# FDIC FIL-26-2012: Risk-based Capital Rules Final Rule on Risk-Based Capital Standards: Market Risk

> Federal · Agency guidance · Superseded

URL: https://www.frixlaw.com/law-library/statutes/FDIC_FIL12026

## Section

- **Citation:** FDIC FIL-26-2012
- **Heading:** Risk-based Capital Rules Final Rule on Risk-Based Capital Standards: Market Risk
- **Jurisdiction:** Federal
- **Kind:** Agency guidance
- **Status:** Superseded
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** FDIC Financial Institution Letters / Risk-based Capital Rules Final Rule on Risk-Based Capital Standards: Market Risk

## Text

Vol. 77
Thursday,
No. 169
August 30, 2012
Part V
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 3
Federal Reserve System
12 CFR Parts 208 and 225
Federal Deposit Insurance Corporation
12 CFR Part 325
Risk-Based Capital Guidelines: Market Risk; Rule
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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
1 For simplicity, and unless otherwise indicated,
the preamble to this final rule uses the term ‘‘bank’’
to include banks and bank holding companies
(BHCs). The terms ‘‘bank holding company’’ and
‘‘BHC’’ refer only to bank holding companies
regulated by the Board.
2 The BCBS is a committee of banking supervisory
authorities, which was established by the central
bank governors of the G–10 countries in 1975. It
consists of senior representatives of bank
supervisory authorities and central banks from
Argentina, Australia, Belgium, Brazil, Canada,
China, France, Germany, Hong Kong SAR, India,
Indonesia, Italy, Japan, Korea, Luxembourg, Mexico,
the Netherlands, Russia, Saudi Arabia, Singapore,
South Africa, Spain, Sweden, Switzerland, Turkey,
the United Kingdom, and the United States.
Documents issued by the BCBS are available
through the Bank for International Settlements Web
site at http://www.bis.org.
3 The agencies’ general risk-based capital rules are
at 12 CFR part 3, appendix A and 12 CFR part 167
(OCC); 12 CFR parts 208 and 225, appendix A
(Board); and 12 CFR part 325, appendix A (FDIC).
4 In 1997, the BCBS modified the MRA to remove
a provision pertaining to the specific risk capital
requirement under the internal models approach
(see http://www.bis.org/press/p970918a.htm)
is.org.
3 The agencies’ general risk-based capital rules are
at 12 CFR part 3, appendix A and 12 CFR part 167
(OCC); 12 CFR parts 208 and 225, appendix A
(Board); and 12 CFR part 325, appendix A (FDIC).
4 In 1997, the BCBS modified the MRA to remove
a provision pertaining to the specific risk capital
requirement under the internal models approach
(see http://www.bis.org/press/p970918a.htm).
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
[Docket ID: OCC–2012–0002]
RIN 1557–AC99
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R–1401]
RIN 7100–AD61
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064–AD70
Risk-Based Capital Guidelines: Market
Risk
AGENCY: Office of the Comptroller of the
Currency, Department of the Treasury;
Board of Governors of the Federal
Reserve System; and Federal Deposit
Insurance Corporation.
ACTION: Joint final rule.
SUMMARY: The Office of the Comptroller
of the Currency (OCC), Board of
Governors of the Federal Reserve
System (Board), and Federal Deposit
Insurance Corporation (FDIC) are
revising their market risk capital rules to
better capture positions for which the
market risk capital rules are appropriate;
reduce procyclicality; enhance the rules’
sensitivity to risks that are not
adequately captured under current
methodologies; and increase
transparency through enhanced
disclosures. The final rule does not
include all of the methodologies
adopted by the Basel Committee on
Banking Supervision for calculating the
standardized specific risk capital
requirements for debt and securitization
positions due to their reliance on credit
ratings, which is impermissible under
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010.
Instead, the final rule includes
alternative methodologies for
calculating standardized specific risk
capital requirements for debt and
securitization positions.
DATES: The final rule is effective January
1, 2013
r debt and securitization
positions due to their reliance on credit
ratings, which is impermissible under
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010.
Instead, the final rule includes
alternative methodologies for
calculating standardized specific risk
capital requirements for debt and
securitization positions.
DATES: The final rule is effective January
1, 2013.
FOR FURTHER INFORMATION CONTACT:
OCC: Roger Tufts, Senior Economic
Advisor, Capital Policy Division, (202)
874–4925, or Ron Shimabukuro, Senior
Counsel, or Carl Kaminski, Senior
Attorney, Legislative and Regulatory
Activities Division, (202) 874–5090,
Office of the Comptroller of the
Currency, 250 E Street SW.,
Washington, DC 20219.
Board: Anna Lee Hewko, Assistant
Director, (202) 530–6260, Connie
Horsley, Manager, (202) 452–5239, Tom
Boemio, Manager, (202) 452–2982,
Dwight Smith, Senior Supervisory
Financial Analyst, (202) 452–2773, or
Jennifer Judge, Supervisory Financial
Analyst, (202) 452–3089, Capital and
Regulatory Policy, Division of Banking
Supervision and Regulation; or
Benjamin W. McDonough, Senior
Counsel, (202) 452–2036, or April C.
Snyder, Senior Counsel, (202) 452–
3099, Legal Division. For the hearing
impaired only, Telecommunication
Device for the Deaf (TDD), (202) 263–
4869.
FDIC: Karl Reitz, Chief, Capital
Markets Strategies Section,
kreitz@fdic.gov; Bobby R. Bean,
Associate Director, bbean@fdic.gov;
Ryan Billingsley, Chief, Capital Policy
Section, rbillingsley@fdic.gov; David
Riley, Senior Policy Analyst,
dariley@fdic.gov, Capital Markets
Branch, Division of Risk Management
Supervision, (202) 898–6888; or Mark
Handzlik, Counsel, mhandzlik@fdic.gov,
Michael Phillips, Counsel,
mphillips@fdic.gov, Greg Feder,
Counsel, gfeder@fdic.gov, or Ryan
Clougherty, Senior Attorney,
rclougherty@fdic.gov; Supervision
Branch, Legal Division, Federal Deposit
Insurance Corporation, 550 17th Street
NW., Washington, DC 20429
Capital Markets
Branch, Division of Risk Management
Supervision, (202) 898–6888; or Mark
Handzlik, Counsel, mhandzlik@fdic.gov,
Michael Phillips, Counsel,
mphillips@fdic.gov, Greg Feder,
Counsel, gfeder@fdic.gov, or Ryan
Clougherty, Senior Attorney,
rclougherty@fdic.gov; Supervision
Branch, Legal Division, Federal Deposit
Insurance Corporation, 550 17th Street
NW., Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Overview of Comments
1. Comments on the January 2011 Proposal
2. Comments on the December 2011
Amendment
III. Description of the Final Market Risk
Capital Rule
1. Scope
2. Reservation of Authority
3. Definition of Covered Position
4. Requirements for the Identification of
Trading Positions and Management of
Covered Positions
5. General Requirements for Internal
Models
Model Approval and Ongoing Use
Requirements
Risks Reflected in Models
Control, Oversight, and Validation
Mechanisms
Internal Assessment of Capital Adequacy
Documentation
6. Capital Requirement for Market Risk
Determination of the Multiplication Factor
7. VaR-based Capital Requirement
Quantitative Requirements for VaR-based
Measure
8. Stressed VaR-based Capital Requirement
Quantitative Requirements for Stressed
VaR-based Measure
9. Modeling Standards for Specific Risk
10. Standardized Specific Risk Capital
Requirement
Debt and Securitization Positions
Treatment Under the Standardized
Measurement Method for Specific Risk
for
Modeled Correlation Trading Positions and
Non-modeled Securitization Positions
Equity Positions
Due Diligence Requirements for
Securitization Positions
11. Incremental Risk Capital Requirement
12. Comprehensive Risk Capital
Requirement
13. Disclosure Requirements
IV. Regulatory Flexibility Act Analysis
V. OCC Unfunded Mandates Reform Act of
1995 Determination
VI. Paperwork Reduction Act
VII. Plain Language
I
ng Positions and
Non-modeled Securitization Positions
Equity Positions
Due Diligence Requirements for
Securitization Positions
11. Incremental Risk Capital Requirement
12. Comprehensive Risk Capital
Requirement
13. Disclosure Requirements
IV. Regulatory Flexibility Act Analysis
V. OCC Unfunded Mandates Reform Act of
1995 Determination
VI. Paperwork Reduction Act
VII. Plain Language
I. Introduction
The first international capital
framework for banks 1 entitled
International Convergence of Capital
Measurement and Capital Standards
(1988 Capital Accord) was developed by
the Basel Committee on Banking
Supervision (BCBS) 2 and endorsed by
the G–10 central bank governors in
1988. The OCC, the Board, and the FDIC
(collectively, the agencies) implemented
the 1988 Capital Accord in 1989
through the issuance of the general risk-
based capital rules.3 In 1996, the BCBS
amended the 1988 Capital Accord to
require banks to measure and hold
capital to cover their exposure to market
risk associated with foreign exchange
and commodity positions and positions
located in the trading account (the
Market Risk Amendment (MRA) or
market risk framework).4 The agencies
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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
5 61 FR 47358 (September 6, 1996). In 1996, the
Office of Thrift Supervision did not implement the
market risk framework for savings associations and
savings and loan holding companies. However, also
included in today’s Federal Register, the agencies
are proposing to expand the scope of their market
risk capital rules to apply to Federal and state
savings associations as well as savings and loan
holding companies
6, 1996). In 1996, the
Office of Thrift Supervision did not implement the
market risk framework for savings associations and
savings and loan holding companies. However, also
included in today’s Federal Register, the agencies
are proposing to expand the scope of their market
risk capital rules to apply to Federal and state
savings associations as well as savings and loan
holding companies. Therefore, the market risk rule
would not apply to savings associations or savings
and loan holding companies until such times as the
agencies’ were to finalize their proposal to expand
the scope of their market risk capital rules. The
agencies’ market risk capital rules are at 12 CFR
part 3, appendix B (OCC); 12 CFR parts 208 and
225, appendix E (Board); and 12 CFR part 325,
appendix C (FDIC).
6 The June 2010 revisions can be found in their
entirety at http://bis.org/press/p100618/annex.pdf.
7 In the context of the market risk capital rules,
the specific risk-weighting factor is a scaled
measure that is similar to the ‘‘risk weights’’ used
in the general risk-based capital rules (e.g., the zero,
20 percent, 50 percent, and 100 percent risk
weights) for determining risk-weighted assets. The
measure for market risk is multiplied by 12.5 to
convert it to market risk equivalent assets, which
are then added to the denominator of the risk-based
capital ratios.
8 76 FR 1890 (January 11, 2011).
implemented the MRA with an effective
date of January 1, 1997 (market risk
capital rule).5
In June 2004, the BCBS issued a
document entitled International
Convergence of Capital Measurement
and Capital Standards: A Revised
Framework (Basel II), which was
intended for use by individual countries
as the basis for national consultation
and implementation. Basel II sets forth
a ‘‘three-pillar’’ framework that includes
ffective
date of January 1, 1997 (market risk
capital rule).5
In June 2004, the BCBS issued a
document entitled International
Convergence of Capital Measurement
and Capital Standards: A Revised
Framework (Basel II), which was
intended for use by individual countries
as the basis for national consultation
and implementation. Basel II sets forth
a ‘‘three-pillar’’ framework that includes
(1) Risk-based capital requirements for
credit risk, market risk, and operational
risk (Pillar 1); (2) supervisory review of
capital adequacy (Pillar 2); and (3)
market discipline through enhanced
public disclosures (Pillar 3).
