ANNEXURE 6: Document Enhanced: SAMA's Finalized Guidance Document for the Implementation of Basel II.5 , 2012

Effective from Jul 21 2014 - Jul 20 2014
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The following guideline to read as part of Section 3.8 “Securitization liquidity facilities – IRB Approach”, Page 14 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
If a bank‘s internal assessment process is no longer considered adequate, SAMA may preclude the bank from applying the internal assessment approach to its ABCP (Asset Backed Commercial Paper) exposures, both existing and newly originated, for determining the appropriate capital treatment until the bank has remedied the deficiencies. In this instance, the bank must revert to the Supervisory Formula or, if not available, to the method described in paragraph 639, International Convergence of Capital Measurement and Capital Standards
(Refer to Paragraph 622 of International Convergence of Capital Measurement and Capital Standards – June 2006)
The following guideline to be included in Section G “IRB Approaches”, Page 23 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
Liquidity Facility
Liquidity facilities are treated as any other securitisation exposure and receive a CCF of 100% unless specified differently in paragraphs 638 to 641 of International Convergence of Capital Measurement and Capital Standards – June 2006. If the facility is externally rated, the bank may rely on the external rating under the RBA. If the facility is not rated and an inferred rating is not available, the bank must apply the SF, unless the IAA can be applied.
An eligible liquidity facility that can only be drawn in the event of a general market disruption as defined in paragraph 580 of International Convergence of Capital Measurement and Capital Standards – June 2006, is assigned a 20% CCF under the SF. That is, an IRB bank is to recognise 20% of the capital charge generated under the SF for the facility. If the eligible facility is externally rated, the bank may rely on the external rating under the RBA provided it assigns a 100% CCF rather than a 20% CCF to the facility.
When it is not practical for the bank to use either the bottom-up approach or the topdown approach for calculating KIRB, the bank may, on an exceptional basis and subject to SAMA‘s consent, temporarily be allowed to apply the following method. If the liquidity facility meets the definition in paragraph 578 or 580 of International Convergence of Capital Measurement and Capital Standards – June 2006, the highest risk weight assigned under the standardised approach to any of the underlying individual exposures covered by the liquidity facility can be applied to the liquidity facility. If the liquidity facility meets the definition in paragraph 578 of International Convergence of Capital Measurement and Capital Standards – June 2006, the CCF must be 50% for a facility with an original maturity of one year or less, or 100% if the facility has an original maturity of more than one year. If the liquidity facility meets the definition in paragraph 580 of International Convergence of Capital Measurement and Capital Standards – June 2006, the CCF must be 20%. In all other cases, the notional amount of the liquidity facility must deducted.
(Refer to Paragraph 637- 639 of International Convergence of Capital Measurement and Capital Standards – June 2006)
The following guideline to be included in Section G “IRB Approaches”, Page 23 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
Treatment of credit risk mitigation for securitization exposures
As with the RBA, banks are required to apply the CRM techniques as specified in the foundation IRB approach of Section III when applying the SF. The bank may reduce the capital charge proportionally when the credit risk mitigant covers first losses or losses on a proportional basis. For all other cases, the bank must assume that the credit risk mitigant covers the most senior portion of the securitisation exposure (i.e. that the most junior portion of the securitisation exposure is uncovered). Examples for recognising collateral and guarantees under the SF are provided in Annex 7 of International Convergence of Capital Measurement and Capital Standards – June 2006.
(Refer to Paragraph 642 of International Convergence of Capital Measurement and Capital Standards – June 2006)
The following guideline to be included in Section G “IRB Approaches”, Page 23 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
Capital requirement for early amortization provision
An originating bank must use the methodology and treatment described in paragraphs 590 to 605 of International Convergence of Capital Measurement and Capital Standards – June 2006, for determining if any capital must be held against the investors‘interest. For banks using the IRB approach to securitisation, investors‘ interest is defined as investors‘ drawn balances related to securitisation exposures and EAD associated with investors‘ undrawn lines related to securitisation exposures.
(Refer to Paragraph 643 of International Convergence of Capital Measurement and Capital Standards – June 2006)
The following guideline to be included in B “Specific Changes with regard to Market Risk Under Basel II.5” - Page 20 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
709(iii).	The capital charge for specific risk is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer. In measuring the risk, offsetting will be restricted to matched positions in the identical issue (including positions in derivatives). Even if the issuer is the same, no offsetting will be permitted between different issues since differences in coupon rates, liquidity, call features, etc. mean that prices may diverge in the short run.
