ANNEXURE 7: Document Enhanced: Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

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The following guideline to be included in Section 4.3 “Qualitative Standards” (b), Page 46 of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004 Qualitative Standards

The unit should also conduct the initial and on-going validation of the internal model.

The following footnotes to be included in Section 4.3 Qualitative Standards of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

Page 46 Section 4.3 (b) - Further guidance regarding the standards that SAMA will expect can be found in paragraph 718(xcix) of Revisions to the Basel II market risk framework – Dec 2010

Page 46 Section 4.3 (c) - The report, Risk management guidelines for derivatives, issued by the Basel Committee in July 1994 further discusses the responsibilities of the board of directors and senior management.

Page 47 Section 4.3 (f) - Though banks will have some discretion as to how they conduct stress tests, their SAMA will wish to see that they follow the general lines set out in paragraphs 718(Lxxvii) to 718(Lxxxiiii) of Revisions to the Basel II market risk framework – Dec 2010f

(Refer to Paragraph 718(Lxxiv) of Revisions to the Basel II market risk framework – Dec 2010)

The following guideline is added to Section 4.4 “Specification of Market Risk Factors” (a), Page 48 of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

Specification of market risk factors

(a)

Factors that are deemed relevant for pricing should be included as risk factors in the value-at-risk model. Where a risk factor is incorporated in a pricing model but not in the value-at-risk model, the bank must justify this omission to the satisfaction of SAMA. In addition, the value-at-risk model must capture nonlinearities for options and other relevant products (e.g. mortgage-backed securities, tranched exposures or n-th-to-default credit derivatives), as well as correlation risk and basis risk (e.g. between credit default swaps and bonds). Moreover, SAMA has to be satisfied that proxies are used which show a good track record for the actual position held (i.e. an equity index for a position in an individual stock).

(Refer to Paragraph 718(Lxxv)(a) of Revisions to the Basel II Market Risk Frameworks – Dec 2010)

The following guideline to be included in Section 4.5 “Quantitative Standards”, Page 50 of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

Quantitative standards

Original Paragraph to be deleted:

(c)

In calculating value-at-risk, an instantaneous price shock equivalent to a 10 days movement in prices is to be used, i.e. the minimum "holding period" will be ten trading days. Banks may use value-at-risk numbers calculated according to shorter holding periods scaled up to ten days by the square root of time (for the treatment of options, also see (h) below).

The amended paragraph would reads as follows:

(c)

Original Paragraph to be deleted:

(e)

Banks should update their data sets no less frequently than once every three months and should also reassess them whenever market prices are subject to material changes. SAMA may also require a bank to calculate its value-at-risk using a shorter observation period if, in SAMA‘s judgment, this is justified by a significant upsurge in price volatility.

The amended paragraph would reads as follows:

(e)

Banks should update their data sets no less frequently than once every three months and should also reassess them whenever market prices are subject to material changes. This updating process must be flexible enough to allow for more frequent updates. SAMA may also require a bank to calculate its value-at-risk using a shorter observation period if, in the SAMA‘s judgment, this is justified by a significant upsurge in price volatility.

Original Paragraph to be deleted:

(i)

Each bank must meet, on a daily basis, a capital requirement expressed as the higher of (I) its previous day‘s value- at-risk number measure according to the parameters specified in this section and (ii) an average of the daily value-at-risk measures on each of the preceding sixty business days, multiplied by a multiplication factor.

The amended paragraph would reads as follows:

(i)

In addition, a bank must calculate a ‗stressed value-at-risk‘ measure. This measure is intended to replicate a value-at-risk calculation that would be generated on the bank‘s current portfolio if the relevant market factors were experiencing a period of stress; and should therefore be based on the 10-day, 99th percentile, one-tailed confidence interval value-at- risk measure of the current portfolio, with model inputs calibrated to historical data from a continuous 12-month period of significant financial stress relevant to the bank‘s portfolio. The period used must be approved by SAMA and regularly reviewed. As an example, for many portfolios, a 12-month period relating to significant losses in 2007/2008 would adequately reflect a period of such stress; although other periods relevant to the current portfolio must be considered by the bank.

