1. Stress and scenario testing seek to anticipate possible losses or risks that might occur or become manifest. In applying them an Authorised Person needs to decide how far forward to forecast and may want to consider the following factors:
a. how quickly it would be able to identify events or changes in circumstances that might lead to a loss occurring or risk crystallising; and
b. after the event or circumstance has been identified, how quickly and effectively the Authorised Person could act to prevent or mitigate any resulting loss occurring or risk crystallising and to reduce its Exposure to any further adverse event or change in circumstance.
2. For example, the time horizon over which stress and scenario testing would need to be carried out for the Market Risk arising from the holding of Investments would depend upon:
a. the extent to which there is a regular, open and transparent market in those assets, which would allow fluctuations in the value of the Investment to be more readily and quickly identified; and
b. the extent to which the market in those assets is liquid (and would remain liquid in the changed circumstances contemplated in the stress or scenario test) which would allow the Authorised Person, if needed, to sell its holding so as to prevent or reduce its Exposure to future price fluctuations.
3. Authorised Persons should focus on those scenarios and combinations of scenarios that are considered reasonably likely to occur. For this purpose other risks and losses include business risk, i.e. the potential impact of changes in business plans, future activities, and the business or economic environment.
4. In identifying what realistic combinations of losses or risks might occur or crystallise, an Authorised Person should take into account scenarios in which expected correlations occur and where they might break down.
5. In identifying scenarios and assessing their impact, an Authorised Person should take into account how changes in circumstances might impact upon:
a. the nature, scale and mix of future activities; and
b. the behaviour of Counterparties, and of the Authorised Person itself, including the exercise of choices (including Options embedded in Financial Instruments).
6. In determining whether it would have adequate financial resources in the event of each identified adverse scenario, an Authorised Person should:
a. only include financial resources that could reasonably be relied upon as being available in the circumstances of the identified scenario; and
b. consider any legal or other restriction on the purposes for which financial resources may be used, including any restriction on the transfer to the Regulator of assets held in other jurisdictions.