(1) For the purposes of Rule 5.11.3, an Authorised Person's internal model must meet the following criteria:
(a) the Authorised Person's stress scenarios must cover a range of factors that can create extraordinary losses or gains in trading portfolios, or make the control of risk in those portfolios very difficult. These factors include low-probability events in all major types of risks, including the various components of market, credit, and Operational Risks;
(b) the Authorised Person's stress tests must be both of a quantitative and qualitative nature, incorporating both Market Risk and liquidity aspects of market disturbances. Quantitative criteria must identify plausible stress scenarios to which the Authorised Person could be exposed. Qualitative criteria must emphasise that two major goals of stress testing are to evaluate the capacity of the Authorised Person's capital to absorb potential large losses and to identify steps the Authorised Person can take to reduce its risk and conserve capital; and
(c) the Authorised Person must combine the use of supervisory stress scenarios with stress tests developed by the Authorised Person itself to reflect their Specific Risk characteristics. Information is required in three broad areas:
(i) supervisory scenarios requiring no simulations by the Authorised Person — the Authorised Person must have information on the largest losses experienced during the reporting period available for supervisory review. This loss information must be compared to the level of capital that results from an Authorised Person's internal measurement system;
(ii) supervisory scenarios requiring a simulation by the Authorised Person — the Authorised Person must subject its portfolio to a series of simulated stress scenarios and provide the Regulator with the results (e.g., the sensitivity of the Authorised Person's Market Risk Exposure to changes in the assumptions about volatilities and correlations); and
(iii) scenarios developed by the Authorised Person itself to capture the specific characteristics of its portfolio.
(2) In addition to the scenarios prescribed under (1)(c), an Authorised Person must also develop its own stress tests which it identifies as most adverse, based on the characteristics of its portfolio, for example, problems arising in a key region of the world combined with a sharp move in oil prices. The Authorised Person must also provide the Regulator with a description of the methodology used to identify and carry out the scenarios as well as with a description of the results derived from these scenarios.