Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Moral hazard wikipedia , lookup
Securitization wikipedia , lookup
Business valuation wikipedia , lookup
Lattice model (finance) wikipedia , lookup
Derivative (finance) wikipedia , lookup
Corporate finance wikipedia , lookup
Interbank lending market wikipedia , lookup
Financial economics wikipedia , lookup
Hedge (finance) wikipedia , lookup
THIS TEKST IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (unofficial consolidated text) • Official Gazette of the Republic of Slovenia, No. 135/06 of 21 December 2006 – basic text (in force since 1 January 2007). • Official Gazette of the Republic of Slovenia, No. 104/07 of 16 November 2007 – Amendments and Additions (in force since 24 November 2007). Pursuant to point 5 of Article 129 and Article 405 of the Banking Act (Official Gazette of the Republic of Slovenia, No 131/06) and paragraph 1 of Article 31 of the Bank of Slovenia Act (Official Gazette of the Republic of Slovenia No 72/06 - official consolidated text), the Governing Board of the Bank of Slovenia issues the following REGULATION ON THE CALCULATION OF CAPITAL REQUIREMENTS FOR MARKET RISKS FOR BANKS AND SAVINGS BANKS * 1. GENERAL PROVISIONS Article 1 (content of the regulation) (1) This regulation defines in detail the rules relating to calculating the capital requirements for market risks for banks and saving banks (hereinafter: banks). (2) Market risk for the purposes of this regulation comprises: (a) position risk (specific and general risk of price changes in financial instruments) − associated with debt instruments − associated with equity instruments (b) settlement and counterparty credit risk (c) foreign exchange risk (d) commodity risk (e) risk of exceeding the maximum allowable exposure from trading. (3) When this regulation refers to provisions of other regulations, these provisions shall be applied according to the text in force. Article 2 (general terms) (1) The terms used in this regulation are the same as those defined in Banking Act (Official Gazette of the Republic of Slovenia, No. 131/06; hereinafter: ZBan-1), such as: (b) local firm in the second paragraph of Article 14, (d) probability of default (hereinafter: PD) in the first paragraph of Article 115, (e) default in the second paragraph of Article 115, (f) loss given default (hereinafter: LGD) in the fourth paragraph of Article 115, (g) conversion figure (hereinafter: CF) in the fifth paragraph of Article 115, (h) expected loss (hereinafter: EL) in the sixth paragraph of Article 115, (i) a repurchase transaction in Article 117, _____________________________________ The official language of the document translated herein is Slovene. In case of any doubt or misuderstanding the Slovene version should therefore be considered final. ………………….. * Sklep o izračunu kapitalske zahteve za tržna tveganja za banke in hranilnice (Uradni list 135/06 in 104/07). THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (j) a securities or commodities lending or borrowing transaction in Article 118, (k) cash assimilated instrument in Article 119, (l) originator in the sixth paragraph of Article 120, (m) sponsor in the seventh paragraph of Article 120, (n) a financial instrument in the first paragraph of Article 121, (o) a derivative instrument in the fifth paragraph of Article 121, (p) a convertible security in the third paragraph of Article 121, (q) a warrant in the fourth paragraph of Article 121, (r) a regulated market referred to in Article 122. (2) For the purpose of this regulation the following definitions shall apply: (a) "over-the-counter (OTC) derivate instruments” are financial instruments defined in Annex I to this regulation, other than those instruments to which an exposure value of zero is attributed in accordance with Table 7 of Article 48 of this regulation; (b) "stock financing" means positions where physical stock has been sold forward and the cost of funding has been locked in until the date of the forward sale; (c) "clearing member" means a member of the exchange or the clearing house which has a direct contractual relationship with the central counterparty (market guarantor); (d) "delta" means the expected change in an option price as a proportion of a small change in the price of the instrument underlying the option; (e) a "central counterparty" is an entity that legally interposes itself between counterparties to transactions (contracts) traded on one or more financial markets, becoming the buyer to every seller and the seller to every buyer; (f) "counterparty credit risk" (hereinafter: CCR) is the risk that the counterparty to a transaction could default before the final settlement of the transaction’s cash flows; (g) "long settlement transactions" are transactions where a counterparty undertakes to deliver a security, a commodity or a foreign currency against cash, other financial instruments, or commodities, or vice versa, at a settlement or delivery date that is contractually specified as more than the market standard for this particular transaction, or at least five business days after the date on which the credit institution enters into the transaction; (h) "margin lending transactions" mean transactions in which a credit institution extends credit in connection with the purchase, sale, carrying or trading of securities. Margin lending transactions do not include other loans that happen to be secured by securities collateral; (i) an "eligible external credit assessment institution" (hereinafter: eligible ECAI) is an ECAI that the Bank of Slovenia has placed on the list of eligible ECAIs for a particular category of exposure pursuant to the Regulation on the Recognition of External Credit Assessment Institutions (Official Gazette of the Republic of Slovenia, No. 135/06; hereinafter: the ECAI regulation); (j) "credit quality step" is the step to which the Bank of Slovenia maps the individual credit assessment of an eligible ECAI; (k) "management body" is the management board in a two-tiered bank management system or the executive directors of the management board in a one-tiered bank management system; (l) "investment firm" is investment firm in the first paragraph of Article 14 in ZBan-1 for which Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC; (m) "institutions" are credit institutions and investment firms; (n) a "recognised exchange" is an exchange from Annex II of this regulation and which meets the following conditions: 1. it functions regularly, 2. it has rules: – issued or approved by the appropriate authorities of the home country of the exchange, and – defining the conditions for the operation of the exchange, the conditions of access to the exchange as well as the conditions that shall be satisfied by a contract before it can effectively be dealt on the exchange; and 2 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 3. it has a clearing mechanism whereby contracts listed are subject to daily margin requirements which, in the opinion of the Bank of Slovenia, provide appropriate protection. Article 3 (terms relating to netting sets, hedging sets and related expressions) For the purposes of this regulation the following definitions of netting sets, hedging sets, and related expressions shall apply: (a) "netting set" means a group of transactions with a single counterparty that are subject to a legally enforceable bilateral netting arrangement and for which netting is recognised under Article 70 of this regulation and the Regulation on Credit Protection (Official Gazette of the Republic of Slovenia, No 135/06; hereinafter: Regulation on Credit Protection). Each transaction that is not subject to a legally enforceable bilateral netting arrangement, which is recognised under Article 70 of this regulation, should be interpreted as its own netting set for the purpose of this regulation; (b) "risk position" means a risk number that is assigned to a transaction under the Standardised Method set out in Articles 50 to 52 of this regulation following a predetermined algorithm; (c) "hedging set" means a group of risk positions from the transactions within a single netting set for which only their balance is relevant for determining the exposure value under the Standardised Method set out in Articles 50 to 52 of this regulation; (d) "margin agreement" means a contractual agreement or provisions of an agreement under which one counterparty must supply collateral to a second counterparty when an exposure of that second counterparty to the first counterparty exceeds a specified level. Collateral means financial collateral, real estate collateral, other physical collateral, and monetary receivables; (e) "margin threshold" means the largest amount of an exposure for a counterparty that remains outstanding until one party has the right to call for collateral; (f) "margin period of risk" means the time period from the last exchange of collateral covering a netting set of transactions with a defaulting counterparty until that counterparty is closed out and the resulting market risk is re-hedged; (g) "effective maturity under the internal model method, for a netting set with maturity greater than one year" (effective maturity) means the ratio of the sum of expected exposure over the life of the transactions in the netting set discounted at the risk-free rate of return divided by the sum of expected exposure over one year in a netting set discounted at the risk-free rate. This effective maturity may be adjusted to reflect rollover risk by replacing expected exposure with effective expected exposure for forecasting horizons under one year; (h) "cross-product netting" means the inclusion of transactions of different product categories within the same netting set pursuant to the Cross-Product Netting rules set out in Article 70 of this regulation; (i) "current market value" means the net market value of the portfolio of transactions within the netting set with the counterparty. Both positive and negative market values are used to calculate the current market value. Article 4 (terms relating to distributions) For the purposes of this regulation, the following definitions of distribution shall apply: (a) "distribution of market values" means the forecast of the probability distribution of net market values of transactions within a netting set for some future date (the forecasting horizon), given the realised market value of those transactions up to the present time; (b) "distribution of exposures" means the forecast of the probability distribution of market values that is generated by setting forecast instances of negative net market values equal to zero; (c) "risk-neutral distribution" means a distribution of market values or exposures at a future time period where the distribution is calculated using market-implied values that express risks such as market volatility; 3 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (d) "actual distribution" means a distribution of market values or exposures at a future time period where the distribution is calculated using historic or realised values such as volatilities calculated using past price or rate changes. Article 5 (terms relating to exposure measures and adjustments) For the purposes of this regulation, the following definitions of exposure measures and adjustments shall apply: (a) "current exposure" means the market value of a transaction or portfolio of transactions within a netting set with a counterparty that would be lost upon the default of the counterparty, assuming no recovery on the value of those transactions in bankruptcy. If the market value is negative, the value is given as zero; (b) "peak exposure" means a high percentile of the distribution of exposures at any particular future date before the maturity date of the longest transaction in the netting set; (c) "expected exposure" means the average of the distribution of exposures at any particular future date before the longest maturity transaction in the netting set matures; (d) "effective expected exposure (Effective EE)” at a specific date means the maximum expected exposure that occurs at that date or any prior date. Alternatively, it may be defined for a specific date as the greater of the expected exposure at that date, or the effective exposure at the previous date; (e) "expected positive exposure (EPE)" means the weighted average over time of expected exposures where the weights are the proportion that an individual expected exposure represents of the entire time interval. When calculating the minimum capital requirement, the average is taken over the first year or, if all the contracts within the netting set mature within less than one year, over the time period of the longest maturity contract in the netting set; (f) "effective expected positive exposure (Effective EPE)" means the weighted average over time of effective expected exposure over the first year, or, if all the contracts within the netting set mature within less than one year, over the time period of the longest maturity contract in the netting set, where the weights are the proportion that an individual expected exposure represents of the entire time interval; (g) "credit valuation adjustment" means an adjustment to the mid-market valuation of the portfolio of transactions with a counterparty; this adjustment reflects the market value of the credit risk due to any failure to perform on contractual agreements with a counterparty; this adjustment may reflect the market value of the credit risk of the counterparty or the market value of the credit risk of both the counterparty and the bank; (h) "one-sided credit valuation adjustment" means a credit valuation adjustment that reflects the market value of the credit risk of the counterparty to the bank, but does not reflect the market value of the credit risk of the bank to the counterparty. Article 6 (terms relating to CCR-related risk) For the purposes of this regulation, the following definitions of CCR-related risks shall apply: (a) "rollover risk" means the amount by which expected positive exposure is understated when future transactions with a counterpart are expected to be conducted on an ongoing basis; the additional exposure generated by those future transactions is not included in calculation of EPE; (b) "general wrong-way risk" arises when the PD of counterparties is positively correlated with general market risk factors; (c) "specific wrong-way risk" arises when the exposure to a particular counterparty is positively correlated with the PD of the counterparty due to the nature of the transactions with the counterparty. A credit institution shall be considered to be exposed to Specific Wrong-Way Risk if the future exposure to a specific counterparty is expected to be high when the counterparty's PD is also high. 4 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 2. CAPITAL REQUIREMENT FOR MARKET RISK Article 7 (calculation of capital requirement) (1) The capital requirement for market risk is equal to the amount of: (a) the capital requirements calculated for trading book business, i.e. for: − position risk (in accordance with Articles 15 to 42 of this regulation); − settlement and counterparty credit risk (in accordance with Articles 43 to 74 of this regulation); − risk of exceeding the maximum allowable exposure from trading (in accordance with Article 93 of this regulation); (b) the capital requirements calculated for all business (non-trading and trading book items), i.e. for: − foreign exchange risk (in accordance with Articles 75 and 76 of this regulation); − commodities risk (in accordance with Articles 77 to 80 of this regulation). (2) Banks may also use internal models to calculate capital requirements for position risk, exchange rate risk and/or commodities risk (in accordance with Articles 81 to 92 of this regulation), or use a combination of internal models and the methods defined in Articles 15 to 42, 75, 76 and 77 to 80 of this regulation, but only if authorised by the Bank of Slovenia or the competent authority of another Member State to use internal models to calculate capital requirements for position risk, exchange rate risk and/or commodities risk. (3) Instead of calculating the capital requirements for their trading book items in accordance with Articles 15 to 42 of this regulation, banks may calculate them in accordance with the Regulation on the Calculation of Capital Requirements for Credit Risk using the Standardised Approach for Banks and Savings Banks (Official Gazette of the Republic of Slovenia, No 135/06; hereinafter: Standardised Approach Regulation) or the Regulation on the Calculation of Capital Requirements for Credit Risk Using an Internal Ratings-Based Approach for Banks and Savings Banks (Official Gazette of the Republic of Slovenia, No 135/06; hereinafter: the IRB Approach Regulation), if at the same time the following conditions have been fulfilled: (a) the trading book business of such institutions does not normally exceed 5% of their total business; (b) their total trading book positions do not normally exceed EUR 15 million; and (c) the trading book business of such institutions never exceeds 6% of their total business and their total trading book positions never exceed EUR 20 million. (4) For the purpose of points (a) and (c) of the preceding paragraph, total business shall refer to onand off-balance-sheet business (from B.-1 to B.-4 on the balance sheet). When the size of on- and offbalance-sheet business is assessed, debt instruments shall be valued at their market prices or their nominal value or amortised cost, equities at their market prices, and derivatives according to the nominal or market values of the instruments underlying them. Long positions and short positions shall be summed regardless of their signs. (5) The spot rate shall be used to convert the value of trading business or the total position referred to in the third paragraph of this article into euros. (6) Irrespective of the third paragraph of this article, the Bank of Slovenia may issue a decision requiring banks that meet the conditions set out in that paragraph to calculate the capital requirements for trading book business in accordance with Articles 15 to 42, 43 to 74 and 93 of this regulation, if the trading book business is significant in terms of overall bank business. 5 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Article 8 (calculating capital requirements when limits are exceeded) (1) If a bank should, for a lengthier period, exceed either or both of the limits imposed in points (a) and (b) of the third paragraph of Article 7 of this regulation, or if it exceeds either or both of the limits imposed by point (c) of the third paragraph of Article 7 of this regulation, it must calculate capital requirements in accordance with Articles 15 to 42, 43 to 74 and 93 of this regulation for trading book business, and not in accordance with the Standardised Approach Regulation or the IRB Approach Regulation. The bank must immediately notify the Bank of Slovenia of exceeding the stated limits. (2) A bank shall be deemed to have exceeded either or both of this limits imposed in points (a) and (b) of the third paragraph of Article 7 of this regulation, if it exceeds either or both of the stated limits three times per month, within the period for which it is required to report to the Bank of Slovenia on calculation of and compliance with capital requirements for market risk. 3. DEFINITION OF TRADING BOOK Article 9 (general) (1) The trading book of an institution shall consist of all positions in financial instruments and commodities held either with trading intent or in order to hedge other elements of the trading book and which are either free of any restrictive covenants on their tradability or able to be hedged. (2) Positions held with trading intent are those held intentionally for short-term resale and/or with the intention of benefiting from actual or expected short-term price differences between buying and selling prices or from other price or interest rate variations. These positions include proprietary positions and positions arising from client servicing and market making. (3) Trading intent shall be evidenced on the basis of strategies, polices, and procedures set up by the bank in accordance with Article 10 of this regulation. The distinction between trading book and nontrading business is based on objective criteria that are used consistently and defined in advance in internal documents. (4) Banks must establish and maintain systems and controls for the management and valuation of their trading book in accordance with Articles 12 and 13. (5) In accordance with Article 14 of this regulation, banks may include internal hedges against risk for non-trading items in the trading book. Article 10 (evidence of trading intent) For the purposes of managing positions/portfolios intended for trading, banks must produce and take into consideration: (a) a clearly documented trading strategy for positions/portfolios, approved by senior management and including the expected holding horizon; the intent of acquiring a financial instrument or commodity, or concluding a contract in relation to a financial instrument or commodity must be known before the actual acquisition or conclusion of contract; evidence of trading intent is given on the basis of the bank’s expectations or wishes in relation to trading and/or generating earnings from changes in prices, interest rates, or historical patterns of bank operations and methodologies used to evaluate risk; 6 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (b) clearly defined policies and procedures for the active management of the position, which shall include the following: − there must be a trading desk in which all trading positions are entered; − the position limits are set and monitored for appropriateness; − dealers have the autonomy to enter into/manage the position within agreed limits and according to the approved strategy; − senior management are notified of positions as part of the risk management process; − positions are actively monitored with reference to market information sources and an assessment made of the marketability or hedge-ability of the position or its component risks, including the assessment of, the quality and availability of market inputs to the valuation process, level of market turnover, sizes of positions traded in the market; and (c) clearly defined policy and procedures to monitor positions against the institution's trading strategy, including the monitoring of turnover and sale positions in the institution's trading book. Article 11 (trading policies and procedures) (1) Banks shall have clearly defined policies and procedures for determining which exposures to include in the trading book for the purposes of calculating their capital requirements, consistent with the criteria set out in Article 9 of this regulation, and taking into account the bank's risk management capabilities and practices. Compliance with these policies and procedures shall be fully documented and subject to periodic internal audit. (2) Banks must have clearly defined policies and procedures for overall management of the trading book. These policies and procedures shall address at least: (a) the activities the institution considers to be trading and as constituting part of the trading book for capital requirement purposes; (b) the extent to which an item can be marked-to-market daily by reference to an active, liquid two-way market; (c) for positions that are marked-to-model, the extent to which the bank can: − identify all material risks relating to these positions; − hedge all material risks of these items with instruments for which an active, liquid two-way market exists; − derive reliable estimates for the key assumptions and parameters used in the internal model; (d) the extent to which the bank can – and to which it is required to – generate valuations for the exposures that may be subject to consistent external validation; (e) the extent to which legal restrictions or other operational requirements would impede the bank's ability to effect a liquidation or hedge of the position in the short term; (f) the extent to which the bank can – and to which it is required to – actively manage risk; (g) the extent to which the bank may transfer risk or positions between the non-trading and trading books and the criteria for such transfers. (3) Banks may only include positions that represent items set out in points (a), (b) and (c) of the second paragraph of Article 22 of the Regulation on the Calculation of the Capital of Banks and Savings Banks (Official Gazette of the Republic of Slovenia, No 135/06; hereinafter: the Capital Regulation) as equity or debt instruments, as appropriate, in their trading book, if they demonstrate they are an active market maker for these positions. In this case, the bank must have adequate systems and controls to monitor trading of eligible own funds instruments. For the purposes of this paragraph, a bank shall be deemed an active market maker, if it can demonstrate that it maintains stable security buying and selling prices, and that it is, at any time, prepared and capable of immediately purchasing and selling securities at publicly accessible listings. 7 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Furthermore, the bank must have performed these transactions regularly and frequently with unrelated counterparties at market prices for at least one year. (4) Banks may include trading-related repo-style transactions accounted for in its non-trading books in the trading book for capital requirement purposes, but only if all such transactions are included. For this purpose, trading-related repo-style transactions are defined as transactions that meet the requirements in the second paragraph of Article 9 and Article 10 of this regulation, where both legs are in the form of either cash or securities that can be included in the trading book. Regardless of where they are booked, all repo-style transactions are subject to a non-trading book counterparty credit risk (CCR) capital requirement calculation. Article 12 (systems and controls for management and valuation of the trading book) (1) Banks must establish and maintain systems and controls sufficient to provide prudent and reliable valuation estimates for trading book positions. These rules require banks to ensure that the value applied to each of its trading book positions appropriately reflects the current market value. This value shall contain an appropriate degree of certainty with regard to the dynamic nature of trading book positions, the demands of prudential soundness and the mode of operation and purpose of capital requirements with regard to trading book positions. (2) The systems and controls referred to in the first paragraph of this article must include the following elements: (a) documented policies and procedures for the process of valuation of trading book positions; this includes clearly defined responsibilities of the various areas involved in the determination of the valuation, market information and the review of its appropriateness, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, and month-end and ad-hoc verification procedures; and (b) reporting lines for the department accountable for the valuation process that are clear and independent of the front office; the reporting line shall ultimately be to the management board. (3) Banks must revalue trading book positions according to current market prices (marking-to-market). If that is not possible, they must mark-to-model their positions. Positions must be revalued at least daily. (4) Marking-to-market means revaluing positions at least on a daily basis at readily available close out prices that are independently sourced, such as exchange prices, screen prices, or quotes from several independent reputable brokers. (5) When marking-to-market, the more prudent side of bid/offer shall be used, unless the bank is a significant market maker in the particular type of financial instrument or commodity in question and can close out at mid market (between the sale and purchase price). (6) Marking-to-model is defined as any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input. (7) The following requirements must be complied with, if banks use marking-to-model to value trading book positions: (a) senior management must be aware of the trading book positions that are subject to marking-tomodel and must understand the materiality of the uncertainty this creates in the reporting of the risk/performance of the business; (b) market inputs must, where possible, be in line with market prices, and the appropriateness of the market inputs for a particular position being valued and the parameters of the model must be assessed on a frequent basis; 8 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (c) where available, valuation methodologies which are accepted market practice for particular financial instruments or commodities shall be used; (d) where the model is developed by the bank itself, it must be based on appropriate assumptions, which have been assessed and tested by suitably qualified parties that did not participate in the development process; the model must be developed and approved independently of the front office and must be independently tested, including validation of the mathematical calculations, assumptions and software; (e) there shall be formal change control procedures in place and a secure copy of the model shall be held and periodically used to check valuations; (f) those responsible for risk management must be aware of the weaknesses of the model used and how best to reflect them in the valuation output; (g) the model shall be subject to periodic review to determine the accuracy of its performance (e.g. assessing the continued appropriateness of assumptions, analysis of profit and loss versus risk factors, comparison of actual close out values to model outputs). (8) Independent price verification should be performed in addition to daily marking-to-market or marking-to-model. This is the process by which market prices or model inputs are regularly verified for accuracy and independence. While daily marking-to-market may be performed by dealers, verification of market prices and model inputs should be performed by a unit independent of the dealing room/front office, at least monthly (or, depending on the nature of the market/trading activity, more frequently). Where independent pricing sources are not available or pricing sources are more subjective, prudent measures such as valuation adjustments may be appropriate. Article 13 (valuation adjustments to trading book positions) (1) Notwithstanding the fact that banks must value trading book positions in accordance with international accounting reporting standards, they must also have appropriate procedures for valuation adjustments to trading book positions. These adjustments are only considered for the purposes of calculating bank capital in accordance with the sixth paragraph of this article. Banks must review valuation adjustments on an ongoing basis. (2) Banks must produce valuation adjustments to trading book positions due to: unearned credit spreads, close-out costs, operational risks, early termination, investing and funding costs, future administrative costs and model risk. (3) If possible, banks must also produce a valuation adjustment for less liquid trading book positions. Less liquid positions could arise from both market events and situations in the banks (e.g. concentrated positions and/or stale positions). (4) Banks must consider the following factors when determining whether to make a valuation adjustment: the amount of time it would take to hedge out the position/risks within the position, the volatility and average of bid/offer spreads, the availability of market quotes (number and identity of market makers), and the volatility and average of trading volumes, market concentrations, the aging of positions, the extent to which valuation relies on marking-to-model, and the impact of other model risks. (5) If banks use third party valuations or marking-to-model for valuations of trading book positions, they shall consider whether to apply a valuation adjustment for this reason. (6) If the valuation adjustment from the first paragraph of this Article is material, in accordance with point (c) of Article 12 of the Capital Regulation, the bank must deduct them from the bank’s original own funds. If the valuation adjustment from the first paragraph of this Article is not material, in accordance with Article 25 of the Capital Regulation, the bank must deduct them from the additional own funds eligible to cover market risk. 9 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE For the purpose of this paragraph of this article, an adjustment shall be considered material, if the bank makes an adjustment in position value that exceeds 2% of the value of the portfolio to which the position in question refers. Article 14 (internal hedging against risk arising from non-trading items) (1) An internal hedge is a position that materially or completely offsets the component risk element of a non-trading book position or a set of positions. Positions arising from internal hedges are eligible for trading book capital treatment, provided that they are held with trading intent and that the general criteria on trading intent and prudent valuation specified in Articles 10 to 13 of this regulation are met. Banks must respect the following requirements, in particular: (a) internal hedges shall not be primarily intended to avoid or reduce capital requirements; (b) internal hedges shall be properly documented and subject to specific internal approval and audit procedures; (c) internal hedge transactions must be dealt with according to market conditions; (d) the bulk of the market risk that is generated by the internal hedge shall be dynamically managed in the trading book within the authorised limits; and (e) internal hedging transactions must be carefully monitored, and that monitoring guaranteed by appropriate procedures. (2) The treatment referred to in the first paragraph of this Article applies to the capital requirements applicable to the non-trading book leg of the internal hedge. (3) Notwithstanding the second paragraph of this Article, when a bank hedges a non-trading book credit risk exposure using a credit derivative in its trading book, the non-trading book exposure is not deemed to be hedged for the purposes of calculating capital requirements, unless the bank purchases a credit derivative meeting the requirements set out in Article 40 of the Credit Protection Regulation from an eligible third party protection provider for non-trading exposure. When a bank purchases such third party protection, which is recognised as a hedge for a non-trading book exposure for the purposes of calculating capital requirements, neither the internal nor external credit derivative hedge shall be included in the trading book for the purposes of calculating capital requirements. 