Commission Delegated Regulation (EU) 2024/1085 of 13 March 2024 supplementing Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to regulatory technical standards on the assessment methodology under which competent authorities verify an institution’s compliance with the requirements to use internal models for market risk

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	2024/1085	17.6.2024

THE EUROPEAN COMMISSION,

Having regard to the Treaty on the Functioning of the European Union,

Having regard to Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and amending Regulation (EU) No 648/2012 [^ntr1-L_202401085EN.000101-E0001], and in particular Article 325az(8), first subparagraph, point (b), and third subparagraph, thereof,

Whereas:

• (1) Institutions are only allowed to use internal models for market risk if they comply with the requirements laid down in Regulation (EU) No 575/2013. Institutions should not only comply with those requirements when they apply for permission to use those internal models, but also when they use those models, and when they apply for material extensions or changes to such internal models. It is therefore appropriate to lay down that competent authorities, when they verify whether institutions comply with those requirements, apply the same criteria and the same assessment methodology to each of those phases. However, for reasons of efficiency and to reduce administrative burdens, competent authorities, when assessing compliance by institutions that have already been granted permission to use such alternative internal models, should not be required to reassess such permission. They should rather only assess compliance with those rules that are relevant to the scope of the assessment concerned, and build, in each case, on the conclusions from previous assessments.

• (2) To ensure that institutions comply on a continuous basis with the requirements laid down in Regulation (EU) No 575/2013, competent authorities should evaluate the overall quality of the solutions, systems and approaches implemented by an institution, and request constant improvements and adaptations to changed circumstances.

• (3) To ensure harmonisation and comparability of supervisory practices across different jurisdictions, competent authorities’ assessment of whether institutions comply with the requirements laid down in Regulation (EU) No 575/2013 should comply with prescriptive assessment techniques. Competent authorities should, however, be able to take into account the nature, size and complexity of an institution’s structure and business model, the complexity of the alternative internal models, the nature of the financial products those models cover, the quality of information provided by the institution concerned, and the resources they have at their disposal. Competent authorities should therefore, when they assess whether an institution complies with the requirements laid down in Regulation (EU) No 575/2013, be granted a certain discretion, enabling them to carry out additional checks and to apply the most appropriate methods for verifying compliance with particular requirements. In addition, to enable competent authorities to conduct that assessment in a proportionate manner, and given the broad range of financial products available in trading activities, it is necessary to lay down categories of financial products of increasing level of complexity, on which competent authorities should base their assessment.

• (4) To ensure sufficient in-house understanding of the alternative internal model, including outsourced operations, it is necessary to lay down that, despite any outsourcing of some risk tools, IT systems, and risk management solutions, all key tasks, activities or functions related to the internal model are to be conducted by the risk control unit referred to in Article 325bi(1), point (b), of Regulation (EU) No 575/2013. For the same reasons, those rules should also require that the risk control unit implements adequate controls and performs quality and validation tests for any outsourced solution, that full documentation on those controls and test is available in all cases, and that competent authorities assess any tools and IT solutions obtained from third party vendors in a manner similar to cases where they have been fully developed via internal processes.

• (5) Governance and operational aspects play a central role in the proper functioning of the alternative internal model. The methodology to verify whether an institution complies with the requirements laid down in Regulation (EU) No 575/2013 (‘assessment methodology’) should therefore comprehensively assess those governance and operational aspects, including the trading desk set-up, the role of the senior management and the management body, the risk-control unit, and the independent review of the alternative internal model itself.

• (6) The assessment methodology relating to governance aspects should take into account that certain institutions that ask for permission to use the alternative internal model approach already obtained approval, before Regulation (EU) No 575/2013 was amended by Regulation (EU) 2019/876 of the European Parliament and of the Council [^ntr2-L_202401085EN.000101-E0002], to use an internal model to calculate the own funds requirements for market risk. It is therefore necessary to lay down assessment rules that are similar to those laid down in the past for those aspects that were not amended by Regulation (EU) 2019/876, and to introduce new rules that cover new provisions introduced by that Regulation, including the trading desk requirements laid down in Article 104b of Regulation (EU) No 575/2013.

• (7) To enable competent authorities to assess compliance with the requirements for the validation and review of alternative internal models, institutions should perform the internal validation of the model at least annually. While initial validation should cover all methodologies applied throughout the internal model, it is appropriate to lay down, in consideration of staff and resources constraints, that the annual validation focuses on at least the main issues detected either in previous internal validations or previous internal audit reviews, and on any changes or new methodologies introduced in the alternative internal model.

• (8) Trading activities and financial markets are evolving constantly and rapidly. To enable competent authorities to take those characteristics into account when assessing whether institutions comply with the requirements laid down in Regulation (EU) No 575/2013, the assessment methodology should contain qualitative and procedural standards with regard to the formal approval by the institution of new financial instruments and products, and their introduction in the trading area. Standards for a formal new product approval policy are necessary to ensure that the introduction of new financial instruments and products, which may pose additional risk factors or require methodological changes to the internal risk measurement models, is fully compatible with the comprehensive control and validation.

• (9) The quality of data and the accuracy of risk estimation and of calculation of own funds requirements for market risk are highly dependent on the reliability of the IT systems used for that purpose. Equally, the continuity and consistency of the risk management processes and the calculation of own funds requirements for market risk can only be ensured where such IT systems are safe, secure, and reliable, and where the IT infrastructure is sufficiently robust. It is therefore necessary that, when assessing the market risk internal models, competent authorities also check the reliability of the institution’s IT systems and the robustness of the IT infrastructure used for the internal models.

