(a) General requirement. A Board-regulated institution that measures
the specific risk of a portfolio of debt positions under section 217.207(b)
using internal models must calculate at least weekly an incremental
risk measure for that portfolio according to the requirements in this
section. The incremental risk measure is the Board-regulated institution’s
measure of potential losses due to incremental 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. With the prior approval of the Board, a Board-regulated
institution may choose to include portfolios of equity positions in
its incremental risk model, provided that it consistently includes
such equity positions in a manner that is consistent with how the
Board-regulated institution internally measures and manages the incremental
risk of such positions at the portfolio level. If equity positions
are included in the model, for modeling purposes default is considered
to have occurred upon the default of any debt of the issuer of the
equity position. A Board-regulated institution may not include correlation
trading positions or securitization positions in its incremental risk
measure.
(b) Requirements
for incremental risk modeling. For purposes of calculating the
incremental risk measure, the incremental risk model must:
(1) Measure incremental risk over a one-year
time horizon and 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.
(i) A constant level of risk assumption
means that the Board-regulated institution rebalances, or rolls over,
its trading positions at the beginning of each liquidity horizon
over the one-year horizon in a manner that maintains the Board-regulated
institution’s initial risk level. The Board-regulated institution
must determine the frequency of rebalancing in a manner consistent
with the liquidity horizons of the positions in the portfolio. The
liquidity horizon of a position or set of positions is the time required
for a Board-regulated institution to reduce its exposure to, or hedge
all of its material risks of, the position(s) in a stressed market.
The liquidity horizon for a position or set of positions may not be
less than the shorter of three months or the contractual maturity
of the position.
(ii) A constant position assumption
means that the Board-regulated institution maintains the same set
of positions throughout the one-year horizon. If a Board-regulated
institution uses this assumption, it must do so consistently across
all portfolios.
(iii) A Board-regulated institution’s selection of a constant position
or a constant risk assumption must be consistent between the Board-regulated
institution’s incremental risk model and its comprehensive risk model
described in section 209 of this subpart, if applicable.
(iv) A Board-regulated institution’s
treatment of liquidity horizons must be consistent between the Board-regulated
institution’s incremental risk model and its comprehensive risk model
described in section 209, if applicable.
(2) Recognize the impact of correlations
between default and migration events among obligors.
(3) Reflect the effect of issuer and market
concentrations, as well as concentrations that can arise within and
across product classes during stressed conditions.
(4) Reflect netting only of long and short
positions that reference the same financial instrument.
(5) Reflect any material mismatch
between a position and its hedge.
(6) Recognize the effect that liquidity
horizons have on dynamic hedging strategies. In such cases, a Board-regulated
institution must:
(i) Choose to model the rebalancing
of the hedge consistently over the relevant set of trading positions;
(ii) Demonstrate that
the inclusion of rebalancing results in a more appropriate risk measurement;
(iii) Demonstrate
that the market for the hedge is sufficiently liquid to permit rebalancing
during periods of stress; and
(iv) Capture in the incremental risk
model any residual risks arising from such hedging strategies.
(7) Reflect
the nonlinear impact of options and other positions with material
nonlinear behavior with respect to default and migration changes.
(8) Maintain consistency
with the Board-regulated institution’s internal risk management methodologies
for identifying, measuring, and managing risk.
(c) Calculation of incremental
risk capital requirement. The incremental risk capital requirement
is the greater of:
(1) The average of the incremental risk
measures over the previous 12 weeks; or
(2) The most recent incremental risk measure.
