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08 January 2021 Supervision Supervision label Supervision Q&A

Question:

How can an investment firm apply for permission to use the K-factor Clearing Margin Given (K-CMG) to calculate its capital requirement for Risk-to-Market (RtM)?

Answer:

We may grant permission to use K-CMG to calculate the RtM capital requirement for all positions that are subject to clearing, or on a portfolio basis, where the whole portfolio is subject to clearing or margining. A number of conditions apply. They are set out in Article 23(1) of the IFR and are further elaborated in an EBA regulatory technical standard.

To ensure we can assess whether the conditions of Article 23(1) of the IFR are met, investment firms wishing to use K-CMG must submit the following information when applying for permission:

  1. An up-to-date organisation chart of the group of which the investment firm is part, including the parent company/companies.

  2. A statement from the investment firm confirming that the following conditions are met: (i) The execution and settlement of all transactions (all positions that are subject to clearing, or on a portfolio basis, where the whole portfolio is subject to clearing or margining) take place under the responsibility of a clearing member or qualifying central counterparty (QCCP) and (ii) the relevant clearing member is a bank or a class 1 investment firm within the meaning of the IFR/IFD.

  3. An explanation demonstrating that the use of K-CMG is justified, for example because the main trading activities of the investment firm are subject to clearing and margining under the responsibility of a clearing member.

  4. An explanation demonstrating that the clearing member's margin requirements are sufficient to cover losses that may result from at least 99% of the exposures movements over an appropriate time horizon with at least a two‐business days holding period. The explanation must also demonstrate that the margin models used by that clearing member are designed to achieve a level of prudence similar to that required in the provisions on margin requirements in Article 41 of Regulation (EU) No 648/2012 (EMIR).

  5. Policy documents demonstrating that K-CMG is an appropriate methodology that reflects the nature of the investment firm's trading movements, including trading positions, expected holding periods, trading strategies and the time required to reduce the risks associated with the trading positions.

  6. Policy documents demonstrating that the investment firm regularly compares the results of its own risk assessment to the margin requirements set by the clearing member, to determine whether the latter are still an appropriate indicator for the market risk to which the investment firm is exposed.

  7. A comparison between the capital requirements calculated on the basis of the K-NPR and the K-CMG methodologies, explaining the difference. This comparison must include an explanation showing that the following four factors have been considered: (i) The trade strategies in question;, (ii) the investment firm's risk management system,; (iii) the investment firm's capital requirement level; and, (iv) the result of the SREP (Supervisory Review and Evaluation Process) (if available).

  8. An overview of all trading desks, demonstrating that the two methods (K-NPR and K-CMG) are applied consistently in equal cases, given the nature of the trading book positions and the business strategy.

Based on the information submitted we will assess whether the application for permission meets the conditions of Article 23 of the IFR. If that is the case, we will grant permission to use K-CMG for the calculation of the capital requirement for RtM.

Continuing obligations once permission has been granted

In view of Article 3(2) of the EBA regulatory technical standard, an investment firm must inform DNB:

  1. If it changes its methodology for calculating a trading desk's market risk. Such a change is permitted no more than once every two years, or in the event of a major change to the business strategy or operations of the trading desk. If the change does not meet these conditions, the investment firm no longer meets the conditions for using K-CMG.

  2. If the business strategy of a trading desk changes and this leads to a change in 20% or more in the capital requirements for that trading desk based on the K-CMG approach.

  3. If the clearing member’s margin model changes and this results in a change in
    the margins required of 10% or more for the same portfolio of underlying positions for a trading desk.

In the event of point (ii) or (iii) the investment firm must make a new comparison as specified under point 7.

Sector(s)

  • Investment firms