• (10) One of the novelties of the new market risk framework laid down in Part Three, Title IV, Chapter 1b, of Regulation (EU) No 575/2013 is the determination of own funds requirements on the basis of expected shortfall measures. It is necessary to ensure that institutions actively monitor the accuracy of those figures. It is therefore appropriate to require institutions to directly back-test their expected shortfall measures as part of the internal back-testing programme required by Article 325bj of Regulation (EU) No 575/2013. As there is not yet an established methodology among market participants for back-testing an expected shortfall measure, no specific methodology should be prescribed, and institutions should be left free to take into account the evolution of new techniques and best practices in that regard, in line with the qualitative requirements set out in Article 325bi of that Regulation.

• (11) Internal-risk measurement models can only considered to be implemented with integrity, as referred to in Article 325bi(1) of Regulation (EU) No 575/2013, where all regulatory requirements are met. In addition, several building blocks of the Basel reforms in the area of market risk have been implemented in Union law by means of delegated acts, inter alia, Commission Delegated Regulation (EU) 2022/2058 [^ntr3-L_202401085EN.000101-E0003], Commission Delegated Regulation (EU) 2022/2059 [^ntr4-L_202401085EN.000101-E0004], Commission Delegated Regulation (EU) 2022/2060 [^ntr5-L_202401085EN.000101-E0005], Commission Delegated Regulation (EU) 2023/1577 [^ntr6-L_202401085EN.000101-E0006], Commission Delegated Regulation (EU) 2023/1578 [^ntr7-L_202401085EN.000101-E0007] and Commission Delegated Regulation (EU) 2024/397 [^ntr8-L_202401085EN.000101-E0008]. It follows that competent authorities should consider whether institutions comply with the requirements laid down Regulation (EU) No 575/2013, taking into account those delegated acts. To ensure a comprehensive assessment of compliance of market risk internal models, it is necessary to specify techniques for competent authorities to assess institutions’ compliance with aspects covered both by the Regulation (EU) No 575/2013 and by those delegated regulations. For that reason, competent authorities should examine specific documentation that institutions are required to produce.

• (12) The back-testing and the profit and loss attribution requirements provide a solid basis for a critical monitoring of the performance of the internal-risk measurement model. It is therefore necessary to lay down assessment rules to consider the results of those tests. In relation to back-testing, it should be ensured that overshootings are critically analysed to identify potential weaknesses in the model, and that institutions monitor whether the changes in the portfolios’ values are driven by modellable or by non-modellable risk factors. Furthermore, in light of the profit and loss attribution test results, competent authorities should assess the accuracy of the pricing functions employed by the institution, as their accuracy is essential for a sound calculation of the own funds requirements.

• (13) In order to ensure the consistent application of the requirements laid down in Article 325bh of Regulation (EU) No 575/2013, it is necessary to further specify those requirements. Whether institutions comply with those requirements should be assessed on the basis of the broad risk factor categories referred to in Table 2 of Article 325bd of Regulation (EU) No 575/2013. It is therefore necessary, for each of those categories, to lay down how competent authorities are to assess whether basis risk is captured, and whether the treatment of curves and surfaces in the internal risk-measurement model is sound.

• (14) Due to the fast changing and evolving nature of financial markets, unreliable, inaccurate, incomplete, or outdated data result in errors in the risk estimation and in the calculation of own funds requirements, including in market risk models. In the context of risk management processes of an institution, such erroneous data may also lead to poor management decisions. Consequently, to ensure the reliability and high quality of data and their proper use in the internal processes and the processes for the calculation of own funds requirements, the way data are collected and stored and the procedures for such collecting and storing should be well documented, including a full description of the characteristics, quality checks, automatic filters, and specific sources of daily data. Competent authorities, when they assess market risk internal models, should therefore give particular attention to the quality and reliability of the data used for modelling purposes, and to the processes applied to ensure that such quality and reliability are maintained.

• (15) To ensure a correct calculation of the own funds requirements, competent authorities, when they assess the overall quality of the data, should assess whether the approach employed by the institution to proxy time series is sound. The assessment methodology should therefore verify that the requirements set out in Regulation (EU) No 575/2013 governing the usage of proxies are complied with. Where relevant, the rules laid down in that assessment methodology should differ depending on whether the time series for which a proxy has been used relates to a risk factor that passed the modellability assessment, or to a risk factor that did not.

• (16) In relation to the internal default risk model, and more in particular Articles 325bn, 325bo, 325bp of Regulation (EU) No 575/2013, it is necessary that the assessment methodology ensures that those risk models lead to accurate results. The rules laid down in the assessment methodology should therefore cover all aspects affecting the outcome of those models, including the scope of the positions captured by those models, the estimates of default probabilities and losses given default, the choice of systematic risk factors to simulate the default of issuers, and all modelling assumptions made by the institution, including any copula assumption made for simulating the default of multiple issuers.

• (17) Risks stemming from climate change and broader environmental issues are changing the risk picture for the financial sector and are expected to become even more prominent. Considering the importance of those risk drivers, competent authorities should verify that institutions consider those risk drivers in their stress testing programmes referred to in Article 325bi(1), point (g), Regulation (EU) No 575/2013. In that context, institutions have already taken steps to include environmental risks in their stress testing programmes. However, to ensure that institutions have sufficient time to fully reflect those risks in their stress testing programmes, competent authorities should assess compliance of institutions with any requirements related to climate change and broader environmental related aspects only as of 1 January 2025. Similarly, in light of the complexity of the implementation of the expected shortfall direct backtesting, institutions should be given an additional period before competent authorities assess their compliance in this area. Hence, the related date of application of the assessment should be set to start as of 1 January 2026.

• (18) This Regulation is based on the draft regulatory technical standards submitted to the Commission by the European Banking Authority.

