Article 40
Assessment of the capability of the internal risk-measurement model to capture non-linearities
1. When assessing an institution’s compliance with Article 325bh(1), point (b), of Regulation (EU) No 575/2013 in relation to requirements on the effectiveness and capability of the internal-risk measurement model to capture non-linearities of options and other products for an institution using a sensitivity-based approach, competent authorities shall verify whether:
|
(a) |
the internal risk-measurement model captures at least the material first- and second-order terms of Taylor series approximations to reflect the change in the prices due to changes in relevant risk factors, including the cross-gamma risk represented by material joint-moves in risk factors; |
|
(b) |
the sensitivity-based approach leads to appropriate results, including where severe shocks are applied to the risk factors. |
2. For the purposes of paragraph 1, competent authorities may apply the following steps in the following order:
|
(a) |
identify products for which competent authorities want to test the materiality of the order terms of a Taylor series approximation, and the appropriateness of the sensitivity-based approach under severe shock; |
|
(b) |
identify a business day in the stress period where the returns observed for the risk factors in those products were particularly high, where positive, or particularly low, where negative; |
|
(c) |
require the institution to calculate the hypothetical and theoretical changes in the values of those products in accordance with Delegated Regulation (EU) 2022/2059, under the scenario identified by the returns on the business day identified in accordance with point (b); |
|
(d) |
based on the results of the calculation referred to in point (c), assess whether the sensitivity-based approach leads to appropriate results. |