This is the final part of our FRTB four-part look at SBM core mechanics. Parts A through C built the complete delta, vega and curvature formulas, and the sensitivity definitions that feed them — all implicitly assuming a clean, single underlying risk factor. Real portfolios are messier: instruments often reference an index, a basket of names, or a fund. This article covers how those basket-referencing instruments get broken down — or deliberately not broken down — into the individual sensitivities the rest of this series’ machinery expects and describing the look through approach.
The Look-Through Approach: The Default Rule
For delta and curvature risk, the starting rule for index instruments and multi-underlying options is to use a look-through approach — treating the position as if the bank held each constituent directly, rather than treating the index as one opaque instrument. A bank may opt out of this default only for instruments referencing a listed, widely recognised and accepted equity or credit index, and only where every one of the following five conditions is met.
| # | Condition |
| 1 | It is possible to look through the index — meaning the constituents and their respective weightings are known. |
| 2 | The index contains at least 20 constituents. |
| 3 | No single constituent within the index represents more than 25% of the total index. |
| 4 | The largest 10% of constituents represents less than 60% of the total index. |
| 5 | The total market capitalisation of all the index’s constituents is no less than USD 40 billion. |
Sourced from MAR21.31, including all five conditions in full.
https://www.bis.org/basel_framework/chapter/MAR/21.htm?inforce=20230101&published=20260323
One Consistency Requirement That Applies Regardless
Whichever way a bank goes — look-through or not — one rule holds for any given instrument: the sensitivity inputs used for the delta and curvature risk calculations must be consistent with each other. A bank cannot look through the index for delta purposes while treating it as a single opaque position for curvature purposes on the same instrument.
The “No Look-Through” Approach — How It Actually Works
Where a bank opts not to apply the look-through approach under the conditions above, a single sensitivity is calculated for the entire index the instrument references. That sensitivity then gets mapped to a specific delta risk bucket, following one rule:
- If more than 75% of the index’s constituents (by weighting) would map to one specific sector bucket — bucket 1 through 11 for equity risk, or bucket 1 through 16 for CSR — the entire index sensitivity is mapped to that single sector bucket, and treated exactly like any other single-name sensitivity within it.
- In every other case, the sensitivity may instead be mapped to a dedicated “index” bucket — bucket 12 or 13 for equity risk, or bucket 17 or 18 for CSR.
When Look-Through Is Mandatory, and the Netting Rules That Follow
The look-through approach must always be used for two categories: indices that fail any of conditions 2 through 5 above, and any multi-underlying instrument referencing a bespoke, custom-built set of equities or credit positions — as opposed to a genuinely widely-recognised index.
Once look-through is adopted, three further rules apply:
- For index instruments and multi-underlying options other than the CTP, sensitivities to the constituent risk factors from those instruments are allowed to net, without restriction, against sensitivities to single-name instruments held elsewhere in the portfolio.
- Index CTP instruments are treated differently: they cannot be broken down into their constituents at all. An index CTP is instead considered a single risk factor in its own right, and the issuer-level netting described above does not apply to it.
- Where look-through is adopted, it must be applied consistently through time, and used for every identical instrument referencing the same index.
| A One-Way Door, Just Like RBC25’s Switching Rule The standard’s own footnote here describes an asymmetric rule that should feel familiar from Article 2: a bank can initially choose not to apply the look-through approach, and later decide to start applying it. But once look-through has been adopted for a certain type of instrument referencing a particular index, reverting back to a “no look-through” approach requires supervisory approval. This is the same structural idea as RBC25’s restriction on switching instruments between the trading book and banking book — moving toward the more risk-sensitive, transparent treatment is easy; moving back toward the simpler treatment is deliberately made harder. |
Sourced from MAR21.34, including its footnote.
Equity Investments in Funds That Can Be Looked Through
For equity investments in funds that qualify for look-through under RBC25.8(5)(a) — the condition we covered in Article 2 — banks must apply a look-through approach, treating the underlying positions of the fund as if they were held directly by the bank, taking into account the bank’s share of the fund’s equity and any leverage in the fund structure.
Two situations soften this rule:
- If the fund itself holds an index instrument that meets the MAR21.31 criteria above, the bank must still look through the fund overall, but may then separately choose to apply the “no look-through” treatment for that specific index holding within the fund, per MAR21.33.
- For funds that track an index benchmark, a bank may skip look-through entirely and simply treat the fund as a position in the tracked index — but only where the fund’s absolute tracking difference (ignoring fees and commissions) is less than 1%, and that tracking difference is checked at least annually, defined as the annualised return difference between the fund and its benchmark over the trailing 12 months of available data.