• (19) The European Banking Authority has conducted open public consultations on the draft regulatory technical standards on which this Regulation is based, analysed the potential related costs and benefits and requested the advice of the Banking Stakeholder Group established in accordance with Article 37 of Regulation (EU) No 1093/2010 of the European Parliament and of the Council [^ntr9-L_202401085EN.000101-E0009],

HAS ADOPTED THIS REGULATION:

CHAPTER 1 GENERAL PROVISIONS

Article 1

Structure of the assessment

• (a) the governance aspects, in accordance with Chapter 2 of this Regulation;

• (b) aspects relating to the internal risk-measurement model used to compute the expected shortfall measure and the stress scenario risk measure, in accordance with Chapter 3 of this Regulation;

• (c) aspects relating to the internal default risk model used to compute the additional own funds requirement for default risk, in accordance with Chapter 4 of this Regulation.

For the purposes of the first subparagraph, competent authorities shall apply the principles related to proportionality in accordance with Article 2, the quality of the documentation in accordance with Article 3, and the outsourcing arrangements in accordance with Article 4.

• (a) require the institution to remove the positions corresponding to those product classes from that trading desk;

• (b) refuse to grant permission to calculate the own funds requirements in accordance with the internal model approach for that trading desk.

• (a) require the institution to remove the positions corresponding to those product classes from that trading desk;

• (b) refuse to grant the permission to calculate the own funds requirements in accordance with the internal model approach for that trading desk.

Article 2

Proportionality – product categories and model complexities

Competent authorities shall apply the assessment methodology set out in this Regulation in a manner that is proportionate to the size and complexity of the trading activities included in the internal model, based on the following categories of financial instruments in increasing order of complexity:

• (a) simple instruments without optionality;

• (b) instruments, other than those referred to in point (a), without path-dependent features, on a single underlying, including indices, with a continuous payoff in the same currency as the underlying;

• (c) instruments with path-dependent features, instruments on multiple underlyings, instruments with payoffs in currencies that are different to that of the underlying, and any other instruments that are not referred to in points (a) or (b).

Article 3

Quality and auditability of documentation

Competent authorities shall verify that the documentation submitted by an institution in support of its application for permission to use an internal model for the calculation of own funds requirements for market risk is of sufficient quality and is sufficiently detailed and accurate to allow for examination by qualified third parties.

Competent authorities shall in particular verify that:

• (a) the documentation concerned is approved at the appropriate management level of the institution with sufficient authority delegated by the management body for the purposes of internal models;

• (b) the institution has established policies which ensure high-quality standards for internal documentation, including internal accountability to ensure that the documentation concerned is complete, consistent, accurate, updated, approved in accordance with point (a), and secure;

• (c) the documentation set out in the policies referred to in point (b) provides for the identification of the type of document, the author, the reviewer, the authorising agent, the owner, the dates of development and approval, the version number, and the history of amendments;

• (d) the institution accurately and diligently documents the policies, procedures, and methodologies it applies pursuant to this Regulation;

• (e) the documentation concerned is sufficiently detailed to enable qualified third parties to understand all aspects of the internal risk-measurement model.

Article 4

Outsourcing

• (a) tasks and responsibilities reserved for the risk control unit are not outsourced;

• (b) the senior management and the management body are actively involved in the supervision of any tasks outsourced by the institution, and in the acquisition of any IT risk management tool solutions from third parties;

• (c) the institution itself has sufficient knowledge about any outsourced tasks, activities or functions and of the structure of any data and methodologies obtained from a third party, and is able to verify the quality of the work performed by the third party to which it outsources its tasks, as well as the results of that work;

• (d) the internal audit and the ongoing monitoring by the institution of any outsourced tasks, activities and functions are not limited or inhibited by such outsourcing;

• (e) full access to all relevant information is granted to competent authorities.

• (a) interview or require the submission of written statements from any of the following:

• (i) staff and senior management of the institution;

• (ii) the management body of the institution;

• (iii) the third party to whom the task, activity or function have been outsourced;

• (b) review other relevant documents of the institution or the third party.

CHAPTER 2 ASSESSMENT OF QUALITATIVE REQUIREMENTS

Article 5

Overview of the assessment of qualitative requirements

When assessing an institution’s compliance with the qualitative requirements set out in Article 325bi of Regulation (EU) No 575/2013, competent authorities shall:

• (a) verify whether the institution has a clear organisational structure for the governance and management of the market risk model, including well defined, transparent and appropriate lines of responsibility;

• (b) verify whether the decision-making process of the institution regarding all aspects of market risk internal models is clearly established in the institution’s internal documentation;

• (c) verify, in accordance with Article 6:

• (i) the adequacy of the composition of the senior management and the management body;

• (ii) the role of the senior management and the management body;

• (d) verify, in accordance with Article 7, whether the set-up of the trading desks for which the institution is in the process of being granted the approval, or has already obtained the approval, is adequate;

• (e) assess, in accordance with Article 8, the internal governance and oversight of the institution in relation to the risk control unit;

• (f) assess, in accordance with Article 9, whether the internal policy is adequate for the introduction of new products;

• (g) verify, in accordance with Article 10, whether the internal model is reviewed independently;

• (h) assess:

• (i) in accordance with Article 11, the adequacy of the internal validation process and of its outcome;

• (ii) in accordance with Article 12, the scope of the validation and its completeness;

• (i) assess, in accordance with Article 13, the adequacy of the internal regular reporting;

• (j) assess:

• (i) in accordance with Article 14, the adequacy of position limits;

• (ii) in accordance with Article 15, the adequacy of the process to update those limits;

• (iii) in accordance with Article 16, the adequacy of the process followed where those limits are breached;

• (k) assess:

• (i) in accordance with Article 17, the adequacy ofthe stress testing programme;

• (ii) in accordance with Article 18, the adequacy of reverse stress-testing scenarios and ad-hoc stress-testing scenarios;

• (l) assess, in accordance with Article 19, the adequacy of the IT systems;

• (m) verify, in accordance with Article 20, whether the internal risk-measurement model, including any pricing model, has a proven track record of being reasonably accurate in measuring risks, and does not differ significantly from the models that the institution uses for its internal risk management.

