(a) General requirement.
(1) Subject to the prior approval of the
Board, a Board-regulated institution may use the method in this section
to measure comprehensive risk, that is, all price risk, for one or
more portfolios of correlation trading positions.
(2) A Board-regulated institution that
measures the price risk of a portfolio of correlation trading positions
using internal models must calculate at least weekly a comprehensive
risk measure that captures all price risk according to the requirements
of this section. The comprehensive risk measure is either:
(i) The
sum of:
(A) The Board-regulated institution’s modeled
measure of all price risk determined according to the requirements
in paragraph (b) of this section; and
(B) A surcharge for the Board-regulated institution’s
modeled correlation trading positions equal to the total specific
risk add-on for such positions as calculated under section 210 of
this subpart multiplied by 8.0 percent; or
(ii) With approval of the
Board and provided the Board-regulated institution has met the requirements
of this section for a period of at least one year and can demonstrate
the effectiveness of the model through the results of ongoing model
validation efforts including robust benchmarking, the greater of:
(A) The Board-regulated institution’s modeled measure of all price
risk determined according to the requirements in paragraph (b) of
this section; or
(B) The
total specific risk add-on that would apply to the bank’s modeled
correlation trading positions as calculated under section 210 of this
subpart multiplied by 8.0 percent.
(b) Requirements
for modeling all price risk. If a Board-regulated institution
uses an internal model to measure the price risk of a portfolio of
correlation trading positions:
(1) The internal model must measure comprehensive
risk over a one-year time horizon at a one-tail, 99.9 percent confidence
level, either under the assumption of a constant level of risk, or
under the assumption of constant positions.
(2) The model must capture all material
price risk, including but not limited to the following:
(i) The
risks associated with the contractual structure of cash flows of the
position, its issuer, and its underlying exposures;
(ii) Credit spread risk, including nonlinear
price risks;
(iii)
The volatility of implied correlations, including nonlinear price
risks such as the cross-effect between spreads and correlations;
(iv) Basis risk;
(v) Recovery rate
volatility as it relates to the propensity for recovery rates to affect
tranche prices; and
(vi) To the extent the comprehensive risk measure incorporates the
benefits of dynamic hedging, the static nature of the hedge over the
liquidity horizon must be recognized. In such cases, a Board-regulated
institution must:
(A) Choose to model the rebalancing of the
hedge consistently over the relevant set of trading positions;
(B) Demonstrate that the
inclusion of rebalancing results in a more appropriate risk measurement;
(C) Demonstrate that the
market for the hedge is sufficiently liquid to permit rebalancing
during periods of stress; and
(D) Capture in the comprehensive risk model
any residual risks arising from such hedging strategies;
(3) The Board-regulated
institution must use market data that are relevant in representing
the risk profile of the Board-regulated institution’s correlation
trading positions in order to ensure that the Board-regulated institution
fully captures the material risks of the correlation trading positions
in its comprehensive risk measure in accordance with this section;
and
(4) The Board-regulated
institution must be able to demonstrate that its model is an appropriate
representation of comprehensive risk in light of the historical price
variation of its correlation trading positions.
(c) Requirements for stress
testing.
(1) A Board-regulated institution must
at least weekly apply specific, supervisory stress scenarios to its
portfolio of correlation trading positions that capture changes in:
(i) Default rates;
(ii) Recovery rates;
(iii) Credit spreads;
(iv) Correlations of underlying exposures; and
(v) Correlations of a correlation trading
position and its hedge.
(2) Other requirements.
(i) A Board-regulated institution must
retain and make available to the Board the results of the supervisory
stress testing, including comparisons with the capital requirements
generated by the Board-regulated institution’s comprehensive risk
model.
(ii) A Board-regulated
institution must report to the Board promptly any instances where
the stress tests indicate any material deficiencies in the comprehensive
risk model.
(d) Calculation of comprehensive risk capital requirement. The comprehensive risk capital requirement is the greater of:
(1) The average of the comprehensive
risk measures over the previous 12 weeks; or
(2) The most recent comprehensive risk
measure.