4. CALCULATING CAPITAL REQUIREMENTS FOR POSITION RISK 4.1. General Provisions Article 15 (netting) (1) The excess of an institution's long (short) positions over its short (long) positions in the same equity, debt and convertible issues and identical financial futures (options, warrants and covered warrants) shall be its net position in each of those different instruments. In calculating the net position, positions in derivative instruments may be treated as positions in the underlying (or notional) security or securities, in accordance with Articles 17 to 20 of this regulation. Banks’ holdings of their own debt instruments shall be disregarded in calculating specific risk. (2) No netting shall be possible between the position of a convertible security and the position of the financial instrument underlying it. (3) All net positions in financial instruments in foreign currency must be converted, irrespective of their signs, into the reporting currency according to the valid spot exchange rate, before their aggregation. 10 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Article 16 (general rules for breaking down the positions of particular instruments) The positions of the particular instruments set out in Articles 17 to 20 of this regulation are broken down into hypothetical positions in the following manner: (a) if the underlying instrument is a debt instrument: – into a debt instrument, where the particular instrument depends on the price (interest rate) of the specifically defined underlying debt instrument it refers to; and/or – into a hypothetical debt instrument that covers the interest rate risk arising from future payments and received cash flows (including hypothetical payments and receipts); as they generated to reflect a general position risk (and not a specific position risk), they are called hypothetical risk-free debt instruments; − into debt instruments and hypothetical debt instruments together; (b) if the underlying instrument is an equity: − into hypothetical positions in individual equities, baskets of equities, or equity indices; (c) if the underlying instrument is a commodity: − into hypothetical positions in the commodities to which they refer. Article 17 (interest rate futures, forward rate agreements, and forward commitments to buy or sell debt instruments) (1) Interest rate futures, forward rate agreements (FRAs) and forward commitments to buy or sell debt instruments shall be treated as combinations of hypothetical long and short positions in underlying financial instruments, as defined in the second to fifth paragraphs of this article. (2) For the purposes of this article, long position means a position in which a bank has set the interest rate it will receive at some time in the future, and short position means a position in which it has set the interest rate it will pay at some time in the future. (3) A long interest rate futures position shall be treated as a combination of a short position in a riskfree zero coupon debt security maturing on the delivery date of the futures contract and a long position in a risk-free zero-coupon debt security maturing on the delivery date of the futures contract, plus the agreed contract period. (4) A sold FRA shall be treated as a long position in a risk-free zero coupon debt security maturing on the settlement date, plus the agreed or contracted period, and a short position in a risk-free zero coupon debt security maturing on the settlement date. (5) A forward commitment to buy a debt instrument shall be treated as a combination of a short position in a risk-free zero coupon debt security maturing on the delivery date and a long (spot) position in the bond to which the forward contract refers, with maturity the same as the bond’s remaining maturity. (6) Calculations of the capital requirements for a specific risk , positions in risk-free zero coupon debt securities shall be included in the first category (weighting 0%) in Table 1 of Article 28 of this regulation, and the position in the bond shall be included in the appropriate category in the same table. (7) Banks may use, as the capital requirement for the contracts set out in the first paragraph of this article, if they are traded on recognised exchanges listed in Annex II of this regulation, a sum that is equal to the margin required for such contracts by the exchange in question. (8) Banks may use, as the capital requirement for the contracts set out in the first paragraph of this article, which are traded OTC, that are cleared by a recognised clearing house listed in Annex II of this 11 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE regulation, a sum that is equal to the margin required for such contracts by the clearing house in question. Article 18 (options) (1) Options on interest rates, debt instruments, equities, equity indices, financial futures, swaps and foreign currencies shall be treated as if they were positions equal in value to the amount of the underlying instrument to which the option refers, multiplied by its delta for the purposes of this chapter. The latter positions may be netted off against any offsetting positions in the identical instruments underlying the options. In calculating capital requirements in respect of position risk, the positions in options shall be treated as a combination of hypothetical long and short positions; i.e. they are broken down into the positions in the underlying instruments to which the options refer. The capital requirement for a written OTC option must be calculated in relation to the underlying instrument to which the options refer. (2) The delta used shall be that of a recognised exchange listed in Annex II of this regulation where the options are traded. For options for which there is no available delta from a recognised exchange, or for OTC options, banks may calculate the delta themselves, if they demonstrate that their delta calculation model is appropriate. The Bank of Slovenia may prescribe a delta calculation methodology. (3) The delta-weighted positions for underlying instruments shall be taken into account for the calculation of capital requirements in respect of position risks as follows: (a) a purchased call option as a long position (b) a written call option as a short position (c) a purchased put option as a short position, and (d) a written put option as a long position. (4) It is essential that banks safeguard against other risks associated with options, apart from delta. Banks therefore must calculate the additional capital requirement for other risks associated with options, e.g. risks of changes to the delta (gamma risk), or volatility of the underlying instrument (vega risk). Gamma and vega used shall be that of a recognised exchange listed in Annex II of this regulation where the options are traded. For options for which there is no available gamma and vega from a recognised exchange, or for OTC options, banks may calculate the gamma and vega themselves, if they demonstrate that their models for calculation are appropriate. The Bank of Slovenia may prescribe a calculation methodology for gamma and vega. (5) Banks may use, as the capital requirement for the options set out in the first paragraph of this article, if they are traded on recognised exchanges listed in Annex II of this regulation, a sum that is equal to the margin required for such options by the exchange in question. (6) Banks may use, as the capital requirement for the contracts set out in the first paragraph of this article, which are traded OTC and are cleared by a recognised clearing house listed in Annex II of this regulation, a sum that is equal to the margin required for such contracts by the clearing in question. (7) Banks may use, as the capital requirement for the purchase options set out in the first paragraph of this article, if they are traded on recognised exchanges or as OTC options, a sum that is equal to the requirement required for the financial instruments to which the options refer. The capital requirement defined in the manner shall not exceed the market value of the options referred to in the first paragraph of this article. Article 19 (warrants) Warrants relating to debt instruments and equities shall be treated in the same way as options. 12 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Article 20 (swaps) Banks must treat swaps (e.g. cross-currency swaps, interest rate swaps, equity swaps) for interest rate risk on the same basis as on-balance sheet instruments. Thus, an interest rate swap for which banks receive a floating rate interest and pay fixed rate interest shall be treated as equivalent to a combination of a long position in a floating rate instrument of maturity equivalent to the period until the next time the interest rate is set and a short position in a fixed rate instrument with the same maturity as the swap itself. Article 21 (treatment of the protection seller) Unless otherwise stated, the nominal value of a credit derivative shall be used for the calculation of the capital requirement against the position risk of the party assuming the credit risk ("protection seller"). When calculating the capital requirement for the specific risk of the party, except for total return swaps, the maturity of the credit derivative contract is used instead of the maturity of the obligation. The positions are therefore set as follows: (a) a total return swap creates a long position in the general market risk of the reference obligation and a short position in the general market risk of a government bond, which is assigned a 0% risk weight using the standard approach for calculating the capital requirement for credit risk and has a maturity equivalent to the period until the next interest rate fixing; It also creates a long position in the specific risk of the reference obligation; (b) a credit default swap does not create a position for the general market risk; for the purposes of specific risk, banks must record a synthetic long position in an obligation of the reference entity, unless the derivative has an external rating and meets the conditions for a qualifying debt item (debt from a qualified issuer); in that case a long position in the derivative is recorded. If premium or interest payments are due under the credit default swap, these cash flows must be represented as notional positions in government bonds; (c) a single name credit linked note (CLN) creates a long position in the general market risk of the note itself, as an interest rate product. For the purpose of specific risk, a synthetic long position is created in an obligation of the reference entity; an additional long position is created in the obligation of the note issuer; where the credit linked note has an external rating and meets the conditions for a qualifying debt item, a single long position with the specific risk of the note need only be recorded; (d) in addition to a long position in the specific risk of the issuer of the note, a multiple name credit linked note providing proportional protection creates a position in the obligations of each reference entity, with the total nominal amount of the credit linked note assigned across the positions according to the proportion of the total nominal amount that each exposure to a reference entity represents. Where more than one obligation of a reference entity can be selected, the obligation with the highest risk weight determines the specific risk. Where a multiple name credit linked note has an external rating and meets the conditions for a qualifying debt item, only a single long position for the specific risk of the note need to be taken into account; (e) a first-asset-to-default credit derivative creates a position for the nominal amount in an obligation of each reference entity; if the size of the maximum credit event payment is lower than the capital requirement calculated using the method in the preceding sentence, the maximum credit event payment amount may be taken as the specific risk capital requirement (capital charge); a second-asset-to-default credit derivative creates a position for the nominal amount in an obligation of each reference entity less one (the one with the lowest specific risk capital charge); if the size of the maximum credit event payment is lower than the capital requirement calculated using the method in the preceding sentence, the maximum credit event payment amount may be taken as the specific risk capital charge; 13 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE if a first- or second-asset-to-default derivative has as external rating and meets the conditions for a qualifying debt item, then the protection seller only has to calculate one capital requirement for the specific risk reflecting the rating of the credit derivative. Article 22 (treatment of the protection buyer) (1) For the party transferring credit risk (the "protection buyer"), the positions are determined as the mirror image of the protection seller’s positions, with the exception of a credit-linked note (which does not create any short position in the issuer). If at a given moment there is a call option in combination with a step-up, this moment is treated as the maturity of the protection. In the case of nth to default credit derivatives, protection buyers are allowed to offset specific risk for n-1 of the underlying obligations (i.e., the n-1 assets with the lowest capital requirement for specific risk). (2) Banks that mark-to-market and manage the interest rate risk on the derivative instruments referred to in Articles 17 to 20 of this regulation on the basis of a discounted cash flow, may use sensitivity models to calculate the positions in the derivative instruments. These models may also be used to calculate positions in bonds that are amortised over their residual life, rather than via one final repayment of principal. The positions determined in this manner shall be included in the calculation of the capital requirement for general market risk of the debt instruments. (3) Banks may only use the sensitivity models referred to in the second paragraph of this regulation, if authorised by the Bank of Slovenia. The Bank of Slovenia shall issue this permission if the following two conditions are met: (a) the models generate positions that have the same sensitivity to interest rate changes as the underlying instruments; (b) this sensitivity must be assessed with reference to independent movements in sample rates across the yield curve, with at least one sensitivity point in each of the maturity bands set out in Table 2 of the fourth paragraph of Article 32. (4) Banks shall prove that they meet the conditions specified in the third paragraph of this article by submitting the following documentation as part of the request for the permission: (a) documentation on the type of financial instruments for which they intend to use the sensitivity model, and on the basic information on the models; (b) documentation proving that the models generate positions that have the same sensitivity to interest rate changes as the underlying instruments; (c) documentation that demonstrates that the sensitivity is assessed with reference to independent movements in sample rates across the yield curve, with at least one sensitivity point in each of the maturity bands set out in Table 2 of the fourth paragraph of Article 32. (5) Banks must meet the conditions referred to in the third paragraph of this article on an ongoing basis from the moment the Bank of Slovenia issues its permissions onwards. (6) More detailed instructions on the form for requesting a Bank of Slovenia permission to use sensitivity models to calculate positions in derivatives or the form for requesting an amendment to this permission are set out in Annex III of this regulation. (7) The Bank of Slovenia shall withdraw the permission for use of sensitivity models, if: (a) a bank acts in contradiction with the Bank of Slovenia order, or a Bank of Slovenia order with additional measures for the correction of a violation in fulfilment of the conditions from the third paragraph of this article; (b) a bank seriously violates the fulfilment of the conditions from the third paragraph of this article. 14 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Article 23 (treatment of a protection buyer without the use of sensitivity models) Banks that do not use sensitivity models, may treat as fully matched those positions in a hypothetical risk-free debt instruments that derived from derivative instruments referred to in Articles 17 to 20 of this regulation and that meet at least the following conditions: (a) the positions are of the same value and denominated in the same currency; (b) the reference rate (for floating rate positions) or coupon (for fixed rate positions) for derivative positions closely match the interest rate or coupon for the positions they are being matched with (the widest possible gap between the two is 15 basis points); (c) the positions mature: − on the same day, if the residual maturity of the positions is less than one month, − within seven days, if the residual maturity of the positions is between one month and one year, − within 30 days, if the residual maturity of the positions is over one year. Article 24 (treatment of securities in repurchase transactions and lending and borrowing transactions) The transferor of securities or guaranteed rights relating to title to securities in repurchase agreements and the lender of securities in a securities lending or borrowing shall include these securities in the calculation of its capital requirement for position risk, provided that such securities meet the criteria for inclusion in the trading book referred to in Article 9 of this article. Article 25 (specific and general risks) (1) The position risk on a debt instrument or equity (or debt or equity derivative) shall be divided into two components in order to calculate the capital requirement against it, for specific and general risk. (2) Specific risk is the risk of a price change in the relevant financial instrument due to factors related to its issuer or in the case of a derivative financial instrument, the issuer of the underlying instrument. (3) General risk is the risk of a price change in the relevant instrument due to a change in the level of interest rates (in the case of a traded debt instrument or debt derivative) or due to price movement on the capital market (in the case of an equity or equity derivative) that is unrelated to any specific attributes of individual instruments. Article 26 (calculation of capital requirement for position risk) The capital requirement for position risk shall be calculated as the sum of capital requirements for the position risk of debt instruments and equities. 4.2. Debt Instruments Article 27 (calculation of capital requirement for position risk of debt instruments) (1) Banks must classify its net positions in debt instruments according to the currency in which they are denominated. The capital requirement for general and specific risk must be calculated for the net position in each currency separately. (2) The capital requirement for position risk on debt instruments shall be calculated as the sum of the capital requirement for specific and general risk on the debt instruments. Specific risk capital requirement for debt instruments shall be calculated in accordance with Articles 28 to 30 of this 15 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE regulation, and the capital requirement for general risk on debt instruments in accordance with Article 31 of this regulation. Article 28 (specific risk) (1) Banks must classify all net positions in debt instruments calculated in accordance with the first paragraph of Article 15 of this regulation into the appropriate debt instrument category from Table 1 in this paragraph, and on the basis of their issuer/obligor, external or internal credit assessment, and their residual maturity. The classified net positions in debt instruments must then be multiplied by the weightings prescribed in accordance with Table 1 in this paragraph for the individual category of debt instrument to which they belong. Specific risk capital requirement for debt instruments shall be calculated as the sum of its weighted positions (regardless of whether they are long or short). Table 1: Categories of debt instruments and prescribed weightings for the calculation of specific risk capital requirement (capital charge) for debt instruments Weightings for specific risk capital charge Debt securities issued or guaranteed by central governments, issued by 0% central banks, international organisations, multilateral development banks or Member States' regional governments or local authorities, and which would qualify for credit quality step 1 in accordance with the Standardised Approach Regulation, or which would receive a 0% risk weight under the described rules. Debt securities issued or guaranteed by central governments, or issued 0.25%, if the residual term by central banks, international organisations, multilateral development to final maturity is 6 banks or Member States' regional governments or local authorities, months or less and which would qualify for credit quality step 2 or 3 in accordance with the Standardised Approach Regulation. 1.00%, if the residual term to final maturity is greater Debt securities issued or guaranteed by institutions and which would than 6 and up to and qualify for credit quality step 1 or 2 in accordance with the including 24 months Standardised Approach Regulation. 1.60%, if the residual term Debt securities issued or guaranteed by institutions and which would to final maturity exceeds qualify for credit quality step 3 in accordance with Article 18 of the 24 months Standardised Approach Regulation. Categories of debt instruments 1 2 Debt securities issued or guaranteed by corporates and which would qualify for credit quality step 1 or 2 in accordance with the Standardised Approach Regulation. 3 Other qualifying items as defined in Article 30 of this regulation. Debt securities issued or guaranteed by central governments, or issued 8.00% by central banks, international organisations, multilateral development banks or Member States' regional governments or local authorities or institutions, and which would qualify for credit quality step 4 or 5 in accordance with the Standardised Approach Regulation. Debt securities issued or guaranteed by corporates and which would qualify for credit quality step 3 or 4 in accordance with the Standardised Approach Regulation. 16 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 4 Exposures for which a credit assessment by a nominated ECAI is not available. Debt securities issued or guaranteed by central governments, or issued 12.00% by central banks, international organisations, multilateral development banks or Member States' regional governments or local authorities or institutions, and which would qualify for credit quality step 6 in accordance with the Standardised Approach Regulation. Debt securities issued or guaranteed by corporates and which would qualify for credit quality step 5 or 6 in accordance with the Standardised Approach Regulation. (2) Banks must use the maximum weighting shown in Table 1 in first paragraph of this article, which is 12%, for debt instruments for which there is an increased risk due to the insufficient solvency of the issuer or liquidity of the instrument. Article 29 (special rules for calculating the capital requirement for specific risk) (1) Banks that use the IRB approach to calculate the capital requirement for credit risk, shall determine the credit quality for the purposes of the first paragraph of this article, on the basis of obligors’ PD assessment according to the exposures in Table 1 of the first paragraph of Article 28 of this regulation. The PD must be equal or lower than that, which in accordance with the rules for the risk weight of exposures to corporates from the Standard Approach Regulation, which would qualify for the relevant credit quality step. (2) Instruments issued by unqualified issuers are attributed a weighting for specific risk of 8% or 12% in accordance with Table 1 of the first paragraph of Article 28 of this regulation. The Bank of Slovenia can require banks to use a higher specific risk capital requirement (capital charge) for such instruments and/or to disallow offsetting for the purposes of defining the extent of general market risk between such instruments and any other debt instruments. (3) For securitisation exposures that are deducted in the calculation of the limits on individual capital components in accordance with the first paragraph and point (g) of the second paragraph of Article 22 of the Capital Regulation, or which are risk weighted in accordance with the Rules on the Calculation of Capital Requirements for Credit Risk in Securitisation (Official Gazette of the Republic of Slovenia, No 135/06; hereinafter: Securitisation Regulation) with a weighting of 1250%, banks must apply a capital requirement that is no lower than the results for the two possible treatments for securitised exposures. For unrated liquidity facilities the bank must apply a capital requirement that is no lower than that defined in accordance with Articles 18 to 20 and 30 to 33 of the Securitisation Regulation. (4) Banks may assign a 0%-weighting to debt securities issued or guaranteed by central governments, or issued by central banks, international organisations, multilateral development banks or Member States' regional governments or local authorities, instead of the weightings prescribed in Table 1 of the first paragraph of Article 28 of this regulation, where these debt securities are denominated and funded in domestic currency. The 0%-weighting may in that case be applied irrespective of the credit quality of the debt securities in question. (5) Irrespective of the weightings prescribed in Table 1 of the first paragraph of Article 28 of the Regulation, for the purpose of covering the bonds defined in Item 10 of the second paragraph of Article 2 and Article 45 of the Standard Approach Regulation, banks may use the same weightings as for qualifying items with the same residual maturity as such bonds, reduced in the following manner: (a) if a subordinated unsecured exposure to an issuer is assigned a risk weight of 20% for the purposes of calculating the capital requirement, the appropriate debt instrument weighting from 17 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Table 1 in the first paragraph of Article 28 of this regulation (appropriate weighting for qualifying items) shall be reduced by 50%; (b) if a subordinated unsecured exposure to an issuer is assigned a risk weight of 50% for the purposes of calculating the capital requirement, the appropriate debt instrument weighting from Table 1 in the first paragraph of Article 28 of this regulation (appropriate weighting for qualifying items) shall be reduced by 60%; (c) if a subordinated unsecured exposure to an issuer is assigned a risk weight of 100% for the purposes of calculating the capital requirement, the appropriate debt instrument weighting from Table 1 in the first paragraph of Article 28 of this regulation (appropriate weighting for qualifying items) shall be reduced by 50%; (c) if a subordinated unsecured exposure to an issuer is assigned a risk weight of 150% for the purposes of calculating the capital requirement, the appropriate debt instrument weighting from Table 1 in the first paragraph of Article 28 of this regulation (appropriate weighting for qualifying items) shall be reduced by 33.3%. Article 30 (definition of other qualifying items) The qualifying items from the second category of debt instruments in Table 1 of the first paragraph of Article 28 of this regulation shall include: (a) long and short positions in debt instruments, which would in accordance with the Standardised Approach Regulation qualify for credit quality step that corresponds to investment grade; For the purpose of this regulation, credit assessments with credit quality step from 1 to 3 shall be deemed investment grade; (b) long and short positions in debt instruments which, because of the solvency of the issuer, have a PD that meets the investment grade referred to under point (a), if the bank uses the IRB approach to calculate capital requirements for credit risk; (c) long and short positions in debt instruments, which do not have an external credit assessment from an nominated ECAI and that meet the following conditions: − they are sufficiently liquid; − their investment quality is at least equivalent to the investment quality of the positions referred to under point (a) of this paragraph; − the debt instrument to which these positions refer are listed on at least one regulated market in a Member State or on a recognised exchange listed in Annex II of this regulation; (d) long and short positions in debt instruments, issued by institutions that meet the following conditions: − they are sufficiently liquid; − their investment quality is at least equivalent to the investment quality of the positions referred to under point (a) of this paragraph; (e) long and short positions in debt instruments issued by institutions, that are subject to supervisory and regulatory arrangements comparable to those under this regulation, which meets at least credit quality step 2, in accordance with the rules on the standardised approach to capital requirement for credit risk. If the Bank of Slovenia assesses that debt instruments that are treated as qualifying items are subject to too high a degree of specific risk, it may require banks to cease treating them as qualifying items for in the calculation of capital requirements. 