As no particular model is prescribed under paragraph (f) above, different techniques might need to be used to translate the model used for value-at-risk into one that delivers a stressed value-at-risk. For example, banks should consider applying anti-thetic14 data, or applying absolute rather than relative volatilities to deliver an appropriate stressed value- at-risk. The stressed value-at-risk should be calculated at least weekly.

Each bank must meet, on a daily basis, a capital requirement expressed as the sum of:

■

The higher of (1i) its previous day‘s value-at-risk number measured according to the parameters specified in this section (VaRt-1); and (2ii) an average of the daily value-at-risk measures on each of the preceding sixty business days (VaRavg), multiplied by a multiplication factor (mc);

plus.

■

The higher of (1) its latest available stressed-value-at-risk number calculated according to (i) above (sVaRt-1); and (2) an average of the stressed value-at-risk numbers calculated according to (i) above over the preceding sixty business days (sVaRavg), multiplied by a multiplication factor (ms).

Therefore, the capital requirement (c) is calculated according to the following formula:

Original Paragraph to be deleted:

(j)

The multiplication factor will be set by SAMA on the basis of their assessment of the quality of the bank‘s risk management system, subject to an absolute minimum of 3. Banks will be required to add to this factor a "plus" directly related to the ex-post performance of the model, thereby introducing a built-in positive incentive to keep high the predictive quality of the model. The plus will range from 0 to 1 based on the outcome of so-called "backtesting". If the backtesting results are satisfactory and the bank meets all of the qualitative and quantative standards the plus factor could be zero.

In specific the following methods is to be appropriated:

Multiplication Factor

The multiplication factor is the summation of the following three elements.

(a)

The minimum multiplication factor of 3;

(b)

The "plus" factor ranging from 0 to 1 based on the number of back testing exceptions in the past 250 trading days as set out in Table below, or the backtesting "plus" factor agreed with SAMA; and

(c)

Any additional "plus" factor as agreed with SAMA

"Plus" Factor Based on the Number of Backtesting

Exceptions for the Past 250 Trading Days

Number of Exceptions "Plus" factor

0	0.00
1	0.00

Green zone
2	0.00
3	0.00
4	0.00
5	0.40
6	0.50
Yellow zone
7	0.65
8	0.75
9	0.85
Red zone
10 or more	1.00

The amended paragraph would reads as follows:

The multiplication factors mc and ms will be set by SAMA on the basis of their assessment of the quality of the bank‘s risk management system, subject to an absolute minimum of 3 for mc and an absolute minimum of 3 for ms. Banks will be required to add to these factors a "plus" directly related to the ex-post performance of the model, thereby introducing a built-in positive incentive to maintain the predictive quality of the model. The plus will range from 0 to 1 based on the outcome of so-called "backtesting. " The backtesting results applicable for calculating the plus are based on value-at-risk only and not stressed value-at-risk. If the backtesting results are satisfactory and the bank meets all of the qualitative standards set out in paragraph 718(Lxxiv), Revisions to the Basel II Market Risk Frameworks – Dec 2010, the plus factor could be zero. The Annex 10a of this Framework (International Convergence of Capital Measurement and Capital Standards – June 2006) presents in detail the approach to be applied for backtesting and the plus factor. SAMA will have national discretion to require banks to perform backtesting on either hypothetical (i.e. using changes in portfolio value that would occur were end-of-day positions to remain unchanged), or actual trading (i.e. excluding fees, commissions, and net interest income) outcomes, or both.

Original Paragraph to be deleted:

(k)

As stated earlier in Section 4.1 banks using models will be subject to a separate capital charge to cover the specific risk of interest rate related instruments and equity securities as defined in the standardized approach to the extent that this risk is not incorporated into their models. However, for banks using models, the total specific risk charge applied to interest rate related instruments or to equities should in no case be less than half the specific risk charges calculated according to the standardized methodology.

