(3)

Annex V is amended as follows: (a) point 1 is replaced by the following: ‘1. The competent authorities shall, subject to the conditions laid down in this Annex, allow institutions to calculate their capital requirements for position risk, foreign-exchange risk and/or commodities risk using their own internal risk-management models instead of or in combination with the methods described in Annexes I, III and IV. Explicit recognition by the competent authorities of the use of models for supervisory capital purposes shall be required in each case.’; (b) in point 4, the second paragraph is replaced by the following: ‘The competent authorities shall examine the institution’s capability to perform back-testing on both actual and hypothetical changes in the portfolio’s value. Back-testing on hypothetical changes in the portfolio’s value is based on a comparison between the portfolio’s end-of-day value and, assuming unchanged positions, its value at the end of the subsequent day. The competent authorities shall require institutions to take appropriate measures to improve their back-testing programme if deemed deficient. As a minimum, the competent authorities shall require institutions to perform back-testing on hypothetical (using changes in portfolio value that would occur were end-of-day positions to remain unchanged) outcomes.’; (c) point 5 is replaced by the following: ‘5. For the purpose of calculating capital requirements for specific risk associated with traded debt and equity positions, the competent authorities shall recognise the use of an institution’s internal model if, in addition to compliance with the conditions in the remainder of this Annex, the internal model meets the following conditions: (a) it explains the historical price variation in the portfolio; (b) it captures concentration in terms of magnitude and changes of composition of the portfolio; (c) it is robust to an adverse environment; (d) it is validated through back-testing aimed at assessing whether specific risk is being accurately captured. If the competent authorities allow such back-testing to be performed on the basis of relevant sub-portfolios, these must be chosen in a consistent manner; (e) it captures name-related basis risk, namely institutions shall demonstrate that the internal model is sensitive to material idiosyncratic differences between similar but not identical positions; (f) it captures event risk. The institution’s internal model shall conservatively assess the risk arising from less liquid positions and positions with limited price transparency under realistic market scenarios. In addition, the internal model shall meet minimum data standards. Proxies shall be appropriately conservative and may be used only where available data is insufficient or is not reflective of the true volatility of a position or portfolio. An institution may choose to exclude from the calculation of its specific risk capital requirement using an internal model those positions in securitisations or n-th-to-default credit derivatives for which it meets a capital requirement for position risks in accordance with Annex I with the exception of those positions that are subject to the approach set out in point 5l. As techniques and best practices evolve, institutions shall avail themselves of those new techniques and practices. An institution shall not be required to capture default and migration risks for traded debt instruments in its internal model where it is capturing those risks through the requirements set out in points 5a to 5k.’; (d) The following points are inserted: ‘5a. Institutions subject to point 5 for traded debt instruments shall have an approach in place to capture, in the calculation of their capital requirements, the default and migration risks of its trading book positions that are incremental to the risks captured by the value-at-risk measure as specified in point 5. An institution shall demonstrate that its approach meets soundness standards comparable to the approach set out in Articles 84 to 89 of Directive 2006/48/EC, under the assumption of a constant level of risk, and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging and optionality. Scope 5b. The approach to capture the incremental default and migration risks shall cover all positions subject to a capital charge for specific interest rate risk but shall not cover securitisation positions and n-th-to-default credit derivatives. Subject to supervisory approval, the institution may choose to consistently include all listed equity positions and derivatives positions based on listed equities for which such inclusion is consistent with how the institution internally measures and manages risk. The approach shall reflect the impact of correlations between default and migration events. The impact of diversification between, on the one hand, default and migration events and, on the other hand, other market risk factors shall not be reflected. Parameters 5c. The approach to capture the incremental risks shall measure losses due to default and internal or external ratings migration at the 99,9 % confidence interval over a capital horizon of 1 year. Correlation assumptions shall be supported by analysis of objective data in a conceptually sound framework. The approach to capture the incremental risks shall appropriately reflect issuer concentrations. Concentrations that can arise within and across product classes under stressed conditions shall also be reflected.The approach shall be based on the assumption of a constant level of risk over the one-year capital horizon, implying that given individual trading book positions or sets of positions that have experienced default or migration over their liquidity horizon are re-balanced at the end of their liquidity horizon to attain the initial level of risk. Alternatively, an institution may choose to consistently use a one-year constant position assumption. 5d. The liquidity horizons shall be set according to the time required to sell the position or to hedge all material relevant price risks in a stressed market, having particular regard to the size of the position. Liquidity horizons shall reflect actual practice and experience during periods of both systematic and idiosyncratic stresses. The liquidity horizon shall be measured under conservative assumptions and shall be sufficiently long that the act of selling or hedging, in itself, would not materially affect the price at which the selling or hedging would be executed. The determination of the appropriate liquidity horizon for a position or set of positions is subject to a floor of 3 months. The determination of the appropriate liquidity horizon for a position or set of positions shall take into account an institution’s internal policies relating to valuation adjustments and the management of stale positions. When an institution determines liquidity horizons for sets of positions rather than for individual positions, the criteria for defining sets of positions shall be defined in a way that meaningfully reflects differences in liquidity. The liquidity horizons shall be greater for positions that are concentrated, reflecting the longer period needed to liquidate such positions. The liquidity horizon for a securitisation warehouse shall reflect the time to build, sell and securitise the assets, or to hedge the material risk factors, under stressed market conditions. 