18 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Article 31 (general risk) Banks may use an approach to calculate the capital requirement for general risk based on maturity (in accordance with Article 32 of this regulation), or based on duration (in accordance with Article 33 of this regulation). The bank must apply the chosen approach on a consistent basis. Article 32 (maturity-based approach) (1) The procedure for calculating capital requirements against general risk involves two basic steps. First, all positions shall be weighted according to maturity (as defined in the second paragraph of this article), in order to compute the amount of capital required against them. Second, this requirement shall be reduced, if a weighted position is held alongside an opposite (long/short) weighted position within the same maturity band. A reduction in the requirement shall also be allowed when the opposite weighted positions fall into different maturity bands, with the size of this reduction depending both on whether the two positions fall into the same zone, or not, and on the particular maturity band group they fall into. There are three groups of maturity bands or zones altogether. (2) Banks shall assign their net positions to the appropriate maturity bands defined in column 2 or 3, as appropriate, in Table 2 in the fourth paragraph of this article. It shall assign them on the basis of residual maturity in the case of fixed rate debt instruments and on the basis of the period until the interest rate is next set in the case of floating rate debt instruments. Banks must also distinguish between debt instruments with a coupon of 3% or more and those with a coupon of less than 3% and allocate them appropriately to column 2 or 3 in Table 2 in the fourth paragraph of this article. Each position must then be multiplied by the appropriate weighting from column 4 of the mentioned Table. (3) The banks shall then work out the sum of the weighted long positions and the sum of the weighted short positions in each maturity band. The matched weighted position in an individual maturity band shall be the lower of the sum of the weighted long and the short positions in that maturity band, while the unmatched weighted position for an individual band shall be the difference between them. The total of the matched weighted positions in all bands shall then be calculated. (4) Banks must then compute the totals of the unmatched weighted long or unmatched weighted short positions from all maturity bands within an individual zone. The matched weighted position of an individual maturity group is the lower of the sum of unmatched weighted debts or the sum of unmatched weighted short positions in that zone. The unmatched weighted position of an individual zone is the difference between these two sums. Table 2: Classifying net positions according to residual maturity Zone (1) 1 2 3 Maturity band Interest rate of 3% Interest rate of less or more than 3% (2) 0 ≤ 1 month > 1 ≤ 3 months > 3 ≤ 6 months > 6 ≤ 12 months > 1 ≤ 2 years > 2 ≤ 3 years > 3 ≤ 4 years > 4 ≤ 5 years > 5 ≤ 7 years (3) 0 ≤ 1 month > 1 ≤ 3 months > 3 ≤ 6 months > 6 ≤ 12 months > 1.0 ≤ 1.9 years > 1.9 ≤ 2.8 years > 2.8 ≤ 3.6 years > 3.6 ≤ 4.3 years > 4.3 ≤ 5.7 years 19 Weighting (%) Assumed interest rate change (%) (4) (5) 0.00 0.20 0.40 0.70 1.25 1.75 2.25 2.75 3.25 1.00 1.00 1.00 0.90 0.80 0.75 0.75 0.65 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE > 7 ≤ 10 years > 10 ≤ 15 years > 15 ≤ 20 years > 20 years > 5.7 ≤ 7.3 years > 7.3 ≤ 9.3 years > 9.3 ≤ 10.6 years > 10.6 ≤ 12.0 years > 12.0 ≤ 20.0 years > 20.0 years 3.75 4.50 5.25 6.00 8.00 12.50 0.65 0.60 0.60 0.60 0.60 0.60 (5) Banks must then match the unmatched weighted positions of zones 1 and 2, to determine the matched weighted position between zones 1 and 2. Then they must also match the remainder of the unmatched weighted position of zone 2, and the unmatched weighted position of zone 3, in order to calculate the matched weighted position between zones 2 and 3. (6) Banks may change the order of matching referred to in the fifth paragraph of this article in order to calculate the weighted position between zones 2 and 3 first, and then calculate the weighted position between zones 1 and 2. (7) Banks must then match the remaining unmatched weighted position for zone 1 and the remaining unmatched weighted position of zone 3. (8) Finally, banks must add the residual unmatched weighted positions, i.e. the positions not matched in the calculations in accordance with the fifth to seventh paragraphs of this article. (9) The capital requirement against general risk stemming from debt financial instruments shall be calculated as the sum of: (a) 10% of the sum of the matched weighted positions in all maturity bands; (b) 40% of the matched weighted position in zone 1; (c) 30% of the matched weighted position in zone 2; (d) 30% of the matched weighted position in zone 3; (e) 40% of the matched weighted position between zones 1 and 2 and between zones 2 and 3; (f) 150% of the matched weighted position between zones 1 and 3; and (g) 100% of the residual unmatched weighted positions. Article 33 (duration-based approach) (1) Under an approach based on duration, banks must take the market value of each fixed rate debt instrument and calculate its yield to maturity, which is the implied discount rate for that instrument. In the case of floating rate instruments, the institution shall take the market value of each instrument and calculate its yield for a period equal to the time when the interest rate will next be set. (2) The bank shall then calculate the modified duration of each debt instrument on the basis of the following formula: MD = D (1 + r ) Where: MD = modified duration D = duration r = yield to maturity Ct = cash payment in time t m = total maturity t = time 20 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE m D= tCt ∑ (1 + r ) t =1 m t Ct ∑ (1 + r ) t =1 t (3) Banks must then classify each debt instrument in the appropriate zone in Table 3 in this paragraph. They must do this on the basis of the modified duration. Table 3: Classifying debt instruments according to modified duration Zone Modified duration (in years) (1) 1 2 3 (2) > 0.0 ≤ 1.0 > 1.0 ≤ 3.6 > 3.6 Assumed interest rate change (in %) (3) 1.00 0.85 0.70 (4) Banks shall then calculate the duration-weighted position for each debt instrument by multiplying its market price by its modified duration and by the relevant assumed interest rate change, as set out in Table 3 in the third paragraph of this article. (5) Banks must calculate the long and short duration-weighted positions within each zone and match them within individual zones. The matched duration-weighted position for an individual zone is the lower of the sum of the duration-weighted long positions and the sum of the duration-weighted short positions. The unmatched duration-weighted position for an individual zone is the difference between the two sums. Banks then continues the calculation of the matched and unmatched duration-weighted positions in accordance with the fifth to eighth paragraphs of Article 32 of this regulation. (6) The capital requirement against general risk stemming from debt financial instruments shall be calculated as the sum of: (a) 2% of the matched duration-weighted position for each zone; (b) 40% of the matched duration-weighted positions between zones 1 and 2 and between zones 2 and 3; (c) 150% of the matched duration-weighted position between zones 1 and 3; and (d) 100% of the residual unmatched duration-weighted positions. 4.3. Equities Article 34 (calculation of capital requirement for the position risk of equities) (1) The capital requirement for position risk for equities shall be calculated as the sum of the capital requirement for specific and general risk for these instruments. (2) Banks must separately sum all their net long positions and all their net short positions in equities, calculated in accordance with the first paragraph of Article 15 of this regulation. The sum of absolute 21 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE values of all net long and net short positions represents a bank’s overall gross position in equities. A bank’s overall net position shall be the difference between them all net long and all net short positions. Article 35 (specific risk) (1) Banks shall calculate the capital requirement for specific risk for equities by multiplying their total gross position in equities, as defined in the second paragraph of Article 34, by 4%. (2) Irrespective of the first paragraph of this article, banks may calculate the capital requirement for specific risk by multiplying their total gross position in equities by 2%, for equities that meet the following conditions: (a) the equities are not those of issuers which have only issued traded debt instruments that currently attract an 8% or 12% weighting in Table 1 in the first paragraph of Article 28, or that only attract a lower requirement because they are guaranteed or secured; (b) the equities are adjudged highly liquid; they account for highly liquid if they are included in one of the indexes from Annex IV of this regulation; and (c) no individual position shall comprise more than 5% of the value of the bank's whole equity portfolio; exceptionally an individual position may represent up to 10% of the value of an entire equity portfolio, provided that the total of such positions does not exceed 50% of the entire portfolio. Article 36 (general risk) Banks shall calculate the capital requirement for general risk for equities by multiplying their total net position in equities, as defined in the second paragraph of Article 34, by 8%. Article 37 (stock index futures) (1) Stock index futures, the delta-weighted equivalents of options in stock index futures and stock indices collectively referred to hereafter as "stock index futures", may be broken down into positions in each of their constituent equities. Positions that are treated as positions in individual equities included in the stock indices set out in Annex IV of this regulation, and may be netted against opposite positions in equivalent equities. (2) Banks that have netted off their positions in one or more of the equities constituting a stock index future against one or more positions in the stock index future itself shall ensure that they have adequate capital to cover the risk of loss caused by the future's values not moving fully in line with that of its constituent equities. They must do the same when they hold opposite positions in stock index futures which are not identical in respect of their maturity, their composition or both. (3) Irrespective of the first and second paragraph of this article, stock index futures which are exchange traded and relate to broadly diversified indices pursuant to Annex IV of this regulation shall have a weighting of 8% when calculating the capital requirement for general risk, but no capital requirement for specific risk. Banks must include these positions in the calculation of net positions referred to in the second paragraph of Article 34 of this regulation, but exclude them from the calculation of the overall gross position in the same paragraph. (4) If a stock index future is not broken down into its underlying positions, banks must treat it as if it were an individual equity. The capital requirement for the specific position risk shall not be calculated for stock index futures that are exchange-traded and that represent a broadly diversified index pursuant to Annex IV of this regulation. 22 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 4.4. Underwriting Article 38 (calculation of capital requirement for underwriting positions) (1) Banks may use the following procedure for the calculation of its capital requirements for position risk, in the case of underwriting debt and equity instruments: (a) calculating the net position, which is the difference between the bank's overall commitment stemming from underwriting and the portion of the position already transferred to third parties that have bought the securities or have made a commitment to sub-underwrite them. (b) reducing the net positions in accordance with the reduction factors set out in Table 4; Table 4: Reduction factors working day 0: 100% working day 1: 90% working days 2 to 3: 75% working day 4: 50% working day 5: 25% after working day 5: 0% (c) calculating its capital requirement for the position risk using these reduced underwriting positions. (2) “Working day zero” shall be the working day on which the bank becomes unconditionally committed to accepting a known quantity of securities at an agreed price. (3) Banks must continually ensure that it holds sufficient capital against the risk of loss that exists from the moment of initial commitment and working day 1. 4.5. Treatment of Trading Book Positions Hedged by Credit Derivatives Article 39 (calculation of capital requirement for specific risk of trading book positions hedged by credit derivatives) (1) The capital requirement for specific risk for trading book positions hedged by credit derivatives may be reduced in accordance with the second to fifth paragraph of this article. (2) When the values of two legs of a transaction always move in the opposite direction and approximately to the same extent, a specific risk capital charge shall not be applied to either leg. This treatment shall be permitted in the following cases: (a) the two legs consist of completely identical instruments; or (b) a long cash position is hedged by a total rate-of-return swap (or vice versa) and there is an exact match between the reference obligation and the underlying exposure (i.e., the cash position); the maturity of the swap itself may be different from that of the underlying exposure. (3) Specific risk capital charge may also be reduced, if the values of both legs always move in the opposite direction, and there is an exact match in terms of the reference obligation, the maturity of 23 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE both the reference obligation and the credit derivative, and the currency of the underlying exposure. In addition, key features of the credit derivative contract should not cause the price movement of the credit derivative to materially deviate from the price movements of the cash position. If a transaction meeting the criteria from the preceding subparagraph transfers risk, the capital requirement for specific risk shall be reduced by 80% (specific risk offset) for the leg of the transaction with the higher capital requirement, while the specific risk requirements for the other leg shall be zero. (4) The specific risk capital requirement may be partially reduced, when the values of two legs usually move in opposite directions. This treatment shall be possible in the following cases: (a) when the positions fall under point (b) of the second paragraph of this article, but there is an asset mismatch between the reference obligations and the underlying exposure; however the positions do meet the following conditions: − in case of bankruptcy, the reference obligation ranks pari passu simultaneously with or is junior to the underlying obligation, − the obligor for the underlying and reference obligation is the same; both obligations have legally enforceable cross-default or cross-acceleration clauses, or (b) the position falls under point (a) of the second paragraph of this article or the third paragraph of this article, but there is an exchange rate or maturity mismatch between the credit protection and the underlying asset (exchange rate mismatches should be included in the normal reporting foreign exchange risk in accordance with Articles 75 and 76 of this regulation); or (c) the position falls under the third paragraph of this article, but there is an asset mismatch between the cash position and the credit derivative. The underlying asset must be included in the deliverable obligations in the credit derivative documentation. In the cases set out in points (a), (b) and (c), rather than adding the specific risk capital requirements for each side of the transaction, only the higher of the two capital requirements shall apply. (5) In all situations not falling under the fourth paragraph of this article, a specific risk capital requirement will be calculated against both legs of the positions. 4.6. Treatment of Positions in CIUs in the Trading Book Article 40 (calculation of capital requirement for positions in CIUs in the trading book) (1) The capital requirement for positions in collective investment undertakings – investment funds (hereinafter: CIUs) that are included in the trading book in accordance with Article 9 of this regulation shall be calculated in accordance with the methods set out in the second to fourth paragraphs of this article and in accordance with Articles 41 and 42 of this regulation. (2) Without prejudice to the other provisions of this chapter, positions in CIUs shall be subject to a capital requirement for position risk (specific and general) with a weighting of 32%. Without prejudice to the provisions of point (a) of the second paragraph of Article 75 or point (b) of Article 86 of this regulation, if the modified gold treatment of point (a) of the third sub-paragraph of the second paragraph of Article 75 of this regulation is used in accordance with these provisions, then a weighting of no more than 40% shall be used when calculating the capital requirement for position risk (specific and general) and exchange rate risk for positions in CIUs. (3) Banks may determine the capital requirement for positions in CIUs that meet the criteria set out in the first paragraph of Article 41 of this regulation by the methods set out in the first to fourth paragraphs of Article 42 of this regulation. 24 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (4) Unless stated otherwise, no netting is permitted between the underlying investments of a CIU and other positions held by a bank. Article 41 (criteria for CIUs) (1) The methods set out in Article 42 of this regulation may be used to calculate capital requirements for positions in CIUs supervised or with registered office within the European Union, if they meet the following criteria: (a) the CIU's prospectus or equivalent document must include: − the categories of assets for which the CIU has authorisation; − if investment limits apply, the relative limits and the methodologies to calculate them; − if leverage is allowed, the maximum level of leverage; − if investment in OTC financial derivatives or repo-style transactions are allowed, a policy to limit counterparty risk arising from these transactions; (b) the CIU must report on its business in half-yearly and annual reports to enable an assessment to be made of the assets and liabilities, income and operations over the reporting period; (c) the units/shares of the CIU are redeemable in cash, out of the undertaking's assets, on a daily basis at the request of the unit holder; (d) investments in the CIU shall be segregated from the assets of the CIU manager; and (e) banks must perform an adequate risk assessment of the CIU. (2) The methods set out in Article 42 of this regulation may also be used to calculate the capital requirements for positions in CIUs from eligible third countries listed in Annex V of this regulation, if they meet the requirements set out in point (a) to (e) of the first paragraph of this article, for positions in CIUs from eligible third countries where this is permitted by the supervisory authorities of other Member States. Article 42 (capital requirement calculation method) (1) If a bank monitors the underlying investments of CIUs on a daily basis, it may calculate the capital requirement for position risk (general and specific) for positions in those underlying instruments, instead of the positions in CIUs. This capital requirement shall be calculated in accordance with the methods set out in this chapter (in Articles 15 to 42 of this regulation), or internal models, if authorised by the Bank of Slovenia. Netting is permitted between positions in the underlying investments of the CIU and other positions held by a bank, if a bank holds a sufficient quantity of CIU units to enable redemption/creation in exchange for the underlying investments. (2) Banks may calculate the capital requirement for position risk (general and specific) for positions in CIUs in accordance with the methods set out in this chapter (in Articles 15 to 42 of this regulation), or internal models, if authorised by the Bank of Slovenia. This capital requirement is calculated for hypothetical positions in the instruments that comprise the external index or basket of instruments that track movements in the CIU’s value if the following criteria are met: (a) the purpose of the CIU's investment policy is to replicate the composition and performance of an existing external index or fixed basket of equities or debt securities; and (b) a minimum correlation of 0.9 between daily price movements of the CIU and the index or basket of equities or debt securities it tracks can be clearly established over a minimum period of six months; "Correlation" in this context means the correlation coefficient between daily returns on the CIU and the index or basket of equities or debt securities it tracks. (3) If a bank does not monitor the underlying investments of CIUs on a daily basis, it may calculate the capital requirement for position risk (general and specific) subject to the following criteria: (a) it will be assumed that the CIU first invests to the maximum extent allowed under its investment policy in the asset classes attracting the highest capital requirement for position risk 25 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (general and specific), and then continues making investments in descending order until the maximum total investment limit is reached. The position in the CIU will be treated as a direct holding in the CIU assets mentioned; (b) banks shall take account of the maximum indirect exposure that they could achieve by taking leveraged positions through the CIU when calculating their capital requirement for position risk, by proportionally increasing the position in the CIU up to the maximum exposure to the underlying instruments in which the CIU invests, on the basis of its the investment policy; and (c) the maximum capital requirement for position risk (general and specific) calculated in accordance with this paragraph shall be no more than that set out in the second paragraph of Article 40 of this regulation. (4) The capital requirement for position risk (general and specific) relating to investments in CIUs which is calculated in accordance with the first and third paragraphs of this article, may be calculated and reported for banks by a third party, under condition that the calculation is correct and on time. 5. CALCULATING CAPITAL REQUIREMENTS FOR SETTLEMENT AND COUNTERPARTY CREDIT RISK 5.1. Settlement/Delivery Risk Article 43 (capital requirements for settlement/delivery risk) For the purposes of calculating the capital requirement for settlement/delivery risk, banks must calculate the price difference arising from transactions in which financial instruments (debt instruments, equities, foreign currencies and commodities, except for repurchase and reverse repurchase agreements or commodities or securities lending or borrowing) are not settled after their due delivery date. The difference in the price referred to in the preceding sentence is the difference between the agreed settlement price and the current market price of the instruments, foreign currencies and commodities in question. Banks calculate the capital requirement for settlement/delivery risk by multiplying this difference by the appropriate factor in column 2 of Table 5 of this paragraph. Table 5: Capital requirement weightings for settlement/delivery risk Number of working days after due settlement date Weighting (%) (1) (2) 5—15 8 16—30 50 31—45 75 46 or more 100 Article 44 (calculation of capital requirements for free deliveries) (1) Banks must hold own funds, as set out in Table 6, if: (a) it has paid for securities, foreign currencies or commodities before receiving them or it has delivered securities, foreign currencies or commodities before receiving payment for them; and 26 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (b) in the case of cross-border transactions, one day or more has elapsed since it made that payment or delivery. Table 6: Capital treatment for free deliveries (1) (2) (3) Transaction type Free delivery (1) (2) Up to first contractual payment or No capital treatment delivery leg From first contractual payment or Treat as an exposure delivery leg up to four days after second contractual payment or delivery leg From 5 business days post second Deduct value transferred plus current contractual payment or delivery leg positive exposure from own funds (if it exists) until extinction of the transaction (2) Banks that use the IRB approach, can assign PDs to free delivery exposures as set out in line 2 of Table 6 of the first paragraph of this article, based on the external ratings of the counterparties, if they have no other non-trading exposure to these counterparties. Banks using their own estimates of loss given defaults (LGDs) may apply an LGD of 45% to free delivery exposures treated according to line 2 of Table 6, provided that they apply it to all such exposures. Alternatively, banks using the IRB approach for exposures treated according to line 2 of Table 6 of the first paragraph of this article, may apply the risk weight defined in the Standard Approach Regulation, providing that they apply them to all such exposures or that they apply a 100% risk weight to all such exposures. (3) If the amount of positive exposure resulting from free delivery transactions is not material, institutions may apply a risk weight of 100% to these exposures. (4) In cases of system-wide failure of a settlement or clearing system, the Bank of Slovenia may decide that banks do not need to meet the capital requirement set out in Article 43 of this regulation and the first paragraph of this article. In such circumstances a transaction that is not settled by a counterparty shall not be deemed as a default for the purposes of credit risk. When the situation is rectified, the Bank of Slovenia shall decide on whether banks must re-fulfil the capital requirement in question. 5.2. Counterparty Credit Risk (CCR) Article 45 (calculation of capital requirement for CCR) (1) Banks must hold own funds against the CCR arising from exposures due to the following: (b) OTC derivative instruments and credit derivatives; (c) repurchase agreements, reverse repurchase agreements, securities or commodities lending or borrowing transactions based on securities or commodities included in the trading book; (d) margin lending transactions based on securities or commodities; and (e) long settlement transactions. (3) Exposure values and risk weighted exposure amounts for the exposures referred to in the first paragraph of this article shall be calculated in accordance with the Standardised Approach Regulation or in accordance with the IRB Approach Regulation. Banks must apply the rules set out in Article 46 of this regulation. 