(Refer to Paragraph 709(iii) of International Convergence of Capital Measurement and Capital Standards – June 2006)
The following guideline to be included in Section 2 “Prudent valuation guidance ”, Page 70 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
The original paragraph was as follows:
Prudent valuation guidance
690.	This section provides banks with guidance on prudent valuation for positions in the trading book. This guidance is especially important for less liquid positions which, although they will not be excluded from the trading book solely on grounds of lesser liquidity, raise supervisory concerns about prudent valuation.
The revised paragraph wold read as follows:
Prudent valuation guidance
690).	This section provides banks with guidance on prudent valuation for positions that are accounted for at fair value, whether they are in the trading book or in the banking book. This guidance is especially important for positions without actual market prices or observable inputs to valuation, as well as less liquid positions which, raise supervisory concerns about prudent valuation. The valuation guidance set forth below is not intended to require banks to change valuation procedures for financial reporting purposes. SAMA would assess a bank‘s valuation procedures for consistency with this guidance. One factor in a supervisor‘s assessment of whether a bank must take a valuation adjustment for regulatory purposes under paragraphs 718(cx) to 718(cxii) of International Convergence of Capital Measurement and Capital Standards – June 2006, should be the degree of consistency between the bank‘s valuation procedures and these guidelines.
(Refer to revisions to the Basel II Market Risk Framework 2010 (718 c))
The following guideline to be included in Section 2 “Prudent valuation guidance ” (i). Systems and controls, Page 70 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
The original paragraph was as follows:
Systems and controls
692.	Banks must establish and maintain adequate systems and controls sufficient to give management and supervisors the confidence that their valuation estimates are prudent and reliable. These systems must be integrated with other risk management systems within the organisation (such as credit analysis). Such systems must include:
■	Documented policies and procedures for the process of valuation. This includes clearly defined responsibilities of the various areas involved in the determination of the valuation, sources of market information and review of their appropriateness, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, end of the month and ad-hoc verification procedures; and
■	Clear and independent (i.e. independent of front office) reporting lines for the department accountable for the valuation process. The reporting line should ultimately be to a main board executive director.
The revised paragraph would read as follows:
692.	Banks must establish and maintain adequate systems and controls sufficient to give management and SAMA the confidence that their valuation estimates are prudent and reliable. These systems must be integrated with other risk management systems within the organisation (such as credit analysis). Such systems must include:
■	Documented policies and procedures for the process of valuation. This includes clearly defined responsibilities of the various areas involved in the determination of the valuation, sources of market information and review of their appropriateness, guidelines for the use of unobservable inputs reflecting the bank‘s assumptions of what market participants would use in pricing the position, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, end of the month and ad-hoc verification procedures; and
■	Clear and independent (ie independent of front office) reporting lines for the department accountable for the valuation process. The reporting line should ultimately be to a main board executive director.
(Refer to revisions to the Basel II Market Risk Framework 2010 (718 cii))
The following guideline to be included in Section 2 “Prudent valuation guidance ” (ii) Valuation Methodologies, Marking to Market, Page 70 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
Original paragraph was as follows:
694.	Banks must mark-to-market as much as possible. The more prudent side of bid/offer must be used unless the institution is a significant market maker in a particular position type and it can close out at mid-market.
The revised paragpraph would read as follows:
Banks must mark-to-market as much as possible. The more prudent side of bid/offer should be used unless the institution is a significant market maker in a particular position type and it can close out at mid-market. Banks should maximise the use of relevant observable inputs and minimise the use of unobservable inputs when estimating fair value using a valuation technique. However, observable inputs or transactions may not be relevant, such as in a forced liquidation or distressed sale, or transactions may not be observable, such as when markets are inactive. In such cases, the observable data should be considered, but may not be determinative.
(Refer to revisions to the Basel II Market Risk Framework 2010 (718 civ))
The following guideline to be included in Section 2 “Prudent valuation guidance ” (ii) Valuation Methodologies, Marking to Model, Page 70 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 212
(In addition to the original text)
The original paragraph was as follows
Marking to model
695.	Where marking-to-market is not possible, banks may mark-to-model, where this can be demonstrated to be prudent. Marking-to-model is defined as any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input. When marking to model, an extra degree of conservatism is appropriate. Supervisory authorities will consider the following in assessing whether a mark-to-model valuation is prudent:
■	Senior management should be aware of the elements of the trading book which are subject to mark to model and should understand the materiality of the uncertainty this creates in the reporting of the risk/performance of the business.
