paper will be prepared to elaborate on this.
In Section 2, we review the FX delta risk charge under the standardized approach
of BCBS (2019a). In Section 3, we illustrate numeric examples of FX delta risk
charges using the reporting currency approach and the base currency approach. Fur-
ther, we show the characteristics of the triangular relationship of currency pairs in
Section 4 and apply the triangular relationship of currency pairs to illustrate the
invariance of the delta FX risk charge of any reporting currency in Section 5. To
indicate a special case of anomalies, we illustrate the variance and invariance of
a portfolio with a pegged reporting currency in Section 6. Finally, we propose a
solution to mitigate such issues in Section 7.

2 FOREIGN EXCHANGE DELTA RISK CHARGE

2.1 Reporting currency approach
According to BCBS (2019a), an FX risk bucket is set for each exchange rate between
the currency in which an instrument is denominated and the reporting currency. A
risk weight (RW) equal to 15% applies to all the FX sensitivities. For the specified
currency pairs (eg, EURUSD, USDJPY, USDGBP, etc) and for currency pairs form-
ing first-order crosses across these specified currency pairs, the above RW may, at
the discretion of the bank, be divided by the square root of 2. In this paper, we call
the specified currency pairs “major currency pairs” and those outside the specified
list “nonmajor currency pairs”. That is,
RWnonmajor CCY pair 15%
RWmajor CCY pair D p D p D 10:6%:
2 2
As the FX rate is the only risk factor in each FX risk bucket, each FX position is
assigned to a risk bucket. No within-bucket aggregation is required: we just need to
perform across-bucket aggregation among all the FX positions.
S TEP 1 Each FX position is assigned to a risk bucket. According to BCBS
(2019a), the FX sensitivity is measured by changing the exchange rate by 1 per-
centage point (ie, 0.01 in relative terms) and dividing the resulting change in the
market value of the instrument by 0.01 (ie, 1%). For the FX spot position of a given
risk factor k, the FX position amount is the sensitivity (Sk ) of the FX position to the
reporting currency:
Sk D FX positionk :
S TEP 2 The risk-weighted sensitivity (WSk ) is defined as

WSk D RWk Sk :

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S TEP 3 This is when we would perform within-bucket aggregation. However,

since each FX position is assigned to a risk bucket, no within-bucket aggregation
is needed.
S TEP 4 We perform across-bucket aggregation:
sX XX
FX delta risk charge D WS2k C kl WSk WSl ; (2.1)
k k k¤l

where kl D 0:6 is the prescribed correlation between risk factor k and risk factor l.

2.2 Base currency approach

Subject to supervisory approval, FX risk may alternatively be calculated relative to a
base currency instead of to the reporting currency. Banks first choose a base currency
and calculate the FX risk against the base currency. Having calculated the FX delta
risk charge following the steps discussed in the previous section, the FX delta risk
charge relative to the base currency is converted into the reporting currency using the
spot FX rate (Preport;base ), reflecting the FX risk between the base currency and the
reporting currency:

FX delta risk charge D FX delta risk charge in base currency  Preport;base : (2.2)

3 NUMERIC EXAMPLE OF FOREIGN EXCHANGE DELTA RISK

CHARGE
3.1 Using the reporting currency approach
Here, we reuse the worked example 3 illustrated in BCBS (2019b). The example is
based on a CAD reporting bank; the net open FX
p positions are set out in Table 1. We
that the BCBS applied RW D 30%= 2 in its 2016 example (BCBS 2016)
highlight p
but 15%= 2 in its 2019 example (BCBS 2019b). So, we illustrate the results of both
RW D 21:2% and RW D 10:6% (see Table 2) for completeness.

3.2 Using the base currency approach

Again, we reuse the worked example 3 illustrated in BCBS (2019b): see Tables 3
and 4.
The interesting question is why the delta FX risk charges calculated using the
reporting currency approach and the base currency approach are different. To explain
this, we have to understand the characteristics of the triangular relationship of
currency pairs.

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 A review of the FX base currency approach 61

TABLE 1 Delta FX risk charge using the reporting currency approach (RW D 21.2%,
 D 0.6).

Position in CAD CAD CHF EUR JPY SGD USD

Net open FX position (Sk ) 30 50 20 60 30 50

RWk 21.2% 21.2% 21.2% 21.2% 21.2%

Delta FX risk (in CAD): 14.23.

TABLE 2 Delta FX risk charge using the reporting currency approach (RW D 10.6%,
 D 0.6).

Position in CAD CAD CHF EUR JPY SGD USD

Net open FX position (Sk ) 30 50 20 60 30 50

RWk 10.6% 10.6% 10.6% 10.6% 10.6%

Delta FX risk (in CAD): 7.12.