Basel II retained much of the MRA;
however, after its release, the BCBS
announced that it would develop
improvements to the market risk
framework, especially with respect to
the treatment of specific risk, which
refers to the risk of loss on a position
due to factors other than broad-based
movements in market prices. As a
result, in July 2005, the BCBS and the
International Organization of Securities
Commissions (IOSCO) jointly published
The Application of Basel II to Trading
Activities and the Treatment of Double
Default Effects (the 2005 revisions). The
BCBS incorporated the 2005 revisions
into the June 2006 comprehensive
version of Basel II and followed its
‘‘three-pillar’’ structure. Specifically, the
Pillar 1 changes narrow the types of
positions that are subject to the market
risk framework and revise modeling
standards and procedures for
calculating minimum regulatory capital
requirements. The Pillar 2 changes
require banks to conduct internal
assessments of their capital adequacy
with respect to market risk, taking into
account the output of their internal
models, valuation adjustments, and
stress tests
the types of
positions that are subject to the market
risk framework and revise modeling
standards and procedures for
calculating minimum regulatory capital
requirements. The Pillar 2 changes
require banks to conduct internal
assessments of their capital adequacy
with respect to market risk, taking into
account the output of their internal
models, valuation adjustments, and
stress tests. The Pillar 3 changes require
banks to disclose certain quantitative
and qualitative information, including
their valuation techniques for covered
positions, the soundness standard used
for modeling purposes, and their
internal capital adequacy assessment
methodologies.
The BCBS began work on significant
changes to the market risk framework in
2007 and developed reforms aimed at
addressing issues highlighted by the
financial crisis. These changes were
published in the BCBS’s Revisions to the
Basel II Market Risk Framework,
Guidelines for Computing Capital for
Incremental Risk in the Trading Book,
and Enhancements to the Basel II
Framework (collectively, the 2009
revisions).
The 2009 revisions place additional
prudential requirements on banks’
internal models for measuring market
risk and require enhanced qualitative
and quantitative disclosures,
particularly with respect to banks’
securitization activities. The revisions
also introduce an incremental risk
capital requirement to capture default
and credit quality migration risk for
non-securitization credit products. With
respect to securitizations, the 2009
revisions require banks to apply a
standardized measurement method for
specific risk to these positions, except
for ‘‘correlation trading’’ positions
(described further below), for which
banks may choose to model all material
price risks. The 2009 revisions also add
a stressed Value-at-Risk (VaR)-based
capital requirement to banks’ existing
general VaR-based capital requirement
the 2009
revisions require banks to apply a
standardized measurement method for
specific risk to these positions, except
for ‘‘correlation trading’’ positions
(described further below), for which
banks may choose to model all material
price risks. The 2009 revisions also add
a stressed Value-at-Risk (VaR)-based
capital requirement to banks’ existing
general VaR-based capital requirement.
In June 2010, the BCBS published
additional revisions to the market risk
framework including a floor on the risk-
based capital requirement for modeled
correlation trading positions (2010
revisions).6
Both the 2005 and 2009 revisions
include provisions that reference credit
ratings. The 2005 revisions also
expanded the ‘‘government’’ category of
debt positions to include all sovereign
debt and changed the standardized
specific risk-weighting factor for
sovereign debt from zero percent to a
range of zero to 12.0 percent based on
the credit rating of the obligor and the
remaining contractual maturity of the
debt position.7
The 2009 revisions include changes to
the specific risk-weighting factors for
rated and unrated securitization
positions. For rated securitization
positions, the revisions assign a specific
risk-weighting factor based on the credit
rating of a position, and whether such
rating represents a long-term credit
rating or a short-term credit rating. In
addition, the 2009 revisions provide for
the application of higher specific risk-
weighting factors to rated
resecuritization positions relative to
similarly-rated securitization exposures.
Under the 2009 revisions, unrated
securitization positions were to be
deducted from total capital, except
when the unrated position was held by
a bank that had approval and ability to
use the supervisory formula approach
(SFA) to determine the specific risk add-
on for the unrated position
g factors to rated
resecuritization positions relative to
similarly-rated securitization exposures.
Under the 2009 revisions, unrated
securitization positions were to be
deducted from total capital, except
when the unrated position was held by
a bank that had approval and ability to
use the supervisory formula approach
(SFA) to determine the specific risk add-
on for the unrated position. Finally,
under Basel III: A Global Regulatory
Framework for More Resilient Banks
and Banking Systems (Basel III),
published by the BCBS in December
2010, and revised in June 2011, certain
items, including certain securitization
positions, that had been deducted from
total capital are assigned a risk weight
of 1,250 percent.
On January 11, 2011, the agencies
issued a joint notice of proposed
rulemaking (January 2011 proposal) that
sought public comment on revisions to
the agencies’ market risk capital rules to
implement the 2005, 2009, and 2010
revisions.8 The key objectives of the
proposal were to enhance the rule’s
sensitivity to risks not adequately
captured, including default and credit
migration; enhance modeling
requirements in a manner that is
consistent with advances in risk
management since the agencies’ initial
implementation of the MRA; modify the
definition of ‘‘covered position’’ to
better capture positions for which
treatment under the rule is appropriate;
address shortcomings in the modeling of
certain risks; address procyclicality; and
increase transparency through enhanced
disclosures. The objective of enhancing
the risk sensitivity of the market risk
capital rule is particularly important
because of banks’ increased exposures
to traded credit and other structured
products, such as credit default swaps
(CDSs) and asset-backed securities, and
exposures to less liquid products.
Generally, the risks of these products
have not been fully captured by VaR
models that rely on a 10-business-day,
one-tail, 99.0 percent confidence level
soundness standard
e is particularly important
because of banks’ increased exposures
to traded credit and other structured
products, such as credit default swaps
(CDSs) and asset-backed securities, and
exposures to less liquid products.
Generally, the risks of these products
have not been fully captured by VaR
models that rely on a 10-business-day,
one-tail, 99.0 percent confidence level
soundness standard.
When publishing the January 2011
proposal, the agencies did not propose
to implement those aspects of the 2005
and 2009 revisions that rely on the use
of credit ratings due to certain
provisions of the Dodd-Frank Wall
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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
9 Public Law 111–203, 124 Stat. 1376 (July 21,
2010). Section 939A(a) of the Dodd-Frank Act
provides that not later than 1 year after the date of
enactment, each Federal agency shall: (1) Review
any regulation issued by such agency that requires
the use of an assessment of the credit-worthiness of
a security or money market instrument; and (2) any
references to or requirements in such regulations
regarding credit ratings. Section 939A further
provides that each such agency ‘‘shall modify any
such regulations identified by the review under
subsection (a) to remove any reference to or
requirement of reliance on credit ratings and to
substitute in such regulations such standard of
credit-worthiness as each respective agency shall
determine as appropriate for such regulations.’’ See
15 U.S.C. 78o–7 note.
10 The consultative document is available at
http://www.bis.org/publ/bcbs219.htm.
Street Reform and Consumer Protection
Act (the Dodd-Frank Act).9 The January
2011 proposal did not include new
specific risk add-ons but included as an
interim solution the treatment under the
agencies’ current market risk capital
rules
ermine as appropriate for such regulations.’’ See
15 U.S.C. 78o–7 note.
10 The consultative document is available at
http://www.bis.org/publ/bcbs219.htm.
Street Reform and Consumer Protection
Act (the Dodd-Frank Act).9 The January
2011 proposal did not include new
specific risk add-ons but included as an
interim solution the treatment under the
agencies’ current market risk capital
rules. Subsequently, after developing
and considering alternative standards of
creditworthiness, the agencies issued in
December 2011 a joint notice of
proposed rulemaking (NPR) that
amended the January 2011 proposal
(December 2011 amendment) to include
alternative methodologies for
calculating the specific risk capital
requirements for covered debt and
securitization positions under the
market risk capital rules, consistent
with section 939A of the Dodd-Frank
Act. The agencies are now adopting a
final rule, which incorporates comments
received on both the January 2011
proposal and December 2011
amendment and includes aspects of the
BCBS’s 2005, 2009, and 2010 revisions
(collectively, the MRA revisions) to the
market risk framework.
II. Overview of Comments
The agencies received six comment
letters on the January 2011 proposal and
30 comment letters on the December
2011 amendment from banking
organizations, trade associations
representing the banking or financial
services industry, and other interested
parties. This section of the preamble
highlights commenters’ main concerns
and briefly describes how the agencies
have responded to comments received
in the final rule. A more detailed
discussion of comments on specific
provisions of the final rule is provided
in section III of this preamble.
1. Comments on the January 2011
Proposal
While commenters expressed general
support for the proposed revisions to
the agencies’ market risk capital rules,
many noted that the BCBS’s market risk
framework required further
improvement in certain areas
he final rule. A more detailed
discussion of comments on specific
provisions of the final rule is provided
in section III of this preamble.
1. Comments on the January 2011
Proposal
While commenters expressed general
support for the proposed revisions to
the agencies’ market risk capital rules,
many noted that the BCBS’s market risk
framework required further
improvement in certain areas. For
example, some commenters expressed
concern about certain duplications in
the capital requirements, such as the
requirement for both a VaR-based
measure and a stressed VaR-based
measure, because such redundancies
would result in excessive capital
requirements and distortions in risk
management. A different commenter
noted that the use of numerous risk
measures with different time horizons
and conceptual approaches may
encourage excessive risk taking.
Although commenters characterized
the conceptual overlap of certain
provisions of the January 2011 proposal
as resulting in duplicative capital
requirements, the agencies believe that
these provisions provide a prudent level
of conservatism in the market risk
capital rule.
One commenter noted that the rule’s
VaR-based measure has notable
shortcomings because it may encourage
procyclical behavior and regulatory
arbitrage. This commenter also asserted
that because marked-to-market assets
can experience significant price
volatility, the proposal’s required
capital levels may not be sufficient to
address this volatility. The agencies are
concerned about these issues but believe
that the January 2011 proposal
addressed these concerns, for example,
through the addition of a stressed VaR-
based measure
bitrage. This commenter also asserted
that because marked-to-market assets
can experience significant price
volatility, the proposal’s required
capital levels may not be sufficient to
address this volatility. The agencies are
concerned about these issues but believe
that the January 2011 proposal
addressed these concerns, for example,
through the addition of a stressed VaR-
based measure.
Commenters generally encouraged the
agencies to continue work on the
fundamental review of the market risk
framework recently published as a
consultative document through the
BCBS, and one asserted that the
agencies should wait until this work is
completed before revising the agencies’
market risk capital rules.10 While the
agencies are committed to continued
improvement of the market risk
framework, they believe that the
proposed modifications to the market
risk capital rules are necessary to
address current significant shortcomings
in banks’ measurement and
capitalization of market risk.
Commenters also expressed concern
that the January 2011 proposal differs
from the 2005 and 2009 revisions in
some respects, such as excluding from
the definition of covered position a
hedge that is not within the scope of the
bank’s hedging strategy, providing a
more restrictive definition of two-way
market, and establishing a surcharge for
correlation trading position equal to 15
percent of the specific risk capital
requirements for such positions.
Commenters expressed concern that
such differences could place U.S. banks
at a competitive disadvantage to certain
foreign banking organizations. In
response to commenters’ concerns, the
agencies have revised the definition of
two-way market and adjusted the
surcharge as discussed more fully in
sections II.3 and II.12, respectively, of
this preamble.
2
requirements for such positions.
Commenters expressed concern that
such differences could place U.S. banks
at a competitive disadvantage to certain
foreign banking organizations. In
response to commenters’ concerns, the
agencies have revised the definition of
two-way market and adjusted the
surcharge as discussed more fully in
sections II.3 and II.12, respectively, of
this preamble.