27 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (4) If a credit derivative included in a trading book forms part of an internal hedge and is recognised as eligible collateral in accordance with the Credit Protection Regulation, it shall be deemed that there is no counterparty risk for that credit derivative. (5) The capital requirement for CCR shall be 8% of the total risk weighted exposure amounts. Article 46 (exposure value and risk weighted exposure amounts for derivatives) (1) The list of derivatives set out in Annex I of this regulation shall apply for the purposes of the third paragraph of Article 45 of this regulation. (2) For the purposes of the third paragraph of Article 45 of this regulation, the exposure value for derivatives, repurchase transactions, securities or commodities lending or borrowing transactions, margin lending transactions, and long settlement transactions shall be calculated in accordance with Articles 47 to 74 of this regulation. (3) For the purposes of the third paragraph of Article 45 of this regulation, banks shall not be permitted to use the Financial Collateral Simple Method set out in the Credit Protection Regulation, for calculating risk weighted exposure amounts. (4) For the purposes of the third paragraph of Article 45 of this regulation, in the case of repurchase transactions and securities or commodities lending or borrowing transactions booked in the trading book, all financial instruments and commodities that are eligible to be included in the trading book may be recognised as eligible collateral. For exposures due to OTC derivative instruments booked in the trading book, commodities that are eligible to be included in the trading book may also be recognised as eligible collateral. For the purposes of calculating volatility adjustments where financial instruments or commodities that are not eligible under the Credit Protection Regulation are lent, sold or provided, or borrowed, purchased or received as collateral or otherwise, and the bank is using the Supervisory Volatility Adjustments Approach to calculate adjustments, such instruments and commodities shall be treated in the same way as non-main index equities listed on a recognised exchange. If banks use their own estimate of volatility adjustments for financial instruments or commodities which are not eligible as collateral under the regulation on credit protection, the volatility adjustments must be calculated for each individual financial instrument and commodity. Where, in accordance with the regulation on credit protection, a bank uses the Internal Models Approach, this may also be used for trading book items. (5) For the purposes of the third paragraph of Article 45 of this regulation, in relation to eligible master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions, netting across positions in the trading book and the non-trading book shall only be possible, when the netted transactions fulfil the following conditions: (a) all transactions are marked-to-market daily; and (b) any items borrowed, purchased or received under the transactions may be recognised as eligible financial collateral in accordance with the Credit Protection Regulation, without the application of the fourth paragraph of this article. 28 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 5.3. Calculation of the Exposure Value for Derivatives, Repurchase Transactions, Securities or Commodities Lending or Borrowing Transactions, Margin Lending Transactions, and Long Settlement Transactions 5.3.1. Method Selection Article 47 (selection of the method for the calculation of the exposure value ) (1) Banks shall calculate the exposure value for the financial instruments listed in Annex I of this regulation using the Mark-to-Market Method, the Original Exposure Method, the Standardised Method (hereinafter: SM) or Internal Models Method (hereinafter: IMM). Banks that do not meet the conditions set out in the third paragraph of Article 7 of this regulation shall not be permitted to use the Original Exposure Method. Use of the Original Exposure Method is also not permitted for specifying the exposure value for the derivatives listed in point 3 of Annex I of this regulation. The combined use of the Mark-to-Market Method, Original Exposure Method, SM or IMM shall be permitted within a group associated in a manner defined in Article 56 of the Companies Act (Official Gazette of the Republic of Slovenia, Nos 42/06 and 60/06 – amended; hereinafter: ZGD-1), however, not within a single legal person. The combined use of the Mark-to-Market Method and the SM within one legal person shall be permitted, if one of these methods is used for cases specified in the third paragraph of Article 52 of this regulation. (2) If a bank has been authorised by the Bank of Slovenia or the competent authority of another Member State, it may use the IMM from Articles 53 to 68 of this regulation to determine the exposure value for: (a) the financial instruments listed in Annex I of this regulation; (b) repurchase transactions; (c) securities or commodities lending or borrowing transactions; (d) margin lending transactions, and (e) long settlement transactions. (3) If a bank purchases a credit derivative against a non-trading book exposure, or against a CCR exposure, it may calculate its capital requirement for hedged asset in accordance with Articles 103 to 110 of the Credit Protection Regulation, or in accordance with the second paragraph of Article 51 and the fifth paragraph of Article 52 or Articles 35 and 36 of the IRB Approach Regulation. In such cases the exposure value for CCR for these credit derivatives is set to zero. (4) The exposure value for CCR from sold credit default swaps in the non-trading book, where they are treated as credit protection provided by the bank and subject to a capital requirement for credit risk for the full nominal amount, is set to zero. (5) Based on the Mark-to-Market Method, the Original Exposure Method, SM or IMM, the exposure value for a given counterparty is equal to the sum of all exposure values calculated for each netting set with the counterparty in question. (6) An exposure value of zero for CCR can be attributed to derivatives, or repurchase transactions, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions outstanding with a central counterparty and that have not been rejected by the central counterparty. Furthermore, an exposure value of zero can be attributed to credit risk exposures to central counterparties that result from the derivatives, repurchase transactions, securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions that the bank has outstanding with the central counterparty. The central counterparty CCR exposures to all participants in its arrangements shall be fully collateralised on a daily basis. 29 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (7) Exposures arising from long settlement transactions can be calculated using the Mark-to-Market Method, Original Exposure Method, SM or IMM, regardless of the methods chosen for treating OTC derivatives and repurchase transactions, securities or commodities lending or borrowing transactions, and margin lending transactions. Banks that use the IRB approach to calculate the capital requirement for long settlement transactions shall permanently use the risk weights prescribed by the standard approach, irrespective of the materiality of those positions. (8) For the Mark-to-Market Method and the Original Exposure Method, banks must ensure that the nominal (hypothetical) amount to be taken into account is an appropriate measure of the instrument/contract’s risk. If, for example, a contract provides for a multiplication of cash flows, the nominal or hypothetical amount must be adjusted for that purpose to take into account the effects of multiplication on the risk structure of the contract/instrument. 5.3.2. Mark-To-Market Method Article 48 (calculation of exposure value with the mark-to-market method) The exposure value for the financial instruments listed in Annex I of this regulation shall be calculated in accordance with the Mark-to-Market Method as follows: (a) calculating the replacement cost of all contracts with a positive value, by revaluating all contracts using current prices based on current market value; for contracts with a negative value the current exposure is set at zero; (b) the potential future credit exposure is calculated for the residual maturity of the contract so that the notional value or value of the underlying instruments are multiplied using the conversion factors given in Table 7; the value of potential future credit exposure is not calculated for singlecurrency “floating/floating” interest rate swaps, for which only the current replacement cost is calculated; contracts which do not fall within one of the five categories indicated in this table shall be treated as contracts concerning commodities other than precious metals; for contracts with multiple exchanges of principal, the percentages from Table 7 are multiplied by the number of remaining payments still to be made according to the contract; for contracts that are structured to settle outstanding exposure following specified payment dates and where the terms are reset such that the market value of the contract is “zero” on these specified dates, the residual maturity would be equal to the time until the next reset date. In the case of interest rate contracts that meet these criteria and have a remaining maturity of over one year, the percentage shall be no lower than 0.5%. Table 7: Conversion factors for calculation of potential future credit exposure Residual maturity Interest rate contracts Contracts concerning foreign exchange rates and gold Contracts concerning equities Contracts concerning precious metals except gold Contracts concerning commodities other than precious metals (1) (2) (3) (4) (5) (6) 0% 1% 6% 7% 10% One year or less 30 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Over 1 year, not exceeding 5 years 0.5% 5% 8% 7% 12% Over 5 years 1.5% 7.5% 10% 8% 15% When calculating potential future credit exposure for total return swaps and credit swaps the notional value of the instrument shall be multiplied by the following percentages: − where the reference obligation is such that a direct exposure of the bank in that obligation would be treated as a qualifying item referred to in Articles 28, 29 and 30 of this regulation: 5%; − where the reference obligation is such that a direct exposure of the bank in that obligation would not be treated as a qualifying item referred to in Articles 28, 29 and 30 of this regulation: 10%; − in the case of a credit default swap, an bank whose exposure arising from the swap represents a long position in the underlying instrument shall be permitted to use a figure of 0% for potential future credit exposure, unless the credit default swap is subject to closeout on the insolvency of the entity whose exposure arising from the swap represents a short position in the underlying instrument, even though the underlying instrument has not defaulted. Where the credit derivative provides protection in relation to "nth to default" among a number of underlying obligations, the percentage figure of those prescribed in the first to third indent of the preceding paragraph which is to be applied is determined by the obligation with the nth lowest credit quality; this in turn is determined by whether it is one that if incurred by the bank would be a qualifying item in accordance with Articles 28, 29 and 30 of this regulation. (c) the exposure value is the sum of current replacement cost and potential future credit exposure. 5.3.3. Original Exposure Method Article 49 (calculation of exposure value with the original exposure method) The exposure value for the financial instruments listed in Annex I of this regulation shall be calculated in accordance with the Original Exposure Method as follows: (a) the notional amount of each instrument is multiplied by the conversion factors in Table 8 of this article; for interest rate contracts banks may select the residual maturity or the original maturity for the purposes of Table 8 of this article; Table 8: Conversion factors for calculation of original exposure Original maturity Interest rate contracts Contracts concerning foreign exchange rates and gold (1) (2) (3) 0.5% 2% Over 1 year not exceeding 2 years 1% 5% Additional conversion factor for each additional year 1% 3% One year or less 31 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (b) the original exposure thus obtained shall be the exposure value. 5.3.4. SM (Standardised Method) Article 50 (calculation of exposure value with the SM) (1) The Standardised Method (SM) can be used only for OTC derivatives and long settlement transactions. The exposure value shall be calculated separately for each netting set. The exposure value shall be determined net of collateral, as follows: ⎛ exposure value = β * max⎜⎜ CMV − CMC ; ⎝ ∑ ∑ j i ⎞ RPTij − ∑ RPClj * CCRMj ⎟⎟ , l ⎠ where: CMV = ∑ CMVi i CMC = ∑ CMCl l where: β = 1.4; CMV = current market value of the portfolio of transactions within the netting set with a counterparty gross of collateral; CMVi = the current market value of transaction i; i = index designating transaction; CMC = the current market value of the collateral assigned to the netting set; CMCl = the current market value of collateral l; l = index designating collateral; j = index designating hedging set category. These hedging sets correspond to risk factors for which risk positions of opposite sign can be offset to yield a net risk position on which the exposure measure is then based; RPTij = risk position from transaction i with respect to hedging set j; RPClj = risk position from collateral l with respect to hedging set j; CCRMj = CCR Multiplier set out in Table 10 in Article 52 of this regulation with respect to hedging set j; Collateral received from a counterparty has a positive sign and collateral posted to a counterparty has a negative sign. The collateral recognised under the SM method is the collateral referred to in Article 13 of the Credit Protection Regulation and the fourth paragraph of Article 46 of this regulation. 32 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (2) When an OTC derivative transaction with a linear risk profile stipulates the exchange of a financial instrument for payment, the payment part is referred to as the payment leg. Transactions that stipulate the exchange of payment against payment consist of two payment legs. The payment legs consist of the contractually agreed gross payments, including the notional amount of the transaction. Banks may disregard the interest rate risk from payment legs with a remaining maturity of less than one year for the purposes of calculating transactions with the SM method. Banks may treat transactions that consist of two payment legs that are denominated in the same currency (e.g. interest rate swaps) as a single aggregate transaction. The treatment for payment legs applies to the aggregate transaction. (3) Transactions with a linear risk profile with equities (including equity indices), gold, other precious metals or other commodities as the underlying financial instruments are mapped to a risk position in the respective equity (or equity index) or commodity and an interest rate risk position for the payment leg. If the payment leg is denominated in a foreign currency, it is additionally mapped to a risk position in the respective currency. (4) Transactions with a linear risk profile with a debt instrument as the underlying instrument are mapped to an interest rate risk position for the debt instrument and another interest rate risk position for the payment leg. Transactions with a linear risk profile that stipulate the exchange of payment against payment, including foreign exchange forwards, are mapped to an interest rate risk position for each of the payment legs. If the underlying debt instrument is denominated in a foreign currency, the debt instrument is mapped to a risk position in this currency. If the payment leg is denominated in a foreign currency, it is additionally mapped to a risk position in the respective currency. The exposure value assigned to a foreign exchange basis swap transaction is zero. (5) The size of a risk position from a transaction with linear risk profile is the effective notional value (market price multiplied by quantity) of the underlying financial instruments (including commodities), converted to the bank's domestic currency, except for debt instruments. (6) For debt instruments and for payment legs, the size of the risk position is equal to the effective notional value of the outstanding gross payments (including the notional amount) converted to the credit institution's domestic currency and multiplied by the modified duration of the debt instrument, or payment leg, respectively. (7) The size of a risk position from a credit default swap is the notional value of the reference debt instrument multiplied by the remaining maturity of the credit default swap. (8) The size of a risk position from an OTC derivative with a non-linear risk profile, including options and swaptions, is equal to the delta equivalent effective notional value of the financial instrument that underlies the transaction, except in the case of an underlying debt instrument. Article 51 (calculation of risk position with the SM) (1) The size of a risk position from an OTC derivative with a non-linear risk profile, including options and swaptions, of which the underlying is a debt instrument or a payment leg, is equal to the delta equivalent effective notional value of the financial instrument or payment leg multiplied by the modified duration of the debt instrument, or payment leg, respectively. (2) For the determination of risk positions, collateral received from a counterparty is to be treated as a claim on the counterparty under a derivative contract (long position) that is due on the current day, while collateral posted is to be treated like an obligation to the counterparty (short position) that is due on the current day. (3) Credit institutions may use the following formulae to determine the size and sign of a risk position: (a) for all instruments other than debt instruments: 33 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE – effective notional value or delta equivalent of notional value = p ref ∂V ∂p Where: pref = price of the underlying instrument, expressed in the reference currency of the underlying instrument; V = value of the financial instrument (in the case of an option, this is the option price, and in the case of a transaction with a linear risk profile, this is the value of the underlying instrument itself); p = price of the underlying instrument, expressed in the same currency as V; (b) for debt instruments and the payment legs of all transactions: – effective notional value multiplied by the modified duration, or – delta equivalent in notional value multiplied by the modified duration = ∂V ∂r Where: V = value of the financial instrument (in the case of an option this is the option price and in the case of a transaction with a linear risk profile this is the value of the underlying instrument itself or of the payment leg, respectively); r = interest rate. If V is denominated in a currency other than the reference currency, the derivative must be converted into the reference currency by multiplication with the relevant exchange rate. (4) The risk positions are to be grouped into hedging sets. For each hedging set, the absolute value amount of the sum of the resulting risk positions is computed. This sum is termed the “net risk position” and is part of the formula set out in the first paragraph of Article 50 of this regulation: net risk position = ∑ RPT − ∑ RPC ij i lj l (5) For interest rate risk positions from money deposits received from a counterparty as collateral, from payments leg and from the underlying debt instruments, to which a capital requirement (capital charge) of more than 1.60% applies in accordance with Table 1 in Article 28 of this regulation, there are six hedging sets for each currency stated in Table 9 of this paragraph. Hedging sets are defined by a combination of the criteria “maturity” and “referenced interest rates”. Table 9: Combinations of hedging sets Government-referenced interest rates (1) Maturity Maturity Maturity (2) One year or less Over 1 year, not exceeding 5 years More than 5 years Non-government-referenced interest rates (3) One year or less Over 1 year, not exceeding 5 years More than 5 years (6) For interest rate risk positions from underlying debt instruments or payment legs for which the interest rate is linked to a reference interest rate that represents a general market interest level, the remaining maturity is the length of the time interval up to the next re-adjustment of the interest rate. In all other cases, it is the remaining life of the underlying debt instrument or in the case of a payment leg, the remaining life of the transaction. (7) There is one hedging set for each issuer of a reference debt instrument that underlies a credit default swap. 34 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (8) For interest rate risk positions from money deposits that are posted with a counterparty as collateral when that counterparty does not have debt obligations of low specific risk outstanding and from underlying debt instruments, to which a capital requirement (capital charge) of more than 1,60% applies in accordance with Table 1 in Article 28 of this regulation, there is one hedging set for each issuer. When a payment leg emulates such a debt instrument, there is also one hedging set for each issuer of the reference debt instrument. Banks may assign risk positions that arise from debt instruments of a certain issuer, or from reference debt instruments of the same issuer that are emulated by payment legs, or that underlie a credit swap, to the same hedging set. Article 52 (different hedging sets for SM) (1) Underlying financial instruments other than debt instruments shall only be assigned to the same respective hedging sets, if they are identical or similar instruments. In all other cases they shall be assigned to separate hedging sets. The similarity of instruments is established as follows: (a) equities are similar if they have the same issuer; An equity index is treated as a separate issuer; (b) derivatives based on precious metals are similar if they relate to the same metal; A precious metal index is treated as a separate precious metal; (c) derivatives based on electric power are similar instruments if their delivery rights and obligations refer to the same peak or off-peak load time interval within any 24-hour interval; and (d) derivatives based on commodities are similar if they relate to the same commodity; A commodity index is treated as a separate commodity. (2) The CCR multipliers (CCRM) for the different hedging set categories are set out in Table 10 of this paragraph. Table 10: CCRM Hedging set categories CCRM 1. Interest rates 2. Interest rates for risk positions from a reference debt instrument that underlies a credit default swap and to which a capital charge of 1.60%, or less, applies under Table 1 of Article 28 of this regulation 3. Interest rates for risk positions from a debt instrument or reference debt instrument to which a capital charge of more than 1.60% applies under Table 1 of Article 28 of this regulation 4. Exchange rates 5. Electric power 6. Gold 7. Equity 8. Precious Metals (except gold) 9. Other commodities (excluding precious metals and electricity) 10. Underlying instruments of OTC derivatives that are not in any of the above categories 0.2% 0.3% 0.6% 2.5% 4.0% 5.0% 7.0% 8.5% 10.0% 10.0% The underlying instruments of OTC derivatives referred to in point 10 of Table 10 in this paragraph shall be assigned to separate individual hedging sets for each category of underlying instrument. 35 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (3) For transactions with a non-linear risk profile or for payment legs and transactions with debt instruments as underlying for which the credit institution cannot determine the delta or the modified duration, respectively, with an instrument model for calculating capital requirements for market risk for which the bank has acquired Bank of Slovenia permission, banks shall use the Mark-to-Market Method. Netting shall not be recognised. This means that the exposure value shall be determined as if there were a netting set that comprises just the individual transaction. (4) Banks must have appropriate procedures in place to verify whether a transaction set to be included in a netting set is covered by a legally enforceable netting contract that meets the requirements set out in Article 70 of this regulation. (5) Banks that make use of collateral to mitigate their CCR must have internal procedures in place to verify that, prior to recognising the effect of collateral in its calculations, the collateral meets the requirements of the Credit Protection Regulation. 5.3.5. Internal Model Method (IMM) 5.3.5.1 Level of Use for IMM Article 53 (general) (1) Banks may only apply the IMM, if they have acquired Bank of Slovenia permission, and on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. (2) Banks may apply the IMM to calculate the exposure value for: (a) derivatives listed in Annex I of this regulation and, optionally, also from long settlement transactions; or (b) repurchase transactions, securities or commodities lending or borrowing transactions, margin lending transactions, and long settlement transactions; or (c) derivatives listed in Annex I of this regulation, repurchase transactions, securities or commodities lending or borrowing transactions, margin lending transactions, and, optionally, long settlement transactions. (3) Without prejudice to the first paragraph of Article 47 of this regulation, banks may permanently exclude from the application of the IMM exposures that are not material in terms of size and risk. Article 54 (Roll out of IMM) (1) Banks may sequentially implement the IMM if they have acquired Bank of Slovenia permission, and on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. (2) During the sequential implementation of the IMM, banks may use the Mark-to-Market Method or SM to calculated the exposure value from transactions for which they do not yet use IMM, in accordance with a Bank of Slovenia permission, or on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. In such case, banks shall not be required to use a specific type of model. Article 55 (combined use) If banks do not have a Bank of Slovenia permission to use IMM to calculate the exposure value from transactions in OTC derivatives and long settlement transactions, they must use the Mark-to-Market 36 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Method or the SM. In such cases the combined use of the Mark-to-Market Method and SM shall be permitted, however, only within a banking group that uses IMM on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. It shall only be permitted within a single bank, if that bank is required to use the Mark-to-Market Method for the purposes of the third paragraph of Article 52 of this regulation. 5.3.5.2 Permission to use the IMM Article 56 (conditions and documentation for granting permission) (1) The Bank of Slovenia shall issue the permission for use of the IMM, if a bank meets the following conditions: (a) it meets the requirements for correct calculation of exposure value set out in Articles 59 and 60 of this regulation; (b) it meets the requirements for the EPE model set out in Articles 62 to 67 of this regulation; (c) it meets the validation requirements for EPE model set out in Article 68 of this regulation. (2) Banks shall prove that they meet the conditions specified in the first paragraph of this article by submitting the documentation set out in Annex VI as part of the request for permission: (a) on the type of transactions for which it intends to use IMM (for transactions from point (a) or (b) or (c) of the second paragraph of Article 53 of this regulation), on its plan for the sequential implementation of IMM and basic information on the internal models; (b) on meeting the requirements for correct calculation of exposure value set out in Articles 59 and 60 of this regulation; (c) on meeting the requirements for the EPE model set out in Articles 62 to 67 of this regulation; (d) on meeting the validation requirements for EPE model set out in Article 68 of this regulation. (3) Banks must meet the conditions referred to in the first paragraph of this article on an ongoing basis from the moment the Bank of Slovenia issues its permission to use IMM. If a bank ceases to meet the conditions set out in the first paragraph of this article, it must submit a timetable for re-achieving compliance with the requirements of this regulation to the Bank of Slovenia or demonstrate that the effect of not meeting said requirements is immaterial. (4) In the operative part of the decision on granting permission for use of the IMM, the Bank of Slovenia shall expressly state the type of transactions for which a bank is permitted to use the IMM (for transactions under Items (a) or (b) or (c) of the second paragraph of Article 53 of this regulation) and whether it is permitted to use its own estimate of α. If after being granted permission to use the IMM, a bank intends to expand its use of the model to other transaction types or to decrease its use so that certain transaction types are no longer covered by the IMM, or if it no longer intends to use its own estimate of α, it must submit a request to amend the permission in question. (5) In the operative part of the decision on granting permission to use the IMM, the Bank of Slovenia shall expressly define the roll out plan for the implementation of IMM. In case of changes to this plan, the bank must submit a request to amend the permission in question. (6) More detailed instructions on the form for requesting a Bank of Slovenia permission to use IMM or the form for requesting an amendment to this permission are set out in Annex VI of this regulation. (7) The provisions of the first to sixth paragraphs of this article shall also apply mutatis mutandis when an EU parent bank and its subsidiaries or banks and other institutions subordinate to an EU parent financial holding company intend to use IMM in a bank group and jointly submit a request for permission to use IMM on the basis of Article 291 of the ZBan-1. 