The amended paragraph would reads as follows:

Banks using models will also be subject to a capital charge to cover specific risk (as defined under the standardised approach for market risk) of interest rate related instruments and equity securities. The manner in which the specific risk capital charge is to be calculated is set out in paragraphs 718(Lxxxvii) to 718(xcviii), Revisions to the Basel II Market Risk Frameworks – Dec 2010

The following footnotes to be included in Section 4.5 of the SAMA‘s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

Page 50 Section 4.5 (d) - A bank may calculate the value-at-risk estimate using a weighting scheme that is not fully consistent with (d) as long as that method results in a capital charge at least as conservative as that calculated according to (d)

Page 52 Section 4.5 (j) - Firms should consider modelling valuation changes that are based on the magnitude of historic price movements, applied in both directions – irrespective of the direction of the historic movement.

(Refer to Paragraph 718(Lxxvi) of Revisions to the Basel II Market Risk Frameworks – Dec 2010)

The following guidelines to be included in Section 4.9 “Combination of Internal Models and the Standardized Methodology” point (a) Pg 58 of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

(The following is added to the original content)

However, banks may incur risks in positions which are not captured by their models, for example, in remote locations, in minor currencies or in negligible business areas. Such risks should be measured according to the standardised methodology

(Refer to Paragraph 718(Lxxxvi) of Revisions to the Basel II market risk framework – Dec 2010)

The following guidelines to be included in Section 4.7" Stress Testing" (a)Scenarios requiring no simulations by the bank, Pg 56 of the SAMA‘s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004

The original paragraph was as follows

Scenarios requiring a simulation by the bank.

Banks should subject their portfolios to a series of simulated stress scenarios and provide SAMA with the results. These scenarios could include testing the current portfolio against past periods of significant disturbance, for example the 1987 equity crash, the ERM crisis of 1993 or the fall in bond markets in the first quarter of 1994, incorporating both the large price movements and the sharp reduction in liquidity associated with these events. A second type of scenario would evaluate the sensitivity of the bank‘s market risk exposure to changes in the assumptions about volatilities and correlation. Applying this test would require an evaluation of the historical range of variation for volatilities and correlation‘s and evaluation of the bank‘s current positions against the extreme values of the historical range. Due consideration should be given to the sharp variation that at times has occurred in a matter of days in periods of significant market disturbance. The 1987 equity crash, the suspension of the ERM, or the fall in bond markets in the first quarter of 1994, for example, all involved correlation within risk factors approaching the extreme values of 1 or -1 for several days at the height of the disturbance.

The revised paragraph would read as follows:

Scenarios requiring a simulation by the bank

Banks should subject their portfolios to a series of simulated stress scenarios and provide SAMA with the results. These scenarios could include testing the current portfolio against past periods of significant disturbance, for example, the 1987 equity crash, the Exchange Rate Mechanism crises of 1992 and 1993 or, the fall in bond markets in the first quarter of 1994, the 1998 Russian financial crisis, the 2000 bursting of the technology stock bubble or the 2007/2008 sub-prime crisis, incorporating both the large price movements and the sharp reduction in liquidity associated with these events. A second type of scenario would evaluate the sensitivity of the bank‘s market risk exposure to changes in the assumptions about volatilities and correlations. Applying this test would require an evaluation of the historical range of variation for volatilities and correlations and evaluation of the bank‘s current positions against the extreme values of the historical range. Due consideration should be given to the sharp variation that at times has occurred in a matter of days in periods of significant market disturbance. For example, the above-mentioned situations involved correlations within risk factors approaching the extreme values of 1 or -1 for several days at the height of the disturbance.

(Refer to Paragraph 718 (Lxxxii of Revisions to the Basel II Market Risk Frameworks – Dec 2010

The following guidelines to be included as a separate section “Treatment of specific risk” on Pg 53 of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004 as a replacement of the original section 4.6, Specific Risk Calculation, Pg 53 of the SAMA’s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004.

