PIB 5.11 PIB 5.11 Use of Internal Market Risk Models
PIB 5.11.1 PIB 5.11.1
Authorised Firmin Category1, 2 or 5 may use an internal model to calculate its Market Risk Capital Requirementor any components of its Market Risk Capital Requirementif its internal model and its use have been approved in writing by the DFSA.
PIB 5.11.1 Guidance
Guidancein respect of criteria for use of internally developed Market Riskmodels is provided in PIB section A5.9.
DFSAapproves the use of an internal model, it may:(a) impose, withdraw or amend at any time conditions in respect of the use of the internal model; and(b) withdraw approval if it forms the view that the internal model or its use is no longer suitable for the calculation of the Authorised Firm's Market Risk Capital Requirementor any component of it.
Authorised Firmwhich uses an internal model in accordance with PIB Rule 5.11.1 must have in place a rigorous and comprehensive stress-testing programme which meets the criteria set out in PIB Rule A5.9.4.
PIB 5.11.4 PIB 5.11.4
Authorised Firmthat has received approval for the use of an internal model may only revert to calculating its Market Risk Capital Requirementor any component of it in accordance with PIB App5 with the prior written consent of the DFSA.
PIB 5.11.4 Guidance1. This section sets out the conditions under which an
Authorised Firmis permitted to use an internal model to calculate its Market Risk Capital Requirementor any component of its Market Risk Capital Requirement. An Authorised Firmthat wishes to use an internal model to calculate any part of this requirement is required to apply to the DFSA. Internal models will commonly permit more extensive Nettingof long and short positions and have greater risk sensitivity.2. In assessing whether to give approval, the DFSAwill consider an Authorised Firm'srisk management standards; the quantitative model standards; the stress-testing and back-testing standards and the process surrounding the calculation of the appropriate regulatory Capital Requirement.3. The DFSAwill usually only give its approval for the use of an internal risk model if:a. the use of the model to calculate the Market Risk Capital Requirementhas been approved by another appropriate regulator or the DFSAis satisfied having been provided by the Authorised Firmwith such opinions from independent experts as it may require, that the model adequately addresses Market Riskrequirements;b. use of the methodology is integrated into the governance and control framework of the Authorised Firm. Specifically, the Governing Bodyand senior management of the Authorised Firmreceives and reviews appropriate reports in respect of the entity;c. it is satisfied that the Authorised Firm'srisk management system is conceptually sound and is implemented with integrity;d. the Authorised Firmhas sufficient numbers of staff skilled in the use of sophisticated models not only in the trading area but also in the risk control, audit, and if necessary, back office areas;e. the Authorised Firm'smodels have a proven track record of reasonable accuracy in measuring risk; andf. the Authorised Firmregularly conducts stress tests.4. In determining whether an internal value at risk (VaR) model meets the standard for approval, the DFSAwill apply the criteria set out in PIB section A5.9, which are based on the Basel Market RiskCapital Amendment 1996 and Basel Revisions to the Basel II Market Riskframework 2009 and which can be grouped under the following headings:a. qualitative standards;b. specification of Market Riskfactors;c. quantitative standards;d. adjustments to Market Risk Capital Requirements;e. stress testing; andf. combination of internally developed models and the Standardised Methodology.5. In addition to value-at-risk models, the DFSArecognises option risk aggregation models and interest rate 'pre-processing' or sensitivity models, as set out under the EU's Capital Adequacy Directive (these are the so-called 'CAD1 models').6. Option risk aggregation models analyse and aggregate options risks for interest rate, equity, foreign exchange and commodity options.7. Interest rate pre-processing models are used to calculate weighted positions for inclusion in an Authorised Firm'sinterest rate Market Risk Capital Requirementcalculation under the Duration Method.