Document ID: chunk:federal_register_of_legislation:F2022L01562:body:0:p16
Version: federal_register_of_legislation:F2022L01562
Segment Type: other
Provision Reference: 
Character Range: 40792–43973

equivalents).
12.         An ADI may only use mark-to-model if:
(a)          marking-to-market is not possible;
(b)          use of mark-to-model valuation can be demonstrated to be prudent; and
(c)          the valuation procedure applies an extra degree of conservatism.
13.         In order for a mark-to-model valuation process to be reliable:
(a)          senior management of the ADI must be aware of the elements of fair valued positions that are subject to mark-to-model and understand the materiality of the uncertainty this creates in the reporting of risk/reward of the business undertaken;
(b)          market inputs in the model process must be sourced, to the extent possible, in line with market prices. The ADI must regularly review the appropriateness of market inputs used for the particular position being valued;
(c)          where available, generally accepted valuation methodologies for particular products must be used as far as possible;
(d)          where a model is developed by the ADI itself, it must be:
(i)            based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process;
(ii)         developed or approved independently of the area within the ADI that will be utilising the model for its business activities; and
(iii)       tested independently, including validating the mathematics, the assumptions and the software implementation;
(e)          there must be formal change control procedures in place and a secure copy of the model must be held and periodically used to check valuations;
(f)           the ADI's risk management function must be aware of the weaknesses in the model and how best to address such weaknesses in the valuation output;
(g)          the model must be subject to periodic review by the ADI to determine the accuracy of its performance, including:
(i)            assessment of the appropriateness of assumptions utilised; and
(ii)         analysis of profit and loss versus risk factors;
(h)          comparison must be made between actual close-out values to model outputs; and
(i)            valuation adjustments must be made, as appropriate, including to cover the uncertainty of model valuations (refer to paragraphs 14 to 21 of this Attachment).

Valuation adjustments
14.         If an ADI uses fair value measurement, it may need to adjust the values produced by its mark-to-market and mark-to-model valuation methodologies. If an ADI seeks to make such adjustments it must:
(a)          apply a rigorous and consistent process to determine valuation adjustments as appropriate;
(b)          consider whether any valuation adjustments are necessary where third-party valuations are used in mark-to-market or mark-to-model; and
(c)          take into account, at a minimum, the following matters:
(i)            close-out costs;
(ii)         unearned credit spreads;
(iii)       operational risks;
(iv)        early termination;
(v)          investing and funding costs;
(vi)        any future administrative costs; and
(vii)     as appropriate, model risk.
15.         Valuation adjustments that need to be made must, unless