37 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (8) The Bank of Slovenia shall issue an EU parent bank or a bank controlled by an EU parent financial holding company a permission to use IMM to calculate exposure value on the basis of the decision set out in the third and fourth paragraphs of Article 291 of the ZBan-1. (9) The Bank of Slovenia shall issue a subsidiary bank with registered office in the Republic of Slovenia that has submitted a request for issue of a permission together with an EU parent bank or a bank controlled by an EU financial holding company with a permission to use IMM on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. Article 57 (withdrawal of permission) (1) The Bank of Slovenia shall withdraw permission for use of IMM: (a) if a bank acts in contradiction with the Bank of Slovenia order , or an order with additional measures for the correction of a violation in fulfilment of the conditions set out in the first paragraph of Article 56 of this regulation; (b) if a bank seriously violates the conditions set out in the first paragraph of Article 56 of this regulation; (c) if a bank acts in contradiction with the Bank of Slovenia order, or an order with additional measures for the correction of a violation relating to inaccuracy in the calculation of internal models. (2) The Bank of Slovenia shall also withdraw a bank’s permission to use the IMM in a banking group on the basis of a decision on the withdrawal of a permission to use IMM in a banking group, which shall follow mutatis mutandis the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. (3) A bank that has had its permission to use IMM withdrawn by the Bank of Slovenia, must start to apply the Mark-to-Market Method or SM to calculate the exposure value of transactions in question from the day the decision on withdrawal of the permission. Article 58 (permission for transition from IMM to the Mark-to-Market Method or SM) (1) Banks using IMM may replace that method with Mark-to-Market Method or SM only with the permission from the Bank of Slovenia. When such permission is issued, the Bank of Slovenia permission to use the IMM shall be deemed to have ceased validity. (2) The Bank of Slovenia shall issue the permission referred to in the first paragraph of this article, if the bank demonstrates good cause for changing the method. (3) The instructions on the form for requesting the permission referred to in the first paragraph of this article are set out in Annex VII of this regulation. 5.3.5.3 Exposure Value Article 59 (defining exposure value) (1) The exposure value shall be measured at the level of the netting set. The model must specify the forecasting distribution for changes in the market value of the netting set attributable to changes in market variables, such as interest rates, foreign exchange rates. The model must then compute the exposure value for the netting set at each future date given the changes in the market variables. For margined counterparties, the model may also capture future collateral movements. 38 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (2) Banks may include eligible financial collateral as defined in Article 13 of the Credit Protection Regulation and the fourth paragraph of Article 46 of this regulation in their forecasting distributions for changes in the market value of the netting set, if the quantitative, qualitative and data requirements for the IMM are met for the collateral. (3) The exposure value shall be calculated as the product of α times Effective EPE, as follows: Exposure value = α × Effective EPE Where: α = 1.4; The Bank of Slovenia may require a higher α; Effective EPE = estimated expected exposure (EE ) as the average exposure at future date t, t where the average is taken across possible future values of relevant market risk factors; The internal model estimates EE at a series of future dates t , t , t etc. 1 2 3 (4) Effective EE shall be computed recursively as: Effective EEtk = max (Effective EE tk-1 ; EE ) tk where: t = current date; 0 effective EE = current exposure. t0 (5) Effective EPE is the average Effective EE during the first year of future exposure. If all contracts in the netting set mature within less than one year, EPE is the average of EE until all contracts in the netting set mature. Effective EPE is computed as a weighted average of Effective EE: Effective EPE = min(1 year maturity) ∑ Effective EEt k =1 k * Δt k , where: the weights ∆t = t – t k k k-1 allow for the case when future exposure is calculated at dates that are not equally spaced over time. (6) EE or peak exposure measures shall be calculated based on a distribution of exposures that accounts for the possible non-normality of the distribution of exposures. (7) Banks may use a measure for determining exposure value to each counterparty that is more conservative than α multiplied by the Effective EPE defined in the third paragraph of this article. Article 60 (use of own estimate of α) (1) Notwithstanding the third paragraph of Article 59, banks may use their own estimates of α, with a minimum value for α of 1.2, where α shall equal the ratio of internal capital from a full simulation of CCR exposure across counterparties (numerator) and internal capital based on EPE (denominator). In the denominator, EPE shall be used as if it were a fixed outstanding amount. Banks shall demonstrate that their internal estimates of α capture in the numerator material sources of stochastic dependency of 39 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE distribution of market values of transactions or of portfolios of transactions across counterparties. Internal estimates of α must take account of the granularity of portfolios. (2) Banks must ensure that the numerator and denominator of α are calculated in a consistent fashion with respect to the modelling methodology, parameter specifications and portfolio composition. The approach used to calculate α must be based on a bank's internal capital approach, be well documented and subject to independent validation. In addition, banks must review their estimates on at least a quarterly basis, and more frequently when the composition of the portfolio varies over time. Banks must also assess the model risk. (3) Where appropriate, volatilities and correlations of market risk factors used in the joint simulation of market and credit risk should be conditioned on the credit risk factor to reflect potential increases in volatility or correlation in an economic downturn. (4) If the netting set is subject to a margin agreement, banks shall use one of the following EPE measures: (a) Effective EPE without taking into account the margin agreement; (b) the threshold, if positive, under the margin agreement plus an add-on that reflects the potential increase in exposure over the margin period of risk. The add-on is calculated as the expected increase in the netting set's exposure beginning from a current exposure of zero over the margin period of risk. A threshold of five business days for netting sets consisting only of repostyle transactions subject to daily remargining and daily mark-to-market, and a ten business days threshold for all other netting sets is imposed on the margin period of risk used for this purpose; (c) if the internal model captures the effects of margining when estimating EE, the model's EE measure may be used directly in the equation set out in the fourth paragraph of Article 59 of this regulation. 5.3.5.4 Minimum Requirements for the EPE Model Article 61 (requirements for EPE model) Banks EPE models must meet the requirements set out in Articles 62 to 67 of this regulation. Article 62 (CCR management) (1) Banks must have a control unit that is responsible for the design and implementation of its CCR management system, including the initial and on-going validation of the model. This unit must control input data integrity and produce and analyse reports on the output model. The unit must evaluate the relationship between measures of risk exposure and credit and trading limits. This unit must be independent of trading units. It must be adequately staffed and must report directly to the senior management of the bank. The work of this unit must be closely integrated into the bank's day-to-day credit risk management process. Its output must, accordingly, be an integral part of the process of planning, monitoring and controlling the credit institution's credit and overall risk profile. (2) Banks must have CCR management policies, processes and systems that are sound and implemented with integrity. A sound CCR management framework must include the identification, measurement, management, approval and internal reporting of CCR. (3) Banks’ risk management policies must take account of market, liquidity, and legal and operational risks that can be associated with CCR. Banks must not undertake business with a counterparty without assessing its creditworthiness in advance, and must take due account of settlement and pre-settlement 40 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE credit risk. These risks shall be managed as comprehensively as practicable at the counterparty level (aggregating CCR exposures with other credit exposures) and at the bank-wide level. (4) The management board and senior management of banks must be actively involved in the CCR control process and must regard this as an essential aspect of the business, to which significant resources need to be devoted. Senior management must be aware of the limitations and assumptions of the model used and the impact these can have on the reliability of the output. Senior management must also consider the uncertainties of the market environment and operational issues and be aware of how these are reflected in the model. (5) The daily reports prepared on a bank's exposures to CCR shall be reviewed by a level of management with sufficient seniority and authority to enforce both reductions of positions taken by individual credit managers or traders and reductions in the bank's overall CCR exposure. (6) A bank's CCR management system must include internal credit and trading limits. Credit and trading limits must be related to the bank’s risk measurement model in a manner that is consistent over time and that is well understood by credit managers, traders and senior management. (7) A bank's measurement of CCR shall include measuring daily and intra-day usage of credit lines. Banks must measure current exposure gross and net of collateral. At portfolio and counterparty level, banks must calculate and monitor peak exposure or potential PFE at the confidence interval they select. Banks must take account of any large or concentrated positions they hold, including by groups of related counterparties, by industry, by market, etc. (8) Banks must have a routine and rigorous stress-testing programme in place as a supplement to the CCR analysis based on the day-to-day output of the model. The results of this stress testing shall be reviewed periodically by senior management and shall be reflected in the CCR policies and limits set by the management and the management board. Where stress tests reveal particular vulnerability to a given set of circumstances, banks must take prompt action to manage those risks appropriately. Article 63 (documentation and control of CCR) (1) Banks must have a routine in place for ensuring compliance with a documented set of internal policies, controls and procedures concerning the operation of the CCR management system. A bank’s CCR management system must be well documented and must provide an explanation of the empirical techniques used to measure CCR. (2) Banks must conduct an independent review of their CCR management system regularly through their own internal auditing process. This review shall include both the activities of the trading units and of the independent CCR control unit. A review of the overall CCR management process must take place at regular intervals and must specifically address, at least: (a) the adequacy of the documentation of the CCR management system and process; (b) the organisation of the CCR control unit; (c) the integration of CCR measures into daily risk management; (d) the approval process for risk pricing models and valuation systems used by front (trading) and back-office personnel; (e) the validation of any significant change in the CCR measurement process; (f) the scope of CCR captured by the model; (g) the integrity of the management information system; (h) the accuracy and completeness of CCR data; (i) the verification of the consistency, timeliness and reliability of data sources used to run models, including the independence of such data sources; (j) the accuracy and appropriateness of volatility and correlation assumptions; (k) the accuracy of valuation and risk transformation calculations; and 41 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (l) the verification of the model's accuracy through frequent back-testing. Article 64 (use test) (1) The distribution of exposures generated by the model used to calculate effective EPE shall be closely integrated into the bank’s day-to-day CCR management process. The model's output shall accordingly play an essential role in the credit approval, CCR management, internal capital allocation, and corporate governance of the bank. (2) Banks must keep records on the use of models that generate a distribution of exposures to CCR. Thus, banks demonstrate that they have been using a model to calculate the distributions of exposures upon which the EPE calculation is based that meets the minimum requirements for at least one year prior to receiving the Bank of Slovenia permission to use the IMM. (3) The model used to generate a distribution of exposures to CCR must be part of the CCR management framework and must include the identification, measurement, management, approval and internal reporting of CCR. This framework shall include the measurement of usage of credit lines (aggregating CCR exposures with other credit exposures) and internal capital allocation. In addition to EPE, banks must measure and manage current exposures. Where appropriate, banks measure current exposure gross and net of collateral. The use test shall be satisfied if banks use other CCR measures, such as peak exposure or PFE, based on the distribution of exposures generated by the same model, to compute EPE. (4) Banks must have the systems capability to estimate EE daily if necessary, unless they demonstrate that their exposures to CCR warrant less frequent calculation. Banks must calculate EE along a time profile of forecasting horizons that adequately reflects the time structure of future cash flows and maturity of the contracts and in a manner that is consistent with the materiality and composition of the exposures. (5) Exposure shall be measured, monitored and controlled until the maturity of all contracts in the netting set (not just to the one year horizon). Banks must have procedures in place to identify and control the risks for counterparties where the exposure rises beyond the one-year horizon. The forecast increase in exposure shall be an input to be taken into account by the bank’s internal capital model. Article 65 (stress testing) (1) Banks must have in place sound stress testing processes for use in the assessment of capital requirements for CCR. Banks must compare these stress tests with the EPE measures and must treat them within the internal capital adequacy assessment process (ICAAP). Stress testing shall also involve identifying possible events or future changes in economic conditions that could have unfavourable effects on their credit exposures and an assessment of their ability to withstand such changes. (2) Banks must stress test their CCR exposures, including jointly stressing market and credit risk factors. Stress tests of CCR must take concentration risk into account (to a single counterparty or groups of counterparties), correlation risk across market and credit risk, and the risk that liquidating the counterparty's positions could move the market. Stress tests shall also consider the impact on a bank's own positions of such market moves and integrate that impact in its assessment of CCR. 42 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Article 66 (taking wrong-way risk into account) (1) Banks must give due consideration to exposures that give rise to a significant degree of General Wrong-Way Risk. (2) Banks must have procedures in place to identify, monitor and control cases of Specific WrongWay Risk, beginning at the inception of a transaction and continuing through the life of the transaction. Article 67 (integrity of the modelling process) (1) The model shall reflect transaction terms and specifications in a timely, complete, and conservative fashion. Such terms shall include at least contract notional amounts, maturity, reference assets, margining arrangements, and netting arrangements. The terms and specifications shall be maintained in a database that is subject to formal and periodic audit. The process for recognising netting arrangements shall require signoff by legal staff to verify the legal enforceability of netting and be input into the database by an independent unit. The transmission of transaction terms and specifications data to the model must also be subject to internal audit. Formal reconciliation processes must be in place between the model and source data systems to verify on an ongoing basis that transaction terms and specifications are reflected correctly or at least conservatively in the EPE. (2) The model shall employ current market data to calculate current exposures. When using historical data to estimate volatility and correlations, at least three years of historical data shall be used and shall be updated quarterly or more frequently if market conditions warrant. The data shall cover a full range of economic conditions, such as a full business cycle. A unit independent from the business unit shall validate the price supplied by the business unit. The data shall be acquired independently of the lines of business, fed into the model in a timely and complete fashion, and maintained in a database subject to formal and periodic audit. A credit institution shall also have a well-developed data integrity process to clean the data of erroneous and/or anomalous observations. To the extent that the model relies on proxy market data, including, for new products, where three years of historical data may not be available, internal policies shall identify suitable proxies and the credit institution shall demonstrate empirically that the proxy provides a conservative representation of the underlying risk under adverse market conditions. If the model includes the effect of collateral on changes in the market value of the netting set, the credit institution shall have adequate historical data to model the volatility of the collateral. (3) The model must be subject to a validation process. Banks must clearly articulate the process in their policies and procedures. The validation process must include the kind of testing needed to ensure model integrity and identify conditions under which assumptions are violated and may result in an understatement of EPE. The validation process must include a review of the intelligibility of the model. (4) Banks must monitor the risks arising from market conditions and have processes in place to adjust their estimation of EPE when those risks become significant. This includes the following: (a) banks must identify and manage its exposures to specific wrong-way risk; (b) for exposures with a rising risk profile after one year, banks must compare the estimate for the EPE model over one year with the EPE model over the life of the exposure, on a regular basis; (c) for exposures with a residual maturity below one year, banks must compare on a regular basis the replacement cost (current exposure) and the realised exposure profile, and/or store data that would allow such a comparison. 43 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (5) Banks must have appropriate procedures in place to verify whether a transaction set to be included in a netting set is covered by a legally enforceable netting contract that meets the requirements set out in Articles 69 to 73 of this regulation. (6) Banks that make use of collateral to mitigate their CCR must have internal procedures in place to verify that, prior to recognising the effect of collateral in its calculations, the collateral meets the requirements of the Credit Protection Regulation. 5.3.5.5 Validation Requirements for EPE models Article 68 (general) The validation of a bank’s EPE model must meet with the following requirements: (a) the model must be qualitatively validated in accordance with Articles 84 to 87 and 89 to 91 of this regulation; (b) interest rates, foreign exchange rates, equity prices, commodity prices, and other market risk factors shall be forecast over long time horizons for the purpose of measuring CCR exposure. The performance of the forecasting model for market risk factors shall be validated over a long time horizon; (c) the pricing models used to calculate CCR exposure for a given scenario of future shocks to market risk factors must be tested as part of the model validation process. Pricing models for options shall take into account the nonlinearity of option value with respect to market risk factors; (d) the EPE model shall capture transaction-specific information in order to aggregate exposures at the level of the netting set; banks must verify whether transactions are assigned to the appropriate netting set within the model; (e) the EPE model shall also include transaction-specific information to capture the effects of margining; it must take into account both the current amount of margin and margin that would be passed between counterparties in the future; such a model shall account for the nature of margin agreements (unilateral or bilateral), the frequency of margin calls, the margin period of risk, the minimum threshold of unmargined exposure a bank is willing to accept, and the minimum transfer amount. The model must either model the mark-to-market change in the value of collateral posted or define the changes in accordance with the Credit Protection Regulation; (f) static, historical back-testing on representative counterparty portfolios shall be part of the model validation process; At regular intervals, banks must conduct such back-testing on a number of representative counterparty portfolios (actual or hypothetical). These representative portfolios must be chosen based on their sensitivity to the material risk factors and correlations to which the credit institution is exposed. 5.3.6 Contractual Netting (Contracts for Novation and Netting Agreements) 5.3.6.1 Possible Types of Contractual Netting Article 69 (general) (1) For the purpose of Articles 69 to 73 of this regulation the following definitions shall apply: (a) "counterparty" means any natural or legal person that has the power to conclude a netting agreement; (b) "contractual cross product netting agreement" means a written bilateral agreement between a bank and a counterparty which creates a single legal obligation covering all included bilateral master agreements and transactions belonging to different product categories. (2) For the purposes of cross product netting, the following are deemed as different product categories: 44 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (a) repurchase transactions, reverse repurchase transactions, securities and commodities lending and borrowing transactions; (b) margin lending transactions, and (c) the instruments listed in Annex I of this regulation. (3) Banks may take the following types of contractual netting into account as risk-reducing: (a) bilateral contracts for novation between a bank and its counterparty under which the existing mutual claims and obligations that are the subject of the novation contract, are automatically amalgamated in such a way that this novation fixes one single binding obligation, i.e. claim and when it is thus created all former obligations and claims are extinguished; (b) bilateral netting agreements between a bank and its counterparty; (c) contractual cross product netting agreements for banks that have received Bank of Slovenia permission to use the IMM method for transactions falling under the scope of that method; netting across transactions concluded by members of a group connected in the manner defined by Article 56 of the Companies Act (ZGD-1), where the reference obligation ranks simultaneously with (pari passu) or is later than (junior to) the underlying obligation, shall not recognised for the purposes of calculating capital requirements. 5.3.6.2 Conditions for Recognition of Netting Contracts Article 70 (general) (1) Banks may only take the contracts set out in Article 69 of this regulation into account as riskreducing, if the following conditions are fulfilled: (a) the contract stipulates that in the case of a counterparty's default, bankruptcy, liquidation and other similar circumstances, the bank shall have one single obligation (in the case of net negative mark-to-market value), or one single claim (in the case of net positive mark-to-market value) against its counterparty, while all prior obligations and claims which are the subject of the netting agreement are extinguished; (b) a bank must have independent reasoned legal opinions with grounds stating that agreement content is compliant with the conditions referred to in point (a) of this article and that in the case of a legal action, the contract will be a valid and binding legal source for competent courts of law, pursuant to: – the law of the country in which the counterparty has its registered office or in the case where its counterparty's branch or a bank's branch is involved, also under the law of the country in which the branch has its registered office; – the law of the country that applies to the individual transaction that is the subject of the contract; – the law of the country that applies to other legal acts necessary to effect the contractual netting; (c) banks have procedures in place to ensure that the legal validity of its contractual netting is kept under review in the light of possible changes in the relevant law; (d) banks must maintain all relevant documentation; (e) banks must factor the effects of netting into the measurement of each counterparty's aggregate credit risk exposure and must manage its CCR on such a basis; (f) the credit risk to each counterparty is aggregated to establish a single legal exposure across all transactions; this aggregation shall be factored in when defined credit limit purposes and calculating internal capital. (2) Banks cannot take any contract into account as risk-reducing, if it contains a provision enabling a solvent counterparty to make limited payments or no payments at all to an insolvent counterparty, even if the insolvent counterparty is a net creditor (i.e. a walkaway clause). 45 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (3) In addition to the conditions set out in the first paragraph of this article, contractual cross product netting agreements must also meet the following criteria: (a) the net sum referred to in point (a) of the first paragraph of this article, must be the sum of the positive and negative values of each individual master agreement and the positive and negative mark-to-market values of the individual transactions (the "Cross-Product Net Amount); (b) the written and reasoned legal opinions referred to in point (b) of the first paragraph of this article must address the validity and enforceability of the entire contractual cross-product netting agreement under its terms, and the impact of the netting arrangement on the material provisions of any individual bilateral master agreement included. A legal opinion shall be generally recognised in the Member State in which the bank has acquired a permission to perform banking services, or a memorandum of law that addresses all relevant issues in a reasoned manner; (c) banks must have the procedure set out in point (c) of the first paragraph of this article to verify that any transaction that should be included in a netting set is covered by a legal opinion; (d) taking into account the contractual cross-product netting agreement, banks must continue to comply with the requirements for the recognition of bilateral netting and the requirements of the Credit Protection Regulation regarding the recognition of credit risk mitigation with respect to each individual bilateral master agreement and transaction included. 5.3.6.3 Effects of Recognising Contractual Netting Article 71 (general) (1) If banks use the SM set out in Articles 50 to 52 of this regulation or the IMM set out in Articles 53 to 68 of this regulation to calculate the exposure value for financial instruments referred to in Annex I of this regulation, contractual netting shall be recognised as set out therein. (2) If banks calculate exposure value for the financial instruments listed in Annex I of this regulation using the Mark-To-Market Method or the Original Exposure Method, contractual netting shall be recognised as defined in Articles 72 and 73 of this regulation. Article 72 (treatment of contracts for novation in the application of the Mark-To-Market Method or Original Exposure Method) In contracts for novation the single net amounts fixed by the contracts shall be weighted, rather than the gross amounts covered by such contracts, as follows: (a) in the Mark-to-Market Method the replacement costs and nominal amounts or values of underlying instruments may be acquired by taking into account contracts for novation; (b) in the original exposure method the nominal amounts of the instruments may be acquired by taking into account contracts for novation; the conversion factors set out in Table 8 of Article 49 of this regulation shall be used therein. Article 73 (treatment of contractual netting agreements in the application of the Mark-To-Market Method or Original Exposure Method) (1) If banks apply the Mark-to-Market Method, contractual netting agreements shall be treated in the following manner: (a) the replacement cost arising from the instruments included in the contractual netting agreement shall be obtained on the basis of the hypothetical net amount which results from the netting agreement; where netting leads to net obligations for the bank, the replacement cost shall be included in the calculation as '0'; 46 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (b) the potential future credit exposure arising from the instruments included in netting agreements may be reduced by applying the following equation: PCEred = 0.4 x PCEgross + 0.6 x NGR x PCEgross Where: PCEred = the reduced figure for potential future credit exposure for all contracts with a given counterparty included in a legally valid bilateral netting agreement; PCEgross = the sum for all potential future credit exposure for all contracts with a given counterparty which are included in a legally valid bilateral netting agreement and are calculated by multiplying their notional principal amounts by the percentages set out in Table 7 of Article 48 of this regulation; NGR = − separate calculation: the quotient of the net replacement cost for all contracts included in a legally valid bilateral netting agreement with a given counterparty, and the gross replacement cost for all contracts included in a legally valid bilateral netting agreement with that counterparty; − aggregate calculation: the quotient of the sum of the net replacement cost calculated on a bilateral basis for all counterparties taking into account the contracts included in legally valid netting agreements, and the gross replacement cost for all contracts included in legally valid netting agreements. Banks may decide themselves whether to calculate the NGR pursuant to the first or second indent above, where the selected method must be applied consistently. For the calculation of the potential future credit exposure according to the above formula, perfectly matching contracts included in the netting agreement may be taken into account as a single contract with a notional principal equivalent to the net receipts. Perfectly matching contracts are forward foreign-exchange contracts or similar contracts in which a notional principal is equivalent to cash flows if the cash flows fall due on the same value date and fully or partly in the same currency. (2) If banks apply the original exposure method, netting contracts shall be treated in the following manner: (a) perfectly matching contracts included in the netting agreement may be taken into account as a single contract with a notional principal equivalent to the net receipts; the notional principal amounts are multiplied by the relevant conversion factors set out in Table 8 of Article 49 of this regulation; (b) for all other contracts included in the netting agreement, the notional (hypothetical) value of the contract may be multiplied by the reduced conversion factors set out in Table 11 of this item; for interest rate contracts, banks may select the residual maturity or the original maturity for the purposes of Table 11 of this article. Table 11: Reduced conversion factors for calculation of original exposure Original maturity Interest rate contracts One year or less Over 1 year, not exceeding 2 years Additional conversion factor for each additional year 0.35% 0.75% Contracts concerning foreign exchange and gold 1.50% 3.75% 0.75% 2.25% 47 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 5.4 Specific Features of Calculating Expected Losses in Line with the IRB Approach Article 74 (general) (1) If banks calculate risk weighted exposure amounts for the purposes of the capital requirement for settlement/delivery risk and CCR using the IRB approach for calculating capital requirement for credit risk, and if they appropriately take the CCR into account in the valuation of a position included in the trading book, the expected loss amount for the counterparty risk exposure shall be zero. Banks must be capable of demonstrating that they have taken CCR sufficiently into account in the valuation of a position included in the trading book. (2) If banks fail to sufficiently take CCR into account in the valuation of a position included in the trading book, they may off-set the expected loss (EL) amount arising therefrom with any excess of value adjustments/provisions beyond the amount of expected losses from the non-trading book (calculated in accordance with the fourth paragraph of Article 15 of the IRB Approach Regulation). 