CP13/6 - CRD IV for Investment Firms - Financial Conduct Authority

FCA 2013/xx
standards for data quality, aim to improve them over time and measure its
performance against those standards. Furthermore, a firm should ensure that
its data is of high enough quality to support its risk management processes
and the calculation of its capital requirements (see article 175(1) of the EU
CRR).
Use of models and mechanical methods to produce estimates of parameters
4.3.30 G Further detail of standards that the FCA will expect a firm to meet when it
assesses compliance with article 174 of EU CRR are set out in the sections on
probability of default (PD), loss given default (LGD) and exposure at default
(EAD).
4.3.31 G In assessing whether the external data used by a firm to build models is
representative of its actual obligors or exposures, the FCA expects a firm to
consider whether this data is appropriate to its own experience and whether
adjustments are necessary (see article 174 of the EU CRR).
Calculation of long averages PD, LGD and EAD
4.3.32 G To estimate PDs that are long run averages of one-year default rates for
obligor grades or pools, the FCA expects a firm to estimate expected default
rates for the grade/pool over a representative mix of good and bad economic
periods, rather than simply taking the historic average of default rates actually
incurred by the firm over a period of years. The FCA expects that a long run
estimate will be changed when there is reason to believe that the existing long
run estimate is no longer accurate, but expect that it will not be automatically
updated to incorporate the experience of additional years as these may not be
representative of the long run average (see article 180 of the EU CRR).
4.3.33 G To demonstrate compliance with article 144(1) of the EU CRR, the FCA
expects a firm to take into account the following factors in understanding
differences between their historic default rates and their PD estimates, and in
adjusting the calibration of their estimates as appropriate:
(1) the rating philosophy of the system and the economic conditions in the
period over which the defaults have been observed;
(2) the number of defaults, as a low number is less likely to be
representative of a long run average. Moreover, where the number of
internal defaults is low, there is likely to be a greater need to base PDs
on external default data as opposed to purely internal data;
(3) the potential for under-recording of actual defaults; and
(4) the level of conservatism applied.
4.3.34 G The FCA expects a firm that is unable to produce a long run estimate, as
described above, will need to amend their rating system so that the PD used
as an input into the IRB own funds requirement is an appropriately
conservative estimate of the actual default rate expected over the next year
(see article 179(1)(f) of the EU CRR).
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