Where a bank has a VaR measure that incorporates specific risk from equity risk positions and where the supervisor has determined that the bank meets all the qualitative and quantitative requirements for general market risk models, as well as the additional criteria and requirements set out in paragraphs 718(Lxxxviii) to 718(xci-2-) Revisions to the Basel II market risk framework – Dec 2010, the bank is not required to subject its equity positions to the capital charge according to the standardised measurement method as specified in paragraphs 718(xix) to 718(xxviii) Revisions to the Basel II market risk framework – Dec 2010.

For interest rate risk positions other than securitisation exposures and n-th-to-default credit derivatives, the bank will not be required to subject these positions to the standardised capital charge for specific risk, as specified in paragraphs 709(ii) to 718, Revisions to the Basel II market risk framework – Dec 2010, when all of the following conditions hold:

■

The bank has a value-at-risk measure that incorporates specific risk and SAMA has determined that the bank meets all the qualitative and quantitative requirements for general market risk models, as well as the additional criteria and requirements set out in paragraphs 718(Lxxxviii) to 718(xci-2-), Revisions to the Basel II market risk framework – Dec 2010; and

■

SAMA is satisfied that the bank‘s internally developed approach adequately captures incremental default and migration risks for positions subject to specific interest rate risk according to the standards laid out in paragraphs 718(xcii) and 718(xciii), Revisions to the Basel II market risk framework – Dec 2010.

The bank is allowed to include its securitisation exposures and n-th-to-default credit derivatives in its value-at-risk measure. Notwithstanding, it is still required to hold additional capital for these products according to the standardised measurement methodology, with the exceptions noted in paragraphs 718(xcv) to 718(xcviii), Revisions to the Basel II market risk framework – Dec 2010.

Treatment of specific risk

The criteria for supervisory recognition of banks‘ modelling of specific risk require that a bank‘s model must capture all material components of price risk Banks need not capture default and migration risks for positions subject to the incremental risk capital charge referred to in paragraphs 718(xcii) and 718(xciii) Revisions to the Basel II market risk framework – Dec 2010) and be responsive to changes in market conditions and compositions of portfolios. In particular, the model must:

•

Explain the historical price variation in the portfolio; (The key ex ante measures of model quality are "goodness-of-fit" measures which address the question of how much of the historical variation in price value is explained by the risk factors included within the model. One measure of this type which can often be used is an R-squared measure from regression methodology. If this measure is to be used, the risk factors included in the bank‘s model would be expected to be able to explain a high percentage, such as 90%, of the historical price variation or the model should explicitly include estimates of the residual variability not captured in the factors included in this regression. For some types of models, it may not be feasible to calculate a goodness-of-fit measure. In such instance, a bank is expected to work with SAMA to define an acceptable alternative measure which would meet this regulatory objective.)

•

Capture concentrations (magnitude and changes in composition); (The bank would be expected to demonstrate that the model is sensitive to changes in portfolio construction and that higher capital charges are attracted for portfolios that have increasing concentrations in particular names or sectors.)

•

Be robust to an adverse environment; (The bank should be able to demonstrate that the model will signal rising risk in an adverse environment. This could be achieved by incorporating in the historical estimation period of the model at least one full credit cycle and ensuring that the model would not have been inaccurate in the downward portion of the cycle. Another approach for demonstrating this is through simulation of historical or plausible worst-case environments.)

•

Capture name-related basis risk; (Banks should be able to demonstrate that the model is sensitive to material idiosyncratic differences between similar but not identical positions, for example debt positions with different levels of subordination, maturity mismatches, or credit derivatives with different default events.)

•

Capture event risk; (For equity positions, events that are reflected in large changes or jumps in prices must be captured, e.g. merger break-ups/takeovers. In particular, firms must consider issues related to survivorship bias.)

•

Be validated through backtesting (Aimed at assessing whether specific risk, as well as general market risk, is being captured adequately.)

The bank's model must conservatively assess the risk arising from less liquid positions and/or positions with limited price transparency under realistic market scenarios. In addition, the model must meet minimum data standards. Proxies may be used only where available data is insufficient or is not reflective of the true volatility of a position or portfolio, and only where they are appropriately conservative.

Further, as techniques and best practices evolve, banks should avail themselves of these advances.

