MORNBFI Vol. 1 - Planters Development Bank

APP. Q-1509.12.31c. Appropriate risk measurementmethodologies, limits structure, monitoringand management information systemThe process of measuring, monitoringand controlling risk should be carried outindependently from individuals conductingderivatives activities. An independent systemof reporting exposures to both senior levelmanagement and to the BOD is critical tothe effectiveness of the process.(1) Measurement methodologiesAn FI must be able not only toaccurately quantify the multiple riskexposures arising from its derivativesactivities but also aggregate similar risksacross the different activities of the FI to thefullest extent possible. An FI must developa risk measurement model appropriate toits portfolio. Accordingly, an FI mustevaluate the assumptions used,computational requirements, procedures forcomputing the risk metric, sourcing of inputsused in the measurement process, includingthe theoretical reasons for a particular inputchoice, and how these concepts apply tothe FI’s portfolio.The risk measurement system should bestructured to enable management to initiateprompt remedial action, facilitate stresstesting,and assess the potential impact ofvarious changes in market factors onearnings and capital. A risk measurementsystem is considered sound if it is capableof comprehensively capturing risks from: (a)the FI’s on and off-balance sheet exposure;(b) all relevant market factors; and (c) normalcircumstances and stress events. Sound riskmeasurement practice includes identifyingpossible events or changes in marketbehavior that could have unfavorable effectson the FI and assessing the ability of the FIto withstand these events or changes. Thestress testing should include not onlyquantitative exercises that computepotential gains or losses but also qualitativeanalyses of actions that management mighttake under particular scenarios.An FI’s risk measurement systemshould provide appropriate pricing andvaluation procedures to ensure bestexecution for both proprietary trading andthose undertaken for clients and a mark-tomarket/model(MTM) methodology forderivatives instruments that followsestablished MTM regulations and PhilippineAccounting Standards (PAS 39).New measurement models, whetherdeveloped internally or purchased fromvendors, should be subject to an initialvalidation before it is used. Internallydeveloped models require more intensiveevaluation where they have not beenmarket-tested by external parties. Thevalidation process should consist of a reviewof the logic, mathematical or statisticaltheories, assumptions, internal processesand overall reliability of an FI’s measurementmodels, including the compatibility of themeasurement model with the FI’stechnology and systems. The validationmust be undertaken by a technical expertindependent from the unit that developedthe model. For example, pricing systemsdeveloped by a trader is required to beindependently validated by a correspondingtechnical expert from the FI’s riskmanagement unit. If no such personnel fromthe risk management unit exists, anindependent validation may be performedby internal audit provided that internal audithas the necessary expertise. An FI may alsoavail of the services of an independentoutside expert. Thereafter, the frequencyand extent to which models are validateddepends on changes that affect pricing, riskpresentation or the existing controlenvironment. Changes in market conditionsthat affect pricing and risk conventions,which model performance, should triggeradditional validation review.Risk management policies shouldclearly address the scope of the validationprocess, the frequency of validations,documentation requirements, andQ RegulationsAppendix Q-15 - Page 4Manual of Regulations for Non-Bank Financial Institutions