For the purposes of point (a), competent authorities shall take into account the nature and size of the institution, and the scale and complexity of its activities.

Article 6

Assessment of the adequacy of the composition and role of the management body and senior management

• (a) verify whether the institution, in its documentation of the risk management system, describes:

• (i) the composition, the roles and responsibilities of the management body and senior management;

• (ii) the roles and responsibilities of each member of the management body and senior management;

• (b) verify whether the senior management is constituted of members that represent the highest hierarchical levels below the management body, and has defined responsibility for the proper functioning of the internal model for market risk;

• (c) verify whether the composition of any internal committee structure established by the management body to support its decision-making is adequate, as required by paragraph 2;

• (d) verify whether the role of the senior management is adequate, as required by paragraph 3;

• (e) verify whether the role of the management body, and of the committees constituting the internal committee structure referred to in point (c), are adequate, as required by paragraph 4.

Where an institution’s management body delegates any of its tasks to an internal committee, competent authorities shall, in the context of those delegated tasks, make the assessments required by this Regulation at the level of the internal committee designated by the management body.

• (a) for each committee of the internal committee structure, the management body has clearly set out its mandate, hierarchy, reporting lines, permanent members, frequency of meetings, and levels of responsibility;

• (b) the internal committee structure has a committee that assesses any new product, proposes those products to the senior management for approval, and monitors those products and whether the risk control unit, and any other function of the institution that is affected by the introduction of a new product, are represented in such committee;

• (c) the governance underpinning the internal committee structure allows for the effective and timely control of all internal position limits referred to in Article 325bi(1), point (b), of Regulation (EU) No 575/2013;

• (d) the governance underpinning the internal committee structure ensures active involvement of the management body in the risk-control process as required by Article 325bi(1), point (c), of Regulation (EU) No 575/2013;

• (e) as part of the internal documentation, the institution has documented all aspects referred to in point (a).

• (a) the senior management of the institution takes appropriate corrective actions where weaknesses of the internal risk-measurement model or the internal default risk model are identified by any of the following:

• (i) the risk control unit;

• (ii) the qualified parties tasked with the validation of the internal model (‘validation function’);

• (iii) the internal audit function;

• (iv) any other control function of the institution;

• (b) the senior management of the institution is informed of, and follows up on, the recommendations made by the internal audit, the risk control unit, the validation function, in relation to the internal risk-measurement model or the internal default risk model;

• (c) the senior management of the institution is able to ensure the overall quality of the institution’s governance of the valuation of positions included in the internal risk-measurement model or the internal default risk model.

• (a) on the basis of a proposal from the risk control unit, approves all relevant policies and procedures related to the implementation of the internal model, including the appropriate organisational structure, to ensure that the internal model is implemented with integrity;

• (b) on the basis of a proposal from the risk control unit and after due consideration of the conclusions and recommendations resulting from the validation process, approves the methodologies for assessing market risk applied in the internal model;

• (c) on the basis of an assessment from the risk control unit and after due consideration of the conclusions and recommendations resulting from the validation process, approves any new products;

• (d) on the basis of a proposal from the risk control unit, approves and updates the internal position limits;

• (e) on the basis of a proposal from the risk control unit laying down and assessing the acceptable level of risk, approves the acceptable level of risk, the internal capital allocation and the budget by trading desk;

• (f) adopts the approval procedure for breaches of internal position limits;

• (g) approves or requires corrective actions in relation to breaches of the internal position limits escalated by the risk control unit in accordance with Article 16(1), point (b);

• (h) on the basis of a proposal from the risk control unit:

• (i) approves the stress testing programme;

• (ii) discusses the results of the stress tests;

• (iii) assesses potential action, and where necessary, takes corrective actions.

Article 7

Assessment of whether trading desks comply with Article 104b of Regulation (EU) No 575/2013

When assessing whether trading desks comply with Article 104b of Regulation (EU) No 575/2013, competent authorities shall:

• (a) review the business strategy referred to in Article 104b of that Regulation as documented in the internal policies of the institution under Article 325bi(1), point (e), of that Regulation, and verify whether:

• (i) internal policies clearly describe the economic rationale of the business strategy, including its primary activities, trading, and hedging strategies;

• (ii) internal policies describe the features of the financial instruments and commodities traded by the trading desk, and contains a regularly updated and comprehensive list of those financial instruments and commodities;

• (iii) the institution highlights in its internal policies the instruments that are most frequently traded and that contribute the most to the acceptable level of risk for the trading desk;

• (iv) internal policies describe risk factor’s types inherent in the financial instruments and commodities referred to in point (ii);

• (v) internal policies clearly describe how the instruments and commodities referred to in point (ii) are hedged, what are the expected slippages and mismatches of hedges, and what is the expected holding period for the positions in the trading desk;

• (vi) the business strategies of the trading desks are distinctive, as required by Article 104b(2), point (a), of Regulation (EU) No 575/2013, by:

• (1) identifying the main characteristics of the trading desks in terms of business strategy, including primary activities, trading and hedging strategies;

• (2) verifying that the main characteristics referred to in point (1) meaningfully differ from one trading desk to another;

• (b) verify whether transactions between trading desks are consistent with the business strategies of those trading desks and that those transactions are not performed to:

• (i) reduce the own funds requirements for market risk;

• (ii) meet the profit and loss attribution requirements;

• (iii) meet the back-testing requirements;

• (c) review the organisational structure referred to in Article 104b(2), point (b), of Regulation (EU) No 575/2013 and the annual business plan referred to in Article 104b(2), point (e), of that Regulation, as documented in the internal policies of the institution under Article 325bi(1), point (e), of that Regulation;