Banks which apply modelled estimates of specific risk are required to conduct backtesting aimed at assessing whether specific risk is being accurately captured. The methodology a bank should use for validating its specific risk estimates is to perform separate backtests on sub-portfolios using daily data on sub-portfolios subject to specific risk. The key sub- portfolios for this purpose are traded-debt and equity positions. However, if a bank itself decomposes its trading portfolio into finer categories (e.g. emerging markets, traded corporate debt, etc.), it is appropriate to keep these distinctions for sub-portfolio backtesting purposes. Banks are required to commit to a sub-portfolio structure and stick to it unless it can be demonstrated to SAMA that it would make sense to change the structure.

Banks are required to have in place a process to analyse exceptions identified through the backtesting of specific risk. This process is intended to serve as the fundamental way in which banks correct their models of specific risk in the event they become inaccurate. There will be a presumption that models that incorporate specific risk are "unacceptable" if the results at the sub-portfolio level produce a number of exceptions commensurate with the Red Zone as defined in Annex 10a of this Framework (International Convergence of Capital Measurement and Capital Standards – June 2006). Banks with "unacceptable" specific risk models are expected to take immediate action to correct the problem in the model and to ensure that there is a sufficient capital buffer to absorb the risk that the backtest showed had not been adequately captured.

In addition,

The bank must have an approach in place to capture in its regulatory capital default risk and migration risk in positions subject to a capital charge for specific interest rate risk, with the exception of securitisation exposures and n-th-to-default credit derivatives, that are incremental to the risks captured by the VaR-based calculation as specified in paragraph 718(Lxxxviii) of Revisions to the Basel II market risk framework – Dec 2010 ("incremental risks"). No specific approach for capturing the incremental default risks is prescribed; The Committee provides guidelines to specify the positions and risks to be covered by this incremental risk capital charge. meets its aim.

The bank must demonstrate that it the approach used to capture incremental risks meets a soundness standard comparable to that of the internal-ratings based approach for credit risk as set forth in this Framework, under the assumption of a constant level of risk, and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging, and optionality. A bank that does not capture the incremental default risks through an internally developed approach must use the specific risk capital charges under the standardised measurement method as set out in paragraphs 710 to 718 and 718(xxi) of Revisions to the Basel II market risk framework – Dec 2010 / International Convergence of Capital Measurement and Capital Standards – June 2006 (for paragraph not superseded by Revisions to the Basel II market risk framework, 2010.

Subject to SAMA‘s approval, a bank may incorporate its correlation trading portfolio in an internally developed approach that adequately captures not only incremental default and migration risks, but all price risks ("comprehensive risk measure"). The value of such products is subject in particular to the following risks which must be adequately captured:

•

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.

The approach must meet all of the requirements specified in paragraphs 718(XCiii), 718(XCvi) and 718(xcvii) of Revisions to the Basel II market risk framework – Dec 2010. This exception only applies to banks that are active in buying and selling these products. For the exposures that the bank does incorporate in this internally developed approach, the bank will be required to subject them to a capital charge equal to the higher of the capital charge according to this internally developed approach and 8% of the capital charge for specific risk according to the standardised measurement method. It will not be required to subject these exposures to the treatment according to paragraph 718(XCiii) of Revisions to the Basel II market risk framework – Dec 2010. It must, however, incorporate them in both the value-at-risk and stressed value-at-risk measures

For a bank to apply this exception, it must

•

Have sufficient market data to ensure that it fully captures the salient risks of these exposures in its comprehensive risk measure in accordance with the standards set forth above;

•

Demonstrate (for example, through backtesting) that its risk measures can appropriately explain the historical price variation of these products; and

•

Ensure that it can separate the positions for which it holds approval to incorporate them in its comprehensive risk measure from those positions for which it does not hold this approval.