4 CHARACTERISTICS OF THE TRIANGULAR RELATIONSHIP OF

CURRENCY PAIRS AND THE IMPLICATIONS
Denote by PXY the spot FX rate of XY . This is aligned with the market convention.
One unit of currency X converts to PXY units of currency Y .
Given the triangular relationship of currency pair

PZY
PXY D ;
PZX
by applying differentiation to both sides, we have
 
d.PZY / 1
d.PXY / D C .PZY / d.P ZX ;
/
.PZX / .PZX /2
     
d.PXY / 1 d.PZY / 1 1
D C .PZY / .P ZX ;
/
PXY PXY .PZX / PXY .PZX /2
     
d.PXY / PZX d.PZY / PZX 1
D C .PZY / .P ZX ;
/
PXY PZY .PZX / PZY .PZX /2
d.PXY / d.PZY / d.PZX /
D ;
PXY .PZY / PZX
   
d.PXY / d.PZY / d.PZX /
Var D Var ;
PXY .PZY / PZX
2 2 2
XY D ZY C ZX 2ZY;ZX ZY ZX ; (4.1)

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TABLE 3 Delta FX risk charge using the base currency approach (RW D 21.2%,  D 0.6).

CAD CHF EUR JPY SGD USD Total

Positions in FX ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚…„ƒ
risk bucket CAD CAD CHF CAD EUR CAD JPY CAD SGD CAD USD CAD CAD

S (in USD) 23.9 23.7 39.9 39.5 16.0 15.8 47.9 47.4 23.9 23.7 39.9 39.5 23.9
WS (in USD) 5.1 5.0 8.5 8.4 3.4 3.4 10.2 10.1 5.1 5.0 8.5 8.4 5.1

USDCAD spot rate: 1.2534. Delta FX risk (in CAD): 14.73. Numbers in bold are those used in across-bucket aggregation (step 4).

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TABLE 4 Delta FX risk charge using the base currency approach (RW D 10.6%,  D 0.6).

CAD CHF EUR JPY SGD USD Total

Positions in FX ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚…„ƒ
risk bucket CAD CAD CHF CAD EUR CAD JPY CAD SGD CAD USD CAD CAD

S (in USD) 23.9 23.7 39.9 39.5 16.0 15.8 47.9 47.4 23.9 23.7 39.9 39.5 23.9
WS (in USD) 2.5 2.5 4.2 4.2 1.7 1.7 5.1 5.0 2.5 2.5 4.2 4.2 2.5

USDCAD spot rate: 1.2534. Delta FX risk (in CAD): 7.36. Numbers in bold are those used in across-bucket aggregation (step 4).

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where XY is the volatility of the spot FX rate of currency pair XY, ie,
s  
d.PXY /
Var :
PXY

As an example, if we define X D USD, Y D JPY and Z D EUR, we can present

the formula as follows:
2 2 2
USDJPY D EURJPY C EURUSD 2EURJPY;EURUSD EURJPY EURUSD :

This formula illustrates some interesting and important characteristics of the volatil-
ities of currency pairs under the triangular relationship.
If the volatilities of the three currency pairs are given, the correlation can be
written as follows:
2 2 2
EURJPY C EURUSD USDJPY
EURJPY;EURUSD D : (4.2)
2EURJPY EURUSD

Application example 1
All volatilities are equal, and then the correlation is 0.5.
If USDJPY D EURJPY D EURUSD , then

EURJPY;EURUSD D 0:5: (4.3)

Application example 2
If two volatilities and correlations are given, the remaining volatility is implied.
For example, if EURJPY D EURUSD and EURJPY;EURUSD D 0, then
USDJPY
EURJPY D EURUSD D p : (4.4)
2
In general, the formula allows three degrees of freedom only, and you cannot
specify the four variables (three volatilities and correlations) at the same time.

5 ILLUSTRATION OF THE INVARIANCE OF ANY REPORTING

CURRENCY
Given that the currency pairs in the examples are in the major currency pair list, the
RWs for all FX positions are the same. To the best of our knowledge, the BCBS cal-
ibrates RWs based on the volatilities of the risk factors. For illustration, we assume
that RWs are linearly proportional to the FX volatilities and RWs, and that the volatil-
ities in the formulas in Section 4 are interchangeable. For any two FX positions in
the example (eg, EUR and USD) and the reporting currency (CAD), the volatilities

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TABLE 5 Delta FX risk charge using the reporting currency approach (RW D 21.2%,
 D 0.5).