2. Comments on the December 2011
Amendment
While many commenters responding
to the December 2011 amendment
commended the agencies’ efforts to
develop viable alternatives to credit
ratings, most commenters indicated that
the amendment did not strike a
reasonable balance between accurate
measurement of risk and
implementation burden. Commenters’
general concerns with the December
2011 amendment include its overall
lack of risk sensitivity and its
complexity. The agencies have
incorporated a number of changes into
the final rule based on feedback
received from commenters, including
modifications to the approaches for
determining capital requirements for
corporate debt positions and
securitization positions proposed in the
December 2011 amendment. These
changes are intended to increase the risk
sensitivity of the approaches as well as
simplify and reduce the difficulty of
implementing the approaches.
A few commenters asserted that the
proposal exceeded the intent of the
Dodd-Frank Act because the Dodd-
Frank Act was limited to the
replacement of credit ratings and did
not include provisions that, in their
estimation, would significantly increase
capital requirements and thus
negatively affect the economy. While
the agencies acknowledge that capital
requirements may generally increase
under the final rule, the agencies also
believe that the approach provides a
prudent level of conservatism to address
factors such as modeling uncertainties
and that changes to the current rules are
necessary to address significant
shortcomings in the measurement and
capitalization of market risk
the economy. While
the agencies acknowledge that capital
requirements may generally increase
under the final rule, the agencies also
believe that the approach provides a
prudent level of conservatism to address
factors such as modeling uncertainties
and that changes to the current rules are
necessary to address significant
shortcomings in the measurement and
capitalization of market risk.
One commenter suggested that the
agencies allow banks a transition period
of at least one year to implement the
market risk capital rule after
incorporation of alternatives to credit
ratings. The agencies believe that a one-
year transition period is not necessary
for banks to implement the credit
ratings alternatives in the final rule. The
agencies have determined based on
comments and discussions with
commenters that the information
required for calculation of capital
requirements under the final rule will
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11 The agencies’ advanced approaches rules are at
12 CFR part 3, appendix C (OCC); 12 CFR part 208,
appendix F, and 12 CFR part 225, appendix G
(Board); and 12 CFR part 325, appendix D (FDIC).
For purposes of this preamble, the term ‘‘credit risk
capital rules’’ refers to the general risk-based capital
rules and the advanced approaches rules (that also
include operational risk capital requirements), as
applicable to the bank using the market risk capital
rule.
be available to banks. Other commenters
indicated that the proposal would be
burdensome for community banks if the
agencies used the proposed approaches
to address the use of credit ratings in the
general risk-based capital rules
rules and the advanced approaches rules (that also
include operational risk capital requirements), as
applicable to the bank using the market risk capital
rule.
be available to banks. Other commenters
indicated that the proposal would be
burdensome for community banks if the
agencies used the proposed approaches
to address the use of credit ratings in the
general risk-based capital rules. The
agencies believe that it is important to
align the methodologies for calculating
specific risk-weighting factors for debt
positions and securitization positions in
the market risk capital rules with
methodologies for assigning risk weights
under the agencies’ other capital rules.
Such alignment reduces the potential
for regulatory arbitrage between rules.
The agencies are proposing similar
credit rating alternatives in the three
notices of proposed rulemaking for the
risk-based capital requirements that are
published elsewhere in today’s Federal
Register.
Several commenters requested
extensions of the comment period citing
the complexity of the December 2011
amendment and resulting difficulty of
assessing its impact in the time period
given as well as the considerable burden
faced by banks in evaluating various
regulations related to the Dodd-Frank
Act within similar time periods. The
agencies considered these requests but
believe that sufficient time was
provided between the agencies’
announcement of the proposed
amendment on December 7, 2011, and
the close of the comment period on
February 3, 2012, to allow for adequate
analysis of the proposal. The agencies
also met with a number of industry
participants during the comment period
and thereafter in order to clarify the
intent of the comments. Accordingly,
the agencies chose not to extend the
comment period on the December 2011
amendment.
III. Description of the Final Market
Risk Capital Rule
1
comment period on
February 3, 2012, to allow for adequate
analysis of the proposal. The agencies
also met with a number of industry
participants during the comment period
and thereafter in order to clarify the
intent of the comments. Accordingly,
the agencies chose not to extend the
comment period on the December 2011
amendment.
III. Description of the Final Market
Risk Capital Rule
1. Scope
The market risk capital rule
supplements both the agencies’ general
risk-based capital rules and the
advanced capital adequacy guidelines
(advanced approaches rules)
(collectively, the credit risk capital
rules) 11 by requiring any bank subject to
the market risk capital rule to adjust its
risk-based capital ratios to reflect the
market risk in its trading activities. The
agencies did not propose to amend the
scope of application of the market risk
capital rule, which applies to any bank
with aggregate trading assets and trading
liabilities equal to 10 percent or more of
total assets or $1 billion or more. One
commenter stated that the $1 billion
threshold for the application of the
market risk capital rule is not a
particularly risk-sensitive means for
determining the applicability of the
rule. This commenter also expressed
concern that the proposed threshold is
too low, and recommended an
adjustment to recognize the relative risk
of exposures, calculated by offsetting
trading assets and liabilities. The
agencies believe that the current scope
of application of the market risk
requirements reasonably identifies
banks with significant levels of trading
activity and therefore have retained the
existing threshold criteria. While the
agencies are concerned about placing
undue burden on banks, the agencies
believe that the thresholds provided in
the final rule are reasonable given the
risk profile of banks identified by the
current scope of application
market risk
requirements reasonably identifies
banks with significant levels of trading
activity and therefore have retained the
existing threshold criteria. While the
agencies are concerned about placing
undue burden on banks, the agencies
believe that the thresholds provided in
the final rule are reasonable given the
risk profile of banks identified by the
current scope of application.
Consistent with the January 2011
proposal, under the final rule, the
primary federal supervisor of a bank
that does not meet the threshold criteria
would be still be able to apply the
market risk capital rule to a bank.
Conversely, the primary federal
supervisor may exclude a bank from
application of the rule if the supervisor
were to deem it necessary or appropriate
given the level of market risk of the
bank or to ensure safe and sound
banking practices.
2. Reservation of Authority
The January 2011 proposal contained
a reservation of authority that affirmed
the authority of a bank’s primary federal
supervisor to require the bank to hold
an overall amount of capital greater than
would otherwise be required under the
rule if that supervisor determined that
the bank’s capital requirement for
market risk under the rule was not
commensurate with the market risk of
the bank’s covered positions. In
addition, the agencies anticipated that
there may be instances when the
January 2011 proposal would generate a
risk-based capital requirement for a
specific covered position or portfolio of
covered positions that is not
commensurate with the risks of the
covered position or portfolio. In these
circumstances, a bank’s primary federal
supervisor could require the bank to
assign a different risk-based capital
requirement to the covered position or
portfolio of covered positions that more
accurately reflects the risk of the
position or portfolio
covered position or portfolio of
covered positions that is not
commensurate with the risks of the
covered position or portfolio. In these
circumstances, a bank’s primary federal
supervisor could require the bank to
assign a different risk-based capital
requirement to the covered position or
portfolio of covered positions that more
accurately reflects the risk of the
position or portfolio. The January 2011
proposal also provided authority for a
bank’s primary federal supervisor to
require the bank to calculate capital
requirements for specific positions or
portfolios using either the market risk
capital rule or the credit risk capital
rules, depending on which outcome
more appropriately reflected the risks of
the positions. The agencies did not
receive any comment on the proposed
reservation of authority and have
adopted it without change in the final
rule.
3. Definition of Covered Position
The January 2011 proposal modified
the definition of a covered position to
include trading assets or trading
liabilities (as reported on schedule RC–
D of the Call Report or Schedule HC–D
of the Consolidated Financial
Statements for Bank Holding
Companies) that are trading positions.
The January 2011 proposal defined a
trading position as a position that is
held by the bank for the purpose of
short-term resale or with the intent of
benefiting from actual or expected short-
term price movements or to lock in
arbitrage profits. Therefore, the
characterization of an asset or liability
as ‘‘trading’’ for purposes of U.S.
Generally Accepted Accounting
Principles (U.S. GAAP) would not on its
own determine whether the asset or
liability is a ‘‘trading position’’ for
purposes of the January 2011 proposal.
That is, being reported as a trading asset
or trading liability on the regulatory
reporting schedules is a necessary, but
not sufficient, condition for meeting this
aspect of the covered position definition
under the January 2011 proposal
rinciples (U.S. GAAP) would not on its
own determine whether the asset or
liability is a ‘‘trading position’’ for
purposes of the January 2011 proposal.
That is, being reported as a trading asset
or trading liability on the regulatory
reporting schedules is a necessary, but
not sufficient, condition for meeting this
aspect of the covered position definition
under the January 2011 proposal. Such
a position would also need to be either
a trading position or hedge another
covered position. In addition, the
trading asset or trading liability must be
free of any restrictive covenants on its
tradability or the bank must be able to
hedge the material risk elements of the
position in a two-way market.
One commenter was concerned that
this and other references to a two-way
market in the January 2011 proposal
could be construed to require that there
be a two-way market for every covered
position. The January 2011 proposal did
not require that there be a two-way
market for every covered position but
did use that standard for defining some
covered positions, such as certain
correlation trading positions. Rather, in
identifying its trading positions, a
bank’s policies and procedures must
take into account the extent to which a
position, or a hedge of its material risks,
can be marked-to-market daily by
reference to a two-way market.
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ions. Rather, in
identifying its trading positions, a
bank’s policies and procedures must
take into account the extent to which a
position, or a hedge of its material risks,
can be marked-to-market daily by
reference to a two-way market.
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53064
Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
12 See Financial Accounting Standards Board
Statement 157. This statement defines fair value,
establishes a framework for measuring fair value in
U.S. GAAP and expands disclosures about fair
value measurement. The fair value hierarchy gives
the highest priority to quoted prices (unadjusted) in
active markets for identical assets or liabilities
(Level 1) and the lowest priority to unobservable
inputs (Level 3). Level 3 securities are those for
which inputs are unobservable in the market.
The January 2011 proposal defined a
two-way market as a market where there
are independent bona fide offers to buy
and sell so that a price reasonably
related to the last sales price or current
bona fide competitive bid and offer
quotations can be determined within
one day and settled at that price within
five business days. Commenters
expressed concern about the proposed
definition of a two-way market
including a requirement for settlement
within five business days because it
would automatically exclude a number
of markets where settlement periods are
longer than this time frame. In light of
commenters’ concerns, the agencies
have modified this aspect of the
definition in the final rule to require
settlement within a ‘‘relatively short
time frame conforming to trade
custom.’’
Another commenter requested
clarification regarding whether
securities held as available for sale
under U.S. GAAP may be treated as
covered positions under the rule
er than this time frame. In light of
commenters’ concerns, the agencies
have modified this aspect of the
definition in the final rule to require
settlement within a ‘‘relatively short
time frame conforming to trade
custom.’’
Another commenter requested
clarification regarding whether
securities held as available for sale
under U.S. GAAP may be treated as
covered positions under the rule. This
commenter also indicated that a narrow
reading of the definitions of trading
position and covered position could be
interpreted to require banks to move
positions between treatment under the
market risk and the credit risk capital
rules during periods of market stress. In
particular, the commenter expressed
concern about changes in capital
treatment due to changes in a bank’s
short-term trading intent or the lack of
a two-way market during periods of
market stress that might be temporary.
The commenter suggested that a bank
should be able to continue to treat a
position as a covered position if it met
the definitional requirements when the
position was established,
notwithstanding changes in markets that
led to a longer than expected time
horizon for sale or hedging.
The agencies note that under section
3 of the final rule, as under the
proposed rule, a bank must have clearly
defined policies and procedures that
determine which of its positions are
trading positions. With respect to the
frequency of movement of positions,
consistent with the requirements under
U.S. GAAP, the agencies generally
would expect re-designations of
positions as trading or non-trading to be
rare. Thus, in general, the agencies
would not expect temporary market
movements as described by the
commenter to result in re-designations.
