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CRR ToolDelegated Regulation 2024/1085
Article 18

Article 18 - Assessment of the adequacy of the reverse and ad-hoc stress testing scenarios

Article 18

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

1.   When assessing the adequacy of the reverse stress testing scenarios referred to in Article 325bi(1), point (g), of Regulation (EU) No 575/2013, competent authorities shall verify whether:

(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.

2.   When assessing the adequacy of ad hoc stress testing scenarios as part of the stress testing programmes referred to in Article 325bi(1), point (g), of Regulation (EU) No 575/2013, competent authorities shall verify whether the risk control unit, when designing the ad hoc stress testing scenarios concerned, takes into account the composition, at the last reporting date, of the portfolio of positions included in the scope of the internal model. Competent authorities shall in particular verify:

(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.