Position in CAD CAD CHF EUR JPY SGD USD

Net open FX position (Sk ) 30 50 20 60 30 50

RWk 21.2% 21.2% 21.2% 21.2% 21.2%

Delta FX risk (in CAD): 15.59.

TABLE 6 Delta FX risk charge using the reporting currency approach (RW D 10.6%,
 D 0.5).

Position in CAD CAD CHF EUR JPY SGD USD

Net open FX position (Sk ) 30 50 20 60 30 50

RWk 10.6% 10.6% 10.6% 10.6% 10.6%

Delta FX risk (in CAD): 7.79.

of EURUSD, CADUSD and CADEUR are set to 10.6% in accordance with BCBS
(2019a). As mentioned in Section 4, under the characteristics of the triangular rela-
tionship of currency pairs, if three volatilities are given, the correlation should be
implied. Based on (4.3), the implied correlation should be 0.5.
As a uniform correlation of 0.6 is adopted in the FX risk charge, this creates an
inconsistency in the triangular relationship. If we set the correlation to 0.5 in the
examples in Section 3, we will find that the FX risk charges are the same for both the
reporting currency and the base currency approaches (see Tables 5–8).
Without loss of generality, we can choose any one of the currencies in the portfolio
and even a currency not covered in the portfolio as the base currency to calculate the
FX risk charge, as the same preferential RW is allowed for the first-order crosses
across the major currency pairs. It can be shown that the calculated delta FX risk
charge is the same for any base currency chosen. This observation was first made by
Youngsuk Lee (see Farag 2017). Here, we focus on numerical examples and explain
the reason using the triangular relationship.
These examples illustrate and prove the invariance of the delta FX risk charge
of any reporting currency as well as the invariance between the reporting currency
approach and the base currency approach. The key condition is that the volatilities
and correlations must be set consistently. These results align with our economic intu-
ition that the FX risk of a zero MtM portfolio to a bank should be independent of the
reporting currency. The translation of the FX risk charge from the base currency to
the reporting currency does not necessarily create extra variation in the risk charge
calculation.

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T. Yu

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TABLE 7 Delta FX risk charge using the base currency approach (RW D 21.2%,  D 0.5).

CAD CHF EUR JPY SGD USD Total

Positions in FX ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚…„ƒ
risk bucket CAD CAD CHF CAD EUR CAD JPY CAD SGD CAD USD CAD CAD

S (in USD) 23.9 23.7 39.9 39.5 16.0 15.8 47.9 47.4 23.9 23.7 39.9 39.5 23.9
WS (in USD) 5.1 5.0 8.5 8.4 3.4 3.4 10.2 10.1 5.1 5.0 8.5 8.4 5.1

USDCAD spot rate: 1.2534. Delta FX risk (in CAD): 15.59. Numbers in bold are those used in across-bucket aggregation (step 4).

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TABLE 8 Delta FX risk charge using the base currency approach (RW D 10.6%,  D 0.5).

CAD CHF EUR JPY SGD USD Total

Positions in FX ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚ …„ ƒ ‚…„ƒ
risk bucket CAD CAD CHF CAD EUR CAD JPY CAD SGD CAD USD CAD CAD

S (in USD) 23.9 23.7 39.9 39.5 16.0 15.8 47.9 47.4 23.9 23.7 39.9 39.5 23.9
WS (in USD) 2.5 2.5 4.2 4.2 1.7 1.7 5.1 5.0 2.5 2.5 4.2 4.2 2.5

USDCAD spot rate: 1.2534. Delta FX risk (in CAD): 7.79. Numbers in bold are those used in across-bucket aggregation (step 4).

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In the examples above, the delta FX risk charges calculated using a correlation
of 0.6 are lower than the invariant result calculated using a correlation of 0.5, and
we can interpret the correlation of 0.6 as creating an “over-offsetting” effect in that
particular situation that lowers the risk charges. The BCBS requires banks to cal-
culate the risk charge from “medium”, “high” and “low” correlation scenarios, ie,
kl D 0:6, 0:75 and 0:45, and to take the largest value from the three scenarios in
the aggregation process. We believe that this method helps to mitigate such limita-
tions for most situations. However, we would like to illustrate a particular situation in
which the “over-offsetting” effect will be amplified, and that situation is as follows:
a bank calculating the risk charge relative to a reporting currency pegged to another
currency (eg, USDHKD).