• (d) verify whether for each trading desk, the institution has identified one or two head dealers, and that where two head dealers have been appointed, they either have roles, responsibilities, and authorities that are clearly separated, or one has ultimate oversight over the other;

• (e) review the reports referred to in Article 104b(2), points (d) and (f), of Regulation (EU) No 575/2013, and verify whether all aspects referred to in those points are complied with;

• (f) verify whether the institution duly documents and justifies cases where a dealer is assigned to more than one trading desk as referred to in Article 104b(3) of Regulation (EU) No 575/2013, and, for that purpose:

• (i) review the responsibility of that dealer in the context of the trading desks to which he or she has been assigned;

• (ii) verify whether the tasks performed by the dealer in one trading desk as per the business strategy of that desk do not contradict, nor create any conflict with, the tasks that the dealer performs for the other trading desks;

• (g) verify whether the rationale for the inclusion of the trading desks in the scope of the alternative internal model approach meets all of the following conditions:

• (i) the rationale is documented in the internal policies as required by Article 325bi(1), point (e), of Regulation (EU) No 575/2013;

• (ii) the rationale ensures consistency in the approach used for calculating the own funds requirements for market risk among trading desks managing similar positions;

• (iii) the rationale is coherent with the business strategy of the trading desks as referred to in Article 104b(2), point (a), of Regulation (EU) No 575/2013;

• (h) verify whether the business strategy entails that at least 10 % of the own funds requirements for market risk are calculated in accordance with the internal model approach.

For the purposes of point (a)(i), competent authorities shall verify whether the business strategy specifies how much of the trading activities are customer driven, and whether the business strategy entails trade origination and structuring, or execution of services, or both.

For the purposes of point (b), competent authorities may, where appropriate, require the institution to provide a sample of transactions between trading desks, including between trading desks for which the institution computes the own funds requirements with the internal model approach and trading desks for which the institution uses the standardised approach.

Article 8

Assessment of the internal governance and oversight of the institution in relation to the risk control unit

• (a) is completely separate and independent from the personnel and the management functions responsible for the trading business areas;

• (b) is duly represented in the institution’s decision-making bodies and is involved in the decision-making process where any of the following issues are on the agenda:

• (i) the approval of new methodologies for assessing market risk and of any changes to existing methodologies;

• (ii) the approval of the establishment of a trading desk;

• (iii) the approval or update of reports and inventories within the remit of the risk control unit;

• (iv) the setting of the acceptable level of risk;

• (v) the setting and regular update of the internal limit structure;

• (vi) the approval of limit breaches;

• (vii) the approval of new products or new business lines;

• (viii) the approval of pricing models used for risk purposes;

• (ix) the approval of stress testing programmes;

• (x) the approval of IT infrastructure systems related to risk management tools;

• (c) is adequate, is proportionate to the size of the institution and the risks of the business, and has the resources necessary to perform its tasks effectively;

• (d) has sufficiently experienced, qualified and trained staff to undertake all relevant activities for the effective risk management of the internal model and for monitoring and challenging the actions of other units, in particular of the trading business units;

• (e) is responsible for the outcome of the calculations based on the internal-risk measurement model and the internal default risk model.

• (a) the risk control unit is composed of one or more separate organisational structures in the institution’s organisational chart;

• (b) the heads of the risk control unit or units are senior managers of the institution;

• (c) the staff and the senior management responsible for the risk control unit are not responsible for any trading business activities;

• (d) senior managers of the risk control unit and those responsible for business areas have different reporting lines to the management body of the institution;

• (e) the variable remuneration of the staff and senior management responsible for the risk control unit is not linked to the performance of the tasks related to trading business areas under their supervision in a way that hinders or impedes their independence.

• (a) the documented view of the risk control unit when either the management body or the relevant committee of the internal committee structure discuss any of the issues referred to in paragraph 1, point (b);

• (b) the minutes of the institution’s management body or relevant committee of the internal committee structure, and the action points reflected therein;

• (c) the reports of the risk control unit about internal position limits, and any decisions regarding limit breaches;

• (d) information provided by the staff and senior management of the institution, where appropriate.

For the purposes of point (b), competent authorities shall assess the degree of involvement of the risk control unit when the institution’s management body or relevant committee of the internal committee structure discuss any of the issues referred to in paragraph 1, point (b). Competent authorities shall identify cases where the view of the risk control unit and the final decision taken by either the management body or the relevant committee of the internal committee structure diverge.

Article 9

Assessment of the new product policy

When assessing whether the internal policies referred to in Article 325bi(1), point (e), of Regulation (EU) No 575/2013 are adequate for the introduction of any new product, including new financial instruments, activities, markets, booking locations or business lines, competent authorities shall verify whether:

• (a) the risk control unit has documented a new product policy and the management body has approved that policy, including a definition of ‘new product’;

• (b) the internal committee structure has a committee (‘new product committee’) that assesses, controls and monitors all issues arising from the introduction of new products, including, where relevant:

• (i) assessing regulatory compliance;

• (ii) reviewing any pricing models used for risk purposes;

• (iii) specifying the market parameters to be used for calibration purposes, the way the calibration is to be done, and the frequency of update of the calibration;

• (iv) introducing any new methodologies for assessing market risk;

• (v) assessing the impacts on the acceptable level of risk, capital adequacy, and profitability;

• (vi) ensuring the availability of front, back and middle office resources and internal tools and expertise that allow for the understanding and monitoring of any associated new risks;

• (vii) specifying and proposing to the management body the restrictions in terms of maturities, underlying, counterparties, and internal limits for such new product;

• (viii) assessing the adequacy of the accounting schemes and ensuring that the internal reporting appropriately reflects the underlying risks;

• (c) the management body, based on an assessment by the new product committee, authorises the trading of new products;