Equity Investments in Funds That Cannot Be Looked Through
This section covers funds that fail the RBC25.8(5)(a) look-through test, but where the bank still has daily price quotes and knowledge of the fund’s mandate — meeting RBC25.8(5)(b) instead, also from Article 2. For these funds, a bank may calculate capital requirements using one of three methods.
| Method | How It Works |
| 1. Index-tracking treatment | If the fund tracks an index benchmark and meets the same tracking-difference conditions from MAR21.35(2) above, the bank may treat the fund as a position in the tracked index, mapping the sensitivity to sector or index buckets per MAR21.33. |
| 2. Hypothetical portfolio (supervisory approval required) | The bank treats the fund as a hypothetical portfolio invested, to the maximum extent its mandate allows, first in the assets attracting the highest SBM capital requirements, then progressively into lower-capital assets. Where more than one risk weight could apply to a given exposure, the maximum applicable risk weight must be used. |
| 3. Unrated equity exposure | The bank treats its investment in the fund as an unrated equity exposure, allocated to the “other sector” bucket (bucket 11). |
Method 2 comes with two further conditions worth noting in full: the hypothetical portfolio must be subject to market risk capital requirements on a standalone basis, separate from any other positions subject to market risk capital — the same standalone concept we defined in Article 4B. And the counterparty credit risk and CVA risk of any derivatives within this hypothetical portfolio must be calculated using the simplified methodology set out in paragraph 80(vii)(c) of the banking book equity investment in funds treatment.
Method 3 comes with its own follow-up obligation: banks choosing the unrated equity exposure treatment must also separately consider, given the fund’s mandate, whether the Default Risk Capital risk weight prescribed to the fund is sufficiently prudent — a requirement we will return to in Article 19B — and whether the Residual Risk Add-On should apply, which we will cover in Article 21.
Sourced from MAR21.36, including all three methods and their sub-conditions.
What Happens If a Fund Doesn’t Meet Either Look-Through Condition?
This scenario closes the loop with RBC25.8(5), which we covered in Article 2. Net long equity investments in a fund that cannot be looked through, and does not meet the RBC25.8(5) conditions at all, must be assigned to the banking book — reinforcing the mandatory banking book treatment from that earlier article. Net short positions in such funds are treated differently again: they are excluded from any trading book capital requirement under the market risk framework entirely, with the net short position instead subjected to a flat 100% capital requirement.
Vega Risk for Multi-Underlying Instruments: A Practical Simplification
The final paragraph of this chapter addresses vega specifically, and offers a genuine simplification. Multi-underlying options — including index options — are usually priced based on the implied volatility of the option itself, rather than the implied volatilities of its individual underlying constituents. Because of this, a look-through approach may not need to be applied for vega risk purposes at all, regardless of which approach — look-through or not — was used for that same instrument’s delta and curvature risk calculations.
Where a look-through is not applied for vega purposes, the vega risk relating to an index’s implied volatility is mapped using the identical 75% threshold rule we saw earlier: if more than 75% of the index’s constituents (by weighting) map to a single specific sector bucket, the sensitivity goes to that sector bucket; otherwise, it may be mapped to a dedicated index bucket. A footnote reiterates the same maturity tenor mapping requirement from Article 8C’s vega coverage: the implied volatility of the option must be mapped to one or more maturity tenors.
Sourced from MAR21.38, including its footnote.
The Complete Look-Through Decision Tree
| Situation | Treatment |
| Index meets all 5 MAR21.31 conditions | Bank may choose look-through or the single-sensitivity “no look-through” approach. |
| Index fails any MAR21.31 condition, or bespoke multi-underlying basket | Look-through is mandatory. |
| Fund qualifies for look-through under RBC25.8(5)(a) | Look-through mandatory, with an index-holding carve-out and an index-tracking carve-out available. |
| Fund fails look-through but meets RBC25.8(5)(b) | Bank chooses from three methods: index-tracking treatment, hypothetical portfolio, or unrated equity exposure. |
| Fund fails both RBC25.8(5)(a) and (b) | Net long → banking book. Net short → excluded from trading book capital, 100% flat charge instead. |
| Vega risk on multi-underlying instruments | Look-through may be skipped regardless of the delta/curvature approach chosen, since pricing is usually based on the option’s own implied volatility. |
Looking Ahead
This completes MAR21.1 through MAR21.38 — the entire general-provisions backbone of the Sensitivities-Based Method across Articles 8A through 8D. Every remaining SBM article now moves risk class by risk class, starting with General Interest Rate Risk, supplying the specific risk factor definitions, buckets, risk weights and correlations that plug directly into the formulas this four-part mini-series has now covered in full.
Frequently Asked Questions
When can a bank skip the look-through approach for an index?
Only for a widely recognised, listed index that meets all five conditions in MAR21.31: known constituents and weightings, at least 20 constituents, no single constituent over 25% of the index, the largest 10% under 60% of the index, and total constituent market capitalisation of at least USD 40 billion.
Can a bank switch back to a no-look-through approach after adopting look-through?
Only with supervisory approval. A bank can move from no-look-through to look-through freely, but reverting requires approval — an asymmetric rule similar to RBC25’s restriction on switching instruments between the trading book and banking book.
What happens to a fund investment that fails both RBC25.8(5) look-through conditions?
A net long position must be assigned to the banking book. A net short position is excluded from trading book market risk capital entirely and instead faces a flat 100% capital requirement.
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