■	Market inputs should be sourced, to the extent possible, in line with market prices (as discussed above). The appropriateness of the market inputs for the particular position being valued should be reviewed regularly.
■	Where available, generally accepted valuation methodologies for particular products should be used as far as possible.
■	Where the model is developed by the institution itself, it should be based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process. The model should be developed or approved independently of the front office. It should be independently tested. This includes validating the mathematics, the assumptions and the software implementation.
■	There should be formal change control procedures in place and a secure copy of the model should be held and periodically used to check valuations.
■	Risk management should be aware of the weaknesses of the models used and how best to reflect those in the valuation output.
■	The model should be subject to periodic review to determine the accuracy of its performance (e.g. assessing continued appropriateness of the assumptions, analysis of P&L versus risk factors, comparison of actual close out values to model outputs).
■	Valuation adjustments should be made as appropriate, for example, to cover the uncertainty of the model valuation (see also valuation adjustments in 698 to 701).
The revised paragraph would read as follow
Only where marking-to-market is not possible, should banks mark-to-model, but this must be demonstrated to be prudent. Marking-to-model is defined as any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input. When marking to model, an extra degree of conservatism is appropriate. Supervisory authorities will consider the following in assessing whether a mark-to-model valuation is prudent:
■	Senior management should be aware of the elements of the trading book or of other fair-valued positions which are subject to mark to model and should understand the materiality of the uncertainty this creates in the reporting of the risk/performance of the business.
■	Market inputs should be sourced, to the extent possible, in line with market prices (as discussed above). The appropriateness of the market inputs for the particular position being valued should be reviewed regularly.
■	Where available, generally accepted valuation methodologies for particular products should be used as far as possible.
■	Where the model is developed by the institution itself, it should be based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process. The model should be developed or approved independently of the front office. It should be independently tested. This includes validating the mathematics, the assumptions and the software implementation.
■	There should be formal change control procedures in place and a secure copy of the model should be held and periodically used to check valuations.
■	Risk management should be aware of the weaknesses of the models used and how best to reflect those in the valuation output.
■	The model should be subject to periodic review to determine the accuracy of its performance (eg assessing continued appropriateness of the assumptions, analysis of P&L versus risk factors, comparison of actual close out values to model outputs).
■	Valuation adjustments should be made as appropriate, for example, to cover the uncertainty of the model valuation (see also valuation adjustments in 698 to 701).
(Refer to revisions to the Basel II Market Risk Framework 2010 (718 cv))
The following guideline to be included in Section 2 “Prudent valuation guidance ” (iii) Valuation adjustments or reserves, Page 71/72 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
The original paragraph was as follows:
698.	Banks must establish and maintain procedures for considering valuation adjustments/reserves. Supervisory authorities expect banks using third-party valuations to consider whether valuation adjustments are necessary. Such considerations are also necessary when marking to model.
The revised paragraph would read as follow
698.	As part of their procedures for marking to market, banks must establish and maintain procedures for considering valuation adjustments/reserves. Supervisory authorities expect banks using third-party valuations to consider whether valuation adjustments are necessary. Such considerations are also necessary when marking to model.
(Refer to revisions to the Basel II Market Risk Framework 2010 (718 cviii))
The following guideline would be a new subsection to be included in Section 2 “Prudent valuation guidance ” (iv) Adjustment to the current valuation of less liquid positions for regulatory capital purposes, Page 71/72 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
Adjustment to the current valuation of less liquid positions for regulatory capital purposes
701 A.	Banks must establish and maintain procedures for judging the necessity of and calculating an adjustment to the current valuation of less liquid positions for regulatory capital purposes. This adjustment may be in addition to any changes to the value of the position required for financial reporting purposes and should be designed to reflect the illiquidity of the position. SAMA expect banks to consider the need for an adjustment to a position‘s valuation to reflect current illiquidity whether the position is marked to market using market prices or observable inputs, third-party valuations or marked to model.
Bearing in mind that assumptions made about liquidity in the market risk capital charge may not be consistent with the bank‘s ability to sell or hedge out less liquid positions where appropriate, banks must take an adjustment to the current valuation of these positions, and review their continued appropriateness on an on-going basis. Reduced liquidity may have arisen from market events. Additionally, close-out prices for concentrated positions and/or stale positions should be considered in establishing the adjustment. Banks must consider all relevant factors when determining the appropriateness of the adjustment for less liquid positions. These factors may include, but are not limited to, the amount of time it would take to hedge out the position/risks within the position, the average volatility of bid/offer spreads, the availability of independent market quotes (number and identity of market makers), the average and volatility of trading volumes (including trading volumes during periods of market stress), market concentrations, the aging of positions, the extent to which valuation relies on marking-to-model, and the impact of other model risks not included in paragraph 718 (cx), the Basel II Market Risk Framework 2010.
