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CRR ToolDelegated Regulation 2024/1085
Article 12

Article 12 - Assessment of the adequacy of the scope and completeness of the internal validation

Article 12

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

1.   When assessing whether the scope of the internal validation referred to in Article 325bj of Regulation (EU) No 575/2013 is adequate, competent authorities shall verify whether 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.

2.   When assessing the completeness of the internal validation process, competent authorities shall verify whether:

(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.

3.   For the purposes of paragraph 2, point (b), competent authorities shall:

(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.