• (d) where the management body delegates the authorisation task to the new product committee:

• (i) the volume allowed for the new product is restrictive enough to prevent any material losses stemming from such new products, including, where appropriate, shorter trial periods for products referred to in Article 2, point (c);

• (ii) the authorisation is delegated separately for each type of new product and always for a limited period of time, with a maximum of 6 months;

• (iii) the authorisation, if renewed, is only renewed once by the management body;

• (iv) after a one-year period, all relevant issues referred to in point (b) are addressed, or no additional trading in that new product is allowed;

• (e) without the specific approval from the new product committee, the business areas are not authorised to trade new products before the issues referred to in point (b) are addressed;

• (f) in the specific cases where traders are allowed to trade new products that do not comply with point (b), the new-product committee approves the transactions on an individual basis and within the limits referred to in point (d)(i);

• (g) the new product committee meets frequently enough to evaluate and approve any new product transaction and to monitor all the issues referred to in point (b) that those transactions may pose;

• (h) transactions are monitored individually until all issues referred to in point (b) have been fully addressed and, based on an assessment by the new product committee, the management body confirms that the transactions are fully incorporated into all relevant IT systems and controlled via the regular risk-management system;

• (i) all new products, regardless of their degree of incorporation into the IT systems, are computed both in the internal risk-measurement model and in the daily changes to the portfolio’s value used for back-testing and profit and loss attribution test purposes.

Article 10

Independent review of the internal risk-measurement model

• (a) the reviewer is independent;

• (b) the resources assigned to the review are appropriate;

• (c) the process established within the institution to address the recommendations made by the reviewer is adequate;

• (d) the reviewer reviews the internal risk-measurement models on at least an annual basis, and includes the conclusions of that review in a report submitted to the senior management and the management body;

• (e) the report referred to in point (d) provides sufficient information to the senior management and the management body of the institution on all elements referred to in Article 325bi(2) and Article 325bp(7) of Regulation (EU) No 575/2013, and identifies the areas in the annual work plan that require a more detailed compliance analysis of those elements;

• (f) the review is adequate, proportionate to the size and the complexity of the portfolios concerned, and effective in identifying shortcomings.

• (a) the review is proportionate to the nature, size, and complexity of the institution’s business and organisational structure, and in particular to the complexity of the internal models and their implementation;

• (b) the reviewer has resources that are adequate to undertake all relevant activities, and sufficiently experienced and qualified staff;

• (c) the reviewer is not, nor has been involved in any aspect of the design and implementation of the internal model subject to review;

• (d) the reviewer is independent from the staff and management function responsible for the business and risk control units;

• (e) the variable remuneration of the staff and management responsible for the review is not linked to the performance of the tasks related to the institution’s trading business areas in a way that hinders or impedes their independence.

Article 11

Assessment of the validation of any internal risk measurement models, and of the outcome of such validation

• (a) the validation process is conducted by staff that is not nor has been involved in any way in the development of the internal model subject to validation;

• (b) the validation process is conducted with sufficient resources, including experienced and qualified staff;

• (c) the variable remuneration of the staff and senior managers responsible for the validation process is not dependent on the performance of the tasks related to the institution’s risk control or business areas in a way that hinders or impedes their independence;

• (d) all necessary corrective measures resulting from the validation process are reflected in the validation report referred to in paragraph 2, and implemented in a timely manner;

• (e) a decision-making process is in place to ensure that the senior management of the institution takes into account the findings and recommendations resulting from the validation process;

• (f) the reviewer referred to in Article 10(1), point (a), regularly assesses the compliance with the conditions referred to in Article 10(1), points (e) and (f).

• (a) verify whether the recommendations, findings, and conclusions of the validation process are included in a validation report that identifies and describes:

• (i) the validation methodology;

• (ii) the tests performed;

• (iii) the reference dataset used;

• (iv) the respective data cleansing processes;

• (b) verify whether the conclusions, findings and recommendations of the validation report are directly communicated to, and considered by, the management body of the institution before that management body approves a model to be applied for the calculation of own funds requirements and before any subsequent changes in the methodologies are applied;

• (c) verify whether any remedial measure proposed by the validation functions is documented in the validation report and is accompanied by a timeline that is adequate for fixing the identified deficiencies;

• (d) verify whether an escalation process is included in the internal policies of the institution for those remedial measures that are overdue, and whether, based on evidence from the past, that process is followed;

• (e) assess the overall quality of the outcome of the validation process by comparing the deficiencies identified in the assessment of the internal model in accordance with this Regulation with the deficiencies identified by the validation unit in the validation process.

Article 12

Assessment of the adequacy of the scope and completeness of the internal validation

• (a) critically reviews all aspects of the methodologies and pricing functions used for capital purposes, including those applied to new products, thereby taking account of strengths and weaknesses compared to any alternative methodologies;

• (b) verifies:

• (i) the choice of market data;

• (ii) the mapping of risk factors to the relevant liquidity horizon;

• (iii) the mapping of a real price observation to a risk factor or to a bucket for which it is considered representative;

• (iv) the proxying approaches used;

• (c) verifies whether the distributional and any other relevant stochastic assumptions and parameters of the underlying stochastic processes, including volatility and correlation, are well justified, including with regard to:

• (i) the tails of the distributions relevant for the calculation of the expected shortfall risk measures referred to in Article 325bb of Regulation (EU) No 575/2013;

• (ii) the stress scenario risk measure referred to in Article 325bk of Regulation (EU) No 575/2013;

• (d) assesses the soundness of any empirical correlations used both within and across the broad categories of risk factors to calculate the unconstrained expected shortfall measure referred to in Article 325bh(2) of Regulation (EU) No 575/2013;

• (e) assesses the correlation assumptions made in the calculation of the own funds requirements for default risk, including:

• (i) the choice of the relevant copula, where modelled explicitly;