6. CALCULATION OF CAPITAL REQUIREMENTS FOR FOREIGN EXCHANGE RISK Article 75 (general) (1) Banks must calculate capital requirements for foreign exchange risk, if the overall net foreign exchange position and the net position in gold, calculated in accordance with the second paragraph of this article, exceed 2% of its own funds. In that case, banks shall calculate their capital requirement for foreign exchange risk by multiplying the net foreign exchange position and net position in gold by 8%. (2) The overall net foreign-exchange position and net position in gold shall be calculated in the following method for the purposes of capital requirements for foreign-exchange risk: (a) First, the net open position in each currency, including the reporting currency and gold, shall be calculated. This net position shall consist of the sum of the following elements (positive or negative): − the net spot position (i.e. all asset items less all liability items, including accrued interest, in the currency in question or, for gold, the net spot position in gold); − the net forward position (all amounts to be received, less all amounts to be paid under forward exchange and gold transactions, including currency and gold futures, and the principal on currency swaps not included in the spot position); − irrevocable guarantees (and similar instruments) that are certain to be called and likely to be irrecoverable; guarantees and credits in a specific currency with foreign exchange margin in that currency or any another collateral payable in that currency shall be included in the calculation of the net open off-balance sheet position in the amount of the uncovered part; if banks also have an approved general loan for such guarantees or credits, the potential obligation is only included in the calculation of the net off-balance sheet position once, even if disclosed twice in the bank’s off-balance sheet; − net future income/expenses that have not yet matured but are already fully hedged by foreign currency futures; if the bank decides to apply this treatment, it must be exercised on a consistent basis; − the net delta equivalent for the total book of foreign exchange and gold options; − the market value of other options, i.e. non-foreign exchange and non-gold options. Any positions which banks have opened in order to hedge against the adverse effect of the exchange rate on its capital adequacy ratio may be excluded from the calculation of net open foreign exchange positions. Such positions should be of a non-trading or structural nature and banks must notify the 48 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Bank of Slovenia of their exclusion, and any variation of the terms of their exclusion in advance. Banks may exclude positions that are deducted in the calculation of own funds from the calculation of net open foreign exchange positions. Banks must notify the Bank of Slovenia of their exclusion. In the case of CIUs, their actual foreign exchange positions shall be taken into account in the calculation of the net open position. Banks may rely on third party reporting of the foreign exchange position of the CIU, where the correctness of this report is adequately ensured. If banks are not aware of the foreign exchange positions in a CIU, it shall be assumed that the CIU is invested up to the maximum extent allowed under the CIU's investment policy in foreign exchange and banks shall, for trading book positions, take account of the maximum indirect exposure that they could achieve by taking leveraged positions through the CIUs. This shall be done by proportionally increasing the position in the CIU up to the maximum exposure to the underlying investment items resulting from the CIU’s investment policy. The assumed position of the CIU in foreign exchange shall be treated as a separate currency according to the treatment of investments in gold, subject to the following modifications: − if the CIU’s investment direction is know, the CIU’s total long position may be added to the total long open foreign exchange position, and the CIU’s total short position may be added to the total short open foreign exchange position. There would be no netting allowed between such positions prior to the calculation. Banks may use the net present value when calculating the net open position in each currency and in gold; (b) then the net short and long positions in each currency, except for the reporting currency, and the net long or short position in gold shall be converted at spot rates into the reporting currency. They shall then be summed separately to form the total of the net short positions and the total of the net long positions respectively. The higher of these two totals shall be the institution's overall net foreign exchange position. (3) Net positions in composite currencies may be broken down into the component currencies according to the quotas in force. Article 76 (calculating capital requirements for positions in foreign currencies within ERM2) Banks may exclude positions in foreign currencies within ERM2 from the calculation pursuant to Article 75 of this regulation. The capital requirement for these positions shall be calculated by calculating the matched positions in these currencies and multiplying them by a weight no lower than half of the maximum permissible variation laid down by the ERM2 agreement. Banks must treat these unmatched positions in these currencies in accordance with Article 75 of this regulation. 7. CALCULATING CAPITAL REQUIREMENTS FOR COMMODITIES RISK Article 77 (Calculation of positions in commodities) (1) Commodities pursuant to this regulation primarily include the following: (a) precious metals, agricultural products, minerals, etc.; (b) derivatives and other financial instruments based on commodities. 49 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (2) Each position in commodities or commodity derivatives shall be expressed in terms of the standard unit of measurement. The spot price in each commodity shall be expressed in the reporting currency based on the spot foreign exchange rate. (3) Positions in gold or gold derivatives shall be considered as being subject to foreign exchange risk and treated according to the provisions of this regulation for the purpose of calculating the capital requirement for market risk. (4) Positions which are purely stock financing may be excluded from the calculation of the capital requirement for commodities risk. (5) Interest and foreign exchange risk not covered by Articles 78 to 80 of this regulation shall be included in the calculation of general risk for debt instruments and the calculation of foreign exchange risk. (6) Banks must protect themselves against the liquidity risk that may exist on some markets, when the short position in a commodity falls due before the long position. (7) For the purpose of the first paragraph of Article 80 of this regulation, the excess of a bank's long (short) positions over its short (long) positions in the same commodity and identical commodity futures, options and warrants shall be its net position in each commodity. Banks may treat positions in commodity derivatives as positions in the underlying commodity as set out in the first, second and third paragraph of Article 78 of the regulation. (8) Banks may treat the following positions as positions in the same commodity: (a) positions in different subcategories of commodities in cases where the subcategories are deliverable against each other; (b) positions in similar commodities if they are close substitutes and if a minimum correlation of 0.9 between price movements can be clearly established over a minimum period of one year. Article 78 (capital requirements for particular instruments) (1) Commodity futures and forward commitments to buy or sell individual commodities shall be incorporated in the measurement system as notional amounts in terms of the standard unit of measurement and assigned a maturity with reference to the expiry date. Banks may use, as the capital requirement against the risk associated with commodity futures, if they are traded on recognised exchanges listed in Annex II of this regulation, a sum that is equal to the margin required for such contracts by the exchange in question. Banks may use, as the capital requirement against the risk associated with OTC commodity derivatives of the type referred to in this paragraph, if they are cleared by a recognised clearing house referred to in Annex II of this regulation, a sum that is equal to the margin required for such contracts by the clearing house in question. (2) Commodity swaps, where one side of the transaction is a fixed price and the other the current market price, shall be incorporated into the maturity ladder approach as set out in Article 79 of this regulation, as a series of positions equal to the notional amount of the contract, with each position corresponding to each payment on the swap. These positions are slotted into the maturity ladder set out in Table 12 of the first paragraph of Article 79 of this regulation. These positions are treated as long positions, if the bank is paying a fixed price and receiving a floating price, and short positions if the bank is receiving a fixed price and paying a floating price. 50 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Commodity swaps where the sides of the transaction are in different commodities are to be reported in the relevant reporting ladder for the maturity ladder approach. (3) Options on commodities or on commodity derivatives must be treated as if they were positions equal in value to the amount of the underlying instruments to which the options refer, multiplied by their deltas. These positions may be netted off against any offsetting positions in the identical underlying commodity or commodity derivative. The delta used shall be the delta calculated by a recognised exchange listed in Annex II of this regulation where the options are traded. For options for which there is no available delta from a recognised exchange, or OTC options, banks may calculate the delta themselves, if they demonstrate that their delta-calculation model is appropriate. The Bank of Slovenia may prescribe a delta-calculation methodology. It is essential that banks also take safeguards against other risks associated with options, apart from the delta calculation. Banks therefore must calculate the additional capital requirement for other risks associated with options, e.g. risks of changes to the delta (gamma risk), or volatility of the underlying instrument (vega risk). The gamma and vega computed by a recognised exchange listed in Annex II of this regulation where the options are traded shall be used. For options for which there is no available gamma and vega from a recognised exchange, or OTC options, banks may calculate the gamma and vega themselves, if they demonstrate that their calculation models are appropriate. The Bank of Slovenia may prescribe a calculation methodology for gamma and vega. Banks may use, as the capital requirement against written exchange-traded commodity options, if they are traded on recognised exchanges listed in Annex II of this regulation, a sum that is equal to the margin required for such contracts by the exchange in question. Banks may use, as the capital requirement for the contracts set out in the first paragraph of this article, which are traded OTC and which are cleared by a recognised clearing house listed in Annex II of this regulation, a sum that is equal to the margin required for such contracts by the clearing in question. Banks may use, as the capital requirement on bought exchange-traded or OTC commodity options, a sum that is equal to the requirement required for the type of commodity to which the options refer. The capital requirement defined in the manner shall not exceed the market value of the options. The requirement for a written OTC option shall be set in relation to the commodity underlying it. (4) Warrants relating to commodities shall be treated in the same way as commodity options as referred to in the third paragraph of this article. (5) Banks that conclude repurchase agreements or commodities lending transactions which require them to transfer commodities or guaranteed rights must include such commodities in the calculation of its capital requirements for commodity risk. Article 79 (calculation of capital requirement using the maturity ladder approach) (1) Banks must use their maturity ladder for each commodity in accordance with Table 12 in this paragraph. All positions in that commodity and all positions which are regarded as positions in the same commodity in accordance with the eighth paragraph of Article 77 shall be assigned to the appropriate maturity band. Physical stocks shall be assigned to the first maturity band. 51 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Table 12: Maturity ladder for positions in commodity Maturity band (1) 0 ≤ 1 month > 1 month ≤ 3 months > 3 months ≤ 6 months > 6 months ≤ 12 months > 1 year ≤ 2 years > 2 years ≤ 3 years > 3 years Spread rate (%) (2) 1.50 1.50 1.50 1.50 1.50 1.50 1.50 (2) Banks may offset positions, which are treated as positions in the same commodity in accordance with the eighth paragraph of Article 77 of this regulation, and assign them on a net basis to the appropriate maturity bands. These are: (a) positions in contracts maturing on the same date; (b) positions in contracts maturing within 10 days of each other if the contracts are traded on markets which have daily delivery dates. (3) The banks must then calculate the sum of the long positions and the sum of the short positions in each maturity band. The sum of the long (short) position that are matched by the short (long) positions in a given maturity band shall be the matched weighted position in that maturity band, while the residual long or short position shall be the unmatched position for the same band. (4) That part of the unmatched long (short) position for a given maturity band that is matched by the unmatched short (long) position in the next maturity band shall be the matched position between two maturity bands. That part of the unmatched long or short position between two bands shall be the unmatched position. (5) The capital requirement for each commodity shall be calculated on the basis of the relevant maturity ladder as the sum of the following: (a) the sum of the matched long and short positions, multiplied by the appropriate spread rate as indicated in Table 12 in the first paragraph of this article for each maturity band and by the spot price for the commodity; (b) the matched position between two maturity bands for each maturity band into which an unmatched position is carried forward, multiplied by 0.6% (carry rate) and by the spot price for the commodity; (c) the residual unmatched positions (the remainder after matching is complete) multiplied by 15% (outright rate) and by the spot price for the commodity. (6) The overall capital requirement for commodity risk shall be calculated as the sum of the capital requirements calculated for each commodity, in accordance with the first to fifth paragraphs of this article. Article 80 (calculation of capital requirement using the simplified approach) (1) The capital requirement for each commodity shall be calculated as the sum of: (a) 15% of the net position, long or short, multiplied by the spot price for the commodity; (b) 3% of the gross position, long plus short, multiplied by the spot price for the commodity. 52 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (2) The overall capital requirement for commodity risk shall be calculated as the sum of the capital requirements calculated for each commodity, in accordance with the first paragraph of this article. 8. USE OF INTERNAL MODELS TO CALCULATE CAPITAL REQUIREMENTS FOR POSITION RISK, EXCHANGE RATE RISK AND/OR COMMODITIES RISK 8.1. Permission to Use Internal Models Article 81 (general) Banks may use internal models or a combination of models and the methods defined in Articles 15 to 42, 75 and 76, and 77 to 80 of this regulation to calculate the capital requirement for position risk, exchange rate risk and/or commodity risk, but only if authorised by the Bank of Slovenia or on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1, on the use of internal models to calculate the capital requirements for position risk, exchange rate risk and/or commodity risk, and the use of combinations of internal models and methods set out in Articles 15 to 42, 75 and 76, and 77 to 80 of this regulation. Article 82 (conditions and documentation for granting permission) (1) The Bank of Slovenia shall grant permission for the use of internal models to calculate capital requirements for position risk, foreign currency risk and/or commodity risk, if, in addition to its risk management system being appropriately planned and fully implemented, banks shall implement the following conditions: (a) the qualitative standards set out in Article 84 to 87 of this regulation; (b) quantitative standards set out in Article 88 of this regulation; (c) the validation of models and back-testing is implemented in accordance with Articles 90 and 91 of this regulation; (d) additional conditions for internal models to calculate capital requirements for specific risk, if the bank uses those set out in Article 89 of this regulation. (2) Banks shall demonstrate that they meet the conditions specified in the first paragraph of this article by submitting the following documentation set out in Annex VIII as part of the request for permission: (a) documentation on general information on internal models and combined use of internal models and methods defined in Articles 15 to 42, 75 and 76 and 77 to 80 of this regulation, if the bank decides on such use; (b) documentation on compliance with the qualitative standards set out in Article 84 to 87 of this regulation; (c) documentation on compliance with the quantitative standards set out in Article 88 of this regulation; (d) documentation on compliance with the criteria for validation of internal models and backtesting in accordance with Articles 90 and 91 of this regulation; (e) documentation on meeting additional conditions for the approval of internal models to calculate capital requirements for specific risk referred to Article 89 of this regulation, if used by the bank. 53 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (3) Banks must be in continual compliance with the conditions referred to in the first paragraph of this article from the day the Bank of Slovenia granted its permission for the use of internal models to calculate capital requirement for position risk, exchange rate risk and/or commodity risk. (4) In the Bank of Slovenia's order to grant permission for the use of internal methods to calculate capital requirements for position risk, foreign currency risk and/or commodity risk, it shall be stated whether or not, in accordance with Article 87 of this regulation, the bank may use empirical correlations with risk categories and across them. Banks that do not comply with the conditions for use of these empirical correlations must immediately submit a request to amend the permission to the Bank of Slovenia. (5) In the Bank of Slovenia's order to grant permission for the use of internal methods to calculate capital requirements for position risk, foreign currency risk and/or commodity risk, it shall be defined the combined use of the internal models and methods defined in Articles 15 to 42, 75 and 76, and 77 to 80 of this regulation, if a bank decides to use a combined approach. If a bank intends to change its combined use of internal models and methods defined in Articles 15 to 42, 75 and 76, and 77 to 80 of the regulation, it must acquire a new permission from the Bank of Slovenia. (6) More detailed instructions on the form for requesting a Bank of Slovenia permission to use internal models to calculate capital requirement for position risk, exchange rate risk and/or commodity risk or the form for requesting an amendment to this permission are set out in Annex VIII of this regulation. (7) The provisions of the first to sixth paragraphs of this article shall also apply mutatis mutandis when an EU parent bank and its subsidiaries or banks and other institutions subordinate to an EU parent financial holding company intend to use internal models in a bank group and, on the basis of Article 291 of the ZBan-1, jointly submit a request for permission to use internal models to calculate capital requirements for position risk, exchange rate risk and/or commodity risk. (8) The Bank of Slovenia shall issue an EU parent bank or a bank controlled by an EU parent financial holding company a permission to use internal methods to calculate capital requirement for position risk, exchange rate risk and/or commodity risk, on the basis of the decision set out in the third and fourth paragraphs of Article 291 of the ZBan-1. (9) The Bank of Slovenia shall issue a subsidiary bank with registered office in the Republic of Slovenia that has submitted a request for issue of a permission together with an EU parent bank or a bank controlled by an EU financial holding company with a permission to use internal methods to calculate capital requirements for position risk, exchange rate risk and/or commodity risk, on the basis of the decision set out in the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. Article 83 (withdrawal of permission) (1) The Bank of Slovenia shall withdraw the permission to use internal models to calculate its capital requirements for position risk, foreign exchange risk and commodities risk: (a) if banks act in contradiction with the Bank of Slovenia order, or an order with additional measures ordering the correction of a violation in fulfilment of the conditions set out in the first paragraph of Article 82 of this regulation; (b) if banks seriously violate the conditions set out in the first paragraph of Article 82 of this regulation; (c) if banks act in contradiction with the Bank of Slovenia's order, or an order with additional measures ordering the correction of a violation relating to inaccuracy in the calculation of internal models (when numerous overshootings in the actual/hypothetical changes in portfolio value compared to changes in portfolio value calculated by the model indicator the inaccuracy of internal models). 54 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (2) The Bank of Slovenia shall also withdraw a bank’s permission to use advance approach in a banking group on the basis of a decision on the withdrawal of a permission to use internal methods to calculate capital requirements for position risk, exchange rate risk and/or commodity risk in a banking group, which shall follow mutatis mutandis the third, fourth and sixth paragraphs of Article 291 of the ZBan-1. 8.2. Qualitative Standards Article 84 (general) Banks using internal models to calculate their capital requirements for position risk, foreign exchange risk and commodities risk must comply with the following qualitative standards: (a) the internal risk measurement model must be closely integrated with the daily risk management process and must serve as the basis for reporting risk exposures to senior management; (b) they must have a risk management unit that is organisationally and operationally independent of business trading units, and it must report directly to senior bank management. The unit must be responsible for designing and implementing the risk management system and the production and analysis of daily reports on the output of the model and on the appropriate measures to be taken in terms of trading limits. The unit must also conduct the initial and on-going validation of the internal model; (c) banks’ management board and senior management must be actively involved in the risk management process; the daily reports produced by the risk management unit must be reviewed by a level of management with sufficient authority to enforce both reductions of positions taken by individual traders as well as in the institution's overall risk exposure; (d) they must have sufficient numbers of staff skilled in the use of models in the trading, risk management, auditing and back-office areas; (e) they must have established procedures for monitoring and ensuring compliance with a documented set of internal policies and controls concerning the overall operation of the risk measurement system; (f) their models must have a proven track record of reasonable accuracy in measuring risks; (g) they must frequently conduct a programme of stress testing and the results of these tests are reviewed by senior management and reflected in the policies and limits it sets. When stress testing detects particular sensitivity to various circumstances, the bank must immediately adopt measures to manage the risks appropriately. The stress test programme shall particularly address illiquidity of markets in stressed market conditions, concentration risk, one way markets (markets in which either supply or demand dominates), event and jump-to-default risks, non-linearity of products, deep out-of-the-money positions, positions subject to the gapping of prices and other risks that may not be captured appropriately in a VaR model. The shocks applied shall reflect the nature of the portfolios and the time it could take to hedge out or manage risks under severe market conditions; (h) the risk management unit must regularly carry out back-testing; (i) the risk measurement system must be subject to regular reviews by the internal audit service; the reviews must cover the operations of the business trading units and the risk management units; at least once a year, banks must conduct an overall review of risk management processes, which must include at least: − the adequacy of the documentation of the risk management system and processes and the organisation of the risk management unit; − the integration of market risk measures into daily risk management and the integrity of the management information system; 55 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE − the process for approving the risk pricing models and valuation models used by front and back-office staff; − the scope of market risks captured by the risk measurement model and the validation of any significant changes in the risk measurement process; − the accuracy and completeness of position data, the accuracy and appropriateness of volatility and correlation assumptions, and the accuracy of valuation and risk sensitivity calculations; − the verification process the institution employs to evaluate the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources; and − the verification process used to evaluate the back-testing that is conducted to assess the models' accuracy. Article 85 (other option risks) Models must accurately capture all the material price risks of options or option-like instruments. All other risks not captured in the model must be adequately covered by own funds. Article 86 (risk factors) Internal models must capture a sufficient number of risk factors, depending on a bank's level of activity in the respective markets and in particular the following: (a) interest rate risk: internal models must incorporate a set of risk factors corresponding to the interest rates in each currency in which the bank has interest rate sensitive on- or off-balance sheet positions. The banks must model the yield curves using one of the generally accepted approaches. For material exposures to interest rate risk in the major currencies and markets, the yield curve shall be divided into a minimum of six maturity segments, to capture the variations of volatility of rates along the yield curve. The models must also capture the risk of less than perfectly correlated movements between different yield curves; (b) exchange rate risk: internal models must incorporate risk factors corresponding to gold and to the individual foreign currencies in which the institution's positions are denominated; for CIUs the actual foreign exchange positions of the CIU shall be taken into account. Banks may rely on third party reporting of the foreign exchange position of the CIU, where the correctness of this report is adequately ensured. If banks are not aware of the foreign exchange positions of a CIU, this position should be carved out and treated in accordance with the first and second paragraphs of Article 75 of this regulation. (c) equity risk: models must use a separate risk factor at least for each of the equity markets in which the bank holds significant positions; 56 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (d) commodity risk: models must use a separate risk factor at least for each commodity in which banks hold significant positions. The models must also capture the risk of less than perfectly correlated movements between similar, but not identical, commodities and the exposure to changes in forward prices arising from maturity mismatches. Models must also take account of market characteristics, and particularly delivery dates and the scope provided to traders to close out positions. Article 87 (use of empirical correlations) Banks may use empirical correlations within risk categories and across risk categories if their system for measuring correlations is sound and implemented with integrity. 