(a) General requirement. A Board-regulated institution must use
one or more internal models to calculate daily a VaR-based measure
of the general market risk of all covered positions. The daily VaR-based
measure also may reflect the Board-regulated institution’s specific
risk for one or more portfolios of debt and equity positions, if the
internal models meet the requirements of paragraph (b)(1) of section
217.207. The daily VaR-based measure must also reflect the Board-regulated
institution’s specific risk for any portfolio of correlation trading
positions that is modeled under section 217.209. A Board-regulated
institution may elect to include term repo-style transactions in its
VaR-based measure, provided that the Board-regulated institution includes
all such term repo-style transactions consistently over time.
(1) The Board-regulated institution’s internal
models for calculating its VaR-based measure must use risk factors
sufficient to measure the market risk inherent in all covered positions.
The market risk categories must include, as appropriate, interest
rate risk, credit spread risk, equity price risk, foreign exchange
risk, and commodity price risk. For material positions in the major
currencies and markets, modeling techniques must incorporate enough
segments of the yield curve—in no case less than six—to capture differences
in volatility and less than perfect correlation of rates along the
yield curve.
(2) The VaR-based
measure may incorporate empirical correlations within and across risk
categories, provided the Board-regulated institution validates and
demonstrates the reasonableness of its process for measuring correlations.
If the VaR-based measure does not incorporate empirical correlations
across risk categories, the Board-regulated institution must add the
separate measures from its internal models used to calculate the VaR-based
measure for the appropriate market risk categories (interest rate
risk, credit spread risk, equity price risk, foreign exchange rate
risk, and/or commodity price risk) to determine its aggregate VaR-based
measure.
(3) The VaR-based
measure must include the risks arising from the nonlinear price characteristics
of options positions or positions with embedded optionality and the
sensitivity of the fair value of the positions to changes in the volatility
of the underlying rates, prices, or other material risk factors. A
Board-regulated institution with a large or complex options portfolio
must measure the volatility of options positions or positions with
embedded optionality by different maturities and/or strike prices,
where material.
(4)
The Board-regulated institution must be able to justify to the satisfaction
of the Board the omission of any risk factors from the calculation
of its VaR-based measure that the Board-regulated institution uses
in its pricing models.
(5) The Board-regulated institution must demonstrate to the satisfaction
of the Board the appropriateness of any proxies used to capture the
risks of the Board-regulated institution’s actual positions for which
such proxies are used.
(b) Quantitative requirements for VaR-based measure.
(1) The VaR-based measure must
be calculated on a daily basis using a one-tail, 99.0 percent confidence
level, and a holding period equivalent to a 10-business-day movement
in underlying risk factors, such as rates, spreads, and prices. To
calculate VaR-based measures using a 10-business-day holding period,
the Board-regulated institution may calculate 10-business-day measures
directly or may convert VaR-based measures using holding periods other
than 10 business days to the equivalent of a 10-business-day holding
period. A Board-regulated institution that converts its VaR-based
measure in such a manner must be able to justify the reasonableness
of its approach to the satisfaction of the Board.
(2) The VaR-based measure must be based
on a historical observation period of at least one year. Data used
to determine the VaR-based measure must be relevant to the Board-regulated
institution’s actual exposures and of sufficient quality to support
the calculation of risk-based capital requirements. The Board-regulated
institution must update data sets at least monthly or more frequently
as changes in market conditions or portfolio composition warrant.
For a Board-regulated institution that uses a weighting scheme or
other method for the historical observation period, the Board-regulated
institution must either:
(i) Use an effective observation period
of at least one year in which the average time lag of the observations
is at least six months; or
(ii) Demonstrate to the Board that its
weighting scheme is more effective than a weighting scheme with an
average time lag of at least six months representing the volatility
of the Board-regulated institution’s trading portfolio over a full
business cycle. A Board-regulated institution using this option must
update its data more frequently than monthly and in a manner appropriate
for the type of weighting scheme.
(c) A Board-regulated institution must divide its
portfolio into a number of significant subportfolios approved by the
Board for subportfolio backtesting purposes. These subportfolios must
be sufficient to allow the Board-regulated institution and the Board
to assess the adequacy of the VaR model at the risk factor level;
the Board will evaluate the appropriateness of these subportfolios
relative to the value and composition of the Board-regulated institution’s
covered positions. The Board-regulated institution must retain and
make available to the Board the following information for each subportfolio
for each business day over the previous two years (500 business days),
with no more than a 60-day lag:
(1) A daily VaR-based measure for the subportfolio
calibrated to a one-tail, 99.0 percent confidence level;
(2) The daily profit or loss
for the subportfolio (that is, the net change in price of the positions
held in the portfolio at the end of the previous business day); and
(3) The p-value of the
profit or loss on each day (that is, the probability of observing
a profit that is less than, or a loss that is greater than, the amount
reported for purposes of paragraph (c)(2) of this section based on
the model used to calculate the VaR-based measure described in paragraph
(c)(1) of this section).