• (ii) the choice and weights of the systematic risk factors referred to in Article 325bp of Regulation (EU) No 575/2013;

• (iii) the ability of the model to explain default clusters;

• (f) assesses the assumptions made to obtain estimates of default probabilities and losses given default to compute own funds requirements for default risk;

• (g) assesses the assumptions made in relation to the modelling of hedges in the computation of own funds requirement for default risk as referred to in Article 325bo of Regulation (EU) No 575/2013;

• (h) analyses the results of the stress testing programme, including the results relating to default risk, and extracts relevant conclusions, if any, around methodological flaws or weaknesses stemming from particular market scenarios;

• (i) applies and analyses the results obtained for the hypothetical portfolios referred to in Article 325bj(3), point (c), of Regulation (EU) No 575/2013 to ensure that the internal model can account for structural features, including, where relevant, the following:

• (i) basis risks between different yield curves;

• (ii) less than perfectly correlated movements between similar but not identical positions;

• (iii) name-related basis risk and basis stemming from similar but not identical credit or equity positions;

• (iv) concentration risk;

• (j) verifies the robustness of the implementation of the internal risk measurement model in IT systems, and ensures that all business and support units apply methodologies consistently and for all relevant geographic areas;

• (k) verifies the appropriateness and materiality of the proxies by assessing:

• (i) the percentage of proxied time series used;

• (ii) the percentage marginal contribution of proxied time series;

• (iii) the impact that proxy usage may have in the recognition of diversification effects.

• (a) for the internal validation conducted when the model is initially developed, the institution has performed and documented a complete validation process for all methodologies applied in the internal model;

• (b) for the periodic internal validation, the institution has conducted a complete validation, or has done the validation on areas to be validated following the changes referred to in paragraph 3 on:

• (i) any new methodologies required by the introduction of new products;

• (ii) areas related to any issues identified in the conclusions of previous validations and internal audit reviews.

• (a) verify whether the internal policies of the institution ensure that the internal periodic validation is performed at least annually, and each time significant structural changes in the market or changes to the composition of the portfolio occur that may lead to the internal model no longer being adequate, including the following:

• (i) a number of overshootings that deviate significantly from the number anticipated by the model calibration;

• (ii) large market losses relative to the level predicted by risk metrics;

• (iii) a significant change in the institution’s business that may challenge the modelling assumptions;

• (iv) unusual and significant misalignments between the theoretical and hypothetical changes to the portfolios’ values;

• (b) verify whether the internal periodic validation is based on a work plan, approved by the management body, and that that work plan sets out:

• (i) the scope of the internal validation;

• (ii) the tasks performed by the validation unit;

• (iii) the priorities of the internal validation;

• (c) assess how the work plan referred to in point (b) ensures that a comprehensive and risk-oriented internal validation process is performed, and that relevant aspects are not omitted from the scope of the internal validation.

Article 13

Assessment of the adequacy of reporting

When assessing the adequacy of the reports referred to in Article 104b(2), points (d) and (f), and Article 325bi(1), point (b), of Regulation (EU) No 575/2013, competent authorities shall verify:

• (a) whether the institution maintains an inventory of those reports, specifying their content, frequency and addressees;

• (b) whether the inventory referred to in point (a) has been approved at the appropriate management level and is updated in consultation with the risk control unit.

Article 14

Assessment of adequacy of trading limits

When assessing the adequacy of trading limits referred to in Article 103(2), point (b)(ii), Article 104b(2), points (c) and (f), and Article 325bi(1), point (b), of Regulation (EU) No 575/2013, competent authorities shall verify whether:

• (a) the institution has a clear breakdown of trading limits that is consistent with the acceptable level of risk set by the institution and the budget of each trading desk;

• (b) the choice of the trading limits reflects the trading strategy of the trading desk and the nature of the underlying risks;

• (c) the trading limits include the following:

• (i) a value-at-risk limit for the maximum level of portfolio aggregation at which the internal model is applied;

• (ii) a value-at-risk limit for each trading desk for which the institution calculates its own funds requirement for market risk with the internal risk-measurement model;

• (d) the institution has a further breakdown in the value-at-risk limits, proportional to the institution’s trading strategies;

• (e) all internal limits, including those referred to in point (c), are properly documented and formally approved;

• (f) as part of the limit approval and update process, the risk control unit assesses and documents the consistency and compatibility between the value-at-risk limits approved by the management body and the rest of the internal limits not based on value-at-risk, including sensitivities or loss trigger;

• (g) the institution properly documents and formally approves an inventory of authorised instruments and underlying risk positions that traders can enter.

For the purposes of point (c)(i), the value-at-risk limit shall be the sum of individual value-at-risk limits when the permission to use the internal model approach, as referred to in Article 325(1), point (b), of Regulation (EU) No 575/2013, has not been granted.

Article 15

Assessment of the adequacy of the process to update trading limits

• (a) the update process is coordinated and duly documented by the risk control unit;

• (b) the proposal for updating the trading limits reflects any changes in:

• (i) the acceptable level of risk set by the institution;

• (ii) the expected activity or in the budget objectives of the trading desks;

• (c) the proposal for updating the trading limits takes into account, over the period where the trading limit applicable at the time of the update has been used:

• (i) the average level of use of the trading limits applicable at the time of the update;

• (ii) the number and magnitude of trading limit breaches.

Article 16

Assessment of the adequacy of the process relating to trading limit breaches

• (a) the institution has a clear and documented procedure for the approval by the management body of breaching trading limits;

• (b) the management body has specified materiality conditions according to which any breach of the trading limits are to be reported to the management body itself, irrespective of the level where the trading limits have been approved;

• (c) the risk control unit documents any breaches of the trading limits and reports such breaches to the responsible committee, sub-committee or individual manager;

• (d) the committee, sub-committee or individual manager referred to in point (c) either takes action when a trading limit is breached, or reports such breach to the management body, in accordance with point (b);

• (e) the documentation referred to in point (c) comprises the magnitude and main causes of the breach of the trading limit, including:

• (i) any increase in the trading positions;

• (ii) any methodological changes introduced in the internal risk-measurement model;

• (iii) any developments in market conditions.