In those limited circumstances where a
bank re-designates a covered position,
the bank should document the reasons
for such action.
Commenters suggested allowing a
bank to treat as a covered position any
hedge that is outside of the bank’s
hedging strategy
us, in general, the agencies
would not expect temporary market
movements as described by the
commenter to result in re-designations.
In those limited circumstances where a
bank re-designates a covered position,
the bank should document the reasons
for such action.
Commenters suggested allowing a
bank to treat as a covered position any
hedge that is outside of the bank’s
hedging strategy. The proposed
definition of covered position included
hedges that offset the risk of trading
positions. The agencies are concerned
that a bank could craft its hedging
strategies to recognize as covered
positions certain non-trading positions
that are more appropriately treated
under the credit risk capital rules. For
example, mortgage-backed securities
that are not held with the intent to
trade, but are hedged with interest rate
swaps, would not be covered positions.
The agencies will review a bank’s
hedging strategies to ensure that they
are not being manipulated in an
inappropriate manner. Consistent with
the concerns raised above, the agencies
continue to believe that a position that
hedges a trading position must be
within the scope of a bank’s hedging
strategy as described in the rule. Thus,
the final rule retains the treatment that
hedges outside of a bank’s hedging
strategy as described in the final rule are
not covered positions.
Other commenters sought clarification
as to whether an internal hedge
(between a banking unit and a trading
unit of the same bank) could be treated
as a covered position if it materially or
completely offset the risk of a non-
covered position or set of positions,
provided the hedge meets the definition
of a covered position. The agencies note
that internal hedges are not recognized
for regulatory capital purposes because
they are eliminated in consolidation
between a banking unit and a trading
unit of the same bank) could be treated
as a covered position if it materially or
completely offset the risk of a non-
covered position or set of positions,
provided the hedge meets the definition
of a covered position. The agencies note
that internal hedges are not recognized
for regulatory capital purposes because
they are eliminated in consolidation.
Commenters inquired as to whether
the phrase ‘‘restrictive covenants on its
tradability,’’ in the covered position
definition, applies to securities
transferable only to qualified
institutional buyers as required under
Rule 144A of the Securities Act of 1933.
The agencies do not believe an
instrument’s designation as a 144A
security in and of itself would preclude
the instrument from meeting the
definition of covered position. Another
commenter asked whether level 3
securities could be treated as covered
positions.12 The agencies note that there
is no explicit exclusion of level 3
securities from being designated as
covered positions, as long as they meet
the requirements of the covered position
definition.
One commenter requested
clarification as to whether the rule
would permit a bank to determine at the
portfolio level whether a set of positions
satisfies the definition of covered
position, provided the bank is able to
demonstrate a sufficiently robust
process for making this determination.
Another commenter found it confusing
and operationally challenging that the
definition of covered position had
requirements both at the position level,
for example, specific exclusions, and at
the portfolio level, in regard to hedging
strategies. The commenter felt that
many of the definitional requirements
are better suited to assessment at a
portfolio level based on robust policies
and procedures. The agencies require
that the covered position determination
be made at the individual position level
quirements both at the position level,
for example, specific exclusions, and at
the portfolio level, in regard to hedging
strategies. The commenter felt that
many of the definitional requirements
are better suited to assessment at a
portfolio level based on robust policies
and procedures. The agencies require
that the covered position determination
be made at the individual position level.
The requirements for policies and
procedures for identifying trading
positions, defining hedging strategies,
and management of covered positions
are requirements for application of the
market risk capital rule broadly.
The January 2011 proposal included
within the definition of a covered
position any foreign exchange or
commodity position, regardless of
whether it is a trading asset or trading
liability. With prior supervisory
approval, a bank could exclude from its
covered positions any structural
position in a foreign currency, which
was defined as a position that is not a
trading position and that is (1)
Subordinated debt, equity, or minority
interest in a consolidated subsidiary
that is denominated in a foreign
currency; (2) capital assigned to a
foreign branch that is denominated in a
foreign currency; (3) a position related
to an unconsolidated subsidiary or
another item that is denominated in a
foreign currency and that is deducted
from the bank’s tier 1 and tier 2 capital;
or (4) a position designed to hedge a
bank’s capital ratios or earnings against
the effect of adverse exchange rate
movements on (1), (2), or (3).
Also, the proposed definition of
covered position had several explicit
exclusions. It explicitly excluded any
position that, in form or substance, acts
as a liquidity facility that provides
support to asset-backed commercial
paper, as well as all intangible assets,
including servicing assets. Intangible
assets were excluded because their risks
are explicitly addressed in the credit
risk capital rules, often through a
deduction from capital
several explicit
exclusions. It explicitly excluded any
position that, in form or substance, acts
as a liquidity facility that provides
support to asset-backed commercial
paper, as well as all intangible assets,
including servicing assets. Intangible
assets were excluded because their risks
are explicitly addressed in the credit
risk capital rules, often through a
deduction from capital. The agencies
received no comment on these
exclusions and have incorporated them
into the final rule.
The definition of covered positions
also excluded any hedge of a trading
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53065
Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
13 In a synthetic securitization, a company uses
credit derivatives or guarantees to transfer a portion
of the credit risk of one or more underlying
exposures to third-party protection providers. The
credit derivative or guarantee may be collateralized
or uncollateralized.
position that the bank’s primary federal
supervisor determines is outside the
scope of a bank’s hedging strategy. One
commenter objected to that exclusion;
however, the agencies believe that
sound risk management should be
guided by explicit strategies subject to
appropriate oversight by bank
management and, therefore, have
retained this provision in the final rule.
Under the final rule and as proposed,
the covered position definition excludes
any equity position that is not publicly
traded, other than a derivative that
references a publicly traded equity; any
direct real estate holding; and any
position that a bank holds with the
intent to securitize. Equity positions
that are not publicly traded include
private equity investments, most hedge
fund investments, and other such
closely-held and non-liquid investments
that are not easily marketable
that is not publicly
traded, other than a derivative that
references a publicly traded equity; any
direct real estate holding; and any
position that a bank holds with the
intent to securitize. Equity positions
that are not publicly traded include
private equity investments, most hedge
fund investments, and other such
closely-held and non-liquid investments
that are not easily marketable. Direct
real estate holdings include real estate
for which the bank holds title, such as
‘‘other real estate owned’’ held from
foreclosure activities, and bank
premises used by a bank as part of its
ongoing business activities. With
respect to such real estate holdings, the
determination of marketability and
liquidity can be difficult or even
impractical because the assets are an
integral part of the bank’s ongoing
business. Indirect investments in real
estate, such as through real estate
investment trusts or special purpose
vehicles, must meet the definition of a
trading position to be a covered
position. One commenter sought
clarification that indirect real estate
holdings (such as an exposure to a real
estate investment trust) could qualify as
a covered position. The agencies note
that such an indirect investment may
qualify, provided the position otherwise
meets the definition of a covered
position.
Commenters requested clarification
regarding whether hedge fund
exposures that hedge a covered position
are within the scope of a bank’s hedging
strategy qualify for inclusion in the
definition of a covered position.
Generally, hedge fund exposures are not
covered positions because they typically
are equity positions (as defined under
the final rule) that are not publicly
traded. The fact that a bank has a
hedging strategy for excluded equity
positions would not alone qualify such
positions to be treated as covered
positions under the rule.
Positions that a bank holds with the
intent to securitize include a ‘‘pipeline’’
or ‘‘warehouse’’ of loans being held for
securitization
lly
are equity positions (as defined under
the final rule) that are not publicly
traded. The fact that a bank has a
hedging strategy for excluded equity
positions would not alone qualify such
positions to be treated as covered
positions under the rule.
Positions that a bank holds with the
intent to securitize include a ‘‘pipeline’’
or ‘‘warehouse’’ of loans being held for
securitization. The agencies do not view
the intent to securitize these positions
as synonymous with the intent to trade
them. Consistent with the 2009
revisions, the agencies believe the
positions excluded from the covered
position definition have significant
constraints in terms of a bank’s ability
to liquidate them readily and value
them reliably on a daily basis.
The covered position definition also
excludes a credit derivative that a bank
recognizes as a guarantee for purposes
of calculating its risk-weighted assets
under the agencies’ credit risk capital
rules if the credit derivative is used to
hedge a position that is not a covered
position (for example, a credit
derivative hedge of a loan that is not a
covered position). This treatment
requires the bank to include the credit
derivative in its risk-weighted assets for
credit risk and exclude it from its VaR-
based measure for market risk. This
treatment of a credit derivative hedge
avoids the mismatch that arises when
the hedged position (for example, a
loan) is not a covered position and the
credit derivative hedge is a covered
position. This mismatch has the
potential to overstate the VaR-based
measure of market risk because only one
side of the transaction would be
reflected in that measure. Accordingly,
the final rule adopts this aspect of the
proposed definition of covered position
without change.
Under the January 2011 proposal, in
addition to commodities and foreign
exchange positions, a covered position
includes debt positions, equity
positions, and securitization positions
asure of market risk because only one
side of the transaction would be
reflected in that measure. Accordingly,
the final rule adopts this aspect of the
proposed definition of covered position
without change.
Under the January 2011 proposal, in
addition to commodities and foreign
exchange positions, a covered position
includes debt positions, equity
positions, and securitization positions.
Consistent with the January 2011
proposal, the final rule defines a debt
position as a covered position that is not
a securitization position or a correlation
trading position and that has a value
that reacts primarily to changes in
interest rates or credit spreads.
Examples of debt positions include
corporate and government bonds,
certain nonconvertible preferred stock,
certain convertible bonds, and
derivatives (including written and
purchased options) for which the
underlying instrument is a debt
position.
The final rule defines an equity
position as a covered position that is not
a securitization position or a correlation
trading position and that has a value
that reacts primarily to changes in
equity prices. Examples of equity
positions include voting or nonvoting
common stock, certain convertible
bonds, commitments to buy or sell
equity instruments, equity indices, and
a derivative for which the underlying
instrument is an equity position.
Under the final rule as under the
January 2011 proposal, a securitization
is defined as a transaction in which (1)
All or a portion of the credit risk of one
or more underlying exposures is
transferred to one or more third parties;
convertible
bonds, commitments to buy or sell
equity instruments, equity indices, and
a derivative for which the underlying
instrument is an equity position.
Under the final rule as under the
January 2011 proposal, a securitization
is defined as a transaction in which (1)
All or a portion of the credit risk of one
or more underlying exposures is
transferred to one or more third parties;
(2) the credit risk associated with the
underlying exposures has been
separated into at least two tranches that
reflect different levels of seniority; (3)
performance of the securitization
exposures depends upon the
performance of the underlying
exposures; (4) all or substantially all of
the underlying exposures are financial
exposures (such as loans, commitments,
credit derivatives, guarantees,
receivables, asset-backed securities,
mortgage-backed securities, other debt
securities, or equity securities); (5) for
non-synthetic securitizations, the
underlying exposures are not owned by
an operating company; 13 (6) the
underlying exposures are not owned by
a small business investment company
described in section 302 of the Small
Business Investment Act of 1958 (15
U.S.C. 682); and (7) the underlying
exposures are not owned by a firm an
investment in which qualifies as a
community development investment
under 12 U.S.C. 24 (Eleventh).
Under the final rule, a bank’s primary
federal supervisor may determine that a
transaction in which the underlying
exposures are owned by an investment
firm that exercises substantially
unfettered control over the size and
composition of its assets, liabilities, and
off-balance sheet exposures is not a
securitization based on the transaction’s
leverage, risk profile, or economic
substance
nder the final rule, a bank’s primary
federal supervisor may determine that a
transaction in which the underlying
exposures are owned by an investment
firm that exercises substantially
unfettered control over the size and
composition of its assets, liabilities, and
off-balance sheet exposures is not a
securitization based on the transaction’s
leverage, risk profile, or economic
substance. Generally, the agencies
would consider investment firms that
can easily change the size and
composition of their capital structure, as
well as the size and composition of their
assets and off-balance sheet exposures,
as eligible for exclusion from the
securitization definition.
