| (12) | Counterparty credit risk: further operational requirements relating to internal controls and the integrity of the bank's modelling process |
As a minimum, a bank that wishes to adopt the internal model method for the measurement of the bank's exposure to counterparty credit risk—
| (a) | shall have in place a robust internal model that calculates, amongst other things, expected positive exposure or EPE— |
| (i) | which model shall reflect transaction terms and specifications in a timely, complete and conservative manner— |
| (A) | which terms may include— |
| (i) | the notional amounts of contracts; |
| (ii) | the maturity of transactions, contracts or agreements; |
| (iii) | any relevant reference asset; |
| (iv) | any collateral threshold amount; |
| (v) | any relevant margining arrangement or agreement; |
| (vi) | any relevant netting arrangement or agreement; |
| (B) | which terms and specifications shall reside in a secure database that is subject to formal and periodic audit; |
| (C) | the transmission of which transaction terms and specifications to the bank's internal model shall be subject to internal audit; |
| (ii) | which EPE model and any modifications made to the model shall be subject to a robust internal model validation process, which model validation process— |
| (A) | shall be duly articulated in the bank's policies and procedures; |
| (B) | shall specify the type of testing required in order to ensure model integrity; |
| (C) | shall identify conditions under which assumptions made may be violated, resulting in an understatement of EPE; |
| (D) | shall include a review of the comprehensiveness of the bank's EPE model, including whether or not the EPE model sufficiently covers all products that may have a material impact on the bank's exposure to counterparty risk; |
| (E) | shall comply with the additional requirements specified in subregulation (8)(e). |
| (i) | when the model that is used to calculate, among other things, Effective EPE is calibrated using historic market data, the bank uses current market data to calculate current exposures, and at least three years of historical data is used to estimate parameters of the model, provided that— |
| (A) | the bank may use market implied data to estimate parameters of the model; and |
| (B) | in all cases, relevant data shall be updated quarterly or more frequently if warranted by market conditions; |
| (ii) | when calculating the Effective EPE using a stress calibration, the bank also calibrates Effective EPE using— |
| (A) | three years of data that include a period of stress to the credit default spreads of the bank's counterparties; or |
| (B) | market implied data from a suitable period of stress, |
Provided that, in order to assess the adequacy and effectiveness of the aforesaid stress calibration,
| (i) | the bank shall demonstrate to the satisfaction of and in a manner and time interval determined in writing by the Registrar, which shall be no less frequently than quarterly, that the stress period coincides with a period of increased CDS or other credit spreads, such as loan or corporate bond spreads, for a representative selection of the bank's counterparties with traded credit spreads, provided that when the bank does not have adequate credit spread data for a counterparty, the bank shall map each relevant counterparty to specific credit spread data based on relevant region, internal rating and business types; |
| (ii) | the exposure model for all relevant counterparties shall use data, either historic or implied, that includes the data from the stressed credit period, and the bank shall use such data in a manner consistent with the method used for the calibration of the Effective EPE model for/ to current data; |
| (iii) | the bank shall create several benchmark portfolios that are vulnerable to the same main risk factors to which the bank is exposed, provided that the exposure to the said benchmark portfolios shall be calculated using— |
| (aa) | current positions at current market prices, stressed volatilities, stressed correlations and other relevant stressed exposure model inputs from the 3-year stress period; and |
| (bb) | current positions at end of stress period market prices, stressed volatilities, stressed correlations and other relevant stressed exposure model inputs from the 3-year stress period, |
| (iv) | the Registrar may request the bank to adjust the stress calibration if the exposures of the said benchmark portfolios deviate substantially; |
| (c) | shall have in place a robust process for the recognition of any netting arrangement or agreement, which netting arrangement or agreement— |
| (i) | shall be subject to signoff by legal staff of the bank in order to verify the legal enforceability of the relevant netting arrangement or agreement; |
| (ii) | shall be captured into the relevant database by an independent unit. |
| (d) | shall have in place a formal reconciliation process between the bank's internal model and its source data systems in order to verify on an ongoing basis that transaction terms and specifications are duly reflected in the bank's calculation of EPE. |
