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Status: Please note you should read all Brexit changes to the FCA Handbook and BTS alongside the main FCA transitional directions. Where these directions apply the 'standstill', firms have the choice between complying with the pre-IP completion day rules, or the post-IP completion day rules. To see a full list of Handbook modules affected, please see Annex B to the main FCA transitional directions.

You are viewing the version of the document as on 2021-01-01.

SECTION 4 Initial margin models

Article 14 General requirements

  1. (1)

    Where a counterparty uses an initial margin model, that model may be developed by any of, or both, counterparties or by a third-party agent.

    Where a counterparty uses an initial margin model developed by a third-party agent, the counterparty shall remain responsible for ensuring that that model complies with the requirements referred to in this Section.

  2. (2)

    Initial margin models shall be developed in a way that captures all the significant risks arising from entering into the non-centrally cleared OTC derivative contracts included in the netting set, including the nature, scale, and complexity of those risks and shall meet the following requirements:

    1. (a)

      the model incorporates risk factors corresponding to the individual currencies in which those contracts in the netting set are denominated;

    2. (b)

      the model incorporates interest rate risk factors corresponding to the individual currencies in which those contracts are denominated;

    3. (c)

      the yield curve is divided into a minimum of six maturity buckets for exposures to interest-rate risk in the major currencies and markets;

    4. (d)

      the model captures the risk of movements between different yield curves and between different maturity buckets;

    5. (e)

      the model incorporates separate risk factors at least for each equity, equity index, commodity or commodity index which is significant for those contracts;

    6. (f)

      the model captures the risk arising from less liquid positions and positions with limited price transparency within realistic market scenarios;

    7. (g)

      the model captures the risk, otherwise not captured by other features of the model, arising from derivative contracts where the underlying asset class is credit;

    8. (h)

      the model captures the risk of movements between similar, but not identical, underlying risk factors and the exposure to changes in values arising from maturity mismatches;

    9. (i)

      the model captures main non-linear dependencies;

    10. (j)

      the model incorporates methodologies used for back-testing which include statistical tests of the model's performance;

    11. (k)

      the model determines which events trigger a model change, calibration or other remedial action.

  3. (3)

    The risk management procedures referred to in Article 2(1) shall ensure that the performance of the model is monitored on a continuous basis including by back-testing the model at least every 3 months.

    For the purposes of the first subparagraph, back testing shall include a comparison between the values produced by the model and the realised market values of the non-centrally cleared OTC derivative contracts in the netting set.

  4. (4)

    The risk management procedures referred to in Article 2(1) shall outline the methodologies used for undertaking back-testing, including statistical tests of performance.

  5. (5)

    The risk management procedures referred to in Article 2(1) shall describe what results of the back-testing would lead to a model change, recalibration or other remediation action.

  6. (6)

    The risk management procedures referred to in Article 2(1) shall ensure that counterparties retain records of the results of the back-testing referred to in paragraph 3 of this Article.

  7. (7)

    Counterparties shall provide all the information necessary to explain the calculation of a given value of the initial margin model to the other counterparty in a way that a knowledgeable third party would be able to verify that calculation.

  8. (8)

    The initial margin model shall reflect parameter uncertainty, correlation, basis risk and data quality in a prudent manner.