6 ILLUSTRATION FOR A PORTFOLIO WITH A PEGGED

REPORTING CURRENCY
On June 28, 2019, the Hong Kong Monetary Authority (HKMA) published a con-
sultation paper (HKMA 2019) to outline the local implementation of the FRTB in
Hong Kong. Since HKD is pegged to USD, the HKMA proposed a preferential
RW D 1:3% for USDHKD to capture the fluctuation of USDHKD within the con-
vertibility undertaking range (ie, 7.75–7.85) under the linked exchange rate system.
However, banks using the FX base currency approach with USD as the selected base
currency will not be allowed to use this preferential RW. While we believe that this
constraint is not necessary, we would like to illustrate with examples the related
issues when the RW of USDHKD is set to 1.3%.
This example is based on an HKD reporting bank; the net open FX positions are
set out in Table 9. For ease of comparison, the FX positions of the bank are major
currencies with RW D 10:6%, and the RW of USDHKD is set to 1.3% for both the
reporting currency and the base currency approaches.
We calculate the delta FX risk charge based on the steps in Section 3. The results
based on different correlation scenarios are shown in Table 10.
These results are not desirable, as the differences between the delta FX risk
charges under the two approaches range from 18% to 58%. Even though we take
the highest value among the three correlation scenarios, the difference is still up to
18%. Might we conclude that the reporting currency approach underestimates the
delta FX risk charge, or that the base currency approach overestimates the charge?
To answer this, we recall the triangular relationship in Section 4.
Applying (4.1), we define X D USD, Y D CHF and Z D HKD (without loss of
generality, we can replace CHF for currencies other than USD and HKD):
2 2 2
USDCHF D HKDCHF C HKDUSD 2HKDCHF;HKDUSD HKDCHF HKDUSD : (6.1)

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 A review of the FX base currency approach 69

TABLE 9 Net open FX positions.

Position in HKD HKD CHF EUR JPY SGD USD

Net open FX position 1 965 150 300 300 260 2 155

Applying (4.2), when we set HKDUSD D 1:3% and HKDCHF D USDCHF D 10:6%
according to the specification in HKMA (2019), we obtain the following result:
2 2 2
HKDCHF C HKDUSD USDCHF
HKDCHF;HKDUSD D
2HKDCHF HKDUSD
HKDUSD
D
2HKDCHF
D 0:0613:

Recalling the observation in Section 4, when HKDUSD , HKDCHF and USDCHF are
given, HKDCHF;HKDUSD has to be implied. In this example, the uniformly applied
correlation of 0.6, which largely deviates from the appropriated value of 0.0613,
amplifies the “over-offsetting” effect in across-bucket aggregation. One of the key
reasons is that the RWs and correlations calibrated by the BCBS are based on general
currency pairs for USD or EUR reporting banks without considering the applications
to a pegged reporting currency.

7 SUGGESTED SOLUTION
In order to determine the solution, we first need to calculate the true delta FX risk
charge (the benchmark). For any CCY ¤ USD; HKD, since HKDUSD , HKDCCY
and USDCCY are given, we have to assign an appropriate correlation to the delta
FX risk charge aggregation formula instead of a uniform number of 0.6. By setting
HKDCCY;HKDUSD D 0:0613 and D 0:5 for the other currency pairs, we determine
the true delta FX risk charge D 49:38 under both the reporting currency and the base
currency approaches. This value is 7% over and 9% below the risk charges using the
HKMA reporting approach and the base currency approach, respectively.

7.1 Solution from calculating the delta FX risk charge using the
reporting currency approach
To prevent the proposed solution from deviating from the BCBS approach, we pro-
pose continuing the use of the uniform correlation of kl D 0:6 for normal currency
pairs except HKDCCY;HKDUSD D 0:0613.

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TABLE 10 Delta FX risk charge under the HKMA (2019) solution.

Delta FX risk
charge (in HKD)
Correlation ‚ …„ ƒ
‚ …„ ƒ Reporting Base
CCY pair 1 currency currency %
vs pair 2 approach approach difference

0.6 39.58 52.24 32

0.75 31.66 49.89 58
0.45 46.16 54.50 18
Maximum of the 46.16 54.50 18
three scenarios

For an HKD reporting bank with a preferential RW of USDHKD D 1:3%, the

proposed across-bucket aggregation formula is
FX delta risk charge
s XX X
D WS2k C hl WSh WSl C 2 h;HKDUSD WSh WSHKDUSD ; (7.1)
h h¤l h

where h is any non-USD currency against HKD (ie, HKDCCY).

The delta FX risk charge using the proposed solution is 46.63. Although it is 5.6%
below the benchmark value of 49.38, by following the BCBS aggregation process,
we can decrease the difference by taking the largest of the three correlation scenarios
to generate a much better result of 50.69.
We summarize the results in Table 11 for ease of comparison.
Without loss of generality, we rewrite (4.2) in terms of RWs:
PEGUSD RWPEGUSD
PEGCCY;HKDUSD D D ; (7.2)
2PEGCCY 2RWPEGCCY
where PEG is the pegged currency (eg, HKD) and CCY is any major currency.
Therefore, for other banks with a pegged reporting currency, if a particular RW is
set against USD, they can apply (7.2) to calculate an appropriate .