Based on a particular transaction’s
leverage, risk profile, or economic
substance, a bank’s primary federal
supervisor may also deem an exposure
to a transaction to be a securitization
exposure, even if the exposure does not
meet the criteria in provisions (5), (6),
or (7) above. A securitization position is
a covered position that is (1) an on-
balance sheet or off-balance sheet credit
exposure (including credit-enhancing
representations and warranties) that
arises from a securitization (including a
resecuritization) or (2) an exposure that
directly or indirectly references a
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-
balance sheet or off-balance sheet credit
exposure (including credit-enhancing
representations and warranties) that
arises from a securitization (including a
resecuritization) or (2) an exposure that
directly or indirectly references a
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53066
Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
securitization exposure described in (1)
above.
Under the final rule as under the
January 2011 proposal, a securitization
position includes nth-to-default credit
derivatives and resecuritization
positions. The rule defines an nth-to-
default credit derivative as a credit
derivative that provides credit
protection only for the nth-defaulting
reference exposure in a group of
reference exposures. In addition, a
resecuritization is defined as a
securitization in which one or more of
the underlying exposures is a
securitization exposure. A
resecuritization position is (1) an on- or
off-balance sheet exposure to a
resecuritization or (2) an exposure that
directly or indirectly references a
resecuritization exposure described in
(1).
Some commenters expressed the
desire to align the proposed definition
of securitization in the market risk
capital rule with the Basel II definition.
For instance, one commenter suggested
excluding from the definition of a
securitization exposures that do not
resemble what is customarily thought of
as a securitization. The agencies note
that the proposed definition is
consistent with the definition contained
in the agencies’ advanced approaches
rules and believe that remaining
consistent is important in order to
reduce regulatory capital arbitrage
opportunities across the rules
ing from the definition of a
securitization exposures that do not
resemble what is customarily thought of
as a securitization. The agencies note
that the proposed definition is
consistent with the definition contained
in the agencies’ advanced approaches
rules and believe that remaining
consistent is important in order to
reduce regulatory capital arbitrage
opportunities across the rules.
The January 2011 proposal and the
final rule define a correlation trading
position as (1) a securitization position
for which all or substantially all of the
value of the underlying exposures is
based on the credit quality of a single
company for which a two-way market
exists, or on commonly traded indices
based on such exposures for which a
two-way market exists on the indices; or
(2) a position that is not a securitization
position and that hedges a position
described in (1) above. Under this
definition, a correlation trading position
does not include a resecuritization
position, a derivative of a securitization
position that does not provide a pro rata
share in the proceeds of a securitization
tranche, or a securitization position for
which the underlying assets or reference
exposures are retail exposures,
residential mortgage exposures, or
commercial mortgage exposures.
Correlation trading positions may
include collateralized debt obligation
(CDO) index tranches, bespoke CDO
tranches, and nth-to-default credit
derivatives. Standardized CDS indices
and single-name CDSs are examples of
instruments used to hedge these
positions. While banks typically hedge
correlation trading positions, hedging
frequently does not reduce a bank’s net
exposure to a position because the
hedges often do not perfectly match the
position. The agencies are adopting the
definition of a debt, equity,
securitization, and correlation trading
position in the final rule as proposed
are examples of
instruments used to hedge these
positions. While banks typically hedge
correlation trading positions, hedging
frequently does not reduce a bank’s net
exposure to a position because the
hedges often do not perfectly match the
position. The agencies are adopting the
definition of a debt, equity,
securitization, and correlation trading
position in the final rule as proposed.
The agencies note that certain aspects
of the final rule, including the definition
of ‘‘covered position,’’ are substantially
similar to the definitions of similar
terms used in the agencies’ proposed
rule that would implement section 619
of the Dodd-Frank Act, familiarly
referred to as the ‘‘Volcker rule.’’ The
agencies intend to promote consistency
across regulations employing similar
concepts to increase regulatory
effectiveness and reduce unnecessary
burden.
Section 619 of the Dodd-Frank Act
contains certain prohibitions and
restrictions on the ability of a bank (or
nonbank financial company supervised
by the Board under Title I of the Dodd-
Frank Act) to engage in proprietary
trading and have certain interests in, or
relationships with, a covered fund as
defined under section 619 of the Dodd-
Frank Act and applicable regulations or
private equity fund. Section 619 defines
proprietary trading to mean engaging as
a principal for the trading account, as
defined under section 619(h)(6), of a
bank (or relevant nonbank) in the
purchase or sale of securities and other
financial instruments.
In November 2011, the agencies,
together with the SEC sought comment
on an NPR that would implement
section 619 of the Dodd-Frank Act (the
Volcker NPR)
. Section 619 defines
proprietary trading to mean engaging as
a principal for the trading account, as
defined under section 619(h)(6), of a
bank (or relevant nonbank) in the
purchase or sale of securities and other
financial instruments.
In November 2011, the agencies,
together with the SEC sought comment
on an NPR that would implement
section 619 of the Dodd-Frank Act (the
Volcker NPR). The Volcker NPR
includes in the definition of ‘‘trading
account’’ all exposures of a bank subject
to the market risk capital rule that fall
within the definition of ‘‘covered
position,’’ except for certain foreign
exchange and commodity positions,
unless they otherwise are in an account
that meets the other prongs of the
Volcker NPR ‘‘trading account’’
definition. Those prongs focus on
determining whether a banking entity
subject to section 619 of the Dodd-Frank
Act is acquiring or taking a position in
securities or other covered instruments
principally for the purpose of short-term
trading. Specifically, the definition of
‘‘trading account’’ under the Volcker
NPR would include any account that is
used by a bank to acquire or take one
or more covered financial positions for
the purpose of (1) Short-term resale, (2)
benefitting from actual or expected
short-term price movements, (3)
realizing short-term arbitrage profits, or
(4) hedging one or more such positions.
These standards correspond with the
definition of ‘‘trading position’’ under
the final market risk capital rule and are
generally the type of positions to which
the proprietary trading restrictions of
section 13 of the BHC Act, which
implements section 619 of the Dodd-
Frank Act, were intended to apply
(3)
realizing short-term arbitrage profits, or
(4) hedging one or more such positions.
These standards correspond with the
definition of ‘‘trading position’’ under
the final market risk capital rule and are
generally the type of positions to which
the proprietary trading restrictions of
section 13 of the BHC Act, which
implements section 619 of the Dodd-
Frank Act, were intended to apply.
Thus, the Volcker NPR would cover all
positions of a bank that receive trading
position treatment under the final
market risk capital rule because they
meet a nearly identical standard
regarding short-term trading intent,
thereby eliminating the potential for
inconsistency or regulatory arbitrage in
which a bank might characterize a
position as ‘‘trading’’ for regulatory
capital purposes but not for purposes of
the Volcker NPR.
Covered positions generally would be
subject to the Volcker NPR unless they
are foreign exchange or commodity
positions that would not otherwise fall
into the definition of ‘‘trading account’’
under the Volcker NPR or would
otherwise be eligible for one of the
exemptions to the prohibitions under
the Volcker NPR and section 619 of the
Dodd-Frank Act.
4. Requirements for the Identification of
Trading Positions and Management of
Covered Positions
Section 3 of the January 2011
proposal introduced new requirements
for the identification of trading
positions and the management of
covered positions. These new
requirements would enhance prudent
capital management to address the
issues that arise when banks include
more credit risk-related, less liquid, and
less actively traded products in their
covered positions. The risks of these
positions may not be fully reflected in
the requirements of the market risk
capital rule and may be more
appropriately captured under credit risk
capital rules
new
requirements would enhance prudent
capital management to address the
issues that arise when banks include
more credit risk-related, less liquid, and
less actively traded products in their
covered positions. The risks of these
positions may not be fully reflected in
the requirements of the market risk
capital rule and may be more
appropriately captured under credit risk
capital rules.
Consistent with the January 2011
proposal, the final rule requires a bank
to have clearly defined policies and
procedures for determining which of its
trading assets and trading liabilities are
trading positions as well as which of its
trading positions are correlation trading
positions. In determining the scope of
trading positions, the bank must
consider (1) the extent to which a
position (or a hedge of its material risks)
can be marked to market daily by
reference to a two-way market; and (2)
possible impairments to the liquidity of
a position or its hedge.
In addition, a bank must have clearly
defined trading and hedging strategies.
The bank’s trading and hedging
strategies for its trading positions must
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be approved by senior management. The
trading strategy must articulate the
expected holding period of, and the
market risk associated with, each
portfolio of trading positions. The
hedging strategy must articulate for each
portfolio the level of market risk the
bank is willing to accept and must detail
the instruments, techniques, and
strategies the bank will use to hedge the
risk of the portfolio. The hedging
strategy should be applied at the level
at which trading positions are risk
managed at the bank (for example,
trading desk, portfolio levels)
positions. The
hedging strategy must articulate for each
portfolio the level of market risk the
bank is willing to accept and must detail
the instruments, techniques, and
strategies the bank will use to hedge the
risk of the portfolio. The hedging
strategy should be applied at the level
at which trading positions are risk
managed at the bank (for example,
trading desk, portfolio levels).
Also consistent with the January 2011
proposal, the final rule requires a bank
to have clearly defined policies and
procedures for actively managing all
covered positions. In the context of non-
traded commodities and foreign
exchange positions, active management
includes managing the risks of those
positions within the bank’s risk limits.
For all covered positions, these policies
and procedures, at a minimum, must
require (1) Marking positions to market
or model on a daily basis; (2) assessing
on a daily basis the bank’s ability to
hedge position and portfolio risks and
the extent of market liquidity; (3)
establishment and daily monitoring of
limits on positions by a risk control unit
independent of the trading business
unit; (4) daily monitoring by senior
management of the information
described in (1) through (3) above; (5) at
least annual reassessment by senior
management of established limits on
positions; and (6) at least annual
assessments by qualified personnel of
the quality of market inputs to the
valuation process, the soundness of key
assumptions, the reliability of parameter
estimation in pricing models, and the
stability and accuracy of model
calibration under alternative market
scenarios.
The January 2011 proposal introduced
new requirements for the prudent
valuation of covered positions,
including maintaining policies and
procedures for valuation, marking
positions to market or to model,
independent price verification, and
valuation adjustments or reserves
timation in pricing models, and the
stability and accuracy of model
calibration under alternative market
scenarios.
The January 2011 proposal introduced
new requirements for the prudent
valuation of covered positions,
including maintaining policies and
procedures for valuation, marking
positions to market or to model,
independent price verification, and
valuation adjustments or reserves.
Under the proposal, a bank’s valuation
of covered positions would be required
to consider, as appropriate, unearned
credit spreads, close-out costs, early
termination costs, investing and funding
costs, future administrative costs,
liquidity, and model risk. These
valuation requirements reflect the
agencies’ concerns about deficiencies in
banks’ valuation of less liquid trading
positions, especially in light of the prior
focus of the market risk capital rule on
a 10-business-day time horizon and a
one-tail, 99.0 percent confidence level,
which has proven at times to be
inadequate in reflecting the full extent
of the market risk of less liquid
positions.
Several commenters expressed
concern about including consideration
of future administrative costs in the
valuation process because they believe
calculation of this estimate would be
difficult and arbitrary and would result
in only a minor increase in total costs.
In response to commenters’ concern, the
agencies removed this requirement from
the final rule. In all other respects, the
agencies are adopting the proposed
requirements for the valuation of
covered positions.
