Regulation (EU) No 575/2013 of the European Parliament and of the CouncilDangos y teitl llawn

[X1 [F1 Section 3 U.K. Internal default risk model

Article 325bl U.K. Scope of the internal default risk model

1. All the positions of an institution that have been assigned to the trading desks for which the institution has been granted permission as referred to in Article 325az(2) shall be subject to an own funds requirement for default risk where those positions contain at least one risk factor that has been mapped to the broad categories of ‘ equity ’ or ‘ credit spread ’ risk factors in accordance with Article 325bd(1). That own funds requirement, which is incremental to the risks captured by the own funds requirements referred to in Article 325ba(1), shall be calculated using the institution's internal default risk model. That model which shall comply with the requirements laid down in this Section.

2. For each of the positions referred to in paragraph 1, an institution shall identify one issuer of traded debt or equity instruments related to at least one risk factor.

Article 325bm U.K. Permission to use an internal default risk model

1. Competent authorities shall grant an institution permission to use an internal default risk model to calculate the own funds requirements referred to in Article 325ba(2) for all the trading book positions referred to in Article 325bl that are assigned to a trading desk for which the internal default risk model complies with the requirements set out in Articles 325bi, 325bj, 325bn, 325bo and 325bp.

2. Where the trading desk of an institution, to which at least one of the trading book positions referred to in Article 325bl has been assigned, does not meet the requirements set out in paragraph 1 of this Article, the own funds requirements for market risk of all positions in that trading desk shall be calculated in accordance with the approach set out in Chapter 1a.

Article 325bn U.K. Own funds requirements for default risk using an internal default risk model

1. Institutions shall calculate the own funds requirements for default risk using an internal default risk model for the portfolio of all trading book positions as referred to in Article 325bl as follows:

(a) the own funds requirements shall be equal to a value-at-risk number measuring potential losses in the market value of the portfolio caused by the default of issuers related to those positions at the 99,9 % confidence interval over a one-year time horizon;

(b) the potential loss referred to in point (a) means a direct or indirect loss in the market value of a position which was caused by the default of the issuers and which is incremental to any losses already taken into account in the current valuation of the position; the default of the issuers of equity positions shall be represented by the value for the issuers' equity prices being set to zero;

(c) institutions shall determine default correlations between different issuers on the basis of a conceptually sound methodology, using objective historical data on market credit spreads or equity prices that cover at least a 10 year period that includes the stress period identified by the institution in accordance with Article 325bc(2); the calculation of default correlations between different issuers shall be calibrated to a one-year time horizon;

(d) the internal default risk model shall be based on a one-year constant position assumption.

2. Institutions shall calculate the own funds requirement for default risk using an internal default risk model as referred to in paragraph 1 on at least a weekly basis.

3. By way of derogation from points (a) and (c) of paragraph 1, an institution may replace the one-year time horizon with a time horizon of sixty days for the purpose of calculating the default risk of some or all of the equity positions, where appropriate. In such case, the calculation of default correlations between equity prices and default probabilities shall be consistent with a time horizon of sixty days and the calculation of default correlations between equity prices and bond prices shall be consistent with a one-year time horizon.

Article 325bo U.K. Recognition of hedges in an internal default risk model

1. Institutions may incorporate hedges in their internal default risk model and may net positions where the long positions and short positions relate to the same financial instrument.

2. In their internal default risk models, institutions may only recognise 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 by explicitly modelling the gross long and short positions in the different instruments, including modelling of basis risks between different issuers.

3. In their internal default risk models, institutions shall capture material risks between a hedging instrument and the hedged instrument that could occur during the interval between the maturity of a hedging instrument and the one-year time horizon, as well as the potential for significant basis risks in hedging strategies that arise from differences in the type of product, seniority in the capital structure, internal or external ratings, maturity, vintage and other differences. Institutions shall recognise a hedging instrument only to the extent that it can be maintained even as the obligor approaches a credit event or other event.