8.3. Quantitative Standards Article 88 (general) Banks’ internal models must take into consideration the following quantitative standards in calculating value-at-risk (VaR): (a) at least daily calculation of the value-at-risk measure; (b) the value-at-risk (VaR) must be calculated with a 99th percentile, one-tailed confidence interval (effective trading loss cannot exceed losses calculated using the model in more than 1 case out of 100); (c) In calculating the value-at-risk, a factor that reflects price volatility over a 10-day period (holding period) shall be used; (d) the value-at-risk is calculated on the basis of an effective historic observation period of at least one year, except where a shorter observation period is justified by a significant upsurge in price volatility; (e) the data sets used for calculating value-at-risks shall be updated at least once every three months, and whenever market prices are subject to material changes this shall be done more often. 8.4. Additional Conditions for the Use of Internal Models to Calculate Capital Requirements for Specific Risk Article 89 (general) (1) If banks also use internal models to calculate capital requirements for specific risk arising from debt instruments and equities, the models must meet the following conditions: (a) they must explain the historical price variation in the portfolio; (b) they must capture concentration in terms of magnitude and changes of composition of the portfolio; (c) they cannot be too sensitive to adverse market movement (they must be robust); (d) they must be validated through back-testing aimed at assessing whether specific risk is being accurately captured; (e) they must capture basis risk; banks must demonstrate that the internal model is sensitive to material idiosyncratic differences between similar but not identical positions; 57 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (f) they must capture event risk. (2) The banks referred to in the first paragraph of this article must also meet the following conditions: (a) when a bank is subject to event risk that is not reflected in its VaR (value-at-risk) measure, because it is beyond the 10-day holding period and 99-percent confidence interval (low probability and high severity events), the bank must ensure that the impact of such events is factored in to its internal capital assessment; (b) internal models must conservatively assess the risk arising from less liquid positions and positions with limited price transparency under realistic market scenarios. In addition, the models must also meet minimum data standards. Proxies must be appropriately conservative and may only be used where the data available is insufficient or is not reflective of the true volatility of a position or portfolio. (3) The banks referred to in the first paragraph of this article must take into account the development of techniques and best practice in the use of models. (4) Furthermore, the banks referred to in the first paragraph of this article must have a method in place to capture, in the calculation of its capital requirements, the default risk of its trading book positions that exceeds the default risk captured by the value-at-risk measure. To avoid double counting when calculating their incremental default risk charge (additional capital requirement for default risk), banks may take into account the extent to which default risk has already been incorporated into the value-atrisk measure, especially for risk positions that could and would be closed within 10 days in the event of adverse market conditions or other indications of deterioration in the credit environment. If banks capture their incremental default risk through a surcharge, they shall have methodologies for validating the measure in place. Banks must demonstrate that their approach meets soundness standards comparable to the IRB approach, under the assumption of a constant level of risk, and adjusted where appropriate to reflect the impact of liquidity, concentrations, hedging and optionality. Banks that do not capture the increment default risk with internal models, must calculate the surcharge on the basis of the standardised approach or the IRB approach. (5) For cash or synthetic securitisation exposures that would be subject to a deduction treatment set out in Articles 14, 16 and 22 and 26 and 29 of the Securitisation Regulation, or risk weighted at 1250% as set out in the Securitisation Regulation, these positions shall be subject to a capital requirement that is no less than the requirement set forth under that treatment. Banks dealing in these exposures may apply a different approach, if they can demonstrate, in addition to trading intent, that a liquid two-way market exists for the securitisation exposures or, in the case of synthetic securitisations that rely solely on credit derivatives, for the securitisation exposures themselves or all their constituent risk components. A two-way market shall be deemed to exist, if there are independent good faith offers to buy and sell so that a price reasonably related to the last sales price or current good faith competitive bid and offer quotations can be determined within one day and settled at such a price within a relatively short time conforming to trade custom. Banks may act in a different manner, if they have sufficient market data to ensure that they fully capture the concentrated default risk of these exposures in their internal models for measuring the incremental default risk in accordance with the rules set out in the fourth paragraph of this article. 58 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 8.5. Internal Model Validation and Back-Testing Article 90 (validation processes) Banks must have adequate processes in place to ensure that their internal models have been adequately validated by suitably qualified parties independent of the model development process, and to ensure that they are conceptually sound and adequately capture all material risks. Validation must be conducted when internal models are initially developed and when any significant changes are made. Validation must also be conducted on a periodic basis, especially when significant structural changes in the market or changes to the composition of the portfolio occur that might lead to the internal models no longer being adequate. Banks must take developments in technique and best practice into account when validating models. Model validation must not be limited to back-testing, but must include at least the following: (a) tests to demonstrate that any assumptions made within the internal model are appropriate and do not underestimate or overestimate the risk; (b) in addition to the back-testing defined in Articles 90 and 91 of this regulation, banks must also carry out their own internal model validation tests in relation to the risks and structures of their portfolios; (c) the use of hypothetical portfolios to demonstrate that the internal models can account for particular structural features that may arise, for example material basis risks and concentration risk. Article 91 (back-testing) (1) Banks must monitor the accuracy and performance of their internal models by conducting backtesting. Back-testing must provide a comparison for each business day between the one-day value-atrisk measure generated by the internal model to calculate the portfolio's end-of-day positions and the one-day change of the portfolio's value by the end of the subsequent business day. (2) Banks must demonstrate their capability to perform back-testing on both actual and hypothetical changes in the portfolio's value. Back-testing on hypothetical changes in the portfolio's value shall be based on a comparison between the portfolio's end-of-day value and, assuming unchanged positions, its value at the end of the subsequent day. Banks must carry out appropriate measures to improve their back-testing programmes, if they are deemed deficient. Banks must perform back-testing on hypothetical trading portfolio (using changes in portfolio value that would occur were end-of-day positions to remain unchanged) and on actual trading (excluding fees, commissions, and net interest income) outcomes. 8.6. Calculation of Capital Requirements Article 92 (capital requirement amount) (1) The capital requirements for position risk, exchange rate risk and/or commodities risk is the higher figure of: (a) the previous day’s value-at-risk measure, plus, where appropriate, the incremental default risk charge (additional capital requirement for default risk), calculated in accordance with the fourth paragraph of Article 89 of this regulation; 59 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (b) the average daily value-at-risk for the preceding 60 business days, multiplied by a factor of at least 3, adjusted by the plus factor referred to in the second paragraph of this article, to which is added, where appropriate, the incremental default risk charge, calculated in accordance with the fourth paragraph of Article 89 of this regulation. (2) The multiplication factor from point (b) of the first paragraph of this article shall be increased by a plus-factor ranging from 0 to 1 in accordance with Table 14 of this paragraph, depending on the number of overshootings over the limits set out under the established value-at-risk model, and established by means of back-testing for the preceding 250 business days. The overshootings must be calculated consistently by means of actual and hypothetical changes in the portfolio value. An overshooting shall mean a one-day change in the portfolio value, which overshoots the appropriate one-day measure of value-at-risk (VaR), calculated by applying the model. In order to determine the plus factor, the bank shall consistently determine the number of excesses on limits at least quarterly. Table 14: Plus factors for overshooting actual/hypothetical changes in the portfolio value with respect to changes calculated by the model Number of overshootings Plus factor (1) (2) Fewer than 5 0.00 5 0.40 6 0.50 7 0.65 8 0.75 9 0.85 10 or more 1.00 For the purpose of ongoing monitoring of the adequacy of the plus factor, banks must immediately, and no later than within 5 business days, notify the Bank of Slovenia of overshootings identified by means of back-testing, which would trigger an increase in the plus factor. 9. CAPITAL REQUIREMENT FOR RISK OF EXCEEDING THE MAXIMUM ALLOWABLE EXPOSURE FROM TRADING Article 93 (calculation of capital requirement) (1) Banks must calculate the capital requirement for exceeding the maximum-permitted exposure from the trading book, if the total exposure calculated in accordance with Article 4 of the Regulation on Large Exposures of Banks and Savings Banks (Official Gazette of the Republic of Slovenia, No 135/06; hereinafter: Large Exposure Regulation), overshoots the restrictions set out in Article 8 of the Large Exposure Regulation. 60 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (2) The capital requirement for the risk of exceeding the maximum allowable exposure from the trading book shall be calculated on the basis of the individual trading exposures to individual persons which requires the calculation of the highest capital requirement for specific risk and/or the highest capital risk for counterparty/settlement risk and CCR and the amount which equals the amount of the excess trading exposure (overshooting referred to in the first paragraph of Article 11 of the Large Exposure Regulation). (3) If the excess trading exposure persists for 10 days or less, the additional capital requirement for the risk of exceeding the maximum allowable exposure shall be 200% of capital requirement for specific risk and/or counterparty/settlement risk for the relevant exposures referred to in the second paragraph of this article. (4) If the excess trading exposure persists for over 10 days, banks must classify the individual exposures referred to in the second paragraph of this article in an appropriate category of column 1 of Table 15 of this paragraph in ascending order (from lowest to highest) of their capital requirement for specific risk and/or counterparty/settlement risk. Banks shall calculate the capital requirement as the sum of the specific risk requirements and/or the counterparty/settlement risk, multiplied by the corresponding factor in column 2 in Table 15 of this paragraph. Table 15: Factors for increasing capital requirements for risk of exceeding the maximum allowable exposure 10. Excess over capital limits Factor (1) (2) up to 40% 200% From 40% to 60% 300% From 60% to 80% 400% From 80% to 100% 500% From 100% to 250% 600% over 250% 900% SPECIAL FEATURES OF CALCULATING CONSOLIDATED CAPITAL REQUIREMENTS FOR MARKET RISK Article 94 (possibility of offsetting positions) (1) For the purposes of calculating capital requirements for position risk and risk from exceeding the maximum allowable exposure from trading on a consolidated basis, it may be permitted to offset positions in trading books of other institutions in accordance with the rules set out in Articles 15 to 42 and/or Articles 81 to 92 of this regulation or in accordance with the Large Exposure Regulation and Article 93 of this regulation. 61 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE For the purposes of calculating capital requirements for foreign exchange risk on a consolidated basis, foreign exchange positions in one institution may be permitted to offset foreign exchange positions in other institutions, in accordance with the rules set out in Articles 75 and 76 and/or Articles 81 to 92 of this regulation. For the purposes of calculating capital requirements for commodities risk on a consolidated basis, commodities positions in one institution may be permitted to offset commodities positions in other institutions, in accordance with the rules set out in Articles 77 and 80 and/or Articles 81 to 92 of this regulation. (2) For the purposes of calculating capital requirements on a consolidated basis, the offsetting referred to in the first paragraph of this article may only be permitted with institutions that operate on the basis of a permission from the Bank of Slovenia or Securities Market Agency. Furthermore, the following conditions must also be fulfilled: (a) the institutions in question must have sufficient capital on an individual basis; (b) the institutions in question must have concluded contracts guaranteeing mutual financial support between them. (3) The offsetting referred to in the first paragraph of this article may also be permitted with institutions operating on the basis of permission from the competent authorities of other member states, if they fulfil the criteria from points (a) and (b) of the second paragraph of this article, and if the institutions are obliged to fulfil on an individual basis the capital requirements imposed in Articles 18, 20 and 28 of Directive 2006/49/EC of the European Parliament and the Council on the capital adequacy of investment firms and credit institutions (hereinafter: Directive 2006/49/EC). (4) The offsetting referred to in the first paragraph of this article may also be permitted with firms from the appropriate third countries listed in Annex V of this regulation, if, in addition to the conditions set out in points (a) and (b) of the second paragraph of this article, the following conditions are also fulfilled: (a) if they operate on the basis of a permission from a competent authority in the appropriate third country in question, and if they satisfy the definition of a bank, or are classified as an investment firm from an appropriate third country; (b) if on an individual basis they meet capital requirements that comply with the capital requirements laid down in Directive 2006/49/ES; (c) no regulation exists in the third country in question that would significantly affect the conclusion of contracts to guarantee mutual support between members of a group. 11. TRANSITIONAL AND FINAL PROVISION Article 95 (postponement of use of standardised approach to calculating credit risk capital requirements) Banks that pursuant to Article 405 of the Banking Act (ZBan-1) defer the start of use of the standardised approach for calculating capital requirements for credit risk until 1 January 2008, shall until that date, when calculating capital requirements for market risk: (a) for the purposes of the first paragraph of Article 46 of this regulation apply, instead of Annex I of this regulation, Annex I of the Regulation on the Capital Adequacy of Banks and Savings Banks (Official Gazette of the Republic of Slovenia, Nos 24/02, 85/02, 22/03, 36/04, 68/04, 103/04, 124/04, 62/05, 67/05 and 74/06) and, instead of the provisions of Articles 47 to 73 of this regulation, shall apply Item 14 and Annex III of the Regulation on the Capital Adequacy of Banks and Savings Banks; (b) instead of the fourth paragraph of Article 46 of this regulation, apply Item 28.2.2 of the Regulation on the Capital Adequacy of Banks and Savings Banks; 62 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE (c) read references to Article 4 of the Large Exposure Regulation in Article 93 of this regulation as references to Chapter XI of the Regulation on the Capital Adequacy of Banks and Savings Banks; (d) read references to Article 8 of the Large Exposure Regulation in Article 93 of this regulation as references to Chapter III of the Regulation on the Capital Adequacy of Banks and Savings Banks (Official Gazette of the Republic of Slovenia, Nos 24/02, 22/03, 65/03 and 44/04). (2) Banks that begin to use the standardised approach or the IRB approach to calculate the capital requirement for credit risk during 2007 must begin to apply the provisions of this regulation from the date it begins using the above mentioned approach. Article 96 (entry into force and commencement of application of the regulation) This regulation shall commence application on 1 January 2007, except for the provisions relating to own estimates of LGDs (and CFs), which shall commence application on 1 January 2008. President of the Governing Board of the Bank of Slovenia dr. Marko Kranjec 63 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX I: TYPES OF DERIVATIVES 1. INTEREST RATE CONTRACTS (a) (b) (c) (d) (e) (f) single-currency interest rate swaps basis swaps forward rate agreements interest rate futures interest rate options purchased other derivative financial instruments of similar nature. 2. FOREIGN EXCHANGE CONTRACTS AND CONTRACTS CONCERNING GOLD (a) (b) (c) (d) (e) (f) cross-currency interest rate swaps forward foreign exchange contracts currency futures currency options purchased other derivative financial instruments of similar nature contracts concerning gold of a nature similar to instruments in (a) to (e). 3. CONTRACTS OF A SIMILAR NATURE Contracts of a similar nature include contracts similar to those listed in points 1(a) to (e) and 2(a) to (d) that are related to a different basis. These include as a minimum the following financial instruments: (a) options, futures, swaps, forward rate agreements and any derivative contracts based on securities, currencies, interest rates or yields, or other derivatives, financial indices or financial measures that can be settled physically or in cash; (b) options, futures, swaps, forward rate agreements and any derivative contracts based on commodities that must be settled in cash or may be settled with cash at the option of one of the parties; (c) options, futures, swaps, and any derivative contract relating to commodities that can be physically settled either by trading on a stock exchange and/or on Multilateral Trading Facilities (MTF); (d) options, futures, swaps, forward contracts, and any derivative contracts based on commodities that can be physically settled and are not dealt with in point (c) and not traded for commercial purposes, which have the characteristics of other derivative financial instruments, and which may be settled via recognised clearing houses or are subject to daily settlements; (e) financial contracts for differences; (f) options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties, as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this part, which have the characteristics of other derivative financial instruments, having regard to whether they are traded on a regulated market or an MTF, are cleared and settled through recognised clearing houses or are subject to daily settlements. 4. CREDIT DERIVATIVES 64 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX II: RECOGNISED EXCHANGES AND CLEARING HOUSES Banks may request that stock exchanges or clearing houses be added to this list. Recognised stock exchanges Alberta Stock Exchange American Stock Exchange Amsterdam Pork and Potato Terminal Market (Termijnmarkt Amsterdam BV) Amsterdam Stock Exchange (Amsterdamse Effectenbeurs) Antwerp (Effectenbeursvennootschap van Antwerpen) Athens Stock Exchange (ASE) Australian Stock Exchange Basle Stock Exchange (Basler Effektenborse) Barcelona Stock Exchange (Bolsa de Valores de Barcelona) Belgian Futures & Options Exchange (BELFOX) Berlin Stock Exchange (Berliner Börse) Bilbao Stock Exchange (Bolsa de Valores de Bilbao) Bologna Stock Exchange (Borsa Valori de Bologna) Bordeaux (Bourse de Bordeaux) Bremen Stock Exchange (Bremer Wertpapierbörse) Brussels Stock Exchange (Société de la Bourse des Valeurs Mobilières)/ (Effecten Beursvennootschap van Brussel) Chicago Board of Trade Chicago Board Options Exchange Chicago Mercantile Exchange Coffee, Sugar and Cocoa Exchange Inc. Copenhagen Stock Exchange (Kobenhavns Fondsbors) DTB Deutsche Terminbörse The Dublin Stock Exchange Düsseldorf Stock Exchange (Rheinisch-Westfalische Börse zu Düsseldorf) European Options Exchange Financiele Termijnmarkt, Amsterdam Finnish Options Exchange Florence Stock Exchange (Borsa Valori di Firenze) Frankfurt Stock Exchange (Frankfurter Wertpapierbörse) Genoa Stock Exchange (Borsa Valori di Genova) Geneva Stock Exchange (Bourse de Geneve) Hamburg Stock Exchange (Hanseatische Vertpapier Börse Hamburg) Hannover (Niedersächsische Börse zu Hannover) Helsinki Stock Exchange (Helsingin Arvopaperipörssi Osuuskunta) Hong Kong Futures Exchange International Petroleum Exchange of London Ltd Irish Futures & Options Exchange (IFOX) Kansas City Board of Trade Lille (Bourse de Lille) Lisbon Stock Exchange (Bolsa de Valores de Lisboa) Ljubljana Stock Exchange (Ljubljanska Borza d.d.) London International Financial Futures & Options Exchange London Metal Exchange Ltd London Stock Exchange Luxembourg Stock Exchange (Société de la Bourse de Luxembourg SA) Lyon (Bourse de Lyon) 65 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Madrid Stock Exchange (Bolsa de Valores de Madrid) Marché à Terme International de France (MATIF) Marché des Options Négociables de Paris (MONEP) Marseille (Bourse de Marseille) MEFF Renta Fija MEFF Renta Variable Mercato Italiano Derivati (IDEM) Mercato Italiano Futures (MIF) Mid American Commodity Exchange Milan Stock Exchange (Borsa Valori de Milano) Montreal Exchange Munich Stock Exchange (Bayerische Börse in München) Nagoya Stock Exchange Nancy (Bourse de Nancy) Nantes (Bourse de Nantes) Naples Stock Exchange (Borsa Valori di Napoli) National Association of Securities Dealers Incorporated (NASDAQ) New York Cotton Exchange New York Futures Exchange New York Mercantile Exchange New York Stock Exchange OM Stockholm AB OMLX, The London Securities and Derivatives Exchange Ltd Oporto Stock Exchange (Bolsa de Valores do Porto) Osaka Securities Exchange Oslo Stock Exchange (Oslo Bors) Pacific Stock Exchange Palermo Stock Exchange (Borsa Valori de Palermo) Paris Stock Exchange Philadelphia Board of Trade Philadelphia Stock Exchange Rome Stock Exchange (Borsa Valori di Roma) Singapore International Monetary Exchange Limited (SIMEX) Stockholm Stock Exchange (Stockholm Fondbörs) Stock Exchange of Hong Kong Ltd Stock Exchange of Singapore Stuttgart Stock Exchange (Baden-Württembergische Wertpapierbörse zu Stuttgart) Swiss Futures and Options Exchange (SOFFEX) Sydney Futures Exchange Tokyo Stock Exchange Tokyo International Financial Futures Exchange Toronto Stock Exchange Trieste Stock Exchange (Borsa Valori di Trieste) Turin Stock Exchange (Borsa Valori de Torino) Valencia Stock Exchange (Bolsa de Valores de Valencia) Vancouver Stock Exchange Venice Stock Exchange (Borsa Valori de Venezia) Vienna Stock Exchange Zurich Stock Exchange (Zürcher Börse) Recognised clearing houses Austrian Kontroll Bank (OKB) Board of Trade Clearing Corporation 66 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Cassa di Compensazione e Garanzia S. p. A (CCG) Central Securities Clearing Corporation (KDD Centralna Klirinško Depotna Družba d.d.) Commodity Clearing Corporation The Emerging Markets Clearing Corporation European Options Clearing Corporation Holding BV (EOCC) Guarantee Fund for Danish Options and Futures (Garantifonden for Danske Optioner OG Futures) (FUTOP) Kansas City Board of Trade Clearing Corporation Hong Kong Futures Exchange Clearing Corporation Ltd Hong Kong Securities Clearing Company Ltd London Clearing House (LCH) Norwegian Futures & Options Clearing House (Norsk Opsjonssentral A.S.) N.V. Nederlandse Liquidatiekas (NLKKAS) OM Stockholm AB (OM) Options Clearing Corporation OTOB Clearing Bank AG (OTOB) Société de Compensation des Marchés Conditionnels (SCMC) Sydney Futures Exchange Clearing House (SFECH Ltd) 67 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX III Recipient: Banka Slovenije Slovenska cesta 35 1505 Ljubljana Applicant: (Name and registered office of the bank, list of legal representatives entitled to submit an application or issue an authorisation to submit an application) Authorised person 1: (Personal name or company name, address of residence or registered office) APPLICATION FOR THE ISSUE OF BANK OF SLOVENIA'S PERMISSION TO USE SENSITIVITY MODELS TO CALCULATE POSITIONS IN DERIVATIVES Contact person in charge of the application Position Title Telephone E-mail Signatures of legal representatives and/or authorised persons _________________________________________________________________________________ _________________________________________________________________________________ _________________________________________________________________________________ ___________________________________________________________________________ ______ 1 Only completed if the bank has one. In that case the appropriate authorisation must be submitted with the application. 68 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE JUSTIFICATION OF THE APPLICATION SECTION A – Documentation on types of financial instruments for which you intend to use the sensitivity model and the basic information on the models, as defined in point (a) of the fourth paragraph of Article 22 of this regulation. A1. Submit a table of the sensitivity models you intend to use and for each one state the product for which it will be used (types of financial instrument set out in Articles 17 to 20 of this regulation, and bonds that are amortised over the residual life, rather than one final repayment of principal). A2. Describe the sensitivity models and the sensitivity assessment methodology. SECTION B – Documentation proving that the models generate positions that have the same sensitivity to interest rate changes as the underlying instruments, as set out in point (b) of the fourth paragraph of Article 22 of this regulation. Submit the required information and documentation for each sensitivity model intended for use. B1. Describe the model, with a special emphasis on the sensitivity assessment methodology. B2. How do you take into account the underlying financial instruments in assessing sensitivity? SECTION C – Documentation that demonstrates that the sensitivity is assessed with reference to independent movements in sample rates across the yield curve, with at least one sensitivity point in each of the maturity bands set out in Table 2 of the fourth paragraph of Article 32, as stipulated in point (c) of the fourth paragraph of Article 22 of this regulation. Submit the required information and documentation for each sensitivity model intended for use. C1. Describe in detail the design of your own yield curve, including: − what period is taken into account; − which financial instruments are taken into account? C2. What assumptions are used in designing your own yield curve, for example: − the use of positive or negative movement in the yield curve and explanation of this use; − range of changes taken into account (one or more base points based on the maturity or financial instrument); − how many maturity bands or points representing the yield curve do you use? C3. Describe the reasons for the use of individual assumptions in designing changes in your own yield curve. C4. Which sample interest rates are used to assess sensitivity? C5. Banks should also add mutatis mutandis the required documentation from the application for issue of the Bank of Slovenia permission for the use of internal models to calculate capital requirement for position risk, exchange rate risk and/or commodity risk set out in Annex VIII. 69 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX IV: VERY LIQUID EQUITY INDICES Individual shares on the following indices shall be deemed as liquid: Country Australia Index All Ordinaries Austria Hong Kong ATX (Austrian Korea Traded Index) BEL20 The Netherlands TSE35, TSE 100, Singapore TSE 300 CAC40, SBF 250 Spain DAX Sweden Dow Jones Stoxx Switzerland 50 Index, FTSE Eurotop 300, MSCI Euro Index Hang Seng 33 UK Italy MIB-30 Belgium Canada France Germany European Country Japan USA 70 Index Nikkei 225, Nikkei 300, TOPIX Kospi AEX Straits Time Index IBEX 35 OMX SMI FTSE 100, FTSE Mid 250, FTSE All Share S&P 500, Dow Jones Industrial Average, NASDAQ Composite, Russell 2000 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX V: LIST OF APPROPRIATE THIRD COUNTRIES The following countries shall be dealt with as appropriate third countries for the purposes of this regulation: Australia Canada Hong Kong Japan Singapore Switzerland USA 71 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX VI Recipient: Bank of Slovenia Slovenska cesta 35 1505 Ljubljana Applicant: (Name and registered office of bank, list of legal representatives entitled to submit an application or issue an authorisation to submit an application) Authorised person 1: (Personal name or company name, address of residence or registered office) APPLICATION FOR THE ISSUE OF BANK OF SLOVENIA'S PERMISSION TO USE THE INTERNAL MODEL METHOD (IMM) TO CALCULATE EXPOSURE VALUES Contact person in charge of the application Position Title Telephone E-mail Signatures of legal representatives and/or authorised persons _________________________________________________________________________________ _________________________________________________________________________________ _________________________________________________________________________________ ___________________________________________________________________________ ______ 1 Only completed if the bank has one. In that case the appropriate authorisation must be submitted with the application. 