42.Note that the Standards defines the term “commodity type” for purposes of calculation of exposure for CCR. A commodity type is defined as a set of commodities with broadly similar risk drivers, such that the prices or volatilities of commodities of the same commodity type may reasonably be expected to move with similar direction and timing and to bear predictable relationships to one another. For example, a commodity type such as coal might include several types of coal, and a commodity type such as oil might include oil of different grades from different sources. The prices of commodities of a given type may not move precisely in lock step, but they are likely to move in the same direction at roughly the same time, due to their dependence on common forces in commodity markets. Long and short trades within a single commodity type can be fully offset.

43.For commodity derivatives, defining individual commodity types is operationally difficult. In fact, it is generally not possible to fully specify all relevant distinctions between commodity types, and as a result, a single commodity type is likely to include individual commodities that in practice differ to some extent in the dynamic behaviour they exhibit. As a result, not all basis risk is likely to be captured. Nonetheless, banks should attempt to minimize unrecognized basis risk through sound definitions of commodity types.

44.The Standards requires a bank to establish appropriate governance processes for the creation and maintenance of the list of defined commodity types used by the bank for CCR calculations, with clear definitions and independent internal review or validation processes to ensure that commodities grouped as a single type are in fact similar. A bank can only use the specifically defined commodity types it has established through its adequately controlled internal processes.

45.Trades within the same commodity hedging set (Energy, Metals, Agriculture, and Other) enjoy partial offsetting through the use of correlation values established in the Standards, with correlation values varying by asset subclass. More specifically, partial offsetting applies only to the systematic component, not the issuer-specific or idiosyncratic component. Note that Electricity is a sub-class of the Commodity asset class, but is itself part of the broader Energy hedging set, rather than constituting a distinct hedging set.