Directive 2006/49/EC of the European Parliament and of the Council (repealed)Show full title

5. For the purpose of calculating capital requirements for specific risk associated with traded debt and equity positions, the competent authorities may 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 competent authorities allow this 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, that is institutions shall demonstrate that the internal model is sensitive to material idiosyncratic differences between similar but not identical positions; and

(f)

it captures event risk.

The institution shall also meet the following conditions:

• where an institution is subject to event risk that is not reflected in its value‐at‐risk measure, because it is beyond the 10-day holding period and 99 percent confidence interval (low probability and high severity events), the institution shall ensure that the impact of such events is factored in to its internal capital assessment; and

• 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.

Further, as techniques and best practices evolve, institutions shall avail themselves of these advances.

In addition, the institution shall have an approach in place to capture, in the calculation of its capital requirements, the default risk of its trading book positions that is incremental to the default risk captured by the value-at-risk measure as specified in the previous requirements of this point. To avoid double counting, an institution may, when calculating its incremental default risk charge, take into account the extent to which default risk has already been incorporated into the value‐at‐risk measure, especially for risk positions that could and would be closed within 10 days in the event of adverse market conditions or other indications of deterioration in the credit environment. Where an institution captures its incremental default risk through a surcharge, it shall have in place methodologies for validating the measure.

The 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.

An institution that does not capture the incremental default risk through an internally developed approach shall calculate the surcharge through an approach consistent with the either the approach set out in Articles 78 to 83 of Directive 2006/48/EC or the approach set out in Articles 84 to 89 of that Directive.

With respect to cash or synthetic securitisation exposures that would be subject to a deduction treatment under the treatment set out in Article 66(2) of Directive 2006/48/EC, or risk-weighted at 1,250 % as set out in Part 4 of Annex IX to that Directive, these positions shall be subject to a capital charge that is no less than set forth under that treatment. Institutions that are dealers in these exposures may apply a different treatment where they can demonstrate to their competent authorities, in addition to trading intent, that a liquid two-way market exists for the securitisation exposures or, in the case of synthetic securitisations that rely solely on credit derivatives, for the securitisation exposures themselves or all their constituent risk components. For the purposes of this section a two-way market is deemed to exist where there are independent good faith offers to buy and sell so that a price reasonably related to the last sales price or current good faith competitive bid and offer quotations can be determined within one day and settled at such a price within a relatively short time conforming to trade custom. For an institution to apply a different treatment, it shall have sufficient market data to ensure that it fully captures the concentrated default risk of these exposures in its internal approach for measuring the incremental default risk in accordance with the standards set out above.