Adjustment to the Current Valuation of Less Liquid Positions for Regulatory Capital Purposes
CA-16.1.11A
Banks must establish and maintain procedures for judging the necessity of and calculating an adjustment to the current valuation of less liquid positions for regulatory capital purposes. This adjustment may be in addition to any changes to the value of the position required for financial reporting purposes and should be designed to reflect the illiquidity of the position. The CBB expects banks to consider the need for an adjustment to a position's valuation to reflect current illiquidity whether the position is marked to market using market prices or observable inputs, third-party valuations or marked to model.
Added: January 2012CA-16.1.11B
'Less liquid positions' would generally involve positions in OTC financial instruments or commodities which are not listed or which are not traded through a central counterparties (such as NYSE Euronext or Chicago Mercantile Exchange) or which do not have readily available secondary market prices or observable inputs to valuation.
Added: January 2012CA-16.1.12
Bearing in mind that the assumptions made about liquidity in the market risk capital charge may not be consistent with the bank's ability to sell or hedge out less liquid positions, where appropriate, banks must take an adjustment to the current valuation of these positions, and review their continued appropriateness on an on-going basis. Reduced liquidity may have arisen from market events. Additionally, close-out prices for concentrated positions and/or stale positions should be considered in establishing the adjustment. Banks must consider all relevant factors when determining the appropriateness of the adjustment for less liquid positions. These factors may include, but are not limited to, the amount of time it would take to hedge out the position/risks within the position, the average volatility of bid/offer spreads, the availability of independent market quotes (number and identity of market makers), the average and volatility of trading volumes (including trading volumes during periods of market stress), market concentrations, the aging of positions, the extent to which valuation relies on marking-to-model, and the impact of other model risks not included in Paragraph CA-16.1.11A.
Added: January 2012CA-16.1.12A
For complex products including, but not limited to, securitisation exposures and n-th-to-default credit derivatives, banks must explicitly assess the need for valuation adjustments to reflect two forms of model risk: the model risk associated with using a possibly incorrect valuation methodology; and the risk associated with using unobservable (and possibly incorrect) calibration parameters in the valuation model.
Added: January 2012CA-16.1.13
The adjustment to the current valuation of less liquid positions made under Paragraph CA-16.1.12 must impact Tier 1 regulatory capital and may exceed those valuation adjustments made under financial reporting standards and Paragraphs CA-16.1.10 and CA-16.1.11.
Added: January 2012
