SECTION 4 Initial margin models
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.
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:
the model incorporates risk factors corresponding to the individual currencies in which those contracts in the netting set are denominated;
the model incorporates interest rate risk factors corresponding to the individual currencies in which those contracts are denominated;
the yield curve is divided into a minimum of six maturity buckets for exposures to interest-rate risk in the major currencies and markets;
the model captures the risk of movements between different yield curves and between different maturity buckets;
the model incorporates separate risk factors at least for each equity, equity index, commodity or commodity index which is significant for those contracts;
the model captures the risk arising from less liquid positions and positions with limited price transparency within realistic market scenarios;
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;
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;
the model captures main non-linear dependencies;
the model incorporates methodologies used for back-testing which include statistical tests of the model's performance;
the model determines which events trigger a model change, calibration or other remedial action.
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.
The risk management procedures referred to in Article 2(1) shall outline the methodologies used for undertaking back-testing, including statistical tests of performance.
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.
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.
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.
The initial margin model shall reflect parameter uncertainty, correlation, basis risk and data quality in a prudent manner.