MIFIDPRU 3 Annex 8R Prudent valuation and additional valuation adjustments

1 Application and purpose

8.1

R

(1)

This annex applies for the purposes of calculating additional valuation adjustments under article 34 of the UK CRR (as applied by MIFIDPRU 3.3.1AR).

(2)

Any reference to the UK CRR in this annex is to the UK CRR as applied and modified by MIFIDPRU 3.3.1R.

8.2

G

(1)

Under article 34 of the UK CRR, a firm must apply the requirements of article 105 of the UK CRR to the firm’s assets measured at fair value when calculating the amount of its own funds.

(2)

Under MIFIDPRU 3.3.1AR, a firm is only required to apply article 34 of the UK CRR to positions held within its trading book.

Sources of market data

8.3

R

(1)

Where a firm calculates an AVA based on market data, it must consider the same range of market data as the data used in the independent price verification process referred to in article 105(8) of the UK CRR, subject to the adjustments in this rule.

(2)

A firm must consider the full range of available and reliable market data sources to determine a prudent value, including each of the following to the extent relevant:

(a)

exchange prices in a liquid market;

(b)

trades in the financial instrument or a very similar instrument, either from the firm’s own records or, where available, trades from across the market;

(c)

tradable quotes from brokers and other market participants;

(d)

consensus service data;

(e)

indicative broker quotes; and

(f)

counterparty collateral valuations.

[Note: article 3 of BTS 2016/101.]

Determination of AVAs

8.4

R

(1)

A firm must calculate the value of assets for which the firm must determine AVAs in accordance with this rule.

(2)

The value in (1) is the sum of the absolute value of fair-valued assets and liabilities, as stated in the firm’s financial statements in accordance with the applicable accounting framework, modified as follows:

(a)

exactly matching offsetting fair-valued and liabilities must be excluded; and

(b)

where a change in the accounting valuation of fair-valued assets and liabilities would:

(i)

only be partially reflected in common equity tier 1 capital, the value of those assets or liabilities must only be included in proportion to the impact of the relevant valuation change on common equity tier 1 capital; or

(ii)

have no impact on common equity tier 1 capital, the value of those assets or liabilities must be excluded.

[Note: article 4 of BTS 2016/101.]

8.5

R

A firm’s total AVAs are 0.1% of the sum of the assets calculated under MIFIDPRU 3 Annex 8.4R(1).

[Note: articles 5 and 6 of BTS 2016/101.]

Documentation, systems and controls

8.6

R

A firm must appropriately document its prudent valuation methodology and its policies on the following:

(1)

the range of methodologies for quantifying AVAs for each valuation position;

(2)

the hierarchy of methodologies for each asset class, product, or valuation position;

(3)

the hierarchy of market data sources used in the AVA methodology;

(4)

the required characteristics of market data to justify a zero AVA for each asset class, product, or valuation position; and

(5)

the fair-valued assets and liabilities for which a change in accounting valuation has a partial or no impact on common equity tier 1 capital according to MIFIDPRU 3 Annex 8.4R(2)(b).

[Note: article 18(1) of BTS 2016/101.]

8.7

R

The firm must ensure that the documentation and policies in MIFIDPRU 3 Annex 8.6R are:

(1)

reviewed at least annually; and

(2)

approved by the firm’s senior management following each review. [Note: article 18(3) of BTS 2016/101.]

8.8

R

A firm must:

(1)

maintain records to allow the calculation of AVAs at valuation exposure level to be analysed; and

(2)

ensure that the senior management of the firm are provided with information from the AVA calculation process to permit them to understand the level of valuation uncertainty on the firm’s portfolio of fair-valued positions.

[Note: article 18(3) of BTS 2016/101.]

Systems and controls requirements

8.9

R

A firm must ensure that AVAs are authorised and subsequently monitored by an independent control function.

[Note: article 19(1) of BTS 2016/101.]

8.10

R

(1)

A firm must have:

(a)

effective controls related to the governance of all fair-valued positions; and

(b)

adequate resources to implement the controls in (a) and ensure robust valuation processes even during a stressed period.

(2)

The controls and processes in (1) must include the following:

(a)

a review of the performance of the firm’s valuation model at least annually;

(b)

approval by senior management of all significant changes to valuation policies;

(c)

a clear statement of the firm’s risk appetite for exposure to positions subject to valuation uncertainty, which must be monitored at an aggregate firm-wide level;

(d)

independence in the valuation process between risk-taking and internal control functions; and

(e)

a comprehensive internal audit process relating to valuation processes and controls.

[Note:article 19(2) of BTS 2016/101.]

8.11

R

(1)

A firm must:

(a)

have effective and consistently applied controls relating to the valuation process for all fair-valued positions; and

(b)

ensure that the controls in (a) are subject to regular internal audit review.

(2)

The controls in (1) must include the following:

(a)

a precisely defined firm-wide product inventory, ensuring that every valuation position is uniquely mapped to a product definition;

(b)

valuation methodologies for each product in the inventory covering:

(i)

the choice and calibration of model;

(ii)

fair value adjustments;

(iii)

independent price verification;

(iv)

AVAs;

(v)

the methodologies applicable to the product; and

(vi)

the measurement of valuation uncertainty.

(c)

a validation process ensuring that, for each product, both the risk-taking and relevant control functions approve the product-level methodologies described in point (b) and certify that they reflect the actual practice for every valuation position mapped to the product;

(d)

defined thresholds based on observed market data for determining when valuation models are no longer sufficiently robust;

(e)

a formal independent price verification process based on prices independent from the relevant trading desk;

(f)

a new product approval process referencing the product inventory and involving all internal stakeholders relevant to risk measurement, risk control, financial reporting and the assignment and verification of valuations of financial instruments; and

(g)

a new deal review process to ensure that pricing data from new trades are used to assess whether valuations of similar valuation exposures remain appropriately prudent.

[Note: article 19(3) of BTS 2016/101.]