7.2 Alternative calculation using the base currency approach with

USD as the base currency
For an HKD reporting bank, alternatively, the bank can choose USD as the base
currency and apply the base currency approach with USDCCY;USDHKD D 0:0613. We
can calculate the same delta FX risk charge of 46.63 with the preferential RW of
USDHKD D 1:3%.

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 A review of the FX base currency approach 71

TABLE 11 Delta FX risk charge under different solutions.

Delta FX risk charge

Correlation (in HKD)
‚ …„ ƒ ‚ …„ ƒ
CCY pair Reporting Base
CCY pair 1 vs currency currency %
vs pair 2 USDHKD approach approach difference

HKMA (2019)
0.6 0.6 39.58 52.24 32
0.75 0.75 31.66 49.89 58
0.45 0.45 46.16 54.50 18
Maximum of the 46.16 54.50 18
three scenarios

Suggested solution
0.6 0.0613 46.63 46.63 0
0.75 0.0613 42.19 42.19 0
0.45 0.0613 50.69 50.69 0
Maximum of the 50.69 50.69 0
three scenarios

Benchmark
0.5 0.0613 49.38 49.38 0

7.3 Alternative calculation using the base currency approach with

CHF as the base currency
If the bank adopts a non-USD currency, eg, CHF, as the base currency and applies
the base currency approach, the RWs of CHFUSD and CHFHKD are 10.6%, and the
preferential RW of 1.3% is not applied in the aggregation formula directly. Instead,
we set
2
HKDUSD RWHKDUSD2
CHFUSD;CHFHKD D 1 2
D1 D 0:9924:
2CHFCCY 2RW2CHFCCY

Again, we can calculate the same delta FX risk charge of 46.63.

7.4 Alternative proof for the condition of invariance and its

implications
Interestingly, recalling (2.2), by setting the aggregation formula of the reporting cur-
rency approach equal to that of the base currency approach for a zero MtM FX spot

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72 T. Yu

portfolio, we get

FX delta risk charge in reporting currency

D FX delta risk charge in base currency  Preport;base :

We can prove the same results alternatively:

 the relation in (4.1) is a necessary condition to allow the equality to hold, and

 the spot FX rate to convert the delta FX risk charge from the base currency to
the reporting currency is cancelled out and is not a condition for the equality
to hold.

By exploiting the triangular relationship between the reporting currency, the base
currency and the other currencies, we can assign an appropriate correlation to calcu-
late an invariant delta FX risk charge, regardless of which reporting/base currency is
chosen.
The examples above show that the preferential RW of USDHKD D 1:3% works
for the base currency approach with USD as the selected base currency.
BCBS (2019a) requires banks to demonstrate that calculating FX risk using the
base currency approach does not inappropriately reduce capital requirements relative
to those calculated without the base currency approach. This paper provides a bench-
mark method for practitioners to offer this proof. In fact, if appropriate correlations
are set using the triangular relationship, this exercise is not necessary. Therefore, it
is better for local regulators to conduct quantitative impact studies with banks to test
the correlation parameters set under the local jurisdiction.

8 CONCLUSION
We illustrated several numerical examples to show the invariance of the delta FX
risk charge. The delta FX risk charge is invariant regardless of the reporting cur-
rency of the bank. It is also invariant whether the reporting currency approach or the
base currency approach is used. The key condition is that the volatilities and corre-
lations have to be set consistently. We believe the parameters set by the BCBS are
calibrated based on USD or EUR reporting banks. When banks and regulators local-
ize the BCBS standards, special attention should be paid when the volatility of the
reporting currency against USD or EUR deviates greatly (over or below) from the
uniform setup of 10.6%. This is particularly the case for pegged reporting currencies
with extremely low volatilities and emerging market currencies with high volatili-
ties. Finally, we proposed a workable solution with a minimal change to the BCBS
aggregation formula to fix such cases.

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DECLARATION OF INTEREST
This work represents the intellectual views of the author and not his employer. Any
errors are his responsibility. The author reports no conflicts of interest. The author
alone is responsible for the content and writing of the paper.

ACKNOWLEDGEMENTS
The author is grateful to Roy Ng and Rainbow Lui for their inspiring input and useful
comments.

REFERENCES
BCBS (2016). Minimum capital requirements for market risk. Standards, January, Basel
Committee on Banking Supervision. URL: https://bit.ly/3rjyK0j.
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