Article 325bp U.K. Particular requirements for an internal default risk model

1. The internal default risk model referred to in Article 325bm(1) shall be capable of modelling the default of individual issuers as well as the simultaneous default of multiple issuers, and shall take into account the impact of those defaults in the market values of the positions that are included in the scope of that model. For that purpose, the default of each individual issuer shall be modelled using two types of systematic risk factors.

2. The internal default risk model shall reflect the economic cycle, including the dependency between recovery rates and the systematic risk factors referred to in paragraph 1.

3. The internal default risk model shall reflect the nonlinear impact of options and other positions with material nonlinear behaviour with respect to price changes. Institutions shall also have due regard to the amount of model risk inherent in the valuation and estimation of price risks associated with those products.

4. The internal default risk model shall be based on data that are objective and up-to-date.

5. To simulate the default of issuers in the internal default risk model, the institution's estimates of default probabilities shall meet the following requirements:

(a) the default probabilities shall be floored at 0,03 %;

(b) the default probabilities shall be based on a one-year time horizon, unless stated otherwise in this Section;

(c) the default probabilities shall be measured using, solely or in combination with current market prices, data observed during a historical period of at least five years of actual past defaults and extreme declines in market prices equivalent to default events; default probabilities shall not be inferred solely from current market prices;

(d) an institution that has been granted permission to estimate default probabilities in accordance with Section 1 of Chapter 3 of Title II shall use the methodology set out therein to calculate default probabilities;

(e) an institution that has not been granted permission to estimate default probabilities in accordance with Section 1 of Chapter 3 of Title II shall develop an internal methodology or use external sources to estimate default probabilities; in both situations, the estimates of default probabilities shall be consistent with the requirements set out in this Article.

6. To simulate the default of issuers in the internal default risk model, the institution's estimates of loss given default shall meet the following requirements:

(a) the loss given default estimates are floored at 0 %;

(b) the loss given default estimates shall reflect the seniority of each position;

(c) an institution that has been granted permission to estimate loss given default in accordance with Section 1 of Chapter 3 of Title II shall use the methodology set out therein to calculate loss given default estimates;

(d) an institution that has not been granted permission to estimate loss given default in accordance with Section 1 of Chapter 3 of Title II shall develop an internal methodology or use external sources to estimate loss given default; in both situations, the estimates of loss given default shall be consistent with the requirements set out in this Article.

7. As part of the independent review and validation of the internal models that they use for the purposes of this Chapter, including for the risk-measurement system, institutions shall:

(a) verify that their approach for the modelling of correlations and price changes is appropriate for their portfolio, including the choice and weights of the systematic risk factors in the model;

(b) perform a variety of stress tests, including sensitivity analyses and scenario analyses, to assess the qualitative and quantitative reasonableness of the internal default risk model, in particular with regard to the treatment of concentrations; and

(c) apply appropriate quantitative validation including relevant internal modelling benchmarks.

The tests referred to in point (b) shall not be limited to the range of past events experienced.

8. The internal default risk model shall appropriately reflect issuer concentrations and concentrations that can arise within and across product classes under stressed conditions.

9. The internal default risk model shall be consistent with the institution's internal risk management methodologies for identifying, measuring, and managing trading risks.

10. Institutions shall have clearly defined policies and procedures for determining the default assumptions for correlations between different issuers in accordance with point (c) of Article 325bn(1) and the preferred choice of method for estimating the default probabilities in point (e) of paragraph 5 of this Article and the loss given default in point (d) of paragraph 6 of this Article.

11. Institutions shall document their internal models so that their correlation assumptions and other modelling assumptions are transparent to the competent authorities.

12. EBA shall develop draft regulatory technical standards to specify the requirements that an institution's internal methodology or external sources are to fulfil for estimating default probabilities and losses given default in accordance with point (e) of paragraph 5 and point (d) of paragraph 6.

EBA shall submit those draft regulatory technical standards to the Commission by 28 September 2020 .

Power is delegated to the Commission to supplement this Regulation by adopting the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.] ]

Editorial Information

X1 Substituted by Corrigendum to Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (OJ L 176, 27.6.2013, p. 1).

Textual Amendments

F1 Inserted by Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012 (Text with EEA relevance).