General
1. When assessing whether an institution is able to develop and validate the internal model for equity exposures and to assign each exposure to the range of application of an internal models approach for equity exposures as required by points (f) and (h) of Article 144(1) and Articles 186, 187 and 188 of Regulation (EU) No 575/2013, competent authorities shall evaluate all of the following:
(a)
the adequacy of the data used, in accordance with Article 77;
(b)
the adequacy of the models, in accordance with Article 78;
(c)
the comprehensiveness of the stress-testing programme, in accordance with Article 79;
(d)
the integrity of the model and modelling process, in accordance with Article 80;
(e)
the adequacy of the assignment of exposures to the internal models approach, in accordance with Article 81;
(f)
the adequacy of the validation function, in accordance with Article 82.
2. For the purposes of the evaluation under paragraph 1, competent authorities shall apply all of the following methods:
(a)
review the institution’s relevant internal policies and procedures;
(b)
review the institution’s technical documentation on the methodology and process of the development of the internal model for equity exposures;
(c)
review and challenge the relevant development manuals, methodologies and processes;
(d)
review the roles and responsibilities of the different units and internal bodies involved in the design, validation and application of the internal model for equity exposures;
(e)
review the relevant minutes of the institution’s internal bodies, including the management body, or committees;
(f)
review the relevant reports on the performance of the internal models for equity exposures and the recommendations by the credit risk control unit, validation function, internal audit function or any other control function of the institution;
(g)
review the relevant progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during monitoring, validations and audits;
(h)
obtain written statements from or interview the relevant staff and senior management of the institution.
3. For the purposes of the evaluation under paragraph 1, competent authorities may also apply any of the following additional methods:
(a)
request and analyse data used in the process of development of internal models for equity exposures;
(b)
conduct their own or replicate the institution’s Value at Risk estimations using relevant data supplied by the institution;
(c)
request the provision of additional documentation or analysis substantiating the methodological choices and the results obtained;
(d)
review the functional documentation of the IT systems used for the value at risk calculation;
(e)
review other relevant documents of the institution.
Adequacy of the data
When assessing the adequacy of the data used to represent the actual return distributions on equity exposures in accordance with Article 186 of Regulation (EU) No 575/2013, competent authorities shall verify that:
(a)
the data represents the risk profile of the institution’s specific equity exposures;
(b)
the data is sufficient to provide statistically reliable loss estimates, or it has been adequately adjusted in order to attain model outputs that achieve appropriate realism and conservatism;
(c)
the data used comes from external sources or, where internal data is used, it is independently reviewed by a relevant control function of the institution;
(d)
the data reflects the longest available period in order to provide a conservative estimate of potential losses over a relevant long-term or business cycle, and in particular that it includes the period of significant financial stress relevant to the institution’s portfolio;
(e)
where converted-quarterly data from a shorter horizon is used, that the conversion procedure is supported by empirical evidence through a well-developed and documented approach and applied conservatively and consistently over time;
(f)
the longest time horizon is chosen which allows the estimation of the 99 percentile with non-overlapping observations.
Adequacy of the models
When assessing the adequacy of the models used to estimate the equity return distributions for the calculation of own funds requirements in accordance with Article 186 of Regulation (EU) No 575/2013, competent authorities shall verify that:
(a)
the model is appropriate for the risk profile and complexity of an institution's equity portfolio, and that where the institution has material holdings with values that are highly non-linear in nature, the model accounts for that in an appropriate manner;
(b)
the mapping of individual positions to proxies, market indices and risk factors is plausible, intuitive and conceptually sound;
(c)
the selected risk factors are appropriate and effectively cover both general and specific risk;
(d)
the model adequately explains the historical price variation;
(e)
the model captures both the magnitude of potential concentrations and changes in their composition.
Comprehensiveness of the stress-testing programme
1. When assessing the comprehensiveness of the stress-testing programme required under Article 186(g) of Regulation (EU) No 575/2013, competent authorities shall verify that the institution is able to provide loss estimates under alternative adverse scenarios and that those scenarios are different from the ones used by the internal model but still likely to occur.
2. For the purpose of the assessment under paragraph 1, competent authorities shall verify that:
(a)
the alternative adverse scenarios are relevant to the specific holdings of the institution, reflect significant losses to the institution and capture effects which are not reflected in the outcomes of the model;
(b)
the outcomes of the model under the alternative adverse scenarios are used in the actual risk management for the equity portfolio and are periodically reported to senior management;
(c)
the alternative adverse scenarios are periodically reviewed and updated.
Integrity of the model and modelling process
1. When assessing the integrity of the models and modelling process required under Article 187 of Regulation (EU) No 575/2013, competent authorities shall verify that:
(a)
the internal model is fully integrated into the management of the non-trading book equity portfolio, the overall management information systems of the institution and the institution's risk management infrastructure and is used to monitor the investment limits and the risk of equity exposures;
(b)
the modelling unit is competent and independent from the unit responsible for managing the individual investments.
2. For the purpose of the assessment under paragraph 1(a), competent authorities shall verify that:
(a)
the institution’s management body and senior management are actively involved in the risk control process in the sense that they have, endorsed a set of investment limits based, among other factors, on the internal model’s results;
(b)
the reports produced by the risk control unit are reviewed by persons at a level of management with sufficient authority to enforce reductions of positions as well as reduction in the institution’s overall risk exposure;
(c)
action plans are in place for market crisis situations affecting activities within the model’s scope, describing the events that trigger them and the planned actions.
3. For the purpose of the assessment under paragraph 1(b), competent authorities shall verify that:
(a)
the staff and the senior management responsible for the modelling unit do not perform tasks relating to managing the individual investments;
(b)
the senior managers of modelling units and of units responsible for managing the individual investments have different reporting lines at the level of the management body of the institution or the committee designated by it;
(c)
the remuneration of the staff and of the senior management responsible for the modelling unit is not linked to the performance of the tasks relating to managing the individual investments.
Adequacy of assignment of exposures to the internal models approach
When assessing the adequacy of the assignment of each exposure in the range of application of an approach for equity exposures to the internal models approach in accordance with Article 144(1)(h) of Regulation (EU) No 575/2013, competent authorities shall evaluate the definitions, processes and criteria for assigning or reviewing the assignment.
Adequacy of the validation function
When assessing the adequacy of the validation function with regard to the requirements laid down in point (f) of Article 144(1) and Article 188 of Regulation (EU) No 575/2013, competent authorities shall apply Articles 10 to 13 and shall verify that:
(a)
the institution compares the first percentile of the actual equity returns with the modelled estimates at least on a quarterly basis;
(b)
the comparison referred to in point (a) makes use of an observation period equal at least to one year and of a time horizon that allows the computation of the first percentile based on non-overlapping observations;
(c)
where the percentage of observations below the estimated first percentile of equity returns is above 1 %, this is adequately justified and relevant remedial actions are taken by the institution.
Source: EUR-Lex (Publications Office of the EU), © European Union, reuse permitted under Commission Decision 2011/833/EU.