Article 17

Assessment of the adequacy of the stress testing programme

• (a) the institution reviews scenarios applied as part of the stress testing programme at least annually;

• (b) the risk control unit runs the stress test scenarios determined in the stress testing programme frequently and at least every month, and at a higher frequency where the institution has significant trading activities;

• (c) the scenarios to be applied as part of the stress testing programme comprise, apart from historically observed or hypothetical scenarios, scenarios resulting from reverse stress testing and ad-hoc scenarios designed to address the relevant specific risk drivers;

• (d) the scenarios referred to in point (c) are reviewed at least on an annual basis.

• (a) losses arising from events, including credit events;

• (b) hypothetical rating downgrades;

• (c) market events on specific issuers’ types;

• (d) changes to copulas’ types and parameters, where modelled explicitly.

Article 18

Assessment of the adequacy of the reverse and ad-hoc stress testing scenarios

• (a) the risk control unit applies the reverse stress test as a tool to identify possible combinations of severe events and risk concentrations within the institution, including severe events and risk concentrations that derive from environmental risks;

• (b) the analysis performed with the reverse stress test complements the regular stress testing;

• (c) when identifying the scenario or scenarios resulting from reverse stress testing, the risk control unit assesses:

• (i) the business lines where traditional risk management models indicate an exceptionally good trade-off between risk and return;

• (ii) new products and new markets which have not experienced severe strains;

• (iii) exposures where there are no liquid two-way markets;

• (iv) foreign exchange exposures either pegged or subject to a cap or floor to other currencies;

• (v) positions in deep out-of-the-money options, in particular digital options;

• (vi) events not considered in the stress period used to calibrate the expected shortfall risk measures referred to in Article 325bb of Regulation (EU) No 575/2013;

• (vii) environmental risks in the form of both physical and transition risks.

• (a) whether the risk control unit uses the results obtained from sensitivity analysis towards single risk factors, considered individually and jointly, to identify scenarios that include the stress of a combined set of plausible risk factors;

• (b) whether the risk control unit explicitly has considered the following elements when establishing the ad hoc stress testing scenarios:

• (i) the illiquidity of markets in stressed market conditions, gapping of prices, concentration risk, and one-way markets;

• (ii) an event resulting in a rise in correlation across instruments or risk factors, or a sharp foreign exchange shift scenario, stemming from any currencies which are subject to a peg, cap, or floor at the time of the review, which are breaking those relationships, where such an event occurs at the same time as an event as referred to in point (i);

• (iii) event risks for equities and jump-to-default risk for credit positions, by considering either of the following:

• (1) four instantaneous defaults with zero recovery of the long debt positions in the current portfolio with the largest exposure and the two largest equity long positions in the current portfolio;

• (2) the event risk stemming from a sharp rise in equity prices for the two largest short positions;

• (iv) the non-linearity of products, by applying full revaluation of all positions to reflect non-linearity effects accurately, and by applying large enough shocks to trigger the exercise of some deep out-of-the-money options, in particular digital options;

• (v) event risks stemming from environmental risk drivers;

• (vi) other risks that may not be captured appropriately in the internal models, including risks derived from the use of proxies and the potential misalignment between a proxy and the underlying risk.

For the purposes of point (b)(i), the risk control unit may consider larger shocks to reflect the impossibility of unwinding positions in a timely manner, in particular for cash instruments, that is caused by the fact that positions are concentrated, or that are due to a sharp increase in market illiquidity.

For the purposes of point (b)(iv), the risk control unit may, in particular:

• (a) assess the potential risk incurred when hedging positions valued using a proxy;

• (b) apply the stressed scenario movements to the proxy while keeping illiquid positions constant.

Article 19

Assessment of the internal risk-measurement model in relation to the robustness of the IT systems

• (a) assess the robustness of the IT systems during the last 250 business days;

• (b) verify whether:

• (i) appropriate remediation capabilities are in place in case of system breakdown;

• (ii) the institution is able to re-calculate any affected risk metrics;

• (iii) back-testing overshootings produced by technical problems are exceptional.

Article 20

Assessment of reasonable accuracy of the internal risk-measurement model, including pricing model

• (a) verify whether the institution has inventories, whereby those inventories comprise:

• (i) the pricing functions or methods used in the internal-risk measurement model and the pricing functions or methods used to calculate the end-of-day value of the portfolio;

• (ii) for each of the pricing functions or methods referred to in point (i), a concise description, the main features, assumptions, key parameters of those pricing functions or methods, how those features, assumptions and parameters were calibrated, and how those pricing functions or methods are implemented;

• (iii) a description of the scope of financial instruments and commodities included in the internal-risk measurement model covered by each pricing function or method;

• (iv) a description of the scope of financial instruments and commodities covered by each pricing function or method in the calculation of the end-of-day-value of the portfolio;

• (v) one or more metrics to measure the materiality of positions priced with the corresponding pricing function or method in the internal risk-measurement model;

• (vi) one or more metrics to measure the materiality of positions priced with the corresponding pricing function and method in the calculation of the end-of-day-value of the portfolio;

• (vii) a comprehensive mapping between the pricing functions and methods used in the internal risk-measurement model and the pricing functions and methods used in the calculation of the end-of-day-value of the portfolio;

• (b) verify whether the inventories referred to in point (a) are updated at least annually, and whether the internal policies of the institution provide for a specific update whenever that would be necessary due to substantial changes in the information provided in the inventories;