Financial Services (Investment and Fiduciary Services)
FINANCIAL SERVICES (CAPITAL ADEQUACY OF INVESTMENT FIRMS) REGULATIONS 2007
the cumulative risk arising from multiple defaults, including the ordering of defaults, in tranched products;
credit spread risk, including the gamma and cross-gamma effects;
volatility of implied correlations, including the cross effect between spreads and correlations;
basis risk, including both:
the basis between the spread of an index and those of its constituent single names, and
the basis between the implied correlation of an index and that of bespoke portfolios;
recovery rate volatility, as it relates to the propensity for
recovery rates to affect tranche prices; and
to the extent the comprehensive risk measure incorporates benefits from dynamic hedging, the risk of hedge slippage and the potential costs of rebalancing such hedges.
For the purpose of this point, an institution shall have sufficient market data to ensure that it fully captures the salient risks of those exposures in its internal approach in accordance with the standards set out in this point, demonstrates through back testing or other appropriate means that its risk measures can appropriately explain the historical price variation of those products, and is able to separate the positions for which it holds approval in order to incorporate them in the capital charge in accordance with this point from those positions for which it does not hold such approval.
With regard to portfolios subject to this point, the institution shall regularly apply a set of specific, predetermined stress scenarios. Such stress scenarios shall examine the effects of stress to default rates, recovery rates, credit spreads, and correlations on the profit and loss of the correlation trading desk. The institution shall apply such stress scenarios at least weekly and report at least quarterly to the competent authority the results, including comparisons with the institution’s capital charge in accordance with this point. Any instances where the stress tests indicate a material shortfall of this capital charge shall be reported to the competent authority in a timely manner. Based on those stress testing results, the competent authority shall consider a supplemental capital charge against the correlation trading portfolio as set out in regulation 83 of the the Financial Services (Capital Adequacy of Credit Institutions) Regulations 2007.
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Repealed Subsidiary 2007/002