5e. Hedges may be incorporated into an institution’s approach to capture the incremental default and migration risks. Positions may be netted when long and short positions refer to the same financial instrument. Hedging or diversification effects associated with long and short positions involving different instruments or different securities of the same obligor, as well as long and short positions in different issuers, may only be recognised by explicitly modelling gross long and short positions in the different instruments. Institutions shall reflect the impact of material risks that could occur during the interval between the hedge’s maturity and the liquidity horizon as well as the potential for significant basis risks in hedging strategies by product, seniority in the capital structure, internal or external rating, maturity, vintage and other differences in the instruments. An institution shall reflect a hedge only to the extent that it can be maintained even as the obligor approaches a credit or other event. For trading book positions that are hedged via dynamic hedging strategies, a rebalancing of the hedge within the liquidity horizon of the hedged position may be recognised provided that the institution: (i) chooses to model rebalancing of the hedge consistently over the relevant set of trading book positions, (ii) demonstrates that the inclusion of rebalancing results in a better risk measurement, and (iii) demonstrates that the markets for the instruments serving as hedges are liquid enough to allow for such rebalancing even during periods of stress. Any residual risks resulting from dynamic hedging strategies must be reflected in the capital charge. 5f. The approach to capture the incremental default and migration risks shall reflect the nonlinear impact of options, structured credit derivatives and other positions with material nonlinear behaviour with respect to price changes. The institution shall also have due regard to the amount of model risk inherent in the valuation and estimation of price risks associated with such products. 5g. The approach to capture the incremental default and migration risks shall be based on data that are objective and up-to-date. Validation 5h. As part of the independent review of their risk measurement system and the validation of their internal models as required in this Annex, institutions shall, with a view to the approach to capture incremental default and migration risks, in particular: (i) validate that its modelling approach for correlations and price changes is appropriate for its portfolio, including the choice and weights of its systematic risk factors; (ii) perform a variety of stress tests, including sensitivity analysis and scenario analysis, to assess the qualitative and quantitative reasonableness of the approach, particularly with regard to the treatment of concentrations. Such tests shall not be limited to the range of events experienced historically; (iii) apply appropriate quantitative validation including relevant internal modelling benchmarks. The approach to capture the incremental risks shall be consistent with the institution’s internal risk management methodologies for identifying, measuring, and managing trading risks. Documentation 5i. An institution shall document its approach to capturing incremental default and migration risks so that its correlation and other modelling assumptions are transparent to the competent authorities. Internal approaches based on different parameters 5j. If the institution uses an approach to capturing incremental default and migration risks that does not comply with all requirements of this point but that is consistent with the institution’s internal methodologies for identifying, measuring and managing risks, it shall be able to demonstrate that its approach results in a capital requirement that is at least as high as if it was based on an approach in full compliance with the requirements of this point. The competent authorities shall review compliance with the previous sentence at least annually. The Committee of European Banking Supervisors shall monitor the range of practices in this area and draw up guidelines in order to secure a level playing field. Frequency of calculation 5k. An institution shall perform the calculations required under its chosen approach to capture the incremental risk at least weekly. 5l. The competent authorities shall recognise the use of an internal approach for calculating an additional capital charge instead of a capital charge for the correlation trading portfolio in accordance with point 14a of Annex I provided that all conditions in this point are fulfilled. Such an internal approach shall adequately capture all price risks at the 99,9 % confidence interval over a capital horizon of 1 year under the assumption of a constant level of risk, and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging and optionality. The institution may incorporate any positions in the approach referred to in this point that are jointly managed with positions of the correlation trading portfolio and may then exclude those positions from the approach required under point 5a. The amount of the capital charge for all price risks shall not be less than 8 % of the capital charge that would be calculated in accordance with point 14a of Annex I for all positions incorporated in the charge for all price risks. In particular, the following risks shall be adequately captured: (a) the cumulative risk arising from multiple defaults, including the ordering of defaults, in tranched products; (b) credit spread risk, including the gamma and cross-gamma effects; (c) volatility of implied correlations, including the cross effect between spreads and correlations; (d) basis risk, including both: (i) the basis between the spread of an index and those of its constituent single names, and (ii) the basis between the implied correlation of an index and that of bespoke portfolios; (e) recovery rate volatility, as it relates to the propensity for recovery rates to affect tranche prices; and (f) to the extent the comprehensive risk measure incorporates benefits from dynamic hedging, the