5. General Requirements for Internal
Models
Model Approval and Ongoing Use
Requirements. The January 2011
proposal would have required a bank to
receive the prior written approval of its
primary federal supervisor before using
any internal model to calculate its
market risk capital requirement
, the
agencies are adopting the proposed
requirements for the valuation of
covered positions.
5. General Requirements for Internal
Models
Model Approval and Ongoing Use
Requirements. The January 2011
proposal would have required a bank to
receive the prior written approval of its
primary federal supervisor before using
any internal model to calculate its
market risk capital requirement. Also, a
bank would be required to promptly
notify its primary federal supervisor
when the bank plans to extend the use
of a model that the primary federal
supervisor has approved to an
additional business line or product type.
The agencies consider these
requirements to be appropriate and are
adopting them in the final rule.
One commenter on the January 2011
proposal inquired as to whether models
used by the bank, but developed by
parties outside of the bank (commonly
referred to as vendor models), are
permissible for calculating market risk
capital requirements given approval
from the bank’s primary federal
supervisor. The agencies believe that a
vendor model may be acceptable for
purposes of calculating a bank’s risk-
based capital requirements if it
otherwise meets the requirements of the
rule and is properly understood and
implemented by the bank.
The final rule, consistent with the
January 2011 proposal, requires a bank
to notify its primary federal supervisor
promptly if it makes any change to an
internal model that would result in a
material change in the amount of risk-
weighted assets for a portfolio of
covered positions or when the bank
makes any material change to its
modeling assumptions
stood and
implemented by the bank.
The final rule, consistent with the
January 2011 proposal, requires a bank
to notify its primary federal supervisor
promptly if it makes any change to an
internal model that would result in a
material change in the amount of risk-
weighted assets for a portfolio of
covered positions or when the bank
makes any material change to its
modeling assumptions. The bank’s
primary federal supervisor may rescind
its approval, in whole or in part, of the
use of any internal model and determine
an appropriate regulatory capital
requirement for the covered positions to
which the model would apply, if it
determines that the model no longer
complies with the market risk capital
rule or fails to reflect accurately the
risks of the bank’s covered positions.
For example, if adverse market events or
other developments reveal that a
material assumption in an approved
model is flawed, the bank’s primary
federal supervisor may require the bank
to revise its model assumptions and
resubmit the model specifications for
review. In the final rule, the agencies
made minor modifications to this
provision in section 3(c)(3) to improve
clarity and correct a cross-reference.
Financial markets evolve rapidly, and
internal models that were state-of-the-
art at the time they were approved for
use in risk-based capital calculations
can become less effective as the risks of
covered positions evolve and as the
industry develops more sophisticated
modeling techniques that better capture
material risks
ection 3(c)(3) to improve
clarity and correct a cross-reference.
Financial markets evolve rapidly, and
internal models that were state-of-the-
art at the time they were approved for
use in risk-based capital calculations
can become less effective as the risks of
covered positions evolve and as the
industry develops more sophisticated
modeling techniques that better capture
material risks. Therefore, under the final
rule, as under the January 2011
proposal, a bank must review its
internal models periodically, but no less
frequently than annually, in light of
developments in financial markets and
modeling technologies, and to enhance
those models as appropriate to ensure
that they continue to meet the agencies’
standards for model approval and
employ risk measurement
methodologies that are, in the bank’s
judgment, most appropriate for the
bank’s covered positions. It is essential
that a bank continually review, and as
appropriate, make adjustments to its
models to help ensure that its market
risk capital requirement reflects the risk
of the bank’s covered positions. A
bank’s primary federal supervisor will
closely review the bank’s model review
practices as a matter of safety and
soundness. The agencies are adopting
these requirements in the final rule.
Risks Reflected in Models. The final
rule requires a bank to incorporate its
internal models into its risk
management process and integrate the
internal models used for calculating its
VaR-based measure into its daily risk
management process. The level of
sophistication of a bank’s models must
be commensurate with the complexity
and amount of its covered positions. To
measure its market risk, a bank’s
internal models may use any generally
accepted modeling approach, including
but not limited to variance-covariance
models, historical simulations, or Monte
Carlo simulations. A bank’s internal
models must properly measure all
material risks in the covered positions
to which they are applied
rate with the complexity
and amount of its covered positions. To
measure its market risk, a bank’s
internal models may use any generally
accepted modeling approach, including
but not limited to variance-covariance
models, historical simulations, or Monte
Carlo simulations. A bank’s internal
models must properly measure all
material risks in the covered positions
to which they are applied. Consistent
with the January 2011 proposal, the
final rule requires that risks arising from
less liquid positions and positions with
limited price transparency be modeled
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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
14 See Supervisory Guidance on Model Risk
Management, issued by the OCC and Federal
Reserve (April 4, 2011).
conservatively under realistic market
scenarios. The January 2011 proposal
also would require a bank to have a
rigorous process for re-estimating, re-
evaluating, and updating its models to
ensure continued applicability and
relevance. The final rule retains these
proposed requirements for internal
models.
Control, Oversight, and Validation
Mechanisms. The final rule, consistent
with the January 2011 proposal, requires
a bank to have a risk control unit that
reports directly to senior management
and that is independent of its business
trading units. In addition, the final rule
provides specific model validation
standards similar to those in the
advanced approaches rules.
Specifically, the final rule requires a
bank to validate its internal models
initially and on an ongoing basis. The
validation process must be independent
of the internal models’ development,
implementation, and operation, or the
validation process must be subjected to
an independent review of its adequacy
and effectiveness
on
standards similar to those in the
advanced approaches rules.
Specifically, the final rule requires a
bank to validate its internal models
initially and on an ongoing basis. The
validation process must be independent
of the internal models’ development,
implementation, and operation, or the
validation process must be subjected to
an independent review of its adequacy
and effectiveness. The review personnel
do not necessarily have to be external to
the bank in order to achieve the
required independence. A bank should
ensure that individuals who perform the
review are not biased in their
assessment due to their involvement in
the development, implementation, or
operation of the models.
Also consistent with the January 2011
proposal, the final rule requires
validation to include an evaluation of
the conceptual soundness of the internal
models. This should include an
evaluation of empirical evidence and
documentation supporting the
methodologies used; important model
assumptions and their limitations;
adequacy and robustness of empirical
data used in parameter estimation and
model calibration; and evidence of a
model’s strengths and weaknesses.
Validation also must include an
ongoing monitoring process that
includes a review of all model processes
and verification that these processes are
functioning as intended and the
comparison of the bank’s model outputs
with relevant internal and external data
sources or estimation techniques. The
results of this comparison provide a
valuable diagnostic tool for identifying
potential weaknesses in a bank’s
models. As part of this comparison, the
bank should investigate the source of
any differences between the model
estimates and the relevant internal or
external data or estimation techniques
and whether the extent of the
differences is appropriate.
Validation of internal models must
include an outcomes analysis process
that includes backtesting
dentifying
potential weaknesses in a bank’s
models. As part of this comparison, the
bank should investigate the source of
any differences between the model
estimates and the relevant internal or
external data or estimation techniques
and whether the extent of the
differences is appropriate.
Validation of internal models must
include an outcomes analysis process
that includes backtesting. Consistent
with the 2009 revisions, the January
2011 proposal required a bank’s
validation process for internal models
used to calculate its VaR-based measure
to include an outcomes analysis process
that includes a comparison of the
changes in the bank’s portfolio value
that would have occurred were end-of-
day positions to remain unchanged
(therefore, excluding fees, commissions,
reserves, net interest income, and
intraday trading) with VaR-based
measures during a sample period not
used in model development.
The final rule, consistent with the
January 2011 proposal, requires a bank
to stress test the market risk of its
covered positions at a frequency
appropriate to each portfolio and in no
case less frequently than quarterly. The
stress tests must take into account
concentration risk, illiquidity under
stressed market conditions, and other
risks arising from the bank’s trading
activities that may not be captured
adequately in the bank’s internal
models. For example, it may be
appropriate for a bank to include in its
stress testing large price movements,
one-way markets, nonlinear or deep out-
of-the-money products, jumps-to-
default, and significant changes in
correlation. Relevant types of
concentration risk include
concentration by name, industry, sector,
country, and market. Market
concentration occurs when a bank holds
a position that represents a concentrated
share of the market for a security and
thus requires a longer than usual
liquidity horizon to liquidate the
position without adversely affecting the
market
nd significant changes in
correlation. Relevant types of
concentration risk include
concentration by name, industry, sector,
country, and market. Market
concentration occurs when a bank holds
a position that represents a concentrated
share of the market for a security and
thus requires a longer than usual
liquidity horizon to liquidate the
position without adversely affecting the
market. A bank’s primary federal
supervisor will evaluate the robustness
and appropriateness of any bank stress
tests required under the final rule
through the supervisory review process.
One commenter advocated an
exemption from the proposed
backtesting requirements for vendor
models, and stated that banks using the
same vendor model would be
duplicating their efforts. The agencies
believe that each bank must be
responsible for ensuring that its market
risk capital requirement reflects the
risks of its covered positions. Each bank
generally customizes some aspects of a
vendor model and has a unique trading
profile. Therefore, effective backtesting
of either a vendor-provided or
internally-developed model requires
reference to a bank’s experience with its
own positions, which is consistent with
guidance issued by the OCC and the
Board with respect to the use of internal
and third-party models.14
Consistent with the January 2011
proposal, the final rule requires a bank
to have an internal audit function
independent of business-line
management that at least annually
assesses the effectiveness of the controls
supporting the bank’s market risk
measurement systems, including the
activities of the business trading units
and independent risk control unit,
compliance with policies and
procedures, and the calculation of the
bank’s measure for market risk. The
internal audit function should review
the bank’s validation processes,
including validation procedures,
responsibilities, results, timeliness, and
responsiveness to findings
measurement systems, including the
activities of the business trading units
and independent risk control unit,
compliance with policies and
procedures, and the calculation of the
bank’s measure for market risk. The
internal audit function should review
the bank’s validation processes,
including validation procedures,
responsibilities, results, timeliness, and
responsiveness to findings. Further, the
internal audit function should evaluate
the depth, scope, and quality of the risk
management system review process and
conduct appropriate testing to ensure
that the conclusions of these reviews are
well-founded. At least annually, the
internal audit function must report its
findings to the bank’s board of directors
(or a committee thereof). The final rule
adopts the January 2011 proposal’s
requirements pertaining to control,
oversight, and validation mechanisms.
Internal Assessment of Capital
Adequacy. The final rule, consistent
with the January 2011 proposal, requires
a bank to have a rigorous process for
assessing its overall capital adequacy in
relation to its market risk. This
assessment must take into account
market concentration and liquidity risks
under stressed market conditions as
well as other risks that may not be
captured fully in the VaR-based
measure.
Documentation. The final rule also
adopts as proposed the requirement that
a bank document adequately all material
aspects of its internal models; the
management and valuation of covered
positions; its control, oversight,
validation and review processes and
results; and its internal assessment of
capital adequacy. This documentation
will facilitate the supervisory review
process as well as the bank’s internal
audit or other review procedures.
6. Capital Requirement for Market Risk
Consistent with the January 2011
proposal, the final rule requires a bank
to calculate its risk-based capital ratio
denominator as the sum of its adjusted
risk-weighted assets and market risk
equivalent assets
adequacy. This documentation
will facilitate the supervisory review
process as well as the bank’s internal
audit or other review procedures.
6. Capital Requirement for Market Risk
Consistent with the January 2011
proposal, the final rule requires a bank
to calculate its risk-based capital ratio
denominator as the sum of its adjusted
risk-weighted assets and market risk
equivalent assets. However, the agencies
are making changes to this calculation
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15 76 FR 37620 (June 28, 2011).