In addition to these data and modelling criteria, for a bank to apply this exception it must regularly apply a set of specific, predetermined stress scenarios to the portfolio that receives internal model regulatory capital treatment (i.e., the ‗correlation trading portfolio‘). These stress scenarios will examine the implications of stresses to (i) default rates, (ii) recovery rates, (iii) credit spreads, and (iv) correlations on the correlation trading desk‘s P&L. The bank must apply these stress scenarios at least weekly and report the results, including comparisons with the capital charges implied by the banks‘ internal model for estimating comprehensive risks, at least quarterly to SAMA. Any instances where the stress tests indicate a material shortfall of the comprehensive risk measure must be reported to SAMA in a timely manner. Based on these stress testing results, SAMA may impose a supplemental capital charge against the correlation trading portfolio, to be added to the bank‘s internally modelled capital requirement. For guidance on conducting stress tests for correlation trading portfolio, refer Annex of Revisions to the Basel II market risk framework – Dec 2010.

A bank must calculate the incremental risk measure according to paragraph 718(xcii) of Revisions to the Basel II market risk framework – Dec 2010, and the comprehensive risk measure according to paragraph 718(xcv) of Revisions to the Basel II market risk framework – Dec 2010, at least weekly, or more frequently as directed by SAMA. The capital charge for incremental risk is given by a scaling factor of 1.0 times the maximum of (i) the average of the incremental risk measures over 12 weeks; and (ii) the most recent incremental risk measure. Likewise, the capital charge for comprehensive risk is given by a scaling factor of 1.0 times the maximum of (i) the average of the comprehensive risk measures over 12 weeks; and (ii) the most recent comprehensive risk measure. Both capital charges are added up. There will be no adjustment for double counting between the comprehensive risk measure and any other risk measures.

(Refer to Paragraph 718(xc) of Revisions to the Basel II market risk framework – Dec 2010)

The following guidelines to be included as a separate section "Model Validation Standards" on Pg 55 of the SAMA‘s Detailed Guidelines Notes on the Maintenance of Adequate Capital Against Market Risk by Saudi Banks, 2004 Model Validation Standards

It is important that banks have processes in place to ensure that their internal models have been adequately validated by suitably qualified parties independent of the development process to ensure that they are conceptually sound and adequately capture all material risks. This validation should be conducted when the model is initially developed and when any significant changes are made to the model. The validation should also be conducted on a periodic basis but especially where there have been any significant structural changes in the market or changes to the composition of the portfolio which might lead to the model no longer being adequate. More extensive model validation is particularly important where specific risk is also modelled and is required to meet the further specific risk criteria. As techniques and best practices evolve, banks should avail themselves of these advances. Model validation should not be limited to backtesting, but should, at a minimum, also include the following:

(a)

Tests to demonstrate that any assumptions made within the internal model are appropriate and do not underestimate risk. This may include the assumption of the normal distribution, the use of the square root of time to scale from a one day holding period to a 10 day holding period or where extrapolation or interpolation techniques are used, or pricing models;

(b)

Further to the regulatory backtesting programmes, testing for model validation should be carried out using additional tests, which may include, for instance:

•

Testing carried out using hypothetical changes in portfolio value that would occur were end-of-day positions to remain unchanged. It therefore excludes fees, commissions, bid-ask spreads, net interest income and intra-day trading;

•

Testing carried out for longer periods than required for the regularbacktesting programme (e.g. 3 years). The longer time period generally improves the power of the backtesting. A longer time period may not be desirable if the VaR model or market conditions have changed to the extent that historical data is no longer relevant;

•

Testing carried out using confidence intervals other than the 99 percent interval required under the quantitative standards;

•

Testing of portfolios below the overall bank level;

(c)

The use of hypothetical portfolios to ensure that the model is able to account for particular structural features that may arise, for example:

Where data histories for a particular instrument do not meet the quantitative standards in paragraph 718(Lxxvi) and where the bank has to map these positions to proxies, then the bank must ensure that the proxies produce conservative results under relevant market scenarios;

•

Ensuring that material basis risks are adequately captured. This may include mismatches between long and short positions by maturity or by issuer;

•

Ensuring that the model captures concentration risk that may arise in an undiversified portfolio.

(Refer to Paragraph 718(xcix) of Revisions to the Basel II market risk framework – Dec 2010)

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