risk of hedge slippage and the potential costs of rebalancing such hedges. For the purpose of this point, an institution shall have sufficient market data to ensure that it fully captures the salient risks of those exposures in its internal approach in accordance with the standards set out in this point, demonstrates through back testing or other appropriate means that its risk measures can appropriately explain the historical price variation of those products, and is able to separate the positions for which it holds approval in order to incorporate them in the capital charge in accordance with this point from those positions for which it does not hold such approval. With regard to portfolios subject to this point, the institution shall regularly apply a set of specific, predetermined stress scenarios. Such stress scenarios shall examine the effects of stress to default rates, recovery rates, credit spreads, and correlations on the profit and loss of the correlation trading desk. The institution shall apply such stress scenarios at least weekly and report at least quarterly to the competent authorities the results, including comparisons with the institution’s capital charge in accordance with this point. Any instances where the stress tests indicate a material shortfall of this capital charge shall be reported to the competent authorities in a timely manner. Based on those stress testing results, the competent authorities shall consider a supplemental capital charge against the correlation trading portfolio as set out in Article 136(2) of Directive 2006/48/EC. An institution shall calculate the capital charge to capture all price risks at least on a weekly basis.’; (e) point 6 is replaced by the following: ‘6. Institutions using internal models which are not recognised in accordance with point 5 shall be subject to a separate capital charge for specific risk as calculated in accordance with Annex I.’; (f) point 7 is replaced by the following: ‘7. For the purposes of points 10b(a) and (b), the results of the institution’s own calculation shall be scaled up by the multiplication factors (mc) and (ms). Those factors shall be at least 3.’; (g) in point 8, the first paragraph is replaced by the following: ‘For the purposes of points 10b(a) and (b), the multiplication factors (mc) and (ms) shall be increased by a plus-factor of between 0 and 1 in accordance with Table 1, depending on the number of overshootings for the most recent 250 business days as evidenced by the institution’s back-testing of the value-at-risk measure as set out in point 10. The competent authorities shall require the institutions to calculate overshootings consistently on the basis of back-testing on hypothetical and actual changes in the portfolio’s value. An overshooting is a one-day change in the portfolio’s value that exceeds the related one-day value-at-risk measure generated by the institution’s model. For the purpose of determining the plus-factor the number of overshootings shall be assessed at least quarterly and shall be equal to the higher of the number of overshootings under hypothetical and actual changes in the value of the portfolio.’; (h) point 9 is deleted; (i) point 10 is amended as follows: (i) point (c) is replaced by the following: ‘(c) a 10-day equivalent holding period (institutions may use value-at-risk numbers calculated according to shorter holding periods scaled up to 10 days by, for example, the square root of time. An institution using that approach shall periodically justify the reasonableness of its approach to the satisfaction of the competent authorities);’; (ii) point (e) is replaced by the following: ‘(e) monthly data set updates.’; (j) the following points are inserted: ‘10a. In addition, each institution shall calculate a “stressed value-at-risk” based on the 10-day, 99th percentile, one-tailed confidence interval value-at-risk measure of the current portfolio, with value-at-risk model inputs calibrated to historical data from a continuous 12-month period of significant financial stress relevant to the institution’s portfolio. The choice of such historical data shall be subject to approval by the competent authorities and to annual review by the institution. The Committee of European Banking Supervisors shall monitor the range of practices in this area and draw up guidelines in order to ensure convergence. Institutions shall calculate the stressed value-at-risk at least weekly. 10b. Each institution shall meet, on a daily basis, a capital requirement expressed as the sum of points (a) and (b) and an institution that uses its internal model to calculate the capital requirement for specific position risk shall meet a capital requirement expressed as the sum of points (c) and (d), as follows: (a) the higher of: (i) its previous day’s value-at-risk number calculated in accordance with point 10 (VaRt-1); and (ii) an average of the daily value-at-risk measures in accordance with point 10 on each of the preceding sixty business days (VaRavg), multiplied by the multiplication factor (mc); (b) the higher of: (i) its latest available stressed-value-at-risk number in accordance with point 10a (sVaRt-1); and (ii) an average of the stressed value-at-risk numbers calculated in the manner and frequency specified in point 10a during the preceding sixty business days (sVaRavg), multiplied by the multiplication factor (ms); (c) a capital charge calculated in accordance with Annex I for the position risks of securitisation positions and nth to default credit derivatives in the trading book with the exception of those incorporated in the capital charge in accordance with point 5l; (d) the higher of the institution’s most recent and the institution’s 12 weeks average measure of incremental default and migration risk in accordance with point 5a and, where applicable, the higher of the institution’s most recent and its 12-week-average measure of all price risks in accordance with point 5l. 10c. Institutions shall also carry out reverse stress tests.’; (k) in point 12, the first paragraph is replaced by the following: ‘12. The risk-measurement model shall capture a sufficient number of risk factors, depending on the level of activity of the institution in the respective markets. Where a risk factor is incorporated into the institution’s pricing model but not into the risk-measurement model, the institution shall be able to justify such an omission to the satisfaction of the competent authority. In addition, the risk-measurement model shall capture nonlinearities for options and other products as well as correlation risk and basis risk. Where proxies for risk factors are used they shall show a good track record for the actual position held. In addition, the following shall apply for individual risk types:’.