For complex products including, but not limited to, securitisation exposures and n-th-to-default credit derivatives, banks must explicitly assess the need for valuation adjustments to reflect two forms of model risk: the model risk associated with using a possibly incorrect valuation methodology; and the risk associated with using unobservable (and possibly incorrect) calibration parameters in the valuation model.
The adjustment to the current valuation of less liquid positions made under paragraph 718 (cxi), the Basel II Market Risk Framework 2010, must impact Tier 1 regulatory capital and may exceed those valuation adjustments made under financial reporting standards and paragraphs 718 (cviii) and 718 (cix), the Basel II Market Risk Framework 2010 (Refer to revisions to the Basel II Market Risk Framework 2010 (718 cx))
The following guideline to be included in B “Specific Changes with regard to Market Risk Under Basel II.5”, Page 20 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
Original Paragraph to be deleted:
•	Para 709 (ii)1 relating to co-relation Trading portfolio – refer to para 709.
•	Para 709 (ii-1)1: Transitional period to 31/12/2013 for securitized exposure which are not included in the corelation trading portfolio according to para 709ii.
•	Para 712 (ii)1 of the Basel II Framework relating to specific risk for unrated securitized securities will be amended.
•	Changes as per para 712iii.
The amended paragraph would reads as follows:
709(ii).	The minimum capital requirement is expressed in terms of two separately calculated charges, one applying to the "specific risk" of each security, whether it is a short or a long position, and the other to the interest rate risk in the portfolio (termed "general market risk") where long and short positions in different securities or instruments can be offset. The bank must, however, determine the specific risk capital charge for the correlation trading portfolio as follows: The bank computes (i) the total specific risk capital charges that would apply just to the net long positions from the net long correlation trading exposures combined, and (ii) the total specific risk capital charges that would apply just to the net short positions from the net short correlation trading exposures combined. The larger of these total amounts is then the specific risk capital charge for the correlation trading portfolio.
709(ii-1-).	During a transitional period until 31 December 2013, the bank may exclude positions in securitisation instruments which are not included in the correlation trading portfolio from the calculation according to paragraph 709(ii) and determine the specific risk capital charge as follows: The bank computes (i) the total specific risk capital charge that would apply just to the net long positions in securitisation instruments in the trading book, and (ii) the total specific risk capital charge that would apply just to the net short positions in securitisation instruments in the trading book. The larger of these total amounts is then the specific risk capital charge for the securitisation positions in the trading book. This calculation must be undertaken separately from the calculation for the correlation trading portfolio.
709(iii).	The capital charge for specific risk is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer. In measuring the risk, offsetting will be restricted to matched positions in the identical issue (including positions in derivatives). Even if the issuer is the same, no offsetting will be permitted between different issues since differences in coupon rates, liquidity, call features, etc. mean that prices may diverge in the short run. (This clause is also referred to in a row above, in this annexure)
712(ii).	However, since this may in certain cases considerably underestimate the specific risk for debt instruments which have a high yield to redemption relative to government debt securities, SAMA will have the discretion:
•	To apply a higher specific risk charge to such instruments; and/or
•	To disallow offsetting for the purposes of defining the extent of general market risk between such instruments and any other debt instruments.
(Refer to Paragraph 709(ii), 709(ii-1-), and 712(ii) of Revisions to the Basel II Market Risk Framework – Dec 2010.)
(Refer to Paragraph 709(iii) International Convergence of Capital Measurement and Capital Standards – June 2006)
The following guideline to be included in 718(xxi) “Specific and general Market Risk”, Page 87 of the SAMA’s Finalized Guidance Document for the Implementation of Basel II.5, 2012
(In addition to the original text)
Original Paragraph to be deleted:
718 (xxi)	The capital charge for specific risk will be 8%, unless the portfolio is both liquid and well-diversified, in which case the charge will be 4%. Given the different characteristics of national markets in terms of marketability and concentration, national authorities will have discretion to determine the criteria for liquid and diversified portfolios. The general market risk charge will be 8%.
The amended paragraph would reads as follows:
The capital charge for specific risk and for general market risk will each be 8%.
(Refer to Paragraph 718(xxi) of Revisions to the Basel II Market Risk Framework – Dec 2010.)