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Methodologies for Determining Capital Standards for Internationally Active Securities Firms
Executive Summary
- In July 1995, the Technical Committee of IOSCO (the Technical Committee) issued a report on "the implications for securities supervisors of the increased use of value at risk models by securities firms". In view of the significance of market risk capital requirements for securities firms, the Technical Committee took the view that the state of knowledge and experience on the use of value at risk (VaR) at that time was insufficient to allow VaR to be used for regulatory capital purposes. In particular, the Technical Committee called for more work to be done on model testing and the development of "standards of best practice" to be adopted by firms which wish to use VaR models for regulatory purposes.
- To ensure that the 1995 recommendation was kept under review, the Technical Committee set up a prudential taskforce to examine the key issues. It has become clear that much of the work that the Technical Committee called for in 1995 has been undertaken or is in progress.
- Overall, greater familiarity with the theory of modelling and the growing body of experience in its application, means that the Technical Committee is prepared to accept that VaR models can have a role to play in the setting of regulatory capital for market risk. However, supervisors need to be mindful of the limitations of VaR methodologies. The market risk capital charge should be increased over and above the VaR output to address these limitations.
- Supervisors need to ensure that they have the resources and the expertise to make appropriate supervisory judgements about the quantitative and qualitative aspects of a VaR approach. The adoption of VaR models involves a shift to greater reliance on a firm's controls and therefore requires an enhancement in the supervisor's ability to assess their effectiveness.
- While VaR models can have a role to play in setting regulatory capital for market risks, the Technical Committee believes that for credit risk VaR methodologies are currently being developed and may have a role in the future for regulatory capital purposes.
- If VaR is going to provide the starting point for calculating market risk regulatory capital, supervisors should not lose sight of all the other risks that cannot be easily quantified such as legal risk and operational risk. To cover these other risks it is envisaged that additional capital or "buffers" should be introduced over and above the market risk capital charge. To this end, the report sets out a number of possible avenues that supervisors and securities firms might wish to explore to ensure that appropriate buffers and other complementary approaches are put in place.
- A combination of the new market risk capital charge, the existing charge for credit risk and additional buffers can provide sufficient capital. However, there is no implication in this report that the adoption of VaR models will lead to a fall in the current level of regulatory capital, but will instead enable firms to manage their risks more efficiently.
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Methodologies for Determining Capital Standards for Internationally Active Securities Firms
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