As a result, firms have increasingly been turning to more sophisticated statistically based risk management methodologies based on option and portfolio theory. These techniques have led to the development in some firms in recent years of risk management models, commonly known as value at risk models. These models, which aim to estimate the likely loss which the firm will suffer in the event of particular market movements, have been receiving increasing regulatory interest recently both as a mechanism for improved internal controls within authorised firms, and also as a basis for calculating the capital requirement for the market risk which a firm is assuming.

Value at risk measures have recently been proposed for regulatory purposes in some jurisdictions. The recent proposal from the Basle Committee on Banking Supervision, if approved, will allow banks to calculate their market risk requirement based on their internal value at risk models with effect from I January 1998. The European Union's Capital Adequacy Directive which comes into effect on l January 1996 recognises value at risk models for the purposes of calculating the capital requirements for foreign exchange, and a recent decision will now allow banks and securities firms within the EU which have operational value at risk models to use a 'benchmarking' approach when calculating the capital requirement for other elements of their market risk. In addition, the recent report of the DPG in the United States uses value at risk models as the basis for reporting to the SEC and CFTC on the activities of the affiliated swap vehicles of authorised broker dealers

Consequently, value at risk models will play an increasingly important role within the securities industry, and some securities regulators will increasingly rely on the outputs of these models for regulatory purposes. This will have significant implications for both the management of the firms and for the regulators of those firms. The purpose of this paper is to identify the principal issues for consideration by securities regulators when supervising firms which use such models, and to outline some of the implications of setting regulatory capital standards based on the output of internal value at risk models.