72 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE JUSTIFICATION OF THE APPLICATION SECTION A – Documentation on the type of transactions for which it intends to use the internal models methodology (IMM) (for transactions from points (a) or (b) or (c) of the second paragraph of Article 53 of this regulation), on its roll out plan for the sequential implementation of IMM and basic information on the internal models, as set out in point (a) of the second paragraph of Article 56 of this regulation. A1. Clarify whether you are submitting this application at the group or individual level. A2. Submit a list of persons included in the calculation of capital requirements for market risk using IMM in a group, and state the responsible persons. If, pursuant to Article 291 of the ZBan-1, an EU parent bank and its subsidiaries or banks and other institutions subordinate to an EU parent financial holding company jointly submit an application to the Bank of Slovenia for the issue and permission to use the IMM, state a list of these persons and the responsible persons. A3. For which types of transaction do you intend to use the IMM (for transactions from Items (a) or (b) or (c) of the second paragraph of Article 53 of this regulation)? A4. Do you intend to use your own estimate of alpha (α)? A5. Submit a table of the internal models you intend to use, and for each of them state: − which transactions they will used for; − a list of products which the internal model will cover. A6. If you intend to implement IMM sequentially, describe in detail the sequential implementation: − start and end of implementation; − types of transaction for which IMM will be used. SECTION B – Documentation on meeting the requirements for the correct calculation of exposure values using IMM, as defined in point (b) of the second paragraph of Article 56 of this regulation. B1. Full description of the methodology for calculating exposure with calculation examples. Banks must present: − calculation of exposure values; − calculation of EPE and EE; − own estimate of alpha (α), if produced in-house; − list of assumptions used in calculations and analysis thereof; − assumptions used in the distribution of movements in the market value of variables used; − use of margin agreements and inclusion of collateral values; − method of taking EPE into account. SECTION C – Documentation on meeting the minimum requirements for the EPE model, as defined in point (c) of the second paragraph of Article 56 of this regulation. Submit the required information and documentation for each internal model intended for use. C1. Submit an organisational chart, emphasising the display of organisational units responsible for the design and application of the counterparty credit risk (CCR) management system. 73 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE C2. Describe in detail all the tasks, powers and responsibilities of the organisational units or employees that relate to the IMM, and particularly CCR control units. C3. Describe the procedures used to evaluate the EPE model, and particularly: − controlling integrity of input data; − producing analyses of EPE model results; − verifying the ratios between measures of risk exposure and credit and trading limits. C4. Describe the reporting chain for CCR control units and the inclusion of senior management in the CCR management system. C5. Submit documentation relating to the overall functioning of the EPE model, policies and descriptions of procedures to monitoring and ensuring compliance with a documented set of internal policies and controls and providing an explanation of the empirical techniques used to measure CCR. C6. Submit examples of CCR exposure reports, reports on limit utilisation, and list of report recipients that use the reports in their work. C7. Describe the system for linking credit and trading limits within the CCR management system. C8. Describe the CCR exposure monitoring system by demonstrating calculations of peak or potential future exposure. C9. Submit the internal audit service's annual plan including reviews of trading unit operations and CCR control unit operations, with an emphasis on: − the documentation of the CCR management system; − the organisation of the CCR control unit; − the inclusion of CCR management measures; − the scope of CCR captured by the model; − the integrity of the management information system; − the accuracy and completeness of CCR data; − the accuracy and appropriateness of volatility and correlation assumptions; − the verification of the model's accuracy by back-testing. C10. Describe how the distribution of exposures generated by the model is included in the daily CCR management process, how EPE model results are taken into account in credit approval, CCR management and internal capital allocation. C11. Submit records on the use of the EPE model to generate the CCR exposure distribution for at least one past year. C12. Describe how the EPE model to generate the CCR exposure distribution is included in CCR management and submit use test documentation. C13. How frequently is EE assessed? Clarify the reasons for this frequency. C14. How do you determine and control CCR where exposure rises beyond the one-year horizon? C15. Submit a report on the results of stress testing with a detailed written analysis and measures adopted, and representation of the relationship between the results of stress-testing results and the limit system. C16. Describe the results of the stress testing for CCR exposure with an emphasis on concentration 74 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE risk, correlation risk across market and credit risk, and the risk that liquidating positions could move the market. C17. Describe the method of giving due consideration to exposures that give rise to a significant degree of General Wrong-Way Risk. C18. Describe the method of giving due consideration to exposures that give rise to a significant degree of Specific Wrong-Way Risk. C19. Describe procedures established for recognising netting agreements. C20. How are transaction specifications inputted into the database and what are the formal procedures in place to verify that transactions terms and specifications on an ongoing basis? How is this expressed in the EPE model? C21. Describe the method of acquiring data or proxies used in the EPE model, the length of time series for observations, frequency of updating, price verification procedure, and the quality of data or proxies. C22. Describe the method of taking into account the volatility of collateral in the EPE model. C23. Submit documentation on the EPE model validation process. C24. Describe how EPE model estimates are adapted. C25. Describe procedures used to verify whether a transaction including in a netting set is covered by a legally enforceable netting contract. C26. Describe the procedures used to verify whether collateral to mitigate CCR meets the regulatory requirements. SECTION D – Documentation on meeting the requirements for EPE model validation, as defined in point (d) of the second paragraph of Article 56 of this regulation. Submit the required information and documentation for each internal model intended for use. D1. Describe how the EPE model is included in the daily risk management process. D2. Submit an organisational chart of the bank with an emphasis on representing the organisational units for trading, risk management, back office, internal audit services and other units related to the EPE model. D3. Describe in detail all the tasks, powers and responsibilities of the organisational units or employees that relate to the EPE model. D4. Describe the tasks of senior management responsible for trading, and senior management responsible for back office and market risk management. D5. Submit documentation relating to the overall functioning of the EPE model, policies and descriptions of procedures to monitoring and ensuring compliance with a documented set of internal policies and controls, as follows: − policy used for integrated market risk management; − detailed description of instruments captured by the model; − the description of technical implementation of EPE model (software and hardware) with a manual describing managing software for internal model application; − documentation describing the method of allocating an individual position in the non- 75 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE trading or trading book; − management board resolution approving the EPE model. D6. Describe the procedures used to evaluate the accuracy and validity of the EPE model. D7. Submit a list of all market risk factors used in the EPE model, together with a statement of the source of data on the factors (e.g. Reuters), a statement of the length of time series for the data, and the frequency of acquiring current data. D8. Describe the action plan in case of problems in daily data acquisition. D9. Submit the internal audit services' annual review plan, with an emphasis on the planned review of the EPE model and organisational units related to internal models. D10. Submit the internal audit service's findings relating to reviews of the EPE model and processes and organisational units related to the EPE model. D11. Submit internal audit service’s findings on the verification of the quality of input data used by the EPE model. D12. Describe how the forecasting accuracy of the EPE model is verified in respect of marketing risk factors. D13. Describe how specific information for an individual transaction in a netting set (aggregated exposure at the netting set level, margin data, data on the market value of collateral or changes in the market value of collateral). D14. Describe the method of static back-testing on representative counterparty portfolios (actual or hypothetical). 76 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX VII Recipient: Banka Slovenije Slovenska cesta 35 1505 Ljubljana Applicant: (Name and registered office of bank, list of legal representatives entitled to submit an application or issue an authorisation to submit an application) Authorised person 1: (Personal name or company name, address of residence or registered office) APPLICATION FOR THE ISSUE OF BANK OF SLOVENIA'S PERMISSION FOR THE TRANSFER FROM THE INTERNAL MODEL METHOD (IMM) TO THE MARK-TO-MARKET METHOD OR THE STANDARDISED METHOD (SM) FOR CALCULATING EXPOSURE VALUES Contact person in charge of the application Position Title Telephone E-mail Signatures of legal representatives and/or authorised persons _________________________________________________________________________________ _________________________________________________________________________________ _________________________________________________________________________________ ___________________________________________________________________________ ______ 1 Only completed if the bank has one. In that case the appropriate authorisation must be submitted with the application. 77 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE JUSTIFICATION OF THE APPLICATION General data on the change in approach as defined in Article 58 of this regulation A1. Reason the grounds for the transfer from the internal model method (IMM) to the mark-tomarket method or the standardised method (SM) for calculating exposure values. A2. State and provide grounds for the date of transfer. 78 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX VIII Recipient: Banka Slovenije Slovenska cesta 35 1505 Ljubljana Applicant: (Name and registered office of bank, list of legal representatives entitled to submit an application or issue an authorisation to submit an application) Authorised person 1: (Personal name or company name, address of residence or registered office) APPLICATION FOR THE ISSUE OF BANK OF SLOVENIA'S PERMISSION FOR THE USE OF INTERNAL MODELS TO CALCULATE CAPITAL REQUIREMENTS FOR POSITION RISK, FOREIGN EXCHANGE RISK AND/OR COMMODITIES RISK Contact person in charge of the application Position Title Telephone E-mail Signatures of legal representatives and/or authorised persons _________________________________________________________________________________ _________________________________________________________________________________ _________________________________________________________________________________ ___________________________________________________________________________ ______ 1 Only completed if the bank has one. In that case the appropriate authorisation must be submitted with the application. 79 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE JUSTIFICATION OF THE APPLICATION SECTION A – Documentation on general information on models and potential combined use of internal models and other methods of calculating capital requirements for position risk, foreign exchange risk and commodities risk defined in this regulation, as set out in point (a) of the second paragraph of Article 82 of this regulation. A1. Clarify whether you are submitting this application at the group or individual level. A2. Submit a list of persons included in the calculation of capital requirements for position risk, foreign exchange risk and/or commodities risk using internal models in a group, and state the responsible persons. If, pursuant to Article 291 of the ZBan-1, an EU parent bank and its subsidiaries or banks and other institutions subordinate to an EU parent financial holding company jointly submit to the Bank of Slovenia an application for the issue and permission to use the internal models to calculate the capital requirements for position risk, foreign exchange risk and/or commodities risk, state a list of these persons and the responsible persons. A3. Submit a table of the internal models you intend to use, and for each of them state: – for the calculation of which capital requirement you will use it; – a list of products which the internal model will cover. A4. Do you intend to combine the use of internal models with the use of other methods to calculate capital requirements for position risk, foreign exchange risk and/or commodities risk set out in this regulation? If you do intend to do so, describe the combined use in detail. A5. Describe the reasons for the combined use of internal models with the use of other methods to calculate capital requirements for position risk, foreign exchange risk and/or commodities risk set out in this regulation. SECTION B – Documentation on meeting the qualitative standards for the use of internal models, as defined in point (b) of the second paragraph of Article 82 of this regulation. Submit the required information and documentation for each internal model intended for use. B1. State which risks are covered by the internal model (general risk, specific risk, foreign exchange risk, commodities risk). B2. Describe how the internal model is included in the daily risk management process. B3. Submit an organisational chart of the bank with an emphasis on representing the organisational units for trading, risk management, back office, internal audit services and other units related to the internal model. B4. Describe in detail all the tasks, powers and responsibilities of the organisational units or employees that relate to the internal model. B5. Describe the tasks of senior management responsible for trading, and senior management responsible for back office and market risk management. B6. Describe the reporting chain for internal model results and state the uses of model results. Submit cases of daily reports and analyses of internal model results. 80 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE B7. Submit documentation relating to the overall functioning of the internal model, policies and descriptions of procedures to monitoring and ensuring compliance with a documented set of internal policies and controls, as follows: − policy used for integrated market risk management; − detailed description of instruments captured by the model; − the description of technical implementation of the internal model (software and hardware) with a manual describing managing software for internal model application; − documentation describing the method of allocating an individual position in the nontrading or trading book; − management board resolution approving the internal model. B8. Describe in detail and provide grounds for the model approach used (Variance-Covariance Approach, Historical Simulation, Monte Carlo simulation) with all strengths and weaknesses of the validation methods used. B9. Describe the procedures used to evaluate the accuracy and validity of the internal model. B10. Describe in detail the limits system (definition, control, measures in case of overdraft…). B11. Describe in detail the method for defining the sensitivity measure. B12. Submit a list of all market risk factors used in the internal model, together with a statement of the source of data on the factors (e.g. Reuters), a statement of the length of time series for the data, and the frequency of acquiring current data. B13. Describe the method for calculating return for instruments included in the internal model from risk factors (e.g. logarithmic yields). B14. Describe the validation methods and methodological bases for defining the variability and covariance and a detailed description of the measures used to define the compliance of the variance-covariance matrix (including a test of the probability distribution's stability). B15. Describe in detail the data integrity verification method. B16. Describe the action plan in case of problems in daily data acquisition. B17. Submit the internal audit services' annual review plan, with an emphasis on the planned review of the internal model and organisational units related to internal model. B18. Submit the internal audit service's findings relating to reviews of the internal model and processes and organisational units related to the internal model. B19. Submit the internal audit service’s findings on the verification of the quality of input data used in the internal model. SECTION C – Documentation on meeting the quantitative standards for the use of internal models, as defined in point (c) of the second paragraph of Article 82 of this regulation. Submit the required information and documentation for each internal model intended for use. C1. Describe the frequency of value-at-risk (VaR) calculations and the frequency with which data time series are updated. C2. Describe the procedures for achieving, in accordance with this regulation, the defined confidence level and the holding period (factor reflecting a holding period defined in 81 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE accordance with this regulation). C3. State the length of the data observation period and provide grounds for this definition. C4. Describe the statistical assumptions on the distribution of market risk factors used. SECTION D – Documentation on compliance with the criteria for internal model validation and back-testing, as defined in point (d) of the second paragraph of Article 82 of this regulation. Submit the required information and documentation for each internal model intended for use. D1. Submit the test schedule and results of testing internal model implementation, which indicates that none of the assumptions included in the internal model overvalue or undervalue risk. D2. Submit documentation indicating that the risk management unit regularly implements backtesting, which must clearly indicate that the back-testing is carried out in accordance with this regulation. D3. Submit reports on the results of back-testing for the preceding 250 business days. D4. Describe and clarify the methods for calculating trading results used in back-testing. D5. Submit documentation indicating that the risk management unit regularly implements stresstesting, which must clearly indicate that the stress-testing is carried out in accordance with this regulation. D6. Submit documentation on the selection of stress test scenarios and a detailed description of the exclusion of irrelevant stress-test scenarios from the mass of possible scenarios. D7. Submit reports on stress-testing results with a detailed written analysis and measured adopted. D8. Describe the methodology for calculating potential losses from various stress-testing scenarios. D9. Describe how the results of stress-testing are taken into account when defining limits. D10. Submit a report on processing errors internal model results. D11. Describe the methods and procedures for identifying and verifying unusual phenomena (divergence from average calculations, extreme results, results that cause suspicion that the input data were inappropriate). D12. Describing tests used in (sub)portfolios to confirm the correctness and completeness of position data. SECTION E – Documentation on compliance with additional conditions for approval of internal models to calculate capital requirements for specific risk, as defined in point (e) of the second paragraph of Article 82 of this regulation. Submit the required information and documentation for each internal model intended for use. E1. Describe the testing method that confirms that the internal model is capable of explaining the historical price variation in the portfolio. E2. Describe the verification method that ensures that the internal model is sensitive to changes in portfolio structure. The internal model must adequately explain increased concentration of the portfolio in an individual sector or increased exposure to an individual issuer via VaR. 82 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE E3. Describe the verification method that ensures that the internal model is capable of explaining the increased risk in case of an unfavourable economic environment. E4. Submit a report on the results of back-testing that makes clear that the internal model is capable of capturing the specific and general risk with sufficient accuracy. E5. Describe the verification method that ensures that the internal model is capable of explaining material idiosyncratic differences between similar but not identical positions with sufficient accuracy. E6. Describe the verification method that ensures that the internal model is capable of capturing unanticipated events with sufficient accuracy (changes in issuer credit assessment = migration risk, mergers, takeovers, etc.). E7. Describe how the effects of event risk are managed that are not captured by value-at-risk (VaR) and must be included in the internal capital assessment. E8. Clarify how risk arising from less liquid positions and positions with limited price transparency is assessed. E9. Describe the methodology used to calculate the default charge for trading book positions that exceed the default risk captured in the value-at-risk (VaR) calculation on the basis of the an internal model. E10. Describe the methodology used to calculate capital requirements for synthetic exposures arising from synthetic securitisation. 83 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE ANNEX IX: CAPITAL REQUIREMENTS FOR GAMMA AND VEGA RISK RELATING TO OPTIONS When banks issue options and do not use internal option-valuation models to calculate capital requirements for options-related risk, the capital requirements for options may be calculated using the delta-plus approach. Since the delta-plus approach does not cover all risks stemming from options, the banks must calculate additional capital requirements against other non-delta risks (gamma and vega risks), and namely for each option position (also for hedged positions) separately. The banks must, for the purpose of calculating the capital requirements against gamma and vega risk on portfolios of options, classify individual positions in options for each risk category. The offsetting of gamma and vega impacts of individual positions may only be allowed within an individual risk category, as follows: − for foreign currencies and gold options, gold and each foreign currency pair represent a separate risk category; − for options on equities, equities of individual markets of one country represent their own risk category; if a stock is listed on more markets in different countries, the qualifying market is the one with the largest volume of trading in the respective stock, i.e. the market where the issuer has its registered office; − for options on bonds and interest rates, each currency and each maturity band (as set out under the approach based on maturity, and the approach based on duration) represents its risk category. 1. Delta risk The delta (δ) of an option represents the change in the price of option in the case of a minor change in the price of the underlying instrument. In mathematical terms, delta is the first partial derivative of the function of the option price with respect to the price of the underlying instrument. δ = ∂ of option price ∂ of underlying instrument price For the purpose of calculating the capital requirement for position and foreign exchange risks, the positions in options shall be treated as a combination of hypothetical long and short positions, i.e. they are broken down into the positions in the underlying financial instruments. These positions are then multiplied by the appropriate delta, which represents the position delta value. The delta value of the positions are taken into account in calculating capital requirements for position risk in accordance with the third paragraph of Article 18 of this regulation, and exchange rate risk in accordance with Articles 75 and 76 of this regulation. 2. Gamma risk The gamma (γ) of an option represents the relative change of the delta of an option in the case of a minor price change in the underlying instrument. In mathematical terms, gamma is the second partial derivative of the function of the option price with respect to the underlying instrument. Calculating the gamma risk requires calculating the so-called gamma impact, which arises from a Taylor series expansion as the following function of the option price: gamma impact = 1 2 × position × γ × (ΔB ) 2 ΔB from the equation above is the expected change in the price of the underlying instrument, while the position is defined according to the instrument type (see Table 1). 84 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE Table 1 position ΔB (maturity-based approach) ΔB(duration-based approach) Equity Individual equity Market value × 0.08 Foreign currency Nominal value Market value × 0.08 Market value × 0.08 Market value × 0.08 Interest rates Nominal value Assumed interest rate change as per Table 2 Assumed interest rate change as per Table 3 Bonds Nominal value/100 Weight as per Table 2 × future price bonds Duration × assumed interest rate change as per Table 3 × future price bonds Table 2 Rank Weight (%) Assumed interest rate change 0.00 0.20 0.40 0.70 1.25 1.75 2.25 2.75 3.25 3.75 4.50 5.25 6.00 1.00 1.00 1.00 0.90 0.80 0.75 0.75 0.70 0.65 0.60 0.60 0.60 8.00 0.60 12.50 0.60 Zone 1 1 1 1 2 2 2 3 3 3 3 3 3 Interest rate of 3% or more 0 to 1 month From 1 to 3 months From 3 to 6 months From 6 to 12 months From 1 to 2 years From 2 to 3 years From 3 to 4 years From 4 to 5 years From 5 to 7 years From 5 to 10 years From 10 to 15 years From 15 to 20 years More than 20 years 3 3 Interest rate of less than 3% 0 to 1 month From 1 to 3 months From 3 to 6 months From 6 to 12 months From 1.0 to 1.9 years From 1.9 to 2.8 years From 2.8 to 3.6 years From 3.6 to 4.3 years From 4.3 to 5.7 years From 5.7 to 7.3 years From 7.3 to 9.3 years From 9.3 to 10.6 years From 10.6 to 12.0 years From 12.0 to 20.0 years More than 20.0 years Table 3 Zone 1 2 3 Modified duration (in years) 0.0 to 1.0 From 1.0 to 3.6 years More than 3.6 years Assumed interest rate change (%) 1.00 0.85 0.70 Aggregation of gamma impacts For the calculation of the capital requirement for the gamma risk associated with an options portfolio, banks shall first add individual gamma impacts within individual risk categories resulting in either a positive or a negative net gamma impact for each risk category. The absolute value of the sum of all net gamma impacts that are negative for each risk category represents the capital requirement for gamma risk. 85 THIS TEXT IS UNOFFICIAL TRANSLATION AND MAY NOT BE USED AS A BASIS FOR SOLVING ANY DISPUTE 3. Vega risk The vega (Λ) of an option expresses the change in the price of options due to a minor change in the price volatility of the underlying instrument. In mathematical terms vega is the first partial derivative of the function of the price option relating to price volatility of its underlying instrument. Calculating vega requires calculating the so-called vega impact, which arises from a Taylor series expansion as the following function of the option price: Vega impact = position × Λ × volatility 4 It is assumed that a change in volatility is one quarter of current volatility (± 25%). Aggregation of vega impacts For the calculation of capital requirements for the vega risk associated with an options portfolio, banks shall first add individual vega impacts within individual risk categories resulting in either a positive or a negative net vega impact for each risk category. The absolute value of the sum of all net vega impacts represents the capital requirement for vega risk. In addition to the aforementioned options risks, the banks must be conscious of other risks also associated with options, such as rho risk (the rate of change of the value of the option with respect to the interest rate) and theta risk (the rate of change of the value of the option with respect to time). 86