16 Section 171 of the Dodd-Frank Act (12 U.S.C.
5371) requires the agencies to establish
consolidated minimum risk-based capital
requirements for depository institutions, bank
holding companies, savings and loan holding
companies, and nonbank financial companies
supervised by the Board that are not less than the
capital requirements the agencies establish under
section 38 of the Federal Deposit Insurance Act to
apply to insured depository institutions, regardless
of total asset size or foreign financial exposure
(generally applicable risk-based capital
requirements). Currently, the general risk-based
capital rules (supplemented by the market risk
capital rule) are the generally applicable risk-based
capital rules for purposes of section 171 of the
Dodd-Frank Act. 12 U.S.C. 5371.
in the final rule for banks subject to the
advanced approaches rules (as amended
in June 2011 to implement certain
provisions in section 171 of the Dodd-
Frank Act).15 Under the advanced
approaches rules, a bank is required to
calculate its risk-based capital
requirements under the general risk-
based capital rules and the advanced
approaches rules for purposes of
determining compliance with minimum
regulatory capital requirements
dvanced approaches rules (as amended
in June 2011 to implement certain
provisions in section 171 of the Dodd-
Frank Act).15 Under the advanced
approaches rules, a bank is required to
calculate its risk-based capital
requirements under the general risk-
based capital rules and the advanced
approaches rules for purposes of
determining compliance with minimum
regulatory capital requirements. Thus, a
bank subject to the advanced
approaches rules is required to calculate
both a general risk-based capital ratio
denominator based on the general risk-
based capital rules and an advanced
risk-based capital ratio denominator
based on the advanced approaches
rules, each supplemented by the market
risk capital rules as appropriate.16
Consequently, a bank subject to the
advanced approaches rules and the
market risk capital rules is also required
to calculate both general adjusted risk-
weighted assets and advanced adjusted
risk-weighted assets under the market
risk capital rules as the starting point to
determine its risk-based capital ratio
denominators. The agencies have
revised the mechanics of section 4 of the
final rule to be consistent with the risk-
based capital ratio calculation
requirements under the advanced
approaches rules.
To calculate general market risk
equivalent assets, a bank must multiply
its general measure for market risk by
12.5. A bank subject to the advanced
approaches rules also must calculate its
advanced market risk equivalent assets
by multiplying its advanced measure for
market risk by 12.5. The final rule
requires a bank’s general and advanced
measures for market risk to equal the
sum of its VaR-based capital
requirement, its stressed VaR-based
capital requirement, specific risk add-
ons, incremental risk capital
requirement, comprehensive risk capital
requirement, and capital requirement
for de minimis exposures, each
calculated according to defined
applicable requirements
he final rule
requires a bank’s general and advanced
measures for market risk to equal the
sum of its VaR-based capital
requirement, its stressed VaR-based
capital requirement, specific risk add-
ons, incremental risk capital
requirement, comprehensive risk capital
requirement, and capital requirement
for de minimis exposures, each
calculated according to defined
applicable requirements. The
components of the two measures for
market risk described above are the
same except for a potential difference
stemming from the specific risk add-ons
component. This difference arises
because a bank may not use the SFA
(discussed further below) to calculate its
general measure for market risk for
securitization positions while it must
use the SFA, provided the bank has
sufficient information, to calculate its
advanced measure for market risk for
the same positions. Consistent with the
proposal, under the final rule, no
adjustments are permitted to address
potential double counting among any of
the components of a bank’s measure(s)
for market risk.
The final rule requires a bank to
include in its measure for market risk
any specific risk add-on as required
under section 7 of the rule, determined
using the standardized measurement
methods described in section 10 of the
rule. For a bank subject to the advanced
approaches rules, these standardized
measurement methods may include the
SFA for securitization positions as
discussed further below, where both the
securitization position and the bank
would meet the requirements to use the
SFA. Such a bank must use the SFA in
all instances where possible to calculate
specific risk add-ons for its
securitization positions. The agencies
expect banks to use the SFA rather than
the simplified supervisory formula
approach (SSFA) in all instances where
the data to calculate the SFA is
available. The agencies expect a bank to
apply the SFA on a consistent basis for
a given position
A. Such a bank must use the SFA in
all instances where possible to calculate
specific risk add-ons for its
securitization positions. The agencies
expect banks to use the SFA rather than
the simplified supervisory formula
approach (SSFA) in all instances where
the data to calculate the SFA is
available. The agencies expect a bank to
apply the SFA on a consistent basis for
a given position. For instance, if a bank
is able to calculate a specific risk add-
on for a securitization position using the
SFA, the agencies would expect the
bank to continue to have access to the
information needed to perform this
calculation on an ongoing basis for that
position. If the bank were to change the
methodology it used for calculating the
specific risk add-on for such a
securitization position, it should be able
to explain and justify the change in
approach (e.g., based on data
availability) to its primary federal
supervisor.
As described above, a bank subject to
the advanced approaches rules must
calculate two market risk equivalent
asset amounts: a general measure for
market risk and an advanced measure
for market risk. A bank subject to the
advanced approaches rules may not use
the SFA to calculate its general measure
for market risk, because this
methodology is not available under the
general risk-based capital rules.
The final rule requires a bank to
include in both its general measure for
market risk and its advanced measure
for market risk its capital requirement
for de minimis exposures. Specifically,
a bank must add to its general and
advanced measures for market risk the
absolute value of the market value of
those de minimis exposures that are not
captured in the bank’s VaR-based
measure unless the bank has obtained
prior written approval from its primary
federal supervisor to calculate a capital
requirement for the de minimis
exposures using alternative techniques
that appropriately measure the market
risk associated with those exposures
market risk the
absolute value of the market value of
those de minimis exposures that are not
captured in the bank’s VaR-based
measure unless the bank has obtained
prior written approval from its primary
federal supervisor to calculate a capital
requirement for the de minimis
exposures using alternative techniques
that appropriately measure the market
risk associated with those exposures.
The agencies have made conforming
changes to the proposed requirements
for a bank to calculate its risk-based
capital ratio denominator under the
final rule. With regard to a bank’s total
risk-based capital numerator, the final
rule, like the January 2011 proposal,
eliminates tier 3 capital and the
associated allocation methodologies.
As proposed, the final rule requires a
bank’s VaR-based capital requirement to
equal the greater of (1) the previous
day’s VaR-based measure, or (2) the
average of the daily VaR-based measures
for each of the preceding 60 business
days multiplied by three, or such higher
multiplication factor required based on
backtesting results determined
according to section 4 of the rule and as
discussed further below. Similarly, the
final rule requires a bank’s stressed VaR-
based capital requirement to equal the
greater of (1) the most recent stressed
VaR-based measure; or (2) the average of
the weekly stressed VaR-based measures
for each of the preceding 12 weeks
multiplied by three, or such higher
multiplication factor as required based
on backtesting results determined
according to section 4 of the rule. The
multiplication factor applicable to the
stressed-VaR based measure for
purposes of this calculation is based on
the backtesting results for the bank’s
VaR-based measure; there is no separate
backtesting requirement for the stressed
VaR-based measure for purposes of
calculating a bank’s measure for market
risk.
Determination of the Multiplication
Factor
ding to section 4 of the rule. The
multiplication factor applicable to the
stressed-VaR based measure for
purposes of this calculation is based on
the backtesting results for the bank’s
VaR-based measure; there is no separate
backtesting requirement for the stressed
VaR-based measure for purposes of
calculating a bank’s measure for market
risk.
Determination of the Multiplication
Factor. Consistent with the January
2011 proposal, the final rule requires a
bank, each quarter, to compare each of
its most recent 250 business days of
trading losses (excluding fees,
commissions, reserves, net interest
income, and intraday trading) with the
corresponding daily VaR-based measure
calibrated to a one-day holding period
and at a one-tail, 99.0 percent
confidence level. The excluded
components of trading profit and loss
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17 Default risk is the risk of loss on a position that
could result from the failure of an obligor to make
timely payments of principal or interest on its debt
obligation and the risk of loss that could result from
bankruptcy, insolvency, or similar proceeding. For
credit derivatives, default risk means the risk of loss
on a position that could result from the default of
the reference name or exposure(s). Idiosyncratic
risk is the risk of loss in the value of a position that
arises from changes in risk factors unique to that
position.
18 See section 2 of the final rule for a complete
definition of a term repo-style transaction.
are usually not modeled as part of the
VaR-based measure. Therefore,
excluding them from the regulatory
backtesting framework will improve the
accuracy of the backtesting and provide
a better assessment of the bank’s
internal model
t
arises from changes in risk factors unique to that
position.
18 See section 2 of the final rule for a complete
definition of a term repo-style transaction.
are usually not modeled as part of the
VaR-based measure. Therefore,
excluding them from the regulatory
backtesting framework will improve the
accuracy of the backtesting and provide
a better assessment of the bank’s
internal model.
The agencies sought comment on any
challenges banks may face in
formulating the proposed measure of
trading loss, particularly whether any
excluded components described above
would present difficulties and the
nature of those difficulties. Commenters
expressed concern about challenges in
calculating trading loss net of the above
excluded components, noting that many
banks only have trading gain and loss
data which includes these components.
According to commenters, because
historical data are not always available
for the components excluded from
trading losses, it would be difficult to
immediately create historical trading
gains and losses that exclude these
components. Commenters also indicated
that banks will need to make changes to
their systems to support this
requirement. Because of these concerns,
commenters requested additional time
to come into compliance with the new
requirement.
The agencies acknowledge these
implementation concerns and recognize
that banks may not be able to
immediately implement the new
backtesting requirements. Therefore, the
agencies have specified in the final rule
that banks will be allowed up to one
year after the later of either January 1,
2013, or the date on which a bank
becomes subject to the rule, to begin
backtesting as required under the final
rule. In the interim, consistent with
safety and soundness principles, a bank
subject to the rule as of January 1, 2013,
should continue to follow their current
regulatory backtesting procedures, in
accordance with its primary federal
supervisor’s expectations
either January 1,
2013, or the date on which a bank
becomes subject to the rule, to begin
backtesting as required under the final
rule. In the interim, consistent with
safety and soundness principles, a bank
subject to the rule as of January 1, 2013,
should continue to follow their current
regulatory backtesting procedures, in
accordance with its primary federal
supervisor’s expectations.
One commenter expressed concern
with the proposed backtesting
requirements. In particular, the
commenter described the frequency of
calculations required for determining
the number of exceptions as
burdensome and unnecessary. The
agencies believe that the comparison of
daily trading loss to the corresponding
daily VaR-based measure is a critical
part of a bank’s ongoing risk
management. Such comparisons
improve a bank’s ability to make prompt
adjustment to its market risk
management to address factors such as
changing market conditions and model
deficiencies. A high number of
exceptions could indicate modeling
issues and warrants an increase in
capital requirements by a higher
multiplication factor. Accordingly, the
agencies believe the multiplication
factor and associated backtesting
requirements provide appropriate
incentives for banks to regularly update
their VaR-based models and have
adopted the proposed approach for
determining the number of daily
backtesting exceptions. With the
exception of the timing consideration
discussed above for calculating daily
trading losses, the final rule retains the
proposed backtesting requirements.
7. VaR-Based Capital Requirement
Consistent with the January 2011
proposal, section 5 of the final rule
requires a bank to use one or more
internal models to calculate a daily VaR-
based measure that reflects general
market risk for all covered positions
iming consideration
discussed above for calculating daily
trading losses, the final rule retains the
proposed backtesting requirements.
7. VaR-Based Capital Requirement
Consistent with the January 2011
proposal, section 5 of the final rule
requires a bank to use one or more
internal models to calculate a daily VaR-
based measure that reflects general
market risk for all covered positions.
