Directive 2006/49/EC of the European Parliament and of the Council (repealed)Show full title

3. Institutions shall have processes in place to ensure that their internal models have been adequately validated by suitably qualified parties independent of the development process to ensure that they are conceptually sound and adequately capture all material risks. The validation shall be conducted when the internal model is initially developed and when any significant changes are made to the internal model. The validation shall also be conducted on a periodic basis but especially where there have been any significant structural changes in the market or changes to the composition of the portfolio which might lead to the internal model no longer being adequate. As techniques and best practices evolve, institutions shall avail themselves of these advances. Internal model validation shall not be limited to back-testing, but shall, at a minimum, also include the following:

(a)

tests to demonstrate that any assumptions made within the internal model are appropriate and do not underestimate or overestimate the risk;

(b)

in addition to the regulatory back-testing programmes, institutions shall carry out their own internal model validation tests in relation to the risks and structures of their portfolios; and

(c)

the use of hypothetical portfolios to ensure that the internal model is able to account for particular structural features that may arise, for example material basis risks and concentration risk.