18. Constant level of risk assumption over the one-year capital horizon

When modelling a constant level of risk over the one-year capital horizon, institutions should rebalance or roll-over positions at the end of each liquidity

15 horizon to new positions, so as to ensure the same initial level of risk as at the start of the liquidity horizon.

When assuming a one-year constant position, which implies not adopting liquidity horizons, institutions should consistently apply to all IRC positions an instantaneous shock over the one-year capital horizon (referred to as „one-year constant position assumption‟).

From a modelling perspective, the constant level of risk may be reflected as the replacement of positions, if a migration or a default has occurred over the liquidity horizon, with positions that have risk characteristics equivalent to those of the original positions at the start of the liquidity horizon.

Modelling a constant level of risk over the one-year capital horizon may be achieved, for example, on the basis of the approach outlined hereafter. With respect to calculating losses over liquidity horizons, an institution may choose to assume that instantaneous shocks are applied to ratings (or spreads). This implies that, in this case, the institution does not have to integrate the time effect: positions keep their original residual maturities at the end of each liquidity horizon; in other words, there is no ageing of positions. Furthermore, there is no need to consider potential changes in market conditions when revaluating the portfolio at the time of rebalancing (in particular, credit spreads by rating can be kept constant). As a result, measurement of losses within IRC does not take into account the timing of each migration or default event, and the P&L is computed as of today.

Modelling the ageing of positions should not be allowed in IRC modelling, given the expected tremendous challenges and the observed difficulties associated with modelling the ageing of positions, together with the substantial regulatory arbitrage this could result in. This justifies that, at the present stage, a conservative approach is preferred.