Acadia commented on the European Banking Authority (EBA) publishing its finalized Regulatory Technical Standards (RTS) on Initial Margin (IM) model validation.
The RTS on IM Model Validation has been crafted to ensure robust and accurate assessments of IM models used by counterparties to calculate initial margin requirements for non-cleared derivatives. By establishing these validation standards, the EBA aims to further strengthen risk management frameworks and promote a safer financial system in line with the global rules for non-cleared margin.
While the RTS first draft was initially published in November of 2021, this final version outlines much of the same requirements of the last version. In short, counterparties under EU Margin rules will have a standard supervisory procedure and requirement to validate and backtest the IM model used for the exchange of regulatory IM.
The validation requirements will come in a year to year phased in approach, starting with the largest firms then to smaller firms based on the global AANA (average aggregate notional amount) calculation standards, in order to minimize market disruption. The EBA also outlines standard and simplified approaches to the validation and backtesting requirements, including the ability to use third party providers to ease in the implementation of these requirements.
Some of the key features of the IM Model Validation include:
- Minimum requirements: The RTS specifies the minimum criteria that banks must fulfill when validating their IM models. This includes the need for a clear governance framework, model documentation, validation policies, and processes.
- Independent validation: The EBA emphasizes the importance of independent validation, ensuring that the process is conducted by qualified personnel who are not directly responsible for the development or use of the models.
- Model risk management: The RTS highlights the need for banks to establish robust model risk management frameworks. This includes clear policies and procedures for model validation, ongoing monitoring, and periodic model reviews.
- Documentation and reporting: Counterparties are required to maintain thorough documentation of their validation processes and outcomes. Additionally, they must report any material deficiencies or weaknesses identified during the validation process to the competent authorities.
- The ability to outsource to external providers of the IM Model: To ease the burden on counterparties the EBA allows for firms to use a third party outsource provider to perform IM Model Validation services.
- Two different validation approaches: A standard approach for Uncleared Margin Rules (UMR) AANA Phases 1-4 and a Simplified approach for UMR AANA Phases 5 and 6
- A Phase in schedule approach: To ensure an orderly transition and reduce market disruption the EBA has put forth a scheduled approach to the RTS implementation. Firms with €750 billion gross notional of uncleared OTC derivatives (Phases 1-4) are subject to the standard approach as outlines in the RTS and will begin one year after entry into force, firms at or above €50 billion subject to the simplified approach will go live two years after entry into force, all other firms between €49.9 billion and €8 billion will go live three years after entry into force.
John Pucciarelli, Acadia head of Industry and Regulatory Strategy, said in a statement: “We applaud the EBA for their efforts on the RTS to help bring much needed clarity and standards to the IM Model validation process. Acadia, as always, stands with our clients to inform, educate and offer scalable and cost-effective solutions to ensure a smooth transition to comply with these requirements. Our team of dedicated experts will continue to unpack the RTS and we will provide updates, guidance and clarity over the coming weeks and months.”