The daily VaR-based measure also may
reflect the bank’s specific risk for one or
more portfolios of debt or equity
positions and must reflect the specific
risk for any portfolios of correlation
trading positions that are modeled
under section 9 of the rule. The rule
defines general market risk as the risk of
loss that could result from broad market
movements, such as changes in the
general level of interest rates, credit
spreads, equity prices, foreign exchange
rates, or commodity prices. Specific risk
is the risk of loss on a position that
could result from factors other than
broad market movements and includes
event and default risk as well as
idiosyncratic risk.17 Like the January
2011 proposal, the final rule also allows
a bank to include term repo-style
transactions in its VaR-based measure
even though these positions may not
meet the definition of a covered
position, provided the bank includes all
such term repo-style transactions
consistently over time.
Under the final rule, a term repo-style
transaction is defined as a repurchase or
reverse repurchase transaction, or a
securities borrowing or securities
lending transaction, including a
transaction in which the bank acts as
agent for a customer and indemnifies
the customer against loss, that has an
original maturity in excess of one
business day, provided that it meets
certain requirements, including being
based solely on liquid and readily
marketable securities or cash and
subject to daily marking-to-market and
daily margin maintenance
requirements.18 While repo-style
transactions typically are close adjuncts
to tradi
ustomer and indemnifies
the customer against loss, that has an
original maturity in excess of one
business day, provided that it meets
certain requirements, including being
based solely on liquid and readily
marketable securities or cash and
subject to daily marking-to-market and
daily margin maintenance
requirements.18 While repo-style
transactions typically are close adjuncts
to trading activities, U.S. GAAP
traditionally has not permitted
companies to report them as trading
assets or trading liabilities. Repo-style
transactions included in the VaR-based
measure will continue to be subject to
the requirements under the credit risk
capital rules for calculating capital
requirements for counterparty credit
risk.
As in the January 2011 proposal, the
final rule adds credit spread risk to the
list of risk categories to be captured in
a bank’s VaR-based measure (that is, in
addition to interest rate risk, equity
price risk, foreign exchange rate risk,
and commodity price risk). The VaR-
based measure may incorporate
empirical correlations within and across
risk categories, provided the bank
validates its models and justifies the
reasonableness of its process for
measuring correlations. If the VaR-based
measure does not incorporate empirical
correlations across market risk
categories, the bank must add the
separate measures from its internal
models used to calculate the VaR-based
measure to determine the bank’s
aggregate VaR-based measure. The final
rule, as proposed, requires models to
include risks arising from the nonlinear
price characteristics of option positions
or positions with embedded optionality.
Consistent with the 2009 revisions
and the proposed rule, the final rule
requires a bank to be able to justify to
the satisfaction of its primary federal
supervisor the omission of any risk
factors from the calculation of its VaR-
based measure that the bank includes in
its pricing models
from the nonlinear
price characteristics of option positions
or positions with embedded optionality.
Consistent with the 2009 revisions
and the proposed rule, the final rule
requires a bank to be able to justify to
the satisfaction of its primary federal
supervisor the omission of any risk
factors from the calculation of its VaR-
based measure that the bank includes in
its pricing models. In addition, a bank
must demonstrate to the satisfaction of
its primary federal supervisor the
appropriateness of any proxies used to
capture the risks of the actual positions
for which such proxies are used.
Quantitative Requirements for VaR-
based Measure. Like the January 2011
proposal, the final rule does not change
the existing quantitative requirements
for the daily VaR-based measure. These
include a one-tail, 99.0 percent
confidence level, a ten-business-day
holding period, and a historical
observation period of at least one year.
To calculate VaR-based measures using
a 10-day holding period, the bank may
calculate 10-business-day measures
directly or may convert VaR-based
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19 Using the square root of time assumes that
daily portfolio returns are independent and
identically distributed. When this assumption is
violated, the square root of time approximation is
not appropriate.
measures using holding periods other
than 10 business days to the equivalent
of a 10-business-day holding period. A
bank that converts its VaR-based
measure in this manner must be able to
justify the reasonableness of its
approach to the satisfaction of its
primary federal supervisor
distributed. When this assumption is
violated, the square root of time approximation is
not appropriate.
measures using holding periods other
than 10 business days to the equivalent
of a 10-business-day holding period. A
bank that converts its VaR-based
measure in this manner must be able to
justify the reasonableness of its
approach to the satisfaction of its
primary federal supervisor. For
example, a bank that computes its VaR-
based measure by multiplying a daily
VaR amount by the square root of 10
(that is, using the square root of time)
should demonstrate that daily changes
in portfolio value do not exhibit
significant mean reversion,
autocorrelation, or volatility
clustering.19
Consistent with the January 2011
proposal, the final rule requires a bank’s
VaR-based measure to be based on data
relevant to the bank’s actual exposures
and of sufficient quality to support the
calculation of its risk-based capital
requirements. The bank must update its
data sets at least monthly or more
frequently as changes in market
conditions or portfolio composition
warrant. For banks that use a weighting
scheme or other method to identify the
appropriate historical observation
period, the bank must either (1) use an
effective observation period of at least
one year in which the average time lag
of the observations is at least six months
or (2) demonstrate to its primary federal
supervisor that the method used is more
effective than that described in (1) at
representing the volatility of the bank’s
trading portfolio over a full business
cycle. In the latter case, a bank must
update its data more frequently than
monthly and in a manner appropriate
for the type of weighting scheme. In
general, a bank using a weighting
scheme should update its data daily.
Because the most recent observations
typically are the most heavily weighted,
it is important for a bank to include
these observations in its VaR-based
measure
business
cycle. In the latter case, a bank must
update its data more frequently than
monthly and in a manner appropriate
for the type of weighting scheme. In
general, a bank using a weighting
scheme should update its data daily.
Because the most recent observations
typically are the most heavily weighted,
it is important for a bank to include
these observations in its VaR-based
measure.
Also consistent with the January 2011
proposal, the final rule requires a bank
to retain and make available to its
primary federal supervisor model
performance information on significant
subportfolios. Taking into account the
value and composition of a bank’s
covered positions, the subportfolios
must be sufficiently granular to inform
a bank and its supervisor about the
ability of the bank’s VaR-based model to
reflect risk factors appropriately. A
bank’s primary federal supervisor must
approve the number of significant
subportfolios the bank uses for
subportfolio backtesting. While the final
rule does not prescribe the basis for
determining significant subportfolios,
the primary federal supervisor may
consider the bank’s evaluation of factors
such as trading volume, product types
and number of distinct traded products,
business lines, and number of traders or
trading desks.
The final rule, consistent with the
January 2011 proposal, requires a bank
to retain and make available to its
primary federal supervisor, with no
more than a 60-day lag, information for
each subportfolio for each business day
over the previous two years (500
business days) that includes (1) A daily
VaR-based measure for the subportfolio
calibrated to a one-tail, 99.0 percent
confidence level; (2) the daily profit or
loss for the subportfolio (that is, the net
change in price of the positions held in
the portfolio at the end of the previous
business day); and (3) the p-value of the
profit or loss on each day (that is, the
probability of observing a profit less
than or a loss greater than reported in
for the subportfolio
calibrated to a one-tail, 99.0 percent
confidence level; (2) the daily profit or
loss for the subportfolio (that is, the net
change in price of the positions held in
the portfolio at the end of the previous
business day); and (3) the p-value of the
profit or loss on each day (that is, the
probability of observing a profit less
than or a loss greater than reported in
(2) above, based on the model used to
calculate the VaR-based measure
described in (1) above).
Daily information on the probability
of observing a loss greater than that
which occurred on any given day is a
useful metric for banks and supervisors
to assess the quality of a bank’s VaR
model. For example, if a bank that used
a historical simulation VaR model using
the most recent 500 business days
experienced a loss equal to the second
worst day of the 500, it would assign a
probability of 0.004 (2/500) to that loss
based on its VaR model. Applying this
process many times over a long interval
provides information about the
adequacy of the VaR model’s ability to
characterize the entire distribution of
losses, including information on the size
and number of backtesting exceptions.
The requirement to create and retain
this information at the subportfolio level
may help identify particular products or
business lines for which the model does
not adequately measure risk.
The agencies solicited comment on
whether the proposed subportfolio
backtesting requirements would present
any challenges and, if so, the specific
nature of such challenges. In addition,
the agencies sought comment on how to
determine an appropriate number of
subportfolios for purposes of these
requirements. The agencies also
requested comment on whether the p-
value is a useful statistic for evaluating
the efficacy of the VaR model in gauging
market risk, as well as whether the
agencies should consider other statistics
and, if so, why
re of such challenges. In addition,
the agencies sought comment on how to
determine an appropriate number of
subportfolios for purposes of these
requirements. The agencies also
requested comment on whether the p-
value is a useful statistic for evaluating
the efficacy of the VaR model in gauging
market risk, as well as whether the
agencies should consider other statistics
and, if so, why.
Several commenters urged the
agencies to provide discretion and
flexibility in identifying significant
subportfolios. In particular, the
commenters asked the agencies to allow
banks to identify subportfolios based on
the internal management structure of
the bank. Notwithstanding these
comments, the agencies believe the final
rule, like the January 2011 proposal,
provides an appropriate level of
flexibility, as it does not prescribe a
specific basis or parameters for
determining significant subportfolios.
Some commenters urged the agencies to
be sensitive to the operational
challenges associated with meeting
subportfolio backtesting requirements
that would be caused by organizational
changes and model enhancements. The
agencies recognize the operational
challenges involved in meeting these
requirements and will consider them as
part of the ongoing evaluation of a
bank’s compliance with the backtesting
requirements. Some commenters stated
that the p-value statistic does not add
sufficient explanatory power to warrant
the calculation effort, and instead
recommended the use of ‘‘band breaks’’
to detect VaR model deficiencies.
The agencies believe that the p-value
statistic adds significant explanatory
power and will facilitate a more
appropriate evaluation of the VaR
models by both banks and supervisors.
The agencies believe that the so-called
band-break methodology generally fails
to recognize modeling deficiencies
comprehensively and view the p-value
as an improvement over this
methodology
el deficiencies.
The agencies believe that the p-value
statistic adds significant explanatory
power and will facilitate a more
appropriate evaluation of the VaR
models by both banks and supervisors.
The agencies believe that the so-called
band-break methodology generally fails
to recognize modeling deficiencies
comprehensively and view the p-value
as an improvement over this
methodology. VaR models and the
break-band methodology evaluate only
one statistic at the tail of the profit and
loss distribution while the p-values
provide information to banks and
supervisors regarding the
appropriateness of the entire profit and
loss distribution. The agencies have
thus decided to adopt the proposed
subportfolio backtesting requirements in
the final rule as proposed.
8. Stressed VaR-Based Capital
Requirement
Like the January 2011 proposal,
section 6 of the final rule requires a
bank to calculate at least weekly a
stressed VaR-based measure using the
same internal model(s) used to calculate
its VaR-based measure. The stressed
VaR-based measure supplements the
VaR-based measure, which, due to
inherent limitations, proved inadequate
in producing capital requirements
appropriate to the level of losses
incurred at many banks during the
financial market crisis that began in
mid-2007. The stressed VaR-based
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measure, which, due to
inherent limitations, proved inadequate
in producing capital requirements
appropriate to the level of losses
incurred at many banks during the
financial market crisis that began in
mid-2007. The stressed VaR-based
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measure mitigates the procyclicality of
the minimum capital requirements for
market risk and contributes to a more
appropriate measure of the risks of a
bank’s covered positions.
Quantitative Requirements for
Stressed VaR-based Measure. To
determine the stressed VaR-based
measure, the final rule, consistent with
the January 2011 proposal, requires a
bank to use the same model(s) used to
calculate its VaR-based measure but
with model inputs calibrated to reflect
historical data from a continuous 12-
month period that reflects a period of
significant financial stress appropriate
to the bank’s current portfolio. The
stressed VaR-based measure must be
calculated at least weekly and be no less
than the bank’s VaR-based measure. The
agencies generally expect that a

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---

Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FDIC_FIL12026. Check the current official text before relying on it. Not legal advice.