PRA Explains Approach to CCR Calculation Under Internal Models Method
PRA published a statement that sets out its approach to calculate exposure for counterparty credit risk, or CCR, under the internal models method (IMM). It published another statement that sets out its approach for the Value-at-Risk (VAR) back-testing, with this temporary approach being relevant for firms experiencing an elevated level of VAR back-testing exceptions. Both these statements have been published in light of the COVID-19 outbreak.
Statement on exposure value for counterparty risk under IMM
The Capital Requirements Regulation (CRR) does not preclude firms using the IMM to measure the exposure value, including collateral which has not yet settled at the time of calculation. Where a shortfall between the collateral for which a firm has called and the collateral which has settled arises as a result of the ordinary collateral settlement cycle, including this shortfall in the calculation of exposure may lead to unwarranted volatility in the exposure value and therefore unwarranted volatility in risk-weighted assets. Firms with permission under CRR Article 285 are required to capture the effects of margining within the calculation of Effective Expected Positive Exposure, which is derived from the profile of estimated Expected Exposure. PRA considers that firms are not required to estimate the initial Expected Exposure recognizing only collateral that has settled at the time of calculation. According to PRA, a firm which calculates the initial Expected Exposure on the basis of collateral that has not yet settled would be expected to monitor the impact of this modeling choice on an ongoing basis and hold capital against any understatement of economic risk. Firms would not be expected to recognize collateral in the initial Expected Exposure which has been called for but disputed by the counterparty.
If a firm makes a change to any IMM model as a result of this guidance then this would constitute a post-approval model change requiring post-notification as per Section 6.16 of PRA Supervisory Statement SS12/13, unless the impact of that change exceeded the materiality threshold as set out in Section 6.10(b) of the statement, in which case it would require pre-notification as set out in Section 6.15.
Statement on temporary approach to VAR back-testing exceptions
PRA mentioned that the exceptional levels of market volatility over the past few weeks have led to an elevated level of VAR back-testing exceptions across the industry. To mitigate the possibility of excessively pro-cyclical market risk capital requirements through the automatic application of a higher VAR multiplier, PRA will allow firms—on a temporary basis—to offset increases due to new exceptions through a commensurate reduction in risks-not-in-VAR (RNIV) capital requirements. The statement notes that the baseline number of back-testing exceptions to be used, which will determine the point at which the RNIV reduction starts, should be agreed with PRA at the outset. Firms are expected to continue to monitor and analyze exceptions during this temporary period and, when the situation returns to normal (that is, after the end of the temporary period), PRA will consider which (if any) of the exceptions can reasonably be discounted (per section 6 of PRA supervisory statement on market risk). This approach will be reviewed by PRA after six months—that, is in September 2020.
Related Links
Keywords: Europe, UK, Banking, Value-at-Risk, COVID-19, CRR, Counterparty Credit Risk, Back-Testing, Risk-Weighted Assets, Regulatory Capital, Internal Models, PRA
Featured Experts

María Cañamero
Skilled market researcher; growth strategist; successful go-to-market campaign developer

Nicolas Degruson
Works with financial institutions, regulatory experts, business analysts, product managers, and software engineers to drive regulatory solutions across the globe.

Patrycja Oleksza
Applies proficiency and knowledge to regulatory capital and reporting analysis and coordinates business and product strategies in the banking technology area
Related Articles
US Agencies Issue Several Regulatory and Reporting Updates
The Board of Governors of the Federal Reserve System (FED) adopted the final rule on Adjustable Interest Rate (LIBOR) Act.
ECB Issues Multiple Reports and Regulatory Updates for Banks
The European Central Bank (ECB) published an updated list of supervised entities, a report on the supervision of less significant institutions (LSIs), a statement on macro-prudential policy.
HKMA Keeps List of D-SIBs Unchanged, Makes Other Announcements
The Hong Kong Monetary Authority (HKMA) published a circular on the prudential treatment of crypto-asset exposures, an update on the status of transition to new interest rate benchmarks.
EU Issues FAQs on Taxonomy Regulation, Rules Under CRD, FICOD and SFDR
The European Commission (EC) adopted the standards addressing supervisory reporting of risk concentrations and intra-group transactions, benchmarking of internal approaches, and authorization of credit institutions.
CBIRC Revises Measures on Corporate Governance Supervision
The China Banking and Insurance Regulatory Commission (CBIRC) issued rules to manage the risk of off-balance sheet business of commercial banks and rules on corporate governance of financial institutions.
HKMA Publications Address Sustainability Issues in Financial Sector
The Hong Kong Monetary Authority (HKMA) made announcements to address sustainability issues in the financial sector.
EBA Updates Address Basel and NPL Requirements for Banks
The European Banking Authority (EBA) published regulatory standards on identification of a group of connected clients (GCC) as well as updated the lists of identified financial conglomerates.
ESMA Publishes 2022 ESEF XBRL Taxonomy and Conformance Suite
The General Board of the European Systemic Risk Board (ESRB), at its December meeting, issued an updated risk assessment via the quarterly risk dashboard and held discussions on key policy priorities to address the systemic risks in the European Union.
FCA Sets up ESG Committee, Imposes Penalties, and Issues Other Updates
The Financial Conduct Authority (FCA) is seeking comments, until December 21, 2022, on the draft guidance for firms to support existing mortgage borrowers.
FSB Reports Assess NBFI Sector and Progress on LIBOR Transition
The Financial Stability Board (FSB) published a report that assesses progress on the transition from the Interbank Offered Rates, or IBORs, to overnight risk-free rates as well as a report that assesses global trends in the non-bank financial intermediation (NBFI) sector.